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Episode 39: Industry Outlook for Manufacturers

Bryan Powrozek
Dec 13, 2023
 

 

In this episode of The Sound of Automation podcast, we sit down with Mike Devereux who leads Wipfli's industrial products segment. Bryan and Mike discuss the key drivers impacting manufacturers and what they should look out for going into the new year.

From increased revenue expectations and industry 4.0 spend to better cash flow management and strategic planning, the majority of manufacturing executives we spoke to are cautiously optimistic about 2024. Listen in to learn more about our predictions for the new year and how to successfully manage and grow your manufacturing business. 

Transcript:

Mike Devereux 00:00

Companies need to realize I think that change management is really kind of part of this implementation. So it's not just, hey, I get to go spend and make this nice capital expenditure. But what am I going to do with the information? What am I going to do with the throughputs and the benefits that the technology really should be bringing to me? 

Intro/Outro Narrator 00:20

Welcome to the Sound of Automation brought to you by Wipfli, a top 20 advisory and accounting firm. 

Bryan Powrozek 00:40

Hello and welcome to the Sound of Automation. I'm Bryan Powrozek with Wipfli and joining me today is my colleague, Mike Devereux. Mike, how's everything going? 

Mike Devereux 00:47

Doing fantastic, thanks, Bryan. 

Bryan Powrozek 00:49

We're going to hit on a couple, a couple of subjects I know near and dear to your heart. Little bit of update on manufacturing, talk about the Wipfli Manufacturing Report and then some thoughts on what manufacturers can do with that. It's near the end of the year, so tax planning is always a good option here, but before we kick off the main topic, I guess just want to give us a little introduction on yourself and talk a little bit about your background. 

Mike Devereux 01:13

Yeah, sure. Well, I'm Mike Devereux, as you mentioned, I'm a partner with Wipfli. I'm a tax key through and through. I get up every morning and look at what tax law and what tax legislation or tax guidance might have come out that impacts our manufacturing clients. But I help Wipfli by leading the industrial products manufacturing group. So as you know, we've got 45 offices across the country and serve a little over 7 ,000 manufacturers, retailers and distributors. Well, I tend to focus on the manufacturing piece, whether that's machinery manufacturers, metal manufacturers, vendors, welders, stampers, plastics processors, you name it, wood manufacturing. That kind of falls within the industrial products manufacturing. And that's what I wake up thinking about every morning. 

Bryan Powrozek 02:05

So along those lines, you know, Wipfli has done a survey of some of those clients of ours, the manufacturing clients, and just to get a gauge on what they see going on in the industry. And I don't know if the report's out yet or if it's coming out soon, but any significant findings you can share with us from that report? 

Mike Devereux 02:25

Yeah, it is forthcoming, Bryan. It'll be out here shortly. In fact, I think the approvals all just were going through last week. But there were a few things that kind of stood out to us. I mean, for one, many are thinking about the recessionary trajectory, I'll say. We're not having negative quarters of GDP or anything like that, but people are just feeling like a recession might be in the offing or might be there. Now, from a political perspective, I don't think that the current administration is going to let that happen from a recessionary perspective, but that doesn't stop manufacturers' concern about it. That coupled with the fact that almost 90%, I think it was 88% percent, expected increased revenues in 2024. That sentiment of, hey, we're headed towards a recession, but we're going to grow through the recession, I think is unique. There are some companies that experienced that during COVID. Their businesses, frankly, took off during COVID, and others were harmed a great deal, and even some went out of business in specific industries. But the manufacturing community has this sense of resilience that they're going to grow despite the macroeconomic things that are happening on the forefront. That, to me, really kind of shocked me a little. 

Bryan Powrozek 03:51

Yeah, you know, and it's interesting you mentioned that the COVID recession is really kind of a tale of two different economic conditions, right? You had the individuals, which, you know, with, if you were in hospitality, things like that, you had, you had a pretty tough time getting through the pandemic. But then a lot of the manufacturers, you know, especially when you think about automation or anybody delivering any of those PPP stuff like that, they had great years because they were ramping up trying to meet demand. So, yeah, it'll be interesting. Yeah, I almost kind of feel like next year could be one of those recessions we talk ourselves into that people, they, they're concerned about things. So they start maybe spending less. And then next thing, you know, you find yourself there. But, but overall, I would agree, you know, in talking with my clients, seeing a lot of, you know, cautious optimism about '24, but, but expecting a good year. 

