1. - 1 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved VALUE MANAGEMENT PAST, PRESENT, & FUTURE (A WORK-IN-PROGRESS) Financial Management Association International Denver, Colorado October 9, 2003 By Rawley Thomas President LifeCycle Returns, Inc. Rawley@LCRT.com

2. - 2 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat THE CONCEPT OF VALUE MANAGEMENT THE CONCEPT OF VALUE MANAGEMENT A strong correlation exists between enterprise value and the spread between CER (cash economic return) and cost of capital Econometric DCF models can be built and validated against historical data to quantify this correlation and identify the key operating drivers which most significantly impact value Managements can use these models to analyze their own corporate performance and to improve their decision making and value generation Portfolio managers can use these models for buy / sell decisions

3. - 3 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat FUNDAMENTAL PRINCIPLES

4. - 4 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat BASIC CONCEPT OF THE LIFECYCLE VALUE MANAGEMENT MODEL Utilization of economic cash flows and current asset valuation allows investors and managers to avoid wrong investment decisions based on historical accounting measures

5. - 5 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat SOPHISTICATED INVESTORS CAN APPLY THE SAME CASH RATE OF RETURN CONCEPTS TO BOTH CORPORATE AND COMMON STOCK INVESTMENTS BECAUSE … Corporate InvestmentCommon Stock Investment Internal Rate of Return of Cash-Out and Cash-In Flows Return on Investment Purchase Assets Liquidate Assets Gross Cash Flow Sell Stock Purchase Stock Dividends Return on Investment Geometric Mean of Annual Returns Assuming Dividends Reinvested at the then Price.

6. - 6 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat MOST ASSETS PRODUCE A NEARLY LEVEL USEFUL OUTPUT UNTIL FAILURE, INSTEAD OF THE STRAIGHT LINE OR THE DECLINING BALANCE CURVE REFLECTING DEPRECIATED PLANT Output Time (2) Most Assets Produce Nearly Level Output… Until Failure (1) Constant Output = Constant Dollar Level Annuity Economic Life (3) Straight Line Depreciation Net Plant (4) Accelerated Depreciation Net Plant Failure (One Horse Shay) (Economic Value Added Implicit Assumption)

7. - 7 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat ECONOMIC VERSUS ACCOUNTING ANNUAL PERFORMANCE MEASURES In order to accurately reflect asset productivity, economic measures should assume constant dollar level annuities of cash flows In contrast, traditional accounting measures, like RONA (Return On Net Assets), do not reflect the reality of asset utilization. They only reflect the IRR of the underlying project, when the output declines linearly.

8. - 8 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat TRADITIONAL ACCOUNTING MEASURES FIRST UNDERSTATE AND THEN OVERSTATE ECONOMIC RETURNS AS ASSETS AGE (ASSUMING CONSTANT OUTPUT = CONSTANT DOLLAR LEVEL ANNUITY) (A DESIRED ANNUAL PERFORMANCE MEASURE REFLECTS THE PROJECT IRR) NOTE: The Annual CER each and every year precisely equals the IRR of the project. -$10,000 PROJECT $1,740 Life = 8 Years IRR = 8.00% Annual Performance Measures of Project Year 12345678 Income490 Depreciation1,250 Gross Cash Flow1740 Gross Plant10000 Accumulated Depreciation125025003750500062507500875010000 Net Plant87507500625050003750250012500 Return on Net Assets = RONA = Income/Net Plant5.60%6.53%7.84%9.80%13.07%19.60%39.20%∞ Cash Economic Return (CER)8.00% Difference-2.40%-1.47%-0.16%1.80%5.07%11.60%31.20%∞ Return on Gross Assets 17.40%

9. - 9 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat CASH ECONOMIC RETURN REFLECTS THE AVERAGE INTERNAL RATE OF RETURN OF ALL THE PROJECTS IN PLACE Cash Economic Return Existing Projects

10. - 10 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat EMPIRICAL SUPERIORITY OF CASH ECONOMIC RETURNS (CER’s) Source: See http:\\ HOLTValue.com. CFROI ® is a registered trademark of CSFB HOLT Value Associates. R2R2 P/E versus E.P.S. Growth0.06 Price/Book versus ROE Spread0.39 Value/Cost versus CFROI ® Spread 0.65 See Also: John D. Martin and J. William Petty, Value Based Management: The Corporate Response to the Shareholder Revolution, Harvard Business School Press, Boston, ©2000 and Bartley J. Madden, Cash Flow Return on Investment Valuation: A Total System Approach to Valuing the Firm, Butterworth Heinemann, Boston, ©1999.

