Form 10-Q for the quarterly period ended September 30, 2006
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


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 September 30, 2006

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

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

487 East Middlefield Road, Mountain View, CA   94043
(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  ¨    NO  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x            Accelerated filer  ¨            Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

 

Shares Outstanding June 30, 2007

Common stock, $.001 par value   243,838,287

 



Table of Contents

TABLE OF CONTENTS

 

          Page

Explanatory Note

   3
PART I—FINANCIAL INFORMATION   

Item 1.

  

Condensed Consolidated Financial Statements (Unaudited)

   14

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   63

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   78

Item 4.

  

Controls and Procedures

   80
PART II—OTHER INFORMATION   

Item 1.

  

Legal Proceedings

   82

Item 1A.

  

Risk Factors

   87

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   106

Item 6.

  

Exhibits

   106

Signatures

   107

Certifications

  

 

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Explanatory Note

In this Form 10-Q, we are restating our condensed consolidated balance sheet as of December 31, 2005, the related consolidated statements of income for the three and nine months ended September 30, 2005, and condensed consolidated statements of cash flows for the nine months ended September 30, 2005. In our Form 10-K for the year ended December 31, 2006 to be filed with the SEC (the “2006 Form 10-K”), we are restating our consolidated balance sheet as of December 31, 2005 and the related consolidated statements of income, stockholders’ equity, comprehensive income and cash flows for the years ended December 31, 2005 and 2004, and the related quarters for 2005.

This Form 10-Q also reflects the restatement of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 for the three and nine months ended September 30, 2005. The decision to restate was based on the results of an independent review (the “Review”) into our historical stock option granting practices that was conducted under the direction of an ad hoc group of our independent directors who had not served on our Compensation Committee before 2005 (“Ad Hoc Group”).

Previously filed annual reports on Form 10-K and quarterly reports on Form 10-Q affected by the restatements have not been amended and should not be relied upon.

We first learned of the potential issues associated with our past stock option grants from a May 16, 2006 article published by the Center for Financial Research and Analysis (“CFRA”) in which we were referenced as one of 15 public companies with one or two stock grants between 1997 and 2002 that the CFRA suggested were timed at, or close to, 40-day lows in the applicable company’s stock price or preceding a material change in stock price. Promptly after learning of the CFRA article, and prior to receiving the grand jury subpoena or the informal SEC request described below, the Ad Hoc Group, with the assistance of independent outside counsel, Cleary Gottlieb Steen & Hamilton LLP (“Cleary Gottlieb”), began reviewing the facts and circumstances of the timing of our historical stock option grants for the period January 1998 to May 2006 (“relevant period”). We believe that the analysis was properly limited to the relevant period. In addition to Cleary Gottlieb, the Ad Hoc Group was assisted in its Review by independent forensic accountants (collectively the “Review Team”).

On June 27, 2006, we announced that we had received a grand jury subpoena from the U.S. Attorney for the Northern District of California requesting documents relating to our stock option grants and practices dating back to January 1, 1995, and had received an informal request for information from the Securities and Exchange Commission (“SEC”) related to our stock option grants and practices. On February 9, 2007, we subsequently received a formal order of investigation from the SEC. We are fully cooperating with the U.S. Attorney’s investigation and the SEC investigation.

On November 21, 2006, we announced that the Ad Hoc Group had determined the need to restate our historical financial statements to record additional non-cash, stock-based compensation expense related to past stock option grants.

On March 30, 2007, we requested guidance from the Office of the Chief Accountant of the SEC (the “OCA”) concerning certain accounting issues relating to the restatement of our historical financials and the Review. On June 25, 2007, we concluded our discussions with the OCA regarding these accounting issues.

On May 29, 2007, we announced that Stratton Sclavos, our then-current Chairman and Chief Executive Officer, had resigned from his position with us. Following Mr. Sclavos’ resignation, the Board elected director William A. Roper, Jr. as our President and CEO and Edward Mueller as our Chairman of the Board of Directors.

On July 10, 2007, Ms. Dana L. Evan our then-current Executive Vice President of Finance and Administration and Chief Financial Officer resigned from the Company.

 

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On July 5, 2007 and July 12, 2007, the Board of Directors appointed Albert E. Clement as the Chief Accounting Officer and Executive Vice President, Finance and Chief Financial Officer, respectively, of the Company.

The Review Team tested grants made on 239 dates, incurred 21,800 person-hours, searched more than 11 million pages of physical and electronic documents and conducted 75 interviews of 33 current and former directors, officers, employees, and advisors. We announced on January 31, 2007 that the Ad Hoc Group’s Review was substantially completed and that, based on a review of the totality of evidence and the applicable law, the Review did not find intentional wrongdoing by any current member of the senior management team or the former CEO. The Ad Hoc Group’s Review concluded that we failed to implement appropriate processes and controls for granting, accounting for, and reporting stock option grants and that corporate records in certain circumstances were incomplete or inaccurate.

The Review Team examined all grants to Section 16 officers and directors during the relevant period, as well as 7 annual performance grants to rank and file employees and 179 acquisition, new hire and promotion, and other grants to rank and file employees on 239 dates from January 1998 through January 2006.

The Review Team identified 8,164 stock option grants made on 41 dates during the relevant period for which measurement dates were incorrectly determined. The measurement dates required revision because the stated date either preceded or was subsequent to the proper measurement date and the stock price on the stated date was generally lower than the price on the proper measurement date. In several instances, the Review Team also determined that the stock price assigned on the initial grant dates was subsequently modified, without being given the required accounting and disclosure treatment.

As part of the restatement, the grants during the relevant period were organized into categories based on grant type and process by which the grant was finalized. The evidence related to each category of grant was analyzed including, but not limited to, electronic and physical documents, document metadata, and witness interviews. Based on the relevant facts and circumstances, and consistent with the accounting literature and recent guidance from the SEC, the controlling accounting standards were applied to determine, for every grant within each category, the proper measurement date. If the measurement date was not the originally assigned grant date, accounting adjustments were made as required, resulting in stock-based compensation expense and related income tax effects.

Measurement Date Hierarchy

We have adopted the following framework for determining the measurement dates of our stock option grants and have applied this framework to each grant based on the facts, circumstances and availability of documentation.

 

   

We reviewed the date of the minutes of the Board of Directors or Compensation Committee meetings for grants made at such meetings when the number of options and exercise price for each recipient had been clearly approved. Where the Review Team determined that the meeting date was not the measurement date, the Review Team determined the actual date of approval of the grant via other documentary evidence and interviews.

 

   

When a grant was approved by unanimous written consent (“UWC”), the measurement date was the date of the Compensation Committee’s approval of the UWC as established by available evidence, such as receipt of signature pages of the UWC, contemporaneous telephone and/or e-mail communications.

 

   

If a grant was approved by the CEO under authority delegated by the Compensation Committee, the measurement date was the date on which the CEO communicated approval to the Human Resources Department, the Compensation Committee or the respective employees indicating final approval of both the number of options and exercise price.

 

   

If a grant was approved by the CEO based on the mistaken belief that he had delegated authority to do so (de facto or “substantive” authority), the measurement date was the date on which the CEO

 

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communicated approval to either the Human Resources Department, the Compensation Committee or the respective employees indicating final approval of both the number of options and exercise price.

 

   

In the event the date on which the CEO communicated approval was not evident from the approval forms, the measurement date was the date on which other available evidence, such as the surrounding e-mail communications, established the date the CEO approved the grant.

 

   

In the event the date of CEO approval could not be established by reviewing other available evidence, such as e-mails, the measurement date was the date on which the number of options and exercise price were entered into our option tracking database (Equity Edge).

 

   

Except for grants to Section 16 officers which require Compensation Committee approval, for new hire grants and promotion grants , prior to March 13, 1998, the measurement date was the date the Compensation Committee approved the grant (as described above). For new hire grants and promotion grants after March 13, 1998 and prior to September 2000 and after September 30, 2002, the measurement date was the 15th day or the last day of the month (or the prior business day if that day was not a business day) following the actual and documented start date or promotion date of the respective employee receiving the grant. New hire grants and promotion grants made in the period September 1, 2000 through September 30, 2002 required CEO approval. For new hire grants and promotion grants in the period September 1, 2000 through September 30, 2002, the measurement date was the date on which the CEO communicated approval to either the Human Resources Department, the Compensation Committee or the respective employees indicating final approval of both the number of options and exercise price. If that date could not be determined, the measurement date was based on the date on which the number of options and exercise price were entered into Equity Edge.

After determining the measurement date through the steps in the above Measurement Date Hierarchy, we then determined if there were any changes to the individual recipients, exercise prices or amount of shares granted after such measurement date. If there were no changes following such measurement date, then that date would be used. If we identified changes following such measurement date, then we would evaluate whether the changes should delay the measurement date for the entire list of grants on that date, result in a repricing, or result in separate accounting for specific grants.

Director Grants

Required Granting Actions: Grants to directors under the 1998 Director Plan (the “Director Plan”) were automatic and non-discretionary; the Director Plan did not require the CEO, the Board or the Compensation Committee to review or approve director grants. Each new director received an initial grant of a specified number of options on the date of his or her appointment and annually on the anniversary of the initial grant to be priced on the appointment or anniversary date, respectively. Directors serving before the Director Plan was adopted received an annual grant on the anniversary of their previous grant.

Method for Determining Proper Measurement Dates: For the initial grant, the measurement date was the date the director was appointed to the Board, as reflected in Board minutes. In the absence of Board minutes, the measurement date was the date specified in the proxy statement or, if not clear, the date of the first Board meeting attended by the new director. For anniversary grants, the measurement date was the annual anniversary of the initial grant (or the next business day if such date was not a business day).

Executive Grants

Required Granting Actions: The Compensation Committee is required to approve all grants to executive officers. For grants to the former CEO, the Review Team concluded that, in all but three cases (including the February 2002 grant described below), the Compensation Committee or the Board of Directors approved the grant on the stated grant date, resulting in a correct measurement date.

 

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Method for Determining Proper Measurement Dates: For grants other than the February/May 2002 grant described below, including the other two grants to the former CEO referred to above, please refer to the Measurement Date Hierarchy above.

Acquisition Grants

Required Granting Actions: CEO authorization required. The Board of Directors implicitly delegated to the CEO authority to approve grants to employees from acquisitions when the Board approved an acquisition.

Method for Determining Proper Measurement Dates: Refer to the Measurement Date Hierarchy above.

Annual Refresh Grants

Required Granting Actions: The Compensation Committee was required to approve all annual refresh grants through and including the 2004 annual refresh grant. In 2005, the Compensation Committee delegated to the CEO the authority to approve rank and file annual refresh grants.

Method for Determining Proper Measurement Dates: Refer to the Measurement Date Hierarchy above.

Extended Grants

Required Granting Actions: The Compensation Committee or the Board of Directors is required to approve all extensions of grants.

Method for Determining Proper Measurement Dates: Extended grants are a modification of a previous award. Available documentation was used to establish the modification date and to measure the additional compensation charge.

Retention and Off-Cycle Grants

Required Granting Actions: The Compensation Committee is required to approve all retention and off-cycle grants.

Method for Determining Proper Measurement Dates: Refer to the Documentation Hierarchy above. For the February/May 2002 retention grant described below, the former CEO approved the grants to rank and file employees.

New Hire and Promotion Grants

Required Granting Actions: New hire grants and promotion grants made after March 13, 1998 and prior to September 2000 and those made after September 30, 2002 were automatic and did not require the CEO, the Board or the Compensation Committee review or approval. Prior to March 13, 1998, the Compensation Committee was required to approve all new hire and promotion grants. New hire grants and promotion grants made in the period September 1, 2000 through September 30, 2002 required CEO approval.

Method for Determining Proper Measurement Dates: Refer to the Measurement Date Hierarchy above.

The 8,164 grants previously identified as having incorrectly determined measurement dates were classified into the following six categories: (1) 27 grants on 11 dates to persons elected or appointed as members of the Board of Directors (“Director Grants”); (2) 33 grants to executive officers (“Executive Grants”); (3) 2,908 grants to employees issued after an acquisition, newly hired employees and promoted employees under the new hire and promotion grants program described below (“New Hire and Promotion Grants Program”), and other grants to a large number of non-executives; (4) 4,226 grants made in broad-based awards to large numbers of employees, usually on an annual basis (“Annual Refresh Grants”); (5) 964 off-cycle performance grants; and (6) 6 grants

 

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whereby the expiration dates were extended (“Extended Grants”). All references to the number of option shares, option exercise prices, and share prices have been adjusted for all subsequent stock splits.

As discussed below, it was determined that the originally assigned grant dates for 8,164 grants were not ascribed the proper measurement dates for accounting purposes. Accordingly, after accounting for forfeitures, stock-based compensation expense of $171.4 million on a pre-tax basis was recognized over the respective awards’ vesting terms for the periods from 1998 to 2006. As noted below, we also considered alternative measurement dates for eight grant dates which, if applied, would have resulted in additional stock-based compensation expense of approximately $25.7 million. The adjustments made to reflect the proper measurement dates for accounting purposes and the financial statement impact of the alternative measurement dates considered by us, were determined by category as follows:

Director Grants: 64 director grants were made on 36 dates during the relevant period. Of the 64 grants, there were 27 grants to directors for which it was determined that the originally determined grant dates preceded or succeeded the measurement dates, 11 grants were in excess of plan parameters, and some of the dates were selected in hindsight based on an advantageous share price. Of the 27 grants with measurement date issues, 26 of the grants involved periods of 5 days or less and resulted in a stock-based compensation expense of less than $100,000 in the aggregate. Revisions to measurement dates for Director grants were made where the wrong date was selected based on the requirements of the Director plan and where incorrect start dates were used for the date the director joined the Board of Directors. The excess grants have been historically honored by us. As a result, $0.3 million of stock-based compensation expense was recognized.

Executive Officer Grants: It was determined that for 33 of the grants to executive officers, the originally determined grant dates preceded the measurement dates or the grant dates and exercise prices were subsequently changed. Some of these dates were selected in hindsight based on an advantageous share price. As the stock prices on the originally determined grant dates were lower than the stock prices on the proper measurement date, $28.1 million of stock-based compensation expense was recognized. The revised measurement dates for various executive officer grants were based on Compensation Committee meeting dates, signed UWCs, delayed CEO approval, and for one date the measurement date was based on the date on which the number of options and exercise price were entered into Equity Edge. We also considered an alternative measurement date for one grant date which would have increased the compensation expense by approximately $130,000 for that grant. The authority for 21 grants, which have been historically honored by us, is based on the CEO’s presumed authority.

New Hire and Promotion Grants Program: We concluded that the new hire and promotion grants made pursuant to the New Hire and Promotion Grants Program within the pre-established guidelines did not require an adjustment, with the exception of the grants made from September 1, 2000 to September 30, 2002. For the 1,728 grants made during that time period, management concluded that the measurement dates occurred only on the dates of the CEO approval. Due to practical difficulties in ascertaining the actual dates of the CEO approval for many new hire and promotion grants in that time period, the measurement date was based on the date on which the number of options and exercise price were entered into Equity Edge. The incremental stock-based compensation expense associated with the New Hire and Promotion Grants during the relevant period was $11.9 million.

Acquisition Grants: After the consummation of certain acquisitions, we granted stock options to employees of the acquired entities. It was determined that the measurement dates for 1,180 option grants required revision because the stated grant dates preceded the proper measurement dates and the approval authority was based on CEO approval. Some of these dates were chosen in hindsight based on an advantageous share price. Of the 1,180 grants, 1,048 grants were extinguished as part of our exchange program which commenced in November 2002. Due to issues associated with the measurement dates for the acquisition grants, $36.2 million of additional stock-based compensation expense was recognized during the relevant period. We also considered an alternative measurement date for three different acquisition grant dates which, if they had been used, would have increased the compensation expense by approximately $675,000.

 

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Annual Refresh Grants: During the relevant period, 3,782 broad-based grants were made to employees under an annual program (the “Refresh Grants”) for which the originally assigned grant dates were not the proper measurement dates. Some of these dates were chosen in hindsight based on an advantageous share price, and the authority for some of the Refresh Grants was the CEO’s presumed authority. For one of the annual Refresh Grants which occurred in August 2000, there was conflicting documentation and inconclusive evidence with respect to the measurement date. It was determined that the most appropriate measurement date, due to the lack of affirmative evidence otherwise, was the date on which the number of options and exercise price were entered into Equity Edge, and based on that date, $19.2 million of stock-based compensation expense was recognized in the period 2000 to 2002. These grants were extinguished in December 2002 as part of our exchange program which commenced in November 2002. We did not approve or process any stock option grants to existing employees during the period of the tender offer or agree or imply that we would compensate employees for any increases in the market price during the tender period. The Review also determined that the annual refresh grants for the years 1999, 2001, 2004, and a portion of the 2003 grant had a measurement date that was later than the date that was originally used. In these cases, where the measurement dates were revised, the authority for the grants varied and included new dates based on UWCs by the Compensation Committee or approvals by the CEO. Where approval was not determinable based on the above, we utilized the date on which the number of options and exercise price were entered into Equity Edge. Due to the errors in measurement dates associated with the annual refresh grants, stock-based compensation expense of $55.1 million was recognized. We also considered alternative measurement dates for two Refresh Grants which did not create additional compensation charge where one alternative measurement date had a lower price than the original grant date and the options for the second alternative measurement date were cancelled prior to the one-year cliff vesting date.

Off-Cycle Performance Grants: There were 964 performance grants made to employees on March 15, 2001 and October 1, 2003. These dates were chosen in hindsight based on an advantageous share price, and the authority for these grants was the CEO’s de facto authority. The revised measurement dates were based on the dates of the UWC for the March 15, 2001 grant and e-mail correspondence for the October 1, 2003 grant. Due to the errors in measurement dates associated with the off-cycle performance grants, stock-based compensation expense of $5.6 million was recognized. We also considered an alternative measurement date for the October 1, 2003 grant which, if it had been used, would have decreased the compensation expense by approximately $100,000 for that grant.

Extended Grants: During the relevant period, there were 6 stock option extensions (including one to the former CEO described below) whereby an option was extended beyond its expiration or termination date and for which a compensation charge had not been recorded. As a result, $2.1 million of stock-based compensation expense was recognized.

The former CEO received certain options from Network Solutions, Inc. (“NSI”) in his capacity as a NSI director prior to our acquisition of NSI. Upon receiving legal advice, management extended the term of those options beyond their original expiration date. The former CEO exercised those options on May 24, 2002. The Ad Hoc Group reviewed the extension of these options and determined that the legal advice was incorrect and that the options should not have been extended. Upon learning of this determination in January 2007, the former CEO voluntarily paid $174,425 to us, reflecting the after-tax net profit he received from the exercise of those options.

2002 Retention Grants: Between February and May 2002, the Compensation Committee considered special option grants as a retention incentive for executive officers and other executives and key employees, since in many cases the exercise prices of options previously granted to these individuals were significantly above the then current market price for shares of our common stock. These retention grants are summarized as follows:

Grants to Executive Officers and Other Executives: We determined that 68 grants of options for a total of 4,631,000 shares to executive officers and other executives were finalized on April 10, 2002 rather than the stated grant date of February 21, 2002. The Review Team was unable, after review of detailed documentation, including multiple draft versions of the February 12, 2002 Compensation Committee minutes, approval forms

 

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(which were undated) and email correspondence, to affirmatively determine when the grants to executive officers and other executives were approved. In accordance with our measurement date hierarchy for grants described above, we determined that April 10, 2002 was the correct measurement date because that was the date that other grants, including certain executive grants, were entered into Equity Edge. The grant price as of the measurement date was $23.74, the closing market price of our stock on April 10, 2002. Because the stated exercise price of the grants was set based on the closing market price on February 21, 2002 of $22.71 and preceded the measurement date, an incremental $1.3 million of stock-based compensation expense was recognized.

