Verisign Inc/Ca Q1 FY2020 Earnings Call

Good day, everyone. Welcome to VeriSign's First 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.

Thank you, Operator. Welcome to VeriSign's First 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 first 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, which identify risk factors that would cause actual results to differ materially from those contained in the forward-looking statements. VeriSign retains its long-standing 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 results and 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.

Thanks, David, and good afternoon, everyone. As we confront the global challenges brought on by COVID-19, our primary focus is on ensuring the safety of our workforce, managing our operations effectively, supporting our local communities, and assisting small businesses through our partners. While the challenges we face from COVID-19 are unprecedented, they are within the scope of our usual preparations for disruptions caused by various events. Our readiness plans, which we regularly practice, include maintaining critical Internet infrastructure while most of our employees work remotely. We are equipped to sustain all of our services, including the registry services for .com and .net, adhering to the high standards set by ICANN, even under the challenging circumstances created by COVID-19. Furthermore, to support our local communities, we made an initial donation of $2 million during the first quarter to first responders and medical personnel in Northern Virginia, the United Way’s Worldwide COVID-19 Community Response and Recovery Fund, and Semper Fi & America's Fund as announced in March. More details on our efforts to protect our employees, manage operations, and assist communities and small businesses can be found on our company blog at verisign.com. Now, I would like to discuss updates and our first quarter results. I'm pleased to report another strong quarter for VeriSign, during which we concentrated on our core business, grew the domain name base, and achieved consistent financial results. On March 27, we announced a third amendment to the .com registry agreement with ICANN and a separate binding letter of intent, establishing a new collaboration framework for security, stability, and resilience in the domain system. We are satisfied with the outcome of this process and are confident that these agreements will benefit the public interest by ensuring pricing stability and supporting the security and resilience of .com and the essential Internet functions it underpins globally. Additionally, we announced that in response to the global disruptions from COVID-19, we have frozen registry fees for all TLDs, including .com and .net, until the end of 2020. As mentioned last quarter regarding the letter of intent, we have made a one-time commitment of $4 million annually for five years starting on January 1, 2021, to ICANN to support initiatives that preserve and enhance the security, stability, and resilience of the DNS and the Internet. We believe the funded activities will benefit the entire Internet community. Also, in February, Todd Strubbe was promoted from Executive Vice President and Chief Operating Officer to President and Chief Operating Officer, which further strengthens our senior management team. Now for some first quarter operational highlights: as of the end of March, the total domain name base for .com and .net was 160.7 million, with 147.3 million names for .com and 13.4 million names for .net, reflecting a year-over-year growth rate of 3.8%. During the first quarter, we processed 10 million new registrations, resulting in an increase of 1.83 million names in the domain name base. Although we cannot fully measure our renewal rates until 45 days after the quarter ends, we anticipate that the renewal rate for the first quarter of 2020 will be around 75.4%. This preliminary rate compares to 75.0% in the first quarter of 2019 and 73.8% in the fourth quarter of 2019. I also want to point out a typo in our press release that was issued this afternoon. It mistakenly states "fourth quarter of 2020" instead of "fourth quarter of 2019" when referring to the 73.8% renewal rate. To clarify, the renewal rate for the fourth quarter of 2019 was indeed 73.8%. Now, regarding 2020, we expect the domain name base growth rate to be between 2% and 3.75%. Acknowledging the uncertainty due to COVID-19, this updated range reflects a more cautious outlook on domain name base growth for the remainder of the year. During the first quarter, we continued our share repurchase program, acquiring 1.3 million shares of common stock for $245 million. As of March 31, 2020, there remains $826 million authorized and available under our current share repurchase program, which does not have an expiration date. Our financial position remains robust, with $1.139 billion in cash, cash equivalents, and marketable securities at the close of the quarter. We continue to evaluate our overall liquidity and investment needs and are considering the best uses for our cash, including potential share repurchases.

