VeriSign, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless otherwise noted.
Business context
VeriSign operates domain-name registry infrastructure, principally for .com and .net. Its continuing reportable businesses were Naming Services and Other Services; Network Intelligence and Availability revenue was not significant. At June 30, 2010, approximately 101.5 million .com and .net domain names were active, up 9% year over year.
On May 19, VeriSign agreed to sell its Authentication Services business, including VeriSign Japan and certain intellectual property and facilities, to Symantec for approximately $1.28 billion cash. The sale had not closed by the filing date. The business’s current and historical results were classified as discontinued operations.
Financial results and liquidity
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Continuing-operations revenue | $168.7 million | $154.3 million | $331.2 million | $304.0 million |
| Operating income | $50.6 million | $43.0 million | $104.2 million | $76.2 million |
| Operating margin | 30.0% | 27.9% | 31.5% | 25.1% |
| Continuing income, net of tax | $26.3 million | $16.9 million | $56.0 million | $37.9 million |
| Net income attributable to VeriSign stockholders | $35.2 million | $34.9 million | $86.6 million | $99.9 million |
| Diluted earnings per share | $0.19 | $0.18 | $0.47 | $0.52 |
Revenue and operating income growth in continuing operations primarily reflected 9% growth in .com and .net names and the effect of earlier registry fee increases. Continuing-operations revenue rose 9% in both periods. Cost of revenue fell 6% in Q2 and 9% in the first half; sales and marketing increased 28% and 31%, respectively. Reported net income attributable to shareholders fell 13% for the first half, largely as discontinued-operations income declined.
Discontinued operations generated revenue of $101.8 million in Q2 and $203.7 million in the first half, versus $172.1 million and $380.1 million in the respective 2009 periods. Income from discontinued operations attributable to VeriSign shareholders was $8.9 million in Q2 and $30.5 million in the first half, compared with $18.0 million and $61.9 million. First-half 2010 discontinued results included a $10.3 million one-time tax expense related to the anticipated sale.
First-half operating cash flow was $250.3 million, up from $121.3 million. Investing activities used $497.2 million, including substantial purchases of marketable securities; financing activities used $242.2 million, primarily reflecting $281.9 million of common-stock repurchases. Cash and cash equivalents declined $614.2 million to $862.9 million. At June 30, cash and marketable securities totaled $1.337 billion, excluding amounts classified within assets held for sale.
Total assets were $2.392 billion and total liabilities were $1.916 billion. Convertible debentures were carried at $575.9 million, including the contingent-interest derivative; the filing reports their fair value at $1.1 billion. The $500 million credit facility, maturing June 7, 2011, had no borrowings. Management said cash, investments and operating cash generation should cover working capital, capital expenditures and debt service for the next 12 months.
Material changes and capital allocation
- Continuing operations became more concentrated in Naming Services following the planned Authentication Services sale. Management reported that Naming Services and Authentication Services represented 61% and 39% of consolidated revenue, respectively, in the first half of 2010.
- VeriSign repurchased 10.2 million shares for $277.9 million in the first half. On July 27, the board increased the total share-repurchase authorization to $1.5 billion; the program has no expiration date.
- Assets held for sale were $681.7 million and related liabilities were $340.5 million at June 30.
- The expanded restructuring plan included relocation of corporate functions from Mountain View to Dulles, Virginia. Estimated pre-tax cash severance and termination costs totaled $20.6 million; expected excess-facility exit costs were $14.2–$16.9 million. Additional non-cash stock-compensation charges were expected but could not be estimated. Remaining charges were expected through the end of fiscal 2011.
Outlook, risks and contingencies
Management expected continued growth in active .com and .net names and higher fiscal 2010 Naming Services revenue, supported by registration growth and fee increases effective July 1, 2010: .com fees increased 7% to $7.34 and .net fees increased 10% to $4.65. Management expected cost of revenue, sales and marketing, research and development, and general and administrative expenses as a percentage of revenue to remain generally consistent with first-half levels for the remainder of 2010. The filing cautions that outlook depends on market conditions and is subject to change.
Key risks include dependence on .com and .net registrations and ICANN agreements, including renewal risk for .net in 2011 and .com in 2012; concentration in Naming Services after the sale; sale-closing, transition-service, employee-retention and relocation risks; cyberattacks or service interruptions; economic and competitive pressures; and debt, tax and investment-market risks. The sale agreement includes a 60-month indemnity for certain legal claims: VeriSign’s obligation begins after aggregate claims exceed $4 million, covers 50% thereafter, and is capped at $125 million.
The Ninth Circuit’s amended order in the CFIT antitrust case found the complaint plausibly alleged Sherman Act claims relating to the 2006 .com registry agreement, assuming its allegations were true at that pleading stage. The case was expected to return to district court; VeriSign said the outcome and any loss could not be reasonably estimated. Separate historical stock-option derivative and class matters were settled and dismissed for an amount described as not significant. The company also reported $33.9 million of gross unrecognized tax benefits; a California tax examination of its 2005 return was ongoing.
Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing also warns that the business sale and corporate-function relocation could raise control and reporting risks.
Important facts for investors to verify
- Whether and when the Symantec transaction closed, final proceeds, taxes, and any material post-closing adjustments or retained liabilities.
- Actual .com and .net registration growth, renewal rates, and revenue impact from the July 2010 fee increases and future ICANN agreements.
- Restructuring charges, transition-service costs, relocation execution, and any resulting employee or internal-control disruption.
- Cash and investment balances after the sale, share repurchases, and other capital uses; and the company’s ability to meet debenture and credit-facility obligations.
- Developments in the CFIT antitrust litigation, the sale-related indemnity exposure, and tax examinations or unrecognized tax benefits.