July 12

CFOJULY/AUGUST 2012 | WWW.CFO.COM

FINANCE TRAINING THE

DELL WAY

THE 2012 WORKING

CAPITAL SCORECARD

RECIPE FOR PROFITS AT POPEYES

No one ever thought implementing Dodd-Frank would be easy

At Exelis, Defense Never Rests

Lessons From JPMorgan’s Botched Hedge

UnfinishedBusiness

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Cover photo-illustration by Stephen Webster. This page, clockwise from top left: Matthew Furman, David Plunkert, Stan Kaady

38Unfinished BusinessTwo years after the passage of the Dodd-Frank Act, the law’s implementation is far behind schedule, and its success is still in doubt. By Randy Myers

46Too Much Of A Good ThingWorking capital is piling up at America’s largest companies. By Russ Banham

51 ◗ The 2012 Working Capital ScorecardThe best and worst performers in 20 industries.

FeaturesJuly/August 2012 Volume 28, No. 6

contents

DoDD-frank

act

“Our business has four key areas that align well with where our government cus-tomers are headed, based on their public comments.”

›› Peter Milligan, cfo of Exelis

34

34 ›› On the Record

Defensive ManeuversDefense contractor Exelis is ready to adjust to an era of reduced Pentagon spending, says CFO Peter Milligan.

Interview by Edward Teach

60 ›› Take-Away

Recipe for ProfitsPopeyes Louisiana Kitchen CFO Mel Hope talks about collaborating with franchisees to grow the business.

Interview by Marielle Segarra

People to Watch

Mel Hope

1cfo.com | July/August 2012 | CFO

2 CFO | July/August 2012 | cfo.com From top to bottom: Miguel Davilla, courtesy Make Meaning, Bloomberg/Getty Images, Gordon Studer

contents

15 | Accounting & tAX

Renewed Concerns About RenewablesKey tax credits for investments in renewable-energy projects could soon begin to expire. ◗ By Kathleen Hoffelder

The Second-Greatest RiskCFOs of multinational companies rank transfer-pricing risk just behind global compliance. ◗ By Kathleen Hoffelder

18 | cApitAl MArkets

Finding Life after DebtAn acquisition saves a software company from crushing leverage. ◗ By Vincent Ryan

Private Equity’s Picky AppetitePE firms are craving service and health-care targets, according to a new survey. ◗ By Vincent Ryan

21 | growth coMpAnies

Hands-On GrowthThe finance chief of Make Meaning says the start-up has what it takes to bring customers through the door. Can it keep them coming back? ◗ By Marielle Segarra

23 | huMAn cApitAl

Training at Dell: Here,There, And EverywhereThe computer giant’s financial-education programs rely on a mix of long-distance and local learning. ◗ By David McCann

26 | risk MAnAgeMent

The Hedge That Wasn’tJPMorgan Chase’s $2 billion trading miscue is a costly lesson in how not to protect against potential losses. ◗ By Vincent Ryan

29 | strAtegy

Hawaiian’s Big Apple VentureHow Hawaiian Airlines’s CFO prepared for the launch of an ambitious new route. ◗ By David Rosenbaum

Euro Slide Sparks M&A InterestThe weakening currency makes European assets more attractive. ◗ By Andrew Sawers

32 | technologyDigging Out from Big DataUnstructured data is piling up in corpo-rate computers, making compliance and other tasks far more difficult. ◗ By David Rosenbaum

Up Front4 ››From the editor7 ››letters

11 ››topline The Supreme Court upholds the Affordable Care Act ◗ FASB and the IASB approve two accounting methods for lease expenses ◗ most CFOs expect employees to delay retirement ◗ CEO turnover rises ◗ com-panies have cash but won’t spend it, says a recent survey ◗ and more.

55 ››business outlook Duke University/CFO Survey Results

Muddling ThroughCFOs continue to hire, but are less optimistic. By Kate O’Sullivan

58 ››FielD notes Perspectives from CFO Research

Putting Social Networks to WorkCompanies are finding real economic value in cooperation and social media. By Josh Hyatt

By the Numbers

18

21

23

32

July/August 2012 Volume 28, No. 6

2.5% The average by which U.S. CFOs say they will expand their full-time domes-tic workforce over the next 12 months.

© 2012 AT&T Intellectual Property. All rights reserved. AT&T, the AT&T logo and all other AT&T marks contained herein are trademarks of AT&T Intellectual Property and/or AT&T affi liated companies.

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CFO, Vol. 28, No. 6 (ISSN 8756-7113), is published 10 times a year, with combined January/February and July/August issues, and distributed to qualified chief financial officers by CFO Publishing LLC, 51 Sleeper St., Boston, MA 02210(executive and editorial offices). Copyright ©2012, CFO Publishing LLC. All rights re-served. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of CFO Publishing LLC. Requests for reprints and permissions should be directed to FosteReprints, (866) 879-9144; E-mail: [email protected]; website: www.fostereprints.com. Subscriptions: U.S. and possessions: 1 year $65; 2 years $100; 3 years $130; foreign, 1 year $120 U.S. funds only. Periodicals postage paid at Boston, MA, and additional mailing offices. POSTMASTER: Send address changes to CFO, P.O. Box 1233, Skokie, IL 60076-8233. CFO is a registered trademark of CFO Publishing LLC. SUBSCRIBER SERVICES: To order a subscription or change your address, write to CFO, P.O. Box 1233, Skokie, IL 60076-8233, or call (800) 877-5416; or visit our website at www.cfo.com/subscribe. For questions regarding your subscription, please contact [email protected]. To order back issues, call (617) 345-9700, ext. 3200. Back issues are $15 per copy, prepaid, and VISA/MasterCard orders only. Mailing list: We make a portion of our mailing list available to reputable firms.

Kory Addis

leadershipGeneral Mills CFO Don Mulligan will explain how to build top-notch finance teams at CFO’s CFO Rising: The Future of Fi-nance conference in Las Vegas, September 30–October 3, 2012. See www.cfo.com/conferences.

accountingIf you want expert advice on presenting financials in an easy-to-comprehend way, check out Painting with Numbers, by former high-tech CFO Randall Bolten (John Wiley, April, $39.95). Among other things, you’ll learn why pie charts are bad, why a “natural P&L” is good, and why you should never, ever “be sleazy about the vertical axis.” See www.johnwiley.com.

global businessBritish economist Roger Boo-tle won the £250,000 Wolfson Economics Prize in July for his analysis of how countries could leave the euro with the least amount of fuss. See “How to Break Up the Euro” on cfo.com.

from theeditor

EdITOR’S PICkS

There have been numerous accom-plishments (however controversial), including the establishment of the Financial Stability Oversight Council, the Consumer Financial Protection Bureau, “say on pay” shareholder vot-ing, and hedge-fund registration and reporting. But some of the thorniest provisions of the law remain on the drawing board, such as the Volcker Rule, which would limit banks’ propri-etary trading. One seasoned observer told Myers that implementing Dodd-Frank wouldn’t be finished until “at least well into 2013.”

Even partial progress on Dodd-Frank is too much for those who con-tinue to insist that the law is unneces-sary or worse and should be repealed, either in whole or in part. One promi-nent critic of the Volcker Rule has been Jamie Dimon, the superstar CEO of JPMorgan Chase. It was more than a lit-tle embarrassing for Dimon, therefore, when JPMorgan revealed in May that its chief investment office had lost at least $2 billion on an ill-advised trade (“The Hedge That Wasn’t,” page 26).

There have been many criticisms of Dodd-Frank—it goes too far, it doesn’t go far enough, it’s too complex, it’s a brake on the economy, and so on. But as Myers reminds us, it’s hard to fault the motivation behind this sweeping overhaul of the nation’s financial sys-tem. After all, it wasn’t long ago that the government was forced to pump trillions of dollars into the system to keep it from failing, while millions of people lost their jobs, their savings, and their homes.

Elsewhere in this issue we offer the latest installment of one of our most popular features, the annual working capital scorecard, done in cooperation with REL Consulting (“Too Much of a Good Thing,” page 46). See how your company stacks up against some of the best (and worst) performers in work-ing capital management in Corporate America. CFO

Edward TeachExecutive Editor

4 CFO | July/August 2012 | cfo.com

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer

Protection Act. Two years later, regulators are still hard at work putting the mammoth law into effect. Although they have written thousands of pages of rules, they are far from finished, as contributing editor Randy Myers reports in our cover story, “Unfinished Business” (page 38).

dodd-frank at two››

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working. Jobs, and the skills needed to perform them, are also changing, so some jobs are becoming obsolete; others are having some or all of the tasks automated; and many jobs have expanded the use of technology, thus requiring workers to perform them in new, and different, ways.

The anticipated drama of the baby boomers’ exit hasn’t really material-ized, thanks in equal measure to the poor economy, delayed retirement plans, and unprecedented opportuni-ties for older workers. While the age wave may be hitting some industries harder than others, the earlier con-cerns simply haven’t come to pass. In fact, many older workers have fared better in the down economy than their younger counterparts.

Dr. Katherine L. Y. GreenGreen Consulting Group LLC

Chevy Chase, Maryland

w The Bright Side of the CloudCloud computing is a way that small companies can allocate much-needed resources to other, more beneficial top drivers, such as sales and marketing (“Made for Each Other,” June). When smaller companies begin to realize that software as a service is the best way to manage data, they will see the inherent benefit that the cloud presents.

Darrin MarionVia E-mail

develop an integration process for the postmerger period, a failure due to: (1) not understanding how to achieve revenue and cost synergies; (2) not re-taining key employees and customers; and (3) not understanding the corpo-rate culture of the acquired company.

Can a company right a poor post-integration process? The answer is yes, but it will cost a heck of a lot of share-holder value. Although there remain questions about the value of M&A, companies today need to continue making acquisitions in order to stay competitive.

Richard SummoVia E-mail

w Another BurdenThe other burden, besides taxes, that is even more significant to those affect-ed is audits (“Small Businesses Spend

w How to Succeed at M&AIn my experience, the main reason for merger failures is poor management in the postmerger integration phase (“Do Mergers Add Value After All?” Strategy, June). Most companies fail to

Stephen Webster

LETTERS


Go to “The Real Reason Companies Aren’t Investing” on cfo.com to see how readers responded to this post (and to add your own thoughts as well).

It’s the Equity Risk Premium, StupidThere are plenty of justifications companies can give for why they aren’t allocating capital to new projects or buying assets, but most of them tend to be pretty vague. “Uncertainty,” whether due to the state of the global economy, the European sovereign debt crisis, or federal regulatory creep, is my least favorite excuse that CFOs give.

The truth is, there’s a far better apologia that com-panies could present for not investing, and it’s rooted in a classic principle of corporate finance. I’m speak-

ing of the equity risk premium, a key ingredient in the calculations finance departments make to decide whether to invest in a project. As Professor Aswath Damodaran of New York University defines it, the ERP is the “ex-tra return that investors collectively demand for investing their money in stocks instead of holding it in a riskless or close-to-riskless investment.”

A key point is that the value of the ERP is affected by the entire stock market, not just the individual company’s shares. So the overall risk aver-sion of equity investors affects the ERP.

And therein lies the problem. In the wake of the financial crisis, the Facebook IPO debacle, and developments in high-frequency trading, the perceived risk of holding an equity portfolio has increased. Investors want a higher return to compensate for the risk. The equity markets, as embod-ied in the ERP, are dampening business investment.

Best of the BlogsVincent Ryan

No Dire Straits For BoomersIn regard to the worry over baby boomers leav-ing the workforce, the institutional-knowledge challenge is being solved in many ways, and is cre-

ating less turmoil than projected by many business analysts (“When the Boomers Go,” June). Many people age 50 and over are staying on because they need, or want, to continue

Send to: The Editor, CFO, 51 Sleeper St., Boston, MA 02210,or e-mail us at: [email protected] include: Your full name, title, company name, address, and telephone number. Letters are subject to editing for clarity and length.

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Editorial Offices

More Time on Taxes,” Topline, June). Sales-tax audits can be brutal, and IRS audits can take months, a year, or more—and large amounts of employee and tax-attorney time.

Ronald J. Cappuccio, J.D., LL.M. (Tax)Via E-mail

◗ COLI Is A-OKYour story “Key-Person Insurance: A Cash-Flow Caveat” (May) provided important information on this “in-creasingly popular tactic.”

Corporate-owned life insurance (COLI) has long provided numerous benefits to shareholders and high- producing, quality executives who help to maximize shareholder value. COLI provides nonqualified plan spon-sors with a cost-efficient asset that offsets the liability of the participants’ account balances on the plan sponsor’s balance sheet. For example, plan spon-sors can use COLI policies to mirror the rate plan that participants earn in their voluntary nonqualified deferred-compensation plans. As a result, COLI helps companies reduce future liabili-ties, with an asset that should consis-tently grow in value. And with non-qualified retirement plans increasingly important for many executives earn-ing more than $150,000 annually, COLI facilitates effective asset-liability man-agement.

Contrary to what is stated in the article’s last two paragraphs, there was no 2004 regulation that led to the COLI market being “essentially dead” from 2004 to 2010. By contrast, COLI has continued to grow in popularity since that time. In 2004, the COLI Best Practices Provision was first proposed and later became law as part of the Pension Protection Act of 2006. The measure and its high standards were widely supported by the industry’s leading practitioners.

Mike PowersExecutive Director

The Todd OrganizationCleveland


IBM, the IBM logo, ibm.com, Smarter Planet and the planet icon are trademarks of International Business Machines Corp., registered in many jurisdictions worldwide. Other product and service names might be trademarks of IBM or other companies. A current list of IBM trademarks is available on the Web at www.ibm.com/legal/copytrade.shtml. © International Business Machines Corporation 2011. All rights reserved.

How a car dealer is driving a safer business.As the world becomes more interconnected, threats and risks are growing exponentially. Fortunately, on a smarter planet, we have the tools to help protect critical data and business continuity. Gruppo Intergea is a midsize company with about 460 employees that sells cars in Northern Italy. They wanted to improve the security of their IT infrastructure — a critical part of their daily operations. With help from IBM and its Business Partners, Gruppo Intergea implemented a smart security solution that can proactively scan their data across their network to identify threats and block them before they can damage business operations. So Gruppo Intergea can be protected not only from known security threats, but also from other vulnerabilities that may not have been on their radar. As a result, their network can stay up, and their data stays safer. To see how IBM and its Business Partners can help your midsize business work smarter, visit ibm.com/engines/auto. Let’s build a smarter planet.

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The U.S. Supreme Court’s ruling that upheld the constitu-

tionality of virtually the entire Patient Protection and Affordable Care Act will have major repercussions for businesses as they weigh whether to change their em-ployee benefit plans over the next two years.

Many companies expect-ed the court to strike down the individual mandate, a decision that could have un-raveled the entire law. But in a 5-4 decision issued on June 28, the court ruled that the mandate, which requires most U.S. citizens to obtain

some health coverage if they don’t have it, is constitu-tional because it falls under Congress’s taxing powers. The court did strike down part of the law, ruling that states have the option to keep their current Medicaid funding even if they decline to expand their Medicaid programs.

Starting in January 2014, firms with more than 50 em-ployees that forgo providing health insurance to full-time employees will be required to pay a “no coverage” pen-alty. That per-employee penalty, however, will be less than what virtually all

employers currently pay for providing health insur-ance. Employees that do not receive insurance through their companies may be able to purchase it through fed-

erally subsidized insurance exchanges in each state.

While the court’s deci-sion creates some certainty for companies, CFOs’ ini-tial reaction to the law was largely unfavorable. Some worried that the law opens the door for more federal regulation, which they said is preventing businesses from investing in expansion. They also said the complex-ity of the law will make it hard to calculate the cost of hiring additional employees as they enter into the bud-geting process for 2013.

Despite the ruling, the Affordable Care Act is sure to remain a contentious is-sue both in Congress and in the upcoming November elections. ◗ vincent ryan

ToplineStatS of the month

Kevin Dietsch/Landov

health care

Annual rate of sales of new homes in May, the highest monthly rate since April 2010.

369K

Rise of new auto sales in June from a year earlier.

22%

Increase in orders for durable goods in May, after two consecutive monthly decreases.

1.1%

High Court Upholds Health-Care ReformThe Supreme Court’s ruling leaves companies with decisions to make.

Protesters and supporters gath-er in front of the U.S. Supreme Court as they await a ruling on the Affordable Care Act.

Sources: U.S. Census Bureau, Autodata Corp.


Topline

bookshelf

the best is yet to come

Do you ever throw down your newspaper or iPad in disgust after read-ing the latest news about jobs or budget deficits and fret about the inevi-table decline of the United states? stop worrying, advises Daniel Gross, the economics editor of Yahoo finance. In his new book, Better, Stronger, Faster: The Myth of American Decline...and the Rise of a New Economy (simon & schuster, $26), Gross as-sures us that our current economic slump is just a temporary setback. We’re not Japan or the british empire, he says, nor is China quite the juggernaut that it’s cracked up to be, for that matter. bad things have happened to the U.s. economy many times be-fore, yet it always emerg-es from the experience, well, better, stronger, and faster.

“Restructuring is a core national competency,” Gross declares, pointing out that the United states rebounded faster from the Great Recession than its peers. Drawing on his ex-tensive travels in the U.s. and abroad, Gross pres-ents much evidence of new green shoots of pros-perity. CFO

After months of heat-ed debate, the Fi-nancial Accounting

Standards Board and the International Account-ing Standards Board split their differences in June, deciding to allow compa-nies to account for lease expenses on the balance sheet using one of two ap-proaches, depending on the type of lease. The two methods the standards-setters agreed on were the “right of use” approach (Approach A) and the “whole-contract method” (Approach D).

