VeriSign, Inc.

Good day, everyone. Welcome to VeriSign's third quarter 2020 earnings call. Today's conference is being recorded. Recording of this call is not permitted unless preauthorized. Now, at this time, I'd like to turn the conference over to Mr. David Ashley, Vice President of Investor Relations and Corporate Treasurer. Please go ahead, sir.

Thank you, Operator. Welcome to VeriSign's third 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 Strube, President and COO, and George Kilgus, 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 third quarter 2020 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. 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. In a moment, Jim and George will provide some prepared remarks, and afterwards, 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. Today, VeriSign reports $318 billion in revenue for the quarter, up 3.1% from the same quarter a year ago. But before we dive deeper into our results, I wanted to speak just a bit about COVID-19 and how we're addressing it within VeriSign. With the increased demand for and the lack of online services during the COVID-19 pandemic, secure and reliable operation of our infrastructure has become even more important. Our focus remains on our mission, which is to ensure the availability of our critical internet infrastructure for the benefit of internet users. We continue to operate our registry services for COM and NET and our read operations at the rigorous standards of performance and availability governed by our agreements with ICANN, while most of our employees continue to work remotely. Now I'll address our quarterly results. The third quarter of 2020 was another consistent quarter for VeriSign in which we focused on our core business, expanded the domain name base and delivered solid financial results. Regarding third quarter operational highlights, at the end of September, the domain name base in .com and .net totaled 163.7 million, consisting of 150.3 million names for .com and 13.4 million names for .net, with a year-over-year growth rate of 4%. During the third quarter, we processed 10.9 million new registrations, and the domain name base increased by 1.65 million names. Although renewal rates are not fully measurable until 45 days after the end of the quarter, we believe that the renewal rate for the third quarter of 2020 will be approximately 73.4%. This preliminary rate compares to 73.7% achieved in the third quarter of 2019 and 72.8% last quarter. For 2020, we now expect a domain name-based growth rate of between 3.5 and 4%. This updated range reflects the strength we have seen in new registrations and our expectations for domain name-based growth for the remainder of the year, balanced with the ongoing uncertainty presented by COVID-19. During the third quarter, we continued our share repurchase program that resulted in 823,000 shares of common stock repurchased for $170 million. At quarter end, $506 million remained available and authorized under the current share repurchase program, which has no expiration date. Our financial and liquidity position remained stable with $1.15 billion in cash, cash equivalents, and marketable securities at the end of the quarter. We continually evaluate the overall liquidity and investing needs of the business and consider the best uses for our cash, including potential share repurchases. And now I'd like to turn the call over to George.

Thank you, Jim, and good afternoon, everyone. As mentioned, for the quarter ended September 30, 2020, the company generated revenue of $318 million, up 3.1% year-over-year, and delivered operating income of $207 million, compared with $206 million in the same quarter a year ago. Operating expenses totaled $111 million, up from $103 million in the third quarter a year ago and up from $108 billion last quarter. The increase in operating expense reflects our continued investments throughout the year in personnel to support our cybersecurity and infrastructure initiatives, among other factors. The operating margin in the quarter came to 65% compared to 66.7% in the same quarter a year ago and 65.8% last quarter. Net income totaled $171 million compared to $154 million a year earlier, which produced diluted earnings per share of $1.49 in the third quarter this year compared to $1.30 for the same quarter last year. As noted in our earnings release, net income for the third quarter included a previously unrecognized income tax benefit of $24 million, which increased diluted earnings per share by 21 cents and resulted from the re-measurement of VeriSign's accrual for uncertain tax positions. Operating cash flow for the third quarter was 140 million and free cash flow was 125 million compared with 208 million and 197 million respectively for the third quarter last year. Operating cash flow and free cash flow in the third quarter were both lower mainly due to the permitted deferral of $52 million in U.S. federal tax payments until the third quarter, which we mentioned in our last quarter's call. I will now discuss updated full-year 2020 guidance. Revenue is now expected to be in the range of $1,262,000,000 to $1,267,000,000. This revenue range reflects the updated domain name-based growth of between 3.5% and 4%, that Jim mentioned earlier. The operating margin, which includes stock-based compensation, is now expected to be between 64.75% and 65.25%. This guidance range reflects our expectation of incremental and continued investments in our operational infrastructure and security capabilities, as well as sales and marketing expenses during the fourth quarter of 2020. Interest expense and non-operating income net is still expected to be an expense of between 75 and $80 million. Capital expenditures are now expected to be between 45 million and $50 million. We now expect our full year effective tax rate to be a net benefit of between 6% and 9%, which reflects the 168 million and 24 million of previously unrecognized income tax benefits recorded in the first quarter and the third quarter, respectively. Cash taxes for 2020 are still expected to be in the range of 18% to 20% of pre-tax income. In summary, VeriSign continue to demonstrate sound financial performance during the third quarter, and we look forward to continuing our focused execution for the remainder of 2020. Now I'll turn the call back to Jim for his closing remarks.

