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VeriSign, Inc. (NASDAQ:VRSN)

Q1 2007 Earnings Call

May 02, 2007 5:00 pm ET

Executives

Ken Bond - Investor Relations

Stratton Sclavos - President, Chairman & CEO

Dana Evan - CFO

Analysts

Todd Raker - Deutsche Bank

Ed Maguire - Merrill Lynch

Rob Owens - Pacific Crest Securities

Sarah Friar - Goldman Sachs

Israel Hernandez - Lehman Brothers

Terry Rice - Wedbush Morgan Securities

Steve Ashley - Robert W. Baird

Shaul Eyal - CIBC World Markets

Scott Kessler - Standard & Poor's Equity

Presentation

Operator

Good day, everyone, and welcome to the VeriSign Incorporated First Quarter 2007 Earnings Conference Call. Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Mr. Ken Bond. Please go ahead, sir.

Ken Bond

Thank you, Cynthia and good afternoon, everyone and thank you for joining us for VeriSign's first quarter 2007 earnings conference call. I am here today with Stratton Sclavos, Chairman and CEO of VeriSign, and Dana Evan, our Chief Financial Officer.

The Q1 2007 press release is available on First Call Market Wire, as well as the VeriSign Investor Relations website at Investor.verisign.com. A replay of this call will be available beginning at 5 p.m. pacific time via telephone at 888-203-1112 or 719-457-0820 for interpret callers. The pass code for both phone numbers is 6843620.

For those of you joining us via webcast we invite to you view the slide presentation, which accompanies today's conference call and includes the summary of non-GAAP measures, used by VeriSign and a description of the items excluded in our non-GAAP financial information compared to gross GAAP.

All at approximately 3 p.m. pacific time we will post the same slides, as well as, some operational metrics to our website. Financial results in today's press release are unaudited, and the matters we will be discussing today include forward-looking statements, and as such are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC.

Specifically, the most recent report on Forms 10-K and 10-Q and any applicable amendments, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements.

Due to the previously announced restatement of prior period financial statements relating to the internal review of VeriSign's historical stock option grants, completed in January by our Board of Directors. VeriSign is not providing detailed GAAP or non-GAAP financials for the quarter ended March 31, 2007. Dana will provide additional detail later in this call.

In a moment Stratton will review our first quarter and he will provide some insights into the performance of our businesses. Dana will then follow with a discussion of preliminary non-GAAP financial results for Q1. Following Dana's remarks we will open the call for your questions. Unauthorized recording of this conference call is not permitted, and be anticipate this call will end at approximately 3 p.m.

With that I will like to turn the call over to Stratton.

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Stratton Sclavos

Thanks, Ken, and good afternoon, everyone. Let me add my welcome to all of you attending today's call. As our results for Q1 indicate, we saw overall performance for the company that was in line with our expectations to start the year. Revenue for the quarter came in at $379 million. Revenue growth, excluding the contribution of Jamba! was 4% quarter-over-quarter and 20% year-over-year.

Other highlights in the quarter included the continuing momentum in our two core franchising of DNS and SSL and the announcement of our project Titan initiative to expand and fortify our global infrastructure. The Titan initiative will allow us to reliably service the continued growth in Internet usage and protect against increasing threats and cyber attacks.

On the strategic front, we continue to make progress and see strong interest in our content delivery services, especially for video-on-demand solutions. We're also making good progress in the consumer authentication market, as adoption of our VeriSign identity protection services through eBay's PayPal units has been strong since the February launch.

As we discussed on last quarter's call, we believe 2007 marked a new phase for VeriSign. We have reorganized the company with maniacal focus on customer success, rapid innovation and expanded operating leverage. While we're only a quarter into our new structure, I can say that we're pleased with the earlier results and committed to our full year plans.

Like many successful companies, one of VeriSign's core assets on our people. Their commitment and passion continue to drive our execution against our strategic goals. Over the last ten years, however, we have invested a significant amount of development and capital into another core asset, our globally deployed digital infrastructure.

While initially used only for our DNS business, our digital infrastructure is quickly becoming the foundation for critical components of almost all of our customer facing services. The VeriSign infrastructure has unique scope, with state-of-the-art capabilities and intelligent routing, ultra high performance directories, massively distributed storage, IP and SS7 signaling and real time monitoring.

It has unmatched scale with more than 70 global points of presence, 64 gigabit per second of network bandwidth, 15,000 computing nodes and over 1,000 technology professionals, all supporting over 400,000 customers every day.

And lastly, we believe it gives us a global advantage, with five nines reliability, instant scalability, network and protocol independence, and a global view into escalating online activity and threats.

Today, in addition to our global Internet services for DNS and SSL, this infrastructure is also providing key components for our emerging services in messaging, security, and content delivery. These capabilities are helping us deliver new industry focused solutions for customers in telecommunications, media and entertainment, financial services, and large scale enterprises.

With the emergence of consumer driven web services and the surge in web-ready wireless devices, the Internet we know today is radically different from the one that we knew just five years ago. Project Titan will take us beyond Atlas, our current infrastructure architecture and into a new realm of performance and scale.

By 2010 we'll have more than 100 points of presence, with an aggregate 200 gigabits per second of network bandwidth, capable of handling over 4 trillion interactions per day. Titan gives us the headroom we need to enable and protect the world's network interactions as we head into the next decade of Internet growth.

