NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands except share and per share data)
(Unaudited)
1. Basis of Presentation
As of
September 30, 2017
, Town Sports International Holdings, Inc. (the “Company” or “TSI Holdings”), through its wholly-owned subsidiary, Town Sports International, LLC (“TSI, LLC”), owned and operated
164
fitness clubs (“clubs”). The clubs are comprised of
118
clubs in the New York metropolitan market (
102
of which were under the “New York Sports Clubs” brand name and
16
of which were under the “Lucille Roberts” brand name),
28
clubs in the Boston metropolitan market under the “Boston Sports Clubs” brand name,
10
clubs (
one
of which is partly-owned) in the Washington, D.C. metropolitan market under the “Washington Sports Clubs” brand name,
five
clubs in the Philadelphia metropolitan market under the “Philadelphia Sports Clubs” brand name and
three
clubs in Switzerland. The Company also has
one
partly-owned club that operates under a different brand name in Washington, D.C. as of
September 30, 2017
. The Company’s operating segments are classified by geographical regions, which include the New York, Boston, Philadelphia, Washington, D.C. and Switzerland regions. These operating segments are the level at which the chief operating decision makers review discrete financial information and make decisions about segment profitability based on earnings before income tax depreciation and amortization. The Company has determined that these operating segments have similar economic characteristics and meet the criteria which permit them to be aggregated into
one
reportable segment.
The condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and should be read in conjunction with the Company’s
December 31, 2016
consolidated financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2016
. The year-end condensed consolidated balance sheet data included within this Form 10-Q was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“US GAAP”). Certain information and footnote disclosures that are normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted pursuant to SEC rules and regulations. The information reflects all normal and recurring adjustments which, in the opinion of management, are necessary for a fair statement of the financial position and results of operations for the interim periods set forth herein. The results for the
three and nine months ended
September 30, 2017
are not necessarily indicative of the results for the entire year ending
December 31, 2017
.
The Company experienced declining revenue from members in the past several years as the fitness industry was highly competitive in the geographic regions in which the Company competes. Also, the prior strategy of converting to a low-cost gym resulted in additional revenue pressure for the past few years. New members joined at lower monthly rates and cancellations of members paying higher rates negatively impacted the Company's results and liquidity. In response to this, the Company implemented cost-savings initiatives in 2015, 2016 and 2017, which mitigated in part the impact the decline in revenue had on its profitability and cash flow from operations.
The Company continues to recover from its prior strategy of converting to a low-cost gym. The Company focuses on increasing membership in existing clubs to increase revenue. The Company may consider additional actions within its control, including certain club acquisitions, the closure of unprofitable clubs upon lease expiration and the sale of certain assets. The Company may also consider additional strategic alternatives, including opportunities to reduce TSI, LLC’s existing debt and further cost-savings initiatives. The Company’s ability to continue to meet its obligations is dependent on its ability to generate positive cash flow from a combination of initiatives, including those mentioned above. Failure to successfully implement these initiatives could have a material adverse effect on the Company’s liquidity and its operations, and the Company would need to implement alternative plans that could include additional asset sales, additional reductions in operating costs, additional reductions in working capital, debt restructurings and the deferral of capital expenditures. There can be no assurance that such alternatives would be available to the Company or that the Company would be successful in their implementation.
Change in Estimated Average Membership Life
The average membership life was
26 months
for the
nine months ended September 30, 2017
and
25 months
for the full year of 2016. The Company monitors factors that might affect the estimated average membership life including retention trends, attrition trends, membership sales volumes, membership composition, competition, and general economic conditions, and adjusts the estimate as necessary on an annual basis.
Joining fees, as well as related direct and incremental expenses of membership acquisition, which may include sales commissions, bonuses and related taxes and benefits, are deferred and recognized, on a straight-line basis, in operations over the estimated average membership life or
12 months
to the extent these costs are related to the first annual fee paid at the time of enrollment, or within the first month of membership. Annual fees are amortized over
12 months
.
2. Recent Accounting Pronouncements
In August 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The updated standard expands the range of transactions that qualify for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. It is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase the transparency as to the scope and results of hedging programs. This standard is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements.
In January 2017, the FASB issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment.” This standard eliminates the second step of the goodwill impairment test, where a determination of the fair value of individual assets and liabilities of a reporting unit was needed to measure the goodwill impairment. As a result of ASU No. 2017-04, an entity should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and then recognize an impairment charge, as necessary, for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to that reporting unit. This standard is effective prospectively for annual and interim periods beginning on or after December 15, 2019, and early adoption is permitted on testing dates after January 1, 2017. The Company early adopted the updated guidance for the fiscal year beginning January 1, 2017 with no impact on the Company’s financial statements.
In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.” This ASU clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. The Company early adopted the updated guidance for the fiscal year beginning September 1, 2017 with no impact on the Company’s financial statements.
In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (A Consensus of the FASB Emerging Issues Task Force).” This ASU provides specific guidance over eight identified cash flow issues. This standard is effective for interim and annual periods beginning after December 15, 2017, and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements.
