MIAMI MIRROR TRUE REFLECTIONS

SERIES: THE CRUNCH FITNESS FIASCO

CRUNCH FITNESS AND THE GOLDEN SQUASH

Who is to blame for The Crunch Fiasco? By David Arthur Walters The Miami Mirror June 14, 2011 MIAMI BEACH The Crunch brand is amazing and its been mismanaged in the past five years, proclaimed Mark Mastrov, the Bill Gates of the fitness industry, in his press release after he had snatched Crunch Fitness out of bankruptcy as preplanned. Ultimately the proof is how you operate. We can go in there and do a turnaround. It will definitely be challenging. Marc Tascher had spearheaded the previous effort to turn Crunch around and had chipped several of his own successful clubs into the deal to purchase Crunch from Bally Fitness, but he was brushed aside by his equity firm partner, Angelo, Gordon & Company, after a brief four months as figurehead of the ill-fated firm, AGT Crunch Acquisition LLC. Angelo Gordon had gone out of its way to praise him, instilling confidence in investors, then turned around and squashed the legendary squash man, leading us to suspect that he had been duped we shall elaborate our conspiracy theory, From Bats to Vultures, elsewhere. Tascher had enjoyed a remarkable reputation within the industry before he had the bright idea of taking over the Crunch brand, and his experience had been somewhat parallel to Mastrovs: Young man, get into the right place at the right time, pour your heart into it and stay put until getting out is good. Angelo Gordon had seemingly loved the fitness industry sage at first sight when Sagent Advisors brought him over with the Crunch proposition, yet he would be treated like a pariah in no time. What happened? Was Tascher to blame for much of the mismanagement referred to by Mastrov? We do not think so; we believe the failure to turn around crunch should be placed on Angelo, Gordon & Company, the $10 billion turnaround firm that cast Tascher out, only to become Mastrovs bedfellow in Crunch and other ventures, such as amazing Madonnas promising Hard Candy Fitness club chain. Leveraged buyout firms are notorious for saddling their targets with debt while calling themselves equity funds. We believe the vulture equity fund overleveraged the new venture in an attempt to suck exorbitant interest from the firms electronic funds transfers flowing from the membership accounts. We do not see the interest rate on the debt disclosed in the bankruptcy documents, nor do we see the high interest rate as a cause of the fiasco, but we notice with some interest the disclosed 18% compounded quarterly on the senior preferred stock. The relatively steady cash flow of fitness chains along with demographics favorable to the fitness business rendered them appetizing targets to a few hungry funds a decade ago, but thus far the demographics and other positive factors have not panned out as expected, as is evident in the
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relatively high interest rate on the borrowings used to purchase fitness company stock. That is not to say that the fitness industry had not grown remarkably; from 2000 to 2009, according to the International Health, Racquet and Sports Club Association, its revenues grew at a compound rate of 5.9%; the number of fitness clubs grew in that period by a compound rate of 6.4%, while the number memberships grew by only 3.7%. But the health industry, as we know all too well, had gotten way out of hand, in large part due to demand fueled by insurance coverage and tax deductibility, which is not provided for fitness clubs to any great extent. Doctors may prescribe rehabilitation services, and some insurance companies now include fitness club membership in their plans. So-called silver fitness memberships for aging boomers are provided by Medicare Advantage providers, who have recently started to base their coverage on actual attendance by the insured at gym. Tellingly, one of the first things that Crunch Fitness did was terminate its acceptance of profitable silver fitness memberships at a former Taschermanaged club that AGT Crunch Acquisition had branded a Crunch, discriminating against people on the basis of their age in favor of its preferred 18-40 target group. Michael Ross, president and owner of Gem Star Fitness Center in Manhattan, now known as the West End Sports Club, said he did not know that the insurance program, which had been yielding the club $6,000 net profit per month, had been cancelled until he overheard members complaining about it in the locker room some time after Crunch signs had been slapped up on the gym. This event allegedly occurred in December 2006, several months after Tascher had been shoved aside by his partner Angelo Gordon. Gem Stars lawsuit and another former Tascher-managed clubs suit against Crunch et al alleging racketeering will be discussed elsewhere. Fitness and health are naturally related if fitness means being fit to live a long life free of disease, yet one can be fit for many things that are not that healthy, say, fit to play professional football and suffer from brain damage. Absent an incentive or mandate to join a gym, people may exercise on their own, or sit at desks and couches for many hours a day thus multiplying their risk of premature death by several times a recent study indicates that exercise does not