Tucows Inc (TCX) 2009 Q1 法說會逐字稿

Welcome to Tucows Inc. Q1 2009 conference call. This conference call is being recorded. I'll now turn the call over to [James McNally]. Please go ahead, James.

Thank you, operator. Good afternoon, and thank you for joining us today. With me is Elliott Noss, our President and Chief Executive Officer, and Mike Cooperman, our Chief Financial Officer. Earlier this afternoon, Tucows issued a news release reporting our results for the first quarter of 2009. The news release and financial statements are available on our web site.

Please visit Tucowsinc.com and click on investors. Before we begin today, I would like to point out the matters include forward-looking statements and as such, are subject 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 form 10-Q. We urge you to read our securities filings for a full description of the risk factors applicable to our business.

I would now like to turn the call over to Elliott. Elliott?

Thank you, James. Good afternoon and thanks for joining us today. For today's call, I'll begin with an overview of our performance and some of the highlights for the first quarter of 2009. Mike will then provide a detailed review of our financial results for the quarter, and I'll close the call with a discussion of two components of our business that I haven't talked about much recently, to give you a better understanding of how they fit into our overall strategy.

First, the financial review. The first quarter was a solid quarter financially. Revenue came in at over $20 million, up more than 7% from the first quarter of last year. Net income was just shy of $1 million, compared with a loss of $1.1 million for the first quarter of 2008. And we generated cash flow from operations in excess of $900,000, compared with just over $100,000 for the same quarter last year. We would now like to review each of our businesses from an operational perspective.

First, the OpenSRS domain service. The momentum we saw at the end of 2008 carried into the first quarter of this year. On our last call, we talked about the strong growth in new registrations, and early indications were that the first quarter looked even better. That early performance continued through February and March, and I'm very pleased to report that the first quarter of 2009 was our best quarter for new registrations since the second quarter of 2000, which was the first full quarter after the launch of OpenSRS and just months after the end of the network solutions monopoly.

On a year-over-year basis, new registrations were up a healthy 21%. Renewals were also strong again this quarter, growing 16%. Strong growth and new registrations and above-average industry renews have alowwed our domains under management to increase by 7% from a year earlier to $7.9 million. It appears that our current competitive position is especially strong. While Verisign reported solid growth in domain registration this quarter, we experienced roughly double their growth in new registrations, and had a renewal rate that was a few points above what they reported as the industry average. Both of these competitive indicators look quite positive.

In addition, the pipeline for new resellers continues to look robust. We're improving our services at an increasing rate. Our focus on wholesale customers is paying off. I do, however, want to caution that entering the second quarter, we have started to see the first impact of the economic slowdown on domain registration, with a slight weakening in the momentum that we've seen the last few quarters. We've observed this across a broad range of our customers and confirmed this with checks with others in the market. This was also consistent with Verisign's comments on its Q1 conference call. We strongly feel that this is a macro-occurrence and not Tucows specific.

Turning to e-mail, our OpenSRS wholesale e-mail service continues to provide stable, low-cost, outsourced e-mail solutions for web hosts and ISPs. As discussed last quarter, e-mail is impacted by the economy much more than the main registration.

Unlike domain registration, the decision to outsource the e-mail to OpenSRS typically requires moving from customers doing it themselves and not surprisingly in this environment, our customers are reluctant to take on added costs. For most of these decisions, we believe it comes down more to when they'll be making the move to outsourcing rather than if they'll outsource at some point. Let me note here that our e-mail service is becoming more efficient. As we are now fully benefiting from the work we did last year to consolidate numerous legacy e-mail platforms to a single reliable system.

In addition, this quarter will include a significant upgrade to web mail with a much improved calendar, a shared calendaring system, RSSVs and significantly improved response times. The value proposition for our e-mail service continues to improve as both the service gets better and provisioning it becomes more efficient. Overall, we remain optimistic about our e-mail service, despite the reality that some perspective customers will be postponing the decision to outsource until they feel comfortable taking on additional expenses again. We feel e-mail will continue to become more and more strategic to our customers and the difficulties in providing a competitive service themselves will continue to increase.

