From the December-January 2009 issue of Treasury & Risk magazine

CFOs to Watch: Steering Through Troubled Times

This CFO Keeps Wal-Mart on Top By Richard Gamble

Tom Schoewe is sleeping well these days, partly because of $2 billion he didn't borrow in 2007. "That July, the treasury
group came to me," the Wal-Mart CFO recalls, "with a good plan for how we could borrow the $2 billion we were scheduled to borrow. They had done their homework and come up with a creative plan for a bond offering we could do at a low cost. We were growing nicely. The borrowing was part of our formal business plan. I reviewed it, liked the
way it was crafted and approved it. I ran it

by the executive finance committee and they approved it. We were ready to go. But that night, driving home, I started to think what might happen if we challenged ourselves and looked for a way to meet our goals without taking on that debt." The next morning Schoewe huddled with treasurer Charles Holley and the CFOs of Wal-Mart's three primary subsidiaries and asked them, "How would it hurt us if we didn't borrow that $2 billion?" Out of that session came an ultimately successful campaign the Wal-Mart finance team wryly dubbed "Don't Borrow $2 Billion" or simply "DB2B." "We tasked ourselves with finding the money other ways, by managing inventory tighter, by working with suppliers and increasing A/P," Schoewe says. It worked. And it worked again a year later when another scheduled $2 billion borrowing was canceled. "That's $4 billion we didn't have to borrow, due to the underlying strength of our business and financial operations," Schoewe boasts.

Back in 2007, in a booming economy, such corporate frugality must have seemed to Wal-Mart's investment bankers about as fashionable as a bag of Great Value split peas. It wasn't necessary. It was quaint. Then came September, October, November and December of 2008 and it wasn't quaint any more. Wal-Mart seems to be riding out the economic turmoil fairly well, even with the dramatic cutback in consumer spending. It is sailing along not so much because it took bold, decisive action at the first signs of trouble, but because it took careful, prudent action well before there were signs of trouble. Not borrowing $4 billion is just part of Wal-Mart's retrenchment. From 2000 to 2006, Wal-Mart was in high-growth mode. It was arguably the hottest corporation on the planet. Growth in stores and sales, revenue were soaring, but growth was expensive and the flip side of the explosive growth was a steady decline in return on invested capital. So in 2005 Wal-Mart shifted gears and began to slow its growth. In 2004 and 2005, Wal-Mart was opening 250 to 280 new supercenter stores a year. Capital spending peaked in 2007 at $17 billion. In its current fiscal year, Wal-Mart will open 160 to 165 new supercenters, and just 140 are planned for next year, Schoewe reports.

The slowdown--and dramatic operating improvement-- stopped the ROI slide. In fact the company reported a gain in ROI in its most recent quarter. "Not many companies can say that," Schoewe says. Now the company has found a good balance between growth and ROI, he adds.

Slower growth (but still adding annual revenue at a rate of about $30 billion a year), coupled with improved operating experience, meant less debt on the balance sheet and less money tied up in working capital. The result, besides the uptick in ROI, was a stunning surge in free cash flow, Schoewe says. "In the first three quarters of this year, we had positive free cash flow of $2 billion. In the first three quarters of last year, we had negative free cash flow of $1.3 billion. Did we improve free cash flow by $3.3 billion over the course of one year? That's exactly what we did."

Wal-Mart wasn't expecting a 2008 recession that erupted in violent market distortions and a credit freeze in September, but it was ready for one anyway--carrying less debt, settled into a slower growth mode, and building up hoards of cash with its free cash flow performance. It currently holds $6 billion of cash and equivalents on its balance sheet, compared to $47 billion in total debt.

However, Wal-Mart didn't entirely avoid frantic reactions when the financial storm hit. It moved aggressively to protect its cash, Schoewe says. "Preservation of capital became our top priority. The treasury group was very aggressive at making sure we knew where all our money was and that it would be there for us the next day. Traditionally we would review investment performance weekly or monthly. For a while, we were reviewing it daily if not hourly. I was personally involved in those daily discussions about where our money should be. The rules had changed. Liquidity was disappearing. We consolidated the banks that held our cash down to four or five where we had lasting relationships and great confidence."