In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting.” Under this standard, all excess tax benefits and tax deficiencies will be recorded as an income tax expense or benefit in the income statement in the period in which the awards vest or are exercised. Excess tax benefits will be classified as an operating activity in the statement of cash flows. The standard also allows an entity to elect an accounting policy to either estimate the number of forfeitures or account for forfeitures when they occur. In addition, entities can withhold up to the maximum individual statutory tax rate without classifying the awards as a liability. This standard was effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company adopted the updated guidance for the fiscal year beginning January 1, 2017 with no material impact on the Company’s financial statements. The Company elected to account for forfeitures of share-based payments by recognizing forfeitures of awards as they occur. Refer to Note
8
- Stock-Based Compensation for further detail.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (topic 842),” to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This standard is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of this standard is permitted. The Company is evaluating the impact of this standard on its financial statements.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (Topic 606). The standard provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes current revenue recognition guidance. The revenue standard contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The new standard also includes enhanced disclosures which are significantly more comprehensive than those in existing revenue standards. In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of ASU No. 2014-09 for all entities by one year, to annual reporting periods beginning after December 15, 2017. Early adoption is permitted for annual reporting periods beginning after December 15, 2016. The standard allows for either “full retrospective” adoption, meaning the standard is applied to all of the periods presented, or “modified retrospective” adoption, meaning the standard is applied only to the most current period presented in the financial statements. In addition, the FASB issued ASU No. 2016-08, ASU No. 2016-10, and ASU No. 2016-12 in March 2016, April 2016, and May 2016, respectively, to help provide interpretive clarifications on the new guidance in FASB Accounting Standards Codification (“ASC”) Topic 606. To date, the Company has formed a committee to evaluate the impact of ASC Topic 606 on its financial statements and is currently in the process of finalizing this impact, including how costs associated with contracts for customers are deferred and recognized. At this time, the Company will adopt this guidance beginning on January 1, 2018 using the modified retrospective method.
3
. Long-Term Debt
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
2013 Term Loan Facility outstanding principal balance
|
$
|
200,439
|
|
|
$
|
202,000
|
|
Less: Unamortized discount
|
(3,150
|
)
|
|
(3,851
|
)
|
Less: Deferred financing costs
|
(1,064
|
)
|
|
(1,324
|
)
|
Less: Current portion due within one year
|
(2,082
|
)
|
|
(2,082
|
)
|
Long-term portion
|
$
|
194,143
|
|
|
$
|
194,743
|
|
2013 Senior Credit Facility
On November 15, 2013, TSI, LLC, an indirect, wholly-owned subsidiary, entered into a
$370,000
senior secured credit facility (“2013 Senior Credit Facility”), among TSI, LLC, TSI Holdings II, LLC, a newly-formed, wholly-owned subsidiary of the Company (“Holdings II”), as a Guarantor, the lenders party thereto, Deutsche Bank AG, as administrative agent, and Keybank National Association, as syndication agent. The 2013 Senior Credit Facility consists of a
$325,000
term loan facility maturing on November 15, 2020 (“2013 Term Loan Facility”) and a
$45,000
revolving loan facility maturing on November 15, 2018 (“2013 Revolving Loan Facility”). Proceeds from the 2013 Term Loan Facility of
$323,375
were issued, net of an original issue discount (“OID”) of
0.5%
, or
$1,625
. Debt issuance costs recorded in connection with the 2013 Senior Credit Facility were
$5,119
and are being amortized as interest expense and are recorded as a contra-liability to long-term debt on the accompanying condensed consolidated balance sheets. The Company also recorded additional debt discount of
$4,356
related to creditor fees. The proceeds from the 2013 Term Loan Facility were used to pay off amounts outstanding under the Company’s previously outstanding long-term debt facility, and to pay related fees and expenses. None of the revolving loan facility was drawn upon as of the closing date on November 15, 2013 but loans under the 2013 Revolving Loan Facility may be drawn from time to time pursuant to the terms of the 2013 Senior Credit Facility. The borrowings under the 2013 Senior Credit Facility are guaranteed and secured by assets and pledges of capital stock by Holdings II, TSI, LLC, and, subject to certain customary exceptions, the wholly-owned domestic subsidiaries of TSI, LLC.
Borrowings under the 2013 Term Loan Facility and the 2013 Revolving Loan Facility, at TSI, LLC’s option, bear interest at either the administrative agent’s base rate plus
2.5%
or a LIBOR rate adjusted for certain additional costs (the “Eurodollar Rate”) plus
3.5%
, each as defined in the 2013 Senior Credit Facility. With respect to the outstanding term loans, the Eurodollar Rate has a floor of
1.00%
and the base rate has a floor of
2.00%
. Commencing with the last business day of the quarter ended March 31, 2014, TSI, LLC is required to pay
0.25%
of the principal amount of the term loans each quarter, which may be reduced by voluntary prepayments. As of
September 30, 2017
, TSI, LLC has made a total of
$23,580
in principal payments on the 2013 Term Loan Facility.
On January 30, 2015, the 2013 Senior Credit Facility was amended (the “Amendment”) to permit TSI Holdings to purchase term loans under the credit agreement. Any term loans purchased by TSI Holdings will be canceled in accordance with the terms of the credit agreement, as amended by the Amendment. The Company may from time to time purchase term loans in market transactions, privately negotiated transactions or otherwise; however the Company is under no obligation to make any
such purchases. Any such transactions, and the amounts involved, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. As of
September 30, 2017
, TSI Holdings had a cash balance of approximately
$1,725
.
