Verisign Inc

NASDAQ:VRSN

Earnings Call Transcript 2020-Q2

[Operator]

Good day, everyone. Welcome to VeriSign's Second Quarter 2020 Earnings Call. Today's conference is being recorded. Recording of this call is not permitted unless preauthorized.

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, VP & Corporate Treasurer]

Thank you, operator. Welcome to VeriSign's second quarter 2020 earnings call. Thank you to everyone for joining our call today, and we hope each of you are staying safe and healthy.

Joining me remotely from their respective locations are Jim Bidzos, Executive Chairman and CEO; Todd Strubbe, President and COO; and George Kilguss, Executive Vice President and CFO. Thank you in advance for your patience if we experience any interference, delays or sound quality issues during today's call. This call and presentation are being webcast from the Investor Relations website, which is available under About VeriSign on verisign.com. There you will also find our second quarter 2020 earnings release. At the end of this call, the presentation will be available on that site and within a few hours, a 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. VeriSign does not update financial performance or guidance during the quarter and most of it is done through public disclosure.

The financial results in today's call and the matters we will be discussing today include GAAP results and two non-GAAP measures used by VeriSign, adjusted EBITDA and free cash flow. GAAP to non-GAAP reconciliation information is appended to the slide presentation, which will be found on the Investor Relations section of our website available after this call.

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.

[James Bidzos, Founder, Executive Chairman & CEO]

Thanks, David, and good afternoon, everyone. With the increased demand for and reliance on internet services during the COVID-19 crises, securing reliable operation of our infrastructure becomes even more important. Our focus remains on our mission, which is to ensure the availability of our critical infrastructure.

We have been and are prepared to continue operating all of our services including registry services for dotcom and dotnet and our route operations at the rigorous standards of performance and availability governed by ICANN with more of our employees continuing to work remotely.

Our focus on mission is emphasized by the fact that the company last week marked 23 years of 100% availability of the dotcom and dotnet domain name resolution system. This achievement is the result of the dedication and expertise of our team and our specialized infrastructure.

Also as part of our response to the COVID-19 crisis, we announced in March a freeze of the wholesale prices in all of our TLDs including dotcom through the end of 2020. Today given the current environment we're further extending that price raise for the wholesale prices in all of our TLDs through March 31, 2021. Additionally, we're also extending the waiver of the wholesale restore fee for expired domain names through the end of 2020.

Now I'll address our quarterly results. Q2 of 2020 was another consistent quarter for VeriSign in which we focused on our core business, expanded the domain name base and delivered solid financial results. Regarding second quarter operational highlights, at the end of June the domain name base in dotcom and dotnet totaled $162.1 million consisting of 148.7 million names for dotcom and 13.4 million names for dotnet with a year-over-year growth rate of 3.8%.

During the second quarter we processed 11.1 million new registrations and the domain name base increased by 1.41 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 second quarter of 2020 will be approximately 72.8%. This preliminary rate compares to 74.2% achieved in the second quarter of 2019 and 75.4 last quarter.

For 2020, we now expect a domain name base growth rate of between 2.75% and 4%. This updated range which recognizes the ongoing uncertainty presented by COVID-19 reflects the strength we've seen in new registrations and our expectation for domain name base growth for the balance of the year.

During the second quarter, we continued our share repurchase program that resulted in 730,000 shares of common stock repurchased for $150 million. At June 30, 2020, $676 million remained available and authorized under the current share repurchase program, which has no expiration.

Our financial and liquidity position remains stable with $1.2 billion in cash, cash equivalents and marketable securities at the end of the quarter. We continually evaluate the overall liquidity and investing needs of the business and consider the best uses for our cash including potential share repurchases.

Now I'd like to turn the call over to George.

[George Kilguss, EVP & CFO]

Thanks Jim and good afternoon, everyone. For the quarter ended June 30, 2020, the company generated revenue of $314 million up 2.6% from the same quarter in 2019 and delivered operating income $207 million up 2.5% from $202 million in the same quarter a year ago.

Operating expense totaled $108 million up from $105 million in the second quarter a year ago and up from $106 million last quarter. The sequential increase in operating expense is primarily a result of increased sales and marketing spend during the quarter.

The operating margin in the quarter came to 65.8% compared to 65.9% in the same quarter a year ago. Net income totaled $152 million compared to $148 million a year earlier, which produced diluted earnings per share of $1.32 in the second quarter this year compared to $1.24 for the same quarter last year.

Operating cash flow for the second quarter was $215 million and free cash flow was $204 million compared with $165 million and $154 million respectively in the second quarter last year. Operating cash flow in the second quarter benefited from lower cash tax payments due to the permitted deferral of approximately $50 million in US federal tax payments until the third quarter of 2020. Additionally the deferred revenue balance increased during the quarter as a result of the strength in new registrations.

I will now discuss full year 2020 guidance. Revenue is now expected to be in the range of $1.255 billion to $1.265 billion. This revenue range forecast reflects the updated domain name base growth of between 2.75% and 4% as Jim mentioned earlier.

Operating margin which includes stock-based compensation is still expected to be between 64.5% and 65.5%. This guidance range reflects our expectation of incremental and continued investment in our operational infrastructure, securing capabilities and sales and marketing expense during the remainder of 2020.

Interest expense and non-operating income net is now expected to be an expense of between $75 million and $80 million. This updated range reflects the additional $5 million gain recognized during the second quarter to the sale of our security services business.

Capital expenditures are still expected to be between $45 million and $55 million. We still expect our full year effective tax rate to be a benefit of between 2% and 5% which reflects the $168 million income tax benefit recognized in the first quarter. For the balance of 2020, we still expect that expense as a percent of pretax income of between 19% to 22%. Cash taxes for 2020 are now expected to be in the range of 18% to 20% of pretax income.

In summary, Verisign continue to demonstrate sound financial performance during the second quarter and we look forward to continuing our focused execution in the second half of 2020.

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

[James Bidzos, Founder, Executive Chairman & CEO]

Thank you, George. I'd like to say again that our priorities are our mission of ensuring the availability of our critical infrastructure and the safety of our people. Internet usage has increased during the pandemic and reliance on online services even more so. For many people who are working from home and isolating at home, online services are critical and more businesses and individuals and network depend on internet infrastructure for their livelihood. Our record of dotcom and Verisign for their hard work in maintaining our uptime record even during the pandemic.

Given that participants are dialing in remotely for this call, I'd like to walk through a few questions which we believe are on your mind before we open the call for your additional questions. The first question, with today's announced extension of the price freeze, how should we think about limited pricing flexibility you have for dotcom?

First as a reminder, the wholesale price for dotcom domain names has been unchanged at $7.85 for eight years since 2012. Also as a reminder, our wholesale prices for dotcom are governed by our registry agreement with ICANN. The retain price that the end user actually pays for a domain name is set by the retail channel, which is the registrars who have no regulation of their pricing. Additionally, there's a unregulated secondary market for domain names.

With that background, under amendment three to the dotcom registry agreement, Verisign is not permitted to raise the wholesale price of dotcom domain names by up to 7% in each of the final four years of every six year period. Within the current six year period, the first year in which we may increase the wholesale price ends on October 25, 2021 and we expect to effectuate a dotcom wholesale price increase before that October 21 date -- 2021 date.

The second question, are there any updates on the status of dotweb? Answer, as we noted last quarter, a final hearing is currently scheduled to begin on August 03 in the Independent Review Process or IRP that affiliates initiated in November 2018. That hearing is scheduled to take place on videoconferencing. As a reminder Verisign is not a party in these IRP proceedings, but was granted the right to participate in certain limited aspects.

Also as a reminder an IRP under ICANN's bylaws is for the purpose of ensuring that ICANN follow its own policies and procedures when making decisions. Our expectation is that following the resolution of the IRP the ICANN board will make the final decision on the delegation of the dotweb PLT.

Question three, can you help me better understand what is impacting the increase in new registrations and the lower preliminary quarterly renewal rate for the second quarter? Most of the strength in new registrations came from registrars in North America. While we don't have the same visibility that retailers do, based on feedback from our retailers they are seeing increased demand from small businesses getting online. This strength was partially offset by slower activity from registrars in China.

As it relates to the preliminary quarterly renewal rate, the year-over-year decrease is primarily related to the lower overall first time renewal rate. Year-over-year the overall previous renewal rate remained relatively consistent.

Question four, are there any updates to the donations you announced earlier this year? Yes, there are. During the first quarter, we made an initial $2 million donation to organizations assisting those impacted by COVID-19 locally and nationally. During the second quarter, we made a cash contribution of $1 million to the Equal Justice initiative in support of their work.

