VeriSign, Inc. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Unaudited results; comparisons are against the corresponding 2009 periods. The August 9 sale of Authentication Services to Symantec means continuing operations principally reflect Naming Services, with historical Authentication Services results presented as discontinued operations. Unless noted, dollar amounts are in millions.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue from continuing operations | $172.6 | $156.8 | $503.8 | $460.8 |
| Operating income | $59.4 | $34.1 | $163.7 | $110.3 |
| Operating margin | 34% | 22% | 32% | 24% |
| Continuing-operations net income | $44.8 | $20.9 | $100.8 | $58.8 |
| Net income attributable to VeriSign stockholders | $784.9 | $53.6 | $871.5 | $153.5 |
| Diluted EPS | $4.48 | $0.28 | $4.82 | $0.79 |
- Revenue grew 10% in Q3 and 9% for the nine-month period. Naming Services revenue rose 11% and 10%, respectively; Other Services revenue declined and was immaterial.
- Cost of revenue was $40.3 million in Q3 and $120.6 million year to date, down 4% and 8%, respectively. Approximate gross margin, calculated from reported revenue less cost of revenue, was 76.7% in Q3 versus 73.1%, and 76.1% year to date versus 71.7%.
- Q3 and nine-month net income included discontinued-operations income attributable to stockholders of $740.1 million and $770.7 million. The sale generated a reported after-tax gain of $736.5 million; therefore, total net income and EPS substantially reflect a one-time divestiture rather than recurring continuing operations.
- Operating cash flow was $168.5 million for nine months, down from $222.0 million. Investing cash flow was $616.8 million, including divestiture proceeds; financing used $211.3 million, primarily reflecting share repurchases. Cash and equivalents increased to $2,060.2 million from $1,477.2 million at year-end 2009; marketable securities were $488.9 million.
- At September 30, total liabilities were $1,678.6 million. Convertible debentures were carried at $578.3 million, while their quoted fair value was $1.3 billion. The company had no borrowings under its $500 million credit facility and subsequently notified the agent it would terminate the facility effective November 3, 2010.
Material changes and management commentary
- The Authentication Services sale reshaped the business; Naming Services now provides substantially all continuing revenue. Active .com and .net domain names reached 103.5 million, up 9% year over year.
- Management attributed Naming Services growth to higher registration volumes and registry fee increases. .com fees rose 7% and .net fees 10% effective July 1, 2010. The filing says the company expected Naming Services revenue to increase for full-year 2010 versus 2009, and expected cost of revenue as a percentage of revenue to remain consistent through the rest of 2010 and in 2011.
- Management expected sales and marketing and research and development as a percentage of revenue to remain consistent through the rest of 2010. It expected general and administrative expense as a percentage of revenue to remain consistent for the remainder of 2010, then decrease in 2011 as transition services wind down.
- A $1.5 billion share repurchase authorization was approved in July. VeriSign repurchased 15.3 million shares for $423.5 million during the first nine months; $1.38 billion remained authorized at September 30.
- The 2010 restructuring plan includes the move of corporate functions from Mountain View, California, to Dulles, Virginia. Estimated pre-tax cash severance and related termination costs are $22.3 million; expected excess-facility exit costs are $14.2–$16.9 million. The company expected remaining cash and stock-based charges over several quarters through the end of 2011.
Risks, contingencies, and unusual items
- The company faces antitrust litigation concerning the .com registry agreement. The Ninth Circuit allowed the claims to proceed at the pleading stage; the case was remanded, with trial scheduled for December 2011. VeriSign said the outcome and any loss could not be reasonably estimated.
- VeriSign agreed to certain indemnification obligations to Symantec for legal claims related to the sold business: obligations apply after aggregate claims exceed $4 million, cover 50% of qualifying claims thereafter, and are capped at $125 million. The company said a loss was neither probable nor reasonably estimable.
- Other risks include renewal and terms of .net and .com registry agreements, domain-registration trends, cyberattacks or service interruptions, customer and registrar concentration, transition-service obligations, employee attrition and relocation execution, and the reduced revenue diversity after the sale.
- The company signed a 15-year, five-month office lease in Reston, Virginia, with disclosed minimum lease payments of $105.6 million. A 28% customer revenue concentration was reported for both Q3 and the first nine months of 2010.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It cautioned that controls provide reasonable, not absolute, assurance.
Important facts for investors to verify
- Separate recurring Naming Services earnings and cash generation from the Authentication Services sale gain and discontinued-operations results.
- Track .com and .net registration growth, renewal trends, fee arrangements, and registry-agreement renewals, particularly .net in 2011 and .com in 2012.
- Review the CFIT antitrust case, other retained litigation, and the scope and potential cost of indemnification and transition-service obligations.
- Assess remaining restructuring, relocation, and lease costs against management’s expected timing and savings.
- Monitor cash deployment, share repurchases, and the convertible debentures’ cash-settlement requirements and market value.