VeriSign, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. VeriSign operates domain-name registry services, principally for .com and .net, and also provides internet security services. Security Services revenue was not significant relative to consolidated revenue.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change / context |
|---|---|---|---|
| Revenue | $281.9 million | $258.4 million | Up 9% |
| Operating income | $166.8 million | $144.2 million | Up 16%; operating margin 59% vs. 56% |
| Net income | $107.5 million | $88.2 million | Up 22%; net margin 38% vs. 33% |
| Diluted EPS | $0.82 | $0.66 | Basic EPS was $0.98 vs. $0.75 |
| Operating cash flow | $143.6 million | $132.7 million | Up 8% |
| Cash and marketable securities | $1.896 billion | $1.915 billion at Dec. 31, 2015 | Includes $1.662 billion of marketable securities, primarily U.S. Treasuries |
Cost of revenue increased 5% to $50.6 million; sales and marketing declined 11% to $20.0 million; R&D declined 2% to $16.7 million; and general and administrative expense increased 6% to $27.8 million. Interest expense rose to $28.8 million from $22.0 million, largely reflecting the 2025 senior notes issued in 2015. The effective tax rate was 24% in both periods.
At March 31, 2016, total assets were $2.324 billion and total liabilities were $3.432 billion; stockholders’ deficit was $1.108 billion. Principal debt outstanding was $1.25 billion of senior notes and $1.25 billion of 3.25% subordinated convertible debentures. No borrowings were outstanding under the $200 million revolving credit facility. Cash, cash equivalents and marketable securities held by foreign subsidiaries totaled $1.2 billion and were intended to remain indefinitely reinvested offshore.
Business developments and period comparisons
- The .com/.net domain base reached 142.5 million, up 7% year over year; 2.7 million net names were added in Q1. New registrations were 10.0 million, compared with 8.7 million.
- Revenue growth reflected the larger domain base and .net fee increases in February 2015 and February 2016. The annual .net fee increased to $7.46; .com remained $7.85 under the current agreement.
- Registrations from China had been unusually elevated in the second half of 2015 and Q1 2016, then returned to a more normalized pace by quarter-end. China revenue rose 75% year over year; management cautioned that the registration volumes were inconsistent and periodic.
- Operating cash flow increased, while financing cash flow shifted to a $158.3 million use, versus $330.3 million provided in Q1 2015. The prior-year period included senior-note proceeds. Q1 2016 common-stock repurchases were $172.4 million in cash-flow reporting, including $149.9 million under the repurchase program.
Outlook, risks and unusual items
- Management expected revenue to continue increasing during the remainder of 2016, supported by recent registrations and the 2015 and 2016 .net fee increases. It expected cost of revenue as a percentage of revenue to decrease slightly; full-year sales and marketing as a percentage of revenue to be comparable with 2015; and interest expense to remain consistent with Q1. No specific full-year revenue or earnings guidance was provided.
- The board authorized up to $1.0 billion of repurchases; $915.8 million remained available at March 31. The company repurchased an additional 0.5 million shares for $44.4 million through April 27.
- The convertible debentures were eligible for holder conversion through June 30, 2016 after the stock-price trigger was met. Management did not expect material near-term conversion, but stated that substantial conversions could require additional financing if cash and operating cash were insufficient. Contingent interest of $6.8 million was scheduled for August 2016; $6.5 million was paid in February.
- Key risks include dependence on .com/.net agreements and regulatory approvals, competition and changing internet-use patterns, cybersecurity incidents and service outages, evolving internet governance, and potential restrictions on registry operations in China. Management had applied for PRC licenses and warned that delays or failure to obtain them could restrict services to China-based registrars.
- The company reported ordinary-course investigations, claims and lawsuits that management did not expect to have a material adverse effect, while noting litigation outcomes and costs remain uncertain. Disclosure controls were concluded effective; no material change in internal control was reported. Management said existing liquidity, operations and credit capacity should cover needs for at least 12 months.
- Unusual/non-cash items included a $1.1 million unrealized gain on the contingent-interest derivative, compared with a $7.0 million loss in Q1 2015, contributing to the change in non-operating results. The filing also notes potential tax-deduction recapture on settlement of the convertible debentures.
Important facts for investors to verify
- Whether domain-base growth and renewal rates remain durable after the elevated China registration activity; the Q4 2015 renewal rate was 73.3%, and the final rate is not measurable until 45 days after quarter-end.
- Progress on PRC licensing and the implications of regulatory developments for registrations and renewals.
- Convertible-debenture conversion, contingent-interest payments, and potential cash or financing needs; verify the terms and amount of any settlement.
- Repurchase pace and funding, given the large authorization, substantial debt, and offshore concentration of cash.
- Renewal and pricing terms for the .com agreement, which expires November 30, 2018, and the company’s ability to sustain growth amid competitive and technological changes.