Tucows Inc (TCX) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to Tucows Inc first quarter fiscal 2010 conference call. Earlier this afternoon Tucows issued a news release reporting its financial results for the first quarter of fiscal 2010. The news release and financial statements are available on the Company's website at tucowsinc.com under the investors heading. Please note that today's call is being broadcast live over the Internet and will be archived both for replay by telephone and via the Internet beginning approximately one hour following the completion of this call. Details on how to access the replays are available in today's news release reporting the first quarter financial results, as well as at Tucows' website.

Before we begin today, let me remind you that matters the Company will be discussing 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 the Company's documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q. The Company urges you to read its security filings for a full description of the risk factors applicable for its businesses. I would now like to turn the call over to Tucows' President and Chief Executive Officer, Mr Elliot Noss. Please go ahead, sir.

Thank you, operator. Good afternoon, and thanks for joining us today. With me is Michael Cooperman, Tucows' Chief Financial Officer. As per the usual format for our calls, I will begin with a brief overview of our financial performance and some of the operational highlights for the quarter. Mike will review our financial results in more detail, and I will return for some concluding comments before opening the call up to questions. First, an overview of the financial results.

Q1 marked another quarter of solid financial performance for Tucows with results that continue to demonstrate the consistency and reliability in our business. At a high level, revenue for the first quarter was $20.4 million, up about 2% from the first quarter of last year. I will note that this growth is despite the expected impact of the loss of revenue from email and direct navigation sales that we have discussed previously. Adjusted cash EBITDA for the first quarter was $2.3 million, and we once again generated positive cash flow from operations of $1.4 million.

Turning to some operating highlights with OpenSRS, I would now like to briefly review those highlights and starting with OpenSRS. The domain service is the foundation of the consistency and reliability in our business, and that was evidenced again in the first quarter of 2010. The domain service saw continued steady growth in transaction volumes. New registrations grew almost 12% compared to the fourth quarter of 2009 and 12% on a year-over-year basis, factoring out the special registry promotions in the first quarter of 2009. Renewals were up 24% from the fourth quarter and 11% on a year-over-year basis. I will note that with respect to the sequential growth, renewals tend to spike in the first quarter given that this was the quarter we first launched our domain registration service in 2000. Our renewal rate, already several points above the industry average, saw a small bump in the first quarter. The result of both the improved economic environment and improved retention in a specific segment of our customer base that we acquired several years ago.

Continued growth in our transaction volumes pushed the number of domains under management to more than 10 million. We're proud to say that we're one of only three domain registrars that have reached this milestone. It is a testament to our wholesale business model, as well as our strong competitive position. All of this contributed to year-over-year domain service revenue growth over 8%, and we have seen this momentum in growth continue in April. We are seeing more customers in the pipeline going live as we get better and more efficient at getting our resellers started with us. A number of these new customers are coming from markets outside of North America which are now consistently seeing higher growth. We have always talked about our global footprint and clearly that is having a positive impact. I also note that for the first time since the launch of the domain service in 2000 we're seeing consistency in gross margin.

As expected, email service revenue declined somewhat markedly compared to Q1 of last year, the result of the departure of the three large customers at various points throughout 2009 as discussed on previous calls. We have a good base to build from going forward. Our email service is now very solid and extremely strong relative to the competition. We are heads down around selling and looking to build our book of business from here. All of the trends that initially attracted us to email and made us think it was a strong strategic opportunity for Tucows are still present. And we are seeing the emergence of new opportunities as privacy and users control of their own information, things we strongly believe in, become more of a mainstream issue.

YummyNames, our domain portfolio group, had another solid quarter, highlighted by strong performance from individual name sales. The strong momentum in brandable names that we have discussed in prior quarters continued throughout Q1, the result of increased auction activity, as well as the increased exposure through our distribution agreements with NameMedia and Sedo. We have also increased our promotional efforts around Gems. These are the names in our portfolio with the highest value. We are seeing and will continue to see the transition in YummyNames revenue from bulk sales of direct navigation names to individual sales of brandables in Gems. We expect these growth areas inside of YummyNames to continue to contribute positively to the business. Overall, YummyNames is continuing to perform well.

Moving to Butterscotch, revenue was consistent year-over-year, and some of the work in the pipeline has us confident that we will see growth in the remainder of the year. All of the key traffic metrics for Butterscotch continue to trend in the right direction during Q1. Notably, page views were up 9% from the fourth quarter, site visits were up 13%, and video plays were up 23%. The number of videos available on Butterscotch at the end of Q1 increased to more than 2,500 from 2,000 at the end of Q4.

