Tatum Senior Executive Networking Group, April 16, 2008, V3.0

Senior Executive Networking Group – New England
“Early Warning Signals – What Every Senior
Executive Needs to Know”
April 16, 2008

© 2008 Tatum, LLC All rights reserved.

TATUM IS THE LARGEST AND FASTEST-GROWING EXECUTIVE
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HELPING COMPANIES IN TRANSITION TO ACCELERATE BUSINESS
SUCCESS AND CREATE MORE VALUE

© 2008 Tatum, LLC All rights reserved. 2

MAJOR BUSINESS TRANSITION OR LIFE-CYCLE STAGES INCLUDE:
TEMPORARY LOSS OR NEED TO AUGMENT FINANCIAL OR TECHNOLOGY


LEADERSHIP
CHANGES IN CAPITAL STRUCTURE


HIGH GROWTH


UNDERPERFORMANCE


MERGER OR ACQUISITION



Tatum’s National Footprint

37
Offices
~1000 Professionals


“Early Warning Signals – What Every Senior Exec Needs to Know”

What are Early Warning Signals
How to interpret them
How to employ them to your advantage


“Early Warning Signals – What are they?”

Operating Cash Flow % Revenue
Cash Conversion Efficiency

Return on Non-Cash Working Capital (ROWC)
Operating Profit / (A/R + Inventory – A/P)
Working Capital Efficiency

Cash-to-Cash Cycle Time (C2C)
Working Capital Efficiency --- in an actionable way

Indicators of where cash is and isn’t


Other Important Indicators

Return on Assets

Return on Capital Employed

Altman Z-Index or Z-Score (Bankruptcy Indicator)

All are good performance measures, but
it generally takes longer to affect them

OPERATING CASH FLOW % REVENUE


What’s Goodness?
D D
Industry 2006 2005 Industry 2006 2005
Biotechnology 23% 27% -4% Computers & Peripherals 11% 13% -2%
Pharmaceuticals 23% 21% 2% Household Products 11% 12% -1%
Semiconductors & Semi Equip 22% 21% 1% Industrial Conglomerates 11% 15% -4%
Diversified Telecommunications 21% 22% -1% Metals and Mining 10% 12% -2%
Communication Equipment 19% 20% -1% Airlines 9% 8% 1%
Energy Equipment & Services 18% 15% 3% Chemicals 9% 8% 1%
Electric Utilities 17% 16% 1% Aerospace and Defense 8% 10% -2%
Multi-Utilities 15% 11% 4% Food Products 8% 9% -1%
Independent Power Producers 14% 9% 5% Machinery 8% 8% 0%
Road & Rail 14% 15% -1% Paper & Forest Products 6% 7% -1%
Beverages 13% 15% -2% Electronic Equip & Instruments 4% 5% -1%
Gas Utilities 13% 8% 5% Food & Staples 3% 3% 0%
Household Durables 3% 4% -1%
1,000 largest public
companies with US HQ
Source: 2007 REL/CFO Cash Masters Scorecard,
CFO Magazine, Dec. 2007


Who Improved? Declined?
D D
Industry 2006 2005 Industry 2006 2005
Independent Power Producers 14% 9% 5% Machinery 8% 8% 0%
Gas Utilities 13% 8% 5% Food & Staples 3% 3% 0%
Multi-Utilities 15% 11% 4% Road & Rail 14% 15% -1%
Energy Equipment & Services 18% 15% 3% Household Products 11% 12% -1%
Pharmaceuticals 23% 21% 2% Food Products 8% 9% -1%
Semiconductors & Semi Equip 22% 21% 1% Electronic Equip & Instruments 4% 5% -1%
Electric Utilities 17% 16% 1% Household Durables 3% 4% -1%
Airlines 9% 8% 1% Diversified Telecommunications 21% 22% -1%
Chemicals 9% 8% 1% Communication Equipment 19% 20% -1%
Paper & Forest Products 6% 7% -1%
Beverages 13% 15% -2%
Metals and Mining 10% 12% -2%
Computers & Peripherals 11% 13% -2%
Aerospace and Defense 8% 10% -2%
Industrial Conglomerates 11% 15% -4%
1,000 largest public
Biotechnology 23% 27% -4%
companies with US HQ
Source: 2007 REL/CFO Cash Masters Scorecard,
CFO Magazine, Dec. 2007


CASH-TO-CASH CYCLE TIME (C2C)


C2C: Definition

C2C – # days from day of payment for purchases to day of
collection from customer

Cash-to-Cash

2 1
IDS DSO
3 Smaller = Better
DPO
Days of Sales Outstanding (DSO): # of days it takes for a customer to pay.
1.
365 * (Ave A/R, last 4 qtrs) / (Annual Sales or Sales last 4 quarters)
Inventory Days of Supply (IDS): # of days of inventory in the company.
2.
365 * (Ave Inv, last 4 qtrs) / (Annual COGS or COGS last 4 quarters)
Days of Payables Outstanding (DPO): # of days for an inv purchase to be paid.
3.
365 * (Ave A/P, last 4 qtrs) / (Annual COGS + D Inv; or COGS + D Inv last 4 qtrs)
DSO + IDS – DPO = C2C

C2C: What’s Goodness?

