March 1, 2012

The Strength in Service Center Capital Investment

Why they are spending on everything from bending metal to bending cyberspace.

Certainly this slow-growth economy has offered little to cheer about. But if there is any smiling at all, it's from the strongest metals service centers across North America. They mostly had a decent 2011, and found creative and competitive ways to spend some of the cash they've been holding on to.

This year will be much of the same, as centers indicate they are confident enough in the economy to maintain strong capital spending budgets. “When times are good, you tend to use cash,” says David Hannah, chairman and chief executive officer at Reliance Steel & Aluminum, based in Los Angeles, California. “When times are difficult, sales are slow and receivables shrink. Then inventory and expenses are reduced and this creates a large amount of cash flow.”

And this in turn creates plenty of opportunity to invest in new efficiencies from forklifts to financial management systems. For some, last year's enthusiasm for spending was fueled in part by tax incentives born in early 2009 U.S. economic stimulation programs and dead by New Year's Day 2012. “The 100% accelerated depreciation was a good incentive for 2011 spending. It helped motivate our company to move forward with some projects,” explains Marc A. Schupan, CEO of Kalamazoo, Michigan-based Schupan & Sons, Inc. “The other point is that if you have a strong balance sheet, the banks are desperately looking for good projects to loan money for. Investing in equipment to improve efficiencies which lead to profitability is much more attractive than real estate-related projects.”

For others the federal tax break was simply a fortunate footnote. And this year the muscular capital budgets are primarily part of aggressive business plans to stay lean, cost efficient and competitive. Investing while costs are relatively low makes sense in strategic and tactical ways.

“Our business model is to manage for the down cycles which means we maintain adequate liquidity and a strong balance sheet to ensure we have ready access to capital,” says Jack A. Hockema, president, CEO and chairman at Kaiser Aluminum, based in Foothill Ranch, California. “That model enables us to invest consistently through the full business cycle. A manifestation of this business model is that we expect organic investments over the next five years at an annual pace similar to the prior five years.”

Michael Goldberg, president and CEO at A.M. Castle & Co., reports the company's capital expenditures for 2011 and 2012 total 1% of revenue for each year, although he did not attach a dollar amount to those expenditures. However, according to the company's third-quarter earnings conference call, “consolidated net sales for year-to-date September were $850.2 million, which is $142.1 million, or 20.1%, higher than the first nine months of 2010.”

Kaiser Aluminum's Hockema says: “Our organic capital investment has averaged approximately $60 million per year over the past five years, and we expect capital spending levels averaging approximately $50 million to $60 million per year over the next five years. This level is more than double our depreciation rate and facilitates top-line and bottom-line growth.”

Hannah, at Reliance, says his company budgeted slightly more than $200 million for 2011, not including acquisitions. “The end-of-the-year total expenditure will fall below that since our needs changed throughout the year,” he says. “But still, the final figure will fall between $150 [million] and $200 million.” Hannah reports that the 2012 capital budget has not been finalized as of this writing but he expects it to be “significantly higher.”

And that is not just for the big guys. Schupan & Sons, Inc., a $270-million, third-generation, family-owned metals and plastics business, reports its total capital expenditures for 2011 were approximately $2.4 million. “At this time, we have funds set aside for improvements in response to customer needs,” says Schupan. “This may potentially be another $1.5 million for capital projects in 2012.”

What Are They Buying?

For the most part the metal service center executives interviewed said they have been buying purely practical technologies: new computer systems and equipment that they believe give them an important edge in their markets, be they global, regional or local. “I would say that we don't have the patience to be a first adopter of new technologies,” explains Sherri Meachum, director of IT at Schupan & Sons. “We prefer to wait until they are proven and become mainstream. At the same time, we don't want to wait too long, either.”

Hockema agrees. “We do not invest in technology for the sake of technology. Rather, we determine the best technology to meet the defined need and to be compatible with the commitment to employ lean value streams.” For example, Kaiser Aluminum is investing in casting, homogenizing, rolling, extrusion, heat treating and material handling automation. “Our aerospace/automotive investments are to expand our capacity to supply aluminum semi-fabricated products for use in the aerospace and automotive industries,” he explains.

Hannah says Reliance also spent significantly on equipment technologies with an emphasis on splitters and blanking lines. The company is looking for the technologies to better produce tight tolerance blanks for operations downstream including stamping, roll forming, and punching and notching.

The company has also invested in material handling equipment, safety equipment and, in the way of IT, human resources information system (HRIS) technology. Material handling equipment cuts processing time, boosts productivity and increases safety by decreasing the labor intensity of the processing. In other words, fewer workers are needed to handle the material and, if the material handling systems are fully integrated, the automated process removes the need for workers to physically wrestle the materials.

“We purchased forklifts and side loaders, as well as cranes, conveyors and updates to our automated storage and retrieval systems,” Hannah said. “Some of these are additions to support our increased sales volume in 2011 [tons were up about 12%] and some were replacements.”