11. - 11 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat APPLICATIONS

12. - 12 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat SPREAD SWITCHES CHANGE DECISIONS % A Old Plant Trap: Expand Low Return Business B New Plant Trap: Divest New Plant C Goodwill Trap: Starve High Return Business RONA Hurdle CER Hurdle RONA – Return on Net Assets CER – Cash Economic Return

13. - 13 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat IMPROVED MEASUREMENTS (PORTFOLIO) GREATER INSIGHTS SUPERIOR DECISIONS Portfolio Applications TraditionalLCRT Framework CER (Cash Economic Return) E.P.S.RisingPurchaseCERDecliningSell P/ELowPurchaseCER< Cost of Capital and Growing Sell E.P.S.LevelAvoidCERRisingBuy

14. - 14 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat IMPROVED MEASUREMENTS (CORPORATE) GREATER INSIGHTS SUPERIOR DECISIONS Corporate Applications TraditionalLCRT Framework RONA (Return on Net Assets) onCER (Cash Economic Return) on New PlantLowDivestNew PlantHighExpand Old PlantHighExpandOld PlantLowRestructure With Goodwill LowRestrict Investment Without Goodwill HighExpand Aging PlantIncreasingReward Management Aging PlantDecreasingInstall New Management ValuationPerpetuity of Cash Flow Over-value High Return Firms Under-value Low Return Firms Regresses toward corporate mean Valuations not systematically biased high or low

15. - 15 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat THE LIFE CYCLE OF THE AVERAGE FIRM Growth Phase Decay from Drop-Outs Due to Acquisition & Bankruptcy Investors price for these expectations in Firms’ life cycles and associated cash flows. Corporate Average Start-Up Growth Phase Surviving Mature Firm Fade

16. - 16 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat CROSS SECTIONAL RESULTS DISPLAY COMPANIES AT THE CURRENT STAGE OF THEIR LIFE CYCLE CER Fade-to = 9.1 Median = 4.8 CER = 9.1 - 35.1/GI^.4 Best Fit Line Using Least Absolute Deviations N = 5,513 Non-Financial, Non-Utility, Non-Real Estate Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

17. - 17 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat VALUATION: SIMPLE DISCOUNTED CASH FLOW PRESENT VALUE PRINCIPLES Since the corporate rate of return of 20% exceeds the investor’s discount rate of 10%, the price of $109 exceeds the $100 cost of the Gross Investment. Gross Investment Time 0Time 1 $100 $120 Value $109 $20 Gross Cash Flow 20% Return

18. - 18 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat KEY VALUE MANAGEMENT OBJECTIVE FUNCTIONS AND HOW TO MEASURE THEM FOR SINGLE COMPANIES AND ACROSS LARGE UNIVERSES (“What Gets Measured Gets Done”) Corporate Managers – Explain Current Stock Price Level Investment Managers – Predict Future Stock Price Change

19. - 19 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat AN INTRINSIC VALUE CHART ENABLES US TO VISUALIZE THE MEASUREMENT OF ROBUSTNESS AND ACCURACY OF A DCF MODEL PRICE LEVEL USING ONLY ACTUAL REPORTED FINANCIAL DATA AND THE SAME GLOBAL PARAMETERS ACROSS THE ENTIRE UNIVERSE TO DRIVE A MECHANICAL LIFE CYCLE FORECAST OF CASH FLOWS FOR EACH COMPANY Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

20. - 20 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat AN INTRINSIC VALUE CHART EXTENDS TO MEASURE THE ROBUSTNESS AND ACCURACY OF EXPLAINING CONCURRENTLY CAPITAL GAINS (PRICE CHANGE) FROM THE VALUATION MODEL Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

21. - 21 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat AN INTRINSIC VALUE CHART FURTHER EXTENDS TO MEASURE THE ROBUSTNESS AND ACCURACY OF PREDICTING CAPITAL GAINS FROM MODEL VS. ACTUAL DIFFERENCES Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

