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July 1, 2005

Executive Chartbook: How Do You Match Up?

A newly revamped Executive Chart Book gives metals executives-even those from privately held companies-a way to benchmark their own performance and to inform decisions based on historical industry trends.

It is tempting to take 2004's favorable results at face value, but the fact remains that metals service centers don't exist in a Lake Wobegon world where all the industry's players are above average. Last year's rising tide lifted some companies more than others, and executives know they must measure how well they fared relative to their competitors. A revamped Executive Chart Book (See “A New, Slimmer Chart Book,” below) offers a new, clearer picture of those relative performance measures.

On a broad level, the data generated by the roughly 120 participating companies in 2004 show an extraordinarily profitable year for metals service centers, but also one in which productivity increased and company managers maintained spending and borrowing discipline. Sales rose 43% over 2003 totals and pretax profit margin jumped nearly seven-fold to 9%. Higher prices were the primary contributor to improved profitability. The dramatic sales improvement came on an increase in tonnage shipped of just 7.8%. (The Metals Activity Reports show an increase in industry tonnage of 12.1% from 2003 to 2004. All figures are industry averages.) “That indicates a heavy amount of pricing power,” says Roger K. Harvey, president of Value Associates Ltd., the consulting company that redesigned the Chart Book based on input from a group of service center chief financial officers. Pricing power also is reflected in last year's industry gross margin of 27%, up from 24.7% in 2003.

Drilling down a bit further, operations contribution (sales minus cost of goods and plant and delivery expense) jumped to 19% of sales from 11% in 2003, a significant increase that can be attributed to operating leverage. Meanwhile, overall operating expenses, including sales, general and administrative expenses, or SG&A, fell to 67% of sales from 91%. “SG&A stayed flat in 2004, so there wasn't the typical reaction of increasing overhead when sales go up,” Harvey says.

Operating efficiency measures showed a general improvement in asset management. Asset turnover was a healthy 2.76, indicating that every dollar of investment generated $2.76 in sales, up from a recent low of $2.04 in 2002. This measure, in turn, reflects substantially improved levels of inventory and receivables relative to sales. “Just because we hit a year last year when margins were much higher than normal, I don't think people took their foot off the gas as we accelerated toward expense control,” says Mike Janson, chief financial officer of SOS Metals in West Chester, Ohio.

Days of inventory, which were as high as 94 in 2001 and 2002, fell to 82 last year. Days of receivables were trimmed to 41 last year from 44 in 2001 and 2002. “While we have seen a dramatic increase in sales,
it was not brought about by expanding the inventory base or relaxing receivables management, rather it was a demand pulled increase in sales,” Harvey says.

On the financial management side, the debt-to-equity ratio rose slightly to 118% from 114% the previous year. It was still well below debt levels seen in the late-1990s and 2000. Industry debt levels “are not high or low relative to other distributors,” Harvey says. And given the amount of cash available for debt payments, debt levels are hardly a concern on an industry-wide basis. The industry generated cash from operations last year that was more than 22 times the amount of scheduled interest service, a ratio that was nearly 10 times higher than it was in 2003. “The bottom line is that the typical service center has a good balance between debt and equity financing,” Harvey says.

OFF THE CHARTS

Given these improved benchmarks, it is not surprising that two bottom-line measures of profitability, return on assets and return on equity, were virtually off the charts compared with those of previous years. Return on assets, a measure of profit generated by a company's equity and debt, was 24%, up from 3% in 2003 and more than seven times higher than levels seen in the late 1990s. Return on equity was 56%, reflecting robust profitability that was achieved without assuming higher levels of leverage.

“It was the big-picture dynamics that caused such a drastic turnaround,” says Rick Marabito, chief financial officer of Olympic Steel in Bedford Heights, Ohio. A major boost in demand from industrializing nations such as India and China followed a period of consolidation in the steel industry into a handful of financially stable companies. In addition, the rapid pace of the recovery in demand, following several declining years, also was a key factor in last year's improved pricing. Steel mills were initially reluctant to step up production, leading to declining inventories and a tight supply situation in the United States. “It took the mills a while to be convinced there was truly an ongoing increase in demand,” says Everett Chesley, chief financial officer of Integris Metals in Minneapolis.

By most measures, 2004 was an unusual year, but industry executives say the year's data still provide useful benchmarks for their companies. “One of the advantages of a benchmark is you're not just looking at historical performance; you're using it to compare yourself to a much improved industry,” Chesley says. “What you're trying to do is beat your competition and be a leader in the market, whatever year it is.”

To what degree last year's favorable conditions will carry on into 2005 remains to be seen, although early indicators have been promising. Ultimately, industry ratios will head back toward their long-run averages; companies must learn from their relative performance last year how to manage the cooling-off period. “Just because I had a good year last year doesn't mean I couldn't have had a better year,” says SOS Metals' Janson. “There are a lot of underlying things you need to continue to deal with, like expense control and inventory turnover. Sometimes when you have a real good year it's sort of easy to forget about those things.”

 

 A NEW, SLIMER CHART BOOK

Slimmed down and automated, the Executive Chart Book now offers a timely, more concise breakdown of a company's performance relative to the broad industry, its own sub-sector or companies of similar size. The data entry form has been reduced to two pages from 17 pages and moved online (though paper submissions remain an option). The overall time commitment required for collecting and submitting data to the benchmarking program has been reduced to a matter of hours from an estimated four or five days.

“The big move this year was a dramatic reduction in the size of the input,” says Everett Chesley, chief financial officer of Integris Metals in Minneapolis. “The objective was to focus on key metrics and forego some of the outlying metrics for the sake of simplicity, speed and increased participation.”

Formerly, the time lag between data collection and distribution limited the Chart Book's usefulness. Reports were compiled annually and shipped in April as companies were already closing the books on the first quarter of their new year. Now new data are immediately factored into the 150 ratios and performance measures tracked by the Chart Book. Turnaround can be instantaneous, and benchmarks are applicable as soon as a critical mass of companies has reported. Also, beginning this year, results will be available on a quarterly basis rather than annually. Roger K. Harvey, president of Value Associates, the consulting company that automated the Chart Book and manages the data collection process for the Metals Service Center Institute, says that over time the online database will keep five years' worth of quarterly data and five years of annual data on hand.

Color-keyed charts and graphs, which can easily be customized, quickly make it plain whether a company is above, at or below average on a given measure. Data also can be downloaded into a spreadsheet for further analysis, or can be repackaged for presentation to boards of directors, department heads, investors and others.

“Reports in the past were more detailed, but the ratio of reward to work put into it are much greater in the new product,” says Mike Janson, chief financial officer of SOS Metals in West Chester, Ohio.

The Chart Book's industry benchmarks are particularly important for the large majority of metals service centers that are privately held, says Rick Marabito, chief financial officer of Olympic Steel in Bedford Heights, Ohio, one of a handful of publicly traded companies in the industry. “Private companies don't get to see a lot of peer data,” he says. “For a lot of them this may be the only real source of benchmarking.”