Summary of TOWN SPORTS INTERNATIONAL HOLDINGS INC

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation
Introduction
In this Form 10-Q, 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.
We are the second largest owner and operator of fitness clubs in the Northeast and Mid-Atlantic regions of the United States. As of September 30, 2008, we owned and operated 164 clubs that collectively served approximately 519,000 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 customer is college-educated, typically between the ages of 21 and 50 and earns an annual income of between $50,000 and $150,000. We believe that the upper value segment that we serve 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 September 30, 2008, approximately 38% of our members participated in our passport membership plan that allows unlimited access to all of our clubs in our clusters for a higher monthly membership fee. The remaining 62% of our members participate in a gold membership plan that allows unlimited access to a designated club and access to all other clubs in the chain 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 40 locations (more than twice as many as our nearest competitor) and operated a total of 112 clubs under the "New York Sports Clubs" brand name within a 120-mile radius of New York City as of September 30, 2008. We operated 23 clubs in the Boston region under our "Boston Sports Clubs" brand name, 19 clubs (two of which are partly-owned) in the Washington, D.C. region under our "Washington Sports Clubs" brand name and seven clubs in the Philadelphia region under our "Philadelphia Sports Clubs" brand name as of September 30, 2008. In addition, we operated three clubs in Switzerland as of September 30, 2008. 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 consider that we have two principal sources of revenue:
• Membership revenue: Our largest sources of revenue are dues and initiation fees paid by our members. These comprised 81.3% of our total revenue for the nine months ended September 30, 2008. We recognize revenue from membership dues in the month when the services are rendered. Approximately 95% of our members pay their monthly dues by Electronic Funds Transfer, or EFT, while the balance is paid annually in advance. We recognize revenue from initiation fees over the expected average life of the membership.

• Ancillary club revenue: For the nine months ended September 30, 2008, we generated 12.4% of our revenue from personal training and 5.1% of our revenue from other ancillary programs and services consisting of programming for children, group fitness training and other member activities, as well as sales of miscellaneous sports products.

In addition, we receive revenue (approximately 1.2% of our revenue for the nine months ended September 30, 2008) from the rental of space in our facilities to operators who offer wellness-related offerings, such as physical therapy. 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 as Fees and Other revenue.

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Our revenues, operating income and net income for the three months ended September 30, 2008 were $128.1 million, $11.6 million and $3.8 million, respectively. Our revenues, operating income and net income for the nine months ended September 30, 2008 were $383.8 million, $42.1 million and $15.5 million, respectively.
Our operating and selling expenses are comprised of both fixed and variable costs. Fixed costs include club and supervisory salary and related expenses, occupancy costs, including certain elements of rent, housekeeping 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 systems, purchasing and member relations, legal and consulting fees and real estate development 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.
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 labor, materials and 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 budget approximately 4.0% 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 connection, facility remodeling is also considered where appropriate.
The valuation of intangible assets requires assumptions and estimates of many critical factors, including revenue and market growth, operating cash flows and discount rates. The Company has experienced declines in both its consolidated operating results and its stock price during the three months ended September 30, 2008 as compared to the prior quarter. The Company believes that this decline is reflective of the current macro-economic state of the US economy, the significant increase in trade float resulting from the distribution of the Common Stock by Bruckmann, Rosser, Sherrill and Co., L.P. on September 16, 2008, as described in the Company's Current Report on Form 8-K, filed with the SEC on September 18, 2008, and a decrease in the market's expectations of the Company's future earnings. Stock prices have been at these historic lows for a very short period of time. Adverse changes in expected operating results and/or unfavorable changes in other economic factors used to estimate fair values could result in a material non-cash impairment charge in the future. Management believes that these declines are temporary. The determination as to whether a triggering event exists that would warrant an interim review of goodwill and whether a write-down of goodwill is necessary involves significant judgment based on short-term and long-term projections of the Company. Management will continue to monitor factors affecting the valuation of intangible assets and determine if any further interim review of goodwill is needed.
Historical Club Growth
The following table sets forth our club growth during each of the quarters in 2007 and the first three quarters of 2008.

