Ingemar Lanevi: So, the primary, if you want to sum it down into one statement only, it really comes back to cash flow. It’s the fundamental reason for why I personally believe using leasing as a way of acquiring your technology makes the most economic sense.

It’s an asset that everybody knows it completely depreciates in value. It’s like buying a car. As soon as you drive it off the lot, you drop X percent in value. It’s pretty much the same thing with high-tech equipment.

There is a continuous evolution of technology. It gets better and faster and smarter and more efficient on a daily, monthly, yearly basis.

And cost keeps going down through the floor.

So, it clearly, to me, shows that there is a strong indication or a will, if you wish, that owning something like that really, truly doesn’t make any sense at all. Because it doesn’t retain its economic value over a longer period of time.

So, my whole premise is, why should I spend expensive capital up front to acquire that piece of plastics/metal type of thing that, again, and I know full well that in three years, four years, whatever the time frame is, it’s going to be worth less and really have no real return to me at that point in time.

Granted, I’ve gotten value out of being able to use it over its life, but I can find other ways to pay for that usage benefit by doing another alternative in terms of acquiring it, and that’s where the lease comes into play in my mind.

And if you take it one step further, if you look at how companies are being valued today by analysts and more serious investors, it’s starting, and has been for now a couple of years, driving the valuation mechanism more towards a cash flow approach.

The more we put new accounting rules in place that are non-cash in nature, the most recent one that came out was obviously the stock option expensing, which in and of itself is a complete non-cash expense that companies have to take to the GAAP accounting statements.

So when you look at an EPS number, you really are not looking at a true comparison to what really has been earned by this entity that is available for the common shareholders at the end of the day.

So, people are moving more towards a cash-flow matrix, looking at cash flow as being more of the way to value the company. And they do the same kind of matrices where they take the free cash flow per share and then do multiples on that.

And that’s how they come up with a valuation in terms of whether a company’s doing a good job or a bad job in terms of generating value to the shareholders.

And, again, if you look at the leasing transaction in itself and what that actually brings to the table with regards to free cash flow, there’s a double whammy.

There is, one, that the monthly lease payment, typically, if it’s a hardware-based solution, there is a fair market value transaction that you do on the lease. Which typically means that the residual value in the transaction is something that you, for lack of a better word, you outsource to the leasing company.

So, you don’t retain the residual risk anymore. You basically push that over to the leasing company. It’s for them to worry about: what they’re going to do with that at the end of the lease term.

And that, in and of itself, will drive a lower monthly payment versus a cash purchase where you depreciate the asset (again, presume it is the same term) over three years. The lease payment will be lower on a month-by-month basis. On an undiscounted basis, it will be lower cash flow out the door.

So that means your cash flow operations will be a higher number and therefore drive a positive cash flow impact to the cash flow analysis that I just went through.

The second piece of the puzzle is, again, since you did not have to spend the CAPEX, and the capital up front to buy the IT asset, that is the second component that goes into the free cash flow calculation.

It takes the cash flow operation, backs up the CAPEX expense for quarter, and that’s how you get the free cash flow number.

So, by not spending the capital, obviously my deduction becomes a smaller deduction and therefore, again, it pushes my free cash flow number to a higher number.

Both generating, again, significant value from a free cash flow per share metric that, again, a lot of analysts are really looking at in terms of value in a company.

In our “how-to” article in this issue, we explore the challenges and problems facing companies at the End of Term and explain How to Fix Poor End of Term Performance. The first step revolves around clearly articulating and communicating to internal stakeholders why your firm leases equipment.

The biggest threat to the economics of a lease, in which the lessor has taken a meaningful residual, is mismanagement at the end of the lease term. In the worst case, poor End of Term (EOT) management can lead to evergreen payments, in which the lessee misses the lessor’s notification deadline or fails to return the equipment on time and continues to pay for the equipment on a month-to-month basis. It can also lead to forced buyouts, double payments in the refresh cycle, and sub-optimal financial decisions. In this article, we explore why companies mismanage the EOT process and then examine the many tactics, techniques, and tools that companies can use to improve their EOT performance.

“I Don’t Have the Time or Resources to Return Equipment On-time”

No one likes another deadline added to their plate. Many equipment managers and users inside Fortune 1000 companies view returning equipment at the end of the lease term as a burden – an artificial deadline imposed by management with no direct benefit to them. Equipment managers often argue that they do not have the resources to decommission equipment at the end of term or manage the logistics of the return and refresh on schedule. They would prefer to continue using the equipment until the end of its life without considering the expiration of the warranty, the costs of maintenance, and other factors that increase total cost of ownership, until the equipment either is no longer useful or breaks and must be replaced.

