威瑞信 (VRSN) 2013 Q3 法說會逐字稿

Good evening, ladies and gentlemen, thank you for standing by. Welcome to the VeriSign third quarter 2013 earnings conference call. As a reminder, today's call is being recorded. I would now like to turn the call over to Mr. David Atchley, Senior Director of Investor Relations and Corporate Director. Please go ahead, sir.

Thank you, Katherine, and good afternoon, everyone. Welcome to VeriSign's third quarter 2013 earnings call. I am David Atchley, and here with me are Jim Bidzos, Executive Chairman, President and CEO; George Kilguss, Senior Vice President and CFO; and Pat Kane, Senior Vice President, Naming and Directory Services. This call, and our presentation are being webcast from the Investor Relation section our website, www.verisigninc.com. There you will also find our third quarter 2013 earnings release. At the end of this call, the presentation will be available on that site. And within a few hours, the replay of the call will be posted.

Financial results in our press release are unaudited, and our remarks include forward-looking statements that are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent form -- report on Forms 10-K and 10-Q, and any applicable amendments which identify risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. VeriSign retains its long-standing policy not to comment on financial performance or guidance during the quarter, unless it is done through a public disclosure.

The financial results in today's call and the matters we will be discussing today include GAAP and 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, Jim and George will provide some prepared remarks, and afterward we will open up the call for your questions. Unauthorized recording of this call is not permitted With that, I would like to turn the call over to Jim.

Thanks, David, and good afternoon, everyone. Our third quarter results demonstrate that we are on track with our full-year 2013 plans. We reported revenue of $244 million, which was 9% higher year-over-year and delivered strong financial performance, including $134 million in free cash flow. We processed 8.3 million new registrations during the third quarter and added 1.55 million net new names, bringing our name base to a total of 125.9 million active dot-com and dot-net domain names. Our balance sheet remains strong, with $1.8 billion in cash, cash equivalents, and marketable securities at the end of the quarter. We continue to see benefits from our focus and discipline in the execution of our strategic framework to protect, grow and manage the business.

As part of managing our business, during third quarter we continued our share repurchase program by repurchasing 6.8 million shares for $331 million. At the end of third quarter, $697 million remained available and authorized under the current share repurchase program. We continually evaluate the overall cash and investing needs of the business, and consider the best uses for our cash including potential share repurchases.

In today's press release, we announced an update related to our work in reviewing our current tax structure. As you will note from the press release, we expect to file for a worthless stock deduction that if claimed, we estimate will yield an income tax benefit of approximately $300 million to $400 million, which will be recognized in the fourth quarter. Our tax work remains ongoing, and we expect to provide further updates during our fourth quarter earnings call. George will discuss this update in more details in a few moments.

For the last few quarters, I have discussed our continuing focus on innovation and intellectual property. Our R&D team continues to actively research and develop new concepts, and to evaluate new ideas to improve our current technologies and services and to invent new ones. These efforts support our strategic framework, and enhance our ability to create innovative technologies and services. As part of our IP strategy, we have made and continue to make substantial investments in IP. Over the last several years, these investments have included a significant increase in the number of patent applications filed by VeriSign in the United States and Europe. This increase in patent applications supports our strategy to continuously serve our customers and partners in innovative ways through our products and services, and to make sure that others only use our IP under appropriate licenses from VeriSign.

Over the years, VeriSign's commitment to performance and reliability in our registry operations has led us to innovate energetically, and to develop capabilities that are not available from off-the-shelf products. As of the end of the third quarter, VeriSign has a patent portfolio with a combined total of 231 patents and patent applications in the US, plus 304 granted and pending patent applications in other countries. Our patent portfolio includes 127 granted or pending applications in the US, that we believe protect inventions that enable our core registry operations. While we have not decided the best ways to fully utilize our IP assets, and it is too early to provide guidance on how we can use them in the future, supporting our business goals and strategic framework will always drive those decisions.

More information about VeriSign's leadership through innovation is available in our new white paper titled, VeriSign Innovation Exceeding the Standard for Registry Operations, located at VeriSignInc.com/innovation. An additional resource to better understand how our US patents pertain to VeriSign's product and service offerings is available at VeriSignpatents.com. We also have the goal through our innovation efforts to offer additional product and services. This work is ongoing, and we are pleased with the progress. This summer, the Company hired a senior product executive to lead the development of these new products and services. We had hoped to announce a new product before the end of the year, but this is taking a little longer. However, I m pleased to say that we are in the process of contracting with the customer to pilot this product. Currently, we don't have more to say about this pilot program or offering, but we will keep you updated when appropriate on our efforts.

ICANN continues to make progress on its new gTLD program. This week the first four IDNs, or internationalized domain names, as part of this program were delegated into the root zone. At this point, we are not sure of the timing for our own new gTLD applications, or for the backend registry services that we will be providing, but we will provide updates as appropriate regarding the status of our applications.

I will comment now on third quarter operating highlights. At the end of September, the total base of active registered domain names in dot-com and dot-net was 125.9 million, consisting of 110.7 million for dot-com, and 15.2 million names for dot-net. This represents an increase of 5% year-over-year. In the third quarter, we added 1.55 million net names to the domain name base, after processing 8.3 million new gross registrations.

In the second quarter of 2013, the renewal rate was 72.7%, compared with 72.9% for the second quarter of 2012. While renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal rate for the third quarter of 2013 will be approximately 72.5%, or flat as compared to the third quarter of 2012. As we have discussed over the last few quarters, the overall renewal rate softened primarily due to the lower renewal rates for first-time renewing names. Given our forecast for zone growth, including the factors affecting first-time renewal rates and seasonal trends, we expect dot-com and dot-net names added to zone in the fourth quarter to be between 1.1 million and 1.5 million names. As noted in prior calls, updates to the zone are posted on our website at least once per day, to allow you to track how the zone is growing throughout the coming quarter. Now I would like to turn the call over to George.

Thanks, Jim, and good afternoon, everyone. As we stated on prior calls, we have been examining our tax structure. Today I would like to discuss the results of our tax work to date. During the fourth quarter of 2013, we expect to liquidate for tax purposes one of our domestic subsidiaries, which we expect will allow us to claim a worthless stock deduction on our 2013 federal income tax return. If claimed, based on our preliminary estimates, we expect to record an income tax benefit during the fourth quarter of 2013 ranging from approximately $300 million to $400 million related to the worthless stock deduction, net of valuation allowances and uncertain tax positions recorded as required under US GAAP.

The worthless stock deduction may be subject to audit and adjustment by the IRS, which could result in reversal of all, part, or none of the income tax benefit, or could result in a benefit higher than the net amount we initially record. We cannot guarantee that the liquidation of this subsidiary will occur as described or at all, or what the ultimate outcome, use or the amount of the benefit we receive would be, if any. The financial statement carrying value of this subsidiary is not material.

While we expect our domestic operations to generate sufficient taxable income to fully use the expected tax benefits of the ordinary loss from the worthless stock deduction, we are analyzing and evaluating various scenarios for realizing the benefit. Although our current intent remains to indefinitely reinvest outside of the US those funds held by foreign subsidiaries that have not been previously taxed in the US, and accordingly we have not provided deferred US taxes for such funds, we anticipate reevaluating our overall business structure and financing of foreign operations as part of this analysis.

If the conclusion of this analysis results in a change to our current strategy related to foreign operations, we may be required to accrue for an additional US tax obligation, although we can not predict what such amount, if any, may be. Based upon the audited statutory financial statements of our foreign subsidiaries as of December 31, 2012, on a combined basis our foreign subsidiaries have up to approximately $600 million of distributable capital under applicable foreign statutes. We do not know what the ultimate outcome if any, will be resulting from this analysis and evaluation.

I would now like to discuss our third quarter financial results. During the quarter, we generated revenue of $244 million, up 9% year-over-year, and delivered GAAP operating income of $133 million, up 14.3%, from $116 million in the third quarter of 2012. The GAAP operating margin in the quarter came to 54.5%, compared to 51.9% in the same quarter a year ago. GAAP net income totaled $81 million compared to $78 million a year earlier, which produced diluted GAAP earnings per share of $0.53 in the third quarter of this year, compared to $0.47 for the third quarter last year. As of September 30, 2013, the Company maintained total assets of $2.3 billion. Liabilities totaled $2.8 billion at the quarter-end.

I will now review some of our key third quarter operating metrics, which are revenue, deferred revenue, non-GAAP operating margin, non-GAAP EPS, operating cash flow and free cash flow. I will then discuss our 2013 full-year guidance. As mentioned, revenue totaled $244 million for the third quarter. 61% of our revenue was derived from customers in the US, and 39% was from foreign customers. Deferred revenue at quarter-end totaled $858 million, a $45 million increase from the year-end 2012. Third quarter non-GAAP operating expense which excludes $10.6 million of stock-based compensation totaled $100 million, compared with $98 million in the second quarter of 2013, and $98 million in the same quarter a year ago.

Non-GAAP operating margin for the third quarter expanded to 58.8%, compared to 56.4% in the same quarter of 2012. Non-GAAP net income for the third quarter was $90 million, resulting in non-GAAP diluted earnings per share of $0.59, compared to $0.50 in the third quarter of 2012, and $0.58 last quarter. With respect to taxes, we continue to use a non-GAAP tax rate of 28% for our non-GAAP net income and non-GAAP EPS calculations. In 2013, we now expect to pay cash taxes of approximately $25 million to $30 million, assuming we claim the benefit of the worthless stock deduction in 2013. We had a weighted average diluted share count of 153 million shares in the third quarter, compared to 159 million shares in the second quarter. Dilution related to the convertible debentures was 10.5 million shares based on the average share price during the third quarter, compared with 9.2 million for the same quarter in 2012. The share count was reduced by the full effect of second quarter repurchase activity and the weighted effect of the 6.8 million shares repurchased during the third quarter.

Operating cash flow was $134 million for the third quarter, compared to $147 million in the second quarter of 2013, and $122 million for the third quarter last year. Third quarter free cash flow was $134 million. Of the $1.8 billion in cash, cash equivalents and marketable securities at the end of the quarter, $389 million was domestic, with the remainder held internationally.

With respect to 2013, our full-year guidance includes updates to our revenue and capital expenditure projections as follows. Revenue for 2013 is now expected to be in the range of $960 million to $965 million, representing an annual growth rate of 10%. This is an increase from the $952 million to $962 million or a growth rate of 9% to 10% given on our last earnings call. Non-GAAP gross margin is still expected to be at least 80%. Full year 2013 non-GAAP operating margin is still expected to be between 58% and 59%, as we expect an acceleration of sales and marketing spend during the fourth quarter. Our non-GAAP interest expense and non-GAAP non-operating income net is still expected to be an expense of between $60 million and $62 million for 2013. Capital expenditures for the year are now expected to be between $65 million and $75 million, changed from the $60 million to $80 million range given on our last call. Our guidance is based on expectations about the outlook for our business, in addition to our financial projections for interest income and expense.

In summary, the Company continues to demonstrate sound performance in the third quarter. We have grown non-GAAP operating income and net income, as compared with Q3 2012. We have maintained a strong balance sheet, and expect strong operating cash flow generation to continue as a result of our financial model.

Finally, I wanted to note to you an update in our reporting schedule going forward. After reviewing the reporting schedule of our peer group, and with the desire to decrease the time between our fourth quarter earnings release and the issuance of our 10-K, we expect our fourth quarter and full-year 2013 earnings release and earnings call to be held two weeks later than in the past. This change affects only our fourth quarter and full-year earnings release. Other quarterly dates would remain similar to prior practice. We expect to hold our fourth quarter 2013 and full-year 2013 earnings release and earnings call during the first week of February 2014. Now I will return the call back to Jim for his closing remarks.

Thank you, George. During the third quarter, we furthered our work to protect, grow and manage the business, while delivering value. We have protected our business by providing over 15 years of 100% availability of the dot-com and dot-net registries. This track record is due to the strength and experience of our people, our commitment to excellence, our specialized and purpose-built network, and the extensive redundancy built into our infrastructure. Our focus on innovation supports our business growth initiatives, as we continuously work to develop new products and services.

Finally, we have been managing the business effectively through expansion of operating margins and delivering value to shareholders. In addition to the $300 million to $400 million expected income tax benefit we announced today, through the third quarter of this year, we have repurchased 16.9 million shares for $797 million, representing 11% of the 153.4 million shares that were outstanding at the end of 2012. We remain committed to offering the security and stability that are at the core of our business, and provide value to our customers, employees and shareholders. We will now take your questions. Operator, we are ready for the first question.

Thank you.

(Operator Instructions)

And we will take our first question from Gregg Moskowitz with Cowen and Company.

Okay. Thank you very much, and good afternoon. Nice to see another solid quarter, although I did want to ask, just given the strength we saw in net ads this quarter, I was a bit surprised to see deferred revenue be essentially flat on a sequential basis. Just wondering if there were any one-time items or adjustments that might have gone into deferred?

Nothing material, Gregg. This is George Kilguss. We had a minor true-up in the quarter, but it wasn't material related to our dot jobs operation. But, no, we had a good quarter with regard to gross additions. They came in a little stronger than we expected, but we are pleased with those results.

Okay, great. And George, you mentioned that you do expect to accelerate your sales and marketing spend in Q4. Could you put a finer point on the nature and amount of the increased investment there?

Well, Gregg, we don't guide to fourth quarter sales and marketing. But if you will recall, back on our comments in -- earlier in the year, we did have an amount of roughly about $5 million that we had delayed into a later parts of the year. We have a number of marketing activities that are going on right now, and we have registrars subscribing up for some of those programs. So we absolutely are expecting that spend to increase. But some of those -- that spend is dependent on registrars and other folks subscribing up the programs. But we absolutely have a significant amount of marketing going on in the fourth quarter.

And George, is any of that in relation to new gTLDs, or is it completely independent from that?

I would say, most of the programs that are running today are on primarily com and net activities.

Right. Okay. One last one for me, as a clarification regarding the worthless stock, would the income tax benefit if it does arise in Q4, would that be treated as GAAP only, or do you envision treating that in non-GAAP format as well?

No, it would just be from a GAAP perspective.

Okay. That is what I figured. Just wanted to clarify. Thanks very much.

(Operator Instructions)

And Sterling Auty with JPMorgan has our next question.

Yes, thanks, hello. The $600 million in capital available to be distributed internationally is, a far cry from the actual international cash balance that is offshore. Can you talk to us about what causes the limitation? What you might be able to do with that other international cash, beyond just this program?

Sure, Sterling. So let me first say, that as it relates to the $600 million discussed in our prepared remarks, this was the combined amount of distributable reserves in our foreign subsidiaries as of December 31, 2012, which is the last statutory audits that we have had filed. My intent in the disclosure was to simply provide the shareholders some more insight into foreign capital structure, as they have had questions around this area in the past. As you know, we get questions around foreign cash balances all the time. And I was just letting folks know that we were bound by certain foreign statutes. The distributable reserves, just for clarification, are the amount of funds as of 12/31/2012 that the foreign entities could have distributed through dividends to the US patent at that time.

Again, while we have not changed from our current position of these funds being indefinitely invested overseas, we are conducting additional reviews in the area, and will go through an valuation process on that. We will provide you an update on an analysis that is ongoing on the fourth quarter. To be a little more specific, the amounts over the distributable reserves overseas -- I think we have mentioned this before, some of our cash overseas came from divestitures. And that is where really the balance of those distributable -- those amounts, that cash over there has come from, from the divestitures, other than from generating income over there. And we are looking at that, and I will have more to hopefully say to you on our fourth quarter call.

So the last part that you just said, there is the chance or you are looking into ways, that perhaps the amounts above the $600 million, could also be utilized beyond just international?

Yes, we are looking in evaluating and reevaluating our international cash, we are looking at that. That work is ongoing. I don't have any determinations here today to talk about, but we are clearly looking at that.

Okay. And then, Jim, I want to talk a little bit about the new products. It has been some time. You mentioned that you were hopeful to get a product out. It doesn't look like it is going to come this year. But you had a new head put in place, in terms of a head of new products. And what I am curious about, how you are doing the business planning around the new solution that you are constantly taking to pilot, in terms of types of returns that you are expecting to get out of the investment, or how much investment you are going to put around it? So what is the strategy, in terms of how you are thinking about putting new products into the marketplace, and how much investment will go to support it?

Well, we don't -- we obviously can't guide to expenses directly attributable to any new product, or anything specific about the product's expenses. But going back to what we set out as goals for some of the innovation that we funded, going back over a year ago, we look for products that would leverage the existing network, that could be covered by intellectual property for us, and that yielded margins similar to the core business. So those are the goals for the new products. And when we say we are pleased with the progress that we are making with some of the products coming out of, out of what we call, the hive, our innovation facility here. They are meeting those requirements.

So we also mentioned back when we talked about the innovation, that what we were doing is exploiting intellectual capital that the Company had, that we had a lot of good ideas in how to utilize our network in more efficient ways to offer new products and services, things that would leverage the investment that we already made in this high availability, high performance, purpose-built network. So I can tell you that it meets all of those requirements. I think it is early to say more than that. But -- and you are right, we are now engaged in contracting for a pilot for this product. So we are making progress, but I think beyond that, it is too early to say more.

Last question, if I may. The changes to the algorithms and search engines, there has been some talk that maybe there are some additional ones that occurred over the last month or so? Is that the case? And it seems like the name additions are still pretty good. Are we getting to the point of diminishing returns, where maybe some of those changes are having less and less impact on the actual growth in the zone?

So --

Go ahead, Pat. Why don't you --?

This is Pat. So what I think what you are referring to is Hummingbird release at Google. And basically, they pushed that out on October 3. And the foundation for this release appears to be more about natural conversation. So they are really looking at the mobile space right now with that. And we have not seen a lot of impact on the domain names because of that. But it is a change, and things I have read about -- by this from Google, is the first major, really restructuring change since 2001 on the algorithm. So they are going to keep tweaking on it. But it is really one of these things that is geared toward mobility, I believe.

Okay. Thank you.

Thank you. And we will go on to Steve Ashley with Robert W. Baird.

Great. George, I was just going back into the tax planning and the worthless stock, involved in it, is a subsidiary. I am just wondering if there was any color you could give us around this subsidiary, and where the value of this asset had been, or where it is coming from?

Yes, sure. I mean, all that I can really tell you is that it is a subsidiary that has a large tax basis. And it was prior -- it was part of a prior acquisition. But the worthless stock deduction really is a situation, where we -- we have a situation where a stock can become worthless, and you take a claim for that. And so, that happens on the occurrence of certain events, and the event that we are talking about, is the expectation of liquidating this subsidiary.

Great. And then if I could just maybe turn to the new gTLDs. You mentioned four have gone all the way through the funnel, and have been delegated to the root, and those were four IDNs. And it didn't sound like those were any of the ones that you currently own. But as we just look going forward, I am just wondering if you have any comments about what the general timing of ICANN moving names through the process, and getting the 220 potential customers you have through that process. And maybe the other gTLDs that you own directly, as we look into next year, if you have any expectation or color you can provide us around that?

Yes, I think it is early for us to predict what is going to happen to our own applications, or the applications of our other customers. There are -- the four IDNs that were delegated this week, the first of those was actually contracted back in the ICANN meeting in Durbin, which was mid-July. So they are very early. I am not sure exactly what the contracting status of all the applications are, but I believe it is around or less than 100 that are in contracting. So we have less than 10% that have reached the contracting phase. And until that is done, they can't get on to the delegation phase.

And there is still some work in the -- they are pursuing something called the alternate path to delegation that I can't provide. It just very, very recently, and they have to do some blocking of second level domains. The non-alternate path is a more comprehensive security and stability planning qualitative analysis. So there is -- and I can't -- I am sorry, ICANN is still actually developing that process. They are conducting more study to provide more data to inform that process. So I think it is early at this point, to speculate exactly what the pace and timing for these other ones would be. Pat, do you want to add anything to that?

Well, I think that is exactly right. It is basically, if you move forward on either path, there is a process, you can accept the standard agreement, but if you negotiate and you want other terms inside that agreement, it will certainly take longer. And that is going to be up to the individual applicant at that point in time.

Thank you so much.

Sure.

(Operator Instructions)

And we will now go to Phil Winslow with Credit Suisse.

Hi, this is [Harry Heyer] for Phil. Thanks for taking the question. I know you talked a little bit about building out your IP portfolio, and I was wondering if you might be able to give a little bit of detail on your IP monetization strategy?

We have not yet finalized that strategy. As I mentioned, it is too early for us to detail that. I think, what we announced today is the availability of two resources on our website. The first one is the white paper, and I would encourage you to read it. It is easier to read, than it is for me to describe. It is essentially a -- I will try though anyway, it is a survey of the innovation that we have done, that we brought to our infrastructure that we think will benefit our customers, whether it is all of the global internet users who benefit from our resolution services, or from our backend registry services customers.

So again, the white paper is available at verisigninc.com/innovation. And so, that gives you a lot of context, in terms of how the patents are grouped, and what particular areas you will find. We describe our innovation efforts, and then some of the IP that those efforts have yielded by category. So I think you will be able to get a broad idea, a big picture idea of where we have been innovating, and some rough idea of the categories and number of patents we have in that area.

And I also mentioned that we do have another resource, VeriSignpatents.com. And there what you will find is a specific list of patents, and how they apply to the various products and services that we offer. So if you are interested in just absolute number of patents that apply to various services offered by VeriSign, you will find what is essentially sort of a patent marketing website there. So beyond that, we have not gone into any detail on how this portfolio of intellectual property will be used, other than to say, we will certainly explore ways to further our business interests with it.

Got it. Thank you very much.

Thank you. And our final question will come from Walter Pritchard with Citi.

Hi, just kind of tagging on that, the IP question there outside -- this is Ken Long for Walter. So tagging on that IP question, I mean is it -- I mean it seems like it is somewhat, at this stage, it might be somewhat limited to potentially pursuing licensing from other registries, which would make sense with a bunch of gTLDs coming along? I mean, is it more than that? Should we be looking at you being potentially being able to license this to other internet service providers? Or is it more limited to just registry, registrar type functionality?

All right, it is more than that. I mean, we operate a high reliability infrastructure that involves high performance and redundancy. And so, these patents cover the entire broad swath of the technology category that applies to everything we do, which is certainly at its core, a registry operation. Some of these functions interact with registrar functions, and intersect with them. But again, I would encourage you -- I think you will find the white paper very informative in this regard.

Got you. I will definitely check it out. And then second, we haven't heard you talk much about the NIA business recently. Any color on how that business is growing, and should we still kind of view that as an area of kind of serious investment from you?

I'm sorry, I didn't hear the very last part. (Multiple Speakers).

Should we -- I guess -- just a -- should we still view that as an area where you are putting good resources behind, in terms of investing in that particular business?

Well, we have made substantial investments over the years at NIA. And I mentioned in recent calls, three quarters ago, two quarters ago, that what we were doing was streamlining NIA, and structuring it better to scale going forward, that we were aligning expenses with revenue in the business, and we are making progress in all of those areas. It is still at the point where we are not calling it out separately or talking about it separately. But in the three categories, I-defense which is threat intelligence, managed DNS, and also DDOS, we do see opportunities in all those areas, and we continue to actively grow that business. I think at some point, we will get to a point where we will talk about it separately, but we are not there now.

Got it. Great. Thanks a lot.

Thank you.

Thank you. And we have no additional questions. I would like to turn the conference back over to Mr. David Atchley for any final or closing remarks.

Thank you, Katherine. 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.

Thank you. Again, ladies and gentlemen, that does conclude today's conference. Thank you again for your participation.