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FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

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

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

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

The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant as of June 30, 2003, was approximately $286.3 million, based on the closing price of the registrant’s common stock as reported by the New York Stock Exchange at that date. For purposes of this computation, affiliates of the registrant include the registrant’s executive officers and directors as of June 30, 2003. As of February 29, 2004, 34,030,044 shares of the registrant’s common stock were outstanding.

Portions of the definitive Proxy Statement for the 2004 Annual Meeting of Stockholders are incorporated into Part III of this Form 10-K.

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TABLE OF ADDITIONAL REGISTRANTS

           The address for service of each of the additional registrants is c/o Bally Total Fitness Holding Corporation, 8700 West Bryn Mawr Avenue, 2^nd Floor, Chicago, Illinois  60631, telephone 773-380-3000. The primary industrial classification number for each of the additional registrants is 7991.

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PART I

           Except as otherwise stated, the information contained in this Form 10-K is as of December 31, 2003, the end of the registrant’s last fiscal year. This Form 10-K contains forward-looking statements which involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the registrant to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. See “Forward-Looking Statements” in Item 7 of this Form 10-K.

ITEMS 1 AND 2.   BUSINESS AND PROPERTIES

General

           Bally Total Fitness Holding Corporation, a Delaware corporation, is the largest commercial operator of fitness centers in North America in terms of revenues, number of members, and number and square footage of its facilities. As of February 29, 2004, we operated 418 fitness centers and had approximately four million members. Our fitness centers are concentrated in major metropolitan areas in 29 states and Canada, with 350 fitness centers located in the top 25 metropolitan areas in the United States and Toronto, Canada. We operate fitness centers in over 50 major metropolitan areas representing 63% of the United States population and over 16% of the Canadian population. Our members made an estimated 150 million visits to our fitness centers in 2003.

           We offer value to our members by providing access to state-of-the-art fitness facilities with affordable membership programs. Bally fitness centers feature a variety of cardiovascular and strength equipment and offer extensive personal training, weight management and group fitness training programs. In addition, many of our fitness centers include pools, racquet courts, spinning rooms or other athletic facilities. Our current fitness center prototype achieves efficiency by focusing on those fitness services our members use most frequently. We have clustered our fitness centers in major metropolitan areas in order to reach the greatest population and achieve marketing and operating efficiencies. Over 87% of our fitness centers are located in markets in which we have five or more facilities, with our largest concentrations in the New York, Los Angeles, Chicago, Baltimore/Washington D.C., Boston, Dallas, Houston, Detroit, San Francisco, Toronto, Portland, Seattle, Philadelphia, Atlanta and Miami areas.

           The majority of our fitness centers use the service mark “Bally Total Fitness®", including 10 upscale centers that are known as “Bally Sports Clubs^SM ”. The nationwide use of the service mark enhances brand identity and increases advertising efficiencies. Pursuant to our strategy of targeted market segmentation, we have opened or acquired new facilities during the past few years that operate under upscale brands, including 27 fitness centers as “Crunch Fitness ^SM ”, 10 fitness centers as “The Sports Clubs of Canada™”, seven as “Pinnacle Fitness®” and four as “Gorilla Sports ^SM ”.

           We market our clubs to consumers through the use of a variety of membership options and payment plans. Our membership options range from single-club memberships to premium memberships, which provide additional amenities and access to all of our fitness centers nationwide. Similarly, we offer a broad range of payment alternatives. Typically, our Bally Total Fitness branded club members pay an initial membership fee which can either be financed or paid-in-full at the time of joining. Members who choose to finance their initial membership fee generally do so for up to 36 months, subject to state, provincial and local regulations and minimum down payment requirements. In addition to the initial membership fee, members are generally required to pay monthly membership dues in order to use our fitness facilities. Recently we have added a new “pay-as-you-go” membership type allowing members to join without a long-term commitment. We believe the various memberships and payment plans offered, in addition to our strong brand identity and the convenience of multiple locations, constitute distinct competitive advantages. Membership plans in our upscale clubs generally include a higher level of club amenities than the Bally Total Fitness clubs, and are also differentiated by single, multi-club, and all-club membership programs. New members of our upscale clubs generally pay a lower initial membership fee than new members of our Bally Total Fitness clubs, but pay higher monthly dues throughout the term of the membership.

           We elected to change our accounting methods effective January 1, 2003 related to the recognition of revenue from membership contracts, initial membership origination costs, and asset retirement obligations. See Management’s Discussion and Analysis of Financial Condition and Results of Operations—Summary of Significant Accounting Policies, and Notes to Consolidated Financial Statements for more details. In this Report on Form 10-K, unless otherwise noted, numerical disclosures contained in Items 1 and 2 have been conformed to

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the change in accounting method and are presented on a pro forma basis in prior years as if the change in accounting method had been previously adopted for all periods presented.

           We make certain filings with the Securities and Exchange Commission, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, available free of charge through our website, www.ballyfitness.com, as soon as reasonably practicable after they are filed with the Securities and Exchange Commission. Our press releases are also available on our website.

Business Strategy

           Our continuing business focus is to grow our membership base and maximize our yield-per-member. We define yield-per-member as the dollar amount generated per member through initiation fees, monthly dues, products and services revenues and finance charges earned. Our average yield-per-member was $256 during 2003 and $242 in 2002. We expect to continue to grow our membership base as well as maximize our yield-per-member using the following strategies:

           Optimize Our Product and Service Offerings. We are increasingly using our clubs for the delivery of value-added products and services such as personal training, private-label nutritional products, group exercise classes, fitness related merchandise, member magazines and our Weight Management Program. Integrating these ancillary products and services into our core fitness center operations positions Bally as the primary source for all of our members’ wellness and fitness needs. In addition, our private-label nutritional products are sold in approximately 2,500 select retail, grocery and drug store outlets and our licensed portable exercise equipment is sold in over 2,200 retail outlets. We are committed to the continuing development and integration of new and innovative products and services. Our extensive groupings of club operations and brand mix allow us to “test-market” new products and services without exposing our entire operation to the outcome of the introduction.

           Realize the Benefit of Recent Investments. We have invested over $400 million in greenfield expansion, acquisitions, and expansion of existing facilities since 1997. In order to strengthen operating results and cash flows, we scaled back our club expansion plans in 2002 and 2003 and will continue to do so for the next several years. We intend to focus our attention on improving operating margins and cash flows in our existing fitness centers to capitalize on our recent investments and to realize the benefits of reduced capital expenditures. Our immature fitness centers generally require over a full year of operations before generating incremental operating income. By slowing club expansion, we intend to realize the cash flow benefits from reduced capital expenditures as well as from the natural maturation of our 135 clubs less than 5 years old. We expect our immature clubs, as they mature, to contribute higher levels of operating income.

           Expand and Optimize Our Marketing. We will continue to leverage the position of the Bally brand, which we believe is the most recognized brand name of fitness centers in North America. During 2003 we fundamentally reshaped our entire marketing approach and organization, hiring a Chief Marketing Officer and Executive Creative Director to guide our marketing turnaround. During the year, our new team modernized our creative approach and expanded our marketing message to speak to multiple customer segments in the 18-54 year old demographic, rather than relying only on our traditional 18-34 year old target. We created advertising specifically targeting women, men, seniors and Hispanic consumers and added new specialty advertising agencies to assist in reaching these target consumers. We continue to explore Internet-based approaches to marketing to new members and are expanding our web-site as a customer relationship management tool. During 2003, we continued the roll out of more customer friendly approaches to pricing our memberships by giving consumers more flexibility in payment terms, such as the continued expansion of non-obligatory pay-as-you-go membership options.

           Improve Operating Efficiencies. After a period of rapid expansion by adding new clubs in addition to the acquisition of most of our upscale brands, we have consolidated our operations to realize economies of scale. In particular, we launched several initiatives to improve operating efficiencies and reduce operating costs, including energy management programs and staff reductions during 2003. We have also eliminated local area offices and modified some of our incentive and compensation programs to better reward profitability.

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Fitness Centers

           Most of our fitness centers are located near regional, urban and suburban shopping areas and business districts of major cities. Fitness centers vary in size, available facilities and types of services provided. All of our fitness centers contain a wide variety of state-of-the-art progressive resistance, cardiovascular and conditioning exercise equipment, as well as free weights. A member’s use of a fitness center may include group exercise programs or personal training instruction stressing cardiovascular conditioning, strength development or improved appearance. New members are offered orientations on the recommended use of exercise equipment by our personnel.

           Our current prototype fitness center generally focuses on those fitness services our members most frequently use, such as well-equipped cardiovascular, strength and free weight training areas along with a wide variety of group fitness classes. Services that receive a far-lower degree of member use, such as swimming pools, running tracks, racquet courts or other athletic facilities have been de-emphasized. Our prototype fitness center, which tends to range from 25,000 to 30,000 square feet, has recently averaged approximately 26,000 square feet and costs approximately $2 million to construct, exclusive of purchased real estate and exercise equipment and net of landlord contributions. The prototype is designed to cost less to construct and maintain than our older facilities and has the capacity to accommodate significantly more members than older fitness centers of the same size because it focuses on the most widely used amenities. We generally invest approximately $400,000 ($300,000 through lease programs) for exercise equipment in a prototype fitness center. Beginning in 2003, we developed a new version of our prototype that was meant to be more inviting with an updated color scheme, higher end looking material and a greater use of technology. This new model will be continually updated and used in all new and remodeled clubs.

           Pursuant to franchise agreements, six clubs operate in the United States as Bally Total Fitness brand clubs—five in Upstate New York and one in Massachusetts. Internationally, four clubs operate as Bally Total Fitness brand clubs pursuant to franchise agreements—one in The Bahamas, two in South Korea and one in Mexico. Pursuant to a joint venture agreement in which the Company holds a 35% interest with China Sports Industry Co., Ltd., nine fitness centers are operated in China—one under the joint venture and eight operated as franchisees of the joint venture.

