UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
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☒ |
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
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☐ |
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)
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Pennsylvania |
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23-2707366 |
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(State or Other Jurisdiction of |
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(I.R.S. Employer |
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Incorporation or Organization) |
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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):
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Large accelerated filer ☐ |
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Accelerated filer ☐ |
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Non-accelerated filer ☐ |
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Smaller reporting company ☒ |
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(Do not check if a smaller reporting company) |
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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
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PART I FINANCIAL INFORMATION | ||
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Item 1. |
Consolidated Financial Statements |
1 |
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Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012 |
1 | |
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Consolidated Statements of Operations and Comprehensive Income (unaudited) for the three and nine months ended September 30, 2013 and 2012 |
2 | |
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Consolidated Statements of Cash Flows (unaudited) for the three and nine months ended September 30, 2013 and 2012 |
3 | |
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Notes to Consolidated Financial Statements (unaudited) |
4 | |
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Item 2. |
Management's Discussion and Analysis of Financial Condition and Results of Operations |
16 |
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Item 3. |
Quantitative and Qualitative Disclosures About Market Risk |
34 |
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Item 4. |
Controls and Procedures |
35 |
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PART II OTHER INFORMATION | ||
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Item 1. |
Legal Proceedings |
36 |
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Item 1A. |
Risk Factors |
36 |
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Item 4. |
Mine Safety Disclosures |
36 |
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Item 6. |
Exhibits |
37 |
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Signatures |
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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 Accounts receivable, net of allowance for doubtful accounts of $89,981 as of September 30, 2013 and $73,970 as of December 31, 2012 Inventory Prepaid expenses and deposits Derivative instrument asset, current portion (note 4) Prepaid domain name registry and ancillary services fees, current portion Deferred tax aset, current portion Income taxes recoverable Total current assets Derivative instrument asset, long-term portion (note 4) Prepaid domain name registry and ancillary services fees, long-term portion Property and equipment Deferred tax asset, long-term portion (note 7) Intangible assets (note 5) Goodwill Total assets Liabilities and Stockholders' Equity Current liabilities: Accounts payable Accrued liabilities Customer deposits Derivative instrument liability, current portion (note 4) Loan payable, current portion (note 6) Deferred revenue, current portion Accreditation fees payable, current portion Deferred tax liability, current portion (note 7) Income taxes payable (note 7) Total current liabilities Deferred revenue, long-term portion Accreditation fees payable, long-term portion Deferred rent, long-term portion Deferred tax liability, long-term portion (note 7) 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 Additional paid-in capital Deficit Accumulated other comprehensive income Total stockholders' equity Total liabilities and stockholders' equity Commitments and contingencies (note 10)
$
11,549,948
$
6,415,679
4,869,466
4,413,265
338,110
587,104
4,241,402
5,081,408
258,188
412,944
45,801,683
45,170,167
672,175
-
311,470
1,730,631
68,042,442
63,811,198
208,221
31,838
12,031,926
12,318,723
1,833,258
1,352,144
5,417,075
5,970,462
15,630,479
16,415,651
18,873,127
18,873,127
$
122,036,528
$
118,773,143
$
2,631,198
$
1,928,459
3,187,213
2,522,229
4,072,325
4,955,671
310,865
-
6,900,000
3,700,000
56,188,897
54,997,887
497,404
512,847
-
914,429
923,280
1,255,108
74,711,182
70,786,630
15,801,411
16,002,464
137,117
145,592
71,898
54,150
5,158,000
5,234,100
-
-
11,797,362
10,084,417
28,520,120
33,931,529
(14,252,274
)
(17,509,843
)
91,712
44,104
26,156,920
26,550,207
$
122,036,528
$
118,773,143
See accompanying notes to unaudited consolidated financial statements
Tucows Inc.
