威瑞信 (VRSN) 2010 Q3 法說會逐字稿

Good day, and welcome to the third-quarter 2010 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Nancy Fazioli. Please go ahead.

Thank you, Operator. Good afternoon everyone, and thank you for joining us for VeriSign's third quarter 2010 earnings conference call. I'm Nancy Fazioli, Director of Investor Relations. I am 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 2010 earnings press release. 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 in 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 discuss in detail in our documents filed with the SEC, specifically the most recent report on Forms 10-K and 10-Q, and any applicable amendments which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. I would like to remind you that in light of Regulation FD, VeriSign retains it's long standing policy to not comment on financial performance or guidance during the quarter, unless it is done through public disclosure.

The financial results in today's press release and the matters we will be discussing today include non-GAAP measures used by VeriSign. GAAP to non-GAAP reconciliation information is appended to our press release and slide presentation, both of which can be found on our Investor Relations website. In a moment, Mark and Brian will provide some prepared remarks, and afterwards 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. We are pleased with the performance of the business this quarter. We continue to see strength in the Internet trends that drive our business. Also the team's ongoing operational discipline and execution, leading up to, and following the close of the sale of Authentication Services is helping to drive positive results. There's still a lot of work to be done, as we transition the Authentication business. We are very focused on a smooth transition, which is on track, and which we expect to be largely completed in the mid 2011 timeframe.

I'll now cover the highlights of our financial results for the third quarter. Revenue in the third quarter for Naming Services was $172 million, representing an 11% year-over-year increase. Naming Services is comprised of registry services, and Network Intelligence and Availability or NIA services. Non-GAAP earnings per share was $0.27 cents, compared to $0.16 in Q3 2009. Non-GAAP operating margin was 43.1%, compared to 33.7% in Q3 2009. During the quarter, we utilized $146 million of cash to repurchase 5.1 million shares, leaving us with repurchase authorization of approximately $1.4 billion. In August, we received $1.28 billion dollars in proceeds from the sales of the Authentication business, which brings our cash down to the end of the third quarter to $2.55 billion, approximately 65% of which is held domestically.

Operationally, in Naming Services, the base of registered names and .coms and .net this quarter totaled 103.5 million names at the end of September, a 9% increase year-over-year. Two million net names were added to the domain name base this quarter. During the third quarter, we processed 7.5 million new registrations, which is a 7% increase year-over-year. The 2010 Q2 renewal rate was 73.2%, up from 72.1% in Q1 2010. While renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal late for Q3 2010 will be approximately 73%.

For net domain name additions, we expect that Q4 net names added in the base, to be between 1.7 and 2 million names. Q4 has a larger expiring name base than the third quarter, and an increased of first-time renewing names in the expiring name base. In addition, in some previous years in the fourth quarter, we've seen some registrars do year-end inventory reviews, resulting in some deletions at the very end of the year. While we review accounts on a regular basis, it is possible that there could be some deletions resulting from this kind of activity, that would not appear in our regular account reviews.

On the infrastructure front, the growth of the Internet that is a positive for our business, will continue to put increased demands on our infrastructure. In the third quarter, we processed on average 66 billion DNS queries per day, up from 63 billion queries on average per day last quarter. Also last quarter, I highlighted exciting developments with the implementation of DNSSEC and the Root Zone, and the forthcoming implementation in the .net zone later this year, and the .com zone next year. This is one of the most significant security enhancements to the DNS ever, and we are proud of our leadership roles there. As we continue to show leadership for next digital decade, we will plan to continuously invest in our infrastructure, to enhance our readiness for any future DNS requirements.

Finally, as I know it is an area of interest for investors, we will continue to update you with regards to public developments in the case filed by the Coalition For ICANN Transparency, or CFIT against VeriSign. In August, we requested a case management conference with the district court, to begin the process to resolve this matter through summary disposition or trial. That conference was held on Friday, October 22, and the Court established a timeline for the litigation, including among other things, adopting the parties for proposed schedule, summary judgement on certain threshold issues, with a hearing set for March 2011, and for final summary judgement with a hearing set in October 2011. The court also set the trial date for December 5, 2011. Beyond the procedural updates, given that this is ongoing litigation, we will not be commenting further, other than to reiterate that we continue to feel confident about the case, and will defend our position vigorously. With that, I will turn the call over to Brian.

