AFFINITY GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
(1) BASIS OF PRESENTATION
Principles of Consolidation – The consolidated financial statements include the accounts of Affinity Group, Inc. (“AGI”) and its subsidiaries (collectively the “Company”), in accordance with U.S. generally accepted accounting principles, and pursuant to the rules and regulations of the Securities and Exchange Commission. In March 2005, Affinity Group Holding Corp. (“AGHC”) formed a holding company, Affinity Group Holding, Inc., a Delaware corporation (“AGHI”) at which time contributed 100% of the outstanding shares of common stock of AGI to AGHI. AGHI is the direct parent of the Company.
On March 7, 2006, AGHC filed an election with the Internal Revenue Service to change its tax status from a Subchapter C corporation to a Subchapter S corporation (“S corporation”). This change of tax status election was to be effective as of January 1, 2006. The election for change in tax status to an S corporation included AGHC and all its subsidiaries with the exception of Camping World, Inc. and its wholly-owned subsidiaries, which are to remain Subchapter C corporations. During the first quarter of 2006, the Company continued to file as Subchapter C corporations since AGHC had not received approval from the IRS regarding its S corporation change of tax status election. As such, the Company recorded a $1.5 million tax provision for the first quarter of 2006. Approval for the S corporation change of tax status election was received from the IRS in the second quarter of 2006. This approval for change in tax status was granted retroactive to January 1, 2006. Pursuant to FAS 109, “Accounting for Income taxes”, a change in tax status resulting from an S corporation election requires that all deferred tax accounts be revalued upon formal approval of the S corporation status. Accordingly, all deferred tax accounts of AGHC and its subsidiaries, excluding Camping World, Inc. and its wholly owned subsidiaries, were revalued to account for the tax effect for the change to the S corporation status. The effect of this revaluation on the deferred tax accounts has been recorded in the income tax provision in the second quarter.
These interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes in the Company’s 10-K report for the year ended December 31, 2005 as filed with the Securities and Exchange Commission. In the opinion of management of the Company, these consolidated financial statements contain all adjustments of a normal recurring nature necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented.
5
(2) RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued Interpretation No. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109.” FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN No. 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the possible impact implementing FIN No. 48 may have on its financial position and results of operations.
(3) DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
The Company’s three principal lines of business are Membership Services, Publications, and Retail. The Membership Services segment includes the operations of the Good Sam Club, Coast to Coast Club, Camping World’s President’s Club and Camp Club USA for recreational vehicles (“RV”) owners, campers and outdoor vacationers, and the Golf Card Club for golf enthusiasts. The Publications segment publishes a variety of publications for selected markets in the recreation and leisure industry, including general circulation periodicals, directories, and RV and powersports industry trade magazines, and produces outdoor recreational consumer events. The Retail segment sells specialty retail merchandise and services for RV owners primarily through the Camping World retail supercenters, mail order catalogs and its website. The Company evaluates performance based on profit or loss from operations before income taxes.
The reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology, management expertise and marketing strategies.
6
(3) DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
The Company does not allocate income taxes or unusual items to segments. Financial information by reportable business segment is summarized as follows (in thousands):
| | Membership | | | | | | | |
| | Services | | Publications | | Retail | | Consolidated | |
THREE MONTHS ENDED JUNE 30, 2006 | | | | | | | | | |
Revenues from external customers | | $ | 37,512 | | $ | 16,584 | | $ | 84,907 | | $ | 139,003 | |
Depreciation and amortization | | 889 | | 1,059 | | 2,029 | | 3,977 | |
Gain on sale of property and equipment | | — | | — | | 2 | | 2 | |
Interest income | | 1,563 | | — | | 1 | | 1,564 | |
Interest expense | | — | | 87 | | 3,483 | | 3,570 | |
Segment operating profit | | 11,215 | | 2,722 | | 512 | | 14,449 | |
THREE MONTHS ENDED JUNE 30, 2005 | | | | | | | | | |
Revenues from external customers | | 34,401 | | 15,301 | | 83,510 | | 133,212 | |
Depreciation and amortization | | 787 | | 542 | | 1,770 | | 3,099 | |
Gain (loss) on sale of property and equipment | | — | | (5 | ) | 3 | | (2 | ) |
Interest income | | 1,167 | | — | | 3 | | 1,170 | |
Interest expense | | — | | 69 | | 2,622 | | 2,691 | |
Segment operating profit | | 10,653 | | 3,763 | | 3,446 | | 17,862 | |
| | | | | | | | | | | | | |
| | Membership | | | | | | | |
| | Services | | Publications | | Retail | | Consolidated | |
SIX MONTHS ENDED JUNE 30, 2006 | | | | | | | | | |
Revenues from external customers | | $ | 70,460 | | $ | 39,687 | | $ | 145,726 | | $ | 255,873 | |
Depreciation and amortization | | 1,799 | | 2,079 | | 4,006 | | 7,884 | |
Gain on sale of property and equipment | | — | | 5 | | 8 | | 13 | |
