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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-23593
VERISIGN, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3221585
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1350 Charleston Road, Mountain View, CA 94043-1331
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 961-7500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Shares Outstanding
Class April 30, 2001
----- ------------------
Common stock, $.001 par value 200,871,229
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TABLE OF CONTENTS
Page
----
PART I--FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)...... 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 33
PART II--OTHER INFORMATION
Item 1. Legal Proceedings............................................ 35
Item 6. Exhibits and Reports on Form 8-K............................. 36
Signatures............................................................. 37
2
PART I--FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
As required under Item 1--Condensed Consolidated Financial Statements
(Unaudited) included in this section are as follows:
Financial Statement Description Page
------------------------------- ----
. Condensed Consolidated Balance Sheets
As of March 31, 2001 and December 31, 2000............................. 4
. Condensed Consolidated Statements of Operations
For the Three Months Ended March 31, 2001 and 2000..................... 5
. Condensed Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2001 and 2000..................... 6
. Notes to Condensed Consolidated Financial Statements.................. 7
3
VERISIGN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
March 31, December
2001 31, 2000
----------- -----------
ASSETS
------
Current assets:
Cash and cash equivalents.......................... $ 363,649 $ 460,362
Short-term investments............................. 546,281 565,913
Accounts receivable, net........................... 161,150 128,011
Prepaid expenses and other current assets.......... 29,182 32,146
----------- -----------
Total current assets............................. 1,100,262 1,186,432
Property and equipment, net.......................... 114,736 105,602
Goodwill and other intangible assets, net............ 16,286,314 17,656,641
Long-term investments................................ 333,729 209,145
Deferred income taxes................................ 21,572 --
Other assets, net.................................... 28,708 37,402
----------- -----------
$17,885,321 $19,195,222
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable and accrued liabilities........... $ 204,378 $ 193,952
Accrued merger costs............................... 12,004 18,814
Deferred revenue................................... 435,340 452,713
----------- -----------
Total current liabilities........................ 651,722 665,479
----------- -----------
Long-term deferred revenue........................... 106,349 55,575
Other long-term liabilities.......................... 3,306 3,560
----------- -----------
Total long-term liabilities...................... 109,655 59,135
----------- -----------
Commitments and contingencies
Stockholders' equity:
Preferred stock--par value $.001 per share
Authorized shares: 5,000,000
Issued and outstanding shares: none............... -- --
Common stock--par value $.001 per share
Authorized shares: 1,000,000,000
Issued and outstanding shares: 200,486,576 and
198,639,497 excluding 40,000 shares held in
treasury......................................... 200 199
Additional paid-in capital......................... 21,699,787 21,670,647
Notes receivable from stockholders................. (248) (245)
Unearned compensation.............................. (38,041) (36,365)
Accumulated deficit................................ (4,540,303) (3,162,926)
Accumulated other comprehensive income (loss)...... 2,549 (702)
----------- -----------
Total stockholders' equity....................... 17,123,944 18,470,608
----------- -----------
$17,885,321 $19,195,222
=========== ===========
See accompanying notes to condensed consolidated financial statements
4
VERISIGN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended
March 31,
---------------------
2001 2000
----------- --------
Revenues................................................. $ 213,413 $ 34,071
----------- --------
Costs and expenses:
Cost of revenues....................................... 74,340 12,462
Sales and marketing.................................... 64,451 13,633
Research and development............................... 19,887 4,429
General and administrative............................. 31,166 3,682
Amortization of goodwill and other intangible assets... 1,374,769 61,014
----------- --------
Total costs and expenses............................. 1,564,613 95,220
----------- --------
Operating loss....................................... (1,351,200) (61,149)
Other income:
Interest and investment income (loss).................. (53,200) 35,236
Other income (expense), net............................ 37 (389)
----------- --------
Total other income (loss)............................ (53,163) 34,847
----------- --------
Loss before income taxes and minority interests.......... (1,404,363) (26,302)
Income tax benefit....................................... 27,196 --
----------- --------
Loss before minority interests........................... (1,377,167) (26,302)
Minority interest in net (income) loss of subsidiary..... (210) 147
----------- --------
Net loss............................................. $(1,377,377) $(26,155)
=========== ========
Net loss per share:
Basic and diluted...................................... $ (6.90) $ (.24)
=========== ========
Shares used in per share computation:
Basic and diluted...................................... 199,520 108,847
=========== ========
See accompanying notes to condensed consolidated financial statements
5
VERISIGN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended
March 31,
-----------------------
2001 2000
----------- ----------
Cash flows from operating activities:
Net loss............................................ $(1,377,377) $ (26,155)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization of property and
equipment........................................ 11,821 2,173
Amortization of goodwill and other intangible
assets, net...................................... 1,374,769 61,014
Gain on sale of marketable securities............. -- (32,623)
Write-down of investments......................... 74,690 --
Minority interest in net income of subsidiary..... 210 (147)
Deferred income taxes............................. (27,196) --
Amortization of unearned compensation............. 3,765 25
Loss on disposal of property and equipment........ -- 77
Changes in operating assets and liabilities:
Accounts receivable............................... (32,087) (10,503)
Prepaid expenses and other current assets......... 3,317 (1,796)
Accounts payable and accrued liabilities.......... 8,034 2,198
Deferred revenue.................................. 26,097 8,352
----------- ----------
Net cash provided by operating activities....... 66,043 2,615
----------- ----------
Cash flows from investing activities:
Purchases of short-term investments................. (399,631) (2,000)
Proceeds from maturities and sales of short-term
investments........................................ 415,269 72,913
Purchases of long-term investments.................. (189,845) (72,043)
Proceeds from maturities and sales of long-term
investments........................................ 8,478 34,705
Purchases of property and equipment................. (20,308) (3,330)
Cash acquired in purchase transactions, less amounts
paid............................................... -- 3,378
Transaction costs................................... (6,715) (6,264)
Other assets........................................ 5,579 (339)
----------- ----------
Net cash provided by (used in) investing
activities..................................... (187,173) 27,020
----------- ----------
Cash flows from financing activities:
Collections on notes receivable from stockholders... (3) 45
Net proceeds from issuance of common stock.......... 26,030 8,230
----------- ----------
Net cash provided by financing activities....... 26,027 8,275
----------- ----------
Effect of exchange rate changes on cash............... (1,610) 91
----------- ----------
Net increase (decrease) in cash and cash equivalents.. (96,713) 38,001
Cash and cash equivalents at beginning of period...... 460,362 70,382
----------- ----------
Cash and cash equivalents at end of period............ $ 363,649 $ 108,383
=========== ==========
Supplemental cash flow disclosures:
Noncash investing and financing activities:
Issuance of common stock for business
combinations..................................... $ -- $1,529,741
=========== ==========
Unrealized gain (loss) on investments, net of
tax.............................................. $ 4,861 $ (8,162)
=========== ==========
See accompanying notes to condensed consolidated financial statements
6
VERISIGN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The accompanying interim unaudited condensed consolidated balance sheets,
statements of operations and cash flows reflect all adjustments, consisting of
normal recurring adjustments and other adjustments, that are, in the opinion of
management, necessary for a fair presentation of the financial position of
VeriSign, Inc. and its subsidiaries, (VeriSign or the Company), at March 31,
2001, and the results of operations and cash flows for the interim periods
ended March 31, 2001 and 2000.
The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company in accordance with the instructions for Form 10-Q
pursuant to the rules and regulations of the Securities and Exchange Commission
("SEC") and, therefore, do not include all information and notes normally
provided in audited financial statements and should be read in conjunction with
the financial statements of the Company for the year ended December 31, 2000
included in the annual report previously filed on Form 10-K.
The results of operations for any interim period are not necessarily
indicative, nor comparable to the results of operations for any other interim
period or for a full fiscal year. Prior periods have been reclassified for
comparative purposes.
The carrying amount of cash and cash equivalents, investments, accounts
receivable, and accounts payable approximate their respective fair values.
Note 2. Goodwill and Other Intangible Assets
At March 31, 2001, VeriSign had $16.3 billion of goodwill and other
intangible assets resulting from several acquisitions completed during 2000,
including the acquisition of Network Solutions, Inc. Total consideration for
acquisitions completed in 2000 was approximately $21.3 billion and all of these
acquisitions were accounted for as purchase business combinations. Goodwill and
other intangible assets are being amortized on a straight-line basis over
useful lives of two to four and one-half years.
VeriSign reviews its goodwill and other intangible assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
of these assets may not be recoverable. Such events or circumstances include,
but are not limited to, a significant decrease in the fair value of the
underlying business, a significant decrease in the benefits realized from the
acquired business, or a significant change in the operations of the acquired
business.
Recoverability of goodwill and other intangible assets is measured by
comparison of the carrying amount to future undiscounted net cash flows the
assets are expected to generate. If assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the goodwill and other intangible assets exceeds their fair market
value. To date, results of operations and cash flows from VeriSign's
acquisitions have been consistent with original expectations and no adjustments
to the carrying value of goodwill and other intangible assets have been
required, however, changes in the economy, the business in which the Company
operates and VeriSign's own relative performance could change the assumptions
used to evaluate the recovery of goodwill and other intangible assets. VeriSign
monitors the preceding factors to identify events or circumstances which would
cause the Company to test for impairment and revise its assumptions on the
estimated recovery of goodwill and other intangible assets.
7
VERISIGN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 3. Commitments and Contingencies
Legal Proceedings
The Department of Justice ("DOJ") Antitrust Division issued a Civil
Investigative Demand ("CID"), seeking information and documents concerning the
then pending acquisition by VeriSign of THAWTE. VeriSign has complied with the
information requests of the CID, and has provided additional information to the
DOJ to alleviate their concerns about the potential competitive effects of the
transaction. While management believes that the transaction does not violate
the antitrust laws, it is possible that the DOJ may ultimately raise an
objection. Formal objection could lead to further proceedings or litigation
that could have an adverse material effect on VeriSign, and could include the
licensing or divestiture of assets acquired in the transaction.
VeriSign is engaged in other complaints, lawsuits and investigations arising
in the ordinary course of business. VeriSign believes that it has adequate
legal defenses and that the ultimate outcome of these actions will not have a
material effect on VeriSign's consolidated financial position and results of
operations.
Note 4. Long-term Investments
VeriSign invests in debt and equity securities of technology companies for
business and strategic purposes. These investments are included in long-term
investments. Investments in non-public companies are accounted for under the
cost method. For these non-quoted investments, VeriSign regularly reviews the
assumptions underlying the operating performance and cash flow forecasts in
assessing each investment's carrying value. Investments in public companies are
recorded at fair market value with the associated unrealized gain or loss
included in accumulated other comprehensive income. VeriSign identifies and
records impairment losses on its investments when circumstances indicate that a
decline in the fair value of an investment is other than temporary.
During the first quarter of 2001 the Company had a write-down of investments
totaling $74.7 million on certain public and non-public equity security
investments. As of March 31, 2001 the Company determined that the decline in
value of certain of the Company's public and non-public equity investments was
other than temporary.