Products and Services

           Our fitness center operations provide a unique platform for the delivery of value-added products and services to our fitness-conscious members. By integrating personal training, private-label nutritional products, and our Weight Management Program into our core fitness center operations, we have positioned the Bally Total Fitness brand as the total source for all of our members’ wellness and fitness needs.

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Membership Plans

           We offer prospective members a choice of membership plans. These membership plans are distinguished primarily by their priority of access to in-club services and access to other fitness centers we operate, either locally or system wide and by the level of fitness-related products and services included in the membership program. From time to time, we also offer special membership plans, which limit a member’s access to a single fitness center and to certain days and non-peak hours. Similarly, we offer a broad range of payment alternatives. Most memberships sold require a substantial initiation fee and relatively low monthly dues. We also offer “pay-as-you-go” memberships, which require higher monthly payments for the duration of the membership but offer the consumer a choice in terms of length of commitment.

           The one-time initial membership fees for joining our Bally Total Fitness brand fitness centers, excluding limited special offers and corporate programs, generally range from approximately $700 to $1,600 and can be financed for up to 36 months, subject to down payment requirements and state, provincial and local regulations. Generally, the initial membership fee is based on:

• The membership plan selected;
• The diversity of facilities and services available at the fitness center of enrollment;
• Market conditions; and
• Seasonal promotional strategies.

           In addition to one-time initial membership fees, Bally Total Fitness brand club members generally pay monthly dues to maintain membership privileges. Monthly dues are generally charged at a fixed rate during the finance period and may increase thereafter, subject to stated terms.

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           Our upscale branded clubs – The Sports Clubs of Canada, Gorilla Fitness, Pinnacle Fitness and Crunch Fitness – offer memberships with lower initial membership fees generally ranging from $50 to $225, but carrying monthly dues ranging from $49 to $94 per month during an initial obligatory term, generally between 12 and 24 months, and subject to increase thereafter. Our upscale Bally Sports Clubs branded clubs offer memberships similar to Bally Total Fitness brand clubs in terms of 36 month financing of the initial membership fee, but ranging from $1,400 to $2,100, in addition to monthly dues during the initial financing period, and dues ranging from $29 to $54 thereafter, subject to increase.

           Members who finance their initial membership fees or choose monthly pay-as-you-go payment programs may either choose monthly statement billing, or the more popular electronic payment option where the fixed monthly payment is automatically deducted from a checking, savings or credit card account each month. Electronic payment options are selected by more than 70% of all new members.

Sales and Marketing

           We devote substantial resources to the marketing and promotion of our fitness centers and their services under each of the brands we operate. We believe strong marketing support is critical to attracting new members at both existing and new fitness centers. The majority of our fitness centers use the branded service mark “Bally Total Fitness,” including 10 upscale fitness centers that are known as “Bally Sports Clubs.” The nationwide use of the service mark enhances brand identity and increases advertising efficiencies. Pursuant to our strategy of targeted market segmentation, we have opened or acquired new facilities during the past few years that operate under more trendy or upscale brands, including 27 fitness centers as “Crunch Fitness”, 10 as “The Sports Clubs of Canada”, seven as “Pinnacle Fitness” and four as “Gorilla Sports”.

           We operate fitness centers in over 50 major metropolitan areas representing 63% of the United States population and over 16% of the Canadian population with 350 of our fitness centers located in the top 25 metropolitan areas in the United States and Toronto, Canada. Concentrating our fitness centers in major metropolitan areas increases the efficiency of our marketing and advertising programs and enhances brand identity and word-of-mouth marketing.

           We spent $56.9 million in 2003, $55.5 million in 2002 and $54.0 million in 2001, for advertising and promotion. Historically, we have primarily advertised on television and, to a lesser extent, through direct mail, newspapers, telephone directories, radio, outdoor signage and other promotional activities. In late 2003, we fundamentally reshaped our entire marketing approach and organization, modernizing our creative approach and expanding our marketing message to reach multiple customer segments in the 18-54 year old demographic, rather than relying only on our traditional 18-34 year old target. We created advertising specifically targeting women, men, seniors and Hispanic consumers and added new specialty agencies to assist in reaching these target consumers.

           Our sales and marketing programs emphasize the benefits of health, physical fitness and exercise by appealing to the public’s desire to look and feel better. Advertisements are augmented with individual sales presentations made by sales personnel in our fitness centers. We believe the various membership and payment plans, in addition to our strong brand identity and the convenience of multiple locations, constitute distinct competitive advantages.

           Our marketing efforts also include corporate membership sales and in-club marketing programs. Open houses and other activities for members and their guests are used to foster member loyalty and introduce fitness centers to prospective members. Referral incentive programs involve current members in the process of new member enrollments and enhance member loyalty. Direct mail reminders encourage renewal of existing memberships. We also attract membership interest from internet visitors to our home page at www.ballyfitness.com and www.crunch.com and continue to explore ways to use the internet as a customer relationship management tool.

           In 2003, we continued to benefit from new and existing strategic marketing alliances heightening public awareness of our fitness centers and the Bally Total Fitness brand. Our licensed Bally Total Fitness line of portable exercise equipment is carried in more than 2,200 retail stores in the United States and Canada and in more than 10 mail order catalogs with distribution in North America and the United Kingdom. Strategic alliances during 2003 included Visa USA®, MasterCard®, Sports Display, Inc., Pepsi-Cola Company, Muzak®, Tylenol®, Starkist®, Discovery™ Channel, Lean Cuisine®, Sony®, Colgate-Palmolive Company (Simply White™), Unilever (Dove®), and Gatorade®. These alliances provide products for our members to use and/or sample as well as an incremental source of revenue for us.

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Account Servicing

           In 2003, we consolidated member processing and collection activities from our Towson, Maryland regional service center into our newer, state of the art Norwalk, California national service center. All of our member services, collection and new member processing activities are now handled by the Norwalk facility allowing for further efficiencies through centralization of these high volume activities.

           All collections for past-due accounts are initially handled internally by our national service center. We systematically pursue past-due accounts by utilizing a series of computer-generated correspondence and telephone contacts. Our power-dialer system assists in the efficient administration of our in-house collection efforts. Based on period of delinquency, members are contacted by collectors. At 60 days past due, members are generally denied entry to the fitness centers. Delinquent accounts are generally written off after 90 or 194 days without payment, depending on delinquency history. Accounts that are written off are reported to credit reporting bureaus, and selected accounts are then sold to a third-party collection group.

           We prioritize our collection approach based on credit scores and club usage, among other criteria, at various levels of delinquency. By tailoring our membership collection approach to reflect a delinquent member’s likelihood of payment, we believe that we can collect more of our membership receivables at a lower cost. To credit score, we use a national bureau, which charges a nominal fee per account.

Competition

           We are the largest commercial operator of fitness centers in North America in terms of revenues, number of members, and number and square footage of facilities. We are the largest operator, or among the largest operators, of fitness centers in every major market in which we operate fitness centers. Within each market, we compete with other commercial fitness centers, physical fitness and recreational facilities established by local governments, hospitals, and businesses for their employees, the YMCA and similar organizations, and, to a certain extent, with racquet, tennis and other athletic clubs, country clubs, weight-reducing salons and the home-use fitness equipment industry. We also compete, to some extent, with entertainment and retail businesses for the discretionary income of our target markets. However, we believe our brand identity, operating experience, membership options, ability to allocate advertising and administration costs over all of our fitness centers, nationwide operations, purchasing power and account processing and collection infrastructure, provide us with distinct competitive advantages. Future competitive factors may emerge which may lessen our ability to compete as effectively.

           We believe competition has increased to some extent in certain markets, reflecting the public’s enthusiasm for fitness and the decrease in the barriers to entry into the market due to financing available from, among others, landlords, equipment manufacturers and private equity sources. We believe our brand identity is strong, membership plans are affordable and we have the flexibility to be responsive to economic conditions.

           Our pursuit of new business initiatives, particularly the sale of weight loss services, nutritional products and apparel, has us competing against large, established companies with more experience selling products on a retail basis. In some instances, our competitors in these business initiatives have substantially greater financial resources than we have. We may not be able to compete effectively against these established companies.

Properties

           At February 29, 2004, we operated 418 fitness centers in 29 states and Canada. At February 29, 2004, we owned 50 fitness centers and leased either the land, building or both for the remainder of our fitness centers. Aggregate rent expense, including office and administrative space, was $135.9 million in 2003, $129.1 million in 2002 and $113.6 million in 2001. Most of our leases require us to pay real estate taxes, insurance, maintenance and, in the case of shopping center and office building locations, common-area maintenance fees. A limited number of leases also provide for percentage rental based on receipts. Various leases also provide for periodic rent adjustments based on changes in the Consumer Price Index, most with limits provided to protect us from large increases in annual rental payments. One fitness center accounted for approximately 1% of our net revenues during 2003. We believe we can expand the number of members we have with the capacity at our properties.

           The leases for fitness centers we have entered into in the last five years generally provide for an initial term of 15 years. Most leases give us at least one five-year option to renew and often two or more such options.

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           Our executive office is located in leased office space in Chicago, Illinois. We also lease space in Norwalk, California for our national service center, and Towson, Maryland for our information systems and telemarketing facilities.

Trademarks and Trade Names

           The majority of our fitness centers use the service mark “Bally Total Fitness”, including 10 upscale centers that are known as “Bally Sports Clubs.” Other facilities operate under the names Crunch Fitness, The Sports Clubs of Canada, Pinnacle Fitness and Gorilla Sports. The use of these trademarks and service marks enhance brand identity and increases advertising efficiencies.

