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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 MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO _______________
COMMISSION FILE NUMBER: 000-23593
VERISIGN, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3221585
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1350 CHARLESTON ROAD, MOUNTAIN VIEW, CA 94043-1331
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 961-7500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO ___
---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Shares Outstanding
Class April 30, 1999
----- --------------
Common stock, $.001 par value 25,060,832
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TABLE OF CONTENTS
Page
----
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements............................................... 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................ 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 21
PART II -- OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.......................... 22
Item 6. Exhibits and Reports on Form 8-K................................... 22
Signatures.................................................................... 23
Summary of Trademarks......................................................... 24
EXHIBIT
Exhibit 27.01 Financial Data Schedule (available in EDGAR format only)
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The consolidated financial statements included under this item are as follows:
SEQUENTIALLY
NUMBERED
Financial Statement Description PAGE
- ---------------------------------------------------- ------------
Consolidated Balance Sheets
As of March 31, 1999 and December 31, 1998.......... 4
Consolidated Statements of Operations
For the Three Months Ended March 31, 1999 and 1998.. 5
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 1999 and 1998.. 6
Notes to Consolidated Financial Statements.......... 7
3
VERISIGN, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
1999 1998
---------- -------------
ASSETS
Current assets:
Cash and cash equivalents................................ $108,949 $ 22,786
Short-term investments................................... 48,334 18,959
Accounts receivable...................................... 13,217 9,769
Prepaid expenses and other current assets................ 4,422 2,174
-------- --------
Total current assets................................... 174,922 53,688
Property and equipment, net............................... 10,467 9,234
Other assets, net......................................... 3,577 1,373
-------- --------
$188,966 $ 64,295
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable......................................... $ 6,094 $ 5,472
Accrued liabilities...................................... 3,915 4,035
Deferred revenue......................................... 15,997 13,096
-------- --------
Total current liabilities.............................. 26,006 22,603
-------- --------
Minority interest in subsidiary........................... 714 964
-------- --------
Commitments
Stockholders' equity:
Preferred stock, $.001 par value;
5,000,000 shares authorized; none issued................ -- --
Common stock, $.001 par value;
Authorized: 50,000,000 shares;
Issued and outstanding: 24,999,328 shares in 1999 and
23,086,692 shares in 1998............................... 25 23
Additional paid-in capital............................... 215,980 92,797
Notes receivable from stockholders....................... (109) (409)
Deferred compensation.................................... (250) (276)
Accumulated deficit...................................... (53,400) (51,407)
-------- --------
Total stockholders' equity............................. 162,246 40,728
-------- --------
$188,966 $ 64,295
======== ========
See accompanying Notes to Consolidated Financial Statements
4
VERISIGN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended March 31,
------------------------------
1999 1998
-------------- --------------
Revenues..................................... $15,582 $ 6,662
------- -------
Costs and expenses:
Cost of revenues............................ 6,601 4,020
Sales and marketing......................... 7,515 4,720
Research and development.................... 2,988 1,671
General and administrative.................. 1,907 1,735
------- -------
Total costs and expenses................... 19,011 12,146
------- -------
Operating loss............................. (3,429) (5,484)
Other income................................. 1,186 392
------- -------
Loss before minority interest.............. (2,243) (5,092)
Minority interest in net loss of subsidiary.. 250 389
------- -------
Net loss................................... $(1,993) $(4,703)
======= =======
Basic and diluted net loss per share......... $(.08) $(.27)
======= =======
Shares used in per share computation......... 23,938 17,253
======= =======
See accompanying Notes to Consolidated Financial Statements
5
VERISIGN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Three Months Ended March 31,
------------------------------
1999 1998
--------------- -------------
Cash flows from operating activities:
Net loss........................................... $ (1,993) $ (4,703)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization..................... 1,097 896
Minority interest in net loss of subsidiary....... (250) (389)
Stock-based compensation.......................... 26 26
Loss on disposal of property and equipment........ 65 --
Changes in operating assets and liabilities:
Accounts receivable.............................. (3,448) (2,491)
Prepaid expenses and other current assets........ (2,248) (263)
Accounts payable................................. 622 (929)
Accrued liabilities.............................. (120) 1,257
Deferred revenue................................. 2,901 1,767
-------- --------
Net cash used in operating activities............ (3,348) (4,829)
-------- --------
Cash flows from investing activities:
Purchases of short-term investments................ (40,081) (36,563)
Maturities and sales of short-term investments..... 10,706 7,471
Purchases of property and equipment................ (2,344) (1,126)
Other assets....................................... (2,255) (22)
-------- --------
Net cash used in investing activities............ (33,974) (30,240)
-------- --------
Cash flows from financing activities:
Collections on notes receivable from stockholders.. 300 --
Net proceeds from issuance of common stock......... 123,185 43,930
-------- --------
Net cash provided by financing activities........ 123,485 43,930
-------- --------
Net change in cash and cash equivalents............. 86,163 8,861
Cash and cash equivalents at beginning of period.... 22,786 4,942
-------- --------
Cash and cash equivalents at end of period.......... $108,949 $ 13,803
======== ========
See accompanying Notes to Consolidated Financial Statements
6
VERISIGN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying interim unaudited consolidated balance sheets and statements
of operations and cash flows reflect all normal recurring adjustments that are,
in the opinion of management, necessary for a fair presentation of the financial
position of VeriSign, Inc. at March 31, 1999, and the results of operations and
cash flows for the interim periods ended March 31, 1999 and 1998.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions for Form 10-Q and, therefore, do
not include all information and footnotes necessary for a complete presentation
of VeriSign's results of operations, financial position and cash flows. We filed
audited consolidated financial statements that included all information and
footnotes necessary for a complete presentation for each of the years in the
three-year period ended December 31, 1998 in our 1998 Annual Report on Form 10-
K.