Looking at our domain portfolio business, YummyNames, we continue to see success on all fronts. During the quarter, we completed a bulk sale of roughly 2500 names for nearly $1 million. Related to that sale, we also executed an arrangement with the buyer that should provide some regularity to this revenue stream over the next 12 to 18 months. In addition, we continue to focus on selling domains of high value to a targeted prospects base. Due to this ongoing focus on demand generation, we saw a significant increase in premium domain leads and sales. Even excluding the previously-mentioned bulk sale, domain name sales pretty much doubled over the last quarter.

Our switch to a new expired domain name auction partner during this quarter has also proven to be very successful in increasing revenue, with monthly auction revenue now in the mid to high-five figures. A solid increase.

The one challenging portion of the YummyNames business currently is the advertising revenue from direct navigation. It decreased to $447,000 for the quarter, down 29% compared to Q1 2008 and roughly 18% compared to Q4 2008. This reduction, the result of both weakness in advertising in general as well as reduced payouts by Google and Yahoo!, have been felt industrywide. Also, keep in mind that as we sell large portfolios of direct navigation domains, there will, of course, be a reduction in our parking revenue, offset by the revenue generated from the sale of the portfolio. YummyNames continues to be one of the most efficient parts of our operation with a very small team being able to generate high revenue per employee.

But YummyNames is just part of the story of increased efficiency within the business. If you look at the way we have performed, the metrics that you will see consistently trending upward are revenue per employee and billed gross margin per employee. We have achieved this while continuing to grow the number of customers we supply. We have the same number of employees today as we did four years ago. We have nearly twice the number of customers and nearly twice the number of domain names under management. In other words, we're continually driving efficiencies in the business.

I would now like to turn the call over to Mike to review our financial results in greater detail. Mike?

Thanks, Elliott. Net revenue for the first quarter of fiscal 2009 increased by 7% to $20.1 million from $18.7 million for the first quarter of fiscal 2008. Primarily as a result of higher contributions from traditional domain name registration services and portfolio services. Cost of revenues before net costs for the first quarter increased by 13% or $1.4 million to $12.6 million from $11.2 million. The increase was primarily the result of the impact of the registry price increase of 7% that was levied by some of our domain name suppliers last year.

I would remind you that ICANN has given the registries the right to levy two additional price increase up to 7% in two of the next four years. Net costs for the first quarter decreased by $1.2 million or 43% to $1.6 million compared to the first quarter of last year. Primarily the result of lower co-location costs stemming from the closure and relocation of our US -based colocation facilities following the successful completion of the e-mail migration at the end of last summer. The decrease is also the result of the restructuring we implemented last November, as well as a decline of 373,000 in network depreciation costs, again, primarily due to our retiring most of the older hardware used at our closed colocation facilities.

Gross margin for the first quarter increased to 29% from 25% for the corresponding quarter of last year. Essentially, as a result of the reduction in network costs that I mentioned a moment ago. The positive impact of this decrease in network costs was partially offset by the net decrease in the gross margin contribution from our various service categories that I will now discuss.

Gross margin from traditional domain registration services decreased slightly to $2.8 million from $2.9 million for the first quarter of fiscal 2008. As a percentage of domain registration revenue, gross margin decreased to 19.8% from 22.8%, essentially the result of a shift in the sales mix to higher volume, lower price customers from higher priced, lower volume customers. The actions we have been taking over the past few years to fortify our already strong competitive position in the traditional domain registration service market continued to have their intended effect, as we continue to achieve growth in new registrations and domain under management.