Seasonality of Business

           Historically, we experience greater membership fee originations in the first quarter and lower membership fee originations in the fourth quarter, while advertising expenditures are typically lower during the fourth quarter. Our products and services business may have the effect of further increasing the seasonality of our business.

Employees

           At February 29, 2004, we had approximately 22,200 employees, including approximately 11,630 part-time employees. The distribution of our employees is summarized as follows:

• Approximately 21,210 employees are involved in fitness center operations, including sales personnel, instructors, personal trainers, supervisory and facility personnel;

• Approximately 800 employees are involved in the operation of our member processing and collection centers, including management information systems;

• Approximately 65 employees are product and service development and operations support personnel; and

• Approximately 125 employees are accounting, marketing, human resources, real estate, legal and administrative support personnel.

           We are not a party to a collective bargaining agreement with any of our employees. Although we experience high turnover of non-management personnel, historically we have not experienced difficulty in obtaining adequate replacement personnel. Periodically, our sales personnel become somewhat more difficult to replace due, in part, to increased competition for skilled retail sales personnel.

Government Regulation

           Our operations and business practices are subject to regulation at federal, state, provincial and local levels. The general rules and regulations of the Federal Trade Commission and of other federal, state, provincial and local consumer protection agencies apply to our advertising, sales and other trade practices.

           State and provincial statutes and regulations affecting the fitness industry have been enacted or proposed in all of the states and provinces in which we conduct business. Typically, these statutes and regulations prescribe certain forms and regulate the terms and provisions of membership contracts, including:

• Giving the member the right to cancel the contract, in most cases, within three business days after signing;

• Requiring an escrow for funds received from pre-opening sales or the posting of a bond or proof of financial responsibility; and, in some cases,

• Establishing maximum prices and terms for membership contracts and limitations on the financing term of contracts.

           In addition, we are subject to numerous other types of federal, state and provincial regulations governing

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the sale, financing and collection of memberships, including, among others, the Truth-in-Lending Act and Regulation Z adopted thereunder, as well as state and provincial laws governing the collection of debts. These laws and regulations are subject to varying interpretations by a large number of state, provincial and federal enforcement agencies and the courts. We maintain internal review procedures in order to comply with these requirements and believe our activities are in substantial compliance with all applicable statutes, rules and regulations.

           Under so-called “cooling-off” statutes in most states and provinces we operate in, new members of fitness centers have the right to cancel their memberships for a period of three to ten days after the date the contract was entered into and are entitled to refunds of any payment made. The amount of time new members have to cancel their membership contract depends on the applicable state and provincial law. Further, our membership contracts provide that a member may cancel his or her membership at any time for qualified medical reasons or if the member relocates a certain distance away from a Bally fitness center. In addition, a membership may be cancelled in the event of a member’s death. The specific procedures for cancellation in these circumstances vary according to differing state and provincial laws. In each instance, the canceling member is entitled to a refund of prepaid amounts only. Furthermore, where permitted by law, a cancellation fee is due upon cancellation, and we may offset that amount against any refunds owed.

           We are a party to some state and federal consent orders. The consent orders essentially require continued compliance with applicable laws and require us to refrain from activities not in compliance with those laws. From time to time, we make minor adjustments to our operating procedures to remain in compliance with those consent orders.

           Our nutritional products are subject to regulation by one or more federal agencies, including the Food and Drug Administration (the “FDA”) and the FTC. For example, the FDA regulates the formulation, manufacture and labeling of vitamin and other nutritional supplements in the United States while the FTC is principally charged with regulating marketing and advertising claims.

           Since 1995, we have offered a program of transferring membership receivables balances into a credit card program funded and managed by an independent financial institution. During 2003, we terminated the program for reasons of unsatisfactory performance. We have made claims for improper charges exceeding $30 million. The independent financial institution has made counterclaims for $5.3 million and other declaratory relief including as to the sharing of financial responsibility for future losses under the program against us that we have denied and for which no provision has been made as of December 31, 2003. The matter has been submitted to arbitration and is set for hearing in June 2004. The ultimate outcome of this dispute cannot be fully determined.

           The Company is also involved in various claims and lawsuits incidental to its business, including claims arising from accidents at its fitness centers. In the opinion of management, the Company is adequately insured against such claims and lawsuits, and any ultimate liability arising out of such claims and lawsuits will not have a material adverse effect on the financial condition or results of operations of the Company. In addition, from time to time, customer complaints are investigated by governmental bodies. In the opinion of management, none of the complaints or investigations currently pending will have a material adverse effect on our financial condition or results of operations.

           Item 4 is inapplicable.

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EXECUTIVE OFFICERS OF THE REGISTRANT

           Paul A. Toback was named Chairman of the Board of Directors in May 2003 and was elected a Director in March 2003 and President and Chief Executive Officer in December 2002. He was Executive Vice President from February 2002 to December 2002, Chief Operating Officer from June 2001 to December 2002, Senior Vice President, Corporate Development from March 1998 to June 2001 and a Vice President, from November 1997 to March 1998. From 1995 to 1997, Mr. Toback was Chief Operating Officer of Globetrotters Engineering Corp., and from 1993 to 1994, he served as Executive Assistant to the Chief of Staff at the White House. Prior to 1993, Mr. Toback was Director of Administration for the City of Chicago. Mr. Toback is an attorney licensed to practice in Illinois and is 40 years of age.

           John W. Dwyer was elected a Director in August 2001, Executive Vice President in November 1997, a Senior Vice President in 1995, Vice President and Chief Financial Officer in May 1994 and was Treasurer from October 1996 to June 2001. Mr. Dwyer was Corporate Controller of Bally Entertainment Corporation between June 1992 and December 1996 and a Vice President between December 1992 and December 1996. Mr. Dwyer is 51 years of age.

           Julie Adams was elected Senior Vice President, Membership Services in February 2003, was Vice President, Membership Services from September 1997 to February 2003, Vice President, Controller from 1993 to September 1997, Controller from March 1991 to 1993 and Director of Financial Reporting from August 1985 to March 1991. Ms. Adams is 58 years of age.

           William G. Fanelli was elected Senior Vice President, Finance in June 2001, was Senior Vice President, Operations from November 1997 to June 2001 and was Vice President, Strategic Operations from November 1996 to November 1997. Mr. Fanelli was Director, Business Development of Bally Entertainment Corporation from October 1993 to December 1996. Mr. Fanelli is 41 years of age.

           Cary A. Gaan was elected Senior Vice President and General Counsel in January 1991 and Secretary in April 1996. Mr. Gaan served as a Vice President from 1987 to 1991. Mr. Gaan is 58 years of age.

           Harold Morgan was elected Senior Vice President, Chief Administrative Officer in February 2003, was Senior Vice President, Human Resources from September 1995 to February 2003 and was Vice President from January 1992 to September 1995. Mr. Morgan was Vice President, Human Resources of Bally Entertainment Corporation between December 1992 and December 1996. Mr. Morgan is 47 years of age.

           Martin Pazzani was elected Senior Vice President and Chief Marketing Officer in August 2003. Prior to joining the Company, Mr. Pazzani was President and Founder of The Global Marketing Revolution, Inc., a marketing consultancy, from October 2002 to August 2003. From June 1997 to October 2002, Mr. Pazzani was Corporate Senior Vice President and Worldwide Director of Foote, Cone and Belding Worldwide’s global business and strategy consulting division. Prior to June 1997, Mr. Pazzani held various marketing and strategy-related positions at DDB Needham Worldwide, Western International Media (now Initiative Media), Rocket Science Advertising and Heublein/RJR Nabisco/Grand Metropolitan Plc. (now Diageo). Mr. Pazzani is 47 years of age.

           John H. Wildman was elected Senior Vice President, Chief Operating Officer in December 2002, was Senior Vice President, Sales and Marketing from November 1996 to December 2002 and Vice President, Marketing from September 1995 to November 1996. For approximately four years prior thereto, Mr. Wildman was a Senior Area Director. Mr. Wildman is 44 years of age.

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PART II

           Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “BFT”. The following table sets forth, for the periods indicated, the high and low quarterly sales prices for a share of our common stock as reported on the NYSE.

           As of February 29, 2004, there were 7,435 holders of record of our common stock.

           We have not paid a cash dividend on our common stock since we became a public company in January 1996 and do not anticipate paying dividends in the foreseeable future. The terms of our revolving credit agreement restrict us from paying dividends without the consent of the lenders during the term of the agreement. In addition, the indentures for our senior notes and senior subordinated notes generally limit dividends paid by us to the aggregate of 50% of consolidated net income, as defined, earned after January 1, 1998 and the net proceeds to us from any stock offerings and the exercise of stock options and warrants.

           In 2003, we changed our accounting for the recognition of financed initial membership fees from our prior 22-month pool deferral method to a preferable modified cash method of recognition and implemented EITF 00-21 “Revenue Arrangements with Multiple Deliverables.” We also changed our accounting for the recognition of recoveries of unpaid dues on inactive membership contracts from accrual-based estimations to a preferable cash basis of recognition. Concurrently with the change in accounting for membership fees, we also changed our method of accounting in 2003 for initial membership origination costs from our prior method where such costs were deferred and recognized over the same period used for revenue recognition to a preferable method of expensing such costs as incurred. These accounting changes were all implemented as of the beginning of 2003 as a cumulative effect of changes in accounting and as a result we recorded non-cash charges of $441 million related to the change to the modified cash basis of accounting for membership fees and adoption of EITF 00-21, $21 million related to the change regarding unpaid dues on inactive membership contracts and $119 million related to the change in accounting for initial membership fee origination costs.

           As a result of the accounting changes described in the preceding paragraph and the lower level of proforma historical earnings under the new revenue recognition policies, we additionally recorded a special tax provision of $50.5 million in 2003 to reduce previously recognized deferred tax assets.

