VeriSign, Inc. — Q3 2013 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2013. VeriSign operates domain-name registry services, principally for .com and .net, and also provides network intelligence and availability services. It reported approximately 125.9 million active .com and .net domain names at quarter-end, up 5% year over year. Registry Services generated substantially all revenue.
Financial performance
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Revenue | $243.7 million | $223.5 million | $719.5 million | $643.4 million |
| Operating income | $132.7 million | $116.1 million | $398.1 million | $322.0 million |
| Net income | $80.9 million | $77.9 million | $252.3 million | $214.4 million |
| Diluted EPS | $0.53 | $0.47 | $1.60 | $1.30 |
| Operating margin | 54.5% | 51.9% | 55.3% | 50.0% |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $432.0 million | $366.9 million |
Q3 revenue increased 9% and operating income increased 14% year over year; nine-month revenue rose 12% and operating income rose 24%. Nine-month net income increased 18%. The filing attributes registry revenue growth chiefly to a 5% increase in .com and .net domain names and prior fee increases. Nine-month operating cash flow increased 18%.
At September 30, cash and cash equivalents were $117.6 million and marketable securities were $1.689 billion, totaling $1.807 billion. All marketable securities were U.S. government debt with maturities under one year. The company had $750 million of 4.625% senior notes due 2023 and $1.25 billion principal of 3.25% subordinated convertible debentures due 2037. The debentures were classified as current because holders could convert through December 31, 2013. The $200 million revolving credit facility had no borrowings outstanding. Stockholders’ deficit was $493.8 million.
Changes, capital allocation, and unusual items
- Interest expense rose to $21.1 million in Q3 from $12.6 million, and to $53.5 million for nine months from $37.5 million, primarily reflecting the April issuance of $750 million senior notes.
- The company repurchased 16.9 million shares for $797.1 million during the first nine months; $697.1 million remained authorized at September 30. It reported an additional 0.7 million shares repurchased for $37.9 million through October 23.
- Nine-month investing cash outflow was $317.1 million, chiefly reflecting net purchases of marketable securities and $50.2 million of property and equipment purchases. Financing cash outflow was $125.0 million, including repurchases and repayment of the $100 million credit-facility borrowing, partly offset by senior-note proceeds.
- The nine-month effective tax rate was 26%, versus 25% in the comparable 2012 period. A $3.0 million gain on sale of an investment partly offset non-operating losses, including a $9.7 million nine-month fair-value loss on the convertible-debenture contingent-interest derivative.
Outlook, risks, and contingencies
- Management expected 2013 revenue to exceed 2012 revenue, supported by growth in .com and .net registrations and fee increases. It anticipated continued domain-name growth, while noting economic uncertainty and search-engine changes could reduce registration demand and renewal rates.
- The .net fee increased from $5.11 to $5.62 on July 1, 2013; a further increase to $6.18 was scheduled for February 1, 2014. Management expected cost of revenue as a share of revenue to remain consistent; sales and marketing and interest expense as shares of revenue were expected to increase in the remainder of 2013.
- Management expected to liquidate a domestic subsidiary for tax purposes in Q4 2013 and estimated a potential $300–$400 million tax benefit from a worthless-stock deduction, net of valuation allowances and uncertain tax positions. The deduction and benefit were uncertain and subject to IRS review. The company was also evaluating foreign-subsidiary funding and tax structure; $1.4 billion of cash, cash equivalents, and marketable securities was held by foreign subsidiaries, and repatriation could trigger additional U.S. tax.
- Management believed available liquidity, operating cash flow, and the revolving facility would be sufficient for at least 12 months. However, if convertible-debenture holders convert, cash settlement needs could exceed available cash and operating cash flow and require financing.
- Key risks include dependence on .com and .net, ICANN and government agreements and pricing restrictions, uncertain effects and operational risks of new gTLDs, cyberattacks or service outages, competition, and substantial debt. A derivative shareholder lawsuit concerning incentive compensation plans was subject to a recommended dismissal; the plaintiff filed a voluntary dismissal notice, but the court’s dismissal was pending a 21-day period for possible shareholder intervention. VeriSign stated it did not expect pending matters to materially affect its financial condition, results, or cash flows.
Important facts for investors to verify
- Whether the anticipated $300–$400 million tax benefit was realized, its final amount, and any related IRS or foreign-repatriation tax consequences.
- Whether convertible-debenture holders converted or required cash settlement after the December 31, 2013 conversion window, and the resulting liquidity or dilution impact.
- Subsequent share repurchases, remaining authorization, and the effect of repurchases on cash, debt, and per-share results.
- Actual .com and .net registration and renewal trends, the effect of the .net price increase, and the timing and economics of new-gTLD activity.
- Developments in the shareholder litigation and any material cyber, service-continuity, contractual, or indemnification contingencies.