Transcript
Welcome to Tucows’ Third Quarter 2020 Management Commentary. We have pre-recorded prepared remarks regarding the quarter and outlook for the Company. A transcript of these remarks is also available on the Company’s website. In lieu of a live question and answer period following the remarks, shareholders, analysts, and prospective investors are invited to submit their questions to Tucows’ management via email at [email protected], until Tuesday, November 10. Management will address your questions directly, or in a recorded audio response and transcript that will be posted to the Tucows website on Tuesday, November 17 at approximately 4 p.m. Eastern Time. We would also like to advise that the updated Tucows Quarterly KPI Summary, which provides key metrics for all of our businesses for the last seven quarters, as well as 2018, 2019, and year-to-date, is available in the Investors section of the website along with the updated Ting Build Scorecard and Investor Presentation. Please note that the KPI Summary has been modified to reflect our transition from a Mobile Virtual Network Operator to a Mobile Services Enabler. This means the mobile metrics that are no longer applicable to our business have been removed. Now for management’s prepared remarks. On Thursday, November 5, Tucows issued a news release reporting its financial results for the third quarter ending September 30, 2020. That news release, and the company’s financial statements are available on the company's website at tucows.com, under the Investors section. Please note that the following discussion may include forward-looking statements, which, as such, are subject to risks and uncertainties that could cause actual results to differ materially. These risk factors are described in detail in the company's documents filed with the SEC, specifically the most recent reports on the Forms 10-K and 10-Q. The company urges you to read its security filings for a full description of the risk factors applicable to its business. I would now like to turn the call over to Tucows’ President and Chief Executive Officer, Mr. Elliot Noss.
Thanks, Monica. Q3 2020 was another strong quarter of performance. I want to emphasize that our revenue and gross margin figures for the third quarter reflect our shift to a Mobile Services Enabler model from an MVNO model, alongside the sale of most of the Ting Mobile customer base to DISH Networks, which occurred a third of the way through the quarter. Dave will provide more details, but here’s a brief overview. The main issue is the compensation we received for the customer base. The money received from the earn-out on the sold customers is being recorded under Other Income, which appears below Operating Income as a gain on the sale of the Ting Mobile assets. This income will persist for well over five years. When we evaluated this transaction, we aimed to enhance the cash contribution to the overall business and took into account all amounts received in our analysis. We recognized it would complicate our reporting, but we trust our investors will follow along, and we prioritize cash generation. The amount in other income will approximate what the sold customers would have produced on a contribution basis and will decrease over time, roughly in line with churn. Consequently, as we move towards the MSE business, our reported revenue and gross margin results will be negatively affected, as all that revenue and a significant portion of the associated expenses are now included in other income. However, we are incorporating these earnings into our adjusted EBITDA results, which may offer a clearer year-over-year view of our operational results. For revenue and gross margin, the best way to assess our Q3 performance is by focusing solely on the Domains and Ting Internet businesses, excluding the impact of Mobile. Revenue from our Domains and Ting Internet operations for Q3 was $65.5 million, down 1% from $66.4 million in the same period last year. A notable increase from Ting Internet was offset by a decline in Domains; however, it’s worth noting that last year's Domains revenue included a $1.9 million bulk sale as we exited that business. If we exclude that bulk portfolio sale, revenue for Domains and Ting Internet was up 2% year-over-year. Gross margin for the Domains and Ting Internet businesses for Q3 remained roughly unchanged year on year at $21.8 million. However, excluding the bulk portfolio sale, year-over-year gross margin for Domains and Ting Internet rose by 10%, though net income reflects the net impacts of the mobile business transition. The year-over-year comparison was influenced by three main factors that I want to highlight. I've already mentioned the large portfolio sale in Q3 of last year, which contributed approximately $1.5 million after tax. Additionally, net income for Q3 2020 was impacted by a higher effective tax rate this year, which Dave will elaborate on shortly. We also incurred a one-time, non-cash write-down of $3.5 million on the sale of Ting Mobile assets, included in other income. Excluding the write-down, net income was $3.4 million, or $0.33 per share, compared to $4.2 million, or $0.40 per share in Q3 of last year, both down 19%. Adjusted EBITDA for Q3 was $13.4 million, compared to $14.8 million. Cash flow from operations was $11.4 million, a slight increase from $11.2 million in Q3 last year, demonstrating the ability of the Domains and Mobile Services businesses to generate cash consistently for investing in the significant growth opportunity presented by Ting Internet. Looking at each of our distinct businesses, the Domains business had a solid quarter, benefiting from the ongoing digitization surge due to the pandemic. This acceleration is now decelerating. After adjusting for the $1.9 million bulk portfolio sale last year, gross margin for the Domains business grew by 5% year-over-year despite a 1% revenue decrease, as we continue to prioritize gross margin in this business. Including the large portfolio sale, gross margin fell by 5% alongside a 4% revenue decrease. Wholesale saw a year-over-year gross margin growth of 8%, with the Domain Services component rising 17%, mainly due to a 5% growth in total registrations, from 3.9 million to 4.1 million. We experienced a healthy quarter for new registrations, up 30%. We expect growth to slow down in the fourth quarter as new transaction activity decreases but still anticipate year-over-year increases not seen in the modern domain name era. Our wholesale renewal rate slightly increased to 79% in Q3, well above the industry average, highlighting the quality of our resellers and the strong attachment of their domains to real businesses. In Wholesale Domains’ Value Added Services, gross margin dollars declined by 10% year-over-year, mainly due to some one-time events and natural fluctuations in expiry stream revenue. Our Retail Domains channel also benefited from heightened transaction activity due to the pandemic. Total registrations increased by 6% year-over-year to 387,000, with new registrations rising by 20%. However, gross margin for the Retail channel was flat compared to Q3 of last year, due to deferred revenue accounting delaying the positive impact from higher transaction volumes, along with a decline in higher-priced Enom-related names, which now contribute slightly more than 10% of the Retail channel's gross margin. The Retail channel’s renewal rate remained solidly above the industry average at 82%, similar to Q2. In my August remarks on Q2, I discussed the advantages of the new domains infrastructure across all three businesses and how we’ve extracted common functional elements to develop transferable capabilities and institutional knowledge. At this point in the year, we are deep into budget planning for 2021. As we shift the platform from retail to MSE services, we plan to leverage some key structural and architectural work done on the Domains platform. We have reassigned a core team that worked on the new Domains platform’s essential functions to the DISH initiative to maximize that important work, where we believe it will yield significant short-term returns on investment. Regarding Ting Mobile, there isn’t much news to share currently. I will outline how I believe you should think about and monitor this business in the coming months, quarters, and years. The Mobile business will revolve around three key areas: the earn-out from the legacy subscriber base sold to DISH, the platform fees on the MSE platform, and the revenue and costs related to professional services, including transitional services. For now, there will also be a line called Retail, representing the small number of Verizon subscribers that remain with us. The legacy base, generating the earn-out, continues to churn at historically low rates since COVID. Things will pick up when Ting Mobile introduces new DISH-enabled pricing, which should be coming soon. We anticipate that thousands of legacy customers will take advantage of that pricing, which should help reduce our churn rate. The gross margin per subscriber will depend on how new pricing influences consumption. Based on our street tests, we believe it will stabilize within a comfortable range. Once we adjust to the new churn rate and monthly gross margin per subscriber on the legacy base, I expect the earn-out to be fairly predictable as it declines gradually over time. The small contribution you will see from transitional services in the first several quarters reflects the personnel that DISH is effectively contracting to maintain the retail business. This line resembles our previous mobile device sales in two ways. Firstly, revenue will closely follow expenses with a narrow margin. In other words, TSA revenue may appear more exciting than it actually is. Secondly, it does not correlate directly to the true health of the strategic mobile business, which will be driven by MSE platform revenue in the long term. Regarding the MSE fees, these will increase gradually in the upcoming quarters as we add new subscribers on Ting Mobile and will see significant growth once we complete the Boost migration in 2021. We are optimistic for substantial upside in 2022 and beyond as DISH expands its mobile business and we potentially invite more providers onto the platform. Presently, we have started our work earnestly to assist DISH with the Boost migration. After our first quarter operating under the new model, we are confident that Mobile’s contribution to the overall business will grow as anticipated. We expect this segment to show growth after the Boost migration, a welcome shift from the flat or declining performance we've had in recent years. For the upcoming period, the mobile section of our quarterly call will be smaller. As we have one customer, you can monitor their progress during their investor calls. We will keep you informed about the essential information to follow this business, but it will be easier to track for now. Moving on to Ting Internet, the third quarter further showcases our efforts to expand the business, achieving new highs in subscriber growth and CapEx spending. However, we view these as modest gains compared to our ongoing learning in building and operating more efficiently, as well as the foundational work for accelerated growth and the opportunities that lie ahead. We are even more optimistic about fiber Internet access, having been so prior to the pandemic, which has underscored the importance of high-capacity, symmetrical bandwidth. We strongly believe that the best is yet to come in this area. Our CapEx investment continues to rise, with $10.7 million spent in Q3, a 25% increase from Q3 last year. We passed 3,700 new addresses, 2,600 of which became serviceable, bringing our total to 50,500 serviceable addresses, a 48% increase from Q3 last year. A significant increase in serviceable addresses was driven by lighting central office facilities in Fuquay-Varina, North Carolina, in Q2, and Centennial, Colorado, in Q3. We plan to light more facilities in both North Carolina and Colorado in Q4, further expanding our serviceable addresses and fueling our subscriber growth. In Q3, we achieved our largest quarterly net subscriber increase of 1,200, raising our total to 13,700 subscribers. The demand for Ting fiber remains robust. The surge in demand for fiber due to the pandemic, combined with reduced installations in the initial COVID months, created a significant backlog of orders for us. We are diligently working through the backlog and enhancing our installation capacity, yet the backlog persists this quarter due to rising demand and orders. We view this as a positive challenge and are focused on adding resources and streamlining processes to address it. Increasing our build velocity is a key focus for our fiber business at this stage, given the growth trajectory of Ting fiber operations and the foundations we've established with people, platforms, and processes to support scale. However, there is also a pressing urgency, as we observe a compressed timeline for the generational shift from coax to fiber, accelerated by the nationwide demand for fiber-to-the-premises service due to the pandemic. As we plan for 2021, we aim to significantly boost our CapEx spending compared to 2020. Investors should anticipate our continued investment in fiber, news about new markets, and the evolution of our operations and products reflecting our commitment to ramping up this business. We will enter new markets that provide year-round build velocity to complement our seasonal builds in Colorado and Idaho, as well as explore new methods for faster build and installation. One innovation is microtrenching, which has been widely used in Europe and has been utilized in North America for about a decade. We can now find experts with solid track records who use best practices in this area. This new deployment technique for Ting offers a cost-effective and significantly faster alternative to traditional underground drilling and boring, and helps us navigate cities and areas with restricted access to public right-of-way, a challenge we've faced in older communities. Expect to see us utilize microtrenching more extensively in 2021. Another goal for 2021 is to offer a comprehensive product lineup to business, institutional, and residential customers. Having been in this business for five years, expanding our offerings aligns with our natural growth trajectory. This will create additional revenue streams, focusing more on increasing take rates by filling gaps in our product offerings. We are already experiencing rising demand for our new products, such as TV streaming boxes and Mesh WiFi extenders for residential customers. Our private infrastructure partner SiFi Networks, deploying in Fullerton, California, began lighting its network at the end of Q2, with Ting’s first customers coming online in early July. Our infrastructure partner, Netly Fiber, active in Solana Beach, California, completed its first phase of passed addresses at the end of Q2, and we began lighting our first customers in August. We are now working to fulfill installation of pre-orders in serviceable areas in both markets.
Thank you, Elliot. Since Elliot has already covered the financial details of the Mobile Services business at the beginning, I won’t reiterate those points but will address them specifically in relation to the results. Please refer to our news release for an explanation of those details and their impact on our Q3 results. Total net revenue for the third quarter of 2020 was $74.3 million, which is a 16% decrease from $88.1 million in the same quarter last year. The primary reason for this decrease, as Elliot mentioned, was the sale of the Ting Mobile customer relationships on August 1st. Additionally, the significant bulk domains sale in Q3 last year from our Portfolio business contributed to this decline, as we have exited that business. However, this decline was partially offset by strong growth in Ting Internet revenue, mainly due to the Cedar Acquisition in January of this year and the continued expansion of our Ting Internet services customer base. The cost of revenues before network costs decreased by 13% to $48.3 million from $55.8 million in Q3 last year, primarily due to the lower revenue. As a percentage of revenue, this cost rose slightly to 65% because the improved mix in our Domains business was counterbalanced by the shift in mobile revenues, including the addition of low-margin transition services to DISH. Gross margin before network costs for the third quarter fell by 20% to $26 million from $32.4 million, with this decline primarily linked to the sale of Ting Mobile assets and to a lesser extent, the significant portfolio sale in Q3 2019. It’s important to note that the margin generated by the mobile customers sold to DISH is now part of the earn-out recorded in other income. As a percentage of revenue, gross margin decreased to 35% from 37% in Q3 2019. Now moving on to the gross margin for Domain Services and Network Access. For Domain Services, the gross margin for the third quarter decreased by 5% to $18.9 million from $19.9 million in the same quarter last year. However, if we exclude the large bulk domains sale I mentioned earlier, gross margin increased by 5%. As a percentage of revenue, the gross margin for Domain Services remained the same as last year at 31%, but when excluding last year’s bulk sale, gross margin increased by 2% year-on-year. Within Domain Services, gross margin for the Wholesale Channel increased by 8% to $14.4 million from $13.3 million for the same quarter last year, due to year-over-year growth in the number of Domains managed and our sustained focus on managing for gross margin, especially with high-quality customers. The gross margin percentage for Wholesale rose to 28% from 25%. Retail Domain Services gross margin remained unchanged from last year at $4.4 million, holding steady at 50% as a percentage of revenue. Now, regarding Network Access, gross margin for the third quarter fell by 43% to $7.1 million from $12.5 million in the same quarter last year. The significant majority of that decrease is due to the loss of revenue and margin from the Ting Mobile customers sold to DISH in the last two months of the quarter. The gross margin for Mobile Services plummeted by 61% year-over-year to $4.1 million from $10.6 million as a result of the transition in that business from Retail Services for the first month of the quarter to our MSE model for the last two months. The prior year's comparative period was entirely Retail Services. However, we did generate $1.1 million in other income from the Gain on the Sale of Ting Customer Assets, representing the earn-out on that customer base minus a $3.5 million non-cash write-down of certain intangible assets from previous MVNO customer relationship acquisitions. For the Fiber Internet Services business, gross margin rose by 52% to $3 million from $2 million in Q3 last year, boosted by the contributions from Cedar Networks, acquired at the start of the year, along with continued growth in the Ting Internet subscriber base. As a percentage of revenue, the gross margin for Network Access increased to 53% from 51% last year, with Mobile Services dropping to 47% from 49%, and Fiber Internet Services declining to 64% from 68%. Year-to-date in 2020, the gross margin as a percentage of revenue for the fiber business stands at 62%. Now looking at costs, network expenses for Q3 2020 rose by 26% to $6 million from $4.8 million in the same period last year, primarily due to higher amortization from the continued expanding Fiber Services network and the incremental effects from the Cedar acquisition. Total operating expenses for Q3 2020 decreased by 2% to $18.6 million from $19 million in Q3 last year. This decrease reflects reduced costs associated with the Ting Mobile assets sold to DISH, such as customer service and fulfillment. Those costs are now included in the net earn-out within other income. Normalized for this impact, expenses increased by $1.4 million due to the following: excluding Cedar’s acquisition impact from January 1st this year, people costs increased by $1.8 million due to a larger workforce supporting business expansion, including Ting Internet expansion and the Ting MSE platform build, alongside $0.4 million from anticipated higher performance bonuses year-to-date compared to last year due to better business performance. These increases were balanced by a $0.2 million expense reduction from capitalizing development costs connected to our domains platform work. We began capitalizing the efforts associated with our new tools last year. Cedar-related expenses added $0.6 million for the quarter, mainly workforce-related. Marketing costs decreased by $0.2 million while travel and other discretionary expenses decreased by $0.4 million. Amortization of intangible assets fell by $0.2 million due to the write-down of Ting Mobile assets, countered by setting up intangible assets for Cedar customer relationships and network rights totaling $5.6 million this year. Last year also saw a loss from disposing of property & equipment for $0.1 million with no corresponding loss this year. As a percentage of revenue, total operating expenses rose to 25% from 22%, mainly owing to the decreased revenue in Q3 this year as a result of the sale of Ting Mobile customer relationships to DISH. Net income for the third quarter of 2020 was $0.7 million or $0.07 per share, compared to $4.2 million or $0.40 per share in the same quarter last year. Net income was affected by the non-cash write-down of certain assets related to the sale of the Ting Mobile customer relationships to DISH. Excluding the after-tax impact of the write-down, net income would have been $3.4 million or $0.33 per share, down 19% year-over-year. The main drivers of this decline, excluding the write-down, were the significant bulk domain name sale in the third quarter of 2019 and a higher estimated annual effective tax rate resulting from the geographic mix of our income. Adjusted EBITDA for the third quarter fell by 11% to $13.3 million from $14.8 million in the same quarter last year. Excluding the impact of last year's large bulk domain name sale, adjusted EBITDA actually increased by 3%. Turning to our balance sheet and cash flows, cash and cash equivalents at the end of Q3 2020 stood at $10.2 million, compared to $8.9 million at the end of Q2 this year and $12.0 million at the end of Q3 last year. During the third quarter, we generated $11.4 million in cash from operations, slightly up from $11.2 million in the same quarter last year. However, cash from operations was significantly offset by our investment of an additional $10.6 million in property and equipment, mainly for the Ting Internet buildout. We did not repurchase any stock during the quarter. Deferred revenue at the end of Q3 was $154 million, a slight decrease from $155 million at the end of Q2 this year, remaining flat compared to the end of Q3 last year. That completes my remarks, and I will now pass it back to Elliot.
Thanks, Dave. In the value investment community, the idea of an owner's manual resonates with many investors, and I consider these ongoing transcripts to be a similar resource. This quarter, there are a couple of important elements worth highlighting. First, I've discussed how we plan to track our mobile business moving forward, which has been a significant part of my opening remarks and will likely continue to be so. Second, we have expectations for Ting Fiber in the upcoming years. I previously mentioned that we now anticipate the majority of the transition from coax to fiber in the U.S. to occur over the next five to six years, rather than the 10-12 years we had initially expected. I've also pointed out multiple times that significant investment is flowing into this asset class globally, especially in the U.S. There are financial implications I want to clarify for you. The first is our intention to speed up an already ambitious plan to expand fiber deployment. We've seen a growing influx of capital in this space. In a yield-starved environment, established assets in a robust infrastructure sector like fiber-to-the-home are fetching very high valuations. Fiber operates like a utility but generates business-like returns. Currently, if one has the capability to build and manage these assets, they can achieve EBITDA multiples between four and five times, creating a strong incentive to expand as much as possible. We will continue to attract and invest in top-tier management talent in this area. This leads to a second point: as we ramp up our construction efforts, especially in new areas, it will momentarily weigh down our cash EBITDA. Meanwhile, we are observing solid growth in cash generation in the markets where we already operate. Essentially, we are pursuing two initiatives within the same business segment – developing assets that will yield significant EBITDA and managing already established assets that provide consistent returns and command high multiples. Our challenge will be to help you, the investor, grasp the relationship between these two facets. This entails enhancing our metrics for Fiber, including providing in-depth analyses at the city level. The third aspect I want to bring to your attention is that our status as a public company is quite unique in this space in the U.S. When we examine other leading management teams navigating the shift from coax to fiber, they are primarily backed by private equity or infrastructure funds, which allow them to focus on long-term capital gains rather than short-term quarterly results. We want to address this directly. We believe our investors predominantly think long-term, and so do we. We are confident about maintaining access to capital as we progress, since the combination of a capital-scarce environment, the surplus of available funding, and the allure of our sector offers ample opportunity without necessitating changes to our corporate structure. Nonetheless, we want our investors to recognize our distinct position in this context. The fourth factor in our growth is differentiating between the growth driven by our initiatives and the growth in direct operating expenses on a city level. We need to equip investors with more tools and information to assist in this understanding. To clarify, the fiber machine refers to the centralized costs essential for constructing and launching fiber assets. We expect these centralized costs to decrease relative to capital expenditures over time. In conclusion, there is a shared consensus among various stakeholders involved in the coax to fiber transition—be it infrastructure funds, private equity firms, bankers, consultants, or suppliers—that management talent is the most scarce resource, not capital or opportunities. We firmly believe that our management team is best positioned to tackle this challenge. We acknowledge the value of our extensive background in the ISP sector since the early days of dial-up, as this experience is crucial. While building fiber is vital initially, operating these assets is critical for the long haul. Additionally, we believe we are the only operator that develops and maintains our own software system, which gives us significant advantages in speed and customer experience, as well as cost efficiency. As we move into this next phase, we will require a bit more from our investors and will strive to provide them with the necessary tools to keep pace. We are confident that our investors are ready for this challenge, and we anticipate rewarding them significantly for their support. I look forward to receiving your written questions and discussing the topics that interest you in more depth. Please send your inquiries to [email protected] by November 10, and anticipate the posting of our recorded Q&A audio response and transcript on the Tucows website on Tuesday, November 17, around 4 p.m. Eastern Time.