Users miss return deadlines for a variety of reasons. Some users become attached to their machine, such as a car or a PC, and are reluctant to give it up and learn to use a new one; some consider their other responsibilities to be more important than dealing with return tasks; and some just ignore the issue or procrastinate.

Human behavior is difficult to predict, control and incent. Resistance to returning equipment on time is natural given how busy many people are, especially during a recession when headcount cuts have resulted in everyone having to do more with less. However, human nature aside, most people will comply with a request to return equipment, if given the chance – and a little help from their firm. The truth is most firms don’t give their equipment managers and users that chance.

Can’t Find Equipment; Don’t Know EOT Options

Many companies fail to track equipment during the lease term and can’t find it at the end of term. They don’t know where the equipment is or who is using it. If they can’t find it, they can’t return it. Even if they know where the equipment is, some companies do not track the date they are required to notify the lessor of their EOT intentions or they neglect to follow up. Many companies also don’t track their return options, which can vary widely. So, when the EOT arrives, they can’t perform the economic analysis to determine which option is best.

Zombie Portfolio and Evergreen Payments

The decentralized nature of a business can inhibit a company’s EOT performance. In many large companies, leasing is a decentralized, local activity in which buyers engage and select lessors on their own, resulting in a cornucopia of EOT provisions. In highly diversified businesses, with several lines of business, a decentralized approach to leasing addresses the fact that each line of business has different equipment needs and financial dynamics. In other cases, businesses have grown through acquisition and each acquisition brought with them their own approach to leasing. In a decentralized environment, EOT performance depends exclusively on local management and execution, which has many competing priorities. If the local manager responsible for tracking the EOT leaves the company, quite often the relationships and understanding of the EOT process goes with them, resulting in an unmanaged, zombie portfolio that rolls into evergreen payments – a lessor’s dream come true.

In the sales process, every lessor will pitch their strong EOT support for lessees. Many attempt to differentiate themselves here with their superior capabilities, especially their website, and customer support. In practice, for many lessors, nothing could be further from the truth. Many of them want evergreen payments. These payments are critical to the Return on Equity and Return on Asset metrics, which are key to their business model. If you believe the upfront sales pitch, prima facia, that the lessor will make it easy for you at the EOT, you may be sorely mistaken. Even if the stated intention of the Lessor is truthful, administrative difficulties in addition to system and staff turnover issues can create problems for the lessee at EOT. As I explain below, lessees need to take matters into their own hands.

Buy Out Everything

In order to avoid evergreen payments, some executives at large lessees will simply adopt a policy to buy out every lease when it comes to term if the equipment is not returned on time. If the leases were originally negotiated with caps, this approach, although crude, can still yield benefits if the Present Value of total payments, including the buyout, does not exceed the original cost. It is certainly better than a zombie, evergreen portfolio. However, it avoids dealing with the root of the problem – the broken return process. Worst of all, it leaves money on the table.

Ambiguous Objectives and Delayed, Sub-optimal Decisions

It may be helpful to break the EOT return process down into two sequential phases (or subprocesses): decision-making and execution. In the decision-making phase, companies fail when those individuals responsible for analyzing EOT options and making a decision fail to do so on-time. Many firms lease in order to improve working capital. With this objective, the emphasis is on timely returns to ensure that the Present Value savings calculated in the original lease vs. buy analysis is protected and the lessor bears the responsibility of monetizing their equity investment in the equipment. This is true of PC leasing programs, for example. However, returning equipment at the end of the initial term may not always be the best economic decision.

For example, let’s assume a hospital leases a 64-slice CT scanner for a four-year initial term with two one-year renewal terms. Then, let’s say in year four, the physicians evaluate the next generation of equipment (a 256-slice machine), consider their EOT options, perform their cost-benefit analysis, and determine that the economics do not justify a change at the end of the initial term. However, their research indicates that the prices of the 256-slice machines will drop over the next year, shifting the economics of their analysis to favor a replacement. In their analysis, they conclude that when prices drop, migrating to the 256-slice machines will: 1) bring better information to the health care providers, improving patient care; 2) enable them to do more procedures in less time without adding staff; and 3) help the hospital to keep pace with its competitors. So, the medical community decides to schedule a refresh in 12 months – at the end of the first renewal term.

If the hospital had simply returned the equipment on time at the end of the initial term and had not considered their EOT options carefully, it would have resulted in a sub-optimal financial decision: they would have paid too much for the new machine by adopting it too early.

The hospital’s primary objective with leasing is to mitigate the risk of technological obsolescence. Leasing enables the hospital to upgrade or add new equipment that may hit the market with much greater flexibility when compared to a purchase.

