Tucows Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results; financial amounts are in U.S. dollars. Tucows operates Network Access Services, including Ting mobile and fiber internet, and Domain Services, including wholesale and retail domain registration and related services.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $81.1 million | $84.2 million | $176.9 million | $153.8 million |
| Gross profit | $22.2 million | $21.3 million | $44.8 million | $38.3 million |
| Gross margin | 27.3% | 25.3% | 25.3% | 24.9% |
| Operating income | $5.7 million | $7.1 million | $11.4 million | $10.1 million |
| Net income | $3.6 million | $5.2 million | $7.4 million | $7.7 million |
| Diluted EPS | $0.33 | $0.49 | $0.68 | $0.71 |
| Adjusted EBITDA | $11.2 million | $10.4 million | $21.6 million | $16.7 million |
Q2 revenue declined 4%, while first-half revenue rose 15%. Q2 gross margin improved, but operating income and net income fell year over year as operating expenses and taxes increased. Adjusted EBITDA, a non-GAAP measure, increased in both periods.
- Segment trends: Q2 Network Access Services revenue increased 12% to $24.3 million; Domain Services revenue declined 9% to $56.8 million. For the first half, Network Access revenue rose 17% to $47.9 million and Domain Services revenue rose 14% to $129.0 million.
- Key operating measures: Ting had 282,000 mobile subscribers and 163,000 accounts at quarter-end, versus 278,000 subscribers and 165,000 accounts a year earlier. Domains under management fell to 24.1 million from 28.8 million; quarterly domain registrations provisioned were 4.382 million versus 4.903 million.
Cash, debt and liquidity
- Cash and cash equivalents were $11.2 million at June 30, down from $18.0 million at December 31, 2017.
- First-half operating cash flow was $15.3 million, compared with $10.5 million a year earlier. Investing used $13.6 million, including $12.4 million of property and equipment additions, primarily for fiber expansion. Financing used $8.6 million, including $10.8 million of loan repayments and a $1.2 million payment for the remaining Ting Virginia interest; $2.5 million was drawn on the credit facility.
- Loan payable had a $68.7 million carrying value ($69.4 million scheduled principal), of which $17.7 million was current. Scheduled principal repayments include $8.8 million for the remainder of 2018 and $17.9 million in 2019.
- The $140 million secured credit facility has variable rates and financial covenants. Tucows reported compliance at June 30, 2018. Management said operating cash flow should cover working capital, capital expenditures and debt repayments for at least the next 12 months.
Material changes, outlook and risks
- First-half revenue included $14.6 million of accelerated recognition associated with the January transfer of 2.65 million domain names to Namecheap; related accelerated costs were $14.5 million. This one-time timing effect, along with eNom and Otono acquisitions, affects comparisons. The filing does not provide a clear quantified measure of underlying growth excluding these factors.
- The Namecheap transfer followed a preliminary injunction. Namecheap continues to seek direct and consequential damages; Tucows says it believes the claims lack merit and does not consider the litigation material.
- Tucows expects 2018 capital expenditures on fiber network construction to increase significantly. Sandpoint service began in Q2; Centennial was expected to launch in the second half of 2018. No numeric revenue or earnings guidance is provided.
- Management cites competitive pricing and churn risks in mobile and domain services, potential customer migrations, and flat-to-declining trends in domain parking advertising and domain sales. Mobile services also depend on network partners’ coverage and performance.
- GDPR requirements effective May 25, 2018 may increase compliance costs or affect WHOIS privacy revenue; the filing notes potential fines of up to 4% of annual total revenue for certain violations. Foreign-currency exposure is material: a hypothetical 10% adverse exchange-rate move was estimated to reduce quarterly net income by approximately $0.9 million before hedging. A 1% adverse interest-rate move would add about $0.7 million to annual interest expense at the reported loan balance.
- Topic 606 was adopted using the modified retrospective method; prior-year figures were not restated. Management said the adoption had no material impact on revenue timing or cash flows. Lease accounting standard adoption was planned for Q1 2019; the company was assessing the impact, particularly on office leases.
Investor verification points
- Assess revenue and earnings trends apart from the $14.6 million accelerated domain revenue and associated costs, as well as acquisition effects.
- Track domain customer migrations, domains under management, renewal activity and the financial impact of the Namecheap dispute.
- Monitor fiber build-out spending, launch progress, operating cash flow and cash available for debt service.
- Review credit-facility covenant headroom, repayment schedule and sensitivity to variable interest rates.
- Evaluate mobile subscriber/account trends, competitive churn, foreign-exchange exposure and GDPR compliance costs or revenue effects.