-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, O6ziHavNsETiMLkLsSvork/YGxcVcGSW92HnB7vRAberOxCKfwmDrH/JO4LTSVWR 3zzxX79gz9SWAj5yaHa99w== 0001047469-98-026608.txt : 19980709 0001047469-98-026608.hdr.sgml : 19980709 ACCESSION NUMBER: 0001047469-98-026608 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 15 FILED AS OF DATE: 19980708 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FITNESS HOLDINGS INC CENTRAL INDEX KEY: 0001016182 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 943215690 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-58669 FILM NUMBER: 98661658 BUSINESS ADDRESS: STREET 1: 6668 OWENS DR CITY: PLEASANTON STATE: CA ZIP: 94588 BUSINESS PHONE: 5104163100 MAIL ADDRESS: STREET 2: 5020 FRANKLIN AVENUE CITY: PLEASANTON STATE: CA ZIP: 94588 S-1 1 S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 8, 1998. REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ FITNESS HOLDINGS, INC. (Exact name of registrant as specified in its charter) DELAWARE 7991 94-3215690 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification Number)
5020 FRANKLIN DRIVE, PLEASANTON, CALIFORNIA 94588 (925) 416-3100 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) GILBERT K. FREEMAN CHIEF FINANCIAL OFFICER FITNESS HOLDINGS, INC. 5020 FRANKLIN DRIVE PLEASANTON, CALIFORNIA 94588 (925) 416-3100 (Name, address, including zip code, and telephone number, including area code, of agent for service) ------------------------ COPIES TO: Mr. David E. King Frank L. Schiff, Esq. Mark Kessel, Esq. McCown De Leeuw & Co., Inc. White & Case LLP Shearman & Sterling 65 East 55th Street 1155 Avenue of the Americas 599 Lexington Avenue 36th Floor New York, New York 10036-2787 New York, New York 10022-6069 New York, New York 10022 (212) 819-8200 (212) 848-4000 (212) 355-5500
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT. ------------------------ If any of the securities being registered on this Form are being offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. / / If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / ------------------------------ CALCULATION OF REGISTRATION FEE
TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE (1)(2) REGISTRATION FEE Common Stock........................ $75,000,000 $22,125
(1) Estimated solely for purposes of computing the registration fee pursuant to Rule 457. (2) The amount of shares registered also includes any shares initially offered or sold outside the United States that are thereafter sold or resold in the United States. Offers and sales of shares outside the United States are being made pursuant to the exemption afforded by Rule 901 of Regulation S and this Registration Statement shall not be deemed effective with respect to such offers and sales. ------------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SUBJECT TO COMPLETION, DATED JULY 8, 1998 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. [LOGO] SHARES FITNESS HOLDINGS, INC. COMMON STOCK (PAR VALUE $.001 PER SHARE) ------------------------ Of the shares of Common Stock offered, shares are being offered by the Company in the United States and shares are being offered by the Company in a concurrent international offering outside the United States. The initial public offering price and the aggregate underwriting discount per share will be identical for both offerings. See "Underwriting." Prior to the offering, there has been no public market for the Common Stock. It is estimated that the initial public offering price per share will be between $ and $ . For factors considered in determining the initial public offering price, see "Underwriting." SEE "RISK FACTORS", BEGINNING ON PAGE 10, FOR CERTAIN CONSIDERATIONS RELEVANT TO AN INVESTMENT IN THE COMMON STOCK. Application will be made to list the Common Stock for trading on the Nasdaq National Market, subject to official notice of issuance, under the symbol "FITN". ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------
INITIAL PUBLIC UNDERWRITING PROCEEDS TO OFFERING PRICE DISCOUNT (1) COMPANY (2) --------------------- --------------------- --------------------- Per Share................................. $ $ $ Total(3).................................. $ $ $
- ------------------------ (1) The Company and the MDC Entities have agreed to indemnify the U.S. Underwriters and the International Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (2) Before deducting estimated expenses of $ payable by the Company. (3) The MDC Entities have granted the U.S. Underwriters an option for 30 days to purchase up to an additional shares of Common Stock at the initial public offering price per share, less the underwriting discount solely to cover over-allotments. Additionally, the MDC Entities have granted the International Underwriters a similar option with respect to an additional shares as part of the concurrent international offering. If such options are exercised in full, the total initial public offering price, underwriting discount and proceeds to the MDC Entities will be $ , $ and $ , respectively. See "Underwriting." ------------------------ The shares offered hereby are offered severally by the Underwriters, as specified herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. It is expected that certificates for the shares will be ready for delivery in New York, New York, on or about , 1998, against payment therefore in immediately available funds. GOLDMAN, SACHS & CO. BT ALEX( BROWN NATIONSBANC MONTGOMERY SECURITIES LLC ------------------------ The date of this Prospectus is , 1998. [Photographs of fitness centers/Map indicating locations of fitness centers.] THE COMPANY INTENDS TO FURNISH TO ITS STOCKHOLDERS AUDITED ANNUAL FINANCIAL STATEMENTS AND QUARTERLY REPORTS CONTAINING UNAUDITED INTERIM FINANCIAL INFORMATION FOR THE FIRST THREE FISCAL QUARTERS OF EACH FISCAL YEAR OF THE COMPANY. -------------------------- CERTAIN PERSONS PARTICIPATING IN THESE OFFERINGS MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THESE OFFERINGS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." PROSPECTUS SUMMARY THE FOLLOWING IS A SUMMARY OF CERTAIN INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS. REFERENCE IS MADE TO, AND THIS SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, THE MORE DETAILED INFORMATION AND FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, CONTAINED ELSEWHERE IN THIS PROSPECTUS. ALL REFERENCES TO THE "COMPANY" OR "24 HOUR FITNESS" SHALL BE DEEMED TO REFER TO FITNESS HOLDINGS, INC. AND ITS SUBSIDIARIES AND ITS PREDECESSORS, AND ALL REFERENCES TO "HOLDINGS" SHALL BE DEEMED TO REFER TO FITNESS HOLDINGS, INC., IN EACH CASE UNLESS INDICATED OTHERWISE. ALL REFERENCES TO FISCAL YEARS CONTAINED HEREIN SHALL BE DEEMED TO REFER TO THE APPLICABLE FISCAL YEAR OF THE COMPANY, WHICH ENDS ON DECEMBER 31. UNLESS OTHERWISE INDICATED, THE SOURCES FOR ALL INDUSTRY DATA AND STATISTICS CONTAINED HEREIN ARE ESTIMATES CONTAINED IN OR DERIVED FROM INDUSTRY STUDIES BELIEVED BY THE COMPANY TO BE RELIABLE, AND ALL OF THE COMPANY'S OPERATING DATA IS PRESENTED AS OF APRIL 30, 1998. UNLESS OTHERWISE INDICATED, ALL INFORMATION CONTAINED IN THIS PROSPECTUS REFLECTS (I) A -FOR-1 STOCK SPLIT DECLARED ON , 1998 AND DISTRIBUTED ON , 1998 AND (II) NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTIONS. THE COMPANY The Company is a leading owner-operator of fitness centers, operating 173 facilities under the brand name "24 Hour Fitness" in nine western States. Through these facilities, the Company provides a broad array of fitness, sport, nutritional and other services to its 1.6 million members. The Company has grown to become the second largest commercial owner-operator of fitness centers in the United States in terms of revenues and number of fitness centers, and is the largest commercial owner-operator of fitness centers in California, the industry's largest market. The Company believes that it differentiates itself from its competitors by offering: (i) 24 hour access at a majority of its facilities; (ii) consistently well-equipped, well-maintained fitness centers; (iii) professionally trained staff focused on quality customer service; and (iv) month-to-month membership plans that feature low initiation fees and affordable monthly dues. The Company's net revenues have increased from $33.0 million in fiscal 1993 to $261.9 million in fiscal 1997, and its EBITDA has increased from a negative $0.5 million in fiscal 1993 to a positive $13.4 million in fiscal 1997. The Company operates 123 fitness-only centers and 50 multi-sport centers. Fitness-only centers are typically less than 25,000 square feet and offer aerobic, cardiovascular and weight lifting facilities. Multi-sport centers are typically between 25,000 and 60,000 square feet and, in addition to the services and amenities offered by fitness-only centers, offer one or more of the following additional amenities: squash courts, racquetball courts, basketball courts, swimming pools, steam and sauna rooms, and whirlpools. As part of its clustering strategy, the Company often locates multi-sport centers in a market with several fitness-only centers and offers its members the use of both types of facilities for a higher membership fee. The Company believes that the health and fitness center industry has been enjoying, and will continue to enjoy, a period of pronounced growth. The industry has benefited from, and helped to create, an increasing awareness among the general public of the importance of physical exercise as a condition for good health. The International Health, Racquet and Sportsclub Association ("IHRSA") reported that, in 1997, there were approximately 13,800 commercial health and fitness centers in the United States which generated aggregate revenue of approximately $9.0 billion. American Sports Data, Inc. ("ASDI"), a consumer panel research organization, reported that memberships in health and fitness centers have grown from 13.8 million in 1987 to 20.8 million in 1996. The Company estimates that there are fewer than 20 companies that own and operate more than 20 commercial health and fitness centers in the United States. The Company believes that the fragmented 3 nature of this industry presents significant opportunities for the Company to grow its operations by continuing to pursue its acquisition strategy. As the second largest commercial multi-site owner-operator in the United States, the Company enjoys substantial economies of scale in management, advertising, and purchasing of equipment and supplies. The Company pursues a three-pronged growth strategy based upon (i) maximizing revenue growth and profit margins at existing fitness centers through growth in new memberships and sales of ancillary products and services, (ii) acquiring single-site and multi-site chains of fitness centers as a method of entering new markets and furthering its clustering strategy, and (iii) developing new fitness centers on a greenfield basis. OPERATING STRATEGY The Company pursues a disciplined operating strategy which has helped to successfully position "24 Hour Fitness" as a nationally recognized brand of fitness centers. The Company attributes its growth and performance to several factors, including the following: CONVENIENT ACCESS. Since the Company believes that convenience is a high priority for its members, a majority of the Company's facilities are open 24 hours a day, seven days a week. In addition, the Company's clustering strategy provides convenient access to multiple locations near its members' homes and places of work. WELL-EQUIPPED, WELL-MAINTAINED FITNESS CENTERS. The Company is committed to offering fitness centers that are fully equipped with the latest in sports technology and equipment, including complete lines of state-of-the-art cardiovascular equipment, free weights and weight training machines. The Company has a comprehensive maintenance and capital expenditure program designed to continually maintain and upgrade its exercise equipment and facilities. In addition, the Company believes that the cleanliness and maintenance of its facilities are important to existing and prospective members, and therefore employee compensation is linked to these factors. PROFESSIONALLY TRAINED, CUSTOMER-ORIENTED FITNESS SERVICE STAFF. Each of the Company's fitness centers features a professionally trained staff to assist and supervise members with their exercise regimens. Through training and ongoing educational requirements, the Company ensures that its fitness service staff provides safe, consistent and effective exercise assistance and supervision. AFFORDABLE PRICING STRUCTURE. Members of the Company's fitness centers enjoy quality health and fitness services at affordable prices. The Company's individual monthly dues for new members typically range from $19 to $35, and individual one-time initiation fees for new members typically range from $49 to $299, depending upon the type of membership plan, the particular fitness center and its amenities. These membership plans differentiate the Company from some of its competitors that charge a substantial one-time initiation fee. Emphasizing monthly dues encourages a focus on quality customer service which management believes results in higher customer satisfaction and improved member retention. In fiscal 1997, approximately 70% of the Company's net revenues were from monthly dues. In excess of 90% of the Company's dues collected monthly are paid by electronic funds transfer, which the Company believes significantly increases collection rates of, and reduces the cost of collecting, monthly dues. HIGH MEMBER RETENTION RATES. The Company devotes significant attention to retaining its members and, as a result, has been able to achieve what it believes to be some of the highest member retention rates among commercial multi-site fitness center owner-operators. These high member retention rates provide the Company with a stable base of recurring revenues and reduce costs associated with membership attrition. Existing members are also an important source of new member referrals. 4 CLUSTERING OF FITNESS CENTERS. The Company seeks to establish a prominent presence in each of its markets by clustering several fitness centers in a particular area. This strategy enables the Company to achieve significant market penetration and to leverage management, advertising and purchasing expenses thereby achieving greater economies of scale. This strategy also promotes recognition of the "24 Hour Fitness" brand name and contributes to high member retention rates. STRONG BRAND NAME. The Company devotes substantial resources to advertising and marketing aimed at enhancing its brand image. The Company employs a full time corporate advertising staff that oversees its radio, television, print and direct response advertising, image advertising and promotional events aimed at attracting new members and developing the "24 Hour Fitness" brand name. The Company also allocates a portion of its advertising and promotion budget to local club managers to enable them to engage in local advertising and promotions at the individual facility level. HIGHLY EXPERIENCED MANAGEMENT TEAM. The Company's management team has been at the forefront of the fitness industry for over 15 years and is led by the Company's founder, Mark S. Mastrov, who started the Company with a single fitness center in 1983. As the Company's business has grown, Mr. Mastrov has recruited and developed an experienced management team. The seven senior members of this team have more than 94 cumulative years of experience in the health and fitness center industry. GROWTH STRATEGY From January 1, 1996 to April 30, 1998, the Company grew from 109 facilities to 173 facilities. The Company plans to continue to expand by opening and acquiring a total of at least 35 fitness centers in fiscal 1998 (of which 16 had been opened or acquired by April 30, 1998) and approximately 35 additional fitness centers in fiscal 1999. This planned expansion is expected to be accomplished through the construction of new greenfield facilities, the acquisition of individual fitness centers, primarily in existing markets, and the acquisition of multi-site operators in new and existing markets. The Company has developed a three-pronged growth strategy that builds on the successes of the Company's management in operating, developing and acquiring fitness centers. The key elements of this growth strategy are: INCREASE REVENUES AND OPERATING INCOME AT EXISTING FITNESS CENTERS. The Company seeks to leverage the operating performance of its existing fitness centers through growth in fitness center revenues. Due to the high fixed cost component of operating expenses, revenue growth at existing clubs generally results in significantly increased operating income and cash flow. Total combined revenues, before change in deferred revenues, at fitness centers which the Company operated at least 13 months increased 13.8% in fiscal 1996, 12.9% in fiscal 1997 and 16.9% in the three months ended March 31, 1998. The Company's strategy for increasing revenues and operating income in existing fitness centers emphasizes the following: - ATTRACT NEW MEMBERS. The Company uses a variety of methods to attract new members, including radio, television, print and direct response advertising, image advertising, existing member referral programs and sponsorship of numerous community programs. The Company also seeks to increase its membership by offering corporate membership programs and establishing relationships with health maintenance organizations ("HMOs"). The Company has approximately 5,000 companies participating in its corporate membership programs with approximately 200,000 members enrolled. - INCREASE ANCILLARY REVENUES. The Company has developed a broad portfolio of complementary services and products, including: one-on-one personal training services, weight loss and nutritional counseling, and retail offerings of athletic clothing, juices, sports drinks and nutritional supplements. The Company believes that further expansion of these ancillary products and 5 services, particularly in its more recently opened or acquired fitness centers, will provide an opportunity to continue to increase net revenues. Revenues from ancillary services were $15.8 million for fiscal 1996 and $34.2 million for fiscal 1997, or approximately 8.8% and 13.1% of net revenues, respectively, for each period. ACQUIRE ADDITIONAL FITNESS CENTERS. Historically, acquisitions of fitness centers have played a key role in the Company's growth strategy. From January 1, 1996 through March 31, 1998, the Company acquired 46 additional fitness centers, of which 36 were acquired in acquisitions of multi-site operators. In addition, as of June 1, 1998, the Company had entered into letters of intent with respect to an additional two acquisitions of multi-site operators representing an additional 12 fitness centers. The Company purchases individual fitness centers primarily in existing markets in order to increase its economies of scale, further its clustering strategy and increase its market share. Acquisitions of underperforming fitness centers also provide the Company with opportunities to improve operating performance through the implementation of the Company's operating strategy. The Company has and will continue to pursue acquisitions of multi-site operators and individual fitness centers having a combination of attractive locations, strong management teams and significant growth potential. DEVELOP NEW LOCATIONS. From January 1, 1996 through March 31, 1998, the Company developed 19 greenfield fitness centers as a complement to its acquisition strategy. Developing greenfield sites allows the Company to control every aspect of the design and construction of a fitness center in accordance with its operational philosophy. The Company develops fitness centers on a greenfield basis both as a way of entering new markets and expanding its presence in existing markets. ------------------------ Holdings was incorporated in Delaware in November 1994 as a holding company for its principal operating subsidiary, 24 Hour Fitness, Inc., a California corporation, which was incorporated in June 1983. The Company's principal executive offices are located at 5020 Franklin Drive, Pleasanton, California 94588, and its telephone number is (925) 416-3100. 6 THE OFFERINGS (1) Shares of Common Stock Offered: United States Offering..................... shares International Offering..................... shares Total.................................... shares Total Common Stock to be Outstanding after the Offerings.............................. shares Use of Proceeds (2).......................... Up to $ million of the net proceeds of the Offerings will be used to reduce the outstanding indebtedness under the Senior Credit Facility (as defined herein), approximately $6.0 million will be used to pay the Success Fee (as defined herein) under an existing contractual arrangement to Banque Nationale de Paris ("BNP"), the lender under the Senior Credit Facility, approximately $ million of the net proceeds to pay a fee to certain MDC Entities in connection with the termination of the existing Management Services Agreement with such entities and the remaining proceeds of the Offerings will be used for general corporate purposes. See "Use of Proceeds", "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview" and "Certain Relationships and Related Transactions." Proposed Nasdaq National Market Symbol....... FITN
- ------------------------ (1) Excludes shares issuable upon the exercise of outstanding options and warrants. Immediately prior to the consummation of the Offerings, approximately of these options were fully vested. Upon consummation of the Offerings an additional options will vest pursuant to the terms of the Company's equity incentive plans. (2) Holdings will not receive any proceeds from the sale of shares of Common Stock by the MDC Entities (as defined herein), pursuant to the Underwriters' over-allotment options, if, and to the extent that, such options are exercised. See "Principal and Selling Stockholders." 7 SUMMARY CONSOLIDATED FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
HISTORICAL PRO FORMA THREE HISTORICAL FISCAL YEAR MONTHS FISCAL YEAR ENDED ENDED ENDED DECEMBER 31, DECEMBER 31, MARCH 31, -------------------------------------------------------- --------------- --------- 1993 1994 1995 1996 1997 1997(1) 1997 --------- --------- ---------- ---------- ---------- --------------- --------- STATEMENT OF OPERATIONS DATA: Net revenues (2): Membership revenues....................... $ 35,612 $ 39,684 $ 108,668 $ 196,573 $ 258,776 $ 263,503 $ 61,696 Change in deferred revenues............... (4,227) (1,304) (18,683) (32,403) (31,069) (32,355) (10,131) --------- --------- ---------- ---------- ---------- --------------- --------- Net membership revenues................. 31,385 38,380 89,985 164,170 227,707 231,148 51,565 Ancillary revenues........................ 1,639 2,891 8,009 15,839 34,197 35,429 6,425 --------- --------- ---------- ---------- ---------- --------------- --------- Total net revenues...................... 33,024 41,271 97,994 180,009 261,904 266,577 57,990 Operating expenses: Fitness center operating expenses......... 26,044 32,689 83,947 162,054 226,809 230,314 50,981 General and administrative expenses (3)... 8,377 6,018 17,441 24,830 30,866 31,119 6,386 Depreciation and amortization............. 1,942 2,494 7,447 13,653 20,244 20,880 4,133 Provision for severance................... -- -- -- 3,600 635 635 -- Change in deferred membership origination costs (4)............................... (890) (718) (5,838) (10,244) (9,843) (9,843) (2,598) --------- --------- ---------- ---------- ---------- --------------- --------- Total operating expenses................ 35,473 40,483 102,997 193,893 268,711 273,105 58,902 --------- --------- ---------- ---------- ---------- --------------- --------- Income (loss) from operations............... (2,449) 788 (5,003) (13,884) (6,807) (6,528) (912) Interest expense (5)........................ 101 165 5,600 9,280 18,372 18,865 2,917 Debt offering costs (6)..................... -- -- -- -- 999 999 -- --------- --------- ---------- ---------- ---------- --------------- --------- Income (loss) before income taxes........... (2,550) 623 (10,603) (23,164) (26,178) (26,392) (3,829) Income tax benefit (expense)................ 956 (260) 3,853 8,394 9,171 9,260 1,371 --------- --------- ---------- ---------- ---------- --------------- --------- Net income (loss)........................... $ (1,594) $ 363 $ (6,750) $ (14,770) $ (17,007) $ (17,132) $ (2,458) --------- --------- ---------- ---------- ---------- --------------- --------- --------- --------- ---------- ---------- ---------- --------------- --------- Net income (loss) per share (7): Basic..................................... Diluted................................... Weighted average shares outstanding: Basic..................................... Diluted................................... SELECTED OPERATING DATA: EBITDA (8).................................. $ (507) $3,282 $2,444 $ (231) $13,437 $14,352 $3,221 Number of fitness centers open at period end....................................... 24 32 109 137 157 157 140 Average revenues per fitness center (9)..... $1,719 $1,472 $1,675 $1,793 $ 1,985 $ 1,986 $ 488 Comparable fitness center revenues increase (10)...................................... 4.5% 8.0% 8.5% 13.8% 12.9% 12.9% 12.0% 1998 --------- STATEMENT OF OPERATIONS DATA: Net revenues (2): Membership revenues....................... $ 78,674 Change in deferred revenues............... (10,909) --------- Net membership revenues................. 67,765 Ancillary revenues........................ 12,889 --------- Total net revenues...................... 80,654 Operating expenses: Fitness center operating expenses......... 70,598 General and administrative expenses (3)... 7,585 Depreciation and amortization............. 5,391 Provision for severance................... -- Change in deferred membership origination costs (4)............................... (2,838) --------- Total operating expenses................ 80,736 --------- Income (loss) from operations............... (82) Interest expense (5)........................ 5,280 Debt offering costs (6)..................... -- --------- Income (loss) before income taxes........... (5,362) Income tax benefit (expense)................ 1,631 --------- Net income (loss)........................... $ (3,731) --------- --------- Net income (loss) per share (7): Basic..................................... Diluted................................... Weighted average shares outstanding: Basic..................................... Diluted................................... SELECTED OPERATING DATA: EBITDA (8).................................. $5,309 Number of fitness centers open at period end....................................... 172 Average revenues per fitness center (9)..... $ 544 Comparable fitness center revenues increase (10)...................................... 16.9%
AT MARCH 31, 1998 --------------------------- ACTUAL AS ADJUSTED(11) --------- ---------------- SELECTED BALANCE SHEET DATA: Working capital deficit................................................................ $ (75,887) $ Total assets........................................................................... 266,912 Long-term debt, excluding current portion.............................................. 202,877 Stockholders' deficit.................................................................. (109,417)
- ------------------------------ 8 (1) Represents the pro forma results of the Company's operations assuming that the acquisition of Northwest Fitness, Inc. had occurred on January 1, 1997. See "Pro Forma Combined Financial Information." (2) Membership revenues in any given period are comprised of all cash collected for non-refundable, one time initiation fees and all membership dues collected in that period, regardless of when services are actually provided. The portion of these membership revenues relating to new member initiation fees are deferred and recognized on a straight line basis over the average expected life of the memberships, currently estimated at 32 months. The portion of these membership revenues relating to dues for services not yet provided are recognized as revenues in the period in which services are actually provided. Change in deferred revenues is the amount of cash collected in a prior period and recognized as revenue in the current period less the amount of cash collected in the current period and deferred and recognized as revenues in a future period. (3) On February 14, 1997 the Company issued approximately stock options pursuant to its equity incentive plans and recognized a compensation charge of $417,000 in connection with such issuance. Upon completion of the Offerings, certain of these options will vest pursuant to the terms of the Company's equity incentive plans which will cause the Company to recognize an additional compensation charge of $ million in the quarter in which this vesting occurs. Such vesting is currently expected to occur in the third quarter of 1998. (4) Change in deferred membership origination costs reflects commissions related to new membership sales which are deferred and recognized on a straight-line basis over the average expected life of the memberships, currently estimated at 32 months. (5) In connection with the Company's fiscal 1997 distributions to its stockholders of $57.5 million, the Company paid a $1.0 million success participation fee to its lender, which is included in interest expense. Upon completion of the Offerings, the Company will be obligated to make an additional Success Fee payment to its lender of approximately $6.0 million, which will be included in interest expense in the quarter in which such payment is made. See Note 12 to the Company's Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Overview." (6) Debt offering costs reflect the write-off of one-time costs associated with a contemplated offering of debt securities. (7) In fiscal 1997, the Company adopted Statement of Financial Accounting Standard No. 128 "Earnings per Share." All earnings per share amounts presented are in accordance with this statement. (8) EBITDA is defined as income (loss) from operations before depreciation and amortization. Income (loss) from operations excludes interest, taxes and the write-off of debt offering costs. EBITDA is presented because management believes it is a useful indicator of the Company's capacity to service and/or incur debt and as a measure of the Company's operating performance. EBITDA is not a measure of performance under Generally Accepted Accounting Principles ("GAAP") and should not be considered in isolation or as a substitute for income (loss) from operations or cash flows or as a measure of the Company's profitability or liquidity in assessing the Company's overall financial condition. The Company's measure of EBITDA may not be comparable to similar measures used by other companies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." (9) Average revenues per fitness center is calculated as combined membership and ancillary revenues divided by the product of the total number of fitness centers multiplied by their weighted average months in operation. For fiscal 1993 and 1994, average revenues per fitness center do not include revenues from the 24 Hour Workout Centers (as defined herein). (10) Comparable fitness center revenues increase is calculated by comparing combined membership and ancillary revenues for the current period for fitness centers that were operated by the Company for at least 13 months to combined membership and ancillary revenues for the same period in the prior year. Comparable fitness center revenues increase does not include change in deferred revenues and, therefore, may not be indicative of growth in total net revenues at comparable fitness centers. (11) Adjusted to reflect the sale by the Company of the Common Stock offered hereby at an assumed initial public offering price of $ per share and the application of the estimated net proceeds therefrom. 9 RISK FACTORS THIS PROSPECTUS INCLUDES "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT AND SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). SUCH STATEMENTS ARE IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS OR PHRASES INCLUDING, BUT NOT LIMITED TO, "INTENDED," "WILL," "SHOULD," "MAY," "STRATEGICALLY POSITIONED," "EXPECTS," "EXPECTED," "ANTICIPATES," AND "ANTICIPATED." THESE FORWARD-LOOKING STATEMENTS ARE BASED ON THE COMPANY'S CURRENT JUDGMENTS AND EXPECTATIONS AS OF THE DATE OF THIS PROSPECTUS. ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL FACTS INCLUDED IN THIS PROSPECTUS, INCLUDING THOSE REGARDING MARKET TRENDS, THE COMPANY'S FINANCIAL POSITION, BUSINESS STRATEGY, PROJECTED COSTS, AND PLANS AND OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, ARE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT THE EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, THERE CAN BE NO ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO HAVE BEEN CORRECT. BECAUSE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY. IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE COMPANY'S EXPECTATIONS ("CAUTIONARY STATEMENTS") ARE DISCLOSED BELOW AND ELSEWHERE IN THIS PROSPECTUS INCLUDING, WITHOUT LIMITATION, IN CONJUNCTION WITH THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS PROSPECTUS. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS ACTING ON BEHALF OF THE COMPANY ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS. THE COMPANY EXPRESSLY DISCLAIMS, HOWEVER, ANY INTENT OR OBLIGATION TO UPDATE ITS FORWARD-LOOKING STATEMENTS. PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS IN ADDITION TO THE OTHER INFORMATION SET FORTH IN THIS PROSPECTUS BEFORE MAKING AN INVESTMENT IN THE COMMON STOCK OFFERED HEREBY. NET LOSSES The Company has incurred net losses of $6.8 million, $14.8 million and $17.0 million for fiscal 1995, 1996 and 1997, respectively. Since January 1, 1993, the Company has incurred cumulative net losses of $43.5 million. Such losses have resulted from a variety of costs, including, but not limited to, amortization of goodwill and debt financing costs resulting from the Company's acquisition strategy. The Company expects to continue to incur operating losses at least through the beginning of fiscal 1999. The amount of net losses and the time required by the Company to reach profitability are highly uncertain. There can be no assurance that the Company will be able to achieve profitability on a sustained basis. COMPETITION The health club industry is fragmented and competitive. The Company competes within each market in which it operates with other commercial health clubs, as well as with physical fitness and recreational facilities established by local governments and businesses for their employees, by tax exempt, non-profit organizations such as university fitness centers and the YMCA and YWCA, and to a lesser extent, physical therapy clinics, racquet and tennis clubs, country clubs and weight-reducing salons. The Company also competes with manufacturers of home fitness equipment. In addition, there are relatively few barriers to entry into this market by new competitors, which may include companies which are larger and have greater resources than the Company. Additionally, consolidation in the fitness and health club industry is likely to result in increased competition among participants, particularly large multi-facility operators like the Company. This increased competition may manifest itself in (i) increased competition for attractive acquisition candidates and resulting increase in cost of acquiring additional fitness centers and (ii) an increase in the number of operators who are able to achieve substantial economies of scale. See "Business--Competition." As the Company pursues new business initiatives, particularly the sale of nutritional products and apparel, the Company competes against large established companies with more experience in selling such products on a retail basis and, in some instances, with substantially greater financial resources than the Company. There can be no assurance that the Company will be able to compete effectively in this area with such established companies. 10 REGIONAL CONCENTRATION OF OPERATIONS Although the Company has developed fitness centers in several states, a majority of the Company's fitness centers are currently located in California and therefore performance will be particularly influenced by developments in that market. Factors which are outside the Company's control and which could have a material adverse effect on its results of operations or financial condition include local or regional economies, weather conditions, earthquakes and demographic and population changes. There can be no assurance that this geographic concentration of the Company's business will not have a material adverse effect on its results of operations or financial condition in the future. RELIANCE ON SUCCESSFUL EXPANSION PLANS The Company's growth strategy depends to a significant degree upon its ability to successfully develop, acquire and profitably operate new fitness centers. The Company plans to open an aggregate of at least 19 fitness centers during the remainder of 1998 and approximately 35 additional fitness centers in 1999, through both acquisition and greenfield development. The successful acquisition and development of new fitness centers on a timely basis will depend on a number of factors, including the identification and availability of suitable locations or acquisition candidates, the acquisition or lease of such locations on acceptable terms, the resolution of any zoning or other regulatory issues relating to such locations, the availability of adequate financing (See "--Highly Leveraged Financial Position"), the construction of new facilities, the hiring, training and retention of qualified employees, the ability of management to effectively control the expansion process, and other factors, some or all of which may be beyond the Company's control. As a result, there can be no assurance that the Company will be able to implement its growth strategy, to open new fitness centers on a timely and cost-efficient basis or to operate its new fitness centers profitably. If the expected operating efficiencies from such transactions do not materialize, if the Company fails to integrate new businesses into its existing business, or if the costs of such integration exceed expectations, the Company's operating results and financial condition would be adversely affected. ATTRACTION AND RETENTION OF MEMBERS The profitability of the Company's fitness centers is dependent on the Company's ability to achieve and maintain member retention rates at its fitness centers. There are numerous factors that could lead to a decline in member retention rates or that could prevent the Company from increasing its membership at newer fitness centers, including the public perception that certain industry participants fail to comply with consumer protection regulations, the ability of the Company to deliver quality service at a competitive cost, the presence of direct and indirect competition in the areas in which the Company's fitness centers are located, the public's interest in fitness and general economic conditions. As a result of these factors, there can be no assurance that the Company's membership levels will be adequate to maintain or permit the expansion of its operations. See "Business--Operating Strategy" and "--Growth Strategy." HIGHLY LEVERAGED FINANCIAL POSITION The Company's long-term debt includes indebtedness under the Company's senior revolving credit facility (the "Senior Credit Facility") with BNP, as agent, and certain other lenders. After giving effect to the Offerings (based on an assumed initial offering price of $ per share), at March 31, 1998, the Company would have had total indebtedness of approximately $ million. In addition, interest expense excluding amortization of bank fees in fiscal 1997 totaled $16.3 million. The Company may incur additional indebtedness in the future, subject to certain limitations contained in the instruments governing its indebtedness. The Company's recent losses, total indebtedness and provisions of existing debt instruments may limit the Company's ability to raise capital, pay dividends or borrow money. The provisions in the Senior Credit Facility limit the Company's ability to borrow additional funds, to pay dividends and to grant security interests, and require the Company to maintain certain financial ratios, 11 including those relating to cash flow and interest expense. As a result of these limitations, the Company may be more vulnerable to economic downturns, may not be able to exploit certain business opportunities when they arise and may have less flexibility to respond to changing economic conditions, each of which could have a material adverse effect on the Company's financial condition and results of operations. SYSTEMS UPGRADE The Company has expanded substantially over the past several years, primarily as a result of acquisitions. The process of integrating acquired businesses has placed significant demands on the Company's management information systems. To address these demands, the Company is in the process of upgrading and replacing its management information systems and has hired additional personnel, including a chief information officer. This process of upgrading and replacing its management information systems has required, and will continue to require, substantial attention from members of senior management. The Company has made, and may be required in the future to make, significant financial expenditures to complete the upgrade of its management information systems, and no assurance can be given that such system upgrade will be completed successfully. The failure by the Company to successfully upgrade its management information systems could have a material adverse effect on its results of operations. Many currently installed computer systems and software products are coded to accept only two-digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four-digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. The Company has assessed its management information systems and does not currently expect that any material expenditures will be required in connection with the modifications that will be required for such systems. Moreover, the Company has recently implemented or is in the process of implementing new systems that are already Year 2000 compliant and it does not believe that the total cost of any potential modification of such management information systems will be material. A substantial portion of the Company's revenues is received through electronic funds transfer over computer networks which the Company does not control. There can be no assurance that the Company or its vendors will be able to successfully modify on a timely basis their respective management information systems to comply with Year 2000 requirements. DEPENDENCE ON KEY PERSONNEL The Company is highly dependent on its management team. The Company believes that its continued success will depend to a significant extent upon the efforts and abilities of its Chief Executive Officer, Mark S. Mastrov, and certain other key employees. The Company maintains key person life insurance for Mr. Mastrov. See "Management--Directors and Executive Officers." POTENTIAL LIABILITY Use of the Company's fitness centers poses some potential health risks to members, their children or guests through exertion and use of exercise equipment, swimming pools or other on-site facilities or services. There can be no assurance that a claim against the Company for death or injury suffered by members, their children or guests while at a fitness center will not be asserted or that the Company would be able to successfully defend any claim that might be asserted. In addition, the Company offers babysitting services, which pose some risk of exposure to claims associated with child care. The Company, like other employers whose employees have close physical contact with each other and with customers, is subject from time to time to the risk of litigation arising out of the alleged misconduct of employees. The Company currently maintains general liability coverage; however, there can be no assurance that the Company will be able to maintain such liability insurance on acceptable terms in the future or that any such insurance will provide adequate coverage against potential claims. In addition, the Company, from time to time, may be required to incur capital expenditures to bring one or more of its 12 facilities into full compliance with the Americans with Disabilities Act. No assurance can be made that such expenditures will not be material. GOVERNMENT REGULATION The Company's operations and business practices are subject to federal, state and local government regulation in the various jurisdictions in which its fitness centers are located, including (i) regulations that prescribe certain forms and provisions of membership contracts and govern the advertising, sale, financing and collection of such memberships, (ii) state and local health regulations, and (iii) federal regulation of health and nutritional supplements. The Company believes that it is in substantial compliance with all such applicable regulations and that the cost of such compliance is not expected to have a material adverse effect on the Company's financial condition or results of operation. However, future events, such as changes in existing regulations or the enactment of new regulations, could have a material adverse effect on the Company's financial condition or results of operation. See "Business--Government Regulation." CONTROL OF THE COMPANY BY CERTAIN STOCKHOLDERS Upon completion of the Offerings, approximately % of the Common Stock will be owned beneficially by McCown De Leeuw & Co. III, L.P., McCown De Leeuw & Co. (Asia) III, L.P. and Gamma Fund, L.L.C. (the "MDC Entities") and approximately % of the Common Stock will be owned beneficially by management of the Company (approximately % and %, respectively, if the Underwriters' over-allotment options are exercised in full). See "Principal and Selling Stockholders." These stockholders could, by combining their voting power, exercise control over the Company. In addition, the MDC Entities will likely have the ability, as a result of their beneficial ownership of shares, to control the outcome of most matters submitted to a vote of stockholders, including votes with respect to the board of directors, a merger or sale of Holdings or an amendment of Holdings' Certificate of Incorporation (the "Certificate of Incorporation"). IMMEDIATE AND SUBSTANTIAL DILUTION; ABSENCE OF DIVIDENDS The Company's existing stockholders acquired their shares of Common Stock at a cost substantially below the initial public offering price, and purchasers of the shares of Common Stock offered hereby will experience immediate and substantial dilution in net tangible book value per share. See "Dilution." The Company does not anticipate declaring any cash dividends on its capital stock in the foreseeable future. See "Dividend Policy" and "Use of Proceeds." CERTAIN PROVISIONS RELATING TO CHANGES IN CONTROL; POTENTIAL ANTI-TAKEOVER EFFECT Certain provisions of the Certificate of Incorporation and Holdings' By-laws (the "By-laws") may have the effect of delaying, deferring or preventing a change in control of the Company. These provisions include authorization for the Board of Directors to issue preferred stock in series and to affix rights, preference and privileges, including voting rights, on such shares without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Although the ability to issue preferred stock may provide flexibility in connection with possible acquisitions and other corporate purposes, such issuance may make it more difficult for a third party to acquire, or may discourage a third party from acquiring, a majority of the voting stock of the Company. At this time, the Company does not intend to issue shares of preferred stock. The Certificate of Incorporation and By-laws also provide that directors may be removed only for cause. Section 203 of the Delaware General Corporation Law ("Delaware Law") restricts certain business combinations with interested stockholders (as defined by such statute). As permitted by Delaware Law, Holdings has expressly elected, in the Certificate of Incorporation, not to be governed by Section 203. See "Description of Capital Stock-- Delaware Law and Certain Charter and By-law Provisions." 13 SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS AND POTENTIAL ADVERSE EFFECT ON MARKET PRICE The market price of the Common Stock could be adversely affected by the availability for sale of shares held by the MDC Entities, certain executive officers and other existing stockholders of the Company. Collectively, these stockholders will own approximately % of the outstanding Common Stock (approximately % if the Underwriters' over-allotment option is exercised in full), after the Offerings. The MDC Entities, such executive officers and certain other existing stockholders of the Company have agreed not to sell such shares for a period of 180 days following the date of the Offerings without the prior written consent of Goldman, Sachs & Co. ("Goldman Sachs"), on behalf of the Representatives of the Underwriters. After expiration of such 180-day period such shares may be sold in accordance with Rule 144 (subject to the holding period and volume limitations of such Rule) promulgated under the Securities Act of 1933, as amended (the "Securities Act"), or upon registration under the Securities Act without regard to the holding period and volume limitations of Rule 144. In addition, the Company intends to file a registration statement under the Securities Act within days after the date of this Prospectus, covering the sale of the shares of Common Stock reserved for issuance under the Company's existing employee and director stock option plans. Upon the effective date of such registration statement, there will be outstanding options to purchase a total of shares of the Company's Common Stock. Upon expiration of the Underwriters lock-up agreements, up to shares will be eligible for sale into the public market, assuming that all options eligible for vesting by that time have vested and depending upon the Company's achievement of certain goals. See "Underwriting" and "Shares Eligible for Future Sale." Pursuant to (i) the Stockholders Agreement (as defined below) between the Company and the existing stockholders of the Company (the "Holders") and (ii) the Registration Rights Agreement (as defined below) between the Company and the MDC Entities, the Holders and the MDC Entities are entitled to certain rights with respect to registration of such shares under the Securities Act. If the Company proposes to register any of its securities under the Securities Act, either for its own account or for the account of other security holders, the Holders are entitled to notice of the registration and are entitled to include, at the Company's expense, such shares therein, provided, among other conditions, that the underwriters of any offering have the right to limit the number of shares included in the registration. In addition, the Registration Rights Agreement provides that, under certain circumstances, the MDC Entities may require the Company to file a registration statement with respect to the shares of Common Stock held by the MDC Entities and the Holders. The sale of a substantial number of these shares of Common Stock in the public market following the Offerings could adversely affect the market price of the Common Stock and could impair the Company's ability to raise capital at that time through the sale of equity securities. See "Underwriting" and "Shares Eligible for Future Sale." LACK OF A PRIOR PUBLIC MARKET Prior to the Offerings, there has been no public market for the Common Stock, and there can be no assurance that an active trading market in the Common Stock will develop after the Offerings or be sustained. The initial public offering price has been determined through negotiations between the Company and the Representatives of the Underwriters. Such price may not be indicative of the market price for the Common Stock after the Offerings. See "Underwriting" for a discussion of the factors considered in determining the initial public offering price. The liquidity of, and the market prices for, the Common Stock can be expected to vary with changes in market and economic conditions, the financial condition and prospects of the Company and other factors that generally influence the market prices of securities. Such fluctuations may significantly affect liquidity and market prices independent of the financial performance of and prospects for the Company. 14 USE OF PROCEEDS Assuming an initial public offering price of $ per share, the net proceeds to the Company from the Offerings, after deducting underwriting discounts and estimated offering expenses payable by the Company, are estimated to be $ million. The Company intends to use (i) $ million of the net proceeds to reduce outstanding indebtedness under the Senior Credit Facility, (ii) approximately $6.0 million to pay the Success Fee under an existing contractual arrangement to BNP, the lender under the Senior Credit Facility, (iii) approximately $ million of the net proceeds to pay a fee to certain MDC Entities in connection with the termination of the existing Management Services Agreement with such entities, and (iv) the remaining net proceeds, for general corporate purposes. The indebtedness to be repaid was incurred in connection with the Recapitalization (as defined in "Certain Relationships and Related Transactions") and the Company's subsequent acquisitions, has a final maturity of December 2004 and had a weighted average interest rate of 9.1% as of March 31, 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operation--Overview" and "--Liquidity and Capital Resources." DIVIDEND POLICY The Company intends to retain all earnings for the operation and expansion of its business and does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will depend upon the Company's results of operations, financial condition and capital requirements, as well as such other factors as the Company's Board of Directors may consider. The Company's Senior Credit Facility contains certain provisions restricting its ability to pay dividends. In fiscal 1997, the Company declared and paid three cash distributions under a single plan of recapitalization to stockholders totaling $57.5 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." 15 CAPITALIZATION The following table sets forth at March 31, 1998 the capitalization of the Company and the pro forma capitalization of the Company, as adjusted to give effect to the sale of the shares of Common Stock being offered by the Company at an assumed initial public offering price of $ per share and the application of the estimated net proceeds therefrom as set forth under "Use of Proceeds."
MARCH 31, 1998 ------------------------ AS REPORTED AS ADJUSTED ----------- ----------- (DOLLARS IN THOUSANDS) Current portion of long-term debt................................... $ 6,981 $ ----------- ----------- ----------- ----------- Long-term debt, excluding current portion: Revolving credit facility......................................... $ 11,959 $ Term loans........................................................ 172,500 Other long-term indebtedness (1).................................. 18,418 ----------- Total long-term debt, excluding current portion................. 202,877 ----------- ----------- Stockholders' deficit: Common stock, $.001 par value, shares authorized, shares issued and shares outstanding ( shares outstanding as adjusted)...................... 2 Capital deficit................................................... (7,145) Treasury stock.................................................... (1,713) Unearned compensation............................................. (3,602) Accumulated deficit............................................... (96,959) ----------- ----------- Total stockholders' deficit......................................... (109,417) ----------- ----------- Total capitalization................................................ $ 93,460 $ ----------- ----------- ----------- -----------
- ------------------------ (1) Includes notes issued in connection with the Family Fitness Acquisition and Texas Acquisition (each as defined herein). See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview." 16 DILUTION As of March 31, 1998, the Company had a net tangible book deficit of approximately $178.1 million or $ per share. Net tangible book value per share is equal to total tangible assets (total assets less intangible assets) less total liabilities of the Company, divided by the number of shares of Common Stock then outstanding. Without taking into account any adjustment in net tangible book value attributable to operations after March 31, 1998, after giving effect to the sale by the Company of shares in the Offerings at an assumed initial public offering price of $ per share, the net tangible book value of the Company as of March 31, 1998 (after the deduction of an assumed underwriting discount and estimated offering expenses and the application of the net proceeds, as described under "Use of Proceeds"), would have been $ million or $ per share. This represents an immediate increase in net tangible book value of $ per share to existing stockholders and an immediate dilution of $ per share to new investors. The following table illustrates this per share dilution: Assumed initial public offering price per share (1)...... $ --------- Net tangible book value per share as of March 31, 1998................................................. $ Increase per share attributable to new investors....... --------- Pro forma net tangible book value per share after the Offerings.............................................. --------- Dilution per share to new investors (2).................. $ --------- ---------
- ------------------------ (1) Before deduction of underwriting discounts and estimated offering expenses payable by the Company. (2) "Dilution" is determined by subtracting the pro forma net tangible book value per share after the Offerings from the amount of cash paid by a new investor for a share of Common Stock. The following table summarizes, on a pro forma basis as of March 31, 1998, the number of shares of Common Stock purchased from the Company, total consideration paid and the average price paid per share by the existing stockholders and new investors who purchase Common Stock pursuant to the Offerings (based upon an assumed initial public offering price of $ per share and before deduction of estimated underwriting discounts and offering expenses):
SHARES PURCHASED TOTAL CONSIDERATION ------------------------ ------------------------ AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ----------- ----------- ----------- ----------- --------------- Existing stockholders.............................. % $ % $ New investors (1).................................. ----- ----- ----- ----- Total............................................ 100.0% $ 100.0% ----- ----- ----- ----- ----- ----- ----- -----
- ------------------------ (1) If the Underwriters' over-allotment option is exercised in full, the number of shares held by new investors will increase to or approximately % of the total number of shares outstanding after the Offerings. The above information assumes no exercise of the underwriters' over-allotment options or of any outstanding stock options. See "Management--Stock Option Plan." 17 SELECTED CONSOLIDATED FINANCIAL INFORMATION (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) The following table sets forth selected historical consolidated financial information of the Company for each of the five years in the period ended December 31, 1997 and for the three-month periods ended March 31, 1997 and 1998. The selected statement of operations and balance sheet data as of December 31, 1996 and 1997 and for the years ended December 31, 1995, 1996 and 1997 have been derived from the consolidated financial statements of the Company included elsewhere in this Prospectus, which have been audited by Deloitte & Touche LLP. The selected consolidated financial information as of December 31, 1995 and as of and for the years ended December 31, 1993 and 1994 has been derived from consolidated financial statements not included herein. The statement of operations and balance sheet data as of and for the three months ended March 31, 1997 and 1998 have been derived from the Company's quarterly financial information included herein and reflect all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for a fair presentation, in accordance with generally accepted accounting principles, of the results for such periods. The results for the three-month periods are not indicative of the results to be expected for the full year or for any other interim period.
THREE MONTHS ENDED FISCAL YEAR ENDED DECEMBER 31, MARCH 31, ----------------------------------------------------- -------------------- 1993 1994 1995 1996 1997 1997 1998 --------- --------- --------- --------- --------- --------- --------- STATEMENT OF OPERATIONS DATA: Net revenues (1): Membership revenues........................... $ 35,612 $ 39,684 $ 108,668 $ 196,573 $ 258,776 $ 61,696 $ 78,674 Change in deferred revenues................... (4,227) (1,304) (18,683) (32,403) (31,069) (10,131) (10,909) --------- --------- --------- --------- --------- --------- --------- Net membership revenues..................... 31,385 38,380 89,985 164,170 227,707 51,565 67,765 Ancillary revenues............................ 1,639 2,891 8,009 15,839 34,197 6,425 12,889 --------- --------- --------- --------- --------- --------- --------- Total net revenues.......................... 33,024 41,271 97,994 180,009 261,904 57,990 80,654 Operating expenses: Fitness center operating expenses............. 26,044 32,689 83,947 162,054 226,809 50,981 70,598 General and administrative expenses (2)....... 8,377 6,018 17,441 24,830 30,866 6,386 7,585 Depreciation and amortization................. 1,942 2,494 7,447 13,653 20,244 4,133 5,391 Provision for severance....................... -- -- -- 3,600 635 -- -- Change in deferred membership origination costs (3)................................... (890) (718) (5,838) (10,244) (9,843) (2,598) (2,838) --------- --------- --------- --------- --------- --------- --------- Total operating expenses.................... 35,473 40,483 102,997 193,893 268,711 58,902 80,736 --------- --------- --------- --------- --------- --------- --------- Income (loss) from operations................... (2,449) 788 (5,003) (13,884) (6,807) (912) (82) Interest expense (4)............................ 101 165 5,600 9,280 18,372 2,917 5,280 Debt offering costs (5)......................... -- -- -- -- 999 -- -- --------- --------- --------- --------- --------- --------- --------- Income (loss) before income taxes............... (2,550) 623 (10,603) (23,164) (26,178) (3,829) (5,362) Income tax benefit (expense).................... 956 (260) 3,853 8,394 9,171 1,371 1,631 --------- --------- --------- --------- --------- --------- --------- Net income (loss)............................... $ (1,594) $ 363 $ (6,750) $ (14,770) $ (17,007) $ (2,458) $ (3,731) --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Net income (loss) per share (6): Basic......................................... Diluted....................................... Weighted average shares outstanding: Basic......................................... Diluted....................................... SELECTED OPERATING DATA: EBITDA (7)...................................... $ (507) $ 3,282 $ 2,444 $ (231) $ 13,437 $ 3,221 $ 5,309 Number of fitness centers open at period end.... 24 32 109 137 157 140 172 Average revenues per fitness center (8)......... $ 1,719 $ 1,472 $ 1,675 $ 1,793 $ 1,985 $ 488 $ 544 Comparable fitness center revenues increase (9)........................................... 4.5% 8.0% 8.5% 13.8% 12.9% 12.0% 16.9%
18
AT DECEMBER 31, AT MARCH 31, ----------------------------------------------------- -------------------- 1993 1994 1995 1996 1997 1997 --------- --------- --------- --------- --------- --------- SELECTED BALANCE SHEET DATA: Working capital (deficit)........... $ (9,977) $ 2,768 $ (33,897) $ (52,799) $ (65,373) $ (53,230) $ (75,887) Total assets........................ 21,748 37,949 130,846 192,688 247,071 204,688 266,912 Long-term debt, excluding current portion........................... 711 14,703 71,641 110,002 200,395 132,276 202,877 Stockholders' deficit............... (4,024) (3,646) (17,877) (32,646) (105,836) (49,317) (109,417)
- ------------------------------ (1) Membership revenues in any given period are comprised of all cash collected for non-refundable, one time initiation fees and all membership dues collected in that period, regardless of when services are actually provided. The portion of these membership revenues relating to new member initiation fees are deferred and recognized on a straight line basis over the average expected life of the memberships, currently estimated at 32 months. The portion of these membership revenues relating to dues for services not yet provided are recognized as revenues in the period in which services are actually provided. Change in deferred revenues is the amount of cash collected in a prior period and recognized as revenue in the current period less the amount of cash collected in the current period and deferred and recognized as revenues in a future period. (2) On February 14, 1997 the Company issued approximately stock options pursuant to its equity incentive plans and recognized a compensation charge of $417,000 in connection with such issuance. Upon completion of the Offerings, certain of these options will vest pursuant to the terms of the Company's equity incentive plans which will cause the Company to recognize an additional compensation charge of $ million in the quarter in which this vesting occurs. Such vesting is currently expected to occur in the third quarter of 1998. (3) Change in deferred membership origination costs reflects commissions related to new membership sales which are deferred and recognized on a straight-line basis over the average expected life of the memberships, currently estimated at 32 months. (4) In connection with the Company's fiscal 1997 distributions to its stockholders of $57.5 million, the Company paid a $1.0 million success participation fee to its lender, which is included in interest expense. Upon completion of the Offerings, the Company will be obligated to make an additional Success Fee payment, to its lender of approximately $6.0 million, which will be included in interest expense in the quarter in which such payment is made. See Note 12 to the Company's Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Overview." (5) Debt offering costs reflect the write-off of one-time costs associated with a contemplated offering of debt securities. (6) In fiscal 1997, the Company adopted Statement of Financial Accounting Standard No. 128 "Earnings per Share." All earnings per share amounts presented are in accordance with this statement. (7) EBITDA is defined as income (loss) from operations before depreciation and amortization. Income (loss) from operations excludes interest, taxes and the write-off of debt offering costs. EBITDA is presented because management believes it is a useful indicator of the Company's capacity to service and/or incur debt and as a measure of the Company's operating performance. EBITDA is not a measure of performance under GAAP and should not be considered in isolation or as a substitute for income (loss) from operations or cash flows or as a measure of the Company's profitability or liquidity in assessing the Company's overall financial condition. The Company's measure of EBITDA may not be comparable to similar measures used by other companies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." (8) Average revenues per fitness center is calculated as combined membership and ancillary revenues divided by the product of the total number of fitness centers multiplied by their weighted average months in operation. For fiscal 1993 and 1994, average revenues per fitness center do not include revenues from the 24 Hour Workout Centers (as defined herein). (9) Comparable fitness center revenues increase is calculated by comparing combined membership and ancillary revenues for the current period of fitness centers that were operated by the Company for at least 13 months to combined membership and ancillary revenues for the same period in the prior year. Comparable fitness center revenues increase does not include change in deferred revenues and, therefore, may not be indicative of growth in total net revenues at comparable fitness centers. 19 PRO FORMA COMBINED FINANCIAL INFORMATION (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) The following unaudited pro forma combined financial information (the "Pro Forma Combined Financial Information") is based on the historical consolidated financial statements of the Company and has been prepared to illustrate the effects of the Company's May 31, 1997 acquisition (the "Portland Acquisition") of substantially all of the assets of Northwest Fitness, Inc. ("Northwest"), as if it had occurred on January 1, 1997. The Pro Forma Combined Financial Information and accompanying notes are based upon assumptions that the Company believes are reasonable and should be read in conjunction with the audited financial statements and the notes thereto of the Company and Northwest included elsewhere in this Prospectus. The Pro Forma Combined Financial Information is not necessarily indicative of either future results of operations or the results that might have occurred if the foregoing transactions had been consummated on January 1, 1997.
NORTHWEST ACTUAL COMPANY FIVE ACTUAL MONTHS YEAR ENDED ENDED DECEMBER 31, MAY 31, PRO FORMA PRO FORMA 1997 1997 ADJUSTMENTS COMBINED -------------- ------------- --------------- ----------- Net revenues: Membership revenues.................................... $ 258,776 $ 4,727 $ 263,503 Change in deferred revenues............................ (31,069) (1,286) (32,355) -------------- ------------- ----------- Net membership revenues.............................. 227,707 3,441 231,148 Ancillary revenues..................................... 34,197 1,232 35,429 -------------- ------------- ----------- Total net revenues................................... 261,904 4,673 266,577 Operating expenses: Fitness center operating expenses...................... 226,809 3,505 230,314 General and administrative expenses.................... 30,866 253 31,119 Depreciation and amortization.......................... 20,244 283 $ 353(1) 20,880 Provision for severance................................ 635 -- 635 Change in deferred membership origination costs........ (9,843) -- (9,843) -------------- ------------- ------ ----------- Total operating expenses............................. 268,711 4,041 353 273,105 -------------- ------------- ------ ----------- Income (loss) from operations............................ (6,807) 632 (353) (6,528) Interest expense......................................... 18,372 106 387(2) 18,865 Debt offering costs...................................... 999 -- 999 Income (loss) before income taxes........................ (26,178) 526 (740) (26,392) Income tax benefit....................................... 9,171 -- 89(3) 9,260 -------------- ------------- ------ ----------- Net income (loss)........................................ $ (17,007) $ 526 $ (651) $ (17,132) -------------- ------------- ------ ----------- -------------- ------------- ------ ----------- Income (loss) per share: Basic.................................................. Diluted................................................ Weighted average shares outstanding: Basic.................................................. Diluted................................................
- ------------------------------ (1) Reflects the amortization of goodwill and membership lists related to the acquisition of Northwest on a straight line basis over 40 years and four years, respectively. The acquisition of Northwest was accounted for as a purchase resulting in $7 million of goodwill. Results of Operations after the acquisition date are included in Company Actual Year Ended December 31, 1997 financial information. (2) Reflects additional interest expense on borrowings under the Company's line of credit incurred in conjunction with the acquisition of Northwest. Interest expense was computed at a weighted average rate of 9.1%, which is approximately the Company's borrowing rate under the Senior Credit Facility at May 31, 1997. (3) Includes income tax benefit of $310,000 related to the pro forma adjustments discussed in (1) and (2) above at the Company's statutory income tax rates and also provides income tax expense of $221,000 as if Northwest had been taxed as a "C" corporation rather than as an "S" corporation for the five months ended May 31, 1997. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is based on the historical results of operations for fiscal 1995, 1996, and 1997, and the three month periods ended March 31, 1997 and 1998. During the three years ended December 31, 1997, the Company increased its number of fitness centers from 32 to 157 by opening new fitness centers and acquiring single-site fitness centers and multi-site chains of fitness centers. Acquisitions of multi-site chains of fitness centers having three or more sites during this period included: (i) the 50% interest not previously owned by the Company in six 24 Hour Workout fitness centers (the "24 Hour Workout Centers") in January 1995; (ii) all of the outstanding common stock of Family Fitness Holding Company, Inc. in June 1995 (the "Family Fitness Acquisition"), which owned 68 fitness centers in three states; (iii) three fitness centers in Hawaii in March 1996 (the "Hawaii Acquisition"); (iv) twelve fitness centers in Texas in October 1996 (the "Texas Acquisition"); (v) four Sports Connection fitness centers in Southern California in October 1996 (the "Sports Connection Acquisition") and (vi) the Portland Acquisition. In February 1998, the Company completed the acquisition of three fitness centers in Boise, Idaho (the "Boise Acquisition") and seven fitness centers in Houston, Texas (the "Houston Acquisition"). All of these acquisitions were accounted for using the purchase method of accounting; accordingly, the results of the acquired fitness centers are included with the Company's results from the date of purchase. This discussion should be read in conjunction with the audited and unaudited financial statements of the Company, Northwest and Family Fitness Holding Company, Inc. included elsewhere in this Prospectus, and the Pro Forma Combined Financial Information for fiscal 1997, which appears on page 20 of this Prospectus. The following table indicates the Company's fitness center growth since January 1, 1995. HISTORICAL FITNESS CENTER GROWTH (NUMBER OF FITNESS CENTERS)
THREE MONTHS YEAR ENDED DECEMBER 31, ENDED MARCH 31, ------------------------------------- ----------- 1995 1996 1997 1997 ----- ----- ----- ----- Beginning of period.......................................................... 32 109 137 137 Greenfield facilities........................................................ 6 7 9 2 Acquired facilities (1)...................................................... 68 19 7 -- Other acquired facilities.................................................... 3 4 4 1 Closed facilities............................................................ -- (2) -- -- --- --- --- --- End of period................................................................ 109 137 157 140 --- --- --- --- --- --- --- --- 1998 ----- Beginning of period.......................................................... 157 Greenfield facilities........................................................ 3 Acquired facilities (1)...................................................... 10 Other acquired facilities.................................................... 2 Closed facilities............................................................ -- --- End of period................................................................ 172 --- ---
- ------------------------ (1) Includes multi-site chains with three or more fitness centers. OVERVIEW The Company is a leading commercial owner-operator of fitness centers, operating 173 facilities as of April 30, 1998 under the brand name "24 Hour Fitness" in nine western states. Through these facilities, the Company provides a broad array of fitness, sport, nutritional and other services to its 1.6 million members. The Company's combined membership and ancillary revenues increased at a compound annual growth rate ("CAGR") of 58.5%, from $116.7 million in fiscal 1995 to $293.0 million in fiscal 1997, primarily due to the acquisition of several multi-site fitness center chains and, to a lesser extent, to 21 increased comparable fitness center revenues and the development of new greenfield fitness centers. Comparable fitness center revenues are calculated by comparing combined membership and ancillary revenues for the current period for fitness centers that were open at least 13 months to combined membership and ancillary revenues for the same period in the prior year. The increase in comparable fitness center revenues does not include change in deferred revenues and therefore may not be indicative of growth in total net revenues at comparable fitness centers. Comparable fitness center revenues increased 13.8% in fiscal 1996, 12.9% in fiscal 1997 and 16.9% in the three months ended March 31, 1998. The increase in comparable fitness center revenues is attributable to growth in the existing membership base and increased revenues from ancillary services and products, such as personal training, nutritional counseling and retail sales. Membership revenues in any given period are comprised of all cash collected for non-refundable, one time initiation fees and all membership dues collected in that period, regardless of when services are actually provided. The portion of these membership revenues relating to new member initiation fees are deferred and recognized on a straight line basis over the average expected life of the memberships, currently estimated at 32 months. The portion of these membership revenues relating to dues for services not yet provided are recognized as revenues in the period in which services are actually provided. Change in deferred revenues is the amount of cash collected in a prior period and recognized as revenue in the current period less the amount of cash collected in the current period and deferred and recognized as revenues in a future period. Net membership revenues are comprised of membership revenues adjusted by the change in deferred revenues. At March 31, 1998, the Company had cumulative deferred revenues of $117.3 million which represented cash received but not yet recognized as net revenues. Ancillary revenues are comprised of revenues from services and products, including one-on-one personal training services, weight loss and nutritional counseling, and retail sales. The Company's operating expenses are comprised of both fixed and variable costs. Fixed costs include rent, utilities, janitorial and depreciation. Variable costs are primarily salary related expenses, advertising and supplies. For the periods presented, fixed and variable costs are partially offset by change in deferred membership origination costs which reflects the deferral of commissions related to new membership sales and which are recognized on a straight-line basis over the average expected life of the memberships. As fitness centers mature and increase their membership base, fixed costs are leveraged against increasing revenues and operating margins improve. From fiscal 1995 through fiscal 1997, the Company's total operating expenses, as a percentage of net revenues, decreased from 105.1% to 102.5% due to increased leverage of fixed operating expenses over higher net revenues. From fiscal 1995 through fiscal 1997, the Company's change in deferred membership origination costs, as a percentage of total net revenues, decreased from 6.0% to 3.8% primarily due to increased leverage of these costs over higher net revenues. From fiscal 1995 through fiscal 1997, the Company's EBITDA grew at a CAGR of 134.5%, from $2.4 million to $13.4 million. EBITDA is defined as income (loss) from operations before depreciation and amortization. Income (loss) from operations excludes interest, taxes and the write-off of debt offering costs. EBITDA is presented because management believes it is a useful indicator of the Company's capacity to service and/or incur debt and as a measure of the Company's operating performance. EBITDA is not a measure of performance under GAAP and should not be considered in isolation or as a substitute for income (loss) from operations or cash flows or as a measure of the Company's profitability or liquidity in assessing the Company's overall financial condition. The Company's measure of EBITDA may not be comparable to similar measures used by other companies. As a result of the Offerings, the Company expects to incur charges in fiscal 1998 of approximately $ million for the accelerated vesting of stock options and approximately $6.0 million for a success participation fee (the "Success Fee"). The Success Fee arises under a letter agreement between the Company and BNP dated as of July 1, 1995, by which, under certain triggering events, such as the Offerings, the Company shall pay the Success Fee to BNP. The Company also anticipates that it will use 22 a portion of the proceeds of the Offerings to reduce outstanding indebtedness under the Senior Credit Facility. The Company is currently negotiating with BNP to restructure its existing credit facilities, although there can be no assurance that the Company will be able to do so. RESULTS OF OPERATIONS The table below reflects summary statement of operations data, expressed as a percentage of net revenues.
YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, ------------------------------- -------------------- 1995 1996 1997 1997 1998 --------- --------- --------- --------- --------- Net revenues................................................. 100.0% 100.0% 100.0% 100.0% 100.0% Operating expenses: Fitness center operating expenses.......................... 85.7 90.0 86.6 87.9 87.5 General and administrative expenses........................ 17.8 13.8 11.8 11.0 9.4 Depreciation and amortization.............................. 7.6 7.6 7.7 7.2 6.7 Provision for severance.................................... -- 2.0 0.3 -- -- Change in deferred membership origination costs............ (6.0) (5.7) (3.8) (4.5) (3.5) --------- --------- --------- --------- --------- Total operating expenses................................. 105.1 107.7 102.6 101.6 100.1 --------- --------- --------- --------- --------- Loss from operations......................................... (5.1) (7.7) (2.6) (1.6) (0.1) Interest expense............................................. 5.7 5.2 7.0 5.0 6.5 Debt offering costs.......................................... -- -- 0.4 -- -- --------- --------- --------- --------- --------- Loss before income taxes..................................... (10.8) (12.9) (10.0) (6.6) (6.6) Income tax benefit........................................... 3.9 4.7 3.5 2.4 2.0 --------- --------- --------- --------- --------- Net loss..................................................... (6.9)% (8.2)% (6.5)% (4.2)% (4.6)% --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- EBITDA....................................................... 2.5% (0.1)% 5.1% 5.6% 6.6%
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997 The Company's membership revenues increased $17.0 million or 27.5% from $61.7 million in the three months ended March 31, 1997 to $78.7 million in the three months ended March 31, 1998. The Company's ancillary revenues increased $6.5 million or 100.6% from $6.4 million in the three months ended March 31, 1997 to $12.9 million in the three months ended March 31, 1998. Membership and ancillary revenues increased as a result of the Portland, Boise and Houston Acquisitions and the acquisition or construction of other additional fitness centers, and also due to increased comparable fitness center revenue. The increase in ancillary revenues was also driven by the introduction of ancillary products and services into a number of existing fitness centers. The increase in membership and ancillary revenues was comprised of $12.4 million from new fitness centers and $11.1 million from comparable fitness centers. Comparable fitness center revenues increased 16.9%, in the three months ended March 31, 1998 primarily reflecting growth in new memberships and increased ancillary revenues. The net change in deferred revenues decreased membership revenues by $10.1 million in the three months ended March 31, 1997 and $10.9 million in the three months ended March 31, 1998. As a result of the foregoing, net revenues increased $22.7 million or 39.1%, from $58.0 million in the three months ended March 31, 1997, to $80.7 million in the three months ended March 31, 1998. Fitness center operating expenses decreased as a percentage of net revenue from $51.0 million or 87.9% of net revenues in the three months ended March 31, 1997 to $70.6 million or 87.5% of net revenues in the three months ended March 31, 1998. The decrease was primarily due to increased leverage of fixed operating expenses over higher net revenues, which was partially offset by higher 23 advertising and compensation expenses incurred in the 1998 period primarily related to additional personnel. General and administrative expenses decreased as a percentage of net revenue from $6.4 million or 11.0% of net revenue in the three months ended March 31, 1997 to $7.6 million or 9.4% of net revenue in the three months ended March 31, 1998. The decrease was primarily due to increased leverage of fixed operating expenses over higher net revenues. Depreciation and amortization expenses decreased as a percentage of net revenue from $4.1 million or 7.2% of net revenues in the three months ended March 31, 1997 to $5.4 million or 6.7% of net revenues in the three months ended March 31, 1998. The decrease was primarily due to increased leverage of depreciation and amortization expenses over higher net revenues and the change in the estimated useful life of the Company's equipment from five to seven years effective January 1, 1998. The decrease was partially offset by the increased depreciation and amortization expenses incurred by the Company in connection with its recent acquisitions. Interest expense increased from $2.9 million in the three months ended March 31, 1997 to $5.3 million in the three months ended March 31, 1998 due to higher outstanding debt to finance acquisitions, internal growth and fiscal 1997 distributions to stockholders. Net loss increased from $2.5 million in the three months ended March 31, 1997 to $3.7 million in the three months ended March 31, 1998 due to an increase in interest expense in the three months ended March 31, 1998, partially offset by a decrease in total operating expenses as a percentage of net revenues. EBITDA increased from $3.2 million in the three months ended March 31, 1997 to $5.3 million in the three months ended March 31, 1998 primarily due to the reduction of operating expenses as a percentage of net revenues. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 The Company's membership revenues increased $62.2 million or 31.6% from $196.6 million in fiscal 1996 to $258.8 million in fiscal 1997. The Company's ancillary revenues increased $18.4 million or 115.9% from $15.8 million in fiscal 1996 to $34.2 million in fiscal 1997. Membership and ancillary revenues increased as a result of the Hawaii, Texas, Sports Connection and Portland Acquisitions and the addition of other new fitness centers and increased comparable fitness center revenues. The increase in ancillary revenues was also driven by the introduction of ancillary products and services into a number of existing fitness centers. The increase in membership and ancillary revenues was comprised of $54.2 million from new fitness centers and $26.4 million from comparable fitness centers. Comparable fitness center revenues increased 12.9% in fiscal 1997, primarily reflecting growth in new memberships and increased ancillary revenues. The net change in deferred revenue decreased membership revenues by $32.4 million in fiscal 1996 and $31.1 million in fiscal 1997. As a result of the foregoing, net revenues increased $81.9 million or 45.5%, from $180.0 million in fiscal 1996 to $261.9 million in fiscal 1997. Fitness center operating expenses decreased as a percentage of net revenue from $162.1 million or 90.0% of net revenue in fiscal 1996 to $226.8 million or 86.6% of net revenue in fiscal 1997. The decrease was primarily due to increased leverage of fixed operating expenses over higher net revenues. General and administrative expenses decreased as a percentage of net revenue from $24.8 million or 13.8% of net revenue in fiscal 1996 to $30.9 million or 11.8% of net revenue in fiscal 1997. The decrease in fiscal 1997 was due to increased leverage of general and administrative expenses over higher net revenues and was partially offset by $5.4 million in one-time charges recorded in fiscal 1997 primarily related to the accelerated vesting of certain stock options and the write-off of certain fixed and intangible assets. Depreciation and amortization expenses increased as a percentage of net revenues from $13.7 million or 7.6% of net revenues for fiscal 1996 to $20.2 million or 7.7% of net revenues in fiscal 1997. The increase was primarily due to the increased depreciation and amortization expenses incurred by the Company in connection with its recent acquisitions and greenfield development projects. 24 Interest expense increased from $9.3 million in fiscal 1996 to $18.4 million in fiscal 1997 due to higher average outstanding debt used to finance acquisitions, internal growth and fiscal 1997 distributions to stockholders. Net loss increased from $14.8 million in fiscal 1996 to $17.0 million in fiscal 1997 primarily due to an increase in interest expense and the incurrence of $1.0 million of debt offering costs in fiscal 1997, partially offset by a decrease in total operating expenses as a percentage of net revenues in fiscal 1997 and the fact that the Company recorded a charge of $3.6 million in fiscal 1996 and $600,000 in fiscal 1997 related to severance payments to former Family Fitness management. EBITDA increased from a negative $0.2 million in fiscal 1996 to a positive $13.4 million in fiscal 1997, primarily due to the decrease in total operating expenses as a percentage of net revenues, which was partially offset by $5.4 million in non-recurring charges in fiscal 1997 comprised of compensation charges related to the accelerated vesting of options of $1.5 million and the write-off of certain fixed and intangible assets of $3.9 million. YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 The Company's membership revenues increased $87.9 million or 80.9% from $108.7 million in fiscal 1995 to $196.6 million in fiscal 1996. The Company's ancillary revenues increased $7.8 million or 97.8% from $8.0 million in fiscal 1995 to $15.8 million in fiscal 1996. Membership revenues increased as a result of the Family Fitness Acquisition, the addition of other new fitness centers and increased comparable fitness center revenues. Ancillary revenues increased as a result of the introduction of ancillary products and services into a number of existing fitness centers. The increase in membership and ancillary revenues was comprised of $81.3 million from new fitness centers, including those acquired in the Family Fitness Acquisition, and $14.4 million from comparable fitness centers. Comparable fitness center revenues increased 13.8% in fiscal 1996, primarily reflecting growth in new memberships and increased ancillary revenues. The net change in deferred revenues decreased membership revenues by $18.7 million in fiscal 1995 and $32.4 million in fiscal 1996. As a result of the foregoing, net revenues increased $82.0 million or 83.7% million, from $98.0 million in fiscal 1995 to $180.0 million in fiscal 1996. Fitness center operating expenses as a percentage of net revenues increased from $83.9 million or 85.7% of net revenues in fiscal 1995 to $162.1 million or 90.0% of net revenues in fiscal 1996. The increase was primarily due to the Family Fitness Acquisition and the fact that Family Fitness had a higher operating cost structure than the Company and this cost structure was only consolidated in the Company's financial operations for six months in 1995 and for a full 12 months in 1996. The Company has over time been able to more effectively leverage these fixed operating costs in order to take advantage of synergies from this acquisition. General and administrative expenses decreased as a percentage of net revenue from $17.4 million or 17.8% of net revenue in fiscal 1995 to $24.8 million or 13.8% of net revenue in fiscal 1996. The decrease as a percentage of net revenues was due to increased leverage of fixed operating expenses over higher net revenues, which was partially offset by higher management expenses related to the Family Fitness centers that were only consolidated in the Company's financial operations for six months in 1995 and twelve months in fiscal 1996. Interest expense increased from $5.6 million in fiscal 1995 to $9.3 million in fiscal 1996 due to higher average outstanding debt used to finance acquisitions and internal growth. Net loss increased from $6.8 million in fiscal 1995 to $14.8 million in fiscal 1996 primarily due to the increase of fitness center operating expenses as a percentage of net revenues in fiscal 1996 and severance payments of $3.6 million to former Family Fitness management in fiscal 1996, which were partially offset by the decrease in general and administrative expenses as a percentage of net revenues in fiscal 1996. 25 EBITDA decreased from a positive $2.4 million in fiscal 1995 to a negative $0.2 million in fiscal 1996 primarily due to the increase of fitness center operating expenses as a percentage of net revenues and severance payments of $3.6 million to former Family Fitness management in fiscal 1996, which were partially offset by the decrease in general and administrative expenses as a percentage of net revenues. LIQUIDITY AND CAPITAL RESOURCES The Company has historically satisfied its liquidity needs through cash flows from operations and various borrowing arrangements. Principal liquidity needs have included capital expenditures for existing fitness centers, the acquisition and development of new fitness centers, debt service and the payment of distributions to stockholders. In March 1997, and again in December 1997, the Company amended its existing credit facilities to increase its available borrowings from $88.0 million to a total available credit facility of $225.0 million. The December credit agreement (the "Senior Credit Facility") consists of a $125.0 million term loan ("Term Loan B") expiring in December 2004, a $50.0 million term loan ("Term Loan A") and a $50 million working capital line of credit expiring December 2002. Principal payments on Term Loan A are due in quarterly installments of varying amounts from $2.5 million to $4.0 million, plus interest, beginning March 31, 1999 and on Term Loan B in quarterly installments of $0.3 million, plus interest, beginning March 31, 2000. The Senior Credit Facility contains certain restrictive financial covenants including debt to adjusted earnings ratios and interest and fixed charges to adjusted earnings ratios and prohibits the declaration or payment of dividends, except to make a dividend payment to its shareholders through proceeds received as of the refinancing date. The borrowings are secured by all of the assets of the Company. The Senior Credit Facility also provides for the issuance of letters of credit. The Company had irrevocable letters of credit outstanding in the amount of $151,000 as of December 31, 1997. In February 1998, the Company issued an additional letter of credit for $1.0 million related to a software purchase which expires March 1999. The Senior Credit Facility also requires the Company to maintain interest rate hedges on notional principal amounts of not less than $70.0 million, prior to March 1998, and $100.0 million thereafter. Accordingly, in March 1997, the Company entered into an interest rate swap transaction with BNP. Under this interest rate swap agreement, the Company is a fixed rate payor, effectively converting the variable interest rate on $70.0 million of debt under its Senior Credit Facility into a fixed rate of 6.3% plus a bank margin based on the Company's leverage ratio. This interest rate swap agreement expires in March 1999; however, BNP has the option to extend the term to March 2000. Additionally, in March 1998, the Company entered into an interest rate swap transaction with a second international financial institution. Under this interest rate swap agreement, the Company will be a fixed rate payor, effectively converting the variable interest rate on $50.0 million of debt under its Senior Credit Facility into a fixed rate of 5.7% plus a bank margin based on the Company's leverage ratio. This second interest rate swap agreement expires in March 2003; however, the financial institution has the option to cancel the second interest rate swap agreement as of March 2001. Under the Senior Credit Facility, the Company pays variable interest rates based, at its election, on BNP's prime rate or LIBOR plus a marginal rate, which changes depending on the Company's leverage ratio. Including the interest rate swap agreements, the Company's weighted average interest rate as of March 31, 1998 was 9.1%. The Company pays an annual commitment fee based on the unused portion of the working capital line of credit under the Senior Credit Facility. The Company's hedging strategy in entering into the interest rate swap transactions is to limit its overall exposure to interest rate fluctuations and to reduce its cost of capital. The Company believes that the fixed rate in such interest rate swap transactions will lessen the volatility of its interest expense. However, no assurance can be given that such a strategy will lower the volatility of interest expense or reduce its cost of capital. 26 In conjunction with the Offerings, proceeds of approximately $ million (based on an assumed initial public offering price of $ per share) will be used to repay a portion of the Company's bank debt. The Company is currently negotiating with BNP to restructure its existing credit facilities. There can be no assurance that the Company will be able to restructure these credit facilities. Cash flow from operations was $3.4 million in the three months ended March 31, 1997, $13.7 million in the three months ended March 31, 1998, and $9.5 million, $19.1 million and $21.6 million in fiscal 1995, 1996 and 1997, respectively. These increases for each of the annual comparable periods 1995 through fiscal 1997, and the comparable three months ended March 31, 1997 and 1998 were primarily due to revenues from newly acquired and greenfield fitness centers, revenue growth in comparable fitness centers and increased leverage of fixed operating costs. Capital expenditures were $15.7 million for the three months ended March 31, 1998, and $48.5 million, $41.6 million, and $39.4 million in fiscal 1995, 1996 and 1997, respectively. Historical capital expenditures have been, and future expenditures are anticipated to be, primarily for remodeling facilities, replacement of equipment, development of new fitness centers and acquisition of fitness centers. Of these amounts, capital expenditures related to acquisitions were $8.4 million in the three months ended March 31, 1998, and $41.4 million, $21.9 million and $11.8 million in fiscal 1995, 1996 and 1997, respectively. Additionally, capital expenditures primarily related to new equipment for, and facility renovations of, existing fitness centers and management information systems were $2.8 million in the three months ended March 31, 1998, and $9.5 million, $9.1 million and $18.9 million in fiscal 1995, 1996 and 1997, respectively. The remaining portion of capital expenditures in each period was used primarily for the development of new greenfield facilities. The Company anticipates making additional capital expenditures of $24.0 million during the remainder of fiscal 1998 and 1999 related to new equipment for, and facility renovations of, its existing facilities. In addition, based on its historical experience in, and current expectations regarding, opening and acquiring new facilities, the Company currently anticipates that it will make capital expenditures during the remainder of fiscal 1998 of between $20 and $30 million in order to open new facilities, acquire new facilities, complete construction currently in progress and further upgrade its management information systems. INCOME TAXES The Company has deferred tax assets of $28.4 million and $36.6 million at December 31, 1996 and 1997. The realization of deferred tax assets are dependent upon future income for financial reporting purposes and, in some cases, future taxable income. The majority of the Company's deferred tax assets are deferred revenues and deferred rent, whose realization is dependent upon future income for financial reporting purposes but not for income tax purposes. Deferred revenue and costs of $25.1 million at December 31, 1997 and $18.3 million at December 31, 1996 relates to net cash collected in prior and current periods to be recognized in future periods over the average member life. Since such amounts have previously been reported as income for income tax reporting purposes, the recognition of this deferred tax asset will not result in future taxes payable. Additionally, deferred rent of $6.0 million at December 31, 1997 and $4.6 million at December 31, 1996 resulted from the recognition of lease expenses for financial reporting purposes prior to the actual payment and, thus, recognition for income tax reporting purposes. The ultimate recognition of this deferred tax asset is not contingent on the Company's ability to achieve future taxable income. Management believes that a significant portion of its losses generated in fiscal 1997 and 1996 resulted from duplicative or additional general and administrative costs related to its acquisitions and other non-recurring charges. In fiscal 1997, the Company had non-recurring expenses related to the write-off of debt offering costs of $1.0 million, compensation charges related to the accelerated vesting of options of $1.5 million and the write-off of certain fixed and intangible assets of $3.9 million. In fiscal 1996, the Company 27 incurred significant charges related to the integration of Family Fitness Holding Company and, additionally, paid non-recurring severance payments of $3.6 million related to this acquisition. Management believes it is more likely than not that sufficient taxable income will be generated in future periods to utilize the deferred tax assets that are dependent upon such taxable income. The amount of deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced. EFFECT OF RECENT CHANGES IN ACCOUNTING STANDARDS In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive Income, which prescribes standards for reporting comprehensive income and its components. Comprehensive income consists of net income or loss for the current period and other comprehensive income (income, expenses, gains and losses that currently bypass the income statement and are reported directly as a separate component of equity). SFAS 130 requires that components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Adoption of this statement will not impact the Company's consolidated financial position, results of operations or cash flows, and any effect will be limited to the form and content of its disclosures. The Company adopted SFAS 130 during the three months ended March 31, 1998, which resulted in no differences between the amounts of comprehensive loss and the net loss shown on the statement of operations. In 1997, the FASB issued SFAS 131, Disclosures About Segments of an Enterprise and Related Information, which establishes annual and interim reporting standards for a company's operating segments. Adoption of this Statement will not impact the Company's consolidated financial position, results of operations or cash flows, and any effect will be limited to the form and content of its disclosures. SFAS 131 is effective for the Company's fiscal 1998. In June 1998, FASB issued SFAS 133, Accounting for Derivative Instruments and Hedging Activities, which defines derivatives, requires that all derivatives be carried at fair value, and provides for hedge accounting when certain conditions are met. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Although the Company has not fully assessed the implications of this new statement, the Company does not believe adoption of this statement will have a material impact on the Company's financial statements. YEAR 2000 Many currently installed computer systems and software products are coded to accept only two-digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four-digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. The Company has assessed its management information systems and does not currently expect that any material expenditures will be required in connection with the modifications that will be required for such systems. Moreover, the Company has recently implemented or is in the process of implementing new systems that are already Year 2000 compliant and it does not believe that the total cost of any potential modification of such management information systems will be material. There can be no assurance, however, that the Company or its vendors will be able to modify timely and successfully their respective management information systems to comply with Year 2000 requirements. 28 BUSINESS GENERAL The Company is a leading owner-operator of fitness centers, operating 173 facilities under the brand name "24 Hour Fitness" in nine western States. Through these facilities, the Company provides a broad array of fitness, sport, nutritional and other services to its 1.6 million members. The Company has grown to become the second largest commercial owner-operator of fitness centers in the United States in terms of revenues and number of fitness centers, and is the largest commercial owner-operator of fitness centers in California, the industry's largest market. The Company believes that it differentiates itself from its competitors by offering: (i) 24 hour access at a majority of its facilities; (ii) consistently well-equipped, well-maintained fitness centers; (iii) professionally trained staff focused on quality customer service; and (iv) month-to-month membership plans that feature low initiation fees and affordable monthly dues. The Company's net revenues have increased from $33.0 million in fiscal 1993 to $261.9 million in fiscal 1997, and its EBITDA has increased from a negative $0.5 million in fiscal 1993 to a positive $13.4 million in fiscal 1997. The Company operates 123 fitness-only centers and 50 multi-sport centers. Fitness-only centers are typically less than 25,000 square feet and offer aerobic, cardiovascular and weight lifting facilities. Multi-sport centers are typically between 25,000 and 60,000 square feet and, in addition to the services and amenities offered by fitness-only centers, offer one or more of the following additional amenities: squash courts, racquetball courts, basketball courts, swimming pools, steam and sauna rooms, and whirlpools. As part of its clustering strategy, the Company often locates multi-sport centers in a market with several fitness-only centers and offers its members the use of both types of facilities for a higher membership fee. The Company believes that the health and fitness center industry has been enjoying, and will continue to enjoy, a period of pronounced growth. The industry has benefited from, and helped to create, an increasing awareness among the general public of the importance of physical exercise as a condition for good health. IHRSA reported that, in 1997, there were approximately 13,800 commercial health and fitness centers in the United States which generated aggregate revenues of approximately $9.0 billion. ASDI reported that memberships in health and fitness centers have grown from 13.8 million in 1986 to 20.8 million in 1996. The Company estimates that there are fewer than 20 companies that own and operate more than 20 commercial health and fitness centers in the United States. The Company believes that the fragmented nature of this industry presents significant opportunities for the Company to grow its operations by continuing to pursue its acquisition strategy. As the second largest commercial multi-facility owner-operator in the United States, the Company enjoys substantial economies of scale in management, advertising, and purchasing of equipment and supplies. The Company pursues a three-pronged growth strategy based upon (i) maximizing revenue growth and profit margins at existing fitness centers through growth in new memberships and sales of ancillary products and services, (ii) acquiring single-site and multi-site chains of fitness centers as a method of entering new markets and furthering its clustering strategy, and (iii) developing new fitness centers on a greenfield basis. HISTORY The Company was founded in California in 1983 by Mark S. Mastrov and certain partners for the purpose of owning and operating a single health club. By the end of 1994, the Company operated 32 fitness centers. In December 1994, the MDC Entities acquired a controlling interest in the Company through a leveraged recapitalization. Subsequently, in June 1995, the Company completed the Family Fitness Acquisition which tripled the number of fitness centers owned and operated by the Company, 29 adding an additional 68 locations. Since that time, the Company has continued to expand, completing the Hawaii Acquisition in March 1996, the Texas Acquisition and the Sports Connection Acquisition in October 1996, the Portland Acquisition in May 1997, the Boise Acquisition and the Houston Acquisition in February 1998, and the Omaha Acquisition in April 1998. Additional growth has been provided by acquisitions of single fitness centers and the development of an additional 19 fitness centers on a greenfield basis since January 1, 1996. The following graph shows components of the Company's growth from fiscal 1992 through March 31, 1998. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
ACQUISITIONS OF SINGLE- Existing Greenfield site and Multi-site Fitness Centers Fitness Centers Fitness Centers 1992 18 0 0 1993 18 2 3 1994 24 5 3 1995 32 6 71 1996 107 7 23 1997 137 9 11 3/31/98 157 3 12
The following table summarizes the Company's acquisitions of multi-site chains of three or more fitness centers completed in the three years preceding April 30, 1998.