We also determined that the Compensation Committee repriced 1,870,000 of these options on May 24, 2002, with an exercise price of $10.08, the closing market price of our stock on May 24, 2002. We determined that these grants were a reprice based on a UWC of the Compensation Committee. The accounting impact of the repricing was not recorded at the time of the Compensation Committee approval and we did not properly disclose the circumstances of these grants. In accordance with FIN 44 and after applying variable accounting, we recognized incremental stock-based compensation expense of approximately $15.8 million, net of reversals, for the periods between 2002 and 2006. Had we considered an alternative measurement date between the periods from February 13, 2002 through April 25, 2002, compensation expense would have increased by up to $25.0 million for these grants.

Grants to Employees: Broad-based employee grants were also considered during the February to May 2002 period. The Review Team determined that the CEO, under his presumed authority, approved 305 broad-based employee grants on or about March 20, 2002 with a grant price of $26.42, the closing market price of our stock on that date. These awards were communicated shortly thereafter to the employees. We determined that March 20, 2002 was a definitive measurement date for the awards to the employees.

The grants to employees previously approved by the CEO on March 20, 2002 were submitted for approval to the Compensation Committee as evidenced in a UWC dated May 24, 2002. The Compensation Committee approved the 305 employee grants with an exercise price of $10.08, the market value of our common stock on May 24, 2002. Therefore the employee awards were re-priced on that date. Although the awards had been communicated to the employees and disclosed in our Form 10-Q for the first quarter of 2002, the accounting impact of the repricing was not recorded at the time of the Compensation Committee approval and we did not properly disclose the circumstances of these grants. As a result of the repricing, and after applying variable accounting, approximately $6.6 million, net of reversals of additional stock-based compensation expense has been recorded for the periods between 2002 and 2006.

Retention Grants to our former CEO: In the February 12, 2002 Compensation Committee meeting, the Committee considered the number and vesting period of a proposed option award to the CEO. The Review Team found multiple draft versions of the minutes for the February 12, 2002 meeting of the Compensation Committee and concluded that the signed minutes were inaccurate. Attendees at the meeting have different recollections of the business conducted. One draft, unapproved version of those minutes, stated the number of options to be awarded to the CEO was 1,200,000, while the signed version of the minutes approved by the members of the Compensation Committee in late May 2002 stated that the number of options to be awarded was 600,000. Both versions of the minutes stated that the grant date and the exercise price was February 21, 2002 and $22.71. The minutes of a Board meeting held on February 12, 2002, after the Compensation Committee meeting, also indicate that the CEO was awarded 1,200,000 options at the February 12, 2002 Compensation Committee meeting.

We have determined that the measurement date for the 1,200,000 options to the CEO was February 12, 2002 with a grant price of $26.31, the closing market price of our stock on that date, and that the options were repriced on February 21, 2002 with a grant price of $22.71, the closing market price of our stock on that date. Subsequently, 600,000 options of the 1,200,000 options were repriced on May 24, 2002 with a grant price of $10.08, the closing market price of our stock on that date. The accounting impact of the repricings was not recorded at the time of the Compensation Committee approval and we did not properly disclose the circumstances of these grants. As a result of the repricing, and after applying variable accounting, approximately

 

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$7.5 million, net of reversals, of additional stock-based compensation expense has been recorded for the periods between 2002 and 2006.

Actions Taken by the Board with respect to Grants: As part of the Review, the Board of Directors confirmed all option grants (including those to our former CEO and CFO) that the Review Team concluded had authority issues as legally binding and enforceable obligations of ours as of the date of such grant. In addition, the Board of Directors decided to modify the following grants to the former CEO and CFO in 2007 and no reversal of compensation expense was recorded for these negative modifications in the financial statements.

Former CEO: An option grant to the former CEO of 100,000 shares originally dated December 29, 2000 at an exercise price of $74.188 was modified to a new exercise price of $127.31.

Former CEO: The February 2002 option grant to the former CEO of 600,000 shares originally dated February 21, 2002 at an exercise price of $22.71 was modified to a new exercise price of $26.31.

Former CFO: An option grant to the CFO of 25,000 shares originally dated December 29, 2000 at an exercise price of $74.188 was modified to a new exercise price of $127.31.

Former CFO: An option grant to the CFO of 125,000 shares originally dated August 1, 2000 at an exercise price of $151.25 was modified to a new exercise price of $165.22.

Former CFO: An option grant to the CFO of 40,000 shares originally dated March 15, 2001 at an exercise price of $34.438 was modified to a new exercise price of $42.26. The CFO’s 409A tax election described below modified 1,667 of these options and the Board of Directors determined to modify the remaining 38,333 options.

Former CFO: A grant to the CFO of 90,000 shares originally dated September 6, 2001 at an exercise price of $34.16 was modified to a new exercise price of $38.30. The CFO’s 409A tax election described below modified 11,250 of these options and the Board of Directors determined to modify the remaining 78,750 options.

Former CFO: The February 2002 option grant to the CFO of 100,000 shares originally dated February 21, 2002 at an exercise price of $22.71 was modified to a new exercise price of $23.74.

Other: We and the Review Team also determined that the former CEO received an option grant in October 1998 for 100,000 shares (95,928 non-qualified stock options (“NQSOs”) and 4,072 incentive stock options (“ISOs”), which split to options for 200,000 shares in May 1999 and then split again to options for 400,000 shares in November 1999 when we announced a stock split during those respective periods. The account statements and monthly reporting statements for November 1 and December 1, 2000 showed that the former CEO held options for 400,000 shares at the split-adjusted price of $7.67. However, the Ad Hoc Group determined that sometime between December 1, 2000 and January 1, 2001, we erroneously changed the former CEO’s options to reflect the pre-split amount of 100,000 shares instead of 400,000 shares, but at the post-split price of $7.67. The error was never subsequently corrected. Therefore, the former CEO did not receive the benefit of the additional 300,000 options arising from the two stock splits, which expired in 2005. Based on a determination by the Board of Directors after the Ad Hoc Group’s Review in May 2007, we have agreed to pay the former CEO $5,459,430, reflecting the gain he would have realized from the exercise of these options prior to their expiration, based on the weighted-average price of stock options exercised by the former CEO in August 2005.

The other principal factual findings of the Review included the following:

 

   

The human resources, accounting, and legal departments failed to implement appropriate processes and controls. During 2000 through 2003, the option grant process was characterized by a high degree of informality and relatively little oversight.

 

   

The Review found no evidence that accounting personnel were aware of the deficient practices used in selecting grant dates.

 

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The Review found instances of incomplete and inaccurate corporate records, including two sets of Committee minutes that were inaccurate.

 

   

The Review found no evidence of fictitious individuals being granted options.

 

   

Options found to be misdated, have a date chosen in hindsight based on an advantageous share price, repriced, or unauthorized with a stated exercise price lower than the share price at the actual approval date will result in adverse tax consequences to the recipients and us.

 

   

In light of the Review’s other findings, our disclosures related to option grants were inaccurate in some respects.

The principal recommendations of the Ad Hoc Group’s Review included the following:

 

   

The Board or the Compensation Committee should approve all grants that the Review found to be unauthorized, with the exception of certain grants made to our former CEO and CFO. The Board or the Compensation Committee should consider whether to cancel or request forfeiture of any options granted to the former CEO and CFO that were determined to be unauthorized, misdated, have a date chosen in hindsight based on an advantageous share price, or repriced, and then should consider the appropriate equity compensation for these officers for the periods covered by the Review.

 

   

We should develop and implement detailed written grant policies.

 

   

We should designate individuals in the legal and accounting departments to oversee the documentation of and accounting for option grants.

 

   

We should develop and implement improved training and controls relating to option granting practices to ensure that all personnel involved in the granting and administration of stock options understand the relevant option plans and accounting, tax, and disclosure requirements.

 

   

We should award regular grants (new hire, promotion, and annual performance) at predetermined dates and with all approvals documented and finalized on those dates.

The Board has adopted all of the Review’s findings and recommendations. We, under the direction of the Audit Committee and the Compensation Committee, and with the assistance of PricewaterhouseCoopers LLP, have implemented or are in the process of implementing the recommendations.

Based on the results of the Review, we has recorded additional non-cash stock-based compensation expense (benefit) net of related income tax effects related to past stock option grants of $1.5 million for the first quarter ended March 31, 2006, ($21.6 million) and $36.9 million in fiscal years 2005 and 2004, respectively. These adjustments were recorded based on the evidence and findings from the Ad Hoc Group’s review, including analysis of the measurement dates for the 8,164 stock option grants made on 41 dates during the relevant period that the Review determined were incorrect.

 

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The incremental impact from recognizing stock-based compensation expense resulting from the Ad Hoc Group’s Review of past stock option grants is as follows (dollars in thousands):

 

Fiscal Year

   As
Restated
    As
Previously
Reported
   Pre-Tax
Expense
(Income)
Adjustments
    After Tax
(Income)
Expense
Adjustments
 

1998

   $ 1,288     $ 1,280    $ 8     $ 8  

1999

     7,057       104      6,953       6,953  

2000

     24,814       1,722      23,092       23,092  

2001

     42,500       7,803      34,697       34,697  

2002

     70,066       18,956      51,110       51,110  

2003

     35,010       7,389      27,621       27,621  
                               

Total 1998 – 2003 impact

     180,735       37,254      143,481       143,481  

2004

     46,835       3,136      43,699       36,873  

2005 (2)

     (10,588 )(2)     6,312      (17,670 )     (21,560 )

2006 (1)

     66,285       64,438      1,847 (1)     1,532 (1)
                               

Total

   $ 283,267     $ 111,140    $ 171,357     $ 160,326  
                               

(1) Pre-tax expense adjustments are through March 31, 2006 and represent amounts being reported pursuant to FAS123R whereas all other amounts are reported pursuant to APB 25.
(2) Includes $0.8 million of other stock-based compensation adjustments that were unrelated to past stock option grants.

Additionally, the pro forma expense under SFAS No. 123 in Note 1 in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q has been restated to reflect the impact of these adjustments for the three and nine months ended September 30, 2005.

As noted above we considered alternative measurement dates for eight grants which, if applied, would have resulted in additional stock-based compensation of approximately $25.7 million. With the exception of these eight grants, there was no uncertainty on the measurement date for option grants. The table below shows what the incremental impact to stock-based compensation expense would have been by category of grant had these alternative measurement dates been applied (in thousands):

 

Category

   Pre-Tax
Expense
(Income)
 

Director Grants

   $ —    

Executive Grants

     100  

Acquisition Grants

     675  

Annual Refresh Grants

     —    

Extended Grants

     —    

Retention and Off-Cycle Grants

     (100 )

New Hire and Promotion Grants

     —    

2002 Retention Grants

     25,000  
        

Total

   $ 25,675  
        

Tax Implications

We evaluated the impact of the restatements on our global tax provision and have determined that a portion of the tax benefit relating to stock-based compensation expense formerly associated with stock option deductions is attributable to continuing operations. We identified deferred tax assets totaling $16.3 million at December 31, 2005 which reflect the benefit of tax deductions from future employee stock option exercises. We have not realized this or any other deferred tax asset relating to taxing jurisdictions within the United States as of

 

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December 31, 2005. See Note 15 of Notes to Condensed Consolidated Financial Statements regarding our realization of United States-based deferred tax assets.

We also believe that we should not have taken a tax deduction under Internal Revenue Code (IRC) Section 162(m) in prior years for stock option related amounts pertaining to certain executives. Section 162(m) limits the deductibility of compensation above certain thresholds. As a result, our tax net operating losses associated with the stock option intra-period allocation have decreased by $12.6 million. We continues to apply a valuation allowance to our tax net operating losses relating to stock options exercised prior to the adoption of SFAS No. 123R, “Share-Based Payment.” Pursuant to Footnote 82 of SFAS No. 123R, we recognize financial statement benefit of these tax net operating losses when such losses reduce cash taxes paid.

Section 409A of the Internal Revenue Code (“Section 409A”) imposes significant penalties on individual income taxpayers who were granted stock options that were unvested as of December 31, 2004 and that have an exercise price of less than the fair market value of the stock on the date of grant (“Affected Options”). These tax consequences include income tax at vesting, an additional 20% tax and interest charges. In addition, the issuer of Affected Options must comply with certain reporting and withholding obligations under Section 409A.

These adverse tax consequences may be avoided for unexercised Affected Options if the exercise price of the Affected Option is adjusted to reflect the fair market value at the time the option was granted (as such measurement date is determined for financial reporting purposes). Under Treasury regulations, Affected Options held by executive officers or directors were to be amended on or before December 31, 2006 to avoid the adverse tax consequences of Section 409A; holders of Affected Options who are not executive officers or directors of us have until December 31, 2007 to amend their Affected Options to avoid the adverse tax consequences of Section 409A. Four of our current and former executive officers and a current director holding Affected Options elected to increase the exercise price of their Affected Options to the market price on December 31, 2006. Effective December 31, 2006, the exercise prices of Affected Options held by D. James Bidzos, a current board member, Dana Evan, former Chief Financial Officer, Robert Korzeniewski, Executive Vice President of Corporate Development, Judy Lin, former Executive Vice President of Security Services and Mark McLaughlin, Executive Vice President of Products, Marketing and Customer Support, were adjusted so that these options will not be subject to Section 409A. We are currently considering actions to avoid or alleviate certain of the adverse tax consequences associated with Affected Options for employees who are not executive officers of ours and whether to offer compensation to the executive officers and director who elected to increase the exercise price of their Affected Options as of December 31, 2006. Should we decide to take actions to avoid or alleviate these adverse tax consequences associated with current and former employees’ outstanding Affected Options, we estimate the related compensatory payments would be approximately $11.6 million. In June 2007, we made payments of approximately $0.9 million on behalf of current and former employees who exercised Affected Options in 2006 under the IRS and California Franchise Tax Board 409A Compliance Resolution Programs. We estimate the cost to participate in these compliance resolution programs, including a gross-up payment to the affected employees will be approximately $1.9 million.

 

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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 September 30, 2006 and December 31, 2005

   15

•   Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2006 and 2005

   16

•   Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005

   17

•   Notes to Condensed Consolidated Financial Statements

   18

 

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VERISIGN, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

    

September 30,

2006

   

December 31,

2005

 
     (Unaudited)     (As Restated) (1)  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 439,250     $ 476,826  

Short-term investments

     220,564       378,006  

Accounts receivable, net of allowance for doubtful accounts of $15,408 and $11,559 at September 30, 2006 and December 31, 2005, respectively

     326,844       279,766  

Prepaid expenses and other current assets

     229,795       78,008  

Deferred tax assets

     123,954       15,907  

Current assets of discontinued operations

     5,689       5,295  
                

Total current assets

     1,346,096       1,233,808  
                

Property and equipment, net

     591,626       558,272  

Goodwill

     1,441,923       1,068,963  

Other intangible assets, net

     325,859       225,302  

Restricted cash and investments

     48,962       50,972  

Long-term note receivable

     —         26,419  

Long-term deferred tax assets

     206,603       —    

Other assets, net

     22,139       16,985  
                

Total long-term assets

     2,637,112       1,946,913  
                

Total assets

   $ 3,983,208     $ 3,180,721  
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable and accrued liabilities

   $ 691,036     $ 567,848  

Accrued restructuring costs

     4,529       7,440  

Deferred revenue

     436,874       371,566  

Short-term debt

     199,000       —    

Short-term deferred tax liabilities

     1,975       —    

Current liabilities of discontinued operations

     4,997       6,822  
                

Total current liabilities

     1,338,411       953,676  
                

Long-term deferred revenue

     154,455       127,175  

Long-term accrued restructuring costs

     1,751       10,876  

Other long-term liabilities

     5,159       4,995  

Long Term deferred tax liabilities

     25,694       19,072  
                

Total long-term liabilities

     187,059       162,118  
                

Total liabilities

     1,525,470       1,115,794  
                

Commitments and contingencies

    

Minority interest in subsidiaries

     47,442       41,485  

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: 243,828,646 and 246,418,940 (excluding 35,456,975 and 28,981,444 shares held in treasury at September 30, 2006 and December 31, 2005, respectively)

     244       246  

Additional paid-in capital

     23,318,396       23,368,460  

Unearned compensation

     —         (24,199 )

Accumulated deficit

     (20,899,965 )     (21,308,512 )

Accumulated other comprehensive loss

     (8,379 )     (12,553 )
                

Total stockholders’ equity

     2,410,296       2,023,442  
                

Total liabilities and stockholders’ equity

   $ 3,983,208     $ 3,180,721  
                

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2006     2005     2006     2005  
           (As Restated) (1)           (As Restated) (1)  

Revenues

   $ 399,513     $ 401,113     $ 1,163,021     $ 1,223,446  
                                

Costs and expenses:

        

Cost of revenues

     144,480       126,858       430,663       383,654  

Sales and marketing

     95,164       113,333       279,010       376,000  

Research and development

     33,188       24,866       92,509       69,842  

General and administrative

     69,094       39,526       188,990       125,256  

Restructuring, impairment, and other (reversals) charges, net

     (84 )     537       (4,279 )     (3,821 )

Amortization of other intangible assets

     30,977       26,235       90,809       73,896  

Acquired in-process research and development

     1,200       1,800       16,700       6,100  
                                

Total costs and expenses

     374,019       333,155       1,094,402       1,030,927  
                                

Operating income

     25,494       67,958       68,619       192,519  

Non-operating income:

        

Minority interest

     (719 )     (1,221 )     (2,124 )     (3,397 )

Other income, net

     4,755       14,390       38,858       43,285  
                                

Income from continuing operations before income taxes

     29,530       81,127       105,353       232,407  

Income tax expense (benefit)

     14,423       29,212       (302,127 )     90,692  
                                

Net income from continuing operations

     15,107       51,915       407,480       141,715  

Net income from discontinued operations, net of tax

     167       4,934       1,067       13,343  
                                

Net income

   $ 15,274     $ 56,849     $ 408,547     $ 155,058  
                                

Basic net income per share from:

        

Continuing operations

   $ 0.06     $ 0.20     $ 1.67     $ 0.55  

Discontinued operations

     —         0.02       —         0.05  
                                
   $ 0.06     $ 0.22     $ 1.67     $ 0.60  
                                

Diluted net income per share from:

        

Continuing operations

   $ 0.06     $ 0.20     $ 1.65     $ 0.53  

Discontinued operations

     —         0.01       —         0.05  
                                
   $ 0.06     $ 0.21     $ 1.65     $ 0.58  
                                

Shares used in per share computation:

        

Basic

     243,536       260,369       244,620       259,259  
                                

Diluted

     245,657       266,079       247,005       266,107  
                                

 


(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

    

Nine Months Ended

September 30,

 
     2006     2005  
           (As Restated) (1)  

Cash flows from operating activities:

    

Net income

   $ 408,547     $ 155,058  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation of property and equipment

