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Author: sleejohnson Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 197  
Subject: Q2 Results Date: 8/9/2001 11:22 PM
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I just got done listening to the conference call and reviewing the earnings announcement and these are my thoughts. Any comments would be welcome.

Sales were down compared to last year and were well below the 18-19 M projected during the last confenece call. Betker primarily blamed the economy and the lack of any big sales in the outdoor water play segment. He said sales were picking up and they had already booked or shipped 50% of projected 3Q revenues during the month of July alone.

Gross margins were down to 42.6% compared to 46.6% last year. During the call, Betker said they expect GM to go back to 45% in Q3 and Q4.

SG&A was up 26% even though sales were down. Part of this is due to acqusitions last year, but SG&A was higher than last quarter both in absolute dollars(4.9 million vs. 4.2 million) and as a percentage of sales (33.7% vs. 30.4%). Since there have been no acqusitions since last quarter, this is a problem for me. During the call, Betker said that the SG&A was up in part due to a $240,000 legal fees expense (he didn't say what for) and consolidating the Fibar acquisition. Betker said that without those two items, SG&A would have been down $100,000 compared to last year.

Operating margin fell to 4.8% due to the increased SG&A and lower sales.

The net margin was a loss of $57,000.

Turning to the balance sheet, KARE fell out of compliance with covenants on its credit facility and has negotiated waivers from its senior lenders. However, until terms of a new creidit facility are agreed upon, the $39,450,000 debt will be shown as a current liability instead of a long-term liability. Betker said they expect to complete negotiation of a new creidt facility within 30 days at which time the terms will be released to the public and the debt will be reclassified as a long term debt. Utilization of the credit facility increaed by 1.46 million last quarter.

Ignoring the credit facility, I calculate a Flow Ratio of 5.77.

Inventories were up substantially over last year, while A/R was down just a little. Betker said DSO was 60 days, and the company's target is 55 days. I calculate DSO at 102 days using just this quarter's sales. During the call, Betker said KARE would move aggressively to reduce inventories in 3Q (he didn't say how), but stated that gross margins would be maintained at about 45%.

Encouragingly, the company reported postive cash flow of $1 million for the quarter. We'll see the details on the cash flow when they file their 10-K on 8-14-01. They plan to do even better next quarter with the reduction in inventory.

For forward guidance, Betker projected revenues of 15 to 20 million for Q3 and 12 to 14 million for Q4. He also projected EPS of .13 to .20 for Q3 and .09 to .15 for Q4. He said the large ranges were due to uncertainty in the market.

In general, Betker tried to sound encouraging that business was picking up and that they look forward to making a lot of sales during the fall and winter when water parks and other outdoor facilities make buying decisions. He also said their initial exploration of foreign sales was encouraging.

The company's EPS projections amount to .28 to .41 for the year. Given the poor sales performance, declining earnings, and weak balance sheet, I am reluctant to place a p/e multiple higher than 8 to 10 on KARE. That suggests a price range of $2.24 to $4.10. Based on that, I'd have to say KARE is fairly priced at the current level of approximately $3.00 pending any further positive or negative developments.

The next significant event should be the announcment of the new creidt facility conditions in about 30 days. See you then.

Slee






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Author: koch Three stars, 500 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 192 of 197
Subject: Re: Q2 Results Date: 8/10/2001 1:33 AM
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Hey, Slee,

Thanks for the great summary.

I have no idea how much KARE is worth. However, I have a question: You say that KARE is worth a P/E of 8 to 10. I wonder if you are giving due consideration to their level of debt? Right now they have about $6 / share in debt!

Another way of putting it: If KARE had $0 in debt, would you value them at $8.24 to $10.10 per share?

--steve-o

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Author: sleejohnson Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 193 of 197
Subject: Re: Q2 Results Date: 8/10/2001 10:10 PM
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I have a question: You say that KARE is worth a P/E of 8 to 10. I wonder if you are giving due consideration to their level of debt? Right now they have about $6 / share in debt!

Another way of putting it: If KARE had $0 in debt, would you value them at $8.24 to $10.10 per share?


No. A reduction in a company's debt does not necessariliy translate dollar for dollar into an increase in market cap. In KARE's situation, I was using P/E as a valuation tool basically as a surrogate for future free cash flows. I did not do a DCF analysis becuase I have too much uncertainty regarding the future cash flows.

In some cases, debt can be good, at least if the company is able to invest the proceeds in something that gives a better return than the interest they pay. Still, it is usually better to have little or no debt.

For example, consider Comapny A, which has 100 shares selling at $1 each ($100 market cap) and coincidentlally has a book value (equity) of $100. Let's say Comapny A earns $15/year net profits for a return on equity of 15% and a p/e ratio of 6.67. Now, let's say company A borrows $100 as long term debt at 10% interest and uses the proceeds to buy $100 of assets. Let's say these new assets also give a return of 15%. Comapny will now earn $30 before interest and $20 after interest. ROE is now 20$ and EPS is $0.20. Which is worth more, Company A with no debt and $0.15 EPS or Comapny A with a debt to equity ratio of 1 and $0.20 EPS? The former is less risky, but the latter offers better prospects if nothing goes wrong.

I accounted for the debt level by adjusting the P/E. If KARE had no debt, I might be inclined to give it a P/E of 10 or 12. KARE's debt is fairly high, however. It might look like a debt to equitiy ratio of about 1, but if you subtract out goodwill and intangible assets, you'e find the debt to "tangible equity" (not a real term), the ratio is more like 3. So if you wanted to adjust the P/E down to 5 or 6 because of the debt and the risk that they won't be able to renegotiate the credit facility on favorable terms, I won't argue with you.

Slee



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Author: koch Three stars, 500 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 194 of 197
Subject: Re: Q2 Results Date: 8/11/2001 1:06 AM
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Slee,

I'm glad to hear you're in-depth with your analysis. I can completely see your point of investing with high risk for future return. I just wanted to make sure that everyone was aware of the relatively high debt.

--steve-o

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Author: sleejohnson Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 195 of 197
Subject: Re: Q2 Results Date: 8/11/2001 2:11 PM
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I can completely see your point of investing with high risk for future return. I just wanted to make sure that everyone was aware of the relatively high debt.

I take it you are TFV?

I probably should have been more clear in my post that "weak balance sheet" included the substantial debt burden KARE carries. I should also clarify that when I say KARE is "fairly valued" at 3.00, that is NOT my version of a "buy" recommendation. I try to buy companies at prices well below fair value. I don't think I would pay more than 1.50 for KARE based on what I know right now.

I believe the current price of about 3.00 reflects the expectation that KARE will be able to get a new credit facility on fairly decent terms. Therefore, I'm not expecting any spike up if/when the terms of a new credit facility are announced and I think there's a good chance the price will go down if the market is not pleased with the terms. Do you have a view on this?

Slee

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Author: DADUNCHDA One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 196 of 197
Subject: Re: Q2 Results Date: 1/20/2002 8:11 AM
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Some time has passed but at this point but I doubt these shares will fall below $3.oo for any length of time. Rather, I expect them to top $5.50 in the near term.
DADUNCHDA

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