The Inoculated Investor

BB&T Conference Notes- 8/10/11
San Francisco 1-on-1 Conference The Ritz-Carlton, San Francisco Schedule for Benjamin Claremon - Cove Street Capital Wednesday, August 10, 2011 07:45-08:25 am Diamond Foods, Inc. Steve Neil, Linda Segre 09:30-10:10 am CIBER, Inc. Gary Kohn, Claude Pumilia 10:15-10:55 am Perficient, Inc. Jeff Davis 11:00-11:40 am Kansas City Southern Bill Galligan, Mike Upchurch 12:45-01:25 pm Tyson Foods, Inc. Julie Kegley, Dennis Leatherby, Jim Lochner 01:30-02:10 pm The Gorman-Rupp Company Jeff Gorman, Wayne Knabel 03:45-04:25 pm Kirby Corporation Steve Holcomb, Joe Pyne

Diamond Foods: CFO Steven Neil Description Diamond Foods, Inc., a packaged food company, engages in processing, marketing, and distributing snack products, as well as culinary, in-shell, and ingredient nuts. Its snack products include glazed nuts, roasted and mixed nuts, breakfast trail mix products, microwave popcorn products, and potato and tortilla chips. The company’s culinary nuts comprise shelled nuts, pegboard nuts, and harvest reserve premium nuts. Its in-shell nuts consist of uncracked nuts and mixed nuts; and ingredient/food service products include shelled and processed nuts, and custom-processed nuts. The company offers its products under the Emerald, Pop Secret, Kettle, and Diamond of California brand names. Diamond Foods, Inc. sells its products directly to retailers and indirectly through wholesale distributors, who serve independent and small regional retail grocery store chains and convenience stores. The company offers its products in the United States, the United Kingdom, Germany, the Netherlands, Spain, Italy, Canada, South Korea, Turkey, and Japan. Diamond Foods, Inc. was founded in 1912 and is based in San Francisco, California.
Ticker Current Price Market Cap ($mm) Enterprise Value ($mm) Dividend Yield Average Volume (mm) *Data from Capital IQ DMND $71.85 $1,579 $2,150 0.30% 0.24 TTM EBITDA ($mm) TTM EPS 5 Yr. Avg. Op. Margin 5 Yr. Avg. EBITDA Margin Trailing EV/EBITDA Trailing P/E Ratio $135 $2.15 5.40% 7.06% 15.9x 33.3x

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Market and Company Background  Nuts o

o Popcorn o 28% market share for Pop Secret o Pop Secret is now in Sam’s Club and Wal-Mart after not being available for a while o Much higher margins than nuts  Cost of corn is much lower than the cost of commodity nuts Bought Kettle Brand in 2010 o Is an all-natural product o 6 month shelf life instead of 3 months with other chips o This acquisition got them outside of the US  Profitable business in the UK  55% revenue comes from the UK The Pringles deal will close by the end of year o Great brand, especially outside the US  Is the number 4 chip brand in the world in terms of sales o It was an orphan brand  It was the last food asset at P&G o Is a manufactured crisp  15-18 month shelf life  Means that it can go around the world o Nice infrastructure for them to pick up o Want to use Pringles to lever Kettle and other brands o The acquisition will cause non-North America revenue to increase from 21% to 46% and move snack from 58% of revenue to 83% of revenue o Pringles is under-represented in grocery  Brand is in convenience stores to some extent but more so in mass stores like Target and Wal-Mart  Want to focus more on grocery going forward o All of their buyers are the same for the chips, nuts and Pringles  Which is why it is easy for them to integrate the additional brands Biggest cost are commodities o 30%-40% of total COGS o The second biggest cost is trade funds  These are netted against sales so you never see it on the P&L  Represent how much you have to pay to market the brand to retailers  Have developed a lot of leverage with the buyers  Allows you to get more SKUs in their stores  Having all three brands in convenience stores is important

Planters is their largest nut competitor and is peanut focused  Emerald is focused on younger consumers  Share is about 10% of the market Diamond is the culinary nut brand with market share 10x the next largest brand

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor   If you are negotiating with the same buyer, you have more leverage Not being the biggest (Frito Lay is) is actually an advantage sometimes o The stores want multiple brands on the shelves and they like brands to compete  2 nationally branded and one store brand o They like to be one of the alternatives to the other major brands o They can do wholesale delivery (which is much cheaper) or manage the shelf for the stores

Growth Drivers  What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In other words, what are the main drivers of Diamond’s performance? o They are focused on profitable revenue growth  Normal growth is 2-3% in this business but they have grown 20% o Increased scale in COGS or in OPEX  Revenue synergies  Brands make other brands stronger o Execution  Have earned trust from Wall Street  Believe they are great students of the game  Try to get the analysts to their plants to educate them o Want analysts to understand their business  Give full year guidance and the next quarter guidance o Also give 5 year guidance o Seasonality makes quarters lumpy depending on the timing of harvests o Try to be transparent as can be  The non-retail business is a great cash generator and gives them scale o But after they acquire Pringles, non-retail sales will not be that impactful anymore o Retail is going to 87% of the total Pretty aggressive acquisition activity with Kettle Foods and Pringles recently o What made the company believe that this was the right time to make acquisitions?  Started off with a list of what companies they would like to buy and what was for sale  Pop Secret was on there as well as Pringles and Kettle o Started going through this exercise 3.5 years ago  Had been speaking with the brands and investment banks at that time  Were targeting companies that could come on the market that fit their strategic goals o Needed to be in the position to act when something came on the market o Won’t go into frozen food because it is a different buyer  Will stay in their niche o If a buy was a good idea, they were willing to pursue it, even if they were in the midst of an integration  Have been able to start integration of Pringles now before the close because of the Reverse Morris Trust