In December 2015, TSI Holdings purchased
$29,829
principal amount of debt outstanding under the 2013 Senior Credit Facility in the open market for
$10,947
, or
36.7%
of face value. On April 21, 2016, TSI Holdings settled a transaction to purchase
$8,705
principal amount of debt outstanding under the 2013 Senior Credit Facility for
$3,787
, or
43.5%
of face value. On May 6, 2016, TSI Holdings settled another transaction to purchase
$62,447
principal amount of debt outstanding under the 2013 Senior Credit Facility for
$25,978
, or
41.6%
of face value. The April and May transactions created total net gains on extinguishment of debt in the
nine months ended September 30, 2016
of
$37,893
with a tax effect of
$13,451
. The gain on extinguishment of debt was net of the write-off of deferred financing costs and debt discount of
$545
and
$1,561
, respectively, and other costs related to the transaction. All of the above purchased debt was transferred to TSI, LLC and canceled.
In May 2017, TSI, LLC loaned
$5,000
to Town Sports Group, LLC (“TSI Group”), a newly-formed wholly-owned subsidiary of TSI Holdings, at a rate of LIBOR plus
9.55%
per annum. In addition to the interest payments, TSI Group is required to repay
1.0%
of the principal amount of the loan,
$50
per annum, on a quarterly basis commencing September 30, 2017. The loan is secured by certain collateral. This transaction has no impact on the Company's consolidated financial statements as it is eliminated in consolidation.
The terms of the 2013 Senior Credit Facility provide for a financial covenant in the situation where the total utilization of the revolving loan commitments (other than letters of credit up to
$5,500
at any time outstanding) exceeds
25%
of the aggregate amount of those commitments. In such event, TSI, LLC is required to maintain a total leverage ratio, as defined in the 2013 Senior Credit Facility, of no greater than
4.50
:1.00. As of
September 30, 2017
, TSI, LLC had outstanding letters of credit of
$7,207
and a total leverage ratio that was below
4.50
:1.00. Other than these outstanding letters of credit, TSI, LLC did not have any amounts utilized on the 2013 Revolving Loan Facility. The terms of the 2013 Senior Credit Facility include a financial covenant under which the Company is not able to utilize more than
25%
or
$11,250
in accordance with terms of the 2013 Revolving Loan Facility if the total leverage ratio exceeds 4:50:1:00 (calculated on a proforma basis to give effect to any borrowing). The 2013 Senior Credit Facility also contains certain affirmative and negative covenants, including covenants that may limit or restrict TSI, LLC and Holdings II’s ability to, among other things, incur indebtedness and other liabilities; create liens; merge or consolidate; dispose of assets; make investments; pay dividends and make payments to shareholders; make payments on certain indebtedness; and enter into sale leaseback transactions, in each case, subject to certain qualifications and exceptions. In addition, at any time when the total leverage ratio is greater than
4.50
:1.00, there are additional limitations on the ability of TSI, LLC and Holdings II to, among other things, make certain distributions of cash to TSI Holdings. The 2013 Senior Credit Facility also includes customary events of default (including non-compliance with the covenants or other terms of the 2013 Senior Credit Facility) which may allow the lenders to terminate the commitments under the 2013 Revolving Loan Facility and declare all outstanding term loans and revolving loans immediately due and payable and enforce its rights as a secured creditor.
TSI, LLC may prepay the 2013 Term Loan Facility and 2013 Revolving Loan Facility without premium or penalty in accordance with the 2013 Senior Credit Facility. Mandatory prepayments are required relating to certain asset sales, insurance recovery and incurrence of certain other debt and commencing in 2015 in certain circumstances relating to excess cash flow (as defined) for the prior fiscal year, as described below, in excess of certain expenditures. Pursuant to the terms of the 2013 Senior Credit Facility, the Company is required to apply net proceeds in excess of
$30,000
from sales of assets in any fiscal year towards mandatory prepayments of outstanding borrowings.
In addition, the 2013 Senior Credit Facility contains provisions that require excess cash flow payments, as defined therein, to be applied against outstanding 2013 Term Loan Facility balances. The excess cash flow is calculated annually for each fiscal year ending December 31 and paid
95
days after the fiscal year end. The applicable excess cash flow repayment percentage is applied to the excess cash flow when determining the excess cash flow payment. Earnings, changes in working capital and capital expenditure levels all impact the determination of any excess cash flow. The applicable excess cash flow repayment percentage is
50%
when the total leverage ratio, as defined in the 2013 Senior Credit Facility, exceeds or is equal to
2.50
:1.00;
25%
when the total leverage ratio is greater than or equal to
2.00
:1.00 but less than
2.50
:1.00 and
0%
when the total leverage ratio is less than
2.00
:1.00. The excess cash flow calculation performed as of
December 31, 2016
did not result in any required payments in April 2017. The next excess cash flow payment is due in April 2018, if applicable.
As of
September 30, 2017
, the 2013 Term Loan Facility has a gross principal balance of
$200,439
and a balance of
$196,225
net of unamortized debt discount of
$3,150
and unamortized debt issuance costs of
$1,064
. As of
September 30, 2017
, both the unamortized balance of debt issuance costs and unamortized debt discount are recorded as a contra-liability to long-term debt on the accompanying condensed consolidated balance sheet and are being amortized as interest expense using the effective interest method.