And Wal-Mart did take other steps in response to the deteriorating economy. In October, when the financial world was rocked by events, Wal-Mart was continuing a share-repurchase program that was helping to sustain the company's share price. After a day of meetings in Dallas, Schoewe became uneasy about spending down Wal-Mart's cash reserves to buy back shares, so he picked up a phone and called Holley and said, "Charles, I'm thinking we should suspend our share repurchase program." and Holley said, "Tom, I've been thinking just the same thing. Let me call Lee [Scott, Wal-Mart's outgoing CEO] and see what he thinks." He found out that Lee was having identical thoughts. "All three of us were thinking the same thing on the same day. That's what we call management that is aligned," Schoewe says.

With the financial turmoil, Schoewe spends more time at Wal-Mart's Bentonville, Ark., headquarters and less time on the road these days. He had to spend more time reassuring investors and analysts during one period, but that was temporary, he says.

If Wal-Mart is riding out the recession in good form so far, what about its critical supply chain, which includes many suppliers, large and small, foreign and domestic? Are they strong enough to keep supplying the merchandise Wal-Mart customers expect? Here Schoewe gets guarded in his remarks. Wal-Mart certainly relies on a network of suppliers. Some of them are experiencing distress. Wal-Mart helps them by always paying promptly on the negotiated due date, he says. Wal-Mart is reluctant to pay early. "We may help out a distressed supplier in some circumstances, but that's an exception," he says. "We're not in the business of paying early."

While Wal-Mart has raised a few hackles in the past by being outspoken about political activity, particularly when it concerns organized labor, Schoewe ducks a question about what Washington should be doing to help the economy. "We'll just run the best retail operation we can and leave it up to the government to decide what would be the best way to cure the national and global economy," he says.

Schoewe will be working with a new CEO after January, but he's not worried about big changes. Mike Duke is a known quantity around Wal-Mart. "We're carrying out a strategic plan. Lee and all his direct reports, including Mike Duke, were involved in developing that plan. That's why Wal-Mart management is so well aligned at the corporate and operating level," Schoewe says.

Asked about CFO stress and high turnover nationally in the CFO position, Schoewe says, "I'm sleeping well. My first responsibility is to recruit, train and support a first-rate financial team, and they are doing a great job. Providing financial leadership for a $400 billion corporation isn't easy, even in good times, but it's manageable because of our high-performance team."

Dealing with market angst came to a head for Schoewe in October when "we had 200-300 analysts come to Bentonville for our annual analyst meeting," he recalls. "Normally, they'd be focused on micro trends in our business performance, but this year the outside world was going crazy and many of them were worried about whether they'd even have jobs to go back to. Before I went out to talk with them, I asked Charles what we should say at a time like this. And we agreed that our message should be simple. 'We have a stronger balance sheet than we had a year ago. We have an appropriate strategy for the times. Our operations are firing on all cylinders. And we are hiring.'"


Preventing Loss From Disasters--Natural and Financial By Russ Banham

CFO Jeffrey Burchill is at the finance helm of FM Global, an insurer that absorbs the worldwide commercial and industrial property risks of nearly one-third of the companies listed in the Standard & Poor's 500 Index. Obviously, these are large concerns, and in the last year Burchill has traveled extensively to meet personally with their CFOs and boards of directors, reassuring them that the insurer has the financial capacity to pay their future potential claims. "Their boards and audit committees were thinking, 'If it can happen to AIG, can it happen to you?'" Burchill says. The beneficiary of a record $150 billion federal bailout to keep it afloat, American International Group Inc. has cast dark clouds across the entire property and casualty insurance industry.

