Tucows Inc. — Q1 2013 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2013, compared with Q1 2012. Tucows distributes domain registration and related internet services through wholesale, retail and portfolio businesses; its retail operations include Ting mobile service. All amounts below are U.S. dollars.
Key financial results
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Revenue | $30.0 million | $27.5 million |
| Gross profit / margin | $6.5 million / 21.6% | $6.8 million / 24.8% |
| Operating income / margin | $0.30 million / 1.0% | $2.04 million / 7.4% |
| Net income / diluted EPS | $0.08 million / $0.00 | $1.66 million / $0.03 |
| Cash from operations | $0.42 million | $2.08 million |
- Revenue grew 9%, but cost of revenue rose 14% to $23.5 million, reducing gross profit by about $0.35 million. Reported net income was also affected by higher operating expenses, a $0.23 million loss on currency forward contracts versus a $0.56 million gain in Q1 2012, and the absence of $0.51 million of prior-year other income from an intangible-asset sale.
- Revenue mix: wholesale $24.6 million (+3%); retail $4.3 million (up from $1.85 million); portfolio $1.13 million (down from $1.89 million). Retail growth included $2.3 million of Ting device and service sales. Value-added wholesale revenue was essentially flat.
- Operating cash flow declined 80% year over year to $0.42 million, reflecting low earnings and working-capital movements, including cash used for prepaid domain-registration costs.
- At March 31, cash was $4.29 million, total assets $117.1 million and stockholders’ equity $20.0 million. Current assets were $62.1 million and current liabilities $75.6 million. Deferred revenue totaled approximately $72.4 million.
- Loan balances totaled $8.1 million, up from $3.7 million at year-end; the company reported $6.9 million of additional borrowing availability under its $14 million demand-loan facilities. It was in compliance with its financial covenants. Interest expense was $0.10 million.
Material changes and management commentary
- Retail revenue rose with Ting’s launch and growth: Ting had 16,000 subscribers and 26,000 devices under management at quarter-end, adding 6,000 subscribers and 11,000 devices during the quarter. Ting-related costs and marketing contributed to higher retail costs and sales and marketing expense.
- Wholesale domain revenue increased modestly despite 2.5 million new, renewed and transferred-in registrations, down from 2.6 million a year earlier. Domain names under management totaled 14.1 million, including 3.4 million managed for other accredited registrars.
- Portfolio revenue declined, principally because of lower sales of high-value domains and reduced vendor marketing programs. Management said it was shifting sales efforts toward business buyers as domain investors assessed the potential effects of new generic top-level domains (gTLDs).
- The company repurchased 4.1 million shares in a Dutch auction at $1.50 per share and another 143,073 shares under a new buyback program. The quarter’s cash-flow statement reports $6.54 million used for repurchases. The new program authorized up to $10 million of repurchases over 12 months.
- Management stated that operating cash flow should be adequate for working capital, capital spending and loan repayments for at least the next 12 months. No formal revenue or earnings guidance was provided.
Outlook, risks and contingencies
- Management identified competition and pricing pressure in domain services, the uncertain effects of ICANN’s new gTLD program, and potential reductions in vendor market-development funding as risks to revenue and margins.
- Revenue is primarily in U.S. dollars while a substantial portion of expenses is in Canadian dollars. Forward contracts had a $23.3 million notional amount; a modeled 10% adverse currency move was estimated to reduce quarterly net income by approximately $0.6 million. Contract fair value was a net liability of about $0.19 million.
- Domain advertising revenue depends on third-party providers’ traffic assessments and policies; domain sales can also reduce advertising revenue and cause quarterly variability. One customer represented 13% of accounts receivable at quarter-end, though no customer exceeded 10% of quarterly revenue.
- Management did not expect ordinary-course legal claims, individually or in aggregate, to materially harm the business, but noted litigation can entail expense and management distraction. Gross unrecognized tax benefits were approximately $0.4 million; management expected they could decrease in the following 12 months as reviews and assessments proceed.
- Management reported no subsequent events and no material change in internal control over financial reporting during the quarter. The results are interim and are not necessarily indicative of full-year performance.
Important facts for investors to verify
- Whether Ting can sustain subscriber and revenue growth while controlling device, network and customer-acquisition costs.
- Whether wholesale domain volumes and margins withstand customer migrations to their own registrar accreditations, registry fee changes and new gTLD competition.
- How currency movements affect operating costs and the value and effectiveness of the company’s forward contracts.
- Whether operating cash flow and liquidity support debt service and planned repurchases; review covenant headroom, facility terms and the impact of buybacks on cash and debt.
- Whether portfolio advertising and domain-sale revenue recover, and whether the company’s reported share count reconciles: 40,121,797 shares at March 31 versus 40,263,709 outstanding as of May 13, 2013.