     78,272       64,930  

Amortization of other intangible assets

     90,809       73,896  

Acquired in-process research and development

     16,700       6,100  

Provision for doubtful accounts

     1,576       1,249  

Stock-based compensation and other

     49,044       (14,674 )

Restructuring, impairment, and other reversals, net

     (4,279 )     (3,821 )

Net gain on sale and impairment of investments

     (21,260 )     (8,265 )

Minority interest in net income of subsidiary

     2,124       3,397  

Tax benefit associated with stock options

     —         19,538  

Deferred income taxes

     (299,137 )     (8,519 )

Loss on disposal of property and equipment

     —         186  

Changes in operating assets and liabilities:

    

Accounts receivable

     16,677       (69,798 )

Prepaid expenses and other current assets

     (94,059 )     (34,337 )

Accounts payable and accrued liabilities

     5,307       85,740  

Deferred revenue

     80,781       75,243  
                

Net cash provided by operating activities

     331,102       345,923  
                

Cash flows from investing activities:

    

Purchases of investments

     (536,569 )     (256,967 )

Proceeds from maturities/sales of investments

     693,731       231,136  

Purchases of property and equipment

     (139,044 )     (79,673 )

Cash paid in business combinations, net of cash acquired

     (543,821 )     (66,653 )

Net proceeds received on long-term note receivable and investment

     47,786       16,609  

Other assets

     125       (5,683 )
                

Net cash used in investing activities

     (477,792 )     (161,231 )
                

Cash flows from financing activities:

    

Proceeds from issuance of common stock from option exercises and employee stock purchase plan

     52,668       56,644  

Repurchase of common stock

     (135,000 )     (256,819 )

Change in net assets of subsidiary

     332       605  

Proceeds from drawdown of credit facility, net

     299,000       —    

Debt issuance costs

     (3,381 )     —    

Repayment of debt and long-term liabilities

     (102,362 )     (1,650 )
                

Net cash provided by (used in) financing activities

     111,257       (201,220 )
                

Effect of exchange rate changes on cash and cash equivalents

     1,020       (4,169 )
                

Net decrease in cash and cash equivalents

     (34,413 )     (20,697 )

Cash and cash equivalents at beginning of period

     478,660       330,641  
                

Cash and cash equivalents at end of period

     444,247       309,944  

Cash and cash equivalents of discontinued operations

     (4,997 )     (2,491 )
                
   $ 439,250     $ 307,453  
                

Cash flows from discontinued operations:

    

Net cash provided by operating activities

   $ 3,162     $ 17,181  
                

Supplemental cash flow disclosures:

    

Cash paid for income taxes, net of refunds received

   $ 20,367     $ 19,140  
                

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation and Summary of Significant Accounting Policies

Interim Financial Statements

The accompanying condensed consolidated financial statements have been prepared by VeriSign, Inc. and its subsidiaries (“VeriSign” or 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. In the opinion of management, all adjustments (consisting of normal recurring accruals and other adjustments) considered necessary for a fair presentation have been included. 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. These condensed consolidated financial statements and the accompanying notes should be read in conjunction with the Company’s annual consolidated financial statements and the notes thereto for the year ended December 31, 2006 included in the 2006 Annual Report on Form 10-K to be filed with the SEC (the “2006 Form 10-K).

Reclassifications

VeriSign accounted for the November 2005 sale of its payment gateway business as a discontinued operation in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (“SFAS 144”). Accordingly, the Condensed Consolidated Financial Statements have been reclassified for all periods presented to reflect its payment gateway business as discontinued operations. Unless noted otherwise, discussions in the notes to Condensed Consolidated Financial Statements pertain to continuing operations.

Stock-based Compensation

Prior to January 1, 2006, VeriSign accounted for stock-based awards under the intrinsic value method, which followed the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations. The intrinsic value method of accounting resulted in compensation expense for restricted stock awards at fair value on date of grant based on the number of shares granted and the quoted price of the Company’s common stock, and for stock options to the extent option exercise prices were set below market prices on the date of grant. To the extent stock awards were forfeited prior to vesting, the corresponding previously recognized expense was reversed as an offset to operating expenses.

Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123R, Share-Based Payment (“SFAS 123R”). SFAS 123R replaced SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and superseded APB 25. VeriSign elected the modified prospective application method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. For stock-based awards granted on or after January 1, 2006, the Company will amortize stock-based compensation expense on a straight-line basis over the requisite service period, which is the vesting period. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period under the pro forma provisions of SFAS 123.

VeriSign recognized incremental stock-based compensation expense of $5.4 million and $28.5 million during the three and nine months ended September 30, 2006, respectively, as a result of the adoption of SFAS 123R. See Note 3, “Stock-Based Compensation” for further information regarding stock-based compensation assumptions and expenses.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The Financial Accounting Standards Board’s (“FASB”) Staff Position No. 123R-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards (“FSP 123R-3”), provides an elective method for calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS 123R. FSP 123R-3 provides that an entity may make a one-time election to adopt the transition method. An entity may take up to one year from its initial adoption of SFAS 123R to make the election. During the second quarter of 2006, VeriSign elected the short-cut transition method described in FSP 123R-3, and analyzed its effect on the Company’s Condensed Consolidated Financial Statements for the periods presented. The election of the transition method did not have a material impact on VeriSign’s condensed consolidated financial statements.

The following table illustrates the effect on net income and net income per share on the Company’s condensed consolidated statements of income, if VeriSign had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation:

 

    

Three months ended

September 30,

2005

   

Nine months ended

September 30,

2005

 
     As Restated (1)     As Restated (1)  
     (In thousands, except per share data)  

Net income, as reported

   $ 56,849     $ 155,058  

Deduct: Credit for stock-based compensation, net of tax

     (6,955 )     (9,997 )

Deduct: Stock-based compensation determined under the fair value method for all awards, net of tax

     (16,964 )     (52,404 )
                

Pro forma net income

   $ 32,930     $ 92,657  
                

Earnings per share:

    

Basic:

    

As reported

   $ 0.22     $ 0.60  

Pro forma stock-based compensation

     (0.04 )     (0.13 )
                

Pro forma net income per share

   $ 0.18     $ 0.47  
                

Diluted:

    

As reported

   $ 0.21     $ 0.58  

Pro forma stock-based compensation

     (0.09 )     (0.24 )
                

Pro forma net income per share

   $ 0.12     $ 0.34  
                

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

Critical accounting policies and significant management estimates

The Company’s Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expenses during the period reported. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. Management bases its estimates and judgments on historical experience, market trends, and other factors that are believed to be reasonable under the circumstances. These estimates form the basis for judgments about the carrying value of assets and liabilities that are not readily

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

apparent from other sources. Actual results may differ from what the Company anticipates, and different assumptions or estimates about the future could change its reported results. Management believes critical accounting policies as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2006 reflect the more significant judgments and estimates used in preparation of its financial statements.

Note 2. Restatement of Condensed Consolidated Financial Statements

In this Form 10-Q, the Company is restating its condensed consolidated balance sheet as of December 31, 2005, the related consolidated statements of income for the three and nine months ended September 30, 2005, and condensed consolidated statements of cash flows for the nine months ended September 30, 2005. In the Company’s Form 10-K for the year ended December 31, 2006 to be filed with the Securities and Exchange Commission (the “2006 Form 10-K”), the Company is restating its consolidated balance sheet as of December 31, 2005 and the related consolidated statements of income, stockholders’ equity, comprehensive income and cash flows for the years ended December 31, 2005 and 2004, and the related quarters for 2005.

The decision to restate was based on the results of an independent review (the “Review”) into the Company’s historical stock option granting practices that was conducted under the direction of an ad hoc group of VeriSign’s independent directors who had not served on the Company’s Compensation Committee before 2005 (“Ad Hoc Group”).

Previously filed annual reports on Form 10-K and quarterly reports on Form 10-Q affected by the restatements have not been amended and should not be relied upon.

On June 27, 2006, the Company announced that it had received a grand jury subpoena from the U.S. Attorney for the Northern District of California requesting documents relating to VeriSign’s stock option grants and practices dating back to January 1, 1995, and had received an informal request for information from the Securities and Exchange Commission (“SEC”) related to VeriSign’s stock option grants and practices. On February 9, 2007, the Company subsequently received a formal order of investigation from the SEC.

On November 21, 2006, VeriSign announced that the Ad Hoc Group had determined the need to restate VeriSign’s historical financial statements to record additional non-cash, stock-based compensation expense related to past stock option grants.

On March 30, 2007, the Company requested guidance from the Office of the Chief Accountant of the SEC (the "OCA") concerning certain accounting issues relating to the restatement of its historical financials and the Review. On June 25, 2007, the OCA and the Company concluded their discussions regarding these accounting issues.

The Ad Hoc Group with the assistance of Cleary Gottleib began reviewing the facts and circumstances of the timing of VeriSign’s historical stock option grants for the period from January 1998 through May 2006. The Company announced on January 31, 2007 that the Ad Hoc Group’s Review was substantially completed and that, based on a review of the totality of evidence and the applicable law, the Review’s report did not find intentional wrongdoing by any current member of the senior management team or the former CEO. The Ad Hoc Group’s Review concluded that the Company failed to implement appropriate processes and controls for granting, accounting for, and reporting stock option grants and that corporate records in certain circumstances were incomplete or inaccurate.

The Review Team examined all grants to Section 16 officers and directors during the relevant period, as well as 7 annual performance grants to rank and file employees and 179 acquisition, new hire and promotion, and other grants to rank and file employees on 239 dates from January 1998 through January 2006.

 

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The Review Team identified 8,164 stock option grants made on 41 dates during the relevant period for which measurement dates were incorrectly determined. The measurement dates required revision because the stated date either preceded or was subsequent to the proper measurement date and the stock price on the stated date was generally lower than the price on the proper measurement date. In several instances, the Review Team also determined that the stock price assigned on the initial grant dates was subsequently modified, without being given the required accounting and disclosure treatment.

As part of the restatement, the grants during the relevant period were organized into categories based on grant type and process by which the grant was finalized. The evidence related to each category of grant was analyzed including, but not limited to, electronic and physical documents, document metadata, and witness interviews. Based on the relevant facts and circumstances, and consistent with the accounting literature and recent guidance from the SEC, the controlling accounting standards were applied to determine, for every grant within each category, the proper measurement date. If the measurement date was not the originally assigned grant date, accounting adjustments were made as required, resulting in stock-based compensation expense and related income tax effects.

Measurement Date Hierarchy

The Company has adopted the following framework for determining the measurement dates of its stock option grants and has applied this framework to each grant based on the facts, circumstances and availability of documentation.

 

   

The Company reviewed the date of the minutes of the Board of Directors or Compensation Committee meetings for grants made at such meetings when the number of options and exercise price for each recipient had been clearly approved. Where the Review Team determined that the meeting date was not the measurement date, the Review Team determined the actual date of approval of the grant via other documentary evidence and interviews.

 

   

When a grant was approved by unanimous written consent (“UWC”), the measurement date was the date of the Compensation Committee’s approval of the UWC as established by available evidence, such as receipt of signature pages of the UWC, contemporaneous telephone and/or e-mail communications.

 

   

If a grant was approved by the CEO under authority delegated by the Compensation Committee, the measurement date was the date on which the CEO communicated approval to the Human Resources Department, the Compensation Committee or the respective employees indicating final approval of both the number of options and exercise price.

 

   

If a grant was approved by the CEO based on the mistaken belief that he had delegated authority to do so (de facto or “substantive” authority), the measurement date was the date on which the CEO communicated approval to either the Human Resources Department, the Compensation Committee or the respective employees indicating final approval of both the number of options and exercise price.

 

   

In the event the date on which the CEO communicated approval was not evident from the approval forms, the measurement date was the date on which other available evidence, such as the surrounding e-mail communications, established the date the CEO approved the grant.

 

   

In the event the date of CEO approval could not be established by reviewing other available evidence, such as e-mails, the measurement date was the date on which the number of options and exercise price were entered into the Company’s option tracking database (Equity Edge).

 

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Except for grants to Section 16 officers which require Compensation Committee approval, for new hire grants and promotion grants , prior to March 13, 1998, the measurement date was the date the Compensation Committee approved the grant (as described above). For new hire grants and promotion grants after March 13, 1998 and prior to September 2000 and after September 30, 2002, the measurement date was the 15th day or the last day of the month (or the prior business day if that day was not a business day) following the actual and documented start date or promotion date of the respective employee receiving the grant. New hire grants and promotion grants made in the period September 1, 2000 through September 30, 2002 required CEO approval. For new hire grants and promotion grants in the period September 1, 2000 through September 30, 2002, the measurement date was the date on which the CEO communicated approval to either the Human Resources Department, the Compensation Committee or the respective employees indicating final approval of both the number of options and exercise price. If that date could not be determined, the measurement date was based on the date on which the number of options and exercise price were entered into Equity Edge.

After determining the measurement date through the steps in the above Measurement Date Hierarchy, the Company then determined if there were any changes to the individual recipients, exercise prices or amount of shares granted after such measurement date. If there were no changes following such measurement date, that date would be used. If the Company identified changes following such measurement date, then the Company would evaluate whether the changes should delay the measurement date for the entire list of grants on that date, result in a repricing, or result in separate accounting for specific grants.

Director Grants

Required Granting Actions: Grants to directors under the 1998 Director Plan (the “Director Plan”) were automatic and non-discretionary; the Director Plan did not require the CEO, the Board or the Compensation Committee to review or approve director grants. Each new director received an initial grant of a specified number of options on the date of his or her appointment and annually on the anniversary of the initial grant to be priced on the appointment or anniversary date, respectively. Directors serving before the Director Plan was adopted received an annual grant on the anniversary of their previous grant.

Method for Determining Proper Measurement Dates: For the initial grant, the measurement date was the date the director was appointed to the Board, as reflected in Board minutes. In the absence of Board minutes, the measurement date was the date specified in the proxy statement or, if not clear, the date of the first Board meeting attended by the new director. For anniversary grants, the measurement date was the annual anniversary of the initial grant (or the next business day if such date was not a business day).

Executive Grants

Required Granting Actions: The Compensation Committee is required to approve all grants to executive officers. For grants to the former CEO, the Review Team concluded that, in all but three cases (including the February 2002 grant described below), the Compensation Committee or the Board of Directors approved the grant on the stated grant date, resulting in a correct measurement date.

Method for Determining Proper Measurement Dates: For grants other than the February/May 2002 grant described below, including the other two grants to the former CEO referred to above, please refer to the Measurement Date Hierarchy above.

 

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Acquisition Grants

Required Granting Actions: CEO authorization required. The Board of Directors implicitly delegated to the CEO authority to approve grants to employees from acquisitions when the Board approved an acquisition.

Method for Determining Proper Measurement Dates: Refer to the Measurement Date Hierarchy above.

Annual Refresh Grants

Required Granting Actions: The Compensation Committee was required to approve all annual refresh grants through and including the 2004 annual refresh grant. In 2005, the Compensation Committee delegated to the CEO the authority to approve rank and file annual refresh grants.

Method for Determining Proper Measurement Dates: Refer to the Measurement Date Hierarchy above.

Extended Grants

Required Granting Actions: The Compensation Committee or the Board of Directors is required to approve all extensions of grants.

Method for Determining Proper Measurement Dates: Extended grants are a modification of a previous award. Available documentation was used to establish the modification date and to measure the additional compensation charge.

Retention and Off-Cycle Grants

Required Granting Actions: The Compensation Committee is required to approve all retention and off-cycle grants.

Method for Determining Proper Measurement Dates: Refer to the Documentation Hierarchy above. For the February/May 2002 retention grant described below, the former CEO approved the grants to rank and file employees.

New Hire and Promotion Grants

Required Granting Actions: New hire grants and promotion grants made after March 13, 1998 and prior to September 2000 and those made after September 30, 2002 were automatic and did not require the CEO, the Board or the Compensation Committee review or approval. Prior to March 13, 1998, the Compensation Committee was required to approve all new hire and promotion grants. New hire grants and promotion grants made in the period September 1, 2000 through September 30, 2002 required CEO approval.

Method for Determining Proper Measurement Dates: Refer to the Measurement Date Hierarchy above.

The 8,164 grants previously identified as having incorrectly determined measurement dates were classified into the following six categories: (1) 27 grants on 11 dates to persons elected or appointed as members of the Board of Directors (“Director Grants”); (2) 33 grants to executive officers (“Executive Grants”); (3) 2,908 grants to employees issued after an acquisition, newly hired employees and promoted employees under the new hire and promotion grants program described below (“New Hire and Promotion Grants Program”), and other grants to a large number of non-executives; (4) 4,226 grants made in broad-based awards to large numbers of employees, usually on an annual basis (“Annual Refresh Grants”); (5) 964 off-cycle performance grants; and (6) 6 grants whereby the expiration dates were extended (“Extended Grants”). All references to the number of option shares, option exercise prices, and share prices have been adjusted for all subsequent stock splits.

 

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As discussed below, it was determined that the originally assigned grant dates for 8,164 grants were not ascribed the proper measurement dates for accounting purposes. Accordingly, after accounting for forfeitures, stock-based compensation expense of $171.4 million on a pre-tax basis was recognized over the respective awards’ vesting terms for the periods from 1998 to 2006. The adjustments made to reflect the proper measurement dates for accounting purposes were determined by category as follows:

Director Grants: 64 director grants were made on 36 dates during the relevant period. Of the 64 grants, there were 27 grants to directors for which it was determined that the originally determined grant dates preceded or succeeded the measurement dates, 11 grants were in excess of plan parameters, and some of the dates were selected in hindsight based on an advantageous share price. Of the 27 grants with measurement date issues, 26 of the grants involved periods of 5 days or less and resulted in a stock-based compensation expense of less than $100,000 in the aggregate. Revisions to measurement dates for director grants were made where the wrong date was selected based on the requirements of the Director Plan and where incorrect start dates were used for the date the director joined the Board of Directors. The excess grants have been historically honored by the Company. As a result, $0.3 million of stock-based compensation expense was recognized.

Executive Officer Grants: It was determined that for 33 of the grants to executive officers, the originally determined grant dates preceded the measurement dates or the grant dates and exercise prices were subsequently changed. Some of these dates were selected in hindsight based on an advantageous share price. As the stock prices on the originally determined grant dates were lower than the stock prices on the proper measurement date, $28.1 million of stock-based compensation expense was recognized. The revised measurement dates for various executive officer grants were based on Compensation Committee meeting dates, signed UWCs, delayed CEO approval, and for one date the measurement date was based on the date on which the number of options and exercise price were entered into Equity Edge. The authority for 21 grants, which have been historically honored by the Company, is based on the CEO’s presumed authority.

New Hire and Promotion Grants Program: The Company concluded that the new hire and promotion grants made pursuant to the New Hire and Promotion Grants Program within the pre-established guidelines did not require an adjustment, with the exception of the grants made from September 1, 2000 to September 30, 2002. For the 1,728 grants made during that time period, management concluded that the measurement dates occurred only on the dates of the CEO approval. Due to practical difficulties in ascertaining the actual dates of the CEO approval for many new hire and promotion grants in that time period, the measurement date was based on the date on which the number of options and exercise price were entered into Equity Edge. The incremental stock-based compensation expense associated with the New Hire and Promotion Grants during the relevant period was $11.9 million.

