The Pileup Of Questions About FruehaufMichael Schroeder
It looked like a rock-solid stock offering. When Fruehauf Trailer Corp., once the nation's dominant truck-trailer maker, sold 33% of itself to the public in July, 1991, at $11 a share, investors snapped up the stock. After all, Randolph W. Lenz, chairman of Fruehauf's parent, Terex Corp., had said shortly before the offering that Fruehauf's "cash flow and overall liquidity remain healthy due to our strong working capital position, and we look forward to improved earnings prospects as the economy recovers." The good news continued. By April, 1992, the shares had surged to $17.75 apiece. Last July, Arthur E. Rowe, then Fruehauf's CEO, boasted: "We're well on our way to being virtually debt-free in the near term."
But the good news was too good to be true. It appears that the company may have been less than diligent in disclosing in a timely fashion a lot of its problems, brought on at least in part by the recession. During the second quarter of 1991, slumping sales and earnings caused Southfield (Mich.)-based Fruehauf to fall out of compliance with the terms of its loan agreement with a group of banks. Just before the initial public offering, it skated perilously close to default on the bank loans, which are fully secured, yet it didn't inform prospective investors of that. Not until March, 1992--long after the IPO--did the manufacturer finally disclose to shareholders its lack of compliance with the loan agreement.
TIGHTER LEASH. Moreover, in late 1991, the Securities & Exchange Commission ruled that the company had used overly aggressive bookkeeping--chiefly, counting excess pension-fund money as income--to puff up reported second- and third-quarter earnings. The SEC pressured Fruehauf to lower earnings dramatically for the two periods (table). Since then, under more conservative accounting, the company has run a red-ink gusher each quarter. Losses in 1992 through Sept. 30 total $28 million (chart).
Investors have suffered. Since April, the stock has sunk to 5. "This is a case of a company tricking the investing public," says Howard M. Schilit, an accounting professor at American University. Terex, which now has 42% of the stock, retains voting control of Fruehauf.
In a three-hour-long interview with BUSINESS WEEK on Dec. 1, Lenz and other top executives denied that the company has misled investors in any way. Lenz says Fruehauf was not in default under its bank agreements at the time of the public offering because the banks had granted it a waiver. Marvin B. Rosenberg, Fruehauf's secretary, says the company was not required to disclose that the banks had given it a reprieve on loan violations. Lenz also asserts that Fruehauf has never missed a bank payment and that it was never required to disclose potential defaults. Nevertheless, David J. Langevin, a vice-president at KCS Industries Inc., a management firm controlled by Lenz that has operational control of Fruehauf and Terex, says: "We have to come out with very conservative earnings statements from this point forward. Even much more conservative than our previous ones."
On top of all that, the SEC has begun an investigation into other questionable accounting practices at Terex alleged in an Oct. 12 BUSINESS WEEK story. "The SEC has adorned us with a number of comments," including a 10-page letter requesting information and documents, confirms Langevin.
In fairness, Fruehauf has been struggling since late 1986, when it was overloaded with debt from a $1.4 billion leveraged buyout by management led by Merrill Lynch & Co. From then until Terex bought Fruehauf's truck-trailer division for $231 million in July, 1989, the company had cumulative operating losses of $90 million. (The other part of the company, K-H Corp., was sold to Varity Corp. in 1989.)
Yet Terex looked like a miracle worker for a while. Even though the company's purchase coincided with the beginning of a sharp cyclical downturn in the truck-trailer business, the Fruehauf unit posted a profit of $2.3 million for 1990, according to the stock-offering prospectus. Current and former executives say the bulk of the earnings came from fulfillment of backlogged orders, shaving overhead, and drawing down reserves.
Once those quick gains were exhausted, the reality of the recession began to bite. Fruehauf posted a $4 million loss for the first quarter of 1991, putting pressure on its dwindling cash resources. The loss, if it continued, would have put Fruehauf in default of its banks' terms, which required profits of $8 million for the first six months of the year. In May, to forestall that possibility, it was able to get amendments to the loan requirements drawn up by the bank group. Among other things, the banks lowered the income threshold from $8 million to $2 million for the first six months of 1991.
