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: Macro
Strategy AnalysisIndustry Analysis: Macro
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
Accounting AnalysisExplanation of transaction 2.
Depreciation Expense (Straight Line)
= Capital Cost / Economic Life
If the Economic Life is increased then depreciation expense is lowered resulting in higher net income
Assets = Liabilities + Equity
-3.2 -3.2
Revenue -
Expense = N. Income
+3.2 -3.2
Accounting Analysis2. Increase in estimated lives of assets
Accounting AnalysisExplanation of transaction 3.
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
Assets = Liabilities + Equity
+ 4.0 -4.0
Revenue -
Expenses = N. Income
+4.0 -4.0
Accounting AnalysisExplanation of transaction 4.
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
Assets = Liabilities + Equity
-2.4 -2.4
Revenue -
Expense = N. Income
+2.4 -2.4
Accounting Analysis4. LIFO inventory liquidated
Accounting AnalysisExplanation of transaction 5.
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
Assets = Liabilities + Equity
-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
Assets = Liabilities + Equity
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
Assets = Liabilities + Equity
-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
Assets = Liabilities + Equity
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
Assets = Liabilities + Equity
? ?
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?