Mike Devereux 04:47

And everybody had workforce challenges, right? So we had some in the manufacturing community were able to kind of pick up a new source of workers with the hospitality industry being down or closed and so forth. Those individuals went, they didn't remain unemployed, right? They learned new skills and some of those forward thinking manufacturers went out and found those individuals that maybe had background in hospitality in the restaurant business working for hotels. And I'll tell you, those people just doesn't necessarily come back if you don't believe me, try and get a dinner reservation on a Friday night at a nice restaurant or just the something that we're used to somebody like me that travels quite a bit for work that they clean your room every day, right? At the hotel you're staying at. Those workers have kind of moved over on to other different industries, manufacturing being one of those winners. But contrasting that a little bit, they still struggle. I mean, workforce is still one of the biggest challenges routinely mentioned. And I think it has been for the last four or five years in these manufacturing surveys as that. And so people are looking at technology. I mean, one of the other things that we saw in our survey was I think it was over 70% intended to either invest in or increase their industry 4 .0 spent. Now, that's a broad, you know, somebody says industry 4.0, what are we really talking about? There's all kinds of different ways they could be thinking about that. 

And when, and if you look at the survey result, operations was by far the largest. 70% of the company said they're going to invest or start to investigate AI and artificial intelligence in their industry, in their operations. So what are they looking at? They want more visibility. They want looking at quality, maybe different vision systems that are so that you can do in -line quality checks. There's could be looking for underperforming assets or underperforming cells by getting real -time information off those machines and really seeing what your utilization truly is. Because all too often we make gut decisions based upon maybe innuendos, maybe something how we think, something might be running or, hey, this is our largest customer. We need to focus on this downtime cell right now where in all reality from a company profitability or job profitability perspective, we might be better suited on focusing on cell 34 and 48. I'm just making up facts here. But really just getting better visibility. So is that, I think, kind of where we're seeing a lot of traction is people want better visibility into, well, maybe I can get more out of those assets that I have, or maybe I can get more throughput or more revenue for full -time equivalent. That's a metric that I see quite a bit. 

So how do I really kind of improve operations? And that is the investment. Now the second kind of largest bucket, so to speak, of investment was in front of us in the growth. One of our directors in our manufacturing group, his name's Sean Myers, he spoke at a conference last week that he and I were at on how you can use artificial intelligence to really accelerate growth. And it's not just on the sales side. It's not just creation of pipeline, but it's the customer service. And I think that goes a long way is how can you improve upon the service that you're providing to your existing customers so that you've got revenue spend, it's not new customers, but how do you get more with the same relationship that you've already gotten place? And we're seeing some of that investment artificial intelligence in that space as well. 

Bryan Powrozek 08:43

Yeah, because really, you know, and I think you kind of illustrated it very well there. This labor issue, it's like a balloon, right? You push it on one side, it's going to move over to another. So you move these people from hospitality into manufacturing. And then once hospitality comes back up, they've got a shortage. So with having a smaller labor pool, they're just going to move around the market to wherever the dollars, frankly, are probably going to come from dollars or other, you know, flexibility in terms of work life and whatever it might be. So the shortage is there to stay. It's how do you how do you respond to it? And in almost kind of what you're talking about there is that lean methodology or that six sigma methodology of payloads, rather than just saying we think implementing a new ERP or putting in this process is going to be the silver bullet that solves all of our challenges. Let's actually sit down and look at it, measure it, figure out where that, you know, the most bang for our buck is going to be, and then go after solutions that are going to fix those problems. So 

Mike Devereux 09:44

Yeah, yeah, you bring up a good point. I think there was almost 60% of the respondents said that technical know -how or technical ability or training is kind of a barrier of why they haven't implemented some of those things. And so, companies need to realize, I think, that change management is really kind of part of this implementation. So it's not just, hey, I get to go spend and make this nice capital expenditure. But what am I going to do with the information? What am I going to do with the throughputs and the benefits that the technology really should be bringing to me? And that's a challenge. I mean, a lot of people don't thrive on change. It's a unique characteristic to want to change on a regular basis. People like, I wouldn't say monotonous, but they like routines. They like the ability to go back to the same thing that they're doing. And this is a differentiator. It's a big change. And with that comes managing that change. And it's more than training. There's a coaching aspect to it. So what are you doing with that data? What other things? What is the data telling you? What is the story that comes from the information that I'm now receiving, hopefully, in a real -time fashion? 

