INUV

Business Context and Reporting Period

Company: Kowabunga! Inc. (f/k/a Think Partnership, Inc.)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: A provider of interactive performance-based advertising networks and technology platforms. Operations are organized into two continuing segments: Network (affiliate marketing, search, lead generation) and Direct (lead generation, online education). The company divested its Advertising Segment and portions of its Direct Segment (Cherish, iLead Media), reporting them as discontinued operations.

Key Financial Metrics

Note: The 2008 Net Loss includes $80.6 million in non-cash impairment charges ($40.2M continuing, $40.4M discontinued).

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 86% to $51.6 million, driven primarily by the Network Segment which grew 125% to $42.7 million. The Direct Segment remained flat at $10.0 million.
• Margin Compression: Gross margin declined significantly from 62% in 2007 to 36% in 2008. This was attributed to market conditions narrowing search marketing margins and a business model shift in the affiliate network to recognize revenue on a gross basis rather than net.
• Impairment Charges: The company recorded $80.6 million in total impairment of goodwill and intangible assets due to declines in market capitalization and the decision to divest certain units. No such charges were recorded in 2007.
• Discontinued Operations: The Advertising Segment and specific Direct Segment units were classified as discontinued operations, resulting in a $37.9 million net loss for 2008 compared to a $2.0 million profit in 2007.

Outlook, Risks, and Contingencies

• Liquidity and Debt Restructuring: On March 18, 2009, the company renegotiated its loan agreement with Wachovia Bank. The maximum revolving credit was reduced to $8.0 million (further reducing to $6.0 million in Oct 2009), and the maturity date was accelerated to March 31, 2010. Interest rates were increased significantly (LIBOR + 4% to 7%).
• Divestitures: The sale of the Cherish subsidiary was completed in February 2009 for $750,000 cash plus a potential earnout. The company decided to retain iLead Media as a continuing operation in early 2009.
• Customer Concentration: A single customer accounted for 30.7% of net revenue in 2008. The five largest customers accounted for 53.2% of total net sales.
• Internal Controls: Management identified a material weakness in internal controls over financial reporting due to insufficient accounting personnel (CFO and Controller departures) and lack of segregation of duties.
• Legal Proceedings: The company is subject to an SEC investigation regarding stock sales in 2007 and various employment disputes and litigation regarding email marketing practices.

Investor Verification Checklist

• Debt Covenants: Verify compliance with the new Wachovia covenants (Total Debt to EBITDA ratio of 2.00:1 and Fixed Charge Coverage of 2.50:1) given the accelerated maturity date of March 2010.
• Asset Impairment: Review the valuation methodology used for the $80.6 million impairment charge to ensure it reflects current market realities.
• Customer Concentration: Assess the risk associated with the top customer representing over 30% of revenue and the top five representing over 50%.
• Internal Controls: Monitor the remediation of the material weakness in internal controls, specifically the hiring of the new CFO and implementation of formal closing procedures.
• Contingent Consideration: Evaluate the potential liability of approximately $6.4 million in contingent earnout payments from past acquisitions.