create and sustain a culture of maximized … and sustain a culture of maximized value and ......

CREATE AND SUSTAIN A CULTURE OF MAXIMIZED

VALUE AND PERFORMANCE

JAMES R. BLAKE

MOREY’S PIERS NOVEMBER 2010

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“CREATE AND SUSTAIN A CULTURE OF MAXIMIZED VALUE AND PERFORMANCE” A. Why is Growing a Business and Building Value Complicated?

1) Competing Goals! a) Maximize Profits b) Cash Available for Taxes/Distributions c) Grow Business d) Regulatory Compliance e) Attracting and Compensating Best and Brightest f) Getting All of the Key People on the Same Set of Objectives

2) Who are Stakeholders?

a) Owners/Investors Internal b) Employees Internal c) Business Partners External d) Banks/Lending Institutions External e) Community

3) Who Drives the Business – Key Stakeholders?

a) Owners/Investors b) Employees

4) How Do We Get Owners and Employees to Work with the Same Attitudes and Drive

to Success?

a) Understand Success b) Effects of Success c) Understand the Drivers of Success d) Work as one with much to gain or lose

5) Achieving A Win/Win with Owners/Executive/Key Employees

a) Clear Strategic Objectives b) Simplify the Metrics for Success c) Put Together a Long Term Incentive Plan That Rewards Long Term Thinking d) Make Key Players Partners in Success

B. The Key Elements in Building Value

1) Expectations

2) Traditional Methods a) Profit – Annually/Quarterly/Monthly – EPS (Earnings Per Share) b) Project/Investment Returns c) Cash Flow

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d) Problem

- Too much emphasis on the short term - Profits can be manipulated - Does not take into consideration building value and long term results

3) DEFINTIONS TO EVA

a) NOPAT = Net Operating Profit After Taxes

WACC = Weighted Average Cost of Capital Invested Capital = Equity & Debt

b) MVA = Market Value Added Measured by market value of the business less accumulated equity on Balance Sheet. Value of Business to others (market) – Equity of Owners Market Value Added

c) EVA = Economic Value Added Measured in absolute dollars by taking the net Operating Profit after tax and subtracting the cost of capital times the invested capital. NOPAT (Net Operating Profit After Tax) WACC x Cost of Capital (WACC=The % of Interest /Aggregate Loan Rates)

EVA Calculation ($Millions) Sales $2,436 Cost of Sales 1,700 Sales, General, Admin. Costs 400 Taxes 134 NOPAT $ 202 Invested Capital 1,500 X WACC 12 % Capital Charge 180 Economic Value Added $ 22

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The Secrets of Value Creation Earn more than your WACC on all that you do

You must earn more than what it cost to get your money

Consistently grow NOPAT Investors won’t pay more tomorrow for a company that is smaller

d) The Connection

Making EVA grow makes MVA grow

Over twice a powerful as making only EPS grow High EVA over time produces high MVA

The Price/Book Ratio goes up

4) Understanding the Elements

a) What is WACC “Weighted Average Cost of Capital” ALL THE ASSETS YOU USE ARE PAID FOR FROM THE RIGHT SIDE OF THE BALANCE SHEET

b) The Two Sources of Money

Debt Equity

c) The Cost of Debt =

The Interest on the Debt d) The Cost of Equity =

What Investors Could Earn by Investing Elsewhere

(It’s Opportunity Cost)

e) WACC = The Weighted Average of the Cost of Debt and the Cost of Equity Typical WACCs: 7% to 12%

High if company is riskier Lower if company is less risky

5) The Secrets of Value Creation

Earn More than your WAAC on all that you do You must earn more than what it costs to get your money

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Consistently grow NOPAT Investors won’t pay more tomorrow for a company that is smaller

6) Strategic Planning Directives

Make NOPAT go up Earn more than WACC on all that you do New Capital Projects should earn more than WACC Get rid of operations that do not earn your WACC

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7) How It Works

BASIS ECONOMIC PROFIT CALCULATION XYZ COMPANY

NET OPERTING PROFIT AFTER TAXES (NOPAT) CALCULATION:

Sales $25,000,000

Cost of Sales <210,000>

Gross Margin $24,790,000

Total Operating Expense <$21,603,000>

Income from Operations before Taxes 3,870,000

Taxes 53,000

NOPAT (Net Operating Profit After Tax) $3,817,000

INVESTED CAPITAL (IC) CALCULATION:

Total Assets 26,100,000

Less: Accounts Payable <687,000>

Less: Other Current Liabilities (Non Debt) <1,430,000>

INVESTED CAPITAL $23,983,000

RETURN ON INVESTED CAPITAL AT END OF YEAR:

NOPAT $3,817,000

Invested Capital @ End of Year 23,983,000

NOPAT/IC 15.90%

ECONOMIC VALUE ADDED (EVA) CALCULATION:

NOPAT $3,817,000

Less Capital Charge: Invested Capital @ End of Year $23,983,000

X Cost of Capital (assumed 10%) x10%

Capital Charge $2,398,300

Calculated EVA (difference EVA less Capital Charge) $1,418,700

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8) Year to Year Effect

BASIC ECONOMIC VALUE TARGET ANALYSIS

XYZ COMPANY

2008 2009 2010 2011 2012 2013

Actual Actual Forecast Proforma Proforma Proforma

Economic Value Added 1,418,700 1,178,900 1,567,524 1,969,500 2,417,500 2,807,500

Change 338,200 <239,800> 518,624 400,000 450,000 390,000

Recommended Targets (Used Graduated Increase) 20% Growth in EVA

1,600,000 2,000,000 2,400,000 2,800,000

C. Take Away Points

To make your company worth more tomorrow:

Grow NOPAT

Earn more than WACC on all that you do

Get rid of operations that earn less than WACC

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INCENTIVE PLAN A. Connecting the Key Stakeholders to the Concept of Growing Value over the Long Run.

1. Shareholder/Owners Have a stake in growing business as the more it grows the more their investment is worth.

2. Key Members of Management Team

a) Need to know the connection between short term profits and long term growth.

b) They need a long term Incentive Program that makes them partners in long term growth.

c) Multiyear incentive based on growth to include earnings and investment.

B. Bonus Plan Design

1. Pay target bonuses to Key Associates if the EVA target for the year is met, and

2. Pay more if EVA is bigger than last year 3. Pay more if return on invested capital is greater than target return

4. Needs to be based on long term performance

Reasons a) Prevent Manipulated Profits b) Think Strategically on Capital

1) Purchases 2) Unproductive Assets

5. Build a Multiple Year Program

a) Through absolute dollar increase

b) Through ROIC – Return on Invested Capital Percent

C. Steps to Company’s ROIC Bonus Plan

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1. What is ROIC?

ROIC is a value of performance for a Company that compares both the company’s

net income exclusive of financing costs and non-operating revenue and expenses (which

is called NOPAT) against the total invested Capital (net assets) of the Company. It is a

measure of performance that focuses on generating excess earnings beyond the

earnings required to cover the risk adjusted cost of capital for a business of our nature.

ROIC is measured at the end of each fiscal year.

To increase the market value of a Company each year is an important measure of

the success of an organization. It not only benefits the shareholders but also allows for

additional dollars to be available for additional investment and deployment to other

Company stakeholders, the employee associates. Only measuring profits leaves out an

important element; namely, the expenditures required for the purchase of assets and

capital improvements and whether or not those assets are producing a return. ROIC

takes both into consideration to insure that the Company gets the most out of the assets

it has purchased.

To keep this simpler than it would otherwise be, we are going to focus on

measuring and reporting on ROIC. And while there is more to it, the bottom line is that

when the targeted minimum ROIC is exceeded, bonus bank dollars will be accumulated

(yes, if we fall short of the ROIC target, bonus bank dollars are reduced).

2. Incentive Plan to Reward Increasing ROIC

Each year the Company wants to ensure that its Return on Invested Capital meets

or exceeds its risk sensitive rate of return threshold. In order to achieve this, the entire

management and supervisory team play a key role in making the decisions that will

positively affect the Company’s Return on Invested Capital. Therefore, the

shareholders believe this incentive Plan is an important, appropriate, and respectful

investment towards the Company’s meeting its financial and quality goals. The Plan

works as follows.

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Steps

a) A targeted annual ROIC is established based on historical data and the

Company’s judgment as to a reasonable risk sensitive rate of return on

invested capital for the upcoming year. This ROIC projection is related to

Operating and Capital Budgeting.

Target Return: WACC & Risk Factor Weighted Average Cost of Capital

Cost of Debt 6% Return on Investment 8% WACC = 6.7% Risk = 5.3%

Target Return 12%

b) Key personnel who have the greatest impact on the decisions that affect ROIC

will be invited to participate.

c) Each participant will have a bonus pool account set up in his/her name. This

account will remain from year to year with net accumulated bonus dollars less

payouts of 1/3 of available dollars on an annual basis. All initial participants,

who have been employed by TMO for a minimum of two (2) consecutive years

will receive a Company paid “start-up bonus” contributed to each of their

individual accounts at the beginning of the program. This will occur at the start

of this 2006 program.

d) Based on the target rate of Return on Invested Capital, each amount calculated

on the actual return over or under will be added or reduced from the total of the

Bonus Bank. The distribution of these amounts to individual accounts will be

based on each participant’s base annual calendar year compensation (no

bonuses or incentives) as a percent of the total of all participants’ base annual

compensation adjusted at management’s discretion for any other factors

believed to be appropriate.

e) Examples of Incentive Programs

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CONCLUSION

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MAKE YOUR KEY PLAYERS PARTNERS IN SUCCESSFULLY GROWING THE BUSINESS QUESTIONS AND ANSWER PERIOD

create and sustain a culture of maximized … and sustain a culture of maximized value and ......

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