BDO Manufacturing Output Newsletter - Fall 2015

October 2015


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Table of Contents

Data Security for Manufacturers: Don’t Let Cyber Attacks Take a ‘Byte’ out of Your Bottom Line
Spotlight on: Fabricated Metals
Spotlight on: Machinery
PErspective in Manufacturing
Did you know...

Data Security for Manufacturers: Don’t Let Cyber Attacks Take a ‘Byte’ out of Your Bottom Line

By Rick Schreiber and Shahryar Shaghaghi

Cybersecurity challenges are becoming more prevalent and complex for manufacturers as consumers embrace and demand advanced technologies. The costs associated with data breaches are also rising, with an average cost increase of more than 23 percent since 2013, according to the latest research by Ponemon Institute.

Furthermore, external breaches from hackers are only part of the concern. The latest annual Internet Trends report from analyst Mary Meeker highlights that 20 percent of breaches are attributed to insiders with malicious intent. Her report also suggests that many breaches go undetected, with 70 percent flagged to companies by outsiders. And manufacturing executives are taking note of these threats. The latest BDO Manufacturing RiskFactor Report found that 86 percent of public manufacturing companies cited concerns about network and data security in their 10-K filings, up from 78 percent in 2014.

To mitigate exceedingly costly cybersecurity risks, manufacturing companies must examine their technology infrastructure holistically and methodically, considering the various scenarios that could lead to data vulnerabilities and cyber attacks. Manufacturers should review both internal and external risks, and include measures that better protect not only their own data, but also the end users’ data that could be transmitted via their products. Once a preventative plan is in place, a thorough action plan is equally important should a data breach occur. With so many variables at play, covering all the bases is critical to maintaining secure IT infrastructure.

Looking Under the Hood

A thorough evaluation of data vulnerabilities starts with taking a risk-based approach and assessment associated with the applications and infrastructure components of the organization, and identifying the organization’s most valuable and vulnerable assets. For manufacturers, intellectual property and patents are often the most sensitive information. A good evaluation process must take into consideration every employee who has access to data from creation to disposal, and implement the proper controls, layers and value chains in order to ensure maximum protection.

As data assets are identified and classified, companies should consider:
  • Whether the data is at rest or in motion;
  • Where and how the information is stored and who can access it;
  • Potential threats that could expose the data to vulnerabilities; and
  • Ramifications to the company if the information is hacked or stolen.

Once this assessment is completed, data must be classified, with each data asset assigned a low-, medium- or high-risk rating so that the proper degree of control can be applied to the data. For example, very sensitive data may be protected with multi-factor authentication using biometrics, such as a fingerprint scanner. Once the protection has been established, threat modeling techniques can then help identify gaps in the data’s life cycle that could expose it to security threats.

Employee education and training are critical to maintaining a secure IT infrastructure, to ensure not only that the staff upholds best practices to keep information secure, but also understands the consequences of lax behavior since internal attacks can and do occur, whether intentional or unintentional. Third-party vendors should also be required to adhere to strict data standards.

Pumping the Brakes before Racing Ahead

Manufacturers must also assess the ever-growing and evolving data risks that lie within products themselves. Technological innovations like 3D printing and in-vehicle Wi-Fi are breaking new ground in manufacturing and opening doors for producers and consumers alike. However, innovative methods and products also raise questions, and companies must marry their investments in innovation with due diligence to implement proper internal controls and security precautions.

For instance, auto manufacturers have found themselves entering uncharted territory as wireless Internet and other software capabilities are becoming commonplace in cars. Already new litigation is in progress to regulate manufacturers’ activities around the security of user data transmitted via their products. Manufacturers must ask themselves: “What kind of equipment malfunction could hackers create if they were to gain access to these systems?”; “How much, and what types of customer data could they pass along to others?”; “What cybersecurity responsibility falls on manufacturers?”

Creating user-friendly products that are also embedded with proper controls and security measures may take longer to get to market, but doing so gives the product a long-term competitive advantage. Manufacturers would be wise to make data regulation as integral to the manufacturing design process as the functionality of the products.