Bryan Powrozek 11:02

So I guess if we take that as kind of the background, right, that the manufacturers, they're expecting, you know, at least in our survey, are expecting an increase in '24. They know they want to invest in some of these technologies. So that's going to be, you know, additional money. They know they're going to have to lay out to, whether they're doing it internally or they're hiring somebody to help them with it, you're going to have to invest resources to implement some of these technologies. But then there's also these concerns hanging out there on the horizon of inflation, recession, all this other stuff. So how does a manufacturer navigate that? Because it's almost like you're margin for error shrinks, right, that even though your industry or your business may be doing well, if there's other, you know, macroeconomic concerns that are floating around out there, you've got to make sure you hit, you know, kind of, you always want to do and get these things as correct as possible. But, you know, what are, what are some considerations manufacturers should have for 24 to kind of make sure that if they go after some of these things, they'll, you know, they'll be successful as possible. 

Mike Devereux 12:10

Well, there's an underlying theme that I keep hearing and talking about with our clients, and that's cash, right? Managing cash, if there's going to be concern over the inflationary environment that we're in, the recession that we may be close to or feeling like at least, you're going to continue to have the labor shortages and the supply chain issues that have presented themselves over the last couple of years. And so, cash is king, and I've got a partner out in Scottsdale, Arizona that I hear him say that on a regular basis, cash and king. And as you might imagine, he's in our M & A advisory services group. But it's important from an operational perspective, right? From a cash flow management, are you doing 13 -week cash flows? Are you coming up with capital spending plans? How is the information that is happening out on your shop floor, in your sales office, in your back office accounting impacting those projections and needs for new capital? Do I need that extra machine? I tell you a quick story. We were talking with an in our perspective client, they're not a client yet, and they were saying they were going to buy three new, three new molding machines over the next six months. And I just asked the simple question, why? What is it? Are they different tonnage machines? Are they unique in some way? Are they going to get more efficiency? Are the old ones just old? And you're repairing them a lot? And he said, no, we need more capacity because the other ones are running at a pretty good, well, at full capacity, right? They had planned downtime, but not a lot of unplanned downtime. And I asked, what is that information? What is that information based on? Is it a gut? He said, well, no, I walk out and I talk to my operators and they're running all the time. And so we got into a conversation of really, what is your true utilization? Is there a way to get more throughput out of the same machines and the same number of operators out on that floor? 

And we're still in that kind of early stages, but now there's an interest in really kind of getting the information off those machines to understand, is it really a need to go spend $600 ,000 on that machine? And if they're looking at three of them, what's the potential cost associated with that? Maybe they don't need three, maybe they need two. And so looking at cash flow, looking at what your future capital spend is going to be, and then you can't not think about benefits and hiring and retention. Because we all think of labor shortages and workforce as a concern of ours. We don't want to put ourselves in a position that is going to hamstring the company because, I mean, even though people have this recessionary trend, they're hiring, right? I don't know many manufacturers that aren't at least considering good talent on a pretty regular basis. Supply chain, perhaps just from TIP's perspective, terms and conditions, I'd brush those off and look at those on a pretty regular basis and look at payment terms and so forth. That flows into your cash flow, but that's kind of one of the underlying themes is to manage your cash through these type of environments. 

