Tucows Q3 2006 Earnings Call Transcript

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Tucows Inc. (NYSEMKT:TCX) Q3 2006 Earnings Call November 6, 2006 5:00 PM ET

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Executives

Leona Hobbs - Manager, Communications

Elliot Noss - President, Chief Executive Officer, Director

Michael Cooperman - Chief Financial Officer

Analysts

Thanos Moschopoulos - BMO Capital Markets

Justin Kew - Desjardin Securities

Steven Newman - Newman Financial

David Jackson - SeekingAlpha.com

Warren Derilak - Raymond James

Operator

Good afternoon, ladies and gentlemen. Welcome to the Tucows third quarter fiscal 2006 financial results conference call. Please note that today’s presentation will be archived for replay both by telephone and via the Internet, beginning approximately one hour following the completion of the call. To access the archived conference all by telephone, dial 416-695-5800, or 1-800-408-3053, and enter the passcode 3202095, followed by pound. The telephone replay will be available until November 13, 2006, at midnight.

To access the archived conference call via the Internet, go to www.tucowsinc.com, and click on investor relations.

I would now like to turn the call over to Ms. Leona Hobbs, Manager of Communications, Tucows Incorporated. This call is being recorded Monday, November 6, 2006. 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. My name is Leona Hobbs and I am the recently appointed Communications Manager here at Tucows.

Before we get started, I would like to thank Hilda Kelly for her work supporting the investor relations efforts of the company. Hilda will continue in her capacity as Elliot’s executive assistant. I look forward to supporting our shareholder community moving forward.

Today, following market close, Tucows issued a news release reporting the company’s results for the third quarter of fiscal 2006, ended September 30, 2006. The news release is available on our website by clicking on About Tucows, then Investor Relations, and finally on Quarterly Financials.

You can also contact me directly for a copy of the news release by telephone at 416-538-5450, or by e-mail at ir@tucows.com, and I will send it to you. If you would like to receive future news releases by e-mail, please also let me know.

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 our full description of the risk factors applicable to our business.

I would now like to turn the call over to Elliot.

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Tucows Inc. (AMEX: TCX) is the largest Internet services provider for hosting companies and ISPs. Through 7,000 partners globally we provide millions of email boxes and manage over five million domains. Tucows remains one of the most popular download sites on the Internet.

Tucows Inc. makes the Internet easier and more effective by reducing business complexity for our B2B and B2C customers as they acquire and deliver services to millions of Internet users around the world.

View our SEC filings, news releases, and learn more about our company and services.

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Elliot Noss

Thank you, Leona. Good afternoon, and thanks for joining us today. As is usual, today’s call will follow a similar format. I will begin with an overview of the highlights for the third quarter. Mike will then provide a detailed review of our financial results for the quarter and the year-to-date, and finally, I will return to review our success in achieving the objectives we laid out for the company at this time last year.

Let me begin with our financial highlights for the quarter. The third quarter was another strong quarter financially for Tucows, with results that are indicative of increased momentum in our business. We delivered another quarter of record revenue of $16.9 million, a 40% increase over the same quarter of last year, and our 15th consecutive quarter of revenue growth, adjusting for the one-time accounting transaction in the third quarter of 2004.

Adjusted EBITDA, which you will recall excludes items that are not ongoing in nature, grew 41% to $1.5 million.

Net income was $1.9 million, boosted by a significant windfall that I will discuss more in a few moments.

Net deferred revenue, or deferred revenue less prepaid registry fees, grew almost 15% compared to the same point last year, and 3% from the second quarter of the year.

Advertising revenue was $1.3 million this quarter, and I note that while much of that growth was driven by the contribution of direct navigation, we are also seeing the continued return to form or our content business. The important thing is that this is a 20% increase quarter over quarter, and a 78% increase year over year in what is an extremely high margin revenue stream.

In past quarters, when looking at the contribution from domain registration versus other Internet services, we have included revenue from Domain Direct in our domain registration revenue. This has tended to slightly overstate the percentage of gross margin that has come from domain names, as Domain Direct, our retail business, includes revenue from services other than domain names. With the addition this quarter of NetIdentity, the portion of retail revenue from other Internet services is now sufficiently large that we have reclassified that revenue under other Internet services.

With this adjustment, it is now the case that more than 58% of billed gross margin is generated by non-domain revenue, or revenue from other Internet services. Because that does include some amount of margin from domain registration that occurs in the Domain Direct business, that number is slightly overstated, but not by very much.

By our old calculation, that number would have been relatively flat compared to the second quarter of roughly 50%, but now that it includes the NetIdentity contribution, which is clearly from other Internet services, it is about 8 percentage points higher. By the way, the reason we do not split the retail revenue artificially is so that this disclosure is consistent with the public disclosure made under GAAP.

There were a couple of other financial items related to the quarter that I would like to discuss.

