Verisign Inc

NASDAQ:VRSN

Earnings Call Transcript 2017-Q4

[Operator]

Good day everyone. Welcome to VeriSign's Fourth Quarter and Full Year 2017 Earnings Call. Today's conference is being recorded. An unauthorized recording of this call is not permitted.

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

[David Atchley]

Thank you, operator and good afternoon, everyone. Welcome to VeriSign's fourth quarter and full year 2017 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 fourth quarter and full year 2017 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.

[Jim Bidzos, Executive Chairman, President and CEO]

Thanks David and good afternoon everyone. I'm pleased to report another solid quarter which kept the strong 2017 for VeriSign. Fourth quarter and full year 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.

In 2017 VeriSign delivered strong financial performance reporting $1.165 billion in revenues, resulting in $653 million in free cash flow and generating full year 2017 non-GAAP operating margins of 65.3%. 2017 was a strong year for the .com and .net domain name base, in which the company processed 36.7 million registrations and finished the with 146.4 million links. During the year we marked more than 20 years of uninterrupted availability of the VeriSign DNS for .com and .net. Also last year we renewed the .net registry agreement for another 6 years until 2023.

During the quarter, we continued our share repurchase program by repurchasing 1.3 million for $145 million. during the full year 2017, we repurchased 6.3 million shares for $593 million. Effective today the board of directors increased the amount of VeriSign common stock authorized for share repurchase by approximately $586 million to a total of 1 billion authorized and available under the share repurchase program which have no expression.

Our final position in 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 December, the domain name base in .com and .net totaled $146.4 million, consisting of 131.9 million names for .com and 14.5 million names for .net. During the fourth quarter we processed 9 million new registrations and the domain name base increased by 0.57 million names. During the quarter we continue to see strength from domestic registrars which was offset by a lower second time renewal rate associated with the remaining China surge names from late 2015. Although renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal rate for the fourth quarter of 2017 will be 72.2%.

We expect full year 2018 domain name base growth guidance to be between 2% and 3%. For the first quarter we expect an increase to the domain name base of between 1.5 million to 2 million registrations. I would like to comment now on a recent positive development in our efforts to become the registry operator for .web. You may have seen the 8K we filed in January, in it we disclosed that the U.S. Department of Justice's anti-trust division notified us that it had closed its investigation regarding the .web top level domain.

We're now engaged in ICANN process to move the delegation of .web forward. However as this is ICANN's process we cannot say when it will conclude and while it's possible that our operation of .web will commence this year the 2018 revenue guidance we will provide does not include any revenue from .web. Of course, we will provide with updates as appropriate.

And now I would like to turn the call over to George.

[George Kilguss, Executive Vice President and CFO]

Thank you, Jim, and good afternoon, everyone. For the year ended December 31, 2107 the company generated revenue of 1.165 million up 2% from 2016 and delivered GAAP operating income of 708 million up 3% from 687 million for the full year 2016. Revenue for the fourth quarter totaled $296 million, up 3.2% year-over-year and up by 1.1% sequentially.

During the quarter, 60% of our revenue was from customers in the U.S. and 40% was from customer abroad. As it relates to fourth quarter GAAP results, operating income totaled $176 million compared with $169 million in fourth quarter 2016. The operating margin in the quarter came to 59.7% compared to 59% in the same quarter a year ago.

Net income totaled $103 million compared to $106 million a year earlier, which produced diluted earnings per share of $0.83 in the fourth quarter of this year compared to $0.84 for the fourth quarter last year. As of December 31, 2017, the company maintained total asset of 2.9 billion and total liabilities of 4.2 billion. Assets included 2.4 billion of cash, cash equivalence and marketable securities of which 729 million were held domestically with the remainder held abroad.

I'll now review some additional fourth quarter financial metrics, which include non-GAAP operating margin, non-GAAP earnings per share, operating cash flow and free cash flow. And then we'll discuss our 2018 full year guidance.

As it relates to non-GAAP metrics, fourth quarter operating expense, which excludes $13 million of stock-based compensation totaled $106 million compared to $97 million last quarter and $103 million in the same quarter a year ago.

Non-GAAP operating expenses were higher in the fourth quarter as we had indicated on our last call primarily due to an increase in sales and marketing spending in the fourth quarter. Non-GAAP operating margin for the fourth quarter was 64.1% compared to 63.9% in the same quarter of 2016.

Non-GAAP net income for the fourth quarter was $119 million resulting in a non-GAAP diluted earnings per share of $0.96 based on a weighted average diluted share count of 124.3 million shares. This compares to the $0.92 in the fourth quarter of 2016 and $1 last quarter based on $125.5 million and $124.1 million weighted average diluted shares respectively.

