Tucows Inc (TCX) 2010 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to Tucows and Company's fourth quarter fiscal 2010 conference call. Earlier this afternoon, Tucows issued a news release reporting its financial results for the fourth quarter of fiscal 2010. This news release and financial statements are available in 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 for replay both 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 fourth quarter's financial results as well as at Tucows' website.

Before we begin today, let me remind you that the 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 risks factors are described in detail in the Company's documents filed with the SEC, specifically the most recent reports on Form 10-K and Form 10-Q. The Company urges you to read its Securities filings for a full description of the risk factors applicable for its business. 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. This afternoon's call will follow our usual format. I will begin with a brief overview of the financial and operational highlights for the fourth quarter and the year. Mike will then review our financial results in more detail. And I will return for some concluding comments before opening the call up to questions. Our financial performance for both the fourth quarter and the year continued to demonstrate the consistency and reliability in our business. Revenue for the quarter grew by 8.6% from the same period of 2009 to $22.1 million, and for the full year grew by 4.5% to $84.6 million, both records. I will note that each of these was achieved despite the lower contributions from our email service and direct navigation name sales. Once again, we generated solid cash flow from operations. $2.3 million for the quarter and $6.8 million for the year, up 8% over 2009.

In addition, we had another extremely efficient year for CapEx, which was even lower than the already efficient levels of the previous year. During the fourth quarter, each of the components of our business continued to perform well. OpenSRS Domain Services again experienced year-over-year growth in transaction volumes with total registrations up 11%, renewal transactions up 16%, and new registrations up 2%. I will note that growth in new registrations was somewhat lower this quarter as a result of two large customers becoming accredited registrars. We continue to do business with each of these customers, and there will be a relatively small impact on gross margin dollars.

Outside those two resellers, new registrations continued the robust year-over-year growth experienced throughout 2010. Again, our renewal rate remains several points above the industry average. Domains under management were up 5.3% year-over-year to $10.2 million, another record. All of this resulted in a year-over-year increase in domain service revenue of 13.8%. Our competitive position remained strong, and we had a number of significant customer wins during the quarter, including two sizable additions. We also had a couple of notable wins within our OpenSRS email offering and continue to be encouraged by the strength of the pipeline. The migrations of both customers are proceeding well, and we expect them to be completed before the end of the month.

These wins contributed to a 32% growth in the number of active email boxes from a year earlier. These sizable editions will position email for strong year-over-year growth beginning in Q1. On last quarter's call, we announced the imminent launch of our latest reseller offering, goMobi, a service that allows website owners to very easily set up a mobile version of their website. As a reminder, a goMobi-enabled website will identify the type of device that a visitor to the site is using and customize the user interface to that particular device. We launched goMobi towards the end of the quarter, and I am pleased to report that things are progressing well. The offer is gaining traction and feedback from customers has been very positive.

As is typical with any OpenSRS rollout, it will take some time for our resellers to integrate our offering into their businesses. Several of our largest customers and many of our smaller ones have already done so, and many more are working on it. Just as encouraging is the fact that a number of new self-serve service providers, largely web designers, are coming to OpenSRS for the first time because they want to offer goMobi to their customers. As I discussed last quarter, we see mobile computing as the dominant trend in technology today. It's something that we believe we are positioned to capitalize on in a number of ways.

Our domain portfolio group, YummyNames, continues to perform well. Individual domain name sales, that is sales of brandable names and Gems, were up almost 50% compared with the fourth quarter of 2009, reaching their highest level ever. We expect to see strong year-over-year performance for YummyNames in 2011, although the general decline in syndicated search revenue will still have a slight dampening effect on year-over-year comparisons. Our retail offering, Hover, continues its strong performance. New transactions, which include new domains, transfers in, domain email accounts, and personal name email accounts, increased their momentum from already good levels, up 17% over Q3 and 56% over Q2. Of particular note, the number of transfers in for Q4 grew 85% for Q3 -- from Q3 and outpaced transfers out by two to one.

