Harnischfeger Case Group Members: Mark Breen Greg Callow Marv Franz Mary Mumcuoglu Tracey Weiler

Harnischfeger CaseHarnischfeger Case

Group Members:Group Members:

Mark BreenMark Breen

Greg CallowGreg Callow

Marv FranzMarv Franz

Mary Mary Mumcuoglu Mumcuoglu

Tracey WeilerTracey Weiler

AgendaAgenda

Case FactsCase Facts Strategy AnalysisStrategy Analysis Accounting AnalysisAccounting Analysis Group TaskGroup Task Future Prospects for Future Prospects for

HarnischfegerHarnischfeger QuestionsQuestions

Case FactsCase Facts

Machinery EquipmentMachinery Equipment 2 Segments-Heavy Equipment & 2 Segments-Heavy Equipment &

Industrial Technologies Group (ITG)Industrial Technologies Group (ITG) Expected growth in material Expected growth in material

handling & engineering serviceshandling & engineering services Financed rapid growth in 70’s Financed rapid growth in 70’s

through debt – leads to problems through debt – leads to problems when market shrinks in 80’swhen market shrinks in 80’s

Case FactsCase Facts

Company ends up in violation of Company ends up in violation of debt covenantsdebt covenants

Recovery planRecovery plan– Change in managementChange in management– Cost ReductionsCost Reductions– Reorientation of Company’s businessReorientation of Company’s business– Debt restructuring and recapitalizationDebt restructuring and recapitalization

Strategy AnalysisStrategy AnalysisIndustry Analysis: MacroIndustry Analysis: Macro

Improving general business Improving general business conditions Drop in price of oil conditions Drop in price of oil

Supply side economics – Supply side economics – conservative fiscal policiesconservative fiscal policies

Coming out of recessionComing out of recession High interest ratesHigh interest rates



Strategy AnalysisStrategy AnalysisIndustry Analysis: Porter’s 5 Industry Analysis: Porter’s 5 ForcesForces Rivalry Among Existing Firms: HighRivalry Among Existing Firms: High

– Low growth for cranes & mining equip.Low growth for cranes & mining equip.– Higher growth for ITGHigher growth for ITG– Concentration - Few firmsConcentration - Few firms– Switching cost - HighSwitching cost - High– High fixed to variable costs - less for High fixed to variable costs - less for

ITGITG– High exit costs – less for ITGHigh exit costs – less for ITG– Conclusion: Rivalry is High - less for ITGConclusion: Rivalry is High - less for ITG

Strategy AnalysisStrategy AnalysisIndustry Analysis: Porter’s 5 Industry Analysis: Porter’s 5 ForcesForces Threat of New Entrants: LowThreat of New Entrants: Low

– High cost of establishing economies of scale High cost of establishing economies of scale – High capital investment requiredHigh capital investment required– Access to distribution channels is difficultAccess to distribution channels is difficult– Threat of new entrants is higher for ITGThreat of new entrants is higher for ITG

Treat of Substitute Products: LowTreat of Substitute Products: Low– Similar price and PerformanceSimilar price and Performance– Consumers willingness to switch products -Consumers willingness to switch products -

LowLow

Strategy AnalysisStrategy AnalysisIndustry Analysis: Porter’s 5 Industry Analysis: Porter’s 5 ForcesForces Bargaining Power of Buyers: LowBargaining Power of Buyers: Low

– Switching costs – HighSwitching costs – High– Alternative products – FewAlternative products – Few– Importance of quality – HighImportance of quality – High– Importance of cost – HighImportance of cost – High

Bargaining Power of Suppliers: LowBargaining Power of Suppliers: Low– Switching cost – LowSwitching cost – Low– Alternative products – ManyAlternative products – Many– Quality and Cost considerations -HighQuality and Cost considerations -High

Strategy AnalysisStrategy AnalysisIndustry Analysis: Porter’s 5 Industry Analysis: Porter’s 5 ForcesForces Overall: The market for cranes and Overall: The market for cranes and

mining machinery is less attractive mining machinery is less attractive than the market for ITG products & than the market for ITG products & servicesservices

The income statement of The income statement of Harnischfeger will likely show losses or Harnischfeger will likely show losses or low profitability for the near futurelow profitability for the near future

Therefore, Harnischfeger needs to be a Therefore, Harnischfeger needs to be a low cost producer to survivelow cost producer to survive