Thanks, Mark, and thanks everyone for joining us today. Mark gave you the highlights for the quarter, so I would like to just dive into the key financial metrics that we are focused on for the year-- revenue, deferred revenue, non-GAAP operating margin, non-GAAP EPS growth, and free cash flow. As we noted, revenue for Naming Services was $172 million, up 3% from the prior quarter, and up 11% year-over-year. From a continuing operations perspective, we are still on track to wind down the final non-core business, Content Portal Service, or CPS in Q4. The business contributed $364,000 in revenue during the quarter, to bring continuing operations revenue to $173 million. Deferred revenue for Naming Services ended the quarter at $654 million, an increase of $13 million or 2% from Q2, and up 13% from the same period in 2009.

Non-GAAP operating expenses were approximately $98 million, down 2% quarter-over-quarter, and down approximately 5% year-over-year. Non-GAAP operating margin was 43.1% in the third quarter, compared to 40.5% in Q2. As we noted the last quarter, there are a number of moving parts related to the transition of the Authentication Services business to Symantec. We expect to have those substantially completed by mid-year 2011. By the interim, we may see some variability in the operating margins, as we head towards the 45% range in the second quarter of 2011, as we discussed last quarter.

A quick comment on the Transition Services Agreement with Symantec. We still expect the bulk of the TSAs to be completed in mid-2011. Note that the income from the TSA hits the other income line, and a reasonable estimate is still $5 million for the second half of 2010, as well as for the first half of 2011. Non-GAAP net income for the third quarter was $48 million, resulting in non-GAAP earnings per share of $0.27, compared to $0.24 in Q2, and $0.16 in the same period in 2009, a 69% increase from Q3 2009.

We exited third quarter with a diluted share count of 175 million shares. During the third quarter, we repurchased 5.1 million shares. Operating cash flow on a consolidated basis was negative $82 million in Q3, a one-time impact to cash resulting from taxes owed related to the sale of Authentication Services. Free cash flow was $47 million in Q3, given $155 million in excess tax benefits, and $26 million in capital expenditures in the quarter. Year-to-date capital expenditures are running $69 million, which includes approximately $20 million in spend during the year related to Authentication Services. 8% to 10% of the new revenue run rate is still a reasonable way to think about CapEx going forward for the remaining business.

Just an additional note to clarify this significant increase in excess tax benefits. We would have paid cash taxes related to the sale of Authentication Services, if not for net operating losses-related stock options. Due to the use of the stock option NOLs, the cash flow statement must reflect the classification of $155 million as a use of cash and cash from operations, and a source of cash in the fin -- financial -- financing section of the cash flow statement. In the appendix, our slide presentation that will be posted on the website following the call, we have a cash flow reconciliation that you may find helpful.

Moving onto guidance. At this point, we believe we are making good progress to achieve or exceed our full-year guidance. Naming Services revenue growth for 2010 of approximately 10%. Non-GAAP gross margins in the 77% to 78% range. Q4 exit non-GAAP operating margin increase to 42% to 43% from previous guidance of 40% to 41%. Non-GAAP other loss net is expected to be $20 million for 2010. Our guidance is based on continued growth and increased operating efficiencies in our business.

I would like to express appreciation of our employees during this transitional time in the business. Their hard work has enabled us to keep the transition of divested businesses on track. I am very proud of the operational discipline the team has shown over the past several quarters. Going forward, we believe that we will be able to scale the business to a smaller footprint, while continuing to seek opportunities to grow. Thanks for your time today. Operator, we are ready for the first question.

(Operator Instructions)

We will now go to the first question from Todd Raker from Deutsche Bank. Please go ahead.

Two questions for you, guys. First of all, could you just talk about the stock buyback. Anything that prevented you in the quarter from buying stock? Were you guys blacked out as a result of the Symantec transaction at all? Just trying to get a sense of what we should be thinking in run rate. And secondly, can you talk about the potential pricing? And I know you are you're guiding, well, I won't call it conservative, but net adds down here in Q4, but the growth profile still seems pretty healthy on a unit basis. What is it likelihood, we get the last price increase announced? Thanks.

Hi, Todd.This is Mark. On the buybacks side, we don't comment on any blackout periods we may be in -- and I can't get into the details about that. All we can do is report what we have done at the end of the quarter, in the quarter. So I really can't give any further than that. And on the pricing side, also as you know we taken three out of four of the cost price increases we could take. We couldn't comment, whether we intend to take the fourth one, or when -- either as well. We do think about those, as we've mentioned before. We take a lot of things into account. So we look at those,a including the economy, and how the business is doing, and how the registars are doing. And some other factors. A lot of positives in the -- a lot of those areas today, but we cannot comment as top if or when we take an expiration (inaudible).

Mark, maybe can help us, because. net auto renew is in June of next year. What is the timeframe, if you wanted to take one more price increase across .net? Can you do it all the way up to June, or is there some timeframe when you have to do that.

We could take the pricing, we could notice the pricing increase in .net, right up to the end of the term of the contract. If you were within a few months, or you noticed, or inside that six-month notice period. Then the increase would take effect, post the renewal.

Okay, thanks, guys.

Thanks, Todd.

Your next question from Rob Owens with Pacific Crest Securities. Please go ahead.

Thank you, and good afternoon, everyone. I was curious how the new names added this quarter, it slowed sequentially, I think it was the first kind of single digit number you've seen in a while. And do you think this is a function of just of tougher compares, or something you are seeing in the economy or anything from a geography standpoint?

Hi, Rob. It's mark. I think of the new unit thats came into -- we have two million net units which is a strong showing. and on the new site, we had 7.5 million. and if you look back on a historical basis over the last few years, the -- one 3.5 year average on net names in the quarter is about 7.3. So actually it's a pretty strong showing for net units, if you look backwards.

Okay. And then, you filed a couple patents recently, at least I think it was published that there were patents filed just with regard to scoring and ranking of traffic and to domain names. Any comment there, or is that for future potential services you guys are looking at?

We do a lot of electrical property work, Rob, so we have 200 patents on file or that have been issued or being filed. So that is regular course of business for us, to try and protect intellectual property developed. We wouldn't get into specifics, as to what we do to commercialize them, unless we had already done so.

All right. Thanks.

(Operator Instructions)

We will now go to our next question from Sterling Auty with JPMorgan.

Yes, thanks, hi, guys. I was wondering is there any change in the sources for the new names. You talked about the momentum that is building. Was there any new factors that have helped driving name growth?

Hi, Sterling. No, they are the same. So the big picture around this is, we continue to see good growth in the base itself. And then, you peel it back on the renewals, those are going up nicely mostly because the previously renewed base is increasing. The new units, the sources are continuing to be the same, strong international growth, and inside that growth in the unit standpoint, the BRIC countries continue to deliver very nicely. So there is nothing -- no dramatic shifts in the trends we are seeing.

And then, on the renewal rate, anything that we should think about in terms of renewal rate as we enter, from a seasonal factor, both the third and fourth quarter, and longer-term into the 2011 timeframe?

The -- we have we had more expiring names this quarter, than last quarter. So we always have to watch how many names are in the expiring names. That doesn't impact the renewal rate, it impacts the math, as a result of those things. In the mix, we had slightly more, or we will have slightly more expiring names, first time expiring names in the mix. So the combination of those things, comes out in the wash on the overall renewal rate. And expiring base, is fairly steady as percentage of the base, but the number gets bigger, because the base is getting bigger. Does that make sense?

Absolutely. Thank you.

Your next question comes from Walter Pritchard with Citi.

It's Walter. Now that you guys have SLL closed, do you guys have any more clarity on the timing of transition expenses, and how we should think about lumpiness in terms of margins going forward?

Hi, this is Brian. On the -- as I mentioned in the prepared remarks the Transition Services Agreements go until mid 2011. And the Transition Services Agreements are broken into things that can be taken out of the business, such as staff that are doing billing, collections and international locations. The majority of it is network services and infrastructure that we are providing that we will keep post transitions. And so we expect that mid next year for that to be complete. And the lumpiness in the margins, you will probably see the next two quarters.

Okay, and then secondly, on headcount, it looks like you are flat as quarter. Is that the number we should expect the Company to be at going forward, or do you expect it to go up for the next few quarters?

There's a couple puts and takes on headcount. So, where we are trying to manage the business to an overall margin profile, and not necessarily to a particular head count profile. And as we're ramping down on the West Coast, and ramping down up on the East Coast, we will have duplication of staff for a period of time. There's also another headcount to the TSA's, as those roll off the headcount will go on. And then we're also investing back into NIA network inter-operability and availability. There is some puts and takes through the headcount is probably in the next two or three quarters will be, one quarter it may go down, next quarter it may go up, just because of the puts and takes related to the Transition Services Agreement.

