FORM 10-K

For the transition period from

Commission file number: 333-114210

Town Sports International Holdings, Inc.

888 SEVENTH AVENUE
NEW YORK, NEW YORK 10106
(212) 246-6700
(Address, including zip code and telephone number,
including area code, of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None

     Indicate by check mark whether the Registrant (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 Registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes þ No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part IV of this Form 10-K or any amendment to this Form 10-K. þ

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No þ

     The aggregate market value of Common Stock held by non-affiliates of the Registrant: Not applicable

     As of March 22, 2005 , there were 1,311,809 shares of Class A Common Stock of the Registrant outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
None

TABLE OF CONTENTS

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TOWN SPORTS INTERNATIONAL, INC.
PART I

Item 1. Business

General

     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 December 31, 2004, we owned and operated 135 fitness clubs and partly owned and operated two fitness clubs. These 137 clubs collectively served approximately 383,000 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 members’ areas of both employment and residence. Our target member is college-educated, typically between the ages of 21 and 50 and earns an annual income between $50,000 and $150,000.

     Our goal is to develop the premier health club network in each of the major metropolitan regions we serve. We believe that clustering clubs allows us to achieve strategic operating advantages that enhance our ability to achieve this goal. When entering new regions, we develop 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 suburbs and ancillary communities. Capitalizing on this clustering of clubs, as of December 31, 2004, approximately 50% 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 fitness clubs we operate under our New York Sports Club (“NYSC”) brand name. We are the largest fitness club operator in Manhattan with 37 locations and operate a total of 92 clubs under the NYSC name within a 50 mile radius of New York City. We operate 19 clubs in the Boston region and 17 clubs in the Washington, DC region under our Boston Sports Club (“BSC”) and Washington Sports Club (“WSC”) brand names, respectively and have begun establishing a similar cluster in the Philadelphia region with six clubs under our Philadelphia Sports Club (“PSC”) brand name. In addition, we operate three clubs in Switzerland. We employ localized brand names for our clubs to create an image and atmosphere consistent with the local community and to foster recognition as a regional network of quality fitness clubs rather than a national chain.

     Historically, we have sold month-to-month membership payment plans that are generally cancelable by our members at any time with 30 days notice. Effective October, 2003, in an effort to improve our membership retention and to offer our members a wider range of available membership types from which to chose, we also began to sell one and two year commit memberships. These commit memberships are sold at a discount to the month-to-month non-commit membership plan. The one year commit membership is typically sold at the same monthly rate as the non-commit plan, (and dues are paid monthly) but with a discounted initiation fee. The two year commit memberships are typically sold at a 10% discount to the month-to-month plan also with a discounted initiation fee. As of December 31, 2004, approximately 59% of our members were under a month-to-month non-commit membership plan and 41% were under a commit membership plan. We believe members prefer to have the choice to commit for a year or two or to have the flexibility of the month-to-month non-commit plan.

     We have experienced significant growth over the past five years through a combination of (i) acquiring existing, privately owned, single and multi-club businesses, and (ii) developing and opening “greenfield” club locations (a greenfield club is a new location we have constructed). From January 1, 2000, to December 31, 2004, we have acquired 20 existing clubs and opened 37 greenfield clubs. In addition we have relocated four clubs, sold one club, and closed one club to increase our total clubs under operation from 86 to 137. From January 1, 2004 through December 31, 2004 we opened five new clubs and we acquired three clubs. We have achieved revenue growth over the five year period ended December 31, 2004 from $222.8 million for the year ended December 31, 2000 to $353.0 million for the year ended December 31, 2004.

     This growth has not only been driven by the addition of acquired and greenfield club locations, but also through mature club revenue growth, which has ranged from 1.6% to 18.6% for the five year period ended December 31, 2004. Such growth was 2.1% for the year ended December 31, 2004. Mature club revenue, (defined as those clubs that we operated for more than 24 months) growth has enabled us to increase revenue per weighted average club over the five year period ended December 31, 2004. Revenue per weighted average club (as defined in Selected Financial Data) has risen from $2.4 million for the year ended December 31, 2000 to $2.6 million for the year ended December 31, 2004. Based on our historical experience, a new club tends to achieve significant increases in revenues during its first three years of operation as it matures. Because clubs experience little incremental cost associated with such revenue increases, we realize a greater proportionate increase in profitability. This operating leverage has allowed us to

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achieve increases in cash flows from operations over the five year period ended December 31, 2004 which has improved from $42.6 million in 2000 to $57.1 million for the year ended December 31, 2004.

     Over our 31-year history, we have developed and refined a model club format that allows us to cost effectively construct and efficiently operate our fitness clubs. Our urban model club ranges in size from approximately 15,000 to 25,000 square feet and averages approximately 20,000 square feet and our suburban clubs vary in size from 15,000 square feet to 90,000 square feet, with one club being 200,000 square feet. Excluding this single large club, our average suburban club is 25,000 square feet. Clubs typically have an open fitness area to accommodate cardiovascular and strength-training exercise, as well as special purpose rooms to accommodate group fitness class instruction and other exercise programs as well as massage. Locker rooms generally include a sauna and steam room. We seek to provide a broad array of high quality exercise programs and equipment that is both popular and effective, while reinforcing the quality exercise experience that we strive to make available to our members. We establish at least one flagship club that has amenities such as swimming pools or racquet and basketball courts in each of our key target areas.

     We engage in detailed site analyses and selection process based upon information provided by our development software to identify potential target areas for additional clubs based upon population demographics, psychographics, traffic and commuting patterns, availability of sites and competitive market information. In addition to our existing 137 clubs in operation, we have three clubs that are completely constructed and pre-selling memberships in advance of their February 2005 opening.We also have nine new sites for which we have entered into lease commitments, and we have identified approximately 70 target areas in which we may add clubs under the brand names NYSC, BSC, WSC, or PSC. Once we begin to approach saturation of these regions, we will explore expansion opportunities in other markets in the United States sharing similar demographic characteristics to those in which we currently operate.

     We possess an experienced management team, four of the top five executives of which have been working together at the Company since 1990. We believe that we have the depth, experience and motivation to manage our internal and external growth, and that we have put in place the infrastructure and systems to manage effectively our planned expansion. We believe that the presence of such infrastructure will enable us over time to leverage certain fixed cost aspects of corporate overhead to realize increased operating margins as we continue to expand our club base.

Industry Overview

     Demographic trends have helped fuel the growth experienced by the fitness industry over the past decade. The industry has benefited from the aging of the “baby boomer” generation (ages 39 to 57) and the coming of age of their offspring, the “echo boomers” (ages eight to 26). In 2003, Americans over the age of fifty-five account for 6.9 million members, up nearly fourfold since 1993. Government-sponsored reports, such as the Surgeon General’s Report on Physical Activity & Health (1996) and the Call to Action to Prevent and Decrease Overweight and Obesity (2002) have helped to increase the general awareness of the benefits of physical exercise to these demographic segments over those of prior generations. Membership penetration (defined as club members as a percentage of the total U.S. population over the age of fourteen and under the age of 85) has increased significantly from 10.9% in 1990 to 17.5% in 2003.

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Fitness Club Revenues(1)
(in $ billions)

U.S. Fitness Clubs Membership
(in millions)

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     Total U.S. fitness club industry revenues increased from $6.5 billion in 1993 to $14.1 billion in 2003, while the total number of clubs increased from 11,655 in 1993 to 23,497 in 2003. Growth in club memberships increasing from 22.9 million in 1993 to 39.4 million in 2003. The fitness club industry continues to be highly fragmented. Less than 10% of clubs in the United States are owned and operated by companies that own more than 25 clubs, and the two largest fitness club operators each generate less than 8% of total fitness club revenues.

     As a large operator with recognized brand names, leading regional market shares and an established operating history, we believe we are well positioned to benefit from these favorable industry dynamics.

     We believe that the growth in fitness club memberships is attributable to several factors. Americans are focused on achieving a healthier, more active and less stressful lifestyle. Of the factors members consider very important in their decision to join a fitness club, the most commonly mentioned is health, closely followed by appearance related factors including muscle tone, looking better and weight control. We believe that the increased emphasis on appearance and wellness in the media has heightened the focus on self image and fitness and will continue to do so. We also believe that fitness clubs provide a more convenient venue for exercise than outdoor activities, particularly in densely populated metropolitan areas. According to published industry reports, convenience is an important factor in choosing a fitness club.

     We believe the industry can be segregated into three tiers based upon price, service and quality: (i) an upper tier consisting of clubs with monthly membership dues averaging in excess of $99 per month; (ii) a middle tier consisting of clubs with monthly membership dues averaging between $35 and $99 per month; and (iii) a lower tier consisting of clubs with monthly membership dues averaging less than $35 per month. We compete in the middle tier in terms of pricing and because of our wide array of programs and services coupled with our commitment to customer service and our convenience to members work and home, we are positioned toward the upper end of this tier. Based upon the quality and service we provide to our members, we believe that we provide an attractive value to our members at the monthly membership dues we charge.

Marketing

     Our marketing campaign, which has become a large driver of our brand, is directed by our in-house media department which is headed by the Chief Executive Officer and our Vice President of Marketing. This team develops advertising strategies to convey each of the our regionally branded networks as the premier network of fitness clubs in that region. Our media team’s goal is to achieve broad awareness of our regional brand names primarily through radio, television, newspaper, billboard, and direct mail advertising. We believe that clustering clubs creates economies in our marketing and advertising strategy that increase the efficiency and effectiveness of these campaigns.

     Advertisements generally feature creative slogans that communicate the serious approach we take toward fitness in a provocative and/or humorous tone, rather than pictures of our clubs, pricing specials or members exercising. Promotional marketing campaigns will typically feature opportunities to participate in value-added services such as personal training for a limited time at a discount to the standard rate. We will also offer reduced initiation fees to encourage enrollment. Additionally, we frequently sponsor member referral incentive programs. Such incentive programs include a free month of membership, personal training sessions, or sports equipment.

     We also engage in public relations and special events to promote our image in the local communities. We believe that these public relations efforts enhance our image and the image of our local brand names in the communities in which we operate. We also seek to build our community image through advertising campaigns with local and regional retailers.

     Our web site www.mysportsclubs.com, provides information about club locations, program offerings, exercise class schedules and on-line promotions. The site also provides our members a venue to give us direct feedback on all of our services and offerings. We also use the site to promote career opportunities with the Company.

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Sales

     Sales of new memberships are generally handled at the club level. We employ approximately 465 “in-club” membership consultants who are responsible for new membership sales. Each club generally has two or three full-time and one part-time

membership consultants. These consultants report directly to the club general manager, who in turn report to their District Managers. Membership consultants’ compensation consists of a base salary plus commission. Sales commissions range from $45 to $70 per new member enrolled. We provide additional incentive-based compensation in the form of bonuses contingent upon individual, club and Company-wide enrollment goals. Membership consultants must successfully complete a three-month, in-house training program through which they learn our sales strategy. In making a sales presentation, membership consultants emphasize: (i) the proximity of our clubs to concentrated commercial and residential areas convenient to where target members live and work; (ii) the obligation on the part of the enrollee; (iii) the price/value relationship of a Town Sports membership; and (iv) access to value-added services. We believe that providing employees with opportunities for career advancement is essential to our ability to attract and retain qualified sales personnel. We also have a corporate sales department which has a staff of over 20 whose responsibility is to solicit group memberships through senior level corporate contacts.

     We believe that clustering clubs allows us to sell memberships based upon the opportunity for members to utilize multiple club locations to differing degrees. We have a streamlined membership structure to simplify the sales process. In addition, our proprietary centralized computer software ensures consistency of pricing and controls enrollment processing at the club level. As of December 31, 2004, our existing members were enrolled under three principal types of memberships.

     The Passport Membership, priced from $47 to $95 per month, is our higher priced membership and entitles members to use any Town Sports club at any time. This membership is held by approximately 50% of our members. In addition, we have introduced a Passport Premium membership at two select clubs, that includes a greater array of member services and facilities, at a price of $115 per month.

     The Gold Membership, priced from $38 to $86 per month based on the market area of enrollment, enables members to use a specific club, or a group of specific clubs, at any time and any Town Sports club during off-peak times. This membership is held by over 49% of our members.

     The Off-peak Membership, priced from $39 to $75 per month, is the least expensive membership, and allows members to use any Town Sports club only during off-peak times. This membership is held by approximately 1% of our members.

     We also offer group or corporate membership plans that vary in price depending on the respective group’s needs. These plans are typically offered at a discount to that of individual plans.

     We are currently offering our Passport memberships at $95 per month for month-to-month memberships and $89 per month for one year commit memberships. Our Gold memberships are priced from $39 to $89 depending on the offerings and services provided at a given club as well as its location.