The two approaches differ greatly from each other, but together they seem to satisfy a variety of constituents, as well as the boards. Approach A takes the right-of-use asset of a lease and amor-tizes it in a straight-line fashion, while Approach D lets the lessee allocate lease payments evenly throughout the lease.

The boards’ decision clarifies how to account for equipment leases and real es-tate leases: equipment leases should fall under the right-of-use approach, and real estate leases should fall under the whole-contract method. In earlier discussions

at the joint board meeting, FASB originally opted for a two-method model and the IASB favored a one-method model. But after a second vote, both boards agreed on the dual approach.

Several market partici-pants say they would wel-come the combination of the two approaches. “I be-lieve it is the approach that will appeal to the greatest number of people affected by the standard,” says Dee Mirando-Gould, a former associate chief auditor with the Public Company Ac-

counting Oversight Board and now direc-tor at MorganFranklin, a business consult-ing and technology solutions firm. The two-lease model “is closer to the econom-ics of leases in that some leases transfer ownership rights [for which the whole-contract method is best], while others merely transfer a right of use,” adds Bill Bosco, president of lease-accounting firm Leasing 101 and a member of a FASB/IASB working group that provides input to the boards.

FASB and the IASB will publish a joint exposure draft on the topic in the fourth quarter of 2012. ◗ kathleen hoffelDeR

leasInG

Two Ways about ItFASB and the IASB have agreed to allow two approaches to accounting for lease expenses on the balance sheet.

in search of the

next big

thing

Is a percentage of your firm’s budget invested in pursuit of major innovations?

How much of the innovation work is your firm doing?

■ Yes ■ No

39% 61%

■ Transformational■ Moderate■ Incremental

44%

24% 32%

15%If yes, what percentage?

“I believe it is the approach that will appeal to the greatest number of people af-fected by the standard.”›› Dee Mirando-Gould, formerly of the PCAOB

▼

Source: Duke University/

CFO Magazine Global Business Outlook Survey 12 CFO | July/August 2012 | cfo.com

from last year.But not all is doom and

gloom, according to Jim Morrison, CFO of plastics compounding firm Teknor Apex and chair of the AICPA’s Business Indus-try Executive Committee. Morrison does not con-sider the 2-point drop that dire, considering the index has dropped 9 to 10 points in some years. “We might have been in a holding pat-tern for a while, but we are going to resume growth,” Morrison says. “It may not happen right away. There’s

still optimism that over the next year, we will be on a growth pattern rather than a downward spiral.” ◗ K.H.

CFOs looking for a promotion may take heart from the latest annual survey of CEO succes-

sion from consultancy Booz & Co. Last year, the percentage of top bosses who departed the world’s 2,500 largest companies rose to 14.2%—that’s 355 CEOs who moved out—from 11.6% in 2010.

The improved outlook for the econ-omy may be partly responsible for the acceleration in CEO turnover. “Boards are increasingly seeking new leaders to help drive growth in a recovering global economy,” the survey authors write. But there’s at least a hard bar-gain, if not a catch: the need to ride the upswing “places a distinct burden on those newly elevated CEOs to prove

More CEOs Go

A majority of executives surveyed by the American Institute of Certified Public Accountants in the second quarter said their companies have enough cash or have increased their cash this year, but they remain reluctant to deploy it.

Forty-three percent of the 1,250 senior executives in the AICPA Business and Industry Outlook Survey said their com-panies have “about the right amount” of cash currently, while 36% said cash as-sets have increased from the first quar-ter to the second quarter of 2012. Almost half of those surveyed were CFOs, while 22% were controllers. Sixty-nine percent represented privately owned firms.

But 24% of the total respondent base

said they were hesitant to deploy their excess cash, an increase from 20% who felt that way last quarter. Only 12% said they would actu-ally use it.

The reluctance to spend cash may stem from an overall negative take on the economy. The AICPA’s CPA Outlook Index dropped two points, to 67 from 69, from the first quarter of 2012 to the second. Similar-ly, expectations for revenue, profit, and employment growth slid this quarter, though they were essentially unchanged

Have Cash, Won’t Spend

24%of those surveyed said they were hesi-tant to deploy their excess cash, up from 20% last quarter.

themselves early in their tenure.”

Overall, 2.2% of CEOs lost their jobs because of merger-and-acquisition ac-tivity, 2.2% were forced out for other reasons, and the re-maining 9.8% planned their departures.

Good news for CFOs with their eye on the CEO role: so-called insider CEOs, those promoted from with-in the firm rather than ap-pointed from outside, serve longer and, more important, create more value for share-holders. From 2009 to 2011, these CEOs’ firms outper-formed local market indexes by 4.4%, compared with 0.5% for external CEOs.

The bad news: those insider promo-tions are harder to get. In 2011, 22% of CEOs were appointed from outside, compared with just 14% back in 2007.

The Booz survey makes no mention of the role of CFOs in succession plan-ning. It does, however, carry advice to newly appointed CEOs from Andre-Michel Ballester, CEO of the Italian company Sorin Group: “The first is-sue is to create a leadership team very quickly, making decisions on who are

the keepers and who are the leavers in the first few weeks.”

And therein lies a warning: CFOs who don’t get the top job themselves should quickly cement their relation-ship with the successful CEO candi-date. In fact, recent research by recruit-ing firm Korn/Ferry suggests that 28% of CFOs leave their company within two years of an external CEO’s ap-pointment. If another internal candi-date gets the CEO role, there is only a 10% chance the CFO will leave for new pastures. ◗ AndrEW SAWErS

HuMAn CAPITAl▼

CASH FlOW


-0.6%-2%

0

2

4

6%

■ Insider ■ Outsider

-1.3%

3.9%

5.1%

3.6%

2.2%

4.4%

0.5%

’09-’11’06-’08’03-’05’00-’02

Source: CEO Succession Report: 12th Annual Global CEO Succession Study (Booz & Co.)

The Insider’s EdgeMedian shareholder returns of companies where the outgoing CEO had been promoted from within vs. recruited externally.

›› The bad news: insider promotions are harder to get. In 2011, 22% of CEOs were appointed from out-side, up 8% from 2007.

Thinkstock

Topline

Even employees who have tra-ditional pensions will be work-ing longer than they planned—and their bosses know it.

In a recent survey con-ducted by CFO Research in collaboration with Prudential Financial, about 70% of senior finance executives said they believe their companies’ em-

ployees will be forced to delay retirement because of insufficient savings. (CFO Research and Prudential conducted similar surveys in 2009 and 2010.) The 186 finance executives surveyed work at large and midsize companies, all with defined-benefit (DB) pension plans with assets of at least $250 million. Employers also said that employ-ee benefits are critical to attracting and retaining talent, with three-quarters agreeing that employee satisfaction with benefits is impor-tant to the success of their company.

So what’s a CFO to do? The survey suggests that finance execu-tives are exploring new ways to manage those financial risks that pose threats to both a company’s bottom line and an employee’s nest egg. This year’s survey found an increase in the percentage of companies likely to transfer DB plan risk to a third-party insurer. Because pension plans are guaranteed, employers have to pay extra if the investments underperform. With that in mind, “we are fig-uring out a way to move future risks off of our company’s balance sheet,” said the CFO of a health-care company. While only 5% of respondents had transferred DB plan risk to a third-party insurer, 43% said they were likely to do so within two years, up from 30% in 2010.

Finance executives in the study also said they will explore prod-ucts that can dampen the market’s volatility and encourage employ-ees to keep their own investments in defined-contribution plans intact. These executives are becoming more interested in exploring how using strategies such as target-date funds, stable-value prod-ucts, and guaranteed-income products might help bolster employee retirement investments. ◗ Josh hyatt and david owens

retirement plans

To download the report, “The Future of Retirement and Employee Benefits,” go to www.cfo.com/research

Retirement:A Recalculated Risk

If you would like to submit a question to Bill “MrExcel” Jelen, go to CFO’s Spreadsheet Community Center at www.cfo.com/spreadsheets.

A Refreshing ChangeQ: I’ve discovered that

some of the underlying

data in my pivot table is

wrong. After I correct a

number, the pivot table

does not appear to include

the change. Why does this

happen, and how do I hold

on to my updates?

A: There is an important concept to understand

about pivot tables: When you create a pivot

table, all the data is loaded into memory to allow

it to calculate quick-

ly. Changing the

data on the original

worksheet does not

automatically up-

date the pivot table.

›› You need to se-

lect a cell in the

pivot table. The Piv-

otTable ribbon tabs will appear. On the Options

tab, click the Refresh icon to recalculate the pivot

table from the worksheet data (see Figure 1). The

result should be that the pivot table is updated.

›› One word of caution: Making changes to the

underlying data could cause the table to grow.

For example, if you reclassify some records from

the East region to the Southeast region, be aware

that clicking the Refresh button will cause the

table to grow by one column. If there happens to

be other data in that column, Excel will warn you

and ask if it is okay to overwrite those cells.

Ask MrExcel

Bill Jelen

Figure #1

Anticipating DelaysMore than two-thirds of CFOs expect employees to have to put off retirement.

0%

20

40

60

80%

Don’t KnowNoYes

14%17%

69%

14 CFO | July/August 2012 | cfo.com Thinkstock

Wind-project developers or solar-facility owners typically have tax-eq-uity partnerships with large-company investors such as Google or Chevron, where both sides benefit: the develop-ers get necessary capital and the inves-tors get big tax write-offs. Corporate investors in wind, geothermal, and bio-energy projects are currently eligible for the production tax credit (PTC), which provides an income-tax credit of 2.2 cents per kilowatt hour for up to the first 10 years a facility is open. They can also take the investment tax credit (ITC), a one-time tax break of 30% on their investments, or an equiv-alent cash payment from the U.S. Trea-sury Department.

But sooner or later, that could all change. The PTC for wind projects, which companies can exchange for a cash grant, is set to expire at the end of this year, while the geothermal and other bioenergy PTCs expire at the end of 2013. Treasury’s 1603 grant, which provides cash payments worth 30% of the total cost of a renewable project, is also phasing out. Named after Section 1603 of the American Recovery and Reinvestment Act of 2009, the grant is now available only to projects that began construction in 2011. Solar ITCs, meanwhile, are set to expire in 2016.

The uncertainty surrounding the renewable-project market is already slowing project development. Some

participants are hopeful that Congress will extend the credits at the 11th hour, but typically, when lawmakers do re-new these credits, they tend to extend them for no more than a year or two.

Demand for tax-equity financing already exceeds the supply of funds available. Only $3.6 billion in tax-equity funds will be available for renewable-energy projects in 2012, but the demand for renewable-project financing in 2011 was $7.5 billion, according to an Ameri-can Council on Renewable Energy survey last year. “That source of capi-

If long-standing renewable-energy credits expire as scheduled starting this year, companies that have

taken advantage of those hefty tax breaks for wind and solar financing will have to consider new alternatives.

Renewed Concerns About RenewablesKey tax credits for investments in renewable-energy projects could soon begin to expire. By Kathleen Hoffelder

››

Ferran Traite Soler

accounting & tax

tal that is helping the industry grow is going to slow down if those incen-tives are not there,” says Brent Stahl, principal and partner at law firm Stahl, Bernal & Davies. In fact, that’s already happening, as only those wind projects

already under way are still receiving the tax credits.

Investors have been lured to the projects in the past few years, when the tax savings increased dramatically. “The cash-on-cash return that a firm is paying a tax-equity investor may be 3%, but in sub-stance the tax-equity investor is earning a very high return be-cause it’s using these tax attributes to shel-ter or reduce the tax burden on [its] other income,” says Mark Regante, a partner at

law firm Milbank, Tweed, Hadley & McCloy. “In the case of accelerated-depreciation deductions, the benefit is like an interest-free loan from the gov-ernment.”

Before the recession, investors in solar facilities were earning a 6% to 8% aftertax internal rate of return;

The uncertainty surrounding the renewable-project market is already slowing project development. Some are hopeful that Congress will extend the tax credits at the 11th hour.


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“ Ryan has been a trusted partner of CBS Corporation for many years, consistently delivering incredible value and substantial savings.”Christopher Fontana Director, State and Local Tax

Thinkstock

The Second- Greatest RiskCFOs of multinational companies rank transfer-pricing risk just behind global compliance.

◗ Multinational CFOs are increasing-ly looking to avoid the double taxa-

tion that can occur from manufactur-ing a product in one jurisdiction and selling it in another. Transfer pricing, the movement of goods and services in order to allocate profits, has become a high-ranking concern for finance chiefs of multinational companies, ac-cording to a survey by Alvarez & Mar-sal Taxand.

Thirty percent of the 60 large- company senior finance executives surveyed ranked transfer pricing as their greatest risk, just behind global compliance, at 32%. Transfer pricing

now they can reap an IRR of more than 10% on the renewable deals. If the tax credits expire, however, other alternatives for in-vesting in renewable proj-ects could become more popular. For example, market participants have started to discuss a master limited partnership as a fi-nancing vehicle, similar to the model for pipeline busi-nesses, says Stahl. The con-cept would be a first for the renewables sector.

Already-existing tax-

was also the second-highest risk for the respondents from 158 smaller com-panies with less than $1 billion in an-nual revenue, with 20% saying transfer pricing was their greatest risk, com-pared with 23% who named global compliance.

“Once something goes wrong in the transfer-pricing area, it becomes a huge controversy very quickly, espe-cially if there are two countries in-volved,” says Kent Wisner, managing director of international tax at A&M Taxand. “Even in a lower tax jurisdic-tion like Ireland, they need tax revenue just like the United States does.”

Staying one step ahead of the tax penalties that may accompany trade distortions involving tangible or in-tangible assets, for example, is a key concern of businesses today. The risks become more pronounced as merger-and-acquisition activity picks up.

Once a physical transfer-pricing

equity structures could also draw new interest. Sale-leaseback structures, where a developer sells a project to an investor, could prove useful for in-vestors with short-term horizons. And inverted-lease structures that let an investor lease a proj-ect directly from a devel-oper could also become more popular, say market participants. Similarly, accelerated-depreciation federal-tax incentives, in-cluding credits for solar-

project investments that extend over a five-year period, are not expiring yet and could be more appealing with the traditional credits going away, Stahl says. So far, relatively few companies have taken advantage of these incen-tives.

Interest in these alternatives varies by market. The wind sector may need more investor support, but the solar industry is better equipped to stand on its own because of its retail appeal, says Milbank’s Regante. There are more tax-equity investors in the solar market now than a year ago, he says, and developers are finding ways to get their projects financed. CFO

$7.5billionDemand for renewable-energy project financing in 2011

$3.6billionTax-equity financ-ing available for renewable-energy projects in 2012

Source: American Council on Renewable Energy

Financing shortFall

structure is in place at a company, however, keeping it operating often becomes less of a burden to financial executives, according to A&M Tax-and’s survey. Only 7% of the largest-company executives surveyed saw transfer pricing as a burden to their ongoing operations. The survey in-cluded responses from more than 300 financial executives, with more than 70% representing smaller companies.

◗ K.H.

“Even in a lower tax jurisdic-tion like Ireland, they need tax revenue

just like the U.S. does.”›› Kent Wisner, A&M Taxand

those lovely intangibles

“The fact is that it is simply very difficult to identify or measure intangible assets. High market-to-book ratios may provide indications of their existence and value. However, after the excesses of the dot-com bubble, there is under-standable reluctance to record them on the balance sheet.”

—hans hoogervorst, IASB chairman, in a June 20 speech

Verbatium

accounting & tax


Finding Life after DebtAn acquisition saves a software company from crushing leverage. By Vincent Ryan

Miguel Davilla/theispot

capital Markets

approaching 10 times was off the ta-ble,” says Samuelson.

By December 2010, Infor had a new management team and profits were growing again. But that didn’t solve the capital-structure problem: Infor was still more than nine times lever-aged. The company considered sev-eral options for right-sizing its capital structure and chose one true to its his-tory: acquire a company that Infor and Golden Gate could “overequitize” and combine with Infor to bring leverage levels down, Samuelson says.

Lawson to the RescuePublicly held Lawson Software, with $800 million in revenues, had the scale to help fix Infor’s capital structure. But a take-private transaction for Lawson still would not have brought Infor’s le-verage down to a level that was “palat-able in the capital markets,” says Sam-uelson. And as the company was trying to close the deal in 2011, the earthquake in Japanese occurred and the euro-zone crisis flared up, making the debt markets difficult again.

As a result, Golden Gate Capital financed the $2 billion Lawson unso-licited takeover separately and kept the company a stand-alone entity. But the PE firm eventually combined the companies this year, after it and Sum-mit Partners kicked in $1 billion of new equity. Infor used $600 million of that sum to pay down debt. At the same time, Infor obtained a $3.4 billion first-lien bank loan and raised $1.9 billion in a public bond issue, one of the larg-est post-credit-crunch refinancings in high tech.

Those transactions lowered the le-verage of the combined Infor-Lawson to 6.5 times EBITDA. The addition of Lawson’s cash flow also helped. Infor

Acquisitions have killed many companies, but Infor may be one of the few saved by one. Leveraged to the

hilt two years ago, the company, which makes enterprise-resource-planning software, has returned from the brink of a major restructuring. A merger with fellow ERP software

››

recalls Samuelson; “the debt was in-credibly inexpensive, and we could get as much as we wanted.” So Infor went from financing acquisitions almost en-tirely with equity to “a more tradition-al leveraged-buyout-type capital struc-ture,” he says.

