Harnischfeger Case

Group Members:
Mark Breen
Greg Callow
Marv 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 70s
through debt leads to problems
when market shrinks in 80s

Case Facts

Company ends up in violation of

debt covenants
Recovery plan

Change in management
Cost Reductions
Reorientation of Companys business
Debt restructuring and
recapitalization

Strategy Analysis

Industry 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 Analysis

Industry Analysis: Macro

Strategy Analysis

Industry Analysis: Macro

Strategy Analysis

Industry Analysis: Porters 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 Analysis

Industry Analysis: Porters 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 Analysis

Industry Analysis: Porters 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 Analysis

Industry Analysis: Porters 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
Analysis

Differentiation:
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

Analysis

Short term factors for success

Maintaining 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

Analysis

Long 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 Analysis

Explanation of transaction 1.
Depreciation is a method that reduces
the value of capital assets over time
Switch from accelerated to straight
line retroactively
Revenues
Less: Depreciation Expense
= Net Income

Accounting Analysis

1. Change in depreciation
method
Assets
=
Liabilities + Equity
-11.0
Revenue Expense
+11.0

-11.0
=

N.
Income
-11.0

Accounting Analysis

Explanation 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

Accounting Analysis

2. Increase in estimated lives of

assets
Assets

Liabilities + Equity

-3.2
Revenue Expense
+3.2

-3.2
=

N.
Income
-3.2

Accounting Analysis

Explanation 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 Analysis

3. Increase in rates of return on

pension assets
Assets

Revenue Expenses
+4.0

Liabilities + Equity
+ 4.0

-4.0

N.
Income
-4.0

Accounting Analysis

Explanation 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

Accounting Analysis

4. LIFO inventory liquidated

Assets

Liabilities + Equity

-2.4
Revenue Expense
+2.4

-2.4
=

N.
Income
-2.4

Accounting Analysis

Explanation 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

Accounting Analysis

5. Decrease in bad debt reserves

Assets

Liabilities + Equity

-2.9
Revenue Expense
+2.9

-2.9
=

N.
Income
-2.9

Accounting Analysis
6. Change in fiscal year

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 Analysis
6. Change in Fiscal Year
Assets

Revenue Expense
?
?

Liabilities + Equity

N.
Income
?

Accounting Analysis

7. Drop in R & D Spending

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 Analysis

7. Drop in R & D Spending

Assets

Liabilities + Equity

-1.3
Revenue Expense
+1.3

-1.3
=

N.
Income
-1.3

Accounting Analysis

8. Transactions with Kobe

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 Analysis
8. Transactions with Kobe
Assets

Revenue Expense
-28
-28

Liabilities + Equity

N.
Income
0

Accounting Analysis

9. Re-structuring of long-term
debt
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 Analysis

9. Long term debt restructuring

Assets

Revenue Expense
?

Liabilities + Equity
?

N.
Income
?

Accounting Analysis:

Comparative Statements
ADJ.

%
change

Effect on
N.I.

44%

11 M

13%

3.2 M

16%

4.0 M

10%

2.4 M

12%

2.9 M

5%

1.3

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 companys
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 writedown 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?