     By clustering a group of clubs in a geographic area, the value of our memberships is enhanced by our ability to offer Passport Memberships, which allow our members to use any of our clubs at any time. We believe the popularity of the Passport Membership results from the broader privileges and greater convenience this membership plan provides through the opportunity for members to access club facilities near to both their homes and workplace. Our clustering strategy also allows us to provide access to special facilities and programs such as tennis, squash, basketball and racquetball courts, swimming pools and programs targeted at children and other groups, through flagship locations strategically located in key target areas, without offering such facilities or programs in every location.

     In joining a club, a new member signs a membership agreement which obligates the member to pay a one-time initiation fee and a one-time processing fee and monthly dues on an ongoing basis. Monthly Electronic Funds Transfer “EFT” of individual membership dues averaged approximately $66 per month for the year ended December 31, 2004. During that same period, initiation fees and processing fees averaged $78 for EFT members. We collect 92.6% of all monthly membership dues through EFT and EFT revenue constituted over 74.2% of consolidated revenue for the year ended December 31, 2004. Substantially all other membership dues are paid in full in advance. Our membership agreements call for monthly dues to be collected by EFT based on credit card or bank account debit authorization contained in the agreement. We believe that our EFT program of monthly dues collection provides a predictable and stable cash flow for us, reduces the traditional accounts receivable function, and minimizes bad-debt write-offs while providing a significant competitive advantage in terms of the sales process, dues collection, and working capital management. In addition, it enables us to increase our dues in an efficient and consistent manner which we typically do annually by between 1% and 3%, in line with cost of living increases. During the first week of each month, we receive the EFT dues for that month initiated by a third party EFT processor. Discrepancies and insufficient funds incidents are researched and resolved by our in-house account services department.

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     Our monthly net EFT revenue has increased by $6.9 million or 45.1% from $15.3 million in December, 2000 to $22.3 million in December, 2004. While we strongly encourage monthly EFT memberships, approximately 8% of our members (often corporate or group memberships) purchase paid-in-full memberships for a one year term.

Ancillary Club Revenue

     Over the past five years we have expanded the level of ancillary club services provided to our members. Ancillary club revenue has increased by $22.1 million from $30.9 million in 2000 to $53.0 million in 2004. Increases in personal training revenue in particular have contributed to $15.0 million of the increase in ancillary revenue during this period. In addition we have added Sports Club for Kids and Group Exclusives (both additional fee for service programs) at selected clubs. Ancillary club revenue as a percentage of total revenue has increased from 13.9% for the year ended December 31, 2000 to 15.0% for the year ended December 31, 2004. Personal training revenue as a percentage of sales increased from 8.9% of revenue in 2000 to 9.9% of revenue in 2004.

Club Format and Locations

     Our clubs are typically located in well-established, middle or upper-income residential, commercial or mixed urban neighborhoods within major metropolitan areas which are capable of supporting the development of a cluster of clubs. Our clubs generally have relatively high “retail” visibility, and close proximity to transportation. In the New York City, Boston and Washington, DC markets, we have created clusters of clubs in urban areas and their commuter suburbs aligned with our operating strategy of offering our target members the convenience of multiple locations close to where they live and work, reciprocal use privileges and standardized facilities and services. We have begun establishing a similar cluster in Philadelphia.

     Approximately half of the clubs we operate are urban clubs while half are suburban. Our urban clubs generally range in size from 15,000 to 25,000 square feet and average approximately 20,000 square feet. Our suburban clubs vary in size from 15,000 square feet to 90,000 square feet, with one club being 200,000 square feet. Excluding this single large club, the average suburban club is 25,000 square feet. Membership for each club generally ranges from 2,000 to 4,500 members at maturity. Although club members represent a cross-section of the population in a given geographic market, our target member is college educated, between the ages of 21 and 50 and has an annual income of between $50,000 and $150,000.

     Our facilities include state-of-the-art cardiovascular equipment, including upright and recumbent bikes, steppers, treadmills, and elliptical motion machines; strength equipment and free weights, including Cybex, Icarian, Nautilus, Free Motion, and Hammer Strength equipment; group exercise and cycling studio(s); the Sportsclub Network entertainment system; locker rooms, including shower facilities, towel service, and other amenities such as saunas and steam rooms; babysitting, and a retail shop. Each of our clubs are equipped with automated external defibrillators (“AED’s”). Personal training services are offered at all locations and massage is offered at most clubs, each at an additional charge. At certain flagship locations, additional facilities are also offered, including swimming pools, racquet and basketball courts. Also, we have significantly expanded the availability of fee-based programming at many of our clubs, including programs targeted at children, members and non-member adult customers.

     We also offer our Xpressline strength workout at all of our clubs. Xpressline is a trainer-supervised, eight-station total-body circuit workout designed to be used in “twenty two minutes”, and accommodates all fitness levels. This service is provided for free to our members. We have also introduced FitMap, which is a visual tool that provides our members with guidance on how to use our equipment through safe progressions of difficulty.

     We have over 5,000 Sportsclub Network personal entertainment units installed in our clubs. The units are typically mounted on cardiovascular equipment and are equipped with a color screen for television viewing; some also have a compact disk player and audio cassette players. The Sportsclub Network also broadcasts our own personalized music video channel that provides us with a direct means of advertising products and services to our membership base.

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Club Services and Operations

     We emphasize consistency and quality in all of our club operations, including:

     Management. We believe that our success is largely dependent on the selection and training of our staff and management. Our management structure is designed, therefore, to support the professional development of highly motivated managers who will execute our directives and support growth.

     Our enterprise is divided under regional operating lines, whereby our regional vice presidents of operations oversee the profit responsibility of a defined group, or cluster, of clubs. Reporting to these officers are regional functional departments as well as district managers. Reporting to these district managers are the individual club general managers. General managers are responsible for the day-to-day management of each club. At each level of responsibility, compensation is structured to align the company’s goals for profitability to each region, district or club.

     Corporate functional departments have been established to compliment each specific area of our clubs’ services, such as sales, training, group exercise programs, fitness equipment, programming, personal training, facility and equipment maintenance, housekeeping and laundry. This centralization allows local general managers at each club to focus on customer service, club staffing and providing a high quality exercise experience.

     Our club support division acts as the coordinator for all departments, and ensures consistency of policies and procedures across the entire organization.

     Personal Training. All of our fitness clubs offer one-on-one personal training, which is sold by the single session or in multi-session packages. We have implemented a comprehensive staff education curriculum which progresses from basic knowledge and practical skills to advanced concepts and training techniques. Our education program provides professional standards to ensure that our trainers provide superior service and fitness expertise to our members. There are four levels of professional competency for which different levels of compensation are paid, with mandatory requirements trainers must meet in order to achieve and maintain such status. We believe the qualifications of the personal training staff helps ensure that members receive a consistent level of quality service throughout our club base. We believe that our personal training programs provide valuable guidance to our members and a significant source of incremental revenue from value-added services. In addition, we believe that members who participate in personal training programs have a longer membership life.

     Group Fitness. Our commitment to providing a quality workout experience to our members extends to the employment of program instructors, who teach aerobics, cycling, strength conditioning, boxing, yoga, Pilates and step aerobics classes, among others. Our clustering strategy enables us to staff program instructors and professional personal trainers at more than one club. As a result, we can vary a given club’s instructors, while providing instructors sufficient classes to effectively and economically treat these instructors as full-time employees. All program instructors report to a centralized management structure, headed by the Vice President of Programs and Services whose department is responsible for overseeing auditions and providing in-house training to keep instructors current in the latest training techniques and program offerings. We also provide Group Exclusive offerings to our members, which are for-fee based programs that have smaller groups and provide more focused, and typically more advanced training classes. Some examples of these offerings include: Pilates, boxing camps, and cycling.

     Sports Clubs for Kids. During 2000, we began offering programs for children under the Sports Club for Kids (“SCfK”) brand. As of December 2004, SCfK was operating in 16 locations throughout our NYSC, BSC, and PSC regions. In addition to extending fitness offerings to a demographic not previously served by us, we expect that SCfK programming will help position our suburban clubs as family clubs, which should provide us with a competitive advantage. Depending upon the facilities available at a location, Sports Clubs for Kids programming can include traditional youth offerings such as day camps, sports camps, swim lessons, hockey and soccer leagues, gymnastics, dance, martial arts and birthday parties. It also can include innovative and proprietary programming such as Kidspin Theater, a multi-media cycling experience, and non-competitive “learn-to-play” sports programs. In selected locations we also offer laser tag.

     Employee Compensation and Benefits. We provide performance-based incentives to our management. Senior management compensation, for example, is tied to our overall performance. Departmental directors, district managers and general managers can achieve bonuses tied to financial and member retention targets for a particular club or group of clubs. We offer our employees various benefits including; health, dental, disability, insurance, pre-tax healthcare and dependent care accounts, and a 401(k) plan. We believe the availability of employee benefits provides us with a strategic advantage in attracting and retaining quality managers, program instructors and professional personal trainers and that this strategic advantage in turn translates into a more consistent and higher quality workout experience for those members who utilize such services.

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Proprietary Centralized Information Systems

     We are utilizing a proprietary system developed internally to track and analyze sales, leads, and membership statistics, the frequency and timing of member workouts, multi-club utilization, value-added services and demographic profiles by member, which enables us to develop targeted direct marketing programs and to modify our broadcast and print advertising to improve consumer response. This system also assists us in evaluating staffing needs and program offerings. In addition, we rely on certain data gathered through our information systems to assist in the identification of new markets for clubs and site selection within those markets.

Information System Developments

     We recognize the value of enhancing and extending the uses of information technology in virtually every area of our business. After developing an information technology strategy to support the business strategy, we developed a comprehensive multi-year plan to replace or upgrade key systems.

     In 2003 we implemented a new fully integrated club management system. This system incorporates browser-based technology and open architecture to allow for scalability to support our projected growth and diversification of services. This system provides enhanced functionality for member services, contract management, electronic billing, point of sale, scheduling resources, and reservations. This club management system is continually enhanced to extend support for new business functionalities and to integrate with other applications. Plans for 2005 include integration with a customer relationship management software and a document management software.

     Our website was expanded in 2004 to incorporate e-business functionality for the sale of corporate memberships. We have built an intranet to provide the portal for the various browser-based applications utilized within the Company. Development of intranet features to support corporate communications, human resources programs, and training is ongoing. During the year, data warehousing capabilities were developed to enable enhanced managerial and analytical reporting.

     Numerous infrastructure changes have been implemented to accommodate our growth, to provide network redundancy, efficiencies in operations, and to improve management of all components of the technical architecture. In 2004, we constructed the Company’s disaster recovery site as well as a purpose-built member call center in a facility in Pennsylvania. The disaster recovery facility, including full network redundancy will be completely operational for key business systems in the first quarter of 2005.

Strategic Planning

     During 2001, we began a strategic planning process. That process produced a set of core values, a mission statement and a clear vision for our future. In support of this top-level strategic focus were a series of six strategic objectives. These, in turn, were supported by strategic initiatives. Finally, a series of quarterly metrics were established to help our senior management gauge our progress toward achieving our objectives.

     In the first two years after the initial strategic plan was issued, progress with initiatives was closely monitored by senior management and the plan was refined annually. By 2004, the Plan had become an integral part of TSI’s Executive Committee (who are comprised of the Chairman, Chief Executive Officer, Chief Financial Officer, Chief Development Officer, Chief Information Officer, Chief Operations Officer and our Senior Vice President of Strategic Planning) decision making process. Reflecting its role in the structural decisions being made, it was reviewed and refined quarterly. The execution of initiatives supporting each of the six strategic objectives for 2004 became the responsibility of the Executive Committee, with every member other than the Chairman responsible for at least one objective.

     The plan objectives have produced significant changes in our approach to our brand, our core business development process, our customer experience, our sales process and our technology strategy. Among these changes are a “flattening” of our club management structure, giving in-club management broader responsibility. This was coupled with a reduction of the span of control of district managers so that they can focus on fewer locations. Together with our information technology strategies, such changes reduced the administrative burden placed upon our club management staff and provide a platform for improved customer service. Other objectives have resulted in, among other changes, the realignment of direct responsibility for the in-club membership sales process, a new division handling corporate sales activity and club-level responsibility for personal training sales and service delivery.

     Our core business development initiatives have improved our ability to target markets and enhanced the accuracy of our business model. Finally, our information technology initiatives have resulted in an Intranet platform that now serves as the portal through which employees access many enterprise-wide software systems. It also provides information about marketing promotions, details about clubs and services, corporate directories and resources related to the administration of human resources.

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     For 2005, we plan to drive the strategic planning process further into the organization. Selected divisions will develop strategy documents to improve the focus and efficiency of these groups. Because divisional strategy plans will support the our overall plan, they will improve the alignment of business processes with our high-level strategy.