Interest income | | 2,939 | | — | | 6 | | 2,945 | |
Interest expense | | — | | 181 | | 6,979 | | 7,160 | |
Segment operating profit | | 21,687 | | 9,184 | | (3,807 | ) | 27,064 | |
SIX MONTHS ENDED JUNE 30, 2005 | | | | | | | | | |
Revenues from external customers | | 66,824 | | 32,499 | | 142,576 | | 241,899 | |
Depreciation and amortization | | 1,759 | | 1,016 | | 3,488 | | 6,263 | |
Gain (loss) on sale of property and equipment | | — | | (5 | ) | 3 | | (2 | ) |
Interest income | | 2,170 | | — | | 5 | | 2,175 | |
Interest expense | | — | | 159 | | 5,212 | | 5,371 | |
Segment operating profit | | 21,012 | | 8,191 | | 1,788 | | 30,991 | |
| | | | | | | | | | | | | |
7
The following is a reconciliation of income from operations to the Company’s consolidated financial statements for the three and six months ended June 30, 2006 and 2005 (in thousands):
| | THREE MONTHS ENDED | | SIX MONTHS ENDED | |
| | 6/30/2006 | | 6/30/2005 | | 6/30/2006 | | 6/30/2005 | |
Income From Operations Before Taxes | | | | | | | | | |
Total profit for reportable segments | | $ | 14,449 | | $ | 17,862 | | $ | 27,064 | | $ | 30,991 | |
Unallocated G & A expense | | (4,232 | ) | (4,591 | ) | (8,382 | ) | (9,733 | ) |
Unallocated depreciation and amortization expense | | (618 | ) | (721 | ) | (1,235 | ) | (1,255 | ) |
Unallocated interest income, net of intercompany elimination | | (1,169 | ) | (992 | ) | (2,221 | ) | (1,831 | ) |
Unallocated interest expense, net of intercompany elimination | | (3,130 | ) | (3,669 | ) | (6,180 | ) | (7,175 | ) |
Unallocated debt restructure expense | | (693 | ) | — | | (693 | ) | — | |
Income from operations before taxes | | $ | 4,607 | | $ | 7,889 | | $ | 8,353 | | $ | 10,997 | |
The following is a reconciliation of assets of reportable segments to the Company’s consolidated financial statements as of June 30, 2006 and December 31, 2005 (in thousands):
| | 6/30/2006 | | 12/31/2005 | |
Membership services segment | | $ | 164,711 | | $ | 162,562 | |
Publications segment | | 86,405 | | 89,104 | |
Retail segment | | 216,381 | | 207,736 | |
Total assets for reportable segments | | 467,497 | | 459,402 | |
Capitalized finance costs not allocated to segments | | 8,043 | | 9,568 | |
Corporate unallocated assets | | 8,310 | | 16,376 | |
Elimination of intersegment receivable | | (85,827 | ) | (69,886 | ) |
Total assets | | $ | 398,023 | | $ | 415,460 | |
(4) STATEMENTS OF CASH FLOWS
Supplemental disclosures of cash flow information for the six months ended June 30 (in thousands):
| | 2006 | | 2005 | |
Cash paid during the period for: | | | | | |
Interest | | $ | 14,123 | | $ | 12,382 | |
Income taxes | | 75 | | 5,138 | |
| | | | | | | |
In February 2006, the Company assumed $1.4 million of liabilities and issued $0.4 million of debt in the acquisition of Plus Events consumer shows and related assets of H & S Productions, LLC.
8
(4) STATEMENTS OF CASH FLOWS (continued)
On March 7, 2006, AGHC made an S corporation change of tax status election effective for 2006, which included AGI and all its subsidiaries with the exception of Camping World, Inc. and its wholly-owned subsidiaries, which will remain Subchapter C corporations. With the exception of built-in gains taxes, S corporations do not pay income taxes but pass the income and related income tax liability through to their stockholders. To assist the stockholders with its income tax liability, the Company made distributions of $2.6 million to the stockholder in the form of a dividend in March 2006.
5) GOODWILL AND INTANGIBLE ASSETS
The Company reviews goodwill and indefinite-lived intangible assets for impairment at least annually. The Company performs its annual impairment test during the fourth quarter. Based on the results of this test, we recorded an impairment charge of $4.3 million in 2005 related to the Golf Card Club, which is included in the membership services segment.
There were no changes in the Company’s goodwill by business segment for the six months ended June 30, 2006 and 2005.
Finite lived intangible assets, related accumulated amortization and weighted average useful life consisted of the following at June 30, 2006 (in thousands, except as noted):
| | Weighted | | | | | | | |
| | Average Useful | | | | Accumulated | | | |
| | Life (in years) | | Gross | | Amortization | | Net | |
Membership and customer lists | | 6 | | $ | 26,939 | | $ | (9,192 | ) | $ | 17,747 | |
Resort and golf course participation agreements | | 23 | | 13,515 | | (12,074 | ) | 1,441 | |
Non-compete and deferred consulting agreements | | 15 | | 18,455 | | (12,064 | ) | 6,391 | |
Deferred financing costs | | 7 | | 10,942 | | (4,251 | ) | 6,691 | |
| | | | $ | 69,851 | | $ | (37,581 | ) | $ | 32,270 | |
(6) NOTES OFFERING, GUARANTOR AND NON-GUARANTOR FINANCIAL INFORMATION
In February 2004, the Company issued $200.0 million of 9% Senior Subordinated Notes (“Senior Subordinated Notes”) due 2012 pursuant to the AGI Indenture. On June 8, 2006, the Company amended its Amended and Restated Credit Agreement to permit the Company to repurchase up to $30.0 million of the Senior Subordinated Notes from time to time as and when the Company determines. The Company purchased and retired $24.8 million of the Senior Subordinated Notes in June 2006. Interest is payable on the Senior Subordinated Notes twice a year on February 15 and August 15. The Company’s present and future restricted subsidiaries will guarantee the Senior Subordinated Notes
9
with unconditional guarantees of payment that will rank junior in right of payment to their existing and future senior debt, but will rank equal in right of payment to their existing and future senior subordinated debt.