The company’s pro forma lever-age after the 2006 deals was 6.5 times EBITDA (earnings before interest, taxes, depreciation, and amortization). Then the economy nose-dived, and Infor suffered large declines in EBIT-DA and profits, pushing its leverage to 10 times EBITDA. Although servicing debt was never an issue, “the ability to refinance debt certainly at anything

vendor Lawson Software, combined with an injection of equity capital, was the key factor in Infor’s revival.

“I think a lot of people thought the endgame would be bankruptcy or some kind of negotiated restructuring with existing lenders,” says Infor CFO Kevin Samuelson. But Infor avoided that outcome.

How did Infor get so deep into debt? In 2006, it was a four-year-old company owned by private-equity firm Golden Gate Capital and humming along at a good clip. But that year it spent $2.5 billion on acquisitions in a short period of time. The credit mar-kets had opened up to software firms,


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Stephen Webster

now has a window of six years be-fore any meaningful maturities and $350 million to $400 million of free cash flow after debt service. The com-pany is now looking to spend heavily in international markets in the next 18 months, and going public is also on its radar screen. “With the proceeds of an [initial public offering], we could pay down debt and get to a more normal-ized public-company debt level,” says Samuelson. For Infor, at least, there is life after debt. CFO

Private Equity’s Picky AppetitePE firms are craving service and health-care targets, according to a new survey.

◗ Private-equity firms have been choosy investors this year, express-

ing a preference for service and health-care companies for potential takeovers and greater portfolio exposure. Ac-cording to financial sponsors, both in-dustries will provide superior value in the current economic climate.

The second-quarter Rothstein Kass/CFO Midsize Private-Equity Firm Ba-rometer surveyed PE firms with assets

of $150 million to $1 billion and found that 52% of deals these firms completed so far in 2012 were in the service sector. Health care, including pharmaceuticals and biotech, came in second, at 31%.

A substantial chunk of the 85 PE firms polled said they were weighing service-industry deals, particularly in the IT services, financial services, and insurance subsectors. When asked about catalysts for service-sector value creation, 41% of survey participants said service firms will get a lift from the recovering economy this year. The service sector is also offering reason-able valuations and plentiful deal op-portunities, participants said.

On the health-care front, a major-ity of the PE managers (61%) said they had either increased their holdings in health care, were weighing deals, or were investigating future investment. By subsector, 34% of those surveyed cited instruments and supply compa-nies as targets; about 28%, diagnostics; just under 24%, home health care; and about 22%, appliances and equipment.

The PE managers surveyed were mostly unified about what will spur value creation in health care: the aging populace. “Health care is rapidly evolv-ing, with advances in everything from cancer-fighting drugs to noninvasive diagnostics and health-care analytics,” says Jeff Somers, a principal in the private-equity group practice at Roth-stein Kass. “These diverse and innova-tive companies offer a wealth of op-portunities to PE firms looking to take nascent technologies to the next level.”

Of course, by focusing too much on services and health care, PE firms could sow the seeds of lower returns. Somers warns that a “clustering” of deals in

big dogs in derivativesSix financial-services firms account for an excess of 75% of derivative assets and liabilities carried on the balance sheets of a cross-industry sample of 100 U.S. companies, according to Fitch Ratings.

The firms are JPMorgan Chase, Bank of America, Goldman Sachs, Citi-group, Morgan Stanley, and Wells Fargo.

The notional amount of all derivatives held by the 100 companies was about $300 trillion at year-end 2011.

Editor’s Choice

services or health care could have an impact on deal flow and valuations.

While PE firms are optimistic about opportunities, the deals in front of them obviously haven’t been com-pelling enough to move them off the M&A sidelines. The vast majority of the 85 funds in the Rothstein Kass survey have closed one or no deals to date in 2012. Thirty-five percent have closed two to three deals, and 11% have done four to five transactions.

Rothstein Kass, a provider of pro-fessional services to alternative invest-ment firms, polls PE fund managers quarterly. ◗ V.R.

capital markets

Source: Second-quarter Rothstein Kass/CFO Midsize Private-Equity Firm Barometer

Top three reasons service companies will provide value in 2012

Lift from improving economy

Reasonable valuations

Plentiful opportuni-ties to do

deals

0%

20

40

60

80%

0%

80%

41% 38%33%

Top three reasons health-care companies will provide value in 2012

Aging populace

Innovation in drugs, treat-

ment, or diagnostics

Health-care legislation

0%

20

40

60

80%

0%

20

40

60

80%66%

33%22%

Where the Deals ArePE firms say service and health-care companies are the best bets for 2012.


Now, Lipschitz is hoping his win-ning streak will continue at Make Meaning, a start-up “experiential re-tail” chain where he is finance chief. At Make Meaning stores, customers de-sign, decorate, and make the products they buy, whether candles, jewelry, stationery, soap, or other crafts.

Experiential retail, says Lipschitz, draws customers to stores by provid-ing a hands-on, interactive experience that they can’t get elsewhere, includ-ing (and especially) the Internet. The idea isn’t new; many chains have in-corporated experiential retail into their stores for years. Customers at

L.L. Bean’s flagship store in Freeport, Maine, can take kayaking, archery, and fishing classes. Children marvel at the lifesize toy soldiers and giant floor pi-ano at the FAO Schwarz store on Fifth Avenue in Manhattan. Other chains offering experiential retail include American Girl, Lego, and Apple.

But Make Meaning is taking the idea a step further. Although its stores do sell cards, candy, and other products for children, most of its business comes from customers crafting their way to the cash register—whether putting decorations on cakes, brushing paint onto ceramics, or melting wax into can-

dles. And that’s the whole point.“There is a big difference between

doing something for the experience, which really is kind of the pottery-store model, versus doing something with a commerce objective in mind, and basically letting you personalize your product,” says Sucharita Mul-puru, retail analyst at Forrester. “It sounds like these guys are about activ-ity first and commerce after.”

Crafting a New BusinessSince its launch less than two years ago, Make Meaning has opened four stores—in Manhattan; Scottsdale, Ari-zona; and Dedham, Massachusetts, a Boston suburb. So far it has seen more than 300,000 visitors, and 12,000 peo-ple have signed on as members, at an annual cost of $36 for individuals and $149 for families. The firm now has about 200 employees, and though Lip-schitz wouldn’t disclose sales numbers,

he says they have exceeded manage-ment’s expecta-tions.

Like all growing companies, Make

Meaning has had to take risks. One of the biggest: offering so many activities, each requiring niche expertise, un-der one roof. To keep things operating smoothly, the company has hired top-tier consultants, such as Elisa Strauss of Confetti Cakes, a well-known Manhat-tan bakery. Make Meaning is also staff-ing its corporate office with entertain-ment-industry experts, including vice president of operations Don Watson, who held the same title at the House of Blues chain of music clubs.

When Wayne Lipschitz was controller of Wolfgang Puck Worldwide, the firm grew from 12 units to more

than 20. As controller of The Cheesecake Factory, he helped the chain grow from 19 restaurants to over 40. And during his time there as CFO, the Coffee Bean & Tea Leaf chain grew from fewer than 100 stores to more than double that.

››

Images courtesy of Make Meaning

GROWTH COMPANIES

Hands-On GrowthThe finance chief of Make Meaning says the start-up has what it takes to bring customers through the door. Can it keep them coming back?By Marielle Segarra

Visitors decorate cakes and watch their candles cool at a Make Meaning store.


Shelling out for top talent was criti-cal, says Lipschitz. “Obviously, we’ve taken a risk by bringing on the best people, as opposed to growing as a mom-and-pop,” he says. “But execution is about bringing in the right people so we can grow the concept as quickly as possible. Where we had a corporate of-fice of a couple of people not very long ago, we now have an infrastructure that’s ready, willing, and able to sup-port the growth ahead of us.”

For now, the company is outsourc-ing its accounting function, including bill paying and dealing with vendors, to a firm that specializes in multiunit retail businesses. “We do not have a big team, so we’ve decided to really focus on what we do best, serving up a cus-tomer experience,” Lipschitz says. As the company grows larger, it will bring accounting back in-house, he adds.

Fundamental QuestionsAs with any novel, experience-based concept, keeping traffic and growth steady could be a challenge for the company, says Forrester’s Mulpuru. “The fundamental questions of a busi-ness like this are: Can it scale, what’s the frequency of visitation, and who’s going to be their core customer?” she says. “It can’t be a place where you do a candle once and never come back. It’s got to keep engaging you.”

When it comes to customers, chil-dren are a big part of Make Meaning’s business, but the company also markets to an older crowd, Lipschitz says. “Our challenge is to make sure that we’re of-fering a lot for adults so that it doesn’t just become a kid concept,” he says. To that end, the company plans to obtain a

beer and wine license for each store.Make Meaning also conducts mar-

ket research to determine what crafts it should add to its offerings. “We can add and take out experiences all the time,” Lipschitz says. Indeed, the company’s newest addition, cake decorating, was a result of such research, and it has al-ready driven significant sales since it was introduced this year, he says.

Lipschitz believes Make Meaning’s intricate, specialty-based store expe-rience will act as a barrier to entry to other companies. “There are many moving pieces, from the time that you walk in the door and are greeted by our host to the time that the production person pulls your glass or your ceramic out of the kiln,” he explains. “For any-one to develop this kind of concept, we’re light-years ahead of where they

growth spurtsPrivate companies’ average annual sales growth jumped from 7.6% in March to 9.6% at the end of June, according to the Sageworks Private Company Indicator. Average annual net profit margin also rose, from 6.6% in March to 7.9% in May and June, its highest point in at least five years.

Editor’s Choice

would have to be to be a risk to us.”How far can Make Meaning grow

its own concept? Lipschitz says the company is eyeing major markets across the country, particularly those with high-income demographics and a solid base of children. Eventually, he says, it hopes to open at least 800 stores globally. Those are high hopes, given the state of the economy and the reluctance of consumers to spend.

But Lipschitz is building Make Meaning’s business to be scalable, something he learned from his previ-ous experience. He says he keeps the big picture in view, constantly re-minding his team, “If we’re doing this for two units, we’re going to have to do it for several hundred, so we need to make it a much easier and more ef-ficient process.” CFO

Are You Experienced?Other companies have their own versions of experiential retail.

Build-A-BEAr At Build-A-Bear stores, customers construct their own stuffed ani-mals, choosing the furry exteriors, adding in sound buttons and hearts, and stuffing and clothing their new pals.

WinE And dEsign At locations of this Raleigh, N.C.-based franchise, local artists teach painting and customers bring their own wine. The stores also offer programs for children, but BYOJB (bring your own juice box).

AmEricAn girl At American Girl stores, children go on scavenger hunts, have after-noon tea, and take their dolls to the hair salon.

FAO schWArz Tourists flock to the FAO Schwarz flagship store in New York to see the life-size toy soldiers, a giant floor piano, and other interactive accoutrements.

l.l. BEAn Customers can take kayaking, archery, and fishing classes at L.L. Bean’s flagship store in Freeport, Maine.

lEgO During monthly in-store events, children learn to build miniature Lego models for free. They can also create their own custom minifigures throughout the month.

Growth companies


Most Fortune 100 companies have substantial formal programs for educating their top finance talent, and

Dell is no exception. But the Round Rock, Texas-based computer giant may have a slight edge, thanks in part to its use of a simple tactic.

››

Bloomberg/Getty Images

Human capital

Training at Dell: Here, There, and EverywhereThe computer giant’s financial-education programs rely on a mix of long-distance and local learning. By David McCann

“I don’t know of anoth-er company that combines the two approaches,” says Tom Conine, founder of TRI Corp., which helps large companies design, develop, and implement financial-education pro-grams (Dell is a client). “Going for-ward, decision-makers have to be able to work both virtually and face-to-face, and the team dynamics of the two are very different,” says Conine. He credits the dual approach to Dell CFO Brian Gladden and Alicia Davis, the company’s director of global finance

learning and development.The approach supports three edu-

cation programs, geared toward fi-nance professionals with varying lev-els of experience. In addition to the FDP, there is the Financial Rotation Program (FRP), for top talent with 5 to 7 years’ experience, and the Global Financial Excellence Program (GFEP), generally for those with 10 to 12 years’ experience who have just received or are about to receive their first execu-tive appointments.

Learning Through SimulationsDell’s educational effort began in 2009, though the programs are still consid-ered new in the company’s culture. “These are contemporary programs that deal with the realities of today,” says Gladden. To that end, all three programs feature simulations, in which participants form teams that make business decisions for hypothetical companies.

The simulations in-crease in complexity from one program level to the next. They require partici-pants to make decisions rel-ative to the entire business, about pricing, production, cost, new products, market direction, and more. “Simu-

lations are effective because you learn by doing,” observes Conine. “When you do that, you make mistakes that you learn a lot from. The simulations are also competitive, and most finan-cial people thrive around that.”

The simulations force participants to work under four different types of

“These are contem-porary programs that deal with the realities of today.”

›› Brian Gladden, CFO of Dell

Almost all companies of Dell’s size are globalized, and most try to homog-enize their training programs as much as possible. They generally educate their employees in one of two ways: either virtually via the Internet or in classrooms scattered around the world. Dell, however, uses both of those meth-ods. For example, for the third and fourth semesters of the company’s Fi-nancial Development Program (FDP), a two-year program for high-potential recent college graduates and under-graduate interns, teams work virtually for several weeks and then convene for a week in Austin, Texas.


stress. They have to deal with time pressure, limited information, scarce resources, and divergent opinions from teammates. “When you mix those ele-ments together,” observes Conine, “it makes for real-world decision making under conditions of uncertainty.” The simulator runs the various decisions made through an econometric model and spits out hard-number results.

In addition to the simulations, the FDP calls for participants to rotate among roles that include segment and operating-expense analysis, intercom-pany accounting, cash-management analysis, pricing, corporate planning, competitive analysis, financial services, credit analysis, external reporting, bud-geting and forecasting, and logistics.

About 50 employees are enrolled each year in the entry-level FDP, which lasts two years. FDP graduates branch off to internal audit or finance roles. Within three years, they are eli-gible for consideration in the Financial Rotation Program. That lasts for three years, with three different one-year as-signments, many outside participants’ home countries. Roles include investor relations, assistant controllership, pro-curement (where a person would be an analyst for a commodity buyer), opex roles such as supporting the marketing budget, financial planning and analy-sis, treasury, foreign exchange, and cash management.

There is also a tax role, which Davis calls “relatively unique to our rotation, to understand not necessarily how to do an accrual but how value-added tax or transfer pricing works.” Participants don’t necessarily choose which assign-ments they get, she adds, but they can express a preference.

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it pays to be publicThree out of four CFOs (74%) received a raise in 2011, according to a survey by Grant Thornton and the Financial Executives Research Foundation. The average salary increase was 4%, compared with 3% in 2010. Public- company CFOs received an average base salary of $286,500 last year, versus $197,400 for private-company finance chiefs.

Editor’s Choice

tion to certain nonfinancial-employee groups. People from marketing, sales, research and development, and infor-mation technology will take four mod-ules built around the income statement, the balance sheet, factors affecting profitability, and key financial ratios.

As a result of the programs, Dell is now more consistently focused on a core set of operational financial tools, says Gladden. “A good example is in-come variance, driving a consistent set of tools across the firm to measure the results of our business units,” he says.

Can the return on Dell’s investment in the educational programs be quanti-fied? Gladden says they pay for them-selves through less reliance on recruit-ers to find talent. Since he came to Dell as CFO in 2008, Gladden has tried to instill in his top staff the mind-set that they are building a 25-year career at the company, “rather than just joining to get a certain set of experiences to make you more attractive in the ex-ternal market,” he says. “This is about developing a culture and leadership capabilities for the long term.” CFO

Studying Financial ExcellenceAt the third program level, the Global Financial Excellence Program, partici-pants do benchmarking work at other companies, which are selected based on their reputation for maintaining best practices. The Dell employees work with the CFO and finance staff to understand how the issues those com-panies are dealing with relate to Dell. In turn, those companies send finance staffers to Dell for similar learning.

The GFEP participants also work on a team project; they deliver the results to Dell chairman and CEO Michael Dell. Last year’s project focused on “purpose-driven companies”—those companies that execute against strate-gies that are clear, concise, and brand-ed. Key take-aways included how ev-ery team member “lives the brand” at Coca-Cola, how the business-integra-tion processes at Stanley Works func-tion, and how executives are involved in recruiting at Goldman Sachs.

Meanwhile, Dell is developing a program to provide financial educa-

educating dellFinancial training at Dell comes in three parts.

Financial Development program. Two-year entry-level program for high-potential recent college graduates and undergraduate interns. Areas covered include segment and operating-expense analysis, intercompany accounting, cash-management analysis, pricing, credit analysis,external reporting, and logistics.

Financial rotation program. Three-year program for top employees with 5 to 7 years’ experience. Consists of three one-year assignments, often outside participants’ home countries. Areas covered include in-vestor relations, assistant controllership, procurement, financial planning and analysis, treasury, and foreign exchange.

global Financial excellence program. For employees with 10 to 12 years’ experience who have received (or are close to receiving) their first executive appointments. Participants visit best-practices companies to see how their CFOs and finance teams handle various issues.