Strategy Analysis:Strategy Analysis:Competitive Strategy Competitive Strategy AnalysisAnalysisDifferentiation:Differentiation: Strategic shift from manufacturing Strategic shift from manufacturing

cranes cranes Still manufacturing mining Still manufacturing mining

equipmentequipment Low cost- Economies of Scale, Low cost- Economies of Scale,

Efficiency Concerns, Cost Control, Efficiency Concerns, Cost Control, Little differentiationLittle differentiation

Strategy Analysis:Strategy Analysis:Competitive Strategy Competitive Strategy AnalysisAnalysis New Strategy – Focus on the high New Strategy – Focus on the high

tech part of businesstech part of business Creation of ITGCreation of ITG Differentiation – High R&D Differentiation – High R&D

required, Innovation, skilled staff, required, Innovation, skilled staff, customization requires flexibility customization requires flexibility and customer service and customer service

Strategy Analysis:Strategy Analysis:Context for Accounting Context for Accounting AnalysisAnalysisShort term factors for successShort term factors for successMaintaining financing/liquidityMaintaining financing/liquidity

-Look for accounting to improve -Look for accounting to improve revenue, cash flow, expense revenue, cash flow, expense

reduction, reduction, reported earningsreported earnings•Ex. Policy changes: revenue Ex. Policy changes: revenue recognition, recognition, inventory, depreciationinventory, depreciation Estimates: allowances for reserves, Estimates: allowances for reserves,

pension forecast, depreciation pension forecast, depreciation

Strategy Analysis:Strategy Analysis:Context for Accounting Context for Accounting AnalysisAnalysisLong Term factors for successLong Term factors for success Industrial Technologies Group: Industrial Technologies Group:

- Growing high tech materials - Growing high tech materials handling and systems businesshandling and systems business

-Manufacturing firms continued -Manufacturing firms continued emphasis on cost reduction emphasis on cost reduction programsprograms

Secure R&D funding, innovation, Secure R&D funding, innovation, strategic alliances, skilled staff, etc.strategic alliances, skilled staff, etc.

Accounting AnalysisAccounting AnalysisExplanation of transaction 1.Explanation of transaction 1.

Depreciation is a method that reduces Depreciation is a method that reduces the value of capital assets over timethe value of capital assets over time

Switch from accelerated to straight Switch from accelerated to straight line retroactivelyline retroactively

RevenuesRevenues

Less: Depreciation ExpenseLess: Depreciation Expense

= Net Income= Net Income

Accounting AnalysisAccounting Analysis1. Change in depreciation 1. Change in depreciation methodmethod

AssetsAssets == LiabilitiesLiabilities + Equity+ Equity

-11.0-11.0 -11.0-11.0

Revenue Revenue --

ExpenseExpense == N. N. IncomeIncome

+11.0+11.0 -11.0-11.0


Depreciation Expense (Straight Line)Depreciation Expense (Straight Line)

= Capital Cost / Economic Life= Capital Cost / Economic Life

If the Economic Life is increased If the Economic Life is increased then depreciation expense is then depreciation expense is lowered resulting in higher net lowered resulting in higher net incomeincome


-3.2-3.2 -3.2-3.2

Revenue Revenue --


+3.2+3.2 -3.2-3.2

Accounting AnalysisAccounting Analysis2. Increase in estimated lives of 2. Increase in estimated lives of assetsassets


Components of Pension Expense:Components of Pension Expense:Current Service CostCurrent Service Cost+Interest on Accrued Pension Liability+Interest on Accrued Pension Liability-Expected Earning on Assets-Expected Earning on Assets+Amortization of start up costs+Amortization of start up costs+Amortization of prior service cost from +Amortization of prior service cost from

amendmentsamendments+/- Amortization of actuarial gain/loss+/- Amortization of actuarial gain/loss

Higher expected earnings produce a lower Higher expected earnings produce a lower pension expense resulting in higher net incomepension expense resulting in higher net income

Expected earnings tied in to general market Expected earnings tied in to general market conditionsconditions

Accounting AnalysisAccounting Analysis3. Increase in rates of return on 3. Increase in rates of return on pension assetspension assets


+ 4.0+ 4.0 -4.0-4.0

Revenue Revenue --

ExpensesExpenses == N. N. IncomeIncome

+4.0+4.0 -4.0-4.0


LIFO (Last In First Out) is a method LIFO (Last In First Out) is a method of valuing inventory where the latest of valuing inventory where the latest costs of raw materials are used in costs of raw materials are used in determining cost of goods sold (it is determining cost of goods sold (it is assumed that the last unit added to assumed that the last unit added to inventory is the first sold)inventory is the first sold)

Since inventory is liquidated at lower Since inventory is liquidated at lower cost than current cost, COGS is cost than current cost, COGS is lower and Net Income is higherlower and Net Income is higher


-2.4-2.4 -2.4-2.4

Revenue Revenue --


+2.4+2.4 -2.4-2.4

Accounting AnalysisAccounting Analysis4. LIFO inventory liquidated4. LIFO inventory liquidated


Bad debt reserve is an estimate of Bad debt reserve is an estimate of accounts receivable that will not be accounts receivable that will not be collected.collected.

