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Tucows, Inc.(NASDAQ:TCX)

Q4 2009 Earnings Call

February 16, 2010 5:00 pm ET

Executives

Elliot Noss - President and CEO

Michael Cooperman - CFO

Analysts

Thanos Moschopoulos - BMO Capital Markets

Operator

Welcome to Tucows, Inc.’s fourth quarter fiscal 2009 conference call. Earlier this afternoon, Tucows issued a news release reporting its financial results for the fourth quarter of fiscal 2009. The news release and financial statements are available on the company’s website at tucowsinc.com under the Investors heading.

Please note that today’s call is being broadcast live over the Internet and will be archived for replay both by telephone and via the Internet, beginning approximately one hour following the completion of this call. Details or how to access the replays are available in today’s news release report to the third quarter financial results as well as at Tucows website.

Before we begin today, let me remind you that the matters that the company will be discussing include forward-looking statements, and as such, are subject to risks and uncertainties that could cause actual results to differ materially. These risk factors are described in detail in the company’s documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q. The company urges you to read its 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.

Elliot Noss

Thank you, operator. Good afternoon, and thanks for joining us today. With me is Michael Cooperman, Tucows Chief Financial Officer.

In keeping with the usual format for our calls, I will begin with a brief overview of our financial performance and some of the operational highlights for the fourth quarter and the fiscal year. I will then turn things over to Mike for a detailed review of our financial results. Then I will return for some concluding comments before opening the call up to questions.

The fourth quarter capped off a year in which we delivered consistently solid financial performance driven by our strong competitive position and increased efficiency within the business. Revenue for the fourth quarter increased 6.1% year-over-year to $20.3 million and marked our fourth consecutive quarter of revenue in excess of $20 million. Revenue for the year was a record high and surpassed the $80 million mark for the first time at just shy of $81 million.

Net income less other income was $7.7 million. Cash flow from operations was $6.5 million and cash EBITDA was $7.6 million, all of which were up significantly from 2008. We are especially pleased with these results in the context of the challenging economic environment.

Looking at the individual elements of our business the OpenSRS domain service continued to perform well in the fourth quarter. Both new and renewal registrations showed growth compared to the third quarter with new registrations up more than 10%. On a year-over-year basis new registrations were up more than 18% and renewals were up just over 10%. Again, we see this growth as demonstrative of our strong competitive position.

Year-over-year growth in the number of transactions elevated domains under management to almost 9.7 million, an increase of 9% compared to 2008 year-end levels. For 2009 as a whole, domain service revenue grew almost 10% compared to 2008. We believe the momentum we experienced in the OpenSRS domain service towards the end of 2009 bodes well for the performance of this area of our business in 2010 as we continue to grow revenue from our existing customers and win new business. OpenSRS remains the most consistent part of an extremely consistent business.

YummyNames, our domain portfolio group also had another strong quarter with revenue up 78% year-over-year. It is now the case that YummyNames is generating consistent revenue on a quarterly basis. In 2009 YummyNames revenue grew by 35% compared to 2008. On our last call, I mentioned we were experiencing strong momentum selling brandable domain names. That momentum carried on throughout the remainder of the fourth quarter and resulted in almost $250,000 of sales in the quarter.

Where you can really see the progress in this component of our business is the number of individual name transactions which has grown more than tenfold to over 150 in the fourth quarter of 2009 from just 14 in the fourth quarter of 2008 with the average price remaining relatively constant. This strength in brandable domain sales which I will note provides a much greater opportunity for growth than bulk sales is the result of exposing our inventory to a wider audience through our distribution agreements with Name Media and now Sedo, the leading secondary domain market and distribution networks and continued efficiency in our day to day processes. Our unique focus on brandable names is paying off.

Going forward we have also stepped up our relationship with Oversee, the leading auction house in the industry which should help grow our sale of Gems which is another area of potential growth although much less predictable than brandable names.

