VERISIGN INC/CA 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion in conjunction with the 2020 Form 10-K and the interim unaudited Condensed Consolidated Financial Statements and related notes included in Part I, Item I of this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements are based on current expectations and assumptions and involve risks and uncertainties, including, among other things, statements regarding our expectations about (i) the impact from the effects of the COVID-19 pandemic, (ii) the growth in revenues for the remainder of 2021, (iii) Cost of revenues, Sales and marketing expenses, Research and development expenses, General and administrative expenses, quarterly Interest expense, and quarterly Non-operating income (loss), net, for the remainder of 2021, (iv) our annual effective tax rate for 2021, and (v) the sufficiency of our existing cash, cash equivalents and marketable securities, and funds generated from operations, together with our borrowing capacity under the unsecured revolving credit facility. Forward-looking statements include, among others, those statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors” in Part I, Item 1A of the 2020 Form 10-K. You should also carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q or Current Reports on Form 8-K that we file in 2021. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update publicly or revise such statements, whether as a result of new information, future events, or otherwise, except as required by law. For purposes of this Quarterly Report on Form 10-Q, the terms “Verisign,” “the Company,” “we,” “us,” and “our” refer to VeriSign, Inc. and its consolidated subsidiaries. Overview We are a global provider of domain name registry services and internet infrastructure, enabling internet navigation for many of the world’s most recognized domain names. We enable the security, stability, and resiliency of key internet infrastructure and services, including providing root zone maintainer services, operating two of the 13 global internet root servers, and providing registration services and authoritative resolution for the . com and . net top-level domains (“TLDs”), which support the majority of global e-commerce. As of September 30, 2021, we had 172.1 million .com and .net registrations in the domain name base. The number of domain names registered is largely driven by continued growth in online advertising, e-commerce, and the number of internet users, which is partially driven by greater availability of internet access, as well as marketing activities carried out by us and our registrars. Growth in the number of domain name registrations under our management may be hindered by certain factors, including overall economic conditions, competition from country code top-level domains (“ccTLDs”), other generic top-level domains (“gTLDs”), services that offer alternatives for an online presence, such as social media, and ongoing changes in the internet practices and behaviors of consumers and businesses. Factors such as the evolving practices and preferences of internet users, and how they navigate the internet, as well as the motivation of domain name registrants and how they will manage their investment in domain names, can negatively impact our business and the demand for new domain name registrations and renewals. Business Highlights and Trends • We recorded revenues of $334.2 million and $987.3 million during the three and nine months ended September 30, 2021, an increase of 5% and 4%, respectively, compared to the same periods in 2020. • We recorded operating income of $221.3 million and $644.7 million during the three and nine months ended September 30, 2021, an increase of 7% and 4%, respectively, compared to the same periods in 2020. • As of September 30, 2021, we had 172.1 million .com and .net registrations in the domain name base, which represents a 5% increase from September 30, 2020, and a net increase of 1.5 million domain name registrations from June 30, 2021. • During the three months ended September 30, 2021, we processed 10.7 million new domain name registrations for .com and .net compared to 10.9 million for the same period in 2020. • The final . com and . net renewal rate for the second quarter of 2021 was 75.4% compared to 72.8% for the second quarter of 2020. Renewal rates are not fully measurable until 45 days after the end of the quarter. 