威瑞信 (VRSN) 2003 Q3 法說會逐字稿

welcome to the VeriSign Incorporated conference call. Today's call is being recorded. At this time for opening remarks, I would like to turn the call over to Steven Gateoff. Please go ahead sir.

Thank you, operator. Good afternoon everyone, and welcome to VeriSign's third quarter 2003 earnings call. I'm here today with Stratton Sclavos, Chairman and CEO of VeriSign; Dana Evan, our CFO; and Katie Baird, Director of Investor Relations'.

Before we begin, we'd like to remind everyone that other than the historical financial data, the matters that we will be discussing today may include forward-looking statements, and as such, are subject to the risks and uncertainties described in our 2002 annual report, and other reports filed with the SEC. We'd like you to know that our financial results were released to the news wires after the markets closed this afternoon. The press release related to financial information discussed on the call, and a reconciliation of GAAP and pro forma financial information can be found on our Website at www.VeriSign.com. This call is being web cast live both on our Website and at streetevents.com.

So far as today's call, we've got a lot to cover between reviewing Q3 results, discussing the announced sale of our Network Solutions business unit, and providing guidance looking forward. In a moment, Stratton will provide both a high level view of the quarter, and a detailed discussion of each of our business units. Dana will follow with a review of Q3 financial results and guidance going forward. She'll then open the call for your questions. We anticipate the call ending at approximately 3:00 p.m.

Before we get started, I wanted to cover some important administrative logistics for this coming January's earnings call. As you know, VeriSign typically holds its quarterly earnings call on the fourth Thursday following quarter end. We wanted to let everyone know, so that you can plan accordingly, that for the January 2004 earnings call, some of our executive management has committed to participate in an industry conference overseas during our usual date for earnings. As a result, we are planning to hold January's earnings call one week later, on January 29. You should, of course, expect to see our standard press release in January confirming the date and logistics for the call. With that, I'd like to turn things over to Stratton.

Thanks, Steven. Good afternoon everyone. Let me add my welcome to all of you attending today's call. As I'm sure most of you expect, we have quite a bit to cover today, including a discussion of the general business environment as we currently see it, our business unit performance for the quarter, the planned divestiture of Network Solutions, and our outlook for Q4 and beyond. As you can see from our earnings release, our operating performance in the third quarter was modestly ahead of Q2 and our guidance.

For the most part, all of our business unit metrics came in ahead of plan, allowing us to show sequential growth in our telecommunications and Internet services groups, and for the first time in six quarters, growth in the overall corporate revenue as well. While we still feel a sustainable recovery in IT and telecom spending is not likely to materialize for several more quarters, we were pleased to see quarter-over-quarter growth in both the telecom and Internet groups. In the Internet services group specifically, we benefited from increased demand for our security and payment services, as well as surprisingly strong growth in the base of Active.com and NetName.

In the telecom services group, roughly half of our sequential growth of $4m came from recurring services, while the rest came from a non-recurring project for one of our telecom customers. All in all, we are seeing some improvements in our customers' operating performance, and correspondingly, their future spending intentions. Like many companies in the industry, we are monitoring this activity closely, and we'll be prepared to respond when the demand strengthens. It's important to note, that we believe our managed services model will be a competitive advantage during any spending recovery, as customers will look to balance the cost, complexity and compliance issues associated with new IT and telecom initiatives.

Let me now move to the proposed Network Solution sale. As we announced last week, VeriSign has signed a definitive agreement to sell the Network Solutions unit to Pivotal Private Equity. VeriSign will receive a total of $100m in cash and notes, and we'll retain a 15% equity stake in the new entity. We expect the transaction to close this quarter. The strategic rationale for the sale is very simple, in one word, focus. Over the past few years we have come to believe that VeriSign's core purpose is to build and operate transformational infrastructures that become indispensable to society. The managed communication, security and directory services that we provide from our telecommunications and Internet services groups are examples of critical infrastructure services that fit this mission. Network Solutions' domain name and value added web presence services are not.

While we believe the management team at Network Solutions has done a tremendous job in improving the performance of the unit over the last 24 months, we feel there is no longer a fit with our strategic goal. The sale allows VeriSign to be completely focused on being the best in the world at critical infrastructure services, while allowing Network Solutions to pursue its own destiny. Dana will provide further guidance regarding the step period, and its affect on Q4 revenue and earnings in a few minutes.

I'd like to now run through the metrics for each business unit for Q3, and then give you some thoughts on our outlook for Q4 and beyond. Starting with Network Solutions, we added approximately 430,000 new names in Q3, and renewed or extended approximately 700,000 more. The renewal rate for the quarter came in at just over 57%, up from Q2's 56%. We ended the quarter with approximately 8.2 million names under management, slightly ahead of our projection. Average selling price and term for both new and renewed names, remained firm at the previous quarter's levels.

The main highlight during the quarter was the successful conversion to a new billing system after an 18-month development and integration effort. All indications are that the new system will improve operating efficiency, packaging flexibility and customer satisfaction. While the business unit has certainly seen its challenges over the last few years, we believe the management team and the employees of Network Solutions have shown a level of commitment and execution second to none in their industry. We wish them well in their future as an independent company.

