Tucows Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; filed November 6, 2019. Amounts are in U.S. dollars unless otherwise noted. The company operates Network Access Services, including Ting mobile and fiber internet, and Domain Services, including wholesale and retail domain registration.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $88.1m | $83.5m | $251.2m | $260.4m |
| Gross profit | $27.6m | $24.3m | $74.7m | $69.0m |
| Gross margin | 31.3% | 29.0% | 29.7% | 26.5% |
| Operating income | $8.6m | $7.6m | $19.4m | $19.1m |
| Net income | $4.2m | $5.3m | $9.6m | $12.7m |
| Diluted EPS | $0.39 | $0.50 | $0.89 | $1.18 |
| Adjusted EBITDA | $14.8m | $11.9m | $35.7m | $33.4m |
| Cash from operating activities | $11.2m | $11.2m | $27.2m | $26.5m |
Q3 revenue rose 6%, while nine-month revenue fell 4%. Q3 operating margin was 9.8% versus 9.2%; net margin was 4.8% versus 6.4%. For the nine-month periods, operating margin was 7.7% versus 7.3%, and net margin was 3.8% versus 4.9%. Adjusted EBITDA is a non-GAAP measure; the company cautions it is not a substitute for GAAP performance or a liquidity measure.
Balance sheet, cash flow and liquidity
- At September 30, cash and equivalents were $12.0m, total assets $419.3m, and stockholders’ equity $87.0m.
- Loan payable was $105.9m gross, or $105.0m net of unamortized issuance costs; the carrying value was $105.0m. Cash less gross debt implies approximately $93.9m of net debt.
- The amended secured credit facility provides $180m of commitments plus a $60m accordion, with a four-year term. The company reported compliance with its financial covenants. Interest is variable; a 1% rate increase would add approximately $1.0m to annual interest at the period-end loan balance.
- Nine-month investing cash outflow was $62.7m, including $31.2m of property and equipment additions, mainly for fiber expansion, and $28.0m net cash paid for Ascio. Financing cash inflow was $34.9m. Cash decreased $0.6m from year-end 2018.
- Current assets were $147.1m and current liabilities $166.1m. Current liabilities include substantial deferred revenue and customer deposits, so the current ratio should be interpreted in light of the company’s advance-billing model.
Material changes and drivers
- Q3 Domain Services revenue increased 8% to $63.5m, including $5.8m from Ascio, acquired March 18, 2019. Nine-month Domain Services revenue declined to $179.7m, partly reflecting the absence of $16.3m of accelerated revenue recognized in 2018 from Namecheap bulk domain transfers.
- Network Access Services revenue was broadly flat in Q3 at $24.6m. Mobile revenue declined as the subscriber base weakened and handset sales fell; Ting Internet and other services grew. At quarter-end Ting Mobile had 294,000 subscribers and 166,000 accounts; Ting Internet had 10,000 accounts and 34,000 serviceable addresses.
- Gross profit improved, and management attributed adjusted EBITDA growth mainly to eNom cost synergies and stronger portfolio revenue, partly offset by higher Ting Mobile usage costs. Nine-month earnings fell despite slightly higher operating income, reflecting higher interest expense and a higher effective tax rate.
- Prior-year comparisons were affected by bulk Namecheap transfers that accelerated recognition of revenue and related costs. The acquisition of Ascio contributed $11.9m of revenue and $1.3m of losses from acquisition through September 30; its purchase price allocation remained preliminary.
Outlook, risks and unusual items
- No specific full-year revenue or earnings guidance is provided. Management expected fiber-network capital expenditures to increase significantly during fiscal 2019 and believed operating cash flow would cover anticipated working capital, capital expenditures and loan repayments for at least 12 months.
- Tucows signed a five-year Verizon wholesale wireless agreement, with service expected to be operational by late 2019 and annual minimum-spend requirements. The T-Mobile agreement expires December 19, 2019; a 12-month customer migration run-off follows. Migration costs, customer churn and network-partner terms are material risks.
- Management cited intensifying mobile and domain-services price competition, subscriber churn, erosion among non-core domain customers, lower domain advertising yields, foreign-exchange exposure, GDPR and other privacy-law uncertainty, acquisition integration, and the ability to fund fiber expansion and service debt.
- For the nine months, income tax expense was $6.2m and the effective tax rate 39%, versus $3.8m and 23% in 2018. The company disclosed uncertainty around a tax-methodology position related to prepaid registry fees; it believes the position is more likely than not to be sustained, but an adverse outcome could cause incremental tax, interest and penalties.
- The company repurchased 101,816 shares for $5.0m under its $40m buyback authorization. Legal claims were described as ordinary-course matters not expected to have a material adverse effect; management cautioned outcomes cannot be predicted with certainty.
- After quarter-end, Tucows entered additional currency forwards with $30.5m U.S. notional, and agreed to acquire Cedar Holdings, a Colorado fiber provider, for an expected $15.0m, subject to regulatory approval and specified milestone payments.
Investor verification priorities
- Assess whether mobile subscriber retention and migration from T-Mobile to Verizon and other networks meet management’s expectations, including the resulting costs and minimum-spend commitments.
- Separate recurring Domain Services trends from Ascio’s contribution and the prior-year Namecheap accelerated revenue; monitor domain volumes, customer losses and renewal trends.
- Review fiber capital expenditure needs, construction progress, operating cash generation and the effect on debt and covenant headroom.
- Verify Ascio’s final purchase accounting and integration performance, and the Cedar acquisition’s closing, consideration and milestone conditions.
- Monitor the effective tax rate, prepaid-registry-fee tax position, variable-rate debt exposure, and foreign-exchange hedging.