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SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549




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FORM 10-K



|  |                                                                                         
|- | ----------------------------------------------------------------------------------------
|x | Annual Report pursuant to Section 13 or 15(d) of the
    Securities Exchange Act of 1934

For the fiscal year ended December 31,
2003




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

For the transition period from


Commission file number: 333-40907

Town Sports International, Inc.


(Exact name of Registrant as specified in its
charter)


|                                                                                 |  |                                                        
|-------------------------------------------------------------------------------- |  | -------------------------------------------------------
|                                                                                
|NEW YORK
     (State or other jurisdiction of
    incorporation or organization) |  | 13-2749906
    (I.R.S. Employer
    Identification No.)

888 SEVENTH AVENUE

NEW YORK, NEW YORK 10106


(212)-246-6700


(Address, including zip code and telephone
number,


including area code, of registrants
principal executive offices)


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

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

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

Indicate by check mark whether the Registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).  Yes o No x

The aggregate market value of Common Stock held
by non-affiliates of the registrant: Not applicable

As of June 30, 2003, there were
1,176,043 shares of Class A Common Stock of the
Company outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Certain exhibits filed with the Registrants
Registration Statements on Form S-1 and Forms S-4
(File Nos. 333-61439, 333-40907 and 333-82607, as
amended) are incorporated by reference into Part IV of this
Report on Form 10-K.



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TABLE OF CONTENTS



|                            |                                                                                               |  |  |  |  |  |  | 
|--------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                     
|                            | Item 1. Business                                                                             
|                            | Item 2. Properties                                                                           
|                            | Item 3. Legal Proceedings                                                                    
|                            | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                    
|                            | Item 5. Market for Registrants Common Equity and Related Shareholder Matters                
|                            | Item 6. Selected Financial Data                                                              
|                            | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                            | Item 7A. Quantitative and Qualitative Disclosures About Market Risks                         
|                            | Item 8. Financial Statements and Supplementary Data                                          
|                            | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|                            | Item 9A. Controls and Procedures                                                             
|PART III                   
|                            | Item 10. Directors and Executive Officers of the Registrant                                  
|                            | Item 11. Executive Compensation                                                              
|                            | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|                            | Item 13. Certain Relationships and Related Transactions                                      
|                            | Item 14. Principal Accountant Fees and Services                                              
|PART IV                    
|                            | Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K                    
|SUBSIDIARIES OF THE COMPANY
|SECTION 302 CERTIFICATION  
|SECTION 302 CERTIFICATION  
|SECTION 302 CERTIFICATION  
|SECTION 906 CERTIFICATION  
|SECTION 906 CERTIFICATION  



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TABLE OF CONTENTS

|     |     |                                                                      |                                                                                           |  |    |    | 
|---- | --- | -------------------------------------------------------------------- | ----------------------------------------------------------------------------------------- |  | -- | -- | 
|     |     |                                                                      |                                                                                           | 
|     |     | Page                                                                
|ITEM |     |                                                                     
|     |     |                                                                     
|     |     | PART I                                                               |                                                                                           |  |    |   
|     | 1.  |                                                                      | Business                                                                                  |  |    | 1  | 
|     | 2.  |                                                                      | Properties                                                                                |  |    | 10 | 
|     | 3.  |                                                                      | Legal Proceedings                                                                         |  |    | 14 | 
|     | 4.  |                                                                      | Submission of Matters to a Vote of Security
    Holders                                   |  |    | 14 | 
|     |     | PART II                                                              |                                                                                           |  |    |   
|    
|     | 5.  |                                                                      | Market for Registrants Common Stock and
    Related Shareholder Matters                  |  |    | 14 | 
|     | 6.  |                                                                      | Selected Financial Data                                                                   |  |    | 15 | 
|     | 7.  |                                                                      | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |    | 18 | 
|     | 7A. |                                                                      | Quantitative and Qualitative Disclosures About
    Market Risks                           |  |    | 27 | 
|     | 8.  |                                                                      | Financial Statements and Supplementary Data                                               |  |    | 27 | 
|     | 9.  |                                                                      | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure  |  |    | 28 | 
|     | 9A. |                                                                      | Controls and Procedures                                                                   |  |    | 28 | 
|     |     | PART III                                                             |                                                                                           |  |    |   
|    
|10.  |     | Directors and Executive Officers of the Registrant                   |                                                                                           |  | 29 |   
|11.  |     | Executive Compensation                                               |                                                                                           |  | 31 |   
|12.  |     | Security Ownership of Certain Beneficial Owners
    and Management   |                                                                                           |  | 33 |   
|13.  |     | Certain Relationships and Related Transactions                       |                                                                                           |  | 34 |   
|14.  |     | Principal Accountant Fees and Services                               |                                                                                           |  | 35 |   
|     |     | PART IV                                                              |                                                                                           |  |    |   
|    
|15.  |     | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K |                                                                                           |  | 36 |   

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TOWN SPORTS INTERNATIONAL, INC.






PART I







Item 1.     Business


General

Town Sports International, Inc. and its
subsidiaries (as used herein, the Company,
Town Sports, we, us and
our) is one of the two leading owners and operators
of fitness clubs in the Northeast and Mid-Atlantic regions of
the United States. As of December 31, 2003, we owned and
operated 127 fitness clubs and partly owned and operated
two fitness clubs. These 129 clubs collectively served
approximately 342,000 members. We develop clusters of clubs
to serve densely populated major metropolitan regions in which a
high percentage of the population commutes to work. We service
such populations by clustering clubs near the highest
concentrations of our target members areas of both
employment and residence. Our target member is college-educated,
typically between the ages of 21 and 50 and earns an annual
income between $50,000 and $150,000.

Our goal is to develop the premier health club
network in each of the major metropolitan regions we serve. We
believe that clustering clubs allows us to achieve strategic
operating advantages that enhance our ability to achieve this
goal. When entering new regions, we develop clusters by
initially opening or acquiring clubs located in the more central
urban markets of the region and then branching out from these
urban centers to suburbs and ancillary communities. Capitalizing
on this clustering of clubs, as of December 31, 2003,
approximately 52% of our members participated in a membership
plan that allows unlimited access to all of our clubs for a
higher membership fee.

We have executed this strategy successfully in
the New York region through the network of fitness clubs we
operate under our New York Sports Club (NYSC) brand
name. We are the largest fitness club operator in Manhattan with
36 locations and operate a total of 86 clubs under the NYSC name
within a defined radius of New York City. We operate 19 clubs in
the Boston region and 15 clubs in the Washington, DC region
under our Boston Sports Club (BSC) and Washington
Sports Club (WSC) brand names, respectively and have
begun establishing a similar cluster in the Philadelphia region
with six clubs under our Philadelphia Sports Club
(PSC) brand name. In addition, we operate three
clubs in Switzerland. We employ localized brand names for our
clubs to create an image and atmosphere consistent with the
local community and to foster recognition as a regional network
of quality fitness clubs rather than a national chain.

We sell month-to-month membership payment plans
that are generally cancelable by our members at any time with
30 days notice. Effective October, 2003 we also began to
sell one and two year commit memberships at a discount to the
month-to-month non-commit membership plan. The one year commit
membership is typically the same monthly rate, which is paid
monthly as the month-to-month plan but with a discounted
initiation fee, and the two year commit memberships are
typically at a 10% discount to the month-to-month plan also with
a discounted initiation fee. As of December 31, 2003,
approximately 81% of our members had a month-to-month non-commit
membership plan. We believe members prefer to have the choice to
commit for a year or two at a discount to the month-to-month
plan or to have the flexibility of the month-to-month non-commit
plan.

We have experienced significant growth over the
past several years through a combination of (i) acquiring
existing, privately owned, single and multi-club businesses, and
(ii) developing and opening greenfield club
locations (a greenfield club is a new location we have
constructed). From January 1, 1999, to December 31,
2003, we acquired 21 existing clubs, opened
46 greenfield clubs, relocated five clubs, sold one club,
and closed one club to increase our total clubs under operation
from 69 to 129. We currently plan to open twelve more clubs
prior to December 31, 2004. We have achieved revenue growth
over the five year period ended December 31, 2003 at a
compound annual rate of approximately 21.3% from
$158.2 million for the year ended December 31, 1999 to
$342.5 million for the year ended December 31, 2003.
This growth has been driven not only by the addition of acquired
and greenfield club locations, but also through mature club
revenue growth, which has ranged from 1.6% to 18.6% for the five
year period ended December 31, 2003 and averaged 10.5% over
that period. Such growth was 1.6% for the year ended
December 31, 2003. Mature club, defined as those clubs that
we operated for more than 24 months, revenue growth has
enabled us to increase revenue per





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weighted average club over the five year period
ended December 31, 2003. Revenue per weighted average club
(as defined in Selected Financial Data) has risen from
$2.1 million for the year ended December 31, 1999 to
$2.7 million for the year ended December 31, 2003.
Based on our historical experience, a new club tends to achieve
significant increases in revenues during its first three years
of operation as it matures. Because clubs experience little
incremental cost associated with such revenue increases, we
realize a greater proportionate increase in profitability. This
operating leverage has allowed us to achieve consistent
increases in cash flows from operations over the five year
period ended December 31, 2003. Cash flows from operations
improved from $29.5 million in 1999 to $58.3 million
for the year ended December 31, 2003. Net income improved
from $49,000 in 1999 to $7.4 million for the year ended
December 31, 2003.


Over our 30-year history, we have developed and
refined a model club format that allows us to cost effectively
construct and efficiently operate our fitness clubs. Our urban
model club ranges in size from approximately 15,000 to 25,000
square feet and averages approximately 20,000 square feet and
our suburban clubs vary in size from 15,000 square feet to
75,000 square feet, with one club being 200,000 square feet.
Excluding this single large club, our average suburban club is
25,000 square feet. Clubs typically have an open space to
accommodate cardiovascular and strength-training exercise, as
well as special purpose rooms to accommodate group fitness class
instruction and other exercise programs as well as massage.
Locker rooms generally include a sauna and steam room. We seek
to provide a broad array of high quality exercise programs and
equipment that is both popular and effective, while reinforcing
the quality exercise experience we strive to make available to
our members. We strive to establish at least one flagship club
that has amenities such as swimming pools or racquet and
basketball courts in each of our key target areas.

We engage in detailed site analyses and selection
process based upon information provided by our customized
development software to identify potential target areas for
additional clubs based upon population demographics,
psychographics, traffic and commuting patterns, availability of
sites and competitive market information. In addition to our
existing 129 clubs under operation and the seven sites for
which we have entered into lease commitments, we have identified
approximately 70 target areas in which we may add clubs
under the brand names NYSC, BSC, WSC, or PSC. Once we begin to
approach saturation of these regions, we will explore expansion
opportunities in other markets in the United States sharing
similar demographic characteristics to those in which we
currently operate.

We possess an experienced management team, four
of the top five executives of which have been working together
at the Company since 1990. We believe that we have the depth,
experience and motivation to manage our internal and external
growth, and that we have put in place the infrastructure and
systems to manage effectively our planned expansion. We believe
that the presence of such infrastructure will enable us over
time to leverage certain fixed cost aspects of corporate
overhead to realize increased operating margins as we continue
to expand our club base. This operating leverage has already
helped us to increase operating income as a percent of revenue
increased to 12.8% for the year ended December 31, 2003
compared to 6.9% in 1999.

Industry Overview

Demographic trends have helped fuel the growth
experienced by the fitness industry over the past decade. The
industry has benefited from the aging of the baby
boomer generation (ages 39 to 57) and the coming of
age of their offspring, the echo boomers (ages eight
to 26). In 2001, Americans over the age of fifty-five account
for 6.9 million members, up nearly fourfold since 1993.
Government-sponsored reports, such as the Surgeon Generals
Report on Physical Activity & Health (1996) and the
Call to Action to Prevent and Decrease Overweight and Obesity
(2002) have helped to increase the general awareness of the
benefits of physical exercise to these demographic segments over
those of prior generations. Membership penetration (defined as
club members as a percentage of the total U.S. population
over the age of six) has increased significantly from 7.4% in
1990 to 13.5% in 2001.

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Fitness Club Revenues(1)

(in $ billions)

CLUB REVENUES



| |     |                                                           
| | --- | ----------------------------------------------------------
| | (1) | Industry revenues for 1991 and 1992 are not
    available.

U.S. Fitness Clubs Membership

(in millions)

CLUB MEMBERSHIP

Total U.S. fitness club industry revenues
increased at a compound annual growth rate of 8.1% from
$6.5 billion in 1993 to $13.1 billion in 2002, while
the total number of clubs increased at a compound annual growth
rate of 4.7%, from 12,146 in 1991 to 20,207 in 2002. Growth in
club memberships outpaced club growth during this period,
increasing at a compound annual growth rate of 5.1% from
20.9 million in 1991 to 36.3 million in 2002.

Notwithstanding these longstanding growth trends,
the fitness club industry continues to be highly fragmented.
Less than 10% of clubs in the United States are owned and
operated by companies that own more than 25 clubs, and the
two largest fitness club operators each generate less than 8% of
total fitness club revenues.

As a large operator with recognized brand names,
leading regional market shares and an established operating
history, we believe we are well positioned to benefit from these
favorable industry dynamics.

We believe that the growth in fitness club
memberships is attributable to several factors. Americans are
focused on achieving a healthier, more active and less stressful
lifestyle. Of the factors members consider very important in
their decision to join a fitness club, the most commonly
mentioned is health, closely followed by appearance related
factors including muscle tone, looking better and weight
control. We believe that the increased emphasis on appearance
and wellness in the media has heightened the focus on self image
and fitness and will continue to do so. We also believe that
fitness clubs provide a more convenient venue for exercise than
outdoor activities, particularly in densely populated
metropolitan areas. According to published industry reports,
convenience is an important factor in choosing a fitness club.

We believe the industry can be segregated into
three tiers based upon price, service and quality: (i) an
upper tier consisting of clubs with monthly membership dues
averaging in excess of $95.00 per month; (ii) a middle tier
consisting of clubs with monthly membership dues averaging
between $45.00 and $95.00 per month; and (iii) a lower tier
consisting of clubs with monthly membership dues averaging less
than $45.00 per month. We compete in the middle tier in terms of
pricing and because of our wide array of programs and services
coupled with our commitment to customer service and our
convenience to work and home we are

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positioned toward the upper end of this tier.
Based upon the quality and service we provide to our members, we
believe that we provide an attractive value to our members at
the monthly membership dues we charge.


Marketing

Our marketing campaign, which has become a large
driver of the brand, is directed by our in-house media
department which is headed by the Chief Executive Officer and
the newly appointed V.P. of Marketing. This team develops
advertising strategies to convey each of the our regionally
branded networks as the premier network of fitness clubs in that
region. Our media teams goal is to achieve broad awareness
of our regional brand names primarily through radio, television,
newspaper, billboard, and direct mail advertising. We believe
that clustering clubs creates economies in our marketing and
advertising strategy that increase the efficiency and
effectiveness of these campaigns.

Advertisements generally feature creative slogans
that communicate the serious approach we take toward fitness in
a provocative and/or humorous tone, rather than pictures of our
clubs, pricing specials or members exercising. Promotional
marketing campaigns will typically feature opportunities to
participate in value-added services such as personal training
for a limited time at a discount to the standard rate. We will
also offer reduced initiation fees to encourage enrollment.
Additionally, we frequently sponsor member referral incentive
programs. Such incentive programs include a free month of
membership, personal training sessions, and sports equipment.

We also engage in public relations and special
events to promote our image in the local communities. We believe
that these public relations efforts enhance our image and the
image of our local brand names in the communities in which we
operate. We also seek to build our community image through
co-operative advertising campaigns with local and regional
retailers.

We maintain the following web site:
www.mysportsclubs.com that provides information about club
locations, program offerings, exercise class schedules and
on-line promotions. Our web site provides our members a venue to
give us direct feedback on all of our services and offerings. We
also use our web site to promote career opportunities.

Sales

Sales of new memberships are generally handled at
the club level. We employ approximately 465 in-club
membership consultants who are responsible for new membership
sales. Each club generally has two or three full-time and one
part-time membership consultants. These consultants report both
to our area sales managers, who in turn report to our Vice
President Sales. Membership consultants compensation
consists of a base salary plus commission. Sales commissions
range from $45 to $70 per new member enrolled. We provide
additional incentive-based compensation in the form of bonuses
contingent upon individual, club and Company-wide enrollment
goals. Membership consultants must successfully complete a
three-month, in-house training program through which they learn
our sales strategy. In making a sales presentation, membership
consultants emphasize: (i) the proximity of our clubs to
concentrated commercial and residential areas convenient to
where target members live and work; (ii) for non-commit
membership plans, the lack of a long-term obligation on the part
of the enrollee; (iii) the price value relationship of a
Town Sports membership; and (iv) access to value-added
services. We believe that providing employees with opportunities
for career advancement is essential to our ability to attract
and retain qualified sales personnel. We also employ seven
full-time corporate sales managers whose responsibility is to
solicit group memberships through senior level corporate
contacts.

We believe that clustering clubs allows us to
sell memberships based upon the opportunity for members to
utilize multiple club locations to differing degrees. We have a
streamlined membership structure to simplify the sales process.
In addition, our proprietary centralized computer software
ensures consistency of pricing and controls enrollment
processing at the club level. We generally offer three principal
types of memberships:



| |                                                                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Passport Membership, priced from $45 to $92
    per month, is our higher priced membership and entitles members
    to use any Town Sports club at any time. This membership is held
    by approximately

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| |                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 52% of our members. In addition, we have
    introduced a Passport Premium membership for a select club, that
    includes more member services, at a price greater than $100 per
    month.                                                                                                       
|
| | The Gold Membership, priced from $39 to $84 per
    month based on the market area of enrollment, enables members to
    use a specific club, or a group of specific clubs, at any time
    and any Town Sports club during off-peak times. This membership
    is held by over 47% of our members.
|
| | The Off-peak Membership, priced from $39 to $75
    per month, is the least expensive membership, and allows members
    to use any Town Sports club only during off-peak times. This
    membership is held by approximately 1% of our members.                                                   
|
| | We also offer corporate membership plans that
    vary in price depending on the respective corporations
    needs. The corporate membership plans are typically at a
    discount to that of individual membership plans.                                                                        

By clustering a group of clubs in a geographic
area, the value of our memberships is enhanced by our ability to
offer Passport Memberships, which allow our members to use any
of our clubs at any time. We believe the popularity of the
Passport Membership results from the broader privileges and
greater convenience this membership plan provides through the
opportunity for members to access club facilities near to both
their homes and workplace. Our clustering strategy also allows
us to provide access to special facilities and programs such as
tennis, squash, basketball and racquetball courts, swimming
pools and programs targeted at children and other groups,
through flagship locations strategically located in key target
areas, without offering such facilities or programs in every
location.

In joining a club, a new member signs a
membership agreement which obligates the member to pay a
one-time initiation fee and monthly dues on an ongoing basis.
Monthly Electronic Funds Transfer EFT of individual
membership dues averaged approximately $70 per month for the
year ended December 31, 2003. During that same period,
initiation fees averaged $74 for EFT members. We collect 92.8%
of all monthly membership dues through EFT and EFT revenue
constituted over 73% of consolidated revenue for the year ended
December 31, 2003. Substantially all other membership dues
are paid in advance. Based upon a study of the membership base
at our clubs open over 24 months, the average length of our
memberships is approximately 24 months. Our membership
agreements call for monthly dues to be collected by EFT based on
credit card or bank account debit authorization contained in the
agreement. We believe that our EFT program of monthly dues
collection provides a predictable and stable cash flow for us,
eliminates the traditional accounts receivable function, and
minimizes bad-debt write-offs while providing a significant
competitive advantage in terms of the sales process, dues
collection, and working capital management. In addition, it
enables us to increase our dues in an efficient and consistent
manner which we typically do annually by between 1% and 3%, in
line with cost of living increases. During the first week of
each month, we receive the EFT dues for that month initiated by
a third party EFT processor. Discrepancies and insufficient
funds incidents are researched and resolved by our in-house
staff. For the year ended December 31, 2003, we experienced
an average of uncollected EFT dues of 1.3%.

Our total monthly EFT revenue has increased by
$10.1 million or 88.6% from $11.4 million in December,
1999 to $21.5 million in December, 2003. While we
strongly encourage monthly EFT memberships, approximately 7% of
our members (often corporate group members) purchase
paid-in-full memberships for a one year term.

Ancillary Revenue

Over the past five years we have expanded the
level of ancillary services provided to our members. Ancillary
revenue has increased by $28.7 million from
$17.3 million in 1999 to $46.0 million in 2003.
Increases in personal training revenue in particular have
contributed to $18.9 million of the increase in ancillary
revenue from 1999 to 2003. In addition the Company has added
Sports Club for Kids and Group Exclusives (both additional fee
for service programs) at selected clubs. Ancillary revenue as a
percentage of total revenue has increased from 10.9% for the
year ended December 31, 1999 to 13.4% for the year ended

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December 31, 2003. Personal training revenue
as a percentage of sales increased from 7.7% of revenue in 1999
to 9.1% of revenue in 2003.


Club Format and Locations

Our clubs are typically located in
well-established, higher-income residential, commercial or mixed
urban neighborhoods within major metropolitan areas which are
capable of supporting the development of a cluster of clubs. Our
clubs generally have relatively high retail
visibility, and close proximity to transportation. In the New
York City, Boston and Washington, DC markets, we have created
clusters of clubs in urban areas and their commuter suburbs in
accordance with our operating strategy of offering our target
members the convenience of multiple locations close to where
they live and work, reciprocal use privileges and standardized
facilities and services. We have begun establishing a similar
cluster in Philadelphia.

Approximately half of the clubs we operate are
urban clubs while half are suburban. Our urban clubs generally
range in size from 15,000 to 25,000 square feet and average
approximately 20,000 square feet. Our suburban clubs vary in
size from 15,000 square feet to 75,000 square feet, with one
club being 200,000 square feet. Excluding this single large
club, the average suburban club is 25,000 square feet.
Membership for each club generally ranges from 2,000 to 4,500
members at maturity. Although club members represent a
cross-section of the population in a given geographic market,
our target member is college educated, between the ages of 21
and 50 and has an annual income of between $50,000 and $150,000.

Our facilities include state-of-the-art
cardiovascular equipment, including upright and recumbent bikes,
steppers, treadmills, and elliptical motion machines; strength
equipment and free weights, including Cybex, Icarian, Nautilus,
Free Motion, and Hammer Strength equipment; group exercise and
cycling studio(s); the Sportsclub Network entertainment system;
locker rooms, including shower facilities, towel service, and
other amenities such as, saunas and steamrooms; babysitting, and
a retail shop. Personal training services are offered at all
locations and massage is offered at most clubs, each at an
additional charge. At certain flagship locations, additional
facilities also are offered, including swimming pools, racquet
and basketball courts. Also, we have significantly expanded the
availability of fee-based programming at many of our clubs,
including programs targeted at children, members and non-member
adult customers.

We have completed the launch of our Xpressline
strength workout. Xpressline is a trainer-supervised,
eight-station total-body circuit workout designed to accommodate
all fitness levels. This service is a free service provided to
our members. We have also introduced FitMap, which is a visual
tool that provides our members with guidance on how to use our
equipment through safe progressions of difficulty.

We have over 5,000 Sportsclub Network personal
entertainment units installed in our clubs. The units are
typically mounted on cardiovascular equipment and are equipped
with a color screen for television viewing, a compact disk
player and most models have audio cassette players. The
Sportsclub Network also broadcasts our own personalized music
video channel that provides us with a direct means of
advertising products and services to our membership base.

Club Services and Operations

We emphasize consistency and quality in all of
our club operations, including:

Management.We
believe that our success is largely dependent on the selection
and training of our staff and management. Our management
structure is designed, therefore, to support the professional
development of highly motivated managers who will execute our
directives and support growth.

Corporate departments are responsible for each
area of club services, such as exercise group programs, fitness
programming, personal training, facility and equipment
maintenance, housekeeping and laundry. This centralization
allows local general managers at each club to focus on customer
service, club staffing and providing a high quality exercise
experience. General managers are responsible for the day-to-day
manage-

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ment of each club, and directly report to
district managers, who liaise with senior operations management
and other corporate staff ensuring consistent service at all
locations.


Personal Training.All of our fitness clubs offer
one-on-one personal training, which is sold by the single
session or in multi-session packages. We have implemented a
comprehensive staff education curriculum which progresses from
basic knowledge and practical skills to advanced concepts and
training techniques. Our education program provides professional
standards to ensure that our trainers provide superior service
and fitness expertise to our members. There are four levels of
professional competency for which different levels of
compensation are paid, with mandatory requirements trainers must
meet in order to achieve and maintain such status. We believe
the qualifications of the personal training staff helps ensure
that members receive a consistent level of quality service
throughout our club base. We believe that our personal training
programs provide valuable guidance to our members and a
significant source of incremental revenue from value-added
services. In addition, we believe that members who participate
in personal training programs have a longer membership life.

Group Fitness.Our
commitment to providing a quality workout experience to our
members extends to the employment of program instructors, who
teach aerobics, cycling, strength conditioning, boxing, yoga,
pilates and step aerobics classes, among others. Our clustering
strategy enables us to staff program instructors and
professional personal trainers at more than one club. As a
result, we can vary a given clubs instructors, while
providing instructors sufficient classes to effectively and
economically treat these instructors as full-time employees. All
program instructors report to a centralized management
structure, headed by the Vice President of Programs and Services
whose department is responsible for overseeing auditions and
providing in-house training to keep instructors current in the
latest training techniques and program offerings. We also
provide Group Exclusive offerings to our members, which are
for-fee based programs that have smaller groups and provide more
focused, and typically more advanced training classes. Some
examples of these offerings include: Pilates, boxing camps, and
cycling.

Sports Clubs for
Kids.During 2000, we began offering
programs for children under the Sports Club for Kids
(SCFK) brand. As of December 2003, SCFK was
operating in 15 locations throughout our NYSC, BSC, and PSC
regions. In addition to extending fitness offerings to a market
not previously served by us, we expect that SCFK programming
will help position our suburban clubs as family clubs, which
should provide us with a competitive advantage. Depending upon
the facilities available at a location, Sports Clubs for Kids
programming can include traditional youth offerings such as day
camps, sports camps, swim lessons, hockey and soccer leagues,
gymnastics, dance, martial arts and birthday parties. It also
can include innovative and proprietary programming such as
Kidspin Theater, a multi-media cycling experience, and
non-competitive learn-to-play sports programs. In
selected locations we also offer laser tag.

Employee Compensation and
Benefits.We provide performance-based
incentives to our management. Senior management compensation,
for example, is tied to our overall performance. Departmental
directors, district managers and general managers have bonuses
tied to financial and member retention targets for a particular
club or group of clubs. We offer our employees various benefits
including; health, dental, disability, insurance, pre-tax
healthcare and dependent care accounts, and a 401(k) plan. We
believe the availability of employee benefits provides us with a
strategic advantage in attracting and retaining quality
managers, program instructors and professional personal trainers
and that this strategic advantage in turn translates into a more
consistent and higher quality workout experience for those
members who utilize such services.

Proprietary Centralized Information
Systems

We are utilizing a proprietary system developed
internally to track and analyze sales, leads, and membership
statistics, the frequency of member workouts, multi-club
utilization, value-added services and demographic profiles by
member, which enables us to develop targeted direct marketing
programs and to modify our broadcast and print advertising to
improve consumer response. This system also assists us in
evaluating staffing needs and program offerings. In addition, we
rely on certain data gathered through our information systems to
assist in the identification of new markets for clubs and site
selection within those markets.

7



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##### Table of Contents



Information System Developments

We recognize the value of enhancing and extending
the uses of information technology in virtually every area of
our business. After developing an information technology
strategy to support the business strategy, we developed a
comprehensive multi-year plan to replace or upgrade key systems.

During 2001, we implemented a new time capture
system that integrates with our payroll processing system. This
system integrates with the new club management system to fully
automate the various compensation plans for all employees. In
addition, during 2002, we implemented a new budgeting and
forecasting product that was expanded in 2003 for data
warehousing capabilities which will enable enhanced managerial
and analytical reporting. We implemented application and
telephone systems to manage our internal customer service center
which supports information technology, facilities, equipment and
Sportsclub Network service call requests for all locations.
Numerous infrastructure changes were implemented to accommodate
our growth, to provide network redundancy, efficiencies in
operations, and to improve management of all components of the
technical architecture.

In 2003 we implemented a new fully integrated
club management system. This system incorporates contemporary
browser-based technology and open architecture to allow for
scalability to support our projected growth and diversification
of services. This system provides enhanced or new functionality
for member services, contract management, electronic billing,
point of sale, scheduling resources, and reservations.

Our website will be expanded in 2004 to
incorporate e-business functionality such as sales of products,
services and memberships. We have built an intranet to provide
the portal for the newly implemented browser-based application.
Development of intranet features to support corporate
communications, human resources programs, and training is
ongoing.

In 2004, we will also implement an updated
Disaster Recovery plan that will include a designated hot
site, recovery procedures, data restoration testing, and
training of personnel.

Strategic Planning

During 2001, the Company began a strategic
planning process. That process, spearheaded by the Chairman and
the Chief Executive Officer, produced a new set of Core Values,
a revised Mission Statement and a set of five-year performance
targets. In 2002, more than 40 projects were completed in
support of the Plans Strategic Initiatives and Objectives.
Our Chairman and Chief Executive led the strategy process, which
produced significant changes in our approach to our Brand, our
Core Business Development process and our Intranet strategy.

The Strategic Plan was updated in 2003 with new
Strategic Initiatives in several areas. Senior Management
continues to support the Strategic Planning process and believes
that accomplishing our strategic objectives will cause us to
attain the five-year performance targets outlined in the 2003
Plan.

Intellectual Property

We have registered, various trademarks and
service marks with the U.S. Patent and Trademark Office,
including New York Sports Clubs, Washington Sports Clubs,
Boston Sports Clubs, Philadelphia Sports Clubs, TSI,and
Town Sports International, Inc.We continue to register
other trademarks and service marks as they are created.

Competition

The fitness club industry is highly competitive
and continues to become more competitive as the number of health
clubs in the U.S. has increased from 12,146 in 1991 to 20,207 in
2002. We compete with other fitness clubs, physical fitness and
recreational facilities established by local governments and
hospitals and by businesses for their employees, amenity and
condominium clubs, the YMCA and similar organizations and, to a
certain extent, with racquet and tennis and other athletic
clubs, country clubs, weight reducing salons and the home-use
fitness equipment industry. We also compete with other
entertainment and retail businesses for

8



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##### Table of Contents



the discretionary income of our target markets.
There can be no assurance that we will be able to compete
effectively in the future in the markets in which we operate.
Competitors, which may include companies which are larger and
have greater resources than we have, may enter these markets to
our detriment. These competitive conditions may limit our
ability to increase dues without a material loss in membership,
attract new members and attract and retain qualified personnel.
Additionally, consolidation in the fitness club industry could
result in increased competition among participants, particularly
large multi-facility operators that are able to compete for
attractive acquisition candidates, and real estate availability
thereby increasing costs associated with expansion through both
acquisitions, and greenfields.


We believe that our market leadership, experience
and operating efficiencies enable us to provide the consumer
with a superior product in terms of convenience, quality service
and affordability. We believe that there are significant
barriers to entry in our urban markets, including restrictive
zoning laws, lengthy permit processes and a shortage of
appropriate real estate, which could discourage any large
competitor from attempting to open a chain of clubs in these
markets. However, such a competitor could enter these markets
more easily through one or a series of acquisitions.

Employees

At December 31, 2003, the Company had
approximately 7,200 employees, of which approximately 2,750 were
employed full-time. Approximately 325 employees were corporate
personnel working in the Manhattan, Boston or Washington, DC
offices. We are not a party to any collective bargaining
agreement with our employees. We have never experienced any
significant labor shortages nor had any difficulty in obtaining
adequate replacements for departing employees and consider our
relations with our employees to be good. We believe that we
offer employee benefits (including health, dental, disability
insurance, pre-tax healthcare and dependent care accounts, and a
401(k) plan) which are superior to those generally offered by
our competitors.

Government Regulation

Our operations and business practices are subject
to regulation at the federal, state and, in some cases, local
levels. State and local consumer protection laws and regulations
govern our advertising, sales and other trade practices.

Statutes and regulations affecting the fitness
industry have been enacted in states in which we conduct
business; many other states into which we may expand have
adopted or likely will adopt similar legislation. Typically,
these statutes and regulations prescribe certain forms and
provisions of membership contracts, afford members the right to
cancel the contract within a specified time period after
signing, require an escrow of funds received from pre-opening
sales or the posting of a bond or proof of financial
responsibility, and may establish maximum prices for membership
contracts and limitations on the term of contracts. In addition,
we are subject to numerous other types of federal and state
regulations governing the sale of memberships. These laws and
regulations are subject to varying interpretations by a number
of state and federal enforcement agencies and the courts. We
maintain internal review procedures in order to comply with
these requirements, and believe that our activities are in
substantial compliance with all applicable statutes, rules and
decisions.

Under so-called state cooling-off
statutes, a member has the right to cancel his or her membership
for a period of three to ten days (depending on the applicable
state law) and, in such event, is entitled to a refund of any
initiation fee paid. In addition, our membership contracts
provide that a member may cancel his or her membership at any
time for medical reasons or relocation a certain distance from
the nearest club. The specific procedures for cancellation in
these circumstances vary due to differing state laws. In each
instance, the canceling member is entitled to a refund of
prepaid amounts only. Furthermore, where permitted by law, a
cancellation fee is due upon cancellation and we may offset such
amount against any refunds owed.