cancel the risk accrued by sitting down for long periods, so we suggest standing up at work by means of elevated desks. Fitness club memberships can be a hard sell when based on the health argument: People tend not to participate in improving their health because they do not believe they will get sick; they do not appreciate the seriousness of symptoms of bad health they experience; they do not believe the programs offered will be of much help to them; and nothing happens that would cause them to change their behavior until it is too late. To paraphrase Malcolm Gladwells Tipping Point, something has to be thrown at them that will stick and get them to stop by the health club; sophisticated advertising campaigns wrought to frighten or amuse people will not do the trick. Psychological resistance along with high rents and interest rates do not bode well for the accelerated growth of the fitness industry overall in this country even though the market is far from saturated. It is with that and more in mind that Angelo Gordon should have put up more equity for the Crunch venture, and should have been patient enough to ride out the storm, giving their experienced club manager and his people ample time to build up a loyal membership with service, as Howard Schultz did with Starbucks, instead of panicking and changing horses; or the transaction-oriented money managers should not have done the deal in the first place.

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We blame Angelo Gordon even though investors naturally prefer to blame the entrepreneur instead of the investment bank, and write the loss off to mismanagement; after all, how could highly esteemed and educated persons responsible for $10 billion of assets be incompetent not to say crooked? No, blame the entrepreneur. For example, make Donald Trump take the blame for the Trump Shuttle, which he viewed as a luxurious advertising vehicle for his brand an enterprise that would have done well enough if he had had time to learn some modesty and turn it into a work horse and not the banks led by Citigroup that loaned him 19 times his equity, debt amounting to 95% of the assets. (The author may approach The Donald with his Trump Blimp concept after concluding this series). Yes, it was Taschers idea to obtain funds to buy the Crunch clubs from Bally in the first place, but it was also his idea to rebuild its membership over the next five to seven years, not to pump and dump it. He observed that Crunch was a widely recognized, popular brand with considerable internal value despite Ballys neglect; marketing staff and personal trainers were in place, and, most importantly, he believed its members loved the brand hence were loyal. He said the brand was outstanding, that the public perceived it as cool and edgy, an image the population wants to identify with; the brand had taken on a life of its own, standing apart from its early adopters. There was plenty of opportunity for people to climb aboard its bandwagon inasmuch as being cool and edgy and counter-cultural has become traditional. Tascher certainly was the right man for the job. Indeed, Angelo Gordon could not have secured the investors without him. But it did not take the vulture investment firm long to marginalize him, and then pick his bones clean along with other investors and creditors. He must have known a vulture when he saw one, but money does not grow on trees. What we want to see influences what we do see in all our fallibility. Vultures are ugly on the ground but quite beautiful when soaring aloft. Despite the sight and smell of carrion (American vultures such as the turkey vulture have a sense of smell), few vulture equity venues will get involved with troubled fitness chains given the experience with them over the past decade. Still Angelo Gordon had advertised itself as an agnostic investor in troubled companies, meaning that it was willing to feed on anybody. That was Mastrovs cue after he had fallen out with his own private equity partner in his former business, 24 Hour Fitness. He was circling on high when he got wind of the Crunch financing by Angelo Gordon, and, when Crunch, drained of its blood by a brood of consultants, staggered and fell flat, he winged in to secure his position at the gruesome feast he may profit mightily by franchising the brand into a McCrunch operation. In any event, we should know something about the key man in the deal with Bally Fitness if we want to understand the Crunch fiasco. In comparison to Mastrov, the darling of the fitness industry, he has not gotten the press he deserves. We hear that Tascher is known in the industry as a win-win guy sincerely interested in striking an equitable balance between the interests of all stakeholders customers, employees, community, shareholders. He was an SDS leader in his college days he is not known as a pump and dumper or the sort of fellow who would cop out to the Man and sell his soul to maximize shareholder value. He was a health club man from the get go. He co-founded of Town Sports International, a company that began in 1973 with a commercial squash club company owned by Harry (H.F.) Saint. Saint hired Tascher fresh out of college, his first employee in New York, because Tascher had no experience and therefore no preconceptions about the industry.