Intellectual Property

     We have registered, various trademarks and service marks with the U.S. Patent and Trademark Office, including New York Sports Clubs, Washington Sports Clubs, Boston Sports Clubs, Philadelphia Sports Clubs, TSI, and Town Sports International, Inc. We continue to register other trademarks and service marks as they are created.

Competition

     The fitness club industry is highly competitive and continues to become more competitive as the number of health clubs in the U.S. has increased from 11,655 in 1993 to 23,497 in 2003. While we do not believe that there are dominant competitors in our markets, we compete with other fitness clubs, physical fitness and recreational facilities established by local governments and hospitals and by businesses for their employees, amenity and condominium clubs, the YMCA and similar organizations and, to a certain extent, with racquet and tennis and other athletic clubs, country clubs, weight reducing salons and the home-use fitness equipment industry.

     The principal methods of competition include, pricing and ease of payment, required level of members’ contractual commitment, level and quality of services, training and quality of supervisory staff, size and layout of facility and convenience of location with respect to access to transportation.

     We consider our service offerings to be in the mid-range of the value/service proposition and designed to appeal to a large portion of the population who attend fitness facilities. Competitors offering lower pricing and a lower level of service could compete effectively against our facilities if such an operator is willing to accept operating margins that are lower than ours. Furthermore, smaller and less expensive “weight loss” facilities designed to attract their target market present a competitive alternative for the de-conditioned market. The trend to larger outer-suburban family fitness centers, where there is more likely to be suitable real estate, could also compete effectively against our suburban “fitness-only” models.

Competitive position measured by # clubs

     We also compete with other entertainment and retail businesses for the discretionary income of our target demographics. There can be no assurance that we will be able to compete effectively in the future in the markets in which we operate. Competitors, which may include companies which are larger and have greater resources than we have, may enter these markets to our detriment. These competitive conditions may limit our ability to increase dues without a material loss in membership, attract new members and attract and retain qualified personnel. Additionally, consolidation in the fitness club industry could result in increased competition among participants, particularly large multi-facility operators that are able to compete for attractive acquisition candidates and real estate availability, thereby increasing costs associated with expansion through both acquisitions, and greenfields.

     We believe that our market leadership, experience and operating efficiencies enable us to provide the consumer with a superior product in terms of convenience, quality service and affordability. We believe that there are significant barriers to entry in our urban markets, including restrictive zoning laws, lengthy permit processes and a shortage of appropriate real estate, which could discourage any large competitor from attempting to open a chain of clubs in these markets. However, such a competitor could enter these markets more easily through one, or a series of, acquisitions.

Employees

     At December 31, 2004, we had approximately 7,650 employees, of which approximately 2,900 were employed full-time. Approximately 370 employees were corporate personnel working in our Manhattan, Boston, Philadelphia or Washington, D.C. offices. We are not a party to any collective bargaining agreement with our employees. We have never experienced any significant labor shortages nor had any difficulty in obtaining adequate replacements for departing employees and consider our relations with our employees to be good. We believe that we offer employee benefits (including health, dental, disability insurance, pre-tax healthcare and dependent care accounts, and a 401(k) plan) which are superior to those generally offered by our competitors.

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Government Regulation

     Our operations and business practices are subject to regulation at the federal, state and, in some cases, local levels. State and local consumer protection laws and regulations govern our advertising, sales and other trade practices.

     Statutes and regulations affecting the fitness industry have been enacted in jurisdictions in which we conduct business; many others into which we may expand have adopted or likely will adopt similar legislation. Typically, these statutes and regulations prescribe certain forms and provisions of membership contracts, afford members the right to cancel the contract within a specified time period after signing, require an escrow of funds received from pre-opening sales or the posting of a bond or proof of financial responsibility, and may establish maximum prices for membership contracts and limitations on the term of contracts. In addition, we are subject to numerous other types of federal and state regulations governing the sale of memberships. These laws and regulations are subject to varying interpretations by a number of state and federal enforcement agencies and the courts. We maintain internal review procedures in order to comply with these requirements, and believe that our activities are in substantial compliance with all applicable statutes, rules and decisions.

     Under so-called state “cooling-off” statutes, a new member has the right to cancel his or her membership for a short period set by the applicable jurisdictional law and, in such event, is entitled to a refund of any initiation fee and dues paid. In addition, our membership contracts provide that a member may cancel his or her membership at any time for medical reasons or relocation a certain distance from the nearest club. The specific procedures and reasons for cancellation vary due to differing jurisdictional laws. In each instance, the canceling member is entitled to a refund of prepaid amounts only. Furthermore, where permitted by law, a fee is due upon cancellation and we may offset such amount against any refunds owed.

Forward-Looking Statements

     Certain statements in this Annual Report on our Form 10-K for the year ended December 31, 2004 are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding future financial results and performance, potential sales revenue, legal contingencies and tax benefits. These statements are subject to various risks, and uncertainties, many of which are outside of our control, including the level of market demand for our services, competitive pressure, the ability to achieve reductions in operating costs and to continue to integrate acquisitions, environmental matters, the application of Federal and state tax laws and regulations, and other specific factors discussed herein and in other Securities and Exchange Commission (“SEC”) filings by us. The information contained herein represents our best judgment as of the data hereof based on information currently available; however, we do not intend to update this information except as required by law, to reflect developments or information obtained after the date hereof and disclaim any legal obligation to the contrary. Such statements also will be influenced by the factors described below in “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Factors That May Affect Future Results”.

Available Information

     We are subject to the informational requirements of the Securities Exchange Act of 1934 and, in accordance therewith, file reports and other information with the SEC. Such reports and other information can be inspected and copied at the Public Reference Room of the SEC located at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington D.C. 20549 and at a regional public reference facility maintained by the SEC located at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material can be obtained from the Public Reference Room of the SEC at prescribed rates. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Such material may also be accessed electronically by means of the SEC’s home page on the Internet at http://www.sec.gov.

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Item 2. Properties

     The following table provides information regarding our club locations:

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     We own the 151 East 86th Street location, which houses a fitness club and a retail tenant that generated $788,000 of rental income for us during the year ended December 31, 2004. Our fitness clubs occupy leased space pursuant to long-term leases (generally 15 to 25 years, including options). In the next five years (ending December 31, 2009), only three locations will expire without any renewal options. In each case we will endeavor to extend the lease or relocate the club or its membership base.

     We lease approximately 40,000 square feet of office space in New York City, and have smaller regional offices in Fairfax, VA, East Brunswick, NJ, Old Bridge, NJ, Philadelphia, PA, Stamford, CT and Wakefield, MA, for administrative and general corporate purposes. We also lease warehouse and commercial space in Long Island City, Queens, NY and Brooklyn, NY, for storage purposes and for the operation of a centralized laundry facility for certain of our New York Sports clubs.

     As of December 31, 2004, 135 of the existing fitness clubs were wholly owned by us. Location No. 121 and 122 listed above were managed and partly owned by us, with our profit sharing percentages approximating 20% and 45% respectively. In addition, we provide management services at four university fitness clubs in which we have no equity interest.

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Item 3. Legal Proceedings

     On February 13, 2003 in an action styled Joseph Anaya vs. Town Sports International, Inc. et al., an individual filed suit against us in the Supreme Court, New York County, alleging that on January 14, 2003, he sustained serious bodily injury at one of our club locations. He filed an amended complaint on September 17, 2003, seeking $2.0 billion in damages for personal injuries. His cause of action seeking punitive damages in the amount of $250.0 million dollars was dismissed on January 26, 2004. While the Company is unable to determine the ultimate outcome of the above action, it intends to contest the matter vigorously.

     We have in force $51.0 million of insurance to cover claims of this nature. If any such judgement exceeds the amount we are covered by insurance by $2.5 million, we would be in default under the credit agreement governing Town Sports International, Inc.’s senior secured revolving credit facility. Also, if any uninsured judgement, when aggregated with any other judgements not covered by insurance equals $5.0 million or more, the judgement would constitute an event of default under the indenture governing the notes. It is possible that a final settlement or award related to these matters may exceed our insurance coverage.

Depending upon the outcome, this matter may have a material effect on our consolidated financial position, results of operations or cash flow.

Item 4. Submission of Matters to a Vote of Security Holders

     Not applicable

PART II

Item 5. Market for Registrant’s Common Equity and Related Shareholder Matter

     Not applicable

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Item 6. Selected Financial Data

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(In $000s, except club and membership data)

     Set forth below is TSI Holdings’ selected historical consolidated financial, other data and club and membership data as of the dates and for the periods presented. The selected historical consolidated statement of operations data for the years ended December 31, 2002, 2003, and 2004 and the selected historical consolidated balance sheet data as of December 31, 2003 and 2004, were derived from the audited consolidated financial statements, which are included herein. The selected historical consolidated statement of operations data for the year ended December 31, 2000 and 2001 and the selected historical consolidated balance sheet data as of December 31, 2000, 2001 and 2002 were derived from our audited consolidated financial statements of the Company, which are not included herein. The information contained in this table and accompanying notes should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and accompanying notes thereto appearing elsewhere herein.

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(2)	In the quarter ended March 31, 2004, the Company performed its annual impairment test. Goodwill impairment testing requires a comparison between the carrying value and fair value of reportable goodwill. If the carrying value exceeds the fair value, goodwill is considered impaired. The amount of the impairment loss is measured as the difference between the carrying value and the implied fair value of goodwill, which is determined using discounted cash flows. As a result of this review, the Company determined that the goodwill at one of its remote clubs was not recoverable. The goodwill impairment associated with this under performing club amounted to $2.0 million. A deferred tax benefit of $881,000 has been recorded in connection with this impairment. Since this club is remote from one of the Company’s clusters, it does not benefit from the competitive advantage that our clustered clubs have, and as a result it is more susceptible to competition. We have reduced our projections of future cash flows of this club to take into account the impact of a recent opening of a competitor.
(3)	The $7.8 million loss on extinguishment of debt recorded in 2003 is a result of the refinancing of our debt on April 16, 2003. In connection with this refinancing, we wrote-off $3.7 million of deferred financing costs related to extinguished debt, paid a $3.0 million call premium, and incurred $1.0 million of additional interest on the 9 3/4% Old Notes representing interest incurred during the 30 day redemption notification period.
(4)	In the quarter ended December 31, 2002, we closed or sold two remote underperforming, wholly-owned clubs. In connection with the closure of one of the clubs, we recorded club closure costs of $996 related to the write-off fixed assets. We have accounted for these two clubs as discontinued operations and, accordingly, the results of their operations have been classified as discontinued in the Consolidated Statement of Operations and prior periods have been reclassified in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets To Be Disposed Of.

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Loss from operations (shown in $’000s) from these discontinued clubs was as follows for the periods presented:

(5)	Effective January 1, 2002 we implemented SFAS 142. In connection with the SFAS 142 transitional impairment test we recorded a $1.3 million write-off of goodwill. A deferred tax benefit of $612 was recorded as a result of this goodwill write-off, resulting in a net cumulative effect of change in accounting principle of $689 in 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. The impairment loss recorded was measured by comparing the carrying value to the fair value of goodwill.
(6)	During 2000, we acquired two formerly partly-owned clubs and relocated one club on expiration of lease.
(7)	Includes wholly-owned or partly-owned and managed clubs.
(8)	Represents members at wholly-owned or partly-owned clubs.
(9)	We define mature clubs as those clubs operated by us for more than 24 months.
(10)	Revenue per weighted average club is calculated as total revenue divided by the product of the total numbers of clubs and their weighted average months in operation as a percentage of the total year.
(11)	We had 153,637 shares of Series A Redeemable Preferred Stock (“Series A”) outstanding at December 31, 2000, 2001, 2002 and 2003. We have reclassified our 2001 financial statements to account for a redemption feature included in the Series A stock, in accordance with the guidance in EITF Topic No. D-98: Classification and Measurement of Redeemable Securities (“EITF Topic No. D-98”). EITF Topic No. D-98 provided additional guidance on the appropriate classification of redeemable preferred stock upon the occurrence of an event that is not solely within the control of an issuer. EITF Topic No. D-98 requires retroactive application in the first fiscal quarter ending after December 15, 2001 by reclassifying the financial statements of prior periods. The carrying value of the Series A stock, which was previously presented as a component of stockholders’ deficit, has been reclassified as redeemable preferred stock outside of stockholders’ deficit. The reclassification of the 2001 financial statements for the Series A stock had no effect on our net income, net loss attributable to common stockholders, cash flow provided by operations or total assets. The following sets forth the overall effect (in $’000s) of the reclassification on our stockholders’ deficit:

The balance sheet data for all periods presented have been adjusted to reflect the above reclassification.

(12)	In 2004 a common stock distribution totaling $68.9 million was paid.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with the “Selected Consolidated Financial and Other Data” and our consolidated financial statements and the related notes included elsewhere in this annual report. This annual report contains, in addition to historical information, forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

     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 December 31, 2004, we operated 137 clubs that collectively served approximately 383,000 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 members’ areas of both employment and residence. Our target member is college-educated, typically between the ages of 21 and 50 and has an annual income of between $50,000 and $150,000.

