Tucows Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. All amounts are U.S. dollars. Tucows distributes domain registration and other Internet services, primarily through its OpenSRS reseller network. Results are consolidated and unaudited.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $25.1 million | $21.2 million | $70.7 million | $62.5 million |
| Gross profit / margin | $6.1 million / 24.1% | $4.9 million / 23.2% | $16.8 million / 23.7% | $15.1 million / 24.2% |
| Operating income (loss) | $(0.7) million | $1.1 million | $0.6 million | $1.2 million |
| Net income (loss) | $(1.2) million | $1.1 million | $0.1 million | $0.9 million |
| Operating cash flow | $1.6 million | $1.9 million | $3.2 million | $4.4 million |
- Q3 revenue rose 18%; nine-month revenue rose 13%. OpenSRS generated 86% of Q3 revenue and 87% of nine-month revenue. Domain Services alone represented 78% and 79%, respectively.
- Q3 gross margin improved, while nine-month gross margin edged lower. Revenue growth reflected higher domain-registration volumes, registry fee increases passed through to customers, and the EPAG acquisition. Domain registrations processed rose 19% in Q3 to 2.2 million; domains under management were 11.7 million, including EPAG’s approximately 400,000 domains.
- Q3 operating results included a $2.2 million unrealized loss on foreign-exchange forwards, compared with a gain of $0.1 million in Q3 2010. Nine-month forward-contract losses were $2.5 million versus $1.7 million. The Q3 tax provision was $0.4 million despite a pretax loss; nine-month provision was $0.8 million on pretax income of $0.9 million.
- Cash and equivalents were $4.7 million at September 30, up from $4.2 million at year-end 2010. Nine-month investing cash use was $3.0 million, including $2.4 million for EPAG net of acquired cash. Financing cash provided was $0.3 million; the comparable 2010 period used $8.3 million, including $6.9 million for share repurchases.
- Current assets were $56.0 million and current liabilities $63.4 million, a current ratio of approximately 0.88. Deferred revenue totaled $68.9 million, reflecting advance customer payments for services to be provided. The filing says the business model’s upfront, non-refundable payments support recurring revenue and operating cash flow.
- Loan payable was $1.6 million on the balance sheet, primarily related to EPAG financing. The amended Bank of Montreal facilities include an $8.0 million acquisition/repurchase facility and a separate $1.0 million operating line, undrawn at quarter-end. The company reported compliance with its financial covenants.
Material changes and unusual items
- On August 1, Tucows acquired German registrar EPAG for approximately $2.4 million in cash, funded by a $2.5 million draw under its credit facility; $1.0 million was repaid in August. EPAG contributed $0.6 million revenue and a $17,000 net loss from August 1 through September 30. Its acquisition added $0.9 million of goodwill and $1.7 million of identified intangible assets.
- Q3 general and administrative expense increased 102% to $1.3 million, partly reflecting higher professional, facility and workforce costs. Nine-month expense rose 71% to $3.5 million. Loss from operations turned negative in Q3, with the forward-contract valuation loss a major contributor.
- Hover revenue increased 18% in Q3 and 13% year to date. Butterscotch revenue fell 36% in Q3 and 27% year to date, reflecting weaker desktop-software advertising and nonrecurring corporate video revenue from 2010. YummyNames rose 43% in Q3 but declined 3% year to date, with parked-page advertising affected by vendor and advertising-network changes.
- Canadian-dollar strength increased reported operating costs, while foreign-exchange movements also affected hedge valuations. A hypothetical 10% adverse currency move was estimated to reduce Q3 net income by approximately $0.5 million, all else equal.
Outlook, commentary and risks
- Management stated that operating cash flow should cover anticipated working capital, capital expenditures and loan repayments for at least the next 12 months. No specific revenue or earnings guidance was provided.
- Management expects domain-registration volumes to increase incrementally over the long term, but notes market volatility and uncertainty about the impact of new ICANN TLDs expected to begin in 2012. Competition and price pressure are material risks.
- Verisign supply agreements expire in 2012. The filing notes Verisign may increase .com or .net fees by up to 7% once in 2011 or 2012, subject to notice requirements. Registry and ICANN fees constrain Tucows’ control over a significant portion of domain-service costs.
- Forward contracts had a total notional amount of $31.85 million and a net fair-value liability of $1.62 million at quarter-end. Tucows does not apply hedge accounting, so valuation changes flow through earnings. The company also flags risks to parked-page advertising, Butterscotch advertising, customer/vendor relationships, tax-asset realization, and its ability to maintain margins.
- Management said ordinary-course legal claims were not expected to have a material adverse effect, but acknowledged litigation could incur expense and divert attention. The filing reports no material change in internal control over financial reporting and says disclosure controls were effective.
Investor verification priorities
- Assess whether recurring domain-volume growth and EPAG’s contribution can offset margin pressure, competition and the high concentration of revenue in OpenSRS Domain Services.
- Review the scale, maturity profile and earnings volatility of the foreign-exchange contracts, and distinguish non-cash mark-to-market losses from realized cash impacts.
- Reconcile near-term liquidity, deferred revenue obligations and loan repayments with management’s 12-month cash sufficiency statement; confirm covenant headroom and facility availability.
- Track the 2012 Verisign agreement renewal and any registry price changes, as well as the commercial and competitive effects of new TLDs.
- Monitor Butterscotch and parked-page advertising trends, tax provisions and deferred-tax assumptions, and EPAG integration and cross-selling performance.