Earnings Call Transcript - VRSN Q3 2023

Operator, Operator

Good day, everyone. Welcome to Verisign's Third Quarter 2023 Earnings Call. Today's conference is being recorded. Recording of this conference is not permitted unless preauthorized. At this time, I'd like to turn the conference over to Mr. David Atchley, Vice President of Investor Relations and Corporate Treasurer. Please go ahead, sir.

David Atchley, Vice President of Investor Relations and Corporate Treasurer

Thank you, operator. Welcome to Verisign's third 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 two non-GAAP measures used by Verisign, adjusted EBITDA and free cash flow. GAAP to non-GAAP reconciliation information is appended to the slide presentation, which 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 and CEO

Thank you, David. Good afternoon to everyone, and thank you for joining us. We delivered another solid quarter by focusing on our mission as a critical Internet infrastructure operator. In addition to delivering on our mission during the third quarter, I'm pleased with the financial results, which show the continued strength of our business model during this uncertain macroeconomic period. For the third quarter, revenues grew 5.4% year-over-year, while EPS grew 15.8% year-over-year. At the end of September, the domain name base in .com and .net totaled 173.9 million domain names, up slightly from 173.8 million names at the end of 2022. During the third quarter, the domain name base decreased by 0.5 million domain names. From a new registration perspective, the third quarter ended with 9.9 million new registrations, flat with the same quarter last year. We believe that the renewal rate for the third quarter of 2023 will be approximately 73.4% compared to 73.7% a year ago. While there are many factors that drive demand for domain names, the core value proposition for domain names remains strong, and we're seeing broad-based engagement from our registrar channel. However, even with those fundamentals intact, low demand from China remains the primary source of drag on the overall domain name base growth. Excluding registrars based in China, both our domain name base and new registrations are up year-over-year through Q3. With this current trend, we now expect the change in the domain name base for full year 2023 to be between negative 0.4% and positive 0.4%. This updated range reflects continued uncertainty primarily due to the weakness we're seeing from China. Our financial and liquidity position remained stable with $943 million in cash, cash equivalents and marketable securities at the end of the quarter. During the third quarter, we repurchased 1.1 million shares for $220 million. At quarter end, $1.34 billion remained available and authorized under the current share repurchase program. Regarding web, today, I posted Altanovo's IRP complaint and ICANN's answer to its website. I urge anyone interested in this issue to read it, as I believe it will help you understand our current and past statements on .web. We think ICANN's answer is informative, and I'd like to read the concluding paragraph from ICANN's document. First, I just want to clarify that the reference to NDC here is a company new .co, which is Verisign's partner in the .web application. The conclusion reads as follows: 'After an exhaustive first .web IRP and an extremely thorough evaluation process following that IRP, I can determine that NDC did not violate the guidebook or the auction rules. I can fully comply with its articles, bylaws and internal policies and procedures when it made that determination, and the Board's resolution is entitled to difference under the bylaws' enshrinement of the business judgment rule. Accordingly, Altanovo's IRP request should be denied.' We agree with ICANN. We continue to believe that this IRP followed by Altanovo and its backers has been filed for the purpose of delay. I will also repeat our intention, which is to bring .web to market by this company that has operated .com and .net with reliability and confidence for nearly 30 years. With its newly available namespace, .web will add more choice of registrations for our global channel of thousands of registrars and there are millions of potential customers in a new generic top level domain. Now I'd like to turn the call over to George. I will return when George has completed his financial report with closing remarks.

George Kilguss, Executive Vice President and CFO

Thanks, Jim, and good afternoon, everyone. For the quarter ended September 30, 2023, the Company generated revenue of $376 million, up 5.4% from the same quarter of 2022 and delivered operating income of $254 million, an increase of 7.4% from the same quarter a year ago. Operating expense in the third quarter totaled $122 million compared to $123 million last quarter and $120 million a year earlier. Net income totaled $188 million compared to $169 million a year earlier, which produced diluted earnings per share of $1.83 for the third quarter of 2023 compared to $1.58 for the same quarter of 2022. Operating cash flow for the third quarter of 2023 was $245 million, and free cash flow was $217 million compared with the $262 million and $255 million, respectively, in the year ago quarter. Operating cash flow and free cash flow for the nine-month period ended September 30, 2023, totaled $650 million and $609 million, respectively, and were up from $614 million and $595 million for the same nine-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 $1.495 billion. Operating income is now expected to be between $995 million and $1 billion. Interest expense and nonoperating income net, which includes interest income estimates, is now expected to be an expense of between $25 million to $35 million. Capital expenditures are still expected to be between $45 million to $55 million. And the GAAP effective tax rate is now expected to be between 21% and 24%. In summary, Verisign continued to demonstrate sound financial performance during the third quarter of 2023 and we look forward to continuing to deliver on our mission and our objectives to finish the year. Now I'll turn the call back to Jim for his closing remarks.