Gross margin from domain portfolio services increased to $1.7 million from $727,000 for the corresponding quarter of last year. And as a percentage of domain portfolio revenue, increased to 90% from 80%. This growth is primarily the result of an increase of $1.2 million in sales of names from our portfolio, which included a sale concluded in February for 2,500 names for an aggregate payment of $1 million. As Elliott mentioned, the sale agreement also entitles the buyer to purchase up to an additional 1.8 million of domain names from us at any time before June 2010 on terms similar to this sale.

The $1.2 million increase in portfolio and names sales was partially offset by a decrease of $200,000 in the revenue we earned from the delivery of third party advertisements on park pages and auction sales. The small decrease in gross margin from park pages reflects the generally slow market for advertising that most businesses are currently experiencing. Gross margin from e-mail services decreased to $942,000 from $1.5 million for the first quarter of last year. This decline is in line with our prior guidance and reflects two factors we have discussed on previous calls.

The first is the loss of the enterprise customers we acquired from critical parts that were considered not to be a strategic fit for us going forward. The second is the loss of three media portal companies for whom e-mail is only a small component of their overall service offerings, and who have chosen to include their e-mail services as part of larger supply contracts for competitive and cost control reasons. We had originally expected the remaining media portal company to have also migrated by the end of the first quarter of this year. This customer has, however, delayed their plans and will now only migrate later this year.

As a percentage of e-mail revenue, our gross margin percentage fell to 84% from 93%. The result of our incurring a one-time cost of $78,000 related to software enhancements that were acquired for the web mail service upgrades that Elliott discussed earlier. Gross margin from retail services decreased to $787,000 from $1.1 million for the first quarter of fiscal 2008. The decrease is primarily the result of the loss in the first quarter of this year of the contributions of our retail hosting assets following their sale last year.

Gross margin percentage for retail services fell from 61% from 66%. This decrease is due to the implementation of a more stream-lined pricing policy as we migrated our customers from our three retail brands onto the platform. Gross margin for other services declined marginally to $1.2 million from $1.3 million for the same quarter last year, and essentially reflects the generally slower market for advertising that I discussed a moment ago.

Total operating expenses for the first quarter decreased by just over $800,000 or almost 15% to $4.7 million or 23% of net revenue, from $5.5 million or 29% of net revenue for the first quarter of fiscal 2008. Core operating expenses, which we define as those expenses relating to ongoing sales, marketing, development and administrative costs, decreased on a dollar basis by $1.3 million to $3.5 million, from $4.9 million for the first quarter of last year. And as a percentage of revenue, to 18% from 26%. This lower expenditure level was primarily achieved through our focus on cost management as well as the reduction in head count that we announced in November of last year.

Other operating expenses increased by just over $.5 million to $1.2 million or 6% of net revenue, from $650,000 or 4% of net revenue for the first quarter of last year. The increase is primarily the result of the impact of foreign exchange. I will remind you that a substantial portion of our fixed expenses are incurred in Canadian dollars, and our policy is to attempt to mitigate exchange risk by buying foreign exchange contracts. During the first quarter of this year, we recognized the loss on our foreign exchange contracts of $660,000, inclusive of a mark to market gain of $85,000. This compares to a loss in foreign exchange in the first quarter of last year of $135,000 which was inclusive of a mark to market loss of $255,000.

Net income for the first quarter was $1 million or $.01 cent per share, compared to a net loss of $1.1 million or $0.01 per share for the first quarter of last year.

I will note that this quarter marks the first quarter that we have recorded a current tax expense. Prior to this year, the taxes we have been recording have primarily related to our estimate for federal alternative minimum tax obligations. The first quarter tax expense of $107,000 is based on the effective tax rate we expect to be in effect for the 2009 year after taking into account any remaining loss carry-forwards or credits we have.

Turning to our balance sheet, cash and cash equivalents at the end of the first quarter decreased by $1.4 million to $4 million from $5.4 million at the end of fiscal 2008. This decrease resulted from the investment of these funds, as well as the $913,000 we generated in cash flow from operating activities, a total of $2.3 million in two activities. $1.8 million for the repurchase of our shares. And $479,000 to pay down our credit line.

