UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-K

 

þ Annual Report pursuant to Section 13 OR 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2009

 

o Transition Report pursuant to Section 13 OR 15(d) of the Securities Exchange Act of 1934

For the transition period from

 

Commission file number: 000-52013

Town Sports International Holdings, Inc.

(Exact name of Registrant as specified in its charter)

 

(212) 246-6700

(Registrant’s telephone number,

including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

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

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes o No þ

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.  Yes þ No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No þ

 

The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2009 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $64.3 million (computed by reference to the last reported sale price on The Nasdaq National Market on that date). The registrant does not have any non-voting common stock outstanding.

 

As of March 10, 2010, there were 22,610,699 shares of Common Stock of the Registrant outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement for the 2010 Annual Meeting of Stockholders, to be filed not later than April 30, 2010, are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K.

 

 

TOWN SPORTS INTERNATIONAL HOLDINGS, INC.

 

FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding future financial results and performance, potential sales revenue, legal contingencies and tax benefits, and the existence of adverse litigation and other risks, uncertainties and factors set forth under Item 1A., entitled “Risk Factors”, of this Annual Report on Form 10-K and in our reports and documents filed with the Securities and Exchange Commission (“SEC”). You can identify these forward-looking statements by the use of words such as “outlook”, “believes”, “expects”, “potential”, “continues”, “may”, “will”, “should”, “seeks”, “approximately”, “predicts”, “intends”, “plans”, “estimates”, “anticipates” or the negative version of these words or other comparable words. These statements are subject to various risks, and uncertainties, many of which are outside our control, including the level of market demand for our services, competitive pressure, the ability to achieve reductions in operating costs and to continue to integrate club acquisitions, environmental initiatives, the application of Federal and state tax laws and regulations, and other specific factors discussed herein and in other SEC filings by us. We believe that all forward-looking statements are based on reasonable assumptions when made; however, we caution that it is impossible to predict actual results or outcomes or the effects of risks, uncertainties or other factors on anticipated results or outcomes and that, accordingly, one should not place undue reliance on these statements. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update these statements in light of subsequent events or developments. Actual results may differ materially from anticipated results or outcomes discussed in any forward-looking statement.

 

PART I

 

 

In this Annual Report, unless otherwise stated or the context otherwise indicates, references to “TSI Holdings”, “Town Sports”, “TSI”, “the Company”, “we”, “our” and similar references refer to Town Sports International Holdings, Inc. and its subsidiaries and references to “TSI, LLC” and “TSI, Inc.” refer to Town Sports International, LLC (formerly known as Town Sports International, Inc.), our wholly-owned operating subsidiary.

 

General

 

Based on number of clubs, we are the second largest owner and operator of fitness clubs in the Northeast and Mid-Atlantic regions of the United States and the fifth largest fitness club owner and operator in the United States. As of December 31, 2009, the Company, through its subsidiaries, operated 161 fitness clubs under our four key regional brand names; “New York Sports Clubs” (NYSC), “Boston Sports Clubs” (BSC), “Philadelphia Sports Clubs” (PSC) and “Washington Sports Clubs” (WSC). These clubs collectively served approximately 486,000 members, excluding short-term and seasonal memberships, as of December 31, 2009. We owned and operated a total of 109 clubs under the “New York Sports Clubs” brand name within a 120-mile radius of New York City as of December 31, 2009, including 39 locations in Manhattan where we are the largest fitness club owner and operator (more than twice as many as our nearest competitor). We owned and operated 25 clubs in the Boston region under our “Boston Sports Clubs” brand name, 18 clubs (two of which are partly-owned) in the Washington, D.C. region under our “Washington Sports Clubs” brand name and six clubs in the Philadelphia region under our “Philadelphia Sports Clubs” brand name as of December 31, 2009. In addition, we owned and operated three clubs in Switzerland as of December 31, 2009. 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.

 

We have developed and refined our fitness club model through our clustering strategy, offering fitness clubs close to our members’ workplaces and homes. We target all individuals within each of our regions who aspire to a healthy lifestyle. We believe that the majority of our members have household income levels between $50,000 and $150,000. We believe this is not only the broadest sector of the market, but also provides the greatest growth opportunities. Our goal is to be the most recognized health club network in each of the four major metropolitan

regions we serve. We believe that our strategy of clustering clubs provides significant benefits to our members and allows us to achieve strategic operating advantages. In each of our markets, we have developed clusters by initially opening or acquiring clubs located in the more central urban markets of the region and then expanding our market coverage from these urban centers to suburbs and neighboring communities.

 

We currently offer three types of memberships in our clubs: “Passport”, “Regional Passport” and “Gold”. The Regional Passport Membership was added in the fourth quarter of 2008 and allows a member access to all of our clubs within a single region, while the Passport Membership allows access to all clubs in all four regions. As of December 31, 2009, approximately 40% of our members held a Passport or Regional Passport Membership and 60% of our members held a Gold Membership, which allows unlimited access to a designated or “home” club at all times and access to all of our other clubs during off-peak hours. Gold members may also pay a per visit fee of $7.50 to use non-home clubs during peak hours. Members can elect to commit to a predetermined minimum contract period of one or two years in order to benefit from reduced dues and joining fees. Alternatively, our memberships are available on a month-to-month basis.

 

Over our 36-year history, we have developed and refined our club formats that allow us to cost-effectively construct and efficiently operate our fitness clubs in the different real estate environments in which we operate. Our fitness-only clubs average approximately 20,000 square feet, while our multi-recreational clubs average 40,000 square feet. The aggregate average size of all of our clubs is approximately 26,000 square feet. Our clubs typically have an open fitness area to accommodate cardiovascular and strength-training equipment, as well as special purpose rooms for group fitness classes and other exercise programs. We seek to provide a broad array of high-quality exercise programs and equipment that are popular and effective, promoting the quality exercise experience that we strive to make available to our members. When developing clubs, we carefully examine the potential membership base and the likely demand for supplemental offerings such as swimming, basketball, children’s programs, tennis or squash and, provided suitable real estate is available, we will add one or more of these offerings to our fitness-only format. For example, a multi-recreational club in a family market may include Sports Clubs for Kids programs, which can include swim lessons and sports camps for children.

 

Throughout 2009, the ongoing U.S. and global economic recession has resulted in additional significant pressures and declines in consumer confidence and economic growth. These economic conditions have led to reduced consumer spending and have contributed to an increase in member cancellations, a decrease in new memberships and reductions in revenue from ancillary services and marketing. These economic conditions could continue to adversely affect our business and results of operations.

 

Industry Overview

 

Total U.S. fitness club industry revenues increased at a compound annual growth rate of 6.8% from $10.6 billion in 1999 to $19.1 billion in 2008, according to the most recent information released by the International Health, Racquet and Sportsclub Association, or IHRSA. Total U.S. fitness club memberships increased at a compound annual growth rate of 4.5% from 30.6 million in 1999 to 45.5 million in 2008, and total number of fitness clubs increased at a compound annual growth rate of 7.7% from 15,372 in 1999 to 30,022 in 2008, according to IHRSA. Membership penetration (defined as club members as a percentage of the total U.S. population over the age of six) has increased from 12.9% in 1999 to 16.0% in 2008 according to IHRSA.

 

In 2008, health club members attended clubs an average of 101 days, with 40% visiting their clubs at least 100 times during the year, according to IHRSA. During the economic recession of the last two years, attendance at health clubs has increased nearly 7%.

 

Obesity continues to be a growing problem in the United States. The Center for Disease Control and Prevention found that 68% of U.S. adults were considered overweight or obese in 2007-2008, an increase from 64.5% in 1999-2000. As healthcare costs rise in the United States, some of the focus in combating obesity and other diseases is being directed at prevention. Both government and medical research has shown that exercise and other physical activity plays a critical role in preventing obesity and other health conditions, thereby reducing healthcare costs.

 

Demographic trends have helped drive the growth experienced by the fitness industry over the past decade. The industry has benefited from the aging “baby boomer” and “Eisenhower” generations as they place greater emphasis on their health, including a focus on fitness.

As the focus on exercise and overall healthy lifestyles continue to fuel the health club industry, we believe that we are well positioned to benefit from these dynamics as a large operator with recognized brand names, leading regional market shares and an established operating history.

 

Competitive Strengths

 

We believe the following competitive strengths are instrumental to our success:

 

Strong market position with leading brands.  Based on number of clubs, we are the fifth largest fitness club owner and operator in the United States and the second largest fitness club owner and operator in the Northeast and Mid-Atlantic regions of the United States. We are the largest fitness club owner and operator in the New York and Boston regions, the second largest owner and operator in the Washington, D.C. region and the fifth largest owner and operator in the Philadelphia region. We attribute our positions in these markets in part to the strength of our localized owner and operator brand names, which foster recognition as a local network of quality fitness clubs.

 

Regional clustering strategy provides significant benefits to members.  By operating a network of clubs in a concentrated geographic area, the value of our memberships is enhanced by our ability to offer members access to any of our clubs, which provides the convenience of having fitness clubs near a member’s workplace and home. Approximately 40% of our members have a Regional Passport or Passport Membership, and because these memberships offer enhanced privileges and greater convenience, they generate higher monthly dues than Gold Memberships. Regional clustering also allows us to provide special facilities to all of our members within a local area, such as swimming pools and squash, tennis and basketball courts, without offering them at every location. In the year ended December 31, 2009, 36% of all club usage was by members visiting clubs other than their home clubs.

 

Regional clustering strategy designed to enhance revenues and achieve economies of scale.  We believe our regional clustering strategy allows us to enhance revenue and earnings growth by providing high-quality, conveniently located fitness facilities on a cost-effective basis. Regional clustering is attractive to corporations seeking to promote a healthy lifestyle by providing discounted group memberships to their employees. We also partner with many groups that serve our communities, including the New York City Police and Fire Departments in our New York Sports Clubs region, the Southeastern Pennsylvania Transportation Authority (SEPTA) in our Philadelphia Sports Clubs region, and the District of Columbia Government, including all city agencies in our Washington Sports Clubs region. We believe that potential new entrants would need to establish or acquire a large number of clubs in a market to compete effectively with us. Our clustering strategy also enables us to achieve economies of scale with regard to sales, marketing, purchasing, general operations and corporate administrative expenses and reduces our capital spending needs. Regional clustering also provides the opportunity for members who relocate within a region to remain members of our clubs, thus aiding in member retention.

 

Expertise in site selection and development process.  We believe that our expertise in site selection and development provides an advantage over our competitors given the complex real estate markets in the metropolitan areas in which we operate and the relative scarcity of suitable sites. Before opening or acquiring a new club, we undertake a rigorous process involving demographic and competitive analysis, financial modeling, site selection and negotiation of lease and acquisition terms to ensure that a location meets our criteria for a model club. We believe our flexible club formats are well suited to the challenging real estate environments in our markets.

 

Focus on the member experience through innovative programs and initiatives.  We offer various innovative fitness programming, creating diverse ways for our members to reach their fitness goals, such as:

 

 

Business Strategy

 

In the long-term, we seek to maximize our net member growth, revenues, earnings and cash flows using the following strategies:

 

Retain members through our focus on the member experience.  Our company’s mission is “Improving Lives Through Exercise.” We enact our mission through our “Engage and Inspire” operational excellence platform which is designed to inspire members to embrace regular exercise and achieve their fitness goals by securing their loyalty through customer service and providing state-of-the-art facilities, programs and services. We tailor the hours of each club to the needs of the specific member demographic utilizing each club; offer a variety of ancillary services, including personal training, group classes, small group training, Sports Clubs for Kids programs, and the XpressLine program (a supervised, high-intensity, efficient workout program). We offer a variety of different sports facilities in each regional cluster of clubs; offer modern, varied and well-maintained exercise and fitness equipment; and offer an assortment of additional amenities including access to babysitting, sports massage and pro shops. Through hiring, developing and training a qualified and diverse team that is passionate about fitness and health; maintaining and enhancing our programs and services; and continually increasing our attention to individual member needs, we expect to demonstrate our commitment to increase the quality of the member experience, and thereby increase net membership.

