VeriSign, Inc. — Q2 2012 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2012, compared with the corresponding 2011 periods. VeriSign operates one reportable segment, Naming Services, principally the .com and .net domain registries; it reported approximately 118.5 million active .com and .net domain names, up 8% year over year. NIA services were not significant to consolidated revenue.
Key financial results
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $214.1 | $189.8 | $419.9 | $371.4 |
| Operating income | $107.0 | $82.1 | $205.9 | $147.6 |
| Operating margin | 50% | 43% | 49% | 40% |
| Net income (loss) | $68.5 | $(10.6) | $136.5 | $30.2 |
| Diluted EPS | $0.42 | $(0.06) | $0.83 | $0.18 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $245.2 | $103.2 |
- Q2 revenue increased 13% year over year, primarily from 8% growth in .com and .net names and registry fee increases. The .com fee rose from $7.34 to $7.85 and the .net fee from $4.65 to $5.11, effective January 15, 2012.
- Q2 cost of revenue was $42.8 million, or 20% of revenue, versus $40.7 million, or 21%. Operating income rose 30%; lower general and administrative and restructuring costs contributed alongside revenue growth.
- Six-month operating cash flow increased 138%. The company attributed the improvement primarily to revenue growth and the absence of the $100.0 million contingent-interest payment made to convertible debenture holders in 2011; higher income tax payments partly offset the increase.
- Cash and cash equivalents were $315.6 million at June 30, 2012, versus $1.313 billion at December 31, 2011. Marketable securities rose to $1.122 billion from $32.9 million. Cash plus marketable securities totaled $1.438 billion, compared with $1.346 billion at year-end.
- Six-month investing cash outflow was $1.116 billion, mainly reflecting $1.098 billion of marketable-security purchases; financing cash outflow was $125.6 million, including $152.7 million of share repurchases. The company repurchased 3.7 million shares for $144.5 million under its buyback program, with $686.9 million remaining authorized.
- At June 30, total liabilities were $2.001 billion and stockholders’ deficit was $59.2 million. Debt included $597.9 million of convertible debentures, including the contingent-interest derivative, and $100.0 million of long-term debt. The filing reports the convertible debentures’ fair value as $1.8 billion. Deferred revenue totaled $803.7 million, including current and long-term balances.
Material changes and unusual items
- Compared with Q2 2011, net results swung from a $10.6 million loss to $68.5 million income. The prior-year quarter included $100.0 million of contingent interest related to the May 2011 special dividend; this was not a recurring operating cost in 2012. Prior-year results also included losses from discontinued operations.
- Q2 2012 included a $3.1 million non-operating loss from remeasurement of the contingent-interest derivative, primarily reflecting an increase in VeriSign’s stock price. The six-month derivative loss was $4.0 million.
- The six-month 2012 effective tax rate was 25%, versus 3% in 2011; 2011 included a discrete tax benefit related to contingent interest. The 2012 rate reflected, among other factors, lower-taxed foreign income and valuation-allowance releases.
- Cash and cash equivalents declined as funds were shifted into marketable securities, primarily short-term U.S. Treasury bills. The company said $1.2 billion of cash and cash equivalents and marketable securities was held by foreign subsidiaries and was intended to remain permanently reinvested abroad; repatriation could require additional U.S. tax.
Outlook, commentary, and risks
- Management expected fiscal 2012 revenue to increase versus 2011, citing continued .com and .net registration growth and the January 2012 price increases as names renew at higher prices. It also expected domain-name growth to continue in 2012, particularly in targeted international markets.
- Management expected cost of revenue, sales and marketing, and general and administrative expense as a percentage of revenue to decrease during the remainder of 2012. It expected research and development expense as a percentage of revenue to increase as it invested in product development. The filing provides no numerical earnings or revenue guidance.
- ICANN approved renewal of the .com registry agreement for December 1, 2012 through November 30, 2018; the U.S. Department of Commerce was still reviewing the renewal under the Cooperative Agreement. Substantially all revenue depends on Registry Services, making the agreement and continued .com/.net registration and renewal trends significant risks.
- Management noted that changes to Google search and pay-per-click policies may reduce the profitability of some websites and affect registrations or renewals; it believed some affected first-time renewals did not renew in Q2. New gTLDs expected to begin offering registration opportunities in 2013 could add competition and operational demands. VeriSign applied for 14 gTLDs and had been selected to provide back-end services for approximately 220 applications, but success and financial impact were uncertain.
- Risks highlighted include registration and renewal trends, competition and new gTLDs, cybersecurity attacks and service interruptions, economic and regulatory developments, reliance on ICANN and government agreements, and obligations related to divested businesses. The company said existing liquidity and operating cash generation should be sufficient for working capital, capital spending, and debt service for the next 12 months.
- Contingencies include a derivative lawsuit filed in March 2012 concerning incentive compensation plans; defendants moved to dismiss and intended to defend the case. VeriSign also has indemnification obligations related to its divested Authentication Services business, including a cap reduced to $50 million in February 2012. Management did not believe current matters would materially adversely affect financial condition or results, while noting litigation outcomes are uncertain.
Most important facts for investors to verify
- Whether the Department of Commerce approved the .com registry agreement renewal, and whether the renewal terms preserve the expected business model.
- Subsequent .com and .net registration, renewal, and pricing trends, including any continuing effects from search-advertising policy changes.
- Execution and costs of the new gTLD applications and back-end registry commitments, and any measurable effect on the core registries.
- Cash deployment, repurchases, foreign cash repatriation tax exposure, and the company’s ability to meet convertible-debt obligations.
- Developments in the derivative lawsuit and divestiture-related indemnification or retained liabilities.