VeriSign, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. VeriSign provides domain-name registry services, principally for .com and .net, and internet security services. Its .com and .net domain-name base was 133.0 million at quarter-end.
Financial performance and liquidity
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $258.4 million | $248.8 million | +4% |
| Operating income | $144.2 million | $139.6 million | +3% |
| Operating margin | 55.8% | 56.1% | Down slightly |
| Net income | $88.2 million | $94.4 million | −7% |
| Diluted EPS | $0.66 | $0.64 | +3% |
| Operating cash flow | $132.7 million | $141.6 million | −6% |
Net income fell despite higher revenue and operating income, primarily reflecting a $7.0 million unrealized loss on the convertible-debenture contingent-interest derivative, versus a $5.3 million gain in Q1 2014. Net margin was approximately 34.1%, compared with 37.9%.
- Cash and marketable securities: $1.871 billion at March 31, 2015, including $705.9 million cash and cash equivalents and $1.165 billion marketable securities. Treasury securities held at quarter-end mature in less than one year.
- Debt: $750 million of 4.625% senior notes due 2023; $500 million of 5.25% senior notes due 2025, issued March 27; and $1.25 billion principal amount of 3.25% subordinated convertible debentures due 2037. No borrowings were outstanding under the $200 million revolving facility.
- Financing and buybacks: Financing cash flow was $330.3 million, including net proceeds from the 2025 notes, while share repurchases used $178.3 million. The company repurchased 2.7 million shares for $159.8 million and had $916.6 million remaining under its $1.0 billion authorization.
- Balance sheet: Total liabilities were $3.556 billion and stockholders’ deficit was $947.9 million at quarter-end.
Material changes and operating trends
- Revenue growth was driven mainly by a 3% increase in the .com/.net domain base and .net fee increases in February 2014 and February 2015. The .net annual fee rose from $6.18 to $6.79 in February 2015; .com remained $7.85 under the current agreement.
- The company added 1.5 million net names in Q1 and processed 8.7 million new registrations, versus 8.6 million a year earlier. The final Q4 2014 renewal rate was 72.5%, compared with 72.2% for Q4 2013.
- General and administrative expense rose 17%, primarily due to $2.0 million of certain non-income taxes and higher salary and benefits costs. Sales and marketing expense rose 10%, partly due to accelerated channel-marketing programs; R&D expense declined 7%.
- Cash from operations decreased, reflecting higher interest and tax payments and payments to employees and vendors, partly offset by increased customer receipts. Cash and cash equivalents increased by $514.3 million overall, including proceeds from the new notes.
Outlook, risks and contingencies
- Management expected the domain-name base to continue growing during the remainder of 2015, though at a limited rate, and expected fiscal 2015 revenue to increase. It expected cost of revenues as a percentage of revenue to decrease slightly; sales and marketing and R&D ratios to remain consistent; and G&A as a percentage of revenue to decrease slightly. Interest expense as a percentage of revenue was expected to rise due to the 2025 notes.
- Management stated that existing liquidity, operating cash generation and the revolving facility should be sufficient for working capital, capital expenditure and debt service needs for at least 12 months. However, $970.2 million of cash and marketable securities was held by foreign subsidiaries and intended to remain indefinitely invested abroad; repatriation could trigger additional U.S. taxes.
- The convertible debentures were convertible at holders’ option through June 30, 2015 after the share-price trigger was met. The company said it intended and believed it could settle principal in cash, but conversion activity beyond available cash and operating funds could require additional financing. A $5.2 million contingent-interest payment was made in February, and $5.5 million was payable in August 2015.
- Key business risks include dependence on .com/.net registry revenue, renewal and registration trends, new gTLD competition, ICANN and government agreements and pricing constraints, changes in internet use and search practices, and cyberattacks or service disruptions affecting critical DNS infrastructure. The filing also discusses leverage, debt covenants, foreign-cash access and tax uncertainty, including potential IRS review of the 2013 worthless-stock deduction.
- The company reported various legal matters and stated it did not believe they would materially adversely affect its financial condition, results or cash flows; outcomes and possible losses could not generally be estimated. A Symantec-related indemnification for certain claims is subject to a $4.0 million threshold and a $50.0 million cap.
- Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported. Management reported no significant change in market-risk exposure since year-end.
Important facts for investors to verify
- Whether domain-base growth, registration renewals and .net fee changes sustain the revenue outlook, particularly amid new gTLD competition and search-policy changes.
- The effect of the derivative’s valuation swings and contingent-interest payments on reported earnings and cash flow.
- Convertible-debenture conversion activity and the company’s ability to meet any cash-settlement needs without additional borrowing or dilution.
- How much foreign-held liquidity is practically available for U.S. needs after potential repatriation taxes, and compliance with debt covenants.
- Developments in ICANN, .com agreement renewal and pricing restrictions, DNS security and stability, litigation, and the IRS review risk tied to the prior tax deduction.