NUMBER OF FITNESS CENTERS PRIMARY TRANSACTION DATE ACQUIRED AREAS SERVED - -------------------------------------- ----------------- --------------- ----------------------------------------- Family Fitness Acquisition June 1995 68 Los Angeles, San Diego, Las Vegas Hawaii Acquisition March 1996 3 Honolulu Texas Acquisition October 1996 12 Houston, Dallas Sports Connection Acquisition October 1996 4 Los Angeles Portland Acquisition May 1997 7 Portland (Oregon) Boise Acquisition February 1998 3 Boise Houston Acquisition February 1998 7 Houston Omaha Acquisition April 1998 3 Omaha
30 OPERATING STRATEGY The Company pursues a disciplined operating strategy which has helped to successfully position "24 Hour Fitness" as a nationally recognized brand of fitness centers. The Company attributes its growth and performance to several factors, including the following: CONVENIENT ACCESS. Since the Company believes that convenience is a high priority for its members, a majority of the Company's facilities are open 24 hours a day, seven days a week. In addition, the Company's clustering strategy provides convenient access to multiple locations near its members' homes and places of work. The Company's current intention is to expand its 24 hours a day, seven days a week policy to substantially all of its fitness centers by the end of fiscal 1998. The Company believes that its 24 hour policy has fostered a high level of brand name recognition and has allowed the Company to attract members with non-traditional schedules. The Company also provides other services, including babysitting services, at most of its fitness centers for a nominal fee. WELL-EQUIPPED, WELL-MAINTAINED FITNESS CENTERS. The Company is committed to offering fitness centers that are fully equipped with the latest in sports technology and equipment, including complete lines of state-of-the-art cardiovascular equipment, free weights and weight training machines. The Company periodically reviews, tests and, where appropriate, purchases newly introduced lines of equipment. Each fitness center typically features equipment from the leading manufacturers, including (i) 80 to 120 pieces of cardiovascular equipment, (ii) barbells, dumbbells, benches and other free weight equipment, and (iii) 60 to 80 weight training machines. The Company has a comprehensive maintenance and capital expenditure program designed to continually maintain and upgrade its exercise equipment and facilities. In addition, the Company believes that the cleanliness and maintenance of its facilities are important to existing and prospective members, and therefore employee compensation is linked to these factors. PROFESSIONALLY TRAINED, CUSTOMER-ORIENTED FITNESS SERVICE STAFF. The Company devotes substantial resources to ensure that each fitness center provides safe, consistent and effective exercise assistance and supervision. Each of the Company's fitness centers features a professionally trained staff to assist and supervise members with their exercise regimens, provide one-on-one personal training, and lead aerobics and group exercise classes. Each personal trainer is required to either (i) complete a 64 hour personal training course sponsored by the Company or (ii) present evidence that the prospective personal trainer has been certified by an accredited organization, such as the American College of Sports Medicine. In addition, each fitness trainer is required to complete a 16 hour introductory training course, at the fitness center level. The Company also sponsors on-going training classes and workshops for its personal trainers, and each aerobics instructor is required to be certified by an independent accredited organization acceptable to the Company. AFFORDABLE PRICING STRUCTURE. Members of the Company's fitness centers enjoy quality health and fitness services at affordable prices. The Company's individual monthly dues for new members typically range from $19 to $35 and individual one-time initiation fees for new members typically range from $49 to $299, depending upon the type of membership plan, the particular fitness center and its amenities. These membership plans differentiate the Company from some of its competitors that charge a substantial one-time initiation fee. Emphasizing monthly dues encourages a focus on quality customer service which management believes results in higher customer satisfaction and improved member retention. In fiscal 1997, approximately 70% of the Company's net revenues were from monthly dues. In excess of 90% of the Company's dues collected monthly are paid by electronic funds transfer, which the Company believes significantly increases collection rates of, and reduces the cost of collecting, monthly dues. HIGH MEMBER RETENTION RATES. The Company believes that its success in retaining its members is a result of its focus on customer satisfaction and service. The Company devotes significant attention to 31 retaining its members and, as a result, has been able to achieve what it believes to be some of the highest member retention rates among commercial multi-site fitness center owner-operators. These high member retention rates provide the Company with a stable base of recurring revenues and reduce costs associated with membership attrition. Existing members are also an important source of new member referrals. The Company also promotes member retention by, among other things, (i) actively encouraging new members to work out early in their memberships through its "Fitstart" program in which a fitness trainer introduces the member to the fitness center and custom-designs an appropriate personal exercise program for the member, (ii) having personal trainers offer free one-on-one personal training sessions to certain members who have not used a fitness center for more than 30 days during their memberships, and (iii) directing members who have expressed a desire to end their memberships to fitness center or corporate personnel who have specialized sales and retention training. CLUSTERING OF FITNESS CENTERS. The Company seeks to establish a prominent presence in each of its markets by clustering several fitness centers in a particular area. This strategy enables the Company to achieve significant market penetration and to leverage management, advertising and purchasing expenses thereby achieving greater economies of scale. This strategy also promotes recognition of the "24 Hour Fitness" brand name and contributes to high member retention rates. STRONG BRAND NAME. The Company devotes substantial resources to advertising and marketing aimed at enhancing its brand image. In fiscal 1997, the Company spent approximately $19.0 million on advertising and promotion. The Company employs a full time corporate advertising staff that oversees its radio, television, print and direct response advertising, image advertising and promotional events aimed at attracting new members and developing the "24 Hour Fitness" brand name. The Company also allocates a portion of its advertising and promotion budget to local club managers to enable them to engage in local advertising and promotions at the individual facility level. HIGHLY EXPERIENCED MANAGEMENT TEAM. The Company's management team has been at the forefront of the fitness industry for over 15 years and is led by the Company's founder, Mark S. Mastrov, who started the Company with a single fitness center in 1983. As the Company's business has grown, Mr. Mastrov has recruited and developed an experienced management team. The seven senior members of this team have more than 94 cumulative years of experience in the health and fitness center industry. GROWTH STRATEGY From January 1, 1996 to April 30, 1998, the Company grew from 109 facilities to 173 facilities. The Company plans to continue to expand by opening and acquiring a total of at least 35 fitness centers in fiscal 1998 (of which 16 had been opened or acquired by April 30, 1998) and approximately 35 additional fitness centers in fiscal 1999. This planned expansion is expected to be accomplished through the construction of new greenfield facilities, the acquisition of individual fitness centers, primarily in existing markets, and the acquisition of multi-site operators in new and existing markets. The Company has developed a three-pronged growth strategy that builds on the successes of the Company's management in operating, developing and acquiring fitness centers. The key elements of this growth strategy are: INCREASE REVENUES AND OPERATING INCOME AT EXISTING FITNESS CENTERS. The Company seeks to leverage the operating performance of its existing fitness centers through growth in fitness center revenues. Due to the high fixed cost component of operating expenses, revenue growth at existing clubs generally results in significantly increased operating income and cash flow. Total combined revenues, before change in deferred revenues, at fitness centers which the Company operated at least 13 months increased 13.8% in fiscal 1996, 12.9% in fiscal 1997 and 16.9% in the three months ended March 31, 32 1998. The Company's strategy for increasing revenues and operating income in existing fitness centers emphasizes the following: - ATTRACT NEW MEMBERS. The Company uses a variety of methods to attract new members, including radio, television, print and direct response advertising, image advertising existing member referral programs, and sponsorship of numerous community programs. In order to capitalize on the response to its advertising and promotional efforts, each of the Company's fitness centers has its own team of sales counselors who are trained to emphasize the benefits of fitness and regular exercise to prospective members while explaining to them that those benefits can best be realized through membership in the Company's fitness centers. The Company also seeks to increase its membership by offering corporate membership programs and establishing relationships with several HMOs (including Health Net and PacifiCare, two of the largest HMOs in California). Under these programs, the Company offers discounted memberships to the members of the participating corporation or HMO, which memberships are sometimes further subsidized by the sponsoring entity. The Company has approximately 5,000 companies participating in its corporate membership programs with approximately 200,000 members enrolled. The Company is also exploring the effectiveness of capitalization programs under which HMOs pay the Company a nominal fixed fee per HMO member in return for access, often on a limited basis, to the Company's facilities. - INCREASE ANCILLARY REVENUES. The Company has developed a broad portfolio of complementary services and products, including: one-on-one personal training services, weight loss and nutritional counseling, and retail offerings of athletic clothing, juices, sports drinks and nutritional supplements. The Company believes that further expansion of these ancillary products and services, particularly in its more recently opened or acquired fitness centers, will provide an opportunity to continue to increase net revenues. The Company has also begun to combine services and product offerings designed to help members achieve specific goals. The newest such offering, the Accelerated Results Program, combines one-on-one personal training and a customized nutritional software system into a six week program that accelerates body composition changes. Custom menu plans and workouts are designed for the member by certified fitness professionals, and appropriate supplements are recommended. Revenues from ancillary services were $15.8 million for fiscal 1996 and $34.2 million for fiscal 1997, or approximately 8.8% and 13.1% of net revenues, respectively, for each period. ACQUIRE ADDITIONAL FITNESS CENTERS. Historically, acquisitions of fitness centers have played a key role in the Company's growth strategy. From January 1, 1996 through March 31, 1998, the Company acquired 46 additional fitness centers, of which 36 were acquired in acquisitions of multi-site operators. In addition, as of June 1, 1998, the Company had entered into letters of intent with respect to an additional two acquisitions of multi-site operators representing an additional 12 fitness centers. The Company purchases individual fitness centers primarily in existing markets in order to increase its economies of scale, further its clustering strategy and increase its market share. Acquisitions of underperforming fitness centers also provide the Company with opportunities to improve operating performance through the implementation of the Company's operating strategy. The Company has and will continue to pursue acquisitions of multi-site operators and individual fitness centers having a combination of attractive locations, strong management teams and significant growth potential. DEVELOP NEW LOCATIONS. From January 1, 1996 through March 31, 1998, the Company developed 19 greenfield fitness centers as a complement to its acquisition strategy. Developing greenfield sites allows the Company to control every aspect of the design and construction of a fitness center in accordance with its operational philosophy. The Company develops fitness centers on a greenfield basis both as a way of entering new markets and expanding its presence in existing markets. 33 FITNESS CENTERS The fitness centers operated by the Company are fully equipped with the latest in sports technology and equipment. Each fitness center contains a large co-ed exercise area, an extensive free weight area, an aerobics/exercise room offering a variety of classes, clean and well-equipped locker rooms and a professionally trained staff. The multi-sport centers are typically between 25,000 and 60,000 square feet and, in addition to fitness-only amenities, offer one or more of the following: squash courts, racquetball courts, basketball courts, swimming pools, steam and sauna rooms, and whirlpools. FACILITIES. Each of the Company's fitness centers offers, on average, 80 to 120 pieces of state-of-the-art cardiovascular equipment from the leading manufacturers. Each of the Company's fitness centers features an extensive free weight area providing a complete line of barbells, dumbbells, benches and other free weight equipment manufactured by the leading manufacturers in the industry and between 60 and 80 weight training machines manufactured by the industry's leading suppliers. The Company believes that it generally offers significantly more pieces of cardiovascular equipment and more weight machines than most other fitness-only and multi-sport fitness centers in the industry. The Company periodically reviews, tests and, when appropriate, purchases newly-introduced lines of equipment. Each of the Company's fitness centers also features a separate aerobics/exercise room with special flooring and sound system and offers a broad selection of aerobic and exercise classes designed for all age groups and fitness levels. In addition, multi-sport centers with swimming pool facilities offer low-impact therapeutic aqua-aerobics classes. FITNESS CENTER MAINTENANCE. The Company places a high priority on having clean and well-maintained fitness centers. The Company subjects each of its fitness centers to an extensive audit pursuant to which each fitness center is regularly inspected on an unannounced basis. The items inspected by auditors include equipment condition, locker room cleanliness, air conditioning, ventilation and music levels. Each fitness center also has a service manager who has the day-to-day responsibility of ensuring that the fitness center meets the Company's high maintenance and cleanliness standards. The Company also places a high priority on minimizing the time during which equipment is out of service. As a result, the Company has established strict guidelines requiring the expeditious repair, or removal from the exercise floor, of any temporarily inoperable exercise equipment. FITNESS CENTER PERSONNEL. The Company's management structure is designed to provide each fitness center with autonomy, while maintaining certain Company-wide standards. In addition, the Company promotes its growth strategy by providing most fitness center personnel with performance-based compensation. Each fitness center has a general manager, assistant manager, weekend manager and service manager. A fitness center's staff also includes a fitness supervisor, aerobic supervisor, front desk supervisor and baby sitting and maintenance personnel, each of whom reports to the service manager. As part of the Company's marketing efforts, each fitness center also has a number of sales counselors who report to the assistant general manager and weekend manager. See "Advertising and Marketing." MEMBERSHIP PLANS INDIVIDUAL MEMBERSHIPS. The Company offers a variety of individual membership plans. Most memberships require the payment of a modest initiation fee and monthly membership dues. These plans differentiate the Company from some of its competitors that charge a substantial one-time initiation fee. The Company offers different membership plans based on (i) the number of fitness centers to which a member has access, (ii) limitations on access to fitness centers to certain days and times, and (iii) the amount of the initiation fee, if any, and the monthly dues. HMO MEMBERSHIPS. The Company currently offers memberships to the participants in Health Net and PacifiCare, two of the largest HMOs in California. The Company intends to further capitalize on the 34 national emphasis on health care cost reduction and the benefits of regular exercise by pursuing relationships with other HMOs. The Company believes that offering conveniently located facilities that are clean, professionally run and well-maintained will be an attraction to other HMOs. CORPORATE MEMBERSHIPS. Corporate memberships are also available, which generally provide for discounted initiation fees for a corporation's employees or, in some cases, memberships that are partially subsidized by employers. Currently, the Company has arrangements with approximately 5,000 corporations (including Bank of America, Wells Fargo & Company and the Hewlett Packard Company). The Company's corporate membership program currently yields in excess of 4,000 new members monthly. ANCILLARY REVENUES In addition to its membership programs, the Company has developed a strong portfolio of complementary services and products, including: one-on-one personal training services, weight loss and nutritional counseling and retail offerings of athletic clothing, juices, sports drinks and nutritional supplements. The Company believes that further expansion of these ancillary products and services, particularly in its more recently opened or acquired fitness centers, will provide an opportunity to continue to increase net revenue. In fiscal 1997, ancillary products and services accounted for 13.1% of the Company's net revenues. The Company combines various ancillary services, such as personal training and nutritional counseling into packages of services which members can purchase to enhance the benefits of their fitness center memberships. PERSONAL TRAINING. All of the Company's fitness centers offer one-on-one personal training which is sold by the single session or in multi-session packages. In most instances, the personal training program can be easily expanded into new clubs that the Company acquires or opens. ACCELERATED RESULTS PROGRAM. To provide a comprehensive weight loss program, the Company also intends to expand its offering of its proprietary nutritional program, the Accelerated Results Program, to all locations from the approximately 110 locations already served. The Accelerated Results Program combines six one-on-one personal training sessions and a proprietary nutritional software system into a six week program that accelerates desired results. The program includes a custom software program for designing a menu based on the member's typical eating habits. PHYSICAL THERAPY. The Company has entered into various joint venture arrangements with providers of physical therapy services who lease space in certain of the Company's fitness centers and provide physical therapy to the Company's member base and to the general public. RETAIL SALES. The Company currently offers retail sales of clothing (including 24 Hour Fitness branded and independent label workout gear) at all of its fitness centers. The Company intends to include a full pro-shop in all new fitness centers and remodels. The Company is also developing mininutrition centers and juice bars in many clubs that include the Accelerated Results Program supplements, as well as other leading brands of performance supplements. ADVERTISING AND MARKETING In order to increase awareness of the benefits of exercise and the convenience of its facilities the Company has implemented an ongoing advertising and marketing program designed to appeal to a broad range of potential members. In fiscal 1996, the Company consolidated its operations under the "24 Hour Fitness" name in order to create a broadly identifiable brand name. In fiscal 1997, the Company spent approximately $19.0 million on advertising and promotion. Targeted advertising which the Company also uses to generate "walk-ins" and to increase daily membership sales, primarily consists of print, direct mail, radio and television advertising, including infomercials. The Company also uses image advertising to increase brand name recognition and the Company's overall identification. 35 Advertising on buses and billboard campaigns in its existing markets are the two forms of image advertising most frequently used by the Company. Image advertising includes billboards in major league sports stadiums, such as 3Com (Candlestick) Park, the baseball park for the San Francisco Giants and the football stadium for the San Francisco 49ers, the LA Forum, the basketball arena for to the Los Angeles Lakers, Qualcomm (Jack Murphy) Stadium, the baseball park for the San Diego Padres and the football stadium for the San Diego Chargers, and Mile High Stadium, the football stadium for the Denver Broncos, as well as the Sears Point Raceway and the California Speedway. The Company frequently sponsors promotions targeted to current and prospective members. Since as many as 50% of the Company's new members cite a referral from an existing member as among their reasons for joining one of the Company's fitness centers, the Company believes that it is important to continually add to the value of an existing member's membership. The Company increases its name recognition and member appreciation by occasionally distributing free water-bottles and T-shirts bearing the Company logo. The Company has also sponsored promotions for trips to Hawaii, Jamaica or Las Vegas and gives current members an entry ticket for every work-out or referral of a potential member. The Company has encouraged prospective members to join in the past by allowing them to attend a fitness center for a certain number of days free of charge and to enter contests to win a trip for two to Hawaii, Europe or Las Vegas, or to receive free home exercise equipment with the purchase of a specified membership. To further increase its visibility, the Company also frequently participates in promotional events with local and national businesses, including sponsorship of the Escape from Alcatraz, an internationally televised event staged in San Francisco, and Bumps & Jumps, a series of ski events staged in Lake Tahoe, Colorado and Idaho. The Company also sponsors various community and charitable events, such as local high school sports and programs such as P.A.S.S. (a high-school learning program for student athletes) and Macy's Passport (benefiting AIDS treatment). In addition, the Company frequently donates used exercise equipment to local high school sports programs. The Company's advertising and promotional efforts are reinforced by the Company's sales personnel who emphasize the benefits of fitness and regular exercise and that those benefits can best be realized through membership at the Company's fitness centers. Each fitness center has its own team of Company-certified sales counselors. Each prospective sales counselor must complete a sales training program at an individual fitness center and is then required to attend a week-long training seminar at the corporate offices led by Company executives. The Company further incentivizes its sales counselors during their tenure through a variety of cash incentives and sales contests. In addition to sales counselors employed at individual fitness centers, at the corporate level the Company employs a full-time in-house advertising staff. COMPETITION The health and fitness center industry is competitive and fragmented. There are generally four types of facilities in the industry: (i) "fitness-only" facilities, (ii) multi-sport centers, (iii) "mega-clubs," which are multi-purpose sports clubs averaging over 60,000 square feet which typically have large initiation fees and substantial membership dues and (iv) niche clubs, which are less than 10,000 square feet and usually focus on niche activities, such as personal training or weight loss. The Company, which offers primarily fitness-only centers and multi-sports centers, is the second largest commercial owner-operator of fitness centers in the United States in terms of both sales and number of facilities, and is also the largest commercial owner-operator of fitness centers in California. The Company estimates there are fewer than 20 companies that own and operate more than 20 commercial health and fitness centers in the United States. The Company believes that the principal competitive factors influencing its business are convenience, cleanliness, price and customer service. Within each market, the Company competes with other fitness centers, "mega-clubs," physical fitness and recreational facilities established by local governments, non-profit organizations and businesses for their employees, racquet and tennis clubs, country clubs and weight reducing salons. The Company also competes with other entertainment and 36 retail businesses for the discretionary income of its target market. In addition, the Company competes with the manufacturers of home health equipment. As the Company pursues new business initiatives, particularly the sale of nutritional products and apparel, the Company will face additional competitors within such retail markets. See "Risk Factors--Competition." GOVERNMENT REGULATION The operations and business practices of the Company are subject to regulation at the federal, state and local levels. State and local consumer protection laws and regulations, as well as state and local health regulations, govern the Company's operations, advertising, sales and other trade practices. Statutes and regulations affecting the fitness industry have been enacted in California, and many other states into which the Company has or 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, the Company is subject to numerous other 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. In this regard, the California Civil Code imposes a maximum limit on the amounts that may be charged pursuant to a contract for health studio services. The Company maintains internal review procedures in order to comply with these requirements, and believes that its activities are in substantial compliance with all applicable statutes, rules and decisions. Under various state "cooling-off" statutes, a member has the right for a period of three to ten days (depending on the applicable state law) to cancel his or her membership and, in such event, is entitled to a refund of any down payment made. In addition, the Company's 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 fitness center. 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 to the Company upon cancellation and the Company may offset such amount against any refunds owed. As the Company pursues new business initiatives by selling nutritional supplements, juices and sports drinks, the Company may become increasingly subject to the extensive federal and state regulations governing the manufacture and sale of nutritional and food products in the United States. The U.S. Food and Drug Administration and the Federal Trade Commission in particular have, in recent years, made it a high priority to scrutinize the products and the claims regarding those products made by the manufacturers of nutritional supplements. The Company currently relies on the manufacturers of its food and nutritional products to test these products and obtain the appropriate regulatory approvals and consents. There can be no assurance that the failure of these manufacturers to obtain such consents or approvals or that some other misconduct by these manufacturers will not have a material adverse effect on the Company's financial condition or results of operations. See "Risk Factors--Government Regulation." PROPERTIES The Company operates 173 fitness centers in the following locations: Los Angeles/Orange County (62), San Francisco Bay area (36), San Diego (15), Sacramento (9), Boise (3), Omaha (2), Portland, Oregon area (8), Dallas (7), Houston (12), Las Vegas (4), Hawaii (7), Denver (5) and Reno (3). The Company leases all of its facilities. Most of these leases are operating leases generally with renewal options of 5 to 10 years, exercisable at the option of the Company. Certain of these leases include 37 escalation clauses requiring periodic payment of additional rent in stipulated amounts or increases in rent based upon changes in the Consumer Price Index. In addition to its fitness centers, the Company leases its executive offices in Pleasanton, California, a regional processing center in Carlsbad, California, and two small distribution and storage facilities for fitness equipment located in San Diego and Pleasanton, California. INSURANCE The Company maintains policies of insurance with coverages deemed sufficient by management to protect the Company from losses, damages or claims suffered or made in the operation of its business. No assurance can be given, however, that one or more claims will not fall outside the limits of coverage of such insurance policies or exhaust the coverage afforded by such policies, in which case such a claim could have a material adverse effect on the business, assets and results of operations of the Company. EMPLOYEES The Company has over 11,500 employees, of which approximately 3,500 are full-time. None of the Company's employees is represented by a labor union or is subject to a collective bargaining agreement. Although the Company experiences high turnover of non-management personnel, the Company has never experienced any labor shortages nor had any difficulty in obtaining adequate replacements for departing employees. The Company considers its relations with its employees to be good. INTELLECTUAL PROPERTY The Company is the owner in the United States of the trademarks and servicemarks used to identify the Company including "24 Hour Fitness." This trademark is material to the ongoing operations of the Company. ENVIRONMENTAL MATTERS The Company is subject to federal, state and local environmental laws and regulations relating to the use, storage, emission, discharge, generation, handling, treatment and disposal of certain hazardous materials, substances and wastes. The Company believes that it currently conducts its operations in substantial compliance with applicable environmental laws and regulations. Based on the Company's experience to date, the Company believes that the future cost of compliance with existing environmental laws and regulations, and liability for known environmental claims, will not have a material adverse effect on the Company's financial condition or results of operations. LEGAL PROCEEDINGS From time to time, the Company is involved in litigation that it considers to be in the normal course of business. However, the Company is not presently involved in any legal proceedings which the Company expects individually or in the aggregate to have a material adverse effect on the Company's financial condition, results of operations or liquidity. 38 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The directors and executive officers of Holdings and 24 Hour Fitness are:
NAME AGE POSITION - ----------------------- --- ----------------------------------------------------------- Mark S. Mastrov 40 President, Chief Executive Officer and Director Gilbert K. Freeman 56 Executive Vice President and Chief Financial Officer Ronald Thompson 42 Chief Operating Officer Karen S. Behnke 41 Director Donald F. Dorward 66 Director David E. King 39 Director and Chairman George E. McCown 63 Director Peter Roy 42 Director Gary Schoenfeld 35 Director William Walsh 66 Director Ray A. Wilson 70 Director
MARK S. MASTROV. President, Chief Executive Officer and Director of the Company since 1986. Mr. Mastrov co-founded 24 Hour Nautilus Fitness Centers in 1983. He is responsible for all club operations, acquisitions, administrative functions, and all real estate and construction activities. GILBERT K. FREEMAN. Executive Vice President and Chief Financial Officer of the Company since 1994. Prior to joining the Company, Mr. Freeman served as Executive Vice President and Chief Financial Officer of Chevys, Inc. for four years, where he directed new restaurant real estate development, as well as managed Chevys, Inc. corporate finance, information services and legal affairs. RONALD THOMPSON. Chief Operating Officer of the Company since March 1998. Mr. Thompson joined the Company following the Family Fitness Acquisition in 1995 and was named Southwest division president of 24 Hour Fitness in 1997. Prior to joining the Company, Mr. Thompson served as regional manager for Family Fitness Centers since 1979. KAREN S. BEHNKE. Director of the Company since November 1996. Ms. Behnke is currently a consultant to healthcare clients such as Blue Cross/Blue Shield of Minnesota and the Company. Ms. Behnke founded Execu-Fit Health Programs, Inc. in 1983 and served as its President until its sale to PacifiCare Health Systems in 1991 and, thereafter, served as a Vice-President at PacifiCare Health Systems until 1996. DONALD F. DORWARD. Director of the Company since November 1995. Mr. Dorward most recently assumed responsibility as managing director of Grey Advertising in San Francisco. He previously operated Dorward & Associates, Inc., a consulting organization specializing in communications and marketing. In 1971, Mr. Dorward co-founded Allen & Dorward, a San Francisco based advertising agency, which was sold to Mojo-MDA, a publicly held Australian based advertising agency, in 1986. Mr. Dorward served as the Chairman and Chief Executive Officer of Mojo's U.S. operations until 1989, when Mojo was merged into Chiat-Day. Since the end of 1990, Mr. Dorward has also served on the board of directors of Schwab Funds, the mutual fund division of Charles Schwab & Co. DAVID E. KING. Director of the Company since 1994, and Chairman since 1997. Mr. King is a general partner of MDC Management Company III, L.P., which is the general partner of McCown De Leeuw & Co. III, L.P., and McCown De Leeuw & Co. III, (Europe) L.P., a general partner of MDC Management Company IIIA, L.P., which is the general partner of McCown De Leeuw & Co. III (Asia), L.P. and a member of Gamma Fund, LLC. Mr. King has been associated with McCown De Leeuw & Co., Inc. since 1990, and serves as a director of several privately-held companies. 39 GEORGE E. MCCOWN. Director of the Company since 1994. Mr. McCown is a managing general partner of MDC Management Company III, L.P., which is the general partner of McCown De Leeuw & Co. III, L.P., and McCown De Leeuw & Co. III (Europe) , L.P., a managing general partner of MDC Management Company IIIA, L.P., which is the general partner of McCown De Leeuw & Co. III (Asia), L.P. and a member of Gamma Fund, LLC. Mr. McCown was the co-founder in 1984 of McCown De Leeuw & Co., Inc., an affiliate of McCown De Leeuw & Co. III, L.P. He also serves as Chairman of Building Materials Holding Corporation, Vice-Chairman of Vans, Inc. and a director of FiberMark, Inc., and Nimbus CD International, Inc. He also serves as a director of several privately-held companies. PETER ROY. Director of the Company since November 1995. Mr. Roy has been President of Whole Foods Market, the nations largest retailer of natural and organic foods, since 1993. Prior to joining Whole Foods Market, Mr. Roy was founder and President of the Natural Foods Network, an industry trade association. GARY SCHOENFELD. Director of the Company since 1994. Mr. Schoenfeld has been President and Chief Executive Officer of Vans, Inc. since 1995. Mr. Schoenfeld was associated with McCown De Leeuw & Co., Inc. from 1988 to 1995. WILLIAM WALSH. Director of the Company since 1996. Mr. Walsh is currently a consultant with the San Francisco 49ers. Previously, Mr. Walsh was head football coach at Stanford University from 1992 until 1994. Prior to that, Mr. Walsh was a football analyst for NBC Sports from 1989 until 1992. Mr. Walsh was inducted into the Professional Football Hall of Fame in 1993. RAY A. WILSON. Director of the Company since 1995. Mr. Wilson began in the fitness industry in his early twenties, and today has over 47 years of experience in the health club industry. Mr. Wilson founded Family Fitness Centers in 1977. Mr. Wilson's accomplishments include being the original designer of the Lifecycle Exercise Bicycle. The Board of Directors presently consists of nine members, each of whom holds office until the next annual meeting of the stockholders, until his successor has been elected or until his withdrawal or resignation. The Board of Directors has established a compensation committee comprised of three non- employee directors. The Board of Directors has also established an audit committee currently comprised of three directors, two of whom are independent directors. DIRECTORS' COMPENSATION The Company pays each of its directors who are not compensated as officers of the Company and are not employees of McCown De Leeuw & Co., Inc. or its affiliates a fee of $2,500 per meeting of the Board of Directors attended and $1,500 per committee meeting attended. The Company also reimburses each director for out-of-pocket expenses incurred in attending meetings of the Board of Directors and its committees. The Company has adopted the Fitness Holdings, Inc. 1995 Stock Option Plan for Non-Employee Directors (as amended, restated, modified or supplemented from time to time, the "Directors' Plan"). The Directors' Plan is designed to maintain the Company's ability to attract and retain the services of experienced and highly qualified outside directors and to create a proprietary interest of such directors in the Company's continued success. Under the Directors' Plan, grants of stock options will be made to each member of the Board of Directors who is (a) not an employee of the Company or its affiliates and (b) otherwise not eligible for selection to participate in any plan of the Company or its affiliates that entitles participants to acquire securities or derivative securities of the Company (an "Eligible Director"). An aggregate of shares of common stock of Holdings are subject to the Directors' Plan. Notwithstanding the foregoing, adjustments will be made by the Board of Directors of Holdings in the number and class of shares of common stock available under the Directors' Plan and the number, class and price 40 of shares of common stock subject to outstanding option grants, in each such case to reflect changes in the Company's corporate structure or capitalization, such as through a merger or stock split. On November 14, 1995, each Eligible Director was granted an option that permits such director, for a period of up to ten years from the date of grant (unless the period is shortened by the director's retirement, death, disability (as defined in the Directors' Plan) or a change in control of Holdings (as defined in the Directors' Plan)), to purchase from Holdings shares of common stock at an exercise price equal to $ per share. Each person who subsequent to November 14, 1995, becomes an Eligible Director will, subject to availability of shares for grants under the Directors' Plan, receive an option under the Directors' Plan when he or she is first elected or appointed to the Holdings' Board of Directors and otherwise satisfies the requirements for participation in the Directors' Plan. Any such option granted under the Directors' Plan subsequent to November 14, 1995, will permit the Eligible Director, for a period of up to ten years from the date of grant (unless the period is shortened by the Eligible Director's retirement, death, disability (as defined in the Directors' Plan) or a change in control of Holdings (as defined in the Directors' Plan)), to purchase from Holdings shares of common stock at the fair market value (as defined in the Directors' Plan) of such shares on the date such option is granted. Generally, each option granted is immediately exercisable on such grant date with respect to 28% of the total number of shares of common stock covered by such option and becomes cumulatively exercisable with respect to an additional 24% of the total number of shares covered by the option on each of the three succeeding anniversary dates of such grant date; provided, however, each option shall be fully exercisable upon (i) the attainment of age 70 by the optionee or (ii) the death or disability (as defined in the Directors' Plan) of the optionee. Notwithstanding the foregoing, in no event may an option under the Directors' Plan be exercised after ten years from the date it was granted. Except in certain limited circumstances, an option terminates upon termination of the optionee's directorship with Holdings. Unless an option provides otherwise, its exercise price may be paid in U.S. dollars by check or bank draft, by tendering shares of common stock already owned by the optionee for at least six months having a fair market value (as defined in the Directors' Plan) on the date of exercise equal to the cash exercise price, any combination of such U.S. dollars and common stock or in accordance with a "cashless exercise" program. Notwithstanding the foregoing, in general, in the event of a change in control of Holdings (as defined in the Directors' Plan), all of an optionee's then outstanding options immediately become exercisable (unless a resolution of the Board of Directors of Holdings specifically directs otherwise). The Directors' Plan will terminate upon the earlier to occur of (i) the adoption of a resolution of the Holdings Board of Directors terminating the Directors' Plan, (ii) the date all shares of common stock subject to the Directors' Plan are purchased according to the Directors' Plan's provisions or (iii) ten years from the date of adoption of the Directors' Plan by the Holdings Board of Directors. Pursuant to the Director's Plan, (i) on November 14, 1995, the Company granted each of Peter Roy and Donald Dorward the option to purchase from the Company shares at a per share purchase price equal to $ , (ii) on May 16, 1996, the Company granted William Walsh the option to purchase from the Company shares at a per share purchase price equal to $ and (iii) on November 14, 1996, the Company granted Karen S. Behnke the option to purchase from the Company shares at a per share purchase price equal to $ . EXECUTIVE COMPENSATION The following table sets forth, for fiscal 1997, the annual and long-term compensation for services in all capacities to the Company of the Company's Chief Executive Officer and each of the Company's other executive officers whose annual compensation exceeded $100,000 (the "Named Executives"). 41 SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION ------------------------------------ NAME FISCAL OTHER AND YEAR ANNUAL ALL OTHER POSITION ENDED SALARY BONUS COMPENSATION COMPENSATION - ---------------------------------------------------------- --------- --------- --------- -------------- --------------- Mark S. Mastrov........................................... 12/31/97 $ 586,000 $ 613,000 -- $ 24,000(1) President, Chief Executive Officer Gilbert K. Freeman........................................ 12/31/97 208,000 41,000 -- 20,000(1) Executive Vice President, Chief Financial Officer Ronald Thompson........................................... 12/31/97 23,000 552,000 -- -- Chief Operating Officer
- ------------------------------ (1) Represents car allowance. The following table sets forth all grants of stock options to the Named Executives in the Summary Compensation Table during fiscal 1997: OPTION GRANTS IN FISCAL 1997
POTENTIAL REALIZABLE INDIVIDUAL GRANTS ------------------------------------------------------------ VALUE AT ASSUMED NUMBER ANNUAL RATES OF PERCENT OF TOTAL OF STOCK SHARES OPTIONS PRICE UNDERLYING GRANTED TO APPRECIATION(2) OPTIONS EMPLOYEES IN EXERCISE PRICE EXPIRATION -------------------- NAME GRANTED FISCAL YEAR PER SHARE(1) DATE 5% 10% - -------------------------------- ----------- ----------------- --------------- ----------- --------- --------- Ronald Thompson................. 1.3% $ 2/14/07 $ $
- ------------------------------ (1) The per share exercise price is equal to the fair market value of the shares on the date of grant. (2) The dollar amounts under the 5% and 10% columns in the table are the result of calculations prescribed by the rules of the Commission. No options were exercised by the Named Executives during fiscal 1997. The following table provides information relating to the number and value of shares of the Company subject to options held by the Named Executives as of December 31, 1997. AGGREGATED OPTION EXERCISES IN FISCAL 1997 AND OPTION VALUES AT FISCAL YEAR-END
NUMBER OF VALUE OF UNEXERCISED SECURITIES UNDERLYING IN-THE-MONEY UNEXERCISED OPTIONS OPTIONS AT AT FISCAL YEAR-END FISCAL YEAR-END(1) ----------------------------- ----------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ----------------------------------------------------------- ------------ --------------- ------------ --------------- Mark S. Mastrov............................................ Gilbert K. Freeman......................................... Ronald Thompson............................................
- ------------------------ (1) For purposes of this table, fair value is the most recent value of a share of Common Stock as determined by the Compensation Committee of the Holdings Board of Directors for the purpose of granting options. STOCK OPTION PLAN. The Company has adopted the Fitness Holdings, Inc. 1994 Stock Option Plan and Stock Award Plan (as amended, restated, modified or supplemented from time to time, the "Fitness Plan"). The Fitness Plan is designed to maintain the Company's ability to attract and retain highly qualified and experienced employees and consultants and to give such employees as well as certain 42 consultants a continued proprietary interest in the success of the Company. Subject to adjustment as noted below, the Fitness Plan provides for the grant of options or awards covering up to shares of common stock of Holdings. The Fitness Plan is administered by a compensation committee (the "Committee"), which has been appointed by the Board of Directors of Holdings. The Committee is authorized to set the terms of the grants under the Fitness Plan. The Committee has the authority to grant incentive stock options, stock options other than incentive stock options ("non-qualified stock options"), stock appreciation rights in tandem with such options, awards of restricted stock, bonuses payable in stock or any combination thereof. Options and other awards under the Fitness Plan may be granted by the Committee to key salaried employees, including officers (but excluding non-employee directors), and consultants of the Company and its subsidiaries. The Board of Directors of Holdings is able to amend, alter or discontinue the Fitness Plan, but no amendment, alteration or discontinuation will be permitted to be made which would (i) impair the rights of any holder of restricted stock, stock bonus or option (and related stock appreciation rights, if any) already granted without his or her written consent, or (ii) without the approval of the Stockholders (except as a result of adjustments in response to certain capital changes), (A) increase the maximum number of shares reserved for the Fitness Plan, (B) decrease the option price of an option (and related stock appreciation rights, if any) to less than 100% of the fair market value of the common stock of Holdings on the date the option (and related stock appreciation rights, if any) was granted, (C) change the class of persons eligible to receive an award of restricted stock or options (and related stock appreciation rights, if any) under the Fitness Plan or (D) extend the duration of the Fitness Plan. The Committee may also amend outstanding awards under the Fitness Plan, but no such amendment may impair the rights of any holder of an award without his or her written consent. No award or option may be granted under the Fitness Plan after December 29, 2004. Incentive stock options and non-qualified stock options may be granted either singly or in combination with the other awards under the Fitness Plan. Each option under the Fitness Plan will be permitted to provide for stock appreciation rights. A stock option granted under the Fitness Plan will be exercisable and subject to such other terms and conditions as the Committee determines. The exercise price for all options shall not be less than 100% of the fair market value of the common stock on the date of the grant. A stock option granted under the Fitness Plan shall not be exercisable more than ten years after the date it was granted. Unless an option provides otherwise, its exercise price may be paid in U.S. dollars by check or bank draft, by tendering shares of common stock already owned by the optionee for at least six months having a fair market value (as defined in the Fitness Plan) on the date of exercise equal to the cash exercise price or by any combination of these two methods. Participants may be awarded shares of common stock in accordance with the Fitness Plan ("Restricted Stock"). Restricted Stock awards may be made in addition to or in lieu of option grants. During a period set by the Committee, and/or until the attainment of performance goals set by the Committee, in each case set at the time of each award of Restricted Stock, a Restricted Stock award recipient is prohibited from selling, transferring, pledging or assigning shares of Restricted Stock, unless the recipient dies, terminates employment by reason of permanent disability (as determined by the Committee), retires after attaining both 59 1/2 years of age and five years of continuous service with the Company or, if provided in the recipient's award agreement, there is a change in control of the Company, as defined therein, in which case, shares of Restricted Stock become free of all restrictions. Unless and to the extent the recipient's award agreement provides otherwise or the Committee determines, in its sole discretion, that forfeiture of a particular award of Restricted Stock might not be in the best interest of the Company, Restricted Stock shall be forfeited if the recipient terminates employment other than under circumstances described in the preceding sentence. 43 In lieu of cash bonuses otherwise payable to eligible employees under the Company's or applicable subsidiaries' compensation practices, the Committee may determine that such bonuses shall be payable in whole or in part in common stock. Any such shares of common stock shall be subject to such terms as the Committee may determine in its sole discretion. Adjustments will be made in the number and class of shares of common stock available under the Fitness Plan, the number and class of shares of common stock under each option and Restricted Stock award and the price of shares subject to outstanding option grants, in each such case to reflect changes in common stock as a result of changes in the Company's corporate structure or capitalization, such as through a merger or stock split. No Restricted Stock awards have been made under the Fitness Plan. Non-qualified stock options to purchase shares of common stock were granted under the Fitness Plan in exchange for options granted under previous Company option plans. In addition, new non-qualified options to purchase shares of common stock have been granted under the Fitness Plan to employees of the Company including the Named Executives. Of such amount, options to purchase shares of common stock were granted as of December 29, 1994 under stock option award agreements that provide that 20% of the options granted thereunder shall vest at the end of each year, so that all such options will have fully vested after 5 years. Of these options, Messrs. Mastrov and Freeman received options to purchase shares and shares of common stock, of Holdings respectively. Non-qualified stock options to purchase shares of Common Stock were also granted as of May 16, 1996 under stock option award agreements that provide that the options granted thereunder shall vest, with respect to one-half of the optioned shares, over 5 years if the Company meets certain performance targets and, with respect to the other half of the optioned shares, upon the occurrence of a liquidation event (including an initial public offering), but, in any event, 8 years from the date of grant, if the option is not previously terminated. Of these options, Messrs. Mastrov and Freeman received options to purchase shares and shares of common stock, respectively. After giving effect to the above grants, there are shares of common stock available to be optioned or awarded under the Fitness Plan. Non-qualified stock options to purchase shares of Common Stock were also granted as of January 1 and April 1, 1998, under stock option award agreements that provide that the options granted thereunder shall vest, with respect to one-half of the optioned shares, over five years if the Company meets certain performance targets and, with respect to the other half of the optioned shares, upon the occurrence of a liquidation event (including an initial public offering), but, in any event, eight years from the date of grant, if the option is not previously terminated. Of these options, Messrs. Mastrov and Freeman received options to purchase shares and shares of common stock, respectively. In addition, non-qualified stock options to purchase an aggregate of shares were granted as of June 23, 1995, February 14, 1997 and April 1, 1998 to Mr. Thompson under stock option award agreements all of which provide that the options granted thereunder shall vest, with respect to one-half of the optioned shares, over 5 years if the Company meets certain performance targets and, with respect to the other half of the optioned shares, upon the occurrence of a liquidation event (including an initial public offering) but, in any event, will vest at various dates through 2006, if the option is not previously terminated. Upon consummation of the Offerings, 50% of the performance-vested options outstanding shall vest, including 50% of the performance-vested options of Messrs. Mastrov, Freeman and Thompson. EMPLOYMENT AGREEMENT. The Company and Mr. Mastrov entered into an employment agreement effective as of January 1, 1997, as amended pursuant to a letter agreement dated December 22, 1997. The agreement sets forth certain terms of employment of Mr. Mastrov as President and Chief Executive Officer of the Company including a base salary of $550,000 and provisions for performance based 44 bonuses, stock options and expenses. The agreement has an initial term of one year and, if not otherwise terminated, is automatically extended for three additional one-year terms. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION In December 1994, the Board of Directors established the Committee to administer the Company's executive compensation program. During fiscal 1997, David E. King, George E. McCown and Peter Roy served as members of the Committee, each of whom are non-employee directors of the Company. 45 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding the beneficial ownership as of April 30, 1998, and as adjusted to reflect the sale by the Company of the Common Stock offered hereby by (i) each person known by the Company to beneficially own more than five percent of the Common Stock, (ii) each of the Company's directors, (iii) each Named Executive and (iv) all directors and executive officers as a group. Except as otherwise noted, the Company believes the persons listed below have sole investment and voting power with respect to the Common Stock owned by them.
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED PRIOR TO THE OFFERINGS AFTER THE OFFERINGS ------------------------------ ---------------------------------- NUMBER OF PERCENT OF TOTAL NUMBER OF PERCENT OF TOTAL NAME OF BENEFICIAL OWNER SHARES VOTING POWER(1) SHARES VOTING POWER - --------------------------------------------------- ----------- ----------------- ------------- ------------------- McCown De Leeuw & Co. III, L.P. (2)(7)............. 55.2% McCown De Leeuw & Co. III (Europe), L.P. (2)(7).... 55.2 McCown De Leeuw & Co. III (Asia), L.P. (2)(7)...... 55.2 Gamma Fund, LLC (2)(7)............................. 55.2 Charles Ayres (2)(7)............................... 55.2 Mark S. Mastrov (3)................................ 16.4 Gilbert K. Freeman (4)............................. 4.6 Ronald Thompson.................................... 2.2 Karen S. Behnke (5)................................ * David E. De Leeuw (2)(7)........................... 55.2 Donald Dorward (6)................................. * Robert B. Hellman, Jr. (2)(7)...................... 55.2 David E. King (2)(7)............................... 55.2 George E. McCown (2)(7)............................ 55.2 Peter Roy (6)...................................... * Leonard B.C. Schlemm (8)........................... 14.5 Gary Schoenfeld.................................... -- William Walsh (6).................................. * Ray A. Wilson...................................... 1.0 Steven Zuckerman (2)(7)............................ 55.2 All directors and executive officers as a group (10 persons)......................................... 89.6
- ------------------------ * Less than 1% 46 (1) The information as to beneficial ownership is based on statements furnished to the Company by the beneficial owners. As used in this table, "beneficial ownership" means the sole or shared power to vote, or direct the voting of a security, or the sole or shared investment power with respect to a security (i.e., the power to dispose of, or direct the disposition of). A person is deemed as of any date to have "beneficial ownership" of any security that such person has the right to acquire within 60 days after such date. For purposes of computing the percentage of outstanding shares held by each person named above, any security that such person has the right to acquire within 60 days of the date of calculation is deemed to be outstanding, but is not deemed to be outstanding for purposes of computing the percentage ownership of any other person. (2) Includes shares owned by McCown De Leeuw & Co. III, L.P., an investment partnership whose general partner is MDC Management Company III, L.P. ("MDC III"), shares held by McCown De Leeuw & Co. III (Europe), L.P., an investment partnership whose general partner is MDC Management Company IIIE, L.P. ("MDC IIIE"), shares held by McCown De Leeuw & Co. III (Asia), L.P., an investment partnership whose general partner is MDC Management Company IIIA, L.P. organized under the laws of California ("MDC IIIA"), and shares owned by Gamma Fund, LLC, a California limited liability company ("Gamma Fund"). The members of Gamma Fund are George E. McCown, David De Leeuw, David E. King, Robert B. Hellman, Jr., Charles Ayres and Steven Zuckerman, who are also the only general partners of MDC III and MDC IIIE and MDC IIIA. Voting and dispositive decisions regarding the Common Stock owned by MDC III and MDC IIIE and MDC IIIA are made by Mr. McCown and Mr. De Leeuw, as Managing General Partners of each of such partnerships, who together have more than the required two-thirds-in-interest vote of the Managing General Partners necessary to effect such decision on behalf of any such entity. Voting and dispositive decisions regarding the Common Stock owned by Gamma Fund are made by a vote or consent of a majority in number of the members of Gamma Fund. No general partner is able to individually direct the voting or disposition of Common Stock beneficially owned by MDC III and MDC Offshore. Messrs. McCown, De Leeuw, King, Hellman, Ayres and Zuckerman have no direct ownership of any shares of Common Stock and disclaim beneficial ownership of any shares of Common Stock except to the extent of their proportionate partnership interests or membership interests (in the case of Gamma Fund). The address of all MDC Entities is c/o McCown De Leeuw & Co., Inc., 3000 Sand Hill Road, Building 3, Suite 290, Menlo Park, California 94025. (3) Includes shares subject to stock options exercisable within 60 days. (4) Includes shares subject to stock options exercisable within 60 days. (5) Includes shares subject to stock options exercisable within 60 days. (6) Includes shares subject to stock options exercisable within 60 days. (7) The foregoing information assumes no exercise of the Underwriters over-allotment options. If the over-allotment options are exercised in full, the number of shares and the percentage of shares beneficially owned by the MDC Entities will be shares and % and shares and %, respectively. (8) The address of Leonard B.C. Schlemm is c/o The Forza Group Limited, Devon House, 58-60 St. Katharine's Way, London E19 9LR, England. 47 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In December 1994, the Company was recapitalized (the "Recapitalization") through a series of transactions. 24 Hour Fitness entered into a Stock Subscription Agreement with the MDC Entities pursuant to which the MDC Entities purchased shares of 24 Hour Fitness for an aggregate consideration of $11.7 million in cash. Simultaneously with this sale, 24 Hour Fitness entered into a Purchase Agreement with each of Mark S. Mastrov, Leonard B.C. Schlemm and Gilbert K. Freeman (the "Management Stockholders"), pursuant to which 24 Hour Fitness agreed to repurchase shares from such stockholders. Prior to the Recapitalization, each of the Management Stockholders was indebted to 24 Hour Fitness pursuant to certain promissory notes in the following amounts: Mr. Mastrov, approximately $156,000, Mr. Schlemm, approximately $156,000 and Mr. Freeman approximately $706,000. Such indebtedness to the Company was cancelled on behalf of each Management Stockholder in exchange for an equivalent reduction in the consideration owed to such Management Stockholder by 24 Hour Fitness for the repurchase of their shares. In connection with the financing of the Recapitalization, certain persons associated with W.E. Myers & Co. were granted warrants (the "Warrants") exercisable into shares of Common Stock for an aggregate price of $ . The Warrants are fully exercisable and expire on December 29, 2004. 24 Hour Fitness entered into a Management Services Agreement (the "Services Agreement") with MDC Management Company III, L.P., a California limited partnership and affiliate of the MDC Entities ("MDC Management") dated December 29, 1994, and amended as of December 18, 1997. Pursuant to the Services Agreement, 24 Hour Fitness has agreed to pay MDC Management a fee in the amount of $350,000 each year, adjusted upward by $100,000 each year until such fee equals $1.0 million per year, subject to certain limitations plus reimbursement for out of pocket expenses, in exchange for services in obtaining equity, debt, lease and acquisition financing, as well as providing other financial and consulting services for the operation and growth of 24 Hour Fitness. The Services Agreement is scheduled to terminate on December 28, 2004, unless otherwise terminated in accordance with its provisions. The Company paid $1.5 million $500,000 and $1.2 million to MDC Management in fiscal 1995, 1996 and 1997, respectively. Of these amounts $350,000, $450,000 and $550,000 represented annual fees paid to MDC Management under the Services Agreement during fiscal 1995, 1996 and 1997, respectively. Remaining amounts include payment of expenses and certain advisory and transactional fees paid to MDC Management in connection with the Recapitalization and the Company's acquisitions. MDC Management will be entitled to a fee in the amount of $650,000 for services rendered pursuant to the Services Agreement during the year ended December 31, 1998. Pursuant to a Stock Purchase Agreement, dated as of June 23, 1995, between the Company, as purchasers, and Family Fitness Holdings Limited Partnership (the "Partnership") and the other sellers named therein, the Company acquired all of the outstanding common stock of Family Fitness which owned 68 fitness centers in three states. Immediately following the Family Fitness Acquisition, Family Fitness merged with and into 24 Hour Fitness. The total purchase price was approximately $80.6 million, including acquisition costs, and consisted of cash of approximately $43.0 million, a seller note of $10.1 million, assumed liabilities of $10.1 million, and shares of common stock then valued at $3.5 million. In addition, the Company was originally required to make "earnout" payments of up to $15.0 million payable in four annual installments, based on achieving certain cumulative earnings levels, of which $3.8 million was paid in 1996. In December 1996, the Company fixed the amount due under the earnout by removing all contingencies and issuing a note payable in the amount of $10.1 million, bearing interest at 9.0% per annum, the last installment of which, in the amount of $3.8 million, is due April 15, 1999. 24 Hour Fitness issued a promissory note dated December 31, 1995 (the "24 Hour II Note") in the principal amount of $4.4 million to the Partnership, which note bears interest at the rate of 9.0% per annum. The 24 Hour II Note matures on November 20, 1998. The indebtedness evidenced by this 24 48 Hour II Note is also subordinated to the prior payment in full in cash of certain debt obligations of 24 Hour Fitness. In June 1998, the Company participated in the re-capitalization of the Forza Group Limited ("FGL"), a company incorporated in England, which, until such recapitalization, had been predominately a distributor of health and fitness equipment within Europe, the Russian Federation and the Middle East. Pursuant to a subscription agreement between, amongst others, the Company and FGL, the Company subscribed for 2,284 convertible preferred shares, par value L1 each, in FGL for total consideration of L1.0 million (or approximately $1.6 million). This represents ownership of approximately 5% in the entire issued share capital of FGL as of June 1, 1998. It is anticipated that the Company will enter into an advisory services agreement under which, for an annual fee, it will provide advisory and management services to FGL. Mr. Mastrov and Mr. Schlemm are shareholders in FGL and have been invited to participate in the FGL share option plan. McCown De Leeuw & Co., Inc. (through certain of its affiliates) holds a majority of the outstanding shares of FGL. Mr. Mastrov is a director and chairman of the board of directors of FGL. McCown De Leeuw Co., Inc. has also agreed (through one of its affiliates) to provide advisory services to FGL for an agreed fee. The Company entered into a consulting agreement with Leonard B.C. Schlemm, a former director of the Company, in December 1994, which was replaced by an agreement on similar terms with Barclay & Page Fitness Consulting Services, Inc., a company of which Mr. Schlemm was a controlling shareholder. The consulting agreements provided for a base consulting fee of up to $200,000 annually, plus an additional fee at the Board of Director's discretion. The consulting agreement was renewed for 1996 and terminated in July 1997 pursuant to its terms. Fees of $970,000, $367,000 and $75,000 were paid for services rendered in fiscal 1995, 1996 and 1997, respectively. In 1992, the Company entered into an arrangement with three companies known as Sportech Health Systems (Sunnyvale), Inc., Sportech Health Systems (Fremont), Inc. and Sportech Health Systems (Larkspur), Inc. (collectively, the "Sportech Entities") pursuant to which such entities provide physical therapy programs in certain of the Company's fitness centers. Mark S. Mastrov and Sandra Schlemm, the wife of Leonard B.C. Schlemm, together owned more than 50% of each Sportech Entity. In September 1994, the Company loaned the Sportech Entities an amount equal to $276,573, which indebtedness was guaranteed by Mr. Mastrov and Ms. Schlemm. In October 1996, the Company acquired all of the outstanding common stock of the Sportech Entities for $530,000, including forgiveness of the outstanding loan and interest payable thereon. The Sportech Entities have since been dissolved. In December 1994, Holdings, the MDC Entities and certain management stockholders (collectively, the "Stockholders") entered into a Stockholders Agreement (the "Stockholders Agreement"). The Stockholders Agreement contains, among other things, restrictions on the transfer of shares of the Common Stock of Holdings, certain registration rights with respect to such Common Stock and matters related to the election of the Board of Directors of Holdings. In July 1998, the MDC Entities and the Company entered into a Registration Rights Agreement (the "Registration Rights Agreement") pursuant to which the MDC Entities may require the Company to file registration statements with respect to shares of Common Stock held by the MDC Entities and the Holders. The registration rights provisions of the Stockholders Agreement and the Registration Rights Agreement provide that the Stockholders and/or the MDC Entities may require Holdings to use its best efforts to include shares owned by them in one or more registered offerings, other than in connection with an initial public offering, of equity securities of Holdings, subject to marketing restrictions determined by the managing underwriter. Prior to February 1996, the Company leased its corporate headquarters at 6668 Owens Drive, Pleasanton, California, from Mr. Mastrov and Ms. Schlemm pursuant to an Operating Lease Agreement dated as of December 20, 1991. The annual rent paid by the Company in fiscal 1994 and 1995 was 49 $246,600 and $285,000, respectively and the rent paid by the Company in the first two months of fiscal 1996 was $49,960. In February 1996, the building was sold by Mr. Mastrov and Ms. Schlemm to an independent third party, which has continued to lease such premises to the Company. The Company currently leases its administrative office for its Southern California division, which is located in Carlsbad, California, from T.I.F.F. Investors, Ltd. ("TIFF"), a California limited partnership. Lease payments of $290,000, $727,000 and $760,000 were made to TIFF in fiscal 1995, 1996 and 1997, respectively. The limited partners of TIFF include Ray A. Wilson, a director of the Company. This lease is scheduled to expire in September 2001. The Company paid $132,000, $264,000 and $272,000 in fiscal 1995, 1996 and 1997, respectively, for the lease of club facilities owned by shareholders of the Company, including Mr. Wilson. In fiscal 1997, the Company paid $195,000 in interest and $920,000 in principal to Ronald Thompson, the Company's Chief Operating Officer, related to notes payable issued in conjunction with the Family Fitness Acquisition. In March 1997, Holdings paid $1.7 million to repurchase shares of Common Stock from Mr. Wilson and simultaneously acquired an option to purchase Mr. Wilson's remaining shares. In June 1998, the Company agreed to buy an additional shares of Common Stock from Mr. Wilson at a price of $ per share. In fiscal 1997, the Company declared and paid three cash distributions under a single plan of recapitalization to stockholders totaling $57.5 million. At the time of these distributions, notes receivable from Mr. Freeman in the amount of $200,000 plus interest thereon were repaid. In fiscal 1997, the Company incurred $867,000 of construction costs to build a fitness club on land owned by Mr. Wilson. Of this amount, $336,000 related to architectural and engineering costs which have no future benefit to Mr. Wilson. The Company ultimately decided to abandon the construction project and recorded a write-off of the costs incurred as general and administrative expenses in fiscal 1997. 50 SHARES ELIGIBLE FOR FUTURE SALE The market price of the Common Stock could be adversely affected by the availability for sale of shares held by the MDC Entities, certain executive officers and other existing stockholders of the Company. Collectively, these stockholders will own approximately % of the outstanding Common Stock (approximately % if the Underwriters' over-allotment option is exercised in full), after the Offerings. The MDC Entities, such executive officers and certain other existing stockholders of the Company have agreed not to sell such shares for a period of 180 days following the date of the Offerings without the prior written consent of Goldman Sachs, on behalf of the Representatives of the Underwriters. After expiration of such 180-day period such shares may be sold in accordance with Rule 144 (subject to the holding period and volume limitations of such Rule) promulgated under the Securities Act, or upon registration under the Securities Act without regard to the holding period and volume limitations of Rule 144. In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated), including an "affiliate," who has paid for shares is entitled, beginning two years from the later of the date of acquisition of the shares from the Company or from an affiliate of the Company, to sell within any three-month period up to that number of shares that does not exceed the greater of (i) one percent of the shares outstanding, as shown by the most recent report or statement published by the Company, and (ii) the average weekly reported volume of trading in the shares during the four calendar weeks preceding the date on which notice of sale is filed with the Securities and Exchange Commission. A person (or persons whose shares are aggregated) who is not deemed an affiliate of the Company and who has paid for his shares is entitled, beginning three years from the later of the date of the acquisition from the Company or from an affiliate of the Company, to sell such shares under Rule 144(k) without regard to the volume limitations described above. Affiliates continue to be subject to such volume limitations after the three-year holding period. The MDC Entities acquired their shares of Common Stock on December 29, 1994. Pursuant to (i) the Stockholders Agreement between the Company and the Holders, and (ii) the Registration Rights Agreement between the Company and the MDC Entities, the Holders and the MDC Entities are entitled to certain rights with respect to registration of such shares under the Securities Act. If the Company proposes to register any of its securities under the Securities Act, either for its own account or for the account of other security holders, the Holders are entitled to notice of the registration and are entitled to include, at the Company's expense, such shares therein, provided, among other conditions, that the underwriters of any offering have the right to limit the number of shares included in the registration. In addition, the Registration Rights Agreement provides that, under certain circumstances, the MDC Entities may require the Company to file a registration statement with respect to the shares of Common Stock held by the MDC Entities and the Holders. Following the Offerings, the Company intends to file registration statements under the Securities Act to register shares of Common Stock issuable upon the exercise of stock options granted under the Fitness Plan. Shares issued upon the exercise of stock options after the effective date of such registration statement generally will be available for sale in the open market. Immediately following the completion of the Offerings, the Company estimates that there will be shares issuable upon the exercise of options outstanding under the Fitness Plan and shares of Common Stock reserved for future grants of options. The Company is unable to estimate the number of shares that may be sold under Rule 144 or otherwise because this will depend on the market price for the Common Stock of the Company, the individual circumstances of the sellers and other factors. Prior to the Offerings, there has been no public market for the Common Stock. Future sales of shares of Common Stock or the availability for sale of substantial amounts of Common Stock, or the perception that such sales could occur, could adversely affect prevailing market prices for the Common Stock and could impair the Company's future ability to raise capital through an offering of its equity securities. 51 DESCRIPTION OF CAPITAL STOCK The following brief description of the Company's capital stock does not purport to be complete and is subject in all respects to applicable Delaware law and to the provisions of the Company's Certificate of Incorporation and By-laws, copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part. The authorized capital stock of the Company consists of shares of Voting Common Stock (the "Common Stock"), par value $.001 per share, and shares of Preferred Stock, par value $ per share (the "Preferred Stock"). Immediately following the completion of the Offerings, there will be outstanding shares of Common Stock and shares of Common Stock reserved for issuance upon exercise of outstanding options and warrants. COMMON STOCK Holders of the Common Stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Holders of Common Stock do not have cumulative voting rights and therefore holders of a majority of the shares voting for the election of directors can elect all of the directors. In such event, the holders of the remaining shares will not be able to elect any directors. Holders of the Common Stock are entitled to receive such dividends as may be declared from time to time by the Board of Directors out of funds legally available therefor, subject to the terms of the agreements governing the Company's long-term debt. The Company does not anticipate paying cash dividends in the foreseeable future. See "Dividend Policy." In the event of the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities. The Common Stock has no preemptive, conversion or redemption rights and is not subject to further calls or assessments by the Company. Immediately upon consummation of the Offerings, all of the then outstanding shares of Common Stock will be validly issued, fully paid and nonassessable. The Transfer Agent and Registrar for the Common Stock is . PREFERRED STOCK The Board of Directors has the authority, without any vote or action by the stockholders, to issue Preferred Stock in one or more series and to fix the designations, preferences, rights, qualifications, limitations and restrictions thereof, including the voting rights, dividend rights, dividend rate, conversion rights, terms of redemption (including sinking fund provisions), redemption price or prices, liquidation preferences and the number of shares constituting any series. In addition, the issuance of Preferred Stock by the Board of Directors could be utilized, under certain circumstances, as a method of preventing a takeover of the Company. There are no shares of Preferred Stock outstanding, and there are no agreements or understandings for the designation of any series of Preferred Stock or the issuance of shares thereunder. WARRANTS In connection with the financing of the Recapitalization, certain persons associated with W.E. Myers & Co. were granted the Warrants exercisable into shares of Common Stock for an aggregate purchase price of $ . The Warrants are fully exercisable and expire on December 29, 2004. 52 DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS In the Certificate of Incorporation, Holdings has expressly elected not to be governed by Section 203 of Delaware Law, which imposes certain restrictions with respect to business combinations with interested stockholders. The Certificate of Incorporation and the By-laws contain provisions which may have the effect of delaying, deferring or preventing a change in control of Holdings. Such provisions (i) authorize the Board of Directors to issue preferred stock in series, with the terms of each series to be fixed by the Board of Directors and (ii) permit directors to be removed only for cause. Accordingly, these provisions related to a classified board could also delay, defer or prevent a change in control of Holdings. LIMITATION OF LIABILITY AND INDEMNIFICATION AGREEMENTS The Certificate of Incorporation provides that to the fullest extent permitted by Delaware Law, a director of Holdings shall not be liable to Holdings or its stockholders for monetary damages for breach of fiduciary duty as a director. Under current Delaware Law, liability of a director may not be limited (i) for any breach of the director's duty of loyalty to Holdings or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) in respect of unlawful dividend payments or stock redemptions or repurchases, and (iv) for any transaction from which the director derives an improper personal benefit. The effect of the provision of the Certificate of Incorporation is to eliminate the rights of Holdings and its stockholders (through stockholders' derivative suits on behalf of Holdings) to recover monetary damages against a director for breach of the fiduciary duty of care as a director (including breaches resulting from negligent or grossly negligent behavior) except in the situations described in clauses (i) through (iv) above. This provision does not limit or eliminate the rights of Holdings or any stockholder to seek nonmonetary relief such as an injunction or rescission in the event of a breach of a director's duty of care. In addition, the By-laws provide that Holdings shall indemnify its directors, officers, employees and agents to the fullest extent permitted by Delaware Law. In addition, prior to the consummation of the Offerings, Holdings will enter into agreements (the "Indemnification Agreements") with each of the directors and officers of Holdings pursuant to which Holdings agrees to indemnify such director or officer from claims, liabilities, damages, expenses, losses, costs, penalties or amounts paid in settlement incurred by such director or officer and arising out of his capacity as a director, officer, employee and/or agent of the corporation of which he is a director or officer to the maximum extent provided by applicable law. Furthermore, such director or officer shall be entitled to an advance of expenses to the maximum extent authorized or permitted by law to meet the obligations indemnified against. The Indemnification Agreements also obligate Holdings to purchase and maintain insurance for the benefit and on behalf of its directors and officers insuring against all liabilities that may be incurred by such director or officer in or arising out of his capacity as a director, officer, employee and/ or agent of Holdings. To the extent that the Board of Directors or the stockholders of Holdings may in the future wish to limit or repeal the ability of Holdings to indemnify directors and officers, such repeal or limitation may not be effective as to directors and officers who are currently parties to the Indemnification Agreements, because their rights to full protection are contractually assured by the Indemnification Agreements. It is anticipated that similar contracts may be entered into, from time to time, with future directors and officers of Holdings. Holdings maintains a standard policy of officers' and directors' liability insurance. 53 LEGAL MATTERS The validity of the Common Stock will be passed upon for the Company, by White & Case LLP, New York, New York. Certain legal matters relating to the Offerings will be passed upon for the Underwriters by Shearman & Sterling, New York, New York. EXPERTS The consolidated financial statements of the Company as of fiscal 1996 and 1997 and for each of the three years in the period ended December 31, 1997 and the financial statements for Northwest Fitness, Inc. as of and for the year ended December 31, 1996 and as of and for the five months ended May 31, 1997 and the consolidated financial statements for Family Fitness Holding Company, Inc. as of and for the nine months ended June 30, 1995, included in this Prospectus, have been audited by Deloitte & Touche LLP, independent auditors, as stated in their reports appearing herein, and have been so included in reliance upon the reports of such firm, given upon their authority as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed a registration statement on Form S-1 (the "Registration Statement," which term encompasses all amendments, exhibits and schedules thereto) with respect to the shares of Common Stock offered hereby with the United States Securities and Exchange Commission (the "Commission") under the Securities Act. This Prospectus, which constitutes a part of the Registration Statement, does not contain all the information set forth in the Registration Statement, certain items of which are contained in schedules and exhibits to the Registration Statement as permitted by the rules and regulations of the Commission. Statements contained in this Prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete. With respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. The Registration Statement may be inspected and copied at the Public Reference Room of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the following regional offices of the Commission: 7 World Trade Center, New York, New York 10048, and Northwest Atrium Center, SW West Madison Street, Chicago, Illinois 60606. Copies of such material can be obtained from the Public Reference Section of the Commission at its Washington address at prescribed rates. Upon completion of the Offerings, the Company will be subject to the informational reporting requirements of the Securities Exchange Act of 1934, as amended. In addition, the Commission maintains a World Wide Web site on the Internet at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants that file electronically with the commission. The Company intends to furnish to its stockholders annual reports containing consolidated financial statements of the Company audited by its independent accountants and quarterly reports containing unaudited condensed consolidated financial statements for each of the first three quarters of each fiscal year. 54 INDEX TO FINANCIAL STATEMENTS FITNESS HOLDINGS, INC.
PAGE --------- Independent Auditors' Report............................................................................... F-2 Consolidated Balance Sheets at December 31, 1996 and 1997 and March 31, 1998 (unaudited)................... F-3 Consolidated Statements of Operations for the Years Ended December 31, 1995, 1996 and 1997 and for the Unaudited Three Months Ended March 31, 1997 and 1998..................................................... F-4 Consolidated Statements of Changes in Stockholders' Deficit for the Years Ended December 31, 1995, 1996 and 1997 and for the Unaudited Three Months Ended March 31, 1997 and 1998.................................... F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1996 and 1997 and for the Unaudited Three Months Ended March 31, 1997 and 1998..................................................... F-6 Notes to Consolidated Financial Statements................................................................. F-7 NORTHWEST FITNESS, INC. Independent Auditors' Report............................................................................... F-21 Balance Sheets at December 31, 1996 and May 31, 1997....................................................... F-22 Statements of Operations for the Year Ended December 31, 1996 and the Five Months Ended May 31, 1997....... F-23 Statements of Changes in Stockholders' Equity (Deficit) for the Year Ended December 31, 1996 and the Five Months Ended May 31, 1997................................................................................ F-24 Statements of Cash Flows for the Year Ended December 31, 1996 and the Five Months Ended May 31, 1997....... F-25 Notes to Financial Statements.............................................................................. F-26 FAMILY FITNESS HOLDING COMPANY, INC. Independent Auditors' Report............................................................................... F-31 Consolidated Balance Sheet at June 30, 1995................................................................ F-32 Consolidated Statement of Operations for the Nine Months Ended June 30, 1995............................... F-33 Consolidated Statement of Changes in Stockholders' Deficit for the Nine Months Ended June 30, 1995......... F-34 Consolidated Statement of Cash Flows for the Nine Months Ended June 30, 1995............................... F-35 Notes to Consolidated Financial Statements................................................................. F-36
F-1 The accompanying consolidated financial statements will give effect to an increase in the number of authorized shares into a to be determined amount and the related exchange of each share of common stock of the Company into a to be determined amount of shares of common stock in August 1998. Accordingly, certain share and per share amounts in the accompanying financial statements have been left blank pending determination of such amounts. The above opinion is in the form which will be signed by Deloitte & Touche LLP upon completion of such exchange of the Company's outstanding common stock described in Note 14 to the consolidated financial statements and assuming that from July 7, 1998 to the date of such completion, no other material events have occurred that would affect the accompanying consolidated financial statements or required disclosure therein. Deloitte & Touche LLP San Francisco, California July 7, 1998 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Fitness Holdings, Inc. Pleasanton, California: We have audited the accompanying consolidated balance sheets of Fitness Holdings, Inc. and its subsidiary (the "Company") as of December 31, 1996 and 1997, and the related consolidated statements of operations, changes in stockholders' deficit, and cash flows for each of the three years in the period ended December 31, 1997. These consolidated 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 in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Fitness Holdings, Inc. and its subsidiary as of December 31, 1996 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. San Francisco, California June 4, 1998 (August , 1998 as to Note 14) F-2 FITNESS HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ---------------------------- MARCH 31, 1996 1997 1998 ------------- ------------- ------------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash............................................................... $ 1,369,000 $ 4,584,000 $ 7,119,000 Accounts receivable................................................ 3,102,000 2,892,000 3,321,000 Prepaid expenses and other......................................... 3,371,000 5,220,000 4,786,000 Deferred income taxes.............................................. 11,812,000 14,532,000 15,977,000 Deferred membership origination costs.............................. 10,947,000 17,042,000 18,644,000 ------------- ------------- ------------- Total current assets............................................. 30,601,000 44,270,000 49,847,000 ------------- ------------- ------------- PROPERTY AND EQUIPMENT--Net.......................................... 69,316,000 86,574,000 94,856,000 GOODWILL AND OTHER INTANGIBLE ASSETS--Net............................ 62,014,000 65,051,000 68,665,000 DEFERRED INCOME TAXES................................................ 16,581,000 24,092,000 24,801,000 DEFERRED MEMBERSHIP ORIGINATION COSTS................................ 9,383,000 13,131,000 14,366,000 OTHER ASSETS......................................................... 4,793,000 13,953,000 14,377,000 ------------- ------------- ------------- TOTAL ASSETS......................................................... $ 192,688,000 $ 247,071,000 $ 266,912,000 ------------- ------------- ------------- ------------- ------------- ------------- LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES Accounts payable................................................... $ 11,642,000 $ 10,948,000 $ 9,783,000 Accrued expenses................................................... 18,468,000 23,093,000 29,854,000 Deferred revenues.................................................. 47,895,000 70,583,000 78,969,000 Current portion of long-term debt (including notes to related parties of $4,987,000, $4,691,000 and $4,310,000 (unaudited) in 1996, 1997 and 1998)............................................. 5,090,000 4,894,000 6,981,000 Other.............................................................. 305,000 125,000 147,000 ------------- ------------- ------------- Total current liabilities........................................ 83,400,000 109,643,000 125,734,000 ------------- ------------- ------------- DEFERRED REVENUES.................................................... 25,044,000 34,215,000 38,298,000 DEFERRED RENT........................................................ 4,335,000 7,827,000 8,709,000 LONG-TERM DEBT (Including notes to related parties of $22,939,000, $18,129,000 and $18,129,000 (unaudited) in 1996, 1997 and 1998).... 110,002,000 200,395,000 202,877,000 OTHER (Including obligations to related parties of $1,838,000, $621,000 and $579,000 (unaudited) in 1996, 1997 and 1998).......... 2,553,000 827,000 711,000 COMMITMENTS AND CONTINGENCIES (Note 12) ------------- ------------- ------------- TOTAL LIABILITIES.................................................... 225,334,000 352,907,000 376,329,000 ------------- ------------- ------------- STOCKHOLDERS' DEFICIT: Common stock, $.001 par value, 10,000,000 shares authorized, 2,262,000, 2,292,000 and 2,292,000 (unaudited) shares issued and 2,262,000, 2,248,000 and 2,248,000 shares outstanding............ 2,000 2,000 2,000 Capital deficit.................................................... (7,403,000) (7,145,000) (7,145,000) Treasury stock..................................................... -- (1,713,000) (1,713,000) Unearned compensation.............................................. -- (3,752,000) (3,602,000) Accumulated deficit................................................ (25,245,000) (93,228,000) (96,959,000) ------------- ------------- ------------- Total stockholders' deficit...................................... (32,646,000) (105,836,000) (109,417,000) ------------- ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT.......................... $ 192,688,000 $ 247,071,000 $ 266,912,000 ------------- ------------- ------------- ------------- ------------- -------------
See notes to consolidated financial statements. F-3 FITNESS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS YEAR ENDED DECEMBER 31, ENDED MARCH 31, ------------------------------------------- -------------------------- 1995 1996 1997 1997 1998 ------------- ------------- ------------- ------------ ------------ (UNAUDITED) NET REVENUES: Membership revenues.................. $ 108,668,000 $ 196,573,000 $ 258,776,000 $ 61,696,000 $ 78,674,000 Change in deferred revenues (Note 6)................................. (18,683,000) (32,403,000) (31,069,000) (10,131,000) (10,909,000) ------------- ------------- ------------- ------------ ------------ Net membership revenues............ 89,985,000 164,170,000 227,707,000 51,565,000 67,765,000 Ancillary revenues................... 8,009,000 15,839,000 34,197,000 6,425,000 12,889,000 ------------- ------------- ------------- ------------ ------------ Total net revenues................. 97,994,000 180,009,000 261,904,000 57,990,000 80,654,000 ------------- ------------- ------------- ------------ ------------ OPERATING EXPENSES: Fitness center operating expenses.... 83,947,000 162,054,000 226,809,000 50,981,000 70,598,000 General and administrative expenses........................... 17,441,000 24,830,000 30,866,000 6,386,000 7,585,000 Depreciation and amortization........ 7,447,000 13,653,000 20,244,000 4,133,000 5,391,000 Provision for severance.............. 3,600,000 635,000 Change in deferred membership origination costs (Note 6)......... (5,838,000) (10,244,000) (9,843,000) (2,598,000) (2,838,000) ------------- ------------- ------------- ------------ ------------ Total operating expenses........... 102,997,000 193,893,000 268,711,000 58,902,000 80,736,000 ------------- ------------- ------------- ------------ ------------ LOSS FROM OPERATIONS................... (5,003,000) (13,884,000) (6,807,000) (912,000) (82,000) INTEREST EXPENSE....................... 5,600,000 9,280,000 18,372,000 2,917,000 5,280,000 DEBT OFFERING COSTS (Note 8)........... -- -- 999,000 -- -- ------------- ------------- ------------- ------------ ------------ LOSS BEFORE INCOME TAXES............... (10,603,000) (23,164,000) (26,178,000) (3,829,000) (5,362,000) INCOME TAX BENEFIT..................... 3,853,000 8,394,000 9,171,000 1,371,000 1,631,000 ------------- ------------- ------------- ------------ ------------ NET LOSS............................... $ (6,750,000) $ (14,770,000) $ (17,007,000) $ (2,458,000) $ (3,731,000) ------------- ------------- ------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------ NET LOSS PER SHARE: Basic: Diluted: WEIGHTED AVERAGE SHARES OUTSTANDING: Basic................................ ------------- ------------- ------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------ Diluted.............................. ------------- ------------- ------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------
See notes to consolidated financial statements. F-4 FITNESS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
COMMON STOCK TOTAL ------------------------ CAPITAL TREASURY UNEARNED ACCUMULATED STOCKHOLDERS' SHARES AMOUNT DEFICIT STOCK COMPENSATION DEFICIT DEFICIT ----------- ----------- ------------ ----------- -------------- ------------- -------------- BALANCE, January 1, 1995.................. 3,049,000 $ 3,000 $ 76,000 $ -- $ -- $ (3,725,000) $ (3,646,000) EXERCISE OF STOCK OPTIONS............... 2,000 20,000 -- -- -- 20,000 ISSUANCE OF COMMON STOCK................. 368,000 3,499,000 -- -- -- 3,499,000 REPURCHASE OF COMMON STOCK (Note 9)........ (1,157,000) (1,000) (10,999,000) -- -- -- (11,000,000) NET LOSS................ -- -- -- -- -- (6,750,000) (6,750,000) ----------- ----------- ------------ ----------- -------------- ------------- -------------- BALANCE, December 31, 1995.................. 2,262,000 2,000 (7,404,000) -- -- (10,475,000) (17,877,000) EXERCISE OF STOCK OPTIONS............... -- -- 1,000 -- -- -- 1,000 NET LOSS................ -- -- -- -- -- (14,770,000) (14,770,000) ----------- ----------- ------------ ----------- -------------- ------------- -------------- BALANCE, December 31, 1996.................. 2,262,000 2,000 (7,403,000) -- -- (25,245,000) (32,646,000) EXERCISE OF STOCK OPTIONS............... 30,000 -- 258,000 -- -- -- 258,000 TAX BENEFIT ON EXERCISE OF STOCK OPTIONS...... -- -- -- -- -- 838,000 838,000 REPURCHASE OF COMMON STOCK (Note 9)........ (44,000) -- -- $(1,713,000) -- -- (1,713,000) DISTRIBUTIONS TO STOCKHOLDERS (Note 9).................... -- -- -- -- -- (57,486,000) (57,486,000) STOCK OPTIONS GRANTED AT LESS THAN FAIR VALUE (Note 10)............. -- -- -- -- $ (3,752,000) 5,672,000 1,920,000 NET LOSS................ -- -- -- -- (17,007,000) (17,007,000) ----------- ----------- ------------ ----------- -------------- ------------- -------------- BALANCE, December 31, 1997.................. 2,248,000 2,000 (7,145,000) (1,713,000) (3,752,000) (93,228,000) (105,836,000) AMORTIZATION OF UNEARNED COMPENSATION (Unaudited)........... -- -- -- -- 150,000 -- 150,000 NET LOSS (Unaudited).... -- -- -- -- (3,731,000) (3,731,000) ----------- ----------- ------------ ----------- -------------- ------------- -------------- BALANCE, March 31, 1998 (Unaudited)........... 2,248,000 $ 2,000 $ (7,145,000) $(1,713,000) $ (3,602,000) $ (96,959,000) $(109,417,000) ----------- ----------- ------------ ----------- -------------- ------------- -------------- ----------- ----------- ------------ ----------- -------------- ------------- --------------
See notes to consolidated financial statements. F-5 FITNESS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH YEAR ENDED DECEMBER 31, 31, -------------------------------------------- ------------- 1995 1996 1997 1997 ------------- ------------- -------------- ------------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss................................................... $ (6,750,000) $ (14,770,000) $ (17,007,000) $ (2,458,000) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization............................ 7,447,000 13,653,000 20,244,000 4,133,000 Amortization of debt issuance costs...................... 832,000 1,172,000 2,092,000 355,000 Provision for deferred income taxes...................... (3,303,000) (9,177,000) (9,367,000) 537,000 Amortization of unearned compensation.................... -- -- 1,920,000 -- Write-off of debt offering costs......................... -- -- 999,000 Provision for severance.................................. -- 3,600,000 635,000 -- Write-off of intangible assets........................... -- -- 1,645,000 -- Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable.................................... (136,000) (860,000) 210,000 (392,000) Prepaid expenses and other............................. (153,000) 1,245,000 (4,395,000) 115,000 Accounts payable and accrued expenses.................. (1,228,000) 1,325,000 1,211,000 (6,785,000) Deferred rent and other liabilities.................... 688,000 2,008,000 3,492,000 589,000 Deferred membership origination costs.................. (5,838,000) (10,244,000) (9,843,000) (2,598,000) Deferred revenue....................................... 18,683,000 32,403,000 31,069,000 10,131,000 Other.................................................. (767,000) (1,214,000) (1,262,000) (277,000) ------------- ------------- -------------- ------------- Net cash provided by operating activities............ 9,475,000 19,141,000 21,643,000 3,350,000 ------------- ------------- -------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment........................ (11,077,000) (19,689,000) (27,681,000) (10,098,000) Acquisition of businesses, net of cash acquired............ (41,385,000) (21,885,000) (11,760,000) (157,000) Proceeds from investment maturities........................ 4,000,000 -- -- -- ------------- ------------- -------------- ------------- Net cash used in investing activities................ (48,462,000) (41,574,000) (39,441,000) (10,255,000) ------------- ------------- -------------- ------------- ------------- ------------- -------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (payments) under revolving credit agreement................................................ 1,977,000 28,359,000 (24,900,000) 14,052,000 Proceeds from long-term borrowings......................... 63,350,000 -- 275,000,000 100,000,000 Debt issuance costs........................................ (3,368,000) (236,000) (9,525,000) (3,816,000) Repayments of long-term borrowings......................... (19,350,000) (6,364,000) (160,106,000) (87,985,000) Principal payments on (proceeds from) equipment notes payable and capital leases............................... (1,677,000) (769,000) (515,000) 120,000 Distributions to stockholders.............................. -- -- (57,486,000) (12,500,000) Repurchase of common stock................................. (11,000,000) -- (1,713,000) (1,713,000) Proceeds from exercise of stock options.................... 20,000 1,000 258,000 -- ------------- ------------- -------------- ------------- Net cash provided by financing activities............ 29,952,000 20,991,000 21,013,000 8,158,000 ------------- ------------- -------------- ------------- NET INCREASE (DECREASE) IN CASH.............................. (9,035,000) (1,442,000) 3,215,000 1,253,000 CASH, BEGINNING OF YEAR...................................... 11,846,000 2,811,000 1,369,000 1,369,000 ------------- ------------- -------------- ------------- CASH, END OF YEAR............................................ $ 2,811,000 $ 1,369,000 $ 4,584,000 $ 2,622,000 ------------- ------------- -------------- ------------- ------------- ------------- -------------- ------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for interest................................. $ 3,489,000 $ 8,563,000 $ 14,447,000 $ 1,905,000 Cash payments for (refunds of) taxes....................... 955,000 1,134,000 (250,000) -- Property and equipment acquired in exchange for equipment notes payable............................................ 947,000 413,000 228,000 228,000 Acquisitions of businesses (see Note 2) Liabilities assumed and incurred......................... 31,484,000 1,684,000 790,000 -- Stockholder note issued.................................. 10,100,000 10,063,000 -- -- Debt issued and assumed.................................. 1,980,000 4,835,000 392,000 -- Stock issued............................................. 3,499,000 -- -- -- 1998 ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss................................................... $ (3,731,000) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization............................ 5,391,000 Amortization of debt issuance costs...................... 442,000 Provision for deferred income taxes...................... (2,154,000) Amortization of unearned compensation.................... 150,000 Write-off of debt offering costs......................... -- Provision for severance.................................. -- Write-off of intangible assets........................... -- Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable.................................... (429,000) Prepaid expenses and other............................. (423,000) Accounts payable and accrued expenses.................. 5,746,000 Deferred rent and other liabilities.................... 633,000 Deferred membership origination costs.................. (2,837,000) Deferred revenue....................................... 10,909,000 Other.................................................. 8,000 ------------- Net cash provided by operating activities............ 13,705,000 ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment........................ (7,316,000) Acquisition of businesses, net of cash acquired............ (8,425,000) Proceeds from investment maturities........................ -- ------------- Net cash used in investing activities................ (15,741,000) ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (payments) under revolving credit agreement................................................ 5,000,000 Proceeds from long-term borrowings......................... -- Debt issuance costs........................................ -- Repayments of long-term borrowings......................... -- Principal payments on (proceeds from) equipment notes payable and capital leases............................... (429,000) Distributions to stockholders.............................. -- Repurchase of common stock................................. -- Proceeds from exercise of stock options.................... -- ------------- Net cash provided by financing activities............ 4,571,000 ------------- NET INCREASE (DECREASE) IN CASH.............................. 2,535,000 CASH, BEGINNING OF YEAR...................................... 4,584,000 ------------- CASH, END OF YEAR............................................ $ 7,119,000 ------------- ------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for interest................................. $ 1,626,000 Cash payments for (refunds of) taxes....................... -- Property and equipment acquired in exchange for equipment notes payable............................................ -- Acquisitions of businesses (see Note 2) Liabilities assumed and incurred......................... 1,560,000 Stockholder note issued.................................. -- Debt issued and assumed.................................. -- Stock issued............................................. --
See notes to consolidated financial statements. F-6 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 1. DESCRIPTION OF THE COMPANY AND ACCOUNTING POLICIES Fitness Holdings, Inc., ( the "Company"), a Delaware corporation, was formed in November 1994 as a holding company for its wholly owned subsidiary, 24 Hour Fitness, Inc. At March 31, 1998, the Company owned and operated 172 fitness centers in California, Colorado, Hawaii, Nevada, Oregon, Texas and Washington. The Company operates its fitness centers under the name "24 Hour Fitness." BASIS OF PRESENTATION--The Company maintains its accounting records on the accrual basis of accounting. The consolidated financial statements include the accounts of Fitness Holdings, Inc. and its wholly-owned subsidiary. All intercompany balances and transactions have been eliminated in consolidation. INTERIM FINANCIAL INFORMATION--The unaudited condensed consolidated financial statements included herein as of March 31, 1998 and for the three-month periods ended March 31, 1997 and 1998 have been prepared from the records of the Company without audit, and in the opinion of management, include all adjustments (consisting of only normal recurring accruals) necessary to present fairly the consolidated financial position at March 31, 1998, and the consolidated results of operations and cash flows for the three-month periods ended March 31, 1997 and 1998. The results for the three-month periods are not indicative of the results to be expected for the full year or for any other interim period. USE OF ESTIMATES--The preparation of financial statements in conformity with generally accepted accounting principles 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 date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. PROPERTY AND EQUIPMENT are stated at cost (estimated fair value at the date of acquisition for acquired assets) and depreciated using the straight-line method over estimated useful lives of 5 to 8 years. Leasehold improvements are amortized over the lesser of the lease term or estimated useful life of the improvements. Whenever events or changes in circumstances indicate that the carrying amount of its assets may not be recoverable, the Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews for impairment the carrying value of its long-lived identifiable assets and related intangibles to be held and used in the future. DEBT ISSUANCE COSTS are amortized over the terms of the related credit agreements (see Note 8). Interest expense for the years ended December 31, 1995, 1996 and 1997 includes $832,000, $1,172,000 and $2,092,000 of such amortization, respectively. INTANGIBLE ASSETS--Goodwill related to acquisitions is amortized on a straight-line basis over 20-40 years. Membership lists are amortized on a straight-line basis over the estimated membership periods, ranging from 2 to 4 years. Favorable lease rights are amortized over the related lease terms. Whenever events or changes in circumstances indicate that the carrying amount of its assets may not be recoverable, the Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews for impairment the carrying value of its long-lived identifiable assets and related intangibles to be held and used in the future. Additionally, the Company periodically assesses the recoverability of the carrying value of its goodwill, based on a review of projected, undiscounted cash flows of the related operations. F-7 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 1. DESCRIPTION OF THE COMPANY AND ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION--The Company charges members non-refundable one-time initiation fees and monthly membership dues. New member initiation fees are deferred and recognized in operations on a straight line basis over the average expected life of the memberships, currently estimated at 32 months. Membership dues are recognized as revenue in the period in which services are provided. Membership dues received in advance are recorded as deferred revenue and recognized on a straight-line basis over the term during which services are provided. Ancillary revenues include retail sales and fees for personal training, nutritional counseling and other services, and are recognized as revenues in the period in which services are provided. DEFERRED RENT--The Company leases premises for all of its fitness centers. A number of the leases include scheduled base rent increases over their term. The total amount of base rent payments, including scheduled increases, is expensed straight-line over the term of the leases. Deferred rent represents the excess of such amounts over actual cash payments. FITNESS CENTER OPERATING EXPENSES--Included in fitness center operating expenses is the cost of sales of merchandise inventories of $809,000, $2,320,000 and $5,248,000 for the years ended December 31, 1995, 1996 and 1997, respectively. Deferred membership origination costs, substantially all of which are sales commissions, are deferred and amortized on a straight-line basis over the average expected life of the memberships. ADVERTISING--The Company expenses the production costs of advertising the first time the advertising takes place. Advertising expense was $9,432,000, $17,691,000 and $19,007,000 for the years ended December 31, 1995, 1996 and 1997. INCOME TAXES--The Company accounts for income taxes under the asset and liability method (see Note 11). STOCK-BASED COMPENSATION--The Company measures compensation expense for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25") (see Note 10). FAIR VALUE OF FINANCIAL INSTRUMENTS--The carrying value of cash, accounts receivable, accounts payable and long-term debt approximate their estimated fair values. To estimate the fair value of long-term debt, the Company uses those interest rates that are currently available to it for issuance of debt with similar terms and remaining maturities. RECLASSIFICATIONS--Certain 1995 and 1996 amounts have been reclassified to conform with the 1997 presentation. NET LOSS PER SHARE--In 1997, the Company adopted the provisions of Statement of Financial Accounting Standards No. 128, EARNINGS PER SHARE ("SFAS 128"), which superseded APB Opinion No. 15. Net loss per share for all periods presented reflects the adoption of SFAS 128. SFAS 128 requires companies to present basic earnings per share and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if options to issue common stock or other dilutive securities were exercised into common stock. Basic earnings per share and diluted earnings per share are F-8 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 1. DESCRIPTION OF THE COMPANY AND ACCOUNTING POLICIES (CONTINUED) equivalent in 1995, 1996 and 1997 and for the unaudited three month periods ended March 31, 1997 and 1998 because of net losses in each period. NEW ACCOUNTING PRONOUNCEMENTS--In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), REPORTING COMPREHENSIVE INCOME, which prescribes standards for reporting comprehensive income and its components. Comprehensive income consists of net income or loss for the current period and other comprehensive income (income, expenses, gains and losses that currently bypass the income statement and are reported directly as a separate component of equity). SFAS 130 requires that components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company adopted SFAS 130 during the first quarter of 1998. Comprehensive loss equals net loss for all periods presented. In 1997, the FASB issued SFAS 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, which establishes annual and interim reporting standards for a company's operating segments. Adoption of this Statement will not impact the Company's consolidated financial position, results of operations or cash flows, and any effect will be limited to the form and content of its disclosures. SFAS 131 is effective for the Company's fiscal 1998. In June 1998, the FASB issued SFAS 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which defines derivatives, requires that all derivatives be carried at fair value, and provides for hedge accounting when certain conditions are met. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Although the Company has not fully assessed the implications of this new statement, the Company does not believe adoption of this statement will have a material impact on the Company's financial statements. 2. ACQUISITIONS During the three-month period ended March 31, 1998, the Company acquired 10 fitness centers. The total purchase price was $9,949,000 (unaudited), including acquisition costs, and consisted of cash of $8,389,000 and assumed liabilities of $1,560,000. The total combined excess of the purchase price over the fair value of net identifiable assets acquired (consisting primarily of fixed assets, merchandise inventories and customer lists) of $3,186,000 (unaudited) was recorded as goodwill. Results of operations after the acquisition date are included in the consolidated statement of operations. In May 1997, the Company acquired a fitness center chain consisting of 7 fitness centers. The combined total purchase price was $11,820,000, including acquisition costs, and consisted of $11,673,000 in cash and a $147,000 promissory note due to a seller. The total combined excess of the purchase price over the fair value of net identifiable assets acquired (consisting primarily of fixed assets, merchandise inventories, and customer lists) of $7,153,000 was recorded as goodwill. Results of operations after the acquisition date are included in the consolidated statements of operations. During 1996, the Company completed three acquisitions of fitness center chains, acquiring a total of 20 fitness centers. The combined total purchase price was $25,049,000, including acquisition costs, and consisted of $20,449,000 in cash and a $4,600,000 promissory note due to a seller. The total combined excess of the purchase price over the fair value of net identifiable assets acquired of $15,275,000 was F-9 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 2. ACQUISITIONS (CONTINUED) recorded as goodwill. Results of operations after the acquisition date are included in the consolidated statements of operations. The following pro forma information gives effect to the Northwest Fitness, Inc. and Landhigh Investments, Inc. acquisitions, completed in May 1997 and October 1996, respectively, as if the two acquisitions had taken place at January 1, 1996. The Company considers the remainder of the 1996 and 1997 acquisitions to be insignificant for pro forma purposes. The pro forma information includes adjustments for interest expense that would have been incurred to finance the purchases, amortization of intangibles arising from the transactions and the related income tax impacts. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transactions been effected on the assumed dates.