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Town Squash Inc. would eventually become Town Sports International. Tascher would eventually replace Saint, and eventually, in 1996, sell out and start his own clubs. Today TSI is a public company, having gone public in 2006 to partly relieve it from a debt burden that had grown from 1.15x total capital (indebtedness capital less deficit equity) in 2003, to 3.56x total capital in 2005. By the end of 2010, according to its annual report, it operated 160 clubs with approximately 493,000 members we have reason to believe the membership numbers provided in its annual reports are unreliable. The company was hit hard by the Great Recession: gross revenue dropped from $507 million in 2008 to $462 million in 2010. Unlike the Crunch brand that Tascher would eventually fall in love with, Town Sports International employs localized brand names for its clubs (New York Sports Clubs, Boston Sports Clubs, Washington Sports Clubs, and Philadelphia Sports Clubs) to create an image and atmosphere consistent with the local community and to foster recognition as a local network of quality fitness clubs rather than a national chain. Saint and Taschers innovative promotions fostered the squash boom; when that played out, they turned to health clubs. Tascher had an electronic funds transfer system installed, which would soon generate 90 percent of the enterprises revenues. EFT became the industrys financial backbone, enabling clubs to sell annual memberships, and then automatically charge members accounts a flat amount each month instead of collecting an initiation fee and a fee for each use of the facilities. That way, space-time could be leveraged by a certain multiple of maximum peakhour capacity in order to yield optimum revenue. But that is not to say that Tascher turned to the churn-and-burn or seduce-and-abandon methodology made infamous by Mastrovs 24 Hour Fitness and its ilk; at least he emphasized service over sales as a matter of habit ingrained by early experience; the squash business made money whenever people played squash; i.e., you wanted people to actually play squash so you could get court fees. TSI was Saints day job; he was a writer at heart. He no doubt had considerable influence on Tascher. Quaker principles were instilled in Saint at Haverford College; he studied philosophy in Germany, and inherited a real estate business before he went into the squash business. He had in fact sold a short story for $600 while in college, but figured writing was a rather poor way to make a living. However that might be, he cashed out of TSI in 1981 and wrote a popular novel, Memoirs of an Invisible Man, which was made into a movie. The book and rights yielded him $3 million or more. Saint himself is rumored to have gone off to Europe to enjoy the spoils, where he mysteriously disappeared, only to surface from time to time here and there. Attempts are reportedly being made currently by the CIA to locate him with an experimental quantum device invented by a Bulgarian scientist during the Cold War. Tascher, replacing Saint, became CEO. The current (2011) president of Town Sports International, Robert Giardina, was hired in 1981 to manage one of the Town Squash clubs. He had previously worked for the nations largest health chain, European Health Spa, and had been disillusioned by its focus on sales over service. According to TSI copywriting, the most important key to TSIs success was in retaining members by getting results: members were satisfied when their fitness programs made them fit.
