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Executives

David Atchley - Corporate Treasurer

D. James Bidzos - Founder, Executive Chairman, Chief Executive officer and President

George E. Kilguss - Chief Financial Officer

Patrick S. Kane - Senior Vice President and General Manager of Naming Services

Analysts

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Philip Winslow - Crédit Suisse AG, Research Division

Walter H. Pritchard - Citigroup Inc, Research Division

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

Daniel T. Cummins - ThinkEquity LLC, Research Division

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Gray Powell - Wells Fargo Securities, LLC, Research Division

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

Jaimin Soni - BofA Merrill Lynch, Research Division

VeriSign (VRSN) Q2 2012 Earnings Call July 26, 2012 4:30 PM ET

Operator

Good day, and welcome to the VeriSign Second Quarter 2012 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to David Atchley. Please go ahead, sir.

David Atchley

Thank you, operator, and good afternoon, everyone. Thank you for joining us on VeriSign's Second Quarter 2012 Earnings Conference Call. I am David Atchley, Director of Investor Relations and Corporate Treasurer. I'm here today with Jim Bidzos, Executive Chairman, President and CEO; George Kilguss, Senior Vice President and CFO; and Pat Kane, Senior Vice President and General Manager of Naming Services.

Please note that this call and accompanying slide presentation are being webcast from the Investor Relations section of our corporate website, www.verisigninc.com. Please refer to that website for important information, including the second quarter 2012 earnings press release. A replay of this call will be available on the website within a few hours. Today's slide presentation will also be available for download after the call.

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.

I would like to remind you that in light of Regulation FD, VeriSign retains its long-standing policy to not comment on financial performance or guidance during the quarter, unless it is done through a public disclosure. The financial results in today's press release 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 press 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. Unauthorized recording of this conference call is not permitted.

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

D. James Bidzos

Thanks, David, and good afternoon, everyone. The second quarter was another solid quarter for VeriSign, and we're pleased with the results. In Naming, we processed 8.4 million new registrations in Q2, a second quarter record, while adding 1.81 million net names, finishing the quarter with 118.5 million names in the domain name base. We were also able to achieve ongoing operating margin expansion through disciplined operations. Our balance sheet remains strong with $1.4 billion in cash and marketable securities.

During the second quarter, we continued our share repurchase program by repurchasing 1.9 million shares for $76 million. Thus far, in 2012, we have repurchased approximately 3.7 million shares or about $144 million, and we have approximately $687 million remaining in our share repurchase program, which has no expiration. We continually evaluate the overall cash and investing needs of the business and consider the best uses for our cash, including potential share repurchases.

On June 23, 2012, ICANN approved the renewal of VeriSign's agreement to service the operator of the .com registry for the term commencing on December 1, 2012, through November 30, 2018. As you may know, the .com renewal agreement terms, including the pricing provisions, are substantially the same as the terms contained in the existing agreement, except for new provisions regarding indemnification and audit rights.

The U.S. Department of Commerce, under an agreement called the Cooperative Agreement, is now reviewing the renewal of the .com registry agreement. We expect their approval on the renewal of the .com agreement by November 30.

During the month of July, we marked 15 years of uninterrupted uptime for the .com and .net zone infrastructure. This is a tremendous achievement and I would like to recognize the efforts of our engineering and operation teams for meeting this milestone. We continue to make protecting our DNS infrastructure a priority, while continuing to meet and exceed requirements of our service-level agreements.

I'll comment now on second quarter operating highlights. In our Naming business, the base of registered names in .com equaled 103.7 million names, while .net equaled 14.8 million names. The total base of registered names in common net was approximately 118.5 million at the end of June. This represents increases of 7.8% year-over-year and 1.6% quarter-over-quarter.

In the second quarter, we added 1.81 million net names to the domain name base and we processed 8.4 million new registrations or a 4.2% increase in new registrations over the same period a year ago.

The first quarter of 2012 renewal rate was 73.9%. 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 2012 will be approximately 72.9%. This rate compares to 73.1% achieved in the second quarter of 2011.

While Q2 is our second strongest quarter on record for new registrations, our net names added to the domain name base was at the low end of our guidance, primarily driven by what appears to be a softer-than-expected preliminary Q2 renewal rate. Our first time renewal rate was the main driver of the decrease in the preliminary second quarter renewal rate. First time renewal rates are driven by many factors, and 2 factors had incremental impacts in the second quarter.

