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" refer to Town Sports International, LLC (formerly known as Town Sports International, Inc.), our wholly-owned operating subsidiary.
Based on the number of clubs, we are one of the leading owners and operators of fitness clubs in the Northeast and Mid-Atlantic regions of the United States and one of the largest fitness club owners and operators in the United States. As of September 30, 2009, the Company, through its subsidiaries, operated 165 fitness clubs under our four key brand names: "New York Sports Clubs;" "Boston Sports Clubs;" "Philadelphia Sports Clubs;" and "Washington Sports Clubs". These clubs collectively served approximately 494,000 members, excluding short-term and seasonal members. We are the largest fitness club owner and operator in Manhattan with 39 locations (more than twice as many as our nearest competitor) and owned and operated a total of 111 clubs under the "New York Sports Clubs" brand name within a 120-mile radius of New York City as of September 30, 2009. We owned and operated 26 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 six clubs in the Philadelphia region under our "Philadelphia Sports Clubs" brand name as of September 30, 2009. In addition, we owned and operated three clubs in Switzerland as of September 30, 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. Our club model targets the "upper value" market segment, comprising individuals aged between 21 and 60 with income levels between $50,000 and $150,000 per year. We believe that the 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.
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 September 30, 2009, approximately 39% of our members participated in our Passport or Regional Passport Memberships and 61% of our members participate in 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. 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.
We have two principal sources of revenue:
• Membership revenue: Our largest sources of revenue are dues and initiation fees paid by our members. These dues and initiation fees comprised 82.0% of our total revenue for the nine months ended September 30, 2009. We recognize revenue from membership dues in the month when the services are rendered. Approximately 96% 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 life of the membership. Prior to April 1, 2009, the expected life of a membership was 30 months. Effective April 1, 2009, we changed our estimated membership life to 28 months. See Note 1 - Basis of Presentation to the consolidated financial statements in this Form 10-Q.

• Ancillary club revenue: For the nine months ended September 30, 2009, we generated 11.7% 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.

We also receive revenue (approximately 1.0% of our revenue for the nine months ended September 30, 2009) from the rental of space in our facilities to operators who offer wellness-related services such as physical therapy. In addition, we sell in-club advertising

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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.
Our revenues, operating income and net income (loss) for the three months ended September 30, 2009 were $120.4 million, $1.4 million and ($1.5) million, respectively, and $128.1 million, $11.6 million and $3.8 million, respectively, for the three months ended September 30, 2008. Our revenues, operating income and net income for the nine months ended September 30, 2009 were $371.1 million, $15.6 million and $1.7 million, respectively, and $383.8 million, $42.1 million and $15.5 million, respectively, for the nine months ended September 30, 2008.
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, member relations, legal and consulting fees and real estate development and management 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. Similarly, as clubs mature and the member base decreases at these clubs, total fixed costs related to the base are spread over a lower revenue amount.
Our primary capital expenditures relate to the construction or acquisition of new club facilities and upgrading and expanding of 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% 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. As we renew and extend leases on older clubs, we often consider committing to upgrades or remodeling at these clubs where we deem it to be appropriate.
In the three months ended March 31, 2009, the Company performed its annual goodwill impairment test. The test was performed as a roll-forward of the December 31, 2008 test. Please refer to Note 5 - Goodwill and Intangible Assets to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2008 for information on the specific assumptions used.
Goodwill impairment testing requires a comparison between the carrying value and fair value of reportable goodwill. If the carrying value exceeds the fair value, goodwill is considered impaired. The amount of the impairment loss is measured as the difference between the carrying value and the implied fair value of goodwill, which is determined using discounted cash flows. The 2009 impairment test supported the recorded goodwill balances and as such no impairment of goodwill was required. The valuation of intangible assets requires assumptions and estimates of many critical factors, including revenue and market growth, operating cash flows and discount rates. 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. Given the current economic environment and the uncertainties regarding the impact on the Company's business, there can be no assurance that the Company's estimates and assumptions regarding the duration of the ongoing economic downturn, or the period or strength of recovery, made for purposes of the Company's goodwill impairment testing as of March 31, 2009 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 in the quarter ending March 31, 2010 or prior to that period, if any such change constitutes a triggering event outside of the quarter from 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. There were no events triggering a review of goodwill for the three months ended September 30, 2009.