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FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on our
Form 10-K for the year ended December 31, 2003 are
forward-looking statements, including, without limitation,
statements regarding future financial results and performance,
potential sales revenue, legal contingencies and tax benefits.
These statements are subject to various risks and uncertainties,
many of which are outside of our control, including the level of
market demand for our services, competitive pressures, the
ability to achieve reductions in operating costs and to continue
to integrate acquisitions, environmental matters, the
application of Federal and state tax laws and regulations, and
other specific factors discussed herein and in other Securities
and Exchange Commission filings by us. The information contained
herein represents our best judgement as of the date hereof based
on information currently available; however, we do not intend to
update this information except as required by law, to reflect
development or information obtained after the date hereof and
disclaim any legal obligation to the contrary.






|        |           
|------- | ----------
|Item 2. | Properties

The following table provides information
regarding our club locations:

|                       |               |         |                          |                           |  |                 | 
|---------------------- | ------------- | ------- | ------------------------ | ------------------------- |  | --------------- | 
|                       |               |         |                          | Date Opened or Management
|Location               |               | Address |                          | Assumed                  
|                      
|                      
|New York Sports Clubs: |               |         |                          |                           |  |                
|                       | 1. Manhattan  |         | 151 East 86th Street     |                           |  | January, 1977   | 
|                       | 2. Manhattan  |         | 61 West 62nd Street      |                           |  | July, 1983      | 
|                       | 3. Manhattan  |         | 614 Second Avenue        |                           |  | July, 1986      | 
|                       | 4. Manhattan  |         | 151 Reade Street         |                           |  | January, 1990   | 
|                       | 5. Manhattan  |         | 1601 Broadway            |                           |  | September, 1991 | 
|                       | 6. Manhattan  |         | 50 West 34th Street      |                           |  | August, 1992    | 
|                       | 7. Manhattan  |         | 349 East 76th Street     |                           |  | April, 1994     | 
|                       | 8. Manhattan  |         | 248 West 80th Street     |                           |  | May, 1994       | 
|                       | 9. Manhattan  |         | 502 Park Avenue          |                           |  | February, 1995  | 
|                       | 10. Manhattan |         | 117 Seventh Avenue South |                           |  | March, 1995     | 
|                       | 11. Manhattan |         | 303 Park Avenue South    |                           |  | December, 1995  | 
|                       | 12. Manhattan |         | 30 Wall Street           |                           |  | May, 1996       | 
|                       | 13. Manhattan |         | 1635 Third Avenue        |                           |  | October, 1996   | 
|                       | 14. Manhattan |         | 575 Lexington Avenue     |                           |  | November, 1996  | 
|                       | 15. Manhattan |         | 278 Eighth Avenue        |                           |  | December, 1996  | 
|                       | 16. Manhattan |         | 200 Madison Avenue       |                           |  | February, 1997  | 
|                       | 17. Manhattan |         | 131 East 31st Street     |                           |  | February, 1997  | 
|                       | 18. Manhattan |         | 2162 Broadway            |                           |  | November, 1997  | 
|                       | 19. Manhattan |         | 633 Third Avenue         |                           |  | April, 1998     | 
|                       | 20. Manhattan |         | 1657 Broadway            |                           |  | July, 1998      | 
|                       | 21. Manhattan |         | 217 Broadway             |                           |  | March, 1999     | 
|                       | 22. Manhattan |         | 23 West 73rd Street      |                           |  | April, 1999     | 
|                       | 23. Manhattan |         | 34 West 14th Street      |                           |  | July, 1999      | 
|                       | 24. Manhattan |         | 503-511 Broadway         |                           |  | July, 1999      | 
|                       | 25. Manhattan |         | 1372 Broadway            |                           |  | October, 1999   | 
|                       | 26. Manhattan |         | 300 West 125th Street    |                           |  | May, 2000       | 
|                       | 27. Manhattan |         | 102 North End Avenue     |                           |  | May, 2000       | 
|                       | 28. Manhattan |         | 14 West 44th Street      |                           |  | August, 2000    | 
|                       | 29. Manhattan |         | 128 Eighth Avenue        |                           |  | December, 2000  | 
|                       | 30. Manhattan |         | 2521-23 Broadway         |                           |  | August, 2001    | 
|                       | 31. Manhattan |         | 3 Park Avenue            |                           |  | August, 2001    | 
|                       | 32. Manhattan |         | 19 Irving Place          |                           |  | November, 2001  | 

10



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|                         |  |                               |  |                           |                 | 
|------------------------ |  | ----------------------------- |  | ------------------------- | --------------- | 
|                         |  |                               |  | Date Opened or Management
|Location                 |  | Address                       |  | Assumed                  
|                        
|                        
|33. Manhattan            |  | 160 Water Street              |  |                           | November, 2001  | 
|34. Manhattan            |  | 230 West 41st Street          |  |                           | November, 2001  | 
|35. Manhattan            |  | 1221 Avenue of the Americas   |  |                           | January, 2002   | 
|36. Manhattan            |  | 200 Park Avenue               |  |                           | December, 2002  | 
|37. Brooklyn, NY         |  | 110 Boerum Place              |  |                           | October, 1985   | 
|38. Brooklyn, NY         |  | 1736 Shore Parkway            |  |                           | June, 1998      | 
|39. Brooklyn, NY         |  | 179 Remsen Street             |  |                           | May, 2001       | 
|40. Brooklyn, NY         |  | 453 Fifth Avenue              |  |                           | August, 2003    | 
|41. Queens, NY           |  | 69-33 Austin Street           |  |                           | April, 1997     | 
|42. Queens, NY           |  | 153-67 A Cross Island Parkway |  |                           | June, 1998      | 
|43. Queens, NY           |  | 2856-2861 Steinway Street     |  |                           | February, 2004  | 
|44. Staten Island, NY    |  | 300 West Service Road         |  |                           | June, 1998      | 
|45. Scarsdale, NY        |  | 696 White Plains Road         |  |                           | October, 1995   | 
|46. Mamaroneck, NY       |  | 124 Palmer Avenue             |  |                           | January, 1997   | 
|47. White Plains, NY     |  | 1 North Broadway              |  |                           | September, 1997 | 
|48. Croton-on-Hudson, NY |  | 420 South Riverside Drive     |  |                           | January, 1998   | 
|49. Larchmont, NY        |  | 15 Madison Avenue             |  |                           | December, 1998  | 
|50. Nanuet, NY           |  | 58 Demarest Mill Road         |  |                           | May, 1998       | 
|51. Great Neck, NY       |  | 15 Barstow Road               |  |                           | July, 1989      | 
|52. East Meadow, NY      |  | 625 Merrick Avenue            |  |                           | January, 1999   | 
|53. Commack, NY          |  | 6136 Jericho Turnpike         |  |                           | January, 1999   | 
|54. Oceanside, NY        |  | 2909 Lincoln Avenue           |  |                           | May, 1999       | 
|55. Long Beach, NY       |  | 265 East Park Avenue          |  |                           | July, 1999      | 
|56. Garden City, NY      |  | 833 Franklin Avenue           |  |                           | May, 2000       | 
|57. Huntington, NY       |  | 350 New York Avenue           |  |                           | February, 2001  | 
|58. Syosset, NY          |  | 49 Ira Road                   |  |                           | March, 2001     | 
|59. West Nyack, NY       |  | 3656 Palisades Center Drive   |  |                           | February, 2002  | 
|60. Woodmere, NY         |  | 158 Irving Street             |  |                           | March, 2002     | 
|61. Stamford, CT         |  | 6 Landmark Square             |  |                           | December, 1997  | 
|62. Stamford, CT         |  | 16 Commerce Road              |  |                           | January, 1998   | 
|63. Danbury, CT          |  | 38 Mill Plain Road            |  |                           | January, 1998   | 
|64. Stamford, CT         |  | 1063 Hope Street              |  |                           | November, 1998  | 
|65. Norwalk, CT          |  | 250 Westport Avenue           |  |                           | March, 1999     | 
|66. Greenwich, CT        |  | 6 Liberty Way                 |  |                           | May, 1999       | 
|67. Westport, CT         |  | 427 Post Road, East           |  |                           | January, 2002   | 
|68. Greenwich, CT        |  | 67 Mason Street               |  |                           | February, 2004  | 
|69. East Brunswick, NJ   |  | 8 Cornwall Court              |  |                           | January, 1990   | 
|70. Princeton, NJ        |  | 301 North Harrison Street     |  |                           | May, 1997       | 
|71. Freehold, NJ         |  | 200 Daniels Way               |  |                           | April, 1998     | 
|72. Matawan, NJ          |  | 163 Route 34                  |  |                           | April, 1998     | 
|73. Old Bridge, NJ       |  | Gaub Road and Route 516       |  |                           | April, 1998     | 
|74. Marlboro, NJ         |  | 34 Route 9 North              |  |                           | April, 1998     | 
|75. Fort Lee, NJ         |  | 1355 15th Street              |  |                           | June, 1998      | 
|76. Ramsey, NJ           |  | 1100 Route 17 North           |  |                           | June, 1998      | 
|77. Mahwah, NJ           |  | 7 Leighton Place              |  |                           | June, 1998      | 
|78. Parsippany, NJ       |  | 2651 Route 10                 |  |                           | August, 1998    | 
|79. Springfield, NJ      |  | 215 Morris Avenue             |  |                           | August, 1998    | 

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|                         |                         |         |                                     |                           |  |                 | 
|------------------------ | ----------------------- | ------- | ----------------------------------- | ------------------------- |  | --------------- | 
|                         |                         |         |                                     | Date Opened or Management
|Location                 |                         | Address |                                     | Assumed                  
|                        
|                        
|                         | 80. Colonia, NJ         |         | 1250 Route 27                       |                           |  | August, 1998    | 
|                         | 81. Franklin Park, NJ   |         | 3911 Route 27                       |                           |  | August, 1998    | 
|                         | 82. Plainsboro, NJ      |         | 10 Schalks Crossing                 |                           |  | August, 1998    | 
|                         | 83. Somerset, NJ        |         | 120 Cedar Grove Lane                |                           |  | August, 1998    | 
|                         | 84. Hoboken, NJ         |         | 221 Washington Street               |                           |  | October, 1998   | 
|                         | 85. West Caldwell, NJ   |         | 913 Bloomfield Avenue               |                           |  | April, 1999     | 
|                         | 86. Jersey City, NJ     |         | 147 Two Harborside Financial Center |                           |  | June, 2002      | 
|                         | 87. Newark, NJ          |         | 1 Gateway Center                    |                           |  | October, 2002   | 
|                         | 88. Ridgewood, NJ       |         | 129 S. Broad Street                 |                           |  | June, 2003      | 
|                         | 89. Westwood, NJ        |         | 35 Jefferson Avenue                 |                           |  | Opening 2004    | 
|                         | 90. Livingston, NJ      |         | 39 W. North Field Rd.               |                           |  | Opening 2004    | 
|Boston Sports Clubs:     |                         |         |                                     |                           |  |                
|                         | 91. Boston, MA          |         | 561 Boylston Street                 |                           |  | November, 1991  | 
|                         | 92. Allston, MA         |         | 15 Gorham Street                    |                           |  | July, 1997      | 
|                         | 93. Boston, MA          |         | 1 Bulfinch Place                    |                           |  | August, 1998    | 
|                         | 94. Natick, MA          |         | Sherwood Plaza, 124 Worcester Rd    |                           |  | September, 1998 | 
|                         | 95. Weymouth, MA        |         | 553 Washington Street               |                           |  | May, 1999       | 
|                         | 96. Boston, MA          |         | 201 Brookline Avenue                |                           |  | June, 2000      | 
|                         | 97. Wellesley, MA       |         | 140 Great Plain Avenue              |                           |  | July, 2000      | 
|                         | 98. Andover, MA         |         | 307 Lowell Street                   |                           |  | July, 2000      | 
|                         | 99. Lynnfield, MA       |         | 425 Walnut Street                   |                           |  | July, 2000      | 
|                         | 100. Lexington, MA      |         | 475 Bedford Avenue                  |                           |  | July, 2000      | 
|                         | 101. Franklin, MA       |         | 750 Union Street                    |                           |  | July, 2000      | 
|                         | 102. Framingham, MA     |         | 1657 Worcester Street               |                           |  | July, 2000      | 
|                         | 103. Danvers, MA        |         | 50 Ferncroft Road                   |                           |  | July, 2000      | 
|                         | 104. Cambridge, MA      |         | 625 Massachusetts Avenue            |                           |  | January, 2001   | 
|                         | 105. East Cambridge, MA |         | 6 Museum Way                        |                           |  | January, 2001   | 
|                         | 106. Boston, MA         |         | 361 Newbury Street                  |                           |  | November, 2001  | 
|                         | 107. West Newton, MA    |         | 1359 Washington Street              |                           |  | November, 2001  | 
|                         | 108. Boston, MA         |         | 350 Washington Street               |                           |  | February, 2002  | 
|                         | 109. Waltham, MA        |         | 840 Winter Street                   |                           |  | November, 2002  | 
|Washington Sports Clubs: |                         |         |                                     |                           |  |                
|                         | 110. Washington, D.C.   |         | 214 D Street, S.E.                  |                           |  | January, 1980   | 
|                         | 111. Washington, D.C.   |         | 1835 Connecticut Avenue, N.W.       |                           |  | January, 1990   | 
|                         | 112. Washington, D.C.   |         | 1990 M Street, N.W.                 |                           |  | February, 1993  | 
|                         | 113. Washington, D.C.   |         | 2251 Wisconsin Avenue, N.W.         |                           |  | May, 1994       | 
|                         | 114. Washington, D.C.   |         | 1211 Connecticut Avenue, N.W.       |                           |  | July, 2000      | 
|                         | 115. Washington, D.C.   |         | 1345 F Street, N.W.                 |                           |  | August, 2002    | 
|                         | 116. Washington, D.C.   |         | 5346 Wisconsin Ave., N.W.           |                           |  | February, 2002  | 
|                         | 117. Washington, D.C.   |         | 1990 K Street, N.W.                 |                           |  | February, 2004  | 
|                         | 118. Washington, D.C.   |         | 7th & H Street, N.W.                |                           |  | Opening 2004    | 
|                         | 119. Bethesda, MD       |         | 4903 Elm Street                     |                           |  | May, 1994       | 
|                         | 120. North Bethesda, MD |         | 10400 Old Georgetown Road           |                           |  | June, 1998      | 
|                         | 121. Germantown, MD     |         | 12623 Wisteria Drive                |                           |  | July, 1998      | 
|                         | 122. Silver Spring, MD  |         | Wayne Ave                           |                           |  | Opening 2004    | 
|                         | 123. Alexandria, VA     |         | 3654 King Street                    |                           |  | June, 1999      | 
|                         | 124. Sterling, VA       |         | 21800 Town Center Plaza             |                           |  | October, 1999   | 

12



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##### Table of Contents



|                           |                           |         |                            |                           |  |                 | 
|-------------------------- | ------------------------- | ------- | -------------------------- | ------------------------- |  | --------------- | 
|                           |                           |         |                            | Date Opened or Management
|Location                   |                           | Address |                            | Assumed                  
|                          
|                          
|                           | 125. Fairfax, VA          |         | 11001 Lee Highway          |                           |  | October, 1999   | 
|                           | 126. West Springfield, VA |         | 8430 Old Keene Mill        |                           |  | September, 2000 | 
|                           | 127. Clarendon, VA        |         | 2700 Clarendon Boulevard   |                           |  | November, 2001  | 
|Philadelphia Sports Clubs: |                           |         |                            |                           |  |                
|                           | 128. Philadelphia, PA     |         | 220 South 5th Street       |                           |  | January, 1999   | 
|                           | 129. Philadelphia, PA     |         | 2000 Hamilton Street       |                           |  | July, 1999      | 
|                           | 130. Chalfont, PA         |         | One Highpoint Drive        |                           |  | January, 2000   | 
|                           | 131. Cherry Hill, NJ      |         | Route 70 and Kings Highway |                           |  | April, 2000     | 
|                           | 132. Philadelphia, PA     |         | 1735 Market Street         |                           |  | October, 2000   | 
|                           | 133. Ardmore, PA          |         | 34 W. Lancaster Avenue     |                           |  | March, 2002     | 
|Swiss Sports Clubs:        |                           |         |                            |                           |  |                
|                           | 134. Basel, Switzerland   |         | St. Johanns-Vorstadt 41    |                           |  | August, 1987    | 
|                           | 135. Zurich, Switzerland  |         | Glarnischstrasse 35        |                           |  | August, 1987    | 
|                           | 136. Basel, Switzerland   |         | Basel FC Soccer Stadium    |                           |  | August, 2001    | 



---



| | 
| | 
| | 



| |                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have also signed two leases for greenfield
    club development. These locations are, however, part of
    development projects and are subject to various conditions,
    including delivery of the space as specified in the lease.

13



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##### Table of Contents



We own the 151 East 86th Street location,
which houses a fitness club and a retail tenant that generated
$614,000 of rental income for us during the year ended
December 31, 2003. Our fitness clubs occupy leased space
pursuant to long-term leases (generally 15 to 25 years,
including options). In the next five years (ending
December 31, 2008), only one of our fitness club leases
will expire without any renewal option.

We lease approximately 40,000 square feet of
office space in New York City, and have smaller regional offices
in Fairfax, VA, East Brunswick, NJ, Old Bridge, NJ,
Philadelphia, PA, Stamford, CT and Wakefield, MA, for
administrative and general corporate purposes. We also lease
warehouse and commercial space in Long Island City, New York, NY
and Brooklyn, NY, for storage purposes and for the operation of
a centralized laundry facility for certain New York fitness
clubs.

As of December 31, 2003, 127 of the existing
fitness clubs were wholly owned by us and two were managed and
partly owned (the Partly Owned Clubs). In addition,
we provide management services at two fitness clubs in which we
have no equity interest.




Item 3.  Legal
Proceedings

On February 13, 2003, an individual filed
suit against us in the Supreme Court, New York County, alleging
that on January 14, 2003, he sustained an injury at one of
our club locations resulting in serious bodily injury. He filed
an amended complaint on September 17, 2003 seeking two
billion dollars in damages for personal injuries. His cause of
action seeking punitive damages in the amount of two hundred and
fifty million dollars was dismissed on January 26, 2004. We
have in force fifty one million dollars of insurance coverage to
cover claims of this nature. We intend to vigorously contest
this lawsuit and presently anticipate that these matters will be
covered by insurance.

We are a party to various lawsuits arising in the
normal course of business. We believe that the ultimate outcome
of these matters will not have a material adverse effect on our
business, results of operations, cash flows, or financial
condition.




Item 4.  Submission of
Matters to a Vote of Security Holders

Not applicable.




PART II




Item 5.  Market for
Registrants Common Equity and Related Shareholder
Matters

Not applicable.

14



---



##### Table of Contents






Item 6.  Selected Financial
Data

SELECTED HISTORICAL CONSOLIDATED FINANCIAL
DATA

(In thousands, except club and membership
data)


Set forth below is our selected historical
consolidated financial, other operating data and club and
membership data as of the dates and for the periods presented.
The selected historical consolidated statement of operations
data for the years ended December 31, 2001, 2002, and 2003
and the selected historical consolidated balance sheet data as
of December 31, 2002 and 2003, were derived from the
audited Consolidated Financial Statements, which are included
herein. The selected historical consolidated statement of
operations data for the year ended December 31, 1999 and
2000 and the selected historical consolidated balance sheet data
as of December 31, 1999, 2000 and 2001 were derived from
our audited consolidated financial statements of the Company,
which are not included herein. The information contained in this
table and accompanying notes should be read in conjunction with
Managements Discussion and Analysis of Financial
Condition and Results of Operations and the Consolidated
Financial Statements and accompanying notes thereto appearing
elsewhere herein.

|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |         |  
|---------------------------------------------------------------------------------------------------------------------------------- | -------------------------------- | ----------------------- | ------- | ------- | - | ---- | ------- | ------- | - | ---- | ------- | ------- | - | - | ------- | ------- | - | - | ------- | ------- | -
|                                                                                                                                   |                                  |                        
|                                                                                                                                   |                                  | Year Ended December 31,
|                                                                                                                                   |                                  |                        
|                                                                                                                                   |                                  | 1999                    |         | 2000    |   | 2001 |         | 2002    |   | 2003
|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |     
|Statement of Operations Data:                                                                                                      |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Revenues                                                                                                                           |                                  | $                       | 158,184 |         |   | $    | 223,828 |         |   | $    | 281,633 |         |   | $ | 319,427 |         |   | $ | 342,541 |        
|Operating expenses:                                                                                                                |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                                                                   | Payroll and related              |                         |         | 63,838  |   |      |         | 90,801  |   |      |         | 112,766 |   |   |         | 129,105 |   |   |         | 130,585 |  
|                                                                                                                                   | Club operating                   |                         |         | 52,048  |   |      |         | 68,806  |   |      |         | 88,941  |   |   |         | 99,113  |   |   |         | 111,069 |  
|                                                                                                                                   | General and administrative       |                         |         | 10,797  |   |      |         | 14,626  |   |      |         | 18,785  |   |   |         | 21,368  |   |   |         | 21,995  |  
|                                                                                                                                   | Depreciation and amortization(1) |                         |         | 20,513  |   |      |         | 26,248  |   |      |         | 32,185  |   |   |         | 31,748  |   |   |         | 34,927  |  
|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Operating income                                                                                                                   |                                  |                         | 10,988  |         |   |      | 23,347  |         |   |      | 28,956  |         |   |   | 38,093  |         |   |   | 43,965  |        
|Loss on extinguishment of debt(2)                                                                                                  |                                  |                         |        |         |   |      |        |         |   |      |        |         |   |   |        |         |   |   | 7,773   |        
|Interest expense, net of interest income                                                                                           |                                  |                         | 10,243  |         |   |      | 13,120  |         |   |      | 14,527  |         |   |   | 16,421  |         |   |   | 23,226  |        
|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Income from continuing operations before
    provision for corporate income tax                                                    |                                  |                         | 745     |         |   |      | 10,227  |         |   |      | 14,429  |         |   |   | 21,672  |         |   |   | 12,966  |        
|Provision for corporate income tax                                                                                                 |                                  |                         | 622     |         |   |      | 5,031   |         |   |      | 6,853   |         |   |   | 9,709   |         |   |   | 5,537   |        
|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Income from continuing operations                                                                                                  |                                  |                         | 123     |         |   |      | 5,196   |         |   |      | 7,576   |         |   |   | 11,963  |         |   |   | 7,429   |        
|Loss from discontinued operations of closed
    clubs(3) (including loss on club closure of $996 in 2002), net
    of income taxes |                                  |                         | (74     | )       |   |      | (365    | )       |   |      | (530    | )       |   |   | (767    | )       |   |   |        |        
|Cumulative effect of a change in accounting
    principle, net of income tax
    benefit of $612(4)                                |                                  |                         |        |         |   |      |        |         |   |      |        |         |   |   | (689    | )       |   |   |        |        
|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Net income                                                                                                                         |                                  |                         | 49      |         |   |      | 4,831   |         |   |      | 7,046   |         |   |   | 10,507  |         |   |   | 7,429   |        
|Accreted dividends on preferred stock                                                                                              |                                  |                         | (7,880  | )       |   |      | (9,016  | )       |   |      | (10,201 | )       |   |   | (11,543 | )       |   |   | (10,984 | )      
|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Net loss attributable to common stockholders                                                                                       |                                  | $                       | (7,831  | )       |   | $    | (4,185  | )       |   | $    | (3,155  | )       |   | $ | (1,036  | )       |   | $ | (3,555  | )      
|                                                                                                                                   |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Other Data:                                                                                                                        |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|Non-cash rental lease expense, net of non-cash
    income                                                                          |                                  | $                       | 3,061   |         |   | $    | 2,976   |         |   | $    | 4,224   |         |   | $ | 1,670   |         |   | $ | 1,650   |        
|Cash provided by (used in):                                                                                                        |                                  |                         |         |         |   |      |         |         |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                                                                   | Operating activities             |                         |         | 29,496  |   |      |         | 40,573  |   |      |         | 44,348  |   |   |         | 50,805  |   |   |         | 58,253  |  
|                                                                                                                                   | Investing activities             |                         |         | (55,078 | ) |      |         | (70,048 | ) |      |         | (58,358 | ) |   |         | (40,182 | ) |   |         | (42,734 | )
|                                                                                                                                   | Financing activities             |                         |         | 33,553  |   |      |         | 5,715   |   |      |         | 16,103  |   |   |         | (10,530 | ) |   |         | 19,732  |  

15



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##### Table of Contents



|                                                        |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                        |  |                        
|                                                        |  | Year Ended December 31,
|                                                        |  |                        
|                                                        |  | 1999                    |         | 2000 |  | 2001 |         | 2002 |  | 2003
|                                                        |  |                         |         |      |  |      |         |      |  |     
|Club and Membership Data:                               |  |                         |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|New clubs opened(5)                                     |  |                         | 14      |      |  |      | 9       |      |  |      | 12      |   |  |   | 8       |   |  |   | 3       |  
|Clubs acquired(5)                                       |  |                         | 4       |      |  |      | 11      |      |  |      | 2       |   |  |   | 4       |   |  |   |        |  
|Closed, relocated or sold clubs                         |  |                         | (1      | )    |  |      | (1      | )    |  |      |        |   |  |   | (2      | ) |  |   | (3      | )
|Wholly-owned clubs operated at
    end of period(5)     |  |                         | 82      |      |  |      | 103     |      |  |      | 117     |   |  |   | 127     |   |  |   | 127     |  
|Total clubs operated at end of period(6)                |  |                         | 86      |      |  |      | 105     |      |  |      | 119     |   |  |   | 129     |   |  |   | 129     |  
|Members at end of period(7)                             |  |                         | 203,000 |      |  |      | 278,000 |      |  |      | 317,000 |   |  |   | 342,000 |   |  |   | 342,000 |  
|Mature club revenue increase(8)                         |  |                         | 16.0    | %    |  |      | 18.6    | %    |  |      | 12.3    | % |  |   | 4.1     | % |  |   | 1.6     | %
|Revenue per weighted average club
    (in thousands)(9) |  | $                       | 2,130   |      |  | $    | 2,428   |      |  | $    | 2,619   |   |  | $ | 2,606   |   |  | $ | 2,691   |  

|                                               |  |                    |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|---------------------------------------------- |  | ------------------ | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                               |  |                   
|                                               |  | As of December 31,
|                                               |  |                   
|                                               |  | 1999               |         | 2000 |  | 2001 |         | 2002 |  | 2003
|                                               |  |                    |         |      |  |      |         |      |  |     
|Balance Sheet Data:                            |  |                    |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         |  
|Working capital deficit(10)                    |  | $                  | (1,015  | )    |  | $    | (38,414 | )    |  | $    | (42,565 | ) |  | $ | (43,192 | ) |  | $ | (9,087  | )
|Total assets                                   |  |                    | 215,678 |      |  |      | 256,085 |      |  |      | 296,005 |   |  |   | 314,250 |   |  |   | 362,199 |  
|Long-term debt, including current installments |  |                    | 132,202 |      |  |      | 144,498 |      |  |      | 163,979 |   |  |   | 160,943 |   |  |   | 261,877 |  
|Redeemable senior preferred stock              |  |                    | 42,066  |      |  |      | 48,029  |      |  |      | 54,687  |   |  |   | 62,125  |   |  |   |        |  
|Redeemable Series A preferred stock(11)        |  |                    | 23,216  |      |  |      | 26,580  |      |  |      | 30,432  |   |  |   | 34,841  |   |  |   | 39,890  |  
|Total stockholders deficit                    |  | $                  | (28,813 | )    |  | $    | (30,491 | )    |  | $    | (32,797 | ) |  | $ | (31,740 | ) |  | $ | (34,294 | )




|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Effective January 1, 2002 we implemented
    Statement of Financial Accounting Standards (SFAS)
    No. 142 No. 142 (SFAS 142), Goodwill and
    Other Intangible Assets. In connection with this
    implementation we no longer amortize goodwill, but rather test
    it for impairment when circumstances indicate it is necessary,
    and at a minimum annually. A reconciliation of reported net
    income to net income adjusted for the impact of SFAS 142 is
    as follows for the presented periods:

|                       |  |                         |        |      |  |      |        |   |  |   |        |  
|---------------------- |  | ----------------------- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                       |  |                        
|                       |  | Year ended December 31,
|                       |  |                        
|                       |  | 1999                    |        | 2000 |  | 2001
|                       |  |                         |        |      |  |     
|Net income as reported |  | $                       | 49     |      |  | $    | 4,831  |   |  | $ | 7,046  |  
|Goodwill amortization  |  |                         | 2,845  |      |  |      | 3,545  |   |  |   | 4,436  |  
|Deferred tax benefit   |  |                         | (1,195 | )    |  |      | (1,064 | ) |  |   | (1,344 | )
|                       |  |                         |        |      |  |      |        |   |  |   |        |  
|Net income as adjusted |  | $                       | 1,699  |      |  | $    | 7,312  |   |  | $ | 10,138 |  
|                       |  |                         |        |      |  |      |        |   |  |   |        |  



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | The $7.8 million loss on extinguishment of debt
    recorded in 2003 is a result of the refinancing of our debt on
    April 16, 2003. In connection with this refinancing, we
    wrote-off $3.7 million of deferred financing costs related to
    extinguished debt, paid a $3.0 million call premium, and
    incurred $1.0 million of additional interest on the 9 3/4%
    old Notes representing interest incurred during the 30 day
    redemption notification period.                                                                                                                                                                                                                         
|   
|(3) | In the fourth quarter of 2002, we closed or sold
    two remote underperforming, wholly-owned clubs. In connection
    with the closure of one of the clubs, we recorded club closure
    costs of $996 related to the write-off fixed assets. We have
    accounted for these two clubs as discontinued operations and,
    accordingly, the results of their operations have been
    classified as discontinued in the Consolidated Statement of
    Operations and prior periods have been reclassified in
    accordance with Statement of Financial Accounting Standards
    (SFAS) No. 144, Accounting for the
    Impairment of Long-Lived Assets and Long-Lived Assets To Be
    Disposed Of.

16



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##### Table of Contents



Loss from operations of these discontinued clubs
was as follows for the periods presented:

|                                                                                                 |  |                         |      |      |  |      |      |      |  |   |      |   |  |   |        |  
|------------------------------------------------------------------------------------------------ |  | ----------------------- | ---- | ---- |  | ---- | ---- | ---- |  | - | ---- | - |  | - | ------ | -
|                                                                                                 |  |                        
|                                                                                                 |  | Year Ended December 31,
|                                                                                                 |  |                        
|                                                                                                 |  | 1999                    |      | 2000 |  | 2001 |      | 2002
|                                                                                                 |  |                         |      |      |  |      |      |     
|Loss from operations of discontinued clubs,
    (including loss of club closure of $996 in 2002) |  | $                       | (125 | )    |  | $    | (597 | )    |  | $ | (894 | ) |  | $ | (1,318 | )
|Benefit for corporate income tax                                                                 |  |                         | (51  | )    |  |      | (232 | )    |  |   | (364 | ) |  |   | (551   | )
|                                                                                                 |  |                         |      |      |  |      |      |      |  |   |      |   |  |   |        |  
|Loss from discontinued operations                                                                |  | $                       | (74  | )    |  | $    | (365 | )    |  | $ | (530 | ) |  | $ | (767   | )
|                                                                                                 |  |                         |      |      |  |      |      |      |  |   |      |   |  |   |        |  



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(4) | Effective January 1, 2002 we implemented
    SFAS 142. In connection with the SFAS 142 transitional
    impairment test we recorded a $1.3 million write-off of
    goodwill. A deferred tax benefit of $612 was recorded as a
    result of this goodwill write-off, resulting in a net cumulative
    effect of change in accounting principle of $689 in 2002. The
    write-off of goodwill related to four, remote underperforming
    clubs. The impairment test was performed with discounted
    estimated future cash flows as the criteria for determining fair
    market value. The impairment loss recorded was measured by
    comparing the carrying value to the fair value of goodwill.



|    |                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|(5) | During 1999, we relocated one club. During 2000,
    we acquired two formerly partly-owned clubs and relocated one
    club on expiration of lease.
|   
|(6) | Includes wholly-owned or partly-owned and managed
    clubs.                                                                                       
|   
|(7) | Represents members at wholly-owned or
    partly-owned clubs.                                                                                      
|   
|(8) | We define mature clubs as those clubs operated by
    us for more than 24 months.                                                                  



|    |                                                                                                                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(9) | Revenue per weighted average club is calculated
    as total revenue divided by the product of the total numbers of
    clubs and their weighted average months in operation as a
    percentage of the total year.



|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Working capital deficit is calculated as current
    assets less current liabilities. We normally operate with a
    working capital deficit because we receive dues or fee revenue
    either (i) during the month services are rendered, or
    (ii) when paid-in-full in advance. As a result, we have no
    material accounts receivable, and record a deferred revenue
    liability for membership or ancillary services billed in
    advance. We also record deferred revenue liability, because
    initiation fees are received at enrollment and are deferred and
    recognized over the estimated average term of a membership.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|    
|(11) | We had 153,637 shares of Series A
    Redeemable Preferred Stock (Series A)
    outstanding at December 31, 1999, 2000, 2001, 2002 and
    2003. We have reclassified our 2001 financial statements to
    account for a redemption feature included in the Series A
    stock, in accordance with the guidance in EITF Topic
    No. D-98: Classification and Measurement of Redeemable
    Securities (EITF Topic No. D-98). EITF
    Topic No. D-98 provided additional guidance on the
    appropriate classification of redeemable preferred stock upon
    the occurrence of an event that is not solely within the control
    of an issuer. EITF Topic No. D-98 requires retroactive
    application in the first fiscal quarter ending after
    December 15, 2001 by reclassifying the financial statements
    of prior periods. The carrying value of the Series A stock,
    which was previously presented as a component of
    stockholders deficit, has been reclassified as redeemable
    preferred stock outside of stockholders deficit. The
    reclassification of the 2001 financial statements for the
    Series A stock had no effect on our net income, net loss
    attributable to common stockholders, cash flow provided by
    operations or total assets. The following sets forth the overall
    effect of the reclassification on our stockholders deficit:

|                                                     |  |                    |         |      |  |      |         |   |  |   |         |  
|---------------------------------------------------- |  | ------------------ | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                     |  |                   
|                                                     |  | As of December 31,
|                                                     |  |                   
|                                                     |  | 1999               |         | 2000 |  | 2001
|                                                     |  |                    |         |      |  |     
|Stockholders deficit prior to
    reclassification  |  | $                  | (5,597  | )    |  | $    | (3,911  | ) |  | $ | (2,365  | )
|Reclassification of Series A stock                   |  |                    | (23,216 | )    |  |      | (26,580 | ) |  |   | (30,432 | )
|                                                     |  |                    |         |      |  |      |         |   |  |   |         |  
|Stockholders deficit after the
    reclassification |  | $                  | (28,813 | )    |  | $    | (30,491 | ) |  | $ | (32,797 | )
|                                                     |  |                    |         |      |  |      |         |   |  |   |         |  

17



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##### Table of Contents





| |                                                                                                               
| | --------------------------------------------------------------------------------------------------------------
| | The balance sheet data for all periods presented
    have been adjusted to reflect the above reclassification.




