Yes, I read that article, there is also another excellent article by Christopher Byron on TheStreet.com about BFT:
Christopher Byron: Sweating It Out with Bally
By Christopher Byron
Special To TheStreet.com
9/17/98 5:10 PM ET
There's nothing -- and I mean nothing -- like the sight of an ultra-ripped, real-life
version of Linda Hamilton, straining orgasmically within the enveloping steel
embrace of a pec fly machine as her rock-hard delts and six-pack abs glisten with oil
and sweat.
Well, that at least is the theory behind those Bally fitness commercials that have
been running day and night on television lately. Their unsubtle pitch: Join one of
these clubs and if you're a gal, you'll come out looking like one of the babes on your
screen; or if you're a guy, join up and you'll at least get a chance to hit on one.
So let us grant that Bally Total Fitness (BFT:NYSE), the Chicago-based outfit that
owns the operation, knows how to capture the attention of psychosocially challenged
couch potatoes all over America. The company operates 325 fitness centers (which
in an earlier age we might have just called "gyms") for roughly 4 million such people
in 27 states -- the only nationwide fitness chain of its kind in the U.S.
Wall Street takes all this to mean that there are bright days ahead for the company,
which emerged as a stand-alone business in 1996 when Bally Entertainment, a
hotel and gambling enterprise, spun it off as a stock dividend to shareholders. The
undercapitalized operation instantly ran into trouble as angry customers complained
of poorly maintained clubs, overcrowded conditions, broken equipment, blah blah
blah.
But a new top management team, led by two former accountants, now appears to be
leading a turnaround, and a period of cavernous losses a year ago seems to have
come to an end. Losses of $32 million in the second half of 1997 have given way to a
$4.1 million net gain -- or 17 cents per share -- in the first half of 1998. And the
roughly half-dozen Wall Street analysts who follow the stock think the trend will
continue and even accelerate. They project that the company will report as much as
$1.47 per share of net income in 1999.
And what red-blooded American male wouldn't hope but that they're right, for when it
comes to TV commercials, which would you rather watch: an aerobics class full of
5% body fat women in their 20s with sweat trickling down their chests, or James
Brolin reassuring you that half the cars serviced by Aamco don't need a new
transmission?
Unfortunately, a look at Bally's financials for recent quarters suggests that it is too
soon to pronounce a turnaround. At best, evidence won't appear until early next
spring, when, according to company Chief Executive Lee Hillman, Bally moves from
being a cash-consumer to a cash-generator. If that doesn't happen, then a skeptic
would be justified in dismissing claims of a turnaround as based on little more than
accounting gimmickry -- a conjurer's trick to hide the fact that the company simply
cannot stop burning through cash.
At issue here is what financial analysts refer to as provisioning for doubtful accounts
-- a situation that arises in Bally's case from the fact that the bulk of the company's
revenues derive from membership contracts sold on the installment plan.
When a company sells a product or service on the installment plan, accounting rules
generally permit the company to record the full face-value of the sale as immediate
income even though the actual cash money will only dribble in a little bit at a time
over the coming months. But the Securities and Exchange Commission now
requires companies such as Bally, once having entered the sum as revenue, to then
defer it -- 100 cents on the dollar -- to be recognized in stages over the coming three
years. But this only takes care of part of the problem.
After all, what happens if the buyer who signs such a contract -- in this case, an
installment-plan membership -- decides later on that the service is junk and simply
walks away from the contract? How are companies that record installment-plan
revenues when they don't yet have the actual money in hand supposed to account
for that possibility?
Accounting rules say that the reporting company is supposed to set aside a portion
of the claimed income as a cost-item on the statement. The set-aside portion should
be labeled "Provision for Doubtful Receivables," or some such.
Moreover, the uncollected portion of the installment contract, minus the reserve item
from the Statement of Operations, is supposed to be added to the company's
balance sheet as an asset labeled "accounts receivable."
Then, as the installment contract is paid off, the accounts receivable number on the
balance sheet gets reduced accordingly -- and if the entire amount winds up being
paid off, the unused portion of the reserve for doubtful receivables gets added back to
income as a credit in the next reporting period. This way, an investor should be able
to tell, at any given moment, what the real income and assets picture is for a
company that is reporting sales for which it hasn't yet received payment.
In the case of Bally, this results in an apparent under-reserving for doubtful
receivables -- a situation that makes the company's bottom line look healthy, even
though the operation seems plainly to be running out of money. You'd never know it,
though, from a hasty look at the company's financial statements.
So let us begin with Bally as it has been presenting itself to investors and the world,
caked with anti-wrinkle cream and Extencils Dramatic Length Curling Mascara from
Lancome. In the three-month period that ended June 30, Bally reported total
revenues of $180,876,000 -- an improvement of nearly 12% over the year before. But
according to the company's last 10Q quarterly filing with the SEC for the April-June
1998 period, only $7,545,000 of that total consisted of revenues from one-time
upfront fees for memberships paid in full. Another $46,629,000 consisted of monthly
dues collected from existing members, along with $107,504,000 from payments on
installment plans recognized during the period.
