VeriSign, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. VeriSign provides domain-name registry services, principally for .com and .net; security services are not significant to consolidated revenue. Its .com/.net domain-name base was 143.2 million, up 7% year over year.
Financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $286.5m | $262.5m | $568.3m | $521.0m |
| Operating income | $176.3m | $149.0m | $343.0m | $293.2m |
| Net income | $113.2m | $93.0m | $220.7m | $181.2m |
| Diluted EPS | $0.87 | $0.70 | $1.68 | $1.36 |
| Operating margin | 61.5% | 56.7% | 60.3% | 56.3% |
| Net margin | 39.5% | 35.3% | 38.8% | 34.8% |
Q2 revenue rose 9%, operating income 18%, and net income 22% year over year. For the first half, revenue rose 9%, operating income 17%, and net income 22%. Higher .com/.net domain-name volumes and .net fee increases drove revenue growth. Final Q1 renewal rate was 74.4%, versus 73.4% a year earlier; Q2 registrations were 8.6 million, compared with 8.7 million.
For the first half, operating cash flow was $304.3m, versus $307.6m; investing cash flow was $(58.5)m, versus $(489.3)m; and financing cash flow was $(303.4)m, versus $176.7m. Cash and cash equivalents were $171.0m and marketable securities $1.736bn at June 30, 2016, totaling $1.907bn, compared with $1.915bn at year-end 2015. Treasury securities made up most of the marketable portfolio and had maturities under one year.
At June 30, total debt carrying value was approximately $1.869bn: $1.236bn in senior notes and $632.3m in subordinated convertible debentures, including the contingent-interest derivative. Principal outstanding was $750m of 4.625% senior notes due 2023, $500m of 5.25% senior notes due 2025, and $1.25bn of 3.25% subordinated convertible debentures due 2037. No borrowings were outstanding on the $200m revolving credit facility. The balance sheet reported a $1.127bn stockholders’ deficit.
Changes, outlook and notable items
- Operating margin improved as total costs and expenses fell to 38.5% of revenue in Q2 from 43.3% a year earlier. Sales and marketing and R&D expenses declined; G&A expense increased, including higher legal and employee costs.
- Management expected second-half 2016 revenue to remain consistent with the first half. It expected cost of revenue and R&D ratios to remain generally consistent, sales and marketing as a percentage of revenue to rise in the remainder of the year but be comparable to 2015 for the full year, and G&A and interest expense to remain generally consistent.
- VeriSign announced a .net annual registration fee increase from $7.46 to $8.20, effective February 1, 2017. The .com fee was $7.85 under the current agreement through November 30, 2018, subject to limited contractual exceptions.
- The company repurchased 3.5 million shares for $299.8m in the first half; $765.9m remained under its $1.0bn authorization at June 30. It repurchased an additional 0.5 million shares for $42.3m through July 27.
- Subordinated debentures were convertible at holders’ option through September 30, 2016 after the stock-price trigger was met. Management did not expect material near-term conversions but cautioned that conversion and settlement funding needs were uncertain. A $6.8m contingent-interest payment was scheduled for August 15, 2016.
- After quarter-end, the company incurred a commitment to pay approximately $130m for assignment of contractual rights, subject to third-party consent, with payment expected in Q3 2016.
- About $1.3bn of cash and marketable securities was held by foreign subsidiaries and intended to remain indefinitely reinvested offshore; U.S. repatriation could incur additional tax. Management said available liquidity, operating cash flow and borrowing capacity should cover expected needs for at least 12 months.
- Key risks include dependence on .com/.net registry agreements and regulatory approvals, domain-name demand and renewal trends, competition from ccTLDs and new gTLDs, cyberattacks and service disruptions, and substantial debt. One registrar accounted for approximately 30% of revenue. The filing reported no litigation expected by management to have a material adverse effect, while noting litigation uncertainty and potential costs.
Important facts for investors to verify
- Whether domain-base growth, registration volumes and renewal rates sustain the revenue trend, particularly after the reported China registration surge normalized.
- Progress and approvals for the .com agreement extension and Root Zone Maintainer Service Agreement, and the timing and impact of the announced .net price increase.
- Whether convertible-debenture holders convert by September 30, and the resulting cash, share dilution, contingent-interest and tax effects.
- Completion, consent requirements and cash impact of the approximately $130m contractual-rights assignment.
- Availability and potential U.S. tax cost of offshore liquidity, alongside ongoing debt service and share repurchases.