Item 7.  Managements
Discussion and Analysis of Financial Condition and Results of
Operations

Forward-Looking Statements

Certain statements in this Annual Report on our
Form 10-K for the year ended December 31, 2003 are
forward-looking statements, including, without limitation,
statements regarding future financial results and performance,
potential sales revenue, legal contingencies and tax benefits.
These statements are subject to various risks and uncertainties,
many of which are outside of our control, including the level of
market demand for our services, competitive pressures, the
ability to achieve reductions in operating costs and to continue
to integrate acquisitions, environmental matters, the
application of Federal and state tax laws and regulations, and
other specific factors discussed herein and in other Securities
and Exchange Commission filings by us. The information contained
herein represents managements best judgement as of the
date hereof based on or as to information currently available;
however, we do not intend to update this except as required by
law, information to reflect development or information obtained
after the date hereof and disclaim any legal obligation to the
contrary.

Historical Club Growth

|                                                                  |  |                         |    |      |  |      |     |      |  |      |     |  |  |  |     |   |  |  |     |  
|----------------------------------------------------------------- |  | ----------------------- | -- | ---- |  | ---- | --- | ---- |  | ---- | --- |  |  |  | --- | - |  |  | --- | -
|                                                                  |  |                        
|                                                                  |  | Year Ended December 31,
|                                                                  |  |                        
|                                                                  |  | 1999                    |    | 2000 |  | 2001 |     | 2002 |  | 2003
|                                                                  |  |                         |    |      |  |      |     |      |  |     
|Clubs at beginning of period                                      |  |                         | 69 |      |  |      | 86  |      |  |      | 105 |  |  |  | 119 |   |  |  | 129 |  
|Greenfield clubs(1)                                               |  |                         | 14 |      |  |      | 9   |      |  |      | 12  |  |  |  | 8   |   |  |  | 3   |  
|Acquired clubs                                                    |  |                         | 4  |      |  |      | 11  |      |  |      | 2   |  |  |  | 4   |   |  |  |    |  
|Sold, relocated or closed clubs                                   |  |                         | (1 | )    |  |      | (1  | )    |  |      |    |  |  |  | (2  | ) |  |  | (3  | )
|                                                                  |  |                         |    |      |  |      |     |      |  |      |     |  |  |  |     |   |  |  |     |  
|Clubs at end of period(2)                                         |  |                         | 86 |      |  |      | 105 |      |  |      | 119 |  |  |  | 129 |   |  |  | 129 |  
|                                                                  |  |                         |    |      |  |      |     |      |  |      |     |  |  |  |     |   |  |  |     |  
|Number of partly owned clubs included at the end
    of period(3) |  |                         | 4  |      |  |      | 2   |      |  |      | 2   |  |  |  | 2   |   |  |  | 2   |  



---



|    |                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | A Greenfield club is a new location
    constructed by us.                                                                                                                                
|   
|(2) | We include in the club count wholly owned and
    partly owned clubs. In addition, as of December 31, 2003 we
    managed two additional clubs in which we did not have an equity
    stake.
|   
|(3) | In March 2000, two clubs previously managed by us
    were purchased. Including these two clubs, the total number of
    clubs opened or acquired in 2000 totals 22.                        

Introduction

We are one of the two leading owners and
operators of fitness clubs in the Northeast and Mid-Atlantic
regions of the United States. As of December 31, 2003, we
operated 129 clubs that collectively served approximately
342,000 members. We develop clusters of clubs to serve densely
populated major metropolitan regions in which a high percentage
of the population commutes to work. We service such populations
by clustering clubs near the highest concentrations of our
target members areas of both employment and residence. Our
target member is college-educated, typically between the ages of
21 and 50 and has an annual income of between $50,000 and
$150,000.

Our goal is to develop the premier health club
network in each of the major metropolitan regions we enter. We
believe that clustering clubs allows us to achieve strategic
operating advantages that enhance our ability to achieve this
goal. In entering new regions, we develop these clusters by
initially opening or acquiring clubs located in the more central
urban markets of the region and then branching out from these
urban centers to suburbs and ancillary communities. Capitalizing
on this clustering of clubs, as of December 31, 2003,
approximately 52% of our members participated in a membership
plan that allows unlimited access to all of our clubs for a
higher membership fee.

18



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##### Table of Contents



We have executed this strategy successfully in
the New York region through the network of clubs we operate
under our NYSC brand name. We are the largest fitness club
operator in Manhattan with 36 locations and operate a total
of 86 clubs under the NYSC name within a defined radius of
New York City. We operate 19 clubs in the Boston region,
15 clubs in the Washington D.C. region under our BSC
and WSC brand names respectively and have begun establishing a
similar cluster in the Philadelphia region with six clubs under
is PSC brand name. In addition we operate three clubs in
Switzerland. Our goal is to increase our club count by ten
percent per year. In 2003, we slowed our club expansion plans
and maintained our club count at 129 while we recapitalized the
company to position it for future growth. While we maintained
our club count at 129 in 2003 we plan to open or acquire
12 clubs in 2004. We employ localized brand names for our
clubs to create an image and atmosphere consistent with the
local community, and to foster the recognition as a local
network of quality fitness clubs rather than a national chain.

Our operating and selling expenses are comprised
of both fixed and variable costs. The fixed costs include salary
expense, rent, utilities, janitorial expenses and depreciation.
Variable costs are primarily related to sales commissions,
advertising and supplies. As clubs mature and increase their
membership base, fixed costs are typically spread over an
increasing revenue base and operating margins tend to improve.

During the last several years, we have increased
revenues, operating income, net income, and cash flows provided
by operating activities by expanding our club base in New York,
Boston, Washington, DC, and Philadelphia. As a result of
expanding our club base and the relatively fixed nature of our
operating costs, our operating income has increased from
$11.0 million for the year ended December 31, 1999 to
$44.0 million for the year ended December 31, 2003.
Net income improved from $49,000 in 1999 to $7.4 million for the
year ended December 31, 2003. Cash flows provided by
operating activities increased from $29.5 million in 1999
to $58.3 million for the year ended December 31, 2003. We
expect growth in revenues and operating income to continue as
the 29 clubs opened or acquired since the beginning of 2001
continue to mature. Based on our historical experience, a new
club tends to experience significant increase in revenues during
its first three years of operation as it reaches maturity.
Because there is relatively little incremental cost associated
with such increasing revenue, there is a greater proportionate
increase in profitability. We believe that the revenues and
operating income of these 29 clubs will increase as they
mature. As a result of our expansion, however, operating income
margins may be negatively impacted in the near term, as further
new clubs are added.

Mature Club Revenue

We define mature clubs as those clubs that were
operated by us for the entire period of the period presented and
that same entire period of the preceeding year. Under this
definition, mature clubs for periods shown are those clubs that
were operated for more than 24 months. Our mature club revenue
increased 16.0%, 18.6%, 12.3%, 4.1%, and 1.6% for the years
ended December 31, 1999, 2000, 2001, 2002 and 2003,
respectively. We believe the decline in mature club revenue
growth has been driven primarily by general economic softness,
particularly in the New York metropolitan region. We have also
seen increases in competition throughout our markets and this
has depressed revenue growth at select mature clubs throughout
our chain. In addition, we believe that the decline in mature
club revenue growth is also attributable to the increasing age
of our mature clubs.

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##### Table of Contents



Results of Operations

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

|                                                                                  |  |                         |       |      |  |      |       |    |  |  |       |   
|--------------------------------------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                                                                  |  |                        
|                                                                                  |  | Year Ended December 31,
|                                                                                  |  |                        
|                                                                                  |  | 2001                    |       | 2002 |  | 2003
|                                                                                  |  |                         |       |      |  |     
|Revenues                                                                          |  |                         | 100.0 | %    |  |      | 100.0 | %  |  |  | 100.0 | % 
|Operating expenses:                                                               |  |                         |       |      |  |      |       |    |  |  |       |   
|Payroll and related                                                               |  |                         | 40.0  |      |  |      | 40.4  |    |  |  | 38.1  |   
|Club operating                                                                    |  |                         | 31.6  |      |  |      | 31.1  |    |  |  | 32.5  |   
|General and administrative                                                        |  |                         | 6.7   |      |  |      | 6.7   |    |  |  | 6.4   |   
|Depreciation and amortization                                                     |  |                         | 11.4  |      |  |      | 9.9   |    |  |  | 10.2  |   
|                                                                                  |  |                         |       |      |  |      |       |    |  |  |       |   
|Operating income                                                                  |  |                         | 10.3  |      |  |      | 11.9  |    |  |  | 12.8  |   
|Loss on extinguishment of debt                                                    |  |                         |      |      |  |      |      |    |  |  | 2.2   |   
|Interest expense                                                                  |  |                         | 5.3   |      |  |      | 5.1   |    |  |  | 6.8   |   
|Interest income                                                                   |  |                         | (0.1  | )    |  |      |      |    |  |  |      |   
|                                                                                  |  |                         |       |      |  |      |       |    |  |  |       |   
|Income from continuing operations before
    provision for corporate income taxes |  |                         | 5.1   |      |  |      | 6.8   |    |  |  | 3.8   |   
|Provision for corporate income taxes                                              |  |                         | 2.4   |      |  |      | 3.1   |    |  |  | 1.6   |   
|                                                                                  |  |                         |       |      |  |      |       |    |  |  |       |   
|Income from continuing operations                                                 |  |                         | 2.7   |      |  |      | 3.7   |    |  |  | 2.2   |   
|Loss from discontinued operations of closed
    clubs, net of income tax          |  |                         | (0.2  | )    |  |      | (0.2  | )  |  |  |      |   
|Cumulative effect of a change in accounting
    principle, net of income tax      |  |                         |      |      |  |      | (0.2  | )  |  |  |      |   
|                                                                                  |  |                         |       |      |  |      |       |    |  |  |       |   
|Net income                                                                        |  |                         | 2.5   |      |  |      | 3.3   |    |  |  | 2.2   |   
|Accreted dividends on preferred stock                                             |  |                         | (3.6  | )    |  |      | (3.6  | )  |  |  | (3.2  | ) 
|                                                                                  |  |                         |       |      |  |      |       |    |  |  |       |   
|Net loss attributable to common stockholders                                      |  |                         | (1.1  | )%   |  |      | (0.3  | )% |  |  | (1.0  | )%
|                                                                                  |  |                         |       |      |  |      |       |    |  |  |       |   

YEAR ENDED DECEMBER 31, 2003 COMPARED
TO

THE YEAR ENDED DECEMBER 31,
2002


Revenues.Revenues
increased $23.1 million or 7.2%, to $342.5 million
during 2003 from $319.4 million in 2002. This increase
resulted from the 12 clubs opened or acquired in 2002
(approximately $14.8 million), and the three clubs opened
in 2003 (approximately $3.1 million). In addition, revenues
increased during 2003 by approximately $4.9 million or 1.6%
at our mature clubs (clubs owned and operated for at least
24 months). In 2003 we received $2.8 million of
insurance proceeds related to our business interruption
insurance settlement; a $1.8 million increase over the
$1.0 million received in 2002. These increases were offset
by a $1.7 million decrease in revenue related to three
clubs we relocated in 2003.

Our mature club revenue increased 12.3%, 4.1% and
1.6% for the years ended December 31, 2001, 2002 and 2003,
respectively. We believe the decline in mature club revenue
growth had been driven primarily by the general economic
climate, particularly in the New York metropolitan region. We
have also seen increases in competition throughout our markets
and this has depressed revenue growth at select mature clubs
throughout our chain. In addition, we believe that the decline
in mature club revenue growth is also attributable to the
increasing age of our mature clubs.

Operating Expenses.Operating expenses increased $17.2 million, or 6.1% to
$298.6 million in 2003, from $281.3 million in 2002.
This increase was due to a 3.3% increase in the total months of
club operations to 1,528 in 2003 from 1,479 in 2002. The
increase is also attributable to increases in club operating
costs, particularly occupancy costs and utilities.

Payroll and related expenses increased by
$1.5 million, or 1.1% to $130.6 million in 2003, from
$129.1 million in 2002. This increase was partially offset
by a $1.0 million decrease in non-cash compensation expense
which decreased from $1.2 million in 2002 to $197,000 in
2003. The non-cash compensation expense

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incurred during 2002 principally related to
outstanding Series B stock options and such options were
exercised in the first quarter of 2003.


Club operating increased by $12.0 million,
or 12.1% to $111.1 million in 2003, from $99.1 million
in 2002. This increase is attributable to a 3.3% increase in the
total months of club operations to 1,528 in 2003 from 1,479 in
2002. The increase is also attributable to a $2.4 million
or 20.6% increase in utilities and a $7.6 million or 13.8%
increase in occupancy costs. Occupancy costs increased due to
increases in real estate taxes as well as increases in base rent
associated with the opening of three flagship locations and
several club expansions.

General and administrative increased by $627,000,
or 2.9% to $22.0 million in 2003, from $21.4 million
in 2002. This increase is principally attributable to a $369,000
increase in liability and property insurance, as well as
increases in information technology maintenance and related
costs.

Depreciation and amortization increased by
$3.2 million or 10.0% to $34.9 million in 2003, from
$31.7 million in 2002. This increase is principally due to
a full year of depreciation and amortization for fixed asset
additions, acquisitions or club openings in 2002. The increase
is also attributable to depreciation related to the three clubs
opened in 2003 as well as depreciation related to 2003
expansions and renovations.

Loss on Extinguishment of
Debt.The $7.8 million loss on
extinguishment of debt recorded in 2003 is a result of the
refinancing of our debt on April 16, 2003. In connection
with this refinancing, we wrote-off $3.7 million of
deferred financing costs related to extinguished debt, paid a
$3.0 million call premium, and incurred $1.0 million
of additional interest on the 9 3/4% old Notes representing
interest incurred during the 30 day redemption notification
period.

Interest Expense.Interest expense increased $7.1 million to $23.7 million in
2003 from $16.6 million in 2002. Interest expense increased
$8.8 million due to the refinancing of our Senior Notes as
discussed in Financing Activities. This increase was partially
offset by decreases in interest on credit line and subordinated
credit line borrowings, which were completely repaid on
April 16, 2003 in connection with the refinancing.

Interest Income.Interest income increased $306,000 to $444,000 in 2003 from
$138,000 in 2002. This increase is due to increases in cash
balances in 2003 compared to 2002.

Provision for Corporate Income
Taxes.The provision for corporate
income taxes decreased $4.2 million from $9.7 million
in 2002 to $5.5 million in 2003. Our effective tax rate
decreased to 42.7% in 2003 from 44.8% in 2002 principally due to
decreases in the effective New York State and New York City
rates. With the exception of deferred tax assets of $384,000
related to certain state net operating loss carry-forwards,
which have been reserved for, we expect future taxable income to
be sufficient to realize the $16.8 million of net deferred
tax assets.

Accreted Dividends on Preferred
Stock.Accreted dividends on the
Preferred Stock decreased $559,000 to $11.0 million in
2003, from $11.5 million in 2002. Accreted dividends on
Series A preferred stock increased $640,000 due to the
compounding of accreted and unpaid dividends, and accreted
dividends on the Series B preferred stock increased
$1.1 million due to the increase in shares outstanding.
These increases were offset by a $2.3 million decrease in
redeemable senior preferred stock dividends. The redeemable
senior preferred stock was redeemed in April 2003 and no
dividends were accreted thereafter.

YEAR ENDED DECEMBER 31, 2002 COMPARED
TO

THE YEAR ENDED DECEMBER 31,
2001


Revenues.Revenues
increased $37.8 million or 13.4%, to $319.4 million during
2002 from $281.6 million in 2001. This increase resulted
from the 14 clubs opened or acquired in 2001 (approximately
$17.0 million), and the 12 clubs opened or acquired in 2002
(approximately $9.1 million). In addition, revenues
increased during 2002 by approximately $11.1 million or 4.1% at
our mature clubs (clubs owned and operated for at least 24
months). The mature club revenue increase is attributable to a
1.6% increase in membership, a 2.2% increase in dues, and a 0.3%
increase in ancillary revenues.

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our mature club revenue increased 18.6%, 12.3%
    and 4.1% for the years ended December 31, 2000, 2001 and
    2002, respectively. We believe the decline in mature club
    revenue growth had been driven primarily by general economic
    softness, particularly in the New York metropolitan region. In
    addition, we believe that the decline in mature club revenue
    growth is also attributable to the increasing age of our mature
    clubs.

Operating Expenses.Operating expenses increased $28.6 million, or 11.3% to
$281.3 million in 2002, from $252.7 million in 2001.
This increase was due to a 13.9% increase in total months of
club operations to 1,479 in 2002 from 1,298 in 2001. This
increase was partially offset by a $437,000 decrease in
depreciation and amortization from 2001 to 2002. In accordance
with SFAS 142 as of January 1, 2002 goodwill is no
longer being amortized.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Payroll and related expenses increased by $16.3
    million, or 14.4% to $129.1 million in 2002, from
    $112.8 million in 2001. This increase was primarily
    attributable to the acquisition or opening of 12 clubs in
    2002 and a full year of operating the 14 clubs opened or
    acquired in 2001. This increase was also attributable to an
    increase in health and workers compensation insurance, and
    payroll associated with fee-for-service programs.
|
| | Club operating increased by $10.2 million,
    or 11.4% to $99.1 million in 2002, from $88.9 million
    in 2001. This increase is primarily attributable to the
    acquisition or opening of 12 clubs in 2002 and the
    additional expenses attributable to operating the 14 clubs
    opened or acquired in 2001.                                                                                                                                                        
|
| | General and administrative increased by
    $2.6 million, or 13.8% to $21.4 million in 2002, from
    $18.8 million in 2001. This increase is principally
    attributable to a $1.3 million increase in liability and
    property insurance, and increases attributable to expenses
    associated with our expansion, including the enhancement of our
    management communication and information systems.                                                               
|
| | Depreciation and amortization decreased by
    $437,000, or 1.4% to $31.7 million in 2002, from
    $32.2 million in 2001. A $2.3 million and a
    $1.6 million increase in depreciation and amortization
    expense related to clubs opened or acquired in 2001 and 2002,
    respectively was offset by a $4.3 million decrease in
    goodwill amortization expense.                                                                                                     

Interest Expense.Interest expense increased $1.6 million to
$16.6 million in 2002 from $14.9 million in 2001,
primarily as a result of an increase in subordinated credit
borrowings associated with our club base expansion.

Interest Income.Interest income decreased $253,000 to $138,000 in 2002 from
$391,000 in 2001. This decrease is due to lower interest rates
earned on cash balances in 2002 as compared to 2001.

Provision for Income Tax.The provision for income taxes
increased $2.8 million from $6.9 million in 2001 to
$9.7 million in 2002. Our effective tax rate decreased to
45% in 2002 from 48% in 2001. This decrease is due to a decrease
in goodwill amortization which was not deductible for taxes and
decreases in the effective New York State and City rates. With
the exception of deferred tax assets of $384,000 related to
certain state net operating loss carry-forwards which have been
reserved for, we expect future taxable income to be sufficient
to realize the $20.3 million of net deferred tax assets.

Discontinued Operations.In the fourth quarter of 2002, we
closed or sold two unprofitable, wholly-owned clubs. In
connection with the closure of one of the clubs we recorded club
closure costs of $996 related to the write-off of fixed assets.
We have accounted for these two clubs as discontinued operations
and, accordingly, the results of their operations have been
classified as discontinued in the Consolidated Statement of
Operations, and prior periods have been reclassified in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed of.

Revenues and pre-tax losses for these
discontinued clubs were $1.7 million and $894,000 in 2001,
and $1.6 million and $322,000 in 2002, respectively.

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Cumulative Effect of a Change in Accounting
Principle.In connection with the
implementation of SFAS 142 we recorded a goodwill write-off
of $1.3 million in the first quarter of 2002. A deferred
tax benefit of $612,000 was recorded in connection with this
goodwill write-off, resulting in a net cumulative effect of a
change in accounting principle of $689,000.

Accreted
Dividends on Preferred Stock

Accreted dividends on the Preferred Stock
increased $1.3 million to $11.5 million in 2002, from $10.2
million in 2001. This increase is due to the compounding of
accreted dividends.

Liquidity and Capital Resources

Historically, we have satisfied our liquidity
needs through cash from operations and various borrowing
arrangements. Principal liquidity needs have included the
acquisition and development of new clubs, debt service
requirements and other capital expenditures necessary to
maintain, expand and renovate existing clubs.

Operating
Activities.Net cash provided by
operating activities for the year ended December 31, 2003
was $58.3 million compared to $50.8 million during the
year ended December 31, 2002. Cash flows from operations
has improved with our increase in operating income, and in
addition, because of the favorable impact of managements
exercise of stock options in 2003, which provided us with a
current tax deduction of approximately $8.6 million.

Investing Activities.We invested $42.7 million and
$40.2 million in capital expenditures and asset
acquisitions during the years ended December 31, 2003 and
2002, respectively, primarily as a result of our expansion
efforts. Our capital expenditures are net of landlord
contributions of $617,000 and $3.5 million respectively for
the years ended December 31, 2003 and 2002. We estimate
that for the year ended December 31, 2004, we will invest
an additional $60.0 million in capital expenditures, which
includes $7.2 million that management intends to invest to
expand and renovate certain existing clubs, $14.5 million
to maintain existing clubs and to maintain our management
information systems, and $2.0 million to further upgrade
our management information system. The remainder of our 2004
capital expenditures will be to build or acquire clubs. This
$60.0 million in expenditures will be funded by cash flow
provided by operations and available cash on hand.

Financing Activities.On April 16, 2003 we successfully
completed a refinancing of our debt. This refinancing included
an offering of $255.0 million of 9 5/8% Senior Notes
(Existing Notes) that will mature April 15,
2011. We also entered into of a new $50.0 million senior
secured revolving credit facility (the Senior Credit
Facility) that will expire April 15, 2008. The
Existing Notes accrue interest at 9 5/8% per annum and
interest is payable semiannually on April 15, and
October 15. In connection with this refinancing, we
wrote-off $3.7 million of deferred financing costs related
to extinguished debt, paid a call premium of $3.0 million
and incurred $1.0 million of interest on the 9 3/4%
Notes representing the interest incurred during the 30 day
redemption notification period. The uses of proceeds from the
Note offering were as follows:

|                                                                       |  |          |         | 
|---------------------------------------------------------------------- |  | -------- | ------- | 
|                                                                       |  | ($000s)
|                                                                       |  |         
|Redemption of existing 9 3/4% Senior Notes,
    principal and interest |  | $        | 126,049 | 
|Call premium on existing 9 3/4% Senior Notes                           |  |          | 3,048   | 
|Redemption of senior preferred stock, at
    liquidation value         |  |          | 66,977  | 
|Repayment of line of credit principal borrowings
    and interest      |  |          | 4,013   | 
|Repayment of subordinated credit principal
    borrowings and interest |  |          | 9,060   | 
|Underwriting fees and other closing costs                              |  |          | 9,578   | 
|Available for general corporate purposes                               |  |          | 36,275  | 
|                                                                       |  |          |         | 
|Total use of funds                                                     |  | $        | 255,000 | 
|                                                                       |  |          |         | 

We currently have a substantial amount of debt.
As of December 31, 2003, our total consolidated debt is
$261.9 million. Our substantial debt could have significant
consequences, including:



| |   |                                                                                      
| | - | -------------------------------------------------------------------------------------
| |  | Making it more difficult to satisfy our
    obligations;                             
|
| |  | Increasing our vulnerability to general adverse
    economic and industry conditions;

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| |   |                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Limiting our ability to obtain additional
    financing to fund future working capital, capital expenditures,
    acquisitions of new clubs and other general corporate
    requirements;                                                                                              
|
| |  | Requiring a substantial portion of our cash flow
    from operations for the payment of interest on our debt and
    reducing our ability to use our cash flow to fund working
    capital, capital expenditures, acquisitions of new clubs and
    general corporate requirements; and
|
| |  | Limiting our flexibility in planning for, or
    reacting to, changes in our business and the industry in which
    we operate.                                                                                                                                                        

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

Net cash provided by financing activities was
$19.7 million for the year ended December 31, 2003
compared to net cash used in financing activities of
$10.5 million for the same period in 2002 and compared to
net cash provided by financing activities of $16.1 million
for the same period in 2001.

As of December 31, 2003, we had
$255.0 million of Senior Notes outstanding. The Senior
Notes bear interest at a rate of 9 5/8% and mature in 2011.
Under the provisions of the Senior Note Indenture, we may not
issue additional Senior Notes without modification of the
indenture with the bondholders consent. Our line of credit
with our principal bank provides for direct borrowings and
letters of credit of up to $50.0 million. The line of
credit carries interest at our option based upon the Eurodollar
borrowing rate plus 4.0% or the banks prime rate plus 3.0%
as defined, and we are required to pay a commitment fee of 0.75%
per annum on the daily unutilized amount. As of
December 31, 2003, no borrowings were outstanding under
this line. As of December 31, 2003 outstanding letters of
credit totaled $1.7 million. As of December 31, 2003,
we had approximately $48.3 million available under the line
of credit, which matures in April 2008, and has no scheduled
amortization requirements. As of December 31, 2003 we also
had $40.8 million of cash on hand.

The line of credit contains restrictive covenants
including a leverage ratio and interest coverage ratio and
dividend payment restrictions and is collateralized by all the
assets of the Company. As of December 31, 2003 our Net
Leverage Ratio, and Net Interest Coverage Ratio as defined by
the terms of the line of credit agreement are 3.3 and 3.2 to
1.0, respectively. Our ability to incur additional debt is
limited by the terms of the line of credit facility in that the
Net Leverage Ratio, as defined, cannot exceed 4.0 to 1.0 and the
Net Interest Coverage Ratio must be greater than 2.25 to 1.0.
Our common stock is not publicly traded and therefore our
ability to raise equity financing is not as readily available as
it is for companies that have publicly traded common stock.

We believe that we have or will be able to obtain
or generate sufficient funds to finance our current operating
and growth plans through the end of 2007, any material
acceleration or expansion of that plan through additional
greenfields or acquisitions (to the extent such acquisitions
include cash payments) may require us to pursue additional
sources of financing prior to the end of 2007. There can be no
assurance that such financing will be available, or that it will
be available on acceptable terms. The line of credit accrues
interest at variable rates based on market conditions,
accordingly, future increases in interest rates could have a
negative impact on net income.

Notes payable were incurred upon the acquisition
of various clubs and are subject to the right of offset for
possible post acquisition adjustments arising out of operations
of the acquired clubs. These notes bear interest at rates
between 5% and 9%, and are non-collateralized. The notes are due
on various dates through 2012.

24



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##### Table of Contents



The aggregate long-term debt, capital lease,
operating lease, and Redeemable Preferred Stock Obligations as
of December 31, 2003 were as follows:

|                                   |  |                        |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |         | 
|---------------------------------- |  | ---------------------- | ------- | --------- |  | --------- | ------ | --------- |  | ------- | ------- |  |  | - | ------ |  |  | - | ------- | 
|                                   |  |                       
|                                   |  | Payments Due by Period
|                                   |  |                       
|                                   |  |                        |         | Less than |  |           |        | After    
|Contractual Obligations            |  | Total                  |         | 1 year    |  | 1-3 years |        | 4-5 years |  | 5 years
|                                   |  |                        |         |           |  |           |        |           |  |        
|Long-Term Debt(1)                  |  | $                      | 259,358 |           |  | $         | 1,191  |           |  | $       | 1,451   |  |  | $ | 849    |  |  | $ | 255,867 | 
|Capital Lease Obligations(2)       |  | $                      | 2,519   |           |  | $         | 2,295  |           |  | $       | 224     |  |  | $ |       |  |  |   |        | 
|Operating Lease Obligations(3)     |  | $                      | 620,953 |           |  | $         | 50,976 |           |  | $       | 103,159 |  |  | $ | 96,987 |  |  | $ | 369,831 | 
|Redeemable Preferred Stock(4)      |  | $                      | 39,890  |           |  | $         | 39,890 |           |  |         |        |  |  |   |       |  |  |   |        | 
|                                   |  |                        |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |         | 
|Total Contractual Cash Obligations |  | $                      | 922,720 |           |  | $         | 94,352 |           |  | $       | 104,834 |  |  | $ | 97,836 |  |  | $ | 625,698 | 
|                                   |  |                        |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |         | 



---

Notes:



|    |                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The long-term debt contractual cash obligations
    include principal payment requirements only. Interest on our
    9 5/8% Senior Notes amounts to $24.5 million annually.                                                              
|   
|(2) | Capital lease obligations represent principal and
    interest payments.                                                                                                                                                                 
|   
|(3) | Operating lease obligations include base rent
    only. Certain leases provide for additional rent based on
    increases in real estate tax indexation, utilities, and defined
    amounts based on the operating results of the lessee.
|   
|(4) | The redeemable preferred stock was redeemed in
    February 2004 and therefore has been included as due in less
    than one year.                                                                                                       

On February 4, 2004 the Company and its
shareholders and Town Sports International Holdings, Inc.,
(TSI Holdings) a newly formed company, entered
into a Restructuring Agreement. In connection with this
Restructuring, the holders of the Companys Series A
Preferred Stock, Series B Preferred Stock and Class A
Common stock contributed their shares of the Company to TSI
Holdings for an equal amount of newly issued shares of the same
form in TSI Holdings. Immediately following this exchange
TSI Holdings contributed to the Company the certificates
representing all of the Company shares contributed in the
aforementioned exchange and in return the Company issued 1,000
shares of common stock to TSI Holdings, and cancelled on
its books and records the certificate representing Company
Shares contributed to it by TSI Holdings.

On February 4, 2004 TSI Holdings
successfully completed an offering of 11.0% Senior Discount
Notes (the Discount Notes) that will mature in
February 2014. TSI Holdings received a total of $124,807 in
connection with this issuance. Fees and expenses related to this
transaction totaled approximately $4,375. No cash interest is
required to be paid prior to February 2009. The accreted value
of each Discount Note will increase from the date of issuance
until February 1, 2009, at a rate of 11.0% per annum
compounded semi-annually such that on February 1, 2009 the
accreted value will equal $213,000, the principal value due at
maturity. Subsequent to February 1, 2009 cash interest on
the Discount Notes will accrue and be payable semi-annually in
arrears February 1 and August 1 of each year,
commencing August 1, 2009. The Discount Notes are
structurally subordinated and effectively rank junior to all
indebtedness of the Company.

On February 6, 2004 all of TSI
Holdings outstanding Series A stock and Series B
stock were redeemed for a total of $50,634. TSI Holdings expects
to pay a common stock dividend in March 2004 with the remaining
proceeds from the Senior Discount Note offering.

Legal Proceedings

On February 13, 2003, an individual filed
suit against us in the Supreme Court, New York County, alleging
that on January 14, 2003, he sustained an injury at one of
our club locations resulting in serious bodily injury. He filed
an amended complaint on September 17, 2003 seeking two
billion dollars in damages for personal injuries. His cause of
action seeking punitive damages in the amount of two hundred and
fifty million dollars was dismissed on January 26, 2004. We
have in force fifty one million dollars of insurance coverage to
cover claims of this nature. We intend to vigorously contest
this lawsuit and presently anticipate that these matters will be
covered by insurance.

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We are a party to various lawsuits arising in the
normal course of business. We believe that the ultimate outcome
of these matters will not have a material adverse effect on our
business, results of operations, cash flows, or financial
condition.

Recent Accounting Pronouncements

In May 2003, the FASB issued Statement
No. 150, Accounting for Certain Financial Instruments
with Characteristics of Both Liability and Equity(FAS 150), which establishes standards for how an
issuer classifies and measures certain financial instruments
with characteristics of both liabilities and equity.
FAS 150 is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective
at the beginning of the first interim period beginning after
June 15, 2003. As of December 31, 2003 the Company
does not have financial instruments within the scope of this
pronouncement.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest Entities.
Interpretation No. 46 requires a variable interest entity,
or VIE, to be consolidated by a company if that company is
subject to a majority of the risk of loss from the VIEs
activities or is entitled to receive a majority of the
entitys residual return or both. Interpretation
No. 46 also provides criteria for determining whether an
entity is a VIE subject to consolidation. Interpretation
No. 46 also sets forth certain disclosures regarding
interests in VIE that are deemed significant, even if
consolidation is not required. In December 2003, a modification
to Interpretation No. 46 was issued (Interpretation
No. 46R) which delayed the effective date until no later
than fiscal periods ending after March 31, 2004 and
provided additional technical clarifications to implementation
issues. The Company does not currently have any variable
interest entities as defined in Interpretation No. 46R. The
Company does not expect that the adoption of this statement will
have a material impact on the consolidated financial statements.

September 11,
2001 Events

The terrorist attacks of September 11, 2001
(the September 11 events), resulted in a
tremendous loss of life and property. Secondarily, those events
interrupted the operations at four of our clubs located in
downtown Manhattan. Three of the affected four clubs were back
in operation by October 2001, and the fourth club reopened in
September 2002.

We carry business interruption insurance to
mitigate certain lost revenue and profits experienced with the
September 11 events. In this regard in the third quarter of 2001
a $175,000 insurance receivable was recorded representing an
estimate of costs incurred in September 2001. Such costs
included rent, payroll benefits, and other club operating costs
incurred during period of closure. In 2002, we collected this
$175,000 receivable and received additional on-account payments
of $1.0 million. In 2003, we received $2.8 million
from our insurer and we entered into a final settlement
agreement. These on-account and final payments were classified
with fees and other revenues when received.

