The Starting Line: VeriSign CEO challenges growth skeptics

This has been a lousy year for most technology companies, but it's been good for VeriSign.

Now a few analysts wonder if things will stay strong for the domain name registrar and provider of systems for online ID verification and payment authentication.

Over the past several quarters, dot-coms wilted as the stock market collapsed, communications companies floundered in a bandwidth glut, computer vendors and chipmakers sagged helplessly before a maturing PC market, and the equipment suppliers for all those segments watched unhappily as the U.S. economy swirled closer to recession. Meanwhile, VeriSign CEO Stratton Sclavos will remind anyone who listens that his company hasn't disappointed yet.

His company has chugged along steadily, never wavering from financial targets set back in January. Last week seemed to deliver another solid report: VeriSign reported third-quarter earnings that topped First Call's consensus estimate by a penny per share, and it told analysts to raise their fourth-quarter earnings forecasts slightly.

But some Wall Street observers believe the company's full-speed-ahead performance could hit a bump soon. Just before VeriSign reported third-quarter earnings, Salomon Smith Barney put a "neutral" rating on VeriSign stock. Bear Stearns did the same the day after VeriSign's quarterly report. Both brokerages cited worries about slowing growth in VeriSign's core businesses, registering domain names and installing systems for digital certificates.

Their fears aren't baseless. The company's registrations of .com and .net names has slowed this year; its deferred revenue grew just 2.6 percent in the third quarter, less than originally expected. VeriSign's delays in launching new domains such as .biz and .info haven't helped, but the company argues the registration slump is temporary.

Investors trembled further after VeriSign late Thursday filed notice of a plan to sell up to $750 million of new shares, which would dilute the holdings of stockholders.

The nervousness had an impact on the stock price. VeriSign lost more than a fifth of its market value Friday, yet Sclavos disputes any suggestion of cracks in his company's armor.

Despite analyst skepticism, VeriSign last week predicted 2002 revenue of $1.35 billion to $1.45 billion, or growth of up to 47 percent, in line with previous forecasts. And VeriSign told analysts to stick with their estimates for next year's operating profit.

Sclavos spoke to CNET News.com after his company's conference call with analysts.

Q: Your bottom-line guidance is staying the same for next year, largely because you expect your operating margins to grow a bit. How are you doing that?
A: The company is relatively unique, right? We own an infrastructure that delivers a set of trust services to pretty much everybody on the Internet today. And so, in that respect...the more (sales) volume we grow (in the Internet) infrastructure (business), the more operating (margin) leverage we get. And that has been true all year long, as you've seen, and we believe it will be true again next year.

More customers drive higher operating margins off of the infrastructure (business), and that's how we'll do it.

So basically it's more a function of increasing business faster than costs increase, as opposed to cutting expenses?

That's right.

There have been some questions raised about the gap between your long-term and short-term deferred revenue growth. I was wondering if you could explain why long-term deferred revenue seems to be growing a bit faster.
Deferred revenue is generated because we sell a certain number of our services on a yearly subscription or a two-year subscription. Anything that's sold for a 12-month subscription goes into short-term deferred; anything that has 13 months or more, that component goes into long-term (deferred).

This year, what we've actually been doing is selling two-year renewals for domain names and for many of our other services, and so that is fueling growth in the long-term deferred.

In the short-term deferred, you're coming off of last year when many people were buying one-year names, and now you're replacing them. So in essence, it's not growing because you're just simply replacing last year's. Whereas the long term is new, because last year you weren't selling the two-year subscriptions, and now you are. So on a comparable basis, it (long-term deferred revenue) seems to be growing faster.

So next year, short-term deferred revenue should suddenly start to grow faster as these two-year contracts become one-year contracts?

Well, in fact, what happens is, as something moves from 13 months to 12 months, it jumps from long-term to short-term, so it ends up being a fairly linear movement. But you're right, short-term will start to grow again, as it did, in fact, this quarter.

There are some observers, some analysts out there, who believe that domain name registration is slowing, especially for the traditional .com and .net names. How much do these new extensions offset that?
A couple of things, I'd say. First of all, people have to remember that we went from nine million names in January of 2000 to 28 million names in December of 2000. So in essence, you grew 217 percent in a single year.

This year, what you're seeing is, basically, the absorption of all of that into the system: Speculators turning names back in, free names that were given out not being renewed, and a variety of (other) things. So I think this is really a reset year on the domain name side. But again, I point out, that's because the year before it grew outrageously.

As we head into 2002, we actually believe .com and .net will begin to grow again, and in fact, we're starting to see that in our current daily registrations. We did about 2.6 million new registrations for .com and .net in the third quarter; we expect to do that again here in the fourth quarter, if not a little bit better. That's one side--that .com and .net are kind of through their cycle here and look to grow again in '02.

.biz and .info, we think, represent opportunities equivalent to about 15 percent of what .com is. So .com and .net represent about 30 million (units), so you could say 4.5 million units available in .biz, and 4.5 million units available in .info.

We expect that will offset...or contribute certainly new revenues to us, because we'll be a provider of those as well.

The other side of your business includes the public key infrastructure (PKI), and you said during the conference call that a lot of your PKI demand seems to be fueled by traditional retailers and commerce guys going online. Can you give us some figures, some color maybe, to quantify that?
We have close to 4,000 enterprise customers now. That is up from, to be quite honest, I think somewhere below 2,000 at the beginning of the year. So it's more than doubled this year.

And then from the merchant side, we've gone from about...20,000 in the first quarter to now 56,000. It's not (growth from) new dot-coms; it is the traditional Fortune 500, Fortune 1000, or traditional merchants in the physical world now creating a Web presence and needing our services to help them secure it or help them process payments.

How much of that market is penetrated?
Our estimate is about 5 percent, and I think that's a reasonable number.

You're about to buy Illuminet Holdings. Once you do that, what other areas of your business do you think would still need to be beefed up?
We like the businesses we're in. With Illuminet, we've moved into a fourth area: voice. That's going to be a very significant growth driver, a very significant strategic acquisition for the company.

I don't think you're going to find us branching into another new area, as much as (you'd find us) potentially filling in areas in the existing four engines--as we call them--of naming, authentication, payments and now voice.

So you don't see another major acquisition anytime soon?
Certainly not outside of the main areas we're in.

No more Network Solutions or Illuminets or anything like that?
You never say never, but there's nothing like that on the horizon.

Obviously there are more domain name service competitors popping up because of regulation on the domain registration area, and as more rivals pop up, some investors might be thinking: "These guys get some of their business because they hook people through registration, and as they lose at least a bit of that domain business, that might ripple through the rest of their business."
Less than 5 percent of our security services come as a direct result of the domain name registration. The rest of that was the traditional VeriSign business we started in, and we continue to drive new demand there outside of the domain name registration process. We like being able to do the one-stop shop, but traditionally most of that (security) business comes directly to us.

How accurate is the characterization that VeriSign's goal is to become a dominant Switzerland-like infrastructure provider that all the online ID services will use?
The way I'd answer that is that, we do believe we have a unique business proposition. We provide digital trust services across the spectrum of naming, authentication and payment. And frankly, when you boil down commerce and communication to their base elements, identity, authentication and payment are three components that everybody needs.

So in essence, we do look to provide those services to customers of the Microsoft .Net initiative, customers of the Sun Liberty Alliance, and other Web services/environments as they come up. We think we are in a position to be the underlying foundation for much of that.