VeriSign's (VRSN) CEO Jim Bidzos on Q2 2016 Results - Earnings Call Transcript

| About: VeriSign, Inc. (VRSN)

VeriSign, Inc. (NASDAQ:VRSN)

Q2 2016 Earnings Conference Call

July 28, 2016, 04:30 PM ET

Executives

David Atchley - VP, IR

Jim Bidzos - President & CEO

Todd Strubbe - EVP & COO

George Kilguss - EVP & CFO

Analysts

Walter Pritchard - Citigroup

Matt Broome - Cowen and Company

Sterling Auty - JPMorgan

Steven Ashley - Robert W. Baird & Company, Inc.

Priya Parasuraman - Wells Fargo Securities

Operator

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

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

David Atchley

Thank you operator, and good afternoon, everyone. Welcome to VeriSign's second-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 second-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 and 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.

Jim Bidzos

Thanks, David, and good afternoon everyone. I'm pleased to report a solid first half of 2016 for VeriSign. Second-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 $286 million, up 9.1% year-over-year, and we delivered strong financial performance, including $161 million in free cash flow. We processed 8.6 million new registrations during the second quarter, and added 0.78 million net new names, ending with 143.2 million common net domain names in the 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 second quarter, we continued our share repurchase program by repurchasing 1.7 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 had been working on the Root Zone maintainer services agreement, and the .com registry agreement extension amendment. At the end of June, ICANN posted the RZMA for public review and the .com registry agreement amendment for public comment, after which our respective Boards of Directors will be asked to approve the agreements. After this, the .com RA extension amendment, which extends the term of the RA until November 30, 2024, will be sent to NTIA for review and approval, according to their processes.

I'll comment now on second-quarter operating highlights. At the end of June, the domain name base in .com and .net was 143.2 million, consisting of 127.5 million names for .com and 15.8 million names for .net. This represents an increase of 7.3% year-over-year.

In the first quarter of 2016, the renewal rate was 74.4%, compared with 73.4% for the same quarter of 2015. While renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal rate for the second quarter of 2016 will be approximately 73.7%. This preliminary rate compares favorably to 72.7% achieved in the second 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 second quarter, as we had anticipated, activity from registrars in China normalized.

Also, as discussed during the last two quarters, we still expect the fourth quarter of 2016 to be somewhat unique, as the expiring domain name base in that quarter will have a larger than normal 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 the last two quarters, deletions could exceed additions for the fourth quarter of 2016. Based on these and other factors, we expect the third-quarter 2016 net change to the domain name base to be an increase of 0.5 million, and between 0.5 million and 1.0 million names, and we are now forecasting full-year 2016 domain name base growth rate to be between 1% and 2%.

Lastly, today we announced an increase in the annual wholesale fee for a .net domain name registration, as allowed by our agreement with ICANN. As of February 1, 2017, the annual wholesale fee for a .net domain name registration will increase from $7.46 to $8.20. And now, I'd like to turn the call over to George.

George Kilguss

Thanks, Jim, and good afternoon everyone. Revenue for the second quarter totaled $286 million, up 9.1% year-over-year, and up 1.6% sequentially. During the quarter, 58% of our revenue was from customers in the US, and 42% was from international customers.

GAAP operating income in the second quarter totaled $176 million, up 18.3% from $149 million in the second quarter of 2015. The GAAP operating margin in the quarter came to 61.5%, compared to 56.7% in the same quarter a year ago. GAAP net income totaled $113 million, compared to $93 million a year earlier, which produced diluted GAAP earnings per share of $0.87 in the second quarter this year, compared to $0.70 for the second quarter last year.

As of June 30, 2016, the Company maintained total assets of $2.3 billion, and total liabilities of $3.4 billion. Assets included $1.9 billion of cash, cash equivalents and marketable securities, of which $609 million were held domestically, with the remainder held abroad.

I'll now review some additional second-quarter financial 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.

Second-quarter non-GAAP operating expense, which excludes $11 million of stock-based compensation, totaled $99 million, as compared to the $103 million in the first quarter of 2016, and $102 million in the same quarter a year ago. The sequential decline in expenses is primarily a result of seasonally lower employer payroll tax withholdings in the quarter.

Non-GAAP operating margin for the second quarter was 65.4%, compared to 61.3% in the same quarter of 2015. The improved margin performance in the quarter was aided by our strong net add performance in the first quarter, and the timing of some sales and marketing expenditures being moved to the second half of the year.

Non-GAAP net income for the second quarter was $119 million, resulting in non-GAAP diluted earnings per share of $0.91, based on a weighted average diluted share count of 130.6 million shares. This compares to $0.74 in the second quarter of 2015, and $0.85 last quarter, based on 133.3 million and 131.6 million weighted average diluted shares respectively.

Dilution related to the convertible debentures was 21.9 million shares, based on the average share price during the second quarter, compared with 17 million for the same quarter in 2015, and 21.1 million shares last quarter. The share count was reduced by the full effect of first-quarter 2016 repurchase activity, and the weighted effect of the 1.7 million shares repurchased during the second quarter.

Both operating cash flow and free cash flow for the second quarter were $161 million, compared with $175 million and $171 million respectively for the second quarter last year. With respect to full-year 2016 guidance, revenue for 2016 is now expected to be in the range of $1.130 billion to $1.140 billion, representing an annual growth rate of approximately 6.5% to 7.5%. This revenue guidance is narrowed from the $1.125 billion to $1.140 billion range given on our last earnings call. The 2016 revenue range reflects our current outlook and our updated expectation of full-year 2016 domain name base growth of between 1% and 2%.

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 still expected to be an expense of between $110 million and $116 million. Capital expenditures for the year are still expected to be between $35 million and $45 million.

Cash taxes for the year are also still expected to be between $10 million to $20 million, due to our domestic tax attributes, including cash tax benefits from our convertible debentures, substantially all of the expected cash taxes in 2016 are international. In summary, the Company continued to demonstrate sound financial performance during the second quarter. Now, I'll turn the call back to Jim for his closing remarks.

Jim Bidzos

Thank you, George. In closing, during the second quarter, we continued to protect, grow and manage the business, while delivering value to our shareholders.

Since the start of this quarter, the Company achieved two important milestones. First, we marked 19 continuous years of 100% availability of the .com and .net DNS. This peerless record is due to the expertise of our people, and our specialized infrastructure. As businesses and economic activity rely increasingly on digital infrastructure, availability will become more important.

Second, we were informed earlier this month by the Chinese government that we are now licensed to provide domain name registry services for .com and .net in the PRC. We believe that .com and .net are the first non-China based registries to be fully licensed in China.

We think 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 the most efficient manner. We will now take your questions, and operator, we're ready for the first question.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Walter Pritchard with Citi.

Walter Pritchard

Hi. Thanks. One question for George, and then for Jim. George, on the OpEx, when you did, looks like it was pretty constrained in the first half of the year, you mentioned some marketing programs. Is that typical with what you've done in past years?

It doesn't seem like they've really stepped down necessarily the margins in the second half, and I'm wondering how this year might be different in terms of what you're driving in the business.

George Kilguss

Sure, Walter. As you mentioned, if you look at our marketing expenses, sales and marketing expenses, they were actually flat sequentially, but they were down year-over-year by about $4 million. There are a number of programs that we run, some that we direct specifically that we take a look at, others that -- programs that we open up to registrars to submit programs to us.

As we evaluate some of those programs that come in for us, clearly we're looking at those to see if it's going to have the right impact for our business, and if it's going to generate positive returns for us.

Sometimes some of those programs that get submitted are not that attractive for us, and so we look to solicit additional proposals from registrars, as well as redirecting some of our programs. Depending on what's going on around the globe, as you might expect, there's a number of geopolitical things happening, and so we take those and other factors into place.

I don't think there's anything unique here, other than we do have some programs that we did not execute on in the second half of -- the first half of the year, and we expect to execute on those in the second half of the year. So we're expecting our sales and marketing expense to increase in the second half of the year.

Walter Pritchard

And then for Jim, on the IDNs, I know that Korea and Japan have rolled out, I think we're pretty early still in the process, but would love to hear any update on registration volumes, how we should maybe look at those in terms of the ramp of volumes versus what we see in other gTLDs, and any sort of update on that process.

Jim Bidzos

Sure, I'll let Todd give you a little color on the progress of our IDNs. I'll just say upfront that remember that we're roughly six months into our IDN program. We started in Japan. It was the very first one.

We're learning from that. We're working with partners and introducing new products. There are some infrastructure challenges, and that there are a lot of Internet applications that don't fully support IDNs, so there's some things that are continuing to develop. We try to strike a balance between adoption, growth and revenue.

So there are a lot of factors that go into this. It's a little bit early. I don't think we're going to be able to give you a lot of detail, but Todd, if you want to add anything to that?