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Historical Club Count
   The following table sets forth the changes in our club count during each of
the quarters in 2008 and the first three quarters of 2009.

                                                     2008                                         2009
                                Q1         Q2         Q3         Q4        Total        Q1         Q2         Q3
Wholly owned clubs operated
at beginning of period           159        160        161        162         159        164        165        164
New clubs opened                   2          3          1          3           9          4          -          -
Clubs acquired                     -          -          -          -           -          -          -          -
Clubs closed, relocated or
merged                            (1 )       (2 )        -         (1 )        (4 )       (3 )       (1 )       (1 )

Wholly owned clubs at end
of period                        160        161        162        164         164        165        164        163

Total clubs operated at end
of period (1)                    162        163        164        166         166        167        166        165

(1) Includes wholly-owned and partly-owned clubs. In addition to the above, as of September 30, 2009 and December 31, 2008, we managed four university fitness clubs in which we did not have an 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 growth as revenue for the 13th month and thereafter as applicable as compared to the same period in the prior year. Growth in comparable club revenue as compared to the same period in the prior fiscal year has decreased sequentially for each of the three-month periods ended in 2008 and in each of the three-month periods ended March 31, 2009, June 30, 2009 and September 30, 2009. The increase (decrease) in comparable revenue as compared to the same period in the prior fiscal year was as follows:

                 2008:
                 Three months ended March 31, 2008          4.5 %
                 Three months ended June 30, 2008           3.2 %
                 Three months ended September 30, 2008      2.2 %
                 Three months ended December 31, 2008      (1.4 )%
                 2009:
                 Three months ended March 31, 2009         (2.1 )%
                 Three months ended June 30, 2009          (6.3 )%
                 Three months ended September 30, 2009     (7.0 )%

As shown above, comparable club revenue has been trending downward during 2008 and throughout 2009. This downward trend is expected to continue in the fourth quarter of 2009.
In the three months ended September 30, 2009, membership at our comparable clubs decreased 5.5% as compared to the same period in the prior year. This drop in membership coupled with expected decreases in personal training revenue are expected to result in a further decline in comparable club revenue and therefore operating margins.

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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 ,
                                                    2009              2008              2009              2008
Revenue                                             100.0 %           100.0 %            100.0 %          100.0 %

Operating expenses:
Payroll and related                                  39.4              38.3               39.5             38.1
Club operating                                       37.9              34.7               37.1             33.5
General and administrative                            6.7               6.8                6.4              6.8
Depreciation and amortization                        11.9              10.5               11.6             10.1
Impairment of fixed assets                            2.9               0.7                1.2              0.5

                                                     98.8              91.0               95.8             89.0

Operating income                                      1.2               9.0                4.2             11.0
Interest expense                                      4.5               4.5                4.3              4.7
Interest income                                         -              (0.1 )                -             (0.1 )
Equity in the earnings of investees and
rental income                                        (0.4 )            (0.5 )             (0.4 )           (0.4 )

Income (loss) before provision
(benefit) for corporate income taxes                 (2.9 )             5.1                0.3              6.8
Provision (benefit) for corporate income
taxes                                                (1.7 )             2.1               (0.2 )            2.8

Net income (loss)                                    (1.2 )%            3.0 %              0.5 %            4.0 %

Total revenue for the three months ended September 30, 2009 decreased $10.8 million, or 9.1%, at clubs opened for more than 24 months when compared to the same period last year. Total revenue for the nine months ended September 30, 2009 decreased $26.9 million, or 7.4%, at clubs opened for more than 24 months when compared to the same period last year. Our operating margins decreased to 1.2% and 4.2% in the three and nine months ended September 30, 2009, respectively, from 9.0% and 11%, respectively, in the same periods in the prior year.
Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008
Revenue was comprised of the following for the periods indicated (in 000's):