Thank you, Jim, and good afternoon, everyone. For the quarter ended March 31, 2020, the company generated revenue of $313 million, up 2% from the same quarter in 2019, and delivered operating income of $206 million, up 3% from $200 million in the same quarter a year ago. Operating expense totaled $106 million, flat with the first quarter a year ago and lower from $112 million last quarter. The sequential decrease in operating expense is primarily a result of a decrease in sales and marketing expenses in the quarter, partially offset by the $2 million in donations that Jim mentioned earlier. The operating margin in the quarter came to 66% compared to 65.4% in the same quarter a year ago. Net income totaled $334 million compared to $163 million a year earlier, which produced diluted earnings per share of $2.86 in the first quarter this year compared to $1.35 for the same quarter last year. As noted in our earnings release, net income for the quarter included the recognition of $168 million of previously unrecognized income tax benefits. This income tax benefit increased diluted earnings per share by $1.44. As of March 31, 2020, the company maintained total assets of $1.754 billion and total liabilities of $3.163 billion. Assets included $1.139 billion of cash, cash equivalents and marketable securities. Operating cash flow for the first quarter was $180 million, and free cash flow was $169 million compared with $187 million and $178 million, respectively, for the first quarter last year. I will now discuss full year 2020 guidance. Revenue is still expected to be in the range of $1.250 billion to $1.265 billion. This revenue range forecast reflects the updated domain name base growth rate of between 2% and 3.75% that Jim mentioned earlier. The 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, security 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 $80 million and $85 million. This updated range reflects lower expected interest income on cash balances due to decreased interest rates. Capital expenditures are still expected to be between $45 million and $55 million. We now 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 expect tax expense as a percent of pretax income of between 19% and 22%. Cash taxes for 2020 will not be impacted by the remeasurement of our accrual for uncertain tax positions discussed earlier and are expected to still be in the range of 18% to 21% of pretax income. In summary, VeriSign continued to demonstrate sound financial performance during the quarter, and we look forward to continuing our focused execution for the balance of 2020 during this period of market uncertainty.

Thank you, George. Before moving to the question-and-answer portion of this call, I would like to acknowledge the efforts of critical staff, not only here at VeriSign but everywhere, and the hard work and commitment they are demonstrating during this crisis. We appreciate the training, skill and dedicated effort of our team, which remains focused on operating our critical infrastructure. I hope everyone remains well and continues to stay safe. Given that participants are dialing in remotely for this call, we would like to walk through a few questions which we know are on your mind before we open the call for your additional questions. The first question I'll ask and then answer is, could you provide more information then on COVID-19's impacts to your business in terms of your infrastructure, supply chain, customers, demand for .com and .net and capital allocation? The answer is that we recognize that VeriSign operates critically within the infrastructure that's relied on now more than ever. Protecting unconditionally the infrastructure that operates registry services for .com and .net as well as our root operations remains job one. The company's readiness plans, which are routinely exercised, include the ability to maintain critical Internet infrastructure with most employees working remotely. VeriSign maintains multiple redundant operation centers as well as hundreds of service locations distributed worldwide across six continents. VeriSign's diverse DNS infrastructure is not dependent on a single type of technology, vendor or power source at a given location, and VeriSign technical teams across the globe are able to perform key functions from multiple locations. We are prepared to continue to operate all of our services, including registry services for .com and .net and our route operations at the rigorous standards of performance governed by ICANN even in the demanding environment created by COVID-19. In respect to our supply chain, we're monitoring these issues and are taking action where appropriate to ensure that we continue to have everything necessary for the ongoing operation of our infrastructure. It is important to remember that our infrastructure is not dependent on a single type of technology, vendor or power source at a given location. With regards to our customers, these are clearly uncertain times for businesses and the economy. As we discussed in our blog post, we're taking actions to help small businesses through our channel partners. In order to support individuals and small businesses affected by this crisis, VeriSign is freezing registry prices for all of our TLDs, including .com and .net, through the end of 2020. In addition, from April 2 until June 1, VeriSign is waiving what is known as the restore fee for .com and .net domain names. Typically, when a domain name registration is deleted by a registrar, there is a period of time during which the person who registered the name can pay a one-time restore fee to get it back before the name goes back into general availability. This helps protect registrants who may have accidentally let their domain names lapse at an inopportune time. As it relates to demand for .com and .net domain names, we see in today's results that we saw a good demand for new registrations during the first quarter as well as an improved preliminary renewal rate. That being said, as I stated earlier, recognizing the uncertainty over the duration and economic impact of the COVID-19 crisis, the updated guidance range reflects a more cautious view of domain name base growth for the rest of the year. As a reminder, you can track the performance of the domain name base with daily updates on our website. Finally, regarding capital allocation, recognizing that these are unprecedented times and that it is a period of market uncertainty for at least the next quarter, our capital return will be more in line with historical amounts. The second question I'll ask and address: with amendment 3 finalized, when can you take price increases for .com? Amendment 3 for the COM Registry Agreement reflects certain changes agreed to under Amendment 35 to the cooperative agreement with the U.S. Department of Commerce, including the pricing changes, which allow limited .com price increases in each of the last four years of every six-year period. The first period began on October 26, 2018. Therefore, October 26, 2020 was the earliest date that VeriSign could have taken a price increase. That said, as we announced in March, VeriSign is freezing its registry prices for all of our top-level domains, including .com and .net, through the end of 2020 in order to support individuals and small businesses affected by the COVID-19 pandemic. Also, as a reminder, the .com and .net registry agreements require VeriSign to provide six months' notice of any price increase. Now the third and last question I'd like to answer before we take yours: Are there any updates on the status of .web? As mentioned on our last call, we were awaiting a ruling on whether VeriSign could participate in the arbitration called an independent review process under ICANN's rules. As announced in our 10-K in February, the arbitration panel permitted VeriSign and new .co to participate in aspects of the independent review process. We do not have further updates at this time. Now we'll open the call for your questions. As a reminder, due to the remote nature of participants, we will do our best to respond to each question, and we appreciate your patience if we experience technical issues. Operator, we're ready for the first question.

And we'll take our first question today from Rob Oliver with Baird.

Great. And, Todd, congratulations on your promotion. Jim, you guys are already a model of efficiency, but, yes, answering your own questions takes it to a new level. You've taken most of mine, but I did want to just flush out the strong renewal rates, which were very strong, and maybe get a bit more color on what you guys are seeing in terms of domain activity. I mean, the slight tweak down of the revised range is fairly modest. And just curious what you guys are seeing and how that plays into your forecasting about any residual effects on SMBs from COVID-19?

This is Jim. I'll ask George to answer the substance of your question. I would just say beforehand that there's obvious significant economic impact from COVID-19. And we're talking about Q1 here, but, obviously, this is going to last more than one quarter. So I would just say, again, for clarity that our more cautious view because of this crisis is reflected in all of our guidance. But George, let me have you answer the question, if you would.

Sure. Rob, it's George. From a renewal rate perspective, we did see renewal rates tick up a little bit from year ago levels. When we take a deeper look, we see the previously renewed rate really being the driver of that. So we're seeing people who have renewed names previously continue to hold on to those names. And as we talked about before, that's a normal function that we've seen previously as the base stages. As we look at the domain name base performance itself, clearly here in the first quarter, as Jim mentioned, we had what actually was a good Q1. New units were up 2.1% from a year ago and delivered $1.8 million. As you mentioned, we're keeping an eye on the domain name base and demand for the rest of the year. In the quarter, we saw good strength from the United States registrars. And I would say the China market was a little softer, but the strength from the U.S. registrars really outpaced that and overcompensated for that, helping the domain name base to continue to grow here in Q1.

Our next question will come from Nick Jones with Citi.

Just two quick ones, one on the .com pricing agreement. I guess, just one on the timing without, I guess, asking for specific timing. But as you aren't taking any pricing increases in 2020, are you able to implement that on October 26, say, in early 2021? And if you were to take it in 2021, the way the contract reads, are you then not able to take the October 26, 2021? Ultimately, could you do two price increases in the same year? I'm not sure if you follow me, but that's my first one. And then I have a quick follow-up.

Okay. Well, I think the best way I can answer your question. First of all, let me just say that your question is actually sort of getting to a process that we employ. So rather than try to interpret that on the fly, let me just give you some facts about that. Under Amendment 3 that I think will be helpful to answer your question, under Amendment 3 to the COM agreement, VeriSign is allowed to take a price increase in each of the last four years of every six-year period of up to 7% over the maximum price in the preceding pricing year. Pricing year is defined as October 26 to October 25. This time frame is consistent with Amendment 35 to the cooperative agreement that established the start of the six-year period as of October 26, 2018. So those are the sort of the facts of the mechanics, and I think that should help you kind of get to where you want me to.