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TSI then counted on people to work out efficiently and effectively to maintain its reputation, unlike companies that cater to the crowd that does not show up very often yet continues to pay dues. Incidentally, now a customer can pay $10 a month for membership at Planet Fitness, paying much less for something they never use; the new Crunch Fitness franchises are charging $9.95. Giardina eventually became Taschers partner, prompting Tascher to focus on the health club or general fitness side of the business instead of squash only. The racket and fitness clubs sported individual names instead of one brand name. Tascher wanted to create a major brand to consolidate marketing and to expand. He presented a plan to do just that in 1995, but his plan was ultimately greeted with disapproval by the majority shareholder. He resigned as CEO in 1996 and worked behind the scenes to find investors for a leveraged buyout of the company. He managed to obtain two offers to pry his stake loose, but the offer that would finally be accepted was the one obtained by the management team. Until Taschers memoirs are published, we can only speculate on what went on at the time, and whether or not he made the right judgment call. We imagine that his departure was not very friendly. He was the second largest shareholder when the leveraged buyout cashed him out. Obviously, he believed that getting out of TSI was the right thing to do, that the future of the company was no longer as bright as he wanted it to be, at least not something he wanted to gamble his years of work on. For one thing, he was probably weary of agonizing over the mounting debt, which persisted or was made worse after the buyout. Bruckmann, Rosser, Sherrill & Co., the private equity firm effecting the 1996 buyout, had wanted to sell the company for $600 million in 2002 but could not find a buyer, so it refinanced the company, taking no cash out. Although the company had been left with a large negative number in its paid-in capital account that persisted for years after the 1996 leveraged buyout, and although the buyout had left the firm with an 11% interest rate on its indebtedness, Tascher may have had some regrets over not having kept a stake in the firm after the subsequent IPO in 2006, offering 8,950,000 shares at a maximum of $14 per share. More recently, TSI investors tripled their money in anticipation of far more favorable financing; TSI announced on May 11, 2011, that it had entered into a new credit facility for $350 million at LIBOR plus 5.50%, which allowed it to fully redeem the 11% notes, thus cutting its interest almost in half. If the savings were applied retroactively, to 2010, that would have left it with a profit of around .40 per share instead of a penny loss per share. It could be headed to a profit of .60 to .70 per share in 2011. The deficit equity persists due to a residual negative balance in its capital-paid-in account. Wherever good lives evil also resides, and in what ratio we cannot say some analysts, having gone beyond good and evil, are indifferent to debt/equity its all capital to them. The virtues and vices of leverage had to have become obvious to Tascher long before he wedged his own clubs into Crunch for a 20% stake in the $45 million deal with Bally Fitness. Long gone was the dream of fitness industry entrepreneurs that cash flow off electronic fund transfers would suffice to grow their fitness outfits when commercial banks were not lending to such risky businesses; they turned to investment banks and were saddled with debt to finance growth.
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The debt eventually taken on by the Crunch partnership must have troubled Tascher, but money whatever its source still has its attractions, as gamblers who turn to loan sharks know all too well. His Town Squash Inc. had taken on debt during its expansion but managed to outrun its debt service with increased revenues by getting into general fitness. And then his Town Sports International Inc, having taken that name in 1993, took on enormous debt to finance its sports and health club growth; its cash flow before debt service, was allegedly, according to a frequently repeated press report, 30% back in the good old days, i.e. when the industry was booming as baby boomers turned to exercise while insurers and employers collaborated to reduce health care costs. Since the leveraged buyout, cash provided by operations before financing and investment activities was 17.4% or revenue in 1997, 10.3% in 1998, 18.6% in 1999, 18.1% in 2000, 15.3% in 2001, 15.9% in 2002, 17.0% in 2003,16.3% in 2004, 13.2% in 2005, 17.3% in 2006, 17.5% in 2007, 18.9% in 2008, 15.7% in 2009, and 11.1% in 2010 (we apologize to readers for our numerical litany and references to confounding margins and ratios herein in hopes they might be meaningful to someone). We cannot say at this time whether the golden age of 30% ever existed at all or if it did for how long. For all we know, the financial Utopia might have been a Dystopia the members felt pretty good working out in the gyms, but the indebtedness stress put on executives may have been traumatic. Earnings before interest, depreciation, taxes and amortization (EBIDTA) is another commonly used margin referred to by financial analysts since depreciation and amortization are not current cash expenses, but represent the spreading out over the years of up-front capital expenditures, and happen to be of considerable magnitude in capital intensive industries, adding those annual charges back to operating income before interest and taxes can give a better but still inadequate picture