Turning to our content services business the fourth quarter marked the first anniversary of the launch of butterscotch. Since 1994 Tucows has made software accessible to the average consumer through reviews and downloads at Tucows.com. Now with butterscotch we have expanded on that mission making all consumer technology accessible through video shows and tutorials. The first year of this broader mission has been a great success operationally.

During that period we have been keenly focused on steadily growing content that is both timely and relevant targeting key trending topics like the Windows 7 launch in October as well as ever green content. The end of the fourth quarter we had more than 2,000 videos available on butterscotch. At the same time, as we discussed early on, it has been our goal to gradually migrate Tucows.com users over to butterscotch through increased integration of the two sites, an integration that has been readily apparent to anyone visiting those sites today.

Our progress on both fronts is also evident in the butterscotch traffic metrics. Page views for the fourth quarter of 2009 almost doubled from the second quarter and site visits were up almost 90%. Moreover, video plays have steadily ramped higher with each successive quarter reaching 1.4 million in the fourth quarter of 2009, up from 1.1 million in the third quarter. In addition, daily video plays on You Tube have doubled for three consecutive quarters from 400 per day in the first quarter of 2009 to 3,200 in the fourth quarter.

From a financial perspective although the fourth quarter 2009 revenue was relatively flat year-over-year we have managed to transition our advertiser base to be healthier and less dependent on search based advertising than in the past. Ad Sense revenue has trailed off dramatically and we have replaced that with video advertising, corporate video and greater success with strategic advertising.

Turning to Hover, our biggest success in 2009 was the completion of the integration of our three retail brands; our own legacy domain direct brands in the IYD identity brands that we added through acquisitions. We have presented a cleaner, simpler way to register and manage domain names and email addresses and for the first time in a number of years we have positioned the retail platform to something we can grow.

This line of revenue has been flat to down for the last several years. Right now in creating a simpler experience we may have overshot the mark somewhat. We have learned some valuable lessons and expect to launch the next generation of Hover this quarter. It is worth noting that 2010 has started off very well for Hover especially with respect to renewals.

In summary, we are pleased with the overall performance of the business for the fourth quarter and for the fiscal year. We are experiencing strong growth in both OpenSRS and YummyNames and the success of the relaunches of butterscotch and Hover should begin to show up in our financial results going forward. Accordingly, in 2010 we expect top line growth to come from a number of areas across our business and we expect to continue to deliver solid cash flow from operations. At the same time, we continue to be focused on driving efficiencies within our business.

I would now like to turn the call over to Mike to walk through our financial results in detail.

Michael Cooperman

Thanks Elliott. Net revenue for the fourth quarter of fiscal 2009 was $20.3 million, an increase of 6.1% from $19.2 million in the comparable quarter last year and marked our fourth consecutive quarter of revenue in excess of $20 million.

This year-over-year growth was primarily driven by increased contributions from domain services and YummyNames which were partially offset by the expected declines in email and Hover revenues that we highlighted in prior calls. Cost of revenues before network costs for the quarter increased by $1.1 million or 8.6% to $13.7 million from $12.7 million for the fourth quarter of 2008.

Network costs for the quarter decreased by $130,000 or 7.9% to $1.5 million from $1.7 million for the fourth quarter of last year. This decrease resulted primarily from a lower depreciation expense of $216,000 which was partially offset by slightly higher people costs to support the increased level of business activity.

Gross margin for the fourth quarter remained essentially unchanged from the same quarter of 2008 at 25% largely the result of a shift in the sales mix as well as the lower network costs I discussed a moment ago. Gross margin from our OpenSRS service which includes domain services, email services and other wholesale services was $4 million or 24% of net sales compared to $4.5 million or 27% of net sales for the fourth quarter of 2008. This decrease primarily resulted from the declining email revenue as well as the impact of the registry price increases and the success we have been seeing from our strategy to grow revenue from higher volume, lower priced customers.

Gross margin from domain services was $2.6 million, down marginally from $2.7 million in the same quarter of fiscal 2008. On a percentage basis, gross margin from domain services decreased to 17.3% from 19.4% for the reasons I have already mentioned. I would also like to note that Verisign has announced it will implement a further price increase of 7% effective July 1 of this year.

As expected gross margin from email services decreased to $689,000 from $1 million for the fourth quarter of 2008 for the reasons we have discussed at length in previous calls. The last of the three media companies who made the decision to bundle their email requirements into larger supply contracts completed its migration during the quarter. So going forward we would expect to see this revenue stream stabilize.

Gross margin percentage for email services was 86% down from 92% for the fourth quarter of last year. Gross margin for the YummyNames, our domain portfolio services category, increased by $649,000 to $1.3 million from $680,000 for the same quarter of fiscal 2008. This increase was due to the strong domain name sales that Elliott described earlier which grew by 945,000 compared to the fourth quarter of 2008. These increases were partially offset by a decrease of 296,000 in the delivery of third-party advertisements on parked pages.

As we have explained on past calls, this decrease is a direct result of the impact the success our domain sales has on the volume of names we have available for advertising purposes. Gross margin percentage for YummyNames increased to 87% from 80% in the fourth quarter of 2008. Gross margin for Hover, our retail services group decreased to $764,000 from $866,000 for the fourth quarter of 2008. This decrease is primarily the result of our decision to reclassify certain retail customers acquired in the IYD acquisition that did not meet our definition of retail customers to OpenSRS as well as our decision to temporarily scale back our business development efforts while we transitioned our retail customers from our domain direct net identity and IYD services to Hover.

Gross margin percentage for Hover increased to 63% from 60% for the fourth quarter of fiscal 2008. Gross margin for butterscotch, our content services group decreased slightly to $449,000 from $458,000 for the same quarter of fiscal 2008. As Elliott discussed earlier any revenue decrease we have seen from either the Tucows website or in the contraction in yields from our syndicated Google fees have mostly been offset by an increase in advertising and video revenue. As a percentage of net revenue gross margin increased to 98% from 97%.

Total operating expenses for the fourth quarter of fiscal 2009 decreased by $3.1 million or 46% to $3.8 million or 18% of net revenue from $6.9 million or 36% of net revenue for the corresponding quarter of fiscal 2008. Breaking down total operating expenses into core and other expenses, core operating expenses which we define as those expenses relating to ongoing sales, marketing, development and administrative costs decreased by $78,000 or 2% to $3.9 million from $4 million for the same quarter of fiscal 2008.

As a percentage of revenue, core operating expenses decreased to 19% from 26%. The decrease in core operating costs is primarily related to our continued focus on controlling costs, in particular bank fees which were $200,000 lower as a result of the initiative we introduced at the beginning of 2009 to recover some of our payment processing fees. This decrease was partially offset by an increase in people related costs of $105,000.

Included in people costs in the fourth quarter is the amount of $180,000 for at risk compensation that was earned during 2009 as a result of stronger performance of the company. No at risk compensation was paid during the fourth quarter of 2008.

Other operating income for the quarter was $83,000 compared to other operating expense of $3 million for the same quarter of fiscal 2008. The favorable change in other operating expenses of just over $3 million is mainly attributable to foreign exchange and to a lesser extent the restructuring we announced in November 2008.

Looking at foreign exchange in more detail, we recognized a gain on foreign exchange of $540,000 during the quarter, inclusive of a mark to market gain of $277,000. This compares to a loss on foreign exchange for the fourth quarter 2008 of $2.2 million inclusive of a mark to market loss of $1.4 million.

As I highlighted on last quarter’s call, the mark to market accounting process has resulted in a significant non-cash derivative instrument asset on our balance sheet. At the end of December this non-cash asset has increased to $2.2 million from $2 million at the end of September. Please remember this asset will reverse in future accounting periods as we undertake mark to market assessments of our outstanding foreign exchange contracts and at that time will result in a recognition of a significant non-cash loss on foreign exchange for those periods in which these forward contracts [unwind].

Other operating expenses were also favorably impacted by the absence of $251,000 in severance costs we incurred in the fourth quarter of 2008 related to our reorganization. Net income for the fourth quarter of 2009 increased to $1.7 million or $0.03 per share from $1 million or $0.01 per share in the fourth quarter of 2008.

I will note that in addition to the foreign exchange impact that I described earlier, net income for the fourth quarter of 2009 benefited from a tax recovery of $493,000 while net income for the fourth quarter of 2008 benefited from other income of $3.2 million generated by the sale of the company’s equity position in affiliates.

Turning to the balance sheet, at December 2009 our balance sheet is significantly stronger than it was at December 2008. Cash and cash equivalents at the end of the fourth quarter of fiscal 2009 increased to $9.6 million from $5.4 million at the end of the fourth quarter fiscal 2008 and $8.2 million at the end of the third quarter. The increase in cash of $1.4 million from the third quarter of 2009 is attributable to the generation of $2.9 million in cash flow from operations which was partially offset by our repaying $479,000 on our bank loans, our investing $381,000 to acquire fixed assets and our use of $574,000 to repurchase 785,000 shares under the third modified Dutch tender auction offer which was completed in October.

I will note that subsequent to the end of the fourth quarter we used an additional $4.5 million in cash to purchase shares tendered in our most recent modified auction tender offer which concluded in January. After this tender the number of shares outstanding decreased by almost 12.5 million or 17% to 60 million.

I would also like to note that even after taking into consideration the payment for the most recent tender our cash position at December was more or less unchanged from the end of 2008 while our shareholder equity has increased by 45% from the end of 2008. Deferred revenue at the end of the fourth quarter of fiscal 2009 was $56.3 million, an increase of 4% from $54.2 million at the end of the fourth quarter of fiscal 2008 and a slight decrease from the $56.5 million at the end of the third quarter of fiscal 2009.

To conclude, we believe that the ability of our business to consistently generate cash flow remains strong. Our business remains well positioned to steadily grow our top line and we are experiencing the benefits of the initiatives we have undertaken to improve the efficiency of our business and manage costs. All of this supports our overriding objective to build long-term value and provide a strong foundation from which to continue to return capital to shareholders.

I would like to now turn the call back to Elliott.

Elliott Noss

Thanks Mike. It has been one year since we initiated the first of four modified Dutch auction tenders as part of our stated objective to return capital to shareholders. The most recent offer which was announced in December and closed January 13th was the most successful to date. That offer, as Mike talked about, provided the opportunity for shareholders to tender their shares at a price ranging from $0.61 to $0.70 per share.

Our intention was to purchase up to five million shares with the option of purchasing up to an additional 1.34 million shares if the offer was over-tendered. A very strong response resulted in tenders that exceeded this total and as a result we repurchased 6.34 million shares or almost 10% of our pre-offer outstanding shares at a price of $0.70 for a total of just over $4.4 million.

Total shares outstanding are now just over 60 million. All told, in the last 12 months we have purchased 12.4 million shares or more than 17% of the company for a total of less than $7.2 million. It remains our objective to continue to return capital to shareholders. In the short-term following the completion of the most recent Dutch tender, we implemented an open market share buyback program under which we have the ability to repurchase up to $10 million worth of stock via AMEX or up to 3.748 million shares or approximately 10% of our public float on the CSX. This Friday, February 19th, we will be in a position to buy on the open market.

As I have discussed on our calls a number of times in the past, one of the things that the public company structure does well is provide an efficient mechanism to return capital to shareholders either through share repurchase or payment of a dividend. We are not at this time announcing another Dutch tender offer. We will, however, continue to evaluate that option and for now will be opportunistic with respect to purchases in the open market. As always we will make any decision in this regard based on what we think the run rate multiple of EBITDA is at the time.

As we move forward we will continue to evaluate all means by which to return capital to shareholders. The hallmark of this business is and has been for some time consistent growth. I have been doing the same job for 14 years now and revenue has grown every year during that period. Again in 2009 we posted a new record. You can see the consistency [by] the different revenue streams. The OpenSRS business sells millions of units through over 10,000 service providers around the world, all at a very low price.

Virtually without exception we are selling subscription services and like the rest of the business names under management grows every year. The most important parts of the YummyNames, butterscotch and Hover businesses are also now extremely consistent. As a business operator that is what we strive for. As a business operator that is what we strive for. As a business owner, that is extremely desirable.

Yet markets today tend to be looking for catalysts for discontinuous change for public companies. As I have said, that is not what we deliver. While some may look at this as a negative, we believe the approach we have taken and our commitment to returning capital we are turning that consistency into a real demonstrable strength.

With that I would like to open the call to questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Thanos Moschopoulos - BMO Capital Markets.

Thanos Moschopoulos - BMO Capital Markets

You talked about the growth prospects on a number of different fronts. Just as we kind of look towards 2010 could you just tell maybe which of your lines of businesses you are most optimistic on? Which might represent a particularly good source of upside over the next year?

Elliott Noss

What I think you will see is sort of a couple of different things. First, with both butterscotch and Hover, with content and retail, those businesses over the last few years have been a bit of a drag on growth. So simply turning those businesses into a bit of a tailwind instead of a headwind would really help the overall growth picture.

We think there is good, consistent, reliable growth coming from the OpenSRS business which you will be able to see a little bit more effectively. I think with each of the businesses we are talking about with Hover, Yummy, butterscotch and especially with OpenSRS for us it is just about putting our heads down and grinding out more growth each month.

So again if you made me say hey what is the one thing I would look for in outsized growth I have always felt the opportunity around personal names was under-utilized. But at the end of the day in the day to day of the business I think there is really material and important growth opportunities in each of those lines of the business and they are primarily just about selling more and to more people.

Thanos Moschopoulos - BMO Capital Markets

On the premium domain side you talked about how on the one hand we have increasing distribution with some of the new partners we are bringing on. On the other hand you cautioned last quarter we are going to see a drop off from some of the non-repeatable sales going away. As you blend those together would it be fair to assume we will be looking at sort of a slight decline in 2010 from that combined stream relative to 2009? Is that the right way to look at it?

Elliott Noss

I think that is a conservative view. We always prefer a conservative view. I think again there in particular some of those bulk sales may have held down the growth. It is also one of the toughest areas to predict. We are really seeing greater interest in businesses from marketers, from entrepreneurs in appropriately naming their businesses. There is a much greater willingness or a much greater recognition that the right thing to do when you are starting a business on the internet is often to spend $500-5,000 and get an excellent name instead of trying to drop a vowel or be cute with some exotic CCTLD when naming a business.

That is happening on the demand side. It is tough to say how that will ramp up. I think that I am hoping for growth and would be just fine if that business was roughly flattish.

Thanos Moschopoulos - BMO Capital Markets

On the OpenSRS side in the past when we had ICANN price increases it seems like that really hasn’t had a noticeable impact on growth. Is that fair or do you typically tend to see a bit of an impact in the subsequent months when a price increase is kind of put forth?

Elliott Noss

I think the impact we see tends to be a little bit less than our competition to the extent there is impact because of our cost plus pricing. But there hasn’t been, this is the third price increase under the current contract if I am not mistaken and there hasn’t been a noticeable decrease to date. We are hoping for the same. We think that over time trees don’t grow to the sky and folks should be thoughtful about increasing the price but I don’t think the one we are going to see this year is going to impact our numbers.

Thanos Moschopoulos - BMO Capital Markets

On the OpEx side it sounds like we are looking for costs to remain stable over the next few months?

Elliott Noss

I think that is right. I think what you will continue to see is improved efficiency in the business. We really focused on driving more dollars out of relatively the same cost structure. You have heard me talk about efficiency like that for years. We think there is still plenty of that efficiency left in the business. There is lots of leverage in our business.

Operator

There are no further questions at this time.

Elliott Noss

Thanks very much operator. We 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 lines.

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Source: Tucows, Inc. Q4 2009 Earnings Call Transcript

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