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Verisign Inc  (NASDAQ:VRSN)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to VeriSign's Third Quarter 2018 Earnings Call. (Operator Instructions)

At this time, I would 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, and good afternoon, everyone. Welcome to VeriSign's Third Quarter 2018 Earnings Call.

With me are Jim Bidzos, Executive Chairman, President and CEO; Todd Strubbe, Executive Vice President and COO; and George Kilguss, Executive Vice President and CFO.

This call and our presentation are being webcast from our Investor Relations website, which is available under About VeriSign on verisign.com. There, you will also find our third quarter 2018 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, which identify risk factors that could 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 and non-GAAP measures used by VeriSign. GAAP to non-GAAP reconciliation information is appended to our earnings release and slide presentation as applicable, each of which can be found in the Investor Relations section of our website. 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.

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

Thanks, David, and good afternoon, everyone.

I'm pleased to report another solid quarter for VeriSign. Third quarter results were in line with our objectives of offering security and stability to our customers while generating profitable growth and providing long-term value to our shareholders.

We reported revenue of $306 million, up 4.6% year-over-year, and delivered solid financial performance, including non-GAAP EPS of $1.23, up 23% year-over-year. During the third quarter, we continued our share repurchase program by repurchasing 1.1 million shares for $175 million.

Our financial position remains strong with $1.2 billion in cash, cash equivalents and marketable securities at the end of the quarter. We continually evaluate the overall cash and investing needs of the business and consider the best uses for our cash, including potential share repurchases.

At the end of September, the domain name base in .com and .net totaled 151.7 million, consisting of 137.6 million names for .com and 14.1 million names for .net. During the third quarter, we processed 9.5 million new registrations and the domain name base increased by 2 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 2018 will be 75%. This preliminary rate compares to 74.4% achieved in the year-ago quarter.

We now expect full-year 2018 domain name base growth of between 4.2% and 4.6%, with an increase to the domain name base for the fourth quarter of 2018 of between 0.9 million to 1.4 million net additions.

Beginning with 2019 guidance, on our next earnings call, we plan to focus our guidance related to changes in the domain name base on annual changes. Starting next year, we no longer intend to provide guidance on quarterly net additions. This change reflects our commitment to managing the business for long-term growth and stability while aligning all of our guidance to be focused on key annual business and financial metrics.

The daily transparency into net additions to the domain name base, which is updated twice per day, will continue to be available on our website.

As indicated in our earnings release today, we have entered into an agreement with NeuStar to sell the rights, economic benefits, and obligations, in all customer contracts related to our Security Services business.

Transaction includes the sale of customer agreements related to our DDoS Protection, Managed DNS, DNS Firewall, and Recursive DNS services. We will retain our proprietary technology, network assets, critical infrastructure, software and public DNS service to focus solely on supporting our core mission, which is ensuring the security, stability and resiliency of our core infrastructure.

As part of the transaction, we will continue to support the Security Services customers during the transition to NeuStar, pursuant to a Transition Services Agreement that is expected to be executed at closing.

The transaction is subject to customary regulatory approval and is expected to close shortly following receipt of such approval.

We are committed to focusing on our core mission of providing critical Internet infrastructure, including Root Zone management, operation of two of the 13 global Internet root servers, operation of .gov and .edu, and authoritative resolution for the .com and .net top-level domains, which support the majority of global e-commerce. For this reason, we're transitioning our Security Services customers to NeuStar.

To update you on our discussion about the Cooperative Agreement, we are mindful of the upcoming expiration and are progressing with the NTIA to amend the Cooperative Agreement by mutual agreement. When we are able to provide more information, we will do so.

I will tell you that we are confident that an amended agreement can be executed before the expiration of the current term, which is the end of November. However, until that process is complete, there is nothing more that we can disclose at this time.

And now, I'd like to turn the call over to George.

George Kilguss -- Executive Vice President and Chief Financial Officer

Thanks, Jim, and good afternoon, everyone.

Revenue for the third quarter totaled $306 million, up 4.6% year-over-year and up by 1.1% sequentially. Operating income for the period totaled $195 million compared with $181 million in the third quarter of 2017. The operating margin in the quarter came to 63.8% compared to 61.9% in the same quarter a year ago.

Net income totaled $138 million compared to $115 million a year earlier, which produced diluted earnings per share of $1.13 in the third quarter this year compared to $0.93 for the same quarter last year.

As of September 30, 2018, the Company maintained total assets of $1.9 billion and total liabilities of $3.3 billion. Assets included $1.2 billion of cash, cash equivalents and marketable securities, of which $508 million were held domestically with the remainder held abroad.

