Tucows Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; comparative periods ended September 30, 2011. Unaudited consolidated results are in U.S. dollars. Tucows distributes domain registration and other Internet services through wholesale, retail and portfolio businesses; retail includes Ting mobile service.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $29.25 million | $25.09 million | $84.94 million | $70.70 million |
| Gross profit / margin | $6.45 million / 22.1% | $6.06 million / 24.1% | $19.90 million / 23.4% | $16.77 million / 23.7% |
| Operating income (loss) / margin | $2.26 million / 7.7% | ($0.74 million) / (2.9%) | $5.37 million / 6.3% | $0.53 million / 0.7% |
| Net income (loss) / margin | $1.64 million / 5.6% | ($1.18 million) / (4.7%) | $3.99 million / 4.7% | $0.12 million / 0.2% |
| Basic / diluted EPS | $0.04 / $0.03 | ($0.02) / ($0.02) | $0.09 / $0.08 | Approximately $0 / approximately $0 |
| Operating cash flow | $2.24 million | $1.62 million | $4.32 million | $3.20 million |
- Revenue rose 17% in Q3 and 20% for the nine-month period. Wholesale remained the largest stream; retail revenue more than doubled in Q3, including $0.9 million of Ting device sales. Portfolio revenue was broadly flat in Q3 and up 13% year to date.
- Cost of revenue increased 20% in Q3 and 21% year to date, outpacing revenue growth. Retail costs rose with Ting device sales and service volumes; wholesale costs reflected higher domain volumes and January 2012 registry fee increases.
- Currency forward contracts produced a $0.62 million Q3 gain and a $0.79 million nine-month gain, versus losses of $1.85 million and $1.37 million in the comparable 2011 periods. This materially affected the year-over-year operating comparison; the contracts are not accounted for as hedges.
Financial position and liquidity
- At September 30, 2012, cash was $4.97 million, total assets $118.76 million and stockholders’ equity $25.95 million. Current assets were $62.38 million and current liabilities $70.82 million.
- Loan payable was $4.0 million, classified as current; no operating demand loan was drawn. The $8.0 million revolving facilities are payable on demand at the lender’s discretion. Tucows reported compliance with its financial covenants.
- Nine-month investing cash use was $0.16 million. Financing cash use was $5.60 million, including $9.12 million for share repurchases, partly offset by $4.0 million in loan proceeds. Cash declined $1.44 million from year-end 2011.
- Deferred revenue totaled $73.3 million at September 30, versus $74.5 million at June 30 and $68.9 million a year earlier. Management attributed the quarterly decline partly to two customers moving domain names to their own registrar accreditation; remaining deferred revenue on transferred names was recognized during Q3.
Changes, outlook and risks
- Growth reflected greater transaction volumes, EPAG (acquired in August 2011), registry fee pass-throughs, and more domain names provisioned on the company’s platform. Domain registrations processed were 2.252 million in Q3, up from 2.154 million; total domains under management reached 14.165 million, versus 11.716 million a year earlier.
- Ting had more than 5,000 subscribers and 8,000 devices under management at quarter-end, adding approximately 3,000 subscribers and 4,500 devices in Q3.
- Management expected operating cash flow to cover working capital, capital expenditures and loan repayments for at least 12 months. It anticipated incremental long-term domain registration growth, but gave no quantified financial guidance and cautioned that market volatility and new gTLDs could alter results.
- Four gTLD applications remained after two of six applications were withdrawn and refunded. Fees associated with the remaining applications were capitalized; management saw potential opportunities but no assurance of awards or commercial success. It expected new gTLD delegations to begin in 2013.
- Key risks include competition and pricing pressure, registry and ICANN fees, dependence on vendors and advertising partners, foreign-exchange exposure, and uncertainty around gTLD expansion. A hypothetical 10% adverse currency move was estimated to reduce Q3 net income by approximately $0.5 million.
- In October, Tucows entered into $19.3 million of additional currency forwards for 2013–2014. On November 13, it announced a planned Dutch auction tender offer for up to 6.5 million shares at $1.35–$1.50 per share. Legal claims were described as ordinary-course matters not expected to have a material adverse effect, though litigation could entail costs and management distraction.
Investor verification priorities
- Assess how much of reported profit improvement came from currency-forward gains and whether operating performance remains strong without those gains.
- Verify the revenue and future renewal impact of the two customers’ registrar transfers, including the amount of deferred revenue recognized in Q3, which the filing does not quantify clearly.
- Track gross margin and Ting’s unit economics as device sales and retail costs grow.
- Review cash needs and lender exposure: cash was $4.97 million against a $4.0 million demand loan, and facilities may be callable at the bank’s discretion.
- Confirm the size, funding and completion of the planned tender offer, and the effect of further buybacks on liquidity and share count.
- Monitor gTLD application outcomes, related capitalized costs, and potential effects of new TLDs on existing registration volumes and pricing.