Jim Bidzos, Executive Chairman and CEO

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 returned value to our shareholders. While there is ongoing turbulence in the economy due to macroeconomic and geopolitical issues, and there continues to be low demand from China, the fundamentals of our business remain strong. These strong business fundamentals and our focus on managing items within our control continue to deliver strong financial results, including steady growth in revenue, operating income, and EPS. 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

And our first question will come from Rob Oliver with Robert W. Baird.

Rob Oliver, Analyst

Jim, I'd like to start certainly noted the comments relative to China and that the rest of the business would have been up on the demand front had it not been for China. So loud and clear on that. Just curious to hear your take on the China market right now, maybe what you're hearing from your partners on the ground there as to when things might stabilize or if there's anything else going on in that market that we should be aware of. And then I had a follow-up.

Jim Bidzos, Executive Chairman and CEO

Okay. Thanks, Rob. So with respect to China, as we mentioned in our prepared remarks, for the past several quarters, our domain name demand from China-based registrars has been weak as a result of several factors. They include challenging economic conditions, a more stringent regulatory environment and the impact of a weaker local currency combined with retail pricing adjustments. We believe these factors combined have driven down demand in China, which has been offset by domain and gains in other geographies. As you can see in the geographic revenue table filed in our 10-Q this afternoon, we generated $22 million or about 6% of revenue in the quarter from China-based registrars and that revenue was down about $5 million from the year ago quarter. The remaining $354 million of revenue in the quarter from registrars outside of China was up $24 million or about 7%. So we're able to drive both top line and operating income growth even as our China registrars adjust to their specific set of factors. To your specific question of when we think things will normalize for our China-based registrars, I would say two things. One, the only certainty is change, and the future developments that influence that change are not within our control. So your guess would be as good as ours. And two, I think the term 'perfect storm' is overused, but it feels a bit like that here. I feel that the chances that change will be helpful is at least as likely as not.

Rob Oliver, Analyst

Okay, great. Jim, thank you for the insightful information. My follow-up is about the ICANN post regarding .web. It's pretty clear what their stance is, but I apologize if I should already know this. The journey with .web has been quite extensive. Now that ICANN has shared their opinion, what is our current position? What should we anticipate moving forward, and what do you believe the next steps will be?

Jim Bidzos, Executive Chairman and CEO

Thank you for your question. First, I recommend everyone read the document, as it clearly outlines ICANN's response. I clarified that NBC refers to new .co, a company we partnered with under the Domain Acquisition Agreement, and you will see that terminology used throughout. Regarding what to expect next, it’s important to note that this is a legal proceeding we are not currently part of, although that could change. The next steps involve the formation of a panel, and the documents made public today include the IRP complaint from Altanovo and ICANN’s response. We will be monitoring those developments closely. At this point, we have no additional information, but we encourage you to review the available documents, which provide some insight into the issues that will be addressed when the proceedings commence.

Operator, Operator

And we'll take our last question from Ygal Arounian with Citi.

Ygal Arounian, Analyst

I want to explore the rate of domain growth further, particularly considering the challenges in China. Could you provide some insights on the domain growth outside of China? You mentioned the revenue growth by region, so it would be helpful to understand how domain growth varies by region as well, including any brand differences. Additionally, how does pricing factor into the revenue growth across different regions? Overall, what are you observing in terms of geography and domains? Even though the situation is more favorable compared to China, it still falls short of historical averages, so what do you think are the reasons behind that?

