A Warren Buffett Quote About Cash Flows

Every year in the Berkshire Hathaway Inc.(NYSE: BRK $213,725.00) annual reports, chairman Warren Buffett shares his investment philosophy and strategies.

I recently went through each annual report since 2000 and did a search for the phrase "cash flow".
Each report averages about 20 pages and after searching 15 reports the phrase "cash flow" only was found once. (in 2000)

6/1/2000

Warren Buffett, Chairman of Berkshire Hathaway: click to  <2000 Annual Report:

"Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years.
Market commentators and investment managers who glibly refer to growth and value styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component--usually a plus, sometimes a minus-- in the value equation."

Titan Machinery's Inventory Reduction Guidance will Lower Future Sales Significantly

Creditors Forcing Titan To Switch Gears

report by Michael Markowski, www.OnlinefinancialSector.com

When Titan Machinery released its fiscal 2014 year end results on April 10, 2014, it forecasted or provided guidance for its operating cash flow.  Titan stated that it was going to generate $60 million to $80 million in positive non GAAP operating cash flow for its current fiscal year ending January 31, 2015.  It further stated that the method that it would utilize for the Company to generate positive operating cash flow in a fiscal year for the first time in at least six years was its liquidation or its reduction of its equipment inventories by $250 million.  Under Titan’s inventories reduction guidance total inventories would decline from $1.08 billion as of January 31, 2014 to $758 million by January 31, 2015. 

We are highly confident that the decision by Titan’s management to reduce its inventories to $758 million will result in a decline in the Company’s revenue and profits for fiscal 2016 as compared to fiscal 2015.  Fiscal 2016, would be the second consecutive year that Titan’s revenues decline.  Titan, based on its own guidance that it has already given, will depart fiscal 2015 by reporting its first annual revenue decline since it’s been a public company. 

Those who are invested in Titan’s shares are having a great time at the grand party that started as soon as its management concluded their conference call.  During the call, which included a 23 page presentation, Titan’s management provided details and highlights for its fiscal 2014 earnings report.  It also provided guidance for fiscal 2015. 

Every great party always ends with a hangover.  As Titan moves through fiscal 2015, the analysts making of and publishing their projections for its next fiscal year (2016) beginning on February 1, 2015, will become increasingly paramount.   As the analysts and Titan’s institutional investors begin to do their homework we have no doubt that they will come to the same conclusion that we have come to.  Doubts as to whether or not Titan can continue to be a growth company or even meet its EPS projections for 2015 will begin to surface.  During 2013, Titan’s management lowered it EPS guidance for its 2014 fiscal year three consecutive times.  . 

Titan Machinery’s EPS Guidance for Fiscal Year (FY) January 31, 2014

Date of Guidance EPS Estimate FY 2014 Final EPS  FY 2014 04/10/13 $2.00-$2.30 $0.78 05/23/13 $1.70-$2.00 $0.78 09/05/13 $1.20-$1.50 $0.78 12/05/13 $0.55-$0.75 $0.78

There was one highlight at the bottom of page 19 of the presentation which Titan’s management provided to analysts and investors on April 10, 2014 that raised our eyebrows.  It was that the company had “$410.7 Million Available on $1.2 Billion Floorplan lines of Credit”.  On November 14, 2013, Titan’s Credit Agreement with Wells Fargo had been amended.  Under the amended terms and conditions Titan’s Net Leverage Ratio (Total Liabilities/Tangible Equity) was permitted to be a maximum of 3.5 for any fiscal period on or after January 31, 2014.  

According to the Balance Sheet data which Titan published in its April 10^th press release its Total Liabilities were $1.15 billion on January 31, 2014.  Titan’s permitted Total Liabilities under the Credit Agreement that was amended on November 14, 2013 was $1.31 billion.  The maximum net amount that Titan could have increased its Total Liabilities by as of January 31^st was $160 million and not the $410.7 million that the company claimed was available via its unused portion of its Floorplan lines of Credit.  The difference between the two amounts is $250.7 million.  

On April 3, 2014, which was one week before Titan announced its earnings, the company’s Credit Agreement with Wells Fargo was again amended.  Under the new terms the Company’s Consolidated Net Leverage Ratio was decreased from 3.5 to 3.25 by October 31, 2014 and to 3.0 by January 31, 2015.  The Total Liabilities permitted under the amended terms was $1.22 billion for fiscal quarters ending July and October 31^st and $1.12 billion on January 31^st.  This assumes no change in Titan’s tangible book value.  In its guidance Titan indicated that the company would take a $4.2 million pre-tax charge associated with the company’s realignment that it expects to be realized in the first quarter of fiscal 2015.  This charge could lower Titan’s tangible book value and reduce it permitted Total Liabilities. 