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That’s what experts are saying about a trading loss that knocked more than $20 billion off the bank’s market value, sparked probes by the Justice Department and the Securities and Exchange Commission, forced cred-it-rating agencies to issue negative outlooks for the bank, and turned the spotlight on a bank unit that was set up to invest excess deposits but also gen-erate a sizable profit.

According to JPMorgan, the bank’s chief investment office was invest-ing in a benchmark for credit-default swaps designed to mitigate the bank’s overall credit exposure, especially the possibility of higher interest rates and inflation. But the hedge was risky in

itself, and the positions in derivatives were so large that they distorted the market, experts say.

JPMorgan also may have failed to fully understand its exposure because it was relying too heavily on value at risk (VaR), a common risk model that estimates the potential loss in value of a risky asset or portfolio over a certain number of trading days.

In May, JPMorgan stated that the trading positions—reportedly on a se-ries of the 10-year Markit CDX North American Investment Grade index—were “riskier, more volatile, and less effective as an economic hedge than the firm previously believed.” JPMor-gan CEO Jamie Dimon admitted that

they were “flawed, complex, poorly reviewed, poorly executed, and poorly monitored.” Later that month at the bank’s annual shareholder meeting in Tampa, Dimon added that he couldn’t justify the mistake.

Improper from the Start“It screamed improper credit-risk management to us from the very be-ginning,” says Matthew Streeter, a product manager at FINCAD, speaking

of when he heard about the incident. (FINCAD is a developer of derivatives risk-management software.)

For one thing, the credit-index bets introduced secondary risk exposures that JPMorgan executives apparently didn’t take into account, says Streeter. A key question to ask about hedging, he says, is whether a hedge exposes the insured to risk above and beyond the risk the hedge is supposed to miti-gate.

For another, the trades JPMorgan was making were so large that they were moving the market for the hedg-ing instrument, concentrating a lot of risk on one side of the trade. “Any hedge on a $650 billion book will abso-lutely drive the market,” Streeter says.

Also, JPMorgan’s chief investment office was doing what Streeter calls “speculative hedging”: hedging with the intention of making a profit. As Ryan Gibbons, managing partner of GPS Capital Markets, told CFO two

The $2 billion trading loss at JPMorgan Chase that came to light in May stemmed from fundamental mis-

takes by risk managers—in particular, the belief that a hedge on credit exposures could both reduce the bank’s risk and earn billions of dollars at the same time.

The Hedge That Wasn’tJPMorgan Chase’s $2 billion trading miscue is a costly lesson in how not to protect against potential losses. By Vincent Ryan

››

Jim Lo Scalzo/EPA /Landov

RISKMANAGEMENT

The trading positions JPMorgan Chase took were “flawed, complex, poorly reviewed, poorly executed, and poorly monitored,” according to the firm’s CEO, Jamie Dimon.


years ago, big gains and losses from hedging spell trouble (see “Seven Pil-lars of Hedging Wisdom,” CFO.com). When companies make money from hedging, they tend to forget what their core businesses are, said Gibbons. At the high point of the chief investment office’s performance, in 2009, it man-aged nearly 17% of the bank’s assets and generated $3.1 billion in yearly income.

But a former finance chief at JPMor-gan takes the stand that hedging is in-herently risky, and that if the firm was taking a risk, it should have expected to get paid for it. “Who says you don’t earn money on a hedge?” Dina Dublon, finance chief of JPMorgan Chase from 1998 to 2004, asked CFO in May. “The only time hedging is not risk-taking is when you sell the position you are try-ing to hedge; anything else, you’re tak-ing risk.”

Dublon said JPMorgan’s chief in-vestment office was not a separate entity when she was finance chief, but was housed within the bank’s treasury function. Whether or not her finance department hedged credit risk depend-ed on the price of the hedge, she said. “Sometimes you do, sometimes you don’t.”

What Value at Risk?When JPMorgan revealed the loss on May 10, it said its risk measure had underestimated the portfolio’s volatil-ity. In the first quarter, JPMorgan was monitoring its positions using a new VaR model, which was indicating the chief investment office unit value at risk was $67 million. But JPMorgan scrapped that model and returned to an older version once the loss was dis-covered. It restated the VaR for its first quarter as $129 million.

“A VaR of $67 million at a 95% con-fidence level implies the [chief invest-ment office] should not incur losses of more than $67 million on more than three business days during the quar-ter,” wrote CreditSights analyst David Hendler in a report. But the restate-ment meant that the office “may have incurred losses in excess of $129 mil-lion on three days.” Hendler concluded that the losses put in question not only the accuracy of JPMorgan’s VaR mod-els but also the data being input into those models.

A March 2008 report by a group of senior global-banking regulators, “Observations on Risk Management Practices During the Recent Market Turbulence,” noted that many banks used VaR, but did so in conjunction with notional limits, stress tests, and forward-looking scenario analysis. “Firms that avoided significant un-expected losses used a wide range of risk measures to discuss and challenge views on credit and market risk,” said the report.

Despite all the tools available, regu-lators and large, complex banking or-ganizations face a tough task in judging the riskiness of many nontraditional

commercial-banking activities, testi-fied Federal Deposit Insurance Corp. vice chair Thomas Hoenig to a Senate committee in May. “Trading and mar-ket-making are high-frequency activi-ties that can take place between [regu-lator] exams with little evidence that they ever occurred,” he stated; moni-toring trading on a “high-frequency basis” would be costly for banks and regulators.

Hoenig is proposing a strict divi-sion of some of the banking functions conducted by the big universal banks like JPMorgan. Under his proposal, commercial banks would be allowed to perform some investment-banking activities but would be prevented from making markets in derivatives or secu-rities and trading securities or deriva-tives for their own account or a cus-tomer’s.

But there is little enthusiasm on Wall Street for such an arrangement. Asked by a Senate committee in June to comment about whether the Dodd-Frank Act’s so-called Volcker Rule, which would limit banks’ proprietary trading, could have prevented JPMor-gan’s loss, CEO Dimon replied that the rule was “unnecessary.” CFO

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ESSENTIAL KNOWLEDGEWhat skill sets do risk managers need? An intimate knowledge of the business and industry (cited by 67% of respondents) and a strategic view of risk and risk management’s role (64%) above all, according to a February survey of C-suite members by the Risk and Insurance Management Society and Marsh. Only 25% cited insurance knowledge.

Editor’s Choice

The Real VaR Steps UpAverage value at risk at JPMorgan Chase’s chief investment office

Source: SEC filings

Restated May 10

Reported April 13

$0

30

60

90

120

$150

1Q’12

4Q’11

3Q’11

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1Q’11

$129

$67$69

$48$51$60

5 In $ millions

The FDIC’s Hoenig would bar commer-cial banks from trading securi-

ties or derivatives for their own account.›› Thomas Hoenig, vice chair of the FDIC


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certain economic times like these. But the airline is betting that the lure of nonstop service to Hawaii—complete with a complimentary hot meal—will pay off.

The airline business is fundamen-tally a “terribly difficult industry,” says Topping, who came to Hawaiian in 2011 after spending 16 years at no-frills carrier Southwest Airlines. Bank-ruptcy is common; in the past 10 years more than a dozen airlines, including giants like American, United, North-west, Delta, and US Airways, have filed for Chapter 11 protection. Hawaiian too filed for bankruptcy in 2003, but it emerged 2 years later with, as one observer noted, “a better sense of who they are.”

Hawaiian’s Big Apple VentureHow Hawaiian Airlines’s CFO prepared for the launch of an ambitious new route.By David Rosenbaum

Image courtesy of Hawaiian Airline

strategy

In June, Hawaiian Airlines launched its first daily non-stop flight between New York and Honolulu. That may

not seem like much, yet it contributed to Hawaiian growing its overall capacity by nearly 25%. Starting a new air route “is always a risk,” says CFO Scott Topping, especially in un-

››

Source: Hawaiian Airlines 2011 annual report

Growth Gains Altitude (in $ thousands) 2011 2010 2009 2008 2007

Operating revenue 1,650,459 1,310,093 1,183,306 1,210,865 982,555

Net income (loss) (2,649) 110,255 116,720 28,586 7,051

are usually packaged as part of a vaca-tion sold through retail, says Robert Mann, president of an eponymous air-line analysis and consulting firm. This means Topping must work closely with the travel trade. “It’s an indirect ticket sale with extensive costs: commissions

to retailers, dis-counts to wholesal-ers, high marketing costs,” says Mann.

Hawaiian also partnered with Jet-Blue Airways to get its Honolulu flight off the ground. Ha-

waiian’s planes will fly out of JetBlue’s JFK terminal, and JetBlue will handle some of the ground services, including baggage handling. Hawaiian also has a code-share agreement with JetBlue, in which Hawaiian code is on connecting JetBlue flights. And the airlines have a reciprocal frequent-flier agreement, which goes a long way toward mitigat-ing Hawaiian’s risk.

It’s the PlanesTo fly from New York to Honolulu, more than anything else, one needs to have big, long-range, expensive planes. By year-end, Hawaiian will have nine 295-seat Airbus A330 aircraft in its fleet, at a cost of about $200 million each, says Topping. Five more A330s are coming in 2013. That’s not to men-tion even bigger, more-expensive

“We’re focused on being a destina-tion carrier,” confirms Topping. “We bring people to Hawaii. We stick to our knitting.”

Launching Hawaiian’s nonstop flight between Honolulu International Airport and John F. Kennedy Interna-tional Airport, however, entailed some complicated financial stitching. For starters, travel to Hawaii, like all pri-marily leisure destinations, is largely wholesaler driven; trips to the islands

Hawaiian uses Airbus A330s, costing about $200 million each, to fly nonstop be-tween Honolulu and New York.


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Euro Slide Sparks M&A InterestThe weakening currency makes European assets more attractive.

With the euro hitting record lows against the U.S. dollar, currency ana-lysts are getting out their rulers to see how far they can extrapolate the downward trend. Corporate strate-gists, meanwhile, are eyeing ever more affordable European targets for acquisition.

The euro touched $1.23 at the beginning of June, down from this year’s high of $1.35 at the beginning of March. That drop has prompted some foreign-exchange experts to say they can’t rule out the possibility of the euro hitting parity with the dol-lar if Greece leaves the single Europe-an currency. (Most experts agree that parity following a so-called Grexit would be an extreme scenario. More likely, they believe, would be a fall of about 10 cents from current levels.)

David Woo, head of global rates and currencies research at Bank of America Merrill Lynch, predicts the euro will continue to slide to around $1.20, then start recovering toward $1.30 by year-end. He argues that the situation will have to deteriorate further before either Europe or the United States issues any aggressive policies in response. “The only thing that can stem the dollar’s rise is very aggressive monetary easing from the Fed,” he says. “I don’t think that’s on the cards until things get worse.”

Still, while the euro may not be a particularly cheap currency at the moment, underlying European as-sets are cheap, Woo says. Not only is the dividend yield of the Eurostoxx

50 index significantly above that of the S&P 500, “the differential is now literally two standard deviations” from the historical norm, he says. Moreover, the fact that Spanish gov-ernment bond yields are at 6.5% or more, compared with 1.5% yields for 10-year U.S. Treasuries, means the market “is basically discounting an almost 60% devaluation of Spain over the next 10 years,” Woo says.

As the price of European assets continues to slide, U.S. companies are starting to consider acquisitions in Europe, Woo says. “These assets are starting to look really attractive,” he says. “They can purchase European

DIvErSITy DIvIDENDCompanies with more-diverse boards outperform their peers, according to a recent McKinsey study of 180 publicly traded firms in the U.S., France, Germany, and the UK. The study found that returns on equity were on average 53% higher for companies in the top quartile of executive-board diversity than they were for those in the bottom quartile.

Editor’s Choice

planes, Airbus A350s, ordered for 2017. Topping says one of his biggest du-

ties in supporting Hawaiian’s growth strategy is making sure it’s adequately funded. “We have to be proactive in trying to line up debt or lease financing for the 2013 aircraft deliveries,” he says. “The funding for three of those five [planes] is already taken care of. Stay-ing ahead of this is the biggest risk.”

Hawaiian took a negative net- income hit in 2011 after purchasing 15 airplanes it had on lease. “The trans-action was value-creating, but from an accounting perspective there was a $70 million one-time charge that hit the books,” says Topping. On the bright side, “if you look at cash flow from leasing to owning, it’s positive.”

Not surprisingly, given his South-west Airlines pedigree, Topping keeps a close eye on costs. But Hawaiian does serve complimentary hot meals in flight, making it the only American carrier currently to do so. Why the perk? “We bring Hawaii to the world,” he replies. “We understand hospitality. The Hawaii vacation starts when you get on the plane, not when you get off.”

Besides, Topping says, “it’s a long flight.” CFO

Hawaiian’s planes will fly out of JetBlue’s JFK In-ternational terminal, and JetBlue will handle some of the ground services.

“The only thing that can stem the dollar’s rise is very aggres-sive monetary easing coming from the Fed. I don’t think that’s on the

cards until things get worse.”

›› David Woo, Bank of America Merrill Lynch

companies more cheaply than at any time over the last 10 years.” In March, for example, UPS agreed to acquire Dutch group TNT Express for €5.2 bil-lion ($6.5 billion). In April, Watson Pharmaceutical sealed a deal for Ac-tavis for €4.25 billion from Deutsche Bank, which took control of the in-debted group in 2008.

Of course, if sentiment improves, or if Europe introduces a policy to re-duce the risk premium for European assets, the euro might get a boost as money flows in to scoop up European assets, Woo adds. ◗ AndrEw SAwErS is editor of Cfo european Briefing, a Cfo online puBliCation.

strategy


Industry Regulation Authority rules. “You have to retain electronic com-munications for six years at least,” says Malone. “And FINRA rules require that you review 20% of the communi-cations. I average about 80%. I don’t want to miss something.”

The financial-services industry is intensely regulated, which is one reason why Malone is chained to his desk. According to a recent CFO.com report, FINRA regulators are paying closer attention to broker-dealers than

ever before, even as the Commodity Futures Trading Commission is turn-ing up the heat on broker-dealer ac-counting policies. (See “Watchdogs Put Closer Eye on Broker-Dealer Ac-counting,” CFO.com.)

Another reason Malone stays put at lunch is the sheer volume of infor-mation that streams across his screen. Before he came to Crews in 2004, Malone worked at a small firm with 18 employees. There, he simply ac-cessed the company’s Microsoft Ex-

change Server and performed keyword searches for “bad” words. “For me,” he says, “a [bad] keyword is guarantee. I don’t want to see that word. I can’t have a salesperson, a stock broker, use guarantee in a communication. The other big bad word is complaint. If we receive a complaint from a customer, the salesperson is not supposed to communicate with that customer. The rule says the complaint has to go to the salesperson’s supervisor and escalate to the compliance department.”

As for data retention, at his previ-ous job that meant burning e-mails and other communications to a CD. “It wasn’t bad for 18 people,” says Malone, “but when you get to 200 employees, like Crews, it wouldn’t be feasible.”

Malone needs more-sophisticated IT at Crews, which provides under-writing and financial-advisory services to debt issuers, among other banking services. Every morning he fires up ZL Technologies’s Unified Archive Com-pliance Manager tool and keeps it run-ning all day, checking for noncompli-ant communications that run counter to company policies and could violate federal regulations.

Malone doesn’t have to search for the bad words; the software extracts and highlights them. Using ZL Tech-nologies’s eDiscovery product, which goes beyond keyword searching into concept searching—exposing patterns that could signal fraudulent intent, such as the misspellings spammers use to confound spam filters or the cod-ed communications that conspirators tend to employ—Malone vets about 8,000 e-mails a day.

“Businesses are struggling with surging volumes of content,” says Bri-an Hill, principal analyst at Forrester,

Gordon Studer

TECHNOLOGY

Digging Out from Big Data Unstructured data is piling up in corporate computers, making compliance and other tasks far more difficult. By David Rosenbaum

Carter Malone, vice president of compliance at invest-ment bank Crews & Associates, never leaves his desk,

not even for lunch. Malone’s job is to review the content and ensure the proper storage of all electronic communications that come in and out of Crews pursuant to Financial

››


an IT consultancy. Much of that con-tent is unstructured—such as Word documents, PDFs, e-mails, voice mails, video, and, increasingly, social-media inputs (tweets, Facebook “likes,” and so on)—and therefore is inaccessible to traditional enterprise resource plan-ning systems with their stored invoices and tables of numbers.

Digital LandfillsAll that data can cause organizations to accumulate “digital landfills” that gen-erate significant costs in storage, tax IT resources, and clog up a company’s information pathways, creating knowl-edge-management tangles, says Hill. It can be difficult to gain access to the data you need, he says, if your compa-ny’s information systems have become a digital dump site.

In the age of Big Data, it’s critical for companies to have policies for data disposal as well as retention, says Hill. However, “disposal needs to be done in light of potential litigation concerns,” he points out, and needs to be suspend-ed if legal matters are pending. In 2010, for example, FINRA fined investment bank Piper Jaffray $700,000 for its fail-ure to produce requested e-mails.

There’s a substantial return on in-vestment for businesses in digging out from under digital landfills by using new archiving and discovery technolo-gies, says Hill. The return comes not only in lower IT costs and improved knowledge management, but also in the reduced risk of lengthy, costly fo-rensic data reviews prior to and dur-ing lawsuits. “Preparing adequately for that alone can have a very significant ROI,” says Hill.

