To All: Taking a careful look at BFT's revenue recognition.
We start by showing how a recent change in accounting
practice resulted in a significant boosted 96 and 97 revenues.
Compare the following selected historical financial data from
the 1996 10K and the 1997 10K. notice how the accounting
change resulted in better revenues and bottom line in 96
(previous years are not that relevant as the company was a
subsidiary of entertainment). Notice, however, how the Cash
flows do not change. Look at the significantly negative cash
flows from operations, particularly in 97. The lesson: keep
your eyes on the ball: smart people follow cash flows.
From the 97 10K:
ITEM 6. SELECTED FINANCIAL
DATA<TABLE><CAPTION>
YEARS ENDED DECEMBER
31,
------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(Dollar amounts in millions, except per
share data)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Net revenues $661.0 $639.2 $653.4 $682.0
$666.7
Depreciation and amortization 52.9 55.9 57.4 58.9
60.4
Operating income (loss) 19.9 19.1 5.0 (16.1)
(18.1)
Loss before extraordinary item and cumulative effect on
prior years
of change in accounting
for income taxes (a)(b) (23.5) (24.9) (31.4) (39.5)
(31.4)
Basic and diluted loss per common share (pro forma for
1995)(c) (1.51) (2.04) (3.25)BALANCE
SHEET DATA
(AT END OF YEAR)
Cash and equivalents $ 61.7 $ 16.5 $ 21.3 $ 12.8
$ 11.0
Installment contracts
receivable, net 343.6 300.2 303.4 284.1
322.7
Total assets 967.6 893.3 936.5 951.0
1,016.7
Long-term debt, less
current maturities 405.4 376.4 368.0 289.7
305.7
Stockholders' equity 70.3 24.2 31.7 34.8
50.6
OTHER FINANCIAL DATA
EBITDA(d) $ 72.8 $ 75.0 $ 62.4 $ 42.8 $
42.3
Cash provided by (used in):
Operating activities (35.9) (5.3) (9.9) 32.8
49.9
Investing activities (16.1) (9.8) (42.1) (21.4)
(36.1)
Financing activities 97.2 10.4 60.4 (9.6)
(13.6)
</TABLE>
From the 1996 10K:
ITEM 6. SELECTED FINANCIAL DATA<CAPTION>
Years ended December 31,
------------------------------------------------
1996 1995 1994 1993
1992
------ ------ ------ ------ ------
(Dollar amounts in millions, except per
share data)
<S> <C> <C> <C> <C>
<C>
STATEMENT OF OPERATIONS DATA
Net revenues $625.6 $661.7 $661.5 $694.8
$744.7
Depreciation and amortization 55.9 57.4 58.9
60.4 57.8
Operating income (loss) 3.7 7.6 (37.2) .8
24.3
Loss before extraordinary item and cumulative effect on
prior years
of change in accounting
for income taxes (41.2)(a) (25.2) (50.8)
(28.0)(b) (7.5)
Loss per common share (pro
forma for 1995 and 1994)(c) (3.38) (3.08)
(6.44)BALANCE SHEET DATA
(AT END OF YEAR)
Cash and equivalents $ 16.5 $ 21.3 $ 12.8 $
11.0 $ 10.7
Installment contracts
receivable, net 300.2 303.4 284.1 322.7
327.8
Total assets 813.5 846.3 860.2 923.3
919.4
Long-term debt, less
current maturities 376.4 368.0 289.7 305.7
269.8
Stockholders' equity 216.5 240.3 234.3 261.3
264.5
OTHER FINANCIAL DATA
EBITDA(d) $ 59.7 $ 65.0 $ 21.6 $ 61.2
$ 82.1
Cash provided by (used in):
Operating activities (5.3) (9.9) 32.8 49.9
64.5
Investing activities (9.8) (42.1) (21.4) (36.1)
(25.1)
Financing activities 10.4 60.4 (9.6) (13.6)
(41.8)
</TABLE>
Important to notice is the fact that the change in accounting is
mentioned in the press release for 97 results but not in the 97
10K (are some notes may be missing from the SEC electronic
filling but available in the paper sec forms in the annual
report?):
biz.yahoo.com
A. The financial data presented above for the 1996 periods
have been
restated to reflect a change in the Company's method of
recognizing
membership revenue. In addition, interest income for
the 1996 periods
has been reclassified to conform with the 1997
presentation. The
Company was an indirect wholly owned subsidiary of
Bally Entertainment
Corporation ("Entertainment") until Entertainment
spun-off the
Company to its stockholders on January 9, 1996.
