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By S.L. Mintz
As second quarter 2010 results come into focus, the latest report by the Georgia Tech Financial Analysis Lab furnishes a short list of first quarter cash flow margin leaders.
Among standouts, two small companies bear slim similarity except in one key respect: sturdy free cash flow margin despite a punishing recession.
But like other companies that have mastered the art of generating cash, the two now face the challenge of what to do with that cash. Unlike others, they may be better positioned to meet the challenge.
BadgerMeter, a century-old supplier of water monitoring controls to municipalities weathered the recession without a hiccup in its cash flow, notwithstanding a slowdown in sales in 2009 that CFO Rick Johnson blames on uncertainty spawned by the stimulus package. Cities and towns held back rather than jeopardize chances for stimulus money. Nevertheless, Wisconsin-based BadgerMeter recorded banner earnings in 2009, its best year.
With debt nearly paid off and its pension plan almost fully funded, the company can put free cash flow to work to fund dividends, stock buybacks or acquisitions. It's leaning toward the latter, says Johnson; small- to medium-size acquisitions that bolster the core flow measurement business and offset depreciation and amortization. "If we weren't doing this," says Johnson, "we'd be building a war chest of cash."
In Lawrence, Mass., six-year-old NxStage Medical is the only company with a home hemodialysis indication cleared by the FDA. The challenging road to its first profitable quarter nevertheless leaves cash flow to invest in good opportunities. On the eve of a cash crunch, NxStage swallowed an acquisition without choking off its cash flow.
Customers can elect to buy or rent, a choice that affects cash flow. Since the fourth quarter of 2009, NxStage has recorded an increase in equipment purchases, which has had a favorable effect on operating cash flow.
NxStage now is looking to go from preserving cash to chalking up profits. "We mapped out four years ago this is how we're going to do it. Not everything has worked 100 percent as planned," says CFO Robert Brown, "but without ever being cash flow positive we've managed to generate enough cash for operations and research and development."
Like a roster of companies, Badger and NxStage beat historical odds in the worst recession since the 1930s. "As the recession continued, companies generated more cash," says Charles Mulford, finance professor and director of the Financial Analysis Lab. "That is the opposite of what I expected using past recessions as a guide. If this progressed more like 2001, we would have seen free cash flow margin and free cash fall significantly."
The comprehensive study weighed data provided by cash flow analytics from 3,848 companies in 20 sectors based on 12 months through the first quarter of 2010. Findings boil down to a cash flow margin index that measures free cash flow as a percentage of revenues, an index that the Lab has tracked since 2000. The news almost exhibits irrational exuberance. Coming out of a recession, companies notched an all time high on the free cash flow margin index: 6.69. That compares with a low of 2.43 in March 2001 and a previous expansion high of 5.14 in June 2004.