All of the Company’s subsidiaries have jointly and severally guaranteed the indebtedness under the Senior Subordinated Notes except for CWFR Capital Corp. Full financial statements of the Guarantors have not been included because, pursuant to their respective guarantees, the Guarantors are jointly and severally liable with respect to the Senior Subordinated Notes.
10
AFFINITY GROUP, INC. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table is derived from the Company’s Consolidated Statements of Operations and expresses the results from operations as a percentage of revenues and reflects the net increase (decrease) between periods:
| | SIX MONTHS ENDED | |
| | 6/30/2006 | | 6/30/2005 | | Inc/(Dec) | |
| | | | | | | |
REVENUES: | | | | | | | |
Membership services | | 27.5 | % | 27.6 | % | 5.4 | % |
Publications | | 15.5 | % | 13.4 | % | 22.1 | % |
Retail | | 57.0 | % | 59.0 | % | 2.2 | % |
| | 100.0 | % | 100.0 | % | 5.8 | % |
| | | | | | | |
COSTS APPLICABLE TO REVENUES: | | | | | | | |
Membership services | | 18.0 | % | 17.6 | % | 8.5 | % |
Publications | | 10.2 | % | 9.0 | % | 20.5 | % |
Retail | | 34.3 | % | 34.9 | % | 3.6 | % |
| | 62.5 | % | 61.5 | % | 7.5 | % |
| | | | | | | |
GROSS PROFIT | | 37.5 | % | 38.5 | % | 3.0 | % |
| | | | | | | |
OPERATING EXPENSES: | | | | | | | |
Selling, general and administrative | | 25.5 | % | 25.8 | % | 4.4 | % |
Depreciation and amortization | | 3.6 | % | 3.1 | % | 21.3 | % |
| | 29.1 | % | 28.9 | % | 6.3 | % |
| | | | | | | |
INCOME FROM OPERATIONS | | 8.4 | % | 9.6 | % | (6.7 | )% |
| | | | | | | |
NON-OPERATING ITEMS: | | | | | | | |
Interest income | | 0.3 | % | 0.1 | % | 110.5 | % |
Interest expense | | (5.1 | )% | (5.2 | )% | 6.3 | % |
Debt extinguishment expense | | (0.3 | )% | — | | 100.0 | % |
Other non-operating items, net | | — | | — | | 76.7 | % |
| | (5.1 | )% | (5.1 | )% | 8.9 | % |
| | | | | | | |
INCOME FROM OPERATIONS BEFORE INCOME TAXES | | 3.3 | % | 4.5 | % | (24.0 | )% |
| | | | | | | |
INCOME TAX EXPENSE | | (9.8 | )% | (1.6 | )% | 526.8 | % |
| | | | | | | |
NET (LOSS) INCOME | | (6.5 | )% | 2.9 | % | (335.0 | )% |
15
RESULTS OF OPERATIONS
Three Months Ended June 30, 2006
Compared With Three Months Ended June 30, 2005
Revenues
Revenues of $139.0 million for the second quarter of 2006 increased by $5.8 million, or 4.3%, from the comparable period in 2005.
Membership services revenues of $37.5 million for the second quarter of 2006 increased by $3.1 million, or 9.0%, from the comparable period in 2005. This revenue increase was largely attributable to a $1.9 million increase in member events revenue primarily due to timing of the Good Sam Club annual rally, which occurred in the second quarter of 2006 versus the third quarter of 2005, an $0.8 million increase in extended vehicle warranty program revenue due to the continued growth of contracts in force, a $0.3 million revenue increase in emergency road service programs due to increased enrollment and a $0.1 million increase from our new discount camping club, Camp Club USA.
Publication revenues of $16.6 million for the second quarter of 2006 increased $1.3 million, or 8.4%, from the comparable period in 2005 primarily attributable to $0.9 million of revenue from the consumer shows acquired in December 2005 and the consumer shows acquired from H & S Productions, LLC in February 2006, $0.5 million of revenue relating to Powerboat Magazine acquired in May 2005, $0.3 million of revenue relating to an additional issue of Boating Industry magazine, and $0.1 million of additional book revenue. These increases were partially offset by $0.5 million of reduced revenue relating to one less issue of ATV Magazine.
Retail revenues of $84.9 million increased $1.4 million, or 1.7%, from the comparable period in 2005. Store merchandise sales increased approximately $2.2 million over the second quarter of 2005 due to a $6.7 million revenue increase from the addition of seventeen new stores over the past eighteen months, partially offset by a same store sales decrease of $4.5 million, or 7.5%, compared to an 8.4% increase in the second quarter of 2005.
Same store sale calculations for a given period include only those stores that were open both at the end of that period and at the beginning of the preceding fiscal year. The increase in store merchandise sales was partially offset by a $0.5 million decrease in mail order sales, and a $0.3 million decrease in installation and service work.
Costs Applicable to Revenues
Costs applicable to revenues totaled $87.7 million for the second quarter of 2006, an increase of $5.1 million, or 6.1%, from the comparable period in 2005.
16
Membership services costs and expenses of $25.0 million increased approximately $2.7 million, or 12.1%, from the comparable period in 2005. This increase consisted of a $2.0 million increase in member event costs primarily due to timing of the Good Sam Club annual rally, $0.4 million of marketing and program expenses associated with increased enrollment in the extended vehicle warranty programs and emergency road service programs, and $0.3 million of incremental marketing and fulfillment costs relating to the start-up of a new discount camping club, Camp Club USA.