                                                2007                                                2008
                       Q1           Q2           Q3           Q4          Total         Q1           Q2           Q3
Wholly owned
clubs operated
at beginning of
period                 147          150          150          152          147          159          160          161
New clubs opened         3            1            2            8           14            2            3            1
Clubs acquired           -            -            -            1            1            -            -            -
Clubs closed,
relocated or
merged                   -           (1 )          -           (2 )         (3 )         (1 )         (2 )          -

Wholly owned
clubs at end of
period                 150          150          152          159          159          160          161          162

Total clubs
operated at end
of period (1)          152          152          154          161          161          162          163          164

(1) Includes wholly owned and partly owned clubs. In addition to the above, as of September 30, 2008 and December 31, 2007, we managed four and five university fitness clubs, respectively, in which we did not have an equity interest.

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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 growth as revenue
for the 13th month and thereafter as applicable as compared to the same period
at the prior year. Comparable club revenue growth was 2.2% and 3.3% for the
three and nine months ended September 30, 2008, respectively.
Results of Operations
   The following table sets forth certain operating data as a percentage of
revenue for the periods indicated:

                                                        Three Months                        Nine Months
                                                    Ended September 30,                 Ended September 30,
                                                   2008              2007              2008              2007
Revenue                                             100.0 %          100.0 %            100.0 %          100.0 %

Operating expenses:
Payroll and related                                  38.3             36.5               38.1             37.5
Club operating                                       34.7             35.6               33.5             33.8
General and administrative                            6.8              7.0                6.8              7.1
Depreciation and amortization                        10.5              9.2               10.1              9.5
Impairment of fixed assets                            0.7                -                0.5                -

                                                     91.0             88.3               89.0             87.9

Operating income                                      9.0             11.7               11.0             12.1
Loss on extinguishment of debt                          -                -                  -              3.5
Interest expense                                      4.5              5.5                4.7              5.6
Interest income                                      (0.1 )           (0.3 )             (0.1 )           (0.2 )
Equity in the earnings of investees and
rental income                                        (0.5 )           (0.4 )             (0.4 )           (0.4 )

Income before provision for corporate
income taxes                                          5.1              6.9                6.8              3.6
Provision for corporate income taxes                  2.1              2.6                2.8              1.4

Net income                                            3.0 %            4.3 %              4.0 %            2.2 %

   Three Months Ended September 30, 2008 Compared to Three Months Ended
September 30, 2007
Revenue (in $'000s) was comprised of the following:

                                                     Three Months Ended September 30,
                                                 2008                                2007
                                      Revenue          % Revenue          Revenue          % Revenue          % Growth
Membership dues                      $ 101,025               78.9 %      $  93,735               78.8 %             7.8 %
Initiation fees                          3,505                2.7 %          3,202                2.7 %             9.5 %

Membership revenue                     104,530               81.6 %         96,937               81.5 %             7.8 %

Personal training revenue               14,871               11.6 %         13,243               11.2 %            12.3 %
Other ancillary club revenue             7,281                5.7 %          7,245                6.1 %             0.5 %

Ancillary club revenue                  22,152               17.3 %         20,488               17.3 %             8.1 %
Fees and other revenue                   1,427                1.1 %          1,461                1.2 %            (2.3 )%

Total revenue                        $ 128,109              100.0 %      $ 118,886              100.0 %             7.8 %

The increase in revenue was driven primarily by growth in membership revenue and ancillary club revenue. For the three months ended September 30, 2008, revenue increased $736,000, or 0.7%, compared to the three months ended September 30, 2007 at our clubs opened or acquired prior to September 30, 2006. For the three months ended September 30, 2008, revenue increased $10.5 million compared to the three months ended September 30, 2007 at the 24 clubs opened or acquired subsequent to September 30, 2006. These increases in revenue were offset by a $1.7 million revenue decrease related to the seven clubs that were closed subsequent to September 30, 2006.
Comparable club revenue increased 2.2% for the three months ended September 30, 2008 compared to the three months ended September 30, 2007. Of this 2.2% increase, 0.9% was due to an increase in membership, 0.9% was due to an increase in price and

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0.4% was due to an increase in ancillary club revenue and fees and other revenue. Comparable club revenue has been slowly trending down during 2008. Comparable club revenue increased 4.5% for the three months ended March 31, 2008, 3.2% for the three months ended June 30, 2008 and 2.2% for the three months ended September 30, 2008 compared to the same respective periods in 2007. This downward trend could continue in future quarters. Operating expenses (in $'000s) were comprised of the following:

                                           Three Months Ended
                                              September 30,
                                           2008          2007         % Variance
         Payroll and related             $  49,171     $  43,331             13.5 %
         Club operating                     44,398        42,360              4.8 %
         General and administrative          8,697         8,368              3.9 %
         Depreciation and amortization      13,423        10,950             22.6 %
         Impairment of fixed assets            839             -            100.0 %

         Operating expenses              $ 116,528     $ 105,009             11.0 %

Operating expenses increased from 2007 to 2008 due to the following factors:
Payroll and related. This increase was attributable to a 7.8% increase in the total months of club operation from 451 to 486 and discounting of our membership initiation fees. We have been discounting our new member initiation fees in an effort to drive membership sales. Our payroll costs that we defer are limited to the amount of these initiation fees, thus causing an increase in payroll of approximately $2.1 million when compared to prior year. In addition, payroll costs directly related to our personal training, group fitness training, and programming for children increased $1.8 million or 17.9%, principally due to the increase in revenue related to these programs.
Club operating. This increase was principally attributable to the following:
• Rent and occupancy expenses increased $2.6 million. Rent and occupancy costs increased $2.8 million at clubs that opened after July 1, 2007 or that are currently under construction and increased $248,000 at our clubs opened prior to July 1, 2007. Rent and occupancy expenses decreased $347,000 at our clubs closed and/or relocated after July 1, 2007.

• Advertising and marketing expenses decreased $1.5 million to $2.3 million from $3.8 million, primarily due to a reduction in general awareness advertising in 2008. We have decreased advertising expense as we discount our new member initiation fees in an effort to drive membership sales.

Depreciation and amortization. This increase was principally due to expanded clubs and fifteen new clubs added subsequent to September 30, 2007.
Impairment of fixed assets: For the three months ended September 30, 2008, the Company recorded an impairment loss of $839,000 on fixed assets related the planned closure of a club prior to its lease expiration. The impairment loss is included as a separate line in operating income on the consolidated statement of operations.
Interest Expense
Interest expense decreased $710,000 or 10.9% for the three months ended September 30, 2008 compared to the three months ended September 30, 2007. This decrease is a result of the February 27, 2007 refinancing of the 9 5/8% Senior Notes (the "Old Senior Notes") with our Term Loan Facility at a variable rate. For the three months ended September 30, 2007, the average variable interest rate was approximately 7.1%, while the average rate for the three months ended September 30, 2008 decreased to approximately 4.31%. Interest Income
Interest income decreased $268,000 to $76,000 for the three months ended September 30, 2008 from $344,000 for the three months ended September 30, 2007 due to a decrease in interest rates, as well as a decrease in the monthly average cash balance.

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Provision for Corporate Income Taxes
     We recorded an income tax provision of $2.7 million for the three months
ended September 30, 2008 compared to a provision of $3.1 million for the three
months ended September 30, 2007, calculated using the Company's effective tax
rate.
Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30,
2007
Revenue (in $'000s) was comprised of the following:

                                           Nine Months Ended September 30,
                                         2008                          2007
                                Revenue       % Revenue       Revenue       % Revenue
Membership dues                $ 301,696            78.6 %   $ 278,537            78.7 %      8.3 %
Initiation fees                   10,393             2.7 %       9,181             2.6 %     13.2 %

Membership revenue               312,089            81.3 %     287,718            81.3 %      8.5 %
Personal training revenue         47,712            12.4 %      42,646            12.0 %     11.9 %
Other ancillary club revenue      19,517             5.1 %      19,529             5.5 %      0.0 %

Ancillary club revenue            67,229            17.5 %      62,175            17.5 %      8.1 %
Fees and other revenue             4,504             1.2 %       4,148             1.2 %      8.6 %

Total revenue                  $ 383,822           100.0 %   $ 354,041           100.0 %      8.4 %

