No. 1: JORDAN WILLIAMS, INCORPORATED 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 mid level 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 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 partner is NetKnowledge, Inc. NetKnowledge is an infrastructure and service 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 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 NetKnowledges 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. 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 2004/fiscal 2003, NetKnowledge (NK) suffered losses of $29,693,086/$19,909,857. Inspite 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 2004, operating expenses increased substantially resulting in an increased loss. However, as per our discussions with executives at NK, the increase 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 2004 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 level of 80 percent of the amounts in fiscal 2003, 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 2007, revenue of $30,322,337 will exceed expenses of $27,609,269). Calculation of revenue estimate for year 3 Revenue in Fiscal 2004 $17,547,648 Revenue in fiscal 2005 (fiscal 2004 with 20% increase) $21,057,178 Revenue in fiscal 2006 (fiscal 2005 with 20% increase) $25,268,614 Revenue in fiscal 2007 (fiscal 2006 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 for fiscal 2004, the company signed contacts with three additional Fortune 500 clients to deliver services in 2005. The revenue from this prestigious group of clients is, of course, not reflected in the financial statements for 2004. 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 2004, NK had approximately $20,000,000 in cash and cash equivalents. The net decrease in cash and cash equivalents in fiscal 2004 was approximately $10,000,000. Thus, it appears that the company will be able to survive for atleast two years (through fiscal 2006). 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 2006 (i.e., through fiscal 2007). 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 2006, 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 Website. Required: The financial statements for Net Knowledge fro fiscal 2004 and fiscal 2003 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? Net Knowledge, Inc. Income Statements Year Ended December 31, 2004 Year Ended December 31, 2003 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 As of December 31, 2004 As of December 31, 2003 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 stockholdersequity As of December 31, 2004 As of December 31, 2003 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 2001 and 2000 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. Statement of Cash Flows Year Ended December 31, 2004 Year Ended December 31, 2003 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