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Quarter 3, 2009
Free Cash Margin Index:
Recession Lows

2.43%, 4.12% (Mar. 2001, Dec. 2008)

Current

5.36% (Sep. 2009)

Last Expansion High

5.14% (Jun. 2004)

In this research paper we report free cash margin and its determining factors for our sample of 3,704 non-financial companies with market caps exceeding $50 million measured for the twelve months ended September 2009. Our results indicate that for the September 2009 period, free cash margin improved to 5.36%, which is its highest level since we began tracking the metric in March 2000. The improvement appears to be driven primarily by a decrease in capital expenditures. As a percent of revenue capital spending is now lower than it has been for any reporting period since March 2000 – even significantly lower than it was during the 2001 recession. Increases in capital spending will weigh on free cash margin in future periods.

In the third quarter we did note a significant increase in inventory days, which is now at pre-recession levels. Receivables days and payables days also increased, but remain below pre-recession amounts.

For the twelve months ended September 2009, eleven industry sectors reported improved free cash margin from the same period in 2008, while one sector saw free cash margin decline. Eight sectors saw their free cash margin remain relatively stable.


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Announcing the Availability of Industry Cash Flow Spreadsheets - Quarter 2, 2009

The Georgia Tech Financial Analysis Lab is pleased to announce the availability of detailed spreadsheet data chronicling trends in free cash margin and its component factors for the 20 four-digit GICS industry sectors and the 61 six-digit GICS non-financial industries we follow. In this research report we highlight these findings for the second quarter of 2009 and examine the results for several individual companies.

For the twelve months ended June 2009, eight industry sectors reported improved free cash margin from the same period in 2008, while two sectors saw free cash margin decline. Ten sectors saw their free cash margin remain relatively stable.

Individual companies with improved free cash margin that are examined in this report are Home Depot Inc (HD), Campbell Soup Co. (CPB), and Archer-Daniels-Midland Co. (ADM). Companies with declining free cash margin examined here are Merck & Co. (MRK), Pacific Gas & Electric Co. (PCG), and Southern Co. (SO).


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Summary Review - Quarter 2, 2009
Free Cash Margin Index:
Recession Lows

2.43%, 4.12% (Mar. 2001, Dec. 2008)

Current

4.76% (Jun. 2009)

Expansion High

5.14% (Jun. 2004)

In this research report we provide our flash measure of free cash margin for all non-financial companies measured through June, 2009. Detailed industry data for the quarter will be published soon. We found that for the twelve months ended June, 2009, free cash margin improved to 4.76%, up from the recession low of 4.12% reached in December 2008 and up from the 4.60% registered for the twelve months ended March 2009. Thus, the improvements noted in the March quarter continued into June, suggesting the much-discussed turnaround in the U. S. economy remained on track.

In the June 2009 reporting period, free cash margin improved even though profitability, as measured by operating cushion, declined slightly. Driving the improvement in free cash margin were noteworthy reductions in both capital spending and the cash cycle. Income taxes paid as a percentage of revenue also declined. While the continued improvement in free cash margin is a positive development and consistent with the improvements noted in share prices since early March, the long-term viability of the Recovery will require a return to improving profitability. More specifically, confirmation of the end of the recession on a cash flow basis will require an improving cash margin driven more by improving profitability, as evidenced by improving operating cushion, and less through reductions in capital spending and the cash cycle.


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In this research report we survey the cash flow reporting practices for a sample of fifteen of the largest, independent and publicly-traded U.S. commercial banks. In the process, we find many reasons why cash flows are typically not important measures of financial performance for the banks. For our sample, we adjust reported operating cash flows for classification differences, for non-cash transfers of loans and investments between categories that impact operating cash flow, and for the effects of acquisitions. In the adjustment process we find some notable changes to operating cash flow. In particular, we see declines in adjusted operating cash flow for Bank of America, JP Morgan Chase and Wells Fargo, and increases in adjusted operating cash flow for Citigroup, Fifth Third Bancorp, KeyCorp, PNC Financial and SunTrust Banks. We seek your comments on how bank cash flows should be measured.

Analysts who evaluate the financial performance of commercial banks will want to give consideration to adjustments such as these when examining bank finances. Bank regulators and the FASB may also want to consider these adjustments and the somewhat limited disclosures of information relevant for the adjustments that are presently provided by the banks. More detailed information on items such as brokered deposits and acquisition-related cash flows would be helpful.


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Summary Review - Quarter 1, 2009
Free Cash Margin Index:
Recession Low
2.43% (Mar. 2001)
Current
4.60% (Mar. 2009)
Expansion High
5.14% (Jun. 2004)

In this research report we provide a “flash” measure of free cash margin for all non-financial companies measured through March, 2009. We found that for the twelve months ended March, 2009, free cash margin improved to 4.60%, up from the recession low of 4.12% reached in December 2008, but down slightly from the 4.72% registered during the twelve months ended March, 2008. This is a particularly striking development in that it is the first twelve-month period since December 2007 that we have seen improvement in free cash margin. The implication is that the firms in our sample are in the process of turning the corner in terms of financial performance. It also provides support for the improvement in stock prices we have seen since early March 2009.

In the March 2009 reporting period, free cash margin improved even as profitability, as measured by operating cushion, declined. Driving the improvement in free cash margin was a small reduction in capital spending and a more sizable decrease in the cash cycle. Firms are truly becoming “lean and mean” and dealing well with a noted decline in profitability. We look forward to reviewing the data for the June 2009 quarter to see if the improvements noted in March are continuing. Confirmation of the end of the recession on a cash flow basis will require an improving cash margin driven more by improving profitability, as evidenced by improving operating cushion, and less through reductions in capital spending and the cash cycle.