If the hospital had purchased the equipment and depreciated it on a straight-line basis over its economic life of 7 years, replacing the old with the new equipment after 5 years would be a much more expensive decision. If the hospital could not sell the old equipment at a price that covers the remaining value, it would be forced to write off up to two years of depreciation (cost), assuming the equipment sits idle. By leasing, the hospital can capture significant savings (two years of depreciation) by returning the equipment to the lessor at the right time. The lessor then has the challenge of finding a buyer for the old equipment.

While this is just one example, many medical devices used by hospitals and many other kinds of high technology used by corporations, such as computer servers and storage and networking equipment, are subject to frequent upgrades or major improvements. Every 3-5 years there is a new generation of product. By leasing this equipment, the risk of obsolescence is transferred to the lessor, as the owner of the equipment, and, in this case, the hospital’s financial community benefits from the flexibility to respond to the future needs of the medical community and save the hospital a considerable amount of money. The challenge here is timing. When the hospital acquires the equipment, the hospital’s finance team and physicians do not know exactly when the new technology will become available and affordable. Structuring a lease with multiple return/renewal options is a useful tactic. However, it must also be recognized that if your objective is obsolescence risk mitigation, it may make sense to renew the equipment or buy out the lease even if the total amount of the payments exceeds the original cost. This contrasts sharply with the objective of maximizing working capital.

The overarching point here is that if you don’t have clarity about your objectives – why you lease – and you don’t make timely, well-informed decisions at the EOT to meet those objectives, your leasing program is likely to perform poorly.

Poor Execution Hurts Cost Savings

In the execution phase, companies fail when those individuals responsible for executing the decision (timely lessor notification of intentions, decommissioning, removal, packaging, shipping, and lessor receipt confirmation, replacement ordering, configuration, and deployment) fails to do so on-time. Even if the equipment manager makes a clear, timely decision to return equipment, if someone downstream fails to execute their role in the refresh process in a timely manner, it can result in overpayment, in which the company is forced to pay beyond the lease term. Or it could result in double payments, in which the company is forced to pay for the lease on the old equipment and the new equipment simultaneously because the cut-over takes too long.

Fixing the EOT Process

There is no silver bullet – no single trick – that will fix a broken end of term process. Rather, with a broader view of the end-to-end lease lifecycle, there are a variety of tactics, techniques, and tools you can employ to improve the EOT process, including new processes and procedures, automation, and policies.

Let’s first turn our attention to some of the “human nature” excuses for poor EOT performance discussed above. When equipment managers argue that they do not have the resources to decommission, return, and refresh equipment to meet the strict requirements of the lease EOT, be skeptical. In order to minimize operational cost, equipment managers should pursue a predictable equipment refresh strategy, whether buying or leasing. If you wait until equipment is inoperable before replacing it, then your resource allocation will be unpredictable. Where there is uncertainty and risk, there is typically cost. If the planned refresh is unpredictable, then you may likely have to increase staffing in order to manage the peaks in returns, whether purchasing or leasing. By minimizing the peaks and troughs in the return cycle, you can staff for a constant stream of equipment refreshes. Even if you purchase equipment, you still need a systematic approach to refreshing the equipment, otherwise you miss out on productivity gains and your maintenance costs will exceed the profit contribution of the equipment, as the value of the equipment diminishes and your break-fix costs increase.

Ask the Equipment Manager(s) for a Return and Refresh Plan

Equipment managers must have a coherent, planned refresh policy that is based on a predictable schedule, whether the assets are purchased or leased. If your operations teams lack competency or resources in this area, the introduction of leasing and the deadlines that go with it might be just the thing to force them to rethink their resource allocation strategy carefully to improve equipment management. This will also reduce risk and create savings in the process. If you are an IT outsourcing company (let’s say for PC desktops), you might consider charging your clients more for untimely returns – because it costs you more to support them.

Now it may be true that the equipment manager lacks resources for the refresh process. However, more than likely the equipment manager is not interested or not measured on the success of the refresh process and reduction in total cost of ownership. For example, if the engineering team in a high-tech company manages their own equipment lifecycle, it is unlikely that the responsible equipment manager is measured on the effectiveness, risks, and costs of the equipment lifecycle. Engineers are paid (and typically prefer) to spend their time designing and building things, not attending to the refresh of old equipment, especially on someone else’s schedule. However, the equipment manager may not know how to run this kind of operational process, and may need advice and training.

Ask the equipment manager making the “lack of resources” argument to give you a plan for managing the refresh process (again whether the equipment is leased or purchased). Ask them to diagnose, measure, and explain with data why returning equipment on a schedule is difficult to do. Ask them to show you a report on return performance with metrics such as the percentage of on-time return performance by each equipment user and the aging of the late returns. Finally, ask the equipment manager to analyze and explain how much the unpredictability in equipment user returns is costing the company and how much savings the company would enjoy if the EOT process, both decisions and execution, was managed like clockwork. Once you have a return and refresh plan and a sense of the savings, the equipment manager will likely be more open to leasing.

