威瑞信 (VRSN) 2009 Q3 法說會逐字稿

Good day, and welcome to the third quarter 2009 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Nancy Fazioli in Investor Relations. Please go ahead, ma'am.

Thank you, operator. Good afternoon, everyone, and thank you for joining us for VeriSign's third quarter 2009 earnings conference call. I'm Nancy Fazioli in Investor Relations, and I'm here today with Mark McLaughlin, President and CEO, and Brian Robins, Executive Vice President and CFO. Please note that this call and accompanying slide presentation are being webcast from our investor relations website, located at Investor.VeriSign.com. Please refer to our website for important information, including the Q3 2009 earnings press release and a reconciliation of our GAAP to non-GAAP information. A replay of this call will be available on our website within a few hours. Today's slide presentation will also be available for download after the call.

Financial results from today's press release are unaudited, and the matters we will be discussing today include forward-looking statements, and as such are subject to the risks and uncertainties that we discussed in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, and any applicable amendments which identify important risk factors which could cause actual results to differ materially from those contained in the forward-looking statements. Additionally, financial results in today's press release and the matters we will be discussing today include non-GAAP measures used by VeriSign. Our non-GAAP income statement and a description of items excluded from our non-GAAP financial information are located on the VeriSign Investor Relations website. In a moment, Mark and Brian will provide some prepared remarks, and afterward we will open up the call for your questions. Unauthorized recording of this conference call is not permitted.

With that, I would like to turn the call over to Mark. Mark?

Thanks, Nancy. Good afternoon, everyone. Before jumping into the results for the quarter, I'm pleased to tell you that with the early fourth quarter closings of Global Security Consulting and Messaging and Mobile Media Services, we've now essentially completed the significant restructuring that we took on as a Company two years ago this month. We're in active negotiations to sell MDG Services, the one small business remaining. We expect that prepaid billing services and content porter services will be wound down and the transition service agreements will be completed by the end of 2010. As the proceeds from the sale of these 13 assets as in addition to the sale of our remaining interest in Jamba are approximately $750 million. We're happy to be closing out this chapter in VeriSign's history. We'd like to thank our entire team for two years of hard work in negotiating and finalizing these sales, as well as having our core and noncore businesses continuing to deliver strong results throughout this transformative period for VeriSign.

Also, as we discussed in the last earnings call, on June 5th, the Ninth Circuit Court of Appeals reversed an appeal of the May 2007 US District Court dismissal of the case filed against VeriSign by the Coalition For ICANN Transparency, or CFIT. In the opinion the case was remanded to the US district court for the Northern District of California for further proceedings. On July 2 of 2009 VeriSign filed a Ninth Circuit petition for rehearing which is still pending. We have no further updates at this time. There is no prescribed time frame for the court to respond to our petition. We are able to say very little about pending litigation matters, but remain confident in our position, and will continue to defend this case vigorously.

Now, turning to the results for the quarter. Overall I'm pleased with the performance this quarter. We met our revenue guidance for Q3 while tight expense management enabled us to continue to increase profitability. Third quarter revenue in our core business was $257 million, which represents 6% year-over-year growth. Our non-GAAP operating margin for the quarter was 38.6%, a slight improvement over last quarter, as we continue to focus on core expense reductions from our last few remaining divest businesses as well as tight expense controls. Non-GAAP earnings per share was $0.33 which represents strong year-over-year growth. We repurchased approximately 1.2 million shares of common stock in the quarter, for an aggregate of $25 million. On the cash side, our year-to-date operating cash flow is approximately $222 million and we have over $1.4 billion in cash in the balance sheet.

With that, I'll now turn to the business unit operating results for the quarter. We're pleased with our naming results this quarter. The base of registered names in .com and .net totaled 94.9 million names at the end of the quarter. This is an increase of 1.4 million net names added to the domain name quarter-over-quarter and a 6% increase in net names year-over-year. We ended the quarter with registered domain names ahead of our forecast as we saw strengthening in renewal rates. In the third quarter, we processed 7 million new names, this is flat quarter over quarter, and up from 6.9 million names in Q3, 2008.

The Q2 renewal rate rounded up to 70%, while renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal rate for Q3 will also be 70%. As we look forward, given the data we have at this point in the quarter, we would expect the Q4 net names added to the domain name base to be consistent to slightly up from Q3. We believe the domain name base will grow from 1.2 to 1.5 million names. As such, we believe the Q4 domain name base will grow by a net change of 1.2 to 1.5 million names. On the infrastructure side of the naming business, our average daily query load during the quarter increased from 49 to 54 billion per day, with continued 100% uptime. We continue to demonstrate VeriSign's ability to operate global networks at massive scale with exceptional reliability.

And before I conclude my update on naming, I wanted to note that the joint partnership agreement or JPA between the Department of Commerce and ICANN expired on September 30 and is replaced by the affirmation of commitments or AOC. Under the terms of the AOC, the US Department of Commerce will continue its involvement with ICANN. The adoption of the AOC does not impact our existing registry agreements with ICANN for the operation of .com and .net nor does it influence our existing agreement with the department of commerce.

Now, moving on to authentication services. While pleased with unit growth in our authentication service business, we continue to feel some pressure in the current environment. In business authentication, we saw the installed base of SSL certificates increase to 1.2 million certificates in the third quarter compared to 1.17 million last quarter and approximately 1.1 million certificates in Q3 2008. This represents a 9% year-over-year growth in the base.

The annualized average unit revenue or AUR for the installed base of VeriSign, GeoTrust and Thawte-branded certificates for the third quarter was $234 which compares to $241 for the prior quarter. We continue to see increased price pressure as customers request discounts. Also, the AUR decline continues to be impacted by mix shift as the GeoTrust brands grows faster than our overall portfolio. We are focused on reversing these AUR trends and we look forward to outlining our current and planned efforts in this regard at our analyst day later this month. In the last earnings call, you may recall we mentioned we'd be focusing our efforts in our user authentication business on partnerships, specifically to have VeriSign identify protection or VIP more tightly integrated into applications that can drive demand. Jim Bidzos, in particular, has been focused on utilizing his relationships in this regard. The partnership with RSA that we announced in October is a great example of this effort and we will continue to look for additional partnership opportunities that make sense for this business.

I also want to take this opportunity to let you know that Chris Babel, the General Manager of the Authentication Business will be leaving VeriSign. We want to thank Chris for his ten plus years of hard work and contributions to VeriSign and wish him well in his new endeavors. In general, we are pleased with our results for the quarter and excited about the future. Having substantially completed our divestitures in our core product strategy, we are looking forward to 2010. We are also looking forward to outlining our strategy and plans later this month at analyst day.

I'll now turn the call over to Brian for a review of our financial results for the third quarter. Brian.

Thanks, Mark. And thanks to everyone for joining us this afternoon.

Before I get into the details of our results for our core business, I'd like to update you on a change in our presentation of the noncash interest expense related to FSB, APB 14-1. The amortization to debt discount on our convertible bonds. In order to provide greater transparency, noncash interest expense is now excluded from the non-GAAP presentation. We feel the non-GAAP presentation is more reflective of our operating results, and more in line with our peers.

Moving on to the Q3 results. Revenue for our core business was $257 million, up 1% sequentially and up 6% year-over-year. Growth was largely driven by continued strength in naming services, with revenue up 10% year-over-year and authentication services revenue was up 2% year over year. In Q3, there was no material impact to revenue from FX changes. Our non-GAAP core operating margin was 38.6%.

As we have completed our last major divestiture, we have taken out substantially all the duplicate shared services costs. We expect fourth quarter margin to be in line with third quarter as we continue to look for and execute greater efficiencies across the Company, we will aim to incrementally increase margins throughout next year. In non-GAAP other income and expense, we incurred a loss of approximately $7 million for our core operations. This excludes $1.7 million in noncash interest expense related to FSB, APB 14-1. This loss was roughly in line with what we expected, and what we continue to expect next quarter. Non-GAAP net income for the third quarter was $64 million, resulting in non-GAAP earnings per share of $0.33. The diluted share count used in EPS calculations was 193 million shares, flat quarter over quarter. We have existing authorization for $905 million for additional share repurchases that we periodically consider in the form of open market purchases, ASRs and other strategies. In Q3 we did share repurchases of approximately $25 million or 1.2 million shares.

Moving on to the cash flow and balance sheet items. Operating cash flow was approximately $105 million in the third quarter and was $222 million year to date. The $222 million year to date excludes $101 million of excess tax benefit associated with tax -- associated with stock-based compensation that appears in financing cash flow. At analyst day, I'll be introducing a cash flow metric that will help you to better track changes in cash flow. With the majority of the divestitures behind us, there will be less noise and greater consistency in cash flow in 2010.

Consolidated capital expenditures were $25 million in the quarter and $66 million year to date. Of the $25 million, approximately 80% represents capital expenditures for core services. We ended the quarter with a strong balance sheet with ending cash, cash equivalents and restricted cash of $1.4 billion, up approximately $124 million from the prior quarter. During the quarter, we repurchased $25 million worth of stock and received divestiture proceeds of approximately $45 million. There were no distributions in Q3 from the reserve funds, and there remains $32 million in these funds that are currently classified in other current assets.

Net consolidated DSO for the fourth quarter was 29 days, down one day from last quarter. Deferred revenue from continuing operations ended the quarter at $881 million, up $3 million from Q2. We ended the quarter with approximately 2,650 employees, down 150 from last quarter, primarily stemming from the divestitures.

Moving on to our outlook. For Q4, we expect revenue for the core businesses will be $258 million to $262 million, flat, to up 2%. As previously indicated, we expect Q4 non-GAAP operating margin and other income to be in line with Q3. We're looking forward to our analyst day in two weeks, and an opportunity to present to you our go-forward strategy and vision for the Company. The event will be web cast via a link on our Investor Relations website as well as available for replay.

We now would like to open up the call for your questions. Operator?

(Operator Instructions). And we'll go first to Sterling Auty with JPMorgan. Mr. Auty, please go ahead, your line is open. And due to no response, we'll move on to Todd Raker with Deutsche Bank.

Hey, guys, two questions for you. First, $1.4 billion of cash on the balance sheet, can you talk about stock buy back versus acquisitions and what you're thinking strategically with such a strong balance sheet? And secondly, can you just talk about -- at your analyst day two years ago, you kind of hinted that you thought the employee run rate would be about 2,000 employees when the divestitures were all done. You're still well above that level. On an employee base, where do you see this thing going over the next 12 to 18 months? Thanks.

Hey, Todd, it's Mark. On the use of cash, as I think we mentioned in the past, we've taken a pretty conservative view on cash given the economic outlook. Given what appears to be a turning point in the economy, we feel better on that aspect when we consider the use of cash. As Brian said, we have about $900 million in buy back authorization the Board currently repurchased about $100 million of this to date and we'll talk more about use of cash in proceeds at analyst day coming up later in November.

And I'll take the employee one. There's about -- as I said, we have 2,650 employees at the end of the quarter. About 600 of those are related to the divestitures and so I estimate that our end of year head count will be right at about 2,000, maybe about 2050.

Okay. Thanks, guys.

And we'll go next to Phil Winslow with Credit Suisse.

Hi, guys. Just a question on just the pricing trends on the SSL certificates base. Obviously you continue to get good growth in GeoTrust, but last quarter you commented on some pricing pressure at the high end of the core VeriSign base. Any changes there this quarter and how would you just sort of expect ASPs to trend? We saw a slight reacceleration and sort of a year-over-year decline this quarter. Thanks.

Yes, Phil, thanks. Yes, we still see continued pressure, particularly in the high end of the VeriSign brand from an ASP basis. So as I membered, we're pretty focused on reversing those trends. We'll get into some of the actions we're going to take at analyst day as far as services and other strategies, so we'll talk more about that later this month.

And then your change on the accounting for the convert, that occurred in this quarter, Q3, correct?

Yes, that's correct.

All right, thank you.

Thank you.

And we'll go next to Steve Ashley with Robert W. Baird.