of how much cash is generated to pay interest and taxes. Analysts have noted that TSI is in the habit of providing a peculiar definition of EBIDTA, which obviously differs from the EBIDTA margin they would normally calculate from the numbers on its statements. TSI stated its own version of EBIDTA margin as averaging 21% from 2001 to 29.4% in 2007, and then it fell from there to 22.2% in 2010. Taschers own collection of clubs, doing business under the mantle of Sports Fitness Ventures, were said to be faring better even without the peculiar adjustments used by TSI, with an average EBITDA margin of 31% Interestingly, as revealed by the registration for a $85 million note offering for the 12-month period ending way back in August 31, 1997, shortly after the leveraged buyout, indebtedness was 6.22 times EBITDA, and the company warned that its ratio of indebtedness to total capital as formally calculated by its accountants was at 130%, meaning that a substantial portion of its cash flow would be dedicated to debt service, that it might have difficulty getting additional financing, and that any downturn could be ruinous. But the firm went on growing with the help of its lenders. We believe Tascher must have been relieved to get out when he did, by way of the leveraged buyout, and not have to walk the deeply indebted high wire any more, although the LBO must have made the indebtedness worse. Surely, we surmise, he must have been troubled by the indebted structure of Crunch Fitness when he got into that deal a decade later; it would have taken a great deal of smooth talk to get him into it. Indeed, something is wrong with the picture

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presented by the public record; it looks like Tascher was duped, like the cat who drags in a mouse just to have it snatched from his jaws by a bigger cat. In July 9, 2001, Wall Street Transcript CEO Interview Richard Pyle, the executive who was identified as chiefly responsible for finances at Town Sports International since 1987, we discover that he liked another rule-of-thumb to see how the firm was doing, called EBITDAR: rent is added back onto the margin, to get earnings before interest, taxes, depreciation, amortization, and rent. We look at that as a reflection of profitability or cash flow, shall we say, before rent, he said, and that's the only way to compare all of the health club businesses on one piece of paper. Since many club operators own their real estate, this is the one metric where everyone is on a level playing field. That does make sense for sake of comparison. But we note well that we have all sorts of margins to choose from; just take your pick, and your loss might look pretty good after all. Town Sports International accountants are masters of adding things back that are not entirely visible on its financials. We regret that Tascher is not talking. We would like to know if he crossed swords with Pyle, who probably answered to the majority owners rather than to Tascher when it came to financing. Being CEO does not come with the power of ownership; although Tascher was the second largest shareholder at TSI; he did not have the ultimate control. He left the company on solid ground in terms of membership service, and it managed to muddle ahead financially as it rode the growth wave of the industry. He went on to own and/or manage the Sports Fitness Venture clubs, some of which were valuable enough to gain him his equity in the Crunch deal. Yet he only had 20% of AGT Crunch Acquisition; he did not have control; he was marginalized after a mere four months at the helm; he was not given the chance to hire his own key people and build a loyal membership with good service. What a shame that is, as we can see by the results leading up to bankruptcy. No matter what we add back to Crunchs dismal August 2009 financial statement to come up with our list of capital letters, we cannot drag Crunch into the black. There are margins, and then there are margins. Your margin is the one you can eat. If you are a small equity investor, then the bottom line, your earnings per share after everything is said and done, is your margin after Uncle Sam takes his bite. Please watch out for USURY and FRAUD lest your margin at the table amounts to nothing. In a January 1, 1994 article penned by Jill Andresky Fraser for an Inc magazine issue featuring six ways entrepreneurs can save the world, Tascher was quoted as saying that a successful club should bring in a 40% pretax margin. Now there is an admirable ideal. A pretax margin is net income before taxes; 40% would be wildly successful for a large fitness chain just try to find that net before taxes alone somewhere. We note that income before taxes of the highly successful public company Life Time Fitness recently averaged around 17% of revenue. For the sake of fitness club entrepreneurs who are patiently looking for a perfectly reliable rule, searching for the Snark instead of waiting for Godot, we believe he was misunderstood by the journalist: he was probably not referring to a 40% pretax margin. He revealed his secret calculation method to the Inc. journalist: Every month, Tascher monitors the performance of each club (and of the corporation) according to that ratio, so that as clubs mature and
