VeriSign, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. VeriSign operates critical internet infrastructure, primarily the .com and .net domain registries; Security Services revenue was not significant to consolidated revenue.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $305.8 million | $292.4 million | $907.5 million | $869.6 million |
| Operating income | $195.0 million | $181.1 million | $573.4 million | $531.3 million |
| Operating margin | 63.8% | 61.9% | 63.2% | 61.1% |
| Net income | $137.7 million | $114.9 million | $400.3 million | $354.4 million |
| Net margin | 45.0% | 39.3% | 44.1% | 40.8% |
| Diluted EPS | $1.13 | $0.93 | $3.25 | $2.85 |
Revenue rose 5% in Q3 and 4% for the nine-month period. Operating income increased 8% in both periods. Q3 basic EPS was $1.13 versus $1.15; the filing attributes the changed share count in part to issuance of 26.1 million shares upon conversion of the debentures.
- Cash flow: Nine-month operating cash flow was $479.3 million, down from $503.6 million. Investing provided $984.4 million, largely reflecting net maturities and sales of marketable securities; financing used $1.697 billion, primarily for the $1.25 billion convertible-debenture principal settlement and share repurchases.
- Liquidity: At September 30, cash and cash equivalents were $231.6 million and marketable securities were $947.4 million. Securities were primarily U.S. Treasury debt and matured in less than one year. A $200 million revolving credit facility had no borrowings outstanding.
- Debt: Carrying value of senior notes was $1.784 billion; principal outstanding was $750 million due 2023, $500 million due 2025, and $550 million due 2027. The $1.25 billion subordinated convertible debentures were settled May 1, 2018, with principal paid in cash and 26.1 million shares issued for the conversion value above principal.
- Capital returns: VeriSign repurchased 3.2 million shares for $424.9 million under its program during the first nine months; $638.3 million remained authorized at quarter-end. Cash flow reporting shows $459.8 million of total common-stock repurchases, including amounts placed in treasury for tax withholding.
Material changes and operating trends
- The .com/.net domain name base was 151.7 million, up 4% year over year; 9.5 million new registrations were processed in Q3 versus 8.9 million a year earlier. The final .com/.net renewal rate for Q2 2018 was 75.0%, compared with 74.0% for Q2 2017.
- Growth reflected a 5% increase in the .com base and higher .net fees effective February 2017 and February 2018, partly offset by a 6% decline in the .net base. U.S. revenue increased 8% in Q3; other geographic revenue was broadly flat.
- Q3 sales and marketing expense declined 26%, primarily because of lower marketing campaigns. Nine-month cost of revenue declined 1%; R&D rose 8% and G&A rose 3%.
- Interest expense fell to $22.6 million in Q3 from $37.8 million, following settlement of the convertible debentures. Nine-month results included a $6.6 million extinguishment loss; prior-year results included a $10.4 million gain on the iDefense sale.
Outlook, commentary and risks
- Management expected revenue growth to remain consistent with the nine-month pace for the remainder of 2018, driven by aggregate .com growth and current and prior .net price increases. It expected cost of revenue, sales and marketing, R&D, and G&A as percentages of revenue to remain consistent; quarterly interest expense was expected to decrease following the debenture settlement.
- Management stated existing liquidity, operating cash generation, and available borrowing capacity should cover working capital, capital expenditures, and debt service for at least the next 12 months.
- On October 24, 2018, VeriSign agreed to sell customer contracts for its Security Services business to Neustar. Consideration is $50 million at closing plus a contingent payment, with total consideration capped at $120 million; closing was subject to regulatory approval. VeriSign agreed not to compete in the divested business for 36 months and planned to retain its technology, network assets, and public DNS service.
- The .com Cooperative Agreement with the U.S. Department of Commerce was scheduled to expire November 30, 2018 unless extended at the DOC’s discretion. The filing also describes required negotiations and public-interest review concerning .com agreement terms; changes could adversely affect the business.
- Other key risks include dependence on .com/.net registry agreements, competitive and behavioral shifts affecting registrations and renewals, cybersecurity and service disruption, evolving privacy and regulatory requirements, international exposure, and substantial indebtedness. Management reported no litigation expected to materially affect financial condition, results, or cash flows, while noting litigation may still be costly. Disclosure controls were assessed as effective.
- The nine-month effective tax rate was 19%, including $12.6 million of benefits from adjustments to provisional Tax Act amounts and $7.2 million of excess stock-compensation tax benefits and lower-taxed foreign income. State tax effects remained provisional and were expected to be finalized in Q4 2018.
Important facts for investors to verify
- Outcome and terms of the DOC review and any extension or amendment of the .com Cooperative Agreement.
- Neustar transaction approval, closing, customer transition, and final contingent consideration.
- Future .com/.net registration-base growth and renewal rates, particularly the continuing decline in the .net base.
- Cash generation and capital allocation after the large debenture settlement and ongoing share repurchases.
- Final tax effects of the Tax Act and exposure to cyber, operational, regulatory, and debt-related risks.