 

Drive comparable club revenue and profitability growth by implementing our business strategy.  Our near-term financial performance will depend largely on the growth of revenue at clubs that we have operated for more than 12 months. We define comparable club revenue as revenue at those clubs that were operated by us for over 12 months and comparable club revenue growth as revenue for the 13th month and thereafter as compared to the same period in the prior year. Historically, comparable club revenue growth has been a contributing factor in our revenue growth, with comparable club revenue growth for each of the four years from 2005 to 2008, ranging between 2.2% to 7.9%. However, in part as a result of the ongoing economic recession and the impact on consumer spending, we experienced higher member attrition and lower average revenue per member in 2009. As a result, for the year ended December 31, 2009, our comparable club revenue declined 5.6% compared to growth of 2.2% for the year ended December 31, 2008. We experienced a comparable club revenue decrease of 7.1% in the fourth quarter of 2009, and we expect comparable club revenue to continue to be negative throughout 2010, however at lesser levels. Comparable club revenue growth is dependent in part upon the success of our strategic initiatives, including our “Engage and Inspire” operating initiative and our focus on ancillary revenues. Our “Engage and Inspire” initiative is expected to continue to enhance the member experience and therefore increase member loyalty, new member referrals and retention. Improved ancillary services will both enhance the member experience and provide us with a means for increasing comparable club revenues without a similar increase in fixed costs. Despite current challenges, we continue to emphasize operational excellence and invest in the training programs which differentiate our brand exhibiting expertise in fitness, group exercise and small group training. By making sustainable improvements to our membership experience, we expect to return to positive comparable revenue growth as we begin to benefit from our initiatives.

 

Provide state-of-the-art fitness equipment and services.  To help members develop and maintain a healthy lifestyle, train for athletic events or lose weight, each of our clubs has a large array of cardiovascular machines and resistance training equipment and free weights. Exercise equipment is arranged to allow for easy movement from machine to machine, facilitating a convenient and efficient workout. Equipment in these areas is arranged in long parallel rows that are clearly labeled by muscle group, which allows members to conveniently customize their exercise programs and reduce downtime during their workouts. We have technicians who service and maintain our equipment on a timely basis. In addition, we have personal viewing television screens on most pieces of cardiovascular equipment and have plans to expand the features of these screens in 2010. Most clubs have between one and three studios used for exercise classes, including at least one large studio used for most group exercise classes, a cycling studio and a mind and body studio used for yoga and Pilates classes. We offer a large variety of group fitness classes at each club and these classes generally are at no additional cost to our members. The volume and variety of activities at each club allow each member to enjoy the club, whether customizing their own workout or participating in group activities and classes.

Grow ancillary and other non-membership revenues.  We intend to grow our ancillary and other non-membership revenues through a continued focus on increasing the additional value-added services that we provide to our members as well as capitalizing on the opportunities for other non-membership revenues such as in-club advertising and retail sales. Non-membership revenues have increased from $66.8 million, or 17.2% of revenues for the year ended December 31, 2005, to $86.2 million, or 17.8% of revenues for the year ended December 31, 2009. We intend to continue to enhance and expand the current range of programs and quality of value-added services that we offer to our members, such as personal and small group training. These sources of ancillary and other non-membership revenues generate incremental profits with minimal capital investment and assist in attracting and retaining members.

 

Realize benefits from maturation of recently opened clubs.  From January 1, 2008 to December 31, 2009, we opened 13 clubs. Based on our experience, a new club tends to achieve significant increases in revenues during its first three years of operation as the number of members grows. Because there is relatively little incremental cost associated with such increasing revenues, there is a greater proportionate increase in profitability. We believe that the revenues and profitability of this group of 13 clubs will improve as the clubs reach maturity.

 

Marketing

 

Our marketing strategy primarily focuses on growing our membership base, increasing profitability on a per customer basis and building and sustaining brand equity. In pursuit of these objectives, we have the combined advantages, relative to many of our competitors, of existing high levels of brand awareness and preference, leading market positions and the ability to derive economies of scale from a regional multi-club platform and a centralized marketing function. We are organized to enable close collaboration between our marketing, sales, fitness and operations staff, all under the direction of our Chief Operating Officer. This helps align efforts around operational objectives and new product development while ensuring a primary focus on the member experience.

 

Brand awareness and preference is aided by a number of factors, including the visibility of multiple retail locations and associated signage across each region, a membership base of 486,000 as of December 31, 2009, who generate word-of-mouth and referrals, a 36-year operating history and continual advertising investment. All of these factors provide a strong foundation for our ongoing marketing and advertising efforts.

 

Our regional concentration and clustering strategy creates economies of scale in our marketing and advertising investments which increase their overall efficiency and effectiveness. Clustering enables broader reach and higher frequency for regional advertising campaigns that typically include a mix of traditional media including radio, newspapers, magazines, out-of-home (especially transit-based) and some television and geo-targeted and behaviorally targeted digital media, such as paid search, email blasts, online banners and video, as well as other emerging new media vehicles. These broader market efforts are bolstered by local marketing plans and tactics, which include direct mail, local sponsorships and co-promotions, community relations and outreach and street-level lead generation activities. Optimization of marketing mix through measurement and modeling of the effectiveness of various media investments and formats continues to be a priority.

 

We are positioned in the upper-value segment of the health club market and our advertising and marketing communications support and reinforce our position by consistently conveying high quality, market-leading convenience and a relevant and differentiated product offering. In contrast to most health club advertising, we generally forego depicting images of hard bodies, facilities and gym equipment. Instead, we favor messaging focused on linking the current promotional offering to a relevant message supporting the widely accepted and numerous benefits of exercise. We believe this approach is easily communicated and understood and makes our product more approachable for all consumers regardless of their health club experience.

 

Promotional marketing campaigns will typically feature opportunities to participate in a variety of value-added services such as personal training, small group training and youth centered sports activities. We also may offer reduced joining fees to encourage enrollment. Additionally, we frequently sponsor member referral incentive programs and other types of member appreciation, acquisition activities and internal promotions to enhance loyalty and to encourage more members to take advantage of our ancillary services.

We also engage in public relations, sponsorships and special events to promote our brand image across our network, regionally and in our local communities. We have created custom programming garnering media interest, such as Pilates Together and Catwalk Confidence, among others. We have been featured in national broadcast television shows, such as Regis and Kelly, Good Morning America, Entertainment Tonight, and the CBS Early Show; major newspapers, such as New York Times, Washington Post, Boston Globe, and the Wall Street Journal; and seen in magazines, such as: Fitness, Self and Shape. Additionally, in 2009, we were named “Best Gym for People on the Go” as part of Improper Bostonian magazine’s “Boston’s Best” issue and “Best Health Club” by the Washington Post Express.

 

In addition, we participate in and sponsor events in each of our regions. We are a five-time sponsor of the JPMorgan Chase Corporate Challenge Series running event in both the New York and Boston metropolitan regions. In 2009, this popular annual event attracted nearly 40,000 participants in New York and 14,000 in Boston. Boston Sports Clubs is also a two-time sponsor of the Tufts 10K for Women, an event that attracted 7,400 competitors in 2009. New York Sports Clubs’ sponsorship of the annual TD Bank Five Boro Bike Tour helped to turn out a TSI team of nearly 650 members and employees — all riding in logo jerseys — who completed the 42-mile ride along with 37,000 other cyclists.

 

Our association with professional sports teams also enhances our brands and their status in the communities in which we operate. Boston Sports Clubs is the official health club of the Boston Red Sox and Washington Sports Clubs has the same designation with the Washington Nationals baseball team, as well as an association with the Washington Redskins Cheerleaders. The baseball sponsorships include interactive in-stadium promotions which energize the fans during home games. Additionally, New York Sports Clubs is the official health club of the NY Jets Flight Crew. This sponsorship includes programming in our clubs with appearances by the Flight Crew, as well as, signage in Giants stadium.

 

Our philosophy of giving back to our communities includes sponsoring company-wide and local charitable efforts. Developed in 2009 and launched in early January 2010, we partnered with the City of New York and the Fire Department of New York (FDNY) to develop and deliver easier access to cardiopulmonary resuscitation (“CPR”) training. Called “CPR to Go”, the graduates of this 40 minute class headed by FDNY EMS trainers, will become certified and therefore will be able to assist in providing CPR. Our club management teams and staff are also encouraged to organize and engage in charitable activities. Some recent events benefited organizations such as the Michael J Fox Foundation for Parkinson’s, Tower of Hope, Family Research Foundation, Muscular Dystrophy Association, American Cancer Society, the Muscular Dystrophy Association, Susan G. Komen Race for the Cure, Avon Walk for Breast Cancer, NYCares, Toys for Tots, as well as many smaller local and specific charities including Augie’s Quest, a fund raising effort named after a health and fitness club pioneer stricken with Amyotrophic Lateral Sclerosis commonly referred to as Lou Gehrig’s Disease.

 

In 2009, we revamped our principal web site, www.mysportsclubs.com. We improved the site to facilitate its navigation, functionality and usability and to enhance the member experience. The site provides information about club locations, program offerings, exercise class schedules and sales promotions. The web site also allows our members to give us direct feedback about our service levels and enables prospective members to sign-up for a paid two-week trial membership in our clubs. Prospective members can also initiate their membership enrollment process using our web site. In addition, job seekers can begin the employment application process through the site and investors can access financial information and resources. Similar enhancements were made to our ancillary business sites, such as Sports Clubs for Kids and there are plans to improve access to personal training information on our web site. Additionally, we are planning for the addition of community functions such as social networks, polling features and discussion boards.

 

Sales

 

We sell our memberships through three channels; at the club level, through our corporate and group sales division or online through our web site. We employ approximately 360 “in-club” membership consultants who are responsible for new membership sales in and around their designated club locations. Each club generally has between two and four consultants. These consultants report directly to the club general manager, who in turn reports to a district manager. We provide additional incentive-based compensation in the form of commissions and bonuses,

contingent upon individual, club and company-wide enrollment goals. Membership consultants must successfully complete a two-month, in-house training program through which they learn our sales strategy. In making a sales presentation, membership consultants attempt to match the needs to each prospective member by emphasizing all the aspects of our clubs’ selection of equipment, classes and multi-recreational offerings, if available, and the quality of our staff.

 

In mid-December 2008, we launched the selling of individual memberships online for our standard membership types. This sales channel links directly to our principal web site and an existing web site, which is tailored to selling memberships for pre-established corporate and group programs. The online sales channel offers a high degree of convenience for customers who know and trust our brand and do not require up-front interaction with a membership consultant to make their decision. In addition, selling online significantly reduces our cost of sale. Members who joined online accounted for approximately 4.4% of memberships sold in 2009.

 

Our corporate and group sales division consists of approximately 20 full-time employees located throughout our markets, who concentrate on building long-term relationships with local and regional companies and large groups. Corporate and group members accounted for approximately 13% of our total membership base as of December 31, 2009. We offer numerous programs to meet our corporate and group clients’ needs including an online enrollment program as well as a fully operational call center for enrollment. We believe this focus on relationship building, providing the corporate customer with options for enrollment and our clustering strategy will continue to lead to new group participation in the future. Corporate and group sales are typically sold at a discount to our standard rates. Corporations frequently subsidize the costs of memberships provided to their employees.

 

In 2010, we will emphasize new products and enhanced purchasing flexibility for our corporate and group partners and new types of membership packages, such as the senior and couples memberships added in the second half of 2009.

 

We believe that clustering clubs allows us to sell memberships based upon the opportunity for members to utilize multiple club locations near their workplace and their home. As of December 31, 2009, our existing members were enrolled under three principal types of memberships:

 

 

We have also developed special membership packages for key segments of our consumer and member base. Examples of such specialized memberships are those designed for senior citizens, TSI alumni, students or couples memberships. We periodically emphasize these specialized membership packages in accordance with our marketing and sales strategic plan.

By operating a network of clubs in a concentrated geographic area, the value of our memberships is enhanced by our ability to offer members access to any of our clubs in a specific geographic area through the Regional Passport Membership or access to our clubs in all geographic regions through a Passport Membership. These membership plans provide the convenience of having fitness clubs near a member’s workplace and home. Approximately 40% of our members have the Regional Passport or Passport Membership and because these memberships offer broader privileges and greater convenience, they typically generate higher monthly dues than single club memberships. Regional clustering also allows us to provide special facilities within a local area, such as swimming, basketball, children’s programs, tennis and squash, without offering them at every location. In the year ended December 31, 2009, 36% of all club usage was by members visiting clubs other than their home clubs.

 

We offer both “month-to-month” and “commit” membership payment plans. Month-to-month memberships may be cancelled by our members at any time with 30 days notice. Under the commit model, new members commit to a one- or two-year membership. These memberships are priced at a moderate discount to the month-to-month membership. In 2009, 85% of our newly enrolled members opted for a commit membership, down from 97% in 2008. We decreased the price gap between the commit membership and the month-to- month membership in 2009 as we saw the month-to-month membership gain popularity due to its flexibility in a time of decreased consumer confidence. As of December 31, 2009, approximately 14% of our members had originated under a month-to-month non-commit membership and 86% had originated under a commit membership. When a members’ commit period is over, they retain their membership as a month-to-month member until they choose to cancel. As of December 31, 2009, approximately 67% of our total members were on a month-to-month basis. We believe members prefer to have the flexibility to choose between committing for one or two years or to join under the month-to-month non-commit membership.

