Security Analysis

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Security Analysis

The Role of the Cash Flow Statement

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Balance Sheet Review

Identify Financial Risk (Leverage) Identify Value in Distressed Situations

(Stocks Near or Below Net Cash) Confirm Quality of EPS Growth (EPS vs

BV Growth) Identify Competitive Advantage

(Asset Turnover and Cash Conversion Cycle)

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Cash Flow Statement

What Does It Do?

Why Do We Care?

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What does it Do? Provides Info As To Differences in

Timing Between Revenue and Expense Recognition Under GAAP and the Associated Cash Inflows and Outflows

Shows If and How Company Generated or Consumed Cash – and serves as the basis for estimating FCFE

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Why Else Do We Care? Depicts Ability of a Company to Pay

Bills

Shows Ability to Self Finance Growth

Provides Clues to Future EPS Surprises

Shows Changes in Operating Efficiency

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Krispy Kreme Statement of Cash Flows as Reported

Sales 665,592 491,549 394,354 35%

PERIOD ENDING 1-Feb-04 2-Feb-03 3-Feb-02Net Income 57,087 33,478 26,378 70%Operating Activities, Cash Flows Provided By or Used In Depreciation 19,723 12,271 7,959 Adjustments To Net Incom 49,363 20,723 14,361 Changes In Accounts Receivable (17,629) (7,390) (13,317) 238%Changes In Liabilities (2,130) (420) 5,488 Changes In Inventories (3,804) (7,866) (3,977) 16%Changes In Other Operating Activities (7,057) 240 (682)Total Cash Flow From Operating Activities 95,553 51,036 36,210 87%Investing Activities, Cash Flows Provided By or Used InCapital Expenditures (79,649) (83,196) (37,310)Investments 21,670 358 7,877 Other Cash flows from Investing Activities (128,262) (11,736) (22,830)Total Cash Flows From Investing Activities (186,241) (94,574) (52,263)Financing Activities, Cash Flows Provided By or Used InDividends Paid - - - Sale Purchase of Stock 19,518 6,708 21,335 Net Borrowings 64,458 44,861 5,636 Other Cash Flows from Financing Activities (4,462) 2,268 3,960 Total Cash Flows From Financing Activities 79,514 53,837 30,931 Effect Of Exchange Rate Changes - - - Change In Cash and Cash Equivalents ($11,174) $10,299 $14,878

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Krispy Kreme Cash Flow Without Financing Activities

YEAR ENDED FEB. 1, 2004 FEB. 2, 2003 FEB. 3, 2002CASH FLOW FROM OPERATING ACTIVITIES:Net income 57,087 33,478 26,378Items not requiring cash:Depreciation and amortization 19,723 12,271 7,959Tax benefit from exercise of nonqualified stock options 42,806 13,795 9,772Other adjustmetns to ne income 6,557 6,928 4,589Change in assets and liabilities:Receivables (17,629) (7,390) (13,317)Inventories (3,804) (7,866) (3,977)Prepaid expenses (1,047) (331) (682)Income taxes, net (6,010) 571 (2,575)Accounts payable 4,068 (33) 3,884Accrued expenses (766) (9,296) 4,096Arbitration award (9,075) 9,075 0Other long-term obligations 3,643 (166) 83

-Net cash provided by operating activities 95,553 51,036 36,210

-CASH FLOW FROM INVESTING ACTIVITIES:Purchase of property and equipment (79,649) (81,060) (34,114)Acquisition of franchise markets, net of cash acquired (122,352) (4,965) (20,571)Acquisition of business, net of cash acquired 4,052 0 0Investments in unconsolidated joint ventures (7,377) (7,869) (1,218)Increase in other assets (2,585) (1,038) (4,237)

-Net cash used for investing activities - core business (186,241) (92,984) (52,263)

Starting Point For Estimating Free Cash Flow (90,688) (41,948) (16,053)