As of
September 30, 2017
, there were
no
outstanding 2013 Revolving Loan Facility borrowings and outstanding letters of credit issued totaled
$7,207
. The unutilized portion of the 2013 Revolving Loan Facility as of
September 30, 2017
was
$37,793
, with borrowings under such facility subject to the conditions applicable to borrowings under the Company’s 2013 Senior Credit Facility, which conditions the Company may or may not be able to satisfy at the time of borrowing.
Fair Market Value
Based on quoted market prices, the 2013 Term Loan Facility had a fair value of approximately
$189,164
and
$163,115
at
September 30, 2017
and
December 31, 2016
, respectively, and is classified within level 2 of the fair value hierarchy. Level 2 is based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. The fair value for the Company’s 2013 Term Loan Facility is determined using observable current market information such as the prevailing Eurodollar interest rate and Eurodollar yield curve rates and includes consideration of counterparty credit risk.
For the fair market value of the Company’s interest rate swap instrument refer to Note
4
- Derivative Financial Instruments.
4
. Derivative Financial Instruments
In its normal operations, the Company is exposed to market risks relating to fluctuations in interest rates. In order to minimize the possible negative impact of such fluctuations on the Company’s cash flows the Company may enter into derivative financial instruments (“derivatives”), such as interest-rate swaps. Derivatives are not entered into for trading purposes and the Company only uses commonly traded instruments. Currently, the Company has used derivatives solely relating to the variability of cash flows from interest rate fluctuations.
The Company originally entered into an interest rate swap arrangement on July 13, 2011 in connection with the Company’s previous credit facility. In connection with entering into the 2013 Senior Credit Facility, the Company amended and restated the interest rate swap agreement initially entered into (and amended in August 2012 and November 2012). Effective as of November 15, 2013, the closing date of the 2013 Senior Credit Facility, the interest rate swap arrangement had a notional amount of
$160,000
and will mature on May 15, 2018. The swap effectively converts
$160,000
of the current outstanding principal of the total variable-rate debt under the 2013 Senior Credit Facility to a fixed rate of
0.884%
plus the
3.5%
applicable margin and the Eurodollar rate, which has a floor of
1%
. As permitted by ASC 815, Derivatives and Hedging, the Company has designated this swap as a cash flow hedge, the effects of which have been reflected in the Company’s condensed consolidated financial statements for the
three and nine months ended
September 30, 2017
and
2016
. The objective of this hedge is to manage the variability of cash flows in the interest payments related to the portion of the variable-rate debt designated as being hedged.
When the Company’s derivative instrument was executed, hedge accounting was deemed appropriate and it was designated as a cash flow hedge at inception with re-designation being permitted under ASC 815, Derivatives and Hedging. Interest rate swaps are designated as cash flow hedges for accounting purposes since they are being used to transform variable interest rate exposure to fixed interest rate exposure on a recognized liability (debt). On an ongoing basis, the Company performs a quarterly assessment of the hedge effectiveness of the hedge relationship and measures and recognizes any hedge ineffectiveness in the condensed consolidated statements of operations. For the
three and nine months ended
September 30, 2017
and
2016
, hedge ineffectiveness was evaluated using the hypothetical derivative method. There was no hedge ineffectiveness for the
three and nine months ended
September 30, 2017
and
2016
.
Accounting guidance on fair value measurements specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs create the following fair value hierarchy:
|
|
•
|
Level 1—Quoted prices for
identical
instruments in active markets.
|
|
|
•
|
Level 2—Quoted prices for
similar
instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
|
|
|
•
|
Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable
.
|
This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.
The fair value for the Company’s interest rate swap is determined using observable current market information such as the prevailing Eurodollar interest rate and Eurodollar yield curve rates and include consideration of counterparty credit risk. The following table presents the aggregate fair value of the Company’s derivative financial instrument:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using:
|
|
Total
Fair Value
|
|
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
|
|
Significant Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Interest rate swap liability as of September 30, 2017
|
$
|
512
|
|
|
$
|
—
|
|
|
$
|
512
|
|
|
$
|
—
|
|
Interest rate swap liability as of December 31, 2016
|
$
|
1,511
|
|
|
$
|
—
|
|
|
$
|
1,511
|
|
|
$
|
—
|
|
The swap contract liability of
$512
and
$1,511
is recorded as a component of accrued expenses as of
September 30, 2017
and
December 31, 2016
, respectively, with the offset to accumulated other comprehensive income (
$290
and
$854
, net of taxes, as of
September 30, 2017
and
December 31, 2016
, respectively) on the accompanying condensed consolidated balance sheet.
There were no significant reclassifications out of accumulated other comprehensive income during the
three and nine months ended
September 30, 2017
and
2016
and the Company does not expect that significant derivative losses included in accumulated other comprehensive income at
September 30, 2017
will be reclassified into earnings within the next
12 months
.
5. Related Party
On April 25, 2017, the Company approved the appointment of Stuart M. Steinberg as General Counsel of the Company, effective as of May 1, 2017. Furthermore, the Company and Mr. Steinberg's law firm (the “Firm”) previously entered into an engagement letter agreement (the “Agreement”) dated as of February 4, 2016, and as amended and restated effective as of May 1, 2017, pursuant to which the Company engaged the Firm to provide general legal services requested by the Company. Mr. Steinberg continues to provide services for the Firm while employed by the Company. The Agreement provides for a monthly retainer fee payable to the Firm in the amount of
$21
, excluding litigation services. The Company will also reimburse the Firm for any expenses incurred in connection with the Firm’s services to the Company. In connection with this arrangement, the Company incurred legal expenses payable to the Firm in the amount of
$67
and
$119
for the
three and nine months ended
September 30, 2017
, respectively. These amounts were classified within general and administrative expenses on the condensed consolidated statements of operations for each of the
three and nine months ended
September 30, 2017
.