First, search engine adjustments made over the past several months affected the economics, which drove domain monetization rates in the first half of 2012. While monetization rates have increased for better performing sites, lower performing sites do not seem to be benefiting. We believe that some of these first time renewing, lower performing sites did not renew during the quarter as a result of these changes, leading to the lower renewal rate. We have seen these search engine changes in the past and the resulting impacts on first time renewing names and our overall renewal rate. Historically, the domain monetization community has adjusted within several months.

Secondly, we also believe that some additional promotional activity by registrars during the middle of 2011 led to a lower first time renewal rate this year. We expect the third quarter net names added to the base to be between 1.6 million and 1.9 million names, reflecting continued growth in the underlying drivers of the Internet and seasonality.

Also, please note that starting tonight, we will make available a summary of the number of active domain names registered in the .com and net registries and the number of .com and .net domain names that are registered but not configured for use in the respective top-level domain zone file. This information will be available from links on our corporate and Investor Relations website, which will also include definitions and explanations of the data. This additional information will continue to increase transparency into the overall size of common net zones as well as increase the frequency that this summary level information is available.

Our NIA business continues to exhibit steady year-over-year bookings growth. We are focusing our efforts to scale the NIA business to achieve quality of revenue and stable growth while better aligning expenses with revenue.

Now, let me turn over the call to our CFO, George Kilguss.

George E. Kilguss

Thanks, Jim, and good afternoon, everyone. I'm pleased to be with you today and to now be part of the VeriSign team. For the 3 months ended June 30, 2012, the company generated revenue of $214 million, up 13% from year-ago level and 4% sequentially. Of note, during the second quarter, revenue included an out-of-period adjustment that reduced revenue by reclassifying approximately $1.8 million from previously recognized revenue back into deferred revenue. Without this onetime reclassification, revenue would have approached $216 million in the quarter.

During the quarter, the company also delivered GAAP operating income of $107 million, up 30% from $82 million in the second quarter of 2011. GAAP operating margin in the quarter also improved to 50%, up from 43% from the comparable period a year ago, which was a result of expenses remaining relatively flat from year-ago levels. GAAP net income totaled $68 million compared to a GAAP net loss of $11 million a year earlier.

As Jim mentioned, our balance sheet remains strong. As of June 30, 2012, the company maintained total assets of $1.9 billion, of which $1.4 billion was in cash and marketable securities. Of this $1.4 billion total, approximately $250 million was domestic with the remainder held overseas.

Total liabilities were $2 billion as of the second quarter, up slightly from $1.9 billion at year end. Total debt on the balance sheet was $698 million at quarter end, consisting of $100 million of outstandings drawn under our $200 million credit facility and the $598 million present value of our $1.25 billion in convertible debentures. The convertible debentures will continue to be accreted onto our balance sheet to its $1.25 billion face value over its 25-year remaining term.

Let me now recap our performance for the second quarter for our key operating metrics, which are revenue, deferred revenue, non-GAAP operating margin, non-GAAP earnings per share, operating cash flow and free cash flow, then I will discuss our 2012 full year guidance.

As mentioned, revenue totaled $214 million in the second quarter, up 13% year-over-year. Approximately 60% of our revenue was derived in the U.S. and 40% was from foreign operations. Revenue from international sources grew 14.7% in the second quarter compared to the same quarter a year ago and slightly faster than our domestic-sourced revenue, which grew 11.6% for the same comparative period. Deferred revenue ended the quarter at $804 million, a $75 million increase from year end and $90 million increase from the second quarter of 2011.

Second quarter non-GAAP operating expenses, which excludes $8.5 million of stock-based compensation, totaled $99 million and was flat sequentially.

Non-GAAP operating margin for the second quarter continued to expand and totaled 54% compared to 51.9% in the first quarter of 2012. Our second quarter operating margin improvement was driven by revenue growth and our ability to keep expenses in line with the previous quarter. We will continue to look for further efficiencies in our business model and other ways to improve our operating margin.

Non-GAAP net income for the second quarter was $74 million, resulting in a non-GAAP diluted earnings per share of $0.45 compared to $0.38 in the second quarter of 2011 and $0.42 last quarter.