     Each club facility is subject to a long-term facility lease with a third party landlord, with the exception of our East 86th Street, New York City, where we own part of the underlying real estate. Our principal capital investment is thus in the facility improvements and equipment and furnishings of each facility. Our clubs are located for maximum convenience to our members in urban or suburban areas, close to transportation hubs, or office or retail centers.

     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 suburbs and ancillary communities. Capitalizing on this clustering of clubs, as of December 31, 2004, approximately 50% of our members participated in a membership plan that allows unlimited access to all of our clubs for a higher membership fee.

     Clustering of clubs also affords us significant additional benefits, including:

	1)	Providing our members access to an extensive network of locations;
	2)	Lower capital investment overall, by locating special programs, such as pools, racquet sports, etc. at selected clubs only;
	3)	More cost effective regional management and control;
	4)	Allocating certain costs such as advertising in a focused region over multiple locations;
	5)	Strengthening brand awareness.

     We have executed this strategy successfully in the New York region through the network of clubs we operate under our NYSC brand name. We are the largest fitness club operator in Manhattan with 37 locations and operate a total of 92 clubs under the NYSC name within a 50 mile radius of New York City. We operate 19 clubs in the Boston region, 17 clubs in the Washington D.C. region under our BSC and WSC brand names respectively and have begun establishing a similar cluster in the Philadelphia region with six clubs under the PSC brand name. In addition we operate three clubs in Switzerland. Our goal is to increase club square footage by ten percent per year, going forward. In 2003, we slowed our club expansion plans and maintained our club count at 129 while we recapitalized the Company to position it for future growth. In 2004, we opened or acquired six clubs in our NYSC market and two in our WSC market.

     We employ localized brand 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.

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     We consider that we have three principal sources of revenue:

          1) Our largest sources of revenue are dues and initiation fees paid by our members. This comprises over 83.6% of our total 2004 revenue. We recognize revenue from membership dues in the month when the services are rendered. Over 90% of our members pay their monthly dues by Electronic Funds Transfer, while the balance pay annually in advance. We recognize revenue from initiation fees over the expected average life of the membership, which is 24 months. It is important therefore to operate facilities that are convenient, offer good price/value relationship and have a wide variety of fitness service offerings in order to attract and retain members at each facility. More recently, our initiation fees recognized per new member sale have been depressed by our efforts to combat discounting by competitors in certain of our markets, as well as our offering of term commitment memberships at a discounted initial fee.

          2) We generated 9.9% of our 2004 revenue from personal training and 5.1% of revenue referred to as Other ancillary club revenue. Other ancillary club revenue consists of programming for children, group fitness training and other member activities, as well as sales of miscellaneous sports products. This total ancillary club revenue stream has increased as a percentage of total revenue more recently as we have focused on increasing revenue per member from our maturing club base.

          3) The balance of our revenue (approximately 1.4% in 2004) principally relates to rental of space in our facilities to operators who offer wellness-related offerings such as physical therapy. In addition, we generate management fees from certain club facilities that we do not wholly own. Revenue from sales of in-club advertising and sponsorships is also included in this section. We refer to this as Fees and Other revenue. Settlements from our business interruption insurance claim associated with the September 11 Events are seperately disclosed. These settlements occurred in 2002 and up until final settlement during 2003 and totaled $1.0 million and $2.8 million for the years ended December 31, 2002 and 2003, respectively.

     Revenue (in $’000s) is accordingly made up as follows:

     Our operating and selling expenses are comprised of both fixed and variable costs. Fixed costs include club and supervisory salary and related expenses, occupancy costs including certain elements of rent, housekeeping, contracted maintenance expenses as well as depreciation. General and administrative expenses include costs relating to our centralized support functions, such as accounting, information systems, purchasing and member relations, consulting fees, as well as real estate development expenses.

     Variable costs are primarily related to ancillary club revenue related payroll, membership sales compensation, advertising, utilities, certain facility repairs, insurance and club supplies.

     As clubs mature and increase their membership base, fixed costs are typically spread over an increasing revenue base and our operating margins tend to improve.

     Our primary capital expenditures relate to the construction of new club facilities and upgrading and expanding our existing clubs. The construction and equipment costs for a new center approximates $3.0 million, on average, which could vary based on the costs of construction labor, as well the planned service offerings and size and configuration of the facility. We perform routine improvements at our clubs and replacement of the fitness equipment each year for which we budget approximately 4.0% of each club’s annual revenue. Expansions of certain facilities are also performed from time to time, when incremental space becomes available on economic terms, and utilization and demand for the facility dictates. In this connection, facility remodeling is also considered where appropriate.

     During the last several years, we have increased revenues, operating income and cash flows provided by operating activities by expanding our club base in New York, Boston, Washington, D.C., and Philadelphia. As a result of expanding our club base and the relatively fixed nature of our operating costs, our operating income has increased from $22.3 million for the year ended December 31, 2000 to $34.3 million for the year ended December 31, 2004. Cash flows provided by operating activities increased from $42.6 million in 2000 to $57.1 million for the year ended December 31, 2004.

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     We have focused on building or acquiring club facilities in areas where we believe the market is underserved or where new units are intended to replace existing units at their lease expiration. Based on our historical experience, a new club tends to experience significant increase in revenues during its first three years of operation as it reaches maturity. Because there is relatively little incremental cost associated with such increasing revenue, there is a greater proportionate increase in profitability. We believe that the revenues and operating income of our immature clubs will increase as they mature. As a result of our expansion, however, operating income margins may be negatively impacted in the near term, as further new clubs are added.

Historical Club Growth

Mature Club Revenue

     We define mature clubs as those clubs that were operated by us for the entire period of the period presented and that same entire period of the preceeding year. Under this definition, mature clubs for periods shown are those clubs that were operated for more than 24 months. Our mature club revenue increased 18.6%, 12.3%, 4.1%, 1.6% and 2.1% for the years ended December 31, 2000, 2001, 2002, 2003 and 2004 respectively. We believe the decline in mature club revenue growth has been driven primarily by general economic softness, particularly in the New York metropolitan region. We have also seen increases in competition throughout our markets and this has depressed revenue growth at select mature clubs throughout our chain. In addition, we believe that the decline in mature club revenue growth is also attributable to a decrease in our club growth rate. Typically, clubs that are three and four years old show greater revenue improvements than our more mature clubs. Therefore, to the extent the rate of club growth decreases, we would expect a negative impact on future increases in mature club revenue growth.

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Results of Operations

     The following table sets forth certain operating data as a percentage of revenue for the periods indicated:

	Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003

     Revenues. Revenues increased $11.8 million or 3.5%, to $353.0 million during 2004 from $341.2 million in 2003. This increase resulted from the 3 clubs opened or acquired in 2003 (approximately $4.9 million), and the eight clubs opened or acquired in 2004 (approximately $4.6 million). In addition, revenues increased during 2004 by approximately $6.8 million or 2.1% at our mature clubs (clubs owned and operated for at least 24 months). These increases were offset by a $2.5 million decrease in revenue related to the three clubs we relocated in 2003. In 2003 we received $2.8 million of insurance proceeds related to our business interruption insurance final settlement and such proceeds were classified with Fees and Other revenue. In 2004, no such business interruption proceeds were received.

     The 2.1% increase in mature club revenue is due to a 2.8% increase in membership and a 1.4% increase in ancillary revenue offset by a 2.1% decrease in membership price.

     Our mature club revenue increased 4.1%, 1.6% and 2.1% for the years ended December 31, 2002, 2003 and 2004, respectively.

     Operating Expenses. Operating expenses increased $20.2 million, or 6.8% to $318.8 million in 2004, from $298.6 million in 2003. The increase was due to the following factors:

     Payroll and related expenses increased by $7.7 million, or 5.9% to $138.3 million in 2004, from $130.6 million in 2003. This increase was attributable to the following factors:

	•	In connection with the Restructuring and distribution to common stockholders of TSI Holdings, vested option holders, who did not exercise their options were paid a one-time bonus recorded as payroll expense in TSI under GAAP. This one-time payment totaled $1.1 million.
	•	In an effort to increase membership satisfaction and improve our membership retention rates we have increased the level of in-house training and club support personnel; and we have moved from third-party contracted equipment maintenance and housekeeping services to in-house supplied labor for the services. These customer service efforts resulted in $2.4 million increase in payroll with a commensurate savings in club operating expenses.
	•	Personal training and Sports Clubs for Kids programming payroll increased $2.0 million, or 9.3%, to support increases in revenue generated by these programs and services.
	•	Payroll related to management in our legal, marketing, training and development and club operations departments increased a total of $486,000.
	•	Payroll taxes and benefits increased $1.5 million due to increases in total payroll and increases in healthcare costs.

     Club operating increased by $5.7 million, or 5.1% to $116.8 million in 2004, from $111.1 million in 2003. This increase is principally attributable to the following:

•

A $4.1 million increase in rent expense principally resulting from increases related to clubs that have opened since, or expanded after, December 2003.

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	•	Facility repairs and maintenance costs increased $1.9 million, or 27.0% . Incremental costs to serve our initiative to increase member satisfaction and improve member retention have contributed to this increase.
	•	In addition, we experienced a $611,000 increase in utilities due to increases in utility rates, and a 5.1% increase in square footage in operation.
	•	The aforementioned increases in club operating expense were partially offset by a $789,000 decrease in advertising costs as well as a $314,000 decrease in equipment maintenance costs which were predominately outsourced to third parties in 2003 and moved to in-house labor in 2004.

     General and administrative increased by $2.7 million or 12.3% to $24.7 million in 2004, from $22.0 million in 2003:

	•	Liability insurance expense increased by $690,000. Premiums increased $327,000 coupled with a favorable adjustment of $363,000 recorded in the first quarter of 2003, where we had adjusted our reserves related to premium audits.
	•	We also experienced an increase of $700,000 in data communication lines costs. This related to the correction of our service provider’s billing errors in the first half of 2004 amounting to approximately $429,000. These costs have also increased due to data-line redundancies created at our clubs to safeguard against single line outages. Furthermore, data-line traffic has increased in 2004 with the completion of our Club Network systems rollout in 2003.
	•	Accounting and tax consulting fees increased $622,000 principally due to an increase in accounting services related to our Senior Discount Note offering in February of 2004, and increases in consulting with respect to the Sarbanes Oxley Act - Section 404.
	•	Legal fees increased by $447,000 principally due to an increase in number of new club leases and expansions executed
	•	In an effort to increase member satisfaction and improve member retention rates, we have increased staff development and recruiting costs. These customer service efforts resulted in an increase of $292,000 over the prior year.

     Depreciation and amortization increased by $2.0 million or 5.7% to $36.9 million in 2004, from $34.9 million in 2003. This increase is principally attributable to increases in depreciation at new, expanded and remodeled clubs.

     Goodwill Impairment. In the quarter ended March 31, 2004, the Company performed its annual impairment test. Goodwill impairment testing requires a comparison between the carrying value and fair value of reportable goodwill. If the carrying value exceeds the fair value, goodwill is considered to be impaired. The amount of the impairment loss is measured as the difference between the carrying value and the implied fair value of goodwill, which is determined using discounted cash flows. As a result of this review, the company determined that the goodwill at one of its remote clubs was not recoverable. The goodwill impairment associated with this under performing club amounted to $2.0 million. A deferred tax benefit of $881,000 has been recorded in connection with this impairment. Since this club is remote from one of the Company’s clusters, it does not benefit from the competitive advantage that our clustered clubs have, and as a result it is more susceptible to competition. We have reduced our projections of future cash flows of this club to take into account the impact of a recent opening of a competitor.

     Interest Expense. Interest expense increased $15. 6 million to $39.3 million in 2004 from $23.7 million in 2003. Interest expense increased $12.8 million due to the issuance of Senior Discount Notes in February 2004 while the remainder of the increase was principally due to the refinancing of our Senior Notes in April 2003 as discussed in Financing Activities.

     Interest Income. Interest income increased $299,000 to $743,000 in 2004 from $444,000 in 2003. This increase is due to increases in cash balances in 2004 compared to 2003. Average interest rates earned on cash balances also increased in 2004 when compared to 2003.

     Equity in the earnings of investees and rental income. Equity in the earnings of investees and rental income increased from $1.4 million in 2003 to $1.5 million in 2004 principally due to increases in rent charged to our tenant.

     Provision for Corporate Income Taxes. The provision for corporate income taxes decreased $4.4 million from $5.5 million in 2003 to $1.1 million in 2004. In 2004 we recorded tax charges related to:

	•	A $597,000 increase in the deferred tax valuation allowance to reserve for state net operating losses that may not be utilized in future periods.
	•	Change in the allocation factors used in the computation of our New York State taxes, caused by revenue, payroll and asset growth outside of New York State, resulting in a deferred tax charge of approximately $340,000;
	•	Relief of our deferred tax asset totaling $1.1 million, associated with deferred compensation expense associated with stock options now exercised.

