Tucows Inc.
Q1 2007 Earnings Call Transcript

Published: 11 May 2007

[Operator:]

Good afternoon, ladies and gentlemen. Welcome to the Tucows Inc., First Quarter Fiscal 2007 Results Conference Call. Please note that today's call will be archived for replay both by telephone and via the internet, beginning approximately 1 hour following completion of the call. To access the archived conference call by telephone, dial 416-640-1917 or 877-289-8525 and answer the pass code 2122-8036. The telephone replay will be available until Thursday May 17, 2007 at mid-night. To access the archived conference call via the internet, go to www.about.tucows.com. I would now like to turn the call over to Leona Hobbs, the Director of Communications for Tucows Inc. This call is being recorded Thursday May 10, 2007. Please go ahead, Ms. Hobbs.

[Leona Hobbs:]

Thank you, operator. Good afternoon, everyone, and thank you for joining us for today's call. With me is Elliot Noss, Tucows President and Chief Executive Officer; and Michael Cooperman, our Chief Financial Officer. Today, following market close, Tucows issued a news release reporting the company's results for the first quarter of fiscal 2007 ended March 31, 2007. The news release and other information for investors is available by going to about.tucows.com and clicking on Investors. Before we begin today, I would like to point out that the matters we will be discussing include forward-looking statements, and as such, are subject to risks and uncertainties that would cause actual results to differ materially. These risk factors are described in detail in our documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q. We urge 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 Elliot.

[Elliot Noss:]

Thanks, Leona. Good afternoon, and thanks for joining us today. As per our usual format, I'll begin with an overview of the highlights of the first quarter. Mike will then provide a detailed review of our financial results. And finally, I'll return to talk about why I believe that Tucows continues to represent tremendous value for investors. First the financial highlights. We are quite pleased with our first quarter results. Subject to the caveats expressed numerous times in our previous quarters, revenue grew to a record $17.8 million, an increase of 16% compared to the first quarter of last year. Adjusted net income was $2.4 million, also a record, and up 62% compared to the first quarter of last year, our 17th consecutive quarter of revenue growth and profitability. Net income was $0.7 million, marking our 19th consecutive quarter of profitability. And cash flow from operations was $1.1 million, our 21st consecutive quarter in positive territory. Net deferred revenue or deferred revenue less prepaid registry fees increased 12% compared to the end of the first quarter of last year. In summary, our financial results for the first quarter have put us firmly on track to achieving our objective of cash flow from operations in the range of $10 million to $12 million for the year. Turning to service highlights. There are three service developments I would like to talk about. First, as we have discussed before, we have developed the next evolution of our email system. On the fourth quarter 2006 conference call, I indicated that we expected to be releasing our new system to customers in the March timeframe. I also indicated that the problems we were solving with that release were focused on the backend infrastructure of the email system, and subsequent to that release, we would turn our attention to the user experience and in particular to webmail. Subsequent to those comments, we were fortunate enough to discover a webmail solution provided by a local company Nitido, located just minutes from our office here in Toronto. Their webmail was the first that we had seen that we felt was legitimately competitive with the best webmail offerings in the world. And you have all heard me identify those in the past, as those provided by Google, Yahoo and Microsoft. We were able to reach an agreement with Nitido, whereby, we have now partnered with them incorporating their webmail technology with our email platform. Accordingly, we decided to delay the March release of our new system until this month, when we could launch an email service that we not only feel is world-class in its dependability, reliability, email deliverability and ease of integration. But also, it is a user experience and specifically a webmail experience that we feel is the only one available to service providers on a hosted basis that is competitive with that of Google, Yahoo and Microsoft. And for our customers, it is better because it is not accompanied by advertising and of course, includes the hands-on support that a good service provider delivers. I said numerous times, that the importance of email to Internet users is greater than it has ever been before. And the service providers have a much greater need to outsource the delivery of email, in order to be competitive with the best email on the market. I also note, that with the launch of this improved service. We will be able to re-engage and ramp-up our sales efforts. As I have talked about in the past, the sales cycle around services such as these does take time. Though, we don’t expect to see specific result next quarter, but due soon thereafter. Given that on that stage, we are pleased with the level of growth in the business this quarter. And expect to continue to see that growth in the mid-teens for the top-line and better than that for the bottom-line. Turning now to the Tucows content side, I have talked about in the past. We have been reinventing our content side, Tucows software libraries, to bring them into the 21st century. Evolving them from its roots, as a software download site to one that helps people use the Internet more effectively. When Tucows first rose to popularity in the mid 90's, it was about two things

[Michael Cooperman:]

Thanks Elliot. As Elliot discussed, in the first quarter, we continued to deliver solid financial performance. We achieved record revenue, strong cash flow from operations, and continued growth in our differed revenue balance. Notably, this was the first quarter in which we achieved adjusted net income in excess of $2 million and perhaps more importantly, our results for the first quarter leave us solidly on track to achieve our cash flow from operations target up to $10 million to $12 million for fiscal 2007. Turning to the numbers, net revenue for the first quarter increased 16% to $17.8 million from $15.3 million for the corresponding quarter of fiscal 2006. Net revenue from domain name and other internet services increased by $1.9 million or 13%, to $16.4 million from $14.4 million. Revenue from domain registration was up 12% year-over-year to $11.9 million and accounted for 67% of total revenue compared to 70% for the first quarter of last year. Revenue from other internet services remained essentially flat at 25% of total revenue compared to the same quarter of last year and while we are disappointed in this growth level, as Elliot explained, with the release of our upgraded email system, we expect growth to begin to ramp over the next few quarters. The primary drivers that we expect to contribute to the continued shift in revenue mix are the increased contribution to other internet services or hosted email, the recognition of revenue from our recently acquired CNAME domain name portfolio and to a lesser extent, the revenue we generate from the sale of domain names. Revenue from advertising and other content sources for the first quarter increased 65% to $1.4 million from $844,000 for the first quarter of 2006. Main contributor to the growth in advertising and other content revenue continues to be direct navigation revenue, which accounted for $475,000 of the increase. Excluding direct navigation revenue, advertising and other content source revenue grew 9%. Advertising and other revenue as a portion of total revenue increased to 7.8% from 5.5% for the first quarter of 2006. Cost of revenues for the first quarter increased to $12.1 million from $10.5 million from the first quarter of last year, primarily as a result of higher costs attributable to increased volumes of domain registrations and other internet services of $1.2 million, and an increase in network costs of $372,000. Cost of domain names, this portion of total cost of revenues was 72.6%, compared to $73.1 million from the corresponding quarter of fiscal 2006. While the cost of other internet services was 8.4% of the total cost of revenues compared to 8.9% for the first quarter of last year. Gross margin for the quarter was 32%, up marginally from both 31% to the first quarter of 2006 and 30% for the fourth quarter of 2006, pretty much in line with our expectation. Operating expenses for the first quarter decreased by $579,000 to $5 million or 28% of net revenue from $5.5 million or 36% of net revenue for the same quarter of fiscal 2006. As I usually do, to assist you in understanding our operating expenses, I will discuss them in terms of core operating expenses and other operating expenses. As a reminder, we define core operating expenses, as those costs relating to ongoing sales, marketing, development and administrative costs. For the first quarter, core operating expenses remained essentially flat with $4.8 million compared to the first quarter of last year. This speaks primarily to the good job we've been doing around expenses. Core operating expenses decreased as a percentage of net revenue to 27% from 31% for the first quarter of last year. Other operating expenses for the first quarter decreased by $595,000 by $166,000 compared to the first quarter of last year, essentially for four reasons

[Elliot Noss:]

Thanks, Michael. If you are listening to this call, you are likely a shareholder and if you are a shareholder, you are likely to be frustrated with the price of our stock. I can't tell you, how many times a month, somebody, an investor, a customer, a supplier, an employee asked me why our stock trades were traced. If any of you listening to these calls regularly know while we've stepped up our efforts in terms of marketing the company, our primary focus is on operating the business. And we think that in terms of operating the business, we've done a good job. I'm sure most of you also know that last quarter we announced the open market share buyback program. And as noted, under that program, last quarter, we bought and canceled 1.5 million shares. When we're engaging in open market transactions, we have to follow both AMEX and TSX rules. And within the slightly more stringent TSX rules, we bought all of the stock we were able to buy. Every quarter that the business moves forward and the stock price remained the same, the value in the stock increases. We will continue to look at all of the options available to us to see that this value is reflected in the price. As everyone on this call recognizes, investing is about risk and reward, with the objective being to maximize reward and minimize risk. And thinking about what I believe, there is such value in Tucows, I was thinking about the Tucows' investment proposition, those factors that I feel make this company an attractive, long-term investment opportunity. And what I've realized is that what those factors add up to for investors is low risk, low market risk, low business risk and low financial risk. From a market perspective, and I have said many times before, we have a significant wind in our bags. All of the macro metrics, growth in internet usage, growth in internet advertising, et cetera, are trending in the right direction and within this macro environment, the market for internet services is rapidly expanding. As the internet services market grows, the service provider market, our customers also grows. As a trusted supplier to more than 7,000 service provider customers worldwide, we are well positioned to capitalize on this huge secular growth. We participate in strong growing markets, less market risk. From a business perspective, we have a strong track record of execution. The existing management team has directed the evolution of Tucows from a share ware website to a leading diversified internet services company, growing from revenue of $4 million to more than $60 million over the past seven years. We have achieved 22 consecutive quarters of positive cash flow from operations, 19 consecutive quarters of profitability, and 17 consecutive quarters of revenue growth. As you have heard me say earlier and many times previously, we have significant leverage in our business. The benefits of which are just now becoming evidence in our financial results. We deliver consistently strong business results, low business risk. Finally, from a financial perspective, with 90% of our revenue recurring, both management and investors have excellent visibility into the future. With a strong balance sheet, supported by the steady generation of cash flow from operations, we have well established customer relationships with the majority of our growth expected to be generated by existing customers. We have relatively low capital expenditure requirements or other needs for capital. We have a high degree of reliability, predictability and visibility. Low financial risks. Make no mistake about it. Tucows is a growing business. We've consistently delivered growth over the years from $4 million in revenue in '99 to $60 million in revenue in 2006. And you line up the reward of our solid consistent growth against this low level of risk. We believe, it puts Tucows in an extremely favorable light. I would now like to open the call for questions. Operator?

[Operator:]

Thank you. Ladies and gentlemen, we will now conduct the question and answer session. (Operator Instructions). One moment for your first question. Your first question comes from Thanos Moschopoulos of BMO Capital Market. Please go ahead.

[Thanos Moschopoulos:]

Hi good afternoon.

[Elliot Noss:]

Hi, Thanos.

[Thanos Moschopoulos:]

Hi, Elliot. It's regarding the Nitido relationship. I just want to dig down a bit more there. Is this one-time licensing fee you're paying? Is this subject to the volumes you are doing? How does that work?

[Elliot Noss:]

This is a one-time licensing fee as well as a small ongoing royalty.

[Thanos Moschopoulos:]

Okay. Not significant enough there, really have to worry about it from a margin perspective?

[Elliot Noss:]

No, it doesn’t impact our go-to-marketability at all.

[Thanos Moschopoulos:]

Okay. And could you actually spell Nitido? I was having difficulty --

[Elliot Noss:]

Nitido. It's actually a Spanish word.

[Thanos Moschopoulos:]

Okay. And just to clarify. You said the integration there is complete and you're not going to market with that combined offering?

[Elliot Noss:]

That's right. In the month of May, that will be coming up.

[Thanos Moschopoulos:]

Okay. Any specific features that will -- so this is being on par with some of the other services or are there specific features that would perhaps take you ahead of those, in your view?

[Elliot Noss:]

First and most importantly, I think it’s a fantastic webmail experience. We've now started to use that webmail internally on top of the new infrastructure we built. And, I would tell you that the early kitchen table tests are extremely positive. In terms of going beyond, some of the things that you've seen from a lot of the big folks, that I generally mentioned, I do think that there is really interesting treatment of video and image files that, it's a matter of taste but it's better than anything that I've seen. I look forward to showing you some of that. But I think that really, where we want to step out and differentiate is now over the coming quarters where our view of webmail as desktop will really start to become more evident.

[Thanos Moschopoulos:]

Okay. On the NetIdentity side, you said that the customer attention there has been good. Can we assume over 80% range or --?

[Elliot Noss:]

I don't have a break down of our percentages and I would need to kind of ground those in historical, but I am really comfortable to say it exceeded our expectations. We tend to be realistic when we are looking at the business as you know. And, we were quite pleased. The numbers are good and they provide sort of a great base to go forward from. And really, I think more than anything else, it speaks to the stickiness of that surname as email address concepts. We think we in no way want to use that stickiness to take anything for granted. We just wouldn't think like that. But, boy, if you've had your surname for years as your email address, as we believed it would be, it's very, very difficult to give that up. And we think going forward as we start to make that available for the wholesale channel that stickiness becomes something that we can leverage on a much broader scale.

[Thanos Moschopoulos:]

Okay. On the OpEx side, you came a bit below my numbers, which is good. Going forward, anymore opportunities for continued cost savings or should we expect that to rise going forward to the business, can you just spill that out?

[Elliot Noss:]

Well, I'm just going to push it back to that standard metric that I've put out where OpEx should grow no more than half the rate, as margin is growing. We've gone through some pretty big changes around the email platform, around the email defense platform. It is often the case, if that stuff settles down it’s always possible that opportunities present themselves.

[Thanos Moschopoulos:]

Okay. And, I guess can we talk a bit about the [park pages] business. You are seeing some good growth there. I guess can you provide a bit of color as to how that's proceeding, I mean the shifts you are taking to help that continue further?

[Elliot Noss:]

Sure. I think that we are now to the place where we are starting to sharpen the pencil a bit around things like the layout around the park page and trying to look at steps to refine our yields. Its not something you would see live on the web right now, but that's certainly where the work is going on. I would note though that the growth that we've experienced has really been a function of volume. One of the things that's been experienced industry wide and it's been discussed in a number of other places is that on a pure yield basis, some of the Google yields have been actually going down. And, obviously that's not something that we expected to happen nor do we expect to continue. But it is something that we've had to manage into.

[Thanos Moschopoulos:]

Okay. If you could define what do you mean by yield?

[Elliot Noss:]

It's just what your take will be per 1,000 pages.

[Thanos Moschopoulos:]

Okay. I got you. Like what proportion of the people coming to, let's say, watch click on something.

[Elliot Noss:]

No. It's less about the clicks.

[Thanos Moschopoulos:]

Okay.

[Elliot Noss:]

More about the value of those clicks.

[Thanos Moschopoulos:]

I got you. Okay. And then my final question, the domain business seems to do well, I guess no particular changes in the committed front there, just continues to proceed as it has historically with ongoing good growth.

[Elliot Noss:]

Yeah. I think that's right. The next big change will really be if something happens in the process for new gTLDs, and that work is ongoing on a policy level and hopefully over the next couple of quarters, we will see some real progress there.

[Thanos Moschopoulos:]

Okay, great. Thanks. I'll pass the line.

[Elliot Noss:]

Thanks, Thanos.

[Operator:]

Your next comes from [Warren Deralac] of Raymond James. Please go ahead.

[Warren Deralac:]

Hi, gentlemen. Good quarter.

[Elliot Noss:]

Thanks, Warren.

[Warren Deralac:]

Couple of questions and thoughts, more on the peripheral side of things, in light of the business revenue increasing in the scale you talked about where you create some leverage there. And what we may [foresee] this value in stock price here. The guidelines and restrictions you have on buying back shares. Is there a serious consideration given to other means of doing it, at a pace that maybe more apt to benefit the company's shareholders on a timeliness basis? And then, I'll just look to the other question, and that is again peripheral question. Will there come a time where consideration might be given also to both credibility and exposure to consider the NASDAQ Exchange over the AMEX?

[Elliot Noss:]

Let me deal with the second question first. And so, I will come back to that buyback question. Warren, I think right now, as it relates to NASDAQ. It's not something we are really discussing or thinking. But I will tell you that our experience was for years. I had people saying to me, that one of the reasons that the stock price was undervalued was because we traded on the OTC. As, you know, the stock traded on the OTC from 2001 through 2005. We expected, when we did the secondary offering in 2005 and listed on the AMEX and the TSX that, that would in a significant way address that comment. And I will tell you that all of the shareholders at the time that we spoke to the banks, analysts, et cetera, felt the same way, "Yes, boy that will be much better". We experienced no benefit from that effectively, as it relates to the stock price. So, I think its kind of something that as you are looking at it from a distance, I understand you, sort of saying, "Hey, you know, what about this?" But our experience was what it was, and I really think that information is readily available now and markets have reached such a level of efficiency that I am not sure that, that would have a material impact. It’s not to say that at some time it doesn’t become appropriate for a host of other reasons. I don’t believe it’s the cure to the ills of the stock price. And as it relates to your first question, I think I kind of referenced back two earlier comments that I made in my remarks. One that, it is certainly the case that every quarter the business continues to progress and the stock price stays the same. We just think there is more value in the stock. And two, its incumbent upon us to look at all of our options in that regard.

[Warren Deralac:]

Okay, thank you.

[Elliot Noss:]

Thanks, Warren.

[Operator:]

Your next question comes from Aram Fuchs of Fertilemind Capital. Please go ahead.

[Aram Fuchs:]

Yeah, it’s Aram Fuchs, Fertilemind Capital. I don't agree with you, Elliot, I don’t think it matters what stock seems here as, I think it's important just to focus on generating free cash flow. And with that in mind, I was wondering if you could tell us, what shareholders got for their $1.2 million and expenses for new hardware for the email and what shall we look going forward on CapEx for that business?

[Elliot Noss:]

Sure. So, I think first, when you say what shareholders got, I think that was part of just kind of laying in what we needed to sort of do the launch to step up at a systems level. I don't think that's something that you would expect to see on a continuous basis. We made the comment previously that CapEx for 2007 would be below levels of 2006 and we are quite happy to stick to that. I think given the nature of the work, the type of work that we did, let's say for Q3, Q4, Q1 of this year, that, what you've seen are some outsides CapEx investments. It was also the case that this quarter, we moved datacenters. That something that you do once every four, five or six years and our VP in charge of that, her comment is we want this move to be done so well that we never move again. Obviously, when you do a move like that, when you are moving hundreds of servers, it's an opportunity to upgrade around some switches and some routers and other equipment of that nature. So, you have also seen that play a role here. And then you get down to things like, hey, let's improve the racking and the cabling et cetera. So, you've got some events that are not part of the run rate business, but I think it is contributed to that.

[Aram Fuchs:]

And then regarding the NetIdentity, when will you open that up to your resellers, the surname based emails. And why do you think you've been pretty patient with that process?

[Elliot Noss:]

Well, I don't think anybody in this building would call me patient. I appreciate you saying that. So, I will take that as a corporate comment as opposed to a personal one. I think that Aram, because of a bunch of unintended stuff, anybody here planned for some of the problems that we experienced in the back half of last year. And that just back ups the road now. So, instead of playing offense, which, work like this would be, you end up playing defense. And that just backs things up. So, I don't have a release date, I can just tell you that I think we are all very excited to get that out as soon as possible.

[Aram Fuchs:]

And just one last question about spam industry wide, it seems that surge in spam in Q4 of '06 and perhaps the first part of '07 has been solved. Is that a correct assumption, at least temporarily?

[Elliot Noss:]

When you say solved, I think in an industry level, what everybody is doing is just digging deeper trenches and putting more and more sentries around the forts. They just get used to operating in thinner oxygen. I guess it would be the best way to describe it. So no, I don't think it's solved. I think it's a cat and mouse game that we have to continually be playing. At the same time, it's a lot more effective for us to do that in a centralized way. If we are doing it right, then it is for service providers in a one-off way around 50,000, 5,000, 1,000 customers having to lay the stuff in. So, we think that as the macro trends that probably helps the business, not hurts it.

[Aram Fuchs:]

Great. Thanks for your time.

[Elliot Noss:]

Thanks Aram.

[Operator:]

(Operator Instructions). There are no further questions at this time. Please continue.

[Elliot Noss:]

Thank you, operator. We will look forward to speaking with you all again next quarter.

[Operator:]

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