13 Table of Contents • During the three months ended September 30, 2021, we repurchased 0.8 million shares of our common stock for an aggregate cost of $172.4 million. As of September 30, 2021, there was approximately $565.1 million remaining available for future share repurchases under our share repurchase program. • We generated cash flows from operating activities of $600.9 million during the nine months ended September 30, 2021, compared to $535.0 million for the same period in 2020. Pursuant to our agreements with the Internet Corporation for Assigned Names and Numbers (“ICANN”), we make available files containing all active domain names registered in the .com and .net registries. Further, we also make available a summary of the active zone count registered in the .com and .net registries and the number of .com and .net domain name registrations in the domain name base. The zone counts and information on how to obtain access to the zone files can be found at https://www.Verisign.com/zone. The domain name base is the active zone plus the number of domain names that are registered but not configured for use in the respective top-level domain zone file plus the number of domain names that are in a client or server hold status. The domain name base may also reflect compensated or uncompensated judicial or administrative actions to add or remove from the active zone an immaterial number of domain names. These files and the related summary data are updated at least once per day. The update times may vary each day. The number of domain names provided in this Form 10-Q are as of midnight of the date reported. COVID-19 Update The United States and the global community we serve are facing unprecedented challenges posed by the COVID-19 pandemic. In response to the pandemic, we have established a task force to monitor the pandemic and have taken a number of actions to protect our employees, including restricting travel, modifying our sick leave policy to encourage quarantine and isolation when warranted, and directing most of our employees to work from home. We have implemented our readiness plans, which include the ability to maintain critical internet infrastructure with most employees working remotely. We believe that the effects of the pandemic to date have led to an increase in the demand for domain names, particularly as businesses and entrepreneurs have been seeking to establish or expand their presence online in response to the pandemic. Our revenues continued to grow during 2020 and the nine months ended September 30, 2021 primarily driven by an increase in the domain name base for the . com TLD; however, the situation remains uncertain and hard to predict. The broader implications of the pandemic on our business and operations and our financial results, including the extent to which the effects of the pandemic will impact future growth in the domain name base, remain uncertain. The duration and severity of the economic disruptions from the pandemic may ultimately result in negative impacts on our business and operations, results of operations, financial condition, cash flows, liquidity and capital and financial resources. For further discussion, see “Risk Factors – The effects of the COVID-19 pandemic have impacted how we operate our business, and the extent to which the effects of the pandemic will impact our business, operations, financial condition and results of operations remains uncertain” in Part 1, Item 1A of the 2020 Form 10-K. Results of Operations The following table presents information regarding our results of operations as a percentage of revenues: Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Revenues 100.0 % 100.0 % 100.0 % 100.0 % Costs and expenses: Cost of revenues 14.3 14.2 14.4 14.2 Sales and marketing 2.8 2.6 2.9 2.5 Research and development 5.9 6.2 6.0 5.9 General and administrative 10.8 12.0 11.4 11.8 Total costs and expenses 33.8 35.0 34.7 34.4 Operating income 66.2 65.0 65.3 65.6 Interest expense (5.6) (7.1) (6.5) (7.2) Non-operating income (loss), net — 0.3 (0.2) 1.6 Income before income taxes 60.6 58.2 58.6 60.0 Income tax (expense) benefit (13.7) (4.4) (12.5) 9.6 Net income 46.9 % 53.8 % 46.1 % 69.6 % 14 Table of Contents Revenues Our revenues are primarily derived from registrations for domain names in the .com and .net domain name registries. We also derive revenues from operating domain name registries for several other TLDs and from providing back-end registry services to a number of TLD registry operators, all of which are not significant in relation to our consolidated revenues. For domain names registered in the . com and . net registries we receive a fee from registrars per annual registration that is determined pursuant to our agreements with ICANN. Individual customers, called registrants, contract directly with registrars or their resellers, and the registrars in turn register the domain names with Verisign. Changes in revenues are driven largely by changes in the number of new domain name registrations and the renewal rate for existing registrations as well as the impact of new and prior price increases, to the extent permitted by ICANN and the Department of Commerce (“DOC”). New registrations and the renewal rate for existing registrations are impacted by continued growth in online advertising, e-commerce, and the number of internet users, as well as marketing activities carried out by us and our registrars. We also offer promotional incentive-based discount programs to registrars based upon market conditions and the business environment in which the registrars operate. On October 26, 2018, Verisign and the DOC amended the Cooperative Agreement. The amendment, among other items, extends the term of the Cooperative Agreement until November 30, 2024 and permits the price