On the other hand, Reliance Steel and Aluminum will dramatically shift its capital spending to IT for the foreseeable future. “Over the next five to seven years, we will be modifying or replacing nearly all our IT systems,” says Hannah. Reliance, like so many other large metal service centers, is struggling with a multitude of systems inherited through acquisitions. “We currently have 15 to 17 systems in place with one overlying technology, Hyperion, to pull things together,” he says. Not only are these systems aging, but also the patchwork is difficult to maintain, integrate and expand cost effectively.

Upgrading Business Intelligence

Hyperion, the technology currently used by Reliance, is a business intelligence product from Oracle, the global data software giant. It is designed to offer planning, human resources and financial reporting in one package. A.M. Castle & Co. is using Oracle, too. “We're continuing our 2008 and 2009 IT investment strategy in Oracle and implemented its use in Europe in 2011,” says Goldberg. The company opted to adapt its processes to fit Oracle's pre-design rather than invest heavily in customizing the software to fit its existing processes.

A.M. Castle & Co. is focused on increasing its footprint internationally and to that end it is spending most of its investments on IT technologies—among those are warehousing and inventory systems—followed by processing and material handling automation which, in theory at least, can increase process time by as much as 50% and productivity by as much as 75%.

In 2011, Schupan & Sons spent approximately $1.4 million on additional processing equipment and another $1 million on facility expansion for one of its Kalamazoo, Michigan, locations. The equipment was for bending, sawing and computer numerical control machining improvements for growth and efficiency. For 2012, the company is planning an upgrade to its delivery fleet vehicles to improve order response time and a possible expansion to its newly completed building addition on its Kalamazoo facility “as we are anticipating significant growth over the next three years,” says Schupan.

His company continually invests in IT improvements as one of the best strategies for competing with larger companies, especially in providing super responsive service. “We spent about $160,000 in 2011 upgrading to a fiber optic connection to the Internet and a VoIP [Voice over Internet Protocol] phone system,” says Schupan. “This phone system is state-of-the-art and links our 10 facilities and has had a very positive impact for our three metal and plastic distribution centers. The system allows our inside sales staff to respond quickly to our customers needs with a routing capability that sends the call to the first available sales person at any of the service center facilities.”

“One of the key benefits we have gained with the new VoIP system is that our two new locations in Toledo and Dayton are now connected to our voice network,” adds Sherri Meachum, Director of IT at Schupan & Sons. “This allows us to leverage personnel resources between locations for more efficient handling of incoming sales calls. Now that we have station-to-station dialing between all 10 locations, we anticipate it will reduce our long-distance costs but we don't have an exact dollar savings yet.”

“Another benefit is it includes a conference bridge service so we don't have to pay for any outside service for conference calling,” she explains. “This will allow us to better leverage our cellular and wireless connectivity.”

For 2012, Schupan & Sons has a particularly aggressive $200,000 tech spending program that will include upgrading IT servers and computer workstations company wide and installing a sophisticated new Business Intelligence (BI) system designed to identify, extract and analyze business data and then automatically and on-demand parse this information into reports suitable for various workers from salespeople to accounting and processing departments. It will also redesign its website and create an off-site data backup system by year's end.

“When looking at new technologies, we want to adopt ones that will allow our customers to interact with us in the way that works best for them,” says Schupan. “We want doing business with us to be as simple and effective as possible. That means providing a variety of options from telephone to e-mail to access through the Web.”

The Lure of the Cloud

In years past, capital expenditures were a simple and straightforward indicator of technology investments. Simply put, technology investment was a neat budget line item that was easily read and understood. But the increasing popularity of cloud computing, renting IT services of practically any type over the Internet from an independent contractor or vendor, has changed the accounting rules, if not the IT investment strategies.

Companies no longer have to buy servers, license software and maintain their electronic business systems themselves. They get a cloud computing company to do all that for them. They rent a portal and access, with no capital spending on computer services. IT becomes an operating expense instead. Such accounting and cost flexibility can be an important advantage to companies in general and metal service centers in particular as it enables more timely, responsive and up-to-date spending. And easier cost cutting when necessary.

“Services in the cloud are a part of our 2012 budget discussions now,” says Hannah. “We just haven't decided yet which, if any, technologies we will rent from the cloud and which we will buy outright.”

Despite the challenges in deciding the best technologies to invest in—and how to invest in them—metal service centers are viewing these choices as an opportunity to more effectively customize their services to fit customer demand.

“Our company philosophy is responding to our customers' needs as opposed to, 'Here is what we do,' and try to fit their needs into a non-flexible system,” explains Schupan. “We believe that thought process has been responsible for our growth even in these difficult times. We are excited about our long-term future. Being agile is the key.”

Pam Baker has written hundreds of articles in leading technology, business and finance publications. She has also authored several analytical studies on technology, eight books and an award-winning documentary on paper-making.