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membership growth slows, Town Sports' cost-to-revenue ratio remains constant. The ratio is also used to make sure that expansion projects make financial sense. "I've got three main costs marketing, space, and payroll and I won't consider expanding into a new club unless its projected cost ratio works," quoth Tascher. He is speaking of what is may be called club expenses; no mention is made of general and administrative expenses or overhead, which every company also has to pay. Tascher said he used his rule-of-thumb ratio, based on the three cost factors, to help gauge how much cash to keep on hand as soon as building new clubs entered a risky phase. At a time similar to this, when we have got four clubs under construction, our cash reserves are superior for the reason that I know there are uncertainties about how much cash well need along with how long it will take for those clubs to get going. However as soon as those uncertainties are reduced, it will be better to spend down reserves if we need cash, rather than rely on our credit lines. In other words, Taschers rule is that he desired to control costs so that he would have 40% of his revenue left over after paying out cash for labor, marketing, and rent, and then the cash revenue actually collected would be sufficient to build reserves and use them for growing the business. Cash flow analyses might serve him better, but at least he could keep the major direct cost factors under his thumb. Of course one has to pay administrative expenses, which may be one reason he was antipathetic to paying high fees to outside consultants; and then there is the debt service, which would usually be the interest if debt is continually rolled over. From the little information we have been able to glean about his subsequent companies under Sports Fitness Ventures, we see he was a little shy of the 40%, with a margin of 37% EBITDA and before overhead. Well, our golden squash player may be a frustrated financial genius for all we know in our ignorance and impoverishment. One thing we are sure of; he knows how to build up clubs with loyal memberships. If we are to fault him a Crunch, it is in going for the Angelo Gordon deal. Tascher was out of the TSI picture and was set for life due to the leveraged buyout. He could have gone on to write a novel himself like Saint, he too aspired to be a writer. But he kept active in the industry with the eight health clubs he either owned or managed via Sports and Fitness Ventures LLC, six of which he contributed to the deal to buy Crunch from Bally Total Fitness of the six, one was managed and it would be dropped by Crunch, so the SFV contribution was described in bankruptcy documents as five additional clubs from entities unrelated to [the twenty five] Bally clubs. Tascher obviously had not given up his branding notion and his ambition to build another health club empire. Given his past string of successes, we cannot blame Tascher, soon to become CEO of the new Crunch holding company, AGT Crunch Acquisition LLC, for his enthusiasm when the deal was announced. "We are excited about working with the strong Crunch team of dedicated employees to take the brand to the next level, he said. We intend to build upon the strong foundation that is already in place, including improved operational infrastructure, great people, dynamic programming, superior locations and a loyal membership base."
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The timing and the financial structuring was bad, but that being said, we must not think that the eventual failure of the Crunch takeover from Bally was entirely due to financial foolishness associated with the macroeconomic circumstances of boom and bust. After all, TSI had turned its meager $2.3 million profit in 2008 after write-offs, and Life Time Fitness Inc., with roughly 600,000 members in 83, 24-hour centers emphasizing family recreation, posted a profit of $71.8 million for 2008 (its EBDITA was a whopping $221.5 million, or 28.8% of revenue, and its debt was only 52% of total capital). In any event, someone must be blamed when things go south, whether on the micro or macro level, and it is more convenient to blame the CEOs than the investors from whom entrepreneurs need a virtually inexhaustible supply of funds for their ventures. When business is not going well, the manager is blamed and fired even when we do not know for sure exactly what he did or did not do that put the enterprise into bad straits. Say good bye to Tascher as CEO of Crunch Fitness. Since Tascher had 20% equity in the $45 million Crunch deal, we suppose his loss to be at least $9 million. Add to that the loss of his unsecured claim for the balance of his management fee and any paid compensation that might be clawed back, plus attorneys fees, incidental costs, and damages and the like. We see that Tascher got one of his clubs back, the Rock Creek Sports Club in Silver Spring, Maryland, but he and his partner Paul London had to pay $705,000 for it. Noting well that Paul London and other members of the distinguished London family were investors in AGT Crunch Acquisition, we conclude that they placed no blame on Tascher for the fiasco. We also note well that Jonathan Roosevelt and other members of the illustrious Roosevelt family were investors in AGT Crunch Acquisition and evidently have no regrets about Taschers role in Crunch, for Jonathan Roosevelt is Taschers partner in a Healthy Fit, an attractive holistic health club for women located in Mamaroneck, New York. As of this writing, we find no record that Tascher and others have filed suits in New York County against Angelo Gordon and its advisors and crisis managers, but the Crunch Fiasco certainly smells of bats and vultures, wherefore we recommend that everyone concerned go over the details, especially the general ledgers and contracts, with a fine-toothed comb. -To Be Continued-

Note: The author, motivated by his love of the Crunch brand, seeks justice for Crunch.

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