6
. Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and the interest rate swap. Although the Company deposits its cash with more than
one
financial institution, as of
September 30, 2017
,
$33,266
of the cash balance of
$59,294
was held at
one
financial institution. The Company has not experienced any losses on cash and cash equivalent accounts to date, and the Company believes that, based on the credit ratings of these financial institutions, it is not exposed to any significant credit risk related to cash at this time.
The counterparty to the Company’s interest rate swap is a major banking institution with a credit rating of investment grade or better and no collateral is required, and there are no significant risk concentrations. The Company believes the risk of incurring losses on derivative contracts related to credit risk is unlikely.
7. (Loss) Earnings Per Share
Basic (loss) earnings per share (“EPS”) is computed by dividing net (loss) earnings applicable to common stockholders by the weighted average numbers of shares of common stock outstanding during the period. Diluted EPS is computed similarly to basic EPS, except that the denominator is increased for the assumed exercise of dilutive stock options and unvested restricted stock calculated using the treasury stock method.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Weighted average number of common shares outstanding — basic
|
26,683,425
|
|
|
25,748,400
|
|
|
26,662,455
|
|
|
25,487,352
|
|
Effect of dilutive share based awards
|
—
|
|
|
—
|
|
|
—
|
|
|
660,377
|
|
Weighted average number of common shares outstanding — diluted
|
26,683,425
|
|
|
25,748,400
|
|
|
26,662,455
|
|
|
26,147,729
|
|
|
|
|
|
|
|
|
|
(Loss) earnings per share:
|
|
|
|
|
|
|
|
Basic
|
$
|
(0.50
|
)
|
|
$
|
(0.21
|
)
|
|
$
|
(0.62
|
)
|
|
$
|
0.33
|
|
Diluted
|
$
|
(0.50
|
)
|
|
$
|
(0.21
|
)
|
|
$
|
(0.62
|
)
|
|
$
|
0.32
|
|
For the
three and nine months ended
September 30, 2017
, there was no effect of dilutive stock options and unvested restricted common stock on the calculation of diluted EPS as the Company had a net loss for these periods. There would have been
19,022
and
37,811
anti-dilutive shares had the Company not been in a net loss position for the
three and nine months ended
September 30, 2017
, respectively.
For the
three months ended September 30, 2016
, there was no effect of dilutive stock options and unvested restricted common stock on the calculation of diluted EPS as the Company had a net loss for this period. There would have been
149,060
anti-dilutive shares had the Company not been in a net loss position for this period. For the
nine months ended September 30, 2016
, the Company did not include stock options to purchase
1,003,077
shares of the Company's common stock in the calculations of diluted EPS because the exercise prices of those options were greater than the average market price and such inclusion would be anti-dilutive.
8
. Stock-Based Compensation
The Company’s 2006 Stock Incentive Plan, as amended and restated in April 2015 (the “2006 Plan”), authorizes the Company to issue up to
3,500,000
shares of common stock to employees, non-employee directors and consultants pursuant to awards of stock options, stock appreciation rights, restricted stock, in payment of performance shares or other stock-based awards. The Company amended the 2006 Plan to increase the aggregate number of shares of common stock issuable under the 2006 Plan by
1,000,000
shares to a total of
4,500,000
in May 2016, and by
2,000,000
shares to a total of
6,500,000
in May 2017.
Under the 2006 Plan, stock options must be granted at a price not less than the fair market value of the stock on the date the option is granted, generally are not subject to re-pricing, and will not be exercisable more than
ten
years after the date of grant. Options granted under the 2006 Plan generally qualify as “non-qualified stock options” under the U.S. Internal Revenue Code. As of
September 30, 2017
, there were
2,494,017
shares available to be issued under the 2006 Plan. At
September 30, 2017
, the Company had
102,758
stock options outstanding and
1,366,331
shares of restricted stock outstanding under the 2006 Plan.
In September 2016, the Chief Operating Officer’s employment with the Company was terminated. As a result of the termination, the Company partially accelerated certain share awards previously granted to the Chief Operating Officer. The Company incurred non-cash severance expense of
$250
related to this acceleration.
Stock Option Awards
The Company did not grant any stock options during the
three and nine months ended
September 30, 2017
.
Total compensation expense, classified within Payroll and related on the condensed consolidated statements of operations, related to stock options outstanding was
$5
and
$15
for the
three and nine months ended
September 30, 2017
, respectively, compared to
$15
and
$151
for the
three and nine months ended
September 30, 2016
, respectively. As of
September 30, 2017
, a total of
$42
in unrecognized compensation expense related to stock options is expected to be recognized over a weighted-average period of
2.0 years
.
Restricted Stock Awards
On
March 8, 2017
, the Company issued
26,000
shares of restricted stock under the 2006 Plan. The fair value per share for such restricted stock awards was
$4.00
, representing the closing stock price on the date of grant. These shares will vest in three equal installments on each of the first
three
anniversaries dates of the grant.