Use
of Estimates and Critical Accounting Policies

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the dates of the financial statements and the reported
amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.

The most significant assumptions and estimates
relate to the allocation and fair value ascribed to assets
acquired in connection with the acquisition of clubs under the
purchase method of accounting, the useful lives, recoverability
and impairment of fixed and intangible assets, deferred income
tax valuation, valuation of, and expense incurred in, connection
with stock options and warrants, legal contingencies and the
estimated membership life.

Our one-time member initiation fees and related
direct expenses are deferred, and recognized, on a straight-line
basis, in operations over an estimated membership life of 24
months. This estimated membership

26



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##### Table of Contents



life has been derived from actual membership
retention experienced by us. Although the average membership
life approximated 24 months over each of the past several years;
this estimated life could increase or decrease in future
periods. Consequently the amount of initiation fees and direct
expenses deferred by us would increase or decrease in similar
proportion.


Fixed assets are recorded at cost and depreciated
on a straight-line basis over the estimated useful lives of the
assets, which are thirty years for building and improvements,
five years for club equipment, furniture, fixtures and computer
equipment, and three years for computer software. Leasehold
improvements are amortized over the shorter of their estimated
useful lives or the remaining period of the lease. Expenditures
for maintenance and repairs are charged to operations as
incurred. The cost and related accumulated depreciation or
amortization of assets retired or sold are removed from the
respective accounts and any gain or loss is recognized in
operations. The costs related to developing web applications,
developing HTML web pages and installing developed applications
on the web servers are capitalized and classified as computer
software. Web site hosting fees and maintenance costs are
expensed as incurred.

Long-lived assets, such as fixed assets and
intangible assets are reviewed for impairment when events or
circumstances indicate that the carrying value may not be
recoverable. Estimated undiscounted expected future cash flows
are used to determine if an asset is impaired, in which case the
assets carrying value would be reduced to fair value.
Actual cash flows realized could differ from those estimated and
could result in asset impairments in the future. In 2003, no
impairment charge was recorded on long-lived assets.

Effective January 1, 2002 we implemented
SFAS 142. There were no changes to the estimated useful lives of
amortizable intangible assets due to the SFAS 142
implementation. In connection with the SFAS 142 transition
impairment test we recorded a $1.3 million write-off of
goodwill. A deferred tax benefit of $612,000 was recorded as a
result of this goodwill write-off, resulting in a net cumulative
effect of change in accounting principle of $689,000, in the
first quarter of 2002. The write-off of goodwill related to
four, remote underperforming clubs. The impairment test was
performed with discounted estimated future cash flows as the
criteria for determining fair market value. Goodwill has been
allocated to reporting units that closely reflect the regions
served by our four trade names; New York Sports Club, Boston
Sports Club, Washington Sports Club and Philadelphia Sports
Club, with certain more remote clubs that do not benefit from a
regional cluster being considered single reporting units. In
2003, the Company did not have to record a charge to earnings
for an impairment of goodwill as a result of its annual review
conducted during the first quarter.

As of December 31, 2003 our net deferred tax
assets totaled $16.8 million. These net assets represent
cumulative net temporary differences that will
result in tax deductions in future years. The realizability of
these assets greatly depends on our ability to generate
sufficient future taxable income. Our pre tax profit was
$13.5 million, $20.4 million and $13.0 million, and
current tax liabilities were $11.0 million,
$10.3 million and $2.1 for the years ended
December 31, 2001, 2002 and 2003, respectively. Because
there is currently no evidence we will not continue to be
profitable, the weight of available evidence indicates we will
be able to realize these net deferred tax assets. If at some
time in the future, the weight of available evidence does not
support the realizability of a portion of, or the entire net
deferred tax asset, the write-down of this asset could have a
significant impact on our financial statements.

Inflation

We believe that inflation has not had a material
impact on our results of operations for the three year period
ended December 31, 2003.






Item 7A.  Quantitative and
Qualitative Disclosures About Market Risks


Not applicable






Item 8.  Financial
Statements and Supplementary Data


The Registrants financial statements and
supplementary data are listed in the index appearing under
item 15(a)(1) and 15(a)(2) .

27



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Item 9.  Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure


None.






Item 9A.  Controls and
Procedures


As of the end of the period covered by this
Annual Report on Form 10-K, the effectiveness of our
disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) promulgated under the
Securities Exchange Act of 1934) was evaluated by our
management, with the participation of our Chief Executive
Officer and our Chief Financial Officer. Based on the
evaluation, our Chief Executive Officer and our Chief Financial
Officer have concluded that our disclosure controls and
procedures are effective, as of the end of the period covered by
this Report. The Company continuously considers opportunities to
enhance controls and procedures. In the fourth quarter of 2003
the Company completed the rollout of a new point-of-sale club
management system. This system provides for operating and
accounting efficiencies and enhances the Companys ability
to bill members electronically as well as monitor usage and
revenue at the member level. There were no changes in our
internal control over financial reporting that occurred during
our last fiscal quarter (the quarter ended December 31,
2003) that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.

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##### Table of Contents






PART III




Item 10.  Directors and
Executive Officers of the Registrant

|                        |  |     |    |          |  |                                                   
|----------------------- |  | --- | -- | -------- |  | --------------------------------------------------
|Name                    |  | Age |    | Position
|                        |  |     |    |         
|Mark Smith              |  |     | 44 |          |  | Chairman and Director                             
|Robert Giardina         |  |     | 46 |          |  | Chief Executive Officer, Office of the President  
|Alexander Alimanestianu |  |     | 45 |          |  | Chief Development Officer, Office of the President
|Richard Pyle            |  |     | 45 |          |  | Chief Financial Officer, Office of the President  
|Randy Stephen           |  |     | 46 |          |  | Chief Operating Officer                           
|Keith E. Alessi         |  |     | 49 |          |  | Director                                          
|Paul Arnold             |  |     | 57 |          |  | Director                                          
|Bruce Bruckmann         |  |     | 50 |          |  | Director                                          
|J. Rice Edmonds         |  |     | 33 |          |  | Director                                          
|Jason Fish              |  |     | 46 |          |  | Director                                          

Mark Smithjoined us
in 1985 and has served as Chief Executive Officer from 1995 to
2001 and became Chairman in January 2002. Prior to these
appointments, he held the position of Executive Vice President
of Development and International Operations. Mr. Smith has
also served as a director since September 1995. He was appointed
to the Board of the International Health, Racquet and Sportsclub
Association (the club industry trade association) in 2001.
Before joining us, Mr. Smith was a chartered accountant
with Coopers & Lybrand in New York City, London and New
Zealand, and a professional squash player.

Robert Giardinajoined us in 1981 and has served as
President and Chief Operating Officer from 1992 to 2001, and
became Chief Executive Officer in January 2002. With over
20 years of experience in the club industry, Mr. Giardina
has expertise in virtually every aspect of facility management
and club operations. In addition to operations,
Mr. Giardina has primary responsibility for sales and
marketing.

Alexander Alimanestianujoined us in 1990 and became Executive
Vice President, Development in 1995 and Chief Development
Officer in January 2002. From 1990 to 1995,
Mr. Alimanestianu served as Vice President and Senior Vice
President. Before joining us, he worked as a corporate attorney
for six years with one of our outside law firms.
Mr. Alimanestianu has been involved in the development or
acquisition of over 100 of our clubs.

Richard Pyle,a
British chartered accountant, joined us in 1987 and has been
chiefly responsible for our financial matters since that time,
as a Vice President in 1988, Senior Vice President and Chief
Financial Officer in 1992 and Executive Vice President and Chief
Financial Officer in 1995, successively. Before joining us,
Mr. Pyle worked in public accounting (in the United States,
Bermuda, Spain and England) specializing in the hospitality
industry, and as the corporate controller for a British public
company in the leisure industry.

Randy Stephenjoined
us in 2002 as Chief Operating Officer. Prior to joining us and
since 1987, Mr. Stephen held various positions with Circuit
City Stores, including Director of Human Resources and General
Manager. In 1995, he was appointed Circuit City Stores
Vice President, Corporate Operations, focusing on marketing,
promotions and business process re-engineering and in 1996 he
became the Northeast Division President. Prior to 1987,
Mr. Stephen worked with several premier retailers including
Eastern Mountain Sports, Eddie Bauer, Keeger & Sons and
Britches of Georgetown.

Keith E. Alessihas
served as a director of Town Sports since April 1997.
Mr. Alessi is an adjunct professor of Law at Washington and
Lee University School of Law. Mr. Alessi served as
President, Chief Executive Officer and a director of
Telespectrum Worldwide, Inc. from March 1998 to April 2000. From
May 1996 to March 1998, Mr. Alessi served as Chairman,
President and Chief Executive Officer of Jackson Hewitt, Inc.

Paul Arnoldhas
served as a director of Town Sports since April 1997. Mr. Arnold
has served as Chairman and Chief Executive Officer of Cort
Business Services, Inc., a Berkshire Hathaway Company, since

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2000. From 1992 to 2000, Mr. Arnold served
as President, Chief Executive Officer and Director of Cort
Business Services. Prior to 1992, Mr. Arnold held various
positions over a 24 year period within Cort Furniture Rental, a
division of Mohasco Industries. Mr. Arnold is currently a
Director of Relocation Central Corp. and Penhall International,
Inc.


Bruce Bruckmannhas
served as a director of Town Sports since December 1996. Since
1994, Mr. Bruckmann has served as Managing Director of BRS.
From 1983 until 1994, Mr. Bruckmann served as an officer
and subsequently a Managing Director of Citicorp Venture
Capital, Ltd. Mr. Bruckmann is currently a director of
Penhall International, Inc., Mohawk Industries, Inc., H&E
Equipment Services L.L.C. and Anvil Knitwear, Inc. and a
director of several private companies.

J. Rice Edmondshas served as a director of Town
Sports since July 2002. Mr. Edmonds is a Principal of BRS.
Prior to joining BRS in 1996, Mr. Edmonds worked in the high
yield finance group of Bankers Trust. Mr. Edmonds is
currently a director of H&E Equipment Services L.L.C. and
several other private companies.

Jason Fishhas been
a director of Town Sports since December 1996. Mr. Fish is a
co-founder and President of CapitalSource Inc., and a member of
CapitalSources board of directors, a position he has held
since September 2000. Prior to founding CapitalSource, Mr. Fish
was employed from 1990 to 2000 by Farallon Capital Management,
L.L.C., serving as a managing member from 1992 to 2000. Before
joining Farallon, Mr. Fish worked at Lehman Brothers Inc.,
where he was a Senior Vice President responsible for its
financial institution investment banking coverage on the West
Coast.

Code of Ethics

The Company has adopted a written Code of
Business Conduct and Ethics, which applies to all officers,
directors and employees, including our principal executive
officer, principal financial officer and principal accounting
officer or controller. Interested persons may obtain a copy of
our Code of Business Conduct and Ethics without charge by
writing to Town Sports International, Inc., Attention: Robert
Herbst, Vice President and General Counsel, 888 Seventh Avenue,
New York, New York 10106.

Audit Committee

The Audit Committee of the Board of Directors is
comprised of three directors, who are all financially literate.
Keith Alessi is an audit committee financial expert
within the meaning of the regulations of the Securities and
Exchange Commission.

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##### Table of Contents






Item 11.     Executive
Compensation

The following summarizes, for the year indicated,
the principal components of compensation for our Chief Executive
Officer and the other four highest compensated executive
officers (collectively, the named executive
officers). The compensation set forth below fully reflects
compensation for work performed on our behalf.

Summary Compensation Table

|                            |                            |        |      |        |  |          |         |              |  |                         |         |         |  |  |   |   |  |  |       |   | 
|--------------------------- | -------------------------- | ------ | ---- | ------ |  | -------- | ------- | ------------ |  | ----------------------- | ------- | ------- |  |  | - | - |  |  | ----- | - | 
|                            |                            |        |      |        |  |          |         |              |  | Long-Term              
|                            |                            |        |      |        |  |          |         |              |  | Compensation           
|                            |                            |        |      |        |  |          |         | Other Annual |  | Awards Common Stock    
|                            |                            |        |      | Salary |  | Bonus(1) |         | Compensation |  | Underlying Options/SARs
|Name and Principal Position |                            | Period |      | ($)    |  | ($)      |         | ($)          |  | (#)                    
|                            |                            |        |      |        |  |          |         |              |  |                        
|Mark Smith                  |                            |        | 2003 |        |  |          | 434,594 |              |  |                         | 511,133 |         |  |  |  |   |  |  | 6,000 |  
|                            | Chairman                   |        |      | 2002   |  |          |         | 426,072      |  |                         |         | 429,224 |  |  |   |  |  |  |       |  | 
|                            |                            |        |      | 2001   |  |          |         | 413,662      |  |                         |         | 364,597 |  |  |   |  |  |  |       |  | 
|                           
|Robert Giardina             |                            |        | 2003 |        |  |          | 412,179 |              |  |                         | 406,227 |         |  |  |  |   |  |  | 6,000 |  
|                            | Chief Executive Officer,   |        |      | 2002   |  |          |         | 404,097      |  |                         |         | 327,312 |  |  |   |  |  |  |       |  | 
|                            | Office of the President    |        |      | 2001   |  |          |         | 392,327      |  |                         |         | 276,678 |  |  |   |  |  |  |       |  | 
|                           
|Richard Pyle                |                            |        | 2003 |        |  |          | 306,270 |              |  |                         | 251,746 |         |  |  |  |   |  |  | 5,000 |  
|                            | Chief Financial Officer,   |        |      | 2002   |  |          |         | 236,539      |  |                         |         | 252,815 |  |  |   |  |  |  |       |  | 
|                            | Office of the President    |        |      | 2001   |  |          |         | 215,035      |  |                         |         | 216,258 |  |  |   |  |  |  |       |  | 
|                           
|Alexander Alimanestianu     |                            |        | 2003 |        |  |          | 306,270 |              |  |                         | 251,746 |         |  |  |  |   |  |  | 5,000 |  
|                            | Chief Development Officer, |        |      | 2002   |  |          |         | 236,539      |  |                         |         | 252,815 |  |  |   |  |  |  |       |  | 
|                            | Office of the President    |        |      | 2001   |  |          |         | 215,035      |  |                         |         | 216,258 |  |  |   |  |  |  |       |  | 
|                           
|Randy Stephen               |                            |        | 2003 |        |  |          | 225,000 |              |  |                         | 95,755  |         |  |  |  |   |  |  | 4,000 |  
|                            | Chief Operating Officer,   |        |      |        |  |          |         |              |  |                         |         |         |  |  |   |   |  |  |       |   | 
|                            | Senior Vice President      |        |      |        |  |          |         |              |  |                         |         |         |  |  |   |   |  |  |       |   | 
|                           
|Deborah Smith(2)            |                            |        | 2002 |        |  |          | 178,098 |              |  |                         | 171,690 |         |  |  |  |   |  |  |      |  
|                            | Senior Vice President,     |        |      | 2001   |  |          |         | 172,911      |  |                         |         | 145,839 |  |  |   |  |  |  |       |  | 



---

(1) Includes annual bonus payments under our
Annual Bonus Plan.

(2) Ms. Smith has resigned her position with
the Company effective January 2003.

Option/SAR Grants During the Year Ended
December 31, 2003

In 2003 common stock options with an exercise
price of $144.00 and a term of ten years were granted to named
executive officers as follows:

|                        |  |      
|----------------------- |  | -----
|Mark Smith              |  | 6,000
|Robert Giardina         |  | 6,000
|Richard Pyle            |  | 5,000
|Alexander Alimanestianu |  | 5,000
|Randy Stephen           |  | 4,000

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Aggregated Option/SAR Exercises During the
Years Ended December 31, 2003 and 2003 Year-End Option/SAR
Values

The following summarizes exercises of stock
options (granted in prior years) by the named executive officers
during the year ended December 31, 2003 as well as the
number and value of all unexercised options held by the named
executive officers as of December 31, 2003.

|                        |  |             |   |             |  |                   |   |                           |  |                           |           |           |  |  |              |  |  |  |           |  |  |  |   | 
|----------------------- |  | ----------- | - | ----------- |  | ----------------- | - | ------------------------- |  | ------------------------- | --------- | --------- |  |  | ------------ |  |  |  | --------- |  |  |  | - | 
|                        |  |             |   |             |  |                   |   |                           |  |                          
|                        |  |             |   |             |  |                   |   | Number of Securities      |  | Value of Unexercised     
|                        |  |             |   |             |  |                   |   | Options/SARs              |  | In-the-Money Options/SARs
|                        |  | Shares      |   |             |  |                   |   | at FY-End(#)              |  | at FY-End ($)(1)         
|                        |  | Acquired on |   | Value       |  |                   |   | Exercisable/Unexercisable |  | Exercisable/Unexercisable
|                        |  | Exercise(#) |   | Realized($) |  | Value Realized($) |   |                           |  |                          
|Name                    |  | Common      |   | Common      |  | Preferred         |   | Common                    |  | Common                    |           | Preferred
|                        |  |             |   |             |  |                   |   |                           |  |                           |           |          
|Mark Smith              |  |             |  |             |  |                   |  |                           |  | $                         | 2,479,901 |           |  |  | 10,030/4,800 |  |  |  | 529,800/0 |  |  |  |  | 
|Robert Giardina         |  |             |  |             |  |                   |  |                           |  |                           | 1,899,575 |           |  |  | 10,029/4,800 |  |  |  | 529,740/0 |  |  |  |  | 
|Richard Pyle            |  |             |  |             |  |                   |  |                           |  |                           | 1,596,961 |           |  |  | 9,828/4,800  |  |  |  | 529,680/0 |  |  |  |  | 
|Alexander Alimanestianu |  |             |  |             |  |                   |  |                           |  |                           | 1,575,547 |           |  |  | 9,828/4,000  |  |  |  | 529,680/0 |  |  |  |  | 
|Randy Stephen           |  |             |  |             |  |                   |  |                           |  |                           |          |           |  |  | 800/3,200    |  |  |  |          |  |  |  |  | 
|Deborah Smith           |  |             |   |             |  |                   |   |                           |  |                           | 540,653   |           |  |  | 5,750/0      |  |  |  | 338,400/0 |  |  |  |  | 




|    |                                                                                                                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Value realized is based upon the fair market
    value of the stock at the exercise date minus the exercise
    price. Fair market value was determined in good faith by the
    Board of Directors and was based upon an independent valuation.

Town Sports International, Inc. Stock Option
Plan

Our board of directors has adopted a stock option
plan, which provides for the grant to some of our key employees
and/or directors of stock options. The compensation committee of
our board of directors administers the stock option plan. The
compensation committee has broad powers under the stock option
plan, including exclusive authority (except as otherwise
provided in the stock option plan) to determine:



| |     |                                          
| | --- | -----------------------------------------
| | (1) | who will receive awards,                 
|
| | (2) | the type, size and terms of awards,      
|
| | (3) | the time when awards will be granted, and
|
| | (4) | vesting criteria, if any, of the awards. 

Options awarded under the plan are exercisable
into shares of our common stock. The total number of shares of
common stock as to which options may be granted may not exceed
162,759 shares of common stock. Options may be granted to
any of our employees and directors.

If we undergo a reorganization, recapitalization,
stock dividend or stock split or other change in shares of our
common stock, the compensation committee may make adjustments to
the plan in order to prevent dilution of outstanding options.
The compensation committee may also cause options awarded under
the plan to become immediately exercisable if we undergo
specific types of changes in the control of our Company.

Compensation of Directors

We reimburse directors for any out-of-pocket
expenses incurred by them in connection with services provided
in such capacity.

Compensation Committee Interlocks and Insider
Participation

The current members of our compensation committee
are Bruce Bruckmann, Paul Arnold and Mark Smith. Bruce Bruckmann
and Paul Arnold are non-employee directors.

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Management Equity Agreements

We have entered into executive stock agreements
with our named executive officers. Pursuant to these executive
stock agreements, our named executive officers each have
purchased our shares of common stock at a purchase price of
$1.00 per share.

Our Benefit Plans

We maintain a 401(k) defined contribution plan
and are subject to the provisions of the Employee Retirement
Income Security Act of 1974 (ERISA). The plan
provides for us to make discretionary contributions; however, we
elected not to make contributions for the years ended
December 31, 1999 and 2000. The plan was amended, effective
January 1, 2001, to provide for an employer matching
contribution in an amount equal to 25% of the participants
contribution with a limit of five hundred dollars per annum. In
February 2002, 2003, and 2004, employer matching contributions
totaling $200,000, $200,000 and $195,000 were made for the Plan
years ended December 31, 2001 and 2002 and 2003
respectively.




Item 12.  Security Ownership
of Certain Beneficial Owners and Management

|                                                                                                    |                            |              |         |                |  |           |      |           |   |  |         |         |  |  |         |   | 
|--------------------------------------------------------------------------------------------------- | -------------------------- | ------------ | ------- | -------------- |  | --------- | ---- | --------- | - |  | ------- | ------- |  |  | ------- | - | 
|                                                                                                    |                            | Common       |         |                |  |           |      |          
|                                                                                                    |                            | Stock        |         | Percentage of  |  | Series A  |      | Series B 
|                                                                                                    |                            | Beneficially |         | Common Stock   |  | Preferred |      | Preferred
|Name                                                                                                |                            | Owned(1)     |         | Outstanding(1) |  | Stock     |      | Stock    
|                                                                                                    |                            |              |         |                |  |           |      |          
|BRS(2)
    126 East 56th Street, 29th Floor
    New York, New York 10022                            |                            |              | 504,456 |                |  |           | 36.6 | %         |   |  | 104,330 |         |  |  |        |  
|Farallon Partners, L.L.C.(3)
    One Maritime Plaza, Suite 1325
    San Francisco, California 94111 |                            |              | 270,091 |                |  |           | 19.8 | %         |   |  | 41,045  |         |  |  |        |  
|The Canterbury Entities
    600 Fifth Avenue, 23rd Floor
    New York, New York 10020               |                            |              | 139,437 |                |  |           | 10.1 | %         |   |  |        |         |  |  |        |  
|CapitalSource Holdings L.L.C
    4445 Willard Avenue
    Chevy Chase, Maryland 20815                |                            |              | 23,000  |                |  |           | 1.7  | %         |   |  |        |         |  |  |        |  
|Rosewood Capital L.P.
    One Maritime Plaza, Suite 1330
    San Francisco, California 94111        |                            |              | 17,908  |                |  |           | 1.3  | %         |   |  |        |         |  |  | 109,541 |  
|Executive Officers and Directors:                                                                   |                            |              |         |                |  |           |      |           |   |  |         |         |  |  |         |  
|                                                                                                    | Mark Smith(4)              |              |         | 76,155         |  |           |      | 5.6       | % |  |         |        |  |  |         |  | 
|                                                                                                    | Robert Giardina(4)         |              |         | 60,680         |  |           |      | 4.4       | % |  |         |        |  |  |         |  | 
|                                                                                                    | Richard Pyle(4)            |              |         | 52,410         |  |           |      | 3.8       | % |  |         |        |  |  |         |  | 
|                                                                                                    | Alexander Alimanestianu(4) |              |         | 51,836         |  |           |      | 3.8       | % |  |         |        |  |  |         |  | 
|                                                                                                    | Deborah Smith(4)           |              |         | 15,908         |  |           |      | 1.3       | % |  |         |        |  |  |         |  | 
|                                                                                                    | Randy Stephen              |              |         | *              |  |           |      | *         |   |  |         |         |  |  |         |   | 
|                                                                                                    | Bruce C. Bruckmann(5)      |              |         | 517,642        |  |           |      | 37.6      | % |  |         | 107,057 |  |  |         |  | 
|                                                                                                    | J. Rice Edmonds(6)         |              |         | 504,456        |  |           |      | 36.6      | % |  |         | 104,330 |  |  |         |  | 
|                                                                                                    | Jason Fish(7)              |              |         | 23,000         |  |           |      | 1.7       | % |  |         |        |  |  |         |  | 
|                                                                                                    | Paul Arnold                |              |         | *              |  |           |      | *         |   |  |         | 591     |  |  |         |  | 
|                                                                                                    | Keith Alessi               |              |         | *              |  |           |      | *         |   |  |         | 591     |  |  |         |  | 
|Executive Officers and Directors as a Group:                                                        |                            |              |         |                |  |           |      |           |   |  |         |         |  |  |         |  
|                                                                                                    | 11 Persons(8)              |              |         | 813,531        |  |           |      | 59.0      | % |  |         | 108,240 |  |  |         |  | 



---



|  |                         
|- | ------------------------
|* | Represents less than 1%.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Beneficial ownership is determined in accordance
    with Rule 13d-3 under the Exchange Act. In computing the
    number of shares beneficially owned by a person and the
    percentage ownership of that person, shares of common stock
    subject to options held by that person that are currently
    exercisable or exercisable within 60 days of March 15,
    2004 are deemed outstanding. Such shares, however, are not
    deemed outstanding for the purposes of computing the percentage
    ownership of any other person.

33



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##### Table of Contents





|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Excludes shares held individually by
    Mr. Bruckmann and other individuals (and affiliates and
    family members thereof), each of whom are employed by BRS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(3) | Farallon Capital Partners, L.P., Farallon Capital
    Institutional Partners, L.P., Farallon Capital Institutional
    Partners II, L.P. and R.R. Capital Partners, L.P.
    (collectively, the Farallon Entities), directly
    hold, in aggregate, the shares listed above. As the general
    partner of each of the Farallon Entities, Farallon Partners,
    L.L.C. (FPLLC), may, for purposes of Rule 13d-3
    under the Exchange Act, be deemed to own beneficially the shares
    held by the Farallon Entities. FPLLC disclaims beneficial
    ownership of such shares. All of the above-mentioned entities
    disclaim group attribution.
|   
|(4) | Includes options to acquire common stock, options
    exercisable within 60 days, pursuant to the option plan.
    Messrs. Smith, Giardina, Pyle, and Alimanestianu each hold
    such options on 8,830, 8,829, 8,828, and 8,828 shares of common
    stock, respectively. The address for each of these named
    executive officers is the same as the address of our principal
    executive offices.                                                                                                                                                                                                                                                  
|   
|(5) | Includes 504,456 shares held by BRS, and
    approximately 2,276 shares held by certain other family
    members of Mr. Bruckmann. Mr. Bruckmann disclaims
    beneficial ownership of such shares held by BRS.                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(6) | Includes shares held by BRS. Mr. Edmonds
    disclaims beneficial ownership of such shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(7) | Includes shares held by CapitalSource
    Holdings, L.L.C. Mr. Fish is a co-founder and
    president of CapitalSource Inc. Mr. Fish disclaims
    beneficial ownership of such shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|(8) | Includes (i) shares held by BRS, which may
    be deemed to be owned beneficially by Messrs. Bruckmann and
    Edmonds, and (ii) shares held by CapitalSource, which may
    be deemed to be owned beneficially by Mr. Fish.                                                                                                                                                                                                                                                                                                                                                                                                                              

Excluding the shares beneficially owned by BRS
and CapitalSource, the directors and named executive officers as
a group beneficially own (i) 272,889 shares of common
stock (which represents approximately 19.8% of the common stock
on a fully diluted basis), and (ii) 1,182 shares of
series A preferred stock.




Item 13.  Certain
Relationships and Related Transactions

Redeemable Senior Preferred Stock

In November 1998, we issued 40,000 shares of
Redeemable Senior Preferred Stock (Senior). After
the payment of fees and expenses of approximately $400,000 we
received net proceeds of approximately $39.6 million. The
Senior stock was redeemed in April 2003 at an aggregate
redemption value of 67.0 million

Registration Rights Agreement

In connection with the 1996 Recapitalization, we,
BRS, the Farallon Entities, Canterbury Mezzanine Capital, L.P.
(CMC), certain members of management and other
shareholders of the Company entered into a Registration Rights
Agreement, dated December 10, 1996 (as amended on
November 13, 1998, in connection with the issuance of
Senior Preferred Stock, the Registration Rights
Agreement). Pursuant to the terms of the Registration
Rights Agreement, BRS, the Farallon Entities and CMC have the
right to require us, at our expense of and subject to certain
limitations, to register under the Securities Act all or part of
the shares of Common Stock (the Registrable
Securities) held by them. BRS is entitled to demand up to
three long-form registrations at any time and unlimited
short-form registrations. Farallon is entitled to demand one
long-form registration (but only one year after we have
consummated an initial registered public offering of our Common
Stock) and up to three short-form registrations. CMC is entitled
to demand up to two short-form registrations.

All holders of Registrable Securities are
entitled to an unlimited number of piggyback
registrations, with us paying all expenses of the Offering,
whenever we propose to register our Common Stock under the
Securities Act. Each such holder is subject to certain pro rata
limitations on its ability to participate in such a
piggyback registration. In addition, pursuant to the
Registration Rights Agreement, we have agreed to indemnify all
holders of Registrable Securities against certain liabilities,
including certain liabilities under the Securities Act.

Professional Services Agreement

In connection with the Recapitalization,
Bruckmann, Rosser, Sherrill & Co., Inc. (BRS
Co.), an affiliate of BRS, and the Company entered into a
Professional Services Agreement, whereby BRS Co. agreed to
provide us certain advisory and consulting services. In exchange
for such services, BRS Co. receives an annual fee of $250,000
per calendar year while they own at least 20.0% of our
outstanding Common Stock.

34



---



##### Table of Contents






Item 14.     Principal
Accountant Fees and Services

Town Sports International, Inc. was billed for
the following services provided by
PricewaterhouseCoopers LLP, the Companys principal
independent accountants, during December 31, 2002 and 2003:

|                      |  |      |         |      |  |   |         | 
|--------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                      |  | 2002 |         | 2003
|                      |  |      |         |     
|Audit fees(1)         |  | $    | 318,000 |      |  | $ | 396,000 | 
|Audit related fees(2) |  |      | 17,000  |      |  |   | 20,000  | 
|Tax fees(3)           |  |      | 61,000  |      |  |   |        | 
|All other fees(4)     |  |      | 377,000 |      |  |   | 50,000  | 
|                      |  |      |         |      |  |   |         | 
|Total                 |  | $    | 773,000 |      |  | $ | 466,000 | 
|                      |  |      |         |      |  |   |         | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Audit fees include fees for (i) the audits
    of the Companys consolidated financial statements,
    including services related to statutory audits of certain of the
    Companys subsidiaries, (ii) review of the unaudited
    condensed consolidated interim financial statements included in
    quarterly reports and (iii) the review of debt offerings
    and issuance of comfort letters.
|   
|(2) | Audit related fees include fees for audits of the
    Companys employee benefit plan.                                                                                                                                                                                                                                                                                                                
|   
|(3) | Tax fees include fees for tax advice on state
    related matters.                                                                                                                                                                                                                                                                                                                                    
|   
|(4) | All other fees relate to consultations regarding
    insurance claims and establishment of a captive insurance
    company.                                                                                                                                                                                                                                                                           

The Audit Committees policy is to
pre-approve all audit and permissible non-audit services
provided by the independent accountants. These services may
include audit services, audit-related services, tax services,
and other services. Pre-approval is generally provided for up to
one year and is detailed as to the particular service or
category of services. The Audit Committee may also pre-approve
particular services on a case-by-case basis. The Audit Committee
pre-approved 100% of the audit fees, audit-related fees, and all
other fees for the fiscal year ended December 31, 2003.

The Audit Committee determined that the provision
of services discussed above is compatible with maintaining the
independence of PricewaterhouseCoopers LLP from the Company.

35



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##### Table of Contents






PART IV




Item 15.  Exhibits,
Financial Statement Schedules, and Reports on
Form 8-K

(a) Document List

1.  Financial Statements

The following consolidated financial statements
of Town Sports International Inc. are included in Item 8:

|                                                                                                          |  |      |     | 
|--------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                          |  | Page
|                                                                                                          |  |     
|Report of independent auditors                                                                            |  |      | F-1 | 
|Consolidated balance sheets at December 31,
    2002 and 2003                                             |  |      | F-2 | 
|Consolidated statements of operations for the
    years ended December 31, 2001, 2002 and 2003            |  |      | F-3 | 
|Consolidated statements of stockholders
    deficit for the years ended December 31, 2001, 2002 and 2003 |  |      | F-4 | 
|Consolidated statements of cash flows for the
    years ended December 31, 2001, 2002 and 2003            |  |      | F-5 | 
|Notes to consolidated financial statements                                                                |  |      | F-6 | 

2.  Financial statement schedules

All schedules for which provision is made in the
applicable accounting requirements of the Securities and
Exchange Commission are not required or the required information
has been included within the financial statements or the notes
thereto.