Communicate Corporate Objectives and Personal Benefits

Of course, it is imperative to communicate the objectives of the leasing program and how it benefits the company, how it impacts each budget manager, and the responsibility of the equipment managers. For example, “Our company leases medical equipment primarily to hedge technology obsolescence risk. In the event that there is a major improvement in a medical technology that our company wants to adopt in the future, if we have leased the equipment, we can save money. If leased, we can return the equipment to the lessor before the end of the economic life of the equipment and the lessor will have to monetize the remaining value in the equipment. This is important because it brings us budget flexibility, maximizes returns on our capital investments, and brings opportunities to our health care providers to improve patient care. Therefore, it is important that each equipment manager return equipment on-time.”

An effective way to communicate this message is to capture a video of your Treasurer or CFO or CIO explaining the corporate strategy and the responsibility of each user then make the video available on your intranet and send out a link to the video to all stakeholders by email.

Track the Leased Equipment Information During the Term

You can improve the EOT process by deploying software that tracks the key information for leases and leased equipment. Knowing where equipment is at the end of term makes it easier to return it. Leased equipment software will allow you to track the equipment during the term and assure that you remain in compliance with your lease. You can configure the software to send out email notifications once or twice per year requesting that equipment managers (either the financial owners or the physical users) attest to the accuracy of the information about each asset, including the equipment description, serial number, location, and General Ledger account code. This diligence and attention can result in additional benefits. For example, if equipment changes location, you can notify the lessor so that property taxes are properly collected and remitted, and insurance coverage is properly maintained for the leased equipment.

Send Automated Notifications Requesting EOT Decision

If the information about the equipment is correct, as you approach the EOT, you can configure the software to send automated EOT notifications by email. Effective notifications will include the applicable EOT options in the lease schedule and the economic analysis for each option. Ideally, the system should provide a mechanism for the equipment manager to indicate their EOT intentions (return, renew for x period, buyout). If you want to discourage renewals or buyouts, you can require an explanation or an approval step.

Use a Transparent Escalation Plan

If you want to make sure users make a timely decision, you can also include an escalation plan that is visible to them. Example: “Please respond within three days (company policy). If you do not respond within seven days, an automated notification will be sent to . If you do not respond within 14 days, an automated notification will be sent to .” If the software has access to your corporate hierarchy, it may be possible to automate the escalation process. When a supervisor is notified, they should have in the email notification all of the information that they need to follow-up with it. You may find it necessary to “nag” the equipment manager with notifications on a routine basis until they respond.

Review Aging Reports with Responsible Executives

With this kind of leased equipment management technology in place, you can generate reports that will further help you to improve EOT performance. On a weekly basis, you can generate an aging report and review it with the appropriate executives to resolve problems and devise new tactics for improving performance.

Automate the Notification of All Stakeholders in the Return Chain

When the appropriate equipment manager makes the EOT decision, you can then notify everyone involved in the execution phase of the process. Again, an effective software solution will automate this for you. You can notify the lessor about the decision and request that they prepare the appropriate documentation. If the decision is to return and refresh, notifications should be sent to the logistics coordinators responsible for physically managing the return process. In the message, you can provide them with guidance as to the appropriate workflow for the EOT process, including getting an RMA number from the lessor and instructions for packaging and shipping. The EOT process should also include a notification to the appropriate buyer to initiate the lease of the replacement equipment with the appropriate deadlines to ensure that there is sufficient overlap of the old and new equipment to bring about a timely swap while avoiding double payments. Once the equipment is shipped, you can send a message to the lessor requesting confirmation of receipt. With the sheer number of stakeholders involved in the EOT process, an effective software solution that combines automated notifications with EOT workflow will be essential to successfully navigating the rapids of EOT.

Improve and Communicate EOT Policies

Beyond the software-driven tactics, you can also use policy in a variety of ways to improve EOT performance. You can design the policy to require timely decision-making and execution, for example: “Equipment managers will receive a notification at least 120 days before the notification deadline to the lessor. Equipment managers have 30 days to make a decision about their EOT intentions for the equipment. If the decision is a return, the equipment must be decommissioned and made available to the logistics coordinator by the deadline indicated in the notification. The equipment must be shipped within three days of the end of term.”

Add Incentives or Penalties

If you want to add teeth to your policy, you can also develop financial incentives or penalties for on-time returns. For example, you could charge their budget based on the math for a purchase based on straight line depreciation over the term and then if the EOT decision and execution are carried out on-time, they can earn the savings from leasing. Or you could just keep it simple: determine who the most important manager is in each department with regard to the EOT process and give them a cash bonus at the end of the year if the return performance meets an important metric (e.g. percentage improvement over previous year or overall return performance exceeds 85%). You could make it competitive and offer the manager with the best return performance a larger bonus. In another example, you could add an internal penalty to the rental expense if the equipment manager chooses a renewal or fails to respond to the notifications and the lease goes month-to-month. If you decide to use an incentive or a penalty, you must be able to carry it out logistically and enforce it, otherwise you are introducing unnecessary complexity which may have unintended consequences.