           In applying the new accounting for membership revenues as described above, it was determined in consultation with our independent auditors that our previous methodology of accounting for the deferral of prepayments of non-obligatory dues resulted in errors in calculating deferred revenue related to prepaid dues. As a result the Company has restated prior periods in accordance with the requirements of Accounting Principles Board Opinion No. 20 “Accounting Changes.” The impact of the correction to previously reported net revenues and net income was a reduction of $8.0 million ($.25 per diluted share), $10.6 million ($.36 per diluted share),

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and $4.9 million ($.18 per diluted share) in each of the years 2002, 2001 and 1999, respectively, and an increase in reported net revenues and net income in 2000 of $4.0 million ($.14 per diluted share). The impact of the correction to previously reported deferred revenue and stockholders’ equity was an increase in deferred revenue and a decrease in stockholders’ equity of $43.0 million, $35.0 million, $24.4 million and $28.4 million at the end of each of the years 2002 through 1999, respectively.

           We also adopted in 2003 the provisions of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations,” and recorded a non-cash cumulative effect adjustment of $.2 million to provide for future restoration obligations on the Company’s leaseholds.

           The accompanying Selected Financial Data includes statement of operations data on a proforma basis for the accounting changes described above as if they had been in effect in each of the years presented, and on a restated basis correcting the errors in calculating deferred revenue for prepaid non-obligatory dues in the years presented.

           In 2002, the Company recorded a pre-tax non-cash charge of $55 million reflected as a reduction in net revenues to reduce the carrying value of installment accounts receivable, recorded a charge of $7.3 million to provide for amounts pursuant to a separation agreement upon the retirement of the Company’s former CEO, settled a class action lawsuit for $6.5 million and wrote down the carrying value of our retail store inventories by $3.4 million. We also adopted in 2002 the provision of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” and ceased amortization of goodwill and indefinite lived trademarks, and reduced our tax valuation allowance against net operating losses realized in prior periods by $4.0 million. Because the proforma results are presented on a modified cash basis, the $55 million charge to reduce the carrying value of installment accounts receivable does not apply to 2002 proforma results.

           In 2001, we recorded a net benefit of special items of $8.3 million to record special charges of $6.7 million primarily related to the September 11^th tragedy and a one-time markdown of retail apparel, offset by a reduction of our tax valuation allowance of $15 million. In 2000, we recorded a one-time non-cash charge of $6.5 million to write off third-party internet investments and we reduced our tax valuation allowance by $20.0 million. In 1999, in accordance with AICPA Statement of Position 98-5, Reporting Costs of Start-up Activities, we wrote off unamortized start-up costs of $.3 million as a cumulative effect of a change in accounting principle.

           EBITDA from continuing operations before special charges is defined as net income (loss) before depreciation and amortization, income taxes and interest expense (and cumulative effect of accounting change, special charges and loss from discontinued operations where applicable). EBITDA as adjusted additionally excludes stock-based compensation and other, net. We have presented EBITDA supplementally because we believe this information is useful given the significance of our depreciation and amortization and because of our highly leveraged financial position. The table below includes a reconciliation from net income (loss) to EBITDA. This data should not be considered as an alternative to any measure of performance or liquidity as promulgated under generally accepted accounting principles (such as net income or cash provided by/used in operating, investing and financing activities), nor should this data be considered as an indicator of our overall financial performance. Also, the EBITDA definition used by us may not be comparable to similarly titled measures reported by other companies.

Index

Index

           The following discussion of the financial condition and results of operations of Bally should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes in Item 8 of this Report.

General

           Our continuing business focus is to grow our membership base and maximize our yield-per-member. We expect to accomplish this by optimizing our product and services offerings, by realizing the benefits of our recent investments in new and acquired fitness centers, through continued expansion and optimization of our marketing approach and through improvements in our operating efficiencies.

           Optimize Our Product and Service Offerings. We are increasingly using our clubs for the delivery of value-added products and services such as personal training, private-label nutritional products, group exercise classes, fitness related merchandise, member magazines and our Weight Management Program. Integrating these ancillary products and services into our core fitness center operations positions Bally as the primary source for all of our members’ wellness and fitness needs. In addition, our private-label nutritional products are sold in approximately 2,500 select retail, grocery and drug store outlets and our licensed portable exercise equipment is sold in over 2,200 retail outlets. We are committed to the continuing development and integration of new and innovative products and services. Our extensive groupings of club operations and different brands allow us to “test-market” new products and services without exposing our entire operation to the outcome of the introduction.

           Realize the Benefit of Recent Investments. We have invested over $400 million in greenfield expansion, acquisitions, and expansion of existing facilities since 1997. In order to strengthen operating results and cash flows, we scaled back our club expansion plans in 2002 and 2003 and will continue to do so for the next several years. We intend to focus our attention on improving operating margins and cash flows in our existing fitness centers to capitalize on our recent investments and to realize the benefits of reduced capital expenditures. Our immature fitness centers generally require over a full year of operations before generating incremental operating income. By slowing club expansion, we intend to realize the cash flow benefits from reduced capital expenditures as well as from the natural maturation of our 135 clubs less than 5 years old. We expect our immature clubs, as they mature, to contribute higher levels of operating income.

           Expand and Optimize Our Marketing. We will continue to leverage the position of the Bally brand, which we believe is the most recognized brand name of fitness centers in North America. During 2003 we fundamentally reshaped our entire marketing approach and organization, hiring a Chief Marketing Officer and Executive Creative Director to guide our marketing turnaround. During the year, our new team modernized our creative approach and expanded our marketing message to speak to multiple customer segments in the 18-54 year old demographic, rather than relying only on our traditional 18-34 year old target. We created advertising specifically targeting women, men, seniors and Hispanic consumers and added new specialty agencies to assist in reaching these target consumers. We continue to explore Internet-based approaches to marketing to new members and are expanding our web-site as a customer relationship management tool. During 2003, we continued the roll out of more customer friendly approaches to pricing our memberships by giving consumers more flexibility in payment terms, such as the continued expansion of non-obligatory pay-as-you-go membership options.

           Improve Operating Efficiencies. After a period of rapid expansion by adding new clubs in addition to the acquisition of most of our upscale brands, we have consolidated our operations to realize economies of scale. In particular, we launched several initiatives to improve operating efficiencies and reduce operating costs, including staff reductions during 2003. We have also eliminated local area offices and modified some of our incentive and compensation programs to better reward profitability.

Index

Summary of Significant Accounting Policies

Changes in accounting principles

           We elected to change our accounting methods effective January 1, 2003 related to the recognition of revenue from membership contracts, initial membership origination costs, and asset retirement obligations. The cumulative effect as of January 1, 2003 of these changes in accounting principles has been charged to the 2003 statement of operations. These charges are discussed below.

           As required, we adopted the provisions of EITF 00-21 “Revenue Arrangements with Multiple Deliverables” as it relates to revenues included in initial membership contracts. Under the previously acceptable method, revenues allocated to products and services included in initial membership contracts, including financed contracts, were recognized upon delivery to the member. The new pronouncement limits the amount of revenue we can recognize upon delivery of the products and services to cash collected upon membership origination. Limiting early recognition to cash collected resulted in a reversal of amounts previously recognized upon membership sale, and an increase in amounts deferred to be recognized during future periods.

           Concurrent with the adoption of EITF 00-21, we elected to adopt a modified cash basis of accounting for the recognition of membership fees effective January 1, 2003. Under the new method, membership revenue is recognized as income at the later of when it is collected, or in the case of paid-in-full memberships or accelerated receipts from financed memberships, when earned. This changes the pre-2003 22-month pool deferral method that amortized revenues from financed initial membership fees on the straight-line basis, after application of estimated uncollectible amounts. The use of the modified cash basis, which is viewed by us and by our independent auditors as a preferable accounting method, recognizes membership revenue over a longer period than the previous method. We have also applied the modified cash basis of recognition to our accounting for non-obligatory membership dues. Since monthly dues are collected in arrears, prior to 2003 we included in other assets a receivable for uncollected dues at the end of each period. Under the modified cash basis, the recognition of membership dues revenue has been changed to the later of either collected or earned consistent with our new policy for membership fees. As a result, the receivable for earned but uncollected dues has been reversed and is included as a component of the cumulative effect adjustment.

           Concurrent with our change to the modified cash basis of revenue recognition as described above, in 2003 we additionally changed our accounting principle for initial membership origination costs from the pre-2003 method whereby such costs were deferred and recognized over the same period used for revenue recognition to expensing such costs as incurred. This change has also been determined to be a preferable method when considered along with the modified cash basis adopted for membership fee recognition.

           In the second quarter of 2003, we changed our accounting for the recognition of recoveries of unpaid dues on inactive membership contracts from accrual-based estimations to a cash basis of recognition, which was considered a preferable method of accounting for such past due amounts.

           We believe these changes in accounting to recognize membership revenues at the later of when collected or earned and to expense membership origination costs as incurred will result in financial reporting that is more understandable to the reader. The new methods also reduce the impact of estimations in the financial reporting process by eliminating the need to estimate the amount and timing of future member collections for purposes of revenue and expense recognition.

           We also implemented the provisions of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations,” in the first quarter of 2003. It requires that we recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are then capitalized as part of the carrying amount of the long-lived asset. As a result, a non-cash cumulative adjustment of $.2 million was recorded to provide for estimated future restoration obligations on our leaseholds.

Index

           The following table presents the components of the cumulative effect charge as of the beginning of 2003 (in thousands):

           The lower level of proforma historical earnings under the new recognition policies required the establishment of valuation reserves against previously recognized deferred tax assets. As a result, deferred tax assets were reduced by $50.5 million in the first quarter of 2003.