Publication costs and expenses of $11.6 million for the second quarter of 2006 increased $1.4 million, or 13.7%, from the comparable period in 2005 primarily due to a $0.7 million increase relating to the newly acquired consumer shows, $0.4 million of additional costs attributable to the newly acquired Powerboat Magazine title, $0.3 million of additional book marketing costs, and $0.1 million of increased costs relating to the additional issue of Boating Industry magazine. These increases were partially offset by $0.1 million of reduced costs relating to one less issue of ATV Magazine.
Retail costs applicable to revenues increased $1.0 million, or 1.9%, to $51.1 million primarily as a result of seventeen new stores opened over the past eighteen months. The retail gross profit margin of 39.9% for the second quarter of 2006 decreased slightly from 40.0% for the comparable period in 2005.
Operating Expenses
Selling, general and administrative expenses of approximately $35.1 million for the second quarter of 2006 increased $2.4 million compared to the second quarter of 2005 primarily due to an increase in retail selling and general and administrative expenses of approximately $2.4 million consisting of increases in wages, advertising, operating insurance, travel and training, and other retail general and administrative expenses, and a $0.6 million increase due to the newly acquired consumer shows, partially offset by a $0.6 million decrease in deferred executive compensation expense. The increase in selling, general and administrative expenses was primarily due to new store openings and other marketing programs.
Depreciation and amortization expense of $4.6 million increased approximately $0.8 million over the prior year primarily due to increased depreciation on additional capital expenditures at Camping World, and amortization of intangible assets associated with the purchase of Powerboat Magazine in May 2005 and the acquisition of consumer shows in December 2005 and February 2006.
Income from Operations
Income from operations for the second quarter of 2006 totaling $11.6 million decreased $2.5 million compared to the second quarter of 2005. This decrease was primarily due to increased operating expenses of $3.2 million and reduced gross profit for the publications operations of $0.1 million partially offset by increased gross profit for retail and membership services operations of $0.4 million each.
17
Non-Operating Items
Non-operating items were $7.0 million for the second quarter of 2006, compared to $6.2 million for the same period in 2005. This $0.8 million increase comprises of $0.7 million of debt extinguishment expense relating to the repurchase and retirement of $24.8 million of the Company’s Senior Subordinated Notes, and $0.3 million of additional interest expense in 2006 primarily due to higher interest rates, partially offset by a $0.2 million increase in interest income.
Income before Income Taxes
Income before income taxes for the second quarter of 2006 was $4.6 million, or $3.3 million lower than the second quarter of 2005. This decrease was attributable to a $2.5 million decrease in income from operations for the current period, $0.7 million of debt extinguishment expense and a $0.1 million increase in net interest expense.
Income Tax Expense
The Company recorded $23.4 million of income tax expense for the second quarter of 2006, an increase of $20.6 million from the second quarter of 2005. This increase was primarily due to AGHC’s S corporation change of tax status election effective for 2006, which included AGI and all its subsidiaries, with the exception of Camping World, Inc. and its wholly-owned subsidiaries which will remain Subchapter C corporations. As a result, all deferred tax assets and liabilities were revalued with the exception of those related to Camping World, Inc. and its wholly-owned subsidiaries and other potential built-in gains.
Net (Loss) Income
Net loss in the second quarter of 2006 was $18.8 million compared to net income of $5.1 million for the same period in 2005 primarily due to income tax expense of $23.4 million in the second quarter of 2006 as a result of the S corporation change of tax status election for the Company (other than Camping World, Inc. and its wholly-owned subsidiaries) being effective during the quarter as discussed above.
Segment Profit
Segment profit of $14.4 million for the second quarter of 2006 (before unallocated depreciation and amortization, general and administrative, interest, and income tax expense) decreased $3.4 million, or 19.1%, from the comparable period in 2005.
Membership services segment profit of approximately $11.2 million for the second quarter of 2006 increased $0.6 million, or 5.3%, from the comparable period in 2005. This increase was largely attributable to a $0.6 million increase in profit from emergency road service products, and a $0.5 million increase in profit from the extended vehicle warranty programs, partially offset by a $0.3 million decrease in profit for Camp Club USA due to marketing expenses associated with the new club and a $0.2 million decrease in profit recognized on our RV financing program.
18
Publication segment profit of $2.7 million for the second quarter of 2006 decreased $1.0 million, or 27.7%, from the comparable period in 2005. This decrease was largely attributable to a $0.5 million profit decrease attributable to period costs within the newly acquired show groups, a $0.4 million decrease in profit relating to a reduced number of issues of ATV Magazine, and a $0.1 million decrease in profit from the books group.
Retail segment profit of $0.5 million for the second quarter of 2006 decreased by $2.9 million, or 85.1% from the comparable period in 2005. This decrease resulted primarily from a $2.4 million increase in selling, general and administrative expenses, a $0.9 million increase in interest expense relating to intercompany debt issued as a result of the Camping World, Inc. $40.0 million dividend declared and paid in the form of a note on December 23, 2005, and a $0.3 million increase in depreciation expense, partially offset by a $0.7 million increase in gross profit margin.
Six Months Ended June 30, 2006
Compared With Six Months Ended June 30, 2005
Revenues
Revenues of $255.9 million for the first six months of 2006 increased by approximately $14.0 million, or 5.8%, from the comparable period in 2005.
Membership services revenues of $70.5 million for the first six months of 2006 increased by approximately $3.6 million, or 5.4%, from the comparable period in 2005. This revenue increase was largely attributable to a $1.9 million increase in member events revenue primarily due to timing of the Good Sam Club annual rally, which occurred in the second quarter of 2006 versus the third quarter of 2005, a $1.6 million increase in extended vehicle warranty program revenue due to the continued growth of contracts in force, and a $0.5 million revenue increase in emergency road service programs due to increased enrollment. These increases were partially offset by a $0.4 million net reduction in membership services revenue resulting primarily from reduced enrollment in the Coast to Coast and Golf Card Clubs.