With Hover Q1 marked the first quarter of billings growth in some time and results through April have been equally encouraging. Clearly these simplified domain registration and management processes that we implemented last year are having an impact on this business. This was especially evident in our renewal rate, which was up 9% from the previous quarter. In addition, two recent changes make us even more excited going forward. Hover recently introduced no holds customer service, which means that Hover's customers will now have their support calls answered directly by a human being without having to deal with an annoying phone system. Unsurprisingly, customers have been delighted with this. In addition, we relaunched the home page of Hover and instituted a new sales process that has greatly increased conversions. All of which we believe will help us continue to grow from this new foundation.

In summary, the top line performance across each of the components of our business continues to demonstrate the consistency and reliability in our model. The cost side of the equation, however, is also a major contributor to our consistency and reliability. Over the past few years we have often discussed the considerable leverage in our business, our ability to scale revenue in the absence of a proportional increase in expenses, that leverage is readily apparent in a comparison of our operating margin over the last few years. In 2006 total cash operating expenses, including network costs, were 36%, over a third of billings. In 2009 that number was just 24%. A look at our head count underscores this point. As we have grown our billings by more than 15% over the last three years, we have reduced our average head count by about 17%, and I will note that we achieved this within the context of a 10% appreciation in the Canadian dollar over that period, as well as a general increase in the level of salaries as we have elevated the quality of our personnel.

My intention here is not to intimate that we will be cutting costs going forward. We have and will continue to effectively manage our cost structure, but where we really see opportunity on the expense side is in continuing to reap the rewards of the leverage in our business as we grow our revenue. I would now like to turn the call over to Mike to walk through our financial results in detail. Mike.

Thanks, Elliot. Net revenue for the first quarter of fiscal 2010 was $20.4 million, an increase of 2% from $20.1 million for the first quarter of last year. I will review the impact on the quarter of revenue for each of our services in my comments on gross margin contribution. Cost of revenues before natural costs for the quarter increased by $1.1 million or 8.7%, to $13.7 million from $12.6 million for the same quarter of last year. Network costs were down marginally compared to the first quarter of last year at $1.6 million. In assessing all of our operating costs including network costs, I think it important to bear in mind the significant strengthening of the Canadian dollar relative to the US dollar that we have seen over the past year or so. You will recall that the majority of our network and operating costs are in Canadian dollars. In fact, when compared to the first quarter last year, the Canadian dollar has appreciated on average by approximately 15%.

Gross margin for the first quarter of this year was 25%, down from 29% for the same quarter of last year, primarily the result of a shift in our sales mix from higher margin services to lower margin domain names. Gross margins from our OpenSRS service, which includes domain services, email services, and other wholesale services was $4 million or 20% of net sales, compared with $4.5 million or 22% of net sales for the first quarter of 2009. This decrease is primarily attributable to the expected loss of three media portal email customers that we have previously discussed, and to a lesser extent on the success we have been seeing from our strategy to grow revenue from higher volume, lower price customers as we continue to aggressively compete to attract new resellers and retain existing customers.

Gross margin from domain services on a dollar basis was essentially flat when compared to the first quarter of last year at $2.8 million. On a percentage basis gross margin from domain services fell to 18.1% from 20%, primarily due to the increase that registry price increases have had on our percentage gross margin, and to a lesser extent on the strategy to compete for higher volume, lower priced customers. As a reminder, our gross margin percentage will be further impacted by an additional 7% price increase that the VeriSign registry will implement on July 1 of this year.

Gross margin from email services decreased to $531,000 from $942,000 for the first quarter of last year, largely as a result of the expected loss of the three media portal customers. As our marketing efforts have not yet to date been successful in offsetting these customer losses, they continue to impact our email gross margin. With the last of these customers having completed their migration, we now look forward to building from our current base. As a percentage of revenue, gross margin for email services was relatively unchanged from the corresponding quarter of last year.

Gross margin for YummyNames decreased by $171,000 to $1.5 million, from $1.7 million for the same quarter of last year. This decrease essentially results from an impact our sales and non-strategic domain names has had on our inventory of domain names and the fact that we were able to sell the bulk of our backlog of non-strategic names during fiscal 2009. This is impacted on the value of names we have available for our regular bi-monthly sale of names, as well as the number of names we have available for parking purposes. These decreases have been partially offset by the continued success we have been having with brandable and Gem names. Gross margin percentage for YummyNames decreased slightly to 88%, from 90% for the first quarter of last year.

Gross margin for Hover decreased to $730,000 from $787,000 for the first quarter of 2009, mainly as a result of the previously announced steps we took to improve our retail platform while we were transitioning our retail customers from Domain Direct Net Identity and IYD services to our new retail platform. These initiatives have now reached the stage where our retail platform is well positioned to begin to grow. Gross margin percentage for Hover increased to 65% from 61% for the first quarter of last year. Mainly as a result of the changes we have made to the Hover platform allowing us to achieve an average -- higher average selling price for our services.