           In applying the new accounting method for membership revenue as described above, we undertook an evaluation of our methods and processes related to accounting for the deferral of revenue for prepayments of non-obligatory membership dues. In consultation with our independent auditors, it was determined that our previous methodology resulted in errors in calculating prepaid dues and accelerated dues recognition for certain prepaying members. As a result, we have restated prior periods in accordance with the requirements of Accounting Principles Board Opinion No. 20 “Accounting Changes.” The impact of the correction was to reduce previously reported net revenues and net income by $8.0 million and $10.6 million in 2002 and 2001, respectively, and to increase previously reported deferred revenue and decrease stockholders’ equity by $43.0 million and $35.0 million at December 31, 2002 and 2001, respectively.

Other revenue recognition issues

           Revenues for membership initiation fees that are paid in full when sold continue to be deferred and recognized over the life of the contract, generally 36 months, on the straight-line method. Prepayments of non-obligatory monthly dues continue to be deferred and recognized ratably over the applicable prepayment period. Revenue from the sales of multiple session personal training contracts continue to be deferred and recognized as personal training sessions are performed.

Property and equipment

           Depreciation of buildings, equipment and furnishings (including assets under capital leases) is provided on the straight-line method over the estimated useful lives of the related assets. Buildings are depreciated over 30 years and useful lives for equipment and furnishings range from three to 15 years. Amortization of leasehold improvements is provided on the straight-line method over the lesser of the estimated useful lives of the improvements or the lease periods.

Index

Results of Operations

           The following is a summary of the components of net revenue, operating expenses and operating income (loss) comparing 2003 to proforma and restated 2002 and 2001 (in millions):

Comparison of the years ended December 31, 2003 and 2002

           Net revenue for 2003 was $953.5 million compared to $911.3 million in 2002 on a proforma basis. This represents a 5% increase in total net revenue or $42.2 million. This increase in total net revenue resulted from the following:

• Membership revenue increased to $743.4 million from $729.2 million in 2002 on a proforma basis, an increase of $14.2 million (2%) from the prior year, including $11.1 million received as cash proceeds from the sale of previously written off installment accounts receivable. Dues revenue in 2003 equaled more than half of total membership revenue.

• Products and services revenue increased to $192.3 million from $162.5 million in 2002 on a proforma basis, an increase of $29.8 million (18%), primarily reflecting the continued growth of personal training services and nutritional product sales.

• Miscellaneous revenue decreased $1.7 million (9%) from 2002.

           Proforma net revenue in 2002 increased by $6.4 million from the historical restated amounts. The effect of the change in accounting for revenue recognition had the largest effect on products and services revenue, which decreased by $55.2 million, offset by an increase in membership revenue of $6.6 million, additionally the special charge to the membership receivable reserve of $55 million in the historical restated amounts does not apply to the proforma amounts determined on a modified cash basis.

           The weighted-average number of fitness centers operated by the Company during 2003 increased to 414 from 412 during 2002, including an increase in the weighted-average number of centers operating under our upscale brands from 56 to 57. During 2003, we opened 13 new fitness centers within our major metropolitan areas. In April 2002 we acquired seven additional fitness centers with our acquisition of Planet Fitness in the Boston area. At December 31, 2003, we operated a total of 58 upscale fitness centers: 27 as “Crunch Fitness”, 10 as “Bally Sports Clubs”, 10 as “The Sports Clubs of Canada”, seven as “Pinnacle Fitness” and four as “Gorilla Sports”.

           Gross committed membership fees is a measure which includes the total potential future value of all initial membership fee revenue, dues revenue, earned finance charges and membership-related products and services revenue from new membership sales originations in a period. It is measured on a gross basis before consideration of any uncollectible amounts. We track gross committed membership revenue as an indicator of the

Index

success of our current sales activities and believe it to be a useful measure to allow investors to understand current trends in membership sales.

           The following table shows new membership originations and other key data for 2003, 2002 and 2001 (in thousands, except months and location data):

           Gross committed membership fees originated during 2003 decreased 3% compared to 2002, with a 6% decrease at same clubs. The number of new members joining increased 3% during 2003 compared with 2002, with no change at same clubs. The average committed duration of memberships originated during 2003 was 30.5 months, the same as in 2002. The gross committed monthly membership fees originated during 2003 averaged $39.72 versus $42.68 in 2002, a 7% decrease. The decrease in the monthly average membership price during the year is due to an increase in the sale of add-on family memberships.

           Proforma operating costs and expenses in 2002 were $6.5 million higher than historical restated 2002 expenses because of the effect of expensing membership origination costs as incurred on a proforma basis. The proforma operating costs and expenses included some reclassifications to conform to the 2003 presentation.

           Fitness center operating expenses increased $24.4 million (4%) from proforma 2002 amounts, and $32.8 million (6%) from restated 2002 amounts, reflecting increases in occupancy, insurance and personnel costs in 2003. Products and services expenses increased $25.4 million (18%) from proforma 2002 to support the revenue growth of product and service offerings. The operating margin from products and services increased to $29.5 million in 2003 from proforma 2002 of $25.2 million, a 17% increase with a margin of 15% in both 2003 and 2002. Member processing and collection center expenses increased $5.0 million (11%) from restated 2002 amounts, and $4.7 million (10%) from proforma 2002, reflecting higher costs of operations and inefficiencies during the consolidation of our Towson, Maryland regional service center into our Norwalk, California national service center. Advertising expenses increased $1.3 million (2%) compared to the prior year. General and administrative expenses increased $6.1 million (19%) compared to the prior year to support our overall growth strategy as well as year end adjustments for insurance costs. Depreciation and amortization expense increased $3.2 million (4%) in 2003 largely as a result of increased expenditures for property and equipment and acquired fitness centers during 2002.

           The operating loss for 2003 was $22.6 million compared to an operating loss of $19.0 million in 2002 on a proforma basis. This increase of $3.6 million (19%) was due to a $42.2 million increase in net revenue (5%), offset by an increase in operating costs and expenses before depreciation and amortization of $42.6 million (5%) and an increase in depreciation and amortization of $3.2 million.

           EBITDA as adjusted (defined in Item 6, Selected Financial Data) was $131.3 million in 2003 versus $141.3 million and $196.3 million in 2002 on a proforma and restated basis, respectively. This represents a 7% decline from the 2002 proforma level (see Item 6, Selected Financial Data, for a reconciliation of net income or loss to EBITDA).

           Special charges in 2002 included $7.3 million to provide for amounts related to a separation agreement entered into when our former CEO retired, $3.4 million to write-down inventory shortages, and $6.5 million to settle a class action lawsuit arising in the early 1990’s.

           Finance charges earned in excess of interest expense totaled $15.2 million in 2003, an increase of $2.9 million over last year resulting principally from higher finance rates earned.

Index

Comparison of the years ended December 31, 2002 and 2001

           Restated net revenue for 2002 was $904.9 million compared to $840.9 million in 2001, an increase of $64.0 million (8%), inclusive of $73.0 million (9%) attributable to Crunch Fitness and offset by a special charge of $55 million to strengthen our installment contracts receivable reserves. Proforma net revenue for 2002 was $911.3 million compared to 2001 proforma net revenue of $771.8 million, a $139.5 million (18%) increase. The increase in total net revenues, exclusive of the special charge, resulted from the following:

• Restated membership revenue increased $43.6 million (6%) from the prior year to $722.6 million from $679.0 million in 2002. The provision for doubtful receivables and cancellations, included as a direct reduction of membership revenue, was 41% of the gross financed portion of originations for both periods. Proforma membership revenue increased $85.9 million to $729.2 million, a 13% increase over 2001 proforma membership revenue.

• Restated products and services revenue increased $72.7 million (50%) over 2001, primarily reflecting the continued growth of personal training services, nutritional product sales and the addition of Crunch Fitness, which accounted for $19.5 million of the increase. Proforma products and services revenue increased $51.1 million (46%), to $162.5 million compared to proforma 2001 amounts.

• Miscellaneous revenue increased $2.7 million (16%) over 2001, reflecting increases in sub-rental income, franchise fees and co-marketing revenue.

           Proforma net revenue in 2002 decreased by $48.5 million from the historical restated amounts. The effect of the change in accounting for revenue recognition had the largest effect on products and services revenue, which decreased by $55.1 million. The special charge to membership receivable reserve of $55 million in the historical restated amounts does not apply to the proforma amounts, which are determined on a modified cash basis. Proforma net revenue in 2001 decreased by $69.1 million from the historical restated amounts. The effect of the change in accounting for revenue recognition decreased proforma 2001 membership revenue from the restated amount by $35.7 million, and decreased products and services revenue by $33.5 million.

           The weighted-average number of fitness centers during 2002 increased to 412 from 385 during 2001, a 7% increase, including a 56% increase in the weighted-average number of centers operating under our upscale brands from 36 to 56, largely resulting from the acquisition of Crunch Fitness. During 2002, we opened 14 new fitness centers within our major metropolitan areas. In April 2002 we acquired seven additional fitness centers with our acquisition of Planet Fitness in the Boston area. At December 31, 2002, we operated a total of 56 upscale fitness centers: 23 as “Crunch Fitness”, 10 as “Bally Sports Clubs”, 10 as “The Sports Clubs of Canada”, seven as “Pinnacle Fitness” and six as “Gorilla Sports”.

           Gross committed membership fees increased 5% compared to 2001. The gross committed monthly membership fees originated during 2002 averaged $42.68 versus $39.63 in 2001, an 8% increase. This increase results primarily from higher monthly dues included in memberships originated at our Bally Total Fitness clubs, the addition of Crunch Fitness with its higher membership fee structure, and an increase in new memberships originated which include a personal training component. The number of new members joining increased 1% during 2002 compared with a year ago, with a 2% decrease at our Bally Total Fitness clubs. The average committed duration of memberships originated during 2002 was 30.5 months versus 31.0 months in the prior year, a 2% decrease. This decrease results primarily from the shorter commitment term of memberships offered at Crunch Fitness, the addition of five new clubs in states and provinces that limit contract duration to twelve months, and an increase in the number of shorter commitment membership programs available at Bally Total Fitness clubs.