Bryan Powrozek 15:43

It's really about getting the right information that you need to manage your business, right? And even going back to some of the industry 4 .0 stuff and digital transformation concepts you were talking about at the outset, it's helping the business owner understand the true state of their business so they can make educated decisions on what to do next. And to your example of, buy the three machines or maybe you only need two. If you don't have all that information around you and you're not able to kind of look at that and look at the whole business case or you mentioned employee retention, right? And so if you're going to increase your benefits or maybe offer a new benefit to try and entice some people to join your organization or stay with your organization, how does that factor into the overall strategic plan? And in doing that, is that put you at a, yes, you're at an advantage, you're attracting more employees, but now your operations are running under what you would like them to. And if one of these other concerns they have of inflation and interest rates and all this stuff, if that goes in another negative direction, is that the next domino that kind of starts pushing you down the path of not having a sustainable business versus a business that can take advantage of? Because that's one of the interesting things when you get into these recessionary periods, right? Those are really the opportunities where the good businesses lay the foundation for that next step of growth, right? 

Mike Devereux 17:09

It is, it is. I mean, we saw a number of companies look at that there's supply chains differently over the last two years, to, for example, and looked at it from a, rather than just in time, they looked at it from a risk mitigation perspective. You know, how, where do I have risk? Where do I have the highest amount of risk? I even saw some of our clients create scorecards. And so they're scoring their different suppliers, scoring the uniqueness of a potential material and how hard it might get, and kind of creating this risk -based analysis, and then focusing their efforts on supply chain on where there might be weaknesses that could cause a devastating impact to the company. Well, that's, that's planning. That's part of your strategic plan, and how often are you looking, kind of doing a deep dive on your strategic plan and looking at ways that I can increase opportunity or mitigate risk? And so, you know, some of it was forced, right? We didn't, it wasn't just a, hey, let's go, let's go evaluate our supply chain. They were, companies were forced to really kind of reckon with some of the risks that were inherent in their supply chain, whether that's single supplier, whether that's single material that I can't deviate away from, from a particular contractual issue, and what are the, how are we going to work with my customer to identify a backup material in the event that that situation occurs? And so, you know, that's just, I got an example of, of how do you, how do you focus some of your detail planning in line with your overall strategic plan? 

Bryan Powrozek 18:41

Something you mentioned there, I guess, curious to hear what you're seeing within your clients and others in the industry. But speaking of risks, cybersecurity is another major area. Well, you and I were just on a call a little bit ago where they were talking about how some of the bad actors in cybersecurity are now using AI to help make their attempts more realistic. The example they gave on the call is you're used to identifying those emails based on poor English grammar and you can tell that that's not coming from a native English speaker. But now, if you've got artificial intelligence that's making this sound like it's coming from a native English speaker, it's harder for people to catch onto those things. So what are you seeing in the cybersecurity arena within your client base? 

Mike Devereux 19:32

You know as you describe it's scary. I mean I we had a guest speaker this morning on our Manufacturing retail and distribution scrum and he spoke today About some of those things and it's not just email phishing schemes and so forth It's we what if they can hack into your in your machines, right? And what happens if they can throw off tolerances and really kind of think the average days that that a bad actor might spend in the system before doing anything was over 200 days. Well talk about a new fear unlocked of just being monitored on a regular basis before any of this stuff happens and they're finding like you said new ways and using AI to get around folks. I mean even recording someone's voice and then duplicating that voice so that it's no longer okay, well I've got some new instructions on where to wire that well now I make a phone call and somebody's duplicating there that person's voice on the back and saying yeah go ahead and wire the money. That's scary. All right. 

I mean and so yeah what are you really need to get your arms around because you can't I don't know that you can be 100% protected right? I mean because there's there are always access points and so you really want to try and figure out ways to mitigate the risk in a high hot highest and best use of the resources that you have at hand and so what does that mean? I think that means assessing on a regular basis a means of risk mitigation. Well, what do I mean by that? It's really can diving into what risks exist and what is the potential likelihood? Of that so that could mean penetration testing it could be In the guard team calls them different red team or for purple team testing where either they're working kind of Independent and all hands on deck and we're trying to penetrate a particular system on the clients on our clients behalf or anything to working with the CFO or the controller or the president of the company on specific areas of risk that we might be able to penetrate and so forth and it's kind of working collaborative. So there's all kinds of different ways you can go about assessing risk, but I think the important part is doing it on a regular basis and not just that thinking kind of put your head in the sands and you know, we're protected or you know we've got this room. Get a second set of eyes. 