It also gives us the platform to maintain our leadership in existing services, while we develop new services that can leverage the same scope, scale and reach. We plan to more fully discuss our digital infrastructure capabilities and plans at our upcoming analyst day.

Moving now to the business metrics for the quarter, I want to start by reminding you that we're currently evaluating new reporting segment that is better aligned with the new organizational model and our key strategic objectives. We appreciate all the suggestions we have received from both the buy side and sell side and hope to have our thoughts finalized in the next few months.

That being said, we will report Q1's metrics in a consistent manner with last quarter. So, let's begin with the information and security product lines. The information and security services product line includes our core DNS and SSL services, as well as, managed security, real-time publishing and supply chain offerings.

We saw continued strength in our DNS registry business, as we processed approximately 7 million new registrations for .com and .net domain names. We also saw another 10 million names renewed or extended, adding up to a record 17 million domain name transactions in Q1.

Renewal rates remain strong as well, coming in at an estimated 76% for the quarter. VeriSign's adjusted base of active names at the end of the period stood at 69 million, up 6% sequentially and 28% year-over-year. Growth came from all segments of the market, including traditional corporate and SMB, international, and pay-per-click. The pay-per-click size of the market remains a small, but consistent percentage within our new name sales and overall base.

With the continuing rise in internet users and usage, our digital infrastructure is now handling an average of 30 billion DNS requests per day, up almost 70% from year ago levels.

We also recently announced that effective October 15th, 2007, prices for .com and .net names would increase by 7% and 10% respectively to $6.42 and $3.85. Additionally, consistent with our new contract with ICANN, we received approval to launch a new real-time zone update service.

Through this new service accredited registrars and other potential customers we will be able to see changes to our zone files every five minutes. This type of data service is one of many we hope to launch in the coming years. While we do not expect the initial service to contribute materially to our results, it does pointed to the benefits inherent in our new contract with ICANN, as it relates to the rapid development and approval of new services.

Moving to our security services business, we'll start with the core SSL offerings. We sold over 202,000 SSL certificates during the quarter. This brings our combined VeriSign active base to 850,000 units, up 5% sequentially and 12% year-over-year. We're also the first company to introduce and issue extended validation certificates to support new security features in Microsoft's Vista and IE7 products.

Demand for EV certificates was solid in Q1 through both the retail and enterprise channels. To date we have sold over 1,000 EV certificates, which we believe establishes us as the number one provide in the market by a very wide margin.

We would expect the EV adoption cycle to be consistent with previous premium priced SSL products, and as such we're anticipating domestic up sell rates of 5% in the retail channel and 10% in the enterprise channel by the end of this year. Performance in Q1 would suggest we are on track to meet these targets.

In order to provide better transparency into the financial drivers of the SSL business, we are introducing two new metrics for Q1 '07. The first is annualized average selling price across the entire base of VeriSign, GeoTrust and Thawte Branded certificates. The second is average term.

The annualized ASP in Q1 was $290, up from $273 in Q4. The average term in Q1 was approximately 16 months. Moving forward, these new metrics, combined with the active base numbers, should give a very clear picture of the impact of the overall SSL business to the VeriSign P&L.

An exciting emerging business we've been developing over the last two years is our consumer authentication offering. VeriSign identity protection services and the VeriSign identity protection network, combined to provide a network based authentication paradigm for the Internet at large.

Hardware or software credentials that are VIP certified, such as the new display card from Innovative Card Technology that was introduce this week can be used acrossed all participating VIP partner sites, to provide strong authentication and protect against identity theft.

Leading e-commerce and online financial service companies such as eBay, PayPal, Yahoo and Charles Schwab have signed on the issue and/or accept VIP credentials at their site. With PayPal’s official rollout in February, we've seen strong initial up take over the credentials by consumers and expect to see adoption continue to ramp throughout the summer.

The network component of VIP is a perfect example of an Internet scaled service that runs on our global infrastructure, providing the scalable and secure real-time validation capability that can support millions of online users.

Rounding out the security services portfolio is the MSS and iDefense services for network protection. We now actively manage and monitor over 5,000 network devices and provide advanced threat detection remediation services for leading enterprises around the world. Recent news coverage regarding A&I and DNS security threats highlight the importance of these services to our customers as we were able to proactively warn, isolate, and ultimately protect their networks from harm.

We believe our layered security approach to protecting end-users, websites and networks gives our customers the ability to exploit the opportunities in today’s Any Era. We also believe we have the right portfolio of security services at the right time in the market.

Let's now move to our communications product lines. We're reporting the communications revenue in three categories for Q1. The first is communications in commerce, which includes our network database and billing services.

The second is content and messaging, which includes our wireless and broadband content services combined with our wireless messaging services.

And the third category is the professional services, which predominantly include our wireless consulting and implementation services. Dana will provide the revenue break down by product line.

Please note that the revenue associated with messaging services that was previously rolled out within communications of commerce is now in the content and messaging breakout.

A key driver in the legacy C&C business in Q1 was the continued growth in wireless billing at MetroPCS and Leap, as we now support over 11.4 million wireless users with our billing and payment services up 39% year-over-year and 10% sequentially.

These gains were offset by a decline in connectivity and database revenues as well as a lack of new demand for our prepaid services during the quarter. We would expect this dynamic to continue throughout the course of 2007.