Growth in new customers remains strong with the number of customer additions up 21% from Q3. With each quarter, we are seeing more evidence that Hover's value proposition is a simple, no hassle domain registration management tool and email service is resonating with our retail customers. The momentum in billings growth we saw earlier in the year continued with billings up 29% from Q4 2009, marking the fourth consecutive quarter of year-over-year improvement. Hover's strong performance is also the result of some innovative marketing approaches and excellent use of social media. Butterscotch, our content services group, also continues to perform well. Page traffic and site visits continue to grow, although at somewhat slower rates than we saw earlier in the year. Video plays were more or less flat compared with Q3, the result of the reallocation of resources to mobile lifestyle content.

As I discussed on our last call, during the quarter, we began to shift the focus of our content from mainstream technology to mobile lifestyle technology to capitalize on the massive trend towards smartphones, tablets, and always connected technologies. This is something you will continue to see throughout 2011. Lastly, growth offsite in video plays continued at significant rates. As I stated at the outset, overall, a very solid fourth quarter that was, again, indicative of the consistency and reliability in our business. I would now like to turn the call over to Mike to review our financial results for the quarter in greater detail. Mike?

Thanks, Elliot.Net revenues for the fourth quarter of fiscal 2010 increased 8.6% to a record $22.1 million from $20.3 million for the fourth quarter of 2009. Cost of revenues before network costs increased by $1.9 million or 14% to $15.6 million from $13.7 million for the same quarter of 2009. Gross margin for the quarter decreased slightly to $5 million from $5.1 million for the fourth quarter of 2009. On a percentage basis, gross margin decreased to 23% from 25%, largely the result of the 7% price increase implemented by VeriSign in July 2010 as well as the continued shift in sales mix from higher margin services to lower margin domain name services. Gross margin from our OpenSRS services, which include domain names services, email services, and other wholesale services, was $3.9 million or 21% of net sales compared with $4 million or 24% of net sales to the same quarter of 2009.

This decrease in gross margin percentage is primarily attributable to the lost contribution of the media portal email customers that we had previously discussed and to a lesser extent, the success of our strategy to grow revenue from higher volume lower-priced customers. Gross margins for domain services component of OpenSRS increased to $2.7 million from $2.6 million. As a percentage of revenue, domain services gross margin decreased to 15.8% from 17.3% due mainly to the VeriSign price increase I mentioned a moment ago. YummyNames continues to meaningfully contribute to gross margin, with gross margins remaining flat at $1.3 million for the quarter compared to the fourth quarter of 2009. Gross margin, as a percentage basis, were slightly higher at 88% compared with 87%. Hover continues to build a solid base for future growth. Gross margin for the fourth quarter was $774,000, more or less unchanged from the same quarter a year earlier.

As Elliot discussed earlier, we are continuing to see the benefits of the redevelopment of our retail platform in 2009 as well as the implementation of our marketing programs following each relaunch. As we have noted on previous calls, these initiatives resulted in a decrease in deferred revenue balances for Hover during fiscal 2009, which is reflected in these results. With Hover now experiencing increased sales volumes, higher cash receipts, and a return to growth in deferred revenue, we expect to see the results of these initiatives reflected in Hover's results going forward. On a percentage basis, gross margin for Hover increased to 66% from 63% due to the introduction of higher margin retail offerings.

Gross margin for Butterscotch decreased marginally to $424,000 from $449,000 for the same quarter of 2009. The decrease is primarily the result of lower revenue from traditional banner ads as well as the significant decrease we have experienced in AdSense revenue following Google's elimination of their program at the enterprise level. As a percentage of net revenue, Butterscotch gross margin was unchanged at 98%.

Turning to the cost for the quarter. I will again remind you that a significant portion of our operating costs are in Canadian dollars and our results should, therefore, be viewed in the context of the unfavorable impact of the stronger Canadian dollar relative to the US dollar as had on our performance. As some context for my discussion of costs, when compared with the fourth quarter of 2009, the Canadian dollar strengthened by approximately 4% relative to the US dollar. Network costs for the quarter were down approximately 5% to just under $1.5 million, continuing to reflect the improved deficiency we have experienced in operating and managing our colocation facilities. Despite the strengthening of the Canadian dollar relative to the US dollar, total operating expenses for the quarter were relatively unchanged from the same period of 2009 at $3.8 million. As a percentage of revenue, total operating expenses decreased to 17% of revenue from 18% for the fourth quarter of 2009.

