VeriSign, Inc.
Q2 2006 Earnings Call Transcript
Published:
- Operator:
- Thanks for holding, everyone. Welcome to this VeriSign second quarter of 2006 results conference call. Today’s call is being recorded and at this time for opening remarks, I’d like to turn the call over to Tom McCallum. Please go ahead, sir.
- Tom McCallum:
- Thank you, operator. Good afternoon, everyone. Thank you for joining us for VeriSign’s second quarter of 2006 results call. I’m here today with Stratton Sclavos, the Chairman and CEO of VeriSign and Dana Evans, our CFO. In a moment, Stratton will review Q2 and will provide us with insight into the business’ performance. Dana will then follow with a detailed review with our Q2 financial results and she will then make some forward-looking guidance. We will then follow with a Q&A session. You may anticipate the call will end at approximately 3
- Stratton Sclavos:
- Thanks, Tom, and good afternoon, everyone. Let me add my welcome to all of you attending today’s call. As our results for Q2 indicate, we had solid performance across our lines of business, meeting or exceeding our financial projections for the quarter. We’re also pleased to see the mobile content business continue its progress towards stability and growth, with B to C performance slightly ahead of our earlier projection. The results show a very productive quarter in terms of strategic execution, as we made significant progress in building out our intelligent infrastructure portfolio through newly launched services and the organizational integration of key acquisitions including m Qube, Kontiki and 3 United. All in all, we are pleased with our results for Q2 and are looking forward to incremental growth throughout the rest of the year as demands for our broad portfolio of services continues. With that, let me dive into Q2 highlights for the business units, and then say a few words about our outlook for Q3. Let’s begin with the Communications Services Group. As you’ll recall, we report the CSG group’s revenues in two categories
- Dana L. Evans:
- Thanks, Stratton, and thanks to all of you for joining us this afternoon. As you can see from our results, VeriSign delivered another solid quarter in Q2, demonstrating consistent growth in both the Communications and Internet Services Group, which in turn drove revenue and earnings performance at the high end of our guidance. During the quarter, we also saw several significant financial events. We closed the m Qube acquisition, repurchased approximately $60 million of VeriSign common stock, and entered into a banking agreement that provides a $500 million credit facility to be used for general corporate purposes. While we certainly expect to continue to generate healthy cash flows and maintain strong cash balances, this added funding source provides us both financial and operating flexibility to execute against our strategic plan while we effectively manage our investment portfolio and our cost of capital. Additionally, in Q2 our Board of Directors approved a new $1 billion stock repurchase plan. The repurchases under this plan will be financed by the company’s working capital and opportunistically executed. As we said before, we believe that investing our cash in VeriSign share repurchases will be a long-term value creation vehicle for our shareholders. For now, let’s turn to the financial results for the quarter, starting with the income statement-related items. On a consolidated basis, VeriSign reported second quarter revenue of $392 million. These revenue results came in at the high end of the guidance we gave at our May Analyst Day due primarily to stronger than expected demand in the domain name business and the positive trend towards stabilization we are now seeing in the Jamba!/Jamster B2C business. Looking at the detailed revenue broken down by reporting unit, both the Communication Services and Internet Services Groups grew approximately 5% sequentially this past quarter, with the Internet Services Group delivering approximately $186 million of revenue, or 48% of the total, and the Communications Services Group reporting $206 million for Q2, or 52% of total revenue. Within the core Communications and Commerce line of business, revenues were $120 million in the quarter. The Mobile Content line of business, which includes Jamba!/Jamster as well as the new mobile and broadband infrastructure services, delivered revenues of $86 million. Jamba!/Jamster represented $74 million of this number, and was higher than our expectations for revenues in the mid $60 million range. The Mobile Content results were driven primarily by a move towards stabilization in key geographies and early adoption in Eastern Europe and China. Moving to our international operations, the percentage of revenue driven from our international customers, affiliates and subsidiaries picked up a bit from last quarter to 31% for Q2. Growth in our EMEA and Asian regions in both security and communications services drove this increase. Looking at cost of revenues and gross margin, our cost of revenue for the second quarter was up approximately $9 million from Q1, to $144 million. This translates into a 63.3% gross margin for the second quarter, slightly below our previous guidance, driven mainly by the acquired revenues in the quarter which come at lower growth margins than the company average. Turning to operating expenses and related items, total operating expenses for Q2 were $169 million, up slightly from $163 million in Q1. This op ex level drove non GAAP operating income of $79 million for the quarter, up $4 million from Q1 and translating into a 20% operating margin for Q2 in line with our guidance. As it related to employee headcount, we ended the quarter with around 4,640 people, up 240 primarily due to the m Qube acquisition. VeriSign reported non GAAP, pre tax income for the second quarter of $84 million. Non GAAP earnings per share for Q2 was $0.24, which came in at the top end of our guidance of $0.23 to $0.24. GAAP EPS for the quarter was $1.42. This EPS number includes stock-based compensation expenses of $13 million and certain, one time tax benefits totalling $327 million primarily relating to the release of a deferred tax asset valuation allowance. This earnings per share calculation uses diluted weighted-average shares outstanding of approximately 247 million shares for Q2. Now moving on to the balance sheet and cash flow items, cash balances decreased by $76 million in Q2, translating into cash, equivalents and short-term investments totalling $734 million. Significant components contributing to cash balances at the end of the quarter included cash inflows resulting from operating cash flow of $91 million and a draw down on our credit facility of $174 million. These inflows were offset by outflows of $266 million for the m Qube transaction, $37 million of capital expenditures and $60 million for stock repurchases at an average price of $21.67. As it relates to accounts receivable, net DSO for the second quarter came in at 53 days, up from the previous quarter’s DSO of 48 days but within our targeted range. The increase you see here is primarily due to a $34 million increase in receivables from acquired companies, over 70% of which is coming from m Qube. Total deferred revenue on the balance sheet was $560 million at the end of Q2, up $21 million from the previous quarter. The solid growth here was driven primarily from better than expected bookings and strong renewal rates in the domain name registry business and consistent, deferred revenue growth from our security business. Moving on to cash flow metrics, operating cash flow for Q2 came in at approximately $91 million. The cash flow number in the quarter was adversely impacted by approximately $15 million due to certain tax-related activities. Lastly, with Q2 capital expenditures of $37 million, free cash flow for the quarter was $54 million before taking into account acquisition. That completes the financial review. Let me now turn towards our outlook for Q3. As it relates to revenue guidance for the quarter, we anticipate revenue in the $400 million range. This reflects the expectation that the Communications Services Group will represent approximately 51% of revenue in Q3, and the Internet Services Group approximately 49%. In the Communications Services Group, we are forecasting a decline in the core Communications and Commerce revenue stemming from continued consolidation in the Tier I carrier space as SBC integrates its AT&T acquisition and we see the effects from the Verizon/MCI consolidation. For the Mobile Content business, we look for revenues in the low $90 million range, with Jamba!/Jamster contributing approximately $70 million to that number. The Jamba!/Jamster forecast reflects our expectation that we will continue to experience a stabilization trend in this business, offset a bit by some typical summer seasonality. Looking at our expectation for the Internet Services Group, this guidance anticipates relatively consistent growth coming from both the Information and Security Services businesses. Turning to margins for Q3, we would expect gross margins to be relatively flat, in the 63% range, reflecting the reality of lower gross margins in our acquired companies which naturally dilute our consolidated gross margin percentage. In terms of operating expenses, we will continue to execute on our plan for investing in growth and next generation services while remaining focused on expense management in all areas across all businesses. This is just a modest increase in Q3 for operating expenses. Thus, given the revenue/expense profile I just laid out, we would expect operating margins to be in the 20% range, relatively consistent with Q2. Taking into account our forecast for interest expense related to the credit facility which is netted against our normal quarterly interest income, we would look for net other income of approximately $3 million in Q3. As it relates to share count, we would forecast a diluted share count of approximately 244 million shares for the quarter. So in summing this all up, given the anticipated Q3 revenue levels, the full quarter’s effect of all acquisition expenses and the margin guidance I just gave, we are guiding to earnings per share for Q3 of $0.24 on an after-tax basis, using a 30% effective tax rate. This EPS guidance also reflects a fully $0.01 of the dilution we anticipate as a result of our recent acquisitions as well as the additional interest expense for projected debt balances. Lastly, in looking at operating cash flow, we would expect to generate a base level of cash flow in Q3 of approximately $90 to $100 million. So in summary, we are pleased with the results this past quarter. As we look to Q3, the solid performance we expect from the Internet Services Group and the trend towards stabilization of the Jamba!/Jamster business earlier than previously forecast provides us a base from which we believe we can continue to grow revenue and profits in the second half of 2006. And with that, I’d like to open the call for your questions. Operator, may we have the first question, please?
- Operator:
- Absolutely. (Operator Instructions) First up is Peter Cooper at Morgan Stanley.