                                                      Three Months Ended September 30,
                                                  2009                                2008
                                       Revenue          % Revenue          Revenue          % Revenue          % Variance
Membership dues                       $  95,400               79.2 %      $ 101,025               78.9 %            (5.6 )%
Initiation fees                           3,113                2.6 %          3,505                2.7 %           (11.2 )%

Membership revenue                       98,513               81.8 %        104,530               81.6 %            (5.8 )%

Personal training revenue                13,526               11.2 %         14,871               11.6 %            (9.0 )%
Other ancillary club revenue              7,243                6.0 %          7,281                5.7 %            (0.5 )%

Ancillary club revenue                   20,769               17.2 %         22,152               17.3 %            (6.2 )%
Fees and other revenue                    1,167                1.0 %          1,427                1.1 %           (18.3 )%

Total revenue                         $ 120,449              100.0 %      $ 128,109              100.0 %            (6.0 )%

For the three months ended September 30, 2009, revenue increased $5.1 million at the 22 clubs opened or acquired subsequent to September 30, 2007. This increase in revenue was offset by decreases in revenue of 9.1%, or $10.8 million, at clubs opened or acquired prior to September 30, 2007 and $2.0 million related to the 11 clubs that were closed subsequent to September 30, 2007.
Comparable club revenue decreased 7.0% for the three months ended September 30, 2009 compared to the same period in the prior year. Of this 7.0% decrease, 3.7% was due to a decrease in membership, 1.3% was due to a decrease in price and 2.0% was due to a decrease in ancillary club revenue and fees and other revenue.

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Fees and other revenue decreased 18.3% for the three months ended September 30, 2009 compared to the same period in the prior year primarily due to a decrease in marketing revenue as we had less demand for our in-club advertising programs.
Operating expenses were comprised of the following for the periods indicated (in 000's):

                                           Three Months Ended
                                              September 30,
                                           2009          2008         % Variance
         Payroll and related             $  47,487     $  49,171           (3.4 )%
         Club operating                     45,589        44,398            2.7 %
         General and administrative          8,103         8,697           (6.8 )%
         Depreciation and amortization      14,353        13,423            6.9 %
         Impairment of fixed assets          3,473           839          313.9 %

         Operating expenses              $ 119,005     $ 116,528            2.1 %

Operating expenses for the three months ended September 30, 2009 were impacted by a 0.8% increase in the total months of club operation from 486 to 490 and a 5.7% increase in club member usage as well as the following factors:
Payroll and related. This decrease for the three months ended September 30, 2009 compared to the same period in the prior year was primarily due to a decrease in ancillary club payroll of $1.2 million directly related to the decrease in ancillary club revenue and a decrease of $674,000 in club commissions and bonuses related to the decrease in the number of memberships sold.
These decreases were partially offset by increases resulting from the discounting of 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 of approximately $431,000 in payroll expense.
Club operating. This increase was principally attributable to the following:
• Rent and occupancy expenses increased $1.6 million for the three months ended September 30, 2009 compared to the same period in the prior year. Rent and occupancy costs increased $718,000 at clubs that opened after July 1, 2008 and increased $1.5 million at our clubs that opened prior to July 1, 2008. Rent and occupancy expenses decreased $661,000 at our clubs that were closed after July 1, 2008.

• Expenses relating to laundry and towels decreased $695,000 for the three months ended September 30, 2009 compared to the same period in the prior year primarily related to the opening of our laundry facility in Elmsford, NY in January 2009.

