TMCnet News
VERISIGN INC/CA - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion in conjunction with the interim unaudited Condensed Consolidated Financial Statements and related notes. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. Forward-looking statements include, among others, those statements including the words "expects," "anticipates," "intends," "believes" and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section titled "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q. You should also carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q or Current Reports on Form 8-K that we file in 2014 and our 2013 Form 10-K, which was filed on February 21, 2014, which discuss our business in greater detail. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document. Overview We are a global provider of domain name registry services which power the navigation of the Internet by operating a global infrastructure for a portfolio of TLD's that includes .com, .net, .tv, .edu, .gov, .jobs, .name and .cc as well as two of the world's 13 Internet root servers ("Registry Services"). Our product suite also includes Network Intelligence and Availability ("NIA Services") consisting of DDoS Protection Services, iDefense and Managed DNS. We have one reportable segment consisting of Registry Services and NIA Services. As of March 31, 2014, we had approximately 128.5 million domain names registered under the .com and .net registries, our principal registries. The number of domain names registered is largely driven by continued growth in online advertising, e-commerce, and the number of Internet users, which is partially driven by greater availability of broadband, as well as advertising and promotional activities carried out by us and third-party registrars. Growth in the number of domain names has been hindered by certain factors, including changes to the marketing strategies of certain registrars, overall economic conditions and ongoing changes to search algorithms used by Google and other Internet search engines that negatively affect the profitability of certain types of websites, and as a result, reduce demand for new domain name registrations and renewals. Revenues from NIA Services are not significant in relation to our consolidated revenues. Business Highlights and Trends • We recorded revenues of $248.8 million during the three months ended March 31, 2014. This represents an increase of 5% as compared to the same period in 2013. • We recorded operating income of $139.6 million during the three months ended March 31, 2014. This represents an increase of 5% as compared to the same period last year. • We added 1.28 million net new names during the first quarter, ending with 128.5 million active domain names in the zone for .com and .net, which represents a 4% increase over the zone at the end of the first quarter in 2013. • In the first quarter, we processed 8.6 million new domain name registrations for .com and .net as compared to 8.8 million for the same period in 2013. • The final .com and .net renewal rate for the fourth quarter of 2013 was 72.2% compared with 72.9% for the same quarter in 2012. Renewal rates are not fully measurable until 45 days after the end of the quarter. • On January 31, 2014, our Board of Directors authorized the repurchase of up to $527.6 million of common stock, in addition to the $472.4 million of our common stock remaining available for repurchase under the previous 2013 Share Buyback Program, for a total repurchase authorization of up to $1.0 billion of its common stock. • During the three months ended March 31, 2014, we repurchased 2.4 million shares of our common stock under the 2014 Share Buyback Program for $131.7 million. As of March 31, 2014, $868.3 million remained available for further repurchases under the 2014 Share Buyback Program. • Through April 23, 2014, we repurchased an additional 0.7 million shares for $35.2 million under the 2014 Share Buyback Program. • We generated cash flows from operating activities of $141.6 million during the three months ended March 31, 2014, a decrease of 6% as compared to the same period last year. 13-------------------------------------------------------------------------------- Table of Contents • Effective February 1, 2014, the domain name registration fees for the .net TLD increased from $5.62 to $6.18, per our agreement with ICANN. Pursuant to our agreements with ICANN, Verisign makes available on its website at www.verisigninc.com/zone files containing all active domain names registered in the .com and .net registries. At the same website address, Verisign makes 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 are not configured for use. These files and the related summary data are updated at least once per day. The update times may vary each day. The summary data provided on the website includes domain names that, at the time of publication, were recently purchased and subject to a five day grace period during which the domain names may be deleted and a credit may be issued to a registrar (the "add grace period"). The number of active domain names subject to the add grace period is typically immaterial. The numbers provided in this Form 10-Q are the numbers as of midnight of the date reported, include domain names registered but not configured for use, and do not include domain names subject to the add grace period and therefore cannot be compared to the summary posted on our website. Information available on, or accessible through, this website is not incorporated herein by reference. We announce material financial information to