Tucows Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited consolidated results; amounts are U.S. dollars unless noted.
Business context
Tucows provides mobile phone and fixed Internet services, alongside wholesale and retail domain registration and related Internet services. Its principal offerings are Network Access Services, including Ting, and Domain Services. At quarter-end, Ting managed about 144,000 mobile subscribers and 227,000 devices; Tucows managed 14.8 million domain names.
Financial highlights
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $47.5 million | $42.9 million | $93.1 million | $83.4 million |
| Gross profit | $15.8 million | $12.9 million | $31.0 million | $25.1 million |
| Gross margin | 33.4% | 30.0% | 33.3% | 30.1% |
| Operating income | $6.1 million | $3.9 million | $12.4 million | $8.3 million |
| Net income | $4.1 million | $2.3 million | $8.5 million | $5.1 million |
| Diluted EPS | $0.38 | $0.20 | $0.79 | $0.44 |
| Adjusted EBITDA | $7.1 million | $4.3 million | $13.9 million | $9.6 million |
Quarterly revenue rose 11%; six-month revenue rose 12%. Adjusted EBITDA is a non-GAAP measure, and the company revised its definition during 2016; prior-period amounts were recast.
- Revenue drivers: Q2 Network Access revenue grew 23% to $19.0 million, primarily as Ting’s larger subscriber base lifted mobile services. Domain Services revenue increased 4% to $28.5 million. Retail revenue grew 18%; portfolio revenue was up slightly for the quarter but down for the half-year.
- Profitability: Gross margin improved as revenue growth outpaced cost-of-revenue growth. Operating expenses increased, notably sales and marketing, which rose 12% in Q2 and 24% year to date, primarily to support Ting growth.
- Cash flow and liquidity: Operating cash flow was $7.7 million for the first half, versus $5.2 million a year earlier. Cash was $5.9 million at June 30, down $1.8 million from year-end. Current assets of $73.3 million were below current liabilities of $86.4 million.
- Debt: Loan balances totaled $9.1 million at June 30 ($6.0 million revolving demand loan and $3.1 million reducing facility), compared with $3.5 million at year-end. The credit facility provides up to $14 million across the demand loan facilities; Tucows reported compliance with its financial covenants.
Material changes and unusual items
- On April 1, Tucows acquired Melbourne IT’s international reseller channel for $6.0 million plus $0.2 million of legal and registry-related transaction costs. The acquisition was funded by a $6.0 million credit-facility draw and contributed customer-relationship intangibles.
- The company repurchased 308,416 shares for $7.2 million in the first half under a new $40 million buyback authorization; $32.8 million remained available at June 30.
- Investing cash outflow was $8.1 million in the first half, including the acquisition and $1.8 million of property and equipment investment, principally for fiber expansion.
- Other income included recognition of a portion of a $1.5 million gain related to waiving rights to the .online registry and entering a three-year joint marketing agreement. Six-month 2016 recognition was $0.3 million.
- Six-month results included $24,879 of impairment for domain names not renewed. Foreign-exchange hedging produced a net derivative liability of $0.2 million at June 30; the balance sheet also presented derivative assets and liabilities separately.
Outlook, commentary and risks
Management stated that operating cash flow should be adequate for working capital, capital expenditures and loan repayments for at least the next 12 months. No specific revenue or earnings guidance was provided. The company may pursue additional financing to support faster expansion, product development or acquisitions.
Management cited mobile-sector price competition, subscriber churn, Ting’s mobile-network-operator dependence and service costs, and the ability to sustain positive net subscriber additions as risks. Domain Services faces pricing pressure, large customers migrating to their own registrar accreditations, and uncertainty in advertising and portfolio-name sales. Currency movements are also a risk because revenue is primarily in U.S. dollars while a substantial portion of expenses is in Canadian dollars; management’s sensitivity analysis estimated that a hypothetical 10% adverse exchange-rate move would reduce quarterly net income by about $0.6 million. Legal claims were described as ordinary-course matters not expected to have a material adverse effect; the filing reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether Ting subscriber growth and retention can persist amid heightened competition, churn and pressure on pricing and network costs.
- How much the Melbourne IT channel contributes to revenue, margins and domain volumes, and whether customer migrations offset that growth.
- Cash generation and working-capital requirements, given negative working capital, reduced cash, planned investment and ongoing buybacks.
- Debt repayment capacity and continued compliance with credit-facility covenants as borrowing has increased.
- The comparability of adjusted EBITDA after the definition change, and the effects of foreign-exchange exposure and hedging on reported results.