C2C: 2007 Aberdeen Group Working Capital Optimization Study
Definition of past 2 years
Maturity C2C Return on Capital
Average C2C
Class > = < > = <

Best in Class
11 Days 92% 8% 0% 90% 10% 0%
Top 20%

Industry Ave
54 Days 54% 45% 1% 58% 38% 4%
Middle 46%

Laggards
64 Days 18% 53% 29% 3% 45% 52%
Bottom 35%

 Supply Chain and Financial Management Maturity of 400 companies surveyed

 Best in Class C2C for top 20% of companies (~80) was 11 days!

 %’s above indicate % of companies, by maturity class, whose C2C & ROWC
improved, stayed the same, or declined over the past 2 years.


C2C: Why so useful?
Effective Short Term Measure of Working Capital
Performance

Measured in Days not $:
Easy to Remember
Easy to Benchmark;
Improvement is easy to quantify: 1 Day of W/C typically > $100K

C2C becoming more mainstream

C2C Improvement Opportunities are Actionable


C2C: Becoming Mainstream
HP
“Our working capital
2007 2006 2005
requirements depend upon
our effective management
DSO 43 40 39

of the cash conversion
IDS 34 38 35
cycle, which represents
effectively the number of
DPO (50) (59) (52)

days that elapse from the
C2C 27 19 22
day we pay for the purchase
Cash Impact of D C2C of raw materials to the
($1,940M) $693M

collection of cash from our
+ 8 Days - 3 Days
customers.”
Why is an 8 day
Source: 2007 HP 10-K
C2C decline important?


Dell
“Our direct business model
2007 2006 2005
allows us to maintain an
DSO 31 29 27
efficient asset management
system in comparison to our
IDS 5 5 4

major competitors. We are
DPO (78) (77) (73)
capable of minimizing
inventory risk while collecting
C2C (42) (43) (42)

amounts due from customers
Cash Impact of D C2C ($183M) $80M

before paying vendors, thus
+ 1 Day - 1 Day
allowing us to generate annual
Why is an 1 day
cash flows from operating
C2C decline
activities that typically exceed
Source: 2007 Dell 10-K
important?
net income.”

Why are HP and Dell highlighted?
Recognizable co’s who have embraced and achieved C2C excellence.

Demonstrate that cash value of a day of working capital is significant

Demonstrate why C2C improvements are valuable when:
―margins are under competitive pressures!


What is C2C for IBM? Apple?
IBM and Apple do not specifically mention C2C in their annual
stockholder filings.
However their recent C2C performances clearly indicate:
― They closely manage their working capital and
― Find it strategically and tactically important to continually find greater efficiencies in
their cash conversion cycles.
2007 C2C:
― IBM; 6.4!
― Apple: (58.2)!


C2C can also be used for software and service companies who
don’t have inventory!
While processes for providing services aren’t required by GAAP to be
“costed and capitalized” as with companies with inventory and
manufacturing activities,
These processes can still be analyzed in a C2C-like fashion.
Examples of Processes used:
―Insurance Company: (Claims and New Customer Appraisal /
Renewal)
― 3rd Party Healthcare Provider: (Receivables optimization)
―Any service provider: (Warranty Services, Returns, CRM)


C2C: Actionable by Benchmarking
C2C can also be an actionable metric;
To quantify cash opportunities!
To indicate potential business processes which can yield cash
opportunities.

How?

Through Benchmarking or “Show me the money!”


VALCOmeter™ 2007
Share of Market of Selected Companies Analyzed The value of cash opportunities

Industry Classification
Company Ticker Latest Fiscal Pd
Zoll Medical ZOLL Med Appliances and Equipment Oct-06
(Select Company Above) # of Fiscal Periods Analyzed 5 YEARS
Total Rev $ of Market for Co's Selected $ 6,656,766
Quartile 1 Quartile 2
Grwth % % of Total Grwth % % of Total
Company Rev $K Company Rev $K
Invacare Corp 1,498,035 8.5% 22.5% 1 Conmed Corp 646,812 9.3% 9.7%
Steris Corp 1,197,407 5.4% 18.0% 2 Hologic 462,680 26.5% 7.0%
3 DJO Incorporated 413,058 23.5% 6.2%
4 Datascope 373,000 4.1% 5.6%
5
17
18
19
20
Qtle 1 Total Rev 2,695,442 40.5% Qtle 2 Total Rev 1,895,550 28.5%