Select Lessors Carefully and Take Control of Your Leasing Process

Regardless of what lessors tell you in the sales process, there are lessors who really don’t want the equipment back and those that really do want the equipment back. The ones that do want the equipment back, may have poor EOT data and communication processes, causing increased work and complexity for the lessee. If you really want to prevent Evergreen scenarios, a corporate lessee has to create their own processes independent of the lessor to accommodate for inadequate support from the lessor (whether intentional or not).

IBM Global Finance (IGF) and HP Financial Services (HPFS) each have a multi-billion dollar revenue subsidiary that is exclusively focused on computer component reuse, remanufacturing, and remarketing. In order to keep their operations flowing smoothly, they need a predictable stream of incoming equipment. That being said, both of these firms still have “impedance” or “friction” in their return and acceptance processes. Also, it should be clear that if any of their leases extend into evergreen payment scenarios, they do not lose money. Their remanufacturing and remarketing subsidiaries put them in a position to win regardless of how the lessee performs at the end of term.

Lessees need to place more emphasis upfront in the lease negotiation process. In addition to running a competitive process with a detailed RFP, lessees should perform due diligence on each lessor to ensure they are capable of delivering on what they promise in their proposal. Lessees should look for those lessors that do have strong remarketing and take-back reputations. Lessees should also test for reasonable return provisions and look for notification deadlines that are attainable. For example, one of the largest vendor captive lessors only makes FMV’s known 60 days prior to lease end, and then require a 30 day notification. This gives the lessee only a 30 day window to notify (60-30) them. The lessor also requires you to print out a form, tick some boxes, sign the form, and send it back to them. (By contrast, one of the large networking equipment lessors accepts a simple email as notification, a low impedence, low friction approach.) Moreover, some lessors continue with Evergreen invoicing even when the Lessee has advised them of their return or buyout intentions. These are all unnecessary steps creating an unnecessary burden on the lessee.

The point here is that you get what you inspect, not what you expect. The lessee needs to have their own independent process and controls, with step-by-step reconciliation throughout the term, in order to be in a position to scrutinize their evergreen invoicing and ensure the charges from the lessor are legitimate. If you don’t have control of your own EOT process, you won’t be in a position to manage your lessors effectively, and will likely overpay.

Equipment lessors provide a valuable financial service and can be helpful and healthy financial partners. Every lessee should want a vibrant and profitable lessor community competing for their business. However, lessees need to make sure that they take full responsibility for their own actions in a lease contract to ensure that a lessor’s profits are not achieved because of the lessee’s poor EOT performance. If you return and refresh on-time, or establish reasonable renewal terms and buyout caps to protect yourself from the unknown, you and your lessor can have a win-win relationship.

Help Your Team Perform EOT

Most employees want their company to perform well. They want to excel in their work and contribute to the company’s success. You can help them perform their responsibilities in the EOT process by clarifying the objectives and benefits of leasing, reminding everyone in the EOT process through automated notifications, giving them the information required to make timely EOT decisions, simplifying execution, and improving EOT policies. If your firm needs additional expertise or resources to implement these suggestions, you can outsource the administration of your lessee leasing process to a qualified third-party provider.

If your leasing portfolio is large and your EOT process is broken, you can generate substantial savings for your company by fixing it. With the roadmap above, you can quantify the savings, and make the internal business case. There is no longer any reason to tolerate poor EOT performance.

If you have any thoughts or feedback about this article or any ideas to contribute about fixing the EOT leasing process, please respond below. Or you can send an email to keeler@lesseeadvocate.com.

Ingemar Lanevi: So, a couple of things. Obviously it starts with a whole economic analysis and the modeling thing that I talked about. Making sure that you have an ability to articulate the cash flow value and the benefits for why a lease program is a lot better than a cash capital outlay program that you might be running today if you don’t have a leasing program in place.

It all starts with that. And, again, making sure that your executive team understands what that means and what the value of that whole thing brings.

And, again, the way that I’ve found to be the easiest way to convince people was really getting back to the budget discussion again. The way that I convinced the CIO at the time to do the first deal that we ever did, which was a service renewal, I got it done at 0 percent financing and it saved about $4,000 a month because of the 0 percent financing.

And, again, we were able to negotiate the purchase price up front that was very aggressive and the whole thing. But at 0 percent financing, again, comparing it to what he would have seen in his budget beforehand, it was a much higher number.

