Tucows Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Amounts are in U.S. dollars. Tucows provides Network Access Services, including Ting mobile and fixed internet, and Domain Services, including wholesale and retail domain registration. Results include eNom from its January 20, 2017 acquisition.
Financial performance and liquidity
- Q2 revenue: $84.2 million, up 78% from $47.2 million in Q2 2016. Domain Services generated $62.8 million; Network Access Services generated $21.5 million.
- Q2 profit: Gross profit was $21.3 million (about 25.3% margin), versus $15.6 million (about 33.1%) a year earlier. Operating income was $7.1 million, versus $6.1 million. Net income was $5.2 million, versus $4.1 million; diluted EPS was $0.49, versus $0.38.
- First-half results: Revenue was $153.8 million, up 67%. Gross profit was $38.3 million (about 24.9% margin), versus $30.0 million (about 32.6%). Operating income fell to $10.1 million from $12.4 million; net income declined to $7.7 million from $8.5 million. Diluted EPS was $0.71 versus $0.79.
- Adjusted EBITDA, a non-GAAP measure: $10.3 million for Q2 versus $6.9 million; $16.5 million for the first half versus $14.2 million. Management attributed the increase primarily to eNom and growth in domain services and Ting Mobile, partly offset by Fiber-to-the-Home investment.
- Cash flow: Operating cash flow was $8.1 million in Q2 versus $2.6 million, and $10.5 million for the first half versus $8.2 million. First-half investing used $84.8 million, largely reflecting the $76.2 million eNom acquisition (net of acquired cash), plus $6.6 million of property and equipment additions. Financing provided $74.3 million, primarily from borrowing for eNom and fiber investment.
- Cash and liquidity: Cash was $15.1 million at June 30, essentially unchanged from year-end. Current assets were $158.9 million and current liabilities $185.1 million, a working-capital deficit of $26.2 million. Much of the balance-sheet movement reflects prepaid registry fees and deferred revenue associated with eNom and domain services.
- Debt: Loan payable was $86.0 million carrying value ($18.3 million current and $67.7 million long-term), versus $10.2 million at December 31, 2016. Q2 net interest expense was $1.0 million; first-half net interest expense was $1.8 million. The amended credit facility provides up to $140 million and bears variable rates. Tucows reported compliance with its financial covenants at June 30.
Material changes versus prior periods
- The eNom acquisition was the principal driver of the sharp increase in revenue, domain registrations, deferred revenue, goodwill, intangible assets and debt. Management reported 28.8 million domains under management at June 30, versus 14.8 million a year earlier; the reseller network grew to approximately 39,000.
- Domain Services accounted for 75% of Q2 revenue, versus 60% a year earlier. eNom-related fair-value accounting reduced acquired deferred revenue to approximately 10% below its historical cost basis, negatively affecting reported domain-service gross margins.
- Q2 Ting Mobile service revenue benefited from a larger subscriber base. Ting had about 170,000 subscribers and 278,000 devices under management, versus 144,000 and 227,000 a year earlier.
- First-half operating income and net income declined despite revenue and adjusted EBITDA growth, with increased amortization of acquired intangibles, operating costs and interest expense among the factors. The 2017 income-tax provision also included $2.2 million of excess share-based-compensation tax benefits for the first half.
Outlook, commentary and risks
- Management said operating cash flow should be adequate for anticipated working capital, capital expenditures and loan repayments for at least the next 12 months. No specific revenue, earnings or adjusted EBITDA guidance was provided.
- Tucows warned that Ting could experience substantially higher-than-normal churn in Q3 2017 following RingPlus’s shutdown. It issued $35 service credits to eligible migrated customers and noted many might leave after using them.
- Risks include intense pricing competition in mobile and domain services; large domain customers moving registrations to their own accreditations or systems; pressure on domain advertising and portfolio-sale revenue; reliance on mobile network partners; integration of eNom; debt service and variable interest rates; and U.S.-dollar/Canadian-dollar exchange movements. A hypothetical 10% adverse currency move was estimated to reduce first-half net income by about $0.7 million.
- The eNom purchase-price allocation remained preliminary, with tax-related balances and other potential adjustments pending. Management expected to finalize it by September 30, 2017. The filing reported ordinary-course legal claims that management did not expect to have a material adverse effect.
- Management stated disclosure controls were effective; the assessment excluded eNom’s internal controls, which were still being evaluated. No material changes to the previously disclosed risk factors were reported.
Important facts for investors to verify
- How much of reported growth and margin performance is attributable to eNom, including the final purchase-price allocation and acquired deferred-revenue accounting effects.
- Whether Ting subscriber and device growth persists after the RingPlus credits expire and elevated churn subsides.
- Domain registration volumes, retention of large reseller customers, and trends in domain advertising and portfolio sales.
- Debt repayment capacity, covenant headroom, variable-rate exposure and planned Fiber-to-the-Home capital spending.
- Future operating cash flow and working-capital needs, given the reported current-liability balance exceeding current assets.