I tell this to companies all the time is once you get to a certain size you need to have more than one advisor in a particular space because that gives one way of competition of people bringing new ideas and so forth and I think Wipfli's pretty darn good at bringing our clients and prospective clients ideas to either create opportunity or mitigate risk. But it also allows you to just get different perspectives on what might be helpful to your business. One thing that that you know, we're hearing our clients need have a need for is and dusting off, what are you doing from a cyber insurance perspective? And are you complying with the representations you made because a horrible thing is no I've got cyber insurance and then an event occurs and later find out that you weren't following specific policies that were required in order to maintain that level of cyber insurance and then you're out the money from the cyber insurance premiums that you paid, plus you're out the money from the bad actors and you're getting no recruitment at all. And so that's kind of the worst of all world situation. 

And so have somebody reviewing those cyber insurance contracts and making sure that you've got compliance so that so that you're not wasting your money on your premiums that might go to somewhere up some other way to mitigate risk 

Bryan Powrozek 23:25

Yeah, exactly. Well, and even like you said, you know, with that, with some of that penetration testing or those other forms to check and see, you know, I think everyone feels, oh, yeah, we've got these practices or policies in place. And so we're taking care of everything we can from a cyber. But unless you're actually testing that and confirming, yeah, you could just be, you could be thrown away a bunch of money on something that's giving you this false sense of confidence that you're protected, and you're really not giving that benefit from it. So no, I think that's a, I think that's a great recommendation for business owners. So as a self-professed tax geek, I'd be remiss without letting you, you know, talk a little bit about what you're seeing for the end of the year and just some of the hot topics that you're talking to your clients about to help them prepare for year end. 

Mike Devereux 24:15

So a couple of different comments there. One, I want to talk about some tax legislation. And I think it impacts every manufacturer you have listening to this podcast. And that is some of the things that the change as a result of law changes made from the tax cuts and Jobs Act. We refer to them as tax cuts and Jobs Act clips or laws that took effect not when the law was signed but took effect in the future. So what happened in 2017 is they had really, really expansive tax reform where they lowered tax rates. They put in 100% bonus depreciation, new methods of accounting for small and mid -sized taxpayers, just a whole slew of different benefits. And really a lot of them had some great impact on the manufacturing community. They were manufacturing friendly, so to speak. But what was not manufacturing friendly is they had these different revenue razors. They were built into the into the law themselves. And so beginning in tax year 2022, taxpayers had to start capitalizing their research expenditures. And if that research happened in the United States, they got to advertise those over a five -year period. If it happened outside the United States, it's a 15 -year period. Drastic, drastic change from what taxpayers have been used to since 1954. 

And that's just expensing or deducting the research expenditures as they're paid or incurred. If I spend $100,000 on John Salary, and he's an engineer, and he's doing research and development for me, historically I've just always been able to deduct $100,000 of John Salary that reduced taxable income to result in whatever my taxable income was to result in my tax liability. Now that $100,000, I have to amortize over a five-year period. And here's even another kicker, it's midpoint convention. So I don't get 20% in year one, I get 10% in year one. Well, in 2022, we saw a number of manufacturers' tax bills just take a significant, because research is part of their job, or part of their role. They're doing research and developing new products, improving existing products, developing or improving manufacturing processes, developing new techniques, writing software. These are all things that qualify as research under the tax code. We've always thought since 1981, as research as a good thing. '81 is when they enacted the R & D tax credit, and really put this incentive in, permanent tax savings, right? This, what I'm talking about, the deductibility versus capitalization and amortization, that's a timing difference. It's a pretty big timing difference. 

So if I'm a $25 million manufacturer and I had $2 million of research expenditures, I only deducted $200,000 this year, not $2 million. So I got $1.8 million of additional taxable income? And let's say at 30%, you're around 600,000, or so additional tax on a $25 million manufacturer? And take that across the company that has maybe a hundred employees, and that's a huge tax per employee. It is another way to look at it. There were also limitations put on the ability to deduct interest expense. So today, my average sales are over $29 million. Then I'm required to look to see whether or not I can deduct the interest expense. I'm limited to 30% of EBIT now. It used to be EBITDA of it. So that put this new limitation. So I've got leveraged equipment, I've got leveraged over my building, and so I've got this debt that I'm servicing out here, and I'm paying interest expense on that debt. And historically, I've just been able to deduct that interest expense. Well, now they're penalizing companies that are leveraged on, and think about the manufacturing community. We're a very capital intensive industry. 