Acquisition Grants: After the consummation of certain acquisitions, the Company granted stock options to employees of the acquired entities. It was determined that the measurement dates for 1,180 option grants required revision because the stated grant dates preceded the proper measurement dates and the approval authority was based on CEO approval. Some of these dates were chosen in hindsight based on an advantageous share price. Of the 1,180 grants, 1,048 grants were extinguished as part of the Company’s exchange program which commenced in November 2002. Due to issues associated with the measurement dates for the acquisition grants, $36.2 million of additional stock-based compensation expense was recognized during the relevant period.

Annual Refresh Grants: During the relevant period, 3,782 broad-based grants were made to employees under an annual program (the “Refresh Grants”) for which the originally assigned grant dates were not the proper measurement dates. Some of these dates were chosen in hindsight based on an advantageous share price, and the authority for some of the Refresh Grants was the CEO’s presumed authority. For one of the annual Refresh

 

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(Unaudited)

 

Grants which occurred in August 2000, there was conflicting documentation and inconclusive evidence with respect to the measurement date. It was determined that the most appropriate measurement date, due to the lack of affirmative evidence otherwise, was the date on which the number of options and exercise price were entered into Equity Edge, and based on that date, $19.2 million of stock-based compensation expense was recognized in the period 2000 to 2002. These grants were extinguished in December 2002 as part of the Company’s exchange program which commenced in November 2002. The Company did not approve or process any stock option grants to existing employees during the period of the tender offer or agree or imply that it would compensate employees for any increases in the market price during the tender period. The Review also determined that the annual refresh grants for the years 1999, 2001, 2004, and a portion of the 2003 grant had a measurement date that was later than the date that was originally used. In these cases, where the measurement dates were revised, the authority for the grants varied and included new dates based on UWCs by the Compensation Committee or approvals by the CEO. Where approval was not determinable based on the above, the Company utilized the date on which the number of options and exercise price were entered into Equity Edge. Due to the errors in measurement dates associated with the annual refresh grants, stock-based compensation expense of $55.1 million was recognized.

Off-Cycle Performance Grants: There were 964 performance grants made to employees on March 15, 2001 and October 1, 2003. These dates were chosen in hindsight based on an advantageous share price, and the authority for these grants was the CEO’s de facto authority. The revised measurement dates were based on the dates of the UWC for the March 15, 2001 grant and e-mail correspondence for the October 1, 2003 grant. Due to the errors in measurement dates associated with the off-cycle performance grants, stock-based compensation expense of $5.6 million was recognized.

Extended Grants: During the relevant period, there were 6 stock option extensions (including one to the former CEO described below) whereby an option was extended beyond its expiration or termination date and for which a compensation charge had not been recorded. As a result, $2.1 million of stock-based compensation expense was recognized.

The former CEO received certain options from Network Solutions, Inc. (“NSI”) in his capacity as a NSI director prior to VeriSign’s acquisition of NSI. Upon receiving legal advice, management extended the term of those options beyond their original expiration date. The former CEO exercised those options on May 24, 2002. The Ad Hoc Group reviewed the extension of these options and determined that the legal advice was incorrect and that the options should not have been extended. Upon learning of this determination in January 2007, the former CEO voluntarily paid $174,425 to VeriSign, reflecting the after-tax net profit he received from the exercise of those options.

2002 Retention Grants: Between February and May 2002, the Compensation Committee considered special option grants as a retention incentive for executive officers and other executives and key employees, since in many cases the exercise prices of options previously granted to these individuals were significantly above the then current market price for shares of VeriSign’s common stock. These retention grants are summarized as follows:

Grants to Executive Officers and Other Executives: The Company determined that 68 grants of options for a total of 4,631,000 shares to executive officers and other executives were finalized on April 10, 2002 rather than the stated grant date of February 21, 2002. The Review Team was unable, after review of detailed documentation, including multiple draft versions of the February 12, 2002 Compensation Committee minutes, approval forms (which were undated) and email correspondence, to affirmatively determine when the grants to executive officers and other executives were approved. In accordance with the Company’s measurement date hierarchy for grants described above, the Company determined that April 10, 2002 was the correct measurement

 

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date because that was the date that other grants, including certain executive grants, were entered into Equity Edge. The grant price as of the measurement date was $23.74, the closing market price of the Company’s stock on April 10, 2002. Because the stated exercise price of the grants was set based on the closing market price on February 21, 2002 of $22.71 and preceded the measurement date, an incremental $1.3 million of stock-based compensation expense was recognized.

The Company also determined that the Compensation Committee repriced 1,870,000 of these options on May 24, 2002, with an exercise price of $10.08, the closing market price of the Company’s stock on May 24, 2002. The Company determined that these grants were repriced based on a UWC of the Compensation Committee. The accounting impact of the repricing was not recorded at the time of the Compensation Committee approval and the Company did not properly disclose the circumstances of these grants. In accordance with FIN 44 and after applying variable accounting, the Company recognized incremental stock-based compensation expense of approximately $15.8 million, net of reversals, for the periods between 2002 and 2006.

Grants to Employees: Broad-based employee grants were also considered during the February to May 2002 period. The Review Team determined that the CEO, under his presumed authority, approved 305 broad-based employee grants on or about March 20, 2002 with a grant price of $26.42, the closing market price of the Company’s stock on that date. These awards were communicated shortly thereafter to the employees. The Company determined that March 20, 2002 was a definitive measurement date for the awards to the employees.

The grants to employees previously approved by the CEO on March 20, 2002 were submitted for approval to the Compensation Committee as evidenced in a UWC dated May 24, 2002. The Compensation Committee approved the 305 employee grants with an exercise price of $10.08, the market value of the Company’s common stock on May 24, 2002. Therefore the employee awards were re-priced on that date. Although the awards had been communicated to the employees and disclosed in the Company’s Form 10-Q for the first quarter of 2002, the accounting impact of the repricing was not recorded at the time of the Compensation Committee approval and the Company did not properly disclose the circumstances of these grants. As a result of the repricing, and after applying variable accounting, approximately $6.6 million, net of reversals of additional stock-based compensation expense has been recorded for the periods between 2002 and 2006.

Retention Grants to our former CEO: In the February 12, 2002 Compensation Committee meeting, the Committee considered the number and vesting period of a proposed option award to the CEO. The Review Team found multiple draft versions of the minutes for the February 12, 2002 meeting of the Compensation Committee and concluded that the signed minutes were inaccurate. Attendees at the meeting have different recollections of the business conducted. One draft, unapproved version of those minutes, stated the number of options to be awarded to the CEO was 1,200,000, while the signed version of the minutes approved by the members of the Compensation Committee in late May 2002 stated that the number of options to be awarded was 600,000. Both versions of the minutes stated that the grant date and the exercise price was February 21, 2002 and $22.71. The minutes of a Board meeting held on February 12, 2002, after the Compensation Committee meeting, also indicate that the CEO was awarded 1,200,000 options at the February 12, 2002 Compensation Committee meeting.

The Company has determined that the measurement date for the 1,200,000 options to the CEO was February 12, 2002 with a grant price of $26.31, the closing market price of the Company’s stock on that date, and that the options were repriced on February 21, 2002 with a grant price of $22.71, the closing market price of the Company’s stock on that date. Subsequently, 600,000 options of the 1,200,000 options were repriced on May 24, 2002 with a grant price of $10.08, the closing market price of the Company’s stock on that date. The accounting impact of the repricings was not recorded at the time of the Compensation Committee approval and the Company did not properly disclose the circumstances of these grants. As a result of the repricing, and after applying

 

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variable accounting, approximately $7.5 million, net of reversals, of additional stock-based compensation expense has been recorded for the periods between 2002 and 2006.

Actions Taken by the Board with respect to Grants: As part of the Review, the Board of Directors confirmed all option grants (including those to our former CEO and CFO) that the Review Team concluded had authority issues as legally binding and enforceable obligations of the Company as of the date of such grant. In addition, the Board of Directors has decided to modify the following grants to the former CEO and CFO in 2007 and no reversal of compensation expense was recorded for these negative modifications in the financial statements.

Former CEO: An option grant to the former CEO of 100,000 shares originally dated December 29, 2000 at an exercise price of $74.188 was modified to a new exercise price of $127.31.

Former CEO: The February 2002 option grant to the former CEO of 600,000 shares originally dated February 21, 2002 at an exercise price of $22.71 was modified to a new exercise price of $26.31.

Former CFO: An option grant to the CFO of 25,000 shares originally dated December 29, 2000 at an exercise price of $74.188 was modified to a new exercise price of $127.31.

Former CFO: An option grant to the CFO of 125,000 shares originally dated August 1, 2000 at an exercise price of $151.25 was modified to a new exercise price of $165.22.

Former CFO: An option grant to the CFO of 40,000 shares originally dated March 15, 2001 at an exercise price of $34.438 was modified to a new exercise price of $42.26. The CFO’s 409A tax election described below modified 1,667 of these options and the Board of Directors determined to modify the remaining 38,333 options.

Former CFO: A grant to the CFO of 90,000 shares originally dated September 6, 2001 at an exercise price of $34.16 was modified to a new exercise price of $38.30. The CFO’s 409A tax election described below modified 11,250 of these options and the Board of Directors determined to modify the remaining 78,750 options.

Former CFO: The February 2002 option grant to the CFO of 100,000 shares originally dated February 21, 2002 at an exercise price of $22.71 was modified to a new exercise price of $23.74.

Other: The Company and the Review Team also determined that the former CEO received an option grant in October 1998 for 100,000 shares (95,928 non-qualified stock options (“NQSOs”) and 4,072 incentive stock options (“ISOs”), which split to options for 200,000 shares in May 1999 and then split again to options for 400,000 shares in November 1999 when the Company announced a stock split during those respective periods. The account statements and monthly reporting statements for November 1 and December 1, 2000 showed that the former CEO held options for 400,000 shares at the split-adjusted price of $7.67. However, the Ad Hoc Group determined that sometime between December 1, 2000 and January 1, 2001, the Company erroneously changed the former CEO’s options to reflect the pre-split amount of 100,000 shares instead of 400,000 shares, but at the post-split price of $7.67. The error was never subsequently corrected. Therefore, the former CEO did not receive the benefit of the additional 300,000 options arising from the two stock splits, which expired in 2005. Based on a determination by the Board of Directors after the Ad Hoc Group’s Review in May 2007, the Company has agreed to pay the former CEO $5,459,430, reflecting the gain he would have realized from the exercise of these options prior to their expiration, based on the weighted average price of stock options exercised by the former CEO in August 2005.

 

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The other principal factual findings of the Review’s report included the following:

 

   

The human resources, accounting, and legal departments failed to implement appropriate processes and controls. During 2000 through 2003, the option grant process was characterized by a high degree of informality and relatively little oversight.

 

   

The Review found no evidence that accounting personnel were aware of the deficient practices used in selecting grant dates.

 

   

The Review found instances of incomplete and inaccurate corporate records, including two sets of Committee minutes that were inaccurate.

 

   

The Review found no evidence of fictitious individuals being granted options.

 

   

Options found to be misdated, have a date chosen in hindsight based on an advantageous share price, repriced, or unauthorized with a stated exercise price lower than the share price at the actual approval date will result in adverse tax consequences to the recipients and the Company.

 

   

In light of the Review’s other findings, the Company’s disclosures related to option grants were inaccurate in some respects.

Based on the results of the Review, the Company has recorded additional non-cash stock-based compensation expense (benefit) net of related income tax effects related to past stock option grants of $1.5 million for the first quarter ended March 31, 2006, ($21.6 million) and $36.9 million in fiscal years 2005 and 2004, respectively. These adjustments were recorded based on the evidence and findings from the Ad Hoc Group’s review, including analysis of the measurement dates for the 8,164 stock option grants made on 41 dates during the relevant period that the Review determined were incorrect.

The incremental impact from recognizing stock-based compensation expense resulting from the Ad Hoc Group’s Review of past stock option grants is as follows (dollars in thousands):

 

Fiscal Year

   As
Restated
    As
Previously
Reported
   Pre-Tax
Expense
(Income)
Adjustments
    After Tax
(Income)
Expense
Adjustments
 

1998

   $ 1,288     $ 1,280    $ 8     $ 8  

1999

     7,057       104      6,953       6,953  

2000

     24,814       1,722      23,092       23,092  

2001

     42,500       7,803      34,697       34,697  

2002

     70,066       18,956      51,110       51,110  

2003

     35,010       7,389      27,621       27,621  
                               

Total 1998 – 2003 impact

     180,735       37,254      143,481       143,481  

2004

     46,835       3,136      43,699       36,873  

2005 (2)

     (10,588 )(2)     6,312      (17,670 )     (21,560 )

2006 (1)

     66,285       64,438      1,847 (1)     1,532 (1)
                               

Total

   $ 283,267     $ 111,140    $ 171,357     $ 160,326  
                               

(1) Pre-tax expense adjustments are through March 31, 2006 and represent amounts being reported pursuant to FAS123R whereas all other amounts are reported pursuant to APB25.
(2) Includes $0.8 million of other stock-based compensation adjustments that were unrelated to past stock option grants.

 

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Additionally, the pro forma expense under SFAS 123 in Note 1 in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q has been restated to reflect the impact of these adjustments for the three and nine months ended September 30, 2005.

Tax Implications

VeriSign evaluated the impact of the restatements on its global tax provision and has determined that a portion of the tax benefit relating to stock-based compensation expense formerly associated with stock option deductions is attributable to continuing operations. VeriSign identified deferred tax assets totaling $16.3 million at December 31, 2005 which reflect the benefit of tax deductions from future employee stock option exercises. VeriSign has not realized this or any other deferred tax asset relating to taxing jurisdictions within the United States as of December 31, 2005. See Note 15 of Notes to Condensed Consolidated Financial Statements regarding VeriSign’s realization of United States-based deferred tax assets.

VeriSign also believes that it should not have taken a tax deduction under Internal Revenue Code (IRC) Section 162(m) in prior years for stock option related amounts pertaining to certain executives. Section 162(m) limits the deductibility of compensation above certain thresholds. As a result, VeriSign’s tax net operating losses associated with the stock option intra-period allocation have decreased by $12.6 million. VeriSign continues to apply a valuation allowance to its tax net operating losses relating to stock options exercised prior to the adoption of SFAS 123R, “Share Based Payment.” Pursuant to Footnote 82 of SFAS 123R, VeriSign recognizes financial statement benefit of these tax net operating losses when such losses reduce cash taxes paid.

Section 409A of the Internal Revenue Code (“Section 409A”) imposes significant penalties on individual income taxpayers who were granted stock options that were unvested as of December 31, 2004 and that have an exercise price of less than the fair market value of the stock on the date of grant (“Affected Options”). These tax consequences include income tax at vesting, an additional 20% tax and interest charges. In addition, the issuer of Affected Options must comply with certain reporting and withholding obligations under Section 409A.

These adverse tax consequences may be avoided for unexercised Affected Options if the exercise price of the Affected Option is adjusted to reflect the fair market value at the time the option was granted (as such measurement date is determined for financial reporting purposes). Under Treasury regulations, Affected Options held by an executive officer or directors of VeriSign were to be amended on or before December 31, 2006 to avoid the adverse tax consequences of Section 409A; holders of Affected Options who are not executive officers or directors of VeriSign have until December 31, 2007 to amend their Affected Options to avoid the adverse tax consequences of Section 409A.

Other Matters

As part of the restatement, the Company made other adjustments to previously issued financial statements back to 2002. These adjustments include corrections to revenue, expenses, other income and related income tax adjustments. The adjustments are in addition to the recognition of additional stock compensation expense resulting from the stock option investigation and are fully described in the following restated condensed consolidated balance sheet as of December 31, 2005 and the condensed consolidated statements of income and cash flows for the three and nine months ended September 30, 2005.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents the impact of the financial statement adjustments on the Company’s previously reported condensed consolidated balance sheet as of December 31, 2005:

 

     December 31, 2005  
     As Previously
Reported
    Adjustments     As Restated (1)  
           (In thousands)        
ASSETS       

Current assets:

      

Cash and cash equivalents

   $ 476,826     —       $ 476,826  

Short-term investments

     378,006     —         378,006  

Accounts receivable

     271,883     7,883 (A)     279,766  

Prepaid expenses and other current assets

     80,079     (2,071 )(A)     78,008  

Deferred tax assets

     16,186     (279 )(D)     15,907  

Current assets of discontinued operations

     5,295     —         5,295  
                      

Total current assets

     1,228,275     5,533       1,233,808  
                      

Property and equipment, net

     553,036     5,236 (B)     558,272  

Goodwill

     1,071,910     (2,947 )(B)     1,068,963  

Other intangible assets, net

     225,302     —         225,302  

Restricted cash and investments

     50,972     —         50,972  

Long-term note receivable

     26,419     —         26,419  

Other assets, net

     16,985     —         16,985  
                      

Total long-term assets

     1,944,624     2,289       1,946,913  
                      

Total assets

   $ 3,172,899     7,822     $ 3,180,721  
                      
LIABILITIES AND STOCKHOLDERS’ EQUITY       

Current liabilities:

      

Accounts payable and accrued liabilities

   $ 555,458     12,390 (C)   $ 567,848  

Accrued restructuring costs

     7,440     —         7,440  

Deferred revenue

     368,413     3,153 (A)     371,566  

Current liabilities of discontinued operations

     6,822     —         6,822  
                      

Total current liabilities

     938,133     15,543       953,676  
                      

Long-term deferred revenue

     127,175     —         127,175  

Long-term accrued restructuring costs

     10,876     —         10,876  

Other long-term liabilities

     4,995     —         4,995  

Deferred tax liabilities

     18,560     512 (C)     19,072  
                      

Total long-term liabilities

     161,606     512       162,118  
                      

Total liabilities

     1,099,739     16,055       1,115,794  
                      

Commitments and contingencies

      

Minority interest in subsidiaries

     41,485     —         41,485  

Stockholders’ equity:

      

Preferred stock

     —       —         —    

Common stock

     246     —         246  

Additional paid-in capital

     23,205,261     163,199 (D)     23,368,460  

Unearned compensation

     (13,911 )   (10,288 )(D)     (24,199 )

Accumulated deficit

     (21,147,368 )   (161,144 )(D)(E)     (21,308,512 )

Accumulated other comprehensive loss

     (12,553 )   —         (12,553 )
                      

Total stockholders’ equity

     2,031,675     (8,233 )     2,023,442  
                      

Total liabilities and stockholders’ equity

   $ 3,172,899     7,822     $ 3,180,721  
                      

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

(A) Adjustment to accounts receivable due to the error related to not properly accounting for insurance revenues after Jamba! was acquired. Adjustment to prepaid and other assets was due to the error related to not accounting for software maintenance contracts correctly.
(B) The increase in fixed assets was due to the error in proper accounting treatment for software maintenance contracts. The decrease in goodwill was a result from the understatement of deferred compensation for a 2005 acquisition.
(C) Accounts payable and accrued liabilities increased primarily due to the restatement entries impact from a decrease in income taxes payable which was offset by an increase related to additional liabilities related to the correction of the error with the software maintenance contracts.
(D) The increase additional paid-in-capital was due to the impact of prior period changes to stock-based compensation expenses. The increase to accumulated deficit was primarily due to the impact of prior period changes to stock-based compensation expenses.
(E) Includes prior year’s income statement impact of other matters and stock-based compensation.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents the impact of the financial statement adjustments on the Company’s previously reported condensed consolidated statements of income:

 