So, all of a sudden by just seeing that savings that I presented him with, I got him over the hump.

And he had had some bad experiences in the past with leasing where, again, he had been taken advantage of at the end of term. Things kept going. And he wasn’t informed by the leasing company and six months later he recognized that he had paid whatever: six, seven, eight months extra worth of rental payments unnecessarily.

But this is, again, why the misperception or misconception about the value of leasing comes into play.

And, again, I do; somebody may point fingers toward third-party leasing companies because again, this is typically how they try to make money. It’s all on the back end, typically.

And I think captive programs have a slightly different bias and a slightly different way of looking things that is not really about making money necessarily on the leasing piece; it’s, again, more about selling more equipment.

But, again, the way that I really saw people taking to this concept initially was when I could show the budget savings on a deal-by-deal basis, that’s really where it started resonating with the business owners.

Again, a lot of them didn’t want to listen to the economic discussion: “OK, great, it makes sense when you talk about it the way you talk about it, but I don’t really fully understand what that really means and why that’s a good thing for the shareholders.”

But the one thing they do understand is if I paid a hundred dollars before and now you’re making me pay 87, I’ll take 87 all day long.

Interviewer: So, to summarize what you’re saying, it’s a combination; you used a combination of top-down clear policy mandate, but bottoms up education about the benefits, and then inserting kind of outsourced administration and systems to make sure you never have the evergreen problem again and you’re tracking and measuring the whole time. So, those three components.

Ingemar Lanevi: Correct. Correct. So, again, going back to your original question in terms of the advice, it’s really making sure that everybody understands the value from an economics point of view, because that is, then, what forms the basis for the mandate.

I mean, you can mandate things all day long, but if you can’t support why you’re mandating something, it is hard to convince people that that’s the right thing to do. I can mandate this thing and I can back it up with hard-core numbers that says, “Here is why I’m mandating it.”

It saves us money, economically speaking, for the corporation and shareholders, and by the way, for you Mr. Business Owner, I will save your budget dollars. So, I’m hitting a lot of constituents in the process.

I get the business owners from a budget point of view. I get the executives from an overall cash flow, shareholder value point of view and that forms the basis for why I can now go and mandate this stuff.

And it has been much more accepted by the businesses as a result of that analysis, effectively.

Lastly, again, to your point, obviously making sure that you can manage this whole thing, because if it does take off like ours did, making sure you have enough people to support it is critical.

Because you don’t want to make it blow up, obviously, and have issues and mistakes and challenges because that’s a disaster just waiting to happen immediately.

So, having somebody who can help you facilitate it really helps a lot. And we’ve had great help from our outsource provider who has the system and the infrastructure in place and the knowledge and the know-how to be able to do this very well for us and has become a very integral part of my operations group, making sure that we manage this on an ongoing basis.

Having access to our internal accounting system, having access directly to our business owners, and etcetera, etcertera.

So, that’s a next phase of the whole thing that becomes very critical to making an overall leasing program internally work very well.

Interviewer: Ingemar, thank you.

Ingemar Lanevi: You’re more than welcome.

Ingemar Lanevi: Correct. Correct.

Interviewer: Even if you pay 100 percent, even maybe 101 or 102 percent of that original cost, you still get the cash-flow benefit.

Ingemar Lanevi: So, here’s another way of thinking about that. And we’ve actually seen a couple of deals with one vendor in particular right now that is offering this, which is a three-year dollar buyout lease structure at 0 percent financing.

OK, so, if you think about that, who in their right mind would not take that deal? Versus, again, let’s say it’s a million dollars. Here’s your options: Pay me a million dollars today to get this equipment and use it forever or how long you want. Or, pay me a million dollars split over three years and use the equipment for three years and after three years you pay me a dollar and you can keep on using it for as long as you want.

Anybody who understands anything about time value of money would argue that the 0 percent financing lease deal over three years is by far a better alternative than a cash deal up front, due to the cash flow.

I don’t have to spend a million dollars up front and lose the opportunity value of being able to take that one million dollars and do something totally different with it; i.e., buy back my stock and generate more value for the shareholder as opposed to spending it on buying an asset that I know is going to depreciate in value.

So if I spend a million; the way I’m looking at it, the lease and the purchase; they’re identical. There are two components in both of them. There’s a cost of funds and there’s a residual.

In the cost of funds, in the purchase you need to look at your weighted average cost of capital. That’s just because, again, you’re using the capital of the firm to expend on a purchase because you need that piece of equipment to do something for you.

But there is a cost inherent to that, because you got that from somewhere, either through your earnings or raising more stock or from issuing debt … whatever. In some mechanism; you brought the capital into the company and now you’re spending it to buy a piece of an asset.