 

In joining a club, a new member signs a membership agreement that typically obligates the member to pay a one-time joining fee, if applicable, and monthly dues on an ongoing basis. Monthly electronic funds transfer, or EFT, of individual membership dues on a per-member basis including the effect of promotions and memberships with reduced dues averaged approximately $64 and $66 per month for the years ended December 31, 2009 and 2008, respectively. Throughout 2009, we ran various sales promotions for new members to receive free months of membership and sold discounted membership types, including our couples and friends and family memberships. In July and August 2009 we also decreased dues for our gold memberships approximately five to ten dollars per month at a select 24 clubs. As a result, per-member average dues decreased in 2009. Joining fees collected for new EFT members averaged approximately $20 per member for the year ended December 31, 2009 compared to $45 per member for the year ended December 31, 2008. In the third quarter of 2008, we combined the one-time processing and initiation fees. We promoted new memberships by discounting these fees in 2008 and further discounting these fees in 2009. We collect approximately 96.0% of all monthly membership dues through EFT and EFT membership revenue constituted approximately 76.0% of consolidated revenue for the year ended December 31, 2009. Substantially all other membership dues are paid in full in advance. Our membership agreements call for monthly dues to be collected by EFT based on credit card or bank account debit authorization contained in the agreement. During the first week of each month, we receive the EFT dues for that month after the payments are initiated by a third-party EFT processor. Discrepancies and insufficient funds incidents are researched and resolved by our in-house account services department. We typically increase our existing member dues annually by between 1% and 3% on average, in line with increases in the cost of living. Due to the ongoing economic recession and the impact on consumer spending, in 2009 the total membership dues increase was applied to less than 10.0% of our membership base resulting in an overall dues increase of less than 1%.

 

Usage

 

Our suburban clubs are generally open 5:00 AM to 10:00 PM on weekdays and 7:00 AM to 8:00 PM on weekends while our urban clubs are generally open 5:00 AM to 11:00 PM on weekdays and 8:00 AM to 9:00 PM on weekends. Where member demand is high, certain clubs are open 24 hours. We generally consider our peak usage times to be between 6:00 AM and 8:30 AM and 4:00 PM and 8:30 PM on weekdays. Our hours of business are based on usage patterns at each individual club. Our total club usage was 30.3 million and 28.0 million member visits for the years ended December 31, 2009 and 2008, respectively representing an 8.2% increase in total club usage year over year. Usage per member has increased approximately 9.5% in the year ended December 31, 2009 compared to 2008. In the year-ended December 31, 2009, approximately 36% of total usage or club visits was to members’ non-home clubs.

Non-Membership Revenue

 

Over the past five years, we have expanded the level of ancillary club services provided to our members. Non-membership club revenue has increased by 29.0% from 2005 to 2009 and has increased as a percentage of total revenue from 17.2% in 2005 to 17.8% in 2009, reaching as high as 18.2% in both years ended December 31, 2007 and 2008. Personal training revenue in particular has increased 34.8% over this five year period and increased as a percentage of total revenue from 10.9% in 2005 to 11.7% in 2009. In addition, we offer Sports Clubs for Kids and Small Group Training (both additional fee for service programs) at select clubs. Consumer confidence and consumer spending deteriorated in the second half of 2008 and throughout 2009 resulting in a non-membership revenue decrease in these periods.

 

The table below presents non-membership revenue components as a percentage of total revenue for the years ended December 31, 2005 through 2009.

 

 

Club Format and Locations

 

Our clubs are typically located in middle- or upper-income residential, commercial, urban and suburban neighborhoods within major metropolitan areas that are capable of supporting the development of a cluster of clubs. Our clubs generally have high visibility and are easily accessible. In the New York metropolitan, Boston, Washington, D.C. and Philadelphia markets, we have created clusters of clubs in urban areas and their commuter suburbs aligned with our operating strategy of offering our target members the convenience of multiple locations close to where they live and work, reciprocal use privileges and standardized facilities and services.

 

Approximately 69% of the clubs we operate are fitness-only clubs and the remaining clubs are multi-recreational. Our fitness-only clubs generally range in size from 15,000 to 25,000 square feet and average approximately 20,000 square feet. Our multi-recreational clubs generally range in size from 25,000 square feet to 65,000 square feet, with one club being 200,000 square feet. The average multi-recreational club size is approximately 40,000 square feet. Membership for each club generally ranges from 2,000 to 4,500 members at maturity.

 

We have experienced overall growth over the past five years primarily through developing and opening new club locations that we have constructed, despite the reduction in club openings in 2009. In addition, we have acquired existing, privately owned single and multi-club businesses. From January 1, 2005 to December 31, 2009, we acquired four existing clubs, constructed 42 new clubs and closed or relocated 22 clubs to increase our total clubs under operation from 137 to 161. For the year ended December 31, 2009, we opened four new clubs and closed or relocated nine clubs, decreasing our total clubs under operation from 166 to 161, enabling us to improve the quality and brand strength of the overall portfolio. The clubs we closed were those that were operating at a net loss and collectively had little or no operating cash flow. The average remaining lease term of the nine clubs when closed was 2.3 years and three of the clubs had less than one year remaining. In 2010, we plan to upgrade certain of our existing clubs. We have signed leases for two clubs that we plan to open in 2011.

 

We engage in detailed site analyses and selection processes based, in part, upon information provided by our development software, to identify potential target areas for additional clubs. Target areas are identified based upon population demographics, psychographics, traffic and commuting patterns, availability of sites and competitive market information. We currently have two lease commitments and have identified over 170 target areas in which

we may add clubs under our New York Sports Clubs, Boston Sports Clubs, Washington Sports Clubs or Philadelphia Sports Clubs brand names. In addition, we have identified further growth opportunities in secondary markets located near our existing markets. In the future, we may explore expansion opportunities in other markets in the United States that share similar demographic characteristics to those in which we currently operate.

 

Our facilities include a mix of state-of-the-art cardiovascular equipment, including AMT ellipticals, E Spinners & Arc Trainers along with bikes, steppers, treadmills and elliptical motion machines; free weight and strength equipment, including Cybex, Nautilus, Techno Gym, Strive, Precor, Star Trac and Hammer Strength equipment; group exercise and cycling studios; the entertainment system network; locker rooms, including shower facilities, towel service and other amenities, such as saunas, babysitting, and a pro-shop. Each of our clubs is equipped with automated external defibrillators (AEDs) for use in cardiac arrest emergencies. Personal training services are offered at all locations for an additional charge. At certain locations, additional facilities are also offered, including swimming pools and racquet and basketball courts. Also, we have fee-based programming at many of our clubs, including Small Group Training, children’s programs, and other programs targeting adult members.

 

We also offer our Xpressline strength workout at all of our clubs. Xpressline is an eight-station total-body circuit workout designed to be used in 22 minutes and to accommodate all fitness levels. This service is provided for free to our members.

 

We have over 8,400 personal entertainment units installed in our clubs. The units are typically mounted on or near individual pieces of cardiovascular equipment and are equipped with a flat-panel color screen for television viewing. We believe our members prefer the flexibility to view and listen to the programs of their choice during their cardiovascular workout. The entertainment system 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.

 

In the near future we intend to expand the features of the personal viewing screens at select clubs with a new entertainment system network. These additional features include on demand television and music, iPod/iPhone compatibility and a club information channel. We are planning to begin the roll-out of this system in our Manhattan clubs in 2010.

 

Club Services and Operations

 

Our clubs are structured to provide an enhanced member experience through effective execution of our operating plan. Our club and support team members are the key to delivering a valued member experience and our operations are organized to maximize their overall effectiveness. Our club operations include:

 

Management.  We believe that our success is largely dependent on the selection and development of our team members. Our management structure is designed to strike the right balance between consistent execution of operational excellence and nurturing a leader’s capacity for entrepreneurial decision making. Our learning and development system allows for all club positions to receive training on the key elements of their role as well as development training for growth. We believe a critical component to our growth is our ability to leverage internally developed management talent.

 

Our business is divided into regional operating lines with each reporting to a regional vice president. Reporting to the regional vice presidents are regionally based functional support teams as well as district managers who are responsible for executing the Company’s operating plan within a group of clubs. Reporting to the district managers are the individual club general managers who are responsible for the day-to-day management of each club. At each level of responsibility, compensation is structured to incent driving the member experience and profitability.

 

Functional Support.  Functional teams provide technical expertise and support designed to drive the member experience and revenue growth in specific areas of our clubs’ services, including sales and marketing, fitness and ancillary programming, learning and development as well as facility management and member service.

 

Regional marketing provides locally relevant expertise to support the region in building brand awareness and driving membership sales. Team members work closely with regional leadership and local club management to build and consistently execute sales, brand awareness and community outreach programming across each region.

Driving excellence in fitness and ancillary programming is critical to our success. All of our fitness clubs offer one-on-one personal training, which is sold in single session and multi-session packages. Our fitness teams are trained to provide superior fitness solutions to address member needs. We believe the qualifications of the personal training staff helps ensure that members receive a consistent level of quality service throughout our clubs and that our personal training programs provide valuable guidance to our members and a significant source of incremental revenue for us. Our personal trainers are grouped by professional certification and advanced specialty education. A trainer’s compensation is based on their professional designation and the number of training sessions they perform. We believe that members who participate in personal training programs typically have a longer membership life.

 

Our commitment to providing a quality exercise experience to our members extends beyond just personal training and includes group exercise programming. Our instructors teach a variety of classes including: aerobics, cycling, strength conditioning, boxing, yoga, Pilates and step aerobics classes. Instructors report through local club management and are further supported by regional directors responsible for ensuring consistency in class content, scheduling, training and instruction. We also provide small group training offerings to our members, which are fee-based programs that have smaller groups and provide more focused and typically more advanced classes. Some examples of these offerings include Pilates, boxing camps and cycling camps.

 

In addition to group exercise, we also offer a variety of ancillary programming for children under our Sports Clubs for Kids brand. As of December 31, 2009, Sports Clubs for Kids was being offered in 31 locations throughout our New York Sports Clubs, Boston Sports Clubs and Philadelphia Sports Clubs regions. Our Sports Clubs for Kids programming positions our multi-recreational clubs as family clubs, which we believe provides 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 and birthday parties. It also can include sports performance-based programming such as our Ignite Program, which specializes in training young athletes ages eight to 17 years of age to improve their athletic skills and increase their speed, agility and strength and non-competitive “learn-to-play” sports programs.

 

Functional and leadership skill development plays a critical role in enabling our success. Team member development occurs at both the club level and in the classroom. Managers play a vital role in the development of their teams and partner closely with our learning and development team to advance team member skill for future growth. Our learning programs are consistently designed and focused on building strong functional and leadership skills across the organization. This also includes specialized fitness and group exercise training curriculum.

 

Our facilities and equipment management teams are dedicated to ensuring our clubs and fitness equipment are operating at the highest standard of performance for our members. Local teams are deployed to provide on-site support to clubs as needed.

 

Our club support and member services groups act as a coordinating point for all departments, supporting excellence in program execution and ensuring consistency of policies and procedures across the entire organization that support the member experience.

 

Employee Compensation and Benefits

 

We provide performance-based incentives to our management. Senior management compensation, for example, is tied to our overall performance. Departmental directors, district managers and general managers can achieve bonuses tied to financial and member retention targets. We offer our employees various benefits including health, dental and disability insurance; pre-tax healthcare, commuting 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.

 

Centralized Information Systems

 

We use an integrated information system to sell memberships, bill our members, track and analyze sales and membership statistics, the frequency and timing of member workouts, cross-club utilization, member life, 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. Our information technology strategy is aligned to best support our business strategy and operating plans. We maintain an ongoing comprehensive multi-year program to replace or upgrade key systems and to optimize their performance.

 

We currently utilize a club management system that incorporates functionality for member services, contract management, electronic billing, point of sale, scheduling personal training resources and reservations. This club management system extends support for new business functionalities and new club models and integrates with other applications. We have an application utilizing business intelligence tools and data warehousing capabilities enabling enhanced managerial and analytical reporting of sales and operations.

 

In 2008, we entered into an agreement with Ajilon Solutions, a division of Ajilon Professional Staffing LLC (“Ajilon”), to develop a new enterprise management system for us, which we refer to as our Global Management System (“GIMS”). We expected to begin to deploy GIMS in 2009. In September 2009, we commenced litigation against Ajilon alleging, among other things, breach of contract. See Item 3 — Legal Proceedings. Based on the status of the litigation and a partial assessment of the project, we determined that it was not probable that the Company would continue to develop the system along the lines that we originally anticipated. As a result, the Company has recognized an impairment charge of $10.2 million as of December 31, 2009. We expect to use our existing enterprise management enterprise system for a period of one to two years while we explore other options.

 

In 2007, we implemented a human resources management system and merged it with an existing timekeeping system which was integrated with payroll and relevant financial applications for comprehensive automation of compensation processing and management for all employees. This system has the capability of expanding our talent management, recruiting and performance management processes and will be leveraged as we align it with our new learning and development strategy to train our club team members. The human resources management system allows us to effectively and efficiently serve our team members by providing meaningful information to support their individual growth and development.

