Tucows Inc (TCX) 2012 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to Tucows' second-quarter 2012 conference call. Earlier this afternoon, Tucows issued a news release reporting its financial results for the second quarter. That news release and the financial statements are available on the Company's website at www.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, as well as at Tucows' website.

Before we begin, 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 the 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 Form 10-Q. The Company urges you to read its security 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. Elliott Noss. Please go ahead, Mr. Noss.

Thank you, operator. With me is Michael Cooperman, our Chief Financial Officer. Per our usual format, I'll begin today's call with a brief overview of the financial and operational highlights for the quarter. Mike will then review our financial results in detail. And I'll return with some concluding comments before opening the call up to questions.

The second quarter once again shows the growth, consistency, and leverage in our business. We continued to see meaningful growth across each of our service categories, with overall revenue for the quarter increasing 22% year-over-year to $28.2 million, our ninth consecutive quarter of revenue growth. We continue to generate cash flow from operations, which, in Q2, we used to repurchase additional shares and to take advantage of the new [generic] top-level domain opportunity that I have discussed on past calls.

I'll now review the highlights for each of the three components of our business -- Wholesale, Retail, and Portfolio. Wholesale, which I'll remind you includes our OpenSRS domain service and other value-added services, had another solid quarter. Domain Service transactions were up 12% compared with Q2 of last year to more than $2.3 million, and domain service revenue was up 19%.

Renewal registrations grew a very healthy 27% year-over-year. New registrations were more or less unchanged from Q2 last year. However, I will note that growth was held down by two factors. First, several large resellers launched one-time promotions in Q2 last year; and second, one large reseller this year was acquired by one of our registrar customers who shifted their registrations onto their accreditation on our platform. Outside of these events, new registrations grew 16% year-over-year.

Transfers-in were up 28% after factoring out a large one-time bulk transfer-in during Q2 of last year. Renewal rates remain above the industry average, and have increased slightly to 75%. Total domains under management at the end of the quarter were $13.9 million, up 24% from the end of Q2 last year, and up 15% from the end of the first quarter of this year. The jump from Q1 was primarily the result of the acquisition of a reseller by one of our customers who then shifted new registrations to its accreditation on our platform. Q2 was also another good quarter for our domain name expiry stream, which saw revenue more than double from the second quarter of last year.

Our retail business, which includes Hover and Ting, continued its strong performance in Q2. I note that Ting revenue is still dominated by zero-margin or low-margin device sales and, accordingly, we will talk about Hover and Ting separately when talking about retail. Hover revenue grew 28% year-over-year and 7% sequentially, and we continued our trend of strong customer growth. New transactions, which include new domains, transfers, and e-mail accounts, grew 29% year-over-year, and renewals grew 14% year-over-year. Renewal rates ticked up slightly from an already high level as a result of our great customer service and customer experience. Transfers-in remain strong in Q2, growing 34% year-over-year, with transfers-in exceeding transfers-out by a ratio of 5 to 1, which is an incredible performance in this very competitive space.

Ting is the other component of retail services. Q2 was the first full quarter of operations for Ting. As of the end of June, Ting has been on the market for over four months, and things continue to go quite well. We are extremely pleased with the way that the service is being received, both by customers and by the broader technology, telecom, and mobile communities. We have clearly been identified as a thought leader in the [MBNO] space. Most importantly, customers are saving even more money than we anticipated, and they are thrilled with the customer experience. Again, I point you to the Ting Facebook page and the Ting blog. If you are interested in following Ting's progress, those are the two best places to understand the amazing level of customer engagement we are seeing.