So, there is a cost to that equation which is typically completely ignored by most corporations in the world. Very few are sophisticated enough to take that into consideration.

And, again, NetApp’s the same way. We don’t really look at the fact that there’s a cost of that; I’m trying to instill that discipline, but again, that’s something that doesn’t come natural to people.

The residual aspect of it, again, you take on all the risk on the residual side by buying the piece of asset. So, you retain all the risk on the residual. Technical obsolescence, etcetera, etcetera. You have taken all that on yourself by buying the asset.

In the lease scenario, same two components: There’s a cost of funds involved. Now, with a lease, typically that is your cost of debt.

Because the leasing company will look at you as a creditor and see what is your debt rating and what is your risk from a credit point of view, and they will assign you a cost of debt, which, again, in all corporate theory that you will get your hands on, cost of debt will always be lower than your weighted average cost of capital. Because cost of equity in most cases has a higher cost than cost of debt.

So, purely from the cost of funds layer in the analysis, leasing is a better alternative because it has a lower cost of funds.

Interviewer: So, you could spend your cash, your precious cash on buying another company to bring shareholders returns…

Ingemar Lanevi: Correct. That’s exactly it.

Interviewer: …or you can spend it on equipment, which depreciates.

Exactly. So, you make the choice. Where do you drive the most value to your shareholders? By buying a piece of plastic and metal that will depreciate over the next three years when you’re going to use it and have virtually no value or very limited value after a three-year period?

Or, do you want to use that million dollars to go buy back your stock, if nothing else is available in terms of investments, and generate a certain amount of return to your shareholder by giving him or her the ability to take that money and invest it somewhere else where it can generate a 20, 25 percent return.

That’s the decision-making process in the lease-versus-buy analysis that most people need to go through.

And, again, just to finish off my last thought here in terms of the lease-buy analysis. On the lease side and the residual one are all; we talked about that; that residual piece is outsourced. That’s the whole beauty of it. You pushed that whole thing off to the leasing company. You don’t have to worry about it anymore.

One less headache for you to worry about. This is why I favor a lease structure: Lower cost of funds, outsource the residual, and I’m better off at the end of the day economically speaking, I think.

Ingemar Lanevi: Correct.

Interviewer: … which brings direct economic benefit to the company in addition to the cash flow benefit…

Ingemar Lanevi: Correct. So, if you buy in on the long-term benefits of a lease portfolio or lease program where you habitually do a tech refresh every three years, and if you assume that the residual value in the equipment is, say, 20 percent for the sake of arguments, effectively what you have been able to do is, in perpetuity, you have lowered your IT run rate by that residual value of 20 percent. In perpetuity.

As long as you do the tech refresh, you will never pay for that residual ever again.

Ingemar Lanevi: Correct.

Interviewer: But then you automated…

Ingemar Lanevi: Correct.

Interviewer: And you brought in a partner that had both automation software and outsourcing with leasing expertise…

Ingemar Lanevi: Correct.

Interviewer: And, is that how you got control on the end-to-end process, and has that helped?

Ingemar Lanevi: A lot more control came into place because of that relationship, definitely. Fully well recognized that as we pushed it out and as the mandate became stronger, that, again, I don’t want to see any cash purchase of any serious IT equipment from anybody.

With that mandate, we needed to make sure that we could, obviously, handle the volume, because we were growing quite aggressively back then. This is going back, now, four or five years, when the growth of the company was in the range of 30 to 40 percent year over year.

So, pretty hefty growth, which required more investment from an infrastructure point of view as well as, on the engineering side, more labs to do more development of software products, testing of customer environments, etcetera, etcetera.

That all drove a high utilization, and obviously we needed to make sure we could scale and get a better process in place, because having one guy trying to do all these lease deals and all the documentation and everything attached to it became more and more complex and difficult.

So, again, by outsourcing a big portion of the program in terms of the programmatic piece of it, the administration, the follow-up, and having a system in place which would help us track all the deals out there, knowing when things come to term, getting automatic notifications way in advance before the lease has expired, giving the business owners the ability to have time and runway to plan.

And make decisions: OK, well, I know that server farm over there is going to come due in 12 months. I need to plan, what I am gonna do?

Do I keep it for another 12 months and extend it based on my predetermined price in, do I buy it out because I think I can squeeze another six years of use out of it, or do I start the migration and do I do a tech refresh? Is there a new box out there in that space that I need to stay current in my environment to make sure I can do the proper testing of stuff? Then let’s do the tech refresh.

But, again, have enough time to make that planning and make it all work for everybody involved in the process.

Interviewer: And because you have the controls and you have the data, you can push the data to the decision-makers in the field?

Ingemar Lanevi: Correct.

Interviewer: The financial decision information they need so that they can make the optimal decision at that time.

