Tucows Inc.
Q1 2008 Earnings Call Transcript

Published: 8 May 2008

[Operator:]

Welcome to Tucows Inc., first quarter and year end 2007 conference call. I would like to advise everyone that this conference call is being recorded and we will now turn the call over to Leona Hobbs. Please go ahead Leona.

[Leona Hobbs:]

Thank you, operator. I will start with a clarification. This is the first quarter 2008 conference call. Good afternoon and thank you for joining us today. With me is Elliot Noss, our President and Chief Executive Officer; and Michael Cooperman, our Chief Financial Officer. Earlier this afternoon, Tucows issued a news release reporting our results for the first quarter of fiscal 2008. The news release and other information are available on our website at about.tucows.com and just click 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 could cause actual results to differ materially. These risk factors are described in detail in our documents filed with the SEC, specifically the most recent reports on Form 10-K and 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. On today's call, I will provide an overview of our business during our first quarter ended March 31, 2008. Mike will then review the financial results before returning the call to me for a discussion of our growth opportunities. Turning to the first quarter

[Mike Cooperman:]

Thanks Elliot. As we anticipated our results for the first quarter were negatively impacted by the three factors. Continued strength of the Canadian dollar, price reduction that we implemented on wholesale Domain Registrations in the third quarter of last year, that are competing the increasingly competitive market, and the cost of maintaining multiple email platforms as we continue to transition our customers to our new email service. Net revenue for the first quarter of fiscal 2008 grew 5% compared to the same quarter of last year to $18.7 million, which is our second highest revenue total ever. Growth in revenue was primarily the result of higher Domain Name Registration revenue, Domain Portfolio Service revenue and Retail Services revenue. Cost of revenues including network costs for the first quarter increased by 16% to $14 million and primarily reflects our lower margins following the price reduction on wholesale domain names and the higher registration fees we are paying as result of the 7% registry price increase from October last year. In addition network costs were $92,000 higher than the first quarter of last year, mainly as a result of the additional labor, band width and co-location costs we incurred in the first quarter of this year, as we continue to carry multiple systems at our data centers or our Hosted Email Service. However, as a result of the reversal of an accrued in the first quarter of last year in the amount of $220,000 with some network operation programs that we have set-up in prior periods and choose not to pursue. With respect to the costs associated with the multiple Email platforms as Elliot discussed we are now in the last stages of migrating our customers to our new Hosted Email platform. Our new data center is up and running. With the migrations nearing completion, we expect to realize the benefits and considerable savings we have mentioned here on prior calls during the second half of this year. Gross margins for the first quarter was 25% compared to 32% in the first quarter of last year. The decrease was primarily the result of the impact of the Wholesale Domain Registration price reduction and to a lesser extent on factors like the impact of high network costs due to our carry multiple Email platforms and the increased cost associated with our portfolio Domain names. I think it is worth noting that we are expecting the year-over-year impact from the price reduction to be lower in the second quarter as a result of seasonality and even lower in the third quarter when the price reduction will have been in place for a year. Looking at gross margin contribution for each of our revenue sources

[Elliot Noss:]

Thanks, Mike. If I was an investor looking from a distance at the financial results of Tucows, I would certainly see the last six months as a step back. However, remember strong financials are preceded by strong execution. Inside the building for last year or so and especially the last six months have been marked by some of the best execution at Tucows that I can remember. We believe performance follows. We built and launched a new email platform and data center and will soon complete migrations from the old system. For investors that means drastically reduced operating cost and much simpler maintenance, which leads to increased customer satisfaction and increased sales. We reduced our pricing for domain registration and changed our pricing methodology, which we have now used to reinvigorate a service that strategically feeds both domain portfolio and email services. With Domain portfolio services we changed the way that registrars create value out of domain registration, by positioning ourselves to not only take advantage of revenue growth but also to create a long-term asset in the domain name portfolio. We are nearing the beta date of launch of our new retail platform, which will combine three different unrelated brands under one new brand, creating immediate opportunities to cross sell and attract new customers with a differentiated offering in a crowded market. On this point, I know that a number of investors and customers of retail services. I wish to note that any of your interested at signing up for the beta, should email the owner or myself and we will be happy to get you in. These are not feel good operating notes, but are important milestones that enhance our ability to grow revenue and cut cost, and will greatly contribute to increased cash generation and profitability right away. This quarter marks the financial trough. The event subsequent to quarter end, like the sale of direct navigation names can give investors real comfort' financial performance improves from here. We are far from finished. We will soon be providing some exciting news about the tucows.com website. We have some other non-strategic assets that we are still looking at realizing value from. Lastly, we have announced today that the Board has reinstated the open market stock buyback program that was previously in place. Despite, the rise in the Canadian dollar, despite the required work we had to invest in email and retail, 2008 will have solid increases I revenue and generation over 2007. Solid financial performance invariably follows solid operational performance. With that I will now turn the call over to operator for questions, operator.

