Financing New Ventures - Assignment Example

? Scientific Technology Corporation In the 1980's Science Technology Corporation (STC) was considered the leading manufacturer of computer automated test equipment (ATE) utilized by major electronics manufacturers to monitor performance quality control procedures over the typical short life cycle of electronic products and components (Eeherald, 2006). In 1984 STC held 31% of the market share in the research, design and manufacturing of testing equipment and testing software suites for printed circuit board components. The second largest source of revenues for the company was from its semiconductor manufacturing testing equipment and engineering software which typically cost well over $1 million. This product solution allowed large scale manufacturers of state-of-the-art very large scale integrated circuit (VLSI) manufacturers to monitor, test, and validate the mechanical and structural integrity of their production as part of essential manufacturing quality control procedures. Maintaining a leadership position in the ATE industry was management's main strategic vision. As a company, STC's primary mission and goal of management was to grow and be known as the global leader in designing innovative new testing technologies and providing integrated quality management systems for electronic equipment and components manufacturers (Missionstatements, 2013). As a direct consequence of their objectives the company required to invest heavily in research and development in order to stay ahead of the competition (Nash-Hoff, 2011). As an internal strategy and in order to remain financially feasible and minimize the impact of research and development costs in the company's bottom line, STC aimed to spread their large R&D expenses across a large amount of sales by pursuing participation in most major segments of the industry and market their products and services globally throughout Europe, North America and Asia. As an industry during the period of 1975-1984 the ATE's and computer related technologies were going to a period of constant flux and dramatic shifts in available technologies. The advent of the new technological breakthroughs exponentially expanded the consumer and industrial electronics market, from personal computers to household electronic equipment such as cordless telephones and microprocessor based home appliances to automated teller machines, mainframe computers, and industrial automation equipment (Wordinfo). At the time just like in today's computer market new technological breakthroughs such as the introduction of a new computer chip can change the course of the whole industry and make previous silicone chip products practicably obsolete almost overnight. The traditional product development life cycle of design, building a prototype, redesigning and making a new prototype had become obsolete due to time constraints and the fact that computer chips had become too complex and prohibitively expensive to follow the old industrial design model (Ulrich, Eppinger). The rapid and evolving nature of the industry meant that in order to stay competitive and deliver innovative products that the consumer wanted the firm relied heavily on speed to bring products from initial design to market readiness. The process involved having reliable testing processes and costs considerations that were always paramount in the viability of any new product introduction. High quality, reliable, and cost effective ATE solutions became an essential part of the industry in order for manufacturers to survive and remain competitive. Additionally, with the growth and advent of ever more complex semiconductor components manufacturers found it too complex and cost prohibitive to design and build their own testing equipment in-house. During the period of 1978 to 1984, the industrial ATE market grew at an average of 28% per year and sales increased from $359 million in 1978 to $1.6 billion by 1984. 2) During the period of 1980-1984 STC possessed the broadest testing product lines in the market and reaped the financial benefits in their industry. Their sales increased from $144 million in 1980 to $227 million in 1984, an overall increase of 58%. Although profit levels were not stable the company achieved an average compound growth rate of 12% during the same period. STC netted a profit margin of $10 million in 1980, a $3 million loss in 1981, followed by a dramatic shift in profitability in 1983 with $16.3 million in reported net income. By taking advantage of the generally strong ATE market and increased management and investor confidence in earnings growth of the industry, STC's share price soared from $10 a share in 1982 to a peak price of $42 by June of 1983. The company's management took advantage of the opportunity and issued 1,650,000 common stock shares at a price of $11.50 in June 1982, and again issued an additional 1,800,000 shares at $26 in February of 1983. The aggressive nature of their equity offerings was in response to the anticipated strong market growth that the industry was expected to go through during the next five years. By the end of 1983 the sense of optimism soon fizzled since STC reported $10 million in net income which was much lower than the previous year performance to the disappointment of investors and stakeholders. There were several competing factors that contributed to the sub-par financial performance of the company. STC increased the number of employees and expanded plant capacity in order to meet the expected increased demand for the company's products and services in the near future. Additionally, in order to take advantage of new emerging market opportunities their research and development budget was increased by 32% to a level that amounted to 16% of total sales. The third factor which affected STC's financial performance was that the company had significant problems with a new product in the company's largest division, causing numerous product recalls and expensive repairs to rectify the situation and major manufacturing difficulties with a product line of very large and complex semiconductor testers which resulted in division losses of over $18 million for