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Breeze Technology, Inc.
9. Financials
Budget, Cash Flow Statement (Year 1 by month)
Budget, Cash Flow Statement (Years 2 and 3 by quarter)
Income Statement, Cash Flow Statement (Years 1 - 5), Ratio Analysis
Balance Sheet, Source & Use of Funds

The following assumptions and facts impact the financial statements:

• All figures are shown in US real dollars;

• A significant proportion of our professional advice on accounting, intellectual property, market research and legal issues was provided gratis and thus is not reflected in the financial statements:

• The management team has also negotiated legal and other services on a contingency basis, thus reducing the financial risk and cash expenses;

• From year 3, revenues will begin to flow from manufacturing and/or licensing of other products in addition to the royalty stream derived from the Breeze technology;

• Company policy is to avoid investment in substantial fixed assets, preferring to lease or hire such assets to enhance flexibility and conserve cash flow;

• Tax rates vary widely among jurisdictions and Breeze is presently unsure of its domicile for tax purposes. Breeze wishes to be a good corporate citizen but will nonetheless direct efforts to minimize tax payable. An income tax rate of 33% is assumed payable once yearly in December.

9.1 Fund Raising

The initial seed capital for this business was raised by of a contribution of $700 by each of the three shareholders of Recreation Innovations Inc. to fund investigation of the Breeze proposal. These inquiries illuminated the potential of the venture and were followed by further shareholder contributions of $14,000 each. These funds were used for the development and testing of prototypes, legal and other fees to define and protect intellectual property, establishing legal structure and travel costs.

Once the legal structure was established, these funds were converted to share capital in Breeze. To cover further intellectual property and negotiation expenses and to ensure adequate funding reserves for the remainder of the project, Breeze negotiated with a local investor, Gurumbal Pty Ltd, for $70,000 in funding on the following terms:

• A three year $70,000 bond with a coupon rate of 18%.

• Monthly interest payments, or to compound at coupon rate, at our discretion.

• Secured by directors' guarantees of $70,000 and a lien over Director's shares in Breeze.

9.2 Agreement with the Inventor

The technology assignment documentation requires Breeze to commercialize the invention and pay the inventor $1 million within three years and within 30 days of revenues less operating costs, exceeding $l.5 million. If this payment is not made, the original technology will revert to the inventor. Subsequent technical innovations will be retained by Breeze.

9.3 Royalty Income

It is expected that a commitment fee of $2m will be received in May 1994, followed by quarterly payments at the rate of $2.5m per year for the remainder of year l and year 2. Royalties will increase as the licensee exceeds the base sales levels which have been established as part of the incentive royalty structure. The royalty structure is based on the licensee's wholesale sales and is designed to induce the rapid diffusion of the technology across a wide range of products i.e., the use of a high minimum payment with a reduced royalty rate as volume increases. While our research determined that license fees for proven technology vary from 5% to 8% of wholesale prices, the financial projections are based on more conservative royalty rates as shown in Exhibit VI. These rates may be exceeded in negotiations with licensees.

Exhibit VI: Incentive Royalty Rate Structure

Sales ($m)

Royalty Rate (%)

Base Fee ($m)

0

0.00

2.5

100

2.00

2.5

200

1.75

4.5

400

1.50

8.0

800

1.25

13.0

5000

1 00

55.0

Exhibit VII shows the sensitivity of annual royalty revenues to the diffusion rate into the licensee's product line. The cost for the licensee per pair of shoes is also detailed.

Exhibit VII: Royalty Sensitivity to Diffusion Rate

Mkt. share (%)

Royalties ($m)

Cost per pair ($)

1%

2.50

0.67

5%

5.25

0 28

10%

3.25

0 25

25%

18.63

0.20

9.4 Cash Balances, Dividends and Owners' Equity

As seen in thc financial spreadsheets, Cash Balances remain positive throughout, at least double each year, and exceed $10 million in year 5. Such cash balances arc considered necessary as a contingency for legal attack against theft of intellectual property relating to Breeze's technology and to build a fund to take advantage of opportunities that may arise. Dividend payouts are substantial, accumulating to $4.9m over 5 years. Owners' Equity grows from $363,820 in year I to $1 5.3m in year five.

