VeriSign - Q2 2023

Transcript

Operator (participant)

Good day, everyone. Welcome to Verisign's Q2 2023 earnings call. Today's conference is being recorded. Recording of this call is not permitted unless pre-authorized. At this time, I would like to turn the conference over to Mr. David Atchley, Vice President, Investor Relations and Corporate Treasurer. Please go ahead, sir.

David Atchley (VP, Investor Relations and Corporate Treasurer)

Thank you, Operator. Welcome to Verisign's second 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. 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 successful quarter by focusing on our mission as a critical infrastructure operator. The quarter included the renewal of the .net registry agreement and solid financial results. Additionally, last week, we marked 26 years of 100% availability in the .com, .net domain name resolution system. Throughout the various global challenges over the past 26 years, from the pandemic to natural disasters to evolving cyber threats, our purpose-built network has kept billions of people worldwide continuously connected to what matters most. The work we do to operate, protect, and evolve key Internet infrastructure has never been more important than it is today. Reaching this mark is a testament to the ongoing investments made in our platforms, processes, and people.

On June 30, we announced the renewal of the .net registry agreement with ICANN, as expected, given the presumptive right of renewal in our agreement. The business terms of the agreement, such as pricing, the fees paid to ICANN, our renewal rights, and the 6-year term of the agreement are unchanged. The next renewal for the .net registry agreement will be June 2029. In addition to delivering on our mission during the Q2, I'm pleased with the financial results, which show the continued strength of our business during this uncertain macroeconomic period. For the Q2, revenues grew 5.7% year-over-year, while EPS grew 16.2% year-over-year.

At the end of June, the domain name base in .com and .net totaled 174.4 million domain names, up from 174.3 million in Q2 2022, and up from 173.8 million names at the end of 2022. During the Q2, the domain name base decreased by 0.3 million domain names, offsetting some of the 1 million names we added during the Q1. From a new registration perspective, the Q2 delivered a 1.5% year-over-year increase, with 10.2 million new registrations, compared to 10.1 million last year. We believe that the renewal rate for Q2 2023 will be approximately 73.4%, compared to 73.8% 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, with these fundamentals intact, low demand from China remains the primary source of drag on the overall domain name-based growth. With this current trend, we now expect a domain name-based growth rate of between 0% and 1% for the full year of 2023. This updated range reflects continued uncertainty, especially the weakness we continue to see related to China. Our financial and liquidity position remains stable, with $936 million in cash, cash equivalents, and marketable securities at the end of the quarter. During the Q3, we repurchased 1 million shares for $220 million.

Effective today, the board of directors has increased the amount authorized for share repurchase of Verisign common stock by $1.14 billion to a total of $1.5 billion, authorized and available under the share repurchase program, which has no expiration. On .web, as many of you have seen from our statement on May third, ICANN's board of directors dismissed Afilias's objections regarding the .web auction and directed that NDC's .web application move forward. This was a significant finding by the board, and we're pleased that our role in the auction was proved to be consistent with ICANN's policies. Subsequently, according to ICANN's website, Afilias has filed another IRP complaint, presumably challenging the board's decision. This filing has not been posted nor has any response from ICANN. ICANN has placed NDC's .web application, sorry, on hold now.

Given the board's decision, we see no basis for any further delay in delegating .web, but this is an ICANN process, and we're not yet involved in it. Finally, as announced in today's earnings release, we have given notice of a price increase of $0.99 to the annual wholesale price for .net domain names, which will raise the price from $9.92 to $10.91, effective February 1, 2024. Now I'd like to turn the call over to George. I'll return when George has completed his financial report with closing remarks. George?

George Kilguss (Executive VP and CFO)

Thanks, Jim, and good afternoon, everyone. For the quarter ended June 30, 2023, the company generated revenue of $372 million, up 5.7% from the same quarter of 2022. Delivered operating income of $249 million, an increase of 5.4% from the same quarter a year ago. Operating expense in the second quarter totaled $123 million, compared to $123 million last quarter and $116 million a year earlier. Net income totaled $186 million, compared to $167 million a year earlier, which produced diluted earnings per share of $1.79 for the Q3 of 2023, compared to $1.54 for the same quarter of 2022.

