Verisign Inc

NASDAQ:VRSN

Earnings Call Transcript 2023-Q2

[Operator]

Good day, everyone. Welcome to VeriSign's Second Quarter 2023 Earnings Call. Today's conference is being recorded. [Operator Instructions]

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]

Thank you, operator. Welcome to VeriSign's second quarter 2023 earnings call. Joining me are Jim Bidzos, Executive Chairman and CEO; Todd Strubbe, President and COO; and George Kilguss, Executive Vice President and CFO. 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 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 report on Form 10-K. VeriSign does not update 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 results and 2 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 can be found on the Investor Relations section of our website available after this call.

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.

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

Thank you, David. Good afternoon to everyone and thank you for joining us. We delivered another successful quarter by focusing on our mission as a critical infrastructure operator. The quarter included the renewal of the .net registry agreement and solid financial results. Additionally, last week, we marked 26 years of 100% availability in the .com, .net domain name resolution system. Throughout the various global challenges over the past 26 years, from the pandemic to natural disasters to evolving cyber threats, our purpose-built network has kept billions of people worldwide continuously connected to what matters most. The work we do to operate, protect and evolve key Internet infrastructure has never been more important than it is today. Reaching this mark is a testament to the ongoing investments made in our platforms, processes and people.

On June 30, we announced the renewal of the .net registry agreement with ICANN, as expected, given the presumptive right of renewal in our agreement. The business terms of the agreement such as pricing, the fees paid to ICANN, our renewal rights and the 6-year term of the agreement are unchanged. The next renewal for the .net registry agreement will be June of 2029. In addition to delivering on our mission during the second quarter, I'm pleased with the financial results which showed the continued strength of our business during this uncertain macroeconomic period. For the second quarter, revenues grew 5.7% year-over-year while EPS grew 16.2% year-over-year. At the end of June, the domain name base in .com and .net totaled 174.4 million domain names, up from 174.3 million in Q2 2022 and up from 173.8 million names at the end of 2022. During the second quarter, the domain name base decreased by 0.3 million domain names, offsetting some of the 1 million names we added during the first quarter.

From a new registration perspective, the second quarter delivered a 1.5% year-over-year increase with 10.2 million new registrations compared to 10.1 million last year. We believe that the renewal rate for the second quarter of 2023 will be approximately 73.4% compared to 73.8% a year ago. While there are many factors that drive demand for domain names, the core value proposition for domain names remain strong and we're seeing broad-based engagement from our registrar channel. However, with these fundamentals intact, low demand from China remains the primary source of drag on the overall domain name base growth. With this current trend, we now expect a domain name base growth rate of between 0% and 1% for the full year of 2023. This updated range reflects continued uncertainty, especially the weakness we continue to see related to China.

Our financial and liquidity position remained stable with $936 million in cash, cash equivalents and marketable securities at the end of the quarter. During the third quarter, we repurchased 1 million shares for $220 million. Effective today, the Board of Directors has increased the amount authorized for share repurchase of VeriSign common stock by $1.14 billion to a total of $1.5 billion authorized and available under the share repurchase program which has no expiration.

On .web, as many of you have seen from our statement on May 3, ICANN's Board of Directors dismissed Afilias' objections regarding the .web auction and directed that NDC's .web application move forward. This was a significant finding by the Board and we're pleased that our role in the auction was proved to be consistent with ICANN's policies. Subsequently, according to ICANN's website, Afilias has filed another IRP complaint, presumably challenging the Board's decision. This filing has not been posted nor has any response from ICANN. ICANN has placed NDC's .web application on hold now. Given the Board's decision, we see no basis for any further delay in delegating .web but this is an ICANN process and we're not yet involved in it.

Finally, as announced in today’s earnings release, we have given notice of a price increase of $0.99 for the annual wholesale price for .net domain names which will raise the price from $9.92 to $10.91 effective February 1, 2024.

And now, I'd like to turn the call over to George. I'll return when George has completed his financial report with closing remarks. George?

