Scanlon Technologies, Inc.
Anne Scanlon founded Scanlon Technologies, Inc., in 1993. The company designed andmanufactured high-tech products that were used in various industries ranging fromsemiconductor to aviation. Over the years, Scanlon Technologies reported a compound annual growth rate in revenues of over 20% due to high demand for the company's products and Anne'ssuperior management skills. By the end of 1996, it was clear that any further growth would haveto come from international expansion. However, establishing manufacturing operations andopening up sales and marketing offices abroad required a significant amount of capital. Anneconsidered investing more of her own money into the business; however, given that she alreadyhad most of her wealth tied up in the company, she decided against the idea. Moreover, shebelieved that the amount of funds Scanlon Technologies needed to raise for expansion was in thetens of millions. In her mind, there was only one clear solution-go public.
In September 1996, Anne hired J.P. Suisse, a top tier investment bank, to take ScanlonTechnologies public. On January 1, 1997, the company, which was authorizedto sell 20 million (common stock) and 10 million (preferred stock), issued(one millionshares of common stock) in an Initial Public Offering (IPO) and began trading on the New YorkStock Exchange under the ticker symbol STI. The stock, which had a (par value of $1), was soldfor ($20 per share) and (climbed to $26 a share) by the end of its first trading day.As expected, the funds raised in the IPO were used to open offices all over the world aswell as build a second manufacturing plant in Toronto, Canada. Over the next couple of years,business was good and the company was able to generate enough cash to maintain its level ofoperations.
In October 1999, Anne learned that Kadehjian Solutions Coporation, a competitor, wasconsidering the option of being acquired. Anne believed that such an acquisition would positionScanlon Technologies as the industry leader. One of Kadehjian's requirements for such anacquisition was that it be an all-cash transaction. Anne knew that this would require ScanlonTechnologies to raise approximately($7 million).Ann contracted J.P. Suisse to discuss raising these funds through the capital markets. Then managing directors at J.P. Suisse recommended that Scanlon Technologies employ acombination of debt and equity securities. Anne agreed and on January 1, 2000, the companyissued an additional (one hundred thousand shares) of its ($1 par value common stock) at ($40 pershare.) On the same day, the company issued($2 million in bonds at 95.8), due in(5 years)with(5%)interest payable annually (at year end). The market interest rate at the time was (6% per year).Also on January 1, 2000, Scanlon Technologies issued$1.3 million in zero-coupon (i.e. nointerest) convertible bonds, also due in (5 years). Each ($1,000 bond)converted into(20 shares of itscommon stock)at any time during the (five-year) period. The convertible bonds were sold for atotal of ($1,100,000.)
On March 2, 2000, Scanlon Technologies acquiredKadehjian Solutions Corporation inan all-cash transaction. Following the acquisition, the company's revenues increasedsignificantly and the company's profit margins reached a new high of 30%. In addition to itsoutstanding income statement performance, the company was generating a significant amount ofcash from its operating activities. As a result, On June 30, 2000, Scanlon Technologies' Board ofDirectors declared and (paid a dividend of $0.10 per share).
On December 31, 2000, the company made the first interest payment on the ($2 million) inbonds.At that time the effective interest ratehad risen to 7% due to market conditions.
In January of 2001, the high-tech industry suddenly entered a slump and the stock ofScanlon Technologies plummeted along with the entire industry. Anne believed that the selloffwas overdone and, on February 1, 2001, decided to repurchase10, 000 shares of common stockfor $20 per share.
By June 30, 2001, there were strong indicators that the economic slowdown was comingto an end, as evidenced by the fact that related industries were starting to show signs of recovery.At the time, the Board was in the midst of deciding whether to declare and pay a dividendsimilarly to the one paid in the previous year. Eventually, after strong arguments by variousdirectors, the Board decided to declare a stock dividend. Thus, on June 30, 2001, ScanlonTechnologies' Board declared and issued a dividend of one new share for every ten existingshares. At the time, the market price of STI stock was trading at $29 per share.
By December 2001, STI stock was back at its all-time high level and managementdecided to resell the sharesit had previously repurchased for the current market price of $50 pershare. Moreover, given that Scanlon Technologies had a significant amount of cash on itsbalance sheet, Anne decided on January 15, 2002, to retire all of its outstanding (non-convertible) debt for a payment of only $1, 865,000.
By September 2002,the stock of Scanlon Technologies reached an all-time high of $68per share and management was contemplating a 2 for 1 stock split.
1. Prepare the accounting journal entries needed to record the actual andcontemplated capital financing transactions described above &for each transactions do you think the GAAP treatment of the actual and contemplated financingtransactions reflect the economic substance of the transactions? If not, whichchanges in GAAP would you recommend to the FASB?