Calling the Body Shop

No one is immune from data breaches in today’s complex cyber landscape, but manufacturers are particularly prone to threats. Manufacturing ranks as the third most commonly breached industry, according to the Verizon 2015 Data Breach Investigations Report.

Should a data breach occur, having an incident response plan in place can help ease the pressure in the heat of the moment. Affected systems should immediately be closed off from the remainder of the company’s infrastructure in order to pinpoint the root cause. When a data breach does occur, use it as a learning experience, extracting as much information as possible about how and why the incident occurred. That information can then be used to strengthen IT infrastructure by plugging holes and establishing improved monitoring programs to detect threats. Reaction plans should be tested and updated regularly to ensure any future threat responses are as effective and efficient as possible.

Above all, reporting incidents promptly and properly is essential. Data security incidents can be highly visible and heavily scrutinized, putting the company’s reputation at stake. A proper plan should detail the step-by-step process of reporting the incident and relevant details to all appropriate parties following a data breach. This could include self-reporting information to regulators, or simply letting customers know that their data has been compromised and sharing the measures the company is taking to rectify the situation.

Preventing Accidents

Advanced preparation can make a world of difference when a data breach occurs. Exhaustive and detailed plans can minimize reaction times and keep issues from escalating into a situation that could be potentially damaging to a company’s reputation and competitive edge. Setting regular, comprehensive tune-ups to examine potential problem areas and regularly assessing the impact of future innovations can prevent expensive losses and future damage.

This article originally appeared in Manufacturing Business Technology.

Rick Schreiber is the national leader of BDO’s Manufacturing & Distribution practice, and may be reached at [email protected].


Spotlight on: Fabricated Metals

More Manufacturers May Use R&D Credits Under Pending Legislation

By Chai Hoang and Joseph Eliya

Designed to encourage investment in innovation, R&D tax credits can sometimes be overlooked by fabricated metals products manufacturers, when in fact they are accessible to many small- and medium-sized manufacturers in the sector. It’s important to note that a company need not necessarily be producing an end product to qualify. Often, fabricated metals producers are engaging in projects aimed at implementing design, manufacturing or process improvement at the parts level. While many may not feel that such projects fall under the scope of R&D, many of the investments in improvement made by fabricated metals manufacturers to stay competitive in fact qualify as R&D from the government’s perspective. The following excerpt from a recent Global Trade article authored by our colleagues Chai Hoang and Joseph Eliya explores proposed legislation that could extend these tax credits and benefit manufacturers in the fabricated metals sector.

With the recent tax-extenders vote from the U.S. Senate Finance Committee, manufacturers are anticipating the extension of various tax items that have proven beneficial to the industry in the past. The legislation would extend the research and development tax credit (a.k.a. R&D tax credit or research credit) and other tax relief items through 2016, providing manufacturers greater certainty around tax planning and their expected tax liability.

The tax-extenders bill is legislation that temporarily extends expiring provisions of the tax code.

The R&D Tax Credit is particularly important to manufacturers, as many manufacturing companies are likely performing qualified research activities and thus could benefit from the credit. As recent IRS data illustrates, in 2012 manufacturing represented over 60 percent of the research credits claimed across the economy.

Under previous legislation the research credit could be applied only to income taxes, but an important innovation in the current bill permits small businesses to claim the credit against their payroll taxes.

Many startups and smaller businesses pay minimal or even zero income taxes but do, however, typically owe payroll taxes. Thus, since the extenders package allows small businesses to claim the research credit against their payroll taxes, smaller manufacturers may find a greater incentive to claim the research credit as a way to offset some or possibly all of their payroll taxes.

Further, the tax-extenders package contains a provision that allows companies to claim the tax credit against their alternative minimum tax, making the credit available to another set of manufacturing companies that may have previously been unable to take advantage of the credit.

The extenders package is especially important for small and startup manufacturers, but companies of all sizes may benefit from the passage of the bill. If the package is enacted, manufacturers that use the tax credit will benefit from increased earnings per share and cash flow and a reduced effective tax rate.