Now let's move to the content and messaging product lines. We saw a strong growth in messaging volumes during the quarter as we delivered over 16 billion SMS messages, up 118% from the year ago period and 22% sequentially. Premium messaging and MMS volumes in the quarter were up 48% year-over-year to 93 million messages.

Important to point out, however, that we are seeing some challenge in the core messaging business both internal and external. On the internal front we've seen slower than planned integration of our technical platforms and some recurring service issues. These are being addressed very a aggressively by a senior cross-functional team and we believe we'll have the issues resolved in the next few months.

External issues include pricing pressures as competitors become more aggressive and or desperate. We would expect the market to stabilize later in the years as consolidation occurs and more advanced services take hold.

We remain optimistic about the messaging business becoming our next core franchise as market growth, customer interest and our ability to leverage our global infrastructure all look promising.

On the content delivery front we continued to see strong interest in our Intelligent Content Distribution Network or ICDN. The ICDN is designed to support the delivery of all forms of content including long format high definition video, high fidelity audio and large software applications.

The service combines advanced video streaming capability with our proprietary Kontiki peer-to-peer technology and our globally deployed digital infrastructure. As such the ICDN can provide unmatched scale and efficiency in delivery of rich media content.

With the market for Internet based video-on-demand beginning emerge, we are targeting our ICDN services as media and entertainment companies, network service providers and large distributed enterprises. Our simple goal is to establish ubiquitous platform for legitimate peer assisted delivery of professional and user generated content.

We believe the VeriSign ICDN solution positions us to be a market leader over the long-term. Our proven peer-to-peer technology is now in its sixth generation and is powering three of the four leading sites that is provide long form high resolution video services over the internet.

At the recent national association of broadcasters show, we announced the partnership with Lions Gate Entertainment to build and promote a showcase for rich media delivery. The online showcase uses Lions gate content and VeriSign technology and demonstrates an integrated offering of our three screen solutions. Please visit www.verisign.tv to get a pre view of the next generation of integrated entertainment services.

Moving on to the professional services area, we now have combined our all our consulting and implementation teams into a single group. As we discuss on last quarter's call, the inCode acquisition gives us a well respected consulting and implementation team to leverage as we begin to offer end-to-end solution to our largest customers. I would say that the early returns are very promising in terms of being able to raise the level of executive engagement and commitment on some of our most important projects.

So, in summing up Q1, I would say our new organization hit the ground running and delivered what we expected. Our goals for the year are very straightforward. We call it VeriSign 3D to drive, disrupt, and deliver. Using our unmatched digital infrastructure, we want to drive continued momentum in our core DNS and SSL franchise while we disrupt the new emerging markets such as video-on-demand and consumer authentication and deliver customer success, rapid innovation and operating leverage for our customers, employees and shareholders.

Thanks for your attention, and now let me turn the call over to Dana.

Dana Evan

Thanks, Stratton, and thanks to all of you for joining us this afternoon. Before discussing VeriSign's financial results, let me start with a quick update regarding the restatement of our prior period financial statement.

As you recall in January we publicly announced that the ad hoc group of independent directors had substantially completed its review of VeriSign's historical stock option grants. We also announced that this review did not find any intentional wrongdoing by any current member of the senior management team.

On March 1st we filed a notice with the SEC disclosing that we would be unable to file our 2006 10-K because the audit of the restatement had not been completed and that we intend to do file this 10-K as promptly as practicable after completion of the restatement audit.

As a reminder, this restatement will affect the years and interim periods from 2002 to 2005 as well as the first quarter of 2006. This restatement will drive additional non-cash stock-based compensation expense related to past stock option grants within the financial statements for these periods.

In light of these ongoing activities, we will not be providing full GAAP or non-GAAP results at this time. We will provide you with as much financial information as possible including preliminary non-GAAP results and guidance.

Please note, however, that these are preliminary numbers and represent what we believe the numbers would be without any impact or changes resulting from the stock option review and restatement.

Now let's turn towards our first quarter financial results. Overall Q1 was a solid quarter for VeriSign. We delivered revenue and operating results in line with the business outlook we provided last quarter and saw continued strengthening in our balance sheet.

These financial results were delivered while we underwent significant change across the Company executing on our companywide reorganization and the restructuring associated with that, divesting our Jamba mobile content business and integrating our acquisition of inCode.

On a consolidated basis VeriSign delivered Q1 revenue of $379 million. We continue to see sequential growth in our core businesses with especially strong performance from our SSL and DNS franchises.

The revenue within professional services was a bit light, however, compared to what we had expected. As a reminder, the majority of revenue for professional services is recognized as projects are delivered and completed, and therefore is not as linear as our traditional recurring revenue businesses.

As we turn to revenue by reporting unit, I would like to point out that we will be modifying the way we report revenue in future periods. Having spent a great deal of time designing and implementing our new organizational and business structure as well as having discussed various reporting scenarios with investors we anticipate finalizing our new reporting structure shortly after completing the restatement process.

While not fully complete, we would expect the new reporting structure to break out professional services from our other product lines given the fundamental differences in the business model and margin structure for this business.

Of the remaining products and services, we will likely have a second revenue segment, which would include our core services such as naming, security, and content and messaging with a third segment representing our legacy communications and billing services.

We are still working through the finer points of the new reporting framework but as a rough approximation under this proposed segmentation we would have seen a Q1 revenue distribution as follows: 70% in core services, 25% in communication and billing, and 5% in professional services.