[Operator:]

Thank you. Ladies and gentlemen we will now conduct the question and answer session (Operator Instructions) The first question comes from Thanos Moschopoulos from BMO Capital Markets go ahead.

[Thanos Moschopoulos:]

Hi, Good afternoon.

[Elliot Noss:]

Hi, Thanos.

[Thanos Moschopoulos:]

Elliot regarding the hosting customers that you sold off, roughly how much revenue would be associated with that business. If used some back of the envelope math that we saw looking about a $1 million or $2 million in a year. Is that about right?

[Elliot Noss:]

Year closer to your low-end and high-end, we have released the financial details but its pretty easy to find, people pay revenue multiples in this industry at pre-time wage.

[Thanos Moschopoulos:]

Okay.

[Elliot Noss:]

Your are in the right place.

[Thanos Moschopoulos:]

Okay, I am just going a bit more deeper into the sales that you made following quarter end I mean, obviously the sale of names will be potentially one of your highest growth areas going forward and still I guess one of the most challenging ones, just try to model for -- outside observers like ourselves, can you provide me a bit more color as to what type of regularity we should expect to see in this revenue streams going forward and may be how the process went in this particular instance, in terms of timeframe, in terms of how the bottom is lined up, in terms of how the names are chosen to be sold, that kind of thing?

[Elliot Noss:]

Sure. So let me start with the good news Thanos. This sale is the start of this being easier to bottom, it is not [very difficult] So, good news there for you. The way this worked is we take a bundle of -- as we talked about in the past we really wanted to bring some regularity to this. So we take a bundle of names that literally are from our perspective, financial assets. So we are really picking a group of names that is going to be not more than X in total and will provide a specific level of revenue that we believe is based on our historical performance. We will then place them essentially in an account that will allow a prescreened group of buyers to follow along through the course of roughly 30 days. They can all watch the names, they can see how they perform, and they can see them using the usual metrics as they as inventory holders are very familiar with. At the end of the process they win.

[Thanos Moschopoulos:]

Okay. So I guess what gives you confidence that this can become more regular is, you are basically choosing the [batch] size, you are choosing when and how to make the prescreening available. So again as long as you keep in this in sort of a regular basis…?

[Elliot Noss:]

What gives me the most comfort is that the buyers are saying, hey, bring it on, we love more.

[Thanos Moschopoulos:]

Right.

[Elliot Noss:]

Right more than anything else. We would like to do it on a regular basis. Regular might be monthly, it might be bi-monthly but it is a regular basis where there is always some names under viewing and there are always some names under transaction.

[Thanos Moschopoulos:]

Okay.

[Elliot Noss:]

We have an inflow of names every month. Right. We think it is appropriate to have an outflow as well.

[Thanos Moschopoulos:]

Right. Okay. Okay. That is to say it seems there is an appetite there as far as the buyer’s perspective.

[Elliot Noss:]

Look from a buyer’s perspective -- the [joke] in that business, this is a great financial investment. One of the things that we are choosing to do here, I will be explicit about it, who knows, maybe I will take some heat for this. We are certainly selling less than we think our multiple should be in the market, right. So it would be easy for me to just pile up this revenue and kind of hide things a bit. I do not think that is the right long-term approach to value them, right. So these are good financial investments so there'll be no shortage of buyers.

[Thanos Moschopoulos:]

Okay. Regarding the names that you are holding onto, how far along are we in the process in terms of getting your optimization partner to really go back and optimize the landing pages there. Is that process pretty much complete, or is there still further room for upside as they go back and try to [screws up] more revenue from that?

[Elliot Noss:]

So I think that there is, first of all, always room for upside and tweaking. I would say that big optimizations we have taken advantage of. There is a little bit of optimizing to do on a portion of the inventory, maybe 15 or so percent of it; that really has not been optimized yet. Then you can start looking for more micro opportunities; that can be names that might fall into a certain category that you can get upside returns on that type of things.

[Thanos Moschopoulos:]

Okay. Just finally on the email business, I guess you covered a lot of this in your prepared remarks. I thought that we would see a bit more growth by this point in time. Again, there is really an issue where you are just waiting for the migration to be complete and once that is done, we should have some of the yields have been in the pipelines start to come to fruition?

[Elliot Noss:]

Well, I think that as much as anything else, migrations are a non-trivial task and they really consumed a lot of the time and effort of everybody. It is not a technology exercise and isolation. Sales account management marketing, those people are all spending lots and lots of time working through the migration. I might say that they have got to prepare customers. They have got to work with customers on specific one-off needs that they might have. The bigger the customers, the most complicated their needs. So it takes up a lot of their energy and time in the. However, on the top of that, I think that we are just starting to get to the place where fruit is ripening in the pipeline. So, we are seeing more deals fall out with more and more regularity. Once we are finished with migrations, then we can really start to turn and focus a bit more on the self-served business, where there are really big opportunities as well.

[Thanos Moschopoulos:]

Okay, great. Thanks a lot. I will back in line.

[Elliot Noss:]

Thanks.

[Operator:]

(Operator Instructions) Your next question comes from Robert Cavallo from Research Capital. Please go ahead.

[Robert Cavallo:]

Hi, guys. How are you today?

[Elliot Noss:]

Hi, Rob.

[Robert Cavallo:]

Just a couple of quick questions for you. Maybe just taking a step back, looking at, I guess, the G&A costs you are talking in the non-core. Maybe you can just quickly recap those again. I got, I guess, the $135,000 on [cruise ship] that was related to the FX impact. The amortization figure again you stated was, was that $385,000?

[Mike Cooperman:]

That is right.

[Robert Cavallo:]

Then there is a $137,500 from an accrual last year that was there, so I am assuming that means that the $166 last year plus the $137 would be a better?

[Mike Cooperman:]

Would be better compared to.

[Robert Cavallo:]

A better comparison. Okay, so I do have that straight. Ohe on the gross margins, did you indicate the gross margin was going to be lower over the next quarter or two?

[Mike Cooperman:]

No, I said that the impact of the price reduction would have less of an impact in the second quarter.

[Robert Cavallo:]

Okay.

[Mike Cooperman:]

Less of an impact in the third quarter, because the cost reduction occurred in the third quarter of last year so it would have been around for a period of the third quarter, for the full year.

[Robert Cavallo:]

Okay. Sorry about that. I misunderstood. Another quick question, I guess, do you know, can you give me a rough ballpark of the number of domains you have under management at quarter-end?

[Elliot Noss:]

It is a little bit under $6.8 million now and that is direct and then there is another million or so indirect, I think it has been 7 something like that 6, 7, 8.

[Robert Cavallo:]

Okay, it is the high six. Okay, perfect. Then you said up to maybe just under $8 million?

[Elliot Noss:]

Yeah, I think it is 7.9% because you probably get the cake for $8 million ready pretty soon internally of course.

[Robert Cavallo:]

Okay.

[Elliot Noss:]

I was not asking for the cake.

[Robert Cavallo:]

No. Then one last question, I guess, just on the messaging revenue.

[Elliot Noss:]

Yeah.

[Robert Cavallo:]

Could we, I guess start looking for this to grow going forward or just trying to continue that what we see in the last year or so?

[Elliot Noss:]

I think we can look forward to grow going forward I mean there is a possibly that we can have next quarter kind of around the same number, but if we do, that will be because there might be another enterprise customer to trade out that will set off against the ones coming in. However, you are seeing pretty much the floor there. It should grow -- I mean what I know and what I see, it should grow next quarter.

[Robert Cavallo:]

Okay. But, you are saying obviously not necessarily worse case, but this past quarter you are sort of at bottom?

[Elliot Noss:]

Yeah. If it is not, it is really, really close, I mean in terms of dollars, not in terms of time.

[Robert Cavallo:]

Sure. However, the going lets say second half of this year and into '09…

[Elliot Noss:]

It is going to be settled all right.

[Robert Cavallo:]

Okay. That sounds good. I tried shooting everything I had for now.

[Elliot Noss:]

Great, thanks.

[Robert Cavallo:]

Thank you.

[Operator:]

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

[Aram Fuchs:]

Yeah. You mentioned that you are now unhappy with the efficiency of selling direct navigation names. I was wondering if you can talk about the generics, you had previously last year signed up with Fabulous and [After Name] in trying their premium.

[Elliot Noss:]

Yeah.

[Aram Fuchs:]

Is that working well, I thought Fabulous consummated a pretty generous deal towards GoDaddy; to use GoDaddy's retail call centers. What other interesting ideas are out there, that can help us?

[Elliot Noss:]

So there we are deeply engaged and the difference between retail and wholesale is in getting our biggest customers to start selling it and we are sold on it; we think that it is demonstrable based on what is going on with GoDaddy in a couple of the other retailers out there that there is very nice money to be made there. We now have to go through the exercise of having our sales folks be able to help our customers learn how to sell it. So it is just that indirect is holding it up but there is some very specific programs that are focused on just that kind of coming in the second half, that June, July timeframe. I think when you are talking about those premiums, those gems, those brandables, there we are going to see a more immediate financial impact on selling them ourselves directly out of the inventory, with some of the efforts that I talked about with direct sales being put against that. Those are just very, very lucrative transactions. On a $5000 name where we are making 20% that we are splitting with our customers it is $500 on our end for the transaction, When we are selling out of the Gems, it is 50,000 or 100,000 more for transaction. So why you see the more immediate impact and remember the [patent] numbers. We can sell three, four, five Gems a quarter for 10 years and not have problem. Right.

[Aram Fuchs:]

Right. So there is some sort of other arbitrating line between pushing that to retail partners and then the Gems right. Is that what we are going to use there; three different strategies there?

[Elliot Noss:]

If it is not baked into there, who is lookup Aram?

[Aram Fuchs:]

Right.

[Elliot Noss:]

Then it is not effective. Right.

[Aram Fuchs:]

Right.

[Elliot Noss:]

It is really teaching them to treat that who is lookup, almost like a search is from a marketing perspective and everything about the way that search is commercialized?

[Aram Fuchs:]

Right.

[Elliot Noss:]

It is changing people's aspects because of not the way they see the Domain name lookup right now.

[Aram Fuchs:]

Okay, but that is basically the [upside] space there is no other complication, right?.

[Elliot Noss:]

No, no absolutely. That is just, hey put it in your results, here is how you market it. Here is how you deal with the $5000 transaction instead of $15 transaction, Here is all the support that we provide behind it. Then we have customers’ interest. Once you have got them interested then it is okay. That is getting them in the roadmap.

[Aram Fuchs:]

Okay.

[Elliot Noss:]

Right. However, still -- how are they going to cut.

[Aram Fuchs:]

And then what can you tell us on the thinking behind stock buyback versus dividend. Is there anything that you can give us color on?

[Elliot Noss:]

I think that both have a place and that it is going to be situational. We got a note that we have got to deal with the end of June, Aram, and you know I think that is going to take precedence to either. Then it is a question of, I would almost call it tactical versus strategic; buyback is tactical, dividend is more strategic. In other words, to go down that dividend road is a very long-term decision. It is not one that where the business in the balance sheet are at this quarter would make a lot of sense. However, I think that both of those have their place.

[Aram Fuchs:]

Okay, and lastly the data in the retail business, can you talk about what you see in it about the strategy behind, what are you improving there that you think will benefit the retail business.

[Elliot Noss:]

All right. I just want to get you into debate Aram. You are on my target list.

[Aram Fuchs:]

Okay, I will be there.

[Elliot Noss:]

Excellent and this is in a couple of weeks, you will see. Then next quarter when you come on and ask a question you can tell us how much you like it.

[Aram Fuchs:]

Okay, good. Thanks for your time.

[Elliot Noss:]

Thanks there.

[Operator:]

There are no further questions at this time. Please continue.

[Elliot Noss:]

Great. Thanks Operator. I look forward to seeing you all next quarter.

[Operator:]

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