Publication revenues of $39.7 million for the first six months of 2006 increased $7.2 million, or 22.1%, from the comparable period in 2005 primarily attributable to $5.8 million of revenue from the consumer shows acquired in December 2005 and the consumer shows acquired from H & S Productions, LLC in February 2006, $1.0 million of additional revenue from the boating magazine group, primarily relating to the acquisition of Powerboat Magazine in May 2005, $0.5 million of revenue related to an additional issue of powersports-related magazines, and $0.4 million of revenue from the updated edition of the campground atlas. These revenue increases were partially offset by a $0.5 million decrease in advertising and subscription revenue for the RV-related titles.
Retail revenues of $145.7 million increased $3.2 million, or 2.2%, over the first six months of 2005. Store merchandise sales increased approximately $4.0 million over
19
the first six months of 2005 due to a $9.3 million revenue increase from the addition of seventeen new stores over the past eighteen months, partially offset by a same store sales decrease of $5.3 million or 5.1%, compared to a 7.3% increase in the first six months of 2005. Same store sale calculations for a given period include only those stores that were open both at the end of that period and at the beginning of the preceding fiscal year. This revenue increase was partially offset by a $0.4 million decrease in mail order sales, and a $0.4 million decrease in installation and service fees.
Costs Applicable to Revenues
Costs applicable to revenues totaled $159.8 million for the first six months of 2006, an increase of $11.2 million, or 7.5%, from the comparable period in 2005.
Membership services costs and expenses of $46.1 million increased approximately $3.6 million, or 8.5%, from the first six months of 2005. This increase consisted of a $2.0 million increase in member event costs primarily due to the timing of the Good Sam Club annual rally, $1.1 million of marketing and program expenses associated with increased enrollment in the extended vehicle warranty programs and emergency road service programs, and $0.5 million of additional costs associated with the start-up of a new discount camping club, Camp Club USA.
Publication costs and expenses of $26.2 million for the first six months of 2006 increased $4.5 million, or 20.5%, from the comparable period in 2005 primarily due to a $2.9 million increase relating to the newly acquired consumer shows, $1.0 million of additional costs attributable to the newly acquired Powerboat Magazine title, $0.4 million of additional costs associated with an updated edition of the campground atlas and $0.2 million of costs associated with an additional issue of powersports-related magazines.
Retail costs applicable to revenues increased $3.1 million, or 3.6%, to $87.5 million primarily due to a decrease in the retail gross profit margin and an increase in sales due to the seventeen new stores opened over the past eighteen months. The retail gross profit margin of 40.0% for the first six months of 2006 decreased from 40.8% for the comparable period in 2005 primarily due to lower sales of higher margin products.
Operating Expenses
Selling, general and administrative expenses of approximately $65.3 million for the first six months of 2006 increased $2.8 million, or 4.4%, compared to the first six months of 2005 primarily due to an increase in retail selling and general and administrative expenses of approximately $3.5 million consisting of increases in wages, operating insurance, travel and training, and other retail general and administrative expenses, a $0.5 million increase due to the newly acquired consumer shows, and $0.3 million of other general and administrative expenses, partially offset by a $1.5 million decrease in deferred executive compensation expense.
20
Depreciation and amortization expense of $9.1 million increased approximately $1.6 million over the prior year primarily due to increased depreciation resulting from additional capital expenditures at Camping World, amortization of intangible assets associated with the purchase of Powerboat Magazine in May 2005 and the acquisition of consumer shows in December 2005 and February 2006.
Income from Operations
Income from operations for the first six months of 2006 totaling $21.6 million decreased $1.6 million compared to the first six months of 2005. This decrease was primarily due to increased operating expenses of $4.4 million partially offset by increased gross profit for the publications operations of $2.8 million.
Non-Operating Items
Non-operating items were approximately $13.3 million for the first six months of 2006, a $1.0 million increase over 2005. This increase comprises of $0.7 million of additional interest expense in 2006 due to increased interest rates and $0.7 million of debt extinguishment expense relating to the repurchase and retirement of $24.8 million of the Company’s Senior Subordinated Notes, partially offset by a $0.4 million increase in interest income.
Income before Income Taxes
Income before income taxes for the first six months of 2006 was $8.4 million, or $2.6 million lower than the first six months of 2005. This decrease was attributable to a $1.6 million decrease in income from operations for the current period, a $0.3 million increase in net interest expense, and $0.7 million of debt extinguishment expense.
Income Tax Expense
The Company recorded $24.9 million of income tax expense for the first six months of 2006, an increase of $20.9 million from the first six months of 2005. This increase was primarily due to AGHC’s S corporation change of tax status election effective for 2006, which included AGI and all its subsidiaries, with the exception of Camping World, Inc. and its wholly-owned subsidiaries which will remain Subchapter C corporations. As a result, all deferred tax assets and liabilities were revalued with the exception of those related to Camping World, Inc. and its wholly-owned subsidiaries and other potential built-in gains.
Net (Loss) Income
Net loss in the first six months of 2006 was $16.5 million compared to net income $7.0 million for the same period in 2005 primarily due to income tax expense of $23.4 million in the second quarter of 2006 as a result of the S corporation change of tax status election for the Company (other than Camping World, Inc. and its wholly-owned subsidiaries) being effective during the quarter as discussed above.
