Tucows Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; unaudited. Amounts are U.S. dollars. Tucows provides Network Access Services, including Ting mobile and fiber internet, and Domain Services, including wholesale and retail domain registration. Comparisons with 2016 are materially affected by the January 2017 acquisition of eNom.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $85.0 million | $49.1 million | $238.8 million | $141.0 million |
| Gross profit | $20.2 million | $16.6 million | $58.4 million | $46.6 million |
| Gross margin | 23.7% | 33.9% | 24.5% | 33.1% |
| Operating income | $6.0 million | $7.2 million | $16.1 million | $19.6 million |
| Net income | $3.4 million | $4.7 million | $11.1 million | $13.3 million |
| Diluted EPS | $0.32 | $0.45 | $1.03 | $1.23 |
| Adjusted EBITDA | $9.4 million | $8.6 million | $26.1 million | $22.8 million |
| Operating cash flow | $7.3 million | $5.3 million | $17.8 million | $13.4 million |
Q3 revenue grew 73%; nine-month revenue grew 69%, primarily from eNom and, to a lesser extent, Ting subscriber growth. Domain Services generated $62.0 million of Q3 revenue, versus $29.8 million a year earlier; Network Access Services generated $23.0 million, versus $19.3 million. Reported growth should be considered alongside the acquisition: eNom contributed $81.3 million of revenue during the first nine months of 2017.
Margins and GAAP earnings weakened despite higher revenue. The filing attributes pressure in part to eNom acquisition accounting: acquired deferred revenue was recorded at a value approximately 10% below its historical basis, reducing revenue and gross margin as it was recognized. Higher operating expenses, amortization of acquired intangibles, and increased borrowing costs also weighed on earnings. Adjusted EBITDA is a non-GAAP measure and is not a substitute for cash flow.
Balance sheet, debt and liquidity
- At September 30, cash and cash equivalents were $12.5 million, down from $15.1 million at December 31, 2016. Operating cash flow for the first nine months was $17.8 million.
- Loan payable was $81.4 million, including $18.3 million current and $63.1 million long-term; cash less reported debt was approximately $68.9 million net debt. Debt rose substantially to finance eNom and fiber investment.
- Total assets were $346.0 million and stockholders’ equity was $48.7 million. Goodwill was $87.5 million, largely related to eNom; acquired intangible assets were $60.6 million.
- Current assets were $151.9 million and current liabilities $182.7 million. The balances include substantial prepaid domain registry fees and deferred revenue, so these totals should be read in light of the company’s advance-payment business model.
- The amended credit facility provides access to up to $140 million and has variable interest rates, scheduled principal repayments, and financial covenants. Tucows reported compliance with covenants at September 30, 2017. Management stated that operating cash flow should be adequate for working capital, capital expenditures and loan repayments for at least the next 12 months.
Nine-month investing cash outflow was $90.1 million, including $76.2 million net cash paid for eNom, $9.5 million of property and equipment, and acquisitions of Otono consumer assets and an additional Ting Virginia interest. Financing cash inflow was $69.7 million, principally from credit-facility borrowings.
Material changes and management commentary
- eNom acquisition expanded the domain business and reseller base. Domain names under management reached 28.3 million, compared with 14.8 million at September 2016; new, renewed and transferred-in registrations were 4.9 million in Q3, versus 2.5 million.
- Ting had approximately 171,000 mobile subscribers and 281,000 devices under management, up from 147,000 and 235,000, respectively, a year earlier. The filing says RingPlus migration brought some customers, but management expects substantially higher-than-normal churn in Q4 2017 as service credits are used and customers may leave.
- Management described domain services as competitive and price-sensitive. Some large customers have moved, or may move, domain activity to their own accreditations or systems. Domain portfolio advertising and sales face flat-to-declining market trends, including lower traffic and advertising yields.
- The company continues investing in fiber-to-the-home expansion and reported $9.5 million of property and equipment additions in the first nine months. It gave no specific financial guidance or quantified revenue outlook in the provided filing text.
- Foreign-exchange exposure remains relevant because revenue is primarily in U.S. dollars while a substantial portion of expenses is in Canadian dollars. A sensitivity analysis estimated that a hypothetical 10% adverse currency movement would reduce nine-month net income by approximately $0.7 million. Forward contracts covered $6.9 million of U.S. dollar notional at quarter end.
Risks, contingencies and unusual items
- Debt-service and refinancing capacity, variable interest rates, and compliance with leverage and fixed-charge covenants warrant monitoring. The credit facility is secured by substantially all company assets.
- Integration and purchase accounting for eNom remained in progress; the purchase-price allocation was preliminary, with tax-related balances and other potential adjustments still subject to finalization.
- The filing identifies competition, subscriber churn, vendor and network-partner performance, fiber build-out execution, domain customer migration, advertising revenue, foreign exchange, and goodwill or intangible impairment as risks.
- Tucows reported ordinary-course legal claims and lawsuits; management did not expect their resolution, individually or collectively, to materially harm its financial position. The filing cautions that litigation can nonetheless entail expense and management distraction.
- The 2017 $40 million share-repurchase program remained authorized through February 28, 2018, but no shares had been repurchased under it through September 30.
- Management said disclosure controls were effective. Its control assessment excluded eNom, acquired in Q1, while the company evaluated eNom’s internal controls.
Important facts for investors to verify
- How much reported revenue and adjusted EBITDA growth is attributable to eNom, and how acquisition integration, purchase-accounting adjustments and synergies develop.
- Whether Q4 Ting churn following RingPlus service credits materially affects subscribers, devices, revenue or customer acquisition costs.
- Domain customer retention, registration volumes and margins, particularly given large-customer migrations and pricing pressure.
- Debt repayment capacity, future interest expense, covenant headroom and the cash requirements of the fiber expansion program.
- Final eNom purchase-price allocation, acquired intangible amortization, and any goodwill or intangible impairment indicators.