Mid-sized Companies Increase Capital Spending

The American economy is on the upswing. Despite rising prices for fuel and commodities such as corn and coffee, the stock market is climbing, consumer incomes are up and factory production has increased for the last few months.

Mid-sized companies’ capital equipment spending also is on the upswing as a result, a marked difference from even a year ago.

New equipment purchases were up 28 percent in February from the previous year, according to the latest statistics available from the Equipment Lease and Finance Association, a trade organization for the $521 billion equipment finance industry. Purchases began climbing in December 2010, when companies bought $9 billion in new equipment, a 27 percent increase from 12 months earlier, says Bill Choi, ELFA vice president of research and industry services.

A majority of ELFA members believe good times are here to stay. More than two thirds (67.5 percent) of members responding to the organization’s March confidence index said they believed business conditions would improve over the next four months, up from just over half (55.3 percent) in February. When it comes to the short-term climate for spending, "Most of our members are very cautious, but they're cautiously optimistic," Choi says.

Corporate executives expect spending on capital expenditures to continue. According to CFO Magazine’s March 2011 quarterly business outlook survey, compiled by Duke University’s Fuqua School of business, U.S. public and private companies expect capital spending to increase 12.1 percent during the next year, compared with a pace of 8.9 percent in February 2010.

Investing for the Future
Satellite Industries is among the mid-sized companies spending again. The $50 million maker of portable toilets used by construction companies recently spent $350,000 upgrading and purchasing molding tools, and an undisclosed amount acquiring a large supplier. The 50-year-old Plymouth, Massachusetts, company also plans to spend $200,000 on computer equipment and software in 2011, according to John Babcock, Satellite’s vice president of finance.

"We have always been a cash conservative company," Babcock says. “Our philosophy is to save cash for recessions and then make strategic investments when the economy is ripe.”

Satellite put that strategy into practice in the years leading up to the recession. When other companies were spending freely, Satellite trimmed costs. “We cut travel, entertainment, professional services. We even bunked together on business trips,” Babcock says.

The company made a strategic acquisition in 2007 at the start of the downturn, but otherwise kept operations lean and held cash in reserves. As a result, although revenue dropped 40 percent in two years, the company stayed in the black.

During the recession, Satellite was able to maintain a strong bank line of credit for working capital, and relied on an American Express corporate card for capital expenditures and other purchases, Babcock says. “We not only got the float on the cash, but we got miles that we used for corporate travel.” By his reckoning, Satellite collects about 1 million points on its corporate card annually, which pays for about 40 round-trip plane tickets.

With the economy improving, Satellite is back in orbit. Although rising prices for fuel and plastic resins have affected the company’s costs and customers' ability to buy, and bank lending hasn’t returned to pre-recession levels, Babcock still is confident. “I am very optimistic about 2011,” he says.

Selective Spending
Timothy Zappala, a partner with Arsenal Capital Partners, a New York City private equity firm, sees a similar wary confidence this year. He believes companies will spend selectively on equipment purchases that will “make new products, expand existing capacity or improve productivity.”

One company in a portfolio of eight manufacturing concerns that Arsenal invests in is doing just that. Novolyte Technologies, a Cleveland-based maker of specialty electrolyte materials, is buying reactors, blend vessels, buildings and instrumentation to meet anticipated higher demand for lithium ion batteries for electric and hybrid vehicles.

Two years ago, companies in Arsenal’s manufacturing portfolio cut capital expenditures to 25 to 50 percent of what they had been in previous years, with purchases focused on plant repairs and other required maintenance items, Zappala says. Last year, as demand for their services rose, the companies increased spending to between 50 percent and 75 percent of what it had been prior to the recession.

This year, Arsenal’s portfolio companies will spend about three-quarters of what they did in 2007, a spending level that Zappala says has become the new normal. “The companies will be very careful to not increase spending and hiring ahead of economic improvement,” he says. In addition to higher cap-ex spending, the firm’s portfolio companies are also starting to rehire for vacant positions, he says.

Poised to Take Advantage of the Upswing
Some companies made strategic capital expenditures during the recession and are poised to take advantage of the upswing because of it.

Rudy's Tortillas, a 66-year-old family business with 300 employees and $39 million in annual revenue, felt the recession as much as anyone. The Dallas-based tortilla wholesaler sells primarily to restaurants, businesses that were battered during the recession. "People were afraid to go out to eat," says Louis Guerra, the company’s CEO.

When times were tough, Rudy's Tortillas didn't lose customers, but orders dropped. The company made up for it by going after regional and national restaurants it previously hadn’t sold to. “The whole goal was to stay level and hope for a turn, so our existing business would improve,” Guerra says. “Now we're starting to see that business has improved, and now we're ahead.”

During the past two years, Rudy’s Tortillas spent $8.5 million on capital expenditures, including $3.5 million on food-processing equipment and $750,000 on enterprise resource planning software. This year, Guerra is looking to invest in equipment to expand the company’s fried tortilla chip line, as well as making other facility improvements.

“A lot of people hold onto cash, fearful of investing,” Guerra says. “But the smartest thing we did was continue to invest back in assets that would improve our business. I think the moment we stop reinvesting in ourselves, we start really going backwards.”