Operating cash flow for the Q2 of 2023 was $145 million, and free cash flow was $139 million, both of which were at similar levels in the year-ago quarter. Operating cash flow and free cash flow for the six-month period ended June 30, totaled $404 million and $392 million, and were up from $352 million and $339 million, respectively, for the same six-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 $1.49 billion-$1.5 billion. This updated revenue range reflects our expectation that the domain name base growth rate will be between 0%-1%, as Jim mentioned.

Operating income is still expected to be between $990 million and $1,005 million. Interest expense and non-operating income net, which includes interest income estimates, is now expected to be an expense of between $30 million to $40 million. Capital expenditures are now expected to be between $45 million to $55 million, and the GAAP effective tax rate is still expected to be between 22% and 25%. In summary, Verisign continued to demonstrate sound financial performance during Q2 2023, and we look forward to continuing to deliver on our mission and our objectives throughout 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 discipline 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. I want to thank our teams for their dedication and focus. 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 (participant)

Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute button is turned off to allow your signal to reach our equipment. Once your question has been stated, please mute your line. Our first question comes from the line of Rob Oliver with Baird.

Rob Oliver (Analyst)

Great. Good afternoon, guys. Jim, my first question is for you. I've got three questions total, but first is for you, and it's, it's on .com. I think we, we all can kind of see real time some of the sluggishness in the market. I think, you know, looks like really, really domain activity in .com has not kind of come back to sort of pre-pandemic levels, maybe as you guys had hoped. I know in your prepared remarks and appreciate the commentary relative to China, but would just love to hear a little bit more about your view there on, on what's happening, whether it be China or if there are other factors. You know, I know Janet Yellen was just over in China, called for stimulus. Sounds like there's some coming.

Just would also love to hear, you know, what you think gets us, gets us out of this rut. Thanks.

Jim Bidzos (Executive Chairman and CEO)

I wish I knew the answer to that, but let me do my best. I'm happy to share what I can. Well, first, there's the obvious macro factors affecting the economy, an extended COVID recovery, declining but still high inflation rates, geopolitics, and the growth rate of new business starts, which, you know, while still improving, are still off their highs. As far as specific factors for our business, I, I don't know how else to put it, Rob. There's China. It's the largest single factor, and it continues to remain soft in both new registrations and renewal rates. Stringent registration rules and a challenging COVID recovery seem to be the main factors there. In the U.S., channel focus is a factor.

As we've seen before, some channel partners shift their focus to ARPU rather than new customer acquisition in times of slower economic activity. That is cyclical. At some point, they, you know, you got to acquire new customers, and so they'll return to that. Our, our revised guidance recognizes the uncertainty that all these factors represent for the remainder of 2023. I'll just add, as far as, you know, things we can control, these include meeting our contractual requirements, obviously, but practicing responsible expense management and focusing on our capital allocation strategy. Continuing to focus on those areas that we can control, that's the key, for us to deliver long-term value creation for our shareholders. If that's helpful.

Rob Oliver (Analyst)

Very helpful. Yep. Thank you. You know, I also appreciate that you, you went into some detail in your prepared remarks on .web. I think, you know, just stepping back now, it's been a 6, almost 7-year journey now, and I, I think investors are, are confused by the landscape and what's going on. It's very hard to know, you know, whether this sort of resets us back to the beginning of the process with the IRP or whether this is now a next step in the process, which would circumvent the need to do that. If you could help us, perhaps provide a little bit more color as to how you view that currently, to the extent that you can.

Jim Bidzos (Executive Chairman and CEO)

Happy to do that. I keep a couple of notes here handy just for that purpose. Let me, well, first of all, it's easy to get confused. I completely understand that there's a lot of, you know, we talk about this every quarter, and there are a lot of terms that we use, acronyms like IRP and CEP, that, you know, even experienced lawyers wouldn't be familiar with if they didn't operate in the ICANN world. So maybe, maybe I can simplify with a little bit of background, what's happened, maybe even define some of these terms. So, first, you know, when we talk about an IRP, Independent Review Panel, that's a lawsuit, not in court, but more like an arbitration demand that someone can bring against ICANN.

However, the only claims allowed are those based on a violation by ICANN of its bylaws. A CEP, you've heard us use that, or Cooperative Engagement Process, is a discussion between a potential IRP filer and ICANN ahead of an IRP. All actions associated with the issue behind the IRP are automatically put on hold during the CEP, and that's kind of what we've been in for the last few weeks. You've also heard, you know, another acronym, NDC. That's, that stands for New.co, and that's a company that Verisign entered into an agreement with about .web. Let me, let me try to simplify just how we got here. I, I don't want to speculate about, you know, what's gonna happen going forward, not just because it's pending litigation, but much of it is ICANN process that's not ours.

Let me just give you a really brief history now that, you know, some of the terms are easier to understand with .web. In 2016, there was an auction for .web. NDC won that auction with our backing. In 2018, a company called Afilias, the plaintiff, filed an IRP seeking to have the IRP panel disqualify NDC and to award .web to them because Afilias objected to the auction and to, to our Verisign's participation with NDC. A few years later, in 2021, after lengthy legally maneuverings, the IRP panel said, "No." The panel said, "ICANN owns the issue, and the panel tells ICANN to go review and decide the issue." Afilias doesn't like that answer and files a follow-up motion asking the panel essentially for a do-over.

The panel once again tells Afilias no, but this time they call Afilias's request frivolous, and they sanction Afilias, ordering Afilias to pay ICANN's attorney fees. During 2022 and early 2023, ICANN then followed the panel's recommendation. They undertook a thorough 16-month review process. In early May of this year, ICANN announced that it had completed its review and had concluded by a board vote that was without objection, that Afilias's accusations were wrong, and that the board directed ICANN staff to proceed with processing NDC's .web application. Afilias then filed the CEP, which then automatically paused the processing of .web. Now Afilias has filed another IRP, that's true, but this time there's something new and substantial.

There's a definitive and affirmative ruling from the ICANN board of directors, again, without objection, that vote, that .web should be awarded to NDC. A vote resulting from a 16-month process that included work by ICANN staff, who reviewed new submissions by Verisign and Afilias, working with their law firms, who were allowed to use and even supplement the entire legal record from the earlier 2-year IRP, a vote that resulted in a finding that .web should be awarded to NDC. That's new, and that's not trivial. We believe that Afilias has been and is still litigating for delay. Now, in terms of next steps, we'll have to see whether ICANN continues with the hold on .web, the .web delegation or not during the IRP. ICANN could continue processing the .web TLD during the IRP, although that decision could be challenged.

We don't believe there should be any further delay, but this is ICANN's process, and we will continue to work within that system. What happens next? You know, I don't want to comment on. As I said, it's pending litigation, but I hope that bit of background and history was helpful.

Rob Oliver (Analyst)

Yeah, it's, it's really helpful. I appreciate that summary, Jim. I'm glad it's on the transcript because I know, I, for one, I'm gonna need to look back at that. Although I've looked at a lot of it.

Jim Bidzos (Executive Chairman and CEO)

Yeah, a lot, lot there, but yeah.

Rob Oliver (Analyst)

Yeah, really, even having lived through a lot of it. I really appreciate it. I, I know, I know I'm not the only one anymore, so I'll squeeze in one last question, and that is just on .net. I just wanted to ask, so it's the second year in a row where you guys are availing yourself of the opportunity to raise price on .net, and that's coming off for a long period where you did not. What, changed for you guys relative to your view to take price now on, on .net? What, if anything, in terms of your mindset, mentality, has, has changed there and, and, relative to .net pricing? Thank you.

George Kilguss (Executive VP and CFO)

Yeah, thanks, Rob. This is George. I mean, if, if you look back at .net, I mean, we had not taken a price increase for quite a period of time. I think the last price increase we took was in 2018, and obviously we announced, and just took one here, in February to $9.92. As we think about .net, we look at the industry, we look at where it's positioned within the marketplace, and we, we think, the price that we're raising it to, that we just announced, is keeping, .net competitive, with the other TLDs within-- which, which it competes with.

Rob Oliver (Analyst)

Great. Thanks, guys. Appreciate it.

Jim Bidzos (Executive Chairman and CEO)

Thanks, Rob.

Operator (participant)

We will take our last question from the line of Yigal Nochomovitz with Citigroup.

Yigal Nochomovitz (Director and SMid Cap Biotech Analyst)

Hey, good afternoon, guys. I want to come back to the overall growth in, in domains. Two parts on that. You know, first, I want to dig into the, the comment about, about China being the, the kind of biggest piece of this, and China is a, a, a much smaller part of your overall revenue base. I just want to understand, like, you know, how, how it's driving that much of impact. Are you saying that domain growth in, in the U.S. is relatively healthy? Is, is there any color you can get to what the growth in, in the U.S. and other regions might be? What X China looks like. The, the, the comment on the, on the channel focus and the channel focusing on, on ARPU versus net ads, I thought was really interesting.

Can you just elaborate on that point a little bit? Like, how responsible are the channel partners for driving the growth? Is it their, you know, their marketing and the way that they push for domain registration? Like, what is their role and how much of an impact can they have in spurring up demand? Thanks.

George Kilguss (Executive VP and CFO)

Yeah, sure, Gal, this is George. Your first question was from kind of a domain name base perspective. You know, we have seen growth here in Q2. I would say, you know, the regions that we report out on, the U.S., EMEA, and our all other segments, from a year-over-year domain name base, have all been growing. China, we've seen that domain name base segment decline. I think if you want to get some relative terms, you, you probably can look in our 10-Q that's filed this afternoon and look at the revenue growth rates of those segments. You'll see that China in the quarter was down about 10%.

EMEA was up about 1%, the U.S. was up about 7%, all, all of the category was up about 15%, that really comprised, the weighted average of that comprised, 5.7%. We're, we're still seeing growth, you know, as far as new units. I would say, China, again, is down. You know, the U.S. was relatively flat here in the Q2 from a new unit perspective, the other markets that we report on were, were up. You know, still seeing some, some growth here, in the market, but China has really been, as Jim mentioned, the, the drag on, on, new unit growth, here, and a little bit on revenue growth as well. Yeah. Jim.

Jim Bidzos (Executive Chairman and CEO)

Your, your question about ARPU. Let me, let me just say one thing up front. You, you can clarify the question after this if you want, but I just want to say that, you know, we, I, I think you know, but we have sort of limited visibility into the end user, obviously, sell only through registrars. I think we, I, the, the point is, is that ARPU is a, a sort of phenomenon that's typical of any business. In certain economic conditions, it becomes more efficient for them to focus on ARPU rather than customer acquisition, as the, the, you know, the cost of those activities vary, and the results are, are different and more advantageous in certain economic conditions.

The observation is based on a phenomenon that affects our channel just like everybody else, not on anything that's particularly unique that we see or understand about it. We can just observe this behavior, obviously, through our own registrations and monitoring their websites and looking at how they, they bundle their products. This is something that every business does, not unique to, to registries, registrars, or the DNS, just to clarify. There's, there's a limit to what, you know, I mean, there's not a, a great insight there, that it's just an observation, a factual observation based on what we see and observe, and it tends to be cyclical. We see that obviously they go through cycles. You focus on ARPU for a while, and then you go back into new customer acquisition. We see that.

I think it was in 2014, we had, we, we had a very visible cycle of this that we went through.

Yigal Nochomovitz (Director and SMid Cap Biotech Analyst)

Okay. I'm, I'm asking because I, I think it's a really interesting comment, and just kind of tie from what we've seen from those channel partners, like, you know, some of the key web builders have talked about marketing efficiency kind of pull back materially on, on, on their marketing spend. Then we also saw some consolidation within the, within the space, on the, on the registrar space. I'm not sure what you think about that, if that has an impact too, or, you know, directly tying it to the, to the marketing, expenses.

Jim Bidzos (Executive Chairman and CEO)

I had some difficulty hearing the last part of that. Marketing spend certainly is another factor in various economic circumstances. Obviously, any retailers are going to vary their, their marketing spend, and that has an effect on us. Obviously, during the pandemic and, and recently, we've seen some of that behavior that affected registrations as well. If I missed anything in the last part of your question, I apologize. Please, please ask again. The line's a bit fuzzy.

Yigal Nochomovitz (Director and SMid Cap Biotech Analyst)

No, that, that, that's it. I think you, you got the spirit of the question. It's really helpful and really interesting.

Jim Bidzos (Executive Chairman and CEO)

Okay.

Yigal Nochomovitz (Director and SMid Cap Biotech Analyst)

I haven't thought about it that way, so, interesting to hear.

Jim Bidzos (Executive Chairman and CEO)

Okay, great. Well, glad it was helpful.

David Atchley (VP, Investor Relations and Corporate Treasurer)

Great. Thanks, Yigal.

Operator (participant)

This concludes today's question and answer session. I will now turn the call back to David Atchley for final comments.

David Atchley (VP, 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 (participant)

This concludes today's call. Thank you for your participation, and you may now disconnect.