Consolidated Statements of Operations and Comprehensive Income
(Dollar amounts in U.S. dollars)
(unaudited)
2013 2012 2013 2012 Net revenues (note 9) Cost of revenues (note 9): Cost of revenues Network expenses (*) Depreciation of property and equipment Amortization of intangible assets (note 5) Total cost of revenues Gross profit Expenses: Sales and marketing (*) Technical operations and development (*) General and administrative (*) Depreciation of property and equipment Amortization of intangible assets (note 5) Loss (gain) on currency forward contracts (note 4) Total expenses Income from operations Other income (expense): Interest expense, net Other income, net Total other income (expense) Income before provision for income taxes Provision for income taxes (note 7) Net income 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 Comprehensive income for the period Basic earnings per common share (note 8) Shares used in computing basic earnings per common share (note 8) Diluted earnings per common share (note 8) Shares used in computing diluted earnings per common share (note 8) (*) Stock-based compensation has been included in operating expenses as follows: Network expenses Sales and marketing Technical operations and development General and administrative
Three months ended September 30,
Nine months ended September 30,
(unaudited)
(unaudited)
$
35,637,085
$
29,246,069
$
96,795,464
$
84,935,989
24,268,961
21,446,084
69,354,366
60,833,420
1,192,450
1,158,885
3,716,471
3,629,639
164,283
157,203
452,711
460,259
11,970
35,910
83,790
107,730
25,637,664
22,798,082
73,607,338
65,031,048
9,999,421
6,447,987
23,188,126
19,904,941
2,998,419
2,037,338
8,792,091
6,287,702
1,215,327
1,010,949
3,097,294
3,229,669
1,869,668
1,486,323
5,266,997
5,018,178
52,972
46,981
158,833
139,918
219,030
219,030
657,090
657,090
(28,068
)
(615,245
)
353,209
(793,516
)
6,327,348
4,185,376
18,325,514
14,539,041
3,672,073
2,262,611
4,862,612
5,365,900
(78,966
)
(50,228
)
(271,756
)
(145,710
)
-
-
-
529,711
(78,966
)
(50,228
)
(271,756
)
384,001
3,593,107
2,212,383
4,590,856
5,749,901
999,747
577,383
1,333,287
1,755,284
2,593,360
1,635,000
3,257,569
3,994,617
494,334
-
47,608
-
$
3,087,694
$
1,635,000
$
3,305,177
$
3,994,617
$
0.06
$
0.04
$
0.08
$
0.09
43,183,583
45,094,678
41,289,876
46,362,261
$
0.06
$
0.03
$
0.07
$
0.08
45,639,900
48,411,429
44,749,232
49,603,870
$
8,755
$
5,979
$
22,813
$
18,354
$
32,681
$
24,116
$
93,000
$
67,047
$
21,549
$
15,600
$
57,166
$
43,490
$
99,801
$
120,676
$
155,904
$
163,041
See accompanying notes to consolidated financial statements
Tucows Inc.
Consolidated Statements of Cash Flows
(Dollar amounts in U.S. dollars)
(unaudited)
2013 2012 2013 2012 Cash provided by: Operating activities: Net income for the period Items not involving cash: Depreciation of property and equipment Amortization of deferred financing charges Amortization of intangible assets Deferred income taxes (recovery) Deferred rent Acquisition of domain names Disposal of domain names Gain on disposition of intangible assets (Gain) loss on change in the fair value of forward contracts Stock-based compensation Change in non-cash operating working capital: Accounts receivable Inventory Prepaid expenses and deposits Prepaid domain name registry and ancillary services fees Income taxes recoverable/payable Accounts payable Accrued liabilities Customer deposits Deferred revenue Accreditation fees payable Net cash provided by operating activities Financing activities: Proceeds received on exercise of stock options Repurchase of common stock Proceeds received on loan payable Repayment of loan payable Net cash provided by (used in) financing activities Investing activities: Additions to property and equipment Proceeds on disposal of intangible assets Net cash used in investing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period Supplemental cash flow information: Interest paid Supplementary disclosure of non-cash investing and financing activities: Property and equipment acquired during the period not yet paid for
Three months ended September 30,
Nine months ended September 30,
(unaudited)
(unaudited)
$
2,593,360
$
1,635,000
$
3,257,569
$
3,994,617
217,255
204,184
611,544
600,177
-
100
-
2,300
231,000
254,940
740,880
764,820
(99,786
)
228,169
(78,103
)
333,111
Excess tax benefits on share-based compensation expense
(1,056,014
)
-
(1,056,014
)
-
7,872
8,258
17,748
21,458
