The 1st CFO Summit in the Republic of Serbia Cash Flow Reducing Spending

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1 The 1st CFO Summit in the Republic of Serbia Cash Flow Reducing Spending May 31, 2012

2 Financially constrained companies are responding to crisis conditions by taking action in the obvious areas Easy-to-Implement Levers Complexity of Implementation High Conserve Capital Control Expenses Impact Stop/Slow investments in machines and market Postpone IT investments Freeze Salaries Reduce Corporate general and administrative expense Low Low High Align Inventory to Sales Restrict Expenses (Travel, Training & Discretionary) Monetize Assets A.T. Kearney, May 31,

3 A recent study analyzed firms' reactions to credit constraints in the crisis and how they adapt their corporate spending plans Results of the study show that: constrained firms planned deeper cuts in tech spending, employment, and capital spending firms also burned through more cash, drew more heavily on lines of credit for fear banks would restrict access in the future, and sold more assets to fund their operations. the inability to borrow externally causes many firms to bypass attractive investment opportunities many firms cancel or postpone their planned investment Corporate Polices: Average Treatment Effects of Financial Constraint over Pre-Crisis and Crisis Periods Policy % Change in Technology Expenditures Difference Between Constrained and Unconstrained Firms Pre-Crisis Period Crisis Period -5,5*** -11,2*** % Change in CAPEX -7,7*** -8,5*** % Change in Marketing Expenditures -5,9*** -11,7*** % Change in Employees -5,6*** -8,4*** % Change in Cash Holdings -3,5-8,5* % Change in Dividend Payout -7,6** -28,4** Note: ***, ** and * indicate statistical significance at the 1%, 5%, and 10% (two-tail) test levels. Source: Campello, Graham, Harvey: "The Real Effects Of Financial Constraints: Evidence From A Financial Crisis", Dec 2009 A.T. Kearney, May 31,

4 The focus of CF spending reduction should be reduction of operating cost and net WC as well as liabilities restructuring Value Creation Model Economic Earnings Operating Profit Revenues Cost X + Volume (t) Price (EUR/t) Fixed cost Variable cost Price Quality Product portfolio Customer portfolio Critical mass Machine/asset utilization Transport efficiency Raw material usage Factor cost Operating Cost Reduction Capital Charge X Capital Employed Cost of Capital (%) + Working Capital Fixed Assets Product portfolio S&OP Network management Product machine allocation Outsourcing Cash management Net Working Capital and CAPEX Reduction Today we will focus on working capital reduction, revision of planned investments and debt restructuring, Note: WC = working capital A.T. Kearney, May 31,

5 Levers for immediate Cash Flow Improvement Working capital reduction Revision of planned investments Debt restructuring A.T. Kearney, May 31,

6 The current economic situation has substantially increased the need to free up net working capital and reduce financial costs Working capital optimization (WCO): Overview Pressure on margins both from supply and demand sides Working capital optimization levers + Accounts payables Debtmarket liquidity shortage Need to free cash flow and reduce financial costs - Accounts receivables - Inventory Main focus Capital cost increase due to interest rate hikes A.T. Kearney, May 31,

7 Working Capital can be reduced by aggressively implementing best practices across the company Working capital optimization Elements I Payables II Receivables III Inventory Improving DSO, DIA (1) Losing Customers Service Level Inventory Level Stress Field Interest Gains Loss of Cash Discounts Monitoring Costs Production & Logistic Costs Typical Drivers Supplier segmentation Payment targets and methods Terms and conditions alignment Trade-off early payment discounts vs. interest gains Country standards and practices Customer segmentation Country business practices Distribution channels No. of payment targets Payment targets and methods Responsibilities Aggressive management of past dues Complaints handling Demand/supply variation "planability Number and complexity of products (SKUs) Value chain design Safety stock determination Dead mover management Responsibilities 1. Note: DSO = Days sales outstanding, DIA = days in arrears (late payments after payment due date) A.T. Kearney, May 31,

8 I Payables can be optimized along ten drivers WCO 1 : Key Payable Drivers and Improvement Hypotheses Key Payables Drivers Payment target IT-payable systems Number of suppliers Order-Invoice matching Total cost of ownership Approvals Responsibility Hypotheses for Improvement Improve terms based on supplier, geography, credit rating, etc. Reduction of IT-payable systems Supplier relationship management, leverage to agree better terms Payment based on purchase orders Best prices against Total Cost of Ownership (TCO) Tighten control over purchase orders to reduce other approvals Payment and accountability by business units 8 Order volume Improve terms for volume consolidation 9 10 Small purchases Price structuring Use of corporate purchasing cards & simplification of order process Optimization of cash discounts against interest gains 1. WCO = Working Capital optimization A.T. Kearney, May 31,