our investors using our investor relations website http://investor.verisign.com, SEC filings, investor events, news and earnings releases, public conference calls and webcasts. We use these channels as well as social media to communicate with our investors and the public about our company, our products and services, and other issues. It is possible that the information we post on social media could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in our company to review the information we post on the social media channels listed below. This list may be updated from time to time on our investor relations website. https://www.facebook.com/Verisign http://www.twitter.com/Verisign http://www.LinkedIn.com/company/verisign http://www.youtube.com/user/verisign http://www.verisigninc.com http://blogs.verisigninc.com The contents of these websites are not intended to be incorporated by reference into this Quarterly Report on Form 10-Q or in any other report or document we file, and any reference to these websites are intended to be inactive textual references only. Results of Operations The following table presents information regarding our results of operations as a percentage of revenues: Three Months Ended March 31, 2014 2013 Revenues 100 % 100 % Costs and expenses: Cost of revenues 19 20 Sales and marketing 8 8 Research and development 8 8 General and administrative 9 8 Total costs and expenses 44 44 Operating income 56 56 Interest expense (9 ) (5 ) Non-operating income (loss), net 3 (2 ) Income before income taxes 50 49 Income tax expense (12 ) (13 ) Net income 38 % 36 % 14-------------------------------------------------------------------------------- Table of Contents Revenues Revenues related to our Registry Services are primarily derived from registrations for domain names in the .com, .net, .cc, .tv, .name, .gov, and .jobs domain name registries. Revenues from .cc, .tv, .name, .gov, and .jobs are not significant in relation to our consolidated revenues. For domain names registered with the .com and .net registries, we receive a fee from third-party registrars per annual registration that is fixed pursuant to our agreements with ICANN. Individual customers, called registrants, contract directly with third-party registrars or their resellers, and the third-party registrars in turn register the .com, .net, .cc, .tv, .name and .jobs domain names with Verisign. Changes in revenues are driven largely by changes in the number of new domain name registrations and the renewal rate for existing registrations as well as the impact of new and prior price increases, to the extent permitted, by ICANN and the DOC. New registrations and the renewal rate for existing registrations are impacted by continued growth in online advertising, e-commerce, and the number of Internet users, which is partially driven by greater availability of broadband, as well as advertising and promotional activities carried out by us and third-party registrars. We increased our .net domain name registration fees from $5.11 to $5.62 on July 1, 2013 and from $5.62 to $6.18 on February 1, 2014. We have the contractual right to increase the fees for .net domain name registrations by up to 10% each year during the term of our .net agreement with ICANN through June 30, 2017. The price of .com domain names is fixed at $7.85 for the duration of the current .com Registry Agreement through November 30, 2018, except that prices may be raised by up to 7% each year due to the imposition of any new Consensus Policy or documented extraordinary expense resulting from an attack or threat of attack on the Security and Stability (each as defined in the .com Registry Agreement) of the DNS, subject to approval of the DOC. We offer promotional marketing programs for our registrars based upon market conditions and the business environment in which the registrars operate. All fees paid to us for .com and .net registrations are in U.S. dollars. Revenues from NIA Services are not significant in relation to our total consolidated revenues. A comparison of revenues is presented below: Three Months Ended March 31, 2014 % Change 2013 (Dollars in thousands) Revenues $ 248,796 5 % $ 236,447 The following table compares domain names ending in .com and .net managed by our Registry Services business: March 31, 2014 % Change March 31, 2013 Active domain names ending in .com and .net 128.5 million 4 % 123.1 million Revenues increased by $12.3 million during the three months ended March 31, 2014, as compared to the same period last year, primarily due to an increase of $11.8 million in revenues from the operation of the registries for the .com and .net TLDs. The increase in revenues from the operation of the registries for the .com and .net TLDs is primarily due to a 4% increase in the number of domain names ending in .com and .net and an increase in the .net domain name registration fees in July 2013 and February 2014. The growth in the number of active domain names was primarily driven by continued Internet growth and new domain name promotional programs. However, ongoing economic uncertainty and changing marketing strategies by certain registrars has limited the rate of growth of the domain name base. Further, according to published reports, Google periodically makes changes to its search algorithms, which may decrease traffic to certain websites, and pay-per-click advertising policies, which may provide less compensation for certain types of websites. This could make such websites less profitable and hinder domain name registration growth. We believe these algorithm changes had a negative effect on the