22. - 22 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat GLOSSARY OF KEY MEASUREMENT TERMS Measurement Types – Maximum of 10 Years – Robustness - % of company years for each firm where the model calculates a valid answer – Ideal is 100% Valid answers can be negative Rates of change (e.g. EPS growth rate) where the divisor is negative are not calculated and treated as zero robustness for that year – Accuracy – geometric mean % error between the model value and the actual value – averaged over 10 years maximum; non- robust company years are excluded; absolute error or signed error as separate measures – like golf, lower scores are better Measurement Applications – Maximum of 10 Years – Explanatory Price Level: Model Price versus Actual Price – Explanatory % Capital Gain Return (CG) – Annual Model CG versus Actual CG Concurrently – Fiscal Year -9 Months to Fiscal Year +3 Months to allow for disclosure lags’ effect on prices – Predictive % Capital Gain (CG) – Annual Predicted Model CG versus Actual CG – Fiscal Year +3 Months to Fiscal Year +15 Months to allow for disclosure lags’ effect on prices

23. - 23 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat APPLICATION OF ROBUSTNESS AND ACCURACY MEASURES TO THREE SIMPLE TRADITIONAL MODELS 8 X EBITDA – Represents ~average market multiple – Benchmark for “explaining” valuation price level – % Spread with actual price level used to “explain” and “predict” % Capital Gains EPS Growth – Traditional variable used to “explain” and “predict” % Capital Gains – By itself, no way to “explain” price level Cash Flow Per Share Growth – Similar to EPS Growth, but based on (Net Income + Depreciation) / No. Shares Outstanding Sample is drawn from about 8,500 industrials, excluding financials and utilities

24. - 24 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat ROBUSTNESS AND ACCURACY MEASURES APPLY TO WHOLE UNIVERSES TO ASSESS THE USEFULNESS OF VALUATION APPROACHES (With no “plugs,” the range of errors is very large!) % CAPITAL GAIN EXPLANTORY EPS Growth Cash Flow Per Share Growth 8 X EBITDA EPS Growth Cash Flow Per Share Growth Conclusion: 8 X EBITDA is superior on both robustness and accuracy dimensions Like golf, lower scores indicate more accuracy. Ideal is 100% Robustness N~5,000 Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

25. - 25 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat % CAPITAL GAIN PREDICTIVE 8 X EBITDA EPS Growth Cash Flow Per Share Growth Conclusion: Again, 8 X EBITDA is superior over both EPS and Cash Flow Per Share Growth. Cash Flow Per Share Growth dominates EPS Growth. NONE of the methods is robust over the entire universe. 8 X EBITDA Cash Flow Per Share Growth EPS Growth Like golf, lower scores indicate more accuracy. Note: 35-40% of the Universe is NOT covered by these measures, because growth cannot be calculated off a negative number. Ideal is 100% Robustness N~5,000 Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

26. - 26 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat ADVANTAGES OF THE LCRT ROBUSTNESS AND ACCURACY MEASURES Don’t depend on the distribution and don’t assume Gaussian Normality Cover the entire universe and all company years without “fudging” outliers with elimination or winsorization Measure two very important separable dimensions of “goodness” – Lack of robustness usually occurs when attempting to calculate a change off a negative number Summarize very large amounts of time series and cross sectional data on two simple charts Display more complete information on individual firm years for total universes than traditional back-tests which focus on average returns for portfolios of companies

27. - 27 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat LCRT’S RESEARCH METHODOLOGY CONTRASTS SHARPLY WITH THE TRADITIONAL VALUATION APPROACH Traditional Approach Forecasts 3-10 Years of Cash Flows Applies Perpetuity or Multiple for Terminal Value Discounts to Present (plan valuation) Implicitly assumes the structure and parameters of the terminal valuation are robust and accurate or “plugs” the parameters to explain current price LCRT Methodology Employs actual data to empirically test robustness and accuracy of valuation models and parameters Extends the best models to use as terminal values in traditional plan valuations May eventually test the best models with forecast security analyst data