           Proforma operating costs and expenses were $6.5 million higher and $1.2 million lower than historical restated operating costs and expenses for 2002 and 2001, respectively. These proforma changes from the historical restated amounts are the result of the change in accounting to expense initial membership origination costs as incurred, rather than on a deferral basis, and include some reclassifications to conform to the 2003 presentation.

Index

           Restated fitness center operating expenses increased $60.8 million (12%), due principally to incremental costs of operating new fitness centers, including Crunch Fitness, which represented approximately $36.3 million of the increase. Proforma fitness center operating expenses increased $70.3 million (14%). Restated products and services expenses increased $50.2 million (55%) to support the revenue growth of product and service offerings. The operating margin from products and services increased to $76.1 million from $53.6 million in 2001, a 42% increase (23% related to same clubs), with a margin of 35% in 2002 compared to 37% in 2001. Proforma products and services expenses increased $48.0 million (52%). Restated member processing and collection center expenses increased $3.0 million (7%) from 2001, reflecting increased costs to serve the higher number of clubs and members as compared to the prior year. Proforma member processing and collection center expenses increased $3.4 million (8%). Advertising expenses increased $1.5 million (3%) compared to 2001. General and administrative expenses increased $4.7 million (17%) compared to 2001 to support our overall growth strategy. Depreciation and amortization expense increased $1.4 million (2%) largely as a result of increased expenditures for property and equipment and acquired fitness centers during the past two years, offset by the elimination of goodwill amortization in 2002 as the result of new accounting standards.

           The restated operating loss for 2002 was $18.9 million compared to restated operating income of $49.3 million in 2001. Our restated operating loss resulted principally from special charges of $72.2 million in 2002 described fully below. Restated operating income for 2002, excluding the 2002 special charges, was $53.3 million compared to restated 2001 operating income of $56.0 million, excluding special charges of $6.7 million. This decrease of $2.7 million (5%) was due to a $119.0 million increase in net revenue (14%), offset by an increase in operating costs and expenses of $120.3 million (17%) and an increase in depreciation and amortization of $1.4 million. The 2001 results included $7.6 million of goodwill amortization which, under current accounting standards, is no longer amortized.

           EBITDA as adjusted (defined in Item 6, Selected Financial Data) was $196.3 million in 2002 versus $196.1 million in 2001 (see Item 6, Selected Financial Data, for a reconciliation of net income or loss to EBITDA). The proforma operating loss was $19.0 million in 2002 compared to $18.6 million in 2001, a $.4 million (2%) increase.

           The special charges in 2002 included $55.0 million recorded as a reduction to net revenues to strengthen our installment contracts receivable reserves. In connection with our intentions to seek alternatives for the financing portion of our business model, we undertook a study to determine the net realizable values of prior years’ sales activity and membership installment contracts receivable on an accelerated monetization basis. Our previous method for estimating the adequacy of balance sheet reserves did not assume an accelerated monetization scenario. The special charge to membership receivables reserves of $55.0 million in the historical restated amounts does not apply to the proforma amounts, which are determined on a modified cash basis. Special charges in 2002 also included $7.3 million to provide for amounts related to a separation agreement entered into when our former CEO retired, $3.4 million to write-down inventory shortages, and $6.5 million to settle a class action lawsuit arising in the early 1990’s. Special charges in 2001 related to cancelled or reformatted marketing events and other direct and indirect costs from disruptions and shutdowns of various club operations and programs resulting from the September 11^th terrorist events and separately, the Company’s repositioning of in-club retail stores. Comparisons made in the prior paragraphs which exclude these special charges from our results have been made because we believe the unusual nature of these charges should be taken into consideration when the trend of our operating results is used by investors.

           Finance charges earned in excess of interest expense totaled $12.3 million in 2002, an increase of $3.9 million over 2001, resulting principally from lower interest rates on our borrowings, and higher installment contracts receivable offset by a decrease in finance rates earned.

Historical Analysis of Restated Prepaid Dues

           As described in the “Changes in accounting principles” section above, in applying the new accounting method for membership revenue we undertook an evaluation of our methods and processes related to accounting for deferral of revenue for prepayments of non-obligatory membership dues. In consultation with our independent auditors, it was determined that our previous methodology resulted in errors in calculating prepaid dues and accelerated dues recognition for certain prepaying members. As a result we have restated prior periods in accordance with the requirements of APB No. 20, “Accounting Changes.”

           The following table discloses the impact the restatement has had on our annual results for the years 1997 through 2002, and on our quarterly results for quarterly periods from first quarter 2000 through fourth quarter 2002. Additionally we are providing the balance sheet impact at December 31, 1996, the earliest period we are able to produce calculations of our prepaid dues under the corrected methodology.

Index

           Prepaid dues are an element of total deferred revenue and represent amounts our members have paid to us for future membership periods. Over the six-year period presented, on a restated basis the deferred revenue from prepaid dues has grown from a balance of $61.7 million at December 31, 1996 to $98.3 million at December 31, 2002. This growth has resulted from increases in our membership base and through increases in the rate charged our members over that period. Additionally, refinements in annual offers to our low usage members has resulted in growth in annual payers, and therefore growth in deferred revenue.

           Growth in prepaid dues revenue from period to period has the impact of reducing reported membership revenue as amounts of dues collected are deferred to be recognized in future periods as earned. A decrease in prepaid dues revenue from period to period has the opposite effect of increasing reported membership revenue. A growth in prepaid dues is indicative of success in our efforts to collect renewal dues for future periods from our members. Also, prepaid dues revenue fluctuates from period to period based on the amounts of direct mail solicitations to our members, and based on the success in any one period of our renewal offers.

           The following table presents the balance of deferred revenue from prepaid dues, excluding acquisition-related prepaid dues, as reported and on a restated basis, and the impact to balance sheet deferred revenue, net revenue and net income (loss) in our statement of operations (in millions):

Index

                                                    Income Statement Member Revenue
                   Balance Sheet Deferred Revenue   --------------------------------
                   -------------------------------   Increase/(Decrease)                             As Reported
                       Prepaid Dues                 in Membership Revenue              -----------------------------------------
                   --------------------   Under-    ---------------------    Over/                                        Net
     Period           As         As      Statement     As          As       (Under)-   Total     Deferred      Net      Income
     Ended         Reported   Restated     Error    Reported    Restated   Statement   Assets     Revenue    Revenue    (Loss)
- -----------------  ---------  ---------  ---------  ---------   ---------  ---------  ---------  ---------  ---------  ---------
Annual data:
Dec. 31, 2002       $  55.3    $  98.3    $  43.0    $   0.2     $  (7.9)   $   8.0   $ 1,771.9   $ 334.7    $ 912.9    $   3.5
Dec. 31, 2001          55.4       90.5       35.0        8.5        (2.2)      10.6     1,716.9     366.3      851.5       80.7
Dec. 31, 2000          63.9       88.3       24.4       (7.7)       (3.7)      (4.0)    1,560.6     389.2      785.9       78.6
Dec. 31, 1999          56.2       84.6       28.4       (5.0)       (9.9)       4.9     1,348.6     373.3      663.0       42.2
Dec. 31, 1998          51.2       74.7       23.5       (0.8)       (4.3)       3.5     1,128.8     361.8      573.8       13.3
Dec. 31, 1997          50.4       70.4       20.0        2.0        (8.8)      10.7       967.6     361.8      525.7      (44.9)
Dec. 31, 1996 (a)      52.4       61.7        9.3                                         893.3     363.5

Quarterly data:
Dec. 31, 2002       $  55.3    $  98.3    $  43.0    $   0.3     $  (1.8)   $   2.1   $ 1,771.9   $ 334.7    $ 183.1    $ (39.2)
Sep. 30, 2002          55.6       96.6       41.0        1.7        (0.6)       2.3     1,858.1     367.3      243.0        7.2
Jun. 30, 2002          57.3       96.0       38.7       (0.3)       (1.8)       1.4     1,840.3     374.7      246.4       16.1
Mar. 30, 2002          57.0       94.2       37.2       (1.5)       (3.7)       2.2     1,787.4     382.4      240.4       19.4
Dec. 31, 2001          55.4       90.5       35.0        4.7        (2.2)       6.9     1,716.9     366.3      211.7       16.3
Sep. 30, 2001          60.1       88.3       28.1        2.9         4.1       (1.2)    1,561.5     377.9      209.7       26.5
Jun. 30, 2001          63.0       92.3       29.3        1.1         2.2       (1.1)    1,598.6     388.7      216.4       19.2
Mar. 30, 2001          64.1       94.5       30.4       (0.2)       (6.2)       6.0     1,584.8     394.4      213.7       18.6
Dec. 31, 2000          63.9       88.3       24.4       (2.4)        2.3       (4.7)    1,560.6     389.2      201.6       11.5
Sep. 30, 2000          61.5       90.6       29.1       (1.6)       (0.8)      (0.7)    1,524.9     403.4      198.9       35.9
Jun. 30, 2000          59.9       89.8       29.8       (2.4)       (2.8)       0.4     1,457.4     398.8      195.3       15.9
Mar. 30, 2000          57.5       87.0       29.4       (1.3)       (2.4)       1.1     1,396.6     389.7      190.1       15.3


(continued):