21
Segment Profit
Segment profit of $27.1 million for the first six months of 2006 (before unallocated depreciation and amortization, general and administrative, interest, and income tax expense) decreased $3.9 million, or 12.7%, from the comparable period in 2005.
Membership services segment profit of $21.7 million for the first six months of 2006 increased $0.7 million, or 3.2%, from the comparable period in 2005. This increase was largely attributable to a $1.1 million increase in profit from emergency road service products, and a $0.6 million increase in profit from the extended vehicle warranty programs, partially offset by a $0.7 million decrease in profit for Camp Club USA due to marketing expenses for the new club and a $0.3 million decrease in profit recognized on our RV financing program.
Publication segment profit of $9.2 million for the first six months of 2006 increased $1.0 million, or 12.1%, from the comparable period in 2005. This increase was largely attributable to a $1.5 million profit increase for the newly acquired show group, partially offset by a $0.5 million decrease in profit for the RV-related magazines.
Retail segment loss for the first six months of 2006 was $3.8 million, resulting in a reduction of profit of $5.6 million from the comparable period in 2005. This decrease in profit resulted primarily from a $3.5 million increase in selling, general and administrative expenses, a $0.5 million increase in depreciation expense and a $1.8 million increase in interest expense relating to intercompany debt issued as a result of the Camping World, Inc. $40.0 million dividend declared and paid in the form of a note December 23, 2005, partially offset by a $0.2 million increase in gross profit margin.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically operated with a working capital deficit. The working capital deficit as of June 30, 2006 and December 31, 2005 was $32.0 million and $6.7 million, respectively. The primary reason for the working capital deficit is the deferred revenue and gains reported under current liabilities in the amount of $63.5 million and $61.0 million as of June 30, 2006 and December 31, 2005, respectively. Deferred revenue is primarily comprised of cash collected for club memberships in advance, which is amortized over the life of the membership. The Company uses net proceeds from this deferred membership revenue to lower its long-term borrowings. The working capital deficit increased compared to the prior year-end primarily due to the purchase and retirement of $24.8 million of the Senior Subordinated Notes and a seasonal increase in accounts payable. Management believes that funds generated by operations together with available borrowings under the Company’s revolving credit line will be sufficient to meet all of the Company’s debt service requirements and capital requirements over the next twelve months.
22
Contractual Obligations and Commercial Commitments
The following table reflects our contractual obligations and commercial commitments at June 30, 2006. This table includes principal and future interest due under our debt agreements based on interest rates as of June 30, 2006 and assumes debt obligations will be held to maturity.
| | Payments Due by Period | |
(in thousands) | | Total | | Balance of
2006 | | 2007 and
2008 | | 2009 and
2010 | | Thereafter | |
| | | | | | | | | | | |
Long-term debt and future interest | | $ | 406,340 | | $ | 14,726 | | $ | 56,295 | | $ | 142,425 | | $ | 192,894 | |
Operating lease obligations | | 132,818 | | 7,476 | | 21,381 | | 17,484 | | 86,477 | |
Deferred compensation | | 5,380 | | — | | 4,285 | | 1,095 | | — | |
Standby and commercial
letters of credit | | 7,104 | | 6,754 | | 350 | | — | | — | |
Grand total | | $ | 551,642 | | $ | 28,956 | | $ | 82,311 | | $ | 161,004 | | $ | 279,371 | |
On June 24, 2003, the Company entered into an Amended and Restated Credit Agreement and a Senior Secured Floating Rate Note Purchase Agreement (as amended, the Senior Credit Facility). The Senior Credit Facility provides for a revolving credit facility of $35.0 million and term loans in the aggregate of $140.0 million. As of June 30, 2006, $109.2 million was outstanding under the term loans. No borrowings were outstanding on the revolving credit facility as of June 30, 2006. Reborrowings under the term loans are not permitted. The interest on borrowings under the Senior Credit Facility is at variable rates based on the ratio of total cash flow to outstanding indebtedness (as defined). Interest rates float with prime and the London Interbank Offered Rates, or LIBOR, plus an applicable margin ranging from 1.50% to 2.50% over the stated rates. As of June 30, 2006, the average interest rate on the term loans was 7.85%, and permitted borrowings under the undrawn revolving facility were $27.9 million. The Company also pays a commitment fee of 0.5% per annum on the unused amount of the revolving credit facility. The aggregate quarterly scheduled payments on the term loans are $350,000. The revolving credit facility matures on June 24, 2008, and the term loans mature on June 24, 2009. The funds available under the Senior Credit Facility may be utilized for borrowings or letters of credit; however, a maximum of $12.5 million may be allocated to such letters of credit. As of June 30, 2006, the Company had letters of credit in the aggregate amount of $7.1 million outstanding. The Senior Credit Facility is secured by virtually all of the Company’s assets and a pledge of the Company’s stock and the stock of the Company’s subsidiaries.
In February 2004, we issued $200.0 million aggregate principal amount of 9% Senior Subordinated Notes due 2012 (“Senior Subordinated Notes”). The Company completed a registered exchange of the Senior Subordinated Notes under the Securities Act of 1933 in August 2004. The proceeds from the sale of the Senior Subordinated Notes were used to fund the tender offer and defeasance of the remaining $100.0 million outstanding principal amount of the subordinated notes previously issued by AGI, prepay $25.0 million of the Term Loans under our Senior Credit Facility, pay a $60.0 million dividend distribution, create a $15.0 million segregated cash account, pay certain prepayment and transaction costs and for
23
general corporate purposes. The amount held in this segregated account, including any earnings thereon, was available to pay stockholder dividends upon satisfaction of a leverage test specified in our Senior Credit Facility. In August and November of 2004, we satisfied the specific leverage test and paid $3.6 million and $11.5 million in dividends, respectively.