YEAR ENDED DECEMBER 31 ---------------------------------- 1996 1997 ---------------- ---------------- (UNAUDITED) Net revenues.............................................. $ 201,291,000 $ 266,577,000 Net loss.................................................. (14,017,000) (17,132,000) Net loss per share: Basic..................................................... $ $ Diluted................................................... $ $
During 1996 and 1997, the Company also acquired certain operating assets of single fitness centers. The consideration paid in 1996 consisted of $1,436,000 in cash and the issuance of notes payable of $235,000. The consideration paid in 1997 consisted of $1,983,000 in cash and the issuance of notes payable of $245,000. The acquired net assets consisted of equipment, customer lists and leases of club premises. On June 30, 1995, the Company acquired all of the outstanding common stock of FFHC, from Family Fitness Holdings Limited Partnership which owned 68 fitness centers in three states. The total purchase price was approximately $80,600,000, including acquisition costs, and consisted of cash of approximately $43,000,000, a seller note of $10,100,000, assumed liabilities of $10,100,000 and 367,894 shares of common stock then valued at $3,499,000. In addition, the Company was originally required to make "earnout" payments of up to $15,000,000 payable in four annual installments, based on achieving certain cumulative earnings levels, of which $3,750,000 was paid in 1996. In December 1996, the Company fixed the amount due under the earnout by removing all contingencies and issuing a note payable in the amount of $10,063,000, bearing interest at 9%. The acquisition was accounted for using the purchase method of accounting, and the operating results subsequent to the acquisition date are included in the Company's consolidated statements of operations. The excess of the purchase price (including earnout payments) over the fair value of the net identifiable assets acquired of $42,298,000 was recorded as goodwill. Effective January 1, 1995, the Company acquired the remaining 50% interest in the 24 Hour Workout Partnership for $3,000,000. The excess of the purchase price over the fair value of the net identifiable assets acquired of $2,200,000 was recorded as goodwill. All of the acquisitions noted above were accounted for using the purchase method of accounting. F-10 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 3. PROPERTY AND EQUIPMENT Property and equipment consisted of the following:
DECEMBER 31, ------------------------------ 1996 1997 -------------- -------------- Leasehold improvements....................................... $ 37,153,000 $ 53,396,000 Exercise equipment........................................... 37,287,000 45,981,000 Office furniture............................................. 10,045,000 12,836,000 Computer equipment........................................... 4,740,000 6,507,000 Construction in progress..................................... 2,303,000 4,986,000 -------------- -------------- Total.................................................. 91,528,000 123,706,000 Less accumulated depreciation................................ (22,212,000) (37,132,000) -------------- -------------- Total property and equipment--net............................ $ 69,316,000 $ 86,574,000 -------------- -------------- -------------- --------------
For the years ended December 31, 1995, 1996 and 1997, depreciation expense for property and equipment was $6,280,000, $11,062,000 and $15,675,000, respectively. 4. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets consisted of the following:
DECEMBER 31, ------------------------------ 1996 1997 -------------- -------------- Goodwill..................................................... $ 57,072,000 $ 62,977,000 Membership lists............................................. 7,699,000 9,039,000 Favorable lease rights....................................... 829,000 829,000 -------------- -------------- Total.................................................. 65,600,000 72,845,000 Less accumulated amortization................................ (3,586,000) (7,794,000) -------------- -------------- Total goodwill and other intangible assets--net.............. $ 62,014,000 $ 65,051,000 -------------- -------------- -------------- --------------
For the years ended December 31, 1995, 1996 and 1997, amortization expense for intangible assets was $1,167,000, $2,591,000 and $4,569,000, respectively. During 1997, general and administrative expenses include a charge of $1,645,000 related to the impairment of intangibles. 5. EMPLOYEE BENEFIT PLAN The Company maintained a voluntary defined contribution 401(k) plan covering certain employees who had met specified service and eligibility requirements. Company contributions were discretionary, and employee contributions had a maximum limit set by law. Company contributions totaled $40,000, $101,000 and $162,000 in 1995, 1996 and 1997, respectively. Subsequent to December 31, 1997, the Company initiated the process to terminate the plan. F-11 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 6. DEFERRED REVENUES AND COSTS Components of deferred revenues were as follows:
YEAR ENDED DECEMBER 31, -------------------------------------------------- 1995 1996 1997 --------------- --------------- ---------------- Beginning deferred revenues................................. $ (18,398,000) $ (39,753,000) $ (72,939,000) Originating from new members................................ (38,654,000) (74,254,000) (97,689,000) Originating from acquisitions............................... (2,672,000) (783,000) (790,000) Revenues recognized......................................... 19,971,000 41,851,000 66,620,000 --------------- --------------- ---------------- Ending deferred revenues.................................... $ (39,753,000) $ (72,939,000) $ (104,798,000) --------------- --------------- ---------------- --------------- --------------- ----------------
Changes in deferred revenues as shown in the consolidated statements of operations represent the difference between deferred revenues originating from new members and recognized. Components of deferred membership origination costs were as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1995 1996 1997 -------------- -------------- --------------- Beginning deferred membership origination costs................ $ 4,248,000 $ 10,086,000 $ 20,330,000 Costs incurred................................................. 9,858,000 19,043,000 25,856,000 Costs amortized................................................ (4,020,000) (8,799,000) (16,013,000) -------------- -------------- --------------- Ending deferred membership origination costs................... $ 10,086,000 $ 20,330,000 $ 30,173,000 -------------- -------------- --------------- -------------- -------------- ---------------
Changes in deferred membership origination costs as shown in the consolidated statements of operations represent the difference between costs incurred and costs amortized. 7. PROVISION FOR SEVERANCE In connection with the termination of employment of certain employees, the Company recorded a provision for severance of $0, $3,600,000 and $635,000 in 1995, 1996 and 1997, respectively. F-12 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 8. LONG-TERM DEBT Long-term debt was as follows:
DECEMBER 31, ---------------------------------- 1996 1997 ---------------- ---------------- MARCH 31, 1998 ---------------- (UNAUDITED) Bank notes payable: Term loan, variable interest (10.25% at December 31, 1997; 9.06% at March 31, 1998), interest only through December 31, 1999, principal payable in quarterly installments of $312,500, plus interest, through September 30, 2004, with final paydown of $119,062,500 on December 31, 2004.................................................... $ 24,000,000 $ 125,000,000 $ 125,000,000 Term loan, variable interest (9.75% at December 31, 1997; 8.56% at March 31, 1998), due in quarterly installments commencing March 31, 1999, of varying amounts from $2,500,000 to $4,000,000, plus interest, through December 31, 2002....................................... 31,000,000 50,000,000 50,000,000 Working capital line of credit, variable interest (9.75% at December 31, 1997; rates ranging from 8.38% to 8.56% at March 31, 1998), due in December 2002................ 31,859,000 6,959,000 11,959,000 Note payable to related parties, 9.0% interest only through January 2002, principal due in full in January 2002....... 10,100,000 10,100,000 10,100,000 Note payable to related parties, interest at 9.0%, payable in three annual installments of $3,750,000, principal and interest, beginning April 1, 1997......................... 10,063,000 6,540,000 6,540,000 Note payable to related party, interest only at 9.0% payable semi-annually, principal due in full on September 30, 2001...................................................... 4,600,000 4,600,000 4,600,000 Note payable to related parties, interest at 9.0%, payable in quarterly installments of principal and interest through November 1998..................................... 3,163,000 1,580,000 1,198,000 Notes payable, interest between 9.0% and 12.0% payable in varying monthly installments through December 2000........ 307,000 510,000 461,000 ---------------- ---------------- ---------------- Total................................................. 115,092,000 205,289,000 209,858,000 Less current portion........................................ 5,090,000 4,894,000 6,981,000 ---------------- ---------------- ---------------- Long-term portion........................................... $ 110,002,000 $ 200,395,000 $ 202,877,000 ---------------- ---------------- ---------------- ---------------- ---------------- ----------------
In March 1997 and in December 1997, the Company refinanced its existing bank debt. Under a restated long-term credit agreement in December 1997 ("Senior Credit Facility"), the Company increased its total credit line to $225,000,000. The Senior Credit Facility consists of a $125,000,000 term loan expiring December 2004 and a $50,000,000 term loan and a $50,000,000 working capital line of credit which expire December 2002. At December 31, 1997, available borrowings included approximately $43,041,000 under the working capital line of credit. The Senior Credit Facility contains certain restrictive financial covenants including debt to adjusted earnings ratios and interest and fixed charges to adjusted earnings ratios and prohibits the declaration F-13 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 8. LONG-TERM DEBT (CONTINUED) or payment of dividends, except to make a dividend payment to its shareholders through proceeds received as of the refinancing date. The borrowings are secured by all of the assets of the Company. The Senior Credit Facility provides for the issuance of letters of credit. The Company had irrevocable letters of credit outstanding in the amount of $151,000 as of December 31, 1997. In February 1998, the Company issued an additional letter of credit for $1,000,000 which expires in 1999 related to a software purchase. The Senior Credit Facility also requires the Company to maintain interest rate hedges on notional principal amounts of not less than $70.0 million, prior to March 1998, and $100.0 million thereafter. Accordingly, in March 1997, the Company entered into an interest rate swap transaction with BNP. Under this interest rate swap agreement, the Company is a fixed rate payor, effectively converting the variable interest rate on $70.0 million of debt under its Senior Credit Facility into a fixed rate based on 6.3% plus a bank margin based on the Company's leverage ratio. This interest rate swap agreement expires in March 1999; however, BNP has the option to extend the term to March 2000. At December 31, 1997, the fair value of this contract was a loss of $812,000. Additionally, in March 1998, the Company entered into an interest rate transaction with a second international financial institution. Under this interest rate swap agreement, the Company will be a fixed rate payor, effectively converting the variable interest rate on a principal amount $50.0 million of debt under the term loan portion of its Senior Credit Facility into a fixed rate based on 5.7% plus a bank margin percentage based on the Company's leverage ratio. This second interest rate swap agreement expires in March 2003; however, the financial institution has the option to accelerate the expiration date to March 2001. Under the term loan portions of the Senior Credit Facility, the Company pays variable interest rates based, at its election, on the bank's prime rate or LIBOR plus a marginal rate, which changes depending on the Company's leverage ratio. Including the interest rate swap agreements, the Company's weighted average interest rate as of March 31, 1998 was 9.1%. The Company pays an annual commitment fee based on the unused portion of the working capital line of credit under the Senior Credit Facility. Scheduled principal payments on long-term debt for years ended December 31 are as follows: 1998......................................................... $ 4,894,000 1999......................................................... 13,582,000 2000......................................................... 13,347,000 2001......................................................... 17,877,000 2002......................................................... 34,339,000 Thereafter................................................... 121,250,000 ------------- Total........................................................ $ 205,289,000 ------------- -------------
In 1997, the Company expensed $999,000 in costs associated with a cancelled private placement of long-term debt. These costs were included on the consolidated statements of operations as debt offering costs. 9. STOCKHOLDERS' DEFICIT In 1997, the Company declared and paid three cash distributions under a single plan of recapitalization to stockholders totaling $57,486,000. In March 1997, the Company paid $1,713,000 to repurchase approximately 44,000 shares of common stock from a stockholder and for an option to repurchase the same stockholder's remaining F-14 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 9. STOCKHOLDERS' DEFICIT (CONTINUED) 44,000 shares of common stock. Subsequent to December 31, 1997, the Company notified the stockholder of its intent to exercise half of the option at a total purchase price of $1,200,000. The Company has outstanding warrants with a third party allowing the purchase of up to 87,584 shares of the Company's common stock for an aggregate purchase price of $602,000. The warrants are fully exercisable and expire on December 29, 2004. On January 3, 1995, the Company completed its 1994 recapitalization by repurchasing 1,156,635 shares of its outstanding common stock for $11,000,000 in cash. 10. STOCK OPTION PLANS Under the 1994 Stock Option and Award Plan, options to purchase shares of common stock are generally granted to key employees at option prices not less than the fair market value of the Company's shares on the date of grant. The Company has reserved 313,501 shares of common stock for issuance under this plan. The options are exercisable for a period of up to ten years from the date of grant and vest at various dates from 2002 to 2005. Fifty percent of the option grants vest immediately upon the occurrence of a liquidity event, including an initial public offering. The remaining fifty percent can vest up to 10% per year for each of the five years succeeding the grant date if the Company achieves certain annual performance measures based on earnings before interest, taxes, depreciation and amortization. In 1997, the Company granted 73,031 options at an exercise price that was below fair market value. Compensation expense related to this grant totaled $4,169,000 of which $417,000 was recognized in 1997 and $3,752,000 was deferred. Unearned compensation expense, which is recorded in stockholders' deficit, is recognized over the related vesting period described in the foregoing paragraph. Also in 1997, 18,000 options were transferred from one stockholder to another. Upon transfer, the vesting of these options was accelerated. For accounting purposes, this transfer was treated as a cancellation and issuance of options with an exercise price below fair market value, accordingly, compensation expense of $1,503,000 was recorded in general and administrative expenses. As a result of the impact on equity of the sum of the cash distributions described in Note 9, in December 1997, the Company repriced its outstanding fixed stock options. Such repricing included a reduction of the exercise price per share and an increase in the number of options held by each individual option holder such that the aggregate intrinsic value of each individual's option holdings was the same both before and after the total of the cash distributions. Because the repricing was performed in accordance with EITF Consensus No. 90-9, CHANGES TO FIXED EMPLOYEE STOCK OPTION PLANS AS A RESULT OF EQUITY RESTRUCTURING, no compensation expense was recorded. Under the 1995 Non-Employee Director's Stock Option Plan, non-qualified options are granted to non-employee directors at prices equal to the fair market value at the date of grant. The Company has reserved 11,500 shares for issuance under the Plan. The options generally vest over a period of three to five years and expire ten years from the date of grant. F-15 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 10. STOCK OPTION PLANS (CONTINUED) Stock option activity for both plans for the three years in the period ended December 31, 1997 was:
NUMBER OF WEIGHTED AVERAGE SHARES EXERCISE PRICE ----------- ------------------ Balance, January 1, 1995......................................................... 169,605 $ 9.51 Granted.......................................................................... 78,197 11.36 Exercised........................................................................ (2,116) 9.51 Canceled......................................................................... (3,891) 9.51 ----------- ------- Balance, December 31, 1995....................................................... 241,795 10.10 Granted.......................................................................... 85,384 31.85 Exercised........................................................................ (144) 9.51 Canceled......................................................................... (7,523) 18.36 ----------- ------- Balance, December 31, 1996....................................................... 319,512 15.31 Granted.......................................................................... 86,884 40.51 Exercised........................................................................ (29,872) 9.51 Canceled......................................................................... (7,970) 15.23 Exchanged as a result of the option repricing discussed above.................... (368,554) 22.25 Issued as a result of the option repricing discussed above....................... 504,602 16.25 ----------- ------- Balance, December 31, 1997....................................................... 504,602 $ 16.25 ----------- ------- ----------- ------- Options exercisable at December 31, 1995......................................... 47,139 $ 9.51 ----------- ------- ----------- ------- Options exercisable at December 31, 1996......................................... 102,931 $ 12.23 ----------- ------- ----------- ------- Options exercisable at December 31, 1997......................................... 185,688 $ 11.30 ----------- ------- ----------- -------
Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123"), requires the disclosure of pro forma net income as though the Company adopted the fair value method of measuring stock based compensation as of the beginning of 1995. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: five year expected life from date of grant; no stock volatility in 1995, 1996 and 1997; risk free interest rates, 5.91% in 1995, 6.42% in 1996 and ranging from 5.75% to 6.25% in 1997; and no dividends during the expected term. The Company's calculations are based on a single option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the 1995, 1996 and 1997 F-16 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 10. STOCK OPTION PLANS (CONTINUED) awards had been amortized to expense over the vesting period of the awards, pro forma net loss and net loss per share would have been:
YEAR ENDED DECEMBER 31, --------------------------------------------- 1995 1996 1997 ------------- -------------- -------------- Pro forma net loss................................................ $ 6,758,000 $ 14,798,000 $ 17,736,000 ------------- -------------- -------------- ------------- -------------- -------------- Pro forma net loss per share...................................... $ $ $ ------------- -------------- -------------- ------------- -------------- --------------
However, the impact of outstanding non-vested stock options granted prior to 1995 has been excluded from the pro forma calculation; accordingly, the 1995, 1996 and 1997 pro forma adjustments are not indicative of future period pro forma adjustments, when the calculation will apply to all future applicable stock options. The weighted average fair value at grant date of stock options granted in 1995, 1996 and 1997 was $2.10, $8.16 and $60.47, respectively. The following table summarizes information about stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------------- -------------------------------- WEIGHTED AVERAGE RANGE OF OPTIONS REMAINING LIFE WEIGHTED AVERAGE OPTIONS WEIGHTED AVERAGE EXERCISE PRICES OUTSTANDING (IN YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ---------------------- ------------ ------------------ ------------------ ------------ ------------------ $6.87................. 263,754 7.2 $ 6.87 140,750 $ 6.87 $19.78 to $25.66...... 226,995 8.7 $ 24.05 43,553 $ 23.86 $66.92................ 13,853 9.9 $ 66.92 1,385 $ 66.92 ------------ ------------ $6.87 to $66.92....... 504,602 185,688 ------------ ------------ ------------ ------------
11. INCOME TAXES The benefit for income taxes consisted of the following:
YEAR ENDED DECEMBER 31, ------------------------------------------- 1995 1996 1997 ------------- ------------- ------------- Current: Federal........................................................... $ 483,000 $ (580,000) $ (143,000) State and local................................................... 67,000 (203,000) (53,000) ------------- ------------- ------------- Total current tax benefit (expense)........................... 550,000 (783,000) (196,000) ------------- ------------- ------------- Deferred: Federal........................................................... 2,474,000 7,213,000 7,356,000 State............................................................. 829,000 1,964,000 2,011,000 ------------- ------------- ------------- Total deferred tax benefit.................................... 3,303,000 9,177,000 9,367,000 ------------- ------------- ------------- Total income tax benefit............................................ $ 3,853,000 $ 8,394,000 $ 9,171,000 ------------- ------------- ------------- ------------- ------------- -------------
The above 1997 income tax benefit excludes $838,000 related to the exercise of employee stock options, which was credited directly to accumulated deficit. F-17 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 11. INCOME TAXES (CONTINUED) The Company's effective tax rate and the statutory federal income tax rate are reconciled as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 1995 1996 1997 --------- --------- --------- Statutory federal income tax benefit rate.................................................. 34.0% 34.0% 34.0% State and local income taxes, net of federal tax benefit................................... 6.1 6.1 5.7 Nondeductible amortization of intangible assets............................................ (3.3) (3.4) (4.5) Other nondeductible expenses............................................................... (0.5) (0.5) (0.2) --- --- --- Effective tax benefit rate................................................................. 36.3% 36.2% 35.0% --- --- --- --- --- ---
The components of the deferred tax assets are as follows:
DECEMBER 31, ------------------------------ 1996 1997 -------------- -------------- Current: Deferred revenue and costs..................................................... $ 7,957,000 $ 12,773,000 Compensation and employee benefits............................................. 1,579,000 320,000 Nondeductible reserves......................................................... 2,077,000 1,249,000 Other.......................................................................... 199,000 190,000 -------------- -------------- Total current.............................................................. 11,812,000 14,532,000 -------------- -------------- Noncurrent: Deferred revenue and costs..................................................... 10,346,000 12,306,000 Deferred rent.................................................................. 4,624,000 6,000,000 Fixed and intangible assets.................................................... 1,814,000 3,434,000 Debt issuance costs............................................................ -- (2,113,000) Tax attribute carryover........................................................ 1,806,000 3,861,000 Nondeductible reserves......................................................... (1,640,000) 503,000 Other.......................................................................... (369,000) 101,000 -------------- -------------- Total noncurrent........................................................... 16,581,000 24,092,000 -------------- -------------- Total deferred tax asset......................................................... $ 28,393,000 $ 38,624,000 -------------- -------------- -------------- --------------
Deferred revenue and costs of $25.1 million at December 31, 1997 and $18.3 million at December 31, 1996 relates to net cash collected in prior and current periods to be recognized in future periods over the average member life. Since such amounts have previously been reported as income for income tax reporting purposes, the recognition of these deferred revenue will not result in future taxes payable. Additionally, deferred rent of $6.0 million at December 31, 1997 and $4.6 million at December 31, 1996 resulted from the recognition of lease expenses for financial reporting purposes prior to the actual payment and, thus, recognition for income tax reporting purposes. The ultimate recognition of these deferred tax assets is not contingent on the Company's ability to achieve future taxable income. Management believes it is more likely than not that sufficient taxable income will be generated in future periods to utilize the deferred tax assets that are dependent upon such taxable income. The amount of deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income are reduced. F-18 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 11. INCOME TAXES (CONTINUED) The Company has available federal and state net operating loss carryforwards for tax purposes of approximately $8,069,000 and $2,595,000, respectively, which expire in 2010 through 2011. 12. COMMITMENTS AND CONTINGENCIES LEASES The Company leases all of its fitness centers and administrative offices. Facility and administrative office leases contain various provisions for renewal options and provide for rent adjustments throughout the lease term. The aggregate future minimum annual rental payments under noncancellable leases in effect at December 31, 1997 are as follows:
CAPITAL LEASES AND EQUIPMENT OPERATING NOTES PAYABLE LEASES --------------- ---------------- 1998....................................................... $ 161,000 $ 43,477,000 1999....................................................... 86,000 43,792,000 2000....................................................... 29,000 43,634,000 2001....................................................... 2,000 41,910,000 2002....................................................... 39,615,000 Thereafter................................................. 275,640,000 --------------- ---------------- Total minimum commitments............................ 278,000 $ 488,068,000 --------------- ---------------- --------------- ---------------- Less amount representing interest.......................... (30,000) --------------- Present value of obligations under capital leases and equipment notes payable.................................. 248,000 Less current portion....................................... (125,000) --------------- Long-term obligations under capital leases and equipment notes payable............................................ $ 123,000 --------------- ---------------
The cost and related accumulated amortization of assets under capital leases aggregated $2,430,000 and $2,013,000, respectively, at December 31, 1996 and $1,487,000 and $1,238,000, respectively, at December 31, 1997. Total rent expense for all operating leases for the years ended December 31, 1995, 1996 and 1997 was $18,742,000, $38,450,000 and $42,558,000, respectively. OTHER The Company is involved in various lawsuits and claims arising in the ordinary course of business. In the opinion of management, after consultation with counsel, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position or results of operations. The Company has entered into an agreement with one of its lenders whereby the Company is obligated to pay a Success Participation Fee ("Success Fee"), as defined. The Success Fee is contingent upon the occurrence of certain events (including an initial public offering, a sale of the Company or a qualifying dividend) and the amount of the fee varies based on which event occurs and the amount of proceeds associated with the event. In connection with the distributions discussed in Note 9, in 1997, the Company paid a total of $1,012,000 to its lender in accordance with this agreement, which was recorded F-19 FITNESS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THREE MONTHS ENDED MARCH 31, 1997 AND 1998 (UNAUDITED) 12. COMMITMENTS AND CONTINGENCIES (CONTINUED) as interest expense. Additional fees could become due upon the future occurrence of any of the above mentioned events. For instance, in the event of an initial public offering in the amount of $ , the success participation fee would be approximately $ . 13. RELATED PARTY TRANSACTIONS The Company leases certain fitness center facilities and administrative office space from various entities owned by stockholders and related parties of the Company. Rent expense under these related party leases was $707,000 in 1995, $1,041,000 in 1996 and $1,032,000 in 1997, respectively. The Company paid $1,500,000, $500,000 and $1,200,000 in 1995, 1996 and 1997, respectively, to a stockholder for management and advisory services. Such fees were recorded as debt issuance costs or general and administrative expenses based on services provided. Additionally, the Company paid $970,000, $367,000 and $75,000 in 1995, 1996 and 1997, respectively, for consulting services provided by another stockholder, which are included in general and administrative expenses. In 1997, the Company incurred $867,000 of construction costs to build a fitness center on land owned by a stockholder. Of this amount, $336,000 related to architectural and engineering costs which have no future benefit to the stockholder. The Company ultimately decided to abandon the construction project and wrote off costs incurred as general and administrative expenses in 1997. In October 1996, the Company acquired all of the outstanding common stock of Sportech, an entity owned in part by certain of the Company's stockholders, for $530,000, including forgiveness of a note receivable and interest receivable thereon of $332,000. 14. SUBSEQUENT EVENTS In 1998, the Board of Directors of the Company effected a -for-one stock split of the Company's common stock. All share and per share data in the accompanying financial statements have been retroactively adjusted to reflect the split. In June 1998, the Company participated in the re-capitalization of the Forza Group Limited ("FGL"), a company incorporated in England, which, until such recapitalization, had been predominately a distributor of health and fitness equipment within Europe, the Russian Federation and the Middle East. Pursuant to a subscription agreement between, amongst others, the Company and FGL, the Company subscribed for 2,284 convertible preferred shares, par value L1 each, in FGL for total consideration of L1.0 million (or approximately $1.6 million). This represents ownership of approximately 5% in the entire issued share capital of FGL as of June 1, 1998. It is anticipated that the Company will enter into an advisory services agreement under which, for an annual fee, it will provide advisory and management services to FGL. ****** F-20 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Northwest Fitness, Inc. We have audited the accompanying balance sheets of Northwest Fitness, Inc. (the "Company") as of December 31, 1996 and May 31, 1997, and the related statements of operations, changes in stockholders' equity (deficit), and cash flows for the year ended December 31, 1996 and the five months ended May 31, 1997. 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 in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Northwest Fitness, Inc. as of December 31, 1996 and May 31, 1997, and the results of its operations and its cash flows for the year ended December 31, 1996 and the five months ended May 31, 1997 in conformity with generally accepted accounting principles. Deloitte & Touche LLP San Francisco, California June 5, 1998 F-21 NORTHWEST FITNESS, INC. BALANCE SHEETS
DECEMBER 31, MAY 31, 1996 1997 -------------- -------------- ASSETS CURRENT ASSETS: Cash............................................................................ $ 439,000 $ 299,000 Accounts receivable............................................................. 3,000 11,000 Prepaid expenses................................................................ 57,000 34,000 Inventories..................................................................... 220,000 136,000 -------------- -------------- Total current assets.......................................................... 719,000 480,000 PROPERTY AND EQUIPMENT--Net....................................................... 4,862,000 4,671,000 OTHER ASSETS...................................................................... 87,000 86,000 -------------- -------------- TOTAL ASSETS...................................................................... $ 5,668,000 $ 5,237,000 -------------- -------------- -------------- -------------- LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable................................................................ $ 160,000 $ 238,000 Accrued expenses................................................................ 270,000 397,000 Deferred revenue................................................................ 1,102,000 1,286,000 Current portion of long-term debt............................................... 442,000 1,447,000 Current portion of capital lease obligations.................................... 63,000 174,000 Dividend payable................................................................ 100,000 -------------- -------------- Total current liabilities..................................................... 2,137,000 3,542,000 -------------- -------------- LONG-TERM DEBT.................................................................... 2,335,000 1,149,000 DEFERRED RENT AND LEASE INCENTIVES................................................ 1,024,000 1,032,000 CAPITAL LEASE OBLIGATIONS......................................................... 109,000 OTHER............................................................................. 15,000 15,000 STOCKHOLDERS' EQUITY (DEFICIT): Common stock, no par value, 200,000 shares authorized, issued and outstanding... 100,000 100,000 Cumulative distributions in excess of earnings.................................. (52,000) (601,000) -------------- -------------- Total stockholders' equity (deficit).......................................... 48,000 (501,000) -------------- -------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT).............................. $ 5,668,000 $ 5,237,000 -------------- -------------- -------------- --------------
See notes to financial statements. F-22 NORTHWEST FITNESS, INC. STATEMENTS OF OPERATIONS
FIVE MONTHS YEAR ENDED ENDED DECEMBER 31, MAY 31, 1996 1997 -------------- ------------- NET REVENUES Membership revenues.............................................................. $ 8,050,000 $ 4,727,000 Change in deferred revenues...................................................... (337,000) (1,286,000) -------------- ------------- Net membership revenues........................................................ 7,713,000 3,441,000 Ancillary revenues............................................................... 2,255,000 1,232,000 -------------- ------------- Total net revenues............................................................. 9,968,000 4,673,000 OPERATING EXPENSES: Fitness center operating expenses................................................ 7,100,000 3,505,000 General and administrative expenses.............................................. 433,000 253,000 Depreciation and amortization.................................................... 645,000 283,000 -------------- ------------- Total operating expenses....................................................... 8,178,000 4,041,000 -------------- ------------- INCOME FROM OPERATIONS............................................................. 1,790,000 632,000 INTEREST EXPENSE................................................................... (288,000) (106,000) -------------- ------------- NET INCOME......................................................................... $ 1,502,000 $ 526,000 -------------- ------------- -------------- -------------
See notes to financial statements. F-23 NORTHWEST FITNESS, INC. STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) YEAR ENDED DECEMBER 31, 1996 AND FIVE MONTHS ENDED MAY 31, 1997
CUMULATIVE COMMON STOCK DISTRIBUTIONS ---------------------- IN EXCESS OF SHARES AMOUNT EARNINGS TOTAL --------- ----------- ------------- -------------- BALANCE, JANUARY 1, 1996........................................ 200,000 $ 100,000 $ (301,000) $ (201,000) Dividend distributions.......................................... (1,253,000) (1,253,000) Net income...................................................... 1,502,000 1,502,000 --------- ----------- ------------- -------------- BALANCE, DECEMBER 31, 1996...................................... 200,000 100,000 (52,000) 48,000 Dividend distributions.......................................... (1,075,000) (1,075,000) Net income...................................................... 526,000 526,000 --------- ----------- ------------- -------------- BALANCE, MAY 31, 1997........................................... 200,000 $ 100,000 $ (601,000) $ (501,000) --------- ----------- ------------- -------------- --------- ----------- ------------- --------------
See notes to financial statements. F-24 NORTHWEST FITNESS, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED FIVE MONTHS DECEMBER 31, ENDED 1996 MAY 31, 1997 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income...................................................................... $ 1,502,000 $ 526,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization................................................. 645,000 283,000 Change in assets and liabilities: Accounts receivable......................................................... 165,000 (8,000) Prepaid expenses............................................................ (29,000) 23,000 Inventories................................................................. (89,000) 84,000 Other assets................................................................ 3,000 1,000 Accounts payable............................................................ (125,000) 78,000 Accrued expenses............................................................ 8,000 126,000 Deferred revenue............................................................ (43,000) 185,000 Deferred rent and lease incentives.......................................... 71,000 8,000 Other....................................................................... (10,000) -------------- -------------- Net cash provided by operating activities................................. 2,098,000 1,306,000 -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment............................................. (236,000) (67,000) -------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of long-term debt.................................................... (407,000) (181,000) Principal payments on capital lease obligations................................. (57,000) (23,000) Dividends paid.................................................................. (1,253,000) (1,175,000) Other........................................................................... 21,000 -------------- -------------- Net cash used in financing activities..................................... (1,696,000) (1,379,000) -------------- -------------- NET INCREASE (DECREASE) IN CASH................................................... 166,000 (140,000) CASH, BEGINNING OF YEAR........................................................... 273,000 439,000 -------------- -------------- CASH, END OF YEAR................................................................. $ 439,000 $ 299,000 -------------- -------------- -------------- -------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for interest.......................................................... $ 288,000 $ 106,000 -------------- -------------- -------------- -------------- Acquisitions of equipment under capital lease................................... $ -- $ 25,000 -------------- -------------- -------------- --------------
See notes to financial statements. F-25 NORTHWEST FITNESS, INC. NOTES TO FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 1996 AND FIVE MONTHS ENDED MAY 31, 1997 1. DESCRIPTION OF COMPANY AND ACCOUNTING POLICIES THE COMPANY--Northwest Fitness, Inc. (the "Company") was incorporated in the State of Oregon in August 1989. The Company owns and operates six fitness centers in Northwest Oregon and one in Washington. Effective June 1, 1997, the Company sold substantially all of its assets (excluding cash and one gym location, which the Company leased to 24 Hour Fitness, Inc.) for $10,385,000 and 24 Hour Fitness, Inc. assumed all of the Company's operating leases. USE OF ESTIMATES--The preparation of financial statements in conformity with generally accepted accounting principles 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 date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. PROPERTY AND EQUIPMENT are stated at cost and depreciated using accelerated methods over the estimated useful lives of the assets which approximate 5 to 7 years. Leasehold improvements are amortized using the straight-line method over the lease term or estimated useful life, whichever is shorter. Whenever events or changes in circumstances have indicated that the carrying amount of its assets might not be recoverable, the Company, using its best estimates based on reasonable and supportable assumptions and projections, has reviewed for impairment the carrying value of long-lived assets. DEFERRED RENT AND LEASE INCENTIVES--The Company leases premises for all of its fitness clubs. A number of the leases include scheduled base rent increases over their term. The total amount of base rent payments, including scheduled increases, is expensed on the straight-line method over the terms of the leases. Deferred rent represents the excess of such amounts over actual cash payments. Sublease revenue is also recognized on a straight-line basis. Deferred rent obligation is net of accrued sublease rental income, which represents the excess of revenues over actual cash payments received. In addition, for certain leases, the Company received cash payments from landlords for the construction of leasehold improvements. These cash payments have been deferred and are being amortized over the term of the related lease. REVENUE RECOGNITION--The Company charges members either monthly membership dues, or an annual fee, paid in advance. Membership dues are recognized as revenue in the period in which services are provided. Membership dues received in advance are recorded as deferred revenue and recognized on a straight-line basis over the term during which services are provided. INCOME TAXES--The Company is an S Corporation for federal and state tax purposes. As such, the Company's income flows through and is taxed at the shareholder level. No provision for income taxes has been made. F-26 NORTHWEST FITNESS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996 AND FIVE MONTHS ENDED MAY 31, 1997 2. PROPERTY AND EQUIPMENT Property and equipment consisted of the following:
DECEMBER 31, MAY 31, 1996 1997 -------------- -------------- Land and building............................................. $ 1,475,000 $ 1,475,000 Leasehold improvements........................................ 2,976,000 2,980,000 Equipment..................................................... 2,356,000 2,420,000 Office furniture.............................................. 240,000 240,000 Computer equipment............................................ 171,000 184,000 -------------- -------------- Subtotal...................................................... 7,218,000 7,299,000 Less accumulated depreciation................................. (2,356,000) (2,628,000) -------------- -------------- Total property and equipment--net........................... $ 4,862,000 $ 4,671,000 -------------- -------------- -------------- --------------
For the year ended December 31, 1996 and the five months ended May 31, 1997, depreciation and amortization expense for property and equipment was $645,000 and $283,000, respectively. 3. BORROWING ARRANGEMENTS The Company had two line of credit agreements with a financial institution. Maximum borrowings available under the two lines were $750,000 and $200,000, of which none was outstanding at December 31, 1996. Both line of credit agreements expired on April 30, 1997, and were not renewed. The credit agreements contained covenants that required the Company to meet certain cash flow coverage and debt to net worth ratios. The Company was not in compliance with the debt to net worth ratio at December 31, 1996; however, the Company received a waiver of compliance from the bank through April 30, 1998. F-27 NORTHWEST FITNESS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996 AND FIVE MONTHS ENDED MAY 31, 1997 4. LONG-TERM DEBT Long-term debt was as follows:
DECEMBER 31, MAY 31, 1996 1997 -------------- -------------- Contract payable to U.S. National Bank due in monthly installments of $26,067 including interest at the rate of 8.8% and maturing in November 1999.......................... $ 801,000 $ 699,000 Note payable to U.S. Bank due in monthly installments of $11,938 including interest at 8.6% and maturing in December 2000........................................................ 483,000 440,000 Contract payable to U.S. Bancorp due in monthly installments of $5,172 including interest at 9% and maturing in May 2009........................................................ 463,000 454,000 Small business loan payable to Colson Services Corporation due in monthly installments of $3,635 including interest at the rate of 6.6% and maturing in January 2014................... 418,000 413,000 Contract payable to Portland Lodge #142, Benevolent and Protective Order of Elks due in monthly installments of $3,822 including interest at the rate of 8.3% and maturing in August 2008.............................................. 346,000 337,000 Contract payable to Schnitzer Investment due in monthly installments of $4,821 including interest at 11% and maturing in June 2003....................................... 266,000 253,000 -------------- -------------- Subtotal...................................................... 2,777,000 2,596,000 Less current portion.......................................... (442,000) (1,447,000) -------------- -------------- Total....................................................... $ 2,335,000 $ 1,149,000 -------------- -------------- -------------- --------------
The note payable to U.S. Bank is secured by property and equipment. Scheduled principal payments on long-term debt for years ending December 31 are as follows: 1997........................................................... $1,424,000 1998........................................................... 56,000 1999........................................................... 61,000 2000........................................................... 66,000 2001........................................................... 72,000 Thereafter..................................................... 917,000 ---------- Total........................................................ $2,596,000 ---------- ----------
F-28 NORTHWEST FITNESS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996 AND FIVE MONTHS ENDED MAY 31, 1997 4. LONG-TERM DEBT (CONTINUED) On June 3, 1997, the proceeds from the sale of the Company were used to repay the contract payable to U.S. National Bank, the note payable to U.S. Bank, and the contract payable to Schnitzer Investment. 5. LEASES The Company leases certain equipment, club facilities, and its corporate headquarters. Facility leases contain various provisions for renewal options and provide for rent adjustments throughout the lease term. Future aggregate minimum annual rental payments under noncancelable leases in effect at December 31, 1996 were as follows:
CAPITAL OPERATING LEASES LEASES ----------- -------------- 1997............................................................ $ 80,000 $ 934,000 1998............................................................ 65,000 966,000 1999............................................................ 63,000 1,007,000 2000............................................................ 16,000 996,000 2001............................................................ 930,000 Thereafter...................................................... 6,001,000 ----------- -------------- Total minimum commitments....................................... 224,000 $ 10,834,000 ----------- -------------- ----------- -------------- Less amount representing interest............................... 52,000 ----------- Present value of obligations under capital leases and equipment notes payable................................................. 172,000 Less current portion............................................ 63,000 ----------- Long-term obligations under capital leases and equipment notes payable....................................................... $ 109,000 ----------- -----------
Total rent expense for all operating leases for the year ended December 31, 1996 and the five months ended May 31, 1997 was $990,000 and $447,000, respectively, of which $264,000 and $115,000, respectively, was paid to a corporation in which the President and a stockholder of the Company are also stockholders, for the lease of one fitness center. Total equipment leased under capital leases and related accumulated depreciation as of December 31, 1996 and May 31, 1997 was $246,000, and $57,000, and $271,000, and $64,000, respectively. SUBLEASES--The Company entered into three subleases for a portion of its leased club facilities. The terms range from four to ten years. One sublease includes a renewal option of two successive five-year periods. Total sublease rental income for the year ended December 31, 1996 and the five-month F-29 NORTHWEST FITNESS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED DECEMBER 31, 1996 AND FIVE MONTHS ENDED MAY 31, 1997 5. LEASES (CONTINUED) period ended May 31, 1997 was $141,000 and $66,000, respectively. Future minimum lease receipts under the leases as of December 31, 1996 were as follows: 1997............................................................. $ 159,000 1998............................................................. 162,000 1999............................................................. 171,000 2000............................................................. 122,000 2001............................................................. 57,000 Thereafter....................................................... 233,000 --------- Total.......................................................... $ 904,000 --------- ---------
All lease and sublease agreements were assigned to 24 Hour Fitness, Inc. on May 31, 1997. F-30 INDEPENDENT AUDITORS' REPORT To the Shareholders of Family Fitness Holding Company, Inc.: We have audited the accompanying consolidated balance sheet of Family Fitness Holding Company, Inc. and subsidiaries as of June 30, 1995, and the related consolidated statements of operations, stockholders' deficit and cash flows for the nine month period then ended. 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 audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Family Fitness Holding Company, Inc. and subsidiaries as of June 30, 1995, and the results of their operations and their cash flows for the nine month period then ended in conformity with generally accepted accounting principles. Deloitte & Touche LLP San Francisco, California June 16, 1998 F-31 FAMILY FITNESS HOLDING COMPANY, INC. CONSOLIDATED BALANCE SHEET
JUNE 30, 1995 --------------- ASSETS CURRENT ASSETS: Cash........................................................................................... $ 1,460,000 Short-term investments available for sale...................................................... 4,000,000 Accounts receivable, net of allowance of $82,000............................................... 470,000 Prepaid rent................................................................................... 2,706,000 Receivable from related parties................................................................ 892,000 Other.......................................................................................... 917,000 --------------- Total current assets......................................................................... 10,445,000 PROPERTY AND EQUIPMENT, net...................................................................... 27,956,000 DEFERRED TAXES................................................................................... 5,302,000 DEPOSITS......................................................................................... 868,000 --------------- TOTAL ASSETS..................................................................................... $ 44,571,000 --------------- --------------- LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Cash overdraft................................................................................. $ 2,889,000 Accounts payable and accrued expenses.......................................................... 4,209,000 Income taxes payable........................................................................... 4,431,000 Accrued compensation........................................................................... 2,267,000 Deferred revenues.............................................................................. 13,168,000 Consulting fees payable to related parties..................................................... 1,829,000 Notes payable and current portion of capital lease obligations to related parties.............. 10,901,000 Current portion of notes payable and capital lease obligations................................. 680,000 Other.......................................................................................... 358,000 --------------- Total current liabilities.................................................................... 40,732,000 CAPITAL LEASE OBLIGATIONS TO RELATED PARTIES..................................................... 3,359,000 LONG-TERM NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS............................................ 734,000 OTHER LONG-TERM LIABILITIES...................................................................... 2,141,000 DEFERRED REVENUE................................................................................. 8,866,000 DEFERRED RENT.................................................................................... 6,883,000 --------------- MINORITY INTEREST IN SUBSIDIARIES................................................................ 1,266,000 COMMITMENTS AND CONTINGENCIES (Note 7) STOCKHOLDERS' DEFICIT: Common stock--no par value, 100,000 shares authorized, 50,989 shares issued and outstanding.... 2,770,000 Accumulated deficit............................................................................ (22,180,000) --------------- Total stockholders' deficit.................................................................. (19,410,000) --------------- TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT...................................................... $ 44,571,000 --------------- ---------------
See notes to consolidated financial statements. F-32 FAMILY FITNESS HOLDING COMPANY, INC. CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED JUNE 30, 1995 ------------------- REVENUES: Membership dues............................................................................ $ 54,640,000 Other membership fees...................................................................... 26,040,000 Other...................................................................................... 1,916,000 ------------------- Total revenues........................................................................... 82,596,000 ------------------- OPERATING EXPENSES: Occupancy.................................................................................. 29,434,000 Salaries and commissions................................................................... 27,967,000 Selling, general and administrative........................................................ 17,785,000 Consulting fees to related parties......................................................... 6,203,000 ------------------- Total operating expenses................................................................. 81,389,000 ------------------- OPERATING INCOME............................................................................. 1,207,000 INTEREST EXPENSE............................................................................. (1,690,000) INTEREST INCOME.............................................................................. 671,000 ------------------- INCOME BEFORE INCOME TAXES AND MINORITY INTEREST IN SUBSIDIARIES............................. 188,000 PROVISION FOR INCOME TAXES................................................................... (71,000) ------------------- INCOME BEFORE MINORITY INTEREST IN SUBSIDIARIES.............................................. 117,000 MINORITY INTEREST IN SUBSIDIARIES............................................................ (18,000) ------------------- NET INCOME................................................................................... $ 99,000 ------------------- -------------------
See notes to consolidated financial statements. F-33 FAMILY FITNESS HOLDING COMPANY, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT
NINE MONTHS ENDED JUNE 30, 1995 ---------------------------------------------------------- COMMON STOCK ------------------------ ACCUMULATED SHARES AMOUNT DEFICIT TOTAL --------- ------------- --------------- --------------- BALANCE, OCTOBER 1, 1994............................ $ 50,989 $ 2,356,000 $ (22,279,000) $ (19,923,000) NET INCOME.......................................... -- -- 99,000 99,000 DEBT FORGIVEN BY SHAREHOLDERS (Note 3).............. -- 414,000 -- 414,000 --------- ------------- --------------- --------------- BALANCE, JUNE 30, 1995.............................. 50,989 $ 2,770,000 $ (22,180,000) $ (19,410,000) --------- ------------- --------------- --------------- --------- ------------- --------------- ---------------
See notes to consolidated financial statements. F-34 FAMILY FITNESS HOLDING COMPANY, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
NINE MONTHS ENDED JUNE 30, 1995 ------------------- OPERATING ACTIVITIES: Net income................................................................................. $ 99,000 Adjustment to reconcile net income to net cash provided by operating activities: Depreciation and amortization............................................................ 7,490,000 Changes in deferred taxes................................................................ (4,379,000) Changes in assets and liabilities: Accounts receivable and receivable from related parties................................ (208,000) Prepaid rent........................................................................... 165,000 Other assets........................................................................... 211,000 Accounts payable and accrued expenses.................................................. (2,167,000) Income taxes payable................................................................... 4,431,000 Accrued compensation................................................................... (1,734,000) Other liabilities...................................................................... 981,000 Deferred revenue....................................................................... (161,000) Deferred rent.......................................................................... 611,000 Other.................................................................................. (38,000) ------------------- Net cash provided by operating activities............................................ 5,301,000 ------------------- INVESTING ACTIVITIES: Purchase of investment securities.......................................................... (12,000,000) Proceeds from investment maturities........................................................ 12,000,000 Additions of property and equipment........................................................ (4,463,000) Proceeds on notes receivable............................................................... 387,000 Proceeds from sale of shares of subsidiaries............................................... 117,000 ------------------- Net cash used in investing activities................................................ (3,959,000) ------------------- FINANCING ACTIVITIES: Repayments of notes payable and capital lease obligations.................................. (4,575,000) ------------------- Net cash used in financing activities................................................ (4,575,000) ------------------- DECREASE IN CASH............................................................................. (3,233,000) CASH AT BEGINNING OF PERIOD.................................................................. 1,804,000 ------------------- NET CASH OVERDRAFT AT END OF PERIOD.......................................................... $ (1,429,000) ------------------- ------------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest..................................................................... $ 1,690,000 ------------------- ------------------- Cash paid for taxes........................................................................ $ 620,000 ------------------- ------------------- Property and equipment acquired under capital leases....................................... $ 3,030,000 ------------------- ------------------- Debt forgiven by stockholders (Note 3)..................................................... $ 414,000 ------------------- -------------------
See notes to consolidated financial statements. F-35 FAMILY FITNESS HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED JUNE 30, 1995 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Family Fitness Holding Company, Inc. ("FFHC"), through its wholly owned and majority owned subsidiaries, operates 69 fitness centers in California, Colorado and Nevada. FFHC was formed on September 30, 1994 for the purpose of reorganizing the ownership structure of the fitness centers and related entities. As of that date, certain ownership interests in the fitness centers and related entities were transferred to FFHC in exchange for ownership in FFHC. As a result, FFHC obtained a majority interest in all entities comprising the Family Fitness Center operations. On June 30, 1995, the Company was sold to Fitness Holdings, Inc. ("FHI"). The accompanying consolidated financial statements reflect an accounting cut-off immediately prior to the transaction. Concurrent with the sale of the Company, 19,102 common shares of the Company were issued and assigned to its shareholders as a means of allocating the proceeds of the sale of the Company to such shareholders. As a result of the transaction, the Company was merged into a subsidiary of FHI (ceasing to exist as a stand-alone legal entity) and became a distinct division of the purchaser ("Southern California Division"). Future financial statements of the Southern California Division, if such financial statements were to be prepared, would differ significantly from the accompanying consolidated financial statements of the Company due to, among other factors, the application of the purchase method of accounting, significant additional and refinanced debt, a revised compensation methodology for management, and conformance of accounting policies with those of the purchaser. BASIS OF PRESENTATION--The accompanying consolidated financial statements reflect the Company's historical financial position, results of operations and cash flows as of and for the nine months ended June 30, 1995 without any consideration of the acquisition of the Company which occurred on June 30, 1995. PRINCIPLES OF CONSOLIDATION--The accompanying consolidated financial statements include the accounts of FFHC and its wholly owned and majority-owned subsidiaries (the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. USE OF ESTIMATES--The preparation of financial statements in conformity with generally accepted accounting principles 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 date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS--The Company considers highly liquid investments purchased with an original maturity date of three months or less to be cash equivalents. SHORT-TERM INVESTMENTS AVAILABLE FOR SALE--Short-term interest bearing investments consist of U.S. government obligations with maturities of less than one year but greater than three months when purchased. These investments are readily convertible to cash and are stated at cost which approximates fair value. F-36 FAMILY FITNESS HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED JUNE 30, 1995 (CONTINUED) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT--Furniture and fixtures and equipment subject to capital leases with bargain purchase options are stated at cost and depreciated using the accelerated and straight-line methods over the estimated useful lives of the assets (generally five to seven years). Leasehold improvements are amortized using the straight line method over the shorter of their estimated useful lives or the term of the related leases. DEFERRED RENT--The Company leases premises for all of its fitness centers. A number of the leases include scheduled base rent increases and/or temporary free rent periods over their term. The total amount of base rent payments, including scheduled increases, is being charged to expense on the straight-line method over the term of the leases. REVENUE RECOGNITION--The Company's principal source of revenue is from the collection of dues on fitness memberships. Memberships sold by the Company generally consist of either a dues contract or a prepaid contract. Under a dues contract, the member pays an initial membership fee and may utilize the Company's facilities and services for as long as monthly dues payments are made by the member. Prepaid memberships have terms of three months to three years and require one payment at the inception of the contract. The initial membership fee on dues contracts that provide for a membership term of one year, is deferred and recognized as income over a 12-month period. Monthly dues are recognized as income as earned. Prepaid fees on membership contracts are deferred and recognized over the term of the contract. INCOME TAXES--The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES, (see Note 6). MINORITY INTEREST IN SUBSIDIARIES--Minority interest in subsidiaries, represents other stockholders' interests in certain majority owned subsidiaries. All minority shareholders are employees or consultants to the Company. RECENTLY ISSUED ACCOUNTING STANDARDS--In 1995 the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 establishes accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. Under SFAS No. 123, the Company may either adopt the new fair value-based accounting method or continue the intrinsic value-based method and provide pro forma disclosures of net income and earnings per share as if the accounting provisions of SFAS No. 123 had been adopted. The Company plans to adopt only the disclosure requirements of SFAS No. 123; therefore, such adoption will have no effect on the Company's consolidated net earnings or cash flows. In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The standard generally requires recognition of impairment in the carrying value of goodwill and other long-lived assets if the undiscounted expected future net cash flows is less than the carrying amount of the assets. If SFAS No. 121 had been adopted in 1995, management believes it would not have had a material effect on the Company's financial condition or results of operations. F-37 FAMILY FITNESS HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED JUNE 30, 1995 (CONTINUED) 2. PROPERTY AND EQUIPMENT Property and equipment at June 30, 1995 was comprised of the following:
Leasehold improvements.................................................................. $ 21,026,000 Equipment............................................................................... 34,109,000 Furniture and fixtures.................................................................. 11,101,000 -------------- Total............................................................................... 66,236,000 Less accumulated depreciation and amortization.......................................... (38,280,000) -------------- Net..................................................................................... $ 27,956,000 -------------- --------------
3. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS TO RELATED PARTIES The Company finances expansion principally through borrowings from related parties, including shareholders and officers of the Company. Improvements to new and existing club facilities are financed through unsecured demand notes payable to related parties, including the founder of the Company. Interest on these notes is generally payable at prime (9% at June 30, 1995) plus 2% to 4%. In connection with certain of these notes, the lenders will also typically enter into consulting agreements with the Company (see Note 8). Acquisition of exercise equipment is financed through capital leases with related parties (see Note 5). The following summarizes the notes payable and capital lease obligations to related parties as of June 30, 1995 (see Note 5).
NOTES CAPITAL LEASES TOTAL -------------- -------------- -------------- Total.................................................. $ 6,310,000 $ 7,950,000 $ 14,260,000 Less current portion................................... (6,310,000) (4,591,000) (10,901,000) -------------- -------------- -------------- Long-term portion...................................... $ -- $ 3,359,000 $ 3,359,000 -------------- -------------- -------------- -------------- -------------- --------------
Interest expense on notes payable and capital lease obligations to related parties for the nine months ended June 30, 1995 was $1,452,000. During 1995 certain stockholders forgave $729,000 of notes payable. Because this was a transaction with stockholders, the gain was recorded as a credit to equity, and is net of the related tax expense of $315,000. 4. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS At June 30, 1995, the Company had a $231,000 note payable to an unrelated entity which bears interest at 10% and is due in February 2008. The note is guaranteed by the founder of the Company. In addition, the Company had various unsecured notes payable to unrelated entities totaling $332,000 which bear interest at rates ranging from 9.7% to 10.0% and mature from May 1996 to December 1997. F-38 FAMILY FITNESS HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED JUNE 30, 1995 (CONTINUED) 4. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS (CONTINUED) The following summarizes notes payable and capital lease obligations to third parties as of June 30, 1995 (see Note 5):
CAPITAL NOTES LEASES TOTAL ------------ ------------ ------------- Total........................................................ $ 563,000 $ 851,000 $ 1,414,000 Less current portion......................................... (157,000) (523,000) (680,000) ------------ ------------ ------------- Long-term portion............................................ $ 406,000 $ 328,000 $ 734,000 ------------ ------------ ------------- ------------ ------------ -------------
5. LEASES The Company leases fitness centers and other facilities under operating leases having terms expiring at various dates through 2015. The leases generally have renewal options of 5 to 10 years, exercisable at the option of the Company. Certain of these leases include step rents and escalation clauses based upon changes in the consumer price index. Total rent expense for all operating leases was $13,408,000 for the nine months ended June 30, 1995. Certain of these facility leases are guaranteed by shareholders and officers of the Company, including the founder. Lease guarantee fees of approximately $68,000 were paid by the Company to these related parties during the nine months ended June 30, 1995. The Company leases its administrative offices from a related party under an operating lease expiring in February 2005. Rent expense for this lease was $284,000 for the nine months ended June 30, 1995. Future minimum lease payments for these administrative offices, which are included in the table below, are approximately $352,000 per year in fiscal 1996 through 2000, and total approximately $264,000 thereafter. The Company also leases certain fitness equipment under capital leases, generally from related parties (see Note 3). Equipment recorded under capital leases was $9,472,000, net of accumulated depreciation of $7,441,000 as of June 30, 1995. F-39 FAMILY FITNESS HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NINE MONTHS ENDED JUNE 30, 1995 (CONTINUED) 5. LEASES (CONTINUED) Future minimum lease payments under capital and operating leases and required future payments for operating lease guarantees are as follows:
OPERATING LEASE GUARANTEE CAPITAL LEASES OPERATING LEASES PAYMENTS -------------- ---------------- ----------- June 30: 1996................................................... $ 5,903,000 $ 15,064,000 $ 80,000 1997................................................... 2,918,000 15,205,000 61,000 1998................................................... 1,097,000 15,129,000 53,000 1999................................................... 15,002,000 48,000 2000................................................... 14,975,000 48,000 Thereafter............................................... 126,774,000 639,000 -------------- ---------------- ----------- Total minimum payments............................... 9,918,000 $ 202,149,000 $ 929,000 ---------------- ----------- ---------------- ----------- Less amount representing interest........................ (1,117,000) -------------- Present value of obligations under capital leases........ 8,801,000 Less current portion..................................... (5,114,000) -------------- Long-term capital lease obligations...................... $ 3,687,000 -------------- --------------
6. INCOME TAXES Deferred tax assets and liabilities reflect the impact of temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts measured by applicable tax laws. Deferred tax assets as of June 30, 1995 consist primarily of: Depreciation and capital leases....................................... $ 1,012,000 Deferred rent......................................................... 2,896,000 Deferred revenue...................................................... 8,978,000 Compensation payable.................................................. 519,000 Prepaid expenses...................................................... 142,000 Other, net............................................................ 832,000 ----------- Total............................................................. 14,379,000 Less valuation allowance............................................ (9,077,000) ----------- Net deferred tax asset.............................................. $ 5,302,000 ----------- -----------
A valuation allowance has been recorded due to the uncertainty of the future realizability of certain of the deferred tax assets. F-40 FAMILY FITNESS HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NINE MONTHS ENDED JUNE 30, 1995 6. INCOME TAXES (CONTINUED) The provision for income taxes consists of the following: Current: Federal.............................................................. $ 3,783,000 State................................................................ 667,000 ----------- Total current...................................................... 4,450,000 ----------- Deferred: Federal.............................................................. (3,722,000) State................................................................ (657,000) ----------- Total deferred..................................................... (4,379,000) ----------- Total.................................................................. $ 71,000 ----------- -----------
Income tax expense excludes $315,000 related to the forgiveness of a stockholder note which was credited to equity (See Note 3). The Company's effective income tax expense differs from expected income taxes using the federal statutory rate of 34% as follows: Expected federal tax expense.............................................. $ 64,000 State and local taxes, net of federal benefit............................. 11,000 Other..................................................................... (4,000) --------- Total..................................................................... $ 71,000 --------- ---------
7. CONTINGENT LIABILITIES Various claims and legal proceedings arising in the ordinary course of business are pending against the Company which seek monetary damages and other relief. The amount of liability from all claims and actions cannot be determined with certainty, but in the opinion of management, the ultimate liability from all pending legal proceedings, asserted legal claims, and known potential legal claims which are probable of assertion will not have a material adverse effect on the consolidated financial position or results of operations of the Company. The Company has entered into option agreements (both written and oral) with certain employees of the Company. Under the terms of the agreements, the individuals have the option to purchase stock in certain subsidiary companies for a price equal to the original issue cost of the subsidiary's stock, plus interest from the date of the agreement to the exercise date. The percentage of stock of the subsidiaries that can be acquired under these agreements range from five to forty percent. The options only become exercisable immediately prior to any sale of the Company or as determined by the founder of the Company at his sole discretion. F-41 FAMILY FITNESS HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NINE MONTHS ENDED JUNE 30, 1995 7. CONTINGENT LIABILITIES (CONTINUED) The Company has entered into stock purchase agreements with certain of the minority stockholders of the Company. Under the terms of these agreements, upon termination of employment, the stockholder must sell, and the Company shall have the option to purchase the stockholder's interest at an amount calculated in accordance with the agreement. 8. RELATED PARTY TRANSACTIONS The Company enters into significant transactions with related parties. The following significant transactions are in addition to those described elsewhere in these consolidated financial statements and related notes. The Company has an agreement with Travellers Acceptance Corporation ("TAC") to provide accounts receivable collection services for a collection fee of 30% of amounts received. The founder and other members of management have an ownership interest in TAC. Collection fees received by TAC during the nine months ended June 30, 1995 were $69,000. From time to time, the Company enters into consulting agreements with related parties who are also lenders (see Note 3) to provide consulting services related to new club operations. These agreements are independent of the note agreements and provide for consulting fees based on future revenues in excess of a agreed upon thresholds. Amounts paid under such agreements during the nine months ended June 30, 1995 were $404,000. An entity controlled by an officer of the Company provides administrative, accounting and other corporate services to the Company. The amounts paid to this entity for the nine months ended June 30, 1995 were $221,000. In the event the founder, at his sole discretion, decides to sell the Company or raise additional capital that may dilute current stockholders' interests, the other stockholders agree to cooperate with the transaction, providing the terms and conditions are substantially the same as the terms and conditions of the founder and all other stockholders. * * * * * * F-42 UNDERWRITING Subject to the terms and conditions of the Underwriting Agreement, the Company has agreed to sell to each of the U.S. Underwriters named below, and each of such U.S. Underwriters, for whom Goldman, Sachs & Co., BT Alex. Brown Incorporated and NationsBanc Montgomery Securities LLC are acting as representatives (the "Representatives of the Underwriters"), has severally agreed to purchase from the Company, the respective number of shares of Common Stock set forth opposite its name below:
NUMBER OF SHARES OF COMMON UNDERWRITER STOCK - ------------------------------------------------------------------------------ -------------- Goldman, Sachs & Co........................................................... BT Alex. Brown Incorporated................................................... NationsBanc Montgomery Securities LLC......................................... -------------- Total..................................................................... -------------- --------------
Under the terms and conditions of the Underwriting Agreement, the U.S. Underwriters are committed to take and pay for all of the shares offered hereby, if any are taken. The U.S. Underwriters propose to offer the shares of Common Stock in part directly to the public at the initial public offering price set forth on the cover page of this Prospectus, and in part to certain securities dealers at such price less a concession of $ per share. The U.S. Underwriters may allow, and such dealers may reallow, a concession not in excess of $ per share to certain brokers and dealers. After the shares of Common Stock are released for sale to the public, the offering price and the other selling terms may from time to time be varied by the Representatives of the Underwriters. The Company has entered into an underwriting agreement (the "International Underwriting Agreement") with the underwriters of the International Offering (the "International Underwriters") providing for the concurrent offer and sale of shares of Common Stock in an International Offering outside the United States. The initial public offering price and aggregate underwriting discounts and commissions per share for the Offerings are identical. The closing of the offering made hereby is a condition to the closing of the International Offering, and vice versa. The representatives of the International Underwriters are Goldman Sachs International, BT Alex. Brown International and NationsBanc Montgomery Securities LLC. Pursuant to the agreement between the U.S. and International Underwriting Syndicates (the "Agreement Between") relating to the Offerings, each of the U.S. Underwriters named herein has agreed that, as a part of the distribution of the shares offered as a part of the U.S. Offering and subject to certain exceptions, it will offer, sell or deliver the shares of Common Stock, directly or indirectly, only in the United States of America (including the States and the District of Columbia), its territories, its possessions and other areas subject to its jurisdiction (the "United States") and to U.S. persons, which term shall mean, for purposes of this paragraph: (a) any individual who is a resident of the United States or (b) any corporation, partnership or other entity organized in or under the laws of the United States or any political subdivision thereof and whose office most directly involved with the purchase is located in the United States. Each of the International Underwriters has agreed or will agree pursuant to the Agreement Between that, as a part of the distribution of the shares offered as a part of the International Offering, and subject to certain exceptions, it will (i) not, directly or indirectly, offer, sell or deliver shares of Common U-1 Stock (a) in the United States or to any U.S. persons or (b) to any person who it believes intends to reoffer, resell or deliver the shares in the United States or to any U.S. persons, and (ii) cause any dealer to whom it may sell such shares at any concession to agree to observe a similar restriction. Pursuant to the Agreement Between, sales may be made between the U.S. Underwriters and the International Underwriters of such number of shares of Common Stock as may be mutually agreed. The price of any shares so sold shall be the initial public offering price, less an amount not greater than the selling concession. The Selling Stockholders have granted the U.S. Underwriters an option exercisable for 30 days after the date of this Prospectus to purchase up to an aggregate of additional shares of Common Stock solely to cover over-allotments, if any. If the U.S. Underwriters exercise their over-allotment option, the U.S. Underwriters have severally agreed, subject to certain conditions, to purchase approximately the same percentage thereof that the number of shares to be purchased by each of them, as shown in the foregoing table, bears to the shares of Common Stock offered hereby. In connection with the Offerings, the Underwriters may purchase and sell the shares of Common Stock in the open market. These transactions may include over-allotment and stabilizing transactions, and purchases to cover syndicate short positions created in connection with the Offerings. Stabilizing transactions consist of certain bids or purchases for the purpose of preventing or retarding a decline in the market price of the Common Stock; and syndicate short positions involve the sale by the Underwriters of a greater number of shares of Common Stock than they are required to purchase from the Company in the Offerings. The Underwriters also may impose a penalty bid, whereby selling concessions allowed to syndicate members or other broker-dealers in respect of the securities sold in the Offerings for their account may be reclaimed by the syndicate if such shares of Common Stock are repurchased by the syndicate in stabilizing or covering transactions. These activities may stabilize, maintain or otherwise affect the market price of the shares of Common Stock, which may be higher than the price that might otherwise prevail in the open market; and these activities, if commenced, may be discontinued at any time. These transactions may be effected on the Nasdaq National Market in the over-the-counter market or otherwise. The Company and other stockholders of the Company have agreed that, during the period beginning from the date of this Prospectus and continuing to and including the date 180 days after the date of this Prospectus, they will not offer, sell, contract to sell or otherwise dispose of, except as provided in the Underwriting Agreement and the International Underwriting Agreement, any securities of the Company that are substantially similar to the shares of Common Stock, including but not limited to any securities that are convertible into or exchangeable for, or that represent the right to receive, shares of Common Stock or any such substantially similar securities (other than any issuances or sales of any of the foregoing securities (i) in connection with the acquisition of or merger with any other corporation or other entity or the acquisition of any assets or properties thereof provided that, prior to the issuance of such securities, the Company shall obtain and deliver to the Underwriters executed copies of an agreement from any such corporation or entity substantially to the effect set forth in the Underwriting Agreement in form satisfactory to the Representatives of the Underwriters or (ii) pursuant to employee stock option, or other employee benefit plans existing on the date of the Underwriting Agreement) without the prior written consent of the Representatives of the Underwriters. The representatives of the Underwriters have informed the Company that they do not expect sales to accounts over which the Underwriters exercise discretionary authority to exceed five percent of the total number of shares of Common Stock offered by them. The Underwriters have reserved for sale, at the initial public offering price, shares of Common Stock for associates and directors of the Company and who have expressed an interest in purchasing such shares of Common Stock in the Offerings. The number of shares available for sale to the general public in the Offerings will be reduced to the extent such persons purchase such U-2 reserved shares. Any reserved shares not so purchased will be offered by the Underwriters to the general public on the same basis as the other shares offered hereby. Prior to the Offerings, there has been no public market for the shares of Common Stock. The initial public offering price will be negotiated among the Company and the representatives of the U.S. Underwriters and the International Underwriters. Among the factors to be considered in determining the initial public offering price of the Common Stock in addition to prevailing market conditions, are the Company's historical performance, estimates of the business potential and earnings prospects of the Company, an assessment of the Company's management and the consideration of the above factors in relation to market valuation of companies in related businesses. The Company has agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act. U-3 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE. ------------------------ TABLE OF CONTENTS
PAGE --------- Prospectus Summary.............................. 3 Risk Factors.................................... 10 Use of Proceeds................................. 15 Dividend Policy................................. 15 Capitalization.................................. 16 Dilution........................................ 17 Selected Consolidated Financial Information..... 18 Pro Forma Combined Financial Information........ 20 Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 21 Business........................................ 29 Management...................................... 39 Principal and Selling Stockholders.............. 46 Certain Relationships and Related Transactions.................................. 48 Shares Eligible for Future Sale................. 51 Description of Capital Stock.................... 52 Legal Matters................................... 54 Experts......................................... 54 Additional Information.......................... 54 Index to Financial Statements................... F-1 Underwriting.................................... U-1
------------------------ UNTIL , 1998 (THE 25TH DAY AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS. SHARES FITNESS HOLDINGS, INC. COMMON STOCK (PAR VALUE $.001 PER SHARE) ------------------------ [LOGO] ------------------------ GOLDMAN, SACHS & CO. BT ALEX( BROWN NATIONSBANC MONTGOMERY SECURITIES LLC REPRESENTATIVES OF THE UNDERWRITERS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The expenses payable in connection with the issuance and distribution of the Common Shares being registered (other than underwriting discount) are estimated as follows: SEC Registration Fee......................... $ 22,125 NASD Filing Fee.............................. 8,000 Printing and Engraving Expenses.............. * Accounting Fees and Expenses................. * Legal Fees and Expenses...................... * Blue Sky Fees and Expenses................... * Transfer Agent's Fees and Expenses........... * Miscellaneous Expenses....................... * --------- Total........................................ $ * --------- ---------
- ------------------------ * To be filed by amendment ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. THE COMPANY Article of the Certificate of Incorporation and Article VI of the By-Laws provide for the indemnification by the Company of each director, officer and employee of the Company to the fullest extent permitted by the Delaware Law, as the same exists or may hereafter be amended. Section 145 of the Delaware Law provides in relevant part that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that such person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe such person's conduct was unlawful. In addition, Section 145 provides that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection with the defense or settlement of such action or suit if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Delaware Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Delaware Court of Chancery or such other court shall deem proper. Delaware Law further provides II-1 that nothing in the above-described provisions shall be deemed exclusive of any other rights to indemnification or advancement of expenses to which any person may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise. Article of the Certificate further provides that a Director of the Company shall not be personally liable to the Company or its stockholders for monetary damages for any breach of fiduciary duty as a Director. Section 102(b)(7) of the Delaware General Corporation Law provides that a provision so limiting the personal liability of a director shall not eliminate or limit the liability of a director for, among other things; breach of the duty of loyalty; acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law; unlawful payment of dividends; and transactions from which the director derived an improper personal benefit. The directors and officers of the Company are insured, under policies of insurance maintained by the Company, within the limits and subject to the limitations of the policies, against certain expenses in connection with the defense of actions suits, or proceedings and certain liabilities which might be imposed as a result of such actions, suits, or proceedings, to which they are parties by reason of being or having been such directors or officers. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES None. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 1.1 Form of Underwriting Agreement.* 3.1 Amended and Restated Certificate of Incorporation of Fitness Holdings, Inc.* 3.2 Bylaws of Fitness Holdings, Inc. 4.1 Form of Certificate representing Common Stock.* 5 Opinion of White & Case LLP as to the validity of the offered shares.* 10.1 Stockholders Agreement dated as of December 29, 1994 by and among 24 Hour Fitness, Inc., McCown De Leeuw & Co. III, L.P., McCown De Leeuw & Co. (Europe) III, L.P., McCown De Leeuw & Co. (Asia) III, L.P., Gamma Fund LLC and certain management stockholders. 10.2 Employment Agreement dated as of December 22, 1997, between Fitness Holdings, Inc. and Mark S. Mastrov. 10.3 Form of Indemnification Agreement.* 10.4 Third Amended and Restated Credit Agreement dated as of December 19, 1997 among 24 Hour Fitness, Inc. as borrower and Fitness Holdings, Inc. as parent guarantor and the restatement lenders, the existing issuing bank and the swing line bank renamed herein as Restatement Lenders, Existing Issuing Bank and Swing Line Bank and Banque Nationale de Paris as administrative agent and syndication agent, and Bankers Trust Company as documentation agent and LaSalle National Bank and Wells Fargo Bank, N.A. as co-agents. 10.5 Fitness Holdings, Inc. 1994 Stock Option and Stock Award Plan. 10.6 Form of Registration Rights Agreement among McCown De Leeuw & Co. III, L.P., McCown De Leeuw & Co. (Europe) III, L.P., McCown De Leeuw & Co. (Asia) III, L.P., Gamma Fund LLC and Fitness Holdings, Inc.* 10.7 Fitness Holdings, Inc. 1995 Stock Option Plan for non-employee directors (as amended and Restated effective May 16, 1996). 10.8 Management Services Agreement dated December 29, 1994 between 24 Hour Fitness, Inc. and MDC Management Company III, L.P.
II-2 10.9 Third Amended and Restated Holdings Pledge Agreement dated December 19, 1997 from Fitness Holdings, Inc., as pledgor, to Banque Nationale de Paris, as administrative agent. 10.10 Third Amended and Restated Holdings Guaranty dated December 19, 1997 from Fitness Holdings, Inc. in favor of the Lenders Party to the Credit Agreement referred to herein, the Hedge Banks referred to in the Credit Agreement and Banque Nationale de Paris, as existing issuing bank, swing line bank and as administrative agent. 10.11 Third Amended and Restated Security Agreement dated December 19, 1997 from the Grantors named herein, as grantors, to Banque Nationale de Paris, as administrative agent. 10.12 Subsidiary Guaranty dated December 19, 1997 from the parties listed on the signature pages hereof as subsidiary guarantor, in favor of the secured parties referred to in the Third Amended and Restated Credit Agreement referred to therein. 10.13 First Amendment to Management Services Agreement dated December 19, 1997 between 24 Hour Fitness, Inc. and MDC Management Company III, L.P. 11 Computation of earnings per share.* 21 Subsidiaries of the Registrant.* 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of White & Case LLP (included in their opinion filed as Exhibit 5).* 24 Powers of attorney from officers and directors of the Company (see page II-4). 27 Financial Data Schedule.
- ------------------------ * To be filed by amendment ITEM 17. UNDERTAKINGS. The undersigned registrant hereby undertakes that (a) insofar as indemnification for liabilities arising under the Securities Act, as amended (the "Securities Act") may be permitted to directors, officers and controlling persons of the Registrants pursuant to the foregoing provisions, or otherwise, the Registrants have been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim of indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue; and (b)(1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective, and (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial BONA FIDE offering thereof. The undersigned registrant hereby undertakes to provide the underwriter at the closing specified in the underwriting agreements certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Registration Statement to be signed on it respective behalf of the undersigned, thereunto duly authorized, in the City of Pleasanton, State of California, on the 8th day of July, 1998. FITNESS HOLDINGS, INC. By: /s/ MARK S. MASTROV ------------------------------------------ Mark S. Mastrov PRESIDENT AND CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mark S. Mastrov and Gilbert K. Freeman, and each of them severally, his true and lawful attorney-in-fact and agents, with full power of substitution and resubstitution, for him and his name, place and stead, in any and all capacities, to sign and all amendments (including post-effective amendments) to this registration statement, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, including any subsequent registration statement filed pursuant to Rule 462(b), granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do an perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agents of either of them, or their or his or her substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities indicated on the dates indicated. SIGNATURES TITLE - ------------------------------ -------------------------- /s/ MARK S. MASTROV - ------------------------------ President, Chief Executive July 8, 1998 Mark S. Mastrov Officer and Director /s/ GILBERT K. FREEMAN - ------------------------------ Chief Financial Officer July 8, 1998 Gilbert K. Freeman /s/ KAREN BEHNKE - ------------------------------ Director July 8, 1998 Karen Behnke /s/ DONALD F. DORWARD - ------------------------------ Director July 8, 1998 Donald F. Dorward /s/ DAVID E. KING - ------------------------------ Chairman of the Board of July 8, 1998 David E. King Directors /s/ GEORGE E. MCCOWN - ------------------------------ Director July 8, 1998 George E. McCown /s/ PETER ROY - ------------------------------ Director July 8, 1998 Peter Roy - ------------------------------ Director July , 1998 Gary Schoenfeld /s/ WILLIAM WALSH - ------------------------------ Director July 8, 1998 William Walsh /s/ RAY A. WILSON - ------------------------------ Director July 8, 1998 Ray A. Wilson II-4 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ------------- ------------------------------------------------------------------------------------------------------- 1.1 Form of Underwriting Agreement.* 3.1 Amended and Restated Certificate of Incorporation of Fitness Holdings, Inc.* 3.2 Bylaws of Fitness Holdings, Inc. 4.1 Form of Certificate representing Common Stock.* 5 Opinion of White & Case LLP as to the validity of the offered shares.* 10.1 Stockholders Agreement dated as of December 29, 1994 by and among 24 Hour Fitness, Inc., McCown De Leeuw & Co. III, L.P., McCown De Leeuw & Co. (Europe) III, L.P., McCown De Leeuw & Co. (Asia) III, L.P., Gamma Fund LLC and certain management stockholders. 10.2 Employment Agreement dated as of December 22, 1997, between Fitness Holdings, Inc. and Mark S. Mastrov. 10.3 Form of Indemnification Agreement.* 10.4 Third Amended and Restated Credit Agreement dated as of December 19, 1997 among 24 Hour Fitness, Inc. as borrower and Fitness Holdings, Inc. as parent guarantor and the restatement lenders, the existing issuing bank and the swing line bank renamed herein as Restatement Lenders, Existing Issuing Bank and Swing Line Bank and Banque Nationale de Paris as administrative agent and syndication agent, and Bankers Trust Company as documentation agent and LaSalle National Bank and Wells Fargo Bank, N.A. as co-agents. 10.5 Fitness Holdings, Inc. 1994 Stock Option and Stock Award Plan. 10.6 Form of Registration Rights Agreement among McCown De Leeuw & Co. III, L.P., McCown De Leeuw & Co. (Europe) III, L.P., McCown De Leeuw & Co. (Asia) III, L.P., Gamma Fund LLC and Fitness Holdings, Inc.* 10.7 Fitness Holdings, Inc. 1995 Stock Option Plan for non-employee directors (as amended and Restated effective May 16, 1996). 10.8 Management Services Agreement dated December 29, 1994 between 24 Hour Fitness, Inc. and MDC Management Company III, L.P. 10.9 Third Amended and Restated Holdings Pledge Agreement dated December 19, 1997 from Fitness Holdings, Inc., as pledgor, to Banque Nationale de Paris, as administrative agent. 10.10 Third Amended and Restated Holdings Guaranty dated December 19, 1997 from Fitness Holdings, Inc. in favor of the Lenders Party to the Credit Agreement referred to herein, the Hedge Banks referred to in the Credit Agreement and Banque Nationale de Paris, as existing issuing bank, swing line bank and as administrative agent. 10.11 Third Amended and Restated Security Agreement dated December 19, 1997 from the Grantors named herein, as grantors, to Banque Nationale de Paris, as administrative agent. 10.12 Subsidiary Guaranty dated December 19, 1997 from the parties listed on the signature pages hereof as subsidiary guarantor, in favor of the secured parties referred to in the Third Amended and Restated Credit Agreement referred to therein. 10.13 First Amendment to Management Services Agreement dated December 19, 1997 between 24 Hour Fitness, Inc. and MDC Management Company III, L.P. 11 Computation of earnings per share.* 21 Subsidiaries of the Registrant.* 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of White & Case LLP (included in their opinion filed as Exhibit 5).* 24 Powers of attorney from officers and directors of the Company (see page II-4). 27 Financial Data Schedule.
- ------------------------ * To be filed by amendment EX-3.2 2 EXHIBIT 3.2 EXHIBIT 3.2 BY-LAWS OF H.E.C. INVESTMENTS, INC., A Delaware Corporation
TABLE OF CONTENTS Page ---- ARTICLE I - CORPORATE OFFICES . . . . . . . . . . . . . . . . . . . . . . . 1 1.1 Registered Office . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Other Offices . . . . . . . . . . . . . . . . . . . . . . . . . 1 ARTICLE II - STOCKHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . 1 2.1 Place of Meetings . . . . . . . . . . . . . . . . . . . . . . . 1 2.2 Annual Meeting . . . . . . . . . . . . . . . . . . . . . . . . 1 2.3 Special Meeting . . . . . . . . . . . . . . . . . . . . . . . . 2 2.4 Notice of Stockholders Meetings . . . . . . . . . . . . . . . . 3 2.5 Manner of Giving Notice; Affidavit of Notice . . . . . . . . . 3 2.6 Quorum . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.7 Adjourned Meeting; Notice . . . . . . . . . . . . . . . . . . . 3 2.8 Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.9 Waiver of Notice . . . . . . . . . . . . . . . . . . . . . . . 4 2.10 Stockholder Action by Written Consent Without a Meeting . . . . 5 2.11 Record Date for Stockholder Notice; Voting; Giving Consents . . 5 2.12 Proxies . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.13 List of Stockholders Entitled to Vote . . . . . . . . . . . . . 7 2.14 Conduct of Business . . . . . . . . . . . . . . . . . . . . . . 7 2.15 Inspectors of Election . . . . . . . . . . . . . . . . . . . . 7 2.16 Inspectors of Election and Procedures for Counting Written Consents . . . . . . . . . . . . . . . . . . . . 8 ARTICLE III - DIRECTORS . . . . . . . . . . . . . . . . . . . . . . . . . . 9 3.1 Powers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 3.2 Number of Directors . . . . . . . . . . . . . . . . . . . . . . 10 3.3 Election, Qualification and Term of Office of Directors . . . . 10 3.4 Resignation and Vacancies . . . . . . . . . . . . . . . . . . . 11 3.5 Place of Meetings; Meetings by Telephone . . . . . . . . . . . 12 3.6 Regular Meetings . . . . . . . . . . . . . . . . . . . . . . . 12 3.7 Special Meetings; Notice . . . . . . . . . . . . . . . . . . . 12 3.8 Quorum . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 3.9 Waiver of Notice . . . . . . . . . . . . . . . . . . . . . . . 13 3.10 Adjourned Meeting Notice . . . . . . . . . . . . . . . . . . . 13 3.11 Board Action by Written Consent Without a Meeting . . . . . . . 14 3.12 Fees and Compensation of Directors . . . . . . . . . . . . . . 14 3.13 Approval of Loans to Officers . . . . . . . . . . . . . . . . . 14 3.14 Removal of Directors . . . . . . . . . . . . . . . . . . . . . 14 3.15 Conduct of Business . . . . . . . . . . . . . . . . . . . . . . 15
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TABLE OF CONTENTS (continued) Page ---- ARTICLE IV - COMMITTEES . . . . . . . . . . . . . . . . . . . . . . . . . . 15 4.1 Committees of Directors . . . . . . . . . . . . . . . . . . . . 15 4.2 Committee Minutes . . . . . . . . . . . . . . . . . . . . . . . 16 4.3 Meetings and Action of Committees . . . . . . . . . . . . . . . 16 ARTICLE V - OFFICERS . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 5.1 Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 5.2 Election of Officers . . . . . . . . . . . . . . . . . . . . . . 17 5.3 Subordinate Officers . . . . . . . . . . . . . . . . . . . . . . 17 5.4 Removal and Resignation of Officers . . . . . . . . . . . . . . 17 5.5 Vacancies in Offices . . . . . . . . . . . . . . . . . . . . . . 17 5.6 Chairman of the Board . . . . . . . . . . . . . . . . . . . . . 17 5.7 President . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 5.8 Vice Presidents . . . . . . . . . . . . . . . . . . . . . . . . 18 5.9 Secretary . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 5.10 Chief Financial Officer . . . . . . . . . . . . . . . . . . . . 19 5.11 Assistant Secretary . . . . . . . . . . . . . . . . . . . . . . 19 5.12 Authority and Duties of Officers . . . . . . . . . . . . . . . . 19 5.13 Representation of Shares of Other Corporations . . . . . . . . . 20 ARTICLE VI - INDEMNITY . . . . . . . . . . . . . . . . . . . . . . . . . . 20 6.1 Indemnification of Directors and Officers . . . . . . . . . . . 20 6.2 Indemnification of Others . . . . . . . . . . . . . . . . . . . 20 6.3 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 ARTICLE VII - RECORDS AND REPORTS . . . . . . . . . . . . . . . . . . . . . 21 7.1 Maintenance and Inspection of Records . . . . . . . . . . . . . 21 7.2 Inspection by Directors . . . . . . . . . . . . . . . . . . . . 22 7.3 Annual Statement to Stockholders . . . . . . . . . . . . . . . . 22 ARTICLE VIII - GENERAL MATTERS . . . . . . . . . . . . . . . . . . . . . . 22 8.1 Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 8.2 Execution of Corporate Contracts and Instruments . . . . . . . . 22 8.3 Stock Certificates; Partly Paid Shares . . . . . . . . . . . . . 23 8.4 Special Designation on Certificates . . . . . . . . . . . . . . 23 8.5 Lost Certificates . . . . . . . . . . . . . . . . . . . . . . . 24 8.6 Construction; Definitions . . . . . . . . . . . . . . . . . . . 24 8.7 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 8.8 Fiscal Year . . . . . . . . . . . . . . . . . . . . . . . . . . 25 8.9 Seal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 8.10 Transfer of Stock . . . . . . . . . . . . . . . . . . . . . . . 25 8.11 Stock Transfer Agreements . . . . . . . . . . . . . . . . . . . 25
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TABLE OF CONTENTS (continued) Page ---- 8.12 Registered Stockholders . . . . . . . . . . . . . . . . . . . . 25 8.13 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 ARTICLE IX - AMENDMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . 26 ARTICLE X - DISSOLUTION . . . . . . . . . . . . . . . . . . . . . . . . . . 26 ARTICLE XI - CUSTODIAN . . . . . . . . . . . . . . . . . . . . . . . . . . 27 11.1 Appointment of a Custodian in Certain Cases . . . . . . . . . . 27 11.2 Duties of Custodian . . . . . . . . . . . . . . . . . . . . . . 27
