As Filed Pursuant to Rule 424(b)(3)
Registration No. 333-114210
PROSPECTUS DATED AUGUST 13, 2004
TOWN SPORTS INTERNATIONAL HOLDINGS, INC.
$213,000,000
EXCHANGE OFFER FOR
11% SENIOR DISCOUNT NOTES DUE 2014
Offer for all outstanding 11% Senior Discount Notes due 2014 (which we refer to
as the "Old Notes") in aggregate principal amount at maturity of $213,000,000 in
exchange for up to $213,000,000 aggregate principal amount at maturity of 11%
Senior Discount Notes due 2014 (which we refer to as the "New Notes") have been
registered under the Securities Act of 1933, as amended.
MATERIAL TERMS OF EXCHANGE OFFER:
- This exchange offers expires at 5:00 p.m., New York City time on September 14,
2004, unless we extend this date.
- We will not receive any proceeds from the exchange offer.
- We can amend or terminate the exchange offer.
MATERIAL TERMS OF NEW NOTES:
- The New Notes will be unsecured senior obligations and will rank senior to all
of our existing and future subordinated debt and pari passu to all of our
existing and future senior debt. The New Notes will be effectively
subordinated to our existing and future secured debt.
- The New Notes are not guaranteed by any of our subsidiaries and will be
structurally subordinated and effectively rank junior to all indebtedness of
our subsidiaries which was $260.9 million as of March 31, 2004. In addition,
our subsidiaries may incur additional debt, which such debt will also,
effectively, rank senior to the New Notes.
- Our ability to make payments on the New Notes is dependent on the earning and
distribution of funds from our subsidiaries and none of our subsidiaries are
obligated to make funds available to us for payment on the New Notes.
- We may redeem the New Notes at any time on or after February 1, 2009. In
addition, at any time prior to February 1, 2007, we may redeem up to 35% of
the New Notes with proceeds of certain equity offerings.
- The terms of the New Notes to be issued in the exchange offer are
substantially identical to the currently outstanding notes, or Old Notes,
except that the transfer restrictions and registration rights relating to the
Old Notes will not apply to the New Notes.
- There is no existing public market for the Old Notes or the New Notes.
FOR A DISCUSSION OF CERTAIN FACTORS THAT YOU SHOULD CONSIDER BEFORE
PARTICIPATING IN THIS EXCHANGE OFFER, SEE "RISK FACTORS" BEGINNING ON PAGE 12 OF
THIS PROSPECTUS.
EACH BROKER-DEALER THAT RECEIVES NEW NOTES PURSUANT TO THE EXCHANGE OFFER MUST
ACKNOWLEDGE THAT IT WILL DELIVER A PROSPECTUS IN CONNECTION WITH ANY RESALE OF
THE NEW NOTES. IF THE BROKER-DEALER ACQUIRED THE OLD NOTES AS A RESULT OF MARKET
MAKING OR OTHER TRADING ACTIVITIES, SUCH BROKER-DEALER MAY USE THE PROSPECTUS
FOR THE EXCHANGE OFFER, AS SUPPLEMENTED OR AMENDED, IN CONNECTION WITH THE
RESALES OF THE NEW NOTES.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THE NEW NOTES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
TABLE OF CONTENTS
PAGE
----
Prospectus Summary................... 1
Risk Factors......................... 12
Disclosure Regarding Forward-Looking
Statements......................... 21
Industry and Market Data............. 21
The Exchange Offer................... 22
Transactions......................... 31
Use of Proceeds...................... 32
Capitalization....................... 33
Selected Consolidated Financial and
Other Data......................... 34
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 37
Business............................. 55
PAGE
----
Management........................... 71
Security Ownership and Certain
Beneficial Owners.................. 76
Certain Relationships and Related
Transactions....................... 78
Description of Other Indebtedness.... 80
Description of Exchange Notes........ 83
Certain Material United States
Federal Income Tax
Considerations..................... 118
Plan of Distribution.................
Legal Matters........................ 118
Experts.............................. 118
Available Information................ 119
Index to Financial Statements........ F-1
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS
ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF
DELIVERY OF THIS PROSPECTUS OR OF ANY SALE OF OUR 11% SENIOR DISCOUNT NOTES DUE
2014.
EACH BROKER-DEALER THAT RECEIVES NEW SECURITIES FOR ITS OWN ACCOUNT
PURSUANT TO THE EXCHANGE OFFER MUST ACKNOWLEDGE THAT IT WILL DELIVER A
PROSPECTUS IN CONNECTION WITH ANY RESALE OF THESE NEW SECURITIES. BY SO
ACKNOWLEDGING AND BY DELIVERING A PROSPECTUS, A BROKER-DEALER WILL NOT BE DEEMED
TO ADMIT THAT IT IS AN "UNDERWRITER" WITHIN THE MEANING OF THE SECURITIES ACT.
THIS PROSPECTUS, AS IT MAY BE AMENDED OR SUPPLEMENTED FROM TIME TO TIME, MAY BE
USED BY A BROKER-DEALER IN CONNECTION WITH RESALES OF NEW SECURITIES RECEIVED IN
EXCHANGE FOR SECURITIES WHERE THOSE SECURITIES WERE ACQUIRED BY THIS BROKER-
DEALER AS A RESULT OF MARKET-MAKING ACTIVITIES OR OTHER TRADING ACTIVITIES. WE
HAVE AGREED THAT, STARTING ON THE EXPIRATION DATE AND ENDING ON THE CLOSE OF
BUSINESS 180 DAYS AFTER THE EXPIRATION DATE, WE WILL MAKE THIS PROSPECTUS
AVAILABLE TO ANY BROKER-DEALER FOR USE IN CONNECTION WITH ANY SUCH RESALE.
i
PROSPECTUS SUMMARY
The following summary contains basic information about us and the
prospectus. It likely does not contain all the information that is important to
you. Because it is a summary, it does not contain all the information that you
should consider before tendering your Old Notes. We encourage you to read this
entire document and the documents we have referred you to. As used herein, "Town
Sports," the "Company," "we," "us," and "our" refer to Town Sports International
Holdings, Inc. ("TSI Holdings") and its subsidiaries and "TSI, Inc." refers to
Town Sports International, Inc. TSI Holdings is a holding company with no
material assets or operations other than its ownership of the common stock of
TSI, Inc., and was formed to serve as the issuer of the Old Notes.
TSI Holdings was legally formed in February 2004. On February 4, 2004, all
equity holders of TSI, Inc. contributed their shares of equity in TSI, Inc. to
TSI Holdings in exchange for an equal pro rata share of equity in TSI Holdings.
TSI, Inc. is the predecessor company of TSI Holdings. As such, all prior year
amounts shown in the Summary Historical and Other Financial Data, Selected
Consolidated Financial and Other Data, Management's Discussion and Analysis and
financial statements have been changed from TSI, Inc. to TSI Holdings, to
reflect the reorganization under common control.
OUR COMPANY
We are one of the two leading owners and operators of fitness clubs in the
Northeast and Mid-Atlantic regions of the United States and the third largest
fitness club operator in the United States, as measured by number of clubs. As
of March 31, 2004, we operated 132 clubs that collectively served approximately
365,000 members. Our goal is to provide the premier health club network in each
of the major metropolitan regions we serve. To optimize convenience to our
members, we cluster clubs near the highest concentrations of our target members'
areas of both employment and residence. Our clusters of clubs serve densely
populated major metropolitan regions in which a high percentage of the
population commutes to work. Our target member is college-educated, typically
between the ages of 21 and 50 and earns an annual income of between $50,000 and
$150,000. Our revenues, operating income and cash flows from operations for the
year ended December 31, 2003 were $342.5 million, $44.0 million and $58.3
million, respectively.
We are the largest fitness club operator in Manhattan with 36 locations
(more than twice as large as our nearest competitor) and have a total of 87
clubs under the New York Sports Clubs ("NYSC") brand name within a 50 mile
radius of New York City. We operate 20 clubs in the Boston region and 16 clubs
in the Washington, D.C. 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 local network of quality fitness clubs rather than a national
chain.
Over our 30-year operating history, we have developed and refined a model
club format that allows us to cost effectively construct and efficiently operate
our fitness clubs. Our model club ranges in size from approximately 15,000 to
25,000 square feet and features a wide variety of state-of-the-art
cardiovascular and strength-training equipment, as well as exercise studios
offering extensive group fitness programs. Some clubs also feature additional
amenities, including swimming pools, squash or tennis courts and physical
therapy centers. Our locker rooms generally include a sauna and steam room. We
offer members a variety of other value-added services for which we receive
additional fees, including personal training, Group Exclusives, massage and
Sports Club for Kids.
1
THE TRANSACTIONS
TSI Holdings was formed to serve as issuer of the Old Notes. Pursuant to a
restructuring agreement, all the stockholders of TSI, Inc. contributed, in
aggregate, their 153,637 shares of Series A Preferred Stock, 109,540 shares of
Series B Preferred Stock and 1,247,673 shares of Class A Common Stock of TSI,
Inc. to TSI Holdings in exchange for a pro rata equal amount of shares of Series
A Preferred Stock, Series B Preferred Stock and Class A Common Stock of TSI
Holdings.
In connection with the issuance of the Old Notes we redeemed the preferred
stock of TSI Holdings and paid a shareholder dividend to holders of the common
stock of TSI Holdings. On February 6, 2004 we redeemed all outstanding shares of
our Series A Preferred Stock for $40,516,014 in aggregate and all outstanding
shares of our Series B Preferred Stock for $10,117,799 in aggregate for a total
of approximately $50,633,813.
On March 15, 2004 the Board of Directors of TSI Holdings approved a common
stock dividend of $52.50 per share to all shareholders of record on March 15,
2004 for a total of $68,930,888. This dividend was paid on March 17, 2004.
We refer to these transactions, collectively, as the "transactions."
Our corporate structure immediately following the transactions is as
follows:
[FLOW CHART]
Our company is incorporated under the laws of the State of Delaware. Our
principal executive offices are located at 888 Seventh Avenue, New York, New
York 10106. Our telephone number is (212) 246-6700. We maintain the following
web site: www.mysportsclubs.com that provides information about club locations,
program offerings and on-line promotions. Information contained on this web
site, however, is not incorporated into or otherwise a part of this prospectus.
PURPOSE OF THE EXCHANGE OFFER
On February 4, 2004, we sold, through a private placement exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) of the
Securities Act,
2
$213,000,000 of aggregate principal amount at maturity of our 11% Senior
Discount Notes due 2014. We refer to these notes as "Old Notes" in this
prospectus.
Simultaneously with the private placement, we entered into a registration
rights agreement with the initial purchaser of the Old Notes. Under the
registration rights agreement, we are required to use our best efforts to cause
a registration statement for substantially identical Notes, which will be issued
in exchange for the Old Notes, to become effective on or within 210 days of
issuance of the Old Notes. We refer to the notes to be registered under this
exchange offer registration statement as "New Notes" and collectively with the
Old Notes, we refer to them as the "Notes" in this prospectus. You may exchange
your Old Notes for New Notes in this exchange offer. You should read the
discussion under the headings "-- Summary of the Exchange Offer," "The Exchange
Offer" and "Description of the New Notes" for further information regarding the
New Notes.
We did not register the Old Notes under the Securities Act or any state
securities law, nor do we intend to after the exchange offer. As a result, the
Old Notes may only be transferred in limited circumstances under the securities
laws. If the holders of the Old Notes do not exchange their Old Notes in the
exchange offer, they lose their right to have the Old Notes registered under the
Securities Act, subject to certain limitations. Anyone who still holds Old Notes
after the exchange offer may be unable to resell their Old Notes.
3
SUMMARY OF THE EXCHANGE OFFER
The Initial Offering of Old
Notes........................... We sold the Old Notes on February 4, 2004 to
Deutsche Bank Securities. We refer to
Deutsche Bank Securities in this prospectus
as the "initial purchaser." The initial
purchaser subsequently resold the Old Notes
to (1) qualified institutional buyers
pursuant to Rule 144A under the Securities
Act and (2) outside the United States in
accordance with Regulation S under the
Securities Act.
Registration Rights Agreement... Simultaneously with the initial sale of the
outstanding securities, we entered into a
registration rights agreement for the
exchange offer. In the registration rights
agreement, we agreed, among other things,
(i) to file a registration statement with
the SEC as soon as practicable after the
issuance of the Old Notes, but in no event
later than 120 days after the issuance of
the Old Notes and (ii) to use our reasonable
best efforts to cause such registration
statement to be declared effective by the
SEC at the earliest possible time, but in no
event later than 210 days after the issuance
of the Old Notes. We also agreed to use our
reasonable best efforts to cause the
exchange offer to be consummated on the
earliest practicable day after the
registration statement is declared
effective, but in no event later than 30
days after the exchange registration
statement is declared effective, unless
required by the Securities Act or the
Exchange Act. The exchange offer is intended
to satisfy our obligations under the
registration rights agreement. After the
exchange offer is complete, you will no
longer be entitled to any exchange or
registration rights with respect to your Old
Notes.
The Exchange Offer.............. We are offering the exchange Notes, which
are being registered under the Securities
Act, in exchange for your Old Notes. This
offer is open only to holders who acquired
Old Notes pursuant to Rule 144A. The Old
Notes may be exchanged in multiples of
$1,000. To be exchanged, an Old Note must be
properly tendered and accepted. All Old
Notes that are validly tendered and not
validly withdrawn will be exchanged. We will
issue New Notes promptly after the
expiration of the exchange offer. See "The
Exchange Offer" for more information.
Resales......................... We believe that the New Notes issued in the
exchange offer may be offered for resale,
resold and otherwise transferred by you
without compliance with the registration and
prospectus delivery provisions of the
Securities Act provided that:
- the New Notes are being acquired in
the ordinary course of your business;
4
- you are not participating, do not
intend to participate, and have no
arrangement or understanding with any
person to participate, in the
distribution of the New Notes issued
to you in the exchange offer;
- you are not an affiliate of ours; and
- you are not a broker-dealer.
If any of these conditions are not satisfied
and you transfer any New Notes issued to you
in the exchange offer without delivering a
prospectus meeting the requirements of the
Securities Act or without an exemption from
registration of your New Notes from these
requirements, you may incur liability under
the Securities Act. We will not assume, nor
will we indemnify you against, any such
liability.
Each broker-dealer that is issued New Notes
in the exchange offer for its own account in
exchange for Old Notes that were acquired by
that broker-dealer as a result of
market-making or other trading activities,
must acknowledge that it will deliver a
prospectus meeting the requirements of the
Securities Act in connection with any resale
of the New Notes. A broker-dealer may use
this prospectus for an offer to resell,
resale or other retransfer of the New Notes
issued to it in the exchange offer.
Expiration Date................. The exchange offer will remain open for at
least 20 full business days and will expire
at 5:00 p.m., New York City time, on
September 14, 2004, unless we decide to
extend the expiration date.
Conditions to the Exchange
Offer........................... The exchange offer is not subject to any
conditions other than that the exchange
offer not violate applicable law or any
applicable interpretation of the staff of
the SEC, that no proceedings have been
instituted or threatened against us which
would impair our ability to proceed with the
exchange offer, and that we have received
all necessary governmental approvals to
proceed with the exchange offer.
Procedures for Tendering Old
Notes........................... We issued the Old Notes as global
securities. When the Old Notes were issued,
we deposited the global securities
representing the Old Notes with The Bank of
New York, as custodian for the Depository
Trust Company, known as DTC, acting as
book-entry depositary. The Bank of New York
issued a certificateless depositary interest
in each global security we deposited with
it, which together represent a 100% interest
in the Old Notes, to DTC. Beneficial
interests in the Old Notes, which are held
by direct or indirect participants in DTC
through the certificateless depositary
interests, are shown on records maintained
in book-entry form by DTC.
5
You may tender your Old Notes through
book-entry transfer in accordance with DTC's
Automated Tender Offer Program, known as
ATOP. When tendering your Old Notes you will
have to make the representations set forth
under "The Exchange Offer -- Procedures for
Tendering Old Notes Held through Brokers and
Banks." Old Notes may be tendered only in
multiples of $1,000 principal amount.
If you are the beneficial owner of
book-entry interests and your name does not
appear on a security position listing of DTC
as the holder of the book-entry interests or
if you are a beneficial owner of Old Notes
that are registered in the name of a broker,
dealer, commercial bank, trust company or
other nominee and you wish to tender the
book-entry interests or Old Notes in the
exchange offer, you should contact the
person in whose name your book-entry
interests or Old Notes are registered
promptly and instruct that person to tender
on your behalf.
A timely confirmation of book-entry transfer
of your outstanding Old Notes into the
exchange agents' account at the DTC, under
the procedures described in this prospectus
under the heading "The Exchange Offer" must
be received by the exchange agent on or
before 5:00 p.m., New York City time, on the
expiration date.
Withdrawal Rights............... You may withdraw the tender of your Old
Notes at any time prior to 5:00 p.m., New
York City time on September 14, 2004, or a
later time if we choose to extend this
exchange offer. Any Old Notes not accepted
by us for exchange for any reason will be
returned to you at our expense promptly
after the expiration or termination of the
exchange offer.
Federal Income Tax
Considerations.................. The exchange of Old Notes will not be a
taxable event for United States federal
income tax purposes. See "Certain United
States Federal Income Tax Considerations."
Use of Proceeds................. We will not receive any proceeds from the
issuance of the New Notes pursuant to the
exchange offer. We will pay all of our
expenses incident to the exchange offer.
Exchange Agent.................. The Bank of New York is serving as the
exchange agent in connection with the
exchange offer.
6
THE NEW NOTES
The form and terms of the New Notes are the same as the form and terms of
the Old Notes, except that the New Notes will be registered under the Securities
Act. As a result, the New Notes will not bear legends restricting their transfer
and will not contain the registration rights and liquidated damage provisions
contained in the Old Notes. The New Notes represent the same debt as the Old
Notes. The Old Notes and the New Notes are governed by the same indenture and
are together considered a "series" of securities under that indenture.
Issuer........................ Town Sports International Holdings, Inc.
The New Notes................. $213,000,000 principal amount at maturity of
11.00% Senior Discount Notes due 2014.
Maturity...................... February 1, 2014.
Interest...................... Prior to February 1, 2009, interest will accrue
on the Notes in the form of an increase in the
accreted value of such Notes. Thereafter, cash
interest on the Notes will accrue and be
payable semiannually in arrears on February 1
and August 1 of each year, commencing on August
1, 2009, at a rate of 11% per annum. The Old
Notes had an initial accreted value of $585.95
per $1,000 principal amount at maturity of the
Notes. The accreted value of each Note will
increase from the date of issuance until
February 1, 2009 at a rate of 11% per annum
compounded semi-annually, reflecting the
accrual of non-cash interest, such that on
February 1, 2009 the accreted value will equal
the principal amount at maturity. See the
definition of "Accreted Value" in "Description
of New Notes -- Certain Definitions" for an
explanation on how the accreted value of the
Notes will change over time.
Original Issue Discount....... Because the Old Notes were issued at a
substantial discount from their principal
amount, the New Notes should be treated as
being issued with substantial original issue
discount for United States federal income tax
purposes. Thus, although cash interest will not
be payable on the Notes prior to August 1,
2009, interest will accrue from the issue date
of the Notes based on the yield to maturity of
the Notes and will generally be included as
interest income (including for periods ending
prior to February 1, 2009) for U.S. federal
income tax purposes in advance of receipt of
the cash payments to which income is
attributable. See "Certain United States
Federal Income Tax Considerations."
Denominations................. $1,000 minimum and $1,000 integral multiples
thereof.
Ranking....................... The Notes will be our unsecured senior
obligations and will rank senior to all of our
existing and future subordinated debt and pari
passu to all of our existing and future senior
debt. The Notes will effectively rank junior to
any of our secured debt to the extent of the
value of the assets securing that debt. The
Notes are structurally subordinated and
effectively rank junior to any debt of TSI,
Inc. As of March 31, 2004, TSI, Inc. had $260.9
million of debt outstanding, excluding
approximately $37.9 million of
7
unutilized borrowings that, subject to certain
limitations, we had available to borrow under
our senior secured revolving credit facility.
Optional Redemption........... We may redeem any of the Notes at any time on
or after February 1, 2009, in whole or in part,
in cash at the redemption prices described in
this prospectus, plus accrued and unpaid
interest and additional interest, if any, to
the date of redemption.
In addition, before February 1, 2007, we may
redeem up to 35% of the aggregate principal
amount at maturity of Notes with the net
proceeds of certain public equity offerings of
TSI Holdings. We may make that redemption only
if, after the redemption, at least 65% of the
aggregate principal amount of Notes remains
outstanding. See "Description of New
Notes -- Optional Redemption."
Mandatory Redemption.......... The New Notes will not be entitled to the
benefit of any mandatory sinking fund.
Change of Control............. Upon a change of control, we will be required
to make an offer to purchase each holder's
Notes at a price equal to 101% of the principal
amount at maturity thereof, plus accrued and
unpaid interest and additional interest, if
any, to the date of purchase. See "Description
of New Notes -- Repurchase at the Option of
Holders -- Change of Control" and "Description
of the New Notes -- Certain
Definitions -- "Change of Control." In
addition, a change of control would constitute
an event of default under TSI, Inc.'s senior
secured revolving credit facility as well as
under the indenture governing TSI, Inc.'s
Senior Notes due 2011. In such an event, the
holders of such debt have the option to
accelerate the payment of such debt. Currently,
TSI, Inc. has no outstanding borrowings under
the senior secured revolving credit facility
and $255 million of Senior Notes due 2011.
Events that could trigger a change of control
include, but are not limited to a:
- liquidation;
- sale of all or substantially all of our
stock; and
- sale of all or substantially all of our
assets.
Asset Sales................... Generally, if we or our subsidiaries, engage in
asset sales, we may be obligated to first
prepay amounts under TSI, Inc.'s senior secured
revolving credit facility and then make an
offer to redeem debt that is ranked pari passu,
including the Notes on a pro rata basis among
holders of such debt.
Covenants..................... The indenture governing the New Notes limits
what we (and most or all of our subsidiaries)
may do. The provisions of the indenture limits
our ability to:
- incur additional indebtedness;
- create certain liens;
8
- permit payment or dividend restrictions
on certain of our subsidiaries;
- pay dividends on, redeem or repurchase
our capital stock;
- make investments;
- sell assets;
- engage in transactions with affiliates;
and
- sell all or substantially all of our
assets or consolidate or merge with or
into other companies.
These covenants are subject to a number of
important exceptions.
Risk Factors.................. You should carefully consider all of the
information in this prospectus and, in
particular, you should evaluate the specific
risk factors set forth under "Risk Factors."
For more complete information about the Notes, see the "Description of New
Notes" section of this prospectus.
9
SUMMARY HISTORICAL AND OTHER CONSOLIDATED FINANCIAL DATA
Set forth below is summary historical and other consolidated financial data
as of December 31, 2002 and 2003 and March 31, 2003 and 2004 and for the years
ended December 31, 2001, 2002 and 2003 and the three months ended March 31, 2003
and 2004 of TSI Holdings and its predecessor TSI Inc. The consolidated statement
of operations data, balance sheet data and other financial data for years ended
December 31, 2001, 2002 and 2003 were derived from our audited consolidated
financial statements included elsewhere in this offering memorandum. The
consolidated statement of operations data, balance sheet data and other
financial data as of March 31, 2003 and 2004 and for the three month periods
then ended were derived from our unaudited condensed consolidated interim
financial statements included elsewhere in this offering memorandum. The
information reflects all adjustments which, in the opinion of management, are
necessary for a fair presentation of the financial position and results of
operations for the interim periods set forth below. All such adjustments are of
a normal and recurring nature. The club and membership data, for all periods
presented, were derived from our unaudited books and records. The information
contained in this table should be read in conjunction with "Selected
Consolidated Financial and Other Data," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements and
accompanying notes thereto appearing elsewhere in this offering memorandum. All
amounts are presented in thousands except club and membership data.
YEARS ENDED DECEMBER 31, THREE MONTHS ENDED MARCH 31,
----------------------------------------------- ----------------------------------
2001 2002 2003 2003 2003 2004 2004
-------- -------- -------- -------------- ------- ------- --------------
(PRO FORMA)(1) (PRO FORMA)(1)
STATEMENT OF
OPERATIONS DATA:
Revenues.............. $281,633 $319,427 $342,541 $342,541 $86,902 $86,464 $86,464
Operating expenses.... 252,677 281,334 298,576 298,576 72,752 81,501 81,501
Operating income...... 28,956 38,093 43,965 43,965 14,150 4,963 4,963
Interest expense, net
of interest
income.............. 14,527 16,421 23,226 37,560 4,210 8,638 9,931
Income tax provision
(benefit)........... 6,853 9,709 5,537 (583) 4,099 (1,617) (2,186)
Income (loss) from
continuing
operations.......... 7,576 11,963 7,429 (785) 5,841 (2,058) (2,782)
Net income (loss)..... 7,046 10,507 7,429 (785) 5,841 (2,058) (2,782)
Net income (loss)
attributable to
common
stockholders........ $ (3,155) $ (1,036) $ (3,555) $ (785) $ 2,615 $(2,841) $(2,782)
======== ======== ======== ======== ======= ======= =======
AS OF DECEMBER 31, AS OF MARCH 31,
----------------------- --------------------
2002 2003 2003 2004
------------ -------- -------- ---------
BALANCE SHEET DATA:
Cash and cash equivalents........................ $ 5,551 $ 40,802 $ 9,052 $ 53,663
Total assets..................................... 314,250 362,199 312,517 374,745
Long-term debt and capital lease obligations,
including current installments................. 160,943 261,877 148,838 387,841
Redeemable senior preferred stock................ 62,125 -- 64,089 --
Series A redeemable preferred stock.............. 34,841 39,890 36,061 --
Series B preferred stock......................... 303 9,961 9,005 --
Stockholders' deficit............................ $(31,740) $(34,294) $(29,437) $(115,591)
10
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------------------------- ------------------
1999 2000 2001 2002 2003 2003 2004
-------- -------- -------- -------- -------- -------- -------
OTHER DATA:
Non-cash rental lease
expense, net of non-
cash income............ $ 3,061 $ 2,976 $ 4,224 $ 1,670 $ 1,650 $ 522 $ 322
Cash provided by (used
in):
Operating activities... 29,496 40,573 44,348 50,805 58,253 23,606 18,930
Investing activities... (55,078) (70,048) (58,358) (40,182) (42,734) (7,418) (7,479)
Financing activities... $ 33,553 $ 5,715 $ 16,103 $(10,530) $ 19,732 $(12,687) $ 1,410
Ratio (deficiency) of
earning to fixed
charges(2)........... 1.0:1.0 1.4:1.0 1.5:1.0 1.7:1.0 1.3:1.00 2.1:1.00 $(3,769)
Pro forma deficiency of
earnings to fixed
charges(2)........... $ (1,605) $(5,062)
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------- -------------------
2001 2002 2003 2003 2004
------- -------- ------- -------- --------
CLUB AND MEMBERSHIP DATA:
Total clubs operated at end of period(3)..... 119 129 129 129 132
Members at end of period(4).................. 317,000 342,000 342,000 356,000 365,000
Mature club revenue increase (decrease)(5)... 12.3% 4.1% 1.6% 1.8% (0.5)%
------------
(1) - Pro forma interest expense, net of interest income as adjusted for the
year ended December 31, 2003 and the three months ended March 31, 2004 has
been adjusted as follows:
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
2003 2004
------------ ------------------
Pro forma interest on New 11% Senior Discount Notes......... $14,097 $1,294
Amortization of deferred financing costs.................... 294 (1)
Interest income............................................. (57) --
------- ------
Total adjustment............................................ $14,334 $1,293
======= ======
- Pro forma income tax provision (benefit) for the year ended December 31,
2003 and the three months ended March 31, 2004 was adjusted applying the
tax rates of the actual results over the respective periods to the
interest charges of $14,334 and $1,293, respectively. This resulted in
tax benefit adjustments of $6,120 and $569 for the year ended December
31, 2003 and the three months ended March 31, 2004 respectively.
- Pro forma net income (loss) attributable to common stockholders for the
year ended December 31, 2003 and the three months ended March 31, 2004
have been adjusted for interest and taxes described above and charges
related to the accretion of preferred stock of $10,984 and $783 for the
year ended December 31, 2003 and the three months ended March 31, 2004,
respectively, have been removed to reflect the redemption of all
preferred stock.
(2) - For purposes of determining the ratio deficiency of earnings to fixed
charges, "earnings" consist of income from continuing operations before
provisions for corporate income taxes and fixed charges. "Fixed charges"
consist of interest expense, which includes the amortization of deferred
debt issuance costs and the interest portion of our rent expense (assumed
to be one third of rent expense).
- Pro forma deficiency of earnings to fixed charges reflects the issuance
of the Old Notes and the use of proceeds thereof as if it had occurred on
the first day of the relevant period.
(3) Includes all clubs wholly-owned or partly-owned and managed. (We operate two
partly-owned clubs under the Washington Sports Club brand name as of
December 31, 2003 and March 31, 2004).
(4) Represents members at clubs wholly-owned or partly-owned and managed.
(5) We define mature clubs as those clubs operated by us for more than 24
months.
11
RISK FACTORS
You should carefully consider the following risk factors as well as the
other information and data included in this prospectus prior to making a
decision on whether to exchange your Old Notes for New Notes. Any of the
following risks could materially adversely affect our business, financial
condition or results of operations. In such case, you may lose all or part of
your original investment.
RISK FACTORS RELATED TO THE NEW NOTES
Because there is no public market for the New Notes, you may not be able to
sell your New Notes.
The New Notes will be registered under the Securities Act, but will
constitute a new issue of securities with no established trading market, and
uncertainty exists with regard to:
- the liquidity of any trading market that may develop;
- the ability of holders to sell their New Notes; or
- the price at which the holders would be able to sell their New Notes.
If a trading market were to develop, the New Notes might trade at higher or
lower prices than their principal amount or purchase price, depending on many
factors, including prevailing interest rates, the market for similar securities
and our financial performance.
We understand that the initial purchaser of the Old Notes presently intends
to make a market in the New Notes. However, it is not obligated to do so, and
any market-making activity with respect to the New Notes may be discontinued at
any time without notice. In addition, any market-making activity will be subject
to the limits imposed by the Securities Act and the Exchange Act, and may be
limited during the exchange offer or the pendency of an applicable shelf
registration statement. An active trading market might not exist for the New
Notes and any trading market that does develop might not be liquid.
In addition, all holders of Old Notes who tender in the exchange offer for
the purpose of participating in a distribution of the New Notes will be deemed
to have received restricted securities, and will be required to comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any resale transaction.
Your Old Notes will not be accepted for exchange if you fail to follow the
exchange offer procedures.
We will issue New Notes pursuant to this exchange offer only after a timely
receipt of your Old Notes (including timely notation in book-entry form).
Therefore, if you want to tender your Old Notes, please allow sufficient time to
ensure timely delivery. If we do not receive your Old Notes, by the expiration
date of the exchange offer, we will not accept your Old Notes for exchange. We
are under no duty to give notification of defects or irregularities with respect
to the tenders of Old Notes for exchange. If there are defects or irregularities
with respect to your tender of Old Notes, we will not accept your Old Notes for
exchange.
If you do not exchange your Old Notes, your Old Notes will continue to be
subject to the existing transfer restrictions and you may be unable to sell your
Old Notes.
We did not register the Old Notes, nor do we intend to do so following the
exchange offer. Old Notes that are not tendered will therefore continue to be
subject to the existing transfer restrictions and may be transferred only in
limited circumstances under the securities laws. If you do not exchange your Old
Notes, you will lose your right to have your Old Notes registered
12
under the federal securities laws. As a result, if you hold Old Notes after the
exchange offer, you may be unable to sell your Old Notes.
If a large number of outstanding Old Notes are exchanged for New Notes
issued in the exchange offer, it may be difficult for holders of outstanding Old
Notes that are not exchanged in the exchange offer to sell their Old Notes,
since those Old Notes may not be offered or sold unless they are registered or
there are exemptions from registration requirements under the Securities Act or
state laws that apply to them. In addition, if there are only a small number of
Old Notes outstanding, there may not be a very liquid market in those Old Notes.
There may be few investors that will purchase unregistered securities in which
there is not a liquid market.
RISKS RELATED TO THE NOTES
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 March 31, 2004, after
giving effect to this offering, our total consolidated debt was $387.8 million.
See "Capitalization" for additional information.
Our substantial debt could have important consequences to you, including:
- making it more difficult for us to satisfy our obligations with respect
to the Notes;
- 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 will permit us and our
subsidiaries to incur substantial additional debt. In addition, as of March 31,
2004, we had $48.3 million of unutilized borrowings under our senior secured
revolving credit facility of which $37.9 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. See
"Description of Other Indebtedness -- Senior Secured Revolving Credit Facility"
for additional information.
Servicing our debt will require, in aggregate, approximately $770 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 $387.8 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 March 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
13
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
you that any refinancing of this kind would be possible or that any additional
financing could be obtained. The inability to obtain additional financing could
have a material adverse effect on our financial condition and on our ability to
meet our obligations to you under the Notes.
TSI Holdings is the sole obligor under the Notes. Its subsidiaries, including
TSI, Inc., do not guarantee TSI Holdings' obligations under the Notes and do
not have any obligation with respect to the Notes; the Notes are structurally
subordinated to the debt and liabilities of TSI Holdings' subsidiaries,
including TSI, Inc. and are effectively subordinated to any of our future
secured debt.
TSI Holdings has no operations of its own and derives all of its revenues
and cash flow from its subsidiaries. TSI Holdings' subsidiaries are separate and
distinct legal entities and have no obligation contingent or otherwise, to pay
amounts due under the Notes or to make any funds available to pay those amounts,
whether by dividend, distribution, loan or other payments.
The Notes are structurally subordinated to all debt and liabilities,
including trade payables, of TSI Holdings' subsidiaries, including TSI, Inc. You
are only entitled to participate with all other holders of the TSI Holdings'
indebtedness and liabilities in the assets of the TSI Holdings' subsidiaries
remaining after the TSI Holdings' subsidiaries have paid all of their debt and
liabilities. TSI Holdings' subsidiaries may not have sufficient funds or assets
to permit payments to TSI Holdings in amounts sufficient to permit TSI Holdings
to pay all or any portion of its indebtedness and other obligations, including
its obligations on the Notes. At March 31, 2004, the aggregate debt of TSI
Holdings' subsidiaries equaled $260.9 million and the aggregate amount of trade
payables, accrued liabilities and other balance sheet liabilities (other than
debt) of TSI Holdings' subsidiaries equaled $102.5 million. In addition, on
March 31, 2004, TSI, Inc. had $37.9 million of additional borrowings available
under its $50.0 million credit facility after giving effect to $1.7 million of
outstanding letters of credit and certain borrowing limitations.
The indenture governing TSI, Inc.'s existing senior notes and TSI, Inc.'s
credit facility permit us and/or our subsidiaries to incur additional
indebtedness, including secured indebtedness, under certain circumstances. See
"Description of Other Indebtedness." If we incur any secured debt in the future,
holders of such secured debt will have claims that are prior to your claims as
holders of the Notes to the extent of the value of the assets securing that
other debt. In the event of a bankruptcy, liquidation or reorganization or
similar proceeding relating to us, holders of secured debt will have a prior
claim to the assets that constitute their collateral.
TSI Holdings may not have access to the cash flow and other assets of its
subsidiaries that may be needed to make payments on the Notes.
TSI Holdings' operations are conducted through its subsidiaries and its
ability to make payment on the Notes is dependent on the earnings and the
distribution of funds from its subsidiaries. However, none of its subsidiaries
is obligated to make funds available to TSI Holdings for payment on the Notes.
In addition, the terms of the indenture governing TSI, Inc.'s existing senior
notes and of TSI, Inc.'s credit facility significantly restrict TSI, Inc. and
its subsidiaries from paying dividends and otherwise transferring assets to TSI
Holdings. Furthermore, TSI Holdings' subsidiaries are permitted under the terms
of TSI, Inc.'s credit facility and other indebtedness (including under the
indenture) to incur additional indebtedness that may severely restrict or
prohibit the making of distributions, the payment of dividends or the making of
loans by such subsidiaries to TSI Holdings.
We cannot assure you that the agreements governing the current and future
indebtedness of TSI Holdings' subsidiaries will permit TSI Holdings'
subsidiaries to provide TSI, Inc. with
14
sufficient dividends, distributions or loans to fund scheduled interest and
principal payments on the Notes when due. See "Description of Indebtedness."
Original Issue Discount -- You will be required to include original issue
discount in your gross income for federal income tax purposes.
The Notes were issued at a substantial discount from their principal amount
at maturity. Although cash interest will not accrue on the Notes prior to
February 1, 2009, original issue discount (the difference between the stated
redemption price at maturity and the issue price of the Notes) will accrue from
the issue date of the Notes. Consequently, a holder of a Note will have income
for tax purposes arising from such original issue discount prior to the receipt
of cash in respect of such income. See "Certain Material United States Federal
Income Tax Considerations."
If a bankruptcy case is commenced by or against TSI Holdings under the
United States Bankruptcy Code, the claim of a holder of any of the Notes with
respect to the principal amount thereof may be limited to an amount equal to the
sum of:
- The initial offering price allocable to the Notes;
- That portion of the original issue discount which is not deemed to
constitute "unmatured interest" for purposes of the Bankruptcy Code; and
- Any original issue discount that was not amortized as of any such
bankruptcy filing would constitute "unmatured interest."
Covenant restrictions under our indebtedness may limit our ability to operate
our business and, in such an event, we may not have sufficient assets to pay
amounts due to you on the Notes.
The indenture governing the 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 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;
15
- 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 March 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 4.00:1.00 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 March 31, 2004 our position relative to such
ratios was 3.01:1.00, 3.50:1.00 and 0.13:1.00, 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 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 amounts due on
the Notes. As a result, you may receive less than the full amount you would be
otherwise entitled to receive on the Notes. See "Description of Other
Indebtedness--Senior Secured Revolving Credit Facility" and "Description of
Notes" for additional information.
We may not have the ability to raise the funds necessary to finance the change
of control offer required by the indenture.
Upon a change of control, subject to certain conditions, we are required to
offer to repurchase all outstanding Notes at 101% of the principal amount
thereof, plus accrued and unpaid interest to the date of repurchase.
The source of funds for that purchase of Notes will be our available cash
or cash generated from our subsidiaries' operations or other sources, including
borrowing, sales of assets or sales of equity. There might not be sufficient
funds available at the time of any change of control to make required
repurchases of Notes tendered. In addition, the terms of our senior secured
revolving credit facility limit our ability to purchase your Notes. Our future
debt agreements may contain similar restrictions and provisions. If the holders
of the Notes exercise their right to require us to repurchase all of the Notes
upon a change of control, the financial effect of this repurchase could cause a
default under our other indebtedness, even if the change of control itself would
not cause a default. Accordingly, it is possible that we will not have
sufficient funds at the time of the change of control to make the required
repurchase of Notes or that restrictions in the indenture, our senior secured
revolving credit facility and the indenture governing the senior notes issued by
TSI, Inc. will not allow such repurchases. See "Description of Notes--Change of
Control" and "Description of Other Indebtedness--Senior Secured Revolving Credit
Facility" for additional information.
16
Federal and state statutes allow courts, under specific circumstances, to void
the Notes and require noteholders to return payments received from us.
Under the federal bankruptcy laws and comparable provisions of state
fraudulent transfer laws, the Notes could be voided, or claims in respect of the
Notes could be subordinated to all of our other debts if, among other things,
we, at the time we incurred the indebtedness evidenced by the Notes:
- were insolvent or rendered insolvent by reason of such indebtedness; or
- were engaged in a business or transaction for which our remaining assets
constituted unreasonably small capital; or
- intended to incur, or believed that we would incur, debts beyond our
ability to pay such debts as they mature.
In addition, any payment by us pursuant to the Notes could be voided and
required to be returned to us, or to a fund for the benefit of our creditors.
The measures of insolvency for purposes of these fraudulent transfer laws
will vary depending upon the law applied in any proceeding to determine whether
a fraudulent transfer has occurred. Generally, however, we would be considered
insolvent if:
- the sum of our debts, including contingent liabilities, were greater than
the fair saleable value of all our assets, or
- if the present fair saleable value of our assets were less than the
amount that would be required to pay our probable liability on existing
debts, including contingent liabilities, as they become absolute and
mature, or
- we could not pay our debts as they become due.
On the basis of historical financial information, recent operating history
and other factors, we believe that we, after giving effect to the indebtedness
incurred in the offering and the application of the proceeds therefrom, will not
be insolvent, will not have unreasonably small capital for the business in which
we are engaged and will not have incurred debts beyond our ability to pay such
debts as they mature. There can be no assurance, however, as to what standard a
court would apply in making such determinations or that a court would agree with
our conclusions in this regard.
The Notes may be considered as a single class of securities with any additional
notes issued pursuant to the indenture.
We may, subject to compliance with certain debt-incurrence covenants as
well as other provisions contained in the indenture, issue additional notes.
Such notes may be considered as a single class of securities for purposes of the
indenture. Holders of such additional notes will be eligible to vote on any
amendment to the indenture and will thereby dilute the voting power of the
holders of the Notes.
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.
17
RISK FACTORS RELATED TO THE COMPANY
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 March 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 you 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 cannot assure you that we will 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 March 31, 2004, we operated 87 fitness clubs in the New York
metropolitan market, 20 fitness clubs in the Boston market, 16 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. In Manhattan we have
experienced a 0.8% decline and a 2.6% decline during the year ended December 31,
2003 and the three months ended March 31, 2004 respectively, in our mature club
revenue and a similar decline in mature club
18
memberships each of which we attribute to the general economic conditions in the
markets we serve as well as to the continuing effects of the events of September
11, 2001. 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."