On March 3, 2006, Affinity Group, Inc. amended its Senior Credit Facility to revise the definition of Consolidated Fixed Charges Ratio and Permitted Tax Distributions. This amendment allows AGI to distribute taxes to its ultimate parent based on its stand-alone tax obligation rather than the tax obligation of its parent, AGHI, until such time that AGHI pays interest on its 10 7/8% Senior Notes in cash instead of by the issuance of additional notes. Further, Affinity Group, Inc. amended the Senior Credit Facility’s covenant restrictions with affiliates to permit a joint venture arrangement between Camping World and FreedomRoads Holding Company, an affiliate of the Company.
On March 6, 2006, Camping World, Inc. (“Camping World”), a wholly-owned subsidiary of Affinity Group, Inc., entered into a Joint Venture Agreement with FreedomRoads Holding Company, LLC, a Minnesota limited liability company (“FreedomRoads”). FreedomRoads is indirectly owned and controlled by Stephen Adams, the Chairman and indirect controlling shareholder of Affinity Group, Inc. FreedomRoads, through its wholly-owned subsidiaries, owns and operates RV dealerships across the United States. The Joint Venture Agreement provides that Camping World and FreedomRoads are to act cooperatively with a view to maximizing synergies and to locate, establish and utilize mutually beneficial relationships that are available only to the parties acting together that would not otherwise be available to either party independently.
On June 8, 2006, AGI amended its Senior Credit Facility to permit the Company to repurchase up to $30.0 million of the Company’s Senior Subordinated Notes from time to time as and when the Company determines. The Company purchased $4,841,000 and $20,000,000 of the Senior Subordinated Notes on June 14, 2006 and June 20, 2006, respectively. The Senior Subordinated Note purchases were made with available cash and the notes purchased have been retired. As of June 30, 2006, $175.2 million of Senior Subordinated Notes remain outstanding.
The AGI Indenture pursuant to which the Notes were issued and the Senior Credit Facility contain certain restrictive covenants relating to, but not limited to, mergers, changes in the nature of the business, acquisitions, additional indebtedness, sale of assets, investments, and the payment of dividends subject to certain limitations and minimum operating covenants. The Company was in compliance with all debt covenants at June 30, 2006.
In March 2005, AGHI, the Company’s parent, issued $88.2 million principal amount of the 10-7/8% senior notes due February 15, 2012 (the “AGHI Notes”). Interest on the AGHI notes is payable semi-annually on February 15 and August 15. For interest payments on and prior to February 15, 2008, AGHI may elect to pay interest on the AGHI Notes in cash or by issuance of additional notes of the same tenor as the AGHI Notes, except the maturity date is March 15, 2010. AGI has not paid any dividends to
24
AGHI to fund payment of interest on the AGHI Notes and AGHI made the interest payments due on August 15, 2005 and February 15, 2006 through issuance of additional notes. AGI expects to issue additional notes of the same tenor as the AGHI Notes through February 15, 2008 to pay interest on the AGHI Notes when and as such interest is due.
In April 2005, Camping World, Inc. acquired the assets of a mail order catalog retailer specializing in recreational vehicle merchandise for $0.6 million. In May 2005, the Ehlert Publishing Group, Inc. acquired the Powerboat Magazine title and related assets from Nordskog Publishing, Inc. for $4.0 million. As part of the purchase, the Company issued $1.5 million of debt and assumed $0.5 million of liabilities. In December 2005, AGI Productions, Inc., a subsidiary of Ehlert Publishing Group, Inc., acquired the consumer outdoor recreation show assets of Royal Productions, Inc. for $8.5 million.
In February 2006, Ehlert Publishing, Inc. acquired the consumer shows and related assets of H & S Productions, LLC for $2.5 million. As part of the purchase, the Company issued $0.4 million of debt and assumed $1.4 million of liabilities.
For the six months ended June 30, 2006, the Company incurred $0.1 million of deferred executive compensation expense under the phantom stock agreements and made payments of $0.8 million on the pay-out provisions of existing phantom stock agreements. The earned incentives under these agreements are scheduled to be paid at various times over the next five years. There are no phantom stock payments scheduled to be made for the remainder of 2006.
Capital expenditures for the first six months of 2006 totaling $7.2 million increased $2.4 million from the first six months of 2005 primarily due to the addition of thirteen new retail stores in 2006. Additional capital expenditures of $7.7 million are anticipated for the balance of 2006, primarily for new Camping World stores, updating existing store fronts, and computer hardware and software upgrades and enhancements.
CRITICAL ACCOUNTING POLICIES
General
The discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to membership programs and incentives, bad debts, inventories, intangible assets, employee health insurance benefits, income taxes, restructuring, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not
25
readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.
Revenue Recognition
Merchandise revenue is recognized when products are sold in the retail stores, shipped for mail and internet orders, or when services are provided to customers. Publication advertising and newsstand sales, net of estimated provision for returns, are recorded at time of delivery. Subscription sales of publications are deferred and recognized over the lives of the subscriptions. Revenues from the emergency road service program (“ERS”) are deferred and recognized over the life of the membership. ERS claim expenses are recognized when incurred. Advances on third party credit card fee revenues are deferred and recognized based primarily on a percentage of credit card receivables held by third parties. Membership revenue is generated from annual, multi-year and lifetime memberships. The revenue and expenses associated with these memberships are deferred and amortized over the membership period. For lifetime memberships, an 18-year period is used, which is the actuarially determined estimated fulfillment period. Promotional expenses, consisting primarily of direct mail advertising, are deferred and expensed over the period of expected future benefit. Renewal expenses are expensed at the time related materials are mailed. Recognized revenues and profit are subject to revisions as the membership progresses to completion. Revisions to membership period estimates would change the amount of income and expense amortized in future accounting periods.