Now, turning to revenue under our existing reporting units, the Internet Services Group grew 4% sequentially and a healthy 20% year-over-year. This sequential growth drove approximately $212 million of revenue in Q1 or 56% of total revenue and was fueled by continued strength in domain names, sales and renewal rates along with solid traction in our Security Services business.

The Communications Services Group delivered revenue of $167 million or 44% of the total. CSG revenue included $25 million from Jamba! which represented one month of revenue prior to the formation of the joint venture on February 1st. Excluding this Jamba! revenue, CSG grew approximately 4% sequentially and 18% year-over-year.

Within our core Communications and Commerce business revenues were $90 million for the quarter excluding the messaging services. Our content services business, which includes one month of Jamba! for the quarter as well as our digital content and messaging services generated revenue of $63 million. After taking out the $25 million of revenue that Jamba! contributed content services was $38 million in Q1.

Geographically the percentage of revenue from our international customers, affiliates and subsidiaries was approximately 19% in the quarter as compared to 29% in Q4. This lower percentage reflects the initial effect of the Jamba! divesture, which was primarily international revenue.

As Q1 revenue only included one month of Jamba! results, we would expect the percentage of revenue from international customers to be lower again in Q2 reflecting a full quarter's effect of this divesture.

Preliminary non-GAAP gross margin reflects our anticipated decline in this metric and was slightly below our previous guidance. As you will recall, we discussed a forecast structural shift in our gross margin on last quarter's earnings call. This shift reflects the direct financial results of integrating inCode professional services into our business model, the transfer of Jamba!, which was at relatively high gross margins into the new Fox joint venture as well as an increase in fees paid to ICANN under our new agreement.

As we look at the gross margin mix for Q1, our professional services business had a more negative impact on gross margin than we had previously anticipated and in our core communications services revenue sharing payments made in conjunction with our C business were also higher than expected both of which caused gross margins to come in a bit light.

Turning to Q1 operating expenses, we saw better than anticipated expense synergies and savings which drove operating margins for the quarter that were consistent with our previous guidance of 19%. After the reduction of head count of approximately 200 people relating to our restructuring, and the transfer of another 575 people into the Jamba! joint venture, we ended the quarter with approximately 4,500 employees down from 5,330 in Q4.

We expect to eliminate approximately 350 positions in total throughout the year as part of our restructuring plan. For the remaining 150 restructured positions, we anticipate approximately 60% to exit the company in Q2, with the remainder occurring evenly throughout the remaining quarters of this year.

Moving now to the balance sheet, cash equivalents and short-term investments at the end of Q1 were approximately $740 million. As expected, we received approximately $188 million from news Corp during the quarter for the Jamba! business and also capitalized on the joint venture with a cash contribution in accordance with our agreement.

Additionally, we repaid the outstanding balance on our line of credit of $199 million. Our ability to generate positive cash flow remains consistently strong and healthy. Continued solid collection efforts in the removal of Jamba! accounts receivable from our balance sheet had the benefit of driving Q1 net DSOs down three days from the previous quarter to 45 days.

Deferred revenue growth is the highlight for the quarter with total deferred revenue coming in at $662 million up $48 million from the previous quarter. This record increase was driven primarily by the combination of strong sales generated in our naming business where we ended the quarter 6% higher with over 69 million names in the adjusted zone and solid bookings delivered in the SSL and authentication security businesses.

Our SSL business showed healthy growth adding almost $15 million to deferred revenue as our install base of certificates increased by $43,000 or 5% sequentially. Lastly, our capital expenditures for the first quarter were approximately $17 million, a bit lighter than we had planned as we got off to a slow spending start for the year.

This CapEx broke down approximately as follows: 42% in communications services group, 17% in Internet Services, and 41% for corporate and infrastructure purposes as we continue to build out our new data center and execute on project tightening.

Let me now spend a couple of minutes updating you on some of our Q1 and first quarter developments starting with the company wide reorganization. As you know, we reorganized the company into a new functional organization as of the beginning of the year, replacing the previous business unit structure with a new combined worldwide sales and services team and an integrated development and products organization.

As a result of the reorganization, we completed our formal restructuring plan in Q1 and recognized a one-time restructuring charge in the quarter of approximately $40 million. The restructuring is comprised of approximately $20 million for workforce related charges, $9 million for facilities, and $11 million for hardware, software and other miscellaneous charges. Approximately $10 million of these charges resulted in cash payments during the quarter.

We would expect this restructuring to drive benefits over the course of the next four quarters, and we anticipate seeing material, positive effects in Q2, which should build incrementally throughout the year as some of these initiatives are longer-lead items. As we discussed last quarter, once the restructuring is fully realized, we would anticipate annualized run rate savings in the $50 million range.

Our joint venture with John Corp began operations at the beginning of February. To date we are pleased with the JV's early progress and satisfied with pro forma results, which were in line with our expectations. We also announced Project Titan in February, a major initiative to expand and diversify our infrastructure ten fold by the year 2010. Project Titan is $100 million plus capital initiative spanning over the next three years.

As a reminder, the 2007 CapEx spending related specifically to Project Titan is reflected in our CapEx plan for the year indicating approximately $200 million of capital expenditures for 2007. Lastly in April we announced that we would be affecting price increases under our ICANN contract and that the registry fee for dot-com names were increased from $6 to $6.42 and the fee for dot-net domain names will increase from $3.50 to $3.85.