the fiscal year 1984. Although Mr. Watson was optimistic about the growth prospects of STC and the industry, however competition was intensifying and many of their competitors were broadening their product lines and getting a foothold in many of the market segments which STC was competing. For example in 1977 only two firms dominated the VLSI market with over an 80% market share. After investing approximately $75 million in research and development and market deployment of their line of VLSI testers, market conditions became brutal after in 1985 when six additional manufacturers entered the arena completely disrupting the market and diminishing STC's prospects for future growth in the segment. Regardless, Mr. Watson believed that STC had a number of core competencies which gave STC an operational advantage against the increasing level of industry competition (Electronicdesignblog, 2012). The company served a large customer base, extensive and broad software, and tester product lines as well as the dominant market share of the printed circuit board test market (Ballentine, 2009). The company was also getting a foothold on the VLSI test market and had been selected as a supplier by the U.S. Department of Defense. Based on these competitive advantages of STC the management team forecast sales were to reach $295 million in 1985 and $843 million in 1989. Although the sale of 3.4 million shares of STC common stock raised $66 million dollars to fund their planned growth, Mr. Watson felt that previous forecasting mistakes and the substantial increase in debt needed to fund Mr. Finson's forecasts could be detrimental to the company's future financial performance. 3) Mr. Finson's financial planning was inherently flawed and was lacking an adequate operational and financial back up plan in order to deal with operational contingencies. Mr. Finson failed to perform his due diligence by not formulating adequate operational and financial strategies to deal with the high risks related to under performing sales figures, defective product development, and recalls as well as the fact that their inventory levels were too high (Anufried, 2013). Their high inventory levels compared with the competition indicated excessive manufacturing production due to overly aggressive growth projections, as well as the exposing STC to high risk of inventory obsolescence which could land STC financially in the red once again the increased costs associated with new product launches as well as financial forecasts which seemed to defy convention hurt the profitability levels (Ventureline). Also increased R&D expenditures required to support the growth of current divisions and expansion of STC into new profitable untapped market segments were not adequately addressed in Mr. Finson's financial plans. Mr. Finson's financial projections assumed that sales would grow at a rate of 30% and the company would achieve an average of 7.5% in net profit margins. If we compare Mr. Finson's 30% projected growth rate with the average historical sales growth rate of 12% for STC since 1980, we can clearly see that his projections were wildly optimistic and speculative. Furthermore these sales growth figures were not objectively supported with new available data nor were they backed up by available historical financial performance data of the company. Although Mr. Finson estimated a 7.5% net profit margin for the next five years, STC's profit levels have been very erratic for the last five years. The company's profitability ranged from a minimum of 1.2% in 1981 to a maximum of 7.8% in 1983. STC's actual average net profit margin from 1980-1984 was only 5.1%, so it does not seem reasonable to expect such a large increase in profitability even in the face of industry growth since increased competition will put additional operational and financial pressures to the company. According to Mr. Finson's financial projections which are overly optimistic, by1989 based on a 7.5% average profit margin the firm's debt will be 35% of total capital which is still inline with their major competitors. With a more realistic average of 5% profit margin, the firm's total debt will jump to $265 million which would increase the company’s debt to a staggering 47% of total capital and put them at a serious disadvantage compared with their main competitors, since they might not be able to secure all the debt financing needed to fuel future growth due to being overleveraged and their EPS will decrease to $2.56 compared with $3.84 forecast for a 7.5% profit margin. 4) As the president of STC, Mr. Watson needs to reassess the firm's focus and long-term strategic goals in order to better compete in the long-term. The company's management is focused in becoming the industry leader by competing in as many of the ATE market segments as possible. The company might be trying to bite too much at once. The highly competitive and fast paced nature of the ATE industry requires heavy R&D spending in order to develop new products and technologies to better serve their customer base in their operating segments. In order to better deal with the unpredictable nature of the industry the company must refocus their operational plans to concentrate on the most profitable segments of the industry, their core competencies, as well as the segments that are forecast to have the highest level of growth and gross margins in order to control overall costs and increase profitability. The company should also evaluate the performance of Mr. Finson as the firm's Chief Financial Officer and whether he is the best person available to do the job, since his financial planning and projections leave a lot of room improvement since he is not visualizing the volatile nature of the industry and becoming complacent with his financial planning and forecasts. The firm's procedures to handle financial projections should be on the side of conservatism in order to better deal with inevitable contingencies that will arise with operations, R&D, as well as projected sales. Advanced Medical Technologies 1) In order for AMT to maintain their aggressive annual growth rate of over 30% it was necessary for the firm to continue to invest aggressively