POINT OF INTEREST. High debt was also making it difficult for Fruehauf to meet the banks' net-worth standards. Encouraged by its bankers, Terex issued a Fruehauf IPO on June 28 to raise cash. The prospectus didn't mention that Fruehauf was having trouble complying with its loan agreements--a fact that would have been of interest to prospective investors. Nor did it mention the significance of the May loan amendments.
"What drove this equity offering exclusively was that they were in violation of the loan agreement," speculates American University's Schilit, adding: "That makes it more egregious that they didn't disclose it in the prospectus." Fruehauf executives deny that and contend that they needed the fresh capital to reduce debt.
Still, the easier loan terms weren't easy enough. To meet the $2 million minimum-profit target for 1991's first half, Fruehauf took $10 million in excess money from its pension fund and fed it into the company's income stream as operating profit. That helped put it in the black for 1991's second quarter. A note in the second-quarter earnings report referred only to a "nonrecurring pension expense adjustment" without disclosing the $10 million amount. Rosenberg, the company's secretary, says Deloitte & Touche, its accounting firm, approved the pension adjustment.
The SEC did not approve, however. So, in November, 1991, Fruehauf removed the gains stemming from the pension adjustment--a move it disclosed in a press release. Revised earnings released later that month showed a loss of $8 million for the second quarter and a barely profitable third. The SEC is permitting Fruehauf to book the $10 million gain, but only by stretching it over 12 1/2 years, starting this year.
Questions about Fruehauf's accounting continued. In October, Fruehauf and Terex dismissed Deloitte. In a letter to the SEC, the accounting firm explained that it had held six meetings with company executives discussing changes it wanted "relating to the financial reporting process and the role of the Audit Committee, and timely discussions with the auditor of proposed significant transactions." Following the BUSINESS WEEK story that month, which raised questions about Terex' accounting practices, the SEC requested information about Terex and Fruehauf from Deloitte. Rosenberg
says the company hired Price Waterhouse to replace Deloitte "strictly on the basis of price." Rosenberg denies that there were any disputes between Fruehauf and Deloitte over accounting practices. Deloitte had no comment.
Whatever the case, Fruehauf's latest quarterly SEC filing exhibits a new openness about its troubles, the result of intensifying disclosure pressure by the SEC. "Our policy is, if it's negative, state it," says Langevin. The unmistakable message: Fruehauf is in desperate need of cash. It admits that half of its bills from suppliers are past due. And because of ever growing losses, the company is in default. It can't meet the banks' more lenient test of $4.2 million in losses for the current six-month period. Fruehauf expects to receive another waiver.
FAT CITY. Under a bank restriction, Fruehauf's operating losses should have forced it to reduce the hefty management fees it has been paying to KCS, the Lenz-controlled management firm. But Rosenberg says the banks allowed continued payments to KCS by granting waivers to the loan terms. Although Fruehauf lost $30 million last year, KCS got paid $3.6 million. And despite three quarterly losses this year, totaling $28 million, KCS has garnered an additional $2.4 million. The company's latest SEC quarterly filing says no more payments will be made to KCS this year.
Fruehauf sees a turnaround in the offing. It just hired a new CEO, Thomas B. Roller, 42, a former president of New Orleans-based Plywood Panels Inc. And the limping tractor-trailer industry should recover with the economy. Lenz says Fruehauf's order backlog has risen 8%, to $93 million, since last year. Indeed, much of this year's losses relate to a $15.5 million reserve in anticipation of an upturn, to be used, for instance, to realign the dealer network.
Nonetheless, how much Fruehauf can capitalize on this projected growth is an open question. Loan terms are a major constraint on its ability to divert cash from debt payments to business expansion. Starved for cash, it will have difficulty making headway against such tough competitors as Great Dane Trailers and Wabash National Corp., which have taken advantage of its woes. Fruehauf insists it will once again be the premier trailer manufacturer. But KCS' Langevin concedes that "you don't change a monstrosity like Fruehauf that went through a terrible LBO in 1986. It's a 10-year process." Meanwhile, investors who bought Fruehauf stock when it was flying high amid rosy forecasts from management must feel like they have been hit by an 18-wheeler.