Are the Earnings at Kirkland's Hiding Something?

Although business headlines still tout earnings numbers, many investors have moved past net earnings as a measure of a company's economic output. That's because earnings are very often less trustworthy than cash flow, since earnings are more open to manipulation based on dubious judgment calls.

Earnings' unreliability is one of the reasons Foolish investors often flip straight past the income statement to check the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can better understand whether the last batch of earnings brought money into the company, or merely disguised a cash gusher with a pretty headline.

Calling all cash flows
When you are trying to buy the market's best stocks, it's worth checking up on your companies' free cash flow once a quarter or so, to see whether it bears any relationship to the net income in the headlines. That's what we do with this series. Today, we're checking in on Kirkland's (Nasdaq: KIRK  ) , whose recent revenue and earnings are plotted below.

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. Dollar values in millions. FCF = free cash flow. FY = fiscal year. TTM = trailing 12 months.

Over the past 12 months, Kirkland's generated $14.1 million cash while it booked net income of $13.6 million. That means it turned 3.1% of its revenue into FCF. That sounds OK.

All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense, either. That's why it pays to take a close look at the components of cash flow from operations, to make sure that the cash flows are of high quality. What does that mean? To me, it means they need to be real and replicable in the upcoming quarters, rather than being offset by continual cash outflows that don't appear on the income statement (such as major capital expenditures).

For instance, cash flow based on cash net income and adjustments for non-cash income-statement expenses (like depreciation) is generally favorable. An increase in cash flow based on stiffing your suppliers (by increasing accounts payable for the short term) or shortchanging Uncle Sam on taxes will come back to bite investors later. The same goes for decreasing accounts receivable; this is good to see, but it's ordinary in recessionary times, and you can only increase collections so much. Finally, adding stock-based compensation expense back to cash flows is questionable when a company hands out a lot of equity to employees and uses cash in later periods to buy back those shares.

So how does the cash flow at Kirkland's look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. Dollar values in millions. TTM = trailing 12 months.

When I say "questionable cash flow sources," I mean items such as changes in taxes payable, tax benefits from stock options, and asset sales, among others. That's not to say that companies booking these as sources of cash flow are weak, or are engaging in any sort of wrongdoing, or that everything that comes up questionable in my graph is automatically bad news. But whenever a company is getting more than, say, 10% of its cash from operations from these dubious sources, investors ought to make sure to refer to the filings and dig in.

With 28.6% of operating cash flow coming from questionable sources, Kirkland's investors should take a closer look at the underlying numbers. Within the questionable cash flow figure plotted in the TTM period above, other operating activities (which can include deferred income taxes, pension charges, and other one-off items) provided the biggest boost, at 22.6% of cash flow from operations. Overall, the biggest drag on FCF came from capital expenditures, which consumed 67.8% of cash from operations.

A Foolish final thought
Most investors don't keep tabs on their companies' cash flow. I think that's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. Better yet, you'll improve your odds of finding the underappreciated home-run stocks that provide the market's best returns.

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Is It Time for Barnes & Noble to Throw In the Towel?

Barnes & Noble storefront, Fifth Ave., New York. Source: BN.com.

Shares of Barnes & Noble  (NYSE: BKS  ) plummeted more than 17% Tuesday after the company turned in dismal fiscal fourth-quarter results. But does this mean all hope is lost for the struggling company to survive over the long term?

First, some perspective
Back in February, I wondered just how many strikes Barnes & Noble would get until it finally threw in the towel.

To be sure, the company had just performed an about-face from its previously optimistic comments regarding the Nook segment, warning investors to expect an fiscal 2013 EBITDA loss from Nook Media that would exceed the segment's $262 million loss in 2012.

Even so, I also noted that Barnes & Noble's core comparable-store sales -- which excludes sales of Nook products -- actually exceeded the company's expectations by falling only 3.1%. What's more, Barnes & Noble did have around $471 million in cash with a relatively manageable debt-to-equity ratio of 0.28 at the end of its previous quarter, so it looked unlikely that the beleaguered bookseller would be going bankrupt anytime in the immediate future.

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Survey says?
Fast-forward to Tuesday's results, and Barnes & Noble's consolidated fourth-quarter revenue decreased 7.4% to $1.3 billion. In addition, its consolidated fourth-quarter net loss was $118.6 million, or more than double last year's $56.9 million loss. Fourth-quarter net losses per share, on the other hand, came in at $2.11, compared to a net loss of $1.06 per share during the company's fiscal 2012.