9 II Account receivables can be optimized along ten drivers WCO 1 : Key Receivable Drivers and Improvement Hypotheses Key Receivables Drivers Payment Target Payment History Payment Means Receivables Management Focus Hypotheses for Improvement Improve terms based on customer, geography, credit rating, etc. Customer relationship & cash discount management Segment customers and use custom approaches for each late segment Payment means as part of the sales contract (e.g. EDI) Reconciliations by sales dept & remind customers prior due dates Order tracking system & incentives based on Working Capital (e.g. KPIs) 6 Complaint Handling Implementation of a customer relationship management system Responsibility Credit Policy Product Range Collection and accountability by business units Improve disparate payment term profiles Manage credit notes Limitation to high gross margin products or SKU 10 Price Structuring 1. WCO = Working Capital optimization Align pricing structure with payment terms Optimize cash discounts A.T. Kearney, May 31,

10 III Inventory optimization is based on improving the ten most important inventory drivers WCO 1 : Key Inventory Drivers and Improvement Hypotheses Key Inventory Drivers Forecast & reaction time Anticipation Speculation Safety stocks Lethargy Proliferation Joint production Minimum batch sizes Lead times Idle times Hypotheses for Improvement Improve forecast accuracy & process times to react on forecast deviation Improve alignment of production planning with order cyclicality Alignment of price cycle information with forecasting (e.g. buy at market lows) Instruments for actual inventory tracking and analysis (e.g. overly conservative assumptions) Improve monitoring, rechecking and decision making process on existing inventory Reduce fragmentation of holding inventory Reaction chain management vs. single product Adaptation, based on long-term production strategy Supplier relationship & performance; throughput times & reliability Transit /quarantine monitoring A.T. Kearney, May 31,

11 Levers for immediate Cash Flow Improvement Working capital reduction Revision of planned investments Debt restructuring A.T. Kearney, May 31,

12 Investment decisions must be prioritized according to a ranking based on the financial and strategic evaluation Impact matrix of investment budget cuts High Investments without strategic justification: Investments with strategic and financial relevance: High impact Financial Evaluation Low CUT IMMEDIATELY Investments without any justification: CUT IMMEDIATELY ADAPT or POSTPONE Investments without financial justification: POSTPONE Low impact Low High Strategic Necessity A.T. Kearney, May 31,

13 Substantial positive EBIT can be realized through reduction of investments and the corresponding depreciation decrease Reduction of investment budget (in mn Euro) Example % Review of investment budget of all units Cutting of investments, which are not necessary to achieve plan figures (e.g. investment in non-core business areas such as new furniture or painting of building) Reduction of investment budget leads to full liquidity savings. Liquidity savings have a positive impact on interest earnings Budget 2012 Reduced Budget ,7 ) EBIT effect Positive depreciation impact only partly in first year due to depreciation period A.T. Kearney, May 31,

14 Levers for immediate Cash Flow Improvement Working capital reduction Revision of planned investments Debt restructuring A.T. Kearney, May 31,

15 Low New money requirements High Several options exist for debt restructuring, differing in liquidity impact and money requirements Debt restructuring: Options 1 Debt buyback Market purchase of debt at a discount, leading to cancellation and reduced cash debt burden Potentially reduces cash drain out of company by reducing interest charges and repayments Example Unity Media: Buyback of 75 mn EUR senior debt, incl. cancellation 2 Recapitalization/ Refinancing Development of new capital structure based on assessment of company s business plan with regard to debt capacity/ debt conditions and cash flow profile Example GVT: Brazilian telecom operator has completed a 500 mn EUR debt recapitalization providing the company with greater flexibility for future changes 5 2 Low 1 Liquidity impact Deleveraging M&A 4 3 Disposal/ divestments of non core assets and/or acquisitions funded by new equity High Example: General Motors started 2006 divesture of its financial service business GMAC; due to the current crisis further reduction from GMAC shares by Cerberus/Chrysler and GM likely 5 3 New money restructuring 4 Deleveraging of business via new money injection and amendment of loan documentation Executor are often private equity company Example A.T.U.: 140 mn EUR new equity to overcome dramatic dropping EBITDA Debt conversion Capital structure recalibration by debt to equity swaps Often done in case of fundamental deleveraging necessary due to company underperformance Example Metrovacesa SA : A consortium around Banco Santander took control of the property company in exchange for canceling 2.2 bn EUR of debt A.T. Kearney, May 31,

16 Results Activities Debt restructuring is typically done in a four step approach, securing fast realization and impact Debt restructuring: Project steps Review company situation Set up restructuring plan Manage negotiations Finalize debt restructuring Review existing business plan, esp. financial projections Set up financial model, incl. scenario planning Review short-term cash flows to determine funding requirements Prepare proposal to lenders in cooperation with company and third party advisers Assist in preparing diligence materials Prepare long list of potential capital providers Prepare market information as backup for negotiations Evaluate and challenge counterparts proposals Moderate negotiation phase as a competitive process Benchmark capital providers Negotiate and finalize last deal details Drive transaction to a close Incorporate new capital structure in reporting and business planning Reviewed and evaluated business plan Detailed company valuation Restructuring plan Comparable deal conditions for benchmarking Short list of capital providers Deal completion Adapted capital structure A.T. Kearney, May 31,

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