Harnischfeger Presentation

Harnischfeger Case

Group Members:Mark BreenGreg CallowMarv Franz

Mary Mumcuoglu Tracey Weiler

Agenda

Case Facts Strategy Analysis Accounting Analysis Group Task Future Prospects for

Harnischfeger Questions

Case Facts

Machinery Equipment 2 Segments-Heavy Equipment &

Industrial Technologies Group (ITG)

Expected growth in material handling & engineering services

Financed rapid growth in 70’s through debt – leads to problems when market shrinks in 80’s

Case Facts

Company ends up in violation of debt covenants

Recovery plan– Change in management– Cost Reductions– Reorientation of Company’s business– Debt restructuring and

recapitalization

Strategy AnalysisIndustry Analysis: Macro

Improving general business conditions Drop in price of oil

Supply side economics – conservative fiscal policies

Coming out of recession High interest rates



Strategy AnalysisIndustry Analysis: Porter’s 5 Forces Rivalry Among Existing Firms:

High– Low growth for cranes & mining

equip.– Higher growth for ITG– Concentration - Few firms– Switching cost - High– High fixed to variable costs - less for

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

ITG

Strategy AnalysisIndustry Analysis: Porter’s 5 Forces Threat of New Entrants: Low

– High cost of establishing economies of scale

– High capital investment required– Access to distribution channels is difficult– Threat of new entrants is higher for ITG

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

Low

Strategy AnalysisIndustry Analysis: Porter’s 5 Forces Bargaining Power of Buyers: Low

– Switching costs – High– Alternative products – Few– Importance of quality – High– Importance of cost – High

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

Strategy AnalysisIndustry Analysis: Porter’s 5 Forces Overall: The market for cranes and

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

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

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

Strategy Analysis:Competitive Strategy AnalysisDifferentiation: Strategic shift from

manufacturing cranes Still manufacturing mining

equipment Low cost- Economies of Scale,

Efficiency Concerns, Cost Control, Little differentiation

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

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

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

Strategy Analysis:Context for Accounting AnalysisShort term factors for successMaintaining financing/liquidity

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

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

pension forecast, depreciation

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

- Growing high tech materials handling and systems business

-Manufacturing firms continued emphasis on cost reduction programs

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

Accounting AnalysisExplanation of transaction 1.

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

Switch from accelerated to straight line retroactively

RevenuesLess: Depreciation Expense= Net Income

Accounting Analysis1. Change in depreciation method

Assets = Liabilities + Equity

-11.0 -11.0

Revenue -

Expense = N. Income

+11.0 -11.0


Depreciation Expense (Straight Line)

= Capital Cost / Economic Life

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


-3.2 -3.2

Revenue -

Expense = N. Income

+3.2 -3.2

Accounting Analysis2. Increase in estimated lives of assets


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

amendments+/- Amortization of actuarial gain/loss

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

Expected earnings tied in to general market conditions

Accounting Analysis3. Increase in rates of return on pension assets


+ 4.0 -4.0

Revenue -

Expenses = N. Income

+4.0 -4.0


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

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


-2.4 -2.4

Revenue -

Expense = N. Income

+2.4 -2.4

Accounting Analysis4. LIFO inventory liquidated


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

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


-2.9 -2.9

Revenue -

Expense = N. Income

+2.9 -2.9

Accounting Analysis5. Decrease in bad debt reserves

Explanation of change: Change of fiscal year from July 31

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

consolidation with the Corporation

Accounting Analysis6. Change in fiscal year


Revenue -

Expense = N. Income

? ? ?

Accounting Analysis6. Change in Fiscal Year

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

million Kobe to reimburse $5.66 million Shortfall of $1.3 million No explicit note about shortfall

Accounting Analysis7. Drop in R & D Spending


-1.3 -1.3

Revenue -

Expense = N. Income

+1.3 -1.3

Accounting Analysis7. Drop in R & D Spending

Explanation of change: Included in net sales were

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

Said to reflect the nature of the transactions with Kobe

Accounting Analysis8. Transactions with Kobe


Revenue -

Expense = N. Income

-28 -28 0

Accounting Analysis 8. Transactions with Kobe

Explanation of change: Subordinated debentures replace

term obligations Debt payable in German marks

retired The new restructuring said to

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

Accounting Analysis9. Re-structuring of long-term debt


? ?

Revenue -

Expense = N. Income

? ?

Accounting Analysis9. Long term debt restructuring

Accounting Analysis:Comparative Statements

ADJ. % change

Effect on N.I.

1 44% 11 M

2 13% 3.2 M

3 16% 4.0 M

4 10% 2.4 M

5 12% 2.9 M

6 - ?

7 5% 1.3

8 - 0

9 - ?

Total 100% 24.8+ M

Group Activity

3 Groups: Managers, Creditors, Investors

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

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

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

affect any business decision you would make on the company?

Group Activity - Summary Roles influence what information you need

for decision making All the accounting changes increase net

income Management incentives may be a reason

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

eliminate management bonuses Financial distress may be another reason why

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

Group Activity - Summary Big picture shows that there are many

possible reasons for the changes Many assumptions are necessary to

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

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

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

Group Activity - Summary Important to recognize that there are a

wide range of reasons for accounting changes

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

Additional Considerations Should there be an impairment of assets

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

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

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

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

Additional Considerations Given the recovery emerging in the

economy, are pension estimates more or less accurate?

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

Future Prospects

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

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

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

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

Future Prospects

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

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

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

Future Prospects

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

accounting choices, but external reporting was extremely conservative

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

may be necessary since investors may want more information

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

Questions?

Documents

Harnischfeger Presentation