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     Accreted Dividends on Preferred Stock. In connection with the February 4, 2004 Senior Discount Note offering, all outstanding Series A and Series B preferred stock were redeemed. After giving effect to these redemptions, our capital structure no longer has outstanding preferred stock and therefore no dividends have been accreted in periods subsequent to February 2004.

	Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002

     Revenues. Revenues increased $23.1 million or 7.2%, to $341.2 million during 2003 from $318.1 million in 2002. This increase resulted from the 12 clubs opened or acquired in 2002 (approximately $14.8 million), and the three clubs opened in 2003 (approximately $3.1 million). In addition, revenues increased during 2003 by approximately $4.9 million or 1.6% at our mature clubs (clubs owned and operated for at least 24 months). In 2003 we received $2.8 million of insurance proceeds related to our business interruption insurance settlement; a $1.8 million increase over the $1.0 million received in 2002. These increases were offset by a $1.7 million decrease in revenue related to the three clubs we relocated in 2003.

     The 1.6% increase in mature club revenue is due to a 0.9% increase in price, a 0.4% increase in membership and a 0.3% increase in ancillary revenue.

     Our mature club revenue increased 12.3%, 4.1% and 1.6% for the years ended December 31, 2001, 2002 and 2003, respectively. We believe the decline in mature club revenue growth had been driven primarily by the general economic climate, particularly in the New York metropolitan region. We have also seen increases in competition throughout our markets and this has depressed revenue growth at select mature clubs throughout our chain. In addition, we believe that the decline in mature club revenue growth is also attributable to the increasing age of our mature clubs.

     Operating Expenses. Operating expenses increased $17.2 million, or 6.1% to $298.6 million in 2003, from $281.3 million in 2002. This increase was due to a 3.3% increase in the total months of club operations to 1,528 in 2003 from 1,479 in 2002. The increase is also attributable to increases in club operating costs, particularly occupancy costs and utilities.

     Payroll and related expenses increased by $1.5 million, or 1.1% to $130.6 million in 2003, from $129.1 million in 2002. This increase was partially offset by a $1.0 million decrease in non-cash compensation expense which decreased from $1.2 million in 2002 to $197,000 in 2003. The non-cash compensation expense incurred during 2002 principally related to outstanding Series B stock options and such options were exercised in the first quarter of 2003.

     Club operating increased by $12.0 million, or 12.1% to $111.1 million in 2003, from $99.1 million in 2002. This increase is attributable to a 3.3% increase in the total months of club operations to 1,528 in 2003 from 1,479 in 2002. The increase is also attributable to a $2.4 million or 20.6% increase in utilities and a $7.6 million or 13.8% increase in occupancy costs. Occupancy costs increased due to increases in real estate taxes as well as increases in base rent associated with the opening of three flagship locations and several club expansions.

     General and administrative increased by $627,000, or 2.9% to $22.0 million in 2003, from $21.4 million in 2002. This increase is principally attributable to a $369,000 increase in liability and property insurance, as well as increases in information technology maintenance and related costs.

     Depreciation and amortization increased by $3.2 million or 10.0% to $34.9 million in 2003, from $31.7 million in 2002. This increase is attributable to:

	•	Increases in depreciation related to our clubs built or acquired in 2002 and 2003 amounting to $1.8 million.
	•	Increases in depreciation related to our 2002 and 2003 club expansions and remodels amounting to $1.6 million.
	•	These increases were offset by a $164,000 decrease in amortization of intangible assets. The membership lists of the eleven clubs acquired in 2000 were fully amortized during 2002 and this gave rise to a $735,000 decrease offset by $571,000 of additional amortization of clubs acquired subsequent to 2000.

     Loss on Extinguishment of Debt. The $7.8 million loss on extinguishment of debt recorded in 2003 is a result of the refinancing of our debt on April 16, 2003. In connection with this refinancing, we wrote-off $3.7 million of deferred financing costs related to extinguished debt, paid a $3.0 million call premium, and incurred $1.0 million of additional interest on the 9 3/4% Notes representing interest incurred during the 30 day redemption notification period.

     Equity in the earnings of investees and rental income. Equity in the earnings of investees and rental income was $1.4 million in 2002 and 2003.

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     Interest Expense. Interest expense increased $7.1 million to $23.7 million in 2003 from $16.6 million in 2002. Interest expense increased $8.8 million due to the refinancing of our Senior Notes as discussed in Financing Activities. This increase was partially offset by decreases in interest on credit line and subordinated credit line borrowings, which were completely repaid on April 16, 2003 in connection with the refinancing.

     On February 4, 2004 we received a total of $124.8 million in connection with the offering of 11.0% Senior Discount Notes (see also Liquidity and Capital Resources). Interest expense including the amortization of deferred financing costs, will increase approximately $13.0 million for the year ending December 31, 2004 when compared to the year ending December 31, 2003 due to this issuance.

     Interest Income. Interest income increased $306,000 to $444,000 in 2003 from $138,000 in 2002. This increase is due to increases in cash balances in 2003 compared to 2002.

     Provision for Corporate Income Taxes. The provision for corporate income taxes decreased $4.2 million from $9.7 million in 2002 to $5.5 million in 2003. Our effective tax rate decreased to 42.7% in 2003 from 44.8% in 2002 principally due to decreases in the effective New York State and New York City rates. With the exception of deferred tax assets of $384,000 related to certain state net operating loss carry-forwards, which have been reserved for, we expect future taxable income to be sufficient to realize the $16.8 million of net deferred tax assets.

     Accreted Dividends on Preferred Stock. Accreted dividends on the Preferred Stock decreased $559,000 to $11.0 million in 2003, from $11.5 million in 2002. Accreted dividends on Series A preferred stock increased $640,000 due to the compounding of accreted and unpaid dividends, and accreted dividends on the Series B preferred stock increased $1.1 million due to the increase in shares outstanding. These increases were offset by a $2.3 million decrease in redeemable senior preferred stock dividends. The redeemable senior preferred stock was redeemed in April 2003 and no dividends have been accreted thereafter.

Liquidity and Capital Resources

     Liquidity. 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.

     Operating Activities. Net cash provided by operating activities for the year ended December 31, 2004 was $57.1 million compared to $58.9 million during the year ended December 31, 2003. Net cash flows from operations have decreased due to the decrease in operating income when adjusted for certain non-cash operating expenses such as depreciation and amortization and goodwill impairment. Net cash provided by operating activities for the year ended December 31, 2003 was $58.9 million compared to $54.3 million for the year ended December 31, 2002. Cash flows from operations improved during this period with our increase in operating income, and in addition, because of the favorable impact of management’s exercise of stock options in 2003, which provided us with a current tax deduction of approximately $8.6 million.

     We normally operate with a working capital deficit because we receive dues and program and services fees either (i) during the month services are rendered, or (ii) when paid-in-full, in advance. As a result, we typically do not have significant accounts receivable. We record deferred liabilities for revenue received in advance in connection with dues and services paid-in-full and for initiation fees paid at the time of enrollment. Initiation fees received are deferred and amortized over a 24 month period, which represents the approximate average life of a member. We do not believe we will have to meet this working capital deficit in the foreseeable future, because as we increase the number of clubs open, we expect we will continue to have deferred revenue balances that reflect services and dues that are paid-in-full in advance at levels similar to, or greater than, those currently maintained. The deferred revenue balances that give rise to this working capital deficit represent cash received in advance of services performed, and does not represent liabilities that must be funded with cash.

     Investing Activities. We invested $40.7 million and $43.4 million in capital expenditures and club acquisitions during years ended December 31, 2004 and 2003, respectively. For the year ending December 31, 2005, we are committed to invest an additional $57.5 million in capital expenditures, which includes $8.4 million that management intends to invest to expand and renovate certain existing clubs, $15.7 million to continue to upgrade and enhance existing clubs and $1.6 million to enhance our management information systems. The remainder of our 2005 capital expenditures will be committed to build or acquire clubs. These expenditures will be funded by cash flow provided by operations and available cash on hand.

     Financing Activities. Net cash provided by financing activities was $265,000 for the year ended December 31, 2004 compared to $19.7 million for the same period in 2003.

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February 4, 2004 Restructuring

     On February 4, 2004 Town Sports International, Inc. (“TSI Inc.”) and affiliates and Town Sports International Holdings (“TSI Holdings”), a newly formed company, entered into a Restructuring Agreement. In connection with this Restructuring, the holders of TSI Inc.’s Series A Preferred Stock, Series B Preferred Stock and Class A Common stock contributed their shares of TSI Inc. to TSI Holdings for an equal amount of newly issued shares of the same form in TSI Holdings. Immediately following this exchange TSI Holdings contributed to TSI Inc. the certificates representing all of TSI Inc.’s shares contributed in the aforementioned exchange and in return TSI Inc. issued 1,000 shares of common stock to TSI Holdings, and cancelled on its books and records the certificate representing TSI Inc.’s shares contributed to it by TSI Holdings.

     On February 4, 2004 TSI Holdings successfully completed an offering of 11.0% Senior Discount Notes (the “Discount Notes”) that will mature in February 2014. TSI Holdings received a total of $124.8 million in connection with this issuance. Fees and expenses related to this transaction totaled approximately $4.4 million. No cash interest is required to be paid prior to February 2009. The accreted value of each Discount Note will increase from the date of issuance until February 1, 2009, at a rate of 11.0% per annum compounded semi-annually such that on February 1, 2009 the accreted value will equal $213.0 million, the principal value due at maturity. Subsequent to February 1, 2009 cash interest on the Discount Notes will accrue and be payable semi-annually in arrears February 1 and August 1 of each year, commencing August 1, 2009. The Discount Notes are structurally subordinated and effectively rank junior to all indebtedness of the Company. TSI Holdings debt is not collateralized by TSI, and TSI Holdings relies on the cash flows of TSI, with restrictions contained in the Senior Note Indenture, to service its debt.

     The use of proceeds from the Discount Note Offering were as follows:

     On February 6, 2004, all of TSI Holdings’ outstanding Series A stock and Series B stock were redeemed for a total of $50.6 million.

     On March 12, 2004, 65,536 vested common stock options of TSI Holdings were exercised. TSI Holdings received $539,000 in cash related to these exercises.

     On March 15, 2004, the Board of Directors of TSI Holdings approved a common stock distribution of $52.50 per share to all shareholders of record on March 15, 2004. This distribution totaled $68.9 million and was paid on March 17, 2004. Also, in lieu of a common stock distribution, vested common option holders were paid a total of $1.1 million recorded as payroll expense.

	April 16, 2003 Refinancing Transaction

     On April 16, 2003, we successfully completed a refinancing of our debt. This refinancing included an offering of $255.0 million of 9 5/8% Senior Notes (“Existing 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 Existing Notes accrue interest at 9 5/8% per annum and interest is payable semiannually on April 15, and October 15. In connection with this refinancing, we 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 Note offering were as follows:

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     As of December 31, 2004, our total consolidated debt was $396.5 million. This substantial amount of debt could have significant consequences, including:

	•	Making it more difficult to satisfy our obligations;
	•	Increasing our vulnerability to general adverse economic and industry conditions;
	•	Limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions of new clubs and other general corporate requirements;
	•	Requiring cash flow from operations for the annual payment of $24.5 million interest on our Senior Notes and reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions of new clubs and general corporate requirements; and
	•	Limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate.

     These limitations and consequences may place us at a competitive disadvantage to other less-leveraged competitors.

     As of December 31, 2004, we had $137.6 million of Senior Discount Notes and $255.0 million of Senior Notes outstanding. Under the provisions of the Senior Note Indenture, TSI 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 $50.0 million. The line of credit carries interest at our option based upon the Eurodollar borrowing rate plus 4.0% or the bank’s prime rate plus 3.0% as defined, and we are required to pay a commitment fee of 0.75% per annum on the daily unutilized amount. As of December 31, 2004, no borrowings were outstanding under this line. As of December 31, 2004 outstanding letters of credit totaled $4.7 million. As of December 31, 2004, we had approximately $45.3 million unutilized under the line of credit, which matures in April 2008, and has no scheduled amortization requirements. In addition, as of December 31, 2004 we had $57.5 million of cash and cash equivalents.

     The Senior Credit Facility contains various covenants including limits on capital expenditures, the maintenance of a consolidated interest coverage ratio of not less than 2.50 and 2.75:1.00 during 2004 and 2005 respectively, and a maximum permitted total leverage ratio of 3.75:1.00 from December 31, 2004 through December 31, 2005 and 3.5:1.00 from December 31, 2005 through September 29, 2006. These covenants limit the Company’s ability to incur additional debt, and as of December 31, 2004, permitted additional borrowing capacity under the Senior Credit Facility was limited to $24.8 million.