 

Our web site utilizes new architectures that allow for flexibility in product offerings, online corporate and group sales, promotion and contest presentations, member self-service, surveying and enhanced member options. The internet capabilities were recently expanded to include more member-focused features. In 2008, we launched additional web capabilities for selling our suite of memberships for all clubs. We have built an intranet to provide a portal for the various browser-based applications that we utilize internally. Our intranet features support corporate communications, human resources programs and training. In 2009, we launched a re-design of our web site, making it easier for our members to navigate through the features.

 

We continuously implement infrastructure changes to accommodate growth, provide network redundancy, better manage telecommunications and data costs, increase efficiencies in operations and improve management of all components of our technical architecture, including disaster recovery. The disaster recovery facility utilizes replication tools to provide fail-over capabilities for supporting our critical club operations and company communications. Since 2007, we have used advanced tools for enhanced management and monitoring of our infrastructure for compliance and improved security.

 

Intellectual Property

 

We have registered various trademarks and service marks with the U.S. Patent and Trademark Office, including, NEW YORK SPORTS CLUBS and NYSC, WASHINGTON SPORTS CLUBS and WSC, BOSTON SPORTS CLUBS and BSC, PHILADELPHIA SPORTS CLUBS and PSC, COMPANIESGETFIT.COM, SPORTS CLUBS FOR KIDS, “           BETTER.”, and TOWN SPORTS INTERNATIONAL. We

continue to register other trademarks and service marks. We believe that our rights to these properties are adequately protected.

 

Competition

 

The fitness club industry is highly competitive and continues to become more competitive. The number of health clubs in the U.S. has increased from 26,830 in 2004 to 30,022 in 2008, based on the most recent information available. In each of the markets in which we operate, we compete with other fitness clubs, physical fitness and recreational facilities.

 

We consider the following groups to be our primary competitors in the health and fitness 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 and pedestrian traffic.

 

We consider our service offerings to be in the mid-range of the value/service proposition and designed to appeal to a large portion of the population who utilize fitness facilities. The number of competitor clubs that offer lower pricing and a lower level of service has been growing in our markets recently. These clubs have and may continue to attract members away from both our fitness-only clubs and our multi-recreational clubs, particularly in this recessionary consumer environment.

 

We also face competition from club operators offering comparable or higher pricing with higher levels of service. The trend to larger outer-suburban family fitness centers, in areas where suitable real estate is more likely to be available, could also compete effectively against our suburban formats.

 

Competitive Position Measured by Number of Clubs

 

 

We also compete with other entertainment and retail businesses for the discretionary income in our target demographics. There can be no assurance that we will be able to compete effectively in the future in the markets in which we operate. Competitors, who 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 and/or newly constructed club locations. This increased competition could increase our costs associated with expansion through both acquisitions and for real estate availability for newly constructed club locations.

 

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 barriers to entry in our metropolitan areas, 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. These barriers of entry are significant in our four metropolitan regions, however they not as challenging in our surrounding suburban locations.

 

Government Regulation

 

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 and (2) state and local health regulations.

 

Statutes and regulations affecting the fitness industry have been enacted in jurisdictions in which we conduct business and other states into which we may expand in the future have adopted or may 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 or in certain circumstances, such as for medical reasons or relocation to a certain distance from the nearest club, 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. The specific procedures and reasons for cancellation vary due to differing laws in the respective jurisdictions, but in each instance, the canceling member is entitled to a refund of unused prepaid amounts. Most recently, several states have proposed legislation that would prohibit the automatic rollover of membership once a member’s commitment period expires. In addition, we are subject to numerous other types of federal and state regulations governing the sale of memberships. These laws and regulations are subject to varying interpretations by a number of state and federal enforcement agencies and 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.

 

The tax treatment of membership dues varies by state. In recent years, some states in which we operate have passed legislation to require sales tax to be collected on membership dues and/or personal training sessions. These taxes have the effect of increasing the payments by our members, which could impede our ability to attract new members or induce members to cancel their membership.

 

Changes in any statutes, rules or regulations could have a material adverse effect on our financial condition and results of operations.

 

Employees

 

At December 31, 2009, we had approximately 8,500 employees, of whom approximately 2,100 were employed full-time. Approximately 375 of those employees were corporate and other club support personnel. We are not a party to any collective bargaining agreement with our employees. We have never experienced any significant labor shortages or had any difficulty in obtaining adequate replacements for departing employees. We consider our relations with our employees to be good.

Available Information

 

We make available through our web site at www.mysportsclubs.com in the “Investor Relations — SEC Filings” section, free of charge, all reports and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Occasionally, we may use our web site as a channel of distribution of material company information. Financial and other material information regarding the Company is routinely posted on and accessible at http://investor.mysportsclubs.com. In addition, you may automatically receive email alerts and other information about us by enrolling your email by visiting the “E-mail Alerts” section at http://investor.mysportsclubs.com/.

 

The foregoing information regarding our website and its content is for convenience only. The content of our website is not deemed to be incorporated by reference into this report nor should it be deemed to have been filed with the SEC.

 

 

Investors should carefully consider the risks described below and all other information in this Annual Report on Form 10-K. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business and operations. If any of the following risks actually occur, our business, financial condition, cash flows or results of operations could be materially adversely affected.

 

Risks Related to Our Business

 

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

 

The performance of our clubs is dependent on our ability to attract and retain members and we may not be successful in these efforts. Most of our members can cancel their club membership at any time under certain circumstances. In addition, there are numerous factors that have in the past and could in the future lead to a decline in membership levels at established clubs or that could prevent us from increasing our membership at newer clubs, including 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.

 

Current negative economic conditions, including increased unemployment levels, have resulted in significant recessionary pressures and further declines in consumer confidence and economic growth. These conditions have and could further lead to reduced consumer spending in the foreseeable future. In the current depressed economic and consumer environment, consumers and businesses may postpone spending in response to tighter credit, negative financial news and/or declines in income or asset values, which could have a material negative effect on the demand for our services and products and such decline in demand may continue as the current recessionary period continues and disposable income declines. Other factors that could influence demand include increases in fuel and other energy costs, conditions in the residential real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence and other macroeconomic factors affecting consumer spending behavior. The current downturn and uncertain outlook in the global economy may materially adversely affect our business and our revenues and profits. As a result of these factors, membership levels might not be adequate to maintain our operations at current levels or permit the expansion of our operations.

 

In addition, to the extent our corporate clients are adversely affected by negative economic conditions, they may decide, as part of expense reduction strategies, to curtail or cancel club membership benefits provided to their respective employees. Any reductions in corporate memberships may lead to membership cancellations as we can not assure that employees of corporate customers will choose to continue their memberships without employer subsidies. A decline in membership levels may have a material adverse effect on our business, financial condition, results of operations or cash flows. We ended 2009 with 24,000 fewer members compared to the end of 2008, a decline that we attribute, in large part, to negative economic conditions during the year.

Low consumer confidence levels and decreased spending could negatively impact our financial position and result in further club closures and fixed asset and goodwill impairments.

 

In the years ended December 31, 2009 and 2008, we closed nine and four clubs, respectively, and recognized $6.7 million and $3.9 million of fixed asset impairments, respectively. In addition, in the year ended December 31, 2008, we recorded goodwill impairment charges of $17.6 million related to our Boston Sports Clubs region. Some of these closures and impairments were due, in large part, to the current economic and consumer environment. If the economic and consumer environment were to continue to deteriorate or if we are unable to improve the overall competitive position of our clubs, our operating performance may continue to decline and we may need to recognize additional impairments of our long-lived assets and goodwill and may be compelled to close additional clubs. In addition, we cannot assure you that we will be able to replace any of the revenue lost from these closed clubs from our other clubs.

 

Our geographic concentration heightens our exposure to adverse regional developments.

 

As of December 31, 2009, we operated 109 fitness clubs in the New York metropolitan market, 25 fitness clubs in the Boston market, 18 fitness clubs in the Washington, D.C. market, six fitness clubs in the Philadelphia market and three fitness clubs in Switzerland. Our geographic concentration in the Northeast and Mid-Atlantic regions and, in particular, the New York area, heightens our exposure to adverse developments related to competition, as well as economic and demographic changes in these regions. Our geographic concentration might result in a material adverse effect on our business, financial condition, cash flows or results of operations in the future.

 

The level of competition in the fitness club industry could negatively impact our revenue growth and profitability.

 

The fitness club industry is highly competitive and continues to become more competitive. In each of the markets in which we operate, 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 in our target demographics. We might not be able to compete effectively in the future in the markets in which we operate. Competitors include companies that are larger and have greater resources than us and they 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 newly constructed club locations, thereby increasing costs associated with expansion through both acquisitions and lease negotiation and real estate availability for newly constructed club locations.

 

The number of competitor clubs that offer lower pricing and a lower level of service have been growing in our markets recently. These clubs have and may continue to attract members away from both our fitness-only clubs and our multi-recreational clubs, particularly in this recessionary consumer environment.

 

Furthermore, smaller and less expensive weight loss facilities present a competitive alternative for consumers. We also face competition from competitors offering comparable or higher pricing with higher levels of service. The trend to larger outer-suburban, multi-recreational family fitness centers, in areas where suitable real estate is more likely to be available, also compete against our suburban, fitness-only models.

 

In addition, large competitors could enter the urban markets in which we operate to attempt to open a chain of clubs in these markets through one, or a series of, acquisitions.

 

Our trademarks and trade names may be infringed, misappropriated or challenged by others.

 

We believe our brand names and related intellectual property are important to our continued success. We seek to protect our trademarks, trade names and other intellectual property by exercising our rights under applicable trademark and copyright laws. If we were to fail to successfully protect our intellectual property rights for any

reason, it could have an adverse effect on our business, results of operations and financial condition. Any damage to our reputation could cause membership levels to decline and make it more difficult to attract new members.

 

If we are unable to identify and acquire suitable sites for new clubs, our revenue growth rate and profits may be negatively impacted.

 

To successfully expand our business over the long term, we must identify and acquire sites that meet the site selection criteria we have established. In addition to finding sites with the right geographical, demographic and other measures we employ in our selection process, we also need to evaluate the penetration of our competitors in the market. We face competition from other health and fitness center operators for sites that meet our criteria and as a result, we may lose those sites, our competitors could copy our format or we could be forced to pay higher prices for those sites. If we are unable to identify and acquire sites for new clubs on attractive terms, our revenue growth rate and profits may be negatively impacted. Additionally, if our analysis of the suitability of a site is incorrect, we may not be able to recover our capital investment in developing and building the new club.

 

We may experience prolonged periods of losses in our recently opened clubs.

 

We have opened a total of 13 new club locations in the 24-month period ended December 31, 2009. Upon opening a club, we typically experience an initial period of club operating losses. Enrollment from pre-sold memberships typically generates insufficient revenue for the club to initially generate positive cash flow. As a result, a new club typically generates an operating loss in its first full year of operations and substantially lower margins in its second full year of operations than a club opened for more than 24 months (“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 depreciation and amortization expenses, which will further negatively impact net income. We may, at our discretion, accelerate or expand our plans to open new clubs, which may temporarily adversely affect results from operations.

 

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 physical exertion and use of our services and facilities, including exercise equipment. Claims might be asserted against us for injury suffered by, or death of members or guests while exercising at a club. We might not be able to successfully defend such claims. As a result, we might not be able to maintain our general liability insurance on acceptable terms in the future or maintain a level of insurance that would provide adequate coverage against potential claims.

 

Depending upon the outcome, these matters may have a material effect on our consolidated financial position, results of operations or cash flows.

 

Security and privacy breaches may expose us to liability and cause us to lose customers.

 

Federal and state law requires us to safeguard our customers’ financial information, including credit card information. Although we have established security procedures and protocol, including credit card industry compliance procedures, to protect against identity theft and the theft of our customers’ financial information, our security and testing measures may not prevent security breaches and breaches of our customers’ privacy may occur, which could harm our business. For example, a significant number of our users provide us with credit card and other confidential information and authorize us to bill their credit card accounts directly for our products and services. Typically, we rely on encryption and authentication technology licensed from third parties to enhance transmission security of confidential information. Advances in computer capabilities, new discoveries in the field of cryptography, inadequate facility security or other developments may result in a compromise or breach of the technology used by us to protect customer data. Any compromise of our security could harm our reputation or financial condition and, therefore, our business. In addition, a party who is able to circumvent our security measures or exploit inadequacies in our security measures, could, among other effects, misappropriate proprietary information, cause interruptions in our operations or expose customers to computer viruses or other disruptions. Actual or perceived vulnerabilities may lead to claims against us. To the extent the measures we have taken prove to be

insufficient or inadequate, we may become subject to litigation or administrative sanctions, which could result in significant fines, penalties or damages and harm to our reputation.