On the certificate side, can you talk about, number one, kind of just generally what kind of growth you're seeing in organizational validated certs versus domain validated certs in terms of revenue growth.

Sure. So, yes, Steve, that kind of breaks down almost exactly along the ends of high end versus low end, so it's on a revenue basis, you'll see more revenue associated with organizational validated certificates just because they're more expensive than domain validated, and then on a unit basis, you'd see more units being moved for domain validated and organizational validated because it's at the low end of the market.

Okay. Can you say if domain validated revenue is up year over year, and is organizational validated down year over year?

No. So it would be the case that both are up year-over-year, but the -- on a relative -- they're both up year-over-year on a relative basis. The DV would be growing at a faster rate than the organization validated.

Can you talk about the plans to replace Chris in his role?

Yes, sure. Chris will be leaving us in mid-November. I'm currently instituting a search for his replacement. I don't have an answer for that yet, but I hope so shortly.

Thank you.

Yes.

And we'll go next to Katherine Egbert with Jefferies.

Hi, good afternoon. Can you talk about the 70% renewal rate that's a little bit on the low end of your historic rate? Is there anything to be concerned about that? You said it rounded up to 70, I believe.

Yes, Katherine. If you look back historically, I mean if you go way back for more than a number of years, you see the renewal rate growing from up into the 60s to into the 70s to the high 70s, around 76% is probably the rough water mark up in that neighborhood and then dropping down to what we currently see at around 70, 71% range. So we're up -- we've changed the forecast a bit because of the renewal rates. These are in terms of basis points of increase over what it was last quarter. So we see, it stabilized right now at around 70 -- between 70, 71%.

Okay. And then you have a nice lift in the operating margin for the quarter. You got it to a nice margin next quarter. What about 2010? Can you just directionally tell us if those margins have any room to increase?

This is Brian. So on fourth quarter, we'll be flat over third quarter slightly up and we aren't giving guidance for 2010 yet. We'll provide that at analyst day, but you can expect to see incremental margin improvement over 2009.

Okay. Thanks a lot, Brian.

And we'll go next to Rob Owens with Pacific Crest.

Great. A couple of questions. First on the growth and deferral, it was fairly flat sequentially. With any of the divestitures, was there any deferred that went away? I was just a little surprised especially given the growth in the domain names this quarter.

Hey, Rob, this is Brian. There's a couple of things. That is a continuing operation, so it does include our prepaid business as well, which we're in the process of winding down and so every quarter we have a wind down of that. There was, as Mark alluded, some softness in the authentication business, so there was -- there was a use of deferred revenue there as well and then we had a smaller increase in deferred revenue pickup than we've typically seen in prior quarters from our Japan subsidiary.

Okay. Is there any way you can get us to kind of a continuing deferred, Brian?

Continuing deferred?

Yes. If you were to take -- if you were to net out the prepaid business?

Yes, I don't have that off the top, but it's -- you know, there was -- you call it a $0.5 million to $1 million decrease related to the prepaid business.

Great. And then second with new GTLBs being pushed out, any thoughts that this is a positive for VeriSign over the next year?

Yes, Rob, it's Mark. I think it's a positive for VeriSign, I think what we're going to see as far as when they would come out, likely that all the guidelines and specifications would be done sometime in mid-2010, but I wouldn't expect to see actual roll outs of these things until the end of 2010 and probably into 2011.

Great. Thanks, Mark.

And we'll go next to Shaul Eyal with with Oppenheimer.

Thank you. Hi. Good afternoon. Quick question, guys. I think ICANN recently passed some sort of resolution that allows domain name in Chinese and other kind of non-Latin script. Is that a positive -- is that an opportunity for you guys or is that some sort of a threat?

No, Shaul. We look at that as an opportunity. So what ICANN just did is they said they were going to allow the introduction for international domain names starting with country code domain names. So think of, you know, .China, .Germany. So that's likely to come out sometime next year. That won't impact us because it's highly -- we don't play in the CCTLD space, so we unlikely would do that. But following that, most likely into 2011, then ICANN would allow for the roll out of the international domain name version of ASCII domain names or GTLBs like .com and .net. So in that case of running .com and .net in those localized versions in different countries, we see that as an opportunity for us.