Dilution related to the convertible debentures was 25.2 million shares based on the average share price during the fourth quarter compared with $20.6 million for the same quarter in 2016 and 24 million shares last quarter.

The share count was reduced by the full effect of third quarter 2017 repurchase activity and the weighted effect of the $1.3 million shares repurchased during the fourth quarter. Operating cash flow for the fourth quarter was $199 million and free cash flow was $190 million compared with $205 million and $198 million respectively for the fourth quarter last year.

Now, I'd like to provide an update on implications to the company of the Tax Cuts and Jobs Act enacted in December 2017, which I'll refer to as the Tax Act.

As stated in today's earnings release, fourth quarter and full year 2017 GAAP financial results include a net $9 million tax expense increase resulting from the Tax Act. This increase is comprised of a provisional income tax expense of $196 million consisting of onetime U.S. taxes on cumulative foreign earnings triggered by the Tax Act and related for withholding taxes. Both net of applying previously unrecognized foreign tax credits. This expense is offset by an income tax benefit of $187 million resulting from the revaluation of our net deferred tax liabilities from 35% to the 21% U.S. federal income tax rate in the Tax Act.

As a result of the onetime U.S. taxes on cumulative foreign earnings we also intend to repatriate by early in the second quarter of 2018 approximately $1.1 billion of cash held by foreign subsidiaries net of foreign withholding taxes based on current exchange rates.

Additionally, on a go-forward basis due to the Tax Act, annual earnings of our foreign subsidiaries will be taxed by the U.S. This allows for annual repatriation without further U.S. taxation of distributable capital reserves from foreign entities. The taxation of foreign earnings and withholding taxes associated with ongoing repatriations will increase cash taxes over the amount the company has historically paid.

Also, the lower corporate tax rates and limitations on the deductibility of interest implemented by the Tax Act, decreases the value of future interest expense deductions. In light of the Tax Act, we're presently evaluating our capital structure including the possible redemption of our convertible debentures.

Finally, since mid-2017, we've used a tax rate of 25% to calculate our non-GAAP net income and non-GAAP earnings per share. Looking ahead we believe the more reasonable estimate of the tax rate to calculate our non-GAAP net income and non-GAAP earnings per share is 22%. As a result, we will begin to use 22% non-GAAP tax rate when reporting first quarter 2018 non-GAAP results.

With respect to full year 2018 guidance, revenue is expected to be in the range of 1,195 million to 1,215 million. Non-GAAP operating margin is still expected to be between 65.5% and 66.5%. Our non-GAAP interest expense and non-GAAP non-operating income net is expected to be an expense of between $115 million and $122 million.

Capital expenditures are expected to be between $45 million and $55 million, and finally cash taxes are expected to be between $70 million and $90 million. This 2018 cash tax guidance reflects our best estimate of the various impacts of the Tax Act including the impacts of our intended repay reaction.

In summary, the company continued to demonstrate sound financial performance during the fourth quarter and the full year 2017.

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

[Jim Bidzos, Executive Chairman, President and CEO]

Thank you, George. 2017 was another solid year for VeriSign, there was further expansion of the domain name based and revenues, we generated an efficiently return value to shareholders, we renewed the .net registry agreement for another six years until 2023 and we mark more than 20 years of uninterrupted availability of the VeriSign DNS for .com and .net.

Finally, or early with this year we discuss that the U.S. Department of Justice notified as closed it investigation regarding the .net top level domain. We continued our work to protect grow advance of business, while continuing our focus on providing long-term value to our shareholders. We think our focus on profitable growth and disciplined execution in extent the long-term lines of growth in our top and bottom line and allow us to continue our consistent track record of generating and returning value to our shareholders in the most efficient manner.

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

[Operator]

[Operator Instructions] We will take our first question from Gregg Moskowitz with Cowen and Company.

[Gregg Moskowitz, Cowen and Company]

In the third quarter the top five keyword searches for .com and while some form of crypto currency and black chain, how incremental do you think crypto has been in driving .com growth as over the past several months or so.

[Jim Bidzos, Executive Chairman, President and CEO]

I don’t think I have it at the tip of my fingers that précis numbers but I don’t believe that they are materially, I've seen a lot of activity in the secondary markets of trading in comp registrations that have crypto in them. But I don’t think that there are any meaningful direct contributions to new net registrations in the numbers that we've reported.

There is just a huge amount of interest in cryptocurrencies and Bitcoin as you know now that it has the exchanges. And what we've seen I would say specifically is a spike in value in the secondary market of -- any multiple keyword names with crypto in them.

[Gregg Moskowitz, Cowen and Company]

Okay, thanks Jim. And then George, you have told us that you would spend more in marketing Q4 and did and then I know I'm dating myself here, but I would have to go all the way back to 2007 to find another quarter where sales and marketing expense grew this much in absolute dollars on a sequential basis. So, can you maybe just sort of give a little bit more color on the activities that you undertook in Q4 as well as what the sales and marketing strategy is for 2018?

[George Kilguss, Executive Vice President and CFO]

Sure. I mean keep in mind though on an annual basis, our total marketing expense is pretty flat year-over-year. As I talked about few quarters ago, we clearly look to execute on marketing programs, that we think drive the best returns for the company and sometimes those programs we have to pivot during the year and we had lighter marketing expenses as we've talked about in the middle of 2017 and we finally got some programs coming out. We didn't make a little bit of a shift away from some register our marketing programs to more direct marketing programs. We did some advertising for our brands both .com and .net both domestically and abroad. And so, we've been doing a little bit more direct marketing as a result of that. And those programs came out in the fourth quarter and will continue to run in the first half of 2018 here.

[Gregg Moskowitz, Cowen and Company]

Okay, great. And then just one last question for me. Can you expand on why your cash taxes are so much higher in 2018? And as part of that is the [indiscernible] tax yield associated with the convert? Is that less valuable going forward under tax reform?

[George Kilguss, Executive Vice President and CFO]

Yes. So as mentioned in my prepared remarks, from a GAAP perspective, we made an accrual for the onetime transition tax and that was partially offset by the revaluation of our DTLs and from a GAAP perspective that was about $9 million.

From a cash tax perspective, as you mentioned we're guiding to $70 million to $90 million in 2018 and that's up from about $28 million this year. As mentioned this reflects a variety of the impacts from the Tax Act including the impacts of our impended repatriation. And while I don't think it make sense with all the puts and takes with the tax calculation, I think the big items impacting the company from a cash tax perspective going forward are really the tax on foreign earnings, the U.S. tax on foreign earnings and then the U.S. limitations on interest deductions partially offset by the U.S. tax rate but that amount does include impact as well from our repatriation.

As far as interest limitations U.S. tax reforms clearly has diminished benefits for interest expense, there are some limitations there. And as a result, I mentioned we are looking at our entire capital structure, we're looking at it, we'll be evaluating it. And as our convert to part of that capital structure we'll look at them as well.

[Operator]

We'll go next to Rob Oliver with Baird.

[Matt Lemenager, Baird]

Good afternoon this is Matt -- in for Rob. I realize I might be early, but just looking to see if there is any plan around .web? Maybe things around go-to-market, how that might look, any different than .com would you be doing extra marketing just to get that brand up and going. Any early thoughts I realize, no expectation in the guidance or anything but any early thoughts.

[Jim Bidzos, Executive Chairman, President and CEO]

I think it's just too early at this point to discuss any details about go-to-market or launch plan for .web. because an ICANN process that we are now engaged in with Department of Justice having closed their investigation of .web and when that process completes, I'm sure we will have a lot more to say but at this point would just be premature.

[Matt Lemenager, Baird]

And on the expectations for domain growth 2% to 3% for this year, any difference in the expectations for U.S. versus international, I know you talked about strength in the economy in the United States and that the China phenomenon has kind roll of, I don’t know if any of the international markets were starting to come back.

[George Kilguss, Executive Vice President and CFO]

In 2017 we absolutely have seen a good U.S. market but have been said that European markets have also done well for us, our expectation is that we will see good growth in both U.S. and international markets next year but we don’t guide to the specific markets over their performances.

[Matt Lemenager, Baird]

Got it and the last question I had, on the repatriation. Would it be fair to assume that the primary use case would be for share repurchases or do you think there would be other avenues that you would look to deploy the repatriated cash?

[George Kilguss, Executive Vice President and CFO]

Well, I think in general, I don’t think there will be a change in how we approach capital allocation. As always, we look to need to business using our strategic frame work of protect, grow and manage and we do what we think is best for the business. As you may recall our strategic frame work includes making sure we maintain and adequate amount of liquidity for the business both today and for tomorrow, what we think the needs are to continue to invest in our protect mission for the network and our business for today and tomorrow, to invest in technology and innovation that we think will drive profitable growth for the business and then once we accomplish those goals, we then evaluate how much excess capital we think appropriate to return to shareholders and in what form. We think that frame work which we have been using for the past six years as service well and we will continue to use that frame work as it relates to the capital corporation.

[Operator]

We will go next to Sterling Auty with JPMorgan.

[Ugam Kamat, JPMorgan]

This is Ugam Kamat on for Sterling Auty. So, Jim, you mentioned that the renewal rate out of China was disappointing, especially the second-time renewal rate. So just wondering what was the renewal rate especially in China? Like you gave the blended renewal rate, but just wondering, what was the renewal rate in China? And how many names are left? And what would be the future renewal rates that you expect to come out from this region?

[George Kilguss, Executive Vice President and CFO]

We don’t guide renewal rates by country as mentioned the cohort that was originally from the 2015 China search that cohort was about 1.4 million names coming into the year and that renewal rate was probably out of blended basis may be about 40%, for that cohort. So, we did have a portion of those names come out, however we were anticipating that, we did comment on that last quarter and that was in the guidance that we gave and we fell within the range of the guidance but most of that cohort now is I would say through the system if many material names. I would expect renewal rates to go back to more normalized rates.

[Ugam Kamat, JPMorgan]

All right, perfect. That's helpful. And secondly, since we are coming closer to the Cooperative Agreement date in October, any particular update that you can give us on the process that you're having with the Department of Commerce? Or any particular survey that they might have done to allow the renewal of Cooperative Agreement or just allow it to expire?

[Jim Bidzos, Executive Chairman, President and CEO]

Well, first of all, I guess just to remind everybody on the call. In late September 2016, NTIA approved the .com registry agreement to be extended to November 30, 2024. At that time, NTIA chose not to extend the cooperative agreement. So, it is currently scheduled to terminate on November 30, 2018. Whether to extend that cooperative agreement or not as NTIA's decision and their process. And so, I can't comment on that. they have the right to conduct the public interest review for the sole purpose of terminating whether or not they will exercise their right to extend the term of the cooperative agreement.

Now one update that is new since the last time we've talked is that David Redl was confirmed as the assistant secretary and administrator of the NTIA in that November of 2017. Unfortunately, there is no update I can give you there, we can't comment on Mr. Redl's appointment or the NTIA in regard to their progress related to the cooperative agreement that's theirs not ours. As soon as we can, we'll share whatever information we do have though.

[Operator]

we'll take our last question from Walter Pritchard with Citi.

[Walter Pritchard, Citi]

Hi thank. I think all my questions have been answered. Just one I wanted to make sure I clarified. On the tax scenario that you've outlined the $70 million to $90 million in the tax reform out of 22%. Does that contemplate within in the convert. And if not does the redeem of the convert potentially have additional tax impact beyond what you've talked about.

[George Kilguss, Executive Vice President and CFO]

So, Walter as I mentioned, we're just evaluating our convertible debentures in conjunction with evaluating our capital structure. So, we're still looking at that. So, our guidance is really based on where we see today or what we're doing it, it's doesn't involve looking at any changes from that fact. We're still evaluating it.

[Walter Pritchard, Citi]

And then is that 70 to 90 cash tax rate, it sounds like that doesn't mean, most companies are talking about having an 8 year [Technical Difficulty].

[George Kilguss, Executive Vice President and CFO]

Yeah so, I think you're referring to the transition tax, Tax Act allows you to look at your taxes and what they would have been with the Tax Act or without. So, it's a with or without calculation. And for us when we do that calculation, we expect to actually defer that amount of tax over the 8 years allowed by the Tax Act.

[Walter Pritchard, Citi]

Okay. So, the 70 to 90 will that be a pretty good number of the next say several years. That include that 8-year period too?

[George Kilguss, Executive Vice President and CFO]

So, as we mentioned previously, we don't guide to a long-term cash tax rate. However, I would say in the short term we expect that that rate to still be below our GAAP tax rate as we use up foreign tax credits. At the end of 2017 we had about $122 million of foreign tax credits. And we now expect to utilize those over the next 2 to 3 years.

[Walter Pritchard, Citi]

But the 70 to 90 does includes still the benefit of some of those foreign tax credits and then those would expire at some point here.

[George Kilguss, Executive Vice President and CFO]

That’s correct.

[Walter Pritchard, Citi]

Okay, any good detail on how much per year you can use of that 122?

[George Kilguss, Executive Vice President and CFO]

Like I said they will probably full utilize it over the next three years, so obviously you’re using more up in the year one and two and probably less in year three but the utilization of FTC to be perfectly candid is somewhat complex and is depended on a variety of factors, so it’s a little bit, clearly I have an idea of what they will be but it's probably premature to give that number because they can change overtime depending on how foreign income is recognized overseas.

[Operator]

And with that, I'd like to turn the call back over to David Atchley for any additional or closing remarks.

[David Atchley]

Thank you, operator. Please call the Investor Relations department with any follow-up questions from this call. Thank you for your participation. This concludes our call. Have a good evening.

[Operator]

Again, this does conclude today's call. You may now disconnect.