     We believe that we have or will be able to obtain or generate, sufficient funds to finance our current operating and growth plans through the end of 2009. 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 2009. There can be no assurance that such financing will be available, or that it will be available on acceptable terms. 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 should borrowings be required.

     Notes payable were incurred upon the acquisition of various clubs and are subject to the right of offset for possible post acquisition adjustments arising out of operations of the acquired clubs. These notes bear interest at rates between 5% an 9%, and are non-collateralized. The notes are due on various dates through 2012.

Contractual Obligations and Commitments Summary

     The aggregate long-term debt, capital lease, and operating lease obligations as of December 31, 2004 were as follows:

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Equity Transactions and Restructuring

     On January 26, 2004 warrants to purchase 71,631 shares of Class A common stock were exercised.

     On February 4, 2004 TSI Inc. and its shareholders and Town Sports International Holdings, Inc., (“TSI Holdings”) a newly formed company, entered into a Restructuring Agreement (“Restructuring”). In connection with the Restructuring, the holders of the TSI’s Series A Preferred Stock, Series B Preferred Stock, and Class A Common stock contributed their shares of TSI to TSI Holdings for an equal amount of newly issued shares of the same form in TSI Holdings. Immediately following this exchange TSI Holdings contributed to TSI the certificates representing all of the TSI’s shares contributed in the aforementioned exchange. In return TSI issued 1,000 shares of common stock to TSI Holdings, and cancelled the certificate representing TSI’s Shares contributed to it by TSI Holdings. In addition as part of the Restructuring, all holders of options to purchase Class A Common stock of TSI exchanged their options for options to purchase an equal number of shares of Class A Common stock of TSI Holdings at strike prices adjusted to reflect the Restructuring.

     On February 4, 2004 TSI Holdings successfully completed an offering of 11.0% Senior Discount Notes (the “Discount Notes”) that will mature in February 2014. TSI Holdings received a total of $124.8 million in connection with this issuance. Fees and expenses related to this transaction totaled approximately $4.4 million. No cash interest is required to be paid prior to February 2009. The accreted value of each Discount Note will increase from the date of issuance until February 1, 2009, at a rate of 11.0% per annum compounded semi-annually such that on February 1, 2009 the accreted value will equal $213.0 million, the principal value due at maturity. Subsequent to February 1, 2009 cash interest on the Discount Notes will accrue and be payable semi-annually in arrears February 1 and August 1 of each year, commencing August 1, 2009. The Discount Notes are structurally subordinated and effectively rank junior to all indebtedness of the Company.

     On February 6, 2004, all of TSI Holdings’ outstanding Series A Preferred stock and Series B Preferred stock were redeemed for a total of $50.6 million.

     On March 12, 2004, 65,536 vested common stock options of TSI Holdings were exercised. TSI Holdings received $539,000 in cash related to these exercises.

     On March 15, 2004, the Board of Directors of TSI Holdings approved a common stock distribution of $52.50 per share to all shareholders of record on March 15, 2004. This distribution totaled $68.9 million and was paid on March 17, 2004. Also, in lieu of a common stock distribution, certain vested common option holders were paid a total of $1.1 million recorded as payroll expense.

Recent Changes in or Recently Issued Accounting Standards

     In June 2004, the FASB issued EITF Issue No. 02-14, “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock.” EITF Issue No. 02-14 address whether the equity method of accounting applies when an investor does not have an investment in voting common stock of an investee but exercises significant influences through other means. EITF Issue No. 02-14 states that an investor should only apply the equity method of accounting when it has investments in either commin stock or in-substance common stock of a corporation, provided that the investor has the ability to exercise significant influences over the operating and financial policies of the investee. The adoption of EITF Issue No. 02-14 had no impact on the company.

     In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payments.” SFAS No. 123R is a revision of SFAS No. 123, “Accounting for Stock Based Compensation,” and supersedes APB 25. Among other items, SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee service received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The effective date of

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SFAS 123R is the first reporting period beginning after June 15, 2005, which is third quarter 2005 for calendar year companies, although early adoption is allowed. SFAS 123R permits companied to adopt its requirements using either a “modified prospective” method, or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all share-based payments granted after that date, and based on the requirements of SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but the “modified retrospective” method also permits entities to restate financial statements of previous periods on proforma disclosures made in accordance with SFAF 123.

          We currently utilize a standard option pricing model (i.e., Black-Scholes) to measure the fair value of stock options granted to employees. While SFAS 123R permits entities to continue to use such a model, the standard also permits the use of a “lattice” model. We have not yet determined which model we will use to measure the fair value of employee stock options upon the adoption of SFAS 123R.

          SFAS 123R also requires that the benefits associated with the tax deduction in excess of recognized compensation cost be reported as a financing cash flow, rather than an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. These future amounts cannot be estimated because they depend on, among other things, when employees exercise stock options.

          We will adopt SFAS 123R effective July 1, 2005; however, we have not yet determined which of the aforementioned adoption methods we will use.

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 interrupted the operations at four of our clubs located in downtown Manhattan. Three of the affected four clubs were back on operation by October 2001, while the fourth club 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 an estimate of costs incurred in September 2001. Such costs included rent, payroll benefits, and other club operating costs incurred during period of closure. In 2002, we collected this $175,000 receivable and received additional on-account payments of $1.0 million. In 2003, we received $2.8 million from our insurer and we entered into a final settlement agreement. These on-account and final payments were classified in Fees and Other revenues when received.

Use of Estimates and Critical Accounting Policies

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

     The most significant assumptions and estimates relate to the allocation and fair value ascribed to assets acquired in connection with the acquisition of clubs under the purchase method of accounting, the useful lives, recoverability and impairment of fixed and intangible assets, deferred income tax valuation, valuation of, and expense incurred in connection with stock options and warrants, legal contingencies and the estimated membership life.

     Our one-time member initiation fees and related direct expenses are deferred, and recognized, on a straight-line basis, in operations over an estimated membership life of 24 months. This estimated membership life has been derived from actual membership retention experienced by us. Although the average membership life approximated 24 months over each of the past several years, this estimated life could increase or decrease in future periods. Consequently, the amount of initiation fees and direct expenses deferred by us would increase or decrease in similar proportion.

     Fixed assets are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets, which are thirty years for building and improvements, five years for club equipment, furniture, fixtures and computer equipment, and three years for computer software. Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining period of the lease. Expenditures for maintenance and repairs are charged to operations as incurred. The cost and related accumulated depreciation or amortization of assets retired or sold are removed from the respective accounts and any gain or loss is recognized in operations. The costs related to developing web applications, developing web pages and installing developed applications on the web servers are capitalized and classified as computer software. Web site hosting fees and maintenance costs are expensed as incurred.

     Long-lived assets, such as fixed assets, and intangible assets are reviewed for impairment when events or circumstances indicate that the carrying value may not be recoverable. Estimated undiscounted expected future cash flows are used to determine if an asset is

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impaired, in which case the asset’s carrying value would be reduced to fair value. Actual cash flows realized could differ from those estimated and could result in asset impairments in the future.

     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. In 2003, the Company did not have to record a charge to earnings for an impairment of goodwill as a result of its annual review conducted during the first quarter.

     As of December 31, 2004 our net deferred tax assets totaled $12.7 million. These net assets represent cumulative net “temporary differences” that will result in tax deductions in future years. The realizability of these assets greatly depends on our ability to generate sufficient future taxable income. Our pre-tax profit was $21.7 million, $13.0 million, and current tax liabilities were $10.3 million and $2.1 million for the years ended December 31, 2002 and 2003, respectively. During the year ended December 31, 2004 our pre-tax loss was $2.8 million. During 2004, we incurred $12.7 million of additional interest expense related to our February 2004, issuance of the Discount Notes. In addition, we incurred $1.1 million of payroll expense related to a special bonus paid to common stockholders and we recorded a $2.0 million goodwill impairment charge. We believe as our club base continues to expand, we will improve our profitability in years going forward and realize our deferred tax assets. Given our profitability in past years and expected future profitability, the weight of available evidence indicates we will be able to realize these net deferred tax assets. If at some time in the future the weight of available evidence does not support the realizability of a portion of, or the entire net deferred tax assets, the write-down of this asset could have a significant impact on our financial statements.

Factors That May Affect Future Results

Our substantial leverage may impair our financial condition and we may incur significant additional debt.

We currently have a substantial amount of debt. As of December 31, 2004, our total consolidated debt was $396.5 million.

          Our substantial debt could have important consequences, including:

	•	making it more difficult for us to satisfy our obligations with respect to our outstanding indebtedness;
	•	increasing our vulnerability to general adverse economic and industry conditions;
	•	limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions of clubs and other general corporate requirements;
	•	requiring a substantial portion of our cash flow from operations for the payment of interest on our debt and reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions of new clubs and general corporate requirements; and
	•	limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate.

These limitations and consequences may place us at a competitive disadvantage to other less-leveraged competitors.

     Subject to specified limitations, the indenture relating to the Discount Notes will permit us and our subsidiaries to incur substantial additional debt. In addition, as of December 31,2004, we had $45.3 million of unutilized borrowings under our senior secured revolving credit facility of which $24.8 million was available subject to certain limitations. If new debt is added to our and our subsidiaries’ current debt levels, the related risks that we and they now face could intensify.

 Servicing our debt will require, in aggregate, approximately $750 million (comprised of principal and interest) of cash, and our ability to generate sufficient cash flows depends upon many factors, some of which are beyond our control.

     Our ability to make payments on and refinance our $396.5 million of debt and to fund planned capital expenditures depends on our ability to generate cash flow in the future. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Contractual and Commitments Summary” for a description of the aggregate long-term debt, capital lease, and operating lease obligations as of December 31, 2004. To some extent, this is subject to general economic, financial, competitive, legislative and regulatory factors and other factors that are beyond our control. We may be unable to continue to generate cash flow from operations at current levels. If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may have to refinance all or a portion of our existing debt or obtain additional financing. We cannot assure that any refinancing of this kind would be possible or that any additional financing could be obtained.

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The inability to obtain additional financing could have a material adverse effect on our financial condition and on our ability to meet our obligations under our debt.

 Covenant restrictions under our indebtedness may limit our ability to operate our business and, in such an event, we may not have sufficient assets pay our indebtedness.

     The indenture governing the Discount Notes and certain of our other agreements regarding our indebtedness contain, among other things, covenants that may restrict our ability to finance future operations or capital needs or to engage in other business activities. The indenture govering the Discount Notes and certain of our other agreements regarding our indebtedness restrict, among other things, our ability and the ability of our restricted subsidiaries to:

	•	borrow money;
	•	pay dividends or make distributions;
	•	purchase or redeem stock;
	•	make investments and extend credit;
	•	engage in transactions with affiliates;
	•	engage in sale-leaseback transactions;
	•	consummate certain asset sales;
	•	effect a consolidation or merger or sell, transfer, lease or otherwise dispose of all or substantially all of our assets; and
	•	create liens on our assets.

     In addition, our senior secured revolving credit facility requires TSI, Inc. to maintain specified financial ratios and satisfy certain financial condition tests that may require TSI, Inc. to take action to reduce its debt or to act in a manner contrary to its business objectives. Such ratios include:

	•	ratio not less than ranging from 2.50:1.00 to 3.50:1.00, depending on the period, of EBITDA as defined in the credit agreement governing our senior secured credit facility to interest expense;
	•	ratio not greater ranging from 4.00:1.00 to 2.75:1.00, depending on the period, of indebtedness to EBITDA as defined in the credit agreement governing our senior secured credit facility; and
	•	ratio not greater than 1.00:1.00 of senior secured indebtedness to EBITDA as defined in the credit agreement governing our senior secured credit facility.

     As of December 31, 2004 we are required to maintain an EBITDA as defined in the credit agreement governing our senior secured credit facility to interest expense ratio of no less than 2.50:1.00, an indebtedness to EBITDA as defined in the credit agreement governing our senior secured credit facility ratio of not greater than 3.75:1.00 and a senior secured indebtedness to EBITDA as defined in the credit agreement governing our senior secured credit facility ratio of not greater than 1.00:1.00. As of December 31, 2004 our position relative to such ratios was 3.11:1.00, 3.43:1.00 and 0.14:1.00, respectively.

     Events beyond our and TSI, Inc.’s control, including changes in general economic and business conditions, may affect our and TSI, Inc.’s ability to meet those financial ratios and financial condition tests. We and TSI, Inc. may be unable to meet those tests and the lenders may decide not to waive any failure to meet those tests. A breach of any of these covenants would result in a default under the indenture governing the Discount Notes, TSI, Inc.’s senior secured revolving credit facility and the indenture governing the senior notes issued by TSI, Inc. If an event of default under TSI, Inc.’s senior secured revolving credit facility occurs, the lenders could elect to declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable. If an event of default occurs under the indenture governing the senior notes issued by TSI, Inc., the noteholders could elect to declare due all amounts outstanding thereunder, together with accrued interest. If any such event should occur, we might not have sufficient assets to pay our indebtedness.