                                                                Balance Sheet Error   Income Statement Error
                            As Restated                         Percent of Reported   Percent of Reported
                   --------------------------------             --------------------  ----------------------
     Period        Deferred      Net     Net Income               Total    Deferred      Net         Net
     Ended         Revenue     Revenue     (Loss)                 Assets   Revenue     Revenue      Income
- -----------------  ---------  ---------  ----------             ---------  ---------  ---------    ---------
Annual data:
Dec. 31, 2002       $ 377.8    $ 904.9    $  (4.5)                  2.4%      12.9%       0.9%       227.2%
Dec. 31, 2001         401.4      840.9       70.1                   2.0%       9.6%       1.2%        13.2%
Dec. 31, 2000         413.6      789.9       82.6                   1.6%       6.3%      -0.5%        -5.1%
Dec. 31, 1999         401.7      658.1       37.3                   2.1%       7.6%       0.7%        11.6%
Dec. 31, 1998         385.3      570.3        9.8                   2.1%       6.5%       0.6%        26.1%
Dec. 31, 1997         381.9      515.0      (55.6)                  2.1%       5.5%       2.0%       -23.9%
Dec. 31, 1996 (a)     372.8                                         1.0%       2.6%

Quarterly data:
Dec. 31, 2002       $ 377.8    $ 181.1    $ (42.4)                  2.4%      12.9%       1.1%        -5.3%
Sep. 30, 2002         408.2      240.8        5.4                   2.2%      11.2%       0.9%        31.7%
Jun. 30, 2002         413.4      244.9       14.9                   2.1%      10.3%       0.6%         8.9%
Mar. 30, 2002         419.6      238.1       17.6                   2.1%       9.7%       0.9%        11.4%
Dec. 31, 2001         401.4      204.8        9.4                   2.0%       9.6%       3.3%        42.3%
Sep. 30, 2001         406.0      210.9       27.7                   1.8%       7.4%      -0.6%        -4.4%
Jun. 30, 2001         418.0      217.5       20.3                   1.8%       7.5%      -0.5%        -5.7%
Mar. 30, 2001         424.8      207.7       12.6                   1.9%       7.7%       2.8%        32.2%
Dec. 31, 2000         413.6      206.3       16.2                   1.6%       6.3%      -2.3%       -40.5%
Sep. 30, 2000         432.5      199.6       36.7                   1.9%       7.2%      -0.4%        -2.1%
Jun. 30, 2000         428.6      194.9       15.5                   2.0%       7.5%       0.2%         2.3%
Mar. 30, 2000         419.2      189.0       14.2                   2.1%       7.6%       0.6%         6.9%

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Liquidity and Capital Resources

           The Company has provided disclosure of free cash flow, defined as cash flow from operations less cash used in investing activities, because management believes that it is an important measure of liquidity and investors are focused on the Company’s ability to reduce overall debt. The following table summarizes free cash flow (deficit) for 2003, 2002 and 2001 (in thousands):

           We presently have no commitments to acquire clubs or real estate during 2004. The Company expects to continue controlled capital spending and is currently planning $45 million (excluding capital leases) of capital spending in 2004. These expenditures primarily fund the continuing maintenance and improvement of existing facilities ($25-$30 million inclusive of equipment leases) while adding eight to ten new clubs.

           We are authorized to repurchase up to 1,500,000 shares of our common stock on the open market from time to time. We repurchased 625,100 shares between August 1998 and November 1999 at an average price of $18 per share and 54,500 shares in February 2002 at $15.73 per share.

           In July 2003, we completed the refinancing of our $132.0 million term loan and $56.0 million outstanding on our revolving credit agreement by issuing $235 million in aggregate principal of 10 ½% Senior Notes due 2011 in two offerings under Rule 144A and Regulation S under the Securities Act of 1933, as amended. We also entered into a new $100 million Senior Secured Revolving Credit Facility due 2008. As a result, we wrote off $2.6 million of unamortized issuance costs from the extinguished debt in the third quarter of 2003. In addition, in July 2003 we paid down $25 million on our Securitization Series 2001-1 and extended the revolving period on $100 million of the balance through July 2005. Monthly amortization on the Series 2001-1 of $5 million begins in November 2004. The amount available under the new credit facility is reduced by any outstanding letters of credit, which cannot exceed $30.0 million. As of February 29, 2004, the Company had outstanding $6.5 million in letters of credit and availability of $52 million on the new credit facility. As of December 31, 2003, our debt service requirements, including interest, through December 31, 2004 were approximately $80.5 million, exclusive of principal payments on the securitization. We expect to refinance the securitization facility prior to it becoming a current maturity, although there are no assurances that the refinancing will be completed. We believe that we will be able to satisfy these short-term requirements for debt service and capital expenditures out of available cash balances, cash flow from operations and borrowings on the revolving credit facility.

           We guarantee the lease on one fitness center, which is part of a joint venture with Holmes Place, Plc. The lease has a 15 year term which began in May 2002 with current annual rental (subject to escalation) of $.6 million. The Company believes that it does not have any obligation to perform under the guarantee as of December 31, 2003.

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           At December 31, 2003, we had future payments required under contractual obligations and other commitments approximately as follows (in millions):

Forward-Looking Statements

           Forward-looking statements in this Form 10-K, including, without limitation, statements relating to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These factors include, among others, the following: general economic and business conditions; the impact of our debt structure; risks related to acquisitions; competition; success of operating initiatives, advertising and promotional efforts; existence of adverse publicity or litigation; acceptance of new product offerings; changes in business strategy or plans; quality of management; availability, terms and development of capital; business abilities and judgment of personnel; changes in, or the failure to comply with, government regulations; regional weather conditions; and other factors described in this Form 10-K or in other of our filings with the Securities and Exchange Commission. We are under no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

           We are exposed to market risk from changes in the interest rates on certain of our outstanding debt. The outstanding loan balance under our bank credit facility and the Series 2001-1 accounts receivable-backed variable funding certificates bear interest at variable rates based on prevailing short-term interest rates in the United States and Europe. Based on 2003’s average outstanding balance of these variable rate obligations, a 100 basis point change in interest rates would have changed interest expense in 2003 by approximately $2.4 million. We have purchased a 7.75% interest rate cap on the Series 2001-1 accounts receivable-backed variable funding certificates which covers the outstanding $100 million through the refinanced period. In September 2003 we entered into interest rate swap agreements whereby our fixed interest commitment on $200 million of outstanding principal on our senior subordinated notes varies based on the short-term interest rate in Europe. A 100 basis point change in the interest rate on the portion of the debt subject to the new swap agreement would change interest expense on an annual basis by $2.0 million. For fixed rate debt, interest rate changes affect their fair market value but do not impact earnings or cash flows. We presently do not use other financial derivative instruments to manage our interest costs. We are subject to minimal foreign exchange and commodity risk.

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REPORT OF INDEPENDENT AUDITORS

           We have audited the accompanying consolidated balance sheets of Bally Total Fitness Holding Corporation as of December 31, 2003 and, as restated, 2002, and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the years ended December 31, 2003 and, as restated, 2002 and 2001. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and the schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.

           We conducted our audits in accordance with auditing standards generally accepted in the United States. 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bally Total Fitness Holding Corporation at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

           As discussed in the Changes in accounting Note to the consolidated financial statements, in 2003, the Company changed its methods of accounting for recognition of revenue from membership contracts, membership origination costs, and asset retirement obligations and, as discussed in the Goodwill, trademarks and intangible assets Note, in 2002, the Company changed its method of accounting for goodwill and intangible assets.

ERNST & YOUNG LLP

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See accompanying notes.

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See accompanying notes.

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See accompanying notes.

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See accompanying notes.

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See accompanying notes.

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See accompanying notes.

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Summary of significant accounting policies

Basis of presentation

           The accompanying consolidated financial statements include the accounts of Bally Total Fitness Holding Corporation (the “Company”) and the subsidiaries that it controls. The Company, through its subsidiaries, is a nationwide commercial operator of fitness centers with 418 facilities, at February 29, 2004, located in 29 states and Canada. Additionally, 19 clubs are operated pursuant to franchise and joint venture agreements in the United States, Mexico, Asia, and the Caribbean. The Company operates in one industry segment, and all significant revenues arise from the commercial operation of fitness centers, primarily in major metropolitan areas in the United States and Canada. Unless otherwise specified in the text, references to the Company include the Company and its subsidiaries.

           The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles, which require the Company’s management to make estimates and assumptions that affect the amounts reported therein. Actual results could vary from such estimates. Certain prior-year amounts have been reclassified to conform to the current-year presentation.

Changes in accounting

           The Company elected to change its accounting methods effective January 1, 2003 related to the recognition of revenue from membership contracts, initial membership origination costs, and asset retirement obligations. The cumulative effect as of January 1, 2003 of these changes in accounting principles has been charged to the 2003 statement of operations. These charges are discussed below.

           As required, the Company adopted the provisions of EITF 00-21 “Revenue Arrangements with Multiple Deliverables” as it relates to revenues included in initial membership contracts. Under the previously acceptable method, revenues allocated to products and services included in initial membership contracts, including financed contracts, were recognized upon delivery to the member. The new pronouncement limits the amount of revenue recognized upon delivery of the products and services to cash collected upon membership origination. Limiting early recognition to cash collected resulted in a reversal of amounts previously recognized upon membership sale and an increase in amounts deferred to be recognized during future periods.

           Concurrent with the adoption of EITF 00-21, the Company has elected to adopt a modified cash basis of accounting for the recognition of membership fees effective January 1, 2003. Under the new method, membership revenue is recognized as income at the later of when it is collected, or in the case of paid-in-full memberships or accelerated receipts from financed memberships, when earned. This changes the pre-2003 22-month pool deferral method that amortized revenues from financed initial membership fees on the straight-line basis, after application of estimated uncollectible amounts. The use of the modified cash basis, which is viewed by management and the Company’s independent auditors as a preferable accounting method, recognizes membership revenue over a longer period than the previous method. The Company has also applied the modified cash basis of recognition to its accounting for non-obligatory membership dues. Since monthly dues are collected in arrears, prior to 2003 the Company had included in other assets a receivable for uncollected dues at the end of each period. Under the modified cash basis of recognition, the recognition of membership dues revenue has been changed to the later of either collected or earned consistent with our new policy for membership fees. As a result, the receivable for earned but uncollected dues has been reversed and is included as a component of the cumulative effect adjustment.