Gross margin for Butterscotch decreased slightly to $451,000 from $501,000 for the same quarter of 2009. As we have discussed previously, the sales mix for Butterscotch has changed significantly over the past several quarters. As we continue to execute on our strategy of exposing more of the tucows.com website traffic to the content rich Butterscotch.com traffic. This market driven shift has resulted in more video based revenue, which for the most part has been offset by the lower yields from our syndicated Google feeds. As a percentage of net revenue, gross margin for Butterscotch decreased to 96% from 99%.

Total operating expenses for the first quarter of 2010 decreased by $473,000 or 10% to $4.2 million or 21% of net revenue, from $4.7 million or 23% of net revenue for the corresponding quarter of last year. Again, I will note that this decrease in operating expenses is within the context of a Canadian dollar that appreciated on average by 15% against the US dollar over the last year. Looking at our total operating expenses in terms of core and other expenses, core operating expenses, which we define as those expenses relating to ongoing sales, marketing, development and administrative costs, increased by $911,000 or 26% to $4.4 million from $3.5 million for the first quarter of last year. As a percentage of net revenue, core operating expenses increased to 21% from 18%. If we exclude the impact of the increase in the Canadian dollar has had on core operating expenses, core operating expenses as a percentage of revenue would only have increased to 19%. The majority of this increase is attributable to higher work force costs, as we reallocated certain network operating functions to customer service and invested in additional marketing and customer service personnel. All of this reflects our increased focus on sales and marketing.

Other operating income for the quarter was $105,000 compared to other operating expenses of $1.2 million for the first quarter of last year. The favorable change in other operating expenses of $1.3 million is primarily the result of foreign exchange. In the first quarter of this year we recognized a gain on foreign exchange of $688,000, inclusive of a mark-to-market gain of $114,000 compared to a loss on foreign exchange for the first quarter of last year of $666,000, inclusive of a mark-to-market gain of $85,000. In addition, other operating expenses was impacted by our incurring a one-time payment of $126,000 in severance costs as part of our sales and marketing initiatives.

I would note for you that as we have highlighted on prior conference calls, the accounting impact of the movement in the Canadian dollar relative to the US dollar on our outstanding forward contracts has resulted in our raising a significant non-cash derivative instrument asset on our balance sheets of $2.3 million at March 2010. As we continue to assess mark-to-market adjustments for open forward contracts in future periods, this asset will reverse as the contracts pertaining to it mature and are exchanged. At that time we will record a significant non-cash loss on foreign exchange for the affected contracts. Net income for the first quarter of 2010 was $569,000 or $0.01 per share, compared with $1 million or $0.01 per share for the first quarter of 2009.

Turning to the balance sheet, cash and cash equivalents at the end of the first quarter of this year increased to $5.2 million from $4 million at the end of the first quarter of last year. However, decreased from $9.6 million at the end of the fourth quarter of last year. The decrease in cash of $4.5 million from the end of 2009 is the result of our using $5.2 million to repurchase 7.3 million shares under the modified Dutch tender auction offer we completed in January and the open market buyback program we launched in February. In addition, we also made capital payments of $479,000 on our bank loan, reducing it to $2.7 million at the end of the quarter. With regard to the bank loan I would also note for you that the cash sweep payment, which will be based on our audited 2009 results and that we will be paying during the second quarter, will be sufficient to pay off in full the outstanding balance of our bank loan. These uses of cash were partially offset by our generating $1.4 million in cash flow from operations. Deferred revenue at the end of the first quarter of 2010 was $59.5 million, an increase of 5% from $56.7 million at the end of the first quarter of last year, and an increase of 6% from $56.3 million at the end of the fourth quarter of last year.

To conclude, the first quarter marks a solid start to 2010. Our results are demonstrative of a consistency in our business driven by the continued momentum in our core domain services unit, the strength of our YummyNames domain portfolio business, and the revitalization we're beginning to see for Butterscotch and Hover. We continue to execute well and spend prudently. Moreover, I think the fact that we will have fully repaid our bank loan a full two years ahead of its scheduled repayment is a further indicator of our ability to consistently generate cash flows from operations. With the repayment of the loan behind us this quarter, we look forward to continuing to deliver on our stated objective of returning capital to shareholders. I would now like to turn the call back to Elliot.

Thanks, Mike. For some time now whenever a shareholder or prospective investor asks me about what makes Tucows a good investment, I answer consistency, reliability, and visibility in the context of growth. We are a milk and eggs type of business. Our revenue base is composed of a large volume of transactions at a low per unit price. The vast majority of our business is subscription based with high renewal rates, and we have very low customer concentration.

