Saturday, June 21, 2014

Financial Statements: Confusion and Mystery Are Built Into The Design

Corporate America's dirty little secret: Financial Statements are Rubic Cubes.

 CFO: "I rely on what the auditors and accountants tell me, they told me it was appropriate". 

The District Attorney and SEC will have their accountants and we'll have ours.

Thursday, June 19, 2014

Declining Profits and Higher Credit Costs Add Risk to Titan Machinery as a Going Concern

by Michael Markowski
Titan Machinery shareholders and investors should be concerned about several new issues surrounding the company’s Balance Sheet and Income statement which are having a direct effect on the credit terms of their $150 million bond with Wells Fargo.  The company increased Total Liabilities for its first quarter ending April 30, 2014 by $38 million to a record $1.19 billion.  These added liabilities increase the risk that Titan could violate the net leverage ratio in the credit agreement that that it has with Wells Fargo.  Management’s strategy to borrow to build up inventory by $41 million to $1.12 billion during its first quarter of 2015 (ending April 30, 2014) and to also increase its inventory during its second quarter (ending July 31, 2014) and then to only have to liquidate at least $291 million in inventory in it last two fiscal quarters to meet its inventory reduction guidance is risky. 

Due to the amending of Titan’s credit agreement with Wells Fargo in April of 2014, the company now has a new minimum net income requirement that it must meet.   With the adding of the new requirement and the company still having to meet its pre-existing  maximum liabilities requirement the risk that Titan might violate its credit agreement increases considerably.   Titan now has two key credit agreement requirements that it must meet which are mutually exclusive.   The conflict between the two requirements is that, should Titan have to liquidate its inventory at a discount in order to reduce its liabilities, it could potentially violate its net income requirement.   Titan increasing its liabilities and inventory over its most recent quarter along with its guidance that it will increase its inventory in its current quarter ending July 31st only exacerbates the situation

Amendments to Wells Fargo credit agreement requirements
Under Wells Fargo’s new “Consolidated Net Income” credit agreement requirement, Titan must maintain minimum net income for its trailing 12 months of $5 million for its second quarter ending July 31, 2015 and third quarter ending October 31, 2014.  The minimum increases to $10 million for its 12 months ending January 31, 2015. 

The third amendment to the Wells Fargo credit agreement specifies that Titan can exclude its after tax losses of $6.1 million ($10.0 million pre-tax) for its fourth fiscal quarter of 2014 and $1.9 million ($3.2 million pre-tax)  for its first fiscal quarter of 2015 from its calculation of Consolidated Net Income.  Based on adding back the combined $8.0 million of the net or after tax charges to Titan’s realized $5.1 million of Consolidated Net Income for its 12 months ended April 31, 2014, the company generated $13.1 million of Consolidated Net Income for its latest trailing 12 months.

The existing “Consolidated Net Leverage Ratio” requirement that Titan must meet is that its Total Liabilities cannot be greater than 3.25 times its tangible equity for its quarters ending July 31st or October 31st.  The ratio lowers to 3.0 for its quarter ending January 31, 2015. 

Based on Titan’s current tangible book value of approximately $370 million at April 30th the company’s Total Liabilities can not exceed $1.20 billion at July 31st or October 31st and $1.11 billion at January 31, 2015.   Due to Titan’s having Total Liabilities of $1.19 billion for its quarter ended April 30th it’s currently within $10 million of the maximum permitted by October 31st.   The current amount exceeds the $1.11 billion in Total Liabilities that Titan is permitted to have at January 31, 2014, by $80 million. 

Wells Fargo Amends Credit Agreement for Protection against Weakening Fundamentals
We believe that the insertion of the new Consolidated Net Income minimums into Titan’s credit agreement was due to Wells Fargo becoming  increasingly nervous after the company had to take write offs for its last two fiscal quarters.  In April Titan reported FY2014 results and disclosed a non-cash impairment charge of $10.0 million ($6.1 million after tax) for its fourth quarter of 2014 and a $3.2 million ($1.9 million after tax) realignment charge for its first quarter of 2015.  Also in April, Titan gave  guidance that it would reduce its inventory by $250 million before the end of its 2015 fiscal year as compared to the amount on hand at January 31, 2014, we suspect that may have been motivated by Wells Fargo tightening..  