           Concurrent with the change to the modified cash basis of revenue recognition as described above, in 2003 the Company has additionally changed its accounting principle for initial membership origination costs from the pre-2003 method whereby such costs were deferred and recognized over the same period used for revenue recognition to expensing such costs as incurred. This change has also been determined to be a preferable method when considered along with the modified cash basis adopted for membership fee recognition.

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           In the second quarter of 2003, the Company changed its accounting for the recognition of recoveries of unpaid dues on inactive membership contracts from accrual-based estimations to a cash basis of recognition, which was considered a preferable method of accounting for such past due amounts.

           The Company also implemented the provisions of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations,” in the first quarter of 2003. It requires that the Company recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are then capitalized as part of the carrying amount of the long-lived asset. As a result, a non-cash cumulative adjustment of $165 was recorded to provide for estimated future restoration obligations on the Company’s leaseholds.

           The changes in accounting relating to revenue recognition and membership origination costs affect how other assets are valued such as the deferred income tax asset and goodwill. The Company did not determine how those amounts would have been valued under the prior methods of accounting for revenue and origination costs. For purposes of disclosing 2003 net income or loss assuming the Company had remained on the previous methods of accounting, the Company has used the same values for the deferred income tax asset and goodwill as are reported in the December 31, 2003 balance sheet under the new methods of accounting. On that basis, had the Company remained on the accounting policies followed prior to the changes in accounting described herein, net loss for 2003 would have been $103,600 or $3.17 per share.

           The following table presents the components of the cumulative effect charge as of the beginning of 2003:

           The lower level of proforma historical earnings under the new recognition policies required the establishment of valuation reserves against previously recognized deferred tax assets. As a result, deferred tax assets were reduced by $50,500 in the first quarter of 2003.

           In applying the new accounting method for membership revenue as described above, the Company undertook an evaluation of its methods and processes related to accounting for the deferral of revenue for prepayments of non-obligatory membership dues. In consultation with its independent auditors, it was determined that the Company’s previous methodology resulted in errors in calculating prepaid dues and accelerated dues recognition for certain prepaying members. As a result, the Company has restated prior periods in accordance with the requirements of Accounting Principles Board Opinion No. 20 “Accounting Changes.” The impact of the correction to previously reported net revenues and net income was a reduction of $8,018 ($.25 per diluted share) and $10,630 ($.36 per diluted share) in 2002 and 2001 respectively, and an increase in previously reported deferred revenue and a decrease in previously reported stockholders’ equity of $43,040 and $35,022 at December 31, 2002 and 2001, respectively.

Consolidation

           The consolidated financial statements include the accounts of the Company. All intercompany accounts and transactions have been eliminated in consolidation. For all acquisitions, account balances and results of operations are included in the consolidated financial statements as of the date acquired.

           In 2003, we adopted FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 addresses consolidation by business enterprises of variable interest entities. Under this

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interpretation, certain entities known as Variable Interest Entities (“VIEs”) must be consolidated by the primary beneficiary of the entity. The primary beneficiary is generally defined as having the majority of the risks and rewards arising from the VIE. For VIEs in which a significant (but not majority) variable interest is held, certain disclosures are required. We have not entered into any arrangements or made any investments which qualify as a VIE. The adoption of FIN 46 did not have any impact on our consolidated financial position, results of operations or cash flows.

Cash equivalents

           The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. The carrying amount of cash equivalents approximates fair value due to the short maturity of those instruments.

Inventory

           Inventory is valued at the lower of cost or market.

Property and equipment

           Depreciation of buildings, equipment and furnishings (including assets under capital leases) is provided on the straight-line method over the estimated useful lives of the related assets. Buildings are depreciated over 30 years and useful lives for equipment and furnishings range from three to 15 years. Amortization of leasehold improvements is provided on the straight-line method over the lesser of the estimated useful lives of the improvements or the lease periods. Depreciation and amortization of property and equipment was $77,008, $73,793 and $64,875 for 2003, 2002 and 2001, respectively.

Software for Internal Use

           Certain costs incurred related to software developed for internal use are accounted for in accordance with the American Institute of Certified Public Accountants’ Statement of Position No. 98-1 (“SOP 98-1”), “Accounting for Costs of Computer Software Developed or Obtained for Internal Use.” Under SOP 98-1, costs incurred in the planning and post-implementation stages are expensed as incurred, while costs relating to application development are capitalized. The capitalized software costs are included in the equipment and furnishings in the consolidated balance sheet. The Company amortizes such software costs over eight years.

Investments

           The Company accounts for its investments in joint ventures using the equity method of accounting.

Goodwill, Trademark and Intangibles

           The Company adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (“SFAS No. 142”) effective January 1, 2002. Under SFAS No. 142, goodwill and intangible assets with indefinite lives, which consist of trademarks, are not amortized but are reviewed for impairment annually, or more frequently if indicators arise. For the Company’s goodwill, if the book value of the Company exceeds its fair value, the fair value of goodwill is determined and compared to the carrying amount of goodwill. If the carrying amount of goodwill or trademarks exceeds their respective fair values, an impairment loss is recorded in an amount equal to that excess.

           Other intangibles consist of leasehold rights, which are amortized using the straight-line method over the respective lease periods.

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Impairment of long-lived assets

           Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets held for use are assessed by a comparison of the carrying amount of the asset to the estimated future undiscounted net cash flows expected to be generated by the asset. If estimated future undiscounted net cash flows are less than the carrying amount of the asset, the asset is considered impaired and expense is recorded in an amount required to reduce the carrying amount of the asset to its fair value.

Deferred finance costs

           Deferred finance costs are amortized over the terms of the related debt using the straight-line method. Included in “Other assets” at December 31, 2003 and 2002 were deferred finance costs of $14,529 and $10,015 respectively, net of accumulated amortization of $20,908 and $17,517, respectively. In 2003, $2,562 of unamortized issuance costs related to refinanced debt was written-off and reported with Other non-operating charges.

Income Taxes

           Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Based upon the Company’s past performance and the expiration dates of its carryfowards, the ultimate realization of all of the Company’s deferred tax assets cannot be assured. Accordingly, the Company records a valuation allowance to reduce deferred tax assets to a level which, more likely than not, will be realized.

Fair Value of Financial Instruments

           Cash and cash equivalents and installment contracts receivables are financial assets with carrying values that approximate fair value. Accounts payable, other accrued expenses and liabilities and the Company’s variable rate debt are financial liabilities with carrying values that approximate fair value. The fair value of the Company’s long-term debt at December 31, 2003 and 2002 approximates its carrying amount except for the Company’s senior subordinated debt, which had a fair market value (based on quoted market prices) of $279,049 and $269,640 at December 31, 2003 and 2002, respectively. The fair values are not necessarily indicative of the amounts the Company could acquire the debt for in a purchase or redemption.

Accounts Receivable and Credit Risk

           Accounts receivable consist of amounts due from the Company’s large population of members. The Company requires down payments from most of its members and in many circumstances utilizes electronic payment options in order to mitigate potential credit risk associated with these receivables. The Company maintains an allowance for doubtful accounts to reflect management’s best estimate of amounts expected to become uncollectible based upon historical experience and other currently available evidence. Adjustments to the allowance are recorded as a direct offset to the deferred revenue account under the new modified cash basis of accounting adopted effective January 1, 2003.

Advertising

           Advertising costs are charged to expense as incurred, or in the case of television commercial productions upon the first showing.

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Membership revenue recognition

           The Company’s fitness centers primarily offer a dues membership, which permits members, upon paying an initial membership fee, which may be financed, to maintain their membership on a month-to-month basis as long as monthly dues payments are not delinquent.

           As noted in the “Changes in accounting” section above, during 2003 the Company changed its recognition policy for membership revenue. Prior to 2003, net membership revenue on financed initial membership fees (net of related allowances for doubtful receivables and cancellations) were deferred and amortized into income on the straight line basis based on the weighted average expected life of the membership term, which was calculated as 22 months. Under the new modified cash basis of recognition adopted, membership revenue on financed initial membership fees is deferred and recognized at the later of when it is collected, or in the case of cash down payments and accelerated receipts, over the period earned. The modified cash basis does not change the recognition method for initial membership fees that are paid in full when sold which are and have been deferred and amortized into income over the expected term of membership, generally 36 months, on the straight line basis.

           An installment account receivable is recorded for the estimated net realizable value of future collections of the up-front initial membership fee upon the origination of a financed membership sale, with an offsetting amount recorded as deferred revenue. Under the new basis of accounting adopted, the carrying value of installment accounts receivable is evaluated and adjustments to the allowance are recorded as a direct adjustment to deferred revenue. Prior to 2003, the provision for doubtful receivables and cancellations was charged directly against membership revenue. Installment contracts related to financed initial membership fees bear interest at, or are adjusted for financial accounting purposes at the time the contracts are sold, to rates for comparable consumer financing. Unearned finance charges are amortized over the term of the contracts on the sum-of-the-months-digits method, which approximates the interest method. In 2003, finance charges earned are part of the revenues that are limited, in the aggregate, to recognition based on the later of when collected or earned.

           Membership revenue related to monthly non-obligatory dues is recognized under the adopted modified cash basis of accounting at the later of when collected, or in the case of prepayments, ratably as earned over future periods. Prior to the 2003 adoption of the modified cash basis of recognition, because monthly dues are collected in arrears, a receivable was recorded for uncollected dues.

           Under our pre-2003 accounting method, costs directly related to the origination of memberships were deferred and amortized using the same method as for initial membership fees as described above. Pursuant to our new accounting under the modified cash basis, such costs are expensed as incurred.

Deferred revenue

           Components of deferred revenues as of December 31, 2003 and 2002 are as follows: