VeriSign (VRSN) D. James Bidzos on Q1 2016 Results - Earnings Call Transcript

| About: VeriSign, Inc. (VRSN)

VeriSign, Inc. (NASDAQ:VRSN)

Q1 2016 Earnings Call

April 28, 2016 4:30 pm ET

Executives

David Atchley, CFA - Vice President, Treasury & Investor Relations

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

George E. Kilguss III - Senior Vice President & Chief Financial Officer

Todd B. Strubbe - Chief Operating Officer & Executive Vice President

Analysts

Steve M. Ashley - Robert W. Baird & Co., Inc. (Broker)

Gregg Moskowitz - Cowen & Co. LLC

Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)

Gray W. Powell - Wells Fargo Securities LLC

Operator

Good day, everyone. Welcome to VeriSign's first quarter 2016 earnings call. Today's conference is being recorded, and unauthorized recording of this call is not permitted.

At this time, I would like to turn the conference over to Mr. David Atchley, Vice President of Investor Relations and Corporate Treasurer. Please go ahead, sir.

David Atchley, CFA - Vice President, Treasury & Investor Relations

Thank you, operator, and good afternoon, everyone. Welcome to VeriSign's first quarter 2016 earnings call. With me are Jim Bidzos, Executive Chairman, President and CEO; Todd Strubbe, Executive Vice President and COO; and George Kilguss, Executive Vice President and CFO.

This call and our presentation are being webcast from the Investor Relations section of our verisign.com website. There, you will also find our first quarter 2016 earnings release. At the end of this call, the presentation will be available on that site and within a few hours, the replay of the call will be posted.

Financial results in our earnings release are unaudited. And our remarks include forward-looking statements that are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically, the most recent reports on Forms 10-K and 10-Q, which identify risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. VeriSign retains its longstanding policy not to comment on financial performance or guidance during the quarter, unless it is done through a public disclosure.

The financial results in today's call and the matters we will be discussing today include GAAP and non-GAAP measures used by VeriSign. GAAP to non-GAAP reconciliation information is appended to our earnings release and slide presentation, as applicable, each of which can be found on the Investor Relations section of our website.

In a moment, Jim and George will provide some prepared remarks. And afterward, we will open up the call for your questions.

With that, I would like to turn the call over to Jim.

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

Thanks, David, and good afternoon, everyone. I'm pleased to report a solid start to 2016 for VeriSign. First quarter results were in line with our objectives of offering security and stability to our customers, while generating profitable growth and providing long-term value to our shareholders.

We reported revenue of $282 million, up 9.1% year-over-year and we delivered strong financial performance, including $143 million in free cash flow. We processed nearly 10 million new registrations during the first quarter and added 2.65 million net new names ending with 142.5 million .com and .net domain names in a domain name base.

Our financial position is strong with $1.9 billion in cash, cash equivalents and marketable securities at the end of the quarter. As a part of managing our business, during the first quarter we continued our share repurchase program by repurchasing 1.8 million shares for $150 million.

We continually evaluate the overall cash and investing needs of the business and consider the best uses for our cash, including potential share repurchases. As we discussed during the last call, ICANN and VeriSign are in the final stages of preparing the Root Zone Maintainer Agreement and the .com Registry Agreement extension documents. We continue to make progress and we'll provide periodic updates as appropriate on our progress towards these objectives.

I'll comment now on first quarter operating highlights. At the end of March, the domain name base in .com and .net was 142.5 million, consisting of 126.6 million names for .com and 15.9 million names for .net. This represents an increase of 7.1% year-over-year.

In the fourth quarter of 2015, the renewal rate was 73.3% compared with 72.5% for the same quarter of 2014. While renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal rate for the first quarter of 2016 will be approximately 74.2%. This preliminary rate compares favorably to 73.4% achieved in the first quarter of 2015.

As we discussed over the last few quarters, there are many factors that drive domain growth. These include but are not limited to, Internet adoption, economic activity, e-commerce activity and registrar go-to-market strategies.

During the first quarter, we continued to see strength in net additions in many parts of the world, both from developed and emerging markets. Also during the quarter, we again saw activity coming from registrars in China that exceeded our expectations. At this point, we expect activity from registrars in China to normalize as we continue through the second quarter.

Also as discussed last quarter, we still expect the fourth quarter of 2016 to be somewhat unique, as the expiring domain name base in that quarter will have a large percentage of first time renewing names as a result of the strong performance during Q3 and Q4 of 2015. While it is difficult to assess what the renewal characteristics of these new names will be, due to the large upcoming Q4 2016 expiring base, we still expect fourth quarter deletions to be elevated. Accordingly, as we stated last quarter, deletions could exceed additions for the fourth quarter of 2016.

Based on these and other factors, we expect the second quarter of 2016 net change to the domain name base to be an increase of between 0.6 million and 1.1 million names, and we are now forecasting the full-year 2016 domain name base growth rate to be between 1% and 2.5%. As an update related to the launch of our IDN versions of .com and .net, the localized Katakana version of .com in Japanese launched in December and will be in general availability starting June 13. Also, we plan to launch the .com and .net Korean IDNs in May.

And now I'd like to turn the call over to George.

George E. Kilguss III - Senior Vice President & Chief Financial Officer

Thank you, Jim, and good afternoon, everyone. Revenue for the first quarter totals $282 million, up 9.1% year-over-year and 3.4% sequentially. During the quarter, 58% of our revenue was from customers in the U.S. and 42% was from international customers.

GAAP operating income for the first quarter totaled $167 million, up 15.6% from $144 million in the first quarter of 2015. The GAAP operating margin in the quarter came to 59.2% compared to 55.8% in the same quarter a year ago. GAAP net income totaled $107 million compared to $88 million a year earlier, which produced diluted GAAP earnings per share of $0.82 in the first quarter this year compared to $0.66 for the first quarter last year.

As of March 31, 2016, the company maintained total assets of $2.3 billion. These assets included $1.9 billion of cash, cash equivalents and marketable securities, of which $667 million were held domestically with the remainder held internationally. Total liabilities were $3.4 billion at the quarter end.

I'll now review some additional first quarter metrics, which include non-GAAP operating margin, non-GAAP earnings per share, diluted share count, operating cash flow and free cash flow. I will then discuss our 2016 full year guidance. First quarter non-GAAP operating expense which excludes $12 million of stock-based compensation totaled $103 million as compared to the $103 million in the fourth quarter of 2015 and compared with $104 million in the same quarter a year ago.

Non-GAAP operating margin for the first quarter was 63.3% compared to 59.7% in the same quarter of 2015. Non-GAAP net income for the first quarter was $112 million, resulting in non-GAAP diluted earnings per share of $0.85 based on a weighted average diluted share count of 131.6 million shares. This compares to $0.74 in the first quarter of 2015 and $0.79 last quarter based on 133.8 million and 133.4 million weighted average diluted shares, respectively.

We had a weighted average diluted share count of 131.6 million shares in the first quarter compared to 133.4 million shares in the fourth quarter. Dilution related to the convertible debentures was 21.1 million shares based on the average share price during the first quarter compared with 15.8 million for the same quarter in 2015 and 21.4 million shares last quarter. The share count was reduced by the full effect of fourth quarter 2015 repurchase activity and the weighted effect of the 1.8 million shares repurchased during the first quarter.

Operating cash flow and free cash flow for the first quarter were $144 million and $143 million, respectively, compared with $133 million and $126 million, respectively, for the first quarter of last year.

With respect to full-year 2016 guidance, revenue for 2016 is now expected to be in the range of $1.125 billion to $1.140 billion representing an annual growth rate of approximately 6% to 7.5%. This revenue guidance is an increase from the $1.110 billion to $1.135 billion revenue range given on our last earnings call. The 2016 revenue range reflects our updated expectation of full-year 2016 domain name base growth, which is now in the range of the 1% to 2.5%.