When Wells Fargo originally loaned Titan Machinery $150 million two years ago, they created the loan in the form a convertible.   The recent poor performance of Titan Machinery’s underlying business has caused the investment bank to move their focus from the equity upside and to zero in on hoping it will ever regain their principal.  Wells Fargo made the mistake of agreeing to price their equity conversion at $43 per share based on Titan's year-end earnings of $44 million for the Fiscal Year 2012.  Had Wells Fargo paid closer attention to Titan’s negative $182 million of cash flow from operations, they would have been more critical of the Titan business model.  With Titan closing eight of its stores 60 days ago, and its trailing 12 month net income dwindling from $44 million in Fiscal 2012 to a mere $5.1 million for the trailing 12 months ending April 30, 2014; the weak quality of its earnings are surfacing.  With the release of its first quarter financials, the company has reported two consecutive quarters of losses for the first time in the company's history.
Wells Fargo has been generating a great deal of fees from the note.  However, with their third amendment of the credit agreement they are now tightening the covenants as it becomes increasingly apparent that there is a risk that Titan may be unable to pay off the loan.   
Orderly liquidation of Inventory could be a problem
Six weeks from now, on August 1st, Titan will enter its second half of fiscal 2015.  Over its last two fiscal quarters, the company will have to liquidate more than $291 million of its inventory to meet the inventory guidance level of $826 million by January 31, 2015.  The actual amount to be liquidated has yet to be determined because management has stated that its inventory will increase for its second 2015 fiscal quarter as compared to the amount of inventory which it had at the end of its first 2015 fiscal quarter but didn’t disclose an exact amount nor range.  

Titan does not have a history of decreasing its inventory between its second and third fiscal quarters.  For its fiscal 2014 third quarter ended October 31, 2013; its inventory increased by $70 million as compared to its prior fiscal second quarter.  In fiscal 2013, Titan’s inventory increased by $110 million from its second to its third quarter.  

The company’s management in its “Q1 2005 earnings presentation”, stated that the prices for used agricultural equipment had been under pressure “due to higher industry levels of used equipment”.  The majority of Titan’s used inventories consist of agricultural equipment due to the fact that the revenue which it derives from selling agricultural equipment is 3.5 times greater than its construction equipment sales.   On June 11th, after the USDA revised their outlook for the 2014 corn crop, an economist predicted that the price of corn would decline by 20% for calendar 2014 as compared to 2013, thereby; potentially reducing farm discretionary income for capital goods investments.

The big question facing Titan is how drastic will the haircut be when it starts to liquidate at least $291 million of its inventory from their present level of $1.17 billion to $826 million?  Assuming a modest discount of 5% would put the company on the threshold of violating its credit agreement with Wells Fargo and a discount of 10% or more would most likely result in Titan violating its credit entirely.
There are many macro challenges facing the machinery equipment industry and Titan only being a reseller, already is at a disadvantage.   It competes directly with manufacturers including Caterpillar (CAT), Deere Co (DE), CNH (CNHI), & AGCO Corp. (AGRO).  During its last two quarters of fiscal 2015, Titan’s management will not only need to generate revenue at a profit, but will also  have the added pressure from Wells Fargo to meet minimum requirements to conform with the amendments to the credit agreement. 

Titan will have to liquidate its inventory to insure that its liabilities do not go above the maximum allowed under its Consolidated Net Leverage Ratio requirement.  Titan will also have to generate the net income to meet its minimum Consolidated Net Income requirement.  A violation of either of the requirements could result in Wells Fargo calling the loan and Titan only having $80 million cash on hand would not be able to return the $150 million which could cause   the company to potentially file for bankruptcy protection.  

Titan’s financial problems are all encompassing
Titan’s financial problems are not limited to its Income Statement and Balance Sheet.   The picture that its Cash Flow Statement paints is not a pretty one.   In its June 2014 announcement for its first quarter 2015 results, Titan stated that it had “generated $10.7 million in adjusted operating cash flow”.  The reality is that Titan generated a negative $54.6 million of operating cash flow for its most recent quarter.  This compared to negative operating cash flow of $6.3 million for its previous year’s same fiscal quarter.  