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor But that has not been a distraction as they are still focusing on their core operations of their existing business  Looking at fill-ins in Europe or Asia o Are aggressive listeners o Pop Chips is on the market  Investment firm that represents them is in the building same building as Diamond  It is in their growth segment  Probably not making money right now due to the investment in the brand Somewhere near $1.3B in debt will be on the balance sheet after the Pringles deal—can you explain the analysis that was undertaken to determine how the management team could be comfortable with that level of debt? o EBITDA is growing so fast with the Pringles deal that they are actually deleveraging due to the acquisition o Don’t care about the amount of debt as long as they have cash flows  Cash gives you choices o Pure dollar amount of debt is not that important o Margins are expanding as well due to acquisitions  Allows them to reinvest in their brands o Any idea what gross debt/EBITDA will look like when the acquisition closes?  Going down to 3x from 4x now Can you talk a little bit about the dilution and the mechanics of the deal? o Is 29M shares issued still the appropriate amount?  29.M shares is the number  P&G realized some savings from the Reverse Morris Trust and that allowed Diamond to pay less  Stock is expensive collateral  As long as they can pay down debt, they would rather issue debt  Being in food is a good thing because the revenues are somewhat stable  Diamond has funded debt  Banks get a return on the commitment  Banks are very selective these days but are knocking down their door  Look for accretive deals  Board and management own 7% of the equity and do not want to dilute the shareholders 

Margins  Which are the higher margin products mentioned in the 10-K? o Does a fully integrated Pringles represent a positive or negative margin shift?  Couple hundred basis point increase in EBITDA margin EBIT margins have gone from 2-5% in 2006-08 to 9.4% in 2010 o What is the main driver of that?

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor  Stock Price  What is Wall Street and the market in general missing about the company/stock at the current level? o Contrarian thesis is that they can be effective against the larger brands  They are competing against two of Frito Lay’s lower margin products  Better to compete with a brand that is not high margin for Frito Lay because they won’t be as aggressive in competing  They competed well with Planters and Orville Redenbacher as well  They have a track record of competing o They have great shares in certain regions  Trying to leverage that around the nation o People are wrong that Pringles is boring  It is value brand for sure  Down from 15% to 7.5% share to day in the US  Outside the US it is a great brand  Very edgy and targets the younger consumers  Have to get the same image in the US o Very mature and profitable in the US Higher margin products than nuts combined with operating leverage

CIBER Inc: CFO Claude Pumilia Description: CIBER is a global information technology (―IT‖) consulting, services and outsourcing company applying practical innovation through services and solutions that deliver tangible results for both commercial and government clients. We compete in a large and growing marketplace offering services that include application development and management, enterprise resource planning (―ERP‖) implementation, change management, project management, systems integration, infrastructure management and end-user computing, as well as strategic business and technology consulting.
Ticker Current Price Market Cap ($mm) Enterprise Value ($mm) Dividend Yield Average Volume (mm) *Data from Capital IQ CBR $3.31 $239 $274 N/A 0.65 TTM EBITDA ($mm) TTM EPS 5 Yr. Avg. Op. Margin 5 Yr. Avg. EBITDA Margin Trailing EV/EBITDA Trailing P/E Ratio $9 ($0.77) 3.54% 5.18% 30.9x NM

Growth Drivers  What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In other words, what are the main drivers of CIBER’s performance? o Increased offshore delivery will drive margin expansion

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor o o Successful realignment of North American operating business  Need to improve efficiency Transforming process and people  Bringing the right skills to the right jobs  Being a successful service firm does not require rocket science  Excellent delivery is key  Fundamentally this is a turnaround  Have made lots of acquisitions and now have lots of P&Ls o This is a weakness these days o Believe there is standardization that could save money

Current Situation  The last few years have been tough for the company. What is going on with the North America division? o The North America business ($500M in revenue) had 35 autonomous offices  The thought was that these would be entrepreneurial and drive their own profitability  Didn’t work as the company got bigger  Have recently blown up the branch model and have centralized  This has caused disruption in the sales force  The discipline required to drive project profitability had been lost Are the government projects that come from the Federal division (11% of revenue) low margin? o Federal business is very separate from the rest of the business  Very different contracting process o Not a part of the core strategy  Something that could be a strategic opportunity o Staffing when done right can be a good margin business

ERP Implementation and Competitive Dynamics  With so many companies implementing ERP systems and those projects often taking far longer than anticipated and costing way more than projected, describe the opportunity for CIBER o What is the company’s value proposition versus the competitors?  Big firm capability with smaller firm intimacy  You get all of their attention versus at Accenture where that might not be the case  Best in class capability and not as costly  More effective because you have the best and brightest people  Don’t sell an experienced team and bring in young graduates  They are way more flexible  They don’t come in and tell people how to do things o My next meeting is with Perficient. How would you distinguish yourself from that firm?  Cognizant, Accenture and IBM solutions are the companies they compete with the most  Don’t see Perficient in the market place as much o Do they bigger players such as Accenture have any real advantage in this space?  Yes, they have a track record of discipline and process that CIBER doesn’t have

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Thus, CIBER doesn’t get to realize the margins that they generate Firms have to transfer knowledge between projects and Accenture is better able to do that due to their long history o But, Accenture has priced at the top and CIOs are looking for a way to cut costs What is the main competitive point right now?  Is it price, speed, customization?  Combination of speed and price o They don’t have the overhead that the other companies have and thus can be more flexible with price  However, they don’t sell on price anymore o They sell on value  But that has allowed them to ask for higher gross margins  Sales people now feel comfortable asking for a higher price How would your partners rate CIBER (Microsoft, Oracle, etc.)?  Would rate them quite highly in their respective areas  What you run into with CIBER is that there is a huge different between Europe and North America  Won an award in the Netherlands because of their excellent service  They do not have strength in SAP in North America but they do in Europe o SAP would say they need to prove themselves in the US  They are building the SAP business in the US  Think they can leverage the European relationship in the US o Do really well when they focus on individual verticals and horizontals as they build out specific expertise  Oracle: good work in the public sector  Microsoft: have a great relationship with the company across the world  

o

o

Economy and Markets  How to you anticipate that your clients will react to all the turmoil roiling through financial markets? o They have not seen people hesitant to roll out an ERP system in Europe o They think they can capitalize on this turmoil and uncertainty by offering staffing and outsourcing solutions  Many firms do not have a budget for full time positions anymore so they have to outsource o For a complex ERP system they might see some hesitance to invest  In 2008 they saw a breakup of big projects due to the financial crisis  But there is huge pent up demand because those projects were put off  Companies need to update and can’t really put these off any longer What is your response to further fiscal contraction? o The Federal business has been affected by budget cycle issues o It is not like demand is changed; it is just pushed out o Not having a budget for the US was an issue earlier in the year

