Bally's plight worsens, executives fired for misleading accounting

After five months of investigation and a corporate and accounting situation that seems to be spiraling downward, Bally Total Fitness has fired two executives and accused its former CEO and CFO of misleading accounting practices. That comes only days after Bally announced it had retained The Blackstone Group to assist in its turnaround strategy.

After five months of investigation and a corporate and accounting situation that seems to be spiraling downward, Bally Total Fitness has fired two executives and accused its former CEO and CFO of misleading accounting practices -- and watched its stock fall 9 percent after the announcement.

That comes only days after Bally announced it had retained The Blackstone Group, a financial advisor and investment bank, to assist in its turnaround strategy, which may include divestiture of non-core assets. The Chicago-based worldwide gym operator (NYSE: BFT) has been trying to regain its balance for nearly a year in light of alleged accounting errors, erosion of investor confidence, an SEC investigation, delayed financial statements, and a pending class-action suit.

In addition, on the heels of the news of dismissals, Standard & Poor's Rating Services announced lowered ratings on Bally, including a dropping of the corporate credit rating to 'CCC+' from 'B-'. At the same time, Standard & Poor's changed its outlook on the ratings to negative from developing. "The rating actions are based on the potential for further delays in the filing of financial statements and on related uncertainties, in light of Bally's Audit Committee's recent findings," Standard & Poor's credit analyst Andy Liu told Dow Jones news services. Standard & Poor's told Dow Jones it believes Bally may be facing a narrower cushion of compliance with bank covenants.

The Securities and Exchange Commission opened an investigation into the company in April 2004 over the recording of prepaid dues. Bally in November said it would restate financial results from 2000 through first quarter 2004 as a result of errors it made in booking revenue. It plans to file new financial statements by July 31, Bally recently said, which it must do to bypass possible default since the statements are much delayed. The investigation was led by former SEC attorney Herbert F. Janick III of Bingham McCutchen, with forensic audit work conducted by PricewaterhouseCoopers.

The Audit Committee review found multiple accounting errors in Bally's financial statements and concluded that Bally's former Chairman and CEO Lee Hillman (from 1996 to 2002) and former CFO John Dwyer (from 1996 to 2004) were responsible for "multiple accounting errors and creating a culture within the accounting and finance groups that encouraged aggressive accounting." Both are CPAs and were previously employed by the company's former auditors, Ernst & Young, and were partners on the engagement teams that audited Bally's former parent company for several years prior to joining the company.   Â

The investigation identified that certain accounting policies and positions were suggested and implemented without a reasonable empirical basis and concluded that Dwyer made a false and misleading statement to the SEC. As a result of the findings, Bally has discontinued payments to Hillman and Dwyer under their severance arrangements and is considering legal action against the two. Â

Hillman is currently president of Liberation Investment Advisory Group, and a member of the board of directors for RCN Corp., Lawson Products Inc., Wyndham Hotels and Resorts, and HealthSouth Corp. where he serves as chairman of the company's audit committee. In September, he and Allan Fisher, former CEO of Holmes Place, gained a controlling interest in entities with exclusive distribution rights for the Power Plate and its Advanced Vibration Technology in North America, the UK, Ireland, Australia, Japan and China.

Hillman told the AP newswire that Bally has "no basis" for the allegations. "These are truly scurrilous allegations," Hillman said. "The company in my view should look internally to its longtime directors who were there at the time. This is a diversion from looking at what is going on internally."   Â

Bally said the investigation also found improper conduct on the part of its Vice President and Controller Ted Noncek (from 2001 to 2005) and Vice President and Treasurer Geoff Scheitlin (former Controller from 1997 to 2001). Bally has terminated their employment, although Noncek has been offered the opportunity to consult with the company on a short-term basis to help finish the audits. Chief Marketing Officer Martin Pazzani bid his own adieu to the company in late December.

Bally also said it believes its former auditors, Ernst & Young, made several errors in the course of its work, and is evaluating its legal options with respect to the accounting firm.    Â

As a result of the investigation and Bally's efforts to comply with the Sarbanes-Oxley Act of 2002, the company identified deficiencies in its internal controls over financial reporting. Deficiencies included: Bally's finance and accounting internal control environment, which lacked acceptable and clearly communicated policies about management's attitudes toward financial reporting; the lack of a permanent CFO; ineffective delegation of authority and responsibility; insufficient instruction to employees responsible for significant estimates emphasizing the need to report using accurate and reasonable assumptions and judgments; and insufficiently experienced and trained staff.

Bally has found a controller replacement, hiring David Reynolds. With more than two decades of experience, Reynolds has served in a variety of senior positions in accounting, finance systems, treasury and investor relations. Most recently, he was the senior vice president and controller of Comdisco Inc.

"A key component to Bally's turnaround plan is attracting top talent with targeted areas of expertise at all levels of the organization. Bringing on David Reynolds is an important step in this initiative," Paul Toback, Bally's chairman and CEO, said in a statement. "His proven track record in financial controls, continual process improvements and broad-based accounting expertise will be an important asset as we work to complete our financial statements while ensuring consistent application of new quality controls and policies."

Shares of Bally fell 9 percent of their value on Feb. 10. The stock was 38 cents lower at $3.75 in late morning action. For additional background, see SNEWS® story, Sept. 20, 2004, "Bally shareholder class-action lawsuit still pending, hearings set," among many other stories in the last year.

SNEWS® View: Likely not much more to say that can't already be read quite clearly in the events as well as between the lines. The current facts paint a picture that seems to indicate the plight at Bally will get much, much worse before it gets much better. That means that club members, many of whom may be completely in the dark about what's happening, may end up being the real losers here.


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