VeriSign, Inc. — Q1 2014 Form 10-Q
Business context and period. Unaudited results cover the three months ended March 31, 2014, compared with Q1 2013. VeriSign operates domain-name registry services, principally .com and .net, as well as Network Intelligence and Availability services. Registry Services generated substantially all revenue; NIA revenue was not significant.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $248.8 million | $236.4 million | +5% |
| Operating income | $139.6 million | $133.3 million | +5% |
| Operating margin | 56% | 56% | Broadly unchanged |
| Net income | $94.4 million | $84.5 million | +12% |
| Diluted EPS | $0.64 | $0.52 | +23% |
| Operating cash flow | $141.6 million | $150.6 million | -6% |
Revenue less cost of revenues implies gross margin of approximately 80.7%, versus 80.0% a year earlier. Cash and cash equivalents were $267.1 million and marketable securities were $1.45 billion at quarter-end, totaling $1.72 billion. The securities were U.S. Treasury debt, all maturing in less than one year. Cash declined $72.2 million during the quarter.
Capital expenditures were $11.3 million. Financing cash outflow was $136.9 million, including $145.6 million of common-stock repurchases in the cash-flow statement. VeriSign reported $750 million principal amount of 4.625% senior notes due 2023 and $1.25 billion principal amount of 3.25% subordinated convertible debentures due 2037. No borrowings were outstanding on its $200 million revolving credit facility. The balance sheet reports $621.1 million of convertible debentures, including the contingent interest derivative, in current liabilities; the filing says the debentures were convertible through June 30, 2014.
Material changes and drivers
- .com and .net active domain names reached 128.5 million, up 4% year over year; the company added 1.28 million net names in Q1. Revenue growth primarily reflected domain-base growth and .net fee increases in July 2013 and February 2014.
- New .com and .net registrations were 8.6 million, compared with 8.8 million in Q1 2013. The final Q4 2013 renewal rate was 72.2%, versus 72.9% for Q4 2012.
- Interest expense rose to $21.4 million from $12.6 million, mainly because of interest on the senior notes issued in April 2013. A $5.3 million non-operating gain from revaluation of the convertible-debenture derivative also benefited Q1 2014, versus a $6.4 million loss in Q1 2013.
- Sales and marketing expense rose 12%, mainly from marketing initiatives; general and administrative expense rose 14%, primarily due to higher stock-based compensation. Operating cash flow fell mainly because of higher income-tax payments and annual bonus payments, partly offset by higher customer receipts.
- Weighted-average basic shares declined to 133.4 million from 152.5 million; the company repurchased 2.4 million shares for $131.7 million at an average $54.39 per share. The board authorized a total $1.0 billion buyback program, with $868.3 million remaining at March 31.
Outlook, commentary and risks
- Management expected active domain names to continue growing and revenue to increase in fiscal 2014 versus 2013, supported by domain-base growth and .net price increases. It also noted that economic conditions and registrar marketing changes may limit domain growth. No numerical full-year revenue or EPS guidance was provided.
- Management expected quarterly interest expense to remain consistent with Q1 levels for the rest of 2014. Cost of revenues and R&D as percentages of revenue were expected to remain broadly consistent; sales and marketing as a percentage of revenue was expected to rise during the remaining quarters, while full-year levels were expected to be comparable to 2013.
- Management expected to repatriate approximately $700–$800 million of foreign-subsidiary cash during Q2 2014, using tax benefits from a previously recorded worthless-stock deduction to offset U.S. tax on the repatriation. Approximately $1.5 billion of cash and marketable securities was held by foreign subsidiaries; remaining untaxed foreign funds were intended to be indefinitely reinvested abroad.
- Management stated existing liquidity, operating cash flow and available credit should meet working-capital, capital-expenditure and debt-service needs for at least 12 months. It cautioned that substantial convertible-debenture conversions could require additional financing if cash and operating funds were insufficient.
- Key business risks include weaker domain registrations or renewals, registrar marketing changes, competition from new gTLDs and ccTLDs, restrictions under ICANN and .com agreements, cyberattacks or service interruptions, and uncertainty around the NTIA’s announced transition of IANA oversight. The filing says the impact of the transition on VeriSign’s Root Zone Maintainer role is uncertain.
- The IRS could challenge the 2013 worthless-stock deduction and related tax benefit. The company reported ordinary-course litigation and said it did not believe the matters would materially adversely affect it, while noting outcomes and potential losses could not generally be estimated. A Symantec indemnity for certain former Authentication Services claims is capped at $50 million and applies after aggregate indemnifiable claims exceed $4 million.
Important facts for investors to verify
- Whether .com and .net registration growth and renewal rates meet management’s expectations, particularly amid registrar marketing changes and new-gTLD competition.
- Completion and tax treatment of the planned $700–$800 million repatriation, and the availability of remaining foreign-held liquidity without additional U.S. tax.
- Convertible-debenture conversion activity, potential cash-settlement requirements, and any resulting financing needs or dilution.
- Progress on the NTIA/IANA transition and any effect on VeriSign’s Root Zone Maintainer role or regulatory and contractual position.
- Any material developments in the IRS review of the worthless-stock deduction, litigation, or the Symantec indemnity exposure.