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."
The interests of our controlling shareholder may be in conflict with your
interests as a holder of Notes.
Bruckmann, Rosser, Sherrill & Co., L.P. and certain of its affiliates
(collectively "BRS") own approximately 36.6% of our common stock on a fully
diluted basis and has the ability to elect a majority of the board of directors
and generally to control the affairs and policies of our company. Circumstances
may occur in which the interests of BRS, as our shareholder, in pursuing
acquisitions or otherwise, could be in conflict with the interests of the
holders of the
19
Notes. See "Security Ownership and Certain Beneficial Owners" and "Certain
Relationships and Related Transactions."
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.
20
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
All statements other than statements of historical facts included in this
prospectus, including, without limitation, statements regarding our future
financial position, business strategy, budgets, projected costs and plans and
objectives of management for future operations, are forward-looking statements.
In addition, forward-looking statements generally can be identified by the use
of forward-looking terminology such as "may", "will", "should", "could",
"expect", "intend", "estimate", "anticipate", "believe" or "continue", "plan",
"potential", "predicts" or the negative thereof or variations thereon or similar
terminology. These statements are only predictions and involve known and unknown
risks, uncertainties and other factors, many of which are beyond our control,
that may cause our actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by any
forward-looking statements. These risks and uncertainties include, but are not
limited to, the following:
- general economic and business conditions, both nationally and in those
regions in which we operate;
- competition;
- changes in our business strategy or plans;
- the loss of any of our management or key personnel; and
- the availability of capital and trade credit to fund our business.
Although we believe that the expectations reflected in our forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements.
Important factors that could cause actual results to differ materially from
our expectations, or "cautionary statements," are disclosed under "Risk Factors"
and elsewhere in this prospectus, including, without limitation, in conjunction
with the forward-looking statements included in this prospectus. We are under no
duty to update any of the forward-looking statements after the date of this
prospectus to conform these statements to actual results.
INDUSTRY AND MARKET DATA
Industry and market data used throughout this prospectus were obtained
through surveys and studies conducted by third parties, industry and general
publications and internal company research. We have not independently verified
market and industry data from third-party sources. We believe internal company
estimates are reasonable and market definitions are appropriate. Neither such
estimates nor these definitions have been verified by any independent sources.
21
THE EXCHANGE OFFER
PURPOSE OF THE EXCHANGE OFFER
Simultaneously with the sale of the Old Notes, we entered into a
registration rights agreement with Deutsche Bank. In the registration rights
agreement, we agreed, among other things, (i) to file a registration statement
with the SEC as soon as practicable after the issuance of the Old Notes, but in
no event later than 120 days after the issuance of the Old Notes and (ii) to use
our reasonable best efforts to cause such registration statement to be declared
effective by the SEC at the earliest possible time, but in no event later than
210 days after the issuance of the Old Notes. We also agreed to use our best
efforts to cause the exchange offer to be consummated on the earliest
practicable day after the registration statement is declared effective, but in
no event later than 30 days after the exchange registration statement is
declared effective, unless required by the Securities Act or the Exchange Act. A
copy of the registration rights agreement has been filed as an exhibit herewith.
We are conducting the exchange offer to satisfy our contractual obligations
under the registration rights agreement. The form and terms of the New Notes are
the same as the form and terms of the Old Notes, except that the New Notes will
be registered under the Securities Act, and holders of the New Notes will not be
entitled to the payment of any additional amounts pursuant to the terms of the
registration rights agreement, as described below.
The registration rights agreements provides that, promptly after the
registration statement has been declared effective, we will offer to holders of
the Old Notes the opportunity to exchange their existing Notes for New Notes
having a principal amount, interest rate, maturity date and other terms
substantially identical to the principal amount, interest rate, maturity date
and other terms of their Old Notes. We will keep the exchange offer open for at
least 30 days (or longer if we are required to by applicable law) after the date
notice of the exchange offer is mailed to the holders of the Old Notes and use
our reasonable best efforts to complete the exchange offer no later than 30 days
after the exchange registration statement is declared effective. The New Notes
will be accepted for clearance through the DTC, Clearstream, Luxembourg and the
Euroclear System with a new CUSIP and ISIN number and common code. All of the
documentation prepared in connection with the exchange offer will be made
available at the offices of The Bank of New York, our exchange agent.
Based on existing interpretations of the Securities Act by the staff of the
SEC, we believe that the holders of the New Notes (other than holders who are
broker-dealers) may freely offer, sell and transfer the New Notes. However,
holders of Old Notes who are our affiliates, who intend to participate in the
exchange offer for the purpose of distributing the New Notes, or who are
broker-dealers who purchased the Old Notes from us for resale, may not freely
offer, sell or transfer the Old Notes, may not participate in the exchange offer
and must comply with the registration and prospectus delivery requirements of
the Securities Act in connection with any offer, sale or transfer of Old Notes.
Each holder of Old Notes who is eligible to and wishes to participate in
the exchange offer will be required to represent that it is not our affiliate,
that it is not a broker-dealer tendering securities directly acquired from us
for its own account and that it acquired the Old Notes and will acquire the New
Notes in the ordinary course of its business and that it has no arrangement with
any person to participate in the distribution of the New Notes. In addition, any
broker-dealer who acquired the Old Notes for its own account as a result of
market-making or other trading activities must deliver a prospectus (which may
be the prospectus contained in this registration statement if the broker-dealer
is not reselling an unsold allotment of Old Notes) meeting the requirements of
the Securities Act in connection with any resales of the New Notes. We will
agree to provide sufficient copies of the latest version of such prospectus to
22
such broker-dealers, if subject to similar prospectus delivery requirements for
a period ending on the earlier of (i) 180 days from the date on which the
exchange offer is consummated (ii) the date on which a broker-dealer is no
longer required to deliver a prospectus in connection with market-making or
other trading activities.
If,
(i) we are not permitted to consummate the Exchange Offer because the
Exchange Offer is not permitted by applicable law or Commission policy; or
(ii) any Holder of Transfer Restricted Securities notifies us prior to the
20th day following consummation of the exchange offer that (a) it is prohibited
by law or Commission policy from participating in the Exchange Offer; (b) that
it may not resell the New Notes acquired by it in the exchange offer to the
public without delivering a prospectus and this prospectus is not appropriate or
available for such resales; or (c) that it is a broker-dealer and owns Old Notes
acquired directly from the Issuer or an affiliate of the Issuer,
then we shall promptly deliver to the holders and the trustee written
notice thereof, or give notice and shall file a shelf registration covering the
resale of the affected securities within 120 days after the shelf notice is
given to the holders and shall use our reasonable best efforts to cause the
shelf registration to be effective under the Securities Act on or prior to the
210th day after the shelf notice is given.
We will use our reasonable best efforts to keep effective the shelf
registration statement until the earlier of (i) two years following the
effective date of the initial shelf registration statement or (ii) the time when
all of the securities have been sold thereunder or are no longer restricted
securities.
In the event that a shelf registration statement is filed, we will provide
to each affected holder copies of the prospectus that is a part of the shelf
registration statement, notify each affected holder when the shelf registration
statement has become effective and take certain other actions as are required to
permit unrestricted resales of the securities. A holder that sells securities
pursuant to the shelf registration statement will be required to be named as a
selling security holder in the prospectus and to deliver a prospectus to
purchasers. A selling holder will also be subject to certain of the civil
liability provisions under the Securities Act in connection with sales and will
be bound by the provisions of the registration rights agreement that are
applicable to it, including certain indemnification rights and obligations.
If we are permitted under SEC rules to conduct the exchange offer and we
have not filed an exchange offer registration statement or a shelf registration
statement by a specified date, if the exchange offer registration statement or
the shelf registration statement is not declared effective by a specified date,
or if either we have not consummated the exchange offer within a specified
period of time or, if applicable, we do not keep the shelf registration
statement effective from a specified period of time, then, in addition to the
interest otherwise payable on the Notes, the interest that is accrued and
payable on the principal amount of the Old Notes will increase at a rate of
0.25% per annum with respect to each subsequent 90-day period until the
requirement is satisfied, up to a additional maximum amount of interest of 1.0%
per annum. Upon the filing of the registration statement, the effectiveness of
the exchange offer registration statement, the consummation of the exchange
offer or the effectiveness of the shelf registration statement, as the case may
be, the additional interest will cease to accrue from the date of filing,
effectiveness or consummation, as the case may be.
If a registration statement is declared effective and we fail to keep it
continuously effective or useable for resales for the period required by the
registration rights agreement, then from the day that the registration statement
ceases to be effective until the earlier of the date that the
23
registration statement is again deemed effective or is useable, the date that is
the second anniversary of our issuance of these securities (or, if Rule 144(k)
under the Securities Act is amended to provide a shorter restrictive period, the
shorter period) or the date as of which all of the applicable securities are
sold pursuant to the shelf registration statement, the interest that is accrued
and payable on the principal amount of the existing Notes will increase at a
rate of 0.25% per annum with respect to each subsequent 90-day period until the
requirement is satisfied, up to a maximum amount of additional interest of 1.0%
per annum.
Any additional amounts will be payable in cash on February 1 and August 1
of each year to the holders of record on the preceding February 1 and August 1,
respectively.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this prospectus,
we will accept any and all Old Notes that were acquired pursuant to Rule 144A
validly tendered and not withdrawn prior to 5:00 p.m., New York City time, on
the expiration date of the exchange offer. We will issue $1,000 principal amount
of New Notes in exchange for each $1,000 principal amount of Old Notes accepted
in the exchange offer. Holders may tender some or all of their Old Notes
pursuant to the exchange offer. However, Old Notes may be tendered only in
integral multiples of $1,000.
The form and terms of the New Notes are the same as the form and terms of
the existing Notes except that:
(i) the New Notes bear a series B designation and a different CUSIP number
from the Old Notes; and
(ii) the New Notes have been registered under the Securities Act and will
therefore not bear legends restricting their transfer.
The New Notes will evidence the same debt as the outstanding securities and
will be entitled to the benefits of the indenture.
Holders of Old Notes do not have any appraisal or dissenters' rights under
the Delaware General Corporations Law, or the indenture in connection with the
exchange offer. We intend to conduct the exchange offer in accordance with the
applicable requirements of the Exchange Act and the rules and regulations of the
SEC.
We will be deemed to have accepted validly tendered Old Notes when, as and
if we have given oral or written notice of our acceptance to the exchange agent.
The exchange agent will act as agent for the tendering holders for the purpose
of receiving the New Notes from us.
If any tendered Old Notes are not accepted for exchange because of an
invalid tender, the occurrence of specified other events set forth in this
prospectus or otherwise, the certificates for any unaccepted Old Notes will be
promptly returned, without expense, to the tendering holder.
Holders who tender Old Notes in the exchange offer will not be required to
pay brokerage commissions or fees or transfer taxes with respect to the exchange
of Old Notes pursuant to the exchange offer. We will pay all charges and
expenses, other than transfer taxes in certain circumstances, in connection with
the exchange offer. See "-- Fees and Expenses" and "-- Transfer Taxes."
24
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The exchange offer will remain open for at least 20 full business days. The
term "expiration date" will mean 5:00 p.m., New York City time, on September 14,
2004, unless we, in our sole discretion, extend the exchange offer, in which
case the term "expiration date" will mean the latest date and time to which the
exchange offer is extended.
To extend the exchange offer, prior to 9:00 a.m., New York City time, on
the next business day after the previously scheduled expiration date, we will:
(1) notify the exchange agent of any extension by oral notice (promptly
confirmed in writing) or written notice,
(2) mail to the registered holders an announcement of any extension, and
(3) issue a notice by press release or other public announcement before
such expiration date,
We reserve the right, in our sole discretion,
(1) if any of the conditions below under the heading "-- Conditions" shall
have not been satisfied,
(A) to delay accepting any Old Notes,
(B) to extend the exchange offer, or
(C) to terminate the exchange offer, or
(2) to amend the terms of the exchange offer in any manner, provided
however, that if we amend the exchange offer to make a material change,
including the waiver of a material condition, we will extend the exchange offer,
if necessary, to keep the exchange offer open for at least five business days
after such amendment or waiver; provided further, that if we amend the exchange
offer to change the percentage of Notes being exchanged or the consideration
being offered, we will extend the exchange offer, if necessary, to keep the
exchange offer open for at least ten business days after such amendment or
waiver.
Any delay in acceptance, extension, termination or amendment will be
followed as promptly as practicable by oral or written notice to the registered
holders.
PROCEDURES FOR TENDERING OLD NOTES HELD THROUGH BROKERS AND BANKS
Since the Old Notes are represented by global book-entry notes, The
Depositary Trust Company or DTC, as depositary, or its nominee is treated as the
registered holder of the Notes and will be the only entity that can tender your
Old Notes for New Notes. Therefore, to tender Old Notes subject to this exchange
offer and to obtain New Notes, you must instruct the institution where you keep
your Old Notes to tender your Old Notes on your behalf so that they are received
on or prior to the expiration of this exchange offer.
The BLUE-colored "Letter of Transmittal" shall be used by you to give such
instructions.
IF YOU WISH TO ACCEPT THIS EXCHANGE OFFER, PLEASE INSTRUCT YOUR BROKER OR
ACCOUNT REPRESENTATIVE IN TIME FOR YOUR OLD NOTES TO BE TENDERED BEFORE THE 5:00
PM (NEW YORK CITY TIME) DEADLINE ON , 2004.
25
To tender your Old Notes in the exchange offer you must represent for our
benefit that:
1. You are acquiring the New Notes for your outstanding Old Notes in the
ordinary course of business;
2. You do not have an arrangement or understanding with any person to
participate in the distribution of New Notes;
3. You are not an "affiliate" as defined under Rule 405 of the Securities
Act;
4. You will also have to acknowledge that if you are not a broker-dealer,
you are not engaged in and do not intend to engage in a distribution of the New
Notes; and
5. You will also have to acknowledge that if you are a broker-dealer, and
acquired the Old Notes as a result of market making activities or other trading
activities, you will deliver a prospectus meeting the requirements of the
Securities Act in connection with any for sale of such New Notes.
You must make such representations by executing the Blue colored "Letter of
Transmittal" and delivering it to the institution through which you hold your
Old Notes.
Such institution will have to acknowledge that such representations were
made by you.
You may tender some or all of your Old Notes in this exchange offer.
However, Notes may be tendered only in integral multiples of $1,000.
When you tender your outstanding Old Notes and we accept them, the tender
will be a binding agreement between you and us as described in this prospectus.
The method of delivery of outstanding Old Notes and all other required
documents to the exchange agent is at your election and risk.
We will decide all questions about the validity, form, eligibility,
acceptance and withdrawal of tendered Old Notes, and our reasonable
determination will be final and binding on you. We reserve the absolute right
to:
(1) reject any and all tenders of any particular Old Note not properly
tendered;
(2) refuse to accept any Old Note if, in our reasonable judgment or the
judgment of our counsel, the acceptance would be unlawful; and
(3) waive any defects or irregularities or conditions of the exchange offer
as to any particular Old Notes before the expiration of the offer.
Our interpretation of the terms and conditions of the exchange offer will
be final and binding on all parties. You must cure any defects or irregularities
in connection with tenders of Old Notes as we will reasonably determine. Neither
us, the exchange agent nor any other person will incur any liability for failure
to notify you or any defect or irregularity with respect to your tender of Old
Notes. If we waive any terms or conditions pursuant to (3) above with respect to
a noteholder, we will extend the same waiver to all noteholders with respect to
that term or condition being waived.
26
PROCEDURES FOR BROKERS AND CUSTODIAN BANKS; DTC ATOP ACCOUNT
In order to accept this exchange offer on behalf of a holder of Old Notes
you must submit or cause your DTC participant to submit an Agent's Message as
described below.
The exchange agent, on our behalf will seek to establish an Automated
Tender Offer Program ("ATOP") account with respect to the outstanding Notes at
DTC promptly after the delivery of this prospectus. Any financial institution
that is a DTC participant, including your broker or bank, may make book-entry
tender of outstanding Old Notes by causing the book-entry transfer of such Notes
into our ATOP account in accordance with DTC's procedures for such transfers.
Concurrently with the delivery of Old Notes, an Agent's Message in connection
with such book-entry transfer must be transmitted by DTC to, and received by,
the exchange agent on or prior to 5:00 pm, New York City Time on the expiration
date. The confirmation of a book-entry transfer into the ATOP account as
described above is referred to herein as a "Book-Entry Confirmation."
The term "Agent's Message" means a message transmitted by the DTC
participants to DTC, and thereafter transmitted by DTC to the exchange agent,
forming a part of the Book-Entry Confirmation which states that DTC has received
an express acknowledgment from the participant in DTC described in such Agent's
Message stating that such participant and beneficial holder agree to be bound by
the terms of this exchange offer.
Each Agent's Message must include the following information:
(1) Account number of the beneficial owner tendering such Notes;
(2) Principal amount of Notes tendered by such beneficial owner; and
(3) A confirmation that the beneficial holder of the Old Notes tendered has
made the representations for the benefit of the Company set forth under
"-- Procedures for Tendering Old Notes Held Through Brokers or Banks" above.
BY SENDING AN AGENT'S MESSAGE THE DTC PARTICIPANT IS DEEMED TO HAVE
CERTIFIED THAT THE BENEFICIAL HOLDER FOR WHOM NOTE ARE BEING TENDERED HAS BEEN
PROVIDED WITH A COPY OF THIS PROSPECTUS.
The delivery of Notes through DTC, and any transmission of an Agent's
Message through ATOP, is at the election and risk of the person tendering Notes.
We will ask the exchange agent to instruct DTC to promptly return those Old
Notes, if any, that were tendered through ATOP but were not accepted by us, to
the DTC participant that tendered such Notes on behalf of holders of the Notes.
ACCEPTANCE OF OUTSTANDING OLD NOTES FOR EXCHANGE; DELIVER OF NEW NOTES ISSUED IN
THE EXCHANGE OFFER
We will accept validly tendered Old Notes when the conditions to the
exchange offer have been satisfied or we have waived them. We will have accepted
your validly tendered Old Notes when we have given oral or written notice to the
exchange a gent. The exchange agent will act as agent for the tendering holders
for the purpose of receiving the New Notes from us. If we do not accept any
tendered Old Notes for exchange because of an invalid tender or other valid
reason, the exchange agent will promptly return the certificates, without
expense, to the tendering holder. If a holder has tendered Old Notes by
book-entry transfer, we will credit the
27
Notes to an account maintained with The Depositary Trust Company. We will credit
the account at The Depositary Trust Company promptly after the exchange offer
terminates or expires.
THE AGENT'S MESSAGE MUST BE TRANSMITTED TO EXCHANGE AGENT ON OR
BEFORE 5:00 PM, NEW YORK CITY TIME, ON THE EXPIRATION DATE
WITHDRAWAL OF TENDERS
You may withdraw your tender of outstanding notes at any time before 5:00
p.m., New York City time, on the expiration date.
For a withdrawal to be effective, you should contact your bank or broker
where your Old Notes are held and have them send an ATOP notice of withdrawal so
that it is received by the exchange agent before 5:00 p.m., New York City time,
on the expiration date. Such notice of withdrawal must:
(1) specify the name of the person that tendered the Old Notes to be
withdrawn;
(2) identify the Old Notes to be withdrawn, including the CUSIP number and
principal amount at maturity of the Old Notes;
(3) specify the name and number of an account at the DTC to which your
withdrawn Old Notes can be credited.
We will decide all questions as to the validity, form and eligibility of
the notices and our determination will be final and binding on all parties. Any
tendered Old Notes that you withdraw will not be considered to have been validly
tendered. We will promptly return any outstanding Old Notes that have been
tendered but not exchanged, or credit them to the DTC account. You may re-tender
properly withdrawn Old Notes by following one of the procedures described above
before the expiration date.
CONDITIONS
Notwithstanding any other term of the exchange offer, we will not be
required to accept for exchange, or issue New Notes for, any Old Notes, and may
terminate or amend the exchange offer as provided in this prospectus before the
expiration date, if:
(1) any action or proceeding is instituted or threatened in any court or by
or before any governmental agency with respect to the exchange offer which, in
our reasonable judgment, might materially impair our ability to proceed with the
exchange offer or any development has occurred in any existing action or
proceeding which may be harmful to us or any of our subsidiaries; or
(2) the exchange offer violates any applicable law or any applicable
interpretation by the staff of the SEC; or
(3) any governmental approval has not been obtained, which we believe, in
our reasonable discretion, is necessary for the consummation of the exchange
offer as outlined in this prospectus.
If we determine in our reasonable discretion that any of the conditions are
not satisfied, we may
(1) refuse to accept any Old Notes and promptly return all tendered Old
Notes to the tendering holders;
28
(2) extend the exchange offer and retain all Old Notes tendered prior to
the expiration of the exchange offer, subject, however, to the rights of holders
to withdraw their Old Notes (see "-- Withdrawal of Tenders"; or
(3) waive the unsatisfied conditions with respect to the exchange offer and
accept all properly tendered Old Notes that have not been withdrawn.
EXCHANGE AGENT
The Bank of New York has been appointed as the exchange agent for the
exchange offer. You should direct all questions, requests for assistance, and
requests for additional copies of this prospectus or to the exchange agent at
the following address:
THE BANK OF NEW YORK
BY OVERNIGHT COURIER OR
BY FACSIMILE: BY HAND: REGISTERED/CERTIFIED MAIL:
------------- ----------------------------- -----------------------------
(212) 298-1915 Attention: 101 Barclay Street, 7 East 101 Barclay Street, 7 East
Customer Service New York, New York 10286 New York, New York 10286
Attention: Corporate Trust Attention: Corporate Trust
Operations Reorganization Operations Reorganization
Unit Unit
DELIVERY TO AN ADDRESS OTHER THAN SET FORTH ABOVE WILL NOT CONSTITUTE A VALID
DELIVERY.
FEES AND EXPENSES
We will bear the expenses of soliciting tenders. The principal
solicitation is being made by mail; however, additional solicitation may be made
by telephone or in person by our and our affiliates' officers and regular
employees.
We have not retained any dealer-manager in connection with the exchange
offer and will not make any payments to brokers, dealers or others soliciting
acceptances of the exchange offer. We will, however, pay the exchange agent
reasonable and customary fees for its services and will reimburse it for its
reasonable out-of-pocket expenses incurred in connection with these services.
We will pay the cash expenses to be incurred in connection with the
exchange offer. Such expenses include fees and expenses of the exchange agent
and trustee, accounting and legal fees and printing costs, among others.
ACCOUNTING TREATMENT
The New Notes will be recorded at the same carrying value as the Old Notes,
which is the accreted value, as reflected in our accounting records on the date
of exchange. Accordingly, we will not recognize any gain or loss for accounting
purposes as a result of the exchange offer. The expenses of the exchange offer
will be deferred and charged to expense over the term of the New Notes.
TRANSFER TAXES
Holders who tender their Old Notes for exchange will not be obligated to
pay any transfer taxes in connection with the exchange. However, holders who
instruct us to register New Notes in the name of, or request that Old Notes not
tendered or not accepted in the exchange offer be returned to, a person other
than a registered tendering holder will be responsible for the payment of any
applicable transfer tax on that transfer.
29
CONSEQUENCES OF FAILURE TO EXCHANGE
The Old Notes that are not exchanged for New Notes pursuant to the exchange
offer will remain restricted securities. Accordingly, the Old Notes may be
resold only:
(1) to us upon redemption thereof or otherwise;
(2) so long as the outstanding securities are eligible for resale pursuant
to Rule 144A, to a person inside the United States who is a qualified
institutional buyer within the meaning of Rule 144A under the Securities Act in
a transaction meeting the requirements of Rule 144A, in accordance with Rule 144
under the Securities Act, or pursuant to another exemption from the registration
requirements of the Securities Act, which other exemption is based upon an
opinion of counsel reasonably acceptable to us;
(3) outside the United States to a foreign person in a transaction meeting
the requirements of Rule 904 under the Securities Act; or
(4) pursuant to an effective registration statement under the Securities
Act,
in each case in accordance with any applicable securities laws of any state
of the United States.
RESALE OF THE NEW NOTES
With respect to resales of New Notes, based on interpretations by the staff
of the SEC set forth in no-action letters issued to third parties, we believe
that a holder or other person who receives New Notes (other than a person that
is our affiliate within the meaning of Rule 405 under the Securities Act) in
exchange for Old Notes in the ordinary course of business and who is not
participating, does not intend to participate, and has no arrangement or
understanding with any person to participate, in the distribution of the New
Notes, will be allowed to resell the New Notes to the public without further
registration under the Securities Act and without delivering to the purchasers
of the New Notes a prospectus that satisfies the requirements of Section 10 of
the Securities Act. However, if any holder acquires New Notes in the exchange
offer for the purpose of distributing or participating in a distribution of the
New Notes, the holder cannot rely on the position of the staff of the SEC
expressed in the no-action letters or any similar interpretive letters, and must
comply with the registration and prospectus delivery requirements of the
Securities Act in connection with any resale transaction, unless an exemption
from registration is otherwise available. Further, each broker-dealer that
receives New Notes for its own account in exchange for Old Notes, where the Old
Notes were acquired by the broker-dealer as a result of market-making activities
or other trading activities, must acknowledge that it will deliver a prospectus
in connection with any resale of the New Notes.
30
THE TRANSACTIONS
TSI Holdings is a holding company with no material assets or operations
other than its ownership of the common stock of TSI, Inc. and was formed to
serve as issuer of the Old Notes.
In connection with, and as a condition to, the offering of the Old Notes,
we consummated the following transactions, which we refer to as the
"transactions."
RESTRUCTURING AGREEMENT
In connection with the transactions, all holders of the equity of TSI,
Inc., or the TSI, Inc. equityholders, Holdings and TSI, Inc. entered into a
Restructuring Agreement, whereby the TSI, Inc. equityholders 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. In connection with this restructuring, certain of the holders of the
stock of TSI Holdings entered into a Stockholders Agreement and Registration
Rights Agreement. See "Certain Relationships and Related Transactions."
PAYMENT OF DIVIDEND TO HOLDERS OF OUR COMMON STOCK
Pursuant to a merger consummated by TSI, Inc. in December 1996, BRS,
certain institutional investors and certain employees of TSI, Inc. acquired the
common stock of TSI, Inc. In addition, pursuant to the merger, TSI, Inc.
instituted an option plan granting certain members of TSI, Inc.'s management
shares of the common stock of TSI, Inc. Pursuant to the Restructuring Agreement,
the TSI, Inc. equityholders exchanged their shares for a pro rata equal amount
of shares of TSI Holdings. Part of the proceeds from the issuance of the Old
Notes was used to make a payment of dividends to holders of the common stock of
TSI Holdings in an aggregate amount of $68.9 million.
REDEMPTION OF PREFERRED STOCK
Pursuant to the December 1996 merger, BRS, certain institutional investors
and certain employees of TSI, Inc. acquired the preferred stock of TSI, Inc. In
addition, pursuant to the merger, TSI, Inc. instituted an option plan granting
certain members of TSI, Inc.'s management options to acquire shares of preferred
stock of TSI, Inc. Pursuant to the Restructuring Agreement, the TSI, Inc.
equityholders exchanged their shares for a pro rata equal amount of shares of
TSI Holdings. With some of the proceeds from the issuance of the Old Notes, we
redeemed all of the issued and outstanding shares of preferred stock of TSI
Holdings then held by BRS, Farallon Capital Partners, L.P. and certain of its
affiliates, Rosewood Capital, L.P. and certain of its affiliates and certain of
our directors in an aggregate amount of $50.6 million. See "Security Ownership
and Certain Beneficial Owners."
31
USE OF PROCEEDS
This exchange offer is intended to satisfy our obligations under the
registration rights agreement. We will not receive any cash proceeds from the
issuance of the New Notes. In consideration for issuing the New Notes
contemplated in this prospectus, we will receive outstanding securities in like
principal amount, the form and terms of which are the same as the form and terms
of the New Notes, except as otherwise described in this prospectus. The old
Notes surrendered in exchange for New Notes will be retired and canceled.
Accordingly, no additional debt will result from the exchange. We have agreed to
bear the expense of the exchange offer.
The gross proceeds from the sale of the Old Notes were approximately
$124,807. We used the net proceeds, together with funds from borrowings under
our new credit facility, as follows (all amounts presented in thousands):
USES:
Redeem preferred stock...................................... $ 50,634
Shareholder dividend(1)..................................... 68,405
Employee bonus in lieu of dividend(2)....................... 1,144
Transaction fees and expenses............................... 4,318
General corporate purposes.................................. 306
--------
Total uses.................................................. $124,807
========
------------
(1) The total dividend amount is shown net of $539 of stock option exercise
proceeds received.
(2) Employees with vested stock options as of the dividend payment date, were
paid bonuses in amounts equivalent to the dividend they would have received
had they exercised and been a common shareholder on the record date.
32
CAPITALIZATION
The following table sets forth our consolidated cash and cash equivalents
and capitalization as of March 31, 2004 which reflects the transactions. This
table should be read in conjunction with our consolidated financial statements
and the related notes to the consolidated financial statements included
elsewhere in this offering memorandum.
All amounts presented in thousands.
AS OF
MARCH 31,
2004
-----------
Cash and cash equivalents................................... $ 53,663
=========
Debt:
Senior secured revolving credit facility.................. $ --(1)
Notes payable for acquired businesses..................... 4,095
Capitalized lease obligations............................. 1,802
Existing senior notes..................................... 255,000
Senior discount notes offered hereby, net of discount..... 126,944
---------
Total debt.................................................. 387,841
Total shareholders' deficit................................. (115,591)
---------
Total capitalization...................................... $ 272,250
=========
---------------
(1) Does not reflect $50,000 in revolving credit loans and letters of credit
available under our senior secured revolving credit facility.
33
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(IN THOUSANDS, EXCEPT CLUB AND MEMBERSHIP DATA)
Set forth below is TSI Holdings' and its predecessor TSI Inc.'s 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, 2001, 2002, and
2003 and the selected historical consolidated balance sheet data as of December
31, 2002 and 2003, 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, 1999 and 2000 and
the selected historical consolidated balance sheet data as of December 31, 1999,
2000 and 2001 were derived from our audited consolidated financial statements of
the Company, which are not included herein. The selected historical consolidated
statement of operations data and other data for the three months ended March 31,
2003 and 2004 and the consolidated balance sheet data as of March 31, 2003 and
2004 were derived from our unaudited consolidated financial statements which are
also included herein. The information reflects all adjustments which, in the
opinion of management, are necessary for a fair presentation of the financial
position and results of operations for the interim periods set forth below. All
such adjustments are of a normal and recurring nature. 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.
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------------------------- -----------------
1999 2000 2001 2002 2003 2003 2004
-------- -------- -------- -------- -------- ------- -------
STATEMENT OF OPERATIONS DATA:
Revenues............................ $158,184 $223,828 $281,633 $319,427 $342,541 $86,902 $86,464
Operating expenses:
Payroll and related............... 63,838 90,801 112,766 129,105 130,585 32,770 36,258
Club operating.................... 52,048 68,806 88,941 99,113 111,069 26,662 27,898
General and administrative........ 10,797 14,626 18,785 21,368 21,995 5,021 6,226
Depreciation and amortization(1).. 20,513 26,248 32,185 31,748 34,927 8,299 9,117
Goodwill impairment(2).............. -- -- -- -- -- -- 2,002
-------- -------- -------- -------- -------- ------- -------
Operating income.................... 10,988 23,347 28,956 38,093 43,965 14,150 4,963
Loss on extinguishment of debt(3)... -- -- -- -- 7,773 -- --
Interest expense, net of interest
income............................ 10,243 13,120 14,527 16,421 23,226 4,210 8,638
-------- -------- -------- -------- -------- ------- -------
Income (loss) from continuing
operations before provision
(benefit) for corporate income
tax............................... 745 10,227 14,429 21,672 12,966 9,940 (3,675)
Provision (benefit) for corporate
income tax........................ 622 5,031 6,853 9,709 5,537 4,099 (1,617)
-------- -------- -------- -------- -------- ------- -------
Income (loss) from continuing
operations........................ 123 5,196 7,576 11,963 7,429 5,841 (2,058)
Loss from discontinued operations of
closed clubs(4) (including loss on
club closure of $996 in 2002), net
of income taxes................... (74) (365) (530) (767) -- -- --
Cumulative effect of a change in
accounting principle, net of
income tax benefit of $612(5)..... -- -- -- (689) -- -- --
-------- -------- -------- -------- -------- ------- -------
Net income (loss) 49 4,831 7,046 10,507 7,429 5,841 (2,058)
Accreted dividends on preferred
stock............................. (7,880) (9,016) (10,201) (11,543) (10,984) (3,226) (783)
-------- -------- -------- -------- -------- ------- -------
Net income (loss) attributable to
common stockholders............... $ (7,831) $ (4,185) $ (3,155) $ (1,036) $ (3,555) $ 2,615 $(2,841)
======== ======== ======== ======== ======== ======= =======
34
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------------------------- -------------------
1999 2000 2001 2002 2003 2003 2004
-------- -------- -------- -------- -------- -------- --------
OTHER DATA:
Non-cash rental lease expense,
net of non-cash income......... $ 3,061 $ 2,976 $ 4,224 $ 1,670 $ 1,650 $ 522 $ 322
Cash provided by (used in):
Operating activities........... 29,496 40,573 44,348 50,805 58,253 23,606 18,930
Investing activities........... (55,078) (70,048) (58,358) (40,182) (42,734) (7,418) (7,479)
Financing activities........... $ 33,553 $ 5,715 $ 16,103 $(10,530) $ 19,732 $(12,687) $ 1,410
CLUB AND MEMBERSHIP DATA:
New clubs opened(6).............. 14 9 12 8 3 -- 3
Clubs acquired(6)................ 4 11 2 4 -- -- --
Closed, relocated or sold
clubs.......................... (1) (1) -- (2) (3) -- --
Wholly-owned clubs operated at
end of period(6)............... 82 103 117 127 127 127 130
Total clubs operated at end of
period(7)...................... 86 105 119 129 129 129 132
Members at end of period(8)...... 203,000 278,000 317,000 342,000 342,000 356,000 365,000
Mature club revenue increase
(decrease)(9).................. 16.0% 18.6% 12.3% 4.1% 1.6% 1.8% (0.5)%
Revenue per weighted average club
(in thousands)(10)............. $ 2,130 $ 2,428 $ 2,619 $ 2,606 $ 2,691 $ 684 $ 670
Ratio (deficiency) of earnings to
fixed charges(11).............. 1.0:1.0 1.4:1.0 1.5:1.0 1.7:1.0 1.3:1.0 2.1:1.0 $ (3,769)
Pro forma (deficiency) of
earnings to fixed charges(12).. $ (1,605) $ (5,062)
AS OF DECEMBER 31, AS OF MARCH 31,
---------------------------------------------------- --------------------
1999 2000 2001 2002 2003 2003 2004
-------- -------- -------- -------- -------- -------- ---------
BALANCE SHEET DATA:
Working capital deficit(13)..... $ (1,015) $(38,414) $(42,565) $(43,192) $ (9,087) $(45,284) $ (2,189)
Total assets.................... 215,678 256,085 296,005 314,250 362,199 312,517 374,745
Long-term debt, including
current installments.......... 132,202 144,498 163,979 160,943 261,877 148,838 387,841
Redeemable senior preferred
stock......................... 42,066 48,029 54,687 62,125 -- 64,089 --
Redeemable Series A preferred
stock(14)..................... 23,216 26,580 30,432 34,841 39,890 36,061 --
Total stockholders'
deficit(14)................... $(28,813) $(30,491) $(32,797) $(31,740) $(34,294) $(29,437) $(115,591)
------------
(1) Effective January 1, 2002 we implemented Statement of Financial Accounting
Standards ("SFAS") No. 142 No. 142 ("SFAS 142"), Goodwill and Other
Intangible Assets. In connection with this implementation we no longer
amortize goodwill, but rather test it for impairment when circumstances
indicate it is necessary, and at a minimum annually. A reconciliation of
reported net income to net income adjusted for the impact of SFAS 142 is as
follows for the presented periods:
YEAR ENDED DECEMBER 31,
---------------------------
1999 2000 2001
------- ------- -------
Net income as reported...................................... $ 49 $ 4,831 $ 7,046
Goodwill amortization....................................... 2,845 3,545 4,436
Deferred tax benefit........................................ (1,195) (1,064) (1,344)
------- ------- -------
Net income as adjusted...................................... $ 1,699 $ 7,312 $10,138
======= ======= =======
(2) In the quarter ended March 31, 2004 the Company performed its annual
impairment test. 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 underperforming club amounted to $2,002. A
deferred tax benefit of $881 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
adjusted our projections of future cash flows to take into account the
impact a new competitor will have on our club. While this club is expected
to generate cash flow in the future, we no longer expect it to operate at
the levels that were projected at the time the club was acquired.
(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
35
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 fourth quarter of 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.
Loss from operations of these discontinued clubs was as follows for the
periods presented:
YEAR ENDED DECEMBER 31,
-------------------------------
1999 2000 2001 2002
----- ----- ----- -------
Loss from operations of discontinued clubs, (including loss
of club closure of $996 in 2002).......................... $(125) $(597) $(894) $(1,318)
Benefit for corporate income tax............................ (51) (232) (364) (551)
----- ----- ----- -------
Loss from discontinued operations........................... $ (74) $(365) $(530) $ (767)
===== ===== ===== =======
(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, or quarter, as applicable.
(11) For purposes of determining the ratio of earnings to fixed charges,
"earnings" consist of income from continuing operations before provisions
for corporate income taxes and fixed charges. "Fixed charges" consist of
interest expense, which includes the amortization of deferred debt issuance
costs and the interest portion of our rent expense (assumed to be one third
of rent expense).
(12) Deficiency of earnings to fixed charges reflects the issuance of the Old
Notes and the use of proceeds thereof as if they had occurred on the first
day of the relevant period.
(13) Working capital deficit is calculated as current assets less current
liabilities.
(14) We had 153,637 shares of Series A Redeemable Preferred Stock ("Series A")
outstanding at December 31, 1999, 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 of the
reclassification on our stockholders' deficit:
AS OF DECEMBER 31,
------------------------------
1999 2000 2001
-------- -------- --------
Stockholders' deficit prior to reclassification............. $ (5,597) $ (3,911) $ (2,365)
Reclassification of Series A stock.......................... (23,216) (26,580) (30,432)
-------- -------- --------
Stockholders' deficit after the reclassification............ $(28,813) $(30,491) $(32,797)
======== ======== ========
The balance sheet data for all periods presented have been adjusted to
reflect the above reclassification.
36
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 prospectus. This prospectus
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 March 31, 2004,
we operated 132 clubs that collectively served approximately 365,000 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 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, 2003, approximately
52% 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 36 locations and operate a total of 87
clubs under the NYSC name within a 50 mile radius of New York City. We operate
20 clubs in the Boston region, 16 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 is PSC brand name. In
addition we operate three clubs in Switzerland. Our goal is to increase our club
count by ten percent per year. 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. We plan to open or acquire eight clubs in our NYSC market
and two in our WSC market or a total of ten clubs in 2004. We opened three clubs
during the three month period ended March 31, 2004.
37
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.
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 84% of our total 2003 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. 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 generate about 14% of our 2003 revenue, referred to as Other
Club revenue, at our facilities from fees for personal training, programing
for children, group fitness training and other member activities, as well
as sales of miscellaneous sports products. This 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 2% in 2003) 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 for income from investments in club facilities
that we do not wholly own. Revenue from sales of in-club advertising and
sponsorships is also included. We refer to this as Fees and Other revenue.
Settlements from our business interruption insurance claim associated with
the September 11 Events are also included during 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. We received $1.3
million in the quarter ended March 31, 2003.
Revenue (in $'000's) is accordingly made up as follows:
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------ -------------------
2001 2002 2003 2003 2004
-------- -------- -------- -------- --------
Membership dues......... $227,073 $257,917 $273,608 $69,091 $69,484
Initiation fees......... 13,287 14,361 13,891 3,519 3,217
Other Club revenue...... 37,840 42,717 48,641 12,080 12,604
Fees and Other.......... 3,433 4,432 6,401 2,212 1,160
-------- -------- -------- ------- -------
Total revenue........... $281,633 $319,427 $342,541 $86,902 $86,464
======== ======== ======== ======= =======
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, insurance and
club supplies.
38
As clubs mature and increase their membership base, fixed costs are
typically spread over an increasing revenue base and 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 approximate $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 3.75% 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, net income, and cash flows provided by operating activities by expanding
our club base in New York, Boston, Washington, DC, 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 $11.0 million for the year ended
December 31, 1999 to $44.0 million for the year ended December 31, 2003. Net
income improved from $49,000 in 1999 to $7.4 million for the year ended December
31, 2003. Cash flows provided by operating activities increased from $29.5
million in 1999 to $58.3 million for the year ended December 31, 2003. Net
income decreased from $10.5 million for the year ended December 31, 2002 to $7.4
million for the year ended December 31, 2003. We incurred $7.8 million of loss
on extinguishment of debt, and $7.1 million of additional interest expense
during the year ended December 31, 2003 principally due to our April 16, 2003
debt refinancing.
