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Stocks K / Koala Corporation


Subject:  Liquidity Date:  6/14/2001  10:25 PM
Author:  koch Number:  182 of 197

Hi, Fools,

I have spoken previously (#163 ) about KARE's cash trouble. I do not hold a position in KARE, and I am certainly not rooting against them. However, I have just read bits of their most recent 10-Q (source: ) and it certainly didn't change my mind. I have copied the section, "Liquidity and Capital Resources" at the bottom of this message. There are at least two parts of it that I feel are downright sneaky, and about which I am curious how other Fools feel.

First, the company states, " cash flow, defined as net income plus non-cash items,
decreased by $536,816 to $1,271,090 for the three months ended March 31, 2001..." What? So, the company is allowed to simply redefine free cash flow, in order to make it seem like cash is just pouring in, well above stated earnings? Here's how The Motley Fool would calculate KARE's free cash flow ( ):

For three months ending March 31, 2001:
Net cash provided by (used in) operating activities (1,532,591)
Capital expenditures (167,134)
Free Cash Flow = (1,699,725)

Note, that the company has defined free cash flow as "Earnings plus depreciation plus amortization," specifically leaving out accounts receivable and payable, which are critical. That makes a difference of minus $1.7 million, which is more than enough to illustrate that KARE was not free cash flow positive. Am I missing something, or does this seem completely dishonest? Please correct me if I am wrong, but I am of the strong opinion that KARE is currently burning cash fairly quickly. (To be more fair, I think managment has previously used this misleading definition of free cash flow, e.g. last year's corresponding 10-Q. However, I cannot find a similar definition elsewhere, , )

The above discussion of free cash flow is important for my second problem with Managment's discussion in the 10-Q. They state, "The aggregate outstanding balance under the credit facility may not exceed 3.5 times consolidated EBITDA (as defined in the loan agreement), determined quarterly on a four quarter trailing basis. Based on the March 31, 2001 financial statements, the aggregate balance available will be $39.0 million, effective May 15, 2001." Now, as of March 31, 2001, they owed $39.5 million, and had $0.2 million in cash. Given the negative cash flow, it is a complete mystery to me how they claim to be in compliance with the $39.0 million limit.

So, let's see here. It takes a non-standard calculation of cash flow in order to say that the company is making money. Furthermore, the company has maxed out its revolving credit facility (the equivalent of a credit card), which is "secured by substantially all of the assets of the Company." I think this is perhaps the apotheosis of a red flag ( I have waited 6 years to use that word). I read a short story last night last night by Faulkner called "Turnabout." In the end, a WWII pilot dives his plane towards the enemy headquarters. Unusually inspired, he keeps diving much longer than required, until he can see between the shingles on the roof. He pulls up at the last minute and his copilot releases the bomb, earning them great exhiliration and some kind of medals. But the narrator points out that had the mission failed, and had the pilot survived, he surely would have been court-martialed for the unauthorized, unneccessary risk. So, the question is, will KARE get the m