Tucows Inc (TCX) 2003 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, welcome to the Tucows third quarter fiscal 2003 conference call. Please note that today's presentation will be archived for replay both by telephone and via the Internet beginning approximately one hour following completion of the call. To access the archived conference call by telephone, dial 416-695-5800, or 1-800-408-3053, and enter the pass code 149-3067. The telephone replay will be available until November 18, 2003, at midnight. To access the archived conference call via the Internet go to www.Tucows.com, and click on about Tucows and then on Investor Relations. I will now turn the call over to Joanna Beckett (ph), director of communications and investor relation, Tucows. This call is being recorded November 11, 2003. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for joining us today for Tucows's third quarter fiscal 2003 conference call. With me is Elliott Noss, Tucows's president and Chief Executive Officer and Michael Cooperman, Chief Financial Officer. Today, following market close, Tucows issued a news release reporting the company's earnings for fiscal 2003 ended September 30, 2003, the news release is available on our web site at www.Tucows.com, by clicking on about Tucows, investor relations and then on quarterly financials. Or you can contact me at 416-538-5442 or e-mail at IR@Tucows.com. And I will send it directly. If you would like to receive future news releases by e-mail again please contact me. Before we begin today, I would like to point out that the matters we will be discussing include forward-looking statements and as such are subjected to risks and uncertainties that could cause actual results to differ materially. These risk factors are described in detail in our documents filed with the SEC. Specifically, the most recent reports on form 10-K, and 10-Q. We urge to you read our securities filings for full description of the risk factors applicable to our business. I would like now to turn the call over to Elliott.

Thank you, Joanna. Good afternoon, and thank you once again for joining us today. For today's call, I'll begin with a review of the highlights for the third quarter of fiscal 2003, Michael will discuss the financial results in greater detail, and I will return to discuss the outlook for the remainder of 2003 and beyond. So first, with the Q3 ‘03 highlights.

In the third quarter, Tucows's continued our trend of consistent, strong operational and financial performance. While we still are experiencing the aggressive pricing our focus on efficiency and productivity within our domain name registration business continues to deliver solid results. At the same time, we progress with the hard work of delivering additional services to our customers. The third quarter was highlighted by the following. A 14% increase in domain name registration transactions, compared to the third quarter of last year. Continued growth in our reseller base, year over year growth in quarterly revenue from continuing domain name and ancillary services of nearly 10%. Year over year growth in deferred revenue from continuing domain name and ancillary services of more than 13%, our eighth consecutive positive cash flow and fifth of profitability. Now for a little deeper look at some of these metrics. Total registrations, including new registrations, renewals, and transfers in, was 785,000, significantly higher than the corresponding quarter last year, and marginally higher than second quarter of this year. And I note that the third quarter, as we've discussed in the past, is typically the seasonal low in the domain registration business. I also note that our performance in this regard was very much in line with the market, despite our premium pricing. Domain names under management increased to more than 3.66 million, representing growth of over 300,000 names or 9% on a year over year basis. As we talked about in the past, two of our very largest customers had become accredited as registrars themselves. Their customer bases have for the most part finishing transferring out and as a result the drag caused by these transfers on our growth and names under management has now been removed. Our renewal rate for the quarter moved above the 60% mark for the first time. Marking our fifth consecutive quarter in improvement in this important area of our business. As we get closer and closer to our likely long-term levels of renewals I'm becoming more comfortable that the quality of our base will deliver a long-term renewal rate in excess of 60%. Average selling price declined for the second consecutive quarter following two years at a relatively constant level. We've seen continuation of two trends I talked about last quarter. First, customers pushing pricing pressure for low end retailers down the distribution chain towards us. And second, the start of a slow transition for Tucows, away from exclusively using unit-based pricing. More important than these affect, however, the downward pricing pressure in my opinion continues to reflect a lack of creativity in retailing of Internet services. And we really believe that over time as the retailing of Internet service is refined as an art, price will be less and less an important factor.