FOR THE YEARS ENDED DECEMBER 31, (IN $000'S)
------------------------------------------------
1999 2000 2001 2002 2003
------- -------- ------- ------- -------
Operating income..................... $10,988 $ 23,347 $28,956 $38,093 $43,965
Increase over prior year........... 112.5% 24.0% 31.6% 15.4%
Net income........................... $ 49 $ 4,831 $ 7,046 $10,507 $ 7,429
Increase (decrease) over prior
year............................ 9,759.2% 45.8% 49.1% (29.3)%
Cash flows from operations........... $29,496 $ 40,573 $44,348 $50,805 $58,253
Increase over prior year........... 37.6% 9.3% 14.6% 14.7%
Operating income, net income and cash flows from operations have decreased
when comparing the quarter ended March 31, 2004 to the quarter ended March 31,
2003. See " -- Three Months Ended March 31, 2004 compared to Three Months Ended
March 31, 2003."
Since 2001, 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 these 29 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.
39
HISTORICAL CLUB GROWTH
THREE
MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------------- ---------
1999 2000 2001 2002 2003 2004
---- ---- ---- ---- ---- ---------
Clubs at beginning of period............... 69 86 105 119 129 129
Greenfield clubs(1)........................ 14 9 12 8 3 3
Acquired clubs............................. 4 11 2 4 -- --
Sold, relocated or closed clubs............ (1) (1) -- (2) (3) --
-- --- --- --- --- ---
Clubs at end of period(2).................. 86 105 119 129 129 132
== === === === === ===
Number of partly owned clubs included at
the end of period(3)..................... 4 2 2 2 2 2
------------
(1) A "Greenfield club" is a new location constructed by us.
(2) We include in the club count wholly owned and partly owned clubs. In
addition, as of December 31, 2003 and March 31, 2004 we managed two
additional clubs in which we did not have an equity stake.
(3) In March 2000, two clubs previously managed by us were purchased. Including
these two clubs, the total number of clubs opened or acquired in 2000 totals
22.
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 16.0%, 18.6%, 12.3%, 4.1%, and 1.6% for the years ended December 31,
1999, 2000, 2001, 2002 and 2003, respectively and mature club revenue increased
1.8% and decreased 0.5% for the three months ended March 31, 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 the increasing age of our mature clubs.
40
Results of Operations
The following table sets forth certain operating data as a percentage of
revenue for the periods indicated:
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
------------------------ ---------------
2001 2002 2003 2003 2004
------ ------ ------ ------ ------
Revenues................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Payroll and related.................... 40.0 40.4 38.1 37.7 42.0
Club operating......................... 31.6 31.1 32.5 30.7 32.3
General and administrative............. 6.7 6.7 6.4 5.8 7.2
Depreciation and amortization.......... 11.4 9.9 10.2 9.5 10.5
Goodwill impairment.................... -- -- -- -- 2.3
----- ----- ----- ----- -----
Operating income....................... 10.3 11.9 12.8 16.3 5.7
Loss on extinguishment of debt........... -- -- 2.2 -- --
Interest expense......................... 5.3 5.1 6.8 4.9 10.2
Interest income.......................... (0.1) -- -- -- (0.2)
----- ----- ----- ----- -----
Income from continuing operations
before provision (benefit) for
corporate income taxes.............. 5.1 6.8 3.8 11.4 (4.3)
Provision (benefit) for corporate income
taxes.................................. 2.4 3.1 1.6 4.7 (1.9)
----- ----- ----- ----- -----
Income (loss) from continuing
operations............................. 2.7 3.7 2.2 6.7 (2.4)
Loss from discontinued operations of
closed clubs, net of income tax........ (0.2) (0.2) -- -- --
Cumulative effect of a change in
accounting principle, net of income
tax.................................... -- (0.2) -- -- --
----- ----- ----- ----- -----
Net income (loss)........................ 2.5 3.3 2.2 6.7 (2.4)
Accreted dividends on preferred stock.... (3.6) (3.6) (3.2) (3.7) (0.9)
----- ----- ----- ----- -----
Net income (loss) attributable to common
stockholders........................... (1.1)% (0.3)% (1.0)% 3.0% (3.3)%
===== ===== ===== ===== =====
Three Months Ended March 31, 2004 Compared to Three Months Ended March 31,
2003
Revenues. Revenues decreased $438,000 or 0.5%, to $86.5 million during the
quarter ended March 31, 2004 from $86.9 million in the quarter ended March 31,
2003. Increases in revenue from the four clubs opened during the last three
quarters of 2002 ($316,000), increases in revenue from the three clubs opened or
acquired during the last three quarters of 2003 ($1.5 million), and from the
three clubs opened during 2004 ($225,000) were offset by decreases in Fees and
Other revenue and decreases related to relocated clubs and a decrease in mature
club revenue. Revenues decreased during the quarter by $428,000 or 0.5% at the
Company's mature clubs (clubs owned and operated for at least 24 months) and
revenues decreased $1.0 million due to the closure and relocation of three
clubs. The underlying leases of these three clubs expired in 2003 and we
relocated the members of these clubs to new clubs that were constructed with
these lease expirations in mind. One of the closed clubs was in Boston,
Massachusetts and the other two were in Manhattan. The new clubs are larger
clubs and they are less than a quarter of a mile away from the clubs they
replaced. Fees and Other revenue decreased $1.1 million principally due to a
$1.3 million on-account business interruption insurance payment received in
January 2003 while in 2004 no insurance claim payments were received since the
matter was settled and paid in 2003.
41
The 0.5% decrease in mature club revenue is due to a 2.6% decrease in price
offset by a 1.7% increase in membership and 0.4% increase in ancillary revenue.
Operating Expenses. Operating expenses increased $8.7 million, or 12.0%,
to $81.5 million in the quarter ended March 31, 2004, from $72.8 million in the
quarter ended March 31, 2003. The increase was due to the following factors:
Payroll and related expenses increased by $3.5 million, or 10.6% to
$36.3 million in the quarter ended March 31, 2004, from $32.8 million in
the quarter ended March 31, 2003. This increase was attributable to several
factors.
- In connection with the Restructuring and distribution to common
stockholders of Town Sports International Holdings, Inc., vested
option holders, who were unable to exercise their options, were paid a
one-time bonus recorded as payroll expense. This one-time payment
totaled $1.1 million.
- While our initiation fees received were lower during the first quarter
of 2004, our variable costs of sale rose slightly, due to increased
commission rates paid. When the initial fees do not exceed the costs,
GAAP requires that we must recognize the loss immediately. This
immediate loss effect, together with increased costs of membership
sales accounted for $1.1 million increase when compared to the prior
year's quarter.
- 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 contracted
housekeeping and equipment maintenance services to internally sourced
employees. These customer service efforts resulted in a $344,000
increase.
- Personal training related payroll increased $276,000 or 6.6% due to a
7.1% increase in personal training revenue.
- Lastly, health and unemployment insurance rates have increased
expenses by $346,000.
Club operating expenses increased by $1.2 million or 4.6% to $27.9
million in the quarter ended March 31, 2004, from $26.7 million in the
quarter ended March 31, 2003. This increase is principally attributable to:
- A $900,000 increase in base rent expense resulting from increases
related to clubs that have opened since January 2003, amounting to
$350,000 and increases related to club expansions of $200,000. The
remainder relates to scheduled rent increases at our existing clubs
averaging 3% per club.
- In addition we experienced a $421,000 increase in utilities due to
increases in utility rates, and a 2.4% increase in square footage in
operation.
- These increases were partially offset by a $116,000 decrease in
contracted cleaning and equipment repair costs realized with our
efforts to source these with in-house labor.
General and administrative expenses increased by $1.2 million, or
23.9% to $6.2 million in the quarter ended March 31, 2004 from $5.0 million
in the quarter ended March 31, 2003 attributable to:
- General and administrative increased $703,000 due to increases in
liability insurance. Premiums increased $340,000 coupled with a
favorable adjustment of $363,000 recorded in the first quarter of
2003, where we had adjusted our reserves related to prior period
premium audits.
42
- We also experienced an increase of $332,000 in data line service
costs. This related to $55,000 of enhanced service levels needed in
connection with the rollout of our Club Networks system and $277,000
related to the correction of the service providers billing errors.
Depreciation and amortization increased by $818,000, or 9.9% to $9.1
million in the quarter ended March 31, 2004, from $8.3 million in the
quarter ended March 31, 2003 attributable to:
- Increases in amortization of software and hardware costs principally
related to our recently rolled-out Club Networks system amounting to
$207,000.
- Increases in depreciation related to new clubs and expanded and
remodeled clubs amounts to $286,000 and $310,000 respectively.
Goodwill Impairment. In the quarter ended March 31, 2004 the Company
performed its annual impairment test and determined that the goodwill at one of
its remote clubs was not recoverable. The goodwill impairment 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 for future cash flows of this club to take into account the impact
of a recent opening of a competitor. While this club is expected to generate
cash flow in the future, we no longer expect it to operate at the levels that
were projected at the time the club was acquired. There was no goodwill
impairment from the 2003 annual impairment testing.
Interest Expense. Interest expense increased $4.6 million to $8.8 million
during the quarter ended March 31, 2004, from $4.2 million in the quarter ended
March 31, 2003. This increase is due to the issuance of $255 million of 9 5/8%
Senior Notes, which refinanced $125 million of 9 3/4% Senior Notes in April
2003, and the issuance of $124.8 million of 11% Senior Discount Notes in
February 2004. These 11% Senior Discount Notes were not outstanding this entire
first quarter, and therefore subsequent quarters in 2004 will reflect a further
increase in interest expense when compared to 2003.
Interest Income. Interest income increased $152,000 to $174,000 in the
quarter ended March 31, 2004 from $22,000 in the quarter ended March 31, 2003.
Interest income increased due to higher levels of cash on hand.
Provision for Income Tax. We have recorded a net income tax benefit of
$1.6 million in the quarter ended March 31, 2004 compared to a tax provision of
$4.1 million in the quarter ended March 31, 2003.
Accreted Dividends on Preferred Stock. Accreted dividends on preferred
stock decreased $2.4 million to $783,000 during the quarter ended March 31,
2004, from $3.2 million in the quarter ended March 31, 2003. This decrease is
due to the redemption of the redeemable senior preferred stock in April 2003 and
the redemption of the Series A and Series B preferred stock in February 2004.
After giving effect to the aforementioned redemption of all outstanding
preferred stock our capital structure no longer has outstanding preferred stock
and therefore no dividends will be accreted in periods subsequent to February
2004.
Allowance for Doubtful Accounts. Our allowance for doubtful accounts has
increased from $120,000 to $822,000 when comparing December 31, 2002 to December
31, 2003. Prior to December 31, 2003 we estimated a net receivable to be
collected from "returned" credit charges that were returned by our credit card
processor in the prior months. During the second half of 2003 our newly
implemented membership billing system allowed us to quantify the gross return
charges, after which we estimated a provision for eventual non-collection. The
net receivable related to these returned items was $144,000 as of December 31,
2002 and $50,000 net of a $698,000 reserve as of December 31, 2003. The
remainder of the allowance
43
for doubtful accounts of $120,000 and $124,000 as of December 31, 2002 and 2003
respectively, principally relate to membership receivables that were acquired as
part of a club acquisition.
Deferred Revenue. Total deferred revenue decreased $322,000 or 1% to $29.6
million as of December 31, 2003 compared to $29.9 million as of December 31,
2002. This decrease is due to a $1.3 million or 9.8% decrease in deferred
initiation fees. Deferred initiation fees have decreased primarily due to a
decrease in the average initiation fee collected per new member from $83 in 2002
to $74 in 2003. These decreases were offset by a $1.0 million or 13.4% increase
in deferred revenue related to private training, commensurate with increases in
private training revenue recognized.
YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31, 2002
Revenues. Revenues increased $23.1 million or 7.2%, to $342.5 million
during 2003 from $319.4 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.
44
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% old Notes
representing interest incurred during the 30 day redemption notification period.
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 were accreted thereafter.
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 will be accreted in periods
subsequent to February 2004.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001
Revenues. Revenues increased $37.8 million or 13.4%, to $319.4 million
during 2002 from $281.6 million in 2001. This increase resulted from the 14
clubs opened or acquired in 2001 (approximately $17.0 million), and the 12 clubs
opened or acquired in 2002
45
(approximately $9.1 million). In addition, revenues increased during 2002 by
approximately $11.1 million or 4.1% at our mature clubs (clubs owned and
operated for at least 24 months). The mature club revenue increase is
attributable to a 1.6% increase in membership, a 2.2% increase in dues, and a
0.3% increase in ancillary revenues.
Our mature club revenue increased 18.6%, 12.3% and 4.1% for the years ended
December 31, 2000, 2001 and 2002, 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, which has had an industry-wide
effect. 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 $28.6 million, or 11.3%
to $281.3 million in 2002, from $252.7 million in 2001. This increase was due to
a 13.9% increase in total months of club operations to 1,479 in 2002 from 1,298
in 2001. This increase was partially offset by a $437,000 decrease in
depreciation and amortization from 2001 to 2002. In accordance with SFAS 142 as
of January 1, 2002 goodwill is no longer being amortized.
Payroll and related expenses increased by $16.3 million, or 14.4% to $129.1
million in 2002, from $112.8 million in 2001. This increase was primarily
attributable to the acquisition or opening of 12 clubs in 2002 and a full year
of operating the 14 clubs opened or acquired in 2001. This increase was also
attributable to an increase in health and workers' compensation insurance, and
payroll associated with fee-for-service programs.
Club operating increased by $10.2 million, or 11.4% to $99.1 million in
2002, from $88.9 million in 2001. This increase is primarily attributable to the
acquisition or opening of 12 clubs in 2002 and the additional expenses
attributable to operating the 14 clubs opened or acquired in 2001.
General and administrative increased by $2.6 million, or 13.8% to $21.4
million in 2002, from $18.8 million in 2001. This increase is principally
attributable to a $1.3 million increase in liability and property insurance, and
increases attributable to expenses associated with our expansion, including the
enhancement of our management communication and information systems.
Depreciation and amortization decreased by $437,000, or 1.4% to $31.7
million in 2002, from $32.2 million in 2001. A $2.3 million and a $1.6 million
increase in depreciation and amortization expenses related to clubs opened or
acquired in 2001 and 2002, respectively, was offset by a $4.3 million decrease
in goodwill amortization expense.
Interest Expense. Interest expense increased $1.6 million to $16.6 million
in 2002 from $14.9 million in 2001, primarily as a result of an increase in
subordinated credit borrowings associated with our club base expansion.
Interest Income. Interest income decreased $253,000 to $138,000 in 2002
from $391,000 in 2001. This decrease is due to lower interest rates earned on
cash balances in 2002 as compared to 2001.
Provision for Corporate Income Taxes. The provision for corporate income
taxes increased $2.8 million from $6.9 million in 2001 to $9.7 million in 2002.
Our effective tax rate decreased to 44.8% in 2002 from 47.5% in 2001. This
decrease is due to a decrease in goodwill amortization which was not deductible
for taxes. 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 $20.3 million of
net deferred tax assets.
Discontinued Operations. In the fourth quarter of 2002, we sold or closed
two remote, underperforming, wholly-owned clubs. We considered these clubs
remote, because they were
46
not geographically located within the cluster of clubs their respective brands
served. One club was a Boston Sports Club operating in Nashua, New Hampshire and
the other was a Washington Sports Club operating in Centreville, Virginia. The
Nashua club was 40 miles away from the nearest Boston Sports Club and the
Centreville club was ten miles away from the nearest Washington Sports Club and
thus did not benefit from any material cross-utilization by our members. The
clubs were not generating operating income at the time of their closure or sale.
In connection with the closure of the Centreville club we recorded club closure
costs of $996 related to the write-off of 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.
Revenue and pre-tax losses for these discontinued clubs were $1.7 million
and $894,000 in 2001, and $1.6 million and $322,000 in 2002, respectively.
Cumulative Effect of a Change in Accounting Principle. In connection with
the implementation of SFAS 142 we recorded a goodwill write-off of $1.3 million
in the first quarter of 2002. A deferred tax benefit of $612,000 was recorded in
connection with this goodwill write-off, resulting in a net cumulative effect of
a change in accounting principle of $689,000.
Accreted Dividends on Preferred Stock. Accreted dividends on the Preferred
Stock increased $1.3 million to $11.5 million in 2002, from $10.2 million in
2001. This increase is due to the compounding of accreted dividends.
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
quarter ended March 31, 2004 was $18.9 million compared to $23.6 million during
the quarter ended March 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 $58.3 million compared to $50.8 million for the year ended
December 31, 2002. Cash flows from operations have improved 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 do 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 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 do not represent liabilities that must be funded with cash.
Investing Activities. We invested $7.5 million and $7.4 million in capital
expenditures during the quarters ended March 31, 2004 and 2003, respectively.
Our capital expenditures are net of landlord contributions of $762,000 for the
quarter ended March 31, 2004. We estimate
47
that for the year ending December 31, 2004, we will invest an additional $45.9
million in capital expenditures, which includes $5.2 million that management
intends to invest to expand and renovate certain existing clubs, $13.9 million
to continue to upgrade and enhance existing clubs and $2.0 million to enhance
our management information systems. The remainder of our 2004 capital
expenditures will be committed to build or acquire clubs. Forecast capital
expenditures for the year ending December 31, 2004 totals $53.4 million. These
expenditures will be funded by cash flow provided by operations and available
cash on hand. We invested $42.7 million and $40.2 million in capital
expenditures and asset acquisitions during the years ended December 31, 2003 and
2002, respectively, primarily as a result of our expansion efforts. Our capital
expenditures are net of landlord contributions of $617,000 and $3.5 million
respectively for the years ended December 31, 2003 and 2002.
Financing Activities. 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 $4.3 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.
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 $68,944 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.
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:
48
($000'S)
--------
Redemption of existing 9 3/4% Senior Notes, principal and
interest.................................................. $126,049
Call premium on existing 9 3/4% Senior Notes................ 3,048
Redemption of senior preferred stock, at liquidation
value..................................................... 66,977
Repayment of line of credit principal borrowings and
interest.................................................. 4,013
Repayment of subordinated credit principal borrowings and
interest.................................................. 9,060
Underwriting fees and other closing costs................... 9,578
Available for general corporate purposes.................... 36,275
--------
Total use of funds.......................................... $255,000
========
As of March 31, 2004, our total consolidated debt was $387.8 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.
Net cash provided by financing activities was $1.4 million for the quarter
ended March 31, 2004 compared to net cash used in financing activities of $12.7
million for the same period in 2003.
Net cash used in financing activities was $19.7 million for the year ended
December 31, 2003 compared to net cash provided by financing activities of $10.5
million for the same period in 2002 and compared to $16.1 million for the same
period in 2001.
As of March 31, 2004, we had $126.9 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 March 31, 2004, no borrowings were outstanding
under this line. As of March 31, 2004 outstanding letters of credit totaled $1.7
million. As of March 31, 2004, we had approximately $48.3 million unutilized the
line of credit, which matures in April 2008, and has no scheduled amortization
requirements. As of March 31, 2004 we also had $52.4 million of cash and cash
equivalents.
The line of credit contains restrictive covenants including a leverage
ratio and interest coverage ratio and dividend payment restrictions and is
collateralized by all the assets of the Company. As of March 31, 2004 our Net
Leverage Ratio, and Net Interest Coverage Ratio as defined by the terms of the
line of credit agreement are 3.5 and 3.0 to 1.0, respectively. Our ability to
incur additional debt is limited by the terms of the line of credit facility in
that the Net Leverage Ratio, as defined, cannot exceed 4.0 to 1.0 and the Net
Interest Coverage Ratio must be greater than 2.5 to 1.0. Accordingly the
availability under this facility was restricted to
49
$37.9 million as of March 31, 2004. Our common stock is not publicly traded and
therefore our ability to raise equity financing is not as readily available as
it is for companies that have publicly traded common stock.
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 2008.
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 2008. 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 AND COMMITMENTS SUMMARY
The aggregate long-term debt, capital lease, and operating lease
obligations as of March 31, 2004 were as follows:
PAYMENTS DUE BY PERIOD (IN $'000)
---------------------------------------------------------
LESS THAN AFTER
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
----------------------- ---------- --------- --------- --------- --------
Long-Term Debt(1)............. $ 386,039 $ 1,167 $ 1,409 $ 747 $382,716
Capital Lease
Obligations(2).............. 1,802 1,650 152 -- --
Operating Lease
Obligations(3).............. 629,263 51,490 103,762 98,095 375,916
---------- ------- -------- ------- --------
Total Contractual Cash
Obligations................. $1,017,104 $54,307 $105,323 $98,842 $758,632
========== ======= ======== ======= ========
------------
Notes:
(1) The long-term debt contractual cash obligations include principal payment
requirements on our 9 5/8% Senior Notes and our 11% Discount Notes. Interest
on our 9 5/8% Senior Notes amounts to $24.5 million annually and our
Discount Notes will accrete another $86.1 million of interest through
maturity.
(2) Capital lease obligations represent principal and interest payments.
(3) Operating lease obligations include base rent only. Certain leases provide
for additional rent based on increases in real estate tax indexation,
utilities, and defined amounts based on the operating results of the lessee.
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 this
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
50
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
$4.3 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 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 $68,944 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.
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 two billion dollars in damages for personal injuries.
His cause of action seeking punitive damages in the amount of two hundred and
fifty 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 fifty one million dollars 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 TSI, 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. We anticipate that these
matters will be covered by insurance.
The Company does not believe this matter will have a material effect on its
consolidated financial position, results of operations or cash flow.
EFFECT ON RECENT CHANGES IN ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. Interpretation No. 46 requires a variable interest
entity, or VIE, to be consolidated by a company if that company is subject to a
majority of the risk of loss from the VIE's activities or is entitled to receive
a majority of the entity's residual return or both. Interpretation No. 46 also
provides criteria for determining whether an entity is a VIE subject to
consolidation. Interpretation No. 46 also sets forth certain disclosures
regarding interests in VIE that are
51
deemed significant, even if consolidation is not required. In December 2003, a
modification to Interpretation No. 46 was issued (Interpretation No. 46R) which
delayed the effective date until no later than fiscal periods ending after March
31, 2004 and provided additional technical clarifications to implementation
issues. The Company does not currently have any variable interest entities as
defined in Interpretation No. 46R. The Company does not expect that the adoption
of this statement will have a material impact on the consolidated financial
statements.
In May 2003, the FASB issued Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liability and Equity (FAS
150), which establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. FAS 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. As of December 31, 2003 the
Company does not have financial instruments within the scope of this
pronouncement.
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 with 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
52
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 HTML 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, goodwill 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 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, 2003 and March 31, 2004 our net deferred tax assets
totaled $16.8 million and $18.6 million respectively. 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 $13.5
million, $20.4 million and $13.0 million, and current tax liabilities were $11.0
million, $10.3 million and $2.1 million for the years ended December 31, 2001,
2002 and 2003, respectively. Because there is currently no evidence we will not
continue to be profitable, 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.
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 2003, our interest income from cash
equivalents would have increased by approximately $500,000. These amounts are
determined by considering the impact of the hypothetical interest rates on our
cash equivalents balance during 2003.
53
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.
54
BUSINESS
OUR COMPANY
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 March 31, 2004,
we owned and operated 130 fitness clubs and partly owned and operated two
fitness clubs. These 132 clubs collectively served approximately 365,000
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, 2003, approximately
52% 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 36
locations and operate a total of 87 clubs under the NYSC name within a 50 mile
radius of New York City. We operate 20 clubs in the Boston region and 16 clubs
in the Washington, DC region under our Boston Sports Club ("BSC") and Washington
Sports Club ("WSC") 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.
We sell month-to-month membership payment plans that are generally
cancelable by our members at any time with 30 days notice. Effective October,
2003 we also began to sell one and two year commit memberships at a discount to
the month-to-month non-commit membership plan. The one year commit membership is
typically the same monthly rate, which is paid monthly as the month-to-month
plan but with a discounted initiation fee, and the two year commit memberships
are typically at a 10% discount to the month-to-month plan also with a
discounted initiation fee. As of December 31, 2003, approximately 81% of our
members had a month-to-month non-commit membership plan. We believe members
prefer to have the choice to commit for a year or two at a discount to the
month-to-month plan or to have the flexibility of the month-to-month non-commit
plan.
We have experienced significant growth over the past several 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, 1999, to
March 31, 2004, we acquired 21 existing clubs, opened 49 greenfield clubs,
relocated five clubs, sold one club, and closed one club to increase our total
clubs under operation from 69 to 132. From January 1, 2004 through March 31,
2004 we opened three new clubs and we currently plan to open or acquire seven
more clubs prior to December 31, 2004. We have achieved revenue growth over the
five year period ended
55
December 31, 2003 from $158.2 million for the year ended December 31, 1999 to
$342.5 million for the year ended December 31, 2003.
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------
1999 2000 2001 2002 2003
-------- -------- -------- -------- --------
Revenue....................... $158,184 $223,828 $281,633 $319,427 $342,541
Increase over prior year.... 41.5% 25.8% 13.4% 7.2%
This growth has been driven not only 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, 2003
and averaged 10.5% over that period. Such growth was 1.6% for the year ended
December 31, 2003. Mature club, defined as those clubs that we operated for more
than 24 months, revenue growth has enabled us to increase revenue per weighted
average club over the five year period ended December 31, 2003. Revenue per
weighted average club (as defined in Selected Financial Data) has risen from
$2.1 million for the year ended December 31, 1999 to $2.7 million for the year
ended December 31, 2003. 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 achieve
consistent increases in cash flows from operations over the five year period
ended December 31, 2003. Cash flows from operations improved from $29.5 million
in 1999 to $58.3 million for the year ended December 31, 2003. Net income
improved from $49,000 in 1999 to $7.4 million for the year ended December 31,
2003.
FOR THE YEARS ENDED DECEMBER 31, (IN $000'S)
------------------------------------------------
1999 2000 2001 2002 2003
------- -------- ------- ------- -------
Operating income..................... $10,988 $ 23,347 $28,956 $38,093 $43,965
Increase over prior year........... 112.5% 24.0% 31.6% 15.4%
Net income........................... $ 49 $ 4,831 $ 7,046 $10,507 $ 7,429
Increase (decrease) over prior
year............................ 9,759.2% 45.8% 49.1% (29.3)%
Cash flows from operations........... $29,496 $ 40,573 $44,348 $50,805 $58,253
Increase over prior year........... 37.6% 9.3% 14.6% 14.7%
Over our 30-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 75,000 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 space 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 we
strive to make available to our members. We strive to 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 customized 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 132 clubs under
operation and the seven sites for which we have entered into lease commitments,
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
56
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. This operating leverage has already helped us to increase
operating income as a percent of revenue increased to 12.8% for the year ended
December 31, 2003 compared to 6.9% in 1999.
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 2001, 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 six) has increased
significantly from 7.4% in 1990 to 13.5% in 2001.
FITNESS CLUB REVENUES(1)
(IN $ BILLIONS)
[FITNESS CLUB REVENUES BAR GRAPHIC]
------------
(1) Industry revenues for 1991 and 1992 are not available.
U.S. FITNESS CLUBS MEMBERSHIP
(IN MILLIONS)
[FITNESS CLUB MEMBERSHIP BAR GRAPHIC]
Total U.S. fitness club industry revenues increased from $6.5 billion in
1993 to $13.1 billion in 2002, while the total number of clubs increased from
12,146 in 1991 to 20,207 in 2002. Growth in club memberships outpaced club
growth during this period, increasing from 20.9 million in 1991 to 36.3 million
in 2002.
57
NUMBER OF U.S. HEALTH, RACQUET, & SPORTS CLUBS (IN 000'S)
(BAR CHART)
Notwithstanding these longstanding growth trends, 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 $95.00 per month; (ii) a middle tier
consisting of clubs with monthly membership dues averaging between $45.00 and
$95.00 per month; and (iii) a lower tier consisting of clubs with monthly
membership dues averaging less than $45.00 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 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 the brand, is
directed by our in-house media department which is headed by the Chief Executive
Officer and the newly appointed V.P. 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
58
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, and
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 co-operative
advertising campaigns with local and regional retailers.
We maintain the following web site: www.mysportsclubs.com that provides
information about club locations, program offerings, exercise class schedules
and on-line promotions. Our web site provides our members a venue to give us
direct feedback on all of our services and offerings. We also use our web site
to promote career opportunities.
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 both to our area
sales managers, who in turn report to our Vice President Sales. 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) for
non-commit membership plans, the lack of a long-term 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 employ seven full-time corporate
sales managers 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. We
generally offer three principal types of memberships:
The Passport Membership, priced from $45 to $92 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 52% of our members.
In addition, we have introduced a Passport Premium membership for a select
club, that includes more member services, at a price greater than $100 per
month.
The Gold Membership, priced from $39 to $84 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 47% of our members.
59
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 corporate membership plans that vary in price depending
on the respective corporation's needs. The corporate membership plans are
typically at a discount to that of individual membership plans.
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 monthly dues on an
ongoing basis. Monthly Electronic Funds Transfer "EFT" of individual membership
dues averaged approximately $70 per month for the year ended December 31, 2003.
During that same period, initiation fees averaged $74 for EFT members. We
collect 92.8% of all monthly membership dues through EFT and EFT revenue
constituted over 73% of consolidated revenue for the year ended December 31,
2003. Substantially all other membership dues are paid in advance. Based upon a
study of the membership base at our clubs open over 24 months, the average
length of our memberships is approximately 24 months. 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, eliminates 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 staff.
For the year ended December 31, 2003, we experienced an average of uncollected
EFT dues of 1.3%.
Our total monthly EFT revenue has increased by $10.1 million or 88.6% from
$11.4 million in December, 1999 to $21.5 million in December, 2003. While we
strongly encourage monthly EFT memberships, approximately 7% of our members
(often corporate group members) purchase paid-in-full memberships for a one year
term.
FOR THE MONTH ENDED DECEMBER 31, (IN $000'S)
-----------------------------------------------
1999 2000 2001 2002 2003
------- ------- ------- ------- -------
Monthly EFT revenue................. $11,424 $15,623 $18,572 $21,410 $21,513
Increase over prior year.......... 36.8% 18.9% 15.3% 0.5%
ANCILLARY REVENUE
Over the past five years we have expanded the level of ancillary services
provided to our members. Ancillary revenue has increased by $28.7 million from
$17.1 million in 1999 to $46.0 million in 2003. Increases in personal training
revenue in particular have contributed to $18.9 million of the increase in
ancillary revenue from 1999 to 2003. In addition the Company has added Sports
Club for Kids and Group Exclusives (both additional fee for service
60
programs) at selected clubs. Ancillary revenue as a percentage of total revenue
has increased from 10.8% for the year ended December 31, 1999 to 13.4% for the
year ended December 31, 2003. Personal training revenue as a percentage of sales
increased from 7.7% of revenue in 1999 to 9.1% of revenue in 2003.
FOR THE YEARS ENDED DECEMBER 31, (IN $000'S)
------------------------------------------------------
1999 % 2000 % 2001
-------- --------- -------- --------- --------
Total Revenue......... $158,184 100.0% $223,828 100.0% $281,633
ANCILLARY REVENUE:
Private training
revenue............. 12,149 7.7% 19,827 8.9% 25,358
Other ancillary
revenue............. 4,905 3.1% 8,967 4.0% 12,578
-------- ----- -------- ----- --------
Total ancillary
revenue............. $ 17,054 10.8% $ 28,794 12.9% $ 37,936
======== ===== ======== ===== ========
FOR THE YEARS ENDED DECEMBER 31, (IN $000'S)
-------------------------------------------------------
% 2002 % 2003 %
--------- -------- --------- -------- ---------
Total Revenue......... 100.0% $319,427 100.0% $342,541 100.0%
ANCILLARY REVENUE:
Private training
revenue............. 9.0% 28,450 8.9% 31,171 9.1%
Other ancillary
revenue............. 4.5% 14,008 4.4% 14,860 4.3%
----- -------- ----- -------- -----
Total ancillary
revenue............. 13.5% $ 42,458 13.3% $ 46,031 13.4%
===== ======== ===== ======== =====
CLUB FORMAT AND LOCATIONS
Our clubs are typically located in well-established, higher-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 in
accordance 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 75,000 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
steamrooms; babysitting, and a retail shop. 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 also are
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 have completed the launch of our Xpressline strength workout. Xpressline
is a trainer-supervised, eight-station total-body circuit workout designed to
accommodate all fitness levels. This service is a free service provided 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, a compact
disk player and most models have audio cassette
61
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.
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.
Corporate departments are responsible for each area of club services, such
as exercise group programs, fitness 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. General managers are
responsible for the day-to-day management of each club, and directly report to
district managers, who liaise with senior operations management and other
corporate staff ensuring consistent service at all locations.
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 2003,
SCFK was operating in 15 locations throughout our NYSC, BSC, and PSC regions. In
addition to extending fitness offerings to a market 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
62
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 have 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.
PROPRIETARY CENTRALIZED INFORMATION SYSTEMS
We are utilizing a proprietary system developed internally to track and
analyze sales, leads, and membership statistics, the frequency 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.
During 2001, we implemented a new time capture system that integrates with
our payroll processing system. This system integrates with the new club
management system to fully automate the various compensation plans for all
employees. In addition, during 2002, we implemented a new budgeting and
forecasting product that was expanded in 2003 for data warehousing capabilities
which will enable enhanced managerial and analytical reporting. We implemented
application and telephone systems to manage our internal customer service center
which supports information technology, facilities, equipment and Sportsclub
Network service call requests for all locations. Numerous infrastructure changes
were implemented to accommodate our growth, to provide network redundancy,
efficiencies in operations, and to improve management of all components of the
technical architecture.
In 2003 we implemented a new fully integrated club management system. This
system incorporates contemporary browser-based technology and open architecture
to allow for scalability to support our projected growth and diversification of
services. This system provides enhanced or new functionality for member
services, contract management, electronic billing, point of sale, scheduling
resources, and reservations.
Our website will be expanded in 2004 to incorporate e-business
functionality such as sales of products, services and memberships. We have built
an intranet to provide the portal for the newly implemented browser-based
application. Development of intranet features to support corporate
communications, human resources programs, and training is ongoing.
In 2004, we will also implement an updated Disaster Recovery plan that will
include a designated back-up and redundant data center available for disaster
recovery procedures, data restoration testing, and training of personnel.
63
STRATEGIC PLANNING
During 2001, the Company began a strategic planning process. That process,
spearheaded by the Chairman and the Chief Executive Officer, produced a new set
of Core Values, a revised Mission Statement and a set of five-year performance
targets. These targets relate to improved customer experience, and therefore
member retention; information technology productivity, market penetration,
ancillary revenue growth, employee retention and succession planning; overall
operating margin improvement and return on capital employed. In 2002, more than
40 projects were completed in support of the Plan's Strategic Initiatives and
Objectives. Our Chairman and Chief Executive Officer led the strategy process,
which has produced significant changes in our approach to our Brand, our Core
Business Development process and our Intranet strategy. Among the results of our
Brand objective was a "flattening" of our club management structure. This gives
in-club management broader responsibility and reduces the span of control of
district managers so that they can focus on fewer locations. Together with our
IT strategies, we anticipate that such changes will reduce the administrative
burden placed upon our club management staff and provide a platform for improved
customer service. Our Core Business Development initiatives have improved our
ability to target markets and enhanced the accuracy of our business model.
Finally, our IT 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.
The Strategic Plan was updated in 2003 with new Strategic Initiatives in
several areas. Senior Management continues to support the Strategic Planning
process and believes that accomplishing our strategic objectives will cause us
to attain the five-year performance targets outlined in the 2003 Plan.
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
12,146 in 1991 to 20,207 in 2002. While we are not aware of any dominant
competitors, 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 are 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
64
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
MARKET # CLUBS POSITION
------ ---------- --------
Boston metro 20 Leading operator
New York metro 86 Leading operator
Philadelphia metro 6 #3 operator
Washington D.C. metro 16 #2 operator, although leader in urban center
Switzerland 3 Local operator only
We also compete with other entertainment and retail businesses for the
discretionary income of our target markets. 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, 2003, the Company had approximately 7,200 employees, of
which approximately 2,750 were employed full-time. Approximately 325 employees
were corporate personnel working in the Manhattan, Boston or Washington, DC
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.
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
65
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 for
cancellation in these circumstances 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 cancellation fee is due
upon cancellation and we may offset such amount against any refunds owed.
66
PROPERTIES
The following table provides information regarding our club locations:
DATE OPENED OR MANAGEMENT
LOCATION ADDRESS ASSUMED
-------------------------------------------------------------------------------------------
NEW YORK SPORTS CLUBS:
1. Manhattan 151 East 86th Street January, 1977
2. Manhattan 61 West 62nd Street July, 1983
3. Manhattan 614 Second Avenue July, 1986
4. Manhattan 151 Reade Street January, 1990
5. Manhattan 1601 Broadway September, 1991
6. Manhattan 50 West 34th Street August, 1992
7. Manhattan 349 East 76th Street April, 1994
8. Manhattan 248 West 80th Street May, 1994
9. Manhattan 502 Park Avenue February, 1995
10. Manhattan 117 Seventh Avenue South March, 1995
11. Manhattan 303 Park Avenue South December, 1995
12. Manhattan 30 Wall Street May, 1996
13. Manhattan 1635 Third Avenue October, 1996
14. Manhattan 575 Lexington Avenue November, 1996
15. Manhattan 278 Eighth Avenue December, 1996
16. Manhattan 200 Madison Avenue February, 1997
17. Manhattan 131 East 31st Street February, 1997
18. Manhattan 2162 Broadway November, 1997
19. Manhattan 633 Third Avenue April, 1998
20. Manhattan 1657 Broadway July, 1998
21. Manhattan 217 Broadway March, 1999
22. Manhattan 23 West 73rd Street April, 1999
23. Manhattan 34 West 14th Street July, 1999
24. Manhattan 503-511 Broadway July, 1999
25. Manhattan 1372 Broadway October, 1999
26. Manhattan 300 West 125th Street May, 2000
27. Manhattan 102 North End Avenue May, 2000
28. Manhattan 14 West 44th Street August, 2000
29. Manhattan 128 Eighth Avenue December, 2000
30. Manhattan 2521-23 Broadway August, 2001
31. Manhattan 3 Park Avenue August, 2001
32. Manhattan 19 Irving Place November, 2001
33. Manhattan 160 Water Street November, 2001
34. Manhattan 230 West 41st Street November, 2001
35. Manhattan 1221 Avenue of the Americas January, 2002
36. Manhattan 200 Park Avenue December, 2002
37. Brooklyn, NY 110 Boerum Place October, 1985
38. Brooklyn, NY 1736 Shore Parkway June, 1998
39. Brooklyn, NY 179 Remsen Street May, 2001
40. Brooklyn, NY 453 Fifth Avenue August, 2003
41. Brooklyn, NY 7118 Third Avenue May, 2004
42. Queens, NY 69-33 Austin Street April, 1997
43. Queens, NY 153-67 A Cross Island Parkway June, 1998
67
DATE OPENED OR MANAGEMENT
LOCATION ADDRESS ASSUMED
-------------------------------------------------------------------------------------------
44. Queens, NY 2856-2861 Steinway Street February, 2004
45. Staten Island, NY 300 West Service Road June, 1998
46. Scarsdale, NY 696 White Plains Road October, 1995
47. Mamaroneck, NY 124 Palmer Avenue January, 1997
48. White Plains, NY 1 North Broadway September, 1997
49. Croton-on-Hudson, NY 420 South Riverside Drive January, 1998
50. Larchmont, NY 15 Madison Avenue December, 1998
51. Nanuet, NY 58 Demarest Mill Road May, 1998
52. Great Neck, NY 15 Barstow Road July, 1989
53. East Meadow, NY 625 Merrick Avenue January, 1999
54. Commack, NY 6136 Jericho Turnpike January, 1999
55. Oceanside, NY 2909 Lincoln Avenue May, 1999
56. Long Beach, NY 265 East Park Avenue July, 1999
57. Garden City, NY 833 Franklin Avenue May, 2000
58. Huntington, NY 350 New York Avenue February, 2001
59. Syosset, NY 49 Ira Road March, 2001
60. West Nyack, NY 3656 Palisades Center Drive February, 2002
61. Woodmere, NY 158 Irving Street March, 2002
62. Baldwin Place, NY 80 East Main St. Opening 2004
63. White Plains, NY 14 City Place Opening 2005
64. Stamford, CT 6 Landmark Square December, 1997
65. Stamford, CT 16 Commerce Road January, 1998
66. Danbury, CT 38 Mill Plain Road January, 1998
67. Stamford, CT 1063 Hope Street November, 1998
68. Norwalk, CT 250 Westport Avenue March, 1999
69. Greenwich, CT 6 Liberty Way May, 1999
70. Westport, CT 427 Post Road, East January, 2002
71. Greenwich, CT 67 Mason Street February, 2004
72. East Brunswick, NJ 8 Cornwall Court January, 1990
73. Princeton, NJ 301 North Harrison Street May, 1997
74. Freehold, NJ 200 Daniels Way April, 1998
75. Matawan, NJ 163 Route 34 April, 1998
76. Old Bridge, NJ Gaub Road and Route 516 April, 1998
77. Marlboro, NJ 34 Route 9 North April, 1998
78. Fort Lee, NJ 1355 15th Street June, 1998
79. Ramsey, NJ 1100 Route 17 North June, 1998
80. Mahwah, NJ 7 Leighton Place June, 1998
81. Parsippany, NJ 2651 Route 10 August, 1998
82. Springfield, NJ 215 Morris Avenue August, 1998
83. Colonia, NJ 1250 Route 27 August, 1998
84. Franklin Park, NJ 3911 Route 27 August, 1998
85. Plainsboro, NJ 10 Schalks Crossing August, 1998
86. Somerset, NJ 120 Cedar Grove Lane August, 1998
87. Hoboken, NJ 221 Washington Street October, 1998
88. West Caldwell, NJ 913 Bloomfield Avenue April, 1999
89. Jersey City, NJ 147 Two Harborside Financial Center June, 2002
90. Newark, NJ 1 Gateway Center October, 2002
68
DATE OPENED OR MANAGEMENT
LOCATION ADDRESS ASSUMED
-------------------------------------------------------------------------------------------
91. Ridgewood, NJ 129 S. Broad Street June, 2003
92. Westwood, NJ 35 Jefferson Avenue June, 2004
93. Livingston, NJ 39 W. North Field Rd. Opening 2004
94. Hoboken, NJ 1225 Willow Avenue Opening 2005
BOSTON SPORTS CLUBS:
95. Boston, MA 561 Boylston Street November, 1991
96. Allston, MA 15 Gorham Street July, 1997
97. Boston, MA 1 Bulfinch Place August, 1998
98. Natick, MA Sherwood Plaza, 124 Worcester Rd September, 1998
99. Weymouth, MA 553 Washington Street May, 1999
100. Boston, MA 201 Brookline Avenue June, 2000
101. Wellesley, MA 140 Great Plain Avenue July, 2000
102. Andover, MA 307 Lowell Street July, 2000
103. Lynnfield, MA 425 Walnut Street July, 2000
104. Lexington, MA 475 Bedford Avenue July, 2000
105. Franklin, MA 750 Union Street July, 2000
106. Framingham, MA 1657 Worcester Street July, 2000
107. Danvers, MA 50 Ferncroft Road July, 2000
108. Cambridge, MA 625 Massachusetts Avenue January, 2001
109. East Cambridge, MA 6 Museum Way January, 2001
110. Boston, MA 361 Newbury Street November, 2001
111. West Newton, MA 1359 Washington Street November, 2001
112. Boston, MA 350 Washington Street February, 2002
113. Waltham, MA 840 Winter Street November, 2002
WASHINGTON SPORTS CLUBS:
114. Washington, D.C. 214 D Street, S.E. January, 1980
115. Washington, D.C. 1835 Connecticut Avenue, N.W. January, 1990
116. Washington, D.C. 1990 M Street, N.W. February, 1993
117. Washington, D.C. 2251 Wisconsin Avenue, N.W. May, 1994
118. Washington, D.C. 1211 Connecticut Avenue, N.W. July, 2000
119. Washington, D.C. 1345 F Street, N.W. August, 2002
120. Washington, D.C. 5346 Wisconsin Ave., N.W. February, 2002
121. Washington, D.C. 1990 K Street, N.W. February, 2004
122. Washington, D.C. 783 Seventh Street, N.W. Opening 2004
123. Washington, D.C. 3222 M Street, N.W. Opening 2004
124. Bethesda, MD 4903 Elm Street May, 1994
125. North Bethesda, MD 10400 Old Georgetown Road June, 1998
126. Germantown, MD 12623 Wisteria Drive July, 1998
127. Silver Spring, MD Wayne Ave Opening 2004
128. Alexandria, VA 3654 King Street June, 1999
129. Sterling, VA 21800 Town Center Plaza October, 1999
130. Fairfax, VA 11001 Lee Highway October, 1999
131. West Springfield, 8430 Old Keene Mill September, 2000
VA
132. Clarendon, VA 2700 Clarendon Boulevard November, 2001
PHILADELPHIA SPORTS CLUBS:
133. Philadelphia, PA 220 South 5th Street January, 1999
134. Philadelphia, PA 2000 Hamilton Street July, 1999
69
DATE OPENED OR MANAGEMENT
LOCATION ADDRESS ASSUMED
-------------------------------------------------------------------------------------------
135. Chalfont, PA One Highpoint Drive January, 2000
136. Cherry Hill, NJ Route 70 and Kings Highway April, 2000
137. Philadelphia, PA 1735 Market Street October, 2000
138. Ardmore, PA 34 W. Lancaster Avenue March, 2002
SWISS SPORTS CLUBS:
139. Basel, Switzerland St. Johanns-Vorstadt 41 August, 1987
140. Zurich, Switzerland Glarnischstrasse 35 August, 1987
141. Basel, Switzerland Basel FC Soccer Stadium August, 2001
------------
We have also signed two leases for greenfield club development. These
locations are, however, part of development projects and are subject to
various conditions, including delivery of the space as specified in the lease.