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor International Operations  What is different about the European business? o In Europe they decided to get more focused  Much less autonomy than there was in North America  Decided to be good in SAP  Were successful in making acquisitions  Kept driving the organization to create expertise in SAP and the utility vertical  Better management discipline and capability  Better financial management  Understanding cycles better o What do you transfer over?  Bring organizational knowledge Where are we in terms of adoption of management information systems in less developed markets? o Probably in the 2nd or 3rd inning in these markets o Huge opportunity and probably very expensive to venture into  So much so that they as ask themselves if CIBER should even be playing in these markets  There are big pockets in developed markets where CIBER is not even in o France and California for example o Upside is more adjacent and easier to extract

Senior Credit Facility Repayment/ Covenants  Glancing through the list of covenants in the 10-K and the recent disclosure in the 10-Q, I see that your lender waived the June 30th restrictions and gave you some breathing room: o $36M in EBITDA by December and a fixed coverage ratio at .95x are the newly modified requirements  What are you doing to meet your targets?  EBITDA was dragged down by goodwill impairments  Are not having the fixed priced project issue anymore  Europe continues to grow (Q4 was strong)  Not going to have the loss in Q2 that they had in North America  They are taking out costs o Blocking and tackling and cash optimization o What have the conversations with your lender been like?  Discussions went surprisingly well  CFO is 3 months into the business  The covenants were written in 2009 o They have been amended the last 4 times  But they get charged $600K for the changes  Feels good about working with the bank  Wants to strengthen the balance sheet and get rid of debt  Can repatriate cash at a lower level due to NOLs and carryforwards

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor What are your options if you are having trouble reaching compliance?  Is there a need to look at raising more capital or refinancing now?  Fundamentally opposed to raising equity given the stock at this level  Repatriation of cash and potential asset sales could provide capital What are you looking to do with the $78M in repayments in 2012 with about $62M in cash right now? o Strategic alternatives for businesses o Want to get rid of the debt  Don’t want term debt  Don’t want a large credit facility o

Stock Price  What is Wall Street and the market in general missing about the company/stock at the current level? o Contrarian thesis is that the company is transforming more than the results would suggest  There has been an influx in talent which can transform the business o There is not a track record yet of consistency  They think they can leverage their success in Europe to build the North America business  Bring the right people to the right spots o The culture of CIBER’s consultants and sales people is a differentiator o The stock has been struggling for so long, this is not a company where people are focused on the stock price  Options were not a big part of compensation until recently  Self-worth of employees is based on a unit’s performance  Have started to communicate more with employees to let them know what is going and how the turnaround is going so far

Perficient Inc.: President and CEO Jeff Davis Description: Perficient, Inc. is an information technology consulting firm. The Company designs, builds and delivers technology solutions using third party software products. The solutions include custom applications, portals and collaboration, eCommerce, online customer management, enterprise content management, business intelligence, business integration, mobile technology, technology platform implementations, and service oriented architectures. The solutions include business analysis, business integration, enterprise content management, customer relationship management, service oriented architectures (SOA) and enterprise service bus (ESB), business intelligence, ecommerce, mobile technology solutions, technology platform implementations and custom applications.
Ticker Current Price Market Cap ($mm) Enterprise Value ($mm) Dividend Yield Average Volume (mm) *Data from Capital IQ PRFT $8.31 $268 $256 N/A 0.16 TTM EBITDA ($mm) TTM EPS 5 Yr. Avg. Op. Margin 5 Yr. Avg. EBITDA Margin Trailing EV/EBITDA Trailing P/E Ratio $23 $0.29 7.74% 10.52% 11.2x 28.6x

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Growth Drivers  What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In other words, what are the main drivers of the company’s performance? o Near term goal is to be at $500M run rate revenue by 2013  Will be close to $300M at the end of this year  Will try to reach $500M through a combo of organic growth and acquisitions  Have been an acquisitive company since the IPO in 1999  Started in 2004: have done 16 since then  Want to hit double digit organic growth  Think they could be a 12-15% grower o Stability in the market from a macro perspective  Their issue is sentiment  Would be fine with a 1.5% GDP growth environment if people weren’t screaming that the sky is falling  Saw that concern in Q2 2010 last year  But didn’t see that this year until now o Are not seeing the impact to the bookings this year  But, the current turmoil feels like déjà vu all over again  Have levered up around verticals: health care and financial services  Are getting great traction in health care o 24% of revenue and 34% of bookings in Q1 o Think that health care will be insulated from macro issues  Health care-related companied need to be more competitive and efficient so they can’t put off investments  Financial services has seen a lot of acquisitions and firms are in the middle of a lot of integration o There are things they couldn’t do until the ERP systems were done with that they are doing now  Buyers have plenty of cash—they have been hoarding cash for the last few years o Gain scale to get a little more visibility in the market  Story is not followed that closely  Have seen a lot of expansion in gross margins  Think they can get to 40% gross and 20% EBITDA margins as a firm o Those would be best in class for a US company

Acquisitions  You make it clear that you seek to grow through acquisitions. Can you talk about your strategy and approach to valuations when it comes to acquisitions? o A buy-side banker is the source of acquisitions  This is a highly fragmented business with many companies in the $10-$20M revenue range  Focus is on enhancing the portfolio from a skills standpoint  These are strategic deals and are not done to just increase revenue

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor o Used to fill gaps in the portfolio o Every deal fits this criteria  Also allows them to get a geographic expansion o Pricing: 5-7x EBITDA multiple target  Have never paid more than 6x yet  The 4 they have done recently were very accretive deals  Company looks for deals that are cash accretive day one  Synergies are quite strong  Are able to help the acquisitions from a systems and a management process standpoint  Get higher productivity out of sales guys and resources  The opportunity to cross sell is the most important thing How do you think about using cash versus issuing shares? o Pretty disciplined around shares o Sometimes they will take principals out  For the most part it is half cash and half stock  Gives them retention and motivation  Have seen most people stay after the 3 year vesting period  Since 2004 about 60% have stayed

Focus on the US  Why have you decided to focus on the US versus someone like CIBER who generates a good amount of revenue overseas? o They are focused on the US and outside of the US only as their clients go outside o This is an $80B industry in the US alone  There is no reason to take on the additional risk and stretch the infrastructure because the size of the market in the US is big enough  The downside is that you don’t get the hedge o What would make you change your mind and pursue expansion overseas?  There is a time when being in Europe and Asia will make sense  But they actually shut down their UK office at some point because it was not profitable