Quartile 3 Quartile 4
Grwth % % of Total Grwth % % of Total
Company Rev $K Company Rev $K
Greatbatch, Inc. 271,142 13.7% 4.1% 1 Cyberonics, Inc. 130,968 6.2% 2.0%
Arthrocare Corp 263,001 31.3% 4.0% 2 Palomar Medical Technologies, Inc. 126,544 49.9% 1.9%
Symmetry Medical, Inc. 253,569 44.9% 3.8% 3 Volcano Corporation 103,048 31.3% 1.5%
Zoll Medical 248,849 13.8% 3.7% 4 Aspect Medical Systems 91,334 23.5% 1.4%
Align Technology 206,354 34.1% 3.1% 5 Cynosure, Inc 78,401 42.7% 1.2%
Candela Corp 149,466 25.0% 2.2% 6 The Spectranetics Corporation 63,490 23.8% 1.0%
7 Micrus Endovascular Corp 58,795 56.3% 0.9%
8 Nxstage Medical, Inc. 20,812 341.4% 0.3%
9
19
20
Qtle 3 Total Rev 1,392,381 20.9% Qtle 4 Total Rev 673,393 10.1%

Zoll Medical and shaded companies are HQ’d in MA


Cash to Cash (C2C) Conversion Cycle
Val ue of C ash O pportunities

Industry Classification
Company Ticker Latest Fiscal Pd # - Fiscal Periods Analyzed
Zoll Medical ZOLL Med Appliances and Equipment Oct-06 5 YEARS

C2C Performance Value of C2C Conversion Cycle Improvement Opportunities

Working Capital
Movement to Median of next Median DSO, 1 Day reduction
IDS D Days
Current Quartile
Current DSO Savings in $K
Quartile Days in $K
78.3 Qtle 4 Quartile 3 68.0 681.8 -10.3 $ 7,029
+
Working Capital
Movement to Median of next Median IDS, 1 Day reduction
DSO D Days
Current Quartile
Current IDS Savings in $K
Quartile Days in $K
127.3 Qtle 3 Quartile 2 95.6 297.4 -31.7 $ 9,437
-
Working Capital
Movement to Median of next Median DPO, 1 Day reduction
DPO D Days
Current Quartile
Current DPO Savings in $K
Quartile Days in $K
38.8 Qtle 3 Quartile 2 54.1 293.3 15.3 $ 4,476
=
Improving C2C performance to median of
the next best quartile, reduces C2C by 57 C2C D Days
Total C2C New C2C Total $K Savings
days or identifies potential cash release of
166.9 109.6 (57.3) $ 20,942
$21M! ROWC improves from 19% to 35%!
Current Quartile
ROWC D %
Current ROWC New ROWC
18.8% Qtle 2 25.5% 35.5%


Client comparison to Competitors and Targets
Comp #1 Client Client Target Comp #3 Comp #4 Comp #5

DSO 51 63 56 25 36 46
IDS 34 26 18 39 34 39
DPO 38 48 48 38 25 40
C2C 47 40 26 27 45 45
ROWC 53% 32% 61% -23% 68% 58%

To equal $M Benchmarking &
Client Target Value Target Setting can
reveal the true worth
DSO (6.5) $ (19)
of the C2C metric.
IDS (8.1) $ (19)
DPO (0.0) $ (5)
C2C (14.6) $ (33) In this case: $33M!

In what cash improvement activities you have led or
participated?


C2C: CAN RELIEVE WORKING CAPITAL PRESSURES



2/3 of 400 companies surveyed indicate outside
(stakeholder) pressure, not internal management
efforts were greatest reason to improve working
capital performance!



Focus today: Reducing Inv & DSO.
Focus tomorrow: Innovators focusing on many other opportunities.

C2C: EASY TO MEASURE; DIFFICULT TO ACHIEVE


C2C: Easy to Measure, Difficult to Achieve

Identification of Cash opportunities is relatively easy

But what are the obstacles for realizing these cash
opportunities?

Typical Working Capital Improvement Efforts require
Business Process Re-Engineering (BPR).
BPR is often a difficult, frustrating, and long process as
exemplified by Figure 1; 4 Phases of a Working Capital BPR
project


C2C – The 4 Phases of a Work Cap D consulting assignment

1 – 4 weeks 2 - 3 months 3 - 6 months 3 - 9 months or longer

Phase 4:
Phase 1: Phase 2: Phase 3:
Implementation
C2C Business Process Business
of New
Benchmarking Documentation, Process Re-
Processes and
Review, & Design &
Software
Recommendations New Software
Selection or
> 3 mo’s until
Existing
specific
Software
understanding of
Enhancements
areas $ W/C
improvements;

> 9 mo’s until any $
W/C improvements
are realized
Figure 1: 4 Phases of Work Capital BPR project


Working Capital BPR projects often require:
Extensive documentation of the key functional areas of
operations and finance; (see Figure 2: Operations and Financial
Functional Areas)
Mapping of documentation to Working Capital Processes DSO,
IDS, & DPO; (see Figure 3: Mapping Processes to Working
Capital Areas).