 

Loss of key personnel and/or failure to attract and retain highly qualified personnel could make it more difficult for us to develop our business and enhance our financial performance.

 

We are dependent on the continued services of our senior management team, particularly Alexander A. Alimanestianu, Chief Executive Officer; Daniel G. Gallagher, Chief Financial Officer; and Martin Annese, 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.

 

Terrorism and the uncertainty of armed conflicts may have a material adverse effect on clubs and our operating results.

 

Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, and other acts of violence or war may affect the markets in which we operate, our operating results or the market on which our common stock trades. 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 any such future terrorist attacks, which may adversely affect our clubs and result in a decrease in our revenues. The potential near-term and long-term effect these attacks may have for our members, the markets for our services and the market for our common stock are uncertain; however, their occurrence can be expected to further negatively affect the United States economy generally and specifically the regional markets in which we operate. The consequences of any terrorist attacks or any armed conflicts are unpredictable; and we may not be able to foresee events that could have an adverse effect on our business.

 

Disruptions and failures involving our information systems could cause customer dissatisfaction and adversely affect our billing and other administrative functions and development of new systems have been and could continue to be costly and has, and in the future may, divert management resources.

 

The continuing and uninterrupted performance of our information systems is critical to our success. Our members may become dissatisfied by any systems disruption or failure that interrupts our ability to provide our services to them. Disruptions or failures that affect our billing and other administrative functions could have an adverse affect on our operating results.

 

We use a fully-integrated information system to sell memberships, bill our members, track and analyze sales and membership statistics, the frequency and timing of member workouts, cross-club utilization, member life, value-added services and demographic profiles by member. This system also assists us in evaluating staffing needs and program offerings. Correcting any disruptions or failures that affected our proprietary system could be difficult, time-consuming and expensive because we would need to use contracted consultants familiar with our system. We believe that, without investing in enhancements, this system is approaching the end of its life cycle. Any failure of our current system could cause us to lose members and adversely affect our business and results of operations.

 

In 2008, we entered into an agreement with Ajilon, to develop for us a new enterprise management system, GIMS. We expected to begin to deploy GIMS in 2009. In September 2009, we commenced litigation against Ajilon alleging, among other things, breach of contract. See Item 3 - Legal Proceedings. Based on the status of the litigation and a partial assessment of the project, we determined that it was not probable that the Company would continue to develop the system along the lines that we originally anticipated. As a result, the Company has recognized an impairment charge of $10.2 million as of December 31, 2009. We expect to use our existing enterprise management enterprise system for a period of one to two years while we explore other options.

 

Changes to any of our software implementation strategies could result in further impairment of software-related assets. We are also subject to the risks associated with the ability of our vendors to provide information technology solutions to meet our needs.

We have implemented numerous infrastructure changes to accommodate our growth, provide network redundancy, better manage telecommunications and data costs, increase efficiencies in operations and improve management of all components of our technical architecture. Our disaster recovery facility utilizes replication tools to provide fail over capabilities for supporting our club operations and company communications. Fire, floods, earthquakes, power loss, telecommunications failures, break-ins, acts of terrorism and similar events could damage either our primary or back-up systems. In addition, computer viruses, electronic break-ins or other similar disruptive problems could also adversely affect our online sites. Any system disruption or failure, security breach or other damage that interrupts or delays our operations could cause us to lose members, damage our reputation, and adversely affect our business and results of operations.

 

The opening of new clubs by us in existing locations may negatively impact our comparable club revenue increases and our operating margins.

 

We currently operate clubs throughout the Northeast and Mid-Atlantic regions of the United States. We opened four clubs in 2009. In addition, we currently have two clubs for which we have signed lease commitments in existing markets. With respect to existing markets, it has been our experience that opening new clubs may attract some memberships away from other clubs already operated by us in those markets and diminish their revenues. In addition, as a result of new club openings in existing markets and because older clubs will represent an increasing proportion of our club base over time, our mature club revenue increases may be lower in future periods than in the past.

 

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

 

Our growth could place strains on our management, employees, information systems and internal controls, which may adversely impact our business.

 

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

 

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. Cash and cash equivalents held in a single commercial bank as of December 31, 2009 were $6.9 million. During any month, this amount may be as high as $30.0 million.

 

Because of the capital-intensive nature of our business, we may have to incur additional indebtedness or issue new equity securities and, if we are not able to obtain additional capital, our ability to operate or expand our business may be impaired and our results of operations could be adversely affected.

 

Our business requires significant levels of capital to finance the development of additional sites for new clubs and the construction of our clubs. If cash from available sources is insufficient or unavailable due to restrictive credit markets, or if cash is used for unanticipated needs, we may require additional capital sooner than anticipated. In the event that we are required or choose to raise additional funds, we may be unable to do so on favorable terms or at all. Furthermore, the cost of debt financing could significantly increase, making it cost-prohibitive to borrow, which could force us to issue new equity securities. If we issue new equity securities, existing shareholders may experience

additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise funds on acceptable terms, we may not be able to execute our current growth plans, take advantage of future opportunities or respond to competitive pressures. Any inability to raise additional capital when required could have an adverse effect on our business plans and operating results.

 

We may incur rising costs related to construction of new clubs and maintaining our existing clubs. If we are not able to pass these cost increases through to our members, our returns may be adversely affected.

 

Our clubs require significant upfront investment. If our investment is higher than we had planned, we may need to outperform our operational plan to achieve our targeted return. Over the longer term, we believe that we can offset cost increases by increasing our membership dues and other fees and improving profitability through cost efficiencies; however, higher costs in certain regions where we are opening new clubs during any period of time may be difficult to offset in the short-term.

 

We may be required to remit unclaimed property to states for unused, expired personal training sessions.

 

We recognize revenue from personal training sessions as the services are performed (i.e., when the session is trained). Unused personal training sessions expire after a set, disclosed period of time after purchase. Recently, the State of New York has informed us that it is currently considering whether we are required to remit the amount received by us for unused, expired personal training sessions to the State of New York as unclaimed property. We currently have between $10.0 million and $15.0 million of unused and expired personal training sessions. We have not recognized any revenue from these sessions and have recorded the amounts as deferred revenue. We do not believe that these amounts are subject to the escheatment or abandoned property laws of any state, including the State of New York. However, in the event that a state, including the State of New York, does not agree with our position, we ultimately may be forced to remit all or a portion of these amounts to such state. In that event, our financial condition may be materially adversely affected.

 

Risks Related to Our Leverage and Our Indebtedness

 

We may be negatively affected by the economic crisis in the United States and key international markets.

 

We must maintain liquidity to fund our working capital, service our outstanding indebtedness and finance investment opportunities. Without sufficient liquidity, we could be forced to curtail our operations or we may not be able to pursue new business opportunities. If our current resources do not satisfy our liquidity requirements, we may have to seek additional financing. The principal sources of our liquidity are funds generated from operating activities, available cash and cash equivalents and borrowings under our $248.8 million senior secured credit facility (the “2007 Senior Credit Facility”), as amended.

 

The capital and credit markets have been experiencing volatility and disruption in the recent past. As a result, one or more of our current lenders could experience financial difficulty, and as a result fail to provide the required lending amounts under our 2007 Credit Agreement. If this should occur, we may need to seek additional financing from other sources. The availability of financing will depend on a variety of factors, such as economic and market conditions, the availability of credit and our credit ratings, as well as the possibility that lenders could develop a negative perception of the prospects of our company or the fitness industry in general. We may not be able to successfully obtain any necessary additional financing on favorable terms, or financing altogether.

 

Economic conditions, both domestic and foreign, may affect our financial performance. Prevailing economic conditions, including unemployment levels, inflation, availability of credit, energy costs and other macro-economic factors, as well as uncertainty about future economic conditions, adversely affect consumer spending and, consequently, our business and results of operations.

 

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

 

We currently have a substantial amount of debt. As of December 31, 2009, our total consolidated debt was $318.4 million. Our substantial debt could have important consequences, including:

 

 

 

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

 

The indenture governing our 11% Senior Discount Notes due in 2014 (“Senior Discount Notes”) will permit us and our subsidiaries to incur substantial additional debt, subject to compliance with provisions of the Indenture. In addition, as of December 31, 2009, we had $49.5 million of unutilized borrowings under our senior secured revolving credit facility. If new debt is added to our and our subsidiaries’ current debt levels, the related risks that we and they currently face could intensify.

 

We may not be able to re-finance our debt at current levels and interest rates.

 

Our Term Loan Facility matures on the earlier of February 27, 2014, or August 1, 2013 if the 11% Senior Discount Notes are still outstanding as of that date. In addition, our Revolving Loan will mature in 2012. Our 11% Senior Discount Notes will mature in 2014. We expect to refinance our outstanding indebtedness under these arrangements with new indebtedness prior to their maturity dates. The availability of refinancing will depend on a variety of factors, such as economic and market conditions, business performance, the availability of credit and our credit ratings, as well as the lenders’ perception of the prospects of our company or our industry generally. We may not be able to successfully obtain any necessary refinancing on favorable terms, including interest rates and financial and other covenants, or at all. In that event, our business and financial condition may be materially adversely affected.

 

We may not have access to the cash flow and other assets of our subsidiaries that may be needed to make payments on our outstanding Indebtedness.

 

Our operations are conducted through our subsidiaries and our ability to make payments on our outstanding Senior Discount Notes is dependent on the earnings and the distribution of funds from our subsidiaries. However, none of our subsidiaries are obligated to make funds available to us for payment on our outstanding Senior Discount Notes. In addition, the terms of the 2007 Credit Agreement governing the 2007 Senior Credit Facility, significantly restrict TSI, LLC and its subsidiaries from paying dividends and otherwise transferring assets to us. Furthermore, our subsidiaries are permitted under the terms of the 2007 Credit Agreement and the indenture governing our Senior Discount Notes 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 us.

 

We cannot assure that the agreements governing the current and future indebtedness of our subsidiaries will permit our subsidiaries to provide TSI, LLC with sufficient dividends, distributions or loans to fund scheduled interest and principal payments on the 2007 Credit Agreement when due.

 

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 settle our indebtedness.

 

The indenture governing our Senior Discount Notes, the 2007 Credit Agreement 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 and that may impact our ability and the ability of our restricted subsidiaries to:

 

 

 

In addition, the 2007 Credit Agreement requires the Company, on a consolidated basis, to maintain a specified financial ratio and satisfy certain financial condition tests that may require us to take action to reduce our debt or to act in a manner contrary to our business objectives. The 2007 Credit Agreement requires the Company, on a consolidated basis, to maintain a maximum total leverage ratio not greater than 4.25:1.00 of consolidated indebtedness to consolidated EBITDA, as defined in the 2007 Credit Agreement. As of December 31, 2009, we were in compliance with such ratio test, with a ratio of 2.31:1.00.

 

Events beyond our control, including changes in general economic and business conditions, may affect our ability to meet certain financial ratios and financial condition tests. We 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 our Senior Discount Notes and the 2007 Credit Agreement. If an event of default under the 2007 Credit Agreement occurs, the lenders could elect to declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable. In the event of default under the indenture governing our Senior Discount Notes, the note holders could elect to declare due all amounts outstanding thereunder, together with accrued interest. If any such event should occur, we might not have sufficient assets to pay our indebtedness.

 

 

None

 

 

We own the 151 East 86th Street location, which houses a fitness club and a retail tenant that generated approximately $2.0 million of rental income for us for the year ended December 31, 2009. We lease the remainder of our fitness clubs pursuant to long-term leases (generally 15 to 25 years, including options). In the next five years, or the period from January 1, 2010 through December 31, 2014, we have leases for six club locations that are due to expire without any renewal options. In each case, we will endeavor to extend the lease or relocate the club or its membership base if appropriate.

 

We lease approximately 36,400 square feet of office space in New York City and have smaller regional offices in Fairfax, VA and Boston, MA, for administrative and general corporate purposes. We also lease warehouse and commercial space in Brooklyn, NY for storage purposes.

 

Beginning January 1, 2009, we lease approximately 82,000 square feet in Elmsford, NY for the operation of a centralized laundry facility for New York Sports Clubs offering towel service, and for construction and equipment storage. This space replaced a laundry facility of 14,000 square feet in Queens, NY. As of June 2009, this space also serves as corporate office space and replaced approximately 10,800 square feet of corporate office space in

Manhattan. Total square footage related to the laundry facility is 42,000 and total square footage related to the corporate office and warehouse space is 40,000.