-iii- BY-LAWS OF H.E.C. INVESTMENTS, INC. ARTICLE I CORPORATE OFFICES 1.1 REGISTERED OFFICE The registered office of the corporation shall be in the City of Dover, County of Kent, State of Delaware. The name of the registered agent of the corporation at such location is Incorporating Services, Ltd. 1.2 OTHER OFFICES The board of directors may at any time establish other offices at any place or places where the corporation is qualified to do business. ARTICLE II STOCKHOLDERS 2.1 PLACE OF MEETINGS Meetings of stockholders shall be held at any place, within or outside the State of Delaware, designated by the board of directors. In the absence of any such designation, stockholders' meetings shall be held at the registered office of the corporation. 2.2 ANNUAL MEETING The annual meeting of stockholders shall be held, each year, on a date and at a time designated by the board of directors. In the absence of any said designation, the annual meeting of stockholders shall be held on the second Tuesday of August in each year at 3:00 p.m. at the principal executive office of the Corporation. At each annual meeting, directors shall be elected, and any other proper business may be transacted. To be properly brought before an annual meeting, business must be (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the board of directors, (b) otherwise properly brought before the meeting by or at the direction of the board of directors, or (c) otherwise properly brought before the meeting by a stockholder. For business to be properly brought before the meeting by a stockholder, the secretary of the corporation must have received notice in writing from the stockholder not less than thirty (30) days nor more than sixty (60) days prior to the meeting; provided, however, that if less than thirty-five (35) days' notice of the meeting is given to stockholders, such notice shall have been received by the secretary not later than the close of business on the seventh (7th) day following the day on which the notice of meeting was mailed. Such written notice to the secretary shall set forth, as to each matter the stockholder proposes to bring before the annual meeting: (i) a brief description of the business, (ii) the name and address, as they appear on the corporation's books, of the stockholder proposing such business, (iii) the number of shares of stock of the corporation beneficially owned by such stockholder and (iv) any material interest of such stockholder in such business. Notwithstanding any provision in the by-laws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 2.2. 2.3 SPECIAL MEETING A special meeting of the stockholders may be called at any time by the board of directors, by the chairman of the board, by the president or by one or more holders holding shares representing in the aggregate the right to cast not less than ten percent (10%) of the votes at the meeting. If a special meeting is called by any person or persons other than the board of directors, the request shall be in writing, specifying the time of such meeting and the general nature of the business proposed to be transacted and shall be delivered personally or sent by registered mail or by telegraphic or other facsimile transmission to the chairman of the board, the president, the chief executive officer or the secretary of the corporation. No business may be transacted at such special meeting otherwise than specified in such notice. The officer receiving the request shall cause notice to be given to the stockholders entitled to vote, in accordance with the provisions of Sections 2.4 and 2.5, that a meeting will be held at the time requested by the person or persons who called the meeting, not less than thirty-five (35) nor more than sixty (60) days after the receipt of the request. If the notice is not given within twenty (20) days after the receipt of the request, the person or persons requesting the meeting may give the notice. Nothing contained in this paragraph of this Section 2.3 shall be construed as limiting, fixing, or affecting the time when a meeting of stockholders called by action of the board of directors may be held. -2- 2.4 NOTICE OF STOCKHOLDERS MEETINGS All notices of meetings of stockholders shall be in writing and shall be sent or otherwise given in accordance with Section 2.5 of these by-laws not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder entitled to vote at such meeting, except as otherwise provided herein or required by law (meaning, here and hereinafter, as required from time to time by the General Corporation Law of Delaware or the certificate of incorporation of the corporation). The notice shall specify the place, date, and hour of the meeting, and, in the case of a special meeting, the purpose or purposes for which the meeting is called. 2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE Written notice of any meeting of stockholders, if mailed, is given when deposited in the United States mail, postage prepaid, directed to the stockholder at his address as it appears on the records of the corporation. An affidavit of the secretary or an assistant secretary or of the transfer agent of the corporation that the notice has been given shall, in the absence of fraud, be prima facie evidence of the facts stated therein. 2.6 QUORUM At any meeting of the stockholders, the holders of a majority, present in person or by proxy, of all of the shares of the stock entitled to vote at the meeting shall constitute a quorum for all purposes, unless or except to the extent that the presence of a larger number may be required by law. Where a separate vote by a class or classes is required, a majority, present in person or by proxy, of the shares of such class or classes entitled to take action with respect to that vote on that matter shall constitute a quorum. If a quorum shall fail to attend any meeting, the chairman of the meeting may adjourn the meeting to another place, date or time. If a notice of any adjourned special meeting of stockholders is sent to all stockholders entitled to vote thereat, stating that it will be held with those present constituting a quorum, those present at such adjourned meeting shall constitute a quorum (but in no event shall a quorum consist of less than one-third of the shares entitled to vote at the meeting), and all matters shall be determined by a majority of the votes cast at such meeting, except as otherwise required by law. 2.7 ADJOURNED MEETING; NOTICE When a meeting is adjourned to another time or place, unless these by-laws otherwise require, notice need not be given of the -3- adjourned meeting if the time and place thereof are announced at the meeting at which the adjournment is taken. At the adjourned meeting the corporation may transact any business that might have been transacted at the original meeting. If the adjournment is for more than thirty (30) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. 2.8 VOTING The stockholders entitled to vote at any meeting of stockholders shall be determined in accordance with the provisions of Section 2.11 of these by-laws, subject to the provisions of Sections 217 and 218 of the General Corporation Law of Delaware (relating to voting rights of fiduciaries, pledgors and joint owners of stock and to voting trusts and other voting agreements). Each stockholder shall have one (1) vote for every share of stock entitled and to vote that is registered in his or her name on the record date for the meeting (as determined in accordance with Section 2.11 of these by-laws), except as otherwise provided herein or required by law. Every stock vote shall be taken by ballots, each of which shall state the name of the stockholder or proxyholder voting and such other information as may be required under the procedure established for the meeting. All elections shall be determined by a plurality of the votes cast, and except as otherwise required by law or provided herein, all other matters shall be determined by a majority of the votes cast affirmatively or negatively. 2.9 WAIVER OF NOTICE Whenever notice is required to be given under any provision of the General Corporation Law of Delaware or of the certificate of incorporation or these by-laws, a written waiver thereof, signed by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders need be specified in any written waiver of notice unless so required by the certificate of incorporation or these by-laws. -4- 2.10 STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING Any action required or permitted to be taken at any annual or special meeting of stockholders may be taken without a meeting, without prior notice, and without a vote if a consent or consents in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered to the corporation at its registered office in Delaware, its principal place of business, or to an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery to the corporation's registered office shall be made by hand or by certified or registered mail, return receipt requested. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. If the action that is consented to is such as would have required the filing of a certificate under any section of the General Corporation Law of Delaware if such action had been voted on by stockholders at a meeting thereof, then the certificate filed under such section shall state, in lieu of any statement required by such section concerning any vote of stockholders, that written notice and written consent have been given as provided in Section 228 of the General Corporation Law of Delaware. 2.11 RECORD DATE FOR STOCKHOLDER NOTICE; VOTING; GIVING CONSENTS In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the board of directors may fix a record date, which shall not be more than sixty (60) nor less than ten (10) days before the date of such meeting, nor more than sixty (60) days prior to any other action. If the board of directors does not so fix a record date: (i) The record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. -5- (ii) The record date for determining stockholders entitled to receive payment of any dividend or other distribution or allotment of rights or to exercise any rights of change, conversion or exchange of stock or for any other purpose shall be at the close of business on the day on which the board of directors adopts the resolution relating thereto. In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the board of directors may fix a record date, which record date shall neither precede nor be more than ten (10) days after the date upon which such resolution is adopted by the board of directors. Any stockholder of record seeking to have the stockholders authorize or take action by written consent shall, by written notice to the secretary, request the board of directors to fix a record date. The board of directors shall promptly, but in all events within ten (10) days after the date on which such notice is received, adopt a resolution fixing the record date. If the board of directors has not fixed a record date within such time, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the board of directors is required by law, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation in the manner prescribed in the first paragraph of Section 2.10 of these by-laws. If the board of directors has not fixed a record date within such time and prior action by the board of directors is required by law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the date on which the board of directors adopts the resolution taking such prior action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the board of directors may fix a new record date for the adjourned meeting. 2.12 PROXIES Each stockholder entitled to vote at a meeting of stockholders or to express consent or dissent to corporate action in writing without a meeting may authorize another person or persons to act for him by a written proxy, filed in accordance with the procedure established for the meeting or taking of action in writing, but no such proxy shall be voted or acted upon after three (3) years from its date, unless the proxy provides for a longer period. Any copy, facsimile telecommunication or other reliable reproduction of the writing or transmission created pursuant to this Section 2.12 may be substituted or used in lieu of the original writing or trans- -6- mission for any and all purposes for which the original writing or transmission could be used, provided that such copy, facsimile telecommunication or other reproduction shall be a complete reproduction of the entire original writing or transmission. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Section 212 (e) of the General Corporation Law of Delaware. 2.13 LIST OF STOCKHOLDERS ENTITLED TO VOTE The officer who has charge of the stock ledger of the corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder for any purpose germane to the meeting during ordinary business hours for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof and may be inspected by any stockholder who is present. Such list shall presumptively determine the identity of the stockholders entitled to vote at the meeting and the number of shares held by each of them. 2.14 CONDUCT OF BUSINESS Such person as the board of directors may have designated or, in the absence of such a person, any executive officer of the corporation, shall call to order any meeting of the stockholders and act as chairman of the meeting. In the absence of the secretary of the corporation, the secretary of the meeting shall be such person as the chairman appoints. The chairman of any meeting of stockholders shall determine the order of business and the procedure at the meeting, including such regulation of the manner of voting and the conduct of discussion as seem to him in order. The date and time of the opening and closing of the polls for each matter upon which the stockholders will vote at the meeting shall be announced at the meeting. 2.15 INSPECTORS OF ELECTION The corporation may, and to the extent required by law, shall, in advance of any meeting of stockholders, appoint one or more inspectors to act at the meeting and make a written report thereof. The corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, -7- the person presiding at the meeting may, and to the extent required by law, shall, appoint one or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his ability. Every vote taken by ballots shall be counted by an inspector or inspectors appointed by the chairman of the meeting. 2.16 INSPECTORS OF ELECTION AND PROCEDURES FOR COUNTING WRITTEN CONSENTS Within three (3) business days after receipt of the earliest dated consent delivered to the corporation in the manner provided in Section 228(c) of the Delaware General Corporation Law or the determination by the board of directors of the corporation that the corporation should seek corporate action by written consent, as the case may be, the secretary may engage nationally recognized independent inspectors of elections for the purpose of performing a ministerial review of the validity of the consents and revocations. The cost of retaining inspectors of election shall be borne by the corporation. Consents and revocations shall be delivered to the inspectors upon receipt by the corporation, the stockholder or stockholders soliciting consents or soliciting revocations in opposition to action by consent proposed by the corporation (the "Soliciting Stockholders") or their proxy solicitors or other designated agents. As soon as consents and revocations are received, the inspectors shall review the consents and revocations and shall maintain a count of the number of valid and unrevoked consents. The inspectors shall keep such count confidential and shall not reveal the count to the corporation, the Soliciting Stockholders or their representatives or any other person or entity. As soon as practicable after the earlier of (i) sixty (60) days after the date of the earliest dated consent delivered to the corporation in the manner provided in Section 228(c) of the Delaware General Corporation Law or (ii) a written request therefor by the corporation or the Soliciting Stockholders (whichever is soliciting consents) (which request, except in the case of corporate action by written consent taken pursuant to the solicitations of not more than ten (10) persons, may be made no earlier than after such reasonable amount of time after the commencement date of the applicable solicitation of consents as is necessary to permit the inspectors to commence and organize their count, but in no event less than five (5) days after such commencement date), notice of which request shall be given to the party opposing the solicitation of consents, if any, which request shall state that the corporation or Soliciting Stockholders, as the case may be, have a good faith belief that the requisite number of valid and unrevoked consents to authorize or fake the action specified in the consents has been -8- received in accordance with these by-laws, the inspectors shall issue a preliminary report to the corporation and the Soliciting Stockholders stating: (i) the number of valid consents; (ii) the number of valid revocations; (iii) the number of valid and unrevoked consents; (iv) the number of invalid consents; (v) the number of invalid revocations; and (vi) whether, based on their preliminary count, the requisite number of valid and unrevoked consents has been obtained to authorize or take the action specified in the consents. Unless the corporation and the Soliciting Stockholders shall agree to a shorter or longer period, the corporation and the Soliciting Stockholders shall have 48 hours to review the consents and revocations and to advise the inspectors and the opposing party in writing as to whether they intend to challenge the preliminary report of the inspectors. If no written notice of an intention to challenge the preliminary report is received within 48 hours after the inspectors' issuance of the preliminary report, the inspectors shall issue to the corporation and the Soliciting Stockholders their final report containing the information from the inspectors' determination with respect to whether the requisite number of valid and unrevoked consents was obtained to authorize and take the action specified in the consents. If the corporation or the Soliciting Stockholders issue written notice of an intention to challenge the inspectors' preliminary report within 48 hours after the issuance of that report, a challenge session shall be scheduled by the inspectors as promptly as practicable. A transcript of the challenge session shall be recorded by a certified court reporter. Following completion of the challenge session, the inspectors shall as promptly as practicable issue their final report to the corporation and the Soliciting Stockholders, which report shall contain the information included in the preliminary report, plus all changes made to the vote totals as a result of the challenge and a certification of whether the requisite number of valid and unrevoked consents was obtained to authorize or take the action specified in the consents. A copy of the final report of the inspectors shall be included in the book in which the proceedings of meetings of stockholders are recorded. ARTICLE III DIRECTORS 3.1 POWERS Subject to the provisions of the General Corporation Law of Delaware and any limitations in the certificate of incorporation or these by-laws relating to action required to be approved by the stockholders or by the outstanding shares, the business and affairs -9- of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the board of directors. 3.2 NUMBER OF DIRECTORS The number of directors of the corporation shall be three (3) people until changed by a proper amendment of this Section 3.2. No reduction of the authorized number of directors shall have the effect of removing any director before that director's term of office expires. 3.3 ELECTION, QUALIFICATION AND TERM OF OFFICE OF DIRECTORS Except as provided in Section 3.4 of these by-laws, directors shall be elected at each annual meeting of stockholders to hold office until the next annual meeting. Directors need not be stockholders unless so required by the certificate of incorporation or these by-laws, wherein other qualifications for directors may be prescribed. Each director, including a director elected to fill a vacancy, shall hold office until his successor is elected and qualified or until his earlier resignation or removal. Nominations for election to the board of directors of the corporation at an annual meeting of stockholders may be made by the board or on behalf of the board by a nominating committee appointed by the board, or by any stockholder of the corporation entitled to vote for the election of directors at such meeting. Such nominations, other than those made by or on behalf of the board, shall be made by notice in writing received by the secretary of the corporation not less than thirty (30) days nor more than sixty (60) days prior to the date of the annual meeting; provided, however, that if less than thirty-five (35) days notice of the meeting is given to stockholders, such nomination shall have been received by the secretary not later than the close of business on the seventh (7th) day following the day on which the notice was mailed. Such notice shall set forth (i) the name and address of the stockholder who intends to make the nomination; (ii) a representation that the nominating stockholder is a holder of record of stock of the corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting and nominate the person or persons specified in the notice; (iii) the number of shares of stock held beneficially and of record by the nominating stockholder; (iv) the name, age, business address and, if known, residence address of each nominee proposed in such notice; (v) the principal occupation or employment of such nominee; (vi) the number of shares of stock of the corporation beneficially owned by each such nominee; (vii) a description of all arrangements or understandings between the nominating stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be -10- made by the nominating stockholder; (viii) any other information concerning the nominee that must be disclosed of nominees in proxy solicitations pursuant to Regulation 14A under the Securities Exchange Act of 1934; and (ix) the consent of such nominee to serve as a director of the corporation if so elected. The chairman of the annual meeting may, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the foregoing procedure. If such determination and declaration is made, the defective nomination shall be disregarded. 3.4 RESIGNATION AND VACANCIES Any director may resign at any time upon written notice to the corporation. When one or more directors so resigns and the resignation is effective at a future date, only a majority of the directors then in office, including those who have so resigned, shall have power to fill such vacancy or vacancies, the vote thereon to take effect when such resignation or resignations shall become effective, and each director so chosen shall hold office as provided in this section in the filling of other vacancies. Unless otherwise provided in the certificate of incorporation or these by-laws: (i) Vacancies and newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having the right to vote as a single class may be filled only by a majority of the directors then in office, although less than a quorum, or by a sole remaining director. (ii) Whenever the holders of any class or classes of stock or series thereof are entitled to elect one or more directors by the provisions of the certificate of incorporation, vacancies and newly created directorships of such class or classes or series may be filled only by a majority of the directors elected by such class or classes or series thereof then in office, or by a sole remaining director so elected. If at any time, by reason of death or resignation or other cause, the corporation should have no directors in office, then any officer or any stockholder or an executor, administrator, trustee or guardian of a stockholder, or other fiduciary entrusted with like responsibility for the person or estate of a stockholder, may call a special meeting of stockholders in accordance with the provisions of the certificate of incorporation or these by-laws, or may apply to the Court of Chancery for a decree summarily ordering an election as provided in Section 211 of the General Corporation Law of Delaware. -11- If, at the time of filling any vacancy or any newly created directorship, the directors then in office constitute less than a majority of the whole board (as constituted immediately prior to any such increase), then the Court of Chancery may, upon application of any stockholder or stockholders holding at least ten (10) percent of the total number of the shares at the time outstanding having the right to vote for such directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in office as aforesaid, which election shall be governed by the provisions of Section 211 of the General Corporation Law of Delaware as far as applicable. 3.5 PLACE OF-MEETINGS; MEETINGS BY TELEPHONE The board of directors of the corporation may hold meetings, both regular and special, either within or outside the State of Delaware. Unless otherwise restricted by the certificate of incorporation or these by-laws, members of the board of directors, or any committee designated by the board of directors, may participate in a meeting of the board of directors, or any committee, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting. 3.6 REGULAR MEETINGS Regular meetings of the board of directors shall be held at such place or places, on such date or dates, and at such time or times as shall have been established by the board of directors and publicized among all directors. A notice of each regular meeting shall not be required. 3.7 SPECIAL MEETINGS; NOTICE Special meetings of the board of directors for any purpose or purposes may be called at any time by the secretary or by any executive officer of the corporation, or by one-third of the directors then in office (rounded up to the nearest whole number) and shall be held at a place, on a date and at a time as such officer or such directors shall fix. Notice of the place, date and time of special meetings, unless waived, shall be given to each director by mailing written notice not less than two (2) days before the meeting or by sending a facsimile transmission of the same not less than two (2) hours before the time of the holding of the meeting. If the circumstances warrant, notice may also be given personally or by telephone not less than two (2) hours before the time of the holding of the meeting. Oral notice given -12- personally or by telephone may be communicated either to the director or to a person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. Unless otherwise indicated in the notice thereof, any and all business may be transacted at a special meeting. 3.8 QUORUM At all meetings of the board of directors, a majority of the authorized number of directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the board of directors, except as may be otherwise specifically provided by statute or by the certificate of incorporation. If a quorum is not present at any meeting of the board of directors, then the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for that meeting. 3.9 WAIVER OF NOTICE Whenever notice is required to be given under any provision of the General Corporation Law of Delaware or of the certificate of incorporation or these by-laws, a written waiver thereof, signed by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the directors, or members of a committee of directors, need be specified in any written waiver of notice unless so required by the certificate of incorporation or these by-laws. 3.10 ADJOURNED MEETING; NOTICE If a quorum is not present at any meeting of the board of directors, then the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present. -13- 3.11 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING Unless otherwise restricted by the certificate of incorporation or these by-laws, any action required or permitted to be taken at any meeting of the board of directors, or of any committee thereof, may be taken without a meeting if all members of the board or committee, as the case may be, consent thereto in writing and the writing or writings are filed with the minutes of proceedings of the board or committee. 3.12 FEES AND COMPENSATION OF DIRECTORS Unless otherwise restricted by the certificate of incorporation or these by-laws, the board of directors shall have the authority to fix the compensation of directors. The directors may be paid their expenses, if any, of attendance of each meeting of the board of directors and may be paid a fixed sum for attendance at each meeting of the board of directors or a stated salary as director. No such payment shall preclude any director from serving the corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings. 3.13 APPROVAL OF LOANS TO OFFICERS The corporation may lend money to, or guarantee any obligation of, or otherwise assist any officer or other employee of the corporation or of its subsidiaries, including any officer or employee who is a director of the corporation or its subsidiaries, whenever, in the judgment of the directors, such loan, guaranty or assistance may reasonably be expected to benefit the corporation. The loan, guaranty or other assistance may be with or without interest and may be unsecured, or secured in such manner as the board of directors shall approve, including, without limitation, a pledge of shares of stock of the corporation. Nothing in this section contained shall be deemed to deny, limit or restrict the powers of guaranty or warranty of the corporation at common law or under any statute. 3.14 REMOVAL OF DIRECTORS Unless otherwise restricted by statute, by the certificate of incorporation or by these by-laws, any director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors; provided, however, that, so long as stockholders of the corporation are entitled to cumulative voting, if less than the entire board is to be removed, no director may be removed without cause if the votes cast against his removal would be sufficient to elect him if then cumulatively voted at an election of the entire board of directors. -14- 3.15 CONDUCT OF BUSINESS At any meeting of the board of directors, business shall be transacted in such order and manner as the board may from time to time determine, and all matters shall be determined by the vote of a majority of the directors present, except as otherwise provided in the certificate of incorporation or these by-laws or as required by law. ARTICLE IV COMMITTEES 4.1 COMMITTEES OF DIRECTORS The board of directors may, by resolution passed by a majority of the whole board, designate one or more committees, with each committee to consist of one or more of the directors of the corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he, she or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the board of directors or in the by-laws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers that may require it; but no such committee shall have the power or authority to (i) amend the certificate of incorporation (except that a committee may, to the extent authorized in the resolution or resolutions providing for the issuance of shares of stock adopted by the board of directors as provided in Section 151(a) of the General Corporation Law of Delaware, fix the designation and any of the preferences or rights of such shares relating to dividends, redemption, dissolution, any distribution of assets of the corporation or the conversion into, or the exchange of such shares for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the corporation or fix the number of shares of any series of stock or authorize the increase or decrease of the shares of any series), (ii) adopt an agreement of merger or consolidation under Section 251 or 252 of the General Corporation Law of Delaware, (iii) recommend to the stockholders the sale, lease or exchange of all or substantially all of the corporation's property and assets, (iv) recommend to the stockholders a dissolution of the corporation or a revocation of a -15- dissolution, or (v) amend the by-laws of the corporation; and, unless the board resolution establishing the committee, a supplemental resolution of the board of directors, the by-laws or the certificate of incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend, to authorize the issuance of stock, or to adopt a certificate of ownership and merger pursuant to Section 253 of the General Corporation Law of Delaware. 4.2 COMMITTEE MINUTES Each committee shall keep regular minutes of its meetings and report the same to the board of directors when required. 4.3 MEETINGS AND ACTION OF COMMITTEES Meetings and actions of committees shall be governed by, and held and taken in accordance with, the provisions of Article III of these by-laws, Section 3.5 (place of meetings and meetings by telephone), Section 3.6 (regular meetings), Section 3.7 (special meetings and notice), Section 3.8 (quorum), Section 3.9 (waiver of notice), Section 3.10 (adjournment and notice of adjournment), and Section 3.11 (action without a meeting), with such changes in the context of those by-laws as are necessary to substitute the committee and its members for the board of directors and its members; provided, however, that the time of regular meetings of committees may be determined either by resolution of the board of directors or by resolution of the committee, that special meetings of committees may also be called by resolutions of the board of directors, and that notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The board of directors may adopt rules for the government of any committee not inconsistent with the provisions of these by-laws. ARTICLE V OFFICERS 5.1 OFFICERS The officers of the corporation shall be a president, a secretary, and a chief financial officer. The corporation may also have, at the discretion of the board of directors, a chairman of the board, one or more vice presidents, one or more assistant secretaries, a controller, one or more assistant controllers, a treasurer, one or more assistant treasurers, and any such other officers as may be appointed in accordance with the provisions of Section 5.3 of these by-laws. Any number of offices may be held by the same person. -16- 5.2 ELECTION OF OFFICERS The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 5.3 or 5.5 of these by-laws, shall be elected by the board of directors, subject to the rights, if any, of an officer under any contract of employment. 5.3 SUBORDINATE OFFICERS The board of directors may appoint, or empower the president to appoint, such other officers and agents as the business of the corporation may require, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in these by-laws or as the board of directors may from time to time determine. 5.4 REMOVAL AND RESIGNATION OF OFFICERS Subject to the rights, if any, of an officer under any contract of employment, any officer may be removed, either with or without cause, by an affirmative vote of the majority of the board of directors at any regular or special meeting of the board or, except in the case of an officer chosen by the board of directors, by any officer upon whom such power of removal may be conferred by the board of directors. Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time specified in that notice, and, unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. 5.5 VACANCIES IN OFFICES Any vacancy occurring in any office of the corporation shall be filled in the manner prescribed in these by-laws for regular appointments to that office. 5.6 CHAIRMAN OF THE BOARD The chairman of the board, if such an officer be elected, shall, if present, preside at meetings of the board of directors and exercise and perform such other powers and duties as may from time to time be assigned to him by the board of directors or as may be prescribed by these by-laws. If there is no president, then the chairman of the board shall also be the chief executive officer of -17- the corporation and shall have the powers and duties prescribed in Section 5.7 of these by-laws. 5.7 PRESIDENT Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board, if there be such an officer, the president shall be the chief executive officer of the corporation and shall, subject to the control of the board of directors, have general supervision, direction, and control of the business and the officers of the corporation. He shall preside at all meetings of the stockholders and, in the absence or non-existence of a chairman of the board, at all meetings of the board of directors. He shall have the general powers and duties of management usually vested in the office of president of a corporation and shall have such other powers and duties as may be prescribed by the board of directors or these by-laws. 5.8 VICE PRESIDENTS In the absence or disability of the president, the vice presidents, if any, in order of their rank as fixed by the board of directors or, if not ranked, a vice president designated by the board of directors, shall perform all the duties of the president and when so acting shall have all the powers of, and be subject to all the restrictions upon, the president. The vice presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the board of directors, these by-laws, the president or the chairman of the board. 5.9 SECRETARY The secretary shall keep or cause to be kept, at the principal executive office of the corporation or such other place as the board of directors may direct, a book of minutes of all meetings and actions of directors, committees of directors, and stockholders. The minutes shall show the time and place of each meeting, whether regular or special (and, if special, how authorized and the notice given), the names of those present at directors' meetings or committee meetings, the number of shares present or represented at stockholders' meetings, and the proceedings thereof. The secretary shall keep, or cause to be kept, at the principal executive office of the corporation or at the office of the corporation's transfer agent or registrar, as determined by resolution of the board of directors, a share register, or a duplicate share register, showing the names of all stockholders and their addresses, the number and classes of shares held by each, the number and date of certificates evidencing such shares, and the -18- number and date of cancellation of every certificate surrendered for cancellation. The secretary shall give, or cause to be given, notice of all meetings of the stockholders and of the board of directors required to be given by law or by these by-laws. He or she shall keep the seal of the corporation, if one be adopted, in safe custody and shall have such other powers and perform such other duties as may be prescribed by the board of directors or by these by-laws. 5.10 CHIEF FINANCIAL OFFICER The chief financial officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, retained earnings, and shares. The books of accounts shall at all reasonable times be open to inspection by any director. The chief financial officer shall deposit all money and other valuables in the name and to the credit of the corporation with such depositories as may be designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the board of directors, shall render to the president and directors, whenever they request it, an account of all of his transactions as chief financial officer and of the financial condition of the corporation and shall have such other powers and perform such other duties as may be prescribed by the board of directors or these by-laws. The duties of the chief financial officer may be allocated by the board of directors among one or more persons, in its discretion. 5.11 ASSISTANT SECRETARY The assistant secretary, or, if there is more than one, the assistant secretaries in the order determined by the stockholders or board of directors (or if there be no such determination, then in the order of their election) shall, in the absence of the secretary or in the event of his or her inability or refusal to act, perform the duties and exercise the powers of the secretary and shall perform such other duties and have such other powers as the board of directors or the stockholders may from time to time prescribe. 5.12 AUTHORITY AND DUTIES OF OFFICERS In addition to the foregoing authority and duties, all officers of the corporation shall respectively have such authority and perform such duties in the management of the business of the -19- corporation as may be designated from time to time by the board of directors or the stockholders. 5.13 REPRESENTATION OF SHARES OF OTHER CORPORATIONS The chairman of the board, the president, any vice president, the chief financial officer, the secretary or assistant secretary of this corporation or any other person authorized by the board of directors or the president or a vice president, is authorized to vote, represent and exercise on behalf of this corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority granted herein may be exercised either by such person directly or by any other person authorized to do so by proxy or power of attorney duly executed by such person having the authority. ARTICLE VI INDEMNITY 6.1 INDEMNIFICATION OF DIRECTORS AND OFFICERS The corporation shall, to the maximum extent and in the manner permitted by the General Corporation Law of Delaware, indemnify each of its directors and officers against expenses (including attorneys' fees), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding, arising by reason of the fact that such person is or was an agent of the corporation. For purposes of this Section 6.1, a "director" or "officer" of the corporation includes any person (i) who is or was a director or officer of the corporation, (ii) who is or was serving at the request of the corporation as a director or officer of another corporation partnership, joint venture, trust or other enterprise, or (iii) who was a director or officer of a corporation that was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. 6.2 INDEMNIFICATION OF OTHERS The corporation shall have the power, to the extent and in the manner permitted by the General Corporation Law of Delaware, to indemnify each of its employees and agents (other than directors and officers) against expenses (including attorney's fees), judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding arising by reason of the fact that such person is or was an agent of the corporation. For purposes of this Section 6.2, an "employee" or "agent" of the corporation (other than a director or officer) includes any person (i) who is or was an employee or agent of the corporation, (ii) who -20- is or was serving at the request of the corporation as an employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or (iii) who was an employee or agent of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. 6.3 INSURANCE The corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of the General Corporation Law of Delaware. ARTICLE VII RECORDS AND REPORTS 7.1 MAINTENANCE AND INSPECTION OF RECORDS The corporation shall, either at its principal executive office or at such place or places as designated by the board of directors, keep a record of its stockholders listing their names and addresses and the number and class of shares held by each stockholder, a copy of these by-laws as amended to date, accounting books and other records. Any stockholder of record, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose the corporation's stock ledger, a list of its stockholders, and its other books and records and to make copies or extracts therefrom. A proper purpose shall mean a purpose reasonably related to such person's interest as a stockholder. In every instance where an attorney or other agent is the person who seeks the right to inspection, the demand under oath shall be accompanied by a power of attorney or such other writing that authorizes the attorney or other agent to so act on behalf of the stockholder. The demand under oath shall be directed to the corporation at its registered office in Delaware or at its principal place of business. -21- 7.2 INSPECTION BY DIRECTORS Any director shall have the right to examine the corporation's stock ledger, a list of its stockholders, and its other books and records for a purpose reasonably related to his position as a director. The Court of Chancery is hereby vested with the exclusive jurisdiction to determine whether a director is entitled to the inspection sought. The Court may summarily order the corporation to permit the director to inspect any and all books and records, the stock ledger, and the stock list and to make copies or extracts therefrom. The Court may, in its discretion, prescribe any limitations or conditions with reference to the inspection, or award such other and further relief as the Court may deem just and proper. 7.3 ANNUAL STATEMENT TO STOCKHOLDERS The board of directors shall present at each annual meeting, and at any special meeting of the stockholders when called for by vote of the stockholders, a full and clear statement of the business and condition of the corporation. ARTICLE VIII GENERAL MATTERS 8.1 CHECKS From time to time, the board of directors shall determine by resolution which person or persons may sign or endorse all checks, drafts, other orders for payment of money, notes or other evidences of indebtedness that are issued in the name of or payable to the corporation, and only the persons so authorized shall sign or endorse those instruments. 8.2 EXECUTION OF CORPORATE CONTRACTS AND INSTRUMENTS The board of directors, except as otherwise provided in these by-laws, may authorize any officer or officers, or agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation; such authority may be general or confined to specific instances. Unless so authorized or ratified by the board of directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. -22- 8.3 STOCK CERTIFICATES; PARTLY PAID SHARES The shares of a corporation shall be represented by certificates, provided that the board of directors of the corporation may provide by resolution or resolutions that some or all of any or all classes or series of its stock shall be uncertificated shares. Any such resolution shall not apply to shares represented by a certificate until such certificate is surrendered to the corporation. Notwithstanding the adoption of such a resolution by the board of directors, every holder of stock represented by certificates and upon request every holder of uncertificated shares shall be entitled to have a certificate signed by, or in the name of the corporation by the chairman or vice-chairman of the board of directors or the president or vice-president, and by the chief financial officer or the secretary or an assistant secretary of the corporation representing the number of shares registered in certificate form. Any or all of the signatures on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate has ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. The corporation may issue the whole or any part of its shares as partly paid and subject to call for the remainder of the consideration to be paid therefor. Upon the face or back of each stock certificate issued to represent any such partly paid shares, upon the books and records of the corporation in the case of uncertificated partly paid shares, the total amount of the consideration to be paid therefor and the amount paid thereon shall be stated. Upon the declaration of any dividend on fully paid shares, the corporation shall declare a dividend upon partly paid shares of the same class, but only upon the basis of the percentage of the consideration actually paid thereon. 8.4 SPECIAL DESIGNATION ON CERTIFICATES If the corporation is authorized to issue more than one class of stock or more than one series of any class, then the powers, the designations, the preferences, and the relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights shall be set forth in full or summarized on the face or back of the certificate that the corporation shall issue to represent such class or series of stock; provided, however, that, except as otherwise provided in Section 202 of the General Corporation Law of Delaware, in lieu of the foregoing requirements there may be set forth on the face or back of the certificate that the corporation shall issue to represent such class or series of stock a statement that the corporation will -23- furnish without charge to each stockholder who so requests the powers, the designations, the preferences, and the relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. 8.5 LOST CERTIFICATES Except as provided in this Section 8.5, no new certificates for shares shall be issued to replace a previously issued certificate unless the latter is surrendered to the corporation and cancelled at the same time. The corporation may issue a new certificate of stock or uncertificated shares in the place of any certificate theretofore issued by it, alleged to have been lost, stolen or destroyed, and the corporation may require the owner of the lost, stolen or destroyed certificate, or his legal representative, to give the corporation a bond sufficient to indemnify it against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate or uncertificated shares. 8.6 CONSTRUCTION; DEFINITIONS Unless the context requires otherwise, the general provisions, rules of construction, and definitions in the General Corporation Law of Delaware shall govern the construction of these by-laws. Without limiting the generality of this provision, the singular number includes the plural, the plural number includes the singular, and the term "person" includes both a corporation and a natural person. 8.7 DIVIDENDS The directors of the corporation, subject to any restrictions contained in (i) the General Corporation Law of Delaware or (ii) the certificate of incorporation, may declare and pay dividends upon the shares of its capital stock. Dividends may be paid in cash, in property, or in shares of the corporation's capital stock. The directors of the corporation may set apart out of any of the funds of the corporation available for dividends a reserve or reserves for any proper purpose and may abolish any such reserve. Such purposes shall include but not be limited to equalizing dividends, repairing or maintaining any property of the corporation and meeting contingencies. -24- 8.8 FISCAL YEAR The fiscal year of the corporation shall be fixed by resolution of the board of directors and may be changed by the board of directors. 8.9 SEAL The corporation may adopt a corporate seal, which may be altered at pleasure, and may use the same by causing it or a facsimile thereof to be impressed or affixed or in any other manner reproduced. 8.10 TRANSFER OF STOCK Upon surrender to the corporation or the transfer agent of the corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction in its books. 8.11 STOCK TRANSFER AGREEMENTS The corporation shall have power to enter into and perform any agreement with any number of stockholders of any one or more classes of stock of the corporation to restrict the transfer of shares of stock of the corporation of any one or more classes owned by such stockholders in any manner not prohibited by the General Corporation Law of Delaware. 8.12 REGISTERED STOCKHOLDERS The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends and to vote as such owner, shall be entitled to hold liable for calls and assessments the person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of another person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware. 8.13 NOTICES Except as otherwise specifically provided herein or required by law, all notices required to be given to any stockholder, director, officer, employee or agent shall be in writing and may in every instance be effectively given by hand delivery, by mail, postage paid, or by facsimile transmission. Any such notice shall be addressed to such stockholder, director, officer, employee or -25- agent at his or her last known address as it appears on the books of the corporation. The time when such notice shall be deemed received, if hand delivered, or dispatched, if sent by mail or facsimile transmission, shall be the time of the giving of the notice. ARTICLE IX AMENDMENTS Any of these by-laws may be altered, amended or repealed by the affirmative vote of a majority of the board of directors or, with respect to by-law amendments placed before the stockholders for approval and except as otherwise provided herein or required by law, by the affirmative vote of the holders of a majority of the shares of the corporation's stock entitled to vote in the election of directors, voting as one class. ARTICLE X DISSOLUTION If it should be deemed advisable in the judgment of the board of directors of the corporation that the corporation should be dissolved, the board, after the adoption of a resolution to that effect by a majority of the whole board at any meeting called for that purpose, shall cause notice to be mailed to each stockholder entitled to vote thereon of the adoption of the resolution and of a meeting of stockholders to take action upon the resolution. At the meeting a vote shall be taken for and against the proposed dissolution. If a majority of the outstanding stock of the corporation entitled to vote thereon votes for the proposed dissolution, then a certificate stating that the dissolution has been authorized in accordance with the provisions of Section 275 of the General Corporation Law of Delaware and setting forth the names and residences of the directors and officers shall be executed, acknowledged, and filed and shall become effective in accordance with Section 103 of the General Corporation Law of Delaware. Upon such certificate's becoming effective in accordance with Section 103 of the General Corporation Law of Delaware, the corporation shall be dissolved. Whenever all the stockholders entitled to vote on a dissolution consent in writing, either in person or by duly authorized attorney, to a dissolution, no meeting of directors or stockholders shall be necessary. The consent shall be filed and shall become effective in accordance with Section 103 of the General Corporation Law of Delaware. Upon such consent's becoming effective in accor- -26- dance with Section 103 of the General Corporation Law of Delaware, the corporation shall be dissolved. If the consent is signed by an attorney, then the original power of attorney or a photocopy thereof shall be attached to and filed with the consent. The consent filed with the Secretary of State shall have attached to it the affidavit of the secretary or some other officer of the corporation stating that the consent has been signed by or on behalf of all the stockholders entitled to vote on a dissolution; in addition, there shall be attached to the consent a certification by the secretary or some other officer of the corporation setting forth the names and residences of the directors and officers of the corporation. ARTICLE XI CUSTODIAN 11.1 APPOINTMENT OF A CUSTODIAN IN CERTAIN CASES The Court of Chancery, upon application of any stockholder, may appoint one or more persons to be custodians and, if the corporation is insolvent, to be receivers, of and for the corporation when: (i) any meeting held for the election of directors the stockholders are so divided that they have failed to elect successors to directors whose terms have expired or would have expired upon qualification of their successors; or (ii) the business of the corporation is suffering or is threatened with irreparable injury because the directors are so divided respecting the management of the affairs of the corporation that the required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division; or (iii) the corporation has abandoned its business and has failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets. 11.2 DUTIES OF CUSTODIAN The custodian shall have all the powers and title of a receiver appointed under Section 291 of the General Corporation Law of Delaware, but the authority of the custodian shall be to continue the business of the corporation and not to liquidate its affairs and distribute its assets, except when the Court of Chancery otherwise orders and except in cases arising under Sections 226(a)(3) or 352(a)(2) of the General Corporation Law of Delaware. -27- EX-10.1 3 EXHIBIT 10.1 Exhibit 10.1 ================================================================================ STOCKHOLDERS AGREEMENT Dated as of December 29, 1994 By and Among 24 HOUR FITNESS, INC., THE MDC ENTITIES, and THE MANAGEMENT STOCKHOLDERS ================================================================================ TABLE OF CONTENTS Page ---- ARTICLE I CERTAIN DEFINITIONS........................................ 2 ss. 1.1 Certain Definitions........................................ 2 ARTICLE II TRANSFER OF SHARES......................................... 3 ss. 2.1 Restrictions............................................... 3 ss. 2.2 Permitted Transfers........................................ 4 ss. 2.3 Sales by MDC Subject to Tag-Along Rights................... 5 ss. 2.4 Grant to MDC of Bring-Along Rights......................... 7 ss. 2.5 Call Upon Termination of Management Stockholder's Employment................................................. 7 ss. 2.6 Registration Rights........................................ 10 ARTICLE III BOARD OF DIRECTORS OF THE COMPANY.......................... 12 ss. 3.1 Board of Directors......................................... 12 ss. 3.2 Election................................................... 13 ARTICLE IV MISCELLANEOUS.............................................. 13 ss. 4.1 Entire Agreement........................................... 13 ss. 4.2 Captions................................................... 13 ss. 4.3 Counterparts............................................... 13 ss. 4.4 Notices.................................................... 13 ss. 4.5 Successors and Assigns..................................... 15 ss. 4.6 GOVERNING LAW.............................................. 15 ss. 4.7 Submission to Jurisdiction................................. 15 ss. 4.8 Benefits Only to Parties................................... 16 ss. 4.9 Termination................................................ 16 ss. 4.10 Publicity.................................................. 17 ss. 4.11 Confidentiality............................................ 17 ss. 4.12 Fee; Expenses.............................................. 18 ss. 4.13 Amendments; Waivers........................................ 18 SCHEDULE A (i) STOCKHOLDERS AGREEMENT STOCKHOLDERS AGREEMENT (this "Agreement"), dated as of December 29, 1994, by and among 24 Hour Fitness, Inc., a Delaware corporation (the "Company"), McCown De Leeuw & Co. III, L.P., a California limited partnership, McCown De Leeuw & Co. Offshore (Europe) III, L.P., a Bermuda limited partnership, MDC Management Co., Inc., a California corporation and Gamma Fund LLC, a California limited liability company (each individually, an "MDC Entity", collectively the "MDC Entities" and collectively together with their Related Persons (as such term is defined in Section 1.1), "MDC"), the individuals listed on Schedule A attached hereto under the heading "Management Stockholders" (each individually, a "Management Stockholder" and collectively, the "Management Stockholders," it being understood that any other member of the management of the Company who becomes a stockholder of the Company (including through the receipt of Restricted Shares (as defined below)) shall be a Management Stockholder) (each of MDC and the Management Stockholders is hereinafter referred to as a "Stockholder", it being understood and agreed that any holder of Common Stock of the Company (including, without limitation, any party to a Success Participation Fee Letter with the Company that elects to acquire Common Stock of the Company pursuant to the terms thereof) during the term of this Agreement shall become a party to this Agreement and shall be referred to within the term "Stockholder"). W I T N E S S E T H : WHEREAS, MDC and the Management Stockholders own shares of Common Stock, par value $.001 per share, of the Company (the "Common Stock"); and WHEREAS, the Stockholders each desire to grant to the others certain rights in connection with the shares of Common Stock now or hereafter owned by them (collectively, with any shares of Common Stock hereafter issued by the Company during the term of this Agreement the "Shares") as set forth herein. NOW, THEREFORE, in consideration of the mutual covenants herein set forth and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: ARTICLE I CERTAIN DEFINITIONS ss. 1.1 Certain Definitions. For purposes of this Agreement, the following terms shall have the following meanings: (a) "Affiliate" shall mean, with respect to any Person, any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For purposes of this definition, "control" (including, with correlative meanings, the terms "controlling," "controlled by" and "under common control with"), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such Person, whether through the ownership of voting securities, by agreement or otherwise. (b) "business day" shall mean any day except a Saturday, a Sunday or other day on which commercial banks are required or authorized to close in New York, New York. (c) "Call Shares" shall mean collectively (i) restricted shares of the Common Stock granted, or (ii) shares of the Common Stock received upon the exercise of options granted, to certain key employees of the Company (or the Company's Subsidiaries) pursuant to the Company's 1994 Stock Option and Stock Award Plan except that shares of Common Stock received upon exercise of options granted to Mark S. Mastrov, Leonard B. C. Schlemm and Gilbert K. Freeman on the date hereof shall not constitute "Call Shares". (d) "IPO" shall mean an initial public offering of the Common Stock. (e) "Person" shall mean and include an individual, a partnership, a joint venture, a corporation, a trust, an unincorporated organization and a government or other department or agency thereof. (f) "Related Persons" shall mean with respect to the MDC Entities, any partnership with the same controlling general partner as any of the MDC Entities and any of the partners of any of the MDC Entities which receive Shares upon a distribution to any such partners by any such MDC Entity; provided that, notwithstanding the above McCown De Leeuw & Co. (Offshore) (Asia) III, L.P., -2- a Bermuda limited partnership, shall be deemed to be a "Related Person" for purposes of this definition when such limited partnership is formed. (g) "Subsidiary" shall mean, with respect to any Person, any corporation, association or other business entity of which more than 50% of the total voting power of shares of capital stock or other equity interests entitled (without regard to the occurrence of any contingency) to vote in the election of directors or other managing authority thereof is at the time owned or controlled, directly or indirectly, by such Person and its Subsidiaries. (h) "Vested Stock Options" shall mean vested stock options for the Common Stock granted to certain key employees of the Company pursuant to the Company's 1994 Option and Stock Award Plan except that the options granted to Mark S. Mastrov, Leonard B. C. Schlemm and Gilbert K. Freeman on the date hereof shall not constitute "Vested Stock Options" for purposes of this definition. ARTICLE II TRANSFER OF SHARES ss. 2.1 Restrictions. (a) No Stockholder shall sell, assign, pledge, or in any manner, transfer any of the Shares or any right or interest therein, to any Person (each such action, a "Transfer") except as permitted by this Agreement. (b) From and after the date hereof, all stock certificates representing Shares held by any of the Stockholders shall bear a legend which shall state as follows: The shares represented by this certificate are subject to certain restrictions against transfer set forth in a Stockholders Agreement dated as of December 29, 1994. A copy of such Stockholders Agreement has been filed in the registered office of the Company in the State of Delaware, where the same may be inspected daily during business hours. (c) In addition to the legend required by Section 2.1(b) above, all stock certificates representing Shares held by any of the Stockholders shall bear a legend which shall state as follows: The shares represented by this certificate have not been registered under the Securities Act of 1933, as amended (the "Securities Act"), and such shares may not be offered, sold, pledged or otherwise transferred except -3- (1) pursuant to an exemption from, or in a transaction not subject to, the registration requirements under the Securities Act or (2) pursuant to an effective registration statement under the Securities Act, in each case in accordance with any applicable securities laws of any State of the United States. (d) In addition to the legends required by Sections 2.1(b) and (c) above, all stock certificates representing Call Shares shall bear a legend which shall state as follows: The shares represented by this certificate are also subject to the Management Call as described in Section 2.5 of the Stockholders Agreement referred to above. Any Call Shares transferred by a Management Stockholder in a Permitted Transfer described in Section 2.2(a)(i) or (ii) shall remain Call Shares of the transferee and certificates representing such shares shall bear the legend required by this Section 2.1(d). (e) Promptly upon execution and delivery of this Agreement, each Stockholder shall deliver to the Secretary of the Company all certificates then held by such Stockholder representing Shares which do not have such legends affixed thereto as are required by Section 2.1 above. The Company shall cause such legends to be affixed promptly to each of such certificates and such certificates to be returned promptly to the registered holder thereof. The Company agrees that it will not cause or permit the Transfer of any Shares to be made on its books unless the Transfer is permitted by this Agreement and has been made in accordance with the terms hereof. ss. 2.2 Permitted Transfers. (a) Notwithstanding anything to the contrary contained herein, a Stockholder may at any time effect any of the following Transfers (each a "Permitted Transfer" and each transferee, a "Permitted Transferee"): (i) A Stockholder's Transfer of any or all Shares owned by such Stockholder following such Stockholder's death by will or intestacy to such Stockholder's legal representative, heir or legatee. (ii) A Stockholder's Transfer of any or all Shares owned by such Stockholder as a gift or gifts during such Stockholder's lifetime to such Stockholder's spouse, children, grandchildren or a trust or other legal entity for the benefit of any Stockholder or any of the foregoing, provided that such Stockholder retains voting control of the Shares so transferred. -4- (iii) A corporate Stockholder's Transfer of all Shares owned by it (i) pursuant to and in accordance with the terms of any merger, consolidation, reclassification of shares or capital reorganization of such corporate Stockholder or (ii) pursuant to a sale of all or substantially all of the stock or assets of such Stockholder. (iv) With respect to any MDC Entity, a Transfer of any or all Shares owned by it to its Related Person. (v) A Transfer by a Stockholder which is made pursuant to Section 2.3, 2.4, 2.5 or 2.6 hereof. (vi) A Transfer by a Stockholder to the Company. (b) In any such Transfer referred to above in Section 2.2(a) (other than a Sale of the Business as provided in Section 2.5 or a public offering pursuant to Section 2.6 hereof in each of which events this Agreement shall terminate in accordance with the provisions of Section 4.9 hereof), the Permitted Transferee shall receive and hold such Shares subject to the provisions of this Agreement as if such Permitted Transferee were an original signatory hereto and shall be deemed to be a party to this Agreement. ss. 2.3 Sales by MDC Subject to Tag-Along Rights. (a) In the event that MDC proposes to effect a Transfer (other than a Permitted Transfer described in Section 2.2(a) (iv) above) of any of the Shares owned by it (the "MDC Stock"), then MDC shall promptly give written notice (the "MDC Notice") to the Company and the other Stockholders at least thirty days prior to the closing of such Transfer. The MDC Notice shall describe in reasonable detail the proposed Transfer including, without limitation, the name of, and the number of shares of MDC Stock to be purchased by, the transferee, the purchase price of each share of MDC Stock to be sold, any other significant terms of such sale and the date such proposed sale is expected to be consummated, it being understood that if such proposed Transfer by MDC is in (i) an IPO or (ii) a public offering pursuant to a registration statement filed under Section 2.6, the subsequent provisions of this Section 2.3 shall not apply. (b) Each Stockholder shall have the right, exercisable upon irrevocable written notice to MDC within twenty days after receipt of the MDC Notice, to participate in such sale of MDC Stock on the same terms and conditions as set forth in the MDC Notice, including, without limitation, the making of all representations, warranties, indemnifications (including participating in any escrow arrangements) and similar agreements, and to sell all or any portion of the number of the Shares owned by it as -5- determined in accordance with the calculation set forth below. Each Stockholder other than MDC electing to participate in the sale described in the MDC Notice (each a "Participant") shall indicate in its notice of election to MDC the maximum number of its Shares it desires to sell in such sale. Each such Participant shall be entitled to sell a "pro rata portion" of such maximum number. To the extent one or more of the Stockholders exercise such right of participation in accordance with the terms and conditions set forth in this Section 2.3, the number of shares of MDC Stock that MDC may sell in the transaction shall be correspondingly reduced. For purposes of this Section 2.3, "pro rata portion" shall mean for each Participant the number of Shares determined by multiplying (i) the total number of Shares owned by such Participant by (ii) a fraction the numerator of which is the number of Shares of MDC Stock proposed to be sold in the MDC Notice and the denominator of which is the sum of (A) the total number of Shares owned by MDC immediately prior to the sale proposed in the MDC Notice and (B) the total number of Shares desired to be sold by all of the Participants electing to participate in the sale. Not later than five days prior to the date scheduled for such sale, MDC shall provide notice to each Participant of the "pro rata portion" of Shares to be sold by such Participant in such sale. (c) Any Participant shall effect its participation in the sale by delivering on the date scheduled for such sale to MDC for delivery to the prospective transferee one or more certificates, in proper form for transfer, which represent the number of Shares which such Participant is entitled to sell in accordance with this Section 2.3. Such stock certificate or certificates that any Participant delivers to MDC shall be delivered on such date to such transferee in consummation of the sale of the Shares pursuant to the terms and conditions specified in the MDC Notice, and MDC shall concurrently therewith remit to each such Participant that portion of the sale proceeds to which such Participant is entitled by reason of its participation in such sale. MDC's sale of Shares in any sale proposed in an MDC Notice shall be effected on the terms and conditions set forth in such MDC Notice. (d) The exercise or non-exercise of the rights of the Stockholders hereunder to participate in one or more sales of Shares made by MDC shall not adversely affect their rights to participate in subsequent sales of Shares subject to this Section 2.3. (e) In no event shall MDC receive special consideration or a control premium in connection with any sale contemplated by this Section 2.3; provided, however, that it is understood that MDC shall be entitled to receive a reasonable transaction fee payable upon the closing of any sale contemplated by this Section 2.3 if MDC provides services in connection with such sale that would customarily be provided -6- by a third party financial advisor. Any such transaction fee shall be approved by the Company's board of directors. ss. 2.4 Grant to MDC of Bring-Along Rights. (a) Each time the Stockholders of the Company meet, or act by written consent in lieu of meeting, for the purpose of approving a "Sale of the Business" (as such term is hereinafter defined), each Stockholder agrees to vote all of its Shares, and to sell all of its shares, as directed by MDC. In order to effect the foregoing covenant, each Stockholder hereby grants to MDC with respect to all of such Stockholder's Shares an irrevocable proxy (which is deemed to be coupled with an interest) for the term of this Agreement with respect to any Stockholder vote or action by written consent to effect the Sale of the Business. As used herein, "Sale of the Business" shall mean any transaction or series of transactions (whether structured as a stock sale, merger, consolidation, reorganization, asset sale or otherwise) negotiated on an arm's-length basis, which results in the sale or transfer of all or substantially all of the assets or shares of capital stock of the Company to an unaffiliated bona fide third party in which all consideration payable to holders of the Common Stock is distributed pro rata pursuant to stock ownership. (b) In furtherance of its covenants in Section 2.4(a), each Stockholder hereby agrees to cooperate fully with MDC and the purchaser in any such Sale of the Business and, to execute and deliver all documents (including purchase agreements) and instruments as MDC and the purchaser request to effect such Sale of the Business, including, without limitation, the making of all representations, warranties and indemnifications (including participating in any escrow arrangements) and similar arrangements, but excluding employment agreements and covenants not to compete (the determination of whether or not to enter into any such agreements being in the sole and absolute discretion of each Stockholder). MDC agrees that upon such Sale of the Business each Stockholder will receive its pro rata share of the consideration paid by the purchaser determined on the basis of such Stockholder's Share ownership. (c) In no event shall MDC receive special consideration or a control premium in connection with a sale contemplated by this Section 2.4; provided, however, that it is understood that MDC shall be entitled to receive a reasonable transaction fee payable upon the closing of any such sale by this Section 2.4 if MDC provides services in connection with such sale that would customarily be provided by a third party financial advisor. Any such transaction fee shall be approved by the Company's board of directors. ss. 2.5 Call Upon Termination of Management Stockholder's Employment. (a) Notwithstanding any other provision of this Agreement to the contrary, upon the -7- death, disability, retirement or termination of employment (each a "Call Event") of any Management Stockholder employed immediately prior to such Call Event by the Company or any of the Company's Subsidiaries, the Company shall, on the terms and subject to the conditions set forth in this Section 2.5, have the right (the "Management Call"), at the option of the Company, to purchase all but not less than all of the Call Shares and Vested Stock Options held by such Management Stockholder, and any Permitted Transferee of Call Shares or Vested Stock Options of such Management Stockholder pursuant to Section 2.2(a)(i) or (ii), by delivering written notice to such Management Stockholder or his or her Permitted Transferees, within 60 days after the occurrence of the Call Event, at the prices set forth below. (b) If the employment of a Management Stockholder is terminated upon death, disability, termination or resignation after a date which is five years from the date hereof or voluntary retirement from full-time employment with the Company or its Subsidiaries at age 59-1/2 or greater after a minimum of five years continuous full-time employment with the Company or its Subsidiaries since the initial date of employment, then the offering price for the Call Shares or Vested Stock Options offered to the Company pursuant to this Section 2.5 shall be equal to the fair market value of such Shares or Vested Stock Options at such time as determined in good faith by the Board of Directors of the Company (without discount for lack of marketability or minority interest). (c) If the employment of a Management Stockholder is terminated (i) by the Company or any Subsidiary of the Company without "cause" (as hereinafter defined) or (ii) as a result of the resignation of such Management Stockholder either (A) with the consent of the Company or (B) for "good reason" (as hereinafter defined), in the case of both clauses (i) and (ii), prior to a date which is five years from the date hereof then the offering price for the Call Shares and Vested Stock Options offered to the Company pursuant to this Section 2.5 shall be an amount equal to the greater of (i) the purchase price originally paid for such Shares and Vested Stock Options by such Management Stockholder and (ii) the Book Value of such Shares and Vested Stock Options. For purposes of this Section 2.5, "Book Value" per Share shall mean an amount equal to the book value per share of the Company after consummation of the transaction contemplated by the Purchase Agreement dated as of the date hereof by and among the Company and the Stockholders (as defined therein), plus or minus, as the case may be, the positive or negative changes in the stockholders' equity per share of Common Stock of the Company (calculated in accordance with generally accepted accounting principles, consistently applied) from the date of the consummation of this Agreement until the last day of the month immediately preceding the month in which the Call Event occurs. "Book Value" per Vested Stock Option shall mean the "Book Value" -8- per share (as calculated above) less the exercise price in respect of such Vested Stock Option. For purposes of this Section 2.5 "good reason" shall mean the occurrence of any of the following events, except for the occurrence of such an event in connection with the termination of a Management Stockholder's employment by the Company or any of its Subsidiaries for cause: (i) a significant reduction in the authorities, duties or responsibilities of such Management Stockholder; or (ii) a reduction in base salary, the reduction or discontinuance of any incentive compensation plan or the taking of any action which materially adversely affects such Management Stockholder's participation in or benefits under any fringe benefit provided to such Management Stockholder; provided that the actions referred to in clause (ii) above (other than with respect to a reduction in base salary) shall not constitute "good reason" events if such actions were taken by the Company or its Subsidiaries as part of an overall plan by the Company or its Subsidiaries and made applicable to the same extent to all executives of the Company or its Subsidiaries. (d) If the employment of a Management Stockholder is terminated by the Company or any Subsidiary "for cause" or as a result of the resignation of such Management Stockholder without the consent of the Company, other than for "good reason" as defined in Section 2.5(c) above, in each case, prior to a date which is five years from the date hereof, then the offering price for the Call Shares or Vested Stock Options held by such Management Stockholder offered to the Company pursuant to this Section 2.5 shall be an amount equal to the lesser of (i) the purchase price originally paid for such Shares and Vested Stock Options by such Management Stockholder and (ii) the Book Value (as previously defined) of such Shares and Vested Stock Options. For purposes of this Section 2.5, a Stockholder shall be deemed to have been terminated "for cause" if his employment was terminated for: (i) embezzlement, theft or other misappropriation of any property of the Company or any Subsidiary, (ii) gross or willful misconduct resulting in substantial loss to the Company or any Subsidiary or substantial damage to the reputation of the Company or any Subsidiary, (iii) any act involving moral turpitude which if the subject of a criminal proceeding could reasonably result in a conviction for a felony involving moral turpitude, fraud or misrepresentation, (iv) gross neglect of his assigned duties to the Company or any Subsidiary, (v) gross breach of his fiduciary obligations to the Company or any Subsidiary, (vi) a breach of his covenant not to compete contained in Article IV of the Purchase Agreement, or (vii) any chemical dependence which materially affects the performance of his duties and responsibilities to the Company or any Subsidiary. (e) If the Company shall elect to exercise the Management Call in accordance with this Section 2.5, the closing of the purchase by the Company shall take place no later than 45 days after the exercise of the Management Call, which time in the -9- case of the death of a Management Stockholder may be extended to provide for probate of such Stockholder's estate. On the date scheduled for such closing, the price for the Shares subject to the Management Call, determined in accordance with this Section 2.5, shall be paid in full to the Management Stockholder holding such Shares (including, if applicable, such Shares held by any Permitted Transferee of such Management Stockholder pursuant to Section 2.2(a)(i) or (ii)) by the Company against delivery of a certificate or certificates, as the case may be, representing the purchased Shares in proper form for transfer. In connection with such closing, such Management Stockholder shall warrant to the Company good and marketable title to the purchased Shares, free and clear of all claims, liens, charges, encumbrances and security interests of any nature whatsoever except those under this Agreement. ss. 2.6 Registration Rights. (a) If the Company intends (other than in connection with an IPO) to register Shares on Form S-1, Form S-2 or Form S-3 or any corresponding form applicable at the time under the Securities Act as then in effect (or any similar statute then in effect), the Company will give written notice to each Stockholder of its intention to do so, at least 15 days prior to the time of the filing of any registration statement or qualification papers, and at the written request of any Stockholder given within 10 days after receipt of any such notice (which request shall specify the number of Shares intended to be sold or disposed of by such Stockholder and shall describe the nature of any proposed sale or other disposition thereof which may include a distribution over a reasonable period of time), the Company will use its best efforts to cause such Shares to be registered or qualified to the extent required (in the opinion of the Company's counsel) to permit the sale or other disposition thereof (in accordance with the methods described by such Stockholder) (such right of each Stockholder to participate in the proposed offering, a "piggy-back right"). The number of Shares that any Stockholder intends to sell shall be subject to underwriters' cutbacks resulting from the underwriters' conclusion that the inclusion of all of the Shares requested to be included in the proposed offering would materially adversely affect the distribution of Shares in such offering or the market price of the Company's Common Stock if such Common Stock is publicly traded. Such underwriters' cutbacks shall be made on a pro rata basis by multiplying the number of Shares that each Stockholder desires to sell in the proposed offering by a fraction the numerator of which shall be the number of Shares that the underwriters deem appropriate to sell in the proposed offering and the denominator of which shall be the total number of Shares that all of the Stockholders initially desire to sell in the proposed offering. (b) All out-of-pocket expenses, disbursements and fees in connection with any action to be taken under this Section 2.6 shall be borne by the Company, including the reasonable fees and expenses of one counsel for all participating -10- Stockholders except in connection with a registration on Form S-3 (or such corresponding form applicable at the time under the Securities Act) in which case the fees and expenses of counsel, if any, for participating Stockholders shall be for each participating Stockholder's own account, provided that the foregoing expenses shall in no event include the underwriters' discount in connection with an offering. (c) In the event of any registration under the provisions of this Section 2.6, the Company, to the extent permitted by law, will indemnify any Stockholder participating in such registration, its respective officers and directors, if any, and each Person, if any, who controls such Stockholder within the meaning of Section 15 of the Securities Act, against all losses, claims, damages and liabilities caused by any untrue statement of a material fact contained in the registration statement or prospectus (and as amended or supplemented if the Company shall have furnished any amendments or supplements thereto), or caused by any omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading and will reimburse such Stockholder, its officers and directors and any Person, if any, who controls such Stockholder within the meaning of Section 15 of the Securities Act, against any legal or other expenses reasonably incurred by such Stockholder, officer, director or Person in connection with investigating or defending any such losses, claims, damages and liabilities, except insofar as such losses, claims, damages or liabilities are caused by any untrue statement or omission contained in information furnished in writing to the Company by such Stockholder participating in such registration or by underwriters expressly for use therein. The obligation of the Company under this Section 2.6 to register securities for any of the Stockholders shall be subject to the condition that each such Stockholder and the underwriters involved in the offering shall furnish to the Company in writing such information as shall be reasonably requested by the Company for use in connection with the preparation of any such registration statement or prospectus and, to the extent permitted by law, shall indemnify the Company, its directors and officers, any other underwriter, the other Stockholders participating in such registration and each Person, if any, who controls the Company, any other underwriter or such other Stockholders, within the meaning of Section 15 of the Securities Act, against all losses, claims, damages and liabilities caused by any untrue statement or omission contained in information so furnished in writing to the Company by such Stockholder or such underwriter expressly for use therein. (d) If the indemnification provided for in this Section 2.6 from the indemnifying party is unavailable to any indemnified party hereunder in respect of any losses, claims, damages or liabilities referred to herein, then the indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or -11- liabilities in such proportion as is appropriate to reflect the relative fault of the indemnifying party and indemnified parties in connection with the actions which resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative fault of such indemnifying party and indemnified parties shall be determined by reference to, among other things, whether any action in question, including any untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact, has been made by, or relates to information supplied by, such indemnifying party or indemnified parties, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action. The amount paid or payable by a party under this Section 2.6 as a result of the losses, claims, damages and liabilities referred to above shall be deemed to include any legal or other fees or expenses reasonably incurred by such party in connection with any investigation or proceeding. The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 2.6(d) were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to herein. (e) As expeditiously as possible after the effectiveness of any registration statement pursuant to this Section 2.6 and prior to such date as shall be certified to the Company as the date upon which the Transfer contemplated by such registration statement will be effected by any participating Stockholder, the Company will deliver in exchange for certificates representing Shares so registered bearing the legends set forth in Section 2.1, certificates therefor not bearing such legends as shall be required to effect such Transfer. In the event that the proposed Transfer is not made as contemplated by any such participating Stockholder, by acceptance thereof such Stockholder shall be deemed to have agreed that it will deliver such certificates not bearing such legends to the Company in exchange for new certificates bearing the legends set forth in Section 2.1 if the Company shall request and the Company agrees that it will make such exchange. (f) The registration rights provided in this Section 2.6 shall terminate after an IPO as to any Stockholder which can immediately sell all of its Shares in a single sale pursuant to Rule 144 under the Securities Act. (g) Each of the Stockholders agrees that in connection with any public offering, such Stockholder will not, without the prior written consent of the Company, directly or indirectly, offer to sell, sell, contract to sell (including, without limitation, any short sale), grant any option for the sale of, acquire any option to dispose of, or otherwise dispose of any Shares for a period of 180 days following the date of the consummation of such public offering. -12- ARTICLE III BOARD OF DIRECTORS OF THE COMPANY ss. 3.1 Board of Directors. (a) Each Stockholder agrees to vote all of the Shares held by such Stockholder so as to elect and maintain a Board of Directors of the Company (the "Board") composed of the following: (i) two persons designated by the Managing Stockholders (who initially shall be Messrs. Schlemm and Mastrov), (ii) two persons designated by McCown De Leeuw & Co. III, L.P., (iii) one person designated by McCown De Leeuw & Co. Offshore (Europe) III, L.P., (iv) as soon as practicable following the date of this Agreement, one person designated by McCown De Leeuw & Co. III, L.P., in consultation with the Management Stockholders, who shall be unaffiliated with the Company, and (v) as soon as practicable following the date of this Agreement, one person designated by McCown De Leeuw & Co. Offshore (Europe) III, L.P., in consultation with the Management Stockholders, who shall be unaffiliated with the Company. (b) In the event that any director designated by any Stockholder for any reason ceases to serve as a director during his term of office, the resulting vacancy on the Board shall be filled by a director designated by the Managing Stockholders or by the MDC Entity who designated such vacating director. ss. 3.2 Election. Promptly upon the execution and delivery of this Agreement, the Stockholders shall each execute a written stockholders consent substantially in the form of Exhibit A attached hereto for purposes of electing directors to the Board. ARTICLE IV MISCELLANEOUS ss. 4.1 Entire Agreement. This Agreement contains the entire agreement between the parties hereto with respect to the subject matter hereof and supersedes all prior arrangements or understandings (whether written or oral) with respect thereto. ss. 4.2 Captions. The Article and Section captions used herein are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. -13- ss. 4.3 Counterparts. For the convenience of the parties, any number of counterparts of this Agreement may be executed by the parties hereto and each such executed counterpart shall be deemed to be an original instrument. ss. 4.4 Notices. All notices, consents, requests, instructions, approvals and other communications provided for herein and all legal process in regard hereto shall be validly given, made or served, if in writing and delivered by personal delivery, overnight courier, telecopier or registered or certified mail, return-receipt requested and postage prepaid addressed as follows: If to the Company, to: 24 Hour Fitness, Inc. c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 Attention: Gilbert K. Freeman Tel.: (510) 416-7399 Fax: (510) 416-7398 with copies to MDC and White & Case if to MDC, to: c/o McCown De Leeuw & Co. 101 East 52nd Street, 31st Floor New York, New York 10022 Attention: David E. King Tel.: (212) 355-5500 Fax: (212) 355-6283 or (212) 355-6945 if to White & Case, to: White & Case 1155 Avenue of the Americas New York, New York 10036 Attention: Frank L. Schiff, Esq. Tel.: (212) 819-8752 -14- Fax: (212) 354-8113 if to any of the Management Stockholders, to the addresses set forth opposite each of their names on Schedule A attached hereto, with a copy to Wilson, Sonsini, Goodrich & Rosati: Wilson, Sonsini, Goodrich & Rosati 650 Page Mill Road Palo Alto, CA 94304-1050 Attention: Jeffrey D. Saper, Esq. Tel.: (415) 493-9300 Fax: (415) 496-4084 or to such other address as any such party hereto may, from time to time, designate in writing to all other parties hereto, and any such communication shall be deemed to be given, made or served as of the date so delivered or, in the case of any communication delivered by mail, as of the date so received. ss. 4.5 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the Company, the Stockholders and their respective heirs, devisees, legal representatives, successors, permitted assigns and other permitted transferees. The rights of a Stockholder under this Agreement may not be assigned or otherwise conveyed by any Stockholder except in connection with a Transfer of Shares which is in compliance with this Agreement; provided, however, the rights of MDC under Sections 2.3, 2.4 and 3.1 are not assignable other than as a result of a Permitted Transfer described in Section 2.2(a)(iv). ss. 4.6 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT REGARD TO SUCH STATE'S CHOICE OF LAW PROVISIONS. ss. 4.7 Submission to Jurisdiction. (a) Each of the parties hereto hereby irrevocably acknowledges and consents that any legal action or proceeding brought with respect to any of the obligations arising under or relating to this Agreement shall be brought in the courts of the State of New York or in the United States District Court for the Southern District of New York, as the party bringing such action or proceeding may elect, and each of the parties hereto hereby irrevocably submits to and accepts with -15- regard to any such action or proceeding, for itself and in respect of its property, generally and unconditionally, the jurisdiction of the aforesaid courts. Subject to Section 4.7(b), the foregoing shall not limit the rights of any party to serve process in any other manner permitted by law. The foregoing consents to jurisdiction shall not constitute general consents to service of process in the State of New York for any purpose except as provided above and shall not be deemed to confer rights on any Person other than the respective parties to this Agreement. (b) Each of the parties hereto hereby waives any right it may have under the laws of any jurisdiction to commence by publication any legal action or proceeding with respect to this Agreement. To the fullest extent permitted by applicable law, each of the parties hereto hereby irrevocably waives the objection which it may now or hereafter have to the laying of the venue of any suit, action or proceeding arising out of or relating to this Agreement in any of the courts referred to in Section 4.7(a) and hereby further irrevocably waives any claim that any such court is not a convenient forum for any such suit, action or proceeding. (c) The parties hereto agree that any judgment obtained by any party hereto or its successors or assigns in any action, suit or proceeding referred to above may, in the discretion of such party (or its successors or assigns), be enforced in any jurisdiction, to the extent permitted by applicable law. (d) The parties hereto agree that the remedy at law for any breach of this Agreement may be inadequate and that should any dispute arise concerning the sale or disposition of any Shares or the voting thereof or any other similar matter hereunder, this Agreement shall be enforceable in a court of equity by an injunction or a decree of specific performance. Such remedies shall, however, be cumulative and nonexclusive, and shall be in addition to any other remedies which the parties hereto may have. (e) The parties hereto agree that the prevailing party or parties, as the case may be, in any action, suit, arbitration or other proceeding arising out of or with respect to this Agreement or the transactions contemplated hereby shall be entitled to reimbursement of all costs of litigation, including reasonable attorneys' fees, from the non-prevailing party. For purposes of this Section 4.7(e), each of the "prevailing party" and the "non-prevailing party" in any action, suit, arbitration or other proceeding shall be the party designated as such by the court, arbitrator or other appropriate official presiding over such action, suit, arbitration or other proceeding, such determination to be made as a part of the judgment rendered thereby. -16- ss. 4.8 Benefits Only to Parties. Nothing expressed by or mentioned in this Agreement is intended or shall be construed to give any Person, other than the parties hereto and their respective successors or permitted assigns, any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision herein contained, this Agreement and all conditions and provisions hereof being intended to be and being for the sole and exclusive benefit of the parties hereto and their respective successors and permitted assigns, and for the benefit of no other Person. ss. 4.9 Termination. This Agreement shall terminate upon the happening of any one of the following events: (a) the voluntary or involuntary dissolution of the Company; (b) the Sale of the Business as provided in Section 2.4; (c) the consummation of an IPO, except that (i) the rights of the Stockholders under Section 2.6 shall survive such termination and (ii) the rights of the Stockholders under Section 2.3 (other than for a sale in the open market pursuant to Rule 144 of the Securities Act) shall survive such termination until the earlier of (a) three years from the date of the IPO and (b) the time MDC shall no longer own at least 25% of the Company's common stock; and (d) if this Agreement has not been renewed or extended by a written instrument on or prior to the tenth anniversary of the date of this Agreement; provided, however, the provisions of Section 4.11 shall survive any termination of this Agreement. ss. 4.10 Publicity. Except as otherwise required by applicable laws or regulations, none of the parties hereto shall issue or cause to be issued any press release or make or cause to be made any other public statement in each case relating to or connected with or arising out of this Agreement or the matters contained herein, without obtaining the prior approval of MDC and the Company to the contents and the manner of presentation and publication thereof. ss. 4.11 Confidentiality. Each of the parties hereto hereby agrees that throughout the term of this Agreement it shall keep (and shall cause its directors, officers, employees, representatives and outside advisors and its affiliates to keep) all non-public information relating to the Company (including any such information received prior to the date hereof) confidential except information which (i) becomes known to -17- such Stockholder from a source, other than the Company, its directors, officers, employees, representatives or outside advisors, which source is not obligated to the Company to keep such information confidential or (ii) becomes generally available to the public through no breach of this Agreement by any party hereto. Each of the parties hereto agrees that such non-public information (a) shall be communicated only to those of its directors, officers, employees, representatives, outside advisors and affiliates who need to know such non-public information and (b) will not be used by such party or its directors, officers, employees, representatives, outside advisors or affiliates either to compete with the Company or to conduct itself in a manner inconsistent with the antitrust laws of the United States or any state. Notwithstanding the foregoing, a party hereto may disclose non-public information if required to do so by a court of competent jurisdiction or by any governmental agency; provided, however, that prompt notice of such required disclosure be given to the Company prior to the making of such disclosure so that the Company may seek a protective order or other appropriate remedy. In the event that such protective order or other remedy is not obtained, the party hereto required to disclose the non-public information will disclose only that portion which such party is advised by opinion of counsel is legally required to be disclosed and will request that confidential treatment be accorded such portion of the non-public information. ss. 4.12 Fee; Expenses. The parties hereto acknowledge that MDC Management Company III, L.P. and MDC Management Co., Inc. (collectively the "MDC Management Entities") (or their respective successors or assigns) shall receive from the Company or its Subsidiaries a transaction fee of $1,000,000 on the date of this Agreement and except as otherwise provided in the Management Services Agreement, dated as of the date hereof, between the Company and the MDC Management Entities, an ongoing management fee of $350,000 per annum adjusted upward by $100,000 each year thereafter until such ongoing management fee shall equal $750,000 per annum, in each case plus reimbursement for its out-of-pocket expenses. The Company shall reimburse each of the respective board representatives who are not employees of the Company for their travel and out-of-pocket expenses incurred in connection with their serving on the Company's board of directors. ss. 4.13 Amendments; Waivers. No provision of this Agreement may be amended, modified or waived without approval of 66-2/3% of the holders of the Common Stock; provided that no such amendment or waiver of a provision of this Agreement which adversely affects the rights of any of the Management Stockholders in a manner that does not adversely affect all other Stockholders equally may be made without such Management Stockholders' consent; provided that the Management Stockholders shall be considered as a group with the determination by the holders of a majority -18- of the outstanding Shares held by the Management Stockholders to be binding on all Management Stockholders. ss. 4.14 Acknowledgment. The parties hereto acknowledge the obligations of the Company and its wholly-owned subsidiary, H.E.C. Investments, Inc. under certain Success Participation Fee Letters entered into from time to time between the Company and H.E.C. Investments, Inc. and the Holders defined therein and the rights of such Holders under this Agreement. -19- IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first set forth above. 24 HOUR FITNESS, INC. By -------------------------------- Name: Title: McCOWN De LEEUW & CO. III, L.P. By MDC Management Company III, L.P., its general partner By -------------------------------- Title: General Partner McCOWN De LEEUW & CO. OFFSHORE (EUROPE) III, L.P. By MDC Management Company IIIE, L.P., its general partner By -------------------------------- Title: General Partner -20- MDC MANAGEMENT CO., INC. By -------------------------------- Title: GAMMA FUND, LLC By -------------------------------- Title: THE MANAGEMENT STOCKHOLDERS ---------------------------------- Name: Mark S. Mastrov ---------------------------------- Name: Leonard B.C. Schlemm ---------------------------------- Name: Gilbert K. Freeman -21- SCHEDULE A Stockholder MDC: McCown De Leeuw & Co. III, L.P. McCown De Leeuw Offshore (Europe) III, L.P. MDC Management Co. Inc. Gamma Fund, LLC Management Stockholders: Mark S. Mastrov 231 Market Place Suite 317 San Ramon, CA 94583 Leonard B. C. Schlemm 3777 The Boulevard Westmount, Quebec Canada H3Y 1T3 Gilbert K. Freeman 19200 Bay Tree Sonoma, CA 95476-6079 David Albert c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 David Atencio c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 Donald Harbich c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 James Hanzalik c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 John Romeo c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 SCHEDULE A Page 2 Raelene Skinner c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 Robert Brooks c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 Tim Simon c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 Todd Smith c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 Wes Wong c/o 24 Hour Nautilus P.O. Box 9071 Pleasanton, California 94566 EX-10.2 4 EXHIBIT 10.2 Exhibit 10.2 FITNESS HOLDINGS, INC. 5020 FRANKLIN DRIVE PLEASANTON, CA 94588 December 22, 1997 VIA PERSONAL DELIVERY Mark S. Mastrov 1894 Highway 50E #4-218 Carson City, NV 89701 RE: EMPLOYMENT AGREEMENT EXTENSION OF TERM Dear Mark: This letter is intended to memorialize the terms upon which we have mutually agreed to extend the term of your employment with Fitness Holdings Inc. (the "Company") for the period January 1, 1998 through December 31, 1998. The terms and conditions of your employment for this period shall the same as the terms and conditions set forth in that certain Employment Agreement by and between you and the Company and effective as of January 1, 1997 ("Employment Agreement"), except as follows: (a) SALARY. Your base salary which shall be payable in equal monthly installments and which shall be subject to withholding and other applicable taxes shall be paid at an annual rate of Five Hundred Fifty Thousand Dollars ($550,000.00). (b) EBITDA BONUS. The schedule used to determine the cash incentive bonus based upon Company EBITDA and as described in Section 4(b)(i) of the Employment Agreement shall be the schedule attached hereto as Schedule 1, as modified by final approval of the 1998 budget by the Board of Directors. (c) TARGET ACHIEVEMENT GOALS BONUS. The Target Achievement Goals used to determine the cash incentive bonus described in Section 4(b)(ii) of the Employment Agreement shall be the goals set forth on the attached Schedule 2. (d) EXPENSES. Your allowance for automobile expenses as set forth in Section 5(a) shall be Two Thousand Five Hundred Dollars ($2,500.00) per month. Mark S. Mastrov December 22, 1997 Page 2 (e) STOCK OPTIONS. On January 1, you shall receive an option grant to purchase 10,000 shares of common stock in the Company at the fair market value of such stock as of December 31, 1997 and as approved by the Board of Directors of the Company. This option shall be governed by and subject to all of the terms of the Company's employee stock option plan. Except as expressly set forth above, all other terms and conditions of the Employment Agreement shall remain in full force and effect. Assuming that you are in agreement with the terms of this letter, please sign and date this letter in the spaces indicated below and return a fully signed copy of this letter to me. Sincerely, David King Chairman AGREED AND ACCEPTED: /s/ Mark S. Mastrov - ------------------------- Mark S. Mastrov Date: date -------------------- Mark S. Mastrov December 22, 1997 Page 3 FITNESS HOLDINGS Mark Mastrov Bonus - 1998 Schedule 1
EBITDA % of % of Bonus Increase Goal EBITDA % Bonus ($000) in EBITDA ---- ------ ------- ------ --------- 80.0% 42,640 70.0% 525 82.5% 43,973 71.7% 538 0.9% 85.0% 45,305 73.9% 555 1.3% 87.5% 46,638 76.8% 576 1.6% 90.0% 47,970 80.3% 602 1.9% 92.5% 49,303 84.3% 632 2.3% 95.0% 50,635 89.0% 667 2.6% 97.5% 51,968 94.2% 707 3.0% - ---------------------------------------------------- 100.0% 53,300 100.1% 750 3.3% - ---------------------------------------------------- 102.5% 54,633 106.5% 799 3.6% 105.0% 55,965 113.5% 851 4.0% 107.5% 57,298 121.2% 909 4.3% - ---------------------------------------------------- 110.0% 58,630 129.4% 970 4.6% - ---------------------------------------------------- 112.5% 59,963 138.2% 1,037 5.0% 115.0% 61,295 147.6% 1,107 5.3% 117.5% 62,628 157.6% 1,182 5.6% - ---------------------------------------------------- 120.0% 63,960 168.3% 1,262 6.0% - ----------------------------------------------------
Mark S. Mastrov December 22, 1997 Page 4 Schedule 2 (Target Achievement Goals) (1) Achieving "same club sales growth" for 1998 vs 1997 at or above 8%. (2) Achieving Miscellaneous Revenues (Personal Training, Nutrition, Retail) at or above 10% of Gross Revenues for 1998. (3) Achieve new greenfield and acquisition club growth as approved by the Board of Directors and the Company Plan. (4) Prepare a plan, to be approved by the Board, by October 1, 1998 for the Southwest Division's "changes after the Earnout". (5) Complete a Senior level Compensation Package Plan. (6) Establish programs for the rollout of the new Information Technology systems, 24 Hour University and the Retail products concept. EMPLOYMENT AGREEMENT This agreement ("Agreement") is effective as of the 1ST DAY OF JANUARY 1997 by and between FITNESS HOLDINGS, INC. a Delaware corporation, with offices at 5020 Franklin Drive, Pleasanton, CA 94588 (the "Company"), and MARK S. MASTROV, an individual with an address of P.O. Box 5141-317, San Ramon, CA 94583 (the "Employee"). RECITALS WHEREAS, the Employee has been and is presently in the employ of the Company and is presently serving as Chief Executive Officer and President of the Company; WHEREAS, the Employee possesses and intimate knowledge of the business and affairs of the Company and its policies, procedures, methods and personnel; WHEREAS, the Company desires to secure the continued services and employment of the Employee on behalf of the Company, and the Employee desires to continue in the employment of the Company, upon the terms and conditions hereinafter set forth. NOW, THEREFORE, in consideration of the mutual covenants and promises contained herein, the parties hereto, each intending to be legally bound hereby, agree as follows: 1. EMPLOYMENT. The Company hereby employees the Employee as Chief Executive Officer and President of the Company (and Chief Executive Officer and President of the Company's wholly-owned subsidiary 24 Hour Fitness, Inc.), and the Employee accepts such employment for the term of the employment specified in Section 3 below (the "Employment Term"). During the Employment Term, the Employee shall serve as the Chief Executive Officer and President of the Company, performing such duties as shall be reasonably required of an executive-level employee of the Company, reporting only to the Board of Directors of the Company (the "Board"), and shall have such other powers and perform such other additional executive duties as may from time to time be assigned to him by the Board. 2. PERFORMANCE. The Employee will serve the Company faithfully and to the best of his ability and will devote substantially all of his time, energy, experience and talents during regular business hours and as otherwise reasonably necessary to such employment, to the exclusion of all other business activities. 3. EMPLOYMENT TERM. a) INITIAL TERM. The Employment Term shall begin on the date of this Agreement and continue until December 31, 1997. b) EXTENSION OF TERM. The Employment Term shall be automatically extended for five (5) successive one (1) year periods on the terms and conditions set forth herein; provided, however, the terms of Section 4 (Compensation) and the goals set forth on Schedule 1 (Target Achievement Goals) shall be reestablished for each such successive year. The Company and Employee shall use their good faith efforts to agree upon such terms and goals no later than thirty (30) days prior to the expiration of the then current year of the Employment Term. In the event that the Company and Employee do not agree upon such terms and goals by said date, this Agreement shall terminate on December 31 of the then current year of the Employment Term. c) Employment during the Employment Term, as said term may be extended, shall at all times be subject to termination at will. 4. COMPENSATION. a) SALARY. During each year of the Employment Term, the Company shall pay the Employee a base salary, payable in equal monthly installments, subject to withholding and other applicable taxes, at an annual rate of Five Hundred Thousand Dollars ($500,000.00) b) CASH INCENTIVE BONUS. i) The Company may pay the Employee for each year of the Employment Term a bonus of up to Five Hundred Thousand Dollars ($500,000.00) based upon the Company's achievement of it's budgeted Cash Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") as adjusted for multi-club acquisitions. Such bonus will be paid at 100% if the Company's EBITDA is equal to the EBITDA approved by the Board and on a pro rata basis, as reflected on Schedule 1, to the extent that the Company's EBITDA is between 80% and 120% of the budgeted amount. In the event that EBITDA is an amount between the specified amounts set forth on Schedule 1, said bonus shall be determined with reference to the formula upon which Schedule 1 is based. Said bonus shall be subject to withholding and other applicable taxes. ii) A performance bonus of $300,000 or higher for each year of the Employment Term will be paid for achievement of the Target Achievement Goals set forth on Schedule 2 hereto. Said bonus shall be subject to withholding and other applicable taxes. c) ADDITIONAL BENEFITS. In addition to the other compensation payable to the Employee hereunder, during the Employment Term, the Company shall permit the Employee to participate in any and all group life insurance plans, medical and dental health benefit plans and employee benefit plans and the like maintained by or on behalf of the Company for its executives. d) PAID TIME OFF. Employee shall be entitled to 30 days of paid vacation during each calendar year of the employment, pro rated for any partial year. Vacation may only be taken at times mutually convenient for the Company and Employee. No more than four weeks of vacation time may be accrued at any time. The Company may elect to pay out all accrued and unused vacation time as of December 31, in January or February of the following year. Such pay out will be at the then prevailing rate of annual compensation. Employee shall be entitled to paid sick leave each year pursuant to the Company's established sick leave policy in effect for such year (currently 2 days are allowed). Company's sick leave policy for employees may be changed from time to time by the Board. Unused sick leave shall not accumulate from year to year, nor shall Employee be compensated for unused sick leave. Employee shall also be entitled to 6 floating holidays during the calendar year. If any of the floating holidays have not been taken by December 31, then the unused amount will be paid to the employee no later than February 28 of the following year. 5. EXPENSES. The Employee shall be reimbursed by the Company for all reasonable expenses incurred by him in connection with the performance of his duties hereunder in accordance with policies established by the Board from time to time and upon receipt of appropriate documentation. In addition, the Company will reimburse the employee monthly (a) Two Thousand Dollars ($2,000.00) for automobile cost and (b) in addition for full out-of-pocket insurance and maintenance of such automobile. 6. SECRET PROCESSES AND CONFIDENTIAL INFORMATION. For the Employment Term and thereafter, (a) the Employee will not divulge, transmit or otherwise disclose (except as legally compelled by court order, and then only to the extent required after prompt notice to the Company of any such order), directly or indirectly, other than in the regular and proper course of business of the Company, any confidential knowledge or information with respect to the operations or finances of the Company or with respect to confidential or secret processes, services, techniques, customers or plans with respect to the Company and (b) the Employee will not use, directly or indirectly, any confidential information for the benefit of anyone other than the Company; provided however, that the Employee has no obligation, express or implied, to refrain from using or disclosing to others any such knowledge or information which is or hereafter shall become available to the public other than through disclosure by the Employee. All new processes, techniques, know-how, inventions, plans, products, patents and devices developed, made or invented by the Employee, alone or with others, while an employee of the Company, shall be and become the sole property of the Company, unless released in writing by the Company, and the Employee hereby assigns any and all rights therein or thereto to the Company. During the term of this Agreement and thereafter, Employee shall not take any action to disparage or criticize to any third parties any of the services of the Company or to commit any other action that injures or hinders the business relationships of the Company. All files, records, documents, memorandums, notes or other documents relating to the business of Company, whether prepared by Employee or otherwise coming into this possession in the course of the performance of his services under this Agreement, shall be the exclusive property of Company and shall be delivered to Company and not retained by Employee upon termination of this Agreement for any reason whatsoever. The provisions of this section requiring assignment of inventions to the Company do not apply to any invention which qualifies fully under the provisions of California Labor Code Section 2870 (attached hereto as Exhibit A). 7. TERMINATION. The employment of the Employee hereunder shall automatically terminate at the end of the Employment Term, unless the parties hereto mutually agree otherwise in writing, at least 30 days prior to expiration of the Employment Term. 8. INSURANCE. The Company may purchase insurance on the life of the Employee, and if it does so, the Employee shall cooperate fully by performing all the requirements of the life insurer which are necessary conditions precedent to the issuance of the life insurance policy issued by it. 9. SEVERANCE. If the Employee's employment is terminated by the Company without "cause" or by the Employee for "good reason" (each as defined in the Amended and Restated Stockholders Agreement, dated as of July 1, 1996 by and among the Company, the Employee and various other parties; PROVIDED that "good reason" shall be interpreted consistent with the provisions of Section 10 of this Agreement), then the Employee shall be entitled to (i) medical and dental benefits as of the date of termination for a period not to exceed six months (which shall be terminated sooner to the extent provided by another employer) and (ii) severance compensation for the 18 months following any such termination, payable in equal monthly installments, subject to withholding and other applicable taxes, at an annual rate of Five Hundred Thousand Dollars ($500,000.00). In addition, the Employee will be entitled to a PRO RATA portion of the bonus compensation referred to in Section 4 (b) hereof as projected from the year-to-date performance, such compensation to be awarded at the discretion of the Board of Directors of the Company. 10. GOOD REASON. Clause 2.5(c)(i) of the Stockholders Agreement defines "good reason" to include "a significant reduction in the authorities, duties or responsibilities of such Management Stockholder." As applied to the Employee, the parties hereto agree that any position other than chief executive officer, reporting only to the Board of Directors of the Company, and to whom all other employees report, directly or indirectly, would constitute a "significant reduction in all authorities, duties or responsibilities" of the Employee. This interpretation shall govern for all purposes, including application of the Stockholders Agreement, this Agreement and any option agreements entered into by the Employee and the Company. 11. NOTICE. Any notices required or permitted hereunder shall be in writing and shall be deemed to have been given when personally delivered or when mailed, certified or registered mail, postage prepaid, to the following addresses: If to the Employee: Mark S. Mastrov 1894 Highway 50E #4-218 Carson City, NV 89701 If to the Company: Fitness Holdings, Inc. 5020 Franklin Drive Pleasanton, CA 94588 Attention: Board of Directors With a copy to: McCown De Leeuw & Co. 101 East 52nd Street, 31st Floor New York, NY 10022 Attention: David E. King 12. GENERAL. a) GOVERNING LAW. The terms of this Agreement shall be governed by and construed under the laws of the State of California. b) ASSIGNABILITY. The Employee may not assign his interest in or delegate his duties under this Agreement. Notwithstanding anything else in this Agreement to the contrary, the Company may assign this Agreement to and all rights hereunder shall inure to the benefit of its wholly-owned subsidiary 24 Hour Fitness, Inc. or any person, firm or corporation succeeding to all or substantially all of the business or assets of the Company by purchase, merger or consolidation. c) ENFORCEMENT COSTS. In the event that either the Company or the Employee initiates an action or claim to enforce any provision or term of this Agreement, the costs and expenses (including attorney's fees) of the prevailing party shall be paid by the other party, such party to be deemed to have prevailed if such action or claim is concluded pursuant to a court order or final judgment which is not subject to appeal, a settlement agreement or dismissal of the principle claims. d) BINDING EFFECT: This Agreement is for the employment of Employee, personally and for the services to be rendered by him and no other person. This Agreement shall be binding upon and inure to the benefit of the Company, its successors and assigns, personal representatives, heirs and legatees. e) ENTIRE AGREEMENT; MODIFICATION. This Agreement constitutes the entire agreement of the parties hereto with respect to the subject matter hereof and may not be modified or amended in any way except in writing by the parties hereto. f) DURATION. Notwithstanding the term of employment hereunder, this Agreement shall continue for so long as any obligations remain under this Agreement. g) SURVIVAL. The covenants set forth in Section 6 of this Agreement shall survive and shall continue to be binding upon Employee notwithstanding the termination of this Agreement for any reason whatsoever. The covenants set forth in Section 6 of this Agreement shall be deemed and construed as separate agreements independent of any other provision of this Agreement. The existence of any claim or cause of action by Employee against Company, whether predicated on this Agreement or otherwise, shall not constitute a defense to the enforcement by Company of any or all covenants. It is expressly agreed that the remedy at law for the breach or any such covenant is inadequate and that injunctive relief shall be available to prevent the breach or any threatened breach thereof. IN WITNESS WHEREOF, the parties hereto, intending to be legally bound, have hereunto executed this Agreement the day and year first written above. FITNESS HOLDINGS, INC. By: By: -------------------------------- -------------------------------- David E. King, Chairman Mark S. Mastrov EXHIBIT A CALIFORNIA LABOR CODE SECTION 2870 EMPLOYMENT AGREEMENTS; ASSIGNMENT OF RIGHTS Section 2870 of the California Labor Code is as follows: a) Any provision is an employment agreement which provides that an employee shall assign, or offer to assign, any of his or her rights in an invention to his or her employer shall not apply to an invention that the employee developed entirely on his or her own time without using the employer's equipment, supplies, facilities, or trade secret information except for those inventions that either: 1) Relate at the time of conception; or reduction to practice of the invention to the employer's business, or actual or demonstrably anticipated research or development of the employer; or 2) Result from any work performed by the employee for the employer. b) To the extent a provision is an employment agreement purports to require an employee to assign an invention otherwise excluded from being required to be assigned under subdivision (a), the provision is against the public policy of this state and is unenforceable. FITNESS HOLDINGS Mark Mastrov Bonus Schedule 1
BITDA % of % of Bonus increase goal EBITDA % bonus ($000) in EBITDA - ---- ------ ------- ------ --------- 80.0% 36,062 70.0% 350 82.5% 37,189 70.9% 355 0.4% 85.0% 38,316 72.7% 363 0.8% 87.5% 39,443 75.2% 376 1.1% 90.0% 40,570 78.6% 393 1.5% 92.5% 41,697 82.7% 414 1.8% 95.0% 42,824 87.7% 438 2.2% 97.5% 43,951 93.4% 467 2.5% - ------------------------------------------------------------- 100.0% 45,078 100.0% 500 2.9% - ------------------------------------------------------------- 102.5% 46,205 107.3% 537 3.3% 105.0% 47,332 115.5% 577 3.6% 107.5% 48,459 124.4% 622 4.0% - ------------------------------------------------------------- 110.0% 49,586 134.1% 671 4.3% - ------------------------------------------------------------- 112.5% 50,713 144.7% 723 4.7% 115.0% 51,840 156.0% 780 5.0% 117.5% 52,967 168.2% 841 5.4% - ------------------------------------------------------------- 120.0% 54,094 181.1% 906 5.7% - -------------------------------------------------------------