The increase will take effect October 15th, and due to our deferred revenue business model, we expect the increase to have less than $1 million effect on 2007 revenue, as the majority of the fee increase will impact 2008 results.

Let me now turn towards our business outlook for 2007. As a reminder, our guidance includes non-GAAP forward-looking statements and actual results may vary for a number of reasons including our financial restatement.

Drilling down a bit into current Q2 period, we anticipate we will drive revenue in a range of approximately $365 million to $370 million for the quarter representing organic revenue growth of approximately 3% to 5% relatively consistent with last quarter and driven by growth across most areas of our business.

As a basis of apples-to-apples comparison, Q1 revenue excluding Jamba was $354 million. As we look at anticipated margins for Q2, we would expect gross margins and operating margins will both be higher in Q2 reflecting early returns of the benefits from our restructuring effort.

We will continue to be focused on discipline around spending in all areas across the company as we execute on our strategic plan and invest for growth and next generation services. As it relates to other income for Q2, we would expect to see other income including VeriSign's portion of the Jamba joint venture to be approximately 6 to $7 million.

As it relates to the share repurchase plan, we are currently precluded from stock repurchases due to the restatement efforts. We would, however, anticipate the full re-assumption of our share repurchase program after completing the restatement of prior period financial statements.

That all being said, due to these factors we have not been able to execute the sizable stock repurchases that we had originally planned for Q2. That would lead to an expectation that share count for the quarter would be flat to slightly up from the 248 million in Q1 as compared to the reduced share count we had originally forecast for Q2.

This reduced forecast for share count also has the effect of reducing our own forecast for Q2 by approximately a penny or so of EPS.

Taking into account the components of the guidance I just laid out, we would expect preliminary pro forma earnings per share in Q2 to be approximately $0.25 on an after tax basis using 30% effective tax rate. As it relates to the full year, our outlook here remains unchanged.

We continue to expect organic top line growth to be consistent with prior guidance, calling for revenue growth of approximately 15% and leading to an expectation of approximately $1.55 billion of revenue for 2007.

We also continue to expect operating margins to expand significantly throughout the year exiting 2007 at 25%. These financial expectations translate into an EPS guidance range of $1.06 to $1.07 for the year.

In summary, we're pleased with our first quarter financial results and business accomplishments including our continued execution on strategic initiatives. As we enter the second quarter, we remain optimistic about our new opportunities, the momentum we are seeing in our core businesses and the resulting growth trajectories we anticipate for revenue, margins and earnings.

We continue to believe our strong financial position allows to us focus on profitable investments, expanding operational leverage, and delivering increased shareholder value.

And with that, we’d like to open up the call for your questions. Operator, may we have the first question, please?

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Todd Raker with Deutsche Bank. Please go ahead.

Todd Raker - Deutsche Bank

So, two quick questions, and you may have covered some of this, but in terms of the Jamba joint venture, you talked about kind of the cash contribution from an ongoing contractual perspective. Can you quantify that for us?

Stratton Sclavos

Yeah, Todd. The joint venture structure has approximately 5% of the net revenues of the JV being paid to VeriSign for delivery of Gateway services. Now, there is a ramp-up period to that as we form the joint venture and get that rolling. So that's likely to be -- we’ll probably kick that in fully starting in Q3.

Todd Raker - Deutsche Bank

Okay. And then second question for you, just in terms of the telecom business, and I know there has been some slightly different definitions of segments here. But if I do an apples-to-apples comparison to the communications and commerce business unit in the December quarter, I kind of get a number here about 104 million down from 113.

Is that in the ballpark? Was that that substantial of a decline in the core business?

Stratton Sclavos

Yeah, it was about 106 versus 113.

Todd Raker - Deutsche Bank

In terms of your expectations going forward, would you expect that to stabilize or expect to continue the decline?

Stratton Sclavos

I think we're going to still see, as we said last quarter, I think, we're expecting zero to minus 5% in kind of the legacy product lines there. Some are growing like the billing business with the wireless or the post-paid billing business is growing, whereas some of the database and network stuff is under the traditional price pressure only to be offset when we see the international volumes start to ramp, so I think you're going to still see the choppy year for the next quarter quarters and certainly as we get into the second half of the year we would like to see it’s stabilize and begin to grow again.

Todd Raker - Deutsche Bank

Okay. Thanks, Stratt.

Stratton Sclavos

Yes.

Operator

We'll take our next question from Ed Maguire with Merrill Lynch. Please go ahead.

Ed Maguire - Merrill Lynch

Yes, good afternoon. I was wondering if you could comment at least on some of the initial uptick you're seeing of the extended validation certificates?

I think providing the ASPs around the certificates is helpful, but where are you seeing initial traction and are the initial results meeting your expectations so far?

Stratton Sclavos

Yeah. I think the initial up take, Ed, is more or less exactly where we thought it would be. Some of the larger brand sites and the financial service firms, as well as online merchants, who can qualify for this and see the green bar as aiding the process of getting someone to complete a sale.

I think we haven't really yet gotten strong deployment in the larger enterprises that have traditionally bought hundreds if not thousands of certificates. We're working many of those deals now, and we're not seeing as much international penetration yet simply because many of the guidelines that the CA form and Microsoft had worked with us on need to be tweaked a bit in order to get the international, especially the Asian markets to be conforming.