Todd Strubbe

Not a lot of detail. Just we are launched in Japan, and we are in general availability. We launched in Korea earlier with two IDNs, and we're in our limited release phase there, and we'll go into general availability on August 30. We don't publish our zone there, but you can see the stats on places like nTLDstats.com.

Walter Pritchard

Got it. Thank you.

Operator

Thank you. Our next question comes from with Gregg Moskowitz with Cowen and Company.

Matt Broome

Thanks very much. This is Matt Broome on for Gregg. So you had very little zone growth in the month of July. Can you walk through why the net add activities have been a lot weaker than what we usually see, as well as what gives you the confidence that things will pick up over the rest of the quarter?

Jim Bidzos

Sure. As you point out, July we've had I think about 133,000 adds quarter to date so far. It's not that different from last year. We typically, when we look at the third quarter results we expect to pick up typically more in the latter half of the quarter.

That tends to be a trend that we've seen historically, at least. But right now, if you were to straight line the net adds that we've had, you'd come to about 453,000. Clearly, we're expecting that to pick up right around the quarter, just based on seasonal trends we've seen previously.

Matt Broome

Okay. Great. Out of the 780,000 net adds in Q2, roughly I guess how much of that came from China?

Jim Bidzos

We don't break out our net adds by country. China continued to perform well for us this year, but so did the US, which is clearly our largest market, and EMEA continued to perform well for us as well.

Matt Broome

Okay. And then just one last one, if you could -- well, what's the latest I guess on timing around the ICANN contract extension for .com? That's it from me. Thanks.

Jim Bidzos

Sure. The .com extension amendment to our registry agreement is out for comment. That period ends in -- on August 12. After that, the Root Zone maintainer agreement and the .com extension contract both will be -- need to be approved by VeriSign's Board of Directors and ICANN's Board of Directors.

After that, they'll be given to NTIA for approval according to NTIA's processes. The only firm date I can give you at this point is the close of the comment period on August 12, and then it's a series of approvals following that.

Operator

Thank you. [Operator Instructions] And we move next to Sterling Auty with JPMorgan.

Sterling Auty

Yes thanks. Hi guys. Just following on that line of questions, I frequently get the question as whether, as part of this process or maybe soon thereafter, would you revisit the pricing situation with the Department of Commerce and have the market study done again, or is that really going to be thought of as separate and maybe sometime down the road?

Todd Strubbe

Sterling, I assume you're talking about the opportunity available to the Company to pursue some review of our pricing?

Sterling Auty

Correct.

Todd Strubbe

That's what you're talking about? Yes, unrelated to the .com extension, unrelated to the Root Zone maintainer agreement. I really can't comment on when we would do that. I would say what I've said before in the past, that I believe that there is some data that's trending favorably for us, in that ICANN has now crossed over 1,000 new gTLDs delegated to the root.

I'm trying not to be too understated, but more than ample consumer choice for new gTLDs for consumers to choose from, and many of these TLDs are priced higher than .com. That data is helpful, but I really can't comment on when we might do that. I think there are a lot of factors we'd consider, and there's a process that we'd follow, but I'm not able to give you any information about exactly when we might do that.

Sterling Auty

Okay. That's fair. And then on the talk of the marketing programs that appear to be shifting to the second half, if I'm not mistaken, I think we were in a similar situation last year, and the year before. What is the drivers behind the timing of it? And can you remind us, did you end up spending those programs in the back half in each of the last two years, or in some cases, would you potentially decide not to spend that money?

George Kilguss

Well, I think in general, Sterling, look, if we can find marketing programs that generate positive rates of return for us and drive shareholder growth, I want to spend as much money in sales and marketing to accomplish that. Clearly, as we get a number of proposals, we offer these programs open to every single registrar, and so they're allowed to submit them. We have to evaluate them.

So we clearly want to make sure that the ones that we're pursuing and accepting meet certain financial criteria. To some degree, it really depends on the proposals that are being submitted to us. Others we direct, as I mentioned to an earlier caller, we're taking a variety of things into consideration.

We're marketing globally, we're looking at certain markets, and there are clearly are things that happen, whether it be, I don't know, a Brexit, or whether it be something that goes on in Turkey or other areas, we may choose to delay a program, or because of other factors outside of our control. So there's a variety of things that we take into consideration.

Last year we did spend more money. We did spend money in the second half of the year. But again, there's a variety of factors that come to lumpiness. Our intention is to invest dollars into the market that will drive incremental profitable growth for the business. So, hopefully that answers your question.

Sterling Auty

Yes, it does. Thanks guys.

Operator

Thank you. We'll take our last question from -- our next question from Steve Ashley with Robert W. Baird.

Steven Ashley

Thank you very much. I think I'd just like to ask the first question on the renewal rates, which have improved here, especially in the first quarter, but still at a good level here. Is that just mix of first-time renewals being lower as a percentage of total, or have you seen any change in first-time renewal rates there? Thank you.

George Kilguss

Yes, thanks for the question. So you're correct, our renewal rates are up about 1% year-over-year, our preliminary renewal rate in the quarter is 73.7%, as Jim mentioned, up from 72%. The improvement we're seeing is primarily in the previously renewed rate. That's up about 80 basis points year-over-year from about 82.7% a year ago to 83.5% this year.

And that improvement in the previously renewed rate, we're seeing that both in U.S. and international markets. On our first time renewal rate, it's also up slightly, but we're primarily seeing that improvement in the U.S. market. On average, that first-time renewal rate is still around the 50% range, though.

Steven Ashley

Okay. Gross margins, 83.6%. I think that's the highest number we may have ever seen. What is contributing to that improvement? Is that sustainable?

George Kilguss

Again, Steve, we look to manage all our expenses, not particularly a particular line item -- in a particular line item. I mean, we've also had slightly lower registration fees in the second quarter versus the first quarter. So because there tends to be more new names in the first quarter, we tend to have higher registration fees for ICANN, than we have in the second quarter.

So it's a little seasonal dip there from that. But we continue to look at our expenses across the board, add resources where we feel it's appropriate, but in total, we're really focused on that total non-GAAP operating expense as a key metric that we're looking to manage.

Steven Ashley

And in terms of the range of outcomes we could see from the Department of Commerce, if we get through the Board approval of VeriSign, if we get through the Board approval of ICANN, if this is sent to the Department of Commerce for approval, is the range of outcomes either thumbs up or thumbs down, or could they separate the two, and say we're willing to do the Root Zone but .com we want back on the old schedule? I'm just wondering if you have any color around that.

Jim Bidzos

The fundamental rationale for the two agreements is addressing the priority, as called for by NTIA of security and stability in the Root Zone. And that's the reason that the .com agreement is being extended, so that it can be coterminous with the Root Zone maintainer agreement. The two agreements are related in that sense.

So hopefully that helps you understand that the two agreements are really part of an effort to provide security and stability during this transition process of Root Zone oversight from NTIA to ICANN. I think in that sense, you view them as part of an effort to assure security and stability during a transition process.

Steven Ashley

Thank you.

Jim Bidzos

Sure.

Operator

Thank you. We will take our last question from Gray Powell with Wells Fargo.

Priya Parasuraman

This is actually Priya Parasuraman for Gray. Just a quick one from me. Could you talk about what's going on in China and whether you expect things to normalize there, and does the fact that you've been licensed change anything?

George Kilguss

Sure, Priya. As we talked about last quarter, we did expect the China volumes to normalize and at least in the second quarter, they absolutely did normalize for us. So at least what we're currently seeing is those are at much more normal levels. As far as the license agreement, I don't really -- I don't have any particular expectations.

We've always operated in China. We've done well there. I think our brand is quite strong there. I don't really have any change of expectation, just related to the license, to how we perform. Anything you want to add, Jim?

Jim Bidzos

Yes, I think the license is important, but we have been operating with the approval of the Chinese government for a period of time, as they introduce new processes for their local registrars to follow. There was a new licensing regime that was announced some time ago.

We've been in that process for a period of time, and as I mentioned in my earlier remarks, we now are the -- as far as we know, the first registries, .com and .net to be approved. So we are licensed for those registries to operate in China, which is important, although we did expect that process would yield the result that it did.

So I don't see any interruption in the availability of our products and their operation in China, so I think it's certainly an important milestone for us, but one that we've been working with the Chinese government on for a period of time. That in and of itself I don't expect to change anything from the registrant point of view. It just simply enables to registrars to comply with local law.

Priya Parasuraman

Thank you.

Jim Bidzos

Sure.

Operator

Thank you. That concludes today's question-and-answer session. Mr. Atchley, at this time, I will turn the conference back to you for additional or closing remarks.

David Atchley

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 our presentation. We thank you for your participation.

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