Verisign Inc

NASDAQ:VRSN

Earnings Call Transcript 2018-Q1

[Operator]

Good day, everyone. Welcome to VeriSign's First Quarter 2018 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, VeriSign, Inc.]

Thank you, operator, and good afternoon everyone. Welcome to VeriSign's first quarter 2018 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 our Investor Relations website, which is available under About VeriSign on verisign.com. There you will also find our first quarter 2018 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 the call for your questions.

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

[D. James Bidzos, VeriSign, Inc.]

Thanks, David, and good afternoon everyone. I'm pleased to report another solid quarter 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 $299 million, up 3.7% year-over-year, and delivered solid financial performance, including non-GAAP EPS of $1.07, up 11% year-over-year.

During the first quarter, we completed the repatriation of a net $1.15 billion of cash held by our foreign subsidiaries which we intend to use in conjunction with the redemption of our convertible debentures, as George will discuss later. Also, we paused our repurchase activities during the 30-day conversion measurement period for our pending May 1 convertible bond redemption. As a result, we returned $125 million to shareholders through the repurchase of 1.1 million shares in the first quarter.

Our financial position remained strong with $2.4 billion in cash, cash equivalents and marketable securities at the end of the quarter. We continually evaluate the overall cash and investing needs of the business, and consider the best uses for our cash, including potential share repurchases. At the end of March, the domain name base in .com and .net totaled 148.3 million, consisting of 133.9 million names for .com and 14.4 million names for .net.

During the first quarter, we processed 9.6 million new registrations and the domain name base increased by 1.91 million names. Although 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 2018 will be 74.9%. This preliminary rate compares to 72.5% achieved in the first quarter of 2017.

We now expect full year 2018 domain name base growth of between 2.5% and 3.25%, with an increase to the domain name base for the second quarter of 2018 of between 0.7 million to 1.2 million net registrations. I also want to report that we are engaged in a dialogue with NTIA concerning the cooperative agreement which is ongoing, but beyond that we don't have more to say at this time.

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

[George E. Kilguss III, VeriSign, Inc.]

Thanks, Jim, and good afternoon everyone. Revenue for the first quarter totaled $299 million, up 3.7% year-over-year and up by 1.3% sequentially. During the quarter, 59% of our revenue was from customers in the U.S. and 41% was from foreign customers.

As it relates to first quarter GAAP results, operating income totaled $185 million compared with $175 million in the first quarter of 2017. The operating margin in the quarter came to 62% compared to 60.7% in the same quarter a year ago. Net income totaled $134 million compared to $116 million a year earlier, which produced diluted earnings per share of $1.09 in the first quarter this year compared to $0.94 for the first quarter last year.

As of March 31, 2018, the company maintained total assets of $2.9 billion and total liabilities of $4.1 billion. Assets included $2.4 billion of cash, cash equivalents and marketable securities, of which $1.8 billion were held domestically with the remainder held abroad. I'll now review some additional first quarter financial metrics, which will include non-GAAP operating margin, non-GAAP earnings per share, operating cash flow and free cash flow. I will then discuss the redemption of our convertible debentures and provide updates on our 2018 full year guidance.

As it relates to non-GAAP metrics, first quarter operating expense, which excludes $13 million of stock-based compensation, totaled $101 million compared to $106 million last quarter and $101 million in the same quarter a year ago. Non-GAAP operating margin for the first quarter was 66.3% compared to 65.1% in the same quarter of 2017. Non-GAAP net income for the first quarter was $132 million, resulting in non-GAAP diluted earnings per share of $1.07 based on a weighted average diluted share count of 123.5 million shares, this compares to $0.96 in both the first quarter of 2017 and last quarter.

As noted in our last call, as a result of the Tax Act and beginning with this quarter's results, the tax rate used to calculate our non-GAAP net income and non-GAAP earnings per share is 22%. Operating cash flow for the first quarter was $90 million and free cash flow was $82 million compared with $148 million and $139 million respectively for the first quarter last year. First quarter 2018 cash flow reflects approximately $61 million in withholding taxes paid in connection with the net $1.15 billion repatriation.

As mentioned last quarter, in light of the Tax Act, we were evaluating our capital structure, including the possible redemption of our convertible debentures. You may have seen that on February 15, the company issued a redemption notice for all the outstanding convertible debentures. This redemption settles next week on May 1, and the company has sufficient domestic liquidity to settle the redemption. If holders elect to convert their debentures, the company intends to settle the $1.25 billion principal value in cash, and the excess value will be settled in shares of the company's stock.

The actual number of shares issued for holders who elect to convert is determined based on an observation period that ran from March 15, 2018, through today. While the calculation is not yet finalized, approximately 26.1 million shares would be issued if all convertible debenture holders elect to convert. For a comparison, 25.6 million shares of dilution related to the convertible debentures was used in calculating our fully diluted shares in our first quarter results, which was based on the average share price during the first quarter. The accounting for the settlement of the debentures will occur during the second quarter.

Historically, the convertible debentures were an important part of the company's capital structure. With U.S. tax reform implemented at the end of last year, many of the tax benefits generated by the convertible debentures were limited. Over time, this instrument became more equity-like in the company's capital structure, and with the diminished tax benefits post-tax reform, we decided to redeem the convertible debentures.

Now, I'd like to provide you some updates to our full year 2018 guidance. Revenue is now expected to be in the range of $1.2 billion to $1.215 billion now from the $1.195 billion to $1.215 billion provided on our last call. Non-GAAP operating margin is still expected to be between 65.5% and 66.5%. Our non-GAAP interest expense and non-GAAP operating income net is now expected to be an expense of between $85 million and $92 million, decreased from the $115 million and $122 million range provided on our last call. The $30 million decrease in the range is primarily due to the redemption of our convertible notes.

Capital expenditures are still expected to be between $45 million and $55 million. Cash taxes are now expected to be between $75 million to $95 million, change from the $70 million to $90 million range provided on our last call. 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, VeriSign, Inc.]

Thank you, George. Overall, this has been another solid quarter for VeriSign. There was further expansion of the domain name base and revenues. We generated and efficiently returned value to shareholders. We continued our work to protect, grow and manage the business, while continuing our focus on providing long-term value to our shareholders.

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

[Operator]

Thank you. And we will take our first question from Sterling Auty with JPMorgan. Please go ahead.

[Sterling Auty, JPMorgan Securities LLC]

Yeah. Thanks. Hi, guys. Wanted to start with Jim, in your prepared remarks, you talked about a discussion now going on with the NTIA regarding the cooperative agreement. Just want to make sure we level set. So, does that mean that between now and November 30, this should come to a conclusion in terms of whether they extend the cooperative agreement or let it sunset? And is there any chance that we could see an announcement prior to that November 30th date?

[D. James Bidzos, VeriSign, Inc.]

Let's see. Well, first of all, you're correct that NTIA may decide to extend the cooperative agreement as is or let it sunset. Additionally, VeriSign and NTIA could mutually agree to amend it per the terms of Amendment 34 of the cooperative agreement. As far as what you might see between now and then, I think this early – I mean, we're engaged, but I think it's too early to say what milestones, when and what they would look like. It's just really too early to say anything more than we did unfortunately.

[Sterling Auty, JPMorgan Securities LLC]

And just a follow-up to that. When the announcement came that they would look at the cooperative agreement before November – or at the November 30th timeline, I think there were some discussion of a public interest study, has that come up in your discussions or is there anything that's been made public around that part in the process?

[D. James Bidzos, VeriSign, Inc.]

Yeah. As I said, it's just – we're engaged. I don't think it'd be appropriate for me to say anything about what's come up in the discussions that we're having, but they're are ongoing. And all I can tell you is that we'll certainly keep you posted, and if there are any milestones or anything to report, we'll do it promptly.

[Sterling Auty, JPMorgan Securities LLC]

All right. Sounds good. And then one question on the business, looking at the domestic/international split, we went through that timeframe with the Chinese names. But I'm really curious, when you look at the international sourced growth in particular, what are you seeing in terms of where the areas of biggest growth at the moment and how do you think about the sustainability of it?

[George E. Kilguss III, VeriSign, Inc.]

Sterling, this is George. I mean, when we talk about growth, we do think the drivers of domain name growth continue to be internet adoption, internet penetration, and continued growth of e-commerce. So, we think that those worldwide metrics bode well for our business. Where growth comes from quarter to quarter does vary. This quarter, in the first quarter, we saw good growth out of the U.S., out of China, and continued results out of our European registrars, registrars in all those areas seem to be performing well for us.

[Sterling Auty, JPMorgan Securities LLC]

Okay. Thank you.

[Operator]

And we will take our next question from Matthew Wells with Citi. Please go ahead.

[Matthew Wells, Citigroup Global Markets, Inc.]

Hi, Jim. This is Matt with Citi. I wanted to ask if you had any update on .web?

[D. James Bidzos, VeriSign, Inc.]

Nothing. Nothing since we last spoke. And for those who weren't here or aren't familiar with what the status is, we're engaged in ICANN's process to move the delegation forward for .web. That's ICANN's process, so we can't say when it'll conclude. Just as a reminder too for all of you looking at the guidance of course, while it's possible that our operation of .web will start this year, we did not include, the 2018 revenue guidance provided does not include any revenue from .web, and we'll give you more updates as available, but unfortunately that's all I can give you now.

[Matthew Wells, Citigroup Global Markets, Inc.]

Thanks on that. And I have one more question. Has .web and that purchase come up with your discussions with the NTIA at all?

[D. James Bidzos, VeriSign, Inc.]