Beginning January 1, 2017, the Company adopted ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting.” As a result of this updated guidance, the Company elected to account for forfeitures of share-based payments by recognizing forfeitures of awards as they occur. The total compensation expense, classified within Payroll and related on the condensed consolidated statements of operations, related to restricted stock was
$379
and
$1,083
for the
three and nine months ended
September 30, 2017
, respectively, compared to
$151
and
$884
for the comparable prior-year periods. In the
three and nine months ended
September 30, 2017
, the Company adjusted the forfeiture estimates to reflect actual forfeitures. The forfeiture adjustment reduced stock-based compensation expense by
$21
and
$164
for the
three and nine months ended
September 30, 2017
, respectively.
As of
September 30, 2017
, a total of
$2,846
in unrecognized compensation expense related to restricted stock awards is expected to be recognized over a weighted-average period of
2.0 years
.
Stock Grants
The Company issued
56,940
and
52,000
shares of common stock to members of the Company’s Board of Directors in respect of their annual retainer on February 1, 2017 and March 8, 2017, respectively. The fair value of the shares issued on February 1, 2017 and March 8, 2017 was
$2.81
and
$4.00
per share, respectively, and was expensed upon the date of grant. The total compensation expense, classified within general and administrative expenses, related to Board of Directors common stock grants was
$368
and
$246
for the
nine months ended September 30, 2017
and
2016
, respectively. There was
no
compensation expense related to Board of Director common stock grants for the
three months ended September 30, 2017
and
2016
.
9
. Fixed Asset Impairment
Fixed assets are evaluated for impairment periodically whenever events or changes in circumstances indicate that related carrying amounts may not be recoverable from undiscounted cash flows in accordance with the FASB guidance. The Company’s long-lived assets and liabilities are grouped at the individual club level, which is the lowest level for which there are identifiable cash flows. To the extent that estimated future undiscounted net cash flows attributable to the assets are less than the carrying amount, an impairment charge equal to the difference between the carrying value of such asset and their fair values is recognized.
In both the
three and nine months ended
September 30, 2017
, the Company tested underperforming clubs and recorded an impairment charge of
$6,497
and on leasehold improvements and furniture and fixtures at clubs that experienced decreased profitability and sales levels below expectations during these periods. In both the three and nine months ended September 30, 2016, the Company recorded impairment charges of
$742
related to underperforming clubs. The fixed asset impairment charges are included as a component of operating expenses in a separate line on the accompanying condensed consolidated statements of operations.
In periods tested, the recoverability of fixed assets, Level 3 inputs were used in determining undiscounted cash flows, which are based on internal budgets and forecasts through the end of the life of the primary asset in the asset group which is normally the life of leasehold improvements. The most significant assumptions in those budgets and forecasts relate to estimated membership and ancillary revenue, attrition rates, discount rates, income tax rates, estimated results related to new program launches and maintenance capital expenditures, which were generally estimated at approximately
1%
of total revenues depending upon the conditions and needs of a given club. The fair value of fixed assets evaluated for impairment was determined considering a combination of a market approach and a cost approach.
10. Goodwill and Other Intangibles
Goodwill was allocated to reporting units that closely reflect the regions served by the Company: New York, Boston, Washington, D.C., Philadelphia and Switzerland, with certain more remote clubs that do not benefit from a regional cluster being considered single reporting units (“Outlier Clubs”). During the third quarter of 2017, the Company acquired the Lucille Roberts Health Club business (“Lucille Roberts”). In connection with this acquisition,
$5,708
of goodwill was added to the Company’s goodwill balance in the New York region. For more information on the Lucille Roberts acquisition, refer to Note
11
- Acquisitions. As of
September 30, 2017
, only the New York and Switzerland regions have remaining goodwill balance.
The Company’s annual goodwill impairment test is performed on the last day of February, or more frequently, should circumstances change which would indicate the fair value of goodwill is below its carrying amount.
Beginning January 1, 2017, the Company early adopted ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment.” This standard eliminated the second step of the goodwill impairment test, where a determination of the fair value of individual assets and liabilities of a reporting unit was needed to measure the goodwill impairment. As a result of this updated guidance, the Company’s annual goodwill impairment test as of
February 28, 2017
was performed by comparing the fair value of the Company’s reporting unit with its carrying amount and then recognizing an impairment charge, as necessary, for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to that reporting unit. The
February 28, 2017
annual impairment test supported the goodwill balance and as such,
no
impairment of goodwill was required.
For the
February 28, 2017
impairment test, fair value was determined by using an income approach, as this was deemed to be the most indicative of the Company’s fair value. Under this income approach, the Company determined fair value based on estimated future cash flows of the Company's
three
clubs located in Switzerland being considered as a single reporting unit (“SSC”), discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit and the rate of return an outside investor would expect to earn, which are unobservable Level 3 inputs. The discounted estimates of future cash flows include significant management assumptions such as revenue growth rates, operating margins, weighted average cost of capital, and future economic and market conditions. The estimated weighted-average cost of capital of SSC was
11.2%
as of
February 28, 2017
. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, discount rates and future market conditions, among others. These assumptions were determined separately for each reporting unit. The Company believes its assumptions are reasonable, however, there can be no assurance that the Company’s estimates and assumptions made for purposes of the Company’s goodwill impairment testing as of
February 28, 2017
will prove to be accurate predictions of the future. If the Company’s assumptions regarding forecasted revenue or margin growth rates of certain reporting units are not achieved, the Company may be required to record goodwill impairment charges in future periods, whether in connection with the Company’s next annual impairment testing or prior to that, if any such change constitutes a triggering event outside the quarter when the annual goodwill impairment test is performed. It is not possible at this time to determine if any such future impairment charge would result.