Now let me move to our telecom services group. As we've described before, the telecom services group has a simple strategy for 2003, deepen the penetration of our existing services within tier one and tier two accounts, while we bring to market new services such as 'do not call' and wireless number portability, and begin the expansion into selected international markets. We ended the quarter with a total of 1,138 telecom customers, and we saw 8.3 billion queries on our databases. This compares to 1,063 customers and 8.1 billion database queries in Q2.

Other highlights during the quarter included several additional tier one wins, for both our existing database services and our new 'do not call' and net discovery services. While we were once again pleased with the level of new business activity in the quarter, we would expect the revenue contribution from these new wins to ramp slowly over the next few quarters, as network integration and service rollouts proceed. While we had expected revenues to be relatively flat from Q2, actual results were up 4% or $4m, quarter-over-quarter. As I mentioned earlier, half of this increase came from higher recurring service revenues, while the remainder came from non-recurring integration services for a large customer.

Without these one time fees, the telecom unit would have still delivered 2% sequential growth, or $103m in revenues. As we head into Q4, we remain cautious about the rate of telecom recovery, but continue to be excited about the long term opportunities we are pursuing in tier one accounts, wireless data, and international markets. To that last point, we also announced this week that we had acquired UNC Embratel, the clearing business of Embratel Brazil. While this is a relatively small acquisition, it supports our strategy of expanding our services into Latin America, and will act as a beachhead for VeriSign in the region. We expect the business to generate $5m-$10m in revenues in 2004.

We also want to address some questions we've had regarding the impact of our Dobson billing contract. As we've discussed previously, Dobson is transitioning off our platform by year's end. The impact to Q4 revenues will be approximately $2m-$3m, while the impact for Q1 '04 and beyond will be approximately $6m-$7m per quarter. As you would expect, we have been factoring this into our planning and growth assumptions all along. As we enter Q4, we now believe that we will be able to replace the lost revenue this quarter, and in Q1, through a combination of new service ramp up, increased international contribution, and organic growth at other billing customers. With these assumptions factored in, we would now expect to achieve flat run rate revenues of $103m-$104m in the telecom group for Q4 and Q1, with some upside opportunity. We would then expect to see telecom revenues grow throughout the remainder of 2004. All in all, we are pleased that we will be able to recover the loss of the Dobson revenue, and move on to growing the overall telecom business next year.

Let's now move on to the Internet services group. The Internet services group combines all the security, payment, naming and directory offerings. The third quarter continued the trends from Q2, with stabilization and modest improvement in several operating metrics. We sold over 93,000 web certs during the quarter, with up sell rates stable at approximately 50%. The total installed base of active Website certificates stood at 375,000 at the end of Q3, up from 373,000 last quarter.

As we have previously forecast, the installed base began to grow again in Q3, and should continue this trend in Q4. The number of active merchants using our payment gateway services climbed to over 96,000, up from 93,000 in Q2, as we helped process approximately 90m unique transactions, with an aggregate value of over $6.9b, up from Q2's $5.8b. On the enterprise security front, we were pleased to see TKI and MS wins in both new and existing accounts, including ADT, BCE Emerges, Campbell's Soup, Baxter Healthcare, SPC, and the Nuclear Regulatory Commission. We do believe the outlook for our managed security services over the next 12-24 months is continuing to improve, especially within the public sector, financial services, healthcare and telecom markets.

Overall we believe that IT security remains a priority in customer spending intentions, and that our service model and breadth of offerings position us as a leading contender in many opportunities. To capitalize on this trend, we have recently launched a new family of security services, that leverages many of our unique infrastructure assets, including our PKI, MSS, payment processing, and DNS resources. We call the new offerings VeriSign Intelligence and Control Services for network security, application security, and commerce security. The value proposition of the new and enhanced services is to provide an enterprise with real time intelligence about the security of their network, users and transactions, while providing them the tools to proactively control their environment. We want to transform IT security from a reactive to a proactive game, empowering our customers to play offense instead of defense. The tag line for the integrated marketing campaign is "Security that sets you free." You should expect to see significant PR and advertising activity from VeriSign and our partners throughout the quarter. You can get more information about the intelligence and control services family at our Website.

Moving to the dot com and dot net registry, we saw over 2.8 milliom new registrations in Q3, up from 2.6 million in Q2. We also renewed or enabled the transfer of over 4.1 million names. The active zone files for common net contained approximately 28.7 million names at the end of the quarter, up 4% from 27.5 million at the end of Q2. As a side note, this active name count represents the highest total ever for combined dot com and dot net names. Of course the other item of note in the registry was the launch and subsequent suspension of our Site Finder navigation service. We believe Site Finder provides a compelling end user experience, and consumers that have been surveyed seem to agree. While there have been many unsubstantiated claims about Site Finder's impact on the internet infrastructure, our testing and subsequent analysis confirm that Site Finder is fully standards compliant, and it's caused no disruption to the operation of the common net infrastructure.

We also believe that Site Finder is a service that falls outside of I-Cam's [ph] technical coordination role for registering services. We have suspended the service temporarily, and have appointed an independent technical review panel to collect feedback and put forth recommendations on how to improve the service going forward. We continue to explore all our options, and we'll make further announcements as necessary.

In other news, the naming and directory services group continues to pursue emerging directory opportunities in new markets such as RFID and voice over IP. We were able to show a proof of concept of our ONS services for RFID and electronic product code at the recent EPC symposium. We remain enthusiastic about the long-term outlet for these services, but would remind you that meaningful revenues in these emerging areas are a way off. Moving forward into Q4, we are looking for sequential revenue growth in all of the financial metrics in the internet services group, and all the business metrics as well.

Summing up, we were pleased with the progress we made in Q3, and the modest overachievement in financial performance. As we look into Q4, we are expecting our telecom and internet end markets to continue, albeit slowly, on their path to recovery. As we get the Network Solutions sale behind us this quarter, we believe that VeriSign will be positioned to enter 2004 as a focused and leading provider of critical infrastructure services for the Internet and telecommunications networks. Our growth strategy moving forward will be based on leveraging our overall technology and infrastructure assets to drive additional penetration of our existing services, to generate incremental revenues from new services, expand our reach into tier one accounts in international, and lastly, demonstrate synergies across our business units by creating unique solutions that combine our core technologies and platforms. As we exit the year and announce our Q4 and full year results, we would expect to be in a position to talk about baseline revenues in the telecom and internet businesses, as well as our short and long-term growth rate assumptions. With that, let me now turn the call over to Dana.

Thanks Stratton, and good afternoon everyone. We are very pleased to have delivered third quarter financial results that exceeded our expectations across almost every metric. VeriSign continued to benefit from further operating efficiencies realized during the quarter, and the corresponding leverage delivered on the income statement. When coupled with our increased revenues and working capital, this generated very healthy cash flow in the period as well.

I'd like to spend the first few minutes today reviewing the detailed results for Q3 and then I'll discuss the financial impact of the pending Network Solutions sale. We'll also provide some high level guidance for the fourth quarter, making some assumptions around the closing of the NSI transaction.

So let's turn to the third quarter results, starting with the income statement. On a consolidated basis, VeriSign reported $268m of revenue for the third quarter, ahead of our guidance of $265m, and up from the $265m reported in Q2. It is important to note that this also marked the first time in several quarters that we've seen a sequential increase in top line revenue, even with the anticipated revenue decline from Network Solutions.

Segmenting Q3 revenue into VeriSign's three reporting units, the Internet Services Group delivered approximately $108m, or 40% of total revenue for the quarter. This compared to $105m in Q2. The modest increase here was due to growth in both Security Services and Naming and Directory Services.

The Telecom Services group reported $105m, or 39% of total revenue, up from $101m, or 38% of revenue, in Q2. Finally, Network Solutions delivered $55m in the quarter, or 21% of total revenue, as compared to $59m in Q2. This decrease was better than our previous guidance for an anticipated decline of $5m to $8m, due to a slight increase in value added services sales that we saw during the quarter.

As in the past, customer concentration has remained extremely low for the company as a whole, and is a reflection of our diversified business model and customer base. Overall, no single customer accounted for even 5% of total revenue in the quarter. We would still note, however, that there are several large customers in the Telecom Services group, including Cingular, Verizon, Alltel and [inaudible], that together make up a meaningful amount of quarterly revenues within this business unit.

Moving to our international operations, the percentage of total revenue that was driven from our international customer affiliates and subsidiaries, was approximately 10% for Q3, up slightly from 9% in Q2. Looking at cost of revenues in gross margins, our cost of revenue for the third quarter was $114m, down modestly from the last quarter. This translates into a 57.3% gross margin for the third quarter, up from 56.4% reported in Q2. The improvement here was due primarily to leverage gained on the increased revenues delivered in the quarter.

Turning to operating expenses and related items, total operating expenses for Q3 were up $104m, consistent with Q2, even though we saw a sequential increase in revenue.

Pro forma operating income was $50m for the third quarter, translating into an 18.5% operating margin. The margin expansion from 17.1% in Q2 was primarily the result of the gross margin improvement I just spoke about, as well as continued strong expense management, particularly within the G&A functions. We ended the quarter with a total employee headcount of approximately 3,100 people, down from 3,145 at the end of Q2.

VeriSign reported pro forma pre-tax income for the third quarter of $51m, up from $48m in Q2, and a pro forma net income of $48m, up from $47m reported last quarter.

Pro forma earnings per share for Q3 was 15 cents, a penny ahead of our guidance, and up from the 14 cents we reported in Q2. This earnings per share has been calculated using a fully diluted, weighted average shares outstanding of approximately 244 million shares for Q3.

Moving onto the balance sheet and cash flow items, we reported another healthy increase in cash, cash equivalents and short-term investments for Q3, which totaled approximately $617m at the end of the quarter. Cash balances increased $87m in Q3, which was primarily attributable to the higher sequential operating income, positive changes in working capital and lower capital expenditures during the quarter.

During Q3, we saw our accounts receivable balance increase marginally, ending the quarter at $103m, up $2m from Q2. This translates into a net DSO for the third quarter of 34 days, consistent with net DSO in Q2.

Total deferred revenue came in at $507m at the end of Q2, a modest increase of approximately $5m from Q2, and in line with our expectations. This growth was mostly attributable to increased deferred revenue in the Registry and Security businesses, while Network Solutions deferred revenue was flat for the quarter.

Moving onto the cash flow metrics, our focused efforts on managing our operations, as well as our balance sheet, continued to generate healthy operating cash flows of approximately $94m in Q3, again ahead of our ongoing expectation for a sustainable cash flow of $60m to $70m per quarter. The key drivers of operating cash flow in the third quarter were attributable to higher operating income for the quarter, up $5m sequentially, in addition to favorable changes in working capital, particularly in pre-paid assets for insurance, accounts payable and deferred revenue balances.

Capital expenditures for the third quarter were $17m, $11m less than was spent in Q2.

With the delivery of strong operating cash flow, and taking into account the lower capital expenditures in Q3, free cash flow for the quarter was approximately $87m, as compared to $55m in Q2.

It is noteworthy to point out that on a run rate basis, cash flow from operations over the past four quarters, has totaled more than $350m. And free cash flow has been nearly $300m. The key cash flow generating capabilities of our business continue to be a key benefit to our financial model.

As it relates to other corporate finance activities, I am pleased to report that VeriSign Japan, our majority owned Japanese subsidiary, is currently in the process of an IPO, which we expect to be completed later this quarter. Our ownership percentage in VSJ will be reduced from 73% currently down to 62% post-IPO.

So now, let's talk about Q4 guidance. As we've previously discussed, we expect the sale of Network Solutions to be completed sometime during the fourth quarter. While we don't know the exact day the transaction will close, we want to provide enough information now and when we report the fourth quarter, to enable you to look at an apples-to-apples comparison of our Q4 guidance, to the actual Q4 results we'll report in January.

Let's begin with the high level indication of what we think Q4 would've looked like with NSI in the numbers for the full quarter. In this scenario, we would've expected consolidated revenue to be approximately flat at $268m, and EPS to be consistent as well at 15 cents.

The revenue expectation associated with this scenario assumes modest growth in the Internet Services group, making up for the expected $4m to $6m decline in Network Solutions and flat revenue in Telecom services.

As we've indicated, we expect the Network Solutions transaction to close during the fourth quarter, which means there will be a stub period for NSI reported in the numbers for Q4. The financial results associated with the stub period will be driven by the closing date of the transaction. Accordingly, for purposes of setting guidance today, we are conservatively assuming a November 1st closing date, and a one-month stub period for NSI.

Using these assumptions, we would look for overall revenues in Q4 to come in at approximately $240m. As it relates to gross margins for Q4, and again assuming a one-month contribution from NSI, we would expect gross margins to be approximately 57% and operating margins to come in at approximately 19%. These margin expectations assume approximately a 10% contribution margin from the one-time NSI one-month stub period.

In addition, as we look to divest the NSI business, we will be taking restructuring charges as part of this divestiture, as well as other business realignments across the company. These charges may include NSI's specific cost, corporate infrastructure and facility costs and other related charges. Therefore, we anticipate taking a restructuring charge over the next few quarters of approximately $75m to $100m, a portion of which will occur in Q4.

Looking forward to Q4, we would expect the fully diluted share count to be in the 250m to 255m range. Taking into account the lost profit dollars related to NSI in Q4, we would expect earnings per share for the quarter to be approximately 13 cents on a fully taxed basis, using a 30% effective tax rate.

This conservative approach to our EPS guidance takes into account the fact that there are certain corporate expenses that are currently allocated to Network Solutions, which will be eliminated over several quarters primarily as part of the restructuring.

As it relates to headcount, approximately 600 people will go with NSI upon the closing of the transaction. So we would look for headcount in Q4 to be closer to 2,500 people for VeriSign.

Now moving onto some balance sheet items, we were pleased with the modest growth we saw in total deferred revenue on the balance sheet in Q3. As we look into Q4, clearly the base of deferred revenue will be smaller, given that the Network Solutions deferred revenue balance is transferred to NSI upon closing of the transaction. that being said, we look for deferred revenue to be in the range of $320m to $330m at the end of Q4.

Looking at operating cash flow, as compared to our previous guidance of a sustainable cash flow range of $60m to $70m per quarter, we would expect to generate cash flow in Q4 at the low end of that range, again assuming a one-month contribution from NSI. To give you some perspective on that, Network Solutions contributed approximately $10m to $12n of cash flow in Q3.

As we've discussed previously, our initiation capital budgets for the year showed a total expenditure of approximately $100m to $130m. Based on what we have seen through the first three quarters, we would expect capital expenditures for the year to come in around $100m, of which NSI will represent approximately 20%. And with that, I'd like to now open the call for your questions.

Operator, can we have the first question please?

Today's question and answer session will be conducted electronically. If you would like to ask a question, you may signal us by pressing star-one on your touchtone telephone. For those of you using a speakerphone today, please release the mute function so your signal will reach our equipment.

Again, it is star-one if you have a question, and we'll go first to Todd Rader, with Credit Suisse First Boston.

Hey guys, I have a few questions for you. First, in the Telecom business, can you quantify how much revenue is coming from products introduced in the last six months? And can you just update us on Do Not Call and COLEA some of the traction you're seeing in some of the new service areas?

Yeah, on the new revenue piece Todd, you know, the new services piece, that would primarily be Do No Call and the Net Discovery, or COLEA services. You know, you're looking at less than 5% of revenues coming from there right now, although, we are seeing an acceleration in wins in new contracts for both of those.

Obviously wireless number portability comes on stream here on November 24th, and we have a few customers we've signed on for that as well. So, as we head into '04, I think we've got a good base of signed contracts for the new services. But revenue ramps will really start then.

And, if you look at the Site Finder service, it was live for a few days. Did you guys actually see revenue from Site Finder in the quarter?

Yeah. It was on for about two weeks, and it generated about $500,000 or so of revenues. That's probably a reasonable number to assume kind of for run rate, although we do believe over time we would have optimized that further.

And Dana, turning to longer-term, when you break End Solve [ph] totally out of the business, can you give us any feel for where margins should settle out, both gross margins and operating margins?

So, you know, if you look at the quarter guidance that I gave you, and then look at the other operating margins in the other business, you're going to see sales of marketing come in at around 19%, 18% to 19%, Research and Development, say, in the kind of mid-single digits and G&A will be at about 15%. Gross margins, you know, at about 57% to 58%.

OK, thanks guys.

Moving on, we'll now hear from Sarah Friar, with Goldman Sachs.

Good afternoon. Dana, just to go back to cash flow guidance, I'm just wondering what's making you so cautious in a way? If I heard you correctly, you said your operating cash flow was $60m. And looking back in the historical quarters Network Solutions contributed about $10m to $12m in cash from operations. So, that would just make your run rate look more like it's around $70mn to $80m a quarter. And in a stronger fourth quarter, wouldn't you expect more?

Well Sarah, the reason why we're being conservative there is primarily because, as we go through this restructuring analysis and start to put that together and actually execute against it, the timing on getting some of those costs directly associated with Network Solutions is not completely clear at this point. So, we're trying to be conservative as those costs start to come out. And as we get to the end of the year, we'll give you operating cash flow guidance for next year, as well.

OK, and then just on the Cap Ex side, I guess it's a similar question. You didn't spend a lot on Cap Ex this quarter. Do you have plans for significantly more Cap Ex in December?

So there were some certain projects that, from a timing standpoint, we just didn't receive the capital against the project in the quarter. We have spent about $56m or so to date through the end of the quarter, and we're looking again, like I said, to be at around $100m spend for the year.

So $56m spent in Q3, or year to date, got it. Then just more broad ranging, you mentioned the opportunities in RFID. Could you give us just a little bit more detail of who you're working with, as you flesh out the specs for RFID? I know we saw you at the EPC symposium working with folks like Exenture [ph] and so on, but maybe talk to us about some of the next steps we might see from you.

Like in most of our businesses, Terri, we're going to be a general-purpose infrastructure provider in that space. So we'll be trying to work with the UCC itself in providing services around ONS and directory mapping, as well as going in with the various integrators, Exenture, IBM and Sun, who've been big players in that space, around building solutions at the enterprise level for corporate ONS and PML type services. So very much the way VeriSign's kind of played a neutral roll in the Internet side, we'll try to do the same thing in RFID.

Is there anyone who could really compete with you, in terms of running that ONS? In terms of lots of transaction look ups that have to be secure and held in kind of a central registry?

I think we feel very good about our competitive position there, because it would run on Atlas and that's clearly got proven capabilities and scale that we don't thing anyone else is able to touch at this point. But I'm sure there will be other bidders there claiming, on paper at least, to be able to do similar things.

OK, great. Thanks a lot.

Now we'll move on to Steve Sigmond with RBC Capital Markets.

Just a question on Site Finder, to revisit that for a moment. Does your Q4 guidance assume that Site Finder will come back on at some point, and Stratton, can you just give us clarification on the regulatory environment and potentially the timing of getting that traffic back online?

The guidance we gave you Steve, assumes that there's no Site Finder revenues in Q4, and at this point it's hard to predict a timing threshold on making some of our decisions going forward. As I said, we'll make those announcements pretty clear when we have something to say. At this point we're just continuing to explore our options.

Then just as a follow up on the MSS business, it sounds like that was a pretty healthy contributor to the growth in the Internet services line. I'm just wondering if you can give us any more details on bookings or book to bill, or some of the large customer wins you're seeing there?

I would say it was a modest contributor, not a healthy contributor, only because in an MSS contract, as you know, when you win the contract then you do the work of actually migrating the devices on. So we didn't see significant contribution there. I think book to bill is not something we tend to think about because of the way the model works. But I would say we have seen healthier pipeline and opportunities, frankly both in PKI and MSS, over the last six to eight weeks. If we can get some of those things closed here in the quarter, we'll see what happens.

Then last question on local number portability hitting here in Q4. What's your expectation on potential incremental revenue in the telecom business from that event?

We're just very cautious about predicting any Q4 impact from that. While I think the 24th is the date, I still believe there's going to be a huge scramble at the end for people to actually really be there. We don't really have a large tier one carrier under contract. Our contracts are currently with more the tier two variety players, who will probably have less impact. Next year we think it's a $5m-$10m business.

Thanks.

Moving on, we'll hear from Rob Owens with Pacific Crest.

Could you just talk a little bit about your authentication business, and what it looked like in the quarter? Especially with the OMB freeze? Then do you think there's some sort of backlog as you head into the next four quarters on that front?