(b) Reports on Form 8-K

February 24, 2004, Current Report, Items 12
and 7

January 23, 2004, Current Report, Items 5
and 7

January 23, 2004, Current Report, Item 9

November 4, 2003, Current Report, Items 12
and 7

(c) Exhibits:

| |    |   |  |                                                                                                                                                                                                                                                                            
| | -- | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2. | 1 |  | Agreement and Plan of Merger dated as of
    November 8, 1996 by and among the Company, various Sellers
    and Option Holders and TSI Recapitalization Sub, Inc.                                                                                                         
| | 2. | 2 |  | Amendment to Agreement and Plan of Merger dated
    as of December 10, 1996 among TSI Merger Sub, Inc., the
    Company and certain stockholders and option holders of the
    Company.                                                                                   
| | 3. | 1 |  | Amended and Restated Certificate of Incorporation
    of the Company.                                                                                                                                                                                                     
| | 3. | 2 |  | By-Laws of the Company.                                                                                                                                                                                                                                                   
| | 3. | 3 |  | Certificate of Amendment of the Certificate of
    Incorporation of the Company, dated as of November 13,
    1998.*                                                                                                                                                       
| | 3. | 4 |  | Certificate of Amendment of the Certificate of
    Incorporation of the Company dated February 24,
    2003.                                                                                                                                                            
| | 4. | 1 |  | Registration Rights Agreement dated as of
    December 10, 1996 by and among the Company, BRS and various
    investors, the Farallon Entities, CMC, and certain
    stockholders.                                                                                        
| | 4. | 2 |  | Registration Rights Agreement dated as of
    June 21, 1999 between the Company and Deutsche Bank
    Securities, Inc.                                                                                                                                                   
| | 4. | 3 |  | First Amendment to Registration Rights Agreement
    by and among the Company, BRS, CMC, Canterbury Detroit Partners
    L.P., Rosewood Capital Partners L.P., the Farallon Entities and
    certain other stockholders of the Company, dated as of
    November 13, 1998.*
| | 4. | 4 |  | Second Amendment to Registration Rights Agreement
    by and among the Company, BRS, CMC, CDP, RC, the Farallon
    Entities, CapitalSource Holdings LLC and certain other
    stockholders of the Company, dated November 6, 2000.***                                     
| | 4. | 5 |  | Indenture dated as of April 16, 2003 between
    the Company and The Bank of New York.*                                                                                                                                                                                    
| | 4. | 6 |  | Purchase Agreement dated as of April 16,
    2003 among the Company, the guarantors party thereto and
    Deutsche Bank Trust Company Americas Incorporated.                                                                                                             

36



---



##### Table of Contents



| |     |   |  |                                                                                                                                                                            
| | --- | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 4.  | 7 |  | Purchases Agreement dated as of April 16,
    2003 between the Company and Deutsche Bank Securities,
    Inc.                                                            
| | 4.  | 8 |  | Registration Rights Agreement dated as of
    April 16, 2003 among the Company, the guarantors party
    thereto and Deutsche Bank Trust Company Americas.               
| | 10. | 1 |  | Credit Agreement dated as of April 16, 2003
    by and among Deutsche Bank Trust Company, the financial
    institutions named therein and the Company.                  
| | 10. | 2 |  | Stock Purchase Agreement among the Company, CMC
    and CDP, dated as of November 13, 1998.*                                                                               
| | 10. | 3 |  | Stock Purchase Agreement among the Company, the
    Farallon Entities and RC, dated as of November 30, 1998.*                                                              
| | 10. | 4 |  | Stock Purchase Agreement among the Company and
    CapitalSource dated as of November 6, 2000.**                                                                           
| | 10. | 5 |  | Shareholders Agreement dated as of
    December 10, 1996 by and among the Company, BRS, the
    Farallon Entities, CMC and certain other stockholders of the
    Company.
| | 10. | 6 |  | Amended and Restated Shareholders Agreement
    among the Company, BRS, the Farallon Entities, RC, CMC, and CDP,
    dated as of November 13, 1998.*                      
| | 21. | 1 |  | Subsidiaries of the Company.                                                                                                                                               
| | 31. | 1 |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                                               
| | 31. | 2 |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                                               
| | 31. | 3 |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                                               
| | 32. | 1 |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                               
| | 32. | 2 |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                               




| |    |                                                                                                              
| | -- | -------------------------------------------------------------------------------------------------------------
| |   | Incorporated by reference to the
    Registrants Registration Statement on Form S-4, File
    No. 333-40907.
|
| |  | Incorporated by reference to the
    Registrants Registration Statement on Form S-4, File
    No. 333-82607.



| |     |                                                                                                                    
| | --- | -------------------------------------------------------------------------------------------------------------------
| |  | Incorporated by reference to the
    Registrants Registration Statement on Form S-4, File
    
     No. 333-40907.



| |     |                                                                               
| | --- | ------------------------------------------------------------------------------
| | *   | Incorporated by reference to the
    Registrants December 31, 1998 Form 10-K.
|
| | **  | Incorporated by reference to the
    Registrants December 31, 1999 Form 10-K.
|
| | *** | Incorporated by reference to the
    Registrants December 31, 2000 Form 10-K.

37



---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of

Town Sports International, Inc:


In our opinion, the accompanying consolidated
balance sheets and the related consolidated statements of
operations, stockholders deficit and cash flows present
fairly, in all material respects, the financial position of Town
Sports International, Inc. and Subsidiaries (the
Company) at December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the
three years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the
United States of America. These financial statements are the
responsibility of the Companys management; our
responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally
accepted in the United States of America, which require that we
plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

As discussed in Notes 2m and 4 to the
financial statements, the Company changed its method of
accounting for goodwill and other intangibles effective
January 1, 2002.

/s/ PRICEWATERHOUSECOOPERS LLP

February 17, 2004 except Note 18, which
is dated March 17, 2004

New York, New York


F-1



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, 2002 and 2003


|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |         |         |  
|--------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ------- | ------- | ------- | - | ------- | ------- | ------- | -
|                                                                      |                                                                                                                                                                                                                           | 2002                                                                        |         | 2003   
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |        
|                                                                      |                                                                                                                                                                                                                           |                                                                            
|                                                                      |                                                                                                                                                                                                                           | (In thousands of dollars, except                                           
|                                                                      |                                                                                                                                                                                                                           | share and per share data)                                                  
|ASSETS                                                               
|Current assets                                                        |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      | Cash and cash equivalents                                                                                                                                                                                                 |                                                                             | $       | 5,551   |         |   | $       | 40,802  |        
|                                                                      | Accounts receivable (less allowance for doubtful
    accounts of $120 and $822 in 2002 and 2003, respectively)                                                                                                            |                                                                             |         | 1,333   |         |   |         | 1,469   |        
|                                                                      | Inventory                                                                                                                                                                                                                 |                                                                             |         | 1,132   |         |   |         | 750     |        
|                                                                      | Prepaid corporate income taxes                                                                                                                                                                                            |                                                                             |         | 3,012   |         |   |         | 4,062   |        
|                                                                      | Prepaid expenses and other current assets                                                                                                                                                                                 |                                                                             |         | 4,430   |         |   |         | 5,322   |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      |                                                                                                                                                                                                                           | Total current assets                                                        |         |         | 15,458  |   |         |         | 52,405  |  
|Fixed assets, net                                                     |                                                                                                                                                                                                                           |                                                                             | 210,823 |         |         |   | 223,599 |        
|Goodwill                                                              |                                                                                                                                                                                                                           |                                                                             | 45,531  |         |         |   | 45,864  |        
|Intangible assets, net                                                |                                                                                                                                                                                                                           |                                                                             | 1,675   |         |         |   | 630     |        
|Deferred tax assets, net                                              |                                                                                                                                                                                                                           |                                                                             | 20,254  |         |         |   | 16,771  |        
|Deferred membership costs                                             |                                                                                                                                                                                                                           |                                                                             | 14,408  |         |         |   | 13,038  |        
|Other assets                                                          |                                                                                                                                                                                                                           |                                                                             | 6,101   |         |         |   | 9,892   |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      |                                                                                                                                                                                                                           | Total assets                                                                |         | $       | 314,250 |   |         | $       | 362,199 |  
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                     
|LIABILITIES, REDEEMABLE PREFERRED STOCK AND
    STOCKHOLDERS DEFICIT
|Current liabilities                                                   |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      | Current portion of long-term debt and capital
    lease obligations                                                                                                                                                       |                                                                             | $       | 5,178   |         |   | $       | 3,486   |        
|                                                                      | Accounts payable                                                                                                                                                                                                          |                                                                             |         | 5,328   |         |   |         | 5,379   |        
|                                                                      | Accrued expenses                                                                                                                                                                                                          |                                                                             |         | 21,634  |         |   |         | 26,006  |        
|                                                                      | Deferred revenue                                                                                                                                                                                                          |                                                                             |         | 26,510  |         |   |         | 26,621  |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      |                                                                                                                                                                                                                           | Total current liabilities                                                   |         |         | 58,650  |   |         |         | 61,492  |  
|Long-term debt and capital lease obligations                          |                                                                                                                                                                                                                           |                                                                             | 155,765 |         |         |   | 258,391 |        
|Deferred lease liabilities                                            |                                                                                                                                                                                                                           |                                                                             | 23,644  |         |         |   | 25,856  |        
|Deferred revenue                                                      |                                                                                                                                                                                                                           |                                                                             | 3,435   |         |         |   | 3,002   |        
|Other liabilities                                                     |                                                                                                                                                                                                                           |                                                                             | 7,530   |         |         |   | 7,862   |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      |                                                                                                                                                                                                                           | Total liabilities                                                           |         |         | 249,024 |   |         |         | 356,603 |  
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|Commitments and contingencies (Note 15)                               |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|Redeemable preferred stock                                            |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      | Redeemable senior preferred stock, $1.00 par
    value; liquidation value $64,512; authorized 100,000 shares;
    40,000 and 0 shares issued and outstanding at December 31,
    2002 and December 31, 2003, respectively |                                                                             |         | 62,125  |         |   |         |        |        
|                                                                      | Series A redeemable preferred stock, $1.00
    par value; at liquidation value; authorized 200,000 shares;
    153,637 shares issued and outstanding at December 31, 2002
    and 2003                                    |                                                                             |         | 34,841  |         |   |         | 39,890  |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             | 96,966  |         |         |   | 39,890  |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|Stockholders deficit                                                 |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      | Series B preferred stock, $1.00 par value;
    at liquidation value; 3,822 and 109,540 shares issued and
    outstanding at December 31, 2002 and 2003, respectively                                                      |                                                                             |         | 303     |         |   |         | 9,961   |        
|                                                                      | Class A voting common stock, $.001 par
    value; issued and outstanding 1,176,043 shares at
    December 31, 2002 and 2003, respectively                                                                                 |                                                                             |         | 1       |         |   |         | 1       |        
|                                                                      | Paid-in capital                                                                                                                                                                                                           |                                                                             |         | (32,149 | )       |   |         | (45,627 | )      
|                                                                      | Unearned compensation                                                                                                                                                                                                     |                                                                             |         | (278    | )       |   |         | (172    | )      
|                                                                      | Accumulated other comprehensive income (currency
    translation adjustment)                                                                                                                                              |                                                                             |         | 293     |         |   |         | 596     |        
|                                                                      | Retained earnings                                                                                                                                                                                                         |                                                                             |         | 90      |         |   |         | 947     |        
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      |                                                                                                                                                                                                                           | Total stockholders deficit                                                 |         |         | (31,740 | ) |         |         | (34,294 | )
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        
|                                                                      |                                                                                                                                                                                                                           | Total liabilities, redeemable preferred stock and
    stockholders deficit |         | $       | 314,250 |   |         | $       | 362,199 |  
|                                                                      |                                                                                                                                                                                                                           |                                                                             |         |         |         |   |         |        

See notes to consolidated financial statements.

F-2



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
OPERATIONS

Years Ended December 31, 2001, 2002 and
2003


|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ------------------------- | ------- | ------ | - | ---- | ------- | ------ | - | - | ------- | ------ | -
|                                                                                                                                                                      |                                                                                   | 2001                      |         | 2002   |   | 2003
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |     
|                                                                                                                                                                      |                                                                                   |                          
|                                                                                                                                                                      |                                                                                   | (In thousands of dollars)
|Revenues                                                                                                                                                              |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|Club operations                                                                                                                                                       |                                                                                   | $                         | 278,200 |        |   | $    | 314,995 |        |   | $ | 336,140 |       
|Fees and other                                                                                                                                                        |                                                                                   |                           | 3,433   |        |   |      | 4,432   |        |   |   | 6,401   |       
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|                                                                                                                                                                      |                                                                                   |                           | 281,633 |        |   |      | 319,427 |        |   |   | 342,541 |       
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|Operating expenses                                                                                                                                                    |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|Payroll and related                                                                                                                                                   |                                                                                   |                           | 112,766 |        |   |      | 129,105 |        |   |   | 130,585 |       
|Club operating                                                                                                                                                        |                                                                                   |                           | 88,941  |        |   |      | 99,113  |        |   |   | 111,069 |       
|General and administrative                                                                                                                                            |                                                                                   |                           | 18,785  |        |   |      | 21,368  |        |   |   | 21,995  |       
|Depreciation and amortization                                                                                                                                         |                                                                                   |                           | 32,185  |        |   |      | 31,748  |        |   |   | 34,927  |       
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|                                                                                                                                                                      |                                                                                   |                           | 252,677 |        |   |      | 281,334 |        |   |   | 298,576 |       
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|                                                                                                                                                                      | Operating income                                                                  |                           |         | 28,956 |   |      |         | 38,093 |   |   |         | 43,965 |  
|Loss on extinguishment of debt                                                                                                                                        |                                                                                   |                           |        |        |   |      |        |        |   |   | 7,773   |       
|Interest expense                                                                                                                                                      |                                                                                   |                           | 14,918  |        |   |      | 16,559  |        |   |   | 23,670  |       
|Interest income                                                                                                                                                       |                                                                                   |                           | (391    | )      |   |      | (138    | )      |   |   | (444    | )     
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|                                                                                                                                                                      | Income from continuing operations before
    provision for corporate income taxes |                           |         | 14,429 |   |      |         | 21,672 |   |   |         | 12,966 |  
|Provision for corporate income taxes                                                                                                                                  |                                                                                   |                           | 6,853   |        |   |      | 9,709   |        |   |   | 5,537   |       
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|                                                                                                                                                                      | Income from continuing operations                                                 |                           |         | 7,576  |   |      |         | 11,963 |   |   |         | 7,429  |  
|Loss on discontinued operations (including loss
    on club closure of $996 in 2002), net of income tax benefits of
    $364 and $551 for 2001 and 2002, respectively |                                                                                   |                           | (530    | )      |   |      | (767    | )      |   |   |        |       
|Cumulative effect of a change in accounting
    principle, net of income tax benefit of $612                                                                          |                                                                                   |                           |        |        |   |      | (689    | )      |   |   |        |       
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|                                                                                                                                                                      | Net income                                                                        |                           |         | 7,046  |   |      |         | 10,507 |   |   |         | 7,429  |  
|Accreted dividends on preferred stock                                                                                                                                 |                                                                                   |                           | (10,201 | )      |   |      | (11,543 | )      |   |   | (10,984 | )     
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       
|                                                                                                                                                                      | Net loss attributable to common stockholders                                      |                           | $       | (3,155 | ) |      | $       | (1,036 | ) |   | $       | (3,555 | )
|                                                                                                                                                                      |                                                                                   |                           |         |        |   |      |         |        |   |   |         |       

See notes to consolidated financial statements.

F-3



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
DEFICIT

Years Ended December 31, 2001, 2002 and
2003


|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |        |        | 
|------------------------------------------------------------------------------------------------------------------- | --------------------------------------- | ------------------------------------------- | ------- | ------------ |  | ------- | ----- | -------- |  | ----------- | --------- | ------------ |  | ------------- | - | -------- |  | ------- | ------- | - |  | - | ---- | - |  | - | --- | --- |  | - | ------- | ------ |  | - | ------- | ------ | ------ | 
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |              
|                                                                                                                    |                                         | Preferred Stock                             |         | Common Stock |  |         |       |          |  |             |           |              |  |              
|                                                                                                                    |                                         | Series B                                    |         | Class A      |  |         |       |          |  | Foreign     |           | Accumulated  |  |              
|                                                                                                                    |                                         | ($1.00 par)                                 |         | ($.001 par)  |  |         |       |          |  | Currency    |           | (Deficit)/   |  | Total        
|                                                                                                                    |                                         |                                             |         |              |  | Paid-in |       | Unearned |  | Translation |           | Retained     |  | Stockholders
|                                                                                                                    |                                         | Shares                                      |         | Amount       |  | Shares  |       | Amount   |  | Capital     |           | Compensation |  | Adjustment    |   | Earnings |  | Deficit
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |        
|                                                                                                                    |                                         |                                            
|                                                                                                                    |                                         | (In thousands of dollars except share data)
|Balance at January 1, 2001                                                                                          |                                         |                                             | 3,822   |              |  | $       | 232   |          |  |             | 1,005,698 |              |  | $             | 1 |          |  | $       | (13,117 | ) |  | $ | (156 | ) |  | $ | 12  |     |  | $ | (17,463 | )      |  | $ | (30,491 | )     
|Common stock issued in connection with
    subordinated credit facility                                             |                                         |                                             |         |              |  |         |       |          |  |             | 23,000    |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|Compensation expenses incurred in connection with
    Series B Preferred stock options                              |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | 993     |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   | 993     |       
|Amortization of unearned compensation                                                                               |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   | 156  |   |  |   |     |     |  |   |         |        |  |   | 156     |       
|Accretion of Series B preferred stock
    dividend ($8.63 per share)                                                |                                         |                                             |         |              |  |         | 33    |          |  |             |           |              |  |               |   |          |  |         | (33     | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   |        |       
|Accretion of Series A redeemable preferred
    stock dividend ($25.07 per share)                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (3,852  | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   | (3,852  | )     
|Accretion of redeemable senior preferred stock
    dividend ($157.90 per share plus accretion of liquidation value) |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (6,658  | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   | (6,658  | )     
|Deferred compensation recorded in connection with
    the issuance of stock options                                 |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | 422     |   |  |   | (422 | ) |  |   |     |     |  |   |         |        |  |   |        |       
|Other comprehensive income, net of taxes:                                                                           |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|                                                                                                                    | Net income                              |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         | 7,046  |  |   |         | 7,046  |       
|                                                                                                                    | Foreign currency translation adjustment |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     | 9   |  |   |         |        |  |   |         | 9      |       
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|                                                                                                                    |                                         | Total comprehensive income                  |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |        | 7,055  | 
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|Balance at December 31, 2001                                                                                        |                                         |                                             | 3,822   |              |  |         | 265   |          |  |             | 1,028,698 |              |  |               | 1 |          |  |         | (22,245 | ) |  |   | (422 | ) |  |   | 21  |     |  |   | (10,417 | )      |  |   | (32,797 | )     
|Common stock issued in connection with warrant
    exercises                                                        |                                         |                                             |         |              |  |         |       |          |  |             | 147,345   |              |  |               |   |          |  |         | 1       |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   | 1       |       
|Vesting of restricted common stock issued in
    connection with subordinated credit facility                       |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | 917     |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   | 917     |       
|Compensation expense incurred in connection with
    Series B Preferred stock options                               |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | 1,137   |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   | 1,137   |       
|Amortization of unearned compensation                                                                               |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   | 70   |   |  |   |     |     |  |   |         |        |  |   | 70      |       
|Accretion of Series B preferred stock
    dividend ($10.20 per share)                                               |                                         |                                             |         |              |  |         | 38    |          |  |             |           |              |  |               |   |          |  |         | (38     | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   |        |       
|Accretion of Series A redeemable preferred
    stock dividend ($28.71 per share)                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (4,409  | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   | (4,409  | )     
|Accretion of redeemable senior preferred stock
    dividend ($177.40 per share plus accretion to liquidation value) |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (7,438  | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   | (7,438  | )     
|Forfeiture of unvested options                                                                                      |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (74     | ) |  |   | 74   |   |  |   |     |     |  |   |         |        |  |   |        |       
|Other comprehensive income, net of taxes:                                                                           |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|                                                                                                                    | Net income                              |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         | 10,507 |  |   |         | 10,507 |       
|                                                                                                                    | Foreign currency translation adjustment |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     | 272 |  |   |         |        |  |   |         | 272    |       
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|                                                                                                                    |                                         | Total comprehensive income                  |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |        | 10,779 | 
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|Balance at December 31, 2002                                                                                        |                                         |                                             | 3,822   |              |  |         | 303   |          |  |             | 1,176,043 |              |  |               | 1 |          |  |         | (32,149 | ) |  |   | (278 | ) |  |   | 293 |     |  |   | 90      |        |  |   | (31,740 | )     
|Series B preferred stock issued in
    connection with the exercise of stock options                                |                                         |                                             | 106,267 |              |  |         | 8,618 |          |  |             |           |              |  |               |   |          |  |         | (8,618  | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   |        |       
|Repurchase of stock                                                                                                 |                                         |                                             | (549    | )            |  |         | (43   | )        |  |             |           |              |  |               |   |          |  |         | (540    | ) |  |   |      |   |  |   |     |     |  |   |         |        |  |   | (583    | )     
|Compensation expense incurred in connection with
    Series B Preferred stock options                               |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | 177     |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   | 177     |       
|Amortization of unearned compensation                                                                               |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   | 21   |   |  |   |     |     |  |   |         |        |  |   | 21      |       
|Accretion of Series B preferred stock
    dividend ($9.84 per share)                                                |                                         |                                             |         |              |  |         | 1,083 |          |  |             |           |              |  |               |   |          |  |         | (305    | ) |  |   |      |   |  |   |     |     |  |   | (778    | )      |  |   |        |       
|Accretion of Series A redeemable preferred
    stock dividend ($32.86 per share)                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (1,219  | ) |  |   |      |   |  |   |     |     |  |   | (3,830  | )      |  |   | (5,049  | )     
|Accretion of redeemable senior preferred stock
    dividend ($121.30 per share plus accretion to liquidation value) |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (2,888  | ) |  |   |      |   |  |   |     |     |  |   | (1,964  | )      |  |   | (4,852  | )     
|Forfeiture of unvested options                                                                                      |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         | (85     | ) |  |   | 85   |   |  |   |     |     |  |   |         |        |  |   |        |       
|Other comprehensive income, net of taxes:                                                                           |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|                                                                                                                    | Net income                              |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         | 7,429  |  |   |         | 7,429  |       
|                                                                                                                    | Foreign currency translation adjustment |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     | 303 |  |   |         |        |  |   |         | 303    |       
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|                                                                                                                    |                                         | Total comprehensive income                  |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |        | 7,732  | 
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       
|Balance at December 31, 2003                                                                                        |                                         |                                             | 109,540 |              |  | $       | 9,961 |          |  |             | 1,176,043 |              |  | $             | 1 |          |  | $       | (45,627 | ) |  | $ | (172 | ) |  | $ | 596 |     |  | $ | 947     |        |  | $ | (34,294 | )     
|                                                                                                                    |                                         |                                             |         |              |  |         |       |          |  |             |           |              |  |               |   |          |  |         |         |   |  |   |      |   |  |   |     |     |  |   |         |        |  |   |         |       

See notes to consolidated financial statements.

F-4



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

Years Ended December 31, 2001, 2002 and
2003


INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS


|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |        |         |  
|--------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------ | ------------------------------------------------------- | ------- | ------ | ------- | ---- | ------- | ------ | ------- | - | -------- | ------ | ------- | -
|                                                                                                          |                                                                    | 2001                                                    |         | 2002   |         | 2003
|                                                                                                          |                                                                    |                                                         |         |        |         |     
|                                                                                                          |                                                                    |                                                        
|                                                                                                          |                                                                    | (In thousands of dollars)                              
|Cash flows from operating activities                                                                      |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Net income                                                                                                |                                                                    | $                                                       | 7,046   |        |         | $    | 10,507  |        |         | $ | 7,429    |       
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Adjustments to reconcile net income to net cash
    provided by operating activities                      |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|                                                                                                          | Depreciation and amortization                                      |                                                         |         | 32,667 |         |      |         | 32,025 |         |   |          | 34,927 |        
|                                                                                                          | Amortization of debt issuance costs                                |                                                         |         | 1,882  |         |      |         | 1,928  |         |   |          | 1,627  |        
|                                                                                                          | Noncash rental expense, net of noncash rental
    income           |                                                         |         | 4,224  |         |      |         | 1,670  |         |   |          | 1,650  |        
|                                                                                                          | Compensation expense incurred in connection with
    stock options |                                                         |         | 1,149  |         |      |         | 1,207  |         |   |          | 198    |        
|                                                                                                          | Net change in certain working capital components                   |                                                         |         | 3,475  |         |      |         | 2,413  |         |   |          | (227   | )      
|                                                                                                          | Decrease (increase) in deferred tax asset                          |                                                         |         | (4,526 | )       |      |         | (1,162 | )       |   |          | 3,483  |        
|                                                                                                          | Decrease (increase) in deferred membership
    costs               |                                                         |         | (1,162 | )       |      |         | 340    |         |   |          | 1,370  |        
|                                                                                                          | Loss on extinguishment of debt                                     |                                                         |         |       |         |      |         |       |         |   |          | 7,773  |        
|                                                                                                          | Goodwill impairment write-off                                      |                                                         |         |       |         |      |         | 1,301  |         |   |          |       |        
|                                                                                                          | Club closure costs                                                 |                                                         |         |       |         |      |         | 996    |         |   |          |       |        
|                                                                                                          | Other                                                              |                                                         |         | (407   | )       |      |         | (420   | )       |   |          | 23     |        
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|                                                                                                          |                                                                    | Total adjustments                                       |         |        | 37,302  |      |         |        | 40,298  |   |          |        | 50,824  |  
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|                                                                                                          |                                                                    | Net cash provided by operating activities               |         |        | 44,348  |      |         |        | 50,805  |   |          |        | 58,253  |  
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Cash flows from investing activities                                                                      |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Capital expenditures, net of effect of acquired
    businesses                                            |                                                                    |                                                         | (57,811 | )      |         |      | (41,393 | )      |         |   | (43,397  | )     
|Proceeds from sale of equipment                                                                           |                                                                    |                                                         |        |        |         |      |        |        |         |   | 176      |       
|Acquisition of businesses, net of cash acquired                                                           |                                                                    |                                                         | (1,272  | )      |         |      | (2,322  | )      |         |   | (130     | )     
|Landlord contributions                                                                                    |                                                                    |                                                         | 725     |        |         |      | 3,533   |        |         |   | 617      |       
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|                                                                                                          |                                                                    | Net cash used in investing activities                   |         |        | (58,358 | )    |         |        | (40,182 | ) |          |        | (42,734 | )
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Cash flows from financing activities                                                                      |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Proceeds from 9 5/8% Senior Note Offering                                                                 |                                                                    |                                                         |        |        |         |      |        |        |         |   | 255,000  |       
|Repayment of 9 3/4% Senior Notes                                                                          |                                                                    |                                                         |        |        |         |      |        |        |         |   | (125,000 | )     
|Premium paid on extinguishment of debt and other
    costs                                                |                                                                    |                                                         |        |        |         |      |        |        |         |   | (4,064   | )     
|Redemption of redeemable senior preferred stock                                                           |                                                                    |                                                         |        |        |         |      |        |        |         |   | (66,977  | )     
|Transaction costs related to 9 5/8% Senior
    Notes                                                      |                                                                    |                                                         |        |        |         |      |        |        |         |   | (9,578   | )     
|Net line of credit (repayments) borrowings                                                                |                                                                    |                                                         | 13,745  |        |         |      | (8,245  | )      |         |   | (14,500  | )     
|Net subordinated credit
    (repayments) borrowings                                                       |                                                                    |                                                         | 5,762   |        |         |      | 2,810   |        |         |   | (9,000   | )     
|Repurchase of Series B preferred stock                                                                    |                                                                    |                                                         |        |        |         |      |        |        |         |   | (583     | )     
|Repayments of other borrowings                                                                            |                                                                    |                                                         | (3,404  | )      |         |      | (5,095  | )      |         |   | (5,566   | )     
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|                                                                                                          |                                                                    | Net cash provided by (used in) financing
    activities |         |        | 16,103  |      |         |        | (10,530 | ) |          |        | 19,732  |  
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|                                                                                                          |                                                                    | Net increase in cash and cash equivalents               |         |        | 2,093   |      |         |        | 93      |   |          |        | 35,251  |  
|Cash and cash equivalents                                                                                 |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Beginning of period                                                                                       |                                                                    |                                                         | 3,365   |        |         |      | 5,458   |        |         |   | 5,551    |       
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|End of period                                                                                             |                                                                    | $                                                       | 5,458   |        |         | $    | 5,551   |        |         | $ | 40,802   |       
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Summary of the change in certain working
    capital components,net of effects of acquired
    businesses |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|Increase in accounts receivable                                                                           |                                                                    | $                                                       | (304    | )      |         | $    | (443    | )      |         | $ | (136     | )     
|Decrease (increase) in inventory                                                                          |                                                                    |                                                         | (433    | )      |         |      | 194     |        |         |   | 382      |       
|Increase in prepaid expenses and other current
    assets                                                 |                                                                    |                                                         | (514    | )      |         |      | (527    | )      |         |   | (137     | )     
|Increase in accounts payable and accrued expenses                                                         |                                                                    |                                                         | 1,745   |        |         |      | 3,751   |        |         |   | 1,036    |       
|(Increase) decrease in prepaid corporate income
    taxes                                                 |                                                                    |                                                         | 1,828   |        |         |      | (3,012  | )      |         |   | (1,050   | )     
|(Decrease) increase in deferred revenue                                                                   |                                                                    |                                                         | 1,153   |        |         |      | 2,450   |        |         |   | (322     | )     
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       
|                                                                                                          |                                                                    | Net change in certain working capital components        |         | $      | 3,475   |      |         | $      | 2,413   |   |          | $      | (227    | )
|                                                                                                          |                                                                    |                                                         |         |        |         |      |         |        |         |   |          |       

See notes to consolidated financial statements.

F-5



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

December 31, 2001, 2002 and
2003


(In thousands of dollars, except share
data)




|   |                   
|-- | ------------------
|1. | Nature of Business

Town Sports International, Inc. and Subsidiaries
(the Company) owns and operates 127 fitness
clubs (clubs) and partly owns and operates two
additional clubs as of December 31, 2003. The Company
operates in a single segment. The Company operates 86 clubs
in the New York metropolitan market, 19 clubs in the Boston
market, 15 clubs in the Washington, D.C. market, six in the
Philadelphia market and three clubs in Switzerland. The
Companys geographic concentration in the New York
metropolitan market may expose the Company to adverse
developments related to competition, demographic changes, real
estate costs, acts of terrorism and economic down turns. The
Companys Swiss operations are immaterial to the
Companys consolidated financial position, results of
operations, and cash flows.



|   |                                               
|-- | ----------------------------------------------
|2. | Summary of Significant Accounting
    Policies



| |                                       
| | --------------------------------------
| | a.     Principles
    of Consolidation

The accompanying consolidated financial
statements include the accounts of Town Sports International,
Inc. (TSI) and all wholly owned subsidiaries. All
significant intercompany accounts and transactions have been
eliminated in consolidation.

Certain reclassifications were made to the
reported amounts at December 31, 2001 and 2002 to conform
to the presentation at December 31, 2003.



| |                               
| | ------------------------------
| | b.     Revenue
    Recognition

The Company receives a one-time non-refundable
initiation fee and monthly dues from its members. The
Companys members have the option to join on a
month-to-month basis or to commit to a one or two year
membership. Month-to-month members can cancel their membership
at any time with 30 days notice. Initiation fees and
related direct expenses, primarily salaries and sales
commissions payable to membership consultants, are deferred and
recognized, on a straight-line basis, in operations over an
estimated membership life of twenty four (24) months. The
amount of costs deferred do not exceed the related deferred
revenue for the periods presented. Dues that are received in
advance are recognized on a pro-rata basis over the periods in
which services are to be provided. Revenues from ancillary
services are recognized as services are performed. Management
fees earned for services rendered are recognized at the time the
related services are performed.

The Company recognizes revenue from merchandise
sales upon delivery to the member.

In connection with advance receipts of fees or
dues, the Company is required to maintain surety bonds totaling
$3,342 pursuant to various state consumer protection laws.



| |                 
| | ----------------
| | c.     Inventory

Inventory consists of athletic equipment,
supplies, headsets for the club entertainment system and
clothing for sale to members. Inventories are valued at the
lower of cost or market by the first-in, first-out method.



| |                        
| | -----------------------
| | d.     Fixed
    Assets

Fixed assets are recorded at cost and depreciated
on a straight-line basis over the estimated useful lives of the
assets, which are thirty years for building and improvements,
five years for club equipment, furniture, fixtures and computer
equipment, and three years for computer software. Leasehold
improvements are amortized over the shorter of their estimated
useful lives or the remaining period of the lease. Expenditures
for maintenance and repairs are charged to operations as
incurred. The cost and related accumulated depreciation

F-6



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

or amortization of assets retired or sold are
removed from the respective accounts and any gain or loss is
recognized in operations. The costs related to developing web
applications, developing HTML web pages and installing developed
applications on the web servers are capitalized and classified
as computer software. Web site hosting fees and maintenance
costs are expensed as incurred.



| |                                                 
| | ------------------------------------------------
| | e.     Advertising
    and Club Preopening Costs

Advertising costs and club preopening costs are
charged to operations during the period in which they are
incurred except for production costs related to television and
radio advertisements, which are expensed when the related
commercials are first aired. Total advertising costs incurred by
the Company during the years ended December 31, 2001, 2002
and 2003 totaled $9,327, $8,888 and $9,783, respectively, and
are included in club operations.



| |                            
| | ---------------------------
| | f.     Use of
    Estimates

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the dates of the financial statements and the reported
amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.

