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TUCOWS INC 10-Q 2013

Documents found in this filing:

  1. 10-Q
  2. Ex-31
  3. Ex-31
  4. Ex-32
  5. Ex-32
  6. Ex-32
tcx20130930_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

OR

 

  

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from           to          

 

Commission file number 1-32600

 

TUCOWS INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Pennsylvania

  

23-2707366

(State or Other Jurisdiction of

  

(I.R.S. Employer

Incorporation or Organization)

  

Identification No.)

 

96 Mowat Avenue,

Toronto, Ontario M6K 3M1, Canada

(Address of Principal Executive Offices) (Zip Code)

 

(416) 535-0123

(Registrant's Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T §232.405 of this chapter during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ☐

  

Accelerated filer ☐

 

  

  

Non-accelerated filer ☐

  

Smaller reporting company ☒

(Do not check if a smaller reporting company)

  

  

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes ☐  No ☒

 

As of November 13, 2013, there were 43,610,423 outstanding shares of common stock, no par value, of the registrant.

 

 
 

 

 

TUCOWS INC.

Form 10-Q Quarterly Report

INDEX

 

PART I

FINANCIAL INFORMATION

 

  

  

Item 1.

Consolidated Financial Statements

1

 

  

  

 

Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012

1

 

  

  

 

Consolidated Statements of Operations and Comprehensive Income (unaudited) for the three and nine months ended September 30, 2013 and 2012

2

 

  

  

 

Consolidated Statements of Cash Flows (unaudited) for the three and nine months ended September 30, 2013 and 2012

3

 

  

  

 

Notes to Consolidated Financial Statements (unaudited)

4

 

  

  

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

16

 

  

  

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

34

 

  

  

Item 4.

Controls and Procedures

35

 

  

  

PART II

OTHER INFORMATION

 

  

  

Item 1.

Legal Proceedings

36

 

  

  

Item 1A.

Risk Factors

36

 

  

  

Item 4.

Mine Safety Disclosures

36

 

  

  

Item 6.

Exhibits

37

 

  

  

Signatures

  

38

 

TRADEMARKS, TRADE NAMES AND SERVICE MARKS

 

 

Tucows®, Butterscotch®, EPAG®, Hover®, OpenSRS®, Platypus®, Ting® and YummyNames® are registered trademarks of Tucows Inc. or its subsidiaries. Other service marks, trademarks and trade names of Tucows Inc. or its subsidiaries may be used in this Quarterly Report on Form 10-Q (this “Quarterly Report”). All other service marks, trademarks and trade names referred to in this Quarterly Report are the property of their respective owners. Solely for convenience, any trademarks referred to in this Quarterly Report may appear without the ® or TM symbol, but such references are not intended to indicate, in any way, that we or the owner of such trademark, as applicable, will not assert, to the fullest extent under applicable law, our or its rights, or the right of the applicable licensor, to these trademarks. 

 

 
 

 

 

PART I.

FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Tucows Inc.

Consolidated Balance Sheets

(Dollar amounts in U.S. dollars)

 

   

September 30,

2013

   

December 31,

2012

 

Assets

 

(unaudited)

         
                 

Current assets:

               

Cash and cash equivalents

  $ 11,549,948     $ 6,415,679  

Accounts receivable, net of allowance for doubtful accounts of $89,981 as of September 30, 2013 and $73,970 as of December 31, 2012

    4,869,466       4,413,265  

Inventory

    338,110       587,104  

Prepaid expenses and deposits

    4,241,402       5,081,408  

Derivative instrument asset, current portion (note 4)

    258,188       412,944  

Prepaid domain name registry and ancillary services fees, current portion

    45,801,683       45,170,167  

Deferred tax aset, current portion

    672,175       -  

Income taxes recoverable

    311,470       1,730,631  

Total current assets

    68,042,442       63,811,198  
                 

Derivative instrument asset, long-term portion (note 4)

    208,221       31,838  

Prepaid domain name registry and ancillary services fees, long-term portion

    12,031,926       12,318,723  

Property and equipment

    1,833,258       1,352,144  

Deferred tax asset, long-term portion (note 7)

    5,417,075       5,970,462  

Intangible assets (note 5)

    15,630,479       16,415,651  

Goodwill

    18,873,127       18,873,127  

Total assets

  $ 122,036,528     $ 118,773,143  
                 
                 

Liabilities and Stockholders' Equity

               
                 

Current liabilities:

               

Accounts payable

  $ 2,631,198     $ 1,928,459  

Accrued liabilities

    3,187,213       2,522,229  

Customer deposits

    4,072,325       4,955,671  

Derivative instrument liability, current portion (note 4)

    310,865       -  

Loan payable, current portion (note 6)

    6,900,000       3,700,000  

Deferred revenue, current portion

    56,188,897       54,997,887  

Accreditation fees payable, current portion

    497,404       512,847  

Deferred tax liability, current portion (note 7)

    -       914,429  

Income taxes payable (note 7)