Both our reseller network and activity levels among those resellers continued to grow. The number of customers who did at least one transaction in the quarter increased by 11% versus the same quarter last year, and 2% compared to the preceding quarter. The number of customers who did at least 10 transactions was up more than 7% year over year and down marginally from the second quarter again we believe that the result of seasonality between the second and third quarters. We had pleasing customer wins in the quarter, as is our practice we won't mention any of these customers specifically. As the domain registration market continues to mature, it behaves like most other markets. In that competitors tend to take ever-narrowing vertical focus. And as a result, we are finding that we have increasing success at addressing competitive opportunities. We chose early on in this game to generally focus on ISP& web hosting companies that compete on service rather than price. We believe our performance in this market and the performance of our competitors in this market reinforces the wisdom of our initial decision. I think it's worth mentioning that in this environment of aggressive pricing, in none of the competitive situations for our major customer wins were we the low cost supplier. While pricing was below our historical levels it was the case as it always has been, that we've been able to win business as a premium to our competition and price consistent to that offered to current customers.

Turning to some of the additional services. Our digital certificates business continue to experience very good growth. The number of digital certificates sold in the third quarter was up almost 15% from the second quarter. And compared to the same quarter of last year, digital certificates were up more than 113%. The percentage of resellers offering our digital certificates to their customers has increased to 50% of our base. We think that this data speaks very powerfully to the willingness of our customers to adopt additional services that we offer. With respect to e-mail, while e-mail was trending upwards in terms of both the number of mailboxes sold during the quarter and the number of customers who have sold mailboxes, it is still not making a material contribution to our results. One of the things that we have learned with the launch of our e-mail service is that many of our customers while not interested in a full blown e-mail service are extremely interested in an outsourced Spam and e-mail defense service. Accordingly, we have introduced an e-mail defense service, including Spam protection, in which we have focused on three characteristics. First, in our internal testing, we placed a premium on finding a solution that created the lowest number of false positives. In fact, our testing showed the number of false positives to be significantly less than 1%. It is our belief that in any Spam solution, it is the number of false positives that tend to lead to the highest levels of customer frustration and accordingly, to the greatest customer service burden.

Second, we focused on ease of use. Spam solution need be for all intents and purposes painless to the end user. Third, we focused on ease of management. Any service, no matter how simplified, can be made more powerful with some level of end user involvement. We believe we've developed a management tool set and interface that maximizes simplicity without sacrificing power for end users. I wish to note that with respect to all of these points, and especially with respect to false positives, we experienced this firsthand in preparation for this conference call. A number of the invitation that is we e-mailed with respect to this call were trapped in other people's Spam filters. Of course, the people that didn't get the invitations were forced to call us and we were forced to engage in remedial steps. It very clearly caused a burden on both the user and the sender of the message. I would also like to note that in anticipation of integrating this service internally, we took down our internal Spam filters for a couple of months and experienced the current onslaught of Spam in its full glory. I can personally say that having gone from no filters for a couple months to our current Spam solution I found it to be extremely efficient and extremely effective. It's also worth noting that we have a higher level of initial interest around this service than we've experienced with any of the new service that is we've launched to date.

There is one other news service that I want to talk about. That we're currently offering in our news services evaluation program, a program for our customers' interested in trying out services under evaluation. We've built a service called BLOGWARE, and you can see this at BLOG.com. There are two points I want to make about this service. First, it is an essentially about site publishing. Second, the marketplace for web hosting and BLOG and BOLGING tools are separate. We feel any distinction between these are art if you feel and we intend to try to bridge that gap. While there's certainly much in the press about BLOG, and tools, and what they mean, what I would suggest is if it's site publishing tools are essentially moving the web away from being the broadcast medium it primarily is today, and turning it into more of a create and consume application much like e-mail. Perhaps the best example of this would be with respect to digital photography. We've built a service we believe provides users with easy to use yet powerful means to manage digital 47ry. You've heard me talk a couple years about digital photography as a growth for Internet services. It's still the case that the vast majority of digital photographs are sent around by e-mail. We hope BLOG will help change that practice and help move the web toward the create and consume application that it should be.

