VeriSign, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. VeriSign operates domain-name registry services, principally for .com and .net; security services are not significant to consolidated revenue.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $287.6 million | $265.8 million | $855.9 million | $786.7 million |
| Operating income | $174.8 million | $154.5 million | $517.8 million | $447.7 million |
| Operating margin | 60.8% | 58.1% | 60.5% | 56.9% |
| Net income | $114.4 million | $92.5 million | $335.1 million | $273.7 million |
| Diluted EPS | $0.90 | $0.70 | $2.58 | $2.06 |
| Operating cash flow | Not separately stated | Not separately stated | $472.5 million | $462.9 million |
For the quarter, revenue rose 8%, operating income 13%, and net income 24% year over year. For the nine months, revenue rose 9%, operating income 16%, and net income 22%. Net margin was 39.8% for Q3 and 39.2% for the nine-month period, compared with 34.8% in both prior-year periods.
Revenue growth primarily reflected a 7% year-over-year increase in the .com/.net domain base and .net price increases. The base reached 144.1 million registrations, up from 135.2 million a year earlier. Q3 new registrations were 8.3 million versus 9.2 million; the final Q2 renewal rate was 73.8% versus 72.7% a year earlier. China revenue grew 62% in Q3, reflecting elevated registrations in the second half of 2015 and first quarter of 2016 that management said had since returned to a more normalized pace.
Cash, liquidity and debt
- At September 30, cash and cash equivalents were $177.8 million and marketable securities were $1.580 billion, totaling $1.758 billion, down from $1.915 billion at year-end 2015. Securities consisted primarily of U.S. Treasury debt and mature within one year.
- Nine-month investing cash use was $50.8 million, including $143.0 million paid toward future assignment of .web contractual rights, pending ICANN approval. Financing cash use was $472.7 million, including $501.9 million of common-stock repurchases. Cash declined by $50.9 million during the period.
- Debt principal outstanding included $1.25 billion of 3.25% subordinated convertible debentures due 2037, $750 million of 4.625% senior notes due 2023, and $500 million of 5.25% senior notes due 2025. No borrowings were outstanding on the $200 million revolving facility. The balance sheet reports $1.864 billion of these debt obligations, including the contingent-interest derivative for the convertible debentures.
- The debentures were convertible at holders’ option through December 31, 2016, after the stock-price trigger was met. Management did not expect material near-term conversions but noted that conversion could require financing if amounts exceeded available cash and operating cash flow. A $7.7 million contingent-interest payment was scheduled for February 2017.
- About $1.3 billion of cash, cash equivalents and marketable securities was held by foreign subsidiaries and intended to remain invested abroad; repatriation could result in additional U.S. taxes. Management said available liquidity, operating funds and the credit facility should cover working capital, capital spending and debt service for at least 12 months.
Material changes and notable items
- On October 20, 2016, the U.S. Department of Commerce approved an extension amendment to the .com Registry Agreement, extending VeriSign’s sole-operator role through November 30, 2024. Related terms require good-faith negotiations with ICANN and the Department of Commerce; the company cautioned that resulting terms could adversely affect its business.
- The .net annual registration fee increased from $6.79 to $7.46 on February 1, 2016; an increase to $8.20 was announced for February 1, 2017. The .com fee was $7.85 under the current agreement, subject to specified limited exceptions.
- The company repurchased 5.8 million shares for $476.8 million during the first nine months, with $588.9 million remaining authorized at quarter-end. It reported an additional 0.7 million shares repurchased for $52.3 million through October 26.
- The NTIA’s IANA transition took effect September 30, 2016. VeriSign began performing root-zone-maintainer functions under a new agreement with ICANN, a governance change management identified as a potential business risk.
- Interest expense for the nine months increased to $86.6 million from $79.1 million, primarily due to the 2025 notes issued in 2015. The effective tax rate was 24%, versus 24% a year earlier.
Outlook, risks and contingencies
Management expected full-year 2016 revenue growth to ease slightly in Q4 compared with the 9% growth recorded for the first nine months. It expected cost of revenue and research and development as a percentage of revenue to remain broadly consistent with the nine-month period, while sales and marketing and general and administrative expense ratios were expected to increase in Q4. Interest expense was expected to remain consistent with the first three quarters. These are management expectations, not quantified full-year guidance.
Key risks include dependence on .com/.net agreements and constrained .com pricing; renewal and registration growth, competition from ccTLDs and new gTLDs, and changes in internet-user behavior; regulatory developments, particularly in China; cyberattacks, DDoS events and service interruptions affecting critical internet infrastructure; consequences of internet-governance changes; debt and potential convertible-debenture settlement obligations; and the tax cost of repatriating offshore funds. The filing reports ordinary-course claims and litigation that management did not believe would materially affect results, while noting outcomes cannot be assured. No significant change in market-risk exposures was reported.
Important facts for investors to verify
- Progress and final terms of the extended .com agreement and related negotiations with ICANN and the Department of Commerce.
- Subsequent .com/.net registration growth, renewal rates, and whether China’s registration activity remains normalized.
- ICANN approval and completion of the .web rights assignment associated with the $145 million deposit.
- Convertible-debenture holder elections, settlement funding needs, and contingent-interest payments.
- Availability and tax implications of offshore liquidity, alongside continued buybacks and debt servicing.