Based on the recently amended Wells Fargo Credit Agreement, Titan’s Total Liabilities for its fiscal quarters ending on July 31, 2014 and October 31, 2014, can only increase by $70 million as compared to what its Total Liabilities were on January 31, 2014.  By January 31, 2015, Titan’s Total Liabilities will have to decline by $30 million as compared to January 31, 2014 for the company to remain under its ratio of 3.0.  The unused portion ($410.7 million) of its Floorplan line of credit will be un-utilizable.

Obviously, the decision that management made to reduce its inventories for the purpose of Titan to begin to generate positive operating cash flow was based on necessity.   However, Titan’s management overreacted in their including a $250 million reduction of inventories by January 31, 2015, in their guidance for Fiscal 2015.  Titan’s management did not do their homework.  They have not seriously considered the ramifications or repercussions from their reducing inventories by 25%. 

There are two issues that Titan’s management should have considered before they calculated the amount of that they were reducing their inventories by for their fiscal 2015 guidance.  If these issues had been considered we believe that they would have made the decision to reduce Titan Machinery’s Inventories by an amount that was much less than $250 million.   

The first issue that they did not address is that there is a strong historical correlation between Titan’s revenue and its Inventories growth rates.  The table below illustrates and compares the growth rates of Titan’s inventories and revenue for its fiscal years 2010 through 2014.  The decline in the growth rate of its inventories for 2014 to 8.5% from 24.2% resulted in a sharp decline in its revenue growth rate to 1.3% from 32.5%.  

Growth Rates for Titan Machinery’s Inventory and Revenue for Fiscal Years 2010 through 2014

Fiscal Year Inventories Growth Rate Revenue Growth Rate 2014 08.5% 01.3% 2013 24.2% 32.5% 2012 74.0% 52.3% 2011 23.5% 20.4% 2010 44.4% 21.4%

The second issue that Titan’s management failed to consider is the company’s historical Revenue/Inventories ratio.  The table below further illustrates the relationship or ratio between Titan’s revenue and its inventories.  The ratio or multiple of Revenue that Titan has generated has ranged between 2.06 and 2.53 times its inventories since 2010. 

Titan Machinery’s Revenue/Inventories Ratios, Fiscal Years 2010 through 2014

Fiscal Year Revenue Inventories Rev/Inv Ratio 2014 2.23B 1.08B 2.06 2013 2.20B 929M 2.37 2012 1.66B 748M 2.22 2011 1.09B 430M 2.53 2010 838M 348M 2.41

Titan has forecasted that it will reduce its inventories from $1.08 billion to $758 million by January 31, 2015.  It’s the one and only forecast in Titan’s guidance that will be easy for them to achieve.

Since Titan’s $250 million reduction in its Inventories is all but guaranteed it’s much easier for even a novice to project future revenue for the company.  Projecting the minimum and maximum ranges of future annual revenue for Titan is as simple as multiplying the projected amount of inventories by the company’s lowest and highest revenue/inventories ratios over its prior five years.  With the reduction in Titan’s inventories we are projecting its revenue range for fiscal 2016 to be $1.56 billion at the low end and $1.91 billion at the high end.  Our top end number for 2016 is below Titan’s low end revenue number of $1.95 billion for fiscal 2015. 

Titan’s management in providing guidance on its operating cash flows and reduction in inventories has painted itself into a corner.  Its due to them not considering the downside regarding the reduction of inventories by 25% in fiscal 2015 as compared to fiscal 2014.  Its extremely difficult for any company to make the argument that they can continue to increase revenue while significantly decreasing inventories.  We have no doubt that savvy investors and analysts will confront Titan’s management with the same mathematical argument that we are making.  Titan’s severe inventory reductions will result in its generating significantly lower revenue and EPS for both its 2015 and 2016 fiscal years.       

As soon as the stock market starts to price in or discount the increasing probability that Titan Machinery will have lower revenue in fiscal 2016 as compared to fiscal 2015, its share price will begin to head lower and go to a single digit price to earnings (PE) multiple or ratio.  Either actual or projected consecutive annual revenue declines will relegate Titan Machinery to being a cyclical tractor dealership play.  Based on Titan’s minimum non GAAP earning per share projection of $.70 and maximum of $1.00, and its history of guiding forecasts down during prior fiscal years we are projecting that its share price will be trading below $10 by the end of 2014.