Titan adjusted its negative operating cash flow from a negative $54,602,000 to an adjusted (NON GAAP) positive cash flow of $10,703,000 for the quarter.  Titan adjusted (or added) the $65,305,000 of cash provided by its Floor Plan financings to its Cash Flow from Operations section of its Cash Flow Statement to reach the positive NON GAAP number.  The only way that it has been able to increase the cash that it has in the bank is by increasing its borrowings or issuing and selling its shares.  Titan’s growth has been totally dependent on growing its short and long term debt which have both increased for the past three consecutive years.  For anyone to say that Titan generates cash from its operations would be a figment of their imagination. 
Net cash used for operating activities
Net change in non-manufacturer floor plan payable
Adjusted net cash provided by operating activities

In my previous April 16, 2014 report on Titan, “Titan Machinery’s Inventory Reduction Guidance will Lower Future Sales Significantly”; I said that based on what I had learned from management’s guidance for fiscal 2015, that Titan would no longer be viewed as a growth company and that it should be “relegated to be a cyclical tractor dealership”.  I also predicted that its share price was “headed to below $10 and that the possibility of it having to file bankruptcy remains.”  The price of a Titan shares have since fallen from $18.51 to as low as $15.34.   Based on the research that I have conducted on its most recent quarterly report and the recent price action of Titan shares, the probability of my predictions happening has increased considerably.

I started following Titan religiously after it had been diagnosed by as having The EPS Syndrome for two consecutive quarters.  The formula for The EPS Syndrome that I developed is based on a Cash Flow/Income Statement anomaly that I discovered when conducting a post mortem autopsy on Enron.  The formula was converted into an algorithm which utilizes to automatically diagnose public companies which have The EPS Syndrome.  Its predicted share price collapses and the bankruptcies of more than 100 companies over the past 10 years.  Over the years, I discovered that those companies having multiple diagnoses, which included Lehman Brothers, had a higher probability of going bankrupt.  We believe that Wells Fargo’s insertion of its new Consolidated Net Income maintenance requirement into Titan’s credit agreement is the catalyst that could put Titan into bankruptcy by as early as this October.  A video about The EPS syndrome that also covers some of those companies that went bankrupt after being diagnosed, including Lehman Brothers, is available.  Titan is the mystery company at the end of the video.     
By Michael Markowski 754-200-5119

New Credit Agreement Requirements Makes Titan Highly Speculative

New Credit Agreement Requirements Makes Titan Highly Speculative
Investors with high risk tolerance looking to make multiples on their investment seek out highly speculative stocks. There are thousands of these stocks available on the over the counter bulletin board and pink sheet market, trading at pennies per share.  Investors are looking at these micro cap stocks that mostly trade below a $10 million market capitalizations and hope the underlying businesses can grow to $100 million valuation one day over the long term.  The common denominator among these stocks is the inability for these businesses to generate enough internal operational cash flow to grow.  These companies are all out seeking financing from Wall Street firms, on both the debt and equity side. Will Titan do another Underwriting soon?

Titan Machinery was a little private reseller of agriculture and construction equipment located in the mid west prior to it successfully going public in December 2007.  
By Titan being a publicly traded company it was able through the years to raise equity and debt to compensate for their inability to generate operational cash flow.  Since February 1,2009 Titan has generated over $517 million in Negative Operational Cash flow.

  • FY2010 Negative $47 million Operational Cash Flow
  •  FY2011 Negative $35 million Operational Cash Flow 
  •  (FY2012 Q2) Equity Underwriting 4.2 million shares @ $28.75
  •  FY2012 Negative $182 million Operational Cash Flow 
  • (FY2013 Q2) Debt Underwriting $150 million Convertible Note 
  •  FY2013 Negative  $115 million Operational Cash Flow 
  •  FY2014 Negative $82 million Operational Cash Flow
  •  FY2015 Q1 Negative $54 million Operational Cash Flow 

Since Wells Fargo has recently made two amendments to the $150 million Credit agreement, Titan’s risk of violating these new covenants has increased substantially. Unlike most high risk micro cap securities that have low market capitalization with high upsides, Titan Machinery trading near $16  per share has an even higher risk with an $330 million downside if it was to default on its note.


Thursday, June 12, 2014

Don't Assume Titan Machinery Will Be Profitable because Management Says So

On Yahoo Finance someone asked "What PE Should Titan Machinery Trade At?"

My Answer:

Your question assumes Titan Machinery will even have any earnings in FY 2015.
I question if Titan will even be profitable this year.
In the company's most recent reported Q1 they loss ($0.20) per share. The quarter prior to that ,Q4, they loss money as well.

We can't expect the management's guidance to mean anything.
Management made the following Guidance for FY2014:
  • On April 10,2013 gave guidance for FY2014 of $2.00-$2.30.
1 month later on:
  • On May 23,2013 guidance for FY2014 was lowered to $1.70-$2.00
3months later on:
  • On September 5,2013 guidance was lowered again to $1.20-$1.50
When the year ended on January 31,2014 the FY2014 EPS came in @ $0.78 per share.