    923,280       1,255,108  

Total current liabilities

    74,711,182       70,786,630  
                 

Deferred revenue, long-term portion

    15,801,411       16,002,464  

Accreditation fees payable, long-term portion

    137,117       145,592  

Deferred rent, long-term portion

    71,898       54,150  

Deferred tax liability, long-term portion (note 7)

    5,158,000       5,234,100  
                 

Stockholders' equity (note 11)

               

Preferred stock - no par value, 1,250,000 shares authorized; none issued and outstanding

    -       -  

Common stock - no par value, 250,000,000 shares authorized; 43,576,861 shares issued and outstanding as of September 30, 2013 and 44,322,159 shares issued and outstanding as of December 31, 2012

    11,797,362       10,084,417  

Additional paid-in capital

    28,520,120       33,931,529  

Deficit

    (14,252,274 )     (17,509,843 )

Accumulated other comprehensive income

    91,712       44,104  

Total stockholders' equity

    26,156,920       26,550,207  

Total liabilities and stockholders' equity

  $ 122,036,528     $ 118,773,143  
                 

Commitments and contingencies (note 10)

               

 

See accompanying notes to unaudited consolidated financial statements

 

 
1

 

 

Tucows Inc.

Consolidated Statements of Operations and Comprehensive Income

(Dollar amounts in U.S. dollars)

(unaudited)

 

    Three months ended September 30,     Nine months ended September 30,  
   

2013

   

2012

   

2013

   

2012

 
      (unaudited)       (unaudited)  
                                 

Net revenues (note 9)

  $ 35,637,085     $ 29,246,069     $ 96,795,464     $ 84,935,989  
                                 

Cost of revenues (note 9):

                               

Cost of revenues

    24,268,961       21,446,084       69,354,366       60,833,420  

Network expenses (*)

    1,192,450       1,158,885       3,716,471       3,629,639  

Depreciation of property and equipment

    164,283       157,203       452,711       460,259  

Amortization of intangible assets (note 5)

    11,970       35,910       83,790       107,730  

Total cost of revenues

    25,637,664       22,798,082       73,607,338       65,031,048  
                                 

Gross profit

    9,999,421       6,447,987       23,188,126       19,904,941  
                                 

Expenses:

                               

Sales and marketing (*)

    2,998,419       2,037,338       8,792,091       6,287,702  

Technical operations and development (*)

    1,215,327       1,010,949       3,097,294       3,229,669  

General and administrative (*)

    1,869,668       1,486,323       5,266,997       5,018,178  

Depreciation of property and equipment

    52,972       46,981       158,833       139,918  

Amortization of intangible assets (note 5)

    219,030       219,030       657,090       657,090  

Loss (gain) on currency forward contracts (note 4)

    (28,068 )     (615,245 )     353,209       (793,516 )

Total expenses

    6,327,348       4,185,376       18,325,514       14,539,041  
                                 

Income from operations

    3,672,073       2,262,611       4,862,612       5,365,900  
                                 

Other income (expense):

                               

Interest expense, net

    (78,966 )     (50,228 )     (271,756 )     (145,710 )

Other income, net

    -       -       -       529,711  

Total other income (expense)

    (78,966 )     (50,228 )     (271,756 )     384,001  
                                 

Income before provision for income taxes

    3,593,107       2,212,383       4,590,856       5,749,901  
                                 

Provision for income taxes (note 7)

    999,747       577,383       1,333,287       1,755,284  
                                 

Net income

    2,593,360       1,635,000       3,257,569       3,994,617  
                                 

Other comprehensive income net of tax of $257,505 for the three months ended September 30, 2013, and $24,800 for the nine months ended September 30, 2013

    494,334       -       47,608       -  
                                 

Comprehensive income for the period

  $ 3,087,694     $ 1,635,000     $ 3,305,177     $ 3,994,617  
                                 
                                 

Basic earnings per common share (note 8)

  $ 0.06     $ 0.04     $ 0.08     $ 0.09  
                                 

Shares used in computing basic earnings per common share (note 8)

    43,183,583       45,094,678       41,289,876       46,362,261  
                                 

Diluted earnings per common share (note 8)

  $ 0.06     $ 0.03     $ 0.07     $ 0.08  
                                 

Shares used in computing diluted earnings per common share (note 8)

    45,639,900       48,411,429       44,749,232       49,603,870  
                                 

(*) Stock-based compensation has been included in operating expenses as follows:

                               

Network expenses

  $ 8,755     $ 5,979     $ 22,813     $ 18,354  

Sales and marketing

  $ 32,681     $ 24,116     $ 93,000     $ 67,047  

Technical operations and development

  $ 21,549     $ 15,600     $ 57,166     $ 43,490  

General and administrative

  $ 99,801     $ 120,676     $ 155,904     $ 163,041  
 

See accompanying notes to consolidated financial statements

 

 
2

 

 

Tucows Inc.