First, as I alluded to a moment ago, we benefited from a pretty significant windfall during the quarter. Some of you long-time Tucows watchers may remember our merger with Infonautics in 2001. Those really reading the fine print may remember that we acquired some patents in that merger.

These patents were not integral to our business, but in retrospect, clearly had value. A year after the merger, we made an arrangement with a company that specializes in patent commercialization.

As you also may recall, earlier this year, we received some licensing revenues from those patents. Recently, the most lucrative of those patents was assigned by that company, generating revenue for Tucows of more than $1.8 million. That income was booked in the third quarter and, subsequent to the quarter, we have received the funds. While we do not expect to generate additional revenue from this patent, we do maintain a small future interest. As you have often heard me say about transactions, you always like to have a little side benefit that you may be able to avail yourself of in the future, and this is a great example of just that.

I note that we did not realize this benefit until five years later -- proof that sometimes you need to be patient with these things.

Second, there is one negative related to the quarter that I would like to discuss. During the quarter, we migrated the NetIdentity customers to our e-mail platform as planned. Quite simply, that did not go well and customers experienced degraded service.

As is often the case, the problem arose due to a combination of factors. We pushed a little more than we should have. We bumped into some additional complexities in the Critical Path operating environment that we had not anticipated, and there were one or two situations of simple human error.

Not surprisingly, all of that combined to create a negative experience for the incoming NetIdentity customers.

We examined a number of alternatives as to how we could do right by those incoming customers, and ultimately decided on an approach that we thought was most appropriate. It also happened to be the most expensive approach.

That approach will cost us approximately $600,000 in cash flow in the fourth quarter. However, because of the nature of our business, impact on profitability will be much more muted.

The financial windfall from the patents made it much easier for us to do what we all thought was the right thing to do by the business and by the customers, and still stay within the financial parameters that we laid out for shareholders. But I want to be clear that we would have done what we felt was right by customers in any event.

As a company, we realize that delighting customers in Internet services is desirable, but reliability is critical.

Inside of Tucows, there is a wealth of experience in Internet services that I do not believe exists in any other company, and we have all dealt with difficult operational situations before. That being said, you can never be reminded too often how important mission critical services like e-mail are. From top to bottom, we are all focused on providing utility-like level of reliability.

You will recall that on the last conference call, following a higher-than-typical capital expenditures for the second quarter, which included investments in the efficiency of the Critical Path platform and our DNS infrastructure, we expected cap-ex going forward to return to more historical levels.

Over the last 60 to 90 days, however, both Tucows and the Internet as a whole have experienced an unprecedented rise in the amount of spam. As a result, we will invest an additional $1 million above plan in the fourth quarter to further strengthen our e-mail infrastructure.

Interestingly, this massive increase in spam is a double-edged sword for this business. While in the short run, it will require additional investment in capital, in the longer term, it is quite likely to increase the need for service providers to outsource anti-spam activity specifically and e-mail in general.

The third point I would make certainly relates to the previous two. Our core operating expenses were a little bit higher than they otherwise might have been, certainly a combination of the effect of that operational complexity I discussed a moment ago and our starting to take steps to deal with it.

Year-to-date, this year, core operating expenses have grown at roughly the same rate as revenue. While operating expenses this year have grown more than we anticipated, given some of the specific places it has grown, and with our acquisitions now absorbed into our operations, we are pretty comfortable in saying that conservatively, next year revenue should grow at least twice the rate of operating expenses.

Just as importantly, we remain well-positioned to achieve our stated goals of generating cash flow from operations for fiscal 2006 of $7 million to $8 million, and cash flow from operations for fiscal 2007 of $10 million to $12 million.

Let me now briefly turn to the integration of NetIdentity. Notwithstanding the issues I mentioned earlier, the integration is complete in other respects. All of the operations are now in-house. The bulk of the work is well behind us, and we are now beginning to see some of the additional benefits.

There is nothing that will expose the depth of a customer’s loyalty to a service more than disruptions to that service, and if there is one thing that we have all come away from this understanding, even better than we did before, it is that e-mail attached to a surname is incredibly powerful in terms of the connection that it creates for a user.

In no way do I want to suggest that this gives us luxury to skimp on performance, but it does absolutely reinforce our view about the fundamental value of owning that asset of surnames.

I am very comfortable that, given some of our efforts around reliability and user experience of the e-mail platform, if we are talking about this on future calls, I will be able to say that those NetIdentity customers are very happy with us as a supplier and very happy that we engaged in this transaction.

We are also starting to see some of the beginnings from those additional benefits that I talked about last quarter. I previously mentioned a couple thousand premium domain names that came along with the transaction, and we are finding under every rock we turn over another gem, another benefit that we did not realize that we had. Until now, we have delayed selling names while we digested the transaction and got a better handle on the market. But we have now started to approach these opportunities.

In addition, as we have worked through more effective ways to monetize the domain portfolio we hold, our learning has been greatly accelerated. That learning creates benefit not just in dealing with the NetIdentity portfolio, but also in dealing with the Tucows parked portfolio.