Sure enough, it turns out the Nook segment ended up costing Barnes & Noble a whopping $475 million during fiscal 2013, or nearly 82% more than last year's aforementioned EBITDA loss. 

In the meantime, while the core Retail segment's earnings did mange to grow 16% for the full-year 2013 to $374 million, its fourth-quarter results were less than compelling, with EBITDA falling 23.9% to $51 million. Fourth-quarter Retail revenue, for its part, dropped 10% to $948 million, hurt by store closures, lower online sales, and a painful comparable-store sales drop of 8.8%.

According to the folks at Barnes & Noble, those comparable-store sales decreases were caused primarily by "lower Nook unit volume and a stronger title lineup in the prior year period including The Hunger Games and Fifty Shades of Grey trilogies." And though digital sales did increase 16.2% for the full year, they actually decreased 8.9% for the fourth quarter, Barnes & Noble says, thanks again to a tough act to follow after those pesky popular trilogies last year.

Call me a skeptic, but...
To me, it seems a tad silly to place the blame on last quarter's mediocre book selection.

Of course, I suppose Barnes & Noble wouldn't necessarily want to point out the fact that they were tardy, to say the least, in finally introducing in-app purchasing on the Nook at the end of March. Or maybe, just maybe, it could be that the Nook is ridiculously outmatched by two superior tablet alternatives offered to consumers in the form of Amazon.com's Kindle devices and Apple's iPad lineup.

Unfortunately, this quarter's core comparable retail sales -- one of the few bright notes last quarter -- offered little reason for optimism this time around, falling 5.8% to remain essentially flat for the year.

It should come as no surprise, then, that Barnes & Noble's press release says the company has decided to (at least partially) throw in the towel, with plans to "significantly reduce losses in the Nook segment by limiting risks associated with manufacturing." Namely, that means B&N will partner in a co-branding effort with yet-to-be-announced "third party manufacturers of consumer electronics products."

In addition, Barnes & Noble will continue building its digital catalog by adding books and launching new Nook apps.

Foolish takeaway
In the end, that'll certainly go a long way toward stopping the bleeding, but that doesn't change the fact that the company's core comparable retail sales are also falling at an increasing rate.

Of course, the company does have some time to right its wrongs, especially considering it ended its fiscal year with just over $160 million in the bank, and having borrowed just $77 million under its $1 billion revolving credit facility.

From an investing standpoint, however, it's not exactly an appealing idea to buy shares in a company with a deteriorating core business simply because it can rack up additional debt to hold it over. In order for Barnes & Noble to prove its worth to shareholders, then, it'll need to show significant tangible progress toward sustained profitability.

In the meantime, there are much better places to put your hard-earned investing dollars to work.

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Is Kinder Morgan's Stock Still Worth Owning?

Kinder Morgan (NYSE: KMI  ) is a selection for the real-money Inflation-Protected Income Growth portfolio. Like any investment, it needs to be reviewed from time to time to see if it's still worth owning. In the brief video below, portfolio manager Chuck Saletta reviews its valuation, balance sheet, and dividends, and decides whether to hold on to the stock or let it go.

To follow the iPIG portfolio as buy and sell decisions are made, watch Chuck's article feed by clicking here. To join The Motley Fool's free discussion board dedicated to the iPIG portfolio, simply click here.

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NextEra and Spectra Team Up for $3 Billion Natural Gas Project

NextEra Energy (NYSE: NEE  ) announced Friday that it's teaming up with Spectra Energy (NYSE: SE  ) to improve Florida's natural gas infrastructure. NextEra subsidiary Florida Power & Light had previously put out a request for proposals to improve its offerings, and this project beat out the next closest idea by almost $600 million.

The joint venture will pour around $3 billion into the construction of Florida's third major pipeline, connecting Alabama to Georgia and Florida consumers. NextEra will also invest an additional $550 million by itself to connect one of its natural gas power plants to the central pipeline hub.

Florida Power & Light President Eric Silagy noted in a statement:

At FPL, we have worked hard to reduce our dependence on foreign oil and to keep our customers' bills low. Since 2001, our investments in cleaner, more efficient, natural gas power plants have saved our customers more than $6 billion on fuel costs. To continue meeting the growing needs of our customers efficiently and reliably in the years ahead, we will need more natural gas than the two existing major pipelines can deliver, which makes a third, independently routed pipeline system absolutely essential.

In addition to using the pipeline itself, NextEra also notes that other corporations can contract pipeline capacity for their own purposes. Construction is expected to begin in 2016, with full operation expected in 2017.

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