Schedule 2 (Target Achievement Goals) (1) Achieving "same club sales growth" for 1997 vs 1996 at or above 7%. (2) Achieving Miscellaneous Revenues (Personal Training, Nutrition, Retail) at or above 10% of Gross Revenues for 1997 (3) Engage an executive search firm and begin the interview process to hire a highly qualified COO, as approved by the Board. (4) Open budgeted new clubs on or ahead of schedule during 1997 (5) Stay within the Board of Directors' approved Capital Expenditure Budget for new clubs as well as Maintenance Capital Expenditures for existing clubs. EX-10.4 5 EXHIBIT 10.4 Exhibit 10.4 COPY AS EXECUTED WITH EXHIBITS D, E, F,G AND L AS SEPARATELY EXECUTED $225,000,000 THIRD AMENDED AND RESTATED CREDIT AGREEMENT Dated as of December 19, 1997 Among 24 HOUR FITNESS, INC. as Borrower and FITNESS HOLDINGS, INC. as Parent Guarantor and THE RESTATEMENT LENDERS, THE EXISTING ISSUING BANK AND THE SWING LINE BANK NAMED HEREIN as Restatement Lenders, Existing Issuing Bank and Swing Line Bank and BANQUE NATIONALE DE PARIS as Administrative Agent and Syndication Agent and BANKERS TRUST COMPANY as Documentation Agent and LASALLE NATIONAL BANK AND WELLS FARGO BANK, N.A. as Co-Agents TABLE OF CONTENTS Page ---- ARTICLE I DEFINITIONS AND ACCOUNTING TERMS..................................2 SECTION 1.01. Certain Defined Terms....................................2 SECTION 1.02. Computation Of Time Periods.............................26 SECTION 1.03. Accounting Terms........................................26 ARTICLE II AMOUNTS AND TERMS OF THE ADVANCES AND THE LETTERS OF CREDIT.....26 SECTION 2.01. The Advances...........................................26 SECTION 2.02. Making the Advances....................................28 SECTION 2.03. Issuance of and Drawings and Reimbursement Under Letters of Credit......................................30 SECTION 2.04. Repayment of Advances..................................32 SECTION 2.05. Termination or Reduction of the Commitments............34 SECTION 2.06 Prepayments............................................35 SECTION 2.07. Interest...............................................37 SECTION 2.08. Fees...................................................38 SECTION 2.09. Conversion of Advances.................................39 SECTION 2.10. Increased Costs, Etc...................................39 SECTION 2.11. Payments and Computations..............................41 SECTION 2.12. Taxes..................................................42 SECTION 2.13. Sharing of Payments, Etc...............................44 SECTION 2.14. Use of Proceeds........................................45 ARTICLE III CONDITIONS OF LENDING..........................................45 SECTION 3.01. Conditions Precedent to the Third Amendment and Restatement.............................................45 SECTION 3.02. Conditions Precedent to Each Borrowing and Issuance.....50 SECTION 3.03. Determinations Under Section 3.01.......................50 ARTICLE IV REPRESENTATIONS AND WARRANTIES..................................51 SECTION 4.01. Representations and Warranties of the Borrower..........51 ARTICLE V COVENANTS OF THE BORROWER........................................56 SECTION 5.01. Affirmative Covenants...................................57 SECTION 5.02. Negative Covenants.....................................60 SECTION 5.03. Reporting Requirements..................................68 SECTION 5.04. Financial Covenants.....................................71 (i) ARTICLE VI EVENTS OF DEFAULT...............................................72 SECTION 6.01. Events of Default.......................................73 SECTION 6.02. Actions in Respect of the Letters of Credit upon Default................................................75 ARTICLE VII THE AGENTS.....................................................76 SECTION 7.01. Authorization and Action...............................76 SECTION 7.02. Agents Reliance, Etc...................................76 SECTION 7.03. Each Agent and Affiliates..............................77 SECTION 7.04. Lender Party Credit Decision...........................77 SECTION 7.05. Indemnification........................................77 SECTION 7.06. Successor Agents.......................................79 ARTICLE VIII MISCELLANEOUS.................................................80 SECTION 8.01. Amendments, Etc........................................80 SECTION 8.02. Notices, Etc...........................................80 SECTION 8.03. No Waiver; Remedies....................................81 SECTION 8.04. Costs and Expenses.....................................81 SECTION 8.05. Right of Setoff........................................83 SECTION 8.06. Binding Effect.........................................83 SECTION 8.07. Assignments and Participations.........................83 SECTION 8.08. Execution in Counterparts..............................86 SECTION 8.09. No Liability of the Issuing Bank.......................86 SECTION 8.10. Confidentiality........................................86 SECTION 8.11. Jurisdiction, Etc......................................87 SECTION 8.12. Governing Law..........................................87 SECTION 8.13. Waiver of Jury Trial...................................88 (ii) THIRD AMENDED AND RESTATED CREDIT AGREEMENT THIRD AMENDED AND RESTATED CREDIT AGREEMENT dated as of December 19, 1997 among 24 HOUR FITNESS, INC., a California corporation (the "Borrower"), FITNESS HOLDINGS, INC., a Delaware corporation (the "Parent Guarantor"), the banks, financial institutions and other institutional lenders listed on the signature pages hereof as the Restatement Lenders (the "Restatement Lenders"), BANQUE NATIONALE DE PARIS ("BNP"), as the existing issuing bank hereunder (the "Existing Issuing Bank"), as swing line bank (the "Swing Line Bank"), as syndication agent (the "Syndication Agent") and as administrative agent (together with any successor appointed pursuant to Article VII, the "Administrative Agent") for the Lender Parties (as hereinafter defined), BANKERS TRUST COMPANY, as documentation agent (the "Documentation Agent") for the Lenders, and LASALLE NATIONAL BANK AND WELLS FARGO BANK, N.A., as co-agents (the "Co-Agents") for the Lenders. PRELIMINARY STATEMENTS: (1) The Borrower is a wholly owned subsidiary of the Parent Guarantor. The Borrower entered into a Credit Agreement dated as of December 29, 1994, as amended and restated on June 30, 1995 and on March 14, 1997 (as further amended, supplemented or otherwise modified through the date hereof, the "Existing Credit Agreement"), with BNP, as Lender, Initial Issuing Bank and Agent thereunder, and the other lenders party thereto (together with BNP, the "Existing Lenders") in order to provide financing for the acquisition and development of Health Club Facilities (as hereinafter defined), and to provide working capital for the Borrower and its Subsidiaries (as hereinafter defined). (2) The Borrower has requested that the Existing Lenders further amend and restate the Existing Credit Agreement so that, immediately upon the Third Restatement Date (as hereinafter defined), the Lender Parties would advance to the Borrower and its Subsidiaries an aggregate amount of up to $225,000,000. (3) The Existing Lenders party to the Existing Credit Agreement and the Borrower have agreed to further amend and restate the Existing Credit Agreement in order to allow such Existing Lenders to assign a portion of their Commitments (as defined in the Existing Credit Agreement) to the Restatement Lenders hereunder and to increase their Term Commitment under the Existing Credit Agreement in order to refinance the Term Facility (as defined in the Existing Credit Agreement), and allow the Borrower to pay transaction fees and expenses and that, from time to time, the Lender Parties would lend to the Borrower and issue Letters of Credit (as hereinafter defined) for the benefit of the Borrower to provide working capital for the Borrower and its Subsidiaries, to provide financing for the acquisition and development of Health Club Facilities and for other purposes as provided herein. The Lender Parties have indicated their willingness to agree to lend such amounts on the terms and conditions of this Agreement. (4) Simultaneously with the execution hereof, the Existing Lenders that are not Restatement Lenders have entered into an Assignment and Agreement, in the form of Exhibit L attached hereto dated as of the date hereof (the "Assignment Agreement"), with the Restatement Lenders hereunder pursuant to which such Existing Lenders have agreed to sell and assign to the Restatement Lenders, and the Restatement Lenders have agreed to purchase and assume, as of the Third Restatement Date, all of such Existing Lenders' rights and obligations under the Existing Credit Agreement on the terms set forth in the Assignment Agreement. After giving effect to such sale and assignment as of the Third Restatement Date, the Commitments (as hereinafter defined) of, and the amount of Advances (as hereinafter defined) owing to, each of the Restatement Lenders will be as set forth on Schedule I. NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements contained herein, the parties hereto hereby agree as follows: ARTICLE I DEFINITIONS AND ACCOUNTING TERMS SECTION 1.01. Certain Defined Terms. As used in this Agreement, the following terms shall have the following meanings (such meanings to be equally applicable to both the singular and plural forms of the terms defined): "Adjusted EBITDA" means, for any Rolling Period, the sum of (a) Consolidated EBITDA of the Parent Guarantor and its Subsidiaries (b) with respect to any Health Club Investment which constitutes an acquisition of a Health Club Facility, EBITDA of such Health Club Facility for such Rolling Period or such shorter period, as appropriate, ending on the last day of the month immediately preceding the date of the consummation of such Health Club Investment if the Lender Parties shall have received financial information of such Health Club Facility with an audit or a review report by a nationally recognized accounting firm acceptable to the Administrative Agent, provided, however, that, with respect to any Health Club Investment consisting of an acquisition of a Health Club Facility with an aggregate acquisition purchase price (including the amount of any indebtedness refinanced or assumed, any earnout or similar Obligation in connection therewith, and all fees and expenses related thereto) which represents less than 5 % of the Consolidated assets of the Parent Guarantor and its Subsidiaries immediately before giving effect to such Health Club Investment, such audit or review report shall only be required at the request of the Administrative Agent and (c) Pro Forma Adjustments. "Administrative Agent" has the meaning specified in the recital of parties to this Agreement. "Administrative Agent's Account" means the account of the Administrative Agent maintained by the Administrative Agent at the Federal Reserve Bank of New York, 33 Liberty Street, New York, New York 10048, ABA No. 026007689, for further credit to Account No. 75042070103, or such other account maintained by the -2- Administrative Agent and designated by the Administrative Agent in a written notice to the Lender Parties and the Borrower. "Advance" means a Term A Advance, a Term B Advance, a Working Capital Advance, a Swing Line Advance or a Letter of Credit Advance. "Affiliate" means, as to any Person, any other Person that, directly or indirectly, controls, is controlled by or is under common control with such Person or is a director or officer of such Person. For purposes of this definition, the term "control" (including the terms "controlling", "controlled by" and "under common control with") of a Person means the possession, direct or indirect, of the power to vote 5 % or more of the Voting Stock of such Person or to direct or cause the direction of the management and policies of such Person, whether through the ownership of Voting Stock, by contract or otherwise. "Agents" means each of the Administrative Agent, the Syndication Agent, the Documentation Agent and the Co-Agents, together, in each case, with any successor or successors of any thereof appointed pursuant to Article VII hereof. "Applicable Lending Office" means, with respect to each Lender Party, such Lender Party's Domestic Lending Office, in the case of a Base Rate Advance, and such Lender Party's Eurodollar Lending Office, in the case of a Eurodollar Rate Advance. "Applicable Margin" means a percentage per annum determined by reference to the Leverage Ratio as set forth below: Leverage Ratio Term A Facility and Term B Facility Working Capital Facility Base Rate Base Rate Advances/Eurodollar Advances/Eurodollar Rate Advances Rate Advances Level I less than 2.00:1.00 0.50%/2.00% 1.00%/2.50% Level II 2.00:1.00 or greater 0.75%/2.25% 1.25%/2.75% but less than 2.75:1.00 Level III 2.75:1.00 or greater -3- but less than 3.50:1.00 1.00%/2.50% 1.50%/3.00% Level IV 3.50:1.00 or greater 1.25%/2.75% 1.75%/3.25% The Applicable Margin shall be determined by reference to the Leverage Ratio in effect from time to time; provided, however, that (a) the Applicable Margin shall be at Level IV for the period commencing on the Third Restatement Date until the quarter ending September 30, 1998, (b) no change in the Applicable Margin shall be effective until three Business Days after the date on which the Administrative Agent receives financial statements pursuant to Section 5.03(c) or (d), as the case may be, and a certificate of the chief financial officer of the Borrower demonstrating such Ratio, and (c) notwithstanding anything herein to the contrary, the Applicable Margin shall be at Level IV upon the occurrence and during the continuance of an Event of Default. "Appropriate Lender" means, at any time, with respect to (a) the Term A Facility, the Term B Facility or the Working Capital Facility, a Lender Party that has a Commitment with respect to such Facility at such time, (b) the Letter of Credit Facility, (i) the Issuing Bank and (ii) if the other Working Capital Lenders have made Letter of Credit Advances pursuant to Section 2.03(c) that are outstanding at such time, each such other Working Capital Lender and (c) the Swing Line Facility, (i) the Swing Line Bank and (ii) if the other Working Capital Lenders have made Swing Line Advances pursuant to Section 2.02(b) that are outstanding at such time, each such other Working Capital Lender. "Assignment Agreement" has the meaning specified in the preliminary statements to this Agreement. "Assignment and Acceptance" means an assignment and acceptance entered into by a Lender Party and an Eligible Assignee, and accepted by the Administrative Agent, in accordance with Section 8.07 and in substantially the form of Exhibit C hereto. "Available Amount" of any Letter of Credit means, at any time, the maximum amount available to be drawn under such Letter of Credit at such time (assuming compliance at such time with all conditions to drawing). "Base Rate" means a fluctuating interest rate per annum in effect from time to time, which rate per annum shall at all times be equal to the higher of: (a) the rate of interest announced publicly by BNP in New York City from time to time as its prime rate (and such term shall not be construed to be its best or most favorable rate); and -4- (b) 1/2 of 1% per annum above the Federal Funds Rate. "Base Rate Advance" means an Advance that bears interest as provided in Section 2.07(a)(i). "BNP" has the meaning specified in the recital of parties to this Agreement. "Borrower" has the meaning specified in the recital of parties to this Agreement. "Borrower's Account" means the account of the Borrower maintained by the Borrower with BNP at its office at 499 Park Avenue, New York, New York 10022, Account No. 20183500107, or such other account as may be agreed to between the Borrower and the Administrative Agent. "Borrowing" means a Term A Borrowing, a Term B Borrowing, a Working Capital Borrowing or a Swing Line Borrowing. "Business Day" means a day of the year on which banks are not required or authorized by law to close in New York City and, if the applicable Business Day relates to any Eurodollar Rate Advances, on which dealings are carried on in the London interbank market. "Capital Expenditures" means, for any Person for any period, the sum of, without duplication, (a) all expenditures made, directly or indirectly, by such Person or any of its Subsidiaries during such period for equipment, fixed assets, real property or improvements, or for replacements or substitutions therefor or additions thereto, that have been or should be, in accordance with GAAP, reflected as additions to property, plant or equipment on a Consolidated balance sheet of such Person and (b) the aggregate principal amount of all Debt (including Obligations under Capitalized Leases) assumed or incurred in connection with any such expenditures. "Capitalized Leases" means all leases that have been or should be, in accordance with GAAP, recorded as capitalized leases. "Cash Equivalents" means any of the following, to the extent owned by the Borrower or any of its Subsidiaries free and clear of all Liens, other than Liens created under the Collateral Documents, and having a maturity of not greater than 90 days from the date of acquisition thereof: (a) readily marketable direct obligations of the Government of the United States or any agency or instrumentality thereof or obligations unconditionally guaranteed by the full faith and credit of the Government of the United States; (b) insured certificates of deposit of or time deposits with any commercial bank that is a Lender Party or a member of the Federal Reserve -5- System, issues (or the parent of which issues) commercial paper rated as described in clause (c), is organized under the laws of the United States or any State thereof and has combined capital and $1 billion; or (c) commercial paper in an aggregate amount of no more than $100,000 per issuer outstanding at any time, issued by any corporation organized under the laws of any State of the United States and rated at least "Prime- 1" (or the then equivalent grade) by Moody's Investors Service, Inc. or "A- 1 (or the then equivalent grade) by Standard & Poor's Ratings Group. "CERCLIS" means the Comprehensive Environmental Response, Compensation and Liability Information System maintained by the U.S. Environmental Protection Agency. "Co-Agents" has the meaning set forth in the recital of parties to this Agreement. "Collateral" means all "Collateral" referred to in the Collateral Documents and all other property that is or is intended to be subject to any Lien in favor of the Administrative Agent for the benefit of the Secured Parties. "Collateral Documents" means the Security Agreement, the Trademark, Copyright and Patent Security Agreement and any other agreement, document or instrument that creates or purports to create a Lien in favor of the Administrative Agent for the benefit of the Secured Parties, including, without limitation, any financing statements. "Commitment" means a Term A Commitment, a Term B Commitment, a Working Capital Commitment or a Letter of Credit Commitment. "Confidential Information" means information that any Loan Party or any of its Subsidiaries furnishes to the Administrative Agent or any Lender Party on a confidential basis, but does not include any such information that is or becomes generally available to the public or that is or becomes available to the Administrative Agent or such Lender Party from a source other than any Loan Party or any of its Subsidiaries (including Foreign Subsidiaries). "Consolidated" refers, with respect to any Person, to the consolidation of accounts of such Person and its Subsidiaries in accordance with GAAP. "Continuing Directors" means, as of any date of determination, any member of the Board of Directors of the Parent Guarantor who (i) was a member of such Board of Directors on the date hereof or (ii) is nominated for election or elected to such Board of Directors with the affirmative vote of the MDC Investors. "Conversion", "Convert" and "Converted" each refer to a conversion of Advances of one Type into Advances of the other Type pursuant to Section 2.09 or 2.10. -6- "Debt" of any Person means, without duplication, (a) all indebtedness of such Person for borrowed money, (b) all Obligations of such Person for the deferred purchase price of property or services, (c) all Obligations of such Person evidenced by notes, bonds, debentures or other similar instruments, (d) all Obligations of such Person created or arising under any conditional sale or other title retention agreement with respect to property acquired by such Person (even though the rights and remedies of the seller or lender under such agreement in the event of default are limited to repossession or sale of such property), (e) all Obligations of such Person as lessee under Capitalized Leases, (f) all Obligations, contingent or otherwise, of such Person under acceptance, letter of credit or similar facilities, (g) all Obligations of such Person to purchase, redeem, retire, defease or otherwise make any payment in respect of any capital stock of or other ownership or profit interest in such Person or any other Person, or any warrants, rights or options to acquire such capital stock, valued, in the case of Redeemable Preferred Stock, at the greater of its voluntary or involuntary liquidation preference plus accrued and unpaid dividends, (h) all net Obligations of such Person in respect of Hedge Agreements, (i) all Debt of others referred to in clauses (a) through (h) above guaranteed directly or indirectly in any manner by such Person, or in effect guaranteed directly or indirectly by such Person through an agreement (i) to pay or purchase such Debt or to advance or supply funds for the payment or purchase of such Debt, (ii) to purchase, sell or lease (as lessee or lessor) property, or to purchase or sell services, primarily for the purpose of enabling the debtor to make payment of such Debt or to assure the holder of such Debt against loss, (iii) to supply finds to or in any other manner invest in the debtor (including any agreement to pay for property or services irrespective of whether such property is received or such services are rendered) or (iv) otherwise to assure a creditor against loss, and (j) all Debt referred to in clauses (a) through (i) above of another Person secured by (or for which the holder of such Debt has an existing right, contingent or otherwise, to be secured by) any Lien on property (including, without limitation, accounts and contract rights) owned by such Person, even though such Person has not assumed or become liable for the payment of such Debt. "Default" means any Event of Default or any event that would constitute an Event of Default but for the requirement that notice be given or time elapse or both. "Documentation Agent" has the meaning set forth in the recital of parties to this Agreement. "Domestic Lending Office" means, with respect to any Lender Party, the office of such Lender Party specified as its "Domestic Lending Office" opposite its name on Schedule I hereto or in the Assignment and Acceptance pursuant to which it became a Lender Party, as the case may be, or such other office of such Lender Party as such Lender Party may from time to time specify to the Borrower and the Administrative Agent. "Earnout Notes" means each of (a) the 9 % promissory notes of the Borrower dated December 31, 1995 in an aggregate principal amount of $1,579,639.97 as of the -7- Third Restatement Date, maturing November 20, 1998 and (b) the 9% promissory notes of the Borrower dated December 31, 1996 in an aggregate principal amount of $6,540,186.00 as of the third Restatement Date, maturing April 15, 1999. "Earnout I Subordination Agreement" has the meaning specified in Section 3.01(f)(xi). "Earnout II Subordination Agreement" has the meaning specified in Section 3.01(f)(xi). "EBITDA" means, for any Person, for any period, (a) net income (or net loss) adjusted to include only the cash impact of deferred revenue and related deferred costs, deferred rental expense, deferred compensation and pre-opening store costs plus (b) the sum of (i) Interest Expense, (ii) income tax expense, (iii) depreciation expense, (iv) amortization expense, (v) extraordinary or unusual losses deducted in calculating net income (or net loss), and (vi) any noncash charges relating to pensions, stock options, stock appreciation rights and other equity-based incentive plans less (c) the sum of (i) interest income, (ii) extraordinary or unusual gains added in calculating net income (or net loss), (iii) any cash payments (to the extent not included in net income) made in respect of any earnouts or similar Obligations in connection with the acquisition of any Health Club Facility in each case determined in accordance with GAAP for such Person for such period; provided, however, that for the purposes of calculating EBITDA the following shall be excluded therefrom (x) such portion of any non-wholly owned Subsidiary's or Affiliates EBITDA that is attributable to interests not owned by such person or any of its wholly owned Subsidiaries and that under GAAP would be otherwise included in calculating EBITDA, (y) the portion of any Subsidiary's or Affiliate's EBITDA that under GAAP would be otherwise included in calculating EBITDA to the extent that the declaration of dividends or similar distributions by that Subsidiary or Affiliate of that EBITDA is restricted by contract or operation of law (other than by this Agreement), and (z) EBITDA of any Foreign Subsidiary that under GAAP would be otherwise included in calculating EBITDA, except to the extent of cash dividends or distributions paid to such person or any of its wholly owned Subsidiaries; and provided, further, that the EBITDA or cash dividends or distributions, as the case may be, of all Foreign Subsidiaries and Affiliates shall not be recognized to the extent such aggregate amount exceeds 10% of the EBITDA of such Person. "Eligible Assignee" means (a) with respect to any Facility (other than the Letter of Credit Facility), (i) a Lender; (ii) an Affiliate of a Lender; (iii) a Related Fund of a Lender; (iv) a commercial bank organized under the laws of the United States, or any State thereof, and having a combined capital and surplus of at least $500,000,000; (v) a savings and loan association or savings bank organized under the laws of the United States, or any State thereof, and having a combined capital and surplus of at least -8- $500,000,000; (vi) a commercial bank organized under the laws of any other country that is a member of the OECD or has concluded special lending arrangements with the International Monetary Fund associated with its General Arrangements to Borrow, or a political subdivision of any such country, and having a combined capital and surplus of at least $500,000,000, so long as such bank is acting through a branch or agency located in the United States; (vii) a finance company, insurance company or other financial institution or fund (whether a corporation, partnership, trust or other entity) that is engaged in making, purchasing or otherwise investing in commercial loans in the ordinary course of its business and having a combined capital and surplus of at least $500,000,000; and (viii) any other Person approved by the Administrative Agent and the Borrower, such approval not to be unreasonably withheld or delayed; and (b) with respect to the Letter of Credit Facility, a Person that is an Eligible Assignee under subclause (iv) or (vi) of clause (a) of this definition and is approved by the Administrative Agent and the Borrower, such approval not to be unreasonably withheld or delayed; provided, however, that neither any Loan Party nor an Affiliate of any Loan Party shall qualify as an Eligible Assignee under this definition. "Environmental Action" means any administrative, regulatory or judicial action, suit, demand, demand letter, claim, notice of non-compliance or violation, notice of liability or potential liability, investigation, proceeding, consent order or consent agreement relating in any way to any Environmental Law, any Environmental Permit or any Hazardous Material or arising from alleged injury or threat to health, safety or the environment, including, without limitation, (a) by any governmental or regulatory authority for enforcement, cleanup, removal, response, remedial or other actions or damages and (b) by any governmental or regulatory authority or third party for damages, contribution, indemnification, cost recovery, compensation or injunctive relief. "Environmental Law" means any federal, state, local or foreign statute, law, ordinance, rule, regulation, code, order, writ, judgment, injunction, decree, or judicial or agency interpretation, policy or guidance relating to pollution or protection of the environment, health, safety or natural resources, including without limitation, those relating to the use, handling, transportation, treatment, storage, disposal, release or discharge of Hazardous Materials. "Environmental Permit" means any permit, approval, identification number, license or other authorization required under any Environmental Law. "Equipment" has the meaning specified in the Security Agreement. "Equity Investors" means the MDC Investors and the management investors listed on Schedule II hereto. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, and the regulations promulgated and rulings issued thereunder. -9- "ERISA Affiliate" of any Person means any other Person that for purposes of Title IV of ERISA is a member of such Person's controlled group, or under common control with such Person, within the meaning of Section 414(b) or (c) of the Internal Revenue Code. "ERISA Event" with respect to any Person means (a) (i) the occurrence of a reportable event, within the meaning of Section 4043 of ERISA, with respect to any Plan of such Person or any of its ERISA Affiliates unless the 30-day notice requirement with respect to such event has been waived by the PBGC; (ii) the requirements of subsection (1) of Section 4043(b) of ERISA (without regard to subsection (2) of such Section) are met with respect to a contributing sponsor, as defined in Section 4001(a)(13) of ERISA, of a Plan, and an event described in paragraph (9), (10), (11), (12) or (13) of Section 4043 (c) of ERISA is reasonably expected to occur with respect to such Plan within the following 30 days; (b) the application for a minimum funding waiver with respect to a Plan; (c) the provision by the administrator of any Plan of such Person or any of its ERISA Affiliates of a notice of intent to terminate such Plan pursuant to Section 4041(a)(2) of ERISA (including any such notice with respect to a plan amendment referred to in Section 4041(e) of ERISA); (d) the cessation of operations at a facility of such Person or any of its ERISA Affiliates in the circumstances described in Section 4062(e) of ERISA that could reasonably be expected to result in a material liability to such Person or any of its ERISA Affiliates pursuant to Section 4062, 4063 or 4064 of ERISA; (e) the withdrawal by such Person or any of its ERISA Affiliates from a Multiple Employer Plan during a plan year for which it was a substantial employer, as defined in Section 4001(a)(2) of ERISA, that could reasonably be expected to result in a material liability to such Person or any of its ERISA Affiliates pursuant to Section 4062, 4063 or 4064 of ERISA; (f) the conditions for imposition of a lien under Section 302(f) of ERISA shall have been met with respect to any Plan; (g) the adoption of an amendment to a Plan of such Person or any of its ERISA Affiliates requiring the provision of security to such Plan pursuant to Section 307 of ERISA; or (h) the institution by the PBGC of proceedings to terminate a Plan of such Person or any of its ERISA Affiliates pursuant to Section 4042 of ERISA that constitutes grounds for the termination of, or the appointment of a trustee to administer, such Plan. "Eurocurrency Liabilities" has the meaning specified in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Eurodollar Lending Office" means, with respect to any Lender Party, the office of such Lender Party specified as its "Eurodollar Lending Office" opposite its name on Schedule I hereto or in the Assignment and Acceptance pursuant to which it became a Lender Party (or, if no such office is specified, its Domestic Lending Office), or such other office of such Lender Party as such Lender Party may from time to time specify to the Borrower and the Administrative Agent. "Eurodollar Rate" means, for any Interest Period for all Eurodollar Rate Advances comprising part of the same Borrowing, an interest rate per annum equal to the rate per -10- annum obtained by dividing (a) the average of the respective rates per annum (rounded upward to the next whole multiple of 1/1 6th of 1%) posted by each of the principal London offices of banks posting rates as displayed on the Telerate screen, page 3750 or such other page as may replace such page on such service for the purpose of displaying the London interbank offered rate of major banks for deposits in U.S. Dollars, at approximately 11:00 A.M. (London time) two Business Days before the first day of such Interest Period for deposits in an amount substantially equal to BNP's Eurodollar Rate Advance comprising part of such Borrowing to be outstanding during such Interest Period (or, if BNP shall not have such a Eurodollar Rate Advance, $1,000,000) and for a period equal to such Interest Period by (b) a percentage equal to 100% minus the Eurodollar Rate Reserve Percentage for such Interest Period. "Eurodollar Rate Advance" means an Advance that bears interest as provided in Section 2.07(a)(ii). "Eurodollar Rate Reserve Percentage" for any Interest Period for all Eurodollar Rate Advances comprising part of the same Borrowing means the reserve percentage applicable two Business Days before the first day of such Interest Period under regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any emergency, supplemental or other marginal reserve requirement) for a member bank of the Federal Reserve System in New York City with respect to liabilities or assets consisting of or including Eurocurrency Liabilities (or with respect to any other category of liabilities that includes deposits by reference to which the interest rate on Eurodollar Rate Advances is determined) having a term equal to such Interest Period. Events of Default" has the meaning specified in Section 6.01; provided, however, that, for purposes of any Subordinated Debt and any Seller Debt, "Events of Default" shall also include the occurrence of a Material Adverse Change. "Existing Credit Agreement" has the meaning specified in the preliminary statements to this Agreement. "Existing Debt" means Debt of the Loan Parties and their Subsidiaries immediately prior to the Third Restatement Date. "Existing Issuing Bank" has the meaning specified in the recital of parties to this Agreement. "Existing Lenders" has the meaning specified in the first preliminary statement of this Agreement. "Existing Letters of Credit" has the meaning specified in Section 2.01(d). -11- "Extraordinary Receipt" means any cash received by or paid to or for the account of any Person not in the ordinary course of business, including, without limitation, pension plan reversions, proceeds of insurance (other than proceeds of business interruption insurance to the extent such proceeds constitute compensation for lost earnings), condemnation awards (and payments in lieu thereof) and indemnity payments; provided, however, that an Extraordinary Receipt shall not include cash receipts received from proceeds of insurance to the extent that such receipts are in respect of loss or damage to equipment, fixed assets or real property and are applied to (i) replace or repair such equipment, fixed assets or real property no later than 12 months after the occurrence of the event giving rise to such receipt, or (ii) reimburse such Person for expenditures incurred to replace or repair such equipment, fixed assets or real property where such expenditures were incurred no later than 12 months after the occurrence of the event giving rise to such receipt or such receipts constitute reimbursement for expenditures incurred within such period in respect thereof. "Facility" means the Term A Facility, the Term B Facility, the Working Capital Facility, the Swing Line Facility or the Letter of Credit Facility. "Federal Funds Rate" means, for any period, a fluctuating interest rate per annum equal for each day during such period (i) to the rate published by the Telerate service on page five of its daily report as the "New York Offered Rate" as of 10:00 A.M. (New York City time) for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) or (ii) if the Telerate service shall cease to publish or otherwise shall not publish such rates for any day that is a Business Day, to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average of the quotations for such day for such transactions received by the Administrative Agent from three Federal funds brokers of recognized standing selected by it. "FFHLP" means Family Fitness Holdings Limited Partnership, a California limited partnership. "FFHLP Subordinated Notes" means the 9% promissory notes of the Borrower dated June 30, 1995 in the aggregate principal amount of $10,100,000 maturing January 1, 2002. "FFHLP Subordination Agreement" has the meaning specified in Section 3.01(f)(xi). "Final Maturity Date" means the earlier of December 31, 2004 and the date of termination in whole of the Term A Commitments, the Term B Commitments, the Letter of Credit Commitments and the Working Capital Commitments pursuant to Section 2.05 or 6.01. -12- "Fiscal Quarter" means a fiscal quarter of the Parent Guarantor ending on each March 31, June 30, September 30 and December 31 in any calendar year. "Fixed Charge Coverage Ratio" means, with respect to any Person for any period, the ratio of (a) Consolidated EBITDA for such Person and its Subsidiaries for such period to (b) the sum of (i) Interest Expense paid in cash of such Person and its Subsidiaries for such period, (ii) regularly scheduled principal payments of Funded Debt of such Person and its Subsidiaries made during such period and (iii) income taxes of such Person and its Subsidiaries that have been paid in cash during such period. "Foreign Subsidiary" means any Subsidiary of the Borrower that is not a U.S. Subsidiary. "Funded Debt" means all Debt of the Parent Guarantor and any of its Subsidiaries that by its terms matures more than one year after the date of creation or matures within one year from such date but is renewable or extendible, at the option of the Parent Guarantor or any of its Subsidiaries, to a date more than one year after such date or arises under a revolving credit or similar agreement that obligates the lender or lenders to extend credit during a period of or more than one year after such date (including, without limitation, all amounts of Funded Debt of the Parent Guarantor and any of its Subsidiaries required to be paid or prepaid within one year after the date of determination), other than the Subordinated Debt, any intercompany debt and any earnout or similar Obligation in connection with the acquisition of any Health Club Facility. "GAAP" has the meaning specified in Section 1.03. "Gamma Fund LLC" means the Gamma Fund LLC, a California limited liability company. "Guaranty Supplement" has the meaning specified in the Subsidiary Guaranty. "Hazardous Materials" means (a) petroleum or petroleum products, radioactive materials, asbestos-containing materials and radon gas and (b) any other chemicals, materials or substances designated, classified or regulated as being "hazardous" or "toxic" or words of similar import under any Environmental Law. "Health Club Facility" means a fitness center or health/athletic club of the type currently operated by the Borrower, or any of its components related to, and located on or adjacent to the premises of, such fitness center or health/athletic club, including' without limitation, the corporate office thereof, cardiovascular and weight training, aerobic classes, sports and rehabilitation therapy and therapeutic massage. "Health Club Investment" means any purchase or other acquisition of all of the capital stock or other ownership or profit interest, warrants, rights, options, obligations or other securities of, or any other investment in, any Health Club Facility or any Capital Expenditure in connection with any Health Club Facility or any other expenditure for any -13- other asset or property (tangible or intangible) in connection with the purchase or development of any Health Club Facility. "Hedge Agreements" means interest rate swap, cap or collar agreements, interest rate future or option contracts, currency swap agreements, currency future or option contracts and other similar agreements. "Hedge Banks" has the meaning specified in the Security Agreement. "Holdings Account" means the account of the Parent Guarantor maintained by the Parent Guarantor with BNP at its office at 499 Park Avenue, New York, New York 10022, Account No. 20194800122, or such other account as may be agreed to between the Parent Guarantor and the Administrative Agent. "Holdings Guaranty" has the meaning specified in Section 3.01(f)(x). "Holdings Notes" means the promissory notes of the Parent Guarantor in favor of the Borrower as described in Schedule IV hereto. "Holdings Pledge Agreement" has the meaning specified in Section 3.01(f)(ix). "Holdings Subordination Agreement" has the meaning specified in Section 3.01(f)(xi). "Indemnified Costs" has the meaning specified in Section 7.05(a). "Indemnified Party" has the meaning specified in Section 8.04(b). "Insufficiency" means, with respect to any Plan, the amount, if any, of its unfunded benefit liabilities, as defined in Section 4001(a)(18) of ERISA. "Intercompany Subordination Agreement" has the meaning specified in Section 5.02(b)(i)(F). "Interest Coverage Ratio" means, with respect to any Person for any period, the ratio of (a) Consolidated EBITDA of such Person and its Subsidiaries for such period to (b) Interest Expense paid in cash of such Person and its Subsidiaries for such period. "Interest Expense" means, with respect to any Person for any period, the amount of interest expense (including the interest component on obligations under Capitalized Leases), whether paid or accrued, on all Debt of such Person and its Subsidiaries for such period, including, without limitation and without duplication, (a) interest expense in respect of Debt resulting from Advances, (b) commissions, discounts and other fees and charges payable in connection with letters of credit (including, without limitation, any Letters of Credit), (c) any net payment payable in connection with Hedge Agreements less any net credits received in connection with Hedge Agreements and (d) all other noncash interest but excluding amortization with regard to deferred financing fees. -14- "Interest Period" means, for each Eurodollar Rate Advance comprising part of the same Borrowing, the period commencing on the date of such Eurodollar Rate Advance or the date of the Conversion of any Base Rate Advance into such Eurodollar Rate Advance and ending on the last day of the period selected by the Borrower pursuant to the provisions below and, thereafter, each subsequent period commencing on the last day of the immediately preceding Interest Period and ending on the last day of the period selected by the Borrower pursuant to the provisions below. The duration of each such Interest Period shall be one, two, three or six months, as the Borrower may, upon notice received by the Administrative Agent not later than 1:00 P.M. (New York City time) on the third Business Day prior to the first day of such Interest Period, select; provided, however, that: (a) the Borrower may not select any Interest Period with respect to any Eurodollar Rate Advance under a Facility that ends after any principal repayment installment date for such Facility unless, after giving effect to such selection, the aggregate principal amount of Base Rate Advances and of Eurodollar Rate Advances having Interest Periods that end on or prior to such principal repayment installment date for such Facility shall be at least equal to the aggregate principal amount of Advances under such Facility due and payable on or prior to such date; (b) Interest Periods commencing on the same date for Eurodollar Rate Advances comprising part of the same Borrowing shall be of the same duration; (c) whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Business Day, provided, however, that, if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the immediately preceding Business Day; and (d) whenever the first day of any Interest Period occurs on a day of an initial calendar month for which there is no numerically corresponding day in the calendar month that succeeds such initial calendar month by the number of months equal to the number of months in such Interest Period, such Interest Period shall end on the last Business Day of such succeeding calendar month. "Internal Revenue Code" means the Internal Revenue Code of 1986, as amended from time to time, and the regulations promulgated and rulings issued thereunder. "Inventory" has the meaning specified in the Security Agreement. "Investment" in any Person means any loan or advance to such Person, any purchase or other acquisition of any capital stock or other ownership or profit interest, warrants, rights, options, obligations or other securities of such Person, any capital contribution to such Person or any other investment in such Person, including, without -15- limitation, any arrangement pursuant to which the investor incurs Debt of the types referred to in clause (i) or (j) of the definition of "Debt" in respect of such Person. "Issuing Bank" means the Existing Issuing Bank and each Eligible Assignee that becomes an issuer of Letters of Credit hereunder pursuant to Section 8.07. "L/C Cash Collateral Account" has the meaning specified in the Security Agreement. "L/C Related Documents" has the meaning specified in Section 2.04(d)(ii)(A). "Lender Party" means any Lender, the Swing Line B ank or the Issuing Bank. "Lenders" means the Restatement Lenders and each Person that shall become a Lender hereunder pursuant to Section 8.07. "Letter of Credit Advance" means an advance made by the Issuing Bank or any Working Capital Lender pursuant to Section 2.03(c). "Letter of Credit Agreement" has the meaning specified in Section 2.03(a). "Letter of Credit Commitment" means, with respect to the Issuing Bank at any time, the amount set forth opposite the Issuing Bank's name on Schedule I hereto under the caption "Letter of Credit Commitment" or, if the Issuing Bank has entered into an Assignment and Acceptance, set forth for the Issuing Bank in the Register maintained by the Administrative Agent pursuant to Section 8.07(e) as the Issuing Bank's "Letter of Credit Commitment", as such amount may be reduced at or prior to such time pursuant to Section 2.05. "Letter of Credit Facility" means, at any time, an amount equal to the aggregate amount of the Issuing Bank's Letter of Credit Commitment at such time. "Letters of Credit" has the meaning specified in Section 2.01(d). "Leverage Ratio" means, with respect to any Person for any Rolling Period, the ratio of (a) Funded Debt of such Person and its Subsidiaries as of the last day for such Rolling Period to (b) Consolidated Adjusted EBITDA of such Person and its Subsidiaries for such Rolling Period. "Lien" means any lien, security interest or other charge or encumbrance of any kind, or any other type of preferential arrangement, including, without limitation, the lien or retained security title of a conditional vendor and any easement, right of way or other encumbrance on title to real property. "Loan Documents" means this Agreement, the Notes, the Holdings Guaranty, the Subsidiary Guaranty, the Holdings Pledge Agreement, the Collateral Documents, each -16- Letter of Credit Agreement and each other agreement evidencing the payment of obligations secured by the Collateral Documents. "Loan Parties" means the Parent Guarantor, the Borrower and each Subsidiary Guarantor. "Management Option Plan" means the 1994 Stock Option and Stock Award Plan of the Parent Guarantor as amended from time to time. "Margin Stock" has the meaning specified in Regulation U. "Material Adverse Change" means any material adverse change in the business, condition (financial or otherwise), operations, performance, properties or prospects of the Loan Parties and their Subsidiaries, taken as a whole. "Material Adverse Effect" means a material adverse effect on (a) the business, condition (financial or otherwise), operations, performance, properties or prospects of the Loan Parties and their Subsidiaries, taken as a whole, (b) the rights and remedies of the Administrative Agent or any Lender Party under any Loan Document or any Related Document or (c) the ability of any Loan Party to perform its Obligations under any Loan Document or any Related Document to which it is or is to be a party. "MDC" means McCown De Leeuw & Co. "MDC III" means McCown De Leeuw & Co. III, L.P., a California limited partnership. "MDC Asia" means McCown De Leeuw & Co. III (Asia), L.P., a Bermuda limited partnership. "MDC Europe" means McCown De Leeuw & Co. III (Europe), L.P., a Bermuda limited partnership. "MDC Investors" means the Gamma Fund LLC, MDC III, MDC Asia, MDC Europe and any other partnership with the same controlling general partner as any of the above. "MDC Management Agreement" means the Management Agreement dated December 29, 1994, as amended through the date hereof, between certain Affiliates of MDC and the Parent Guarantor as further amended from time to time (as permitted by Section 5.02(k)). "Monthly Rolling Period" means, with respect to any month, the consecutive 12-month period ending on the last day of such month. "Multiemployer Plan" of any Person means a multiemployer plan, as defined in Section 4001(a)(3) of ERISA, to which such Person or any of its ERISA Affiliates is -17- making or accruing an obligation to make contributions, or has within any of the preceding five plan years made or accrued an obligation to make contributions. "Multiple Employer Plan" of any Person means a single employer plan, as defined in Section 4001(a)(15) of ERISA, that (a) is maintained for employees of such Person or any of its ERISA Affiliates and at least one Person other than such Person and its ERISA Affiliates or (b) was so maintained and in respect of which such Person or any of its ERISA Affiliates could have liability under Section 4064 or 4069 of ERISA in the event such plan has been or were to be terminated. "Net Cash Proceeds" means, with respect to any sale, lease, transfer or other disposition of any asset or the incurrence or issuance of any Debt or capital stock or other ownership or profit interest, any securities convertible into or exchangeable for capital stock or other ownership or profit interest or any warrants, rights, options or other securities to acquire capital stock or other ownership or profit interest by any Person, or any Extraordinary Receipt received by or paid to or for the account of any Person, the aggregate amount of cash received from time to time (whether as initial consideration or through payment or disposition of deferred consideration) by or on behalf of such Person in connection with such transaction after deducting therefrom only (a) reasonable and customary registration fees, brokerage commissions, underwriting fees and discounts, legal fees, finder's fees and other similar fees and commissions, (b) the amount of taxes payable in connection with or as a result of such transaction and (c) any repayments by such Person of Debt to the extent such Debt is secured by a Lien on the property that is the subject of such sale, lease, transfer or other disposition, in each case to the extent, but only to the extent, that the amounts so deducted are, at the time of receipt of such cash, actually paid to a Person that is not an Affiliate of such Person or any Loan Party or any Affiliate of such Loan Party (other than MDC or an Affiliate of MDC to the extent that such fees are reasonable and customary for similar transactions for such sale, lease, transfer or other disposition) and are properly attributable to such transaction or to the asset that is the subject thereof. "Note" means a Term A Note, a Term B Note or a Working Capital Note. "Notice of Borrowing" has the meaning specified in Section 2.02(a). "Notice of Issuance" has the meaning specified in Section 2.03(a). "Notice of Swing Line Borrowing" has the meaning specified in Section 2.02(b). "NPL" means the National Priorities List under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended. "Obligation" means, with respect to any Person, any payment, performance or other obligation of such Person of any kind, including, without limitation, any liability of such Person on any claim, whether or not the right of any creditor to payment in respect of such claim is reduced to judgment, liquidated, unliquidated, fixed, contingent, -18- matured, disputed, undisputed, legal, equitable, secured or unsecured, and whether or not such claim is discharged, stayed or otherwise affected by any proceeding referred to in Section 6.01(f). Without limiting the generality of the foregoing, the Obligations of the Loan Parties under the Loan Documents include (a) the obligation to pay principal, interest, Letter of Credit commission, premiums, charges, expenses, fees, reasonable attorneys' fees and disbursements, indemnities and other amounts payable by any Loan Party under any Loan Document and (b) the obligation of any Loan Party to reimburse any amount in respect of any of the foregoing that any Lender Party, in its sole discretion, may elect to pay or advance on behalf of such Loan Party. "OECD" means the Organization for Economic Cooperation and Development. "Open Year" has the meaning specified in Section 4.01(y). "Other Taxes" has the meaning specified in Section 2.12(b). "Parent Guarantor" has the meaning specified in the recital of parties to this Agreement. "PBGC" means the Pension Benefit Guaranty Corporation, or any successor thereto. "Permitted Liens" means such of the following as to which no enforcement, collection, execution, levy or foreclosure proceeding shall have been commenced: (a) Liens for taxes, assessments and governmental charges or levies to the extent not required to be paid under Section 5.01(b) hereof; (b) Liens imposed by law, such as materialmen's, mechanics', carriers', workmen's and repairmen's Liens and other similar Liens arising in the ordinary course of business securing obligations that (i) are not overdue for a period of more than 30 days and (ii) either individually or when aggregated with all other Permitted Liens outstanding on any date of determination, do not materially affect the use or value of the property to which they relate; (c) pledges or deposits to secure obligations under workers' compensation laws or similar legislation or to secure public or statutory obligations; and (d) easements, rights of way and other encumbrances on title to real property that do not render title to the property encumbered thereby unmarketable or materially adversely affect the use of such property for its present purposes. "Person" means an individual, partnership, corporation (including a business trust), limited liability company, joint stock company, trust, unincorporated association, joint venture or other entity, or a government or any political subdivision or agency thereof. "Plan" means a Single Employer Plan or a Multiple Employer Plan. "Preferred Stock" means, with respect to any corporation, capital stock issued by such corporation that is entitled to a preference or priority over any other capital stock -19- issued by such corporation upon any distribution of such corporation's assets, whether by dividend or upon liquidation. "Prepayment Amount" has the meaning specified in Section 5.03(a)(ii). "Prepayment Date" has the meaning specified in Section 5.03(a)(ii). "Prepayment Notice" has the meaning specified in Section 5.03(a)(ii). "Pro Forma Adjustments" means (i) any adjustments certified by the chief financial officer of the Parent Guarantor, that would, in the reasonable determination of the Parent Guarantor satisfy the requirements of Rule 11-02(a) of Regulation S-X of the Securities Act of 1933, as amended as if included in a registration statement filed with the Securities and Exchange Commission and (ii) any other operating expense reductions reasonably expected to result from any acquisition of stock or assets of a Health Club Facility, if such expected reductions are (1) set forth in reasonable detail in a plan approved by and set forth in resolutions adopted by the Board of Directors of the Parent Guarantor, and (2) limited to operating expenses specified in such plan (and, if any reductions are set forth in a range, the lowest amount of such range) that would otherwise have resulted in the payment of cash within twelve months after the date of consummation of such transaction, net of any operating expenses (other than extraordinary items, non-recurring or temporary charges and other similar one-time expenses) reasonably expected to be incurred to implement such plan, and that are to be paid in cash during such twelve-month period, certified by the chief financial officer of the Parent Guarantor. "Pro Rata Share" of any amount means, with respect to any Working Capital Lender, Term A Lender, or Term B Lender at any time, the product of such amount times a fraction the numerator of which is the amount of such Working Capital Lender's Working Capital Commitment, Term A Lender's Term A Commitment, or Term B Lender's Term B Commitment, as the case may be, at such time and the denominator of which is the Working Capital Facility, the Term A Facility or the Term B Facility, respectively, at such time. "Quarterly Rolling Period" means, with respect to any Fiscal Quarter, the consecutive period of four Fiscal Quarters ending on the last day of such Fiscal Quarter. "Redeemable" means, with respect to any capital stock or other ownership or profit interest, Debt or other right or Obligation, any such capital stock, ownership interest, Debt, right or Obligation that (a) the issuer has undertaken to redeem at a fixed or determinable date or dates, whether by operation of a sinking fund or otherwise, or upon the occurrence of a condition not solely within the control of the issuer or (b) is redeemable at the option of the holder. "Register" has the meaning specified in Section 8.07(e). -20- "Regulation U" means Regulation U of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Related Documents" means the MDC Management Agreement, the Tax Sharing Agreement, the Holdings Notes, the Holdings Subordination Agreement, the FFHLP Subordinated Note, the FFHLP Subordination Agreement, the Earnout Notes, the Earnout I Subordination Agreement, the Earnout II Subordination Agreement, the Texas Note, the Texas Subordination Agreement, any Intercompany Subordination Agreement, any Seller Debt Document and any Seller Subordination Agreement. "Related Fund" means, with respect to any Lender that is a fund that invests in loans, any other fund that invests in loans and is managed by the same investment advisor as such Lender or by an Affiliate of such investment advisor. "Required Lenders" means Lenders at any time owed or holding at least 51 % of the sum of (a) the aggregate principal amount of the Advances outstanding at such time, (b) the aggregate Available Amount of all Letters of Credit outstanding at such time, (c) the aggregate unused Commitments under the Term A Facilities and Term B Facilities at such time and (d) the aggregate Unused Working Capital Commitments at such time. For purposes of this definition, the aggregate principal amount of the Swing Line Advances owing to the Swing Line Bank and of Letter of Credit Advances owing to the Issuing Bank and the Available Amount of each Letter of Credit shall be considered to be owed to the Working Capital Lenders ratably in accordance with their respective Working Capital Commitments. "Restatement Lenders" has the meaning specified in the recital of parties to this Agreement. "Restricted Capex_Period" means the consecutive 12-month period commencing (A) the date immediately following the end of the last day of the later of any two Quarterly Rolling Periods ending in any single 12-month period prior to January 1, 2001 during which the Leverage Ratio exceeds the level specified in Section 5.02(e)(v)(A), or (B) January 1, 2001. For the purposes of clause (A), such Restricted Capex Period shall end on the date immediately following the end of the last day of the later of any two consecutive Quarterly Rolling Periods during which the Leverage Ratio is equal to or less than the level specified in Section 5.02(e)(v)(A). Notwithstanding anything to the contrary contained in this definition, a new Restricted Capex Period shall commence on the date immediately following the end of the last day of the most recently ended Restricted Capex Period (in the case of clause (A), a new Restricted Capex Period will occur if the Leverage Ratio shall exceed the level specified in Section 5.02(e)(v)(A) during either one of the last two Quarterly Rolling Periods of such recently ended Restricted Capex Period). "Rolling Period" means a Monthly Rolling Period or a Quarterly Rolling Period, as the case may be. -21- "Secured Obligations" has the meaning specified in the Security Agreement. "Secured Parties" means the Agents, the Lender Parties, the Hedge Banks and the other Persons the Obligations owing to which are or are purported to be secured by the Collateral under the terms of the Collateral Documents. "Security Agreement" has the meaning set forth in Section 3.01(f)(viii). "Seller Debt" means Debt permitted under Section 5.02(b)(i)(B). "Seller Debt Documents" means any agreement, instrument or other document evidencing Seller Debt. "Seller Subordination Agreement" has the meaning specified in Section 5.02(b)(i)(B). "Single Employer Plan" of any Person means a single employer plan, as defined in Section 4001(a)(15) of ERISA, that (a) is maintained for employees of such Person or any of its ERISA Affiliates and no Person other than such Person and its ERISA Affiliates or (b) was so maintained and in respect of which such Person or any of its ERISA Affiliates could have liability under Section 4069 of ERISA in the event such plan has been or were to be terminated. "Solvent" and "Solvency" mean, with respect to any Person on a particular date, that on such date (a) the fair value of the property of such Person is greater than the total amount of liabilities, including, without limitation, contingent liabilities, of such Person, (b) the present fair salable value of the assets of such Person is not less than the amount that will be required to pay the probable liability of such Person on its debts as they become absolute and matured, (c) such Person does not intend to, and does not believe that it will, incur debts or liabilities beyond such Person's ability to pay such debts and liabilities as they mature and (d) such Person is not engaged in business or a transaction, and is not about to engage in business or a transaction, for which such Person's property would constitute an unreasonably small capital. The amount of contingent liabilities at any time shall be computed as the amount that, in the light of all the facts and circumstances existing at such time, represents the amount that can reasonably be expected to become an actual or matured liability. "Standby Letter of Credit" means any Letter of Credit issued under the Letter of Credit Facility, other than a Trade Letter of Credit. "Subordinated Debt" means the Earnout Notes, the FFHLP Subordinated Notes, and the Texas Note. "Subsidiary" of any Person means any corporation, partnership, joint venture, limited liability company, trust or estate of which (or in which) 50% or more of (a) the issued and outstanding capital stock having ordinary voting power to elect a majority of -22- the Board of Directors of such corporation (irrespective of whether at the time capital stock of any other class or classes of such corporation shall or might have voting power upon the occurrence of any contingency), (b) the interest in the capital or profits of such limited liability company, partnership or joint venture or (c) the beneficial interest in such trust or estate, is at the time directly or indirectly owned or controlled by such Person, by such Person and one or more of its other Subsidiaries, or by one or more of such Person's other Subsidiaries; provided, however, that for the purposes of this Agreement, all references to "Subsidiary" or "Subsidiaries" shall exclude a Foreign Subsidiary or Foreign Subsidiaries, as the case may be, unless otherwise specifically noted. "Subsidiary Guarantor" means any Subsidiary of the Borrower that shall have executed and delivered a Subsidiary Guaranty pursuant to Sections 5.01(m) or 5.01(o). "Subsidiary Guaranty" has the meaning specified in Section 5.01(o). "Surviving Debt" has the meaning specified in Section 3.01(d). "Swing Line Advance" means an advance made by (a) the Swing Line Bank pursuant to Section 2.01(e) or (b) any Working Capital Lender pursuant to Section 2.02(b). "Swing Line Bank" has the meaning set forth in the recital of parties to this Agreement. "Swing Line Borrowing" means a borrowing consisting of a Swing Line Advance made by the Swing Line Bank. "Swing Line Facility" has the meaning specified in Section 2.01(e). "Syndication Agent" has the meaning set forth in the recital of parties to this Agreement. "Tax Sharing Agreement" means the Tax Sharing Agreement dated as of December 29, 1994 among the Borrower, the Parent Guarantor and NorCal FIT Corp., a California corporation, as amended, supplemented or otherwise modified from time to time in accordance with its terms, to the extent permitted in accordance with the Loan Documents. "Taxes" has the meaning specified in Section 2.12(a). "Term A Advance" has the meaning specified in Section 2.01(a). "Term A Borrowing" means a borrowing consisting of simultaneous Term A Advances of the same Type made by the Term A Lenders. "Term A Commitment" means, with respect to any Term A Lender at any time, the amount set forth opposite such Term A Lender's name on Schedule I hereto under the -23- caption "Term A Commitment" or, if such Term A Lender has entered into one or more Assignments and Acceptances, the aggregate amount set forth for such Term A Lender in the Register maintained by the Administrative Agent pursuant to Section 8.07(e) as such Term A Lender's "Term A Commitment", as such amount may be reduced at or prior to such time pursuant to Section 2.05. "Term A Facility" means, at any time, the aggregate amount of the Term A Lenders' Term A Commitments at such time. "Term A Lender" means any Lender that has a Term A Commitment. "Term A Notes" means promissory notes of the Borrower payable to the order of any Lender, in substantially the form of Exhibit A- I hereto, evidencing the indebtedness of the Borrower to such Lender resulting from the Term A Advance made by such Lender. "Term Advance" means a Term A Advance or a Term B Advance. "Term B Advance" has the meaning specified in Section 2.01(b). "Term B Borrowing" means a borrowing consisting of simultaneous Term B Advances of the same Type made by the Term B Lenders. "Term B Commitment" means, with respect to any Term B Lender at any time, the amount set forth opposite such Term B Lender's name on Schedule I hereto under the caption "Term B Commitment" or, if such Term B Lender has entered into one or more Assignments and Acceptances, the aggregate amount set forth for such Term B Lender in the Register maintained by the Administrative Agent pursuant to Section 8.07(e) as such Term B Lender's "Term B Commitment", as such amount may be reduced at or prior to such time pursuant to Section 2.05. "Term B Facility" means, at any time, the aggregate amount of the Term B Lenders' Term B Commitments at such time. "Term B Lender" means any Lender that has a Term B Commitment. "Term B Notes" means promissory notes of the Borrower payable to the order of any Lender, in substantially the form of Exhibit A-2 hereto, evidencing the indebtedness of the Borrower to such Lender resulting from the Term B Advance made by such Lender. "Termination Date" means the earlier of (a) December 31, 2002 and (b) the date of termination in whole of the Term A Commitments, the Term B Commitments, the Letter of Credit Commitments and the Working Capital Commitments pursuant to Section 2.05 or 6.01. -24- "Texas Note" means the 9% promissory note of the Borrower dated October 24, 1996 in favor of Landhigh Investments, Inc. in the principal amount of $4,600,000 maturing on September 30, 2001. "Texas Subordination Agreement" has the meaning specified in Section 3.01(f)(xi). "Third Restatement Date" has the meaning specified in Section 3.01. "Trade Letter of Credit" means any Letter of Credit that is issued under the Letter of Credit Facility for the benefit of a supplier of Inventory to the Borrower or any of its Subsidiaries to effect payment for such Inventory, the conditions to drawing under which include the presentation to the Issuing Bank of negotiable bills of lading, invoices and related documents sufficient, in the judgment of the Issuing Bank, to create a valid and perfected lien or security interest on such Inventory. "Trademark, Copyright and Patent Security Agreement" has the meaning specified in Section 5.01(m). "Type" refers to the distinction between Advances bearing interest at the Base Rate and Advances bearing interest at the Eurodollar Rate. "Unused Working Capital Commitment" means, with respect to any Working Capital Lender at any time, (a) such Lender's Working Capital Commitment at such time less (b) the sum of (i) the aggregate principal amount of all Working Capital Advances, Swing Line Advances and all Letter of Credit Advances made by such Lender and outstanding at such time and (ii) such Lender's Pro Rata Share of (A) the aggregate Available Amount of all Letters of Credit outstanding at such time, (B) to the extent not included in clause (b)(i) of this definition, the aggregate principal amount of all Letter of Credit Advances made by the Issuing Bank pursuant to Section 2.03(c) and outstanding at such time and (C) to the extent not included in clause (b)(1) of this definition, the aggregate principal amount of all Swing Line Advances made by the Swing Line Bank pursuant to Section 2.02(b) and outstanding at such time. "U.S. Subsidiary" means any Subsidiary of the Borrower organized under the laws of any State of the United States and that has substantially all of its assets located in the United States. "Voting Stock" means capital stock issued by a corporation, or equivalent interests in any other Person, the holders of which are ordinarily, in the absence of contingencies, entitled to vote for the election of directors (or persons performing similar functions) of such Person, if the right so to vote has been suspended by the happening of such a contingency. -25- "Welfare Plan" means a welfare plan as defined in Section 3(l) of ERISA, that is maintained for employees of any Loan Party or in respect of which any Loan Party could have a liability. "Withdrawal Liability" has the meaning specified in Part I of Subtitle E of Title IV of ERISA. "Working Capital Advance" has the meaning specified in Section 2.01(c). "Working Capital Borrowing" means a borrowing consisting of simultaneous Working Capital Advances of the same Type made by the Working Capital Lenders. "Working Capital Commitment" means, with respect to any Working Capital Lender at any time, the amount set forth opposite such Lender's name on Schedule I hereto under the caption "Working Capital Commitment" or, if such Lender has entered into one or more Assignment and Acceptances, set forth for such Lender in the Register maintained by the Administrative Agent pursuant to Section 8.07(e) as such Lender's "Working Capital Commitment", as such amount may be reduced at or prior to such time pursuant to Section 2.05. "Working Capital Facility" means, at any time, the aggregate amount of the Working Capital Lenders' Working Capital Commitments at such time. "Working Capital Lender" means any Lender that has a Working Capital Commitment. "Working Capital Note" means a promissory note of the Borrower payable to the order of any Working Capital Lender, in substantially the form of Exhibit A-3 hereto, evidencing the aggregate indebtedness of the Borrower to such Lender resulting from the Working Capital Advances made by such Lender. SECTION 1.02. Computation Of Time Periods. In this Agreement in the computation of periods of time from a specified date to a later specified date, the word "from" means "from and including" and the words "to" and "until" each mean "to but excluding". SECTION 1.03. Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with generally accepted accounting principles consistent with those applied in the preparation of the financial statements referred to in Section 4.01(f) ("GAAP"). ARTICLE II AMOUNTS AND TERMS OF THE ADVANCES AND THE LETTERS OF CREDIT SECTION 2.01. The Advances. (a) The Term A Advances. Each Term A Lender severally agrees, on the terms and conditions hereinafter set forth, to make a single -26- advance (a "Term A Advance") to the Borrower on any Business Day during the period from the date hereof until December 31, 1997 in an amount not to exceed such Lender's Term A Conunitment at such time. The Term A Borrowing shall consist of Term A Advances made simultaneously by the Term A Lenders ratably according to their Term A Commitments. Amounts borrowed under this Section 2.01(a) and repaid or prepaid may not be reborrowed. (b) The Term B Advances. Each Term B Lender severally agrees, on the terms and conditions hereinafter set forth, to purchase and assume on the Third Restatement Date an undivided interest in the "Term Advances" and "Term Commitments" (as such terms are defined in the Existing Credit Agreement) of the Existing Lenders under the Existing Credit Agreement as set forth on Schedule I to the Assignment Agreement in an amount equal to such Restatement Lender's ratable share thereof as set forth in such Schedule 1. Such purchase shall be made by such payment, on such notice, and otherwise on such terms, as are provided under this Agreement and the Assignment Agreement as though such purchase were a Borrowing hereunder. The "Term Advances" under the Existing Credit Agreement, together with all accrued interest and fees on each such "Advance", so purchased shall be redesignated Term B Advances hereunder. In furtherance of the foregoing, each Restatement Lender hereby authorizes and directs the Administrative Agent to accept the Assignment Agreement on behalf of such Restatement Lender. In addition to the "Term Advances" purchased by the Restatement Lenders pursuant to this Section 2.01(b), each Term B Lender severally agrees, on the terms and conditions hereinafter set forth, to make a single advance (a "Term B Advance") to the Borrower on the Third Restatement Date in an amount equal to the amount by which such Term B Lender's Term B Commitment exceeds the "Term Advances" purchased by such Term B Lender pursuant to this Section 2.01(b) on the Third Restatement Date. The Term B Borrowing shall consist of Term B Advances made simultaneously by the Term B Lenders ratably according to their Term B Commitments. Amounts borrowed under this Section 2.01(b) and repaid or prepaid may not be reborrowed. (c) The Working Capital Advances. Each Working Capital Lender severally agrees, on the terms and conditions hereinafter set forth, to purchase and assume on the Third Restatement Date an undivided interest in the Working Capital Advances and Working Capital Commitments (as such terms are defined in the Existing Credit Agreement) of the Existing Lenders under the Existing Credit Agreement as set forth on Schedule I to the Assignment Agreement in an amount equal to such Restatement Lender's ratable share thereof as set forth in such Schedule I. Such purchase shall be made by such payment, on such notice, and otherwise on such terms, as are provided under this Agreement and the Assignment Agreement as though such purchase were a Borrowing hereunder. The "Working Capital Advances" under the Existing Credit Agreement, together with all accrued interest and fees on each such "Advance", so purchased shall be redesignated Working Capital Advances hereunder. In furtherance of the foregoing, each Restatement Lender hereby authorizes and directs the Administrative Agent to accept the Assignment Agreement on behalf of such Restatement Lender. In addition to the "Working Capital Advances" purchased by the Restatement Lenders pursuant to this Section 2.01(c), each Working Capital Lender severally agrees, on the terms and conditions hereinafter set forth, to make advances (each, a "Working Capital Advance") to the Borrower from time to time on any Business Day during the period from the Third Restatement Date until the -27- Termination Date in an amount for each such Advance not to exceed such Lender's Unused Working Capital Commitment on such Business Day. Each Working Capital Borrowing shall be in an aggregate amount of $2,000,000 or an integral multiple of $100,000 in excess thereof and shall consist of Working Capital Advances made simultaneously by the Working Capital Lenders ratably according to their Working Capital Commitments. Within the limits of each Working Capital Lender's Unused Working Capital Commitment in effect from time to time, the Borrower may borrow under this Section 2.01(c), prepay pursuant to Section 2.06(a) and reborrow under this Section 2.01(c). (d) Letters of Credit. Pursuant to the Existing Credit Agreement, the Existing Issuing Bank has issued Letters of Credit (such Letters of Credit as are outstanding on the Third Restatement Date under the Existing Credit Agreement and set forth on Schedule III being the "Existing Letters of Credit") for the account of the Borrower. Effective as of the Third Restatement Date, each Existing Letter of Credit shall be deemed to be a Letter of Credit under this Agreement and each Existing Lender will be deemed to have sold and transferred an undivided interest and participation in respect of the Existing Letters of Credit and each Working Capital Lender will be deemed to have purchased and received, without further action on the part of any party, an undivided interest and participation in such Existing Letters of Credit, based upon such Working Capital Lender's Pro Rata Share of its Working Capital Commitment under this Agreement. Any such interest and participation so purchased shall automatically become an undivided interest and participation in such Letter of Credit. In addition, the Borrower may request the Issuing Bank, on the terms and conditions hereinafter set forth, to issue, and the Issuing Bank may, if in its sole discretion it elects to do so, issue, additional letters of credit (the "Letters of Credit") for the account of the Borrower from time to time on any Business Day during the period from the Third Restatement Date until 60 days before the Termination Date (i) providing that the aggregate Available Amount under all outstanding Letters of Credit shall not exceed $5,000,000 at any one time and (ii) in an Available Amount for each such Letter of Credit not to exceed the lesser of (x) the Letter of Credit Facility at such time and (y) the Unused Working Capital Commitments of the Working Capital Lenders at such time. No Letter of Credit shall have an expiration date (including all rights of the Borrower or the beneficiary to require renewal) later than the earlier of 60 days before the Termination Date and (A) in the case of a Standby Letter of Credit, one year after the date of issuance thereof, but may by its terms be renewable annually with the consent of the Issuing Bank and the Administrative Agent, and (B) in the case of a Trade Letter of Credit, 60 days after the date of issuance thereof. So long as the Issuing Bank, in its sole discretion, elects to issue Letters of Credit, the Borrower may request the issuance of Letters of Credit under this Section 2.01(d), repay any Letter of Credit Advances resulting from drawings thereunder pursuant to Section 2.03(c) and request the issuance of additional Letters of Credit under this Section 2.01(d). (e) The Swing Line Advances. The Borrower may request the Swing Line Bank to make, and the Swing Line Bank may, if in its sole discretion it elects to do so, make, on the terms and conditions hereinafter set forth, SwingLine Advances to the Borrower from time to time on any Business Day during the period from the Third Restatement Date until the Termination Date (i) in an aggregate amount not to exceed at any time outstanding $3,000,000 (the "Swing Line Facility") and (ii) in an amount for each such Swing Line Borrowing not to -28- exceed the aggregate of the Unused Working Capital Commitments of the Working Capital Lenders at such time. No Swing Line Advance shall be used for the purpose of funding the payment of principal of any other Swing Line Advance. Each Swing Line Borrowing shall be in an amount of $250,000 or an integral multiple of $100,000 in excess thereof and shall be made as a Base Rate Advance. Within the limits of the Swing Line Facility and within the limits referred to in clause (ii) above, so long as the Swing Line Bank, in its sole discretion, elects to make Swing Line Advances, the Borrower may borrow under this Section 2.01(e), repay pursuant to Section 2.04(c) or prepay pursuant to Section 2.06(a) and reborrow under this Section 2.01(e). SECTION 2.02. Making the Advances. (a) Except as otherwise provided in Section 2.02(b) or 2.03, each Borrowing shall be made on notice, given not later than 1:00 P.M. (New York City time) on the third Business Day prior to the date of the proposed Borrowing in the case of a Borrowing consisting of Eurodollar Rate Advances or on the first Business Day prior to the date of the proposed Borrowing in the case of a Borrowing consisting of Base Rate Advances, by the Borrower to the Administrative Agent, which shall give to each Appropriate Lender prompt notice thereof. Each such notice of a Borrowing (a "Notice of Borrowing") shall be in substantially the form of Exhibit B hereto, specifying therein the requested (i) date of such Borrowing, (ii) Facility under which such Borrowing is to be made, (iii) Type of Advances comprising such Borrowing, (iv) aggregate amount of such Borrowing and (v) in the case of a Borrowing consisting of Eurodollar Rate Advances, initial Interest Period for each such Advance. Each Appropriate Lender shall, before 1:00 P.M. (New York City time) on the date of such Borrowing, make available for the account of its Applicable Lending Office to the Administrative Agent at the Administrative Agent's Account, in same day funds, such Lender's ratable portion of such Borrowing in accordance with the respective Commitments under the applicable Facility of such Lender and the other Appropriate Lenders. After the Administrative Agent's receipt of such funds and upon fulfillment of the applicable conditions set forth in Article III, the Administrative Agent will make such finds available to the Borrower by crediting the Borrower's Account; provided, however, that, in the case of any Working Capital Borrowing, the Administrative Agent shall first make a portion of such funds equal to the aggregate principal amount of any Swing Line Advances made by the Swing Line Bank and Letter of Credit Advances made by the Issuing Bank and by any other Working Capital Lender and outstanding on the date of such Working Capital Borrowing, plus interest accrued and unpaid thereon to and as of such date, available to the Swing Line Bank or the Issuing Bank, as the case may be, and such other Working Capital Lenders for repayment of such Swing Line Advances and Letter of Credit Advances. (b) Each Swing Line Borrowing shall be made on notice, given not later than 1:00 P.M. (New York City time) on the date of the proposed Swing Line Borrowing, by the Borrower to the Swing Line Bank and the Administrative Agent. Each such notice of a Swing Line Borrowing (a "Notice of Swing Line Borrowing") shall be in writing in substantially the form of Exhibit B hereto, specifying therein the requested (i) date of such Borrowing, (ii) amount of such Borrowing and (iii) maturity of such Borrowing (which maturity shall be no later than the seventh day after the requested date of such Borrowing). If, in its sole discretion, it elects to make the requested Swing Line Advance, the Swing Line Bank will make the amount thereof available to the Administrative Agent at the Administrative Agent's Account, in same day funds. -29- After the Administrative Agent's receipt of such funds and upon fulfillment of the applicable conditions set forth in Article III, the Administrative Agent will make such funds available to the Borrower by crediting the Borrower's Account. Upon written demand by the Swing Line Bank with an outstanding Swing Line Advance, with a copy of such demand to the Administrative Agent, each other Working Capital Lender shall purchase from the Swing Line Bank, and the Swing Line Bank shall sell and assign to each such other Working Capital Lender, such other Lender's Pro Rata Share of such outstanding Swing Line Advance as of the date of such demand, by making available for the account of its Applicable Lending Office to the Administrative Agent for the account of the Swing Line Bank, by deposit to the Administrative Agent's Account, in same day finds, an amount equal to the portion of the outstanding principal amount of the Swing Line Advance to be purchased by such Lender. The Borrower hereby agrees to each such sale and assignment. Each Working Capital Lender agrees to purchase its Pro Rata Share of an outstanding Swing Line Advance on (i) the Business Day on which demand therefor is made by the Swing Line Bank that made such Advance, provided that notice of such demand is given not later than 1:00 P.M. (New York City time) on such Business Day or (ii) the first Business Day next succeeding such demand if notice of such demand is given after such time. Upon any such assignment by the Swing Line Bank to any other Working Capital Lender of a portion of a Swing Line Advance, the Swing Line Bank represents and warrants to such other Lender that the Swing Line Bank is the legal and beneficial owner of such interest being assigned by it, but makes no other representation or warranty and assumes no responsibility with respect to such Swing Line Advance, the Loan Documents or any Loan Party. If and to the extent that any Working Capital Lender shall not have so made the amount of such Swing Line Advance available to the Administrative Agent, such Working Capital Lender agrees to pay to the Administrative Agent forthwith on demand such amount together with interest thereon, for each day from the date of demand by the Swing Line Bank until the date such amount is paid to the Administrative Agent, at the Federal Funds Rate. If such Lender shall pay to the Administrative Agent such amount for the account of the Swing Line Bank on any Business Day, such amount so paid in respect of principal shall constitute a Swing Line Advance made by such Lender on such Business Day for purposes of this Agreement, and the outstanding principal amount of the Swing Line Advance made by the Swing Line Bank shall be reduced by such amount on such Business Day. (c) Anything in subsection (a) above to the contrary notwithstanding, (i) the Borrower may not select Eurodollar Rate Advances for (x) the period from the Third Restatement Date to the earlier of (A) 90 days from such date and (B) the completion of syndication of the Facilities (as shall be specified by the Administrative Agent in a written notice to the Borrower) or (y) for any Borrowing if the aggregate amount of such Borrowing is less than $2,000,000 or (z) if the obligation of the Appropriate Lenders to make Eurodollar Rate Advances shall then be suspended pursuant to Section 2.09 or Section 2.10 and (ii) with respect to Borrowings consisting of Eurodollar Rate Advances, the Term A Advance, the Term B Advance and the Working Capital Advances may not be outstanding as part of more than eight separate Borrowings. (d) Each Notice of Borrowing and Notice of Swing Line Borrowing shall be irrevocable and binding on the Borrower. In the case of any Borrowing that the related Notice of -30- Borrowing specifies is to be comprised of Eurodollar Rate Advances, the Borrower shall indemnify each Appropriate Lender against any loss, cost or expense incurred by such Lender as a result of any failure to fulfill on or before the date specified in such Notice of Borrowing the applicable conditions set forth in Article III, including, without limitation, any loss (including loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund the Advance to be made by such Lender as part of such Borrowing when such Advance, as a result of such failure, is not made on such date. (e) Unless the Administrative Agent shall have received notice from an Appropriate Lender prior to the date of any Borrowing under a Facility under which such Lender has a Commitment that such Lender will not make available to the Administrative Agent such Lender's ratable portion of such Borrowing, the Administrative Agent may assume that such Lender has made such portion available to the Administrative Agent on the date of such Borrowing in accordance with Section 2.02(a) or (b) and the Administrative Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If and to the extent that such Lender shall not have so made such ratable portion available to the Administrative Agent, such Lender and the Borrower severally agree to repay or pay to the Administrative Agent forthwith on demand such corresponding amount and to pay interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid or paid to the Administrative Agent, at (i) in the case of the Borrower, the interest rate applicable at such time under Section 2.07 to Advances comprising such Borrowing and (ii) in the case of such Lender, the Federal Funds Rate. If such Lender shall pay to the Administrative Agent such corresponding amount, such amount so paid in respect of principal shall constitute such Lender's Advance as part of such Borrowing for all purposes. (f) The failure of any Lender to make the Advance to be made by it as part of any Borrowing shall not relieve any other Lender of its obligation, if any, hereunder to make its Advance on the date of such Borrowing, but no Lender shall be responsible for the failure of any other Lender to make the Advance to be made by such other Lender on the date of any Borrowing. SECTION 2.03. Issuance of and Drawings and Reimbursement Under Letters of Credit. (a) Request for Issuance. Each Letter of Credit shall be issued upon notice, given not later than 1:00 P.M. (New York City time) on the fifth Business Day prior to the date of the proposed issuance of such Letter of Credit, by the Borrower to the Issuing Bank, which shall give to the Administrative Agent prompt notice thereof. Each such notice of issuance of a Letter of Credit (a "Notice of Issuance") shall specify therein the requested (i) date of such issuance (which shall be a Business Day), (ii) Available Amount of such Letter of Credit, (iii) expiration date of such Letter of Credit, (iv) name and address of the beneficiary of such Letter of Credit and (v) form of such Letter of Credit, and shall be accompanied by such application and agreement for a letter of credit as the Issuing Bank may specify to the Borrower for use in connection with such requested Letter of Credit (a "Letter of Credit Agreement"). If (A) the requested form of such Letter of Credit is acceptable to the Issuing Bank in its sole discretion and it has not received notice of objection to such issuance from Lenders holding at least 60% of the -31- Working Capital Commitments and (B) in its sole discretion, the Issuing Bank elects to issue the requested Letter of Credit, the Issuing Bank will, upon fulfillment of the applicable conditions set forth in Article III, make such Letter of Credit available to the Borrower at its office referred to in Section 8.02 or as otherwise agreed with the Borrower in connection with such issuance. In the event and to the extent that the provisions of any Letter of Credit Agreement shall conflict with this Agreement, the provisions of this Agreement shall govern. (b) Letter of Credit Reports. The Issuing Bank shall furnish (i) to the Administrative Agent on the first Business Day of each week a written report summarizing issuance and expiration dates of Letters of Credit issued during the previous week and drawings during such week under all Letters of Credit, (ii) to each Working Capital Lender on the first Business Day of each calendar quarter a written report summarizing issuance and expiration dates of Letters of Credit issued during the preceding calendar quarter and drawings during such calendar quarter under all Letters of Credit and (iii) to the Administrative Agent and each Working Capital Lender on the first Business Day of each calendar quarter a written report setting forth the average daily aggregate Available Amount during the preceding calendar quarter of all Letters of Credit. (c) Drawing and Reimbursement. The payment by the Issuing Bank of a draft drawn under any Letter of Credit shall constitute for all purposes of this Agreement the making by the Issuing Bank of a Letter of Credit Advance, which shall be a Base Rate Advance, in the amount of such draft. In the event of any drawing under a Letter of Credit, the Issuing Bank shall promptly notify the Administrative Agent, and the Administrative Agent shall promptly notify each Working Capital Lender, and each Working Capital Lender shall purchase from the Issuing Bank, and the Issuing Bank shall sell and assign to each such Working Capital Lender, such Lender's Pro Rata Share of such outstanding Letter of Credit Advance as of the date of such purchase, by making available for the account of its Applicable Lending Office to the Administrative Agent for the account of the Issuing Bank, by deposit to the Administrative Agent's Account, in same day funds, an amount equal to the portion of the outstanding principal amount of such Letter of Credit Advance to be purchased by such Lender. Promptly after receipt thereof, the Administrative Agent shall transfer such funds to the Issuing Bank. The Borrower hereby agrees to each such sale and assignment. Each Working Capital Lender agrees to purchase its Pro Rata Share of an outstanding Letter of Credit Advance on (i) the Business Day on which notice of the drawing under the related Letter of Credit is given by the Issuing Bank, provided such notice is given not later than 1:00 P.M. (New York City time) on such Business Day or (ii) the first Business Day next succeeding such demand if such notice is given after such time. Upon any such assignment by the Issuing Bank to any Working Capital Lender of a portion of a Letter of Credit Advance, the Issuing Bank represents and warrants to such Lender that the Issuing Bank is the legal and beneficial owner of such interest being assigned by it, free and clear of any liens, but makes no other representation or warranty and assumes no responsibility with respect to such Letter of Credit Advance, the Loan Documents or any Loan Party. If and to the extent that any Working Capital Lender shall not have so made the amount of such Letter of Credit Advance available to the Administrative Agent, such Working Capital Lender agrees to pay to the Administrative Agent forthwith on demand such amount together with interest thereon, for each day from the date of demand by the Issuing Bank until the date -32- such amount is paid to the Administrative Agent, at the Federal Funds Rate for its account or the account of the Issuing Bank, as applicable. If such Lender shall pay to the Administrative Agent such amount for the account of the Issuing Bank on any Business Day, such amount so paid in respect of principal shall constitute a Letter of Credit Advance made by such Lender on such Business Day for purposes of this Agreement, and the outstanding principal amount of the Letter of Credit Advance made by the Issuing Bank shall be reduced by such amount on such Business Day. (d) Failure to Make Letter of Credit Advances. The failure of any Lender to make the Letter of Credit Advance to be made by it on the date specified in Section 2.03(c) shall not relieve any other Lender of its obligation hereunder to make its Letter of Credit Advance on such date, but no Lender shall be responsible for the failure of any other Lender to make the Letter of Credit Advance to be made by such other Lender on such date. SECTION 2.04. Repayment of Advances. (a) Term Advances. The Borrower shall repay to the Administrative Agent for the ratable account of the Term A Lenders and the Term B Lenders the aggregate outstanding principal amount of the Term A Advances and the Term B Advances, respectively, on the following dates in the amounts indicated (which amounts shall otherwise be reduced as a result of the application of prepayments in accordance with the order of priority set forth in Section 2.06): Term B Date Term A Facility Facility ---- --------------- -------- March 31, 1999 $2,500,000 ______ June 30, 1999 $2,500,000 ______ September 30, 1999 $2,500,000 ______ December 31, 1999 $2,500,000 ______ March 31, 2000 $3,000,000 $312,500 June 30, 2000 $3,000,000 $312,500 September 30, 2000 $3,000,000 $312,500 December 31, 2000 $3,000,000 $312,500 March 31, 2001 $3,000,000 $312,500 June 30, 2001 $3,000,000 $312,500 September 30, 2001 $3,000,000 $312,500 December 31, 2001 $3,000,000 $312,500 March 31, 2002 $4,000,000 $312,500 June 30, 2002 $4,000,000 $312,500 September 30, 2002 $4,000,000 $312,500 December 31, 2002 $4,000,000 $312,500 March 31, 2003 ______ $312,500 -33- June 30, 2003 ______ $312,500 September 30, 2003 ______ $312,500 December 31, 2003 ______ $312,500 March 31, 2004 ______ $312,500 June 30, 2004 ______ $312,500 September 30, 2004 ______ $312,500 December 31, 2004 ______ $119,062,500 provided, however, that the final principal repayment installment of the Term A Facility and the Term B Facility, respectively, shall be, in any event and in each case, in an amount equal to the aggregate outstanding principal amount of the Term A Advances and the Term B Advances, respectively, then outstanding. (b) Working Capital Advances. The Borrower shall repay to the Administrative Agent for the ratable account of the Working Capital Lenders on the Termination Date the aggregate outstanding principal amount of the Working Capital Advances then outstanding. (c) Swing Line Advances. The Borrower shall repay to the Administrative Agent for the account of the Swing Line Bank and each other Working Capital Lender that has made a Swing Line Advance the outstanding principal amount of each Swing Line Advance made by each of them on the earlier of the maturity date specified in the applicable Notice of Swing Line Borrowing (which maturity shall be no later than the seventh day after the requested date of such Borrowing) and the Termination Date. (d) Letter of Credit Advances. (i) The Borrower shall repay to the Administrative Agent for the account of the Issuing Bank and each other Working Capital Lender that has made a Letter of Credit Advance on the earlier of the Termination Date and one Business Day after demand the outstanding principal amount of each Letter of Credit Advance made by each of them. (ii) The Obligations of the Borrower under this Agreement, any Letter of Credit Agreement and any other agreement or instrument relating to any Letter of Credit shall be unconditional and irrevocable, and shall be paid strictly in accordance with the terms of this Agreement, such Letter of Credit Agreement and such other agreement or instrument under all circumstances, including, without limitation, the following circumstances: (A) any lack of validity or enforceability of any Loan Document, any Letter of Credit Agreement, any Letter of Credit or any other agreement or instrument relating thereto (this Agreement and all of the other foregoing being, collectively, the "L/C Related Documents"); -34- (B) any change in the time, manner or place of payment of, or in any other term of, all or any of the Obligations of the Borrower in respect of any L/C Related Document or any other amendment or waiver of or any consent to departure from all or any of the L/C Related Documents; (C) the existence of any claim, setoff, defense or other right that the Borrower may have at any time against any beneficiary or any transferee of a Letter of Credit (or any Persons for whom any such beneficiary or any such transferee may be acting), the Issuing Bank or any other Person, whether in connection with the transactions contemplated by the L/C Related Documents or any unrelated transaction; (D) any statement or any other document presented under a Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (E) payment by the Issuing Bank under a Letter of Credit against presentation of a draft or certificate that does not strictly comply with the terms of such Letter of Credit; (F) any exchange, release or nonperfection of any Collateral or other collateral, or any release or amendment or waiver of or consent to departure from the Holdings Guaranty or any other guaranty, for all or any of the Obligations of the Borrower in respect of the L/C Related Documents; or (G) any other circumstance or happening whatsoever, whether or not similar to any of the foregoing, including, without limitation, any other circumstance that might otherwise constitute a defense available to, or a discharge of, the Borrower or a guarantor. SECTION 2.05. Termination or Reduction of the Commitments. (a) Optional. The Borrower may, upon at least three Business Days' notice to the Administrative Agent, terminate in whole or reduce in part the unused portions of the Term A Commitments, the Term B Commitments and the Unused Working Capital Commitments; provided, however, that each partial reduction of a Facility (i) shall be in an aggregate amount of $1,000,000 or an integral multiple of $100,000 in excess thereof and (ii) shall be made ratably among the Appropriate Lenders in accordance with their Commitments with respect to such Facility. (b) Mandatory. The Working Capital Facility shall be automatically and permanently reduced on the date on which any prepayment is required to be made pursuant to Section 2.06(b)(i) by the amount of such prepayment. SECTION 2.06 Prepayments. (a) Optional. The Borrower may, upon at least one Business Day's notice in the case of Base Rate Advances and three Business Days' notice in the case of Eurodollar Rate Advances, in each case to the Administrative Agent stating the proposed date and aggregate principal amount of the prepayment, and if such notice is given the Borrower shall, prepay the outstanding principal amount of the Advances comprising part of the same Borrowing in whole or ratably in part pursuant to such notice, together with accrued -35- interest to the date of such prepayment on such aggregate principal amount prepaid unless, with respect to such accrued interest, such prepayment is with respect to a Base Rate Advance that is a Working Capital Advance; provided that (i) each partial prepayment (other than prepayments of Swing Line Advances) shall be in an aggregate principal amount of $2,000,000 or an integral multiple of $100,000 in excess thereof (or, with respect to Swing Line Advances, shall be in an aggregate principal amount of $250,000 or an integral multiple of $100,000 in excess thereof) and (ii) if any prepayment of a Eurodollar Rate Advance shall be made other than on the last day of an Interest Period therefor, the Borrower shall also pay any amounts owing pursuant to Section 8.04(c). Each such prepayment of any Term Advances shall be applied subject to subsection (c) below, ratably to the Term A Facility and the Term B Facility and, in each case, ratably to the principal installments thereof. (b) Mandatory. (i) The Borrower shall, on the date of receipt of the Net Cash Proceeds by any Loan Party or any of its Subsidiaries from (A) the sale, lease, transfer or other. disposition of any assets of the Borrower or any of its Subsidiaries (other than any sale, lease, transfer or other disposition otherwise permitted under Section 5.02(d)), (B) the incurrence or issuance by any Loan Party or any of its Subsidiaries of any Debt (other than any Debt permitted, issued or incurred under Section 5.02(b)), (C) an Extraordinary Receipt and (D) the sale or issuance by any Loan Party or any of its Subsidiaries of any capital stock or other ownership or profit interest, any securities convertible into or exchangeable for capital stock or other ownership or profit interest or any warrants, rights or options to acquire capital stock or other ownership or profit interest (other than (x) options and warrants existing on the Third Restatement Date and any options issued pursuant to the Management Option Plan, or in each case, any shares of common stock issued in exchange therefor, (y) proceeds received from the issuance of new shares of the Parent Guarantor's capital stock, which proceeds are solely used to purchase, redeem, retire, defease or otherwise acquire shares of the Parent Guarantor's capital stock then outstanding, provided that such new shares shall contain equal or inferior voting powers, designations, preferences and rights, and (z) proceeds received from the issuance of new shares of the Parent Guarantor's capital stock to any employee of any Loan Party in an aggregate amount, together with all other proceeds received pursuant to this clause (z), not to exceed $1,000,000), prepay an aggregate principal amount of the Advances comprising part of the same Borrowings equal to the amount of such Net Cash Proceeds; provided, however, that, with respect to an initial public offering of the common stock of any Loan Party, such prepayment amount shall be an amount equal to the Net Cash Proceeds of such initial public offering less $15,000,000. Each such prepayment shall be applied as follows: first, subject to subsection (c) below, ratably to the Term A Facility and the Term B Facility and, in each case, ratably to the principal installments thereof, and second, to the extent that no Term Advances remain outstanding, permanently to reduce the Working Capital Facility as set forth in Section 2.06(b)(iv). (ii) The Borrower shall, on each Business Day, prepay an aggregate principal amount of the Working Capital Advances comprising part of the same Borrowings, the Letter of Credit Advances and the Swing Line Advances equal to the amount by which (A) the sum of the -36- aggregate principal amount of (1) the Working Capital Advances, (2) the Letter of Credit Advances and (3) the Swing Line Advances then outstanding plus the aggregate Available Amount of all Letters of Credit then outstanding exceeds (B) the Working Capital Facility on such Business Day. (iii) The Borrower shall, on each Business Day, pay to the Administrative Agent for deposit in the L/C Cash Collateral Account an amount sufficient to cause the aggregate amount on deposit in such Account to at least equal the amount by which the aggregate Available Amount of all Letters of Credit then outstanding exceeds the Working Capital Facility on such Business Day. (iv) Prepayments of the Working Capital Facility made pursuant to clause (i) and (ii) above shall be first applied to prepay Letter of Credit Advances then outstanding until such Advances are paid in full, second applied to prepay Swing Line Advances then outstanding until such Advances are paid in full, third applied to prepay Working Capital Advances then outstanding comprising part of the same Borrowings until such Advances are paid in full and fourth deposited in the L/C Cash Collateral Account to cash collateralize 100% of the Available Amount of the Letters of Credit then outstanding; and, in the case of prepayments of the Working Capital Facility required pursuant to clause (i) above, the amount remaining (if any) after the prepayment in full of the Advances then outstanding and the 100% cash collateralization of the aggregate Available Amount of Letters of Credit then outstanding may be retained by the Borrower and the Working Capital Facility shall be permanently reduced as set forth in Section 2.05(b). Upon the drawing of any Letter of Credit for which funds are on deposit in the L/C Cash Collateral Account, such funds shall be applied to reimburse the Issuing Bank or Working Capital Lenders, as applicable. (v) All prepayments under this subsection (b) shall be made together with accrued interest to the date of such prepayment on the principal amount prepaid and, in the event of any such prepayment of a Eurodollar Rate Advance other than on the last day of an Interest Period therefor, the Borrower shall also make any payments required by Section 8.04(c). (c) Term B Opt-Out. With respect to any prepayment of the Term Advances, the Administrative Agent shall ratably pay the Term A Lenders and Term B Lenders; provided, however, that any Term B Lender, at its option, may elect not to accept such prepayment, in which event the provisions of the next sentence shall apply. Any Term B Lender may elect not to accept its ratable share of the prepayment referred to in any Prepayment Notice, by notice given to the Administrative Agent not later than 1:00 P.M. (New York City time) on the first Business Day prior to the scheduled Prepayment Date (such Term B Lender being a "Declining Lender"). On the Prepayment Date an amount equal to that portion of the Prepayment Amount available to prepay Term B Lenders (less any amounts that would otherwise be payable to the Declining Lenders) shall be applied to prepay Term B Advances owing to Term B Lenders other than Declining Lenders and any amounts that would otherwise have been applied to prepay Term B Advances owing to Declining Lenders shall instead be applied ratably to prepay the remaining Term Advances as provided in Sections 2.06(a) and (b); provided, further, that on prepayment in full of Term Advances owing to Term A Lenders and Term B Lenders other than Declining -37- Lenders, the remainder of any Prepayment Amount shall be applied ratably to prepay Term B Advances owing to Declining Lenders. SECTION 2.07. Interest. (a) Scheduled Interest. The Borrower shall pay interest on the unpaid principal amount of each Advance owing to each Lender from the date of such Advance until such principal amount shall be paid in full, at the following rates per annum: (i) Base Rate Advances. During such periods as such Advance is a Base Rate Advance, a rate per annum equal at all times to the sum of (A) the Base Rate in effect from time to time plus (B) the Applicable Margin, in effect from time to time, payable in arrears quarterly on the last Business Day of each March, June, September and December during such periods, commencing March 31, 1998, on the date such Base Rate Advance shall be Converted, on the date of any prepayment of Base Rate Advances pursuant to Section 2.06(b), on the Termination Date and, except with respect to a Working Capital Advance, on the date of any prepayment pursuant to Section 2.06(a) and on the Final Maturity Date. (ii) Eurodollar Rate Advances. During such periods as such Advance is a Eurodollar Rate Advance, a rate per annum equal at all times during each Interest Period for such Advance to the sum of (A) the Eurodollar Rate for such Interest Period for such Advance plus (B) the Applicable Margin in effect from time to time during such Interest Period, payable in arrears on the last day of such Interest Period and, if such Interest Period has a duration of more than three months, on each day that occurs during such Interest Period every three months from the first day of such Interest Period and on the date such Eurodollar Rate Advance shall be Converted or paid in full. (b) Default Interest. Upon the occurrence and during the continuance of a Default under Section 6.01(c) with respect to any covenant contained in Section 5.04 or under Section 6.01(a), the Borrower shall pay interest on (i) the unpaid principal amount of each Advance owing to each Lender, payable in arrears on the dates referred to in clause (a)(i) or (a)(ii) above and on demand, at a rate per annum equal at all times to 2% per annum above the rate per annum required to be paid on such Advance pursuant to clause (a)(i) or (a)(ii) above and (ii) to the fullest extent permitted by law, the amount of any interest, fee or other amount payable hereunder that is not paid when due, from the date such amount shall be due until such amount shall be paid in full, payable in arrears on the date such amount shall be paid in full and on demand, at a rate per annum equal at all times to 2% per annum above the rate per annum required to be paid on Base Rate Advances pursuant to clause (a)(i) above. (c) Notice of Interest Rate. Promptly after receipt of a Notice of Borrowing pursuant to Section 2.02(a) or any change in the Applicable Margin, the Administrative Agent shall give notice to the Borrower and each Appropriate Lender of the applicable interest rate determined by the Administrative Agent for purposes of clause (a)(i) or (a)(ii) above. SECTION 2.08. Fees. (a) Commitment Fee. The Borrower shall pay to the Administrative Agent for the account of the Lenders a commitment fee on the average daily Unused Working Capital Commitment of such Lender from the date hereof in the case of each Restatement Lender and from the effective date specified in the Assignment and Acceptance -38- pursuant to which it became a Lender in the case of each other Lender until the Termination Date at a rate per annum equal, as of any date, to a percentage determined by reference to the Leverage Ratio as set forth below, in each case payable in arrears quarterly on the last Business Day of each March, June, September and December, commencing March 31, 1998, and on the Termination Date: Leverage Ratio Commitment Fee -------------- -------------- Level I 2.75: 1.00 or greater 0.500% Level II less than 2.75: 1.00 0.375% The commitment fee shall be determined by reference to the Leverage Ratio in effect from time to time; provided, however, that (a) the commitment fee shall be at Level I for the period commencing on the Third Restatement Date until the quarter ending September 30, 1998, (b) no change in the commitment fee shall be effective until three Business Days after the date on which the Administrative Agent receives financial statements pursuant to Section 5.03(c) or (d), as the case may be, and a certificate of the chief financial officer of the Borrower demonstrating such Ratio, and (c) notwithstanding anything herein to the contrary, the commitment fee shall be at Level I upon the occurrence and during the continuance of an Event of Default. (b) Letter of Credit Fees, Etc. (i) The Borrower shall pay to the Administrative Agent for the account of each Working Capital Lender a commission on such Lender's Pro Rata Share of the average daily aggregate Available Amount of all Letters of Credit outstanding from time to time at a rate per annum equal to the Applicable Margin for Eurodollar Rate Advances in effect from time to time payable in arrears quarterly on the last Business Day of each March, June, September and December, commencing March 31, 1998, and on the Termination Date. (ii) The Borrower shall pay to the Issuing Bank, for its own account, such commissions, issuance fees, fronting fees, transfer fees and other fees and charges in connection with the issuance or administration of each Letter of Credit as the Borrower and the Issuing Bank shall agree. (c) Agents' Fees. The Borrower shall pay to each of the Agents for its respective account such fees as may from time to time be agreed between the Borrower and such Agents. SECTION 2.09. Conversion of Advances. (a) Optional. The Borrower may on any Business Day, upon notice given to the Administrative Agent not later than 1:00 P.M. (New York City time) on the third Business Day prior to the date of the proposed Conversion and subject to the provisions of Sections 2.07 and 2.10, Convert all or any portion of the Advances of one Type comprising the same Borrowing into Advances of the other Type; provided, however, -39- that any Conversion of Eurodollar Rate Advances into Base Rate Advances shall be made only on the last day of an Interest Period for such Eurodollar Rate Advances, any Conversion of Base Rate Advances into Eurodollar Rate Advances shall be in an amount not less than the minimum amount specified in Section 2.02(c), no Conversion of any Advances shall result in more separate Borrowings than permitted under Section 2.02(c) and each Conversion of the Advances comprising part of the same Borrowing under any Facility shall be made ratably among the Appropriate Lenders in accordance with their Commitments under such Facility. Each such notice of Conversion shall, within the restrictions specified above, specify (i) the date of such Conversion, (ii) the Advances to be Converted and (iii) if such Conversion is into Eurodollar Rate Advances, the duration of the initial Interest Period for such Advances. Each notice of Conversion shall be irrevocable and binding on the Borrower. (b) Mandatory. (i) On the date on which the aggregate unpaid principal amount of Eurodollar Rate Advances comprising any Borrowing shall be reduced, by payment or prepayment or otherwise, to less than $2,000,000, such Advances shall automatically Convert into Base Rate Advances. (ii) If the Borrower shall fail to select the duration of any Interest Period for any Eurodollar Rate Advances in accordance with the provisions contained in the definition of "Interest Period" in Section 1.01, the Administrative Agent will forthwith so notify the Borrower and the Appropriate Lenders, whereupon each such Eurodollar Rate Advance will automatically, on the last day of the then existing Interest Period therefor, Convert into a Base Rate Advance. (iii) Upon the occurrence and during the continuance of any Event of Default, (x) each Eurodollar Rate Advance will automatically, on the last day of the then existing Interest Period therefor, Convert into a Base Rate Advance and (y) the obligation of the Lenders to make, or to Convert Advances into, Eurodollar Rate Advances shall be suspended. SECTION 2.10. Increased Costs, Etc. (a) If, due to either (i) the introduction of or any change in or in the interpretation of any law or regulation or (ii) the compliance with any guideline or request from any central bank or other governmental authority (whether or not having the force of law), in either case after the date hereof, there shall be any increase in the cost to any Lender Party of agreeing to make or of making, funding or maintaining Eurodollar Rate Advances or of agreeing to issue or of issuing or maintaining Letters of Credit or of agreeing to make or of making or maintaining Letter of Credit Advances (including such increased costs arising from changes in the basis of taxation, other than increased costs in respect of (i) taxes or other taxes, which shall be governed by Section 2.12, and (ii) taxes expressly excluded from the definition of "Taxes" herein), then the Borrower shall from time to time, upon demand by such Lender Party (with a copy of such demand to the Administrative Agent), pay to the Administrative Agent for the account of such Lender Party additional amounts sufficient to compensate such Lender Party for such increased cost. A certificate as to the amount of such increased cost, submitted to the Borrower by such Lender Party, shall be conclusive and binding for all purposes, absent manifest error. -40- (b) If any Lender Party determines that compliance with any law or regulation or any guideline or request from any central bank or other governmental authority (whether or not having the force of law) affects or would affect the amount of capital required or expected to be maintained by such Lender Party or any corporation controlling such Lender Party and that the amount of such capital is increased by or based upon the existence of such Lender Party's commitment to lend or agreement to issue Letters of Credit hereunder and other commitments of such type or the issuance or maintenance of the Letters of Credit (or similar contingent obligations), then, upon demand by such Lender Party (with a copy of such demand to the Administrative Agent), the Borrower shall pay to the Administrative Agent for the account of such Lender Party, from time to time as specified by such Lender Party, additional amounts sufficient to compensate such Lender Party in the light of such circumstances, to the extent that such Lender Party reasonably determines such increase in capital to be allocable to the existence of such Lender Party's commitment to lend or agreement to issue Letters of Credit hereunder or to the issuance or maintenance of any Letters of Credit. A certificate as to such amounts submitted to the Borrower by such Lender Party shall be conclusive and binding for all purposes, absent manifest error. (c) If, with respect to any Eurodollar Rate Advances under any Facility, Lenders owed at least 60 % of the then aggregate unpaid principal amount thereof notify the Administrative Agent that the Eurodollar Rate for any Interest Period for such Advances will not adequately reflect the cost to such Lenders of making, finding or maintaining their Eurodollar Rate Advances for such Interest Period, the Administrative Agent shall forthwith so notify the Borrower and the Appropriate Lenders, whereupon (i) each such Eurodollar Rate Advance under any Facility will automatically, on the last day of the then existing Interest Period therefor, Convert into a Base Rate Advance and (ii) the obligation of the Appropriate Lenders to make, or to Convert Advances into, Eurodollar Rate Advances shall be suspended until the Administrative Agent shall notify the Borrower that such Lenders have determined that the circumstances causing such suspension no longer exist. (d) Notwithstanding any other provision of this Agreement, if the introduction of or any change in or in the interpretation of any law or regulation shall make it unlawful, or any central bank or other governmental authority shall assert that it is unlawful, for any Lender or its Eurodollar Lending Office to perform its obligations hereunder to make Eurodollar Rate Advances or to continue to find or maintain Eurodollar Rate Advances hereunder, then, on notice thereof and demand therefor by such Lender to the Borrower through the Administrative Agent, (i) each Eurodollar Rate Advance under each Facility under which such Lender has a Commitment will automatically, upon such demand, Convert into a Base Rate Advance and (ii) the obligation of the Appropriate Lenders to make, or to Convert Advances into, Eurodollar Rate Advances shall be suspended until the Administrative Agent shall notify the Borrower that such Lender has determined that the circumstances causing such suspension no longer exist. (e) Any Lender claiming any additional compensation under any of the provisions of this Section 2.10 shall use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to change the jurisdiction of its Applicable Lending Office if the making of such change would avoid the need for or reduce the amount of any such additional -41- compensation which may thereafter accrue or, in the case of Section 2.10(c) or 2.10(d), would allow such Lender to continue to find or to maintain Eurodollar Rate Advances and, in any such case, would not, in the sole judgment of such Lender, be disadvantageous to such Lender. SECTION 2.11. Payments and Computations. (a) The Borrower shall make each payment hereunder and under the Notes, irrespective of any right of counterclaim or setoff, not later than 1:00 P.M. (New York City time) on the day when due in U.S. dollars to the Administrative Agent at the Administrative Agent's Account in same day funds. The Administrative Agent will promptly thereafter cause like funds to be distributed (i) if such payment by the Borrower is in respect of principal, interest, commitment fees or any other Obligation then payable hereunder and under the Notes to more than one Lender Party, to such Lender Parties for the account of their respective Applicable Lending Offices ratably in accordance with the amounts of such respective Obligations then payable to such Lender Parties and (ii) if such payment by the Borrower is in respect of any Obligation then payable hereunder to one Lender Party, to such Lender Party for the account of its Applicable Lending Office, in each case to be applied in accordance with the terms of this Agreement. Upon its acceptance of an Assignment and Acceptance and recording of the information contained therein in the Register pursuant to Section 8.07(e), from and after the effective date of such Assignment and Acceptance, the Administrative Agent shall make all payments hereunder and under the Notes in respect of the interest assigned thereby to the Lender Party assignee thereunder, and the parties to such Assignment and Acceptance shall make all appropriate adjustments in such payments for periods prior to such effective date directly between themselves. (b) If the Administrative Agent receives finds for application to the Obligations under the Loan Documents under circumstances for which the Loan Documents do not specify the Advances or the Facility to which, or the manner in which, such funds are to be applied, the Administrative Agent may, but shall not be obligated to, elect to distribute such finds to each Lender Party ratably in accordance with such Lender Party's proportionate share of the principal amount of all outstanding Advances and the Available Amount of all Letters of Credit then outstanding, in repayment or prepayment of such of the outstanding Advances or other Obligations owed to such Lender Party, as the Administrative Agent shall direct and with prior notice thereof to the Borrower. (c) The Borrower hereby authorizes each Lender Party, if and to the extent payment owed to such Lender Party is not made when due hereunder or, in the case of a Lender, under the Note held by such Lender, with notice thereof to the Borrower, to charge from time to time against any or all of the Borrower's accounts with such Lender Party any amount so due. (d) All computations of interest, fees and Letter of Credit commissions shall be made by the Administrative Agent on the basis of a year of 360 days, in each case for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest, fees or commissions are payable. Each determination by the Administrative Agent of an interest rate, fee or commission hereunder shall be conclusive and binding for all purposes, absent manifest error. -42- (e) Whenever any payment hereunder or under the Notes shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of payment of interest or fees, as the case may be; provided, however, that, if such extension would cause payment of interest on or principal of Eurodollar Rate Advances to be made in the next following calendar month, such payment shall be made on the next preceding Business Day. (f) Unless the Administrative Agent shall have received notice from the Borrower prior to the date on which any payment is due to any Lender Party hereunder that the Borrower will not make such payment in full, the Administrative Agent may assume that the Borrower has made such payment in full to the Administrative Agent on such date and the Administrative Agent may, in reliance upon such assumption, cause to be distributed to each such Lender Party, on such due date an amount equal to the amount then due such Lender Party. If and to the extent the Borrower shall not have so made such payment in full to the Administrative Agent, each such Lender Party shall repay to the Administrative Agent forthwith on demand such amount distributed to such Lender Party, together with interest thereon, for each day from the date such amount is distributed to such Lender Party until the date such Lender Party repays such amount to the Administrative Agent, at the Federal Funds Rate. SECTION 2.12. Taxes. (a) Any and all payments by the Borrower hereunder or under the Notes shall be made, in accordance with Section 2.11, free and clear of and without deduction for any and all present or future taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto, excluding in the case of each Lender Party and the Agents, overall net income taxes that are imposed by the United States and overall franchise taxes and net income taxes that are imposed on such Lender Party or the Agents by the state or foreign jurisdiction under the laws of which such Lender Party or the Agents (as the case may be) is organized or any political subdivision thereof and, in the case of each Lender Party, franchise taxes and net income taxes that are imposed on such Lender Party by the state or foreign jurisdiction of such Lender Party's Applicable Lending Office or any political subdivision thereof (all such non-excluded taxes, levies, imposts, deductions, charges, withholdings and liabilities being hereinafter referred to as "Taxes"). If the Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder or under any Note to any Lender Party or the Agents, (i) the sum payable shall be increased as may be necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 2.12) such Lender Party or the Agents (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions and (iii) the Borrower shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law. (b) In addition, the Borrower shall pay any present or future stamp, documentary, excise, property or similar taxes, charges or levies that arise from any payment made hereunder or under the Notes or from the execution, delivery or registration of, or otherwise with respect to, this Agreement or the Notes (hereinafter referred to as "Other Taxes"). -43- (c) The Borrower shall indemnify each Lender Party and the Agents for the full amount of Taxes and Other Taxes, and for the full amount of net income taxes imposed by (i) the United States, (ii) any jurisdiction in which any Agent or any Lender Party is organized, (iii) the jurisdiction of any Lender Party's Applicable Lending Office and (iv) any political subdivision of (i) through (iii) above on amounts payable under this Section 2.12, paid by such Lender Party or such Agent (as the case may be) and any liability (including penalties, additions to tax, interest and expenses) arising therefrom or with respect thereto. This indemnification shall be made within 30 days from the date such Lender Party or such Agent (as the case may be) makes written demand therefor. (d) Within 30 days after the date of any payment of Taxes, the Borrower shall furnish to the Administrative Agent, at its address referred to in Section 8.02, the original receipt of payment thereof or a certified copy of such receipt. In the case of any payment hereunder or under the Notes by or on behalf of the Borrower through an account or branch outside the United States or on behalf of the Borrower by a payor that is not a United States person, if the Borrower determines that no Taxes are payable in respect thereof, the Borrower shall furnish, or shall cause such payor to furnish, to the Administrative Agent, at such address, an opinion of counsel acceptable to the Administrative Agent stating that such payment is exempt from Taxes. For purposes of this subsection (d) and subsection (e), the terms "United States" and "United States person" shall have the meanings specified in Section 7701 of the Internal Revenue Code. (e) Each Lender Party organized under the laws of a jurisdiction outside the United States shall, on or prior to the date of its execution and delivery of this Agreement in the case of each Restatement Lender or Existing Issuing Bank, as the case may be, and on the date of the Assignment and Acceptance pursuant to which it became a Lender Party in the case of each other Lender Party, and from time to time thereafter if requested in writing by the Borrower or the Administrative Agent (but only so long thereafter as such Lender Party remains lawfully able to do so), provide the Administrative Agent and the Borrower with two accurate and complete original signed copies of Internal Revenue Service Form 1001 or 4224, as appropriate, or any successor form prescribed by the Internal Revenue Service, certifying that such Lender Party is exempt from withholding tax on payments under this Agreement or the Notes or in the case of a Lender that is claiming an exemption from United States withholding tax under Section 871(h) or 881(c) of the Internal Revenue Code with respect to payments of "portfolio interest", two accurate and complete signed original Forms W-8 (or any successor form prescribed by the Internal Revenue Service, certifying that such Lender is exempt from or is entitled to a reduced rate of United States withholding tax on payments under this Agreement or the Notes) and, if such Lender delivers such Forms W-8 (or successor form), two signed certificates that such Lender is not (1) a "bank" for purposes of Section 881(c) of the Internal Revenue Code, (2) is not a 10% shareholder (within the meaning of Section 871(h)(3)(B) of the Internal Revenue Code) of the Borrower and (3) is not a controlled foreign corporation related to the Borrower (within the meaning of Section 864(d)(4) of the Internal Revenue Code). If the form provided by a Lender Party at the time such Lender Party first becomes a party to this Agreement indicates a United States interest withholding tax rate in excess of zero, withholding tax at such rate shall be considered excluded from Taxes unless and until such Lender Party provides the appropriate form certifying that a lesser rate applies, whereupon withholding tax at such lesser rate only shall -44- be considered excluded from Taxes for periods governed by such form; provided, however, that, if at the date of the Assignment and Acceptance pursuant to which a Lender Party assignee becomes a party to this Agreement, the Lender Party assignor was entitled to payments under subsection (a) in respect of United States withholding tax with respect to interest paid at such date, then, to such extent, the term "Taxes" shall include (in addition to withholding taxes that may be imposed in the future or other amounts otherwise includable in Taxes) United States withholding tax, if any, applicable with respect to the Lender Party assignee on such date. (f) For any period with respect to which a Lender Party has failed to provide the Borrower with the appropriate form described in subsection (e) (other than if such failure is due to a change in law occurring after the date on which a form originally was required to be provided or if such form otherwise is not required under subsection (e)), such Lender Party shall not be entitled to indemnification under subsection (a) or (c) with respect to Taxes imposed by the United States; provided, however, that should a Lender Party become subject to Taxes because of its failure to deliver a form required hereunder, the Borrower shall take such steps as such Lender Party shall reasonably request to assist such Lender Party to recover such Taxes. (g) If any Lender Party determines, in its sole discretion, that it has actually and finally realized in a year in which a payment under the Loan Documents is made or in any subsequent year, by reason of a refund, deduction or credit of any Taxes paid or reimbursed by the Borrower pursuant to subsection (a) or (c) above in respect of payments under the Loan Documents, a current monetary benefit that it would otherwise not have obtained, and that would result in the total payments under this Section 2.12 exceeding the amount needed to make such Lender Party whole, such Lender Party shall pay to the Borrower, with reasonable promptness following the date on which it actually realizes such benefit, an amount equal to the lesser of the amount of such benefit or the amount of such excess, in each case net of all out-of-pocket expenses in securing such refund, deduction or credit. (h) Any Lender Party claiming any additional amounts payable pursuant to this Section 2.12 shall use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to file any certificate or document requested by the Borrower or to change the jurisdiction of its Applicable Lending Office if the making of such filing or change would avoid the need for or reduce the amount of any such additional amounts which may thereafter accrue and would not, in the sole judgment of such Lender, be disadvantageous to such Lender Party. SECTION 2.13. Sharing of Payments, Etc. If any Lender Party shall obtain at any time any payment (whether voluntary, involuntary, through the exercise of any right of setoff, or otherwise) (a) on account of Obligations due and payable to such Lender Party hereunder and under the Notes at such time in excess of its ratable share (according to the proportion of (i) the amount of such Obligations due and payable to such Lender Party at such time to (ii) the aggregate amount of the Obligations due and payable to all Lender Parties hereunder and under the Notes at such time) of payments on account of the Obligations due and payable to all Lender Parties hereunder and under the Notes at such time obtained by all the Lender Parties at such time or (b) on account of Obligations owing (but not due and payable) to -45- such Lender Party hereunder and under the Notes at such time in excess of its ratable share (according to the proportion of (i) the amount of such Obligations owing to such Lender Party at such time to (ii) the aggregate amount of the Obligations owing (but not due and payable) to all Lender Parties hereunder and under the Notes at such time) of payments on account of the Obligations owing (but not due and payable) to all of the Lender Parties hereunder and under the Notes at such time obtained by all the Lender Parties at such time, such Lender Party shall forthwith purchase from the other Lenders Parties such participations in the Obligations due and payable or owing to them, as the case may be, as shall be necessary to cause such purchasing Lender Party to share the excess payment ratably with each of them; provided, however, that if all or any portion of such excess payment is thereafter recovered from such purchasing Lender Party, such purchase from each other Lender Party shall be rescinded and such other Lender Party shall repay to the purchasing Lender Party the purchase price to the extent of such Lender Party's ratable share (according to the proportion of (A) the purchase price paid to such Lender Party to (B) the aggregate purchase price paid to all of the Lender Parties) of such recovery