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STATE-SPONSORED HACKING UK spy chief Jonathan Evans revealed in June that a British company suffered lost revenues of about $1.25 billion because of a state-sponsored cyber- attack against its computer systems. The loss involved intellectual property and “commercial disadvantage in contractual negotiations.” (See “State-led Hacking Cost Company 1 Billion Euros, U.K. Spy Chief Says,” CFO.com.)

Editor’s Choice

“Companies without a plan for unstructured data take on a whole lot of risk,” says Kon Leong, CEO of ZL Technolo-gies. “The Securities and Exchange Commission, health-care regulations, [and] the Federal Rules on Civil Procedure that weigh digital evidence equally with physical evi-dence are all requiring that everything be kept forever.”

As daunting a task as that may seem, Leong illustrates its importance by telling a story about using his own technology to settle a dispute. “We had a trademark,” he recalls. “We saw a competitor use it. We sent them a [cease-and-desist] letter. They sent one back claiming they used it first. It took us 35 seconds to search through the archive for our earliest use of it. End of that argument.”

Leong goes on to make a larger point: that unstructured data—what he calls “the sum total of all human com-munications within an organization, [representing] your corporate memo-ry”—is a potential source of competi-tive advantage. “If you can harness and extract value from that, you’ve gone from gathering unstructured data as a defensive measure for compliance, re-cordkeeping, and litigation support to an offensive position for competitive, strategic advantage,” says Leong.

A Simple RuleHill says a number of software provid-ers offer products for searching, stor-ing, archiving, and retaining Big Data.

They range from large enterprise ven-dors such as Symantec, IBM, and HP Autonomy to smaller providers such as ZL Technologies. As is increasingly the case, their products are offered in both on-premise and software-as-a-service flavors, with the SaaS offerings lowering purchase and implementa-tion costs and making this type of soft-ware more accessible to smaller busi-nesses.

But prevention may be as effective as the cure. At Crews, Malone further mitigates the investment bank’s risks by banning instant messaging for his salespeople, denying them voice mail, blocking web-based e-mail, and put-ting the kibosh on Facebook. There are software providers that offer tech-nological control over social-media communications; Forrester’s Hill cites Actiance as an example. But he stresses that “companies need to train people on the permissible use of so-cial media. There needs to be a strong focus on policies.”

For Malone, when it comes to pol-icy, there’s a simple rule to follow: “I tell all employees that every time they write an e-mail, they should think about reading it in front of a jury,” he says.

That, he adds, seems to sink in. CFO

In the age of Big Data, it’s critical for compa-nies to have policies for data disposal as well as retention. However, “disposal needs to be done in light of potential litiga-tion concerns.”›› Brian Hill, principal analyst, Forrester


Exelis has a very diversified mix of products and services. Can you briefly summarize it?We do a broad range of things in what we call the C4-ISR world—command, control, communications, computers, intelligence, surveillance, and recon-naissance. We make electronic war-fare systems, communications equip-ment, force protection systems, radar systems, sonar, night vision, space-based imaging. Those are some of the major products. On the services side we do logistics solutions, training, security, and support services. Lastly, we’re in air-traffic management. So it is a broad-based, highly diversified business.

Let’s talk about major develop-ments affecting the defense indus-try, starting with the winding down of the wars in Iraq and Afghanistan. What effect is that having on your business?We supplied three main product lines to the DoD in support of those war ef-forts: tactical radios and communica-tions equipment, night-vision goggles, and counter-IED [improvised explo-sive device] jammers. A lot of that has come down over the last few years. In 2009 almost a third of our revenue came from those three products; in 2012, well less than 10%, probably clos-er to 5%, of our revenue comes from those same products. So we’ve already absorbed a big piece of the impact of that decline from the product side.

What about the services side?We don’t have any direct service con-tracts in Iraq at this point, and we had very little there throughout the war.

The defense industry is preparing for leaner times, thanks to deep cuts in military spending. Starting in fiscal 2012, the Budget Control Act of 2011 will reduce the Pentagon’s budget by $487 billion over the next 10 years. That number could more than double because of “sequestra-tion,” a deficit-reduction mechanism in the act that will trigger $500 billion more in defense cuts over the next decade unless Congress changes the law.

Like other defense contractors, Exelis is brac-ing for the cutbacks. Spun off from conglomerate ITT in 2011, the publicly traded McLean, Virginia-based firm relies on the Department of Defense for about 70% of its revenues, which totaled $5.8 billion in 2011. But CFO Peter Milligan says the product portfolio of the diversified defense electronics company is well suited to the “smaller and leaner” military that Defense Secretary Leon Panetta called for earlier this year. Exelis also does a growing business with government agen-cies like the Federal Aviation Administration and NASA, Milligan notes, as well as with military cus-tomers overseas and “a small but growing” num-ber of commercial customers.

The 44-year-old Milligan came to ITT in 2006 from AT&T, where he headed investor relations. He became CFO of ITT Defense in 2010, and the fol-lowing year was named finance chief of the newly spun off Exelis. In June, Milligan talked with CFO about the company’s strategy for adjusting to an uncertain new world where the DoD will still be Exelis’s largest customer, but perhaps not as large as before.

Defensive ManeuversDefense contractor Exelis is ready to adjust to an era of reduced Pentagon spending, says CFO Peter Milligan.

Peter MilliganCFO, Exelis

On the recOrD


‹‹ Peter Milligan with an Exelis pointer/tracker, which helps aircraft thwart heat-seeking missiles.M

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We do have a couple of contracts in Afghanistan.

Another development, of course, is the huge cuts in the Defense bud-get, which could reach nearly $1 trillion over the next 10 years. Yes, it’s making us think hard about what we can do to proactively address cost. Even though half of our business is on the product side, we do have a highly variable cost structure. So when we see changes in throughput—and usually we have a number of quar-ters to adjust for that, since we have a backlog of business that goes back many quarters in some cases—we can quickly adjust. We have reduced our footprint by about 10% over the last three years. We have kept our employ-ee head count fairly flat, but the mix of those who are working on the product side and in services has changed as the profile of our business has changed.

A couple of years ago, before the spin-off, the defense unit of ITT un-derwent a transformation. We consoli-dated a lot of our divisions, taking tens of millions of dollars in costs out and making the business-decision process quicker and more streamlined. That was the beginning of the company positioning itself for what we knew at some point was going to be a [slow-down in the] top line of the DoD.

The challenge that I have, and that everyone in my role has, is that when you don’t know which particular pro-gram is going to get cut, you can’t do too much in terms of proactive deci-sions. You have to wait for some defin-itive answer and hopefully have as few stranded costs as possible when you try to adjust.

In January, Secretary Panetta said he wanted the military to become “smaller and leaner,” one that would be “rapidly deployable and technologically advanced.” Is this an encouraging message for Exelis?Yes, I think it is. Our business has four


Peter Milligan, CFO, Exelis

ON THE RECORD

key areas that align well with where our government customers are headed, based on their public comments. Electronic warfare is an important one; we have a very strong po-sition there. The ISR market is another area. The military collects massive amounts of data, and we make sen-sors that help collect it. We also make soft-ware that helps ana-lyze that data. So that’s the second big piece.

The third area is important not only to the DoD but also in the commercial world, and that’s composites. The aerospace market is becoming more and more interested in composites; its lightweight nature makes it more fuel efficient. The government has a heavy-lift helicopter in development that’s going to be made largely of compos-ites. We have a position on that with Sikorsky as the prime [contractor]. We are also working hard to expand some of our part numbers within Airbus and Boeing and others.

The fourth area is air-traffic man-agement. The FAA has a vision to update the nation’s air-traffic con-trol system. One of the first programs designed to start that very big, prob-ably $15 billion to $20 billion, effort was ADS-B, for automatic dependent surveillance-broadcast. Exelis was awarded a $1.7 billion contract on that program. That has made us a well- recognized and leading air-traffic man-agement provider.

As CFO you spend a fair amount of time speaking with analysts. Do you also talk to people in Wash-ington? Yes, and it’s something that I would

like to do more of. I re-cently spoke to a couple of people in Congress on certain topics, and I’ve made a number of trips to meet some of the se-nior Army leadership with Dave [CEO David Melcher] and others.

What do you talk about?The best ways we can serve them, quite hon-estly. What can we do as an important supplier to help make their mission easier? What can we offer to them in terms of prod-ucts and services that will make their jobs easier, and certainly easier and safer for the soldiers?

Today, in mid-June, Exelis’s stock price is around $10, which is a little lower than it was when the compa-ny was spun off. Are you satisfied with this? How often do you pay at-tention to the stock price?I wouldn’t say I obsess over it, but it’s certainly something that I’ll glance at each day. Right now there’s just over-hang in the industry. If you think about the whole defense market, equity val-ues have come down pretty signifi-cantly over the last 60 days or so. As we get closer to the sequestration, I think there are some investors who are thinking that defense stock is not the most favored place. We have not been disproportionately impacted by that. In fact, if you look across our peer set, our return year-to-date is third in the industry.

Am I happy with where the stock is? My job is in part to create value for shareholders, and we do pay a strong dividend, but we would certainly like to find a way to have the shares ap-preciate.

◗ IntervIew by edward teach

Image courtesy of Exelis

Green dayExelis is a major supplier of night-vision systems for mili-tary ground forces.

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Unfinished BusinessTwo years after the passage of the Dodd-Frank Act, the law’s implementation is far behind schedule, and its success is still in doubt.

By Randy MyeRs photo-illustration by stephen Webster

It’s easy to criticize the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the controversial legislation aimed at strengthen-ing the nation’s financial system. At 848 pages, the law is frightfully obese, yet crucial details are missing. Like most two-year-olds (July 21 marks the second anniversary of its passage) the law is still wobbly on its feet, with prog-ress measured in baby steps. Propo-nents laud it, while critics see a law only its creators could love. Even many who appreciate its mission question whether it will ever be achieved.

“No law can prevent incompetent management or fraud-ulent management,” warns Jeffrey Burchill, CFO of insur-ance company FM Global. “You can penalize people for gross error or gross misconduct, but it’s very difficult to prevent that conduct.”

Dodd-Frank nonetheless aims to try. The most sweep-ing regulatory overhaul of the financial services industry since the Great Depression, the law created several over-sight bodies and a deluge of rules for the industry. Yet be-cause the legislation was drafted so hurriedly, and because the matters it tackles are so complex, Congress left much of the heavy lifting to regulators, saddling them with near-ly 400 rulemaking requirements and calling upon them to

complete dozens of studies.It didn’t happen. By June 1 of this

year, understaffed and overwhelmed regulators—at the Securities and Exchange Commission, the Federal Reserve, the Commodity Futures Trading Commission (CFTC), the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptrol-ler of the Currency, and elsewhere—had finalized only 110 of the 398 regulations they were tasked with crafting, according to law firm Davis Polk & Wardwell. They had missed 148 deadlines, including 21 for which they had not even issued any pro-posed rules. They faced another 140 future rulemaking deadlines, includ-ing 123 where they had no proposed rules on the table, and a clutch of additional rulemaking requirements for which they had been given no deadline. Former SEC commissioner Annette Nazareth, now an attorney with Davis Polk, says it will probably be “at least well into 2013” before rulemaking is completed. In some cases, implementation could stretch beyond that.

“Dodd-Frank was easy to pass in the aggregate, but implementing it has been difficult,” says former SEC attorney John Sten, now a partner at McDermott Will & Emery. Sten

blames not only the size of the task and regulators’ budgetary constraints, but also regulators’ efforts to make sure that any rules they do hand down are both workable and reflective of Congress’s

intent. Toward that end, regulators have spent thousands of hours meeting with business leaders and trade groups to get their input on rulemaking. While some have blamed business lobbying for holding up implementation of the law, Nazareth, who has represented swap dealers, broker-deal-ers, banks, and the Securities Industry and Financial Mar-kets Association in talks with regulators, sees it differently.

“I understand there’s lobbying going on, but there’s also a huge amount of educa-tional activity going on,” she says. “This is a major exer-cise, and regulators have to meet with people to under-stand what the issues are. Regulators welcome that; they really want to get it right.”

“No law can prevent incompetent manage-ment or fraudulent management. You can penalize people for gross error or gross misconduct, but it’s very difficult to prevent that conduct.” —Jeffrey Burchill, CFO, FM GlObal

Unfinished Business



Now, as the third year of implementing Dodd-Frank be-gins, significant pieces of the legislation—some of them ar-guably the most controversial and hardest to implement—loom on the agenda. They include the so-called Volcker Rule, which would bar banks from trading with their own money; regulating the over-the-counter derivatives mar-ket; designating “systemically important” nonbank finan-cial institutions for greater oversight; and calculating bank capital requirements.

Signature Accomplishmentsll this is not to downplay the signature accom-plishments of Dodd-Frank to date. New regu-latory authorities have been created, including the Financial Stability Oversight Council, the

Federal Insurance Office, and the Consumer Financial Pro-tection Bureau. Publicly traded companies must now give shareholders a nonbinding “say on pay” indicating wheth-er they support their companies’ executive-compensation packages. Whistle-blowers now have incentives to bypass internal compliance channels and report potentially illegal or fraudulent activity directly to the SEC.

Hedge-fund advisers are now required to register with the SEC. Beginning in June 2012, the largest funds must file reports on the value of their assets under management, their counterparty risk, their debts, and other key metrics. Also beginning in June, the nation’s largest financial insti-tutions must have “living wills” in place outlining how they will wind down in the event they fail. In April of this year, the SEC and the CFTC issued final rules defining the terms “swap dealer” and “major swap participant,” a critical first step in regulating the over-the-counter derivatives market.

A few of these early initiatives have already had an im-pact on corporate behavior. In response to say-on-pay, notes attorney James Hauser of Brown Rudnick, some companies have been redesigning their compensation plans, revising change-of-control agreements, eliminating tax gross-ups on change-of-control payments, linking equity awards more tightly to total shareholder returns or other performance metrics, and providing more disclosure in their proxy state-ments. Many observers surmised that General Electric was seeking to head off negative say-on-pay votes in April of this year when it announced that, in the wake of “constructive conversations” with shareholders, it would retroactively ap-ply performance measures to stock options it had awarded

Source: SEC (updated 6/20/12). Not all planned activity is listed above. Other regulators are also responsible for rulemaking.

◗ Corporate Governance & DisclosureSection 952: Report to Congress on study and review of the use of compensation consultants and the effects of such use.

Sections 953 and 955: Adopt rules regard-ing disclosure of pay-for-performance, pay ratios, and hedging by employees and directors.

Section 954: Adopt rules regarding recov-ery of executive compensation.

◗ Credit RatingsSection 932: Adopt rules regarding NRSRO [nationally recognized statistical rating organizations] reports of internal controls over the ratings process, preventing sales and marketing activities from influenc-ing the production of ratings, providing for a report to the SEC and “look-back” when an entity subject to a rating employs a person who previously worked for the NRSRO.

Section 932: Adopt rules regarding trans-parency of NRSRO ratings performance.

Section 936: Adopt rules establishing training, experience, and competence standards, and a testing program for

NRSRO analysts.

Section 939F: Report to Congress on study on the rating process for structured fi-nance products and associated conflicts of interest, the feasibility of an assignment system, metrics to determine the accuracy of ratings, and alternative compensation that creates incentives for accurate rat-ings.

◗ DerivativesSection 719(d): Joint report to Congress (with the CFTC) on study regarding stable value contracts.

Sections 763 and 766: Adopt rules on trade reporting, data elements, and real-time public reporting for security-based swaps.

Section 763: Adopt antimanipulation rules for security-based swaps.

Section 763: Adopt rules regarding the registration and regulation of security-based swap execution facilities.

Section 764: Adopt rules regarding the registration and regulation of security-based swap dealers and major security-based swap participants.

Section 765: Adopt rules regarding con-flicts of interest for clearing agencies, ex-ecution facilities, and exchanges involved in security-based swaps.

◗ Market OversightSection 210: Jointly with other financial regulators prescribe recordkeeping re-quirements that will assist the FDIC when acting as a receiver.

Section 417: Report to Congress on study on the state of short selling on exchanges and in the over-the-counter markets.

Section 619: Adopt rules to implement prohibition on proprietary trading and certain relationships with hedge funds and private-equity funds (the Volcker Rule).

Section 917: Report to Congress on study to identify financial literacy among retail investors.

◗ Municipal SecuritiesSection 975: Adopt permanent rules for the registration of municipal advisers.

On The SeC’S AgendA Upcoming rulemaking activity at the Securities and Exchange Commission for implementing the Dodd-Frank Act (estimated July–December 2012)

A

Bob O'Connor

to CEO Jeffrey Immelt in 2010.Elsewhere, many banks have already taken steps to cut

their business ties to hedge funds, as will be required under the Volcker Rule. And growing numbers of banks and busi-nesses are already clearing more of their over-the-counter derivatives trades as will be required by Dodd-Frank, even as they await final rules from federal regulators on exactly which trades must be cleared.

Preventing “Too Big to Fail”till, many of these developments are but a side-show to the real thrust of Dodd-Frank: to pre-vent the unwieldy collapse of systemically im-portant, “too big to fail” financial institutions.

The act attacks the problem from several angles—creat-ing stiffer capital requirements for financial institutions, re-quiring firms that securitize assets to retain some exposure to the resulting securities, creating greater regulation and transparency in the over-the-counter derivatives market, increasing regulation and oversight of credit-rating agen-cies, prohibiting speculative trading by banks, and creat-ing the Financial Stability Oversight Council. (The FSOC brings together the heads of the Treasury Department, the Federal Reserve, the SEC, and other regulatory bodies to monitor financial markets and identify potential threats to U.S. financial stability.)