No. Our discussions with NTIA are about the cooperative agreement, .web we view separately. And the Department of Justice, of course, closed its open investigation of .web. So, it has not come up. We wouldn't expect it to.

[Matthew Wells, Citigroup Global Markets, Inc.]

Thank you. Yes. That's helpful.

[Operator]

And we will take our last question from Rob Oliver with Baird. Please go ahead.

[Matt S. Lemenager, Robert W. Baird & Co., Inc.]

Good afternoon. Thanks. It's Matt Lemenager on for Rob. I've a question on the renewal rate, 74.9% this quarter is a bit higher than it's been trending. And I know we're kind of churning through the China names and things like that, and the renewal rate might be expected to go up. But was there anything that drove the 74.9% renewal rate? Because that ticked up from the highest metric at least in recent years.

[D. James Bidzos, VeriSign, Inc.]

Yeah. Matt, thanks. As you point out, our preliminary renewal rate of 74.9% was a good renewal rate for us, but I think as you also alluded to, when you compare that to our Q1 2017 renewal rate of 72.5%, the change there is really primarily related to a depressed Q1 2017 rate that was negatively impacted by the China surge names that were registered in the first quarter of 2016 that did not renew in the first quarter of 2017.

And while 2017 was still up year-over-year when I exclude those impacts from 2017, it is still really consistent with our normal expectations of a slightly rising renewal rate associated with an aging domain name base. So, I don't think there's anything unusual to call out there, other than the base continues to age, and as a result, renewal rates tend to pick up a slight amount as the previous renewed names become a large proportion of the overall base.

[Matt S. Lemenager, Robert W. Baird & Co., Inc.]

Got it. Thanks. And just given the cash repatriation, just a question I guess on capital allocation, capital structure, and then we paused the buyback this quarter a little bit. Are there any plans to step up the buyback going forward just given the new allocation structure?

[D. James Bidzos, VeriSign, Inc.]

Matt, as in the past, we don't guide to buybacks. We have an active capital allocation process that we look at every quarter, and we try to meet the needs of the business every quarter, and we determine through our strategic framework, protect, grow and manage how much liquidity we need to have for the business, what do we need to invest in the business, what do we need to, and then what we have to return to shareholders. So, we look at that every quarter and make a determination, but we do not provide guidance with regard to buybacks.

[Matt S. Lemenager, Robert W. Baird & Co., Inc.]

Got it. Thank you.

[Operator]

And our last question will be a follow-up question from Matthew Wells with Citi. Please go ahead.

[Matthew Wells, Citigroup Global Markets, Inc.]

Hi, Jim. This question is along the same thread that was just asked. But when you're looking at your framework for capital allocation, does the redemption of the debt and changes to the tax law change, how you look at repurchases versus potentially issuing a dividend?

[D. James Bidzos, VeriSign, Inc.]

Go ahead, George.

[George E. Kilguss III, VeriSign, Inc.]

Sure. I would say, look, whether it was post-tax reform or post-redemption of our convertible debenture, I really don't expect our capital structure or capital allocation philosophy to change. Again, we constantly review the needs of the business and we're really trying to make decisions that are in the best interest of the business. So, we clearly look at the best way to return that capital to shareholders. Historically, we felt that the share repurchases have been in the best interest of the shareholders.

[D. James Bidzos, VeriSign, Inc.]

Yeah. I mean, we're not quite complete yet with the redemption of the bond. That process will be complete soon. We did make a repatriation of the $1.15 billion, and obviously, that will look different going forward. I think we're still really evaluating all the long-term significance of the tax law. I think the one thing I can assure you of is that, our priority of course is protect, grow and manage. And in the manage category, when it comes to making sure that we return generated value to shareholders, we're going to do that in the most efficient way possible.

The philosophy that drives that hasn't changed a bit. I think you're asking a more tactical question as to whether or not some rethinking would lead to some analysis that says a dividend or some shift in or difference or reallocation of buybacks to dividends. And we don't guide to that as George said, but I think that's sort of a tactical question that our ongoing analysis would yield, and if something there changes, we would certainly share it when appropriate.

But fundamentally, nothing has really changed. We're just looking at a very dynamic situation, where the tax law gives us opportunities, and we're still assessing them and looking for what's in the best long-term interest of our shareholders in terms of capital structure and capital allocation relative to our strategy of efficiently returning generated value, that hasn't changed a bit.

[Matthew Wells, Citigroup Global Markets, Inc.]

Okay. Thanks. That color was really helpful. Appreciate your time.

[D. James Bidzos, VeriSign, Inc.]

Thank you.

[Operator]

And this does conclude our question-and-answer session for today. At this time, I would like to turn the call back over to David Atchley for final comments.

[David Atchley, CFA, VeriSign, Inc.]

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]

Ladies and gentlemen, once again, this concludes today's call, and we thank you for your participation. You may now disconnect.