Consolidated Statements of Cash Flows

(Dollar amounts in U.S. dollars)

(unaudited)

 

    Three months ended September 30,     Nine months ended September 30,  
   

2013

   

2012

   

2013

   

2012

 
      (unaudited)       (unaudited)  

Cash provided by:

                               

Operating activities:

                               

Net income for the period

  $ 2,593,360     $ 1,635,000     $ 3,257,569     $ 3,994,617  

Items not involving cash:

                               

Depreciation of property and equipment

    217,255       204,184       611,544       600,177  

Amortization of deferred financing charges

    -       100       -       2,300  

Amortization of intangible assets

    231,000       254,940       740,880       764,820  

Deferred income taxes (recovery)

    (99,786 )     228,169       (78,103 )     333,111  
Excess tax benefits on share-based compensation expense     (1,056,014 )     -       (1,056,014 )     -  

Deferred rent

    7,872       8,258       17,748       21,458  

Acquisition of domain names

    -       -       -       (3,664 )

Disposal of domain names

    8,923       15,142       44,292       38,181  

Gain on disposition of intangible assets

    -       -       -       (508,800 )

(Gain) loss on change in the fair value of forward contracts

    (204,341 )     (698,781 )     361,646       (1,155,147 )

Stock-based compensation

    162,786       166,371       328,883       291,932  

Change in non-cash operating working capital:

                               

Accounts receivable

    758,089       90,239       (456,201 )     (946,592 )

Inventory

    (150,686 )     -       248,994       -  

Prepaid expenses and deposits

    543,111       636,756       840,006       (1,254,712 )

Prepaid domain name registry and ancillary services fees

    1,038,268       905,807       (344,719 )     (3,392,387 )

Income taxes recoverable/payable

    980,969       226,304       1,087,333       466,885  

Accounts payable

    92,473       43,173       700,194       648,250  

Accrued liabilities

    163,300       (279,427 )     664,984       244,738  

Customer deposits

    (595,776 )     (2,781 )     (883,346 )     62,817  

Deferred revenue

    (986,779 )     (1,144,779 )     989,957       4,139,869  

Accreditation fees payable

    (39,835 )     (51,839 )     (23,918 )     (26,660 )
                                 

Net cash provided by operating activities

    3,664,189       2,236,836       7,051,729       4,321,193  
                                 

Financing activities:

                               

Proceeds received on exercise of stock options

    1,136,061       14,186       1,454,255       363,898  
Excess tax benefits on share-based compensation expense     1,056,014       -       1,056,014       -  

Repurchase of common stock

    -       (1,630,643 )     (6,537,616 )     (9,115,833 )

Proceeds received on loan payable

    -       -       5,200,000       4,000,000  

Repayment of loan payable

    (600,000 )     -       (2,000,000 )     (850,000 )
                                 

Net cash provided by (used in) financing activities

    1,592,075       (1,616,457 )     (827,347 )     (5,601,935 )
                                 

Investing activities:

                               

Additions to property and equipment

    (171,442 )     (162,207 )     (1,090,113 )     (666,534 )

Proceeds on disposal of intangible assets

    -       -       -       508,800  

Net cash used in investing activities

    (171,442 )     (162,207 )     (1,090,113 )     (157,734 )
                                 
                                 

Increase (decrease) in cash and cash equivalents

    5,084,822       458,172       5,134,269       (1,438,476 )
                                 

Cash and cash equivalents, beginning of period

    6,465,126       4,511,561       6,415,679       6,408,209  
                                 

Cash and cash equivalents, end of period

  $ 11,549,948     $ 4,969,733       11,549,948       4,969,733  
                                 

Supplemental cash flow information:

                               

Interest paid

  $ 92,610     $ 50,511       289,483       146,342  
                                 

Supplementary disclosure of non-cash investing and financing activities:

                               

Property and equipment acquired during the period not yet paid for

  $ 99,060     $ 167,998       99,060       167,998  
 

See accompanying notes to unaudited consolidated financial statements

 

 
3

 

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1. ORGANIZATION OF THE COMPANY:

 

Tucows Inc., a Pennsylvania corporation (referred to throughout this report as the “Company”, “Tucows”, “we”, “us” or through similar expressions), together with our consolidated subsidiaries, is a global distributor of Internet services, including domain name registration, security and identity products through digital certificates, email and mobile telephony services through its global Internet-based network of Internet Service Providers, web hosting companies and other providers of Internet services to end-users.

 

We were incorporated under the laws of the Commonwealth of Pennsylvania in November 1992 under the name Infonautics, Inc. In August 2001, we completed our acquisition of Tucows Inc., a Delaware corporation, and we changed our name from Infonautics, Inc. to Tucows Inc. Our principal executive office is located in Toronto, Ontario and we have other offices in the Netherlands, Germany and the United States.