So I would say all-in we're seeing uptick from where we thought, and as I said, we are hoping for 5% domestic or retail up-sell domestically, 10% enterprise by the end of the year. The initial results in Q1 would say we will be at or better than those.

Ed Maguire - Merrill Lynch

Okay. And you made some comments about some integration issues with your messaging platforms. What additional costs if any may be associated with that, and what would be your estimated time to resolve some of these issues?

Stratton Sclavos

I think it’s more time than it is money. We would really got the teams done and focused, and as you remember, we brought in three united MQ and our own platforms into this mix, and it’s really a kind of stack of technology that has to get integrated and kind of best of breed chosen from the different architectures, so the architectural integration just took a little bit longer than we had hoped, but I don't think it is going to cost us any substantial more amount, not like another team that has to be deployed here. It’s more the time and service of getting the platform stabilized and up and running.

Ed Maguire - Merrill Lynch

Okay. Thank you.

Operator

We will take our next question from Rob Owens with Pacific Crest. Please go ahead.

Rob Owens - Pacific Crest Securities

Good afternoon, everyone. Stratton, could you talk a little about the registry? You know, $4 million is nearly a record quarter if not a record quarter for you guys there. Realistically what can we expect the year to finish out at? Can you continue this type of run rate and then on the registry front it look like renewal rates were down modestly. Any thoughts there?

Stratton Sclavos

Sure. The registry numbers, you're seeing a relatively consistent as we enter the year we talked about seeing some of the highest weekly new name ads that we had ever seen, and that continued throughout most of the quarter.

There is some seasonality month-over-month as you watch what happens in a typical Q1, Q2, Q3, but we would expect to see pretty strong numbers continue on a weekly basis here throughout the rest of the year, so my bet would be you're going to see absolute growth about the same as this in each of the quarters.

And as renewal rates hold steady, you know, it wouldn't surprise us to see I just saw the numbers yesterday, we certainly over 70 million names in the adjusted base now, would expect that number to probably go up by about 4 million a quarter exiting the year somewhere north of 80 million, so it’s going to be a strong business again.

On renewal rates just to be clear, we have to estimate what those renewal rates are because people have a 45-day grace period to renew. So, the difference between 77 and 76 and the estimate we give may not be material in the end once all that flows through, and I think that's just the team's view of it heading into Q1.

Rob Owens - Pacific Crest Securities

Great. Fair enough. And then the second question, if I can to Dana on the gross margin front, realizing your not getting specifics but you were negatively surprised. And could you reconcile those comments given that telecom one of your weaker gross margin areas came in below plan, it looks like Jamba! maybe a little above plan and you commented it historically how that was a good gross margin area. Where did the surprise come from?

Dana Evan

So, a couple of things. As it relates to your last point, Jamba!, not having two months of Jamba! at mid 60% margins certainly had it affect for the quarter overall, but we expected that, so we’re really surprised as you put it.

We were surprised with the re-pricing in the CNM revenue agreement we hadn't anticipated that, so, that a big piece of it. And then the other piece was the revenue coming inline in professional services, I mean as you know, that's a business where the people are on Board and so if the revenue doesn't come in the gross margin is going to suffer, but we don't expect that to carry through to next quarter and view it as a one-time event.

Rob Owens - Pacific Crest Securities

Okay. Thank you.

Operator

We will take our next question from Sarah Friar with Goldman Sachs. Please go ahead.

Sarah Friar - Goldman Sachs

Good afternoon, everyone. Dana, could you just talk a little about, or Dana or Stratton, the sales force reorganization, how is that proceeded. Are we at a point where everyone knows exactly what they're selling?

And then I know that the second part of that is your strategy is to lead with some consulting and services. So do you feel after the inCode acquisition that you have enough of those people in place or are there other partnerships and so on we should be looking to see you sign as milestones around that go to market strategy?

Stratton Sclavos

Hi, Sarah, I think the -- has really taken hold pretty much as we had hoped to it would. John and the team have kind of laid out fairly structured focus in key vertical in couple of major accounts.

They've done a tremendous amount of sales training of the product portfolios that we think fell into those verticals. And then the consulting teams as you say are leading in many of the situations where we're looking at very large highly integrated solutions that will require anywhere from 6 to 12 months of implementation services onsite with the customer as we roll them out.

From a pipeline perspective, I would tell you John and I are both very, very pleased with what we're seeing in terms of both the size of deals in the pipeline individually and the number of deals in the way it’s building, but we've got to book and turn that business and implement these services.

So, as I said early returns on the sales force combination and the consulting add-on there are very, very good, but we're just 90 days into it.

Sarah Friar - Goldman Sachs

Okay. But you feel at this point we're kind of done in term of the actual transition and people know what it is there, is there probably like to sell on what vertical they’re focused on etcetera?

Stratton Sclavos

Yeah, I think -- if anything, once we see this kick in over the next one or two quarters we're likely to look for additional sales resource internationally because that will be where we now want to take kind of a second swing at this and begin to do the same thing in the international markets.

Sarah Friar - Goldman Sachs

Got it. And Dana quick one for you on CapEx, it seemed kind of light this quarter. I think the lowest I have seen since going back to '05. Is there any reason why you held off? Is that a shape of things to come or is it just a light quarter and we'll see it go back to more normal levels over the next couple of quarters?

