7 Year Itch

THE 7-YEAR ITCH: EXCHANGE OLD FOR NEW

Ensure production quality, keep pace with technology & competition

By Donald A. Kruschke
Executive Vice President
Stopol, Inc.

Thermoforming needs to take a cue from the auto industry.

The typical U.S. consumer purchases or leases a new car every three to five years – regardless of whether the vehicle needs to be replaced or not.

A significant portion of the general public has been conditioned to replace their cars or trucks every few years for a variety of reasons:

• Just wanting the latest and greatest bells and whistles
• Bored with their current car
• Elevation in social status
• Life change such as children dictates the need for a larger car
• Better performance

Of the reasons listed above, only the last two can be considered practical. Yet, people seem to have no problem investing their hard-earned cash in a product that loses 15% of its value once it leaves the lot.

Now consider the thermoforming industry and how processors hold onto machines for up to 15 years — despite a mountain of evidence pointing to the impracticality of this action.

Capital equipment purchases are substantial investments and you have to make sure that you maximize your investment dollars. When you hold onto equipment too long, you are doing a great disservice to yourself, your company and your customers because you are not:

• Getting Full Residual Value
• Maintaining Production Quality
• Keeping Up with Technology
• Leveraging the Tax Code to Your Advantage

The following details exactly why thermoformers need to borrow from the auto industry’s playbook and begin exchanging their old equipment for new equipment every seven years.

GETTING FULL RESIDUAL VALUE

If after owning your car for seven years, someone were to offer you 30% of its original price tag, you would probably pull a muscle leaping at the chance to make that deal. But you know that you will never get an offer like that - at least not for your car.

However, the opportunity to make that deal with your thermoforming machinery is a daily reality.

After seven years, your thermoforming machine should retain at least 30% of its original value. The thermoformer you bought brand new for $700,000 will still be worth $250,000 after year seven. However, that 30% figure will decrease incrementally with each passing year and if you hold onto a piece of equipment too long, it’s only worth will be as scrap material.

“The world is getting smaller, and the world is demanding more quality,” said Brian Crawford, Lyle Industries’ Vice President of Sales. “The world market has evolved and matured considerably and will not accept substandard equipment. The people in Latin America, India and China aren’t just going to take any machine.”

The residual value of your machine can vary, depending on a number of factors.

“After seven years, your residual value can range from 20% to 50%, depending on the condition of the machine,” according to Bill Kent of Brown Machine L.L.C. “You walk into some plants, and the machine is 8 years old but looks like it’s only a couple years old. In others, it’s hard to determine its age.”

When purchasing new equipment, it’s also important to consider features that will make this new machine more attractive in the future - and thus hold a higher residual value, according to Roger Moore, TSL Vice President of Sales.

“You have to consider the original specs on the equipment,” he said. “Sometimes the additional value or cost up front for certain features is little compared to the residual value down the road. Quartz top-heat and bottom-heat tunnels are preferred to calrod or tubular heaters because of the materials being used such as polypropylene.”

Moore added that certain features for thermoformers, such as servo drives, are vital to a machine retaining its residual value.

“There’s always a buyer for everything,” he said. “But trying to sell a non-servo machine in today’s environment is very difficult.”

MAINTAINING PRODUCTION QUALITY

Just like cars and their drivers, thermoforming machines and their usage patterns can be broken down into three general categories:

1. Heavy Use: 7 years old, 5-7 days per week, 2-3 shifts per day.
This is the equivalent of a car driven by a sales rep or someone that puts between 20,000 -40,000 miles on their car each year.
2. Moderate Use: 10 years old, 5-7 days per week, 1 shift per day
This is the average driver that commutes to and from work for a total of about 32 miles daily.
3. Light Use: 10 years old and older, 1 shift per week
This is the clichéd little old lady who only drives her car to church on Sundays.

With most thermoformers falling in the Heavy Use and Moderate Use categories, you can see that the lion’s share of equipment in the industry experiences a substantial amount of wear and tear. As a result, you can count on your machine to suffer considerable losses in both performance and production.

“After seven years, you are definitely going to lose speed and precision,” Lyle’s Crawford said. “As parts loosen up, the running tolerances will be a bit wider. You can retool but if you don’t maintain the press, you’ll lose quality around the edges.”

In addition to a loss in quality, you are also going to experience a significant loss in the machine’s output, ranging from 10% to 25%.