Client Retention  To what do you attribute to your high client retention rates (87% according to the 10-K)? o Quality work and strong relationships with the clients  97% reference-ability with their clients  The 3% they don’t get are small clients that expect the world and don’t want to pay for it o Have to be scrappy as a small company  Every deal is critical to them  It is all about reputation

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Every client has to be satisfied  Have to incentivize employees to focus on this 65% of revenue now comes from Fortune 1000  These firms often have a lot of work and can offer multi-year contracts  The progression towards larger companies is something that they focus on Some clients are never going to be good clients and will never be happy  Small clients are less sophisticated and expect a lot for nothing 

o

o

ERP  With so many companies implementing ERP systems and those projects often taking far longer than anticipated and costing way more than projected, describe the opportunity for Perficient. o They don’t implement ERP systems specifically  But they do support management systems work, with IBM being their largest client  Oracle and Microsoft as well are clients  Are looking to get into ERP implementation o What is driving demand is the need to gain greater efficiencies  Clients need to be more competitive and understand their customers better  Requires a lot of information gathering and data analytics

Competition   Who are you primary competitors? o Smaller boutique firms that specialize in certain verticals Do the bigger players such as Accenture have any real advantage in this space? o Company’s win rate versus the big guys is in the 65% range o Accenture (ACN) is a well-run firm and their advantage may be brand only  The challenge is getting the ability to compete with them  Lack of brand knowledge is the problem for Perficient  ACN does not value the technologists as a firm  Being a technology specialist is not a good way to advance at ACN o They are very focused and have an expertise that stems from having greater depth than the big guys  Their customers (IBM for example) know their name  This begins to shine as you go through the proposal process What is the main competitive point right now? o Is it price, speed, customization?  Pricing is important  ACN will try to compete at the same (lower) rate in some cases  Rates are competitive but they don’t give their services away  Right now the competition mainly surrounds confidence in delivery  Want to be on budget and on time  Most customers aren’t as concerned about saving $1M if the project can be done right

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Balance Sheet  Is having no debt an advantage when competing for contracts? In other words, do clients see it as a symbol of your financial strength and ability to live up to you promises? o It is not much of a concern for the customers or clients o What helps more is being larger than the little boutiques as well as being public and transparent Why would you avoid a modest amount of leverage? o Cash is worthless now and they like to reinvest it in the business o Like to have little cash and use it for acquisitions o Have started a stock buyback program  Are $47M into a $60M buyback program o Would take on debt for a quarter just to put on an acquisition

Consolidation  How is consolidation impacting the markets you serve? o There will always be a lot of small shops  Due to very small barriers to entry o There are a few companies that are still acquiring  A lot are hunkered down however o Diamond was their size and was the only firm out there that was their size  Was taken out at somewhere around a 40% premium Would it make sense to merge with a slightly larger player to better compete with the big boys and maybe cut out some duplicative costs? o It is likely that Perficient would be acquired once it gets to $500M in revenue o The offshore guys are going to need a bigger US presence o They are not running the business with that in mind, however o PWC is a potential acquirer  They did buy Diamond but it is not as scalable a business

Tax Rate  I noticed the 42%+ tax rate over the last three years with a major component over the last 2 years having to do with stock compensation o Is there a way to reduce that rate?  Probably not  Stock comp is coming down at the end of next year o Stock comp won’t scale with revenue because the new CFO has a different philosophy than did his predecessor  They can try to get as much revenue from China as possible to lower the tax rate

Stock Price  What is Wall Street and the market in general missing about the company/stock at the current level? o The Street generally is nervous that Perficient is not a good stock to hold if you have a bearish sentiment at all about the economy

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Thinks they are not as subject to the economy as people think they are People are concerned about an economic pullback  But they are growing 10% when GDP is growing 1.5%  Institutional holdings are strong Prospect of selling the company down the road leads to a little premium  

o

Kansas City Southern: CFO Mike Upchurch Description: Kansas City Southern (KCS) is a holding company with domestic and international rail operations in North America that are focused on the north/south freight corridor connecting commercial and industrial markets in the central United States with many industrial cities in Mexico. The Company is engaged primarily in the freight rail transportation business. It generates revenues by providing its customers with freight delivery services both within its regions, and throughout North America through connections with other Class I rail carriers. KCS’ customers conduct business in a number of different industries, including electric-generating utilities, chemical and petroleum products, paper and forest products, agriculture and mineral products, automotive products and intermodal transportation.
Ticker Current Price Market Cap ($mm) Enterprise Value ($mm) Dividend Yield Average Volume (mm) *Data from Capital IQ KSU $53.96 $5,926 $7,660 N/A 1.17 TTM EBITDA ($mm) TTM EPS 5 Yr. Avg. Op. Margin 5 Yr. Avg. EBITDA Margin Trailing EV/EBITDA Trailing P/E Ratio $714 $2.19 20.96% 30.98% 10.5x 24.7x

Port Arthur Crude Terminal Opportunity  Their partner in this venture (Savage Companies) is private, highly regarded and experienced in this business o Savage actually came to them and said suggested they establish a partnership to take advantage of this growing opportunity o Savage wanted to bring light sweet crude down and KCS had a great property at Port Arthur, Texas for storage  Port is close to largest refineries in the US  The partnership is not yet finalized  Savage will likely have an exclusive agreement  3 unit trains per week is the base case o Savage has been building a facility in the Bakkens oil sands in Canada  It is like the Gold Rush up in this region  Savage is working with Burlington North (BNSF) to bring the crude down to Kansas City and then KCS will bring it down to the Gulf Region  BNSF could take some further down but not that much o They would rather work with the other railroads o It will not take Savage that much time to build a facility on KCS’s property  Will be built at Savage’s cost and Savage will potentially lease the land

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Think the deal could be finalized by the end of the year May start seeing revenue by the middle of 2012 There is not going to be a pipeline anytime soon so this could grow into a very nice business They will not make any investments unless they have a contract for long-term business  More likely that Savage or the oil company would make an investment in any necessary equipment Have owned the 500 acres at Port Arthur for many years   

o

o

Coal Opportunities  There is a possibility that they have a new coal contract o They can’t really talk about it until January o There are 10 plants on their system; they serve 8 now and will likely serve 9 Over the next 2-3 years there will likely be another coal opportunity in Arkansas where a new power plant is being built