The New York-based insurance giant had invested in risky credit default swaps that nearly capsized it--hence the widespread concern among FM Global's blue chip customers about its own investment practices. "I needed to reach out to client boards, CFOs and treasurers in group sessions and one-on-one meetings to assure them that we are financially sound, despite the economic volatility," says Burchill, who joined Johnston, R.I.-based FM Global in 1974 as an accounting manager, rising through the ranks to become senior vice president and CFO in 1999.

"I don't blame them for having concerns," he adds. "In the post-Sarbanes-Oxley environment, they are required to assess the risk of their strategic partners. In our case they're in good hands."

Unlike AIG, which insures both property and casualty risks, FM Global is firmly in the former camp, insuring large property risks in addition to providing a range of well-regarded loss prevention engineering services to clients. One of the oldest insurers in the country--it dates its beginnings to the 1830s--FM Global is a mutual company owned by its policyholders, as opposed to a stock company owned by shareholders. Premiums that remain at the end of the year after claims, investments and operating expenses are deducted are returned to policyholders as dividends.

Its mutualization is helping FM Global weather the current volatility, Burchill says. "We're fortunate in that we don't have to rely on quarterly earnings or even annual earnings (to assist a positive Wall Street valuation)," he says. "We don't have to make short-term decisions that might not be in our best interests over the long run. Nevertheless, we do need to make sure the ratings agencies understand our business model and take into account our methodology for measuring financial and investment risks." Despite the economic crisis, the company maintains a financial strength rating of A+ (Superior) by A.M. Best and AA (Very Strong) by Fitch Ratings, both with a stable rating outlook.

Managing the company's investments is one of Burchill's primary responsibilities. "We invest premiums for policyholders in [the stock of] industry leaders, taking long-term positions," he says. "Although we have a higher percentage of equities in our asset allocation than other insurers, we have no debt on our balance sheet since property claims are settled very quickly [as opposed to longer-tail casualty risks]. Consequently, we are able to take more risk on our balance sheet." To Burchill's credit, FM Global avoided investments in credit derivatives, sub-prime mortgage securities and other "toxic investments," he says. Not that the current economic volatility hasn't taken a bite out of the insurer's investment income. "Obviously, what is dominating the headlines is the economy, and that has put our judgments [on investments] in a sharper light," he adds. "Markets used to swing five percent in a year, and now they swing five percent in a day and ten percent a week."

The financial uncertainty posed by the global recession is a strain, and he is bracing for the climate to worsen, as well as "last for some time," he adds. While reduced stock valuations have contributed to an overall loss of capital for the property/casualty insurance industry--Burchill expects the industry to post an average 15 percent after-tax decline in investments alone for 2008--FM Global's strategy of investing in industry leaders with good free cash flow and excellent balance sheets puts it on solid ground. "With industry leaders you are not going to get into a credit risk situation; just valuation risk," he explains. "Our other key investment position is to have a lot of liquidity. We don't want to have to sell assets with depressed valuations to acquire working capital to pay claims."

The company's underwriting discipline is the other half of its profitable operating model. FM Global insures only "highly protected risk" properties--commercial and industrial buildings that are managed by their owners to reduce the overall exposure to loss. "We know the policies we are writing and the risks associated with them over the long-term," Burchill says. "Buildings must have a predictable loss component, and we price the risk accordingly. We believe all losses are preventable and put our money where our mouth is."

The insurer trusts its underwriting skill to the extent that it retains the lion's share of the risk it assumes, as opposed to ceding it to the global reinsurance market. Assisting its risk assessment is a 1,600-acre Research Campus in West Glocester, R.I., considered one of the world's most sophisticated centers for the scientific study of property loss prevention. The $78 million research and testing center boasts four laboratories--fire technology, natural hazards, electrical hazards and hydraulics--each staffed by distinguished scientists and loss prevention engineers. FM Global is expanding the Research Campus to meet demand by clients for greater natural hazard testing capabilities and will increase the center's staff of 108 by 7% when the project is completed. The company's competence in property loss engineering helps it tread where others dare not. Unlike many insurers that pulled up stakes in the southeastern United States following Hurricane Katrina and her kin, FM Global has expanded its presence in the region.