-
-
-
(3,664
)
8,923
15,142
44,292
38,181
-
-
-
(508,800
)
(204,341
)
(698,781
)
361,646
(1,155,147
)
162,786
166,371
328,883
291,932
758,089
90,239
(456,201
)
(946,592
)
(150,686
)
-
248,994
-
543,111
636,756
840,006
(1,254,712
)
1,038,268
905,807
(344,719
)
(3,392,387
)
980,969
226,304
1,087,333
466,885
92,473
43,173
700,194
648,250
163,300
(279,427
)
664,984
244,738
(595,776
)
(2,781
)
(883,346
)
62,817
(986,779
)
(1,144,779
)
989,957
4,139,869
(39,835
)
(51,839
)
(23,918
)
(26,660
)
3,664,189
2,236,836
7,051,729
4,321,193
1,136,061
14,186
1,454,255
363,898
Excess tax benefits on share-based compensation expense
1,056,014
-
1,056,014
-
-
(1,630,643
)
(6,537,616
)
(9,115,833
)
-
-
5,200,000
4,000,000
(600,000
)
-
(2,000,000
)
(850,000
)
1,592,075
(1,616,457
)
(827,347
)
(5,601,935
)
(171,442
)
(162,207
)
(1,090,113
)
(666,534
)
-
-
-
508,800
(171,442
)
(162,207
)
(1,090,113
)
(157,734
)
5,084,822
458,172
5,134,269
(1,438,476
)
6,465,126
4,511,561
6,415,679
6,408,209
$
11,549,948
$
4,969,733
11,549,948
4,969,733
$
92,610
$
50,511
289,483
146,342
$
99,060
$
167,998
99,060
167,998
See accompanying notes to unaudited consolidated financial statements
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.
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.
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
|
||||||||
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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.
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.
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.
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 | ||||||||
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.
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 | |||||
(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 | ||||||||||||
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 |
— | — | — | — | (16,334 | ) | (16,334 | ) | ||||||||||||||||
|
Balances, September 30, 2013 |
43,576,861 | $ | 11,797,362 | $ | 28,520,120 | $ | (14,252,274 |
) |
$ | 91,712 | $ | 26,156,920 | ||||||||||||
On January 7, 2013, the Company announced that it successfully concluded a modified “Dutch auction tender offer” that was previously announced on November 21, 2012. 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. The purchase price and all transaction costs were funded from available cash and an additional advance under our Amended Credit Facility from the Bank in the amount of $5.2 million. All shares purchased in the tender offer received the same price and all shares repurchased were immediately retired. As a result of the completion of the tender offer, as of January 31, 2013, the Company had 40,226,875 shares issued and outstanding.
On March 1, 2013, the Company announced a stock buyback program. Under this buyback program, the Company may repurchase up to $10 million of the Company's common stock over the 12-month period that commenced on March 1, 2013. The Company repurchased 143,073 shares under this program during the three months ended March 31, 2013 for a total of $259,875.
12. SHARE-BASED PAYMENTS
(a) Stock options
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model, consistent with the guidance on stock compensation. Because option-pricing models require the use of subjective assumptions, changes in these assumptions can materially affect the fair value of the options. The assumptions presented in the table below represent the weighted average of the applicable assumption used to value stock options at their grant date. The Company calculates expected volatility based on historical volatility of the Company's common shares. The expected term, which represents the period of time that options granted are expected to be outstanding, is estimated based on historical exercise experience. The Company evaluated historical exercise behavior when determining the expected term assumptions. The risk-free rate assumed in valuing the options is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option. The Company determines the expected dividend yield percentage by dividing the expected annual dividend by the market price of our common shares at the date of grant.
During the three months ended September 30, 2013, stock options to purchase 90,000 common shares were granted. During the three months ended September 30, 2012, stock options to purchase 220,000 common shares were granted.
