VeriSign, Inc. — Q3 2011 Form 10-Q
Business context and period. The filing covers the quarter and nine months ended September 30, 2011. VeriSign operates Internet infrastructure services in one reportable segment, Naming Services, primarily the .com and .net domain registries. It reported approximately 111.9 million active .com and .net domains, up 8% year over year. NIA services were not significant to revenue.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $197.0 million | $172.3 million | $568.3 million | $501.7 million |
| Operating income | $88.9 million | $59.9 million | $236.5 million | $164.8 million |
| Operating margin | 45.2% | 34.8% | 41.6% | 32.8% |
| Income from continuing operations, net of tax | $58.6 million | $45.1 million | $93.2 million | $101.7 million |
| Net income attributable to VeriSign stockholders | $58.9 million | $784.9 million | $89.1 million | $871.5 million |
| Diluted EPS | $0.36 | $4.48 | $0.53 | $4.82 |
Margins and drivers. Gross margin was approximately 78.8% for Q3 and 78.3% for the nine-month period, versus 76.9% and 76.4% a year earlier. Revenue rose 14% for Q3 and 13% year to date, primarily reflecting 8% growth in .com and .net registrations and the July 2010 registry fee increases. Operating income increased 49% and 44%, respectively, helped by revenue growth and lower general and administrative expense. Prior-year net income included substantial gains from the sale of the Authentication Services business; consequently, reported net income and EPS are not directly comparable. Continuing-operations income gives a more useful comparison.
Cash flow and liquidity. Nine-month operating cash flow was $211.7 million, up from $168.5 million. Investing activities provided $403.2 million, including proceeds from securities sales and maturities; financing activities used $970.1 million, mainly for the $463.5 million special dividend and $548.8 million of share repurchases. Cash and cash equivalents were $1.203 billion at September 30, down from $1.560 billion at year-end; marketable securities were $32.1 million, down from $501.2 million. Total cash, cash equivalents and marketable securities were $1.235 billion. Current liabilities were $639.2 million.
Debt and equity. Convertible debentures, including the contingent-interest derivative, had a carrying value of $586.6 million; disclosed fair value was $1.3 billion. The nine-month interest expense included $100.0 million of contingent interest triggered by the May special dividend. Stockholders’ equity was a deficit of $166.7 million, compared with positive equity of $676.4 million at December 31, 2010. The company repurchased 16.3 million shares for $534.6 million during the first nine months and paid a $2.75-per-share special dividend totaling $463.5 million.
Changes, outlook and material items
- Pricing and growth outlook: Management expected fiscal 2011 revenue to increase versus 2010, supported by continued .com and .net registration growth and the full-year effect of the July 2010 fee increase. A further 7% .com and 10% .net fee increase was announced for January 15, 2012. Management expected continued domain growth, including internationally.
- Expense outlook: Management expected cost of revenues, sales and marketing, and research and development as percentages of revenue to remain broadly consistent for the rest of 2011; it expected general and administrative expense as a percentage of revenue to decline. The 2010 restructuring plan was expected to conclude in Q4 2011, with about $6.2 million of additional charges, primarily excess-facility costs.
- Capital commitments and funding: VeriSign agreed to buy its Reston, Virginia headquarters for $118.0 million. It paid an $11.8 million deposit and expected to close November 15, 2011, paying the remaining $106.2 million. The company was considering repatriating previously taxed foreign cash and debt financing; it gave no assurance that financing or repatriation would be available on favorable terms. It stated that available liquidity and operating cash generation should cover working capital, capital expenditures and debt service for the next 12 months.
- Foreign cash: $1.1 billion of cash, cash equivalents and marketable securities was held by foreign subsidiaries. The company intended to permanently reinvest funds not previously taxed in the U.S.; repatriating them could result in additional U.S. taxes.
- Tax and discontinued operations: The nine-month continuing-operations effective tax rate was 20%, including a $39.7 million discrete tax benefit related to contingent debenture interest. Unrecognized tax benefits were $50.3 million and were expected to increase over the next 12 months. Nine-month discontinued-operations loss primarily reflected retained litigation and a $2.9 million tax charge related to the Authentication Services divestiture.
- Leadership and security: Following the CEO and CFO resignations, Executive Chairman D. James Bidzos became President and CEO, and the controller became Interim CFO. VeriSign disclosed that its corporate network had been breached in 2010 and information exfiltrated; management learned of the incidents in September 2011. The company said it did not believe DNS-supporting servers were breached and reported changes to escalation procedures.
- Contracts and risks: VeriSign renewed its .net registry agreement for six years from July 1, 2011. The .com registry agreement was due to expire in 2012, and the filing identified renewal and possible competition from new top-level domains as significant uncertainties. Risks also included cyberattacks and service interruptions, registrar marketing or renewal changes, economic weakness, regulatory actions, foreign-cash repatriation, and its substantial reliance on registry services.
- Contingencies: The Herbert consumer class action settlement received preliminary court approval; final approval was scheduled for December 19, 2011. VeriSign expected to pay 60% of settlement costs, which it said were accrued and not material, but noted the settlement remained subject to contingencies. Its indemnification agreement with Symantec for certain divested-business claims had a $125 million cap and a $4 million aggregate threshold.
Most important facts for investors to verify
- Whether .com agreement renewal and the announced January 2012 fee increases proceed as expected, and how registration and renewal growth develops.
- How cash generation, share repurchases, dividends and the headquarters purchase affect domestic liquidity, especially given the large foreign-held cash balance and funding plans.
- The debentures’ cash-payment and conversion obligations, including the relationship between their $586.6 million carrying value and $1.3 billion disclosed fair value.
- Whether the disclosed 2010 security breach prompts further remediation, costs, or disclosure, and whether critical registry systems remain secure and available.
- Developments in tax exposures, retained divestiture liabilities, the Herbert settlement, and expected completion costs for restructuring.
- Progress in appointing a permanent CFO and the effects of leadership transition on operations and controls.