Margins  Are your EBITDA margins in the high 30’s achievable consistently? o High 20s operating and high 30s EBITDA margins are achievable o They guide to 150 basis improvement each year  They are in the process of mining out costs  Have removed costs since the recession that have led to 500 basis points of cost reduction o They have taken out much of the low hanging fruit o There are still opportunities on the labor side o More costs cuts may be hard to take out  Volume increases and pricing increases help increase margin as well If we are heading into a slowdown, what can you do to cut costs and hold margins? o Grain and coal move no matter what part of the cycle you are in  Coal is more weather dependent o The rest of the commodities move up or down based on the economic cycle  Electronics and automotive move down with the cycle

Mexico Opportunity  Think they have a great franchise in Mexico that benefits from the manufacturing shift to that country o What inning are we in in terms of the industries being on their lines in Mexico?  Transportation of goods from China to Chicago is 5 times more expensive than the trip from Monterey to Chicago  Plus Mexico is a better place to do business  It is easier to manage your supply chain from Mexico than from China  Think there is going to be a large shift to manufacturing in Mexico  Wages in Mexico could go up  They are not seeing it yet but it is a consideration

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor  Unemployment in Mexico is low and GDP growth is strong  Have not seen an impact from the drug war issue  Working on the railroad is seen as a plus job in Mexico Regulations in Mexico  There were restrictions of some goods that came from Asia to the US  KCS found out about this restriction and were able to have it eliminated  The relationship with Mexico is as good as it has ever been  The hurricane last year was eye opening for the government because it showed how reliant the country was on KCS’s lines  The relationship was solidified by how efficiently KCS got back online

o

Consolidation  How is consolidation impacting the markets you serve? o They are the smallest of the 7 Class 1 railroads so people are always asking if they are for sale o They would be attractive to larger class 1 operators o They claim they are not for sale and think they can generate shareholder value through execution o Would they be interested in acquisitions?  They are small compared to larger carriers and likely could not buy them  They don’t see buying short line companies as valuable  It would have to be a nice piece that fits in their network  The real question is why would you even pursue acquisitions  There are few remaining synergies given the hassles  There wouldn’t be much of the cost takeout  It would be more about revenue synergies and what is going in Mexico o That is the opportunity

Buffett Buys a Railroad  What does it say about the state of the industry that accompany like Berkshire Hathaway, a company that always shied away from capital intensive industries, was willing to buy BNSF? o When you look at the model it is very difficult to replicate the franchise and network o It is insulated from competition and generates huge cash flows o Personal belief is that Buffett got a great bargain in buying BNSF o The business is going to be around for 50 years o There will continue to be the opportunity to chip away truck traffic share and move more by rail o The move by Buffett to by BNSF may be an inflation play.  Does inflation in commodity prices actually help them?  Despite rail rates going up, they go up much less than the underlying commodity prices  If commodity prices continue to go up they will be able to raise prices o Buffett definitely saw price increases coming

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Current state of the industry  Is this year indicative of a normal year? o Rates have gone down since the industry was deregulated o Irrational behavior was driving prices down o Industry got a grip that winning share was not the best way to go forward o Productivity and service level have increased meaningfully in recent years o Regulation of trucking industry makes it hard for trucks to compete with rail

Lazaro Project  Lazaro (Mexico) Phase II o The government is in the process of awarding a 2 nd concession o All of the port operators are interested in this concession o Think it could be 3-4M in TEUs [twenty foot equivalent units—a measure of capacity] over the next few years from 750K now  They are the only company able to service this industry as stipulated by the current concession  They will take all of the growth from this and it will be one of their top 4 growth opportunities for the company as a whole o The port could be as much as 10M TEUs in the next 10-15 years Ownership o They have a 50 year concession on the tracks that expires in 36 years and then have a 50 year option after that o Own most of the train cars and almost all cars are in use  Have a few locomotives that are idle right now but they are older machines Not interested in refrigerated intermodal o They haven’t been looking into it very carefully o They have a lot of other venues for growth and are not interested in refrigerated intermodal at a high cost

Stock Price  What is Wall Street and the market in general missing about the company/stock at the current level? o There has been concern about a double dip and that the company will not hold up as well from a margin standpoint  People point to what happened in the last recession  Believe KSU is a stock for an up cycle; not a down cycle  They have taken out a lot of costs since the last cycle  Are in much better position to weather another cycle  They have taken out $150-$200M costs out of the business  They took a lot of interest expenses out as well  Margin deterioration in Q4 2008 to trough was 8.9% versus the industry at 8.3%  They don’t think they are as at risk this time around

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor   Operating ratio was traditionally higher than the industry average but KCS is a different company today People are seeing the growth opportunities  Are now even above 2007 levels of volume and are up far more than the industry

Tyson Foods: CFO Dennis Leatherby and COO Jim Lochner Description: Tyson Foods, Inc. is a meat protein and food production company. It produces, distributes and markets chicken, beef, pork, prepared foods and related allied products. Its operations are conducted in four segments: Chicken, Beef, Pork and Prepared Foods. It operates a vertically integrated poultry production process. Its integrated operations consist of breeding stock, contract growers, feed production, processing, further-processing, marketing and transportation of chicken and related allied products, including animal and pet food ingredients. Through its wholly owned subsidiary, Cobb-Vantress, Inc. (Cobb), it is engaged in poultry breeding stock supply. It also processes live fed cattle and hogs and fabricate dressed beef and pork carcasses into primal and sub-primal meat cuts, case ready beef and pork and fully-cooked meats.
Ticker Current Price Market Cap ($mm) Enterprise Value ($mm) Dividend Yield Average Volume (mm) *Data from Capital IQ TSN $17.56 $6,575 $8,081 0.90% 4.68 TTM EBITDA ($mm) TTM EPS 5 Yr. Avg. Op. Margin 5 Yr. Avg. EBITDA Margin Trailing EV/EBITDA Trailing P/E Ratio $2,042 $2.28 2.14% 4.04% 4.0x 7.7x

Growth Drivers  What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In other words, what are the main drivers of the company’s performance? o The beef and pork businesses are best in class and sales are at all times highs  Believe this is ongoing and sustainable  Not likely to grow that much off of this base though o Prepared foods and chicken are the growth opportunities  Currently the chicken industry is oversupplied versus demand  Competitors are losing money  Tyson achieved a 1% return on sales while others are losing money  As supply comes back online there will be growth o Mexico is mature o India is small but a good market o Brazil is a good export play o China is the exciting story  Especially as KFC and McDonald’s grow fast o Trying to come up with the correct business model in these markets