 Our cash and cash equivalents are concentrated in one bank.

     Our cash and cash equivalents are held, primarily, in a single commercial bank. These deposits are not collateralized. In the event the bank becomes insolvent, we would be unable to recover most of our cash and cash equivalents deposited at the bank.

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 We may experience losses in our recently opened greenfield clubs.

     We have opened a total of 8 new club locations that we have constructed (or greenfield clubs) in the 24 month period ending December 31, 2004. Upon opening a greenfield club, we typically experience an initial period of club operating losses. Although we often pre-sell memberships, such enrollment typically generates insufficient revenue for the club to generate positive cash flow. As a result, a greenfield club typically generates an operating loss in its first full year of operation and substantially lower margins in its second full year of operations than a mature club. These operating losses and lower margins will negatively impact our future results of operations. This negative impact will be increased by the initial expensing of pre-opening costs which include legal and other costs associated with lease negotiations and permitting and zoning requirements, as well as increased depreciation and amortization expenses, which will further negatively impact net income. A greenfield club typically reaches mature membership levels in three to four years. We may, at our discretion, accelerate or expand our plans to open new greenfield clubs, which may adversely affect results from operations temporarily.

 Our inability to acquire additional capital on acceptable terms to finance future expansion would adversely impact our competitive position.

     The opening of greenfield clubs and the acquisition of existing clubs requires considerable capital. 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. We cannot assure that financing will be available or that it will be available on acceptable terms. The inability to finance accelerated expansion on acceptable terms may negatively impact our competitive position and/or materially adversely affect our business, results of operations or financial condition.

 We may be unable to attract and retain members, which could have a negative effect on our business.

      The performance of our clubs is dependent on our ability to attract and retain members, and we may not be successful in these efforts, or that the membership levels at our clubs will not materially decline. Most of our members can cancel their club membership at any time upon 30 days’ notice. In addition, there are numerous factors that could lead to a decline in membership levels at established clubs or that could prevent us from increasing our membership at newer clubs, including harm to our reputation, a decline in our ability to deliver quality service at a competitive cost, the presence of direct and indirect competition in the areas in which the clubs are located, the public’s interest in sports and fitness clubs and general economic conditions. As a result of these factors, membership levels might not be adequate to maintain or permit the expansion of our operations. In addition, a decline in membership levels may have a material adverse effect on our performance, financial condition and results of operations.

 Our geographic concentration heightens our exposure to adverse regional developments.

     As of December 31, 2004, we operated 92 fitness clubs in the New York metropolitan market, 19 fitness clubs in the Boston market, 17 fitness clubs in the Washington, D.C. market, six fitness clubs in the Philadelphia market and three fitness clubs in Switzerland. Our geographic concentration in the Northeast and Mid-Atlantic regions and, in particular, the New York area, heightens our exposure to adverse developments related to competition, as well as, economic and demographic changes in these regions. Our geographic concentration might result in a material adverse effect on our business, financial condition or results of operations in the future.

 The high level of competition in the fitness club industry could make it difficult for us to generate sufficient cash flow to service our debt.

     The fitness club industry is highly competitive. We compete with other fitness clubs, physical fitness and recreational facilities established by local governments, hospitals and businesses for their employees, amenity and condominium clubs, the YMCA and similar organizations and, to a certain extent,with racquet and tennis and other athletic clubs, country clubs, weight reducing salons and the home-use fitness equipment industry. We also compete with other entertainment and retail businesses for the discretionary income of our target markets. We might not be able to compete effectively in the future in the markets in which we operate. Competitors, which may include companies that are larger and have greater resources than us, may enter these markets to our detriment. These competitive conditions may limit our ability to increase dues without a material loss in membership, attract new members and attract and retain qualified personnel. Additionally, consolidation in the fitness club industry could result in increased competition among participants, particularly large multi-facility operators that are able to compete for attractive acquisition candidates or greenfield locations, thereby increasing costs associated with expansion through both acquisitions, and lease negotiation and real estate availability for greenfields. See “Business–Competition.”

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We could be subject to claims related to health or safety risks at our clubs.

     Use of our clubs poses some potential health or safety risks to members or guests through exertion and use of our services and facilities including exercise equipment. Claims against us for death or injury suffered by members or their guests while exercising at a club might be asserted. We might not be able to successfully defend such claim. Additionally, we might not be able to maintain our general liability insurance on acceptable terms in the future or that such insurance will provide adequate coverage against potential claims. A claim has been filed against us by an individual for injuries sustained at one of our club locations for two billion dollars in damages for personal injuries. “Business — Legal Proceedings.”

 Loss of key personnel and/or failure to attract and retain highly qualified personnel could make it more difficult for us to generate cash flow from operations and service our debt.

     We are dependent on the continued services of our senior management team, particularly Mark Smith, Chairman; Robert Giardina, Chief Executive Officer; Richard Pyle, Chief Financial Officer; Alexander Alimanestianu, Chief Development Officer and Randy Stephen, Chief Operating Officer. We believe the loss of such key personnel could have a material adverse effect on us and our financial performance. Currently, we do not have any long-term employment agreements with our executive officers, and we may not be able to attract and retain sufficient qualified personnel to meet our business needs. See “Management — Directors and Executive Officers.”

 We are subject to extensive government regulation and changes in these regulations could have a negative effect on our financial condition.

     Our operations and business practices are subject to federal, state and local government regulation in the various jurisdictions in which our clubs are located, including: (1) general rules and regulations of the Federal Trade Commission, state and local consumer protection agencies and state statutes that prescribe certain forms and provisions of membership contracts and that govern the advertising, sale, financing and collection of such memberships, (2) state and local health regulations, (3) federal regulation of health and nutritional supplements, and (4) regulation of rehabilitation service providers. Although we are not aware of any proposed changes in any statutes, rules or regulations, any changes in such laws could have a material adverse effect on our financial condition and results of operations. See “Business — Government Regulation.”

 The occurrence of extraordinary events, such as war in Iraq or elsewhere may increase the likelihood of a major terrorist attack in the United States, which may adversely affect our clubs, resulting in a decrease in our revenues.

     The United States is currently engaged in a military action in Iraq. Such military action may increase the likelihood of another major terrorist attack in the United States. Our geographic concentration in the major cities in the Northeast and Mid-Atlantic regions and, in particular, the New York and Washington, D.C. areas, heightens our exposure to such future terrorist attacks, which may adversely affect our clubs and result in a decrease in our revenues. Future terrorist attacks cannot be predicted, and their occurrence can be expected to further negatively affect the United States economy generally, and specifically the regional markets in which we operate.

 Our continued growth could place strains on our management, employees, information systems and internal controls which may adversely impact our business and the value of your investment.

     Over the past five years, we have experienced significant growth in our business activities and operations, including an increase in the number of our clubs. Our past expansion has placed, and any future expansion will place, significant demands on our administrative, operational, financial and other resources. Any failure to manage growth effectively could seriously harm our business. To be successful, we will need to continue to implement management information systems and improve our operating, administrative, financial and accounting systems and controls. We will also need to train new employees and maintain close coordination among our executive, accounting, finance, marketing, sales and operations functions. These processes are time-consuming and expensive, will increase management responsibilities and will divert management attention.

 The opening of new clubs in existing locations may negatively impact our same-center revenue increases and our operating margins.

     We currently operate centers throughout the Northeastern United States. We have committed to open 12 additional centers, three of which opened on February 1, 2005. Each of these 12 openings are in existing markets. With respect to existing markets, it has been our experience that opening new clubs may attract some memberships away from other centers already operated by us in those markets and diminish their revenues. In addition, as a result of new club openings in existing markets, and because older centers will represent an increasing proportion of our club base over time, our mature club revenue increases may be lower in future periods than in the past.

     Another result of opening new clubs is that our club operating margins may be lower than they have been historically while the clubs build membership base. We expect both the addition of pre-opening expenses and the lower revenue volumes characteristic of newly-opened clubs to affect our club operating margins at these new clubs.

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Inflation

     Although we cannot accurately anticipate the effect of inflation on our operations, we believe that inflation has not had, and is not likely in the foreseeable future to have, a material impact on our results of operations.

Seasonality of Business

     Seasonal trends have a limited effect on our overall business. Generally, we experience greater membership growth at the beginning of each year and experience an increased rate of membership attrition during the summer months. In addition, during the summer months, we experience a slight increase in operating expenses due to our outdoor pool and summer camp operations, matched by seasonal revenue recognition from seasonal pool memberships and camp revenue.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

     We do not believe that we have any significant risk related to interest rate fluctuations since we currently only carry fixed-rate debt. We invest our excess cash in highly liquid short-term investments. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our cash equivalents and, therefore impact our cash flows and results of operations. If short-term interest rates were to have increased by 100 basis points during 2004, our interest income from cash equivalents would have increased by approximately $600,000. These amounts are determined by considering the impact of the hypothetical interest rates on our cash equivalents balance during 2004.

Item 8.Financial Statements and Supplementary Data

          The Registrant’s Financial Statements are listed in the index appearing under item 15.

Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

          None

Item 9A. Controls and Procedures

          (a) At the end of the period, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chairman, Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 and 15d-15). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2004 the Company’s disclosure controls and procedures were effective ensuring that material information was properly disclosed by the Company in the reports filed or submitted by the Company under the Exchange Act..

          (b) There have been no changes in the Company’s internal controls over financial reporting during the year ended December 31, 2004 that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

Item 9B. Other Information

          Not Applicable

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PART III

Item 10. Directors, Executive Officers and Key Employees of the Registrant

     The following table sets forth the names, ages and a brief account of the business experience of each person who is a director or executive officer of Town Sports.

     Mark Smith joined us in 1985 and has served as Chief Executive Officer from 1995 to 2001 and became Chairman in January 2002. Prior to these appointments, he held the position of Executive Vice President of Development and International Operations. Mr. Smith has also served as a director since September 1995. He was appointed to the Board of the International Health, Racquet and Sportsclub Association (the club industry trade association) in 2001. Before joining us, Mr. Smith was a chartered accountant with Coopers & Lybrand in New York City, London and New Zealand, and a professional squash player.

     Robert Giardina joined us in 1981 and has served as President and Chief Operating Officer from 1992 to 2001, and became Chief Executive Officer in January 2002. With over 30 years of experience in the club industry, Mr. Giardina has expertise in virtually every aspect of facility management and club operations. In addition to operations, Mr. Giardina has primary responsibility for sales and marketing.

     Alexander Alimanestianu joined us in 1990 and became Executive Vice President, Development in 1995 and Chief Development Officer in January 2002. From 1990 to 1995, Mr. Alimanestianu served as Vice President and Senior Vice President. Before joining us, he worked as a corporate attorney for six years with one of our outside law firms. Mr. Alimanestianu has been involved in the development or acquisition of over 100 of our clubs.

     Richard Pyle, a British chartered accountant, joined us in 1987 and has been chiefly responsible for our financial matters since that time, as a Vice President in 1988, Senior Vice President and Chief Financial Officer in 1992 and Executive Vice President and Chief Financial Officer in 1995, successively. Before joining us, Mr. Pyle worked in public accounting (in the United States, Bermuda, Spain and England) specializing in the hospitality industry, and as the corporate controller for a British public company in the leisure industry.

     Randy Stephen joined us in 2002 as Chief Operating Officer. Prior to joining us and since 1987, Mr. Stephen held various positions with Circuit City Stores, including Director of Human Resources and General Manager. In 1995, he was appointed Circuit City Stores’ Vice President, Corporate Operations, focusing on marketing, promotions and business process re-engineering and in 1996 he became the Northeast Division President. Prior to 1987, Mr. Stephen worked with several premier retailers including Eastern Mountain Sports, Eddie Bauer, Keeger & Sons and Britches of Georgetown.

     Keith E. Alessi has served as a director of Town Sports since April 1997 and is currently serving pursuant to the stockholder’s agreement. Mr. Alessi is an adjunct professor of Law at Washington and Lee University School of Law. Mr. Alessi served as President, Chief Executive Officer and a director of Telespectrum Worldwide, Inc. from March 1998 to April 2000. From May 1996 to March 1998, Mr. Alessi served as Chairman, President and Chief Executive Officer of Jackson Hewitt, Inc.

     Paul Arnold has served as a director of Town Sports since April 1997 and is currently serving pursuant to the stockholder’s agreement. Mr. Arnold has served as Chairman and Chief Executive Officer of Cort Business Services, Inc., a Berkshire Hathaway Company, since 2000. From 1992 to 2000, Mr. Arnold served as President, Chief Executive Officer and Director of Cort Business Services. Prior to 1992, Mr. Arnold held various positions over a 24 year period within Cort Furniture Rental, a division of Mohasco Industries. Mr. Arnold is currently a Director of Relocation Central Corp. and Penhall International, Inc.