There are two other cash-related items that occurred subsequent to the end of the quarter I would like to highlight for you. First, in April, we received a payment of $2.1 million from Afilias in connection with their repurchase of our investment in their company. In addition, subsequent to having sufficient distributable reserves, Afilias will repurchase the remaining portion of our investment for approximately $2 million by December of this year. And second, pursuant to the terms of our credit facility agreement, we are required to make an annual cash sweep payment based on excess cash flow. For fiscal 2009, the cash sweep is $725,000. We made this payment on May 1 and after taking it into account, our loan balance has been reduced to $4.5 million.

Deferred revenue at the end of the first quarter was $56.7 million, up 5.7% from $53.6 million at the end of the first quarter of fiscal 2008, and up 4.5% from $54.2 million at the end of the fourth quarter of 2008.

To conclude, the first quarter was a solid quarter financially. Especially in light of the broader macroeconomic environment. We saw strong growth in our core business and experienced the benefits of the numerous steps we took to strengthen our business last year. I would now like to turn the call back to Elliott.

Thanks, Mike. I would like to spend some time today talking about the role Butterscotch and Hover play within the family of Tucows service offerings. In the past, I've talked at length about the OpenSRS wholesale business, and on the last number of calls, I've detailed the evolution of YummyNames into a significant part of Tucows. Those two do represent three-quarters of the business.

However, I've only briefly touched on Butterscotch and Hover. And because of that, we've had a lot of incoming questions from investors, both existing and prospective, asking us to explain what Butterscotch and Hover are, how they fit into the overall Tucows strategy and whether we're investing in them and if so, why and how much. First, it is important to remember that the launches of Butterscotch and Hover are about reinvigorating long-standing business units. Butterscotch has its roots in the Tucows Software libraries which date back to 1994. And Hover has evolved from Domain Direct which we launched in 1997. In both cases, for the last few years, these have generally been businesses with flat to slightly declining performance that we ran for efficiency. Neither was the strategic focus of the Company and it showed.

Invariably, the question in such situations is what do you do with the business? Do you milk it? Do you sell it? Or do you try to reposition for growth? We have been milking these businesses for many years. For each one, we evaluated our options and in both cases, we decided that there was more opportunity in continuing to operate the business than in divestiture. In making that decision, we relied heavily on our core purpose, making the Internet easier and more effective. For both businesses, we asked ourselves if they aligned with that core purpose. And in both cases, the answer was overwhelmingly yes.

Seeing the strategic fit, we looked at whether we could take a fresh approach to these businesses. Essentially, reinventing them for the 21st century. Then, could we do that in a way that did not require significant capital. I believe that we've been very successful in achieving these goals. Both businesses have now been repositioned for some growth instead of decline. And if you look at our trailing operating expenses, you won't notice the investment required to get there.

First, Butterscotch. As I've talked about in the past, when Tucows. com was at its peak, it wasn't because people loved downloading software. It was because people were using that software to solve a problem on the Internet. With Butterscotch, we've taken that theme of solving people's problems and moved it front and center on the site and in the business strategy. There was a revolution going on with video on the Internet. Internet video views climbed 26% in March alone. And video is a fantastic way to help people solve problems. Butterscotch is all about video that helps people use the Internet and technology. It is about making the Internet easier and more effective. Most importantly, what we're trying to do is to create very high quality video solutions to these problems, very inexpensively. We think we've been successful in this pursuit.

Look at Butterscotch.com. Only five months after launch, they're already more than 800 video tutorials and shows on the site. Much of this content is Evergreen. Content that will last beyond today's headlines and trending topics. And will continue to help people for months and years to come.