first time renewal rate for registrations in recent years. We expect to see continued growth in the number of active domain names during the remainder of 2014 as a result of further Internet growth. In addition we expect to see continued growth internationally in the domain name base, resulting from greater broadband availability, Internet adoption, and expanding e-commerce. We believe certain registrars made changes to their marketing strategies and offered fewer discount programs for domain name registrations during the three months ended March 31, 2014 and may continue to do so in the future. We believe these marketing changes by registrars along with overall economic conditions may limit growth in the number of active domain names during 2014. Although growth in the domain name base may be limited by these factors, we expect revenues will continue to increase in fiscal 2014 as compared to fiscal 2013 as a result of continued growth in the number of active domain names ending in .com and .net and increases in the .net domain name registration fees in July 2013 and February 2014. 15 -------------------------------------------------------------------------------- Table of Contents Geographic revenues We generate revenues in the U.S.; Australia, China, India and other Asia Pacific countries ("APAC"); Europe, the Middle East and Africa ("EMEA"); and certain other countries including Canada and Latin American countries. The following table presents a comparison of our geographic revenues: Three Months Ended March 31, 2014 % Change 2013 (Dollars in thousands) U.S. 151,761 7 % $ 142,147 EMEA 45,149 13 % 40,001 APAC 32,194 (4 )% 33,659 Other 19,692 (5 )% 20,640 Total revenues $ 248,796 $ 236,447 Revenues for our Registry Services business are attributed to the country of domicile and the respective regions in which our registrars are located, however, this may differ from the regions where the registrars operate or where registrants are located. Revenue growth for each region may be impacted by registrars reincorporating, relocating, or from acquisitions or changes in affiliations of resellers. These changes are reflected in the revenue growth in EMEA and the decline in revenue in APAC. Cost of revenues Cost of revenues consist primarily of salaries and employee benefits expenses for our personnel who manage the operational systems, depreciation expenses, operational costs associated with the delivery of our services, fees paid to ICANN, customer support and training, consulting and development services, costs of facilities and computer equipment used in these activities, telecommunications expense and allocations of indirect costs such as corporate overhead. A comparison of cost of revenues is presented below: Three Months Ended March 31, 2014 % Change 2013 (Dollars in thousands) Cost of revenues $ 48,026 2 % $ 47,254 Cost of revenues remained consistent during the three months ended March 31, 2014, as compared to the same period last year. We expect cost of revenues as a percentage of revenues to remain consistent during the remainder of 2014 compared to the three months ended March 31, 2014. Sales and marketing Sales and marketing expenses consist primarily of salaries, sales commissions, sales operations and other personnel-related expenses, travel and related expenses, gTLD application costs, trade shows, costs of lead generation, costs of computer and communications equipment and support services, facilities costs, consulting fees, costs of marketing programs, such as online, television, radio, print and direct mail advertising costs, and allocations of indirect costs such as corporate overhead. A comparison of sales and marketing expenses is presented below: Three Months Ended March 31, 2014 % Change 2013 (Dollars in thousands) Sales and marketing $ 20,289 12 % $ 18,104 Sales and marketing expenses increased during the three months ended March 31, 2014, as compared to the same period last year, primarily due to a $2.8 million increase in consulting and advertising expenses resulting from an increase in product marketing initiatives promoting Registry and NIA services and an increase in corporate marketing expenses. 16 -------------------------------------------------------------------------------- Table of Contents We expect sales and marketing expenses as a percentage of revenues to increase during the remainder of 2014 compared to the three months ended March 31, 2014 as the volume of marketing initiatives increases. We expect sales and marketing expenses as a percent of revenues for full year 2014 to be at comparable levels to 2013. Research and development Research and development expenses consist primarily of costs related to research and development personnel, including salaries and other personnel-related expenses, consulting fees, facilities costs, computer and communications equipment, support services used in our service and technology development, and allocations of indirect costs such as corporate overhead. A comparison of research and development expenses is presented below: Three Months Ended March 31, 2014 % Change 2013 (Dollars in thousands) Research and development $ 18,439 1 % $ 18,176 Research and development expenses remained consistent during the three months ended March 31, 2014, as compared to the same period last year. We expect research and development expenses as a percentage of revenues to remain consistent during the remainder of 2014 compared to the three months ended March 31, 2014. General and administrative General and administrative expenses consist primarily of salaries and other personnel-related expenses for our executive, administrative, legal, finance, information technology and human resources personnel, costs of facilities, computer and communications equipment, management information systems, support services, professional services fees, certain tax and license fees, and bad debt expense, offset by allocations of indirect costs such as facilities and shared services expenses to other cost types. A comparison of general and administrative expenses is presented below: Three Months Ended March 31, 2014 % Change 2013 (Dollars in thousands) General and administrative $ 22,457 14 % $ 19,649 General and administrative expenses increased during the three months ended March 31, 2014, as compared to the same period last year, primarily due to $2.0 million increase in stock-based compensation expenses due to higher expected attainment levels for performance-based RSUs granted in 2013 and a decrease in expense recognized during the three months ended March 31, 2013 as a result of lower actual attainment level for performance-based RSUs granted in 2012. We expect general and administrative expenses as a percentage of revenues to remain consistent during the remainder of 2014 compared to the three months ended March 31, 2014. 17 -------------------------------------------------------------------------------- Table of Contents Interest expense The following table presents the components of Interest expense: Three Months Ended March 31, 2014 2013 (In thousands) Contractual interest on the Subordinated Convertible Debentures $ 10,156 $ 10,156 Contractual interest on Senior Notes 8,672 - Amortization of debt discount on the Subordinated Convertible Debentures 2,282 2,101 Credit facility and amortization of debt issuance costs 491 607 Interest capitalized to Property and equipment, net (216 ) (268 ) Total interest expense $ 21,385 $ 12,596 Contractual interest on the Senior Notes during the three months ended March 31, 2014 is the result of the issuance of the Senior Notes in April 2013. We expect interest expense to remain consistent during each of the remaining quarters of 2014 as compared to the three months ended March 31, 2014. Non-operating income (loss), net The following table presents the components of Non-operating income (loss), net: Three Months Ended March 31, 2014 2013 (In thousands) Unrealized gain (loss) on contingent interest derivative on Subordinated Convertible Debentures $ 5,269 $ (6,433 ) Interest income 316 643 Other, net 931 13 Total non-operating income (loss), net $ 6,516 $ (5,777 ) Unrealized gain (loss) on the contingent interest derivative on the Subordinated Convertible Debentures reflects the change in value of the derivative that results primarily from changes in our stock price. Interest income is earned principally from our surplus cash balances and marketable securities. Income tax expense The following table presents income tax expense and the effective tax rate: Three Months Ended March 31, 2014 2013 (Dollars in thousands) Income tax expense $ 30,293 $ 30,378 Effective tax rate 24 % 26 % The effective tax rate for the three months ended March 31, 2014 and 2013 is lower than the statutory federal rate of 35% primarily due to tax benefits from foreign income taxed at lower rates, partially offset by state income taxes and non-deductible stock-based compensation. 18 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources March 31, December 31, 2014 2013 (In thousands) Cash and cash equivalents $ 267,053 $ 339,223 Marketable securities 1,450,155 1,384,062 Total $ 1,717,208 $ 1,723,285 As of March 31, 2014, our principal source of liquidity was $267.1 million of cash and cash equivalents and $1.5 billion of marketable securities. The marketable securities consist of debt securities issued by the U.S. Treasury meeting the criteria of our investment policy, which is focused on the preservation of our capital through investment in investment grade securities. The cash equivalents consist of amounts invested in money market funds. As of March 31, 2014, all of our marketable securities have contractual maturities of less than one year. Our cash and cash equivalents are readily accessible. For additional information on our investment portfolio, see Note 2, "Cash, Cash Equivalents, and Marketable Securities," of our Notes to Condensed Consolidated Financial Statements in Part I, Item I of this Quarterly Report on Form 10-Q. As of March 31, 2014, the amount of cash and cash equivalents and marketable securities held by foreign subsidiaries was $1.5 billion. During the second quarter of 2014, we expect to complete the repatriation of approximately $700.0 million to $800.0 million of cash held by foreign subsidiaries in a tax efficient manner by using the tax benefits resulting from the worthless stock deduction, which was recognized in the fourth quarter of 2013, to offset the taxable income generated in the U.S. as a result of the repatriation. The repatriation amount is expected to utilize substantially all of the projected available distributable capital reserves of our foreign subsidiaries under applicable foreign statutes. For any funds remaining in the foreign subsidiaries after the repatriation that have not been previously taxed in the U.S., our intent remains to indefinitely reinvest those funds outside of the U.S. and accordingly, we have not provided deferred U.S. taxes for such funds. In the event funds from foreign operations are needed to fund operations in the U.S. and if U.S. tax has not already been provided, we would be required to accrue and pay additional U.S. taxes in order to repatriate these funds. As of March 31, 2014, we had $750.0 million principal amount outstanding of the 4.625% senior unsecured notes due 2023. The Senior Notes are scheduled to mature in May 2023. We also continue to maintain our unsecured revolving credit facility which has a borrowing capacity of $200.0 million. There were no borrowings outstanding under the credit facility as of March 31, 2014. As of March 31, 2014, we had $1.25 billion principal amount outstanding of 3.25% subordinated convertible debentures due 2037. The price of our common stock continued to exceed the Conversion Price Threshold Trigger, currently $44.68, during the first quarter of 2014. Accordingly, the Subordinated Convertible Debentures are convertible at the option of the holder through June 30, 2014. We do not expect a material amount of the Subordinated Convertible Debentures to be converted in the near term as the trading price of the debentures exceeds the value that is likely to be received upon conversion. However, we cannot provide any assurance that the trading price of the debentures will continue to exceed the value that would be derived upon conversion or that the holders will not elect to convert the Subordinated Convertible Debentures. If a holder elects to convert its Subordinated Convertible Debentures, we are permitted under the Indenture to pursue an exchange in lieu of conversion or to settle the conversion value (as defined in the Indenture) in cash, stock, or a combination thereof. If we choose not to pursue or cannot complete an exchange in lieu of conversion, we currently have the intent and the ability (based on current facts and circumstances) to settle the principal amount of the Subordinated Convertible Debentures in cash. However, if the principal amount of the Subordinated Convertible Debentures that holders actually elect to convert exceeds our cash on hand and cash from operations, we will need to draw cash from existing financing or pursue additional sources of financing to settle the Subordinated Convertible Debentures in cash. We cannot provide any assurances that we will be able to obtain new sources of financing on terms acceptable to us or at all, nor can we assure that we will be able to obtain such financing in time to settle the Subordinated Convertible Debentures that holders elect to convert. We believe existing cash, cash equivalents and marketable securities, and funds generated from operations, together with our borrowing capacity under the unsecured revolving credit facility should be sufficient to meet our working capital, capital expenditure requirements, and to service our debt for at least the next 12 months. We regularly assess our cash management approach and activities in view of our current and potential future needs. 19 -------------------------------------------------------------------------------- Table of Contents In summary, our cash flows for the three months ended March 31, 2014 and 2013 are as follows: Three Months Ended March 31, 2014 2013 (In thousands) Net cash provided by operating activities $ 141,629 $ 150,637 Net cash used in investing activities (77,141 ) (78,565 ) Net cash used in financing activities (136,888 ) (122,351 ) Effect of exchange rate changes on cash and cash equivalents 230 (1,837 ) Net decrease in cash and cash equivalents $ (72,170 ) $ (52,116 ) Cash flows from operating activities Our largest source of operating cash flows is cash collections from our customers. Our primary uses of cash from operating activities are for personnel related expenditures, and other general operating expenses, as well as payments related to taxes, interest and facilities. Net cash provided by operating activities decreased during the three months ended March 31, 2014 primarily due to an increase in income tax payments made during the first quarter of 2014 which related primarily to certain non-US jurisdictions. An increase in cash paid to employees and vendors was offset by an increase in cash received from customers. Payments to employees increased primarily due to an increase in payments made during the first quarter of 2014 for 2013 annual bonuses. Cash received from customers increased primarily due to an increase in the number of renewed domain name registrations during the three months ended March 31, 2014, and the increases in the .net domain name registration fees in July 2013 and February 2014. Cash flows from investing activities The changes in cash flows from investing activities primarily relate to purchases, maturities and sales of marketable securities, and purchases of property and equipment. Net cash used in investing activities decreased during the three months ended March 31, 2014, due to a decrease in purchases of property and equipment and an increase in proceeds from maturities and sales of marketable securities, partially offset by an increase in purchases of marketable securities. Cash flows from financing activities The changes in cash flows from financing activities primarily relate to share repurchases, proceeds from and repayments of borrowings, stock option exercises, our employee stock purchase plan ("ESPP"), and excess tax benefits from stock-based compensation. Net cash used in financing activities increased during the three months ended March 31, 2014 primarily due to a decrease in realized excess tax benefits from exercises of stock options and vesting of RSUs, partially offset by an increase in the amount of share repurchases, compared to the same period of the prior year. 20 -------------------------------------------------------------------------------- Table of Contents |