 

2. BASIS OF PRESENTATION:

 

The accompanying unaudited interim consolidated balance sheets, and the related consolidated statements of operations and comprehensive income and cash flows reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair presentation of the financial position of Tucows and its subsidiaries as at September 30, 2013 and the results of operations and cash flows for the interim periods ended September 30, 2013 and 2012. The results of operations presented in this Quarterly Report on Form 10-Q are not necessarily indicative of the results of operations that may be expected for future periods.

 

The accompanying unaudited interim consolidated financial statements have been prepared by Tucows in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosure normally included in the Company's annual audited consolidated financial statements and accompanying notes have been condensed or omitted. These interim consolidated financial statements and accompanying notes follow the same accounting policies and methods of application used in the annual financial statements and should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2012 included in Tucows' 2012 Annual Report on Form 10-K filed with the SEC on March 15, 2013.

 

There have been no material changes to our significant accounting policies during the three and nine months ended September 30, 2013 as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

 

The Company recognizes the effects of events or transactions that occur after the balance sheet date but before financial statements are issued (“subsequent events”) if there is evidence that conditions related to the subsequent event existed at the date of the balance sheet date, including the impact of such events on management's estimates and assumptions used in preparing the financial statements. Other significant subsequent events that are not recognized in the financial statements, if any, are disclosed in the notes to the unaudited interim consolidated financial statements.

 

3. NEW ACCOUNTING POLICIES:

 

Recent Accounting Pronouncements Adopted

 

Testing Indefinite-Lived Intangible Assets for Impairment

 

On January 1, 2013, the Company adopted Accounting Standards Update No. 2012-02, Intangibles —Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”) which allows entities to use a qualitative approach to test indefinite-lived intangible assets for impairment. ASU 2012-02 allows an entity to first perform a qualitative assessment to determine whether it is more likely than not that the indefinite-lived intangible asset is impaired. If an entity concludes that this is the case, it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount. The adoption of ASU 2012-02 did not materially impact the carrying value of our recorded indefinite-lived intangible assets.  The Company will perform its next annual indefinite-lived intangible asset impairment test on December 31, 2013.

 

 
4

 

 

Reclassification Out of Accumulated Other Comprehensive Income

 

The Company adopted Accounting Standards Update No. 2013-02, Comprehensive Income (Topic 220): “Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income.” (“ASU 2013-02”), effective January 1, 2013. ASU 2013-02 was applied prospectively, which requires expanded disclosures for amounts reclassified out of accumulated other comprehensive income by component. The guidance requires the presentation of amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, a cross-reference to other disclosures that provide additional detail about those amounts is required. The adoption of ASU 2013-02 did not materially impact the Company’s consolidated financial statements.

 

Recent Accounting Pronouncements Not Yet Adopted

 

On July 18, 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”).   ASU 2013-11, which is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013, is expected to reduce diversity in practice by providing guidance on the presentation of unrecognized tax benefits and will better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. We are currently evaluating the impact of our pending adoption of ASU 2013-11 on our Consolidated Financial Statements.

 

4. Derivative instruments and hedging activities:

 

Foreign currency forward contracts

 

In October 2012, the Company entered into a hedging program with a Canadian chartered bank to limit the potential foreign exchange fluctuations in its future cash flows related to a portion of payroll, rent and payments to a Canadian domain name registry supplier that are denominated in Canadian dollars and are expected to be paid by its Canadian operating subsidiary. As part of its risk management strategy, the Company uses derivative instruments to hedge a portion of the foreign exchange risk associated with these costs. The Company does not use these forward contracts for trading or speculative purposes. These forward contracts typically mature between one and eighteen months.

 

The Company has designated these transactions as cash flow hedges of forecasted transactions under ASC Topic 815 “Derivatives and Hedging” (ASC Topic 815). As the critical terms of the hedging instrument, and of the entire hedged forecasted transaction, are the same, in accordance with ASC Topic 815, the Company has been able to conclude that changes in fair value or cash flows attributable to the risk of being hedged are expected to completely offset at inception and on an ongoing basis. Accordingly, quarterly unrealized gains or losses on the effective portion of these contracts have been included within other comprehensive income. The fair value of the contracts, as of September 30, 2013, is recorded as derivative instrument assets and liabilities.

 

As of September 30, 2013, the notional amount of forward contracts that the Company held to sell U.S. dollars in exchange for Canadian dollars was $32.8 million, of which $25.5 million met the requirements of ASC Topic 815 and were designated as hedges (September 30, 2012 - $15.1 million of which none were designated as hedges). In addition, as of September 30, 2013, the Company has forward contracts with a notional amount of $7.3 million, which are not accounted for as a hedge. The change in fair value of $16,000 for these contracts is recorded on the statement of operations.

 

 
5

 

 

Fair value of derivative instruments and effect of derivative instruments on financial performance

 

The effect of these derivative instruments on our consolidated financial statements as of, and for the nine months ended September 30, 2013, were as follows (amounts presented do not include any income tax effects).