The early success of some of our tutorial series such as ten-part video series on getting the most from Facebook or Twitter have driven traffic to the site from zero to hundreds of thousands of video views per month in short order. But the primary means of driving traffic is exposing Tucows. com visitors to Butterscotch as effectively as possible. This makes the cost of audience acquisition negligible. Over time, Tucows. com and Butterscotch should blend into one. This is happening already.

If you looked at Butterscotch just three months ago and you looked at it again today, you would see deeper integration between the two sites. This will continue. While there is certainly a small amount of additional expense relative to operating just Tucows. com, in the mid five figures a month or so, we think we've been able to do this very efficiently. Even in the broader context of a very difficult advertising market and despite the fact that online video advertising is a nation's industry. We still believe that by the end of the year, the additional cost will be offset by the additional revenue generated by Butterscotch.

Turning now to Hover. As I mentioned, our retail operations started with the launch of Domain Direct 12 years ago. Since then, we've done two acquisitions that include retail customers as well as selling to smaller sets of web hosting customers. In Q1, we completed a long project to integrate these three brands, customer bases, systems and service offerings into one unified service, Hover.com. Well, the benefits of one platform and customer base are apparent.

I will discuss why selling the hosting portion of the business and giving Hover a very different look and feature set from other retail domain businesses makes strategic sense. We believe that most web hosting providers today offer virtually the same experience as they did ten years ago. And that too many companies are simply trying to move the customer up the stack. By which I mean, leading with a domain name sale and then layering on top as many additional services as possible.

We think that is an okay approach, but that it is overdone and it is not something we were interested in doing with our retail business. We believe that increasingly, people are getting more and more services from a wide variety of web sites, most of which are free. We all get a little bit of something from Google and some other things from Yahoo! and some other things from Microsoft, and a little bit from Amazon and Facebook and Twitter and eBay and our bank and our favorite retailer and our favorite community.

And the majority of small businesses web sites needs can and often are met by free or low-cost tools such as Google sites, Wordpress. com, Weebly or Yola. Or mash-ups of Google maps, Flicker photos, YouTube videos and others. But how does an individual or small business build a unified identity online when using all of these disparate tools? If you take a step back and think about domain names and e-mail addresses, and here I use e-mail addresses as separate from the e-mail service itself. What those things really do is help people locate resources on the Internet.

With this in mind, when developing Hover, we decided to strip those services down to their essentials. In other words, how could we provide a domain name and an e-mail address with a very high level of service and great tools that allow people to connect with all of these other services they were already using today. And that's why you see Hover the way it is.

We believe that Hover has the best URL forwarding service for your own domain name in the market today. And with our personal names portfolio, we, of course, have the best set of e-mail addresses in the world because there is nothing better than first name at last name.com, net or org. We know from our experience in the industry and from talking to countless wholesale customers over many years, that a significant portion, 40%, 50%, as much as 70% of the domain names registered don't get used. With the migrations complete, we are extremely focused on significantly increasing usage of existing services within the current customer base. We're doing this by letting all of these customers experience the true value of Hover through trial personal name accounts and introducing them to our URL forwarding tools.

That's a lot of time that I've now spent talking about two businesses that generate roughly a quarter of our contribution, but I believe it is important that you understand our thinking about these parts of the business. And I want to remind that OpenSRS is by far the largest part of the business representing the other three-quarters.

Before I open the call up to questions, I would like to recap the results of the modified Dutch tender auction that we completed during the first quarter of this year, and comment on two other announcements we made earlier today. Under the tender offer, which was announced February 12 and expired on March 13, shareholders have the opportunity to tender their shares at a price from $0.36 to $0.45. Upon completion of the offer, which I will note was over subscribed, we purchased nearly 4.2 million shares at a price of $0.41 per share for a total dollar investment on our part of approximately $1.7 million.