General and administrative. This $594,000 decrease for the three months ended September 30, 2009 compared to the same period in the prior year was principally attributable to a $430,000 decrease in general liability insurance expense. Our claims activity has been decreasing as a percentage of our revenue, causing a decreased loss trend rate. In addition, we reduced our insurance claims 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 expenses.
Depreciation and amortization. The increase in depreciation and amortization expenses was principally due to the eight clubs that opened after July 1, 2008 as well as the new laundry facility and corporate office in Elmsford, NY, which opened in January 2009.
Impairment of fixed assets. In the three months ended September 30, 2009, we recorded fixed asset impairment charges totaling $3.5 million, which represented the write-offs of fixed assets at two underperforming clubs. In the nine months ended September 30, 2008, we recorded an impairment loss of $839,000 on fixed assets related to 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.

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Interest Expense
Interest expense decreased $405,000, or 7.0%, for the three months ended September 30, 2009 compared to the same period in the prior year. This decrease is primarily a result of the lower variable rate of interest on our Term Loan Facility during the three months ended September 30, 2009. For the three months ended September 30, 2009, the average variable interest rate was 2.1% as compared to 4.3% for the three months ended September 30, 2008. Provision for Corporate Income Taxes
We have determined our income tax provision for September 30, 2009 on a discrete basis based on the results for the first nine months of 2009. We could not reliably estimate our 2009 effective annual tax rate because minor changes in our annual estimated income before provision for corporate income taxes (pre-tax results) could have a significant impact on our annual estimated effective tax rate. Accordingly, we calculated our effective tax rate based on pre-tax results through the nine months ended September 30, 2009.
We recorded a benefit for corporate income taxes of $2.0 million for the three months ended September 30, 2009 compared to a provision of $2.7 million for the three months ended September 30, 2008. The Company's effective tax rate decreased from 41% in the nine months ended September 30, 2008 to (57.7)% in the nine months ended September 30, 2009. Because of the reduction in pre-tax book income, the expected benefits from our Captive Insurance arrangement are giving rise to a tax benefit and negative effective tax rate.
Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008
Revenue was comprised of the following for the periods indicated (in 000's):

                                                      Nine Months Ended September 30,
                                                  2009                                2008
                                       Revenue          % Revenue          Revenue          % Revenue          % Variance
Membership dues                       $ 294,465               79.4 %      $ 301,696               78.6 %            (2.4 )%
Initiation fees                           9,622                2.6 %         10,393                2.7 %            (7.4 )%

Membership revenue                      304,087               82.0 %        312,089               81.3 %            (2.6 )%
Personal training revenue                43,696               11.7 %         47,712               12.4 %            (8.4 )%
Other ancillary club revenue             19,587                5.3 %         19,517                5.1 %             0.4 %

Ancillary club revenue                   63,283               17.0 %         67,229               17.5 %            (5.9 )%
Fees and other revenue                    3,700                1.0 %          4,504                1.2 %           (17.9 )%

Total revenue                         $ 371,070              100.0 %      $ 383,822              100.0 %            (3.3 )%

Revenue decreased 3.3%, to $371.1 million for the nine months ended September 30, 2009 from $383.8 million for the nine months ended September 30, 2008. This decrease in revenue was driven primarily by a decline in membership revenue and ancillary club revenue. For the nine months ended September 30, 2009, revenues increased $19.4 million as compared to the nine months ended September 30, 2008 at the 22 clubs opened or acquired subsequent to September 30, 2007. For the nine months ended September 30, 2009, revenue decreased 7.4% or $26.5 million at our clubs opened or acquired prior to September 30, 2007 and $5.6 million at the 11 clubs that were closed subsequent to September 30, 2007.
Comparable club revenue decreased 5.1% for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. Of this 5.1% decrease, 1.8% was due to a decrease in membership, 1.3% was due to a decrease in price and 2.0% was due to a decrease in ancillary club revenue and fees and other revenue.
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 a $758,000 increase in initiation fee revenue recognized when compared to the same period in the prior year.
Fees and other revenue decreased 17.9% in the nine months ended September 30, 2009 compared to the same period in the prior year primarily due to a decrease in marketing revenue from less demand for our in-club advertising programs.

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

                                      Nine Months Ended September 30,
. . .