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Author: raytoei Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 332  
Subject: A Peek at the Cash Flow Statement Date: 3/4/2004 8:22 PM
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Hi

This Post is in 2 Parts. A Question on FCF and the Answer from a Fellow poster.

Disclaimer: I bought Leap Frog shares today.

-------Part I: The Question -----------------------
Hi,

I culled the following from LeapFrog Entterprise's (LF) recent 8k filing (feb 10th).

I have the following questions regarding Calculation of Free Cash Flow:

(a) FCF = Net cash provided by operating activities less Capital Expenditure


"To calculate free cash flow, all you have to do is go to the cash flow statement and find
the line called "cash flow provided by operations," also known simply as "operating cash flow." Once you've found that, all you have to do is subtract net capital expenditures and what's left is free cash flow. Nothing to it. Really, it's not as tough as you might have it cracked up to be." TMF Grape
http://www.fool.com/portfolios/rulemaker/1999/rulemaker991210.htm

hence,

using TMF Grape's formulae, is it correct that the FCF for Leapfrog 2003 & 2002 is

2003 (A) + (B) = 26,800 + (59,030) = -32,230 (in thousands)
2002 (A) + (B) = 22,470 + (17,582) = 4,888 (in thousands)

Is this correct ?

(b) What is the effect of Net cash provided by financing activities with respect to FCF. Do I add them in out deduct them ?

(c) Lastly, can someone comment or provide insight on this 2003 cash flow statement ?

Disclaimer: I am a newbie in this. I do not own any LF stock. I am interested to find out why is the share dropping (besides the obvious competition from Fisher Price), whether this Cash Flow statement provides any clues.

Thanks!

RayToei
 
Net income $ 72,675 $ 43,444
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and Amortization 16,625 11,904
Provision for allowances for accounts receivable 40,165 25,178
Tax benefit from exercise of stock options and other 39,130 4,908
Other noncash items 7,088 (6,584)
Other changes in operating assets and liabilities:
Accounts receivable (152,287) (79,349)
Inventory (6,437) (38,357)
Prepaid and other current assets (4,305) (2,007)
Notes receivable due from related parties 595 94
Other assets (764) (136)
Accounts payable 27,317 24,433
Accrued liabilities 4,101 26,744
Income taxes payable (17,103) 12,198

--------- ---------
Net cash provided by operating activities (A) 26,800 22,470

--------- ---------
Investing activities:
Purchases of property and equipment (15,810) (14,832)
Purchase of intangible assets (3,000) (250)
Purchases of short term investments (76,136) (2,500)
Sale of short term investments 35,735 --
Sale of investment in related party 181 --

--------- ---------
Net cash used in investing activities (B) (59,030) (17,582)

--------- ---------

Financing activities:
Borrowings under credit agreement -- 182,000
Repayments under credit agreement -- (243,163)
Proceeds from the payment of notes receivable from stockholders 2,624 1,741
Proceeds from the issuance of common stock -- 115,116
Proceeds from the exercise of stock options and employee stock purchase plan 27,960 1,822

--------- ---------
Net cash provided by financing activities (C) 30,584 57,516

--------- ---------
Effect of exchange rate changes on cash 663 154

--------- ---------
Increase (decrease) in cash and cash equivalents (983) 62,558
Cash and cash equivalents at beginning of year 70,827 8,269

--------- ---------
Cash and cash equivalents at end of period $ 69,844 $ 70,827


--------- ---------

-------Part 2: The Reply -----------------------
Author: formorears
Subject: Re: Questions on FCF Calculation with Live Examp
Date: 3/3/04 10:26 PM

Hi RayToei,

You started in a good place -- with questions about cash flows and what insight they might provide us about Leapfrog's (LF) share drop. I'll try to give you some answers, although I hope someone will correct me if they see I am misleading you in any way. Hope this helps you. [I don't own shares of Leapfrog].

(a) FCF = Net cash provided by operating activities less Capital Expenditure

using TMF Grape's formulae, is it correct that the FCF for Leapfrog 2003 & 2002 is

2003 (A) + (B) = 26,800 + (59,030) = -32,230 (in thousands)
2002 (A) + (B) = 22,470 + (17,582) = 4,888 (in thousands)

Is this correct ?

No, this is not correct. Your (B) number is not the capital expenditure number.

Another way to say “Capital Expenditure” is “Purchase of property and equipment”. You will find this under the “Investing activities” heading, but it is not the total of investing activities as you used above in (B), but instead just one piece of investing activities.

So for Leapfrog, the numbers for “Purchase of property and equipment” (also known as Capital Expenditure) are (15,810) for 2003 and (14,832) for 2002. These should be your (B) numbers.

Using these (B) numbers, your free cash flow calculation as defined by TMF Grape would be as follows…

2003 (A) + (B) = 26,800 + (15,810) = 10,990 (in thousands)
2002 (A) + (B) = 22,470 + (14,832) = 7,638 (in thousands)

(b) What is the effect of Net cash provided by financing activities with
respect to FCF. Do I add them in out deduct them ?


You don't add them and you don't deduct them for FCF purposes -- you don't do anything with them in respect to FCF. FCF is computed from numbers higher up in the Cash flow Statement.

The purpose of “Financing activities” section of the Cash flow Statement is to tell you about funds the company borrowed or paid back to lenders, and funds the company received from the sale of stock or paid out for the purchase of its stock.


(c) Lastly, can someone comment or provide insight on this 2003 cash flow statement ?... I am interested to find out why is the share dropping (besides the obvious competition from Fisher Price), whether this Cash Flow statement provides any clues.


Leapfrog's Cash Flow Statement is very informative, so I'm glad you chose to look at it. There are many insights we can find from this statement, but I am going to focus on just one for now…

Please look at the line on the Cash Flow Statement that says “Accounts receivable”. This was (152,287) in 2003 and (79,349) in 2002. Negative numbers here generally are not good. They mean that receivables are increasing. If a company has receivables increasing at a faster rate than sales, it may mean that the company is offering more generous payback terms to its customers – in effect, lending them money.

Looking at the Balance Sheet and Income Statement for Leafrog, you will see that receivables were about 85% of sales at the end of 2003 whereas at the end of 2002 they were about 68% of sales. Not good.

The suspicion here is that Leapfrog offered its customers very liberal payback terms this Christmas season in order to ship and bill more merchandise in Q4. However, that probably means these same customers will not be ordering as much in Q1. The worry among analysts is that Leapfrog was stealing sales from Q1 in order to pump up sales in Q4. So that is one reason the share price has dropped.


There appear to be many other reasons for the share fall. The company's results for Q3 last year came in much lower than expected. This triggered a bunch of class action lawsuits against the company last fall. There also was a management shakeup. In addition, the company (not surprisingly, given the lawsuits) says “it will no longer provide an outlook for its financials on a quarterly basis due to the seasonality of its business”. The short interest ratio for Leapfrog was about 32% at the beginning of February -- not a good sign.

Here are some links to articles that will give you more information about Leapfrog's flop…

LeapFrog shares fall 11 pct on sales worries
http://biz.yahoo.com/rc/040211/manufacturing_leapfrog_stocks_4.html

Is LeapFrog a Prince?
http://www.fool.com/News/mft/2004/mft04021103.htm?source=eptyholnk303100&logvisit=y&npu=y
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