Solely for purposes of establishing inputs for the fair value calculation described above related to goodwill impairment testing, the Company made the following assumptions. The Company developed long-range financial forecasts (
three
years) for all reporting units and assumed known changes in the existing club base. Terminal growth rates were calculated for years beyond the three year forecast. As of
February 28, 2017
, the Company used a terminal growth rate of
2%
.
The Company's next annual impairment test will be performed as of February 28, 2018 o
r earlier, should circumstances change which would indicate the fair value of goodwill is below its carrying amount.
The changes in the carrying amount of goodwill from
December 31, 2016
through
September 30, 2017
are detailed in the charts below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New York
|
|
Boston
|
|
Switzerland
|
|
Outlier
Clubs
|
|
Total
|
Goodwill
|
$
|
31,549
|
|
|
$
|
15,775
|
|
|
$
|
1,175
|
|
|
$
|
3,982
|
|
|
$
|
52,481
|
|
Changes due to foreign currency exchange rate fluctuations
|
—
|
|
|
—
|
|
|
(167
|
)
|
|
—
|
|
|
(167
|
)
|
Less: accumulated impairment of goodwill
|
(31,549
|
)
|
|
(15,775
|
)
|
|
—
|
|
|
(3,982
|
)
|
|
(51,306
|
)
|
Balance as of December 31, 2016
|
—
|
|
|
—
|
|
|
1,008
|
|
|
—
|
|
|
1,008
|
|
Acquired goodwill (Refer to Note 11 - Acquisitions)
|
5,708
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
5,708
|
|
Changes due to foreign currency exchange rate fluctuations
|
—
|
|
|
—
|
|
|
58
|
|
|
—
|
|
|
58
|
|
Balance as of September 30, 2017
|
$
|
5,708
|
|
|
$
|
—
|
|
|
$
|
1,066
|
|
|
$
|
—
|
|
|
$
|
6,774
|
|
Amortization expense was
$123
and
$135
for the
three and nine months ended
September 30, 2017
, respectively, compared to
$9
and
$27
for the comparable prior-year periods. Intangible assets were acquired in connection with the Lucille Roberts acquisition in the
nine months ended September 30, 2017
. Intangible assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2017
|
|
As of December 31, 2016
|
|
Gross Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Intangible
Assets
|
|
Gross Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Intangible
Assets
|
Membership lists
|
$
|
12,744
|
|
|
$
|
(11,344
|
)
|
|
$
|
1,400
|
|
|
$
|
11,344
|
|
|
$
|
(11,344
|
)
|
|
$
|
—
|
|
Favorable lease commitment
|
1,500
|
|
|
—
|
|
|
1,500
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Trade names
|
700
|
|
|
—
|
|
|
700
|
|
|
40
|
|
|
(9
|
)
|
|
31
|
|
Management contracts
|
—
|
|
|
—
|
|
|
—
|
|
|
250
|
|
|
(146
|
)
|
|
104
|
|
|
$
|
14,944
|
|
|
$
|
(11,344
|
)
|
|
$
|
3,600
|
|
|
$
|
11,634
|
|
|
$
|
(11,499
|
)
|
|
$
|
135
|
|
11
. Acquisitions
Acquisition of Lucille Roberts Health Club Business
On September 11, 2017, the Company acquired Lucille Roberts for a net cash purchase price of
$9,450
. The acquisition added
16
clubs to the Company's portfolio in the New York metropolitan region. These
16
clubs continue to operate under the Lucille Roberts trade name.
The acquisition was accounted for using the acquisition method of accounting in accordance with the FASB guidance. Under the acquisition method, the purchase price was allocated to the assets acquired and the liabilities assumed based on their respective estimated fair values as of the acquisition date. Any excess of the purchase price over the fair values of the assets acquired and liabilities assumed was allocated to goodwill. This acquisition was not material to the financial position, results of operations or cash flows of the Company; therefore, the respective pro forma financial information has not been presented. The results of operations of the clubs acquired have been included in the Company’s consolidated financial statements from the date of acquisition.
Acquisition costs incurred in connection with this transaction during the
nine months ended September 30, 2017
, were approximately
$201
and are included in general and administrative expenses in the accompanying condensed consolidated statements of income. The following table summarizes the allocation of the purchase price to the fair value of the assets and liabilities acquired. The purchase price allocation presented below has been prepared on a preliminary basis and changes to the preliminary purchase price allocations may occur as additional information concerning asset and liability valuations are finalized.
|
|
|
|
|
|
September 11, 2017
|
Allocation of purchase price:
|
|
Fixed assets
|
959
|
|
Goodwill
|
5,708
|
|
Definite lived intangible assets:
|
|
Membership lists
|
1,400
|
|
Trade names
|
700
|
|
Favorable lease commitment
|
1,500
|
|
Deferred revenue
|
(796
|
)
|
Other liabilities
|
(21
|
)
|
Total allocation of purchase price
|
$
|
9,450
|
|
The goodwill recognized represents the excess of the purchase price over the fair value of the assets acquired and liabilities assumed. The goodwill is partially attributable to the avoided costs of acquiring the assembled workforce and is not deductible for tax purposes. The definite lived intangible assets acquired will be amortized over their estimated useful lives with the membership lists amortized over the estimated average membership life of
26 months
, the trade name amortized over its estimated useful lives of
five
years and the favorable lease commitment amortized over the remaining life of the lease.