     Bruce Bruckmann has served as a director of Town Sports since December 1996 and is currently serving as a director designated by BRS pursuant to the stockholder’s agreement. Since 1994, Mr. Bruckmann has served as Managing Director of BRS. From 1983

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until 1994, Mr. Bruckmann served as an officer and subsequently a Managing Director of Citicorp Venture Capital, Ltd. Mr. Bruckmann is currently a director of Mohawk Industries, Inc., H&E Equipment Services L.L.C. and Anvil Knitwear, Inc. and several private companies.

     J. Rice Edmonds has served as a director of Town Sports since July 2002 and is currently serving as a director designated by BRS pursuant to the stockholder’s agreement. Mr. Edmonds is a Principal of BRS. Prior to joining BRS in 1996, Mr. Edmonds worked in the high yield finance group of Bankers Trust. Mr. Edmonds is currently a director of H&E Equipment Services L.L.C., Real Mex Restaurants, Inc., McCormick & Schmick Restaurant Corporation, The Sheridan Group, Inc., Penhall International, Inc. and several other private companies.

     Jason Fish has been a director of Town Sports since December 1996 and is currently serving as a director designated by the Farallon Entities pursuant to the stockholder’s agreement. Mr. Fish is a co-founder and President of CapitalSource Inc., and a member of CapitalSource’s board of directors, a position he has held since September 2000. Prior to founding CapitalSource, Mr. Fish was employed from 1990 to 2000 by Farallon Capital Management, L.L.C., serving as a managing member from 1992 to 2000. Before joining Farallon, Mr. Fish worked at Lehman Brothers Inc., where he was a Senior Vice President responsible for its financial institution investment banking coverage on the West Coast.

Code of Ethics

     The Company has adopted a written Code of Ethics and Business Conduct, which applies to all officers, directors and employees, including our principal executive officer, principal financial officer and principal accounting officer or controller. Interested persons may obtain a copy of our Code of Ethics and Business Conduct without charge by writing to Town Sports International, Holdings Inc., Attention: Robert Herbst, Vice President and General Counsel, 888 Seventh Avenue, New York, New York 10106.

Audit Committee

     The Audit Committee of the Board of Directors is comprised of three directors, who are all financially literate. Keith Alessi is an “audit committee financial expert” within the meaning of the regulations of the Securities and Exchange Commission.

Item 11. Executive Compensation

     The following table summarizes the compensation paid to or earned for all services rendered to us in all capacities during 2004, 2003 and 2002 by our Chief Executive Officer and the other four highest compensated executive officers. The table below includes compensation paid by TSI Holdings, Inc. and its predecessor, TSI, Inc., for services rendered on our behalf. We refer to the officers listed in the following table in this Form 10-K as our named executive officers.

Summary Compensation Table

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Option/SAR Grants During the Year Ended December 31, 2004

     In 2004, and in connection with the Transactions, common stock options previously granted to key management in TSI, Inc. were remitted to TSI Holdings, Inc. In addition, certain unvested common stock options were repriced to reflect the diminution in value associated with the common stock distribution of $52.50 per share made on March 17th, as set forth below:

     In addition, formula-based vesting targets were amended to reflect the pro forma effects of the Transactions on TSI Holdings. This amendment similarly affected all holders of unvested common stock options. All other terms and conditions, including term, vesting periods, etc., of the existing common stock options remained unchanged in the restated option agreements.

Aggregated Option/SAR Exercises During the Year Ended December 31, 2004 and 2004 Year-End Option/SAR Values

     The following summarizes exercises of stock options by the named executive officers during the year ended December 31, 2004 as well as the number and value of all unexercised options held by the named executive officers as of December 31, 2004.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information with respect to compensation plans (including individual compensation arrangements) under which equity securities of the Company are authorized for issuance to employees as of December 31, 2004:

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Town Sports International Holdings, Inc. Stock Option Plan

     Our board of directors has adopted a stock option plan, which provides for the grant to our key employees and/or directors of stock options. The compensation committee of our board of directors administers the stock option plan. The compensation committee has broad powers under the stock option plan, including exclusive authority (except as otherwise provided in the stock option plan) to determine:

	(1)	who will receive awards,
	(2)	the type, size and terms of awards,
	(3)	the time when awards will be granted, and
	(4)	vesting criteria, if any, of the awards.

     If we undergo a re-organization, recapitalization, stock dividend or stock split or other change in shares of our common stock, the compensation committee may make adjustments to the plan in order to prevent dilution of outstanding options. The compensation committee may also cause options awarded under the plan to become immediately exercisable if we undergo specific types of changes in the control of our company.

Compensation of Directors

Our two independent directors receive $3,000 for attending board of director meetings in person and $1,000 when attending telephonically. When our Audit or Compensation Committees meet, our independent directors receive $1,000 when attending in person and $500 when attending telephonically on days when there is no board meeting.

     We reimburse directors for any out-of-pocket expenses incurred by them in connection with services provided in such capacity.

Compensation Committee Interlocks and Insider Participation

     The current members of our compensation committee are Bruce Bruckmann, Paul Arnold and Mark Smith. Bruce Bruckmann and Paul Arnold are non-employee directors.

Management Equity Agreements

     We have entered into executive stock agreements with our named executive officers. Pursuant to these executive stock agreements, our named executive officers each have purchased shares of our common stock at a purchase price of $1.00 per share of common stock. In addition, our named executive officers have acquired options to purchase shares of our common stock.

     These agreements contain no minimum purchase requirements. Upon termination of the employment by the Company of those named executive officers, the Company, BRS and the Farallon Entities have a right, but not an obligation, to repurchase all of the shares of stock then held by such terminated named executive officer for fair market value. Fair market value is determined based on the price of publicly traded shares or, if the shares are not publicly traded, then on a formula based on TSI Holding’s earnings over the previous four fiscal quarters, and its capitalization for the quarter most recently ended. The named executive officers do not have a right or obligation under the executive stock agreements to purchase additional shares of TSI Holdings.

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     The table below sets out the number of shares of our common stock purchased by each of our named executive officers pursuant to their respective executive stock purchase agreement and which would be subject to repurchase by the Company at the termination of their employment, as well as the total number of shares that each named executive may be able to purchase pursuant to the options granted under the executive stock purchase agreements.

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Our Benefit Plans

     We maintain a 401(k) defined contribution plan and are subject to the provisions of the Employee Retirement Income Security Act of 1974 (“ERISA”). The Plan provides for us to make discretionary contributions; however, we elected not to make contributions for the year ended December 31, 2000. The Plan was amended, effective January 1, 2001, to provide for an employer matching contribution in an amount equal to 25% of the participant’s contribution with a limit of $500 per annum. In February 2003, 2004 and 2005, employer matching contributions totaling $200,000, $195,000 and $191,000, respectively, were made for the Plan years ended December 31, 2002, 2003 and 2004.

Item 12. Security Ownership of Certain Beneficial Owners and Management

     The following table sets forth (as of March 1, 2005) certain information with respect to the beneficial ownership of the common stock by: (i) each person or entity who owns of record or beneficially more than 5% or more of any class of our voting securities; (ii) each named executive officer and director of TSI Holdings; and (iii) all directors and executive officers as a group.

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     Excluding the shares beneficially owned by BRS and CapitalSource, the directors and named executive officers as a group beneficially own 517,689 shares of common stock (which represents approximately 39.3% of the common stock on a fully diluted basis).

Item 13. Certain Relationships and Related Transactions

Restructuring Agreement

     In connection with the Transactions, the TSI, Inc. equity holders, TSI Holdings and TSI, Inc. entered into a restructuring agreement, dated February 4, 2004, whereby the TSI, Inc. equity holders contributed all their equity holdings in TSI, Inc. to TSI Holdings in exchange for equity shares of TSI Holdings on the same terms and in the same proportions as they held in TSI, Inc.

Stockholders Agreement

     In connection with the transactions and the restructuring TSI Holdings, TSI, Inc., BRS, the Farallon Entities, the Canterbury Entities, Rosewood Capital, L.P., Rosewood Capital IV, L.P., Rosewood Capital IV Associates, L.P., CapitalSource Holdings LLC, Keith Alessi, Paul Arnold, and certain stockholders of the Company listed on the Executive Signature Pages thereto, or the TSI Holdings equity holders, entered into a stockholders’ agreement dated February 4, 2004. Pursuant to the stockholders agreement, the TSI Holdings equity holders agreed to terminate the existing stockholders agreement between the TSI, Inc. equity holders and TSI, Inc. and to vote to fill the six positions on the Board of Directors of TSI Holdings so that, as of the date of the stockholders agreement, it consists of the following:

	•	Two members designated by BRS currently, Bruce Bruckmann and J. Rice Edmonds;
	•	One member designated by the Farallon Entities currently, Jason Fish;
	•	Mark Smith (for so long as he is the Chairman of TSI Holdings); and
	•	Two members designated by holders of the Class A Common Stock of TSI Holdings currently, Keith E. Alessi and Paul Arnold.

     Pursuant to the stockholder’s agreement, BRS will have the right to designate two directors for as long as it holds approximately 4% of the common stock of TSI Holdings and the Farallon Entities will have the right to designate one director as long as it holds approximately 2% of the common stock of TSI Holdings.

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     Each party to the stockholders agreement has the right, subject to certain exceptions, to purchase its pro rata portion of any shares of stock that TSI Holdings issues in the future. Furthermore, the stockholders agreement provides that TSI Holdings will have a right of first refusal to purchase all or a part of any shares of stock proposed to be transferred by any certain stockholder. To the extent Holdings does not exercise this right, BRS and the Farallon Entities would have the right to purchase such shares. If BRS proposes to transfer any shares of stock, the other stockholders could elect to participate in such transfer on a pro rata basis. Finally, in the event of a sale by BRS of its interest of TSI Holdings to an unaffiliated third party, each stockholder will be obligated to sell their shares in connection with such transaction.

Registration Rights Agreement

     In connection with the transactions and the restructuring agreement, TSI Holdings, TSI, Inc. and the TSI Holdings equity holders, agreed to terminate the existing registration rights agreements among the TSI, Inc. equity holders and TSI, Inc. and entered into a new registration rights agreement dated February 4, 2004. Pursuant to the terms of the registration rights agreement, BRS, the Farallon Entities and the Canterbury Entities have the right to require TSI Holdings, at its expense and subject to certain limitations, to register under the Securities Act all or part of the shares of common stock (the “Registrable Securities”) held by them. BRS is entitled to demand up to three long-form registrations at any time and unlimited short-form registrations. Farallon is entitled to demand one long-form registration (but only one year after we have consummated an initial registered public offering of our common stock) and up to three short-form registrations. The Canterbury Entities are entitled to demand up to two short-form registrations. CapitalSource is entitled to demand one short-form registration.

     All holders of Registrable Securities are entitled to an unlimited number of “piggyback” registrations, with TSI Holdings paying all expenses of the offering, whenever TSI Holdings propose to register its common stock under the Securities Act. Each such holder is subject to certain pro rata limitations on its ability to participate in such a “piggyback” registration. In addition, pursuant to the registration rights agreement, TSI Holdings have agreed to indemnify all holders of Registrable Securities against certain liabilities, including certain liabilities under the Securities Act.

Professional Services Agreement

     In connection with our recapitalization in 1996, Bruckmann, Rosser, Sherrill & Co., Inc. (“BRS Co.”), an affiliate of BRS, and TSI Holdings and its predecessor TSI, Inc. entered into a Professional Services Agreement, whereby BRS Co. agreed to provide us certain strategic and financial consulting services. In exchange for such services, BRS Co. receives an annual fee of $250,000 per calendar year while it owns, directly or indirectly, at least 3.66% of our outstanding common stock.

Related Party Transactions

     We believe that the transactions set forth below were on terms no less favorable than we could have obtained from unaffiliated third parties. We intend that all future transactions between us and our officers, directors, principal shareholders and their affiliates will be approved by a majority of our independent and disinterested directors, and will be on terms no less favorable to us than we could obtain from unaffiliated third parties.

     We paid approximately $904,000 in 2002, $848,000 in 2003 and $862,000 in 2004 to an entity of which Mr. Frank Napolitano, one of our officers, is currently a 25% owner, for rent for a multi-recreational club facility that we acquired in 1999. We expect to pay $690,000 in annual base rent and a pro rata share of operating expenses and property taxes on the facility during the term of the lease, which expires in 2015. Pursuant to the lease, we are also obligated to pay percentage rent based upon the revenue of the facility in the future.

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Item 14. Principal Accountant Fees and Services

     Town Sports International Holdings, Inc. was billed for the following services provided by PricewaterhouseCoopers LLP, the company’s Independent Registered Public Accounting Firm during December 31, 2003 and 2004: