威瑞信 (VRSN) 2011 Q1 法說會逐字稿

Good day, everyone, and welcome to the VeriSign first quarter 2011 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 first quarter 2011 earnings conference call. I'm Nancy Fazioli, Director of 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 the Investor Relations section of our new corporate website, www.verisigninc.com. Please refer to that website for important information including the Q1 2011 earnings press release.

A replay of this call will be available on the 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 on our documents filed with SEC , specifically, the most recent reports 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 its longstanding policy to not comment on financial performance or guidance during the quarter unless it is done through a 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, as applicable, each of which can be found on the Investor Relations section of our 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.

Thanks, Nancy. Good afternoon, everyone. We continue to be pleased with the Company's performance. We are seeing a combination of a record number of new domain name registrations and strengthening in renewal rates. Also we continue to achieve ongoing operating and margin expansion through disciplined operations, and our balance sheet remains healthy, which allowed us to declare a special dividend and to have repurchased $200 million in shares in the first quarter.

As a leading Internet infrastructure provider, our business is being driven by the continued growth in underlying Internet trends, such as online advertising, eCommerce, more global Internet users and the paradigm shift to cloud computing. We believe we are well positioned to participate in driving and securing that growth as well as to help our customers strengthen the integrity and effectiveness of their Internet services.

Before getting into first quarter results, I would like to comment on the $2.75 per share special dividend that we announced today. As you may recall, in December of last year, when we paid out a $3 special dividend, we expressed our intention that we would return to shareholders at least the proceeds from the sale of our authentication service business, which was approximately $1.3 billion. With the $3 special dividend in December, the $200 million of share repurchases in the first quarter, and today's $2.75 special dividend we have returned in excess the proceeds of that sale to the shareholders. Post this dividend payment of $463 million, as well as the related contingent interest payment of $100 million to holders of our convertible bonds, we have approximately $1.4 billion remaining on the balance sheet. Following the first quarter share repurchases, we have approximately $1.2 billion remaining in share repurchase authorization, which has no expiration.

Now moving on to first quarter results. In Registry Services, the base of registered names in .com and .net totaled 108 million names at the end of March. This represents a 9% increase year-over-year in the base and an approximately 3% increase quarter-over-quarter. In the first quarter, we processed a record 8.3 million new registrations, which is an approximately 3% increase year-over-year. And in the quarter, we added 2.74 million net names to the Domain Name Base.

On the renewal rate side, the Q4 2010 renewal rate was 72.7%. While renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal rate for the first quarter of 2011 will be between 73.5% and 74%. We expect the Q2 net names added to the Base to be between 2 million and 2.3 million names, which reflects the continued growth in the underlying drivers of the Internet, as well as seasonality.

As many of you are aware, our contract with ICANN for .net comes up for renewal on June 30 of this year. On April 11, we announced that ICANN had posted the negotiated renewal terms for the .net registry agreement for public comment. There are no material changes to the terms of the proposed renewal agreement from the existing agreement. ICANN's internal policies call for a comment period for the proposed agreement which we expect will run for approximately 30 days, and we expect the agreement to be renewed by July 1.

I would also like to highlight that we successfully implemented DNSSEC in the .com zone on March 31, following implementation of DNSSEC and .net in December and the root zone last fall. This is the significant accomplishment by the team that has been in the works for many years and the required collaboration with numerous constituencies in the Internet ecosystem. We are proud of the role that we played in this multi-stakeholder initiative.

With regard to the case filed by the Coalition for ICANN Transparency, or CFIT, against VeriSign, the court established a timeline for the litigation last October that included a summary judgment hearing this past March on certain threshold issues. That hearing took place on March 11 and the matter is pending with the court. We have no other updates on that motion.

Also as noted in our 8-K filed on February 14, the court dismissed CFIT's third amended complaint and allowed for CFIT to amend certain allegations. CFIT subsequently filed a fourth amended complaint and VeriSign filed an answer to that complaint on March 8.

According to court schedule, a final summary judgment hearing is scheduled for October 2011 and a trial date is set for December 5, 2011. Beyond the dates just mentioned, 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 regard to our network intelligence and availability business, we continue to make good progress. On March 31, we announced two enhancements to our Managed DNS Service, including the rollout of support for DNSSEC compliance features as well as Geo Location. These services strengthen our offering and we will continue to strive for a leadership position in this fast growing but fragmented market. With the first quarter results, we're off to a good start for the year and we look forward to updating you on our progress through the year. Thanks for your time, and I will now turn the call over to Brian.

Thanks, Mark, and good afternoon, everyone. As Mark said, this was a good quarter for us, and I'm pleased about the progress we made toward our goals. I'd like to add to Mark's comments regarding the $2.75 per share special dividend, we view the dividend as an efficient return to shareholders given our capital position, following the sale of authentication services. From a taxability perspective, which is impacted by the $100 million contingent interest payment to our convertible bond holders, we believe most, if not all, the dividend would likely be a return of capital to the shareholders and the remainder would be a qualified dividend as defined under the Internal Revenue code.

Let me quickly recap our performance this quarter on our key operating metrics, which are revenue, deferred revenue, non-GAAP operating margin, non-GAAP EPS growth and free cash flow. And then I'll discuss progress towards our annual guidance.

Revenue of $182 million for the first quarter was up 2% from the prior quarter, and up 12% year-over-year. Deferred revenue ended the quarter at $699 million, an increase of $36 million, or 5% from Q4, and up 13% from the same period in 2010. Deferred revenue has been reported on a continuing operations or Naming Services basis since the second quarter of last year, and as of this quarter the balance sheet is also a clean comparison.

Q1 non-GAAP operating expenses were $98 million, down 1% quarter-over-quarter and relatively flat year-over-year. Non-GAAP operating margin for Q1 was 45.9% compared to 44.3% in Q4. We expect continued margin expansion in line with our previously stated intention of achieving 46% to 48% exit margin in the fourth quarter of this year. Non-GAAP net income for the first quarter was $55 million, resulting in non-GAAP earnings per share of $0.32 compared to $0.31 in Q4, and $0.22 in the same period in 2010. Income related to transition services, included as part of our non-operating income on the P&L, was approximately $3.5 million in the first quarter.

A quick comment on taxes. We continue to believe a non-GAAP tax rate of approximately 30% is a reasonable estimate. In 2011, we will pay cash taxes of approximately $40 million, of which $28 million is related to the divestiture of the Authentication Services business. We exit Q1 with a diluted share count of 172 million shares. Dilution related to the convertible debentures was approximately 500,000 shares based on the average share price during the quarter.

Operating cash flow on a consolidated basis was $90 million in first quarter, noting that bonus payments were made in the quarter. Free cash flow was $78 million in Q1, given $4 million in excess tax benefits and $16 million in capital expenditures in the quarter. Capital expenditures are on track this quarter and include certain infrastructure initiatives as well as facilities related expenditures corresponding to the move of corporate headquarters. We now believe capital expenditures would be closer to 10% of revenue in 2011, given anticipated facility spend related to the move of corporate headquarters to our new leased space.

To sum up, we are pleased with our performance. We continue to grow non-GAAP operating income and net income faster than revenue, we have a healthy cash position and the strong cash flow generation capabilities of our business continue to be a key benefit of our financial model.

Before I move on to guidance, I want to touch upon the status of the transition of the Authentication Services business to Symantec and corporate functions to the East Coast. Progress has been good, and we still expect the bulk of the transition to be wrapped up in mid-2011.

As noted previously, income related to transition services in Q1 was approximately $3.5 million and we now expect approximately $2 million in Q2 and approximately $2 million in the second half of the year. I would like to thank the entire time for their collaboration this past quarter. I wish our Mountain View colleagues moving on to new opportunities in the Bay Area all the best in their new endeavors.

With respect to 2011 guidance, revenue for 2011 will be in the range of $756 million to $780 million, or growth of 11% to 14%, up from 10% to 14%. Consistent with 2010, we expect non-GAAP gross margin of approximately 78%. Q4 2011 exit non-GAAP operating margin is expected to be 46% to 48%. Interest expense and non-operating income, net, which I previously referred to as other loss net, is still expected to be $25 million for 2011.

As I mentioned previously, capital expenditures are now expected to be approximately 10% of revenue. Our guidance is based on our forecasts, expectations of continued growth and increased operating efficiencies. I'm excited about the opportunities for the Company. We believe that disciplined execution of opportunities that leverage our competitive advantages will provide a platform for long-term profitable growth. With that, we will move to Q&A. Operator, we are ready for the first question.

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions) We will pause for just a moment to assemble our queue. We will take our first question from Walter Pritchard with Citi.

A few questions. One, I'm wondering if you can you talk about, just on the renewal rate, it seems like the mix is going more towards existing names which should drive the renewal rate up. And you've been a little hesitant to kind of let the assumption that we all use go up there and you did have a better rate this quarter. I'm just wondering if you could talk about sort of the dynamics there and your expectations going forward on renewals?

Sure, Walter, it's Mark. I'll do that. As we've said before, in the renewal rates we look at the mix of the first time expiring names and previously renewed names, and what we've seen consistently over time is that the previously renewal rate is much higher than the first time expiring names. That continues to be the case. We also have a continued shift of the base moving into the direction of becoming previously renewed names. That is a big base of names, there's a lot of names here, so that shift takes time. We are continuing to see it gradually moving in that direction and seeing the benefits with renewal rates approaching the 73%, 74% range.

And just on the revenue growth rate, I guess, the sequential growth was a little lower than we thought, especially if we compare it to sequential growth rates in revenue in the second half of last year. I wonder if you can help us understand if there is anything in there that drove volatility and sequential growth in Q1?

Hey, Walter, this is Brian. There wasn't anything large in there that changed the sequential growth quarter-over-quarter. We had our contra revenue program was a little larger this quarter than it was in first quarter 2010. Our revenue growth quarter-over-quarter was 12% year-over-year.

Year-over-year. Okay. Great, thanks a lot.

And we will go next to Steve Ashley with Robert Baird.

Hi. I wonder if you can just talk about in terms of domain name growth, just qualitatively what you are seeing in North America versus international?

Yes, Steve, happy to take that. Historically, in the last few years we have seen the international side growing at a faster rate than domestic, a much faster rate, usually by multiple percentage points. That has continued through, actually until last quarter and we are seeing in this quarter a bit of a slow down there where that gap is closing, where the international grew at about 1 percentage point higher, and usually we've seen it multiple percentage points higher than that.

That's only one quarter where we've seen this. I don't want to call anything based on just one quarter worth of data. I did look inside the international piece of it to look at various countries and we still continue to see some countries growing at a very, very healthy rate, like China grew at about a 21%, India is still 11%. EMEA as a group is 13%. There were a couple laggers, Brazil was down about 10%. Australia was down about 5%.

There are high growth ones in there, there's been some ones that have dropped off a bit in the last quarter, and when you put that all through the wash, we've got international at about 1 percentage point higher in growth than domestic. But, again, that's one quarter here, and historically we've seen that at a higher rate.

Great. And are there any other registries at this point that are offering DNSSEC?

Yes. There are. A number of them have that.

And just lastly, the progress on the relocation of the headquarters, you talked about transition services but just in terms of your hiring and staffing up in northern Virginia, how is that all going?

This is Brian. We are doing a good job on that, better than expected. Everything has gone to plan. We should be done at the end of second quarter.

Perfect, thank you.

Thank you.

And we will take our next question from Sterling Auty with JPMorgan.

Yes, thanks. I think you partially answered this question, Mark. But if we look at it, December quarter was a tough quarter for new name additions, March was very strong, obviously, seasonality playing a part. But what other factors do you see kind of contributing to the new name growth here, you mentioned international? But what else are you seeing and how are you thinking about that going into June? And can you remind everybody about the seasonality of name additions typically in June?

Sure. What we are seeing there, Sterling, I think, is the, domestic is growing nicely, international continues to grow nicely as well for a combined mix of 8.3 million new registrations on the new side, thus far, which is great. As far as the strength behind this, coming off of a bad economy, that certainly has given a big lift in last 12 months to the Name Base and Internet online advertising spending is up, very, very well in that same period.

So on a quarter-over-quarter basis, I saw a stat the other day saying online advertising has reached its highest level spend ever. I think those are the drivers and we continue to see those drivers move forward. Seasonality-wise, the first quarter is very strong for us, the strongest quarter. We do see seasonality dropping into the second quarter and the third quarter traditionally and kind of flat to uppish a little bit in the fourth quarter. So we would expect that seasonality to continue.

Okay. And then on the non-registry part of the business, when you look at it, you made some kind of qualitative comments, but maybe just a little bit more color in terms of the sequential trends that we should think about, the outside of the naming business, the parts of VeriSign, how should we think about how that should grow through the year?

Take that, Brian.

Hey, Sterling, this is Brian. We don't break down the two businesses. Last year, we said that the NIA business was roughly about $10 million to $15 million. For the most part, at the end of last year and the beginning of this year, we're rebuilding the enterprise sales force. The team did a great job in the first quarter and exceeded their bookings target and they are off to a good start.

Great, thank you.

Thanks, Sterling.

We will go next to Rob Owens with Pacific Crest.

Hi, this is actually Kelly McCleod on for Rob. Just wondering why the special dividend rather than share buybacks?

Hi, Kelly, this is Brian. As we mentioned before, in considering the use of cash we wanted to return at least the proceeds from the Authentication Services sale. As far as the method doing so, we decided to do this in sort of a hybrid approach. We bought back $200million in the first quarter and also declared the special dividend.

This had some advantages with being timely and tax advantageous in the way to get proceeds back to shareholders. We still have $1.4 billion of cash on the balance sheet with a remaining share authorization at $1.2 billion. And so we feel like we have good flexibility and a strong balance sheet.

Okay. And then how should we thinking about share buybacks for the remainder of the year?

So we've committed to returning value to shareholders. We've done what we committed to, we will evaluate that on a quarterly basis.

Great. Thank you very much.

(Operator Instructions) We'll go next to Todd Raker with Deutsche Bank.

Hey, guys, a few questions for you. First of all, can you talk about contract length, deferred revenue stepped up a little bit here, what is driving that relative to the revenue profile?

So the increase in deferred revenue, contract length is average term life on the names is the same. It's about 1.17 years. And the deferred revenue is just a function of the new names that have been registered.

Okay. Can you talk about how much cash is domiciled in the US versus international?

The revenue makeup is about, as related to what we are doing on the dividend, or --?

Yes, well, you've got a significant stock buyback authorization left, you've got a substantial cash balance, $1.4 billion, how much of that --

Yes, of the $1.4 billion in cash, it's about $400 million domestically and $1 billion internationally.

Okay. Thanks. And can you talk about, as you went through the .net renewal process are there and takeaways that we can apply to our thinking about the .com process coming up?

Todd, we are in the .net renewal process, I just want to make that clear. We are in the midst of the 30-day comment period that I can't ask for the negotiated terms between VeriSign and ICANN. We expect the contractor knew by July 1. I think the at highest level the terms of the .net contract and .com contract are almost identical. The only real difference between the two is that for .com in addition to negotiating -- or in addition to getting renewed with ICANN we have to seek the Department of Commerce approval.

Okay. And then one question for you on the CFIT timeline that you walked through, the summary judgment hearing that occurred on March 11, would that apply to fourth amended complaint that CFIT has filed?

No, so the summary judgment is basically asking the court to dismiss either the case or certain portions of the case for various reasons.

Yes.

And then, separate from that, the court had dismissed claims already that they had in their third amended complaint but gave them leave to amend, so they amended for a fourth time.

Okay. So even if you get a positive summary judgment you may still see some ongoing court action on the fourth amended complaint?

It's possible to get some things dismissed and others to still (inaudible.)

Okay, all right. Thanks, guys.

And we will go next to Shaul Eyal with Oppenheimer and Company.

Thank you. Hi, good afternoon, guys. One quick question in mind with respect to cash utilization, you spoke about the dividend and you spoke about the buybacks, with respect to M&A, even though you guys have been divesting over the past couple of years, what are you looking, right now, obviously, you have plenty of cash. Is it more kind of technology tuck-ins type of acquisitions that we might be expecting?

Yes, Shaul, this is Mark. To the extent that we would feel the need to accelerate a product road map sort of things, or go-to-market things, then we may turn to an inorganic basis to do that. But as I said in the past, if we did it, it would be very adjacent to things we are doing today and would be -- you used the term tuck-in, but that kind of size and for that sort of reason.

Got it. Okay. Thank you.

And we will take our next question from Phil Winslow with Credit Suisse.

Hi, guys. I just wanted to dig in a little bit on that contra revenue comment that you made regarding Q1, because just looking at your sequential -- just domain name growth, and then looking at the sequential growth in revenue, I would have expected it to be a couple of million higher. But you did mention just sort of higher contra revenue.

Wondering if you can help us quantify that, was that $2 million, $3 million more than, let's say, last quarter, or year-over-year, and maybe just, for those who aren't familiar with the contra revenue, what does drive that, and what would you expect that to be for the June quarter? Thanks.

This is Brian, Phil. From a contra revenue program, we do marketing campaigns with the registers, help stimulate growth. These are programs that we've done historically on the first quarter every quarter for the last several years. It's really based on the amount of names in the base. And so the program this past quarter was approximately $1 million higher than first quarter 2010.

Got it. And then when you think about it for the June quarter, should that fade away, so we kind of get a step back up then, we're higher than expected kind of growth sequentially?

The June quarter, it varies based on programs that we roll out. The June quarter will be more than it was last year. Third quarter would be last and then fourth quarter would be about the same. And so it just really varies based on the programs that the registers have and we try to work collaboratively with the registers in putting these programs out.

Got it. And will June be higher than March?

Yes.

I think, Phil, the answer to that is that on annual basis we look at the revenue side. We've called out 11% to 14% revenue growth. So regardless as the sort of ups or downs of contra programs that's what the annual revenue basis looks like.

Got it. Thanks, guys.

(Operator Instructions) We will go next to Dan Cummins with ThinkEquity.

Thank you. Two questions, Mark, could you give us an update on your opinion regarding the conditions for enacting price increases for the registries? I think you said last quarter that conditions looked pretty good overall. And then, Brian, CapEx now, the outlook, I think you said was 10% of revenue. I believe prior was 8% to 10%. Can you review for us how much might be registry, how much for growth initiatives?

Yes, Dan, it's Mark. I will take the first question. As I have said in the past, we think about a lot of variables in thinking about pricing, always most important is long-term needs for the business. I think everybody knows we have one price increase remaining at .com, we have plenty of time to take that out through November 2012 to notice that price increase if we choose to do that. Last quarter, I commented on various factors we look at would seem to be in a positive direction. I continue to believe those look positive. Brian, you want to take the CapEx?

Yes, this is Brian. On the CapEx side, we increased it to the higher end of the range that we gave previously related to the moves that we're making from the West Coast to the East Coast and the build-out of our new facility. We don't break down capital between growth initiatives and sort of maintenance and expansion. We have Project Apollo, which is a multi-year project that we are putting capital into our network to handle the increased attacks and increased capacity of query loads.

So is it a non-issue with the regulator?

I'm not sure if we follow the question.

In terms of -- I mean, there is no segregation of assets between stuff that's dedicated for the registry business and stuff that you are doing to grow your business independently.

No.

Okay. Thank you.

Thanks, Dan.

And our final question today comes from Ed Maguire with CLSA.

Yes, just a quick question on your broader strategy toward M&A. I mean, given that you've issued a special dividend and have upped the share repurchase, to leave you really with a relatively small amount of cash, and also taking into account the relocation of some of the staff and some realignment just recently, I mean, have you -- has your fundamental stance toward M&A changed in any respect that caused you to be much more focused on just returning cash at this point?

Ed, so I don't think that our stance on M&A has changed. Historically, when we discuss this topic we've said if we were to look on an inorganic basis for things it's for the reasons I had mentioned earlier, which would be more tactical than be strategic ideas in nature. And just because of that those things tend to be smaller. So I think we still have $1.4 billion in cash and we're generating very healthy cash flow and we've got a great balance sheet, if we need to do something we could.

Okay. And I have one final question, which is the contract you won for .gov, can you talk about some of the economics for some of the new global TLD opportunities, as well as any other potential registry-related businesses that might be out there?

Sure, yes, kind of two separate things there. So we are happy we won the contract for .gov. That's not, that's a new TLD for us to run but it's not a new TLD. It's been out there for a while. Separate from that with the real new TLDs that ICANN intends to introduce next year, it's really going to be a big difference in what those economic models look like, starting first with, are you the front end or the back end. We primarily consider ourselves back end service providers as a registry, as opposed to the front end marketing engine of those things. But we do know that whatever the go-to-market model looks like for that, there is a cost associated with applying for those, which is about a $185,000 registration fee per name.

Okay. Thank you.

Okay. Thanks, Ed.

And I would now like to the call over to Nancy Fazioli for any additional or closing remarks.

Thank you, operator. With regard to events in the second quarter, please note that Mark and Brian will be presenting at the JPMorgan TMT Conference at 3.10 PM Eastern Time on Tuesday, May 17. The webcast registration details will be available on the Investor Relations section of the VeriSign website.

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.

Again, that does conclude today's presentation. We thank you for your participation.