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Lucent Technologies 1999 Income Statement

Reported Net Income $4,766

Less: Sale of Juniper Stock (167)

Pension Accounting Change

(1,308)

Plus: Restructuring Costs 270

Acquisition Related Charges

272

Operating Income Highlighted in 1999 Annual Report

$3,833

Excluded Item: Effect of Pension Accounting Change

$260

Reversal of Prior Restruct. Charge

$93

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Lucent Cash Flow Statement 1998/1999

Net Income $1035 $4,766Cum. Effect of Acct. Change 0 (1308)

Depreciation and Amortization 1,411 1,806

Change in Inventory (403) (1,612)

Change in Receivables (2,161) (3,183)

Change in Other Assets/Liabs 155 (2,320)

Other Items 1,823 1,575

Operating Cash Flow $1,860 (276)

Adjust. for Receivables Sale 0 (600)

Adjusted Operating OCF $1,860 $(876)

1998 1999

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Cash From Operations

Shows Good if Concern if

Questions

If Company generates enough Cash from Operations to Continue w/o External Financing

Positive OK if Negative and seeing Revenue Growth w/modest burn

Negative Especially w/absence of Revenue Growth

Major sources of In and Out flow

Need External Financing

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CFO to Earnings Ratio


Questions

Proportion of Earnings Yielding Cash Conservatism of Accounting

High relative to Industry Low and High Growth and R&D

Low Relative to Industry or Trend falling

Why is it Changing Is Source of Gap Sustainable

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Operating Margins

Shows Good if Concern if Questions

Extent that Revenue Growth can Sustain Profit

High or Improving

Low or Declining. Watch for High Margins and Declining Revenue

Are Changes Consistent with State of Competition New Management?

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Operating Asset Turnover


If Revenue Growth is Created by Operations or Asset Growth Efficiency

Growing or Sector High Level

Declining can Indicate Capitalizing Excess Costs

Recent Restructur-ing Change in Expensing Policy?

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Days Sales Outstanding


Questions

Customer Credit Terms Channel Stuffing

Reduced or Low. Shows efficient capital management

Sudden Rise

Any Receivables discount? Terms in Line with Competitors?Acquisitions?

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Inventory Turnover


Expected Change in Pace of Sales EfficiencyWrite Down Potential

Sustainable increase

Short Term Increase or Concurrent with Increase in DSO

Any potential Supplier ShortagesDoes Company Bill and Hold Sales

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Capital Expenditures to Depreciation Ratio


Questions

If Depreciation is Reasonable Anticipated GrowthConservative?

Stable between1 and 2

High especially if Slow Revenue Growth Consistent Less than1

Does Capex include M&A OutsourcingExcess Sector Capacity?

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Loan Loss Reserves


Proportion of Loans that won’t be Realized with Cash

Low or decreasing

Low (eps may have been overstated)

Compare to Sector NormsDSO and LLR send same message?

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Cash Flow StatementConclusions:

Shows Ability to Pay Bills Shows Ability to Self Finance Shows FCF available to Shareholder Provides Clues to Future EPS

Surprise Shows Changes in Operational

Efficiency

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Stock Selection

Diligence Process No One Route to the Truth Takes Time…But It Accelerates

with Experience Two Decisions: Do I Like This

Company and Do I Like this Price

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Investment Process

Sources of Ideas: Companies, Peers, Technical Personnel, Publications, New Low List

Examine Company Financials and Management Discussion of Results

Assess Return on Capital versus Cost of Capital

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Diligence Process

Look at Company Growth and Margin Prospects By Business Line

Evaluate Competitive Advantage and its Trajectory

Quick Valuation Check Look for “Scuttlebutt” (Suppliers,

Competitors, Employees, Customers)

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Due Diligence

Articulate Key Investment Controversies

More Extensive Valuation Analysis Meet Management If You Can’t Understand an Issue at

any Point, Move On

Documents

Security Analysis