Tucows Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023. Amounts are in U.S. dollars; financial statement amounts are generally shown in millions unless stated otherwise.
Business context
Tucows operates three segments: Ting, providing retail fiber internet; Wavelo, providing software platforms and professional services to communication service providers; and Tucows Domains, providing wholesale and retail domain registration and related services. Tucows Domains remained the largest business, generating 73% of quarterly revenue.
Financial performance and liquidity
| Metric | Q1 2023 | Q1 2022 / comparison |
|---|---|---|
| Revenue | $80.4 million | $81.1 million; down 0.8% |
| Gross profit and margin | $14.1 million; 17.5% | $21.2 million; 26.1% |
| Operating loss | $17.3 million | $4.8 million |
| Net loss | $19.1 million; $1.77 per share | $3.0 million; $0.28 per share |
| Adjusted EBITDA (non-GAAP) | $3.0 million | $11.3 million |
| Operating cash flow | $(5.3) million | $5.4 million |
| Capital expenditures | $31.7 million | $23.1 million |
| Cash and cash equivalents | $11.8 million at March 31 | $23.5 million at December 31, 2022 |
| Credit facility borrowings | $236.9 million principal; $236.0 million net carrying amount | $239.7 million principal at December 31, 2022 |
Current assets were $167.7 million and current liabilities $192.1 million at quarter-end. Deferred revenue was $151.4 million, up from $145.1 million at year-end. The company also reported $124.8 million of redeemable preferred shares as a liability; the preferred units’ aggregate liquidation preference was $125.6 million, plus accrued and unpaid returns and potentially a make-whole premium.
Material changes and operating drivers
- Ting revenue increased 21% to $11.9 million, with 37,000 internet accounts under management, versus 28,000 a year earlier. Owned serviceable addresses rose to 102,000 from 81,000, excluding Simply Bits.
- Wavelo revenue increased 6.6% to $7.3 million, primarily as more DISH subscribers migrated to its MONOS platform.
- Tucows Domains revenue declined $2.3 million to $59.2 million. Management cited normalization in domain registrations and renewals, lower expiry-auction proceeds, and lower retail domain revenue. Domains under management were 24.5 million, down from 25.0 million.
- Cost of revenue rose 11% to $66.4 million, led by a $6.6 million increase in network expenses, including higher network operating costs and depreciation and a $1.9 million impairment charge for damaged Ting conduit and other scrap capital inventory.
- Sales and marketing expense increased 31% to $15.7 million, and technical operations and development expense rose 28% to $4.8 million, primarily reflecting hiring, investment in Ting and Wavelo, and wage inflation.
- Net interest expense rose to $7.9 million from $1.8 million. Tucows also recognized $4.4 million of income from the DISH transferred-asset payment stream, compared with $4.8 million in Q1 2022.
Outlook, risks and unusual items
- No specific consolidated revenue or earnings guidance was provided. Management expects Ting fiber-network capital expenditures to continue increasing during 2023 and is pursuing additional financing to support expansion.
- On March 14, the credit facility maturity was extended to September 30, 2024. During a leverage step-up period, the maximum debt-to-adjusted-EBITDA covenant is 4.50:1 through September 29, 2023, then 4.00:1 through December 30, 2023, and 3.75:1 thereafter; minimum interest coverage is 3.00:1. The company reported compliance with its applicable covenants during the quarter.
- Generate preferred units accrue a 15% annual preferred return, subject to a 13%–17% range under specified conditions. The units include mandatory redemption provisions and may carry a make-whole premium. Generate provided $30 million of additional funding in January; $82.5 million of commitment remained at March 31.
- After quarter-end, on May 4, Ting subsidiaries issued approximately $238.5 million of secured fiber revenue notes: $168.4 million at 5.95%, $23.3 million at 7.40%, and $46.9 million at 9.95%. The notes are secured by specified fiber-related assets and contracts. That day, Ting also redeemed 5.17 million preferred units for $45.7 million, inclusive of a discounted make-whole premium; further preferred-unit issuance was restricted for 365 days and standby fees suspended during that period.
- Management cited inflation and higher interest rates, fiber build costs, competition, foreign-exchange exposure, and dependence on DISH for significant Wavelo platform activity as risks. A 10% adverse currency move was estimated to reduce quarterly net income by approximately $1.6 million before hedging; a 1% adverse interest-rate move was estimated to increase annual borrowing interest by approximately $1.7 million after hedging.
- The company accrued $0.2 million of penalties for a minimum-commitment shortfall under a retained mobile network agreement and expects penalties to continue through the end of 2023.
- Disclosure controls and internal control over financial reporting were not effective at March 31 because of a previously identified material weakness involving controls over capitalization of certain costs. Management reported remediation progress and plans to remediate during 2023, but gave no assurance of success or timing.
- Management said ordinary-course legal claims were not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
Most important facts for investors to verify
- Whether Ting growth and fiber expansion can generate adequate returns given negative operating cash flow, rising network costs, and continued high capital spending.
- Liquidity, covenant headroom, debt-service capacity, and the effects of the May securitization and preferred-unit redemption on consolidated and Ting-level obligations.
- Generate funding milestones, preferred-return and redemption terms, and any restrictions on funding Ting from other subsidiaries.
- DISH concentration and subscriber migration trends for Wavelo, along with DISH receivable collection and the declining transferred-asset payment stream.
- Progress in remediating the capitalization-control material weakness and the status of mobile minimum-commitment penalties.