The FSOC is only getting started on its mission, though,

and regulators have made only partial progress on the other fronts. Few of their tasks have proven more complicated or controversial than implementing the Volcker Rule, which prohibits proprietary trading by banks for their own ac-counts, precludes Fed-regulated financial institutions from owning or sponsoring hedge funds or private-equity funds, and gives regulators the authority to impose additional capital requirements on nonfinancial companies engaged in proprietary trading. Dodd-Frank provides that the Volcker Rule statutory provisions take effect on July 21 of this year, yet regulators at the Fed, the SEC, the FDIC, and the Office of the Comptroller of the Currency were still debating the necessary implementation rules heading into this summer, and it is unlikely that implementation rules will be issued by the deadline. The regulators issued interim guidance that will apply until final rules are adopted.

The delay stemmed in part from the complexity of de-ciding just what constitutes speculative trading and what qualifies as hedging, which the Volcker Rule expressly permits. Regulators also have been the target of vigorous lobbying by bankers opposed to the rule, often led by JP-Morgan Chase chairman and CEO Jamie Dimon—although JPMorgan’s announcement in May that it had lost $2 billion trading credit-default swaps in its own account (with the chance for that number to go much higher) renewed pres-sure on regulators to issue final rules with real teeth. Still at question is whether the JPMorgan Chase trading would have been covered by the Volcker Rule; the bank insists it

S

Fang Zhe /Landov 42 CFO | July/August 2012 | cfo.com

‹‹ Former Federal Reserve chairman Paul Volcker inspired the rule that would bar proprietary trading by banks.

Regulators are still hammering out the details of the Volcker Rule, one of Dodd-Frank’s most controversial provisions.

would not, while skep-tics wonder whether it was, in fact, hedging and not speculating.

Other major initia-tives still on the docket include identify-ing which nonbank financial institutions will qualify as “systemically important financial institutions,” or SIFIs, and therefore be subject to heightened regu-lation under Dodd-Frank; and imple-menting all the rules and regulations pertaining to the over-the-counter de-rivatives, or swaps, market, where most trades will have to be submitted for clearing to central counterparties. The FSOC spelled out in April how it will identify SIFIs, but actually identifying them is expected to take several more months.

Regulating Swapsmplementing Dodd-Frank’s swaps regulations has proved nearly as compli-cated as parsing out regula-

tory language on the Volcker Rule, with much of the controversy centered on whom, and which types of transactions, should be covered by the new rules. In addition to instituting regulation of swap dealers and major swap participants, Dodd-Frank prohibits those entities from receiving any federal assistance, such as advances from a Federal Reserve credit facility or discount window, that is not part of a broad-based eligibility program.

Following the JPMorgan Chase loss, the CFTC began looking into whether the swaps regulations should be extended to cover the overseas units of U.S. insti-tutions, a situation U.S. banks have said would hurt their ability to compete with foreign-based rivals. “The regulation of swaps is still a work in progress,” says Sten. “It may have a bigger impact on the affected U.S. institutions than the Vol-cker Rule.”

Elsewhere, the SEC headed into sum-mer still needing to issue final guidance on how companies should go about re-claiming incentive compensation in cases where companies restate their financial results due to material noncompliance with accounting laws. The Sarbanes-

➽ July also marks the an-niversary of another

landmark piece of legisla-tion: the Sarbanes-Oxley Act of 2002. Aimed at prevent-ing a repeat of the egregious accounting scandals that had felled once high-flying companies like Enron and WorldCom, the law mandat-ed rigorous internal control procedures for publicly traded companies, assigned personal responsibility for accurate financial statements to CEOs and CFOs, required rapid public disclosure of material changes in a company’s financial condition or opera-tions, and imposed a host of other accounting and corporate-governance mandates. Like the Dodd-Frank Act of 2010, Sarbox was written hastily and passed quickly in response to a crisis. Yet at just 66 pages, it was practically a footnote compared with Dodd-Frank, which clocked in at 848 pages.

Ten years later, it is clear that Sarbox did not completely eliminate ac-counting fraud or the sketchy use of off-balance-sheet bookkeeping to mask a company’s true financial condition. When commodities trader Refco col-lapsed in 2005, for example, investigators discovered that its CEO and chair-man had hidden approximately $430 million in bad debts from the company’s auditor and investors. And when Wall Street investment bank Lehman Broth-ers fell in 2008, regulators discovered that it had been using off-balance-sheet accounting to understate the leverage on its books.

Nor has Congress been completely satisfied with what it wrought. Earlier this year, the JOBS (Jumpstart Our Business Startups) Act exempted emerg-ing growth companies, which it identifies as those with annual revenues un-der $1 billion, from certain provisions of both Dodd-Frank and Sarbox.

Still, it is also true that since Sarbox there has been no rash of accounting scandals like the ones that prompted Congress to create the law. This held even in the midst of the 2008 credit crisis, when any corporate executive in-clined to shade the truth might have been tempted to whitewash what was happening to the corporate balance sheet. “The law has had value in bring-ing more integrity and transparency to financial statements,” says Carol Beaumier, an executive vice president with Protiviti, a consulting and inter-nal audit firm.

Whether Sarbox says anything about the future for Dodd-Frank is ques-tionable. “They are very different statutes,” says Annette Nazareth, a former SEC commissioner and now an attorney with Davis Polk & Wardwell. “I think Sarbanes-Oxley had a lot of merit, even though there were parts that didn’t work as well and took some time to resolve. Dodd-Frank was much more am-bitious, and in a lot of places duplicative, with several provisions aimed at solving the same problems. Is it going to make our financial system bet-ter? We hope so, but it’s difficult to say.” ◗ R.M.

10 years after: the sarbanes-Oxley act

I

Unfinished Business

43cfo.com | July/August 2012 | CFOLarry Downing /Landov

President George W. Bush signs the Sarbanes-Oxley Act in the East Room of the White House, July 30, 2002.

Oxley Act of 2002 had a similar but more forgiv-ing “clawback” provision that kicked in only if a restatement was a result

of misconduct. The new law, says Hauser, will likely require firms to amend many of their existing compensation agreements.

Finally, banking regulators are still work-ing on some of the rules needed to fully im-plement the controversial Collins Amend-ment to Dodd-Frank, which adjusts the way bank capital requirements are calculated. One challenge: figuring out how to recon-cile differences between the capital require-ments spelled out in Dodd-Frank and those outlined in Basel III, the global regulatory standard that phases in beginning in 2013.

Getting Dodd-Frank’s rules wrong could impose unnecessary costs on the nation’s financial system and exaggerate, rather than mitigate, the risks the law was intend-ed to minimize. But bad rules can be struck down. Last July, the U.S. Court of Appeals rejected an SEC rule that would have made it easier for shareholders to nominate can-didates to the boards of public companies, arguing that the commission hadn’t ad-equately assessed its costs. “Cost-benefit analysis is extremely challenging,” observes Nazareth, who speculates that it could be-come an issue with other rulemaking decisions, too.

Will It Work?ith so much rulemaking yet to be done, it is probably unfair to ask if Dodd-Frank has suc-ceeded so far in creating a stronger and more secure financial system in the United States. “I

think we’ve got a long way to go before we can judge Dodd-Frank,” says Carol Beaumier, an executive vice president with Protiviti, a consulting and internal audit firm.

Still, skeptics, and outright critics, are abundant. Con-gressional Republicans, who opposed the law, have sub-mitted numerous bills that would scrap all or parts of Dodd-Frank, while Presidential candidate Mitt Romney has vowed to repeal the law if he is elected, though most politi-cal analysts consider that little more than campaign bra-vado. Even if they captured the White House, Republicans would need to muster 60 votes in the Senate, now con-trolled by Democrats, to repeal the law.

That hasn’t stopped the criticism. “I think it [Dodd-Frank] has done little to solve our problems,” says Kevin Williams, CFO of Jack Henry & Associates, a $967 million provider of information-processing solutions to commu-nity banks. In the two years since the law’s passage, Wil-

➽ Keeping track of regulatory prog-

ress on implementing the Dodd-Frank Act is no easy matter. As one attorney recently confessed, “No one really knows what the hell is going on with Dodd-Frank.”

But there are study aids. Law firm Davis Polk & Wardwell publishes a monthly progress report available on its website at www.davispolk.com/Dodd-Frank-Rule-making-Progress-Report/. For anyone just being introduced to the act’s intricacies, “The Dodd-Frank Act: A Cheat Sheet,” published by law firm Morrison & Foerster, is still helpful. It can be found on the firm’s website at www.mofo.com/files/Uploads/Images/SummaryDoddFrankAct.pdf.

Meanwhile, many regulatory agencies are doing their best to keep the public informed as well. The Securities and Exchange Commission has more rulemaking requirements than any other agency, and it rou-tinely publishes news on its latest activities. To see the page where it spotlights its progress on Dodd-Frank, go to www.sec.gov/spotlight/dodd-frank.shtml. ◗ R.M.

Keeping TracKof dodd-franK

W

Unfinished Business

liams notes, the nation’s biggest banks have gotten bigger, not smaller, with the six largest holding assets equal to 63% of the country’s gross domestic product. That makes their potential failure an even bigger concern than it would have been in the past, he contends.

Meanwhile, small community banks are being hurt by the cost of complying with a law written in response to problems created by large banks, says Williams. That charge has been echoed by former FDIC chairman Bill Isaac, now chairman of Fifth Third Bancorp., who has said he wouldn’t be surprised if half of the nation’s community banks go out of business if they don’t get some relief from Dodd-Frank.

“I think Dodd-Frank was a political response to an eco-nomic problem, and history tells us that is not always the best solution,” says Isaac.

If Williams proves prescient, Dodd-Frank will have been a large, costly, and ultimately misguided effort to strength-en the financial markets. Yet in light of the ongoing devas-tation wrought by the 2008 credit crisis—to the financial and housing markets and economies around the world—it is probably unrealistic to expect that policymakers would not have tried. CFO

◗ Randy MyeRs is a contributing editor at CFO.

Dodd-Frank co-sponsor Sen. Christopher Dodd (right) retired from Congress in 2011; Rep. Barney Frank (left) will leave in 2013.

44 CFO | July/August 2012 | cfo.com Roger L. Wollenberg/Landov

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The FuTuRe OF FinanCe

Working capital is piling up at America’s largest companies.

Too Much Of A Good Thing

CFO | July/August 2012 | cfo.com46

By russ BAnhAmillustrAtions By dAvid plunkert

the 2012 CFO/rel Working CApitAl sCoreCArd

◗ It’s one of the most important metrics

for gauging a compa-ny’s efficiency and fi-nancial health. So when a new survey of 1,000 of the largest public com-panies in the United States indicates that their working capital continues to be much larger than is consid-ered prudent, that’s cause for concern.

The annual survey, conducted by REL Consulting, reveals an overall lack of sus-

tained working capital improvement among U.S. companies. After a predictable decrease in working capital during the Great Recession, when companies focused more on the bal-ance sheet, working capital performance has leveled off.

Days working capital (DWC)—the number of days it takes to convert working capital into revenue—did decrease marginally in 2011, from 37.7 days to 37 days. But REL down-plays the improvement, attributing it in part to the compa-nies’ 13% average revenue growth. “To have a 1.9% decrease is a positive, but not by a lot,” says Prathima Iddamsetty, se-nior manager of operations, research, and marketing at REL, a working capital consultancy.

Cash on hand across the group of surveyed companies, dubbed the REL U.S. 1,000, increased by $60.3 billion in 2011, helped in part by companies taking advantage of low interest rates to issue more debt, up by a record $233 billion year-over-year. Those companies now have a staggering $910 billion in excess working capital, including $425 billion in inventory, according to REL. “Way too much cash is being left on the table and not being put toward growth objectives,” says Id-damsetty.

There is a wide gulf between top-performing companies in the upper quartile of the survey and median performers. On average, top performers have 49% less working capital tied up in operations, collect from customers more than two weeks faster, pay suppliers about 10 days slower, and hold less than half the inventory than median companies. (The 2012 CFO/REL Working Capital Scorecard, which begins on page 51, shows the best and worst companies in terms of working capital performance in 20 industries.)

The research indicates little sustainability in working capital improvement. Fewer than 8% of companies managed to reduce days working capital over the past three years, and no company surveyed improved all elements of DWC—in-ventory, receivables, and payables—over the period.

CFOs should care about these results, not just because working capital is a reliable index of efficiency, but because the world is getting more competitive. “When global inves-tors think about where to put their money, they look for where they’re going to get the best return for a given amount of risk,” says Kevin Kaiser, professor of management prac-tice at INSEAD, the international business school. “Having capital tied up is an inefficient use of their investments. In a world where people have choices about where to send their cash, they’re not going to invest it in companies with ineffi-cient working capital practices.”

Gains Not SustainedREL also attributes the modest improvement in DWC to companies doing several things (in addition to the revenue growth already mentioned): collecting faster from custom-ers, getting rid of excess inventory built up during the re-cession, and tightening production. Although days inventory

Companies now have a stagg-ering $910 billion in excess working capital, including $425 billion in inventory, according to REL. “Way too much cash is being left on the table.”

Prathima iddamsetty, senior manager of operations, reL ConsuLting

outstanding fell, the survey indicates that companies turned inventory over slower in 2011 than in the prior year.

“We are more or less back to where we were well before the recession,” says Iddamsetty. “The long-term trends in-dicate virtually no ability to make sustained working capital improvements.”

Many companies that improved working capital dur-ing the recession haven’t continued to do so, says Ashley Sparks, an REL associate. “They made it a priority to get working capital in order, but now they have so much cash they’ve shifted their focus from the balance sheet to the P&L statement,” emphasizing new products and revenue growth, she says.

Overall, corporate efficiency declined in 2011: operating expenses increased by 13%, gross margins decreased by 2.3%, and profitability fell by 0.4%, according to REL. Sparks notes that operating expenses are increasing in tandem with rev-enue growth—$1.2 trillion and $1.1 trillion, respectively, ac-cording to the survey. “Companies are failing to realize the importance of a sustainable, significant, and reinforcing cash flow,” she says. “Revenues are increasing, but so are oper-ating expenses. There is a missed opportunity to limit the


● ● ● the 2012 CFO/reL Working Capital scorecard

David Bowman

ix companies top the REL U.S. 1,000 list in terms of sustained working capital performance:

Colgate-Palmolive, Cubic, Cytec Indus-tries, Deluxe, PH Glatfelter, and Watts Wa-ter Technologies. These companies either improved working capital performance (days working capital and its three major elements) or sustained it (performance did not deteriorate by more than 5%) each year for three successive years.

Working capital performance is “a critical element of how we define suc-cess here,” says Bill McCartney, CFO of Watts Water Technologies, a $1.5 billion (in 2011 revenues) global manufacturer of safety and control packages for residen-tial and commercial applications. “Half our growth here has come from acquisi-tions—36 in the last 11 years—and we’ve been able to finance a lot of it through

At these companies, working capital is working well.

Capital Companies

internal cash flows. We’ve been able to achieve free cash flow in excess of net in-come the last 4 years, thanks to effective-ly managing working capital.”

Working capital also is a key part of the cash flow metrics at Cytec Industries, where it is linked to employees’ annual incentive compensation. The firm estab-lished a target to reduce net working cap-ital in 2009 and challenged the workforce to achieve it. “We linked 20% of every-one’s bonus to achieving the metric,” says CFO Dave Drillock. “They’ve done it now three years in a row.”

The $3 billion specialty materials and chemicals manufacturer did it by seg-menting inventory to better track slow- and fast-moving products, hunting down late payers, and extending terms with vendors. “We did things like hiring more collectors and urging them to make pro-

active phone calls to improve receiv-ables,” Drillock says. “That took our days past due from an average of 12 to 15 days to 5. We then extended terms with ven-dors from 45 days to 60 days, but prom-ised we’d always pay on time. And we de-cided if a product moves slowly, it should be made when needed, whereas we could build inventory for products with a fast turnover.”

“Constantly Chipping Away”Deluxe, a $1.42 billion provider of market-ing tools and web services for small busi-nesses and financial institutions, also has what CFO Terry Peterson calls a “diligent” accounts-receivable process. “After a certain number of days past due, we send a letter and follow up with phone calls to collect the balance,” Peterson explains. “We also push customers to receive elec-tronic invoices, which shaves several days off the payment terms. We’re also more careful in extending credit to small businesses, we reduced the number of our SKUs, and we enhanced forecasting with a new SAP tool to get our inventory in line.”

He adds, “We’re constantly chipping away to get another inch of progress.”

Like the other top-performing compa-nies, $1.2 billion Cubic keeps close watch on its key working capital metric: days sales outstanding plus days inventory outstanding minus days payable out-standing. “We’re a systems integrator for government and transportation, so we don’t have products, but when you’re in the services business it’s all about per-formance,” says John D. Thomas, Cubic’s vice president of finance. “You make de-liveries on time, you get paid on time.”

Cubic also links working capital to se-nior employee compensation. “Our man-agement’s incentive pay has been very good of late because of our high return on net assets,” Thomas says. “People are focused when they negotiate contracts, building in terms they can meet and get-ting advance payments where they can, minimizing the amount of capital used per transaction.”

