Tucows Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; U.S. dollars unless noted. Tucows provides mobile and fixed Internet access through Network Access Services and domain registration and related services through Domain Services.
Financial performance
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $44.6M | $38.9M | $127.9M | $108.9M |
| Gross profit | $14.0M | $11.6M | $39.1M | $29.9M |
| Gross margin | 31.5% | 29.8% | 30.6% | 27.4% |
| Operating income | $5.1M | $3.9M | $13.4M | $6.8M |
| Net income | $3.2M | $2.7M | $8.3M | $4.5M |
| Diluted EPS | $0.28 | $0.23 | $0.72 | $0.39 |
| Operating cash flow | $6.8M | $5.0M | $12.0M | $6.1M |
| Adjusted EBITDA (non-GAAP) | $7.0M | $4.9M | $19.3M | $11.5M |
Q3 revenue rose 15%; nine-month revenue rose 17%. Growth was primarily driven by Ting: Network Access Services revenue increased 70% in Q3 and 82% for nine months. Domain Services revenue declined 4% in Q3 and 1% for nine months. Ting had 122,000 subscribers and 192,000 devices under management, versus 83,000 and 130,000, respectively, a year earlier. Adjusted EBITDA growth was also attributed primarily to Ting.
At September 30, cash and equivalents were $11.9M, up $3.6M from year-end 2014. Current assets were $76.1M and current liabilities $81.9M. Debt included a $3.5M demand-loan balance; the company reported compliance with its credit-facility covenants. The $14M revolving facilities and $1M operating demand loan remained available, with no operating-loan balance outstanding. Nine-month capital expenditures were $2.1M. Management said operating cash flow should cover anticipated working capital, capital expenditures, and loan repayments for at least 12 months.
Material changes and notable items
- Ting Virginia acquisition: Tucows acquired 70% of the BRI Group in February for approximately $3.5M cash consideration, with put/call arrangements on the remaining interest. The acquisition contributed $2.4M of nine-month revenue and had no significant reported net-income impact. Redeemable non-controlling interest was $3.0M at quarter-end.
- Share repurchases: Tucows repurchased 831,409 shares for $18.2M during the first nine months, including a tender offer and open-market buybacks. Shares outstanding fell to 10,727,380 at September 30, from 11,329,732 at year-end 2014.
- .online arrangement: The company received $6.6M after replacing the proposed joint venture with a marketing agreement. A $1.5M gain is to be recognized evenly over the agreement’s three-year term beginning November 2015.
- Foreign-exchange exposure: Forward-contract losses were $0.35M in Q3 and $0.68M for nine months; derivative liabilities totaled $2.18M. A hypothetical 10% adverse currency move was estimated to reduce quarterly net income by approximately $0.7M.
Outlook, risks and controls
- No specific revenue or earnings guidance was provided. Management stated it expected to exceed the fiscal 2015 Adjusted EBITDA target used in its overachievement bonus program.
- Management cited competitive pressure and possible churn or slower subscriber additions in mobile services; reliance on mobile network operators; domain-price competition; migration of large wholesale customers to their own registrar systems; and continued weakness in portfolio advertising and domain-sale revenue.
- Foreign-exchange movements may materially affect results because revenue is primarily in U.S. dollars while a substantial portion of expenses is in Canadian dollars. The company also identified uncertainty from ICANN’s New gTLD expansion.
- Disclosure controls and procedures were reported as ineffective due to a previously identified material weakness in internal control over financial reporting. Remediation was underway; management targeted fiscal 2015 but could not assure successful or timely completion.
- Legal claims were described as arising in the ordinary course; management did not expect them to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors.
- A 10-year Westminster, Maryland fiber-network agreement includes minimum performance commitments and potential payments of up to $100,000 per quarter if specified performance criteria are not met.
Investor verification priorities
- Track Ting subscriber growth, retention, unit economics, and the contribution and capital needs of the Virginia fiber business.
- Assess whether wholesale domain revenue and domain names under management stabilize as large customers migrate, and monitor portfolio revenue trends.
- Review the cash impact and pace of buybacks alongside liquidity, the $3.5M loan, facility availability, and covenant headroom.
- Monitor foreign-exchange hedge losses, the $2.18M derivative liability, and Canadian-dollar exposure.
- Confirm progress in remediating the material weakness and evaluate whether the .online agreement’s deferred gain and Westminster commitments develop as described.