Thank you, George.

I'd like to say again that our priorities continue to be our mission of ensuring the availability of our critical infrastructure and the safety of our people. Internet usage has increased during the pandemic and reliance on online services even more so. For many people who are working from home and isolating at home, online services are critical and more businesses and individuals than ever depend on Internet infrastructure for their livelihood. I'd like to acknowledge the team here at VeriSign for their hard work in maintaining our critical internet infrastructure, even during a pandemic. We'd like to walk through two questions, which we believe are on your mind, before we open the call for your additional questions. First question, are there any updates regarding your plans to use the limited pricing flexibility you have for .com? No updates from what we said last quarter. We still expect to effectuate a .com wholesale price increase before October 25th, 2021, and the prices for all of our TLDs are frozen through March 31st, 2021. Second question, are there any updates on the status of .web? As we noted last quarter, a final hearing was scheduled in August. The hearing took place in early August. The participants, including VeriSign, then submitted their post-hearing briefs. A final decision from the panel may be issued later this year or early next year. As a reminder, VeriSign is not a party in these IRP proceedings, but was granted the right to participate in certain limited aspects. Also, as a reminder, an IRP under ICANN's bylaws is for the purpose of ensuring that ICANN follows its own policies and procedures when making decisions. Our expectation is that following the resolution of the IRP, the ICANN Board will make a final decision on the delegation of the .web TLD. And now we'll open the call for your questions. Operator, we're ready for the first question.

Thank you. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is off to allow your signal to reach our equipment. Also, in order to receive the best signal, please refrain from using your headset to ask a question. We'll take our first question from Rob Oliver with Baird. Please go ahead, sir.

Great. Thank you very much. Thank you guys for taking my questions. I appreciate it. Jim, just to start with you, you know, just overall, I'd love to get your thought on the domain environment, you know, clearly coming out of COVID, a lot of concerns about small business, small business failure, and you guys have, you know, consistently from that time when you took down the guide on domain growth have kind of ratcheted back up and came in at four this quarter, pretty impressive. So I just was wondering if you could maybe step back and talk a little bit about what you're seeing in the environment. You know, a lot of new business starts, and it would seem that that would be offsetting some of the kind of macro concerns that, you know, they may be weighing on small businesses or maybe they're holding on to their websites. We'd love to hear your thoughts there. And then kind of quick follow-up. Thanks.

Okay, thanks for the question. Well, I'll make a comment or two, and then I'll invite George and Todd to comment as they see that market having developed over the crisis. I'll just say that, as I mentioned in my remarks, obviously people are making greater use of the Internet for a wide variety of reasons, for their livelihood or in the pursuit of a livelihood and starting new businesses. Others may not be faring as well. There are a lot of complex reasons that people register, Keep and delete domain names and there's a complex sort of analysis that leads to where the increased dose growth resulted in the quarter Overall and the the numbers speak for themselves in that it was a solid quarter of additional growth There's clearly additional internet usage. There's clearly additional growth in the domain name space as a result of that and it's quite clear as you see in our results and as you observed and Georgetown I'll invite you to comment if you'd like Sure. This is George Kogas.

So as Jim mentioned, we had a good quarter. New registrations were 10.9 million, which was up about 980,000 new names from a year ago, but very similar to last quarter. And the trends that we're seeing here in Q3 are very similar to last quarter in that we saw strength in registrations from North American registrars, EMEA registrars, and APAC registrars. new units from China-based registrars during the quarter were similar to Q2 level. However, they were down a year over year. But overall, a very solid quarter, continuing to see good demand here in the third quarter. And I think, as Jim said, those are just secular trends that we're seeing with people seeing the value and the utility of having a website and getting a domain name to better service their customers and and maximize their e-commerce objectives. I think we're helping to support those small businesses in doing that, and those trends, at least so far this year, have been good for us.