The CFOs were not surprised their companies topped the REL U.S. 1,000. But they can’t offer any simple solutions for their poorer-performing peers. Says Dril-lock, “There’s no magic to improving working capital management. The key is not to take your eye off the ball.” ◗ R.B.

“There’s no magic to improving working capital management. The key is not to take your eye off the ball.”

—Dave Drillock, CFO, Cytec industries

S


Making it WorkTo help create long-term, sustainable working capital improvements, REL Consulting recom-mends the following best practices:

e Make working capital optimization and cash flow im-provement a strategic priority, with visible senior ex-ecutive backing.

r Link cash-flow performance and working capital man-agement to the compensation structure.

t Make cash flow one of the key metrics for performance management within operations and finance.

u Invest in improving demand forecasting and deployment of effective sales and operations planning processes.

i Standardize customer and supplier payment terms, and control exceptions through an escalation process.

o Segment customers and suppliers according to value and risk to support a differentiated approach that ap-plies the company’s resources to those customers and suppliers to improve cash flow.

p Automate and eliminate high-volume, low-value transac-tions to free up resources to focus on high-value custom-ers, suppliers, and transactions.

a Regularly review trade-receivables allowances accord-ing to historical experience, creditworthiness, and age of the trade-receivables balances.

s Create estimates and judgments for age of inventories and other relevant issues that could affect the salable condition of products and their estimated selling prices.

◗ R.B.

amount of working capital it takes to generate revenue.”Kaiser notes that poor working capital performance and

inferior products may go together. “A company with a poor product will provide better payment terms to customers than its competition—45 days instead of 30,” he says. “It will keep more inventory to provide that product on the spot to a buyer. It will pay suppliers faster to make sure the inven-tory is full. In effect, its working capital deficiency drives its revenue growth, not the quality of its goods or services. If this keeps up, it will eventually be overtaken.”

Hoarding CashWhy aren’t companies putting more energy into their work-ing capital management? “For the most part, they have strong

Companies “have strong balance sheets, record cash on hand, and record cash flow from operations over the last five years, so they’re thinking they’ll just sustain things as they are.”

Dan GinsBeRG, associate principal, rel consulting

balance sheets, record cash on hand, and record cash flow from operations over the last five years, so they’re thinking they’ll just sustain things as they are,” says REL associate principal Dan Ginsberg. “This is a common, but shortsighted, attitude.”

Indeed, cash is still king for the REL U.S. 1,000. This is clearly evidenced by the $60 billion increase in cash on hand and the $233 billion increase in debt in 2011. Over a three-year period, cash on hand was $277 billion and accumulated debt $268 billion.

But using debt instead of efficient working capital man-agement to get more cash into the bank account “comes with a long-term cost: eventually they will have to pay [the debt] down,” points out Ginsberg. “They’ll also have to generate a return on their existing assets that exceeds the interest rate, which is not what we’re seeing.”

It’s better to tap working capital as a funding source for long-term growth strategies, says Ginsberg. REL Consulting cites top performers in a broad range of industries, leverag-ing working capital to open up new businesses in emerging markets with growing consumer demand, for instance.

“Top performers have very tight manufacturing time-tables and inventory management practices, in addition to strict collections and payment systems that are standardized across all locations,” says Michael K. Rellihan, an associate principal at REL. “The cash they generate from this high level of working capital efficiency is then applied to the growth agenda. Long-term, the result is a powerful benefit to the bottom line.”

“Only process improvements will provide sustainable cash flow benefits,” adds REL’s Sparks. “This requires work-ing more closely with customers, getting better information to suppliers, and improving demand forecasting. You need to have an underlying process in place to manage working capi-tal on a day-to-day basis; if not, it will be difficult to sustain.”

Kaiser has a similar view: “Building a business with a sus-tainable competitive advantage insists on working capital ef-ficiency,” he says. “They go hand in hand.” CFO

◗ Russ Banham is a contributing editor at CFO.


● ● ● The 2012 CFO/ReL Working Capital scorecard

N/M = not meaningful, because DWC moved from a positive to a negative number or vice versa. Based on financial statements of 1,000 of the largest U.S. public companies (excluding the financial sector), as reported by Capital IQ. Median shown is for the full industry. Source: REL Consulting

Aerospace & Defense

Northrop Grumman 41 -5% 43 12 4% 12 20 0% 20 33 -5% 34 Lockheed Martin 48 5% 45 19 3% 19 18 37% 13 49 -4% 51 Raytheon 66 4% 64 5 -6% 5 22 -1% 22 49 5% 47 Goodrich 61 5% 58 132 1% 131 35 29% 27 158 -2% 162 Spirit AeroSystems 19 15% 17 197 -10% 219 42 8% 39 175 -11% 197 BE Aerospace 49 -7% 53 216 -14% 252 29 -7% 31 236 -14% 274 Median 60 0% 60 57 5% 54 27 5% 26 90 1% 88

Airlines

Southwest Airlines 7 18% 6 9 28% 7 25 11% 22 (8) -8% (9) SkyWest 8 -49% 16 12 -18% 14 22 -23% 29 (2) -277% 1 United Continental 13 -47% 25 6 -17% 7 20 -30% 28 (0) -106% 4 US Airways Group 9 -4% 10 7 -7% 7 11 -9% 12 5 3% 5 Hawaiian 21 25% 17 5 2% 5 18 -8% 19 8 230% 2 Republic Airways 11 12% 10 13 0% 13 6 -7% 6 19 9% 17 Median 10 -8% 11 6 -12% 7 17 -10% 19 (1) 19% (1)

Auto Components

Lear 48 -10% 54 16 -3% 17 52 -7% 56 13 -10% 14 TRW Automotive 50 -6% 53 19 -2% 19 52 -2% 53 17 -12% 19 Tenneco 47 -3% 49 30 -11% 34 59 -8% 64 18 0% 18 Federal-Mogul 63 -1% 63 50 2% 50 41 5% 39 73 -2% 74 Cooper Tire & Rubber 40 -12% 45 65 4% 63 32 -24% 42 73 11% 66 Exide Technologies 64 -3% 66 66 16% 57 53 16% 45 77 -1% 78 Median 51 -4% 54 30 -6% 32 47 -1% 47 35 -9% 39

Building Products

Masco 45 3% 43 38 5% 36 38 28% 29 45 -10% 50 USG 39 -4% 41 37 2% 36 28 4% 27 48 -4% 50 Armstrong World Industries 29 -3% 30 52 -6% 55 27 22% 22 53 -14% 62 Owens Corning 42 5% 40 54 20% 45 33 -4% 35 63 24% 51 Nortek 47 -13% 54 53 -14% 61 27 -19% 34 72 -12% 82 Griffon 68 -23% 89 53 -31% 76 37 -30% 52 84 -25% 113 Median 45 3% 43 45 8% 42 31 -5% 32 59 12% 53

20111-yr. %change 2010 2011

1-yr. %change 2010 2011

1-yr. %change 2010 2011

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DIO DWCDPO

The 2012 Working Capital Scorecard

DSO Best in Industry Worst in Industry

◗ Days Sales Outstanding (DSO): AR/(total revenue/365)Year-end trade receivables net of allowance for doubtful accounts, plus financial receivables, divided by one day of average revenue.

A decrease in DSO represents an improvement, an increase a deterioration. Some companies have securitized receivables, which improve DSO through financing alternatives without improving the underlying customer-to-cash processes such as credit-risk assessment, billing, collections, and dispute management. The scorecard eliminates this distortion by adding securitized receivables back on the balance sheet before calculating DSO.

◗ Days Inventory Outstanding: Inventory (DIO)/(total revenue/365)Year-end inventory plus LIFO reserve, divided by one day of average revenue.

A decrease in DIO is an improvement, an increase a deterioration.

◗ Days Payables Outstanding (DPO): AP/(total revenue/365)Year-end trade payables divided by one day of average revenue.

An increase in DPO is an improvement, a decrease a deterioration. For purposes of the survey, payables exclude accrued expenses.

◗ Days Working Capital (DWC): (AR + inventory - AP)/(total revenue/365)Year-end net working capital (trade receivables plus inventory, minus AP) divided by one day of average revenue.

The lower the number of days, the better. The percentage change is marked N/M (not meaningful) if DWC moved from a positive to a negative number or vice versa.

Note: Many companies use cost of goods sold instead of net sales when calculating DPO and DIO. Our methodology uses net sales across the four working capital categories to allow a balanced comparison.Companies in the survey are categorized using the Global Industry Classification Standard.

How Working

Capital Works


N/M = not meaningful, because DWC moved from a positive to a negative number or vice versa. Based on financial statements of 1,000 of the largest U.S. public companies (excluding the financial

sector), as reported by Capital IQ. Median shown is for the full industry. Source: REL Consulting

Chemicals

TPC Group 28 -17% 34 12 -37% 19 23 -21% 29 17 -28% 24 CF Industries 16 -27% 22 18 -27% 25 6 -26% 8 28 -27% 39 PolyOne 41 0% 41 31 6% 29 38 0% 37 35 5% 33 Ecolab 112 88% 60 59 109% 28 44 109% 21 128 90% 67 Sensient Technologies 56 -7% 60 106 -2% 108 24 -9% 26 138 -3% 142 OM Group 51 8% 47 148 65% 90 41 27% 32 158 51% 105 Median 48 -5% 51 51 1% 51 29 -5% 31 70 0% 70

Communications Equipment

Qualcomm 24 0% 24 19 6% 18 24 -7% 25 19 18% 16 Juniper Networks 47 -11% 53 6 194% 2 27 2% 26 26 -9% 29 EchoStar 59 34% 44 9 92% 5 35 42% 25 32 37% 24 Netgear 81 -12% 92 51 -2% 52 36 0% 36 95 -11% 107 Ciena 87 -14% 101 48 -38% 77 33 -44% 59 103 -14% 119 Tellabs 90 18% 76 41 13% 36 28 1% 27 103 22% 85 Median 62 3% 61 21 -3% 21 28 7% 26 55 -1% 56

Computers & Peripherals

Apple 18 -41% 31 3 -56% 6 49 -27% 67 (29) -6% (31) Dell 38 -1% 39 8 7% 8 69 2% 67 (22) 7% (21) Western Digital 46 -1% 47 22 7% 21 59 6% 56 9 -20% 11 Imation 66 3% 65 59 16% 51 58 6% 55 67 11% 61 Diebold 53 2% 52 57 -1% 57 29 3% 28 82 -1% 82 NCR 66 1% 66 52 -8% 56 35 -7% 38 83 -1% 84 Median 52 13% 47 22 7% 21 42 2% 42 32 26% 26

Containers & Packaging

Crown 34 -7% 36 48 -1% 49 59 -2% 60 23 -8% 25 Graphic Packaging 33 2% 32 42 12% 37 36 11% 32 39 4% 37 Greif 49 -4% 51 37 -11% 42 42 -15% 49 44 2% 43 Rock-Tenn 75 85% 41 61 59% 39 53 72% 31 84 72% 49 AptarGroup 61 -3% 63 46 -6% 49 17 -22% 22 89 0% 90 Sealed Air 90 58% 57 55 24% 44 40 112% 19 105 28% 82 Median 47 6% 45 45 -4% 48 37 8% 34 56 -4% 58

Diversified Telecommunication Services

Level 3 Communications 55 107% 26 N/M N/M N/M 63 90% 33 (8) 22% (7) Frontier Communications 39 -21% 49 N/M N/M N/M 36 -14% 42 3 -59% 7 TW Telecom 26 10% 23 N/M N/M N/M 14 -8% 15 12 44% 8 AT&T 39 -2% 40 3 -11% 4 25 13% 22 18 -19% 22 Verizon Communications 39 -4% 41 3 -20% 4 14 2% 13 28 -9% 31 Windstream 56 52% 37 7 26% 5 25 69% 15 37 38% 27 Median 39 6% 37 - N/M - 25 62% 16 14 -34% 21

Food Products

Darling International 19 -56% 44 10 -55% 23 12 -65% 35 18 -45% 32 Dean Foods 26 -1% 27 13 -1% 13 21 -9% 24 18 9% 16 Flowers Foods 22 3% 22 15 8% 14 15 5% 14 22 5% 21 Hain Celestial 46 2% 45 55 -12% 62 30 -17% 36 71 0% 72 J. M. Smucker 26 38% 19 65 26% 52 18 25% 14 74 30% 57 Seneca Foods 24 15% 21 167 7% 155 20 2% 19 171 9% 157 Median 26 1% 26 42 4% 40 23 -14% 26 45 14% 40

Health-Care Equipment & Supplies

Invacare 52 -5% 54 39 6% 37 30 -1% 30 61 0% 61 West Pharmaceutical Services 45 8% 42 46 -4% 49 27 32% 21 64 -8% 69 Idexx Laboratories 42 7% 40 40 -6% 42 11 46% 7 71 -4% 75 ResMed 81 6% 76 59 -5% 62 16 -16% 19 123 4% 119 Teleflex 68 -9% 75 71 -17% 86 16 -26% 22 124 -11% 140 Zimmer 69 2% 67 76 -6% 81 12 5% 11 133 -3% 137 Median 64 0% 64 49 4% 47 16 -7% 17 97 3% 94

Household Products

Procter & Gamble 28 12% 25 33 11% 30 35 6% 34 25 21% 21 Church & Dwight 35 7% 33 27 -2% 28 31 6% 29 32 0% 32 Clorox 37 -3% 38 29 14% 25 30 3% 29 36 5% 34 Spectrum Brands 41 -21% 52 50 -34% 75 35 -21% 44 55 -33% 83 Central Garden & Pet 44 -5% 46 74 8% 69 26 -3% 27 92 4% 88 Energizer 70 -1% 71 51 -10% 57 23 -2% 23 99 -6% 105 Median 38 -1% 39 39 1% 39 30 5% 29 47 -3% 49

20111-yr. %change 2010 2011

1-yr. %change 2010 2011

1-yr. %change 2010 2011

1-yr. %change 2010

DIO DWCDPODSO Best in Industry Worst in Industry


● ● ● The 2012 CFO/REL Working Capital Scorecard

N/M = not meaningful, because DWC moved from a positive to a negative number or vice versa. Based on financial statements of 1,000 of the largest U.S. public companies (excluding the financial sector), as reported by Capital IQ. Median shown is for the full industry. Source: REL Consulting

Machinery

Paccar 23 -3% 24 21 -23% 27 26 -5% 28 18 -23% 23 Deere 41 -23% 53 71 5% 67 93 -3% 96 19 -23% 25 Navistar International 32 7% 30 45 -5% 48 56 1% 56 22 -3% 22 Terex 66 2% 65 99 -18% 120 43 -9% 47 122 -11% 137 Kennametal 68 7% 63 94 14% 82 34 39% 24 128 5% 121 Joy Global 73 5% 70 111 40% 79 38 24% 30 146 23% 119 Median 56 -3% 58 57 1% 57 32 1% 32 82 -1% 83

Metals & Mining

Cliffs Natural Resources 12 -58% 28 43 5% 41 20 -2% 21 35 -28% 49 Alcoa 23 -17% 28 54 -6% 58 39 -3% 40 38 -16% 45 Sims Metal Management 21 -10% 24 40 6% 38 23 9% 21 39 -4% 41 Allegheny Technologies 50 2% 49 108 1% 107 35 -3% 36 124 2% 121 AM Castle 58 18% 50 132 35% 98 38 36% 28 153 28% 120 Carpenter Technology 57 -2% 57 149 -9% 163 37 -7% 40 168 -7% 181 Median 32 -9% 35 56 -4% 58 23 -6% 24 65 -7% 69

Multiline Retail

Family Dollar Stores N/M N/M N/M 49 3% 48 29 -7% 31 20 23% 16 Dollar General N/M N/M N/M 52 2% 51 26 -2% 27 26 6% 24 Dollar Tree N/M N/M N/M 48 -4% 50 16 -3% 16 32 -5% 34 Belk 4 20% 3 88 4% 84 21 5% 20 70 5% 67 Saks N/M N/M N/M 87 -1% 88 14 21% 12 73 -4% 76 Nordstrom 68 -11% 77 40 4% 38 32 -4% 33 76 -7% 82 Median - N/M - 62 -6% 66 25 9% 23 37 -14% 43

Paper & Forest Products

Verso Paper 27 12% 24 35 9% 32 23 -17% 28 39 37% 29 Louisiana-Pacific 15 2% 14 44 10% 40 16 11% 14 43 6% 41 International Paper 43 3% 41 37 -4% 39 35 -5% 37 45 4% 43 PH Glatfelter 31 -13% 35 52 -6% 55 25 1% 25 58 -12% 66 MeadWestvaco 47 -3% 48 50 -3% 51 38 1% 38 58 -6% 61 Clearwater Paper 33 -18% 41 46 -24% 61 12 -49% 24 67 -13% 77 Median 32 -16% 38 45 -1% 46 24 -9% 26 53 -7% 57

Pharmaceuticals

Bristol-Myers Squibb 57 0% 57 24 5% 23 45 20% 37 36 -15% 43 Allergan 49 2% 48 17 -1% 17 13 -18% 17 53 8% 49 Forest Laboratories 40 11% 36 38 -9% 41 16 39% 11 62 -6% 66 Endo Pharmaceuticals 98 -16% 117 35 -8% 38 35 -32% 51 98 -5% 103 Watson Pharmaceuticals 93 62% 57 71 10% 65 60 173% 22 103 3% 100 Hospira 58 2% 56 92 4% 89 22 -27% 30 128 11% 116 Median 61 6% 58 38 -11% 42 21 -3% 22 77 -1% 78

Software

Intuit 16 14% 14 N/M N/M N/M 12 -19% 15 4 -571% (1) Take-Two Interactive Software 27 -21% 34 8 -30% 11 18 -14% 21 17 -30% 24 Electronic Arts 34 66% 21 8 -22% 10 23 155% 9 19 -13% 21 VMware 93 8% 86 N/M N/M N/M 5 -36% 8 88 13% 78 Parametric Technology 101 14% 89 N/M N/M N/M 5 25% 4 96 13% 85 salesforce.com 110 17% 94 N/M N/M N/M 5 34% 4 105 16% 90 Median 67 -3% 68 1 4% 1 9 -9% 10 58 -1% 59

Specialty Retail

Aaron’s 16 16% 14 N/M N/M N/M 41 0% 40 (25) -8% (27) AutoZone 6 2% 6 111 -2% 114 125 3% 121 (7) 4991% (0) Rent-A-Center 6 -15% 7 1 -28% 1 13 -21% 17 (7) -25% (9) Men’s Wearhouse 9 -17% 11 88 4% 84 19 -12% 22 77 5% 73 Zale N/M N/M N/M 158 -3% 163 30 -15% 35 128 1% 128 Tiffany 18 -16% 22 208 8% 192 11 5% 11 215 6% 203 Median 6 11% 5 52 -2% 53 23 -4% 24 35 1% 34

Textiles, Apparel & Luxury Goods

Skechers USA 40 -18% 48 51 -29% 72 52 17% 45 39 -49% 76 Coach 13 14% 11 37 1% 37 10 -3% 11 39 6% 37 Liz Claiborne 29 -39% 47 46 -29% 65 35 -21% 44 41 -40% 68 Wolverine World Wide 57 -1% 57 65 1% 64 15 -21% 19 107 4% 103 Columbia Sportswear 76 3% 74 79 2% 77 32 0% 32 122 3% 119 Hanesbrands 37 -13% 42 127 13% 112 36 2% 35 128 7% 119 Median 40 -15% 47 56 -10% 62 25 1% 24 71 -16% 85

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DIO DWCDPODSO Best in Industry Worst in Industry


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AUTHORITATIVE.INDEPENDENT. FINANCE-DRIVEN. JUST LIKE YOU.