     Three Months Ended     Nine Months Ended  
     September 30, 2005     September 30, 2005  
     As Previously
Reported
    Adjustments     As
Restated (1)
    As Previously
Reported
    Adjustments     As
Restated (1)
 
     (In thousands, except per share and per share amounts)  

Revenues

   $ 399,705     $ 1,408 (A)   $ 401,113     $ 1,217,380     $ 6,066 (A)   $ 1,223,446  
                                                

Costs and expenses:

            

Cost of revenues

     126,997       (139 )(B)     126,858       383,617       37 (B)     383,654  

Sales and marketing

     113,960       (627 )(B)     113,333       377,344       (1,344 )(B)     376,000  

Research and development

     25,044       (178 )(B)     24,866       70,075       (233 )(B)     69,842  

General and administrative

     49,642       (10,116 )(B)     39,526       141,416       (16,160 )(B)     125,256  

Restructuring, impairments, and other charges (reversals), net

     537       —         537       (1,471 )     (2,350 )(B)     (3,821 )

Amortization of other intangible assets

     26,235       —         26,235       73,896       —         73,896  

Impairment of other intangible assets

     —         —         —         —         —         —    

Acquired in-process research and development

     1,800       —         1,800       6,100         6,100  
                                                

Total costs and expenses

     344,215       (11,060 )     333,155       1,050,977       (20,050 )     1,030,927  
                                                

Operating income

     55,490       12,468       67,958       166,403       26,116       192,519  

Non-operating income:

            

Minority interest

     (1,221 )     —         (1,221 )     (3,397 )     —         (3,397 )

Other income, net

     14,419       (29 )(C)     14,390       43,780       (495 )(C)     43,285  
                                                

Income from continuing operations before income taxes

     68,688       12,439       81,127       206,786       25,621       232,407  

Income tax expense

     28,993       219       29,212       84,985       5,707       90,692  
                                                

Net income from continuing operations

     39,695       12,220       51,915       121,801       19,914       141,715  

Net income from discontinued operations

     4,879       55 (D)     4,934       13,243       100 (D)     13,343  
                                                

Net income

   $ 44,574     $ 12,275     $ 56,849     $ 135,044     $ 20,014     $ 155,058  
                                                

Basic net income per share from:

            

Continuing operations

   $ 0.15       $ 0.20     $ 0.47       $ 0.55  

Discontinued operations

     0.02         0.02       0.05         0.05  
                                    

Net income

   $ 0.17       $ 0.22     $ 0.52       $ 0.60  
                                    

Diluted net income per share from:

            

Continuing operations

   $ 0.15       $ 0.20     $ 0.46       $ 0.53  

Discontinued operations

     0.02         0.01       0.05         0.05  
                                    

Net income

   $ 0.17       $ 0.21     $ 0.51       $ 0.58  
                                    

Shares used in per share computation:

            

Basic

     260,288         260,369       259,254         259,259  
                                    

Diluted

     266,201         266,079       267,045         266,107  
                                    

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

(A) To properly record $3.8 million in insurance revenues that was incorrectly recorded in the fourth quarter of 2005. Recognition of previously unrecognized revenue related to our Jamba business in EMEA.
(B) A reversal of $2.3 million to restructuring expense was recorded in 2005 to correct a charge that should have been recorded in 2003. The charge was properly recorded in 2003. A net reversal of approximately $6.9 million in stock-based compensation expense as a result of the restatement. Additional expenses include deferred stock-based compensation for the understatement of expense relating to assumed options from the LightSurf acquisition and additional expenses to correct an accounting error related to software maintenance amortization which were partially offset with a benefit for payroll taxes as a result of the restatement.
(C) Primarily due to a foreign exchange loss that resulted from revenue adjustments to our Jamba business in EMEA.
(D) Additional stock-based compensation expense related to our stock option investigation allocated to discontinued operations and change in the effective tax rate.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents the impact of the financial statement adjustments on the Company’s previously reported condensed consolidated statement of cash flows:

 

     Nine Months Ended  
     September 30, 2005  
     As
Previously
Reported
    Adjustments     As
Restated (1)
 
     (In thousands)  

Cash flows from operating activities:

      

Net income

   $ 135,044     $ 20,014     $ 155,058  

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation of property and equipment

     64,930       —         64,930  

Amortization of other intangible assets

     73,896       —         73,896  

Acquired in-process research and development

     6,100       —         6,100  

Provision for doubtful accounts

     1,249       —         1,249  

Stock-based compensation and other

     —         (19,018 )     (19,018 )

Non-cash restructuring, impairments and other charges (reversals)

     146       (2,350 )     (2,204 )

Net gain on sale and impairment of investments

     (8,265 )     —         (8,265 )

Minority interest in net income of subsidiary

     3,397       —         3,397  

Tax benefit associated with stock options

     19,538       —         19,538  

Deferred income taxes

     (8,610 )     91       (8,519 )

Amortization of unearned compensation

     4,344       —         4,344  

Loss on disposal of property and equipment

     186       —         186  

Changes in operating assets and liabilities:

      

Accounts receivable

     (63,048 )     (6,750 )     (69,798 )

Prepaid expenses and other current assets

     (35,546 )     1,209       (34,337 )

Accounts payable and accrued liabilities

     72,271       11,852       84,123  

Deferred revenue

     73,873       1,370       75,243  
                        

Net cash provided by operating activities

     339,505       6,418       345,923  
                        

Cash flows from investing activities:

      

Purchases of investments

     (256,967 )     —         (256,967 )

Proceeds from maturities and sales of investments

     231,136       —         231,136  

Purchases of property and equipment

     (73,255 )     (6,418 )     (79,673 )

Cash paid in business combinations, net of cash acquired

     (66,653 )     —         (66,653 )

Net proceeds received on long-term note receivable and investment

     16,609       —         16,609  

Other assets

     (5,381 )     (302 )     (5,683 )
                        

Net cash used in investing activities

     (154,511 )     (6,720 )     (161,231 )
                        

Cash flows from financing activities:

      

Proceeds from issuance of common stock from option exercises and employee stock purchase plan

     56,644       —         56,644  

Repurchase of common stock

     (257,121 )     302       (256,819 )

Proceeds from sale of stock from consolidated subsidiary

     605       —         605  

Repayment of long-term liabilities

     (1,650 )     —         (1,650 )
                        

Net cash used in financing activities

     (201,522 )     302       (201,220 )
                        

Effect of exchange rate changes on cash and cash equivalents

     (4,169 )     —         (4,169 )
                        

Net decrease in cash and cash equivalents

     (20,697 )     —         (20,697 )

Cash and cash equivalents at beginning of period

     330,641       —         330,641  
                        

Cash and cash equivalents at end of period

     309,944             309,944  

Cash and cash equivalents of discontinued operations

     (2,491 )     —         (2,491 )
                        
   $ 307,453       —       $ 307,453  
                        

Cash flows from discontinued operations:

      

Net cash provided by operating activities

   $ 17,181       —       $ 17,181  
                        

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Note 3. Stock-Based Compensation

Effective January 1, 2006, the Company adopted the provisions of SFAS 123R. See Note 1 for a description of VeriSign’s adoption of SFAS 123R.

Stock Option Plans

The majority of VeriSign’s stock-based compensation expense relates to stock options. Historically, stock options have been granted to broad groups of employees at most levels on a discretionary basis. In the second quarter of 2006, the Compensation Committee, in consultation with other members of the Company’s Board of Directors, resolved to grant restricted stock units ("RSUs") instead of stock options to employees below the director level. Employees at or above the director level continue to be eligible to receive stock options as well as RSUs.

As of September 30, 2006, a total of 58,918,293 shares of common stock were reserved for issuance upon the exercise of stock options and for the future grant of stock options or awards under VeriSign’s equity incentive plans.

On May 26, 2006, the stockholders of VeriSign approved the 2006 Equity Incentive Plan (“2006 Plan”). The 2006 Plan replaces VeriSign’s 1998 Directors Plan, 1998 Equity Incentive Plan, and 2001 Stock Incentive Plan. The 2006 Plan authorizes the award of incentive stock options to employees and non-qualified stock options, restricted stock awards, restricted stock units, stock bonus awards, stock appreciation rights and performance shares to eligible employees, officers, directors, consultants, independent contractors and advisors. Options may be granted at an exercise price not less than 100% of the fair market value of VeriSign’s common stock on the date of grant. The 2006 Plan is administered by the Compensation Committee of the Board of Directors which may delegate to a committee of one or more members of VeriSign’s Board of Directors or VeriSign officers the ability to grant awards and take certain other actions with respect to participants who are not executive officers or non-employee directors. All options have a term of not greater than 10 years from the date of grant. Options issued generally vest 25% on the first anniversary date and ratably over the following 12 quarters. A restricted stock unit is an award covering a number of shares of VeriSign common stock that may be settled in cash or by issuance of those shares, which may consist of restricted stock. Restricted stock units will generally vest in four installments with 25% of the shares vesting on each anniversary of the date of grant over 4 years. The Compensation Committee of the Board of Directors, however, may authorize grants with a different vesting schedule in the future. 27,000,000 shares were authorized and reserved for issuance under the 2006 Plan.

The 2001 Stock Incentive Plan (“2001 Plan”) was terminated upon approval of the 2006 Plan. Options to purchase common stock granted under the 2001 Plan remain outstanding and subject to the vesting and exercise terms of the original grant. The 2001 Plan authorized the award of non-qualified stock options and restricted stock awards to eligible employees, officers who are not subject to Section 16 reporting requirements, contractors and consultants. As of September 30, 2006, no restricted stock awards have been made under the 2001 Plan. Options were granted at an exercise price not less than 100% of the fair market value of VeriSign’s common stock on the date of grant. All options were granted at the discretion of the Board and have a term not greater than 10 years from the date of grant. Options issued generally vest 25% on the first anniversary date and ratably over the following 12 quarters. No further options can be granted under the 2001 Plan.

The 1998 Equity Incentive Plan (“1998 Plan”) was terminated upon approval of the 2006 Plan. Options to purchase common stock granted under the 1998 Plan remain outstanding and subject to the vesting and exercise terms of the original grant. The 1998 Plan authorized the award of options, restricted stock awards, restricted

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

stock units and stock bonuses. Options were granted at an exercise price not less than 100% of the fair market value of VeriSign’s common stock on the date of grant for incentive stock options and 85% of the fair market value for non-qualified stock options. All options were granted at the discretion of the Board and have a term not greater than 7 years from the date of grant. Options issued generally vest 25% on the first anniversary date and ratably over the following 12 quarters. Restricted stock awards and restricted stock units entitle the recipient to receive, at VeriSign’s discretion, shares or cash upon vesting. No further options can be granted under the 1998 Plan.

The 1998 Directors Plan (“Directors Plan”) was terminated upon of the approval of the 2006 Plan. Options to purchase common stock granted under the Directors Plan remain outstanding and subject to the vesting and exercise terms of the original grant. Members of the Board who were not employees of VeriSign, or of any parent, subsidiary or affiliate of VeriSign, were eligible to participate in the Directors Plan. The option grants under the Directors Plan were automatic and non-discretionary, and the exercise price of the options was 100% of the fair market value of the common stock on the date of the grant. Each eligible director was initially granted an option to purchase 25,000 shares on the date he or she first became a director (“Initial Grant”). On each anniversary of a director’s Initial Grant or most recent grant if he or she was ineligible to receive an Initial Grant, each eligible director was automatically granted an additional option to purchase 12,500 shares of common stock if the director had served continuously as a director since the date of the Initial Grant or most recent grant. The term of the options under the Directors Plan is ten years and options vest as to 6.25% of the shares each quarter after the date of the grant, provided the optionee remains a director of VeriSign.

The 1995 Stock Option Plan and the 1997 Stock Option Plan (“1995 and 1997 Plans”) were terminated concurrent with VeriSign’s initial public offering in 1998. Options to purchase common stock granted under the 1995 and 1997 Plans remain outstanding and subject to the vesting and exercise terms of the original grant. All shares that remained available for future issuance under the 1995 and 1997 Plans at the time of their termination were transferred to the 1998 Equity Incentive Plan. No further options can be granted under the 1995 and 1997 Plans. Options granted under the 1995 and 1997 Plans are subject to terms substantially similar to those described below with respect to options granted under the 1998 Equity Incentive Plan.

In connection with its acquisitions in 2005 and 2006, VeriSign assumed some of the acquired companies’ stock options. Options assumed generally have terms of seven to ten years and generally vest over a four-year period, as set forth in the applicable option agreement.

1998 Employee Stock Purchase Plan

As of September 30, 2006, VeriSign has reserved 17,589,449 shares for issuance under the 1998 Employee Stock Purchase Plan (“Purchase Plan”). Eligible employees may purchase common stock through payroll deductions by electing to have between 2% and 15% of their compensation withheld. Each participant is granted an option to purchase common stock on the first day of each 24-month offering period and this option is automatically exercised on the last day of each six-month purchase period during the offering period. The purchase price for the common stock under the Purchase Plan is 85% of the lesser of the fair market value of the common stock on the first day of the applicable offering period or the last day of the applicable purchase period. Offering periods begin on February 1 and August 1 of each year. On January 1 of each year, the number of shares available for grant under the Purchase Plan will automatically be increased by an amount equal to 1% of the outstanding common shares on the immediately preceding December 31.

As of January 2007, the Company suspended the purchase of shares under its Purchase Plan because it was not current in its financial reporting under applicable regulations of the SEC. The Company refunded payroll

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

withholdings from employees in February 2007 for the offering period ended January 31, 2007. As of the date of this report, no further payroll withholdings were made in 2007.

Stock-based Compensation

On March 29, 2005, the SEC published Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staff’s views on a variety of matters relating to stock-based payments. SAB 107 requires stock-based compensation to be classified in the same expense line items as cash compensation. The following table sets forth the total stock-based compensation recognized on the Company’s condensed consolidated statements of operations for the periods presented:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2006    2005     2006    2005  
          As Restated (1)          As Restated (1)  
     (In thousands, except per share data)  

Stock-based compensation:

          

Cost of revenue

   $ 2,911    $ 34     $ 10,221    $ 504  

Sales and marketing

     4,001      (443 )     11,184      (411 )

Research and development

     2,495      (2 )     7,337      437  

General and administrative

     6,481      (10,628 )     18,978      (15,911 )
                              

Total stock-based compensation

     15,888      (11,039 )     47,720      (15,381 )

Tax benefit (expense) associated with stock-based compensation expense

     4,369      (4,173 )     11,882      (5,599 )
                              

Net effect of stock-based compensation expense on net income

   $ 11,519    $ (6,866 )   $ 35,838    $ (9,782 )
                              

Net effect of stock-based compensation expense on net income per share:

          

Basic

   $ 0.05    $ (0.03 )   $ 0.15    $ (0.04 )
                              

Diluted

   $ 0.05    $ (0.03 )   $ 0.15    $ (0.04 )
                              

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

On August 9, 2006, the Company suspended stock option exercises (the “Restriction”) because it was unable to file its Quarterly Report on Form 10-Q for the quarter ended June 30, 2006. Under various stock option plans, option holders must exercise their vested stock options within a certain time period following termination of employment (typically, thirty (30), sixty (60) or ninety (90) days, depending on the plan). Due to the Restriction, certain terminated employees have been unable to exercise their stock options prior to the expiration of this time period following termination of employment. As a result, VeriSign’s Board of Directors approved the following: (i) if the period to exercise the participant’s stock options upon termination of employment has expired prior to the expiration of the Restriction, then such participant’s period to exercise his/her stock options upon termination of employment as set forth in the applicable plan is extended by an additional forty five (45) days after the date the Restriction expires; and (ii) if the period remaining to exercise the participant’s stock options is less than forty five (45) days after the Restriction expires, then such participant’s period to exercise his/her stock options upon termination of employment as set forth in the applicable plan is extended by an additional forty five (45) days minus the days remaining to exercise his/her stock options after the date the

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Restriction expires. During the third quarter of 2006, VeriSign recognized $2.2 million of stock-based compensation expense in connection with this extension of time for option exercise in accordance with SFAS 123R.

Prior to the adoption of SFAS 123R, the Company presented unearned compensation as a separate component of stockholders’ equity. In accordance with the provisions of SFAS 123R, on January 1, 2006 VeriSign reclassified the balance in unearned compensation to additional paid-in capital on its balance sheet.

As of September 30, 2006, total unrecognized compensation cost related to unvested stock options and restricted stock awards was $103.1 million and $35.3 million, respectively, and is expected to be recognized over a weighted-average period of 2.9 years and 3.6 years respectively. Stock-based compensation cost capitalized as part of property and equipment was $0.4 million and $1.2 million for the three and nine months ended September 30, 2006, respectively.

VeriSign currently uses the Black-Scholes option pricing model to determine the fair value of stock options and Purchase Plan options. The determination of the fair value of stock-based payment awards using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables.

The following table sets forth the weighted–average assumptions used to estimate the fair value of the stock options and Purchase Plan options for the periods presented:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2006     2005     2006     2005  

Stock options:

        

Volatility

   41 %   53 %   39 %   57 %

Risk-free interest rate

   4.86 %   3.98 %   4.83 %   3.91 %

Expected term

   3.7 years     3.1 years     3.4 years     3.1 years  

Dividend yield

   zero     zero     zero     zero  

Employee Stock Purchase Plan options:

        

Volatility

   32 %   54 %   33 %   55 %

Risk-free interest rate

   5.21 %   2.68 %   5.09 %   2.51 %

Expected term

   1.25 years     1.25 years     1.25 years     1.25 years  

Dividend yield

   zero     zero     zero     zero  

Under SFAS 123R, VeriSign’s expected volatility is based on the combination of historical volatility of the Company’s common stock over the period commensurate with the expected life of the options and the mean historical implied volatility from traded options. The risk-free interest rates are derived from the average U.S. Treasury constant maturity rates during the period, which approximate the rate in effect at the time of grant for the respective expected term. The expected terms are based on the observed and expected time to post-vesting exercise and/or cancellation of options. VeriSign does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero. Under SFAS 123R, VeriSign estimates forfeitures at the time of grant and revises those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and records stock-based compensation expense only for those awards that are expected to vest.