During the nine months ended September 30, 2013, stock options to purchase 571,500 common shares were granted. During the nine months ended September 30, 2012, stock options to purchase 769,000 common shares were granted.
Details of stock option transactions for the three months ended September 30, 2013 and September 30, 2012 are as follows:
|
Three months ended September 30, 2013 |
Three months ended September 30, 2012 |
|||||||||||||||
|
Number of Shares |
Weighted Average exercise price per share |
Number of Shares |
Weighted Average exercise price per share |
|||||||||||||
|
Outstanding, beginning of period |
8,468,485 | $ | 0.71 | 8,524,499 | $ | 0.62 | ||||||||||
|
Granted |
90,000 | 2.23 | 220,000 | 1.38 | ||||||||||||
|
Exercised |
(2,935,373 | ) | 0.39 | (20,187 | ) | 0.70 | ||||||||||
|
Forfeited |
(75,624 | ) | 1.22 | (56,689 | ) | 0.83 | ||||||||||
|
Expired |
(4,750 | ) | 0.36 | (3,000 | ) | 0.44 | ||||||||||
|
Outstanding, end of period |
5,542,738 | $ | 0.91 | 8,664,623 | $ | 0.64 | ||||||||||
|
Options exercisable, end of period |
4,199,238 | $ | 0.78 | 7,160,766 | $ | 0.57 | ||||||||||
The stock options granted during the three and nine months ended September 30, 2013 expire in 2018 and 2020.
Details of stock option transactions for the nine months ended September 30, 2013 and September 30, 2012 are as follows:
|
Nine months ended September 30, 2013 |
Nine months ended September 30, 2012 |
|||||||||||||||
|
Number of Shares |
Weighted Average exercise price per share |
Number of Shares |
Weighted Average exercise price per share |
|||||||||||||
|
Outstanding, beginning of period |
8,592,686 | $ | 0.64 | 8,746,041 | $ | 0.57 | ||||||||||
|
Granted |
571,500 | 1.97 | 769,000 | 1.36 | ||||||||||||
|
Exercised |
(3,511,946 | ) | 0.41 | (693,340 | ) | 0.52 | ||||||||||
|
Forfeited |
(104,752 | ) | 1.21 | (154,064 | ) | 0.80 | ||||||||||
|
Expired |
(4,750 | ) | 0.36 | (3,014 | ) | 0.44 | ||||||||||
|
Outstanding, end of period |
5,542,738 | $ | 0.91 | 8,664,623 | $ | 0.64 | ||||||||||
|
Options exercisable, end of period |
4,199,238 | $ | 0.78 | 7,160,766 | $ | 0.57 | ||||||||||
As of September 30, 2013, the exercise prices, weighted average remaining contractual life and intrinsic values of outstanding options were as follows:
|
Options outstanding |
Options exercisable |
||||||||||||||||||||||||||||||||||||
|
Exercise price |
Outstanding Number |
Weighted average exercise price per share |
Weighted Average remaining contractual life (years) |
Aggregate intrinsic value |
Number exercisable |
Weighted average exercise price per share |
Aggregate intrinsic value |
||||||||||||||||||||||||||||||
| $ | 0.38 | - | $ | 0.60 | 1,349,125 | $ | 0.58 | 1.2 | $ | 2,440,266 | 1,349,125 | $ | 0.58 | $ | 2,440,266 | ||||||||||||||||||||||
| $ | 0.62 | - | $ | 0.70 | 1,531,550 | $ | 0.69 | 3.2 | 2,606,519 | 1,223,550 | $ | 0.69 | 2,086,000 | ||||||||||||||||||||||||
| $ | 0.73 | - | $ | 0.94 | 1,383,813 | $ | 0.80 | 2.2 | 2,196,030 | 1,182,438 | $ | 0.82 | 1,861,747 | ||||||||||||||||||||||||
| $ | 1.05 | - | $ | 2.23 | 1,278,250 | $ | 1.62 | 5.6 | 986,623 | 444,125 | $ | 1.54 | 378,379 | ||||||||||||||||||||||||
| 5,542,738 | $ | 0.91 | |||||||||||||||||||||||||||||||||||