 

The following table provides information regarding our club locations:

 

 

 

On March 1, 2005, in an action styled Sarah Cruz, et al v. Town Sports International, d/b/a New York Sports Club, plaintiffs commenced a purported class action against the Company in the Supreme Court, New York County, seeking unpaid wages and alleging that TSI, LLC violated various overtime provisions of the New York State Labor Law with respect to the payment of wages to certain trainers and assistant fitness managers. On or about June 18, 2007, the same plaintiffs commenced a second purported class action against the Company in the Supreme Court of the State of New York, New York County, seeking unpaid wages and alleging that TSI, LLC violated various wage payment and overtime provisions of the New York State Labor Law with respect to the payment of wages to all New York purported hourly employees. While we are unable at this time to estimate the likelihood of an unfavorable outcome or the potential loss to the Company in the event of such an outcome, we intend to contest this case vigorously. Depending upon the ultimate outcome, this matter may have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

 

On September 14, 2009, the staff of the SEC advised the Company that a formal order of private investigation had been issued with respect to the Company. Since May 2008, the Company has been providing documents and testimony on a voluntary basis in response to an informal inquiry by the staff of the SEC, which primarily relates to the deferral of certain payroll costs incurred in connection with the sale of memberships in the Company’s health and fitness clubs and the time period utilized by the Company for the amortization of (i) such deferred costs into expense and (ii) initiation fees into revenue. The Company continues to discuss these issues with the SEC Staff and to cooperate fully with the Staff’s investigation. The Company cannot predict the outcome of, or the timeframe for, the conclusion of this investigation.

 

On September 22, 2009, in an action styled Town Sports International, LLC v. Ajilon Solutions, a division of Ajilon Professional Staffing LLC (Supreme Court of the State of New York, New York County, 602911-09), TSI, LLC brought an action in the Supreme Court of the State of New York, New York County, against Ajilon for breach of contract, conversion and replevin, seeking, among other things, money damages against Ajilon for breaching its agreement to design and deliver to TSI, LLC a new sports club enterprise management system known as GIMS, including failing to provide copies of the computer source code written for GIMS, related documentation, properly identified requirements documents and other property owned and licensed by TSI, LLC. On October 2, 2009, TSI, LLC moved for preliminary injunctive relief, demanding that Ajilon immediately turn over the completed work product and licenses needed for the project so that TSI, LLC could evaluate the status of the project and plan for its completion. Subsequently, on October 14, 2009, Ajilon brought a counterclaim against TSI, LLC alleging breach of contract, alleging, among other things, failure to pay outstanding invoices in the amount of $2.9 million. On October 15, 2009, the court issued its first ruling on TSI, LLC’s motion for preliminary injunctive relief and ordered Ajilon to provide certain materials created in connection with the project, including the computer source code written for GIMS, and reserved judgment on other aspects of TSI, LLC’s request. On December 10, 2009, the Court

denied TSI, LLC’s application for a preliminary injunction requiring Ajilon to provide certain licenses for software used to run GIMS. TSI, LLC’s claim for permanent relief remains pending. The litigation is currently in the discovery phase, and the Company intends to prosecute vigorously its claims against Ajilon and defend against Ajilon’s counterclaim.

 

In addition to the litigation discussed above, we are involved in various other lawsuits, claims and proceedings incidental to the ordinary course of business. See Note 14 — Contingencies to the consolidated financial statements in this Annual Report. The results of litigation are inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in diversion of significant resources. The results of these other lawsuits, claims and proceedings cannot be predicted with certainty.

 

 

PART II

 

 

Price Range of Common Stock

 

Our common stock currently trades on The NASDAQ Global Market, under the symbol CLUB. The following table sets forth, for each quarterly period in the last two fiscal years, the high and low sales prices (in dollars per share) of our common stock as quoted or reported on The NASDAQ Global Market:

 

 

Holders

 

As of March 10, 2010, there were approximately 95 holders of record of our common stock. There are additional holders who are not “holders of record” but who beneficially own stock through nominee holders such as brokers and benefit plan trustees.

 

Dividend Policy

 

We intend to retain future earnings, if any, to finance the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Consequently, stockholders will need to sell shares of our common stock to realize a return on their investment, if any. No dividends were paid by the Company in the fiscal years ended December 31, 2009 and 2008.

 

The terms of the indenture governing our Senior Discount Notes and the 2007 Senior Credit Facility significantly restrict the payment of dividends by us. Our subsidiaries are permitted under the terms of the 2007 Senior Credit Facility (and under the indenture governing our Senior Discount Notes) to incur additional indebtedness that may severely restrict or prohibit the payment of dividends by such subsidiaries to us. Our

substantial leverage may impair our financial condition and we may incur significant additional debt (see “Item 1A. Risk Factors”).

 

Issuer Purchases of Equity Securities

 

We had a repurchase program that continued through December 31, 2009, but there were no repurchases during the quarter ended December 31, 2009. During the years ended December 31, 2009 and 2008, the Company repurchased 2,095,613 and 1,838,960 shares of common stock, respectively, at a cost of $5.4 million and $4.6 million, respectively.

 

Recent Sales of Unregistered Securities

 

We did not sell any securities during the year ended December 31, 2009 that were not registered under the Securities Act of 1933, as amended.

Stock Performance Graph

 

The graph depicted below compares the annual percentage change in our cumulative total stockholder return with the cumulative total return of the Russell 2000 and the NASDAQ composite indices.

 

COMPARISON OF 43 MONTH CUMULATIVE TOTAL RETURN*
Among Town Sports International Holdings, Inc, The NASDAQ Composite Index
And The Russell 2000 Index

 

 

 

 

 

Notes:

 

 

Notwithstanding anything to the contrary set forth in any of our previous or future filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate by reference this Annual Report on Form 10-K or future filings made by the Company under those statutes, the Stock

Performance Graph is not deemed filed with the Securities and Exchange Commission, is not deemed soliciting material and shall not be deemed incorporated by reference into any of those prior filings or into any future filings made by the Company under those statutes, except to the extent that the Company specifically incorporates such information by reference into a previous or future filing, or specifically requests that such information be treated as soliciting material, in each case under those statutes.

 

 

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(In thousands, except share, per share, club and membership data)

 

The selected consolidated balance sheet data as of December 31, 2009 and 2008 and the selected consolidated statement of operations and cash flow data for the years ended December 31, 2009, 2008 and 2007 have been derived from our audited consolidated financial statements included elsewhere herein. The selected consolidated balance sheet data as of December 31, 2007, 2006 and 2005 and the selected consolidated statement of operations and cash flow data for the years ended December 31, 2006 and 2005 have been derived from our audited consolidated financial statements not included herein. Other data and club and membership data for all periods presented have been derived from our unaudited books and records. Our historical results are not necessarily indicative of results for any future period. You should read these selected consolidated financial and other data, together with the accompanying notes, in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Annual Report and our consolidated financial statements and the related notes appearing at the end of this Annual Report.

 

 

 

 

 

 

 

 

 

 

 

 

You should read the following discussion and analysis of our financial condition and consolidated results of operations in conjunction with the “Selected Consolidated Financial and Other Data” section of this Annual Report and our consolidated financial statements and the related notes appearing at the end of this Annual Report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions (see” FORWARD-LOOKING STATEMENTS” discussion). Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth in “Item 1A. Risk Factors” of this Annual Report.

 

Overview

 

Based on number of clubs, we are the second largest owner and operator of fitness clubs in the Northeast and Mid-Atlantic regions of the United States. As of December 31, 2009, we owned and operated 161 clubs that collectively served approximately 486,000 members. We develop clusters of clubs to serve densely populated major metropolitan regions and we service such populations by clustering clubs near the highest concentrations of our target customers’ areas of both employment and residence. 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 target member is between the age of 21 and 60 and has an annual income of between $50,000 and $150,000. We believe that this “upper-value” segment is not only the broadest segment of the market, but also the segment with the greatest growth opportunities.

 

Our goal is to be the most recognized health club network in each of the four major metropolitan regions we serve. We believe that our strategy of clustering clubs provides significant benefits to our members and allows us to achieve strategic operating advantages. In each of our markets, we have developed 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 neighboring communities. Capitalizing on this clustering of clubs, as of December 31, 2009, approximately 40% of our members participated in our passport or regional passport memberships which allows unlimited access to all of our clubs in our clusters within one, or all of, our regions, respectively, for a higher monthly membership fee. The remaining 60% of our members participate in a gold membership which allows unlimited access to a designated club and access to all other clubs during off-peak hours.

 

We have executed our clustering strategy successfully in the New York region through the network of fitness clubs we operate under our New York Sports Clubs brand name. We are the largest fitness club operator in Manhattan with 39 locations (more than twice as many as our nearest competitor) and operated a total of 109 clubs under the New York Sports Clubs brand name within a 120-mile radius of New York City as of December 31, 2009. We operated 25 clubs in the Boston region under our Boston Sports Clubs brand name, 18 clubs (two of which are partly-owned) in the Washington, D.C. region under our Washington Sports Clubs brand name and six clubs in the Philadelphia region under our Philadelphia Sports Clubs brand name as of December 31, 2009. In addition, we operated three clubs in Switzerland as of December 31, 2009. 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.

 

Throughout the year ended December 31, 2009, the ongoing U.S. and global economic recession has resulted in declines in consumer confidence and economic growth and has led to reduced consumer spending. In addition, both the number of competitors and the number of existing competitor clubs offering lower pricing and reduced levels of service have been growing in our markets. The effect of the economic recession and the growing competition contributed to an increase in member cancellations, decreases in new memberships and reductions in revenue from ancillary services and marketing. During the year ended December 31, 2009 our member base decreased by approximately 24,000 net members. While we do not believe our membership base will continue to decrease at these rates, these factors have and could continue to have an adverse effect on our business and financial performance.

 

In the year ended December 31, 2009, we recorded impairment charges of $10.2 million related to the development of GIMS, an internal-use software project. In September 2009, the Company commenced litigation against the vendor, Ajilon, which was developing this software, alleging, among other things, breach of contract. In connection with this litigation, development of this software project ceased during the third quarter of 2009. It was determined that it was not probable that the Company would continue with the development of this software and the Company is currently exploring other options. See Note 5 — Fixed Assets and Note 14 — Contingencies to the Company’s consolidated financial statements in this Annual Report for further details.

 

The results for the year ended December 31, 2009 include the correction of an accounting error that resulted in a cumulative pre-tax charge of $751,000 to payroll and related expense and a related decrease in deferred membership costs on our consolidated statement of operations and consolidated balance sheet, respectively. Historically, we applied an accounting policy of capitalizing and then amortizing membership consultants’ commissions, bonuses and a portion of their base salaries, and related taxes and benefits, as direct costs of obtaining new members. Company policy limited the costs that could be capitalized to the amount of initiation fee revenue deferred for new memberships. The application of this policy required us to make certain estimates. In connection with a review of the accounting treatment for membership consultant salaries, including the application of the accounting policy and appropriateness of its estimate methodology, we determined that our previous estimates were incorrect. We concluded that it was not clear whether any portion of the consultants’ base salaries and the taxes and benefits related to those base salaries should have been capitalized. While we are no longer

deferring a portion of membership consultants’ salaries and related taxes and benefits, we will continue to defer membership consultants’ commissions and bonuses and portions of taxes and benefits related to those commissions and bonuses. See Note 2 — Correction of an Accounting Error to the consolidated financial statements in this Annual Report for further details.

 

We are in the process of executing a number of key initiatives identified in an environmental sustainability master plan in the areas of energy efficiency, water consumption, recycling and greenhouse gas reduction. While many of the programs are still in the planning stage, we have already begun implementing recycling and lighting retro-fit projects and are preparing for a more aggressive roll-out in the months ahead. We believe these initiatives are helpful to enhancing the member and employee experience while reducing our environmental impacts and certain operating expenses.

 

Revenue and operating expenses

 

We consider that we have two principal sources of revenue:

 

 

In addition, we receive revenue (approximately 1.0% of our total revenue for the year ended December 31, 2009) from the rental of space in our facilities to operators who offer wellness-related offerings, such as physical therapy and juice bars. In addition, we sell in-club advertising and sponsorships and generate management fees from certain club facilities that we do not wholly own. We refer to this revenue as Fees and Other revenue.

 

Our performance is dependent on our ability to continually attract and retain members at our clubs. We experience attrition at our clubs and must attract new members in order to maintain our membership and revenue levels. In the years ended December 31 2009 and 2008, our attrition rate was 45.2% and 40.2%, respectively. We expect attrition to move closer to 2008 levels in 2010 due to an improved member experience, a more stabilized economy and increased retention programs.

 

Our operating and selling expenses are comprised of both fixed and variable costs. Fixed costs include club and supervisory and other salary and related expenses, occupancy costs, including most elements of rent, utilities, housekeeping and contracted maintenance expenses, as well as depreciation. Variable costs are primarily related to payroll associated with ancillary club revenue, membership sales compensation, advertising, certain facility repairs and club supplies.