Got it. Thanks very much.

We'll go next to Sarah Friar with Goldman Sachs.

Great. Thanks for taking my question. Just on the gross margin side, gross margins have been ticking very nicely upwards here and this quarter down a little, I mean I know we're nitpicking a little, but is there anything that impacted the gross margins and as you look forward, would you continue to expect to see expansion from here?

Hi, Sarah, this is Brian. We really tend to focus more on the operating margin and don't focus on the cost categories between gross margin, sales and marketing, R&D and G&A. There are some things that in prior quarters we had the statement of work that has some fluctuations in the cost of revenue and you can expect gross margin to be in the 79 to 80% range.

Okay. Terrific. And then the same just on your -- I mean to say you don't want to focus line by line, but in G&A, you're showing a very nice progression there. As the heads come out through next quarter, is there a reason why that shouldn't continue to go down? I know you guided more flat, but as the heads come out, shouldn't we see kind of a bunch of costs come out in Q4?

Yes. We've taken, as I alluded to in my prepared remarks, we've taken out a lot of the shared services costs out of the business already and so as we account for the businesses that are being divested, that got included in the discontinued operations and so there won't be, additional large decreases. With that said, we're focused like a laser ton cost containment and where we can take costs out of the business. So I would expect G&A to decline as a percentage of revenue and on an absolute basis not increase. I think there's one or two things that we may have next quarter where it may bump up just a tad, but I don't think long term you can expect it to remain at that level or decline.

Terrific. Thank you.

And we'll go next to Kerry Rice with Wedbush.

Thanks a lot. Drilling down a little on domain names first, can you talk a little bit if you saw more advertisers come back because of the economy buying domain names this quarter?

Yes, Kerry, that's kind of hard to tell because, with the -- with the financial distinctions gone between purchasers of what we would call traditional and what we used to call advertising folks, it's difficult to tell for what purpose people are buying because they're buying at the same price now. So specifically, no, I couldn't tell you the difference between the two. One thing that is heartening is that we've heard folks who are in the online advertising business, and the search business say that they're either stabilizing -- seeing stabilization or starting to see some increase and we think that we have some level of correlation related to that on a lightning basis, so if that's true and it continues to go up, we would expect to see that help us.

Could you characterize the kind of acceleration in domain name growth from last quarter driven by any particular trend then or group?

So on a new -- new names -- or the added names into the base, those were flat quarter over quarter, so on the renewals, we saw a bit of an increase on renewals. That was pretty much across the board. So we took that as just a general good news probably due to the economy improving.

Okay. And then on the certificate, can you talk a little bit about the demand for EV certs? I know you said the high end was still seeing some pressure from pricing, but what about demand for EV search, is that picking back up or how would you characterize that?

EV continues to grow well quarter over quarter, but there's a percent of the base that's not yet providing significant positive impacts to the ASP. So we continue to market it and sell it very aggressively, but we're viewing it more closely in line as our high-end certificate offerings and I'll talk more about this in our strategies at analysts day.

Last question, your VeriSign internet defense network services, can you quantify what that was during the quarter, revenue-wise?

We don't have that quantified. We gave some direction previously -- earlier in the year as far as I Defense and the bundle of services around that, but for Internet Defense Network, we've got good response, have a solid pipeline for that and again I'll be getting into new services in a couple of weeks.

Okay. Thank you.

Thank you.

And we'll take a follow-up from Sterling Auty with JPMorgan.

Hey, thanks, guys. Sorry about earlier, too many earnings all at once.

Glad to see you awake.

Hopefully someone didn't ask it in this way, but if I look at the deferred revenue, can you give us some characterization in terms of what the impact on deferred revenue because it looked a little light to me in terms of the SSL unit volume versus maybe duration from either SSL or the naming business or was there actually any adjustment that was done for any of the divestitures?