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Prepared foods range from bacon to pizza crusts to toppings  There is room for growth in prepared foods as well Expect to be investment grade in the coming years  The company is tainted by its past  Underperformed from 2006 to 2008  Management starved the core businesses from capital  Leadership change has focused people on the details and execution o New team saw all of the poor decisions made by the previous management teams and has learned how to incentivize people  Have subdivided the company into smaller business units so that they can focus FY 2010 was the best year in the company’s history  If the stock traded at a decent multiple, the stock could be $23  Plus, there is going to be growth on top of the current numbers  There is not one silver bullet to continued improvement  It will come from all around management execution 

o

o

Raw Materials  What commodities are you most exposed to? What is the best way for the company to protect its margins against volatile commodity prices? o Major inputs  Corn & soybeans make up 42% of chicken COGS  Raise their own chickens  Live cattle  Do not raise their own; buy on spot market  Live hogs  Do not raise their own; buy on spot market o Don’t think they are going to see a big decline in feed costs going forward  Think we are in new normal of higher costs  They have been investing in their facilities to make them more competitive  Are adding mix capability  Other competitors are now pulling back o Can you talk about the hedging strategy a bit?  Strategy is to not take crazy trading risks and call it hedging  If they can buy call options they will to prevent runaway costs  Are willing to pay reasonable insurance premiums  Very conservative strategy

International Opportunity   Major export markets include Canada, Central America, China, the European Union, Japan, Mexico, the Middle East, Russia, South Korea, Taiwan and Vietnam Describe the international opportunity and especially the chicken opportunity in China o In 2010 export revenue was about 32% of the total o In China, KFC does not have franchisees

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor All company owned stores In the US, KFC has a franchisee model and good new ideas often cannot pass to the franchisees  The company-owned model has been one of the reasons for KFC’s success in China o The Chinese-based poultry industry is a small player, is segmented and not vertically integrated  These small players are only thinking about keeping birds alive using antibiotics  Not worried about genetics  KFC has a supply chain challenge of guaranteeing controlled production  They are not getting quality products and people are being poisoned all time in China o This leads companies to look for vertically integrated companies  Companies that owns their own distribution, have a supply chain that works, can focus on genetics and can control the feed quality  Believe they are going to have to go to company-owned farms in China  The outsourced grower model might not work  They will produce them cheaper than the current players in China o Competitors’ leveragability is not good o Cost to produce is 10-15% lower for Tyson  The competitors, over vaccinate, which is costly o Have proven that the model works in India as well  The government has started to regulate the small producers o Tyson is a huge protein producer and the Chinese government will eventually get its arms around protein production  Controlled production is going to be a key and Tyson will be able to charge more for it  There is 1 chicken producer in China that has done well but the market as a whole is not that competitive  McDonald’s does not have any beef items on the menu in China o You have to ask for beef to get it  Demand from the chains led the industry to focus on vertically integrated companies  Land use rights have to be carefully negotiated in China  But, they think they offer the regions a lot and will be able to ―own‖ their own land o Protein production is a priority in China because it provides jobs and offers China the ability to feed its people  Don’t want to go too fast but they are looking at 2 years to get things up and running  In India live production is a competitive advantage  Expect it to be as big a play as China as well  This downturn may shake out the industry and be good for Tyson How do international sale margins compare to those in the US?  

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor o o They think they can exceed the margins outside of the US but there are a number of challenges Think they can charge a premium for their controlled process

Capital Allocation  Is debt repayment a priority? Can you talk a little about the decision between debt repayment and buybacks? o They have gone through a change and have set a goal for the capital structure  Wanted to assure the agencies that they have liquidity  $1.8B in liquidity  Gross Debt to EBITDA: 1.3x or less o 1.2x this quarter  Have been buying shares with excess liquidity o But would rather make acquisitions  Are already spending more CAPEX than D&A o They are investing in their business Is it important to get your credit rating above BBB- on the revolver? o Yes, they want to be rated investment grade by all the rating agencies

Margins  The difference in margins in hogs and cattle comes from much longer production cycle o Supply does not get too high as easily as it is for chicken because it takes longer for the animals to mature  Lag phase leads to higher margins

Acquisition Strategy  Domestic chicken market: very fragmented after Pilgrim’s Pride (17% share) and Tyson (22% share) o Very small players below them o Very diversified group of regional firms  Many of these are in financial trouble due to distress Can’t really roll up these firms because the government will watch Tyson’s actions very carefully when it comes to chicken to prevent a regional monopoly o They would have to move out to the west coast for acquisitions May be better off making acquisitions in prepared foods o Most people don’t know how big they are in pepperoni, taco meat, and pizza crust  There are a lot of people who want to them to buy assets  Both bankers and companies themselves o Pricing and assets have been right though

Stock Price  What is Wall Street and the market in general missing about the company/stock at the current level? o There is no forgiveness for the past sins o Chicken is being held against them

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor o  But chicken only represents 1/3 of their earnings potential Tyson’s Pork and Beef segments are big players in the industry  No livestock risk  Most of the supply comes from the spot market  Very competitive on the cost structure and location

Gorman-Rupp Company: President/CEO Jeff Gorman Description: The Gorman-Rupp Company (Gorman-Rupp) designs, manufactures and sells pumps and related equipment (pump and motor controls) for use in water, wastewater, construction, industrial, petroleum, original equipment, agriculture, fire protection, heating, ventilating and air conditioning (HVAC), military and other liquid-handling applications. The Company operates principally in one business segment, the manufacture and sale of pumps and related fluid control equipment and systems. The Company’s product line consists of pump models ranging in size from 0.25 inch to 144 inches and ranging in rated capacity from less than one gallon per minute to in excess of 750,000 gallons per minute. The types of pumps which the Company produces include self priming centrifugal, standard centrifugal, magnetic drive centrifugal, axial and mixed flow, rotary gear, diaphragm, bellows and oscillating.
Ticker Current Price Market Cap ($mm) Enterprise Value ($mm) Dividend Yield Average Volume (mm) *Data from Capital IQ GRC $27.31 $568 $561 1.30% 0.05 TTM EBITDA ($mm) TTM EPS 5 Yr. Avg. Op. Margin 5 Yr. Avg. EBITDA Margin Trailing EV/EBITDA Trailing P/E Ratio $59 $1.52 11.06% 13.92% 9.6x 17.8x

