Recommendation - Scientific Technology Company

We recommend that Scientific Technology Company implement several immediate cost-cutting measures in order to improve their short-term financial position allowing the company to remain competitive in the current marketplace as well as to ensure future viability in the ATE and VLSI industries. We recommend that Scientific Technology Company immediately shut down its Arizona manufacturing plant. The shutdown and sell off of the fixed assets from the Arizona plant will provide the company with a cash infusion of approximately $21 million. We advise Scientific Technology Company to use this cash infusion to pay towards the $25 million the company has in long-term debt. We also recommend that Scientific Technology Company sell off the $28.33 million in inventories from the Arizona plant. This sell off would bring the company's Inventories as a % of COGS to 55.45%, which is closer to Scientific Technology's competitors 48-50% range. The company's Total Assets as a % of Sales would decrease to 84.88% if these recommendations are implemented. The approximately $50 million dollar savings would decrease COGS to a projected $71 million in 1985 or 24% of sales. These changes would produce an estimated 21.21% return on total assets, an increase from the estimated 16.94% had the Arizona plant remained open. These changes would change 1985 projected EPS from $1.45 to 3.41. With these proposed changes, we also recommend that Scientific Technology Company improve its accounts receivable policy so a decrease in the company's current ratio doesn't occur. In order to see a quick reduction in the estimated accounts receivable going forward we recommend that Scientific Technology Company offer a 2-3% discount to its customers who pay within a 30-day period. We also recommend that for its financial projections going forward, the company limits its accounts receivables balance to 30% of sales.

In the long-term, we recommend that Scientific Technology Company adopt a two-fold strategic policy. We advise the company to model itself after the Japanese firms, such as Takeda Riken, who have adopted aggressive price cutting policies in response to the lower consumer demand for personal computers, a large demand driver for the semiconductor industry. This would be realistic due to the overhead cost savings from lower energy costs, and income tax savings from closing the Arizona plant. If Scientific Technology company were to undercut its closest competitors' price points, we believe the company could see a 3-5% increase in market share. We also recommend that Scientific Technology Company increase its Research and Development budget by 20% of sales in order to diversify and standardize the capability of the ATE software to be used on a variety of systems including: mixed signal test systems, analog test systems, and memory test systems, as well as the VLSI systems. This standardization would allow Scientific Technology Company to differentiate itself from its competitors products, and somewhat mitigate itself from obsolescence issues. Finally, we recommend that Scientific Technology Company increase its SGA expense to 33-34% of its yearly sales in an effort to establish itself in the Asian and Pacific Rim markets, which have seen 70-110% growth in the consumer electronics industries over the past 5-7 years.

The rationale for recommending the closure of the Arizona plant is simple. We feel that in order for Scientific Technology Company to remain viable and to compete in the marketplace it must attempt to improve its earnings per share and its profitability to remain attractive to its existing and potential investors. Last year Science Technology Company increased its R&D expenses by 32% and 184% since 1980. Consequently, the company has increased their sales network throughout the world, and with the implementation of the VLSI project, Scientific Technology greatly increased by 38% in 1983 and 26% in 1984. With this recent expansion and expense in anticipation of future growth, the company has not yet seen an increase in its cash balances or net income to offset the costs. We fear that if the company stays on this path, its earnings per share could decrease despite the potential for enormous growth. To mitigate this potential issue, we recommended closure of the Arizona plant because of the more expense overhead costs due to higher state income taxes and higher energy costs. It was apparent from Mr. Finson's analysis that our main competitors were beating us inventories and net fixed assets as a % of sales, and we wish to improve that. Under our proposal, all employees would be transferred to the other manufacturing plants in Colorado and Minnesota where energy costs and state income taxes are lower. This will bring about a reduction in overall SG&A expenses as well as bring needed cash infusion from the sale of the fixed assets and reduction in inventory. This will help streamline operations as well and improve net income. This will be directly reflected in EPS.

We