“You are going to see a loss in productivity of at least 10%,” Crawford added. “Users of equipment can easily verify this. And many would say that 10% is a somewhat conservative estimate. And this loss in productivity can vary depending on how well the equipment was cared for and maintained.”

Brian Urban, Sencorp, Inc. President and CEO, is one of those people.

“After the seventh year, the machine will be performing with less than 75% efficiency. And that’s without technical upgrades,” Urban said. He added that a 12-year-old machine that has been rebuilt to specifications will still suffer a 25% loss in throughput.

In addition, your costs to maintain and upkeep your presses after the seventh year will increase dramatically, Crawford said.

Another factor is tooling and whether or not it is properly integrated with the machine, said Brown’s Kent. In some instances when using certain materials, you have tooling that does not match the press in terms of speed, so the processor must slow down the entire run.

“And when you ask them, ‘Why don’t you just buy some new tooling for your press?,’ they tell you they can’t because it’s cost prohibitive,” Kent said. “The people doing the bigger production runs can justify paying for the new tooling but the short-run processors can’t.”

All manufacturers agree that the technological improvements occurring over the last five years has given plastic processors the ability to use larger molds.

“Running larger tools or molds and holding higher form air pressures has resulted in a higher yield and a higher quality product from our machines,” TSL’s Moore said.

KEEPING UP WITH TECHNOLOGY

Seven years ago there was no satellite radio in cars - or anywhere else for that matter.

But nowadays, satellite radio is nearly a standard option in most cars.

GPS navigation. Blue tooth-compatible electronic systems. Pre-crash safety systems. Adaptive cruise control. These are all relatively new bells and whistles that the automakers have given us in recent years.

And thermoforming machinery is no different.

There are innovations every year to thermoforming equipment and these enhancements tend to add up over the lifetime of a machine. What may have been a new “bell or whistle” when you purchased the machine is a standard in year four.

“After seven years, you’re obviously going to see better control schemes, heating enhancements, advances in materials, and new designs to make the thermoforming process more precise,” Lyle’s Crawford said.

Some parts — such as drives, motors, computer-programmed controllers, ovens and pneumatic cylinders - seem to improve on an annual basis, Crawford said. And the materials being used are in a state of perpetual improvement.

“There will always be a demand placed on the materials used and their ability to form and cool quickly,” he said. “Plastics materials are constantly evolving.”
Just look one aspect of the thermoforming equation - heating.

Just a decade ago, gas catalytic heaters were highly prevalent, but known for their considerable up-front cost, lack of control, substantial replacement cost, short life, poor uniformity and low temperature. These negatives were enough mandate a change in technology. And when infrared technology surfaced, these “issues” were not only remedied, but the overall performance of the new technology was significantly stronger as well. Infrared heating boasts an efficiency of 80%, while gas catalytic heaters run at a rate of about 30%.

And there is no ceiling to technological advances to thermoforming equipment. They will always occur because competition drives OEMs to seek new ways to improve and further differentiate themselves from one another. Whether it’s an improvement in the thermoforming process or a machine’s reliability, repeatability and precision, technological progress is inevitable.

Plus, processors often compete with each other to respond to customer needs and meet their demands.

“Ultimately, end-user demands will drive change,” Crawford said. “Customers are going to request better and more precise parts from plastics processors and they, in turn, will demand greater quality and performance from their machines. This will obviously come back to the OEMs.”

Kent agreed that processors need to be wary of keeping pace with technology to meet customer and market demands.

“Technology is advancing so rapidly that about every year something new comes out,” he said. “About 20 years ago, it was very difficult to get polypropylene through a thermoformer. Today, people do it and think nothing of it.”

Bob Colletti of Conlet Plastics, Inc. recently added a MAAC Single-Station Comet to his New Millford, Conn., facility and said the linear transducer, quartz elements and two-speed platens in the machine have really made a difference at the company.

“It’s easily the fastest machine in our shop,” Colletti said. “When you upgrade your technology, the impact goes beyond improved efficiencies and production capacity. New equipment adds value to your entire operation because the added capabilities it brings can attract customers.”

“Plus, a new machine like the Comet gives you a great deal of flexibility in terms of how you use the rest of the equipment in your plant,” he added. “Its speed alone frees up other machinery for other jobs.”
Time is of the essence. Especially when it comes to the time it takes to actually get your new equipment.

Macedonia, Ohio-based Joslyn Manufacturing Co. recently added two Royce Routers to their facility.