As of this writing, the bill is with the House of Representatives, which will consider the bill as is or introduce its own legislation. Since enacted in 1981, the R&D Tax Credit has been extended more than 15 times, retroactively or otherwise. Small, medium and large manufacturers alike should take note of the proposed changes to the research credit and determine how the provisions could benefit them.

This article was reprinted from Global Trade magazine with permission. Original article may be viewed here.

Chai Hoang is a senior associate with BDO’s R&D Tax Services practice for the Northeast U.S. region, and may be reached at [email protected].

Joseph Eliya is an associate with BDO’s R&D Tax Services practice for the Midwestern U.S. region, and may be reached at [email protected].


Spotlight on: Machinery

Low Oil Prices Bring Good Fortune to Some Manufacturers, Burdens to Others

By Cathy McNamara

This summer, oil prices hit a six-year low, dipping below $40 per barrel. This marks a substantial decline from prices of $112 per barrel in the U.S. just one year ago. Meanwhile, data from the Institute of Supply Management shows that in September, the manufacturing industry experienced growth for the 33rd month in a row, though at the slowest rate since the spring of 2013. The machinery subsector reported expansion, as well. The ISM reports that despite overall growth among machinery manufacturers, new orders and production fell in the month of September.

Growth in the machinery manufacturing sector, mirroring the U.S. economy as a whole, slowed more than was expected this spring. Now, economic slowdowns in the Asian markets have troubled stock and commodity prices stateside. The persistence of low oil prices has brought about nuanced effects across industry segments, but has particularly affected producers of oil and gas-related machinery and parts. Going forward, we could see some segments benefit, while some could be burdened by the implications of low crude oil prices. At the end of the day, how a company will be impacted largely depends on its product, as well as several other factors.

Lower spending by oil and chemical companies
Oil and chemical companies have been forced to spend less in an effort to turn a profit in the face of a glut of supply, which has caused a dip in production among oil and chemical producers in the Gulf area. Sharp spending cuts could result in challenges for machinery manufacturers who rely on demand from oil and chemical companies, like producers of machinery used in the production of fossil fuels. According to Business Insider, one machinery manufacturing executive noted, “Uncertainty about where the price of oil is headed has everyone on pins and needles.”
However, lower crude oil prices have stimulated global demand for more affordable mineral and energy commodities, and some analysts predict a positive outlook for mining, oil and gas machinery manufacturers. Lower spending and production could result in some stabilization in oil prices in the coming months, as supply lowers to meet lagging demand. To mitigate weakened U.S. demand, oil companies are looking abroad for new business opportunities; however, they continue to be mindful of how the strengthened dollar might impact their work within foreign exchanges. Given the potential for currency fluctuation between the day the deal is signed to when it is completed, manufacturers are looking to hedge against this exposure by locking in forward contracts linked to more stable indexes, like certain commodity prices.

Reduced energy costs could help bring production back to U.S.
Energy costs are at historic lows, and the savings experienced by some manufacturers have helped soften the strain of lost purchasing activity from oil and gas suppliers. While lower energy costs benefit most manufacturers, they slow production and new orders for machinery producers, whose business had been booming in response to energy companies’ high demand before oil prices plummeted.

Lower energy costs result in lower production costs overall, softening the potential blow of a slowdown in new orders. Lower costs also can encourage expansion and increased production in many sectors, particularly among machinery subsectors whose demand is fueled by increases in consumer spending confidence, including producers of commercial and service equipment machinery. Furthermore, lower energy costs have made the U.S. more attractive to manufacturers who may have previously opened factories in other countries in an effort to cut costs. We could see an increase in re-shoring activities, including opening new factories in the U.S. and moving foreign production back stateside if the trend of lower prices continues.