of a .com domain name to be increased, subject to appropriate changes to the .com Registry Agreement, without further DOC approval, by up to 7% in each of the final four years of each six-year period beginning on October 26, 2018. On March 27, 2020, Verisign and ICANN amended the .com Registry Agreement that, among other items, incorporates these changes agreed to with the DOC to the pricing terms. Effective September 1, 2021, we increased the annual registry-level wholesale fee for each new and renewal . com domain name registration from $7.85 to $8.39. We have the contractual right to increase the fees for . net domain name registrations by up to 10% each year during the term of our agreement with ICANN, through June 30, 2023. All fees paid to us for .com and .net registrations are in U.S. dollars. A comparison of revenues is presented below: Three Months Ended September 30, Nine Months Ended September 30, 2021 % Change 2020 2021 % Change 2020 (Dollars in thousands) Revenues $ 334,242 5% $ 317,879 $ 987,268 4% $ 944,768 The following table compares the .com and .net domain name registrations in the domain name base: September 30, 2021 % Change September 30, 2020 .com and .net domain name registrations in the domain name base 172.1 million 5% 163.7 million Revenues increased by $16.4 million and $42.5 million during the three and nine months ended September 30, 2021, respectively, as compared to the same periods last year, primarily due to an increase in revenues from the operation of the registry for the . com TLD driven by a 5% increase in the domain name base for . com . Growth in the domain name base has been primarily driven by continued internet growth and marketing activities carried out by us and our registrars. However, competitive pressure from ccTLDs, other gTLDs, services that offer alternatives for an online presence, such as social media, ongoing changes in internet practices and behaviors of consumers and business, as well as the motivation of existing domain name registrants managing their investment in domain names, and historical global economic uncertainty, has limited the rate of growth of the domain name base in recent years and may do so in the remainder of 2021 and beyond. We expect quarterly revenues will continue to grow during the fourth quarter of 2021 compared to each of the first three quarters of 2021, as a result of continued growth in the aggregate number of . com domain names and the impact of the price increase for .com domain names which became effective September 1, 2021. 15 Table of Contents Geographic revenues We generate revenues in the U.S.; Europe, the Middle East and Africa (“EMEA”); China; and certain other countries, including Canada, Australia, and Japan. The following table presents a comparison of our geographic revenues: Three Months Ended September 30, Nine Months Ended September 30, 2021 % Change 2020 2021 % Change 2020 (Dollars in thousands) U.S. $ 214,352 6% $ 202,934 $ 632,424 5% $ 599,845 EMEA 58,615 8% 54,034 172,717 9% 159,103 China 24,607 (10)% 27,463 74,974 (14)% 86,676 Other 36,668 10% 33,448 107,153 8% 99,144 Total revenues $ 334,242 $ 317,879 $ 987,268 $ 944,768 Revenues in the table above are attributed to the country of domicile and the respective regions in which our registrars are located; however, this may differ from the regions where the registrars operate or where registrants are located. Revenue growth for each region may be impacted by registrars reincorporating, relocating, or from acquisitions or changes in affiliations of resellers. Revenue growth for each region may also be impacted by registrars domiciled in one region, registering domain names in another region. During the three and nine months ended September 30, 2021, revenues increased in all regions except China. Revenues from registrars based in China declined during the three and nine months ended September 30, 2021 as a result of lower new registrations and renewal rates in the country. Cost of revenues Cost of revenues consist primarily of salaries and employee benefits expenses for our personnel who manage the operational systems, depreciation expenses, operational costs associated with the delivery of our services, fees paid to ICANN, customer support and training, costs of facilities and computer equipment used in these activities, telecommunications expense and allocations of indirect costs such as corporate overhead. A comparison of Cost of revenues is presented below: Three Months Ended September 30, Nine Months Ended September 30, 2021 % Change 2020 2021 % Change 2020 (Dollars in thousands) Cost of revenues $ 47,801 6% $ 45,024 $ 142,565 6% $ 134,205 Cost of revenues increased by $2.8 million during the three months ended September 30, 2021, compared to the same period last year, due to a combination of individually insignificant factors. Cost of revenues increased by $8.4 million during the nine months ended September 30, 2021, compared to the same period last year, primarily due to a $4.4 million increase in registry fees payable to ICANN in connection with the operation of the registry for the .com TLD. Allocated overhead expenses also increased by $1.9 million due to an increase in total allocable expenses. We expect Cost of revenues as a percentage of revenues to remain consistent during the remainder of 2021 compared to the nine months ended September 30, 2021. Sales and marketing Sales and marketing expenses consist primarily of salaries and other personnel-related expenses, travel and related expenses, trade shows, costs of computer and communications equipment and support services, facilities costs, consulting fees, costs of marketing programs, such as online, television, radio, print and direct mail advertising costs, and allocations of indirect costs such as corporate overhead. 