Revenue increased $29.8 million, or 8.4%, to $383.8 million for the nine months ended September 30, 2008 from $354.0 million for the nine months ended September 30, 2007. This increase in revenue was driven primarily by growth in membership revenue and ancillary club revenue. For the nine months ended September 30, 2008, revenues increased $6.4 million, or 1.9%, at our clubs opened or acquired prior to September 30, 2006. For the nine months ended September 30, 2008, revenue increased $28.5 million at the 24 clubs opened or acquired subsequent to September 30, 2006. These increases in revenue were offset by a $4.2 million revenue decrease related to the seven clubs that were closed subsequent to September 30, 2006.
Comparable club revenue increased 3.3% for the nine months ended September 30, 2008. Of this 3.3% increase, 1.4% was due to an increase in membership, 1.1% was due to an increase in price and 0.8% was due to an increase in ancillary club revenue and fees and other revenue. Operating expenses (in $'000s) were comprised of the following:

                                            Nine Months Ended
                                              September 30,
                                           2008          2007         % Variance
         Payroll and related             $ 146,228     $ 132,645             10.2 %
         Club operating                    128,799       119,662              7.6 %
         General and administrative         25,898        25,248              2.6 %
         Depreciation and amortization      38,788        33,772             14.9 %
         Impairment of fixed assets          1,981             -            100.0 %

         Operating expenses              $ 341,694     $ 311,327              9.8 %

Operating expenses increased due to the following factors:
Payroll and related. This increase was attributable to a 7.8% increase in the total months of club operation from 1,341 to 1,446 and discounting of our member initiation fees. We have been discounting our new member initiation fees in an effort to drive membership sales. Our payroll costs that we defer are limited to the amount of these initiation fees, thus causing an increase in payroll of approximately $4.6 million when compared to prior year. In addition, payroll costs directly related to our personal training, group fitness training, and programming for children increased $4.7 million, or 15.2%, principally due to the increase in revenue related to these programs.

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Club operating. This increase was primarily due to the following:
• Rent and occupancy expenses increased $7.3 million. Rent and occupancy costs increased $6.7 million at clubs that opened after July 1, 2007, or that are currently under construction and increased $1.2 million at our clubs opened prior to July 1, 2007. Rent and occupancy expenses decreased $477,000 at our clubs closed and/or relocated after July 1, 2007.

• Cleaning, laundry and towel expenses increased $1.6 million due to new club openings, an increase in the number of clubs that used an outsourced laundry service, as well as overall increase in member usage of 12.6%.

• Advertising and marketing expenses decreased $2.6 million to $6.2 million from $8.8 million primarily due to a reduction in general awareness advertising in 2008.

Depreciation and amortization. This increase was principally due to expanded clubs and fifteen new clubs added subsequent to September 30, 2007. 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 nine months ended September 30, 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 the lease expiration dates.
Loss on Extinguishment of Debt
For the nine months ended September 30, 2007 loss on extinguishment of debt was $12.5 million. The proceeds from the New Senior Credit Facility obtained on February 27, 2007 were used to repay $170.0 million, representing the remaining outstanding principal of the Old 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 Old Senior Notes. Net deferred financing costs related to the Old 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 nine months ended September 30, 2008. Interest Expense
Interest expense decreased $2.0 million, or 9.9%, for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007. This decrease is a result of the February 27, 2007 refinancing of the Old Senior Notes with our Term Loan Facility at a variable rate. For the nine months ended September 30, 2007, the average variable interest rate was approximately 7.7%, while the average variable interest rate for the nine months ended September 30, 2008 decreased to approximately 5.3%.
Interest Income
Interest income decreased $591,000, or 67.0%, for the nine months ended September 30, 2008 compared to the nine months ended September 30, 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 $10.7 million for the nine months ended September 30, 2008 compared to $4.9 million for the nine months ended September 30, 2007, calculated using the Company's effective tax rate.

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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 nine months ended September 30, 2008 was $76.9 million compared to $62.6 million for the nine months ended September 30, 2007, for a $14.3 million increase. The net decrease in prepaid expenses and other current assets contributed to a $4.7 million increase in cash primarily due to decreases in pre-payments made to landlords and the timing of other vendor payments. Cash paid for interest decreased $5.7 million.
Excluding the effects of cash and cash equivalent balances, we normally operate with a working capital deficit because we receive dues and program and services fees either (i) for the month services are rendered, or (ii) when paid-in-full, in advance. As a result, we typically do not have significant accounts receivable. We record deferred liabilities for revenue received in advance in connection with dues and services paid-in-full and for initiation fees paid at the time of enrollment. Initiation fees received are deferred and amortized over a 30-month period, which represents the approximate life of a . . .