Note 5. Comprehensive Loss
Comprehensive loss consists of net loss and other comprehensive loss. The
components of comprehensive loss are as follows:
Three Months Ended
March 31,
---------------------
2001 2000
----------- --------
(In thousands)
Net loss............................................ $(1,377,377) $(26,155)
Change in unrealized gain (loss) on investments, net
of tax............................................. 4,861 (8,162)
Translation adjustments............................. (1,610) 91
----------- --------
Comprehensive loss.................................. $(1,374,126) $(34,226)
=========== ========
Note 6. Calculation of Net Loss per Share
Basic net loss per share is computed using the weighted average number of
common shares outstanding during the period. Diluted net loss per share is
computed using the weighted-average number of common shares
8
VERISIGN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and, when dilutive, common equivalent shares from options to purchase common
stock using the treasury stock method. In the periods where the Company has a
net loss, net loss per share on a diluted basis is equivalent to basic net loss
per share because the effect of converting outstanding stock options would be
anti-dilutive. In addition, options to purchase shares of common stock were not
included in the computation of diluted earnings per share in periods where the
options exercise price was greater than the average market price of the common
shares and therefore, the effect would be anti-dilutive. For the three-month
period ended March 31, 2001 options to purchase 26,182,318 shares of common
stock with a weighted average exercise price of $62.66 per share were
outstanding and for the three-month period ended March 31, 2000 options to
purchase 15,591,397 shares of common stock with a weighted average exercise
price of $20.17 per share were outstanding.
The following table represents the computation of basic and diluted net loss
per share.
Three Months Ended
March 31,
---------------------
2001 2000
----------- --------
(In thousands,
except per share
data)
Basic and diluted net loss per share:
Net loss.......................................... $(1,377,377) $(26,155)
=========== ========
Determination of basic and diluted shares:
Weighted average shares outstanding............... 199,520 109,154
Weighted average shares issued and subject to
repurchase agreements............................ -- (307)
----------- --------
Basic and diluted average common shares
outstanding........................................ 199,520 108,847
=========== ========
Basic and diluted net loss per share................ $ (6.90) $ (.24)
=========== ========
Note 7. Segment Information
Description of segments
Effective January 1, 2001, VeriSign organized its business into two
reportable operating segments, the Mass Markets Division and the Enterprise and
Service Provider Division. The segments were determined based primarily on how
the chief operating decision maker ("CODM") views and evaluates VeriSign's
operations. Other factors, including customer base, homogeneity of products,
technology and delivery channels, were also considered in determining the
reportable segments. The performance of each segment is measured based on
several metrics, including gross margin.
The Mass Markets Division provides domain name registration, digital
certificate and payment services and other value-added services to small and
medium sized companies as well as to individual consumers. The Enterprise and
Service Provider Division provides similar products and services to larger
enterprises and service providers who want to establish and deliver secure
Internet-based services for their customers in both business-to-consumer and
business-to-business environments. The "Other" segment consists primarily of
unallocated corporate expenses.
9
VERISIGN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table reflects the results of VeriSign's reportable segments
under VeriSign's management system. These results are used, in part, by
management, in evaluating the performance of, and in allocating resources to,
each of the segments. Internal revenues and gross margin include transactions
between segments that are intended to reflect an arm's length transfer at the
best price available for comparable external transactions. Prior to the
acquisition of Network Solutions in June of 2000, all of VeriSign's revenues
and expenses were included in the Enterprise and Service Provider Division,
therefore comparisons to the quarter ended March 31, 2000 are not relevant.
Enterprise and
Mass Markets Service Provider Total
Division Division Other Segments
------------ ---------------- ------- --------
(In thousands)
Three months ended March
31, 2001:
External revenues....... $136,677 $ 76,736 $ $213,413
Internal revenues....... -- 32,588 -- 32,588
-------- -------- ------- --------
Total revenues........ $136,677 $109,324 $ -- $246,001
======== ======== ======= ========
Segment gross margin.... $ 95,999 $ 47,181 $(4,107) $139,073
======== ======== ======= ========
Assets are not tracked by segment and the CODM does not evaluate segment
performance based on asset utilization.
Reconciliation to VeriSign, as reported
Three Months Ended
March 31,
---------------------
2001 2000
----------- --------
(In thousands)
Revenues:
Total segments.................................... $ 246,001 $ 34,071
Elimination of internal revenues.................. (32,588) --
----------- --------
Revenues, as reported........................... $ 213,413 $ 34,071
=========== ========
Net loss:
Segment gross margin.............................. $ 139,073 $ 21,609
Operating expenses................................ 1,490,273 82,758
----------- --------
Operating loss.................................... (1,351,200) (61,149)
Other income (loss)............................... (53,163) 34,847
Income tax benefit................................ 27,196 --
Minority interest in net (income) loss of
subsidiary....................................... (210) 147
----------- --------
Net loss, as reported........................... $(1,377,377) $(26,155)
=========== ========
10
VERISIGN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Geographic information
Three Months
Ended March 31,
----------------
2001 2000
-------- -------
(In thousands)
Revenues:
United States............................................. $191,519 $22,902
All other countries....................................... 21,894 11,169
-------- -------
Total................................................... $213,413 $34,071
======== =======
VeriSign operates in the United States, Europe, Japan and South Africa. In
general, revenues are attributed to the country in which the contract
originated. However, revenues from all digital certificates issued from the
Mountain View, California facility and domain names issued from the Herndon,
Virginia facility are attributed to the United States because it is
impracticable to determine the country of origin.
As of March 31,
----------------------
2001 2000
----------- ----------
(In thousands)
Long-lived assets:
United States....................................... $16,349,008 $1,104,514
All other countries................................. 414,479 615,515
----------- ----------
Total............................................. $16,763,487 $1,720,029
=========== ==========
Long-lived assets consist primarily of goodwill and other intangible assets,
property and equipment, long-term investments, and other long-term assets.
Note 8. Income Taxes
As of March 31, 2001, we had federal net operating loss carryforwards of
approximately $375.3 million related to stock compensation expense and $135.0
million related to continuing operations. We also had state net operating loss
carryforwards of approximately $154.8 million related to stock compensation
expense and $67.5 million related to continuing operations. The federal net
operating loss carryforwards will expire in 2010 through 2020 and the state net
operating loss carryforwards will expire in 2004 through 2020. The Tax Reform
Act of 1986 imposes substantial restrictions on the utilization of net
operating losses and tax credits in the event of a corporation's ownership
change, as defined in the Internal Revenue Code. Our ability to utilize net
operating loss carryforwards may be limited as a result of such ownership
change.
We have not applied a valuation allowance against the deferred tax assets
resulting from the tax loss generated in the quarter ended March 31, 2001. For
those deferred tax assets generated through December 31, 2000, we continue to
provide a valuation allowance because of the uncertainty regarding their
realization. Our accounting for deferred taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," involves the
evaluation of a number of factors concerning the realizability of our deferred
tax assets. In concluding that a valuation allowance was required, we
considered such factors as our history of operating losses and expected future
losses and the nature of our deferred tax assets. Although our operating plans
assume taxable and operating income in future periods, our evaluation of all of
the available evidence in assessing the realizability of the deferred tax
assets indicated that such plans were not considered sufficient to overcome the
available negative evidence. The possible future reversal of the valuation
allowance will result in future income statement benefit to the extent the
valuation allowance was applied to deferred tax assets generated through
ongoing operations. To the extent the valuation allowance relates to deferred
tax assets generated through stock compensation deductions, the possible future
reversal of such valuation allowance will result in a credit to additional paid
in capital and will not result in future income statement benefit.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
You should read the following discussion in conjunction with the interim
unaudited condensed consolidated financial statements and related notes.
Except for historical information, this Report contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These forward-looking
statements involve risks and uncertainties, including, among other things,
statements regarding our anticipated costs and expenses and revenue mix.
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 may affect future results of
operations and cause or contribute to such differences include, but are not
limited to, those discussed in the section "Factors That May Affect Future
Results of Operations". You should 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 that we have or will
file in 2001 and our Annual Report on Form 10-K for the period ending December
31, 2000, which was filed on March 28, 2001. 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
publicly release any revisions to the forward-looking statements or reflect
events or circumstances after the date of this document.
Overview
VeriSign is a leading provider of trusted infrastructure services to website
owners, enterprises, electronic commerce service providers and individuals. Our
domain name registration, digital certificate, global registry and payment
services provide the critical web identity, authentication and transaction
infrastructure that online businesses need to establish their web identities
and to conduct secure e-commerce and communications. Our services support
businesses and consumers from the moment they first establish an Internet
presence through the entire lifecycle of e-commerce activities.
Our core authentication service offerings were established as the
cornerstone of the business in 1995 with the introduction of website digital
certificates. Through our secure online infrastructure we sell our website
digital certificates to online businesses, large enterprises, government
agencies and other organizations. We have established strategic relationships
with industry leaders, including British Telecommunications plc, Cisco,
Microsoft, RSA Security and VISA, to enable widespread utilization of our
digital certificate services and to assure interoperability with a wide variety
of applications and network equipment. We also offer VeriSign OnSite, a managed
service that allows an organization to leverage our trusted data processing
infrastructure to develop and deploy customized digital certificate services
for use by employees, customers and business partners.
We market our authentication services worldwide through multiple
distribution channels, including the Internet, direct sales, telesales, value
added resellers, systems integrators and our international affiliates. A
significant portion of our authentication services revenues to date have been
generated through sales from our website, but we intend to continue increasing
our direct sales force, both in the United States and abroad, and to continue
to expand our other distribution channels. We continue to build an
international network of affiliates who provide our trust services under
licensed co-branding relationships using our proprietary technology and
business practices. The VeriSign Trust Network now consists of approximately 37
affiliated organizations including British Telecommunications plc in the United
Kingdom, Canadian Imperial Bank of Commerce of Canada, Certplus of France,
eSign of Australia, HiTrust of Taiwan, Roccade of The Netherlands, and Telia in
Sweden. These international service providers utilize common technology,
operating practices and infrastructure to deliver interoperable trust services
for a specific geographic region or vertical market.
12
We market our payment services worldwide through multiple distribution
channels, including the Internet, direct sales, telesales, value added
resellers, and systems integrators. A significant portion of our payment
services revenues to date has been generated through sales from our website,
but we intend to continue increasing our direct sales force, both in the United
States and abroad, and to continue to expand our other distribution channels.
Our registry business, (now VeriSign Global Registry Service) is the
exclusive registry and the leading registrar for second level domain names
within the .com, .net and .org top-level domains under agreements with ICANN
and the Department of Commerce ("DOC"). Internet domain names are unique
identities that enable businesses, other organizations and individuals to
communicate and conduct commerce on the Internet. As a registry, VeriSign
Global Registry Service maintains the master directory of all second level
domain names in the .com, .net and .org top-level domains. VeriSign Global
Registry Service owns and maintains the shared registration system that allows
all registrars, including our own, to enter new second level domain names into
the master directory and to submit modifications, transfers, re-registrations
and deletions for existing second level domain names.