together with an amount equal to such Lender Party's ratable share (according to the proportion of (1) the amount of such other Lender Party's required repayment to (2) the total amount so recovered from the purchasing Lender Party) of any interest or other amount paid or payable by the purchasing Lender Party in respect of the total amount so recovered. The Borrower agrees that any Lender Party so purchasing a participation from another Lender Party pursuant to this Section 2.13 may, to the fullest extent permitted by law, exercise all its rights of payment (including the right of setoff) with respect to such participation as fully as if such Lender Party were the direct creditor of the Borrower in the amount of such participation. SECTION 2.14. Use of Proceeds. The proceeds of the Advances and issuance of Letters of Credit shall be available (and the Borrower agrees that it shall use such proceeds) solely (a) to refinance the facilities under the Existing Credit Agreement, (b) to fund dividend payments to the shareholders of the Parent Guarantor, (c) to pay transaction fees and expenses in connection with the foregoing and the other transactions contemplated hereby, (d) to provide financing for the acquisition and development of Health Club Facilities and (e) to provide working capital and letter of credit support for the Borrower and its Subsidiaries. ARTICLE III CONDITIONS OF LENDING SECTION 3.01. Conditions Precedent to the Third Amendment and Restatement. The third amendment and restatement of the Existing Credit Agreement pursuant hereto shall become effective on and as of the date which shall occur on or prior to December 31, 1997 on which each of the following conditions precedent shall have been satisfied (the "Third Restatement Date"): (a) The Lender Parties shall be satisfied with the corporate and legal structure and capitalization of each Loan Party and each of their Subsidiaries, including the terms and conditions of the charter, bylaws and each class of capital stock of each Loan Party -46- and each such Subsidiary and of each agreement or instrument relating to such structure or capitalization. (b) The Lender Parties shall be satisfied with the terms and conditions of the Loan Documents and the Related Documents. (c) All governmental and third party consents and approvals necessary in connection with this Agreement shall have been obtained (without the imposition of any conditions other than those that are reasonably acceptable to the Administrative Agent) and shall remain in effect, and all applicable waiting periods shall have expired without any action being taken by any competent authority and no law or regulation shall be applicable, in the reasonable judgment of the Administrative Agent, that restrains, prevents or imposes adverse conditions upon this Agreement or any related transactions. (d) The Lender Parties shall be satisfied that all Existing Debt, other than Debt identified on Schedule 3.01(d) hereto (the "Surviving Debt"), has been prepaid, redeemed or defeased in full or otherwise satisfied and extinguished and that all such Surviving Debt shall be on terms and conditions satisfactory to the Lender Parties. (e) There shall exist no action, suit, investigation, litigation or proceeding affecting any Loan Party or any of its Subsidiaries pending or threatened before any court, governmental agency or arbitrator that (i) could reasonably be expected to have a Material Adverse Effect or (ii) purports to affect the legality, validity or enforceability of this Agreement, any Note, any other Loan Document, any Related Document or the consummation of the transactions contemplated hereby and thereby. (f) The Administrative Agent shall have received on or before the Third Restatement Date the following, each dated such day (unless otherwise specified), in form and substance satisfactory to the Lender Parties (unless otherwise specified) and (except for the Notes) in sufficient copies for each Lender Party: (i) The Notes payable to the order of the Lenders. (ii) Certified copies of the resolutions of the Board of Directors of the Borrower and each other Loan Party approving this Agreement, the Notes, each other Loan Document to which it is or is to be a party, and of all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Agreement, the Notes and each other Loan Document. (iii) A copy of the charter of the Borrower and each other Loan Party and each amendment thereto, certified (as of a date reasonably near the Third Restatement Date) by the Secretary of State of the jurisdiction of its incorporation as being a true and correct copy thereof. (iv) A copy of a certificate of the Secretary of State of the jurisdiction of its incorporation, dated reasonably near the Third Restatement Date, listing the -47- charter of the Borrower and each other Loan Party, and each amendment thereto on file in his office and certifying that (A) such amendments are the only amendments to the Borrower's or such other Loan Party's charter on file in his office and (B) the Borrower or such other Loan Party is duly incorporated and in good standing under the laws of the state of the jurisdiction of its incorporation. (v) A telegram from the Secretary of State of the State of Delaware certifying that the Parent Guarantor is duly incorporated and in good standing under the laws of such State on the Third Restatement Date. (vi) A certificate of the Borrower and each other Loan Party, signed on behalf of the Borrower and each other Loan Party by its President and its Secretary or any Assistant Secretary, dated the Third Restatement Date (the statements made in which certificate shall be true on and as of the Third Restatement Date), certifying as to (A) the absence of any amendments to the charter of the Borrower or such other Loan Party since the date of the Secretary of State's certificate referred to in Section 3.01(f)(iv), (B) a true and correct copy of the bylaws of the Borrower or such other Loan Party as in effect on the Third Restatement Date, (C) the due incorporation and good standing of the Borrower or such other Loan Party as a corporation organized under the laws of the jurisdiction of its incorporation, and the absence of any proceeding for the dissolution or liquidation of the Borrower or such other Loan Party, (D) the truth of the representations and warranties contained in the Loan Documents as though made on and as of the Third Restatement Date and (E) the absence of any event occurring and continuing, or resulting from the initial Borrowing, that constitutes a Default. (vii) A certificate of the Secretary or an Assistant Secretary of each Loan Party certifying the names and true signatures of the officers of such Loan Party authorized to sign each Loan Document to which it is, or is to be, a party and the other documents to be delivered hereunder or thereunder. (viii) An amended and restated security agreement in substantially the form of Exhibit D hereto (as further amended, supplemented or otherwise modified from time to time in accordance with its terms, the "Security Agreement"), duly executed by the Borrower, and such further consents or amendments, if any, as the Administrative Agent may request thereto, together with: (A) certificates representing additional Pledged Shares, if any, referred to therein accompanied by undated stock powers executed in blank and instruments evidencing additional Pledged Debt, if any, referred to therein and endorsed in blank, (B) acknowledgment copies or stamped receipt copies of proper additional financing statements, if any, duly filed on or before the Third -48- Restatement Date under the Uniform Commercial Code of all jurisdictions that the Administrative Agent may deem necessary or desirable in order to maintain the perfection and priority of the Liens created under the Collateral Documents, covering the Collateral described in the Security Agreement, (C) completed requests for information, dated on or before the Third Restatement Date, listing all effective financing statements filed in the jurisdictions referred to in clause (B) above that name the Borrower or such Subsidiaries as debtor, together with copies of such financing statements, (D) evidence of the insurance required by the terms of the Security Agreement, (E) copies of additional Assigned Agreements, if any, referred to in the Security Agreement, together with a consent to such assignment, in substantially the form of Exhibit B to the Security Agreement, duly executed by each party to any such Assigned Agreements other than the Borrower or such Subsidiary, (F) evidence that all other action that the Administrative Agent or any Restatement Lender may deem necessary or desirable in order to maintain the perfection and priority of the Liens created under the Security Agreement has been taken, including delivery of Blocked Account Letters in form and substance satisfactory to the Administrative Agent. (ix) An amended and restated pledge agreement in substantially the form of Exhibit E hereto (as further amended, supplemented or otherwise modified from time to time, the "Holdings Pledge Agreement"), duly executed by the Parent Guarantor together with all other certificates, instruments and evidence that the Administrative Agent may deem necessary or desirable in order to perfect and protect the liens and security interests created thereunder. (x) An amended and restated guaranty in substantially the form of Exhibit F hereto (as further amended, supplemented or otherwise modified from time to time, the "Holdings Guaranty"), duly executed by the Parent Guarantor. (xi) Such further consents or amendments, if any, as the Administrative Agent may request with respect to (A) the subordination agreement dated as of June 30, 1995 (the "FFHLP Subordination Agreement") between FFHLP and the Borrower, duly executed by the parties thereto, (B) the subordination agreement dated as of June 30, 1995 (the "Holdings Subordination Agreement") between the Parent Guarantor and the Borrower, duly executed by the parties thereto, (C) the subordination agreement dated as of December 31, 1995 (the "Earnout I Subordination Agreement") between FFHLP and the Borrower, duly executed by -49- the parties thereto, (D) the subordination agreement dated as of December 31, 1996 (the "Earnout II Subordination Agreement") between FFHLP and the Borrower, duly executed by the parties thereto and (E) the subordination agreement dated October 24, 1996 (the "Texas Subordination Agreement") between Landhigh Investments, Inc. and the Borrower, duly executed by the parties thereto. (xii) Forecasts prepared by management of the Parent Guarantor of balance sheets, income statements and cash flow statements on an annual basis for each year through December 31, 2001, in form and substance satisfactory to the Administrative Agent. (xiii) Confirmation of insurance naming the Administrative Agent as insured and loss payee with such responsible and reputable insurance companies or associations, and in such amounts and covering such risks as is satisfactory to the Lender Parties. (xiv) A certificate of the Secretary or an Assistant Secretary of the Borrower certifying that attached thereto is a true, complete and correct copy of each of the Related Documents, duly executed by the parties thereto and which Related Documents are in form and substance satisfactory to the Lender Parties, together with all agreements, instruments and other documents delivered in connection therewith. (xv) A certificate in substantially the form of Exhibit G attesting to the Solvency of the Parent Guarantor and its Subsidiaries taken as a whole after giving effect to the transactions contemplated hereby, from its chief financial officer. (xvi) Favorable opinions of White & Case, counsel for the Borrower, in substantially the form of Exhibits H-1 and H-2 hereto and as to such other matters as any Lender Party through the Administrative Agent may reasonably request. (xvii) A favorable opinion of Shearman & Sterling, counsel for the Administrative Agent, in form and substance satisfactory to the Administrative Agent. (g) All reasonable accrued fees and expenses of the Agents and the Lender Parties (including upfront fees to the Lender Parties and the reasonable accrued fees and expenses of counsel to the Administrative Agent) shall have been paid including, without limitation, all accrued interest and fees under the Existing Credit Agreement through the Third Restatement Date. (h) Before giving effect to this Agreement and the transactions contemplated hereby there shall have occurred no Material Adverse Change since December 31, 1996. -50- (i) The Assignment Agreement shall be in full force and effect and shall not have been terminated and, pursuant thereto, the Commitments and Advances (each as defined in the Existing Credit Agreement) of each Existing Lender shall have been sold and assigned to the Restatement Lenders hereunder on the terms and in the amounts set forth in the Assignment Agreement. SECTION 3.02. Conditions Precedent to Each Borrowing and Issuance. The obligation of each Appropriate Lender to make an Advance (other than a Letter of Credit Advance made by the Issuing Bank or a Working Capital Lender pursuant to Section 2.03(c) and a Swing Line Advance made by the Swing Line Bank or a Working Capital Lender pursuant to Section 2.02(b)) on the occasion of each Borrowing (including on the Third Restatement Date), and the obligation of the Issuing Bank to issue a Letter of Credit (including the initial issuance) and the right of the Borrower to request a Swing Line Borrowing, shall be subject to the further conditions precedent that on the date of such Borrowing or issuance (a) the following statements shall be true (and each of the giving of the applicable Notice of Borrowing, Notice of Swing Line Borrowing or Notice of Issuance and the acceptance by the Borrower of the proceeds of such Borrowing or of such Letter of Credit shall constitute a representation and warranty by the Borrower that both on the date of such notice and on the date of such Borrowing or issuance such statements are true): (i) the representations and warranties contained in each Loan Document are correct on and as of such date, before and after giving effect to such Borrowing or issuance and to the application of the proceeds therefrom, as though made on and as of such date, other than any such representations or warranties that, by their terms, refer to a specific date other than the date of such Borrowing or issuance, in which case as of such specific date; and (ii) no event has occurred and is continuing, or would result from such Borrowing or issuance or from the application of the proceeds therefrom, that constitutes a Default; and (b) the Administrative Agent shall have received such other approvals, opinions or documents as any Appropriate Lender or the Issuing Bank through the Administrative Agent may reasonably request. SECTION 3.03. Determinations Under Section 3.01. For purposes of determining compliance with the conditions specified in Section 3.01, each Lender Party shall be deemed to have consented to, approved or accepted or to be satisfied with each document or other matter required thereunder to be consented to or approved by or acceptable or satisfactory to the Lender Parties unless an officer of the Administrative Agent responsible for the transactions contemplated by the Loan Documents shall have received notice from such Lender Party prior to the Third Restatement Date specifying its objection thereto and such Lender Party shall not have made available to the Administrative Agent such Lender Party's ratable portion of the Borrowing being made on the Third Restatement Date. -51- ARTICLE IV REPRESENTATIONS AND WARRANTIES SECTION 4.01. Representations and Warranties of the Borrower. The Borrower represents and warrants as follows: (a) Each Loan Party (i) is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, (ii) is duly qualified and in good standing as a foreign corporation in each other jurisdiction in which it owns or leases property or in which the conduct of its business requires it to so qualify or be licensed, except where the failure to so qualify or be licensed would not have a Material Adverse Effect and (iii) has all requisite corporate power and authority (including, without limitation, all governmental licenses, permits and other approvals) to own or lease and operate its properties and to carry on its business as now conducted and as proposed to be conducted. All of the outstanding capital stock of the Borrower has been validly issued, is fully paid and nonassessable and is owned by the Parent Guarantor free and clear of all Liens, except those created under the Collateral Documents. (b) Set forth on Schedule 4.01(b) hereto is a complete and accurate list of all Subsidiaries (including Foreign Subsidiaries) of each Loan Party, showing as of the Third Restatement Date (as to each such Subsidiary) the jurisdiction of its incorporation, the number of shares of each class of capital stock authorized, and the number outstanding on the Third Restatement Date, and the percentage of the outstanding shares of each such class owned (directly or indirectly) by such Loan Party and the number of shares covered by all outstanding options, warrants, rights of conversion or purchase and similar rights at the Third Restatement Date. All of the outstanding capital stock of all Subsidiaries of each Loan Party has been validly issued, is fully paid and nonassessable and is owned by such Loan Party or one or more of its Subsidiaries free and clear of all Liens, except those created under the Loan Documents. Each such Subsidiary (i) is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, (ii) is duly qualified and in good standing as a foreign corporation in each other jurisdiction in which it owns or leases property or in which the conduct of its business requires it to so qualify or be licensed, except where the failure to so qualify or be licensed would not have a Material Adverse Effect and (iii) has all requisite corporate power and authority (including, without limitation, all governmental licenses, permits and other approvals) to own or lease and operate its properties and to carry on its business as now conducted and as proposed to be conducted. (c) The execution, delivery and performance by each Loan Party of this Agreement, the Notes, each other Loan Document and each Related Document to which it is or is to be a party, and the consummation of the transactions contemplated hereby and thereby, are within such Loan Party's corporate powers, have been duly authorized by all necessary corporate action, and do not (i) contravene such Loan Party's charter or bylaws, (ii) violate any law (including, without limitation, the Securities Exchange Act of -52- 1934 and the Racketeer Influenced and Corrupt Organizations Chapter of the Organized Crime Control Act of 1970), rule, regulation (including, without limitation, Regulation X of the Board of Governors of the Federal Reserve System), order, writ, judgment, injunction, decree, determination or award, (iii) conflict with or result in the breach of, or constitute a default under, any material contract, loan agreement, indenture, mortgage, deed of trust, lease or other instrument binding on or affecting any Loan Party, any of its Subsidiaries or any of their properties or (iv) except for the Liens created under the Loan Documents, result in or require the creation or imposition of any Lien upon or with respect to any of the properties of any Loan Party or any of its Subsidiaries. No Loan Party or any of its Subsidiaries is in violation of any such law, rule, regulation, order, writ, judgment, injunction, decree, determination or award or in breach of any such contract, loan agreement, indenture, mortgage, deed of trust, lease or other instrument, the violation or breach of which could have a Material Adverse Effect. (d) No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or any other third party is required for (i) the due execution, delivery, recordation, filing or performance by any Loan Party of this Agreement, the Notes, any other Loan Document or any Related Document to which it is or is to be a party, or for the consummation of the transactions contemplated hereby and thereby, (ii) the grant by any Loan Party of the Liens granted by it pursuant to the Loan Documents, (iii) the perfection or maintenance of the Liens created by the Loan Documents (including the first priority nature thereof) or (iv) the exercise by any Agent or any Lender Party of its rights under the Loan Documents or the remedies in respect of the Collateral pursuant to the Collateral Documents, except for the filings made pursuant to the Security Agreement, all of which have been duly obtained, taken, given or made and are in full force and effect or will be taken or made immediately following the Third Restatement Date. All applicable waiting periods in connection with the transactions contemplated hereby and thereby have expired without any action having been taken by any competent authority restraining, preventing or imposing materially adverse conditions upon the rights of the Loan Parties or their Subsidiaries freely to transfer or otherwise dispose of, or to create any Lien on, any properties now owned or hereafter acquired by any of them. (e) This Agreement has been, and each of the Notes, each other Loan Document and each Related Document when delivered hereunder will have been, duly executed and delivered by each Loan Party party thereto. This Agreement is, and each of the Notes, each other Loan Document and each Related Document when delivered hereunder will be, the legal, valid and binding obligation of each Loan Party party thereto, enforceable against such Loan Party in accordance with its terms. (f) The Consolidated balance sheet of the Parent Guarantor and its Subsidiaries as at December 31, 1996, and the related Consolidated statements of income and cash flows of the Parent Guarantor and its Subsidiaries for the fiscal year then ended, accompanied by the report of Deloitte & Touche LLP, independent public accountants, and the Consolidated balance sheet of the Parent Guarantor and its Subsidiaries as at -53- September 30, 1997, and the related Consolidated statements of income and cash flows of the Parent Guarantor and its Subsidiaries for the nine months then ended, duly certified by the chief financial officer of the Parent Guarantor, copies of which have been furnished to each Lender Party, fairly present in all material respects, subject to the possible revenue recognition policy adjustments referred to in Schedule 4.01(f) and, in the case of said balance sheet as at September 30, 1997, and said statements of income and cash flows for the nine months then ended, to year-end audit adjustments, the Consolidated financial position of the Parent Guarantor and its Subsidiaries as at such dates and the Consolidated results of the operations of the Parent Guarantor and its Subsidiaries for the periods ended on such dates, respectively, all in accordance with generally accepted accounting principles applied on a consistent basis; and since December 31, 1996, there has been no Material Adverse Change. (g) The Consolidated forecasted balance sheets, income statements and cash flows statements of the Parent Guarantor and its Subsidiaries delivered to the Lender Parties pursuant to Section 3.01(f)(xii) or 5.03(e) were prepared in good faith on the basis of the assumptions stated therein, which assumptions were reasonable in the light of conditions existing at the time of delivery of such forecasts, and represented, at the time of delivery, the Parent Guarantor's best estimate of its future Consolidated financial performance. (h) None of the information, exhibits or reports furnished by or on behalf of any Loan Party to any Agent or any Lender Party in connection with the negotiation of the Loan Documents or pursuant to the terms of the Loan Documents when taken as a whole contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made therein not misleading. (i) There is no action, suit, investigation, litigation or proceeding affecting any Loan Party or any of its Subsidiaries, including any Environmental Action, pending or threatened before any court, governmental agency or arbitrator that (i) could reasonably be expected to have a Material Adverse Effect or (ii) purports to affect the legality, validity or enforceability of this Agreement, any Note, any other Loan Document or any Related Document or the consummation of the transactions contemplated hereby and thereby. (j) No proceeds of any Advance or drawings under any Letter of Credit will be used to acquire any equity security of a class that is registered pursuant to Section 12 of the Securities Exchange Act of 1934. (k) The Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying Margin Stock, and no proceeds of any Advance or drawings under any Letter of Credit will be used to purchase or carry any Margin Stock or to extend credit to others for the purpose of purchasing or carrying any Margin Stock. (l) Following application of the proceeds of each Advance or drawing under each Letter of Credit, not more than 25% of the value of the assets (either of the -54- Borrower only or of the Borrower and its Subsidiaries on a Consolidated basis), subject to the provisions of Section 5.02(a) or 5.02(d) or subject to any restriction contained in any agreement or instrument between the Borrower and any Lender Party or any Affiliate of any Lender Party relating to Debt and within the scope of Section 6.01(e) will be Margin Stock. (m) No ERISA Event has occurred or is reasonably expected to occur with respect to any Plan of any Loan Party or any of its ERISA Affiliates that has resulted in or is reasonably likely to result in a Material Adverse Effect. (n) Schedule B (Actuarial Information) to the most recently completed annual report (Form 5500 Series) for each Plan of any Loan Party or any of its ERISA Affiliates, if any, copies of which have been filed with the Internal Revenue Service and furnished to the Administrative Agent and each Lender Party, is complete and accurate and fairly presents the funding status of such Plan, and since the date of such Schedule B there has been no change in such funding status which could reasonably be expected to result in a Material Adverse Effect. (o) Neither any Loan Party nor any of its ERISA Affiliates has incurred or is reasonably expected to incur any Withdrawal Liability to any Multiemployer Plan which could reasonably be expected to result in a Material Adverse Effect. (p) Neither any Loan Party nor any of its ERISA Affiliates has been notified by the sponsor of a Multiemployer Plan of any Loan Party or any of its ERISA Affiliates that such Multiemployer Plan is in reorganization or has been terminated, within the meaning of Title IV of ERISA, and to the best knowledge of such Loan Party no such Multiemployer Plan is reasonably expected to be in reorganization or to be terminated, within the meaning of Title IV of ERISA. (q) The aggregate annualized cost (including, without limitation, the cost of insurance premiums) with respect to post-retirement benefits under Welfare Plans (other than as provided in Section 601 of ERISA) for which the Loan Parties and their Subsidiaries are liable could not reasonably be likely to result in a Material Adverse Effect. (r) Neither the business nor the properties of any Loan Party or any of its Subsidiaries are affected by any fire, explosion, accident, strike, lockout or other labor dispute, drought, storm, hail, earthquake, embargo, act of God or of the public enemy or other casualty that could have a Material Adverse Effect. (s) The operations of each Loan Party and each of its Subsidiaries and, to the best of its knowledge, the properties of such Loan Party or such Subsidiary comply in all material respects with all Environmental Laws, all necessary Environmental Permits have been obtained and are in effect for the operations and, to the best of its knowledge, the properties of each Loan Party and its Subsidiaries are in compliance in all material respects with all such Environmental Permits, and no circumstances exist that could (i) -55- form the basis of an Environmental Action against any Loan Party or any of its Subsidiaries or, to the best of its knowledge, any of their properties that could have a Material Adverse Effect or (ii) to the best of its knowledge, cause any such property to be subject to any restrictions on ownership, occupancy, use or transferability under any Environmental Law. (t) None of the properties currently or formerly owned or operated by any Loan Party or any of its Subsidiaries is listed or proposed for listing on the NPL or on the CERCLIS or any analogous foreign, state or local list or is adjacent to any such property; and no underground storage tanks, as such term is defined 42 U.S.C. ss. 6991, are located on any property currently or formerly owned or operated by any Loan Party or any of its Subsidiaries or, to the best of its knowledge, on any adjoining property; and no Hazardous Materials have been released, discharged or disposed of on any property currently or formerly owned or operated by any Loan Party or any of its Subsidiaries. (u) Neither any Loan Party nor any of its Subsidiaries has transported or arranged for the transportation of any Hazardous Materials to any location that is listed or proposed for listing on the NPL or on the CERCLIS or any analogous foreign, state or local list, and all Hazardous Materials generated, used, treated, handled or stored at, or transported to or from, any property currently or formerly owned or operated by any Loan Party or any of its Subsidiaries have been disposed of in a manner not reasonably expected to result in material liability to any Loan Party or any of its Subsidiaries. (v) Neither any Loan Party nor any of its Subsidiaries is a party to any indenture, loan or credit agreement or any lease or other agreement or instrument or subject to any charter or corporate restriction that could have a Material Adverse Effect. (w) The Collateral Documents create a valid and perfected first priority security interest (subject only to Permitted Liens) in all material respects in the Collateral taken as a whole, which security interest secures the payment of the Secured Obligations, and all filings and other actions necessary or desirable to perfect and protect such security interest have been duly taken. The Loan Parties are the legal and beneficial owners of the Collateral free and clear of any Lien, except for the liens and security interests created or permitted under the Loan Documents. (x) Each Loan Party and each of its Subsidiaries has filed, has caused to be filed or has been included in all material tax returns (Federal, state, local and foreign) required to be filed and has paid all taxes shown thereon to be due, together with applicable interest and penalties. (y) Set forth on Schedule 4.01(y) hereto is a complete and accurate list, as of the Third Restatement Date, of each taxable year of each Loan Party and each of its Subsidiaries for which Federal income tax returns have been filed and for which the expiration of the applicable statute of limitations for assessment or collection has not occurred by reason of extension or otherwise (an "Open Year"). -56- (z) Except as set forth on Schedule 4.01(z) hereto, as of the Third Restatement Date, no adjustment to the Federal income tax liability of any Loan Party or any of its Subsidiaries has been proposed by the Internal Revenue Service with respect to Open Years. Except as set forth on Schedule 4.01(z) hereto, no issues have been raised by the Internal Revenue Service in respect of Open Years that, in the aggregate, could have a Material Adverse Effect. (aa) As of the Third Restatement Date, except as set forth on Schedule 4.01(z) hereto and for which adequate reserves have been taken in accordance with GAAP, no adjustment to the state, local and foreign tax liability of any Loan Party or its Subsidiaries has been proposed by any state, local or foreign taxing authority with respect to any taxable period for which the applicable statute of limitations has not expired. No issues have been raised by such taxing authorities that, in the aggregate, could have a Material Adverse Effect. (bb) Each Loan Party is, individually and together with its Subsidiaries, Solvent. (cc) Immediately following the Third Restatement Date, there shall be no Existing Debt (other than Surviving Debt). (dd) Set forth on Schedule 3.01(d) hereto is a complete and accurate list of all Surviving Debt, showing as of the Third Restatement Date the principal amount outstanding thereunder. (ee) Except as set forth in Schedule 4.01(ee), no Loan Party or any of its Subsidiaries owns, as of the Third Restatement Date, any real property. (ff) Set forth in Schedule 4.01(ff) hereto is a complete and accurate list of all leases of real property under which any Loan Party or any of its Subsidiaries is the lessee, showing as of the Third Restatement Date the street address, county or other relevant jurisdiction, state, lessor, lessee, expiration date and annual rental cost thereof. Each such lease is the legal, valid and binding obligation of the lessor thereof, enforceable in accordance with its terms. (gg) Set forth on Schedule 4.01(gg) hereto is a complete and accurate list of all Investments held by any Loan Party or any of its Subsidiaries, showing as of the Third Restatement Date the amount, obligor or issuer and maturity, if any, thereof. (hh) Neither any Loan Party nor any of its Subsidiaries is an "investment company", or an "affiliated person" of, or "promoter" or "principal underwriter" for, an "investment company", as such terms are defined in the Investment Company Act of 1940, as amended. Neither the making of any Advances, nor the issuance of any Letter of Credit, nor the application of the proceeds or repayment thereof by the Borrower, nor the consummation of the other transactions contemplated hereby, will violate any provision -57- of such Act or any rule, regulation or order of the Securities and Exchange Commission thereunder. ARTICLE V COVENANTS OF THE BORROWER SECTION 5.01. Affirmative Covenants. So long as any Advance shall remain unpaid, any Letter of Credit shall be outstanding, any Hedge Agreement with any Hedge Bank shall be in effect or any Lender Party shall have any Commitment hereunder, the Borrower will: (a) Compliance with Laws, Etc. Comply, and cause each of its Subsidiaries to comply with all applicable laws, rules, regulations and orders, such compliance to include, without limitation, compliance with ERISA and the Racketeer Influenced and Corrupt Organizations Chapter of the Organized Crime Control Act of 1970, except, in any case where the failure to do so could not be reasonably expected to have a Material Adverse Effect. (b) Payment of Taxes, Etc. Pay and discharge, and cause each of its Subsidiaries to pay and discharge, before the same shall become delinquent, (i) all taxes, assessments and governmental charges or levies imposed upon it or upon its property and (ii) all lawful claims that, if unpaid, might by law become a Lien upon its property; provided, however, that neither the Borrower nor any of its Subsidiaries shall be required to pay or discharge any such tax, assessment, charge or claim that is being contested in good faith and by proper proceedings and as to which appropriate reserves are being maintained, unless and until any Lien resulting therefrom attaches to its property and becomes enforceable against its other creditors. (c) Compliance with Environmental Laws. Comply, and cause each of its Subsidiaries and all lessees and other Persons operating or occupying its properties to comply, in all material respects, with all applicable Environmental Laws and Environmental Permits; obtain and renew, and cause each of its Subsidiaries to obtain and renew, all Environmental Permits necessary for its operations and properties; and conduct, and cause each of its Subsidiaries to conduct, any investigation, study, sampling and testing, and undertake any cleanup, removal, remedial or other action necessary to remove and clean up all Hazardous Materials from any of its properties, in accordance with the requirements of all Environmental Laws; provided, however, that neither the Borrower nor any of its Subsidiaries shall be required to undertake any such cleanup, removal, remedial or other action to the extent that its obligation to do so is being contested in good faith and by proper proceedings and appropriate reserves are being maintained with respect to such circumstances. (d) Maintenance of Insurance. Maintain, and cause each of its Subsidiaries to maintain, insurance with responsible and reputable insurance companies or associations in such amounts and covering such risks as is usually carried by companies engaged in -58- similar businesses and owning similar properties in the same general areas in which the Borrower or such Subsidiary operates. (e) Preservation of Corporate Existence, Etc. Preserve and maintain, and cause each of its Subsidiaries to preserve and maintain, its corporate or legal existence, rights (charter and statutory), permits, licenses, approvals, privileges and franchises; provided, however, that the Borrower or any of its Subsidiaries may consummate any merger or consolidation permitted under Section 5.02(c). (f) Visitation Rights. At any reasonable time and from time to time, upon prior notice to the Borrower, permit the Administrative Agent or any Lender Party or any agents or representatives thereof, to examine and make copies of and abstracts from the records and books of account of, and visit the properties of, the Borrower and any of its Subsidiaries, and to discuss the affairs, finances and accounts of the Borrower and any of its Subsidiaries with any of their officers or directors and with their independent certified public accountants; provided, however, that a representative of MDC shall have the opportunity to accompany the Administrative Agent, such Lender Party or such agent or representative during any such visit. (g) Preparation of Environmental Reports. At the reasonable request of the Administrative Agent from time to time, provide to the Lender Parties within 60 days after such request, at the expense of the Borrower, an environmental site assessment report for any of its or its Subsidiaries' properties described in such request, prepared by an environmental consulting firm acceptable to the Administrative Agent, indicating the presence or absence of Hazardous Materials and the estimated cost of any compliance, removal or remedial action in connection with any Hazardous Materials on such properties; without limiting the generality of the foregoing, if the Administrative Agent determines at any time that a risk that could reasonably be expected to have a Material Adverse Effect exists and that any such report will not be provided within the time referred to above, the Administrative Agent may retain an environmental consulting firm to prepare such report at the expense of the Borrower, and the Borrower hereby grants and agrees to cause any Subsidiary that owns or operates any property described in such request to grant at the time of such request, to the Administrative Agent, the Lender Parties, such firm and any agents or representatives thereof, an irrevocable nonexclusive license, subject to the rights of tenants, to enter onto their respective properties to undertake such an assessment. (h) Keeping of Books. Keep, and cause each of its Subsidiaries to keep, proper books of record and account, in which full and correct entries shall be made of all material financial transactions and the assets and business of the Borrower and each such Subsidiary in accordance with generally accepted accounting principles in effect from time to time. (i) Maintenance of Properties, Etc. Maintain and preserve, and cause each of its Subsidiaries to maintain and preserve, on a basis consistent with current practices, all -59- of its material properties in good working order and condition, ordinary wear and tear excepted. (j) Compliance with Terms of Leaseholds. Make all payments (except such payments diligently contested in good faith) and otherwise perform all material obligations in respect of all leases of real property to which any Loan Party or any of its Subsidiaries is a party except, in any case, where the failure to do so, either individually or in the aggregate, could not be reasonably expected to have a Material Adverse Effect. (k) Performance of Related Documents. Perform and observe in all material respects all of the terms and provisions of each Related Document to be performed or observed by it, maintain each such Related Document in full force and effect, enforce such Related Document in accordance with its terms, take all such action to such end as may be from time to time reasonably requested by the Administrative Agent and, upon such request of the Administrative Agent, make to each other party to each such Related Document such demands and requests for information and reports or for action as the Borrower is entitled to make under such Related Document. (l) Transactions with Affiliates. Conduct, and cause each of its Subsidiaries to conduct, all transactions otherwise permitted under the Loan Documents with any of their Affiliates on terms that are fair and reasonable and no less favorable to the Borrower or such Subsidiary than it would obtain in a comparable arm's-length transaction with a Person not an Affiliate other than the transactions set forth on Schedule 5.01(l) hereto. (m) Covenant to Give Security. Upon the request of the Administrative Agent (i) following the occurrence and during the continuance of an Event of Default, and at the expense of the Borrower, (A) within ten days after such request, furnish to the Administrative Agent a description of the real and personal properties of the Borrower and its Subsidiaries in detail satisfactory to the Administrative Agent, (B) within 15 days after such request, duly execute and deliver to the Administrative Agent mortgages, pledges, assignments and other security agreements, as specified by and in form and substance satisfactory to the Administrative Agent, securing payment of all the Obligations of the Borrower under the Loan Documents and constituting Liens on all such properties, (C) within 30 days after such request, take whatever action (including, without limitation, the recording of mortgages, the filing of Uniform Commercial Code financing statements, the giving of notices and the endorsement of notices on title documents) as may be necessary or advisable in the opinion of the Administrative Agent to vest in the Administrative Agent (or in any representative of the Administrative Agent designated by it) valid and subsisting Liens on the properties purported to be subject to the security agreements delivered pursuant to this Section 5.01(m), enforceable against all third parties in accordance with their terms and (D) within 60 days after such request, deliver to the Administrative Agent a signed copy of a favorable opinion of counsel for the Borrower, addressed to the Administrative Agent and acceptable to the Administrative Agent, as to the matters contained in clauses (A), (B) and (C) above, as to such security agreements being legal, valid and binding obligations of the Borrower and -60- its Subsidiaries enforceable in accordance with their terms and as to such other matters as the Administrative Agent may reasonably request, and (ii) at any time and from time to time, promptly execute and deliver any and all further instruments and documents and take all such other action as the Administrative Agent may deem desirable in order to obtain or to preserve the full benefits of the Liens created under the Loan Documents, including, without limitation, (A) the execution and delivery of trust, trust deeds or mortgages with respect to any real property acquired by any Loan Party or any of its Subsidiaries, (B) a trademark, copyright and patent security agreement (as amended, supplemented or otherwise modified from time to time, the "Trademark, Copyright and Patent Security Agreement") in form and substance satisfactory to the Administrative Agent, duly executed by each Loan Party and its Subsidiaries, (C) a security agreement supplement in the form of Exhibit A to the Security Agreement, duly executed by each Subsidiary of the Borrower, (D) a Subsidiary Guaranty or Guaranty Supplement, as the case may be, duly executed by each Subsidiary of the Borrower and (E) using reasonable efforts to obtain consents and other agreements of lessors of real property and other third parties, and estoppel letters and other confirmations with respect to any real property of any Loan Party or any of its Subsidiaries, in each case in form and substance satisfactory to the Administrative Agent. (n) Interest Rate Hedging. Enter into on or prior to March 31, 1998, and maintain at all times thereafter, interest rate Hedge Agreements with Persons acceptable to the Administrative Agent, covering a notional amount of not less than $100,000,000 and providing for such Persons to make payments thereunder for a period of no less than two years from the Third Restatement Date to the extent increases in interest are greater than 2% above the Eurodollar Rate in effect on the Third Restatement Date for an Interest Period of three months. (o) Additional Loan Parties. Cause any newly organized or acquired Subsidiary of the Borrower (other than any Subsidiary organized or located outside of the United States) to execute and deliver to the Administrative Agent as promptly as practicable and in any event within 15 days after the organization or acquisition of such Subsidiary (i) a security agreement supplement in the form of Exhibit A to the Security Agreement, (ii) a subsidiary guaranty in form and substance satisfactory to the Administrative Agent (as amended, supplemented or otherwise modified from time to time, the "Subsidiary Guaranty") or a Guaranty Supplement (as defined in the Subsidiary Guaranty), as the case may be, and (iii) from time to time such other documents, agreements, certificates or instruments as the Administrative Agent may reasonably request, in each case in form and substance reasonably satisfactory to the Administrative Agent, and to take all such other actions that may be necessary or that the Administrative Agent may deem reasonably desirable in order to perfect and protect any pledge, assignment or security interest granted by such security agreement (granting a security interest in the receivables, inventory, deposit accounts, equipment, intellectual property and other assets of such Subsidiary) to the Administrative Agent for the benefit of the Lender Parties or to enable the Administrative Agent to exercise and enforce its rights and remedies thereunder. -61- SECTION 5.02. Negative Covenants. So long as any Advance shall remain unpaid, any Letter of Credit shall be outstanding, any Hedge Agreement with any Hedge Bank shall be in effect or any Lender Party shall have any Commitment hereunder, the Borrower will not, at any time: (a) Liens, Etc. Create, incur, assume or suffer to exist, or permit any of its Subsidiaries to create, incur, assume or suffer to exist, any Lien on or with respect to any of its properties of any character (including, without limitation, accounts) whether now owned or hereafter acquired, or sign, file or suffer to exist, or permit any of its Subsidiaries to sign, file or suffer to exist, under the Uniform Commercial Code of any jurisdiction, a financing statement that names the Borrower or any of its Subsidiaries as debtor, or sign or suffer to exist, or permit any of its Subsidiaries to sign or suffer to exist, any security agreement authorizing any secured party thereunder to file such financing statement, or assign, or permit any of its Subsidiaries to assign, any accounts or other right to receive income, excluding, however, from the operation of the foregoing restrictions, the following: (i) Liens created under the Loan Documents; (ii) Permitted Liens; (iii) Liens securing Debt in connection with the construction of a Health Club Facility as permitted by Section 5.02(b)(iii)(E); (iv) purchase money Liens upon or in any real property or equipment acquired or held by the Borrower or any of its Subsidiaries in the ordinary course of business to secure the purchase price of such real property or equipment or to secure Debt incurred solely for the purpose of financing the acquisition of any such real property or equipment to be subject to such Liens, or Liens existing on any such real property or equipment at the time of its acquisition (other than any such Liens created in contemplation of such acquisition that do not secure the purchase price), or extensions, renewals or replacements of any of the foregoing for the same or a lesser amount; provided, however, that no such Lien shall extend to or cover any property other than the property being acquired and no such extension, renewal or replacement shall extend to or cover any property not theretofore subject to the Lien being extended, renewed or replaced; (v) Liens arising in connection with Capitalized Leases, provided that no such Lien shall extend to or cover any Collateral; (vi) any interest or title of a lessor and any restriction or encumbrance to which the interest or title of such lessor may be subject that is incurred in the ordinary course of business; and (vii) bankers' liens and rights of setoff with respect to customary depository arrangements entered into in the ordinary course of business. -62- (b) Debt. Create, incur, assume or suffer to exist, or permit any of its Subsidiaries to create, incur, assume or suffer to exist, any Debt other than: (i) in the case of the Borrower, (A) Debt under the Loan Documents; (B) unsecured Debt incurred solely in connection with the acquisition of a Health Club Facility, the aggregate principal amount of which shall not exceed the cash purchase price of such acquisition plus the amount of any fees and expenses incurred solely in connection with such acquisition; provided that such Debt (1) is issued to the seller or sellers of such Health Club Facilities, (2) is subordinate to the Debt under the Loan Documents and such seller or sellers and the Borrower shall have executed and delivered to the Administrative Agent a subordination agreement, in substantially the form of Exhibit I hereto (a "Seller Subordination Agreement"), (3) has no scheduled principal amortization prior to the date which is six months after the Final Maturity Date, (4) provides that interest shall not exceed a rate of interest of 14 % per annum, of which cash interest shall not exceed a rate of interest per annum equal to the Base Rate in effect from time to time plus 2 % per annum (but in no event shall such cash interest exceed 12 % per annum), (5) shall provide that interest payments thereunder shall be made no more frequently than semi-annually and (6) provided further that, (x) as of the end of the most recently ended Monthly Rolling Period prior to the incurrence of such Debt and calculated immediately before and after giving effect to the incurrence of such Debt, the Parent Guarantor shall be in compliance with the Leverage Ratio set forth in Section 5.02(e)(v)(A) and the Administrative Agent shall have received a certificate of the chief financial officer of the Parent Guarantor, together with a schedule of computations used by the Parent Guarantor in determining such compliance, certifying such compliance, and (y) no Default shall have occurred and be continuing immediately before and after giving effect thereto; (C) Debt in respect of Hedge Agreements with one or more Hedge Banks in a notional amount of not more than $125,000,000; (D) Debt incurred in respect of an earnout or similar Obligation in connection with the acquisition of any Health Club Facility; (E) the Surviving Debt; and (F) Debt owed to any Subsidiary of the Borrower; provided, however, that such obligation (1) is subject to an intercompany subordination agreement in substantially the form of Exhibit K hereto (an "Intercompany Subordination Agreement"), duly executed by the Borrower and each such Subsidiary and (2) is evidenced by a promissory note in form and substance satisfactory to the Administrative Agent, which note shall be pledged under the terms of the -63- Collateral Documents to the Administrative Agent, on behalf of the Secured Parties, immediately upon its creation; (ii) in the case of any of its Subsidiaries, (A) Debt under the Subsidiary Guaranty; and (B) Debt owed to the Borrower by any Subsidiary of the Borrower so long as such Debt is evidenced by a promissory note in form and substance satisfactory to the Administrative Agent, which note shall be pledged under the terms of the Collateral Documents to the Administrative Agent, on behalf of the Secured Parties, immediately upon creation; (iii) in the case of the Borrower and any of its Subsidiaries, (A) Debt secured by Liens permitted by Section 5.02(a)(iv) and (v) and solely covering the acquisition of fitness equipment; (B) Debt secured by Liens permitted under Sections 5.02(a)(iv) and (v) (other than Debt incurred under Section 5.02(b)(iii)(A)) in an aggregate amount not to exceed $2,000,000 at any time outstanding and the amortization of which shall not exceed $300,000 during any 12-month period; (C) trade payables incurred in the ordinary course of business of the Borrower or such Subsidiary not overdue by more than 60 days or that are being diligently contested by the Borrower or such Subsidiary in good faith; (D) endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of business; and (E) other Debt in an aggregate amount not to exceed $5,000,000 at any time outstanding. (c) Mergers, Etc. Merge into or consolidate with any Person or permit any Person to merge into it, or permit any of its Subsidiaries to do so, except that (i) any Subsidiary of the Borrower may merge into or consolidate with any other Subsidiary of the Borrower so long as, in the case of any such merger or consolidation, the Person formed by or surviving such merger or consolidation shall be a wholly owned Subsidiary of the Borrower and (ii) any Subsidiary of the Borrower may merge into the Borrower; provided, however, that, in each case, immediately after giving effect thereto, no event or condition shall have occurred and be continuing that constitutes a Default and, in the case of any such merger to which the Borrower is a party, the Borrower is the surviving corporation. (d) Sales, Etc. of Assets. Sell, lease, transfer or otherwise dispose of, or permit any of its Subsidiaries to sell, lease, transfer or otherwise dispose of, any assets, or -64- grant any option or other right to purchase, lease or otherwise acquire any Collateral, except (i) sales of Inventory or Equipment in the ordinary course of its business; (ii) sales or other dispositions in a transaction authorized by Section 5.02(c); (iii) the sale and leaseback of real property or land for the sole purpose of acquiring Health Club Facilities; and (iv) sales of assets not otherwise permitted under this Section 5.02(d) for cash and for fair value in an aggregate amount not to exceed $1,000,000 in any fiscal year. (e) Investments in Other Persons. Make or hold, or permit any of its Subsidiaries to make or hold, any Investment in any Person other than: (i) Investments existing on the Third Restatement Date and set forth on Schedule 4.01(gg) hereto; (ii) Investments (A) by the Borrower and its Subsidiaries in Cash Equivalents provided that, to the extent such Investments in Cash Equivalents exceed $1,000,000 in aggregate principal amount at any time outstanding, the Administrative Agent may request, for the benefit of the Secured Parties, a valid perfected first priority security interest in such Cash Equivalents, and the Borrower shall take all such action as the Administrative Agent may deem necessary or desirable to perfect and protect such security interest and (B) by the Borrower in Hedge Agreements permitted to be maintained by Section 5.02(b)(i)(C); (iii) Investments consisting of travel advances, employee relocation advances and other advances to employees made in the ordinary course of business not to exceed $750,000 at any time outstanding; (iv) the Investment by the Borrower in Debt of the Parent Guarantor (A) evidenced by the Holdings Notes or (B) to advance money to the Parent Guarantor for the purposes permitted by Section 5.02(f); (v) Investments by the Borrower or any Subsidiary of the Borrower constituting Health Club Investments; provided that: (A) (1) with respect to any Health Club Investment constituting an acquisition of a Health Club Facility, in the event the aggregate acquisition purchase price (including the amount of any indebtedness refinanced or assumed, any earnout or similar Obligation in connection therewith, and all fees and expenses related thereto) represents 10% or more of the Consolidated assets of the Parent Guarantor and its Subsidiaries immediately before giving effect to such Health Club Investment, the Leverage Ratio as of the end of the most recently-ended Monthly Rolling Period prior to the date of such acquisition and calculated immediately before and after giving effect to such event, shall be not more than the ratio set forth below for such Monthly Rolling Period and the Administrative Agent shall have received a certificate of the chief financial officer of the Parent Guarantor certifying such compliance, together with a schedule in form -65- satisfactory to the Administrative Agent of the computations used by the Parent Guarantor in determining compliance therewith: Rolling Period Ending In the Leverage Fiscal Year Ending Ratio ------------------ ----- December 31, 1997 4.50 December 31, 1998 4.50 December 31, 1999 4.25 December 31, 2000 3.75 (2) with respect to any Health Club Investment constituting an acquisition of a Health Club Facility, in the event the aggregate acquisition purchase price (including the amount of any indebtedness refinanced or assumed, any earnout or similar Obligation in connection therewith, and all fees and expenses related thereto) represents 5 % or more of the Consolidated assets of the Parent Guarantor and its Subsidiaries immediately prior to giving effect to such Health Club Investment, such Health Club Facility shall have maintained a positive EBITDA during the most recent period of 12 consecutive months ended immediately prior to the date of its acquisition (such EBITDA may include Pro Forma Adjustments), and (3) with respect to any such Health Club Investment constituting the acquisition of a Health Club Facility, the aggregate acquisition purchase price (including the amount of any indebtedness refinanced or assumed, any earnout or similar Obligation in connection therewith, and all fees and expenses related thereto) shall not exceed, for any single transaction or a series of related transactions, 15 % of the Consolidated assets of the Parent Guarantor and its Subsidiaries immediately prior to giving effect to such Health Club Investment, unless such Health Club Investment shall have been approved in writing by the Required Lenders; and (B) with respect to Health Club Investments during any Restricted Capex Period the aggregate amount of such Health Club Investments (the "Restricted Capex Amount") shall not exceed an amount equal to the product of $75,000 multiplied by the number of Health Club Facilities operated by the Borrower and its Subsidiaries at the beginning of such Restricted Capex Period; provided, however, that if a Restricted Capex Period begins after January 1, 2000 such Restricted Capex Period shall end on December 31, 2000 and such Restricted Capex Amount shall be reduced to an amount equal to the product of (x) such Restricted Capex Amount multiplied by (y) a quotient equal to the number of days in such Restricted Capex Period divided by 360; (vi) Investments by the Borrower in connection with a Health Club Investment in any wholly owned Subsidiary of the Borrower which is or becomes a Subsidiary Guarantor; -66- (vii) Investments in any Person in an amount not to exceed in the aggregate $10,000,000 (including intercompany Debt issued by any Foreign Subsidiary to the Borrower or any of its wholly owned Subsidiaries) at any time outstanding shall have occurred and be continuing at the time of such Investment; and (viii) other Investments in any Person in the United States in an amount not to exceed $3,000,000 in the aggregate at any time outstanding. (f) Dividends, Etc. Declare or pay any dividends, purchase, redeem, retire, defease or otherwise acquire for value any of its capital stock or any warrants, rights or options to acquire such capital stock, now or hereafter outstanding, return any capital to its stockholders as such, make any distribution of assets, capital stock, warrants, rights, options, obligations or securities to its stockholders as such or issue or sell any capital stock or any warrants, rights or options to acquire such capital stock, or permit any of its Subsidiaries to do any of the foregoing or permit any of its Subsidiaries to purchase, redeem, retire, defease or otherwise acquire for value any capital stock of the Borrower or any warrants, rights or options to acquire such capital stock or to issue or sell any capital stock or any warrants, rights or options to acquire such capital stock, except that: (i) the Borrower may make distributions to the Parent Guarantor in order to permit the Parent Guarantor (A) to pay out-of-pocket expenses incurred in the ordinary course of business, (B) to make interest payments in accordance with the terms of the Holdings Notes and the other Debt of the Parent Guarantor described in Section 5.02(e)(iv) above so long as such interest payment is made concurrently with the distribution to the Parent Guarantor and is made by deposit to the Holdings Account, (C) to pay Mark S. Mastrov amounts owing to him under the terms of his employment, (D) to pay Gilbert K. Freeman amounts owing to him under the terms of his employment, (E) to pay fees and expenses in accordance with the terms of the MDC Management Agreement, (F) to make a $40,000,000 dividend payment to its shareholders on the Third Restatement Date and (G) to pay any tax liability of the Parent Guarantor which has become due and payable; (ii) any Subsidiary of the Borrower may declare and pay dividends or distributions in cash to the Borrower or to any Subsidiary of the Borrower; and (iii) shall have occurred and be continuing, (A) the Borrower may make distributions to the Parent Guarantor in order to permit the Parent Guarantor to repurchase shares of capital stock or options therefor of employees or former employees of the Parent Guarantor or any of its Subsidiaries, which distributions shall not exceed $1,000,000 in the aggregate in any 12-month period and (B) at any time following the delivery of the financial statements pursuant to Section 5.03(d) for the fiscal year ending December 31, 1997, the Borrower may make distributions to the Parent Guarantor to permit the Parent Guarantor to repurchase additional shares of capital stock or options therefor of employees or former employees of the Parent Guarantor or any of its Subsidiaries, provided that both before and after giving effect to each such -67- distribution, the Leverage Ratio at the end of the most recently-ended Monthly Rolling Period prior to such distribution shall not exceed 4.25: 1.00 in fiscal year 1998, 3.75: 1.00 in fiscal year 1999, 3.25: 1.00 in fiscal year 2000, 2.50:1 in fiscal year 2001, 2.25:1 in fiscal year 2002, 2.00:1 in fiscal year 2003, and 1.00:1 in fiscal year 2004 and the Administrative Agent shall have received a certificate of the chief financial officer of the Parent Guarantor, together with a schedule of computations used by the Parent Guarantor in determining such compliance, certifying such compliance; (g) Change in Nature of Business. Make, or permit any of its Subsidiaries to make, any material change in the nature of its business as carried on at the Third Restatement Date. (h) Charter Amendments. Amend, or permit any of its Subsidiaries to amend, its certificate of incorporation or bylaws if such amendment could impair the interests or rights of the Administrative Agent or the Lender Parties in any manner. (i) Accounting Changes. Make or permit, or permit any of its Subsidiaries to make or permit, any change in (i) accounting policies or reporting practices, except as required by the Securities and Exchange Commission or generally accepted accounting principles, including the possible revenue recognition adjustments referred to in Schedule 4.01(f) or (ii) its fiscal year. (j) Prepayments, Etc. of Debt. (i) Prepay, redeem, purchase, defease or otherwise satisfy prior to the scheduled maturity thereof in any manner, or make any payment in violation of any subordination terms of, any Debt, other than (A) the prepayment of the Advances in accordance with the terms of this Agreement or of any Debt payable to the Borrower, and (B) required prepayments or redemptions of Surviving Debt in accordance with the terms thereof or as otherwise permitted by Section 5.02(b) (other than with respect to any earnout or similar Obligation in connection with the acquisition of any Health Club Facility, the Subordinated Debt or any Seller Debt) or (ii) amend, modify or change in any manner any term or condition of any Surviving Debt which amendment, modification or change could adversely affect the interests or rights of any Agent or the Lender Parties, or permit any of its Subsidiaries to do any of the foregoing. (k) Amendment, Etc. of Related Documents. Cancel or terminate any Related Document or consent to or accept any cancellation or termination thereof, amend, modify or change in any manner any term or condition of any Related Document or give any consent, waiver or approval thereunder, waive any default under or any breach of any term or condition of any Related Document, agree in any manner to any other amendment, modification or change of any term or condition of any Related Document or take any other action in connection with any Related Document that would impair the value of the interest or rights of the Borrower thereunder or that would impair the rights or interests of any Agent or any Lender Party, or permit any of its Subsidiaries to do any of the foregoing. (l) Negative Pledge. Enter into or suffer to exist, or permit any of its Subsidiaries to enter into or suffer to exist, any agreement prohibiting or conditioning the creation or assumption of any Lien upon any of its property or assets other than any such agreement in favor of the -68- Secured Parties, except with regard to the specific assets referred to in Sections 5.02(a)(iii), (iv) and (v). (m) Partnerships. Become a general partner in any general or limited partnership, or permit any of its Subsidiaries to do so. (n) Speculative Transactions. Engage, or permit any of its Subsidiaries to engage, in any transaction involving commodity options or futures contracts or any similar speculative transactions (including, without limitation, take-or-pay contracts) except for Hedge Agreements permitted under Section 5.02(b)(i)(C). (o) Debt of Foreign Subsidiaries. Permit any Foreign Subsidiary to create, incur, assume or suffer to exist, any Debt, other than (i) Debt that is non-recourse to the Borrower and its Subsidiaries and (ii) Debt owed to the Borrower or any of its Subsidiaries so long as such Debt is evidenced by a promissory note in form and substance satisfactory to the Administrative Agent, which note shall be pledged under the terms of the Collateral Documents to the Administrative Agent, on behalf of the Secured Parties. SECTION 5.03. Reporting Requirements. So long as any Advance shall remain unpaid, any Letter of Credit shall be outstanding, any Hedge Agreement with any Hedge Bank shall be in effect or any Lender Party shall have any Commitment hereunder, the Borrower will furnish to the Lender Parties: (a) Default and Prepayment Notices. (i) Promptly after the Borrower has knowledge of the occurrence of any Default which is continuing, a statement of the chief financial officer of the Borrower setting forth details of such Default and the action that the Borrower has taken and proposes to take with respect thereto, and (ii) as soon as possible and in any event no later than 1:00 P.M. (New York City time) at least three Business Days before any prepayment of Term Advances is to be made by the Borrower pursuant to Section 2.06 (the "Prepayment Date"), written notice of the principal amount of such prepayment (the "Prepayment Amount") and the applicable Prepayment Date. Each such notice (a "Prepayment Notice") shall be by telex or telecopier or otherwise as provided in Section 8.02. (b) Monthly Financials. As soon as available and in any event within 30 days after the end of each month, a Consolidated balance sheet of the Parent Guarantor and its Subsidiaries as of the end of such month and Consolidated statement of income and cash flows of the Parent Guarantor and its Subsidiaries for the period commencing at the end of the previous month and ending with the end of such month and commencing with the end of the previous fiscal year and ending with the end of such month, setting forth in each case in comparative form the corresponding figures for the corresponding period of the preceding year, all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer of the Parent Guarantor as having been prepared in accordance with GAAP, together with (i) a certificate of said officer stating that no Default has occurred and is continuing or, if a Default has occurred and is continuing, a statement as to the nature thereof and the action that the Parent Guarantor or -69- Borrower has taken and proposes to take with respect thereto and (ii) in the event of any change from GAAP in the generally accepted accounting principles used in the preparation of such financial statements, a statement of reconciliation conforming such financial statements to GAAP. (c) Quarterly Financials. As soon as available and in any event within 45 days after the end of each of the first three quarters of each fiscal year of the Parent Guarantor, a Consolidated balance sheet of the Parent Guarantor and its Subsidiaries as of the end of such quarter and Consolidated statement of income and cash flows of the Parent Guarantor and its Subsidiaries for the period commencing at the end of the previous fiscal quarter and ending with the end of such quarter and commencing with the end of the previous fiscal year and ending with the end of such quarter, setting forth in each case in comparative form the corresponding figures for the corresponding period of the preceding fiscal year, all in reasonable detail and duly certified (subject to year-end audit adjustments) by the chief financial officer of the Parent Guarantor as having been prepared in accordance with GAAP, together with (i) a certificate of said officer stating that no Default has occurred and is continuing or, if a Default has occurred and is continuing, a statement as to the nature thereof and the action that the Parent Guarantor or Borrower has taken and proposes to take with respect thereto, (ii) in the event of any change from GAAP in the generally accepted accounting principles used in the preparation of such financial statements, a statement of reconciliation conforming such financial statements to GAAP and (iii) a schedule in form satisfactory to the Administrative Agent of the computations used by the Parent Guarantor in determining compliance with the covenants contained in Sections 5.02(e)(v) and 5.04. (d) Annual Financials. As soon as available and in any event within 90 days after the end of each fiscal year of the Parent Guarantor, a copy of the annual audit report for such year for the Parent Guarantor and its Subsidiaries, including therein a Consolidated balance sheet of the Parent Guarantor and its Subsidiaries as of the end of such fiscal year and Consolidated statement of income and cash flows of the Parent Guarantor and its Subsidiaries for such fiscal year, in each case accompanied by the unqualified opinion of Deloitte & Touche LLP or other independent public accountants of recognized standing acceptable to the Required Lenders, together with (i) a separate report on compliance with contractual provisions related to audited financial statements of such accounting firm to the Lender Parties stating that in the course of the regular audit of the financial statements of the Parent Guarantor and its Subsidiaries, which audit was conducted by such accounting firm in accordance with generally accepted auditing standards, such accounting firm has obtained no knowledge that, with respect to financial and accounting matters pursuant to Sections 5.04(b) and (c) as of the date of their audit, a Default has occurred and is continuing or, if such accounting firm is aware that a Default has occurred and is continuing, a statement as to the nature thereof, (ii) a schedule prepared by the chief financial officer of the Parent Guarantor in form satisfactory to the Administrative Agent of the computations used by the Parent Guarantor in determining, as of the end of such fiscal year, compliance with the covenants contained in Sections 5.02(e)(v) and 5.04, (iii) a certificate of the chief financial officer of the Parent Guarantor -70- stating that no Default has occurred and is continuing or, if a Default has occurred and is continuing, a statement as to the nature thereof and the action that the Parent Guarantor or Borrower has taken and proposes to take with respect thereto and (iv) in the event of any change from GAAP in the generally accepted accounting principles used in the preparation of such financial statements, a statement of reconciliation conforming such financial statements to GAAP. (e) Annual Forecasts. As soon as available and in any event no later than 15 days after the end of each fiscal year of the Parent Guarantor, forecasts prepared by management of the Parent Guarantor, in form satisfactory to the Administrative Agent, of balance sheets, income statements and cash flow statements on a monthly basis for such fiscal year and on an annual basis for the shorter period of (i) the four fiscal years thereafter, and (ii) each fiscal year thereafter until the Final Maturity Date. (f) ERISA Events. Promptly and in any event within 20 Business Days after any Loan Party or any of its ERISA Affiliates knows or has reason to know that any ERISA Event with respect to any Loan Party or any of its ERISA Affiliates has occurred, a statement of the chief financial officer of the Borrower describing such ERISA Event and the action, if any, that such Loan Party or such ERISA Affiliate has taken and proposes to take with respect thereto. (g) Plan Terminations. Promptly and in any event within 20 Business Days after receipt thereof by any Loan Party or any of its ERISA Affiliates, copies of each notice from the PBGC stating its intention to terminate any Plan of any Loan Party or any of its ERISA Affiliates or to have a trustee appointed to administer any such Plan in either case pursuant to Section 4042 of ERISA. (h) Plan Annual Reports. Promptly and in any event within 20 Business Days after a request by the Administrative Agent or any Lender, copies of each Schedule B (Actuarial Information) to the annual report (Form 5500 Series) most recently filed with the Internal Revenue Service with respect to each Plan of each Loan Party or any of its ERISA Affiliates. (i) Multiemployer Plan Notices. Promptly and in any event within five Business Days after receipt thereof by any Loan Party or any of its ERISA Affiliates from the sponsor of a Multiemployer Plan of any Loan Party or any of its ERISA Affiliates, copies of each notice concerning (i) the imposition of Withdrawal Liability by any such Multiemployer Plan, (ii) the reorganization or termination, within the meaning of Title IV of ERISA, of any such Multiemployer Plan or (iii) the amount (if such amount is known by the Borrower) of liability incurred, or that may be incurred, by such Loan Party or any of its ERISA Affiliates in connection with any event described in clause (i) or (ii). (j) Litigation. Promptly after the commencement thereof, notice of all actions, suits, investigations, litigation and proceedings before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, -71- affecting any Loan Party or any of its Subsidiaries or any of their properties of the type described in Section 4.01(i). (k) Securities Reports. Promptly after the sending or filing thereof, copies of all proxy statements, financial statements and reports that any Loan Party or any of its Subsidiaries sends to its stockholders, and copies of all regular, periodic and special reports, and all registration statements, that any Loan Party or any of its Subsidiaries files with the Securities and Exchange Commission or any governmental authority that may be substituted therefor, or with any national securities exchange. (l) Creditor Reports. Promptly after the furnishing thereof, copies of any statement or report furnished to any other holder of the securities of any Loan Party or of any of its Subsidiaries pursuant to the terms of any indenture, loan or credit or similar agreement and not otherwise required to be furnished to the Lender Parties pursuant to any other clause of this Section 5.03. (m) Agreement Notices. Promptly upon receipt thereof, copies of all material notices, requests and other documents received by any Loan Party or any of its Subsidiaries under or pursuant to any Related Document or indenture, loan or credit or similar agreement, and copies of any amendment, modification or waiver of any provision of any Related Document or indenture, loan or credit or similar agreement and, from time to time upon request by the Administrative Agent, such information and reports regarding the Related Documents as the Administrative Agent or any Lender Party through the Administrative Agent may reasonably request. (n) Revenue Agent Reports. Within 10 days after receipt, copies of all Revenue Agent Reports (Internal Revenue Service Form 886), or other written proposals of the Internal Revenue Service, that propose, determine or otherwise set forth positive adjustments to the Federal income tax liability of the affiliated group (within the meaning of Section 1504(a)(1) of the Internal Revenue Code) of which the Borrower is a member aggregating $200,000 or more. (o) Environmental Conditions. Promptly after having actual knowledge thereof, notice of any condition or occurrence on any property of any Loan Party or any of its Subsidiaries that results in a material noncompliance by any Loan Party or any of its Subsidiaries with any Environmental Law or Environmental Permit or could (i) form the basis of an Environmental Action against any Loan Party or any of its Subsidiaries or such property that could have a Material Adverse Effect or (ii) cause any such property to be subject to any restrictions on ownership, occupancy, use or transferability under any Environmental Law. (p) Real Property. As soon as available and in any event within 60 days after the end of each fiscal year, a report identifying all owned or leased real property disposed of or no longer used by the Borrower or any of its Subsidiaries during such fiscal year, a list and description (including the street address, county or other relevant jurisdiction, state, record owner, book value thereof and, in the case of leases of property, lessor, -72- lessee, expiration date and annual rental cost thereof) of all real property acquired or leased during such fiscal year and such other information as may be requested by the Administrative Agent with respect thereto. (q) Other Information. Such other information respecting the business, condition (financial or otherwise), operations, performance, properties or prospects of any Loan Party or any of its Subsidiaries (including Foreign Subsidiaries) as any Lender Party (through the Administrative Agent) may from time to time reasonably request. SECTION 5.04. Financial Covenants. So long as any Advance shall remain unpaid, any Letter of Credit shall be outstanding, any Hedge Agreement with any Hedge Bank shall be in effect or any Lender Party shall have any Commitment hereunder, the Parent Guarantor will: (a) Leverage Ratio. Maintain on a Consolidated basis for itself and its Subsidiaries a Leverage Ratio for each Quarterly Rolling Period set forth below of not more than the amount set forth below for such Rolling Period: Quarterly Rolling Period Ending In Ratio ---------------------------------- ----- Initial Extension of Credit to December 31, 1997 4.75:1.00 January 1, 1998 to December 31, 1998 4.75:1.00 January 1, 1999 to December 31, 1999 4.50:1.00 January 1, 2000 to December 31, 2000 4.00:1.00 January 1, 2001 to December 31, 2001 3.50:1.00 January 1, 2002 to December 31, 2002 3.25:1.00 January 1, 2003 to December 31, 2003 3.00:1.00 January 1, 2004 to December 31, 2004 2.00:1.00 (b) Interest Coverage Ratio. Maintain on a Consolidated basis for itself and its Subsidiaries an Interest Coverage Ratio for each Quarterly Rolling Period set forth below of not less than the amount set forth below for such Rolling Period: Quarterly Rolling Period Ending In Ratio ---------------------------------- ----- Initial Extension of Credit to December 31, 1997 2.25 January 1, 1998 to December 31, 1998 2.25 January 1, 1999 to December 31, 1999 2.50 January 1, 2000 to December 31, 2000 2.75 January 1, 2001 to December 31, 2001 3.00 -73- January 1, 2002 to December 31, 2002 3.25 January 1, 2003 to December 31, 2003 3.50 January 1, 2004 to December 31, 2004 3.75 (c) Fixed Charge Coverage Ratio. Maintain on a Consolidated basis for itself and its Subsidiaries a Fixed Charge Coverage Ratio for each Quarterly Rolling Period hereinafter of not less than 1.75:1.00. ARTICLE VI EVENTS OF DEFAULT SECTION 6.01. Events of Default. If any of the following events ("Events of Default") shall occur and be continuing: (a) the Borrower shall fail to pay any principal of, or interest on, any Advance, or any Loan Party shall fail to make any other payment under any Loan Document, in each case when the same becomes due and payable; or (b) any representation or warranty made by any Loan Party (or any of its officers) under or in connection with any Loan Document shall prove to have been incorrect in any material respect when made; or (c) the Borrower shall fall to perform or observe any term, covenant or agreement contained in Section 2.14, 5.01(b), 5.01(d), 5.01(e), 5.01(f), 5.01(g), 5.01(h), 5.01(j), 5.01(l), 5.01(m), 5.01(n), 5.01(o), 5.02, 5.03 or 5.04; or (d) any Loan Party shall fail to perform any other term, covenant or agreement contained in any Loan Document on its part to be performed or observed if such failure shall remain unremedied for 15 days after such Loan Party has actual knowledge thereof; or (e) any Loan Party or any of its Subsidiaries shall fall to pay any principal of, premium or interest on or any other amount payable in respect of any Debt that is outstanding in a principal or notional amount of at least $1,000,000 in the aggregate (but excluding Debt outstanding hereunder) of such Loan Party or such Subsidiary (as the case may be), when the same becomes due and payable (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise); or any other event shall occur or condition shall exist under any agreement or instrument relating to any such Debt, if the effect of such event or condition is to accelerate, or to permit the acceleration of, the maturity of such Debt or otherwise to cause, or to permit the holder thereof to cause, such Debt to mature; or any such Debt shall be declared to be due and payable or required to be prepaid or redeemed (other than by a regularly scheduled required prepayment or redemption), purchased or defeased, or an offer to prepay, redeem, purchase or defease -74- such Debt shall be required to be made, in each case prior to the stated maturity thereof; or (f) any Loan Party or any of its Subsidiaries shall generally not pay its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, or shall make a general assignment for the benefit of creditors; or any proceeding shall be instituted by or against any Loan Party or any of its Subsidiaries seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, or other similar official for it or for any substantial part of its property and, in the case of any such proceeding instituted against it (but not instituted by it) that is being diligently contested by it in good faith, either such proceeding shall remain undismissed or unstayed for a period of 30 days or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against, or the appointment of a receiver, trustee, custodian or other similar official for, it or any substantial part of its property) shall occur; or any Loan Party or any of its Subsidiaries shall take any corporate action to authorize any of the actions set forth above in this subsection (f); or (g) any one or more judgments or orders for the payment of money that, either individually or in the aggregate, exceed $1,000,000 shall be rendered against any Loan Party or any of its Subsidiaries and either (i) enforcement proceedings shall have been commenced by any creditor upon such judgment or order or (ii) there shall be any period of 10 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; or (h) any nonmonetary judgment or order shall be rendered against any Loan Party or any of its Subsidiaries that could be reasonably likely to have a Material Adverse Effect, and there shall be any period of 10 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; or (i) any material provision of any Loan Document after delivery thereof pursuant to Section 3.01, 5.01(m) or 5.01(o) shall for any reason cease to be valid and binding on or enforceable against any Loan Party to it, or any such Loan Party shall so state in writing; or (j) any Collateral Document after delivery thereof pursuant to Sections 3.01, 5.01(m) or 5.01(o) shall for any reason (other than pursuant to the terms thereof) cease to create a valid and perfected first priority lien on and security interest in any material Collateral purported to be covered thereby; or (k) (i) any Person or two or more Persons acting in concert other than the Equity Investors shall have acquired beneficial ownership (within the meaning of Rule 13d-3 of the Securities and Exchange Commission under the Securities Exchange Act of -75- 1934), directly or indirectly, of Voting Stock of the Parent Guarantor (or other securities convertible into such Voting Stock) representing 35 % or more of the combined voting power of all Voting Stock of the Parent Guarantor; or (ii) the MDC Investors shall for any reason own, directly or indirectly, in the aggregate a lesser percentage of the combined voting power of all Voting Stock of the Parent Guarantor than any other holder of such Voting Stock of the Parent Guarantor; or (iii) the first day on which a majority of the members of the Board of Directors of the Parent Guarantor are not Continuing Directors; or (iv) any Person or two or more Persons acting in concert other than the Equity Investors shall have acquired by contract or otherwise, or shall have entered into a contract or arrangement that, upon consummation, will result in its or their acquisition of the power to exercise, directly or indirectly, a controlling influence over the management or policies of the Parent Guarantor; or (l) any ERISA Event shall have occurred with respect to a Plan of any Loan Party or any of its ERISA Affiliates and such ERISA Event could reasonably be expected to have a Material Adverse Effect; or (m) any Loan Party or any of its ERISA Affiliates shall have been notified by the sponsor of a Multiemployer Plan of any Loan Party or any of its ERISA Affiliates that it has incurred Withdrawal Liability to such Multiemployer Plan in an amount that could reasonably be expected to have a Material Adverse Effect; or (n) any Loan Party or any of its ERISA Affiliates shall have been notified by the sponsor of a Multiemployer Plan of any Loan Party or any of its ERISA Affiliates that such Multiemployer Plan is in reorganization or is being terminated, within the meaning of Title IV of ERISA, and as a result of such reorganization or termination the aggregate annual contributions of the Loan Parties and their ERISA Affiliates to all Multiemployer Plans that are then in reorganization or being terminated have been or will be increased by an amount that could reasonably be expected to have a Material Adverse Effect; then, and in any such event, the Administrative Agent (i) shall at the request, or may with the consent, of the Required Lenders, by notice to the Borrower, declare the obligation of each Appropriate Lender to make Advances (other than Letter of Credit Advances by the Issuing Bank or a Working Capital Lender pursuant to Section 2.03(c) and Swing Line Advances by the Swing Line Bank or a Working Capital Lender pursuant to Section 2.02(b)) and of the Issuing Bank to issue Letters of Credit to be terminated, whereupon the same shall forthwith terminate, and (ii) shall at the request, or may with the consent, of the Required Lenders (A) by notice to the Borrower, declare the Notes, all interest thereon and all other amounts payable under this Agreement and the other Loan Documents to be forthwith due and payable, whereupon the Notes, all such interest and all such amounts shall become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrower, and (B) by notice to each party required under the terms of any agreement in support of which a Standby Letter of Credit is issued, request that all Obligations under such agreement be declared to be due and payable; provided, however, that, in -76- the event of an actual or deemed entry of an order for relief with respect to any Loan Party or any of its Subsidiaries under the Federal Bankruptcy Code, (x) the obligation of each Lender to make Advances (other than Letter of Credit Advances by the Issuing Bank or a Working Capital Lender pursuant to Section 2.03(c) and Swing Line Advances by the Swing Line Bank or a Working Capital Lender pursuant to Section 2.02(b)) and of the Issuing Bank to issue Letters of Credit shall automatically be terminated and (y) the Notes, all such interest and all such other amounts shall automatically become and be due and payable, without presentment, demand, protest or any notice of any kind, all of which are hereby expressly waived by the Borrower. SECTION 6.02. Actions in Respect of the Letters of Credit upon Default. If any Event of Default shall have occurred and be continuing, the Administrative Agent may, and upon the request of the Required Lenders, shall, irrespective of whether it is taking any of the actions described in Section 6.01 or otherwise, make demand upon the Borrower to, and forthwith upon such demand the Borrower will, pay to the Administrative Agent on behalf of the Lender Parties in same day funds at the Administrative Agent's office designated in such demand, for deposit in the L/C Cash Collateral Account, an amount equal to the aggregate Available Amount of all Letters of Credit then outstanding. If at any time the Administrative Agent determines that any funds held in the L/C Cash Collateral Account are subject to any right or claim of any Person other than the Administrative Agent and the Lender Parties or that the total amount of such funds is less than the aggregate Available Amount of all Letters of Credit, the Borrower will, forthwith upon demand by the Administrative Agent, pay to the Administrative Agent, as additional funds to be deposited and held in the L/C Cash Collateral Account, an amount equal to the excess of (a) such aggregate Available Amount over (b) the total amount of funds, if any, then held in the L/C Cash Collateral Account that the Administrative Agent determines to be free and clear of any such right and claim. ARTICLE VII THE AGENTS SECTION 7.01. Authorization and Action. Each Lender Party (in its capacities as a Lender and, to the extent applicable, the Issuing Bank, the Swing Line Bank and a potential Hedge Bank) hereby appoints and authorizes the Administrative Agent to take such action as agent on its behalf and to exercise such powers and discretion under this Agreement and the other Loan Documents as are delegated to the Administrative Agent by the terms hereof and thereof, together with such powers and discretion as are reasonably incidental thereto. As to any matters not expressly provided for by the Loan Documents (including, without limitation, enforcement or collection of the Notes), the Administrative Agent shall not be required to exercise any discretion or take any action, but shall be required to act or to refrain from acting (and shall be fully protected in so acting or refraining from acting) upon the instructions of the Required Lenders, and such instructions shall be binding upon all Lender Parties and all holders of Notes; provided, however, that the Administrative Agent shall not be required to take any action that exposes the Administrative Agent to personal liability or that is contrary to this -77- Agreement or applicable law. The Administrative Agent agrees to give to each Lender Party prompt notice of each notice given to it by the Borrower pursuant to the terms of this Agreement. SECTION 7.02. Agents' Reliance, Etc. None of the Agents nor any of their respective directors, officers, agents or employees shall be liable for any action taken or omitted to be taken by it or them under or in connection with the Loan Documents, except for its or their own gross negligence or willful misconduct. Without limitation of the generality of the foregoing, each Agent: (a) may treat the payee of any Note as the holder thereof until the Administrative Agent receives and accepts an Assignment and Acceptance entered into by the Lender that is the payee of such Note, as assignor, and an Eligible Assignee, as assignee, as provided in Section 8.07; (b) may consult with legal counsel (including counsel for any Loan Party), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken in good faith by it in accordance with the advice of such counsel, accountants or experts; (c) makes no warranty or representation to any Lender Party and shall not be responsible to any Lender Party for any statements, warranties or representations (whether written or oral) made in or in connection with the Loan Documents; (d) shall not have any duty to ascertain or to inquire as to the performance or observance of any of the terms, covenants or conditions of any Loan Document on the part of any Loan Party or to inspect the property (including the books and records) of any Loan Party; (e) shall not be responsible to any Lender Party for the due execution, legality, validity, enforceability, genuineness, sufficiency or value of, or the perfection or priority of any lien or security interest created or purported to be created under or in connection with, any Loan Document or any other instrument or document furnished pursuant thereto; (f) shall incur no liability under or in respect of any Loan Document by acting upon any notice, consent, certificate or other instrument or writing (which may be by telegram, telecopy or telex) believed by it to be genuine and signed or sent by the proper party or parties; and (g) shall incur no liability as a result of any determination whether the transactions contemplated by the Loan Documents constitute a "highly leveraged transaction" within the meaning of the interpretations issued by the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System. SECTION 7.03. Each Agent and Affiliates. With respect to its Commitments, the Advances made by it and the Notes issued to it, each Agent shall have the same rights and powers under the Loan Documents as any other Lender Party and may exercise the same as though it were not an Agent; and the term "Lender Party" or "Lender Parties" shall, unless otherwise expressly indicated, include each Agent in its individual capacity. Each of the Agents and its respective affiliates may accept deposits from, lend money to, act as trustee under indentures of, accept investment banking engagements from and generally engage in any kind of business with, any Loan Party, any of its Subsidiaries (including Foreign Subsidiaries) and any Person who may do business with or own securities of any Loan Party or any such Subsidiary (including Foreign Subsidiaries), all as if such Agent were not an Agent and without any duty to account therefor to the Lender Parties. SECTION 7.04. Lender Party Credit Decision. Each Lender Party acknowledges that it has, independently and without reliance upon any Agent or any other Lender Party and based on the financial statements referred to in Section 4.01 and such other documents and -78- information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon any Agent or any other Lender Party and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement. SECTION 7.05. Indemnification. (a) Each Lender Party severally agrees to indemnify each Agent (to the extent not promptly reimbursed by the Borrower) from and against such Lender Party's ratable share (determined as provided below) of any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever (including, without limitation, reasonable fees and expenses of counsel) that may be imposed on, incurred by, or asserted against such Agent in any way relating to or arising out of the Loan Documents or any action taken or omitted by such Agent under the Loan Documents (collectively, the "Indemnified Costs"); provided, however, that no Lender Party shall be liable for any portion of such Indemnified Costs resulting from such Agent's gross negligence or willful misconduct. Without limitation of the foregoing, each Lender Party agrees to reimburse each Agent promptly upon demand for its ratable share of any costs and expenses (including, without limitation, fees and expenses of counsel) payable by the Borrower under Section 8.04, to the extent that such Agent is not promptly reimbursed for such costs and expenses by the Borrower. For purposes of this Section 7.05(a), the Lender Parties' respective ratable shares of any amount shall be determined, at any time, according to the sum of (i) the aggregate principal amount of the Advances outstanding at such time and owing to the respective Lender Parties, (ii) their respective Pro Rata Shares of the aggregate Available Amount of all Letters of Credit outstanding at such time, (iii) the aggregate unused portions of their Term A Commitments and Term B Commitments at such time and (iv) their respective Unused Working Capital Commitments at such time, provided that the aggregate principal amount of Swing Line Advances owing to any Swing Line Bank and of Letter of Credit Advances owing to any Issuing Bank shall be considered to be owed to the Working Capital Lenders ratably in accordance with their respective Working Capital Commitments. In the case of any investigation, litigation or proceeding giving rise to any Indemnified Costs, this Section 7.05 applies whether any such investigation, litigation or proceeding is brought by any Agent, any Lender, any other Lender Party or a third party. The failure of any Lender Party to reimburse any Agent promptly upon demand for its ratable share of any amount required to be paid by the Lender Parties to such Agent as provided herein shall not relieve any other Lender Party of its obligation hereunder to reimburse such Agent for its ratable share of such amount, but no Lender Party shall be responsible for the failure of any other Lender Party to reimburse such Agent for such other Lender Party's ratable share of such amount. Without prejudice to the survival of any other agreement of any Lender Party hereunder, the agreement and obligations of each Lender Party contained in this Section 7.05(a) shall survive the payment in full of principal, interest and all other amounts payable hereunder and under the other Loan Documents. (b) Each Lender Party severally agrees to indemnify the Issuing Bank (to the extent not promptly reimbursed by the Borrower) from and against such Lender Party's ratable share (determined as provided below) of any and all liabilities, obligations, losses, damages, penalties, actions, judgements, suits, costs, expenses or disbursements of any kind or nature whatsoever -79- that may be imposed on, incurred by, or asserted against the Issuing Bank in any way relating to or arising out of the Loan Documents or any action taken or omitted by the Issuing Bank under the Loan Documents; provided, however, that no Lender Party shall be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgements, suits, costs, expenses or disbursements resulting from the Issuing Bank's gross negligence or willful misconduct. Without limitation of the foregoing, each Lender Party agrees to reimburse the Issuing Bank promptly upon demand for its ratable share of any costs and expenses (including, without limitation, fees and expenses of counsel) payable by the Borrower under Section 8.04, to the extent that the Issuing Bank is not promptly reimbursed for such costs and expenses by the Borrower. For purposes of this Section 7.05(b), the Lender Parties' respective ratable shares of any amount shall be determined, at any time, according to the sum of (i) the aggregate principal amount of the Advances outstanding at such time and owing to the respective Lender Parties, (ii) their respective Pro Rata Shares of the aggregate Available Amount of all Letters of Credit outstanding at such time, (iii) the aggregate unused portions of their respective Term A Commitments and Term B Commitments at such time plus (iv) their respective Unused Working Capital Commitments at such time; provided that the aggregate principal amount of Swing Line Advances owing to any Swing Line Bank and of Letter of Credit Advances owing to any Issuing Bank shall be considered to be owed to the Working Capital Lenders ratably in accordance with their respective Working Capital Commitments. In the case of any investigation, litigation or proceeding giving rise to any Indemnified Costs, this Section 7.05 applies whether any such investigation, litigation or proceeding is brought by any Agent, any Lender, any other Lender Party or a third party. The failure of any Lender Party to reimburse the Issuing Bank promptly upon demand for its ratable share of any amount required to be paid by the Lender Parties to the Issuing Bank as provided herein shall not relieve any other Lender Party of its obligation hereunder to reimburse the Issuing Bank for its ratable share of such amount, but no Lender Party shall be responsible for the failure of any other Lender Party to reimburse the Issuing Bank for such other Lender Party's ratable share of such amount. Without prejudice to the survival of any other agreement of any Lender Party hereunder, the agreement and obligations of each Lender Party contained in this Section 7.05(b) shall survive the payment in full of principal, interest and all other amounts payable hereunder and under the other Loan Documents. SECTION 7.06. Successor Agents. (a) The Administrative Agent may resign as to any or all of the Facilities at any time by giving written notice thereof to the Lender Parties and the Borrower. Upon any such resignation, the Required Lenders shall have the right to appoint a successor Administrative Agent as to such of the Facilities as to which such Agent has resigned. If no successor Administrative Agent shall have been so appointed by the Required Lenders, and shall have accepted such appointment, within 30 days after the retiring Administrative Agent's giving of notice of resignation, then the retiring Administrative Agent may, on behalf of the Lender Parties, appoint a successor Administrative Agent, which shall be a commercial bank organized under the laws of the United States or of any State thereof and having a combined capital and surplus of at least $250,000,000. Upon the acceptance of any appointment as Administrative Agent hereunder by a successor Administrative Agent as to all of the Facilities and upon the execution and filing or recording of such financing statements, or amendments thereto, and such amendments or supplements to any mortgages, and such other instruments or notices, as may be necessary or desirable, or as the Required Lenders may request, -80- in order to continue the perfection of the Liens granted or purported to be granted by the Collateral Documents, such successor Administrative Agent shall succeed to and become vested with all the rights, powers, discretion, privileges and duties of the retiring Administrative Agent, and the retiring Administrative Agent shall be discharged from its duties and obligations under the Loan Documents. Upon the acceptance of any appointment as Administrative Agent hereunder by a successor Administrative Agent as to less than all of the Facilities and upon the execution and filing or recording of such financing statements, or amendments thereto, and such amendments or supplements to any mortgages, and such other instruments or notices, as may be necessary or desirable, or as the Required Lenders may request, in order to continue the perfection of the Liens granted or purported to be granted by the Collateral Documents, such successor Administrative Agent shall succeed to and by all the rights, powers, discretion, privileges and duties of the retiring Administrative Agent as to such Facilities, other than with respect to funds transfers and other similar aspects of the administration of Borrowings under such Facilities, issuances of Letters of Credit (notwithstanding any resignation as Administrative Agent with respect to the Letter of Credit Facility) and payments by the Borrower in respect of such Facilities, and the retiring Administrative Agent shall be discharged from its duties and obligations under this Agreement as to such Facilities, other than as aforesaid. After any retiring Administrative Agent's resignation hereunder as Administrative Agent as to all of the Facilities, the provisions of this Article VII shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Administrative Agent as to any Facilities under this Agreement. (b) Any Agent other than the Administrative Agent may resign at any time by giving written notice thereof to the Lenders and the Borrower and none of such Agents shall have any duties or obligations under this Agreement or the other Loan Documents in their capacities as such agents. ARTICLE VIII MISCELLANEOUS SECTION 8.01. Amendments, Etc. No amendment or waiver of any provision of this Agreement or the Notes or any other Loan Document, nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed (or, in the case of the Collateral Documents, consented to) by the Required Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that (a) no amendment, waiver or consent shall, unless in writing and signed by all of the Lenders, do any of the following at any time: (i) waive any of the conditions specified in Section 3.01 or, in the case of the Third Restatement Date, 3.02, (ii) change the percentage of (x) the Commitments, (y) the aggregate unpaid principal amount of the Advances or (z) the aggregate Available Amount of outstanding Letters of Credit or the number of Lenders that shall be required for the Lenders or any of them to take any action hereunder, (iii) reduce or limit the obligations of the Parent Guarantor under Section 1 of the Holdings Guaranty or otherwise limit the Parent Guarantor's liability with respect to the Obligations owing to the Agents and the Lender Parties, (iv) release all or substantially all of the -81- Collateral and (v) amend this Section 8.01 and (b) no amendment, waiver or consent shall, unless in writing and signed by the Required Lenders and each Lender that has a Commitment under the Facility affected by such amendment, waiver or consent, (i) increase the Commitments of such Lender or subject such Lender to any additional obligations, (ii) reduce the principal of, or interest on, the Notes held by such Lender or any fees or other amounts payable hereunder to such Lender, (iii) postpone any date fixed for any payment of principal of, or interest on, the Notes held by such Lender or any fees or other amounts payable hereunder to such Lender or (iv) change the order of application of any prepayment set forth in Section 2.06 in any manner that materially affects such Lender; provided further that no amendment, waiver or consent shall, unless in writing and signed by the Swing Line Bank or the Issuing Bank, as the case may be, in addition to the Lenders required above to take such action, affect the rights or obligations of the Swing Line Bank or of the Issuing Bank, as the case may be, under this Agreement; and provided further that no amendment, waiver or consent shall, unless in writing and signed by the Administrative Agent in addition to the Lenders required above to take such action, affect the rights or duties of the Agents under this Agreement. SECTION 8.02. Notices, Etc. All notices and other communications provided for hereunder shall be in writing (including telegraphic, telecopy or telex communication) and mailed, telegraphed, telecopied, telexed or delivered, if to the Borrower, at its address at 5020 Franklin Drive, Pleasanton, California 94588, Attention: Mr. Gilbert K. Freeman, telecopier number: (510) 416-7398 with a copy to McCown De Leeuw & Co., 101 East 52nd Street, 31st Floor, New York, New York 10022, Attention: Mr. David E. King, telecopier number: (212) 355-6283, with a copy to White & Case, 1155 Avenue of the Americas, New York, New York 10036, Attention: Frank L. Schiff, Esq., telecopier number: (212) 354-8113; if to any Lender Party that is listed on the signature pages hereto, at its Domestic Lending Office specified opposite its name on Schedule I hereto; if to any other Lender Party, at its Domestic Lending Office specified in the Assignment and Acceptance pursuant to which it became a Lender Party; and if to any Agent, c/o the Administrative Agent at its address at 499 Park Avenue, New York, New York 10022, Attention: Mr. Michael L. Finkelman, Vice President, telecopier number: (212) 418-8269; or, as to each party, at such other address as shall be designated by such party in a written notice to the other parties. All such notices and communications shall, when mailed, telegraphed, telecopied or telexed, be effective when deposited in the mails, delivered to the telegraph company, transmitted by telecopier or confirmed by telex answerback, respectively, except that notices and communications to the Administrative Agent pursuant to Article II, III or VII shall not be effective until received by such Agent. Delivery by telecopier of an executed counterpart of any amendment or waiver of any provision of this Agreement or the Notes or of any Exhibit hereto to be executed and delivered hereunder shall be effective as delivery of a manually executed counterpart thereof. SECTION 8.03. No Waiver; Remedies. No failure on the part of any Lender Party or the Administrative Agent to exercise, and no delay in exercising, any right hereunder or under any Note shall operate as a waiver thereof; nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. -82- SECTION 8.04. Costs and Expenses. (a) The Borrower agrees to pay on demand (i) all reasonable costs and expenses of the Administrative Agent in connection with the preparation, execution, delivery, administration, modification and amendment of the Loan Documents (including, without limitation, (A) all due diligence, collateral review, syndication, transportation, computer, duplication, appraisal, audit, insurance, consultant, search, filing and recording fees and expenses and (B) the reasonable fees and expenses of counsel for the Administrative Agent with respect thereto, with respect to advising the Administrative Agent as to its rights and responsibilities, or the perfection, protection or preservation of rights or interests, under the Loan Documents, with respect to negotiations with any Loan Party or with other creditors of any Loan Party or any of its Subsidiaries (including Foreign Subsidiaries) arising out of any Default or any events or circumstances that may give rise to a Default and with respect to presenting claims in or otherwise participating in or monitoring any bankruptcy, insolvency or other similar proceeding involving creditors' rights generally and any proceeding ancillary thereto) and (ii) all costs and expenses of the Agents and the Lender Parties in connection with the enforcement of the Loan Documents, whether in any action, suit or litigation, any bankruptcy, insolvency or other similar proceeding affecting creditors' rights generally or otherwise (including, without limitation, the reasonable fees and expenses of counsel for the Agents and each Lender Party with respect thereto). (b) The Borrower agrees to indemnify and hold harmless the Agents, each Lender Party and each of their Affiliates and their officers, directors, employees, agents and advisors (each, an "Indemnified Party") from and against any and all Indemnified costs that may be incurred by or asserted or awarded against any Indemnified Party, in each case arising out of or in connection with or by reason of, or in connection with the preparation for a defense of, any investigation, litigation or proceeding arising out of, related to or in connection with (i) the Facilities, the actual or proposed use of the proceeds of the Advances, or the Letters of Credit, the Loan Documents, or any of the transactions contemplated hereby or thereby, including, without limitation, any acquisition or proposed acquisition (including, without limitation, any transactions contemplated hereby and thereby) by the Borrower of any Health Club Facility or (ii) the actual or alleged presence of Hazardous Materials on any property of or operated by any Loan Party or any of its Subsidiaries (including Foreign Subsidiaries) or any Environmental Action relating in any way to any Loan Party or any of its Subsidiaries (including Foreign Subsidiaries), in each case whether or not such investigation, litigation or proceeding is brought by any Loan Party, its directors, shareholders or creditors or an Indemnified Party or any Indemnified Party is otherwise a party thereto and whether or not the transactions contemplated hereby are consummated, except to the extent such Indemnified costs are found in a final, non appealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party's gross negligence or willful misconduct. The Borrower also agrees not to assert any claim against any Agent, any Lender Party or any of their Affiliates, or any of their respective officers, directors, employees, attorneys and agents, on any theory of liability, for special, indirect, consequential or punitive damages arising out of or otherwise relating to the Facilities or any of the transactions contemplated herein or in any other Loan Document or the actual or proposed use of the proceeds of the Advances or the Letters of Credit. -83- (c) If any payment of principal of, or Conversion of, any Eurodollar Rate Advance is made by the Borrower to or for the account of a Lender Party other than on the last day of the Interest Period for such Advance, as a result of a payment or Conversion pursuant to Sections 2.06, 2.09(b)(i) or 2.10(d), acceleration of the maturity of the Notes pursuant to Section 6.01 or for any other reason, the Borrower shall, upon demand by such Lender Party (with a copy of such demand to the Administrative Agent), pay to the Administrative Agent for the account of such Lender Party any amounts required to compensate such Lender for any additional losses, costs or expenses that it may reasonably incur as a result of such payment, including, without limitation, any loss (including loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by any Lender Party to fund or maintain such Advance. (d) If any Loan Party fails to pay when due any costs, expenses or other amounts payable by it under any Loan Document, including, without limitation, fees and expenses of counsel and indemnities, such amount may be paid on behalf of such Loan Party by the Administrative Agent or any Lender Party, in its sole discretion. (e) Without prejudice to the survival of any other agreement of any Loan Party hereunder or under any other Loan Document, the agreements and obligations of the Borrower contained in Sections 2.10 and 2.12 and this Section 8.04 shall survive the payment in full of principal, interest and all other amounts payable hereunder and under any of the other Loan Documents. SECTION 8.05. Right of Setoff. Upon (a) the occurrence and during the continuance of any Event of Default and (b) the making of the request or the granting of the consent specified by Section 6.01 to authorize the Administrative Agent to declare the Notes due and payable pursuant to the provisions of Section 6.01, each Lender Party and each of its respective Affiliates is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and otherwise apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender Party or such Affiliate to or for the credit or the account of the Borrower against any and all of the Obligations of the Borrower now or hereafter existing under this Agreement and the Note or Notes (if any) held by such Lender Party irrespective of whether such Lender Party shall have made any demand under this Agreement or such Note or Notes and although such obligations may be unmatured. Each Lender Party agrees promptly to notify the Borrower after any such setoff and application; provided, however, that the failure to give such notice shall not affect the validity of such setoff and application. The rights of each Lender Party and its Affiliates under this Section 8.05 are in addition to other rights and remedies (including, without limitation, other rights of setoff) that such Lender Party and its respective Affiliates may have. SECTION 8.06. Binding Effect. This Agreement shall become effective when it shall have been executed by the Borrower, the Administrative Agent, each Restatement Lender, the Existing Issuing Bank and the Swing Line Bank and thereafter shall be binding upon and inure to the benefit of the Borrower, the Agents and each Lender Party and their respective -84- successors and assigns, except that the Borrower shall not have the right to assign its rights hereunder or any interest herein without the prior written consent of the Lender Parties. SECTION 8.07. Assignments and Participations. (a) Each Lender may assign to one or more Eligible Assignees all or a portion of its rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitment or Commitments, the Advances owing to it and the Note or Notes held by it); provided, however, that (i) each such assignment shall be of a uniform, and not a varying, percentage of all rights and obligations under and in respect of one or more Facilities, (ii) except in the case of an assignment to a Person that, immediately prior to such assignment, was a Lender or an assignment of all of a Lender's rights and obligations under this Agreement, the amount of the Commitment of the assigning Lender being assigned pursuant to each such assignment (determined as of the date of the Assignment and Acceptance with respect to such assignment) shall in no event be less than $5,000,000 and shall be in an integral multiple of $500,000, (iii) each such assignment shall be to an Eligible Assignee, and (iv) the parties to each such assignment shall execute and deliver to the Administrative Agent, for its acceptance and recording in the Register, an Assignment and Acceptance, together with any Note or Notes subject to such assignment and a processing and recordation fee of $2,000. (b) The Issuing Bank may assign to one or more Eligible Assignees all or a portion of its rights and obligations under the undrawn portion of the Letter of Credit Facility at any time. (c) Upon such execution, delivery, acceptance and recording, from and after the effective date specified in such Assignment and Acceptance, (x) the assignee thereunder shall be a party hereto and, to the extent that rights and obligations hereunder have been assigned to it pursuant to such Assignment and Acceptance, have the rights and obligations of a Lender or Issuing Bank, as the case may be, hereunder and (y) the Lender or Issuing Bank assignor thereunder shall, to the extent that rights and obligations hereunder have been assigned by it pursuant to such Assignment and Acceptance, relinquish its rights and be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Lender's or Issuing Bank's rights and obligations under this Agreement, such Lender or Issuing Bank shall cease to be a party hereto). (d) By executing and delivering an Assignment and Acceptance, the Lender Party assignor thereunder and the assignee thereunder confirm to and agree with each other and the other parties hereto as follows: (i) other than as provided in such Assignment and Acceptance, such assigning Lender Party makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with this Agreement or any other Loan Document or the execution, legality, validity, enforceability, genuineness, sufficiency or value of, or the perfection or priority of Lien created or purported to be created under or in connection with, this Agreement or any other Loan Document or any other instrument or document furnished pursuant hereto or thereto; (ii) such assigning Lender Party makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Borrower or any other Loan Party or the performance or observance by any Loan Party of any of its obligations under any Loan Document or any other instrument or -85- document furnished pursuant hereto or thereto; (iii) such assignee confirms that it has received a copy of this Agreement, together with copies of the financial statements referred to in Section 4.01 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (iv) such assignee will, independently and without reliance upon any Agent, such assigning Lender Party or any other Lender Party and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement; (v) such assignee confirms that it is an Eligible Assignee; (vi) such assignee appoints and authorizes the Administrative Agent to take such action as agent on its behalf and to exercise such powers and discretion under this Agreement or any other Loan Document as are delegated to the Administrative Agent by the terms hereof, together with such powers and discretion as are reasonably incidental thereto; and (vii) such assignee agrees that it will perform in accordance with their terms all of the obligations which by the terms of this Agreement are required to be performed by it as a Lender or Issuing Bank, as the case may be. (e) The Administrative Agent shall maintain at its address referred to in Section 8.02 a copy of each Assignment and Acceptance delivered to and accepted by it and a register for the recordation of the names and addresses of the Lender Parties and the Commitment under each Facility of, and principal amount of the Advances owing under each Facility to, each Lender Party from time to time (the "Register"). The entries in the Register shall be conclusive and binding for all purposes, absent manifest error, and the Borrower, the Administrative Agent and the Lender Parties may treat each Person whose name is recorded in the Register as a Lender Party hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Borrower or any Lender Party at any reasonable time and from time to time upon reasonable prior notice. (f) Upon its receipt of an Assignment and Acceptance executed by an assigning Lender Party and an assignee, together with any Note or Notes subject to such assignment, the Administrative Agent shall, if such Assignment and Acceptance has been completed and is in substantially the form of Exhibit C hereto, (i) accept such Assignment and Acceptance, (ii) record the information contained therein in the Register and (iii) give prompt notice thereof to the Borrower. In the case of any assignment by a Lender, within five Business Days after its receipt of such notice, the Borrower, at its own expense, shall execute and deliver to the Administrative Agent in exchange for the surrendered Note or Notes a new Note to the order of such Eligible Assignee in an amount equal to the Commitment assumed by it under a Facility pursuant to such Assignment and Acceptance and, if the assigning Lender has retained a Commitment hereunder under such Facility, a new Note to the order of the assigning Lender in an amount equal to the Commitment retained by it hereunder. Such new Note or Notes shall be in an aggregate principal amount equal to the aggregate principal amount of such surrendered Note or Notes, shall be dated the effective date of such Assignment and Acceptance and shall otherwise be in substantially the form of Exhibit A-1, or A-2 hereto, as the case may be. (g) Each Lender Party may sell participations in or to all or a portion of its rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitments, the Advances owing to it and the Note or Notes (if any) held by it) to any Person -86- other than any Loan Party or any of its Subsidiaries (including Foreign Subsidiaries) or Affiliates; provided, however, that (i) such Lender Party's obligations under this Agreement (including, without limitation, its Commitments) shall remain unchanged, (ii) such Lender Party shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) such Lender Party shall remain the holder of any such Note for all purposes of this Agreement, and (iv) the Borrower, the Administrative Agent and the other Lender Parties shall continue to deal solely and directly with such Lender in connection with such Lender Party's rights and obligations under this Agreement and (v) no participant under any such participation shall have any right to approve any amendment or waiver of any provision of any Loan Document, or any consent to any departure by any Loan Party therefrom, except to the extent that such amendment, waiver or consent would reduce the principal of, or interest on, the Notes or any fees or other amounts payable hereunder, in each case to the extent subject to such participation, postpone any date fixed for any payment of principal of, or interest on, the Notes or any fees or other amounts payable hereunder, in each case to the extent subject to such participation, or release all or substantially all of the Collateral. (h) Any Lender Party may, in connection with any assignment or participation or proposed assignment or participation pursuant to this Section 8.07, disclose to the assignee or participant or proposed assignee or participant, any information relating to the Borrower furnished to such Lender Party by or on behalf of the Borrower; provided, however, that, prior to any such disclosure, the assignee or participant or proposed assignee or participant shall agree to preserve the confidentiality of any Confidential Information received by it from such Lender Party. (i) Notwithstanding any other provision set forth in this Agreement, any Lender Party may at any time create a security interest in all or any portion of its rights under this Agreement (including, without limitation, the Advances owing to it and the Note or Notes held by it) in favor of any Federal Reserve Bank in accordance with Regulation A of the Board of Governors of the Federal Reserve System, and any Lender Party that is a fund may at any time without the consent of the Administrative Agent and Borrower pledge all or any portion of its interest and rights under this Agreement (including, without limitation, the Advances owing to it and the Note or Notes held by it) to its trustee in support of its obligations to such trustee. (j) The Borrower and each Lender Party agree that, at the request of the Administrative Agent, the Borrower or such Lender will re-execute this Agreement to reflect the assignments that have been effected in accordance with this Section 8.07. SECTION 8.08. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of a signature page to this Agreement by telecopier shall be effective as delivery of a manually executed counterpart of this Agreement. -87- SECTION 8.09. No Liability of the Issuing Bank. The Borrower assumes all risks of the acts or omissions of any beneficiary or transferee of any Letter of Credit with respect to its use of such Letter of Credit. Neither the Issuing Bank nor any of its officers or directors shall be liable or responsible for: (a) the use that may be made of any Letter of Credit or any acts or omissions of any beneficiary or transferee in connection therewith; (b) the validity, sufficiency or genuineness of documents, or of any endorsement thereon, even if such documents should prove to be in any or all respects invalid, insufficient, fraudulent or forged; (c) payment by the Issuing Bank against presentation of documents that do not comply with the terms of a Letter of Credit, including failure of any documents to bear any reference or adequate reference to the Letter of Credit; or (d) any other circumstances whatsoever in making or failing to make payment under any Letter of Credit, except that the Borrower shall have a claim against the Issuing Bank, and the Issuing Bank shall be liable to the Borrower, to the extent of any direct, but not consequential, damages suffered by the Borrower that the Borrower proves were caused by (i) the Issuing Bank's willful misconduct or gross negligence in determining whether documents presented under any Letter of Credit comply with the terms of the Letter of Credit or (ii) the Issuing Bank's willful failure to make lawful payment under a Letter of Credit after the presentation to it of a draft and certificates strictly complying with the terms and conditions of the Letter of Credit. In furtherance and not in limitation of the foregoing, the Issuing Bank may accept documents that appear on their face to be in order, without responsibility for further investigation, regardless of any notice or information to the contrary. SECTION 8.10. Confidentiality. Neither the Administrative Agent nor any Lender Party shall disclose any Confidential Information to any Person without the consent of the Borrower, other than (a) to the Administrative Agent's or such Lender Party's Affiliates and their officers, directors, employees, agents and advisors and to actual or prospective Eligible Assignees and participants, and then only on a confidential basis, or to any direct or indirect contractual counterparties in swap agreements or such contractual counterparties' professional advisors provided that such contractual counterparty or professional advisor to such contractual counterparty agrees in writing to keep such information confidential to the same extent required of the Lenders hereunder, (b) as required by any law, rule or regulation or judicial process and (c) as requested or required by any state, federal or foreign authority or examiner regulating banks or banking. SECTION 8.11. Jurisdiction, Etc. (a) Each of the parties hereto hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or any of the other Loan Documents to which it is or is to be a party, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State court or, to the extent permitted by law, in such federal court. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that any party may otherwise have to commence or participate in any action, suit or -88- proceeding relating to this Agreement or any of the other Loan Documents to which it is or is to be a party, or otherwise to proceed against such party in the court of any other jurisdiction. (b) Each of the parties hereto irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection that it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Agreement or any of the other Loan Documents to which it is or is to be a party in any New York State or federal court. Each of the parties hereto hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. (c) The Borrower irrevocably consents to the service of any and all process in any such action, suit or proceedings address set forth in Section 8.02, or by any other method permitted by law. The Borrower agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. (d) To the extent that the Borrower has or hereafter may acquire immunity from jurisdiction of any court or from any legal process (whether through service of notice, attachment prior to judgment, attachment in aid of execution, execution or otherwise) with respect to itself or its property, the Borrower hereby irrevocably waives such immunity in respect of its Obligations under this Agreement, the Notes, any other Loan Document and any Secured Hedge Agreement to which it is or is to be a party. SECTION 8.12. Governing Law. This Agreement and the Notes shall be governed by, and construed in accordance with, the laws of the State of New York. SECTION 8.13. Waiver of Jury Trial. Each of the Borrower, the Agents and the Lender Parties irrevocably waives all right to trial by jury to the fullest extent permitted by law in any action, proceeding or counterclaim (whether based on contract, tort or otherwise) arising out of or relating to any of the Loan Documents, the Advances or the transactions contemplated hereby or thereby or the actions of any Agent or any Lender Party in the negotiation, administration, performance or enforcement hereof or thereof. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. 24 HOUR FITNESS, INC. By: -------------------------- Name: Title: -89- FITNESS HOLDINGS, INC. By: -------------------------- Name: Title: BANQUE NATIONALE DE PARIS, as Administrative Agent, Issuing Bank, Swing Line Bank and Lender By: -------------------------- Name: Title: By: -------------------------- Name: Title: BANKERS TRUST COMPANY as Documentation Agent By: -------------------------- Name: Title: LASALLE NATIONAL BANK as Co-Agent By: -------------------------- Name: Title: WELLS FARGO BANK, N.A. as Co-Agent -90- By: -------------------------- Name: Title: -91- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. 24 HOUR FITNESS, INC. By: -------------------------- Name: Title: FITNESS HOLDINGS, INC. By: -------------------------- Name: Title: BANQUE NATIONALE DE PARIS, as Administrative Agent, Issuing Bank, Swing Line Bank and Lender By: -------------------------- Name: Title: BANKERS TRUST COMPANY as Documentation Agent By: -------------------------- Name: Title: LASALLE NATIONAL BANK as Co-Agent By: -------------------------- Name: Title: -92- WELLS FARGO BANK, N.A. as Co-Agent By: -------------------------- Name: Title: -93- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. 24 HOUR FITNESS, INC. By: -------------------------- Name: Title: FITNESS HOLDINGS, INC. By: -------------------------- Name: Title: BANQUE NATIONALE DE PARIS, as Administrative Agent, Issuing Bank, Swing Line Bank and Lender By: -------------------------- Name: Title: BANKERS TRUST COMPANY as Documentation Agent By: -------------------------- Name: Title: LASALLE NATIONAL BANK as Co-Agent By: -------------------------- Name: Title: -94- WELLS FARGO BANK, N.A. as Co-Agent By: -------------------------- Name: Title: -95- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. 24 HOUR FITNESS, INC. By: -------------------------- Name: Title: FITNESS HOLDINGS, INC. By: -------------------------- Name: Title: BANQUE NATIONALE DE PARIS, as Administrative Agent, Issuing Bank, Swing Line Bank and Lender By: -------------------------- Name: Title: BANKERS TRUST COMPANY as Documentation Agent By: -------------------------- Name: Title: LASALLE NATIONAL BANK as Co-Agent By: -------------------------- Name: Title: -96- WELLS FARGO BANK, N.A. as Co-Agent By: -------------------------- Name: Title: -97- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. 24 HOUR FITNESS, INC. By: -------------------------- Name: Title: FITNESS HOLDINGS, INC. By: -------------------------- Name: Title: BANQUE NATIONALE DE PARIS, as Administrative Agent, Issuing Bank, Swing Line Bank and Lender By: -------------------------- Name: Title: BANKERS TRUST COMPANY as Documentation Agent By: -------------------------- Name: Title: LASALLE NATIONAL BANK as Co-Agent By: -------------------------- Name: Title: -98- WELLS FARGO BANK, N.A. as Co-Agent By: -------------------------- Name: Title: -99- BANQUE NATIONALE DE PARIS By: -------------------------- Name: Title: By: -------------------------- Name: Title: -100- BANKERS TRUST COMPANY By: -------------------------- Name: Title: -101- LASALLE NATIONAL BANK By: -------------------------- Name: Title: -102- WELLS FARGO BANK, N.A. By: -------------------------- Name: Title: -103- THE ING CAPITAL SENIOR SECURED HIGH INCOME FUND, L.P. By: -------------------------- Name: Title: -104- ARCHIMEDES FUNDING, L.L.C. By: ING Capital Advisors Incorporated, as Collateral Manager By: -------------------------- Name: Title: Vice President & Portfolio Manager -105- KZH - CRESCENT CORPORATION By: -------------------------- Name: Title: Authorized Agent -106- Crescent/Mach I Partners, L.P., by: TCW Asset Management Company, its Investment Manager By: -------------------------- Name: Title: -107- PILGRIM AMERICA PRIME RATE By: -------------------------- Name: Title: FIRST SOURCE FINANCIAL, LLP By First Source Financial, Inc. its Agent Manager By: -------------------------- Name: Title: -108- SCHEDULES Schedule I Commitments and Applicable Lending Offices Schedule 11 Equity Investors Schedule III Existing Letters of Credit Schedule IV Holdings Notes Schedule 3.01(d) Surviving Debt Schedule 4.01(b) Subsidiaries Schedule 4.01(f) Possible Revenue Recognition Policy Adjustments Schedule 4.01(y) Open Years Schedule 4.01(z) Tax Adjustments, Etc. Schedule 4.01(ee) Owned Real Properties Schedule 4.01(ff) Leased Properties Schedule 4.01(gg) Investments Schedule 5.01(l) Transactions with Affiliates EXHIBITS Exhibit A-1 Form of Term A Note Exhibit A-2 Form of Term B Note Exhibit A-3 Form of Working Capital Note Exhibit B Form of Notice of Borrowing Exhibit C Form of Assignment and Acceptance Exhibit D Form of Security Agreement Exhibit E Form of Holdings Pledge Agreement Exhibit F Form of Holdings Guaranty Exhibit G Form of Solvency Certificate Exhibit H-1 Form of Opinion of Borrower's Counsel (New York) Exhibit H-2 Form of Opinion of Borrower's Counsel (California) Exhibit I Form of Seller Subordination Agreement Exhibit J Form of Subsidiary Guaranty Exhibit K Form of Intercompany Subordination Agreement Exhibit L Form of Assignment Agreement EX-10.5 6 EXHIBIT 10.5 Exhibit 10.5 FITNESS HOLDINGS, INC. 1994 STOCK OPTION AND STOCK AWARD PLAN 1. Purpose. The purpose of the Fitness Holdings, Inc. 1994 Stock Option and Stock Award Plan (the "Plan") is to maintain the ability of Fitness Holdings, Inc. (the "Company") and its subsidiaries to attract and retain highly qualified and experienced employees and to give such employees a continued proprietary interest in the success of the Company and its subsidiaries. Pursuant to the Plan, such employees will be offered the opportunity to acquire common stock through the grant of options, stock appreciation rights in tandem with such options, the award of restricted stock under the Plan, bonuses payable in stock or a combination thereof. As used herein, the term "subsidiary" shall mean any present or future corporation which is or would be a "subsidiary corporation" of the Company as the term is defined in Section 424(f) of the Internal Revenue Code of 1986, as amended from time to time (the "Code"). 2. Administration of the Plan. The Plan shall be administered by a compensation committee (the "Compensation Committee") as appointed from time to time by the Board of Directors of the Company (the "Board"), which Compensation Committee shall consist of not less than two (2) members of the Board. No member of the Board shall be appointed to the Compensation Committee who has been granted an option or stock appreciation right or awarded restricted stock or bonuses payable in Common Stock under the Plan within one year prior to appointment. A majority of the members of the Compensation Committee shall constitute a quorum. The vote of a majority of a quorum shall constitute action by the Compensation Committee. In administering the Plan, the Committee may adopt rules and regulations for carrying out the Plan. The interpretation and decision with regard to any question arising under the Plan made by the Committee shall be final and conclusive on all employees of the Company and its subsidiaries participating or eligible to participate in the Plan. The Committee may consult with counsel, who may be counsel to the Company, and shall not incur any liability for any action taken in good faith in reliance upon the advice of counsel. The Committee shall determine the employees to whom, and the time or times at which, grants or awards shall be made and the number of shares to be included in the grants or awards. Within the limitations of the Plan, the number of shares for which options will be granted from time to time and the periods for which the options will be outstanding will be determined by the Committee. Each option or stock or other awards granted pursuant to the Plan shall be evidenced by an Option Agreement or Award Agreement (the "Agreement"). The Agreement shall not be a precondition to the granting of options or stock or other awards; however, no person shall have any rights under any option or stock or other awards granted under the Plan unless and until the optionee to whom such option or stock or other award shall have been granted shall have executed and delivered to the Company an Agreement. The Committee shall prescribe the form of all Agreements. A fully executed original of the Agreement shall be provided to both the Company and the recipient of the grant. 3. Shares of Stock Subject to the Plan. The total number of shares that may be optioned or awarded under the Plan is 313,501 shares of the $0.001 par -2- value common stock of the Company (the "Common Stock") except that said number of shares shall be adjusted as provided in Paragraph 13. Any shares subject to an option which for any reason expires or is terminated unexercised and any restricted stock which is forfeited may again be optioned or awarded under the Plan; provided, however, that forfeited shares shall not be available for further awards if the employee has realized any benefits of ownership from such shares. Shares subject to the Plan may be either authorized and unissued shares or issued shares acquired by the Company or its subsidiaries. 4. Eligibility. Key salaried employees, including officers, of the Company and its subsidiaries (but excluding non-employee directors) and consultants are eligible to be granted options and awarded restricted stock under the Plan and to have their bonuses payable in stock. The employees and consultants who shall receive awards or options under the Plan shall be selected from time to time by the Committee, in its sole discretion, from among those eligible, which may be based upon information furnished to the Committee by the Company's management, and the Committee shall determine, in its sole discretion, the number of shares to be covered by the award or awards and by the option or options granted to each such employee selected. Such key salaried employees and consultants who are selected to participate in the Plan shall be referred to collectively herein as "Participants." 5. Duration of the Plan. No award or option may be granted under the Plan after more than ten years from the date the Plan is adopted by the Board or the date the Plan receives shareholder approval, whichever is earlier, but awards or options theretofore granted may extend beyond that date. 6. Terms and Conditions of Stock Options. All options granted under this Plan shall be either incentive stock options, as defined in Section 422 of the Code, or options other than incentive stock options. Each -3- such option shall be subject to all the applicable provisions of the Plan, including the following terms and conditions, and to such other terms and conditions not inconsistent therewith as the Committee shall determine. (a) The option price per share shall be determined by the Committee. However, subject to Paragraph 6(k), the option price of incentive stock options and other than incentive stock options shall not be less than 100% of the fair market value of a share of Common Stock at the time the option is granted. For purposes of the Plan, the fair market value shall be such value as the Committee, in good faith, shall determine on the relevant date. (b) Each option shall be exercisable pursuant to the attainment of such performance goals and/or during and over such period ending not later than ten years from the date it was granted, as may be determined by the Committee and stated in the Agreement. In no event may an option be exercised more than 10 years from the date the option was granted. (c) An option shall not be exercisable with respect to a fractional share of Common Stock or with respect to the lesser of fifty (50) shares or the full number of shares then subject to the option. No fractional shares of Common Stock shall be issued upon the exercise of an option. If a fractional share of Common Stock shall become subject to an option by reason of a stock dividend or otherwise, the optionee shall not be entitled to exercise the option with respect to such fractional share. (d) Each option shall state whether it will or will not be treated as an incentive stock option. (e) Each option may be exercised by giving written notice to the Company specifying the number of shares to -4- be purchased, which shall be accompanied by payment in full including, if required by applicable law, applicable taxes, if any. Payment, except as provided in the Agreement, shall be (A) in United States dollars by check or bank draft, or (B) by tendering to the Company Common Stock shares already owned by the person exercising the option, which may include shares received as the result of a prior exercise of an option, and having a fair market value, as determined in accordance with Paragraph 6(a), on the date on which the option is exercised equal to the cash exercise price applicable to such option, or (C) by a combination of United States dollars and Common Stock shares as aforesaid. No optionee shall have any rights to dividends or other rights of a shareholder with respect to shares of Common Stock subject to his or her option until he or she has given written notice of exercise of his or her option and paid in full for such shares. (f) Notwithstanding the foregoing, the Committee may, in its sole discretion, grant to a grantee of an option the right (hereinafter referred to as a "stock appreciation right") to elect, in the manner described below, in lieu of exercising his or her option for all or a portion of the shares of Common Stock covered by such option, to relinquish his or her option with respect to any or all of such shares and to receive from the Company a payment having a value equal to the amount by which (a) the fair market value, as determined in accordance with Paragraph 6(a), of a share of Common Stock on the date of such election, multiplied by the number of shares as to which the grantee shall have made -5- such election, exceeds (b) the exercise price for that number of shares of Common Stock under the terms of such option. A stock appreciation right shall be exercisable at the time the tandem option is exercisable, and the "expiration date" for the stock appreciation right shall be the expiration date for the tandem option. A grantee who makes such an election shall receive payment in the sole discretion of the Committee (i) in cash equal to such excess; or (ii) in the nearest whole number of shares of Common Stock of the Company having an aggregate fair market value, as determined in accordance with Paragraph 6(a), which is not greater than the cash amount calculated in (i) above; or (iii) a combination of (i) and (ii) above. A stock appreciation right may be exercised only when the amount described in (a) above exceeds the amount described in (b) above. An election to exercise stock appreciation rights shall be deemed to have been made on the day written notice of such election, addressed to the Committee, is received by the Company c/o McCown De Leeuw & Co., 101 East 52nd Street, 31st Floor, New York, New York 10022, Attention: David E. King. An option or any portion thereof with respect to which a grantee has elected to exercise the stock appreciation rights described above shall be surrendered to the Company and such option shall thereafter remain exercisable according to its terms only with respect to the number of shares as to which it would otherwise be exercisable, less the number of shares with respect to which stock appreciation rights have been exercised. The grant of a stock appreciation right shall be evidenced by such form of agreement as the Committee may prescribe. The agreement evidencing stock appreciation rights shall be personal and will provide that the stock appreciation rights will not be transferable by the grantee otherwise than by will or the laws of descent and distribution and that they will be exercisable, during the lifetime of the grantee, only by him or her. -6- (g) Except as provided in the Agreement, an option may be exercised only if at all times during the period beginning with the date of the granting of the option and ending on the date of such exercise, the grantee was an employee of either the Company or of a subsidiary of the Company or of another corporation referred to in Section 421(a)(2) of the Code. The Agreement shall provide whether, and if so, to what extent, an option may be exercised after termination of continuous employment, but any such exercise shall in no event be later than the termination date of the option. If the grantee should die or become permanently disabled as determined by the Committee, at any time when the option, or any portion thereof, shall be exercisable by him, the option will be exercisable within a period provided for in the Agreement, by the optionee or person or persons to whom his or her rights under the option shall have passed by will or by the laws of descent and distribution, but in no event at a date later than the termination of the option. The Committee may require medical evidence of permanent disability, including medical examinations by physicians selected by it. (h) The option by its terms shall be personal and shall not be transferable by the optionee otherwise than by will or by the laws of descent and distribution as provided in Paragraph 6(g) above. During the lifetime of an optionee, the option shall be exercisable only by the optionee. In the event any option is exercised by the executors, administrators, heirs or distributees of the estate of a deceased optionee as provided in Paragraph 6(g) above, the Company shall be under no obligation to issue Common Stock thereunder unless and until the Company is satisfied that the person or persons exercising the option are the duly appointed legal representative of the deceased optionee's estate or the proper legatees or distributees thereof. -7- (i) Notwithstanding any intent to grant incentive stock options, an option granted will not be considered an incentive stock option to the extent that it together with any earlier incentive stock options permits the exercise for the first time in any calendar year of more than $100,000 in value of Common Stock (determined at the time of grant). (j) The Committee may, but need not, require such consideration from an optionee at the time of granting an option as it shall determine, either in lieu of, or in addition to, the limitations on exercisability provided in Paragraph 6(e). (k) No incentive stock option shall be granted to an employee who owns or would own immediately before the grant of such option, directly or indirectly, stock possessing more than 10% of the total combined voting power of all classes of stock of the Company. This restriction does not apply if, at the time such incentive stock option is granted, the option price is at least 110% of the fair market value of one share of Common Stock, as determined in accordance with Paragraph 6(a), on the date of grant and the incentive stock option by its terms is not exercisable after the expiration of five years from the date of grant. (l) An option and any Common Stock received upon the exercise of an option shall be subject to such other transfer restrictions and/or legending requirements that are specified in the Agreement. 7. Terms and Conditions of Restricted Stock Awards. All awards of restricted stock under the Plan shall be subject to all the applicable provisions of the Plan, including the following terms and conditions, and to such other terms and conditions not inconsistent therewith, as the Committee shall determine. -8- (a) Awards of restricted stock may be in addition to or in lieu of option grants. (b) During a period set by, and/or until the attainment of particular performance goals based upon criteria established by, the Committee at the time of each award of restricted stock (the "restriction period") as specified in the Agreement, the recipient shall not be permitted to sell, transfer, pledge, or otherwise encumber the shares of restricted stock; except that such shares may be used, if the Agreement permits, to pay the option price of any option granted under the Plan provided an equal number of shares delivered to the optionee shall carry the same restrictions as the shares so used. (c) Shares of restricted stock shall become free of all restrictions if, during the restriction period, (i) the recipient dies, (ii) the recipient's employment terminates by reason of permanent disability, as determined by the Committee, (iii) the recipient retires after attaining both 59-1/2 years of age and five years of continuous service with the Company and/or a subsidiary, or (iv) if provided in the Agreement, there is a "change in control" of the Company (as defined in such Agreement). The Committee may require medical evidence of permanent disability, including medical examinations by physicians selected by it. If the Committee determines that any such recipient is not permanently disabled, the restricted stock held by such recipient shall be forfeited and revert to the Company. (d) Unless and to the extent otherwise provided in the Agreement, shares of restricted stock shall be forfeited and revert to the Company upon the recipient's termination of employment during the restriction period for any reason other than death, permanent disability, as determined by the Committee, or retirement after attaining both 59-1/2 years of age and five years of -9- continuous service with the Company and/or a subsidiary, except to the extent the Committee, in its sole discretion, finds that such forfeiture might not be in the best interest of the Company and, therefore, waives all or part of the application of this provision to the restricted stock held by such recipient. (e) Stock certificates for restricted stock shall be registered in the name of the recipient but shall be appropriately legended and returned to the Company by the recipient, together with a stock power, endorsed in blank by the recipient. The recipient shall be entitled to vote shares of restricted stock and shall be entitled to all dividends paid thereon, except that dividends paid in Common Stock or other property shall also be subject to the same restrictions. (f) Restricted stock shall become free of the foregoing restrictions upon expiration of the applicable restriction period and the Company shall then deliver Common Stock certificates evidencing such stock. (g) Restricted Stock and any Common Stock received upon the expiration of the restriction period shall be subject to such other transfer restrictions and/or legending requirements that are specified in the Agreement. 8. Bonuses Payable in Stock. In lieu of cash bonuses otherwise payable under the Company's or applicable subsidiary's compensation practices to employees eligible to participate in the Plan, the Committee, in its sole discretion, may determine that such bonuses shall be payable in Common Stock or partly in Common Stock and partly in cash. Such bonuses shall be in consideration of services previously performed and as an incentive toward future services and shall consist of shares of Common Stock subject to such terms as the Committee may determine in its sole discretion. The number of shares of Common Stock payable in lieu of a bonus -10- otherwise payable shall be determined by dividing such amount by the fair market value of one share of Common Stock on the date the bonus is payable, with fair market value determined as of such date in accordance with Paragraph 6(a). 9. Change in Control. (a) In the event of a change in control of the Company, as defined (if at all) by the Committee in each Agreement, the Committee may, in its sole discretion, provide that any of the following applicable actions be taken as a result, or in anticipation, of any such event to assure fair and equitable treatment of Participants: (i) accelerate time periods for purposes of vesting in, or realizing gain from, any outstanding option or stock appreciation right or shares of restricted stock awarded pursuant to this Plan; (ii) offer to purchase any outstanding option or stock appreciation right or shares of restricted stock made pursuant to this Plan from the holder for its equivalent cash value, as determined by the Committee, as of the date of the change in control; or (iii) make adjustments or modifications to outstanding options or stock appreciation rights or with respect to restricted stock as the Committee deems appropriate to maintain and protect the rights and interests of the Participants following such change in control. (b) In no event, however, may any option be exercised after ten (10) years from the date it was granted. 10. Transfer, Leave of Absence. For the purpose of the Plan: (a) a transfer of an employee from the Company to a subsidiary or affiliate of the Company, whether or not incorporated, or vice versa, or from one subsidiary or affiliate of the Company to another, and -11- (b) a leave of absence, duly authorized in writing by the Company or a subsidiary or affiliate of the Company, shall not be deemed a termination of employment. 11. Rights of Employees. (a) No person shall have any rights or claims under the Plan except in accordance with the provisions of the Plan. (b) Nothing contained in the Plan shall be deemed to give any employee the right to be retained in the service of the Company or its subsidiaries. 12. Tax Withholding Obligations. (a) If required by applicable law, the payment of taxes, if any, upon the exercise of an option pursuant to Paragraph 6(e) or a stock appreciation right pursuant to Paragraph 6(f), shall be in cash at the time of exercise or on the applicable tax date under Section 83 of the Code, if earlier; provided, however, tax withholding obligations may be met by the withholding of Common Stock otherwise deliverable to the optionee pursuant to procedures approved by the Committee. (b) If required by applicable law, recipients of restricted stock, pursuant to Paragraph 7, shall be required to pay taxes to the Company upon the expiration of restriction periods or such earlier dates as elected pursuant to Section 83 of the Code; provided, however, tax withholding obligations may be met by the withholding of Common Stock otherwise deliverable to the recipient pursuant to procedures approved by the Committee. If tax withholding is required by applicable law, in no event shall Common Stock be delivered to any awardee until he has paid to the Company in cash the amount of such tax required to be withheld by the Company or has elected to have his withholding obligations met by the withholding of Common Stock in accordance with the procedures approved by the Committee or otherwise entered into an -12- agreement satisfactory to the Company providing for payment of withholding tax. (c) The Company shall withhold from any cash bonus described in Paragraph 8, an amount of cash sufficient to meet its tax withholding obligations. If the cash portion of such bonus is not sufficient to satisfy such withholding obligation, the tax withholding obligations shall be paid in cash by the recipient or may be met by withholding of Common Stock otherwise deliverable to the recipient pursuant to procedures approved by the Committee. 13. Changes in Capital. Upon changes in the outstanding Common Stock by reason of a stock dividend, stock split, reverse split, subdivision, recapitalization, merger, consolidation (whether or not the Company is a surviving corporation), an extraordinary dividend payable in cash or property, combination or exchange of shares, separation, reorganization or liquidation, the aggregate number and class of shares available under the Plan as to which stock options and restricted stock may be awarded, the number and class of shares under each option and the option price per share shall be correspondingly adjusted by the Committee, such adjustments to be made in the case of outstanding options without change in the total price applicable to such options. 14. Miscellaneous Provisions. (a) The Plan shall be unfunded. The Company shall not be required to establish any special or separate fund or to make any other segregation of assets to assure the issuance of shares or the payment of cash upon exercise of any option or stock appreciation right under the Plan. Proceeds from the sale of shares of Common Stock pursuant to options granted under this Plan shall constitute general funds of the Company. The expenses of the Plan shall be borne by the Company. -13- (b) It is understood that the Committee may, at any time and from time to time after the granting of an option or the award of restricted stock or bonuses payable in Common Stock hereunder, specify such additional terms, conditions and restrictions with respect to such option or stock as may be deemed necessary or appropriate to ensure compliance with any and all applicable laws, including, but not limited to, terms, restrictions and conditions for compliance with federal and state securities laws and methods of withholding or providing for the payment of required taxes. (c) If at any time the Committee shall determine, in its discretion, that the listing, registration or qualification of shares of Common Stock upon any national securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the sale or purchase of shares of Common Stock hereunder, no option or stock appreciation right may be exercised or restricted stock or stock bonus may be transferred in whole or in part unless and until such listing, registration, qualification, consent or approval shall have been effected or obtained, or otherwise provided for, free of any conditions not acceptable to the Committee. (d) By accepting any benefit under the Plan, each Participant and each person claiming under or through such Participant shall be conclusively deemed to have indicated his acceptance and ratification, and consent to, any action taken under the Plan by the Committee, the Company or the Board. (e) The Plan shall be governed by and construed in accordance with the laws of the State of Delaware. 15. Limits of Liability. (a) Any liability of the Company or a subsidiary of the Company to any Participant with respect to any option or award shall be based solely -14- upon contractual obligations created by the Plan and the Agreement. (b) Neither the Company nor a subsidiary of the Company, nor any member of the Committee or the Board, nor any other person participating in any determination of any question under the Plan, or in the interpretation, administration or application of the Plan, shall have any liability to any party for any action taken or not taken in connection with the Plan, except as may expressly be provided by statute. 16. Amendments and Termination. The Board may, at any time, amend, alter or discontinue the Plan; provided, however, no amendment, alteration or discontinuation shall be made which would impair the rights of any holder of an award of restricted stock or option or stock appreciation rights or stock bonus theretofore granted, without his or her written consent, or which, without the approval of the shareholders, would: (a) except as is provided in Paragraph 13, increase the maximum number of shares of Common Stock reserved for the purpose of the Plan; (b) except as is provided in Paragraph 13 of the Plan, decrease the option price of an option to less than 100% of the fair market value, as determined in accordance with Paragraph 6(a), of a share of Common Stock on the date of the granting of the option; (c) change the class of persons eligible to receive an award of restricted stock or options or stock appreciation rights under the Plan; or (d) extend the duration of the Plan. The Committee may amend the terms of any award of restricted stock or option or stock appreciation rights -15- theretofore granted, retroactively or prospectively, but no such amendment shall impair the rights of any holder without his or her written consent. 17. Duration. The Plan shall be adopted by the Board as of the date on which it is approved by a majority of the Company's stockholders, which approval must occur within the period ending twelve months after the date the Plan is adopted. The Plan shall terminate upon the earlier of the following dates or events to occur: (a) upon the adoption of a resolution of the Board, terminating the Plan; or (b) the date all shares of Common Stock subject to the Plan are purchased according to the Plan's provisions; or (c) ten years from the date of adoption of the Plan by the Board. No such termination of the Plan shall affect the rights of any Participant hereunder and all options or stock appreciation rights previously granted and restricted stock and stock bonuses awarded hereunder shall continue in force and in operation after the termination of the Plan, except as they may be otherwise terminated in accordance with the terms of the Plan. -16- EX-10.7 7 EXHIBIT 10.7 Exhibit 10.7 FITNESS HOLDINGS, INC. 1995 STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS (Amended and Restated Effective May 16th, 1996) 1. Purpose of the Plan. The purpose of this Amended and Restated Fitness Holdings, Inc. 1995 Stock Option Plan for Non-Employee Directors (the "Plan") is to maintain the ability of Fitness Holdings, Inc. (the "Company") to attract and retain the services of experienced and highly qualified persons to serve as outside directors on the Company's Board of Directors (the "Board") and to create a proprietary interest of such directors in the Company's continued success. 2. Stock Subject to Plan. The stock which may be issued and sold under the Plan shall be the $0.001 par value common stock of the Company, of a total number not exceeding 10,000 shares, subject to adjustment as provided in Section 9 ("Common Stock"). The stock to be issued may be either authorized and unissued shares or issued shares acquired by the Company or its Subsidiaries. Each stock option granted pursuant to the Plan is referred to herein as an "Option." In the event that Options granted under the Plan shall terminate or expire without being exercised in whole or in part, new Options may be granted covering the shares not purchased under such lapsed Options. 3. Eligibility. Each member of the Board shall be eligible to receive Options in accordance with the terms of the Plan, provided he or she, as of the date of a granting of an Option, (i) is not an employee of the Company or any of its Subsidiaries or affiliates and (ii) is otherwise not eligible for selection to participate in any plan of the Company or any of its Subsidiaries or affiliates that entitles the participant therein to acquire securities or derivative securities of the Company (an "Eligible Director"). Each member of the Board who receives an option hereunder is referred to herein as an "Optionee." As used in the Plan, "Subsidiary" means any corporation in which the Company, directly or indirectly, controls 50% or more of the total combined voting power of all classes of such corporation's stock. 4. Option Grants. (a) Subject to the maximum number of shares which may be purchased pursuant to the exercise of Options, as set forth in Section 2 (as such number may be adjusted pursuant to the provisions of Section 9), and to the approval of the Plan by the stockholders of the Company, an Option to purchase, in the manner and subject to the terms and conditions hereinafter provided, 2,500 shares of the Common Stock shall be and hereby is granted, without further action by the Board, as of the close of business on November __, 1995, to each Eligible Director on such date. Should the Plan not be approved by the stockholders of the Company as aforesaid each Option theretofore granted shall be deemed to have been null and void ab initio. (b) Each person who subsequent to November __, 1995, first becomes an Eligible Director shall (i) on the date of the Annual or Special Meeting of Stockholders of the Company at which he or she is first elected to the Board by vote of the stockholders, or (ii) on the date of appointment to the Board with respect to a director appointed to the Board by the Board to fill a vacancy on the Board, however occurring, whether by the death, resignation or removal of any director, any increase in the number of directors comprising the Board, or otherwise, shall, by reason of such election or appointment and without further action by the Board, be granted as of the close of business on said date an Option to purchase, in the manner and subject to the terms and conditions herein provided and to the extent such number of shares remain available for such purpose hereunder, 2,500 shares of Common Stock. In accordance with the foregoing, each Eligible Director may receive only one Option grant under this Plan. In the event that the number of shares of Common Stock available for grants under the Plan is -2- insufficient to make all grants hereby specified as of the applicable date, then all those Eligible Directors who become entitled to a grant on such date shall share ratably in the number of shares then available for grant under the Plan. (c) It is understood that the Board may, at any time and from time to time after the granting of an Option hereunder, specify such additional terms, conditions and restrictions with respect to such Option as may be deemed necessary or appropriate to ensure compliance with any and all applicable laws, including, but not limited to, terms, restrictions and conditions for compliance with federal and state securities laws and methods of withholding or providing for the payment of required taxes. 5. General Terms and Conditions of Options. Each Option granted under the Plan shall be evidenced by an agreement in such form as the Board shall prescribe from time to time in accordance with the Plan (an "Option Agreement") and shall comply with the following terms and conditions: (a) The Option exercise price shall be the fair market value of the Common Stock on the date the Option is granted. For purposes of the Plan, the fair market value of the Common Stock shall be determined by the Board in good faith; provided that (i) if the Common Stock is listed on a national securities exchange, then the fair market value of the Common Stock shall be the mean between the highest and lowest prices at which the Common Stock is traded on such exchange on the relevant date; provided, however, if there is no sale of the Common Stock on such exchange on such date, then the fair market value of the Common Stock shall be the mean between the bid and asked prices on such exchange at the close of the market on such date or (ii) if the Common Stock is quoted on the over-the-counter market on the relevant date as reported by NASDAQ or any successor thereto, then the fair market value of the Common Stock shall be the mean between the bid and asked prices at which the Common Stock is quoted on such date; provided, however, if no such quotations are -3- available on such date, then the most recent date upon which such quotations are available shall be used. (b) The Option Agreement shall not be a precondition to the granting of Options; however, no person shall have any rights under any Option granted under the Plan unless and until the Optionee to whom such Option shall have been granted shall have executed and delivered to the Company an Option Agreement. A fully executed original of the Option Agreement shall be provided to both the Company and the Optionee. By executing an Option Agreement, an Optionee shall be deemed to have accepted and consented to any action taken under the Plan by the Board or its delegates. (c) All Options shall be nonstatutory stock options not intended to qualify as stock options entitled to special tax treatment under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). (d) Options shall not be transferable by the Optionee otherwise than by will or the laws of descent and distribution, and shall be exercisable during the Optionee's lifetime only by the Optionee. (e) Each Option shall be subject to the following restrictions on exercise: (i) An Option shall not be exercisable, in whole or in part, after the expiration of ten (10) years from the date the Option was granted. To the extent that an Option is not exercised within the ten-year period of exercisability, it shall expire as to the then unexercised part. (ii) Subject to Sections 5(e)(i), 6, 7 and the proviso at the end of this sentence, 28% of the total number of shares of Common Stock covered by the Option (as such number may be adjusted pursuant to the provisions of Section 9) shall become exercisable on the date of the grant of the Option, and an additional 24% -4- of said initial total number of shares shall become cumulatively exercisable on each of the three succeeding anniversary dates of the grant date, provided, however, that the Option shall be fully exercisable upon the attainment of age 70 by the Optionee. (iii) An Option shall not be exercisable with respect to a fractional share or with respect to the lesser of one hundred (100) shares or the full number of shares then subject to the Option. If a fractional share shall become subject to an Option by reason of a stock dividend or otherwise, the Optionee shall not be entitled to exercise the Option with respect to such fractional share. (iv) Except as provided in Section 6, an Option shall not be exercisable in whole or in part unless the Optionee, at the time the Optionee exercises the Option, is, and has been at all times since the date of grant of the Option, an Eligible Director. (v) An Option may only be exercised by delivery of written notice of the exercise to the Company specifying the number of shares to be purchased and by making payment in full for the shares of Common Stock being acquired thereunder at the time of exercise (including applicable withholding taxes, if any); unless the Option Agreement shall otherwise provide, such payment shall be made: (A) in United States dollars by check or bank draft, or (B) by tendering to the Company Common Stock shares already owned for at least six (6) months by the person exercising the Option, which may include shares received as the result of a prior exercise of an Option, and having a fair market value, as determined in accordance with Section 5(a), on the date on which the Option is exercised -5- equal to the cash exercise price applicable to such Option, or (C) by a combination of United States dollars and Common Stock shares as aforesaid, or (D) in accordance with a cashless exercise program under which, if so instructed by the Optionee, shares of Common Stock may be issued directly to the Optionee's broker or dealer upon receipt of the purchase price in cash from the broker or dealer. (vi) If at any time the Board shall determine, in its discretion, that the listing, registration or qualification of shares of Common Stock upon any national securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the sale or purchase of shares of Common Stock hereunder, such Option may not be exercised in whole or in part unless and until such listing, registration, qualification, consent or approval shall have been effected or obtained, or otherwise provided for, free of any conditions not acceptable to the Board in the exercise of its reasonable judgment. 6. Termination of Service. An Option shall terminate upon the termination, for any reason, of the Optionee's directorship with the Company, and no shares may thereafter be purchased under such Option except as follows: (a) Upon retirement as a non-employee director of the Company after five (5) years of service, each unexpired Option held by the Optionee shall, to the extent otherwise exercisable on such date, remain exercisable, in whole or in part, for a period of three (3) years following such retirement. -6- (b) Upon termination of service as a director of the Company by reason of death or disability each unexpired Option held by the Optionee, or in the case of death, the Optionee's executors, administrators, heirs or distributees, as the case may be, shall become immediately exercisable and shall remain exercisable, in whole or in part, for a period of one (1) year after such termination. Disability shall mean an inability as determined by the Board to perform duties and services as a director of the Company by reason of a medically determinable physical or mental impairment, supported by medical evidence, which can be expected to last for a continuous period of not less than six (6) months. In the event any Option is exercised by the executors, administrators, heirs or distributees of the estate of a deceased Optionee, the Company shall be under no obligation to issue Common Stock thereunder unless and until the Company is satisfied that the person or persons exercising the Option are the duly appointed legal representative of the deceased Optionee's estate or the proper legatees or distributees thereof. In no event, however, may an Option be exercised after ten (10) years from the date it was granted. 7. Change in Control. (a) Notwithstanding any other provisions of the Plan, but subject to Section 6 and 7(c), in the event of a change in control of the Company, (i) all of the Optionee's then outstanding Options shall immediately become exercisable, unless directed otherwise by a resolution by the Board adopted prior to and specifically relating to the occurrence of such change in control, and (ii) each Optionee shall have the right within one (1) year after such event to exercise the Option in full notwithstanding any limitation or restriction in any Option Agreement or in the Plan. (b) For purposes of this Section 7, a "change in control" shall be deemed to have occurred if any of the following events shall have occurred: -7- (i) A tender offer or exchange offer is made whereby the effect of such offer is to take over and control the affairs of the Company, and such offer is consummated for the ownership of securities of the Company representing twenty-five percent (25%) or more of the combined voting power of the Company's then outstanding voting securities. (ii) The Company is merged or consolidated with another corporation and, as a result of such merger or consolidation, less than seventy-five percent (75%) of the outstanding voting securities of the surviving or resulting corporation shall then be owned in the aggregate by the former stockholders of the Company, other than affiliates within the meaning of the Securities Exchange Act of 1934, as amended (the "Exchange Act") or any party to such merger or consolidation. (iii) The Company transfers substantially all of its assets to another corporation or entity that is not a wholly owned subsidiary of the Company. (iv) Any person (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Exchange Act) is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing twenty-five percent (25%) or more of the combined voting power of the Company's then outstanding securities, and the effect of such ownership is to take over and control the affairs of the Company. (v) As the result of a tender offer, merger, consolidation, sale of assets, or contested election, or any combination of such transactions, the persons who were members of the Board immediately before the transaction, cease to constitute at least a majority thereof. -8- (c) In no event, however, may any Option be exercised after ten (10) years from the date it was granted. 8. Purchase for Investment. (a) Except as hereafter provided, the holder of an Option shall, upon any exercise thereof, execute and deliver to the Company a written statement, in form satisfactory to the Company, in which such holder represents and warrants that such holder is purchasing or acquiring the shares acquired thereunder for such holder's own account, for investment only and not with a view to the resale or distribution thereof, and represents and agrees that any subsequent offer for sale or distribution of any of such shares shall be made only pursuant to either (i) a registration statement on an appropriate form under the Securities Act of 1933, as amended (the "Securities Act"), which registration statement has become effective and is current with regard to the shares being offered or sold, or (ii) a specific exemption from the registration requirements of the Securities Act, but in claiming such exemption the holder shall, prior to any offer for sale or sale of such shares, obtain a prior favorable written opinion, in form and substance satisfactory to the Company, from counsel for or approved by the Company, as to the applicability of such exemption thereto. The foregoing restriction shall not apply to (a) issuances by the Company so long as the shares being issued are registered under the Securities Act and a prospectus in respect thereof is current or (b) reofferings of shares by affiliates of the Company (as defined in Rule 405 or any successor rule or regulation promulgated under the Securities Act) if the shares being reoffered are registered under the Securities Act and a prospectus in respect thereof is current. (b) The Company may endorse such legend or legends upon the certificates for shares issued upon exercise of an Option granted hereunder and may issue such "stop transfer" instructions to its transfer agent in respect of such shares as, in its discretion, it determines to be necessary or appropriate to prevent a violation of, or to perfect an -9- exemption from, the registration requirements of the Securities Act. 9. Adjustment in the Event of Change in Stock. Upon changes in the outstanding Common Stock by reason of a stock dividend, stock split, reverse split, subdivision, recapitalization, merger (whether or not the Company is the surviving corporation), consolidation, split-up, combination or exchange of shares, reorganization or liquidation, extraordinary dividend payable in cash or property, and the like, the aggregate number and class of shares of Common Stock available under the Plan as to which Options may be awarded, and the number, class and the price of shares of Common Stock subject to outstanding Options shall be appropriately adjusted by the Board (whose determination shall be conclusive). 10. Administration. The Plan shall be administered by the Board. The Board shall have all the powers vested in it by the terms of the Plan, such powers to include authority (within the limitations described herein) to prescribe the form of all Option Agreements. The Board shall, subject to the provisions of the Plan, have the power to construe the Plan, to determine all questions arising thereunder and to adopt and amend such rules and regulations for the administration of the Plan as it may deem desirable. Any decision of the Board in the administration of the Plan, as described herein, shall be final and conclusive. The Board may act only by a majority of its members in office, except that the members thereof may authorize any one or more of their number or the secretary or any other officer of the Company to execute and deliver documents on behalf of the Board. No member of the Board shall be liable for anything done or omitted to be done by such member or by any other member of the Board in connection with the Plan, except as may expressly be provided by statute. 11. Miscellaneous Provisions. (a) No person shall have any rights or claims under the Plan except in accordance with the provisions of the Plan and an Option Agreement. -10- Except as expressly provided for in the Plan, no director or other person shall have any claim or right to be granted an Option under the Plan. Neither the Plan nor any action taken hereunder shall be construed as giving any Eligible Director any right to be retained in the service of the Company as a director or otherwise. (b) An Optionee's rights and interest under the Plan may not be assigned or transferred in whole or in part either directly or by operation of law or otherwise (except in the event of an Optionee's death, by will or the laws of descent and distribution), including, but not by way of limitation, execution, levy, garnishment, attachment, pledge, bankruptcy or in any other manner, and no such right or interest of any participant in the Plan shall be subject to any obligation or liability of such participant. (c) It shall be a condition to the obligation of the Company to issue shares of Common Stock upon exercise of an Option that the Optionee (or any beneficiary or person entitled to act) pay to the Company, upon its demand, such amount, in cash and/or Common Stock, as may be requested by the Company for the purpose of satisfying any liability to withhold federal, state, local or foreign income or other taxes; provided, however, that such withholding obligation may be met by the withholding of Common Stock otherwise deliverable to the Optionee in accordance with such procedures as may be adopted by the Board; provided, further, however, the amount of Common Stock so withheld shall not exceed the minimum required withholding obligation. If the amount requested is not paid, the Company may refuse to issue the shares of Common Stock. (d) The expenses of the Plan shall be borne by the Company. (e) The Plan shall be unfunded. Neither the Company nor the Board shall be required to establish any special or separate fund or to make any other segregation of assets to assure the issuance of shares upon exercise of any -11- Option under the Plan and issuance of shares upon exercise of Options shall be subordinate to the claims of the Company's general creditors. Proceeds from the sale of shares pursuant to Options however shall constitute general funds of the Company. Neither the Company, a Subsidiary or the Board shall be deemed to be a trustee of any amounts to be paid under the Plan. (f) By accepting any Option or other benefit under the Plan, each Optionee and each person claiming under or through such person shall be conclusively deemed to have indicated his acceptance and ratification, and consent to, any action taken under the Plan by the Company or the Board or its delegates. (g) No Optionee shall have any rights to dividends or other rights of a shareholder with respect to shares of Common Stock subject to his or her Option until he or she has given written notice of exercise of his or her Option and paid in full for such shares. (h) The Plan shall be governed by and construed in accordance with the laws of the State of New York. 12. Amendment or Discontinuance. The Board may, at any time and from time to time, as the Board shall deem advisable, amend, alter or discontinue the Plan, including, but not limited to, amendments necessary to qualify for any exemption or to comply with applicable law or regulations, provided, however, that, except as provided in Section 9 above, the Board may not, without further approval by the stockholders of the Company, increase the maximum number of shares of Common Stock as to which Options may be granted under the Plan, increase the number of shares subject to an Option, reduce the Option exercise price described in Section 5(a), extend the period during which Options may be granted or exercised under the Plan or change the vesting period or timing of awards or the class of persons eligible to receive Options under the Plan; it being the intent to include in this proviso any amendment that would have the -12- effect of materially increasing the benefits accruing to Optionees under the Plan, and provided, further, that the Plan provisions affecting the amount of Common Stock to be awarded Eligible Directors, the timing of those awards or the determination of those eligible to receive such awards may not be amended more than once every six (6) months, other than to comport with changes in the Code, the Employee Retirement Income Security Act of 1974, as amended, or the rules thereunder. Notwithstanding the proviso to the immediately preceding sentence, to the extent that, in the opinion of counsel to the Company, stockholder approval of an amendment to the Plan is not required under the Exchange Act (including the rules and regulations promulgated thereunder) in order for the Options under the Plan to continue to be exempt from the operation of Section 16(b) of the Exchange Act, such amendment may be made by the Board acting alone. No amendment, alteration or discontinuation of the Plan shall be made which would materially and adversely affect any right of any Optionee with respect to any Option theretofore granted without such Optionee's written consent. The Board may amend the terms of any outstanding Option Agreement, retroactively or prospectively, but no such amendment shall materially and adversely affect any right of any Optionee without his or her written consent. 13. Limits of Liability. (a) Any liability of the Company to an Optionee, or any other person, with respect to an Option award shall be based solely upon contractual obligations, if any, created by the Plan and the Optionee's Option Agreement. (b) Neither the Company nor any member of the Board, nor any other person participating in any determination of any question under the Plan, or in the interpretation, administration or application of the Plan, shall have any liability to any party for any action taken or not taken in connection with the Plan, except as may expressly be provided by statute. -13- 14. Duration. This Plan shall become effective as of the date on which it is adopted by the Board, subject to approval of the Plan by the stockholders of the Company. This Plan shall terminate upon the earlier of the following dates or events to occur: (a) upon the adoption of a resolution of the Board terminating the Plan; or (b) the date all shares of Common Stock subject to the Plan are purchased according to the Plan's provisions; or (c) ten (10) years from the date of adoption of the Plan by the Board. No such termination of this Plan shall affect the rights of any Optionee hereunder and all Options previously granted hereunder shall continue in force and in operation after termination of the Plan, except as they may be otherwise terminated in accordance with the terms of the Plan. -14- EX-10.8 8 EXHIBIT 10.8 Exhibit 10.8 MANAGEMENT SERVICES AGREEMENT THIS MANAGEMENT SERVICES AGREEMENT (the "Agreement") is entered into as of this 29th day of December, 1994, by and between 24 Hour Fitness, Inc., a Delaware corporation (the "Company"), and MDC Management Company III, L.P., a California limited partnership ("MDC"). NOW, THEREFORE, in consideration of the mutual promises of the parties hereinafter set forth, MDC and the Company hereto agree as follows: 1. RETENTION AS MANAGEMENT ADVISOR. Subject to each of the terms, conditions and provisions of this Agreement, the Company hereby retains MDC and MDC hereby agrees to be retained by the Company to perform those financial and managerial functions set forth in Section 4 of this Agreement. 2. TERM. 2.1 Subject to the provisions for termination set forth herein, this Agreement shall be from the date hereof through December 28, 2004, and automatically renewable annually thereafter unless MDC receives 30 days notice of the termination prior to the renewal date. 2.2 The Company, by written notice to MDC, authorized by a majority of the directors other than those who are partners, principals or employees of MDC (or an affiliate of MDC), may terminate this Agreement for justifiable cause, which shall mean any of the following events: material breach by MDC of any of its obligations hereunder; misappropriation by MDC of funds or property of the Company or other willful breach in the course of the consultancy; any attempt by MDC to secure personal profit related to the business of the Company and not fairly disclosed to and approved by the Board of Directors; or gross neglect by MDC in the fulfillment of its obligations hereunder. 2.3 MDC, by thirty (30) days prior written notice to the Company, may terminate this Agreement at any time. 3. COMPENSATION. 3.1 As compensation to MDC for its management and advisory services to the Company under this Agreement, the Company agrees to pay MDC a fee in the amount of three hundred fifty thousand ($350,000) per year, adjusted upward by $100,000 each year until such fee shall equal $750,000 per year; PROVIDED that in no event shall such fee for any one year exceed .7 of 1% of the consolidated revenues of the Company and its subsidiaries (including, without limitation, the revenues of 24 Hour Workout) for the previous year. Such fee shall be payable in arrears in equal quarterly installments, on the first day of January, April, July and October, commencing on April 1, 1995. 3.2 MDC shall also be entitled to be reimbursed by the Company for all reasonable out-of-pocket costs and expenses incurred by MDC and any of its partners, employees or affiliates in connection with (i) providing the Services under this Agreement, or (ii) serving as a member of the Board of Directors or as an officer of the Company including, without limitation, all travel expenses. Reimbursement shall be provided upon receipt by the Company of invoices from MDC with respect to such costs and expenses. 4. DUTIES AS MANAGEMENT ADVISOR. MDC's duties as a financial and management consultant to the Company under the provisions of this Agreement shall include providing services in obtaining equity, debt, lease and acquisition financing, as well as providing other financial and consulting services for the operation and growth of the Company at any time during the term of this Agreement (the "Services"). Such Services shall be rendered upon the reasonable request of the Company. MDC shall devote as much time as reasonably necessary to the affairs of the Company. 5. DECISIONS. The Company reserves the right to make all decisions with regard to any matter upon which MDC has rendered its advice and consultation, and there shall be no liability to MDC for any such advice accepted by the Company pursuant to the provisions of this Agreement. 6. AUTHORITY OF MANAGEMENT ADVISOR. MDC shall have authority only to act as a consultant and advisor to the Company. MDC shall have no authority to enter into any agreement or to make any representation, commitment or warranty binding upon the Company or to obtain or incur any right, obligation or liability on behalf of the Company. 7. INDEPENDENT CONTRACTOR. Except as may be expressly provided elsewhere in this Agreement, MDC shall act as an independent contractor and shall have complete charge of its personnel engaged in the performance of the Services. 8. BOOKS AND RECORDS. MDC's books and records with respect to the Services and any reimbursable costs ("Books and Records") shall be kept at MDC's office located at 3000 Sand Hill Road, Building 3, Suite 290, Menlo Park, California 94025. The Books and Records shall be kept in accordance with recognized accounting principles and practices, consistently applied, and shall be made available for the Company or the Company's representatives' inspection and copying at all times during regular office hours. MDC shall not be required to maintain the Books and Records for more than three (3) years after termination of this Agreement. -2- 9. CONFIDENTIAL INFORMATION. 9.1 The parties acknowledge that during the course of provision of the Services, the Company may disclose confidential information to MDC or its affiliated companies. MDC shall treat such information as the Company's confidential property and safeguard and keep secret all such information about the Company, including reports and records, customer lists, trade lists, trade practices, and prices pertaining to the Company's business coming to the attention or knowledge of MDC because of any activities conducted by MDC under or pursuant to this Agreement. 9.2 MDC shall exercise its best efforts and shall cause any of its affiliated companies to exercise their best efforts to prevent any confidential information from being disclosed to third parties, except as necessarily required in the performance of the Services and except under terms of confidentiality satisfactory to the Company. This obligation shall remain in effect until the Company shall release MDC or its affiliated companies from their obligations under this paragraph 9, but in no event later than three (3) years after the completion of the Services. MDC shall not use any of the Company's confidential information in any way that is detrimental to the interests of the Company, directly or indirectly, either during the term of this Agreement or at any time thereafter. 10. INDEMNIFICATION. The Company agrees to indemnify and hold MDC and its officers, directors and agents harmless from damages, losses or expenses (including, without limitation, reasonable attorneys' fees and expenses) incurred or paid directly or indirectly, by MDC as a result or arising out of any actions taken by MDC in connection with the performance of the Services under this Agreement except to the extent that such actions resulted solely from the gross negligence or willful misconduct of MDC. The Company hereby further agrees to reimburse MDC for all reasonable fees and expenses incurred in connection with defending any such claim to which MDC is a party, as such fees and expenses are incurred by MDC. 11. NOTICES AND COMMUNICATIONS. 11.1 All communications relating to the day-to-day activities necessary to render the Services shall be exchanged between the respective representatives of the Company and MDC, who will be designated by the parties promptly upon commencement of the Services. 11.2 All other notices, demands, and communications required or permitted hereunder shall be in writing and shall be delivered personally to the respective representatives of the Company and MDC set forth below or shall be mailed by registered mail, postage prepaid, return receipt requested. Notices, demands and communications hereunder shall be effective: (i) if delivered personally, on delivery; or (ii) if mailed, forty-eight (48) hours after deposit thereof in the United States mail addressed to the party to whom such notice, -3- demand, or communication is given. Until changed by written notice, all such notices, demands and communications shall be addressed as follows: If to the Company: 24 Hour Fitness, Inc. P.O. Box 9071 Pleasanton, CA 94566 Attn: Gilbert K. Freeman Tel: (510) 416-7399 Fax: (510) 416-7398 If to MDC: McCown De Leeuw & Co. 101 East 52nd Street 31st Floor New York, New York 10022 Attn: David E. King Tel: (212) 355-5500 Fax: (212) 355-6283 or (212) 355-6945 With copies to: White & Case 1155 Avenue of the Americas New York, New York 10036 Attn: Frank L. Schiff, Esq. Tel: (212) 819-8752 Fax: (212) 354-8113 12. ASSIGNMENTS. MDC shall not assign this Agreement in whole or in part without the prior written consent of the Company; PROVIDED, HOWEVER, that such consent shall not be unreasonably withheld with respect to assignments to MDC's affiliates or wholly-owned subsidiaries; and PROVIDED FURTHER, that any such assignment shall not relieve MDC of any of its obligations under this Agreement. Subject to the foregoing, all the terms and conditions contained herein shall inure to the benefit of and shall be binding upon the parties hereto and their respective heirs, personal representatives, successors and assigns. 13. APPLICABLE LAW AND SEVERABILITY. This document shall, in all respects, be governed by the laws of the State of New York applicable to agreements executed and to be wholly performed within the State of New York. Nothing contained herein shall be construed so as to require the commission of any act contrary to law, and wherever there is any conflict between any provisions contained herein and any contrary present or future statute, law, ordinance or regulation, the latter shall prevail, but the provision of this document which is -4- affected shall be curtailed and limited only to the extent necessary to bring it within the requirements of the law. 14. FURTHER ASSURANCES. Each of the parties hereto shall execute and deliver any and all additional papers, documents and other assurances, and shall do any and all acts and things reasonably necessary in connection with the performance of their obligations hereunder and to carry out the intent of the parties hereto. 15. ATTORNEYS' FEES. In the event any action is instituted by a party to enforce any of the terms and provisions contained herein, the prevailing party in such action shall be entitled to such reasonable attorneys' fees, costs and expenses as may be fixed by the court. 16. TIME OF THE ESSENCE. Time is of the essence of this Agreement and all the terms, provisions, covenants and conditions hereof. 17. CAPTIONS. The captions appearing at the commencement of the paragraphs hereof are descriptive only and for convenience and reference. Should there be any conflicts between any such caption and the paragraph at the head of which it appears, the paragraph and not such caption shall control and govern in the construction of this document. 18. MODIFICATIONS OR AMENDMENTS. No amendment, change or modification of this document shall be valid unless it is in writing and signed by all the parties hereto and expressly states that it is an amendment, change or modification of this Agreement is intended. 19. SEPARATE COUNTERPARTS. This document may be executed in one or more separate counterparts, each of which, when so executed, shall be deemed to be an original. Such counterparts shall, together, constitute and be one and the same. 20. ENTIRE AGREEMENT. This Agreement shall constitute the entire understanding and agreement between the parties hereto and shall supersede any and all letters of intent, whether written or oral, pertaining to the subject matter of this Agreement. -5- IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized officers on the date first appearing above. 24 HOUR FITNESS, INC. By [ILLEGIBLE] --------------------------------- MDC MANAGEMENT COMPANY III, L.P., a California limited partnership By [ILLEGIBLE] --------------------------------- General Partner -6- EX-10.9 9 EXHIBIT 10.9 Exhibit 10.9 EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED THIRD AMENDED AND RESTATED HOLDINGS PLEDGE AGREEMENT Dated December 19, 1997 From FITNESS HOLDINGS, INC., as Pledgor, ----------- to BANQUE NATIONALE DE PARIS, as Administrative Agent ----------------------- TABLE OF CONTENTS Page ---- SECTION 1 Grant of Security................................................3 SECTION 2 Security for Obligations.........................................4 SECTION 3 Pledgor Remains Liable...........................................4 SECTION 4 Delivery of Collateral...........................................4 SECTION 5 Representations and Warranties...................................5 SECTION 6 Further Assurances...............................................6 SECTION 7 Place of Perfection; Records.....................................6 SECTION 8 Voting Rights; Dividends; Etc....................................7 SECTION 9 Transfers and Other Liens; Additional Shares.....................8 SECTION 10 Administrative Agent Appointed Attorney-in-Fact..................8 SECTION 11 Administrative Agent May Perform.................................9 SECTION 12 The Administrative Agent's Duties................................9 SECTION 13 Remedies.........................................................9 SECTION 14 Registration Rights.............................................11 SECTION 15 Indemnity and Expenses..........................................12 SECTION 16 Security Interest Absolute......................................12 SECTION 17 Amendments; Waivers; Etc........................................13 SECTION 18 Addresses for Notices...........................................13 (i) Page ---- SECTION 19 Continuing Security Interest; Assignments under the Credit Agreement ...............................................14 SECTION 20 Release and Termination.........................................14 SECTION 21 Governing Law; Submission to Jurisdiction, Waiver of Jury Trial; Etc ................................................14 Schedule I Pledged Shares Schedule II Existing Liens (ii) EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED THIRD AMENDED AND RESTATED HOLDINGS PLEDGE AGREEMENT THIRD AMENDED AND RESTATED HOLDINGS PLEDGE AGREEMENT, dated December 19, 1997, made by FITNESS HOLDINGS, INC., a Delaware corporation (the "Pledgor"), to BANQUE NATIONALE DE PARIS ("BNP"), as administrative agent (together with any successor agent appointed pursuant to Article VII of the Credit Agreement (as hereinafter defined), the "Administrative Agent") for the lender parties (the "Lender Parties") and other Agents party to the Credit Agreement. PRELIMINARY STATEMENTS: (1) 24 Hour Fitness, Inc., a California corporation (the "Borrower"), is the borrower under a Second Amended and Restated Credit Agreement dated as of March 14, 1997 (as amended, supplemented or otherwise modified, the "Existing Credit Agreement") with the lenders named therein (the "Existing Lenders") and BNP as issuing bank and agent (the "Existing Agent"). Pursuant to a Second Amended and Restated Holdings Pledge Agreement dated March 14, 1997 (the "Existing Pledge Agreement"), the Pledgor assigned and pledged to the Existing Agent for its benefit and the benefit of the issuing bank party to the Existing Credit Agreement and the ratable benefit of the Existing Lenders and certain hedge lenders to secure the payment of all Obligations (as defined in the Existing Credit Agreement) of the Pledgor under, among other things, the Existing Credit Agreement, a security interest in certain property. (2) The Borrower has entered into a Third Amended and Restated Credit Agreement dated as of December 19, 1997 (said Agreement, as it may hereafter be amended, supplemented or otherwise modified from time to time, being the "Credit Agreement"; the terms defined therein and not otherwise defined herein being used herein as therein defined) with the Lender Parties party thereto, BNP as Syndication Agent and as Administrative Agent for the Lender Parties, Bankers Trust Company as Documentation Agent for the Lenders and LaSalle National Bank and Wells Fargo Bank, N.A., as Co-Agents for the Lenders. (3) The Borrower may from time to time invest in Hedge Agreements with one or more Lenders in connection with the Credit Agreement (all such Lenders being, collectively, the "Hedge Banks") to obtain the protection permitted by Section 5.02(b)(i)(C) of the Credit Agreement against fluctuations in certain interest rates. Such Hedge Agreements, copies of which shall be provided to the Administrative Agent, are hereinafter referred to as the "Secured Hedge Agreements". (4) The Pledgor is the owner of the shares of stock, and of the warrants, rights and options to acquire the shares of stock (collectively, the "Pledged Shares"), described on Part EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 2 A of Schedule I hereto and issued by the corporations named therein and of the indebtedness (the "Pledged Indebtedness") described on Part B of Schedule I hereto and issued by the obligors named therein. (5) It is a condition precedent to the making of Advances by the Lender Parties under the Credit Agreement and the issuance of Letters of Credit by the Issuing Bank under the Credit Agreement, and the entering into the Secured Hedge Agreements by the Hedge Banks, that the Pledgor shall have granted the assignment and security interest and made the pledge contemplated by this Agreement. EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 3 NOW, THEREFORE, in consideration of the premises and in order to induce the Lender Parties to make Advances under the Credit Agreement, the Issuing Bank to issue Letters of Credit under the Credit Agreement and the Hedge Banks to enter into arrangements permitted by Section 5.02(b)(i)(C) of the Credit Agreement, the Pledgor hereby agrees with the Administrative Agent for its benefit and the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the other Lender Parties and the Hedge Banks as follows: SECTION 1. Grant of Security. The Pledgor hereby assigns and pledges to the Administrative Agent for its benefit and the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the other Lender Parties and the Hedge Banks, and hereby grants to the Administrative Agent for its benefit and the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the other Lender Parties and the Hedge Banks, a security interest in the following (collectively, the "Collateral"): (a) the Pledged Shares and the certificates representing the Pledged Shares, and all dividends, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the Pledged Shares; (b) the Pledged Indebtedness and the instruments evidencing the Pledged Indebtedness, and all interest, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the Pledged Indebtedness; (c) all additional shares of stock, and all additional warrants, rights or options to acquire shares of stock, from time to time acquired by the Pledgor in any manner, and the certificates representing such additional shares and such additional warrants, rights or options and all dividends, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of such additional shares or such additional warrants, rights or options; (d) all additional indebtedness from time to time owed to the Pledgor in any manner and the instruments evidencing such additional indebtedness, and all interest, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all such additional indebtedness; and (e) all proceeds of any and all of the foregoing Collateral to the extent assignable without consent (including, without limitation, proceeds that constitute property of the types described in clauses (a) through (d) of this Section 1) and, to the EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 4 extent not otherwise included, all (i) payments under insurance (whether or not the Administrative Agent is the loss payee thereof), or any indemnity, warranty or guaranty, payable by reason of loss or damage to or otherwise with respect to any of the foregoing Collateral and (ii) cash. SECTION 2. Security for Obligations. The pledge, assignment and security interest granted under this Agreement by the Pledgor secure the payment of all Obligations of the Pledgor now or hereafter existing under this Agreement and each other Loan Document and under the Secured Hedge Agreements, whether for principal, interest, premiums, fees, expenses or otherwise (all such Obligations being the "Secured Obligations"). Without limiting the generality of the foregoing, this Agreement secures the payment of all amounts that constitute part of the Secured Obligations and would be owed by the Pledgor to the Administrative Agent or any Lender Party under the Loan Documents or the Hedge Banks under the Secured Hedge Agreements but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving the Pledgor. SECTION 3. Pledgor Remains Liable. Anything herein to the contrary notwithstanding, (a) the Pledgor shall remain liable under the contracts and agreements included in the Collateral to the extent set forth therein to perform all of its duties and obligations thereunder to the same extent as if this Agreement had not been executed, (b) the exercise by the Administrative Agent of any of the rights hereunder shall not release the Pledgor from any of its duties or obligations under the contracts and agreements included in the Collateral, and (c) none of the Administrative Agent, the Lender Parties or the Hedge Banks shall have any obligation or liability under the contracts and agreements included in the Collateral by reason of this Agreement, nor shall the Administrative Agent, any Lender Party or any Hedge Bank be obligated to perform any of the obligations or duties of the Pledgor thereunder or to take any action to collect or enforce any claim for payment assigned hereunder. SECTION 4. Delivery of Collateral. All certificates and instruments representing or evidencing Collateral shall be delivered to and held by or on behalf of the Administrative Agent pursuant hereto and shall be in suitable form for transfer by delivery, or shall be accompanied by duly executed instruments of transfer or assignment in blank, all in form and substance reasonably satisfactory to the Administrative Agent. After the occurrence and during the continuance of any Event of Default, the Administrative Agent shall have the right, at any time in its discretion and without notice to the Pledgor, to transfer to or register in the name of the Administrative Agent or any of its nominees any or all of the Collateral, subject only to the revocable rights specified in Section 8(a). In addition, after the occurrence and during the continuance of an Event of Default, the Administrative Agent shall have the right at any time to exchange certificates or instruments representing or evidencing Collateral for certificates or instruments of smaller or larger denominations. EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 5 SECTION 5. Representations and Warranties. The Pledgor represents and warrants as to itself and its Collateral as follows: (a) The principal place of business of the Pledgor or, if the Pledgor has more than one principal place of business, the chief executive office of the Pledgor, and the office where the Pledgor keeps its records concerning the Collateral are located at the address listed below the name of the Pledgor on the signature page hereof. (b) The Pledgor is the legal and beneficial owner of the Collateral free and clear of any Lien. No effective financing statement or other instrument similar in effect covering all or any part of the Collateral is on file in any recording office, except such as may have been filed in favor of the Administrative Agent relating to this Agreement or the other Collateral Documents, the Existing Pledge Agreement or the "Collateral Documents" under the Existing Credit Agreement except as set forth on Schedule II. The Pledgor has no trade names. (c) All of the shares of stock that constitute Pledged Shares have been duly authorized and validly issued and are fully paid and nonassessable. The Pledged Indebtedness has been duly authorized, authenticated or issued and delivered and is the legal, valid and binding obligation of the issuers thereof and is not in default. (d) The Pledged Shares constitute the percentage of the issued and outstanding shares of stock, and/or warrants, rights or options to acquire shares of stock, of the issuers thereof indicated on Part A of Schedule I hereto. The Pledged Indebtedness is outstanding in the principal amount indicated on Part B of Schedule I hereto. (e) This Agreement and the pledge of the Collateral pursuant hereto create a valid and perfected first priority security interest in the Collateral, securing the payment of the Secured Obligations, and all filings and other actions necessary or desirable to perfect and protect such security interest have been duly made or taken. (f) No consent of any other Person and no authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or any other third party is required for (i) the grant by the Pledgor of the assignment and security interest granted hereby, the pledge by the Pledgor of the Collateral pursuant hereto or the execution, delivery or performance of this Agreement by the Pledgor, (ii) the perfection or maintenance of the pledge, assignment and security interest created hereby or (iii) the exercise by the Administrative Agent of its voting or other rights provided for in this Agreement or the remedies in respect of the Collateral pursuant to this Agreement (except as may be required in connection with the disposition of any EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 6 portion of the Collateral by laws affecting the offering and a sale of securities generally), in each case other than the filing of financing and continuation statements under the Uniform Commercial Code, which financing statements have been duly filed, and the filing of the Trademark Security Agreement in the U.S. Patent and Trademark Office, which agreement shall be duly filed on or immediately after the date of the Second Restatement Date. SECTION 6. Further Assurances. (a) The Pledgor agrees that from time to time, at its own expense, it shall promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary, or that the Administrative Agent may deem desirable and may reasonably request, in order to perfect and protect any pledge, assignment or security interest granted or purported to be granted hereby (including, without limitation, the first priority nature thereof) or to enable the Administrative Agent to exercise and enforce its rights and remedies hereunder with respect to any Collateral. Without limiting the generality of the foregoing, the Pledgor shall promptly after an Event of Default: (i) if any Collateral shall be represented or evidenced by a promissory note or other instrument or chattel paper, deliver and pledge to the Administrative Agent hereunder such note, instrument or chattel paper duly indorsed and accompanied by duly executed instruments of transfer or assignment, all in form and substance satisfactory to the Administrative Agent; and (ii) execute and file such financing or continuation statements, or amendments thereto, and such other instruments or notices, as may be necessary or as the Administrative Agent may deem desirable and may reasonably request, in order to perfect and preserve the pledge, assignment and security interest granted or purported to be granted hereby. (b) The Pledgor hereby authorizes the Administrative Agent to file one or more financing or continuation statements, and amendments thereto, relating to all or any part of the Collateral without the signature of the Pledgor where permitted by law. A photocopy or other reproduction of this Agreement or any financing statement covering the Collateral or any part thereof shall be sufficient as a financing statement where permitted by law. (c) The Pledgor shall furnish to the Administrative Agent, upon the Administrative Agent's request either at any time after the occurrence and during the continuance of an Event of Default or in any event, not less than once annually, statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Administrative Agent may reasonably request, all in reasonable detail. SECTION 7. Place of Perfection; Records. The Pledgor shall keep its principal place of business, its chief executive office and the office where it keeps its records concerning the Collateral at the location therefor specified in Section 5(a) or, upon 30 days' prior written notice to the Administrative Agent, at such other locations in a jurisdiction where all actions EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 7 required by Section 6 shall have been taken with respect to the Collateral. The Pledgor shall hold and preserve such records and shall permit representatives of the Administrative Agent at any time during normal business hours to inspect and make abstracts from such records. SECTION 8. Voting Rights; Dividends; Etc. (a) So long as no Event of Default shall have occurred and be continuing and no foreclosure proceedings shall have been instituted: (i) The Pledgor shall be entitled to exercise or refrain from exercising any and all voting and other consensual rights pertaining to the Collateral or any part thereof for any purpose not prohibited by the terms of this Agreement, the other Loan Documents or the Secured Hedge Agreements; provided, however, (ii) The Pledgor shall be entitled to receive and retain any and all dividends, distributions and interest paid in respect of the Collateral; provided, however, that any and all (A) dividends and interest paid or payable other than in cash in respect of, and instruments and other property and assets received or receivable or otherwise distributed in respect of, or in exchange for, any Collateral, (B) dividends and other distributions paid or payable in cash in respect of any Collateral in connection with a partial or total liquidation or dissolution or in connection with a reduction of capital, capital surplus or paid-in-surplus and (C) cash paid or payable or otherwise distributed in respect of principal of, or in redemption of, or in exchange for, any Collateral shall be, and shall be forthwith delivered to the Administrative Agent to hold as, Collateral and, if received by the Pledgor, shall be received in trust for the benefit of the Administrative Agent, shall be segregated from other property and assets or funds of the Pledgor and shall be forthwith delivered to the Administrative Agent as Collateral in the same form as so received (with any necessary endorsement or assignment). The Pledgor, promptly upon the request of the Administrative Agent, shall execute such documents and do such acts as may be necessary or desirable in the judgment of the Administrative Agent to give effect to this clause (ii). (iii) The Administrative Agent shall execute and deliver (or cause to be executed and delivered) to the Pledgor all such proxies and other instruments as the Pledgor may request for the purpose of enabling the Pledgor to exercise the voting and other consensual rights that it is entitled to exercise pursuant to subparagraph (i) of this EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 8 Section 8(a) and to receive the dividends, distributions or interest payments that it is authorized to receive and retain pursuant to clause (ii) of this Section 8(a). (b) Upon the occurrence and during the continuance of an Event of Default and upon exercise of foreclosure remedies by the Administrative Agent under Section 13 hereof: (i) All rights of the Pledgor to (A) exercise or refrain from exercising the voting and other consensual rights that it would otherwise be entitled to exercise pursuant to subparagraph (i) of Section 8(a) shall, upon notice to the Pledgor by the Administrative Agent, cease and (B) receive the dividends, interest payments and other distributions that it would otherwise be authorized to receive and retain pursuant to subparagraph (ii) of Section 8(a) shall automatically cease, and all such rights shall thereupon become vested in the Administrative Agent, which shall thereupon have the sole right to exercise or refrain from exercising such voting and other consensual rights and to receive and retain as Collateral such dividends, interest payments and other distributions. (ii) All dividends, interest payments and other distributions that are received by the Pledgor contrary to the provisions of clause (i) of this Section 8(b) shall be received in trust for the benefit of the Administrative Agent, shall be segregated from other property and assets or funds of the Pledgor and shall be forthwith paid over to the Administrative Agent as Collateral in the same form as so received (with any necessary endorsement or assignment). SECTION 9. Transfers and Other Liens; Additional Shares. (a) The Pledgor agrees not (i) to sell, assign (by operation of law or otherwise) or otherwise dispose of, or grant any option with respect to, any of the Collateral or (ii) to create or suffer to exist any Lien upon or with respect to any of the Collateral, except for the pledge, assignment and security interest created by this Agreement. (b) The Pledgor shall (i) cause each issuer of the Pledged Shares not to issue any stock or other securities in addition to or in substitution for the Pledged Shares issued by such issuer, except to the Pledgor, and (ii) pledge to the Administrative Agent hereunder, immediately upon its acquisition (directly or indirectly) thereof, any and all additional shares of stock or other securities of each issuer of the Pledged Shares. SECTION 10. Administrative Agent Appointed Attorney-in-Fact. The Pledgor hereby irrevocably appoints the Administrative Agent the Pledgor's attorney-in-fact, with full authority in the place and stead of the Pledgor and in the name of the Pledgor or otherwise, upon the occurrence and continuance of an Event of Default, to take any action and to execute any EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 9 instrument that the Administrative Agent may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation: (a) to ask for, demand, collect, sue for, recover, compromise, receive and give acquittance and receipts for moneys due and to become due under or in respect of any of the Collateral; (b) to receive, indorse and collect any drafts, instruments, and other documents in connection with Section 10(a) above (including, without limitation, all instruments representing any dividend, interest payment or other distribution in respect of the Collateral or any part thereof) and give full discharge for the same; and (c) to file any claims, to take any action or to institute any proceedings that the Administrative Agent may deem necessary or desirable for the collection of any of the Collateral or otherwise to enforce the rights of the Administrative Agent with respect to any of the Collateral or to enforce the rights of the Administrative Agent with respect to any Collateral. SECTION 11. Administrative Agent May Perform. If the Pledgor fails to perform any agreement contained herein, the Administrative Agent may upon notice to Pledgor, itself perform, or cause the performance of, such agreement, and the expenses of the Administrative Agent incurred in connection therewith shall be payable by the Pledgor under Section 15(b). SECTION 12. The Administrative Agent's Duties. The powers conferred on the Administrative Agent hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon it to exercise any such powers. Except for the exercise of reasonable care in the safe custody and preservation of any Collateral in its possession and the accounting for moneys actually received by it hereunder, the Administrative Agent shall have no duty as to any Collateral, as to ascertaining or taking action with respect to calls, conversions, exchanges, maturities, tenders or other matters relative to any Collateral, whether or not the Administrative Agent, any Lender Party or any Hedge Bank has or is deemed to have knowledge of such matters, or as to the taking of any necessary steps to preserve rights against any parties or any other rights pertaining to any Collateral. The Administrative Agent shall be deemed to have exercised reasonable care in the custody and preservation of any Collateral in its possession if such Collateral is accorded treatment substantially equal to that which BNP accords its own property of like tenor. SECTION 13. Remedies. If any Event of Default shall have occurred and be continuing: EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 10 (a) The Administrative Agent may exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party upon default under the Uniform Commercial Code in effect in the State of New York at such time (the "Code") (whether or not the Code applies to the affected Collateral), and also may (i) require the Pledgor to, and the Pledgor hereby agrees that it shall at its own expense and upon request of the Administrative Agent forthwith, assemble all or part of the Collateral as directed by the Administrative Agent and make it available to the Administrative Agent at a place to be designated by the Administrative Agent that is reasonably convenient to both parties and (ii) without notice except as specified below, sell the Collateral or any part thereof in one or more parcels at public or private sale, at any exchange or broker's board or at any of the Administrative Agent's offices or elsewhere, for cash, on credit or for future delivery, and upon such other terms as the Administrative Agent may deem commercially reasonable. The Pledgor agrees that, to the extent notice of sale shall be required by law, at least ten days' notice to the Pledgor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. The Administrative Agent shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. The Administrative Agent may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. (b) Any cash held by the Affirmative Agent as Collateral and all cash proceeds received by the Administrative Agent in respect of any sale of, collection from, or other realization upon all or any part of the Collateral may, in the discretion of the Administrative Agent, be held by the Administrative Agent as collateral for, and/or then or at any time thereafter applied (after payment of any amounts payable to the Administrative Agent pursuant to Section 15) in whole or in part by the Administrative Agent for its benefit, the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the other Lender Parties and the Hedge Banks against, all or any part of the Secured Obligations in such order as the Administrative Agent shall elect. In determining the amounts owing to the Hedge Banks under the Secured Hedge Agreements, the Administrative Agent shall be entitled to rely, and be fully protected in relying, upon the Agreement Values of the Secured Hedge Agreements. The term "Agreement Value" means, with respect to any Secured Hedge Agreement at any date of determination, the amount, if any, that would be payable to the Hedge Bank in respect of any "agreement value" under such Secured Hedge Agreement as though such Secured Hedge Agreement were terminated on such date, calculated as provided in the International Swap Dealers Association, Inc. Standard Form of Interest Rate and EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 11 Currency Exchange Agreement, 1987 Edition. Each determination of Agreement Value shall be made by the Administrative Agent in good faith and in reliance on any information (including information provided by such Hedge Bank) that it believes accurate, but without any obligation to verify such information. Any surplus of such cash or cash proceeds held by the Administrative Agent and remaining after payment in full of all of the Secured Obligations shall be paid over to the Pledgor or to whomsoever may be lawfully entitled to receive such surplus. (c) The Administrative Agent may exercise any and all rights and remedies of the Pledgor in respect of the Collateral. (d) All payments received by the Pledgor in respect of the Collateral shall be received in trust for the benefit of the Administrative Agent, shall be segregated from other funds of the Pledgor and shall be forthwith paid over to the Administrative Agent in the same form as so received (with any necessary endorsement or assignment). SECTION 14. Registration Rights. If the Administrative Agent shall determine to exercise its right to sell all or any of the Collateral pursuant to Section 13, the Pledgor agrees that, upon request of the Administrative Agent, the Pledgor will, at its own expense: (a) execute and deliver, and cause each issuer of the Collateral contemplated to be sold and the directors and officers thereof to execute and deliver, all such instruments and documents, and do or cause to be done all such other acts and things, as may be necessary or, in the opinion of the Administrative Agent, advisable to register such Collateral under the provisions of the Securities Act of 1933, as from time to time amended (the "Securities Act"), to cause the registration statement relating thereto to become effective and to remain effective for such period as prospectuses are required by law to be furnished, and to make all amendments and supplements thereto and to the related prospectus that, in the opinion of the Administrative Agent, are necessary or advisable, all in conformity with the requirements of the Securities Act and the rules and regulations of the Securities and Exchange Commission applicable thereto; (b) use its best efforts to qualify the Collateral under the state securities or "blue sky" laws and to obtain all necessary governmental approvals for the sale of the Collateral, as reasonably requested by the Administrative Agent; (c) cause each such issuer to make available to its security holders, as soon as practicable, an earnings statement that will satisfy the provisions of Section 11(a) of the Securities Act and the rules and regulations thereunder; EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 12 (d) provide the Administrative Agent with such other information and projections as may be necessary or, in the opinion of the Administrative Agent, advisable to enable the Administrative Agent to effect the sale of such Collateral; and (e) do or cause to be done all such other acts and things as may be necessary to make such sale of the Collateral or any part thereof valid and binding and in compliance with applicable law. The Administrative Agent is authorized, in connection with any sale of the Collateral pursuant to Section 13, to deliver or otherwise disclose to any prospective purchaser of the Collateral (i) any registration statement or prospectus, and all supplements and amendments thereto, prepared pursuant to subsection (a) above, (ii) any information and projections provided to it pursuant to subsection (d) above and (iii) any other information in its possession relating to the Collateral. SECTION 15. Indemnity and Expenses. (a) The Pledgor agrees to indemnify the Administrative Agent, each Lender Party and each Hedge Bank and each of their respective officers, directors, employees, agents and advisors (each an "Indemnified Party") from, and hold each of them harmless against, any and all claims, damages, losses, liabilities and expenses (including, without limitation, reasonable fees and reasonable expenses of counsel) arising out of or in connection with or resulting from this Agreement (including, without limitation, enforcement of this Agreement), except to the extent that such claims, damages, losses, liabilities and expenses are found in a final, nonappealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party's gross negligence or willful misconduct. (b) The Pledgor agrees to pay to the Administrative Agent, upon demand, the amount of any and all expenses, (including, without limitation, the reasonable fees and reasonable expenses of its counsel and of any experts and agents) that the Administrative Agent may incur in connection with (i) the administration of this Agreement, (ii) the custody, preservation, use or operation of, or the sale of, collection from, or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the rights of the Administrative Agent or any Lender Party or any Hedge Bank hereunder or (iv) the failure by the Pledgor to perform or observe any of the provisions hereof. SECTION 16. Security Interest Absolute. The obligations of the Pledgor under this Agreement are independent of the Secured Obligations, and a separate action or actions may be brought and prosecuted against the Pledgor to enforce this Agreement, irrespective of whether any action is brought against the Borrower or any other Person or whether the Borrower or such other Person is joined in any such action or actions. All rights of the Administrative Agent and the pledge, assignment and security interest hereunder, and all obligations of the Pledgor hereunder, shall be absolute and unconditional, irrespective of: EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 13 (i) any lack of validity or enforceability of any Loan Document, and Secured Hedge Agreement or any other agreement or instrument relating thereto; (ii) any change in the time, manner or place of payment of, or in any other term of, all or any of the Secured Obligations, or any other amendment or waiver of or any consent to any departure from any Loan Document or any Secured Hedge Agreement, including, without limitation, any increase in the Secured Obligations resulting from the extension of additional credit to the Borrower or any of its Subsidiaries or otherwise; (iii) any taking, exchange, release or non-perfection of any other collateral, or any taking, release or amendment or waiver of or consent to departure from any guaranty, for all or any of the Secured Obligations; (iv) any manner of application of collateral, or proceeds thereof, to all or any of the Secured Obligations, or any manner of sale or other disposition of any collateral for all or any of the Secured Obligations or any other assets of the Borrower or any of its Subsidiaries; (v) any change, restructuring or termination of the corporate structure or existence of the Pledgor or any of its Subsidiaries; or (vi) any other circumstance that might otherwise constitute a defense available to, or a discharge of, the Pledgor or a third party grantor of a security interest. SECTION 17. Amendments; Waivers; Etc. (a) No amendment or waiver of any provision of this Agreement, and no consent to any departure by the Pledgor herefrom, shall in any event be effective unless the same shall be in writing and signed by the Administrative Agent, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. (b) No failure on the part of the Administrative Agent or any Lender Party or any Hedge Bank to exercise, and no delay in exercising, any right, power or privilege hereunder shall operate as a waiver thereof or consent thereto; nor shall any single or partial exercise of any such right, power or privilege preclude any other or further exercise thereof or the exercise of any other right, power or privilege. SECTION 18. Addresses for Notices. All notices and other communications provided for hereunder shall be in writing (including telecopier, telegraphic or telex communication) and mailed, telecopied, telegraphed, telexed, cabled or delivered, if to the EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 14 Pledgor, addressed to it at the address set forth below the name of the Pledgor on the signature pages hereof, and if to the Administrative Agent or any Lender Party, addressed to it at its address set forth in Section 8.02 of the Credit Agreement, or, as to any Hedge Bank or any other party, at such other address as shall be designated by such party in a written notice to the each other party complying as to delivery with the terms of this Section 18. All such notices and other communications shall, when mailed, telecopied, telegraphed or telexed, be effective when deposited in the mails, delivered to the telegraph company, transmitted by telecopier or confirmed by telex answerback, respectively, addressed as aforesaid. SECTION 19. Continuing Security Interest; Assignments under the Credit Agreement. This Agreement shall create a continuing security interest in the Collateral and shall (a) remain in full force and effect until the latest of (i) the payment in full in cash of the Secured Obligations and all other amounts payable under this Agreement, (ii) the Termination Date and (iii) the termination or expiration of all Secured Hedge Agreements, (b) be binding upon the Pledgor, its successors and assigns, and (c) inure to the benefit of, and be enforceable by, the Administrative Agent, the Lender Parties, the Hedge Banks and their respective successors, transferees and assigns. Without limiting the generality of the foregoing clause (c), any Lender Party may assign or otherwise transfer all or any portion of its rights and obligations under the Credit Agreement (including, without limitation, all or any portion of its Commitment, the Advances owing to it and any Note held by it) to any other Person, and such other Person shall thereupon become vested with all the benefits in respect thereof granted to such Lender Party herein or otherwise, in each case as provided in Section 8.07 of the Credit Agreement. Upon the later of (i) the cash payment in full of the Secured Obligations and all other amounts payable under this Agreement, (ii) the Termination Date, and (iii) the termination or expiration of all Secured Hedge Agreements, the security interest granted hereby shall terminate and all rights to the Collateral shall revert to the Pledgor. Upon any such termination, the Administrative Agent will, at the Pledgor's expense, execute and deliver to the Pledgor such documents as the Pledgor shall reasonably request to evidence such termination. SECTION 20. Release and Termination. Upon the later of (i) the cash payment in full of the Secured Obligations, (ii) the Termination Date and (iii) the termination or expiration of all Secured Hedge Agreements, the pledge, assignment and security interest granted hereby shall terminate and all rights to the Collateral shall revert to the Pledgor. Upon any such termination and reversion, the Administrative Agent shall, at the Pledgor's expense, return to the Pledgor such of the Collateral of the Pledgor in its possession as shall not have been sold or otherwise applied pursuant to the terms of the Loan Documents or the Secured Hedge Agreements and execute and deliver to the Pledgor such documents as the Pledgor shall reasonably request to evidence such termination and reversion. EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 15 SECTION 21. Governing Law; Submission to Jurisdiction, Waiver of Jury Trial; Etc. a) (a) This Agreement shall be governed by and construed in accordance with the laws of the State of New York. Under otherwise defined herein or in the Credit Agreement, terms used in Article 9 of the Code are used herein as therein defined. (b) The Pledgor hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or any other Loan Document or Secured Hedge Agreement to which it is or is to be a party, or for recognition and enforcement of any judgment, and the Pledgor hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State or, to the extent permitted by law, in such federal court. The Pledgor irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection or defense that it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Agreement or any of the other Loan Documents to which it is or is to be a party in any New York State or federal court. The Pledgor hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. The Pledgor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing herein shall affect the right that any party may otherwise have to commence or participate in any action, suit or proceeding relating to this Agreement, any of the other Loan Documents or any Secured Hedge Agreement to which it is or is to be a party, or otherwise to proceed against the Pledgor, in any other jurisdiction. (c) The Pledgor irrevocably consents to the service of any and all process in any such action, suit or proceeding by the mailing of copies of such process to the Pledgor at the address set forth below its name on the signature page hereof, or by any other method permitted by law. The Pledgor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. (d) To the extent that the Pledgor has or hereafter may acquire immunity from jurisdiction of any court or from any legal process (whether through service or notice, attachment prior to judgment, attachment in aid of execution, execution or otherwise) with respect to itself or its property, the Pledgor hereby irrevocably waives such immunity in respect of its Obligations under this Agreement, any other Loan Document and any Secured Hedge Agreement to which it is or is to be a party. EXHIBIT E TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED Page 16 (e) The Pledgor irrevocably waives all right to trial by jury in any action, proceeding or counterclaim (whether based on contract, tort or otherwise) arising out of or relating to this Agreement, any other Loan Document or any Secured Hedge Agreement, the transactions contemplated hereby or thereby or the actions of the Administrative Agent, any Lender Party or the Issuing Bank in the negotiation, administration, performance or enforcement thereof. IN WITNESS WHEREOF, the Pledgor has caused this Agreement to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. FITNESS HOLDINGS, INC. By: -------------------------------------- Title: Gilbert K. Freeman Title: Chief Financial Officer/Executive Vice President Address: EX-10.10 10 EXHIBIT 10.10 Exhibit 10.10 EXHIBIT F TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED THIRD AMENDED AND RESTATED HOLDINGS GUARANTY Dated December 19, 1997 From FITNESS HOLDINGS, INC. in favor of THE LENDERS PARTY TO THE CREDIT AGREEMENT REFERRED TO HEREIN, THE HEDGE BANKS REFERRED TO IN THE CREDIT AGREEMENT and BANQUE NATIONALE DE PARIS, as Existing Issuing Bank, Swing Line Bank and as Administrative Agent --------------------------------------------------------------------- TABLE OF CONTENTS Page ---- SECTION 1 Guaranty; Limitation of Liability................................1 SECTION 2 Guaranty Absolute................................................2 SECTION 3 Waivers..........................................................3 SECTION 4 Payments Free and Clear of Taxes, Etc............................5 SECTION 5 Representations and Warranties...................................6 SECTION 6 Affirmative Covenants............................................7 SECTION 7 Negative Covenants...............................................8 SECTION 8 Amendments; No Waiver; Etc.......................................9 SECTION 9 Notices, Etc.....................................................9 SECTION 10 No Waiver; Remedies..............................................9 SECTION 11 Right of Setoff..................................................9 SECTION 12 Indemnification.................................................10 SECTION 13 Continuing Guaranty; Assignments Under the Credit Agreement.....10 SECTION 14 Governing Law; Submission to Jurisdiction; Waiver of Jury Trial; Etc .....................................................10 (i) THIRD AMENDED AND RESTATED HOLDINGS GUARANTY THIRD AMENDED AND RESTATED HOLDINGS GUARANTY dated December 19, 1997, made by Fitness Holdings, Inc., a Delaware corporation (the "Guarantor"), in favor of the Lenders (the "Lenders") party to the Credit Agreement (as hereinafter defined), the Hedge Banks referred to therein and Banque Nationale de Paris, as the Existing Issuing Bank (the "Issuing Bank"), as the Swing Line Bank (the "Swing Line Bank") and as Administrative Agent (the "Administrative Agent") for the Lender Parties and Agents (as defined in the Credit Agreement) thereunder. PRELIMINARY STATEMENTS. 1. 24 Hour Fitness, Inc., a California corporation ("24 Hour Fitness"), is the borrower under a Second Amended and Restated Credit Agreement dated as of March 14, 1997, as amended (the "Existing Credit Agreement"), with the lenders named therein and Banque Nationale de Paris ("BNP") as issuing bank and agent. Pursuant to a Second Amended and Restated Guaranty dated March 14, 1997, as amended (the "Existing Guaranty"), the Guarantor guaranteed all of the obligations of 24 Hour Fitness under the Existing Credit Agreement. 