Growth Drivers  What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In other words, what are the main drivers of the company’s performance? o Very diversified across markets but are heavily into the water sector  Want to be diversified so that one market can’t really hurt them  Their fortunes are tied to the broader economy but they are not totally at the mercy of out of control factors o How well capital goods move will be important in the future  Being in water is important because you cannot deprive people of water o Acquisitions will play a part but they will not only grow that way  Has to be the right fit before they move but they currently have the room on the balance sheet to make acquisitions o International markets represent the most important opportunity  Based on the need for fresh water and sanitary conditions in emerging markets

Competition

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor  Who would you saw your most formidable competitors are? o Really depends on the market o Most of the pump companies that are left are buried in the financial statements of bigger firms  Think it is an advantage to be independent  They are more flexible and can move fast Of the comps I glanced at, it looks like GRC has some of the highest EBIT margins. What would you say is your competitive advantage versus the rest of the industry? o There is no cost advantage necessarily  Commodity prices are the same and the cost of the engine is the same  Gross margin line is the same o However, the culture of the company stands out among all of the competitors  Still very much a family company  Quality is the most important factor  75 years of reputation in the industry helps them get a foot in the door and to maintain relationships

Consolidation  How is consolidation impacting the markets you serve? o The whole pump industry is very fragmented o Lots of mom and pop businesses  This is a niche product o The National Pump acquisition was a good opportunity  National knew that it had to get into the international markets and thus had to marry up with Gorman Rupp in order to capitalize on the opportunity o There would not be an advantage to hooking up with a big company like ITT  IDEX has been pretty aggressive and ITT is now breaking up so they are not likely to be as active as they have been o The company has an eye out for acquisitions  Have no set target though Have you taken any measures that would allow you to protect margins during the downside of the cycle? o Came out of the bottom of the cycle a lot stronger o Took some big hits as 2009 was a challenging year for all of their markets  But some of their markets did well in 2009 and it helped to be diversified o Have benefitted as the top line grew more than expected  Have continued their capacity investments even when people thought they were crazy to do so How do you manage cost inflation? o Are you typically able to pass along cost increases?  Company never has trouble passing along cost increases  Normally get a premium for their product  Quality of the product is there  Have a lot of loyal customers

International

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor  Can you talk a little bit about the international opportunity? o The key is having the right distribution o Sometimes it takes a few years to get it right o Tend to go with smaller, family-owned distribution o Made an acquisition of National Pump that had low international sales  Think that National’s deep well pumps will do well internationally because the distribution network is already set up How do international margins compare to those in the US? o Pretty much the same  In the total scheme the margins could be a bit less than in the US due to slightly higher SG&A

Family Ownership and Control  How should we think about the family’s 25%+ ownership of the company and the fact that the top positions are filled by Gormans? o High insider ownership: 30% of shares are closely held between the 2 families o Gorman Rupp is a profit sharing company when it comes to the employees o Even though they are public it feels like a family-owned company o Hard to find a company with a better dividend record  39 straight years of dividend increases Recent share split was a way to get the shares out there in a controlled manner o They want to increase the float We like insider large insider ownership. Would you say that the incentives of management are aligned with those of shareholders? o Managers receive a base salary and then a profit sharing component that is a larger percentage than normal

 

Capital Allocation  Talk to me a little about the decision process surrounding the choice of whether to make acquisitions, increase the dividend or invest in CAPEX o Each division manager has the ability to make capital expenditures o Believe in reinvesting in equipment that helps them be more productive o Do measure return on invested capital but it is not as important as other metrics  Especially since comp is based on profit sharing

Backlog  Is the backlog the best barometer of how the company is doing? o Yes, for sure o How much visibility do you typically have into the next year and beyond?  They have about a year of visibility  Some power generation business is longer-term and thus they have a little more visibility o Demand drivers of record backlog

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor   A lot going on in the oil and gas industry Spikes in the power generation business

National Pump acquisition   Owner was looking forward to retirement even though he is staying on Blended well with their agriculture and municipal businesses o It was an overall great fit o They are not turnaround people Like to pay EBITDA numbers under 10x o Multiple on National was around 8x o During the decision process, management reflects on a lot of things  Has to be a fair price  Has to fit with the firm’s marketing capabilities and product offerings  Has to fit culturally Want to stay in the pump business o Do not want to stray away from that

Lack of appreciation by people new to the company     The breadth and diversity of products is not well understood There is a lot of opportunity out there domestically and internationally People are always going to flush toilets Just achieved ISO 14000, which is an environmental standard o They have a love/hate relationship with the EPA  They believe they have to be environmentally responsible company more so than others because they are in the water market

Day-to-day tasks of the CFO   Makes sure that the customers are satisfied and that employees are involved Oversees the business on a day to day basis

Balance Sheet    Goal is to have no debt by year end The National acquisition led to some debt that they expect to be outstanding for only 5 quarters Stability and good dividends are important to investors o Leveraging up the company to make acquisitions is not the way to go o Most acquisitions are cash –based Gives them a ton of flexibility o Have great banking relationships and have access to capital that allows them to make acquisitions or build plants whenever they want Never have to worry about interest rate risk o Never have to beg for cash o Have leverage with banks

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Stock Price  What is Wall Street and the market in general missing about the company/stock at the current level? o Company has a strong balance sheet and is a dividend payer  For the most part people get the picture  Compounded returns since the IPO are very impressive o Most holders have been in the stock for a long time

Economic Downturn  What does their world look like in a situation in which the US is in a prolonged state of fiscal contraction and economic malaise? o Agriculture markets can be cyclical  Make up about 5% of revenue o Construction markets can be seasonal o They are in 7-8 key markets  The biggest market is 20% of total revenue o What about the municipal side of the business?  Funding is an issue  The company caters more to smaller and medium sized municipalities  Demand is flat even though the need is high  Waste water is a priority  Municipalities tend to find the money somewhere and can jack up water rates if need be  Margins are similar pretty much across the board, including municipal contracts  Offer a high amount of value engineering o Design provides an advantage o Nobody ever gets fired for buying from Gorman Rupp  Quality backed up by service o Weak dollar has made their product more price competitive  International revenue is now near 40% of total  Dollar has stabilized but they have continued to execute

Kirby Corp Chairman/CEO Joe Pyne: Description Kirby Corporation is a marine transportation and diesel engine services company. The Company, through its subsidiaries, conducts operations in two business segments: marine transportation and diesel engine services. Its marine transportation segment is engaged in the inland transportation of petrochemicals, black oil products, refined petroleum products and agricultural chemicals by tank barges, and, to a lesser extent, the offshore transportation of dry-bulk cargoes by barge. The Company’s diesel engine services segment is engaged in the overhaul and repair of medium-speed and high-speed diesel engines and reduction gears, and related parts sales.