As a registrar ("Registrar"), our web presence services business markets
second level domain name registration services and other value-added services
that enable our customers to establish their identities on the web. The
Registrar markets its services through a number of distribution channels,
including the Internet, premier partner and business account partner programs,
and strategic alliances. As of March 31, 2001, the Registrar had approximately
15.5 million active domain names in the .com, .net and .org top-level domain.
In December 1992, Network Solutions entered into the Cooperative Agreement
with the National Science Foundation under which Network Solutions was to
provide Internet domain name registration services for five top-level domains:
.com, .net, .org, .edu and .gov. These registration services include the
initial two-year domain name registration and annual re-registration, and
throughout the registration term, maintenance of and unlimited modifications to
individual domain name records and updates to the master file of domain names.
In September 1998, the DOC took over the administration of the Cooperative
Agreement from the National Science Foundation. In October 1998, the
Cooperative Agreement was amended to extend the flexibility period until
September 30, 2000 and to transition to a shared registration system.
On November 10, 1999, Network Solutions, the DOC and ICANN entered into a
series of wide-ranging agreements relating to the domain name system. Under
these agreements, Network Solutions recognized ICANN as the not-for-profit
corporation described in the Cooperative Agreement as amended, became an ICANN-
accredited registrar and agreed to operate the registry in accordance with the
provisions of the registry agreement and the consensus policies established by
ICANN in accordance with the terms of that agreement. Our Registrar will be an
accredited registrar through November 9, 2004 with a right to renew
indefinitely in accordance with the Cooperative Agreement. Our registry charges
registrars $6 per registration per year unless increased to cover increases in
registry costs under circumstances described in the Cooperative Agreement. The
term of the registry agreement extends until November 9, 2003, except in the
event that we effect the legal separation of the ownership of our registry
business from our registrar business by May 31, 2001 as described in the
Cooperative Agreement, then the term will be extended until November 9, 2007.
We recently reached an agreement with ICANN that outlines new terms for the
continuation of our role as both the registry and a registrar for the .com,
.net and .org top-level domains. Under proposed terms for a new agreement, we
would continue to operate the .com registry until at least 2007 and the .net
registry until at least 2006; we would have the ability to continue to operate
both registries beyond these dates under certain conditions as set forth in the
agreements. Additional terms of the agreement would allow us to continue to
operate our registrar business under the .com, .net and .org top-level domains.
The existing structural separation between our registry and registrar
businesses would remain in effect throughout the 2007 term. We would also
continue to operate the .org registry through December 2002 at which point that
registry would return to its status for use by non-profit organizations around
the world. We would ensure an orderly transition of the .org
13
registry and contribute an endowment toward a new non-profit organization that
would operate the .org registry. The proposed agreement is subject to approval
by the DOC. We cannot assure you that the DOC will approve the terms of the
agreement as proposed or at all. Should the agreement terms not be approved, we
will continue under, and comply with, our existing registry agreements.
Results of Operations
We have experienced substantial net losses in the past and we expect to
continue to report losses due to the charges we incur for the amortization of
acquired intangible assets related to our acquisitions. As of March 31, 2001,
we had an accumulated deficit of approximately $4.5 billion, primarily due to
$4.6 billion of goodwill and other intangible asset amortization related to our
acquisitions.
Revenues
The Company recognizes revenue in accordance with SOP 97-2, "Software
Revenue Recognition," as modified by SOP 98-9. SOP 97-2, as modified, generally
requires revenue earned on software arrangements involving multiple elements
such as software products, upgrades, enhancements, post contract customer
support ("PCS"), installation, training, etc. to be allocated to each element
based on the relative fair values of the elements. The fair value of an element
must be based on evidence that is specific to the vendor. If evidence of fair
value does not exist for all elements of a license agreement and PCS is the
only undelivered element, then all revenue for the license arrangement is
recognized ratably over the term of the agreement. If evidence of fair value of
all undelivered elements exists but evidence does not exist for one or more
delivered elements, then revenue is recognized using the residual method. Under
the residual method, the fair value of the undelivered elements is deferred,
and the remaining portion of the arrangement fee is recognized as revenue.
Revenues from authentication services consist of fees for the issuance of
digital certificates, fees for digital certificate service provisioning, fees
for technology and business process licensing to affiliates and fees for
consulting, implementation, training, support and maintenance services. Each of
these sources of revenue has different revenue recognition methods. Revenues
from the sale or renewal of digital certificates are deferred and recognized
ratably over the life of the digital certificate, generally 12 months. Revenues
from the sale of OnSite managed services are deferred and recognized ratably
over the term of the license, generally 12 months.
Revenues from the licensing of digital certificate technology and business
process technology are sold in arrangements involving multiple elements
including PCS, training and other services. PCS can be renewed annually for an
additional fee. The Company uses the PCS renewal rate as evidence of fair value
of PCS. The Company establishes evidence of fair value for training and other
services through the price charged when the same element is sold separately.
Since the Company has established evidence of fair value for all undelivered
elements of these arrangements, revenue is recognized under the residual
method. The fair value of PCS is recognized over the PCS term, training and
other service revenue is recognized when delivered and the remaining portion of
the arrangement fee is recognized after the execution of a license agreement
and the delivery of the product to the customer, provided that there are no
uncertainties surrounding the product acceptance, fees are fixed and
determinable, collectibility is probable, and the Company has no remaining
obligations other than the delivery of PCS.
Revenues from consulting and training services are recognized using the
percentage-of-completion method for fixed-fee development arrangements or as
the services are provided for time-and-materials arrangements.
Revenues from payment services primarily consist of a set-up fee and a
monthly service fee for the transaction processing services. In accordance with
the SEC Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in
Financial Statements," revenues from the set-up fee are deferred and recognized
ratably over the period that the fees are earned. Revenues from the service
fees are recognized ratably over the periods in which the services are
provided. Advance customer deposits received are deferred and allocated ratably
to revenue over the periods the services are provided.
14
Domain name registration revenues consist primarily of registration fees
charged to customers and registrars for domain name registration services.
Revenues from the sale or renewal of domain name registration services are
deferred and recognized ratably over the registration term, generally two
years. Domain name registration revenues consist primarily of registration
fees charged to customers and registrars for domain name registration
services. We defer revenues from the sale or renewal of domain name
registration services and recognize these revenues ratably over the
registration term.
Comparisons of revenues for the quarter ended March 31, 2001 to the quarter
ended March 31, 2000 may not be relevant, as a result of the June 2000
acquisition of Network Solutions, Inc. See our annual report filed on Form 10-
K for the period ending December 31, 2000.
A comparison of revenues for the three-month periods ended March 31, 2001
and 2000 is presented below.
2001 2000 Change
--------- -------- ------
(Dollars in thousands)
First quarter period:
Revenues......................................... $ 213,413 $ 34,071 526%
Revenues increased significantly in the first quarter of 2001 compared to
the first quarter of 2000 primarily due to the acquisition of THAWTE, Signio
and Network Solutions. In addition, we increased sales of our authentication
services, particularly our website digital certificates and VeriSign OnSite
services, expanded our international affiliate network and delivered more
training and consulting services.
During the quarter ended March 31, 2001 the VeriSign website digital
certificate business issued approximately 90,000 new and renewed certificates,
bringing the total installed base to over 305,000 certificates, up 112% from
the first quarter of 2000. The Mass Market installed base (excluding
certificates sold into the Enterprise/Service Provider Divion) grew to
225,000, up 96% over the first quarter of 2000. Additionally, over 200 OnSite
service solutions were sold to enterprises during the first quarter of 2001
bringing the total OnSite service solutions sold to over 1,800, and with the
addition two new service providers in the first quarter of 2001 we now have 37
affiliates in our international network of affiliates, up from 23 in the first
quarter of 2000.
A small portion of our revenue mix is from payment transaction services.
During the quarter ended March 31, 2001, the customer base for these services
had grown 32% over the fourth quarter of 2000 to more than 19,900 online
merchants using VeriSign Payment Services to payment-enable their online
stores and business-to-business commerce activities.
In the first quarter of 2001 approximately 1.0 million new and transferred
.com, .net and .org domain names were registered and over 1.2 million .com,
.net and .org domain names were renewed and extended by the Registrar bringing
the active base of name registrations to 15.5 million at March 31, 2001, an
increase of 57% over the registration base at the end of the first quarter of
2000. The VeriSign Global Registry Service added over 3.1 million domain names
during the first three months of 2001, bringing total unique names to 30.6
million at March 31, 2001, an increase of 120% over the first quarter ended
March 31, 2000.
Revenues from international subsidiaries and affiliates accounted for 10%
of revenues in the first quarter of 2001 and 33% of revenues in the first
quarter of 2000. The percentage decrease in revenues from international
subsidiaries and affiliates from was primarily related to the acquisition of
Network Solutions whose revenue is attributable to the United States.
Costs and Expenses
We accounted for all of our acquisitions in 2000 as purchase business
combinations. Accordingly, the acquired companies' costs and expenses have
been included in our results of operations beginning with their dates of
acquisition. Therefore, comparisons of costs and expenses for the quarter
ended March 31, 2001 to the quarter ended March 31, 2000 may not be relevant,
as the businesses of the combined company were not equivalent.
15
Cost of revenues
Cost of revenues consists primarily of costs related to providing digital
certificate enrollment and issuance services, payment services, domain name
registration services, customer support and training, consulting and
development services and costs of facilities and computer equipment used in
these activities. In addition, with respect to our digital certificate
services, cost of revenues also includes fees paid to third parties to verify
certificate applicants' identities, insurance premiums for our service warranty
plan and errors and omission insurance and the cost of software resold to
customers.
A comparison of cost of revenues for the three-month periods ended March 31,
2001 and 2000 is presented below.
2001 2000 Change
------- ------- ------
(Dollars in thousands)
First quarter period:
Cost of revenues................................. $74,340 $12,462 497%
Percentage of revenues........................... 35% 37%
Growth of revenues was the primary factor in the increase of cost of
revenues in the first quarter of 2001 compared to the first quarter of 2000. We
hired more employees to support the growth of demand for our products and
services during the period and to support the growth of our security consulting
and training activities. We incurred increased expenses for access to third-
party databases, higher support charges for our external disaster recovery
program, increased customer service costs related to our larger customer base
and increased expenses related to the cost of software products resold to
customers as part of network security solution implementations. Our
acquisitions of THAWTE, Signio and Network Solutions have resulted in an
increase in our cost of revenues since their acquisitions in 2000. Future
acquisitions, further expansion into international markets and introductions of
additional products will result in further increases in cost of revenues, due
to additional personnel and related expenses and other factors. We anticipate
that cost of revenues will continue to increase in absolute dollars as a result
of continued growth in all of our lines of business.
Cost of revenues as a percentage of revenues decreased in the first quarter
of 2001 compared to the first quarter of 2000 primarily due to the continued
realization of economies of scale from our technology infrastructure and the
efficiency gains in the certificate enrollment and issuance process. In
addition, revenues derived from our acquisitions have a different cost
structure from our authentication services.
