Tucows Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Unless stated otherwise, 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.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $69.6 million | $44.7 million | +55% |
| Gross profit / margin | $16.9 million / 24.4% | $14.3 million / 32.1% | Margin down |
| Operating income | $3.1 million | $6.3 million | -51% |
| Net income | $2.4 million | $4.4 million | -45% |
| Diluted EPS | $0.23 | $0.41 | Down |
| Adjusted EBITDA (non-GAAP) | $6.2 million | $7.3 million | -15% |
| Cash from operating activities | $2.4 million | $5.6 million | Down |
Revenue growth was principally acquisition-driven: Tucows acquired eNom on January 20, 2017. Domain Services generated $50.5 million of revenue and $9.2 million of gross profit; Network Access generated $19.1 million of revenue and $7.7 million of gross profit. Approximate gross margins were 18.3% and 40.4%, respectively. The consolidated gross margin decline reflects the acquired business mix and acquisition accounting, among other factors.
Ting had approximately 175,000 mobile subscribers and 280,000 devices under management at quarter-end, versus 141,000 subscribers and 221,000 devices a year earlier. Domain names under management totaled 29.6 million, versus 13.3 million, substantially reflecting eNom. Q1 domain registration transactions were 4.9 million, versus 2.4 million.
At March 31, cash was $15.0 million, total assets were $351.7 million, and total stockholders’ equity was $40.0 million. Loan payable was $90.5 million net of unamortized debt costs (approximately $75.4 million net debt after cash). Current assets of $160.8 million were below current liabilities of $185.7 million; these balances include substantial prepaid registry fees and deferred revenue associated with domain services. Deferred revenue was $165.9 million.
Material changes and unusual items
- On January 20, Tucows acquired eNom for preliminary consideration of $77.8 million; cash paid net of cash acquired was $76.2 million. The preliminary purchase allocation included $64.5 million of goodwill and $44.3 million of identifiable intangible assets. The allocation remained subject to final valuation and tax-related adjustments.
- The acquisition was primarily funded with an $84.5 million draw under a revised secured credit facility. Total facility capacity increased to $140 million; the facility has a four-year term and variable interest rates. Q1 interest expense was $0.9 million, versus $0.05 million a year earlier.
- Acquired eNom deferred revenue was recorded at fair value, approximately 10% below its historical cost basis, reducing recognized revenue and gross margins as related services were delivered. New acquired intangibles also increased Q1 amortization to $1.8 million from $0.07 million.
- Q1 income tax was a $0.1 million recovery, including approximately $1.0 million of excess share-based-compensation tax benefits under a newly adopted accounting standard. The prior-year comparative revenue and sales-and-marketing expense each include a $0.9 million classification correction; the correction did not affect operating income or net income.
- In February, Tucows acquired an additional 20% of Ting Virginia for $2.0 million. The remaining 10% interest has a put option exercisable in 2019, with a stated redemption value of $1.2 million.
Outlook, risks, and contingencies
- Management stated that operating cash flow should be adequate for working capital, capital expenditures, and loan repayments for at least the next 12 months. The filing provides no specific revenue or earnings guidance.
- Tucows expected substantially higher-than-normal Ting churn in Q2 2017: 18,500 RingPlus accounts migrated after that MVNO shut down, and Tucows offered each activated customer a $35 service credit. Management cautioned that many may leave after using the credit.
- Management cited intense mobile and registrar competition, potential customer churn, large registrar customers migrating to their own systems, and flat-to-declining trends in domain advertising and sales. Fiber expansion requires continued investment.
- Foreign-exchange exposure remains material because revenue is primarily in U.S. dollars while a major portion of expenses is in Canadian dollars. A modeled 10% adverse currency move was estimated to reduce quarterly net income by approximately $0.7 million. Tucows had $20.2 million of U.S.-dollar forward contracts outstanding.
- The amended credit agreement requires a maximum funded-debt-to-EBITDA ratio (tightening over time) and a minimum fixed-charge coverage ratio of 1.20:1. The company reported compliance at March 31, 2017. If year-end leverage exceeds 2.25:1, the agreement may require repayment of 50% of defined excess cash flow.
- Management did not expect ordinary-course legal claims, individually or collectively, to materially harm the company, while noting outcomes cannot be assured. Disclosure controls were assessed as effective, but eNom’s internal controls were excluded from the assessment while Tucows evaluates them.
Important facts for investors to verify
- How much of reported revenue and domain growth is attributable to eNom versus underlying organic performance, and whether integration produces the anticipated efficiencies.
- The final eNom purchase-price allocation, including goodwill, deferred tax balances, and the effect of fair-value deferred-revenue accounting on margins.
- Debt repayment schedule, interest-rate exposure, covenant headroom, and the cash needs of fiber expansion and the share-repurchase authorization.
- Whether RingPlus-related churn materialized and how Ting subscriber growth, retention, and service-credit costs developed after quarter-end.
- Domain customer migration, renewal trends, and the continuing performance of domain advertising and portfolio sales.
- The filing reports no Q1 purchases under the newly authorized $40 million buyback; investors should verify subsequent repurchases and share-count changes.