Cooperatives: What We Expect to See in 2019 – Dennis Gardiner, Managing Partner, CPA

This year started out with a whimper compared to last year’s angst over the roll out of the Tax Cuts and Jobs Act (TCJA), particularly as 199 appeared to be axed and replaced by 199A.

That was probably one of the most trying times as we attempted to digest and disseminate information as it was coming to us without a lot of clarity. But the dust has settled (or has started to) and we (you) are adapting. Now you get to deal with no export soybean bid as the president’s trade war wages on.

What does 2019 hold for the industry and our clients? As always, our perspective comes from involvement in your audits, board and annual meetings, planning sessions and visiting with management. Here are our thoughts.

Capital Expenditures – Again some slow-down is anticipated; yet still spending your depreciation expense. Budgets seem to be tightening as cooperatives adapt to the leaner years they    are starting to experience. The “build it and they will come” mentality is not the approach we see our clients taking in the coming year.

+ Local (Operating) Earnings – Your grain business, certainly corn, appears to have a carry in the market, similar to what you have had in the past. Soybeans will be the challenge for most of you with the current China-US trade war. Competition for the seed and chemical business continues to ramp up, further stressing margins and reducing volume sales. Milk prices are likely to stay down as stocks continue to build. Drying is likely to be down as 2018 was not a wet crop. Storage should be higher with grain prices, carry in the corn market and soybean uncertainty. Precision agronomy income continues to increase.

+ Fertilizer Sales –Lower commodity prices and greater use of precision agriculture are likely to drive down fertilizer sales tons. We hear fertilizer prices are going up, particularly nitrogen prices. Also, a lot of the NH3 sales are being pushed to the spring with last fall’s weather.

Expenses – With operating results as they were the last few years, and the merger frenzy we went through, we see much greater focus on addressing expenses. After the dust settled on some of the mergers, managers and board members see their challenges in right-sizing their companies. Fixed expenses are not likely to decrease, depreciation may stabilize, at best. Personnel costs will continue to increase as cooperatives face a new work force, competition for talent and ever-increasing benefit costs.

Credit Risks – Diligence and adherence are the most important principles to stay true to in this risk area of your operation. Having strict credit policies AND adhering to them will help our clients weather any concerns that surface. Most of you have been very good at managing this risk—don’t let up.

+ Cybersecurity – Similar to the above topic, diligence and adherence are the best way to protect your organization from cyber risks. You can’t read any news without seeing another company you do business with has compromised your personal information. Educating your staff, working with your vendors, and strengthening your controls will help to reduce your vulnerability to hacking and cyber fraud. We expect to see continued improvement in controls over information, access restrictions to your systems, applications, data, third party records and sensitive data.

+ Fraud – Many of your organizations have continued to grow, hiring new employees, or replacing employees through attrition. Having a strong “tone-at-the-top,” creating an ethical work environment and having zero-tolerance to fraud will help mitigate your fraud risks. You should do a fraud risk assessment of your organization, its divisions and accounting functions. By doing so, you can address areas of susceptibility before they become a problem. More will turn to a third-party “whistle-blower” hotline, to provide for anonymous reporting.

+ Mergers – A slow-down, not likely. Although this varies by states that we serve, the merger of smaller companies seems to be over the hump. That said, some of the remaining smaller cooperative mergers are likely from a manager’s retiring or another strained year’s results. Next, we could see some sizable “peer on peer” mergers. There is likely to be some of these in the coming year, or at least talks initiated. The “kumbaya” merger approach may be diminishing as successor cooperatives take a more discerning look at how their potential merger partner has performed, its facilities (condition and strategic location), and its workforce. We keep getting asked, “is bigger better?”

+ Acquisitions – These opportunities will continue to come to you—from “ma and pa” or smaller businesses that have been competitors in your trade areas. The cooperative will continue to be a magnet for these businesses as they consider exiting, and perhaps working to retirement to have health insurance for the owners. We would expect to see more of these in the coming years.

+ Retained Earnings – Equity without a patron’s name on it continues on a fast-track and difficult to slow down, either by dollar amount or as a percentage of total equity. Smaller allocations, larger cash percentages, continued use of 199 / 199A(g) internally to reduce taxable income and robust equity revolvements continue to tilt the percentage of equity of permanent capital higher.

+ Non-Qualified Patronage Allocations – We have more discussions on non-qualified patronage today than ever. Many more cooperative presentations focus on this tool as a means of addressing the concern—if it is one—of the “tilt” of total equity towards permanent capital versus equity that has a member’s name on it.

+ People – Invest in them! I have had so many conversations with management over the last year about their challenges in finding and retaining talent (which Gardiner + Co. is not immune to either). Key concerns seem to be finding staff to work outside (in all the weather conditions they have to endure), long hours, weekends, holidays, etc. We are going to be challenged by this. Sorry, no crystal ball here to answer this one for you. That said, the answer with the new work force may very well be to hire more staff to do the job it took fewer to do before, or sharing amongst departments. You’ll probably have to throw out the “this is how we have always done it” thought process. From what I have observed, even the idea of higher compensation, overtime, etc., doesn’t resolve the problem. Another key concern is retaining your management staff. Moving among companies does not bother the current generation. Our outlook for this issue, unfortunately, is that it continues and for sure does not get better.

+ Technology – There doesn’t seem to be a way to spend enough to keep up with technology advances. We see plenty of clients switching data-processing vendors, with no clear winner (or loser). Mobility to allow users and members to access the system and their accounts from any mobile device is the trend. Unfortunately, some of these enhancements and advancements in technology may expose you to more cybersecurity worries. This risk and reality of the digital era has to be managed proactively. Most of our clients are actively involved in precision agriculture for the benefit of their member producers.

+ Tax Cuts and Jobs Act (TCJA) – Once all of our cooperative clients are filing 2018 returns (which is only true for December closes at this stage), we will move beyond any confusion all the last year of noise has created. At the end of the day, nothing has changed for the cooperative. You are (or will be) dealing with 199A(g) instead of 199. From the cooperative perspective, we will be having the same discussions we have had in the past, the use of or the ability to allocate the deduction has not changed. Now, from the patron perspective, that is not true. Corporate farmers will NOT be able to use any allocation of 199 or 199A(g) if they are year-end tax filers. They got a 40% savings in their tax rates from 35% to 21%. And for non-corporate farmers, there is a transition rule that will affect their tax returns as it relates to sales they made to the cooperative from January 1, 2018 through your fiscal year end. (See the article later on in the newsletter for details.)

There is one reality that came out of TCJA. Depending on your patron member’s earnings level and paid W-2 wages, they will incur a potential reduction of their 20% of qualified business income (QBI) deduction. This reduction can be as large as 9% of the 20% QBI deduction, bringing it down to 11%. This does not apply to corporate farmers. Cooperatives that DO NOT pay any patronage (qualified or non-qualified) or DOES NOT allocate any 199A(g), could be putting themselves at a disadvantage for the patron. This will force you to message the other positives of doing business with the cooperative: shorter lines, faster pits/legs, shorter drives, more equipment to serve the patron timely, better bids, better prices, revolvement of older equity, etc. Unfortunately, area tax preparers are tuned into this and we have heard from clients that these tax preparers are bringing this up with their tax clients (who are your patrons).

The future is as bright as ever for cooperatives. But that does not mean you are cruising and will not have your share of challenges. Cooperatives have always been resilient and are up for what the future brings! We are very proud of our long history with so many of you and the industry, and we strive to be a source for you to address and overcome your challenges!

Happy New Year!