 

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General Option Information

The following table summarizes stock option activity for the nine months ended September 30, 2006 and for the years ended December 31, 2005 and 2004:

 

    

Nine Months Ended

September 30, 2006

   2005    2004
     Shares    

Weighted-

Average

Exercise

Price

   Shares    

Weighted-

Average

Exercise

Price

   Shares    

Weighted-

Average

Exercise

Price

Outstanding at beginning of period

   35,638,232     $ 31.51    32,878,169     $ 33.74    31,999,664     $ 36.87

Assumed in business combinations

   797,306       1.48    1,645,508       3.71    687,659       4.79

Granted

   6,855,037       20.23    10,053,156       25.95    9,156,123       20.20

Exercised

   (2,466,900 )     12.40    (5,343,504 )     11.48    (4,391,205 )     11.04

Forfeited

   (3,333,169 )     44.76    (2,919,635 )     35.84    (3,971,347 )     46.19

Expired

   (1,731,735 )     35.19    (675,462 )     126.32    (602,725 )     44.62
                          

Outstanding at end of period

   35,758,771       28.59    35,638,232       31.51    32,878,169       33.74
                          

Exercisable at end of period

   23,447,133       33.94    26,404,992       41.36    17,085,569       48.19
                          

Weighted-average fair value of options granted during the period

     $ 6.80      $ 10.80      $ 11.91

Total intrinsic value of options exercised during the period (in thousands)

     $ 26,197      $ 78,731      $ 49,580

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

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The following table summarizes information about stock options outstanding as of September 30, 2006:

 

     Stock Options Outstanding    Stock Options Exercisable

Range of

Exercise Prices

  

Shares

Outstanding

  

Weighted-Average

Remaining

Contractual Life

  

Weighted-Average

Exercise Price

  

Shares

Exercisable

  

Weighted-Average

Exercise Price

$    0.09–$    9.99

   1,935,603    4.12 years    $ 3.95    1,220,519    $ 4.73

$  10.00–$  13.78

   3,057,561    3.19 years      11.75    2,480,052      11.48

$  13.79

   2,260,901    2.42 years      13.79    2,061,601      13.79

$  13.80–$  19.99

   8,956,905    4.58 years      17.46    2,684,167      17.04

$  20.00–$  24.99

   5,931,093    4.55 years      22.77    1,403,265      22.62

$  25.00–$  29.99

   7,865,547    4.19 years      26.72    7,846,368      26.72

$  30.00–$  39.99

   1,959,936    3.50 years      33.91    1,959,936      33.91

$  40.00–$  59.99

   1,537,159    4.34 years      54.67    1,537,159      54.67

$  60.00–$  99.99

   734,502    1.03 years      81.38    734,502      81.38

$100.00–$253.00

   1,519,564    0.81 years      155.03    1,519,564      155.03
                  
   35,758,771    3.91 years      28.59    23,447,133      33.94
                  

Intrinsic value is calculated as the difference between the market value as of September 29, 2006 and the exercise price of the stock options. The closing price of VeriSign’s stock was $20.20 on September 29, 2006, as reported by the NASDAQ Global Select Market. The aggregate intrinsic value of stock options outstanding and stock options exercisable with an exercise price below $20.20 as of September 30, 2006 was $96.3 million and $62.2 million, respectively. The weighted-average remaining contractual life for stock options exercisable at September 30, 2006 was 3.38 years.

The following table summarizes unvested restricted stock award activity for the nine months ended September 30, 2006 and for the years ended December 31, 2005 and 2004:

 

    

Nine Months Ended

September 30, 2006

   2005    2004
     Shares    

Weighted-

Average

Grant-Date

Fair Value

   Shares    

Weighted-

Average

Grant-Date

Fair Value

   Shares   

Weighted-

Average

Grant-Date

Fair Value

Unvested at beginning of period

   322,433     $ 27.97    275,000     $ 22.20    150,000    $ 12.88

Granted

   1,724,807       18.44    222,683       25.26    125,000      33.38

Released

   (15,198 )     28.55    (166,250 )     14.88    —        —  

Forfeited

   (59,597 )     22.03    (9,000 )     26.40    —        —  
                         
   1,972,445       19.81    322,433       27.97    275,000      22.20
                         

Upon exercise of stock options or vesting of restricted stock awards, VeriSign will issue common stock. To cover the minimum statutory tax withholding requirements, the Company will place a sufficient portion of vested restricted stock awards into treasury and make a cash payment to the Internal Revenue Service and state tax authorities to cover the applicable withholding taxes.

Stock Option Acceleration

On December 29, 2005, the Board of Directors of VeriSign approved the acceleration of the vesting of unvested and “out-of-the-money” stock options that had an exercise price per share in excess of $24.99, all of

 

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which were previously granted under VeriSign’s stock option plans and that were outstanding on December 29, 2005. Options to purchase approximately 8.8 million shares of common stock or 47% of the total outstanding unvested options on December 29, 2005 were subject to the acceleration. The options accelerated included certain options previously granted to executive officers and directors of VeriSign.

The acceleration was accompanied by restrictions imposed on any shares purchased through the exercise of accelerated options. Those restrictions will prevent the sale of any such shares prior to the date such shares would have originally vested had the optionee been employed on such date (whether or not the optionee is actually an employee at that time).

The purpose of the accelerated vesting was to enable the Company to reduce compensation expense associated with these options in future periods, beginning with the first quarter of 2006, in its condensed consolidated financial statements, pursuant to SFAS 123R. The acceleration of the vesting of these options did not result in a charge to expenses in 2005.

Note 4. Business Combinations

GeoTrust

On September 1, 2006, VeriSign completed its acquisition of GeoTrust, Inc. (“GeoTrust”), a Needham, Massachusetts based supplier of SSL and other solutions to secure e-business transactions. VeriSign’s purchase price of $127.4 million consisted of approximately $125.3 million in cash consideration and $2.1 million in direct transaction costs. The acquisition has been accounted for as a purchase and, accordingly, the total purchase price has been allocated to the tangible and intangible assets acquired and the liabilities assumed based on their respective fair values on the acquisition date. GeoTrust’s results of operations have been included in the consolidated financial statements from the date of acquisition. As a result of the acquisition of GeoTrust, VeriSign recorded goodwill of $100.1 million and other intangible assets of $29.5 million, which have been assigned to the Internet Services Group segment. The goodwill represents the excess value over both tangible and intangible assets acquired. The goodwill in this transaction is attributable to the anticipated ability to better serve the reseller channel with technologies and services that are specifically tailored to individual needs. None of the goodwill for GeoTrust is expected to be deductible for tax purposes. The overall weighted-average life of the identified amortizable assets acquired in the purchase of GeoTrust is 5.4 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives.

The in-process research and development acquired in the GeoTrust acquisition consisted primarily of research and development efforts required to develop the acquired in-process technology.

VeriSign determined the fair value of the acquired in-process research and development by estimating the projected cash flows related to the project or service and future revenues to be earned upon commercialization of the service. VeriSign discounted the resulting cash flows back to their net present values. VeriSign based the net cash flows from such projects on its analysis of the respective markets and estimates of revenues and operating profits related to these projects. The in-process research and development is expensed upon acquisition because they have no future alternative uses.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The allocation of the purchase price to the assets acquired and liabilities assumed based on the estimated fair value of GeoTrust was as follows:

 

    

September 1,

2006

   

Weighted
Average
Amortization

Period

     (In thousands)     (Years)

Current assets

   $ 7,819    

Long-term assets

     24,635    

Goodwill

     100,081    

Customer relationships

     12,450     6

Existing technology

     6,940     5

Non-compete agreement

     3,100     3

In-process research and development

     1,200    

Trade name

     5,800     6
          

Total assets acquired

     162,025    
          

Liabilities assumed

     (34,602 )  
          

Net assets acquired

   $ 127,423    
          

m-Qube

On May 1, 2006, VeriSign completed its acquisition of m-Qube, Inc. (“m-Qube”), a Watertown, Massachusetts based privately held mobile channel enabler that helps companies develop, deliver and bill for mobile content, applications and messaging services. VeriSign’s purchase price of $269.2 million for all of the outstanding capital stock and vested options of m-Qube consisted of approximately $266.0 million in cash consideration and $2.4 million in direct transaction costs. VeriSign also assumed $0.8 million of unvested stock options of m-Qube. The acquisition has been accounted for as a purchase and, accordingly, the total purchase price has been allocated to the tangible and intangible assets acquired and the liabilities assumed based on their respective fair values on the acquisition date. m-Qube’s results of operations have been included in the consolidated financial statements from the date of acquisition. As a result of the acquisition of m-Qube, VeriSign recorded goodwill of $160.0 million and other intangible assets of $98.2 million, which have been assigned to the Communications Services Group segment. The goodwill represents the excess value over both tangible and intangible assets acquired. The goodwill in this transaction is attributable to the anticipated ability to provide an end-to-end technology platform, carrier relationships and value-added services to consumer facing companies and their service providers to use wireless broadband as a content delivery, marketing and communications channel. None of the goodwill for m-Qube is expected to be deductible for tax purposes. The overall weighted-average life of the identified amortizable assets acquired in the purchase of m-Qube is 5.3 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives.

The in-process research and development acquired in the m-Qube acquisition consisted primarily of research and development efforts required for the completion of all planning, design, development, and test activities that are necessary to establish that the product or service can be produced to meet its design specifications including features, functions, and performance.

VeriSign determined the fair value of the acquired in-process research and development by estimating the projected cash flows related to the project or service and future revenues to be earned upon commercialization of the service. VeriSign discounted the resulting cash flows back to their net present values. VeriSign based the net

 

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(Unaudited)

 

cash flows from such projects on its analysis of the respective markets and estimates of revenues and operating profits related to these projects. The in-process research and development is expensed upon acquisition because they have no future alternative uses.

The allocation of the purchase price to the assets acquired and liabilities assumed based on the estimated fair value of m-Qube was as follows:

 

    

May 1,

2006

   

Weighted
Average
Amortization

Period

     (In thousands)     (Years)

Current assets

   $ 76,061    

Long-term assets

     4,304    

Goodwill

     159,978    

Carrier relationships

     36,300     7

Existing technology

     35,700     5

Non-compete agreement

     10,600     2

Content provider relationship

     8,000     5

In-process research and development

     4,600    

Trade name

     3,000     1
          

Total assets acquired

     338,543    
          

Liabilities assumed

     (69,353 )  
          

Net assets acquired

   $ 269,190    
          

Kontiki

On March 14, 2006, VeriSign completed its acquisition of Kontiki, Inc. (“Kontiki”), a Sunnyvale, California-based provider of broadband content services. VeriSign’s purchase price of $59.6 million for all of the outstanding capital stock and vested options of Kontiki consisted of approximately $57.1 million in cash consideration and $2.3 million in direct transaction costs. VeriSign also assumed $0.2 million of unvested stock options of Kontiki. The acquisition has been accounted for as a purchase and, accordingly, the total purchase price has been allocated to the tangible and intangible assets acquired and the liabilities assumed based on their respective fair values on the acquisition date. Kontiki’s results of operations have been included in the consolidated financial statements from the date of acquisition. As a result of the acquisition of Kontiki, VeriSign recorded goodwill of $23.6 million and other intangible assets of $33.5 million, which have been assigned to the Communications Services Group segment. The goodwill represents the excess value over both tangible and intangible assets acquired. The goodwill in this transaction is attributable to the anticipated ability to expedite large file downloads on the Internet. None of the goodwill for Kontiki is expected to be deductible for tax purposes. The overall weighted-average life of the identified amortizable assets acquired in the purchase of Kontiki is 6.4 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives.

The in-process research and development acquired in the Kontiki acquisition consisted primarily of research and development efforts required for the completion of all planning, design, development, and test activities that are necessary to establish that the product or service can be produced to meet its design specifications including features, functions, and performance.

 

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(Unaudited)

 

VeriSign determined the fair value of the acquired in-process research and development by estimating the projected cash flows related to the project or service and future revenues to be earned upon commercialization of the service. VeriSign discounted the resulting cash flows back to their net present values. VeriSign based the net cash flows from such projects on its analysis of the respective markets and estimates of revenues and operating profits related to these projects. The in-process research and development is expensed upon acquisition because they have no future alternative uses.

The allocation of the purchase price to the assets acquired and liabilities assumed based on the estimated fair value of Kontiki was as follows:

 

    

March 14,

2006

   

Weighted
Average
Amortization

Period

     (In thousands)     (Years)

Current assets

   $ 3,368    

Long-term assets

     1,648    

Goodwill

     23,562    

Customer relationships

     6,100     8

Existing technology

     7,000     7

Core technology

     3,000     7

In-process research and development

     10,000    

Non-compete agreement

     1,600     2

Trade name

     5,400     5

Customer contracts

     400     1
          

Total assets acquired

     62,078    
          

Liabilities assumed

     (2,433 )  
          

Net assets acquired

   $ 59,645    
          

3united Mobile Solutions

On February 28, 2006, VeriSign completed its acquisition of 3united Mobile Solutions ag (“3united”), a Vienna, Austria-based provider of wireless application services. VeriSign’s purchase price of $71.2 million for approximately 99.8% of the outstanding capital stock of 3united consisted of approximately $70.1 million in cash consideration, and $1.1 million in direct transaction costs. The acquisition has been accounted for as a purchase and, accordingly, the total purchase price has been allocated to the tangible and intangible assets acquired and the liabilities assumed based on their respective fair values on the acquisition date. 3united’s results of operations have been included in the consolidated financial statements from the date of acquisition. As a result of the acquisition of 3united, VeriSign recorded goodwill of $48.3 million and other intangible assets of $26.7 million, which have been assigned to the Communications Services Group segment. The goodwill represents the excess value over both tangible and intangible assets acquired. The goodwill in this transaction is attributable to the anticipated ability to bundle different applications to engage and drive consumers to higher value services such as content, chat or mCommerce. Under Austrian tax law a portion of the goodwill is deductible for tax purposes. The overall weighted-average life of the identified amortizable assets acquired in the purchase of 3united is 6.6 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives.

 

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(Unaudited)

 

The allocation of the purchase price to the assets acquired and liabilities assumed based on the estimated fair value of 3united was as follows:

 

    

February 28,

2006

   

Weighted
Average
Amortization

Period

     (In thousands)     (Years)

Current assets

   $ 8,365    

Long-term assets

     372    

Goodwill

     48,316    

Customer relationships

     5,050     7

Existing technology

     9,720     6

Core technology

     8,200     8

Development contracts

     2,810     6

Non-compete agreement

     450     2

Trade name

     160     1

Order backlog

     340     1
          

Total assets acquired

     83,783    
          

Liabilities assumed

     (12,606 )  
          

Net assets acquired

   $ 71,177    
          

CallVision

On January 24, 2006, VeriSign completed its acquisition of CallVision, Inc. (“CallVision”), a Seattle, Washington-based privately held provider of online analysis applications for mobile communications customers. VeriSign’s purchase price of $38.7 million for all of the outstanding capital stock and vested options of CallVision consisted of approximately $38.1 million in cash consideration and $0.5 million in direct transaction costs. VeriSign also assumed $0.1 million of unvested stock options of CallVision. The acquisition has been accounted for as a purchase and, accordingly, the total purchase price has been allocated to the tangible and intangible assets acquired and the liabilities assumed based on their respective fair values on the acquisition date. CallVision’s results of operations have been included in the consolidated financial statements from the date of acquisition. As a result of the acquisition of CallVision, VeriSign recorded goodwill of $18.0 million and other intangible assets of $12.5 million, which have been assigned to the Communications Services Group segment. The goodwill represents the excess value over both tangible and intangible assets acquired. The goodwill in this transaction is attributable to the anticipated ability to provide online customer self-service with a single view of billing across multiple systems and vendors. None of the goodwill for CallVision is expected to be deductible for tax purposes. The overall weighted-average life of the identified amortizable assets acquired in the purchase of CallVision is 6.3 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives.

The in-process research and development acquired in the CallVision acquisition consisted primarily of research and development efforts required for the completion of all planning, design, development, and test activities that are necessary to establish that the product or service can be produced to meet its design specifications including features, functions, and performance.

VeriSign determined the fair value of the acquired in-process research and development by estimating the projected cash flows related to the project or service and future revenues to be earned upon commercialization of

 

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the service. VeriSign discounted the resulting cash flows back to their net present values. VeriSign based the net cash flows from such projects on its analysis of the respective markets and estimates of revenues and operating profits related to these projects. The in-process research and development is expensed upon acquisition because they have no future alternative uses.

The allocation of the purchase price to the assets acquired and liabilities assumed based on the estimated fair value of CallVision was as follows:

 

    

January 24,

2006

   

Weighted
Average
Amortization

Period

     (In thousands)     (Years)

Current assets

   $ 10,737    

Long-term assets

     1,045    

Goodwill

     18,015    

Customer relationships

     4,700     8

Existing technology

     2,290     4

Core technology

     2,600     8

Non-compete agreement

     620     2

In-process research and development

     500    

Customer contracts

     1,800     4
          

Total assets acquired

     42,307    
          

Liabilities assumed

     (3,600 )  
          

Net assets acquired

   $ 38,707    
          

Other Acquisitions

In addition to the above, VeriSign also acquired two other companies during 2006 for an aggregate purchase price of approximately $25.4 million. These acquisitions were not material on an individual basis or in the aggregate.

All of the Company’s 2006 acquisitions results of operations for periods prior to the date of acquisition were not material on an individual basis or in the aggregate when compared with VeriSign’s consolidated results.

Note 5. Discontinued Operations

On November 18, 2005, the Company completed the sale of certain assets related to its payment gateway business pursuant to an Asset Purchase Agreement, dated October 10, 2005 (the “Agreement”), among PayPal, Inc., PayPal International Limited (collectively, “PayPal”), a wholly owned subsidiary of eBay Inc. Under the Agreement, PayPal acquired certain assets related to VeriSign’s payment gateway business and assumed certain liabilities related thereto for $370 million in cash. The payment gateway business was part of the Internet Services Group segment.

The Company determined that the disposed payment gateway business should be accounted for as discontinued operations in accordance with SFAS 144, “Accounting for the Disposal of or Impairment of Long-Lived Assets”. Consequently, the results of operations of the payment gateway business have been excluded from

 

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(Unaudited)

 

the Company’s results from continuing operations for all periods presented and have instead been presented as discontinued operations.

In connection with the sale of the payment gateway business, the Company entered into a Transitional Service Agreement (“TSA”) with PayPal to provide certain transitional network and customer support services. The related fees are recorded as a direct reduction to the respective costs and expenses included in discontinued operations. The expected cash flows under the TSA do not represent a significant continuation of the direct cash flows of the disposed payment gateway business. In April 2006, PayPal elected to terminate the customer support services provided by VeriSign under the TSA. In September 2006, PayPal elected to terminate the billing services, production services and other transitional services provided under the TSA.

The following table represents revenues from the disposed payment gateway business and the components of earnings from discontinued operations for the three and nine months ended September 30, 2006 and 2005:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2006     2005     2006     2005  
           As Restated (1)           As Restated (1)  
     (In thousands)  

Revenues (A)

   $ (120 )   $ 15,061     $ (89 )   $ 43,207  
                                

Income from disposed payment gateway business (B)

     167       7,381       1,067       19,960  

Income tax expense

     —         (2,447 )     —         (6,617 )
                                

Net income from discontinued operations, net of tax

   $ 167     $ 4,934     $ 1,067     $ 13,343  
                                

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

(A) Revenues for the three and nine months ended September 30, 2006 is negative as a result of net returns for the periods.
(B) Fees paid by PayPal for certain transitional network and other services provided by VeriSign are recorded as an offset to the respective costs and expenses for the three and nine months ended September 30, 2006.

The following table presents the carrying amounts of major classes of assets and liabilities relating to the payment gateway business at September 30, 2006 and December 31, 2005:

 

    

September 30,

2006

  

December 31,

2005

          As Restated (1)
     (In thousands)

Assets:

     

Cash and cash equivalents

   $ 4,997    $ 1,834

Accounts receivable, net

     692      1,931

Prepaid expenses and other current assets

     —        1,530
             

Total current assets of discontinued operations

   $ 5,689    $ 5,295
             

Liabilities:

     

Accounts payable and accrued liabilities

   $ 4,997    $ 6,822
             

Total current liabilities of discontinued operations

   $ 4,997    $ 6,822
             

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Note 6. Restructuring, Impairments, and Other (Reversals) Charges, net

2003 Restructuring Plan

In November 2003, VeriSign initiated a restructuring plan related to the sale of its Network Solutions business and the realignment of other business units. The restructuring plan resulted in reductions in workforce, abandonment of excess facilities, disposals of property and equipment, impairments, and other charges.