Ingemar Lanevi: Correct. So, they get full knowledge of what the whole thing looks like, and again, it starts with a deal up front with this new model of being able to look at all the alternatives and pieces so they can get a sense for what the big-picture savings are as well.

Not just the budget impact that typically is the only one that they really, truly care about. But it’s also an education for them, to let them understand there’s a bigger picture here. There is a cost of funds and a cash-flow benefit that you as a business owner get.

It might not impact you personally from a local budget point of view, but you’re a stockholder in this company as well. You should have the same mindset and urgency to maximize shareholder value as I do.

And, so, again, by educating them to get a full understanding of what the big picture looks like and why, again, this cash flow way of looking at it and the economic value of what that brings to the table is worthwhile. That is helping tremendously.

So, as we move, in the next couple of years, from FAS 13, to IFRS, where everything’s going to come onto the balance sheet, I don’t think you’re concerned about that, because you don’t do it just because it’s an operating cost.

Ingemar Lanevi: Correct. So, personally, I don’t care about the accounting treatment per se, because again, I look at it purely from an economics point of view. This is a cash flow analysis that I do based on pure economics, what generates the most value to the shareholder.

Now, I’m sure that I have people in my own company that would disagree with me, that the accounting is more important than anything else, and the fact that we can keep an FMV lease off balance sheet has some perceived value to them.

Personally, I’m not sure that that’s the case at all. Because to your point, even if I have to put it on my balance sheet, I still get the same kind of cash flow benefit that I just described.

So, even if I have to take my; the example where I have a three-year 0 percent financing deal, again, why wouldn’t I be willing to put it on my balance sheet for three years and have it bleed off?

Because, again, I still pay no financing charge on that money. It’s free money.

And, again, I know enough about the whole leasing business that, again, there’s nothing “free” about it, obviously. It’s a blind discount offered by the manufacturer to the financing company. That’s how they get to where they need to be.

So I need to decide in the purchase scenario: So, how much effort do I need to expend to be able to beat the crap out of the manufacturer (pardon the French); the manufacturer to get him to give me the additional 8 percent discount that is roughly the cost of funds or the three-year deal to get to the same point at the end of the day on a discounted cash flow basis.

I’m saying, if they’re offering it to me without even asking for it, it ain’t worth it. It’s not worth the effort of going back and trying to beat up the manufacturer to get that 8 percent discount.

Let them give it to the financing source and then take advantage of it through the fact that I get to spread my payments over the next three years. It makes more sense to me.

And I’ve been with the company now nine years, since 2000, and came aboard to set up and run the treasury organization for the company, and early on was asked to look at the whole leasing concept and what we, as a company, needed to do in the area of customer financing and have some background having worked at HP in the past and being involved with leasing type of transactions and business.

Therefore, I was asked to head it up and start looking at this.

So early on I started the whole concept of setting up an organization called NetApp Financial Solutions, which is our pseudo-internal captive program, which offers captive leasing products to our customer base.

People who buy NetApp solutions can finance them using NAFS as a vehicle.

Interviewer: NetApp is one of the leading computer storage manufacturers in the world.

Ingemar Lanevi: Correct. We do data management, three and one-half billion dollars in the last year’s revenue. One of the leaders in the market segment in terms of storage management tools. Do both hardware discs as well as a lot of software, obviously.

All of our value that we sell is related to our software products and it’s been very successful in the marketplace selling our solutions.

Interviewer: And you’re a global company, both in terms of your clients and your employees.

Ingemar Lanevi: Correct. We effectively have about 130 or so offices throughout the globe covering pretty much the entire world. Both Europe and even some countries in Africa are being addressed as we speak. And Asia-Pac obviously as well. So it is truly a global organization both in terms as people as well as the reach from our products.

Interviewer: Your organization is a little unique in terms of the treasury organization because you have a background in equipment finance. You set up network appliance financial solutions, which is focused on equipment finance, so you’re kind of in that market every day, both in the capital market side and in talking to clients.

So, as a lessee, you are probably more experienced and have a greater depth of expertise among your staff in regard to leasing, would you say?

Ingemar Lanevi: I; yes; I would definitely agree with that. And I did start, for NetApp, I did start the exercise on the captive side, although I also was working very hard with the IT organization to make sure that we internally looked at financing and leasing alternatives when acquiring capital assets as well in the IT space primarily.

And it took me a bit of time to convince the IT organization at the time that doing leasing has a certain amount of economic value to the lessee and, as such, we should really start looking at that as a way of acquiring technology and get the benefits that are inherent in those kinds of transactions.

So, about four or five years ago, now, I actually got to the point where I was able to put a mandate in place that we no longer would buy any major IT equipment and pay cash for it. Instead, it would be put on a lease schedule of some sort.