28. - 28 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat SEVERAL PROFESSORS ARE COLLABORATING WITH LCRT TO DETERMINE THE ROBUSTNESS AND ACCURACY OF TRADITIONAL MODELS AS NULL HYPOTHESES Adam Gehr of DePaul – Dividend Discount Models Sally Webber of NIU, Jim Wallace of Clairmont, and Doug Clinton of NIU – EVA ® or Residual Income Models – Feltham-Ohlson Model

29. - 29 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat HAVE YOU EVER WONDERED WHY PRACTITIONERS EMPLOY P/E MULTIPLES AND EPS GROWTH INSTEAD OF MORE THEORECTICALLY CORRECT DCF MODELS? EVA ® Model 8 X EBITDA E.P.S. Growth CER Momentum Hypotheses to Test with Professors: As illustrated by the chart at left, most traditional DCF models may be 2 X to 5 X less accurate than simple multiples, thus explaining practitioner preferences for multiples over DCF models for actual practical application.

30. - 30 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat FOR EXPLANATORY PRICE LEVELS, LCRT’S LIFE CYCLE MODEL IS ABOUT AS ROBUST AS 8 X EBITDA, BUT MORE ACCURATE (EPS AND CASH FLOW GROWTH DON’T PRODUCE PRICE LEVELS) 8 X EBITDA LCRT N=7,713 8 X EBITDA N=7,566 Like golf, lower scores indicate more accuracy. Ideal is 100% Robustness Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

31. - 31 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat FOR % CAPITAL GAINS PREDICTIVE, LCRT’S LIFE CYCLE MODEL IS SUBSTANTIALLY MORE ROBUST THAN 8 X EBITDA, BUT SOMEWHAT LESS PREDICTIVE. HOWEVER, 8 X EBITDA YIELDS NO INSIGHTS ON CORPORATE ECONOMIC PERFORMANCE OR BALANCE SHEET EFFECTIVENESS 8 X EBITDA LCRT 8 X EBITDA N=5,157 LCRT N=7,362 Like golf, lower scores indicate more accuracy. Ideal is 100% Robustness Note: 35% of the Universe is NOT covered by 8 X EBITDA. Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

32. - 32 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat A BETTER EXPLANATORY MODEL IS MORE PREDICTIVE R 2 = 0.473 N = 2,752 OLS Least Absolute Deviation LCRT Intrinsic Value Model These results support the intuition of HOLT’s clients, who in the late 1980’s said, “I only employ the model for buy/sell decisions when it tracks well.” “Few strokes separate the best from the worst professional golfers.” Like golf, lower scores indicate more accuracy. This chart violates the instantaneously efficient market hypothesis. It represents an “anomaly” consistent with behavioral finance theory. Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

33. - 33 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat A FINAL THOUGHT We practitioners and academics still have a long way to go to improve the robustness & accuracy of DCF valuation models and their predictive value! Stay tuned.

34. - 34 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat EXTRA SLIDES

35. - 35 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat N = 4,598 Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns N = 4,598

36. - 36 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat N = 6,273 Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

37. - 37 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat LCRT Source: Financial Data from Simplystocks and Calculations from LifeCycle Returns

38. - 38 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat A RELATIVE WEALTH CHARTS ENABLES A STRATEGIC ASSESSMENT OF A FIRM’S HISTORICAL PERFORMANCE

39. - 39 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat BACKGROUND Terry Heiland Co-founder, Senior Vice President Systems Development LifeCycle Returns, Inc. 35 years data processing experience Taught advanced database design Founded Micro-Visions, Inc. in 1982 Developed HOLT/Val Product (1985-1997) Developed HOLT LP Value Search Product (1991-2001) –Database design –Fast Search Capabilities –Graphic Presentations –Intuitive User Interface Design

40. - 40 - LIfeCycle Returns, Inc. © 2003 All Rights Reserved FMA Denver 10-9-03 Rt cat BACKGROUND Rawley Thomas Wesleyan University, BA 1968 (Chemistry and Economics) Carnegie-Mellon University, MSIA 1970 (Industrial Administration/Finance) SuperValu Stores (1970-81) Callard, Madden & Associates (CMA) (1981-85) Co-Founder HOLT Planning (HOLT) 1985-1991 Director of Research, Boston Consulting Group (1991- 2002) Previous Practitioner Director Financial Management Association International (1998-1999) Advisory Boards – DePaul Finance & Northern Illinois Accounting