Now before turning the call over to Mike to review our financial highlights, I would like to spend a few minutes talking about the content side of our business. Which I haven't really discussed much on these conference calls for a number of quarters now. As a reminder, Tucows's original business was as a software down load site and we have always been and still are a leader in providing software for download on a shareware trial fare and free fare trial basis. We host more than 5 how's software applications and 30,000 downloadable titles tested, rated and reviewed by our software experts. This is provided through our international network of 500 partnership sites which provide their users with fast local down loads there are three things I'd like to point out with respect to our content the present time business. First, in September, we signed an agreement with America Online to provide an expanded selection of down loadable con at the present time for AOL members. Tucows is providing a syndicated XML feed that powers the new AOL download center in 9.0. This feed provides AOL members to access to library of software files as well as providing with the opportunity to both submit and rate software themselves. This agreement is an excellent example of the value in producing original content and the win-win economics that can result and we hope to follow on with other similar relationships. Second, for first time in four years, we plan on introducing a new library. Which we expect to broadly launch during the first quarter of next year, although we may provide some sneak peaks this quarter. This knew library will be you neck and will not be a typical Tucows software library. We do believe this relies significantly on our historical strengths. The ability to understand Internet users and their needs and most importantly, the ability to rate and review. We're very excited about this new content, and do expect to be able to generate revenue that is similar to what we do inside the software libraries.

Third, this month, we're officially launching our tenth anniversary celebrations. Throughout the course of the next 12 months we'll be engaging in various events primarily related to our customer relationships but with Internet users in general, that mark a decade of participation in and contribution to the Internet services industry. We've always felt that as the leading supplier of Internet services one of the central elements of our relationships with our customers is their ability to trust us, to identify us as reliable and efficient, and as a partner they can count on. We believe our longevity and proven execution are further proven by reaching this milestone. In an ever changing marketplace such as this, a tenth anniversary is something that we are very proud of. And I would now turn the call over to Mike.

Thanks, Elliott. As we anticipated, in the third quarter, the domain name registration market continued to experience a high level of price competition. Despite the challenging environment, our ongoing success in managing costs and maximizing productivity allowed to us continue our trend of consistent financial performance. Net revenue for the third quarter increased 5 cents to 9.3 million, from 8.9 million for third quarter of last year. Please note that net revenue for the third quarter of last year included 390,000 from our electric library subscription service which we sold partway through that quarter. Excluding this revenue, net revenue from continuing domain name and ancillary services for the quarter increased almost 10% compared to the prior year.

Advertising and other revenue for the third quarter increased compared to the same period last year, growing by 38% to just over 500,000. The increase was primarily attributable to higher revenue generated by our auto resource center over the quarter and coupled with modest increase from revenue of traditional online advertising. Gross margin for the quarter was 38%. Relatively unchanged from both the same quarter last year and the second quarter of this year.

Operating expenses for quarter were 3.5 million, down marginally from 3.6 million for both the third quarter of last year and the second quarter of this year. This small decrease was primarily the result of the gain on foreign exchange in the quarter, increasing by approximately 491,000, compared to the corresponding period of 2002, and primarily reflects the impact of the foreign exchange contracts that we purchased in June 2002 that expire in December of this year. The remaining forward contracts will result in the net gain on change in fair value of forward contract, recognized to date of approximately 316,000 being offset by charges against operations during this period.

Second, as a result of the disposition of both the electric library assets and our registry services business in 2002, approximately 246,000 in costs that were incurred in the third quarter of 2002 were not incurred in the third quarter of 2003. Third, depreciation costs for the recent quarter were approximately 90,000 lower than for the third quarter of last year, primarily as a result of older software now being fully depreciated. These cost reductions as a whole were offset by higher net cost related to payroll of approximately 373,000, and other expenses of approximately 104,000. Additionally, net state tax he can expenses for the recent quarter were approximately 229,000 higher due to a refund of approximately 197,000 received in the third quarter of last year. As a percentage of net revenue, operating expenses declined to 38% from 41% for the third quarter of last year, and 39% for the second quarter of this year. These results underline our continued success in improving operational efficiencies and in managing costs.