I'll now review some additional third quarter financial metrics, which include non-GAAP operating margin, non-GAAP earnings per share, operating cash flow and free cash flow. I will then provide updates on our 2018 full year guidance.

As it relates to non-GAAP metrics, third quarter operating expense, which excludes $15 million of stock-based compensation, totaled $96 million, the same as last quarter and compared to $97 million in the third quarter a year ago. Non-GAAP operating margin for the third quarter was 68.7% compared to 68.2% last quarter and 66.7% in the same quarter of 2017. Non-GAAP net income for the third quarter was $151 million, resulting in non-GAAP diluted earnings per share of $1.23 based on a weighted average diluted share count of 122.3 million shares. This compares to $1.18 last quarter and $1 in the third quarter of 2017.

Operating cash flow for the third quarter was $187 million, and free cash flow was $177 million compared with $175 million and $153 million, respectively, for the third quarter last year.

Now, I'd like to provide updates to our full-year 2018 guidance. Revenue is now expected to be in the range of $1.211 billion to $1.216 billion, increased and narrowed from the $1.205 billion to $1.215 billion range provided on our last call.

Non-GAAP operating margin is now expected to be between 67% and 67.5%, increased and narrowed from the 66% to 67% range provided on the last call. Our non-GAAP interest expense and non-GAAP non-operating income net is now expected to be an expense of between $80 million to $84 million, decreased and narrowed from the $82 million to $89 million range provided on our last call.

Capital expenditures are now expected to be between $40 million to $50 million, decreased from the $45 million to $55 million range provided on our last call. Cash taxes are still expected to be between $80 million and $90 million, unchanged from our last call.

In summary, the Company continued to demonstrate sound financial performance during the third quarter.

Now, I'll turn the call back to Jim for his closing remarks.

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

Thank you, George.

The third quarter was another solid quarter for VeriSign. There was further expansion of the domain name base and revenues. We generated and efficiently returned value to our shareholders.

We continue to work to protect, grow and manage the business while continuing our focus on providing long-term value to our shareholders. We'll now take your questions. Operator, we're ready for the first question.

Questions and Answers:

Operator

Thank you. (Operator Instructions) And we will go first to Sterling Auty at JPMorgan.

Ugam Kamat -- JP Morgan Chase & Co -- Analyst

Hey, guys. This is actually Ugam Kamat on for Sterling. So, you mentioned about your agreement with NeuStar to actually sell your Security Service. Just so that we can model the out years perfectly, how much revenue were you getting from that other business? And how much margins did that particular business have?

George Kilguss -- Executive Vice President and Chief Financial Officer

Ugam, this is George. Thanks for the question. As I'm sure you're aware, VSS is not a material contributor to our overall business. If the transaction closes before year-end, we do not expect a material impact to our 2018 guidance and we will provide 2019 full year guidance on our Q4 call, which will include any impacts from the transaction once it closes.

Ugam Kamat -- JP Morgan Chase & Co -- Analyst

Okay, cool. And on the Cooperative Agreement, you mentioned that it can be amended before the expiration date, but given -- if suppose, say, the process continues, is there a provision where the -- like Cooperative Agreement can be extended for six months until which you are in the negotiation period?

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

I don't have any comments beyond my prepared remarks, so I'll just reiterate that we're progressing with the NTIA to amend the Cooperative Agreement by mutual agreement and that we're confident than an amended agreement can be executed before the expiration of the current term at the end of the -- of November. So, more when we can.

Ugam Kamat -- JP Morgan Chase & Co -- Analyst

All right. And if I could squeeze one last one in. If you see the operating margins for the current quarter, you see that much of the leverage came from sales and marketing expense. Is it something where it is -- it will be the normal course of business that we see such kind of margins? I know you provided 2018 guidance, but just from a qualitative perspective, was there a shift of timing of expenses in the quarter, or is it like more that the focus of the business in terms of the investments has changed?

George Kilguss -- Executive Vice President and Chief Financial Officer

So, with regard to our Q3 expenses, as you can see out (ph) from a non-GAAP basis, our total expenses were about $96 million and we're relatively flat both year-over-year and sequentially. However, as you point out, we did see some movements between the categories. Sequentially, we did have a slight decrease in sales and marketing which was offset by small increases in G&A and cost of goods sold. Now, specifically with sales and marketing, sequentially we were down about $2.5 million quarter-to-quarter, and that primarily was a result of lower direct marketing activities in the quarter.

As you may recall, we increased our direct marketing activities late in 2017, with the intent to do more in 2018. However, as we pursue more direct marketing activities outside of the US, we found it (ph), took and it is taking frankly us longer to execute on those direct marketing activities abroad. So, really no change. Just, I would say, the normal ebb and flow of how marketing expenses get deployed into the marketplace.

Ugam Kamat -- JP Morgan Chase & Co -- Analyst

Awesome. Thank you so much, guys.

Operator

And we'll go next to Matthew Wells at Citi.

Matthew Wells -- Citi -- Analyst

Hi. This is Matt Wells and I'm on for Walter Pritchard. I was just curious, what was the catalyst for transitioning your Security Services business to NeuStar? Is there anything that read into the timing here relative to the Coop (ph)?

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

No, this is completely independent. It's a decision we made to focus exclusively on our core mission. As you know, we operate a great deal of critical infrastructure, where we do resolution, of course not only for .com and .net but for .gov and .edu. We do Root Zone management, we operate two of the 13 Internet root service, and that we just decided that that focus wasn't consistent with continued pursuit of that business, and transitioning into NeuStar made sense for that reason, timing independent of anything else that's going on.

Matthew Wells -- Citi -- Analyst

Thanks, that's helpful. And I know -- I think last time we spoke, the .web process was still hung up with ICANN and timing sounded like it was a little uncertain. Do you have any more clarity on that process, or where it stands?

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

No, no, no updates at this time. I hope to have some in the near future, but nothing to say at this time.

Matthew Wells -- Citi -- Analyst

Okay, thanks. And that's it for me.

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

Okay, Matt, thank you.

Operator

And moving next to Rob Oliver at Robert W. Baird.

Matt Lemenager -- Robert W. Baird Equity Research -- Analyst

Great, good afternoon. It's Matt Lemenager on for Rob. So, my question was on the sales and marketing expense as well. George, you mentioned that it was taking a little longer to execute, is that something -- should we expect that to kind of tick back up? Is it still a priority to get that level deployed -- those marketing expenses deployed? So is that something we should expect to tick back up going forward and maybe into 2019?

George Kilguss -- Executive Vice President and Chief Financial Officer

We'll -- as I said earlier, we'll provide 2019 guidance on our next call. But -- look, we are constantly trying to invest in marketing activities. I think the goal there is for domain name sales to increase with marketing activities, and we fully pursue activities that we think will drive those results. We have switched year-over-year. We've done more direct marketing this year than we've done in prior years, and I just think we're -- we've executed some great campaigns in a variety of markets. But as I said, sometimes the international markets are taking a little bit longer to get that work (ph) through. So, I don't think anything is really different there. We continue to focus and make investments in marketing, and hopefully, that produces increases in domain name sales.

Matt Lemenager -- Robert W. Baird Equity Research -- Analyst

Okay, thanks. And then, my second question was on, Jim, the number of new names process has ticked up nicely this year and been kind of 9.5 million or above each quarter. What's been driving you think? Was there any trends or any higher level comments that you could say driving the increase in the number of domains this year?

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

I'll ask George to comment. I will just say that .com is an incredibly strong brand, you hear me say this all the time and I can't emphasize it enough quite frankly. It's a brand that gets a tremendous amount of exposure, it's the brand that gives you credibility worldwide for your online presence, and I think that has a great deal to do with the continued strength that .com is showing. But George, if you'd like to add some color, please feel free.

George Kilguss -- Executive Vice President and Chief Financial Officer

Yeah. Sure. Matt, as you've observed, Q3 was a good quarter for us, we delivered 2 million net adds (ph) in the quarter, which was up from 1.5 million net adds in the third quarter of 2017, and that improvement is primarily result of gross adds. As you point out, gross adds totaled 9.5 million in the quarter. They were up from 8.9 million a year ago. And this is really the same trend that we've witnessed and reported on pretty much all year. We've had continued gross adds performance from both North American and China registrars. They seem to be performing better this year than they did previously, and that's been a trend that we've seen in previous quarters and it's continued here into the third quarter. So, again, I think it's the strong brand in both those markets and we'll continue to execute on marketing activities to accentuate that brand message into the marketplace.

Matt Lemenager -- Robert W. Baird Equity Research -- Analyst

Got it. Thanks, guys.

Operator

And with no additional questions at this time, Mr. Atchley, I'll turn things back over to you for any 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

And once again that does conclude today's conference. I'd like to thank everyone for joining us today.

Duration: 20 minutes

Call participants:

David Atchley -- Vice President of Investor Relations and Corporate Treasurer

D. James Bidzos -- President, Chief Executive Officer and Executive Chairman of the Board

George Kilguss -- Executive Vice President and Chief Financial Officer

Ugam Kamat -- JP Morgan Chase & Co -- Analyst

Matthew Wells -- Citi -- Analyst

Matt Lemenager -- Robert W. Baird Equity Research -- Analyst

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