Hey, Sterling, this is Brian. On the deferred revenue, as I went through a little earlier, there was -- it's continuing operations and so it includes some businesses that were winding down, such as prepay and so every quarter you'll see -- if you look at the line level of detail a decrease as that business continues to wind down and we aren't going after new sales. Additionally, in our authentication business, there was some weakness as Mark alluded to in his prepared remarks, which had a decline quarter over quarter and in Japan we saw a smaller increase due to the economic softness we're seeing over there.

Okay. And then in terms of I think you've gone into some detail on the pricing, you're holding off to the analyst day, which I understand, but if you were to look at the -- looking at just the pure number that you have, though, the 1.2 million, so if you look at the volumes, when you look at the volumes in the high end versus the volume in the low end and setting EV aside, how would you kind of characterize the -- if you want to call it a short fall relative to your own expectations? Where was the bigger kind of pressure seen from a volume perspective?

At the high end, Sterling. All segments are continuing to grow, growing at different rates and it sort of falls out, slowest rate at the high end, medium at the middle end and the low end grows much faster than either of those two.

All right. Thanks.

Yes.

And we'll go next to Scott Kessler with Standard & Poor's Equity.

Thanks a lot. Can you guys talk a little bit about the pipeline and potential revenue wins with respect to the government vertical more specifically? Thanks.

Yes, sure, Scott. So on the government side, I'll put this into a couple of categories. A number of our services are sold and have been sold for a while directly to the government related to PKI, SSL and the security side of the business. And that continues to be a nice business for us. We have a renewed focus on the government side in terms of having kept I Defense and now our mitigation service, so we're pretty targeted with the government with those things and then the third thing, as Brian mentioned earlier, we occasionally have some opportunities with the government that we take -- we take when we get them for different services, but those tend to be, one-time in nature and not -- not a recurring basis.

So if I could follow up, Mark, so would you indicate that your business in government-related offerings is outperforming, say, the nongovernment operations at this point?

No. No, I wouldn't say that. I would say we have a nice, steady business in the government, but it's -- it's not a major part of our business. You have to remember, Scott, one thing is that everything we sell is on a services basis and usually, as a generalization, the government likes to by-products. It's a little hard to sell services into the government anyway.

Okay. Thanks a lot.

Yes.

(Operator Instructions). And we'll take a follow-up from Katherine Egbert with Jefferies.

Hi, I was just wondering, did I miss it? Did you give out the revenue by segment?

Hi, Catherine, this is Brian. On the revenue side, the breakdown's about 61% for naming and 31% for authentication and the authentication includes VeriSign Japan.

Okay.

And we'll take a follow-up from Phil Winslow with Credit Suisse.

Hi, guys. Just a quick question on the pricing front and .com and .net. Any sort of change in your thought process about when we might or might not see any sort of change there with your contract? Thanks.

No, Phil. So if I take your question as how are we looking at potential price increases, no change in that. We continue to watch that closely, take those one at a time. So if that's what you meant.

Thanks, guys.

And we'll go next to Steve Ashley with Robert W. Baird.

Just would like to follow-up on domain names on the renewal rate. As the PPC names have run off, shouldn't we see renewal rates kind of improve as we move into 2010?

That's possible, Steve, yes. Like I said, we saw quarter over quarter an improvement in renewal rates and, again, it's a little difficult to get into the base now and say what was advertising and traditional, but as a general matter, both appear to be improving slightly.

And in terms of on the cert side at the high end, how are renewal rates running there?

In the mid-50%.

And is that normal? Is that --

Yes, that's in line with the entire -- the entire brand of offerings.

Thank you.

(Operator Instructions). And it appears we have no further questions at this time. I would like to turn it back over to Miss Nancy Fazioli for any additional or closing remarks.

Thank you, operator. We anticipate that our next quarterly conference call, which will reflect our fourth quarter 2009 results will be held on Thursday, February 4th at 2 PM Pacific time. I would like to remind you that in light of regulation FD, VeriSign plans to retain its long-standing policy to not comment on its financial guidance during the quarter unless it has done so through a public disclosure. Please call the Investor Relations department with any follow-up questions for this call. Thank you for your participation and continued support. This concludes our call. Thank you and good evening.

And that concludes today's conference. Thank you for your participation.