VeriSign, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. VeriSign operates domain-name registry services, principally for .com and .net; security-services revenue is not significant. Unless otherwise noted, financial amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $292.4 million | $287.6 million | $869.6 million | $855.9 million |
| Operating income | $181.1 million | $174.8 million | $531.3 million | $517.8 million |
| Operating margin | 61.9% | 60.8% | 61.1% | 60.5% |
| Net income | $114.9 million | $114.4 million | $354.4 million | $335.1 million |
| Diluted EPS | $0.93 | $0.90 | $2.85 | $2.58 |
| Operating cash flow | Not separately stated | Not separately stated | $503.6 million | $488.0 million |
- Q3 revenue rose 2%, operating income 4%, and net income less than 1% year over year. Nine-month revenue increased 2%, operating income 3%, and net income 6%.
- Q3 net margin was 39.3%, versus 39.8% a year earlier; nine-month net margin was 40.8%, versus 39.2%. Cost of revenue was 16.2% of Q3 revenue, compared with 17.3%.
- Interest expense increased to $37.8 million in Q3 from $28.9 million, and to $95.9 million for nine months from $86.6 million, mainly reflecting senior-note interest.
- At September 30, cash and cash equivalents were $286.8 million and marketable securities were $2.079 billion, for $2.366 billion combined. Nearly all debt securities were U.S. Treasury securities maturing in less than one year.
- Balance-sheet debt carrying amounts included $1.782 billion of senior notes and $624.5 million of subordinated convertible debentures, including the contingent-interest derivative. Principal outstanding was $1.8 billion of senior notes and $1.25 billion of convertible debentures. No borrowings were outstanding on the $200 million revolving credit facility. Stockholders’ deficit was $1.230 billion.
- Nine-month investing cash outflow was $531.6 million, including net purchases of marketable securities and $40.6 million of capital expenditures. Financing cash inflow was $81.8 million, including $543.2 million net proceeds from new notes and $474.3 million of common-stock repurchases. Cash increased $54.9 million from year-end 2016.
Business trends and material changes
- The .com/.net domain base reached 145.8 million, up 1% year over year and 1.5 million from June 30. Q3 new registrations were 8.9 million versus 8.3 million a year earlier. The final .com/.net renewal rate for Q2 2017 was 74.0%, versus 73.8% for Q2 2016.
- Revenue growth reflected domain-base growth and .net price increases effective in February 2016 and February 2017. China revenue fell 18% in Q3 and 17% for nine months, as a significant portion of earlier registrations did not renew.
- VeriSign sold iDefense on April 1, 2017, recognizing a $10.4 million gain for the nine-month period. Lower headcount following the sale helped reduce cost of revenue; lower depreciation and R&D costs also contributed. Nine-month G&A expense increased 13%, partly due to compensation and legal costs.
- The company repurchased 5.0 million shares for $447.6 million during the first nine months. At September 30, $622.5 million remained authorized; an additional $41.4 million of repurchases was made through October 25.
- VeriSign issued $550 million of 4.75% senior notes due 2027 in July, intending to use the proceeds for general corporate purposes, including share repurchases. Cash and marketable securities held by foreign subsidiaries totaled $1.6 billion and were intended to remain indefinitely reinvested abroad.
Outlook, risks and contingencies
- Management expected Q4 2017 revenue growth to accelerate versus the nine-month growth rate, citing continued .com growth and prior .net fee increases. It expected cost of revenue as a share of revenue to remain consistent; sales and marketing share to increase; R&D and G&A shares to remain consistent; and interest expense as a share of revenue to increase. No specific full-year revenue or earnings guidance is provided in the filing.
- The .net annual fee was scheduled to rise from $8.20 to $9.02 on February 1, 2018. .com pricing remains contractually restricted, subject to limited exceptions and approval requirements.
- Convertible debentures were convertible at holders’ option through December 31, 2017, following a stock-price trigger. Management did not expect significant near-term conversion but warned that substantial conversion could require additional financing if cash and operating funds proved insufficient. VeriSign expected to pay $9.1 million of contingent interest in February 2018.
- The company said existing liquidity, operating cash flow, and revolver capacity should cover working capital, capital expenditures, and debt service for at least 12 months. It also noted that repatriating foreign-held funds could incur additional U.S. taxes.
- The DOJ issued a Civil Investigative Demand in January 2017 concerning VeriSign becoming the registry operator for .web. The company was cooperating and could not estimate potential outcomes. Other ordinary-course claims and litigation were not expected by management to materially affect results, but outcomes were not assured.
- Key risks include changes to .com/.net agreements and pricing or renewal terms; regulatory and internet-governance changes; competition and shifts in internet-user behavior; cyberattacks, DDoS events and service outages; international and China regulatory exposure; substantial indebtedness and convertible-debt settlement risks; and tax uncertainty. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Investor verification priorities
- Track .com/.net registrations, renewal rates, and the durability of growth, particularly following the decline in China revenue.
- Review the DOJ .web investigation and any developments in the .com Cooperative Agreement, ICANN agreements, and related pricing provisions.
- Assess convertible-debenture conversion, cash settlement capacity, contingent interest, and any need for additional financing.
- Verify the use of 2027-note proceeds, continued share repurchases, and the availability and tax implications of foreign-held liquidity.
- Separate recurring operating performance from the iDefense sale gain and the accounting and tax effects of adopting the new share-based payment standard.