VeriSign, Inc. — Q1 2018 Form 10-Q
Business context and period. The filing reports the three months ended March 31, 2018, compared with Q1 2017. VeriSign operates domain-name registry services, primarily for .com and .net; Security Services revenue was not significant. The company reported 148.3 million .com and .net registrations at quarter-end, up 3% year over year.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $299.3 million | $288.6 million | +4% |
| Operating income | $185.4 million | $175.3 million | +6% |
| Operating margin | 62.0% | 60.7% | +1.3 percentage points |
| Net income | $134.3 million | $116.4 million | +15% |
| Diluted EPS | $1.09 | $0.94 | +16% |
| Operating cash flow | $90.0 million | $148.2 million | Down $58.2 million |
Net margin was 44.9%, versus 40.3% a year earlier. Interest expense rose to $40.8 million from $29.0 million, while non-operating income increased to $7.8 million from $1.3 million. The effective tax rate fell to 12% from 21%; Q1 2018 included $12.1 million of tax benefits from revisions to provisional Tax Act estimates and about $5.5 million of excess stock-compensation tax benefits.
At March 31, cash and cash equivalents were $1.704 billion and marketable securities were $652.7 million. Total cash, cash equivalents and marketable securities were $2.356 billion, compared with $2.415 billion at year-end. Total liabilities were $4.140 billion and stockholders’ deficit was $1.235 billion. Senior notes had $1.8 billion of principal outstanding; subordinated convertible debentures had $1.25 billion of principal outstanding. No borrowings were outstanding on the $200 million revolving credit facility.
Material changes and notable items
- Revenue growth reflected a 4% increase in the .com domain base and .net fee increases in February 2017 and February 2018, partly offset by a 5% decline in the .net domain base. The .net annual fee rose from $8.20 to $9.02 in February 2018; the .com fee remained $7.85.
- Operating cash flow decreased mainly because of higher cash taxes, including foreign withholding taxes paid following repatriation, and higher cash interest payments. Q1 cash paid for income taxes was $73.0 million versus $17.9 million; cash paid for interest was $43.3 million versus $28.2 million.
- Investing cash flow was $1.293 billion, largely reflecting net maturities and sales of marketable securities. Financing cash outflow was $144.9 million, including $152.7 million of share repurchases. The company repurchased 1.1 million shares for $124.9 million and had $938.3 million of authorization remaining.
- The company repatriated $1.15 billion of foreign cash, net of $60.7 million in foreign withholding taxes. Cash and marketable securities held by foreign subsidiaries totaled $550.7 million at quarter-end.
- Adoption of the new revenue standard did not affect revenue recognition, but changed accounting for ICANN fees paid on .com registrations and renewals. VeriSign recorded related assets and a $22.5 million reduction to opening accumulated deficit.
Outlook, risks and contingencies
- Management expected revenue growth for the remainder of 2018 to remain consistent with Q1, supported by continued aggregate .com growth and the February 2018 .net fee increase. It expected cost of revenue as a percentage of revenue, R&D as a percentage of revenue, and G&A as a percentage of revenue to remain consistent with Q1; sales and marketing as a percentage of revenue was expected to increase.
- VeriSign called all outstanding subordinated convertible debentures for redemption on May 1, 2018. Holders could convert through April 30; the company expected to settle up to $1.25 billion principal in cash and any excess conversion value in shares. Management expected quarterly interest expense to decline after extinguishment and non-operating income to decline as invested balances fell. The filing states the conversion spread could require issuance of up to 25.8 million shares based on the March 31 if-converted value.
- Management said existing liquidity, operating cash generation and the revolving facility should be sufficient for working capital, capital expenditures and debt service for at least 12 months.
- The .com Cooperative Agreement with the U.S. Department of Commerce was due to expire November 30, 2018 unless extended at the Department’s discretion. VeriSign was also required to negotiate .com agreement amendments by October 2018; the filing cautions that resulting changes could adversely affect the business.
- Principal risks include dependence on .com and .net agreements and domain demand, competition from country-code and new generic TLDs, evolving internet usage, cybersecurity and service interruptions, changing privacy and other regulation, and tax uncertainty. The DOJ closed its investigation into the .web registry matter on January 9, 2018. Other ordinary-course claims and proceedings were not expected by the company to have a material adverse effect, though litigation outcomes remain uncertain.
- Accounting for certain Tax Act effects remained provisional; the company expected to complete that accounting in Q4 2018. The filing reported no significant change in market-risk exposures and stated disclosure controls were effective.
Investor verification points
- Track .com and .net registration-base growth, renewals, and the effects of the .net fee increase; the Q4 2017 renewal rate was 72.2%, versus 67.6% in Q4 2016.
- Verify the May 1, 2018 debenture redemption outcome, cash payment, any conversion shares issued, and subsequent interest expense.
- Review developments in the .com Cooperative Agreement and registry-contract negotiations, including any changes to pricing or operating terms.
- Assess the sustainability of reported earnings and tax rate, given Tax Act adjustments and stock-compensation tax benefits.
- Monitor operating cash flow, share repurchases, debt service, and liquidity following the debenture settlement.