Net income for the quarter was $1.2 million or $0.02 per share compared with $1.7 million or $0.03 per share for the fourth quarter of 2009. I will note that the fourth quarter of 2009 included a recovery of income taxes of just under $0.5 million compared with a tax accrual of just under $25,000 for the fourth quarter of 2010. Before I move onto the balance sheet and cash flow, I would like to take this opportunity to provide some context for the net income for the full year compared to fiscal 2009. Net income for 2010 was $2.1 million compared with $12.2 million for 2009, a decrease of $10.1 million or 83%. In assessing our fiscal 2010 results relative to fiscal 2009, I would like to remind you of four items that significantly impact this comparison.

One, fiscal 2009 included other income of $4.5 million resulting from our sale of our stake in Afilias and from the patents that we assigned in 2002 to a third party who continues to commercialize them. Second, the impact of the change in fair value on our forward exchange contracts resulted in a loss of $1.4 million compared to a gain of $4.2 million during fiscal 2009, a $5.6 million swing. Third, fiscal 2009 income taxes included the benefit of $556,000 related to a reduction in the Company's recorded deferred tax liability. Finally, when compared with fiscal 2009, the Canadian dollar has strengthened by approximately 9% relative to the US dollar.

Cash and cash equivalents at the end of 2010 was $4.2 million, down from $9.6 million at the end of 2009 and $5.4 million at the end of the third quarter of 2010. Both of these decreases in cash are primarily attributable to the success we have experienced with our share repurchase programs. During the fourth quarter, under our most recent Dutch Auction, we repurchased an additional 3.9 million shares for $2.8 million. This brought the total number of shares we have ] repurchased during fiscal 2010 to 13.7 million for a total investment of $9.7 million. During the quarter, we also made capital repayments of $479,000 on our credit facility with the Bank of Montreal and invested $296,000 in fixed acquisitions.

I would note for you that our liability under the credit facility was $1.3 million as of the end of December. Under the terms of the facility, we expect that this loan will be fully repaid by the end of the second quarter. These uses of cash were partially offset by our generating cash flow from operations during the fourth quarter of $2.3 million and $6.8 million during the full fiscal year. Deferred revenue at the end of the year was $62.6 million, an increase of $6.3 million from $56.3 million at the end of 2010 and $300,000 from $62.3 million at the end of the third quarter of 2010.

Our financial results for both the quarter and the year highlight our ability to benefit from the leverage in our business model. We continue to grow our top line, deliver solid cash flows from operations, while prudently managing costs, all of which are indicative of the underlying health of our business and position us well for the future. I would now like to turn the call back to Elliot. Elliot?

Thanks, Mike. Today I thought I should address a topic that has made its way to the mainstream media recently and something I've started to have more investors ask me about. The introduction of new domain extensions and what it means for Tucows. With several high-profile meetings in the domain space coming up over the next few weeks, there are likely to be some significant near-term developments on this front. And I wanted to share my thoughts on what the new top-level domains would mean for Tucows. Let me preface my comments by noting that while this is certainly very interesting, and we believe potentially very lucrative opportunity for Tucows, we don't expect to see any incremental revenue until the middle of 2012 at the earliest.

For those that aren't aware, I am talking about the potential introduction of a high volume of new domain extensions. Examples would be things like dot web, dot blog, or dot search or a whole new category that is likely to arise around brands, dot Tucows or dot IBM, for example. This will mark a fundamental change in the way domain names are used. While there have been a small number of introductions of new extensions over the past ten years like dot info or dot biz, we would now see hundreds of new extensions in one large wave. In terms of timing, ICANN, the regulator that determines who, how, and when these new extensions are introduced, next meets in San Francisco in March. In addition, some of you may have seen recent media reports about high-level meetings between governments and ICANN next week in Brussels, aimed at resolving the last few issues around the introduction of these new extensions.

It is expected that these meetings are likely to lead to significant developments on this front, which very well could include a specific finite timeline for the introduction process. So what does this mean for Tucows? There are a few thoughts I'd like to share in this regard. But first, I would like to emphasize that this will result in significant change in the domain name world. And where there is change, there are opportunities for innovation. At a high level, we are supportive of this. We are excited about it, and we think that it is a good thing both for our business and the Internet in general.

My first point is that Tucows does not intend to be a mainstream domain name registry and compete with the large existing providers like VeriSign or NeuStar or some of the large operators of country code domain names like those in the UK, Australia, or Germany. We think that there are a large number of competitors in that space, that there is likely to be a lot of competition. That's not where we see a value add. We think that the primary opportunity for Tucows will be the distribution partner. We are one of the very largest registrars in the world. We have the best global distribution channel of any registrar. We recently went over 11,000 partners, and they are all over the world. We expect that with potentially hundreds of new domain extensions competing for shelf space, end user attention and sales, that this benefits large distribution partners, much like a new cereal that wants to reach end users, need work closely with supermarkets and other points of distribution.

Our core OpenSRS is a distribution platform with great relationships, so we think that this is the primary opportunity. In addition to that, we do think that there is an interesting potential opportunity to work with some small number of large brands who intend to obtain their dot brand domain extension. Inside of our existing customer base, there are some very large brands that would naturally look to us for assistance. More importantly, we have a demonstrable ability to be a great back-end partner to others who have their own large brand customer relationships. Moreover, we think there is some room for differentiation and innovation in this specific service offering.

On last quarter's call, I talked about Tucows' ability over the past 15 years to consistently capitalize on industry change. The anticipated introduction of hundreds of new domain extensions provides just such an opportunity for us to do that again. Overall, 2010 was a very solid year for Tucows. Our core domain registration business continued to grow as a result of our strong competitive position, our ability to build and maintain long-term customer relationships as well as our ability to deliver innovative new services. OpenSRS is a tremendous platform. During the year, we introduced several new offerings to our more than 11,000 reseller customers around the world, including our expanded trust services offering and our goMobi offering.

We also launched our unified control panel, which in addition to making it easier for resellers to support their customers, improves our ability to cross-sell and upsell our services. Importantly, we were able to do all of this with minimal capital investments. Hover provided significant improved contributions in 2010. We have successfully repositioned it. We have found opportunities for meaningful customer acquisition. We are quite excited about even more growth for this business unit in 2011.

YummyNames performed well within the context of our focus on brandables and Gems, with an inventory of more than 85,000 names and exclusive access to more than 180,000 names expiring in OpenSRS every month. We are well positioned for the future. We expect solid growth in 2011 as the brandables and Gems market continues to mature. Butterscotch made significant strides in moving from a dated paradigm desktop software downloads towards real opportunities in video and mobile computing. Again, with both Hover and Butterscotch, we have been able to do what we have done with minimal capital investment.

Financially, our business model is allowing us to increase our productivity which has assisted us in offsetting some of the impact of the strong Canadian dollar. Most importantly, our business continues to generate strong cash flows from operations. All of this positions us to continue to deliver on our stated objective to return capital to shareholders. As Mike mentioned earlier, during the fourth quarter we repurchased an additional 3.9 million shares under our fifth modified Dutch Auction tender, bringing our total repurchases for the year to 13.7 million, with more than 20% of shares outstanding at the end of 2009. And our total, since initiating our buybacks to 23.2 million or 30% of the total shares out at the end of 2006, beginning of 2007. More and more, the core value Tucows brings our great distribution network of service providers is showing its value, and that has us quite excited for 2011. With that, I'd like to open the call to questions. Operator?

(Operator Instructions)And we will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Thanos Moschopoulos from BMO Capital Markets. Your line is now open.

Hi. Good afternoon.

Hi Thanos.

Hi Elliot.I appreciate your color and commentary regarding the opportunity with respect to the new top-level domains. Just to drill a little bit further on that, can you clarify -- as that starts to comes into effect and rollout, could this really provide a new step function of growth in your domain business, or might it be a more gradual ramp than that, or is it hard to say at this point?

I would think about it less as a step function and more about increasing the rate of growth in the domains business. So I don't see it necessarily as a new curve or a new line, but I do see it as a step up in the existing growth.

Okay. And there wouldn't be any reason to think that the margins per domain for that new business would be any different than your current business, would it?

I think that remains to be seen. It's going to be to some extent a function of how people innovate in the registry space. So I don't think there's any downside to our margins, certainly from the introduction of new TLDs, but there could be depending on some new or innovative approaches, the opportunity for some higher margin offerings. So I think that, that's at worst a neutral and at best a positive at a marginal level.

Okay. On the YummyNames business, can you remind us at this point, what the relative mix looks like between syndicated search, [parked] pages, revenue versus -- resale auction revenue?

You said resale and auction revenue?

Yes.

You want to break that down? We will give Mike a second there.

Just broad brush strokes.

Just give me one second.

And your commentary is in the mix has certainly been shifting much more towards the sales relative to the search revenue.

That's right. The search revenue -- I want to say in the quarter was in the $0.25 million, $300,000 range. That is down from -- it's been on a steady decline for the last three years or four years.

Yes, from about the $400,000 range down to the $300,000 range, and the rest of the income is in the domain name sales and auction.

Okay.

We think that, that continues as we would be thrilled to see the search revenue or the syndicated revenue be flat. We expect the sales revenue to continue to increase. We've seen with some large portfolio holders, that mix going from all search, just two years ago, to now 50/50 search and sales. We've been focused on sales from the very beginning, so we haven't seen that huge of swing, but, boy, that is industry-wide now.

Okay. Certainly it's showing some consistency as far as building that revenue base. I know it used to be able to (inaudible) in the past, but over the past several quarters, certainly, it's some consistent streams, it looks like.

Yes, we think that the increases will be more in that consistent type of nature, too, where it's just moving the inventory turns a little bit higher with each successive quarters (inaudible).

Okay. Financial question for Mike. And I apologize if you covered this in your prepared remarks, but what would have been the Forex translation gain or loss embedded in the OpEx lines for the quarter?

Embedded in the OpEx lines for the quarter.We -- on the Forex, we made $300,000 odd dollars in the December 2010 quarter, and that was slightly higher than the $260,000 odd that we made in the fourth quarter of 2009.

And always remember that, that sits inside of G&A.

Right. Okay, so it was a $300,000 gain?

That's right. A $300,000 gain in this year versus just [slightly] $300,000 gain in [Q4 '09].

Okay. And as far as your ongoing cash generation, is it safe to assume that you'll probably look to deploy your cash in a manner consistent with the recent past?

Yes. I think that we certainly have nothing to announce, and I think our strategy is the same. We'll always keep our eye open for opportunities, but we are not really focused on M&A. We continue to experience that -- new service launches, things like that, can be well handled inside the OpEx structure. So I think that's a fair comment.

Okay. That's it for me. I will pass the line.

Thanks, Thanos.

(Operator Instructions)The next question comes from the line of Alex Grassino from Laurentian Bank Securities. Your line is open.

Good afternoon, gentlemen. Could you provide me a little bit more color on how you would conceptually see the TLD brandable names working just in terms of the opportunities you could visualize it materializing?

Sure. So -- I believe, first of all, that what you will see at the very onset is a large number of brands who will, first and foremost, make sure they secure their namespace. And I think that you will see then inside of that group. So that will be through the process. Remember, I should probably flush out the timing a little bit. Even with a finite announcement in March, you are going to see the communications process, which I believe lasts three or four months. You are going to see an application process, and then you are going to see those applications work through. So imagine it is spring or summer of 2012, things are coming out the other end. I think you will see a small number of brands start to use their brand namespace as a replacement or supplement to their existing Internet usage, so you might see brands dot com migrate to dot brand. I think that you will see the larger body there watching to see what those innovators do.

And as people wrap their heads around the utility of having their own namespace, their own brand on the Internet, and what that means both in relation to having as an alternative -- a number of different domains across different countries or a number of different subdomains, second levels, directory structures, I think as a lot of that starts to come clear, you will see more and more of those brands start to use it. And when I am talking about opportunities for innovation there, Alex, we think that there is a way to look at that, that is fresh. So today, domain names are thought of and distributed in a very traditional way. You have a registry, you have a registrar, you have an end user. They are all very separate entities, and there is a whole structure and system that is built up around that. I think as that changes, there are some very interesting opportunities to deliver services differently.

Okay, great. Just a follow-up. In terms of the hurdles that would be faced with getting a brandable TLD approved, how high do you see the barriers being and how quick would the process be?

Well, I think you are going to see there -- [you] say how quick will the process be? Again, you will see this communication process, which is really intended to make sure that people all over the world know that this is happening, then you will see a relatively short application window, so that might be in the four week, six week, eight week time frame. Now, during that application window, your -- all of the applications will be secret, confidential. The end of that application window, all the cards will be turned over. Then anytime there is contention for two applicants, two people who want dot blog, for example, that will go to an auction. Now, a lot of the -- when you are talking about hurdles, the $185,000 for an application, if you want, one of the real core generics -- think there about one of the top 100 search terms on Google. There you are probably going to find yourself with some contention and be in an auction. Who is to say with some of these auctions -- if both Google and Microsoft are pursuing dotsearch, where does that auction go? It's pure conjecture.

Now, there are another set of hurdles. Certainly, all of this has a lot of intellectual property protection built into it to ensure that there is no abuse of trademarks, et cetera, that goes on through the process. And that's been really well debated and I think it's baked very tightly into the process. In addition, I do not believe that in the first round, what I referred to in the industry as contentious strings, are likely to get through. So you can think about things there that might bump up against morality issues, and I won't bore you with any examples. But, I don't think -- I think in the first round there will be plenty of applicants that have fairly digestible strings that they are pursuing. I imagine that some of the more contentious ideas will probably end up in later rounds.

Great. And do you think there will be any fail-safe or stopgap measures to prevent what happened with companies like Amazon back in the early 2000s from being, essentially hijacked by other countries like Amazon.GR? I recall a subject of a bit of blackmail or something like that? Do you think there will be some recognition of previous trends there to clean out the process, or do you think a straight dollar value on the application process will be enough of hurdle in and of itself?

I think that the -- that, that high application fee and the auction process is a huge hurdle to what you would think of as large-scale cyber-squatting. It is just not practical. In addition, the remedies relative to where they were in 2000, for example, are very different. And you are also talking about a country code namespace there with dot GR and I can promise you that in 2000 or 2001, the dispute resolution process in the Greek namespace was not mature. So all over the world those processes have really been maturing over the last ten years. There is going to be some very interesting contention though. I mean, some stories I like to tell. Imagine if Apple chooses not to apply for their brand, chooses not to apply for dot Apple, but the US Apple Growers Association does. That is a legitimate use. As long as they are not doing anything that in any way touches on the Apple trademark, well, that is a legitimate use. So you could find dot Apple forever more being dedicated to the fruit.

Great. Okay. And just one final question, shifting gears a little bit. On the goMobi, could you give us a little bit more insight into what you conceptually see the revenue model being for that going forward?

Sure. That's a service that is an add-on service in the purchase path, so somebody now is buying a new web hosting account or perhaps they're -- our customers are remarketing back into their base of existing hosting accounts where you are going to buy this mobile tool to supplement your existing website. You can take a look -- I mean, I can send you some examples off-line. They really -- it really does work very well. They resolved beautifully on smartphones, and it's a very simple monthly fee from us to our resellers, and then they, as is always the case, might choose to bundle it or offer it in a number of different ways. But to this point, the straightest addition is to offer it typically in the $4, $5, $6 a month range to their end users.

Perfect. Thanks. That's all I've got.

Thank you.

There are no further questions at this time. I'll turn the call back over to the presenters.

Thank you all for joining us, and I look forward to speaking with you again next quarter. Thank you, operator.

You're welcome. Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.