In 1983, this reserve was estimated In 1983, this reserve was estimated at 10% of accounts receivable. In at 10% of accounts receivable. In 1984, an estimate of 6.7% was 1984, an estimate of 6.7% was applied resulting in higher accounts applied resulting in higher accounts receivable and thus higher net receivable and thus higher net income income


-2.9-2.9 -2.9-2.9

Revenue Revenue --


+2.9+2.9 -2.9-2.9

Accounting AnalysisAccounting Analysis5. Decrease in bad debt reserves5. Decrease in bad debt reserves

Explanation of change:Explanation of change: Change of fiscal year from July 31 Change of fiscal year from July 31

to September 30.to September 30. Increase in sales by $5.4 MillionIncrease in sales by $5.4 Million Said to provide more timely Said to provide more timely

consolidation with the consolidation with the CorporationCorporation

Accounting AnalysisAccounting Analysis6. Change in fiscal year6. Change in fiscal year


Revenue Revenue --


?? ?? ??

Accounting AnalysisAccounting Analysis6. Change in Fiscal Year6. Change in Fiscal Year

Explanation of change:Explanation of change: Decrease in R & D expense by $7 Decrease in R & D expense by $7

millionmillion Kobe to reimburse $5.66 millionKobe to reimburse $5.66 million Shortfall of $1.3 millionShortfall of $1.3 million No explicit note about shortfallNo explicit note about shortfall

Accounting AnalysisAccounting Analysis7. Drop in R & D Spending7. Drop in R & D Spending


-1.3-1.3 -1.3-1.3

Revenue Revenue --


+1.3+1.3 -1.3-1.3

Accounting AnalysisAccounting Analysis7. Drop in R & D Spending7. Drop in R & D Spending

Explanation of change:Explanation of change: Included in net sales were Included in net sales were

products purchased from Kobe products purchased from Kobe and sold to 3and sold to 3rdrd parties (vs. gross parties (vs. gross margin)margin)

Said to reflect the nature of the Said to reflect the nature of the transactions with Kobetransactions with Kobe

Accounting AnalysisAccounting Analysis8. Transactions with Kobe8. Transactions with Kobe


Revenue Revenue --


-28-28 -28-28 00

Accounting AnalysisAccounting Analysis 8. Transactions with Kobe8. Transactions with Kobe

Explanation of change:Explanation of change: Subordinated debentures replace Subordinated debentures replace

term obligationsterm obligations Debt payable in German marks Debt payable in German marks

retiredretired The new restructuring said to acquire The new restructuring said to acquire

long-term capital with minimum cash long-term capital with minimum cash flow requirements to service itflow requirements to service it

Accounting AnalysisAccounting Analysis9. Re-structuring of long-term 9. Re-structuring of long-term debtdebt


?? ??

Revenue Revenue --


?? ??

Accounting AnalysisAccounting Analysis9. Long term debt restructuring9. Long term debt restructuring

Accounting Analysis:Accounting Analysis:Comparative StatementsComparative Statements

ADJ.ADJ. % % changechange

Effect on Effect on N.I.N.I.

11 44%44% 11 M11 M

22 13%13% 3.2 M3.2 M

33 16%16% 4.0 M4.0 M

44 10%10% 2.4 M2.4 M

55 12%12% 2.9 M2.9 M

66 -- ??

77 5%5% 1.31.3

88 -- 00

99 -- ??

TotalTotal 100%100% 24.8+ M24.8+ M

Group ActivityGroup Activity

3 Groups: Managers, Creditors, 3 Groups: Managers, Creditors, InvestorsInvestors

Instructions: Examine how your role Instructions: Examine how your role would interpret the previously detailed would interpret the previously detailed accounting changes, and discuss:accounting changes, and discuss:– What are the company’s What are the company’s

rationale/motivations behind the changes?rationale/motivations behind the changes?– How useful is the information provided by How useful is the information provided by

the company about the changes?the company about the changes?– Discuss if or how the adjustments would Discuss if or how the adjustments would

affect any business decision you would affect any business decision you would make on the company?make on the company?