"While we cannot prevent an earthquake, we can prevent the damage," Burchill says. "For example, we insist that the commercial and industrial buildings we insure have a valve on the gas line that shuts off natural gas to the facility if the building shakes. We evaluate roofs to insure they are fastened properly and windows to ensure they are wind-resistant. We also have very specific location data to give us a better handle on the potential aggregation of claims, thereby reducing our exposure to loss from a hurricane or earthquake that strikes a particular area."

Like other property insurers, FM Global acquires modeling data on natural catastrophe risk, in its case from vendor RMS. Where it parts company with many of its peers is taking this data and then tinkering with the models using its own engineering data on construction, geography and occupancy. "This way we get a much clearer picture of potential loss scenarios," Burchill says.

Despite FM Global's underwriting track record, scientific research into property risk and its long-term investment philosophy, the company and the rest of the property/casualty insurance market are likely to raise prices and tighten policy terms and conditions in 2009. "We believe the investment markets will be slow to recover, which means that we will need to make money on the core products--something historically that we haven't done," Burchill says, adding that "the only way to replenish losses in investments is with underwriting profits."

While he cannot speculate on the potential increases, given that each client's risk scenario is different, he notes that FM Global's unique position as a mutual company owned by the clients whose risks it absorbs ensures that any increases in premiums will be competitive, fair and equitable.

Doctoring the Crisis With LiquidityBy Richard Gamble

Six months ago, CFO Jeffrey Henderson stayed on top of Cardinal Health's accounts receivables performance by reading a monthly written report. Now he physically meets twice a week with a group that includes the treasurer, business segment CFOs, people from credit and collections and the head of global financial services. "So much is changing so fast that we need to check more often to know what's happening out there," he says. Not that $90 billion Cardinal is getting squeezed by late payments from the hospitals, pharmacies, clinics and doctors' offices that are its primary customers. In fact, days sales outstanding (DSO) actually improved by a day in the third quarter of 2008. "In times like these, some of our customers are having difficulties. We're proud of
the fact that we've been able to stay on course in spite of those issues," he says.

And not that Cardinal is in any kind of liquidity bind. In fact, all three of Cardinal's primary sources of liquidity--a commercial paper program, a receivables securitization program and a cash buildup overseas that can be temporarily repatriated--have continued to function reliably through the market spasms of October and November. But Henderson intends to make sure that liquidity is still there and the balance sheet stays strong, even if things get worse. "Liquidity is precious, and you don't want to let it leak away. Accounts receivable and accounts payable are the places you watch to prevent leaks," he says.

Just being in pretty good shape is not enough these days; you have to tell people. So Henderson takes more time to talk with investors, both on the phone and hitting the road for face-to-face meetings with analysts, fund managers and large shareholders. "These are anxious times and it's important to stay in close communication, not just with investors but with employees, customers and suppliers," he says. "People want clarity about what's going on with our company. Before they wanted to know that we were profitable and had adequate liquidity. Today they want to know in more detail just what that liquidity means."

It helps that health care is one of the relatively stable industries in an unstable global economy. "I guess the good news for us financially is that people continue to get sick and need care," Henderson notes. But he argues that Cardinal's strength also comes from good management. "We keep a conservative balance sheet. We can tap multiple sources of liquidity. We watch our investments closely," he says.

He gives his treasury staff high marks for their risk management skills, particularly in navigating the investment minefield. "We have very stringent risk management processes," he says. "We got out of auction-rate securities over a year ago. We also got out of certain funds when we weren't comfortable with their portfolio holdings, even when the funds were rated triple-A. We've had virtually no write-downs. The risk management oversight from our treasury group has been exceptional."

Foreign exchange and interest rate hedging programs have worked as advertised and offered some protection when foreign currencies plunged in October and November, Henderson says. And because Cardinal chose its counterparties carefully and spread counterparty risk, it avoided problems that plagued some companies, he says.

