Caught between corporate scandals and a difficult economy, CFOs are entering 2003 focused on improving internal practices, strengthening their balance sheets and looking abroad for better markets.

It's been a bad year, and things may not get much better in 2003. Economic growth is weak, consumer spending is flat, and business spending is falling. The trade deficit is huge, and the federal surplus is gone. Corporate fraud has destroyed investor and public confidence, incited stiff regulatory changes, and slashed stock prices.

CFOs at all public companies have been diverted from the critical task of managing through the downturn. Now their focus is on shoring up governance and disclosure practices and driving compliance with the Sarbanes-Oxley Act. As the new year dawns, these issues will continue to draw top priority for most CFOs, followed closely by the need to guide their company through the brutal external economic environment. At many businesses, the top line is so ugly that the focus has shifted down the page to cash flow, profitability and return on capital invested. Of the relatively few companies making decent money, many are making it abroad, and they are determined to continue foreign growth despite higher levels of risk in almost every region.

In this sobering business climate, CFOs face three key challenges heading into 2003: improving governance and disclosure, strengthening the balance sheet despite the ongoing downturn, and pushing ahead with global expansion. The eight CFOs at large corporations whom we interviewed for this story have fared better than most. Still, they anticipate the need to make many changes to steer through what is likely to be another tough year.

Governance and Disclosure

Airgas Inc., the Radnor, Pa.-based industrial gases distributor with $1.6 billion in fiscal 2002 revenues, has always had strong governance and reporting provisions in place, but "given the current environment, we felt we needed to review the entire landscape," says Roger Millay, senior vice president and CFO. The process began in March, when the company conducted a review of current business issues. Then management convened a special meeting of the audit committee.

"The audit committee reviewed the whole gamut of issues and asked for everything that could be relevant," Millay says. "We were confident with the review and had no problems with the recent legislative and regulatory reforms; they were mostly in place at Airgas already. From the outside in, the committee looked at everything we're doing. This represented a more formal approach to the involvement of the audit committee, which will now meet in a special extra meeting every year specifically to address these kinds of external issues," says Millay.

Although Airgas has always required representation letters from its business units, in July it expanded the requirement to key functional leaders. The letters from these leaders are combined with the letters from the business units and presented to a newly established compliance committee, which was activated in August. The compliance committee consists of the vice president-general counsel, vice president-controller, vice president-taxes and director of internal audit. The committee meets independently to review all representations from the business units and key leaders, then reports on those documents to the CEO and the CFO.

In addition to his substantial efforts to reinforce good governance and disclosure, Millay is shifting the focus of Airgas' finance function from transaction processing to strategic support with a new shared services center in Delaware. "We had 20 locations where we did finance administration. The center will allow us to take these transactional processes from the operating units so they can focus on serving customers. It also allows us to increase control and governance," he notes.

Millay says that he is spending more time on governance and disclosure issues, which he considers essential. "This focus is closely tied to our growth strategy," he explains. "Good governance, and the perception and understanding of good governance, are important to our growth strategy. The market's confidence in our governance is essential to attracting capital."

The role of the audit committee is also expanding at R.R. Donnelley, the Chicago-based integrated communications services company with annual revenues of $5.3 billion. "Greater audit committee involvement was prompted by a variety of issues that came to light in other companies," reports Gregory A. Stoklosa, CFO. "It is clear that we need a broader approach to evaluate the risks to the value that we can and should create for our shareholders. It was also a response to issues surrounding the transformation of our company. For example, do we have the right control measures in place as we redesign processes within the company? Is the execution correct? The audit committee will be more involved in developing our overall framework for risk management. In addition, it will be more involved in our earnings announcements and disclosure on a quarterly basis."

In August, the company created a new disclosure committee consisting of the CEO; CFO; treasurer; controller; general counsel; and heads of internal audit, investor relations and communications; together with the audit committee and Deloitte & Touche, Donnelley's external auditor. "Although these parties have traditionally reviewed disclosure, the committee formalizes the process," Stoklosa says. The committee will meet before all quarterly disclosures and assist with CEO and CFO certifications as well as the audit committee's review of disclosure.

Disclosure and communication changes are also under way at PeopleSoft Inc. in Pleasanton, Calif. CFO Kevin T. Parker believes, "It is incumbent that CFOs create a forum for dialogue with shareholders beyond financial statements. We will be doing more conference calls and conferences to talk directly with investors about their concerns and answer their questions in an open and candid environment. Transparency is about accessibility and availability to discuss the issues that are on shareholders' minds."

Parker and PeopleSoft's general counsel are also looking at any exceptions to the company's standardized business practices and reviewing potential risks associated with those exceptions. "We are creating a sense of awareness about these risks that is absolutely elevated from a year ago," Parker notes.

Moving Through the Downturn

With slim prospects for rapid revenue growth, many CFOs are shifting their attention to cash flow, profitability and return on capital. "The economic environment is very uncertain," Parker says. "While we saw a decline in revenues in the first half of 2002, we have seen higher profitability on lower revenues, and our strategy will remain focused on improving internal processes for greater profitability and increasing efficiency regardless of top-line results." Like many CFOs, Parker is developing an "A budget" that assumes an ongoing downturn and a "B budget" based on recovery.

At SAP North America, the Newtown Square, Pa.-based unit of the German software giant, CFO Mark White says that heading into 2003, "our priority may not be revenue growth but market share. Revenue is no longer the end-all." In August, the company instituted a new approach to risk management that provides greater clarity for reporting and disclosure and better financial control in unsteady markets. "We instituted a new policy plus systems and processes to approve customer proposals," White reports. "We have established professional service agreements with customers and upgraded our customer relations management to achieve greater visibility into the status of the deals. We've also tightened payment terms."