Full-year 2016, non-GAAP operating margin is still expected to be between 62.5% and 64%. Our non-GAAP interest expense and non-GAAP non-operating income net is now expected to be an expense of between $110 million and $116 million, lowered from the $114 million to $120 million range as given on our last earnings call.

Capital expenditures for the year are now expected to be between $35 million and $45 million, lowered from the $40 million to $50 million range as given on our last earnings call. Cash taxes for the year are still expected to be between $10 million to $20 million. Due to domestic tax attributes including cash tax benefits from our convertible debentures, substantially all of the expected cash taxes in the 2016 are international. In summary, the company continued to demonstrate sound financial performance during the first quarter.

Now, I'll turn the call back to Jim for his closing remarks.

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

Thank you, George. In closing, during the first quarter, we furthered our work to protect, grow and manage the business while delivering value to our shareholders. We believe that our focus on profitable growth and disciplined execution will extend the long trend lines of growth in our top and bottom line and allow us to continue our consistent track record of generating and returning value to our shareholders in a most efficient manner.

We'll now take your questions. Operator, we're ready for the first question.

Question-and-Answer Session

Operator

Thank you. Our first question comes from Steve Ashley with Robert W. Baird.

Steve M. Ashley - Robert W. Baird & Co., Inc. (Broker)

Thank you very much. So, I guess I'd like to ask, in terms of the revenue growth rate, revenue grew 9.1% year-over-year, but the name file grew 7.1%. Historically, if you look at those two, they've been very close to one another within 10 basis points, and here you have 200 basis points different. Do you have any insight into why the revenue growth rate might have been 200 basis points stronger than the name growth rate?

George E. Kilguss III - Senior Vice President & Chief Financial Officer

Sure, Steve. I think a couple of factors. One, as we mentioned last quarter, we did have a .net price increase that took effect in February of this year. Also really the timing of when the ads came in, we clearly had a very strong 4Q of name additions, and we also had a very strong 1Q name additions. And so, as that revenue waterfalls, that also helped. While not material, our BFS business continue to grow in the quarter as well.

Steve M. Ashley - Robert W. Baird & Co., Inc. (Broker)

Great. And then, you mentioned China, the expectation is that, that should normalize here in the second quarter. What gives you confidence or what leads you to believe that that's going to be the situation?

George E. Kilguss III - Senior Vice President & Chief Financial Officer

Well, I think the short answer is, as we look at the trends, we've seen the demand that happened in the second half of the first quarter kind of ebb and flow. So we saw it come. It was pretty strong for a few weeks and then it came back to more than normalized path. So we don't have a perfect crystal ball, but based on the trends that we've seen that we've been tracking, it seems to be back on the normalized path for that particular region, at least as what we've seen historically.

Steve M. Ashley - Robert W. Baird & Co., Inc. (Broker)

Great. That's helpful. Thanks.

Operator

Our next question comes from Sterling Auty with JPMorgan.

Unknown Speaker

Hi. This is (14:37) for Sterling. Thanks for taking my questions. I wanted to ask about the Japanese IDN, which I believe is in the (14:44) space. (14:45) at this point, are you able to disclose the pricing for the registry fees and also what will be the subsequent IDN fee – what will the subsequent IDN fee priced similarly? Thanks.

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

I'm sorry but that was completely unreadable on our end. I don't know if you are on a cell phone, but none of us in this room could get a word of it, I apologize.

Unknown Speaker

Hello. Can you – is this better?

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

Oh, that's much better.

Unknown Speaker

Sorry. I'm sorry about that. Yeah. Just quickly, I wanted to ask about the Japanese IDN. Are you able to disclose the pricing for the registry fee at this point? And will the subsequent IDNs be priced similarly?

Todd B. Strubbe - Chief Operating Officer & Executive Vice President

Well, so in Japan – hi, this is Todd Strubbe. In Japan, we are currently in our limited release one phase and we enter a GA in June. Our pricing right now has a combination of base pricing and we have lunched premium pricing, so it's a combination. Our general availability pricing is established at $8 for the registrars and then has several tiers associated with premium pricing.

