Tucows Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; unaudited consolidated financial statements. Amounts are U.S. dollars. Tucows distributes domain registration and related internet services through wholesale, retail and portfolio businesses, including its Ting mobile service.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $35.64m | $29.25m | $96.80m | $84.94m |
| Gross profit | $10.00m | $6.45m | $23.19m | $19.90m |
| Income from operations | $3.67m | $2.26m | $4.86m | $5.37m |
| Net income | $2.59m | $1.64m | $3.26m | $3.99m |
| Diluted EPS | $0.06 | $0.03 | $0.07 | $0.08 |
| Operating cash flow | $3.66m | $2.24m | $7.05m | $4.32m |
- Revenue grew 22% for the quarter and 14% year to date. Gross margin was approximately 28.1% in Q3 (22.0% prior year) and 24.0% for nine months (23.4% prior year). Operating margin was approximately 10.3% in Q3 versus 7.7%; year-to-date it was 5.0% versus 6.3%.
- Q3 net income improved, while nine-month operating income and net income declined. Year-to-date results included a $353,000 loss on currency forwards, compared with a $794,000 gain in 2012; 2012 also included $530,000 of other income from selling intangible assets.
- At September 30, cash was $11.55m, total assets $122.04m and stockholders’ equity $26.16m. Current liabilities were $74.71m, including $56.19m of current deferred revenue. Deferred revenue, current and long-term combined, was about $72.0m.
- Loan payable was $6.9m; $8.1m remained available under the $14m demand loan facilities. The company reported compliance with its financial covenants. Nine-month capital expenditures were $1.09m.
- Cash increased $5.13m from year-end 2012. Nine-month financing cash flow was a net use of $0.83m, including share repurchases and loan repayments, partly offset by borrowing and option exercises.
Material changes versus prior comparable period
- Retail/Ting drove much of the growth: retail revenue rose to $6.86m from $2.96m for Q3 and to $16.86m from $7.11m year to date. Ting had 36,000 subscribers and 56,000 devices under management at quarter-end; Q3 additions were 11,000 subscribers and 16,000 devices. Higher mobile device and service sales also increased retail costs.
- Wholesale was broadly flat: Q3 wholesale revenue was $24.61m versus $24.87m; nine-month revenue increased 1% to $73.55m. Domain transactions declined modestly, which management linked to some customers registering under their own accreditations. Total domains under management were 14.24m, versus 14.17m a year earlier.
- Portfolio revenue was unusually strong in Q3: it rose to $4.17m from $1.41m, partly from payments relating to withdrawal of the .media and .marketing gTLD applications. Nine-month portfolio revenue was $6.38m versus $4.90m.
- Sales and marketing expense increased 47% in Q3 and 40% year to date, primarily reflecting Ting workforce and marketing spending. Q3 technical operations expense also included about $0.1m of severance costs and higher incentive accruals.
- The company repurchased and retired 4.11m shares in a January tender offer for $6.17m, plus transaction costs, and repurchased 143,073 shares under its 2013 buyback program. Option exercises increased shares outstanding during the period; 43.58m shares were outstanding at September 30.
Outlook, risks and notable items
- Management said operating cash flow should be adequate for working capital, capital expenditures and loan repayments for at least the next 12 months. The filing provides no formal numeric revenue or earnings guidance.
- Management expected the new gTLD program to create possible domain-volume and revenue opportunities beginning in 2014, but emphasized uncertainty: contested strings may not be awarded, and additional pursuit costs may be significant. Rights-related payments from the .media and .marketing withdrawals contributed to Q3 portfolio revenue.
- Risks highlighted include intense competition and domain-pricing pressure; customer migration to their own registrar accreditations; uncertainty in domain advertising and portfolio sales; potential cancellation of vendor marketing funds; and the evolving new gTLD market.
- Revenue is mainly in U.S. dollars while a substantial portion of expenses is in Canadian dollars. The company had $32.8m notional foreign-exchange forwards outstanding, including $25.5m designated as cash-flow hedges. Its sensitivity analysis estimated that a hypothetical 10% adverse currency move would reduce Q3 net income by approximately $0.5m.
- Various ordinary-course legal claims are pending; management did not expect their resolution to materially harm the company, while noting litigation can be costly and distracting. No subsequent events were reported. Management stated disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Track Ting subscriber and device growth alongside service/device gross margins and the rising marketing and sales expense.
- Separate recurring operating performance from one-time gTLD-related portfolio receipts, domain sales and currency-derivative gains or losses.
- Monitor wholesale domain transaction volumes and customer migration to their own registrar accreditations, as well as deferred revenue trends.
- Review the $6.9m loan balance, facility availability, repayment schedule and covenant headroom; confirm cash generation supports planned obligations.
- Assess foreign-exchange exposure and hedge coverage, and the potential share-count effects of option exercises and repurchases.