2. The Lenders, the Issuing Bank, the Swing Line Bank, and the Agents are parties to a Third Amended and Restated Credit Agreement dated as of December 19, 1997 (as amended, supplemented or otherwise modified, the "Credit Agreement"; the terms defined therein and not otherwise defined herein being used herein as therein defined) with 24 Hour Fitness (the "Borrower") and the Guarantor. The Guarantor will derive substantial direct and indirect benefit from the transactions contemplated by the Credit Agreement. It is a condition precedent to the making of Advances by the Lenders and the Swing Line Bank under the Credit Agreement, the issuing of Letters of Credit by the Issuing Bank under the Credit Agreement and the entering into the Secured Hedge Agreements (as defined in the Security Agreement) by the Hedge Banks that the Guarantor, as owner of 100% of the outstanding shares of stock of the Borrower, shall have executed and delivered this Guaranty. NOW, THEREFORE, in consideration of the premises and in order to induce the Lenders and the Swing Line Bank to make Advances, the Issuing Bank to issue Letters of Credit and the Hedge Banks to enter into Hedge Agreements, the Guarantor hereby agrees as follows: SECTION 1. Guaranty; Limitation of Liability. (a) The Guarantor hereby absolutely, unconditionally and irrevocably guarantees the punctual payment when due, whether at stated maturity, by acceleration or otherwise, of all Obligations of the Borrower now or hereafter existing under the Loan Documents and the Secured Hedge Agreements, whether for principal, interest (including, without limitation, interest after the filing of a petition initiating a proceeding referred to in Section 6.01(f) of the Credit Agreement, whether or not such interest constitutes an allowed claim for purposes of such proceeding), premiums, fees, expenses or otherwise (such Obligations of the Borrower being the "Guarantied Obligations") and agrees to pay any and all reasonable expenses (including, without limitation, reasonable counsel fees and expenses) incurred by the Administrative Agent, any Lender Party or any Hedge Bank in enforcing any rights under this Guaranty or any other Loan Document. Without limiting the generality of the foregoing, the Guarantor's liability shall extend to all amounts that constitute part of the Guarantied Obligations and would be owed by the Borrower to the Administrative Agent, any Lender Party or any Hedge Bank under any of the Loan Documents or any Secured Hedge Agreement but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving the Borrower. (b) (i) Each Guarantor and by its acceptance of this Guaranty, the Administrative Agent and each other Lender, hereby confirms that it is the intention of all such parties that this Guaranty not constitute a fraudulent transfer or conveyance for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act or any similar federal or state law to the extent applicable to this Guaranty. To effectuate the foregoing intention, the Administrative Agent, the other Lenders and the Guarantors hereby irrevocably agree that the Obligations of each Guarantor under this Guaranty shall not exceed the greater of (A) the net benefit realized by such Guarantor from the proceeds of the Advances made from time to time by the Borrower to such Guarantor or to any subsidiary of such Guarantor and (B) the maximum amount that will, after giving effect to such maximum amount and all other contingent and fixed liabilities of such Guarantor that are relevant under such laws, and after giving effect to any collections from, rights to receive contribution from or payments made by or on behalf of any other Guarantor in respect of the Obligations of such other Guarantor under this Guaranty, result in the Obligations of such Guarantor under this Guaranty not constituting a fraudulent transfer or conveyance. For purposes hereof, "Bankruptcy Law" means Title 11, U.S. Code, or any similar Federal or state law for the relief of debtors. (ii) Each Guarantor agrees that in the event any payment shall be required to be made to the Lenders under this Guaranty or any other guaranty, such Guarantor will contribute, to the maximum extent permitted by law, such amounts to each other Guarantor and each other guarantor so as to maximize the aggregate amount paid to the Lenders under the Loan Documents. SECTION 2. Guaranty Absolute. The Guarantor guaranties that the Guarantied Obligations will be paid strictly in accordance with the terms of the Loan Documents and the Secured Hedge Agreements, regardless of any law, regulation or order now or hereafter in effect in any jurisdiction affecting any of such terms or the rights of the Administrative Agent, any Lender Party or any Hedge Bank with respect thereto. The Obligations of the Guarantor under this Guaranty are independent of the Guarantied Obligations and a separate action or actions may be brought and prosecuted against the Guarantor to enforce this Guaranty, irrespective of whether any action is brought against the Borrower or whether the Borrower is joined in any such action or actions. The liability of the Guarantor under this Guaranty shall be absolute and unconditional irrespective of, and the Guarantor hereby irrevocably waives any defenses it may now or hereafter have in any way relating to, any and all of the following: (a) any lack of validity or enforceability of any Loan Document or any Secured Hedge Agreement or any agreement or instrument relating thereto; -2- (b) any change in the time, manner or place of payment of, or in any other term of, all or any of the Guarantied Obligations or any other amendment or waiver of or any consent to departure from any Loan Document or any Secured Hedge Agreement, including, without limitation, any increase in the Guarantied Obligations resulting from the extension of additional credit to the Borrower or any of its Subsidiaries or otherwise; (c) any taking, exchange, release or nonperfection of any Collateral or any taking, release, amendment or waiver of or consent to departure from any other guaranty for all or any of the Guarantied Obligations; (d) any manner of application of Collateral or proceeds thereof to all or any of the Guarantied Obligations or any manner of sale or other disposition of any Collateral for all or any of the Guarantied Obligations or any other property and/or assets of the Borrower or any of its Subsidiaries; (e) any change, restructuring or termination of the corporate structure or existence of the Guarantor or any of its Subsidiaries; or (f) any other circumstance (including, without limitation, any statute of limitations or any existence of or reliance on any representation by the Administrative Agent, any Lender Party or any Hedge Bank) that might otherwise constitute a defense available to, or a discharge of, the Borrower, the Guarantor or any other guarantor or surety. This Guaranty shall continue to be effective or be reinstated, as the case may be, if at any time any payment of any of the Guarantied Obligations is rescinded or must otherwise be returned by the Administrative Agent, any Lender Party or any Hedge Bank upon the insolvency, bankruptcy or reorganization of the Borrower or otherwise, all as though such payment had not been made. SECTION 3. Waivers. (a) The Guarantor hereby waives promptness, diligence, notice of acceptance and any other notice with respect to any of the Guarantied Obligations and this Guaranty and any requirement that the Administrative Agent, any Lender Party or any Hedge Bank protect, secure, perfect or insure any Lien or any property and/or assets subject thereto or exhaust any right or take any action against the Borrower or any other Person or any Collateral. (b) The Guarantor acknowledges that the Administrative Agent may, without notice to or demand upon the Guarantor and without affecting the liability of the Guarantor under this Guaranty, foreclose any mortgage relating to the interests of one or more Loan Parties in properties located in the State of California (or elsewhere) by nonjudicial sale, and the Guarantor hereby waives any defense to the recovery by the Administrative Agent, any Lender Party or any Hedge Bank against the Guarantor of any deficiency or otherwise to the enforcement of this Guaranty after any such nonjudicial sale and any defense or benefits that may be afforded by Sections 580a, 580d and 726 of the California Code of Civil Procedure (the "California Code") or any statute or law in any other jurisdiction having similar effect. -3- Without limitation of the foregoing, the Guarantor (i) acknowledges that following, and as a result of, the completion of any such nonjudicial sale involving interests in real property located in the State of California, the Guarantor may not be permitted to assert or enforce rights of subrogation, reimbursement, exoneration, contribution or indemnification or any other rights or remedies against the Borrower or any other Loan Party for recovery of amounts paid by the Guarantor in respect of any Guarantied Obligations or otherwise, (ii) understands that, in the absence of the waiver set forth in clause (iii) below, the Guarantor may have a defense to the enforcement by any of the Administrative Agent, the Lender Parties and the Hedge Banks of, and to any recovery by any of the Administrative Agent, the Lender Parties and the Hedge Banks against the Guarantor under, this Guaranty following any such nonjudicial sale, by reason of the fact that the Administrative Agent's election to proceed with the completion of any such nonjudicial sale may prevent the Guarantor from asserting or enforcing rights of subrogation, reimbursement, exoneration, contribution or indemnification or other rights or remedies as set forth in clause (i) above, (iii) hereby knowingly waives any such defense and any similar defense that might otherwise be available to the enforcement of, or to any recovery by any of the Administrative Agent, the Lender Parties and the Hedge Banks against the Guarantor under, this Guaranty following any such nonjudicial sale, notwithstanding the fact that such nonjudicial sale may prevent the Guarantor from asserting or enforcing such rights and remedies, and (iv) further knowingly waives any claim against any of the Administrative Agent, the Lender Parties and the Hedge Banks (including any claim for recovery or on account of any payments made by the Guarantor under any of the Loan Documents or any Secured Hedge Agreement) and any right to assert any setoff or counterclaim against any of the Administrative Agent, the Lender Parties and the Hedge Banks, and agrees that its obligations under the Loan Documents shall not be impaired or otherwise affected, in either case as a result of any such loss of subrogation, contribution or reimbursement rights or other rights or remedies for any reason. (c) The Guarantor hereby further irrevocably waives any defense or benefits that may be derived from California Code Sections 2808, 2809, 2810, 2815, 2819, 2845, 2849 or 2850 and comparable provisions of the laws of any other jurisdiction and all other suretyship defenses it would otherwise have under the laws of California or any other jurisdiction. (d) The Guarantor hereby irrevocably waives any duty on the part of the Administrative Agent, any Lender Party or any Hedge Bank to disclose to the Guarantor any matter, fact or thing relating to the business, operation or condition of the Borrower or its property and assets now or hereafter known by the Administrative Agent, such Lender Party or such Hedge Bank. (e) The Guarantor hereby irrevocably waives any claim or other right that it may now or hereafter acquire against the Borrower or any other insider guarantor that arises from the existence, payment, performance or enforcement of the Guarantor's Obligations under this Guaranty, any other Loan Document or any Secured Hedge Agreement, including, without limitation, any right of subrogation, reimbursement, exoneration, contribution or indemnification and any right to participate in any claim or remedy of the Administrative Agent, any Lender Party or any Hedge Bank against the Borrower or such other insider guarantor or any Collateral, whether or not such claim, remedy or right arises in equity or under contract, statute or common -4- law, including, without limitation, the right to take or receive from the Borrower or such other insider guarantor, directly or indirectly, in cash or other property or by setoff or in any other manner, payment or security on account of such claim, remedy or right, until all of the Obligations and all other amounts payable under this Guaranty shall have been paid in full and Commitments shall have expired or terminated. If any amount shall be paid to the Guarantor in violation of the immediately preceding sentence at any time prior to the later of (i) the cash payment in full of the Guarantied Obligations and all other amounts payable under this Guaranty and (ii) the Termination Date, such amount shall be held in trust for the benefit of the Administrative Agent, the Lenders Parties and the Hedge Banks and shall forthwith be paid to the Administrative Agent to be credited and applied to the Guarantied Obligations and all other amounts payable under this Guaranty, whether matured or unmatured, in accordance with the terms of the Loan Documents and the Secured Hedge Agreements or to be held by the Administrative Agent as Collateral for any Guarantied Obligations or other amounts payable under this Guaranty thereafter arising. (f) The Guarantor acknowledges that it will receive direct and indirect benefits from the financing arrangements contemplated by the Loan Documents and that the waivers set forth in this Section 3 are knowingly made in contemplation of such benefits. (g) The Guarantor hereby waives any right to revoke this Guaranty, and acknowledges that this Guaranty is continuing in nature and applies to all Guarantied Obligations, whether existing now or in the future. SECTION 4. Payments Free and Clear of Taxes, Etc. (a) Any and all payments made by the Guarantor hereunder shall be made in accordance with Section 2.12 of the Credit Agreement, free and clear of and without deduction for any and all present or future Taxes except taxes incurred due to a connection between a Lender Party and a taxing jurisdiction or taxes due to the failure of a Lender Party to comply with regulatory requirements. If the Guarantor shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to the Administrative Agent, any Lender Party or any Hedge Bank, (i) the sum payable shall be increased as may be necessary so that, after making all required deductions (including deductions applicable to additional sums payable under this Section 4), the Administrative Agent, such Lender Party or such Hedge Bank, as the case may be, receives an amount equal to the sum it would have received had no such deductions been made, (ii) the Guarantor shall make such deductions and (iii) the Guarantor shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law. If any Lender Party determines, in its sole discretion, that it has actually and finally realized in a year in which a payment under the Loan Document is made or in any subsequent year, by reason of a refund, deduction or credit of any Taxes paid or reimbursed by the Guarantor in respect of payments under the Loan Documents, a current monetary benefit that it would otherwise not have obtained, and that would result in the total payments under this Section 4 exceeding the amount to make such Lender Party whole, such Lender Party shall pay to the Guarantor, with reasonable promptness following the date on which it actually realizes such benefit, an amount equal to the lesser of the amount of such benefit or the amount of such excess, in each case net of all out-of-pocket expenses in securing such refund, deduction or credit. -5- (b) In addition, the Guarantor agrees to pay any present or future Other Taxes. (c) The Guarantor will indemnify the Administrative Agent, each Lender Party and each Hedge Bank for the full amount of Taxes and Other Taxes (including, without limitation, any Taxes or Other Taxes imposed by any jurisdiction on amounts payable under this Section 4) paid by the Administrative Agent, such Lender Party or such Hedge Bank, as the case may be, and any liability (including penalties, additions to tax, interest and expenses (including, without limitation, reasonable fees and disbursements of counsel)) arising therefrom or with respect thereto. This indemnification shall be made within 30 days from the date the Administrative Agent, such Lender Party or such Hedge Bank, as the case may be, makes written demand therefor. (d) Within 30 days after the date of any payment of Taxes, the Guarantor shall furnish to the Administrative Agent, at its address referred to in Section 8.02 of the Credit Agreement, the original receipt of payment thereof or a certified copy of such receipt if any receipt is issued therefor or, if no such receipt is issued, appropriate evidence of payment thereof. If no Taxes are payable in respect of any payment hereunder by the Guarantor through an account or branch outside the United States or on behalf of the Guarantor by a payor that is not a United States person, the Guarantor shall furnish, or shall cause such payor to furnish, to the Administrative Agent, at such address, a certificate from the appropriate taxing authority or authorities or an opinion of counsel acceptable to the Administrative Agent, in either case stating that such payment is exempt from or not subject to Taxes. (e) Without prejudice to the survival of any other agreement of the Guarantor hereunder, the agreements and obligations of the Guarantor contained in this Section 4 shall survive the payment in full of the Guarantied Obligations and all other amounts payable under this Guaranty. SECTION 5. Representations and Warranties. The Guarantor hereby represents and warrants as follows: (a) The Guarantor (i) is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, (ii) is duly qualified and in good standing as a foreign corporation in each other jurisdiction in which it owns or leases property or in which the conduct of its business requires it to so qualify or be licensed except where the failure to so qualify or be licensed would not have a Material Adverse Effect and (iii) has all requisite corporate power and authority to own or lease and operate its properties and to carry on its business as now conducted and as proposed to be conducted. All of the outstanding capital stock of the Borrower has been validly issued, is fully paid and non-assessable and is owned by the Guarantor free and clear of all Liens, except those created under the Collateral Documents. (b) The execution, delivery and performance by the Guarantor of this Guaranty are within the Guarantor's corporate powers, have been duly authorized by all necessary corporate action, and do not (i) contravene the Guarantor's charter or bylaws, (ii) violate any law (including, without limitation, the Securities Exchange Act of 1934 and the -6- Racketeer Influences and Corrupt Organizations Chapter of the Organized Crime Control Act of 1970), rule, regulation (including, without limitation, Regulation X of the Board of Governors of the Federal Reserve System), order, writ, judgment, injunction, decree, determination or award, (iii) conflict with or result in the breach of, or constitute a default under, any loan agreement, contract, indenture, mortgage, deed of trust, lease or other instrument binding on or affecting the Guarantor, any of its Subsidiaries or any of its or their properties or (iv) except for the Liens created under the Collateral Documents, result in or require the creation or imposition of any Lien upon or with respect to any of the properties of the Guarantor or any of its Subsidiaries. The Guarantor is not in violation of any such law, rule, regulation, order, writ, judgment, injunction, decree, determination or award, or in breach of any such contract, loan agreement, indenture, mortgage, deed of trust, lease or other instrument, the violation or breach of which would be reasonably likely to have a Material Adverse Effect. (c) No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or any other third party is required for (i) the due execution, delivery, recordation, filing or performance by the Guarantor of this Guaranty and (ii) the exercise by the Administrative Agent, any Lender Party or any Hedge Bank of its rights under this Guaranty. (d) This Guaranty has been duly executed and delivered by the Guarantor. This Guaranty is the legal, valid and binding obligation of the Guarantor, enforceable against the Guarantor in accordance with its terms. (e) There are no conditions precedent to the effectiveness of this Guaranty that have not been satisfied or waived. (f) The Guarantor has, independently and without reliance upon the Administrative Agent, any Lender Party or any Hedge Bank and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Guaranty. SECTION 6. Affirmative Covenants. (a) The Guarantor covenants and agrees that, so long as any part of the Guarantied Obligations shall remain unpaid, any Letter of Credit shall be outstanding, any Lender Party shall have any Commitment or any Hedge Bank shall have any obligation under any Secured Hedge Agreement, the Guarantor will at all times require, perform or observe, and will cause the Borrower and each of its Subsidiaries, including Foreign Subsidiaries, to perform or observe, all of the terms, covenants and agreements that the Loan Documents, including, without limitation, the provisions of Section 5.04 of the Credit Agreement, and the Secured Hedge Agreements state that the Guarantor or the Borrower or any other Loan Party is to perform or observe or that the Guarantor or the Borrower is to cause any Loan Party's Subsidiaries, including Foreign Subsidiaries, to perform or observe. (b) The Guarantor covenants and agrees that it shall furnish to the Borrower each of the notices and financial statements required to be delivered by the Borrower pursuant to -7- Section 5.03 of the Credit Agreement relating to the Guarantor within the time periods specified for the delivery of such notices in such Section 5.03. (c) The Guarantor covenants and agrees that it shall perform and observe in all material respects all of the terms and provisions of each Related Document to be performed or observed by it, maintain each such Related Document in full force and effect, enforce such Related Document in accordance with its terms, take all such action to such end as may be from time to time reasonably requested by the Administrative Agent and, upon such request of the Administrative Agent, make to each other party to each such Related Document such demands and requests for information and reports or for action as the Borrower is entitled to make under such Related Document. SECTION 7. Negative Covenants. The Guarantor covenants and agrees that, so long as any part of the Guarantied Obligations shall remain unpaid, any Letter of Credit shall be outstanding or any Lender Party shall have any Commitment or any Hedge Bank shall have any obligation under any Secured Hedge Agreement, the Guarantor will not at any time enter into or conduct any business, or engage in any activity (including, without limitation, any action or transaction that is required or restricted with respect to the Borrower and its Subsidiaries under Sections 5.01 and 5.02 of the Credit Agreement without regard to any of the enumerated exceptions to such covenants), other than: (a) holding the capital stock of the Borrower, discharging certain administrative activities otherwise permitted by the Credit Agreement and making payments with respect to certain administrative services and tax liability to the extent contemplated by the Loan Documents (including, without limitation, Section 5.02(f) of the Credit Agreement); (b) performing its Obligations under each Loan Document to which it is a party, including entering into this Agreement and the Holdings Pledge Agreement; (c) issuing stock and stock equivalents, including issuing stock in connection with an initial public offering of the Guarantor's common stock, and/or repurchasing stock and/or stock equivalents; (d) declaring and paying dividends and distributions (x) payable only in common stock of the Guarantor, or (y) as permitted under Section 5.02(f)(i)(F) of the Credit Agreement; (e) purchasing, redeeming, retiring, defeasing or otherwise acquiring shares of its capital stock with the proceeds received from the issuance of new shares of its capital stock with equal or inferior voting powers, designations, preferences and rights; (f) making of any payments required by the Holdings Notes and the other Debt of the Parent Guarantor permitted by clause (j) below; (g) performing its obligations under the MDC Management Agreement; -8- (h) performing its Obligations under the guaranty dated October 24, 1996, from the Guarantor in favor of Landhigh Investments, Inc.; (i) guarantying obligations of the Borrower in connection with operating leases entered into in the ordinary course of business; and (j) issue Debt, provided that such Debt is (x) evidenced by a promissory note in form and substance satisfactory to the Administrative Agent which shall be pledged, under the terms of the Collateral Documents, to the Administrative Agent on behalf of the Secured Parties immediately upon its creation, (y) is subject to an Intercompany Subordination Agreement, duly executed by the Guarantor and the Borrower and (z) is issued solely to the Borrower for the purposes listed in Section 5.02(e)(iv)(B) of the Credit Agreement. SECTION 8. Amendments; No Waiver; Etc. No amendment or waiver of any provision of this Guaranty, and no consent to any departure by the Guarantor therefrom, shall in any event be effective unless the same shall be in writing and signed by the Required Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no amendment, waiver or consent shall, unless in writing and signed by all of the Lenders, do any of the following at any time: (i) release or limit the liability of the Guarantor hereunder, (ii) postpone any date fixed for payment hereunder or (iii) amend this Section 8. SECTION 9. Notices, Etc. All notices and other communications provided for hereunder shall be in writing (including telegraphic, telecopy or telex communication) and mailed, telegraphed, telecopied, telexed or delivered, if to the Guarantor, addressed to it at the address set forth below the name of the Guarantor on the signature page hereof, if to the Administrative Agent or any Lender Party, addressed to it at its address set forth in Section 8.02 of the Credit Agreement or as to any Hedge Bank or any other party at such other address as shall be designated by such party in a written notice to each other party complying as to delivery with the terms of this Section 9. All such notices and other communications shall, when mailed, telecopied, telegraphed or telexed, be effective when deposited in the mails, transmitted by telecopier, delivered to the telegraph company or confirmed by telex answerback, respectively, addressed as aforesaid. SECTION 10. No Waiver; Remedies. No failure on the part of the Administrative Agent, any Lender Party or any Hedge Bank to exercise, and no delay in exercising, any right, power or privilege hereunder shall operate as a waiver thereof or consent thereto; nor shall any single or partial exercise of any such right, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. SECTION 11. Right of Setoff. Upon a) (a) the occurrence and during the continuance of any Event of Default and b) (b) the making of the request or the granting of the consent specified by Section 6.01 of the Credit Agreement to authorize the Administrative Agent -9- to declare the Notes due and payable pursuant to the provisions of such Section 6.01, each Lender Party and each Hedge Bank is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender Party or such Hedge Bank, as the case may be, to or for the credit or the account of the Guarantor against any and all of the Obligations of the Guarantor now or hereafter existing under this Guaranty, whether or not such Lender Party or such Hedge Bank shall have made any demand under this Guaranty. Each Lender Party and each Hedge Bank agrees to notify promptly the Guarantor after any such setoff and application; provided, however, that the failure to give such notice shall not affect the validity of such setoff and application. The rights of each Lender Party and each Hedge Bank under this Section 11 are in addition to other rights and remedies (including, without limitation, other rights of setoff) that such Lender Party and such Hedge Bank may have. SECTION 12. Indemnification. Without limitation on any other Obligations of the Guarantor or remedies of the Administrative Agent, Lender Parties or the Hedge Banks under this Guaranty, the Guarantor shall, to the fullest extent permitted by law, indemnify, defend and save and hold harmless the Administrative Agent, Lender Parties and the Hedge Banks from and against, and shall pay on demand any and all losses, liabilities, damages, costs, expenses and charges (including the reasonable and documented fees and disbursements of the legal counsel of the Administrative Agent, Lender Parties and the Hedge Banks and the reasonable and documented charges of the internal legal counsel of the Administrative Agent, Lender Parties and the Hedge Banks) suffered or incurred by any of the Administrative Agent, Lender Parties or the Hedge Banks as a result of (a) any failure of any Guarantied Obligations to be the legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with its terms, except as enforcement may be limited by bankruptcy, insolvency or other similar laws affecting the rights of creditors generally, or (b) any failure of the Borrower to pay and perform any Guarantied Obligations in accordance with the terms of such Guarantied Obligations. SECTION 13. Continuing Guaranty; Assignments Under the Credit Agreement. This Guaranty is a continuing guaranty and shall (a) remain in full force and effect until the latest of (i) the indefeasible cash payment in full of the Guarantied Obligations and all other amounts payable under this Guaranty, (ii) the Final Maturity Date and (iii) the termination or expiration of all Secured Hedge Agreements, (b) be binding upon the Guarantor, its successors and assigns and (c) inure to the benefit of, and be enforceable by, the Administrative Agent, the Lender Parties and the Hedge Banks and their respective successors, transferees and assigns. Without limiting the generality of the foregoing clause (c), any Lender Party may assign or otherwise transfer all or any portion of its rights and obligations under the Credit Agreement (including, without limitation, all or any portion of its Commitment or Commitments, the Advances owing to it and any Note or Notes held by it) to any other Person and such other Person shall thereupon become vested with all the benefits in respect thereof granted to such Lender herein or otherwise, in each case as provided in Section 8.07 of the Credit Agreement. Upon the later of (i) the payment in full of the Guarantied Obligations and all other amounts payable under this Guaranty, (ii) the Final Maturity Date, and (Ili) the termination or expiration of all Secured Hedge Agreements, the Guaranty granted hereby shall terminate. Upon any such termination, the Administrative Agent -10- will, at the Guarantor's expense, execute and delivery to the Guarantor such documents as the Guarantor shall reasonably request to evidence such termination. SECTION 14. Governing Law; Submission to Jurisdiction; Waiver of Jury Trial; Etc. a) (a) This Guaranty shall be governed by, and construed in accordance with, the laws of the State of New York. (b) The Guarantor hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Guaranty or any other Loan Document or Secured Hedge Agreement to which it is or is to be a party, or for recognition and enforcement of any judgment, and the Guarantor hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State or, to the extent permitted by law, in such federal court. The Guarantor irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection or defense that it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Guaranty or any of the other Loan Documents to which it is or is to be a party in any New York State or federal court. The Guarantor hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. The Guarantor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing herein shall affect the right that any party may otherwise have to commence or participate in any action, suit or proceeding relating to this Guaranty, any of the other Loan Documents or any Secured Hedge Agreement to which it is or is to be a party, or otherwise to proceed against the Guarantor, in any other jurisdiction. (c) The Guarantor irrevocably consents to the service of any and all process in any such action, suit or proceeding by the mailing of copies of such process to the Guarantor at the address set forth below its name on the signature page hereof, or by any other method permitted by law. The Guarantor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. (d) To the extent that the Guarantor has or hereafter may acquire immunity from jurisdiction of any court or from any legal process (whether through service or notice, attachment prior to judgment, attachment in aid of execution, execution or otherwise) with respect to itself or its property, the Guarantor hereby irrevocably waives such inununity in respect of its Obligations under this Guaranty, any other Loan Document and any Secured Hedge Agreement to which it is or is to be a party. (e) The Guarantor hereby irrevocably waives all right to trial by jury in any action, proceeding or counterclaim (whether based on contract, tort or otherwise) arising out of or relating to this Guaranty, any other Loan Document or any Secured Hedge Agreement, the -11- transactions contemplated hereby or thereby or the actions of the Administrative Agent, any Lender Party or any Hedge Bank in the negotiation, administration, performance or enforcement hereof or thereof. IN WITNESS WHEREOF, the Guarantor has caused this Guaranty to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. FITNESS HOLDINGS, INC. By /s/ Gilbert Freeman ---------------------------------- Name: Gilbert Freeman Title:Chief Financial Officer -12- EX-10.11 11 EXHIBIT 10.11 Exhibit 10.11 EXHIBIT D TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT AS SEPARATELY EXECUTED THIRD AMENDED AND RESTATED SECURITY AGREEMENT Dated December 19, 1997 From THE GRANTORS NAMED HEREIN, as Grantors, to BANQUE NATIONALE DE PARIS, as Administrative Agent TABLE OF CONTENTS Page ---- SECTION 1. Grant of Security..................................................3 SECTION 2. Security for Obligations...........................................5 SECTION 3. Grantors Remain Liable.............................................6 SECTION 4. Delivery of Security Collateral and Account Collateral.............6 SECTION 5. Maintaining the L/C Cash Collateral Account........................6 SECTION 6. Investing of Amounts in the L/C Cash Collateral Account............7 SECTION 7. Representations and Warranties.....................................7 SECTION 8. Further Assurances.................................................9 SECTION 9. As to Equipment and Inventory.....................................10 SECTION 10. Insurance........................................................10 SECTION 11. Place of Perfection; Records; Collection of Receivables..........11 SECTION 12. Voting Rights; Dividends; Etc....................................12 SECTION 13. As to the Assigned Agreements....................................13 SECTION 14. Transfers and Other Liens; Additional Shares.....................14 SECTION 15. Administrative Agent Appointed Attorney-in-Fact..................14 SECTION 16. Administrative Agent May Perform.................................15 SECTION 17. The Agent's Duties...............................................15 (i) Page ---- SECTION 18. Remedies.........................................................15 SECTION 19. Registration Rights..............................................16 SECTION 20. Indemnity and Expenses...........................................17 SECTION 21. Security Interest Absolute.......................................18 SECTION 22. Amendments; Waivers; Etc.........................................18 SECTION 23. Addresses for Notices............................................19 SECTION 24. Continuing Security Interest, Assignments under the Credit Agreement.................................................19 SECTION 25. Release and Termination..........................................20 SECTION 26. The Mortgages....................................................20 SECTION 27. Governing Law; Submission to Jurisdiction, Waiver of Jury Trial; Etc..................................................20 (ii) THIRD AMENDED AND RESTATED SECURITY AGREEMENT, dated December 19, 1997, made by 24 Hour Fitness, Inc., a California corporation (the "Borrower" and, together with the Additional Collateral Grantors (as defined in Section 22(c)), the "Grantors"), to BANQUE NATIONALE DE PARIS ("BNP"), as Administrative Agent (together with any successor agent appointed pursuant to Article VII of the Credit Agreement, the "Administrative Agent") for the lender parties (the "Lender Parties") and other Agents party to the Credit Agreement (as hereinafter defined), and as custodian for the Hedge Banks (as hereinafter defined). PRELIMINARY STATEMENTS: (1) 24 Hour Fitness, Inc., a California corporation (the "Borrower"), is the borrower under a Second Amended and Restated Credit Agreement dated as of March 14, 1997 (as amended, supplemented or otherwise modified, the "Existing Credit Agreement") with the lenders named therein (the "Existing Lenders") and BNP as issuing bank and agent (the "Existing Agent"). Pursuant to a Second Amended and Restated Security Agreement dated March 14, 199 (the "Existing Security Agreement"), the Grantors assigned and pledged to the Existing Agent for its benefit and the benefit of the issuing bank party to the Existing Credit Agreement and the ratable benefit of the Existing Lenders and certain hedge lenders to secure the payment of all Obligations (as defined in the Existing Credit Agreement) of the Borrower under, among other things, the Existing Credit Agreement, a security interest in certain property. (2) The Borrower has entered into a Third Amended and Restated Credit Agreement dated as of December 19, 1997 (as amended, supplemented or otherwise modified, the "Credit Agreement"; the terms defined therein and not otherwise defined herein being used herein as therein defined) with Fitness Holdings, Inc., a Delaware corporation, the Lender Parties, Banque Nationale de Paris, as syndication agent and as administrative agent (the "Administrative Agent"), for the Lender Parties, Bankers Trust Company, as documentation agent for the Lenders and LaSalle National Bank and Wells Fargo Bank, N.A., as co-agents for the Lenders. (3) Each Grantor is the owner of the shares of stock, and of the warrants, rights and options to acquire the shares of stock (collectively, the "Pledged Shares"), described opposite such Grantor's name on Part A of Schedule I hereto and issued by the corporations named therein and of the indebtedness (the "Pledged Indebtedness") described opposite such Grantor's name on Part B of Schedule I hereto and issued by the obligors named therein. (4) The Borrower may from time to time invest in Hedge Agreements with one or more Lenders in connection with the Credit Agreement (all such Lenders being, collectively, the "Hedge Banks") to obtain the protection permitted by Section 5.02(b)(i)(C) of the Credit Agreement against fluctuations in certain interest rates. Such Hedge Agreements, copies of which shall be provided to the Agent, are hereinafter referred to as the "Secured Hedge Agreements". (5) The Borrower has opened a non-interest bearing cash collateral account (the "L/C Cash Collateral Account") with BNP at its offices at 499 Park Avenue, New York, New York 10022, Account No. 20183600114, in the name of the Borrower but under the sole dominion and control of the Administrative Agent and subject to the terms of this Agreement. (6) It is a condition precedent to the making of Advances by the Lenders and the Swing Line Bank under the Credit Agreement and the issuance of Letters of Credit by the Issuing Bank under the Credit Agreement, and the entering into of the Secured Hedge Agreement by the Hedge Banks, that the Grantors shall have granted the assignment and security interest and made the pledge contemplated by this Agreement. NOW, THEREFORE, in consideration of the premises and in order to induce the Lenders and the Swing Line Bank to make Advances under the Credit Agreement, the Issuing Bank to issue Letters of Credit under the Credit Agreement and the Hedge Banks to enter into Secured Hedge Agreements, each Grantor hereby agrees with the Administrative Agent for its benefit and the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the Lenders and the Hedge Banks as follows: SECTION 1. Grant of Security. Each Grantor hereby assigns and pledges to the Administrative Agent for its benefit and the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the Lenders and the Hedge Banks, and hereby grants to the Administrative Agent for its benefit and the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the Lenders and the Hedge Banks, a security interest in the following (collectively, the "Collateral"): (a) all of such Grantor's right, title and interest, whether now owned or hereafter acquired, in and to all equipment in all of its forms, wherever located, now or hereafter existing, all fixtures and all parts thereof and all accessions thereto (any and all such equipment, fixtures, parts and accessions being the "Equipment"); (b) all of such Grantor's right, title and interest, whether now owned or hereafter acquired, in and to all inventory in all of its forms, wherever located, now or hereafter existing (including, but not limited to, (i) all raw materials and work in process therefor, finished goods thereof and materials used or consumed in the manufacture or production thereof, (ii) goods in which such Grantor has an interest in mass or a joint or other interest or right of any kind (including, without limitation, goods in which such Grantor has an interest or right as consignee) and (iii) goods that are returned to or repossessed by such Grantor), and all accessions thereto and products thereof and documents therefor (any and all such inventory, accessions, products and documents being the "Inventory"); (c) all of such Grantor's right, title and interest, whether now owned or hereafter acquired, in and to all accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles and other obligations of any kind, now or hereafter -3- existing, whether or not arising out of or in connection with the sale or lease of goods or the rendering of services, and all rights now or hereafter existing and to the extent assignable without consent in and to all security agreements, leases and other contracts securing or otherwise relating to any such accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles or obligations (any and all such accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles and obligations, to the extent not referred to below in clause (d), (e) or (f) below, being the "Receivables", and any and all such leases, security agreements and other contracts being the "Related Contracts"); (d) all of the following (collectively, the "Security Collateral"): (i) the Pledged Shares and the certificates representing the Pledged Shares, and all dividends, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the Pledged Shares; (ii) the Pledged Indebtedness and the instruments evidencing the Pledged Indebtedness, and all interest, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the Pledged Indebtedness; (iii) all additional shares of stock, and all additional warrants, rights or options to acquire shares of stock, from time to time acquired by such Grantor in any manner, and the certificates representing such additional shares and such additional warrants, rights or options and all dividends, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of such additional shares or such additional warrants, rights or options provided, however that, in respect of such additional shares of stock issued by a Person which is not organized under the laws of any State of the United States of America, no such assignment, grant or pledge shall be effective if, as a result of such assignment, grant or pledge, the Administrative Agent would be entitled hereunder upon the occurrence of an Event of Default to exercise, in the aggregate, greater than 66% of the votes entitled to be cast by holders of common stock of such Person at any shareholders' meeting thereof; and (iv) all additional indebtedness from time to time owed to such Grantor in any manner and the instruments evidencing such additional indebtedness, and all interest, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all such additional indebtedness; -4- (e) all of such Grantor's right, title and interest in and to each agreement set forth beneath such Grantor's name on Schedule II hereto and each Secured Hedge Agreement to which such Grantor is now or may hereafter become a party, in each case as such agreement may be amended, supplemented or otherwise modified from time to time (collectively, the "Assigned Agreements"), including, without limitation, (i) all rights of such Grantor to receive moneys due and to become due under or pursuant to the Assigned Agreements, (ii) all rights of such Grantor to receive proceeds of any insurance, indemnity, warranty or guaranty with respect to the Assigned Agreements or any instruments, opinions or documents delivered pursuant thereto, (iii) all rights of such Grantor in and to all mortgages, security agreements, leases or other contracts securing or otherwise relating to the Assigned Agreements, (iv) all claims of such Grantor for damages arising out of or for breach of or default under the Assigned Agreements and (v) all rights of such Grantor to terminate the Assigned Agreements, to perform thereunder and to compel performance and otherwise exercise all remedies thereunder (all such Collateral being the "Agreement Collateral"); (f) all of the following (collectively, the "Account Collateral"): (i) the L/C Cash Collateral Account, all funds held therein and all certificates and instruments, if any, from time to time representing or evidencing the L/C Cash Collateral Account; (ii) all other deposit accounts of such Grantor, all funds held therein and all certificates and instruments, if any, from time to time representing or evidencing such deposit accounts; (iii) all Collateral Investments (as hereinafter defined) from time to time and all certificates and instruments, if any, from time to time representing or evidencing the Collateral Investments; (iv) all notes, certificates of deposit, deposit accounts, checks and other instruments from time to time hereafter delivered to or otherwise possessed by the Administrative Agent for or on behalf of such Grantor in substitution for or in addition to any or all of the then existing Account Collateral; and (v) all interest, dividends, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the then existing Account Collateral; and (g) all proceeds of any and all of the foregoing Collateral to the extent assignable without consent (including, without limitation, proceeds that constitute property of the types described in clauses (a) through (f) of this Section 1) and, to the extent not otherwise included, all (i) payments under insurance (whether or not the Administrative Agent is the loss payee thereof), or any indemnity, warranty or guaranty, -5- payable by reason of loss or damage to or otherwise with respect to any of the foregoing Collateral and (ii) cash. SECTION 2. Security for Obligations. The pledge, assignment and security interest granted under this Agreement by each Grantor secure the payment of all Obligations of such Grantor now or hereafter existing under this Agreement and each other Loan Document and under the Secured Hedge Agreements, whether for principal, interest, premiums, fees, expenses or otherwise (all such Obligations being the "Secured Obligations"). Without limiting the generality of the foregoing, this Agreement secures the payment of all amounts that constitute part of the Secured Obligations and would be owed by any Grantor to the Administrative Agent or any Lender Party under the Loan Documents or the Hedge Banks under the Secured Hedge Agreements but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving such Grantor. SECTION 3. Grantors Remain Liable. Anything herein to the contrary notwithstanding, (a) each Grantor shall remain liable under the contracts and agreements included in the Collateral to the extent set forth therein to perform all of its duties and obligations thereunder to the same extent as if this Agreement had not been executed, (b) the exercise by the Administrative Agent of any of the rights hereunder shall not release any Grantor from any of its duties or obligations under the contracts and agreements included in the Collateral, and (c) none of the Agent, the Lenders Parties or the Hedge Banks shall have any obligation or liability under the contracts and agreements included in the Collateral by reason of this Agreement, nor shall the Agent, any Lender Party or any Hedge Bank be obligated to perform any of the obligations or duties of any Grantor thereunder or to take any action to collect or enforce any claim for payment assigned hereunder. SECTION 4. Delivery of Security Collateral and Account Collateral. All certificates and instruments representing or evidencing Security Collateral or Account Collateral shall be delivered to and held by or on behalf of the Administrative Agent pursuant hereto and shall be in suitable form for transfer by delivery, or shall be accompanied by duly executed instruments of transfer or assignment in blank, all in form and substance reasonably satisfactory to the Agent. After the occurrence and during the continuance of any Event of Default, the Administrative Agent shall have the right, at any time in its discretion and without notice to any Grantor, to transfer to or register in the name of the Administrative Agent or any of its nominees any or all of the Security Collateral and the Account Collateral, subject only to the revocable rights specified in Section 12(a). In addition, after the occurrence and during the continuance of an Event of Default, the Administrative Agent shall have the right at any time to exchange certificates or instruments representing or evidencing Security Collateral or Account Collateral for certificates or instruments of smaller or larger denominations. SECTION 5. Maintaining the L/C Cash Collateral Account. So long as any Advance shall remain unpaid, any Letter of Credit shall be outstanding, any Lender Party shall -6- have any Commitment under the Credit Agreement or any Hedge Bank shall have any obligation under any Secured Hedge Agreement: (a) The Borrower shall maintain the L/C Cash Collateral Account with BNP. (b) It shall be a term and condition of the L/C Cash Collateral Account, notwithstanding any term or condition to the contrary in any other agreement relating to the L/C Cash Collateral Account, and except as otherwise provided in Section 18, that no amount (including, without limitation, interest on Collateral Investments) shall be paid or released to or for the account of, or withdrawn by or for the account of, the Borrower or any other Person from the L/C Cash Collateral Account. (c) Except for the L/C Cash Collateral Account, the Borrower shall maintain each of its deposit and other bank accounts in the State of California and shall promptly (i) notify the Administrative Agent of any such accounts not listed on Schedule V hereto and (ii) notify any bank not so listed of the security interest therein granted hereunder, with a copy of such notice to the Agent. The L/C Cash Collateral Account shall be subject to such applicable laws, and such applicable regulations of the Board of Governors of the Federal Reserve System and of any other appropriate banking or governmental authority, as are in effect from time to time. SECTION 6. Investing of Amounts in the L/C Cash Collateral Account. If requested by the Borrower, the Administrative Agent shall, subject to the provisions of Section 18, from time to time invest: (a) amounts on deposit in the L/C Cash Collateral Account in certificates of deposit of BNP or other overnight funds in the name of the Administrative Agent as the Borrower may select and the Administrative Agent may approve, which approval shall not be unreasonably withheld; and (b) interest paid on such certificates of deposit of BNP or such overnight funds referred to in subsection (a) above, and reinvest other proceeds of any such certificates of deposit of BNP or such overnight funds that may mature or be sold, in each case in such certificates of deposit of BNP or such overnight funds in the name of the Administrative Agent as the Borrower may select and the Administrative Agent may approve, which approval shall not be unreasonably withheld (the certificates of deposit of BNP or such overnight funds referred to in subsection (a) above and in this subsection (b) being, collectively, "Collateral Investments"). Interest and proceeds that are not invested or reinvested in Collateral Investments as provided above shall be deposited and held in the L/C Cash Collateral Account. -7- SECTION 7. Representations and Warranties. Each Grantor represents and warrants as to itself and its Collateral as follows: (a) All of the Equipment and Inventory are located at one or more of the locations specified beneath such Grantor's name on Schedule III hereto. The principal place of business of such Grantor or, if such Grantor has more than one principal place of business, the chief executive office of such Grantor, and the office where such Grantor keeps its records concerning the Receivables, the original copies of each Assigned Agreement to which it is a party and all originals of all chattel paper that evidence its Receivables, are located at the address listed below the name of such Grantor on the signature pages hereof or, in the case of any Additional Collateral Grantor, at the address listed below the name of such Additional Collateral Grantor on its Security Agreement Supplement (each as defined in Section 22(c)). A complete copy of each Assigned Agreement has been delivered to the Agent. None of the Receivables or Agreement Collateral is represented or evidenced by a promissory note or other instrument. (b) Such Grantor is the legal and beneficial owner of the Collateral (or, in the case of any consigned goods comprising Collateral, such Grantor is the legal and beneficial owner of its rights and interest in such consigned goods) in which it is granting a security interest free and clear of any Lien, except for the Permitted Liens and Other Liens permitted under Section 5.02(a) of the Credit Agreement. No effective financing statement or other instrument similar in effect covering all or any part of the Collateral is on file in any recording office, except such as may have been filed in favor of the Administrative Agent relating to this Agreement, the other Collateral Documents, the Existing Security Agreement or the other "Collateral Documents" (as defined in the Existing Credit Agreement), except for the Permitted Liens and Other Liens permitted under Section 5.02(a) of the Credit Agreement. All of the trade names of such Grantor are set forth below its name on Schedule IV hereto. (c) Such Grantor has exclusive possession and control of the Equipment and Inventory. (d) All of the shares of stock that constitute Pledged Shares have been duly authorized and validly issued and are fully paid and nonassessable. The Pledged Indebtedness has been duly authorized, authenticated or issued and delivered and is the legal, valid and binding obligation of the issuers thereof and is not in default. (e) The Pledged Shares constitute the percentage of the issued and outstanding shares of stock, and/or warrants, rights or options to acquire shares of stock, of the issuers thereof indicated on Part A of Schedule I hereto. The Pledged Indebtedness is outstanding in the principal amount indicated on Part B of Schedule I hereto. (f) The Assigned Agreements, true and complete copies of which have been furnished to each Lender Party, (i) have been duly authorized, executed and delivered by -8- each Grantor party thereto and, to the best of each such Grantor's knowledge, by all other parties thereto, (ii) have not been amended, supplemented or otherwise modified and are in full force and effect, and (iii) are binding upon and enforceable against each such Grantor party thereto and, to the best of each such Grantor's knowledge, each of the other parties thereto in accordance with their terms. There exists no violation or default under any Assigned Agreement by any Grantor party thereto or, to the best of each such Grantor's knowledge, by any other party thereto. Each party to any Assigned Agreement, other than any Loan Party thereto and any Lender party to the Secured Hedge Agreements, has executed and delivered to such Grantor a consent, in substantially the form of Exhibit B hereto (or otherwise in form and substance satisfactory to the Collateral Agent), to the assignment of the Agreement Collateral to the Administrative Agent pursuant to this Agreement. (g) Such Grantor has no deposit accounts with more than $5,000 other than the deposit accounts set forth opposite such Grantor's name on Schedule V hereto. (h) This Agreement, the pledge of the Security Collateral pursuant hereto and the pledge and assignment of the Agreement Collateral and the Account Collateral pursuant hereto create a valid and perfected first priority security interest in the Collateral (subject to the Liens expressly permitted under Section 5.02(a) of the Credit Agreement), securing the payment of the Secured Obligations, and all filings and other actions necessary or desirable to perfect and protect such security interest have been duly made or taken. (i) No consent of any other Person and no authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or any other third party is required for (i) the grant by such Grantor of the assignment and security interest granted hereby, the pledge by such Grantor of the Security Collateral pursuant hereto or the execution, delivery or performance of this Agreement by such Grantor, (ii) the perfection or maintenance of the pledge, assignment and security interest created hereby (including the first priority nature of such pledge, assignment or security interest) or (iii) the exercise by the Administrative Agent of its voting or other rights provided for in this Agreement or the remedies in respect of the Collateral pursuant to this Agreement (except as may be required in connection with the disposition of any portion of the Security Collateral by laws affecting the offering and a sale of securities generally), in each case other than the filing of financing and continuation statements under the Uniform Commercial Code, which financing statements have been duly filed. SECTION 8. Further Assurances. (a) Each Grantor agrees that from time to time, at its own expense, it shall promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary, or that the Administrative Agent may deem desirable and may reasonably request, in order to perfect and protect any pledge, assignment or security interest granted or purported to be granted hereby (including, without -9- limitation, the first priority nature thereof) or to enable the Administrative Agent to exercise and enforce its rights and remedies hereunder with respect to any Collateral. Without limiting the generality of the foregoing, each Grantor shall promptly after an Event of Default: (i) mark conspicuously each chattel paper included in the Receivables, each Related Contract, each Assigned Agreement and, at the reasonable request of the Agent, each of its records pertaining to the Collateral with a legend, in form and substance satisfactory to the Agent, indicating that such document, chattel paper, Related Contract, Assigned Agreement or other Collateral is subject to the security interest granted hereby; (ii) if any Collateral shall be represented or evidenced by a promissory note or other instrument or chattel paper, deliver and pledge to the Administrative Agent hereunder such note, instrument or chattel paper duly indorsed and accompanied by duly executed instruments of transfer or assignment, all in form and substance satisfactory to the Agent; and (iii) execute and file such financing or continuation statements, or amendments thereto, and such other instruments or notices, as may be necessary or as the Administrative Agent may deem desirable and may reasonably request, in order to perfect and preserve the pledge, assignment and security interest granted or purported to be granted hereby. (b) Each Grantor hereby authorizes the Administrative Agent to file one or more financing or continuation statements, and amendments thereto, relating to all or any part of the Collateral without the signature of such Grantor where permitted by law. A photocopy or other reproduction of this Agreement or any financing statement covering the Collateral or any part thereof shall be sufficient as a financing statement where permitted by law. (c) Each Grantor shall furnish to the Agent, upon the Agent's request at any time after the occurrence and during the continuance of an Event of Default or, in any event, once annually, statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Administrative Agent may reasonably request, all in reasonable detail. SECTION 9. As to Equipment and Inventory. (a) Each Grantor shall keep its Equipment and Inventory (other than Inventory sold in the ordinary course of business) at the locations specified therefor in Section 7(a) or, upon 30 days' prior written notice to the Agent, at such other locations in a jurisdiction where all action required by Section 8 shall have been taken with respect to such Equipment and Inventory. (b) Each Grantor shall cause the Equipment to be maintained and preserved in the same condition, repair and working order as when new, ordinary wear and tear excepted, and shall forthwith, or in the case of any loss or damage to any of the Equipment as quickly as practicable after the occurrence thereof, make or cause to be made all repairs, replacements and other improvements in connection therewith that are necessary or desirable to such end. Each Grantor shall promptly furnish to the Administrative Agent a statement respecting any material loss or damage to any of the Equipment. (c) Each Grantor shall pay promptly when due all property and other taxes, assessments and governmental charges or levies imposed upon, and all claims (including, -10- without limitation, claims for labor, materials and supplies) against, the Equipment and Inventory other than to the extent not required to be paid under Section 5. 01 (b) of the Credit Agreement. (d) In producing the Inventory, if any, such Grantor shall comply with all requirements of the Fair Labor Standards Act. (e) Upon the Agent's reasonable request at any time after the occurrence and during the continuance of an Event of Default or, in any event, once annually, each Grantor shall furnish to the Agent, each Lender Party and each Hedge Bank a report detailing material changes in the amount and condition of the Equipment, including purchases, depreciation, sales and losses. (f) Not more than once each year or during any Default promptly upon the reasonable request of the Agent, each Grantor shall deliver to the Administrative Agent such warehouse receipts, bills of lading and other documents of title with respect to Inventory and Equipment as are requested, together with copies of all invoices with respect to the Inventory and Equipment. SECTION 10. Insurance. (a) Each Grantor shall, at its own expense, maintain insurance with respect to the Equipment and Inventory in such amounts, against such risks, in such form and with such insurers, as shall be reasonably satisfactory to the Administrative Agent from time to time. Each such policy shall in addition (i) name such Grantor and the Administrative Agent as insured parties thereunder (without any representation or warranty by or obligation upon the Agent) as their interests may appear, (ii) provide that there shall be no recourse against the Administrative Agent for payment of premiums or other amounts with respect thereto and (iii) provide that at least ten days' prior written notice of cancellation or of lapse shall be given to the Administrative Agent by the insurer. Each Grantor shall, if so requested by the Agent, deliver to the Administrative Agent original or duplicate policies of such insurance and, upon the Agent's request at any time after the occurrence and during the continuance of an Event of Default and, in any event, once annually, a report of a reputable insurance broker with respect to such insurance. Further, each Grantor shall, at the request of the Agent, duly execute and deliver instruments of assignment of such insurance policies to comply with the requirements of Section 8. (b) Reimbursement under any liability insurance maintained by any Grantor pursuant to this Section 10 may be paid directly to the Person who shall have incurred liability covered by such insurance. In case of any loss involving damage to any Equipment or Inventory when Section 10(c) is not applicable, such Grantor shall make or cause to be made the necessary repairs to or replacements of such Equipment or Inventory, and any proceeds of insurance maintained by such Grantor pursuant to this Section 10 shall be paid to such Grantor as reimbursement for the costs of such repairs or replacements. (c) Upon the occurrence and during the continuance of any Event of Default, or the actual or constructive total loss (in excess of $100,000 per occurrence) of any Equipment -11- or Inventory, all insurance payments in respect of such Equipment or Inventory shall be paid to and applied by the Administrative Agent as specified in Section 18(b). SECTION 11. Place of Perfection; Records; Collection of Receivables. (a) Each Grantor shall keep its principal place of business and its chief executive office, and the office where it keeps its records concerning the Collateral and the original copies of the Assigned Agreements to which it is a party, and all originals of all chattel paper that evidence its Receivables, at the location therefor specified in Section 7(a) or, upon 30 days' prior written notice to the Agent, at such other locations in a jurisdiction where all actions required by Section 8 shall have been taken with respect to the Collateral. Each Grantor shall hold and preserve such records, Assigned Agreements and chattel paper and shall permit representatives of the Administrative Agent at any time during normal business hours to inspect and make abstracts from such records and chattel paper in accordance with Section 5.01(f) of the Credit Agreement. (b) Except as otherwise provided in this Section 11(b), each Grantor shall continue to collect, at its own expense, all amounts due or to become due such Grantor under the Receivables. In connection with such collections, each Grantor may take (and, at the Agent's direction, shall take) such action as such Grantor or the Administrative Agent may deem necessary or advisable to enforce collection of the Receivables; provided, however, that the Administrative Agent shall have the right at any time after the occurrence and during the continuance of an Event of Default, upon written notice to such Grantor of its intention to do so, to notify the account debtors or obligors under any Receivables of the assignment of such Receivables to the Administrative Agent and to direct such account debtors or obligors to make payment of all amounts due or to become due to such Grantor thereunder directly to the Administrative Agent and, upon such notification and at the expense of such Grantor, to enforce collection of any such Receivables, and to adjust, settle or compromise the amount or payment thereof, in the same manner and to the same extent as such Grantor might have done. After receipt by any Grantor of the notice from the Administrative Agent referred to in the proviso to the immediately preceding sentence, (i) all amounts and proceeds (including instruments) received by such Grantor in respect of the Receivables shall be received in trust for the benefit of the Administrative Agent hereunder, shall be segregated from other funds of such Grantor and shall be forthwith paid over to the Administrative Agent in the same form as so received (with any necessary indorsement or assignment) to be held as cash collateral and applied as provided by Section 18(b), and (ii) such Grantor shall not adjust, settle or compromise the amount or payment of any Receivable, release wholly or partly any account debtor or obligor thereof, or allow any credit or discount thereon. SECTION 12. Voting Rights; Dividends; Etc. (a) So long as no Event of Default shall have occurred and be continuing and no foreclosure proceedings shall have been commenced: (i) Each Grantor shall be entitled to exercise or refrain from exercising any and all voting and other consensual rights pertaining to the Security Collateral or any part -12- thereof for any purpose not prohibited by the terms of this Agreement, the other Loan Documents or the Secured Hedge Agreements. (ii) Each Grantor shall be entitled to receive and retain any and all dividends, distributions and interest paid in respect of the Security Collateral; provided, however, that any and all (A) dividends and interest paid or payable other than in cash in respect of, and instruments and other property and assets received or receivable or otherwise distributed in respect of, or in exchange for, any Security Collateral, (B) dividends and other distributions paid or payable in cash in respect of any Security Collateral in connection with a partial or total liquidation or dissolution or in connection with a reduction of capital, capital surplus or paid-in-surplus and (C) cash paid or payable or otherwise distributed in respect of principal of, or in redemption of, or in exchange for, any Security Collateral shall be, and shall be forthwith delivered to the Administrative Agent to hold as, Security Collateral and, if received by such Grantor, shall be received in trust for the benefit of the Agent, shall be segregated from other property and assets or funds of such Grantor and shall be forthwith delivered to the Administrative Agent as Security Collateral in the same form as so received (with any necessary indorsement or assignment). Each Grantor, promptly upon the request of the Agent, shall execute such documents and do such acts as may be necessary or desirable in the judgment of the Administrative Agent to give effect to this clause (ii). (iii) The Administrative Agent shall execute and deliver (or cause to be executed and delivered) to each Grantor all such proxies and other instruments as such Grantor may request for the purpose of enabling such Grantor to exercise the voting and other consensual rights that it is entitled to exercise pursuant to subparagraph (i) of this Section 12(a) and to receive the dividends, distributions or interest payments that it is authorized to receive and retain pursuant to clause (ii) of this Section 12(a). (b) Upon the occurrence and during the continuance of an Event of Default and upon exercise of foreclosure remedies by the Administrative Agent under Section 18 hereof: (i) All rights of each Grantor to (A) exercise or refrain from exercising the voting and other consensual rights that it would otherwise be entitled to exercise pursuant to subparagraph (i) of Section 12(a) shall, upon notice to such Grantor by the Agent, cease and (B) receive the dividends, interest payments and other distributions that it would otherwise be authorized to receive and retain pursuant to subparagraph (ii) of Section 12(a) shall automatically cease, and all such rights shall thereupon become vested in the Agent, which shall thereupon have the sole right to exercise or refrain from -13- exercising such voting and other consensual rights and to receive and retain as Security Collateral such dividends, interest payments and other distributions. (ii) All dividends, interest payments and other distributions that are received by any Grantor contrary to the provisions of clause (i) of this Section 12(b) shall be received in trust for the benefit of the Agent, shall be segregated from other property and assets or funds of such Grantor and shall be forthwith paid over to the Administrative Agent as Security Collateral in the same form as so received (with any necessary indorsement or assignment). SECTION 13. As to the Assigned Agreements. (a) Each Grantor shall, at its own expense: (i) perform and observe all the terms and provisions of each Assigned Agreement to be performed or observed by it, maintain such Assigned Agreement in full force and effect and enforce each such Assigned Agreement in accordance with its terms, and take all such action to such end as may be from time to time reasonably requested by the Agent; and (ii) furnish to the Agent, promptly upon receipt thereof, copies of all material notices, requests and other documents required under or requested in accordance with Section 5.03(m) that are received by such Grantor under or pursuant to any Assigned Agreement and, from time to time, (A) furnish to the Administrative Agent such information and reports regarding the Collateral as the Administrative Agent may reasonably request and (B) upon the reasonable request of the Agent, make to each other party to any Assigned Agreement such demands and requests for information and reports or for action as such Grantor is entitled to make under such Assigned Agreement. (b) Each Grantor agrees not (i) to cancel or terminate any Assigned Agreement or consent to or accept any cancellation or termination thereof without the consent of the Agent, which consent shall not be unreasonably withheld, (ii) to amend, modify or otherwise change in any manner any material term or material condition of any Assigned Agreement or give any consent, waiver or approval thereunder without the consent of the Agent, which consent shall not be unreasonably withheld, or (iii) to waive any material default under or any material breach of any material term or material condition of any Assigned Agreement without the consent of the Agent, which consent shall not be unreasonably withheld. -14- SECTION 14. Transfers and Other Liens; Additional Shares. (a) Each Grantor agrees not (i) to sell, assign (by operation of law or otherwise) or otherwise dispose of, or grant any option with respect to, any of the Collateral, except for dispositions of property and assets permitted under Section 5.02(d) of the Credit Agreement, or (ii) to create or suffer to exist any Lien upon or with respect to any of the Collateral, except for (A) the pledge, assignment and security interest created by this Agreement and (B) Liens expressly permitted under Section 5.02(a) of the Credit Agreement. (b) Each Grantor shall (i) cause each issuer of the Pledged Shares not to issue any stock or other securities in addition to or in substitution for the Pledged Shares issued by such issuer, except to such Grantor, and (ii) subject to Section l(d)(iii), pledge to the Administrative Agent hereunder, immediately upon its acquisition (directly or indirectly) thereof, any and all additional shares of stock or other securities of each issuer of the Pledged Shares. SECTION 15. Administrative Agent Appointed Attorney-in-Fact. Each Grantor hereby irrevocably appoints the Administrative Agent such Grantor's attorney-in-fact, with full authority in the place and stead of such Grantor and in the name of such Grantor or otherwise, upon the occurrence and continuance of an Event of Default, to take any action and to execute any instrument that the Administrative Agent may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation: (a) to obtain and adjust insurance required to be paid to the Administrative Agent pursuant to Section 10, (b) to ask for, demand, collect, sue for, recover, compromise, receive and give acquittance and receipts for moneys due and to become due under or in respect of any of the Collateral, (c) to receive, indorse and collect any drafts, instruments, chattel paper and other documents in connection with Section 15(a) or 15(b) above (including, without limitation, all instruments representing any dividend, interest payment or other distribution in respect of the Security Collateral or any part thereof) and give full discharge for the same, and (d) to file any claims, to take any action or to institute any proceedings that the Administrative Agent may deem necessary or desirable for the collection of any of the Collateral or otherwise to enforce compliance with the terms and conditions of any Assigned Agreement or to enforce the rights of the Administrative Agent with respect to any of the Collateral. SECTION 16. Administrative Agent May Perform. If any Grantor fails to perform any agreement contained herein, the Administrative Agent may upon notice to such Grantor perform, or cause the performance of, such agreement, and the expenses of the -15- Administrative Agent incurred in connection therewith shall be payable by such Grantor under Section 20(b). SECTION 17. The Agent's Duties. The powers conferred on the Administrative Agent hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon it to exercise any such powers. Except for the exercise of reasonable care in the safe custody and preservation of any Collateral in its possession and the accounting for moneys actually received by it hereunder, the Administrative Agent shall have no duty as to any Collateral, as to ascertaining or taking action with respect to calls, conversions, exchanges, maturities, tenders or other matters relative to any Security Collateral, whether or not the Agent, any Lender Party or any Hedge Bank has or is deemed to have knowledge of such matters, or as to the taking of any necessary steps to preserve rights against any parties or any other rights pertaining to any Collateral. The Administrative Agent shall be deemed to have exercised reasonable care in the custody and preservation of any Collateral in its possession if such Collateral is accorded treatment substantially equal to that which BNP accords its own property of like tenor. SECTION 18. Remedies. If any Event of Default shall have occurred and be continuing: (a) The Administrative Agent may exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party upon default under the Uniform Commercial Code in effect in the State of New York at such time (the "Code") (whether or not the Code applies to the affected Collateral), and also may (i) require each Grantor to, and each Grantor hereby agrees that it shall at its own expense and upon request of the Administrative Agent forthwith, assemble all or part of the Collateral as directed by the Administrative Agent and make it available to the Administrative Agent at a place to be designated by the Administrative Agent that is reasonably convenient to both parties and (ii) without notice except as specified below, sell the Collateral or any part thereof in one or more parcels at public or private sale, at any exchange or broker's board or at any of the Agent's offices or elsewhere, for cash, on credit or for future delivery, and upon such other terms as the Administrative Agent may deem commercially reasonable. Each Grantor agrees that, to the extent notice of sale shall be required by law, at least ten days' notice to such Grantor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. The Administrative Agent shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. The Administrative Agent may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. (b) Any cash held by the Administrative Agent as Collateral and all cash proceeds received by the Administrative Agent in respect of any sale of, collection from, -16- or other realization upon all or any part of the Collateral may, in the discretion of the Agent, be held by the Administrative Agent as collateral for, and/or then or at any time thereafter applied (after payment of any amounts payable to the Administrative Agent pursuant to Section 20) in whole or in part by the Administrative Agent for its benefit, the benefit of the Issuing Bank and the Swing Line Bank and the ratable benefit of the Lenders and the Hedge Banks against, all or any part of the Secured Obligations in such order as the Administrative Agent shall elect. In determining the amounts owing to the Hedge Banks under the Secured Hedge Agreements, the Administrative Agent shall be entitled to rely, and be fully protected in relying, upon the Agreement Values of the Secured Hedge Agreements. The term "Agreement Value" means, with respect to any Secured Hedge Agreement at any date of determination, the amount, if any, that would be payable to the Hedge Bank in respect of any "agreement value" under such Secured Hedge Agreement as though such Secured Hedge Agreement were terminated on such date, calculated as provided in the International Swap Dealers Association, Inc. Standard Form of Interest Rate and Currency Exchange Agreement, 1987 Edition. Each determination of Agreement Value shall be made by the Administrative Agent in good faith and in reliance on any information (including information provided by such Hedge Bank) that it believes accurate, but without any obligation to verify such information. Any surplus of such cash or cash proceeds held by the Administrative Agent and remaining after payment in full of all of the Secured Obligations shall be paid over to the Grantors or to whomsoever may be lawfully entitled to receive such surplus. (c) The Administrative Agent may exercise any and all rights and remedies of the Grantors under or in connection with the Assigned Agreements or otherwise in respect of the Collateral, including, without limitation, any and all rights of any Grantor to demand or otherwise require payment of any amount under, or performance of any provision of, any Assigned Agreement or any other Collateral. (d) All payments received by any Grantor under or in connection with any Assigned Agreement or otherwise in respect of the Collateral shall be received in trust for the benefit of the Agent, shall be segregated from other funds of such Grantor and shall be forthwith paid over to the Administrative Agent in the same form as so received (with any necessary indorsement or assignment). (e) The Administrative Agent may, without notice to any Guarantor, except as required by law, and at any time or from time to time, charge, set off and otherwise apply all or any part of the Secured Obligations against the L/C Cash Collateral Account, or any part thereof. SECTION 19. Registration Rights. If the Administrative Agent shall determine to exercise its right to sell all or any of the Collateral pursuant to Section 18, each Grantor agrees that, upon request of the Agent, such Grantor will, at its own expense: -17- (a) execute and deliver, and cause each issuer of the Collateral contemplated to be sold and the directors and officers thereof to execute and deliver, all such instruments and documents, and do or cause to be done all such other acts and things, as may be necessary or, in the opinion of the Agent, advisable to register such Collateral under the provisions of the Securities Act of 1933, as from time to time amended (the "Securities Act"), to cause the registration statement relating thereto to become effective and to remain effective for such period as prospectuses are required by law to be furnished, and to make all amendments and supplements thereto and to the related prospectus that, in the opinion of the Agent, are necessary or advisable, all in conformity with the requirements of the Securities Act and the rules and regulations of the Securities and Exchange Commission applicable thereto; (b) use its best efforts to qualify the Collateral under the state securities or "blue sky" laws and to obtain all necessary governmental approvals for the sale of the Collateral, as reasonably requested by the Agent; (c) cause each such issuer to make available to its security holders, as soon as practicable, an earnings statement that will satisfy the provisions of Section 11(a) of the Securities Act and the rules and regulations thereunder; (d) provide the Administrative Agent with such other information and projections as may be necessary or, in the opinion of the Agent, advisable to enable the Administrative Agent to effect the sale of such Collateral; and (e) do or cause to be done all such other acts and things as may be necessary to make such sale of the Collateral or any part thereof valid and binding and in compliance with applicable law. The Administrative Agent is authorized, in connection with any sale of the Collateral pursuant to Section 18, to deliver or otherwise disclose to any prospective purchaser of the Collateral (i) any registration statement or prospectus, and all supplements and amendments thereto, prepared pursuant to subsection (a) above, (ii) any information and projections provided to it pursuant to subsection (d) above and (iii) any other information in its possession relating to the Collateral. SECTION 20. Indemnity and Expenses. (a) Each of the Grantors jointly and severally agrees to indemnify the Agent, each Lender Party and each Hedge Bank and each of their respective officers, directors, employees, agents and advisors (each an "Indemnified Party") from, and hold each of them harmless against, any and all claims, damages, losses, liabilities and expenses (including, without limitation, reasonable fees and reasonable expenses of counsel) arising out of or in connection with or resulting from this Agreement (including, without limitation, enforcement of this Agreement), except to the extent that such claims, damages, losses, liabilities and expenses are found in a final, nonappealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party's gross negligence or willful misconduct. -18- (b) Each Grantor jointly and severally agrees to pay to the Agent, upon demand, the amount of any and all expenses (including, without limitation, the reasonable fees and expenses of its counsel and of any experts and agents) that the Administrative Agent may incur in connection with (i) the administration of this Agreement, (ii) the custody, preservation, use or operation of, or the sale of, collection from, or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the rights of the Agent, any Lender Party or the Hedge Bank hereunder or (iv) the failure by such Grantor to perform or observe any of the provisions hereof. SECTION 21. Security Interest Absolute. The obligations of each Grantor under this Agreement are independent of the Secured Obligations, and a separate action or actions may be brought and prosecuted against such Grantor to enforce this Agreement, irrespective of whether any action is brought against the other Grantors or whether the other Grantors are joined in any such action or actions. All rights of the Administrative Agent and the pledge, assignment and security interest hereunder, and all obligations of each Grantor hereunder, shall be absolute and unconditional, irrespective of: (i) any lack of validity or enforceability of any Loan Document, any Secured Hedge Agreement or any other agreement or instrument relating thereto; (ii) any change in the time, manner or place of payment of, or in any other term of, all or any of the Secured Obligations, or any other amendment or waiver of or any consent to any departure from any Loan Document or any Secured Hedge Agreement, including, without limitation, any increase in the Secured Obligations resulting from the extension of additional credit to any Grantor or any of its Subsidiaries or otherwise; (iii) any taking, exchange, release or nonperfection of any other collateral, or any taking, release or amendment or waiver of or consent to departure from any guaranty, for all or any of the Secured Obligations; (iv) any manner of application of collateral, or proceeds thereof, to all or any of the Secured Obligations, or any manner of sale or other disposition of any collateral for all or any of the Secured Obligations or any other assets of the Borrower or any of its Subsidiaries; (v) any change, restructuring or termination of the corporate structure or existence of any Grantor or any of its Subsidiaries; or (vi) any other circumstance that might otherwise constitute a defense available to, or a discharge of, such Grantor or a third-party grantor of a security interest. SECTION 22. Amendments; Waivers; Etc. (a) No amendment or waiver of any provision of this Agreement, and no consent to any departure by any Grantor herefrom, shall in -19- any event be effective unless the same shall be in writing and signed by the Agent, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. (b) No failure on the part of the Agent, any Lender Party or any Hedge Bank to exercise, and no delay in exercising, any right, power or privilege hereunder shall operate as a waiver thereof or consent thereto; nor shall any single or partial exercise of any such right, power or privilege preclude any other or further exercise thereof or the exercise of any other right, power or privilege. (c) Upon the execution and delivery by any Person of a security agreement supplement in substantially the form of Exhibit A hereto (each a "Security Agreement Supplement"), (i) such Person shall be referred to as an "Additional Collateral Grantor" and shall be and become a Grantor, and each reference in this Agreement to "Grantor" shall also mean and be a reference to such Additional Collateral Grantor and (ii) the supplements attached to each Security Agreement Supplement shall be incorporated into and become a part of and supplement Schedules I through V hereto, as appropriate, and the Administrative Agent may attach such supplements to such Schedules, and each reference to such Schedules shall mean and be a reference to such Schedules, as supplemented pursuant hereto. SECTION 23. Addresses for Notices. All notices and other communications provided for hereunder shall be in writing (including telecopier, telegraphic or telex communication) and mailed, telecopied, telegraphed, telexed, cabled or delivered, if to any Grantor, addressed to it at the address set forth below the name of such Grantor on the signature pages hereof (or, in the case of any Additional Collateral Grantor, at the address set forth below the name of such Additional Collateral Grantor on the signature page of its Security Agreement Supplement), and if to the Administrative Agent or any Lender Party addressed to it at its address set forth in Section 8.02 of the Credit Agreement, or, as to any Hedge Bank or any other party, at such other address as shall be designated by such party in a written notice to the each other party complying as to delivery with the terms of this Section 23. All such notices and other communications shall, when mailed, telecopied, telegraphed or telexed, be effective when deposited in the mails, delivered to the telegraph company, transmitted by telecopier or confirmed by telex answerback, respectively, addressed as aforesaid. SECTION 24. Continuing Security Interest; Assignments under the Credit Agreement. This Agreement shall create a continuing security interest in the Collateral and shall (a) remain in full force and effect until the latest of (i) the payment in full in cash of the Secured Obligations and all other amounts payable under this Agreement, (ii) the Termination Date and (iii) the termination or expiration of all Secured Hedge Agreements, (b) be binding upon each Grantor, its successors and assigns, and (c) inure to the benefit of, and be enforceable by, the Agent, the Lender Parties, the Hedge Banks and their respective successors, transferees and assigns. Without limiting the generality of the foregoing clause (c), any Lender Party may assign or otherwise transfer all or any portion of its rights and obligations under the Credit Agreement -20- (including, without limitation, all or any portion of its Commitment or Commitments, the Advances owing to it and any Note or Notes held by it) to any other Person, and such other Person shall thereupon become vested with all the benefits in respect thereof granted to such Lender Party herein or otherwise, in each case as provided in Section 8.07 of the Credit Agreement. Upon the later of (i) the payment in cash in full of the Secured Obligations and all other amounts payable under this Agreement, (ii) the Termination Date and (iii) the termination or expiration of all Secured Hedge Agreements, the security interest granted hereby shall terminate and all rights to the Collateral shall revert to the Grantor. Upon any such termination, the Administrative Agent will, at the Grantor's expense, execute and deliver to the Grantor such documents as the Grantor shall reasonably request to evidence such termination. SECTION 25. Release and Termination. (a) Upon any sale, lease, transfer or other disposition of any item of Collateral in accordance with the terms of the Loan Documents (other than sales of Inventory and Equipment in the ordinary course of business), the Administrative Agent shall, at the appropriate Grantor's expense, execute and deliver to such Grantor such documents as such Grantor shall reasonably request to evidence the release of such item of Collateral from the assignment and security interest granted hereby; provided, however, that (i) at the time of such request and such release, no Default shall have occurred and be continuing, (ii) such Grantor shall have delivered to the Agent, at least ten Business Days prior to the date of the proposed release, a request for release describing the item of Collateral and the terms of the sale, lease, transfer or other disposition in reasonable detail (including, without limitation, the price thereof and any expenses in connection therewith), together with a form of release for execution by the Administrative Agent and a certification by such Grantor to the effect that the transaction is in compliance with the Loan Documents and as to such other matters as the Administrative Agent may request and (iii) the proceeds of any such sale, lease, transfer or other disposition required to be applied in accordance with Section 2.06(b) of the Credit Agreement shall be paid to, or in accordance with the instructions of, the Administrative Agent at the closing thereof. (b) Upon the later of (i) the cash payment in full of the Secured Obligations, (ii) the Termination Date and (iii) the termination or expiration of all Secured Hedge Agreements, the pledge, assignment and security interest granted hereby shall terminate and all rights to the Collateral shall revert to the appropriate Grantor. Upon any such termination and reversion, the Administrative Agent shall, at the appropriate Grantor's expense, return to such Grantor such of the Collateral of such Grantor in its possession as shall not have been sold or otherwise applied pursuant to the terms of the Loan Documents and execute and deliver to such Grantor such documents as such Grantor shall reasonably request to evidence such termination and reversion. SECTION 26. The Mortgages. In the event that any of the Collateral hereunder is also subject to a valid and enforceable Lien under the terms of any Mortgage and the terms of such Mortgage are inconsistent with the terms of this Agreement, then, with respect to such Collateral, the terms of such Mortgage shall be controlling in the case of fixtures and leases, -21- letting and licenses of, and contracts and agreements relating to, the real property, and the terms of this Agreement shall be controlling in the case of all other Collateral. SECTION 27. Governing Law; Submission to Jurisdiction; Waiver of Jury Trial, Etc. (a) This Agreement shall be governed by and construed in accordance with the laws of the State of New York. Unless otherwise defined herein or in the Credit Agreement, terms used in Article 9 of the Code are used herein as therein defined. (b) Each Grantor hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or any other Loan Document or Secured Hedge Agreement to which it is or is to be a party, or for recognition and enforcement of any judgment, and such Grantor hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State or, to the extent permitted by law, in such federal court. Each Grantor irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection or defense that it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Agreement or any of the other Loan Documents to which it is or is to be a party in any New York State or federal court. Each Grantor hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. Each Grantor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing herein shall affect the right that any party may otherwise have to commence or participate in any action, suit or proceeding relating to this Agreement, any of the other Loan Documents or any Secured Hedge Agreement to which it is or is to be a party, or otherwise to proceed against any Grantor, in any other jurisdiction. (c) Each Grantor irrevocably consents to the service of any and all process in any such action, suit or proceeding by the mailing of copies of such process to such Grantor at the address set forth below its name on the signature page hereof, or by any other method permitted by law. Each Grantor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. (d) To the extent that any Grantor has or hereafter may acquire immunity from jurisdiction of any court or from any legal process (whether through service or notice, attachment prior to judgment, attachment in aid of execution, execution or otherwise) with respect to itself or its property, such Grantor hereby irrevocably waives such immunity in respect of its Obligations under this Agreement, any other Loan Document and any Secured Hedge Agreement to which it is or is to be a party. -22- (e) Each Grantor irrevocably waives all right to trial by jury in any action, proceeding or counterclaim (whether based on contract, tort or otherwise) arising out of or relating to this Agreement, any other Loan Document or any Secured Hedge Agreement, the transactions contemplated hereby or thereby or the actions of the Agent, any Lender Party or any Hedge Bank in the negotiation, administration, performance or enforcement thereof. -23- IN WITNESS WHEREOF, each Grantor has caused this Agreement to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. 24 HOUR FITNESS, INC. By: ------------------------------ Name: Title: Address: SCHEDULES Schedule I - Pledged Shares and Pledged Indebtedness Schedule II - Assigned Agreements Schedule III - Location of Equipment and Inventory Schedule IV - Trade Names Schedule V - Deposit Accounts EXHIBITS Exhibit A - Security Agreement Supplement Exhibit B - Form of Consent and Agreement EX-10.12 12 EXHIBIT 10.12 Exhibit 10.12 EXHIBIT J TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT SUBSIDIARY GUARANTY Dated December 19, 1997 From THE PARTIES LISTED ON THE SIGNATURE PAGES HEREOF as SUBSIDIARY GUARANTOR, in favor of THE SECURED PARTIES REFERRED TO IN THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT REFERRED TO HEREIN TABLE OF CONTENTS Page ---- SECTION 1. Subsidiary Guaranty; Limitation of Liability.......................1 SECTION 2. Subsidiary Guaranty Absolute.......................................2 SECTION 3. Waivers and Acknowledgments........................................3 SECTION 4. Subrogation........................................................3 SECTION 5. Payments Free and Clear of Taxes, Etc..............................4 SECTION 6. Representations and Warranties.....................................5 SECTION 7. Covenants..........................................................5 SECTION 8. Amendments, Etc....................................................6 SECTION 9. Notices, Etc.......................................................6 SECTION 10. No Waiver; Remedies................................................6 SECTION 11. Right of Set-off...................................................6 SECTION 12. Indemnification....................................................7 SECTION 13. Continuing Subsidiary Guaranty; Assignments under the Credit Agreement .........................................................7 SECTION 14. Governing Law; Jurisdiction; Waiver of Jury Trial, Etc.............7 (i)(i) SUBSIDIARY GUARANTY, dated __________, 1997 made by the parties listed on the signature pages hereof (each such party, together with the Additional Subsidiary Guarantors (as defined in Section 8(b)), a "Subsidiary Guarantor"), in favor of the Secured Parties (as defined in the Credit Agreement referred to below). PRELIMINARY STATEMENT. Fitness Holdings, Inc., a Delaware corporation, the Lender Parties, Banque Nationale de Paris, as the Existing Issuing Bank, as Swing Line Bank, as Syndication Agent and as Administrative Agent for the Lender Parties, Bankers Trust Company, as Documentation Agent for the Lenders, and LaSalle National Bank and Wells Fargo Bank, N.A., as Co-Agents for the Lenders are parties to a Third Amended and Restated Credit Agreement dated as of December 19, 1997 (said Agreement, as it may hereafter be amended, supplemented or otherwise modified from time to time, being the "Credit Agreement", the terms defined therein and not otherwise defined herein being used herein as therein defined) with 24 Hour Fitness, Inc., a California corporation (the "Borrower"). Each Subsidiary Guarantor may receive a portion of the proceeds of the Advances under the Credit Agreement and will derive substantial direct and indirect benefit from the transactions contemplated by the Credit Agreement. NOW, THEREFORE, in consideration of the premises and other good and valuable consideration, each Subsidiary Guarantor, jointly and severally with each other Subsidiary Guarantor, hereby agrees as follows: SECTION 1. Subsidiary Guaranty; Limitation of Liability. (a) Each Subsidiary Guarantor hereby unconditionally and irrevocably guarantees the punctual payment when due, whether at stated maturity, by acceleration or otherwise, of all Obligations of each other Loan Party now or hereafter existing under the Loan Documents, whether for principal, interest, fees, expenses or otherwise (such Obligations being the "Guaranteed Obligations"), and agrees to pay any and all reasonable expenses (including reasonable counsel fees and expenses) incurred by the Administrative Agent or any other Secured Party in enforcing any rights under this Subsidiary Guaranty or any other Loan Document. Without limiting the generality of the foregoing, each Subsidiary Guarantor's liability shall extend to all amounts that constitute part of the Guaranteed Obligations and would be owed by any other Loan Party to the Administrative Agent or any other Secured Party under the Loan Documents but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving such Loan Party. (b) (i) Each Subsidiary Guarantor and by its acceptance of this Subsidiary Guaranty, the Administrative Agent and each other Secured Party, hereby confirms that it is the intention of all such parties that this Subsidiary Guaranty not constitute a fraudulent transfer or conveyance for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act or any similar federal or state law to the extent applicable to this Subsidiary Guaranty. To effectuate the foregoing intention, the Administrative Agent, the other Secured Parties and the Subsidiary Guarantors hereby irrevocably agree that the Obligations of each Subsidiary Guarantor under this Subsidiary Guaranty shall not exceed the greater of (A) the net benefit realized by such Subsidiary Guarantor from the proceeds of the Advances made from time to time by the Borrower to such Subsidiary Guarantor or any subsidiary of such Subsidiary Guarantor and (B) the maximum amount that will, after giving effect to such maximum amount and all other contingent and fixed liabilities of such Subsidiary Guarantor that are relevant under such laws, and after giving effect to any collections from, rights to receive contribution from or payments made by or on behalf of any other Subsidiary Guarantor in respect of the Obligations of such other Subsidiary Guarantor under this Subsidiary Guaranty, result in the Obligations of such Subsidiary Guarantor under this Subsidiary Guaranty not constituting a fraudulent transfer or conveyance. For purposes hereof, " Bankruptcy Law" means Title 11, U.S. Code, or any similar Federal or state law for the relief of debtors. (ii) Each Subsidiary Guarantor agrees that in the event any payment shall be required to be made to the Secured Parties under this Subsidiary Guaranty or any other guaranty, such Subsidiary Guarantor will contribute, to the maximum extent permitted by law, such amounts to each other Subsidiary Guarantor and each other guarantor so as to maximize the aggregate amount paid to the Secured Parties under the Loan Documents. SECTION 2. Subsidiary Guaranty Absolute. Each Subsidiary Guarantor guarantees that the Guaranteed Obligations will be paid strictly in accordance with the terms of the Loan Documents, regardless of any law, regulation or order now or hereafter in effect in any jurisdiction affecting any of such terms or the rights of the Administrative Agent or any other Secured Party with respect thereto (but subject, however, to the provisions of Section 1 hereof) provided, however, that this Section 2 shall not require any Subsidiary Guarantor to make any payment hereunder to the extent that such payment would violate any applicable law, regulation or order now or hereafter in effect, and binding on such Subsidiary Guarantor. The Obligations of each Subsidiary Guarantor under this Subsidiary Guaranty are independent of the Guaranteed Obligations or any other Obligations of any other Loan Party under the Loan Documents, and a separate action or actions may be brought and prosecuted against such Subsidiary Guarantor to enforce this Subsidiary Guaranty, irrespective of whether any action is brought against the Borrower or any other Loan Party or whether the Borrower or any other Loan Party is joined in any such action or actions. The liability of each Subsidiary Guarantor under this Subsidiary Guaranty shall be irrevocable, absolute and unconditional irrespective of, and each Subsidiary Guarantor hereby irrevocably waives to the fullest extent it may legally and effectively do so any defenses it may now or hereafter have in any way relating to, any or all of the following: (a) any lack of validity or enforceability of any Loan Document or any agreement or instrument relating thereto; (b) any change in the time, manner or place of payment of, or in any other term of, all or any of the Guaranteed Obligations or any other Obligations of any other Loan Party under the Loan Documents, or any other amendment or waiver of or any consent to departure from any Loan Document, including, without limitation, any -2- increase in the Guaranteed Obligations resulting from the extension of additional credit to any Loan Party or any of its Subsidiaries or otherwise; (c) any taking, exchange, release or non-perfection of any Collateral, or any taking, release or amendment or waiver of or consent to departure from any other guaranty, for all or any of the Guaranteed Obligations; (d) any manner of application of Collateral, or proceeds thereof, to all or any of the Guaranteed Obligations, or any manner of sale or other disposition of any Collateral for all or any of the Guaranteed Obligations or any other Obligations of any other Loan Party under the Loan Documents or any other assets of any Loan Party or any of its Subsidiaries; (e) any change, restructuring or termination of the corporate structure or existence of any Loan Party or any of its Subsidiaries; or (f) any other circumstance (including, without limitation, any statute of limitations) or any existence of or reliance on any representation by the Administrative Agent or any other Secured Party that might otherwise constitute a defense available to, or a discharge of, the Borrower, any Subsidiary Guarantor or any other guarantor or surety. This Subsidiary Guaranty shall continue to be effective or be reinstated, as the case may be, if at any time any payment of any of the Guaranteed Obligations is rescinded or must otherwise be returned by any Secured Party or any other Person upon the insolvency, bankruptcy or reorganization of the Borrower or any other Loan Party or otherwise, all as though such payment had not been made. SECTION 3. Waivers and Acknowledgments. Each Subsidiary Guarantor hereby waives promptness, diligence, notice of acceptance and any other notice with respect to any of the Guaranteed Obligations and this Subsidiary Guaranty and any requirement that the Administrative Agent, or any other Secured Party protect, secure, perfect or insure any Lien or any property subject thereto or exhaust any right or take any action against any Loan Party or any other Person or any Collateral. Each Subsidiary Guarantor acknowledges that it will receive direct and indirect benefits from the financing arrangements contemplated by the Loan Documents and that the waivers set forth in this Section 3 are knowingly made in contemplation of such benefits. SECTION 4. Subrogation. No Subsidiary Guarantor will exercise any rights that it may now or hereafter acquire against the Borrower or any other insider guarantor that arise from the existence, payment, performance or enforcement of such Subsidiary Guarantor's Obligations under this Subsidiary Guaranty or any other Loan Document, including, without limitation, any right of subrogation, reimbursement, exoneration, contribution or indemnification and any right to participate in any claim or remedy of the Administrative Agent or any other -3- Secured Party against the Borrower or any other insider guarantor or any collateral, whether or not such claim, remedy or right arises in equity or under contract, statute or common law, including, without limitation, the right to take or receive from the Borrower or any other insider guarantor, directly or indirectly, in cash or other property or by set-off or in any other manner, payment or security on account of such claim, remedy or right, unless and until all of the Guaranteed Obligations and all other amounts payable under this Subsidiary Guaranty shall have been paid in full in cash, and all Hedge Agreements and the Commitments shall have expired or terminated. If any amount shall be paid to any Subsidiary Guarantor in violation of the preceding sentence at any time prior to the later of (a) the payment in full in cash of the Guaranteed Obligations and all other amounts payable under this Subsidiary Guaranty and (b) the later of (i) the Final Maturity Date and (ii) the expiration or termination of all Hedge Agreements, such amount shall be held in trust for the benefit of the Administrative Agent and the other Secured Parties and shall forthwith be paid to the Administrative Agent to be credited and applied to the Guaranteed Obligations and all other amounts payable under this Subsidiary Guaranty, whether matured or unmatured, in accordance with the terms of the Loan Documents, or to be held as collateral for any Guaranteed Obligations or other amounts payable under this Subsidiary Guaranty thereafter arising. If (i) any Subsidiary Guarantor shall make payment to the Administrative Agent or any other Secured Party of all or any part of the Guaranteed Obligations, (ii) all of the Guaranteed Obligations and all other amounts payable under this Subsidiary Guaranty shall be paid in full in cash and (iii) the Final Maturity Date shall have occurred and all Hedge Agreements shall have expired or terminated, the Administrative Agent and the other Secured Parties will, at such Subsidiary Guarantor's request and expense, execute and deliver to such Subsidiary Guarantor appropriate documents, without recourse and without representation or warranty, necessary to evidence the transfer by subrogation to such Subsidiary Guarantor of an interest in the Guaranteed Obligations resulting from such payment by such Subsidiary Guarantor. SECTION 5. Payments Free and Clear of Taxes, Etc. (a) Any and all payments by any Subsidiary Guarantor hereunder shall be made, in accordance with Section 2.11 of the Credit Agreement, free and clear of and without deduction for any Taxes. If any Subsidiary Guarantor shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to any Lender Party or the Administrative Agent, (i) the sum payable shall be increased as may be necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 5) such Lender Party or the Administrative Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) such Subsidiary Guarantor shall make such deductions and (iii) such Subsidiary Guarantor shall pay the full amount deducted to the relevant taxation authority or other governmental authority in accordance with applicable law. (b) In addition, each Subsidiary Guarantor agrees to pay any present or future Other Taxes. -4- (c) Each Subsidiary Guarantor shall indemnify the Administrative Agent and each other Secured Party for and hold it harmless against the full amount of Taxes and Other Taxes (including, without limitation, any Taxes or Other Taxes imposed by any jurisdiction on amounts payable under this Section 5) paid by the Administrative Agent or such other Secured Party (as the case may be) and any liability (including penalties, additions to tax, interest and expenses) arising therefrom or with respect thereto. This indemnification shall be made within 30 days from the date the Administrative Agent or such other Secured Party (as the case may be) makes written demand therefor, together with copies of any tax invoices or receipts, if any, or to the extent available, any other appropriate evidence of payment thereof. (d) Within 30 days after the date of any payment of Taxes, such Subsidiary Guarantor shall furnish to the Administrative Agent, at its address referred to in Section 8.02 of the Credit Agreement, appropriate evidence of payment thereof. In the case of any payment hereunder by or on behalf of any Subsidiary Guarantor through an account or branch outside the United States or on behalf of such Subsidiary Guarantor by a payor that is not a United States person, if such Subsidiary Guarantor determines that no Taxes are payable in respect thereof, such Subsidiary Guarantor shall furnish, or shall cause such payor to furnish, to the Administrative Agent, at such address, an opinion of counsel acceptable to the Administrative Agent stating that such payment is exempt from Taxes. For purposes of this subsection (d) and subsection (e), the terms "United States" and "United States person" shall have the meanings specified in Section 7701 of the Internal Revenue Code. (e) Without prejudice to the survival of any other agreement of any Subsidiary Guarantor hereunder, the agreements and obligations of each Subsidiary Guarantor contained in this Section 5 shall survive the payment in full of the Guaranteed Obligations and all other amounts payable under this Subsidiary Guaranty. SECTION 6. Representations and Warranties. Each Subsidiary Guarantor hereby repeats each of the representations and warranties of the Loan Parties contained in the Credit Agreement and makes each of the representations and warranties below as of the date hereof. (a) There are no conditions precedent to the effectiveness of this Subsidiary Guaranty that have not been satisfied or waived. (b) Such Subsidiary Guarantor has, independently and without reliance upon the Administrative Agent or any Lender Party and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Subsidiary Guaranty, and such Subsidiary Guarantor has established adequate means of obtaining from any other Loan Parties on a continuing basis information pertaining to, and is now and on a continuing basis will be completely familiar with, the financial condition, operations, properties and prospects of such other Loan Parties. -5- SECTION 7. Covenants. Each Subsidiary Guarantor covenants and agrees that, so long as any part of the Guaranteed Obligations shall remain unpaid, any Letter of Credit shall be outstanding, any Bank Hedge Agreement shall be in effect, or any Lender Party shall have any Commitment, such Subsidiary Guarantor will at all times perform or observe, and will cause each of its Subsidiaries to perform or observe, all of the terms, covenants and agreements that the Loan Documents state that Loan Parties are to perform or observe or that the Borrower is to cause such Subsidiary Guarantor or such Subsidiaries to perform or observe. SECTION 8. Amendments, Etc. a) (a) No amendment or waiver of any provision of this Subsidiary Guaranty and no consent to any departure by any Subsidiary Guarantor therefrom shall in any event be effective unless the same shall be in writing and signed by the Administrative Agent and the Required Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no amendment, waiver or consent shall, unless in writing and signed by all of the Secured Parties, (i) reduce or limit the liability of such Subsidiary Guarantor hereunder or release any Subsidiary Guarantor hereunder, (ii) postpone any date fixed for payment hereunder or (iii) amend this Section 8. (b) Upon the execution and delivery by any Person of a guaranty supplement in substantially the form of Exhibit A hereto (each a "Guaranty Supplement"), such Person shall be referred to as an "Additional Subsidiary Guarantor" and shall be and become a Guarantor, and each reference in this Agreement to "Subsidiary Guarantor" shall also mean and be a reference to such Additional Subsidiary Guarantor. SECTION 9. Notices, Etc. All notices and other communications provided for hereunder shall be in writing (including telegraphic, telecopy or telex communication) and mailed, telegraphed, telecopied, telexed or delivered to it, if to any Subsidiary Guarantor, to the address set forth below such Subsidiary Guarantor's signature on the signature pages hereof, if to the Administrative Agent or any other Lender Party, at its address specified in the Credit Agreement, or as to any party at such other address as shall be designated by such party in a written notice to each other party. All such notices and other communications shall, when mailed, telegraphed, telecopied, telexed or sent by courier, be effective, in respect of such notices and communications mailed, five days after being deposited in the mails and otherwise shall be effective when delivered to the telegraph company, transmitted by telecopier, confirmed by telex answerback or delivered to the overnight courier, respectively. Delivery by telecopier of an executed counterpart of any amendment or waiver of any provision of this Subsidiary Guaranty shall be effective as delivery of a manually executed counterpart thereof. SECTION 10. No Waiver; Remedies. No failure on the part of the Administrative Agent or any other Secured Party to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. -6- SECTION 11. Right of Set-off. Upon (a) the occurrence and during the continuance of any Event of Default and (b) the making of the request or the granting of the consent specified by Section 6.01 of the Credit Agreement to authorize the Administrative Agent to declare the Notes due and payable pursuant to the provisions of said Section 6.01, each Lender Party and each of its respective Affiliates is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and otherwise apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender Party or such Affiliate to or for the credit or the account of any Subsidiary Guarantor against any and all of the Obligations of such Subsidiary Guarantor now or hereafter existing under this Subsidiary Guaranty, irrespective of whether such Lender Party shall have made any demand under this Subsidiary Guaranty and although such Obligations may be unmatured. Each Lender Party agrees promptly to notify such Subsidiary Guarantor after any such set-off and application; provided, however, that the failure to give such notice shall not affect the validity of such set-off and application. The rights of each Lender Party and its respective Affiliates under this Section are in addition to other rights and remedies (including, without limitation, other rights of set-off) that such Lender Party and its respective Affiliates may have. SECTION 12. Indemnification. Without limitation on any other Obligations of any Subsidiary Guarantor or remedies of the Secured Parties under this Subsidiary Guaranty, each Subsidiary Guarantor shall, to the fullest extent permitted by law, indemnify, defend and save and hold harmless each Secured Party from and against, and shall pay on demand, any and all losses, liabilities, damages, costs, expenses and charges (including the reasonable fees and disbursements of such Secured Party's legal counsel) suffered or incurred by such Secured Party as a result of any failure of any Guaranteed Obligations to be the legal, valid and binding obligations of any Loan Party enforceable against such Loan Party in accordance with their terms. SECTION 13. Continuing Subsidiary Guaranty; Assignments under the Credit Agreement. This Subsidiary Guaranty is a continuing guaranty and shall (a) remain in full force and effect until the later of the payment in full in cash of the Guaranteed Obligations and all other amounts payable under this Subsidiary Guaranty and the later of the Final Maturity Date and the expiration or termination of all Hedge Agreements, (b) be binding upon each Subsidiary Guarantor, its successors and assigns and (c) inure to the benefit of and be enforceable by the Administrative Agent and the other Secured Parties and their successors, transferees and assigns. Without limiting the generality of the foregoing clause (c), any Secured Party may assign or otherwise transfer all or any portion of its rights and obligations under the Credit Agreement (including, without limitation, all or any portion of its Commitments, the Advances owing to it and the Note or Notes held by it) to any other Person, and such other Person shall thereupon become vested with all the benefits in respect thereof granted to such Secured Party herein or otherwise, in each case as and to the extent provided in Section 8.07 of the Credit Agreement. No Subsidiary Guarantor shall have the right to assign its rights hereunder or any interest herein without the prior written consent of the Secured Parties. -7- SECTION 14. Governing Law; Jurisdiction; Waiver of Jury Trial, Etc. (a) This Subsidiary Guaranty shall be governed by, and construed in accordance with, the laws of the State of New York. (b) Each Subsidiary Guarantor hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Subsidiary Guaranty or any of the other Loan Documents to which it is or is to be a party, or for recognition or enforcement of any judgment, and each Subsidiary Guarantor hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State court or, to the extent permitted by law, in such federal court. Each Subsidiary Guarantor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Subsidiary Guaranty shall affect any right that any party may otherwise have to bring any action or proceeding relating to this Subsidiary Guaranty or any of the other Loan Documents or any Hedge Agreement to which it is or is to be a party, or otherwise to proceed against any Grantor, in the courts of any jurisdiction. (c) Each Subsidiary Guarantor irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection that it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Subsidiary Guaranty or any of the other Loan Documents to which it is or is to be a party in any New York State or federal court. Each Subsidiary Guarantor hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. (d) Each Subsidiary Grantor irrevocably consents to the service of any and all process in any such action, suit or proceeding by the mailing of copies of such process to such Subsidiary Grantor at the address set forth below, or by any other method permitted by law. Each Subsidiary Grantor agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other Jurisdictions by suit on the judgment or in any other manner provided by law. (e) Each Subsidiary Guarantor hereby irrevocably waives all right to trial by jury in any action, proceeding or counterclaim (whether based on contract, tort or otherwise) arising out of or relating to any of the Loan Documents, the transactions contemplated thereby or the actions of the Administrative Agent or any other Secured Party in the negotiation, administration, performance or enforcement thereof. -8- IN WITNESS WHEREOF, each Subsidiary Guarantor has caused this Subsidiary Guaranty to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. By: -------------------------------- Name: Title: By: -------------------------------- Name: Title: By: -------------------------------- Name: Title: EX-10.13 13 EXHIBIT 10.13 Exhibit 10.13 FIRST AMENDMENT TO MANAGEMENT AGREEMENT FIRST AMENDMENT (this "Amendment"), dated as of December __, 1997, by and between 24 HOUR FITNESS, INC., a California corporation (the "Company") and MDC MANAGEMENT COMPANY III, L.P., a California Limited partnership ("MDC"). All capitalized terms used herein and not otherwise defined shall have the respective meanings provided such terms in the Management Agreement referred to below. W I T N E S S E T H : WHEREAS, the Company and MDC are parties to a Management Services Agreement dated as of December 29, 1994 (the "Management Agreement"); NOW, THEREFORE, in consideration of the mutual premises contained herein and other valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. AMENDMENT TO THE MANAGEMENT AGREEMENT 1. Section 3.1 of the Management Agreement shall be deleted in its entirety and replaced with the following: "3.1 As compensation to MDC for its management and advisory services to the Company under this Agreement, the Company agrees to pay MDC a fee in the amount of six hundred fifty thousand ($650,000) per year, commencing January 1, 1998, adjusted upward each year by an amount (not less than $100,000) to be agreed upon by MDC and the Company until such fee shall equal $1,000,000 per year. Such fee shall be payable in arrears in equal quarterly installments, on the first day of January, April, July and October, commencing April 1, 1998." II. MISCELLANEOUS 1. This Amendment is limited as specified and shall not constitute a modification, acceptance or waiver of any other provision of the Management Agreement. 2. This Amendment may be executed in any number of counterparts and by the different parties hereto on separate counterparts, each of which counterparts when executed and delivered shall be an original, but all of which shall together constitute one and the same instrument. A complete set of counterparts shall be lodged with the Company and MDC. 3. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE STATE OF NEW YORK. 4. This Amendment shall become effective as of January 1, 1998, on the date (the "First Amendment Effective Date") when each of the Company and MDC shall have signed a counterpart hereof (whether the same or different counterparts). 5. From and after the First Amendment Effective Date, all references in the Management Agreement shall be deemed to be references to the Management Agreement as modified hereby. *** -2- IN WITNESS WHEREOF, each of the parties hereto has caused this Amendment to be duly executed and delivered as of the date first above written. 24 HOUR FITNESS, INC. By: /s/ Gilbert K. Freeman -------------------------------- Name: Gilbert K. Freeman Title: Executive Vice President/CFO MDC MANAGEMENT COMPANY III, L.P. By: CONFORM? -------------------------------- Name: Title: EX-23.1 14 EXHIBIT 23.1 Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the use in this Registration Statement of Fitness Holdings, Inc. of our report on Northwest Fitness, Inc. dated June 5, 1998 and our report on Family Fitness Holding Company, Inc. dated June 16, 1998 appearing in the Prospectus, which is a part of this Registration Statement, and to the references to us under the headings "Selected Consolidated Financial Information" and "Experts" in such Prospectus. San Francisco, California July 7, 1998 EX-27 15 FDS
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS 3-MOS DEC-31-1997 DEC-31-1998 DEC-31-1997 MAR-31-1998 4,584 7,119 0 0 2,892 3,321 0 0 2,526 2,804 44,270 49,847 123,706 136,162 37,132 41,306 247,071 266,912 109,643 125,734 0 0 0 0 0 0 2 2 (105,838) (109,419) 247,071 266,912 292,973 91,563 261,904 80,654 5,248 1,839 5,248 1,839 263,463 78,897 0 0 18,372 5,280 (26,178) (5,362) (9,171) (1,631) (17,007) (3,737) 0 0 0 0 0 0 (17,007) (3,737) 0 0 0 0
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