[George Kilguss]

Thanks, Jim and good afternoon, everyone. For the quarter ended June 30, 2023, the company generated revenue of $372 million, up 5.7% from the same quarter of 2022 and delivered operating income of $249 million, an increase of 5.4% from the same quarter a year ago. Operating expense in the second quarter totaled $123 million compared to $123 million last quarter and $116 million a year earlier. Net income totaled $186 million compared to $167 million a year earlier which produced diluted earnings per share of $1.79 for the second quarter of 2023 compared to $1.54 for the same quarter of 2022.

Operating cash flow for the second quarter of 2023 was $145 million and free cash flow was $139 million, both of which were at similar levels in the year ago quarter. Operating cash flow and free cash flow for the 6-month period ended June 30 totaled $404 million and $392 million and were up from $352 million and $339 million, respectively, for the same 6-month period a year ago.

I'll now discuss our updated full year 2023 guidance. Revenue is now expected to be in the range of $1.490 billion to $1.500 billion. This updated revenue range reflects our expectation that the domain name base growth rate will be between 0% and 1%, as Jim mentioned. Operating income is still expected to be between $990 million and $1.05 billion. Interest expense and nonoperating income net which includes interest income estimates is now expected to be an expense of between $30 million to $40 million. Capital expenditures are now expected to be between $45 million to $55 million. And the GAAP effective tax rate is still expected to be between 22% and 25%.

In summary, VeriSign continued to demonstrate sound financial performance during the second quarter of 2023 and we look forward to continuing to deliver on our mission and our objectives throughout the year.

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

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

Thank you, George. We strongly believe our strategic focus and disciplined management continue to serve us well, allowing us to deliver another solid quarter in which we provided secure and reliable infrastructure services, managed our business responsibly and efficiently and return value to our shareholders. I want to thank our teams for their dedication and focus.

Thanks for your attention today. This concludes our prepared remarks and now we'll open the call for your questions. Operator, we're ready for the first question.

[Operator]

[Operator Instructions] Our first question comes from the line of Rob Oliver with Baird.

[Rob Oliver, Robert W. Baird]

Jim, my first question is for you. I've got 3 questions total. But first is for you and it's on .com. I think we all can kind of see real-time some of the sluggishness in the market. And it looks like really domain activity in .com has not kind of come back to sort of prepandemic levels maybe as you guys had hoped. I know in your prepared remarks and appreciate the commentary relative to China but would just love to hear a little bit more about your view there on what's happening, whether it be China or if there are other factors? And I know Janet Yellen was just over in China, called for stimulus, sounds like there's some coming. So I just would also love to hear what you think gets us out of this rut.

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

I wish I knew the answer to that but let me do my best. I'm happy to share what I can. Well, first, there's the obvious macro factors affecting the economy and extended COVID recovery declining but still high inflation rates, geopolitics and the growth rate of new business starts which while still improving, are still off their highs. As far as specific factors for our business, I don't know how to put it, Rob, there's China. It's the largest single factor and it continues to remain soft in both new registrations and renewal rates. Stringent registration rules and a challenging COVID recovery seem to be the main factors there. In the U.S., channel focus is a factor. As we've seen before, some channel partners shift their focus to ARPU rather than new customer acquisition in times of slower economic activity. That is cyclical. At some point, they -- you got to acquire new customers. And so they'll return to that. Our revised guidance recognizes the uncertainty that all these factors represent for the remainder of 2023.

I'll just add and as far as things we can control, these include meeting our contractual requirements, obviously but practicing responsible expense management and focusing on our capital allocation strategy. Continuing to focus on those areas that we can control, that's the key for us to deliver long-term value creation for our shareholders. So hopes that's helpful.

[Rob Oliver, Robert W. Baird]

Very helpful, yes. And I also appreciate that you went into some detail in your prepared remarks on .web. And I think just stepping back now; it's been a 6-, almost 7-year journey now. And I think investors are confused by the landscape and what's going on. And it's very hard to know whether this sort of resets us back to the beginning of the process with the IRP or whether this is now a next step in the process which would circumvent the need to do that. If you could help us perhaps provide a little bit more color as to how you view that currently to the extent that you can.