That does. That's helpful. That's helpful. And then the second one, just quickly on kind of new top-level domain, a large registrar acquired a registry that issues new TLDs and some country code TLDs. Does that potentially increase the risk of impacting .com demand? Or do you have any thoughts around that?

So I assume you're referring to GoDaddy's acquisition of NeuStar. So let me just say GoDaddy has been and is an important channel partner for us, and we expect that to continue. End users continue to see tremendous value in the .com and .net top-level domains, and we know that all of our channel partners recognize that value as well. It's also important to note that vertical integration is not new. Several of our registrar channel partners also operate TLD registries, including Google, which has Google Registry and Name.com, which is a registrar that owns Donuts, which is a large registry. In each case, these registrars continue to be important channel partners for VeriSign.

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

George, maybe to start with you. If I look at the revenue results in the quarter, it's stronger than I would have anticipated based on the 1.8 million net names added. So can you comment? Was there something to either the seasonality of those net additions that helped revenue? Or was there any other one-time revenue or non-domain-related revenue that maybe helped the quarter?

There was no non-domain name revenue that was material that we didn't have present in the fourth quarter. I think what may be impacting your perception is we had a very, very strong fourth quarter. And so we had quite a few domains come in the fourth quarter, and that's just waterfalling here into the first quarter and helping us getting a little bit of a tailwind here in Q1.

Okay, great. And then on the GoDaddy acquisition of NeuStar, I'd like to look at it this way. Does this change or influence what you might think about doing with .web and vertical integration or perhaps in terms of future consolidation of registries?

I really don't see that it really has any impact on any thinking about that. As I said, this is not the first time that a registrar has become a registry. There are several of them out there, and those relationships work fine. But I think there's no update on .web, so it's early to speculate about .web per se. But at this point, no real comment to say about that. I mean, we've certainly discussed the ability to be vertically integrated, but let me just say Amendment 35 to the cooperative agreement clarified that the vertical integration within the .com registry was only meant to apply to .com. So we can't be vertically integrated for .com. That clarification is now included in Amendment 3 to the COM Registry Agreement. And the .net registry agreement doesn't have a similar clarification.

Okay. And then on .web, you mentioned what update you did have. Is COVID-19 delaying the process? Or any other color you could provide would be helpful.

I don't believe it has. The proceedings in this arbitration actually began even before the COVID-19 crisis, and all appearances have been conducted via telephone. This is different from court appearances where individuals must be physically present. There is an upcoming hearing scheduled for later this year that is planned to be in person, but I cannot predict what will occur there. Up to this point, everything has been conducted telephonically, so there has been no slowdown so far. Beyond that, I cannot speculate about future developments.

So you mentioned that there is an in-person one later this year. So does that kind of give us an indication that there would not be a resolution to .web, let's say, over the next quarter or so?

I can't speculate about exactly what will happen when. I just know that there was a hearing that was at least planned to be an in-person hearing. I don't know if that's subject to change or not. I'm not familiar with that level of detail with the rules, the flexibility, or the plans or what impact the COVID-19 crisis may have on that particular plan. I just know that things have proceeded so far because, again, all of the proceedings have literally been telephonic.

Got it. And last question. You talked about the supply chains. What does the capacity utilization in the VeriSign network look like today? Do you have ample overhead to handle some of the spikes that we're seeing? Some of the traffic data coming out of Akamai and others showed some pretty significant Internet usage. How is the resiliency from just the performance in capacity utilization within the VeriSign network?

We are very pleased with the performance of our network under increased traffic loads. It's designed with considerable excess capacity. And as I stated earlier, we are prepared for situations like this, which certainly, not just from the work-from-home environment perspective, but also from an increased traffic capacity. Excess capacity to deal with traffic loads has always been a design criterion in our network, and we're accommodating traffic without issues.

That will conclude today's question-and-answer session. I will now turn the conference over to Mr. David Atchley for any additional or closing remarks.

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.

That does conclude today's conference. Thank you for your participation. You may now disconnect.