14-1 JORDAN-WILLIAMS, INCORPORATED [LO 1, 2, 5, 6, 7] Jordan-Williams, Incorporated (JWI), is a major publisher of college textbooks focused on business education. At the companys quarterly strategy meeting,senior management decided to expand into business education materials aimed at corporations that require entry-level and midlevel managers to complete training courses to improve their business skills. For such training, content (in the opinion of JWIs senior management) is best delivered via the Internet since it has cost advantages and allows flexibility in scheduling employee training. JWI has existing content in almost all business areas, including accounting,finance,marketing,management,and information systems,as well as connections to authors who can develop new materials.However,the firm does not have experience delivering content over the Internet and does not have a sales force with experience selling to the corporate training market.Given that JWI wants a rapid entry into this market, it plans to develop a strategic alliance with a company that has experience in selling to the corporate market and in delivery of content via the Internet. One of the companies JWI is considering as a partner is NetKnowledge, Inc. NetKnowledge is an infrastructure and services company that supports corporate communication and training. The company has approximately 65 satellitelinked communication centers that corporations can use for live video conferencing or training. NetKnowledge has also developed a platform to deliver prerecorded training to personal computers via the Internet.For clients that need help developing training materials, NetKnowledge has three production studios for designing and recording client content. A due diligence team from JWI has met with executives from NetKnowledge, viewed demonstrations of content delivered over the Internet using the NetKnowledge platform, and visited a NetKnowledge production facility. The team is quite impressed with NetKnowledge and believes an alliance with the company would be a great fit, since NetKnowledge does not specialize in developing content (it just assists companies with designing and recording content), whereas JWI is a content expert. JWI is going to be investing heavily to modify its existing content to make it more focused on the corporate training market and to make it compatible with NetKnowledges delivery platform. Thus, it wants to gain some assurance CASE c14.qxd 7/18/12 8:17 AM Page 572 that NetKnowledge will be around in the foreseeable future to continue selling and delivering the materials to the corporate market. To assess the financial stability of NetKnowledge, the JWI due diligence team performed financial analyses and held discussions with various executives at NetKnowledge. When finished with its investigation, the due diligence team prepared the following memo supporting a partnership with NetKnowledge. 573 March 25, 2015 TO: Peter Gandrell (CEO), Christine Sayers (CFO), and Drew Marshall (Director of New Initiatives) FROM: Ted Chapman, lead manager, due diligence team investigating NetKnowledge SUBJECT: Report on Financial Condition of NetKnowledge In fiscal 2014/fiscal 2013, NetKnowledge (NK) suffered losses of $31,600,000/$21,200,000. In spite of these losses, the team recommends forming an alliance with NK.NK,like most companies in this space,is an early-stage company,and losses are not unexpected.The important questions to ask are:Does NK have a reasonable plan to become profitable? and Does NK have the cash to survive until profitability is achieved? We believe the answer to both questions is yes. In 2014, operating expenses increased substantially, resulting in an increased loss. However, per our discussions with executives at NK, the increased operating expenses are due in large part to a major advertising campaign and expansion of the sales force.The result is that NK achieved substantial brand recognition, and in 2014 revenue increased by 20 percent. The company believes that, now that it has achieved its brand-recognition goals, it can cut operating expenditures (including advertising and sales force salaries) back to a level of 80 percent of the amounts in fiscal 2013, or $29,520,000 (80% 36,900,000).With current revenue at $18,800,000, and assuming an ongoing revenue growth rate of 20 percent, the company will be profitable in three years (i.e., at the end of fiscal 2017, revenue of $32,486,400 will exceed expenses of $29,520,000). Calculation of revenue estimate for year 3: Revenue in fiscal 2014 $18,800,000 Revenue in fiscal 2015 (fiscal 2014 with 20% increase) 22,560,000 Revenue in fiscal 2016 (fiscal 2015 with 20% increase) 27,072,000 Revenue in fiscal 2017 (fiscal 2016 with 20% increase) 32,486,400 It appears to us that achieving profitability in three years is a very feasible goal. The company has expanded its Web hosting options to a 24/7 basis and is now able to service clients with training demands around the world.In the fourth quarter of fiscal 2014, the company signed contracts with three additional Fortune 500 clients to deliver services in 2012.The revenue from this prestigious group of clients is,of course,not reflected in the financial statements for 2014. Also, keep in mind that our partnership with NK will provide incremental revenue to the company. Of course, achieving profitability will be possible only if the company does not run out of cash. At the end of fiscal 2014, NK had approximately $21,000,000 in cash and cash equivalents.The net decrease in cash and cash equivalents in fiscal 2014 was approximately $11,000,000. Thus, it appears that the company will be able to survive for at least two years (through fiscal 2015). At that point, assuming our net initiative is a success, we may want to make an equity investment in NK to provide the company with the cash it will need to survive a third year beyond 2016 (i.e., through fiscal 2017). Assuming an annual decrease in cash of $11,000,000, we would need to make an equity investment of $12,000,000. At the end of year 3, as discussed above, NK will be profitable and likely able to fund itself internally. An investment of $12,000,000 would give us a substantial equity position in a firm that we predict will be successful. Furthermore, it would allow us to have a substantial say in the direction of NK, thus insuring that the company remains focused on our long-run needs in addition to the needs of its other clients. Alternatively, in light of the fact that the company will be only a year away from profitability at the end of fiscal 2016, if we decide not to make an equity investment, NK should be able to obtain additional debt or equity financing from creditors or investors. If you have any questions, please give me a call. Ill be in the rest of this week, and next week on Monday. After that, Ill be in Chicago working with the group from Balmer Consulting that is developing our new authors Web site. Required The financial statements for NetKnowledge for fiscal 2014 and fiscal 2013 are provided below. You should analyze them as you deem appropriate. Based on your work, comment on the memo from Ted Chapman. Do you agree or disagree with his analysis and conclusions? Would you recommend pursuing an alliance with NK?