“The turnaround was pretty quick compared to others,” said Bret Joslyn. “For us, downtime is a killer. With new machinery, we want to plug it in and have it start running immediately.”

Before adding the Royce Routers, Joslyn had four older machines that were down 30% of the time.

“The improvement in technology warrants the purchase,” Joslyn said. “The speed and holding tolerance of the Royce is exceptional. By adding these two machines, we probably improved our cycle times by over 30%.”

LEVERAGING THE TAX CODE TO YOUR ADVANTAGE

Once you have your equipment, you want to do everything you can to get the most mileage out of your money and to protect your investment.

After the seventh year, you can no longer realize a tax break from depreciation on your capital equipment.

This is where exchanging your old equipment for new comes into play. The Like-Kind Exchange is the perfect tax vehicle for maximizing your new purchase.

Rather than recognize a large taxable gain, IRS Code 1031 allows you defer the tax if you structure the deal as a like-kind exchange rather than as a sale. This enables you to apply all of the appreciation in your property, undiminished by the tax that would otherwise be payable, toward acquiring replacement property.

Essentially, IRS Code 1031 allows the seller to reinvest total sale proceeds. The amount not paid in capital gains tax to federal and state governments allows the investor to build equity. Therefore, tax deferment increases the availability of funds that can be invested and enhances value that is compounded with continuous re-investments.
To qualify for like-kind benefits, the following four conditions must be met:
1. The property traded and received must be used for business or investment purposes.
2. The property traded and received must not be held primarily for sale, such as inventory.
3. The properties must be of a like kind (i.e., real estate can only be exchanged for real estate).
4. The properties must be tangible (i.e., stocks, bonds, notes, securities, evidences of debt, or partnership interests do not qualify).

The most common types of exchanges are as follows:

• Simultaneous Exchange: One in which you trade your property for property that another party already owns (i.e., the transfers occur contemporaneously).

• Deferred Exchange: One in which you transfer property for the other party’s promise to acquire and transfer property of like-kind to you. Deferred exchanges must satisfy two timing rules. First, within 45 days of the transfer of your property, you must give the other party written identification of the property you want to receive. Second, you must receive that property within 180 days after transferring your property or within the due date of your tax return for the year of your transfer. It is recommended that you use an escrow account to handle a deferred exchange. The escrow holder or trustee cannot be a “disqualified” person such as your agent or someone who is “related” to you or your agent.

• Exchanges Handled by Intermediaries: The third and most common way to make a like-kind exchange is to use a qualified intermediary that is contracted to transfer (and acquire, if necessary) both properties. As with an escrow holder or trustee, the intermediary cannot be a disqualified person. Equipped with the appropriate expertise, forms and timelines, Stopol is a qualified intermediary.

The following are a few special rules about like-kind exchanges to keep in mind:

• The tax consequences to the other party do not affect your tax status.

• If the properties are not equal in value, one party can transfer cash or other non-like-kind property to equalize the exchange. Although non-like-kind property is taxable to the recipient, the transaction still qualifies as like-kind.

• If you transfer a liability in the exchange, the liability is treated as cash and is taxable to you.

Although structuring a like-kind exchange can be complex, the tax deferral is often worthwhile. You may want to consult with your tax attorney on how to take advantage of the like-kind exchange law.
Please see the scenario below for an example of how IRS Code 1031 can work for a plastics processor:

Stopol informs Company A of a piece of property that is available.  Company A purchases the property for $300,000 and sells it a few years later for $500,000 - for a profit of $200,000.  Under normal circumstances, Company A is required to pay capital gains taxes on that $200,000.  However, Stopol informs Company A of another piece of property that is available, and Company A purchases it for $500,000.  By structuring the deal as a like-kind exchange, Company A is exempt from capital gains taxes until it makes a profit off the new investment.

CONCLUSION

Our future hinges on our ability to re-condition the industry and how they perceive their equipment.

As stated earlier, we need to steal a page from the auto industry and aggressively promote the benefits of exchanging old equipment for new every seven years. We need to educate the industry

It makes economic sense to trade in your 7-year-old machine and still receive 30% of its residual value rather than trying to “dump” the equipment five years later and receive nothing in return.

It makes business sense to continually upgrade your technology to bolster your performance and further meet the demands and needs of your customers.

And it’s common sense to market your company and its production capabilities as proactive, progressive and forward-thinking - qualities that create value for your customers and for you.