I'd follow that up with several pieces of data that demonstrate this over the long-term. We have grown revenue every year for 14 years. We have generated positive cash flow from operations for the last eight years. The number of domains under management has grown every year since we entered the industry a decade ago. The five individuals on our senior management team have been at Tucows for an average of eight years over the last ten. As I discussed earlier on the call, all of this is supported by a track record of expense control and the significant leverage in our business. While billings have grown almost 15% over the past three years, total cash operating expenses have decreased 23%, again despite the appreciation in the Canadian dollar over that period. At the same time we're able to pursue growth opportunities without consuming too much capital. I again point to the successful relaunches of Butterscotch and Hover, which you don't see in our costs. We continue to deliver on our stated intention to return capital to shareholders. I will note that since we implemented our open market share buyback programs in February of this year we have repurchased an additional 956,000 of our own shares. That brings the total number of shares that we repurchased since the beginning of January 2009 to 13.4 million, or 18% of the Company.

Throughout our history we have consistently demonstrated our ability to grow the business. A decade ago we turned great opportunity in the content business into a great opportunity in the wholesale domain business. We then layered on top of that additional revenue streams from digital certificates and the secondary domain name market and then we reinvented some of those older business lines to add new growth opportunities from previously static or declining revenue streams. While there have certainly been some challenges and even some failures along the way, we have maintained our momentum. We continue to have excellent growth opportunities going forward and have the advantage of being able to capitalize on them in a way that doesn't impact our ability to maintain this consistent, reliable business with the will and demonstrated ability to return capital to shareholders. Most importantly, every year we add more customers. Every year we add more domains. Every year we grow our distribution channel, and that grows the great platform that we have for long-term growth, one that provides consistency and reliability. With that I would like to open the call to questions. Operator.

(Operator Instructions) Your first question is from the line of Jim Kennedy, Marathon Capital. Your line is open.

Hi, Elliot, how are you?

Hi, Jim.

Congratulations on a good quarter.

Thank you.

Elliot, can you articulate, since I am somewhat new to the story, can you articulate the challenges you were talking about growth internationally? Can you talk a little bit about the challenges in terms of how you do that internationally? Is it that much different than what you might do domestically say here in the US versus overseas? Is it incrementally harder? How do you build that momentum globally? What sort of challenge is that?

I think we have always been blessed by the fact that our roots in the software download business, the old tucows.com software libraries were extremely popular, especially outside of North America. So when we launched wholesale domain registration, we came in with people knowing the Tucows and therefore the OpenSRS brands. So we were able to, at the beginning, establish a pretty good footprint globally. Over time all business is local, and where we have done best internationally is where we can actually put some people on the ground in Europe, for example. We have a couple of heads, and we spend a lot of time and effort flying around and meeting people. Both our VP of sales and myself try and get over there at least once or twice every year. Similar, although to a little lesser extent in South America and Africa, where again we have pretty good bases and penetration. Asia, in particular, presents a unique challenge, and that's one that we have really kind of taken a bit of a finer focus to for the next year or two.

Now, we're very lucky that in the wholesale model it is our partners that really do all of the heavy lifting in terms of penetrating a market. So in a market like Poland where we've got a great footprint or any number of markets in Europe, it is that partner that's doing the dealing with the language and providing support in the local language, taking payment according to local currency and custom. So we get away with bits of that. These businesses, hosting businesses, ISP businesses, they are local businesses, and that's true all over the world, and you have to hustle a little more, but there is still incredible leverage in it.

And what sort of language barriers exist in terms of your being able to port things electronically or present them? I know you have local partner that do a lot of the selling and interfacing, but is language an issue?

There is two elements to that. Luckily English is very much the lingua franca of the internet. When we're dealing with a customer, it is overwhelmingly likely that they kind of grew up in and around the internet and have a working knowledge of English so that we're able to conduct business. That being said, our people on the ground in Europe, I want to say cover between six and eight languages between them, and certainly when, again, as we're dealing in certain parts of Asia, language, you really do need that, but at an interface level where the one place where that manifests itself is web mail. When we're selling our email product, our hosted email service, if somebody is providing it to their end-users, we do have to provide a translated version. It is a tad limiting. So I think now we cover somewhere again between eight or nine different languages with our web mail interface, and that's something that we tend to expand on a sort of as-needed basis, based on customer demand.

Got you. Okay. Very good. Thanks a lot.

Thanks, Jim.

(Operator Instructions) There are no further questions in queue. Mr Noss, I turn the call back over to you.

Thanks very much, operator, and we look forward to seeing you all next quarter.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your line.