I think our authentication business overall actually was pretty good in the quarter, when you combine all the SSL business and the other enterprise business. We had a large win in the services industry. As you suggest, our public sector business was a little light for the quarter, predominantly because of that OMB memo, but we do see that breaking clear here relatively soon. So all in all, we felt pretty good about the authentication business, and would expect to see it grow sequentially here in Q4 again.

Then on the 'do not call' front, what's this business going to look like, I think right now you're doing lists for states, once the federal list is implemented? What happens to that revenue stream?

Well we sell to carriers, and those carriers generally are the ones who have telemarketing firms as their clients. So in essence, what we are doing is providing a one-stop shop to a carrier, where they can get real time look up on 23 state databases and when the FTC list comes online, that database as well. So in essence, that's just another data feed into our service that the carriers can take advantage of, rather than having to get 23 separate feeds themselves. So in essence the FTC or not there, doesn't impact this service going forward. We are seeing revenues there today. It's actually running on Atlas for our largest customer in this space, and we are pretty optimistic about watching that come on into 2004.

So the federal list then won't cannibalize the state lists, or it will?

Over time you will see it cannibalized, but several of the states have said they will, over time, consolidate their names into the federal list. But even when there is a single federal list, because we are plugged in already to those telecom carriers, we would expect them to continue using our list and doing the real time call compliance that we can do, such as their auditing, etc.

Great, thanks.

We will now hear from Gene Munster with Piper Jaffray.

Hi everybody. In terms of the certs business, you had a slight up tick from 373,000 to 375,000. Any color in terms of are those VeriSign brand or Thought branded certs? Any one of those two at least gain market share within that overall 375 number?

You know nothing that, I think point-setting trends, they were about the same as they've been.

So as far as ASP per certs, probably pretty consistent from last quarter?

Pretty consistent with last quarter. We're seeing on the SSL line about a $400 or so ASP when you run that, and that's up a little bit from last quarter.

Did you guys give guidance in terms of cert number for the December quarter?

No, I said it would be up again, but probably a modest number, single digit thousand.

OK, just in terms of the MNA side, UNCDO is the first you guys have announced in a long time. Any thoughts in terms of is this an indication of you guys getting a little bit more open to the MNA avenue, or I know you talked about focus at the beginning of the call. How do you balance those two?

I don't think - I can very concisely say we don't expect to be in any new businesses in 2004. We like the businesses we're in, as the divesture of Network Solutions comes about you'll have three infrastructure businesses, in telecom, in directory and in security. We would look to extend, as we did this week, with small international distribution deals with the one we did, or with some technology things. But our expectation is that most of that growth will be organic as we head into '04 with these platforms.

Great, thank you.

Now we'll hear from Gregg Moskowitz with Susquehanna Financial Group.

Thank you very much. Dana, I'm wondering if you can just give a little bit more insight into the deferred revenue that you had mentioned, kind of excluding Network Solutions. Of the 320-330, do you have a sense of what that split would look like short term versus long term?

Not between short term and long term just off the top of my head. Most of the long term deferred was related to NSI. However, the registry and the naming and directory services will have some long term deferred in there as well. What I can give you a little more color on is that NSI ends up taking about $250m of deferred through the sale of the business. Then we will actually get to pick up about $70m of deferred at our registry that we currently have to eliminate.

OK, great. Then Stratton, I was wondering if you could talk a little bit about the DOD's e-voting project. What kind of revenue opportunity does that for you next year? I believe right now there are counties in eight different states who will be participating in the '04 trial. Do you have the opportunity, as well, to expand that over the next year, or how would you do that?

Just to do a level set, we are a subcontractor to Exenture in that bid, and they've been the lead and the prime on that. It's called the DOD Serve project, and it is there for primary elections as well as some state elections next year. So we're pretty excited about the project. I wouldn't expect to see more than $1m-$2m of revenue next year, because it is really kind of the test cases for all of this. But each state has the opportunity to participate, and I believe Exenture and the DOD are getting increasing interest now, as we are starting to put meat on the bones of what this actually looks like, and begin to stand up the system. We've even, here in Q4, received some new revenue under that contract for added services. It's a neat long-term opportunity that I think bodes well for getting into form signing and electronic voting, much broader than just a primary election. But we'll have to see. '04's going to be the proof year.

OK, thank you very much.

Now we'll hear from Ed McGuire with Merrill Lynch.

Could you comment on the progress of migrating services to the Atlas platform, and whether we might be able to see some gross margin improvement from that?

Yes, we are right on track with what we had talked about, bringing on several more services before the end of this year. So as I mentioned previously, 'do not call' for our largest customers up on Atlas. We are in the process of putting some of the number portability work onto Atlas; we should have that part of it up end of year. We have one of the security services coming online in Q1 I believe, on Atlas. So basically there is a roadmap for pretty much every database service between now and the end of next year. We're knocking off about one to two services a quarter between now and then. So from a gross margin improvement perspective, you will probably start to see some of that as we get into the first and second quarter of next year. We're pretty set in our view that we'll be able to demonstrate that.

As a follow up, I apologize if I missed it, but could you talk about the initial uptake of your Internet fraud offering?

Thanks for asking. I think that has shown to be a pretty good bundle this quarter with the merchants. So from kind of a cold start I think we have well north of 1,000 merchants using the service now. Almost 100% feedback that this is a great service and they're saving money from the minute they turn it on. So we have a lot of marketing campaigns to go out and continue to bring the existing base online, and would expect that to be a nice contributor next year, as you get tens of thousands of merchants hopefully using it. But it is definitely proving its worth with the customers, so that's great. We've got great feedback and endorsements, which is helping kind of keep the flywheel accelerating.

Great, thanks very much.

Now we'll hear from Walter Pritchard with Sound View.

Hi, just two questions. I wonder if you could comment on the pricing environment in MSS? One of your competitors noted it sounded like it was getting more aggressive. Then secondly, just sort of outline for us on the telecom side, what gives you comfort of being able to make up the revenue from the Dobson contract going away in the fourth quarter? Thanks.

Pricing environment in MSS, you know I would tell you my own opinion on it is that MSS is really still a very nascent market, and therefore you will walk into one customer that will be looking for price concessions, and you will walk into another, and that price could be as much as 50% higher. So I think the market itself really has not determined thresholds yet around either firewall monitoring and management, or IDS monitoring. So we continue to look at it pretty closely, but quite frankly, I have not seen a consistent trend in either direction. Our goal is to actually be differentiated in the offering with the new intelligence services, where we can bring some of the DNS data and fraud data together, where we will be able to premium price in the market, because we have real time intelligence no one else can bring the customer.

Then just on telecom, and direction you can give us on sort of how the Dobson revenue is replaced?

I think a couple of pieces, you've got initial revenues starting to grow quarter-over-quarter from the new services, 'do not call' and COLEA in particular will get a little bit, a very tiny amount in the WNP this quarter, so that replaces a little bit. Meanwhile some of our other billing customers are actually seeing healthy subscriber growth, so that replaces some of the subscribers we lose from Adoxin [ph]. You're going to see a little bit of contribution from the Embratel acquisition internationally. So it's a combination of bits and pieces here and there at $200k-$500k each, where you add it all up and you can replace the $2m-$3m this quarter, and then next quarter we fully believe we'll get the $6m-$7m back. So I would not have told you, a quarter ago, I believed that would be true. In fact I believe on last quarter's call I said we might be down a little bit in Q1. We now think we can actually stay flat quarter-over-quarter, with some potential upside to actually grow as we see some of this stuff turn on.

Great, thank you.

Now we'll hear from Sterling Auty with JP Morgan.

Hi guys, just two clarifications. Dana, in your guidance, what did you say for revenue for the Internet services group for the fourth quarter?

I said that the revenue would be up. So what we talked about was that revenue number of $240m total that would have the Internet services group growing off of their $108m. The telecom services group being relatively flat, and that growth in the Internet services group would make up the decline that we're expecting in Network Solutions.

OK, and then the contribution margin for the telecom business and the Internet services business?

We don't break out the margins down to that level. The margins in those businesses have stayed relatively constant. What we talked about at our analyst day was margins for telecom in the high 20% range, margins for the Internet services group in the 20% range. Those shouldn't change dramatically. Then you're going to have that sub period for MSI.

OK, and then just lastly, on the MSS business, any update as to the improvement on shrinking loss, or getting to profitability with that?

It's basically going to see linear improvement over the course of the next six quarters. One of the things we haven't really talked too much about is kind of a six-month after picture at Merrill Lynch. I'm very pleased to report we have been on schedule with that project, have migrated over all their devices in North America, and are receiving very positive customer feedback on that. So the business is executing, and what we're trying to do now is to put volume on to the fixed cost infrastructure. So we would expect as more devices come on in the next four to six quarters, you'll continue to see margins improve.

Sterling too, just in case you didn't catch it, we talked about a 19% operating margin guidance for the quarter as well.

OK, great. Thank you.

Now we'll hear from Matt Barzowskas with First Albany.

Thanks. Everyday you see another suit coming up, or someone's trying to bite you over something. What does that do from, I guess, day-to-day management, and from a legal standpoint? Are there additional expenses being taken from that? How are you going to deal with these things, going forward?

I think we live in a great country and the freedoms we enjoy, unfortunately, can be abused sometimes. We think all those suits are groundless and without merit. We'll continue to defend ourselves against them. At the end of the day, that's the cost of doing business as you get larger. It's something we've been used to because the Network Solutions business for some years--I'll remind you on the Network Solutions side of the business in terms of domain name challenges, we've never lost a case, even prior to VeriSign owning it.

So, it's a cost of doing business and we have a very well experienced legal team that works on that in-house. So, from a management distraction point of view, it's very minor.

And from the Network Solutions side, do those things go away as you sell it? Or, is it that you guys have at least something that you have to deal with, going forward?

We will deal with the cases that were there prior to the close of the deal. They will, of course, take any new cases on that come on after the close, as you would expect in a transaction.

OK, thanks.

Now, we'll hear from Dan Cummins, with UBS.

Thank you. I have a couple of questions. Do any of the large Telco contracts roll over, in either of the next two quarters? You mentioned Cingular, Verizon, and Alltel, any of the majors.

No.

OK. Dana, I had a question about $78m of non-cash amortization write-down. Can you kind of cleave that into two? You know, what is run rate, going forward, amortization? What is write-down, which I perceive to be kind of non-recurring? Or is that not right?