2002 Restructuring Plan

In April 2002, VeriSign initiated a plan to restructure its operations to rationalize, integrate and align resources. This restructuring plan included workforce reductions, abandonment of excess facilities, write-offs of abandoned property and equipment, impairments, and other charges.

To date, VeriSign has recorded $161.1 million in restructuring, impairment and other charges (reversals), net under its 2003 and 2002 restructuring plans.

Consolidated net restructuring, impairment, and other charges (reversals) associated with the 2002 and 2003 restructuring plans for the three and nine months ended September 30, 2006 and 2005 are as follows:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
     2006     2005    2006     2005  
           As Restated (1)          As Restated (1)  
     (In thousands)  

Workforce reduction

   $ —       $ —      $ (107 )   $ (1 )

Excess facilities

     (84 )     537      (6,108 )     (3,770 )

Exit costs

     —         —        (13 )     (23 )
                               

Subtotal

     (84 )     537      (6,228 )     (3,794 )

Impairment and other charges (reversals)

     —         —        1,949       (27 )
                               

Net restructuring, impairment, and other (reversals) charges

   $ (84 )   $ 537    $ (4,279 )   $ (3,821 )
                               

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

During the nine months ended September 30, 2006, VeriSign recorded a net reversal of approximately $4.3 million primarily due to an early termination of an existing facility in which VeriSign had previously estimated a significant vacancy period in its projection of sublease income. During the nine months ended September 30, 2005, VeriSign recorded a net reversal of $3.8 million related to excess facilities, primarily in connection with a decision to utilize and build a facility that VeriSign had treated as abandoned and for which it had previously recorded a restructuring charge.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

At September 30, 2006, the accrued restructuring costs associated with the 2003 and 2002 restructuring plans were $6.3 million and consisted of the following:

 

    

Accrued

Restructuring

Costs at

December 31,

2005

  

Reversals and

Adjustments to

Restructuring

Charges

   

Non-Cash

Additions

to the

Accrual

  

Cash

Payments

   

Accrued

Restructuring

Costs at

September 30,

2006

     As Restated (1)                      
          (In thousands)      

Workforce reduction

   $ 107    $ (107 )   $ —      $ —       $ —  

Excess facilities

     18,054      (6,108 )     19      (5,832 )     6,133

Exit costs

     134      (13 )     26        147
                                    

Subtotal

     18,295      (6,228 )     45      (5,832 )     6,280

Other charges (reversals)

     21      (1 )     —        (20 )     —  
                                    

Total accrued restructuring costs

   $ 18,316    $ (6,229 )   $ 45    $ (5,852 )   $ 6,280
                                    

Included in current portion of accrued restructuring costs

   $ 7,440           $ 4,529
                    

Included in long-term portion of accrued restructuring costs

   $ 10,876           $ 1,751
                    

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

Cash payments totaling approximately $6.2 million related to the abandonment of excess facilities under both restructuring plans will be paid over the respective lease terms, the longest of which extends through 2008. The present value of future cash payments related to lease terminations due to the abandonment of excess facilities is expected to be as follows:

 

    

Contractual

Lease

Payments

  

Anticipated

Sublease

Income

    Net
     (In thousands)

2006 (remaining 3 months)

   $ 1,589    $ (11 )   $ 1,578

2007

     3,658      (39 )     3,619

2008

     936      —         936
                     
   $ 6,183    $ (50 )   $ 6,133
                     

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Note 7. Goodwill and Other Intangible Assets

The following table summarizes the changes in the carrying amount of goodwill as allocated to the Company’s operating segments during the nine months ended September 30, 2006:

 

    

Internet

Services

Group

  

Communications

Services

Group

   Total
     (In thousands)

Balance at December 31, 2005

   $ 304,060    $ 764,903    $ 1,068,963

CallVision acquisition

     —        18,015      18,015

3united acquisition

     —        48,316      48,316

Kontiki acquisition

     —        23,558      23,558

m-Qube acquisition

     —        159,978      159,978

GeoTrust acquisition

     100,081      —        100,081

Other acquisitions and adjustments

     22,821      191      23,012
                    

Balance at September 30, 2006

   $ 426,962    $ 1,014,961    $ 1,441,923
                    

Goodwill related to other acquisitions and adjustments was primarily due to $18.9 million related to two acquisitions that occurred in the nine months ended September 30, 2006. The two acquisitions were not material on an individual basis or in the aggregate. The additional $4.1 million in adjustments was related to acquisitions that occurred in 2005. These adjustments are primarily a result of income tax adjustments, adjustments for vested stock options, other additions or reductions that were determined after the initial purchase, and foreign exchange fluctuations.

Purchased goodwill is not amortized but is subject to testing for impairments on at least an annual basis. VeriSign performed its most recent annual impairment test as of June 30, 2006. The fair value of VeriSign’s reporting units is determined using either the income or the market valuation approach or a combination thereof. Under the income approach, the fair value of the reporting unit is based on the present value of estimated future cash flows that the reporting unit is expected to generate over its remaining life. Under the market approach, the value of the reporting unit is based on an analysis that compares the value of the reporting unit to values of publicly traded companies in similar lines of business. In the application of the income and market valuation approaches, VeriSign is required to make estimates of future operating trends and judgments on discount rates and other variables. Actual future results related to assumed variables could differ from these estimates. There was no impairment charges to goodwill from the annual impairment tests conducted as of June 30, 2006 or 2005.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

VeriSign’s other intangible assets are comprised of:

 

     As of September 30, 2006
    

Gross

Carrying

Value

  

Accumulated

Amortization

and

Impairment

   

Net

Carrying

Value

     (In thousands)

Customer relationships

   $ 451,995    $ (332,933 )   $ 119,062

Technology in place

     236,886      (130,530 )     106,356

Carrier relationships

     64,000      (12,894 )     51,106

Non-compete agreement

     26,699      (10,494 )     16,205

Trade name

     33,961      (9,309 )     24,652

Other

     9,950      (1,472 )     8,478
                     

Total other intangible assets

   $ 823,491    $ (497,632 )   $ 325,859
                     
     As of December 31, 2005
    

Gross

Carrying

Value

  

Accumulated

Amortization

and

Impairment

   

Net

Carrying

Value

     As Restated (1)
     (In thousands)

Customer relationships

   $ 421,707    $ (293,312 )   $ 128,395

Technology in place

     166,355      (114,650 )     51,705

Carrier relationships

     27,700      (7,271 )     20,429

Non-compete agreement

     20,828      (12,679 )     8,149

Trade name

     19,870      (4,856 )     15,014

Other

     1,950      (340 )     1,610
                     

Total other intangible assets

   $ 658,410    $ (433,108 )   $ 225,302
                     

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

Fully amortized other intangible assets are not included in the above tables. For the three months ended September 30, 2006 and 2005, amortization of other intangible assets was $31.0 million and $26.2 million, respectively. Amortization of other intangible assets was $90.8 million and $73.9 million for the nine months ended September 30, 2006 and 2005, respectively.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Impairment of other intangible assets

During the nine months ended September 30, 2006, VeriSign wrote off approximately $2.0 million of other intangible assets specifically related to abandoned technology acquired for a specific customer.

Estimated future amortization expense related to other intangible assets at September 30, 2006 is as follows:

 

     (In thousands)

2006 (remaining 3 months)

   $ 31,211

2007

     115,589

2008

     55,469

2009

     47,303

2010

     35,366

2011

     20,745

Thereafter

     20,176
      
   $ 325,859
      

Note 8. Other Balance Sheet Items

Prepaid expenses and other current assets

Prepaid expenses and other current assets consist of the following:

 

     September 30,
2006
   December 31,
2005
          As Restated (1)
     (In thousands)

Prepaid expenses

   $ 87,485    $ 55,836

Other current assets

     62,310      22,172

Securities litigation receivable (2)

     80,000      —  
             

Prepaid expenses and other current assets

   $ 229,795    $ 78,008
             

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

(2) A corresponding amount of $80.0 million is also included in accounts payable and accrued liabilities in the accompanying Condensed Consolidated Balance Sheets, as of June 30, 2006. VeriSign recorded the $80.0 million receivable from the insurers related to reimbursement for the settlement of the Securities Litigation and Derivative Litigation. Under terms of the settlement, the Company and its directors and officers will pay $80.0 in settlement of the lawsuits.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Property and equipment, net

Property and equipment, net consist of the following:

 

    

September 30,

2006

    December 31,
2005
 
           As Restated (1)  
     (In thousands)  

Land

   $ 222,661     $ 222,516  

Buildings

     88,595       74,467  

Computer equipment and purchased software

     664,046       573,536  

Office equipment, furniture and fixtures

     28,651       26,831  

Leasehold improvements

     84,957       84,468  
                
     1,088,910       981,818  

Less accumulated depreciation and amortization

     (497,284 )     (423,546 )
                

Property and equipment, net

   $ 591,626     $ 558,272  
                

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

Accounts Payable and Accrued Liabilities

Accounts payable and accrued liabilities consist of the following:

 

    

September 30,

2006

   December 31,
2005
          As Restated (1)
     (In thousands)

Accounts payable

   $ 29,061    $ 68,293

Employee compensation

     84,155      89,871

Customer deposits

     72,185      27,822

Taxes payable and other tax liabilities

     247,548      229,770

Other accrued liabilities

     178,087      152,092

Securities litigation payable (2)

     80,000     
             
   $ 691,036    $ 567,848
             

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

(2) A corresponding amount of $80.0 million is also included in other current assets in the accompanying Condensed Consolidated Balance Sheets, as of June 30, 2006. VeriSign recorded the $80.0 million payable to account for the settlement of the Securities Litigation and Derivative Litigation. Under terms of the settlement, the Company and its directors and officers will pay $80.0 in settlement of the lawsuits, and will be reimbursed by its insurers.

Note 9. Restricted Cash and Investments

As of September 30, 2006 and December 31, 2005, restricted cash and investments included $45.0 million of cash related to a trust established during 2004 for VeriSign’s director and officer liability self-insurance coverage. Additionally, as of September 30, 2006 and December 31, 2005, VeriSign has pledged approximately $4.0 million and $6.0 million, respectively, as collateral for standby letters of credit that guarantee certain of its contractual obligations, primarily relating to its real estate lease agreements, the longest of which is expected to mature in 2014.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Note 10. Comprehensive Income

Comprehensive income consists of net income adjusted for unrealized gains and losses on marketable securities classified as available-for-sale and foreign currency translation adjustments.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2006     2005     2006    2005  
           As Restated (1)          As Restated (1)  
     (In thousands)  

Net income

   $ 15,274     $ 56,849     $ 408,547    $ 155,058  

Change in unrealized loss on investments, net of tax

     1,909       (2,223 )     2,566      (3,102 )

Foreign currency translation adjustments

     (581 )     (1,567 )     1,608      (3,257 )
                               

Comprehensive income

   $ 16,602     $ 53,059     $ 412,721    $ 148,699  
                               

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

Note 11. Credit Facility

On June 7, 2006, VeriSign entered into a credit agreement (the “Credit Agreement”) with a syndicate of banks and other financial institutions related to a $500 million senior unsecured revolving credit facility (the “Facility”), under which VeriSign, or certain designated subsidiaries may be borrowers. As of September 30, 2006, $199.0 million was borrowed under the Facility.

Loans bear interest at a rate per annum equal to, at the election of VeriSign, the Adjusted LIBOR Rate, plus a margin of between 0.50% and 1.025%, depending on VeriSign’s ratio of funded indebtedness to EBITDA as calculated pursuant to the Credit Agreement (the “Leverage Ratio”), or the higher of the prime rate, as announced from time to time by Bank of America, N.A., and the Federal Funds rate plus 0.50%. If the Company elects the Adjusted LIBOR Rate, interest is payable at maturity. If the Company elects the higher of the prime rate and the Federal Funds rate plus 0.50%, interest is paid quarterly. In addition, VeriSign is required to pay the lenders under the Credit Agreement a commitment fee at a rate per annum of between 0.125% and 0.225%, depending on the Leverage Ratio, payable quarterly in arrears. The interest rate at September 30, 2006 was 5.96%.

The Credit Agreement contains certain affirmative and negative covenants. Affirmative covenants include, among others, financial and other reporting obligations, maintenance of existence, payment of obligations, maintenance of properties, maintenance of insurance, compliance with laws, maintenance of books and records, and maintenance of approvals and authorizations. Negative covenants include, among others, limitations on incurrence of liens, limitations on investments, limitations on incurrence of additional indebtedness, limitations on mergers and acquisitions, limitations on asset sales, limitations on dividends, share redemptions and other restricted payments, limitations on changing its business, limitations on entering into certain types of burdensome agreements and limitations on transactions with affiliates. The Credit Agreement includes two financial covenants, including maintaining the ratio of consolidated EBITDA to consolidated interest charges above 2.50:1.00 for any four fiscal quarters, and maintaining the Leverage Ratio below 3.00:1.00 at any time during any period of four fiscal quarters. The required Lenders under the Facility have waived our compliance with these requirements through July 13, 2007.

The Facility terminates on June 7, 2011 at which time outstanding borrowings under the Facility are due. VeriSign may optionally prepay loans under the Credit Agreement other than Competitive Bid Loans at any time, without penalty, subject to reimbursement of certain costs in the case of LIBOR borrowings.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

As of the date of the filing of this report, VeriSign is not in compliance with certain covenants.

Note 12. Calculation of Net Income Per Share

Basic net income per share is computed by dividing net income (numerator) by the weighted-average number of shares of common stock outstanding (denominator) during the period. Diluted net income per share gives effect to dilutive common equivalent shares, including unvested stock options, employee stock purchases, unvested restricted stock awards, and warrants using the treasury stock method.

The following table represents the computation of basic and diluted net income per share:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2006    2005    2006    2005
          As Restated (1)         As Restated (1)
     (In thousands, except per share data)

Net income:

           

Net income from continuing operations

   $ 15,107    $ 51,915    $ 407,480    $ 141,715

Net income from discontinued operations, net of taxes

     167      4,934      1,067      13,343
                           

Net income

   $ 15,274    $ 56,849    $ 408,547    $ 155,058
                           

Weighted-average shares:

           

Weighted-average common shares outstanding

     243,536      260,369      244,620      259,259

Weighted-average potential common shares outstanding:

           

Stock options

     1,965      5,570      2,241      6,641

Unvested restricted stock awards

     79      55      47      89

Other

     77      85      97      118
                           

Shares used to compute diluted net income per share

     245,657      266,079      247,005      266,107
                           

Net income per share:

           

Basic:

           

Net income from continuing operations

   $ 0.06    $ 0.20    $ 1.67    $ 0.55

Net income from discontinued operations

     —        0.02      —        0.05
                           
   $ 0.06    $ 0.22    $ 1.67    $ 0.60
                           

Diluted:

           

Net income from continuing operations

   $ 0.06    $ 0.20    $ 1.65    $ 0.53

Net income from discontinued operations

     —        0.01      —        0.05
                           
   $ 0.06    $ 0.21    $ 1.65    $ 0.58
                           

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Weighted-average potential common shares do not include stock options with an exercise price that exceeded the average fair market value of VeriSign’s common stock for the period. The following table sets forth the weighted-average potential common shares that were excluded from the computation of diluted net income per share as their effect would have been anti-dilutive:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2006    2005    2006    2005
          As Restated (1)         As Restated (1)
     (In thousands, except per share data)

Weighted-average stock options outstanding

     27,168      15,967      25,468      10,065

Weighted-average exercise price

   $ 34.47    $ 51.91    $ 37.09    $ 70.06

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

Note 13. Commitments and Contingencies

Legal proceedings

VeriSign is engaged in 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 condensed consolidated financial position and results of operations.

Indemnification

VeriSign enters into indemnification agreements with many of its customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against claims brought by third-parties that allege a VeriSign product infringes a patent, copyright or trademark, misappropriates a trade secret, or violates other proprietary rights of that third-party. These indemnification obligations are generally subject to limits as specified in the agreement. It is not possible to estimate the maximum potential amount of future payments VeriSign could be required to make under these indemnification agreements. To date, VeriSign has not incurred significant costs to defend lawsuits or settle claims related to indemnification agreements. VeriSign has not recorded any liabilities for these indemnification agreements at September 30, 2006 or December 31, 2005.

At the Company’s discretion and in the ordinary course of business, VeriSign subcontracts the performance of certain services. VeriSign enters into indemnification agreements that indemnify customers against damage caused by VeriSign’s employees and subcontractors. These indemnification obligations are generally subject to limits as specified in the agreement. It is not possible to estimate the maximum potential amount of future payments VeriSign could be required to make under these indemnification agreements. The Company maintains insurance policies that may enable VeriSign to recover a portion of any such claim. VeriSign has not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements. VeriSign has not recorded any liabilities for these indemnification agreements at September 30, 2006 or December 31, 2005.

Note 14. Segment Information

Description of segments

VeriSign operates its business in two reportable segments: the Internet Services Group and the Communications Services Group.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The Internet Services Group consists of the Security Services business and Information Services business. The Security Services business provides products and services to enterprises and organizations that want to establish and deliver secure Internet-based services for their customers and business partners, including the following types of services: enterprise security services, including VeriSign’s managed security and authentication services, and e-commerce services, including Web trust services. The Information Services business provides registry services as the exclusive registry of domain names in the .com and .net gTLDs and certain ccTLDs, as well as providing certain value added services.

The Communications Services Group provides specialized managed communications services to wireline and wireless telecommunications carriers, cable companies and enterprise customers. VeriSign’s managed communications service offerings include network services, intelligent database and directory services, application services, content distribution and messaging services, and billing and payment services.

The segments were determined based primarily on how the chief operating decision maker (“CODM”) views and evaluates VeriSign’s operations. VeriSign’s Chief Executive Officer has been identified as the CODM as defined by SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. Other factors, including customer base, homogeneity of products, technology and delivery channels, were also considered in determining the reportable segments. Additionally, the performance of the Internet Services Group and the Communications Services Group is the measure used by the CODM for purposes of making decisions about allocating resources between the segments.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table reflects the results of VeriSign’s reportable segments:

 

    

Internet

Services

Group

  

Communications

Services

Group

  

Unallocated

Corporate

Expenses

   

Total

Segments

     (In thousands)

Three months ended September 30, 2006:

          

Revenues

   $ 194,693    $ 204,820    $ —       $ 399,513

Cost of revenues

     41,363      91,322      11,795       144,480
                            

Gross margin

   $ 153,330    $ 113,498    $ (11,795 )   $ 255,033
                            
    

Internet

Services

Group

  

Communications

Services

Group

  

Unallocated

Corporate

Expenses

   

Total

Segments

     As Restated (1)    As Restated (1)    As Restated (1)     As Restated (1)
     (In thousands)

Three months ended September 30, 2005:

          

Revenues

   $ 161,848    $ 239,265    $ —       $ 401,113

Cost of revenues

     32,156      85,319      9,383       126,858
                            

Gross margin

   $ 129,692    $ 153,946    $ (9,383 )   $ 274,255
                            
    

Internet

Services

Group

  

Communications

Services

Group

  

Unallocated

Corporate

Expenses

   

Total

Segments

     (In thousands)

Nine months ended September 30, 2006:

          

Revenues

   $ 554,685    $ 608,336    $ —       $ 1,163,021

Cost of revenues

     118,405      277,343      34,915       430,663
                            

Gross margin

   $ 436,280    $ 330,993    $ (34,915 )   $ 732,358
                            
    

Internet

Services

Group

  

Communications

Services

Group

  

Unallocated

Corporate

Expenses

   

Total

Segments

     As Restated (1)    As Restated (1)    As Restated (1)     As Restated (1)
     (In thousands)

Nine months ended September 30, 2005:

          

Revenues

   $ 460,950    $ 762,496    $ —       $ 1,223,446

Cost of revenues

     96,870      260,095      26,689       383,654
                            

Gross margin

   $ 364,080    $ 502,401    $ (26,689 )   $ 839,792
                            

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Geographic information

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2006    2005    2006    2005
          As Restated (1)         As Restated (1)
     (In thousands)

Americas:

           

United States

   $ 280,562    $ 265,709    $ 810,986    $ 749,128

Other (2)

     11,109      5,029      29,979      15,075
                           

Total Americas

     291,671      270,738      840,965      764,203

EMEA(3)

     76,863      105,166      234,710      389,434

APAC (4)

     30,979      25,209      87,346      69,809
                           

Total revenues

   $ 399,513    $ 401,113    $ 1,163,021    $ 1,223,446
                           

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

(2) Canada and Latin America
(3) Europe, the Middle East and Africa (“EMEA”)
(4) Australia, Japan and Asia Pacific (“APAC”)

VeriSign operates in the United States, Canada, Latin America, Europe, Japan, Australia, South Africa, and India. 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 Dulles, Virginia facility are attributed to the United States because it is impracticable to determine the country of origin.