 

Fair value of derivative instruments in the consolidated balance sheets

 

     

As of

September 30,

2013

 

   

As of

December 31,

2012

 

 

Derivatives

Balance Sheet

Location

 

Fair Value

Asset

(Liability)

   

Fair Value

Asset

(Liability)

 
                   

Foreign currency forward contracts designated as cash flow hedges

Derivative instruments

  $ 139,487     $ 377,703  
                   

Foreign currency forward contracts not designated as cash flow hedges

Derivative instruments

  $ 16,057     $ 67,079  
                   

Total foreign currency forward contracts

Derivative instruments

  $ 155,544     $ 444,782  

 

 

 

Effects of derivative instruments on income and other comprehensive income (OCI) for the three and nine months ended September 30, 2013 is as follows:

 

Derivatives in Cash Flow

 

Hedging Relationship

 

Amount of

Gain or (Loss) Recognized in

OCI on

Derivative

(Effective

Portion)

 

Location of

Gain or (Loss)

Reclassified

from

Accumulated

OCI into

Income

(Effective

 Portion)

 

Amount of

Gain or (Loss) Reclassified

from

Accumulated

OCI into

Income

(Effective

Portion)

   

Location of

Gain or (Loss) Recognized in

Income on

Derivative

(ineffective

Portion and

Amount

Excluded from Effectiveness

Testing)

   

Amount of

Gain or (Loss) Recognized in

Income on

Derivative

(ineffective

Portion and

Amount

Excluded from Effectiveness

Testing)

 
                                   

Foreign currency forward contracts for the three months ended September 30, 2013

  $ 506,509  

Operating expenses

  $ ( 140,893 )            
         

Cost of revenues

  $ 500                  
                                   

Foreign currency forward contracts for the nine months ended September 30, 2013

  $ 63,942  

Operating expenses

  $ ( 179,609 )            
         

Cost of revenues

  $ ( 1,741 )                

 

In addition to the above, for those foreign currency forward contracts not designated as hedged, the Company has recorded a loss (gain) of (28,000) and $(0.6) million for the three months ended September 30, 2013 and September 30, 2012 respectively, and a loss (gain) of $0.4 million and $(0.8) million for the nine months ended September 30, 2013 and September 30, 2012 respectively, in the consolidated statement of operations and comprehensive income.

 

 
6

 

 

5. INTANGIBLE ASSETS:

 

Intangible assets consist of acquired technology, brand, customer relationships, surname domain names and our portfolio of domain names. As reflected in the table below, these balances are being amortized on a straight-line basis over the life of the intangible assets, except for the surname domain names and portfolio domain names, which have been determined to have an indefinite life and which are tested annually for impairment.

 

A summary of acquired intangible assets for the three months ended September 30, 2013 is as follows:

 

   

Technology

2 – 7 years

   

Brand

7 years

   

Customer relationships

4 – 7 years

   

Surname

domain

names

indefinite

life

   

Direct

navigation

domain

names

indefinite

life

   

Total

 
                                                 

Net book value, June 30, 2013

  $ 11,970     $ 311,470     $ 1,458,940     $ 12,102,878     $ 1,985,144     $ 15,870,402  

Sales of domain names

                      (4,218

)

    (4,705

)

    (8,923

)

Amortization expense

    (11,970

)

    (43,410

)

    (175,620

)

                (231,000

)

Net book value, September 30, 2013

  $     $ 268,060     $ 1,283,320     $ 12,098,660     $ 1,980,439     $ 15,630,479  

 

A summary of acquired intangible assets for the nine months ended September 30, 2013 is as follows:

 

   

Technology

2 – 7 years

   

Brand

7 years

   

Customer

relationships

4 – 7 years

   

Surname

domain

names

indefinite

life

   

Direct

navigation

domain

names

indefinite

life

   

Total

 
                                                 

Net book value, December 31, 2012

  $ 83,790     $ 398,290     $ 1,810,180     $ 12,110,017     $ 2,013,374     $ 16,415,651  

Sales of domain names

                      (11,357

)

    (32,935

)

    (44,292

)

Amortization expense

    (83,790

)

    (130,230

)

    (526,860

)

                (740,880

)

Net book value, September 30, 2013

  $     $ 268,060     $ 1,283,320     $ 12,098,660     $ 1,980,439     $ 15,630,479  

 

As of September 30, 2013, the accumulated amortization for the definite life intangibles was $4.9 million.

 

6. LOAN PAYABLE:

 

The Company has credit agreements (collectively the “Amended Credit Facility”) with the Bank of Montreal (the “Bank”) that were amended on November 19, 2012, and which provide it with access to two revolving demand loan facilities (the “2012 Demand Loan Facilities”), a treasury risk management facility and an operating demand loan.

 

Two Revolving Demand Loan Facilities

 

The 2012 Demand Loan Facilities are governed by the terms of the Offer Letter, dated November 19, 2012, between the Company and the Bank.

