Tucows Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012; U.S. dollars. Tucows distributes domain registration, hosted email and other internet services through wholesale, retail and domain-portfolio businesses. The filing reports one operating segment.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $28.15 million | $23.05 million | $55.69 million | $45.60 million |
| Gross profit | $6.63 million | $5.37 million | $13.46 million | $10.71 million |
| Operating income | $1.06 million | $0.71 million | $3.10 million | $1.27 million |
| Net income | $0.70 million | $0.57 million | $2.36 million | $1.29 million |
| Basic / diluted EPS | $0.02 / $0.01 | $0.01 / $0.01 | $0.05 / $0.05 | $0.02 / $0.02 |
- Revenue increased 22% in both Q2 and the first half. Gross margin was approximately 23.5% in Q2 (23.3% prior year) and 24.2% for the first half (23.5% prior year); operating margin was approximately 3.8% and 5.6%, respectively.
- Six-month operating cash flow was $2.08 million, versus $1.59 million. Q2 operating cash flow was only $3,723, versus $825,000 in Q2 2011.
- Cash was $4.51 million at June 30, down $1.90 million from year-end. Current assets of $63.02 million were below current liabilities of $71.75 million, a working-capital deficit of approximately $8.74 million. Deferred domain-related balances are substantial and reflect the company’s prepaid, recurring-service model.
- Loan payable was $4.0 million, all current; the $4.0 million DLR loan is payable on demand at the bank’s discretion. No operating-demand loan balance was outstanding. The company reported compliance with its debt covenants.
Changes and operating drivers
- Wholesale OpenSRS revenue grew 19% in Q2 and the first half, led by domain services. Management attributed growth to higher customer transaction volumes, the EPAG acquisition and passing through January 2012 registry fee increases. Domain registrations processed rose to 2.33 million in Q2 and 4.77 million in the first half.
- Retail revenue rose to $2.30 million in Q2 from $1.28 million, with Ting device sales and Hover marketing cited as drivers. Portfolio revenue also rose, partly due to domain-name sales that management cautioned may not recur at the same level.
- Domain names under management increased to 13.88 million from 11.14 million a year earlier, including domains on other registrars’ accreditations. EPAG contributed $0.96 million of Q2 revenue and reported a Q2 net loss of $43,228.
- Costs of revenue rose 22% in Q2 and 21% for the first half, broadly tracking revenue growth. Retail costs increased substantially, in part due to Ting device sales. Sales and marketing and general and administrative costs also increased; technical operations and development costs declined.
Outlook, risks and unusual items
- No numerical revenue or earnings guidance was provided. Management said it expected operating cash flow to cover anticipated working capital, capital expenditures and loan repayments for at least the next 12 months.
- Management identified competition and domain-registration pricing pressure, registry fee increases, uncertain effects of ICANN’s new gTLD program, variable portfolio advertising and domain-sale revenue, and reliance on market-development funds as risks. Revenue is primarily in U.S. dollars while a substantial portion of expenses is in Canadian dollars; a modeled 10% adverse currency move would reduce quarterly net income by approximately $0.5 million. Forward contracts totaled $20.2 million notional and had a net fair-value liability of approximately $0.24 million.
- During the first half, Tucows sold intangible assets with no book value for $0.5 million, recorded as other income. It also incurred $1.1 million of ICANN evaluation fees for six gTLD applications; two withdrawals were expected to generate a full $0.4 million refund.
- Share repurchases totaled 8.69 million shares through June 30: 7.57 million through a Dutch auction at $0.77 per share and 1.12 million through the issuer bid in Q2 at an average $1.43. The company spent approximately $7.42 million, excluding tender transaction costs, and funded part of the tender with a $4.0 million loan draw.
- Management said ordinary-course legal claims were not expected to have a material adverse effect, while noting that outcomes cannot be assured and litigation may be costly or distracting. Comparative 2011 forward-contract gains were reclassified within expenses; management stated this did not affect previously reported net income or cash flows.
Investor verification priorities
- Assess cash generation and liquidity against the current-liability balance, including the timing and nature of deferred revenue and prepaid registry fees.
- Review the demand-loan terms, repayment schedule, covenant headroom and exposure to the bank’s right to call the loan.
- Separate recurring operating growth from EPAG contribution, Ting device sales, domain-portfolio sales and other nonrecurring income.
- Track domain-registration volumes, registry pricing, new gTLD developments and the effect of currency movements and hedges.
- Confirm continuing share-repurchase activity and the resulting share count; the filing reports 45,484,997 shares outstanding at June 30 and 45,497,497 as of August 10, 2012.