Figure 2: Operations & Financial Functional Activities
Planning Forecasting Distribution Transportation Management
Demand Management Customer Shelf Replenishment
Master Scheduling Delivery Execution Management
Inventory Management Order Consolidation
Business Planning Pick, Pack, and Ship
Capacity Planning Returned Goods Management
Distribution Req'ts Planning System Installation
Channel Sell-through Data analysis

Sourcing Make vs. Buy (Supply Planning) Customer Accounts Receivable Collection
Supplier Relationship Management Accounting Returns and Credit Management
Procurement

Production Material Requirements Planning Customer Product Service Agreements
Production Planning Relationship Customer Requirements Planning
Receiving and Incoming Inspection Management Customer Demand Information Sharing
Material Conversion to
Intermediate or End Products Product Life Cycle New Product Data Management
Repair, Remanufacture, Ramp-up and Stabilization Management
Recycling, and Disposal End-of-life Management
Environmental Management
Finance / Import/Export Management
Order Management Order Creation and Capture Treasury & Supply Chain Financial Planning
Order Scheduling Administration Cash Mgmt & Investment Planning
Order Maintenance Banking Management
Shipment Control Supply Chain Information Systems
Customer Billing Performance Measurement
Customer Inquiry Management
Price or Availability Quotes Source: PRTM, Integrated Supply-Chain Performance Measurement


Figure 3: Mapping Processes to Work Cap Areas
Business Process
Working Capital Area to be Evaluated Areas of Evaluation

1) Collections history
Customer Order 2) Shipment Quality
Days Sales Outstanding to 3) Customer Order Process / Sales Forecast
DSO Cash Collection 4) Sales / Customer IT systems

1) Forecasting / Order taking
2) Postponement & Inventory build signals
3) Demo equipment
Cash Red’ns &
Inventory 4) Eng Change Orders
Cost Savings
Inventory Days of Supply Forecast 5) Part #'s
IDS to 6) Product design
achieved from
Customer 7) Inventory Obsolescence
improvements in
Delivery 8) Product Returns
these opn’s areas!
9) Customer delivery
Easy: C2C calculations 10) Shipment expediting
11) Mfg Information Technology Operating Systems
Difficult: Assess and redesign
of major C2C process areas 1) Supplier Reliability
Days Payable Outstanding Supplier Order 2) Delivery Reliability
DPO to 3) Vendor management
Supplier Payment 4) Procurement coord w/ Customer/Product Demand
5) Procurement Information Technology Systems


These BPR efforts take time and resources before any
indication that change is necessary.
Time, Resources, and Change are common and significant
obstacles in achieving success.

BPR efforts often indicate new / enhanced software is
required.
New or enhanced software also require significant time,
significant resources, and significant management
Often do not produce desired results, certainly not quickly



Key Supplier and / or Customer profitability and working
capital analyses can quickly
Identify potential problems
Target solutions and
Realize cash
Provide focused direction towards Major Re-Engineering efforts

Can be completed in 6 - 8 weeks!


Objective: Rank Suppliers / Customers
and determine drivers of performance
High Adjusted Gross Margin Outcome
High Adjusted Gross Margin
High High or Positive Working Capital
Low or Negative Working Capital
Objective:

Supplier /
Adjusted Gross Margin

Modify terms or
Customer
Protect inventory practices
Profitability
and ROWC
Analysis

Low Adjusted Gross Margin Low Adjusted Gross Margin Analysis
Low or Negative Working Capital High or Positive Working Capital
Duration:
Drive volume;
Keep terms &
inv. practices

~ 6 - 8 weeks

Low

Working Capital
Low High
ROWC = (Gross Mgn – Inv handling , order fulfillment & storage costs) / (Inv + A/R – A/P)

C2C: SUMMARY


C2C: Early Warning Signal
Great indicator of short term trends in operating efficiency

Metric that is easy to remember and benchmark

Easily opens conversation to specific operating areas and
current operating practices

Is actionable; offering significant Cash and Cost savings

Analyze Customer or Supplier profitability and ROWC to
Identify who is causing C2C problems and
Target short-term improvements.


“Early Warning Signals – What Every Senior Exec Needs to Know”

Questions?

Call or Write:
Richard Block, Financial Leadership Partner, Tatum LLC, 233
Needham Street, Suite 300, Newton, MA 02464.
― 617-928-1231 (office)
― 617-283-1001 (cell)
― 617-454-1088 (main)


Tatum Senior Executive Networking Group, April 16, 2008, V3.0

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