Continuing with our intention to create value for our shareholders, today we announced that we will commence a second Dutch tender offer on nearly identical terms to the first. We also announced earlier today that Rawleigh Ralls has been appointed to the Board of Directors at the Company. I would like to close by welcoming Rawleigh to the Board. I've known him for many years, and as the principal of the Lacuna Hedge Fund, Rawleigh also represents our largest shareholder. With the wealth of industry experience Rawleigh gained through his leadership of NetIdentity, as well as the prospective gains through two decades of investing in portfolio management experience, I think it will be a valuable addition to the Board.

And with that, I would like to open the call to questions. Operator?

(Operator Instructions). Your first question comes from Thanos Moschopoulos from BMO Capital Markets.

Elliott, to begin with, regarding your comments on the recession and the fact that you're starting to see an impact in your business, first of all, curious as to why we didn't see much of an impact in the last two quarters. And then how we should think about the magnitude of the potential impact going forward in your view.

Sure. So, as to why we didn't see it earlier, that I couldn't say. We started to see what I would call a slowdown in the growth we were seeing. I talked about the great growth in new registrations. We saw that slow down a bit. It wasn't growing as fast. And we immediately started to dig into both the numbers across all of our customers, check in across the industry and with the registries, and it was something that was out there. So it would be pure guesswork on my part.

I think that where we're holding that today and sort of what the impact will be to our business in particular, again, we would feel good about the way the business has been growing. We feel good about sort of how we're doing competitively. So, it is a little early to say what the impact will be, and we're hoping that kind of that internal growth will make up for any macro slowdown.

Okay. Should we think about maybe in this kind of climate, the ongoing price declines that you're seeing becoming maybe more aggressive. Or for the time being, do people seem to be holding on pricing in this current climate?

We're not seeing that manifest itself in price or in specific price conversations with customers. So again, it is conjecture. But it might be people letting just some extra names lapse. They might have registered a number of variations, ten variations and go down to five, that kind of thing. We're at the point where we're doing that extra second level of digging, and it is nothing -- again, we're still seeing that good growth, but it was enough that we wanted to note it. You would have heard a parallel comment on the Verisign call.

Right. Okay. On the premium domain business, you had the bulk sale. You mentioned that you have this agreement in place with the buyer. How should we think about names going forward? I guess within the parameters of the deal you sign, there is room for some variability there. Might it be fair to think about sort of a million dollar sale every quarter? Or at this point is that kind of an aggressive assumption to make?

That's a little aggressive. I think that we would hope that, at least in bulk sales in total, that we would try and get closer to where we were in 2007 rather than 2008 where that really fell off. And most importantly, we're trying to be a little bit more predictable with it.

Which I think is a good thing. Okay. And then on the Butterscotch side, you mentioned that your video views are up to several hundred thousand a month now at this point. Why isn't the revenue kicking in sooner? Is that just a function of the fact that you're maybe holding off on aggressively monetizing it at this point? Or how should we think about the revenue starting to contribute?

I think it is early days. First of all, video advertising, and I made brief reference to this in my comments, is really nascent. Whether you go from the very low end user generated content on YouTube right up through the classic TV translated onto the Internet in HULU, you'll see experimentation and real early days everywhere. And when you turn a couple few hundred thousand video views and you sort of convert that into CPMs, it is not huge money. So, it is not so much that it is lagging or we're delaying. It is more that the model is playing out and that it is early.

Okay. And then the OpEx side. We saw the benefit from the cost cutting initiatives in November. At this point, should we think about OpEx remaining fairly stable going forward? Or are there other initiatives underway that might lower that further?

We're pretty happy with where we are right now and we think we've got a real -- we feel more productive than we've ever been. So, what we're really thinking about is how much growth can we build on the existing cost base. That's the best way to think about it. That's the way we're thinking about it.

Okay, perfect. Thank you. I'll pass the line.

Thanks.

(Operator Instructions). We have no further questions at this time. Please continue.

Great. Thank you, very much, for joining us, and we look forward to speaking with you next quarter.

Ladies and gentlemen, this concludes the conference call for today.