Last week we discussed the Boyd Group Income Fund (“Boyd”), specifically the Fiscal Year 2014 Income Statement, and how it is both similar and different to the income statements of other operators in the industry. In 2014 Boyd generated an impressive $844 million in sales but reported a net loss of over $15 million. Many in the industry mistakenly assume that because the company operates at a net loss it is only able to remain in business through the benevolence of Wall Street banks. The reality is that Boyd, while operating at a net loss, generates substantial cash for shareholders. And when adjusting for certain accounting idiosyncrasies unique to the legal structure and location of the firm, the company generates a respectable profit. To understand how this is possible is to understand the difference between cash and accrual accounting*, and more generally, how to use corporate finance to drive systemic growth.
*See the footnote at the end of this article for a further explanation of cash vs. accrual accounting.
While Boyd generated a significant net loss on an annual basis, it also generated substantial cash from collision and glass operations. Due to the rules of accrual versus cash accounting, Boyd recognizes expenses as they occur, rather than when they are paid. As a result, there are a number of non-cash expenses that lower the profitability of the company while having little impact on the cash position of the company.
While earning my MBA and while working as an equity analyst, I learned that to better understand the strength of a company, as well as the motivations of management, it is always best to look directly at the statement of cash flows. The cash flow statement tells the reader exactly how much money the business generates and exactly how management is investing and spending the money they make. Every cash flow statement is divided into three categories: operating activities, financial activities, and investing activities.
Management discusses the cash flows beginning on page 25 and the Consolidated Statement of Cash Flows is on page 52 of the 2014 annual report. Copies of the statement of cash flows can be found below.
Cash Flow from Operating Activities
Generally, the Cash Flows from Operating Activities section adjusts net income for non-cash expenses (usually measured as changes to Balance Sheet accounts, which we’ll discuss in more detail next time). Regardless of the $15 million net loss, the company generated $51 million in cash directly from operations in 2014. Cash from operations only includes day to day activities and does not include any cash received from taking on debt, selling stock, or divesting assets. Cash generated from operations represented a respectable 6.0% of sales. More telling, however, is comparing the results year over year. In Fiscal Year 2013 the company only generated $25 million in cash from operations, less than 4.5% of sales. In 2014 the company doubled the cash generated in day to day operations and increased cash margins by a third while increasing sales by 46%.
The ability to grow cash from operations at such an aggressive pace is further proof that the stated strategy of leveraging scale to improve sales while driving down costs is effective. While many owners in the business struggle to grow top line sales by 7% or more, it is incredibly rare to find owners, particularly sizable ones, doubling the amount of cash their firm generates over a given year.
Cash Flows Provided by (Used in) Financing Activities
In the same period, the company also received $91 million in cash from financing activities. Financing activities include Wall Street type activities such as issuing stock or taking on additional debt. A significant reason we talk so much about the role of finance in the collision industry is to highlight the opportunities available to companies such as Boyd that actively use corporate finance to create a competitive advantage.
While the company received a net $91 million in cash from financing, it actually raised nearly $200 million over the course of the year through the sale of stock, draws on a line of credit, and the issuance of regular and convertible debt. In 2014 the company took an $85 million draw against its line of credit to fund four major acquisitions (Hansen’s, Collision Revision, Collex, and Champs). Later in the year the company sold $55 million in stock and issued $55 million in convertible debt, using the bulk of the proceeds to repay the $85 million line of credit and some other long term leases and seller notes. Convertible debt is a type of loan that coverts to equity (stock) after a given time and at the owner’s option. In aggregate, the company paid down $96 million of debt and long term leases in 2014.The company also issued a bit over $7 million in dividends over the course of the year.
Cash Flows Used in Investing Activities
Repeatedly the company has set clear inorganic growth objectives and has executed successfully on these objectives. Inorganic growth, or the purchase of existing collision and glass repair businesses, is considered an investing activity. So too is purchasing or updating facility equipment. Boyd is a serial but disciplined acquirer and continued to invest heavily in acquisitions in 2014. In aggregate, $124 million in acquisitions were completed over the course of the year, but the company only used $101 million in cash for these acquisitions. The remaining $23 million balance was funded by the sellers providing financing to the company and in one rare case a small amount of stock was issued to a seller in lieu of cash compensation. The bulk of the $101 million in cash used in acquisitions was provided by the $85 million draw on the negotiated line of credit discussed above in the Cash Flows Provided by (Used in) Financing Activities. Boyd also invested significantly in existing facilities, spending nearly $6 million on upgrades and equipment over the course of the year.
All in all Boyd had a very profitable and successful 2014 and is primed for further success in 2015. Not only did the company generate substantial cash flows from operations, it significantly improved cash margins year over year. Management also deftly navigated capital markets, raising over $110 million in the course of the year in debt and equity financing while also managing an $85 million line of credit. The company has remained disciplined in its acquisition strategy and according to recent comments from management has a strong deal pipeline and foresees no problem in growing by as many as 32 single locations in 2015.
I’m eager to hear from you. How do you manage your cash flow to maximize your value? Have you considered taking on debt to grow, or perhaps even considered taking on an equity partner? If so, shoot me an email via my contact page to discuss further as we explore Boyd together. I find the transformation in the industry truly fascinating and all communication is kept strictly confidential.
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*Understanding cash vs accrual accounting
For many, there is much confusion how a company that generates a multi-million dollar net loss can still report positive cash flow. This is less uncommon than many assume. To understand the mechanics it is important to understand the difference between cash and accrual accounting. Cash accounting recognizes expense as they are paid whereas accrual accounting recognizes expenses as they are incurred. For tax reasons, some privately held businesses also elect to use cash accounting as a basis for tax preparation. Generally, however, larger more sophisticated businesses utilize accrual accounting as it provides a more accurate representation of what occurred financially in a given period.
The Statement of Cash Flows is designed to reconcile the difference between cash and accrual accounting. Specifically, in Boyd’s case, stating with the $15 million net loss, all of the non-cash items are aggregated to determine the total cash generated from operations and are listed below the line “Items not affecting cash”. Fair value adjustments, write down of good will, depreciation and amortization, etc. are all non-cash accounting expenses. The point of these non-cash accounting expenses is to account for expenses as they occur rather than as they are paid.
Take depreciation for example. Assets have a specific lifespan and are used up over time. In order to accurately account for the general use of an asset, the cost of the asset is spread out over its useful life. The result is that on the income statement, rather than expensing the entire asset at the time of purchase, the expense is spread out and depreciated over time corresponding with the general usage of the asset. When an asset is purchased, there is a negative impact on cash (and a positive impact on assets on the balance sheet).
There is a similar impact when accounts receivable increases (or decreases). Because accounts receivables represent a sale that has not yet been collected, increasing accounts receivable has a negative impact on cash from operations (profit that has not yet been collected) and would be included in the line “Changes in non-cash working capital items”. There would also be a positive impact on AR assets on the balance sheet as profit not yet collected is considered an accounts receivable asset. The same holds true for increasing accounts payable, but in reverse. As accounts payables increase, there is an expense that has not yet been paid. Thus there is a positive impact on cash from operations (expense not yet paid) but an increased liability recognized in AP on the balance sheet.
As always, feel free to shoot me an email on my contact page for additional clarification. We can geek out together.
Cash flows from operating activities