Tucows Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Dollar figures below are U.S. dollars in millions unless stated otherwise. Tucows provides mobile and fiber internet services and domain registration and related services through its Network Access Services and Domain Services segments.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Revenue | $84.1 | $81.1 | $163.1 | $176.9 |
| Gross profit | $24.5 | $22.2 | $47.2 | $44.8 |
| Operating income | $5.7 | $5.7 | $10.8 | $11.4 |
| Net income | $2.6 | $3.6 | $5.4 | $7.4 |
| Diluted EPS | $0.24 | $0.33 | $0.50 | $0.68 |
| Adjusted EBITDA (non-GAAP) | $11.5 | $11.2 | $20.9 | $21.6 |
| Operating cash flow | $7.0 | $5.8 | $16.0 | $15.3 |
- Q2 gross margin was approximately 29.1%, versus 27.3% a year earlier; operating margin was approximately 6.8%, versus 7.0%. First-half gross margin was approximately 28.9%, versus 25.3%; operating margin was approximately 6.6%, versus 6.5%.
- At June 30, cash was $12.0 million. Current assets were $149.9 million and current liabilities $165.7 million. Current liabilities include $130.5 million of current deferred revenue, largely reflecting customer prepayments.
- Gross borrowings were $100.9 million under the revolving credit facility; the balance-sheet carrying amount, net of debt costs, was $99.9 million. Total assets were $414.3 million and stockholders’ equity was $87.0 million.
- First-half investing cash outflow was $51.4 million, including $20.8 million of property and equipment additions, $28.0 million for Ascio net of acquired cash, and $2.5 million advanced for a subsequent mobile subscriber-base acquisition. Financing provided $34.8 million. Cash declined $0.6 million from year-end.
Changes versus comparable periods
- Q2 revenue increased 4%, primarily reflecting $5.2 million of Ascio revenue since its March acquisition. Domain Services revenue rose to $60.5 million, while Network Access Services revenue declined to $23.6 million. First-half revenue fell 8%, substantially reflecting the prior-year Namecheap bulk transfer: 2018 included $14.6 million of accelerated revenue, plus $5.4 million of Namecheap-related revenue absent in 2019.
- Mobile revenue fell 6% in Q2 and 6% in the first half, amid a declining subscriber base and lower handset sales. Ting Mobile had 280,000 subscribers and 157,000 accounts at quarter-end, versus 282,000 and 163,000 a year earlier. Ting Internet had 9,000 accounts versus 5,000, with 34,000 serviceable addresses versus 21,000.
- Domain registrations under management increased to 25.0 million from 24.1 million year over year, including approximately 1.9 million acquired with Ascio. New, renewed and transferred-in registrations were 4.38 million in Q2, essentially flat year over year; first-half volume declined to 8.94 million from 9.27 million.
- Net income declined in both comparison periods despite higher Q2 revenue and gross profit. Higher operating expenses, interest and taxes weighed on earnings. Q2 interest expense was $1.3 million versus $1.0 million; the effective tax rate was 41% versus 25%.
Outlook, commentary and risks
- Management stated operating cash flow should be adequate for anticipated working capital, capital expenditures and loan repayments for at least the next 12 months. It expected fiber-network capital expenditures to increase significantly in 2019. First-half property and equipment additions were $20.8 million.
- On June 14, Tucows replaced its prior facility with a four-year secured credit agreement providing up to $180 million, plus a $60 million accordion. It is interest-only with no scheduled principal repayment during the term; the $100.9 million outstanding was due in 2023 under the disclosed schedule. The company reported compliance with financial covenants at June 30.
- After quarter-end, Tucows agreed to a five-year Verizon wholesale wireless arrangement, with service expected to become operational by late 2019 and minimum spend commitments increasing annually. Tucows also notified T-Mobile it would not renew the agreement expiring December 19, 2019. It expects migration costs, including marketing, and has a 12-month customer run-off period; churn and migration outcomes remain uncertain.
- A May agreement to acquire rights to approximately 150,000 FreedomPop/Unreal Mobile subscribers on Sprint for $3.6 million began migrating customers in July. Customers may accept Ting service, cancel or port elsewhere, so retained subscribers are expected to be fewer than the initial base. A $2.5 million advance was paid in Q2; the balance was due upon migration commencement.
- Management cited mobile price competition, subscriber churn, dependence on mobile network partners, domain-services pricing pressure, erosion among non-core registrar customers, and continued weakness in portfolio advertising and domain-sale trends. Other risks include foreign-exchange exposure, GDPR and other privacy obligations, acquisition integration, fiber build-out demands, and tax uncertainty. A 10% adverse currency move was estimated to reduce quarterly net income by about $0.9 million before hedging; a 1% interest-rate increase would add about $1.0 million of annual interest at the quarter-end debt balance.
- Ascio’s preliminary purchase-price allocation remains subject to final valuation and working-capital adjustments. The acquisition contributed $6.0 million of revenue in the first half and a reported $0.7 million net loss since acquisition. Management did not expect ordinary-course legal claims, individually or collectively, to materially harm financial position.
Most important facts to verify
- Whether the Verizon launch, rising minimum commitments and T-Mobile migration proceed on schedule, and the resulting subscriber retention and costs.
- Whether Ting Mobile customer trends stabilize and fiber growth converts its expanded service footprint into revenue and cash flow.
- How much of the first-half revenue comparison reflects the 2018 Namecheap transfer versus ongoing domain customer and pricing trends.
- Ascio’s final purchase-price allocation, operating contribution and integration performance.
- Credit-facility availability, covenant headroom, interest-rate exposure and the funding required for the planned fiber capital spending.
- The unresolved tax-methodology issue related to prepaid registry fees, and potential GDPR or other privacy-related costs or liabilities.