Quarterly Report (10-q)

 

1. Organization of the Company:

 

Tucows Inc. (referred to throughout this report as the “Company”, “Tucows”, “we”, “us” or through similar expressions) provides simple useful services that help people unlock the power of the Internet. The Company provides U.S. consumers and small businesses with mobile phone services nationally and high-speed fixed Internet access in selected towns. The Company is also a global distributor of Internet services, including domain name registration, digital certificates, and email. It provides these services primarily through a global Internet-based distribution network of Internet Service Providers, web hosting companies and other providers of Internet services to end-users.

 

2. Basis of presentation:

 

The accompanying unaudited interim consolidated balance sheets, and the related consolidated statements of operations and comprehensive income and cash flows reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair presentation of the financial position of Tucows and its subsidiaries as at June 30, 2019 and the results of operations and cash flows for the interim periods ended June 30, 2019 and 2018. The results of operations presented in this Quarterly Report on Form 10-Q are not necessarily indicative of the results of operations that may be expected for future periods.

 

The accompanying unaudited interim consolidated financial statements have been prepared by Tucows in accordance with the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in the Company's annual audited consolidated financial statements and accompanying notes have been condensed or omitted. Other than the exception noted below, these interim consolidated financial statements and accompanying notes follow the same accounting policies and methods of application used in the annual financial statements and should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2018 included in Tucows' 2018 Annual Report on Form 10-K filed with the SEC on March 5, 2019 (the “2018 Annual Report”). There have been no material changes to our significant accounting policies and estimates during the three and six months ended June 30, 2019 as compared to the significant accounting policies and estimates described in our 2018 Annual Report, except as described in Note 3 – Recent accounting pronouncements.

 

 

3. Recent accounting pronouncements:

 

Recent Accounting Pronouncements Adopted

 

ASU 2016 - 02: Adoption of Leases (Topic 842 )

 

 

The Company adopted ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”) as of January 1, 2019.

 

The Company has elected to apply ASU 2016-02 using the modified retrospective approach with the transition relief provided by ASC 2018-11, which allows the Company to use January 1, 2019 as the date of initial application. As a result, all comparative periods have not been restated and continue to be reported under Topic 840.

 

The Company elected the practical expedient to use hindsight when considering the likelihood that lessee options to extend or terminate a lease or purchase the underlying asset will be exercised, and in assessing the impairment of right-of-use assets.

 

The Company elected the practical expedient to separate non-lease components from the associated lease components for its existing datacenter, corporate offices and fiber-optic cable leases at transition.

 

As a result of adopting ASU 2016-02, the most significant effects were the recognition of a right-of-use (“ROU”) asset and lease liability related to operating leases of approximately $8.8 million and approximately $8.3 million, respectively at January 1, 2019. The difference between the ROU asset and lease liability of $0.5 million was due to the net reclassification of previously deferred rent and prepaid expenses of approximately $0.1 million and approximately $0.6 million, respectively to the ROU asset. There was no impact on opening retained earnings on adoption. The adoption of ASU 2016-02 did not have a significant impact on our consolidated statements of comprehensive income or our consolidated statements of cash flows.

 

ASU 2017 -12 : Derivatives and Hedging (Topic 8 15 )

 

In August 2017, the FASB issued ASU No. 2017-12,  Derivatives and Hedging (Topic  815 ): Targeted Improvements to Accounting for Hedging Activities  ("ASU 2017-12”), which better aligns an entity’s risk management activities and financial reporting for hedging relationship through changes to both the designation and measurement guidance for qualifying hedging relationships and presentation of hedge results. The new standard expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and hedged item in the financial statements. This ASU is effective for annual and interim reporting periods beginning after December 15, 2018. The Company adopted the targeted improvements to ASU 2017-12 in the first quarter of 2019 using a modified retrospective approach to existing hedging relationships. The new guidance did not have a material impact on our consolidated financial statements.

 

 

Recent Accounting Pronouncements Not Yet Adopted

 

In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (“ASU 2018-15”). ASU 2018-15 helps entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance on accounting for implementation costs when the cloud computing arrangement does not include a licence and is accounted for as a service contract. The amendments in ASU 2018-15 require an entity (customer) in a hosting arrangement to assess which implementation costs to capitalize vs expense as it relates to a service contract. The amendments also require the entity (customer) to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. ASU 2018-15 will be effective for the Company for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company is currently in the process of evaluating the quantitative impact of ASU 2018-15, and transition methods.

 

4. Other assets:

 

Other assets are comprised of the following:

 

Assets		June 30, 2019				December 31, 2018
Advance funding for July 16, 2019 acquisition of the mobile customer base from STS Media Inc., (note 19)		$	2,501			$	-
		$	2,501			$	-

 

 

5. Acquisitions:

 

(a)	Blue Ridge Websoft

 

On February 27, 2015, Ting Fiber, Inc., one of the Company’s wholly owned subsidiaries, acquired a 70% ownership interest in Ting Virginia, LLC and its subsidiaries, Blue Ridge Websoft, LLC (doing business as Blue Ridge Internet Works), Fiber Roads, LLC and Navigator Network Services, LLC for consideration of approximately $3.5 million.

 

On February 1, 2017, under the terms of a call option in the agreement, Ting Fiber, Inc. acquired an additional 20% interest in Ting Virginia, LLC from the selling shareholders (the “Minority Shareholders”) for consideration of $2.0 million.

 

On February 13, 2018, the Company entered into an agreement with the Minority Shareholders pursuant to which the Minority Shareholders could immediately exercise their put option to sell their remaining 10% ownership interest in Ting Virginia, LLC for $1.2 million to the Company.  The put option was exercised on February 13, 2018 and the Company paid $1.2 million for the remaining 10% ownership interest and Ting Virginia, LLC became a wholly-owned subsidiary of the Company. 

 

 

(b)

Ascio

 

On March 18, 2019, the Company entered into an Asset Purchase Agreement (the “Purchase Agreement”) with its indirect wholly owned subsidiary, Ting Fiber, Inc., and NetNames European Holdings ApS, CSC Administrative Services Limited UK, and Corporation Service Company (“CSC”), pursuant to which Ting Fiber, Inc. purchased from CSC all of the equity of Ascio Technologies, Inc. (“Ascio”), a domain registrar business, and all of CSC’s assets related to that business. The purchase price was $29.5 million, which represented the agreed upon purchase of $29.44 million plus an amount of $21,205 related to the estimated working capital deficiency acquired.

 

 

The Company has prepared a preliminary purchase price allocation of the assets acquired and the liabilities assumed of Ascio based on management’s best estimates of fair value. The final purchase price allocation may vary based on final appraisals, valuations and analyses of the fair value of the acquired assets and assumed liabilities. The preliminary purchase price allocation is pending the finalization of the fair value of deferred revenue and for potential working capital adjustments to assets and liabilities. We expect to finalize this determination on or before December 31, 2019.

 

Goodwill		$	20,039
Cash			1,437
Brand			2,020
Developed technology			2,420
Customer relationships			10,200
Prepaid domain registry fees			9,256
Other assets			2,192
Total assets			47,564
Deferred Revenue			(11,387	)
Deferred Tax Liabilities			(3,040	)
Other liabilities			(3,676	)
Total liabilities			(18,103	)
Preliminary consideration paid		$	29,461

 

As required by Accounting Standards Codification (“ASC”) 805, Business Combinations, the Company has recorded deferred revenue at fair value at the acquisition date, which was determined by estimating the costs associated with customer support services and prepaid domain name registration fees to fulfill the contractual obligations over the remaining life of the contract at the acquisition date plus a normal profit margin.

 

All definite life intangible assets acquired, including brand, developed technology and customer relationships will be amortized over 7 years.

 

The goodwill related to this acquisition is primarily attributable to synergies expected to arise from the acquisition and is not deductible for tax purposes.

 

In connection with this acquisition, the Company incurred total acquisition related costs of $0.5 million of which nil and $0.3 million were included in General & Administrative expenses in the consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2019, respectively.

 

The following table presents selected unaudited pro forma information for the Company assuming the acquisition of Ascio had occurred as of January 1, 2018. This pro forma information does not purport to represent what the Company’s actual results would have been if the acquisition had occurred as of the date indicated or what results would be for any future periods.

 

		Three months ended June 30,				Six months ended June 30,
Dollar amounts in thousands of U.S. Dollars		2018				2019				2018
Net revenues		$	85,952			$	167,787			$	186,998
Net income			2,974				5,496				6,133
Basic earnings per common share			0.28				0.52				0.58
Diluted earnings per common share		$	0.28			$	0.51			$	0.57

 

The amount of revenue recognized since the acquisition date included in the consolidated statements of operations and comprehensive income statement for the three and six months ended June 30, 2019 are $5.2 million and $6.0 million respectively.

 

The net income recognized since the acquisition date included in the consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2019 is a loss of $0.6 million and a loss of $0.7 million respectively.

 

 

6. Derivative instruments and hedging activities:

 

Foreign currency forward contracts

 

In October 2012, the Company entered into a hedging program with a Canadian chartered bank to limit the potential foreign exchange fluctuations incurred on its future cash flows related to a portion of payroll, rent, and payments to Canadian domain name registry suppliers that are denominated in Canadian dollars and are expected to be paid by its Canadian operating subsidiary. As part of its risk management strategy, the Company uses derivative instruments to hedge a portion of the foreign exchange risk associated with these costs. The Company does not use these forward contracts for trading or speculative purposes. These forward contracts typically mature between one and eighteen months.

 

 

The Company has designated certain of these transactions as cash flow hedges of forecasted transactions and foreign currency denominated liabilities under ASC Topic 815, Derivatives and Hedging (“ASC 815”). For certain contracts, as the critical terms of the hedging instrument and the entire hedged forecasted transaction are the same in accordance with ASC 815, the Company has been able to conclude that changes in fair value and cash flows attributable to the risk of being hedged are expected to completely offset at inception and on an ongoing basis. Unrealized gains or losses on these contracts have been included within other comprehensive income (“OCI”). The fair value of the contracts, as of June 30, 2019, is recorded as derivative instrument assets or liabilities. As a result of adopting the targeted improvements on January 1, 2019, for any existing contracts on the effective date of adoption and thereafter, the entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness will be recorded in OCI.

 

As of June 30, 2019, the notional amount of forward contracts that the Company held to sell U.S. dollars in exchange for Canadian dollars was $20.2 million, of which $18.6 million were designated as hedges. As of December 31, 2018, the notional amount of forward contracts that the Company held to sell U.S. dollars in exchange for Canadian dollars was $40.5 million, of which $36.5 million were designated as hedges.

 

Maturity date (Dollar amounts in thousands of U.S. dollars)		Notional amount of U.S. dollars				Weighted average exchange rate of U.S. dollars				Fair Value
July - September 2019		$	9,881			$	1.3136			$	48
October - December 2019			10,327				1.3174				92
		$	20,208			$	1.3156			$	140

  

Fair value of derivative instruments and effect of derivative instruments on financial performance  

 

The effect of these derivative instruments on our consolidated financial statements were as follows (amounts presented do not include any income tax effects).

 

Fair value of derivative instruments in the consolidated balance sheets

 

Derivatives (Dollar amounts in thousands of U.S. dollars)	Balance Sheet Location		As of June 30, 2019 Fair Value Asset				As of December 31, 2018 Fair Value Liability
Foreign Currency forward contracts designated as cash flow hedges (net)	Derivative instruments		$	158			$	(1,069	)
Foreign Currency forward contracts not designated as cash flow hedges (net)	Derivative instruments			(18	)			(207	)
Total foreign currency forward contracts (net)	Derivative instruments		$	140			$	(1,276	)

 

Movement in accumulated other comprehensive income (“AOCI”) balance for the three months ended June 30, 2019 (Dollar amounts in thousands of U.S. dollars):

 

		Gains and losses on cash flow hedges				Tax impact				Total AOCI
Opening AOCI balance - March 31, 2019		$	(264	)		$	64			$	(200	)
Other comprehensive income (loss) before reclassifications			317				(77	)			240
Amount reclassified from AOCI			106				(26	)			80
Other comprehensive income (loss) for the three months ended June 30, 2019			423				(103	)			320
Ending AOCI Balance - June 30, 2019		$	159			$	(39	)		$	120

 

 Movement in AOCI balance for the six months ended June 30, 2019 (Dollar amounts in thousands of U.S. dollars) :

 

		Gains and losses on cash flow hedges				Tax impact				Total AOCI
Opening AOCI balance - December 31, 2018		$	(1,069	)		$	259			$	(810	)
Other comprehensive income (loss) before reclassifications			1,042				(253	)			789
Amount reclassified from AOCI			186				(45	)			141
Other comprehensive income (loss) for the six months ended June 30, 2019			1,228				(298	)			930
Ending AOCI Balance - June 30, 2019		$	159			$	(39	)		$	120

 

 

Effects of derivative instruments on income and OCI for the three months ended June 3 0 , 201 9 are as follows (Dollar amounts in thousands of U.S. dollars):

 

Derivatives in Cash Flow Hedging Relationship		Amount of Gain or (Loss) Recognized in OCI, net of tax, on Derivative			Location of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)		Amount of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)				Location of Gain or (Loss) Recognized in Income on Derivative (ineffective Portion and Amount Excluded from Effectiveness Testing)				Amount of Gain or (Loss) Recognized in Income on Derivative (ineffective Portion and Amount Excluded from Effectiveness Testing)
					Operating expenses		$	(91	)		$	-			$	-
Foreign currency forward contracts for the three months ended June 30, 2019		$	320		Cost of revenues		$	(15	)		$	-			$	-
					Operating expenses		$	(1	)		$	-			$	-
Foreign currency forward contracts for the three months ended June 30, 2018		$	(260	)	Cost of revenues		$	(16	)		$	-			$	-

 

Effects of derivative instruments on income and OCI for the six months ended June 3 0 , 2019 are as follows (Dollar amounts in thousands of U.S. dollars):

 

Derivatives in Cash Flow Hedging Relationship		Amount of Gain or (Loss) Recognized in OCI, net of tax, on Derivative			Location of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)		Amount of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)				Location of Gain or (Loss) Recognized in Income on Derivative (ineffective Portion and Amount Excluded from Effectiveness Testing)				Amount of Gain or (Loss) Recognized in Income on Derivative (ineffective Portion and Amount Excluded from Effectiveness Testing)
					Operating expenses		$	(154	)		$	-			$	-
Foreign currency forward contracts for the six months ended June 30, 2019		$	930		Cost of revenues		$	(32	)		$	-			$	-
					Operating expenses		$	(1	)		$	-			$	-
Foreign currency forward contracts for the six months ended June 30, 2018		$	(243	)	Cost of revenues		$	(16	)		$	-			$	-

 

 

In addition to the above, for those foreign currency forward contracts not designated as hedges, the Company recorded a loss on settlement of less than $0.1 million and a gain of $0.1 million for the change in fair value of outstanding contracts in the consolidated statement of operations and comprehensive income for the three months ended June 30, 2019. The Company recorded a loss on settlement of $0.1 million and a gain of $0.2 million for the change in fair value of outstanding contracts in the consolidated statement of operations and comprehensive income for the six months ended June 30, 2019 in the consolidated statement of operations and comprehensive income.

 

The Company recorded a loss on settlement of less than $0.1 million and a loss of less than $0.1 million for the change in fair value of outstanding contracts the three months ended June 30, 2018 in the consolidated statement of operations and comprehensive income. The Company recorded a loss on settlement of less than $0.1 million and a loss of than then $0.1 million for change in fair value of outstanding contracts for the six months ended June 30, 2018 in the consolidated statement of operations and comprehensive income.

 

7. Goodwill and Other Intangible Assets:

 

Goodwill

 

Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired and liabilities assumed in our acquisitions.

 

The Company's Goodwill balance is $110.1 million as of June 30, 2019 (December 31, 2018 – $90.1 million), up $20.0 million from December 31, 2018, as a result of the acquisition of Ascio (See Note 5 (b) – Acquisitions for more information). The Company's goodwill relates 98% ($108.0 million) to its Domain Services operating segment and 2% ($2.1 million) to its Network Access Services operating segment.

 

Goodwill is not amortized, but is subject to an annual test, or more frequently if impairment indicators are present.

 

 

Other Intangible Assets:

 

Intangible assets consist of acquired brand, technology, customer relationships, surname domain names, direct navigation domain names and network rights. The Company considers its intangible assets consisting of surname domain names and direct navigation domain names as indefinite life intangible assets. The Company has the exclusive right to these domain names as long as the annual renewal fees are paid to the applicable registry. Renewals occur routinely and at a nominal cost. The indefinite life intangible assets are not amortized but are subject to impairment assessments performed throughout the year. As part of the normal renewal evaluation process during the periods ended June 30, 2019 and June 30, 2018, the Company assessed that certain domain names that were originally acquired in the June 2006 acquisition of Mailbank.com Inc. that were up for renewal, should not be renewed.   

 

Intangible assets, comprising brand, technology, customer relationships and network rights are being amortized on a straight-line basis over periods of two to fifteen years.

 

A summary of acquired intangible assets for the three months ended June 30, 2019 is as follows (Dollar amounts in thousands of U.S. dollars) :

    

		Surname domain names				Direct navigation domain names				Brand				Customer relationships				Technology				Network rights				Total
Amortization period		indefinite life				indefinite life				7 years				3-7 years				2 - 7 years				15 years
Balances March 31, 2019		$	11,175			$	1,242			$	10,575			$	36,084			$	2,412			$	503			$	61,991
Acquisition of Ascio Technologies, Inc. (note 5 (b))			-				-				-				-				-				-				-
Acquisition of customer relationships			-				-				-				27				-				-				27
Additions to/(disposals from) domain portfolio, net			(2	)			-				-				-				-				-				(2	)
Amortization expense			-				-				(515	)			(1,736	)			(302	)			(12	)			(2,565	)
Balances June 30, 2019		$	11,173			$	1,242			$	10,060			$	34,375			$	2,110			$	491			$	59,451

 

A summary of acquired intangible assets for the six months ended June 30, 2019 is as follows (Dollar amounts in thousands of U.S. dollars) :

 

		Surname domain names				Direct navigation domain names				Brand				Customer relationships				Technology				Network rights				Total
Amortization period		indefinite life				indefinite life				7 years				4-7 years				2 years				15 years
Balances December 31, 2018			11,176				1,245				9,004				27,292				163				515				49,395
Acquisition of Ascio Technologies Inc. (note 5 (b))			-				-				2,020				10,200				2,420				-				14,640
Acquisition of customer relationships			-				-				-				27				-				-				27
Additions to/(disposals from) domain portfolio, net			(3	)			(3	)			-				-				-				-				(6	)
Amortization expense			-				-				(964	)			(3,144	)			(473	)			(24	)			(4,605	)
Balances June 30, 2019			11,173				1,242				10,060				34,375				2,110				491				59,451

 

The following table shows the estimated amortization expense in future periods, assuming no further additions to acquired intangible assets are made (Dollar amounts in thousands of U.S. dollars) :

 

 

As of June 30, 2019, the accumulated amortization for the definite life intangible assets was $29.2 million. As of December 31, 2018, the accumulated amortization for the definite life intangible assets was $24.5 million.

 

 

8. Loan payable:

 

Amended 2019 Credit Facility

 

On June 14, 2019, the Company and its wholly-owned subsidiaries, Tucows.com Co., Ting Fiber, Inc., Ting Inc., Tucows (Delaware) Inc. and Tucows (Emerald), LLC entered into an Amended and Restated Senior Secured Credit Agreement (the “Amended 2019 Credit Facility”) with Royal Bank (“RBC”), as administrative agent, and lenders party thereto (collectively with RBC, the “Lenders”) under which the Company has access to an aggregate of up to $240 million in funds, which consists of  a $180 million guaranteed credit facility and a $60 million accordion facility. The Amended 2019 Credit Facility replaced the Company’s 2017 Amended Credit Facility.  

 

 

In connection with the Amended 2019 Credit Facility, the Company incurred $0.3 million of fees paid to the Lenders and $0.2 million of legal fees related to the debt issuance.  Of these fees, $0.4 million are debt issuance costs, which have been reflected as a reduction to the carrying amount of the loan payable and will be amortized over the term of the credit facility agreement and $0.1 million have been recorded in General and administrative expenses.

 

The obligations of the Company under the Amended 2019 Credit Agreement are secured by a first priority lien on substantially all of the personal property and assets of the Company and has a four-year term. 

 

2017 Amended Credit Facility

 

Prior to entering into the Amended 2019 Credit Facility, the Company had entered into a secured Credit Agreement (as amended, the “2017 Amended Credit Facility”) on January 20, 2017 with Bank of Montreal (“BMO”), RBC and Bank of Nova Scotia (collectively, the “Previous Lenders”) under which the Company had access to an aggregate of up to $140 million in funds.

 

On March 18, 2019,   the Company entered into the Second Amendment to the 2017 Credit Facility to provide the Previous Lenders’ consent for the acquisition of Ascio (discussed in Note 5 (b) – Acquisitions), advance the acquisition funding and to reallocate borrowing limits between loan facilities. We incurred costs associated with the Second Amendment to the 2017 Credit Facility of $0.2 million, which were recorded as debt issuance costs. 

 

The obligations of the Company under the 2017 Amended Credit Facility were secured by a first priority lien on substantially all of the personal property and assets of the Company and had a four-year term. 

 

Credit Facility Terms

 

The Amended 2019 Credit Facility is revolving with interest only payments with no scheduled repayments during the term.

 

The Amended 2019 Credit Facility contains customary representations and warranties, affirmative and negative covenants, and events of default. The Amended 2019 Credit Facility requires that the Company to comply with the following financial covenants: (i) at all times, a Total Funded Debt to Adjusted EBITDA Ratio (as defined in the Amended 2019 Credit Agreement) of 3.50:1; and (ii) with respect to each fiscal quarter, an Interest Coverage Ratio (as defined in the Amended 2019 Credit Agreement) of not less than 3.00:1. Further, the Company’s maximum annual Capital Expenditures cannot exceed 110% of the forecasted capital expenditures of its annual business plan.   In addition, share repurchases require the Lenders’ consent if the Company’s Total Funded Debt to Adjusted EBITDA ratio exceeds 2.00:1.  As at and for the period ending June 30, 2019, the Company was in compliance with these covenants and as at and for the period ending June 30, 2018, the Company was in compliance with the covenants under the 2017 Amended Credit Facility.

 

Borrowings under the Amended 2019 Credit Facility will accrue interest and standby fees based on the Company’s Total Funded Debt to Adjusted EBITDA ratio and the availment type as follows:

  

 

		If Total Funded Debt to EBITDA is:
Availment type or fee		Less than 1.00				Greater than or equal to 1.00 and less than 2.00				Greater than or equal to 2.00 and less than 2.50				Greater than or equal to 2.50
Canadian dollar borrowings based on Canadian Dollar Offered Rate or U.S. dollar borrowings based on LIBOR (Margin)			1.50%				1.85%				2.35%				2.85%
Canadian borrowings based on Prime Rate or Canadian or U.S. dollar borrowings based on Base Rate (Margin)			0.25%				0.60%				1.10%				1.60%
Standby fees			0.30%				0.37%				0.47%				0.57%

 

The following table summarizes the Company’s borrowings under the Revolver under the Amended 2019 Credit Facility and the prior year borrowings under Facilities A - D of the 2017 Amended Credit Facility (Dollar amounts in thousands of U.S. dollars ) :

 

		June 30, 2019				December 31, 2018
Revolver			100,927
Facility A		$	-			$	1,000
Facility B			-				6,000
Facility C			-				3,232
Facility D			-				54,924
Less: unamortized debt discount and issuance costs			(1,026	)			(555	)
Total loan payable		$	99,901			$	64,601
Less: loan payable, current portion			-				(18,400	)
Loan payable, long-term portion		$	99,901			$	46,201

 

 

The following table summarizes our scheduled principal repayments as of June 30, 2019 (Dollar amounts in thousands of U.S. dollars):

 

Remainder of 2019		$	-
2020			-
2021			-
2022			-
2023			100,927
		$	100,927

 

 

Other Credit Facilit ies

 

Prior to the Company entering into the Amended 2019 Credit Facility and the 2017 Amended Credit Facility, the Company had credit agreements (collectively the “Prior Credit Facilities”) with BMO, which provided the Company with access to a treasury risk management facility and a credit card facility.  All remaining credit facilities under the Prior Credit Facilities have been terminated.

 

9. Income taxes

 

For the three months ended June 30, 2019, we recorded an income tax expense of $1.8 million on income before income taxes of $4.4 million, using an estimated effective tax rate for the fiscal year ending December 31, 2019 (“Fiscal 2019”) adjusted for certain minimum state taxes as well as the inclusion of a $0.4 million tax recovery related to ASU 2016-09, which requires all excess tax benefits and tax deficiencies related to employee share-based payments to be recognized through income tax expense. Comparatively, for the three months ended June 30, 2018, the Company recorded an income tax expense of $1.2 million on income before taxes of $4.8 million, using an estimated effective tax rate for the 2018 fiscal year and adjusted for the $0.2 million tax recovery impact related to ASU 2016-09.

 

For the six months ended June 30, 2019, we recorded an income tax expense of $3.1 million on income before income taxes of $8.5 million, using an estimated effective tax rate for the fiscal year ending December 31, 2019 (“Fiscal 2019”) adjusted for certain minimum state taxes as well as the inclusion of a $0.7 million tax recovery related to ASU 2016-09, which requires all excess tax benefits and tax deficiencies related to employee share-based payments to be recognized through income tax expense. Comparatively, for the three months ended June 30, 2018, the Company recorded an income tax expense of $2.4 million on income before taxes of $9.8 million, using an estimated effective tax rate for the 2018 fiscal year and adjusted for the $0.3 million tax recovery impact related to ASU 2016-09.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the years in which those temporary differences become deductible. Management considers projected future taxable income, uncertainties related to the industry in which the Company operates, and tax planning strategies in making this assessment.

 

The Company recognizes accrued interest and penalties related to income taxes in income tax expense. The Company did not have significant interest and penalties accrued at June 30, 2019 and December 31, 2018, respectively.

 

In Fiscal 2017, in connection with the eNom acquisition, we acquired deferred tax liabilities primarily composed of prepaid registry fees.  As a result, we aligned our tax methodology pertaining to the deductibility of prepaid registry fees for our other subsidiaries.  In Fiscal 2018, we determined that we were in technical violation with respect to the administrative application of the accounting method change relating to the deductibility of prepaid registry fees for these additional subsidiaries. Based on the Company’s examination of administrative practices and precedents by the IRS, we believe that on a more likely than not basis that our tax position will be sustained. If the position is not sustained, then the accounting method change would be deferred into the following taxation period and we may be subject to incremental taxes as well as interest and penalties.

 

 

 

10. Basic and diluted earnings per common share:

 

Basic earnings per common share has been calculated on the basis of net income for the period divided by the weighted average number of common shares outstanding during each year. Diluted earnings per share gives effect to all dilutive potential common shares outstanding at the end of the year assuming that they had been issued, converted or exercised at the later of the beginning of the year or their date of issuance. In computing diluted earnings per share, the treasury stock method is used to determine the number of shares assumed to be purchased from the conversion of common share equivalents or the proceeds of the exercise of options. 

 

The following table reconciles the numerators and denominators of the basic and diluted earnings per common share computation (Dollar amounts in thousands of U.S. dollars, except per share amounts):

 

		Three months ended June 30,								Six months ended June 30,
		2019				2018				2019				2018
Numerator for basic and diluted earnings per common share:
Net income for the period			2,616				3,608				5,415				7,352
Denominator for basic and diluted earnings per common share:
Basic weighted average number of common shares outstanding			10,657,124				10,597,228				10,646,045				10,592,994
Effect of outstanding stock options			182,881				205,779				191,411				204,023
Diluted weighted average number of shares outstanding			10,840,005				10,803,007				10,837,456				10,797,017
Basic earnings per common share			0.25				0.34				0.51				0.69
Diluted earnings per common share			0.24				0.33				0.50				0.68

 

For the three months ended June 30, 2019, outstanding options to purchase 260,700 common shares were not included in the computation of diluted income per common share because all such options’ exercise price was greater than the average market price of the common shares for the period as compared to the three months ended June 30, 2018, where 419,000 outstanding options were not included in the computation.

 

For the six months ended June 30, 2019, outstanding options to purchase 260,700 common shares were not included in the computation of diluted income per common share because all such options’ exercise price was greater than the average market price of the common shares for the period as compared to the six months ended June 30, 2018, where 449,000 outstanding options were not included in the computation.

 

During the three and six months ended June 30, 2019, the Company did not repurchase any shares under the stock buyback program which commenced on February 13, 2019, and will be terminated on or before February 13, 2020.

 

During the six months ended June 30, 2019 the Company did not repurchase any shares under the stock buyback program commenced on February 14, 2018 and terminated on February 13, 2019.

 

During the three and six months ended June 30, 2018, the Company did not repurchase any shares under the stock buyback program commenced on February 14, 2018, which was terminated on February 13, 2019.

 

11. Revenue

 

Nature of goods and services

 

The following is a description of principal activities – separated by reportable segments – from which the Company generates its revenue. For more detailed information about reportable segments. See Note 14 – Segment reporting for more information.

 

(a)

Network Access Services

 

The Company generates Network Access Services revenues primarily through the provisioning of mobile services (“Ting Mobile”). Other sources of revenue include the provisioning of fixed high-speed Internet access (“Ting Internet”) as well as billing solutions to Internet Service Providers (“ISPs”).

 

Ting wireless usage contracts grant customers access to standard talk, text and data mobile services. Ting mobile contracts are billed based on the actual amount of monthly services utilized by each customer during their billing cycle and charged to customers on a postpaid basis. Voice minutes, text messages and megabytes of data are each billed separately based on a tiered pricing program. The Company recognizes revenue for Ting mobile usage based on the actual amount of monthly services utilized by each customer.

 

Ting Internet contracts provide customers Internet access at their home or business through the installation and use of our fiber optic network. Ting Internet contracts are generally prepaid and grant customers with unlimited bandwidth based on a fixed price per month basis. Because consideration is collected before the service period, revenue is initially deferred and recognized as the Company performs its obligation to provide Internet access. Though the Company does not consider the installation of fixed Internet access to be a distinct performance obligation, the fees related to installation are immaterial and therefore revenue is recognized as billed.

 

 

Both Ting Mobile and Ting Internet access services are primarily contracted through the Ting website, for one month at a time and contain no commitment to renew the contract following each customer’s monthly billing cycle. The Company’s billing cycle for all Ting Mobile and Ting Internet customers is computed based on the customer’s activation date. In order to recognize revenue as the Company satisfies its obligations, we compute the amount of revenues earned but not billed from the end of each billing cycle to the end of each reporting period. In addition, revenues associated with the sale of wireless devices and accessories and Internet hardware to subscribers are recognized when title and risk of loss is transferred to the subscriber and shipment has occurred. Incentive marketing credits given to customers are recorded as a reduction of revenue.

 

Our Roam Mobility brand also offers standard talk, text and data mobile services. Roam Mobility customers prepay for their usage through the Roam Mobility website. When prepayments are received the amount is deferred, and subsequently recognized as the Company satisfies its obligation to provide mobile services. In addition, revenues associated with the sale of SIM cards are recognized when title and risk of loss is transferred to the subscriber and shipment has occurred. Incentive marketing credits given to customers are recorded as a reduction of revenue.

 

In those cases, where payment is not received at the time of sale, revenue is not recognized at contract inception unless the collection of the related accounts receivable is reasonably assured. The Company records costs that reflect expected refunds, rebates and credit card charge-backs as a reduction of revenues at the time of the sale based on historical experiences and current expectations. 

 

(b)

Domain Services

   

Domain registration contracts, which can be purchased for terms of one to ten years, provide our resellers and retail registrant customers with the exclusive right to a personalized internet address from which to build an online presence. The Company enters into domain registration contracts in connection with each new, renewed and transferred-in domain registration. At the inception of the contract, the Company charges and collects the registration fee for the entire registration period. Though fees are collected upfront, revenue from domain registrations are recognized ratably over the registration period as domain registration contracts contain a ‘right to access’ license of IP, which is a distinct performance obligation measured over time. The registration period begins once the Company has confirmed that the requested domain name has been appropriately recorded in the registry under contractual performance standards.

 

Domain related value-added services like digital certifications, WHOIS privacy and hosted email provide our resellers and retail registrant customers tools and additional functionality to be used in conjunction with domain registrations. All domain related value-added services are considered distinct performance obligations which transfer the promised service to the customer over the contracted term. Fees charged to customers for domain related value-added services are collected at the inception of the contract, and revenue is recognized on a straight-line basis over the contracted term, consistent with the satisfaction of the performance obligations.

 

The Company is an ICANN accredited registrar. Thus, the Company is the primary obligor with our reseller and retail registrant customers and is responsible for the fulfillment of our registrar services to those parties. As a result, the Company reports revenue in the amount of the fees we receive directly from our reseller and retail registrant customers. Our reseller customers maintain the primary obligor relationship with their retail customers, establish pricing and retain credit risk to those customers. Accordingly, the Company does not recognize any revenue related to transactions between our reseller customers and their ultimate retail customers.

 

The Company also sells the rights to the Company’s portfolio domains or names acquired through the Company’s domain expiry stream. Revenue generated from sale of domain name contracts, containing a distinct performance obligation to transfer the domain name rights under the Company’s control, is generally recognized once the rights have been transferred and payment has been received in full.

 

Advertising revenue is derived through domain parking monetization, whereby the Company contracts with third-party Internet advertising publishers to direct web traffic from the Company’s domain expiry stream domains and Internet portfolio domains to advertising websites. Compensation from Internet advertising publishers is calculated variably on a cost-per-action basis based on the number of advertising links that have been visited in a given month. Given that the variable consideration is calculated and paid on a monthly basis, no estimation of variable consideration is required.

 

 

Disaggregation of Revenue

 

The following is a summary of the Company’s revenue earned from each significant revenue stream (Dollar amounts in thousands of U.S. dollars):

 

Revenue

 

		Three months ended June 30,								Six months ended June 30,
		2019				2018				2019				2018 (1)
Network Access Services:
Mobile Services		$	20,986			$	22,411			$	41,795			$	44,283
Other Services			2,644				1,895				5,087				3,631
Total Network Access Services			23,630				24,306				46,882				47,914
Domain Services
Wholesale
Domain Services			46,485				42,540				89,076				100,968
Value Added Services			4,775				4,601				8,959				9,035
Total Wholesale			51,260				47,141				98,035				110,003
Retail			8,783				8,477				17,425				16,913
Portfolio			444				1,163				728				2,052
Total Domain Services			60,487				56,781				116,188				128,968
		$	84,117			$	81,087			$	163,070			$	176,882

 

 

¹ As a result of the bulk transfer of 2.65 million domain names to Namecheap on January 5, 2018, recognized revenue for the six months ended June 30, 2018 includes $14.6 million related to previously deferred revenue for these names.

 

During the three and six months ended June 30, 2019, no customer accounted for more than 10% of total revenue. During the three months ended June 30, 2018, no customer accounted for more than 10% of total revenue. During the six months ended June 30, 2018, one customer accounted for 11% of revenue. As at June 30, 2019 and December 31, 2018, no customer accounted for more than 10% of accounts receivable.

 

The following is a summary of the Company’s cost of revenue from each significant revenue stream (Dollar amounts in thousands of U.S. dollars): 

 

Cost of Revenue

    

		Three months ended June 30,								Six months ended June 30,
		2019				2018 (1)				2019				2018 (1)
Network Access Services:
Mobile Services		$	10,806			$	11,978			$	21,549			$	23,243
Other Services			956				1,290				2,025				2,230
Total Network Access Services			11,762				13,268				23,574				25,473
Domain Services
Wholesale
Domain Services			37,817				35,844				72,656				87,161
Value Added Services			738				748				1,531				1,605
Total Wholesale			38,555				36,592				74,187				88,766
Retail			4,409				4,446				8,768				8,855
Portfolio			147				195				276				379
Total Domain Services			43,111				41,233				83,231				98,000
Network Expenses:
Network, other costs			2,385				2,701				4,780				5,275
Network, depreciation and amortization costs			2,352				1,727				4,327				3,357
			4,737				4,428				9,107				8,632
		$	59,610			$	58,929			$	115,912			$	132,105

  

¹ As a result of the bulk transfer of 2.65 million domain names to Namecheap on January 5th, 2018, recognized cost of sales for the six months ended June 30, 2018 includes $14.5 million related to prepaid costs for these names.

 

 

Contract Balances

 

The following table provides information about contract liabilities (deferred revenue) from contracts with customers. The Company accounts for contract assets and liabilities on a contract-by-contract basis, with each contract presented as either a net contract asset or a net contract liability accordingly.

 

Given that Company’s long-term contracts with customers are billed in advance of service, the Company’s contract liabilities relate to amounts recorded as deferred revenues. The Company does not have material streams of contracted revenue that have not been billed.

 

Deferred revenue primarily relates to the portion of the transaction price received in advance related to the unexpired term of domain name registrations and other domain related value-added services, on both a wholesale and retail basis, net of external commissions.

 

The opening balance of deferred revenue was $143.7 million as of January 1, 2019. Significant changes in deferred revenue were as follows (Dollar amounts in thousands of U.S. dollars):

 

 

Deferred Revenue

   

 

		Six months ended June 30, 2019
Balance, beginning of period		$	143,694
Acquired in a business combination 1			11,387
Deferred revenue			119,356
Recognized revenue			(117,218	)
Balance, end of period		$	157,219

 

1 The Company acquired Ascio on March 18, 2019. As part of the transition, the Company acquired active domain name contracts for terms ranging from 1 - 10 years, for which the registration fees have already been collected from customers. As required by ASC 805, Business Combinations, the Company has recorded deferred revenue at fair value at the acquisition date, which was determined by estimating the costs associated with customer support services and prepaid domain name registration fees to fulfill the contractual obligations over the remaining life of the contract at the acquisition date plus a normal profit margin.

 

 

Remaining Performance Obligations:

 

For mobile and internet access services, where the performance obligation is part of contracts that have an original expected duration of one year or less (typically one month), the Company has elected to apply a practical expedient to not disclose revenues expected to be recognized in the future related performance obligations that are unsatisfied (or partially unsatisfied) (Dollar amounts in thousands of US dollars).

 

Although domain registration contracts are deferred over the lives of the individual contracts, which can range from one to ten years, approximately 80 percent of our deferred revenue balance related to domain contracts is expected to be recognized within the next twelve months.

 

Deferred revenue related to Roam Mobility and Exact hosting contracts are also deferred over the lives of the individual contracts, which are expected to be fully recognized within the next twelve months.

 

 

 

12. Costs to obtain and fulfill a contract

 

Deferred costs of fulfillment

 

Deferred costs to fulfill contracts generally consist of domain registration costs which have been paid to a domain registry, and are capitalized as Prepaid domain name registry and ancillary services fees. These costs are deferred and amortized over the life of the domain which generally ranges from one to ten years. For the six months ended June 30, 2019, the Company capitalized $83.0 million and also amortized $82.9 million of contract costs, respectively. We also acquired $9.3 million of prepaid domain name registry and ancillary service fees in the Ascio acquisition, which took place on March 18, 2019. Amortization of contract fulfillment costs is primarily included in cost of revenue. The breakdown of the movement in the prepaid domain name registry and ancillary services fees balance for the six months ended June 30, 2019 is as follows (Dollar amounts in thousands of U.S. dollars).

 

Prepaid domain name registry and ancillary services fees

 

 

		Six months ended June 30, 2019
Balance, beginning of period		$	106,527
Acquired in a business combination 1			9,256
Capitalization of costs			82,980
Amortization of costs			(82,915	)
Balance, end of period		$	115,848

 

1 The Company acquired Ascio on March 18, 2019. As part of the transition, the Company acquired active domain name contracts with a terms ranging from 1 - 10 years, for which fees to suppliers were paid in advance.

 

 

13.  Leases

 

 

We lease datacenters, corporate offices and fiber-optic cables under operating leases. The Company does not have any leases classified as finance leases.

 

Our leases have remaining lease terms of 1 year to 19 years, some of which may include options to extend the leases for up to 5 years, and some of which may include options to terminate the leases within 1 year.

 

We have elected to consider leases with a term of 12 months or less as short-term, and as such have not been recognized on the balance sheet. We recognize lease expense for short-term leases on a straight-line basis over the lease term.

 

The Company elected the practical expedient to use hindsight when considering the likelihood that lessee options to extend or terminate a lease or purchase the underlying asset will be exercised, and in assessing the impairment of right-of-use assets.

 

As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of future payments.

 

For corporate offices, datacenter and fiber-optic cable leases, the Company has elected the practical expedient to combine lease and non-lease components.

 

 

The components of lease expense were as follows (Dollar amounts in thousands of U.S. dollars):

 

 

		Three months ended,				Six months ended,
		June 30, 2019				June 30, 2019
Operating Lease Cost (leases with a total term greater than 12 months)		$	826			$	1,897
Short-term Lease Cost (leases with a total term of 12 months or less)			279				403
Variable Lease Cost			193				364
Total Lease Cost		$	1,298			$	2,664

 

 

Lease Cost is presented in general and administrative expenses and network expenses within our consolidated statements of operations and comprehensive income.

 

 

Information related to leases was as follows (Dollar amounts in thousands of U.S. dollars):

 

		Three months ended,				Six months ended,
		June 30, 2019				June 30, 2019
Supplemental cashflow information:
Operating Lease - Operating Cash Flows (Fixed Payments)		$	834			$	1,885
Operating Lease - Operating Cash Flows (Liability Reduction)		$	703			$	1,651
New ROU Assets - Operating Leases		$	41			$	4,468

 

 

Supplemental balance sheet information related to leases:		June 30, 2019				(Transition) January 1, 2019
Weighted Average Discount Rate			5.26	%			5.04	%
Weighted Average Remaining Lease Term (in years)			8.62				5.62

 

 

Maturity of lease liability as of June 30, 2019 (Dollar amounts in thousands of U.S. dollars):

 

 

			June 30, 2019
Remaining of 2019		$	1,056
2020			1,873
2021			1,694
2022			1,621
2023			1,592
Thereafter			6,013
Total future lease payments			13,849
Less interest			2,871
Total		$	10,978

 

 

Operating lease payments include payments under the non-cancellable term and approximately $0.7 million related to options to extend lease terms that are reasonably certain of being exercised.

 

As of June 30, 2019, we have not entered into any additional leases that have not yet commenced.

 

In January 2019, the Company modified a corporate office lease to increase the term, leading to an increase to both the right of use operating lease asset and right of use operating lease liability of $3.9 million.

 

 

1 4 . Segment reporting:

 

(a)  We are organized and managed based on two operating segments which are differentiated primarily by their services, the markets they serve and the regulatory environments in which they operate and are described as follows:

 

1.      Network Access Services - This segment derives revenue from the sale of mobile phones, telephony services, high speed Internet access, billing solutions to individuals and small businesses primarily through the Ting website. Revenues are generated in the U.S.

 

2.      Domain Services – This segment includes wholesale and retail domain name registration services, value added services and portfolio services. The Company primarily earns revenues from the registration fees charged to resellers in connection with new, renewed and transferred domain name registrations; the sale of retail Internet domain name registration and email services to individuals and small businesses; and by making its portfolio of domain names available for sale or lease. Domain Services revenues are attributed to the country in which the contract originates, primarily Canada and the U.S.

 

The Chief Executive Officer (the “CEO”) is the chief operating decision maker and regularly reviews the operations and performance by segment. The CEO reviews gross profit as (a) a key measure of performance for each segment and (b) to make decisions about the allocation of resources. Sales and marketing expenses, technical operations and development expenses, general and administrative expenses, depreciation of property and equipment, amortization of intangibles assets, impairment of indefinite life intangible assets, gain on currency forward contracts and other expense net are organized along functional lines and are not included in the measurement of segment profitability. Total assets and total liabilities are centrally managed and are not reviewed at the segment level by the CEO. The Company follows the same accounting policies for the segments as those described in Notes 2 – Basis of presentation, 3 – Recent accounting pronouncements, and 11 - Revenue.

 

 

Information by operating segments (with the exception of disaggregated revenue, which is discussed in Note 11 - Revenue), which is regularly reported to the CEO is as follows (Dollar amounts in thousands of U.S. dollars):

 

 

Three months ended June 30, 2019		Network Access Services				Domain Services				Consolidated Totals
Net Revenues		$	23,630			$	60,487			$	84,117
Cost of revenues
Cost of revenues			11,762				43,111				54,873
Network expenses			516				1,869				2,385
Depreciation of property and equipment			1,656				382				2,038
Amortization of intangible assets			12				302				314
Total cost of revenues			13,946				45,664				59,610
Gross Profit			9,684				14,823				24,507
Expenses:
Sales and marketing											8,856
Technical operations and development											2,752
General and administrative											4,796
Depreciation of property and equipment											134
Amortization of intangible assets											2,251
Loss (gain) on currency forward contracts											(31	)
Income from operations											5,749
Other income (expenses), net											(1,314	)
Income before provisions for income taxes										$	4,435

 

 

Three months ended June 30, 2018		Network Access Services				Domain Services				Consolidated Totals
Net Revenues		$	24,306			$	56,781			$	81,087
Cost of revenues
Cost of revenues			13,268				41,233				54,501
Network expenses			640				2,061				2,701
Depreciation of property and equipment			903				325				1,228
Amortization of intangible assets			11				488				499
Total cost of revenues			14,822				44,107				58,929
Gross Profit			9,484				12,674				22,158
Expenses:
Sales and marketing											7,852
Technical operations and development											2,355
General and administrative											4,256
Depreciation of property and equipment											102
Amortization of intangible assets											1,827
Loss (gain) on currency forward contracts											52
Income from operations											5,714
Other income (expenses), net											(878	)
Income before provisions for income taxes										$	4,836

 

 

Six months ended June 30, 2019		Network Access Services				Domain Services				Consolidated Totals
Net Revenues		$	46,882			$	116,188			$	163,070
Cost of revenues
Cost of revenues			23,574				83,231				106,805
Network expenses			1,038				3,742				4,780
Depreciation of property and equipment			3,109				730				3,839
Amortization of intangible assets			23				465				488
Total cost of revenues			27,744				88,168				115,912
Gross Profit			19,138				28,020				47,158
Expenses:
Sales and marketing