Tucows Inc. (NASDAQ:TCX) Q3 2022 Earnings Call Transcript

Tucows Inc. (NASDAQ:TCX) Q3 2022 Earnings Call Transcript November 6, 2022

Monica Webb : Welcome to Tucows Third Quarter 2022 Management Commentary. We have prerecorded prepared remarks regarding the quarter and outlook for the company. A Tucows-generated transcript of these remarks with relevant links is also available on the company's website. In lieu of a live question-and-answer period following these remarks, shareholders, analysts and prospective investors are invited to submit questions to Tucows management via e-mail at ir@tucows.com until 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 November 22 at approximately 4:00 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 for full years 2020 and 2021 and also includes historical financial results is available in the Investors section of the website, along with the updated Ting Build Scorecard and investor presentation.

Now for management's prepared remarks. On Thursday, November 3, Tucows issued a news release reporting its financial results for the third quarter ended September 30, 2022. 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 for its business.

Finally, as discussed previously, starting in Q1 of this year, we started reporting as separate businesses, Ting, Wavelo and Tucows Domains, in addition to Tucows Corporate. For those that have not yet done so, I encourage you to watch the video we posted on the Tucows Investor site in February for additional detail and perspective on the rationale for this change. I would now like to turn the call over to Tucows President and Chief Executive Officer, Elliot Noss. Go ahead, Elliot.

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Elliot Noss : Thanks, Monica. Q3 was another solid quarter in a tough operating environment. The world is full of uncertainty. And in times like these, it is important to focus on what you can control. We continue to be grateful that focusing on cash generation is useful if undervalued in good times, but extremely important in times of uncertainty. Q3 was our third quarter managing the businesses under the new corporate structure. As we wrap up our 2023 budget cycle, we have learned important lessons, and we'll be able to refine TCX operations in order to better serve the operating businesses. The change in structure is a success, allowing us important financial flexibility without losing, in fact, in some ways, gaining operational efficiency.

In addition, I would like to reiterate our previously provided guidance. To the above point, we have now provided four points of guidance rather than just one and are pleased that this has not proven unduly difficult. A reminder that as part of changing our reporting by business segments, you will now hear directly from the heads of each business in these remarks as well as from our CFO, Dave Singh, who will cover our financial results in detail. The first speaker is Dave Woroch, Chief Executive Officer, Tucows Domains. Go ahead, Dave.

David Woroch : Thanks, Elliot. Tucows Domains had a relatively flat quarter year-over-year, as both the domain industry and our business continue to return to pre-pandemic levels. The boom of COVID has given way to an echo, but with a continued positive trend when looking over longer time frames. Revenue for Domain services for the third quarter was down 1% from the same quarter of last year, and gross margin was down 2%. Domain Services' adjusted EBITDA was down 9% from Q3 of last year. Here, I will note that the decrease in adjusted EBITDA is a result of both the lower gross margin as well as increased operating expenses and in line with how we have always endeavored to manage this business efficiently and especially now as we approach the anniversary of the new corporate structure, and in an inflationary environment, we are reviewing and streamlining expenses.

Building off my comments in the second quarter, total transactions for the business have continued at the lower pre-pandemic levels that we have discussed in previous quarters. As with many in our industry, we too see the broad-based economic and other challenges and the uncertainty of the global economy. Connected to this, the rapid appreciation from earlier this year in the value of the U.S. dollar has impacted our European business and introduced challenges. For many of our resellers in Europe, we price services in euros and have a cost base in U.S. dollars. The currency impacts from the U.S. dollar gaining strength against the euro has and continues to apply downward pressure to our gross margin. To address this, we have adjusted prices in Q3, and we have announced that we will do so again later this quarter.

Returning to the two segments of our business. In our Wholesale channel, revenue for Q3 was essentially unchanged year-over-year with gross margin down 2%. Within the Wholesale channel, Domain Services revenue was likewise unchanged from the same period last year, while gross margin was down 4%. Revenue for the value-added services component of the Wholesale channel was unchanged year-over-year with gross margin up 2%. Worth noting, the gross margin from Wholesale Domain Services is up 8% when compared to Q3 of 2019 and pre-COVID. In our Retail channel, revenue decreased 4% while gross margin decreased 1% year-over-year. And lastly, our combined overall renewal rate at 80% in Q3 across all Tucows Domains brands remains well above the industry average.

Since we founded the Tucows Domains business early in 2000, we've weathered different global and regional economic cycles and conditions by focusing on managing our business responsibly and with a long-term view. We provide access to domain and related services that have become integral to how consumers and businesses use the Internet for life and work today. We've defined innovation with continual evolution of our domain platform, and we've built a strong global distribution channel for our domain services. Today, in light of the last few years, I'm grateful we can stand on the foundation of such a resilient, consistent business and that we have the people and resources to always be thinking about how we leverage what we can do best to create growth opportunities for our business and our customers.

And I'm excited to tell you more about that beyond my comments in Q2 as it develops. Now over to Justin Reilly, CEO of Wavelo.

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Justin Reilly: Thanks, Dave, and hello TCX investors. I want to frame my comments today by reemphasizing some of my remarks from last quarter. We have now started the migration of Boost customers in earnest. As that process reaches scale, we expect to reach an inflection point in the business sometime around Q2 next year, where we are transitioning from one-off professional services revenues from DISH to ramping up a scalable, high-margin reoccurring revenue model based on subscribers from DISH and Ting. We're extremely excited about the growth trajectory of the business with our current customers and potential new ones. Now the financial report. Year-over-year, revenues and gross profit are up modestly, 5.3% and 2.9%, respectively.

Quarter-over-quarter is where we see the numbers look lumpy as expected, with revenue for Q3 at $4 million, a decline of 55% from Q2 and gross margin at $3.8 million, a decline of 52%. Revenue was down sequentially for two reasons. As we noted last quarter, we had an outsized revenue recognition in Q2 related to bundled professional services included as part of the platform services provided to DISH. This recognition occurs as an accounting treatment of some of the noncash terms in the DISH transaction. This lumpy revenue recognition was seen in Q1 as well. The second sequential revenue impact is from the partial reversal of a contract asset related to the noncash revenue recognition of certain fixed payment components. The contract asset and associated revenue recognition varies based on the estimated relative mix of variable and fixed payments.

And note that the contract asset will unwind over the term of the contract, which is up for renewal in Q3 2024. On the subscriber fee component of revenues, both Wavelo and DISH had hoped to have more Boost subscribers migrated at this point. As we noted above, the migration process is now underway. We are pleased that DISH has been putting new Boost customers on the platform for a while. As always, we recommend you review DISH's disclosures, including the mention in their Q2 remarks of the significance of the CDMA shutdown to their focus and progress. As a reminder from last time, the two most challenging parts of any new customer engagement are network integrations and customer migrations. We've completed three network integrations, T-Mobile, AT&T and DISH 5G in record time, highlighting the agility of Wavelo's platform.

This gives DISH an unparalleled advantage as they compete both in retail wireless and as the fourth MNO. In addition to network integrations, we've built world-class migration tools to help DISH migrate Boost subscribers. As with any hard endeavor, these are iterative exercises and we've recently completed finishing touches to help DISH migrate subscribers more seamlessly. These will be important tools for future Wavelo customers. We're seeing positive signs from DISH's announced plans around financing and build-out that bode well over the next three quarters. DISH has announced its intentions to introduce Boost Infinite, a postpaid offering with disruptive unlimited usage pricing expected over the next few quarters. Postpaid products are typically much stickier than prepaid, which the current Boost base is.

Additionally, DISH is on track to meet their June 2023 deadlines for their 5G deployment with 70% of the U.S. population coverage and 15,000 cell sites. We believe strongly in the compelling proposition from DISH of an extensive, high-quality cell coverage and flexible pricing and packages to attract and retain mobile customers, which in turn benefits Wavelo. There may be no more compelling case for Wavelo's platform than DISH's ability to launch prepaid and postpaid offerings inside of the same billing and provisioning system. This means launching new plans in hours, not months, regardless of when you'd like to bill a customer and regardless of which network provides the service. For those keeping score over the last 25 years of telecom, this has plagued operators as they attempt to adapt to an evolving market of competitors and consumers.

We're confident that Wavelo's flexibility will be a key enabler in helping DISH win in the coming years. Our adjusted EBITDA number for Q3 was negative $0.9 million, which reflects the burn at this point in the growth of the business as we staff up where needed to continue critical development work and round out our core leadership and support teams. And with respect to our burn, one reason the migration of Boost subscribers is important is that, once the majority of Boost customers are transitioned to the platform, those fees will fund most of our OpEx, and accordingly, we'll be investing in more sales and marketing. And for the rest of the year, we're continuing to focus on developing and launching new key features for our two anchor customers, DISH and Ting, and building our go-to-market machine.

Thanks for listening, and now over to Elliot.

Elliot Noss : Thanks, Justin. In Q3, Ting delivered another strong quarter of fiber construction, deploying close to the same record fiber footage as we did in Q2. The serviceable address number is dampened fairly significantly this quarter as we resolved a small issue in California that was administrative in nature that will push roughly 7,000 addresses into Q1 of 2023. Our Q3 fiber CapEx was again near $25 million at $23.7 million. This is up over 70% year-over-year as we continue accelerating our build. We added 2,300 net subscribers in Q3, taking us to 32,600 in total. That represents growth of nearly 8% from last quarter and 42.5% year-over-year. Our total for both Ting-owned and Ting-partner serviceable address additions was 4,800, taking us to 108,500 total serviceable addresses.

We expect those numbers to ramp in Q4 and into 2023 as some of the backlog referred to above comes online. We continue to have a strong pipeline of orders to installs as addresses become serviceable, including in our mature markets, despite increased competition and economic uncertainty. This reinforces our belief that people see Internet service as essential, and they view Ting to be superior to other options. In this regard, I note that our qualitative feedback from customers and our customer engagement scores continue to reinforce our belief that Ting customers truly are the most satisfied ISP customers in the United States. Starting in Q1, on Page 2 of the KPI summary, we provided new disclosure on mature versus growth markets. You may recall, I said these metrics would provide a view of how more mature markets grow as they load customers and generate powerful net margins.

I also noted in Q2 that these numbers were a little uneven on the bottom line as we still have plenty of new construction happening in North Carolina and Colorado, our two largest footprints. That being said, Q3 was strong. The mature market contribution for Q3 is $2.3 million, up 45% from Q2 and 25% year-over-year. More importantly, gross profit grew by 15% quarter-over-quarter and 141% year-over-year to $6.7 million. Ting's revenue grew 7% quarter-over-quarter and 71% year-over-year to $11 million. This will continue to tell a clean story on the top line and be a little more uneven on the bottom line as we continue to build in larger mature footprints. We continue to work on how to best let investors see operating leverage. We are using the 2023 budget process as a forcing mechanism and expect to have more on this next quarter.

For market updates, microtrenching continues in our markets in Culver City, California and Centennial, Colorado as well as our partner markets in California. We also started microtrenching in Alexandria, Virginia in Q3, and that work will accelerate in Q4 with our first customers expected there in early 2023. We've also completed a lot of fiber footage in our North Carolina footprint primarily connecting new greenfield areas. We're also excited for Colorado Springs to start their construction in Q4 of this year and look forward to Aurora, Colorado getting underway in 2023. I'm also pleased to report on our work related to the Ting Internet financing we announced last quarter with Generate Capital. We're actively engaged on strategic and operational fronts with their teams preparing for a busy 2023.

Generate's subsidiary, Ubiquity, has taken over managing our partner markets in Solana Beach and Encinitas, and we're seeing new momentum in completing the Encinitas build, creating a nice foothold in San Diego County. As we round the turn and head for home in 2022, it is worth noting that interest rates, labor costs, and most importantly, the increased expectation of fiber overbuilding have started to chip away at the incredible returns that the coax-to-fiber transition offers. The good news is that our focus on above-market take rates and profitability, and most importantly, our flexibility in providing ISP services on both our own as well as others' networks, has us in a relatively strong position. Focusing on execution plays to our strengths.

And now I'd like to turn the call over to Dave Singh for a deeper dive on our financial results.

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