Okay, great. Thanks, guys.

Your next question comes from Phil Winslow with Credit Suisse. Please go ahead.

Hi, this is Chloe Wayne for Phil Winslow. Can you comment on your expectations for the managed DNS business in the near term, and how should we think about the margin growth profile going forward as you continue to ramp it up? And just as a follow up, when you look at competitors like UltraDNS and [Astral Neustar], what does managed DNS bring to people? Thanks.

Sure. As a general matter, we look at the market opportunity there. We look at the overall market -- it's about a $900 million to $1 billion market that is expected to grow at about 15% on an annual CAGR for the next three to five years. So the market opportunity itself looks attractive. When you get inside that market, it is a fairly fragmented market, as far as who the players are. So we believe that given the network we have, and the experience we have on that network, we have a competitive advantage there, plus some name brand recognition that will help us from a selling perspective. So we have a provided any guidance as to the business itself. It's not material today at this point. But we like the space itself, and we will be involved in the space, and try to grow that business. Relative to other folks at market, from a managed DNS standpoint, other players have a list of services, or a suite of services which managed DNS is one of them, and we have that offering as well. So the idea is to provide ultimately an end-to-end solution for DNS related services that are internal and external DNS.

Great, thanks.

Your next question comes from Sarah Friar with Goldman Sachs.

Mark, can you talk a little bit about some of the newer things like DNSSEC? What can that mean in terms of an revenue opportunity for next year, in terms of how much you charge customers, and what sort of penetration that you think you will get? And then some of the other things, that I was kind of working on, like the new IBMs, and the new TLD's and how do you think about the revenue opportunity and the potential impact of the core registries?

Sure. On the DNSSEC side, there are two aspects for us. On the core naming business itself, DNSSEC is a cost, it's not a revenue generator, because we have do work in order to implement DNSSEC, it is a good thing for the infrastructure, for the world using infrastructure. On the flip side, the potential revenue opportunity in our NIA business, things like IPv6, DNSSEC. They make the network and DNS more complicated. So there is an opportunity there to help manage that on an outsourced basis, as folks say this is more complicated, and we would like somebody to help us out with that. So there is both a cost and revenue opportunity for us, but they're different sides of the business.

And on that IBM side, we expect the new gTLD's which we consider the IBM version of common net to go into application process mid 2011 and be granted sometime in early 2012. So that is the time frame, as far as the market expectation. We think these opportunities for us, we are trying to be a bit measured on that given two factors that we know. And this is a rough analogy, the one thing that we know is that the IDNs that are in the com net base today, that are the English IDN, meaning that com is still in English, even though it might have [khangi] in front of it. There is about a million names in the base today, in our base on that. And then, on global basis if you look at ccTLDs, it would be from countries, that would be prime -- the prime suspects, if you will, as far as sales that are in cyrillic, or some other language that are not English. There is about 16 million or 17 million total ccTLDs that are in those languages. So it is a little harder to be specific at this point, as to where it will come in, but we try to use those sort of things as book ends as for what the opportunity might be.

Okay, that is helpful for analysis too. Thank you.

Your next question is from Dan Cummins with ThinkEquity. Please go ahead.

Thank you, and as you look out, and I know I heard you say managed DNS is very small and young for you. As you look out though, can you talk about your expectations for the distribution model? Why wouldn't this be another wholesale opportunity to work through the big tech partners like GoDaddy, and Intuit, and Symantec and in small medium business? And would expect it would be a mix of wholesale, and the direct retail relationships at the high end?

Yes, Dan. I think the answer is yes to all of those. You got the right idea there. This will look like a traditional sales model, where you go to market, from a small field team going to the high end. And then you'd have an inside sales forces getting into the mid market, and then you would have a channel partners at the lower end of the market. And the lower end of the market, is where I would put our natural partners, our registrars who we'd be in with discussions about distributing all these services. But we intend to cover the gamut of the market through those distribution channels.

Okay, thanks, great.

(Operator Instructions).

We will now go to our next question from Ed Maguire with CLSA. Please go ahead.

Hi, good afternoon. I was wonder if you could shed light on any, of your broader thoughts on the potential uses of cash for M&A, or the possibilities of dividend before the end of this year?