We own the 151 East 86th Street location, which houses a fitness club and a
retail tenant that generated $614,000 of rental income for us during the year
ended December 31, 2003. 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, 2008), only Location No. 85 above (on September 30,
2007) will expire without any renewal option.
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 New York fitness clubs.
As of March 31, 2004, 130 of the existing fitness clubs were wholly owned
by us and Location No. 114 and 115 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 two fitness clubs in which we
have no equity interest.
70
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
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.
NAME AGE POSITION
---- --- --------
Mark Smith............................. 45 Chairman and Director
Robert Giardina........................ 46 Chief Executive Officer, Office of the President
Alexander Alimanestianu................ 45 Chief Development Officer, Office of the
President
Richard Pyle........................... 45 Chief Financial Officer, Office of the President
Randy Stephen.......................... 46 Chief Operating Officer
Robert S. Herbst....................... 45 Vice President and General Counsel
Keith E. Alessi........................ 49 Director
Paul Arnold............................ 57 Director
Bruce Bruckmann........................ 50 Director
J. Rice Edmonds........................ 33 Director
Jason Fish............................. 46 Director
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 20 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
71
with several premier retailers including Eastern Mountain Sports, Eddie Bauer,
Keeger & Sons and Britches of Georgetown.
Robert S. Herbst joined us in November 2003 as Vice President and General
Counsel. From 1984 through 1995, Mr. Herbst was an attorney in private practice
in New York City. He served as Assistant General Counsel of Coty Inc. from 1999
through 2003 and as Senior Corporate Counsel of Pfizer Inc. from 1995 through
1999. Mr. Herbst has a broad background in the fitness industry, having been a
competitive powerlifter and coach for more than 20 years.
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 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 Penhall International, Inc., Mohawk Industries, Inc.,
H&E Equipment Services L.L.C. and Anvil Knitwear, Inc. and a director of 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. 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.
72
EXECUTIVE COMPENSATION
The following summarizes, for the year indicated, the principal components
of compensation for our Chief Executive Officer and the other four highest
compensated executive officers (collectively, the "named executive officers").
The compensation set forth below fully reflects compensation paid by TSI, Inc.
for work performed on our behalf.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
AWARDS
COMMON
STOCK
OTHER ANNUAL UNDERLYING
SALARY BONUS (1) COMPENSATION OPTIONS/SARS
NAME AND PRINCIPAL POSITION PERIOD ($) ($) ($) (#)
--------------------------- ------ ------- --------- ------------ ------------
Mark Smith.......................... 2003 434,594 511,133 -- 6,000
Chairman 2002 426,072 429,224 -- --
2001 413,662 364,597 -- --
Robert Giardina..................... 2003 412,179 406,227 -- 6,000
Chief Executive Officer, 2002 404,097 327,312 -- --
Office of the President 2001 392,327 276,678 -- --
Richard Pyle........................ 2003 306,270 251,746 -- 5,000
Chief Financial Officer, 2002 236,539 252,815 -- --
Office of the President 2001 215,035 216,258 -- --
Alexander Alimanestianu............. 2003 306,270 251,746 -- 5,000
Chief Development Officer, 2002 236,539 252,815
Office of the President 2001 215,035 216,258 -- --
Randy Stephen....................... 2003 225,000 95,755 -- 4,000
Chief Operating Officer,
Senior Vice President
Deborah Smith(2).................... 2002 178,098 171,690 -- --
Senior Vice President, 2001 172,911 145,839 -- --
Operations
------------
(1) Includes annual bonus payments under our Annual Bonus Plan.
(2) Ms. Smith has resigned her position with the Company effective January 2003.
OPTION/SAR GRANTS DURING THE YEAR ENDED DECEMBER 31, 2003
In 2003 common stock options with a term of ten years were granted to named
executive officers as follows:
OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
-------------------------------------------- ANNUAL RATES OF
NUMBER OF PERCENT OF TOTAL STOCK PRICE
SECURITIES OPTIONS/SARS EXERCISE APPRECIATION FOR
UNDERLYING GRANTED TO BASE OPTIONS TERM
OPTION/SARS EMPLOYEES IN PRICE EXPIRATION ---------------------
NAME GRANTED(#) FISCAL YEAR ($/SH) DATE 5% ($) 10% ($)
---- ----------- ---------------- -------- ---------- ------ -------
Mark Smith.................... 6,000 12.9% $144 July 2013 $43,200 $86,400
Robert Giardina............... 6,000 12.9% $144 July 2013 43,200 86,400
Richard Pyle.................. 5,000 10.8% $144 July 2013 36,000 72,000
Alexander Alimannestianu...... 5,000 10.8% $144 July 2013 36,000 72,000
Randy Stephen................. 4,000 8.6% $144 July 2013 28,000 57,600
73
AGGREGATED OPTION/SAR EXERCISES DURING THE YEAR ENDED DECEMBER 31, 2003 AND 2003
YEAR-END OPTION/SAR VALUES
The following summarizes exercises of stock options (granted in prior
years) by the named executive officers during the year ended December 31, 2003
as well as the number and value of all unexercised options held by the named
executive officers as of December 31, 2003.
VALUE OF UNEXERCISED
NUMBER OF SECURITIES IN-THE-MONEY
OPTIONS/SARS OPTIONS/SARS
SHARES AT FY-END (#) AT FY-END ($)(1)
ACQUIRED ON VALUE VALUE EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
EXERCISE (#) REALIZED ($) REALIZED ($) ------------------------- -------------------------
NAME COMMON COMMON PREFERRED COMMON COMMON PREFERRED
---- ------------ ------------ ------------ ------------------------- ----------- -----------
Mark Smith........... -- -- $2,479,901 10,030/4,800 529,800/0 --
Robert Giardina...... -- -- 1,899,575 10,029/4,800 529,740/0 --
Richard Pyle......... -- -- 1,596,961 9,828/4,000 529,680/0 --
Alexander
Alimanestianu...... -- -- 1,575,547 9,828/4,000 529,680/0 --
Randy Stephen........ -- -- -- 800/3,200 -- --
Deborah Smith........ -- -- 540,653 5,750/0 338,400/0 --
------------
(1) Value realized is based upon the fair market value of the stock at the
exercise date minus the exercise price. Fair market value was determined in
good faith by the Board of Directors to be $61.00 per share of common stock
and was based upon an independent valuation dated June 1, 2003.
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. STOCK OPTION PLAN
Our board of directors has adopted a stock option plan, which provides for
the grant to some of 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.
Options awarded under the plan are exercisable into shares of our common
stock. The total number of shares of common stock as to which options may be
granted may not exceed 160,759 shares of common stock. Options may be granted to
any of our employees, directors or consultants.
If we undergo a reorganization, 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 attended telephonically. When our
Audit or Compensation Committees meet, our independent directors receive $1,000
when attended in person and $500 when attended 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.
74
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.
See the agreements filed as Exhibits 10.12 to 10.16 hereto for a description of
the formula. The named executive officers do not have a right or obligation
under the executive stock agreements to purchase additional shares of TSI
Holding's.
The table below sets out the number of shares of our common stock purchase
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.
NUMBER OF SHARES OF COMMON NUMBER OF SHARES OF COMMON
STOCK CURRENTLY HELD STOCK UNDERLYING THE OPTIONS
-------------------------- ----------------------------
Mark Smith.................... 74,955 6,000(1)
Robert Giardina............... 59,480 6,000(1)
Richard Pyle.................. 51,410 5,000(2)
Alexander Alimanestianu....... 50,839 5,000(2)
Randy Stephen................. -- 4,000(3)
(1) The exercise price for 1,200 options, each to purchase one underlying share
of our common stock, is $144.00 and the exercise price for 4,800 options,
each to purchase one underlying share of our common stock, is $91.50.
(2) The exercise price for 1000 options, each to purchase one underlying share
of our common stock, is $144.00 and the exercise price for 3000 options,
each to purchase one share of underlying share of our common stock, is
$91.50.
(3) The exercise price for 800 options, each to purchase one underlying share of
our common stock, is $144.00 and the exercise price for 3,200 options, each
to purchase one underlying share of our common stock, is $91.50.
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 five hundred dollars per annum. In February 2003 and 2004, employer
matching contributions totaling $200,000 and $195,000, respectively, were made
for the Plan years ended December 31, 2002 and 2003.
75
SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS
The following table sets forth (as of March 31, 2004) certain information
with respect to the beneficial ownership of the common stock and preferred 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 named executive
officers. TSI Holdings preferred stock will be redeemed with the proceeds of
this offering and the transactions. See "The Transactions."
COMMON
STOCK PERCENTAGE OF
BENEFICIALLY COMMON STOCK
NAME OWNED(1) OUTSTANDING(1)
---- ------------ --------------
BRS(2)
126 East 56th Street, 29th Floor
New York, New York 10022.................................. 504,456 37.8%
The Farallon Entities(3)
One Maritime Plaza, Suite 1325
San Francisco, California 94111........................... 270,091 20.2%
The Canterbury Entities(4)
600 Fifth Avenue, 23rd Floor
New York, New York 10020.................................. 139,437 10.4%
Executive Officers and Directors:
Mark Smith(5)............................................. 76,155 5.7%
Robert Giardina(5)........................................ 60,680 4.6%
Richard Pyle(5)........................................... 52,410 3.9%
Alexander Alimanestianu(5)................................ 51,839 3.9%
Randy Stephen............................................. * *
Deborah Smith(5).......................................... 21,658 1.6%
Bruce C. Bruckmann(6)..................................... 517,642 38.8%
J. Rice Edmonds(7)........................................ 504,456 37.8%
Jason Fish(8)............................................. 23,000 1.7%
Paul Arnold............................................... * *
Keith Alessi.............................................. * *
Named Executive Officers and Directors as a Group:
11 Persons(9)............................................. 788,290 59.1%
------------
* Represents less than 1%.
(1) Beneficial ownership is determined in accordance with Rule 13d-3 under the
Exchange Act. In computing the number of shares beneficially owned by a
person and the percentage ownership of that person, shares of common stock
subject to options held by that person that are currently exercisable or
exercisable within 60 days of March 15, 2004 are deemed outstanding. Such
shares, however, are not deemed outstanding for the purposes of computing
the percentage ownership of any other person.
(2) Excludes shares held individually by Mr. Bruckmann and other individuals
(and affiliates and family members thereof), each of whom are employed by
BRS. Bruce Bruckmann, Hal Rosser, Stephen Sherrill and Stephen Edwards, as
individuals are the sole shareholders of BRSE Associates, Inc., which is
the General Partner of BRS Partners, LP, which is the General Partner of
Bruckmann, Rosser, Sherrill & Co., LP. All major investment and other
decisions of Bruckmann, Rosser, Sherrill & Co., LP are vested in BRS
Partners, LP.
(3) Includes approximately 14,366 shares held by Farallon Capital Partners,
L.P. ("FLP"), approximately 16,418 shares held by Farallon Capital
Institutional Partners, L.P. ("FCIP"), approximately 8,209 shares by
Farallon Capital Institutional Partners II, L.P. ("FCIPII") and
approximately 2,052 shares held by R.R. Capital Partners, L.P.
(collectively with FLP, FCIP, FCIPII, the "Farallon Entities"), directly
hold, in aggregate, the shares listed above. As the general partner of each
of the Farallon Entities, Farallon Partners, L.L.C. ("FPLLC"), may, for
purposes of Rule 13d-3 under the Exchange Act, be deemed to own
beneficially the shares held by the Farallon Entities. As the managing
members of FPLLC, David I. Cohen, Chun R. Ding, Joseph F. Downes, William
F. Duhamel, Charles E. Ellwein, Richard B. Fried, Monica R. Landry, William
F. Mellin, Stephen L. Millham, Rajiv A. Patel, Derek C. Schrier, Thomas F.
Steyer and Mark C. Wehrly may each, for purposes of Rule 13d-3 under the
76
Exchange Act, be deemed to own beneficially the shares owned by the
Farallon Entities. Each of FPLLC and each of its managing members disclaim
any beneficial ownership of such shares. All of the above-mentioned
entities disclaim group attribution.
(4) Includes approximately 121,529 shares held by Canterbury Mezzanine Capital,
L.P. ("CMC") and approximately 17,908 shares held by Canterbury Detroit
Partners, L.P. ("CDP"), and together with CMC, the "Canterbury Entities").
For purposes of Rule 13d-3, Patrick N.W. Turner and Nicholas B. Dunphy, may
be deemed to own beneficially all shares held by the Canterbury Entities.
(5) Includes options to acquire common stock, options exercisable within 60
days, pursuant to the option plan. Messrs. Smith, Giardina, Pyle, and
Alimanestianu each hold such options on 1,200, 1,200, 1,000, and 1,000
shares of common stock, respectively. The address for each of these named
executive officers is the same as the address of our principal executive
offices.
(6) Includes 504,456 shares held by BRS, and approximately 2,276 shares held by
certain other family members of Mr. Bruckmann. Mr. Bruckmann disclaims
beneficial ownership of such shares held by BRS.
(7) Includes shares held by BRS. Mr. Edmonds disclaims beneficial ownership of
such shares.
(8) Includes shares held by CapitalSource Holdings, L.L.C. Mr. Fish is a
co-founder and president of CapitalSource Inc. Mr. Fish disclaims
beneficial ownership of such shares.
(9) Includes (i) shares held by BRS, which may be deemed to be owned
beneficially by Messrs. Bruckmann and Edmonds, and (ii) shares held by
CapitalSource, which may be deemed to be owned beneficially by Mr. Fish.
Excluding the shares beneficially owned by BRS and CapitalSource, the
directors and named executive officers as a group beneficially own 247,598
shares of common stock (which represents approximately 18.6% of the common stock
on a fully diluted basis).
77
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
RESTRUCTURING AGREEMENT
In connection with the transactions, the TSI, Inc. equityholders, TSI
Holdings and TSI, Inc. entered into a restructuring agreement, whereby the TSI,
Inc. equityholders 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 equityholders, entered into a stockholders' agreement. Pursuant to the
stockholders agreement, the TSI Holdings equityholders 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:
- 2 members designated by BRS currently, Bruce Bruckman and J. Rice
Edmonds;
- 1 member designated by the Farallon Entities currently, Jason Fish;
- Mark Smith (for so long as he is the chief executive officer of TSI
Holdings); and
- 2 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 2 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
1 director as long as it holds approximately 2% of the common stock of TSI
Holdings.
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 equityholders, agreed to terminate the
existing registration rights agreements among the TSI, Inc. equityholders and
TSI, Inc. and entered into a new registration rights agreement. 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
78
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, 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 20.0% of TSI Inc.'s outstanding common
stock. Following this offering BRS Co. will continue to receive the annual fee.
79
DESCRIPTION OF INDEBTEDNESS
SENIOR SECURED REVOLVING CREDIT FACILITY
Our senior secured revolving credit facility, with TSI, Inc., as borrower,
Deutsche Bank Trust Company Americas, as administrative agent, Deutsche Bank
Securities Inc., as joint lead arranger and BNP Paribas Securities Corp., as
joint lead arranger and syndication agent, is a five-year facility, providing
for borrowings of up to $50.0 million (containing a sublimit of $15.0 million
available for the issuance of letters of credit). The facility matures on April
16, 2008.
Permanent reductions to the commitment are required in an amount equal to
(a) 100.0% of the net cash proceeds of all asset sales and dispositions by TSI
Holdings and TSI, Inc. and its subsidiaries, subject to certain exceptions and
reinvestment rights, (b) 100.0% of the net cash proceeds of issuances of certain
debt obligations by TSI Holdings and TSI, Inc. and its subsidiaries, subject to
certain exceptions, and (c) 100.0% of certain insurance proceeds received by TSI
Holdings and TSI, Inc. and its subsidiaries, subject to certain exceptions and
reinvestment rights.
Voluntary prepayments and commitment reductions are permitted in whole or
in part, subject to minimum prepayment or reduction requirements, provided that
voluntary prepayments of eurodollar loans on a date other than the last day of
the relevant interest period are subject to the payment of customary breakage
costs, if any. Such voluntary prepayments and commitment reductions may be made
without premium or penalty.
All of our obligations under the senior secured revolving credit facility
are unconditionally guaranteed by each of TSI Holdings' and TSI, Inc.'s existing
and each subsequently acquired or organized domestic subsidiaries. The senior
secured revolving credit facility and the related guarantees are secured by the
capital stock of TSI, Inc. and by substantially all of the present and future
assets of TSI, Inc. and all present and future assets of each guarantor,
including but not limited to (i) a first-priority pledge of all of the
outstanding capital stock owned by TSI, Inc. and each guarantor (limited to 65%
of the voting stock of TSI, Inc.'s first tier foreign subsidiaries) and (ii)
perfected first-priority security interests in all of TSI, Inc.'s present and
future tangible and intangible assets and the present and future tangible and
intangible assets of each guarantor (in each case, other than certain equipment
assets subject to capitalized lease obligations). Guarantees from foreign
subsidiaries and security in respect thereof may be required in certain
circumstances.
Loans under the senior secured revolving credit facility, at TSI, Inc.'s
option, bear interest at either the base rate or a floating rate equal to the
reserve adjusted London inter-bank offered rate ("LIBOR"), in each case plus a
margin. Overdue principal and, to the extent permitted by law, overdue interest
does, in each case bear interest at the greater of (x) the rate which is 2% in
excess of the rate otherwise applicable to base rate loans and (y) the rate
which is 2% in excess of the rate then borne by such loans. Interest on all
loans under the senior secured revolving credit facility is payable (x) in the
case of base rate loans, quarterly and (y) in the case of LIBOR loans, on the
last day of the interest period applicable thereto and every three months in the
case of interest periods in excess of three months and, in each case, at the
time of repayment of any such loans and at maturity. In addition to paying
interest on any outstanding principal amount under the senior secured revolving
credit facility, we are required to pay an unused revolving credit facility fee
to the senior lenders equal to 0.75% per annum on the unused daily balance of
the revolving credit commitment, commencing on the execution and delivery of the
senior secured revolving credit facility and payable quarterly in arrears, based
upon the actual number of days elapsed in a 360 day year. For each letter of
credit we issue, we will be required to pay (i) a per annum fee equal to the
margin over the LIBOR rate from
80
time to time in effect, (ii) a fronting fee equal to 1/4 of 1% on the aggregate
outstanding stated amounts of such letters of credit, plus (iii) customary
administrative charges.
The credit agreement documentation contains certain customary
representations and warranties by TSI, Inc. It also contains affirmative
covenants requiring TSI Holdings and TSI, Inc. to provide the lenders with
monthly, quarterly and annual financial statements and other periodic reports
concerning the legal and financial situation of TSI Holdings and TSI, Inc. In
addition, the credit agreement documentation contains customary covenants
restricting TSI, Inc.'s ability to, among others (i) declare dividends or redeem
or repurchase capital stock, (ii) prepay, redeem or purchase other debt, (iii)
incur liens, (iv) make loans and investments, (v) incur additional indebtedness,
(vi) amend or otherwise alter debt and other material agreements, (vii) make
capital expenditures, (viii) engage in mergers, acquisitions and asset sales,
(ix) transact with affiliates, and (x) alter the business we conduct. Such
covenants as the restriction on TSI, Inc's ability to declare dividends, make
loans and investments and enter into transactions with affiliates, prevent TSI,
Inc. from providing TSI Holdings funds necessary for TSI Holdings to be able to
redeem the Notes. See "Risk Factors -- Risks Related to the Notes." TSI, Inc. is
also required to comply with specified financial covenants that require TSI,
Inc. to maintain certain ratios, including (i) ratio of EBITDA (as defined in
the credit agreement) to interest expense; (ii) ratio of indebtedness to EBITDA
(as defined in the credit agreement); and (iii) ratio of senior secured
indebtedness to EBITDA (as defined in the credit agreement).
Events of default under the credit agreement documentation include, but are
not limited to, (i) TSI, Inc.'s failure to pay principal or interest when due,
(ii) TSI, Inc.'s material breach of any representations or warranty, (iii)
covenant defaults by TSI, Inc., (iv) events of bankruptcy by TSI, Inc., (v)
cross default to certain other agreements by TSI, Inc., (vi) unsatisfied final
judgments over a certain threshold agreement by TSI, Inc., (vii) failure of
certain employee benefit plans of TSI, Inc. to meet legal requirements, (viii)
failure by the related security agreement to grant the lenders the requisite
security interest in TSI, Inc.'s and it subsidiaries' assets, (ix) defect in the
guarantee granted by the subsidiaries of TSI, Inc., and (x) a change of control
of TSI, Inc. Certain of these events of default apply to TSI Holdings, including
(i) TSI Holdings' material breach of representations and warranties it makes in
any agreements in connection with the credit and security agreement, and (ii) a
change of control of TSI Holdings. TSI, Inc. is obligated to pay the senior
lenders certain syndication and administration fees, reimburse certain expenses
and provide certain indemnities to the senior lenders, the administrative agent
and the arranger, in each case which are customary for credit facilities of this
type.
In connection with the transactions, TSI Holdings entered into a guaranty
agreement, a pledge agreement and a security agreement with the lenders of TSI,
Inc.'s senior secured revolving credit facility.
Pursuant to the guaranty agreement, TSI Holdings guarantees all of TSI,
Inc.'s obligations in connection with the TSI, Inc. senior secured revolving
credit facility. The guaranty agreement contains customary representations and
warranties. The guaranty agreement also contains covenants by TSI Holdings
including a restriction on TSI Holdings and its subsidiaries to make any payment
to redeem, repurchase or acquire any Notes or to amend or modify the indenture
governing the Notes. TSI Holdings would have to obtain the consent of the
lenders of the senior secured revolving credit facility in order to redeem,
repurchase or acquire any of the Notes or to effect an amendment or modification
to the indenture governing the Notes. A breach by TSI Holdings of constitutes an
event of default, and would provide the lenders of the senior secured revolving
credit facility an option to accelerate payment on all outstanding obligations
under the senior secured revolving credit facility.
81
Pursuant to the pledge agreement, TSI Holdings pledged all securities that
it owns, including all outstanding shares of TSI, Inc. to the lenders of TSI,
Inc.'s senior secured revolving credit facility as collateral for TSI, Inc.'s
obligations. Pursuant to the security agreement, TSI Holdings pledges all of its
assets to the lenders of TSI, Inc.'s senior secured revolving credit facility as
collateral for TSI, Inc.'s obligations. In the case of an event of default, the
lenders of TSI, Inc's senior secured revolving credit facility will become
beneficial holders of all outstanding shares of TSI, Inc. as well as all of the
assets of TSI Holdings. Events of default include any event that would
constitute an event of default under the credit agreement and governing the
senior secured revolving credit facility.
9 5/8% SENIOR NOTES DUE 2011
TSI, Inc. issued $255 million principal amount of 9 5/8% Senior Notes due
2011 pursuant to an indenture dated as of April 16, 2003 by and among TSI, Inc.,
the guarantors party thereto and The Bank of New York. Interest is payable
semiannually on April 15 and October 15. The 9 5/8% Senior Notes are redeemable
at any time on or after April 15, 2007 at the redemption prices set forth in the
9 5/8% Senior Notes plus accrued and unpaid interest to the date of redemption.
If a change of control of TSI, Inc. occurs, it is required, subject to certain
conditions, to give holders of the 9 5/8% Senior Notes the opportunity to sell
the notes to us at 101% of their face amount plus accrued and unpaid interest.
82
DESCRIPTION OF NOTES
GENERAL
The Old Notes have been issued and the New Notes will be issued under an
indenture (the "Indenture"), dated as of February 4, 2004, between us and The
Bank of New York, as Trustee. The following summary of the Indenture does not
purport to be complete and is subject to, and is qualified in its entirety by
reference to, the Trust Indenture Act of 1939, as amended (the "TIA"), and to
all of the provisions of the Indenture (a copy of the form of which may be
obtained from us), including the definitions of certain terms therein and those
terms made a part of the Indenture by reference to the TIA as in effect on the
date of the Indenture. The definitions of most of the capitalized terms used in
the following summary are set forth below under "-- Certain Definitions."
The Notes are our unsecured obligations, ranking equal in right of payment
to all of our unsubordinated debt.
The Notes are issued in fully registered form only, without coupons, in
denominations of $1,000 principal amount at maturity and integral multiples
thereof. The Old Notes had an initial accreted value of $585.95 per $1,000
principal amount at maturity of the Notes. Initially, the Trustee will act as
Paying Agent and Registrar for the Notes. The Notes may be presented for
registration or transfer and exchange at the offices of the Registrar, which
initially will be the Trustee's corporate trust office. We may change any Paying
Agent and Registrar without notice to holders of the Notes. We will pay
principal (and premium, if any) on the Notes at the Trustee's corporate office
in New York, New York. At our option, interest may be paid at the Trustee's
corporate trust office or by check mailed to the registered address of Holders.
Any Old Notes that remain outstanding after the completion of the exchange
offer, together with the New Notes issued in connection with the exchange offer,
will be treated as a single class of securities under the Indenture.
PRINCIPAL, MATURITY AND INTEREST
The Notes are unlimited in aggregate principal amount, with $213.0 million
aggregate principal amount at maturity to be issued in this offering and will
mature on February 1, 2014. Additional Notes may be issued from time to time
subject to the limitations set forth under "-- Certain Covenants -- Limitation
on Incurrence of Additional Indebtedness."
No cash interest will accrue on the Notes prior to February 1, 2009,
although for U.S. federal income tax purposes a significant amount of original
issue discount, taxable as ordinary income, will be recognized by a holder as
such discount accretes. The accreted value of each Note will increase from the
date of issuance until February 1, 2009 at a rate of 11% per annum compounded
semi-annually, reflecting the accrual of non-cash interest, such that on
February 1, 2009 the accreted value will equal the principal amount at maturity.
See the definition of "Accreted Value" in "Description of New Notes -- Certain
Definitions" for an explanation on how the accreted value of the Notes will
change over time. See "Material United States Federal Tax Consequences" for a
discussion regarding the taxation of such original issue discount. Cash interest
will accrue on the Notes at 11% per annum from February 1, 2009, or from the
most recent date to which interest has been paid, and will be payable
semiannually on February 1 and August 1 of each year, commencing August 1, 2009,
to the holders of record at the close of business on January 15 and July 15
immediately preceding the applicable interest payment date.
The Notes are not entitled to the benefit of any mandatory sinking fund.
HOLDING COMPANY STRUCTURE
The Company is a holding company and does not have any material assets or
operations other than ownership of TSI. All of its operations are conducted
through its Subsidiaries. Claims of creditors of such Subsidiaries, including
trade creditors, and claims of preferred stockholders
83
(if any) of such Subsidiaries generally have priority with respect to the assets
and earnings of such Subsidiaries over the claims of the Company's creditors,
including holders of the Notes. The Notes, therefore, are structurally
subordinated to creditors (including trade creditors) and preferred stockholders
(if any) of our Subsidiaries including TSI. As of March 31, 2004, the Company
and its subsidiaries had Indebtedness of approximately $387.8 million
outstanding, and our Subsidiaries had Indebtedness and other liabilities of
approximately $260.9 million outstanding including, in both instances, no
borrowings outstanding under the senior credit facility. Although the Indenture
limits the incurrence of Indebtedness and the issuance of preferred stock of our
Restricted Subsidiaries, such limitation is subject to a number of significant
qualifications. Moreover, the Indenture does not impose any limitation on the
incurrence by such Restricted Subsidiaries of liabilities that are not
considered Indebtedness under the Indenture. See "Risk Factors".
REDEMPTION
Optional Redemption. The Notes are redeemable, at the Company's option, in
whole at any time or in part from time to time, on and after February 1, 2009,
upon not less than 30 nor more than 60 days' notice, at the following redemption
prices (expressed as percentages of the principal amount at maturity thereof) if
redeemed during the twelve-month period commencing on February 1 of the year set
forth below, plus, in each case, accrued and unpaid interest thereon, if any, to
the date of redemption:
YEAR PERCENTAGE
---- ----------
2009........................................................ 105.500%
2010........................................................ 103.667%
2011........................................................ 101.833%
2012 and thereafter......................................... 100.000%
Optional Redemption upon Equity Offerings. At any time, or from time to
time, on or prior to February 1, 2007, the Company may, at its option, use the
net cash proceeds of one or more Equity Offerings (as defined below) to redeem
up to 35% of the Notes issued under the Indenture, in each case at a redemption
price equal to 111% of the Accreted Value thereof at the redemption date;
provided that:
(1) at least 65% of the aggregate principal amount at maturity of
Notes issued under the Indenture remains outstanding immediately after any
such redemption; and
(2) the Company shall make such redemption not more than 120 days
after the consummation of any such Equity Offering.
As used in the preceding paragraph, "Equity Offering" means a public or
private offering of Qualified Capital Stock of the Company (other than to a
Subsidiary of the Company) that generates gross proceeds to the Company of at
least $15.0 million.
SELECTION AND NOTICE OF REDEMPTION
In the event that less than all of the Notes are to be redeemed at any
time, selection of such Notes for redemption will be made by the Trustee in
compliance with the requirements of the principal national securities exchange,
if any, on which such Notes are listed or, if such Notes are not then listed on
a national securities exchange, on a pro rata basis, by lot or by such method as
the Trustee shall deem fair and appropriate; provided, however:
(1) that no Notes of a principal amount at maturity of $1,000 or less
shall be redeemed in part; and
84
(2) that if a partial redemption is made with the proceeds of an
Equity Offering, selection of the Notes or portions thereof for redemption
shall be made by the Trustee only on a pro rata basis or on as nearly a pro
rata basis as is practicable (subject to DTC procedures), unless such
method is otherwise prohibited.
Notice of redemption shall be mailed by first-class mail at least 30 but not
more than 60 days before the redemption date to each Holder of Notes to be
redeemed at its registered address. If any Note is to be redeemed in part only,
the notice of redemption that relates to such Note shall state the portion of
the principal amount thereof to be redeemed. A new Note in a principal amount at
maturity equal to the unredeemed portion thereof will be issued in the name of
the Holder thereof upon cancellation of the original Note. On and after the
redemption date Accreted Value will cease to accrete and interest will cease to
accrue, in each case to the extent applicable, on Notes or portions thereof
called for redemption as long as the Company has deposited with the Paying Agent
funds in satisfaction of the applicable redemption price pursuant to the
Indenture.
CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each Holder has the right to
require that the Company purchase all or a portion of such Holder's Notes
pursuant to the offer described below (the "Change of Control Offer"), at a
purchase price equal to 101% of the Accreted Value thereof plus accrued and
unpaid interest to the date of purchase.
Within 30 days following the date upon which the Change of Control
occurred, the Company must send, by first class mail, a notice to each Holder,
with a copy to the Trustee, which notice shall govern the terms of the Change of
Control Offer. Such notice will state, among other things, the purchase date,
which must be no earlier than 30 days nor later than 45 days from the date such
notice is mailed, other than as may be required by law (the "Change of Control
Payment Date"). Holders electing to have a Note purchased pursuant to a Change
of Control Offer will be required to surrender the Note, with the form entitled
"Option of Holder to Elect Purchase" on the reverse of the Note completed, to
the Paying Agent at the address specified in the notice prior to the close of
business on the third business day prior to the Change of Control Payment Date.
The Company will not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set forth
in the Indenture applicable to a Change of Control Offer made by the Company and
purchases all Notes validly tendered and not withdrawn under such Change of
Control Offer.
If a Change of Control Offer is made, there can be no assurance that the
Company will have available funds sufficient to pay the Change of Control
purchase price for all the Notes that might be delivered by Holders seeking to
accept the Change of Control Offer. The Credit Agreement contains, and any
future other agreements relating to other indebtedness to which we become, or
one of our Subsidiaries becomes, a party may contain restrictions or
prohibitions on the Company's ability to repurchase Notes or may provide that an
occurrence of a Change of Control constitutes an event of default under, or
otherwise requires payments of amounts borrowed under, those agreements. If a
Change of Control occurs at a time when the Company is prohibited from
repurchasing the Notes, we could seek the consent of our then existing lenders
or the lenders of TSI to the repurchase of the Notes or could attempt to
refinance the indebtedness containing such prohibitions. If the Company does not
obtain such consent or repay the indebtedness, it would remain prohibited from
repurchasing the Notes. In that case, failure to repurchase tendered Notes would
constitute an Event of Default under the Indenture and may constitute a default
under the terms of other indebtedness that we may enter into from time to time.
In the event the Company is required to purchase outstanding
85
Notes pursuant to a Change of Control Offer, the Company expects that it would
seek third party financing to the extent it does not have available funds to
meet our purchase obligations. However, there can be no assurance that the
Company would be able to obtain such financing.
Neither the Board of Directors of the Company nor the Trustee may waive the
covenant relating to a Holder's right to redemption upon a Change of Control.
Restrictions in the Indenture described herein on the ability of the Company and
its Restricted Subsidiaries to incur additional Indebtedness, to grant liens on
its property, to make Restricted Payments and to make Asset Sales may also make
more difficult or discourage a takeover of the Company, whether favored or
opposed by the management of the Company. Consummation of any such transaction
in certain circumstances may require redemption or repurchase of the Notes, and
there can be no assurance that the Company or the acquiring party will have
sufficient financial resources to effect such redemption or repurchase. Such
restrictions and the restrictions on transactions with Affiliates may, in
certain circumstances, make more difficult or discourage any leveraged buyout of
the Company or any of its Subsidiaries by the management of the Company. While
such restrictions cover a wide variety of arrangements that have traditionally
been used to effect highly leveraged transactions, the Indenture may not afford
the Holders of Notes protection in all circumstances from the adverse aspects of
a highly leveraged transaction, reorganization, restructuring, merger or similar
transaction.
The Company will comply with the requirements of Rule 14e-1 under the
Exchange Act and any other securities laws and regulations thereunder to the
extent such laws and regulations are applicable in connection with the
repurchase of Notes pursuant to a Change of Control Offer. To the extent that
the provisions of any securities laws or regulations conflict with the "Change
of Control" provisions of the Indenture, the Company shall comply with the
applicable securities laws and regulations and shall not be deemed to have
breached its obligations under the "Change of Control" provisions of the
Indenture by virtue thereof. For a definition of "Change of Control" under the
Indenture see "Description of New Notes -- Certain Definitions."
CERTAIN COVENANTS
The Indenture contains, among others, the following covenants:
Limitation on Incurrence of Additional Indebtedness. The Company will not,
and will not permit any of its Restricted Subsidiaries to, directly or
indirectly, create, incur, assume, guarantee, acquire, become liable,
contingently or otherwise, with respect to, or otherwise become responsible for
payment of (collectively "incur") any Indebtedness (other than Permitted
Indebtedness); provided, however, that if no Default or Event of Default shall
have occurred and be continuing at the time of or as a consequence of the
incurrence of any such Indebtedness, (i) the Company may incur Indebtedness
(including, without limitation, Acquired Indebtedness) if on the date of the
incurrence of such Indebtedness, after giving effect to the incurrence thereof,
the Consolidated Fixed Charge Coverage Ratio of the Company is greater than 2.00
to 1.00 and (ii) any of TSI and its Restricted Subsidiaries may incur
Indebtedness (including, without limitation, Acquired Indebtedness) if on the
date of the incurrence of such Indebtedness, after giving effect to the
incurrence thereof, TSI's Consolidated Fixed Charge Coverage Ratio is greater
than 2.00 to 1.00.
Limitation on Restricted Payments. The Company will not, and will not
cause or permit any of its Restricted Subsidiaries to, directly or indirectly:
(1) declare or pay any dividend or make any distribution (other than
dividends or distributions payable in the Qualified Capital Stock of the
Company) on or in respect of shares of the Company's Capital Stock to
holders of such Capital Stock,
86
(2) purchase, redeem or otherwise acquire or retire for value any
Capital Stock of the Company or any warrants, rights or options to purchase
or acquire shares of any class of such Capital Stock,
(3) make any principal payment on, purchase, defease, redeem, prepay,
decrease or otherwise acquire or retire for value, prior to:
(a) any scheduled maturity,
(b) any scheduled or mandatory repayment or
(c) any scheduled sinking fund payment, any Indebtedness of the
Company that is subordinate or junior in right of payment to the Notes;
or
(4) make any Investment (other than Permitted Investments) (each of
the foregoing actions set forth in clauses(1), (2), (3) and (4) being
referred to as a "Restricted Payment");
if at the time of such Restricted Payment or immediately after giving effect
thereto:
(1) a Default or an Event of Default shall have occurred and be
continuing; or
(2) the Company is not able to incur at least $1.00 of additional
Indebtedness (other than Permitted Indebtedness) in compliance with the
covenant described under "Limitation on Incurrence of Additional
Indebtedness"; or
(3) the aggregate amount of Restricted Payments (including such
proposed Restricted Payment) made subsequent to April 16, 2003 (the amount
expended for such purposes, if other than in cash, being the fair market
value of such property as determined reasonably and in good faith by the
Board of Directors of the Company (or if prior to the Issue Date, by the
Board of Directors of TSI)) shall exceed the sum of, without duplication:
(a) 50% of the cumulative Consolidated Net Income (or if
cumulative Consolidated Net Income shall be a loss, minus 100% of such
loss) of the Company earned subsequent to the end of the fiscal quarter
immediately prior to April 16, 2003 (determined as if the Company owned
TSI for all periods prior to the Issue Date) and on or prior to the end
of the most recently ended fiscal quarter for which internal financial
statements are available as of the date the Restricted Payment occurs
(treating such period as a single accounting period), plus
(b) 100% of the aggregate net cash proceeds received by the
Company from any Person (other than a Subsidiary of the Company) from
the issuance and sale subsequent to April 16, 2003 and on or prior to
the date the Restricted Payment occurs of Qualified Capital Stock of the
Company (or if prior to the Issue Date, Qualified Capital Stock of TSI),
plus
(c) without duplication of any amounts included in clause (3)(b)
above, 100% of the aggregate net cash proceeds of any equity
contribution received by the Company from a holder of the Company's
Capital Stock subsequent to April 16, 2003 (or if prior to the Issue
Date, received by TSI from a holder of TSI's Capital Stock) and on or
prior to the date the Restricted Payment occurs, plus
(d) without duplication, an amount equal to the sum of
(x) the net reduction in Investments in Unrestricted
Subsidiaries resulting from dividends, repayments of loans or advances
or other transfers of assets by any Unrestricted Subsidiary to the
Company or any Restricted Subsidiary or the receipt of proceeds by the
Company or any Restricted Subsidiary from the sale or other disposition
of any portion of the Capital Stock of any Unrestricted Subsidiary, in
each case occurring subsequent to April 16, 2003 and
87
(y) the consolidated net Investments on the date of
Revocation made by the Company or any of its Restricted Subsidiaries in
any Subsidiary of the Company that has been designated an Unrestricted
Subsidiary after April 16, 2003 upon its redesignation as a Restricted
Subsidiary in accordance with the covenant described under
"-- Limitation on Designations of Unrestricted Subsidiaries."