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

Friday morning Titan Machinery filed with the Securities & Exchange Commission its annual report (10K) for Fiscal year 2014 for the period ending January 31,2014.

•  FY 2014 Net Income declined 79% from $42 million in FY 2013 to $8.8 million for FY 2014.

• Titan's cash position declined to $74 million from $125 million in FY 2013.
  (Total Liabilities are over $1.1 billion)
  

 In the Footnote Exhibit 10.53 terms of Titan Machinery's $150 million convertible note with Wells Fargo is disclosed with Amendments that were made on April 3,2014.

 (Note Titan's 1st Quarter of FY 2015 ends in less than 3 weeks. Thursday April 10th announced that they would be closing 7 construction sore and 1 agriculture location and the company will be taking a $4.2 million pre-tax charge, or $0.12 per diluted share, associated with the Company’s realignment that it expects to be realized in the first quarter of fiscal 2015.)

  

10 K EX 10.53: THIRD AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

dated as of April 3, 2014

1.1.6    Effective as of the Third Amendment Effective Date, Section 6.12(a) of the Credit Agreement is hereby deleted in its entirety and the following is substituted therefor:

(a)    Consolidated Net Leverage Ratio. Borrower shall maintain, (a) as at the end of each Fiscal Period ending April 30, 2014 through the Fiscal Period ending October 31, 2014, a Consolidated Net Leverage Ratio not greater than 3.25 : 1.00, and (b) as at the end of each Fiscal Period from and after the Fiscal Period ending January 31, 2015, a Consolidated Net Leverage Ratio not greater than 3.00 : 1.00.

1.1.7    Section 6.12(b) of the Credit Agreement is hereby deleted in its entirety and the following is substituted therefor:

(b)    Consolidated Fixed Charge Coverage Ratio. Borrower shall maintain, as at the end of each Fiscal Period, a Consolidated Fixed Charge Coverage Ratio not less than 1.25 : 1.00.

1.1.8    The following is hereby inserted in the Credit Agreement as Section 6.12(c):

(c)    Consolidated Net Income. Borrower shall maintain, (a) as at the end of each Fiscal Period ending January 31, 2014 through the Fiscal Period ending October 31, 2014, for the period consisting of the four consecutive Fiscal Periods ending on such date, a Consolidated Net Income of not less than $5,000,000.00, and (b) as at the end of each Fiscal Period from and after the Fiscal Period ending January 31, 2015, for the period consisting of the four consecutive Fiscal Periods ending on such date, a Consolidated Net Income of not less than $10,000,000.00. For purposes of this Section 6.12(c) only, (a) for all Fiscal Periods through the Fiscal Period ending October 31, 2014, the One-Time Impairment Charge (net of the tax benefit to the extent already included in the determination of Consolidated Net Income) shall be excluded from the calculation of Consolidated Net Income, and (b) for all Fiscal Periods through the Fiscal Period ending October 31, 2014 for that portion of the One-Time Restructuring Charge incurred in the Fiscal Period ending January 31, 2014, and through the Fiscal Period January 31, 2015 for that portion of the One-Time Restructuring Charge incurred in the Fiscal Period ending April 30, 2014, the One-Time Restructuring Charge (net of the tax benefit to the extent already included in the determination of Consolidated Net Income) shall be excluded from the calculation of Consolidated Net Income.

3rd Quarter 10Q Footnote 10.2 Wells Fargo

SECOND AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT

dated as of November 14, 2013

1.1.5       Effective as of October 31, 2013, Sections 6.12(a) and (b) of the Credit Agreement are hereby deleted in their entirety and the following are substituted therefor:

(a)           Consolidated Net Leverage Ratio.  Borrower shall maintain, (a) as at the end of the Fiscal Period ending October 31, 2013, a Consolidated Net Leverage Ratio not greater than 3.75 : 1.00, (b) as at the end of each Fiscal Period beginning with the Fiscal Period ending January 31, 2014 through the Fiscal Period ending October 31, 2014, a Consolidated Net Leverage Ratio not greater than 3.50 : 1.00, (c) as at the end of the Fiscal Period ending January 31, 2015, a Consolidated Net Leverage Ratio not greater than 3.25 : 1.00, and (d) as at the end of each Fiscal Period from and after the Fiscal Period ending April 30, 2015, a Consolidated Net Leverage Ratio not greater than 3.00 : 1.00.