Revenue for our internal parked page business for the third quarter was up 57% from the second quarter, in what is typically the worst quarter of the year for Internet advertising and, if we include revenue from parked pages for NetIdentity, that revenue stream was up 170% quarter on quarter. We are seeing the benefits of that experience and the acceleration of that experience from the NetIdentity portfolio.

Before I turn the call over to Mike, there is one other development in the third quarter that I should discuss. During the quarter, we made a small acquisition of an online calendaring service called Kiko, which you can see at kiko.com. The acquisition was actually transacted over e-bay, which generated a fair bit of buzz just for the manner in which it was done. The acquisition represents a further commitment to having the best hosted e-mail service in the world.

We recognize that for many end users, a calendar that integrates with their e-mail and with their contacts is absolutely essential. It is only since the advent of Ajax and similar web design approaches that the online calendar experience can start to approach the desktop experience.

To be clear, we were not shopping for a calendar service when this opportunity presented itself, but we did recognize the importance of a calendar as a feature, and we were somewhat disappointed with our own internal projected delivery.

When this opportunity arose, it became an easy way of achieving the same end goal of an internal development exercise, but obviously with a much faster timeframe and with a clearly established outcome.

Now, the actual process of buying a company on e-bay was quite interesting in and of itself. If you would like to hear more detail about this, you can go to tucowsblog.com, where there is both a text entry by myself and a podcast, in which I discuss the transaction in more detail.

What is important to recognize again about this acquisition is the additional investments in and commitment to our e-mail platform. With the transaction now completed, we are quite excited to get this service integrated into our offer.

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

Michael Cooperman

Thanks, Elliot. The third quarter of fiscal 2006 was another strong quarter for Tucows, driven by growth across all areas of our business. We recorded our 15th consecutive quarter of record revenue, generated solid growth in adjusted EBITDA, and saw continued growth in our deferred revenue balance.

Net revenue for the third quarter increased 40% to $16.9 million, from $12.1 million for the same quarter last year. Net revenue from domain name and other Internet services increased by $4.2 million, or 37% to $15.6 million, from $11.3 million to the third quarter of last year.

As Elliot mentioned earlier, following the absorption of NetIdentity into Domain Direct, we now feel that the proportion of revenue earned by Domain Direct from other Internet services warrants its inclusion as part of other Internet services rather than as part of domain names, as we have done in previous quarters.

This reclassification resulted in revenue contribution from other Internet services increasing to 25.5% of total revenue, up 10 percentage points from 15.5% for the third quarter of last year. Revenue from domain names, which now excludes Domain Direct, while up 19% on an absolute basis, accounted for just 66.8% of revenue, down 12 percentage points from 78.5% for the third quarter of last year.

The shift in revenue mix from domain names to other Internet service revenues was primarily the result of the contribution of the hosted e-mail assets we acquired from Critical Path in January of this year.

To allow for comparison of the disclosure we made last quarter, I will also provide the numbers using the previous calculation. Revenue from domain names for the third quarter, including Domain Direct, grew 19% on an absolute basis and accounted for 73.1% of total revenue, down 13 percentage points from 86% for the third quarter of last year.

Revenue from other Internet services, excluding Domain Direct, accounted for 19.3% of revenue, compared to 8% for the same quarter of last year.

Revenue from advertising and other content sources for the third quarter increased by 78% to $1.3 million, from $724,000 for the third quarter of last year. $468,000 of this growth was the result of the contribution of direct navigation revenue which, as we have discussed previously, is being included in advertising and other revenue.

If we exclude direct navigation revenue from advertising and other, content sources grew 13% compared to the third quarter of last year. Advertising and other revenue, as a proportion of total revenue, increased to 7.6% from 6% for the third quarter of last year.

Cost of revenues for the third quarter increased to $11.2 million from $7.8 million for the third quarter of last year, primarily as a result of an increase in network costs by $1.5 million to $2 million, from just under $500,000 for the third quarter of last year. As I mentioned on the last call, the majority of the increase in network costs is to support the larger infrastructure associated with hosted e-mail and includes $630,000 of network depreciation and amortization, pertaining primarily to the acquired Critical Path infrastructure that was not incurred in the third quarter last year.

Cost of domain names, which now exclude Domain Direct, as a proportion of total cost of revenues, fell by 13 percentage points to 71.9% from 85.1% for the third quarter of last year, while the cost of other Internet services, which now includes Domain Direct, grew by 1.5 percentage points to 10.1% of total cost of revenues, from 8.6% for the third quarter of last year. These changes were a result of the shift in revenue mix away from domain names and the increase in network costs.

Again, to allow for comparison to last quarter’s disclosure, cost of domain names, including Domain Direct, as a proportion of total costs of revenues, fell by nearly 13 percentage points to 76.1% from 88.7% for the third quarter of last year, while the cost of other Internet services excluding Domain Direct grew by just under 1 percentage point to 5.8% of the total cost of revenues from 5% for the third quarter of last year.

Gross margin for the quarter was 33%, down from 35% in the third quarter of last year, and up from 31% in the second quarter of this year. The year-over-year decrease is primarily attributable to the higher network costs to support and manage our expanded Internet services offering, most notably to support our hosted e-mail platform.

The decrease was also the result of lower gross margin on domain names of 28.4%, compared to 29.7% for the corresponding quarter last year. This decrease in domain name gross margin was expected, and is a result of the continued competitive nature of the domain name space.

Operating expenses for the quarter increased by $2 million to $5.6 million, or 33% of net revenue, from $3.6 million or 30% of net revenue for the third quarter of last year. As I have done in the past, to assist you in understanding our operating expenses, I will break them into two components, core operating expenses and other operating expenses.

As a reminder, we define core operating expenses as those costs related to ongoing sales, marketing, development, and administrative costs.

For the third quarter, these expenses increased by $1.3 million, or 36% to $5.1 million, compared to $3.8 million for the third quarter of last year. The primary contributor to this increase was increased people costs of approximately $1 million relating to our ongoing commitment to stabilize, enhance, and extend our open installation e-mail platform, as well as our ongoing initiatives to improve customer service, product management, and expand our sales reach.

In addition, professional and public listing fees increased by approximately $200,000, primarily the result of incremental cost increases in accounting and legal fees required to manage our increased public profile and growing infrastructure.

As a percentage of net revenue, core operating expenses for the third quarter actually decreased slightly to 30% from 31% for the third quarter of last year.

Other operating expenses for the third quarter increased to $537,000, compared to the third quarter of last year, primarily for the following reasons:

  1. We incurred one-time costs of approximately $176,000 during the quarter relating to severance payments;
  2. As a result of our having adopted FAS-123R, accounting for stock-based compensation, we incurred a charge for stock-based compensation of $59,000;
  3. Depreciation and amortization increased by $134,000 to $273,000, as a result of higher depreciation related to computer equipment and higher amortization resulting from the acquisitions we had made in the current and prior years; and finally,
  4. As a result of the continued strengthening of the Canadian dollar, the third quarter included a foreign exchange loss of $28,000, compared to a gain of $294,000 in the same quarter last year.

Adjusted EBITDA for the third quarter increased 41% to $1.5 million from $1.1 million for the same quarter last year. Adjusted EBITDA as a percentage of net revenue, however, was relatively unchanged at 9%.

As Elliot mentioned earlier in the call, adjusted EBITDA for the third quarter included $1.9 million in other income from the revenue associated with the Infonautics patent. Adjusted EBITDA for the quarter also included $448,000 of net deferred revenue compared to $138,000 for the third quarter last year.

As a reminder, we define adjusted EBITDA as earnings before interest, taxes, depreciation and amortization, adjusted to reflect earnings and expenses that are considered as non-representative of ongoing business, as well as the material amount of cash we collect for domain registrations and other Internet services at the time of activation, which has been deferred, net of prepaid fees.

Net income for the third quarter was $1.9 million, or $0.03 per share, compared to $788,000, or $0.01 per share for the third quarter of last year.

Turning to the balance sheet, cash, short-term investments, and restricted cash at the end of the third quarter decreased to $3.8 million from $7 million at the end of the second quarter of this year, and from $18.4 million at the end of the third quarter last year.

The decrease in cash compared to the end of the second quarter of this year was primarily the result of our electing to repay one of the promissory notes associated with the acquisition of NetIdentity in the amount of $2.1 million, as well as the investment in property and equipment of $788,000, primarily for our Internet services infrastructure during the quarter.

With respect to cash flow, during the third quarter of this year, we used cash of $133,000 to fund operations. To put this in perspective, we actually generated $3.2 million of net income from operating activities. However, this was offset by the use of $3.3 million to fund changes in working capital.

I would remind you that in last quarter’s conference call, we noted that accounts receivable, accounts payable, and accrued expenses had all increased significantly, primarily due to the Critical Path asset acquisition and the impact of the investment in Internet services infrastructure we had made. We also noted that we did not expect these levels to continue.

With respect to accounts payable, this is in fact what transpired, with accounts payable declining by $2.2 million during the quarter.

Accounts receivable, on the other hand, increased by $2.1 million during the quarter, primarily the result of the $1.9 million we recognized from the Infonautics patents. I would note for you that this amount was fully paid on October 20th.

Deferred revenue for the quarter grew to a record $44.7 million, a 20% increase from $37.3 million at the end of the third quarter of fiscal 2005, and a 4% increase from $43.2 million at the end of the second quarter of this year.

In closing, I would like to note that throughout this year, we have invested strategically to strengthen our operations, positioning us well to take advantage of the leverage inherent in our business model as we move forward.

I would now like to hand the call back to Elliot.

Elliot Noss

Thanks, Mike. On our third quarter call last year, our first following a secondary equity offer we completed earlier that summer, I discussed a number of key objectives for the company that we had shared with investors in the road show.

The first was to continue to diversify the business. Clearly we have been successful in this regard, as the contribution to gross margin from Internet services other than domain names has increased to 58% for the third quarter of this year, from 41% for the same quarter last year. I will note that this is not because of poor performance in our domain games business.

On last year’s call, I stated that we expected to build gross margin from our domain registration business to grow between 8% and 12% per year before the contribution of the expired domain name segment of that business. We exceeded this target.

The second objective was to effectively deploy some of the cash balance that we had built up. Since January of this year, we have spent $17.1 million to complete three acquisitions, the host and messaging assets of Critical Path, NetIdentity, and Kiko -- each of which, as I have described previously, will be a significant contributor in its own way to our business going forward.

At the same time, as I discussed at the beginning of the call, we have spent some of that cash this year improving key areas of our operations to position us to really capitalize on the leverage inherent in the business in 2007.

The third objective was to have operating expenses grow at half the rate of billed gross margin. Well, we fell short on this objective. As I discussed earlier, we think it was for the right reasons.

With that said, we cannot ignore the fact that the share price has been flat. We want you to understand what steps we have taken in this regard. I view our investor relationships much like I do those with two other key constituencies -- our employees and our customers. With each of those groups, we try to enter into relationships with people who are buying what we are selling.

In 2006, relative to 2005, we have invested significantly greater time and effort into investor relations. Specifically, we have made it a regular part of our corporate activities to meet potential institutional investors, existing institutional investors and analysts. We have also made it a goal to present a public equity conference as often as possible.

While you have only seen one appearance in this regard, we are very focused on the 2007 conference schedule. These types of investor relations activities are less visible to the average shareholder, but in our view, are consistent with the way we view the company.

Lastly, there are a lot of different ways for companies, especially ones with the cash generation abilities and strong balance sheet of Tucows, to return value to shareholders to help the stock price, and we will examine all of them.

In summary, we have done what we said we were going to do. We have spent a lot time, effort, and money successfully integrating our acquisitions, strengthening our people, all of which positions us for a very strong 2007 financially.

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

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question is from Thanos Moschopoulos, BMO Capital Markets. Please go ahead.

Thanos Moschopoulos - BMO Capital Markets

Starting off with a financial question, could you quantify the transitional costs in the quarter? Is it just the $176,000 for severance?

Michael Cooperman

Yes. Thanos, that $176,000 was not a transitional related cost. That was a cost related to severances that we had to pay for other purposes. We had no transitional costs in the quarter.

Thanos Moschopoulos - BMO Capital Markets

Okay, then we should consider everything as being fully integrated now from a cost perspective?

Elliot Noss

Yes, that is right. I mean, I think if we wanted to be cute about it, Thanos, we could have classified some things as transitional costs, but I must tell you that feels inappropriate to me. I think we are playing it as it lays.

Thanos Moschopoulos - BMO Capital Markets

You did not speak much about Critical Path in your prepared remarks. Could you give us an update on how that is progressing there, as far as new customer acquisition?

Elliot Noss

Sure. You know, I think that business continues to do as we had hoped it would. I referenced a slightly greater level of operational complexity still inherent in that system, and that probably has slowed down the ramp-up, but that business has improved quarter over quarter, and continues to.

It really is the case that you have heard me talk about a couple times, probably more than you care to remember, about there really being an inflection point in the way service providers are having to deal with e-mail. That is really playing itself out.

I am down at ISPCON later on this week, starting tomorrow, and already, we are expecting e-mail to be the thing that is most talked about.

When I referenced earlier an increase in spam, the two things about that that I really want to call out are, first of all, that that is Internet wide. Discussions inside the technical community are really identifying what I would call an unprecedented level of increase. Second, that has just got to be incredibly difficult for service providers still trying to in-source around this stuff.

Thanos Moschopoulos - BMO Capital Markets

And that is a function of the hardware solutions not really being up to task?

Elliot Noss

Well, it is less about the hardware solutions. Most of the people who are trying to do it themselves are therefore forced to play the cat-and-mouse game with spammers themselves, and that just becomes incredibly resource intensive.

Thanos Moschopoulos - BMO Capital Markets

Okay. Just a question on some of the metrics that Mike usually provides, as far as total domains under management at quarter end, and amount of transactions processed in the quarter?

Michael Cooperman

We processed 1.2 million new, renewed and transmitting domain names during the quarter, and our domains under management increased to 5.7 million, compared to September ’05. They increased to 5.7 million. That does not include the names we manage for other registrars.

Elliot Noss

Yes, and I always have to point out that Q3 is the slowest quarter of the year. We were pleased with that quarter and the domain registration.

Thanos Moschopoulos - BMO Capital Markets

With a 15% increase in the billed gross margin, it seems like you are getting some good, continued growth there.

Elliot Noss

Yes.

Thanos Moschopoulos - BMO Capital Markets

Incidentally, are you seeing a lot of growth from the new top-level domains, or has that not really been the source of growth that had been hoped?

Elliot Noss

If you are talking about EU and Moby --

Thanos Moschopoulos - BMO Capital Markets

Yes.

Elliot Noss

EU, I think I did talk about this briefly on the previous call. There is certainly a lot in the press the covered this. That was a little disappointing because the process was one that really exposed them to people who were gaming the system. So people who were playing it straight like us really did not do that well.

With Moby, we were reasonably pleased. We think there has been some pretty good initial traction there, and now that one is really going to be a function of usage. I think that as companies start to do more on a mobile platform, we will see if that works or not.

We had some small pleasant surprises in the CTLB space as well.

Operator

Thank you. The next question is from Justin Kew, Desjardin Securities. Please go ahead.

Justin Kew - Desjardin Securities

Good evening, guys. Elliot, the first question is the Kiko acquisition. What was the cost on this?

Elliot Noss

$258,100 -- that is inclusive of e-bay’s fee, $100 above the next highest bid.

Justin Kew - Desjardin Securities

In terms of the cap-ex, to Michael, in terms of cap-ex for next quarter, you are saying it is an additional $1 million above what you were planning? Is that how I heard it correctly?

Michael Cooperman

Justin, what I was referring to there is last quarter, we indicated that we would be approximately between $2.25 million and $2.75 million over what we spent in 2005. This $1 million is an incremental $1 million to that.

Justin Kew - Desjardin Securities

Okay, so for ’06, so what you are saying then is $3.25 million to $3.75 million?

Elliot Noss

Above ’05.

Michael Cooperman

Above what we stated -- in other words, it is about $5.1 million.

Elliot Noss

Right.

Justin Kew - Desjardin Securities

What is the $1 million for in terms of -- and is it just a one-time, or is this an ongoing expenditure? Obviously spam, like you said, it is insidious and it is here to stay. How do you see this as --

Elliot Noss

Well, I think there are a couple of other factors that are really exacerbating that for us right now. We are still maintaining multiple platforms for both e-mail and anti-spam. That is something that, come early next year, simply will not be the case.

When we are having to deal with, you know, when I say capacity issues, when we are having to deal with this onslaught, we are having to deal with it across multiple systems. From our perspective, they are not systems that are as efficient as they should be.

We could take the low road and let customer experience degrade, because we know that we are going to be in a happy place shortly, but we do not think that is the right way to approach it and so we are overspending and we are over-provisioning, because we think that investing in those customer relationships is just worth doing.

Justin Kew - Desjardin Securities

So you do see it as a one-time, you are going to get it out of the way and then the levels, and obviously the infrastructure is taken up a level?

Elliot Noss

Well, as I put it a little differently, we think that the battle with spam is going to be ongoing, and I think I would be naïve to say it is one time, we will not have to worry about it again. The specific expenses that we have both this quarter and next at a cap-ex level are pretty unique to our current operating environment. That is something that is less efficient than we would like it to be.

When I say that, we are kind of well down the road to dealing with that, but we are forced to make things work as they are right now. We are pretty comfortable saying that this 2006 number is in all likelihood going to be north of the 2007 number. Certainly as I sit here right now, I would be surprised to quite surprised if it was this high next year.

Justin Kew - Desjardin Securities

Michael, just in terms of segmented revenues, I understand moving around, but I did not catch all the numbers, so on an apples-to-apples basis, could you give me the percentages for domain naming, auxiliary advertising, and other then?

Michael Cooperman

You want me just to repeat those numbers for you?

Justin Kew - Desjardin Securities

Yes, or the percentages.

Michael Cooperman

It was 25.5% of total revenue for other Internet services, including Domain Direct. It was --

Elliot Noss

So the rest is domain, 74.5%.

Michael Cooperman

It is 66.8% of revenue was for domain names, and for advertising and other, that was 7.6%.

Justin Kew - Desjardin Securities

This is on apples-to-apples with last year? Sorry, last quarter.

Michael Cooperman

Yes. Every time I referenced a number from last year, it was on an apples-to-apples basis.

Justin Kew - Desjardin Securities

Going forward, maybe we can talk about this offline, but just kind of maybe historically, just so that we can back-flow it in our model so that we have going forward, when we get new numbers, at least they match up.

Elliot Noss

Sure.

Justin Kew - Desjardin Securities

Okay, and that is all for me. Thank you.

Elliot Noss

I hope, Justin, you understood the reason for the reclassification.

Justin Kew - Desjardin Securities

No, no, absolutely. This is part of the -- this is absolutely the right thing to do.

Operator

Thank you. The next question is from Steven Newman, Newman Financial. Please go ahead.

Steven Newman - Newman Financial

My question is a little bit more specific in nature, and I am just kind of wondering, has there been a shift from the Tucows auctions to building up the parked portfolio? If that is the case, what are some of the names that are driving that growth?

Elliot Noss

You said Tucows' options? Or auctions, you said?

Steven Newman - Newman Financial

Yes, sir.

Elliot Noss

Okay, I see. The auctions business for us, and I have talked a little bit about this on previous calls, we really do not see that as a big part of the mix in the secondary market going forward. We are really focused on two things with expiring names. One is to capture the expiring names of value for the purposes of in the short-term, generating parking revenue, but more importantly in the long term, making them available to what I call strategic buyers. In other words, businesses, often small businesses, who want to put those names to use.

From our perspective, when a name falls into our auction state, you know, it is available at Tucows auctions, that means that somebody has seen value, that the folks on our end who try and pick out at the names that have value have missed. We kind of jokingly refer to that internally as a mistake. Does that make sense?

Steven Newman - Newman Financial

Yes, absolutely. Is there a timeframe for when the names that you guys have been withholding will be open for sale to small businesses?

Elliot Noss

Yes, I think we would all like that to be as soon as possible. We are really pretty heads-down focused on a bunch of the e-mail stuff, but it should be very, very late this year or early next year.

Steven Newman - Newman Financial

One last question -- what would you say is the quantity that you guys are currently holding and what would you say would be the average sale price per name?

Elliot Noss

Average sale price, your guess is as good as mine. Quantity, we are certainly getting up into the low- to mid-five-figures.

With average sale price, one of the really interesting things in this industry, and it is one we have obviously had a lot of visibility to over the years, not just in our role as registrar. We are a supplier to a lot of the big players in the industry, on the secondary market side.

Nobody has really kind of tried to do what we are doing, really what I call kind of connecting strategic demand with supply. There is clearly an inverse relationship between price and turnover. In other words, the lower price you want to put on your names, the higher your turnover is going to be.

The goal really is to find that sweet spot that is maximizing total revenue. Right now, there are some sources, huge inventories, that are available to the public, but the average small business has no idea where to find them.

We are not only, Steven, going to be selling names from our inventory. We also plan to expose some of these other large inventories out there on the Internet to our, you know, the demand that comes in through our wholesale channel.

Steven Newman - Newman Financial

If I am understanding correctly, you guys are looking at building out a complete, composite domain marketplace to compete with an Afternic, or a [C-do], or another reseller of domain names?

Elliot Noss

No, not to compete with them at all, because it is my view that what they are doing is different and more focused on what I would call industry insiders.

What we are doing, we have tens of millions of who-is look-ups a month. That is latent demand for domain names. Those people overwhelmingly want a name for their business. They are not concerned with whether it is in the primary market or the secondary market.

The way that we view it, really what we are doing is connecting that demand that is sitting there right now with some of the supply. By the way, the [C-do] and the Afternics, et cetera, generally the players in the market are quite thrilled to expose their inventories to some additional demand. We look at those folks as partners.

Operator

(Operator Instructions)

Our next question is from David Jackson, SeekingAlpha.com. Please go ahead.

David Jackson - SeekingAlpha.com

Thank you. Just a quick question on the expired domain name business. Could you put a percentage number on currently what percentage of your revenues that accounts for, both in terms of as you are selling off domain names, and then also monetizing them through domain parking?

Elliot Noss

It is in the single digits right now. It is in the -- I am going to go off the top of my head and say kind of in the low- to mid-single digits. Obviously it is very high at a margin level, David, much like the Internet advertising business, which is why we classify that there. The growth is, as I talked about on the call, very, very aggressive still.

One of the things that we had a chance to kind of look back on, now that we are late in the year, we are planning for 2007. We have looked back now to when we were in a similar place in 2005, how we estimated what we would do in this space in 2006. We knew we had an offering. We knew it was launching. Obviously we did not have a lot of data for it.

There really is a pretty high fulcrum around this stuff. It is tough to know how high trees are going to grow.

David Jackson - SeekingAlpha.com

Could you then give some kind of sense of what proportion of your gross margin dollars it accounts for?

Elliot Noss

On a gross margin level, boy, it is still going to be single-digits. It is still going to be single-digits. It is small and growing, would be the best way for me to describe it.

You know, if you wanted to kind of get a ballpark sense of it, David, that number is now lumped in with our Internet advertising number. You could look at where we have been historically around the Internet advertising business, which is doing fine, back that out, and you would have a sense of the parked pages contribution, which you could then compare to gross margin or revenue. Are you following what I am saying there?

David Jackson - SeekingAlpha.com

Yes, totally. If I may, another couple of questions. You have this big cap-ex investment coming up in the e-mail system. How are you thinking about the return that you are looking for on that investment? How are you thinking you are going to monetize that investment in terms of whether you are going to charge increased fees, whether it is just going to increase the number of customers you have? How should we think about the return you will get on that investment?

Elliot Noss

I think there is a couple things there. First of all, I need to call out that when you are saying investment in the e-mail system, that really is kind of the end-to-end e-mail system, including anti-spam. To a great extent, a lot of the unplanned expenditures are relating to that anti-spam side, and building out capacity in the very near-term.

It is also the case that we had a platform before with CP. We are still maintaining again two separate platforms, two separate e-mail defense systems, two separate anti-spam systems, and we always had a view of what the end-state looks like. While we are getting from point A to point B, we have to keep those existing pieces running.

I think when you talk about return, it is really going to come from two places. One, increased capacity; two, increased reliability.

It is amazing. We started to go much deeper in terms of engaging with e-mail customers. A lot of people feel that some of the bells and whistles that you are seeing in some of the newer e-mail platforms are what are driving customers’ behavior, but it is all about a lights-out e-mail service.

There is nothing fancy here. This is not about pop-up Google maps on the mouse-over in the e-mail, as I have referred to in the past. It is really just about making it very easy, and when I say easy, remember, David, that I am talking about from a service provider perspective, so that means easy to move their customers over, easy to transition them to a different webmail interface, things like that. Does that make sense?

David Jackson - SeekingAlpha.com

Yes. Have you got optimistic enough projections about your customer growth in this business to financially justify -- It is a pretty big number going --

Elliot Noss

I can say without hesitation, yes. There are two things about it. This is one of those types of services that if you are not doing it efficiently, you have to keep throwing money at it, and if you are doing it efficiently, it is very, very leverage-able.

This is about getting it right, not getting it big.

The other side -- that is on the supply side, David. On the demand side, there is more business out there than we expected there would be, and we were pretty optimistic in the way we looked at it.

David Jackson - SeekingAlpha.com

Great. One last question, just a financial question, if I may. In your cash flow statement, you discussed that your accounts receivable did not fall partly because of the patent payment, where the payment was delayed but has now come in, and that you were expecting the accounts receivable to come down. Also, you were expecting accounts payable also to move.

What are your expectations for next quarter in terms of how those lines actually move and impact your cash flow statement?

Michael Cooperman

Obviously, the quarter is not over yet, so we can only surmise as to direction. I think that, from an accounts receivable perspective, it will be reasonably flattish, outside of that kind of issue --

Elliot Noss

Yes, that is kind of flat back to the second quarter.

Michael Cooperman

Yes. On the accounts payable and accrual side, generally there are some expenditures that you have to pay just before the year-end, that we will obviously pay, and we may use a little bit of money in there. But bear in mind that I do not think the amount of money we will use will be anything close to the amount of money that we will generate from the $1.9 million having already been paid.

David Jackson - SeekingAlpha.com

Okay, great, because you had a net cash out-flow because you kind of accelerated accounts payable during the quarter.

Elliot Noss

Yes.

David Jackson - SeekingAlpha.com

So you are not expecting a swing-back next quarter?

Michael Cooperman

You mean back to a position where we generate cash from those two items? Absolutely.

David Jackson - SeekingAlpha.com

Yes.

Michael Cooperman

No, we definitely are expecting a swing-back to generation of some cash from a combination of receivables and payables.

David Jackson - SeekingAlpha.com

What about payables on its own? Obviously with receivables, you have that really big swing from the patent payment.

Michael Cooperman

That is what I mean. On payables on its own, we may use some monies, but not a significant amount.

David Jackson - SeekingAlpha.com

Okay. Great, thank you very much.

Operator

Thank you. Our next question is from Warren [Derilak], Raymond James. Please go ahead.

Warren Derilak - Raymond James

Just a question, you talked earlier about stock performance the last year has basically been flat. You talked about ’07, trying to get out and tell the story more to analysts, investors, et cetera, which is always good. Aside from that, specifically speaking, you also mentioned enhancing shareholder value wherever you could possibly see doing it, et cetera.

What avenues could you elaborate on? Where could that occur? We are starting to look at what catalyst could actually start moving the stock price of, short of just obviously increased revenue and bottom-line earnings improving. What other avenues maybe that you have shared in the past with us, or ideas you have in mind today?

Elliot Noss

I think that the range of options there is pretty well-known. Frankly, Warren, you probably know them better than I do. The one thing that I really always like to avoid is the C-word -- catalyst. I really think that this is a business that is focused on generating cash and generating more cash next month than last month, and next year than last year.

I think if we keep doing that, then the combination of that cash generation and the ability that gives us, then there is whole range of things we could look at.

I love when folks like yourself have any suggestions for me in that regard. I do not know if you want to make them on the call. Maybe an e-mail afterwards is better, but I am happy to talk about it.

Warren Derilak - Raymond James

Fair enough. Thank you.

Operator

Thank you. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Noss. Please go ahead, sir.

Elliot Noss

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

Operator

The conference has now ended. Please disconnect your lines at this time. Thank you for your participation, and have a great day.

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