We are actively working on an expansion to our VeriSign Cares Program beyond the $3 million the company donated during the first half of the year again with a focus on providing assistance to those impacted during the COVID-19 crisis. I'm sure you have questions and I can only say that these additional efforts should be further along by the time we talk to you again next quarter.

And now we'll open the call for your questions. Operator, we're ready for the first question.

[Operator]

[Operator instructions] And we'll now take our first question from Robert Oliver with Baird.

[Robert Oliver, Robert W. Baird]

Great. Thank you guys for taking my question and thanks for all the color. So on if I can maybe try a little bit more remarkably the domain growth is back now above where it was pre-COVID at least lower end of the range, which is a pretty remarkable. You mentioned some of the drivers there you guys have strength, can you that a little bit more and then China weakness maybe being responsible for the lower renewal rate. Can we perhaps get a little bit more color on that above geographically as well as some of the economic puts and takes around SMBs and what you guys are seeing there and then I had one follow-up? Thanks.

[James Bidzos, Founder, Executive Chairman & CEO]

Okay. Rob I think I simply can try first of all let me just say that basically the strength came from predominantly North America with small businesses getting online as the geography I think we have limited visibility, but let me invite George to comment further.

[George Kilguss, EVP & CFO]

Yes thanks Jim and thanks for the question Rob. So as you mentioned in Q2 we basically strengthened gross additions on new registrations in North America and will say EMEA and APAC were also strongly. They also improved in the quarter year-over-year and China was a little bit lower.

As far as the China gross ads they were similar to the gross ad levels we had last quarter there but they were down from year ago levels. As far as renewal rates, Jim mentioning they were down about 1.4% in total year-over-year and we saw that decline primarily manifests itself in lower first time renewal rates and they were down also in most markets that we track, keep an eye on.

And as Jim also mentioned, we're a thin registry we talk to before. We don’t have direct visibility into the end user. So it's a little more difficult for us to understand the economic impact per se, but in general gross ads were very strong this quarter. Our net ads were good. They were $1.4 million with two was slightly above the second quarter of 2019 only totaled $1.3 million.

[Robert Oliver, Robert W. Baird]

Okay. George, appreciate it and then just a follow-up and I think it makes a lot of sense on the suspension of the price increase given the pandemic and so I guess I would just ask if there's anything beyond the obvious in terms of the rationale there and then you do draw line in the sand that you guys will avail yourself of the price increase, which I believe would get you guys the four years of the final secure. I just want to make sure we understand that properly or if there anything else you can add to flush that out. Thanks again very much gentlemen.

[George Kilguss, EVP & CFO]

Sure thanks Rob. I don’t think I can meet that anything you summarized it accurately. We are taking another freeze of prices through March 31, 2021 that is related to the current environment via data the first year period of our available price increase is October 25, 2021 and you accurately stated that we expect to effectuate dotcom wholesale price increase before that date. I think we're ready for another question, operator.

[Operator]

We'll move to Nic Jones with Citi.

[Nicholas Jones, Citigroup]

The first one as you extend the waiver for retail fees, can you tell me what are the implications there? Is there kind of a building group of domain that are up that could potentially generate some money from these restore fees and maybe fall off, would you then recognize those as churn, I guess as you go walkthrough kind of the dynamic of the restore fee and provide a little bit color on is there any build out coming out and I've one follow-up after that?

[James Bidzos, Founder, Executive Chairman & CEO]

Okay. Let me hand it to George to answer your question.

[George Kilguss, EVP & CFO]

First off the impact of waiving the restore fees is immaterial to our financials and is accounted for in the revenue guidance we provided today. There is a period of time after our registrar deletes the domain name and still this is a redemption rates, it's a 30 day period and the registrar has a chance to get the name back then before those of the general availability.

So those names are talking about. It's already been deleted by the registrar and so this restore fee is in addition to the standard registration renewal fee associated with the domain name renewal and we don’t disclose our wholesale restore fee which is charged for the registrar and of course they determine what the actual retail restore fee is and we've seen many registrars pass on the waiver from a retail perspective. So anecdotally we believe that small businesses and individuals are benefitting from our waiver.

[Nicholas Jones, Citigroup]

Got it. Thank you. And just one follow-up on operating margin with kind of the increased SMB interest in having a digital presence. Is there potential leverage in this sales and marketing bucket throughout the rest of the year as you don’t need to advertise or be as aggressive in an OpEx one, thanks.