(b)           Consolidated Fixed Charge Coverage Ratio.  Borrower shall maintain, (a) as at the end of each Fiscal Period beginning with the Fiscal Period ending October 31, 2013 through the Fiscal Period ending January 31, 2014, a Consolidated Fixed Charge Coverage Ratio not less than 1.15 : 1.00, (b) as at the end of each Fiscal Period beginning with the Fiscal Period ending April 30, 2014 through the Fiscal Period ending October 31, 2014, a Consolidated Fixed Charge Coverage Ratio not less than 1.20 : 1.00, and (c) as at the end of each Fiscal Period from and after the Fiscal Period ending January 31, 2015, a Consolidated Fixed Charge Coverage Ratio not less than 1.25 : 1.00.

FY 2012 10K Footnote 10.43 Original Convertible Indenture

FY 2012 10K Footnote 10.44 Convertible Indenture

• SECTION 6.12                            FINANCIAL COVENANTS.
  
  
  (a)           Consolidated Net Leverage Ratio.  Borrower shall maintain, (a) as at the end of each Fiscal Period beginning with the Fiscal Period ending January 31, 2012 through the Fiscal Period ending January 31, 2014, a Consolidated Net Leverage Ratio not greater than 3.00 : 1.00, and (b) as at the end of each Fiscal Period from and after the Fiscal Period ending April 30, 2014, a Consolidated Net Leverage Ratio not greater than 2.50 : 1.00.
  
  
  (b)           Consolidated Fixed Charge Coverage Ratio.  Borrower shall maintain, as at the end of each Fiscal Period ending after the Closing Date, a Consolidated Fixed Charge Coverage Ratio not less than 1.25 : 1.00 for the then trailing twelve month period.
  
  ******definitions from original indenture:
  
  
  

  “Consolidated Fixed Charge Coverage Ratio” means, as of the last day of a fiscal quarter, for the period consisting of the four consecutive Fiscal Periods ending on such date, subject to Section 1.02(h), the ratio of:  (a) the sum for such period of (without duplication):  (i) Consolidated EBITDAR; minus (ii) all payments in cash for taxes related to income made by Borrower and its Subsidiaries; minus (iii) Capital Expenditures actually made in cash by Borrower and its Subsidiaries (net of any insurance proceeds, condemnation awards or proceeds relating to any financing with respect to such expenditures); minus (iv) Restricted Payments paid in cash by Borrower; to (b) of:  (i) Consolidated Interest Expense; plus (ii) Consolidated Rent Expense; plus (iii) without duplication, all current maturities of long-term Debt (including with respect to Debt that is a capital lease).

  
  

  “Consolidated Interest Expense” means, for any period, for Borrower and its Subsidiaries on a consolidated basis, the sum of (without duplication):  (a) all interest, premium payments, debt discount, fees, charges and related expenses in connection with borrowed money (including capitalized interest) or in connection with the deferred purchase price of assets during such period; plus (b) all payments made under interest rate Swap Contracts during such period to the extent not included in clause (a) of this definition; minus (c) all payments received under interest rate Swap Contracts during such period; plus (d) the portion of rent expense with respect to such period under capital leases that is treated as interest in accordance with GAAP.

  
  

  “Consolidated Leverage Ratio” means, as of any date of determination, the ratio of:  (a)  Consolidated Total Liabilities; to (b) Consolidated Tangible Net Worth.

  
  

  “Consolidated Net Income” means for any period, the sum of net income (or loss) for such period of the Borrower and its Subsidiaries on a consolidated basis determined in accordance with GAAP, but excluding any income of any Person if such Person is not a Subsidiary, except that the Borrower’s direct or indirect equity in the net income of any such person for such period shall be included in such Consolidated Net Income in accordance with GAAP.

  
  

  “Consolidated Net Leverage Ratio” means, as of any date of determination, the ratio of:  (a) the sum of (i) Consolidated Total Liabilities, minus (ii) the amount by which Cash Equivalents held by Borrower and its Subsidiaries as of such date of determination exceed $30,000,000; to (b) Consolidated Tangible Net Worth.

  
  

  “Consolidated Rent Expense” means for such period, total rental expenses attributable to operating leases of the Borrower and its Subsidiaries for real property on a consolidated basis.

Click to Wells Fargo $150 million Indenture disclosure with SEC  "The effective interest rate of the liability component for the period ended January 31,2013 was equal to 7.00%"

Date of Offering : April 18,2012 

Amount of Debt: $150 million Convertible