Great. Thanks. That's helpful. My follow-up, George, is for you. I think you mentioned in your prepared remarks a comment relative to Q4 and sales and marketing expenses, and just wanted to just ask on that. Anything out of the ordinary relative to kind of standard practice on investing in your channel around .com growth and any color you can add there would be great. Thanks very much.

Yeah, Rob. I would say nothing out of the ordinary. I think if you look in the past couple of years, we have tended to spend a little bit more in the sales and marketing area in the fourth quarter just based on the timing of events and This year we had some activities that we're going to do earlier in the year, but with the pandemic in full swing, we kind of pivoted on some of those efforts and we've repositioned them here in the fourth quarter. So I don't think there's anything unusual there, just the normal management of our marketing activities throughout the year. Great.

Thanks again. Thank you. We'll take our next question from Nick Jones with Citigroup.

Great, thanks for taking my questions. I guess two, the first one, I guess a little bit more on .web. Can you expand on the decision that's, I guess, coming either later this year or early next year, I guess, in terms of is this kind of a definitive decision that puts this matter to rest, or is it more of a decision that potentially extends the matter longer? Just any, I guess, color on how to think about the timing of what we're waiting to hear.

Well, we're waiting to hear the final resolution of this IRP. And just as a reminder, this IRP, this form of arbitration that's used in the ICAM community actually involves two parties primarily. That's Affilius, who's essentially the plaintiff here, and ICAM, who is the defendant. And as I mentioned in the question that I asked in answer, this is about whether ICANN follows its own policies and procedures when it makes decisions. So that is what the panel will decide. And our expectation, as I said, is that following that resolution, the ICANN board then, the matter will be returned to ICANN for its process, which is to make a final decision on the delegation of the .web TLD. So that's the expectation. As in any litigation, it's... It's really not proper to speculate on those outcomes, obviously, when something is pending. But we do know in the process what's pending here, which is a decision by the panel. And they have the final hearing was scheduled and it was held. And of course, as a participant, but not a litigant, so to speak, we were there at the table. So we're waiting, hopefully by the end of this year or early next year, we will hear from the panel They will answer the allegations by the plaintiff affiliates against ICANN, and then the matter should be handed to the ICANN board for resolution on the .web issue. That's our expectation, and that's what we hope to see, and we'll certainly share with you what we know when we know it beyond that. Great.

And then a follow-up, just one follow-up on, I guess, just .com market share. So there's some third-party data out there that kind of indicates .com is regaining share despite there kind of being more, you know, I guess, new TLDs. Why do you think that is? You know, is that what you're seeing? Can you speak to kind of, you know, any trends you're seeing there, you know, maybe making .com more popular versus new TLDs? I guess just any thoughts or color around that would be great. Thanks.

Well, I'll just say this. I mean, I don't know what data you're referring to, so I can't really address that specifically. I can tell you, though, that the market does not consist only of .com and then new GTLDs or alternate TLDs. There's a large and thriving market of country code TLDs, like .cn for China, .de for Germany. Many of those have been commercialized, like .co from Columbia. .co is a commercialized TLD that many, many – organizations and individuals have chosen to brand themselves on and there are a large number of those so the market is uh far broader than that com is a good brand and its performance is strong and um registrants like the dot-com brand because it helps them get found but beyond that without seeing what you're referring to i really can't comment on it i would just caution that um um Very often when I've seen people talk about the market, they haven't really considered how large that market is. I would also refer you to our domain name brief. I think there's a good survey of all of the TLDs there. And I think if you look at that, you might get a slightly different picture. So I hope that's helpful.

That is. Thank you for taking my questions.

Certainly.

Thank you. We'll now take our last question from Sterling Audie with J.P. Morgan.

Yeah, thanks. Hi, guys. All right, so going back to the domain name growth, in the context of the guidance that you've given for the full year, it would seem to indicate a slowdown in the year-over-year new registrations embedded in that. So I guess my question is, do you think that there was some one-time, you know, benefits from COVID that you're not factoring into the guidance for the fourth quarter, or what else is kind of influencing influencing how you kind of guided here for full year. Yes, Sterling, this is George. Um, yeah. Uh, so as you know, Sterling, uh, there are just simply less, less selling days. I would put it in, uh, in the fourth quarter. Uh, typically we see the fourth quarter, uh, new registrations, uh, dip seasonally. Uh, so, uh, we're keeping an eye on that. Also, I think there's still some uncertainty with regard to, uh, to COVID and, uh, and how that, uh, that disease may pick up here globally. And so some of that caution is also in the guidance that we're providing. Understood. And I know that .com is a thin registry, but based on your interactions with registrars and industry participants, any sense as to what percentage of domains that are coming on board have e-commerce attached to them at this point or any other type of granular breakdown you might have? Yeah, as you mentioned, as a thin registry, we don't quite have that detail. We do hear from the registrar that they are seeing more small businesses stand up websites and grow that portion of their business, which I think is good for our business. But as far as the granular detail, I don't have that for you. I'm sorry. And that kind of brings, I don't know if you guys have seen it, but um the census bureau has number of business applications and it looks like there was a significant spike in late summer coming into the fall and you know based on that comment i wonder if you're seeing some of those come come in or is there the potential that there might be a delayed tailwind you know from maybe new business formation well uh speaking for myself i haven't seen that data um i i

I don't know that we've correlated any data like that to domain name registrations in our common net zone. I think registrars are probably the first place that there would be some indication of that. I think clearly we have some indication from them that new business starts on the up and that there are increased domain name registrations in the U.S. associated with that. So I think, in general, the answer to your question is yes. There's nothing I can think of in the data that would disagree with what you're saying, but any detail or correlation, I don't think we have any.

Got it. And one housekeeping, George, what's the number of names up for renewal in Q4? In Q4, 34.8 million. All right, great. And very last one, you commented a little bit, so I want to just put a fine point. You know, given bringing down the high end of the operating margin for the full year, what would you say the incremental spend that you're now factoring into that guidance is going to that maybe wasn't there before? Or is that the wrong way to look at it? Well, as I think I mentioned in my prepared remarks, you know, the increased expense year over year is really going to increased headcount. We've added about 34 or 36 heads since the beginning of the year. And a lot of those additional head counts are people that we have focused on our cybersecurity and I would say software network engineering functions. And those show up in our R&D and our G&A functions. And so at the end of the quarter, our head count was about 908 employees. So that was up from 872 at the end of the year. So the only other thing I'll say is, look, we came out of 2018 with a similar level of Fed count. We had about 900 people. We've been as high as 1,000 employees in the business. If you step back and look at the prior years, you know, we've been in a gap operating expense range of around $110, $112 million a quarter, clearly in 2020 here and 2019 as we – We sold the VSS security business. We had some moving pieces as we were reorganizing the company. Right now, we're at about $111 million for the quarter of gap operating expense here. We've been in this range for a long period of time. As we always are, we're managing the expenses of the business to meet the needs of the business. I think we've been doing that reasonably well over the past seven or eight years, and we're going to continue to do that. But to answer your question, it's really been this additional headcount that we've added in our security and stability initiative.

And, Sterling, I would just add to that, you know, there's always a baseline of funding that we make available and increase just simply because a huge aspect of what we do is cybersecurity, which is very difficult to predict. The threat environment is constantly evolving. It's generally always intensifying and increasing, and so there are constant investments we make in training, education, new hires, people, technology, hardening our infrastructure, improving its resiliency that are ongoing. In addition, there are responses that we have to make to new threats that are anticipated. These just are routine and happen all the time, but the precise nature of The precise response and therefore the precise budgetary aspect of the response is difficult to predict. What you're seeing is our best estimates based on a long history of experience of doing these kinds of things. In addition, we fund research and that research evolves. We recently identified, for example, a huge number of queries that were coming into the root servers, a massive spike in queries that were literally the result of unintentional activities which with that browser behavior that we were able to actually highlight, point out, and help rectify and eliminate a huge amount of volume that was hitting all 13 of the root servers. There's quite a bit of this research that we do and publish. We've done work in name collisions. We do a lot of root instrumentation that helps manage and improve performance and security across the net. We identify domains that... are the source of botnets and other sorts of cyber attacks. We share those with different companies, government agencies. So the teams that are working on that are always evolving, growing, training, hiring additional folks. That's our primary mission. We address it in many broad ways, but it's our top priority. So it shouldn't be a surprise that at times you're going to see increased spending on it. It's just the nature of the business that we're in. And that's our expertise and that's our mission.

Makes sense. Thank you, Jim. I really appreciate that.

Sure. Thank you, and that concludes our question and answer session. I would now like to turn the conference back over to Mr. Hatchley 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.

Thank you, and that does conclude today's conference. Thank you all for your participation. You may now disconnect.