VeriSign, Inc. (VRSN) Q4 2014 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the VeriSign's Fourth Quarter and Full Year 2014 Earnings Call. Today's conference is being recorded. Any unauthorized recording of this call is not permitted. At this time, I'd like to turn the conference over to Mr. David Atchley, Vice President of Investor Relations and Corporate Treasurer. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. Welcome to VeriSign's Fourth Quarter and Full Year 2014 Earnings Call. With me are Jim Bidzos, Executive Chairman, President and CEO; George Kilguss, Senior Vice President and CFO; and Pat Kane, Senior Vice President, Naming and Directory Services. This call and our presentation are being webcast from the Investor Relations section of our website, www.verisigninc.com. There you will also find our fourth quarter and full year 2014 earnings release. At the end of this call, the presentation will be available on that site, and within a few hours, the replay of the call will be posted. Financial results in our earnings release are unaudited, and our remarks include forward-looking statements that are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent report on Forms 10-K and 10-Q and any applicable amendments, which identify risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. VeriSign retains its long-standing policy not to comment on financial performance or guidance during the quarter unless it is done through a public disclosure. The financial results in today's call and the matters we will be discussing today include GAAP and non-GAAP measures used by VeriSign. GAAP to non-GAAP reconciliation information is appended to our earnings release and slide presentation, as applicable, each of which can be found on the Investor Relations section of our website. In a moment, Jim and George will provide some prepared remarks, and afterward, we will open up the call for your questions. Unauthorized recording of this call is not permitted. With that, I would like to turn the call over to Jim.

Thanks, David, and good afternoon, everyone. Our fourth quarter and full year 2014 results were in line with our objective of offering security and stability to our customers while generating profitable growth and providing long-term value to our shareholders. During 2014, VeriSign delivered strong financial performance, including reporting $1.010 billion in revenues, expanding free cash flow to $568 million and producing full year non-GAAP operating margins of 60.2%. Exceeding $1 billion marks a significant growth and an important milestone since the completion of our divestiture program in 2010, a year in which we reported $681 million in revenues. Operationally, 2014 was another strong year for the company. VeriSign processed 34 million new domain name registrations and finished the year with 130.6 million names in the domain name base. During the year, we marked more than 17 years of uninterrupted availability of the .com and .net domain name systems. As part of managing our business, during the fourth quarter, we continued our share repurchase program by repurchasing 3.7 million shares for $209 million. During the full year 2014, we repurchased 16.3 million shares for $867 million. Effective January 30, 2015, the Board of Directors increased the amount of VeriSign common stock authorized for repurchase by approximately $453 million to a total of $1 billion authorized and available under the share buyback program, which has no expiration. Our balance sheet remains strong with $1.4 billion in cash, cash equivalents and marketable securities at the end of the quarter. Our strategic framework to protect, grow and manage the business continues to serve us well as we see operational and financial benefits from our focus and discipline. We continually evaluate the overall cash and investing needs of the business and consider the best uses for our cash, including potential share repurchases. As you recall,…

Thanks, Jim, and good afternoon, everyone. During the fourth quarter, we generated revenue of $256 million, up 4.2% year-over-year, and delivered GAAP operating income of $142 million, up 9% from $130 million in the fourth quarter of 2013. The GAAP operating margin in the quarter came to 55.6% compared to 53% in the same quarter a year ago. GAAP net income totaled $65 million compared to $292 million a year earlier, which produced diluted GAAP earnings per share of $0.48 in the fourth quarter this year compared to $1.94 in the fourth quarter of last year. Fourth quarter 2014 net income was decreased by $26 million and diluted earnings per share decreased by $0.19, primarily due to a non-U.S. income tax charge related to a reorganization of certain international operations and a change in estimates for U.S. income tax charges related to the repatriation of offshore assets in 2014. As described, last year, fourth quarter 2013 GAAP results included tax benefits, pretax nonoperating gains and expenses, which collectively increased net income by approximately $218 million and increased diluted earnings per share by $1.45. As of December 31, 2014, the company maintained total assets of $2.2 billion. These assets included $1.4 billion of cash, cash equivalents and marketable securities of which $486 million were held domestically with the remainder held internationally. Total liabilities were $3 billion at the quarter end, down from $3.1 billion a year ago. I'll now review some of our key fourth quarter operating metrics, which are revenue, deferred revenue, non-GAAP operating margin, non-GAAP earnings per share, operating cash flow and free cash flow. I will then discuss our 2015 full year guidance. As mentioned, revenue totaled $256 million for the fourth quarter. 61% of our revenue was derived from customers in the U.S. and 39% was from…

Thanks, George. During the last year, we furthered our work to protect, grow and manage the business while delivering value to our shareholders. We continue to protect the business by providing more than 17 continuous years of 100% availability of the com and net DNS. This peerless record is due to the expertise of our people and our specialized infrastructure. Also, I want to highlight that this quarter marks the 30th anniversaries of both .com and .net. We're proud to be the registry operator of these 2 top-level domains, which are a key component of the Internet's infrastructure. We drive profitable growth by strengthening and marketing our current service offerings. While we continue to actively invest in the development of new products and services where we continue to make progress, we don't have an update at this time. Finally, we have been managing the business effectively as demonstrated by our improved operating margins, improved tax position and by the return of cash to shareholders through share repurchases. During 2014, we repurchased 16.3 million shares, returning $867 million to shareholders, and repatriated $741 million of cash held by our foreign subsidiaries. We remain committed to offering the security and stability that are at the core of our business and make VeriSign a company with an unparalleled DNS service record and a company committed to long-term value creation for our shareholders. We'll now take your questions. Operator, we're ready for the first question.

[Operator Instructions] We'll take our first question from Gray Powell with Wells Fargo.

Just a couple if I may. George, you mentioned the hold status names in your prepared remarks. Can you give us a better sense as to what exactly that means and the impact on the zone files? I just want to make sure that I understand that correctly when doing my daily tracking.

Sure, I'd be happy to, Gray. As mentioned in our prepared remarks, names in an on-hold status have always been reported in our revenues and gross additions. So these are not new names. They just haven't been included in our domain name base definition. So as a result, they've not been included in the total 130.6 million name count. On-hold names are a simply management mechanism used primarily by registrars to place names into a hold status, which removes them from the active zone file and prevent them from resolving. The name, however, is still registered by the registrar regardless of the status. Now these names represent a very small and nonmaterial portion of the domain name base, approximately 400,000 at the start of 2014, and their totals have been relatively constant for many years. I'd also add, however, that registrars use this mechanism -- use of this mechanism has increased during 2014, and as a result, we feel it appropriate to amend our definition to include these names going forward. As mentioned at the end of 2014, the names classified with a hold designation totaled about 870,000, which was an increase of about 470,000 -- 475,000 in 2014, up from 394,000 at the end of 2013. Again, it's a very minor point, but we just want to provide the additional transparency and felt the definitional change would really help in this instance.

Okay, that makes sense, I think. And so I guess, like one day you'll include it in the zone files that we see in your website and it'll look like you added 870,000 names in one day or something like that, but the reality would just be it's a definitional change, is that correct?

Yes, just the base is going up. And as I mentioned, this doesn't affect our guidance as we're trying to guide to gross name additions and deletions. It's just a base that's going up. We get paid for these names, they're in our revenue and it's a small amount, but we felt the additional transparency made sense as registrars' use of these things had increased over the past 12 months.

Okay, that's helpful. And last question, if I may. I know it's kind of tough to call out monthly trends in terms of domain name adds, but we noticed a fairly meaningful slowdown in December and then things really picked up significantly in January. I think you're tracking to, I think, it looks like 650,000 adds so far in the last 35 days. Can you just kind of give us a sense as to what happened there and what the main drivers are?

Yes, sure. So I think what you're seeing in the first month in bit -- a little bit in 2015 really relates to the Chinese New Year. Last year, the new year started, I believe, January 31. This year, it doesn't start till February 19, so it's about 20 years -- 20 days late. And we typically see the activity slow a little bit about a week before the Chinese New Year. So we've just had a good constant demand for domains in the month-to-date period, but we expect it to fall off a little bit as the Chinese New Year kicks in later this month.

We'll take our next question from Gregg Moskowitz with Cowen and Company.

George, Q4 operating margins came in lower than industry is expecting and operating margins for the year effectively came in at the low end of your guidance. Was there anything relating to fourth quarter expenses that you would call out?

Yes. Sure, Gregg. So if you looked at our total non-GAAP operating expense, it actually was -- for the fourth quarter, actually it was down year-over-year, but it was up sequentially by about $3.4 million. And we saw that increase really come primarily in G&A. We saw that being up about $2.4 million and G&A was up in the quarter primarily because we had about $1 million of severance expense in the quarter. And then we have about another $1 million of, what I would call, seasonal fourth quarter expenses that hit us, some of which were related to higher consulting expenses as we approached the year-end. The other increase we had was in R&D, and as far as R&D goes, we saw a slight decrease in the amount of labor that we actually capitalized on the balance sheet. And as a result of that lower amount of capitalization, some of that flowed into the income statement and that was the majority of the increase in the R&D expense.

Okay, that's very helpful. And then, Jim, wanted to ask, just because we've seen sort of ongoing sluggishness with .net, if you had an updated perspective there. Do you see risk of a secular decline from new gTLDs? Or do think that .net will resume growth going forward?

Well, .net is a well-established brand, it's 30 years old. It did dip below 15 million registrations, but it's back over that. I would just point out that, in 2014, .net had 3.6 million gross registrations. And as of the end of December, at the end of the year, that's roughly the same as the total number of registrations in all of the new gTLDs combined. So it's a strong brand, it's been around for 30 years, it's going to be around for the next 30 years. I mentioned on the last call and I think it's still true that there is some confusion with the .net is suffering from, that this -- the 400-plus new gTLDs that are out and available today are sort of bringing some confusion. There are hundreds more that are coming, so I think that will probably continue. But net is a strong brand, 30 years old, well-respected, 3.6 million gross adds last year, 800,000 adds last quarter, so it's going to be around for a while and it will do well.

Okay, perfect. And if I could just ask one, one last one, also on this topic and I appreciate the update earlier on the transliteration front. But just kind of more, if you had any broader thoughts, on new gTLDs and specifically their overall impact to VeriSign's financials going forward, that would be helpful.

Well, I think a specific answer with respect to the financials, I think, is a bit difficult. But in general, I would like Pat to make some comments about new gTLDs. Pat?

So the new gTLDs, I think the story is still out on the success of them. If you take a look at the 400 -- the 400-plus TLDs that are in existence today, at the end of 2014, there were 3.7 million registrations in those 400-plus TLDs. But one of the things in terms of identifying whether they'll be successful or not is really what the renewal rate is and we're just now going to see the beginning of a renewal cycle for this new gTLDs. And the second thing that we take a look at is what does the DNS traffic look like. And so if you think about the com, net DNS base today, we do about 82 billion transactions a day and we don't have any idea what those same transactions would look like for the new gTLDs, but that would be another indicator of success. So it's still -- time will still tell.

[Operator Instructions] We'll go next to Phil Winslow with Crédit Suisse. Philip Winslow - Crédit Suisse AG, Research Division: You commented on some slowdown in the month of December in China then obviously you commented on, actually, China contributing to what was a strong start in January. When you kind of contemplated your guidance for domain names for this year and you kind of think about it, I guess, geographically, did anything sort of jump out to you as you kind of built this? Any sort of change that you've seen over the course of the year? Or as you contemplated 2015 or any kind of reversal of a trend that you may be did see, just any sort of color from a geographic perspective would be great on the guidance.

Yes, sure, Phil, this is George. So as we talked about Q4, we did continue to see growth in emerging markets, but it just wasn't as robust as we had seen exiting Q3 and so that trend waned a little bit. But they still grew. I think, in general, I think by definition, emerging markets they have their ups and downs, they do have some volatility there in their definition of being emerging. But we're still seeing a lot of growth there. More specifically, we still see good activity in China, we still see good activity in India and in Asia Pac. We're still seeing very strong and good demand for the products there and that's where most of the growth is going on internationally. So the U.S. market is a little bit more tepid in regard to that. Philip Winslow - Crédit Suisse AG, Research Division: Got it. And then just one quick follow-up question on the capitalization of R&D. You said it was a little lower this quarter, so therefore expense is higher. When you contemplated your margin guidance for '15 here, what kind of assumption did you make of sort of capitalization versus the levels that you saw in '14?

We expect it to be similar to last year. But again, there are small movements. Fourth quarter I think was about 0.5 million, so it really depends on the projects that we're looking for, what stage those projects are in and if we actually have some products that are coming to market and we're actually developing new functionality, then we'll capitalize that further, the regulations in GAAP. But it really depends on the projects that we're working on, what stage those projects are in and we'll just treat it according to the GAAP regulations as to what get capitalized or not.

We'll take our next question from Walter Pritchard with Citigroup.

This is Ken Wong for Walter. So Jim, in terms -- Q1 being seasonally strongest quarter on domain add, just wondering what you guys are hearing or seeing from your registrar partners in terms of their approach to domains, in .com, in particular? And then also have you guys planned to do anything kind of unique to try to drive activity here?

So first of all, with respect to what registrars may be doing differently. A couple of -- for the last couple of quarters at least, we talked about a shift in registrar marketing tactics where they were looking for increasing ARPU and then a shift back, which gave us some uplift over the last couple of quarters. So I think we continue to see that, which has helped us. As far as commenting on -- I'm sorry, not new gTLDs, but in terms of what we may do in promotion, we constantly run regular programs of promotion with the registrars. We use marketing programs to try to drive resources geographically and through other means. We did recently launch a contest for .com names and a number of other promotions that we're doing. We'll be doing a number of things through the year in recognition of the 30th anniversary of .com, in particular. But I think the best thing that we do is just simply highlight the brand and the widespread adoption of .com. I think if you watched the Super Bowl, for example, I think, pretty much everybody who advertised is branded .com. It's just a strong powerful brand and we do have the benefit of endorsements from every company that brands itself that way.

We also try to move dollars around or invest heavily or more heavy in those markets that we think are growing faster and we think we can gain a competitive advantage. And so we take a careful analysis at all the markets we look at and we make very strong decisions and base decisions as to which markets to go into, to drive growth based on our budget expectations. And so clearly, we're investing internationally in a lot of the growth markets that we talked about.

Got you. And then, George, on the margin guidance, so kind of 60% to 62%, some decent uptick there even in the face of kind of slowing revenue. Which line items would you say you guys are going to be able to extract the most incremental margin from?

So we don't give guidance, Ken, to each individual line item. When you take a look at our K, you'll see that our expectation is that they should be relatively consistent as a percent of revenue to what they are currently. But having said that, we're continuing to actively manage the business, and we always look for opportunities to continue to create efficiencies in the business. And as opportunities present themselves, we look to reinvest in the business as well. I don't think our strategic objectives have changed in the sense that we clearly have a desire to spend more in sales and marketing to drive top line growth and we clearly have a desire to invest in new products and technology that we think can drive positive returns for the company. And so we'll clearly look to invest in those areas and look for savings opportunities in other areas of the business to help fund those opportunities.

And if I could just add something, sorry, to the answer I gave you earlier to your question about com, in particular. I'm just reminded that, earlier today, there was a new record sale in the aftermarket of a .com domain, 360.com sold for just under $17 million. And I think if you've seen -- if you look at the history of some of these aftermarket sales of .com, we had dailymail.com sell for GBP 1 million last year. Z.com sold in a private sale without auction for $6.8 million a few months ago to a Japanese company. We had a porno.com [ph] sold for $8.888 million and 360.com was sold to, I believe, a Chinese company, like I said, for $17 million, that's a new record. It's an incredible statement about the value of the .com brand. I think Daily Mail is a good example because here you don't have -- it's not a single character. It wasn't -- it was purchased because the company had made such an investment in developing its brand in .com that it simply wanted -- sorry, in the U.K. domain that it owned that it wanted the .com equivalent and I think that just simply represents the value of a .com name. 360.com for $17 million, a record that, I think, just says a lot about the value of the brand.

Yes, clearly, the brand still remains kind of the top-selling position for domains. I originally thought there's going to be [indiscernible] that bought it and I quickly [indiscernible].

[Operator Instructions] We'll take our next question from Sterling Auty with JPMorgan. Sterling P. Auty - JP Morgan Chase & Co, Research Division: On the transliteration and new gTLD for your guys, the timing of those 11 transliterations, you mentioned the phases that you have to go through. Can you maybe put some general time ranges? Would you anticipate that these would be in the market more generally in the first half of the year or is it second half of the year?

So this is Pat, Sterling. I think it's really hard to tell because we are going to do -- we're going to ask for a modified Sunrise period and that will likely have to require approval from ICANN. We're not certain of that right now, but that's still going to take some time to get that and going as well as the Sunrise period and then the controlled interruption period for the identification of name collisions is also a long period. So it's hard to say right now as to what the exact time would be.

And Sterling, this is George. As we mentioned last quarter, many of our back-end registry customers qualify as .Brand gTLDs and ICANN gave .Brand applicants until July of this year to finish the agreement process. So I think your back half is much more likely than the front half of the year. Sterling P. Auty - JP Morgan Chase & Co, Research Division: Okay, that makes sense. And could you give us a sense of when those launch in the marketplace, what kind of marketing spend or investment generally are you anticipating to drive those new IDNs into the marketplace?

I think that's tough to say, Sterling, this is Jim. The marketing plan that Pat alluded to that's a little different with different Sunrise period, during the Sunrise period, trademark holders are invited to come in and register their marked names prior to general availability. We have what you might call a much more brand-friendly sort of Sunrise in the sense that we are reserving the transliteration of the brands that are registered in .com. And so that implies that there'll be a different marketing approach. We'll simply be notifying existing registrants brands that the transliteration of their .com registration is available to them. So it's hard to say, it's not a traditional sort of a marketing effort. I think, in general, it means that we're not going to need to go out and promote the availability of these IDNs, although we'll certainly do some of that because people are free to register whatever they like in them. But the brand holders who are registered in .com have their brand name reserved for them in the IDNs. They're protected against somebody else registering a name who doesn't own that name. But it's an opportunity for them to have their brand name in the native language script of countries that they operate in. So I think you can see the obvious benefits of that. Putting a price tag on that marketing effort, I think, is - it's just kind of too early to say what it will be. But it'll be focused. It'll be more focused because it's quite targeted. It's unique, I think, as far as any TLD that's ever been launched.

We'll take our final question from Steve Ashley with Robert W. Baird. Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division: In terms of -- you talked about putting -- registrars putting the names on hold. Why do registrars put names on hold?

Pat, you want to go ahead?

So there are several reasons. One of the most common is that you will get a court order that would ask to put something on hold while it's in dispute. People will also have domains that they don't want to have in the general zone, so that they can have the name registered, but not able to resolve. It may be something detrimental to their corporate brand and they don't want it to be out there. And then the one that we've seen most recently is the 2013 Registrar Accreditation Agreement requires registrars to put on hold domain names that they cannot validate the who-is information. And so that's where we've seen the largest trend these days in terms of what the growth is in those particular hold names. Now once they do validate the who-is data, those names will come out of the hold status and then, of course, be active at that point in time.

Yes, let me just let me just add a couple of quick comments to that. If you're familiar with the so-called dark domains, these are the nonconfigured names where the registrant does not want it to resolve, for example, something that is not flattering about a corporate name. A corporation may defensively register that and they simply don't want it to resolve. We get paid for it, but it doesn't appear in the act -- it does not appear in the active zone. You can think of these hold names, we're going to treat them all together with these dark domains very similarly. So we'll get paid for them, but you'll see them reported in our domain name base, they'll be counted in there. The other thing is that George had mentioned this new 2013 Registrar Accreditation Agreement. This is the new agreement that the registrars signed with ICANN that they operate under. Now the number of accredited registrars is, I think, closer to 1,500 today where it was 900 some years ago. So I think -- I hope what we're seeing here, just to keep everything simple, is that all of them have pretty much signed this during 2014. And I think almost all of the registrars have signed it, a large number of them. So I think there's just this initial sort of compliance effort. Pat mentioned that they have to collect who-is data. This also means that some registrars that do not have direct distribution models, who actually sell indirectly through distributions, may find it a little more difficult or may find that it takes more time to collect accurate who-is data. And so these names will get put on hold while they go about doing that and then eventually they come off hold and then they're up here in the active zone. So that's sort of the activity that goes on. But if you understand how dark domains have worked and been counted, these are just like that. You can now think of these names on hold just like that. Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division: And just real quickly, George, do you -- can you remind me, do you sell globally in U.S. dollars?

Yes, for com and net, the majority of our products we sell in U.S. dollars. So if you're referring to the FX impact in the traditional sense, we don't expect that to have an immediate or impact in our 2015 revenue. That being said, for some non-U.S. buyers of domain names, the strength of the U.S. dollar could create a perceived price increase, which could have an impact on demand. But while the strength of the U.S. dollar may be having some effect on demand, we really haven't seen that in any of our numbers, so it hasn't really been an impact for us to date. Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division: Yes. And just to go back and you may have already given this in the past, but the renewal rates today lower than they were a year ago, 2 years ago. Is that true in every country? Or are some countries more pronounced than others?

Yes, renewal rates vary by country. Typically, in the more mature markets, the renewal rates are higher. In some of the emerging rates, the renewal rates tend to be a little bit lower. Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division: Right. But my question is change. If we look at markets a year ago and today, which have seen the most change?

So we don't break it out by market. I mean, if you -- and if you want to talk about change, I mean, the first-time renewal rate at the end of 2013 was about 52.8% and the first-time renewal rate did come down to about 50.7% for the full year 2014. Previous-renewed rates were very consistent at about 82%. And so we did see some of the first-time renewal rates come down and I think more of that is a function of the growth we're seeing in China, which has typically lower first-time renewal rate than the U.S., which is our largest market now. Again, that's an emerging market. As those markets mature, I would expect those renewal rates to improve, but it's a large market that's growing and is still emerging. And so it's just becoming a larger portion of the base and so you get a weighted average effect on the first-time renewal rate.

Ladies and gentlemen, this concludes today's question-and-answer session. At this time, I'd like to turn the conference back to Mr. David Atchley for any final remarks or comments.

Thank you, operator. Please call the Investor Relations Department with any follow-up questions from this call. Thank you for your participation. This concludes our call. Have a good evening.