in research and development and a rapid expansion of its sales force. The company was very well regarded in the industry for developing innovative new state-of-the art product solutions for a wide range of medical applications. Mr. Hatkins believed through his extensive industry experience and historical growth rates that in order for AMT to maintain its market position the company needed to continue to acquire new sources of capital in order to fund the projected growth of the firm. The company’s management financed its operations through heavy use of short-term credit leasing, some manufacturing facilities, as well as by establishing a partnership with Biology Labs through the sale of equity stock amounting to $7 million for a 5% stake in the business in 1983 and an additional $12 million for 12% of equity by June 1988. The company used the invested funds to maintain adequate capital for general operations, provide for essential R&D efforts, and for future growth and expansion. 2) Biology Labs completed their purchase agreement of 12% of equity by June, 1986 and with their last injection of equity capital from Biology labs, AMT needed an additional line of credit in order to fund their operations. In 1985 the company entered a new leasing agreement for $2.5 million annually which helped offset the loss of additional equity capital injections. ATC had a projected annual growth rate of sales of 30% from 1986-1988. The total projected sales for year-end 1988 taking in consideration the annual compounded projected growth rate amounted to a total of $67.77 million. For the year ended the company needed a total of approximately $40.67 million in operating capital based on a compounded 30% sales growth rate. By assuming a steady 30% increase of expenses and COGS across the board, and discounting the $2.5 million received annually from their new capital lease agreement, the company would need a total of $38.16 million in additional short-term financing in order to meet their COGS requirements and total expenses for the year. 3) By analyzing AMT historical financial results we can conclude that the projected 30% annual growth rate seems reasonable and even conservative based on AMT's historical sales growth rates and the rapid expansion and growth of the medical devices industry. By analyzing the firm's projected financial statements and the progression of the company's quick ratio from 1985 to 1988, we can see that it has a stable current ratio. Therefore based on the positive letter of recommendation of AMT's equity partner Biology Labs, the historical growth progression of the firm, favorable management, and company review from Bank of West (Technology Lending Group); a leading financial lender for technology companies and a favorable projected current ratio of over 1.0 the decision is to grant the line of credit to AMT as requested. The outstanding balance in the line of credit with Bank of San Francisco will be liquidated. The only requirements that the bank requires is for AMT to provide inventory and account receivables as a guarantee against the $8 million line of credit and the outstanding balance paid off by the firm. 4) In my opinion Mr. Haskin's has been effective in managing the relationships with his banking institutions and partners, regardless of the opinion of bank of San Francisco towards the quality of his asset guarantees. In his industry Mr. Haskin's is known for his expertise, professional motivation, and aggressiveness towards getting things done. His education, experience, reputation and performance as a manager speak volumes as to the quality of his company and management team. Therefore in the industry which he competes is driven by access to short term capital and the financial needs of the company must be secured in time in order for the business to succeed in a highly competitive and evolving medical devices market (Jain, 2010). Mr. Haskin's and his firm AMT are going about the right way to secure the best financial deal for himself, the firm, as well as his stakeholders. 5) Both company’s STC and AMT are technology driven companies which compete in highly evolving and competitive markets. Both industry's ATE and medical devices are driven by heavy investments in R&D in order to meet the requirements and expectations of their consumer base and to stay ahead of the competition (Jain, 2010). Constant new product introductions and providing revolutionary technologies that aim to change the landscape of the industry and consumers are the goals of both firms. STC and AMT are known for their state-of-the -art products as well as being leader instead of followers in their respective industries. AMT had difficulty obtaining additional debt financing due to their highly leveraged position which under normal banking and lending standards is a red flag. The medical devices industry depends on short term financing for their survival and to remain profitable, therefore it takes a specialized lender with experience in the industry to adequately evaluate these types of companies. Both companies were not in a position to sell any more equity, since they had already sold a significant stake of their businesses to investors and needed to finance their operations through debt in order to survive. References Anufried, D. (2013). Financial due diligence. [Accessed 7 December 2013] Ballentine, S. (2009). Fabrication Services and the Importance of Automated Production Systems. [Accessed 7 December 2013] Eeherald.com (2006). Electronic components Life Cycle management (Part 6). [Accessed 7 December 2013] Electronicdesignblog.com (2012). How to Choose the Right Electronic Design Company. [Accessed 7 December 2013] Jain, A. (2010). Where Next for Medical R&D? [Accessed 7 December 2013] Missionstatements.com (2013). Company. [Accessed 7 December 2013] Nash-Hoff, M. (2011). The Importance of R&D to the Manufacturer Industry. [Accessed 7 December 2013] Ulrich, K., Eppinger, S. Chapter 14: Prototyping. [Accessed 7 December 2013] Ventureline.com. Inventory Obsolescence Definition. [Accessed 7 December 2013] Wordinfo.info. Advances that have transformed how the world communicates. [Accessed 7 December 2013] Read More