Notwithstanding the foregoing, the provisions set forth in the immediately
preceding paragraph do not prohibit:
(1) the payment of any dividend or redemption payment within 60 days
after the date of declaration of such dividend or the mailing of such
irrevocable redemption notice if the dividend or redemption payment, as the
case may be, would have been permitted on the date of declaration or the
date of mailing of such notice;
(2) if no Default or Event of Default shall have occurred and be
continuing, the acquisition of any shares of Capital Stock of the Company,
either
(a) solely in exchange for shares of Qualified Capital Stock of
the Company or
(b) through the application of net proceeds of a substantially
concurrent sale for cash (other than to a Restricted Subsidiary of the
Company) of shares of Qualified Capital Stock of the Company;
(3) if no Default or Event of Default shall have occurred and be
continuing, the acquisition of any Indebtedness of the Company that is
subordinate or junior in right of payment to the Notes either
(a) solely in exchange for shares of Qualified Capital Stock of
the Company, or
(b) through the application of net proceeds of a substantially
concurrent sale for cash (other than to a Restricted Subsidiary of the
Company) of
(x) shares of Qualified Capital Stock of the Company or
(y) Refinancing Indebtedness;
(4) if no Default or Event of Default shall have occurred and be
continuing, repurchases by the Company of Capital Stock of the Company or
options or warrants to purchase Capital Stock of the Company, stock
appreciation rights or any similar equity interest in the Company from
consultants, directors, officers and employees of the Company or any of its
Subsidiaries or their authorized representatives upon the death,
disability, retirement or termination of employment of such consultants,
directors, officers or employees in an aggregate amount not to exceed
$750,000 in any calendar year plus the amount of any proceeds received
under key-man life insurance policies that are used to make such payments;
(5) if no Default shall have occurred and be continuing, the
purchase, redemption, defeasance or other acquisition or retirement of
Indebtedness of the Company that is subordinate or junior in right of
payment to the Notes in connection with an asset sale net proceeds amount
offer or change of control offer after complying with the covenants set
forth under "-- Limitation on Asset Sales" and "-- Change of Control";
(6) if no Default or Event of Default shall have occurred and be
continuing, Restricted Payments in an aggregate amount not to exceed $10.0
million; and
(7) any payments made in furtherance of the Transactions with the net
proceeds received by the Company from the sale of the Notes on the Issue
Date.
In determining the aggregate amount of Restricted Payments made subsequent to
April 16, 2003 in accordance with clause (3) of the second preceding paragraph,
amounts expended
88
pursuant to clauses (1) , (2)(b), (3)(b)(x), (4) and (6) of the immediately
preceding paragraph shall be included in such calculation.
Limitation on Asset Sales. The Company will not, and will not permit any
of its Restricted Subsidiaries to, consummate an Asset Sale unless:
(1) the Company or the applicable Restricted Subsidiary, as the case
may be, receives consideration at the time of such Asset Sale at least
equal to the fair market value of the assets sold or otherwise disposed of
(as determined in good faith by the Board of Directors of the Company);
(2) at least 75% of the consideration received by the Company or its
Restricted Subsidiary, as the case may be, from such Asset Sale shall be in
the form of cash or Cash Equivalents and shall be received at the time of
such disposition; provided, however, that the amount of:
(a) any liabilities (as shown on the Company's or such Restricted
Subsidiary's most recent balance sheet or the notes thereto) of the
Company or any Restricted Subsidiary (other than liabilities that are by
their terms subordinated to the Notes) that are assumed by the
transferee in such Asset Sale and from which the Company or such
Restricted Subsidiary is released and
(b) any notes, securities or other obligations received by the
Company or by any such Restricted Subsidiary from such transferee that
are immediately converted by the Company or by such Restricted
Subsidiary into cash or Cash Equivalents (to the extent of the cash or
Cash Equivalents received),
shall be deemed to be cash for the purposes of this provision;
(3) upon the consummation of an Asset Sale, the Company shall apply,
or cause such Restricted Subsidiary to apply, the Net Cash Proceeds
relating to such Asset Sale within 360 days of receipt thereof either:
(a) to pay (i) Indebtedness under the Credit Agreement (and, in the
case of any such Indebtedness under any revolving credit facility,
effect a corresponding permanent reduction in the availability under
such revolving credit facility) or other Indebtedness ranking pari passu
with the Notes; provided, however, that if the Company repays such other
pari passu Indebtedness it must make an equal and ratable offer to all
holders of Notes as provided in the following paragraph, or (ii) in the
case of an Asset Sale by a Restricted Subsidiary, Indebtedness of such
Restricted Subsidiary,
(b) to make an investment in properties and assets that replace the
properties and assets that were the subject of such Asset Sale or in
properties and assets that will be used in the business of the Company
and its Restricted Subsidiaries as existing on the Issue Date or in
businesses reasonably related thereto ("Replacement Assets") or
(c) a combination of prepayment and investment permitted by the
foregoing clauses (3)(a) and (3)(b).
On the 361st day after an Asset Sale or such earlier date, if any, as the
Board of Directors of the Company or of such Restricted Subsidiary determines
not to apply the Net Cash Proceeds relating to such Asset Sale as set forth in
clauses (3)(a), (3)(b) and (3)(c) of the next preceding paragraph (each, a "Net
Proceeds Offer Trigger Date"), such aggregate amount of Net Cash Proceeds that
have not been applied on or before such Net Proceeds Offer Trigger Date as
permitted in clauses (3)(a), (3)(b) and (3)(c) of the next preceding paragraph
(each a "Net Proceeds Offer Amount") shall be applied by the Company or such
Restricted Subsidiary to make an offer to purchase (the "Net Proceeds Offer") on
a date not
89
less than 45 nor more than 60 days following the applicable Net Proceeds Offer
Trigger Date, the maximum Accreted Value of Notes and principal amount of other
Indebtedness of the Company that ranks pari passu in right of payment with the
Notes (to the extent required by the instrument governing such other
Indebtedness), that may be purchased out of the Net Proceeds Offer Amount;
provided, however, notwithstanding the foregoing, in the case of an Asset Sale
by a Restricted Subsidiary of the Company, the Company shall not be required to
make a Net Proceeds Offer to the extent such Restricted Subsidiary is not
permitted pursuant to its outstanding Indebtedness to make a Restricted Payment
to the Company. Any Notes and other Indebtedness to be purchased pursuant to a
Net Proceeds Offer shall be purchased pro rata based on the aggregate principal
amount of Notes and such other Indebtedness outstanding and all Notes shall be
purchased at an offer price in cash in an amount equal to 100% of the Accreted
Value thereof, plus accrued and unpaid interest to the date of purchase.
The Company may defer the Net Proceeds Offer until there is an aggregate
unutilized Net Proceeds Offer Amount equal to or in excess of $10.0 million
resulting from one or more Asset Sales (at which time, the entire unutilized Net
Proceeds Offer Amount, not just the amount in excess of $10.0 million, shall be
applied as required pursuant to the preceding paragraph).
In the event of the transfer of substantially all (but not all) of the
property and assets of the Company and its Restricted Subsidiaries as an
entirety to a Person in a transaction permitted under "-- Merger, Consolidation
and Sale of Assets," the successor corporation shall be deemed to have sold the
properties and assets of the Company and its Restricted Subsidiaries not so
transferred for purposes of this covenant, and shall comply with the provisions
of this covenant with respect to such deemed sale as if it were an Asset Sale.
In addition, the fair market value of such properties and assets of the Company
or its Restricted Subsidiaries deemed to be sold shall be deemed to be Net Cash
Proceeds for purposes of this covenant.
Notwithstanding the four immediately preceding paragraphs, the Company and
its Restricted Subsidiaries will be permitted to consummate an Asset Sale
without complying with such paragraphs to the extent:
(1) at least 75% of the consideration for such Asset Sale constitutes
Replacement Assets; and
(2) such Asset Sale is for fair market value;
provided that any consideration not constituting Replacement Assets received by
the Company or any of its Restricted Subsidiaries in connection with any Asset
Sale permitted to be consummated under this paragraph shall constitute Net Cash
Proceeds subject to the provisions of the four preceding paragraphs.
Each Net Proceeds Offer will be mailed to the record Holders as shown on
the register of Holders within 30 days following the Net Proceeds Offer Trigger
Date, with a copy to the Trustee, and shall comply with the procedures set forth
in the Indenture. Upon receiving notice of the Net Proceeds Offer, Holders may
elect to tender their Notes in whole or in part in integral multiples of $1,000
principal amount at maturity in exchange for cash. To the extent Holders
properly tender Notes in an amount exceeding the Net Proceeds Offer Amount,
Notes of tendering Holders will be purchased on a pro rata basis (based on
amounts tendered). A Net Proceeds Offer shall remain open for a period of 20
business days or such longer period as may be required by law.
The Company shall comply with the requirements of Rule 14e-1 under the
Exchange Act and any other securities laws and regulations thereunder to the
extent such laws and regulations are applicable in connection with the
repurchase of Notes pursuant to a Net Proceeds Offer. To the extent that the
provisions of any securities laws or regulations conflict with the "Asset Sale"
provisions of the Indenture, the Company shall comply with the applicable
securities laws
90
and regulations and shall not be deemed to have breached its obligations under
the "Asset Sale" provisions of the Indenture by virtue thereof.
Limitation on Dividend and Other Payment Restrictions Affecting
Subsidiaries. The Company will not, and will not cause or permit any of its
Restricted Subsidiaries to, directly or indirectly, create or otherwise cause or
permit to exist or become effective any encumbrance or restriction on the
ability of any Restricted Subsidiary to:
(1) pay dividends or make any other distributions on or in respect of
its Capital Stock;
(2) make loans or advances or to pay any Indebtedness or other
obligation owed to the Company or any other Restricted Subsidiary; or
(3) transfer any of its property or assets to the Company or any other
Restricted Subsidiary,
in each case except for such encumbrances or restrictions existing under or by
reason of:
(a) applicable law;
(b) the Indenture, the Notes, the Existing TSI Indenture as in
effect on the Issue Date and the Existing TSI Notes and the guarantees
thereof;
(c) customary non-assignment provisions of any contract or any
lease governing a leasehold interest of any Restricted Subsidiary;
(d) any instrument governing Acquired Indebtedness, which
encumbrance or restriction is not applicable to any Person, or the
properties or assets of any Person, other than the Person or the
properties or assets of the Person so acquired (including, but not
limited to, such Person's direct and indirect Subsidiaries);
(e) agreements existing on the Issue Date (other than the Credit
Agreement) to the extent and in the manner such agreements are in effect
on the Issue Date;
(f) the Credit Agreement or an agreement governing any other
Indebtedness of the Company or any Restricted Subsidiary permitted to be
incurred under the Indenture; provided that either (y) with respect to
any agreement governing such other Indebtedness, the provisions relating
to such encumbrance or restriction are no less favorable to the Company
in any material respect than the provisions contained in the Credit
Agreement as in effect on the Issue Date or (z) any encumbrance or
restriction contained in such other Indebtedness does not prohibit
(except upon a default or event of default thereunder) the payment of
dividends or the making of loans or advances in an amount sufficient, as
determined by our Board of Directors in its reasonable and good faith
judgment (including the use of reasonable projections of future
operating performance), to make scheduled payments of cash interest on
the Notes;
(g) restrictions on the transfer of assets subject to any Lien
permitted under the Indenture imposed by the holder of such Lien;
(h) restrictions imposed by any agreement to sell assets or Capital
Stock permitted under the Indenture to any Person pending the closing of
such sale;
(i) customary provisions in joint venture agreements and other
similar agreements in each case relating solely to the respective joint
venture or similar entity or to the equity interest therein;
(j) customary provisions imposed by agreements governing
Indebtedness of a Foreign Restricted Subsidiary permitted to be incurred
under the Indenture to the extent that such encumbrance or restriction
relates solely to the respective Foreign Restricted Subsidiary; and
91
(k) an agreement governing Indebtedness incurred to Refinance the
Indebtedness issued, assumed or incurred pursuant to an agreement
referred to in clause (b) and (d) through (g) above; provided, however,
that the provisions relating to such encumbrance or restriction
contained in any such Indebtedness are no less favorable to the Company
in any material respect as determined by the Board of Directors of the
Company in its reasonable and good faith judgment than the provisions
relating to such encumbrance or restriction contained in agreements
referred to in such clause (b) and (d) through (g) above.
Limitation on Preferred Stock of Restricted Subsidiaries. The Company will
not permit any of its Restricted Subsidiaries to issue any Preferred Stock
(other than to the Company or to a Wholly Owned Restricted Subsidiary) or permit
any Person (other than the Company or a Wholly Owned Restricted Subsidiary) to
own any Preferred Stock of any Restricted Subsidiary.
Limitation of Guarantees by Restricted Subsidiaries. The Company will not
permit any of its Restricted Subsidiaries, directly or indirectly, by way of the
pledge of any intercompany note or otherwise, to assume, guarantee or in any
other manner become liable with respect to any Indebtedness of the Company
(other than Indebtedness represented by any guarantees (including through the
pledge of intercompany notes or otherwise) of Indebtedness under the Credit
Agreement and the Existing TSI Notes), unless, in any such case (a) such
Restricted Subsidiary executes and delivers a supplemental indenture to the
Indenture, providing a Guarantee and (b) if any such assumption, guarantee or
other liability of such Restricted Subsidiary is provided in respect of
Indebtedness that is expressly subordinated to the Notes, the guarantee or other
instrument provided by such Restricted Subsidiary in respect of such
subordinated Indebtedness shall be subordinated to the Guarantee substantially
to the same extent as such Indebtedness is subordinated to the Notes. This
covenant shall not apply to guarantees by Restricted Subsidiaries of
Indebtedness of Restricted Subsidiaries.
Notwithstanding the foregoing, any such Guarantee by a Restricted
Subsidiary of the Notes shall provide by its terms that it shall be
automatically and unconditionally released and discharged, without any further
action required on the part of the Trustee or any Holder, upon: (i) the
unconditional release of such Restricted Subsidiary from its liability in
respect of the Indebtedness in connection with which such Guarantee was executed
and delivered pursuant to the preceding paragraph or (ii) any sale or other
disposition (by merger or otherwise) to any Person which is not a Restricted
Subsidiary of the Company of all of the Company's Capital Stock in, or all or
substantially all of the assets of, such Restricted Subsidiary; provided that
(a) such sale or disposition of such Capital Stock or assets is otherwise in
compliance with the terms of the Indenture and (b) such assumption, guarantee or
other liability of such Restricted Subsidiary has been released by the holders
of the other Indebtedness so guaranteed.
Limitation on Liens. The Company will not, directly or indirectly, create,
incur, assume or permit or suffer to exist any Liens upon any property or assets
of the Company (excluding property, assets and Capital Stock of Restricted
Subsidiaries to secure Indebtedness of Restricted Subsidiaries) whether owned on
the Issue Date or acquired after the Issue Date, or any proceeds therefrom, or
assign or otherwise convey any right to receive income or profits therefrom
unless:
(1) in the case of Liens securing Subordinated Indebtedness, the Notes
are secured by a Lien on such property, assets or proceeds that is senior
in priority to such Liens; and
(2) in all other cases, the Notes are secured on an equal and ratable
basis, except for
(a) Liens existing as of the Issue Date to the extent and in the
manner such Liens are in effect on the Issue Date;
(b) (x) Liens securing Indebtedness permitted by clauses (2) and
(15) of the definition of Permitted Indebtedness and (y) Liens securing
Indebtedness permitted by the covenant described under "-- Limitation on
Additional Indebtedness" (other than
92
Indebtedness permitted by clauses (2) and (15) of the definition of
Permitted Indebtedness); provided that such Indebtedness and all other
Indebtedness secured by Liens permitted by this clause (y) shall, at the
time such Indebtedness is incurred and after giving effect to such
incurrence, not exceed an aggregate principal amount equal to the
difference between (i) 1.25 times Consolidated EBITDA of the Company for
the most recently ended four fiscal quarters for which internal
financial statements are available and (ii) the amount of Indebtedness
then outstanding under clauses (2) and (15) of the definition of
Permitted Indebtedness;
(c) Liens securing the Notes;
(d) Liens of the Company on assets of any Restricted Subsidiary of
the Company;
(e) Liens securing Refinancing Indebtedness that is incurred to
Refinance any Indebtedness that has been secured by a Lien permitted
under the Indenture and that has been incurred in accordance with the
provisions of the Indenture; provided, however, that such Liens
(x) are no less favorable to the Holders and are not more
favorable to the lienholders with respect to such Liens, in each case
in any material respect, than the Liens in respect of the
Indebtedness being Refinanced; and
(y) do not extend to or cover any property or assets of the
Company not securing the Indebtedness so Refinanced,
(f) Liens in favor of the Company; and
(g) Permitted Liens.
Merger, Consolidation and Sale of Assets. The Company will not, in a
single transaction or series of related transactions, consolidate or merge with
or into any Person, or sell, assign, transfer, lease, convey or otherwise
dispose of (or cause or permit any Restricted Subsidiary to sell, assign,
transfer, lease, convey or otherwise dispose of) all or substantially all of the
Company's assets (determined on a consolidated basis for the Company and its
Restricted Subsidiaries) whether as an entirety or substantially as an entirety
to any Person unless:
(1) either:
(a) the Company will be the surviving or continuing corporation or
(b) the Person (if other than the Company) formed by such
consolidation or into which the Company is merged or the Person which
acquires by sale, assignment, transfer, lease, conveyance or other
disposition of properties and assets of the Company and of its
Restricted Subsidiaries substantially as an entirety (the "Surviving
Entity")
(x) will be a corporation organized and validly existing under
the laws of the United States or any State thereof or the District of
Columbia and
(y) will expressly assume, by supplemental indenture (in form
and substance satisfactory to the Trustee), executed and delivered to
the Trustee, the due and punctual payment of the principal of, and
premium, if any, and interest on all of the Notes and the performance
of every covenant of the Notes, the Indenture and the Registration
Rights Agreement on the part of the Company to be performed or
observed;
(2) immediately after giving effect to such transaction and the
assumption contemplated by clause (1)(b)(y) above (including giving effect
to any Indebtedness and Acquired Indebtedness incurred or anticipated to be
incurred in connection with or in respect of such transaction), the Company
or such Surviving Entity, as the case may be,
93
shall be able to incur at least $1.00 of additional Indebtedness (other
than Permitted Indebtedness) pursuant to clause (i) of the covenant
described under "-- Limitation on Incurrence of Additional Indebtedness";
(3) immediately before and immediately after giving effect to such
transaction and the assumption contemplated by clause (1)(b)(y) above
(including, without limitation, giving effect to any Indebtedness and
Acquired Indebtedness incurred or anticipated to be incurred and any Lien
granted in connection with or in respect of the transaction), no Default or
Event of Default shall have occurred or be continuing; and
(4) the Company or the Surviving Entity shall have delivered to the
Trustee an officers' certificate and an opinion of counsel, each stating
that such consolidation, merger, sale, assignment, transfer, lease,
conveyance or other disposition and, if a supplemental indenture is
required in connection with such transaction, such supplemental indenture
complies with the applicable provisions of the Indenture and that all
conditions precedent in the Indenture relating to such transaction have
been satisfied:
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise, in a single transaction or series of transactions) of all or
substantially all of the properties or assets of one or more Restricted
Subsidiaries the Capital Stock of which constitutes all or substantially all of
the properties and assets of the Company, will be deemed to be the transfer of
all or substantially all of the properties and assets of the Company.
The Indenture provides that upon any consolidation, combination or merger
or any transfer of all or substantially all of the assets of the Company in
accordance with the foregoing, in which the Company is not the continuing
corporation, the Surviving Entity shall succeed to, and be substituted for, and
may exercise every right and power of, the Company under the Indenture and the
Notes with the same effect as if such Surviving Entity had been named as such.
Limitations on Transactions with Affiliates.
(1) The Company will not, and will not permit any of its Restricted
Subsidiaries to, directly or indirectly, enter into or permit to exist any
transaction or series of related transactions (including, without
limitation, the purchase, sale, lease or exchange of any property or the
rendering of any service) with, or for the benefit of, any of its
Affiliates (each an "Affiliate Transaction"), other than:
(a) Affiliate Transactions permitted under paragraph (2) below and
(b) Affiliate Transactions on terms that are no less favorable than
those that might reasonably have been obtained in a comparable
transaction at such time on an arm's-length basis from a Person that is
not an Affiliate of the Company or such Restricted Subsidiary.
All Affiliate Transactions (and each series of related Affiliate
Transactions which are similar or part of a common plan) involving aggregate
payments or other property with a fair market value in excess of $2.5 million
will be approved by the Board of Directors of the Company or such Restricted
Subsidiary, as the case may be, such approval to be evidenced by a Board
Resolution stating that such Board of Directors has determined that such
transaction complies with the foregoing provisions. If the Company or any
Restricted Subsidiary enters into an Affiliate Transaction (or a series of
related Affiliate Transactions related to a common plan) that involves an
aggregate fair market value of more than $10.0 million, the Company or such
Restricted Subsidiary, as the case may be, will, prior to the consummation
thereof, obtain an opinion from an Independent Financial Advisor stating that
such transaction or series of related transactions are fair to the Company or to
the relevant Restricted Subsidiary, as the case may be, from a financial point
of view.
94
(2) The restrictions set forth in clause (1) shall not apply to:
(a) reasonable fees and compensation paid to and indemnity provided
on behalf of, our officers, directors, employees or consultants or those
of any Restricted Subsidiary as determined in good faith by the
Company's Board of Directors or senior management,
(b) transactions exclusively between or among the Company and any
of its Restricted Subsidiaries or exclusively between or among such
Restricted Subsidiaries; provided such transactions are not otherwise
prohibited by the Indenture,
(c) Restricted Payments and Permitted Investments permitted by the
Indenture and
(d) management or advisory fees to BRS Group or its affiliates in
accordance with the terms of the Management Agreement as in effect on
the Issue Date or as the same may be modified or amended; provided,
however, that such modification or amendment cannot provide for the
annual payment of such fees in an amount in excess of 1.5% of
Consolidated EBITDA for the immediately preceding fiscal year.
Reports to Holders. Whether or not required by the rules and regulations
of the Commission, so long as any Notes are outstanding, the Company will
furnish the holders of Notes, with a copy to the Trustee:
(1) all quarterly and annual financial information that would be
required to be contained in a filing with the Commission on Forms 10-Q and
10-K if the Company were required to file such Forms, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" that describes the financial condition and results of
operations of the Company and its consolidated Subsidiaries (showing in
reasonable detail, either on the face of the financial statements or in the
footnotes thereto and in Management's Discussion and Analysis of Financial
Condition and Results of Operations, the financial condition and results of
operations of the Company and its Restricted Subsidiaries separate from the
financial condition and results of operations of the Unrestricted
Subsidiaries of the Company, if any) and, with respect to the annual
information only, a report thereon by the Company's certified independent
accountants; and
(2) the information that would be required to be included in all
current reports that would be required to be filed with the Commission on
Form 8-K if the Company were required to file such reports, in each case
within the time periods specified in the Commission's rules and
regulations.
In addition, following the consummation of the exchange offer contemplated
by the Registration Rights Agreement, whether or not required by the rules and
regulations of the Commission, the Company will file a copy of all such
information and reports with the Commission for public availability within the
time periods specified in the Commission's rules and regulations (unless the
Commission will not accept such a filing) and make such information available to
securities analysts and prospective investors upon request. In addition, the
Company has agreed that, for so long as any Notes remain outstanding, it will
furnish to the Holders and to securities analysts and prospective investors,
upon their request, the information required to be delivered pursuant to Rule
144A(d)(4) under the Securities Act.
Limitation on Designations of Unrestricted Subsidiaries. The Company may
designate any Subsidiary of the Company (other than a Subsidiary of the Company
that owns Capital Stock of a Restricted Subsidiary) as an "Unrestricted
Subsidiary" under the Indenture (a "Designation") only if:
(1) no Default shall have occurred and be continuing at the time of or
after giving effect to such Designation; and
95
(2) the Company would be permitted under the Indenture to make an
Investment at the time of Designation (assuming the effectiveness of such
Designation) in an amount (the "Designation Amount") equal to the sum of:
(a) the fair market value of the Capital Stock of such Subsidiary
owned by the Company and its Restricted Subsidiaries on such date and
(b) the aggregate amount of other Investments of the Company and
its Restricted Subsidiaries in such Subsidiary on such date; and
(3) the Company would be permitted to incur $1.00 of additional
Indebtedness (other than Permitted Indebtedness) pursuant to the covenant
described under "-- Limitation on Incurrence of Additional Indebtedness" at
the time of Designation (assuming the effectiveness of such Designation).
In the event of any such Designation, the Company shall be deemed to have
made an Investment constituting a Restricted Payment pursuant to the covenant
described under -- Limitation on Restricted Payments" for all purposes of the
Indenture in the Designation Amount. The Indenture will further provide that the
Company shall not, and shall not permit any Restricted Subsidiary to, at any
time:
(1) provide direct or indirect credit support for or a guarantee of
any Indebtedness of any Unrestricted Subsidiary (including of any
undertaking, agreement or instrument evidencing such Indebtedness); or
(2) be directly or indirectly liable for any Indebtedness of any
Unrestricted Subsidiary.
The Indenture further provides that the Company may revoke any Designation
of a Subsidiary as an Unrestricted Subsidiary (a "Revocation"), whereupon such
Subsidiary shall then constitute a Restricted Subsidiary, if:
(1) no Default shall have occurred and be continuing at the time of
and after giving effect to such Revocation; and
(2) all Liens and Indebtedness of such Unrestricted Subsidiary
outstanding immediately following such Revocation would, if incurred at
such time, have been permitted to be incurred for all purposes of the
Indenture.
All Designations and Revocations must be evidenced by Board Resolutions of
the Company certifying compliance with the foregoing provisions.
Payments for Consent. The Company will not, and will not permit any of its
Restricted Subsidiaries to, directly or indirectly, pay or cause to be paid any
consideration to or for the benefit of any Holder of Notes for or as an
inducement to any consent, waiver or amendment of any of the terms or provisions
of the Indenture or the Notes unless such consideration is offered to be paid
and is paid to all Holders of the Notes that consent, waive or agree to amend in
the time frame set forth in the solicitation documents relating to such consent,
waiver or agreement.
EVENTS OF DEFAULT
The following events are defined in the Indenture as "Events of Default":
(1) the failure to pay interest on any Note when the same becomes due
and payable and the default continues for a period of 30 days;
(2) the failure to pay the principal of any Note, when such principal
becomes due and payable, at maturity, upon redemption or otherwise
(including the failure to make a payment to purchase Notes tendered
pursuant to a Change of Control Offer or a Net Proceeds Offer) on the date
specified for such payment in the applicable offer to purchase;
96
(3) a default in the observance or performance of any other covenant
or agreement contained in the Indenture which default continues for a
period of 30 days after the Company receives written notice specifying the
default (and demanding that such default be remedied) from the Trustee or
the Holders of at least 25% of the outstanding principal amount of the
Notes (except in the case of a default with respect to the covenant
described under "-- Certain Covenants -- Merger, Consolidation and Sale of
Assets," which will constitute an Event of Default with such notice
requirement but without such passage of time requirement);
(4) the failure to pay at final stated maturity (giving effect to any
applicable grace periods and any extensions thereof) the principal amount
of any Indebtedness of the Company or any Restricted Subsidiary, or the
acceleration of the final stated maturity of any such Indebtedness (which
acceleration is not rescinded, annulled or otherwise cured within 20 days
of receipt by the Company or such Restricted Subsidiary of notice of any
such acceleration) if the aggregate principal amount of such Indebtedness,
together with the principal amount of any other such Indebtedness in
default for failure to pay principal at final maturity or which has been
accelerated (in each case with respect to which the 20-day period described
above has passed), aggregates $5.0 million or more at any time;
(5) one or more judgments in an aggregate amount in excess of $5.0
million (to the extent not covered by insurance) shall have been rendered
against the Company or any of its Significant Subsidiaries and such
judgments remain undischarged, unpaid or unstayed for a period of 60 days
after such judgment or judgments become final and nonappealable; or
(6) certain events of bankruptcy affecting the Company or any of its
Significant Subsidiaries.
If an Event of Default (other than an Event of Default specified in clause
(6) above relating to the Company) shall occur and be continuing, the Trustee or
the Holders of at least 25% in principal amount at maturity of outstanding Notes
may declare the Accreted Value of and accrued and unpaid interest, if any, on
all the Notes to be due and payable by notice in writing to the Company and the
Trustee specifying the respective Event of Default and that it is a "notice of
acceleration", and the same shall become immediately due and payable. If an
Event of Default specified in clause (6) above relating to the Company occurs
and is continuing, then all unpaid Accreted Value of, and premium, if any, and
accrued and unpaid interest, if any, on all of the outstanding Notes shall ipso
facto become and be immediately due and payable without any declaration or other
act on the part of the Trustee or any Holder.
The Indenture provides that, at any time after a declaration of
acceleration with respect to the Notes as described in the preceding paragraph,
the Holders of a majority in principal amount at maturity of the Notes may
rescind and cancel such declaration and its consequences:
(1) if the rescission would not conflict with any judgment or decree;
(2) if all existing Events of Default have been cured or waived except
nonpayment of principal or interest that has become due solely because of
the acceleration;
(3) to the extent the payment of such interest is lawful, interest on
overdue installments of interest and overdue principal, which has become
due otherwise than by such declaration of acceleration, has been paid;
(4) if the Company has paid the Trustee its reasonable compensation
and reimbursed the Trustee for its expenses, disbursements and advances;
and
(5) in the event of the cure or waiver of an Event of Default of the
type described in clause (6) of the description above of Events of Default,
the Trustee shall have received an officers' certificate and an opinion of
counsel stating that such Event of Default has been cured or waived.
97
No such rescission shall affect any subsequent Default or impair any right
consequent thereto.
The Holders of a majority in principal amount at maturity of the Notes may
waive any existing Default or Event of Default under the Indenture, and its
consequences, except a default in the payment of the principal of or interest on
any Notes.
Holders of the Notes may not enforce the Indenture or the Notes except as
provided in the Indenture and under the TIA. No Holder of any Note will have any
right to institute any proceeding with respect to the Indenture or for any
remedy thereunder, unless such Holder shall have previously given to the Trustee
written notice of a continuing Event of Default thereunder and unless the
Holders of at least 25% of the aggregate principal amount of the outstanding
Notes shall have made written request, and offered indemnity reasonably
satisfactory to the Trustee, to the Trustee to institute such proceeding as the
Trustee, and the Trustee shall have not have received from the Holders of a
majority in aggregate principal amount of such outstanding Notes a direction
inconsistent with such request and shall have failed to institute such
proceeding within 60 days. However, such limitations do not apply to a suit
instituted by a Holder of such a Note for enforcement of payment of the
principal of and premium, if any, or interest on such Note on or after the
respective due dates expressed in such Note.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, the Trustee is under no obligation to exercise any of its rights or
powers under the Indenture at the request, order or direction of any of the
Holders, unless such Holders have offered to the Trustee reasonable indemnity.
Subject to all provisions of the Indenture and applicable law, the Holders of a
majority in aggregate principal amount at maturity of the then outstanding Notes
have the right to direct the time, method and place of conducting any proceeding
for any remedy available to the Trustee or exercising any trust or power
conferred on the Trustee.
Under the Indenture, the Company is required to provide an officers'
certificate to the Trustee promptly upon any such officer obtaining knowledge of
any Default or Event of Default (provided that such officers shall provide such
certification at least annually whether or not they know of any Default or Event
of Default) that has occurred and, if applicable, describe such Default or Event
of Default and the status thereof.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have its
obligations and the obligations of the Guarantors (if any) discharged with
respect to the outstanding Notes ("Legal Defeasance"). Such Legal Defeasance
means that the Company shall be deemed to have paid and discharged the entire
indebtedness represented by the outstanding Notes, except for:
(1) the rights of Holders to receive payments in respect of the
principal of, premium, if any, and interest on the Notes when such payments
are due;
(2) the Company's obligations with respect to the Notes concerning
- issuing temporary Notes,
- registration of Notes,
- mutilated, destroyed, lost or stolen Notes and
- the maintenance of an office or agency for payments;
(3) the rights, powers, trust, duties and immunities of the Trustee
and our obligations in connection therewith; and
(4) the Legal Defeasance provisions of the Indenture.
98
In addition, the Company may, at its option and at any time, elect to have
the obligations of the Company released with respect to certain covenants that
are described in the Indenture ("Covenant Defeasance") and thereafter any
omission to comply with such obligations shall not constitute a Default or an
Event of Default with respect to the Notes. In the event Covenant Defeasance
occurs, certain events (not including non-payment, bankruptcy, receivership,
reorganization and insolvency events) described under "Events of Default" will
no longer constitute an Event of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance,
(1) the Company must irrevocably deposit with the Trustee, in trust,
for the benefit of the Holders cash in U.S. dollars, non-callable U.S.
government obligations, or a combination thereof, in such amounts as will
be sufficient, in the opinion of a nationally recognized firm of
independent public accountants, to pay the principal of, premium, if any,
and interest on the Notes on the stated date for payment thereof or on the
applicable redemption date, as the case may be;
(2) in the case of Legal Defeasance, the Company shall have delivered
to the Trustee an opinion of counsel in the United States reasonably
acceptable to the Trustee confirming that
(a) the Company has received from, or there has been published by,
the Internal Revenue Service a ruling or
(b) since the date of the Indenture, there has been a change in the
applicable federal income tax law,
in either case to the effect that, and based thereon such opinion of
counsel shall confirm that, the Holders will not recognize income, gain or
loss for federal income tax purposes as a result of such Legal Defeasance
and will be subject to federal income tax on the same amounts, in the same
manner and at the same times as would have been the case if such Legal
Defeasance had not occurred;
(3) in the case of Covenant Defeasance, the Company shall have
delivered to the Trustee an opinion of counsel in the United States
reasonably acceptable to the Trustee confirming that the Holders will not
recognize income, gain or loss for federal income tax purposes as a result
of such Covenant Defeasance and will be subject to federal income tax on
the same amounts, in the same manner and at the same times as would have
been the case if such Covenant Defeasance had not occurred;
(4) no Default or Event of Default shall have occurred and be
continuing on the date of such deposit (other than a Default or an Event of
Default resulting from the borrowing of funds to be applied to such deposit
and the grant of any Lien securing such borrowings);
(5) such Legal Defeasance or Covenant Defeasance shall not result in a
breach or violation of, or constitute a default under, the Indenture (other
than a Default or an Event of Default resulting from the borrowing of funds
to be applied to such deposit and the grant of any Lien securing such
borrowings) or any other material agreement or instrument to which the
Company or any of its Subsidiaries is a party or by which the Company or
any of its Subsidiaries is bound;
(6) the Company shall have delivered to the Trustee an officers'
certificate stating that the deposit was not made by the Company with the
intent of preferring the Holders over any other creditors of the Company or
with the intent of defeating, hindering, delaying or defrauding any other
creditors of the Company or others;
99
(7) the Company shall have delivered to the Trustee an officers'
certificate and an opinion of counsel, each stating that all conditions
precedent provided for or relating to the Legal Defeasance or the Covenant
Defeasance have been complied with;
(8) the Company shall have delivered to the Trustee an opinion of
counsel to the effect that, assuming no intervening bankruptcy of the
Company between the date of deposit and the 91st day following the date of
deposit and that no Holder is an insider of the Company, after the 91st day
following the date of deposit, the trust funds will not be subject to the
effect of any applicable bankruptcy, insolvency, reorganization or similar
laws affecting creditors' rights generally; and
(9) certain other customary conditions precedent are satisfied.
Notwithstanding the foregoing, the opinion of counsel required by clauses
(2)(a) and (3) above need not be delivered if all the Notes not theretofore
delivered to the Trustee for cancellation:
(1) have become due and payable;
(2) will become due and payable on the maturity date within one year;
or
(3) are to be called for redemption within one year under arrangements
satisfactory to the Trustee for the giving of notice of redemption by such
Trustee in the name, and at the expense, of the Company.
SATISFACTION AND DISCHARGE
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights or registration of transfer or exchange of the
Notes, as expressly provided for in the Indenture) as to all Notes then
outstanding when:
(1) either
(a) all the Notes theretofore authenticated and delivered (except
lost, stolen or destroyed Notes which have been replaced or paid and
Notes for whose payment money has theretofore been deposited in trust or
segregated and held in trust by the Company and thereafter repaid to the
Company or discharged from such trust) have been delivered to the
Trustee for cancellation, or
(b) all Notes not theretofore delivered to the Trustee for
cancellation have become due and payable or will be due and payable
within one year and the Company has irrevocably deposited or caused to
be deposited with the Trustee funds in an amount sufficient to pay and
discharge the entire Indebtedness on the Notes not theretofore delivered
to the Trustee for cancellation, for principal of, premium, if any, and
interest on the Notes to the date of deposit together with irrevocable
instructions from the Company directing the Trustee to apply such funds
to the payment thereof at maturity or redemption, as the case may be;
(2) the Company has paid all other sums payable by the Company under
the Indenture; and
(3) the Company has delivered to the Trustee an officers' certificate
and an opinion of counsel stating that all conditions precedent under the
Indenture relating to the satisfaction and discharge of the Indenture have
been complied with.
MODIFICATION OF THE INDENTURE
From time to time, the Company and the Trustee, without the consent of the
Holders, may amend the Indenture for certain specified purposes, including
curing ambiguities, defects or
100
inconsistencies, so long as such change does not, in the opinion of the Trustee,
adversely affect the rights of any of the Holders in any material respect. In
formulating its opinion on such matters, the Trustee will be entitled to rely on
such evidence as it deems appropriate, including, without limitation, solely on
an opinion of counsel. Other modifications and amendments of the Indenture may
be made with the consent of the Holders of a majority in principal amount at
maturity of the then outstanding Notes issued under the Indenture, except that,
without the consent of each Holder affected thereby, no amendment may:
(1) reduce the amount of Notes whose Holders must consent to an
amendment;
(2) reduce the rate of or change or have the effect of changing the
time for payment of interest, including defaulted interest, on any Notes;
(3) reduce the principal or Accreted Value of or change or have the
effect of changing the fixed maturity of any Notes, or change the date on
which any Notes may be subject to redemption or repurchase, or reduce the
redemption or repurchase price therefor;
(4) make any Notes payable in money other than that stated in the
Notes;
(5) make any change in provisions of the Indenture protecting the
right of each Holder to receive payment of principal of and interest on
such Note on or after the due date thereof or to bring suit to enforce such
payment, or permitting Holders of a majority in principal amount at
maturity of Notes to waive Defaults or Events of Default;
(6) after the Company's obligation to purchase Notes arises under the
Indenture, amend, change or modify in any material respect the obligation
of the Company to make and consummate a Change of Control Offer in the
event of a Change of Control or make and consummate a Net Proceeds Offer
with respect to any Asset Sale that has been consummated or modify any of
the provisions or definitions with respect thereto; or
(7) modify or change any provision of the Indenture or the related
definitions affecting the ranking of the Notes in a manner that adversely
affects the Holders; provided, that ranking shall not be affected by the
existence or lack thereof of a security interest or by priority with
respect to a security interest.
GOVERNING LAW
The Indenture provides that it, and the Notes, will be governed by, and
construed in accordance with, the laws of the State of New York but without
giving effect to applicable principles of conflicts of law to the extent that
the application of the law of another jurisdiction would be required thereby.
THE TRUSTEE
The Indenture provides that, except during the continuance of an Event of
Default, the Trustee will perform only such duties as are specifically set forth
in the Indenture. During the existence of an Event of Default, the Trustee will
exercise such rights and powers vested in it by the Indenture, and use the same
degree of care and skill in its exercise as a prudent person would exercise or
use under the circumstances in the conduct of his own affairs.
The Indenture and the provisions of the TIA contain certain limitations on
the rights of the Trustee, should it become a creditor of the Company or of a
Subsidiary of the Company, to obtain payments of claims in certain cases or to
realize on certain property received in respect of any such claim as security or
otherwise. Subject to the TIA, the Trustee will be permitted to engage in other
transactions; provided that if the Trustee acquires any conflicting interest as
described in the TIA, it must eliminate such conflict or resign.
101
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms, as well as any other terms used herein for which no definition is
provided.