And so we sometimes have loans on our pieces of equipment. We don't just go out and cut checks for three new pieces of equipment that cost $600,000. There's financing options, and there's an interest component to that, and now you've got this limitation that's associated with it. And then finally, I mentioned 100% bonus depreciation was put back in place with the tax cuts in Jobs Act, and that 100% bonus depreciation was effective from '18 through '22. And then in 2023, now in the year that we're at now, for anything I buy and place in service this year, I get 80% bonus depreciation, and the remaining 20% gets depreciated over its useful life. And next year, 60% so forth, and it kind of phases out over through 2025. So this, like I said, this capital expenditure, this 100% bonus depreciation is not there. Well, there's three bills out there making their way through the House Ways and Means Committee and whatnot. And there's a negotiation with the Senate going on right now with can they fix those? In other words, get 100% bonus depreciation and put the interest expense limitation back at EBITDA instead of 30% of EBIT. 

Mike Devereux 29:14

And then finally the R & D fix. Right now, some of the negotiation is what's the other offset, because when I say other offset, I don't mean pay for it. I mean other tax credits, because the Senate Democrats would like the enhanced child tax credit renewed. And the cost of that enhanced child tax credit over a year or two is about the same as extending all three of those provisions through 2025. And so that's kind of the negotiation that's happening right now. Just this morning, I read that there are some commentators saying they're going to try and push that through before the end of the year. But they're looking for what legislative vehicle, because they're not just going to pass one of these bills on its own. They're going to put it on another bill or tie it with another kind of must pass piece of legislation in order to get it across the finish line. And these tax provisions would just be part of that. So we're hearing kind of January is when that might happen. If we get an early Christmas present, I'll just be tickled. And we can get the, you know, because this is, I mean, you can see, I mean, I've got clients that passed up new programs, passed up new pieces of equipment that they needed because they had to pay a greater than normal tax bill. Frankly, it's more helpful when the federal government is helping manufacturers than hurting them. And it feels like a little bit they hurt em this past year by just inaction. 

Bryan Powrozek 30:33

Yeah, so I think that's a great kind of piece to end on here because that really ties back to what we were talking this whole way through is that even if you're expecting growth in '24, the margin for error is shrinking. And so if you know that you've got these additional cash needs from taxes or you're going to be paying interest on these things but not necessarily be able to get the tax benefit on all that up front, just really reinforces looking at this holistically around your business when you're putting your strategic plan together and understand where all the cash is going to go because, again cash is king and it's the most important resource you have in your company, one of the most important. And so keeping a focus on all of that as you're making these other operational decisions so that you don't find yourself at the end of '24 if Congress doesn't act and now you've got this huge tax bill and all this interest you can't deduct. It's worth thinking about that on the front end. You don't want to let the tax tail wag the dog for the business but you definitely need to think about it before you get to your end. So Mike, if something you mentioned here resonated with the listener, I guess what's the best way for someone to get in touch with you? 

Mike Devereux 31:47

Well, you can reach out to me either email or on my cell phone, either one, you know, Mike.Devereux@Wipfli.com I'm on the Wipfli website as well. You can find me there. I believe my cell phone numbers on there as well. But love to connect, answer any questions anyone might have. Or as you can tell, I'm a little passionate about some of this stuff. So I'm happy to just kind of talk and chat through any of the ideas we talked about. 

Bryan Powrozek 32:12

Excellent. Well, thanks for the time and appreciate you coming on.

Intro/Outro Narrator 32:17

Thank you for tuning in. Don't forget to like us, subscribe, and share on social. To learn more about Wipfli, visit us at Wipfli.com. That's W -I -P -F -L -I .com. Perspective changes everything. 

 

Author(s)

Bryan Powrozek
CPA, CGMA, CGMA, Senior Manager

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