 

General and administrative expenses include costs relating to our centralized support functions, such as accounting, insurance, information and communication systems, purchasing, member relations, legal and consulting fees and real estate development expenses. Payroll and related expenses are included in a separate line item on the consolidated statement of (loss) income and are not included in general and administrative expenses.

 

As clubs mature and increase their membership base, fixed costs are typically spread over an increasing revenue base and operating margins tend to improve. Conversely, when our membership base declines our operating margins are negatively impacted. During 2009, membership at our clubs open over 24 months decreased approximately 6.3%. As consumer confidence and spending continues to be under pressure and the growth in the number of competitors providing lower cost memberships with lower dues in our markets continues continues, these negative membership trends may continue. These membership base declines have reduced our operating margins in 2009.

Our primary capital expenditures relate to the construction or acquisition of new club facilities and upgrading and expanding our existing clubs. The construction and equipment costs vary based on the costs of construction labor, as well as the planned service offerings and size and configuration of the facility. We perform routine improvements at our clubs and partial replacement of the fitness equipment each year for which we are currently budgeting approximately 4.0% to 5.0% of projected annual revenue. Expansions of certain facilities are also performed from time to time, when incremental space becomes available on acceptable terms and utilization and demand for the facility dictate. In this regard, facility remodeling is also considered where appropriate.

 

In the last two years, our operating income and cash flows provided by operations have decreased. In 2009, operating income decreased 76.8% from 2008 primarily due to an overall decrease of earnings and impairment charges related to our internal-use software project and on fixed assets at nine of our clubs. In 2008, operating income decreased 43.3%from 2007 in large part due to goodwill and fixed asset impairment charges recorded in 2008.

 

 

Historically, we have focused on building or acquiring clubs in areas where we believe the market is underserved or where new clubs are intended to replace existing clubs at their lease expiration. Based on our experience, a new club tends to experience a significant increase in revenues during its first three years of operation as it reaches maturity. Because there is relatively little incremental cost associated with such increasing revenue, there is a greater proportionate increase in profitability. We believe that the revenues and operating income of our immature clubs will increase as they mature. In contrast, operating income margins may be negatively impacted in the near term by our new club openings. In 2009, we closed nine clubs with collectively marginal to no operating cash flow that, in many cases, were at or near the end of their leases. In several cases, we were able to transfer many of the members of those clubs to other clubs thereby enhancing overall profitability. While we do not intend to close clubs in 2010 at this time, we will continue to opportunistically pursue closing underperforming clubs.

 

As of December 31, 2009, 159 of the existing fitness clubs were wholly-owned by us and our consolidated financial statements include the operating results of all such clubs. Two locations in Washington, D.C. were partly-owned and operated by us, with our profit sharing percentages approximating 20% (after priority distributions) and 45%, respectively, and are treated as unconsolidated affiliates for which we apply the equity method of accounting. In addition, we provide management services at four fitness clubs located in colleges and universities in which we have no equity interest.

Comparable Club Revenue

 

We define comparable club revenue as revenue at those clubs that were operated by us for over 12 months and comparable club revenue increase (decrease) as revenue for the 13th month and thereafter as applicable as compared to the same period of the prior year.

 

 

Key determinants of comparable club revenue increases (decreases) are new memberships, member retention rates, pricing and ancillary revenue increases (decreases).

 

As shown above, comparable club revenue has generally been trending downward since the first quarter of 2007.

 

In the year ended December 31, 2009, membership at our comparable clubs decreased 5.2% as compared to the prior year. This decline in membership coupled with expected decreases in personal training revenue is expected to be a contributing factor to decreases in comparable club revenue and therefore operating margins in 2010. We expect the decreases in comparable club revenue to moderate in 2010.

 

Historical Club Count

 

 

 

Results of Operations

 

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

 

 

YEAR ENDED DECEMBER 31, 2009 COMPARED TO
YEAR ENDED DECEMBER 31, 2008

 

Revenue (in $’000s) was comprised of the following for the periods indicated:

 

 

Revenue decreased 4.2% in the year ended December 31, 2009 compared to the year ended December 31, 2008. This decrease in revenue was driven primarily by a decline in membership revenue and ancillary club revenue. For the year ended December 31, 2009, revenues increased $19.6 million as compared to the year ended December 31, 2008 at the 13 clubs opened or acquired subsequent to December 31, 2007. For the year ended December 31, 2009, revenue decreased 6.8% or $32.7 million at our clubs opened or acquired prior to December 31, 2007 and $8.2 million at the 13 clubs that were closed subsequent to December 31, 2007.

Comparable club revenue decreased 5.6% for the year ended December 31, 2009 compared to the year ended December 31, 2008. Of this 5.6% decrease, 2.5% was due to a decrease in membership, 1.2% was due to a decrease in price and 1.9% was due to a decrease in ancillary club revenue and fees and other revenue.

 

Our one-time member initiation fees and a portion of related direct expenses, up to the amount of those initiation fees, are deferred and recognized on a straight-line basis in operations over the estimated membership life. See Note 3 — Summary of Significant Accounting Policies to the consolidated financial statements in this Annual Report. Effective April 1, 2009, we changed the estimated life of our memberships from 30 months to 28 months. The change in estimated membership life is principally due to an unfavorable trend in membership retention rates, and it has the effect of increasing initiation fees revenue recognized in the current period because a shorter amortization period is being applied resulting in an $800,000 increase in initiation fee revenue recognized in the year ended December 31, 2009 when compared to the prior year.

 

Personal training revenue decreased 7.7% for the year ended December 31, 2009 compared to the prior year. We attribute this decrease primarily to reduced consumer spending.

 

Fees and other revenue decreased 22.7% in the year ended December 31, 2009 compared to the prior year primarily due to a decrease in marketing revenue generated by our in-club advertising programs.

 

Operating expenses (in $’000s) were comprised of the following for the periods indicated:

 

 

Operating expenses for the year ended December 31, 2009 were impacted by an 8.2% increase in total club usage year over year and a 1.8% increase in the total months of club operation from 1,935 to 1,970, the effects of which are included in the additional descriptions of changes in operating expenses below.

 

Payroll and related.  This change was primarily impacted by the following:

 

 

These increases were partially offset by a decrease in ancillary club payroll of $2.9 million directly related to the decrease in ancillary club revenue.

As a percentage of total revenue, payroll and related expenses increased to 39.9% in the year ended December 31, 2009 from 38.2% in the prior year.

 

Club operating.  This change was primarily impacted by the following:

 

 

As a percentage of total revenue, club operating expenses increased to 36.9% in the year ended December 31, 2009 from 34.0% in the prior year.

 

General and administrative.  This decrease was principally attributable to a $2.0 million decrease in general liability insurance expense. Our claims experience activity has been decreasing as a percentage of our revenue, resulting in a decreased loss trend rate, and reductions in related claims reserves requirements. In addition, we reduced our insurance reserves because we have lower claims exposure as a result of a decrease in the number of memberships. The remainder of the expense decrease was due to cost reduction efforts realized within various general and administrative expense accounts, including data and phone lines, office supplies and travel. As a percentage of total revenue, general and administrative expenses decreased slightly to 6.5% in 2009 from 6.7% in the prior year.

 

Depreciation and amortization.  The increase in depreciation and amortization expenses was principally due to the acceleration of depreciation related to clubs closed prior to their lease expiration dates in 2009 and to the 13 clubs that opened after December 31, 2007. We also began depreciating the new laundry facility and corporate office in Elmsford, NY, which opened in January 2009.

 

Impairment of fixed assets.  In the year ended December 31, 2009, we recorded fixed asset impairment charges totaling $6.7 million, which represented the write-offs of fixed assets at nine underperforming clubs. During the year ended December 31, 2008, we recorded an impairment loss of $755,000 on fixed assets of a remote club that did not benefit from being part of a regional cluster and did not sustain profitable membership levels given the competition in its market and $1.2 million related to the planned closures of two clubs prior to their lease expiration dates.

 

Impairment of internal-use software.  In the year ended December 31, 2009, we recorded impairment charges of $10.2 million related to an internal-use software project. Although the software project was not yet completed, we determined that it is not probable that we will continue in the development of this project due to pending litigation. See Note 5 — Fixed Assets and Note 14 — Contingencies to the Company’s consolidated financial statements in this Annual Report for further details.

 

Interest Expense

 

Interest expense decreased $2.9 million or 12.3%, from $23.9 million to $21.0 million for the year ended December 31, 2009 compared to the same period in the prior year. This decrease is a result of the lower variable rate of interest on our Term Loan Facility during the year ended December 31, 2009 period. For the year ended December 31, 2008, the average variable interest rate on the Term Loan Facility was approximately 4.9%, while the average variable interest rate for the year ended December 31, 2009 was approximately 2.2%.

 

Provision (Benefit) for Corporate Income Taxes

 

We recorded a benefit for corporate income taxes of $5.8 million for the year ended December 31, 2009 compared to a provision of $9.2 million for the year ended December 31, 2008, calculated using the Company’s effective tax rate. For the year ended December 31, 2009 we recognized a $637,000 charge for the undistributed

earnings of our non-U.S. subsidiaries since we may choose to reinvest those earnings in the U.S. Also in 2009, we recognized state tax benefits of $1.2 million related to self-insurance.

 

YEAR ENDED DECEMBER 31, 2008 COMPARED TO
YEAR ENDED DECEMBER 31, 2007

 

Revenue (in $’000s) was comprised of the following for the periods indicated:

 

 

Revenue increased $33.8 million, or 7.1%, to $506.7 million for the year ended December 31, 2008 from $472.9 million for the year ended December 31, 2007. This increase in revenue was driven primarily by growth in membership dues and personal training revenue. For the year ended December 31, 2008, revenues increased $3.6 million, or 0.8%, at our clubs opened or acquired prior to December 31, 2006 and increased $37.1 million at the 24 clubs opened or acquired subsequent to December 31, 2006. These increases in revenue were offset by a $6.1 million revenue decrease related to the seven clubs that were closed subsequent to December 31, 2006.

 

Comparable club revenue increased 2.2% for the year ended December 31, 2008. Of this 2.2% increase, 1.1% was due to an increase in membership, 0.6% was due to an increase in price and 0.5% was due to an increase in ancillary club revenue and fees and other revenue. However, in part as a result of the current economic and consumer environment, we experienced higher member attrition and lower average revenue per member in 2008 than in 2007. As a result, for the year ended December 31, 2008, our comparable club revenue growth was 2.2%, a decrease compared to 5.2% for the year ended December 31, 2007. We experienced a comparable club revenue decrease of 1.4% in the fourth quarter of 2008, and we expect comparable club revenue to continue to decrease throughout 2009.

 

Operating expenses (in $’000s) were comprised of the following for the periods indicated:

 

Operating expenses increased in 2008 due to the following factors:

 

Payroll and related.  The increase in 2008 was attributable to a 7.6% increase in the total months of club operation from 1,799 to 1,935 and discounting of our member initiation fees. We discounted our new member initiation fees in 2008 in an effort to drive membership sales. Our deferred payroll costs related to new membership contracts are limited to the amount of these initiation fees, thus causing an increase in current payroll expense of approximately $6.0 million when compared to the prior year. In addition, payroll costs directly related to our personal training, group fitness training and programming for children increased $5.1 million, or 14.1%, principally due to the increase in revenue related to these programs. As a percentage of total revenue, payroll and related expenses increased to 38.2% in the year ended December 31, 2008 from 37.5% in the prior year.

 

Club operating.  The increase in 2008 was primarily due to the following:

 

 

As a percentage of total revenue, club operating expenses increased to 34.0% in the year ended December 31, 2008 from 33.1% in the prior year.

 

Depreciation and amortization.  The increase in 2008 was principally due to costs related to expanded clubs and nine new clubs opened in the year ended December 31, 2008. Offsetting these increases are insurance proceeds of approximately $600,000 received for fixed asset damages at two of our clubs.

 

Impairment of fixed assets:  During the year ended December 31, 2008, we recorded fixed asset impairment charges of $3.9 million. There were charges of $2.7 million on fixed assets at six of our underperforming clubs and $1.2 million related to the planned closures of two clubs prior to the lease expiration dates. There were no such charges in the year ended December 31, 2007.

 

Impairment of goodwill:  During the year ended December 31, 2008, we recorded a goodwill impairment charge of $17.6 million. The Company performed an interim impairment test as of December 31, 2008 and concluded that goodwill of $15.8 million of goodwill associated with the Boston Sports Clubs reporting unit was impaired and $1.8 million of goodwill at two of the three Outlier Clubs that did not benefit from being part of regional clusters was impaired. The Company did not have a goodwill impairment charge in the New York Sports Clubs reporting unit given the profitability of this unit.