Accounts Receivable
The Company estimates the collectability of its trade receivables. A considerable amount of judgment is required in assessing the ultimate realization of these receivables including the current credit-worthiness of each customer. Changes in required reserves have been recorded in recent periods and may occur in the future due to the market environment.
Inventory
The Company states inventories at the lower of cost or market. In assessing the ultimate realization of inventories, the Company is required to make judgments as to future demand requirements and compare that with the current or committed inventory levels. The Company has recorded changes in required reserves in recent periods due to changes in strategic direction, such as discontinuances of product lines as well as changes in market conditions due to changes in demand requirements. It is possible that changes in required inventory reserves may continue to occur in the future due to the market conditions.
26
Long-Lived Assets
Purchased intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets, ranging from one to twenty-three years.
Long-lived assets, such as property, plant and equipment and purchased intangible assets with finite lives are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company assesses the fair value of the assets based on the future cash flow the assets are expected to generate and recognize an impairment loss when estimated undiscounted future cash flow expected to result from the use of the asset plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. When an impairment is identified, the Company reduces the carrying amount of the asset to its estimated fair value based on a discounted cash flow approach or, when available and appropriate, comparable market values. The Company determined there were no indicators of impairment of long-lived assets as of December 31, 2005 or June 30, 2006.
The Company has evaluated the remaining useful lives of its finite-lived purchased intangible assets to determine if any adjustments to the useful lives were necessary or if any of these assets had indefinite lives and were therefore not subject to amortization. The Company determined that no adjustments to the useful lives of its finite-lived purchased intangible assets were necessary. The finite-lived purchased intangible assets consist of membership customer lists, resort and golf course agreements, non-compete and deferred consulting agreements and deferred financing costs which have weighted average useful lives of approximately 6 years, 23 years, 15 years and 7 years, respectively.
Indefinite Lived Intangible Assets
The Company evaluates indefinite lived intangible assets for impairment at least annually or when events indicate that an impairment exists in accordance with SFAS No. 142. The impairment test for goodwill and other indefinite-lived intangible assets is calculated annually using fair value measurement techniques.
Determining the fair value of a reporting unit and the fair value of individual assets and liabilities of a reporting unit is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the extent of such charge. The Company’s estimates of fair value utilized in goodwill and other indefinite-lived intangible asset tests may be based upon a number of factors, including assumptions about the projected future cash flows, discount rate, growth rate, determination of market comparables, technological change, economic conditions or changes to the Company’s business operations. Such changes may result in impairment charges recorded in future periods.
27
The fair value of the Company’s reporting units is annually determined using a combination of the income approach and the market approach. Under the income approach, the fair value of a reporting unit is calculated based on the present value of estimated future cash flows. Future cash flows are estimated by the Company under the market approach, fair value is estimated based on market multiples of revenue or earnings for comparable companies.
Based on the results of the annual impairment tests, the Company recorded an impairment charge of $4.3 million in 2005 related to Golf Card Club, which is included in the membership services segment. Future goodwill impairment tests could result in a charge to earnings. The Company will continue to evaluate goodwill on an annual basis and whenever events and changes in circumstances indicate that there may be a potential impairment.
Income Taxes
Significant judgment is required in determining the Company’s tax provision and in evaluating its tax positions. The Company establishes accruals for certain tax contingencies when, despite the belief that the Company’s tax return positions are fully supported, the Company believes that certain positions may be challenged and that the Company’s positions may not be fully sustained. The tax contingency accruals are adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. The Company’s tax provision includes the impact of tax contingency accruals and changes to the accruals, including related interest, as considered appropriate by management.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks relating to fluctuations in interest rates. Our objective of financial risk management is to minimize the negative impact of interest rate fluctuations on our earnings and cash flows. Interest rate risk is managed through the use of a combination of fixed and variable interest debt as well as the periodic use of interest rate collar contracts.
The following information discusses the sensitivity to our earnings. The range of changes chosen for this analysis reflects our view of changes which are reasonably possible over a one-year period. These forward-looking disclosures are selective in nature and only address the potential impacts from financial instruments. They do not include other potential effects which could impact our business as a result of these interest rate fluctuations.
Interest Rate Sensitivity Analysis
At June 30, 2006, we had debt totaling $291.9 million, comprised of $109.2 million of variable rate debt and $182.7 million of fixed rate debt. Holding other variables constant (such as debt levels), the earnings and cash flow impact of a one-percentage point
28
increase/ decrease in interest rates would have an unfavorable/ favorable impact of approximately $1.1 million.
Credit Risk
We are exposed to credit risk on accounts receivable. We provide credit to customers in the ordinary course of business and perform ongoing credit evaluations. Concentrations of credit risk with respect to trade receivables are limited due to the number of customers comprising our customer base. We currently believe our allowance for doubtful accounts is sufficient to cover customer credit risks.
ITEM 4: CONTROL AND PROCEDURES
Within 90 days prior to the filing of this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Regulation 13a-14 under the Securities Exchange Act of 1934. Based upon that evaluation, the President and Chief Executive Officer along with the Senior Vice President and Chief Financial Officer concluded that the disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the periodic SEC filings. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date the Company carried out its evaluation.
29
PART II: OTHER INFORMATION.
None.
30