[George Kilguss, EVP & CFO]

Thanks Nick. I mean clearly every quarter, we're looking at our expenses and making sure we're spending the appropriate amount in each of the categories to drive profitable growth in support of the business. Sales and marketing expense sequentially was up and we do have plans to continue marketing activities throughout the year, but those costs again are factored into the guidance that we provided, but we do expect to continue to invest in sales and marketing activity for the rest of 2020 year.

[Operator]

And we'll take our last question from Sterling Auty with JPMorgan.

[Sterling Auty, JPMorgan]

Couple of questions, so the new guidance for the domain growth for the full year, what have you factored in for the last two quarters in terms of the pace of new registrations and the renewal rate?

[James Bidzos, Founder, Executive Chairman & CEO]

George?

[George Kilguss, EVP & CFO]

So we don’t guide to gross registrations or renewal rates. We guide to the net zone increase. Clearly we've done pretty well here through the first half of the year and we expect that continued demand for the product but as far as what will happen specifically to the renewal rate into a quarter, gross ads, we'll wait and see.

We published the gross ads, the new information in the domain name base on the left side. You can see what is going on there, but our full year guidance is the guidance we provided on breaking out quarterly.

[Sterling Auty, JPMorgan]

So maybe just a follow-up and try it in a different way at least qualitatively, I think if we look at some of the previous economic cycles when we get to this point, we tend to see increased business closures and I think we saw that manifest itself in the renewal rate in the June quarter. Are you at least incorporating the idea of lower renewal rate in the back half and maybe a higher elevation in new registrations just qualitatively?

[George Kilguss, EVP & CFO]

We forecast or model our results that way. We do a lot of algorithmic computations and models that have proven fairly active over the prior period and we use that algorithmic model to guide us not only through the quarters here but also in our planning. It's been very reliable for us and so that's the methodology that we're looking at. It's very hard to go down and forecast demand by and end user or by a registrar of by a country level.

We clearly look at those results but the data is so voluminous that we have to use algorithms that do that and the algorithms which like I said before have been relatively accurate are giving us the range that we put out here for our guidance.

[Sterling Auty, JPMorgan]

That makes sense. Can you give us what the number of domain names up for renewal in the September quarter looks like and how does that compare against what you just had in June and what to really look like versus September a year ago?

[George Kilguss, EVP & CFO]

So the number of names that were up for renewal in the second quarter 2020 was 35.1 million. We expect 34.2 to go up for renewal next quarter in the third quarter. When I go back a year ago in the second quarter of 2019 that was closer to 33.3 million and the third quarter of 2019 was 32.6 million.

[Sterling Auty, JPMorgan]

And then last one and I think I can guess the answer but I still want to ask it anyway because it's been a topic of a lot of investor conversations, you mentioned that you are going to take advantage of the price increase before the October deadline. We know you have the six-month window in terms of announcement, but based on the comments that you’ve given are you leaving open the possibility that you might at least announce the price increase prior to that March timeframe that have extended the price freezes?

[George Kilguss, EVP & CFO]

I am not entirely sure I understand your question, but I think maybe the answer can be determined by having a nearly state as you point out there is a six-month notice that's required to effectuate a price increase before we have to provide six months notice and obviously we will do that. The date of the expiration of the first year of the four price increases available in the six year period is October 25, 2021 and we of course prior to today's announcement are freezing wholesale prices in all of our TLDs through March 31, 2021. So I think a little bit of math could answer your question. Till that point somewhere right.

[Sterling Auty, JPMorgan]

And maybe just to sneak one last one in, Go Daddy's acquisition that you saw registry assets bring let's say a stronger financially sound company into the registry operations, how do you view their entrance into the registry state and how do you think that might influence consolidation of registries moving forward?

[George Kilguss, EVP & CFO]

Well Go Daddy has been and is all it has been an important channel partner for us to obviously ever since probably back to when Bob Parsons started to build their company. We certainly expect that to continue. End users see tremendous value in dotcom and dotnet in those TLDs and we know that our channel partners recognize that value as well.

I just should point out that vertical integration is not new. Several of other of our register channel partners also operate TLD registries. Google has Google Registry, name.com has donuts with over a 200 TLDs in it and each of those cases these registrars continue to be an important channel partner to Verisign for our TLDs. I expect those relationships to continue.

[Operator]

That does conclude our question-and-answer session. I'd like to turn the conference back over to Mr. David for closing remarks.

[David Atchley, VP & Corporate Treasurer]

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]

And once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.