Everyone needs to realize that this company has generated a total of negative $434 million of operational cash flow over last 13 quarters combined.

The Management is deceiving the Public by advertising NON GAAP cash flow. The only reason that that insignificant number was positive in this Q1 is because they add the monies they borrowed in the first quarter to cash flow. (that is why they allowed the floor plan debt to go up, so that they can make their NON GAAP cash flow number to be positive, how ridiculous)

 By increasing their net floor plan debt they were able to report a positive NON GAAP C/F number in Q1. Ridiculous? definitely.

Management has an equity interest in Dealer Sites LLC. Titan recently increased their lease agreements with Dealer Sites from $50million to $100 million last year.
Management is making money on properties, (thanks to Titan footing the bills).
Titan pays for insurance and all expenses of the property although it is owned by outside entity owned by management.
In FY 2012 and FY2013 the 10K disclosed the related party dealings in detail. In April's FY2014 10k , Deloitte allowed Titan to omit this disclosure.

It appears to me that CNH was stuffing Titan with inventory these past few years to boost CNH's own revenue/profit numbers (timely with Fiat deal). The relationship with CNH is very Cozy. A large percentage of the inventory that Titan has parked, they are not paying interest on.

Wells Fargo recently amended the convertible note terms for the 3rd time. (tightening the covenants more and more).
Titan's debt/equity for Q1 increased from .70 to .716

The other big issue here, is what are these Mutual Fund Analysts (Money Managers) getting paid for? Have you seen what ZACKS has been reporting? another joke.

If you look on Morningstar at the list of institutional holders of both the Equity and the Debt, I wonder how do these decision makers have jobs? It is even more scary that mom and pop are trusting their nest egg monies with these amateurs (and they actually pay these funds to manage their money).

oh boy, Wall Street, what a silly place

List of Institutional Holders  


Most OverPriced Stock Titan Machinery Files Proxy Statement

A Review of Securities & Exchange Commissions Comments regarding Titan Machinery Disclosure

Markowski says Titan Machinery Will Be Bankrupt

10K FootNote: Wells Fargo Tightens Debt Agreement (again) on Titan Machinery

Thursday, June 5, 2014

Markowski says Titan Machinery Will Be Bankrupt

Michael Markowski , June 5, 2014 (Titan MAchinery : NASDAQ: TITN)

After TITN reported its FY2014 and Q4 2014 results and especially their FY2015 guidance, I had believed that Titan’s executives had seen the light and had changed their ways.  I had backed off on my prediction that TITN would file for bankruptcy by the end of 2014.  See April 16th report “Titan Machinery's Inventory Reduction Guidance Will Lower Future Sales Significantly”

Based on their Q1 2015 report that they released to today I now believe that probability that Titan’s shares will be at single digits and will file for bankruptcy by the end of 2014 is higher than ever.  Its because of the following:

1.                  Since TITN’s inventories went up by $41 million it will now have to reduce its inventories by $291 million instead of $250 million to meet its inventories reduction guidance that it gave for FY2015.  Instead of spreading the reduction of inventories over four quarters it is going to have to spread the higher amount over three quarters.  This makes it much more probable that TITN will be forced to sell its Inventories at a deeper discount.

2.                  TITN’s operating expenses for the quarter increased by over $2 million as compared to the year earlier quarter.   Operating expenses should have gone down due to the realignment and the closing of the stores. 

3.                  TITN’s Equipment sales increased by 3%.   That its parts sales increased by 9% or at a rate that is 200% higher than its equipment sales indicates that its customers are not purchasing new or used equipment and are instead refurbishing existing equipment.   This increases the probability that TITN is going to have to sell their inventories at a deeper discount. 

4.                  By TITN increasing its Total Liabilities to $1.19 billion and the decline of its tangible book value by $6 million its within $10 million of violating its Debt to Tangible equity ration of 3.25 that it must meet by October of 2014.   If it maintains the status quo it would be in violation of the 3.0 ratio that it must meet by January 2015.

5.                  TITN negative operating cash flow for the quarter was a negative $54.6 million versus a negative $6.3 million for the prior Q1 2014 quarter.  Based on this number I believe that its going to be very difficult for TITN to meet its FY 2015 Cash Flow guidance.   Also, adjusted Cash Flow numbers are poppy cock.   

I am going to prepare a detailed follow up report on this which I intend on posting on Yahoo Finance, and on the

Michael Markowski, Founder of and 

Titan Machinery Reports Q1 Loss of ($0.20)