The most significant assumptions and estimates
relate to the allocation and fair value ascribed to assets
acquired in connection with the acquisition of clubs under the
purchase method of accounting, the useful lives, recoverability
and impairment of fixed and intangible assets, deferred income
tax valuation, valuation of and expense incurred in connection
with stock options and warrants, legal contingencies and the
estimated membership life.



| |                                  
| | ---------------------------------
| | g.     Corporate
    Income Taxes

Deferred tax liabilities and assets are
recognized for the expected future tax consequences of events
that have been included in the financial statements or tax
returns. Under this method, deferred tax liabilities and assets
are determined on the basis of the difference between the
financial statement and tax basis of assets and liabilities
(temporary differences) at enacted tax rates in
effect for the years in which the temporary differences are
expected to reverse. A valuation allowance is recorded to reduce
deferred tax assets to the amount that is more likely than not
to be realized.



| |                                    
| | -----------------------------------
| | h.     Statements
    of Cash Flows

Supplemental disclosure of cash flow information:

|                                                                                        |  |      |        |      |  |      |        |  |  |   |        | 
|--------------------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|                                                                                        |  | 2001 |        | 2002 |  | 2003
|                                                                                        |  |      |        |      |  |     
|Cash paid                                                                               |  |      |        |      |  |      |        |  |  |   |        | 
|Interest (net of amounts capitalized)                                                   |  | $    | 13,887 |      |  | $    | 15,035 |  |  | $ | 24,004 | 
|Income taxes                                                                            |  |      | 10,087 |      |  |      | 13,187 |  |  |   | 3,104  | 
|                                                                                       
|Noncash investing and financing
    activities                                          |  |      |        |      |  |      |        |  |  |   |        | 
|Acquisition of fixed assets included in accounts
    payable and accrued expenses       |  |      | 7,538  |      |  |      | 3,901  |  |  |   | 7,287  | 
|Acquisition of equipment and software financed by
    lessors                           |  |      | 2,853  |      |  |      | 2,575  |  |  |   |       | 
|See Notes 6, 9, 10 and 11 for additional
    noncash investing and financing activities |  |      |        |      |  |      |        |  |  |   |        | 

F-7



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                     
| | ------------------------------------
| | i.     Cash and
    Cash Equivalents

The Company considers all highly liquid debt
instruments which have original maturities of three months or
less when acquired to be cash equivalents. The carrying amounts
reported in the balance sheets for cash and cash equivalents
approximate fair value. The Company owns and operates a captive
insurance company in the State of New York. Under the insurance
laws of the State of New York, this captive insurance company is
required to maintain a cash balance of at least $250. At
December 31, 2003, $252 of cash related to this wholly
owned subsidiary was included within cash and cash equivalents.



| |                                                                 
| | ----------------------------------------------------------------
| | j.     Deferred
    Lease Liabilities and Noncash Rental Expense

The Company recognizes rental expense for leases
with scheduled rent increases on the straight-line basis over
the life of the lease.



| |                            
| | ---------------------------
| | k.     Foreign
    Currency

At December 31, 2003, the Company owns three
Swiss clubs, which use the local currency as their functional
currency. Assets and liabilities are translated into
U.S. dollars at year-end exchange rates, while income and
expense items are translated into U.S. dollars at the
average exchange rate for the period. For all periods presented
foreign exchange transaction gains and losses were not material.
Adjustments resulting from the translation of foreign functional
currency financial statements into U.S. dollars are included in
the currency translation adjustment in stockholders
deficit. The difference between the Companys net income
and comprehensive income is the effect of foreign exchange
translation adjustments, which was immaterial for 2001, and was
$272 and $303 for 2002 and 2003, respectively.



| |                                               
| | ----------------------------------------------
| | l.     Investments
    in Affiliated Companies

The Company has investments in Capitol Hill
Squash Club Associates (CHSCA) and Kalorama Sports
Management Associates (KSMA) (collectively referred
to as the Affiliates). The Company has a limited
partnership interest in CHSCA, which provides the Company with
approximately 20% of the CHSCA profits, as defined. The Company
has a co-general partnership and limited partnership interests
in KSMA, which entitles it to receive approximately 45% of the
KSMA profits, as defined. The Affiliates have operations, which
are similar, and related to, those of the Company. The Company
accounts for these Affiliates in accordance with the equity
method. The assets, liabilities, equity and operating results of
the Affiliates and the Companys pro rata share of the
Affiliates net assets and operating results were not
material for all periods presented.



| |                                                               
| | --------------------------------------------------------------
| | m.     Intangible
    Assets, Goodwill and Debt Issuance Costs

Intangible assets consist of membership lists, a
beneficial lease and covenants-not-to-compete. These assets are
stated at cost and are being amortized by the straight-line
method over their estimated lives. Membership lists are
amortized over 24 months and covenants-not-to-compete are
amortized over the contractual life, generally five years. The
beneficial lease is being amortized over the remaining life of
the underlying club lease.

In accordance with the Statement on Financial
Accounting Standards (SFAS) No. 142
(SFAS 142), Goodwill and Other Intangible
Assets, goodwill has not been amortized subsequent to
December 31, 2001. For the year ended December 31,
2001, goodwill was amortized by the straight-line method over
the remaining lives of the underlying club leases, five to
fifteen years. See Note 4 for further discussion on
Goodwill and Intangible Assets.

F-8



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Debt issuance costs are classified within other
assets and are being amortized as additional interest expense
over the life of the underlying debt, five to eight years, using
the interest method. Amortization of debt issue costs was
$1,882, $1,928 and $1,627 for December 31, 2001, 2002 and
2003, respectively.



| |                                                              
| | -------------------------------------------------------------
| | n.     Accounting
    for the Impairment of Long-Lived Assets

Long-lived assets, such as fixed assets and
intangible assets are reviewed for impairment when events or
circumstances indicate that their carrying value may not be
recoverable. Estimated undiscounted expected future cash flows
are used to determine if an asset is impaired, in which case the
assets carrying value would be reduced to fair value.

Effective January 1, 2002, the Company
adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets, which
replaces SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of. SFAS No. 144 provides updated
guidance concerning the recognition and measurement of an
impairment loss for certain types of long-lived assets, expands
the scope of discontinued operation to include a component of an
entity and eliminates the exemption to consolidation when
control over a subsidiary is likely to be temporary. In 2002,
the Company discontinued operations at two wholly-owned clubs.
As a result of the adoption of SFAS No. 144 the
Company has accounted for these two clubs as discontinued
operations. See Note 17 for further discussion on
Discontinued Operations.



| |                                         
| | ----------------------------------------
| | o.     Concentrations
    of Credit Risk

Financial instruments which potentially subject
the Company to concentrations of credit risk are cash and cash
equivalents. Such amounts are held, primarily, in a single
commercial bank. The Company holds no collateral for these
financial instruments.



| |                                             
| | --------------------------------------------
| | p.     Stock-Based
    Employee Compensation

For financial reporting purposes, the Company
accounts for stock-based compensation in accordance with the
intrinsic value method (APB No. 25). In
accordance with this method, no compensation expense is
recognized in the accompanying financial statements in
connection with the awarding of stock option grants to employees
provided that, as of the grant date, all terms associated with
the award are fixed and the fair value of the Companys
stock is not greater than the amount an employee must pay to
acquire the stock as defined; however, to the extent that stock
options are granted to employees with variable terms or if the
fair value of the Companys stock as of the measurement
date is greater than the amount an employee must pay to acquire
the stock, then the Company will recognize compensation expense.
The fair value of warrants granted to nonemployees for financing
were recorded as deferred financing costs and amortized into
interest expense using the interest method. See Note 10 for
further discussion on stock options and warrants.

F-9



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table illustrates the effect on net
loss attributed to common stockholders if the Company had
applied the fair value recognition provisions of Financial
Accounting Standards Board issued Statement No. 123,
(SFAS 123) Accounting for Stock-Based
Compensation, to stock-based employee compensation.

|                                                            |                                                                                                                                                          |      |        |      |   |      |        |      |   |   |        |      |  
|----------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- | ------ | ---- | - | ---- | ------ | ---- | - | - | ------ | ---- | -
|                                                            |                                                                                                                                                          | 2001 |        | 2002 |   | 2003
|                                                            |                                                                                                                                                          |      |        |      |   |     
|Net loss attributed to common stockholders, as
    reported |                                                                                                                                                          | $    | (3,155 | )    |   | $    | (1,036 | )    |   | $ | (3,555 | )   
|Add                                                         |                                                                                                                                                          |      |        |      |   |      |        |      |   |   |        |     
|                                                            | Stock-based employee compensation expense
    included in reported net loss attributed to common stockholders,
    net of related tax effects            |      |        | 84   |   |      |        | 38   |   |   |        | 12   |  
|Deduct                                                      |                                                                                                                                                          |      |        |      |   |      |        |      |   |   |        |     
|                                                            | Total stock-based employee compensation expense
    determined under fair value based method for all stock option
    awards, net of related tax effects |      |        | (229 | ) |      |        | (142 | ) |   |        | (167 | )
|                                                            |                                                                                                                                                          |      |        |      |   |      |        |      |   |   |        |     
|Pro forma net loss attributed to common
    stockholders    |                                                                                                                                                          | $    | (3,300 | )    |   | $    | (1,140 | )    |   | $ | (3,710 | )   
|                                                            |                                                                                                                                                          |      |        |      |   |      |        |      |   |   |        |     

Since option grants vest over several years and
additional grants are expected in the future, the pro forma
results noted above are not likely to be representative of the
effects on future years of the application of the fair value
based method.

For the purposes of the above pro forma
information, the fair value of each option granted was estimated
on the date of grant using the Black-Scholes option pricing
model and the following assumptions:

|               |  |           |     |          |  |            |         |          |  |            |    |   |  |  |   |  |  |   |        | 
|-------------- |  | --------- | --- | -------- |  | ---------- | ------- | -------- |  | ---------- | -- | - |  |  | - |  |  | - | ------ | 
|               |  |           |     | Weighted |  |            |         |          |  |           
|               |  | Risk-Free |     | Average  |  |            |         | Expected |  | Fair Value
|               |  | Interest  |     | Expected |  | Expected   |         | Dividend |  | at Date   
|Class A Common |  | Rate      |     | Life     |  | Volatility |         | Yield    |  | of Grant  
|               |  |           |     |          |  |            |         |          |  |           
|1999 Grants    |  |           | 5.7 | %        |  |            | 5 years |          |  |            | 60 | % |  |  |  |  |  | $ | 30.10  | 
|2000 Grants    |  |           | 6.6 |          |  |            | 5       |          |  |            | 69 |   |  |  |  |  |  |   | 47.11  | 
|2001 Grants    |  |           | 4.6 |          |  |            | 5       |          |  |            | 72 |   |  |  |  |  |  |   | 111.89 | 
|2003 Grants    |  |           | 3.8 |          |  |            | 6       |          |  |            | 55 |   |  |  |  |  |  |   | 14.50  | 



| |                                            
| | -------------------------------------------
| | q.     Recent
    Accounting Pronouncements

In May 2003, the FASB issued Statement
No. 150, Accounting for Certain Financial Instruments
with Characteristics of Both Liability and Equity(FAS 150), which establishes standards for how an
issuer classifies and measures certain financial instruments
with characteristics of both liabilities and equity.
FAS 150 is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective
at the beginning of the first interim period beginning after
June 15, 2003. As of December 31, 2003 the Company
does not have financial instruments within the scope of this
pronouncement.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest Entities.
Interpretation No. 46 requires a variable interest entity,
or VIE, to be consolidated by a company if that company is
subject to a majority of the risk of loss from the VIEs
activities or is entitled to receive a majority of the
entitys residual return or both. Interpretation
No. 46 also provides criteria for determining whether an
entity is a VIE subject to consolidation. Interpretation
No. 46 also sets forth certain disclosures regarding
interests in VIE that are deemed significant, even if
consolidation is not required. In December 2003, a modification
to Interpretation No. 46 was issued (Interpretation
No. 46R) which delayed the effective date until no later
than fiscal periods ending after March 31, 2004 and
provided additional technical clarifications to implementation
issues. The Company does not currently have any variable
interest entities as defined in

F-10



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Interpretation No. 46R. The Company does not
expect that the adoption of this statement will have a material
impact on the consolidated financial statements.



| |                                               
| | ----------------------------------------------
| | r.     Series A
    Redeemable Preferred Stock

As described in Note 9, the Company has
issued 153,637 shares of Series A Redeemable Preferred
Stock (Series A). The Company has reclassified
its 2001 financial statements to account for a redemption
feature included in the Series A stock in accordance with
the guidance in EITF Topic No. D-98: Classification and
Measurement of Redeemable Securities(EITF Topic
No. D-98). EITF Topic No. D-98 provided
additional guidance on the appropriate classification of
redeemable preferred stock upon the occurrence of an event that
is not solely within the control of an issuer. EITF Topic
No. D-98 requires retroactive application in the first
fiscal quarter ending after December 15, 2001 by
reclassifying the financial statements of prior periods. The
carrying value of the Series A stock, which was previously
presented as a component of stockholders deficit, has been
reclassified as redeemable preferred stock outside of
stockholders deficit. The reclassification of the 2001
financial statements for the Series A stock had no effect
on the Companys net income, net loss attributable to
common stockholders cash flows from operations, or total assets.
The following sets forth the overall effect of the
reclassification on the Companys stockholders
deficit at December 31, 2001:

|                                                    |                                                      |   |         |         |  
|--------------------------------------------------- | ---------------------------------------------------- | - | ------- | ------- | -
|Stockholders deficit prior to
    reclassification |                                                      | $ | (2,365  | )      
|Reclassification of Series A stock                  |                                                      |   | (30,432 | )      
|                                                    |                                                      |   |         |        
|                                                    | Stockholders deficit after the
    reclassification |   | $       | (32,797 | )
|                                                    |                                                      |   |         |        

3.     Fixed
Assets

Fixed assets as of December 31, 2002 and
2003, are shown at cost, less accumulated depreciation and
amortization, and are summarized below:

|                                                |  |      |         |      |  |   |         | 
|----------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                                |  | 2002 |         | 2003
|                                                |  |      |         |     
|Leasehold improvements                          |  | $    | 211,480 |      |  | $ | 234,560 | 
|Club equipment                                  |  |      | 50,937  |      |  |   | 58,376  | 
|Furniture, fixtures and computer equipment      |  |      | 33,779  |      |  |   | 34,703  | 
|Computer software                               |  |      | 4,503   |      |  |   | 7,838   | 
|Building and improvements                       |  |      | 4,995   |      |  |   | 4,995   | 
|Land                                            |  |      | 986     |      |  |   | 986     | 
|Construction in progress                        |  |      | 8,631   |      |  |   | 13,836  | 
|                                                |  |      |         |      |  |   |         | 
|                                                |  |      | 315,311 |      |  |   | 355,294 | 
|Less: Accumulated depreciation and amortization |  |      | 104,488 |      |  |   | 131,695 | 
|                                                |  |      |         |      |  |   |         | 
|                                                |  | $    | 210,823 |      |  | $ | 223,599 | 
|                                                |  |      |         |      |  |   |         | 

Depreciation and leasehold amortization expense
for the years ended December 31, 2001, 2002 and 2003, was
$25,780, $30,645 and $33,987, respectively.

4.     Goodwill and
Intangible Assets

Effective January 1, 2002 we implemented
SFAS 142. There were no changes to the estimated useful
lives of amortizable intangible assets due to the SFAS 142
implementation. In connection with the SFAS 142
transitional impairment test the Company recorded a $1,301
write-off of goodwill. A deferred tax benefit of

F-11



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

$612 was recorded as a result of this goodwill
write-off, resulting in a net cumulative effect of change in
accounting principle of $689, in the first quarter of 2002. The
write-off of goodwill related to four, remote underperforming
clubs. The impairment test was performed with discounted
estimated future cash flows as the criteria for determining fair
market value. Goodwill has been allocated to reporting units
that closely reflect the regions served by our four trade names;
New York Sports Club, Boston Sports Club, Washington Sports Club
and Philadelphia Sports Club, with certain more remote clubs
that do not benefit from a regional cluster being considered
single reporting units.

A reconciliation of reported net income for the
year ended December 31, 2001 to net income adjusted for the
impact of SFAS 142 over that same period is as follows:

|                       |                        |      |        |        | 
|---------------------- | ---------------------- | ---- | ------ | ------ | 
|                       |                        | 2001
|                       |                        |     
|Net income as reported |                        | $    | 7,046  |       
|Goodwill amortization  |                        |      | 4,436  |       
|Deferred tax benefit   |                        |      | (1,344 | )     
|                       |                        |      |        |       
|                       | Net income as adjusted |      | $      | 10,138 | 
|                       |                        |      |        |       

In addition, the Company is required to conduct
an annual review of goodwill for potential impairment. Goodwill
impairment testing requires a comparison between the carrying
value and fair value of reportable goodwill. If the carrying
value exceeds the fair value, goodwill is considered impaired.
The amount of the impairment loss is measured as the difference
between the carrying value and the implied fair value of
goodwill, which is determined using discounted cash flows. In
2003, the Company did not have to record a charge to earnings
for an impairment of goodwill as a result of its annual review
conducted during the first quarter.

The change in the carrying amount of goodwill
from December 31, 2002 through December 31, 2003 is as
follows:

|                             |              |   |        |     | 
|---------------------------- | ------------ | - | ------ | --- | 
|Balance at December 31, 2002 |              | $ | 45,531 |    
|Changes due to               |              |   |        |    
|                             | Currency     |   |        | 203 | 
|                             | Acquisitions |   |        | 130 | 
|                             |              |   |        |    
|Balance at December 31, 2003 |              | $ | 45,864 |    
|                             |              |   |        |    

A summary of our acquired amortizable intangible
assets as of December 31, 2002 and 2003 is as follows:

|                           |  |                   |        |              |  |             |         |   |  |   |       | 
|-------------------------- |  | ----------------- | ------ | ------------ |  | ----------- | ------- | - |  | - | ----- | 
|                           |  |                  
|                           |  | December 31, 2002
|                           |  |                  
|                           |  | Gross             |        |             
|                           |  | Carrying          |        | Accumulated  |  | Net        
|                           |  | Amount            |        | Amortization |  | Intangibles
|                           |  |                   |        |              |  |            
|Acquired intangible assets |  |                   |        |              |  |             |         |   |  |   |       | 
|Membership lists           |  | $                 | 11,054 |              |  | $           | (9,605  | ) |  | $ | 1,449 | 
|Covenants-not-to-compete   |  |                   | 876    |              |  |             | (711    | ) |  |   | 165   | 
|Beneficial lease           |  |                   | 223    |              |  |             | (162    | ) |  |   | 61    | 
|                           |  |                   |        |              |  |             |         |   |  |   |       | 
|                           |  | $                 | 12,153 |              |  | $           | (10,478 | ) |  | $ | 1,675 | 
|                           |  |                   |        |              |  |             |         |   |  |   |       | 

F-12



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                           |  |                   |        |              |  |             |         |   |  |   |     | 
|-------------------------- |  | ----------------- | ------ | ------------ |  | ----------- | ------- | - |  | - | --- | 
|                           |  |                  
|                           |  | December 31, 2003
|                           |  |                  
|                           |  | Gross             |        |             
|                           |  | Carrying          |        | Accumulated  |  | Net        
|                           |  | Amount            |        | Amortization |  | Intangibles
|                           |  |                   |        |              |  |            
|Acquired intangible assets |  |                   |        |              |  |             |         |   |  |   |     | 
|Membership lists           |  | $                 | 10,205 |              |  | $           | (9,630  | ) |  | $ | 575 | 
|Covenants-not-to-compete   |  |                   | 876    |              |  |             | (871    | ) |  |   | 5   | 
|Beneficial lease           |  |                   | 223    |              |  |             | (173    | ) |  |   | 50  | 
|                           |  |                   |        |              |  |             |         |   |  |   |     | 
|                           |  | $                 | 11,304 |              |  | $           | (10,674 | ) |  | $ | 630 | 
|                           |  |                   |        |              |  |             |         |   |  |   |     | 

The amortization expense of the above acquired
intangible assets for each of the five years ending
December 31, 2008 will be as follows:

|                         |  |              |     | 
|------------------------ |  | ------------ | --- | 
|                         |  | Amortization
|                         |  | Expense     
|                         |  |             
|Year Ending December 31, |  |              |     | 
|2004                     |  | $            | 591 | 
|2005                     |  |              | 11  | 
|2006                     |  |              | 11  | 
|2007                     |  |              | 11  | 
|2008                     |  |              | 6   | 
|                         |  |              |     | 
|                         |  | $            | 630 | 
|                         |  |              |     | 

Amortization expense of intangible assets for the
years ended December 31, 2001, 2002 and 2003, was $6,403,
$1,103 and $940, respectively.





|   |                 
|-- | ----------------
|5. | Accrued Expenses

Accrued expenses consist of the following:

|                                               |  |              |        |      |  |   |        | 
|---------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | 
|                                               |  |             
|                                               |  | December 31,
|                                               |  |             
|                                               |  | 2002         |        | 2003
|                                               |  |              |        |     
|Accrued payroll                                |  | $            | 7,817  |      |  | $ | 6,086  | 
|Accrued interest                               |  |              | 2,731  |      |  |   | 5,157  | 
|Accrued construction in progress and equipment |  |              | 2,650  |      |  |   | 5,300  | 
|Accrued occupancy costs                        |  |              | 3,514  |      |  |   | 4,002  | 
|Accrued other                                  |  |              | 4,922  |      |  |   | 5,461  | 
|                                               |  |              |        |      |  |   |        | 
|                                               |  | $            | 21,634 |      |  | $ | 26,006 | 
|                                               |  |              |        |      |  |   |        | 

F-13



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

6.     Long-Term Debt
and Capital Lease Obligations

Long-term debt and capital lease obligations
consist of the following:

|                                          |                   |              |         |         |  |   |         |         | 
|----------------------------------------- | ----------------- | ------------ | ------- | ------- |  | - | ------- | ------- | 
|                                          |                   |             
|                                          |                   | December 31,
|                                          |                   |             
|                                          |                   | 2002         |         | 2003   
|                                          |                   |              |         |        
|Senior Notes 9 5/8%                       |                   | $            |        |         |  | $ | 255,000 |        
|Series B 9 3/4% Senior Notes, due 2004    |                   |              | 125,000 |         |  |   |        |        
|Line of credit borrowings                 |                   |              | 14,500  |         |  |   |        |        
|Subordinated credit borrowings            |                   |              | 9,000   |         |  |   |        |        
|Notes payable for acquired businesses     |                   |              | 6,230   |         |  |   | 4,358   |        
|Capital lease obligations                 |                   |              | 6,213   |         |  |   | 2,519   |        
|                                          |                   |              |         |         |  |   |         |        
|                                          |                   |              | 160,943 |         |  |   | 261,877 |        
|Less: Current portion due within one year |                   |              | 5,178   |         |  |   | 3,486   |        
|                                          |                   |              |         |         |  |   |         |        
|                                          | Long-term portion |              | $       | 155,765 |  |   | $       | 258,391 | 
|                                          |                   |              |         |         |  |   |         |        

The aggregate long-term debt and capital lease
obligations maturing during the next five years and thereafter
is as follows:

|                         |  |            |         | 
|------------------------ |  | ---------- | ------- | 
|                         |  | Amount Due
|                         |  |           
|Year Ending December 31, |  |            |         | 
|2004                     |  | $          | 3,486   | 
|2005                     |  |            | 1,056   | 
|2006                     |  |            | 619     | 
|2007                     |  |            | 632     | 
|2008                     |  |            | 217     | 
|Thereafter               |  |            | 255,867 | 
|                         |  |            |         | 
|                         |  | $          | 261,877 | 
|                         |  |            |         | 

In October 1997, the Company issued $85,000 of
Series B 9 3/4% Senior Notes due October 2004. The net
proceeds from the Senior Notes totaled approximately $81,700.
The transaction fees of approximately $3,300, were accounted for
as deferred financing costs. In June 1999, the Company issued
$40,000 of Senior Notes at a price of 98.75%, providing the
Company with $39,500 of proceeds before expenses relating to the
issuance. The Senior Notes bear interest at an annual rate of
9 3/4%, payable semi-annually. The Senior Notes are
redeemable at the option of the Company on or after
October 15, 2001. For redemption prior to October 15,
2004, the Company would be required to pay a premium as defined.
The $85,000 and $40,000 issuances are collectively referred to
as the Senior Notes. The Senior Notes were redeemed
on April 16, 2003. See the April 16, 2003 Refinancing
Transactions discussed below.

Prior to the April 16, 2003 refinancing
transactions, the Company had a $25,000 line of credit with its
principal bank for direct borrowings and letters of credit. The
line of credit carried interest at the Companys option
based upon the Eurodollar borrowing rate plus 2.50% or the
banks prime rate plus 1.50%, as defined and the Company
was required to pay a commitment commission of 0.375% per annum
based upon the daily unutilized amount. There were $10,500 of
Eurodollar and $4,000 of prime rate based borrowings outstanding
against this line as of December 31, 2002. The interest
rates charged on the Eurodollar borrowings and prime rate based
borrowings outstanding at December 31, 2002 were 4.0% and
6.25%, respectively. In connection with the April 16, 2003
refinancing transactions, this line of credit was terminated.

F-14



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In November 2000, the Company entered into a
Subordinated Credit Agreement (the Subordinated
Agreement) with an affiliate of a stockholder of the
Company. This Subordinated Agreement provided for up to $20,000
of principal borrowings and would have expired December 31,
2004. Interest on principal borrowings accrued at 12.75% per
annum; 9.75% of which was payable on a monthly basis and the
remaining 3% was accruable and payable, at the option of the
Company, through maturity. The Company was charged a fee of
0.083% per month based on the portion of the facility not
utilized. There were $9,000 of Subordinated credit borrowings
outstanding as of December 31, 2002. In connection with the
April 16, 2003 refinancing transactions, this Subordinated
Credit Agreement was terminated.



| |                                           
| | ------------------------------------------
| | April 16, 2003 Refinancing
    Transaction

On April 16, 2003 the Company successfully
completed a refinancing of its debt. This refinancing included
an offering of $255,000 of 9 5/8% Senior Notes
(Notes) that will mature April 15, 2011, and
the entering into of a new $50,000 senior secured revolving
credit facility (the Senior Credit Facility) that
will expire April 15, 2008. The transaction fees of
approximately $9,600 have been accounted for as deferred
financing costs. The Notes accrue interest at 9 5/8% per
annum and interest is payable semiannually on April 15 and
October 15. In connection with this refinancing, the
Company wrote-off $3,709 of deferred financing costs related to
extinguished debt, paid a call premium of $3,048 and incurred
$1,016 of interest on the 9 3/4% Notes representing the
interest incurred during the 30 day redemption notification
period.

The Senior Credit Facility contains various
covenants including limits on capital expenditures, the
maintenance of a consolidated interest coverage ratio of not
less than 2.25:1.00 during 2003, and a maximum permitted total
leverage ratio of 4.00:1.00 during 2003. Loans under the Senior
Credit Facility will, at our option, bear interest at either the
banks prime rate plus 3.0% or the Eurodollar rate plus
4.0%, as defined. There were no borrowings outstanding at
December 31, 2003 and outstanding letters of credit issued
totaled $1,749. The Company is required to pay a commitment fee
of 0.75% per annum on the daily unutilized amount. The
unutilized portion of the Senior Credit Facility as of
December 31, 2003 was $48,251.

Notes payable were incurred upon the acquisition
of various clubs and are subject to the Companys right of
offset for possible post acquisition adjustments arising out of
operations of the acquired clubs. These notes are stated at
rates of between 5% and 9%, and are non-collateralized. The
notes are due on various dates through 2012.

The carrying value of long-term debt, other than
the Senior Notes and the Notes, approximates fair market value
as of December 31, 2002 and 2003 as the debt is generally
short-term in nature. Based on quoted market prices, the Senior
Notes have a fair value of approximately $125,000 at
December 31, 2002 and the Notes have a fair value of
approximately $272,850 at December 31, 2003.

The Companys interest expense and
capitalized interest related to funds borrowed to finance club
facilities under construction for the years ended
December 31, 2001, 2002 and 2003 are as follows:

|                           |  |                          |        |      |  |      |        |  |  |   |        | 
|-------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|                           |  |                         
|                           |  | Years Ended December 31,
|                           |  |                         
|                           |  | 2001                     |        | 2002 |  | 2003
|                           |  |                          |        |      |  |     
|Interest costs expensed    |  | $                        | 14,918 |      |  | $    | 16,559 |  |  | $ | 23,670 | 
|Interest costs capitalized |  |                          | 907    |      |  |      | 354    |  |  |   | 322    | 
|                           |  |                          |        |      |  |      |        |  |  |   |        | 
|                           |  | $                        | 15,825 |      |  | $    | 16,913 |  |  | $ | 23,992 | 
|                           |  |                          |        |      |  |      |        |  |  |   |        | 

The Company leases equipment under noncancelable
capital leases. The initial lease terms range from three to five
years, after which the Company has the right to purchase the
equipment at amounts defined by the agreements.

F-15



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

As of December 31, 2003, minimum rental
payments, under all capital leases, including payments to
acquire leased equipment, are as follows:

|                                    |                                                 |               |       |       | 
|----------------------------------- | ----------------------------------------------- | ------------- | ----- | ----- | 
|                                    |                                                 | Minimum      
|                                    |                                                 | Annual Rental
|                                    |                                                 |              
|Year Ending December 31,            |                                                 |               |       |      
|2004                                |                                                 | $             | 2,337 |      
|2005                                |                                                 |               | 224   |      
|                                    |                                                 |               |       |      
|                                    |                                                 |               | 2,561 |      
|Less: Amounts representing interest |                                                 |               | 42    |      
|                                    |                                                 |               |       |      
|                                    | Present value of minimum capital lease payments |               | $     | 2,519 | 
|                                    |                                                 |               |       |      

The cost of leased equipment included in club
equipment was approximately $12,658 and $12,097 at
December 31, 2002 and 2003, respectively; and the related
accumulated depreciation was $5,686 and $7,544, respectively.



|   |                           
|-- | --------------------------
|7. | Related Party Transactions

The Company entered into a professional service
agreement with Bruckmann, Rosser, Sherrill & Co., Inc.
(BRS), a stockholder of the Company for strategic
and financial advisory services on December 10, 1996. Fees
for such services, which are included in General and
administrative expenses, are $250 per annum, and are payable
while BRS owns 20% or more of the outstanding Common stock of
the Company. No amounts were due BRS at December 31, 2002
and 2003.

The Companys Subordinated Agreement
discussed in Note 6 was entered into with an affiliate of a
stockholder of the Company in 2000. This agreement was
terminated in connection with the April 16, 2003
Refinancing Transaction.



|   |       
|-- | ------
|8. | Leases

The Company leases office, warehouse and
multi-recreational facilities and certain equipment under
noncancelable operating leases. In addition to base rent, the
facility leases generally provide for additional rent based on
increases in real estate taxes and other costs. Certain leases
give the Company the right to acquire the leased facility at
defined prices based on fair value and provide for additional
rent based upon defined formulas of revenue, cash flow or
operating results of the respective facilities. Under the
provisions of certain of these leases, the Company is required
to maintain irrevocable letters of credit, which total $1,749 as
of December 31, 2003.

The leases expire at various times through
December 31, 2027, and certain leases may be extended at
the Companys option.

F-16



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Future minimum rental payments under
noncancelable operating leases are as follows:

|                         |  |               |         | 
|------------------------ |  | ------------- | ------- | 
|                         |  | Minimum      
|                         |  | Annual Rental
|                         |  |              
|Year Ending December 31, |  |               |         | 
|2004                     |  | $             | 50,976  | 
|2005                     |  |               | 51,659  | 
|2006                     |  |               | 51,500  | 
|2007                     |  |               | 49,511  | 
|2008                     |  |               | 47,476  | 
|Aggregate thereafter     |  |               | 369,831 | 
|                         |  |               |         | 
|                         |  | $             | 620,953 | 
|                         |  |               |         | 

Rent expense, including the effect of deferred
lease liabilities, for the years ended December 31, 2001,
2002 and 2003 was $42,341, $52,085 and $59,273, respectively.
Such amounts include additional rent of $7,119, $8,368 and
$10,342, respectively.

The Company, as landlord, leases space to third
party tenants under noncancelable operating leases and licenses.
In addition to base rent, certain leases provide for additional
rent based on increases in real estate taxes, indexation,
utilities and defined amounts based on the operating results of
the lessee. The leases expire at various times through
August 31, 2014. Future minimum rentals receivable under
noncancelable leases are as follows:

|                         |  |               |        | 
|------------------------ |  | ------------- | ------ | 
|                         |  | Minimum      
|                         |  | Annual Rental
|                         |  |              
|Year Ending December 31, |  |               |        | 
|2004                     |  | $             | 2,167  | 
|2005                     |  |               | 2,392  | 
|2006                     |  |               | 2,196  | 
|2007                     |  |               | 1,985  | 
|2008                     |  |               | 1,278  | 
|Aggregate thereafter     |  |               | 5,723  | 
|                         |  |               |        | 
|                         |  | $             | 15,741 | 
|                         |  |               |        | 

Rental income, including noncash rental income,
for the years ended December 31, 2001, 2002 and 2003 was
$1,879, $2,132 and $2,434, respectively. Such amounts include
additional rental charges above the base rent of $982, $1,046
and $679, respectively.



|   |                           
|-- | --------------------------
|9. | Redeemable Preferred Stock



| |                                      
| | -------------------------------------
| | Redeemable Senior Preferred
    Stock

During November 1998, the Company issued
40,000 shares of mandatorily redeemable Senior stock
(Senior) and 143,261 warrants. During 2002 71,630 of
these warrants were exercised and in January 2004 the remaining
71,631 warrants were exercised (see Note 18 Subsequent
Events). The Senior stock had no voting rights except as
required by law. The warrants had an exercise price of $0.01,
expire in November 2008 and are exercisable into an equal number
of shares of Class A Common Stock. After payment of fees
and expenses of approximately $365, the Company received net
proceeds of $39,635. Upon issuance, a $3,416 value was ascribed
to the warrants. The initial fair value of the Senior stock
($36,219) was being accreted to

F-17



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

its liquidation value using the interest method.
The Senior stock was redeemable in November 2008. The Company,
at its option, could redeem the Senior stock at any time without
premium.

The Senior stock had a liquidation value of
$1,000 per share plus cumulative unpaid dividends of $26,977 as
of April 16, 2003. The Senior stock holders were entitled
to a cumulative 12% annual dividend, based on the share price of
$1,000. On April 16, 2003, in connection with the
refinancing transaction discussed in Note 6, all of the
Senior stock was redeemed at a liquidation value of $66,977.
During 2003, the Company recorded $4,852 of accretion, which was
comprised of stock dividend accretion of $2,465 and the
remaining warrant accretion to liquidation value of $2,387.



| |                                        
| | ---------------------------------------
| | Series A Redeemable Preferred
    Stock

During fiscal years 1997 and 1998, the Company
issued 152,455 and 1,182 shares, respectively, of
Series A redeemable preferred stock. As of
December 31, 2002 and 2003, 153,637 shares of
Series A stock were outstanding. Series A stock has
liquidation preferences over Common Stock in the event of a
liquidation, dissolution or winding up of the Company.
Series A stock has no conversion features or voting rights
except as required by law, and rank pari passu.Series A stock has a liquidation value of $100 per
share plus cumulative unpaid dividends of $24,526 as of
December 31, 2003. Series A stockholders are entitled
to a cumulative 14% annual dividend based upon the per share
price of $100. The Company may, at its sole discretion, pay any
dividends by cash or by the issuance of additional Series A
shares. The Company may at any time redeem all or any portion of
the Series A stock at a price equal to the liquidation
value plus cumulative unpaid dividends.