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor
Ticker Current Price Market Cap ($mm) Enterprise Value ($mm) Dividend Yield Average Volume (mm) *Data from Capital IQ KEX $53.51 $3,009 $3,342 N/A 0.41 TTM EBITDA ($mm) TTM EPS 5 Yr. Avg. Op. Margin 5 Yr. Avg. EBITDA Margin Trailing EV/EBITDA Trailing P/E Ratio $337 $2.53 18.98% 26.46% 9.9x 21.3x

Growth Drivers  What are three things that need to happen for revenue and earnings to go up and the stock price to rise? In other words, what are the main drivers of the company’s performance? o Low natural gas prices are important  Natural gas is a feedstock for their customers and customers are hurt by higher prices o Modest capacity additions o A global economy that is growing  These 3 things would create an environment where the stock works o Utilization of fleet right now is in the mid-90s because the petrochemicals business is growing  The whole industry is likely at these levels as well State of the petrochemical market  Still getting better  Provides 2/3rds of revenue o 20% black oil o 10% refined products o The rest is agriculture  This was about the same 4 years ago  Refined products percentage is going to increase as a result of the K-Sea acquisition o Black oil and chemicals are the best places to make money  Agriculture chemicals are carried by old barges US fleet of tank barges  3100 total barges in US o They have 830, a number that represents 27-28% of the market o They are always price takers although the pricing has continued to go up  Expecting peak pricing next year, similar to 2008 (before the crash) o They are still building barges but they are only replacement older equipment  They have taken out capacity  The industry will always overbuild but there is no significant capacity being brought out since most of it is replacement-based  Can’t see real overcapacity for three to four years honestly o Overall fleet age is 23 but will be down to 17 by 2012  Useful life is 30-40 years

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Marine Value Proposition  Do you realize value for being the largest inland barge carrier? o They get value from being the biggest  This was seen in 2008 and 2009 as they achieved rates higher than those of their competitors  Safest, strongest balance sheet, well managed, lots of flexibility, ability to move equipment and can cut costs for customers when needed  Biggest customer is Dow Chemical o Dow is completely dependent on barges and Kirby serviced them during the recent flooding  They have all of Dow’s barge business

Economies of Scale  It looks like there is a cost advantage versus rail and trucking. But how do you establish a competitive advantage versus other barge carriers? o Economies of scale  They think they have that on the Gulf Coast  It is easier to compete with Kirby in the river business but not in the Gulf Coast business  Can take costs out quicker than others and can stay profitable when others are losing money  They went into the financial crisis with 80% of their contracts being long-term o Their customers are so big that Kirby almost never have to deal with people not being able to pay or trying to break the contract  They had some trouble with Lyondell  But now Kirby has all of Lyondell’s business and is actually thinking about buying all of Lyondell’s boats

Margins  As fuel prices decline, do you more than make up for lost demand with cost savings? o Fuel costs are passed on  Theoretically changes in fuel prices are earnings neutral  However, higher energy prices are generally not favorable because they hurt customers and the economy as a whole

CAPEX and Acquisitions  Can you talk about the rationale for the K-Sea acquisition and discuss how the integration is going? o K-Sea’s operations represent an extension of Kirby’s with the added benefit geographic diversity  Talk to the same customer at the same desk  Think they can move things inland and offshore  Think they bought it at the right time  K-Sea had too much capacity but that will rationalize over the next few years  Bought 58 barges and 63 towing vessels

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor  This is high value, offshore equipment There are backend synergies but they have not publicly quantified those as of yet  Going to spend the latter part of the year looking at those  Deal was the first example of a public company buying a public MLP How do look at issuing shares versus taking out debt to make these acquisitions? o Prefer not to issue shares o Had to in the K-Sea acquisition because they did not want to get downgraded by the rating agencies  Kirby wanted the agencies to see that the company was serious about the balance sheet o Have bought back 21M shares since he has been the CEO o They have more control over repurchases than a dividend  They would rather reinvest cash in their business than pay a dividend  But, they will never say never because they are close to generating enough cash able to do everything (including a dividend) 

New barges  What factors do you look at when you decide to bring on new capacity through new barges? o He has been running the Marine side since 1984  Having been taking capacity out since then  Only started adding some capacity in 2007  Any new capacity would be added very carefully Is the make versus buy decision all about the cost per unit? o He would always prefer to buy versus make because when you buy you take off capacity and when you build you increase capacity Barge lead time o It takes 3 months to build a barge o In 2008 visibility was 12 months and now it 18 months  Backlog is good until the customer cancels  Is only as good as the next cycle

Consolidation  Does increased consolidation lead to more rational pricing and less knee jerk response to adding capacity? o All capital intensive businesses face the overcapacity issue  There is always the risk of overbuilding during good times o Pricing is rational right now  But if it gets sloppy, the pricing will get irrational very fast

Competition  Who would you saw your most formidable competitors are? o American Commercial Lines has 10-11% share

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.

The Inoculated Investor Stock Price  What is Wall Street and the market in general missing about the company/stock at the current level? o Most people who study the company think it is a great buy o The issue is whether the price is fair or not  That has a lot to do with where earnings go o He doesn’t think the street is missing a lot about Kirby  Look at who owns Kirby  Thinks long-term investors own the stock  The company kind of sells itself  If it’s not the right stock for certain investors then he doesn’t want them to buy it o If we have more questions, he suggested that we call Steve Holcombe, Kirby’s IR guy  Said we should put him through the ringer  And then if we come to Houston we can see the equipment firsthand

The opinions included in the following posting belong to me and do not necessarily reflect those of Cove Street Capital “CSC” or any of its employees. The information in this posting should not be considered as a recommendation to buy or sell any particular security or to encourage anyone to invest with CSC. Past performance of CSC is not a guarantee or indicator of future results.