Other Health Club Acquisition
In September 2017, the Company entered into an agreement to acquire an existing club, and to purchase the property in which this club is located. In connection with this agreement, the Company deposited
$1,250
into an escrow account in September 2017, which was recorded in prepaid expenses and other current assets on the balance sheet. This acquisition is subject to various closing conditions and the purchase price is being finalized. The Company will assume certain existing liabilities. The Company expects the transaction to be completed in the fourth quarter of 2017 with no material impact on the Company’s financial statements.
12. Income Taxes
The Company recorded an income tax provision inclusive of valuation allowance of
$4,550
and
$11,240
for the
nine months ended
September 30, 2017
and
2016
, respectively, reflecting a negative effective income tax rate of
38%
for the
nine months ended
September 30, 2017
and
58%
for the
nine months ended
September 30, 2016
. For the
nine months ended
September 30, 2017
, the Company recorded a negative effective tax rate based on the Company’s taxable income projection for the full year 2017. For the
nine months ended
September 30, 2017
and
2016
, the Company calculated its income tax provision using the estimated annual effective tax rate methodology.
As of both
September 30, 2017
and
December 31, 2016
, the Company had a net deferred tax liability of
$61
. The Company maintained a full valuation allowance against its U.S. net deferred tax assets as of both
September 30, 2017
and
December 31, 2016
.
As of
September 30, 2017
, the Company had
$1,154
of unrecognized tax benefits and it is reasonably possible that the entire amount could be realized by the Company in the year ending
December 31, 2017
, since the income tax returns may no longer be subject to audit in 2017.
From time to time, the Company is under audit by federal, state, and local tax authorities and the Company may be liable for additional tax obligations and may incur additional costs in defending any claims that may arise. The Company is currently under audit by the Internal Revenue Service for federal income tax returns for the years ended December 31, 2014 and 2015.
The following state and local jurisdictions are currently examining our respective returns for the years indicated: New York State (2010 through 2014), and New York City (2006 through 2014). In a revised letter dated December 12, 2016, the
Company received from the State of New York a revised assessment related to tax years 2006-2009 for
$4,722
, inclusive of
$2,044
of interest. The Company disagreed with the proposed assessment and attended a conciliation conference with the New York State Department of Taxation and Finance Audit section on June 7, 2017, and no settlement was reached. The Company has provided additional documents to support its case, and another conciliation conference will be scheduled once the conciliation conferee reviews the documents. The Company has not recorded a tax reserve related to the proposed assessment. It is difficult to predict the final outcome or timing of resolution of any particular matter regarding these examinations. An estimate of the reasonably possible change to unrecognized tax benefits within the next 12 months cannot be made.
13
. Commitments and Contingencies
On February 7, 2007, in an action styled White Plains Plaza Realty, LLC v. TSI, LLC et al., the landlord of one of TSI, LLC’s former health and fitness clubs filed a lawsuit in the Appellate Division, Second Department of the Supreme Court of the State of New York against it and two of its health club subsidiaries alleging, among other things, breach of lease in connection with the decision to close the club located in a building owned by the plaintiff and leased to a subsidiary of TSI, LLC, the tenant, and take additional space in a nearby facility leased by another subsidiary of TSI, LLC. Following a determination of an initial award, which TSI, LLC and the tenant have paid in full, the landlord appealed the trial court’s award of damages, and on August 29, 2011, an additional award (amounting to approximately
$900
) (the “Additional Award”), was entered against the tenant, which has recorded a liability. Separately, TSI, LLC is party to an agreement with a third-party developer, which by its terms provides indemnification for the full amount of any liability of any nature arising out of the lease described above, including attorneys’ fees incurred to enforce the indemnity. As a result, the developer reimbursed TSI, LLC and the tenant the amount of the initial award in installments over time and also agreed to be responsible for the payment of the Additional Award, and the tenant has recorded a receivable related to the indemnification for the Additional Award. The developer and the landlord are currently litigating the payment of the Additional Award and judgment was entered against the developer on June 5, 2013, in the amount of approximately
$1,045
, plus interest, which judgment was upheld by the appellate court on April 29, 2015. TSI, LLC does not believe it is probable that TSI, LLC will be required to pay for any amount of the Additional Award.
In addition to the litigation discussed above, the Company is involved in various other lawsuits, claims and proceedings incidental to the ordinary course of business, including personal injury, construction matters, employee relations claims and landlord tenant disputes. The results of litigation are inherently unpredictable. Any claims against the Company, 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. The Company establishes accruals for loss contingencies when it has determined that a loss is probable and that the amount of loss, or range of loss, can be reasonably estimated. Any such accruals are adjusted thereafter as appropriate to reflect changes in circumstances. The Company concluded that an accrual for any such matters is not required as of
September 30, 2017
.
14. Subsequent Event
In October 2017, a dividend distribution of
$35.0 million
was made from TSI, LLC to TSI Holdings, Inc.