George Kilguss, Executive Vice President and CFO

I want to highlight a few points. There are certainly many factors at play in the world today. We are still dealing with macroeconomic issues, including high interest rates and ongoing inflation, along with geopolitical factors that are affecting our business similar to other companies. However, as Jim pointed out, we are experiencing growth in registrations outside of China, both in new registrations and in our overall domain name base. While we do not disclose the domain name base for competitive reasons, our geographic revenue disclosures can provide insight into this growth. We maintain consistent pricing across all markets, which ensures a fair comparison. The domain name base continues to demonstrate resilience, and the value of domain names remains strong. Nonetheless, the declines we are observing in China, which represents a smaller segment for us, are affecting overall domain name base growth. Fortunately, we have been able to balance that out with better performance in other regions.

Ygal Arounian, Analyst

Got it. Okay. That's helpful there. And maybe on the cost side. Also, you guys continue to come in ahead of expectations despite the relative softness on the revenue side. So as we kind of get to the end of this year and start looking into 2024, just maybe walk us through how you're thinking about cost and investments and what's needed, what's not and how you're approaching that?

George Kilguss, Executive Vice President and CFO

Yes. We'll provide full year guidance on our next earnings call for 2024. Our expenses or the midpoint of our guidance suggests that our expenses will be lower this year, around 3%, and that's down from prior years. Keep in mind, we did have some costs come out of the business with regard to .tv migrated away from us. That was about $5 million of fees that we paid to .tv that is not picked up this year. But if you were to normalize that out, we're probably at a similar expense growth rate this year than last year. And as you recall, last year, expenses grew about 4% or so. So we'll continue to manage expenses and be responsible. As Jim said, several quarters in a row. During this time of uncertainty, we're trying to control what we can control, and that means being responsible, making sure we're making the right investments and in areas where we can make some efficiencies, we'll do so. But I can assure you, we're making all the necessary investments we need to execute our mission and our strategic framework to protect the Company and meet our SLAs.

Jim Bidzos, Executive Chairman and CEO

Yes. Ygal, this is Jim. George is exactly right. The term responsible expense control for us means that, first and foremost, investment in our infrastructure to provide the critical infrastructure services that we do provide is simply mandatory. We make all of those, but we manage responsibly where we can. And as George said, the next round of earnings will give you full 2024 guidance.

Operator, Operator

And we will go back to Rob Oliver with Robert W. Baird.

Rob Oliver, Analyst

Great. Just squeezing in here with one more. Jim, my question is for you. You mentioned, I think, in response to my earlier question just around the macro, which you characterized some ongoing turbulence and clearly, China is a part of that. But outside of China, that I know you guys are growing outside of that generally. But just be curious to hear your take on the current macro and whether your characterization earlier was anything incremental or if it was sort of the same now as when you entered the quarter, certainly, in terms of Middle East and headlines out there feels sentiment. I think it feels like things are a bit softer, but just wanted to get a sense on what you're seeing and hearing from your partners.

Jim Bidzos, Executive Chairman and CEO

Yes. All the global events, whether it's Ukraine or the Middle East, are influencing the economy and are connected to the geopolitical issues affecting macroeconomic trends and challenges we are encountering. This impact is broad and is noticeable among tech companies across the board. Assessing how these events will affect us in the future is difficult because they are relatively recent, and we lack clear insights at this moment. From what I've observed publicly, there are certainly challenges in the Chinese market, which has the most significant impact felt throughout the tech sector. We keep an eye on these developments but currently have no updates to provide. I appreciate your question, but I don't have trend data or evidence to share at this time. These issues do have some negative effects; people are more cautious, interest rates are rising, leading to various secondary effects. This is what we were referring to. They do put some pressure on the business. Interest rates, in particular, alongside everything else we mentioned, are factors we are considering. As George highlighted, our response is to focus on what we can manage. We ensure that we deliver our services in accordance with our contracts, which is our top priority. Additionally, we continuously engage in responsible expense control. These are the actions we can take, and our business model allows us to maintain solid quarters while we await an improved economic environment.

Operator, Operator

That does conclude the question-and-answer session. I'll now turn the conference back over to Mr. David Atchley for final comments.

David Atchley, Vice President of Investor Relations and Corporate Treasurer

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

Operator, Operator

Thank you. This does conclude today's conference. We do thank you for your participation. Have an excellent day.