We are also pleased with the early performance. On last quarter's call, I shared that gross margins for Ting were expected to be in the 30% to 50% range, and that our objective for 2012 was to see Ting exit the year on a run rate that would have it at or approaching Tucows' second largest service. I'm pleased to report that we are well on track in both of these respects. We would now tighten the gross margin range to 35% to 45%, which is right about where we would like it to be. [I would] add that we now have enough operating history to say that we believe each account will contribute in the range of $120 to $180 per year before customer acquisition costs, which are one-time costs. We remind you that we view an account as a person, while our competitors view an account as a device. Finally, we have enough operating history and customer traction to be comfortable saying that we expect Ting to make a meaningful contribution to Tucows' EBITDA growth in 2013.

Moving now to Portfolio, which, as a reminder, includes the resale of names from our domain names portfolio, and advertising revenue from those names, as well as our two advertising-supported websites. Q2 portfolio revenue increased 19% compared to last year. It was another very solid quarter for individual domain sales, which were up more than 40% from Q2 last year, and exceeded the $1 million mark for the third consecutive quarter. Average selling price was up 25% versus Q2 last year, and sales of [Gems] remains strong.

During the quarter, we undertook two new marketing initiatives to support our inventory sales. In the first, we developed a means by which to package some of our brandable domains to sell in bulk to targeted buyers. We completed three large sales during the quarter, and another one subsequent to quarter-end. We are continuing to mine our inventory for other such opportunities. In the second, we developed an efficient way to categorize the more than 40,000 brandable and Gem domains in our portfolio. Previously, if someone wanted to see our list of wedding-related domains for example, it was an arduous, time-consuming process based on key word searches, and some relevant domains would still be missed. Now we can address such a request in a matter of minutes.

In summary, Q2 was another solid quarter for Tucows. Wholesale continues to benefit from new service introductions and customer wins, retail continues to grow as a result of our relentless focus on customer experience, and our portfolio is providing predictable revenue streams with strong inventory sales. All of that adds up to the consistency and reliability in our results as we continue to deliver steady and improving growth.

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

Thanks, Elliott. Net revenue for the second quarter of 2012 grew by $5.1 million, or 22%, to a record $28.2 million from $23 million for the same quarter of last year. Cost of revenues before network costs was $20.1 million, an increase of $3.9 million, or 24%, from $16.2 million. Gross margin before network costs increased $1.2 million, or 18%, to $8 million, from $6.8 million for the same quarter of 2011. As a percentage of net revenue, gross margin before network cost was down slightly to 29% from 30%.

Before viewing the gross margin for each of our businesses, I would remind you that last quarter we began breaking out our gross margin performance into three service categories -- Wholesale, Retail, and Portfolio. This was done to better reflect the manner in which our revenue streams are generated and assessed internally.

I'll start with Wholesale Services. Wholesale Services includes domain and other value-added services provision through OpenSRS, as well as the sale of domain names in advertising from the OpenSRS Domain Expiry Stream. Gross margin for Wholesale Services for Q2 increased by $890,000, or 18%, to $5.7 million from $4.8 million. As a percentage of revenue, gross margin from wholesale services was unchanged from the second quarter of last year at just under 24%. Gross margin for the domain services component of Wholesale increased by $540,000, or 17%, to $3.7 million. The increase is the result of several factors, most notably the higher transaction volumes from existing customers, and the contribution of the [E-PEG] acquisition that we completed during the third quarter of last year.

Gross margins for the other value-added services component of Wholesale increased $350,000, or 21%, to $2.1 million from $1.7 million. The increase primarily reflects the improved results we have been achieving through our relationship with our current Expiry Stream partner that we migrated to at the end of the second quarter of last year.

Gross margin from retail services, which is primarily composed of services we sell through our Hover website, increased $82,000 or 10%, to $940,000 from $860,000. The increase is the result of the continued success of the initiatives we have undertaken to attract new customers and to retain existing ones. I will note that gross margin growth has been negatively impacted by the effect that the sale of Ting phones has on our margins as a result of our decision to sell Ting phones at, or slightly below, cost. As a percentage of revenue, Retail Services gross margin was 41%, compared with 67% for the second quarter of last year, with the decline again being the result of the sale of Ting phones at, or slightly below, cost.

Gross margin from our Portfolio Revenue stream increased $240,000 or 21%, to $1.4 million from $1.1 million. This increase primarily reflects the impact of the sale of domain names from our portfolio, which totaled $1.1 million for the second quarter, compared to $770,000 for the second quarter of last year. On a percentage basis, gross margin for the Portfolio Revenue stream was 87%, up from 85% for the second quarter of last year.

Turning to costs, network expenses for the second quarter of 2012 decreased $50,000, or 3%, to $1.4 million from $1.5 million, primarily the result of the efficiencies we have realized in operating and managing our co-locations facilities, as well as the lower capital expenditure we require for network equipment.

Total operating expenses were $5.6 million, up $915,000 from $4.7 million for the same quarter last year. The increase was predominantly the result of the impact of our incurring a loss on foreign currency contracts of $384,000 during the quarter, compared to a gain of $117,000 for the second quarter of last year. In addition, additional incremental work force costs of approximately $250,000 and an increase in marketing spend of $100,000 contributed to the increase. As a percentage of revenue, total operating expenses was relatively unchanged from the second quarter of last year at 20%.

Net income for the second quarter of 2012 was $696,000, or $0.02 per share, compared with $566,000, or $0.01 per share for the second quarter of last year. Cash and cash equivalents at the end of the quarter were $4.5 million, up $163,000 from $4.3 million at the end of the same quarter a year ago, and down $1.9 million from the end of the first quarter of this year.

Cash flow generated by operating activities during the second quarter of this year was $4,000, compared with $825,000 from the same quarter of last year. Cash flow generated by operating activities during the quarter was impacted by our investing a total of $1.1 million for applications to create and operate the registries for six new gTLDs under the new gTLD program that Elliott discussed in the past. We subsequently decided to withdraw two of our applications, and still have four undergoing the evaluation process. Under the terms of the new gTLD program, we will receive a refund of $370,000 for the two withdrawn applications.

We also used $1.6 million in cash during the quarter to fund the repurchase of 1.1 million of our shares under our normal course issue bid. In addition, during the quarter, we invested $175,000 in equipment purchases, and made capital repayments of $312,000 on our bank facilities. At the end of the quarter, we had an outstanding balance under our bank facilities of $4 million. Deferred revenue at the end of the second quarter of this year was $74.5 million, an increase of 12% from $66.8 million at the end of the second quarter of last year, and up 2% from the end of the first quarter of this year.

In summary, the second quarter was another solid quarter financially, with our results once again indicative of our ability to generate growth, the consistency and reliability of our business, as well as the leverage that is inherent in our business model. And with that, I would now like to turn the call back over to Elliott. Elliott?

Thanks, Mike. On last quarter's call, I noted that the deadline for applications to create and operate registries under the new generic top level domain program had been extended, but that no firm date was set. That deadline was eventually set, and the applicants and applied for gTLD strings, were revealed on June 13. The program itself was a huge success with a total of 1,930 applications submitted. It is now public that we have applications for four new gTLDs -- group, marketing, .media, andonline. All have contention, meaning at least one other applicant.

Our strategy is to launch these as upgrade top-level domains; that strategy is laid out in our application, which you can view online at www.gTLDresult.ICANN.org. Our goal is to take an operating position in all of these top-level domains, either by ourselves or with partners. In terms of timing, there is now a process of a number of months to evaluate applications and resolve contention. We expect the next milestone to be the ICANN meeting in October, which conveniently for us happens to be in Toronto. So, I expect to be able to tell you more about the contention process on the next conference call.

I've been very conservative in setting investors' expectations around the contribution of the new top-level domains. What I have said until now is not to expect any revenue until 2013 at the earliest. I would now push that back even further; and I would say to not expect any revenue until the second half of 2013, and I would not at all be surprised if that extended into 2014. That is true whether I'm talking about our applications to run a registry ourselves, the four that I've talked about, or any benefits we'll receive by being a registrar. And as any of you who listen to the calls regularly know, I believe the greatest benefit of the new gTLD program to Tucows will be in our role as registrar where we have the best wholesale distribution channel in the world, and are one of the two best distribution partners for new gTLDs in the world.

Finally, as Mike mentioned a couple of moments ago, during the quarter we continued to be active with respect to buying back our shares under our current open market program. During the quarter, we repurchased just over 1.1 million shares at an average price of $1.43 per share, for a total of nearly $1.6 million. The shares we purchased represented 2.4% of shares outstanding at the beginning of the quarter. When added to the modified Dutch Auction tender to be completed in January, to-date in 2012 we have repurchased a total of 8.7 million shares, or 16% of shares outstanding since the end of last year. And since our first Dutch tender in 2007, we have now purchased a total of 31.9 million shares, or 42% of shares outstanding at the end of 2006.

We continue to see the stock as value, and remain committed to our stated objective to return capital to shareholders. We'll continue to weigh our investment in our shares against other uses of capital. While taking advantage of opportunities afforded by the monetization of our off-balance-sheet assets, as I've talked about in the past.

Growth in the existing businesses continues to accelerate. Ting is very much on track, and represents a significant opportunity for the Company. We continue to see efficiency in our business, and we continue to efficiently use the capital that results. We are in a position where continued focus on execution of both our business plan and our finance strategy will allow us to provide strong returns for shareholders.

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

Operator. (Operator Instructions) Our first question comes from the line of Rami Nasser from BMO Capital Markets. Your line is open.

Good afternoon. It is Rami for Thanos Moschopoulos.

Hi Rami.

Hi, how are you?

Good, thanks.

So question on Portfolio Revenues. It was down slightly quarter-over-quarter from Q1, is there a trend there or just normal seasonality?

No, what you are seeing there primarily, is we had an especially strong quarter for Gems in the first quarter. And Gems -- names that go for over $10,000 apiece, they tend to be able to swing things a little bit. So nothing at all by way of trend there; we're still feeling very good about that business.

Okay, good. And on the Retail business, it was very strong this quarter, and I'm guessing Ting had a lot to do with it. What sort of seasonality do you expect for Ting going forward? Is the back-to-school and the Christmas season will have the uptick and so one, or what do think?

Well do remember when you are looking at the retail results, we have all of that phone revenue in there. We would love to show that a little separately, but that is just not possible. So it was a strong quarter, but you do have to remember the phones. The seasonality question is extremely interesting. We are in our first half year of operations at this point, and I've engaged with a bunch of folks in the industry, and the mobile industry tends to have a few different spikes. You mentioned a couple of them, certainly back-to-school, the Christmas season, it turns out Father's Day, a little bit around Valentine's Day apparently, but we are marketing very differently.

We are doing our marketing, as you know, primarily through podcasts and social marketing and social media. So we've -- again, in talking this over with a lot of folks in the industry, we're not quite sure when those typical spikes happen in the industry, if that is going to be positive, neutral, or negative for us. It might be the case that, while everybody else is blanketing television with ads and blanketing buses with billboards, that might take away a little from us. It also might bring people into the purchase process, who will then do a little research and find out about us. So we are really entering our first season like that, and we are just going to sit back and learn with everybody else.

Okay. Now looking at the Ting website, I've noticed that you added some new phones. Could you comment on the phone inventory, do you think it is going to go up or stay stable over the next year?

So, we think that inventory actually might start to tick down a bit. Not because of phones in inventory will tick down a bit, but because we think the days in inventory will start to come down enough to matter a little bit, and we say that primarily for two reasons. One is just the experience reason. We are getting better and better at managing the supply chain and at the same time, Sprint is getting better and better as a partner, especially around wholesale devices. But another factor there is, you're seeing the transition right now at Sprint between WiMAX and LTE phones. And so what that meant was, there were a few more phones than usual going end of life, and a few more phones than usual coming into the mix which required the inventory on our part to be a little bit spikier, so if a phone was going into the light, we knew it was really popular; there was going to be a bit of a gap in that category; we had to over invest a little bit. And similarly, we have to play that transition from WiMAX to LTE, which meant we had to carry a little bit more inventory than we might usually.

Okay, great. Now my last question is on operating expenses. What is your outlook for near-term operating expenses for Q3 and Q4?

We expect things to stay relatively stable. We'll always talk about trying to keep growth and build gross margin such that it drives about a $0.50 on the dollar spend, and OpEx, you know, we think we're going to comfortably be below that as we go forward. So for the second half of the year, things -- you won't see much of a change there.

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

Thanks.

(Operator Instructions) And I have no -- oh, sorry, I do have a question in queue from Jim Kennedy from Marathon Capital Management. Your line is open.

Hi Elliott.

Hi.

Congratulations on a nice quarter.

Thank you.

Quick question on the high-level domain contention process, although it is going to be further defined in October, how does it now stand? How are they thinking that these things will be resolved? I thought maybe they would go to an auction or something; is there a different pathway so far?

Well, the process itself is big. So anybody that we're in contention with, there is a period of time when I can, as letting all of the parties kind of stare each other in the eye a little bit, see if they can resolve the contention, maybe work together, maybe come to some other arrangement. And at the end of that period, which will probably be a few months to six months, then if there is still contention, then there will be an auction. So really when I say, hey, I'll have more to talk about in October after Toronto, that is because we'll be -- it will be a second opportunity to sit down with the folks that we are in contention with. I think everybody in Prague was kind of feeling each other out; there were some good discussions there. I think in Toronto, people are going to get a little bit more serious about trying to sit down and get down to business.

So, obviously you know who you are in contention with.

That's right.

Is that public information at this point?

Yes, it is.

Okay. Where would one find that?

That -- if you go to the URL I referenced earlier, www.gTLDresults.ICANN.org, you will find it; and if you drop me an email, I'll be happy to bounce you a couple of links.

Okay, very good. Thanks a lot.

And the next question is from the line of Aram Fuchs from Fertilemind Capital. Your line is open.

Yes, I was wondering, Mike mentioned something that you are -- about capital efficiency where you are not required to buy equipment with as much horsepower it sounded like; did I infer that correctly or were you trying to communicate something else?

No, I was trying to communicate something else here. The issue for us is that -- we've been able to increase the efficiency with which we run our operations and our network operating costs, and with that, we have had to invest quite a bit less money than we have in the past.

Okay.

We still are investing in whatever equipment we need and are certainly buying all of the horsepower we need.

And, by the way, a lot of those benefits really come from virtualization. Just the gains in utilization are amazing. That is an industry comment, not a Tucows-specific comment.

Right. And on the wholesale channel, is the product split still roughly the same, or are any of those minor products like certs taking off or is there anything we should watch out for, or is it mainly still domains?

The mix is still pretty much the same. We are seeing a growth across most, so there's no significant break-out in anything there. So the mix is roughly the same.

And then again related to the channel, and its sponsorship of Ting, you had mentioned you thought that the channel -- your channel, your resellers, would take up Ting. I was wondering if you could give us an update on the actual gross adds. Are they coming from your direct marketing to consumers up from the channel or what split or any feedback on that?

Yes, I think we'll start to provide a little bit more color next quarter. Where maybe, it was a half a quarter that the program was out now, and I think that right now, we are working through that first iteration. We've had pretty good sign-up, we are starting to see some contribution, but the numbers we are seeing so far are primarily from retail. We are certainly seeing a little bit more, a little bit more, a little bit more on the wholesale side, but that is not yet really kicking into the numbers.

Okay, great. Thank you for your time.

Thanks, Aram.

And there are no further questions in queue, Mr. Noss. I'll turn the call back over to you.

Thank you, operator. We look forward to seeing you all next quarter.

And this concludes today's conference call. You may now disconnect.