Certain of our services, such as implementation consulting and training,
require greater initial personnel involvement and therefore have higher costs
than other types of services. As a result, we anticipate that cost of revenues
as a percentage of revenues will vary in future periods depending on the mix of
services sold.
Sales and marketing
Sales and marketing expenses consist primarily of costs related to sales,
marketing, and external affair activities. These expenses include salaries,
sales commissions and other personnel-related expenses, travel and related
expenses, costs of computer and communications equipment and support services,
facilities costs, consulting fees and costs of marketing programs, such as
Internet, television, radio and print advertising.
A comparison of sales and marketing expenses for the three-month periods
ended March 31, 2001 and 2000 is presented below.
2001 2000 Change
------- ------- ------
(Dollars in thousands)
First quarter period:
Sales and marketing.............................. $64,451 $13,633 373%
Percentage of revenues........................... 30% 40%
16
The Network Solutions acquisition was the primary reason for the increase in
sales and marketing expenses during the first quarter of 2001 compared to the
first quarter of 2000. The Web Presence Services group continues to incur
expenses promoting the value of the .com, .net and .org web addresses as well
as value-added services including web site design tools and other enhanced
service offerings. The remainder of the increase during the first quarter of
2001 was driven by lead and demand generation activities in our authentication
businesses, expansion of our sales force and an increase in international sales
expenses.
While the absolute dollar spending increased for sales and marketing
expenses, we continue to realize a decline in sales and marketing expenses as a
percentage of revenues. This is primarily due to the increase in recurring
revenues from existing customers, which tend to have lower acquisition costs
and the increase in the productivity of the direct and inside sales forces.
We expect sales and marketing expenses to continue to increase on an
absolute dollar basis in the future, primarily related to an expanded sales
force, expanded marketing and demand generation activities, development and
enhancement of partner and distribution channels and promotional activities for
web presence products and services.
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 and the costs of facilities, computer and
communications equipment and support services used in service and technology
development.
A comparison of research and development expenses for the three-month
periods ended March 31, 2001 and 2000 is presented below.
2001 2000 Change
------- ------ ------
(Dollars in
thousands)
First quarter period:
Research and development........................... $19,887 $4,429 349%
Percentage of revenues............................. 9% 13%
Research and development expenses increased in absolute dollars in the first
quarter of 2001 compared to the first quarter of 2000 primarily due to the
acquisition of Network Solutions. This increase relates to the development and
enhancement of new Registry products related to multilingual domain names and
managed domain name system services. In addition, the increase is due to
continued investment in the design, testing and deployment of, and technical
support for our expanded Internet trust service offerings and technology. The
absolute dollar increase reflects the expansion of our engineering staff and
related costs required to support our continued emphasis on developing new
products and services as well as enhancing existing products and services. The
decrease in research and development expenses as a percentage of revenues in
the first quarter of 2001 compared to the first quarter of 2000 is largely due
to different cost structures related to our acquisitions.
We believe that timely development of new and enhanced authentication
services, transaction services, web presence services and technology are
necessary to maintain our position in the marketplace. Accordingly, we intend
to continue to recruit experienced research and development personnel and to
make other investments in research and development. As a result, we expect
research and development expenses will continue to increase in absolute
dollars. To date, we have expensed all research and development expenditures as
incurred.
General and administrative
General and administrative expenses consist primarily of salaries and other
personnel-related expenses for our executive, administrative, legal, finance
and human resources personnel, facilities and computer and communications
equipment, support services and professional services fees.
17
A comparison of general and administrative expenses for the three-month
periods ended March 31, 2001 and 2000 is presented below.
2001 2000 Change
------- ------ ------
(Dollars in
thousands)
First quarter period:
General and administrative......................... $31,166 $3,682 746%
Percentage of revenues............................. 15% 11%
The increase in general and administrative expenses for the first quarter of
2001 compared to the first quarter of 2000 was primarily related to the
acquisition of Network Solutions in June 2000. Expenses also increased due to
additional staffing levels required to manage and support our expanded
operations, the implementation of additional management information systems,
and the expansion of our corporate headquarters.
We anticipate that general and administrative expenses will continue to
increase on an absolute dollar basis in the future as we expand our
administrative and executive staff, add infrastructure, expand facilities and
assimilate acquired technologies and businesses.
Amortization of goodwill and other intangible assets
The amortization of goodwill and other intangible assets was $1.4 billion in
the first three months of 2001 compared to $61 million the first three months
of 2000. The increase was primarily from our acquisition of Network Solutions
in June 2000. We expect to recognize goodwill and other intangible asset
amortization charges related to these acquisitions of approximately $1.4
billion per quarter until the goodwill and other intangible asset balances from
our acquisitions become fully amortized which we currently anticipate ending in
2004. In addition, in the event we complete future acquisitions, we expect to
incur additional goodwill and other intangible asset amortization charges.
VeriSign reviews its goodwill and other intangible assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
of these assets may not be recoverable. Such events or circumstances include,
but are not limited to, a significant decrease in the fair value of the
underlying business, a significant decrease in the benefits realized from the
acquired business, or a significant change in the operations of the acquired
business. To date, results of operations and cash flows from VeriSign's
acquisitions have been consistent with original expectations and no adjustments
to the carrying value of goodwill and other intangible assets have been
required, however, changes in the economy, the business in which the Company
operates and VeriSign's own relative performance could change the assumptions
used to evaluate the recovery of goodwill and other intangible assets.
Other Income
Other income consists primarily of interest earned on our cash, cash
equivalents and short-term and long-term investments and gains or losses on
sales or write-downs of equity investments, as well as the net effect of
foreign currency transaction gains and losses. Other income also includes
charges for any gains or losses on the disposal of property and equipment and
other miscellaneous expenses.
A comparison of other income for the three-month periods ended March 31,
2001 and 2000 is presented below.
2001 2000 Change
-------- ------- ------
(Dollars in thousands)
First quarter period:
Other income.................................. $(53,163) $34,847 (253)%
Percentage of revenues........................ (25)% 102%
18
The change in other income in the first quarter of 2001 compared to the
first quarter of 2000 was primarily due to a write-down of investments totaling
$74.7 million on certain public and non-public equity security investments
offset by $21.5 million of interest income in the first quarter of 2001
compared to a realized gain of $32.6 million from the sale of shares of Keynote
Systems, Inc., and interest income of $2.6 million in the first quarter of
2000. As of March 31, 2001 we determined that the decline in value of certain
of our public and non-public equity securities investments was other than
temporary. We had previously valued certain of these investments at the then
fair market value as part of the Network Solutions acquisition. Our cash and
investments base increased significantly through the acquisition of Network
Solutions in June 2000, which added over $925 million of cash and investments.
We may from time to time recognize gains or losses from the sales, write-downs
or write-offs of our equity investments.
Deferred Income Taxes
We have recorded a $27.2 million tax benefit for the pretax loss not
attributable to the amortization of goodwill and other intangible assets that
are not deductible for tax purposes.
As of March 31, 2001, we had federal net operating loss carryforwards of
approximately $375.3 million related to stock compensation expense and $135.0
million related to continuing operations. We also had state net operating loss
carryforwards of approximately $154.8 million related to stock compensation
expense and $67.5 million related to continuing operations. The federal net
operating loss carryforwards will expire in 2010 through 2020 and the state net
operating loss carryforwards will expire in 2004 through 2020. The Tax Reform
Act of 1986 imposes substantial restrictions on the utilization of net
operating losses and tax credits in the event of a corporation's ownership
change, as defined in the Internal Revenue Code. Our ability to utilize net
operating loss carryforwards may be limited as a result of such ownership
change.
We have not applied a valuation allowance against the deferred tax assets
resulting from the tax loss generated in the quarter ended March 31, 2001. For
those deferred tax assets generated through December 31, 2000, we continue to
provide a valuation allowance because of the uncertainty regarding their
realization. Our accounting for deferred taxes under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," involves the
evaluation of a number of factors concerning the realizability of our deferred
tax assets. In concluding that a valuation allowance was required, we
considered such factors as our history of operating losses and expected future
losses and the nature of our deferred tax assets. Although our operating plans
assume taxable and operating income in future periods, our evaluation of all of
the available evidence in assessing the realizability of the deferred tax
assets indicated that such plans were not considered sufficient to overcome the
available negative evidence. The possible future reversal of the valuation
allowance will result in future income statement benefit to the extent the
valuation allowance was applied to deferred tax assets generated through
ongoing operations. To the extent the valuation allowance relates to deferred
tax assets generated through stock compensation deductions, the possible future
reversal of such valuation allowance will result in a credit to additional paid
in capital and will not result in future income statement benefit.
Minority Interest in Net (Income) Loss of Subsidiary
Minority interest in the net (income) loss of VeriSign Japan K.K. was $(210)
thousand in the first three months of 2001 and $147 thousand in the first three
months of 2000. The change is primarily due to VeriSign Japan's increased
revenue as compared to the first quarter of 2000. As the VeriSign Japan
business continues to develop and evolve, we expect that the minority interest
in net (income) loss of subsidiary will fluctuate.
Factors That May Affect Future Results of Operations
In addition to other information in this Form 10-Q, the following risk
factors should be carefully considered in evaluating us and our business
because these factors currently have a significant impact or may have a
significant impact on our business, operating results or financial condition.
Actual results could differ materially from those projected in the forward-
looking statements contained in this Form 10-Q as a result of the risk factors
discussed below and elsewhere in this Form 10-Q.
19
We have a limited operating history under our current business structure.
We were incorporated in April 1995, and we began introducing our trusted
infrastructure services in June 1995. In addition, we completed several
acquisitions in 2000. Therefore, we have only a limited operating history on
which to base an evaluation of our consolidated business and prospects. Our
prospects must be considered in light of the risks and uncertainties
encountered by companies in the early stages of development. These risks and
uncertainties are often worse for companies in new and rapidly evolving markets
and for companies integrating many businesses. Our success will depend on many
factors, including, but not limited to, the following:
. the successful integration of the acquired companies;
. the rate and timing of the growth and use of Internet protocol, or IP,
networks for electronic commerce and communications;
. the extent to which digital certificates and domain names are used for
these communications or e-commerce;
. the continued growth in the number of web sites;
. the growth in demand for our payment services;
. the continued evolution of electronic commerce as a viable means of
conducting business;
. the demand for our Internet infrastructure services, digital certificates
and web presence services;
. the competition for any of our services;
. the perceived security of electronic commerce and communications over IP
networks;
. the perceived security of our services, technology, infrastructure and
practices; and
. our continued ability to maintain our current, and enter into additional,
strategic relationships.
To address these risks we must, among other things:
. successfully market our Internet infrastructure services, our digital
certificates and our web presence services to new and existing customers;
. attract, integrate, train, retain and motivate qualified personnel;
. respond to competitive developments;
. successfully introduce new Internet infrastructure services and web
presence services; and
. successfully introduce enhancements to our existing Internet
infrastructure services, digital certificates and web presence services
to address new technologies and standards and changing market conditions.
We cannot be certain that we will successfully address these risks.
Our business depends on the future growth of the Internet and adoption and
continued use of IP networks.
Our future success substantially depends on the continued growth in the use
of the Internet and IP networks. If the use of and interest in the Internet and
IP networks does not continue to grow, our business would be harmed. To date,
many businesses and consumers have been deterred from utilizing the Internet
and IP networks for a number of reasons, including, but not limited to:
. potentially inadequate development of network infrastructure;
. security concerns, particularly for online payments, including the
potential for merchant or user impersonation and fraud or theft of stored
data and information communicated over IP networks;
20
. privacy concerns, including the potential for third parties obtaining
personally identifiable information about users to disclose or sell data
without notice to or the consent of such users;
. other security concerns such as attacks on popular websites by "hackers;"
. inconsistent quality of service;
. lack of availability of cost-effective, high-speed systems and service;
. limited number of local access points for corporate users;
. inability to integrate business applications on IP networks;
. the need to operate with multiple and frequently incompatible products;
. government regulation; and
. a lack of tools to simplify access to and use of IP networks.
The widespread acceptance of the Internet and IP networks will require a
broad acceptance of new methods of conducting business and exchanging
information. Organizations that already have invested substantial resources in
other methods of conducting business may be reluctant to adopt new methods.
Also, individuals with established patterns of purchasing goods and services
and effecting payments may be reluctant to change.
Our near-term success depends, in part, on the growth of the web presence
services business.
We may not be able to sustain the revenue growth we have experienced in
recent periods. In addition, past revenue growth may not be indicative of
future operating results. If we do not successfully maintain our current
position as a leading provider of domain name registration services or develop
or market additional value-added web presence products and services, our
business could be harmed.
Our web presence services will account for a significant portion of our
revenue in at least the near term. Our future success will depend largely on:
. continued new domain name registrations;
. re-registration rates of our customers;
. our ability to maintain our current position as a leading registrar of
domain names;
. the successful development, introduction and market acceptance of new web
presence services that address the demands of Internet users;
. our ability to provide robust domain name registration systems; and
. our ability to provide a superior customer service infrastructure for our
web presence services.
Issues arising from implementing agreements with ICANN and the Department of
Commerce could harm our registration business.
The Department of Commerce has adopted a plan for a phased transition of the
Department of Commerce's responsibilities for the domain name system to ICANN.
We face risks from this transition, including the following:
. ICANN could adopt or promote policies, procedures or programs that are
unfavorable to our role in the registration of domain names or that are
inconsistent with our current or future plans;
. the Department of Commerce or ICANN could terminate our agreements to be
the registry or a registrar in the .com, .net and .org top-level domains
if they find that we are in violation of our agreements with them;
21
. if we do not separate ownership of our registry and registrar by May 31,
2001 in accordance with the registry agreement, the term of the registry
agreement will expire in November 2003 and we may not be chosen as the
successor registry;
. if we divest our registrar business in order to receive an extension of
the registry agreement to November 2007, we may not be able to sustain
the revenue growth we have experienced in recent periods;
. the terms of the registrar accreditation contract could change, as a
result of an ICANN-adopted policy, in a manner that is unfavorable to
us;
. the Department of Commerce's or ICANN's interpretation of provisions of
our agreements with either of them described above could differ from
ours;
. the Department of Commerce could revoke its recognition of ICANN, as a
result of which the Department of Commerce would take the place of ICANN
for purposes of the various agreements described above, and could take
actions that are harmful to us;
. ICANN has approved new top-level domains and we may not be permitted to
act as a registrar with respect to those top-level domains;
. the U.S. Government could refuse to transfer certain responsibilities
for domain name system administration to ICANN due to security,
stability or other reasons, resulting in fragmentation or other
instability in domain name system administration; and
. our registry business could face legal or other challenges resulting
from the activities of registrars.
Challenges to ongoing privatization of Internet administration could harm our
web presence services business.
Risks we face from challenges by third parties, including other domestic and
foreign governmental authorities, to our role in the ongoing privatization of
the Internet include:
. legal, regulatory or other challenges, including challenges to the
agreements governing our relationship with, or to the legal authority
underlying the roles and actions of, the Department of Commerce, ICANN
or us, could be brought;
. Congress has held several hearings in which various issues about the
domain name system and ICANN's practices have been raised and Congress
could take action that is unfavorable to us;
. Congress has issued a Conference Report directing the General Accounting
Office to review the relationship between the Department of Commerce and
ICANN and the adequacy of security arrangements under existing
Department of Commerce cooperative agreements. An adverse report could
cause Congress to take action that is unfavorable to us or the stability
of the domain name system;
. ICANN could fail to maintain its role, potentially resulting in
instability in domain name system administration; and
. some foreign governments and governmental authorities have in the past
disagreed with, and may in the future disagree with, the actions,
policies or programs of ICANN, the U.S. Government and us relating to
the domain name system. These foreign governments or governmental
authorities may take actions or adopt policies or programs that are
harmful to our business.
Our quarterly operating results may fluctuate and our future revenues and
profitability are uncertain.
Our quarterly operating results have varied and may fluctuate significantly
in the future as a result of a variety of factors, many of which are outside
our control. These factors include the following:
. continued market acceptance of our trusted infrastructure services;
. the long sales and implementation cycles for, and potentially large
order sizes of, some of our Internet trust services and the timing and
execution of individual contracts;
22
. volume of domain name registrations through our web presence services
business and our Global Registry Service business;
. customer renewal rates for our Internet infrastructure services and web
presence services;
. competition in the web presence services business from competing
registrars and registries;
. the introduction of additional alternative Internet naming systems;
. the timing of releases of new versions of Internet browsers or other
third-party software products and networking equipment that include our
digital certificate service interface technology;
. the mix of all our offered services sold during a quarter;
. our success in marketing other Internet infrastructure services and web
presence value-added services to our existing customers and to new
customers;
. continued development of our direct and indirect distribution channels,
both in the U.S. and abroad;
. market acceptance of our Internet infrastructure services and new
service offerings or our competitors' products and services;
. a decrease in the level of spending for IT related products and services
by enterprise customers;
. our ability to expand operations;
. our success in assimilating the operations and personnel of any acquired
businesses;
. the amount and timing of expenditures related to expansion of our
operations;
. the impact of price changes in our Internet infrastructure services and
web presence services or our competitors' products and services; and
. general economic conditions and economic conditions specific to IP
network and Internet industries.
In addition, we expect a significant increase in our operating expenses as
we:
. amortize goodwill and other intangible assets from our acquisitions;
. increase our sales and marketing operations and activities; and
. continue to update our systems and infrastructure.
If the increase in our expenses is not accompanied by a corresponding
increase in our revenues, our operating results will suffer, particularly as
revenues from many of our services are recognized ratably over the term of the
service, rather than immediately when the customer pays for them, unlike our
sales and marketing expenditures, which are expensed in full when incurred.
Due to all of the above factors, our quarterly revenues and operating
results are difficult to forecast. Therefore, we believe that period-to-period
comparisons of our operating results will not necessarily be meaningful, and
you should not rely upon them as an indication of future performance. Also,
operating results may fall below our expectations and the expectations of
securities analysts or investors in one or more future quarters. If this were
to occur, the market price of our common stock would likely decline.
We face significant competition.
We anticipate that the market for services that enable trusted and secure
electronic commerce and communications over IP networks will remain intensely
competitive. We compete with larger and smaller companies that provide products
and services that are similar to some aspects of our Internet infrastructure
services. Our competitors may develop new technologies in the future that are
perceived as being more secure, effective or cost efficient than the technology
underlying our trust services. We expect that competition will increase in the
near term, and that our primary long-term competitors may not yet have entered
the market.
23
Increased competition could result in pricing pressures, reduced margins or
the failure of our Internet trust services to achieve or maintain market
acceptance, any of which could harm our business. Several of our current and
potential competitors have longer operating histories and significantly greater
financial, technical, marketing and other resources. As a result, we may not be
able to compete effectively.
In connection with our first round of financing, RSA contributed certain
technology to us and entered into a non-competition agreement with us under
which RSA agreed that it would not compete with our certificate authority
business for a period of five years. This non-competition agreement expired in
April 2000. We believe that, because RSA, which is now a wholly-owned
subsidiary of RSA Security, has already developed expertise in the area of
cryptography, its barriers to entry would be lower than those that would be
encountered by our other potential competitors should RSA choose to enter any
of our markets. If RSA were to enter into the digital certificate market, our
business could be materially harmed.
The agreements among ICANN, the Department of Commerce, us and other
registrars permit flexibility in pricing for and term of registrations. Our
revenues, therefore, could be reduced due to pricing pressures, bundled service
offerings and variable terms resulting from increased competition. Some
registrars and resellers in the .com, .net and .org top-level domains are
already charging lower prices for web presence services in those domains. In
addition, other entities are bundling, and may in the future bundle, domain
name registrations with other products or services at reduced rates or for
free.
Our Internet infrastructure services market is new and evolving.
We target our Internet infrastructure services at the market for trusted and
secure electronic commerce and communications over IP networks. This is a new
and rapidly evolving market that may not continue to grow. Accordingly, the
demand for our Internet infrastructure services is very uncertain. Even if the
market for electronic commerce and communications over IP networks grows, our
Internet infrastructure services may not be widely accepted. The factors that
may affect the level of market acceptance of digital certificates and,
consequently, our Internet infrastructure services include the following:
. market acceptance of products and services based upon authentication
technologies other than those we use;
. public perception of the security of digital certificates and IP
networks;
. the ability of the Internet infrastructure to accommodate increased
levels of usage; and
. government regulations affecting electronic commerce and communications
over IP networks.
Even if digital certificates achieve market acceptance, our Internet
infrastructure services may fail to address the market's requirements
adequately. If digital certificates do not sustain or increase their
acceptance, or if our Internet infrastructure services in particular do not
achieve or sustain market acceptance, our business would be materially harmed.
System interruptions and security breaches could harm our business.
We depend on the uninterrupted operation of our various domain name
registration systems, secure data centers and our other computer and
communications systems. We must protect these systems from loss, damage or
interruption caused by fire, earthquake, power loss, telecommunications failure
or other events beyond our control. Most of our systems are located at, and
most of our customer information is stored in, our facilities in Mountain View,
California and Kawasaki, Japan, both of which are susceptible to earthquakes,
and Herndon, Virginia. Though we have back-up power resources, our California
locations are susceptible to recent electric power shortages. All of our web
presence services systems, including those used in our domain name registry and
registrar business are located at our Herndon, Virginia facilities. Any damage
or failure that causes interruptions in any of these facilities or our other
computer and communications systems could materially harm our business.
24
In addition, our ability to issue digital certificates and register domain
names depends on the efficient operation of the Internet connections from
customers to our secure data centers and our various registration systems as
well as from customers to our registrar and from our registrar and other
registrars to the shared registration system. These connections depend upon
efficient operation of web browsers, Internet service providers and Internet
backbone service providers, all of which have had periodic operational problems
or experienced outages in the past. Any of these problems or outages could
decrease customer satisfaction.
A failure in the operation of our various registration systems, our domain
name zone servers, the domain name root servers or other events could result in
deletion of one or more domain names from the Internet for a period of time. A
failure in the operation of our shared registration system could result in the
inability of one or more other registrars to register and maintain domain names
for a period of time. A failure in the operation or update of the master
database that we maintain could result in deletion of one or more top-level
domains from the Internet and the discontinuation of second-level domain names
in those top-level domains for a period of time. The inability of our registrar
systems, including our back office billing and collections infrastructure, and
telecommunications systems to meet the demands of the increasing number of
domain name registration requests and corresponding customer e-mails and
telephone calls, including speculative, otherwise abusive and repetitive e-mail
domain name registration and modification requests, could result in substantial
degradation in our customer support service and our ability to process, bill
and collect registration requests in a timely manner.
We retain certain confidential customer information in our secure data
centers and various registration systems. It is critical to our business
strategy that our facilities and infrastructure remain secure and are perceived
by the marketplace to be secure. Our domain name registration operations also
depend on our ability to maintain our computer and telecommunications equipment
in effective working order and to reasonably protect our systems against
interruption and potentially on such maintenance and protection by other
registrars in the shared registration system. The root zone servers and top-
level domain name zone servers that we operate are critical hardware to our web
presence operations. Therefore, we may have to expend significant time and
money to maintain or increase the security of our facilities and
infrastructure.
Despite our security measures, our infrastructure may be vulnerable to
physical break-ins, computer viruses, and attacks by hackers or similar
disruptive problems. It is possible that we may have to expend additional
financial and other resources to address such problems. Any physical or
electronic break-ins or other security breaches or compromises of the
information stored at our secure data centers and domain name registration
systems may jeopardize the security of information stored on our premises or in
the computer systems and networks of our customers. In such an event, we could
face significant liability and customers could be reluctant to use our Internet
infrastructure services and web presence services. Such an occurrence could
also result in adverse publicity and therefore adversely affect the market's
perception of the security of electronic commerce and communications over IP
networks as well as of the security or reliability of our services.
We rely on a continuous power supply to conduct our operations, and
California's current energy crisis could disrupt our operations and increase
our expenses.
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall below 1.5%,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout the state. If blackouts interrupt our
power supply, we may be temporarily unable to operate. Any such interruption in
our ability to continue operations could delay the development of our products.
Future interruptions could damage our reputation, harm our ability to retain
existing customers and to obtain new customers, and could result in lost
revenue, any of which could substantially harm our business and results of
operations.
Furthermore, the deregulation of the energy industry instituted in 1996 by
the California government and shortages in wholesale electricity supplies have
caused power prices to increase. If wholesale prices continue to
25
increase, our operating expenses will likely increase, as our headquarters and
many of our employees are based in California.
Acquisitions could harm our business.
We made several significant acquisitions in 2000. We could experience
difficulty in integrating the personnel, products, technologies or operations
of these companies. In addition, assimilating acquired businesses involves a
number of other risks, including, but not limited to:
. the potential disruption of our business;
. the potential impairment of relationships with our employees, customers
and strategic partners;
. the additional expenses associated with the amortization of goodwill and
other intangible assets, which we expect will be an aggregate of
approximately $20 billion and will be amortized on a straight-line basis
generally over two to four years;
. the additional expense associated with a write-off of a portion of
goodwill and other intangible assets due to changes in market condition,
the U.S. and global economy or the economy in the markets in which we
compete or because acquisitions are not providing the benefits expected;
. unanticipated costs or the incurrence of unknown liabilities;
. the need to manage more geographically-dispersed operations, such as our
offices in Virginia, North Carolina, South Africa and in the UK;
. diversion of management's resources from other business concerns;
. the inability to retain the employees of the acquired businesses;
. adverse effects on existing customer relationships of acquired
companies;
. the difficulty of assimilating the operations and personnel of the
acquired businesses;
. our inability to incorporate acquired technologies successfully into our
Internet infrastructure services; and
. the inability to maintain uniform standards, controls, procedures and
policies.
If we are unable to successfully address any of these risks for future
acquisitions, our business could be harmed.
Some of our investments in other companies resulted in losses and may result in
losses in the future.
We have equity and debt investments in a number of companies. In most
instances, these investments are in the form of equity and debt securities of
private companies for which there is no public market. These companies are
typically in the early stage of development and may be expected to incur
substantial losses. Therefore, these companies may never become publicly traded
companies. Even if they do, an active trading market for their securities may
never develop and we may never realize any return on these investments.
Further, if these companies are not successful, we could incur charges related
to write-downs or write-offs of these types of assets. In the first quarter of
2001 we determined that the decline in value of certain of our public and
private equity security investments was other than temporary and we recognized
a loss of $74.7 million related to the decline in value of these investments.
Due to the inherent risk associated with some of our investments, and in light
of current stock market conditions, we may incur future losses on the sales,
write-downs or write-offs of our investments.
26
Technological changes will affect our business.
The emerging nature of the Internet, digital certificate business, the
domain name registration business and payment services business, and their
rapid evolution, requires us continually to improve the performance, features
and reliability of our Internet infrastructure services and web presence
services, particularly in response to competitive offerings. We must also
introduce any new Internet infrastructure services and web presence services,
as quickly as possible. The success of new Internet infrastructure services and
web presence services depends on several factors, including proper new service
definition and timely completion, introduction and market acceptance. We may
not succeed in developing and marketing new Internet infrastructure services
and web presence services that respond to competitive and technological
developments and changing customer needs. This could harm our business.
We must manage our growth and expansion.
Our historical growth has placed, and any further growth is likely to
continue to place, a significant strain on our resources. We have grown from 26
employees at December 31, 1995 to over 2,300 employees at March 31, 2001. In
addition to internal growth, our employee base grew through acquisitions. We
have also opened additional sales offices and have significantly expanded our
operations, both in the U.S. and abroad, during this time period. To be
successful, we will need to implement additional management information
systems, continue the development of our operating, administrative, financial
and accounting systems and controls and maintain close coordination among our
executive, engineering, accounting, finance, marketing, sales and operations
organizations. Any failure to manage growth effectively could harm our
business.
We depend on key personnel.
We depend on the performance of our senior management team and other key
employees. Our success will also depend on our ability to attract, integrate,
train, retain and motivate these individuals and additional highly skilled
technical and sales and marketing personnel, both in the U.S. and abroad. There
is intense competition for these personnel. In addition, our stringent hiring
practices for some of our key personnel, which consist of background checks
into prospective employees' criminal and financial histories, further limit the
number of qualified persons for these positions. We have no employment
agreements with any of our key executives that prevent them from leaving us at
any time. In addition, we do not maintain key person life insurance for any of
our officers or key employees other than our President and Chief Executive
Officer. The loss of the services of any of our senior management team or other
key employees or failure to attract, integrate, train, retain and motivate
additional key employees could harm our business.
We rely on third parties who maintain and control root zone servers and route
Internet communications.
We currently administer and operate only two of the 13 root zone servers.
The others are administered and operated by independent operators on a
volunteer basis. Because of the importance to the functioning of the Internet
of these root zone servers, our registry services business could be harmed if
these volunteer operators fail to maintain such servers properly or abandon
such servers which would place additional capacity on the two root zone servers
we operate.
Further, our registry services business could be harmed if any of these
volunteer operators fails to include or provide accessibility to the data that
it maintains in the root zone servers that it controls. In the event and to the
extent that ICANN is authorized to set policy with regard to an authoritative
root server system, as provided in the registry agreement, it is required to
ensure that the authoritative root will point to the top-level domain zone
servers designated by it. If ICANN does not do this, our business could be
harmed.
Our web presence services also could be harmed if a significant number of
Internet service providers decided not to route Internet communications to or
from domain names registered by it or if a significant number of Internet
service providers decided to provide routing to a set of domain name servers
that did not point to our domain name zone servers.
27
We must establish and maintain strategic and other relationships.
One of our significant business strategies has been to enter into strategic
or other similar collaborative relationships in order to reach a larger
customer base than we could reach through our direct sales and marketing
efforts. Examples of these types of relationships include our arrangements with
Cisco, Microsoft and RSA Security. We may need to enter into additional
relationships to execute our business plan. We may not be able to enter into
additional, or maintain our existing, strategic relationships on commercially
reasonable terms. If we fail to enter into additional relationships, we would
have to devote substantially more resources to the distribution, sale and
marketing of our Internet infrastructure services and web presence services
than we would otherwise. Our success in obtaining results from these
relationships will depend both on the ultimate success of the other parties to
these relationships, particularly in the use and promotion of IP networks for
trusted and secure electronic commerce and communications, and on the ability
of these parties to market our Internet infrastructure services successfully.
Furthermore, our ability to achieve future growth will also depend on our
ability to continue to establish direct seller channels and to develop multiple
distribution channels, particularly with respect to our web presence services
business. To do this we must maintain relationships with Internet access
providers and other third parties. Failure of one or more of our strategic
relationships to result in the development and maintenance of a market for our
Internet infrastructure services or web presence services could harm our
business. Many of our existing relationships do not, and any future
relationships may not, afford us any exclusive marketing or distribution
rights. In addition, the other parties may not view their relationships with us
as significant for their own businesses. Therefore, they could reduce their
commitment to us at any time in the future. These parties could also pursue
alternative technologies or develop alternative products and services either on
their own or in collaboration with others, including our competitors. If we are
unable to maintain our relationships or to enter into additional relationships,
this could harm our business.
Some of our Internet trust services have lengthy sales and implementation
cycles.
We market many of our Internet infrastructure services directly to large
companies and government agencies. The sale and implementation of our services
to these entities typically involves a lengthy education process and a
significant technical evaluation and commitment of capital and other resources.
This process is also subject to the risk of delays associated with customers'
internal budgeting and other procedures for approving large capital
expenditures, deploying new technologies within their networks and testing and
accepting new technologies that affect key operations. As a result, the sales
and implementation cycles associated with certain of our Internet trust
services can be lengthy, potentially lasting from three to six months. Our
quarterly and annual operating results could be materially harmed if orders
forecasted for a specific customer for a particular quarter are not realized.
Our services could have unknown defects.
Services as complex as those we offer or develop frequently contain
undetected defects or errors. Despite testing, defects or errors may occur in
our existing or new services, which could result in loss of or delay in
revenues, loss of market share, failure to achieve market acceptance, diversion
of development resources, injury to our reputation, tort or warranty claims,
increased insurance costs or increased service and warranty costs, any of which
could harm our business. Furthermore, we often provide implementation,
customization, consulting and other technical services in connection with the
implementation and ongoing maintenance of our services, which typically
involves working with sophisticated software, computing and communications
systems. Our failure or inability to meet customer expectations in a timely
manner could also result in loss of or delay in revenues, loss of market share,
failure to achieve market acceptance, injury to our reputation and increased
costs.
28
Public key cryptography technology is subject to risks.
Our Internet infrastructure services depend on public key cryptography
technology. With public key cryptography technology, a user is given a public
key and a private key, both of which are required to perform encryption and
decryption operations. The security afforded by this technology depends on the
integrity of a user's private key and that it is not lost, stolen or otherwise
compromised. The integrity of private keys also depends in part on the
application of specific mathematical principles known as "factoring." This
integrity is predicated on the assumption that the factoring of large numbers
into their prime number components is difficult. Should an easy factoring
method be developed, the security of encryption products utilizing public key
cryptography technology would be reduced or eliminated. Furthermore, any
significant advance in techniques for attacking cryptographic systems could
also render some or all of our existing Internet trust services obsolete or
unmarketable. If improved techniques for attacking cryptographic systems were
ever developed, we would likely have to reissue digital certificates to some or
all of our customers, which could damage our reputation and brand or otherwise
harm our business. In the past there have been public announcements of the
successful attack upon cryptographic keys of certain kinds and lengths and of
the potential misappropriation of private keys and other activation data. This
type of publicity could also hurt the public perception as to the safety of the
public key cryptography technology included in our digital certificates. This
negative public perception could harm our business.
Our international operations are subject to certain risks.
Revenues from international subsidiaries and affiliates accounted for
approximately 10% of our revenues in the first three months of 2001 and
approximately 14% of our revenues in the full year of 2000. We intend to expand
our international operations and international sales and marketing activities.
For example, with our acquisition of THAWTE we have additional operations in
South Africa and with our acquisition of Network Solutions we have additional
operations in Asia and Europe. Expansion into these markets has required and
will continue to require significant management attention and resources. We may
also need to tailor our Internet infrastructure trust services and web presence
services for a particular market and to enter into international distribution
and operating relationships. We have limited experience in localizing our
services and in developing international distribution or operating
relationships. We may not succeed in expanding our services into international
markets. Failure to do so could harm our business. In addition, there are risks
inherent in doing business on an international basis, including, among others:
. competition with foreign companies or other domestic companies entering
the foreign markets we are in;
. regulatory requirements;
. legal uncertainty regarding liability and compliance with foreign laws;
. export and import restrictions on cryptographic technology and products
incorporating that technology;
. tariffs and other trade barriers and restrictions;
. difficulties in staffing and managing foreign operations;
. longer sales and payment cycles;
. problems in collecting accounts receivable;
. currency fluctuations;
. difficulty of authenticating customer information;
. political instability;
. failure of foreign laws to protect our U.S. proprietary rights
adequately;
. more stringent privacy policies in foreign countries;
29
. seasonal reductions in business activity; and
. potentially adverse tax consequences.
We have licensed to our affiliates the VeriSign Processing Center platform,
which is designed to replicate our own secure data centers and allows the
affiliate to offer back-end processing of Internet infrastructure services. The
VeriSign Processing Center platform provides an affiliate with the knowledge
and technology to offer Internet infrastructure services similar to those
offered by us. It is critical to our business strategy that the facilities and
infrastructure used in issuing and marketing digital certificates remain secure
and we are perceived by the marketplace to be secure. Although we provide the
affiliate with training in security and trust practices, network management and
customer service and support, these practices are performed by the affiliate
and are outside of our control. Any failure of an affiliate to maintain the
privacy of confidential customer information could result in negative publicity
and therefore adversely affect the market's perception of the security of our
services as well as the security of electronic commerce and communication over
IP networks generally. For further information, please see "System
interruptions and security breaches could harm our business."
All of our international revenues from sources other than VeriSign Japan,
THAWTE Consulting, VeriSign AB and Domain Names are denominated in U.S.
dollars. If additional portions of our international revenues were to be
denominated in foreign currencies, we could become subject to increased risks
relating to foreign currency exchange rate fluctuations.
Our Internet infrastructure services could be affected by government
regulation.
Exports of software products utilizing encryption technology are generally
restricted by the United States and various non-United States governments.
Although we have obtained approval to export our Global Server digital
certificate service, and none of our other Internet infrastructure services are
currently subject to export controls under United States law, the list of
products and countries for which export approval is required could be revised
in the future to include more digital certificate products and related
services. If we do not obtain required approvals we may not be able to sell
specific Internet infrastructure services in international markets. There are
currently no federal laws or regulations that specifically control certificate
authorities, but a limited number of states have enacted legislation or
regulations with respect to certificate authorities. If the market for digital
certificates grows, the United States federal or state or non-United States
governments may choose to enact further regulations governing certificate
authorities or other providers of digital certificate products and related
services. These regulations or the costs of complying with these regulations
could harm our business.
In July 2000, the Electronic Signatures in Global and National Commerce Act,
or "E-Sign," was passed. E-Sign is intended to render digital signatures
legally equivalent to those signed on paper. The execution of E-Sign could
materially and adversely affect our digital certificates services business. For
example, there may be an increasing demand for digital signatures and
certificates as a result of the new E-Sign law. However, due to competition or
other reasons, our services may not be adopted. If we cannot meet market
expectations or demand for our products and services does not increase, our
business may be materially and adversely affected. Furthermore, a successful
implementation of E-Sign may further encourage competitors to enter the
marketplace because of the possible increase in demand for digital signatures
and certificates. This could effectively lower barriers to entry and
increasingly flood the marketplace with competitors, which could, among other
things, result in price erosion. While we cannot assure you that E-Sign will be
effectively implemented or how this implementation will affect our business, we
must continue to meet the demand and expectations of our customers, and our
failure to do so could materially and adversely harm our business.
We face risks related to intellectual property rights.
Our success depends on our internally developed technologies and other
intellectual property. Despite our precautions, it may be possible for a third
party to copy or otherwise obtain and use our trade secrets or other forms of
our intellectual property without authorization. In addition, it is possible
that others may
30
independently develop substantially equivalent intellectual property. If we do
not effectively protect our intellectual property, our business could suffer.
In the future we may have to resort to litigation to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. This type of
litigation, regardless of its outcome, could result in substantial costs and
diversion of management and technical resources.
We also license third-party technology, such as public key cryptography
technology licensed from RSA and other technology that is used in our products,
to perform key functions. These third-party technology licenses may not
continue to be available to us on commercially reasonable terms or at all. Our
business could suffer if we lost the rights to use these technologies. A third
party could claim that the licensed software infringes a patent or other
proprietary right. Litigation between the licensor and a third party or between
us and a third party could lead to royalty obligations for which we are not
indemnified or for which indemnification is insufficient, or we may not be able
to obtain any additional license on commercially reasonable terms or at all.
The loss of, or our inability to obtain or maintain, any of these technology
licenses could delay the introduction of our Internet infrastructure services
until equivalent technology, if available, is identified, licensed and
integrated. This could harm our business.
From time to time, we have received, and may receive in the future, notice
of claims of infringement of other parties' proprietary rights. Infringement or
other claims could be made against us in the future. Any claims, with or
without merit, could be time-consuming, result in costly litigation and
diversion of technical and management personnel, cause product shipment delays
or require us to develop non-infringing technology or enter into royalty or
licensing agreements. Royalty or licensing agreements, if required, may not be
available on acceptable terms or at all. If a successful claim of product
infringement were made against us and we could not develop non-infringing
technology or license the infringed or similar technology on a timely and cost-
effective basis, our business could be harmed.
In addition, legal standards relating to the validity, enforceability, and
scope of protection of intellectual property rights in Internet-related
businesses are uncertain and still evolving. Because of the growth of the
Internet and Internet-related businesses, patent applications are continuously
and simultaneously being filed in connection with Internet-related technology.
There are a significant number of U.S. and foreign patents and patent
applications in our areas of interest, and we believe that there has been, and
is likely to continue to be, significant litigation in the industry regarding
patent and other intellectual property rights.
We have implemented anti-takeover provisions.
Provisions of our Amended and Restated Certificate of Incorporation and
Bylaws contain provisions that could make it more difficult for a third party
to acquire us without the consent of our board of directors. These provisions
include:
. our stockholders may only take action at a meeting and not by written
consent;
. our board must be given advance notice regarding stockholder-sponsored
proposals for consideration at annual meetings and for stockholder
nominations for the election of directors;
. we have a classified board of directors, with the board being divided
into three classes that serve staggered three-year terms;
. vacancies on our board may be filled until the next annual meeting of
stockholders only by majority vote of the directors then in office; and
. special meetings of our stockholders may only be called by the Chairman
of the Board, the President or by the board, not by our stockholders.
31
While we believe these provisions provide for an opportunity to receive a
higher bid by requiring potential acquirors to negotiate with our board of
directors, these provisions may apply even if the offer may be considered
beneficial by some stockholders.
Liquidity and Capital Resources
March 31, December
2001 31, 2000 Change
----------- ----------- ------
(Dollars in thousands)
Cash, cash equivalents and short-term
investments............................... $ 909,930 $ 1,026,275 (11)%
Working capital............................ $ 448,540 $ 520,953 (14)%
Stockholders' equity....................... $17,123,944 $18,470,608 (7)%
At March 31, 2001, our principal source of liquidity was approximately
$909.9 million of cash, cash equivalents and short-term investments, consisting
principally of commercial paper, medium term notes, corporate bonds and notes,
market auction securities, United States government agency securities and money
market funds. The acquisition of Network Solutions in June 2000 added an
additional $867.3 million of liquidity. In addition, we held $96.6 million of
long-term equity minority investments and $237.1 million of corporate debt
securities at March 31, 2001.
Net cash provided by operating activities was $66.0 million in the first
three months of 2001 compared to $2.6 million in the first three months of
2000. The increase was primarily due to an overall increase in net income after
adjustment for non-cash items such as depreciation and amortization and an
overall increase in our deferred revenue balance in which we receive payment in
advance for many of our products and services. The increase in cash provided by
operating activities was partially offset by increases in accounts receivable
and deferred income taxes.
Net cash used in investing activities was $187.2 million in the first three
months of 2001, primarily as a result of $589.5 million used for purchases of
short and long-term investments and $20.3 million used for purchases of
property and equipment partially offset by proceeds of $423.7 million from
sales and maturities of short and long-term investments. Net cash provided by
investing activities in the first three months of 2000 was $27.0 million and
was primarily the result of a sale of a portion of our investment in Keynote
Systems, Inc., partially offset by costs relating to our acquisitions of Thawte
and Signio and capital expenditures for property and equipment. As of March 31,
2001, we also had commitments under noncancelable operating leases for our
facilities for various terms through 2011.
Net cash provided by financing activities was $26.0 million in first three
months of 2001 and $8.3 million in the first three months of 2000. The primary
source of cash provided by financing activities in both periods was from the
issuance of common stock resulting from stock option exercises.
We believe our existing cash, cash equivalents and short-term investments
and operating cash flows, will be sufficient to meet our working capital and
capital expenditure requirements for at least the next 12 months. However, at
some time, we may need to raise additional funds through public or private
financing, strategic relationships or other arrangements. This additional
funding, if needed, might not be available on terms attractive to us, or at
all. Failure to raise capital when needed could materially harm our business.
If we raise additional funds through the issuance of equity securities, the
percentage of our stock owned by our then-current stockholders will be reduced.
Furthermore, these equity securities might have rights, preferences or
privileges senior to those of our common stock.
32
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate sensitivity
The primary objective of VeriSign's investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we have invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate
later rises, the principal amount of our investment will probably decline in
value. To minimize this risk, we maintain our portfolio of cash equivalents and
short-term investments in a variety of securities, including commercial paper,
medium-term notes, corporate bonds and notes, market auction securities, U.S.
government and agency securities and money market funds. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate. In addition, we generally
invest in relatively short-term securities. As of March 31, 2001, 82% of our
non-strategic investments mature in less than one year.
The following table presents the amounts of our cash equivalents and
investments that are subject to market risk by range of expected maturity and
weighted-average interest rates as of March 31, 2001. This table does not
include money market funds because those funds are not subject to market risk.
Maturing in
------------------------------
Six Months More Estimated
Six Months to than One Fair
or Less One Year Year Total Value
---------- ---------- -------- -------- ---------
(Dollars in thousands)
Included in cash and
cash equivalents....... $153,696 $ -- $ -- $153,696 $153,769
Weighted-average
interest rate.......... 5.69% -- --
Included in short-term
investments............ $459,550 $86,296 $ -- $545,846 $546,513
Weighted-average
interest rate.......... 6.06% 5.28% --
Included in long-term
investments............ $ 25,071 $25,815 $169,228 $220,114 $221,089
Weighted-average
interest rate.......... 6.72% 6.02% 5.47%
Exchange rate risk
VeriSign considers its exposure to foreign currency exchange rate
fluctuations to be minimal. All revenues derived from affiliates other than
VeriSign Japan, THAWTE Consulting, VeriSign AB and Domain Names are denominated
in United States Dollars and, therefore, are not subject to exchange rate
fluctuations.
Both the revenues and expenses of our majority-owned subsidiary in Japan as
well as our wholly owned subsidiaries in South Africa, Sweden and the United
Kingdom are denominated in local currencies. In these regions, we believe this
serves as a natural hedge against exchange rate fluctuations because although
an unfavorable change in the exchange rate of the foreign currency against the
United States Dollar will result in lower revenues when translated to United
States Dollars, operating expenses will also be lower in these circumstances.
Because of our minimal exposure to foreign currencies, we have not engaged in
any hedging activities, although if future events or changes in circumstances
indicate that hedging activities would be beneficial, we may consider such
activities.
Equity price risk
We own shares of common stock of several public companies. We value these
investments using the closing market value for the last day of each month.
These investments are subject to market price volatility. We reflect these
investments on our balance sheet at their market value, with the unrealized
gains and losses excluded from earnings and reported in the "Accumulated other
comprehensive income" component of
33
stockholders' equity. We have also invested in equity instruments of several
privately held companies, many of which can still be considered in the startup
or development stages, and therefore, carry a high level of risk. In the first
quarter of 2001 we determined the decline in value of certain public and non-
public equity investments was other than temporary and the Company recognized a
$74.7 million realized loss. Due to the inherent risk associated with some of
our investments, and in light of current stock market conditions, we may incur
future losses on the sales, write-downs or write-offs of our investments.
Currently we do not hedge against equity price changes.
Intangible Asset Risk
We have a substantial amount of intangible assets. Although at March 31,
2001 we believe our intangible assets are recoverable, changes in the economy,
the business in which we operate and our own relative performance could change
the assumptions used to evaluate intangible asset recoverability. We continue
to monitor those assumptions and their consequent effect on the estimated
recoverability of our intangible assets.
34
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As of April 27, 2001, through our Network Solutions subsidiary, we were a
defendant in seventeen active lawsuits involving domain name disputes between
trademark owners and domain name holders. We are drawn into such disputes, in
part, as a result of claims by trademark owners that we are legally required,
upon request by a trademark owner, to terminate the contractual right we
granted to a domain name holder to register a domain name which is alleged to
be similar to the trademark in question. On October 25, 1999, however, the
Ninth Circuit Court of Appeals ruled in our favor and against Lockheed
Corporation, holding that our services do not make us liable for contributory
infringement to trademark owners. Since that time, the frequency of this type
of suit has continued to decline. The holders of the domain name registrations
in dispute have, in turn, questioned our right, absent a court order, to take
any action that affects their contractual rights to the domain names in
question. Although 85 of these kinds of situations over the past six and a half
years have resulted in suits actually naming Network Solutions as a defendant,
as of April 27, 2001, no adverse judgment has been rendered and no award of
damages has ever been made, and no suits are currently pending against Network
Solutions. We believe that we have meritorious defenses and we intend to
vigorously defend ourselves against these claims.
On February 2, 2001, Leon Stambler filed a complaint against us alleging
patent infringement in the United States District Court for the District of
Delaware. The other co-defendants in the suit are RSA Security Inc., First Data
Corporation, Openwave Systems Inc., and Omnisky Corporation. The complaint
alleges that our Secure Site service infringes claim 12 of Mr. Stambler's U.S.
Patent No. 5,793,302 and that our Payflow products infringe claims 1, 28, and
34 of Mr. Stambler's U.S. Patent No. 5,974,148. The complaint seeks judgment
declaring that the defendants have infringed the asserted claims of the
patents-in-suit, preliminary and permanent injunctions against the defendants
from infringing the asserted claims, an order requiring the defendants to pay
damages to compensate Mr. Stambler for the alleged infringement, and an order
awarding Mr. Stambler treble damages for any willful infringement as well as
attorney fees and costs. All of the defendants filed their answers to the
complaint on March 28, 2001. While we cannot predict the outcome of this matter
presently, we believe that the claims against us are without merit and we
intend to vigorously defend ourselves against these claims.
On June 15, 2000, plaintiff David Moran filed a putative shareholder
derivative complaint on behalf of himself and others similarly situated against
Charles Stuckey, Jr., James Bidzos, Richard L. Earnest, Dr. Taher Elgamal,
James K. Sims, Joseph B. Lassiter III, Robert P. Badavas, and against us as a
nominal defendant. The case is captioned Moran v. Stuckey, et.al., No. 1810 NC
(Del. Ch. 2000). The complaint alleges, among other things, that the directors
of RSA Security mismanaged RSA's business, failed to protect its intellectual
property or enforce the terms of its license agreement with us, and that we
violated the terms of the licensing agreement and competed against RSA. On
August 2, 2000, a second shareholder complaint was filed against us and the
aforementioned directors of RSA Security, Inc. by plaintiff James V. Biglan.
That case is captioned Biglan v. Stuckey, et al. Civ. Action No. 18190NC (Del.
Ch. 2000). On September 25, 2000 the Court ordered the cases consolidated under
the Moran caption and named lead counsel for plaintiffs in this matter. We
filed a Motion to Dismiss on November 20, 2000. While we cannot ascertain the
outcome of this matter presently, we currently believe that the claims against
us are without merit and we intend to vigorously defend ourselves against these
claims.
On March 15, 2000, a group of eight plaintiffs filed suit against the U.S.
Department of Commerce, the National Science Foundation and us in the United
States District Court for the Northern District of California. The case,
entitled William Hoefer et al. v. U.S. Department of Commerce, et al., Civil
Action No. 000918-VRW, challenges the lawfulness of the registration fees that
we were authorized to charge for domain name registrations from September 1995
to November 1999. The suit purports to be brought on behalf of all domain name
registrants who paid registration fees during that period and seeks
approximately $1.7 billion in damages. On June 19, 2000, the plaintiffs filed
their first amended complaint, adding two additional plaintiffs.
35
All of the defendants filed motions to transfer the suit to Federal District
Court in the District of Columbia and the court granted those motions on June
28, 2000. The same attorney who unsuccessfully challenged us in a similar
action, known as Thomas, et al. v. Network Solutions, et al., has filed this
new action on behalf of eight former and current domain name registrants. The
suit contains eight causes of action against the defendants based on alleged
violations of Art. I, (S) 8 and the Fifth Amendment of the U.S. Constitution,
the Independent Offices Appropriations Act (31 U.S.C. (S) 9701), the
Administrative Procedures Act, the Sherman Act, and the California Unfair
Competition Act, (S) 17200. The case was docketed with the Federal District
Court in the District of Columbia on July 28, 2000 and on August 4, 2000 the
plaintiffs dismissed the case. Four days later, the same attorney refiled the
same case in the United States District Court for the Eastern District of
Virginia. We filed a motion to dismiss the case and the plaintiffs responded by
filing a First Amended Complaint on September 7, 2000. The current suit
contains fourteen causes of action alleging violations of the Appropriations
Act (31 U.S.C. 9701), the Administrative Procedures Act, the Sherman Act, and
the Chief Financial Officer's Act (31 U.S.C. 902). On October 10, 2000, we
filed another motion to dismiss the case. On October 24, 2000, the National
Science Foundation filed a motion to transfer the case back to the Federal
District Court in the District of Columbia. A hearing on the motion to transfer
the case back to the Federal District Court for the District of Columbia was
held on November 17, 2000. The Court ruled from the bench that the case should
be transferred back to the District of Columbia. Our pending motion to dismiss
the complaint also was transferred under the Order. No judge has been appointed
to the matter, and no hearing date has yet been set on our motion to dismiss.
On January 13, 2000, the Department of Justice Antitrust Division issued a
Civil Investigative Demand, or "CID," seeking information and documents
concerning the then-pending acquisition by us of THAWTE. We provided certain
information and documents to the Department of Justice, and closed the THAWTE
transaction on February 1, 2000. We completed our initial response to the CID
on March 1, 2000, and a supplemental production of documents was completed May
9, 2000. On September 14, 2000, we were notified that senior officials at the
Department of Justice had reviewed a report by the investigatory staff
regarding the transaction, and that the Department had concerns about the
potential competitive effects of the transaction. Our representatives met with
and provided additional information to the Department of Justice during October
2000. While we believe that the transaction does not violate the antitrust
laws, it is possible that the Department may ultimately raise an objection.
Formal objection could lead to further proceedings or litigation that could
have an adverse material effect on us, and could include the licensing or
divestiture of assets acquired in the transaction.
We are involved in various other investigations, claims and lawsuits arising
in the normal conduct of our business, none of which, in our opinion will harm
our business. We cannot assure that we will prevail in any litigation.
Regardless of the outcome, any litigation may require us to incur significant
litigation expense and may result in significant diversion of management
attention. An unfavorable outcome may have a material adverse effect on our
financial position or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended March 31, 2001.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VERISIGN, INC.
/s/ Stratton D. Sclavos
Date: May 11, 2001 By: _________________________________
Stratton D. Sclavos
President and Chief Executive
Officer
(Principal Executive Officer)
/s/ Dana L. Evan
Date: May 11, 2001 By: _________________________________
Dana L. Evan
Executive Vice President of Finance
and Administration and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
37