At Phoenix-based electronic components distributor Avnet Inc., 2002 revenues of $8.9 billion reflect a second tough year. "The current economic and industry environment represents the single greatest challenge at Avnet today and for the larger business community as a whole," says Raymond Sadowski, CFO. As the company moves into 2003, finance has several key roles to play. "Our most significant role comes in migrating Avnet from a sales-and-profit or net income culture to a return-on-capital-employed culture," Sadowski explains. "We are communicating this through an employee training program called 'Driving Value,' which addresses return on capital." In addition, Sadowski and Avnet's vice president for investor relations are teaching a finance course for the company's management.

Fortune Brands Inc., the Lincolnshire, Ill.-based consumer products company with $5.5 billion in annual revenues, launched significant restructuring initiatives three years ago to fortify the balance sheet ahead of the inevitable downturn. "Upgraded supply chains are reducing costs and increasing customer service levels," says Craig Omtvedt, senior vice president and CFO. "At the same time, we're further strengthening the company by reinvesting savings from our cost takeout to build our leading consumer brands and grow the top line. The result of our investments is that several leading brands are gaining share." Inventory improvements in 2001 helped generate free cash flow well above targets, and significant strategic alliances along with the sale of a lower-return business generated additional cash to cut company debt.

"We'll continue our sharp focus on taking cost out of our operations and maximizing efficiencies," Omtvedt says. "That means reducing materials costs through joint purchasing and managing vendor relationships. It means continuously improving manufacturing processes with productivity goals against which we'll measure performance. And it means promoting efficiency with continued investment in equipment upgrades."

Pushing Global Growth

Rapid expansion into foreign markets saved some U.S.-based companies from the full force of the U.S. contraction, and many organizations plan to push investment abroad in 2003. Almost 40 percent of PeopleSoft's licensing revenues are generated outside the United States, up from 15 percent two years ago. Avnet pulls 41 percent of its revenues from outside the Americas, up from 25 percent two years ago. "The region with the fastest growth is Asia and specifically China," Sadowski says. "We've completed a number of major acquisitions in the past few years, and it is now time for us to accelerate our strong focus on leveraging our scope and economic scale to generate higher returns on capital."

R.R. Donnelley moved into China almost a decade ago with a facility in Shenzhen, and the company is completing a second plant in Shanghai. It continues to target less-developed regions where growth is strong and competitors are less entrenched. "When we went into Poland in the mid-1990s, we caught the wave of growing demand for high-end magazines and rode that growth," says Stoklosa. "The economy in China is growing 8 to 10 percent a year, and the fundamentals are strong, much like Poland in the mid-1990s. It does not have the fragile infrastructure or polarized economies of Latin America, so it is a much stronger environment." Although only 10 percent of Donnelley's revenues are generated outside the United States, Stoklosa spends a disproportionate amount of his time on foreign operations, especially risk management issues. He concentrates on cash flow and the structure of joint ventures and customer contracts, with an emphasis on managing currency risks.

Diebold Inc. faced market saturation and recessionary conditions in the United States in 2001 and 2002 but scored strong revenue growth by concentrating on core opportunities and global market share. The company, which produces ATMs and other self-service delivery systems, derives almost 50 percent of its $1.8 billion in annual revenues from foreign markets, up from 20 percent just three years ago. Diebold is also consolidating its move into voting machines, which share commonalities with ATMs. Gregory T. Geswein, CFO of the Canton, Ohio-based corporation, says that Diebold is "looking at core acquisitions around the globe and complementary acquisitions, such as in our continuing move into voting."

With manufacturing operations in relatively high-risk locations such as Argentina, Brazil, China and India, Diebold is updating some risk management practices, including foreign exchange and interest rate exposures. "We are seeing huge growth for ATMs in China and India as they move up the development scale," Geswein says. Although political tensions in India remain extremely high, Geswein is unconcerned. He believes that "the political risk in India is more a perception than a reality. India is a market that understands business acutely and is growing. We won't be backing off."

Upside to the Downside

For some companies, there is an upside to the downside: For those that survive the shakeout, the competitive landscape will be less cluttered. "On a longer-term basis, we see a trend that customers want to buy from large, well-established vendors that can supply them globally," PeopleSoft's Parker notes. "People are flinching away from the smaller, less-established companies. The great shakeout in IT will continue into 2003." Airgas' Millay is also pursuing "what we should be doing to leverage our market leadership position while times are tough. For example, we recently made a large acquisition. This is a tough environment, but it gives us opportunities that we might not have had otherwise."

The upside of the economic downturn is also apparent in the governance arena, where some companies shine a little brighter in comparison with those that have faltered. R.R. Donnelley's Stoklosa believes that the general decline in investor confidence in the United States has had a positive effect on Donnelley's stock price. "We have a very long and conservative history and have always been very frank with our investors and analysts. It's hard to fake cash flow," he says.

The ongoing economic downturn is helping drive the new emphasis on governance and disclosure. Like many companies, SAP focuses much more nowadays on cash flow and profitability and less on the top line. For all companies, "the new focus will benefit governance," says White. "When people chase high revenue growth to drive the stock price, it has a negative impact on governance." With a year of investor rage and economic recession forcing changes in governance, disclosure, internal processes and operational efficiencies, the corporate world may emerge as a better place when recovery finally restores growth. But until then, CFOs have their work cut out for them.