VeriSign, Inc. — Q3 2014 Form 10-Q
Business context and reporting period: Unaudited results for the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. VeriSign operates domain-name registry services, principally .com and .net, and Network Intelligence and Availability services. Registry Services generate substantially all revenue. The company reported approximately 130.0 million active .com and .net names, up 3% year over year.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $255.0 million | $243.7 million | $754.2 million | $719.5 million |
| Operating income | $139.5 million | $132.7 million | $422.2 million | $398.1 million |
| Net income | $95.2 million | $80.9 million | $289.8 million | $252.3 million |
| Diluted EPS | $0.69 | $0.53 | $2.03 | $1.60 |
| Operating margin | 54.7% | 54.5% | 56.0% | 55.3% |
| Net margin | 37.3% | 33.2% | 38.4% | 35.1% |
Revenue increased 5% in both comparison periods. Growth reflected a larger .com/.net domain base and .net fee increases implemented in July 2013 and February 2014. Q3 added 1.1 million net names; 8.7 million new .com/.net registrations were processed, versus 8.3 million a year earlier. The final .com/.net renewal rate for Q2 2014 was 71.8%, compared with 72.7% in Q2 2013.
For the first nine months, operating cash flow was $430.5 million, approximately flat with $432.0 million in 2013. Investing activities provided $114.0 million, versus $317.1 million used in 2013, chiefly reflecting marketable-security maturities and purchases. Financing activities used $649.2 million, including $673.5 million of share repurchases in the cash-flow statement. Cash and cash equivalents fell $105.3 million to $233.9 million.
At September 30, cash and cash equivalents were $233.9 million and marketable securities were $1.241 billion, for combined liquidity of $1.475 billion. Marketable securities were U.S. Treasury securities maturing in less than one year. The company also had $8.1 million of restricted cash. Debt included $750 million of 4.625% senior notes due 2023 and $1.25 billion principal amount of 3.25% subordinated convertible debentures due 2037. The $200 million revolving credit facility had no borrowings outstanding. The balance sheet reports a stockholders’ deficit of $748.8 million.
Material changes and notable items
- Interest expense for the first nine months rose to $64.4 million from $53.5 million, primarily reflecting a full-period effect of the senior notes issued in April 2013.
- The effective tax rate declined to 15% for Q3 from 24%, and to 20% for the nine-month period from 26%. 2014 rates benefited from discrete tax benefits related to the repatriation of foreign funds, including $11.4 million recognized in Q3 and $5.2 million in Q2.
- The company completed a repatriation of approximately $740.9 million of foreign cash, net of $28.1 million of withholding taxes. At quarter-end, $875.8 million of cash, cash equivalents and marketable securities remained held by foreign subsidiaries; the company intends to reinvest these funds abroad indefinitely.
- On July 23, the board authorized a total of up to $1.0 billion for share repurchases. During the quarter, 4.2 million shares were repurchased for $226.3 million; $832.7 million remained available at quarter-end. Through October 22, an additional 1.2 million shares were repurchased for $65.3 million.
- The share price trigger made the convertible debentures convertible at holders’ option through December 31, 2014. Management did not expect material near-term conversions, but noted that cash settlement could require additional financing if conversion demands exceeded available cash and operating funds.
Outlook, commentary and risks
Management expected revenue to increase in fiscal 2014 versus 2013, supported by continued .com/.net name growth and the 2013 and 2014 .net fee increases. It expected further active-domain growth during the remainder of 2014, while noting that economic uncertainty, registrar marketing changes and search-engine changes could constrain growth. The annual .net registration fee was scheduled to rise from $6.18 to $6.79 on February 1, 2015. Management expected cost of revenue, sales and marketing, research and development, general and administrative expenses, and interest expense as percentages of revenue to remain broadly consistent with the reported nine-month levels for the rest of 2014. It believed cash, securities, operating cash generation and available borrowing capacity would be sufficient for working capital, capital expenditures and debt service for at least 12 months.
Key risks include dependence on .com/.net registrations and renewals; pricing and renewal terms under ICANN and government agreements; competition from new gTLDs and alternative ways of navigating the Internet; registrar marketing and renewal trends; cyberattacks, service interruptions and DNS stability; tax audits and uncertainty around tax positions; and debt, conversion and repatriation-related liquidity risks. The company highlighted uncertainty around the effect of ICANN’s new gTLD program and the transition of NTIA oversight of the IANA function. Management said pending litigation and investigations were not expected to have a material adverse effect, but outcomes and potential losses could not generally be estimated. An indemnity to Symantec related to the divested Authentication Services business is subject to a $50 million cap and specified claim thresholds.
Investor verification points
- Track .com/.net registrations, renewal rates, registrar promotions and the realized effect of the February 2015 .net price increase.
- Assess the sustainability of earnings growth alongside lower effective tax rates and the discrete repatriation-related tax benefits.
- Reconcile liquidity available in the U.S. with the $875.8 million held by foreign subsidiaries and potential taxes on further repatriation.
- Monitor share repurchases, remaining authorization, and the dilution or cash needs that could result from convertible-debenture conversions.
- Review new-gTLD competition, ICANN/DOC agreement developments, cybersecurity and DNS operational risks, and any material developments in tax or legal contingencies.