Dana Evan

No, it really was. I mean you're right. It was a historically low first quarter of capital spending. I think, January everybody was focused on expecting the reorganization and making sure they had their new orders in place and had their strategies baked, and so there just wasn't any spending effectively in January.

And so, it will catch up here in this quarter and the next, and we still believe in that $200 million CapEx plan for the year.

Sarah Friar - Goldman Sachs

Great. Okay. Thanks a lot.

Operator

We will take our next question from Israel Hernandez with Lehman Brothers. Please go ahead.

Israel Hernandez - Lehman Brothers

Hi, good afternoon. Can you comment on the pricing environment in the messaging business, particularly in relation to what you're seeing with Sybase 365 now starting to ramp up as part of Sybase. And also with some of the small private guys that out there?

Stratton Sclavos

I don't think the Sybase guys are having any impact at all on us. It’s really the small desperate guys who are all trying to sell themselves and in doing so they trying to show a book of business with customer names in it and probably sacrificing profitability.

This happened to me, MSS business three years ago on the securities side, and we saw it, and they all disappeared within a year or so. I am very confident that's likely to happen here in the messaging business and mean while many this particular business the volumes are so large we believe that there is going to be a flight to quality providers here over the course of the next twelve months, especially as large integrated meet media and entertainment companies start to rely on these types of services to do campaign marketing and integrated promotions, so long story short is I do believe this is a space that will become our next core franchise at VeriSign akin to the DNS and SSL models where we will be able to command or have a commanding market share and over time be able to have premium pricing because of the preferred brand.

Israel Hernandez - Lehman Brothers

Thank you.

Operator

We will take our next question from Scott Sutherland with Wedbush Morgan. Please go ahead.

Terry Rice - Wedbush Morgan Securities

This is actually Terry Rice for Scott. Just a couple questions. You mentioned the telecom came in below plan and it seems like there has been a lot of competitive pricing in that area. Can you talk a little bit about how pricing was there, and then I have a couple of follow-up questions.

Stratton Sclavos

I think you got to be careful with this. As we said before there is six or seven different product lines there, there is post paid billing, prepaid billing, there is clearing, there is database and there is network, and they all have a little bit different set of dynamics in it.

In the network business that ones mostly pricing pressure, generally Syniverse and VeriSign and others kind of going at each other in various competitive bids.

We won Datsun during the quarter and saw some of our business not turn up that we were expecting as the incumbent went in and repriced to another customer much lower than we were willing to go.

So, that dynamic has been there for a few years and think it will continue in network. Database was better than we thought simply because we had predicted more roll off than we had seen.

Really, prepaid billing where we had expected to close some deals internationally as those were the largest prepaid market longer sales cycle than we thought, weren't able to close some of those deals, expect second half of the year we'll see some of that start to ramp.

So it is just a different dynamic in each of those little product lines and as I think as we go to the new reporting once we figure it out, it will be a will lot clear clearer where they all stand. But I would say we're fairly consistent with our commentary from earlier in the year we say 0% to minus 5% in the legacy qualm is a good estimate for the year and should we do better than that, it will be because things don't roll off as quickly and we see some international up take.

Terry Rice - Wedbush Morgan Securities

Okay. Great. And then related to the Jamba! JV, can you give us any quantitative amount and what that contributed to the quarter?

Dana Evan

We had given guidance of $1million to $2 million, and it was in line with that guidance.

Terry Rice - Wedbush Morgan Securities

Okay. And then what about how much inCode contributed?

Dana Evan

Maybe the better way is, I know it is in professional services, so is that the vast majority of professional services?

Stratton Sclavos

Yes. If you think about professional services, about $20 million for the quarter. Assume inCode is about three quarters of that, and the traditional VeriSign consulting is the other quarter.

Terry Rice - Wedbush Morgan Securities

Okay. Great. Thank you very much.

Operator

We will take our next question from Steve Ashley with Robert Baird. Please go ahead.

Steve Ashley - Robert W. Baird

Thank you. In the messaging business do you have any large customer concentration there, Stratton?

Stratton Sclavos

Not really. I think we have 10 to 12 companies that drive a significant amount of the revenue, and then lots and lots and dozens and dozens of small companies that are starting to ramp up.

I think what you'll see in that space is a shakeout as well on the customer front. It is really going to move to larger media companies or aggregators that are capable of licensing a broad catalog of products, so one of the things we're doing as part of our own internal work is actually refocusing to what we believe are either today's or tomorrow's larger volume customers, so I think we'll focus on fewer larger opportunities there, but today there is really not a concentration you would worry about.

Steve Ashley - Robert W. Baird

In terms of your B2B content services if you take Jamba! out, sequentially from $18 million to $38 million, very nice growth there, what were the driver there is, and number two am I correct in assuming that you are deriving very little revenue from Jamba! as a customer in that segment today?

Stratton Sclavos

Yes. There is a switch in there that Dana pointed out. In going from $18 million to $38 million we've also moved the messaging revenues from what used to be commerce and communications and into this segment. So that was about $16 million in the quarter, so it really was up a few million dollars quarter over quarter as a whole.

We had predicted that business would be at about $160 million run rate by now. That is what it is at when you put those altogether, and we're hoping to see that continue to grow north of $200 million run rate by the end of the year.