 

 
7

 

 

Under the terms of the Amended Credit Facility, our prior demand loan facilities have been amended to provide an aggregate of $14 million in funds available through the 2012 Demand Loan Facilities, which consist of a demand loan revolving facility (the “2012 DLR Loan”) and a demand loan revolving reducing facility (the “2012 DLRR Loan”). The 2012 DLR Loan accrues interest at the Bank’s U.S. Base Rate plus 1.25%. The Company may elect to pay interest on the 2012 DLRR Loan either at the Bank’s U.S. Base Rate plus 1.25% or LIBOR plus 2.50%. Aggregate advances under the 2012 Demand Loan Facilities may not exceed $14.0 million and no more than $2.0 million of such advances may be used to finance repurchases of Company common stock. This facility also provided that a one-time repurchase of Company Common Stock of up to US$10,000,000 may be made via Dutch Auction prior to March 31, 2013. The 2012 Demand Loan Facilities are subject to an undrawn aggregate standby fee of 0.20% following the first draw, which such fee is payable quarterly in arrears.

 

Repayment of advances under the 2012 DLR Loan consist of interest only payments made monthly in arrears and prepayment is permitted without penalty. The outstanding balance under the 2012 DLR Loan as of December 31st of each year is to be fully repaid within 30 days of December 31st through an equivalent advance made under the 2012 DLRR Loan. Advances under the 2012 DLRR Loan will be made annually and solely for such purpose. Each advance under the 2012 DLRR Loan is to be repaid in equal monthly principal payments plus interest, over a period of four years from the date of such advance.

 

At December 31, 2012, the outstanding balance under the 2012 DLR Loan was $3.7 million. In accordance with the terms of the Amended Credit Facility, on January 1, 2013, the outstanding balance under the 2012 DLR Loan was fully repaid through an equivalent advance made under the 2012 DLRR Loan. Under the terms of the 2012 DLRR Loan this balance is to be repaid in equal monthly principal payments plus interest through December 31, 2016. At September 30, 2013, the outstanding balance under the 2012 DLRR Loan was $1.7 million.

 

On January 7, 2013, the Company successfully concluded a modified “Dutch auction tender offer”, which was funded from available cash and an advance under the 2012 DLR Loan in the amount of $5.2 million. Under the terms of the offer, the Company repurchased an aggregate of 4,114,121 shares of its common stock at a purchase price of $1.50 per share, for a total of $6,171,656, excluding transaction costs of approximately $106,000. At September 30, 2013, the outstanding balance under the 2012 DLR Loan was $5.2 million.

 

Treasury Risk Management Facility 

 

The Amended Credit Facility also provides for a $3.5 million settlement risk line to assist the Company with hedging Canadian dollar exposure through foreign exchange forward contracts and/or currency options. Under the terms of the Amended Credit Facility, the Company may enter into such agreements at market rates with terms not to exceed 18 months. As of September 30, 2013, the Company held contracts in the amount of $32.8 million to trade U.S. dollars in exchange for Canadian dollars.

 

Operating Demand Loan

 

The Amended Credit Facility also provides the Company with a $1.0 million operating demand loan facility to assist in meeting its operational needs (the “Operating Demand Loan”). The Operating Demand Loan accrues interest at the Bank’s U.S. Base Rate plus 1.25%. Interest is payable monthly in arrears with any borrowing under the Operating Demand Loan fluctuating widely with periodic clean-up, at a minimum on an annual basis. The Company has also agreed to pay to the Bank a monthly monitoring fee of US$500 with respect to this loan. The Operating Demand Loan is payable on demand at any time, at the sole discretion of the Bank, with or without cause, and the Bank may terminate the Operating Demand Loan at any time. As of September 30, 2013, the Company had no amounts outstanding under its Operating Demand Loan.

 

General Terms

 

The Company’s Amended Credit Facility contains customary representations and warranties, affirmative and negative covenants, and events of default. The Company’s obligations under the Amended Credit Facility are guaranteed and secured by a security interest in substantially all of its assets. The Amended Credit Facility also requires that the Company comply with certain non-financial covenants and restrictions. In addition, the Company has agreed to comply with the following financial covenants at all times, which are to be calculated on a rolling four quarter basis: (i) Maximum Total Funded Debt to EBITDA of 2.00:1; and (ii) Minimum Fixed Charge Coverage of 1.20:1. Further, its Maximum Annual Capital Expenditures cannot exceed $3.6 million per year, which limit will be reviewed on an annual basis. As of September 30, 2013, the Company was in compliance with these covenants.

 

 
8

 

 

Scheduled principal loan repayments are as follows:

 

Remainder of 2013

    250,000  

2014

    2,300,000  

2015

    1,750,000  

2016

    1,300,000  

2017

    1,300,000  

 

7. INCOME TAXES

 

For the nine months ended September 30, 2013, the Company recorded a provision for income taxes of $1.3 million on income before income taxes of $4.6 million, using an estimated effective tax rate for its 2013 fiscal year adjusted for certain minimum state taxes. Comparatively, for the nine months ended September 30, 2012, the Company recorded a provision for income taxes of $1.8 million on income before taxes of $5.7 million, using an estimated effective tax rate for its 2012 fiscal year.