"Accreted Value" means, as of any date (the "Specified Date"), the amount
provided below for each $1,000 principal amount at maturity of Notes:
(1) if the Specified Date occurs on one of the following dates (each,
a "Semi-Annual Accrual Date"), the Accreted Value will equal the amount set
forth below for such Semi-Annual Accrual Date:
SEMI-ANNUAL ACCRUAL DATE ACCRETED VALUE
------------------------ --------------
August 1, 2004....................................... $ 617.63
February 1, 2005..................................... $ 651.60
August 1, 2005....................................... $ 687.44
February 1, 2006..................................... $ 725.25
August 1, 2006....................................... $ 765.13
February 1, 2007..................................... $ 807.22
August 1, 2007....................................... $ 851.61
February 1, 2008..................................... $ 898.45
August 1, 2008....................................... $ 947.87
February 1, 2009..................................... $1,000.00
(2) if the Specified Date occurs before the first Semi-Annual Accrual
Date, the Accreted Value will equal the sum of (A) the original issue price
of a Note and (B) an amount equal to the product of (x) the Accreted Value
for the first Semi-Annual Accrual Date less such original issue price
multiplied by (y) a fraction, the numerator of which is the number of days
from the Issue Date to the Specified Date, using a 360-day year of twelve
30-day months, and the denominator of which is the number of days elapsed
from the Issue Date to the first Semi-Annual Accrual Date, using a 360-day
year of twelve 30-day months;
(3) if the Specified Date occurs between two Semi-Annual Accrual
Dates, the Accreted Value will equal the sum of (A) the Accreted Value for
the Semi-Annual Accrual Date immediately preceding such Specified Date and
(B) an amount equal to the product of (x) the Accreted Value for the
immediately following Semi-Annual Accrual Date less the Accreted Value for
the immediately preceding Semi-Annual Accrual Date multiplied by (y) a
fraction, the numerator of which is the number of days from the immediately
preceding Semi-Annual Accrual Date to the Specified Date, using a 360-day
year of twelve 30-day months, and the denominator of which is 180; or
(4) if the Specified Date occurs after the last Semi-Annual Accrual
Date, the Accreted Value will equal $1,000.
"Acquired Indebtedness" means Indebtedness of a Person or any of its
Subsidiaries existing at the time such Person becomes a Restricted Subsidiary or
at the time it merges or consolidates with the Company or any of its Restricted
Subsidiaries or assumed in connection with the acquisition of assets from such
Person and in each case not incurred by such Person in connection with, or in
anticipation or contemplation of, such Person becoming a Restricted Subsidiary
or such acquisition, merger or consolidation.
"Affiliate" means, with respect to any specified Person, any other Person
who directly or indirectly through one or more intermediaries controls, or is
controlled by, or is under common
102
control with, such specified Person. The term "control" means the possession,
directly or indirectly, of the power to direct or cause the direction of the
management and policies of a Person, whether through the ownership of voting
securities, by contract or otherwise; and the terms "controlling" and
"controlled" have meanings correlative of the foregoing.
"Affiliate Transaction" has the meaning set forth under "-- Certain
Covenants -- Limitation on Transactions with Affiliates."
"Asset Acquisition" means
(1) an Investment by the Company or any Restricted Subsidiary in any
other Person pursuant to which such Person shall become a Restricted
Subsidiary or shall be merged with or into the Company or any Restricted
Subsidiary; or
(2) the acquisition by the Company or any Restricted Subsidiary of the
assets of any Person (other than a Restricted Subsidiary) which constitute
all or substantially all of the assets of such Person or comprise any
division or line of business of such Person or any other properties or
assets of such Person other than in the ordinary course of business.
"Asset Sale" means any direct or indirect sale, issuance, conveyance,
transfer, lease (other than operating leases entered into in the ordinary course
of business), assignment or other transfer for value by the Company or any of
its Restricted Subsidiaries (including any Sale and Leaseback Transaction) to
any Person other than the Company or a Restricted Subsidiary of:
(1) any Capital Stock of any Restricted Subsidiary; or
(2) any other property or assets of the Company or any Restricted
Subsidiary other than in the ordinary course of business;
provided, however, that Asset Sales shall not include
(a) a transaction or series of related transactions for which the
Company or its Restricted Subsidiaries receive aggregate consideration of
less than $2.5 million,
(b) the sale, lease, conveyance, disposition or other transfer of all
or substantially all of the assets of the Company as permitted under
"-- Certain Covenants -- Merger, Consolidation and Sale of Assets,"
(c) disposals or replacements of obsolete equipment in the ordinary
course of business,
(d) the sale, lease, conveyance, disposition or other transfer by the
Company or any Restricted Subsidiary of assets or property to the Company
or one or more Restricted Subsidiaries and
(e) any Restricted Payment permitted by the "Limitation on Restricted
Payments" covenant or any Permitted Investment.
"Board of Directors" means, as to any Person, the board of directors of
such Person or any duly authorized committee thereof.
"Board Resolution" means, with respect to any Person, a copy of a
resolution certified by the Secretary or an Assistant Secretary of such Person
to have been duly adopted by the Board of Directors of such Person and to be in
full force and effect on the date of such certification, and delivered to the
Trustee.
"BRS Group" means Bruckmann, Rosser, Sherrill & Co., Inc. and its
Affiliates.
103
"Business Day" means a day other than a Saturday, Sunday or other day on
which commercial banking institutions (including, without limitation, the
Federal Reserve System) are authorized or required by law to close in New York
City.
"Capitalized Lease Obligation" means, as to any Person, the obligations of
such Person under a lease that are required to be classified and accounted for
as capital lease obligations under GAAP and, for purposes of this definition,
the amount of such obligations at any date shall be the capitalized amount of
such obligations at such date, determined in accordance with GAAP.
"Capital Stock" means:
(1) with respect to any Person that is a corporation, any and all
shares, interests, participations or other equivalents (however designated
and whether or not voting) of corporate stock, including each class of
Common Stock and Preferred Stock of such Person; and
(2) with respect to any Person that is not a corporation, any and all
partnership, membership or other equity interests of such Person.
"Cash Equivalents" means:
(1) marketable direct obligations issued by, or unconditionally
guaranteed by, the United States Government or issued by any agency thereof
and backed by the full faith and credit of the United States, in each case
maturing within one year from the date of acquisition thereof;
(2) marketable direct obligations issued by any state of the United
States of America or any political subdivision of any such state or any
public instrumentality thereof maturing within one year from the date of
acquisition thereof and, at the time of acquisition, having one of the two
highest ratings obtainable from either S&P or Moody's;
(3) commercial paper maturing no more than one year from the date of
creation thereof and, at the time of acquisition, having a rating of at
least A-1 from S&P or at least P-1 from Moody's;
(4) certificates of deposit or bankers' acceptances maturing within
one year from the date of acquisition thereof issued by any bank organized
under the laws of the United States of America or any state thereof or the
District of Columbia or any U.S. branch of a foreign bank having at the
date of acquisition thereof combined capital and surplus of not less than
$250.0 million;
(5) repurchase obligations with a term of not more than seven days for
underlying securities of the types described in clause (1) above entered
into with any bank meeting the qualifications specified in clause (4)
above; and
(6) investments in money market funds that invest substantially all
their assets in securities of the types described in clauses (1) through
(5) above.
"Change of Control" means the occurrence of one or more of the following
events:
(1) any sale, lease, exchange or other transfer (in one transaction or
a series of related transactions) of all or substantially all of the assets
of the Company to any Person or group of related Persons for purposes of
Section 13(d) of the Exchange Act (a "Group"), together with any Affiliates
thereof (whether or not otherwise in compliance with the provisions of the
Indenture), other than to a Permitted Holder;
(2) the approval by the holders of Capital Stock of the Company of any
plan or proposal for the liquidation or dissolution of the Company (whether
or not otherwise in compliance with the provisions of the Indenture);
104
(3) any Person or Group, other than a Permitted Holder, shall become
the owner, directly or indirectly, beneficially or of record, of shares
representing more than 50% of the aggregate ordinary voting power
represented by the issued and outstanding Capital Stock of the Company;
(4) the replacement of a majority of the Board of Directors of the
Company over a two-year period from the directors who constituted the Board
of Directors of the Company at the beginning of such period, and such
replacement shall not have been approved by a vote of at least a majority
of the Board of Directors of the Company then still in office who either
were members of any such Board of Directors at the beginning of such period
or whose election as a member of any such Board of Directors was previously
so approved; or
(5) the failure at any time by the Company to beneficially own (as
defined in Rules 13d-3 and 13d-5 under the Exchange Act) directly or
indirectly , 100% of the Common Stock of TSI.
"Change of Control Offer" has the meaning set forth under "-- Change of
Control."
"Change of Control Payment Date" has the meaning set forth under "-- Change
of Control."
"Common Stock" of any Person means any and all shares, interests or other
participations in, and other equivalents (however designated and whether voting
or non-voting) of, such Person's common stock, whether outstanding on the Issue
Date or issued after the Issue Date, and includes, without limitation, all
series and classes of such common stock.
"Consolidated EBITDA" means, for any period, the sum (without duplication)
of:
(1) Consolidated Net Income; and
(2) to the extent Consolidated Net Income has been reduced thereby,
(a) all income taxes of such Person and its Restricted Subsidiaries
paid or accrued in accordance with GAAP for such period (other than
income taxes attributable to extraordinary, unusual or nonrecurring
gains or losses or taxes attributable to sales or dispositions outside
the ordinary course of business),
(b) Consolidated Interest Expense and
(c) Consolidated Non-cash Charges less any non-cash items
increasing Consolidated Net Income for such period, all as determined on
a consolidated basis for such Person and its Restricted Subsidiaries in
accordance with GAAP.
"Consolidated Fixed Charge Coverage Ratio" means with respect to any
Person, the ratio of Consolidated EBITDA of such Person during the four full
fiscal quarters (the "Four Quarter Period") ending on or prior to the date of
the transaction giving rise to the need to calculate the Consolidated Fixed
Charge Coverage Ratio (the "Transaction Date") to Consolidated Fixed Charges of
such Person for the Four Quarter Period. In addition to and without limitation
of the foregoing, for purposes of this definition, "Consolidated EBITDA" and
"Consolidated Fixed Charges" shall be calculated after giving effect on a pro
forma (including any pro forma expense and cost reductions calculated on a basis
consistent with Regulation S-X under the Securities Act) basis for the period of
such calculation to:
(1) the incurrence or repayment of any Indebtedness of such Person or
any of its Restricted Subsidiaries (and the application of the proceeds
thereof) giving rise to the need to make such calculation and any
incurrence or repayment of other Indebtedness (and the application of the
proceeds thereof), other than the incurrence or repayment of Indebtedness
in the ordinary course of business for working capital purposes pursuant to
working capital facilities, occurring during the Four Quarter Period or at
any time subsequent to the
105
last day of the Four Quarter Period and on or prior to the Transaction
Date, as if such incurrence or repayment, as the case may be (and the
application of the proceeds thereof), occurred on the first day of the Four
Quarter Period; and
(2) any asset sales or Asset Acquisitions (including, without
limitation, any Asset Acquisition giving rise to the need to make such
calculation as a result of such Person or one of its Restricted
Subsidiaries (including any Person who becomes a Restricted Subsidiary as a
result of the Asset Acquisition) incurring, assuming or otherwise being
liable for Acquired Indebtedness and also including any Consolidated EBITDA
attributable to the assets that are the subject of the Asset Acquisition or
asset sale during the Four Quarter Period) occurring during the Four
Quarter Period or at any time subsequent to the last day of the Four
Quarter Period and on or prior to the Transaction Date, as if such asset
sale or Asset Acquisition (including the incurrence, assumption or
liability for any such Acquired Indebtedness) occurred on the first day of
the Four Quarter Period. If such Person or any of its Restricted
Subsidiaries directly or indirectly guarantees Indebtedness of a third
Person, the preceding sentence shall give effect to the incurrence of such
guaranteed Indebtedness as if such Person or any such Restricted Subsidiary
of such Person had directly incurred or otherwise assumed such guaranteed
Indebtedness.
Furthermore, in calculating "Consolidated Fixed Charges" for purposes of
determining the denominator (but not the numerator) of this "Consolidated Fixed
Charge Coverage Ratio":
(1) interest on outstanding Indebtedness determined on a fluctuating
basis as of the Transaction Date and that will continue to be so determined
thereafter shall be deemed to have accrued at a fixed rate per annum equal
to the rate of interest on such Indebtedness in effect on the Transaction
Date;
(2) if interest on any Indebtedness actually incurred on the
Transaction Date may optionally be determined at an interest rate based
upon a factor of a prime or similar rate, a eurocurrency interbank offered
rate, or other rates, then the interest rate in effect on the Transaction
Date will be deemed to have been in effect during the Four Quarter Period;
and
(3) notwithstanding clause (1) above, interest on Indebtedness
determined on a fluctuating basis, to the extent such interest is covered
by agreements relating to Interest Swap Obligations, shall be deemed to
accrue at the rate per annum resulting after giving effect to the operation
of such agreements.
"Consolidated Fixed Charges" means, with respect to any Person for any
period, the sum, without duplication, of:
(1) Consolidated Interest Expense; plus
(2) the product of
(a) the amount of all dividend payments on any series of Preferred
Stock of such Person (other than dividends paid or to be paid in such
period in Qualified Capital Stock) paid or required to be paid during
such period, and
(b) a fraction, the numerator of which is one and the denominator
of which is one minus the then current effective consolidated federal,
state and local income tax rate of such Person, expressed as a decimal.
"Consolidated Interest Expense" means, with respect to any Person for any
period, the sum of, without duplication:
(1) the aggregate of the interest expense of such Person and its
Restricted Subsidiaries for such period determined on a consolidated basis
in accordance with GAAP, including without limitation,
(a) any amortization of debt discount,
106
(b) the net costs under Interest Swap Obligations,
(c) all capitalized interest and
(d) the interest portion of any deferred payment obligation; and
(2) the interest component of Capitalized Lease Obligations paid,
accrued and/or scheduled to be paid or accrued by such Person and its
Restricted Subsidiaries during such period as determined on a consolidated
basis in accordance with GAAP.
"Consolidated Net Income" means, with respect to any Person, for any
period, the aggregate net income (or loss) of such Person and its Restricted
Subsidiaries for such period on a consolidated basis, determined in accordance
with GAAP; provided that there shall be excluded therefrom:
(1) after-tax gains or losses from Asset Sales (without regard to the
$2.5 million limitation set forth in the definition thereof) or abandonment
or reserves relating thereto;
(2) after-tax items classified as extraordinary or nonrecurring gains
or losses;
(3) the net income (or loss) of any Person acquired in a "pooling of
interests" transaction accrued prior to the date it becomes a Restricted
Subsidiary or is merged or consolidated with the Company or with any
Restricted Subsidiary;
(4) the net income (but not loss) of any Restricted Subsidiary to the
extent that the declaration of dividends or similar distributions by that
Restricted Subsidiary of that income is restricted by a contract, operation
of law or otherwise (other than restrictions permitted by the "Limitations
on Dividend and Other Payment Restrictions Affecting Subsidiaries"
covenant);
(5) the net income of any Person, other than the Company or a
Restricted Subsidiary, except to the extent of cash dividends or
distributions paid to the Company or to a Restricted Subsidiary by such
Person;
(6) income or loss attributable to discontinued operations (including,
without limitation, operations disposed of during such period whether or
not such operations were classified as discontinued); and
(7) in the case of a successor to the referent Person by consolidation
or merger or as a transferee of the referent Person's assets, any net
income of the successor corporation prior to such consolidation, merger or
transfer of assets.
"Consolidated Non-cash Charges" means, with respect to any Person for any
period, the aggregate depreciation, amortization and other non-cash expenses of
such Person (including, without limitation, charges related to the impairment of
intangibles) and its Restricted Subsidiaries reducing Consolidated Net Income of
such Person for such period, determined on a consolidated basis in accordance
with GAAP (including deferred rent but excluding any such charge which requires
an accrual of or a reserve for cash charges for any future period).
"Covenant Defeasance" has the meaning set forth under "-- Legal Defeasance
and Covenant Defeasance."
"Credit Agreement" means the Credit Agreement dated as of April 16, 2003 by
and among TSI, the lenders from time to time party thereto in their capacities
as lenders thereunder and Deutsche Bank Trust Company Americas, as agent,
together with the related documents thereto (including, without limitation, any
guarantee agreements and security documents), in each case as such agreements
may be amended (including any amendment and restatement thereof), supplemented
or otherwise modified from time to time, including any agreement extending the
maturity of, refinancing, replacing or otherwise restructuring (including
increasing the amount of available borrowings thereunder or adding the Company
or Subsidiaries of the
107
Company or TSI as additional borrowers or guarantors thereunder) all or any
portion of the Indebtedness under such agreement or any successor or replacement
agreement and whether by the same or any other agent, lender or group of
lenders.
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement designed to protect the
Company or any Restricted Subsidiary against fluctuations in currency values.
"Default" means an event or condition the occurrence of which is, or with
the lapse of time or the giving of notice or both would be, an Event of Default.
"Designation" has the meaning set forth under "-- Certain
Covenants -- Limitation on Designations of Unrestricted Subsidiaries."
"Designation Amount" has the meaning set forth under "-- Certain
Covenants -- Limitation on Designations of Unrestricted Subsidiaries."
"Disqualified Capital Stock" means that portion of any Capital Stock which,
by its terms (or by the terms of any security into which it is convertible or
for which it is exchangeable), or upon the happening of any event, matures or is
mandatorily redeemable, pursuant to a sinking fund obligation or otherwise, or
is redeemable at the sole option of the holder thereof on or prior to the final
maturity date of the Notes.
"Domestic Restricted Subsidiary" means a Restricted Subsidiary incorporated
or otherwise organized or existing under the laws of the United States or any
state thereof.
"Equity Offering" has the meaning set forth under
"-- Redemption -- Optional Redemption Upon Equity Offerings."
"Exchange Act" means the Securities Exchange Act of 1934, as amended, or
any successor statute or statutes thereto.
"Existing TSI Indenture" means the indenture dated as of April 16, 2003
among TSI, the guarantors named therein and The Bank of New York, as trustee, as
amended or modified from time to time.
"Existing TSI Notes" means the 9 5/8% Senior Notes due 2011 of TSI issued
under the Existing TSI Indenture.
"fair market value" means, with respect to any asset or property, the price
which could be negotiated in an arm's-length, free market transaction, for cash,
between a willing seller and a willing and able buyer, neither of whom is under
undue pressure or compulsion to complete the transaction. Fair market value
shall be determined by the Board of Directors of the Company acting reasonably
and in good faith and shall be evidenced by a Board Resolution of the Board of
Directors of the Company.
"Farallon" means Farallon Partners, L.L.C. and its Affiliates.
"Foreign Restricted Subsidiary" means a Restricted Subsidiary that is not a
Domestic Restricted Subsidiary.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as may be approved by a significant segment of the accounting
profession of the United States, which are in effect as of April 16, 2003. All
ratios and computations based on GAAP contained in the Indenture shall be
computed in conformity with GAAP applied on a consistent basis, except that
calculations made for purposes of determining compliance with the terms of the
covenants and with other provisions of the Indenture shall be made without
giving effect to (i) the deduction or amortization of any
108
premiums, fees and expenses incurred in connection with any financings or any
other permitted incurrence of Indebtedness and (ii) depreciation, amortization
or other expenses recorded as a result of the application of purchase accounting
in accordance with Accounting Principles Board Opinion Nos. 16 and 17 and FASB
Nos. 141 and 142.
"Guarantee" means each guarantee of the Company's obligations under the
Indenture and the Notes by the Guarantors.
"Guarantor" means: each of the Company's Restricted Subsidiaries that in
the future executes a supplemental indenture in which such Restricted Subsidiary
agrees to be bound by the terms of the Indenture as a Guarantor; provided that
any Person constituting a Guarantor as described above shall cease to constitute
a Guarantor when its respective Guarantee is released in accordance with the
terms of the Indenture.
"incur" has the meaning set forth under "-- Certain Covenants -- Limitation
on Incurrence of Additional Indebtedness."
"Indebtedness" means with respect to any Person, without duplication:
(1) all Obligations of such Person for borrowed money;
(2) all Obligations of such Person evidenced by bonds, debentures,
notes or other similar instruments;
(3) all Capitalized Lease Obligations of such Person;
(4) all Obligations of such Person issued or assumed as the deferred
purchase price of property, all conditional sale obligations and all
Obligations under any title retention agreement (but excluding trade
accounts payable and other accrued liabilities arising in the ordinary
course of business);
(5) all Obligations for the reimbursement of any obligor on any letter
of credit, banker's acceptance or similar credit transaction;
(6) guarantees and other contingent obligations in respect of
Indebtedness referred to in clauses (1) through (5) above and clause (8)
below;
(7) all Obligations of any other Person of the type referred to in
clauses (1) through (6) which are secured by any Lien on any property or
asset of such Person, the amount of such Obligation being deemed to be the
lesser of the fair market value of such property or asset or the amount of
the Obligation so secured;
(8) all Obligations under currency agreements and interest swap
agreements of such Person; and
(9) all Disqualified Capital Stock issued by such Person with the
amount of Indebtedness represented by such Disqualified Capital Stock being
equal to the greater of its voluntary or involuntary liquidation preference
and its maximum fixed repurchase price.
For purposes hereof, the "maximum fixed repurchase price" of any
Disqualified Capital Stock that does not have a fixed repurchase price shall be
calculated in accordance with the terms of such Disqualified Capital Stock as if
such Disqualified Capital Stock were purchased on any date on which Indebtedness
shall be required to be determined pursuant to the Indenture, and if such price
is based upon, or measured by, the fair market value of such Disqualified
Capital Stock, such fair market value shall be determined reasonably and in good
faith by the Board of Directors of the Company. The amount of Indebtedness of
any Person at any date shall be the outstanding balance on such date of all
unconditional Obligations as described above, and the maximum liability upon the
occurrence of the contingency giving rise to the Obligation, on any contingent
Obligations at such date; provided, however, that the amount outstanding at any
time of any Indebtedness incurred with original issue discount is the face
109
amount of such Indebtedness less the remaining unamortized portion of the
original issue discount of such Indebtedness at such time as determined in
conformity with GAAP.
"Independent Financial Advisor" means a firm:
(1) that does not, and whose directors, officers and employees or
Affiliates do not, have a direct or indirect financial interest in the
Company; and
(2) that, in the judgment of the Board of Directors of the Company, is
otherwise independent and qualified to perform the task for which it is to
be engaged.
"Initial Purchaser" means Deutsche Bank Securities Inc.
"Interest Swap Obligations" means the obligations of any Person pursuant to
any arrangement with any other Person, whereby, directly or indirectly, such
Person is entitled to receive from time to time periodic payments calculated by
applying either a floating or a fixed rate of interest on a stated notional
amount in exchange for periodic payments made by such other Person calculated by
applying a fixed or a floating rate of interest on the same notional amount and
shall include, without limitation, interest rate swaps, caps, floors, collars
and similar agreements.
"Investment" means, with respect to any Person, any direct or indirect loan
or other extension of credit (including, without limitation, a guarantee) or
capital contribution to (by means of any transfer of cash or other property to
others or any payment for property or services for the account or use of
others), or any purchase or acquisition by such Person of any Capital Stock,
bonds, notes, debentures or other securities or evidences of Indebtedness issued
by, any other Person. "Investment" shall exclude extensions of trade credit by
the Company and its Restricted Subsidiaries on commercially reasonable terms in
accordance with normal trade practices of the Company or such Restricted
Subsidiary, as the case may be. If the Company or any Restricted Subsidiary
sells or otherwise disposes of any Common Stock of any direct or indirect
Restricted Subsidiary such that, after giving effect to any such sale or
disposition, it ceases to be a Subsidiary of the Company, the Company shall be
deemed to have made an Investment on the date of any such sale or disposition
equal to the fair market value of the Common Stock of such Restricted Subsidiary
not sold or disposed of.
"Issue Date" means February 4, 2004.
"Legal Defeasance" has the meaning set forth under "-- Legal Defeasance and
Covenant Defeasance."
"Lien" means any lien, mortgage, deed of trust, pledge, security interest,
charge or encumbrance of any kind (including any conditional sale or other title
retention agreement, any lease in the nature thereof and any agreement to give
any security interest).
"Moody's" means Moody's Investors Service, Inc.
"Net Cash Proceeds" means, with respect to any Asset Sale, the proceeds in
the form of cash or Cash Equivalents including payments in respect of deferred
payment obligations when received in the form of cash or Cash Equivalents (other
than the portion of any such deferred payment constituting interest) received by
the Company or any of its Restricted Subsidiaries from such Asset Sale net of:
(1) reasonable out-of-pocket expenses and fees relating to such Asset
Sale (including, without limitation, legal, accounting and investment
banking fees and sales commissions);
(2) taxes paid or payable after taking into account any reduction in
consolidated tax liability due to available tax credits or deductions and
any tax sharing arrangements;
110
(3) repayment of Indebtedness that is secured by the assets sold in
the relevant Asset Sale or other Indebtedness that is required to be repaid
in connection with such Asset Sale; and
(4) appropriate amounts to be provided by the Company or any
Restricted Subsidiary, as the case may be, as a reserve, in accordance with
GAAP, against any liabilities associated with such Asset Sale and retained
by the Company or any Restricted Subsidiary, as the case may be, after such
Asset Sale, including, without limitation, pension and other
post-employment benefit liabilities, liabilities related to environmental
matters and liabilities under any indemnification obligations associated
with such Asset Sale.
"Obligations" means all obligations for principal, premium, interest,
penalties, fees, indemnifications, reimbursements, damages and other liabilities
payable under the documentation governing any Indebtedness.
"Permitted Holder" means any of BRS Group, Farallon and their respective
Affiliates.
"Permitted Indebtedness" means, without duplication, each of the following:
(1) Indebtedness under (i) the Notes issued under the Indenture in an
aggregate principal amount not to exceed $213.0 million and any Guarantees
thereof and (ii) the Existing TSI Notes and the guarantees thereof
(including any guarantees thereof by the Company);
(2) Indebtedness incurred pursuant to the Credit Agreement in an
aggregate principal amount at any time outstanding not to exceed $50.0
million incurred under this clause (2), less the amount of all required
principal payments actually made by the Company in respect of the loans
thereunder that were incurred under this clause (2) in accordance with the
provisions set forth under "-- Certain Covenants -- Limitation on Asset
Sales" (which, in the case of revolving loans, are accompanied by a
corresponding permanent commitment reduction);
(3) other Indebtedness (including Capitalized Lease Obligations) of
the Company and its Restricted Subsidiaries outstanding on the Issue Date;
(4) Purchase Money Indebtedness and Capitalized Lease Obligations of
the Company and its Restricted Subsidiaries in an aggregate amount for all
Indebtedness incurred pursuant to this clause (4) not to exceed $20.0
million outstanding at any one time;
(5) Interest Swap Obligations covering Indebtedness of the Company or
any of its Restricted Subsidiaries; provided, however, that such Interest
Swap Obligations are entered into to protect the Company and its Restricted
Subsidiaries from fluctuations in interest rates on Indebtedness incurred
in accordance with the Indenture to the extent the notional principal
amount of such Interest Swap Obligation does not exceed, at the time of
incurrence thereof, the principal amount of the Indebtedness to which such
Interest Swap Obligation relates;
(6) Indebtedness under Currency Agreements; provided, that in the case
of Currency Agreements which relate to Indebtedness, such Currency
Agreements do not increase the Indebtedness of the Company and its
Restricted Subsidiaries outstanding other than as a result of fluctuations
in foreign currency exchange rates or by reason of fees, indemnities and
compensation payable thereunder;
(7) Indebtedness of a Restricted Subsidiary to the Company or to
another Restricted Subsidiary for so long as such Indebtedness is held by
the Company, a Restricted Subsidiary or the holders of a Lien permitted
under the Indenture, in each case subject to no Lien held by a Person other
than the Company, a Restricted Subsidiary or the holders of a Lien
permitted under the Indenture; provided, that if as of any date any Person
other than
111
the Company, a Restricted Subsidiary or the holders of a Lien permitted
under the Indenture owns or holds any such Indebtedness or holds a Lien in
respect of such Indebtedness, such date shall be deemed the incurrence of
Indebtedness not constituting Permitted Indebtedness by the issuer of such
Indebtedness pursuant to this subclause (7);
(8) Indebtedness of the Company to a Restricted Subsidiary for so long
as such Indebtedness is held by a Restricted Subsidiary or the holders of a
Lien permitted under the Indenture, in each case subject to no Lien other
than a Lien permitted under the Indenture; provided that:
(a) any Indebtedness of the Company to any Restricted Subsidiary
that is not a Guarantor is unsecured and subordinated, pursuant to a
written agreement, to the Company's obligations under the Indenture and
the Notes and
(b) if as of any date any Person other than a Restricted Subsidiary
or the holders of a Lien permitted under the Indenture owns or holds any
such Indebtedness or any Person holds a Lien in respect of such
Indebtedness, such date shall be deemed the incurrence of Indebtedness
not constituting Permitted Indebtedness by the Company under this clause
(8);
(9) Indebtedness arising from the honoring by a bank or other
financial institution of a check, draft or similar instrument inadvertently
(except in the case of daylight overdrafts) drawn against insufficient
funds in the ordinary course of business; provided, however, that such
Indebtedness is extinguished within four Business Days of incurrence;
(10) Indebtedness of the Company or any of its Restricted Subsidiaries
represented by letters of credit for the account of the Company or such
Restricted Subsidiary, as the case may be, in order to provide security for
workers' compensation claims, payment obligations in connection with
self-insurance or similar requirements in the ordinary course of business;
(11) Refinancing Indebtedness;
(12) Indebtedness represented by guarantees by the Company or its
Restricted Subsidiaries of Indebtedness otherwise permitted to be incurred
under the Indenture; provided that, in the case of a guarantee by a
Restricted Subsidiary, such Restricted Subsidiary complies with the
covenant described under "Certain Covenants -- Limitation on Issuances of
Guarantees by Restricted Subsidiaries" to the extent applicable;
(13) Indebtedness of the Company or any of its Restricted Subsidiaries
in respect of bid, payment and performance bonds, bankers' acceptances,
workers' compensation claims, surety or appeal bonds, payment obligations
in connection with self-insurance or similar obligations, and bank
overdrafts (and letters of credit in respect thereof) in the ordinary
course of business;
(14) Indebtedness of the Company or any Restricted Subsidiary
consisting of guarantees, indemnities or obligations in respect of purchase
price adjustments in connection with the acquisition or disposition of
assets; and
(15) additional Indebtedness of the Company and its Restricted
Subsidiaries in an aggregate principal amount not to exceed $10.0 million
at any one time outstanding (which amount may, but need not, be incurred in
whole or in part under the Credit Agreement).
For purposes of determining any particular amount of Indebtedness under
"Limitation on Incurrence of Additional Indebtedness" covenant, guarantees,
Liens or letter of credit obligations supporting Indebtedness otherwise included
in the determination of such particular amount shall not be included. For
purposes of determining compliance with the "Limitation on Incurrence of
Additional Indebtedness" covenant, in the event that an item of Indebtedness
112
meets the criteria of more than one of the categories of Permitted Indebtedness
described in clauses (1) through (15) above or is permitted to be incurred
pursuant to the Consolidated Fixed Charge Coverage Ratio provisions of such
covenant, the Company shall, in its sole discretion, classify (or later
reclassify) such item of Indebtedness in any manner that complies with such
covenant. Accrual of interest, accretion or amortization of original issue
discount, the payment of interest on any Indebtedness in the form of additional
Indebtedness with the same terms, the payment of dividends on Disqualified
Capital Stock in the form of additional shares of the same class of Disqualified
Capital Stock and change in the amount outstanding due solely to the result of
fluctuations in the exchange rates of currencies will not be deemed to be an
incurrence of Indebtedness or an issuance of Disqualified Capital Stock for
purposes of the "Limitations on Incurrence of Additional Indebtedness" covenant.
"Permitted Investments" means:
(1) Investments by the Company or any Restricted Subsidiary in any
Person that is or will become immediately after such Investment a
Restricted Subsidiary or that will merge or consolidate into the Company or
a Restricted Subsidiary;
(2) Investments in the Company by any Restricted Subsidiary; provided
that any Indebtedness incurred by the Company evidencing such Investment by
a Restricted Subsidiary that is not a Guarantor is unsecured and
subordinated, pursuant to a written agreement, to the Company's obligations
under the Notes and the Indenture;
(3) Investments in cash and Cash Equivalents;
(4) loans and advances to directors, employees and officers of the
Company and its Restricted Subsidiaries in the ordinary course of business
for bona fide business purposes not in excess of $5.0 million at any one
time outstanding;
(5) Currency Agreements and Interest Swap Obligations entered into in
the ordinary course of the Company's or a Restricted Subsidiary's
businesses and otherwise in compliance with the Indenture;
(6) other Investments, including Investments in Unrestricted
Subsidiaries, not to exceed $10.0 million at any one time outstanding;
(7) Investments in securities of trade creditors or members received
pursuant to any plan of reorganization or similar arrangement upon the
bankruptcy or insolvency of such trade creditors or members or in good
faith settlement of delinquent obligations of such trade creditors or
members;
(8) Investments represented by guarantees that are otherwise permitted
under the Indenture;
(9) Investments the payment for which is Qualified Capital Stock of
the Company;
(10) Investments made by the Company or its Restricted Subsidiaries as
a result of consideration received in connection with an Asset Sale made in
compliance with the covenant described under "-- Certain
Covenants -- Limitation on Asset Sales," and
(11) the acquisition by the Company of obligations of one or more
officers, directors or employees of the Company or any of its Subsidiaries
in connection with such officers', directors' or employees' acquisition of
shares of capital stock of the Company so long as no cash is paid by the
Company or any of its Subsidiaries to such officers, directors or employees
in connection with the acquisition of any such obligations.
113
"Permitted Liens" means the following types of Liens:
(1) Liens for taxes, assessments or governmental charges or claims
either
(a) not delinquent or
(b) contested in good faith by appropriate proceedings and as to
which the Company or its Restricted Subsidiaries shall have set aside on
its books such reserves as may be required pursuant to GAAP;
(2) statutory and contractual Liens of landlords and Liens of
carriers, warehousemen, mechanics, suppliers, materialmen, repairmen and
other Liens imposed by law incurred in the ordinary course of business for
sums not yet delinquent or being contested in good faith, if such reserve
or other appropriate provision, if any, as shall be required by GAAP shall
have been made in respect thereof;
(3) Liens incurred or deposits made in the ordinary course of business
in connection with workers' compensation, unemployment insurance and other
types of social security, including any Lien securing letters of credit
issued in the ordinary course of business consistent with past practice in
connection therewith, or to secure the performance of tenders, statutory
obligations, surety and appeal bonds, bids, leases, government contracts,
performance and return-of-money bonds and other similar obligations
(exclusive of obligations for the payment of borrowed money);
(4) judgment Liens not giving rise to an Event of Default;
(5) easements, rights-of-way, zoning restrictions and other similar
charges or encumbrances in respect of real property not interfering in any
material respect with the ordinary conduct of the business of the Company
or of any of its Restricted Subsidiaries;
(6) any interest or title of a lessor under any Capitalized Lease
Obligation; provided that such Liens do not extend to any property or asset
which is not leased property subject to such Capitalized Lease Obligation;
(7) purchase money Liens to finance property or assets of the Company
or any Restricted Subsidiary acquired after the Issue Date; provided,
however, that
(a) the related purchase money Indebtedness shall not exceed the
cost of such property or assets and shall not be secured by property or
assets of the Company or any Restricted Subsidiary other than the
property and assets so acquired and
(b) the Lien securing such Indebtedness shall be created within 90
days of such acquisition;
(8) Liens upon specific items of inventory or other goods and proceeds
of any Person securing such Person's obligations in respect of bankers'
acceptances issued or created for the account of such Person to facilitate
the purchase, shipment or storage of such inventory or other goods;
(9) Liens securing reimbursement obligations with respect to
commercial letters of credit which encumber documents and other property
relating to such letters of credit and products and proceeds thereof;
(10) Liens encumbering deposits made to secure obligations arising
from statutory, regulatory, contractual or warranty requirements of the
Company or any of its Restricted Subsidiaries, including rights of offset
and setoff;
(11) Liens securing Interest Swap Obligations which Interest Swap
Obligations relate to Indebtedness that is otherwise permitted under the
Indenture;
(12) Liens securing Indebtedness under Currency Agreements;
114
(13) Liens securing Acquired Indebtedness incurred in accordance with
the covenant described under "-- Certain Covenants -- Limitation on
Incurrence of Additional Indebtedness"; provided that
(a) such Liens secured such Acquired Indebtedness at the time of
and prior to the incurrence of such Acquired Indebtedness by the Company
or a Restricted Subsidiary and were not granted in connection with, or
in anticipation of, the incurrence of such Acquired Indebtedness by the
Company or a Restricted Subsidiary and
(b) such Liens do not extend to or cover any property or assets of
the Company or of any of its Restricted Subsidiaries other than the
property or assets that secured the Acquired Indebtedness prior to the
time such Indebtedness became Acquired Indebtedness of the Company or a
Restricted Subsidiary and are no more favorable to the lienholders than
those securing the Acquired Indebtedness prior to the incurrence of such
Acquired Indebtedness by us or a Restricted Subsidiary;
(14) Liens on assets of a Restricted Subsidiary that is not a
Guarantor to secure Indebtedness and other obligations of such Restricted
Subsidiary that are otherwise permitted under the Indenture;
(15) leases, subleases, licenses and sublicenses granted to others
that do not materially interfere with the ordinary course of business of
the Company and its Restricted Subsidiaries;
(16) banker's Liens, rights of setoff and similar Liens with respect
to cash and Cash Equivalents on deposit in one or more bank accounts in the
ordinary course of business;
(17) Liens arising from filing Uniform Commercial Code financing
statements regarding leases;
(18) Liens in favor of customs and revenue authorities arising as a
matter of law to secure payment of customs duties in connection with the
importation of goods; and
(19) additional Liens not to exceed $10.0 million at any one time.
"Person" means an individual, partnership, corporation, limited liability
company, unincorporated organization, trust or joint venture, or a governmental
agency or political subdivision thereof.
"Preferred Stock" of any Person means any Capital Stock of such Person that
has preferential rights to any other Capital Stock of such Person with respect
to dividends or redemptions or upon liquidation.
"Purchase Money Indebtedness" means Indebtedness of the Company or its
Restricted Subsidiaries incurred for the purpose of financing all or any part of
the purchase price or the cost of installation, construction or improvement of
any property.
"Qualified Capital Stock" means any Capital Stock that is not Disqualified
Capital Stock.
"Refinance" means, in respect of any security or Indebtedness, to
refinance, extend, renew, refund, repay, prepay, redeem, defease or retire, or
to issue a security or Indebtedness in exchange or replacement for, such
security or Indebtedness in whole or in part. "Refinanced" and "Refinancing"
shall have correlative meanings.
"Refinancing Indebtedness" means any Refinancing by the Company or any
Restricted Subsidiary of Indebtedness incurred in accordance with the covenant
described under "-- Certain Covenants -- Limitation on Incurrence of Additional
Indebtedness" (other than
115
pursuant to clause (2), (4), (5), (6), (7), (8), (9), (10), (12), (13), (14) or
(15) of the definition of Permitted Indebtedness), in each case that does not:
(1) result in an increase in the aggregate principal amount of
Indebtedness of such Person as of the date of such proposed Refinancing
(plus the amount of any premium required to be paid under the terms of the
instrument governing such Indebtedness and plus the amount of reasonable
expenses incurred by the Company or any Restricted Subsidiary in connection
with such Refinancing); or
(2) create Indebtedness with
(a) a Weighted Average Life to Maturity that is less than the
Weighted Average Life to Maturity of the Indebtedness being Refinanced
or
(b) a final maturity earlier than the final maturity of the
Indebtedness being Refinanced; provided that
(x) if such Indebtedness being Refinanced is Indebtedness solely
of the Company, then such Refinancing Indebtedness shall be
Indebtedness solely of the Company, and
(y) if such Indebtedness being Refinanced is subordinate or
junior to the Notes, then such Refinancing Indebtedness shall be
subordinate to the Notes at least to the same extent and in the same
manner as the Indebtedness being Refinanced.
"Registration Rights Agreement" means the Registration Rights Agreement
dated as of February 4, 2004 among the Company and the Initial Purchaser.
"Replacement Assets" means assets of a kind used or usable in the business
of the Company and its Restricted Subsidiaries as conducted on the date of the
relevant Asset Sale.
"Restricted Subsidiary" means any Subsidiary of the Company that has not
been designated by the Board of Directors of the Company, by a Board Resolution
of the Company delivered to the Trustee, as an Unrestricted Subsidiary pursuant
to and in compliance with the covenant described under "-- Certain
Covenants -- Limitation on Designations of Unrestricted Subsidiaries." Any such
Designation may be revoked by a Board Resolution of the Company delivered to the
Trustee, subject to the provisions of such covenant.
"Revocation" has the meaning set forth under "-- Certain
Covenants -- Limitation on Designations of Unrestricted Subsidiaries."
"S&P" means Standard and Poor's Ratings Service.
"Sale and Leaseback Transaction" means any direct or indirect arrangement
with any Person or to which any such Person is a party, providing for the
leasing to the Company or a Restricted Subsidiary of any property, whether owned
by the Company or any Restricted Subsidiary at the Issue Date or later acquired,
which has been or is to be sold or transferred by the Company or by such
Restricted Subsidiary to such Person or to any other Person from whom funds have
been or are to be advanced by such Person on the security of such Property.
"Significant Subsidiary" will have the meaning set forth in Rule 1.02(w) of
Regulation S-X under the Securities Act.
"Subordinated Indebtedness" means Indebtedness of the Company that is by
its express terms subordinated or junior in right of payment to the Notes.