The following table shows a comparison of property and equipment, net of accumulated depreciation by geographic region for each period presented:

 

    

September 30,

2006

   December 31,
2005
          As Restated (1)
     (In thousands)

Americas:

     

United States

   $ 562,094    $ 534,648

Other

     1,705      670
             

Total Americas

     563,799      535,318

EMEA

     10,712      8,389

APAC

     17,115      14,565
             

Property and equipment, net

   $ 591,626    $ 558,272
             

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

Assets are not tracked by segment and the CODM does not evaluate segment performance based on asset utilization.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Note 15. Income Taxes

For the three and nine months ended September 30, 2006, VeriSign recorded income tax expense of $14.4 million and income tax benefit of $302.1 million, respectively. For the three and nine months ended September 30, 2005, VeriSign recorded income tax expense of $29.2 million and $90.7 million, respectively.

In previous fiscal years, VeriSign provided a tax valuation allowance on its federal and state deferred tax assets based on the Company’s evaluation that realizability of such assets was not “more likely than not” as required by GAAP accounting standards. VeriSign continuously evaluated additional facts representing positive and negative evidence in the determination of the realizability of the deferred tax assets. Such deferred tax assets consisted primarily of net operating loss carryforwards, temporary differences on tax-deductible goodwill and intangibles, and temporary differences on deferred revenue. In the quarter ended June 30, 2006, based on additional evidence regarding our past earnings, scheduling of deferred tax liabilities and projected future taxable income from operating activities, we determined that it is more likely than not that the deferred assets would be realized. Accordingly, we released our valuation allowance of $236.4 million from our deferred tax assets resulting in a credit to statement of operations.

The Company will continue to assess the future realization of net deferred tax assets and believe that it is more likely than not that forecasted income, tax effects of deferred tax liabilities and projected future taxable income from operating activities will be sufficient to support future realization of net deferred tax assets.

However, the Company will continue to apply a valuation allowance on certain tax assets which we did not believe are more likely than not that they would be realized. We continue to apply a valuation allowance on the deferred tax assets relating to capital loss carryforwards and to book write-downs of investments, due to the limited carryforward period and character of such tax attributes. The amount of this deferred tax asset which continues to be subject to a valuation allowance was $44.5 million as of June 30, 2006, the date on which the Company released its valuation allowance on federal and state deferred tax assets.

In the quarter ended June 30, 2006, VeriSign was granted relief from the IRS for an uncertainty regarding a tax benefit resulting from a prior divestiture. As a result, the Company recorded an income tax benefit $113.4 million, increased its deferred tax asset for net operating losses from continuing operations $51.8 million, and reduced income taxes payable $61.6 million.

Note 16. Network Solutions

During the first quarter of 2006, Network Solutions repaid in full all amounts outstanding under the Secured Senior Promissory Note dated November 25, 2003. In addition, Network Solutions redeemed VeriSign’s 15% equity interest in Network Solutions. VeriSign received total payments from Network Solutions in the amount of $47.8 million, which included $26.0 million to reduce the principal balance of the note receivable, $0.1 million of interest income related to the note receivable and the difference of $21.7 million was recorded as a gain on investment in other income. As a result of the redemption of the membership interests, the Company no longer owns equity interests in any Internet domain name registrars.

Note 17. Repurchase of Common Stock

To facilitate the stock repurchase program, designed to return value to the stockholders and minimize dilution from stock issuances, VeriSign repurchases shares in the open market and from time to time enters into structured stock repurchase agreements with third parties.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In 2001, VeriSign and the Board of Directors authorized the repurchase of up to $350 million of the Company’s common stock in open market, negotiated or block transactions. This stock repurchase program was completed in the third quarter of 2005. In 2005, the Board of Directors of VeriSign authorized a new stock repurchase program to repurchase up to $500 million of the Company’s common stock in open market, negotiated or block transactions. This stock repurchase was completed in the second quarter of 2006. On May 16, 2006, the Board of Directors of VeriSign authorized a new $1 billion stock repurchase program to purchase shares of VeriSign’s common stock on the open market, or in negotiated or block trades. As of September 30, 2006, the Company has approximately $984.6 million available under the 2006 stock repurchase program.

The following table sets forth the stock purchases made under the stock repurchase program during the three and nine months ended September 30, 2006 and 2005:

 

    

September 30,

2006

  

September 30,

2005

     (In thousands)

Three months ended:

     

Shares repurchased

     7      8,579

Aggregate purchase price

   $ 136    $ 214,387

Nine months ended:

     

Shares repurchased

     6,423      10,132

Aggregate purchase price

   $ 135,136    $ 256,819

During the nine months ended September 30, 2006, VeriSign settled its $250 million and $75 million Accelerated Share Repurchase (“ASR”) agreements. As a result of settling the respective ASR agreements, VeriSign received an additional 482,459 shares and 10,609 shares of its common stock.

During the nine months ended September 30, 2006, VeriSign entered into a new $60.0 million ASR agreement to purchase approximately 2.8 million shares of its common stock at a price per share of approximately $21.75. On July 25, 2006, VeriSign settled this ASR and received an additional 7,338 shares of its common stock.

Note 18. Other Income, Net

The following table presents the components of other income, net for the periods presented:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
     2006     2005     2006     2005
           As Restated (1)           As Restated (1)
     (In thousands)

Interest income

   $ 6,090     $ 8,129     $ 20,488     $ 23,863

Interest expense

     (2,477 )     —         (4,303 )     —  

Net gain on sale of investments, net of impairments

     14       8,219       21,260       8,265

Other, net

     1,128       (1,958 )     1,413       11,157
                              

Total other income, net

   $ 4,755     $ 14,390     $ 38,858     $ 43,285
                              

(1) See Note 2, “Restatement of Condensed Consolidated Financial Statements,” of the Notes to Condensed Consolidated Financial Statements.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Interest income is derived principally from the investment of VeriSign’s surplus cash balances. Interest expense is derived from borrowings under VeriSign’s credit facility as described in Note 11. Net gain on sale of investments for the nine months ended September 30, 2006 includes approximately $21.3 million of gain on sale of VeriSign’s remaining equity stake in Network Solutions. During the three and nine months ended September 30, 2005, VeriSign recognized a gain of $8.3 million on the sale of an equity investment that was previously impaired, a gain of $6.0 million of other income related to a litigation settlement with a telecommunications carrier and approximately $3.2 million of net foreign currency gains.

Note 19. Recent Accounting Pronouncements

In February 2007, the FASB issued Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets or Financial Liabilities (“SFAS 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. The objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of Statement 157. VeriSign is currently evaluating the effect of SFAS 159 and the impact it will have on its financial position and results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. VeriSign is currently evaluating the effect of SFAS 157 and the impact it will have on its financial position and results of operations.

In September 2006, the U.S. Securities and Exchange Commission released Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”), which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 provides transition guidance for correcting errors and requires registrants to quantify misstatements using both the balance-sheet and income-statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. In the year of adoption only, if the effect is determined to be material, SAB 108 allows registrants to record the effect as a cumulative-effect adjustment to beginning-of-year retained earnings. SAB 108 does not change the requirements within SFAS No. 154, Accounting Changes and Error Corrections for the correction of an error on financial statements. Further, SAB 108 does not change the Staff’s previous guidance in Staff Accounting Bulletin 99 on evaluating the materiality of misstatements. SAB 108 is effective for the Company’s fiscal 2006. VeriSign has evaluated the effect of SAB 108, and believes the impact will be immaterial on its financial position and results of operations.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. The recently issued literature also provides guidance on the recognition, measurement and classification of income tax uncertainties, along with any

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

related interest and penalties. FIN 48 also includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties. We are required to adopt FIN 48 in the first quarter of 2007. The differences between the amounts recognized in the financial statements prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. VeriSign has evaluated the effect of FIN 48, and believes that adoption of this accounting principle will result in a decrease to accumulated deficit of $38.6 million in the first quarter of 2007, an increase to noncurrent deferred tax assets of $28.7 million, and a decrease to income taxes payable of $9.9 million.

In June 2006, the FASB issued Emerging Issues Task Force Issue No. 06-3, How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (“EITF 06-3”). EITF 06-3 provides guidance on an entity’s disclosure of its accounting policy regarding the gross or net presentation of certain taxes and provides that if taxes included in gross revenues are significant, a company should disclose the amount of such taxes for each period for which an income statement is presented (i.e., both interim and annual periods). Taxes within the scope of EITF 06-3 are those that are imposed on and concurrent with a specific revenue-producing transaction. The guidance is effective for interim and annual periods beginning after December 15, 2006. VeriSign has evaluated the effect of EITF 06-3, and believe the impact will be immaterial on its financial position and results of operations.

Note 20. Subsequent Events

On November 30, 2006, VeriSign completed its acquisition of inCode Telecom Group, Inc. (“inCode”), a San Diego, California-based wireless and technology consulting company. VeriSign’s purchase price of $41.8 million consisted of approximately $40.2 million in cash consideration and $1.6 million in direct transaction costs. Immediately upon closing, VeriSign paid $21.7 million of inCode’s outstanding principal debt and assumed liabilities.

On November 30, 2006, the Department of Commerce approved the new ..com agreement that extends VeriSign’s contract with the Internet Corporation for Assigned Names and Numbers (“ICANN”) to operate the .com registry through 2012, effective March 1, 2006.

On January 25, 2007, VeriSign announced a restructuring plan to replace its previous business unit structure with a functional organization consisting of a combined worldwide sales and services team, and an integrated development and products organization. The restructuring plan included workforce reductions, abandonment of excess facilities, disposals of property and equipment, and other charges. In the first quarter of 2007, VeriSign has recorded $26.9 million in restructuring charges under its 2007 restructuring plan.

On January 31, 2007, VeriSign finalized two joint venture agreements with Fox Entertainment (“Fox”), a subsidiary of News Corporation, and various subsidiaries of VeriSign and Fox, and entered into a formation agreement under which VeriSign contributed its Jamba “business to consumer” business and Fox contributed its Fox Mobile Entertainment assets to two joint ventures to provide mobile entertainment to consumers on a global basis. One of the joint ventures is based in the Netherlands, and the other is based in the United States. VeriSign and Fox entered into a joint venture agreement on January 31, 2007. Under the agreement, Fox (through a subsidiary) will own a 51% interest in the joint venture, Netherlands Mobile Holdings, C.V., and VeriSign (through a subsidiary) will own a 49% interest in the joint venture. The parties entered into a substantially similar joint venture agreement with respect to the U.S. based mobile entertainment business. Fox paid VeriSign approximately $192.4 million in cash for its contribution of the Jamba “business to consumer” and VeriSign paid Fox approximately $4.9 million in cash for its contribution of Fox Mobile Entertainment assets.

 

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VERISIGN, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

On February 28, 2007, VeriSign repaid the then-outstanding balance under the Facility of $199 million. See Note 11 “Credit Facility” of our Notes to Consolidated Financial Statements for further information regarding the Facility disclosures.

In the first quarter of 2007, VeriSign decided to sell its wholly-owned Jamba Services GmbH subsidiary. In accordance with SFAS 144, the associated assets and liabilities of Jamba Services will be classified as held for sale and its operations reported as discontinued operations, beginning in the first quarter of 2007.

On May 27, 2007, Stratton D. Sclavos, the Company’s former President, Chief Executive Officer, Chairman of the Board of Directors and member of the Board of Directors of the Company resigned from his positions. Effective May 27, 2007, the Company’s Board of Directors appointed William A. Roper, Jr., to replace Mr. Sclavos as President and Chief Executive Officer, and elected Edward A. Mueller as Chairman of the Board of Directors.

On July 10, 2007, Ms. Dana L. Evan is our then-current Executive Vice President of Finance and Administration and Chief Financial Officer resigned from the Company.

On July 5, 2007 and July 12, 2007, the Board of Directors appointed Albert E. Clement as the Chief Accounting Officer and Executive Vice President, Finance and Chief Financial Officer, respectively, of the Company.

As of the date of the filing of this report, VeriSign is not in compliance with certain covenants under its Credit Agreement related to the Facility, described in Note 11 in the Notes to Condensed Consolidated Financial Statements that require the Company to deliver specified financial statements, compliance certificates and certain other documents to its Lenders. The required Lenders under the Facility have waived VeriSign’s compliance with these requirements through July 13, 2007.

 

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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 might cause or contribute to such differences include, but are not limited to, those discussed in the section “Risk Factors.” You should carefully review the risks described in other documents we filed with the Securities and Exchange Commission from time to time, including Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and Annual Report on Form 10-K for the year ended December 31, 2006. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Report. 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.

Financial information included in the reports on Form 10-K, Form 10-Q and Form 8-K previously filed by VeriSign, the related opinions of our independent registered public accounting firm, and all earnings press releases and similar communications issued by us, for all periods ended on or before March 31, 2006 should not be relied upon and are superseded in their entirety by the information in the Quarterly Reports on Form 10-Q for the quarters ended June 30, 2006 and September 30, 2006 and Annual Report on Form 10-K for the year ended December 31, 2006.

The information below has been adjusted to reflect the restatement of the Company’s financial results which is more fully described in the “Explanatory Note” immediately preceding Part I, Item 1 and in Note 2, “Restatement of Condensed Consolidated Financial Statements,” in Notes to Condensed Consolidated Financial Statements of this Form 10-Q.

Overview

VeriSign, Inc. is a leading provider of intelligent infrastructure services that enable and protect billions of interactions everyday across the world’s voice and data networks. Our business consists of two reportable segments: the Internet Services Group and the Communications Services Group.

The Internet Services Group consists of the Security Services business and Information Services business. The Security Services business provides products and services to enterprises and organizations that want to establish and deliver secure Internet-based services for their customers and business partners, including the following types of services: enterprise security services, including our managed security and authentication services, and e-commerce services, including Web trust services. The Information Services business provides registry services as the exclusive registry of domain names in the .com and .net gTLDs and certain ccTLDs, as well as providing certain value added services.

The Communications Services Group provides specialized managed communications services to wireline and wireless telecommunications carriers, cable companies and enterprise customers. Our managed communications service offerings include network services, intelligent database and directory services, application services, content distribution and messaging services, and billing and payment services.

During the third quarter of 2006, the growth in the Internet Services Group was primarily due to an increase in domain name registrations and renewal rates, an increase in the sale of SSL certificates and a higher demand

 

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for our managed security services. The Internet Services Group recorded revenues of $194.7 million during the third quarter, a 20% growth from the same period last year.

Communications Services Group revenues for the period were $204.8 million, down 14% from the same period last year. The decline was primarily related to Content services which recorded revenue of $105.8 during the quarter, a 19% decline from the same period last year, primarily due to weaker demand for B-to-C mobile content from Europe. Communication and Commerce revenue was $36.4 million for the period, down 12% from the same period last year. The decline in Communication and Commerce revenues was primarily due to consolidation and pricing pressures in our domestic carrier base which have impacted our legacy business over the last 12 months.

We derive the majority of our revenues and cash flows from a relatively small number of products and services sold primarily in the United States, Europe and Japan. In the Internet Services Group, more than 93% of the revenues during the third quarter of 2006 were derived from the sale of registry services, managed authentication and security services, and web certificates. In the Communications Services Group, approximately 78% of the revenues were derived from the sale of mobile and broadband content services, network connectivity services, intelligent database services and billing and payment services.

Acquisitions

On September 1, 2006, we completed our acquisition of GeoTrust, Inc. a Needham, Massachusetts-based supplier of SSL and other solutions to secure e-business transactions. The Company paid approximately $127.4 million consisting of approximately $125.3 in cash consideration and $2.1 million in direct transaction costs.

On May 1, 2006, we completed our acquisition of m-Qube, Inc. (“m-Qube”), a Watertown, Massachusetts-based privately held mobile channel enabler that helps companies develop, deliver and bill for mobile content, applications and messaging services. We paid approximately $269.2 million for all of the outstanding capital stock and vested options of m-Qube.

On March 14, 2006, we completed our acquisition of Kontiki, Inc. (“Kontiki”), a Sunnyvale, California-based provider of broadband content services. We paid approximately $59.6 million for all of the outstanding capital stock and vested options of Kontiki.

On February 28, 2006, we completed our acquisition of 3united Mobile Solutions ag (“3united”), a Vienna, Austria-based provider of wireless application services. We paid approximately $71.2 million for approximately 99.8% of the outstanding capital stock of 3united.

On January 24, 2006, we completed our acquisition of CallVision, Inc. (“CallVision”), a Seattle, Washington-based privately held provider of online analysis applications for mobile communications customers. We paid approximately $38.7 million for all of the outstanding capital stock and vested options of CallVision.

In addition to the above, we also acquired two other companies during the nine months ended September 30, 2006 for an aggregate purchase price of approximately $25.4 million. These acquisitions were not material on an individual basis or in the aggregate.

Critical accounting policies and significant management estimates

The Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expenses during the period reported. By their nature, these estimates and judgments are subject to an

 

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inherent degree of uncertainty. Management bases its estimates and judgments on historical experience, market trends, and other factors that are believed to be reasonable under the circumstances. These estimates form the basis for judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from what we anticipate, and different assumptions or estimates about the future could change our reported results. Management believes critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006 (the “2006 Form 10-K”) reflect the more significant judgments and estimates used in preparation of our financial statements.

In addition to those disclosed in the 2006 Form 10-K, we believe the following critical accounting policies affect our more significant judgments and estimates used in preparing our Condensed Consolidated Financial Statements:

Stock-based compensation

Effective January 1, 2006, we adopted the provisions of, and accounted for stock-based compensation in accordance with, the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards No. 123R (“SFAS 123R”), “Share-Based Payment”. We elected the modified prospective application method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. For stock-based awards granted on or after January 1, 2006, we will amortize stock-based compensation expense on a straight-line basis over the requisite service period, which is the vesting period. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation costs estimated for the SFAS No. 123 pro forma disclosures.

We currently use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. Th