Group Activity - Group Activity - SummarySummary Roles influence what information you need Roles influence what information you need

for decision makingfor decision making All the accounting changes increase net All the accounting changes increase net

incomeincome Management incentives may be a reason Management incentives may be a reason

why management made the changeswhy management made the changes– However, one of the cost cutting measures was to However, one of the cost cutting measures was to

eliminate management bonuseseliminate management bonuses Financial distress may be another reason Financial distress may be another reason

why the company made accounting changes, why the company made accounting changes, for example, renegotiated loan covenants, for example, renegotiated loan covenants, etc.etc.

Group Activity - Group Activity - SummarySummary Big picture shows that there are many Big picture shows that there are many

possible reasons for the changespossible reasons for the changes Many assumptions are necessary to Many assumptions are necessary to

assess the motivations of management, assess the motivations of management, as you never have the full inside as you never have the full inside informationinformation

With limited information you have to With limited information you have to consider a wide range of possibilitiesconsider a wide range of possibilities

Need to be flexible, since there are many Need to be flexible, since there are many explanations for accounting changesexplanations for accounting changes

Group Activity - Group Activity - SummarySummary Important to recognize that there are a Important to recognize that there are a

wide range of reasons for accounting wide range of reasons for accounting changeschanges

Changes in estimates are more difficult Changes in estimates are more difficult to understand than accounting to understand than accounting changes and often require additional changes and often require additional information information

Additional Additional ConsiderationsConsiderations Should there be an impairment of assets related Should there be an impairment of assets related

to their construction equipment business?to their construction equipment business?– Since the company is stopping the manufacturing of Since the company is stopping the manufacturing of

cranes - should there potentially be an increased cranes - should there potentially be an increased write-down of assets related to that line of business? write-down of assets related to that line of business? There might not be much of a resale market There might not be much of a resale market

Presentation of Unconsolidated Companies (especially Presentation of Unconsolidated Companies (especially finance company)finance company)– The relationship with their financing company - Since The relationship with their financing company - Since

the company does not consolidate their finance the company does not consolidate their finance company they could potentially factor receivables and company they could potentially factor receivables and bury any potential bad debt allowance on that line bury any potential bad debt allowance on that line item. It could possibly distort earnings from item. It could possibly distort earnings from operations?operations?

Additional Additional ConsiderationsConsiderations Given the recovery emerging in the Given the recovery emerging in the

economy, are pension estimates more economy, are pension estimates more or less accurate?or less accurate?

Research and Development Research and Development expenditures: Is the company expenditures: Is the company obligated to pay the full 17 million to obligated to pay the full 17 million to get any cash back from Kobe? The get any cash back from Kobe? The notes to the agreement presented in notes to the agreement presented in the case are a little vaguethe case are a little vague

Future ProspectsFuture Prospects

The accounting changes increase net income The accounting changes increase net income and Harnischfeger hopes that this will and Harnischfeger hopes that this will encourage investors to boost the stock priceencourage investors to boost the stock price

Investors may also believe that the changes Investors may also believe that the changes are part of the entire forward looking business are part of the entire forward looking business strategy, and thus stock prices may increasestrategy, and thus stock prices may increase

An increased stock price may help raise capital An increased stock price may help raise capital in the futurein the future– However, if investors have been making adjustments However, if investors have been making adjustments

all along to compare Harnischfeger to other firms in all along to compare Harnischfeger to other firms in the industry, there may be no change in stock pricethe industry, there may be no change in stock price


Investors may see that the changes have Investors may see that the changes have no cash flow implications, or be as a no cash flow implications, or be as a result of management incentivesresult of management incentives

Company went through difficult Company went through difficult negotiations with their lenders to make negotiations with their lenders to make the possibility of bankruptcy more the possibility of bankruptcy more unlikely in the futureunlikely in the future

The company may want to promote itself The company may want to promote itself in a good light with their suppliers, in a good light with their suppliers, customers, and employeescustomers, and employees


The company may want to match external The company may want to match external vs. internal reporting standards. vs. internal reporting standards. – Internal operations seem to be based on industry Internal operations seem to be based on industry

accounting choices, but external reporting was accounting choices, but external reporting was extremely conservative extremely conservative

– This may make internal operations more efficientThis may make internal operations more efficient Same accounting methods as the industry Same accounting methods as the industry

may be necessary since investors may want may be necessary since investors may want more informationmore information

The drop in R&D – Improves short-term The drop in R&D – Improves short-term finance but could possibly impair future finance but could possibly impair future prospects for companyprospects for company

Questions?Questions?

Documents

Harnischfeger Case Group Members: Mark Breen Greg Callow Marv Franz Mary Mumcuoglu Tracey Weiler