- Peter Cooper:
- Hey, great. Thanks very much. I want to focus a little bit on of the things we talked about at the Analyst Day. You’d mentioned, you know, coming together here with the different pieces of the pie from the communications side versus the securities side. Are there any developments there beyond the recent win with Schwab, etc., that would give investors a little more proof of concept here? What you laid out at the Analyst Day?
- Stratton Sclavos:
- Well if you’re talking about kind of the broader initiatives of integrating some of the technologies, Peter, a couple of things I would say. Clearly, in the content distribution, whether it be mobile or broadband, we have been bring to bear both our naming capabilities in terms of [ENUM] capabilities and address translation capabilities. In fact, we do local number portability look up and all kinds of various things in our content businesses with the VeriSign Information Services core technology. In addition, of course, all the DRM technology is backed up by VeriSign security and authentication. So at the development shops, there’s lots of work going on. In fact, as we also talked about at Analyst Day, our security team is having our messaging team build them a [inaudible] technology that will fit in handsets as it relates to VeriSign authentication services going downstream and going mobile. So all that’s in the works in the product shops. I would expect that portfolio of things to be ready for launch in early 07. The ePedigree solution that we talked about, that we delivered in July to Cardinal, actually uses VeriSign digital signature and certificate technology. So again, I’m actually very pleased with the progress we’re making on the product roadmap as it relates to integration. I think the next step for us is in distribution and how we bring those solutions to market for our customers and we’re starting to have some very interesting conversations with large financial service firms as well as carriers about VeriSign becoming more of an end-to end provider for them of mobile solutions as well as enterprise security and commerce solutions. So I would say, from what we talked about at Analyst Day just a few short months ago, we’ve continued strong forward progress on those fronts.
- Peter Cooper:
- Okay, great. Then maybe, how about [inaudible] but there’s been a lot of chatter, a lot of concern we’ve been hearing about, we’re not that worried about it, the [inaudible]. Are there any updates on that at this point?
- Stratton Sclavos:
- I’m not that worried about it either, Peter, and I guess the way I would characterize it at this point is we continue to have constructive dialogue with the Department of Commerce and we’ll expect that to take its course over the next few weeks.
- Peter Cooper:
- Great. Thanks very much.
- Operator:
- Next up, we’ll take a question from Rob Owens at Pacific Crest.
- Rob Owens:
- Yeah, good afternoon guys. Can you talk a little bit about the growth of domain names? I think this is your second largest increase sequentially that you’ve ever seen and when do we start to see that top out, Stratton, on the dot com platform?
- Stratton Sclavos:
- Rob, what a great question. You know, it’s hard to imagine. As I’ve said in the previous conference calls, our goal coming into the year was an average of about 330,000 to 350,000 names per week in terms of net new names. We’ve been averaging north of 420,000, 430,000 all year long. So it’s got strong growth characteristics. One of the things that I think Mark also showed at the Analyst Day is only a very small percent of that is coming from this search-related pay per click market on domains. So in essence, we are benefiting from a global demand more broadly for names right now, I think driven significantly by international uptake of dot com and dot net as well as by local markets beginning to really kind of fulfil the promise that they had about your local retailers, merchants, dentists, lawyers, all putting up web sites as well. So that seems to still be fuelling it. Renewal rates, as you’ve seen, are really at an all-time high and I mean all-time even from the early 90s and so at this point in time, we’re tracking well ahead of plan this year there and we don’t see any near-term obstacles to continuing that growth.
- Rob Owens:
- Now, last quarter didn’t you [expand] some gross margin pressure because you’re doing incremental advertising in that business and did that continue here into the June quarter?
- Stratton Sclavos:
- That was co op marketing activity and it really didn’t impact gross margin because that comes out of marketing expense.
- Dana L. Evans:
- So this quarter the gross margins and the spending in that business were relatively consistent.
- Rob Owens:
- Okay and then lastly, with the Tier I consolidation going on and some of the weakness you’re seeing in the Communications and Commerce business, when would you expect that to flatten out, I guess, if you look at the core and not the messaging side and potentially start to take up?
- Stratton Sclavos:
- I actually think it’ll flatten out here no later than the end of this year. It could pick up actually a little bit in Q4 certainly from Q3. I think we’re right in the middle obviously of big consolidations of a lot of the mergers that happened earlier this year and so that traffic, the inter-carrier traffic has been going away and we’ll see a substantial downtick in that particular network connectivity business this quarter, but we’re expecting that will pick back up again, start growing in Q4, Q1 at the latest.
- Rob Owens:
- Great. Thanks, guys.
- Operator:
- Moving on the Phil Winslow, Credit Suisse.
- Operator:
- Phil, your line’s open if you have a question. All right, then, we’ll move on to Todd Raker at Deutsche Bank.
- Todd Raker:
- Hey, guys. Two questions for you. First, you know, following up Rob’s question, if you look at the core communications business, it looks like you’re seeing for forecasting a sequential decline of about $9 to $10 million. Can you just give us some insight in terms of, is this renewal of large contracts or is this pricing pressure and, you know, if you look at the messaging side, SMS, MMS, how is the growth profile there? Is there any indication that you’re losing traction and momentum around [inaudible] and some of the other messaging functionality?
- Stratton Sclavos:
- So, the downtick is going to be slightly less than you said, Todd. However, it’s really just two simple facts. It’s continuous price pressure on database services for some key carriers, especially now that they have got much more volume, as well as the loss of inter-carrier traffic. So in one case it’s pricing pressure. In the other case, it’s because they no longer require inter carrier links.
- Todd Raker:
- Right.
- Stratton Sclavos:
- And those two things kind of just happened to come together at the same point in time because of those two very large mergers. [Inaudible] Again, volume increases will begin to let that grow again after we’ve reached that, and we don’t see any other contracts coming up for pricing renegotiation for the rest of the tier.
- Dana L. Evans:
- And as Stratton mentioned, Todd, you know a big part of the strategy is, you know, leveraging the technology into these international markets so that we can start to drive revenues from the international market to offset some of this Tier I consolidation in the U.S.
- Stratton Sclavos:
- Yeah and the second part of your question, the SMS revenues are up 100% year over year. The MMS revenues on a messaging basis are also up year over year. What you’re seeing there is a decline in the professional services contracts, where we integrate into these carriers. So we’re not kind of past the integrate phase and into the volume build phase on MMS messaging, although it’s still a relatively small percentage.
- Todd Raker:
- Okay and then, second question, you know, Jamba! put up a pretty good result this quarter. Can you give us some more insight from a geographic perspective? You know, are you seeing Germany and the U.K. starting to outperform your expectations, or is this really the emerging geography coming downstream and starting to offset weakness in established geographies?
- Stratton Sclavos:
- Yeah, I mean, I’ll just rattle them off by kind of key geography. Yeah, the U.K. has pretty much become irrelevant as it relates to revenue contribution because of the steep decline there so that’s really not a factor any longer in declining revenues at Jamba! for any large part. Germany has continued to slow, although it’s still shrinking a little bit, although it remains the biggest market and we did see some months of growth and some months of decline there in the quarter. We did see a substantial uptick in China during the quarter and took some of our first revenues from that marketplace and we’re interested in seeing that continue. The U.S. was, you know, also declined but in recent weeks we’ve actually seen it start to grow again. So there’s, I would say the bigger markets we had are reaching their stabilization point and allowing some of the smaller or newer market start to contribute to growth again, which as you said, led to better than expected results here and I think more confidence in the management team at Jamba! and certainly here at corporate that we’ll be able to extend that performance in Q3 and Q4.
- Todd Raker:
- Okay and just a quick follow up on that. If you look at the Chinese market, I believe the largest carrier there has changed what we’ll call third-party vendor, billing capabilities, where you have to renew your customer on a monthly basis for some value-added services. Is that going to have any impact on you guys?
- Stratton Sclavos:
- We’re tending to be fairly conservative about rev right there and have, you know, seen that stuff coming and built it in so I don’t think it will have an impact for us going forward.
- Todd Raker:
- Okay. Thanks, guys.
- Operator:
- And we’ll go back to Phil Winslow at this time, from Credit Suisse. Mr. Winslow?
- Philip Winslow:
- Yes. Sorry about that earlier. I just want to dig a little bit, just on the ISG group. Last quarter you mentioned a little bit of lightness in some of the services area, security services. Just wondering if you could comment on what you’re seeing there in Q2 and then also, just on the gross margin comment that you all made about your new revenue streams. Wondering if you’d give us a sense of what the gross margin is on the m Qube side of the business versus Jamba!.
- Stratton Sclavos:
- You know, Security and the Internet Services Group had a decent quarter in Q2. I would say no real weakness in Security of any measurable amount and a very strong forecast for Q3, which as you would expect is, you know, pleasantly surprising given we’re in a Q3, summertime in Europe and the rest. So I think the Security team’s on track and going to do well through the rest of the year and of course Internet Services Group being driven by the dot com growth, most of that banked in deferred revenue at this point. But I think we’re very confident and comfortable with the performance over there.
- Dana L. Evans:
- On the gross margin front, most of the acquired companies’ gross margins are just in the low to mid 50% range. From that small a revenue, you really don’t need [a reason lower] than that because they’re in early stages of their business.
- Stratton Sclavos:
- Yes, one of the things that we tend to do with the acquired companies is obviously try to improve their gross margins and their operating margins sequentially, quarter over quarter, so our hope is that those business over time will in fact get to the corporate average in gross margin, if not higher as they achieve critical mass.
- Philip Winslow:
- All right. Great. Thanks, guys.
- Operator:
- Moving on to Goldman Sachs, Sarah Friar.
- Sarah Friar:
- Good afternoon, guys. Stratton, could you just give us some update on the authentication side? I think last quarter you suggested that we might see some early rollouts of PayPal. Has that begun, or when do expect to start to see some traction on that side?
- Stratton Sclavos:
- Good question, Sarah. I actually haven’t seen the latest report but I think the product teams, the initial rollout is an internal rollout at PayPal and if it hasn’t started, it will shortly. I know that they’re on track for that, and then we have quite a long list of items we’re working with them as it relates to international rollouts that look like they will start in Germany, Australia and even potentially China over the course of the next two to three quarters. So as you expect, internal pilot then it will go to external pilot, but they have already in some of the international markets been introducing the technology to the customer set and started to talk about pricing fees and kind of usages. So, you know, I would say on track, plus or minus a few weeks.
- Sarah Friar:
- Okay, so maybe from a revenue perspective, though, we should think about it a little bit more next year than this year? Is that fair?
- Stratton Sclavos:
- Certainly true, because we defer the revenues on [tokens] in any event.
- Sarah Friar:
- Sure. Okay. Okay. But it obviously would be a big [proof] point to get PayPal rolled out.
- Stratton Sclavos:
- Yes, it would be.
- Sarah Friar:
- And the same goes for Schwab. Is it very early stages there or have they started to do any sort of piloting at this point?
- Stratton Sclavos:
- Well initially, of course, they need to be [SFEIC] compliant by end of year so all the focus right now is on implementing our fraud detection solution and that’s proceeding very well and, you know, testing – both load testing as well as performance testing, I think’s very good. And then on the token side, that will come after we complete the project for fraud detection.
- Sarah Friar:
- Okay, got it. Then, on the stock repurchase, are you prepared to get fairly aggressive there or is the $60 million you did this quarter a good run rate level to think about?
- Stratton Sclavos:
- You know, I think we balance our share repurchases with other uses of cash during a period so, you know, we certainly had a lot of cash going out as it related to acquisitions in Q2 and had toned down our stock buyback a little bit. Stock comes under pressure and I certainly wouldn’t expect to have significant amount of cash outlays in acquisitions so far in Q3 so we may in fact become more aggressive. We really do balance it on what we consider to be a reasonable use of cash in a given period across all those uses.
- Sarah Friar:
- And the goal is to, in terms of keeping cash on the balance sheet, what do you feel is a good level for the company? Would you even get yourselves into a net debt position? Would you be prepared to go that far?
- Stratton Sclavos:
- No, that’s – historically, we’ve never been willing to do that and I can’t foresee that coming. I think Dana and I feel comfortable that, you know, half a billion is certainly enough to comfortably run the company, especially with the cash flow characteristics of the business and we’re certainly well north of that at this moment.
- Sarah Friar:
- Okay, and then just a final one in terms of cost. You talk about going overseas with the [Telco] offerings. I know you mentioned that you put a hub in Japan in this quarter. How big of a capital spend is it to do something like that and is that already encompassed in the Capex we saw this quarter, or will there be more of that coming through the next couple of quarters, Dana?
- Dana L. Evans:
- So, it’s a fairly inconsequential amount of capital. It was already in the plan.
- Sarah Friar:
- Okay. Okay, and so you don’t see any other major spends coming around that as you look to China and so on?
- Dana L. Evans:
- No.
- Sarah Friar:
- Okay, great. Okay, thanks a lot.
- Operator:
- Sterling Auty is next, from J.P. Morgan.
- Sterling Auty:
- Yeah, thanks. Two questions. First, on the stabilization of Jamba! in some of he bigger markets, can you kind of add some color as to what you think is driving the success in stabilization? Is it from promotion programs, [because] you talked about a Pepsi promotion program at the Analyst Day? What’s driving the stabilization?
- Stratton Sclavos:
- I don’t want to take too much credit for stabilization, Sterling, in that respect. Let’s say it’s the same as we saw years ago with domain names. It’s the fluff and the false demand is out of the market and so what you’re seeing is more of the real demand and then the team has done a nice job in improving the offerings, improving the clarity, improving, you know, the marketing conversion rate and entering some of these new markets. So I think mostly I would say we’ve reached stabilization out of hitting bottom on real demand and then growth will come from just continuing step by step improvements across the platform. And all those things are helping modestly at this point, but I wouldn’t want to take tremendous credit for them.
- Sterling Auty:
- Okay, and then the last question is, on the going international on some of the core Telco services, you talk about [inaudible] pickup in revenue but I’m a little unclear. Is the pickup in revenue from, like [FT telecom] coming online? How are the contracts actually structured internationally versus domestically?
- Stratton Sclavos:
- They’re relatively the same as they are here, and what we’ve been doing internationally so far is winning signalling business, transport business and then messaging business. So in essence, we’ll be being paid, you know, for particular amounts of messages and signals that are getting sent and so what we have to do, of course, is sign the carrier, integrate with their network, and then give them the inter-carrier connectivity to all the carriers here and abroad that they want to touch, you know, exchange messages with. But let’s just say it’s kind of a very linear ramp in how you do that, in fact, right now with SK we are doing certification testing with one very large carrier here in the U.S. where a lot of their traffic goes. So as we begin carriers up here, connection test and certify, you’ll start to see the revenues grow as the messages flow.
- Sterling Auty:
- And will you actually provide connectivity between carriers and Asia Pacific region locally? Or is it all signalling back to North America?
- Stratton Sclavos:
- We will do both and in fact some of our probably more interesting long-term opportunities are coming from talking to the carriers in Asia about helping them go inter-carrier in their region.
- Sterling Auty:
- Great. Thank you.
- Operator:
- We’ll move to Ed Maguire at Merrill Lynch.
- Edward Maguire:
- Yes, good afternoon. Could you talk about the GeoTrust acquisition? What that will mean for pricing and branding on the digital certificate side?
- Stratton Sclavos:
- Yeah. Obviously until that is complete, we really won’t be talking much about product, pricing and packaging nor do I actually think we have our plans anywhere near [inaudible] through there. Obviously, to get a bigger base of customers right off of the supporting infrastructure should allow us over time to get efficiencies there but again, we’re still in the process of receiving clearance from some international authorities around that acquisition and in doing our own due diligence. So we expect to be able to update folks on that at the end of this quarter.
- Edward Maguire:
- Okay, and back to the Mobile Content side. Just wanted to get a sense of where you saw upside on the consumer side and really, you know, more to the point, you’ve been really pulling away from investing in, you know, on the consumer side although it looks like you got some upside this quarter. Going forward do you expect to continue to expand geographically and invest more in direct to consumer programs or should we really look for that to stabilize or tail off as the more B2B services take their place?
- Stratton Sclavos:
- Well, I think we will continue as we said to run the B2C side in the high teens of margin, potentially a little bit better than that. And so we make our investment trade-off in terms of marketing based on constraining the problem around margin. So to the extent we see things in China or eastern Europe take off, we’ll invest more dollars and to the extent we don’t, we’re not in a position, I would say, to commit aggressively into new spends to try to act as a catalyst. So I think we’re running it, as you say, in a more stable and manageable approach. I would tell you we’re pleasantly surprised with the progress in China at this point and we’ll continue to make incremental investments as we see incremental growth.
- Edward Maguire:
- Okay. That’s all for me. Thanks.
- Operator:
- Next up is Gregg Moskowitz at Susquehanna.
- Gregg Moskowitz:
- Okay, thanks very much. Stratton and Dana, if you were to back out the effect from the Tier I consolidation in Q3, how would Communication and Commerce sequentially performance look? Would it be flattish? Would it still be down a little bit?
- Stratton Sclavos:
- Oh, no. It would be up, actually.
- Gregg Moskowitz:
- It would be up? Okay. Great, and wondering if you can elaborate as well on what gives you the confidence in the 5% sequentially security growth in Q3 and what services specifically are driving that?
- Dana L. Evans:
- That business, much of it that doesn’t go into the deferred revenue which is obviously highly visible, is also on a booking basis and we have solid bookings that we know will be delivered in Q3 that will drive that much above.
- Gregg Moskowitz:
- Okay, but I guess I’m wondering if it’s kind of more in, say, PKI managed services or some of the newer authentication areas?
- Stratton Sclavos:
- We had very strong bookings in SSL, right, coming out of Q2 which does hit deferred revenue and helps. We also had very good pipeline growth, if you will, in the unified authentication business, in the [MSF] business and then kind of more generically, kind of in international markets where we’ve brought on new leadership in Europe that seems to be, you know, acting as a catalyst for generating a lot of new pipeline as well as VeriSign Japan, which underperformed in Q1, starting to get more aggressive as they look into Q3 and Q4. So we’re saying that I think the demand for the security services portfolio we have is increasing and, you know, the team is pretty bullish on Q3 and Q4 right now.
- Gregg Moskowitz:
- Great, and then just lastly, Stratton, is RFID, is your business there still on target for $20 to $25 million in revenues this year and when do you think we move from more of a consultative stage to an actual build out of the EPC network?
- Stratton Sclavos:
- Yeah, I think on a bookings basis we’ll certainly hit that. On the rev rec side of it, it will really depend on when the ePedigree solutions kick in with the various states and when some of the consulting projects go live. So I think we’re still looking very good on a pipeline and booking basis. On a rev rec side, it’s more up to the customers at this point in terms of when they roll out. On the EPC global front, there’s a lot of activity there, lots of pilots still. You know, when we talked about $20 to $25 million, it included all the supply chain services that were EPC, the ePedigree stuff as well as the point of sale stuff. So you put that all together and I think we’re still right there on the bookings target and certainly delivering what we would expect at this point.
- Gregg Moskowitz:
- Okay. Thank you.
- Operator:
- Next, from Cowan & Co., this is Walter Pritchard.
- Walter Pritchard:
- I’m just wondering on the international side, Stratton, on the Telco, first just talk a little bit about your plans, if any, in Europe and then just had a follow up question around [inaudible], should we look in general at STPs placement as the catalyst there and do you need to place more STPs in Asia, or do you plan to place more STPs into Asia as we roll out over those next six months or so?
- Stratton Sclavos:
- Yeah, I mean, let’s talk about Asia first. That STP deployment was thought through and evaluated over the course of about 12 months. So putting it where we put it and putting some redundancy in and getting the network connections we have built up there, were really put there so we could handle what we believe to be that northern Asian traffic which would be China, Japan, Korea and then some of the surrounding areas like Singapore. So we’re very comfortable that that STP placement is going to give us the interconnectivity we need to service that market very aggressively. And just to repeat from last quarter, we are the only U.S. provider with connectivity hardware in that region. So it’s giving us a competitive advantage right now and we think we’ll be able to capitalize on that and certainly are starting to see that. As it relates to Europe, I guess I’m less convinced that that opportunity exists. A more mature market clearly in Western Europe and one in which I’m not sure we bring a lot of value add. Eastern Europe could be an opportunity although there’s nothing planned for this year or early next year in terms of hardware deployment. We’ll see how that market goes. I think we’re more opportunistic there around messaging and content than we are around traditional [voice] connectivity. It just so happens that in Asia there are pretty poor providers that have been delivering those services and we’ve been able to pick up contract wins and market share because of it.
- Walter Pritchard:
- How do we just look at, you made about $100 million in the quarter so in the traditional Telco business primarily in the U.S. and I guess some in Latin America, how do we look at the size of the Asian market opportunity versus what you have in the U.S. already?
- Stratton Sclavos:
- I think it’s a great question, Walter. I don’t know how to size it yet. What I want to see is the contracts in China turn up, the certifications happen with SKT and then [Sing Tel] bring on more of its [inaudible]. So I think as we exit this year, we’ll be in a good position to kind of model what’s happening with traffic and therefore give you a better answer to that. I think the good news for us is we’re starting from a zero base so it’s all incremental revenue, right, coming onto the traditional VPS [system.]
- Walter Pritchard:
- Great. Thanks a lot.
- Operator:
- And we’ll move to Morgan, Keegan’s Chris Hovis.
- Christopher Hovis:
- Good evening, guys. A couple of questions. One, how do you see the pending acquisition of RSA by EMC changing the dynamics in the authentication services space?
- Stratton Sclavos:
- Oh, you know, I haven’t given it a whole lot of thought. I mean, I think that, you know, we’re not sure that customers are looking for their storage hardware provider to be their security expert. Time will tell on that. EMC’s a great company. We buy a ton of their product and we’ll continue to do so. I, you know, I guess we’ll see how that works. Meanwhile, I think the market is moving into some new areas that are highly interesting to us and others around consumer authentication, around content authentication and around kind of the new set of services that Vista is going to enable around media and around user experience. So I’m sure EMC has good strategic reasons for doing it. We don’t think it’s going to impact our strategy much.
- Christopher Hovis:
- Okay, and then the second question. Can you give us the latest update on planned domain name price increases?
- Stratton Sclavos:
- Again, until our contract with the Department of Commerce and ICANN are finalized we really can’t make any comments about what we’ll do. Subsequent to that we’ll take into account market conditions, cost of operations and our ability to withstand the new attacks that we’re starting to see on the Internet and we’ll make the appropriate decisions then.
- Christopher Hovis:
- And where do you think we are in the approval process?
- Stratton Sclavos:
- As I said a little bit earlier, I think we’re still a few weeks away.
- Christopher Hovis:
- Okay. Thanks.
- Operator:
- We have a question now from Kevin Buttigieg at A. G. Edwards.
- Kevin Buttigieg:
- Thank you. Earlier this year obviously you stopped providing annual financial guidance, citing the volatility in the Jamba! business and now obviously you’re seeing more consistency to that business this quarter and then in the forecast as well. Why not return to providing annual financial guidance, particularly with the changes that are now occurring in the core communications business.
- Stratton Sclavos:
- Somehow I think you’d like to get two in a row under your belt, right? No more complex than that. I think if we see similar stable performance out of Jamba! here in a summer period, we see the growth in security that we’re expecting and we see that core return to growth in Q4, then I think as we exit this year we’d be likely to give annual guidance for 07.
- Kevin Buttigieg:
- Okay, thank you.
- Operator:
- Next is Matt [Hedberg], RBC.
- Matt Hedberg:
- Actually, my question’s been answered already. Thank you.
- Operator:
- We’ll move on now to Scott Sutherland, Wedbush Morgan.
- Scott Sutherland:
- Thank you, good afternoon. The first question I want to ask about is on the content side. What do you see on the cost of the licensing of the content? Are there any increases or is it more stable out there?
- Dana L. Evans:
- This quarter - we took a little bit of a margin pressure last quarter on that. This quarter is a little bit more stable and we would expect that to continue.
- Stratton Sclavos:
- I think what happens, as we talked about last quarter, is we renegotiate the contract with the various publishers and content owners at various stages and we tend to have to give up some margin when we do it, but we tend to get access to a broader set of their catalog and be able to take it into new uses like full-track music. So I think we’re kind of going to see stabilization there as we have for the rest of this year.
- Scott Sutherland:
- Okay, and on the dot com with the Department of Commerce, I know I discussed that with some of you at the Analyst Day, but is it something that is just a yes or no or possibly the Department of Commerce would come back to you and say, with some adjustments, this will go through?
- Stratton Sclavos:
- Again, I can’t speak for the Department of Commerce. As I said earlier, we’re having very constructive discussions with them. I think people just have to be patient for a few more weeks and see what happens.
- Scott Sutherland:
- Okay, lastly just quickly, Dana, what was the contribution of m Qube in the quarter?
- Dana L. Evans:
- About $6 million.
- Scott Sutherland:
- Okay, thank you.
- Operator:
- We have time for one more question. This is Katherine Egbert at Jefferies.
- Katherine Egbert:
- Hi, thank you. Just a couple of quick ones. As far as GeoTrust goes, have you passed HSR review yet on that?
- Stratton Sclavos:
- We were not required to file HSR on GeoTrust because of the size of their asset base, but we do have a German filing because of property they owned in Germany that has to go through German regulators and that filing’s been made in recent weeks and then updated again in the last few days. So we’re on a wait and see on that filing.
- Katherine Egbert:
- Okay, thanks, and then Dana, you said there was $15 million in tax activity that was a headwind for cash from operations. What is that?
- Dana L. Evans:
- As you know, we had a very large release of a valuation allowance related to tax benefits and it is the balance sheet effect of the taxes payable and deferred tax after the [accounts] that hits the operating cash flow section of the cash flow statement. It’s pretty complicated tax accounting but that occurred in the quarter that drug what we thought would be operating cash flow a little north of $100 million down a bit.
- Katherine Egbert:
- And it’s non recurring?
- Dana L. Evans:
- That’s correct.
- Katherine Egbert:
- Okay, thanks.
- Operator:
- Thanks again for your participation. That will conclude the question-and-answer session. I’d like now to turn things back over to our speakers for closing remarks.
- Stratton Sclavos:
- Thank you, everyone, for your time today. As always we look forward to talking with you and answering any additional questions you have. Thank you and good evening.
- Operator:
- Again, thanks for joining us. That concludes today’s conference call. Have a good day.
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