Our Korea launch, we just announced, will go into Sunrise phase in May, as Jim said, with the targeted general availability for both Korea streams, the .com and the .net, in late August. And that pricing will likely be very similar to what we have priced in Japan.

Unknown Speaker

Very helpful. Thank you.

Operator

We'll hear next from Gregg Moskowitz with Cowen & Company.

Gregg Moskowitz - Cowen & Co. LLC

Okay. Thank you very much, and good afternoon, everyone. Out of the 2.65 million net names that were added in the quarter, about how much of that came from Asia-Pac?

George E. Kilguss III - Senior Vice President & Chief Financial Officer

So, we don't break out the gross adds by particular region, but what I can tell you is the incremental names that happened in the quarter that were – kind of surprised us was about a million names. So about a million incremental names in the quarter were over and above the trend line that we typically see in China.

Gregg Moskowitz - Cowen & Co. LLC

Okay. And I guess, George, just getting back to your commentary on the ebbs and flows with respect to the second half of Q1 in China. If we sort of think back to Q4, if I recall, you had an extremely strong first six weeks in that quarter and then the activity seemed to die down quite a bit as well. Is the thought on normalization in Q2 a function of seasonality being stronger in Q1 versus Q4? I guess just any commentary there would be helpful.

George E. Kilguss III - Senior Vice President & Chief Financial Officer

Yeah. Clearly, seasonality has some to do with it. Q2 tends to be a little bit less than Q1. Q1 does tend to be our strongest quarter. But when we look at the trends from that particular market, it just deviated from the normal trend that we were expecting. And then again, subsequent to the end of the quarter, it came pretty much back on our expectations. The only other color I can give you is that, in fourth quarter when we saw the demand coming out of China, that was pretty broad spread across many TLDs and across frankly many of our own TLDs, whereas the one that happened in Q1 was fairly localized to .com. I don't have intelligence for all the other TLDs per se, but I can tell you, it was much more centered at .com than the Q4 event.

Gregg Moskowitz - Cowen & Co. LLC

Okay. Great. Thanks. And then just one last question. I guess either for Jim and George. So just in light of the net adds activity in Q1, and then if I take the midpoint of your Q2, new name guidance, based on my math, it looks like the high end of your new 2016 guidance for unit growth, which would be 2.5%, it looks like that would actually imply if I'm not mistaken, net deletions not only for the Q4 as you outlined in your script, but in fact for the entire second half. And just wondering if you could help me understand, I guess, why the unit growth guidance for the full year would not be higher than 1% to 2.5% or is it just a function of conservatism?

George E. Kilguss III - Senior Vice President & Chief Financial Officer

Well, just again in Q4 since the number of incremental names was so strong, we had about 3.5 million incremental names out of a total of 12.2 million. We hadn't seen that level of activity from the investment community over there. And so, it's a little bit of a unicorn. We're not exactly sure what the renewal rates are there. And so, we're just being, I think, prudent as to estimating what renewal rates can be, because we don't quite have an experience with that particular segment of that base and how they'll perform.

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

I think you need just think of it as a conservative approach to forecasting in a situation where we have a situation arising in Q4 that we just simply haven't seen before. We have a lot of data, and we have a lot of forecasting tools, but I think you should view that forecast in that light.

Gregg Moskowitz - Cowen & Co. LLC

Okay. That's helpful. Thank you, guys.

Operator

Our next question comes from Walter Pritchard with Citi.

Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)

Thanks. Could you help us understand as you look out at maybe 1Q 2017? I know you're not providing 2017 guidance in total. But do you expect kind of the same dynamic in that period to persist from what you're seeing in 4Q given the overage in registrations coming out of Asia in the current or in the most recent reported quarter?

