威瑞信 (VRSN) 2002 Q3 法說會逐字稿

Good day, everyone, and welcome to this the VeriSign Incorporated conference call. Today's conference is being recorded. After today's presentation, there will be a Q&A session and we ask that you please press star one at that time if you do have a question.

For opening remarks and introductions I'll turn the conference over to Steven Gatoff

Thank you, operator. Good afternoon, everyone and welcome to VeriSign's third quarter 2002 earnings conference call.

This is Steven Gatoff, Vice President of Finance, and head of Investor Relations. I'm here today with Dana Evan, Chief Financial Officer of VeriSign, and Stratton Sclavos, our Chairman and CEO.

Before we begin, I'd like to remind everyone that the matters we will be discussing today, other than historical financial data, might be forward-looking statements and as such, they are subject to the risks and uncertainties described in our 2001 annual report as well as other reports filed with the SEC.

We would like you to know also our financial results were released to the news wires this afternoon after the markets closed. The press release can be found own our web site at www.verisign.com. This call is being webcast live both on our website and at streetevents.com.

As it relates to the format of the call today, in a moment I'll turn the call over to Stratton who will provide a high-level view of the quarter and do a deep dive into each of our business units. Dana will follow with a detailed review of the Q3 financial results and will provide guidance going forward. She'll then open the call to your questions.

With that I'd like to turn it over to Stratton.

Thanks, Steven.

I'd like to spend the next few minutes reviewing the overall Q3 results and key business highlights for the quarter and outlook for Q4. Then I'll turn the call over to Dana for the financial review.

Given the continued choppiness and uncertainty in global IT and telecom markets in Q3, the quarter was really about managing what we could control. We continued to refocus on our core recurring revenue businesses, we maintained our trajectory on improving operational rigor and cost synergies, we continued to fully fund our key product development initiative's, we continued to improve the overall quality and satisfaction of our customer base, and we made good progress in constructing our plans for international expansion as we head into next year.

We believe our efforts are showing early signs of success. As we were able to meet, and in some cases exceed our financial objectives for the quarter. Revenues for the quarter totals 301 million with pro forma EPS of 14 cents per share on a fully diluted and fully taxed basis. As you will see when Dana reviews the company's financial results, we also saw solid improvement in many balance sheet items.

From a business perspective the quarter was mixed, with some lines of business performing as expected, while others, such as consulting and third-party product resale still struggle. While we were seeing good interest in existing and new telecom authentication and registry services, we believe sales and pricing trends are still difficult to predict. Outside of consulting and third party product sales, however, enterprise prize and service provider division revenues were flat sequentially, while the mass markets division saw a 3% decline.

There were also several strategic highlights in the quarter, including announcements of new and existing partners including Intel, IBM, Mastercard, and Microsoft. As we mentioned on last quarter's call, we continue to see very strong interest from leading players in IT and telecom, to work with VeriSign to design and build new services. We expect to have more announcements in the 4th quarter.

Let me cover the business unit metrics for the quarter. Our mass markets group, compromised of domain name, web certificate, and payment gateway services generated approximately 100 million in revenues in Q3, down 3% from Q2, but slightly better than our forecast.

As you know, in the web presence business, our focus this year has been on improving customer quality and satisfaction, as promotional and speculative names churn out of the base. We have also continued to improve the operational rigor and expense management in this business throughout the year. We ended the quarter with 9.7 million names under management, down from 10.3 million in Q2, but slightly ahead of our original 9.5 million projection.

We added approximately 500,000 new names in the quarter and renewed and extended just over 700,000. The renewal rate came in at 48% for the quarter, up from Q2's 45%. As we stated last quarter, we calculate the renewal rate based on paid names that are contributing revenue to our P&L. In Q3 there were approximately 1.1 million revenue-generating names up for renewal, and there will be approximately 1.1 million names up for renewal in Q4 as well. We are projecting renewal rate of 48% for Q4, although there could be some upside from there.

Average term and selling price for both new and renewed names in Q3 were consistent with Q2. Upsale rates improved to approximately 35% for value added services, such as websites and domain name based email.

Our plan in the web presence business for the rest of the year is to continue to manage expenses in line with market dynamics, while we execute on our strategy of improving our products, customer support and distribution relationships.

Results in the web certificate and payment lines of business during the quarter were as follows. We sold approximately 95,000 websearch during the quarter, with upsale rates at 48%. The total install base of active website certificates remains consistent with Q2 at over 400,000.

The number of active merchants using our payment gateway services climbed to 80,000, up from 75,000 in Q2. We helped process approximately 61 million unique transactions with an aggregate value of over $3.7 billion, up from Q2's $3.4 billion. From the data we have seen, it appears VeriSign is now the largest gateway services provider, with the largest active merchant base, processing the most unique transaction, for the highest aggregate dollar value.

Other highlights in the quarter included our announcements of our relationship with Mastercard and the rollout of our trusted commerce initiative, Both targeted at improving the security and integrity of online transaction. As we move into 2003, we plan to introduce a collection of new services for authentication and content protection, in both wire line and wireless environments. Tuesday's announcement of our new code signing service for Microsoft's SmartPhone OS is the first of these new offerings.

Dana will provide more specific financial guidance for the mass markets group in a few minutes. But now let me move to the enterprise and service provider division.

As you know, we break revenues in the ESP division down into two segments, managed security and network services, and registry and telecom services. The managed security and network services business includes our PKI based authentication and managed security solutions, digital brand management services, consulting services and international affiliates.

The registry and telecom services business includes the directory and resolution services available from VeriSign global registry, as well as the signaling, database, and billing services from the telecom group.

The ESP division generated 201 million of total revenues in Q3. This included approximately 67 million from managed security and network services and 134 million from registry and telecom services.

Drilling down into the Q2 performance for managed security and networks, while the overall market remained choppy, we saw some modestly positive trends, in a relative sense, in the domestic PKI and authentication business. This included renewed interest and some related orders in both the public sector and financial service industries.

Highlights in the quarter included new PKI wins and strong renewals with several large Fortune 1000 companies. We also announced the release of our first jointly developed services from IBM alliance and an agreement with Intel to work together to strengthen the security of their next generation platform, code name (indiscernible).

Our international authentication business and affiliated channels declined slightly in the quarter as we continued to weed out the underperforming partners from both our business and financial metrics. On a positive note, stronger affiliates such as BT and (indiscernible), continued to make progress, while VeriSign made direct inroads into a few key markets such as Germany and Australia.

As we discussed during last quarter's call, the economic difficulties of many of our smaller affiliates and the much broader portfolio of IT and telecom services we now offer, has dictated a revamped international strategy going forward. We plan to implement a more traditional geographic coverage model, utilizing both direct, and indirect channels, of distribution as we enter 2003. Our stronger authentication affiliates, of course, will continue to play an important role in our strategy as we look to significantly increase overall international contribution over the next 24 months.

Turning to our consulting group we continued to see weak demand in the quarter. Pricing and margin pressure on third party products remained consistent with Q1 and Q2, and we have little indication to believe that these trends will reverse any time soon.

Given this back drop, and our desire to focus on our core businesses, with strong margins and recurring revenue profiles, we have decided to exit the general purpose third party resale, training and installation business immediately. While we will continue to honor our existing help desk and maintenance contracts through their term, we will no longer be pursuing orders for firewalls or stand alone products.

Our customers, vendors, and affected employees have all been notified and the transition has progressed smoothly. We expect this change to impact Q4 revenues by approximately 25 to $30 million. We do not, however, anticipate any impact to per share earnings.

While this was a difficult decision, we are confident it is the right move for our customers, employees and shareholders. We will, of course, continue to offer network and security consulting as part of our PKI, authentication, and DNS offerings. We will also continue to build out our managed security service offering, which integrate management and monitoring of network devices, DNS services, and PKI transactions from our secured data centers.

Moving to the registry and telecom services business, let's start with the global registry. The registry saw slightly over 2.7 million new registrations, consistent with Q2's new name count. We also renewed over 2.4 million names and enabled the transfer of 240,000 names. The active zone files for ComNet and (indiscernible) contain 27.5 million names at the end of the quarter, up from 27.3 million at the end of Q2.

Other highlights of the registry included the development of new naming and addressing services to enhance and augment our basis domain name and DNS offering. Some of these new products will roll out in the first half of 2003. In addition, our efforts to bring intelligent telephony services onto the atlas infrastructure remain on track. The only other noteworthy development of the registry was ICANN's announcement of the internet society as the newly proposed operator of the .org top level domain. As per our contract with ICANN we have begun the planning to transition .org to the new operator by the end of the year and have set aside the agreed $5 million endowment in an escrow fund.

Moving to the telecom services group, we added another 19 customer signaling points to our (indiscernible) during the quarter, bringing us to a total of 1,004. We also saw modest volume increase in both database and signaling transactions.

While the weak overall telecom market still persists, we were pleased with the results in our telecom group. We also continue to see good interest in new services such as the SMS intercarrier messaging gateway, our net discovery service bureau, and our do not call service. With customers such as US Cellular, Cellular Mobile and First Cellular signing on during Q3. With this activity in mind we remain cautious about Q4 but believe we will see flat to modest growth in our telecom businesses, based on higher call volumes, wireless subscriber growth, and new services.

Summing up the overall enterprise and service provider division for Q3, I think it's fair to say our results were mixed, with some areas performing as planned and others, such as the third party product business, dictating a new course of action. Dana will provide the detailed guidance for Q4 but I wanted to give you color on what we're currently seeing and expecting.

In the mass markets business we still expect to have approximately 9 million names under management by the end of the year, consistent with our forecast from our analysts' day in May. We also believe we will see steady renewal improvements as the base stabilizes and the majority of names being renewed have some historical track record.

We plan to launch several new distribution relationships as well over the next six months. These efforts will be targeted at new user groups as we look to expand the market for web presence services.

Visibility in the enterprises market remains very limited. Customer and prospect interest in managed service remains very high, but they are still very cautious about IT expenditures and there few, if any, conclusions to draw about future catalysts. While reported revenues in the enterprise business will decline sequentially, due to the exiting of the third party resale business, we do anticipate an up quarter in bookings for PKI and other authentication offerings.

Lastly, looking at telecom, we are planning for small sequential growth in Q4. We believe our customer set and usage base model distinguish us from other players in the space. New services have started to contribute revenue and look to be well positioned to fuel growth in telecom revenues in 2003. Given the overall telecom market, however, we will continue to manage expectations and expenses very prudently.

We still feel excellent about our competitive position across the board and expect to gain market share as the economy recovers. We are also excited about our new strategic partnerships and product development initiatives in the registry, authentication, and telecom businesses. Many of the new offerings will be ready for the market in the first half of 2003. All in all, the markets remain tough, but we are confident we are focused on the right opportunities externally and the right priorities internally.

Thanks for your attention and now let me turn the call over to Dana.

Thanks, Stratton.

As you just heard, VeriSign experienced relatively mixed results this quarter with some lines of business performing as we had expected and others continuing to be impacted by difficult economic environment. Nonetheless, we remain very focused on driving efficiencies in our operations and implementing continued cost control measures across the company. As a result of our efforts, we were pleased to see key financial metrics delivered in line with expectations, and a few areas come in better than expected.

Now turning to the detailed financial results for the quarter, I'll start with the income statement. On a consolidated basis, VeriSign reported $301 million in total revenue for the third quarter, coming in just above the $300 million guidance we had provided.

To segment this revenue by our two reporting divisions, the enterprise and service provider division delivered approximately $201 million, or 67% of total revenue for the quarter, which was consistent with last quarter. And the mass markets division reported $100 million, or 33% of revenue, also in line with Q2.

Within the ESP division, registry and telecom services was approximately $134 million or 44% of total revenue, and managed security and network services contributed $67 million, or 22% of total revenue. This compared to 42% and 25% respectively, in the prior quarter.

On a sequential basis, total revenue declined $16 million, or approximately 5%, as we had anticipated. The decline resulted from a 15% decline in the managed security and network services business, due to the restructuring of our consulting group that Stratton just spoke about, and a 3% decline in mass markets revenues, marginally better than our previous guidance of an anticipated 5 to 10% decline.

Revenues in our telecom and registry services business unit were basically flat quarter over quarter. Customer concentration continues to remain relatively low in our business model, with no single customer accounting for even 5% of total revenues in the quarter.

Regarding reciprocal transaction or barter revenue, as it is commonly referred to, VeriSign had no new reciprocal revenue transaction in Q3, just as we had none in the second quarter. On a cumulative basis, the flow-through of revenue from all prior reciprocal transaction contributed less than a half of 1% of total revenue.

Turning to the global nature of our operations, the percentage of total revenue that was driven from our international affiliates and subsidiaries was approximately 9% in Q3, fairly consistent with where it's been throughout the year. During the quarter, the number of our international affiliates declined to 46. As we have said before, we expect the number of affiliates across the various geographies to decrease over time as markets consolidate, weak participants terminate, and as Stratton indicated, we continue to refocus and retransition our overall international strategy and enter certain markets directly.

Looking at cost of revenues and gross margins, our consolidated cost of revenue for the third quarter was $137 million, down from $146 million in the previous quarter. This translates into a 55% gross margin in Q3, up slightly from 54% in Q2.

The modest 1 percentage point increase in gross margin was due to two main factors. A conscious reduction of our low margin, third-party product resale revenues, and a partial realization of the benefits from the continued restructuring efforts undertaken in the quarter.

As we have committed to do, we continue to focus on strong cost control measures across the entire organization in order to drive efficiencies in our operating margins and to deliver bottom line results, even in the face of the revenue declines we have experienced. We continue to manage those things that are within our control and to run an efficient and scalable operation.

As a result of these ongoing efforts, total operating expenses for Q3 declined to $8 million over Q2 to $118 million. This decrease was in large part due to our restructuring efforts and focused cost-cutting measures across all of VeriSign's business units. Having said that, it's important to note this decrease was partially offset by increased depreciation expense from capital projects that went live in the quarter, and expense increases in the G&A area for insurance and legal costs.

In analyzing our bad debt exposure during the quarter, we took two measures to conservatively reflect the continued difficult business climate and general economic conditions, especially as it relates to some of our international affiliates. Consistent with previous quarters we did not recognize revenue in the quarter on certain affiliates designated to be at risk or nonperforming.

Also consistent with prior quarters, we continued to take a conservative stance in analyzing our accounts receivable balances across the company, and both the bad debt expense in the third quarter of approximately $10 million. This charge was consistent with that taken in Q2 and included a reserve for certain accounts receivables associated with the affiliates, as well as other telecom and enterprise prize customers.

Overall, pro forma operating income was $47 million for the third quarter, translating into a 15.4% operating margin, as compared to 14.5% in the second quarter. This increase in the operating margin from the prior quarter is related to the results of our continued restructuring efforts that I will talk about more in a minute and continued focus on operating (indiscernible) and expense controls across the company.

As you know, we announced a corporate restructuring in the second quarter, through which we have been rationalizing, integrating, and aligning resources across the company. As Stratton previously mentioned, we continued these efforts in Q3 with our restructuring of the consulting services group. In connection with our transition away from noncore third party reselling business, we recorded an additional restructuring charge in Q3 of approximately $6 million.

As we stated on our Q1 call, we had originally anticipated a total restructuring charge of 70 to $80 million over several quarters, to reflect the full restructuring effort. To date we have taken approximately $73 million. On a go-forward basis we anticipate an additional charge of approximately $15 million related to the ongoing restructuring effort. These charges include employee severance, lease and contract terminations, and write-downs of certain property and equipment, including lease hold improvements.

Regarding the number of employees, VeriSign ended the quarter with a consolidated head count of approximately 3,130 people, as compared to 3,190 people as of June 30, and 3,500 at the end of Q1, reflecting the results of our restructuring efforts.

Highlighting other key P&L items, pro forma pretax income was $48 million and pro forma net income was $44 million. Using the pro forma pretax income, on a fully taxed basis at the 30% tax rate, pro forma earnings per share was 14.2 cents. This EPS is calculated based on a fully diluted weighted average shares outstanding of approximately 238 million shares.

Now moving on to the balance sheet and cash flow items. As it relates to cash balances, VeriSign ended the third quarter with cash and cash equivalents of approximately $327 million representing an increase of approximately $45 million over Q2. The primary factors driving the increase in cash balances were improved cash collections, which I'll discuss further in a moment, reduced capital expenditures, and continued focus on working capital management.

Turning to accounts receivable, consolidated AR balances totalled $206 million as of September 30. A $41 million decline from the end of Q2. This translates into a net DSO of 68 days for the third quarter, showing an improvement over the 78-day net DSO reported for Q2 and under a normalized range of 75 to 85 days.

As you can see, we have been very focused on continuing to improve our accounts receivable processees and collection efforts. We experienced strong collections across all business units in the company, particularly at the end of the quarter.

This was particularly evident in our telecom and registry unit where we collected approximately $15 million more in Q3 than Q2. It is also instructive to point out that accounts receivable had a balance of more than $315 million at the end of last year and has been reduced by more than $110 million year to date.

Having said that, while we are encouraged by the significant improvement in our AR balances, we believe that we have likely reached a more normalized, sustainable run rate of collections as we go into Q4. Therefore we do not expect to see the magnitude of improvement in AR collections over the next several quarters as we have seen in the past three quarters. In other words, there was some low hanging fruit to harvest within our telecom group and within our internal processees that drove some of the improved collections during the past quarter. And we now look to maintain consistent management of our accounts receivable balances going forward.

As it relates to long term investment balances, each quarter we review the individual assets in our long-term investment portfolio. The portfolio consists primarily of equity securities of private and publicly held companies that represent technology distribution and strategic partnership investments for VeriSign that were made over the past four years. As a result of our review in Q3, we determined that there were impairments and evaluation of certain investments that were other than temporary, and accordingly recorded a noncash charge of approximately $53 million in our long-term investment portfolio.

Turning to deferred revenue, the decline in total deferred revenue of $29 million, or approximately 5%, was consistent with what we had expected and communicated to you in our Q2 call. The trends we had anticipated in the mass market side of the business drove the decline in consolidated deferred balances, but this was partially offset by some modest growth in deferred revenue on the enterprise side of the business specifically in domestic authentication services. In addition, we would note that consistent with prior quarters, only 20% of the company's total revenue in the third quarter came from deferred revenue from mass market domain name sales.

Moving now to cash flow metrics, VeriSign generated $82 million of operating cash flow in the third quarter, which was meaningfully better than our expectations early in the quarter. Beyond the consistent base of operating cash flow of approximately $50 million that we were expecting, and compared to the operating cash flows in Q2, we saw an additional increased cash flow from the strong AR collection effort I have just discussed. In addition, we also saw a benefit of over $10 million from concerted working capital management during the quarter.

As you know, our business model is naturally geared to generate meaningful cash flow on a consistent basis. However, we would not expect to generate the level of cash flows in Q4 we experienced this quarter. I'll provide more guidance on future cash flows in just a minute.

Capital expenditures for the third quarter were approximately $37 million. To give you an idea of how that breaks down by division, mass markets, telecom and registry services, and corporate and common infrastructure each represents approximately 30% of that total expenditure and enterprises represents 10%. We expect capital expenditures to be flat to slightly declining for Q4 as we close out the second half of the year where our capital expenditures are typically lower.

With the strong operating cash flow and modestly reduced capital expenditures in Q3 free cash flow for the quarter was in excess of $45 million. While better than expected operating cash flow certainly drove most of the increase, our original forecast for flat sequential cash flows and reduced capital expenditures would have driven positive free cash flow for the 3rd quarter, even without the better than expected operating cash flow.

That concludes my review of the third quarter financial results. As you can see, we have been very focused on several key areas, realigning resources and driving operational efficiencies across the company, monitizing the assets on our balance sheet, managing our working capital, and most importantly, keeping focused on our core businesses.

I would like now to turn towards our expectation for the fourth quarter and lay out some high level guidance for both top and bottom line results, as well as provide some color on a few key other items.

Assuming a status quo environment with the economy and IT spending we will continue to take a conservative, yet thoughtful, approach to our forecast for next quarter. As we have discussed previously, visibility in the enterprise space remains limited, we continue to hold a cautious outlook for the telecom market in general and we expect mass markets division to continue to decline in a range consistent with past quarters.

Further, it is important to realize the steps that we are taking to realign our business, such as the restructuring of the consulting group and our exit from the third party product reselling business, will drive a continued focus on our core strategy, which is to fuel our economic engine with high margin annuity based offerings. This, of course, will have the effect of reducing our overall revenues in the near term, as Stratton had discussed. But we also believe over the long term it improves the overall quality of our business, its revenue streams, and the future profitability potential of the company.

At this point, we would look for total revenues in Q4 to be approximately $275 million, gross margins to improve modestly, operating margins to be up marginally, and pro forma EPS to be approximately 14 cents. We anticipate operating cash flows to be approximately $50 million and to once again generate free cash flow in Q4, dependent upon final year end capital expenditures, which should be flat to slightly down sequentially.

Lastly, we would expect deferred revenue to decline in the fourth quarter consistent with previous quarters but in smaller absolute dollar amounts.

I would now like to open the call for your questions. Operator, may we have the first call, please.

At this time we would like to take your questions. Please press star one on your touch tone telephone if you have a question or comment.

First we'll go to Steve Sigmond of RBC Capital Markets.

Quick questions on the enterprise side of the business. Can you talk about the types of projects where you are seeing demand? You indicated public sector and financial services and also some of the relationships you have been working with IBM, how those are playing out?

Yeah. No surprise, right, we are seeing both federal and state projects begin to take on more momentum. We are starting to be notified that we have preliminarily been selected as a vendor of choice in a few of those. We are starting to see more activity, driven by the cyber security initiatives. But also driven by other things that had been going on all year in the government sector around law enforcement activities, as well as health care activities, and things that were going on parallel.

On the financial services side, insurance and banking continues to be the biggest driver of our solutions in PKI and authentication, although we are starting to see some nice added upswings in things like our authentication service bureau where, as you know, last year we turned on our service bureau with Ebay. We're currently averaging about 50,000 unique authentications a week with Ebay, which is much bigger than either we or Ebay had anticipated.

Starting to see a few things here and there. I wouldn't say there's any particular type of project that seems to be generating more interest, other than the public sector stuff.

Can you give us a sense, this was the first sequential up quarter for the registry in quite some time. Can you give us a sense as to your expectations there for Q4?

I think as you saw in the numbers that we -- of new names was consistent with last quarter, and the number of renewed and extended was actually down significantly, which is telling you, of course, there are fewer coming up for renewal every period. That's because terms have started to extend again and because we are coming through, as you know, that big first renewal cycle.

My expectations is names will go up again this quarter in the active zone file. Looks like at least through this part of October we are seeing consistent new name registrations, and certainly within our own registrar base, the number of renewals up is about the same as last quarter. I think we'll start to see that grow again, but I would bet modestly in Q4.

Thanks very much.

Next Todd Raker with CS First Boston.

Few quick questions. Can you give us a little bit more insight in the second party reselling business from an annualized basis, sounds like it's 100 to 140 million in revenue. Can you talk about the profitability of that business, head count associated with it, and how quickly you can get out of it?

It was about, I would say, on a normalized basis about 110 to $120 million of revenue, because it includes, not just third-party product sales for the firewalls, but also the installation services that went along with that and the training classes. We were probably one of the larger third-party training providers around security products that existed. So when you lump that all together, 20, 25 million in product and the rest coming from the training and installation, I would say 110 to 120.

We have notified all our customers, there's probably a handful that we are working on, you know, six to nine month transitions with. We have begun to deliver to them. You'll see that number go basically to zero immediately this quarter. That's one of the benefits of that business. It's too easy to get into, but pretty easy to get out of, as well.

Just talk about the margin structure of that business and how much head count is associated with it?

I'm sorry. Second part of the question. It was marginally profitable on a given quarter and in some quarters it could lose, depending on how much we had in there. We tended to have not wanted to reduce the consulting force.

So, in fact ,what we have done is we have taken out the majority of the sales resource there, about 60 to 65 people. We have retargeted the direct consulting and senior technology people into more of the DNS and PKI initiatives, and the security architecture business, and I think the 60, 65 is probably about all we're going to do there. We'll probably be bringing some people on as we see the enterprise authentication stuff continue to grow.

And housekeeping, G&A was up 5 1/2 million in absolute dollars. It sounds like the bad debt charge of $10 million was consistent with last quarter. What drove the increase there?

Couple things, Todd. We had increased insurance costs. We had increased legal costs with some of the lawsuits that you've seen, some consulting expenses, and some depreciation expenses from some of the projects that went live, Oracle 11-I data center lit up on the East Coast in the quarter. So those were basically most of the increases there.

I think as we go into '03, now that we have Oracle 11-I under our belts, we will be trying to more fully allocate some of the--- what today, is lumped into traditional G&A sense, we'll be trying to more fully allocate into the P&L, so you'll probably see a shift of that because I think G&A is getting a little overburdened with stuff the business unit should be paying for.

If I look at your G&A number, you know, bad debt, 10 million in Q4 and then we're done with that, what's the normalized G&A run rate right now?

I think I would look at this quarter as the normalized rate. Because while bad debt might come down a bit over the next few quarters, some of our other insurance policies are coming up for renewal in the next two quarters, and given that market, we absolutely expect that our insurance costs will continue to go up.

The legal costs, as those lawsuits get settled, those will continue at the rate they're at now at least through the next year is what we anticipate.

I think it's fair to say and I would be surprised if anybody wasn't saying this, given Sarbanes (indiscernible), given the current scrutiny around governance, added diligence the companies are paying to it, audit fees and legal fees and insurance fees are going up year-over-year for everybody.

Can you talk about the E-sign taking the majority stake there, was there any impact in terms of revenues or anything special going on there?

Revenue perspective it really was nominal. A million dollars, maybe a million and a half or so. I think the -- which was consistent with the royalties they would have been paying us on a quarterly basis. There wasn't really anything incremental.

Thanks, guys.

Next Steve Ashley of Robert W. Baird.

Hi, Tim Burn for Steve. He had to step out.

Question on the registrar business. You've talked about how you're trying to improve the customer service level there, and I know one of the activities there is to improve the website tools. I imagine that's going to begin to translate into reduced calls into your call centers. Is that true and can you give us any sense of trends there?

Call volumes have been going down, for the most part, over the last six months. Just as you suggest, because of new tools, because of better call flow, we have a new center we have opened up in Hazelton, which our direct VeriSign personnel, who are better trained than some of the third-party service bureaus we were using. Call volumes have been going down. Call handling times have been going down. Call wait times and dropped calls have all been going down, but we still have a ways to go.

There are two or three new releases scheduled between now and the end of March next year, in terms of customer service tools, and in terms of self-service tools. We would expect to continue to see good progress in both the quality of the customer support and also our ability to reduce costs over time.

Can you give any sense then, Stratton, as to -- you report the retention rate on a quarterly basis, but has there been any trend across quarter? Just qualitatively.

Are you talking about month by month.

Yeah.

I think all the things that that team has done -- the majority of the improvement is coming because the majority of the base is clean now. I think that's -- I won't take any credit for that.

I think -- but the other improvements are both on the marketing side, much better and much earlier communications to our customers about renewals and then on the customer support side, much better experience with us as they go through that process, have tended to say since, really, about March or April, incremental improvement more or less month by month.

Right. To that point, how many nonpay or low cost names do you have left in the customer base, do you have a sense of that?

I believe at the end of this year we will be done all but for 100,000 to 200,000 names, that will always be in the base because of other issues, such as, we gave it to them free because of a credit or some other special promotion. As it relates to speculative or promotional, they'll be gone.

Any sense, Stratton, should we continue to expect that kind of 1.1 million names per quarter as kind of the go-forward number of names up for renewal? Should you stabilize around that level?

It will actually go up in the first half of 2003. Again, I should have the number in front of me, but I don't. Probably 1 1/2 to 1.8, in that first quarter of 2003. Little less, I think, in the second quarter. Then it starts to look more -- I would say kind of if you wanted to model 1 1/2, it's probably a reasonable number moving out.

Okay. On the PKI business, just one quick question, can you give us a sense of the growth trajectory there and maybe do you see differences across geographic regions?

I think -- I was trying to think through trends and things and real trends on pipelines or bookings or customer questions, it's just a choppy market in the enterprise. We had a very large deal come in near the end of the quarter from a financial institution that we kind of didn't expect, and we had a little bit smaller deal kind of push out. It's just very hard to predict it.

I would say interest is still very high and, in fact, improving because of some of the public sector work that we're doing. It's just very hard to call the -- you know, the direction on this stuff right now week by week. Our team feels better. I think some of our issues in the enterprise were more or less self-inflicted and we have tried to resolve that through the exiting of the third-party business, not having people focused on that and through, I think, just a continued improvement of the overall training and talent of the team.

I think we're good to go here in Q4. I hope as we exit Q4 and do that call, I'll be able to give you some more directional statements. The U.S. is definitely better than the rest of the world in that respect, around authentication, although Asia has been pretty good for us.

Finally, Dana, unless I'm misreading something, R&D is down about 25% sequentially. Can you talk a little bit about that, was it haircut across the board, certain projects you were -- decided not to invest in going forward?

Actually, the bulk of that decline is due to a couple of projects that got completed last quarter that were consulting services, outside consulting dollars. The head count reductions really were not that large in the R&D group. As Stratton said previously, we have continued to fund all of the major strategic initiatives all year long that we have been focused on.

Great, thanks.

Next we'll go to Chris Kwak of Bear Stearns.

Can you hear me?

We can.

Just a couple of brief questions. Of this (indiscernible) names, just a housekeeping question, that you added this quarter, how many were C&O?

About 400,000 of those.

So that's 400,000 of the 2.7, is that --

I'm sorry, Chris, I thought you were talking about the registrar.

I was talking about the registrar.

In the registrar, because they sell multi-extensions it was 400 of the 500 were C&O. The 2.7 million at the registry is all C &O, we don't count the others in the number.

Got it. In terms of long-term deferred, it looks like, if I'm looking at my balance sheet correctly, it climbed just a little bit this quarter. Could you just talk to the long-term deferred actually rising this quarter, what really contributed to it?

The two pieces of that are really terms continuing to extend and -- terms -- actually one piece, term extending.

And then in terms of 2003, obviously this brings down revenues for 2003, but any comments on cap ex in 2003 or just guidance overall in 2003? Thanks.

Thanks, Chris. So as you saw, we didn't give detailed guidance for the year, but we would look for cap ex next year to be down from where we will end up this year, in the 150 to 170 range, and as it relates to kind of overall expenditures have not given guidance on that yet, but the revenue Stratton talked about going down in the 110, 120 million range is what you should be thinking about.

Terrific. Thank you.

And we'll now go to Thomas Berquist of Goldman Sachs.

Hi, this is Sara Fire standing in on behalf of Tom. A couple of things.

You have a lot of irons in the fire, a lot of new incremental deals signed. Have you thought about revenue expectations from some of these things like your Intel relationship, some of the IBM stuff you're doing, the Microsoft SmartPhone stuff?

They don't all fit into the same type of bucket. Let us talk a little bit about how we think of them.

We think of the Intel deal very much like we thought of the original Microsoft and Netscape deals in '95 around root keys. We are enabling a high volume product to ship VeriSign ready, if you will.

The browsers really kicked off VeriSign with SSL and web certificates. We think the chip processors and other initiatives in semi conductors will help do a new generation of that same kind of model. There is very little revenue attributed to the Intel deal directly. But it could serve as the base, very much like root keys in the browsers did, for a whole new business line that's currently generating three digit million types of things.

The IBM deal is really a strong product development and joint sales initiative where we are combining our efforts and going out after customers. We do view that one to be more directly involved in distribution of current products and products we are building together with them.

The pipelines there have been building all year. There's 10s and 20s of deals we are pursuing together and we are starting to see them begin to trickle in for closure. In '03 we see that to be a meaningful contributor to channel sales around PKI.

Microsoft SmartPhone is kind of right in the middle, where we will be a provider of services for that platform and just like we do today with code signing, we'll go out to developers and market that service. To the best of my knowledge we have a very, very high market share in code signing services on traditional browsers and downloads and I expect us to do the same in phones. It's a small business, probably 5 or $10 million business.

Sure, makes sense. Maybe just one other thing.

You mentioned, in I think the telecom area, you expected to grow there partially through gaining share and I just wondered if you could talk us through the competitive landscape and where you expect to take some of that share?

Again, we will certainly go after signaling and database services in more carriers including tier one than we have today. I would expect us to gain more of the wallet -- share of wallet in tier one in 2003. In addition in our billing business, as subscribers move from tier one or between tier one to the carriers we bill for, we tend to, at least right now, still have bases that are growing in the wireless subbusiness. So as our customers take share in the overall wireless business, we look like we'll still be able to grow in wireless billings.

In terms of that tier one taking more share of wallet, is that just from the incumbents, sort of the telcos themselves who are doing it in house or is that from any particular competitor?

It's from, you know, all particular competitors, but I think the bigger opportunities are to help the carriers reduce their overall cap ex and be compliant, either with new regulatory models, or enter new product areas like CALIA (phonetic) or the SMS business, the intercarrier SMS business, much more quickly and more cost effectively than they could themselves.

Sure, makes sense. Thanks a lot.

And Drew Brosseau with SG Cowen has our next question.

Just a couple of questions, sort of surrounding 2003, which are-- trying to get a little bit of a feel for the shape of the year, if you will, on a couple of items. First, head count. Secondly, what we should be anticipating about expense levels? And lastly, whether you can comment at all on when you anticipate deferred revenue starting to grow again?

So again, Drew, hard to answer those questions when we haven't given '03 guidance. We're right in the middle of our budgeting for that year. We don't expect things to change dramatically on the expense side and may have some modest head count and pockets where we are investing. No large head count increases, no large expense increases.

And I'm sorry, the second part of the question?

We're trying to get a sense of when the deferred revenue balance will flatten out and start to grow out again?

The second half of next year would be the forecast, given what we can see today.

And similarly on the -- presumably that's largely tied to the registrar base, that's stabilizing here, certainly at the registry, up a little bit. Do you anticipate registrar domain name base flattening out within the next couple of quarters?

I think, you know, we are trying to be as cautious about predicting that as we head into the new year this time, as we weren't last time. So I think we believe it will stabilize. As that deferred revenue turns around, obviously part of that is because that base has stabilized. The decreases should continue to be smaller, and when that uptick occurs is pretty hard to call, but, yeah,, it's probably measured in quarters now.

Okay. Can you just review, so we are prepared for it, what the impact of rolling off .org will be?

There's about -- last time I checked, about 2.2, 2.3 million names in .org. Obviously, we received $6 at the registry for names that are sold there. Our registrar handles about a third of the names, maybe a little bit more than that today, so we actually don't collect the $6 there today, we eliminate that. So you've got now what's left, about 1 1/2 million to 1.6 million that we are getting the $6 on per year. So that will go away over time as the names currently been paid for roll off.

Now, interesting point is we will continue to be able to provide .org services out of our registrar, so it's unlikely we'll see a roll-off in their revenue from that.

It's not a big number and it's smoothed out, sounds like?

That's right. It is a high margin number.

Good point. Thanks a lot.

We'll now hear from Sterling Auty of JP Morgan.

Couple of questions. First can you give us the percentage of total revenue for both consulting and third-party sales in total in this quarter?

You know, to be honest with you, we don't have that broken out right in front of us. It was consistent, I think it's pretty fair to say the fall-off from 317 million to 301 million quarter over quarter, 3 million of that came from the mass markets business. The rest pretty much is continued roll-off of that third-party product business. And I think you'll find the 25 to 30 million impact that I talked about will be there for this quarter, offset by a little bit of growth in telecom and enterprise.

Okay. Switching gears, on the H.O. Systems, can you give us an idea what the revenue contribution per customer is for HO or what the total number of customers you finished the quarter with?

We have just north of 40 customers, we don't break out revenue contribution by customer. Obviously, the two most well-reported once are Dobson and Leap (phonetic). We have Metro PCS in there, who has been a very surprisingly strong contributor to subgrowth.

Then on the enterprise authentication, can you give us an idea, when you're talking about that, is there a split between what part of that is web service certificates, what part is individual PKI certificates?

Everything we talk about in enterprise authentication is managed PKI for clients or network devices. The web server certificate is all counted on the other side of the house.

I think at one time you gave us an idea of what the total number of PKI certificates in that area is, can you give us an update?

Well, there's 5 million plus that have been done in cable modems. Those are very low price points certs. And then, probably a million and a half or so, I want to say, in the end user side. I have not checked that number recently.

Great, thanks.

Now we will go to David Joseph of Morgan Stanley.

Hey guys, glad to have slipped in here.

Telecom, just two really quick questions. Telecom, it sounds like you guys alluded to there being challenges in that space. Just specifically, I was wondering if you're seeing pricing pressure in the HO, wireless billing end of things, or how subgrowth has been there? And if you have been seeing any pressure in the Illuminet end of the business? And then also with regard to the restructuring, have you guys been seeing the savings that you had initially been expecting there?

We have just been reading the papers about telecom, David. It's a weak market. Our -- I would say on the HO side, we continue to find very satisfied customers in HO. As contracts come up for renewal and volumes are up, we tend to do per-user pricing on a volume curve, but I wouldn't say there's dramatic pressure there. In fact, our customers are very happy with that service.

On the Illuminet side, traditional Illuminet side of core signaling and database services, as we've said before, we traditionally build price decreases in and volume increases into the model on a yearly basis, and we saw some pressure in Q1, as you know, less in Q2, about the same in Q3. I wouldn't say anything out of the traditional model around those services. The second piece?

How's the savings realization from the restructuring, is it in line with what you expected, I think you mentioned 30 to $40 million?

It's exactly, probably, smack dab in the middle of that range, and right where we would have expected it to be for this two quarters into it.

Great. Just one last quick question on consulting. I know you guys are restructuring that. In addition to the third-party sales and the economic pressures there, have you guys been seeing any kind of competitive pressures with consulting and how do you really see it contributing to the model on a quarter to quarter basis? I know that at one point your goal was to get it to a 20 to 30 million run rate. Do you see that happening longer term or maybe two to three years down the road?

You know, I think what we have decided, David, there is that even within that business, the only good business to have is recurring revenue business. So we are really now retargeting the entire initiative at things that are dragging certificates or DNS services or managed device services. So I expect that business, you know, will still -- will now be profitable to the tune of the rest of our margin structure. But as it being 20 or 30 million a quarter, not probably for the next 12 to 18 months, but the profitability of the business will be better.

Thank you very much, guys.

Thanks, David.

Next, Jordan Kellen of UBS Warburg.

Hi guys, it's Jordan Klein.

We thought we had a new analyst.

Unless I changed my name.

Dana, you talked last quarter about the strategy for collecting 90% of domain name renewals by the end of the first month. That seems to be paying dividends. Although I'm just curious, because your DSOs and ARs were down. Can you talk about the impact it had there and the big drop, and do you plan to get more benefit from that?

I would say most of the improvement that we saw in the AR balance area was driven predominantly, number one, from the telecom services group. We really put together a whole new program there and went at it hard and collected $15 million more, just in the quarter, than we had in the past. We also saw a nice reduction in our enterprise accounts receivable. The mass markets have kind of rolled out that early invoicing program earlier, late Q2, early Q3, so that was anticipated and not the bigger piece of the improvement.

Right, okay. So that you could benefit more from that going forward, you would expect to, I guess?

I think marginally. I think a lot of that was built into what you saw in the collections this quarter?

Okay. Maybe Stratton or Dana, one of you could address kind of two things and what they might do to future operating costs. Service -- I know you have some initiatives to improve the service on your registrar business. I think you just started to kind of roll those out. Any added costs there? And also Stratton, as you talked about really trying to improve the distribution overseas, away from the affiliates and more towards a direct and indirect channel partners, what sort of costs would you think would be associated with that? Have you looked into that and how much would you kind of expect that to impact things next year?

Yeah. Although I think it's somewhat counter intuitive. Our ability to improve customer support and lower costs in the registrar side of the shop are actually consistent, for a couple of reasons. One, remember we had built that organization during the boom time, and so it was not only supporting about 15 million names rather than the 9 to 9.7 we have now, and it was anticipating continued expansion internationally. So I think just the natural fall-off in volume helps the costs.

And then really it's taken us about a year to architect, build and now start to deploy the initial tool sets that help with self-service and help with the customer service agents themselves being able to handle calls more efficiently.

A very good example is it will be, I think the end of this quarter or early in Q1, where we will have migrated from two distinct databases. One we inherited from the old national science foundation contract and one we started about two years ago on our own registrar business. It's taken us quite a while to migrate all that over. We should be done by end of year. That will drop support costs dramatically because it will be much easier to find a particular customer's name, where they are, and what their rate is. And there are a few other things like that. More detail than you probably wanted. It is not in consistent that we can reduce customer support costs and improve quality over the course of the next year.

On the international side, it's a very good question. I think that's a potential worry that we've heard from some analysts as we go direct internationally it will raise our costs. We have about 200-plus people focused on international today. Our expectation is that we will retarget them, as opposed to add to them dramatically, as we go into these markets. Remember if they're supporting a lot less affiliates, and in certain markets those affiliates are no longer there, then we can target those people at our own initiative. We don't think you'll see dramatic expense increases in the international side, but probably a marginal increase.

Just two quick ones. One, I know you talked about Illuminet not really having any international exposure when you made that acquisition. Any intentions to ramp that up? Secondly, Dana, if I look at the cap ex you talked about for this year, have you ever talked about, or what would be the percent of that that would just be core maintenance cap ex? You know you got to have that every year, no matter what?

Haven't broken that out and talked about it that way. It's interesting, something perhaps we could go off and come back to you with a maintenance amount. Clearly there's some core infrastructure in our authentication services, telecommunications services, registry services that we need to have. And then we always fund some new initiatives for future growth. That being said, we really believe that next year our capital expenditures will come down quite a bit from where they're going to end up this year and a lot of that's going to be driven by just core services.

Okay.

I'm sorry.

The Illuminet had no international?

Sorry, guys. So they do have a business in Latin America, right? And it's 5 to 7%, you know, today of their revenues. I think we feel that that's still an area where there's going to be growth next year. I would think, though, that you're probably no more than 10% of revenues on the telecom side from international next year. Where we're going to do is create some business development initiatives in Asia and in Latin and South America next year to try to stir up business relationships for the telecom group. My expectation is that won't result in significant revenues until 2004.

Thank you very much.

We will now go to Joe Bishop of Intrepid Capital.

Just a quick question. I know you're not talking about 2003 too much, but at least, or actually you have some enterprise business that will probably be down in the domain name business that may be stable to down, in telecom may be stable to up. So it seems like Q1's flat, at best, but probably down. Any thoughts?

Let's see. Not giving 2003 guidance. We think that -- as we said, taking the third-party product business out in one fell swoop gives us the ability to focus on the core recurring revenue businesses. Those businesses are in fact growth businesses, we believe, at least on the enterprise and telecom side in 2003, and the domain name business we think will decline in line with what it's been doing here the last few quarters, which is single digit type of decline. So overall we expect to enter next year in the telecom and enterprise side with growing businesses and on the domain name side with a much improved customer base and much improved margin structure.

Fair enough, thanks.

Due to time constraints, we do have time for only one more question.

Chris Russ of Wachovia securities.

I was wondering if you could comment about the transition of .org at the end of the year and what kind of impact you might expect? I know it's a small percentage of your total domain name business, but what kind of revenue is associated with that business and how would that impact '03, do you think?

I think we described a little bit earlier, Chris, it's about 2.2, 2.3 million names today, about 2/3 of those are sold by other people. We would count those $6 in our stream. So you're really looking at about a $10 million impact to the top line, obviously a little bit less than that to the bottom line, and we'll just move forward from there.

Thanks very much.

At this time I would like to turn the conference back to you, Mr. Gatoff for any closing or additional comments.

That concludes our call today. We would like to thank everyone for taking the time and for your attention. As always, we look forward to talking with you and answering any additional questions you might have. Thanks and good evening.

That concludes the conference call. We thank you all for joining us and have a great day.