116
"Subsidiary", with respect to any Person, means:
(1) any corporation of which the outstanding Capital Stock having at
least a majority of the votes entitled to be cast in the election of
directors under ordinary circumstances shall at the time be owned, directly
or indirectly, by such Person; or
(2) any other Person of which at least a majority of the voting
interest under ordinary circumstances is at the time, directly or
indirectly, owned by such Person.
"Surviving Entity" has the meaning set forth under "-- Certain
Covenants -- Merger, Consolidation and Sale of Assets."
"Transactions" means the manner in which the proceeds received by the
Company from the sale of the Notes on the Issue Date will be used, including the
payment of dividends to the Company's shareholders and the repurchase of TSI's
preferred stock.
"TSI" means Town Sports International, Inc.
"Unrestricted Subsidiary" means any Subsidiary of the Company designated as
such pursuant to and in compliance with the covenant described under "-- Certain
Covenants -- Limitation on Designations of Unrestricted Subsidiaries." Any such
designation may be revoked by a Board Resolution of the Company delivered to the
Trustee, subject to the provisions of such covenant.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing:
(1) the then outstanding aggregate principal amount of such
Indebtedness into
(2) the sum of the total of the products obtained by multiplying
(a) the amount of each then remaining installment, sinking fund,
serial maturity or other required payment of principal, including
payment at final maturity, in respect thereof, by
(b) the number of years (calculated to the nearest one-twelfth)
which will elapse between such date and the making of such payment.
"Wholly Owned Restricted Subsidiary" means any Restricted Subsidiary of
which all the outstanding voting securities (other than in the case of a foreign
Restricted Subsidiary, directors' qualifying shares or an immaterial amount of
shares required to be owned by other Persons pursuant to applicable law) are
owned by the Company or another Wholly Owned Restricted Subsidiary.
117
CERTAIN MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following discussion is based upon current provisions of the Internal
Revenue Code of 1986, as amended, applicable Treasury regulations, judicial
authority and administrative rulings and practice. There can be no assurance
that the Internal Revenue Service (the "IRS") will not take a contrary view, and
no ruling from the IRS has been or will be sought. Legislative, judicial or
administrative changes or interpretations may be forthcoming that could alter or
modify the statements and conditions set forth herein. Any such changes or
interpretations may or may not be retroactive and could affect the tax
consequences to holders. Certain holders (including insurance companies,
tax-exempt organizations, financial institutions, broker-dealers, foreign
corporations and persons who are not citizens or residents of the United States)
may be subject to special rules not discussed below. We recommend that each
holder consult such holder's own tax advisor as to the particular tax
consequences of exchanging such holder's Old Notes for New Notes, including the
applicability and effect of any state, local or foreign tax laws.
The exchange of the Old Notes for New Notes pursuant to the exchange offer
will not be treated as an "exchange" for federal income tax purposes because the
New Notes should not be considered to differ materially in kind or extent from
the Old Notes. Rather, the New Notes received by a holder will be treated as a
continuation of the Old Notes in the hands of such holder. As a result, there
will be no federal income tax consequences to holders exchanging Old Notes for
New Notes pursuant to the exchange offer.
118
PLAN OF DISTRIBUTION
Each broker-dealer that receives new securities for its own account
pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of these new securities. This
prospectus, as it may be amended or supplemented from time to time, may be used
by a broker-dealer in connection with resales of new securities received in
exchange for securities where those securities were acquired as a result of
market-making activities or other trading activities. We have agreed that,
starting on the expiration date and ending on the close of business 180 days
after the expiration date, we will make this prospectus, as amended or
supplemented, available to any broker-dealer for use in connection with any such
resale. In addition, until , 2004, all dealers effecting transactions
in the new securities may be required to deliver a prospectus.
We will not receive any proceeds from any sale of new securities by
broker-dealers. New securities received by broker-dealers for their own account
pursuant to the Exchange Offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions, through
the writing of options on the new securities or a combination of such methods of
resale, at market prices prevailing at the time of resale, at prices related to
such prevailing market prices or negotiated prices. Any such resale may be made
directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any such
broker-dealer and/or the purchasers of any such new securities. Any
broker-dealer that resells new securities that were received by it for its own
account pursuant to the Exchange Offer and any broker or dealer that
participates in a distribution of such new securities may be deemed to be an
"underwriter" within the meaning of the Securities Act and any profit of any
such resale of new securities and any commissions or concessions received by any
such persons may be deemed to be underwriting compensation under the Securities
Act. By acknowledging that it will deliver and by delivering a prospectus, a
broker-dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act.
For a period of 180 days after the expiration date, we will promptly send
additional copies of this prospectus and any amendment or supplement to this
prospectus to any broker-dealer that requests such documents. We have agreed to
pay all expenses incident to the Exchange Offer (including the expenses of one
counsel for the holders of the securities) other than commissions or concessions
of any brokers or dealers and will indemnify the holders of the securities
(including any broker-dealers) against certain liabilities, including
liabilities under the Securities Act.
119
LEGAL MATTERS
The legality of the New Notes and certain other legal matters will be
passed upon for us by Kirkland & Ellis LLP, New York, New York.
EXPERTS
The financial statements of Town Sports International Holdings, Inc. as of
December 31, 2003 and 2002 and for each of the three years in the period ended
December 31, 2003 included in this Prospectus have been so included in reliance
on the report of PricewaterhouseCoopers LLP, an independent registered public
accounting firm, given on the authority of said firm as experts in auditing and
accounting.
120
AVAILABLE INFORMATION
TSI, Inc. is subject to the periodic reporting and other informational
requirements of the Exchange Act, as amended. Under the terms of the indenture,
we agree that, whether or not required by the rules and regulations of the SEC,
so long as any Notes are outstanding, we will furnish to the trustee and the
holders of Notes (i) all quarterly and annual financial information that would
be required to be contained in a filing with the SEC on Forms 10-Q and 10-K, if
we were required to file such Forms, including a "Management's Discussion and
Analysis of Financial Condition and Results of Operations" that describes our
financial condition and results of operations and our consolidated subsidiaries
and, with respect to the annual information only, a report thereon by our
certified independent accountants and (ii) all current reports that would be
required to be filed with the SEC on Form 8-K if we were required to file such
reports. In addition, whether or not required by the rules and regulations of
the SEC, we will file a copy of all such information and reports with the SEC
for public availability (unless the SEC will not accept such a filing) and make
such information available to securities analysts and prospective investors upon
request. Information filed with the SEC may be read and copied by the public at
the Public Reference Room of the SEC at 450 Fifth Street, N.W., Washington, D.C.
20549. The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an
Internet site at http://www.sec.gov that contains reports, proxy and information
statements and other information regarding issuers that file electronically with
the SEC. In addition, we have agreed that, for so long as any Notes remain
outstanding, we will furnish to the holders and to securities analysts and
prospective investors, upon their request, the information required to be
delivered pursuant to Rule 144A(d)(4) under the Securities Act.
121
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Consolidated Annual Financial Statements:
Report of Independent Registered Public Accounting Firm... F-2
Consolidated balance sheets at December 31, 2002 and
2003................................................... F-3
Consolidated statements of operations for the years ended
December 31, 2001, 2002 and 2003....................... F-4
Consolidated statements of stockholders' deficit for the
years ended December 31, 2001, 2002 and 2003........... F-5
Consolidated statements of cash flows for the years ended
December 31, 2001, 2002 and 2003....................... F-6
Notes to consolidated financial statements................ F-7
Condensed Consolidated Interim Financial Statements
(Unaudited)
Condensed Consolidated Balance Sheets as of December 31,
2003 and March 31, 2004................................ F-29
Condensed Consolidated Statements of Operations for the
three months ended March 31, 2003 and 2004............. F-30
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 2003 and 2004............. F-31
Notes to Condensed Consolidated Financial Statements...... F-32
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Town Sports International Holdings, Inc.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' deficit and cash
flows present fairly, in all material respects, the financial position of TOWN
SPORTS INTERNATIONAL HOLDINGS, INC. and SUBSIDIARIES (the "Company") at December
31, 2003 and 2002, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
the standards of the Public Company Accounting Overight Board (United States).
Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Notes 2m and 4 to the financial statements, the Company
changed its method of accounting for goodwill and other intangibles effective
January 1, 2002.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York
February 17, 2004, except as to Note 18,
which is dated March 17, 2004.
F-2
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31, 2002 AND 2003
2002 2003
-------- --------
ASSETS
Current assets
Cash and cash equivalents................................. $ 5,551 $ 40,802
Accounts receivable (less allowance for doubtful accounts
of $120 and $822 in 2002 and 2003, respectively)........ 1,333 1,469
Inventory................................................. 1,132 750
Prepaid corporate income taxes............................ 3,012 4,062
Prepaid expenses and other current assets................. 4,430 5,322
-------- --------
TOTAL CURRENT ASSETS.................................... 15,458 52,405
Fixed assets, net........................................... 210,823 223,599
Goodwill.................................................... 45,531 45,864
Intangible assets, net...................................... 1,675 630
Deferred tax assets, net.................................... 20,254 16,771
Deferred membership costs................................... 14,408 13,038
Other assets................................................ 6,101 9,892
-------- --------
TOTAL ASSETS............................................ $314,250 $362,199
======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities
Current portion of long-term debt and capital lease
obligations............................................. $ 5,178 $ 3,486
Accounts payable.......................................... 5,328 5,379
Accrued expenses.......................................... 21,634 26,006
Deferred revenue.......................................... 26,510 26,621
-------- --------
TOTAL CURRENT LIABILITIES............................... 58,650 61,492
Long-term debt and capital lease obligations................ 155,765 258,391
Deferred lease liabilities.................................. 23,644 25,856
Deferred revenue............................................ 3,435 3,002
Other liabilities........................................... 7,530 7,862
-------- --------
TOTAL LIABILITIES....................................... 249,024 356,603
-------- --------
Commitments and contingencies (Note 15)
Redeemable preferred stock
Redeemable senior preferred stock, $1.00 par value;
liquidation value $64,512; authorized 100,000 shares;
40,000 and 0 shares issued and outstanding at December
31, 2002 and December 31, 2003, respectively............ 62,125 --
Series A redeemable preferred stock, $1.00 par value; at
liquidation value; authorized 200,000 shares; 153,637
shares issued and outstanding at December 31, 2002 and
2003.................................................... 34,841 39,890
-------- --------
96,966 39,890
-------- --------
Stockholders' deficit
Series B preferred stock, $1.00 par value; at liquidation
value; 3,822 and 109,540 shares issued and outstanding
at December 31, 2002 and 2003, respectively............. 303 9,961
Class A voting common stock, $.001 par value; issued and
outstanding 1,176,043 shares at December 31, 2002 and
2003, respectively...................................... 1 1
Paid-in capital........................................... (32,149) (45,627)
Unearned compensation..................................... (278) (172)
Accumulated other comprehensive income (currency
translation adjustment)................................. 293 596
Retained earnings......................................... 90 947
-------- --------
TOTAL STOCKHOLDERS' DEFICIT............................. (31,740) (34,294)
-------- --------
TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' DEFICIT.................................. $314,250 $362,199
======== ========
See notes to consolidated financial statements.
F-3
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
2001 2002 2003
-------- -------- --------
Revenues
Club operations...................................... $278,200 $314,995 $336,140
Fees and other....................................... 3,433 4,432 6,401
-------- -------- --------
281,633 319,427 342,541
-------- -------- --------
Operating expenses
Payroll and related.................................. 112,766 129,105 130,585
Club operating....................................... 88,941 99,113 111,069
General and administrative........................... 18,785 21,368 21,995
Depreciation and amortization........................ 32,185 31,748 34,927
-------- -------- --------
252,677 281,334 298,576
-------- -------- --------
OPERATING INCOME.................................. 28,956 38,093 43,965
Loss on extinguishment of debt......................... -- -- 7,773
Interest expense....................................... 14,918 16,559 23,670
Interest income........................................ (391) (138) (444)
-------- -------- --------
INCOME FROM CONTINUING OPERATIONS BEFORE PROVISION
FOR CORPORATE INCOME TAXES...................... 14,429 21,672 12,966
Provision for corporate income taxes................... 6,853 9,709 5,537
-------- -------- --------
INCOME FROM CONTINUING OPERATIONS................. 7,576 11,963 7,429
Loss on discontinued operations (including loss on club
closure of $996 in 2002), net of income tax benefits
of $364 and $551 for 2001 and 2002, respectively..... (530) (767) --
Cumulative effect of a change in accounting principle,
net of income tax benefit of $612.................... -- (689) --
-------- -------- --------
NET INCOME........................................ 7,046 10,507 7,429
Accreted dividends on preferred stock.................. (10,201) (11,543) (10,984)
-------- -------- --------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS...... $ (3,155) $ (1,036) $ (3,555)
======== ======== ========
See notes to consolidated financial statements.
F-4
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(IN THOUSANDS OF DOLLARS EXCEPT SHARE DATA)
YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
PREFERRED STOCK COMMON STOCK
SERIES B CLASS A FOREIGN ACCUMULATED
($1.00 PAR) ($.001 PAR) CURRENCY (DEFICIT)/
---------------- ------------------ PAID-IN UNEARNED TRANSLATION RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION ADJUSTMENT EARNINGS
------- ------ --------- ------ -------- ------------ ----------- -----------
BALANCE AT JANUARY 1, 2001......... 3,822 $ 232 1,005,698 $1 $(13,117) $(156) $ 12 $(17,463)
Common stock issued in connection
with subordinated credit
facility.......................... 23,000
Compensation expenses incurred in
connection with Series B Preferred
stock options..................... 993
Amortization of unearned
compensation...................... 156
Accretion of Series B preferred
stock dividend ($8.63 per
share)............................ 33 (33)
Accretion of Series A redeemable
preferred stock dividend ($25.07
per share)........................ (3,852)
Accretion of redeemable senior
preferred stock dividend ($157.90
per share plus accretion of
liquidation value)................ (6,658)
Deferred compensation recorded in
connection with the issuance of
stock options..................... 422 (422)
Other comprehensive income, net of
taxes:
Net income........................ 7,046
Foreign currency translation
adjustment...................... 9
Total comprehensive income......
------- ------ --------- -- -------- ----- ---- --------
BALANCE AT DECEMBER 31, 2001....... 3,822 265 1,028,698 1 (22,245) (422) 21 (10,417)
Common stock issued in connection
with warrant exercises............ 147,345 1
Vesting of restricted common stock
issued in connection with
subordinated credit facility...... 917
Compensation expense incurred in
connection with Series B Preferred
stock options..................... 1,137
Amortization of unearned
compensation...................... 70
Accretion of Series B preferred
stock dividend ($10.20 per
share)............................ 38 (38)
Accretion of Series A redeemable
preferred stock dividend ($28.71
per share)........................ (4,409)
Accretion of redeemable senior
preferred stock dividend ($177.40
per share plus accretion to
liquidation value)................ (7,438)
Forfeiture of unvested options..... (74) 74
Other comprehensive income, net of
taxes:
Net income........................ 10,507
Foreign currency translation
adjustment...................... 272
Total comprehensive income......
------- ------ --------- -- -------- ----- ---- --------
BALANCE AT DECEMBER 31, 2002....... 3,822 303 1,176,043 1 (32,149) (278) 293 90
Series B preferred stock issued in
connection with the exercise of
stock options..................... 106,267 8,618 (8,618)
Repurchase of stock................ (549) (43) (540)
Compensation expense incurred in
connection with Series B Preferred
stock options..................... 177
Amortization of unearned
compensation...................... 21
Accretion of Series B preferred
stock dividend ($9.84 per
share)............................ 1,083 (305) (778)
Accretion of Series A redeemable
preferred stock dividend ($32.86
per share)........................ (1,219) (3,830)
Accretion of redeemable senior
preferred stock dividend ($121.30
per share plus accretion to
liquidation value)................ (2,888) (1,964)
Forfeiture of unvested options..... (85) 85
Other comprehensive income, net of
taxes:
Net income........................ 7,429
Foreign currency translation
adjustment...................... 303
Total comprehensive income......
------- ------ --------- -- -------- ----- ---- --------
BALANCE AT DECEMBER 31, 2003....... 109,540 $9,961 1,176,043 $1 $(45,627) $(172) $596 $ 947
======= ====== ========= == ======== ===== ==== ========
TOTAL
STOCKHOLDERS'
DEFICIT
-------------
BALANCE AT JANUARY 1, 2001......... $(30,491)
Common stock issued in connection
with subordinated credit
facility..........................
Compensation expenses incurred in
connection with Series B Preferred
stock options..................... 993
Amortization of unearned
compensation...................... 156
Accretion of Series B preferred
stock dividend ($8.63 per
share)............................ --
Accretion of Series A redeemable
preferred stock dividend ($25.07
per share)........................ (3,852)
Accretion of redeemable senior
preferred stock dividend ($157.90
per share plus accretion of
liquidation value)................ (6,658)
Deferred compensation recorded in
connection with the issuance of
stock options..................... --
Other comprehensive income, net of
taxes:
Net income........................ 7,046
Foreign currency translation
adjustment...................... 9
--------
Total comprehensive income...... 7,055
--------
BALANCE AT DECEMBER 31, 2001....... (32,797)
Common stock issued in connection
with warrant exercises............ 1
Vesting of restricted common stock
issued in connection with
subordinated credit facility...... 917
Compensation expense incurred in
connection with Series B Preferred
stock options..................... 1,137
Amortization of unearned
compensation...................... 70
Accretion of Series B preferred
stock dividend ($10.20 per
share)............................ --
Accretion of Series A redeemable
preferred stock dividend ($28.71
per share)........................ (4,409)
Accretion of redeemable senior
preferred stock dividend ($177.40
per share plus accretion to
liquidation value)................ (7,438)
Forfeiture of unvested options..... --
Other comprehensive income, net of
taxes:
Net income........................ 10,507
Foreign currency translation
adjustment...................... 272
--------
Total comprehensive income...... 10,779
--------
BALANCE AT DECEMBER 31, 2002....... (31,740)
Series B preferred stock issued in
connection with the exercise of
stock options..................... --
Repurchase of stock................ (583)
Compensation expense incurred in
connection with Series B Preferred
stock options..................... 177
Amortization of unearned
compensation...................... 21
Accretion of Series B preferred
stock dividend ($9.84 per
share)............................ --
Accretion of Series A redeemable
preferred stock dividend ($32.86
per share)........................ (5,049)
Accretion of redeemable senior
preferred stock dividend ($121.30
per share plus accretion to
liquidation value)................ (4,852)
Forfeiture of unvested options..... --
Other comprehensive income, net of
taxes:
Net income........................ 7,429
Foreign currency translation
adjustment...................... 303
--------
Total comprehensive income...... 7,732
--------
BALANCE AT DECEMBER 31, 2003....... $(34,294)
========
See notes to consolidated financial statements.
F-5
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
YEARS ENDED DECEMBER 31, 2001, 2002 AND 2003
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
2001 2002 2003
-------- -------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................. $ 7,046 $ 10,507 $ 7,429
-------- -------- ---------
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization............................ 32,667 32,025 34,927
Amortization of debt issuance costs...................... 1,882 1,928 1,627
Noncash rental expense, net of noncash rental income..... 4,224 1,670 1,650
Compensation expense incurred in connection with stock
options................................................ 1,149 1,207 198
Net change in certain working capital components......... 3,475 2,413 (227)
Decrease (increase) in deferred tax asset................ (4,526) (1,162) 3,483
Decrease (increase) in deferred membership costs......... (1,162) 340 1,370
Loss on extinguishment of debt........................... -- -- 7,773
Goodwill impairment write-off............................ -- 1,301 --
Club closure costs....................................... -- 996 --
Other.................................................... (407) (420) 23
-------- -------- ---------
Total adjustments...................................... 37,302 40,298 50,824
-------- -------- ---------
Net cash provided by operating activities.............. 44,348 50,805 58,253
-------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, net of effect of acquired
businesses............................................... (57,811) (41,393) (43,397)
Proceeds from sale of equipment............................ -- -- 176
Acquisition of businesses, net of cash acquired............ (1,272) (2,322) (130)
Landlord contributions..................................... 725 3,533 617
-------- -------- ---------
Net cash used in investing activities.................. (58,358) (40,182) (42,734)
-------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from 9 5/8% Senior Note Offering.................. -- -- 255,000
Repayment of 9 3/4% Senior Notes........................... -- -- (125,000)
Premium paid on extinguishment of debt and other costs..... -- -- (4,064)
Redemption of redeemable senior preferred stock............ -- -- (66,977)
Transaction costs related to 9 5/8% Senior Notes........... -- -- (9,578)
Net line of credit (repayments) borrowings................. 13,745 (8,245) (14,500)
Net subordinated credit (repayments) borrowings............ 5,762 2,810 (9,000)
Repurchase of Series B preferred stock..................... -- -- (583)
Repayments of other borrowings............................. (3,404) (5,095) (5,566)
-------- -------- ---------
Net cash provided by (used in) financing activities.... 16,103 (10,530) 19,732
-------- -------- ---------
Net increase in cash and cash equivalents.............. 2,093 93 35,251
CASH AND CASH EQUIVALENTS
Beginning of period........................................ 3,365 5,458 5,551
-------- -------- ---------
End of period.............................................. $ 5,458 $ 5,551 $ 40,802
======== ======== =========
SUMMARY OF THE CHANGE IN CERTAIN WORKING CAPITAL
COMPONENTS,NET OF EFFECTS OF ACQUIRED BUSINESSES
Increase in accounts receivable............................ $ (304) $ (443) $ (136)
Decrease (increase) in inventory........................... (433) 194 382
Increase in prepaid expenses and other current assets...... (514) (527) (137)
Increase in accounts payable and accrued expenses.......... 1,745 3,751 1,036
(Increase) decrease in prepaid corporate income taxes...... 1,828 (3,012) (1,050)
(Decrease) increase in deferred revenue.................... 1,153 2,450 (322)
-------- -------- ---------
Net change in certain working capital components....... $ 3,475 $ 2,413 $ (227)
======== ======== =========
See notes to consolidated financial statements.
F-6
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2002 AND 2003
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
1. NATURE OF BUSINESS
Town Sports International Holdings, Inc. and Subsidiaries (the "Company" or
"TSI Holdings") owns and operates 127 fitness clubs ("clubs") and partly owns
and operates two additional clubs as of December 31, 2003. The Company operates
in a single segment. The Company operates 86 clubs in the New York metropolitan
market, 19 clubs in the Boston market, 15 clubs in the Washington, D.C. market,
six in the Philadelphia market and three clubs in Switzerland. The Company's
geographic concentration in the New York metropolitan market may expose the
Company to adverse developments related to competition, demographic changes,
real estate costs, acts of terrorism and economic down turns. The Company's
Swiss operations are immaterial to the Company's consolidated financial
position, results of operations, and cash flows.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Town Sports International Holdings, Inc. and all wholly owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Certain reclassifications were made to the reported amounts at December 31,
2001 and 2002 to conform to the presentation at December 31, 2003.
b. REVENUE RECOGNITION
The Company receives a one-time non-refundable initiation fee and monthly
dues from its members. The Company's members have the option to join on a
month-to-month basis or to commit to a one or two year membership.
Month-to-month members can cancel their membership at any time with 30 days
notice. Initiation fees and related direct expenses, primarily salaries and
sales commissions payable to membership consultants, are deferred and
recognized, on a straight-line basis, in operations over an estimated membership
life of twenty four (24) months. The amount of costs deferred do not exceed the
related deferred revenue for the periods presented. Dues that are received in
advance are recognized on a pro-rata basis over the periods in which services
are to be provided. Revenues from ancillary services are recognized as services
are performed. Management fees earned for services rendered are recognized at
the time the related services are performed.
The Company recognizes revenue from merchandise sales upon delivery to the
member.
In connection with advance receipts of fees or dues, the Company is
required to maintain surety bonds totaling $3,342 pursuant to various state
consumer protection laws.
c. INVENTORY
Inventory consists of athletic equipment, supplies, headsets for the club
entertainment system and clothing for sale to members. Inventories are valued at
the lower of cost or market by the first-in, first-out method.
F-7
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
d. ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable principally consists of amounts due from the Company's
membership base. The Company maintains allowances for doubtful accounts for
estimated losses resulting from the inability of the Company's members to make
required payments. The Company considers factors such as: historical collection
experience, the age of the receivable balance, and general economic conditions
that may effect our members ability to pay.
e. FIXED ASSETS
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 HTML 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.
f. ADVERTISING AND CLUB PREOPENING COSTS
Advertising costs and club preopening costs are charged to operations
during the period in which they are incurred except for production costs related
to television and radio advertisements, which are expensed when the related
commercials are first aired. Total advertising costs incurred by the Company
during the years ended December 31, 2001, 2002 and 2003 totaled $9,327, $8,888
and $9,783, respectively, and are included in club operations.
g. USE OF ESTIMATES
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.
h. CORPORATE INCOME TAXES
Deferred tax liabilities and assets are recognized for the expected future
tax consequences of events that have been included in the financial statements
or tax returns. Under this method, deferred tax liabilities and assets are
determined on the basis of the difference between the financial statement and
tax basis of assets and liabilities ("temporary differences") at enacted tax
rates in effect for the years in which the temporary differences are expected to
reverse. A
F-8
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
valuation allowance is recorded to reduce deferred tax assets to the amount that
is more likely than not to be realized.
i. STATEMENTS OF CASH FLOWS
Supplemental disclosure of cash flow information:
2001 2002 2003
------- ------- -------
Cash paid
Interest (net of amounts capitalized)............ $13,887 $15,035 $24,004
Income taxes..................................... 10,087 13,187 3,104
Noncash investing and financing activities
Acquisition of fixed assets included in accounts
payable and accrued expenses.................. 7,538 3,901 7,287
Acquisition of equipment and software financed by
lessors....................................... 2,853 2,575 --
See Notes 6, 9, 10 and 11 for additional noncash
investing and financing activities
j. CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments which have
original maturities of three months or less when acquired to be cash
equivalents. The carrying amounts reported in the balance sheets for cash and
cash equivalents approximate fair value. The Company owns and operates a captive
insurance company in the State of New York. Under the insurance laws of the
State of New York, this captive insurance company is required to maintain a cash
balance of at least $250. At December 31, 2003, $252 of cash related to this
wholly owned subsidiary was included within cash and cash equivalents.
k. DEFERRED LEASE LIABILITIES AND NONCASH RENTAL EXPENSE
The Company recognizes rental expense for leases with scheduled rent
increases on the straight-line basis over the life of the lease.
l. FOREIGN CURRENCY
At December 31, 2003, the Company owns three Swiss clubs, which use the
local currency as their functional currency. Assets and liabilities are
translated into U.S. dollars at year-end exchange rates, while income and
expense items are translated into U.S. dollars at the average exchange rate for
the period. For all periods presented foreign exchange transaction gains and
losses were not material. Adjustments resulting from the translation of foreign
functional currency financial statements into U.S. dollars are included in the
currency translation adjustment in stockholders' deficit. The difference between
the Company's net income and comprehensive income is the effect of foreign
exchange translation adjustments, which was immaterial for 2001, and was $272
and $303 for 2002 and 2003, respectively.
m. INVESTMENTS IN AFFILIATED COMPANIES
The Company has investments in Capitol Hill Squash Club Associates
("CHSCA") and Kalorama Sports Management Associates ("KSMA") (collectively
referred to as the "Affiliates"). The Company has a limited partnership interest
in CHSCA, which provides the
F-9
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company with approximately 20% of the CHSCA profits, as defined. The Company has
a co-general partnership and limited partnership interests in KSMA, which
entitles it to receive approximately 45% of the KSMA profits, as defined. The
Affiliates have operations, which are similar, and related to, those of the
Company. The Company accounts for these Affiliates in accordance with the equity
method. The assets, liabilities, equity and operating results of the Affiliates
and the Company's pro rata share of the Affiliates' net assets and operating
results were not material for all periods presented.
n. INTANGIBLE ASSETS, GOODWILL AND DEBT ISSUANCE COSTS
Intangible assets consist of membership lists, a beneficial lease and
covenants-not-to-compete. These assets are stated at cost and are being
amortized by the straight-line method over their estimated lives. Membership
lists are amortized over 24 months and covenants-not-to-compete are amortized
over the contractual life, generally five years. The beneficial lease is being
amortized over the remaining life of the underlying club lease.
In accordance with the Statement on Financial Accounting Standards ("SFAS")
No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets, goodwill has not
been amortized subsequent to December 31, 2001. For the year ended December 31,
2001, goodwill was amortized by the straight-line method over the remaining
lives of the underlying club leases, five to fifteen years. See Note 4 for
further discussion on Goodwill and Intangible Assets.
Debt issuance costs are classified within other assets and are being
amortized as additional interest expense over the life of the underlying debt,
five to eight years, using the interest method. Amortization of debt issue costs
was $1,882, $1,928 and $1,627 for December 31, 2001, 2002 and 2003,
respectively.
o. ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, such as fixed assets and intangible assets are reviewed
for impairment when events or circumstances indicate that their carrying value
may not be recoverable. Estimated undiscounted expected future cash flows are
used to determine if an asset is impaired, in which case the asset's carrying
value would be reduced to fair value.
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-lived Assets," which replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to Be Disposed Of." SFAS No. 144 provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets, expands the scope of discontinued operation to include a
component of an entity and eliminates the exemption to consolidation when
control over a subsidiary is likely to be temporary. In 2002, the Company
discontinued operations at two wholly-owned clubs. As a result of the adoption
of SFAS No. 144 the Company has accounted for these two clubs as discontinued
operations. See Note 17 for further discussion on Discontinued Operations.
p. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and cash equivalents. Such amounts are
held, primarily, in a single commercial bank. The Company holds no collateral
for these financial instruments.
F-10
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
q. STOCK-BASED EMPLOYEE COMPENSATION
For financial reporting purposes, the Company accounts for stock-based
compensation in accordance with the intrinsic value method ("APB No. 25"). In
accordance with this method, no compensation expense is recognized in the
accompanying financial statements in connection with the awarding of stock
option grants to employees provided that, as of the grant date, all terms
associated with the award are fixed and the fair value of the Company's stock is
not greater than the amount an employee must pay to acquire the stock as
defined; however, to the extent that stock options are granted to employees with
variable terms or if the fair value of the Company's stock as of the measurement
date is greater than the amount an employee must pay to acquire the stock, then
the Company will recognize compensation expense. The fair value of warrants
granted to nonemployees for financing were recorded as deferred financing costs
and amortized into interest expense using the interest method. See Note 10 for
further discussion on stock options and warrants.
The following table illustrates the effect on net loss attributed to common
stockholders if the Company had applied the fair value recognition provisions of
Financial Accounting Standards Board issued Statement No. 123, ("SFAS 123")
Accounting for Stock-Based Compensation, to stock-based employee compensation.
2001 2002 2003
------- ------- -------
Net loss attributed to common stockholders, as
reported......................................... $(3,155) $(1,036) $(3,555)
Add
Stock-based employee compensation expense
included in reported net loss attributed to
common stockholders, net of related tax
effects....................................... 84 38 12
Deduct
Total stock-based employee compensation expense
determined under fair value based method for
all stock option awards, net of related tax
effects....................................... (229) (142) (167)
------- ------- -------
Pro forma net loss attributed to common
stockholders..................................... $(3,300) $(1,140) $(3,710)
======= ======= =======
Since option grants vest over several years and additional grants are
expected in the future, the pro forma results noted above are not likely to be
representative of the effects on future years of the application of the fair
value based method.
For the purposes of the above pro forma information, the fair value of each
option granted was estimated on the date of grant using the Black-Scholes option
pricing model and the following assumptions:
WEIGHTED
RISK-FREE AVERAGE EXPECTED FAIR VALUE
INTEREST EXPECTED EXPECTED DIVIDEND AT DATE
CLASS A COMMON RATE LIFE VOLATILITY YIELD OF GRANT
-------------- --------- -------- ---------- -------- ----------
1999 Grants.................... 5.7% 5 years 60% -- $ 30.10
2000 Grants.................... 6.6 5 69 -- 47.11
2001 Grants.................... 4.6 5 72 -- 111.89
2003 Grants.................... 3.8 6 55 -- 14.50
F-11
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Expected volatility percentages were derived from the volatility of
publicly traded companies considered to have businesses similar to the Company.
r. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liability and Equity (FAS
150), which establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. FAS 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. As of December 31, 2003 the
Company does not have financial instruments within the scope of this
pronouncement.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. Interpretation No. 46 requires a variable interest
entity, or VIE, to be consolidated by a company if that company is subject to a
majority of the risk of loss from the VIE's activities or is entitled to receive
a majority of the entity's residual return or both. Interpretation No. 46 also
provides criteria for determining whether an entity is a VIE subject to
consolidation. Interpretation No. 46 also sets forth certain disclosures
regarding interests in VIE that are deemed significant, even if consolidation is
not required. In December 2003, a modification to Interpretation No. 46 was
issued (Interpretation No. 46R) which delayed the effective date until no later
than fiscal periods ending after March 31, 2004 and provided additional
technical clarifications to implementation issues. The Company does not
currently have any variable interest entities as defined in Interpretation No.
46R. The Company does not expect that the adoption of this statement will have a
material impact on the consolidated financial statements.
s. SERIES A REDEEMABLE PREFERRED STOCK
As described in Note 9, the Company has issued 153,637 shares of Series A
Redeemable Preferred Stock ("Series A"). The Company has reclassified its 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 the Company's net income, net
loss attributable to common stockholders cash flows from operations, or total
assets. The following sets forth the overall effect of the reclassification on
the Company's stockholders' deficit at December 31, 2001:
Stockholders' deficit prior to reclassification............. $ (2,365)
Reclassification of Series A stock.......................... (30,432)
--------
Stockholders' deficit after the reclassification............ $(32,797)
========
F-12
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. FIXED ASSETS
Fixed assets as of December 31, 2002 and 2003, are shown at cost, less
accumulated depreciation and amortization, and are summarized below:
2002 2003
-------- --------
Leasehold improvements..................................... $211,480 $234,560
Club equipment............................................. 50,937 58,376
Furniture, fixtures and computer equipment................. 33,779 34,703
Computer software.......................................... 4,503 7,838
Building and improvements.................................. 4,995 4,995
Land....................................................... 986 986
Construction in progress................................... 8,631 13,836
-------- --------
315,311 355,294
Less: Accumulated depreciation and amortization.......... 104,488 131,695
-------- --------
$210,823 $223,599
======== ========
Depreciation and leasehold amortization expense for the years ended
December 31, 2001, 2002 and 2003, was $25,780, $30,645 and $33,987,
respectively.
4. GOODWILL AND INTANGIBLE ASSETS
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 transitional impairment test the
Company recorded a $1,301 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 the first
quarter of 2002. The write-off of goodwill related to four, remote
underperforming clubs. The impairment test was performed with discounted
estimated future cash flows as the criteria for determining fair market value.
Goodwill has been allocated to reporting units that closely reflect the regions
served by our four trade names; New York Sports Club, Boston Sports Club,
Washington Sports Club and Philadelphia Sports Club, with certain more remote
clubs that do not benefit from a regional cluster being considered single
reporting units.
A reconciliation of reported net income for the year ended December 31,
2001 to net income adjusted for the impact of SFAS 142 over that same period is
as follows:
2001
-------
Net income as reported...................................... $ 7,046
Goodwill amortization....................................... 4,436
Deferred tax benefit........................................ (1,344)
-------
Net income as adjusted.................................... $10,138
=======
In addition, the Company is required to conduct an annual review of
goodwill for potential impairment. 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
F-13
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
cash flows. 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.
The change in the carrying amount of goodwill from December 31, 2002
through December 31, 2003 is as follows:
BALANCE AT DECEMBER 31, 2002................................ $45,531
Changes due to
Currency.................................................. 203
Acquisitions.............................................. 130
-------
BALANCE AT DECEMBER 31, 2003................................ $45,864
=======
A summary of our acquired amortizable intangible assets as of December 31,
2002 and 2003 is as follows:
DECEMBER 31, 2002
-------------------------------------
GROSS
CARRYING ACCUMULATED NET
AMOUNT AMORTIZATION INTANGIBLES
-------- ------------ -----------
ACQUIRED INTANGIBLE ASSETS
Membership lists................................ $11,054 $ (9,605) $1,449
Covenants-not-to-compete........................ 876 (711) 165
Beneficial lease................................ 223 (162) 61
------- -------- ------
$12,153 $(10,478) $1,675
======= ======== ======
DECEMBER 31, 2003
-------------------------------------
GROSS
CARRYING ACCUMULATED NET
AMOUNT AMORTIZATION INTANGIBLES
-------- ------------ -----------
ACQUIRED INTANGIBLE ASSETS
Membership lists................................ $10,205 $ (9,630) $575
Covenants-not-to-compete........................ 876 (871) 5
Beneficial lease................................ 223 (173) 50
------- -------- ----
$11,304 $(10,674) $630
======= ======== ====
The amortization expense of the above acquired intangible assets for each
of the five years ending December 31, 2008 will be as follows:
AMORTIZATION
EXPENSE
------------
YEAR ENDING DECEMBER 31,
2004........................................................ $591
2005........................................................ 11
2006........................................................ 11
2007........................................................ 11
2008........................................................ 6
----
$630
====
F-14
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Amortization expense of intangible assets for the years ended December 31,
2001, 2002 and 2003, was $6,403, $1,103 and $940, respectively.
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
-----------------
2002 2003
------- -------
Accrued payroll............................................. $ 7,817 $ 6,086
Accrued interest............................................ 2,731 5,157
Accrued construction in progress and equipment.............. 2,650 5,300
Accrued occupancy costs..................................... 3,514 4,002
Accrued other............................................... 4,922 5,461
------- -------
$21,634 $26,006
======= =======
6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt and capital lease obligations consist of the following:
DECEMBER 31,
-------------------
2002 2003
-------- --------
Senior Notes 9 5/8%........................................ $ -- $255,000
Series B 9 3/4% Senior Notes, due 2004..................... 125,000 --
Line of credit borrowings.................................. 14,500 --
Subordinated credit borrowings............................. 9,000 --
Notes payable for acquired businesses...................... 6,230 4,358
Capital lease obligations.................................. 6,213 2,519
-------- --------
160,943 261,877
Less: Current portion due within one year.................. 5,178 3,486
-------- --------
Long-term portion........................................ $155,765 $258,391
======== ========
The aggregate long-term debt and capital lease obligations maturing during
the next five years and thereafter is as follows:
AMOUNT DUE
----------
YEAR ENDING DECEMBER 31,
2004........................................................ $ 3,486
2005........................................................ 1,056
2006........................................................ 619
2007........................................................ 632
2008........................................................ 217
Thereafter.................................................. 255,867
--------
$261,877
========
In October 1997, the Company issued $85,000 of Series B 9 3/4% Senior Notes
due October 2004. The net proceeds from the Senior Notes totaled approximately
$81,700. The
F-15
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
transaction fees of approximately $3,300, were accounted for as deferred
financing costs. In June 1999, the Company issued $40,000 of Senior Notes at a
price of 98.75%, providing the Company with $39,500 of proceeds before expenses
relating to the issuance. The Senior Notes bear interest at an annual rate of
9 3/4%, payable semi-annually. The Senior Notes are redeemable at the option of
the Company on or after October 15, 2001. For redemption prior to October 15,
2004, the Company would be required to pay a premium as defined. The $85,000 and
$40,000 issuances are collectively referred to as the "Senior Notes." The Senior
Notes were redeemed on April 16, 2003. See the April 16, 2003 Refinancing
Transactions discussed below.
Prior to the April 16, 2003 refinancing transactions, the Company had a
$25,000 line of credit with its principal bank for direct borrowings and letters
of credit. The line of credit carried interest at the Company's option based
upon the Eurodollar borrowing rate plus 2.50% or the bank's prime rate plus
1.50%, as defined and the Company was required to pay a commitment commission of
0.375% per annum based upon the daily unutilized amount. There were $10,500 of
Eurodollar and $4,000 of prime rate based borrowings outstanding against this
line as of December 31, 2002. The interest rates charged on the Eurodollar
borrowings and prime rate based borrowings outstanding at December 31, 2002 were
4.0% and 6.25%, respectively. In connection with the April 16, 2003 refinancing
transactions, this line of credit was terminated.
In November 2000, the Company entered into a Subordinated Credit Agreement
(the "Subordinated Agreement") with an affiliate of a stockholder of the
Company. This Subordinated Agreement provided for up to $20,000 of principal
borrowings and would have expired December 31, 2004. Interest on principal
borrowings accrued at 12.75% per annum; 9.75% of which was payable on a monthly
basis and the remaining 3% was accruable and payable, at the option of the
Company, through maturity. The Company was charged a fee of 0.083% per month
based on the portion of the facility not utilized. There were $9,000 of
Subordinated credit borrowings outstanding as of December 31, 2002. In
connection with the April 16, 2003 refinancing transactions, this Subordinated
Credit Agreement was terminated.
April 16, 2003 Refinancing Transaction
On April 16, 2003 the Company successfully completed a refinancing of its
debt. This refinancing included an offering of $255,000 of 9 5/8% Senior Notes
("Notes") that will mature April 15, 2011, and the entering into of a new
$50,000 senior secured revolving credit facility (the "Senior Credit Facility")
that will expire April 15, 2008. The transaction fees of approximately $9,600
have been accounted for as deferred financing costs. The 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, the Company wrote-off $3,709 of
deferred financing costs related to extinguished debt, paid a call premium of
$3,048 and incurred $1,016 of interest on the 9 3/4% Notes representing the
interest incurred during the 30 day redemption notification period.