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

I think it's just too early to speculate as to what will happen in Q1, but certainly what happened in Q1 of 2016 is very different than what happened in Q4 of 2015. So, the impact that we're anticipating in Q4 of 2016 really wouldn't be the same in the subsequent quarter. And I think it's sort of a favorable development that there's more of a concentration of .com registrations in the sort of increase in activity in Q1 of 2016

So, it's early to say, but I think there's just a larger number of renewing names, that ratio that exists in Q4 of 2016 is not very likely to be the same in subsequent quarters, it almost certainly won't.

George E. Kilguss III - Senior Vice President & Chief Financial Officer

And the only other thing I'll say is that – when we start seeing these names start to renew late in Q3 and Q4, we'll get some additional information that will help us to answer that question for Q1 and when we provide guidance on our fourth quarter call.

Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)

Okay. Great. And then, just as, Jim, as it relates to the contract processes, you said you're in the final stages there. I assume the next stage here would be a posting of that contract and – posting the agreements in the public comment period. And could you just let us know what your expected dates are to have that process wrapped up?

D. James Bidzos - President, Chief Executive Officer & Executive Chairman

Yeah. I can't speak for all the parties involved. So, I can't give you a date. I can just tell you that we've moved down the road in drafting the agreement and we're much further along in that process and we certainly are making progress and I'm sure that, we'll certainly know more by the next time we talk to you in the following quarter, and it's very possible that something could happen before that.

Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)

Okay. And then just last question for George, on the guide for the year, you did raise your revenue guidance on the back of the strengthened demands. You didn't change your margin guidance, is there a corresponding increase in spending that you're pushing through or what else would explain the difference between higher revenue and margins not going up?

George E. Kilguss III - Senior Vice President & Chief Financial Officer

Looking in our business with the recurring revenue model, we're clearly looking to continue to drive growth that we see various opportunities in various markets and we're trying to be flexible in making investments and marking to drive additional growth. And so we're always putting plans in place for future periods.

We do have some variable costs, as it relates to the fees that are charged for domain names that we pay to ICANN as these fees right up, so we do have some variable costs there. And if you look at some of our costs quarter-over-quarter, we have been investing in the business, but, yeah, I think, what you should imply is that as revenue grows, we're looking to invest in the business and maintain margins in the range we guided to.

Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)

Great. Thank you.

Operator

We'll take our last question from Gray Powell with Wells Fargo Securities.

Gray W. Powell - Wells Fargo Securities LLC

Great. Thanks for taking the questions. Just a couple. So how should we think about the pace of internationalized.com and .net trans order agents (24:27) coming on or going GA over the rest of the year? And do you have any indications of early demand?

George E. Kilguss III - Senior Vice President & Chief Financial Officer

I think, Gray, and I think it's just too early. The limited release phase that we're in right now, those who are able to buy the .komo (24:53), the Japanese name, are limited to those who have the .com and they have to do that sort of the registrar, they have the .com, so the combination of those two has limited the addressable market in that limited release phase. So we'll really start to see once we hit general availability in the June timeframe and the 30, 60, 90 days after that. Same thing with Korea. Korea will be different in that we have both a .com and a .net there, so that will be the first time we'll test both of those strings in that market. And our follow-on plans past Korea, we're working on them and as we learn from Japan and Korea, both will help determine what we do next.

Gray W. Powell - Wells Fargo Securities LLC

Can any of those strings hit in the second half of the year or is it just too early to say?

George E. Kilguss III - Senior Vice President & Chief Financial Officer

I think we're – we would be targeting probably two more strings by the second half of the year, maybe a third. So, we – that would be the high level plans, I'd say, but still not ready to share those yet.

Gray W. Powell - Wells Fargo Securities LLC

Okay, fair enough. Thank you very much.

Operator

At this time, I'll turn the call back over to David Atchley for final comments.

David Atchley, CFA - Vice President, Treasury & Investor Relations

Thank you, operator. Please call the Investor Relations department with any follow-up questions from this call. Thank you for your participation. This concludes our call. Have a good evening.

Operator

This does conclude today's conference. Thank you for your participation. You may now disconnect.

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