JORDAN WILLIAMS, INCORPORATED

Jordan-Williams, Incorporated (JWI) is a major publisher of college textbooks focused on business education. At the company's quarterly strategy meeting senior management decided to expand into business education materials aimed at corporations that require entry-level and mid-level managers to complete training courses to improve their business skills. For such training, content (in the opinion of JWI's senior management) is best delivered via the internet since it has cost advantages and allows for 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 JWI wants a rapid entry into this market, it plans on developing 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 partner1 is NetKnowledge, Inc. NetKnowledge is an infrastructure and services company that supports corporate communication and training. The company has approximately 65 satellite-linked communication centers that corporations can use for live video conferencing or training. NetKnowledge has also developed a platform to deliver pre-recorded 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 only 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 NetKnowledge's delivery platform. Thus, it wants to gain some assurance 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 analysis and held discussions with various executives and NetKnowledge. When finished with its investigation, the due diligence team prepared the following memo supporting a partnership with NetKnowledge

March 25, 2020

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 fisca12019/fisca12018, NetKnowledge (NK) suffered losses of $26,693,086/$19,909,857. 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 2019, 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 2019 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 2018, or $27,609,269 (80% X 34,511,586). With current revenue at $17,547,648, 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 2022, revenue of $30,322,337 will exceed expenses of $27,609,269).

Calculation of revenue estimate for year 3

Revenue in Fiscal 2019

$17,547,648

Revenue in fiscal 2012

(fiscal 2019 with 20% increase)

21,057,178

Revenue in fiscal 2021

(fiscal 2020 with 20% increase)

25,268,614

Revenue in fiscal 2022

(fiscal 2021 with 20% increase)

30,322,337

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 2019, the company signed contracts with three additional Fortune 500 clients to deliver services in 2020. The revenue from this prestigious group of clients is, of course, not reflected in the financial statements for 2019. Also, keep in mind that our partnership with NK will provide incremental revenue to the company.

Of course, achieving profitability will only be possible if the company does not run out of cash. At the end of fiscal 2019, NK had approximately $20,000,000 in cash and cash equivalents. The net decrease in cash and cash equivalents in fiscal 2019 was approximately $10,000,000. Thus, it appears that the company will be able to survive for at least two years (through fiscal 2021). 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 2021 (i.e., through fiscal 2022). Assuming an annual decrease in cash of $10,000,000, we would need to make an equity investment of $10,000,000. At the end of year 3, as discussed above, NK will be profitable and likely able to fund itself internally. An investment of $10,000,000 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 2021, 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. I'll be in the rest of this week, and next week on Monday. After that, I'll be in Portland working with the group from Balmer Consulting that is developing our new Authors' Web site.

NetKnowledge, Inc.

Income Statements

Year Ended

December 31, 2019

Year Ended

December 31, 2018

Revenue

$17,547,648

$14,568,200

Expenses:

Wages and salaries expense

20,683,471

14,462,540

Depreciation of property and equipment

4,061,739

4,287,653

Other general, selling, and administrative

22,274,924

15,761,393

47,020,134

34,511,586

Other income (expense):

Interest income

1,120,000

1,462,000

(Interest expense)

(1,340,600)

(1,428,471)

(220,600)

33,529

Net loss

$(29,693,086)

$(19,909,857)

NetKnowledge, Inc.

Balance Sheets

Year Ended

December 31, 2018

Year Ended

December 31, 2017

Assets

Current assets:

Cash and cash equivalents

$19,951,468

$30,022,146

Accounts receivable

2,894,587

3,671,664

Prepaid expenses and other assets

256,874

483,651

Total current assets

23,102,929

34,177,461

Property and equipment

33,016,763

32,334,303

Less accumulated depreciation

(12,520,394)

(8,458,655)

Total assets

$43,599,298

$58,053,109

Liabilities and stockholders' equity

Current liabilities:

Accounts payable and accrued expenses

$ 5,568,442

$ 4,687,852

Current portion of capital lease obligations

5,657,142

3,485,214

Total current liabilities

11,225,584

8,173,066

Capital lease obligations less current portion

10,751,610

12,965,437

Bonds payable

14,400,584

---

Total liabilities

36,377,778

21,138,503

Stockholders' equity

Common Stock:

Shares issued and outstanding: 2,543,872 in 2017 and 2016

Common stock par value

125,480

125,480

Additional paid-in capital

79,485,662

79,485,662

Accumulated deficit

(72,389,622)

(42,696,536)

Total stockholders' equity

7,221,520

36,914,606

Total liabilities and stockholders' equity

$43,599,298

$58,053,109

NetKnowledge, Inc.

Statements of Cash Flows

Year Ended

December 31, 2019

Year Ended

December 31, 2018

Operating Activities

Net Loss

$(29,693,086)

$(19,909,857)

Adjustment to reconcile net loss to net cash used

in operating activities:

Depreciation and amortization

4,061,739

4,287,653

Changes in operating assets and liabilities:

Decrease in accounts receivable

777,077

(124,587)

Decrease in prepaid expenses and other assets

226,777

(106,440)

Increase in accounts payable and accrued expenses

880,590

(65,804)

Net cash used in operating activities

(23,746,903)

(15,919,035)

Investing activities:

Purchase of property and equipment

(682,460)

2,696,874

Financing activities:

Issuance of bonds

14,400,584

---

Payment of capital lease obligations

(41,899)

(18,564)

Net cash provided by financing activities

14,358,685

(18,564)

Net increase(decrease) in cash and cash equivalents

(10,070,678)

(13,240,725)

Cash and cash equivalents, beginning of period

30,022,146

43,262,871

Cash and cash equivalents, end of period

$19,951,468

$30,022,146

Required:

The financial statements for NetKnowledge for fiscal 2019 and fiscal 2018 are provided above. 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?

Specifically:

1.What is the situation facing JDI?

2.Comment on the following points in the memo prepared by Ted Chapman.

a.Ted believes 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?" What other questions might you have?

b.Ted's analysis suggests that NK will be profitable in three years.On what estimates of revenue and expenses did he base this forecast?Do you agree?

c.Ted estimates that NK is "burning" approximately $10,000,000 of cash per year, based on fiscal 2019.Is this correct? Comment on how cash has been sourced and how it has been used.

d.Ted says, "if we decide not to make an equity investment, NK should be able to obtain additional debt or equity financing from creditors or investors." Do you agree?Why or why not?

3.Should JDI pursue an alliance with NK?Give reasons for and against and then give your recommendation.