Business Context and Reporting Period
Company: Think Partnership Inc. (operating as Kowabunga! Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Headquarters: Clearwater, Florida
Operations: The company provides marketing and technology solutions organized into three segments: Network (affiliate marketing, search, PPC), Direct (lead generation, membership programs, online dating), and Advertising (traditional and interactive marketing). As of March 10, 2008, the company employed 249 persons across eight locations in the U.S. and the U.K.
Key Financial Metrics
| Metric | 2007 | 2006 |
|---|---|---|
| Total Revenue | $73,576,750 | $71,882,328 |
| Gross Profit | $37,797,385 | $44,189,414 |
| Gross Margin | 51.4% | 61.5% |
| Net Income (Loss) | $(1,107,825) | $565,191 |
| Net Loss to Common Shareholders | $(1,243,352) | $(9,666,707) |
| Diluted EPS | $(0.02) | $(0.20) |
| Cash from Operating Activities | $3,981,958 | $1,687,748 |
| Total Assets | $121,125,513 | $120,397,139 |
| Long-Term Debt | $11,099,463 | $11,738,205 |
| Cash and Cash Equivalents | $2,578,246 | $3,031,488 |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 2% to $73.6 million. The Direct segment drove growth with a 19% increase ($36.5M), and the Network segment grew 14% ($19.0M). Conversely, the Advertising segment declined 23% ($19.4M) due to a significant drop in search engine enhancement services.
- Margin Compression: Gross margin decreased from 61% in 2006 to 51% in 2007. This was primarily due to a shift in revenue mix toward lower-margin services (paid search and internal offers) and a decline in high-margin email marketing revenue.
- Profitability: The company reported a net loss of $1.1 million in 2007, compared to a net income of $0.6 million in 2006. However, the net loss allocable to common shareholders improved significantly from $9.7 million in 2006 to $1.2 million in 2007, largely because 2006 included a one-time $6.0 million charge for warrants issued to convert preferred stock and significant preferred stock accretion/dividends.
- Operating Cash Flow: Cash provided by operating activities more than doubled to $4.0 million, driven by a net loss adjusted for significant non-cash items (depreciation, amortization, stock-based compensation) totaling $8.1 million.
Guidance, Outlook, Risks, and Unusual Items
- Subsequent Financing: On February 27, 2008, the company amended its loan agreement with Wachovia Bank, borrowing $15 million in a revolving credit facility and $5 million in a term note. The term note interest rate was effectively fixed at 5.9% via a swap agreement.
- Contingent Consideration: As of December 31, 2007, the company had potential contingent cash payments of approximately $14.4 million related to past acquisitions if financial hurdles are met. These payments are expected to become payable starting in 2009.
- Internal Control Material Weakness: Management and the independent auditor identified a material weakness in internal controls over financial reporting. Specifically, there were no formal processes over change management and end-user access procedures for IT systems, including the General Ledger and revenue-producing applications. The auditor issued an adverse opinion on the effectiveness of internal controls.
- Key Risks: The company faces risks related to the integration of 14 acquired companies, reliance on third-party payment processors, increasing costs of online advertising, and the potential for goodwill impairment. Additionally, the company has a history of losses in five of the last seven years.
- Management Commentary: Management expects to continue investing in product enhancements and member acquisition. They anticipate that the shift in revenue mix toward traditional offline and paid search will continue to impact gross margins.
Investor Verification Checklist
- Internal Controls: Verify the progress of remediation efforts regarding the material weakness in IT change management and access controls identified in the 2007 audit.
- Debt Covenants: Review the financial covenants in the amended Wachovia loan agreement (Total Debt to EBITDA, Fixed Charge Coverage) to assess the risk of default given the company's recent net loss.
- Contingent Liabilities: Assess the likelihood of the $14.4 million in contingent earn-out payments becoming due and the company's ability to fund them from operations.
- Revenue Quality: Analyze the sustainability of the Direct segment's growth, which relies heavily on internal offers and membership programs that may have higher churn or acquisition costs.
- Goodwill Valuation: Monitor the $79.8 million in goodwill for potential impairment charges, especially given the company's stock price volatility and operating losses.