Strong dollar could bring increased consumer spend; threaten U.S. competitiveness
The dollar’s climb to 12-year highs earlier this year has stimulated U.S. production and domestic spending, but has reduced cost-competitiveness of U.S. manufacturers against their Japanese, Brazilian, French and German counterparts, reports Global Trade. While this shift hasn’t been drastic enough to shift the competitive balance – U.S. manufacturers remain more cost effective by about 10 percent overall – we could see international business and exports suffering as foreign buyers pull back slightly. We could also see a more cautious approach to expansion from manufacturers that service international companies.

And increasingly, manufacturers are looking for ways to offset potential financial losses from reduced international activity. In particular, we’ve seen interest in currency-hedged exchange-traded funds and foreign exchange derivatives skyrocket from companies that have a strong business stake in international operations. This investment could help manufacturers mitigate risk while locking in favorable effects of a strong dollar. International companies are also looking to derivatives as a way to stem the impact of the strong dollar, which is translating to lower sales and profits.
However, domestic consumer demand is up, driven by job growth and increased spending power, and could fuel growth in the sector despite export troubles. U.S. consumers are feeling the strength of their dollars, and are capable of purchasing imported goods for less, which builds consumer confidence and frees up additional dollars to be spent on other goods and services. This may help some sectors that produce goods and machinery for the retail, restaurant and travel industries.

Lower oil prices have resulted in a wide array of nuanced effects across the manufacturing industry and even among machinery producers. And if trends continue, low oil prices could contribute to a spur in activity through the remainder of the year. Despite the risk faced by some manufacturers, many forecast that the manufacturing sector will bounce back from slow growth in the first half of the year, as it did in 2014. Overall, we expect that manufacturers across a wide variety of sectors will continue to enjoy the effects of strong demand and low energy costs, while others continue to work to mitigate risks.
Cathy McNamara is an assurance partner in BDO’s Manufacturing & Distribution process, and may be reached at [email protected].

PErspective in Manufacturing

PErspective in Manufacturing is a feature examining the role of private equity in the manufacturing space.

Deal-making in the machinery manufacturing space in 2015 has been mostly on par with last year. According to private equity and venture capital-focused research firm PitchBook, 91 companies in the global machinery manufacturing space have been the subjects of private equity/leveraged buyout activity so far this year, compared with 88 during the same period last year.

Read the PErspective Manufacturing Article

Did you know...

According to the State of Manufacturing Technology report, 93 percent of survey respondents use consumer tablets in their manufacturing operations, 80 percent incorporate consumer mobile devices and 48 percent use sensors to track materials and machines.

After dropping sharply between 2007 and 2013, the number of manufacturing apprentices rose approximately 10 percent in 2014 after the Workforce Innovation and Opportunity Act passed, reports Reuters.

According to the 2015 BDO Manufacturing RiskFactor Report, 80 percent of machinery manufacturers cited retaining key personnel as a business risk, up from 70 percent a year earlier and 60 percent in 2013.

Amid opportunity for domestic expansion and growth, 93 percent of manufacturers report that they are investing in domestic operations, according to the Bank of America Merrill Lynch 2015 CFO Outlook Pulse Survey.

Analysts at the Manufacturers’ Alliance for Production and Innovation predict that the construction supply chain will be the biggest driver of growth in the manufacturing industry, after construction in the manufacturing sector rose 56 percent in the first half of 2015.

According to the latest BDO Capital Manufacturing & Distribution M&A Review and Outlook, manufacturing and distribution companies made up more than 50 percent of private equity add-on investment deals in 2013 and 2014.

For more information on BDO USA's service offerings to this industry, please contact one of the following practice leaders:

Rick Schreiber
Manufacturing & Distribution
Practice Leader


Issy Kotton
Assurance Partner, Los Angeles

Larry Barger
Senior Director, Assurance, Pittsburgh
  Cathy Rozanski McNamara
Assurance Partner, Detroit

Matt Becker 
Tax Partner, Grand Rapids
  Fred Rozelle
Assurance Partner, Detroit


Brian Eccleston 
Assurance Partner, New York


John Tucci
Assurance Partner, Woodbridge


Sean Henaghan
Assurance Partner, Chicago