A summary of transactions related to
Series A stock is as follows:

|                                                                        |  |        |         |          |  |   |        | 
|----------------------------------------------------------------------- |  | ------ | ------- | -------- |  | - | ------ | 
|                                                                        |  |        |         | Carrying
|                                                                        |  | Shares |         | Value   
|                                                                        |  |        |         |         
|Proceeds received in connection with the issuance
    of Series A stock |  |        | 153,637 |          |  | $ | 15,364 | 
|Accretion of Series A stock dividends                                   |  |        |        |          |  |   | 11,216 | 
|                                                                        |  |        |         |          |  |   |        | 
|January 1, 2001 Series A stock                                          |  |        | 153,637 |          |  |   | 26,580 | 
|Accretion to Series A stock dividends                                   |  |        |        |          |  |   | 3,852  | 
|                                                                        |  |        |         |          |  |   |        | 
|December 31, 2001 Series A stock                                        |  |        | 153,637 |          |  |   | 30,432 | 
|Accretion to Series A stock dividends                                   |  |        |        |          |  |   | 4,409  | 
|                                                                        |  |        |         |          |  |   |        | 
|December 31, 2002 Series A stock                                        |  |        | 153,637 |          |  |   | 34,841 | 
|Accretion to Series A stock dividends                                   |  |        |        |          |  |   | 5,049  | 
|                                                                        |  |        |         |          |  |   |        | 
|December 31, 2003 Series A stock                                        |  |        | 153,637 |          |  | $ | 39,890 | 
|                                                                        |  |        |         |          |  |   |        | 

In the event of a change in control as defined,
each holder of Series A stock then outstanding may require
the Corporation, and the Corporation shall be obligated, to
redeem all or any portion of the Series A stock owned by
such holder.

In February 2004, the Company redeemed all of the
Series A stock at a liquidation value of $40,516. See
Note 18, Subsequent Events.



|    |                      
|--- | ---------------------
|10. | Stockholders Deficit



| |                             
| | ----------------------------
| | a.            Capitalization

The Companys certificate of incorporation,
as amended, provides for the issuance of up to
3,500,000 shares of capital stock, consisting of
2,500,000 shares of Class A Voting Common Stock
(Class A), par value $0.001 per share;
500,000 shares of Class B Non-voting Common Stock
(Class B),

F-18



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

par value of $0.001 per share, (Class A and
Class B are collectively referred to herein as Common
Stock); and 200,000 shares of Series B Preferred
Stock (Series B) par value $1.00 per share.
This also includes the redeemable preferred stock discussed in
Note 9, 100,000 shares Senior stock, par value $1.00 per
share and 200,000 shares of Series A stock, par value
$1.00 per share.

All stockholders have preemptive rights to
purchase a pro-rata share of any future sales of securities, as
defined.



| |             
| | ------------
| | Common Stock

Class A stock and Class B stock each
have identical terms with the exception that Class A stock
is entitled to one vote per share, while Class B stock has
no voting rights, except as required by law. In addition,
Class B stock is convertible into an equal number of
Class A shares, at the option of the holder of the majority
of the Class B stock. To date, the Company has not issued
Class B stock.



| |                         
| | ------------------------
| | Series B Preferred Stock

During December 1996, the Company issued
3,857 shares of Series B preferred stock,
3,822 shares of which were outstanding as of
December 31, 2002. During 2003, the Company issued an
additional 106,267 shares and repurchased 549 shares of
previously issued Series B preferred stock which were
retired. The executives sold all of the Series B stock
issued in connection with the 106,267 shares to an
affiliate of a stockholder of the Company. Series B stock
has liquidation preferences over Common Stock in the event of a
liquidation, dissolution or winding up of the Company.
Series B stock has no voting rights except as required by
law, and rank pari passu.Upon consummation
of an IPO, at the option of the holder, each Series B stock
is convertible into Class A Common Stock at prices, at
which the Class A Common Stock is sold in such IPO. The
Company may at any time redeem all or any portion of the
Series B stock at a price equal to the liquidation value
plus cumulative unpaid dividends. Series B stock has a
liquidation value of $35 per share plus cumulative unpaid
dividends of $6,127 as of December 31, 2003. Series B
stockholders are entitled to a cumulative 14% annual dividend
based upon the per share price of $35. The Company may, at its
sole discretion, pay any dividends by cash or by the issuance of
additional Series B shares.

In the event of a change in control, as defined,
each holder of Series B stock then outstanding may require
the Corporation, and the Corporation shall be obligated, to
redeem all or any portion of the Series B stock owned by
such holder. The Series B preferred stockholders do not
control a majority of the votes of the board of directors
through direct representation or other rights.

In February 2004, the Company redeemed all of the
Series B stock at a liquidation value of $10,118. See
Note 18, Subsequent Events.



|   |              
|-- | -------------
|b. | Stock Options



| |                                 
| | --------------------------------
| | Class A Common Stock
    Options

During the year ended May 31, 1997, the
Company adopted the Town Sports International Inc. Common Stock
Option Plan (the Plan). The provisions of the Plan,
as amended and restated, provide for the Companys Board of
Directors to grant to executives and key employees options to
acquire 162,754 shares of Class A stock.

Grants vest in full at various dates between
December 2007 and 2012. The vesting of these grants will be
accelerated in the event that certain defined events occur
including the achievement of annual equity values or the sale of
the Company. The term of each of these grants is ten or eleven
years.

In accordance with APB No. 25, Accounting
for Stock Issued to Employees, the Company recorded unearned
compensation in connection with the 1998 Grants and the 2001
Grants. Such amount is included

F-19



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

within stockholders deficit and represented
the difference between the estimated fair value of the
Class A stock on the date of amendment or grant,
respectively, and the exercise price. Unearned compensation will
be amortized as compensation expense over the vesting period.
During the years ended December 31, 2001, 2002 and 2003,
amortization of unearned compensation totaled $156, $70 and $21,
respectively.

As of December 31, 2003, there were
30,227 shares reserved for future option awards.

As of December 31, 2001, 2002 and 2003, a
total of 76,474, 75,819 and 80,294 Class A Common stock
options were exercisable, respectively.



| |                                     
| | ------------------------------------
| | Series B Preferred Stock
    Options

During the year ended May 31, 1997, the
Company granted 164,783 options (Series B
Options) to certain employees which entitle the holders to
purchase an equal number of shares of Series B stock at an
exercise price of $10.00 per share. Series B Options were
fully vested on the date of grant and expire on
December 31, 2021. The terms of the Series B Options
also contained provisions whereby the exercise price would be
reduced, or in certain cases, the option holder would receive
cash in accordance with a formula as defined. The aggregate
value of, either a reduction in exercise price, or the
distribution of cash is deemed compensatory and, accordingly, is
recorded as a compensation expense. For the years ended
December 31, 2001, 2002 and 2003 compensation expense
recognized in connection with Series B Options totaled
$993, $1,137 and $177, respectively. All Series B Preferred
stock options were exercisable upon grant. There are no shares
of Series B Preferred Stock reserved for future option
grants.

In January 2003, an executive officer of the
Company exercised 9,530 Series B Options, and in turn these
newly issues shares were repurchased by the Company for $540 and
were retired. In February 2003, several executives of the
Company exercised and converted the remaining 148,775
Series B Options in to 106,267 shares of Series B
preferred stock. The difference between the 148,775 options
exercised and the 106,267 shares issued is due to the
remittance of these shares to the Company to cover the purchase
price of the stock. The remitted shares were subsequently
retired by the Company.

F-20



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes the stock option
activity for the years ended December 31, 2001, 2002 and
2003:

|                             |  |         |         |          |  |           |        |          |  |  |          |   |  |   |       | 
|---------------------------- |  | ------- | ------- | -------- |  | --------- | ------ | -------- |  |  | -------- | - |  | - | ----- | 
|                             |  |         |         | Weighted |  |           |        | Weighted
|                             |  |         |         | Average  |  |           |        | Average 
|                             |  | Class A |         | Exercise |  | Series B  |        | Exercise
|                             |  | Common  |         | Price    |  | Preferred |        | Price   
|                             |  |         |         |          |  |           |        |         
|Balance at January 1, 2001   |  |         | 92,682  |          |  | $         | 23.88  |          |  |  | 158,306  |   |  | $ | 10.00 | 
|Granted                      |  |         | 7,400   |          |  | $         | 100.00 | (i)      |  |  |         |   |  |   |       | 
|Exercised                    |  |         | (788    | )        |  | $         | 32.53  |          |  |  |         |   |  |   |       | 
|Forfeited                    |  |         | (512    | )        |  | $         | 25.76  |          |  |  |         |   |  |   |       | 
|                             |  |         |         |          |  |           |        |          |  |  |          |   |  |   |       | 
|Balance at December 31, 2001 |  |         | 98,782  |          |  | $         | 29.32  |          |  |  | 158,306  |   |  | $ | 10.00 | 
|Exercised                    |  |         | (3,100  | )        |  | $         | 22.93  |          |  |  |         |   |  |   |       | 
|Forfeited                    |  |         | (2,200  | )        |  | $         | 84.57  |          |  |  |         |   |  |   |       | 
|                             |  |         |         |          |  |           |        |          |  |  |          |   |  |   |       | 
|Balance at December 31, 2002 |  |         | 93,482  |          |  | $         | 28.23  |          |  |  | 158,306  |   |  | $ | 10.00 | 
|Granted                      |  |         | 46,400  |          |  | $         | 144.00 | (ii)     |  |  |         |   |  |   |       | 
|Exercised                    |  |         | (1,740  | )        |  | $         | 36.14  |          |  |  | (158,306 | ) |  | $ | 10.00 | 
|Forfeited                    |  |         | (7,610  | )        |  | $         | 24.48  |          |  |  |         |   |  |   |       | 
|                             |  |         |         |          |  |           |        |          |  |  |          |   |  |   |       | 
|Balance at December 31, 2003 |  |         | 130,532 |          |  | $         | 69.49  |          |  |  |         |   |  |   |       | 
|                             |  |         |         |          |  |           |        |          |  |  |          |   |  |   |       | 



---



|     |                                                                                                     
|---- | ----------------------------------------------------------------------------------------------------
|(i)  | Option exercise price of these options was less
    than the estimated fair value on the grant date.
|    
|(ii) | Option exercise price was greater than market
    price on the grant date.                          

The following table summarizes stock option
information as of December 31, 2003:

|               |              |                     |        |                     |  |           |            |             |  |           |        |  |  |  |        |        |  |   |        |  | 
|-------------- | ------------ | ------------------- | ------ | ------------------- |  | --------- | ---------- | ----------- |  | --------- | ------ |  |  |  | ------ | ------ |  | - | ------ |  | 
|               |              |                     |        |                    
|               |              | Options Outstanding |        | Options Exercisable
|               |              |                     |        |                    
|               |              |                     |        | Weighted-           |  |           |            |            
|               |              |                     |        | Average             |  | Weighted- |            |             |  | Weighted-
|               |              |                     |        | Remaining           |  | Average   |            |             |  | Average  
|               |              | Number              |        | Contractual         |  | Exercise  |            | Number      |  | Exercise 
|Class A Common |              | Outstanding         |        | Life                |  | Price     |            | Exercisable |  | Price    
|               |              |                     |        |                     |  |           |            |             |  |          
|1997 Grants    |              |                     | 45,586 |                     |  |           | 36 months  |             |  | $         | 1.00   |  |  |  | 45,586 |        |  | $ | 1.00   | 
|1998 Grants    |              |                     | 7,800  |                     |  |           | 52 months  |             |  | $         | 17.50  |  |  |  | 7,800  |        |  | $ | 17.50  | 
|1999 Grants    |              |                     | 9,700  |                     |  |           | 60 months  |             |  | $         | 53.00  |  |  |  | 7,760  |        |  | $ | 53.00  | 
|2000 Grants    |              |                     | 16,446 |                     |  |           | 72 months  |             |  | $         | 75.00  |  |  |  | 9,868  |        |  | $ | 75.00  | 
|2001 Grants    |              |                     | 4,600  |                     |  |           | 101 months |             |  | $         | 100.00 |  |  |  |       |        |  | $ | 100.00 | 
|2003 Grants    |              |                     | 46,400 |                     |  |           | 108 months |             |  | $         | 144.00 |  |  |  | 9,280  |        |  | $ | 144.00 | 
|               |              |                     |        |                     |  |           |            |             |  |           |        |  |  |  |        |        |  |   |        | 
|               | Total Grants |                     |        | 130,532             |  |           |            |             |  |           |        |  |  |  |        | 80,294 |  |   |        |  | 
|               |              |                     |        |                     |  |           |            |             |  |           |        |  |  |  |        |        |  |   |        | 



|    |                   
|--- | ------------------
|11. | Asset Acquisitions

During the period from January 1, 2001
through December 31, 2002, the Company completed the
acquisition of six fitness clubs. There were no club
acquisitions during the year ended December 31, 2003. None
of the individual acquisitions were material to the financial
position, results of operations or cash flows of

F-21



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the Company. The table below summarizes the
aggregate purchase price and the purchase price allocation to
assets acquired:

|                                           |                                     |              |       |       |  |   |       |       | 
|------------------------------------------ | ----------------------------------- | ------------ | ----- | ----- |  | - | ----- | ----- | 
|                                           |                                     |             
|                                           |                                     | Years Ended 
|                                           |                                     | December 31,
|                                           |                                     |             
|                                           |                                     | 2001         |       | 2002 
|                                           |                                     |              |       |      
|Number of clubs acquired                   |                                     |              | 2     |       |  |   | 4     |      
|                                           |                                     |              |       |       |  |   |       |      
|Purchase prices payable in cash at closing |                                     | $            | 1,272 |       |  | $ | 2,322 |      
|Issuance and assumption of notes payable   |                                     |              | 250   |       |  |   | 4,725 |      
|                                           |                                     |              |       |       |  |   |       |      
|                                           | Total purchase prices               |              | $     | 1,522 |  |   | $     | 7,047 | 
|                                           |                                     |              |       |       |  |   |       |      
|Allocation of purchase prices              |                                     |              |       |       |  |   |       |      
|Goodwill                                   |                                     | $            | 1,316 |       |  | $ | 4,479 |      
|Fixed assets                               |                                     |              | 235   |       |  |   | 1,955 |      
|Membership lists                           |                                     |              | 181   |       |  |   | 1,432 |      
|Other net liabilities acquired             |                                     |              | (172  | )     |  |   | (108  | )    
|Deferred revenue                           |                                     |              | (38   | )     |  |   | (711  | )    
|                                           |                                     |              |       |       |  |   |       |      
|                                           | Total allocation of purchase prices |              | $     | 1,522 |  |   | $     | 7,047 | 
|                                           |                                     |              |       |       |  |   |       |      

For financial reporting purposes, these
acquisitions have been accounted for under the purchase method
and, accordingly, the purchase prices have been assigned to the
assets and liabilities acquired on the basis of their respective
fair values on the date of acquisition. The excess of purchase
prices over the net tangible assets acquired has been allocated
to membership lists acquired and goodwill. The results of
operations of the clubs have been included in the Companys
consolidated financial statements from the respective dates of
acquisition. Certain acquisitions have continuing consideration
based on future earnings, which will be capitalized as part of
the purchase price when incurred. The impact of these
acquisitions on the consolidated financial statements of the
Company was not material.



|    |                             
|--- | ----------------------------
|12. | Revenue from Club Operations

Revenues from club operations for the years ended
December 31, 2001, 2002 and 2003 are summarized below:

|                    |  |                          |         |      |  |      |         |  |  |   |         | 
|------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                    |  |                         
|                    |  | Years Ended December 31,
|                    |  |                         
|                    |  | 2001                     |         | 2002 |  | 2003
|                    |  |                          |         |      |  |     
|Membership dues     |  | $                        | 227,073 |      |  | $    | 257,917 |  |  | $ | 273,608 | 
|Initiation fees     |  |                          | 13,287  |      |  |      | 14,361  |  |  |   | 13,891  | 
|Other club revenues |  |                          | 37,840  |      |  |      | 42,717  |  |  |   | 48,641  | 
|                    |  |                          |         |      |  |      |         |  |  |   |         | 
|                    |  | $                        | 278,200 |      |  | $    | 314,995 |  |  | $ | 336,140 | 
|                    |  |                          |         |      |  |      |         |  |  |   |         | 

F-22



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                       
|--- | ----------------------
|13. | Corporate Income Taxes

The provision (benefit) for income taxes for the
years ended December 31, 2001, 2002 and 2003 consisted of
the following:

|         |  |                              |        |           |  |       |        |   |  |   |        |  
|-------- |  | ---------------------------- | ------ | --------- |  | ----- | ------ | - |  | - | ------ | -
|         |  |                             
|         |  | Year Ended December 31, 2001
|         |  |                             
|         |  |                              |        | State and |  |      
|         |  | Federal                      |        | Local     |  | Total
|         |  |                              |        |           |  |      
|Current  |  | $                            | 7,964  |           |  | $     | 3,415  |   |  | $ | 11,379 |  
|Deferred |  |                              | (3,357 | )         |  |       | (1,169 | ) |  |   | (4,526 | )
|         |  |                              |        |           |  |       |        |   |  |   |        |  
|         |  | $                            | 4,607  |           |  | $     | 2,246  |   |  | $ | 6,853  |  
|         |  |                              |        |           |  |       |        |   |  |   |        |  

|         |  |                              |       |           |  |       |       |   |  |   |        |  
|-------- |  | ---------------------------- | ----- | --------- |  | ----- | ----- | - |  | - | ------ | -
|         |  |                             
|         |  | Year Ended December 31, 2002
|         |  |                             
|         |  |                              |       | State and |  |      
|         |  | Federal                      |       | Local     |  | Total
|         |  |                              |       |           |  |      
|Current  |  | $                            | 6,483 |           |  | $     | 4,388 |   |  | $ | 10,871 |  
|Deferred |  |                              | (536  | )         |  |       | (626  | ) |  |   | (1,162 | )
|         |  |                              |       |           |  |       |       |   |  |   |        |  
|         |  | $                            | 5,947 |           |  | $     | 3,762 |   |  | $ | 9,709  |  
|         |  |                              |       |           |  |       |       |   |  |   |        |  

|         |  |                              |       |           |  |       |       |  |  |   |       | 
|-------- |  | ---------------------------- | ----- | --------- |  | ----- | ----- |  |  | - | ----- | 
|         |  |                             
|         |  | Year Ended December 31, 2003
|         |  |                             
|         |  |                              |       | State and |  |      
|         |  | Federal                      |       | Local     |  | Total
|         |  |                              |       |           |  |      
|Current  |  | $                            | 463   |           |  | $     | 1,591 |  |  | $ | 2,054 | 
|Deferred |  |                              | 3,017 |           |  |       | 466   |  |  |   | 3,483 | 
|         |  |                              |       |           |  |       |       |  |  |   |       | 
|         |  | $                            | 3,480 |           |  | $     | 2,057 |  |  | $ | 5,537 | 
|         |  |                              |       |           |  |       |       |  |  |   |       | 

The components of the net deferred tax asset as
of, December 31, 2002 and 2003 are summarized below:

|                                                                   |                                                           |              |        |        |  |   |        |        | 
|------------------------------------------------------------------ | --------------------------------------------------------- | ------------ | ------ | ------ |  | - | ------ | ------ | 
|                                                                   |                                                           |             
|                                                                   |                                                           | December 31,
|                                                                   |                                                           |             
|                                                                   |                                                           | 2002         |        | 2003  
|                                                                   |                                                           |              |        |       
|Deferred tax assets                                                |                                                           |              |        |        |  |   |        |       
|Deferred lease liabilities                                         |                                                           | $            | 9,821  |        |  | $ | 9,998  |       
|Deferred revenue                                                   |                                                           |              | 5,954  |        |  |   | 5,156  |       
|Fixed assets and intangible assets                                 |                                                           |              | 5,032  |        |  |   | 4,054  |       
|Compensation expense incurred in connection with
    stock options |                                                           |              | 4,855  |        |  |   | 1,489  |       
|State net operating loss carry-forwards                            |                                                           |              | 1,151  |        |  |   | 1,431  |       
|Other                                                              |                                                           |              | (1     | )      |  |   | 517    |       
|                                                                   |                                                           |              |        |        |  |   |        |       
|                                                                   |                                                           |              | 26,812 |        |  |   | 22,645 |       
|                                                                   |                                                           |              |        |        |  |   |        |       
|Deferred tax liabilities                                           |                                                           |              |        |        |  |   |        |       
|Deferred costs                                                     |                                                           |              | (6,174 | )      |  |   | (5,490 | )     
|                                                                   |                                                           |              |        |        |  |   |        |       
|                                                                   |                                                           |              | (6,174 | )      |  |   | (5,490 | )     
|                                                                   |                                                           |              |        |        |  |   |        |       
|                                                                   | Net deferred tax assets, prior to valuation
    allowance |              |        | 20,638 |  |   |        | 17,155 | 
|Valuation allowance                                                |                                                           |              | (384   | )      |  |   | (384   | )     
|                                                                   |                                                           |              |        |        |  |   |        |       
|                                                                   | Net deferred tax assets                                   |              | $      | 20,254 |  |   | $      | 16,771 | 
|                                                                   |                                                           |              |        |        |  |   |        |       

F-23



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

As of December 31, 2003, the Company has
state net operating loss (NOL) carry-forwards of
approximately $15,970. Such amounts expire between
December 31, 2004 and December 31, 2021. The
Companys $384 valuation allowance has been maintained
principally for NOL carryforwards, which are subject to
limitations principally due to acquisitions.

Foreign income and the effect of foreign income
taxes was immaterial.

The differences between the U.S. federal
statutory income tax rate and the Companys effective tax
rate were as follows for the years ended December 31, 2003,
2002 and 2001:

|                                                                                               |  |              |    |      |  |      |    |   |  |  |    |  
|---------------------------------------------------------------------------------------------- |  | ------------ | -- | ---- |  | ---- | -- | - |  |  | -- | -
|                                                                                               |  |             
|                                                                                               |  | Years Ended 
|                                                                                               |  | December 31,
|                                                                                               |  |             
|                                                                                               |  | 2001         |    | 2002 |  | 2003
|                                                                                               |  |              |    |      |  |     
|Federal statutory tax rate                                                                     |  |              | 35 | %    |  |      | 35 | % |  |  | 35 | %
|State and local income taxes, net of federal tax
    benefit and change of valuation allowance |  |              | 8  |      |  |      | 9  |   |  |  | 8  |  
|Change in state effective income tax rate                                                      |  |              | 1  |      |  |      |   |   |  |  |   |  
|Non-deductible goodwill and other permanent
    differences                                    |  |              | 3  |      |  |      | 1  |   |  |  |   |  
|                                                                                               |  |              |    |      |  |      |    |   |  |  |    |  
|                                                                                               |  |              | 47 | %    |  |      | 45 | % |  |  | 43 | %
|                                                                                               |  |              |    |      |  |      |    |   |  |  |    |  

14.     September 11,
2001 Events

The terrorist attacks of September 11, 2001
(the September 11 events), resulted in a
tremendous loss of life and property. Secondarily, those events
interrupted the operations at four clubs located in downtown
Manhattan. Three of the affected four clubs were back in
operation by October 2001, while the fourth club reopened
in September 2002.

The Company carries business interruption
insurance to mitigate certain lost revenue and profits
experienced with the September 11 events. In this regard in
the third quarter of 2001 a $175 insurance receivable was
recorded representing an estimate of costs incurred in
September 2001. Such costs included rent, payroll benefits,
and other club operating costs incurred during period of
closure. In 2002, we collected this $175 receivable and received
additional on-account payments of $1,025. In 2003 the Company
received $2,800 from its insurer and the Company entered into a
final settlement agreement. These on-account and final payments
were classified with fees and other revenue when received.

15.     Contingencies

On February 13, 2003, an individual filed
suit against the Company in the Supreme Court, New York County,
alleging that on January 14, 2003, he sustained an injury
at one of our club locations resulting in serious bodily injury.
He filed an amended complaint on September 17, 2003 seeking
two billion dollars in damages for personal injuries. His cause
of action seeking punitive damages, in the amount of two hundred
and fifty million dollars, was dismissed on January 26,
2004. The Company has in force fifty-one million dollars of
insurance coverage to cover claims of this nature. The Company
intends to vigorously contest this lawsuit and presently
anticipates that these matters will be covered by insurance.

The Company is a party to various lawsuits
arising in the normal course of business. Management believes
that the ultimate outcome of these matters will not have a
material effect on the Companys consolidated financial
position, results of operations or cash flows.

F-24



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

16.     Employee
Benefit Plan

The Company maintains a 401(k) defined
contribution plan and is subject to the provisions of the
Employee Retirement Income Security Act of 1974
(ERISA). The Plan provides for the Company to make
discretionary contributions. The Plan was amended, effective
January 1, 2001, to provide for an employer matching
contribution in an amount equal to 25% of the participants
contribution with a limit of five hundred dollars per
individual, per annum. Employer matching contributions totaling
$200 and $195 were made in February 2003 and 2004, respectively,
for the Plan years ended December 31, 2002 and 2003,
respectively.

17.     Discontinued
Operations

In the fourth quarter of 2002, the Company closed
or sold two remote underperforming, wholly-owned clubs. In
connection with the closure of one of the clubs the Company
recorded club closure costs of $996 related to the write-off of
fixed assets. The Company has accounted for these two clubs as
discontinued operations and, accordingly, the results of their
operations have been classified as discontinued in the
consolidated statement of operations and prior periods have been
reclassified in accordance with SFAS No. 144.

Revenues and pre-tax losses for these
discontinued clubs were $1,659 and $894 in 2001 and $1,606 and
$322 in 2002, respectively.

18.     Subsequent
Events

On January 26, 2004 warrants to purchase
71,631 shares of Class A common stock were exercised.

On February 4, 2004 the Company and
affiliates and Town Sports International Holdings
(TSI Holdings), a newly formed company, entered
into a Restructuring Agreement. In connection with this
Restructuring, the holders of the Companys Series A
Preferred Stock, Series B Preferred Stock and Class A
Common stock contributed their shares of the Company to
TSI Holdings for an equal amount of newly issued shares of
the same form in TSI Holdings. Immediately following this
exchange TSI Holdings contributed to the Company the
certificates representing all of the Company shares contributed
in the aforementioned exchange and in return the Company issued
1,000 shares of common stock to TSI Holdings, and
cancelled on its books and records the certificate representing
Company shares contributed to it by TSI Holdings.

On February 4, 2004 TSI Holdings,
successfully completed an offering of 11.0% Senior Discount
Notes (the Discount Notes) that will mature in
February 2014. TSI Holdings received a total of
$124,807 in connection with this issuance. Fees and expenses
related to this transaction totaled approximately $4,375. No
cash interest is required to be paid prior to
February 2009. The accreted value of each Discount Note
will increase from the date of issuance until February 1,
2009, at a rate of 11.0% per annum compounded semi-annually such
that on February 1, 2009 the accreted value will equal
$213,000, the principal value due at maturity. Subsequent to
February 1, 2009 cash interest on the Discount Notes will
accrue and be payable semi-annually in arrears February 1
and August 1 of each year, commencing August 1, 2009.
The Discount Notes are structurally subordinated and effectively
rank junior to all indebtedness of the Company.

On February 6, 2004 all of
TSI Holdings outstanding Series A stock and
Series B stock were redeemed for a total of $50,634.

On March 12, 2004 65,296 vested common stock
options of TSI Holdings were exercised.

On March 15, 2004 the Board of Directors of
TSI Holdings approved a common stock dividend of $52.50 per
share to all shareholders of record on March 15, 2004. This
dividend was paid on March 17, 2004.

F-25



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

19.     Guarantors

The Company and all of its domestic subsidiaries
have unconditionally guaranteed the $255,000 9 5/8% Senior
Notes discussed in Note 6. However, the Companys
foreign subsidiaries have not provided guarantees for these
Notes.

Each guarantor is a wholly owned subsidiary of
the Company and the guarantees are full and unconditional and
joint and severable. The following schedules set forth condensed
consolidating financial information as required by
Rule 3-10f of Securities and Exchange Commission
Regulation S-X at December 31, 2002 and 2003 and for
each of the three years ending December 31, 2003. The
financial information illustrates the composition of the
combined guarantors.

F-26



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Balance
Sheet

December 31, 2002


|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |         |         |  
|--------------------------------------------------------------------- | ------------------------------------------------------------------- | --------------------------------------------------------------------------- | ------- | ---------- | ------- | ------------ | ------- | ------------ | ------- | ------------ | ----- | ------ | ------ | - | -------- | -------- | -------- | - | ------- | ------- | ------- | -
|                                                                      |                                                                     |                                                                             |         |            |         | Non-         |         |              |         |             
|                                                                      |                                                                     |                                                                             |         | Subsidiary |         | Guarantor    |         |              |         |             
|                                                                      |                                                                     | Parent                                                                      |         | Guarantors |         | Subsidiaries |         | Eliminations |         | Consolidated
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |             
|                                                                      |                                                                     |                                                                            
|                                                                      |                                                                     | (All figures in thousands of dollars)                                      
|ASSETS                                                               
|Current assets                                                        |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      | Cash and cash equivalents                                           |                                                                             | $       | 1,575      |         |              | $       | 3,635        |         |              | $     | 341    |        |   | $        |         |          |   | $       | 5,551   |        
|                                                                      | Accounts receivable, net                                            |                                                                             |         | 1,840      |         |              |         | 1,173        |         |              |       | 99     |        |   |          | (1,779   | )        |   |         | 1,333   |        
|                                                                      | Inventory                                                           |                                                                             |         |           |         |              |         | 1,106        |         |              |       | 26     |        |   |          |         |          |   |         | 1,132   |        
|                                                                      | Prepaid corporate income taxes                                      |                                                                             |         | 3,012      |         |              |         |             |         |              |       |       |        |   |          |         |          |   |         | 3,012   |        
|                                                                      | Intercompany receivable (payable)                                   |                                                                             |         | (18,996    | )       |              |         | 20,469       |         |              |       | (1,473 | )      |   |          |         |          |   |         |        |        
|                                                                      | Prepaid expenses and other current assets                           |                                                                             |         | 5,837      |         |              |         | 2,093        |         |              |       |       |        |   |          | (3,500   | )        |   |         | 4,430   |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total current assets                                                        |         |            | (6,732  | )            |         |              | 28,476  |              |       |        | (1,007 | ) |          |          | (5,279   | ) |         |         | 15,458  |  
|Investment in subsidiaries                                            |                                                                     |                                                                             | 206,413 |            |         |              |        |              |         |              |      |        |        |   | (206,413 | )        |          |   |        |        
|Fixed assets, net                                                     |                                                                     |                                                                             | 11,273  |            |         |              | 198,050 |              |         |              | 1,500 |        |        |   |         |          |          |   | 210,823 |        
|Goodwill, net                                                         |                                                                     |                                                                             |        |            |         |              | 44,927  |              |         |              | 604   |        |        |   |         |          |          |   | 45,531  |        
|Intangible assets, net                                                |                                                                     |                                                                             |        |            |         |              | 1,569   |              |         |              | 106   |        |        |   |         |          |          |   | 1,675   |        
|Deferred tax assets, net                                              |                                                                     |                                                                             | 20,866  |            |         |              | (490    | )            |         |              | (122  | )      |        |   |         |          |          |   | 20,254  |        
|Deferred membership costs                                             |                                                                     |                                                                             |        |            |         |              | 14,408  |              |         |              |      |        |        |   |         |          |          |   | 14,408  |        
|Other assets                                                          |                                                                     |                                                                             | 5,038   |            |         |              | 1,063   |              |         |              |      |        |        |   |         |          |          |   | 6,101   |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total assets                                                                |         | $          | 236,858 |              |         | $            | 288,003 |              |       | $      | 1,081  |   |          | $        | (211,692 | ) |         | $       | 314,250 |  
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                     
|LIABILITIES, REDEEMABLE PREFERRED STOCK AND
    STOCKHOLDERS DEFICIT
|Current liabilities                                                   |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      | Current portion of long-term debt and capital
    lease obligations |                                                                             | $       | 5,178      |         |              | $       |             |         |              | $     |       |        |   | $        |         |          |   | $       | 5,178   |        
|                                                                      | Accounts payable                                                    |                                                                             |         | 214        |         |              |         | 5,114        |         |              |       |       |        |   |          |         |          |   |         | 5,328   |        
|                                                                      | Accrued expenses                                                    |                                                                             |         | 9,470      |         |              |         | 13,398       |         |              |       | 545    |        |   |          | (1,779   | )        |   |         | 21,634  |        
|                                                                      | Deferred revenue                                                    |                                                                             |         |           |         |              |         | 26,510       |         |              |       |       |        |   |          |         |          |   |         | 26,510  |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total current liabilities                                                   |         |            | 14,862  |              |         |              | 45,022  |              |       |        | 545    |   |          |          | (1,779   | ) |         |         | 58,650  |  
|Long-term debt and capital lease obligations                          |                                                                     |                                                                             | 155,765 |            |         |              | 3,500   |              |         |              |      |        |        |   | (3,500   | )        |          |   | 155,765 |        
|Deferred lease liabilities                                            |                                                                     |                                                                             | 625     |            |         |              | 23,019  |              |         |              |      |        |        |   |         |          |          |   | 23,644  |        
|Deferred revenue                                                      |                                                                     |                                                                             | 7       |            |         |              | 3,345   |              |         |              | 83    |        |        |   |         |          |          |   | 3,435   |        
|Other liabilities                                                     |                                                                     |                                                                             | 373     |            |         |              | 7,157   |              |         |              |      |        |        |   |         |          |          |   | 7,530   |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total liabilities                                                           |         |            | 171,632 |              |         |              | 82,043  |              |       |        | 628    |   |          |          | (5,279   | ) |         |         | 249,024 |  
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|Redeemable preferred stock                                            |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      | Redeemable senior preferred stock                                   |                                                                             |         | 62,125     |         |              |         |             |         |              |       |       |        |   |          |         |          |   |         | 62,125  |        
|                                                                      | Series A preferred stock                                            |                                                                             |         | 34,841     |         |              |         |             |         |              |       |       |        |   |          |         |          |   |         | 34,841  |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      |                                                                     |                                                                             | 96,966  |            |         |              |        |              |         |              |      |        |        |   |         |          |          |   | 96,966  |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|Stockholders deficit                                                 |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      | Series B preferred stock                                            |                                                                             |         | 303        |         |              |         |             |         |              |       |       |        |   |          |         |          |   |         | 303     |        
|                                                                      | Common stockholders deficit                                        |                                                                             |         | (32,336    | )       |              |         | 205,960      |         |              |       | 160    |        |   |          | (206,120 | )        |   |         | (32,336 | )      
|                                                                      | Accumulated other comprehensive income                              |                                                                             |         | 293        |         |              |         |             |         |              |       | 293    |        |   |          | (293     | )        |   |         | 293     |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total stockholders deficit                                                 |         |            | (31,740 | )            |         |              | 205,960 |              |       |        | 453    |   |          |          | (206,413 | ) |         |         | (31,740 | )
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total liabilities, redeemable preferred stock and
    stockholders deficit |         | $          | 236,858 |              |         | $            | 288,003 |              |       | $      | 1,081  |   |          | $        | (211,692 | ) |         | $       | 314,250 |  
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |        |   |          |          |          |   |         |        