 

In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the years in which those temporary differences become deductible. The Company considers projected future taxable income, uncertainties related to the industry in which we operate, and tax planning strategies in making this assessment.

 

The Company follows the provisions of FASB ASC Topic 740, Income Taxes to account for income tax exposures. The application of this interpretation requires a two-step process that separates recognition of uncertain tax benefits from measurement thereof.

 

The Company had approximately $0.1 million of total gross unrecognized tax benefit as of September 30, 2013 and $0.4 million of total gross unrecognized tax benefit as of December 31, 2012, which if recognized would favorably affect its income tax rate in future periods. The unrecognized tax benefit relates primarily to prior year Pennsylvania state franchise taxes. The decrease of $0.3 million from December 31, 2012 relates to the finalization of prior year German income tax returns and the Company completing its 2012 scientific and research and development claim. The Company recognizes accrued interest and penalties related to income taxes in income tax expense. The Company did not have significant interest and penalties accrued at September 30, 2013 and December 31, 2012, respectively. The Company believes that it is reasonably possible that all of the unrecognized tax benefits will decrease in the next twelve months as it is anticipated that the tax authorities will finalize their review of prior taxes owing in Pennsylvania.

 

8. BASIC AND DILUTED EARNINGS PER COMMON SHARE:

 

Basic earnings per common share has been calculated by dividing net income for the period by the weighted average number of common shares outstanding during each period. Diluted earnings per share has been calculated by dividing net income for the period by the weighted average number of common shares and potentially dilutive common shares outstanding during the period. In computing diluted earnings per share, the treasury stock method is used to determine the number of shares assumed to be purchased from the conversion of common shares equivalents or the proceeds of option exercises.

 

The following table is a summary of the basic and diluted earnings per common share:

 

   

Three months

ended

September 30,

2013

   

Three months

ended

September 30,

2012

   

Nine months

ended

September 30,

2013

   

Nine months

ended

September 30,

2012

 

Numerator for basic and diluted earnings per common share:

                               

Net income for the period

  $ 2,593,360     $ 1,635,000     $ 3,257,569     $ 3,994,617  

Denominator for basic and diluted earnings per common share:

                               

Basic weighted average number of common shares outstanding

    43,183,583       45,094,678       41,289,876       46,362,261  

Effect of outstanding stock options

    2,456,317       3,316,751       3,459,356       3,241,609  

Diluted weighted average number of shares outstanding

    45,639,900       48,411,429       44,749,232       49,603,870  

Basic earnings per common share

  $ 0.06     $ 0.04     $ 0.08     $ 0.09  

Diluted earnings per common share

  $ 0.06     $ 0.03     $ 0.07     $ 0.08  

 

 
9

 

  

For the three months ended September 30, 2013, outstanding options to purchase 404,000 common shares were not included in the computation of diluted income per common share because all such options had exercise prices greater than the average market price of the common shares.

 

For the nine months ended September 30, 2013, outstanding options to purchase 563,000 common shares were not included in the computation of diluted income per common share because all such options had exercise prices greater than the average market price of the common shares.

 

During the nine months ended September 30, 2013, 4,114,121 common shares were repurchased and cancelled under the terms of a modified Dutch auction tender offer announced in December 2012.

 

During the nine months ended September 30, 2013, 143,073 common shares were repurchased and cancelled under the terms of our stock repurchase program announced in March 2013.

 

During the three months ended June 30, 2012, 1,115,304 common shares were repurchased and cancelled under the terms of our stock repurchase program announced in November 2011.

 

During the three months ended March 31, 2012, 7,570,236 common shares were repurchased and cancelled under the terms of a modified Dutch auction tender offer announced in December 2011.

 

The computation of earnings per share and diluted earnings per share for the three and nine months ended September 30, 2013 and 2012 include reductions in the number of shares outstanding due to these repurchases.

 

 
10

 

 

9. SUPPLEMENTAL INFORMATION:

 

(a)           The following is a summary of the Company’s revenue earned from each significant revenue stream:

 

    Three months ended September 30,     Nine months ended September 30,  
   

2013

   

2012

   

2013

   

2012

 
                                 

Wholesale

                               

Domain Services

  $ 22,002,858     $ 22,267,806     $ 65,698,859     $ 65,043,412  

Value Added Services

    2,606,151       2,603,513       7,854,268       7,881,213  

Total Wholesale

    24,609,009       24,871,319       73,553,127       72,924,625  
                                 

Retail

    6,860,921       2,964,943       16,862,957       7,112,823  

Portfolio

    4,167,155       1,409,807       6,379,380       4,898,541  
    $ 35,637,085     $ 29,246,069     $ 96,795,464     $ 84,935,989  

 

During the three and nine months ended September 30, 2013 and 2012, no customer accounted for more than 10% of total revenue. As at September 30, 2013, no customer accounted for more than 10% of accounts receivable, while as at September 30, 2012, one customer accounted for 13% of accounts receivable.

