Tucows Inc. — Q2 2011 Form 10-Q
Business context and period. Unaudited results for the three and six months ended June 30, 2011, compared with the corresponding 2010 periods. Tucows distributes domain registration, email, security and other internet services, primarily through its OpenSRS reseller network. All amounts are U.S. dollars.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $23.05M | $20.85M | $45.60M | $41.29M |
| Gross profit | $5.37M | $5.06M | $10.71M | $10.20M |
| Gross margin | 23.3% | 24.3% | 23.5% | 24.7% |
| Operating income (loss) | $0.71M | ($0.84M) | $1.27M | $0.08M |
| Net income (loss) | $0.57M | ($0.77M) | $1.29M | ($0.20M) |
| Diluted EPS | $0.01 | ($0.01) | $0.02 | $0.00 |
| Operating cash flow | $0.82M | $1.17M | $1.59M | $2.55M |
Q2 operating margin was approximately 3.1%, versus negative 4.0% a year earlier; six-month margin was 2.8%, versus 0.2%. Net margin was approximately 2.5% in Q2 and 2.8% for the six months.
- Revenue drivers: Q2 revenue grew 11%; six-month revenue grew 10%. OpenSRS accounted for 86% of Q2 revenue, with domain services alone at 78%. Tucows attributed OpenSRS growth to higher registration volumes and passing through a July 2010 registry fee increase. Domain transactions rose to 2.147 million in Q2 from 1.822 million; domains under management reached 11.144 million from 10.123 million.
- Other business lines: Q2 Hover revenue rose 15% to $1.28M. YummyNames fell 21% to $1.30M, and Butterscotch fell 44% to $0.39M. For the six months, YummyNames declined 20% and Butterscotch 23%.
- Margins and expenses: Cost of revenue rose 12% in both comparison periods, outpacing revenue growth and reducing gross margin. Q2 G&A increased 89% to $1.13M; the company cited smaller foreign-exchange gains and higher professional and facility costs. The forward-contract fair-value loss was $0.19M in Q2 versus $1.92M in Q2 2010, and $0.31M for six months versus $1.81M.
- Balance sheet and liquidity: Cash was $4.35M at June 30, up from $4.21M at year-end. Current assets were $53.90M and current liabilities $59.39M. Total stockholders’ equity was $25.35M. The filing reports $0.35M of current loan principal outstanding at quarter-end, scheduled to be repaid by September 2011; no borrowings were outstanding on the separate $2.0M repurchase facility or $1.0M operating facility. The company was in compliance with loan covenants.
- Working capital: Deferred revenue was $66.8M at June 30, 2011, compared with $60.0M a year earlier. Prepaid domain registry and ancillary-service fees totaled $53.6M, up 14% year over year. Six-month operating cash flow declined to $1.59M, primarily amid working-capital investment, including registry deposits and receivables.
Changes, outlook and risks
- No formal revenue or earnings guidance is provided. Management said operating cash flows should cover working capital, capital expenditures and loan repayments for at least the next 12 months, and expected cost of sales to rise with transaction volumes and business conditions.
- Management cited competitive and pricing pressure in domain registration, limited ability to raise prices, potential registry fee increases, and uncertainty around new generic top-level domains. Verisign supply agreements were due to expire in 2012; the filing notes a possible additional .com/.net fee increase of up to 7% in 2011 or 2012.
- Currency is a key exposure: revenue is primarily in U.S. dollars while a substantial portion of expenses is in Canadian dollars. The company had $12.6M notional of forward contracts at June 30 and does not apply hedge accounting. A modeled 10% adverse currency move would reduce Q2 net income by approximately $0.5M, holding other variables constant.
- YummyNames faces weaker domain monetization and advertising-vendor changes; Butterscotch faces declining desktop software advertising, with mobile-oriented efforts not assured of offsetting the decline. Management also noted general macroeconomic and online-advertising sensitivity.
- Subsequent events: on July 27, the Bank of Montreal facility was amended, including $8.0M of demand-loan revolving and reducing capacity for permitted purposes. Tucows drew $2.5M on July 28 and acquired EPAG Domainservices GmbH on August 1 for approximately $2.5M in cash.
- An immaterial $0.2M out-of-period adjustment reduced prepaid domain registry assets and Q2 cost of revenue. Six-month other income included $0.4M from patent-related payments; management did not expect future patent revenue to be material. Ordinary-course legal matters were not expected by management to materially affect financial position, though litigation costs and disruption remain possible.
Important facts for investors to verify
- Whether OpenSRS volume growth and registry-fee pass-through can sustain revenue while preserving gross margins.
- Whether declines in YummyNames and Butterscotch advertising and portfolio revenue continue, and whether Hover growth offsets them.
- The cash-flow and debt impact of the EPAG acquisition, amended credit facilities and subsequent borrowing.
- Exposure to Canadian-dollar appreciation, forward-contract valuation swings and registry-vendor pricing or contract changes.
- Whether reported results are affected by the $0.2M out-of-period adjustment; the filing describes it as immaterial.