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

Happy to do that. I keep a couple of notes here handy, just for that purpose. Let me -- well, first of all, it's easy to get confused. I completely understand that. There's a lot of -- we talk about this every quarter and there are a lot of terms that we use, acronyms like IRP and CEP that even experienced lawyers wouldn't be familiar with if they didn't operate in the ICANN world. So maybe I can simplify with a little bit of background what's happened. Maybe even define some of these terms. So first, when we talk about an IRP, independent review panel, that's a lawsuit, not in court but more like an arbitration demand that someone can bring against ICANN. However, the only claims allowed are those based on a violation by ICANN of its bylaws. A CEP, you've heard us use that, or cooperative engagement process, is a discussion between a potential IRP filer and ICANN ahead of an IRP. And all actions associated with the issue behind the IRP are automatically put on hold during the CEP and that's kind of what we've been in for the last few weeks.

You've also heard another acronym, NDC, that's -- that stands for Nu Dot Co and that's a company that VeriSign entered into an agreement with about .web. So let me try to simplify just how we got here. I don't want to speculate about what's going to happen going forward, not just because it's pending litigation but much of it is ICANN process that's not ours. But let me just give you a really brief history now that some of the terms are easier to understand with .web.

So in 2016, there was an auction for .web. NDC won that auction with our backing. In 2018, a company called Afilias, the plaintiff, filed an IRP seeking to have the IRP panel disqualify NDC and to award .web to them because Afilias objected to the auction and to our, VeriSign's, participation with NDC. A few years later in 2021 after a lengthy legally maneuverings, the IRP panel said, no. The panel said, ICANN owns the issue and the panel tells ICANN to go review and decide the issue. But Afilias doesn't like that answer and files a follow-up motion asking the panel essentially for a do-over. And the panel once again tells Afilias, no. But this time, they call Afilias' request frivolous and they sanction Afilias, ordering Afilias to pay ICANN's attorney fees.

During 2022 and early '23, ICANN then follow the panel's recommendation. They undertook a thorough 16-month review process. In early May of this year, ICANN announced that it had completed its review and had concluded, by a Board vote that was without objection, that Afilias' accusations were wrong and that the Board -- and then the Board directed ICANN's staff to proceed with processing NDC's .web application. Afilias then filed the CEP which then automatically paused the processing of .web.

So now Afilias has filed another IRP, that's true. But this time, there's something new and substantial. There's the definitive and affirmative ruling from the ICANN Board of Directors, again, without objection, a vote that .web should be awarded to NDC, a vote resulting from a 16-month process that included work by ICANN's staff who reviewed new submissions by VeriSign and Afilias, working with their law firms, who were allowed to use and even supplement the entire legal record from the earlier 2-year IRP, a vote that resulted in a finding that .web should be awarded to NDC. So that's new and that's not trivial. We believe that Afilias has been and is still litigating for delay.

Now in terms of next steps, we'll have to see whether ICANN continues with the hold on .web, the .web delegation or not during the IRP. ICANN could continue processing the .web PLD during the IRP, although that decision could be challenged. We don't believe there should be any further delay but this is ICANN's process and we will continue to work within that system.

So what happens next? I don't want to comment on, as I said, it's pending litigation but I hope that bit of background and history was helpful.

[Rob Oliver, Robert W. Baird]

Yes, it's really helpful. I appreciate that summary, Jim and I'm glad it's on the transcript because I know for one, I'm going to need to look back at that, although I've looked at a lot of it.

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

Yes, there's a lot there but -- yes.

[Rob Oliver, Robert W. Baird]

Yes, really. You even have me will through a lot of it. I really appreciate it. I know -- and I'm not the only one anymore, so I'll squeeze in one last question and that is just on .net. I just wanted to ask, so it's second year in a row where you guys are availing yourself of the opportunity to raise price on .net. And that's coming off for a long period where you did not. What's changed for you guys relative to your view to take price now on .net? What, if anything, in terms of your mindset, mentality has changed there and -- relative to .net pricing?

[George Kilguss]

Yes. Thanks, Rob. This is George. I mean if you look back at .net, I mean, we had not taken a price increase for quite a period of time. I think the last price increase we took was in 2018. And obviously, we announced and just took one here in February to $9.92. So as we think about .net, we'll look at the industry, we'll look at where it's positioned within the marketplace and we think the price that we're raising it to that we just announced is keeping .net competitive with the other TLDs within the -- which it competes with.