Add to that some $12,184,000 in interest charges on contracts, and another
$7,014,000 in various additional fees. You end up with total claimed revenues of
$180,876,000 -- which, to be frank, is an impressive pile of money for a company in
the lunchtime workout business. Back out of that total some $178,872,000 in
operating expenses, interest charges, taxes and other costs -- including a
$29,306,000 charge for doubtful receivables -- and you end up, bottom line, with a
reported net quarterly income of $2,004,000, a sum Wall Street analysts now expect
to see grow nearly fourfold by the end of next year.
But do these numbers really reflect what's going on with Bally? Not really, since
Bally's positive (and rising) net income needs to be weighed against a
$2-million-per-month cash-flow burn rate.
How rare a feat is it for a company to report negative cash flow and positive net
income? To find out, I queried the Microsoft Investor database of more than 8,000
publicly traded stocks and discovered that of the more than 3,000 stocks traded on
the New York Stock Exchange, exactly three are currently reporting negative cash
flow while claiming positive earnings. On the American Exchange? Four out of
nearly 800. On the Nasdaq? Thirty-three out of more than 5,000. All are companies
you have probably never heard of.
One reason Bally is in this bind is because the company has borrowed to the hilt,
with $407 million of long-term debt on its books, or 2.5 times equity.
Worse, the company is struggling with more than $391 million of current liabilities
against only $289 million of short-term assets, giving it negative working capital in
excess of $100 million -- meaning more borrowings just aren't in the cards.
And here comes the most troublesome part: The company is burning through cash
from operations at a rate of more than $2 million per month, having racked up more
than $62 million in negative cash flow from operations since 1996. Not only has the
company been to the well twice for equity financing since going public ($88.3 million
in August of last year, and another $82.7 million just this last May), but as of June
30 the balance sheet showed cash of only $66 million -- an increase of a mere $43
million since March 30. And don't forget, it was only in May when the company
raised that $82.7 million in its second sale of stock in less than a year.
Now simple arithmetic will tell you that if a company already has $22.6 million on
hand on March 30, then raises another $82.7 million in May, the balance sheet as of
June 30 ought to show somewhere around $105 million in cash. But it doesn't. It
shows only about $66 million. So what happened to the missing $40 million?
What happened is, the company spent $17 million of it on new gym stuff and
whatnot, then burned through the rest ($23 million) simply running the business. But
wait, wasn't this a company that showed a $2 million net profit (revenues minus
expenses) during the period in question?
In fact, Bally is bleeding cash. It's just that the losses don't turn up on the income
statement because the one discretionary item on that statement -- the provision for
doubtful receivables -- is being set way too low.
The company says, "all-in," it is reserving 41% of accounts receivable against
doubtful receivables, which includes $32.7 million for contract cancellations. But in
the quarter ended June 30, the provision-for-doubtfuls item on the income statement
stood at $29.3 million, or roughly only 28% of the $103.6 million worth of installment
contract membership fees sold during the quarter.
Perhaps that income statement provision should have been higher. Why? Because if
you take the revenue reported during the quarter ($180.8 million) and isolate out of it
the cash that Bally actually wound up receiving (account receivables at the start of
the quarter, minus account receivables at the end of the quarter, minus the provision
for doubtful receivables, minus the deferred revenues at the start of the quarter, plus
the deferred revenues at the end of the quarter -- got all that?) you end up with actual
cash money during the quarter of only $128.7 million -- which sure ain't the $151.5
million (gross revenues minus the provision for doubtfuls) that the company had
provided for.
The gap -- $22.8 million -- happens to be almost exactly equal to (a) the company's
negative cash flow for the quarter and (b) the $23 million that one would expect to be
on the company's balance sheet from the May stock sale, but isn't -- the money that
seems to have been spent simply running the company.
And what if that $23 million had been accounted for as an equivalent increase in the
provision for doubtfuls? In that case, Bally wouldn't have reported that $2 million, or 9
cents per share, in earnings. It would have reported a loss of close to 80 cents per
share.
Bally's boss man, Lee Hillman, has said the negative cash flow results from, in
effect, "investing in the company's own receivables," and that Bally will become
cash-flow positive in the first quarter of 1999. But investors are skeptical. From a
high of more than $36 per share this last July, Bally's stock had careened downward
to a Sept. 10 closing price of barely $17.50 per share -- a loss of more than 50% in
value in two months. Meanwhile, short-sellers have begun circling the stock, with
so-called "short interest" now equal to 15% of the market float of the stock, and
rising.
This means the company is in for a tough time if it tries to raise more equity capital
in the period ahead -- although I for one certainly hope things work out all right in the
end. After all, what would TV be like without those Bally commercials. No more pec
fly machines? Nothing but Aamco transmissions from here on out? Will these
outrages never end? You can reach me by email at cbscoop@aol.com.
Editor's note: Readers should note that the company has challenged certain
aspects of this story. Bally has asserted that it and its accountants believe Bally to
be fully reserved for doubtful receivables in Bally's financial statements. Bally also
asserts that under present loan arrangements it has additional borrowing capability
and that 73% ($285.3 million) of its current liabilities were not cash liabilities, but
rather deferred revenues. Bally has also stated that, according to its sources, more
than 800 companies this year have reported negative cash flow and positive
earnings. Bally contends that this story did not adequately reflect these facts.
Christopher Byron tracks the financial markets for several outlets, including The New
York Observer. He appreciates your feedback at cbscoop@aol.com. |