The Pair the third quarter marked fifth straight quarter of profitability with net income of 179,000 or less than 1 cent per share, compared to 596,000 or 1 cent per share for the corresponding quarter last year. In comparing net income for the two quarters, it's worth noting that net income from operations for the third quarter of this year, improved to slightly letter than break-even at 13,000, compared to a loss from operations of 150,000 in the corresponding quarter last year. Other income in the recent quarter, however, was approximately 588,000 lower than the same quarter last year. The recent quarter included the receipt of the final royalty payment of 128,000 in connection with the sale of our recommending industry services assets in 2002, whereas the third quarter last year included a much larger gain of 725,000 associated with the sale of our electric library subscription assets in August 2002.

Our balance sheet continued to strengthen during the quarter, primarily as a result of it being our eighth consecutive quarter of positive cash flow from operations. Cash and restricted cash at the end of the quarter increased to 12.1 million, from 11.5 million at the end of the second quarter. The increase was primarily the result of cash flow from operations for the quarter of 576,000. Our deferred revenue balance at the end of the third quarter increased by 13.4% to 27.5 million, from 24.2 million at the end of the third quarter of last year, and by 3.2%, 26.6 million at the end of the second quarter of this year.

In concluding my remarks, I would like to leave with you the following points. Our core domain name registration business continues to generate consistent steady results even in a very challenging market. Given the likelihood of continued aggressive price competition and absence of significant growth drivers in the domain registration market, we anticipate that these results for domains will remain relatively consistent over the short-term. Our ongoing focus in operating in a disciplined manner and ability to consistently generate cash employee from operations continues to strengthen our financial foundation. It is this foundation that support our ongoing investments in the development and launch of new service offerings as we leverage our business model to provide a broad range of interpret services, position r positioning ourselves for significant growth over the long-term and I'd now like to turn it over to Elliott.

Thanks, Mike. As I talked about in the last call, we're in a transition period. From a wholesaler of domain registrations to a wholesaler of Internet services. In fact, we have always described our business model as being predicated on providing a broad range of Internet services. During this period of transition, we expect to continue providing consistent results as Mike mentioned, from our wholesale domain registration business. However, without the significant growth we've demonstrated in the past. It is also the case during this period that we're invest to go leverage our brand, our business model and the strong relationships built on trust that we enjoy with our customers. As we've discussed, we expect to leverage these strengths to the development and launch of new services to our channel that will contribute to growth in both revenue and earnings over the long-term.

The point of these conference calls is primarily to try and help you, investors, understand our business and our strategy to the greatest degree possible. It's our responsibility as management to help to simplify your understanding of our business. Accordingly, I want to begin to share on these calls a metric that we've started to use internally to track our progress in this transition. That metric is the percentage of gross margin in our wholesale business, that comes from services other than domain names. To provide a bit of context, if we look at 2003, based on results to date and what we expect to achieve for the remainder of the year, the percentage of gross margin from wholesale services other than domain name registrations for this year, is likely to be just over 4%. On a quarterly basis, this metric is increased from just over 2% in the third quarter of 2002, to roughly 4.7% in the current quarter. We're not setting targets at this point. We just started tracking this number internally, and we've just started to understand what moves it and what doesn't. And, we're conscious of fact that that number will be dependent on the length of the sale cycle, the number of services that we introduce, and the match between our services and our customers' needs. As this is a metric that we believe is important for measuring our progress towards the goals that we've set for ourselves, we will be sharing it with you at these conference calls on a go-forward basis.