[Operator]

We will take our last question from the line of Ygal Arounian with Citigroup.

[Ygal Arounian, Citigroup]

I want to come back to the overall growth in domains. Two parts on that. First, I wanted dig to into the comment about China being the kind of biggest piece of this and China is a much smaller part of your overall revenue base. So I just want to understand like how it's driving that impact. So are you saying that domain growth in the U.S. is relatively healthy? Is there any color you can give to what the growth in the U.S. and other regions might be? So what ex-China looks like? And then, the comment on the channel focus and the channel focusing on ARPU versus net adds, that was really interesting. Can you help -- can you just elaborate on that point a little bit? Like how responsible are the channel partners for driving the growth? Is it their marketing and the push for domain registration? Like what is their role and how much of an impact can they have in spurring up demand?

[George Kilguss]

Yes. Sure, Ygal. This is George. So your first question was from kind of a domain name base perspective. We have seen growth here in Q2. I would say the regions that we report out on the U.S., EMEA and our all other segments from a year-over-year domain name base have all been growing. But China, we've seen that domain name base segment decline. I think if you want to get some relative terms, you probably can look in our 10-Q that's filed this afternoon and look at the revenue growth rates of those segments. You'll see that China in the quarter was down about 10%, EMEA was up about 1% and the U.S. was up about 7% and all of the category was up about 15% and that really comprised -- the weighted average of that comprised 5.7%. So we're still seeing growth.

As far as new units, I would say China, again, is down. The U.S. was relatively flat here in the second quarter from a new unit perspective. But the other markets that we report on were up. So still seeing some growth here in the market but China has really been, as Jim mentioned, a drag on new unit growth here and a little bit on revenue growth as well.

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

Yes, Ygal, Jim. Your question about ARPU, let me just say one thing upfront, you can clarify the question after this, if you want but I just want to say that we -- I think you know but we have sort of limited visibility into the end user, obviously, sell only through registrars. So I think the point is, is that ARPU is a sort of phenomenon. It's typical of any business. In certain economic conditions, it becomes more efficient for them to focus on ARPU rather than customer acquisition as the cost of those activities vary and the results are different and more advantageous in certain economic conditions. So the observation is based on a phenomenon that affects our channel just like everybody else, not on anything that's particularly unique that we see or understand about it.

And we can just observe this behavior, obviously, through our own registrations and monitoring their websites and looking at how they bundle their products. But this is something that every business does, not unique to registries, registrars or the DNS, just to clarify. So there's a limit to what -- I mean there's not a great insight there that -- it's just an observation, a factual observation based on what we see and observe. And it tends to be cyclical. We see that, obviously, they go through cycles, you focus on ARPU for a while and then you go back into new customer acquisition. So we see that -- I think it was in 2014, we had a very visible cycle of this that we went through.

[Ygal Arounian, Citigroup]

Okay. I'm asking because I think it was really interesting comment and just kind of tie from what we've seen from those channel partners like some of the key levers you've talked about, marketing efficiencies and to pull back materially on the marketing spend. And then we also saw some consolidation within the space on the [indiscernible]. So I'm not sure if what you think about that, if that has an impact to it, likely tying it to the marketing expenses.

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

I had some difficulty hearing the last part of that. Marketing spend certainly is another factor in various economic circumstances. Obviously, any retailers are going to vary their marketing spend and that has an effect on us. And obviously, during the pandemic and recently, we've seen some of that behavior that affected registrations as well. If I missed anything in the last part of your question, I apologize, please ask again. The line is a bit fuzzy.

[Ygal Arounian, Citigroup]

No, that's it. I think you've got the question. It's really helpful and really interesting. I mean I haven't thought about it that way, so interesting to hear.

[Jim Bidzos, Executive Chairman & Chief Executive Officer]

Okay, great. I was glad it was helpful.

[David Atchley]

Great. Thanks, Ygal.

[Operator]

This concludes today's question-and-answer session. I will now turn the call back to David Atchley for final comments.

[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 concludes today's call. Thank you for your participation and you may now disconnect.