Now I would like to update you on our taxes. As mentioned earlier, our international markets are growing slightly faster than our domestic markets. As a result, the proportion of income being generated overseas is also increasing. Our foreign income is taxed at a lower marginal rate than our domestic income that we expect to see an improvement in our blended tax rate over time. Accordingly, we believe a more reasonable estimate of our non-GAAP tax rate would be 28% going forward, down from our previous estimate of 30%. We expect to use a 28% non-GAAP tax rate when reporting third quarter 2012 non-GAAP results.

In 2012, we now expect to pay cash taxes of about $35 million to $45 million.

We had a weighted average diluted share count of 164 million shares in the second quarter compared to 163 million shares in the first quarter of this year. Dilution related to the convertible debentures was approximately 5.6 million shares based on the average share price during the quarter, an increase of 3.1 million shares from Q1. This increase was partially offset by the full impact of Q1 share repurchase activity and the weighted impact of the 1.9 million shares repurchased during the current quarter.

Operating cash flow was $135 million for the quarter, up from $110 million in Q1 of this year and up compared to $13 million for the same quarter last year, which included a $100 million contingent interest payment to convertible bondholders. Free cash flow was $130 million for the second quarter of 2012, including $8 million in excess tax benefits from stock-based compensation and excluding $13 million in capital expenditures in the quarter.

With respect to 2012 guidance, we now think revenue for 2012 should be in the range of $870 million to $880 million, representing an annual growth rate of between 13% and 14%. We previously gave a range of $870 million to $890 million on the last call.

Non-GAAP gross margin is still expected to be at least 80%. Q4 2012 exit non-GAAP operating margin is now expected to be at least 55%. We previously gave a lower range of 52% to 54% on our last call. Non-GAAP interest expense and non-GAAP nonoperating income net is now expected to be an expense of approximately $39 million for 2012 compared with the $38 million estimate given on our last call.

And finally, capital expenditures for the year are now expected to be slightly lower and fall between 6% and 8% of revenue. We gave a 7% to 10% range on the last call.

Our guidance is based on expectations of continued growth and increased operating efficiencies in our business in addition to our financial projections for interest income and expense.

In summary, we continue to experience solid performance in the second quarter. We have grown non-GAAP operating income and net income, we have maintained a strong balance sheet and expect strong operating cash flow generation to continue as a result of our financial model.

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

D. James Bidzos

Thank you, George. And before opening the call to your questions, I would like to share with you how we're thinking about the business across the 4 areas of focus that we believe will drive value creation. These 4 areas are to protect, grow, innovate and manage the business effectively. First, we protect the business by providing unparalleled registry services and network performance while acting as responsible stewards for the Internet infrastructure which we operate. We'll also continue to work with the Department of Commerce towards the renewal of our .com agreement.

Second, in addition to the organic growth of our Naming business, we see new gTLDs in our NIA business as adjacent potential growth opportunities.

Third, we continue to focus on innovation and value creation through new services that we can build around the domain name system.

And fourth, we believe in managing the business responsibly from a financial perspective. We seek to run the business efficiently and effectively through managing costs and continued margin improvement.

We believe that delivering on these 4 areas with a right balance should provide unparalleled performance for our customers and create value for our shareholders.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from Sterling Auty from JPMorgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

You mentioned the search engine changes heading the renewal rate, can you give us more color on that as well as was there anything else going on during the quarter that may have impacted the renewal rate?

D. James Bidzos

Yes, Sterling, it's Jim. We think there were 2 main things that drove the slight reduction in the renewal rate. First of all, we mentioned that promotion by a large registrar that was very aggressive and led to an unusually larger number of first time renewing names, which I think, coupled with the changes in the search algorithm were the primary contributors to the reduced renewal rate. The monetization community out there has a history. This has happened before. It happened, as you recall, in 2008, and they have a history of rebounding. They generally sort of adapted the changes after 1 quarter or 2 at most. So we expect that to happen in this case, and all of that is factored into the guidance that we gave.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

All right. Great. And you mentioned the 8.4 million new names that were added, can you give us a sense whether maybe international versus domestic, what kind of trends you're seeing in the new name portion of the net names?

D. James Bidzos

Yes. First of all, we obviously don't guide that to new adds, but I will say that -- point out that 8.4

million names is a record for the second quarter and the second highest overall. And I would like George to comment on the impact of domestic versus international.

George E. Kilguss

Sure, Sterling. As I mentioned in my prepared remarks, we're really seeing the international markets grow a little faster than domestically, and they grew 14.5% in the comparable period versus 11.6% domestically. So I think if you use those revenue growth rates, that should give you a consistent idea of the growth that we're seeing internationally versus domestic.