Right. Let me break that up for you. In Q3, that total was comprised of ongoing amortization of about $48m, and then there was a $30m write-down of the goodwill that was on the balance sheet, related to NSI, as a consequence of our signing of the definitive agreement.

So, think $48m, going forward, first at a GAAP number?

No. Actually, going forward, we're going to be looking at amortization of around $22m on a quarterly basis.

OK. And then, on Site Finder, here's your chance to debunk what every trade rag had. You know, $150m of annual revenue opportunity; I was coming up $30m to $50m. What's your take on that? And also, as you think about this asset that you safeguard, it's not ours to keep or to sell. You're going to have to go before a regulator at some point. How do you think about the view that somebody's going to kind of put on you that this was kind of a revenue grab, yadda, yadda, yadda?

I could respond yadda, yadda, yadda. But, I guess my view on Site Finder, for two weeks it generated $500,000. I have no reason to forecast for you that it would've been at a run rate much higher or lower than that, because we just don't know at this point.

We would expect that at that level, it was a non-material kind of amount of revenue, but still, revenue, incremental revenue within the registry nevertheless.

I think the bigger debate here is really around innovation and being able to innovate on that infrastructure that we have, I believe, been very good stewards of over the last three years, including spending our dollars to upgrade the infrastructure to a completely new technology we call Outlet, to upgrade the capacity more than 10X. And that was doing it in a time where everybody else was spending less than IT, and our revenues were going down in that business, as domain names shrank.

So, long-story-short, I think we've done a yeoman's job building it out and keeping it operational. And to suggest that we can't innovate and introduce new services on top of that, I think is a misplaced thought process on I-Cam's part. And we will continue to discuss with them how we get clarity going forward on where that is.

Just to be very clear, though, we have a contract with the Department of Commerce and I-Cam to operate this. We have always delivered at or above the performance levels of that contract, and we have done so at 100% availability for the last six years. So it's not a public trust or a public endowment. It is a contract that we have very strong SLAs in; very strong contractual provisions, which we have always exceeded.

OK, so you won't have to bid for the chance to keep the Registry when it comes up. It's just a renegotiation.

Well, as you'll remember, in Dot Com, the new contracts that we signed two years ago in April, have a term called presumptive right of renewal, which would mean unless we are in breech of that Dot Com contract in those service level provision, we have one-year renewals in perpetuity.

On the Dot Net contract it does come up for re-bid in 2005. And, we would expect to be a leading contender to win that, based on our proven capability to handle the kinds of traffic and resolution loads that you're going to need.

Great, thank you.

Moving on, we'll hear from Steve Ashley, with Robert Baird.

Most of my questions have been answered, but in terms of transferring off the balance sheet about $250m of deferred revenue, are there any corresponding assets on the other side of the balance sheet, either accounts receivable or other cash that accompany that transfer?

The only thing going over on the asset side will be pre-paid registry fees that are associated with those names that have been sold. Their accounts receivable was less than $1m in the quarter, so that's not going over. There's no cash going over, and they will take some of their fixed assets, related to their systems and things.

Great, and Dana, I apologize because I think you were asked and gave this answer and I just missed it, but if we look beyond the fourth quarter off into the first quarter or whenever, and we look at a period in which you do not have Network Solutions for any part of that period, what kind of normalized margins would we see again for gross margins, SG&A and those kinds of things?

Again, we haven't given guidance for next year, but let me try to be a little bit helpful. At a high level, probably 57% or 58% gross margin on the high end of that. 17% to 18% sales and marketing; 6% to 7% R&D; 14% to 15% G&A and operating margins 19%-ish. And as we come into the next call, we'll certainly give you more guidance on that for next year.

Terrific, thanks very much.

And our final question today will come from Todd Raker, with Credit Suisse First Boston.

Hey guys, just a quick follow up; if you look historically with the add-backs, are you giving any revenue guidance in Q4 associated with the fee from the registrar to the registry?

We're not breaking that out, but just to kind of give you an idea, if you look at a one-month stub period for NSI, including what we think the add-back will then be at the registry, it's probably about a $25m number.

OK, because I'm showing $25m right now at Network Solutions, which seems a lot of revenue for one month. And that includes the add-back?

That's right.

OK, perfect.

And that add-back is actually for two months, because the add-back comes with the second two months.

Perfect. That ties perfectly. Now, can you give us what the add-back would've been in the September quarter? I think it was $13m in June. What was it in September?

It was about $12.4m, $12.5m.

And is that a fairly consistent kind of baseline to project into next year?

That number would come down correspondingly with the revenue decline that we've talked about continuing through at least the middle of next year.

OK, so maybe like $10m is a good baseline on the quarterly basis?

I think that might be too low.

OK.

I think the way to think about it, Todd, is if there are names under management for com and net would keep going down, then that number quarterly would keep going down.

Right. OK, thanks guys.

And I think, one other clarifying point I want to make, when I was saying 56 on the capital, I was meaning 56%. Someone told me that I said $56m, so capital was 56% of our budget through the first three quarters, which translates to about $67m.

And there appear to be no further questions. I'll turn the call back over to you for any additional or concluding remarks.

Thanks everyone for taking the time today. As always, we look forward to talking with you and answering any additional questions that you may have. Thank you, and good evening.

And that does conclude this evening's conference call. We thank you for your participation. Have a good afternoon.