9.5 Ratio Analysis and Sensitivity Analysis

The financial ratios show exceptionally conservative values, as can be seen in the projected financial statements. The ratios show encouraging levels of liquidity and profitability and minimal reliance on leverage. Profits and dividends are highly sensitive to the royalty income, but expenses are almost entirely discretionary and would be reduced in line with royalty incomes falling below anticipated levels. A pessimistic scenario was developed, with assumptions that differ from the projected scenario as shown in Exhibit VIII. The end result is income levels less than one-sixth the projected scenario, but even at this level Breeze is profitable, as shown in Exhibit IX.

Exhibit VIII: Expected and Pessimistic Scenario Assumptions

Assumption

Expected Scenario

Pessimistic Scenario

Upfront Commitment Fee

$2,000,000

$500,000

Minimum Annual Royalty

$2,500,000 Base

Zero Base

Roll out products

Begin Year 3

None

Diffusion Rate by Year 5

15%

5%

Maximum Royalty Rate

2.5%

1.25%

Exhibit IX: Expected Scenario Income, Cash Balances and Dividends

 

Year 1 ($)

Year 2 ($)

Year 3 ($)

Year 4 ($)

Year 5 ($)

Income

3,562,500

2,500,000

5,375,000

11,000,000

17,000,000

Expenses

2,399,601

1,587,232

2,571,026

6,037,858

9,236,630

Net Income

1,162,899

912,768

2,803,974

4,962,142

7,763,370

Cash Balance

335,899

648,667

2,557,641

6,019,783

10,733,153

Dividends

900,000

600,000

400,000

1,000,000

2,000,000

Exhibit X: Pessimistic Scenario Income, Cash Balances and Dividends

 

Year 1 ($)

Year 2 ($)

Year 3 ($)

Year 4 ($)

Year 5 ($)

Income

83,000

333,333

1,041,666

1,666,666

2,500,000

Expenses

150,000

250,000

1,100,000

400,000

1,200,000

Net Income

(67,000)

83,333

(58,334)

1,266,666

1,300,000

Cash Balance

47,100

130,433

72,099

1,188,765

1,488,765

Dividends

NIL

NIL

NIL

150,000

1,000,000

Note that to generate sufficient income to cover thc minimal expenses necessary to maintain the relationship with the licensee, thc diffusion rate into the licensee's product line could fall as low as 4% (utilizing the pessimistic royalty rate of 1.25%).

9.6 Capital Value

Valuation of rapidly growing companies is always difficult as both the growth and discount rates are critical. Simple price earnings multiples can often undervalue the company especially if there is considerable growth potential, as is the case with Breeze. Assuming Breeze profits continue to grow, on a long term trend, at a conservative 12% per year and using a discount factor of 20%, the value of the company at year five would be $97 million using a variation on the Gordon share valuation model (Present Value of a constant growth annuity). This value equates to a price earnings multiple of approximately 14 which is at the low end of expectations when compared to technology licensing companies such as Orbital Engine Co. Ltd with a PE multiple exceeding 20.


Breeze Technology, Inc.
Table of ContentsAppendices
0. Executive Summary
1. The Company
2. Market Analysis
3. Strategic Options
4. Marketing Strategy
5. Research & Development
6. Organizational Structure
7. Risk Reduction Strategies
8. Exit & Harvest Strategies
9. Financials
10. Summary
I. Focus Group Analysis
II. Competitor Content Analysis
III. Product Test Results
IV. Inventor's Test Results
V. Resumes of Directors
VI. US Market Data
VII. Technical Drawings


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