Operator

Our next question will come from Phil Winslow with Credit Suisse.

Philip Winslow - Crédit Suisse AG, Research Division

Just a question on margins and then just the domain name guidance. Obviously, you guys have another big margin quarter this quarter and you raised the full year outlook or, I guess, ending -- end-of-the-year outlook. When you think about just your margin structure here, can you give a sense just for anything sort of just the incremental margins are? And especially when you get into potentially the renewal season next year, what are some of the changes to the contract and incremental fees just if that changes at all? And in terms of just the guidance for Q3 for net adds, just wondering what was behind that? Did you assume somewhat lower first year renewal rates or just what was baked into that?

George E. Kilguss

Sure, Winslow, this is George speaking. So with regard to operating margin, clearly, we just updated our guidance to exit fourth quarter at least 55%. I think if you look back historically at how we've done from a margin expansion perspective, it's really come from our revenue growth. We've historically been a pretty good shepherd of our funds and maintaining our operating expenses in line, while we've had growth in between marketing or in between R&D. You've seen, we've managed that expense pretty well. As it relates to net adds guidance, clearly, as Jim mentioned, there have been some changes in the search algorithm and that typically takes a few quarters to wash through. And so we're just reflecting that experience into our current guidance for Q3.

D. James Bidzos

Yes, Phil, this is Jim. I think you'd also asked about ICANN fees next year and its potential impact on margins. I guess I'll leave the math to everyone, but basically the changes in the ICANN .com contract took us from annual fees of roughly $17 million based on an alignment now. The change aligns us with their other registry agreements and it essentially puts us, based on a zone of roughly 100 million names, at about $25 million per year. So roughly $8 million additional ICANN fees in 2013 anticipated.

Operator

We'll now go to Walter Pritchard from Citi for our next question.

Walter H. Pritchard - Citigroup Inc, Research Division

Just wanted to ask about the small reclassification of revenue back to deferred revenue. What was the driver there and is this something that could recur in the future?

George E. Kilguss

Sure, Walter. The $1.8 million nonrecurring revenue charge was related to a system error of the seldom use feature in our revenue recognition database. One of our secondary controls caught the error in our quarterly review process and we made the out-of-period adjustment this quarter. We fixed that system issue, and we've actually implemented a number of additional processes and procedures to avoid this problem from recurring in the future.

Walter H. Pritchard - Citigroup Inc, Research Division

Great. And then just on the renewal rate, I guess, I understand we've seen the search engine changes in the past, and I'm just wondering why you only saw it in the first time renewals and not in the base. It would seem like there probably were some names in the base as well that might have been infected by changes to the search engine and might have also had a lower renewal rate as the result?

Patrick S. Kane

Yes, Walter this is Pat. So we did see it across both the first time renewing names and the previously renewed names, but we saw a larger impact in the first time renewing names.

Operator

And we'll now go to Steve Ashley with Robert W. Baird.

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

In terms of new gTLDs, did you run the expenses for those applications through the P&L this period? And is there anymore expense that we should expect from that in the future?

George E. Kilguss

Steve, no. We recorded most of that expense in Q1. There was, I think, one application that we did incur in Q2, but most of that hit our sales and marketing expense last quarter.

Steven M. Ashley - Robert W. Baird & Co. Incorporated, Research Division

Great. And then I wonder if you could just talk maybe qualitatively about your thoughts on the timing of the next price increase, what kind of considerations would go into that?

D. James Bidzos

Yes, this is Jim. Well, I think it's a bit early probably for us to talk about that. I think every time an opportunity comes for us to know, there's a price increase. We have to take into account the considerations that surround the business. And I guess it's premature really to talk about that. Assuming that, and as we do expect that the .com contract will receive consent from the Commerce Department for the renewal and be effective no later than November 30, then the first opportunity to do so would be in December. So I think we probably be in a better position to talk to you about that then, what the factors, the economic factors, the climate would be and give you some more information then, but I think it's premature at this point.

Operator

And we'll now take a question from Dan Cummins from ThinkEquity.

Daniel T. Cummins - ThinkEquity LLC, Research Division

Question for Jim on your strategy around the Managed Security Services. How is that going? Are you pleased with the progress? And does your higher year-end profit projection reflect any change in your investment posture around some growth initiatives?

D. James Bidzos

Okay. I assume when you said MSS, you meant NIA or am I...

Daniel T. Cummins - ThinkEquity LLC, Research Division

Yes, exactly, the NIA. Exactly.

D. James Bidzos

Okay, okay. Yes, we are still achieving bookings growth as we've planned for that business. I did mention in the last couple of calls and I mentioned again in this call that we are working to scale that business better for the quality of revenue that's more consistent with what we get from our Naming business. And I also mentioned in this call, which I've not mentioned before, that we are looking at ways that we can align expense with revenues. So I think those are some -- we don't break it out separately, of course, but I think that should give you a feel for where we're going with that business.

Daniel T. Cummins - ThinkEquity LLC, Research Division

And does it still figure somewhat in your M&A strategy or potential M&A strategy? I know you said before it's a market you like very much and you've mentioned before the problems associated with finding quality revenue.

D. James Bidzos

Yes, I would say our M&A policy is unchanged and whether it applies to that or any other part of our business, it's the same. We would certainly look at opportunities, if they helped us get on our product roadmap or our strategy faster. We do not have M&A on our radar. That is not part of our strategy. We don't view M&A as a strategy. I think what you should expect from us is if there was a small tuck-in opportunity, we'd look at it, if it helps us accelerate our strategy, but that would be the only reason.

Operator

We'll now go to Rob Owens from Pacific Crest.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

On the revenue reclass, the $1.8 million, was that a cumulative number that you just effectively took in this period or was that something that was an error relative to this period?

George E. Kilguss

Rob, yes, that was a cumulative, I'll call it, error that we accounted for in this period. So approximately -- of the $1.8 million, approximately $1 million is related to 2011 and the balance was related to first quarter of 2012.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Okay, great. And I apologize if I missed this, but what was the net new names guidance for Q3? Was that given earlier on the call?

D. James Bidzos

Yes it was. It was 1.6 million to 1.9 million.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Okay, and sorry about that. We're managing multiple calls. And then lastly, what are names up for renewal in Q3? Do you have that metric in front of you?

D. James Bidzos

Let's see if we can find that. John do you have that?

George E. Kilguss

This is George. I think it's 23.7 million names that are renewing in the third quarter.

Operator

[Operator Instructions] We will now take a question from Gray Powell from Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Just had a couple of quick questions. So I guess longer term, assuming that the .com renewal goes according to plan, once you have that visibility on the next 6 years of revenue, how should we think about your comfort with leverage and potentially increasing your leverage target?

George E. Kilguss

Sure, Gray, this is George. So I would start by saying that, look, I've been in the chair for about 2 months, so we'll continue to take a look and evaluate our capital structure, and this will be something we'll be spending some more time on over the next few quarters. But I can give you maybe a few thoughts that I have developed over the past 2 months. On the leverage side, and being a former lender earlier in my career, I tend to look at the total debt obligations outstanding the company has compared to its EBITDA as a measure of leverage. And when I look at VeriSign, we have, as you know, a $1.25 billion convertible bond plus about $200 million revolving credit facility, so somewhere between $1.35 billion and $1.45 billion of total outstanding debt and commitments today. If you were to simply annualize our second quarter EBITDA and then compare that to the debt level that we have, you probably get a ratio of somewhere between 2.6 or 2.8x. And so the real question we need to answer, as a firm, over the coming quarters is, what is the appropriate leverage ratio for the business. We clearly have some debt capacity, but it's really all a matter of what is the appropriate risk profile for the business. So we'll have to do some more work to do on that, but that's really the current framework that I'm thinking about the debt that we have on the books and some thoughts around our capital structure.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it, that's very helpful. And then just one other question, if I can. What kind of investments should we expect you to incur to support the new gTLDs that you recently won? And should we think about that showing up as -- or I guess when should we think about that showing up as incremental CapEx or OpEx?

George E. Kilguss

Well, clearly, we'll have some incremental cost in bringing those on. I think what we really have to do is to wait for ICANN to go through their process and their approval process, then we'll have a definitive idea of who's been awarded what names. But clearly, we will have some incremental expense to do that. But again, that probably won't affect too much of 2013. But we'll probably give you more information and guidance to that on our fourth quarter call as we give guidance for 2013.