16 Table of Contents A comparison of Sales and marketing expenses is presented below: Three Months Ended September 30, Nine Months Ended September 30, 2021 % Change 2020 2021 % Change 2020 (Dollars in thousands) (Dollars in thousands) Sales and marketing $ 9,410 12% $ 8,389 $ 28,115 18% $ 23,883 Sales and marketing expenses increased by $1.0 million during the three months ended September 30, 2021, compared to the same period last year, due to a combination of individually insignificant factors. Sales and marketing expenses increased by $4.2 million during the nine months ended September 30, 2021, compared to the same period last year, primarily due to an increase in salary and employee benefits expenses, including stock-based compensation, and a combination of individually insignificant factors. Salary and employee benefits expenses, including stock-based compensation, increased by $2.5 million due to an increase in average headcount and higher expenses for salaries and certain employee related benefits. We expect Sales and marketing expenses as a percentage of revenues to increase slightly during the remainder of 2021, compared to the nine months ended September 30, 2021. Research and development Research and development expenses consist primarily of costs related to research and development personnel, including salaries and other personnel-related expenses, consulting fees, facilities costs, computer and communications equipment, support services used in our service and technology development, and allocations of indirect costs such as corporate overhead. A comparison of Research and development expenses is presented below: Three Months Ended September 30, Nine Months Ended September 30, 2021 % Change 2020 2021 % Change 2020 (Dollars in thousands) Research and development $ 19,566 (1)% $ 19,708 $ 59,685 8% $ 55,268 Research and development expenses remained consistent during the three months ended September 30, 2021, compared to the same period last year. Research and development expenses increased by $4.4 million during the nine months ended September 30, 2021, compared to the same period last year, primarily due to an increase in salary and employee benefits expenses, including stock-based compensation, and a combination of individually insignificant factors. Salary and employee benefits expenses, including stock-based compensation, increased by $2.5 million due to a slight increase in average headcount and higher expenses for salaries and certain employee related benefits. We expect Research and development expenses as a percentage of revenues to remain consistent during the remainder of 2021 compared to the nine months ended September 30, 2021. General and administrative General and administrative expenses consist primarily of salaries and other personnel-related expenses for our executive, administrative, legal, finance, information technology and human resources personnel, costs of facilities, computer and communications equipment, management information systems, support services, professional services fees, and certain tax and license fees, offset by allocations of indirect costs such as facilities and shared services expenses to other cost types. A comparison of General and administrative expenses is presented below: Three Months Ended September 30, Nine Months Ended September 30, 2021 % Change 2020 2021 % Change 2020 (Dollars in thousands) General and administrative $ 36,160 (5)% $ 38,109 $ 112,212 —% $ 111,719 General and administrative expenses decreased by $1.9 million during the three months ended September 30, 2021, compared to the same period last year, primarily due to a $2.1 million decrease in external legal costs on various projects. 17 Table of Contents General and administrative expenses increased by $0.5 million during the nine months ended September 30, 2021, compared to the same period last year, due to increases in salary and employee benefits expenses, equipment and software expenses, and stock-based compensation expenses, partially offset by an increase in overhead expenses allocated to other cost types and decreases in legal expenses and charitable contributions. Salary and employee benefits expenses increased by $4.6 million due to an increase in average headcount and higher expenses for certain employee health insurance related benefits. Equipment and software expenses increased by $4.3 million due to expenses related to network security and other software services. Stock-based compensation expenses increased by $3.3 million due to higher achievement levels on certain performance-based RSU grants and increases in the total value of RSUs granted in 2021. Overhead expenses allocated to other cost types increased by $3.7 million due to an increase in the total allocable expenses. Legal expenses decreased by $4.5 million due to a decrease in external legal costs on various projects. Charitable contributions decreased by $2.0 million due to contributions we made during the nine months ended September 30, 2020 to help with immediate COVID-related hardship and to support social justice efforts, compared to ongoing contributions during the nine months ended September 30, 2021. We expect General and administrative expenses as a percentage of revenues to remain consistent during the remainder of 2021 compared to the nine months ended September 30, 2021. Interest expense Interest expense decreased by $3.7 million and $3.2 million in the three and nine months ended September 30, 2021, respectively, compared to the same periods last year due to the lower interest rate on our 2031 Notes compared to the 2023 Notes which were redeemed in June 2021. We expect Interest expense in the fourth quarter of 2021 to be consistent with the third quarter of 2021. Non-operating income (loss), net The following table presents the components of Non-operating income (loss), net: Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (In thousands) Interest income $ 111 $ 805 $ 438 $ 7,500 Loss on extinguishment of debt — — (2,149) — Gain on sale of business — (9) — 5,602 Transition services income — — — 2,100 Other, net 53 (21) 278 60 Total non-operating income (loss), net $ 164 $ 775 $ (1,433) $ 15,262 Interest income decreased in the three and nine months ended September 30, 2021 due to a decline in interest rates on our investments in debt securities. The redemption of the 2023 Notes resulted in a loss on debt extinguishment of $2.1 million related to the unamortized debt issuance costs on the notes during the second quarter of 2021. The gain on sale of business in 2020 represents the excess of the contingent consideration received related to the divested security services business compared to the estimated receivable. The transition services income in 2020 relates to the divested security services business. The transition services agreement ended in February 2020. We do not expect Non-operating income (loss), net to be significant during the remainder of 2021. Income tax expense (benefit) The following table presents Income tax expense (benefit) and the effective tax rate: Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 (Dollars in thousands) Income tax expense (benefit) $ 46,018 $ 13,908 $ 124,083 $ (90,226) Effective tax rate 23 % 8 % 21 % (16) % When compared to the statutory federal rate of 21%, the effective tax rates above reflect a lower effective tax rate on foreign income and excess tax benefits related to stock-based compensation, which are offset by state income taxes and U.S. taxes on foreign earnings, net of foreign tax credits. The effective tax rate for the three and nine months ended September 30, 2020 also reflected the remeasurement of unrecognized tax benefits discussed below. 18 Table of Contents We remeasured certain previously unrecognized income tax benefits, which resulted in the recognition of $24.0 million and $191.8 million of income tax benefits in the three and nine months ended September 30, 2020, respectively. The most significant portion of these tax benefits related to the worthless stock deduction taken in 2013, which resulted in the recognition of a $167.8 million benefit in the first quarter of 2020. These remeasurements were based on written confirmations from the IRS, received in the first and third quarters of 2020, indicating no examination adjustments would be proposed related to the worthless stock deduction or certain other matters reviewed as part of the audit of our federal income tax returns for 2010 through 2014. Notwithstanding these written confirmations, our U.S. federal income tax returns for those years remain under examination by the IRS. We expect our annual effective tax rate for 2021 to be between 20% and 23%. Liquidity and Capital Resources The following table presents our principal sources of liquidity: September 30, December 31, 2021 2020 (In thousands) Cash and cash equivalents $ 256,869 $ 401,194 Marketable securities 941,552 765,713 Total $ 1,198,421 $ 1,166,907 The marketable securities primarily consist of debt securities issued by the U.S. Treasury meeting the criteria of our investment policy, which is focused on the preservation of our capital through investment in investment grade securities. The cash equivalents consist of amounts invested in money market funds, time deposits and U.S. Treasury bills purchased with original maturities of three months or less. As of September 30, 2021, all of our debt securities have contractual maturities of less than one year. Our cash and cash equivalents are readily accessible. For additional information on our investment portfolio, see Note 2, “Financial Instruments,” of our Notes to Condensed Consolidated Financial Statements in Part I, Item I of this Quarterly Report on Form 10-Q. During the three months ended September 30, 2021, we repurchased 0.8 million shares of our common stock for an aggregate cost of $172.4 million. As of September 30, 2021, there was approximately $565.1 million remaining available for future share repurchases under the share repurchase program which has no expiration date. On June 8, 2021, we issued $750.0 million of 2.700% senior unsecured notes due June 15, 2031. On June 23, 2021, we used the net proceeds from the 2031 Notes, along with cash on hand, to redeem all of our $750.0 million aggregate principal amount of outstanding 4.625% senior notes due 2023. As of September 30, 2021, we also had $550.0 million principal amount outstanding of 4.75% senior unsecured notes due 2027 and $500.0 million principal amount outstanding of 5.25% senior unsecured notes due 2025. As of September 30, 2021, there were no borrowings outstanding under our $200.0 million credit facility that will expire in 2024. We believe existing cash, cash equivalents and marketable securities, and funds generated from operations, together with our borrowing capacity under the unsecured revolving credit facility should be sufficient to meet our working capital, capital expenditure requirements, and to service our debt for at least the next 12 months. We regularly assess our cash management approach and activities in view of our current and potential future needs. In summary, our cash flows for the nine months ended September 30, 2021 and 2020 were as follows: Nine Months Ended September 30, 2021 2020 (In thousands) Net cash provided by operating activities $ 600,909 $ 534,962 Net cash used in investing activities (215,093) (305,820) Net cash used in financing activities (533,318) (591,128) Effect of exchange rate changes on cash, cash equivalents, and restricted cash (600) (506) Net decrease in cash, cash equivalents, and restricted cash $ (148,102) $ (362,492) Cash flows from operating activities Our largest source of operating cash flows is cash collections from our customers. Our primary uses of cash from operating activities are for personnel-related expenditures, and other general operating expenses, as well as payments related to taxes, interest and facilities. 19 Table of Contents Net cash provided by operating activities increased during the nine months ended September 30, 2021, compared to the same period last year, primarily due to an increase in cash received from customers, partially offset by increases in cash paid to employees and vendors, cash paid for income taxes, cash paid for interest, and decreases in cash received from interest on investments and from transition services. Cash received from customers increased primarily due to higher domain name registrations and renewals and the impact of the . com price increase which became effective September 1, 2021. The increased volume of renewal transactions was due in part to early renewal transactions before the . com price increase became effective. Cash paid to employees and vendors increased primarily due to the timing of payments and an increase in operating expenses. Cash paid for income taxes increased primarily due to comparatively higher federal, state, and foreign taxes. Cash paid for interest increased as the result of the payment of interest on our 2023 Notes through the date of redemption. Cash received from interest on investments decreased due to a decline in interest rates. Cash received from transition services d ecreased due to the expiration of the transition services agreement related to our divested security services business in February 2020. Cash flows from investing activities The changes in cash flows from investing activities primarily relate to purchases, maturities and sales of marketable securities, purchases of property and equipment and the sale of businesses. Net cash used in investing activities decreased during the nine months ended September 30, 2021, compared to the same period last year, primarily due to a decrease in purchases of marketable securities, net of proceeds from maturities and sales of marketable securities, partially offset by payments received during 2020 related to our divested security services business and an increase in purchases of property and equipment. Cash flows from financing activities The changes in cash flows from financing activities primarily relate to share repurchases, proceeds from and repayment of borrowings, and our employee stock purchase plan. Net cash used in financing activities decreased during the nine months ended September 30, 2021, compared to the same period last year, primarily due to proceeds received from the issuance of the 2031 Notes and a decrease in share repurchases, partially offset by the redemption of our 2023 Notes. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no significant changes in our market risk exposures since December 31, 2020.