Let's take another step. In accounting, revenue is in general
not recognized on a cash basis (i.e., when people pay for the
services), but instead when services are delivered. It seems
quite appropriate that if a BFT customer pays for his/her
membership in full, the revenue not be recognized all at once
but deferred and then accrued (i.e., recognized) over a period
of time. One thing that I found very interesting is that initial
membership fee revenue is actually recognized faster for
financed memberships than for paid in full memberships!
From the 97 10K:
MEMBERSHIP REVENUE RECOGNITION
Revenues from initial membership fees are deferred and
recognized ratably over
the weighted average expected life of the memberships, which
for paid-in-full
memberships and financed memberships sold after December
31, 1993 have been
calculated to be 36 months and 22 months, respectively
(previously 34 months and
20 months, respectively). Costs directly related to the
origination of
memberships (substantially all of which are sales
commissions paid, which are
included in "Fitness center operations") are also deferred and
are amortized
using the same methodology as for initial membership fees
described above. Dues
revenue is recorded as monthly services are provided.
Accordingly, when dues are
prepaid, the prepaid portion is deferred and recognized over
the applicable
term. Installment contracts bear interest at, or are adjusted for
financial
accounting purposes at the time the contracts are sold to, rates
for comparable
consumer financing contracts. Unearned finance charges are
amortized over the
term of the contracts on the sum-of-the-months-digits
method, which approximates
the interest method.
The rationale for the different time frames IMO is
satisfactory, particularly if we consider the fact that the
"effective collection" percent for financed memberships must
be lower than for paid in full (actually quite a bit lower as you
will confirm at the end of this post). This method results in
revenue from financed memberships being recognized at a
rate that is (36/22) or 63.4% faster that for paid in full
memberships! The 10K does mention that financed
memberships have the benefit of bringing in interest
payments and also result in a higher average membership
price but it is never mentioned explicitely that financed
memberships also have the benefit of accelerating revenue
recognition! Read the following analysis on revenue results
carefully before we continue:
RESULTS OF OPERATIONS
Comparison of the years ended December 31, 1997 and
December 31, 1996
Net revenues for 1997 were $661.0 million compared to
$639.2 million in 1996, an
increase of $21.8 million (3%). This increase is substantially
a result of an
increase in initial membership fees originated of $34.8
million (9%) in 1997,
consisting of a $62.3 million (21%) increase in financed
memberships originated
offset, in part, by a $27.5 million (32%) decrease in paid-in-
full memberships
originated. These results generally reflect management's
current strategy of
selling more all-club membership plans (which typically have
been financed and
generate better long-term returns for the Company) and fewer
single-club
membership plans. Accordingly, the average selling price of
contracts sold
increased 18% and the number of contracts sold decreased
10%. Further, these
results were achieved while the average number of fitness
centers selling
memberships decreased from 322 in 1996 to 317 in 1997,
reflecting management's
continuing strategy to improve the quality of the Company's
facilities. During
1997 and 1996, the Company closed 19 older, typically
smaller and less
profitable facilities and sold a fitness center to a franchisee
while opening 8
new, larger facilities, generally based on its new prototype. In
addition,
deferred revenue accounting added only $1.0 million to
revenues in 1997 compared
to $29.8 million in 1996. Dues collected increased $11.2
million (6%) over 1996,
reflecting the Company's continuing strategy of increasing
renewal dues. Finance
charges earned increased $2.8 million (8%) in 1997 due
primarily to the increase
in the size of the receivables portfolio. Fees and other
revenues increased $1.9
million (14%) over 1996, primarily reflecting the sale of
nutritional and other
retail products which the Company began selling in 1997 in
certain of its
fitness centers and the 1997 introduction of the new personal
training program.
Revenue of 661 million is a cool 3% over year ago. We see
that revenue from financed membership grew by 62.3 million.
If this revenue had been for paid in full instead, the revenue
recognized would have been only 62.3/1.634 = 38 million, 24
million lower, which would have left us with revenue of 661-
24 = 637 million or below the 639 million in 96. This is
probably more in line with a 10% decline in the number of
contracts sold than a 3% increase in revenue reported due to
the increase in financed membership fees.