Cardinal takes a scientific approach to liquidity management. The company has $3.5 billion of long-term debt but needs to support large swings in working capital, so it has a $1.5 billion commercial paper (CP) facility and an $850 million accounts receivable (A/R) securitization program. It taps both regularly, depending partly on cost and partly to "test the availability and to keep our name in the market. We have a hierarchy of liquidity sources. When and how we tap each source is transparent to the board and the audit committee. We're likely to use the top three--CP, A/R securitization and repatriated cash--regularly. We would go further down the hierarchy to four additional sources only if we had to," Henderson says.

That hierarchy has now been stress-tested and held up well, Henderson reports. "There was never a day when we couldn't issue commercial paper. We were always able to get the liquidity we needed. It was expensive, but it was there. I doubt if we could have issued the full $1.5 billion, but I think we could have done $200 to $300 million on most days. And we just renewed our A/R securitization facility a few weeks ago without any problems. It's easy to raise liquidity in good times. Now we know we can do it in tough times." Cardinal's CP is rated A2/P2.

More severe tests are still possible, so Henderson has asked the financial planning and analysis (FP&A) staff to run more scenarios, to include more dire what-if assumptions and to push out projections to longer time periods and look for ways to offset negative developments. "FP&A is always critical, and it's even more critical at times like these," he says.

In times of stress, Cardinal pays close attention to its whole supply chain, not just customers. "We're very conscious of the financial condition of our suppliers and try to have alternative suppliers in mind just in case. Most of our suppliers are strong but some are struggling. We consider requests to shorten our terms with suppliers, but there is always a price. We don't want to be the cheapest bank on the block. Whether we shorten terms to our suppliers or lengthen terms for our customers, we expect to be compensated at a market rate."

The crisis has affected Cardinal customers in ways beyond payment timing. Hospitals, unsure of their access to capital, are deferring large equipment purchases, "which is costing us business, at least for now" Henderson observes.

When he came to Columbus, Ohio-based Cardinal in 2004, Henderson brought seven years of experience at Eli Lilly and 15 years at General Motors, a resume rich with senior management experience, both in and out of finance. He's now responsible for worldwide financial operations, IT, global shared services and Canadian operations.

Besides guarding liquidity and staying in close communication with all Cardinal's constituencies, Henderson is in the midst of managing a spin-off of Cardinal's $4 billion med-tech businesses. After years of growth through acquisitions, Cardinal started to rationalize its holdings four years ago, merging like business lines and divesting ones that didn't fit. The result was essentially two distinct companies that would prosper best if each had its own management, board and shareholders, so the spin-off was announced in September.

Before the turmoil hit, Cardinal had already scaled back its share repurchase program to maintain capital flexibility prior to the spin-off. That decision was reinforced over the past couple months as the financial markets have tightened. "It's prudent to carry more cash on your balance sheet in times like these," Henderson says. "So to build our liquidity cushion we started conserving cash." The firm now has $700 million of cash.

As a relatively strong company, Cardinal views the economic turmoil as an opportunity as well as a threat. "You have to plan for the future," Henderson says. "We have an opportunity to make selective investments--in R&D, in our customers, in other assets--that our competitors may not be able to make. Companies that keep investing prudently will come out of this much stronger in three months or 12 or 18 or however long it takes."

With a new administration about to take charge in Washington, Henderson is looking first for decisiveness and consistency to bring an end to the crisis. "It's all about confidence," he says. "What they do doesn't have to be exactly right, but they have to make people feel that they're moving decisively to fix things and that they'll follow through." And when the new administration and Congress turn to health care, Cardinal will be paying close attention. "Anything that increases access to health care and focuses on productivity, cost containment and safety is important to us. That's what we're all about."

If he could get one flash from six months in the future to help him do his job now, Henderson would like to see the spread between corporate and government bonds, which would be a good proxy for how much confidence had recovered. "The key is to get credit flowing again. If the spread was back in a normal range, that would be a good sign that confidence is back," he says. "So would more successful corporate bond offerings."

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