Tucows Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparison with the same periods in 2017 unless noted. Amounts are U.S. dollars. Tucows operates Network Access Services (Ting mobile and fiber internet) and Domain Services (wholesale and retail domains, value-added services, and domain portfolio).
Financial performance
| Metric | Q3 2018 | Q3 2017 | First 9 months 2018 | First 9 months 2017 |
|---|---|---|---|---|
| Revenue | $83.5m | $85.0m | $260.4m | $238.8m |
| Gross profit | $24.3m | $20.5m | $69.0m | $58.8m |
| Operating income | $7.6m | $6.0m | $19.1m | $16.1m |
| Net income | $5.3m | $3.4m | $12.7m | $11.1m |
| Diluted EPS | $0.50 | $0.32 | $1.18 | $1.03 |
| Adjusted EBITDA (non-GAAP) | $11.9m | $9.4m | $33.4m | $26.1m |
| Cash from operating activities | $11.2m | $7.3m | $26.5m | $17.8m |
Gross margin was approximately 29.0% in Q3 2018 versus 24.1% a year earlier, and 26.5% for the first nine months versus 24.6%. Operating margin was approximately 9.2% and 7.3%, respectively, compared with 7.0% and 6.7%. Adjusted EBITDA is a company-defined non-GAAP measure and is not a liquidity measure.
Liquidity, debt, and investment
- Cash and cash equivalents were $10.8m at September 30, 2018, down $7.3m from December 31, 2017. Total assets were $337.5m and stockholders’ equity was $75.4m.
- Loan payable was $64.4m net of unamortized debt costs; scheduled principal repayments totaled $65.0m. The company repaid $15.2m and borrowed $2.5m during the first nine months. It reported compliance with its credit-facility covenants.
- Investing cash outflow was $20.8m, including $19.4m of property and equipment additions, primarily for fiber-network expansion, and $1.2m to acquire the remaining interest in Ting Virginia. Financing cash outflow was $13.1m.
- Current assets were $134.7m and current liabilities $167.5m. Management believes operating cash flow will meet anticipated working-capital, capital-expenditure, and debt-repayment needs for at least the next 12 months.
Material changes versus prior comparable periods
- Q3 revenue fell 2% year over year, while nine-month revenue increased 9%. Growth in mobile, fiber, and eNom-related activity was partly offset by contraction in Domain Services and domain portfolio revenue.
- The Namecheap domain transfers materially affected period comparisons. Accelerated recognition of previously deferred revenue and related registry costs from transfers was $14.6m and $14.5m, respectively, for the 2.65m domains transferred in Q1, and approximately $1.7m each for the 0.24m domains transferred in Q3. These timing effects contributed to nine-month revenue growth and Q3 comparisons.
- Management expected approximately 0.4m additional Namecheap domains to transfer in Q4 2018. Total domains under management declined to 23.3m from 28.3m a year earlier, reflecting Namecheap transfers and other customer migrations. New, renewed, and transferred-in registrations were 4.17m in Q3 versus 4.84m.
- Network Access Services revenue rose to $24.6m in Q3 from $23.2m; mobile accounts and subscribers reached 169,000 and 295,000, respectively. Domain Services revenue declined to $58.9m from $61.8m in Q3, though nine-month segment revenue grew to $187.9m from $174.7m.
- Operating expenses increased, including sales and marketing, technical development, and general and administrative costs. Higher gross profit nevertheless supported increased operating income and earnings.
Outlook, commentary, risks, and unusual items
- Management said capital expenditures for building and expanding the fiber network were expected to increase significantly during fiscal 2018; it gave no specific amount of forward guidance.
- Management attributed adjusted EBITDA growth to eNom, Domain Services, and Ting Mobile, partly offset by investment in the fiber program. Expansion included existing Ting towns and construction in Sandpoint, Idaho, and Centennial, Colorado.
- Key risks include intense mobile and domain-service competition, subscriber churn and bad debt, reliance on mobile-network partners, domain customer migrations and pricing pressure, and declining domain advertising yields. GDPR and evolving privacy rules may create compliance costs, liability, or reduced WHOIS privacy revenue. A hypothetical 10% adverse currency movement was estimated to reduce quarterly net income by approximately $0.8m before hedging; a 1% interest-rate increase on the reported facility balance would add approximately $0.7m in annual interest.
- The Namecheap litigation was settled and dismissed on September 6, 2018; the settlement included an administrative fee for transfer services. Management did not expect other ordinary-course claims to materially harm the company, but noted outcomes cannot be predicted with certainty.
- The company adopted ASC 606 using the modified retrospective method on January 1, 2018. Management said the effect on revenue-recognition timing was not material; prior-year comparisons were not restated. An immaterial classification error in 2017 expense categories was corrected in the comparative presentation.
- The company reported effective disclosure controls and no material changes to internal control over financial reporting. No shares were repurchased under the authorized $40m buyback program during the nine months.
Most important facts for investors to verify
- How much reported revenue and earnings growth reflects sustainable operations versus accelerated recognition from the Namecheap domain transfers, and the timing of the remaining transfer.
- Whether Domain Services stabilizes after the decline in domains under management and customer migrations, and how renewal volumes and margins develop.
- Progress, spending, and subscriber economics for Ting fiber expansion, including the expected fiscal 2018 capital-expenditure increase.
- Cash generation relative to capital spending and scheduled loan repayments, along with covenant headroom and variable-rate debt exposure.
- Mobile subscriber growth, churn, and carrier pricing; domain-service competition; and the financial impact of GDPR and currency movements.