As mentioned previously the merits of financed memberships
are partially discussed (However, the bust in revenues
coming from the accelerated recognition is not explicitly
mentioned). In addition, the increased collection risks for
financed memberships is IMO not fully discussed. They do
mention that that increased used of electronic funds transfers
(EFT) should result in improved collection of financed
memberships but the evidence that the relatively increase in
electronic payments will more than completely offset the
increase in defaults to be expected for financed memberships
is IMO too optimistic. Notice below that despite the
significant increase in Installment Contracts Receivable
resulting from the increased sales of financed memberships,
the allowance for doubtful receivables actually decreased!:
INSTALLMENT CONTRACTS
RECEIVABLE<TABLE><CAPTION>
1997 1996
-------- --------
<S> <C> <C> Current:
Installment contracts receivable $239,448
$226,173
Unearned finance charges (27,709)
(24,467)
Allowance for doubtful receivables and
cancellations (43,728) (48,471)
-------- --------
$168,011 $153,235
======== ========
Long-term:
Installment contracts receivable $226,735
$195,978
Unearned finance charges (14,357)
(11,382)
Allowance for doubtful receivables and
cancellations (36,803) (37,624)
-------- --------
$175,575 $146,972
======== ========
In the data above, "current" refers to receivables within the
next 12 months (this is the meaning of current in accounting:
within a year); "long-term" (non-current) means beyond one
year.
Notice that total receivables in 96 were: 422 million and the
allowance for doubtful receivables was 86.1 million. In 97,
total receivables were: 446 million, a 10.4% increase. The 97
allowance for doubtful accounts was 80.5, a 6.3% decrease!
Notice the swings were in oposite direction, an increase in
receivables and a decrease in the allowance for doubtful
accounts. As far as I was aware, the only justification for this
is the increase in electronic payments and higher down
payments:
from the 97 10K:
- Improve Collections on Financed Contracts - The Company
is maintaining its
focus on increasing downpayments on financed
membership plans and securing
payments by electronic funds transfer ("EFT"), which the
Company's
experience has shown results in higher quality
receivables. This effort
yielded an increase of 11% in the average down payment,
from $73 in 1996
to $81 in 1997. In addition to seeking higher down
payments, the Company
continues to develop improved collection practices based
on information
provided by "credit scoring" and behavioral modeling,
which management
believes will also improve the yield from the receivables
portfolio..
Currently,approximately 80% of all financed memberships
sold are paid by EFT.
Historical
analysis performed by the Company indicates the collection
experience of EFT
accounts is approximately 50% better than coupon book
accounts. As of December
31, 1997, approximately 60% of membership contract
receivables consisted of
EFT-financed memberships compared to 29% at December
31, 1992.
From the 96 10K:
Currently, more than 60% of all financedmemberships sold
are paid by EFT. ..
On average, the Company received a downpayment of
approximately $75 on contracts
that were financed during 1996..
As of December 31,
1996, approximately 51% of membership contract receivables
consisted of
EFT-financed memberships compared to 29% at December
31, 1992, when emphasis on
payments by EFT was introduced by management.
Quesstion: does the increase in EFT from 51% in 96, to 60%
in 97 merits the decrease in Allowance for doubtful accounts
discussed above?
We are getting close to end of the first round of our discission
on revenue recognition. More to come. In the mean time I
want to close with an interesting footnote virtually at the end
of the 97 10K (page 63 after all the signatures):
Dated: March 19, 1998 By: /s/ Liza M. Walsh
Liza M. Walsh
Director 63
<PAGE><TABLE> BALLY TOTAL FITNESS
HOLDING CORPORATION
SCHEDULE II - VALUATION AND
QUALIFYING ACCOUNTS
Years ended December 31, 1997, 1996 and 1995
(All dollar amounts in
thousands)<CAPTION>
Additions
--------------------
Charged
to costs Charged
Balance at and to other
Balance
beginning expenses accounts Deductions
at end
Description of year (a) (b) (c) of
year
----------- ---------- --------- --------- ---------- --------
-
<S> <C> <C> <C> <C>
<C>
1997: Allowance for doubtful receivables and
cancellations $ 86,095 $ 96,078 $ 107,660 $
209,302 $ 80,531
========== ========= =========
========== =========
1996: Allowance for doubtful receivables and
cancellations $ 112,528 $ 80,350 $ 111,736 $
218,519 $ 86,095
========== ========= =========
========== =========
1995: Allowance for doubtful receivables and
cancellations $ 120,329 $ 72,145 $ 114,729 $
194,675 $ 112,528
========== ========= =========
========== =========
-----------<FN>Notes:
(a) Amounts are included as a component of the deferred
revenue computation as
set forth in the "Summary of significant accounting
policies - Membership
revenue recognition" note to the consolidated financial
statements.
(b) Additions charged to accounts other than costs and
expenses primarily
consist of charges to revenues, principally for
cancellations.
(c) Deductions include write-offs of uncollectible amounts,
net of recoveries.
</FN></TABLE>
Try to study this table as homework asignment for the next
class.Hint: look at column ( c ).
Pancho
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