D. James Bidzos

Yes, I would just add to that, that we talked last quarter about the numbers. The number was 220 brands that had signed on to have VeriSign run their back-end registry services, and that number was the result of a process as Pat mentioned in the call last quarter. And I think, as I have mentioned as well, we actually did not take all the business that was available to us there. We do have the benefit of a long history of operating experience, a long reliability record and plus the fact that we just don't run common net, we run under other domains as well. We run .tv and .name and we have a structure that lends itself to supporting this type of multiple domain structure. So I think we're very carefully prepared and positioned and more experienced than -- I think we have a pretty good view into this, so I think George's comments were accurate. And that first of all, we have to wait and see which applications actually get through and what the actual number is. But there was a lot of thought and a lot of process and a lot of careful consideration given to arriving at the 220 number. And so we feel comfortable that we're prepared and our structure is predesigned to support multiple domains. So I think we're in good shape.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it.

Operator

Our next question will come from Gregg Moskowitz from Cowen.

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Just a follow-up on the new gTLDs, curious if there's any update on the process just over the past 4 to 5 weeks from your vantage point? And then also if you have any thoughts as to when you think we could potentially go live?

D. James Bidzos

Well, I'll let Pat comment. I'll just say that we're currently at a point where now the application period is where the reveal is made and everybody sees the strings that are applied for. ICANN is now undertaking its evaluation of all of those applications. But at some point, there will be a process that yield to the ultimate results. And maybe for a little more color, I'll ask Pat to comment.

Patrick S. Kane

And so I think the one thing to keep in mind is that during the evaluation process, there's a lot of things will take place in terms of what ICANN does, what the government advisory committee does and we believe that there'll be additions to the root zone come Q2 of 2013 in terms of things that will be meaningful. It's at the top of the list.

Gregg Moskowitz - Cowen and Company, LLC, Research Division

Okay. And then we saw -- on another note, we saw the world IPv6 launch take place last month. Is there a point at which IPv6 could become a meaningful resonant opportunity for VeriSign? How do you think about that?

D. James Bidzos

Well, I don't know if I can tell you what that point is, but I think that gradually over time, helping our customers transition from IPv4 to IPv6 is certainly an opportunity for us and we are examining, as part of our innovation efforts, the opportunities that we have to add value to that transition process mainly around better security optimization. So we do see that as an opportunity, but I think it's too early to talk about when or exactly what it is.

Operator

We'll now go to Ed Maguire from CLSA.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

I just had a question about the inputs into the capital efficiency. Since you've raised your margin expectations and lowered capital expense guidance for the year, what's behind this? It looks like you're getting greater, greater efficiencies out of your current infrastructure?

George E. Kilguss

I don't think there's anything material behind it, Ed. We continue to be good stewards of the business. We're looking for ways to be more efficient in the business and drive increased profitability. I just think it's continuing being prudent of looking at projects, evaluating them and making sure that we're doing the best job for the shareholders as we can.

D. James Bidzos

I would add to that, that the 4 points of our strategy, protect, grow, innovate and manage, they are there for a reason. We focus on them and in manage, we try to manage the business efficiently. So there is this longer tail of the restructuring that we undertook 5 years ago. I know it's been quite a while since 2007 when we began the divestiture, but it was -- even though it was completed in 2010, there are many opportunities for us to optimize and to do our business more efficiently. When you go from greater than 5,000 employees to roughly 1,000, you don't fix everything overnight. So we're finding efficiencies, and I think that's reflected in our increasing margins.

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

Great. And I did want to follow up, you've made the comment about 220 registry agreements that you signed with the applicants. I'm just wondering if there's a possibility that might change or there are any of the contracts still up for potential bid and it sounds like you've also got a pretty high quality filter in terms of the agreements that you're seeking to go after, so any color there would be helpful.

Patrick S. Kane

Edward, this is Pat. So they're still talking about all the approval process, so that's 220 that we submitted at the end of the application window. So basically, there's no more applications that will be taken by ICANN at this point in time. But we know that we've got other unique services that we can provide to the registry operator, so it doesn't mean that the 220 we have today are the ultimate end set of what we do. But that being said, ICANN still has to approve all of these deals. They still sort of could -- it could go down.

Operator

[Operator Instructions] And we'll now go to Jaimin Soni from Bank of America.

Jaimin Soni - BofA Merrill Lynch, Research Division

Just wanted to go to back to margins quickly. Can you just, if you can, please tell us if the margins that -- are they tracking to your internal plan or are you beating those targets that you have internally? And then going forward, I was just wondering if there's anything that you think is stopping you from really taking this outside that you're getting in margins and investing it in other businesses like the NIA business? Is there some limitation on the scale or demand or some type of technological limitations? What now do you think is the barrier for further investments into other adjacent businesses that can potentially drive top line growth?

D. James Bidzos

John, it's Jim. Let me refer you back to this 4 pillar sort of strategy for managing the business. So protect, grow, innovate and manage. So you're referring to the part we think of as managing the business efficiently, which is where margin expansion will occur. The answer to your question is that we don't really think about it as any single or some number of barriers to increasing margins. We think of it as a balance across those 4 areas. Job one is to protect the business. We have growth areas we've committed investments in. That's all baked into our guidance on margins. We think that we have intellectual capital and intellectual property that we can exploit in innovation, which doesn't require great investment, no great capital vestment. And so what you get through that process of balance is the guidance that we gave you in margins. So I think what you're seeing is sort of a steady growth in margins based on, essentially, a thoughtful balance across those 4 areas of our resources. So I really don't think of it as a single barrier. George, do want to comment further?

George E. Kilguss

I would just say that the company's also commented in previous calls on the long tail of the restructuring. And you can never know until you actually go through the quarter as to what other efficiencies you may obtain. So clearly, obviously, we have guided 52% to 54%, and now we've increased that guidance to 55%. So we're just seeing those efficiencies come out of the business as we manage it on a day-to-day basis.

D. James Bidzos

.

And again, I think that the fact that manage is 1/4 of the -- 1 of the 4 pillars of our strategy, I think, is just our way of saying to you that we pay close attention to that. We're actively looking for opportunities and that long tail of the restructuring not exclusively to save money but to optimize and be more efficient to serve our customers better, and it's working.

Operator

And the last question of the day will come from Sterling Auty from JPMorgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Listen, on the -- where we started with the discussion in terms of the search engine changes, so when Google adapted the AdSense program, which I think was in the summer of 2008, a lot of the discussion that we had was how much of the base of names is actually advertising or pay-per-click driven. Since these are first time renewals and they're trying to drive traffic to those types of pages, is there a similar type of analysis that you've done so we can get a sense as to maybe what portion of the base are first time renewals and what portion of those might be these types of advertising names that could get impacted?

D. James Bidzos

We haven't talked about any specific numbers, I think, actually, Sterling, since 2008. Back then, we did talk about what we believe to be the advertising makeup of the base. My sense of it is now without any specific data to give you at this moment is, first of all, the basis of those element is obviously much larger. I guess would be that the advertising names are probably larger than they were at the time. However, if you look at the renewal rate, at 72.9 over the last 2 quarters, just looking back, I'm sorry, in the 2 periods of 2010 and 2011, the Q2 periods, it differs only by -- and we did not have, by the way, any search engine changes in those periods. You're only talking about, respectively, 0.2 percentage point and 0.3 percentage point difference in the renewal rate. So my sense is that the safety in numbers, periods at work here and that the zone is larger and even though the number of advertising names may be larger, this rather rare change in search engine algorithms, 2008, now 2012, actually had a smaller impact than it did back then. I'm sure you're remember in 2008, the impact was quite significant. Here we are with a larger zone and a larger number of advertising names and yet the impact was rather modest, literally 0.2% compared to the same period a year ago or 0.3% 2010 and 2011. So that's the way we tend to think of it. The impact was very, very modest. I don't know if you want to add anything, Pat?

Patrick S. Kane

Nothing.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

And last question and I'll let you go, is there a sense of whether there's going to be a pickup in registrar marketing and promotional campaigns here in the September quarter that might help offset some of the falloff that you just saw this quarter?

Patrick S. Kane

This is Pat. I think the registrars -- we've got insight at some of their plans, but not all of their plans, of course. I think that they run promotions from time to time and on a regular basis in terms of what's going on and just the kind of clients that they're trying to attract. So I think that you'll see that, yes.

Operator

And that concludes our question-and-answer session for today, and I'd like to turn the call back over to David Atchley for a final comment.

David Atchley

Thank you, operator. With regards to the events in the third quarter, please note that Jim and George will be presenting at the 2012 Citi Technology Conference at 1:30 p.m. Eastern Time on Wednesday, September 5 in New York. The webcast registration details for this conference will be available on the Investor Relations section of the VeriSign website. Please call the Investor Relations Department with any follow-up questions from this call. Thank you for your participation and continued support. This concludes our call. Thank you, and good evening.

Operator

And once again, that does conclude our conference call for today. Thank you for joining.

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