F-27



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Balance
Sheet

December 31, 2003


|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |         |         |  
|--------------------------------------------------------------------- | ------------------------------------------------------------------- | --------------------------------------------------------------------------- | ------- | ---------- | ------- | ------------ | ------- | ------------ | ------- | ------------ | ----- | ------ | ----- | - | -------- | -------- | -------- | - | ------- | ------- | ------- | -
|                                                                      |                                                                     |                                                                             |         |            |         | Non-         |         |              |         |             
|                                                                      |                                                                     |                                                                             |         | Subsidiary |         | Guarantor    |         |              |         |             
|                                                                      |                                                                     | Parent                                                                      |         | Guarantors |         | Subsidiaries |         | Eliminations |         | Consolidated
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |             
|                                                                      |                                                                     |                                                                            
|                                                                      |                                                                     | (All figures in thousands of dollars)                                      
|ASSETS                                                               
|Current assets                                                        |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      | Cash and cash equivalents                                           |                                                                             | $       | 420        |         |              | $       | 39,006       |         |              | $     | 1,376  |       |   | $        |         |          |   | $       | 40,802  |        
|                                                                      | Accounts receivable, net                                            |                                                                             |         | 2,230      |         |              |         | 1,235        |         |              |       | 133    |       |   |          | (2,129   | )        |   |         | 1,469   |        
|                                                                      | Inventory                                                           |                                                                             |         | 0          |         |              |         | 720          |         |              |       | 30     |       |   |          |         |          |   |         | 750     |        
|                                                                      | Prepaid corporate income taxes                                      |                                                                             |         | 4,062      |         |              |         |             |         |              |       |       |       |   |          |         |          |   |         | 4,062   |        
|                                                                      | Intercompany receivable (payable)                                   |                                                                             |         | 7,068      |         |              |         | (5,451       | )       |              |       | (1,617 | )     |   |          |         |          |   |         |        |        
|                                                                      | Prepaid expenses and other current assets                           |                                                                             |         | 6,493      |         |              |         | 2,329        |         |              |       |       |       |   |          | (3,500   | )        |   |         | 5,322   |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total current assets                                                        |         |            | 20,273  |              |         |              | 37,839  |              |       |        | (78   | ) |          |          | (5,629   | ) |         |         | 52,405  |  
|Investment in subsidiaries                                            |                                                                     |                                                                             | 238,166 |            |         |              |        |              |         |              |      |        |       |   | (238,166 | )        |          |   |        |        
|Fixed assets, net                                                     |                                                                     |                                                                             | 11,671  |            |         |              | 210,477 |              |         |              | 1,451 |        |       |   |         |          |          |   | 223,599 |        
|Goodwill, net                                                         |                                                                     |                                                                             |        |            |         |              | 45,058  |              |         |              | 806   |        |       |   |         |          |          |   | 45,864  |        
|Intangible assets, net                                                |                                                                     |                                                                             |        |            |         |              | 630     |              |         |              |      |        |       |   |         |          |          |   | 630     |        
|Deferred tax assets, net                                              |                                                                     |                                                                             | 17,399  |            |         |              | (491    | )            |         |              | (137  | )      |       |   |         |          |          |   | 16,771  |        
|Deferred membership costs                                             |                                                                     |                                                                             |        |            |         |              | 13,038  |              |         |              |      |        |       |   |         |          |          |   | 13,038  |        
|Other assets                                                          |                                                                     |                                                                             | 9,005   |            |         |              | 887     |              |         |              |      |        |       |   |         |          |          |   | 9,892   |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total assets                                                                |         | $          | 296,514 |              |         | $            | 307,438 |              |       | $      | 2,042 |   |          | $        | (243,795 | ) |         | $       | 362,199 |  
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                     
|LIABILITIES, REDEEMABLE PREFERRED STOCK AND
    STOCKHOLDERS DEFICIT
|Current liabilities                                                   |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      | Current portion of long-term debt and capital
    lease obligations |                                                                             | $       | 3,486      |         |              | $       |             |         |              | $     |       |       |   | $        |         |          |   |         | 3,486   |        
|                                                                      | Accounts payable                                                    |                                                                             |         | 220        |         |              |         | 5,159        |         |              |       |       |       |   |          |         |          |   |         | 5,379   |        
|                                                                      | Accrued expenses                                                    |                                                                             |         | 11,416     |         |              |         | 16,091       |         |              |       | 628    |       |   |          | (2,129   | )        |   |         | 26,006  |        
|                                                                      | Deferred revenue                                                    |                                                                             |         |           |         |              |         | 26,621       |         |              |       |       |       |   |          |         |          |   |         | 26,621  |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total current liabilities                                                   |         |            | 15,122  |              |         |              | 47,871  |              |       |        | 628   |   |          |          | (2,129   | ) |         |         | 61,492  |  
|Long-term debt and capital lease obligations                          |                                                                     |                                                                             | 274,947 |            |         |              | (13,056 | )            |         |              |      |        |       |   | (3,500   | )        |          |   | 258,391 |        
|Deferred lease liabilities                                            |                                                                     |                                                                             | 563     |            |         |              | 25,293  |              |         |              |      |        |       |   |         |          |          |   | 25,856  |        
|Deferred revenue                                                      |                                                                     |                                                                             | (64     | )          |         |              | 2,973   |              |         |              | 93    |        |       |   |         |          |          |   | 3,002   |        
|Other liabilities                                                     |                                                                     |                                                                             | 351     |            |         |              | 7,511   |              |         |              |      |        |       |   |         |          |          |   | 7,862   |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total liabilities                                                           |         |            | 290,919 |              |         |              | 70,592  |              |       |        | 721   |   |          |          | (5,629   | ) |         |         | 356,603 |  
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|Redeemable preferred stock                                            |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      | Series A preferred stock                                            |                                                                             |         | 39,890     |         |              |         |             |         |              |       |       |       |   |          |         |          |   |         | 39,890  |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      |                                                                     |                                                                             | 39,890  |            |         |              |        |              |         |              |      |        |       |   |         |          |          |   | 39,890  |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|Stockholders deficit                                                 |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      | Series B preferred stock                                            |                                                                             |         | 9,961      |         |              |         |             |         |              |       |       |       |   |          |         |          |   |         | 9,961   |        
|                                                                      | Common stockholders deficit                                        |                                                                             |         | (44,851    | )       |              |         | 236,845      |         |              |       | 725    |       |   |          | (237,570 | )        |   |         | (44,851 | )      
|                                                                      | Accumulated other comprehensive income                              |                                                                             |         | 596        |         |              |         |             |         |              |       | 596    |       |   |          | (596     | )        |   |         | 596     |        
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total stockholders deficit                                                 |         |            | (34,294 | )            |         |              | 236,845 |              |       |        | 1,321 |   |          |          | (238,166 | ) |         |         | (34,294 | )
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        
|                                                                      |                                                                     | Total liabilities, redeemable preferred stock and
    stockholders deficit |         | $          | 296,515 |              |         | $            | 307,437 |              |       | $      | 2,042 |   |          | $        | (243,795 | ) |         | $       | 362,199 |  
|                                                                      |                                                                     |                                                                             |         |            |         |              |         |              |         |              |       |        |       |   |          |          |          |   |         |        

F-28



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Statement of
Operations

Year Ended December 31, 2001


|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |        | 
|---------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ------------------------------------- | ------- | ---------- | - | ------------ | ------- | ------------ |  | ------------ | ----- | --- | - | - | ------- | ------- | - | - | ------- | ------ | 
|                                                                       |                                                                                   |                                       |         |            |   | Non-         |         |              |  |             
|                                                                       |                                                                                   |                                       |         | Subsidiary |   | Guarantors   |         |              |  |             
|                                                                       |                                                                                   | Parent                                |         | Guarantors |   | Subsidiaries |         | Eliminations |  | Consolidated
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |             
|                                                                       |                                                                                   |                                      
|                                                                       |                                                                                   | (All figures in thousands of dollars)
|Revenues                                                               |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|Club operations                                                        |                                                                                   | $                                     | 113     |            |   | $            | 275,482 |              |  | $            | 2,605 |     |   | $ |        |         |   | $ | 278,200 |       
|Fees and other                                                         |                                                                                   |                                       | 1,272   |            |   |              | 6,012   |              |  |              |      |     |   |   | (3,851  | )       |   |   | 3,433   |       
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|                                                                       |                                                                                   |                                       | 1,385   |            |   |              | 281,494 |              |  |              | 2,605 |     |   |   | (3,851  | )       |   |   | 281,633 |       
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|Operating expenses                                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|Payroll and related                                                    |                                                                                   |                                       | 20,083  |            |   |              | 91,537  |              |  |              | 1,146 |     |   |   |        |         |   |   | 112,766 |       
|Club operating                                                         |                                                                                   |                                       | 447     |            |   |              | 91,089  |              |  |              | 705   |     |   |   | (3,300  | )       |   |   | 88,941  |       
|General and administrative                                             |                                                                                   |                                       | 390     |            |   |              | 18,658  |              |  |              | 288   |     |   |   | (551    | )       |   |   | 18,785  |       
|Depreciation and amortization                                          |                                                                                   |                                       | 2,636   |            |   |              | 29,021  |              |  |              | 528   |     |   |   |        |         |   |   | 32,185  |       
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|                                                                       |                                                                                   |                                       | 23,556  |            |   |              | 230,305 |              |  |              | 2,667 |     |   |   | (3,851  | )       |   |   | 252,677 |       
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|                                                                       | Operating income                                                                  |                                       |         | (22,171    | ) |              |         | 51,189       |  |              |       | (62 | ) |   |         |        |   |   |         | 28,956 | 
|Interest expense                                                       |                                                                                   |                                       | 14,904  |            |   |              | 352     |              |  |              | 12    |     |   |   | (350    | )       |   |   | 14,918  |       
|Interest income                                                        |                                                                                   |                                       | (722    | )          |   |              | (19     | )            |  |              |      |     |   |   | 350     |         |   |   | (391    | )     
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|                                                                       | Income from continuing operations before
    provision for corporate income taxes |                                       |         | (36,353    | ) |              |         | 50,856       |  |              |       | (74 | ) |   |         |        |   |   |         | 14,429 | 
|Provision for corporate income taxes                                   |                                                                                   |                                       | (17,268 | )          |   |              | 24,108  |              |  |              | 13    |     |   |   |        |         |   |   | 6,853   |       
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|                                                                       | Income from continuing operations before equity
    earnings                      |                                       |         | (19,085    | ) |              |         | 26,748       |  |              |       | (87 | ) |   |         |        |   |   |         | 7,576  | 
|Equity earnings from subsidiaries                                      |                                                                                   |                                       | 26,131  |            |   |              |        |              |  |              |      |     |   |   | (26,131 | )       |   |   |        |       
|Loss on discontinued operations, net of income
    tax benefit of $551 |                                                                                   |                                       |        |            |   |              | (530    | )            |  |              |      |     |   |   |        |         |   |   | (530    | )     
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       
|                                                                       | Net income                                                                        |                                       | $       | 7,046      |   |              | $       | 26,218       |  |              | $     | (87 | ) |   | $       | (26,131 | ) |   | $       | 7,046  | 
|                                                                       |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |   |   |         |         |   |   |         |       

F-29



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Statement of
Operations

Year Ended December 31, 2002


|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |        | 
|-------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ------------------------------------- | ------- | ---------- | - | ------------ | ------- | ------------ |  | ------------ | ----- | --- |  | - | ------- | ------- | - | - | ------- | ------ | 
|                                                                                             |                                                                                   |                                       |         |            |   | Non-         |         |              |  |             
|                                                                                             |                                                                                   |                                       |         | Subsidiary |   | Guarantors   |         |              |  |             
|                                                                                             |                                                                                   | Parent                                |         | Guarantors |   | Subsidiaries |         | Eliminations |  | Consolidated
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |             
|                                                                                             |                                                                                   |                                      
|                                                                                             |                                                                                   | (All figures in thousands of dollars)
|Revenues                                                                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|Club operations                                                                              |                                                                                   | $                                     | 241     |            |   | $            | 310,926 |              |  | $            | 3,828 |     |  | $ |        |         |   | $ | 314,995 |       
|Fees and other                                                                               |                                                                                   |                                       | 2,187   |            |   |              | 6,290   |              |  |              |      |     |  |   | (4,045  | )       |   |   | 4,432   |       
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                                                                             |                                                                                   |                                       | 2,428   |            |   |              | 317,216 |              |  |              | 3,828 |     |  |   | (4,045  | )       |   |   | 319,427 |       
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|Operating expenses                                                                           |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|Payroll and related                                                                          |                                                                                   |                                       | 22,184  |            |   |              | 105,390 |              |  |              | 1,531 |     |  |   |        |         |   |   | 129,105 |       
|Club operating                                                                               |                                                                                   |                                       | 564     |            |   |              | 101,088 |              |  |              | 945   |     |  |   | (3,484  | )       |   |   | 99,113  |       
|General and administrative                                                                   |                                                                                   |                                       | 437     |            |   |              | 21,149  |              |  |              | 343   |     |  |   | (561    | )       |   |   | 21,368  |       
|Depreciation and amortization                                                                |                                                                                   |                                       | 2,857   |            |   |              | 28,509  |              |  |              | 382   |     |  |   |        |         |   |   | 31,748  |       
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                                                                             |                                                                                   |                                       | 26,042  |            |   |              | 256,136 |              |  |              | 3,201 |     |  |   | (4,045  | )       |   |   | 281,334 |       
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                                                                             | Operating income                                                                  |                                       |         | (23,614    | ) |              |         | 61,080       |  |              |       | 627 |  |   |         |        |   |   |         | 38,093 | 
|Interest expense                                                                             |                                                                                   |                                       | 16,548  |            |   |              | 351     |              |  |              | 10    |     |  |   | (350    | )       |   |   | 16,559  |       
|Interest income                                                                              |                                                                                   |                                       | (488    | )          |   |              |        |              |  |              | (444  | )   |  |   | 350     |         |   |   | (138    | )     
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                                                                             | Income from continuing operations before
    provision for corporate income taxes |                                       |         | (39,674    | ) |              |         | 60,729       |  |              |       | 617 |  |   |         |        |   |   |         | 21,672 | 
|Provision for corporate income taxes                                                         |                                                                                   |                                       | (17,766 | )          |   |              | 27,296  |              |  |              | 179   |     |  |   |        |         |   |   | 9,709   |       
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                                                                             | Income from continuing operations before equity
    earnings                      |                                       |         | (21,908    | ) |              |         | 33,433       |  |              |       | 438 |  |   |         |        |   |   |         | 11,963 | 
|Equity earnings from subsidiaries                                                            |                                                                                   |                                       | 33,104  |            |   |              |        |              |  |              |      |     |  |   | (33,104 | )       |   |   |        |       
|Loss on discontinued operations, net of income
    tax benefit of $551                       |                                                                                   |                                       |        |            |   |              | (767    | )            |  |              |      |     |  |   |        |         |   |   | (767    | )     
|Cumulative effect of a change in accounting
    principle, net of income tax benefit of $812 |                                                                                   |                                       | (689    | )          |   |              | (689    | )            |  |              |      |     |  |   | 689     |         |   |   | (689    | )     
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                                                                             | Net income                                                                        |                                       | $       | 10,507     |   |              | $       | 31,977       |  |              | $     | 438 |  |   | $       | (32,415 | ) |   | $       | 10,507 | 
|                                                                                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       

F-30



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Statement of
Operations

Year Ended December 31, 2003


|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |        | 
|------------------------------------ | --------------------------------------------------------------------------------- | ------------------------------------- | ------- | ---------- | - | ------------ | ------- | ------------ |  | ------------ | ----- | --- |  | - | ------- | ------- | - | - | ------- | ------ | 
|                                     |                                                                                   |                                       |         |            |   | Non-         |         |              |  |             
|                                     |                                                                                   |                                       |         | Subsidiary |   | Guarantors   |         |              |  |             
|                                     |                                                                                   | Parent                                |         | Guarantors |   | Subsidiaries |         | Eliminations |  | Consolidated
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |             
|                                     |                                                                                   |                                      
|                                     |                                                                                   | (All figures in thousands of dollars)
|Revenues                             |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|Club operations                      |                                                                                   | $                                     | 427     |            |   | $            | 331,102 |              |  | $            | 4,611 |     |  | $ |        |         |   | $ | 336,140 |       
|Fees and other                       |                                                                                   |                                       | 3,990   |            |   |              | 6,586   |              |  |              |      |     |  |   | (4,175  | )       |   |   | 6,401   |       
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                     |                                                                                   |                                       | 4,417   |            |   |              | 337,688 |              |  |              | 4,611 |     |  |   | (4,175  | )       |   |   | 342,541 |       
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|Operating expenses                   |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|Payroll and related                  |                                                                                   |                                       | 21,439  |            |   |              | 107,364 |              |  |              | 1,782 |     |  |   |        |         |   |   | 130,585 |       
|Club operating                       |                                                                                   |                                       | 772     |            |   |              | 112,800 |              |  |              | 1,112 |     |  |   | (3,615  | )       |   |   | 111,069 |       
|General and administrative           |                                                                                   |                                       | (123    | )          |   |              | 22,291  |              |  |              | 387   |     |  |   | (560    | )       |   |   | 21,995  |       
|Depreciation and amortization        |                                                                                   |                                       | 3,890   |            |   |              | 30,661  |              |  |              | 376   |     |  |   |        |         |   |   | 34,927  |       
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                     |                                                                                   |                                       | 25,978  |            |   |              | 273,116 |              |  |              | 3,657 |     |  |   | (4,175  | )       |   |   | 298,576 |       
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                     | Operating income                                                                  |                                       |         | (21,561    | ) |              |         | 64,572       |  |              |       | 954 |  |   |         |        |   |   |         | 43,965 | 
|Loss on extinguishment of debt       |                                                                                   |                                       | 7,773   |            |   |              |        |              |  |              |      |     |  |   |        |         |   |   | 7,773   |       
|Interest expense                     |                                                                                   |                                       | 23,891  |            |   |              | 130     |              |  |              | (1    | )   |  |   | (350    | )       |   |   | 23,670  |       
|Interest income                      |                                                                                   |                                       | (794    | )          |   |              |        |              |  |              |      |     |  |   | 350     |         |   |   | (444    | )     
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                     | Income from continuing operations before
    provision for corporate income taxes |                                       |         | (52,431    | ) |              |         | 64,442       |  |              |       | 955 |  |   |         |        |   |   |         | 12,966 | 
|Provision for corporate income taxes |                                                                                   |                                       | (24,100 | )          |   |              | 29,401  |              |  |              | 236   |     |  |   |        |         |   |   | 5,537   |       
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                     | Income from continuing operations before equity
    earnings                      |                                       |         | (28,331    | ) |              |         | 35,041       |  |              |       | 719 |  |   |         |        |   |   |         | 7,429  | 
|Equity earnings from subsidiaries    |                                                                                   |                                       | 35,760  |            |   |              |        |              |  |              |      |     |  |   | (35,760 | )       |   |   |        |       
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       
|                                     | Net income                                                                        |                                       | $       | 7,429      |   |              | $       | 35,041       |  |              | $     | 719 |  |   | $       | (35,760 | ) |   | $       | 7,429  | 
|                                     |                                                                                   |                                       |         |            |   |              |         |              |  |              |       |     |  |   |         |         |   |   |         |       

F-31



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Statement of Cash
Flows

Year Ended December 31, 2001


|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |        |        | 
|------------------------------------------------------------------------------------ | --------------------------------------------------------- | ----------------------------------------- | ------ | ---------- | ------- | ------------ | ------- | ------------ | ------ | ------------ | ---- | --- | --- | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                                     |                                                           |                                           |        |            |         | Non-         |         |              |        |             
|                                                                                     |                                                           |                                           |        | Subsidiary |         | Guarantors   |         |              |        |             
|                                                                                     |                                                           | Parent                                    |        | Guarantors |         | Subsidiaries |         | Eliminations |        | Consolidated
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |             
|                                                                                     |                                                           |                                          
|                                                                                     |                                                           | (All figures in thousands of dollars)    
|Cash flows from operating activities                                                 |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|Net income                                                                           |                                                           | $                                         | 7,046  |            |         | $            | 26,218  |              |        | $            | (87  | )   |     | $ | (26,131 | )      |        | $ | 7,046   |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|Adjustments to reconcile net income to net cash
    provided by operating activities |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|                                                                                     | Depreciation and amortization                             |                                           |        | 2,636      |         |              |         | 29,503       |        |              |      | 528 |     |   |         |        |        |   |         | 32,667 |       
|                                                                                     | Compensation expense in connection with stock
    options |                                           |        | 1,149      |         |              |         |             |        |              |      |    |     |   |         |        |        |   |         | 1,149  |       
|                                                                                     | Noncash rental expenses, net of noncash rental
    income |                                           |        | 56         |         |              |         | 4,168        |        |              |      |    |     |   |         |       |        |   |         | 4,224  |       
|                                                                                     | Amortization of debt issuance costs                       |                                           |        | 1,882      |         |              |         |             |        |              |      |    |     |   |         |       |        |   |         | 1,882  |       
|                                                                                     | Changes in operating assets and liabilities               |                                           |        | (6,317     | )       |              |         | 4,005        |        |              |      | 99  |     |   |         |       |        |   |         | (2,213 | )     
|                                                                                     | Other                                                     |                                           |        | (26,775    | )       |              |         | 229          |        |              |      | 8   |     |   |         | 26,131 |        |   |         | (407   | )     
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|                                                                                     |                                                           | Total adjustments                         |        |            | (27,369 | )            |         |              | 37,905 |              |      |     | 635 |   |         |        | 26,131 |   |         |        | 37,302 | 
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|                                                                                     |                                                           | Net cash provided by operating activities |        |            | (20,323 | )            |         |              | 64,123 |              |      |     | 548 |   |         |        |       |   |         |        | 44,348 | 
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|Net cash used in investing
    activities                                            |                                                           |                                           | (3,893 | )          |         |              | (53,751 | )            |        |              | (714 | )   |     |   |        |        |        |   | (58,358 | )     
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|Net cash used in financing
    activities                                            |                                                           |                                           | 24,349 |            |         |              | (8,491  | )            |        |              | 245  |     |     |   |        |        |        |   | 16,103  |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|                                                                                     |                                                           | Net decrease in cash and cash equivalents |        |            | 133     |              |         |              | 1,881  |              |      |     | 79  |   |         |        |       |   |         |        | 2,093  | 
|Cash and cash equivalents                                                            |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|Beginning of period                                                                  |                                                           |                                           | 57     |            |         |              | 3,311   |              |        |              | (3   | )   |     |   |        |        |        |   | 3,365   |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       
|End of period                                                                        |                                                           | $                                         | 190    |            |         | $            | 5,192   |              |        | $            | 76   |     |     | $ |        |        |        | $ | 5,458   |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |     |   |         |        |        |   |         |       

F-32



---



##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Statement of
Operations

Year Ended December 31, 2002


|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |        |        | 
|------------------------------------------------------------------------------------ | --------------------------------------------------------- | ----------------------------------------- | ------ | ---------- | ------- | ------------ | ------- | ------------ | ------ | ------------ | ---- | --- | ----- | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                                     |                                                           |                                           |        |            |         | Non-         |         |              |        |             
|                                                                                     |                                                           |                                           |        | Subsidiary |         | Guarantors   |         |              |        |             
|                                                                                     |                                                           | Parent                                    |        | Guarantors |         | Subsidiaries |         | Eliminations |        | Consolidated
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |             
|                                                                                     |                                                           |                                          
|                                                                                     |                                                           | (All figures in thousands of dollars)    
|Cash flows from operating activities                                                 |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|Net income                                                                           |                                                           | $                                         | 10,507 |            |         | $            | 31,977  |              |        | $            | 438  |     |       | $ | (32,415 | )      |        | $ | 10,507  |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|Adjustments to reconcile net income to net cash
    provided by operating activities |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|                                                                                     | Depreciation and amortization                             |                                           |        | 2,857      |         |              |         | 28,786       |        |              |      | 382 |       |   |         |       |        |   |         | 32,025 |       
|                                                                                     | Goodwill impairment write-off and club closure
    costs  |                                           |        |           |         |              |         | 2,297        |        |              |      |    |       |   |         |       |        |   |         | 2,297  |       
|                                                                                     | Compensation expense in connection with stock
    options |                                           |        | 1,207      |         |              |         |             |        |              |      |    |       |   |         |       |        |   |         | 1,207  |       
|                                                                                     | Noncash rental expenses, net of noncash rental
    income |                                           |        | (78        | )       |              |         | 1,748        |        |              |      |    |       |   |         |       |        |   |         | 1,670  |       
|                                                                                     | Amortization of debt issuance costs                       |                                           |        | 1,928      |         |              |         |             |        |              |      |    |       |   |         |       |        |   |         | 1,928  |       
|                                                                                     | Changes in operating assets and liabilities               |                                           |        | (3,483     | )       |              |         | 4,768        |        |              |      | 306 |       |   |         |       |        |   |         | 1,591  |       
|                                                                                     | Other                                                     |                                           |        | (32,061    | )       |              |         | (742         | )      |              |      | (32 | )     |   |         | 32,415 |        |   |         | (420   | )     
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|                                                                                     |                                                           | Total adjustments                         |        |            | (29,630 | )            |         |              | 36,857 |              |      |     | 656   |   |         |        | 32,415 |   |         |        | 40,298 | 
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|                                                                                     |                                                           | Net cash provided by operating activities |        |            | (19,123 | )            |         |              | 68,834 |              |      |     | 1,094 |   |         |        |       |   |         |        | 50,805 | 
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|Net cash used in investing
    activities                                            |                                                           |                                           | (3,128 | )          |         |              | (36,805 | )            |        |              | (249 | )   |       |   |        |        |        |   | (40,182 | )     
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|Net cash used in financing
    activities                                            |                                                           |                                           | 23,636 |            |         |              | (33,586 | )            |        |              | (580 | )   |       |   |        |        |        |   | (10,530 | )     
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|                                                                                     |                                                           | Net change in cash and cash equivalents   |        |            | 1,385   |              |         |              | (1,557 | )            |      |     | 265   |   |         |        |       |   |         |        | 93     | 
|Cash and cash equivalents                                                            |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|Beginning of period                                                                  |                                                           |                                           | 190    |            |         |              | 5,192   |              |        |              | 76   |     |       |   |        |        |        |   | 5,458   |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       
|End of period                                                                        |                                                           | $                                         | 1,575  |            |         | $            | 3,635   |              |        | $            | 341  |     |       | $ |        |        |        | $ | 5,551   |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |      |     |       |   |         |        |        |   |         |       

F-33



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##### Table of Contents



TOWN SPORTS INTERNATIONAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Condensed Consolidating Statement of Cash
Flows

Year Ended December 31, 2003


|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |        |        | 
|------------------------------------------------------------------------------------ | --------------------------------------------------------- | ----------------------------------------- | ------ | ---------- | ------- | ------------ | ------- | ------------ | ------ | ------------ | ----- | --- | ----- | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                                     |                                                           |                                           |        |            |         | Non-         |         |              |        |             
|                                                                                     |                                                           |                                           |        | Subsidiary |         | Guarantors   |         |              |        |             
|                                                                                     |                                                           | Parent                                    |        | Guarantors |         | Subsidiaries |         | Eliminations |        | Consolidated
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |             
|                                                                                     |                                                           |                                          
|                                                                                     |                                                           | (All figures in thousands of dollars)    
|Cash flows from operating activities                                                 |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|Net income                                                                           |                                                           | $                                         | 7,429  |            |         | $            | 35,041  |              |        | $            | 719   |     |       | $ | (35,760 | )      |        | $ | 7,429   |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|Adjustments to reconcile net income to net cash
    provided by operating activities |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|                                                                                     | Depreciation and amortization                             |                                           |        | 3,890      |         |              |         | 30,661       |        |              |       | 376 |       |   |         |       |        |   |         | 34,927 |       
|                                                                                     | Compensation expense in connection with stock
    options |                                           |        | 198        |         |              |         |             |        |              |       |    |       |   |         |       |        |   |         | 198    |       
|                                                                                     | Noncash rental expenses, net of noncash rental
    income |                                           |        | (84        | )       |              |         | 1,734        |        |              |       |    |       |   |         |       |        |   |         | 1,650  |       
|                                                                                     | Loss on extinguishment of debt                            |                                           |        | 7,773      |         |              |         |             |        |              |       |    |       |   |         |       |        |   |         | 7,773  |       
|                                                                                     | Amortization of debt issuance costs                       |                                           |        | 1,627      |         |              |         |             |        |              |       |    |       |   |         |       |        |   |         | 1,627  |       
|                                                                                     | Changes in operating assets and liabilities               |                                           |        | 4,011      |         |              |         | 549          |        |              |       | 66  |       |   |         |       |        |   |         | 4,626  |       
|                                                                                     | Other                                                     |                                           |        | (36,277    | )       |              |         | 485          |        |              |       | 55  |       |   |         | 35,760 |        |   |         | 23     |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|                                                                                     |                                                           | Total adjustments                         |        |            | (18,862 | )            |         |              | 33,429 |              |       |     | 497   |   |         |        | 35,760 |   |         |        | 50,824 | 
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|                                                                                     |                                                           | Net cash provided by operating activities |        |            | (11,433 | )            |         |              | 68,470 |              |       |     | 1,216 |   |         |        |       |   |         |        | 58,253 | 
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|Net cash used in investing activities                                                |                                                           |                                           | (4,288 | )          |         |              | (38,120 | )            |        |              | (326  | )   |       |   |        |        |        |   | (42,734 | )     
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|Net cash used in financing activities                                                |                                                           |                                           | 14,566 |            |         |              | 5,021   |              |        |              | 145   |     |       |   |        |        |        |   | 19,732  |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|                                                                                     |                                                           | Net change in cash and cash equivalents   |        |            | (1,155  | )            |         |              | 35,371 |              |       |     | 1,035 |   |         |        |       |   |         |        | 35,251 | 
|Cash and cash equivalents                                                            |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|Beginning of period                                                                  |                                                           |                                           | 1,575  |            |         |              | 3,635   |              |        |              | 341   |     |       |   |        |        |        |   | 5,551   |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       
|End of period                                                                        |                                                           | $                                         | 420    |            |         | $            | 39,006  |              |        | $            | 1,376 |     |       | $ |        |        |        | $ | 40,802  |       
|                                                                                     |                                                           |                                           |        |            |         |              |         |              |        |              |       |     |       |   |         |        |        |   |         |       

F-34



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##### Table of Contents



SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized on March 17, 2004.



| |                                
| | -------------------------------
| | TOWN SPORTS INTERNATIONAL, INC.



| |     |                    
| | --- | -------------------
| | By: | /s/ ROBERT GIARDINA

| |                              
| | -----------------------------
| |                              
| | Robert Giardina              
| | Chief Executive Officer      
| | (principal executive officer)

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|          |  |                                    |  |                                                                                                              |  |               
|--------- |  | ---------------------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | --------------
|          |  |                                    |  |                                                                                                              |  |               
|          |  | Title                              |  | Date                                                                                                        
|Signature |  |                                    |  |                                                                                                             
|          |  |                                    |  |                                                                                                             
|         
|By:       |  | /s/ MARK SMITHMark Smith           |  | Chairman                                                                                                     |  | March 17, 2004
|         
|By:       |  | /s/ ROBERT GIARDINARobert Giardina |  | Chief Executive Officer
    (principal executive officer)                                                    |  | March 17, 2004
|         
|By:       |  | /s/ RICHARD PYLERichard Pyle       |  | Chief Financial Officer and
    office of the President
    (principal financial and
    accounting officer) |  | March 17, 2004
|         
|By:       |  | /s/ KEITH ALESSIKeith Alessi       |  | Director                                                                                                     |  | March 17, 2004
|         
|By:       |  | /s/ PAUL ARNOLDPaul Arnold         |  | Director                                                                                                     |  | March 17, 2004
|         
|By:       |  | /s/ BRUCE BRUCKMANNBruce Bruckmann |  | Director                                                                                                     |  | March 17, 2004
|         
|By:       |  | /s/ RICE EDMONDSRice Edmonds       |  | Director                                                                                                     |  | March 17, 2004
|         
|By:       |  | /s/ JASON FISHJason Fish           |  | Director                                                                                                     |  | March 17, 2004