Tucows Inc. — Q2 2014 Form 10-Q
Business context and period. Tucows provides domain registration and related Internet services through Domain Services, and U.S. mobile phone services through Ting (Network Access Services). This unaudited report covers the quarter and six months ended June 30, 2014; amounts are in U.S. dollars.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $35.59 million | $31.17 million | $69.99 million | $61.16 million |
| Gross profit | $9.53 million | $6.71 million | $18.29 million | $13.19 million |
| Gross margin | 26.8% | 21.5% | 26.1% | 21.6% |
| Operating income | $2.08 million | $0.89 million | $2.88 million | $1.19 million |
| Net income | $1.35 million | $0.59 million | $1.82 million | $0.66 million |
| Diluted EPS | $0.11 | $0.05 | $0.16 | $0.06 |
| Cash from operating activities | $1.13 million | $2.97 million | $1.10 million | $3.39 million |
Revenue mix and margins. Q2 revenue rose 14%, driven by Ting, whose revenue increased 121% to $8.26 million. Domain Services revenue was nearly flat at $27.33 million; retail growth was offset by declines in wholesale and portfolio revenue. For the six months, Ting revenue rose 146% to $14.97 million while Domain Services was essentially unchanged at $55.02 million. Gross margin expanded year over year, while sales and marketing spending increased to support Ting growth.
Cash, liquidity and debt. Cash was $14.16 million at June 30, up from $12.42 million at December 31, 2013. Current assets were $74.76 million versus current liabilities of $75.14 million; the current ratio was approximately 1.0. These balances include substantial prepaid registry fees and deferred revenue. Loan payable was $5.36 million, down from $6.30 million at year-end; the revolving loan was fully repaid and the remaining balance was under the reducing facility, at 5% interest. The company reported compliance with its financial covenants and expected continued compliance for the next 12 months.
Material changes and unusual items
- Operating cash flow for the first half fell to $1.10 million from $3.39 million, despite higher net income. Management attributed the reduction principally to working-capital use, including higher receivables and prepaid registry costs, partly offset by deferred revenue and payables.
- Domain registrations processed were broadly flat at 2.386 million for Q2 and 4.814 million for the first half. Total domains under management declined to 13.569 million from 14.242 million a year earlier, including a reduction in domains managed on reseller accreditations.
- Ting had 73,000 subscribers and 113,000 devices under management at June 30, versus 25,000 and 40,000, respectively, a year earlier.
- The company recorded $577,000 of first-half impairment/write-offs for indefinite-life domain names it chose not to renew, including $326,000 in Q2.
- First-half loss on currency forward contracts was $648,000. The reported derivative liability was $59,000 at June 30. The company held $13.5 million of forward contracts for 2014 exposures; in July it entered additional 2015 hedges with $10.2 million notional value.
- Shares outstanding increased to 11.24 million from 10.91 million at year-end, principally reflecting option exercises. The company repurchased 6,092 shares for $82,000 in the first half.
Outlook, risks and contingencies
- Management expected domain registration volumes to remain relatively flat for 2014, with core growth offset by some large clients moving registrations to their own accreditations. It expected sales and marketing expense to increase in absolute dollars, primarily to support Ting.
- Management believed operating cash flow would be adequate for working capital, capital expenditures and loan repayments for at least the next 12 months. This outlook is subject to execution and operating risks.
- Key risks include domain-sector competition and pricing pressure, dependence on registry vendors and Ting’s mobile network operator, U.S.-dollar/Canadian-dollar exchange movements, and variability in advertising, portfolio sales and vendor market-development funds. A modeled 10% adverse currency movement would have reduced Q2 net income by approximately $0.6 million.
- In July, Tucows withdrew its application for the contested .group gTLD after a private auction; proceeds are to be recorded as portfolio revenue in Q3. The amount is not stated in the filing text.
- Management said ordinary-course legal claims were not expected to have a material adverse effect, while noting litigation may entail expense and distraction. The filing identifies no material change in internal control over financial reporting.
- The company was evaluating the new revenue-recognition standard, effective in 2017, and could not yet estimate its impact. No specific earnings or revenue guidance was provided.
Investor verification priorities
- Track whether Ting’s rapid subscriber and revenue growth translates into sustainable margins and operating cash flow.
- Assess continued domain-volume and domain-under-management trends, including further migrations by large customers and the decline in wholesale revenue.
- Reconcile working-capital movements and deferred revenue with the lower first-half operating cash flow.
- Review Canadian-dollar exposure, forward-contract results and the terms and coverage of the 2015 hedges.
- Confirm the amount and timing of .group auction proceeds in Q3 and any further spending on contested gTLD rights.
- Monitor loan repayments, covenant headroom and share-count effects from option exercises and the buyback program.