The Senior Credit Facility contains various covenants including limits on
capital expenditures, the maintenance of a consolidated interest coverage ratio
of not less than 2.25:1.00 during 2003, and a maximum permitted total leverage
ratio of 4.00:1.00 during 2003. Loans under the Senior Credit Facility will, at
our option, bear interest at either the bank's prime rate plus 3.0% or the
Eurodollar rate plus 4.0%, as defined. There were no borrowings outstanding at
December 31, 2003 and outstanding letters of credit issued totaled $1,749. The
Company is
F-16
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
required to pay a commitment fee of 0.75% per annum on the daily unutilized
amount. The unutilized portion of the Senior Credit Facility as of December 31,
2003 was $48,251.
Notes payable were incurred upon the acquisition of various clubs and are
subject to the Company's right of offset for possible post acquisition
adjustments arising out of operations of the acquired clubs. These notes are
stated at rates of between 5% and 9%, and are non-collateralized. The notes are
due on various dates through 2012.
The carrying value of long-term debt, other than the Senior Notes and the
Notes, approximates fair market value as of December 31, 2002 and 2003 as the
debt is generally short-term in nature. Based on quoted market prices, the
Senior Notes have a fair value of approximately $125,000 at December 31, 2002
and the Notes have a fair value of approximately $272,850 at December 31, 2003.
The Company's interest expense and capitalized interest related to funds
borrowed to finance club facilities under construction for the years ended
December 31, 2001, 2002 and 2003 are as follows:
YEARS ENDED DECEMBER 31,
---------------------------
2001 2002 2003
------- ------- -------
Interest costs expensed............................ $14,918 $16,559 $23,670
Interest costs capitalized......................... 907 354 322
------- ------- -------
$15,825 $16,913 $23,992
======= ======= =======
The Company leases equipment under noncancelable capital leases. The
initial lease terms range from three to five years, after which the Company has
the right to purchase the equipment at amounts defined by the agreements.
As of December 31, 2003, minimum rental payments, under all capital leases,
including payments to acquire leased equipment, are as follows:
MINIMUM
YEAR ENDING DECEMBER 31, ANNUAL RENTAL
------------------------ -------------
2004........................................................ $2,337
2005........................................................ 224
------
2,561
Less: Amounts representing interest....................... 42
------
PRESENT VALUE OF MINIMUM CAPITAL LEASE PAYMENTS........ $2,519
======
The cost of leased equipment included in club equipment was approximately
$12,658 and $12,097 at December 31, 2002 and 2003, respectively; and the related
accumulated depreciation was $5,686 and $7,544, respectively.
7. RELATED PARTY TRANSACTIONS
The Company entered into a professional service agreement with Bruckmann,
Rosser, Sherrill & Co., Inc. ("BRS"), a stockholder of the Company for strategic
and financial advisory services on December 10, 1996. As of December 31, 2003,
BRS owns 36.6% of the Company's outstanding common stock and has the ability to
elect a majority of the board of directors and generally to control the affairs
and policies of the Company. Fees for such services, which are included in
General and administrative expenses, are $250 per annum, and
F-17
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
are payable while BRS owns 20% or more of the outstanding Common stock of the
Company. No amounts were due BRS at December 31, 2002 and 2003.
The Company's Subordinated Agreement discussed in Note 6 was entered into
with an affiliate of a stockholder of the Company in 2000. This agreement was
terminated in connection with the April 16, 2003 Refinancing Transaction.
In February 2003, 109,540 shares of Series B preferred stock held by
management, were sold to an affiliate of a stockholder of the Company for a
total of $8,883. This sale price was equivalent to the liquidation value of the
shares as of the date of sale.
8. LEASES
The Company leases office, warehouse and multi-recreational facilities and
certain equipment under noncancelable operating leases. In addition to base
rent, the facility leases generally provide for additional rent based on
increases in real estate taxes and other costs. Certain leases give the Company
the right to acquire the leased facility at defined prices based on fair value
and provide for additional rent based upon defined formulas of revenue, cash
flow or operating results of the respective facilities. Under the provisions of
certain of these leases, the Company is required to maintain irrevocable letters
of credit, which total $1,749 as of December 31, 2003.
The leases expire at various times through December 31, 2027, and certain
leases may be extended at the Company's option.
Future minimum rental payments under noncancelable operating leases are as
follows:
MINIMUM
YEAR ENDING DECEMBER 31, ANNUAL RENTAL
------------------------ -------------
2004........................................................ $ 50,976
2005........................................................ 51,659
2006........................................................ 51,500
2007........................................................ 49,511
2008........................................................ 47,476
Aggregate thereafter........................................ 369,831
--------
$620,953
========
Rent expense, including the effect of deferred lease liabilities, for the
years ended December 31, 2001, 2002 and 2003 was $42,341, $52,085 and $59,273,
respectively. Such amounts include additional rent of $7,119, $8,368 and
$10,342, respectively.
The Company, as landlord, leases space to third party tenants under
noncancelable operating leases and licenses. In addition to base rent, certain
leases provide for additional rent based on increases in real estate taxes,
indexation, utilities and defined amounts based on the
F-18
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
operating results of the lessee. The leases expire at various times through
August 31, 2014. Future minimum rentals receivable under noncancelable leases
are as follows:
MINIMUM
YEAR ENDING DECEMBER 31, ANNUAL RENTAL
------------------------ -------------
2004........................................................ $ 2,167
2005........................................................ 2,392
2006........................................................ 2,196
2007........................................................ 1,985
2008........................................................ 1,278
Aggregate thereafter........................................ 5,723
-------
$15,741
=======
Rental income, including noncash rental income, for the years ended
December 31, 2001, 2002 and 2003 was $1,879, $2,132 and $2,434, respectively.
Such amounts include additional rental charges above the base rent of $982,
$1,046 and $679, respectively.
9. REDEEMABLE PREFERRED STOCK
Redeemable Senior Preferred Stock
During November 1998, the Company issued 40,000 shares of mandatorily
redeemable Senior stock ("Senior") and 143,261 warrants. During 2002 71,630 of
these warrants were exercised and in January 2004 the remaining 71,631 warrants
were exercised (see Note 18 Subsequent Events). The Senior stock had no voting
rights except as required by law. The warrants had an exercise price of $0.01,
expire in November 2008 and are exercisable into an equal number of shares of
Class A Common Stock. After payment of fees and expenses of approximately $365,
the Company received net proceeds of $39,635. Upon issuance, a $3,416 value was
ascribed to the warrants. The initial fair value of the Senior stock ($36,219)
was being accreted to its liquidation value using the interest method. The
Senior stock was redeemable in November 2008. The Company, at its option, could
redeem the Senior stock at any time without premium.
The Senior stock had a liquidation value of $1,000 per share plus
cumulative unpaid dividends of $26,977 as of April 16, 2003. The Senior stock
holders were entitled to a cumulative 12% annual dividend, based on the share
price of $1,000. On April 16, 2003, in connection with the refinancing
transaction discussed in Note 6, all of the Senior stock was redeemed at a
liquidation value of $66,977. During 2003, the Company recorded $4,852 of
accretion, which was comprised of stock dividend accretion of $2,465 and the
remaining warrant accretion to liquidation value of $2,387.
Series A Redeemable Preferred Stock
During fiscal years 1997 and 1998, the Company issued 152,455 and 1,182
shares, respectively, of Series A redeemable preferred stock. As of December 31,
2002 and 2003, 153,637 shares of Series A stock were outstanding. Series A stock
has liquidation preferences over Common Stock in the event of a liquidation,
dissolution or winding up of the Company. Series A stock has no conversion
features or voting rights except as required by law, and rank "pari passu."
Series A stock has a liquidation value of $100 per share plus cumulative unpaid
dividends of $24,526 as of December 31, 2003. Series A stockholders are entitled
to a cumulative 14% annual dividend based upon the per share price of $100. The
Company may, at
F-19
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
its sole discretion, pay any dividends by cash or by the issuance of additional
Series A shares. The Company may at any time redeem all or any portion of the
Series A stock at a price equal to the liquidation value plus cumulative unpaid
dividends.
A summary of transactions related to Series A stock is as follows:
CARRYING
SHARES VALUE
------- --------
Proceeds received in connection with the issuance of Series
A stock................................................... 153,637 $15,364
Accretion of Series A stock dividends....................... -- 11,216
------- -------
January 1, 2001 Series A stock.............................. 153,637 26,580
Accretion to Series A stock dividends....................... -- 3,852
------- -------
December 31, 2001 Series A stock............................ 153,637 30,432
Accretion to Series A stock dividends....................... -- 4,409
------- -------
December 31, 2002 Series A stock............................ 153,637 34,841
Accretion to Series A stock dividends....................... -- 5,049
------- -------
December 31, 2003 Series A stock............................ 153,637 $39,890
======= =======
In the event of a change in control as defined, each holder of Series A
stock then outstanding may require the Corporation, and the Corporation shall be
obligated, to redeem all or any portion of the Series A stock owned by such
holder.
In February 2004, the Company redeemed all of the Series A stock at a
liquidation value of $40,516. See Note 18, Subsequent Events.
10. STOCKHOLDERS' DEFICIT
A. CAPITALIZATION
The Company's certificate of incorporation, as amended, provides for the
issuance of up to 3,500,000 shares of capital stock, consisting of 2,500,000
shares of Class A Voting Common Stock ("Class A"), par value $0.001 per share;
500,000 shares of Class B Non-voting Common Stock ("Class B"), par value of
$0.001 per share, (Class A and Class B are collectively referred to herein as
"Common Stock"); and 200,000 shares of Series B Preferred Stock ("Series B") par
value $1.00 per share. This also includes the redeemable preferred stock
discussed in Note 9, 100,000 shares Senior stock, par value $1.00 per share and
200,000 shares of Series A stock, par value $1.00 per share.
All stockholders have preemptive rights to purchase a pro-rata share of any
future sales of securities, as defined.
Common Stock
Class A stock and Class B stock each have identical terms with the
exception that Class A stock is entitled to one vote per share, while Class B
stock has no voting rights, except as required by law. In addition, Class B
stock is convertible into an equal number of Class A shares, at the option of
the holder of the majority of the Class B stock. To date, the Company has not
issued Class B stock.
F-20
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Series B Preferred Stock
During December 1996, the Company issued 3,857 shares of Series B preferred
stock, 3,822 and 3,273 shares of which were outstanding as of December 31, 2002
and 2003, respectively. During 2003, the Company issued an additional 106,267
shares in connection with management's exercise of Series B Preferred Stock
Options and repurchased 549 shares of previously issued Series B preferred stock
which were retired. The executives sold all of the Series B stock issued in
connection with the 106,267 shares issued as well as the 3,273 shares already
outstanding to an affiliate of a stockholder of the Company for a total of
$8,883, which was equivalent to the liquidation value of the shares as of the
date of the sale. Series B stock has liquidation preferences over Common Stock
in the event of a liquidation, dissolution or winding up of the Company. Series
B stock has no voting rights except as required by law, and rank "pari passu."
Upon consummation of an IPO, at the option of the holder, each Series B stock is
convertible into Class A Common Stock at prices, at which the Class A Common
Stock is sold in such IPO. The Company may at any time redeem all or any portion
of the Series B stock at a price equal to the liquidation value plus cumulative
unpaid dividends. Series B stock has a liquidation value of $35 per share plus
cumulative unpaid dividends of $6,127 as of December 31, 2003. Series B
stockholders are entitled to a cumulative 14% annual dividend based upon the per
share price of $35. The Company may, at its sole discretion, pay any dividends
by cash or by the issuance of additional Series B shares.
In the event of a change in control, as defined, each holder of Series B
stock then outstanding may require the Corporation, and the Corporation shall be
obligated, to redeem all or any portion of the Series B stock owned by such
holder. The Series B preferred stockholders do not control a majority of the
votes of the board of directors through direct representation or other rights.
In February 2004, the Company redeemed all of the Series B stock at a
liquidation value of $10,118. See Note 18, Subsequent Events.
B. STOCK OPTIONS
Class A Common Stock Options
During the year ended May 31, 1997, the Company adopted the Town Sports
International Inc. Common Stock Option Plan (the "Plan"). The provisions of the
Plan, as amended and restated, provide for the Company's Board of Directors to
grant to executives and key employees options to acquire 162,754 shares of Class
A stock.
Grants vest in full at various dates between December 2007 and 2012. The
vesting of these grants will be accelerated in the event that certain defined
events occur including the achievement of annual equity values or the sale of
the Company. The term of each of these grants is ten or eleven years.
In accordance with APB No. 25, Accounting for Stock Issued to Employees,
the Company recorded unearned compensation in connection with the 2001 Grants.
Such amount is included within stockholders' deficit and represented the
difference between the estimated fair value of the Class A stock on the date of
amendment or grant, respectively, and the exercise price. The Company utilized a
third-party valuation as of June 30, 2000 together with consideration of events
occurring since that date in determining the value of the Company's stock at the
date of grant of the 2001 options. Unearned compensation will be amortized as
compensation expense over the vesting period. During the years ended December
31, 2001, 2002 and 2003, amortization of unearned compensation totaled $156, $70
and $21, respectively.
F-21
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 2003, there were 30,227 shares reserved for future
option awards.
As of December 31, 2001, 2002 and 2003, a total of 76,474, 75,819 and
80,294 Class A Common stock options were exercisable, respectively.
Series B Preferred Stock Options
During the year ended May 31, 1997, the Company granted 164,783 options
("Series B Options") to certain employees which entitle the holders to purchase
an equal number of shares of Series B stock at an exercise price of $10.00 per
share. Series B Options were fully vested on the date of grant and expire on
December 31, 2021. The terms of the Series B Options also contained provisions
whereby the exercise price would be reduced, or in certain cases, the option
holder would receive cash in accordance with a formula as defined. The aggregate
value of, either a reduction in exercise price, or the distribution of cash is
deemed compensatory and, accordingly, is recorded as a compensation expense. The
provisions of the Series B Preferred Stock Option Plan provide for a Special
Accrual equal to a 14% compounded annual return on the difference between the
liquidation value for the shares subject to option, less the $10 per share
exercise price. For the years ended December 31, 2001, 2002 and 2003
compensation expense recognized in connection with Series B Options' Special
Accrual totaled $993, $1,137 and $177, respectively. All Series B Preferred
stock options were exercisable upon grant. There are no shares of Series B
Preferred Stock reserved for future option grants.
In January 2003, an executive officer of the Company exercised 9,530 Series
B Options, and in turn these newly issues shares were repurchased by the Company
for $540 and were retired. In February 2003, several executives of the Company
exercised and converted the remaining 148,775 Series B Options in to 106,267
shares of Series B preferred stock. The difference between the 148,775 options
exercised and the 106,267 shares issued is due to the remittance of these shares
to the Company to cover the purchase price of the stock. The remitted shares
were subsequently retired by the Company.
F-22
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the stock option activity for the years
ended December 31, 2001, 2002 and 2003:
WEIGHTED WEIGHTED
AVERAGE AVERAGE
CLASS A EXERCISE SERIES B EXERCISE
COMMON PRICE PREFERRED PRICE
------- -------- --------- --------
Balance at January 1, 2001........... 92,682 $ 23.88 158,306 $10.00
Granted.............................. 7,400 $100.00(i) --
Exercised............................ (788) $ 32.53 --
Forfeited............................ (512) $ 25.76 --
------- ---------
Balance at December 31, 2001......... 98,782 $ 29.32 158,306 $10.00
Exercised............................ (3,100) $ 22.93 --
Forfeited............................ (2,200) $ 84.57 --
------- ---------
Balance at December 31, 2002......... 93,482 $ 28.23 158,306 $10.00
Granted.............................. 46,400 $144.00(ii) --
Exercised............................ (1,740) $ 36.14 (158,306) $10.00
Forfeited............................ (7,610) $ 24.48 --
------- ---------
Balance at December 31, 2003......... 130,532 $ 69.49 --
======= =========
---------------
(i) Option exercise price of these options was less than the estimated fair
value on the grant date.
(ii) Option exercise price was greater than market price on the grant date.
The following table summarizes stock option information as of December 31,
2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- -----------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
OUTSTANDING LIFE PRICE EXERCISABLE PRICE
----------- ----------- --------- ----------- ---------
Class A Common
1997 Grants......... 45,586 36 months $ 1.00 45,586 $ 1.00
1998 Grants......... 7,800 52 months $ 17.50 7,800 $ 17.50
1999 Grants......... 9,700 60 months $ 53.00 7,760 $ 53.00
2000 Grants......... 16,446 72 months $ 75.00 9,868 $ 75.00
2001 Grants......... 4,600 101 months $100.00 -- $100.00
2003 Grants......... 46,400 108 months $144.00 9,280 $144.00
----------- -----------
Total Grants.......... 130,532 80,294
=========== ===========
11. ASSET ACQUISITIONS
During the period from January 1, 2001 through December 31, 2002, the
Company completed the acquisition of six fitness clubs. There were no club
acquisitions during the year ended December 31, 2003. None of the individual
acquisitions were material to the financial
F-23
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
position, results of operations or cash flows of the Company. The table below
summarizes the aggregate purchase price and the purchase price allocation to
assets acquired:
YEARS ENDED
DECEMBER 31,
---------------
2001 2002
------ ------
Number of clubs acquired.................................... 2 4
====== ======
Purchase prices payable in cash at closing.................. $1,272 $2,322
Issuance and assumption of notes payable.................... 250 4,725
------ ------
TOTAL PURCHASE PRICES.................................. $1,522 $7,047
====== ======
Allocation of purchase prices
Goodwill.................................................. $1,316 $4,479
Fixed assets.............................................. 235 1,955
Membership lists.......................................... 181 1,432
Other net liabilities acquired............................ (172) (108)
Deferred revenue.......................................... (38) (711)
------ ------
TOTAL ALLOCATION OF PURCHASE PRICES.................... $1,522 $7,047
====== ======
For financial reporting purposes, these acquisitions have been accounted
for under the purchase method and, accordingly, the purchase prices have been
assigned to the assets and liabilities acquired on the basis of their respective
fair values on the date of acquisition. The excess of purchase prices over the
net tangible assets acquired has been allocated to membership lists acquired and
goodwill. The results of operations of the clubs have been included in the
Company's consolidated financial statements from the respective dates of
acquisition. One acquisition has contingent consideration totaling $575 based on
future revenue levels and resolution of certain permit requirements which will
be capitalized as part of the purchase price if the contingency is achieved. The
impact of these acquisitions on the consolidated financial statements of the
Company was not material.
12. REVENUE FROM CLUB OPERATIONS
Revenues from club operations for the years ended December 31, 2001, 2002
and 2003 are summarized below:
YEARS ENDED DECEMBER 31,
------------------------------
2001 2002 2003
-------- -------- --------
Membership dues................................ $227,073 $257,917 $273,608
Initiation fees................................ 13,287 14,361 13,891
Other club revenues............................ 37,840 42,717 48,641
-------- -------- --------
$278,200 $314,995 $336,140
======== ======== ========
F-24
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. CORPORATE INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31,
2001, 2002 and 2003 consisted of the following:
YEAR ENDED DECEMBER 31, 2001
-----------------------------
STATE AND
FEDERAL LOCAL TOTAL
------- --------- -------
Current............................................ $ 7,964 $ 3,415 $11,379
Deferred........................................... (3,357) (1,169) (4,526)
------- ------- -------
$ 4,607 $ 2,246 $ 6,853
======= ======= =======
YEAR ENDED DECEMBER 31, 2002
-----------------------------
STATE AND
FEDERAL LOCAL TOTAL
------- --------- -------
Current............................................ $ 6,483 $ 4,388 $10,871
Deferred........................................... (536) (626) (1,162)
------- ------- -------
$ 5,947 $ 3,762 $ 9,709
======= ======= =======
YEAR ENDED DECEMBER 31, 2003
-----------------------------
STATE AND
FEDERAL LOCAL TOTAL
------- --------- -------
Current............................................ $ 463 $ 1,591 $ 2,054
Deferred........................................... 3,017 466 3,483
------- ------- -------
$ 3,480 $ 2,057 $ 5,537
======= ======= =======
F-25
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the net deferred tax asset as of, December 31, 2002 and
2003 are summarized below:
DECEMBER 31,
-----------------
2002 2003
------- -------
Deferred tax assets
Deferred lease liabilities................................ $ 9,821 $ 9,998
Deferred revenue.......................................... 5,954 5,156
Fixed assets and intangible assets........................ 5,032 4,054
Compensation expense incurred in connection with stock
options................................................ 4,855 1,489
State net operating loss carry-forwards................... 1,151 1,431
Other..................................................... (1) 517
------- -------
26,812 22,645
------- -------
Deferred tax liabilities
Deferred costs............................................ (6,174) (5,490)
------- -------
(6,174) (5,490)
------- -------
NET DEFERRED TAX ASSETS, PRIOR TO VALUATION
ALLOWANCE............................................ 20,638 17,155
Valuation allowance......................................... (384) (384)
------- -------
NET DEFERRED TAX ASSETS................................ $20,254 $16,771
======= =======
As of December 31, 2003, the Company has state net operating loss ("NOL")
carry-forwards of approximately $15,970. Such amounts expire between December
31, 2004 and December 31, 2021. The Company's $384 valuation allowance has been
maintained principally for NOL carryforwards, which are subject to limitations
principally due to acquisitions.
Foreign income and the effect of foreign income taxes was immaterial.
The differences between the U.S. federal statutory income tax rate and the
Company's effective tax rate were as follows for the years ended December 31,
2003, 2002 and 2001:
YEARS ENDED DECEMBER 31,
-------------------------
2001 2002 2003
----- ----- -----
Federal statutory tax rate................................. 35% 35% 35%
State and local income taxes, net of federal tax benefit
and change of valuation allowance........................ 8 9 8
Change in state effective income tax rate.................. 1 -- --
Non-deductible goodwill and other permanent differences.... 3 1 --
-- -- --
47% 45% 43%
== == ==
14. 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 clubs located in downtown Manhattan. Three of
the affected four clubs were back in operation by October 2001, while the fourth
club reopened in September 2002.
F-26
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company carries 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 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 receivable and received
additional on-account payments of $1,025. In 2003 the Company received $2,800
from its insurer and the Company entered into a final settlement agreement.
These on-account and final payments were classified with fees and other revenue
when received.
15. CONTINGENCIES
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 two billion dollars in damages for personal injuries.
His cause of action seeking punitive damages in the amount of two hundred and
fifty 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 million of insurance coverage to cover claims of this
nature. To the extent that the judgement exceeds the amount we are covered by
insurance by $2.5 million we would be in default under the credit agreement
governing TSI, 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. The Company anticipates that
this matter will be covered by insurance.
The Company does not believe this matter will have a material effect on its
consolidated financial position, results of operations or cash flows.
16. EMPLOYEE BENEFIT PLAN
The Company maintains a 401(k) defined contribution plan and is subject to
the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA").
The Plan provides for the Company to make discretionary contributions. 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 five hundred dollars per individual, per annum. Employer matching
contributions totaling $200 and $195 were made in February 2003 and 2004,
respectively, for the Plan years ended December 31, 2002 and 2003, respectively.
17. DISCONTINUED OPERATIONS
In the fourth quarter of 2002, the Company closed or sold two remote
underperforming, wholly-owned clubs. In connection with the closure of one of
the clubs the Company recorded club closure costs of $996 related to the
write-off of fixed assets. The Company has accounted for these two clubs as
discontinued operations and, accordingly, the results of their operations have
been classified as discontinued in the consolidated statement of operations and
prior periods have been reclassified in accordance with SFAS No. 144.
Revenues and pre-tax losses for these discontinued clubs were $1,659 and
$894 in 2001 and $1,606 and $322 in 2002, respectively.
F-27
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. SUBSEQUENT EVENTS
On January 26, 2004 warrants to purchase 71,631 shares of Class A common
stock were exercised.
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 $124,807 in connection with this
issuance. Fees and expenses related to this transaction totaled approximately
$4,375. 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 $213,000, 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 stock and
Series B stock were redeemed for a total of $50,634.
On March 12, 2004 65,296 vested common stock options of TSI Holdings were
exercised.
On March 15, 2004 the Board of Directors of TSI Holdings approved a common
stock dividend of $52.50 per share to all shareholders of record on March 15,
2004. This dividend was paid on March 17, 2004.
F-28
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND MARCH 31, 2004
(ALL FIGURES $'000, EXCEPT SHARE DATA)
(UNAUDITED)
DECEMBER 31, MARCH 31,
2003 2004
------------ ---------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 40,802 $ 53,663
Accounts receivable, (less allowance for doubtful accounts
of $822 and $348 as of December 31, 2003 and March 31,
2004, respectively).................................... 1,469 3,154
Inventory................................................. 750 711
Prepaid corporate income taxes............................ 4,062 4,213
Prepaid expenses and other current assets................. 5,322 3,366
-------- ---------
Total current assets.............................. 52,405 65,107
Fixed assets, net........................................... 223,599 220,356
Goodwill.................................................... 45,864 43,843
Intangible assets, net...................................... 630 454
Deferred tax asset, net..................................... 16,771 18,625
Deferred membership costs................................... 13,038 12,532
Other assets................................................ 9,892 13,828
-------- ---------
Total assets...................................... $362,199 $ 374,745
======== =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current portion of long-term debt and capital lease
obligations............................................ $ 3,486 $ 2,817
Accounts payable.......................................... 5,379 3,973
Accrued expenses.......................................... 20,849 17,945
Accrued interest.......................................... 5,157 11,300
Deferred revenue.......................................... 26,621 31,261
-------- ---------
Total current liabilities......................... 61,492 67,296
Long-term debt and capital lease obligations................ 258,391 385,024
Deferred lease liabilities.................................. 25,856 26,341
Deferred revenue............................................ 3,002 2,804
Other liabilities........................................... 7,862 8,871
-------- ---------
Total liabilities................................. $356,603 $ 490,336
-------- ---------
Commitments and contingencies (Note 7)
Redeemable preferred stock:
Series A redeemable preferred stock, $1.00 par value; at
liquidation value; authorized 200,000 shares, 153,637 and
no shares issued and outstanding at December 31, 2003 and
March 31, 2004, respectively.............................. 39,890 --
-------- ---------
39,890 --
-------- ---------
Stockholders' deficit:
Series B preferred stock, $1.00 par value; at liquidation
value; 109,540 and no shares issued and outstanding at
December 31, 2003 and March 31, 2004, respectively..... 9,961 --
Class A voting common stock, $.001 par value; issued and
outstanding 1,176,043 and 1,000 shares at December 31,
2003 and March 31, 2004, respectively.................. 1 1
Paid-in capital........................................... (45,627) (114,059)
Unearned compensation..................................... (172) (162)
Accumulated other comprehensive income (currency
translation adjustment)................................ 596 525
Retained earnings (deficit)............................... 947 (1,896)
-------- ---------
Total stockholders' deficit....................... (34,294) (115,591)
-------- ---------
Total liabilities, redeemable preferred stock and
stockholders' deficit.......................... $362,199 $ 374,745
======== =========
See notes to the condensed consolidated financial statements.
F-29
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2004
ALL FIGURES $'000
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2003 2004
----------- -----------
Revenues:
Club operations........................................... $84,690 $85,304
Fees and other............................................ 2,212 1,160
------- -------
86,902 86,464
------- -------
Operating expenses:
Payroll and related....................................... 32,770 36,258
Club operating............................................ 26,662 27,898
General and administrative................................ 5,021 6,226
Depreciation and amortization............................. 8,299 9,117
Goodwill impairment....................................... -- 2,002
------- -------
72,752 81,501
------- -------
Operating income.......................................... 14,150 4,963
Interest expense............................................ 4,232 8,812
Interest income............................................. (22) (174)
------- -------
Income (loss) before provision (benefit) for corporate
income taxes........................................... 9,940 (3,675)
Provision (benefit) for corporate income taxes.............. 4,099 (1,617)
------- -------
Net income (loss)......................................... 5,841 (2,058)
Accreted dividends on preferred stock....................... (3,226) (783)
------- -------
Net income (loss) loss attributable to common
stockholders........................................... $ 2,615 $(2,841)
======= =======
STATEMENT OF COMPREHENSIVE INCOME (LOSS)
Net income (loss)........................................... $ 5,841 $(2,058)
Foreign currency translation adjustments.................... 45 (71)
------- -------
Comprehensive income (loss)................................. $ 5,886 $(2,129)
======= =======
See notes to the condensed consolidated financial statements.
F-30
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2004
ALL FIGURES $'000
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------
2003 2004
----------- -----------
Cash flows from operating activities:
Net income (loss)......................................... $ 5,841 $ (2,058)
-------- --------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization............................. 8,299 9,117
Goodwill impairment write-off............................. -- 2,002
Compensation expense in connection with stock options..... 187 10
Noncash rental expense, net of noncash rental income...... 522 322
Noncash interest expense.................................. -- 2,137
Amortization of debt issuance costs....................... 597 400
Change in certain operating assets and liabilities
components.............................................. 5,564 8,271
Decrease (increase) in deferred tax asset................. 2,903 (1,854)
(Increase) decrease in deferred membership costs.......... (160) 506
Other..................................................... (147) 77
-------- --------
Total adjustments....................................... 17,765 20,988
-------- --------
Net cash provided by operating activities............... 23,606 18,930
-------- --------
Cash flows from investing activities:
Capital expenditures...................................... (7,418) (8,241)
Landlord contributions.................................... -- 762
-------- --------
Net cash used in investing activities................... (7,418) (7,479)
-------- --------
Cash flows from financing activities:
Issuance of Senior notes, net of fees and expenses........ -- 121,429
Redemption of Series A and Series B preferred stock....... -- (50,634)
Exercise of stock options................................. -- 539
Common stock distribution................................. -- (68,944)
Net line of credit repayment.............................. (10,500) --
Repurchase of preferred stock............................. (583) --
Repayments of borrowings.................................. (1,604) (980)
-------- --------
Net cash used in financing activities................... (12,687) 1,410
-------- --------
Net increase in cash and cash equivalents............... 3,501 12,861
Cash and cash equivalents at beginning of period............ 5,551 40,802
-------- --------
Cash and cash equivalents at end of period.............. $ 9,052 $ 53,663
======== ========
Summary of change in certain operating assets and
liabilities:
Decrease (increase) in accounts receivable................ $ 697 $ (1,209)
Decrease in inventory..................................... 111 39
Decrease in prepaid expenses, prepaid income taxes, and
other current assets.................................... 1,002 1,216
(Decrease) increase in accounts payable, accrued expenses
and accrued interest.................................... (455) 3,783
Increase in deferred revenue.............................. 4,209 4,442
-------- --------
Net changes in certain operating assets and
liabilities............................................ $ 5,564 $ 8,271
======== ========
Supplemental disclosures of cash flow information:
Noncash investing and financing activities:
See also Note 6 for non-cash equity transactions.
See notes to the condensed consolidated financial statements.
F-31
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND MARCH 31, 2004
(ALL FIGURES IN $'000, EXCEPT PER SHARE DATA)
(UNAUDITED)
1. BASIS OF PRESENTATION
Town Sports International Holdings, Inc. ("TSI Holdings" or "the Company")
was incorporated in January 2004, principally for the purpose of issuing debt
that is structurally subordinated to the debt of Town Sports International, Inc.
("TSI"). In conjunction with the financing TSI Holdings entered into a
Restructuring Agreement, redeemed Series A and Series B Preferred Stock, and
paid a common stock distribution (See Note 6).
The condensed consolidated financial statements included herein have been
prepared by Town Sports International Holdings, Inc. and subsidiaries ("TSI
Holdings" or "the Company") pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). The condensed consolidated financial
statements should be read in conjunction with Town Sports International, Inc.'s
December 31, 2003 consolidated financial statements and notes thereto, included
on Form 10-K. The year-end condensed balance sheet data was derived from audited
financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States of America.
Certain information and footnote disclosures which are normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to SEC rules and regulations.
Certain reclassifications were made to the reported amounts at December 31, 2003
to conform to the presentation at March 31, 2004. The Company believes that the
disclosures made are adequate to make the information presented not misleading.
The information reflects all adjustments which, in the opinion of Management,
are necessary for a fair presentation of the financial position and results of
operations for the interim periods set forth herein. All such adjustments are of
a normal and recurring nature. The results for the quarter ended March 31, 2004
are not necessarily indicative of the results for the entire fiscal year ending
December 31, 2004.
2. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
DECEMBER 31, MARCH 31,
2003 2004
(000'S) (000'S)
------------ ---------
Senior Notes 9 5/8%, due 2011............................... $255,000 $255,000
11% Senior Discount Notes due 2014.......................... -- 126,944
Notes payable for acquired businesses....................... 4,358 4,095
Capital lease obligations................................... 2,519 1,802
-------- --------
261,877 387,841
Less, Current portion due within one year................... 3,486 2,817
-------- --------
Long-term portion........................................... $258,391 $385,024
======== ========
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 $124,807 in connection with this
issuance. Fees and expenses related to this transaction totaled approximately
$4,318. 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
F-32
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
that on February 1, 2009 the accreted value will equal $213,000, 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 Holding's debt is not collateralized by TSI, and TSI Holdings
relies on the cash flows of TSI, to service its debt. However, TSI or its
subsidiaries are not obligated to make funds available to TSI Holdings for
payment on the Notes. In addition, the terms of the Senior Note indenture
governing TSI's, existing Senior Notes and of TSI's credit facility
significantly restrict TSI and its subsidiaries from paying dividends, making
loans and otherwise transferring assets to TSI Holdings.
In April 2003 TSI successfully completed a refinancing of its debt. This
refinancing included an offering of $255,000 of 9 5/8% Senior Notes ("Notes")
that will mature April 15, 2011, and the entering into of a new $50,000 senior
secured revolving credit facility (the "Senior Credit Facility") that will
expire April 15, 2008. The transaction fees of $9,572 have been accounted for as
deferred financing costs. The 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, in April 2003 TSI wrote-off $3,709 of deferred financing costs
related to extinguished debt, paid a call premium of $3,048 and incurred $1,016
of interest on the previously outstanding 9 3/4% Notes representing the interest
incurred during the 30 day redemption notification period.
The Senior Credit Facility contains various covenants including limits on
capital expenditures, the maintenance of a consolidated interest coverage ratio
of not less than 2.50:1.00 during 2004, and a maximum permitted total leverage
ratio of 4.0:1.00 during 2004. These covenants limit the Company's ability to
incur additional debt and as of March 31, 2004 the Company's permitted
borrowings under the line of credit totaled $37,911. Loans under the Senior
Credit Facility will, at TSI's option, bear interest at either the bank's prime
rate plus 3.0% or the Eurodollar rate plus 4.0%, as defined. There were no
borrowings outstanding at March 31, 2004 and outstanding letters of credit
issued totaled $1,749. TSI is required to pay a commitment fee of 0.75% per
annum on the daily unutilized amount. The unutilized portion of the Senior
Credit Facility as of March 31, 2004 was $48,251.
3. SEPTEMBER 11, 2001 EVENTS
The terrorist attacks of September 11, 2001 ("the September 11 events"),
resulted in a tremendous loss of life and property. Secondarily, those events
interrupted the operations at four clubs located in downtown Manhattan. Three of
the affected four clubs were back in operation by October 2001, while the fourth
club reopened in September 2002.
The Company carries business interruption insurance to mitigate certain
lost revenue and profits experienced with the September 11 events. In the first
and third quarters of 2003 the Company received $1,300 and $1,500 respectively
from its insurer. In connection with the third quarter payment the Company
entered into a final settlement agreement. These payments were classified with
fees and other revenue when received.
4. GOODWILL AND OTHER INTANGIBLES
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.
F-33
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 is not recoverable. The goodwill impairment associated with
this underperforming club amounted to $2,002. A deferred tax benefit of $881 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 our projections of future cash flows of this club to
take into account the impact of a recent opening of a competitor will have.
While this club is expected to generate cash flow in the future, we no longer
expect it to operate at the levels that were projected at the time the club was
acquired.
The change in the carrying amount of goodwill from December 31, 2003
through March 31, 2004 is as follows:
Balance December 31, 2003................................... $45,864
Changes due to currency..................................... (19)
Goodwill impairment......................................... (2,002)
-------
Balance March 31, 2004...................................... $43,843
=======
Below is a summary of the Company's acquired intangible assets as of
December 31, 2003 and March 31, 2004.
AS OF DECEMBER 31, 2003
(000'S)
------------------------------------------------------------------
ACQUIRED INTANGIBLE ASSETS GROSS CARRYING AMOUNT ACCUMULATED AMORTIZATION NET INTANGIBLES
-------------------------- --------------------- ------------------------ ---------------
Membership Lists................ $10,205 $ (9,630) $575
Covenants-not-to-compete........ 876 (871) 5
Beneficial Lease................ 223 (173) 50
------- -------- ----
$11,304 $(10,674) $630
======= ======== ====
AS OF MARCH 31, 2004
($'000'S)
------------------------------------------------------------------
GROSS CARRYING AMOUNT ACCUMULATED AMORTIZATION NET INTANGIBLES
--------------------- ------------------------ ---------------
Membership Lists................ $10,205 $ (9,802) $403
Covenants-not-to-compete........ 876 (872) 4
Beneficial Lease................ 223 (176) 47
------- -------- ----
$11,304 $(10,850) $454
======= ======== ====
The amortization expense of the above acquired intangible assets for each
of the five years ended December 31, 2008 is as follows:
AGGREGATE AMORTIZATION EXPENSE ($000'S)
---------------------------------------
For the year ended 12/31/04(a) $ 591
For the year ended 12/31/05 11
For the year ended 12/31/06 11
For the year ended 12/31/07 11
For the year ended 12/31/08 6
-------
$ 630
=======
---------------
F-34
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(a) Amortization expense for the three months ended March 31, 2003 and 2004
amounted to $248 and $176, respectively.
5. STOCK-BASED EMPLOYEE COMPENSATION
For financial reporting purposes, the Company accounts for stock-based
compensation in accordance with the intrinsic value method ("APB No. 25"). In
accordance with this method, no compensation expense is recognized in the
accompanying financial statements in connection with the awarding of stock
option grants to employees provided that, as of the grant date, all terms
associated with the award are fixed and the fair value of the Company's stock is
not greater than the amount an employee must pay to acquire the stock as
defined; however, to the extent that stock options are granted to employees with
variable terms or if the fair value of the Company's stock as of the measurement
date is greater than the amount an employee must pay to acquire the stock, then
the Company will recognize compensation expense.
The following table illustrates the effect on net income (loss) attributed
to common stockholders if the Company had applied the fair value recognition
provisions of Financial Accounting Standards Board issued Statement No. 123,
("SFAS 123") Accounting for Stock-Based Compensation, to stock-based employee
compensation.
QUARTER ENDED
MARCH 31,
($'000'S)
----------------
2003 2004
------ -------
Net income (loss) attributed to common stockholders,
as reported......................................... $2,615 $(2,841)
Add:
Stock-based employee compensation expense included
in reported net income attributed to common
stockholders, net of related tax effects......... 6 7
Deduct:
Total stock-based employee compensation expense
determined under fair value based method for all
stock option awards net of related tax effects... (12) (10)
------ -------
Pro forma net income attributed to common
stockholders........................................ $2,609 $(2,844)
====== =======
6. 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 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.
F-35
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 $124,807 in connection with this
issuance. Fees and expenses related to this transaction totaled $4,318. 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 semiannually such that on February
1, 2009 the accreted value will equal $213,000, 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
Holding's debt is not collateralized by TSI, and TSI Holdings relies on the cash
flows of TSI to service its debt.
On February 6, 2004, all of TSI Holdings' outstanding Series A stock and
Series B Preferred stock were redeemed for a total of $50,634.
On March 12, 2004, 65,536 vested common stock options of TSI Holdings were
exercised. TSI Holdings received $539 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 $68,944 and was paid on March 17, 2004.
Also, in lieu of a common stock distribution, vested common optionholders were
paid a total of $1.1 million recorded as payroll expense.
7. CONTINGENCIES
On February 13, 2003, in an action styled Joseph Anaya vs Town Sports
International, Inc. et al. an individual filed suit against the Company 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 two billion dollars in damages for
personal injuries. His cause of action seeking punitive damages, in the amount
of two hundred and fifty 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.
The Company has in force fifty-one million dollars of insurance coverage to
cover claims of this nature. To the extent that the judgement exceeds the amount
we are covered by insurance by $2.5 million we would be in default under the
credit agreement governing TSI, 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. The Company
anticipates that this matter will be covered by insurance.
However, the Company does not expect this matter will have a material
effect on its consolidated financial position, results of operations or cash
flows.
The Company is a party to various lawsuits arising in the normal course of
business. Management believes that the ultimate outcome of these matters will
not have a material effect on the Company's consolidated financial position,
results of operations or cash flows.
F-36
$213,000,000
TOWN SPORTS INTERNATIONAL HOLDINGS, INC.
EXCHANGE OFFER FOR
11% SENIOR DISCOUNT NOTES DUE 2014
---------------------
PROSPECTUS
August 13, 2004
---------------------
We have not authorized any dealer, salesperson or other person to give any
information or represent anything to you other than the information contained in
this prospectus. You may not rely on unauthorized information or
representations.
This prospectus does not offer to sell or ask for offers to buy any of the
securities in any jurisdiction where it is unlawful, where the person making the
offer is not qualified to do so, or to any person who can not legally be offered
the securities.
The information in this prospectus is current only as of the date on its
cover, and may change after that date. For any time after the cover date of this
prospectus, we do not represent that our affairs are the same as described or
that the information in this prospectus is correct, nor do we imply those things
by delivering this prospectus or selling securities to you.
Until November 11, 2004, all dealers that effect transactions in these
securities, whether or not participating in the exchange offer may be required
to deliver a prospectus. This is in addition to the dealers' obligations to
deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.