 

Loss on Extinguishment of Debt

 

For the year ended December 31, 2007, loss on extinguishment of debt was $12.5 million. The proceeds from the 2007 Senior Credit Facility obtained on February 27, 2007 were used to repay $170.0 million, representing the remaining outstanding principal of the 2003 Senior Notes. We incurred $8.8 million of tender premium and $215,000 of call premium together with $335,000 of fees and expenses related to the tender of the 2003 Senior Notes. Net deferred financing costs related to the 2003 Senior Notes and the related facility totaling approximately $3.2 million were expensed in the first quarter of 2007. There were no such costs in the year ended December 31, 2008.

Interest Expense

 

Interest expense decreased $2.5 million, or 9.5%, for the year ended December 31, 2008 compared to the year ended December 31, 2007. This decrease is a result of the February 27, 2007 refinancing of the 2003 Senior Notes with our $185.0 million term loan facility (the “Term Loan Facility”), at a variable rate. For the year ended December, 2007, the average variable interest rate was approximately 7.7%, while the average variable interest rate for the year ended December 31, 2008 decreased to approximately 4.8%.

 

Interest Income

 

Interest income decreased $752,000, or 70.2%, for the year ended December 31, 2008 compared to the year ended December 31, 2007 due to a decrease in interest rates, as well as a decrease in the monthly average cash balance.

 

Provision for Corporate Income Taxes

 

We recorded an income tax provision of $9.2 million for the year ended December 31, 2008 compared to $8.1 million for the year ended December 31, 2007, calculated using the Company’s effective tax rate. For the year ended December 31, 2008 we recognized a $4.7 million charge for the non-deductible goodwill impairment of clubs that were acquired in stock-based transactions in our Boston Sports Clubs region. Also in 2008, we recognized state tax benefits of $1.3 million related to self-insurance. For the year ended December 31, 2007, we recognized a $251,000 tax benefit principally related to Federal employment credits and relief for federal surcharges on our communication expenses previously incurred. Also in 2007, we recognized state tax benefits of $941,000 related to self-insurance.

 

Liquidity and Capital Resources

 

Historically, we have satisfied our liquidity needs through cash generated 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 upgrade, expand and renovate existing clubs.

 

Operating Activities.  Net cash provided by operating activities for the year ended December 31, 2009 was $76.2 million compared to $95.6 million for the year ended December 31, 2008, a decrease of 20.3%. This decrease was primarily related to a decrease in overall earnings. Also contributing to the decrease were the effects of an increase in cash paid for interest and reductions in deferred revenue. Total cash paid for interest increased $3.8 million to $13.8 million. Deferred revenue decreased $8.2 million in the year ended December 31, 2009 and $4.2 million in the prior year. In 2009, we had tax refunds, net of tax payments, of $3.9 million while in 2008 we had tax payments, net of refunds, of $15.9 million for an increase in cash of $19.8 million.

 

Net cash provided by operating activities for the year ended December 31, 2008 increased 15.6% from $82.7 million for the year ended December 31, 2007. Total cash paid for interest decreased $7.1 million to $10.0 million. Cash paid for income taxes decreased $4.8 million to $15.9 million for the year ended December 31, 2008.

 

Investing Activities.  Investing activities in the year ended December 31, 2009 consisted primarily of expanding and remodeling existing clubs and the purchase of new fitness equipment. Net cash used in investing activities decreased 48.2% or $45.8 million in the year ended December 31, 2009 compared to the year ended December 31, 2008. During the year ended December 31, 2009, we spent $23.4 million to upgrade existing clubs, $16.6 million for growth capital expenditures primarily related to clubs added in 2008 and 2009, $4.6 million to enhance our management information systems and $4.7 million for the construction of corporate offices and the completion of our new regional laundry facility in our New York Sports Clubs market. These expenditures were funded by cash flow provided by operations, available cash on hand and, to the extent needed, borrowings from the Revolving Loan Facility.

 

For the year ending December 31, 2010, we currently plan to invest $34.0 million to $37.0 million in capital expenditures. We expect that this 2010 amount will include $25.0 million to continue to upgrade existing clubs and $7.0 million principally related to major renovations at clubs with recent lease renewals and upgrading our in-club entertainment system network. We expect to invest $3.0 million related to enhance our management information

systems. These expenditures will be funded by cash flow provided by operations, available cash on hand and, to the extent needed, borrowings from the $63.8 million Revolving Loan Facility.

 

Net cash used in investing activities was $95.1 million and $97.2 million for the years ended December 31, 2008 and 2007, respectively. During the year ended December 31, 2008, we spent $23.6 million on upgrading existing clubs, $9.1 million to enhance our management information systems, $5.7 million for the construction of a new regional laundry facility in our New York Sports Clubs market and the remaining $57.8 million for the building of new clubs or the expansion of existing clubs. We also received $1.1 million in insurance proceeds during the year ended December 31, 2008.

 

Financing Activities.  Net cash related to financing activities decreased $31.0 million for the year ended December 31, 2009 compared to the year ended December 31, 2008. In the year ended December 31, 2009, we repaid the outstanding borrowings under our Revolving Credit Facility of $19.0 million compared to net borrowings in the year ended December 31, 2008 of $10.0 million. In 2009 we paid $5.4 million related to repurchases of 2.1 million shares of our common stock compared to $4.6 million for the year ended December 31, 2008. Proceeds related to the exercise of stock options decreased $1.2 million in 2009 compared to 2008. In both years ended December 31, 2009 and 2008, we made $1.9 million of principal payments on our outstanding Term Loans.

 

Net cash provided by financing activities was $4.2 million for the year ended December 31, 2008 compared to $12.9 million for the year ended December 31, 2007, a decrease of $8.7 million. For the year ended December 31, 2008, we paid $4.6 million related to repurchases of 1.8 million shares of our common stock. There were no common stock repurchases in the year ended December 31, 2007. For the year ended December 31, 2008, we increased the outstanding borrowings under our Revolving Credit Facility by $10.0 million, and made $1.9 million of principal payments on our outstanding Term Loans.

 

On February 1, 2009, our Senior Discount Notes became fully accreted with an outstanding balance of $138.5 million. Semi-annual cash interest payments of $7.6 million commenced on August 1, 2009. In the year ended December 31, 2009, the August 1, 2009 interest payment of $7.6 million represented a single semi-annual payment. In the year ending December 31, 2010, there are two semi-annual payments scheduled, which will result in an increase in cash paid for interest of $7.6 million on our Senior Discount Notes.

 

We refinanced our debt on February 27, 2007. The net proceeds after issuance costs from the 2007 Senior Credit Facility of $182.4 million were used to repay the remaining principal of $170.0 million of the 2003 Senior Notes. In addition, in the year ended December 31, 2007, we paid a premium and fees in connection with the extinguishment of debt of $9.3 million. These transactions accounted for a $3.0 million increase in cash related to financing activities for the year ended December 31, 2007. There was a $0.9 million decrease in cash received upon the exercise of stock options in the year ended December 31, 2008 when compared to the year ended December 31, 2007.

 

February 4, 2004 Senior Discount Notes

 

On February 4, 2004, TSI Holdings completed an offering of the Senior Discount Notes that will mature in February 2014. These Senior Discount Notes are publicly traded. No cash interest was required to be paid prior to August 2009. The accreted value of each discount note increased from the date of issuance until February 1, 2009, at a rate of 11.0% per annum compounded semi-annually and is currently at the fully accreted principal value. Since February 1, 2009, interest on the Senior Discount Notes is being accrued and is payable semi-annually in arrears February 1 and August 1 of each year, and commenced August 1, 2009. The discount notes are structurally subordinated and effectively rank junior to all indebtedness of TSI, LLC. The debt of TSI Holdings is not guaranteed by TSI, LLC and TSI Holdings relies on the cash flows of TSI, LLC, subject to restrictions contained in the indenture governing the Senior Discount Notes, to service its debt.

 

The indenture governing our Senior Discount Notes contains, 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 governing our Senior Discount Notes restricts, among other things, our ability and the ability of our restricted subsidiaries to: incur additional indebtedness; 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 consolidation or merger or sell, transfer, lease or otherwise dispose of all or substantially all of our assets; and create liens on our assets.

 

The covenant contained in the indenture limiting the incurrence of additional indebtedness allows the Company to incur such indebtedness provided that the Company will continue to be in compliance with a “fixed charge coverage ratio” of greater than 2.00 to 1.00. The indenture does, however, allow the Company and its subsidiaries to incur certain “permitted indebtedness” without regard to the fixed charge coverage ratio. The fixed charge coverage ratio is defined as the ratio of consolidated earnings before interest, taxes, and depreciation and amortization to consolidated interest expense with certain adjustments to these items as specified in the indenture. Reference should be made to the indenture for the detailed definitions of the defined terms used for purposes of the fixed charge coverage ratio (see Exhibit 4.1 to this Report). At December 31, 2009, our fixed charge coverage ratio, as calculated for purposes of the indenture, was 3.93 to 1.00.

 

2003 Senior Credit Facility

 

On April 16, 2003, the Company successfully completed a refinancing of its debt. This refinancing included an offering of $255.0 million of the 9 5 / 8% Senior Notes (the “2003 Senior Notes”) that would have matured April 15, 2011 and the entering into of a senior secured revolving credit facility (the “2003 Senior Credit Facility”) that would have expired on April 15, 2008. Effective July 7, 2006, the 2003 Senior Credit Facility was amended to increase permitted borrowings from $50.0 million to $75.0 million.

 

On June 8, 2006, the Company paid $93.0 million to redeem $85.0 million of the outstanding principal of the 2003 Senior Notes, together with $6.8 million of early termination fees and $1.2 million of accrued interest. Deferred financing costs totaling $1.6 million were written off and fees totaling $222,000 were incurred in connection with this early extinguishment.

 

2007 Senior Credit Facility

 

On February 27, 2007, TSI, LLC entered into the $260.0 million 2007 Senior Credit Facility. The 2007 Senior Credit Facility consisted of a Term Loan Facility, the $75.0 million Revolving Loan Facility and an incremental term loan commitment facility in the maximum amount of $100.0 million, under which borrowing is subject to compliance with certain conditions precedent by TSI, LLC and agreement upon certain terms and conditions thereof between the participating lenders and TSI, LLC. The Revolving Loan Facility replaced the previously existing revolving credit facility of $75.0 million that was to mature on April 15, 2008.

 

A portion of the proceeds were used to purchase $165.5 million aggregate principal amount of the 2003 Senior Notes outstanding on February 27, 2007 and the balance of the proceeds were irrevocably deposited in an escrow account to purchase the remaining $4.5 million, together with a call premium of $200,000, on April 15, 2007, the redemption date. Accrued interest on the 2003 Senior Notes totaling $6.0 million was also paid at closing. The Company incurred $8.8 million of tender premium and approximately $300,000 fees and expenses related to the tender of the 2003 Senior Notes.

 

Deferred financing costs related to the 2003 Senior Notes totaling approximately $3.2 million were expensed in the first quarter of 2007.

 

As a result of an amendment to the 2007 Senior Credit Facility on July 15, 2009 (the “Amendment”), the total amount of borrowings under the Revolving Loan Facility was reduced by 15% from $75.0 million to $63.8 million. Additionally, the Company incurred an aggregate of approximately $615,000 in fees and expenses related to the Amendment. See Note 8 — Long-Term Debt to the Company’s consolidated financial statements in this Annual Report for further details.

 

As of December 31, 2009, TSI, LLC had $179.9 million outstanding under the Term Loan Facility. Borrowings under the Term Loan Facility, at TSI, LLC’s option, bear interest at either the administrative agent’s base rate plus 0.75% or its Eurodollar rate plus 1.75%, each as defined in the 2007 Senior Credit Facility. As of December 31, 2009, TSI, LLC had elected the Eurodollar rate option, equal to 2.1% as of December 31, 2009. Interest calculated under the base rate option would have equaled 4.0% as of December 31, 2009, if TSI, LLC had elected this option. The Term Loan Facility matures on the earlier of (a) February 27, 2014 or (b) August 1, 2013 if the Senior Discount

Notes are still outstanding. TSI, LLC is required to repay 0.25% of principal, or $462,500, per quarter. Quarterly principal payments began on June 30, 2007 and $5.1 million has been paid as of December 31, 2009.

 

The Revolving Loan Facility expires on February 27, 2012 and borrowings under the facility currently, at TSI, LLC’s option, bear interest at either the administrative agent’s base rate plus 1.25% or its Eurodollar rate plus 2.25%, each as defined in the 2007 Senior Credit Facility. TSI, LLC’s applicable base rate and Eurodollar rate margins, and commitment commission percentage, vary with our consolidated secured leverage ratio, as defined in the 2007 Senior Credit Facility. TSI, LLC is required to pay a commitment fee of 0.50% per annum on the daily unutilized amount.

 

TSI, LLC’s applicable base rate and Eurodollar rate margins and commitment commission percentage vary with the Company’s consolidated secured leverage ratio. The following table summarizes the interest rate margins and commitment commission percentages applicable at three separate secured ratio levels as follows: