VeriSign, Inc. (VRSN) Q3 2015 Earnings Report, Transcript and Summary

Good day, everyone. And welcome to VeriSign's third quarter 2015 earnings conference call. Just a reminder that this conference is being recorded and unauthorized recording of this call is not permitted. At this time, I would 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 third quarter 2015 earnings call. With me are Jim Bidzos, Executive Chairman, President and CEO; Todd Strubbe, Executive Vice President and COO and George Kilguss, Senior Vice President and CFO. This call and our presentation are being webcast from the Investor Relations section of our verisign.com website. There you will also find our third quarter 2015 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 longstanding 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. With that, I would like to turn the call over to Jim.

Thanks, David, and good afternoon, everyone. I'm pleased to report another solid quarter for VeriSign. Third quarter results were in line with our objectives of offering security and stability to our customers while generating profitable growth and providing long-term value to our shareholders. We reported revenue of $266 million, up 4.2% year-over-year and we delivered strong financial performance, including $157 million in free cash flow. We processed 9.2 million new registrations during the third quarter and added 1.68 million net new names ending with 135.2 million .com and .net domain names in the domain name base. Our financial position is strong with $1.9 billion in cash, cash equivalents and marketable securities at the end of the quarter. Our commitment to returning value to shareholders continued during the third quarter as we repurchased 2.3 million shares for $156 million. As of September 30, 2015, we have $605 million remaining in our share repurchase program, which has no expiration. 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 discussed on our last call, we're making progress as we prepare to launch the internationalized domain name versions of .com and .net. Our launch preparations are proceeding according to plan as we prepare to begin a phased rollout of the IDNs toward the end of this year. We will provide more information on our launch plans when appropriate. I'll comment now on third quarter operating highlights. At the end of September, the domain name base in .com and .net was 135.2 million, consisting of 120.1 million names for .com and 15.1 million names for .net. This represents an increase of 3.4% year-over-year, as calculated including domain names on hold for both periods. In the third quarter, we added…

Thanks, Jim and good afternoon, everyone. During the third quarter, we generated revenue of $266 million, up 4.2% year-over-year and delivered GAAP operating income of $154 million, up 10.7% from $139 million in the third quarter of 2014. The GAAP operating margin in the quarter came to 58.1%, compared to 54.7% in the same quarter a year ago. GAAP net income totaled $92 million, compared to $95 million a year earlier, which produced diluted GAAP earnings per share of $0.70 in the third quarter this year, compared to $0.69 for the third quarter last year. As of September 30, 2015, the company maintained total assets of $2.6 billion. These assets included $1.9 billion of cash, cash equivalents and marketable securities, of which $794 million were held domestically with the remainder held internationally. Total liabilities were $3.6 billion at the quarter end, up from $3 billion at the end of 2014. I'll now review some of our key third 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 $266 million for the third quarter. 60% of our revenue was derived from customers in the U.S. and 40% was from international customers. Deferred revenue at the end of the third quarter totaled $940 million, a $50 million increase from year-end 2014. Third quarter non-GAAP operating expense, which excludes $12 million of stock-based compensation, totaled $99 million, down from $102 million in the second quarter of 2015 and compared with $101 million in the same quarter a year ago. Non-GAAP operating margin for the third quarter was 62.7% compared to 60.6% in the same quarter of 2014. Non-GAAP net income for the third quarter was $103 million,…

Thank you, George. During the third quarter, we furthered our work to protect, grow and manage the business while delivering value to our shareholders. I'd like to expand a bit on what we think that actually means. I believe the best way to do that is to offer some long-term perspective on VeriSign's performance since the completion of our divestures five years or 20 quarters ago. Our goal then was to simplify the company's business through divestment of non-core assets and to focus on profitability and value creation. Since then, revenue has grown sequentially for 20 straight quarters. Non-GAAP EPS has grown steadily from $0.31 in Q4 2010 to $0.78 in Q3 2015. Free cash flow has grown steadily and was $612 million over the trailing four quarters. Non-GAAP operating margin has risen steadily from 44.3% in Q4 2010 to 62.7% in the most recent quarter. Over the last 20 quarters, we've returned $4.2 billion to our shareholders. We repurchased over 69 million shares for $3.22 billion, which exceeds our domestic free cash flow for the same period, and in that same timeframe, we returned $982 million in special dividends, excluding payments to convert holders triggered by that special dividend. Our $2.75 per share dividend in 2011 was a 100% tax-free return of capital. We believe the long trend lines of growth in the top line and bottom line, along with the consistent track record in returning generated value to our shareholders through effective capital allocation and an efficient capital structure are what matter most to our shareholders. We believe that proper balance within our strategy framework: protect, grow and manage is what makes it possible for us to deliver this type of consistent long-term result and simultaneously serve the interests of our shareholders, employees and customers. We intend to continue our steady focus on long-term consistency. We'll now take your questions and Operator, we're ready for the first question.

Thank you. We'll go first to Steve Ashley from Robert W. Baird. Steven M. Ashley - Robert W. Baird & Co., Inc. (Broker): Hi, thanks very much. Would love to get some color on the acceleration that we saw in growth in domain names, 9.2 million new. That's a number – I don't know the last time we saw a number that high. And you mentioned Asia, but maybe you could give us a little bit more color on, maybe what might have drove that strength?

Sure, Steve. This is George Kilguss. As we mentioned in our prepared remarks, we did see 1.68 million net additions to the domain name base and as you pointed out, there were 9.2 million gross additions in the third quarter. During the third quarter, we saw continued strength in additions coming out of international markets, particularly Asia. Now that region includes markets such as China, India, Indonesia, Vietnam, et cetera, and all those regions we've seen good growth in those regions. We also mentioned that while we believe these markets will continue to perform well, we also believe that the pace of activity we saw in the third quarter will slow sequentially in the fourth quarter. We did give guidance of 1.1 million to 1.6 million. The midpoint of that is about 1.35 million. If you recall, last year we did about 700,000 names in Q4 2014. So we do expect to have good net adds in the fourth quarter. Steven M. Ashley - Robert W. Baird & Co., Inc. (Broker): And so there was not promotional activity by registrars or anything out of the norm during the period in the Asian markets?

When you say out of the norm, I mean registrars do run promotional activities. I believe there is a few registrars that do some around certain holidays. But in most of our marketing programs, we put those in place throughout the year. So we continue to have a consistent level of spend or activity in those markets, but nothing unusual that I'm aware of from a marketing perspective.

Sorry. I would just add to that that nothing extraordinary and I feel I'd be remiss if I didn't just underlie George's comments with the fact that com is just a strong brand and it typically performs well and we see it continue to do so. Steven M. Ashley - Robert W. Baird & Co., Inc. (Broker): And just my last question is on the renewal rates, you projecting them to maybe go down a little bit to 71.8% in the fourth quarter. What – can you give us some color on what might be causing that to go down a little bit?

Yeah. So it's relatively flat year-over-year, Steve. We had 72% last year at this time, 71.8%, so we're talking about 20 basis points. But really the renewal rate is speaking to the registrations that were registered a year ago. We are seeing a little lower tick in the first-time renewal rate, but again that's more as we shift geographies and sell more into what we've talked about emerging markets, international markets, some of those markets have lower first-time renewal rates. But which have improved during the year, but at least quarter – year-over-year, we expect it to go – to be flat. But it – seasonally it tends to go down a little bit in the third quarter based on our historical activity. Steven M. Ashley - Robert W. Baird & Co., Inc. (Broker): Thank you.

Moving on, we'll go next to Sterling Auty at JPMorgan.

Hi. It's actually Mina Confit (17:07) in for Sterling. Thanks for taking my question. I actually have two questions and I just got disconnected. So if you answered them in the meantime, I apologize. The first one is about the new domain name registrations. You had 9.2 million this quarter, which I think is the strongest in the recent quarters. So could you maybe talk a little bit about what might have been the driver for that? And also I was wondering if you could give us a sense of what kind of contribution we should see from the IDNs, if you have any updates on that. Thank you.

Sure. So, as far as the strong adds in the quarter. Again, we saw good activity coming out of international markets, primarily Asia, but those markets I talked about earlier, China, India, Indonesia, Vietnam. We've seen growth in all those markets. So, we're very pleased with that growth over there. It seems to accelerate in the quarter. We're having a good month-to-date as well over there. So, we'll monitor that activity, but we've been – we guided up for the fourth quarter versus last year. We're guiding 1.1 million to 1.6 million, but good demand out of the Asia region is what we're seeing over there.

Great. And this is Jim. If I can just answer the second part of your question or your second question about IDNs. So, the news this quarter is that we are on track to begin a rollout and launch before the end of the year. I think it's early at this point to speculate about how they'll perform or provide any sort of guidance or revenue forecasts. I will say that I think when we're talking to you a quarter from now, obviously the beginning of the rollout with the first IDN or IDNs at that time will give us some things to talk to you about and I'm sure when we're talking about Q1, 2015, by then, we'll actually have been in market. We'll be beyond rollout, we'll be in market and we'll certainly have more data for you or more to talk about then. So, early now, to speculate about any of those things. I think the important news is that we're on track and we're still tracking on our commitment of last quarter to begin our rollout before the end of the calendar year in 2015. That answered your questions?

Yes. Okay. Thank you.

Great. Thanks.

And we'll go next to Fred Ziegel at Topeka Capital Markets.

Hi guys. So just a follow-up to the last question. When you say begin the roll out, do I take that to mean some will be out by the end of the year but not all? And as a follow-on to that question, how should we think about it in – or how do you guys think about it in terms of prioritizing the timing IDN by IDN?

Thanks, Fred. Yeah, so I think the first part of your question had an implicit assumption that is correct, that we are rolling them out in some sequence. I don't want to say that we're certainly not rolling them all out at the same time. And I don't want to say that we're going to roll them out one after the other individually and have 11 separate rollouts. There is going to be a phased rollout that's based on our preparations, market analysis, readiness, ICANN process, a lot of different factors that will go into that. What we do know for certain is that we will begin with the – with at least one IDN before the end of the year. So there is some ICANN process that does play out here. There is a – an early period where brand holders have the ability to come in. There may be some early access opportunities for those who wish to get into the store early, so to speak. But that process will have begun before the end of the year. I expect that certainly by the turn of the year and in Q1, we will be with at least one. I think that's the only thing I can say comfortably without speculating, in-market. So we will be selling and there should be activity and we should be learning and we'll have more to talk about when we do talk about Q1 certainly. More to talk about after Q4, but a lot more to talk about after Q1.

Can you give us an update on what's going on with the .brand marketplace?

Well, I can give you a general high level update there. There were some delays associated with .brands in particular, as ICANN recognized that .brands had needs that were different beyond what ICANN had originally anticipated, different needs as opposed to those who are getting into the business of selling domain names. So, some contractual issues were worked on between the brand community and ICANN and additional time was given to the brands, I believe. I don't have a specific number for you, but a number of brands that engaged in that process, some did sign contracts by a deadline. I believe there was another extension for some additional work by some brands who had special conditions, but we haven't seen a lot of them out in the market yet, but some of them have certainly announced their intentions to roll out their brand TLD. So, they're not visible. It's not that active, but there was some, quite a bit of activity, mostly contract signing with brands. So I would expect that next year you'll see some .brands in the market.

And is it still your sense that they're likely to opt for .brand as a complement to dot.com, as opposed to a replacement?

I certainly think so. I think there are a lot of different ways to think about this, but there's just so much investment in the brand in the .com registration for most of these large brands. I think to use a metaphor that may not be exactly perfect, but I think will give you the idea. If you had a telephone number that you had invested heavily for years extensively in creating awareness for people to – call you and order your product and you – a different number became available and you opted for that. If it costs you $7.85 a year to continue to forward your old number to your new one, you'd do that for as long as you have any number of people calling it. But there are in some cases of these global brands, an extraordinarily large amount of traffic associated with their current domain. So, it's very easy for them to simply redirect that traffic to it. So this is, I think you're getting to a question that I've answered in the past, which is that I don't expect these people who get a .brand to abandon their .com. They're certainly not going to do that, it is their brand. It's inexpensive for them, and there is a heavy investment in branding and traffic. So, I expect it to be either an experiment or a complementary registration, and we'll see how it plays out in the years ahead. But, I certainly don't expect people to abandon their .coms. I just don't think that's going to happen.

Okay, last question from me. Can you give us an update on your initiatives with security services, most notably DNS firewalls and DDoS?

Well, DDoS is one of the products that has been around for a while and is a main contributor to the product sales in our security services unit. The DNS firewall is new, still a bit early to really talk at any level of detail or sort of any generalized trends that we see. The reception is certainly good in the market, I'll say that. And, overall, the security services unit continues to grow, not at the point where we're reporting it separately, of course, but it is growing. And, we'll have more to say about that when it gets to a point where we can.

Okay, thanks.

Sure.

And, we'll go next to Priya Parasuraman with Wells Fargo Securities.

Thank you, this is for Gray Powell. Just a question on the operating margins, which are strong this quarter. Any color on that? And, do you have any increases baked in for the new IDN launch expenses in your guidance?

So Priya, your first question was on the operating margin. Again, our operating expense for the quarter was $99 million. And if you look year-ago, that was about $101 million. So it's not – it's been around $100 million for a while. When I look sequentially of changes, there is really nothing that jumps out at me, per se, in our core. We had a little bit lower depreciation, maybe a little lower travel. In our sales and marketing, while it was down sequentially, if you look at the year-to-date nine-month period, it's relatively flat. There's really a timing of when we rolled expenses out. We rolled them out – those programs a little earlier this year than previous year. So you have some inter-quarter variances. But overall year-to-date from a sales and marketing, we're pretty much on track. R&D we're down a little bit. We've optimized some of our spend in our R&D area and we have a slight head count decrease. And then G&A, we had some legal expenses increase. But overall, if you read on our 10-Q, we expect those major categories to be consistent over the next quarter or so with what we've just rolled out there or just produced.

And I would just add to that, with respect to the comments that I made earlier. There isn't a specific focus on the operating margin, per se, by itself. The operating margin is a fairly consistent trend line, if you draw it over the last five years or the 20 quarters, moving slowly and steadily in a positive direction. And it's – the real focus for us is that it allows us to move the important trend lines of top-line revenue and profit forward and pursue our long-term strategy. I think those are really the important issues. There are always gives and takes, as George said, but again, from a $102 million the year-ago quarter to $99 million this year, I think is roughly equivalent in our view and allows us to continue the trend lines that we're really focused on.

Okay. Great. And then one more, if I may. Any thoughts on seasonality for domain name growth? Looking out towards 2016, I know it's early but I was curious if you think the international growth might skew the seasonality somewhat for 2016?

Well, we'll give you guidance next quarter on our views on 2016, Priya. We can just tell you, if you look at this year, clearly Q1 was a strong quarter from a net adds perspective and Q3 clearly was – Q2 tends to be a little bit lower because of how the deletes come into the base with a lot of the strong adds in Q1 with a 45-day grace period. It tends to slightly increase deletes a little bit in the second quarter. And then the fourth quarter, December has a lot of holidays in the month and globally a lot of countries take holidays off. So, December tends to be a short month for us, and so we tend to see the fourth quarter seasonally be a little lower sequentially than third quarter. But we'll give you some more color on our views on 2016 next quarter.

Okay. Great. Thank you.

And we'll take our final question from Walter Pritchard at Citi.

Hi. Thanks. George, I'm wondering if you can talk about from a sales and marketing perspective on those expenses were probably the area that your OpEx was the lightest versus what we were looking for and I see you did have good strength in names. Did you make a trade-off there in terms of sort of marketing programs that you peeled back during the quarter as you saw the strength? And generally how should we think about the level of sales and marketing, especially marketing spend as we go into Q4 and into early next year?

Yeah. Thanks, Walter. So, there was no conscious effort to pull any programs. As I mentioned earlier to a caller, if you look at the nine-month year-to-date expense in sales and marketing, it's relatively flat. We did this year roll some expenses – I'm sorry, roll some programs out a little earlier in the year. So, a little bit frontloaded. If you look at it on a quarterly basis, we had slightly higher sales and marketing in Q1 and Q2. It's just kind of how it fell this year. We constantly evaluate our programs, but they seem to be performing well. As far as Q4, we expect the expense in sales and marketing to be consistent with what it was this quarter.

Okay. Great. Thank you.

We have no additional questions at this time. I'd like to turn the conference back over to Mr. Atchley for any concluding remarks. Sir?

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.