Thousand Trails, Inc. (Cases 2.1 & 3.1 in White, Sondhi & Fried)

Facts:

Owned and operated private membership resort campgrounds.

Sources of Revenue:

Membership sales:

Initial membership fees. ( accounted for over 2/3 of total revenue)

Annual dues by existing members.Interest on installment receivables (membership sales).

Revenue Recognition Criteria:

Earned when future campgrounds materializedNo refunds, so may be.

Realizability amount of sales in cashVersus amount as installment payment- no guarantee/ recourse of future payments by

members.

-installment sales method – revenue recognized prior to cash collection. (average: 61 months)

Early recognition

Sources of Expenses:

Marketing costs

Preserve development costs.

Expense Recognition:

Preserve improvements capitalized – deferred though cash outlay takes place.

Percentage completion- application without a customer?

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Deferred recognition.

Growth assumptions drive expected revenue and expected expenses resulting in overstatement of revenues and understatement of expenses.

Results in Gap between Income and cash flows.

Other issues – would the current trends continue.

-Past growth rates – how can they be maintained?-Repeat purchases – lifetime membership implies no repeat customers.-Degree to which past growth was a function of expected and promised new campgrounds.- After saturation source of revenue = annual dues & interest on installment payments = 1/3 of revenue per current trends.

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Profitability & Liquidity

Statement of Changes in Financial Position 1981-1983

Definition of Operating Cash flows:

- prior to SFAS 95 so operating, investing and financing not delineated.

- In any case question?

- Does preserve improvements fall in the category of operating cash flows or investing cash flows.

- What is definition under SFAS95 for classifying as an operating activity?

- Are’ nt preserves (or access to them) being sold – in this sense is it inventory and fixed assets?

Free Cash Flow:

Intended to measure cash available to the firm for discretionary uses after making all required cash outlays.

Used as valuation basis

Strict definition:

FCF= CFO less amount of capital expenditures required to maintain existing productive capacity (excludes expansion) Difficult to separate replacement versus expansion –so all capital expenditures .

Also makes it closer to Finance valuation models.

Practical implementation:

FCF = CFO - CFI

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Net income to cash Flows:

See graph.

CFO lags reported income

CFO goes opposite after 1982.

Cash Flow and Income Components:

Revenue recognized versus cash inflow:

’81 ’82 ‘83Revenue 40 56.5 80Cash inflow (27.1) (35.3)

(46.2)

Difference 12.9 21.2 33.8

(46.2=27.7+28.6 – 10.1 (from income stmt))

Collections lagging.

Expense Recognized versus cash outflow: (preserve improvement)

Expense 5.8 8.4 13.0 (I/S)Cash outflow (6.8) (11.3)

(18.4)Difference (1.0) (2.9) (5.4)

Expense recognition being deferred.

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Additional Outlays – Investment in preserves (addition to improvements)

Cash Flow from Investment:

From balance sheet:

Increase in land & improvements 26.1Add: under development 4.3Total 30.4

million.

From cash flow statement:18.4m

Difference 12.0 m

Implies 12 m of non-cash transactions - possibly debt – footnote data confirms this though not available in the

case material)

What does SFAS 95 tell us: should be reported under Significant Non-cash Financing & Investing Activities.

- payments on debt related to preserve properties (4.3 m in 1983) classified as operating activity

- cash from operations under stated by 12 m.

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Financing Cash Flows:

Net borrowings:

’81 ’82 ‘83

From CFOPayments on debt (2.0) (3.7)(4.3)

(preserve improvements)From other sources:Proceeds of borrowings 9.1 8.6 0.9Payments (0.7) (0.7) (1.1)

Net borrowings 6.4 4.2 (4.5)

From balance sheet:

Change in current portionOf LTD 1.5 (5.9-4.4)LTD 4.2 (47.3-43.1)

Total change 5.7 m

Thus increase in debt is 5.7 m based on B/S.Yet, per cash flow debt decreased by 4.5 m.Both are true. Debt on acquisition of preserves (hiding as assets) under development did not pass through cash flow statement.

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- Asset Based Valuation of Thousand Trails:

Resources in place that generate future benefits:

Earnings generating ability Cash convertability/ collectability.

Are operating preserves more akin to inventory or fixed assets?

What future benefits do they provide?Or are these expenses waiting to happen without any matching revenues being generated ?

Are receivables collectible – installment receivables may not be.

From balance sheet (1983): % of total assets

Receivables (net of allowances)

Current 20.8 m 13.7%Non-current 64.1 m42.2%Total 84.9 m 55.9%

Operating preserves 43.8 m. 28.8%

Total 128.7 m 84.7%

So what assets are left?

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Lessons to be Learnt from a Research Perspective Based on a single Unit of observation:

-ability to identify the problem, and search relevant authoritative statements – here Revenue and Expense Recognition, Provisions and definitions of SFAS 95.

-apply the relevant literature to the situation and analyze the pros and cons.

-diagnose the problem if any – in this case the lagging of cash flows and income is likely to continue and affect the solvency of the firm and question the “going concern” assumption.

-we cannot generalize our conclusions regarding Thousand Trails to another firm.

-May need additional historical data beyond the three years provided to do a more comprehensive analysis.

-search for other similar firms, if any, and use as a benchmark.

-to what extent are trends in the camping industry / behavior and inflationary or recessionary trends responsible for the financial situation of Thousand Trails.

-raises concern about whether investors should only be fixated on accrual based earnings. ALTERNATIVELY, what is the incremental information content of cash flows over and beyond accruals.

-this is what the Dechow paper addresses using market data and a pool of firms to make some “on average” conclusions regarding the behavior of investors.

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