Now, there are probably a number of new folks on the call today, so I wanted to do a bit of a look back to allow for a better look forward. Over the last two years, we sold two revenue streams, liberty RMS, our registry service and the electric library subscription service. In both cases we sold because of strategic fit but in doing so we did forgo revenue. In 2003, I've talked on these calls about the release of four new services. An e-mail service, outsource DNS, Spam and e-mail defense, and BLOGWARE. In the next quarter I suspect we'll talk about one and perhaps two more new services. It's also the case over the last four quarters we've experienced nearly 20% increase in the Canadian dollar which has a direct impact on income from operations. Weave also experienced significant margin pressure in our core wholesale domain registration business. Despite all of this, we still grew revenue. Despite all of this, we increased the number of transactions we processed. Despite all of this, we significantly increased operating income. All of which in my view speaks to two efficiencies. The efficiency of our business model, which allows us to introduce new services in a real substantive way for a minimum of investment, and operating efficiencies which speaks to the quality and dedication of our people. We don't know, I don't know, exactly when we will see new services start to make a meaningful impact upon revenue or margin or income. And I would be pleasantly surprised if it was in the next quarter or two. But I do know that I have every confidence that we're doing the right things in the right space with the right people, and I believe the empirical data, the financial results, support that. And that is a combination I would bet on. With, that I'd like to open the call to questions. Operator?

Thank you, Mr. Noss. We will now take questions from the telephone lines. If you have any questions, please press star-1 on your telephone keypad. If you're using a speaker phone, please lift the handset and then press star-1. If at any time you wish to cancel your question, please press the pound sign. Please press star-1 at this time if you have a question. There lab brief pause while the participants register for their questions. Thank you for your patience. The first question is from jean Munster, please go ahead.

Hey, this is actually Scott Nicholas. A couple questions. I'm wondering, looking at the domain business in terms of -- new recommending stations year over year, could you provide some color on what the trends look like across some of the different TLDs, maybe comment TLD, and newer ones on the other side.

What we're seeing is pretty consistent performance across TLDs, in fact even a slight disappointing concentration in the older TLDs, come net. The only one jumped out a bit is ORG. Perhaps that's partly because of the new registry operator or perhaps that's because the historical base. You know, I don't know how much you've been following the recent ICANN meetings, but there was an announcement there that broadly speaking, a process will be launched to hopefully accelerate the adoption of new GTLDs in what sounds like a pretty aggressive way and you might start to see that early in 2005. Now, it's always been my view that the first round of new TLDs weren't necessarily executed upon as well as we would have liked them to. And, you know, we think what that's done is reinforced the com and net brands to date. Long-term we could start to see some of that change.

I'm intrigued by the new Spam defense and e-mail defense offering. I'm just wondering what, if you can give a bit of an overview of the technological approach you're use to counter Spam, if you're using your own technology or working with third parties and using a filtering approach or more of a multilayered strategy.

There's a couple there. We are working with a partner, a company called MX logic out of Denver. We went through a fairly rigorous RFP and internal testing process before selecting them. The one metric that jumped out for us where their solution was the extremely low number of false positives. Now, I think like any Spam vendor today, they're using a layered approach. I really believe that anybody who is trying to get at this problem with a single bullet is going to be in some problem over the midterm. These guys have a long history in the e-mail business, you know, most of the principals and founders over there come from one of the earliest outsourced e-mail companies that I'm aware of, and I've been looking at this stuff a long time. And you know, that's not something where we would want to -- we think it's a very, very deep narrow vertical, and it's a perfect example of a place where Partnering is the natural road for us.

Sure. It's fairly similar in many ways to policing e-mails for viruses. Are you working on those angles as well in terms of content.

Yeah, you'll see, we have -- we do have virus protection, you know, as part of what we're doing today. You know, as I think you're well aware, Scott, you know, there's been some to-ing and fro-ing, so I can't say it will be the term one, but there certainly will be anti-virus -- continue to be anti-virus protection along with what we're doing. The anti-virus market is a little bit less dynamic right now than the Spam market. It's also the case that in terms of both end users and in terms of our customers, the ISPs and web hosting companies, boy is Spam at the top of everyone's list right now.

Great, thank you guys very much.

Thank you, Scott.

. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Noss.

Thanks, to everybody for joining us and we'll speak to you again next quarter. Bye bye.