Tucows Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; comparisons are with the same 2014 periods. Amounts are in U.S. dollars. Tucows provides mobile and fixed Internet access, domain registration and related Internet services.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Revenue | $42.9m | $35.6m | $83.4m | $70.0m |
| Gross profit / margin | $12.9m / 30.0% | $9.5m / 26.8% | $25.1m / 30.1% | $18.3m / 26.1% |
| Operating income / margin | $3.9m / 9.1% | $2.1m / 5.9% | $8.3m / 9.9% | $2.9m / 4.1% |
| Net income | $2.3m | $1.3m | $5.1m | $1.8m |
| Diluted EPS | $0.20 | $0.11 | $0.44 | $0.16 |
| Operating cash flow | $2.2m | $1.1m | $5.2m | $1.1m |
| Adjusted EBITDA (non-GAAP) | $5.4m | $3.3m | $12.3m | $6.6m |
Q2 revenue increased 21% and first-half revenue 19%. Management attributed the increase in adjusted EBITDA primarily to Ting growth. The filing cautions that adjusted EBITDA is a non-GAAP measure and is not a measure of discretionary cash available for investment.
Liquidity, debt and capital
- At June 30, cash and cash equivalents were $15.3m, versus $8.3m at December 31, 2014. Current assets were $80.3m and current liabilities $79.5m, implying working capital of about $0.8m.
- First-half operating cash flow was $5.2m. Investing activities provided net cash of $4.9m, including $6.6m received in connection with the .online arrangement; financing activities used $3.1m, including share repurchases.
- The balance sheet reports a $3.5m loan payable. The credit facility provides up to $14m in revolving loan capacity, plus a $3.5m foreign-exchange settlement line and a $1.0m operating facility. The filing states the company was in compliance with its debt covenants.
- Tucows repurchased 433,409 shares for $8.2m in the first half, through a tender offer and its buyback program. The company reported 11.08m shares outstanding at June 30, compared with 11.33m at year-end.
Material changes and business developments
- Network Access Services: Revenue grew 87% in Q2 and 89% in the first half, to $15.4m and $28.3m, respectively. Ting had 113,000 subscribers and 178,000 devices under management, versus 73,000 and 113,000 a year earlier. The segment also included services from the February acquisition of a 70% interest in the Blue Ridge InternetWorks group.
- Domain Services: Revenue was nearly flat in Q2 and the first half, at $27.5m and $55.0m. Management cited large, low-margin customers moving domain operations to their own accreditations or systems. Total domains under management fell to 13.25m from 13.57m a year earlier.
- Retail domain revenue increased, while wholesale value-added and portfolio advertising/name-sale trends were pressured. Tucows reported 2.4m new, renewed and transferred-in domain registrations in Q2, versus 2.386m a year earlier.
- In February, Tucows acquired 70% of Ting Virginia for approximately $3.6m cash consideration, with assumed debt and redeemable non-controlling interest also included in the purchase accounting. Put/call provisions address the remaining 30%; a put for the remaining interest could require a $3.6m payment on the fourth anniversary.
- The .online joint venture was replaced with a joint marketing agreement. Tucows received $6.6m in proceeds and expects to recognize $1.5m over the agreement’s three-year term once .online is generally available.
Outlook, risks and unusual items
- No formal revenue or earnings guidance is provided. Management said operating cash flow should be adequate for working capital, capital expenditures and loan repayments for at least the next 12 months, and expected to exceed the fiscal 2015 adjusted EBITDA target used for its overachievement bonus program.
- Key risks include competition and pricing pressure in mobile and domain services; Ting subscriber churn and dependence on mobile network operators; migration of large domain customers; effects of ICANN’s new gTLD expansion; and weaker portfolio advertising or domain sales.
- Foreign exchange exposure is significant because much of the expense base is in Canadian dollars while revenue is primarily in U.S. dollars. The company held $24.0m of forward contracts, with a reported $1.5m liability. Its sensitivity analysis estimated a hypothetical 10% adverse currency movement would reduce quarterly net income by about $0.6m.
- Currency-forward-contract losses were $0.6m in Q2 and $1.6m in the first half. First-half capital expenditures were $1.3m; the company also reported a $0.05m impairment of indefinite-life domain assets.
- Management concluded disclosure controls were ineffective because of a previously reported material weakness in internal control over financial reporting. Remediation work was underway, with completion targeted during 2015, but management gave no assurance it would be successful or timely.
- Legal claims arise in the ordinary course of business; management did not expect their resolution to materially harm the company. The filing reports no material changes to the risk factors in the 2014 Form 10-K.
Investor verification priorities
- Reconcile the debt-facility description: the balance sheet and Note 8 identify $3.5m as the 2012 DLR Loan, while the MD&A liquidity section says the DLRR Loan was $3.5m and the DLR Loan was fully repaid.
- Assess the sustainability and margins of Ting’s rapid growth, including subscriber retention, network costs and the contribution from the acquired Virginia business.
- Track domain customer migration, domains under management, wholesale margins, and exposure to gTLD-related competition and portfolio revenue volatility.
- Review the timing and accounting for the .online proceeds, the potential $3.6m minority-interest put obligation, and the company’s ability to maintain liquidity while conducting buybacks and investing in fiber.
- Monitor foreign-exchange hedge results and remediation of the material control weakness; verify any subsequent filing updates on both matters.