So I think it is a good strong business. As you recall we just entered the B2B spaces here over the last 12 to 18 months. We're a little disappointed with our own internal execution and committed and focused on fixing that and as I said we think the market is still there to make this the next core franchise.

Steve Ashley - Robert W. Baird

Just lastly, Dana, housekeeping question. CapEx this year still expected to get up towards $200 million with Project Titan running on for the following two years beyond that would you expect CapEx to remain up around that $200 million range maybe in 2008?

Dana Evan

No. Actually the reason why it hopped up in 2007 was more due to the finalization of the build out of our new data center, and so we expect it to go back down to the $160, $170 million range for '08.

Steve Ashley - Robert W. Baird

Perfect. Thank you.

Operator

And we'll take a follow-up question from Scott Sutherland with Wedbush Morgan. Please go ahead.

Terry Rice - Wedbush Morgan Securities

This is Carey Rice again. Can you talk a little about the GeoTrust certificate? You talked about the high end and now maybe about the low end a little bit?

Stratton Sclavos

I am sorry, in what respect, Carey? The ASP that we gave is a blended ASP for all the brands.

Terry Rice - Wedbush Morgan Securities

Just maybe overall growth in those certificates?

Stratton Sclavos

In the GeoTrust segment which was really targeted at the middle market and the reseller channel for us, we saw above plan growth there in both units and contributions, so very pleased with that performance, and continuing to leverage their presence in those markets, the VeriSign presence at the high-end and the thought presence at the low end to really cover all the spaces in the market and get better economies of scale out of the business, so we're pretty excited about the SSL business this year. It would be our favorite business and alongside DNS with its strong performance.

Terry Rice - Wedbush Morgan Securities

Okay. And then just one housekeeping. Telecommunications queries, did you give that number? You gave it generally, I think?

Stratton Sclavos

Yeah, I didn't give it. I think the number was about $16.1 billion.

Terry Rice - Wedbush Morgan Securities

Okay. Thank you very much.

Dana Evan

That's right. That's right.

Operator

And we'll take our next question from Shaul Eyal with CIBC World Markets. Please go ahead.

Shaul Eyal - CIBC World Markets

Thank you for that. Hi guys. Good afternoon. Certain quick question about your billing activities. Can you talk a little bit about the landscape as it relates to the post and prepaid billing activities? Are you running into the same competitors when kind of bidding for the RSPs on the pre and post paid or is it separate?

Stratton Sclavos

Yeah, I think in the post paid stage certainly domestically what we're really focused on is our two big customers, MetroPCS and Leap cricket both of whom themselves have developed fairly innovative payment models for their customers and targeted large Metro cities here in the U.S. including some very new buys with the latest spectrum auction.

So they are really driving what we are doing in post paid billing, the feature sets they need and the market coverage they need as well as converting them over the course of the rest of the year to our new billing platform. So we're really focus there and post paid this year and frankly our growth will come because of their subscriber growth, which as you saw was very healthy in Q1.

We would expect it to continue that way throughout the year. On the prepaid side, again mostly in the domestic space, we are where we are. Companies like U.S. cellular and the rest. Most of the growth in that space is coming from emerging markets such as India, China, and some places in Eastern Europe, where we really don't have a foot print for coverage today.

So it’s one of the things we're looking at, but it is also why we believe some of the sales cycles for us have been a little bit longer in places like Latin America and the rest is, we're just not well represented in the markets where prepay is a hot item today. So that's one of the things we're looking at and why we backed off a little bit on our expectation for that business early in the year.

Shaul Eyal - CIBC World Markets

That's helpful. Thank you. Is it also fair to assume that the post-paid gross margins are lower than the prepaid right now?

Stratton Sclavos

Gross margins?

Shaul Eyal - CIBC World Markets

Yes, on the post paid.

Stratton Sclavos

Post paid. I don't have that number in front of me. I don't know if that is a true statement or not in our model.

Shaul Eyal - CIBC World Markets

All right. Thank you very much.

Operator

We will take our last question from Scott Kessler with Standard & Poor's Equity. Please go ahead.

Scott Kessler - Standard & Poor's Equity

Thanks a lot. I think you initially disclosed your stock option inquiries in late June of last year and then the company's related practices were actually mentioned in a report in mid-may of last year.

And I guess I am wondering why the restatements and filings haven't been completed at this point and was also wondering if you can indicate when you expect them to be completed, especially, given Dana's comments about not planning for buybacks for Q2? Thanks a lot.

Stratton Sclavos

Sure, Scott. Just all we can do is really relay the facts again as the investigation started in May or early June was concluded I believe in January, February of this year. That's when the Ad Hoc Committee made its report to the Board and we made the announcement. Since that time the work has been going on with the restatement.

And the Committee and outside counsel believe now as we prepare the restatement that in fact we should be clear that information with the Securities & Exchange Commission. So we're in that process right now and again management really has no ability to control the dates there. We will go through the process, and we'll be done when we're done.

Scott Kessler - Standard & Poor's Equity

Fair enough. Thanks a lot.

Operator

This will conclude today's Question and Answer Session. Mr. Bond, I will turn the conference back over r over to you.

Ken Bond

Thank you everyone for your time today. As always we look forward to talking with you and answering any additional questions you may have. Thank you and good evening.

Operator

Ladies and gentlemen, this will conclude today's presentation. We thank you for your participation, and you may disconnect at this time.

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Source: VeriSign Q1 2007 Earnings Call Transcript
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