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Comprehensive Industry Review - Quarter 4, 2008

This research report is one of a series that looks at the cash flow performance of Corporate America. Our primary focus is on free cash margin, or free cash flow measured as a percent of revenue. We also look at the drivers or components of free cash margin in an effort to determine factors behind observed changes. In the current study we conduct a comprehensive review of 20 four-digit GICS non-financial industries and their 61 six-digit GICS sub-industries for a series of rolling twelve-month periods from the first quarter of 2000 through the fourth quarter of 2008.

Recession notwithstanding, due to declining capital expenditures and reduced working capital requirements, free cash margin held up reasonably well during the twelve months ended December 2008. The metric declined to 4.12%, down from a high of 5.14% reached in June 2004, and more recently, the 4.93% level reached in December 2007 and 4.44% in September 2008. With free cash margin at 4.12%, corporate America is generating 4.12 cents of free cash flow for every dollar of revenue generated. The number of industries experiencing declining free cash margin increased from our last report. For our sample as a whole, free cash margin last bottomed at 2.43% during the 2001 recession.

We continue to believe that during the current recession, free cash margin will likely decline to levels that are at or below those found in the 2001 recession, suggesting a continuing contraction of free cash flow of 50% or more from current levels. However, a continuing focus on maintaining low working capital levels and reduced capital expenditures may leave companies better off on a cash flow basis than they were in 2001.


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Comprehensive Industry Review - Quarter 3, 2008

This research report is one of a series that looks at the cash flow performance of Corporate America. Our primary focus is on free cash margin, or free cash flow measured as a percent of revenue. We also look at the drivers or components of free cash margin in an effort to determine factors behind observed changes.

In the current study we conduct a comprehensive review of 20 four-digit GICS non-financial industries and their 61 six-digit GICS sub-industries for a series of rolling twelve-month periods from the first quarter of 2000 through the third quarter of 2008. After bottoming below 2.5% during the 2001 recession, free cash margin has improved markedly and has remained relatively stable above 4.5% since 2002, declining to just below 4.5% for the twelve months ended September 2008. Our expectation is that during the current recession, free cash margin will likely decline to levels that are at or below those found in the 2001 recession. The implication is that over the next year or so, median free cash flow could fall by 50% or more. In this report we provide a summary of our results and identify several representative companies. Please refer to the various industry reports that accompany this introduction for industry details.


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The S&P 500 Non-financials - Quarter 3, 2008

This research report is one of a series that looks at the cash flow performance of Corporate America. Our primary focus is on free cash margin, or free cash flow measured as a percent of revenue. In the current study we look at the non-financials of the S&P 500.

During the twelve months ended September 2008, free cash margin for the S&P 500 nonfinancials declined to 6.70% from 7.13% for the twelve months ended September 2007. Interestingly, operating cash margin improved slightly during the same period, helped by improvements in operating cushion and the operating cycle. It appears that increased capital spending pushed net cash margin lower even as operating cash margin improved. As a point of reference, free cash margin troughed at 4.36% in the 2001 recession. Thus, by all indications, we can expect a significant decline in free cash margin from current levels. While we do not know how far free cash margin might decline, at the present, with a median $666.7 million on hand, these firms had ample cash and short-term investments to help them weather the financial storm.


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Through accelerated depreciation deductions, capital intensive firms are able to postpone or defer the payment of significant amounts of income taxes. Provided they continue their capital spending, these taxes can be deferred indefinitely, providing companies with what is essentially a long-term, interest-free loan from the federal government. However, when capital expenditures are reduced for an extended period, required tax payments will grow as deferred tax liabilities decline and tax payments postponed from prior years become due. Our expectation is that in a deep and continuing recession, as is being experienced currently, firms will reduce capital spending. As a result, capital intensive firms may begin to experience increases in tax payments, resulting in cash payments for taxes that exceed the amount of income tax expense reported on the income statement.

In this research report we use data for 2007 to identify capital intensive firms with significant deferred tax liabilities. The sample firms are divided into two groups: firms with increasing capital expenditures and deferred tax liabilities and firms with decreasing capital expenditures and deferred tax liabilities. While all of the firms are at risk for increased tax payments resulting from an extended period of reduced capital expenditures, the firms in the latter group are more likely to see higher tax payments. Investors may not be expecting such higher tax payments, especially during a recession.


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The Cash Flow Growth Profile™ measures the capacity of a firm to generate cash flow as it grows revenue. The metric is forward looking and reports the amount of incremental cash flow that can be expected for any measured amount of growth in revenue. In this report, using data obtained through the second quarter of 2008, we examine the Cash Flow Growth Profile™ of five technology industries: computer hardware, computer software, information technology services, telecommunications equipment, and semiconductors and related capital equipment. We look at trends in the Profile for the industries and for 59 individual companies. In examining the Cash Flow Growth Profile™, the drivers or determinants of core operating cash flow and free cash flow are highlighted.

Looking at the industry data, there is little evidence of a decline in operating performance through the second quarter of 2008. Indeed, only two industries, Computer Hardware and Information Technology Services saw declines in their Free Cash Growth Profile™ for the twelve months ending with the second quarter of 2008 from the same period in 2007.


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