 

(b)           The following is a summary of the Company’s cost of revenues from each significant revenue stream:

 

 

    Three months ended September 30,     Nine months ended September 30,  
   

2013

   

2012

   

2013

   

2012

 
                                 

Wholesale

                               

Domain Services

  $ 18,580,828     $ 18,644,315     $ 55,519,797     $ 54,275,405  

Value Added Services

    484,619       532,296       1,567,113       1,576,228  

Total Wholesale

    19,065,447       19,176,611       57,086,910       55,851,633  
                                 

Retail

    4,543,084       2,064,448       11,176,620       4,350,722  

Portfolio

    660,430       205,025       1,090,836       631,065  

Network, other costs

    1,192,450       1,158,885       3,716,471       3,629,639  

Network, depreciation and amortization costs

    176,253       193,113       536,501       567,989  
    $ 25,637,664     $ 22,798,082     $ 73,607,338     $ 65,031,048  

 

(c)           The following is a summary of the Company’s property and equipment by geographic region:

 

 

 

   

September 30,

2013

   

December 31,

2012

 

Canada

  $ 1,320,572     $ 1,026,570  

United States

    498,734       306,679  

Germany

    13,952       18,895  
    $ 1,833,258     $ 1,352,144  

 

 

 

(d)           The following is a summary of the Company’s amortizable intangible assets by geographic region:

 

 

 

   

September 30,

 2013

   

December 31,

2012

 

Canada

  $ 499,000     $ 1,062,100  

Germany

    1,052,380       1,230,160  
    $ 1,551,380     $ 2,292,260  

 

 
11

 

  

(e)           The following is a summary of the Company’s deferred tax asset, net of valuation allowance, by geographic region:

 

 

 

   

September 30,

2013

   

December 31,

2012

 

Canada

  $ 6,089,250     $ 5,970,462  
    $ 6,089,250     $ 5,970,462  

 

 

 

10. COMMITMENTS AND CONTINGENCIES:

 

The Company is involved in various legal claims and lawsuits in connection with its ordinary business operations. The Company intends to vigorously defend these claims. While the final outcome with respect to any actions or claims outstanding or pending as of September 30, 2013 cannot be predicted with certainty, management does not believe that the resolution of these claims, individually or in the aggregate, will have a material adverse effect on the Company's financial position.

 

11. STOCKHOLDERS' EQUITY:

 

The following unaudited table summarizes stockholders' equity transactions for the three month period ended September 30, 2013:

 

   

Common stock

     Additional

paid in

             Accumulated

Other

Comprehensive

     

Total

stockholders'

 
   

Number

   

Amount

   

capital

   

Deficit

   

Income

   

equity

 
                                                 

Balances, June 30, 2013

    40,641,488     $ 9,755,391     $ 28,207,230     $ (16,845,634

)

  $ (402,622 )   $ 20,714,365  
                                                 

Exercise of stock options

    2,935,373       2,041,971       (905,910

)

                1,136,061  

Stock-based compensation

                162,786                   162,786  

Excess tax benefit from stock based payment arrangements

                1,056,014                   1,056,014  

Net income for the period

                      2,593,360             2,593,360  

Unrealized loss on foreign currency forward contracts treated as hedges

                            506,509       506,509  

Reclassification to net income due to settlement of foreign currency forward contracts treated as hedges

                            (12,175 )     (12,175 )
                                                 

Balances, September 30, 2013

    43,576,861     $ 11,797,362     $ 28,520,120     $ (14,252,274

)

  $ 91,712     $ 26,156,920  

 

 
12

 

 

The following unaudited table summarizes stockholders' equity transactions for the nine month period ended September 30, 2013:

 

   

Common stock

     Additional

paid in

           Accumulated

Other

Comprehensive

     

Total

stockholders'

 
   

Number

   

Amount

   

capital

   

Deficit

   

Income

   

equity

 
                                                 

Balances, December 31, 2012

    44,322,159     $ 10,084,417     $ 33,931,529     $ (17,509,843

)

  $ 44,104     $ 26,550,207  
                                                 

Exercise of stock options

    3,511,946       2,564,447       (1,110,192

)

                1,454,255  

Repurchase and retirement of shares

    (4,114,121

)

    (822,887

)

    (5,454,854

)

                (6,277,741

)

Normal Course Issuer Bid

    (143,073 )     (28,615 )     (231,260 )                 (259,875 )

Cancellation of restricted stock

    (50

)

                             

Stock-based compensation

                328,883                   328,883  

Excess tax benefit from stock based payment arrangements

                1,056,014                   1,056,014  

Net income for the period

                      3,257,569             3,257,569  

Unrealized loss on foreign currency forward contracts treated as hedges

                            63,942       63,942  

Reclassification to net income due to settlement of foreign currency forward contracts treated as hedges