Tucows Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Unless noted, financial amounts are U.S. dollars. Tucows provides mobile and fixed Internet access, domain registration, and related Internet services.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $79.0 million | $95.8 million | Down 18% |
| Gross profit / margin | $22.7 million / 28.7% | $22.6 million / 23.6% | Profit broadly flat; margin higher |
| Operating income | $5.0 million | $5.7 million | Down 12% |
| Net income / diluted EPS | $2.8 million / $0.26 | $3.7 million / $0.35 | Down 25% / 26% |
| Adjusted EBITDA (non-GAAP) | $9.4 million | $10.4 million | Down 9% |
| Operating cash flow | $9.0 million | $9.6 million | Down 6% |
| Capital expenditures | $10.4 million | $5.1 million | More than doubled |
The revenue comparison is significantly affected by a Q1 2018 bulk transfer of 2.65 million Namecheap domains, which accelerated recognition of $14.6 million in revenue and $14.5 million in related costs. Excluding that unusual prior-year item, the reported revenue decline is less pronounced; the filing does not present a single adjusted comparable revenue figure.
- Segments: Network Access Services revenue was $23.3 million, down 2%; Domain Services revenue was $55.7 million, down 23%. Domain revenue was affected by the prior-year transfer, erosion among non-core wholesale customers, and lower portfolio sales. Ting Internet and retail domain revenue grew.
- Liquidity: Cash was $11.0 million, versus $12.6 million at year-end. Current assets were $146.0 million and current liabilities $191.7 million; these include substantial prepaid domain costs and deferred customer revenue.
- Debt: Loan payable carrying value was $92.8 million ($93.5 million gross principal), up from $64.6 million at December 31, 2018. Interest expense was $1.0 million. The company reported compliance with its credit covenants.
- Deferred revenue: $159.4 million at quarter-end, including $12.5 million assumed in the Ascio acquisition; approximately 80% of domain-contract deferred revenue is expected to be recognized within 12 months.
Material changes and unusual items
- Tucows acquired Ascio Technologies, a domain registrar, on March 18 for approximately $29.5 million. The preliminary allocation included $19.7 million of goodwill and $14.6 million of definite-lived intangible assets. Ascio contributed $0.8 million of revenue and a $0.1 million loss after acquisition; purchase accounting remains preliminary.
- The company drew $32.9 million under its credit facility during the quarter, primarily to fund Ascio and fiber-network investment. The credit facility’s total availability is up to $140 million.
- Property and equipment additions were $10.4 million, primarily supporting Ting fiber expansion. Management expects fiber-network capital expenditures to increase significantly in fiscal 2019.
- Adoption of lease accounting standard ASC 842 resulted in recognition of operating lease right-of-use assets and liabilities; management said adoption did not materially affect earnings or cash flows.
- The $40 million share repurchase authorization announced in February 2019 had no repurchases in the quarter.
Outlook, commentary, and risks
The filing provides no quantified financial guidance. Management said operating cash flow should be adequate for working capital, capital expenditures, and loan repayments for at least the next 12 months, while noting that additional financing may be sought to support expansion, acquisitions, or other needs. Management expects domain registrations to increase over the long term but cautioned that customer migrations and other volatility may affect growth.
- Management attributed lower adjusted EBITDA mainly to weaker Ting Mobile and portfolio domain sales and a negative initial contribution from Ascio; eNom cost synergies partly offset the decline.
- Key risks include intense mobile and domain-services competition, subscriber churn, reliance on mobile network partners and vendors, fiber build-out execution and funding, foreign-exchange exposure, and acquisition integration.
- GDPR and evolving privacy rules may increase compliance costs or affect WHOIS-related revenue, and could create regulatory, contractual, litigation, or market-share risks.
- A 10% adverse foreign-exchange movement was estimated to reduce quarterly net income by about $0.9 million before hedging. A 1% adverse interest-rate change would increase annual interest expense by about $0.9 million at the reported debt balance.
- The company disclosed a tax-methodology administrative issue relating to prepaid registry fees. Management believes its position is more likely than not to be sustained; otherwise, taxes, interest, and penalties could result. Ordinary-course legal matters were not expected by management to have a material adverse effect.
Important facts for investors to verify
- How much of the revenue and earnings decline reflects the one-time Q1 2018 Namecheap acceleration versus underlying customer and product trends.
- Ascio’s final purchase-price allocation, integration progress, and contribution to results after acquisition.
- The pace and returns of Ting fiber investment, planned 2019 capital expenditures, and funding needs under the debt covenants.
- Trends in Ting Mobile accounts and subscribers, wholesale domain customer retention, and domain portfolio monetization.
- Potential outcomes of the prepaid-registry-fee tax matter and the company’s foreign-exchange and variable-rate debt exposure.