In the past, as we've said, we continue to view it this way. From an M&A standpoint, while it's possible that we could do some smaller deals that would help us, from a product road map standpoint where -- a go-to-market standpoint perspective, if we were to do something like that, we would need a few requirements to this core business. It wouldn't be large in size, and it would look that way, meaning it was something on the road map, or the go-to-market would be pretty clear as to why we did that. Speaking in terms of what we might do them, we'd be highly unlikely to do, is large deals, new industries -- it would be unlikely to do anything like that, so from that perspective of the use of cash from an M&A standpoint.

Just on the -- as you look at opportunities to provide registry service, when some of the new global -- global TLD come online. I know you talked about these as an opportunity, but do these -- have you done analysis of what the business profile, and the margin profile of these types of services, might how they might compare to your existing?

Yes, there are two ways to look at, both of them we think are attractive. One is for a new TLD that we might go after ourselves and run. Outside of any marketing that we might have to do around that, from an operational standpoint, we have a lot of economies of scale on the network, to add a new TLD on there. Secondly, we were the back end registry provider for someone else who had the TLD, we would still enjoy the network efficiencies we have by putting a new TLD on a existing large infrastructure. So from a margin perspective, we would expect those two drivers.

All right, thank you.

And now for our last question from Craig Nankervis with First Analysis. Please go ahead.

For you Mark, the guidance for Q4 net name adds is almost flat year-over-year at the midpoint . And I guess I was a little surprised at that. Are there any factors on the negative side this year that influencing your forecast versus your result of a year

There's a couple things you are looking at there, Craig. One, when we look at the expiring names base relative for third quarter, we have more expiring names in the fourth quarter than in the third quarter. And the second thing is, we had a slightly higher mix in the fourth quarter than in the third quarter of names that are up for renewal for the first time. And as you may know, the first time renewal rate is substantially lower than names that have been previously renewed.

Right, but I am sort of more focused not on Q3, but on what you did in Q4 last year, versus what you are guiding this year. And I am trying to understand if there is any end of year dynamics that are different this year, than the end of year dynamics this last year?

No, I think the dynamics is the same, we've seen a couple times in the past, like I said in the script, that a few folks might do some deletions at the end of the year, that we might not be aware of, in the account review, that could happen. We're not certain if that could happen or not. But from a dynamic standpoint, everything else looks the same.

I see. Okay, thank you. Brian, sales and marketing was much lower than I expected. It was $18 million on a non-GAAP basis. Is that is sort of the baseline going forward?

It will be. There's a couple of things in sales and marketing, in the second quarter we had one time expenses. There was the (inaudible) campaign that Symantec took over in our third quarter, so we didn't recognize that in third quarter, whereas we did in the second quarter. Then also we have a one-time program related to the 25th anniversary of .com in the second quarter. So second quarter had a couple one-time events. And as we -- one of the things we did, when we sold our business to Symantec, they took our enterprise sales force, and we're in the process of building up. So it will be -- you can expect it to be sort of flattish to where it is now, and it will gradually grow over time. But the percentage of revenue will likely go down.

Got it, thank you, I appreciate it.

We'll now go to Katherine Egbert with Jefferies.

Hi, this is Ignatius in for Katherine. Can you talk about what you are saying in the BRIC countries. Are you signing up more registrars? Thank you.

Yes, the BRIC countries continue to perform well for us. We look at the -- if we get inside the base, about 60% of the base is domestic, and about 39% to 40% is international. If you get inside of the 40% that is international, about 25% of that is what I call emerging, which is primarily BRIC. If you peel that onion one layer lower, then you find out the BRIC countries growth rate of their units, is twice as high as what might be more mature international -- international countries. So it's -- the BRIC companies continue to perform well, but it's off a lower base. But we've seen really good growth there.

Thank you.

I will now turn the call back over to Ms. Nancy Fazioli. Please go ahead.

Thank you, operator. I would like to remind you that Brian will be presenting at the Credit Suisse 2010 Annual Technology Conference on Tuesday, November 30, as well as the Barclays Capital Technology Conference on December 8th. And that Jamba! NIA Services will present at Lazard Capital Cloud Computing Investor Forum. The webcast registration details will be available on the investor relationship website. Also, Mark recently gave an interview on the Communicator segment of C-SPAN that can be viewed on cspan.org. Please call the Investor Relations department with any follow up questions from this call. Thank you for your participation and continued support. This concludes our call. Thank you, and good evening.

This does conclude today's conference call. Thank you for your participation. Go ahead.