You answered.

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55cfo.com | July/August 2012 | CFOSource for all charts: Duke University/CFO Magazine Global Business Outlook Survey of 773 CFOs—444 from the U.S., 102 from Europe, and 227 from Asia.

Even as the global economy continues to send signals rang-ing from mixed to downright

alarming, U.S. finance chiefs say they still plan to hire at a rela-tively strong pace, according to the latest Duke University/CFO Maga-zine Global Business Outlook Survey, released in June. U.S. CFOs say they will expand their full-time domestic workforces by 2.5% on average over the next 12 months, a bump that could lower the unemployment rate to 7% by the end of the year.

Of the more than 400 U.S. CFOs surveyed in this 65th consecutive quar-terly survey, nearly 30% say their em-ployees are “maxed out,” and 60% are looking to add staff. Finance chiefs will also increase their hiring of temporary employees by just under 1% and ex-pand their offshore outsourced work-forces by 4%.

Muddling ThroughCFOs continue to hire but are less optimistic, according to the latest Duke/CFO Business Outlook Survey. By Kate O’Sullivan

› 2.5% The average by which U.S. CFOs say they will expand their full-time domestic workforce over the next 12 months.

Duke University/CFO Survey ResultsBusiness Outlook

lion in revenue planning to expand their staffs by 6% on average in the next year and those with $100 mil-lion to $499 million in revenue plan-ning to add 4%. Technology, soft-ware, and biotech companies will add more staff than any other sector, with CFOs at those companies forecasting a 5% increase in full-time workers.

Still, despite generally positive hiring plans, the CFO Optimism In-

Tom Fitzsimmons, CFO of TMP Worldwide, a New York–based com-munications firm focusing on recruit-ment advertising programs, says his company is hiring, mostly on the tech-nology side. Fitzsimmons also has a good window into overall hiring based on clients’ plans. While TMP is seeing some growth in its business, “we can attest that we’re not seeing rapid ex-pansion in the private sector, especially in larger corporations,” he says. “Well-managed companies are continuing to acquire talent and expand slowly. But there’s no sense of pressure on corpo-rations to fill their open jobs.”

The survey data supports Fitzsim-mons’s impression: at companies with more than $10 billion in annual rev-enue, there are no plans to hire in the next 12 months. Midsize companies will be the most active recruiters, with those with $500 million to $999 mil-

On the Home FrontCFOs rate their optimism about their companies’ financial prospects compared with last quarter.†

◗ Own company

†CFOs were asked to rate their optimism about their companies on a scale of 0–100, with 0 being least optimistic.

Taking a DipCFOs rate their optimism about their domestic or regional economy compared with last quarter.*

◗ National/regional economy

*CFOs were asked to rate their optimism about the economy on a scale of 0–100, with 0 being least optimistic.

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Q2 ’12Q1 ’12Q4 ’11Q3 ’11

Business Outlook

dex fell in the second quarter, as the 773 finance chiefs surveyed around the globe grew gloomier. U.S. CFOs rate their optimism about the domes-tic economy at 56 out of 100, compared with 59 last quarter. The optimism of Asia’s CFOs dropped notably, falling from 65 last quarter to 58 in May. That marked the first time in the history of the survey that Asia’s CFOs, tradi-tionally more optimistic, fell in line with their U.S. counterparts. They cite consumer demand, government poli-cy, price pressure from competitors, and global financial instability as top concerns. Meanwhile, at 52 out of 100, optimism in Europe lags more than in other regions, not surprisingly given the ongoing debt crisis.

U.S. CFOs cite consumer demand as

their top concern, followed by worries about price pressure from competitors and federal government policies. Glob-al financial instability also continues to weigh on finance chiefs.

Fitzsimmons says the continued softness in the housing market is pro-ducing “emotional problems” for the economy. “As long as people continue to feel less wealthy, there will be cau-tion in consumer spending,” he says, noting that deflated home prices mean that many people have less personal wealth than they did 10 years ago. “We also have a significant number of un-employed or underemployed,” he adds.

Still SpendingFinance chiefs in the United States do continue to plan to spend money

in critical areas, however. Technol-ogy leads the major spending catego-ries, with CFOs reporting a planned increase of 8% on tech spending over the next 12 months, up from 6% last quarter. CFOs also say their compa-nies will increase capital spending by 5% on average in the coming year, down from 7% last quarter. Research-and-development spending and mar-keting-and-advertising spending will both rise by 3%, in line with last quar-ter’s plans.

As they look for growth, 39% of finance chiefs say their companies are spending money on the pursuit of major innovation—investing in proj-ects that, if successful, would have a significant impact on the business. On average, CFOs say their companies are

■ Capital spending

■ Technology spending

■ R&D spending

■ Marketing & advertising spending

Selective Spending12-month % change predicted by U.S. CFOs

Wages: Little Movement12-month % change predicted by U.S. CFOs

Note: Concerns that received identical scores are grouped together.

About the macro economy:

e Consumer demand

r Federal-government agenda/policies

Price pressure from competitors

t Global financial instability

OTheR COnCeRns inCluDe:◗ national employment outlook ◗ Federal budget deficit◗ Cost of fuel ◗ Credit markets/interest rates ◗ state/local government budget deficits

About their own companies:

e Ability to maintain margins

r Attracting and retaining qualified employees

Ability to forecast results

t Cost of health care

OTheR COnCeRns inCluDe:◗ Working capital management ◗ Maintaining morale/ productivity◗ supply-chain risk ◗ Balance-sheet weakness ◗ Managing iT systems

TOp COnCernS OF CFOs


-2%

0

2

4

6%

Number of domestic full-time employees

Number of domestic temporary employees

Number of offshore outsourced employees

Q2Q1Q4Q3Q2Q1Q4Q3Q2

Pricing ParityChange in prices of own-company products

0%

1

2

3

4

5%

Inflation

Q2 ’12Q1 ’12Q4 ’11Q3 ’11

■ No. of offshore outsourced employees

■ No. of domestic full-time employees

■ No. of domestic temporary employees

Staffing Up, Slowly12-month % change predicted by U.S. CFOs

2010 2011 2012

CaSh: Still King

Is it likely that your firm will begin to deploy its cash reserves during the next 12 months?

60% Capital spending

41% Acquisitions

27% Pay down debt

25% Increase hiring

20% Marketing &

advertising

45% Need cash as

a liquidity buffer

42% Lack excess cash to deploy

32% Holding cash until

economic uncertainty declines

19% Few attractive

investment opportunities

4% Want to avoid repatriation tax

On what would cash reserves be spent?

IF YES

Note: Multiple responses permitted.

0% 20 40 60 80 100%

Yes 48% No 52%

spending about 15% of their total bud-get on innovation efforts.

Even with plans to spend, CFOs continue to keep a careful watch on cash, with cash holdings as a percent-age of total assets rising from 16% to 17% over the past year. Slightly fewer than half of respondents say they plan

the global view In Europe, finance chiefs say hiring, R&D, and advertising spending will all be relatively flat over the next year, while capital spending and earnings are both expected to decline. European CFOs plan to hold cash, citing liquidity concerns and economic uncertainty in the region, as well as a lack of attrac-tive investment opportunities.

Asia’s finance chiefs plan to in-crease capital spending by 7% on aver-age over the next 12 months, and ex-pect to increase R&D spending by 4%. Forty percent of Asia’s CFOs say their companies are spending a portion of their budgets on major innovations, in line with their U.S. counterparts. Com-petition for workers in the region con-tinues to be fierce, with finance chiefs planning to boost wages by 7% on average over the next year. CFOs also plan to expand their full-time work-forces in Asia by 3% over the same time period. CFO

7 Of those surveyed, the amount of cash and market-able securities that their firms held as a percentage of total assets was 17%.

Why not?IF NO

to deploy some cash in the next 12 months, with capital spending winning the largest share of the dollars, fol-lowed by spending on acquisitions and debt payments. Most of the finance chiefs who plan to continue to hold cash point to economic uncertainty, saying that they need a liquidity buffer.


ternal networks outperformed their rivals financially. Such capabilities correlated, for instance, with rising market share and thickening operating margins. Twenty-seven percent of the 3,200 global executives in McKinsey’s survey reported that they had gained real economic value through collabora-tive and social-media tools.

Those results were explored ear-lier this year in a CFO Research study sponsored by Ariba, the maker of busi-ness software. Based on interviews with 18 executives, academics, consul-tants, and authors, the study examined how companies have embraced the net-work model of doing business, embed-ding technological advances in every job and using it to generate increased productivity. “Technology is serving as the enabler,” says Walter Wallace, instructor in the department of mana-gerial sciences at Georgia State Uni-versity’s Robinson School of Business. “Businesses now have the tools to take trust to a whole new level.”

Part of this development is due to the emergence of easier-to-use techno-logical tools for internal networking—tools that mimic the capabilities of, for example, Twitter. “A lot of the stuff that is happening out on external social networks is influencing the collabora-tion systems that are being developed for the inside of enterprises,” says Da-vid Armano, executive vice president of innovation and integration at Edel-man Digital, the interactive arm of the

Thinkstock

For some time now, executives have been touting teamwork as a competitive tool. The com-

plexity brought on by globaliza-tion, they argue, creates challenges so grand they can be addressed only by multiple minds. And the rise of internal networks and social-media tools makes far-flung collaboration increasingly fea-sible. Indeed, the knowledge that em-ployees already devote so much time to websites like Facebook and Twitter has surely made more than one CFO won-der: Why can’t we work this way?

That turns out to be a better idea than anyone may have realized. Two years ago, in “The Rise of the Net-worked Enterprise: Web 2.0 Finds Its Payday,” McKinsey & Co. found that companies that used internal and ex-

Putting Social Networks to WorkCompanies are finding real economic value in cooperation and social media. By Josh Hyatt

›

“To be effective, you need to embed the use of social media across the fabric of the company.”›› Richard Binhammer, director of social media and community, Dell

Field Notes

Perspectives from CFO Research

Source: Booz & Co./Buddy Media, 2011

Social StudiesWhich social-media platforms are priorities for large companies?

public-relations firm. “As those evolve, they will change the way employees will work together and the level at which they collaborate.”

Companies are also shifting their goals for the technology, from mere-ly reducing operating costs (travel, for example, or communications) to boosting capabilities such as time to market and rate of innovation through collaboration. “The notion is that col-laboration can be a competitive advan-tage,” says Bruce Weinberg, professor of marketing at the Isenberg School of Management at the University of Mas-sachusetts Amherst. “It’s beyond hav-ing a social-media strategy; it means infusing the company with the kind of collaborative spirit that can give the business an edge.”

Becoming Socially awareAdopting collaboration technology typically starts with the awareness of its value as a marketing or customer-service tool. Richard Binhammer, who is now director of social media and community at Dell, recalls that he first

0%

20

40

60

80

100%

YouTubeTwitterFacebook

94%

77%

42%


More froM Cfo researCh:

To read the full report cited in this article, go to the research page on www.cfo.com. Our research team regularly polls senior finance executives on core aspects of financial management. You’re certain to find insights that are relevant to your most pressing concerns.

Editor’s Choice

sition through social-media tools re-quires patience, flexibility, and adapt-ability. New applications and tools are constantly emerging (have you “pinned” anything lately?). But by sharing information—both internally and externally—a company can tackle problems more readily, collaborate more freely, and compete more flex-ibly.

Does all that teamwork slow things down? Quite the opposite: “Collabo-ration speeds you up and gets you to market. It gets you into the race faster and better and cheaper,” says Zach-ary Tumin, a senior researcher at Har-vard University’s Kennedy School of Government and co-author of a recent book, Collaborate or Perish! Work-ing Across Boundaries in a Networked

began responding to online posts (in blogs, forums, and so on) about the computer giant in 2006, when such posts numbered about 4,000 a day. Today, that figure is up to 25,000. The company now offers formal social- media training to employees.

“We came to a very early realization that the discussions that go on on the Web touch every part of the business,” says Binhammer. “To be effective, you need to embed the use of social media across the fabric of the company.”

Chuck Hollis, vice president for global marketing and chief technology officer at data-storage company EMC, says that about six years ago, he real-ized that “you could take just about any fundamental process you might care about and you could envision it in a social-media world and how it might look different and better.” For exam-ple, using social-networking tools to identify the top candidates for a posi-tion is cheaper than pursuing tradi-tional routes. And an internal social network can help new employees get up to speed much quicker than weeks of training can.

“We do a lot of R&D and project development, which is basically smart people working together,” says Hollis. “More and more those smart people are scattered around the world, and may or may not be badged employ-ees of the company. So how do we start doing collaborative product de-velopment with the very best ideas out there? This other theme, around our core business processes, began to emerge.”

Fortifying a business’s value propo-

Making ConnectionsUsers of Web 2.0 technologies report the following internal benefits:

Source: McKinsey & Co. survey of about 3,200 executives, reported in “The Rise of the Networked Enterprise: Web 2.0 Finds Its Payday,” McKinsey Quarterly, December 2010.

Increasing speed of access to

knowledge

Reducing communication

costs

Increasing speed of access to

internal experts

Decreasing travel costs

77% 60% 52% 44%

41% 40% 29% 28%

Increasing employee

satisfaction

Reducing operational costs

Reducing time to market for

products/services

Increasing number of successful

innovations in new products/services

World. “It’s always been true that col-laboration has given people tremen-dous advantage. Today that advantage is really decisive.”

That’s because the pace of compe-tition is constantly accelerating. “It’s like the [wording] you see on the rear-view mirror of your car: ‘Objects may be closer than they appear,’” says Joel Babbit, co-founder and CEO of Mother Nature Network, which supplies en-vironmental news. “It’s much closer than you think, and it’s coming up right behind you at a speed much faster than before.” CFO

The full report on which this article is based, “Collaborate to Win,” is avail-able for downloading at www.cfo .com/research.


TAKE AWAY

HIS TAKE-AWAY: The Popeyes system is about 98% franchised. We have to be attentive to our franchisees and their needs in order for the whole company to thrive. We make money by capturing a royalty from their revenues. Some companies might simply drive revenues by doing a lot of low-price offerings that don’t make a lot of money for the franchisees. But that works against you in time. You might get a temporary bump by running a deeply discounted promotion, but it would cost you a lot in terms of your credibility with your franchisees, and

you certainly wouldn’t be able to sustain it as a busi-ness model. So we’ve fo-cused on making our fran-chisees more profitable. We started analyzing their P&Ls and pick-ing out areas where they could do better on electricity, food, and labor costs. We’ve stripped out about $32 million to $34 million of costs over the last two to three years. Saving our franchisees-that money is a good expression of our com-mitment to a partnership. ◗ interview by marielle Segarra

Stan Kaady

Popeyes CFO Mel Hope

Recipe for ProfitsnAmE ›› Mel Hope

poSITIon ›› CFO of Popeyes Louisiana Kitchen

prEvIouS poSITIonS ›› SVP of finance and chief accounting officer of AFC Enterprises, the parent company of Popeyes; CFO of First Cambridge HCI Acquisitions, a real estate investment firm in Alabama; accounting, auditing, and business advisory professional for PwC.

noTAblE for ›› Being finance chief of the world’s second-largest fast-food fried-chicken chain. Popeyes has more than 2,000 restaurants in 45 states and 25 other countries.


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