The results of operations for any interim period are not necessarily
indicative of our results of operations for any other future interim period or
for a full fiscal year.
(2) STOCKHOLDERS' EQUITY
In January 1999, VeriSign sold an additional 1,597,500 shares of its common
stock to the public for net proceeds of approximately $121.4 million, after
underwriting discounts and commissions and expenses of the offering.
On March 31, 1999, VeriSign announced a two-for-one stock split for
stockholders of record on May 14, 1999. This stock split is contingent upon
stockholder approval of an increase in the number of authorized shares of
common stock at the 1999 Annual Meeting of Stockholders to be held on May 27,
1999, therefore, the stock split has not been reflected in the March 31, 1999
financial statements.
(3) NET LOSS PER SHARE
Basic loss per share is computed using the weighted-average number of common
shares outstanding during the period. Diluted loss per share is computed using
the weighted-average number of common and dilutive common stock equivalent
shares outstanding during the period. Antidilutive common equivalent shares
excluded from diluted net loss per share for the three months ended March 31,
1999 and 1998 consisted of options to purchase shares of common stock and shares
subject to repurchase of 4,715,771 and 3,412,667 with a weighted-average
exercise price of $20.37 and $2.68, respectively.
(4) COMPREHENSIVE INCOME
Comprehensive income includes all changes in equity during a period except
those resulting from the issuance of stock and distributions to stockholders.
There were no material differences between net loss and comprehensive loss for
the three months ended March 31, 1999 and 1998.
7
VERISIGN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) SEGMENT INFORMATION
VeriSign operates in the United States, Europe and Japan and derives
substantially all of its revenues from sales of Internet trust services. There
have been no significant changes in our operating segments or in the geographic
location of our long-lived assets since December 31, 1998.
(6) RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. Because VeriSign
currently holds no derivative instruments and does not engage in hedging
activities, we expect that the adoption of SFAS No. 133 will have no material
impact on our financial position, results of operations or cash flows. We will
be required to implement SFAS No. 133 for the year ending December 31, 2000.
In December 1998, the AICPA issued SOP No. 98-9, "Modification of SOP 97-2,
Software Revenue Recognition, with Respect to Certain Transactions." SOP No. 98-
9 requires recognition of revenue using the "residual method" in a multiple-
element software arrangement when fair value does not exist for one or more of
the delivered elements in the arrangement. Under the "residual method," the
total fair value of the undelivered elements is deferred and recognized in
accordance with SOP No. 97-2. VeriSign will be required to implement SOP No. 98-
9 for the year ending December 31, 2000. SOP No. 98-9 also extends the deferral
of the application of SOP No. 97-2 to certain other multiple-element software
arrangements through the year ending December 31, 1999. We are evaluating the
provisions of SOP No. 98-9 and we have not yet determined what impact, if any,
SOP No. 98-9 will have on our financial position, results of operations or cash
flows.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion in conjunction with the interim
unaudited consolidated financial statements and notes thereto.
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, mix of revenues and
plans for addressing Year 2000 issues. These 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 these differences include, but are not limited
to, those discussed in the section below entitled "Factors That May Affect
Future Results of Operations." You should carefully review the risks described
in other documents we file from time to time with the Securities and Exchange
Commission, including the Quarterly Reports on Form 10-Q that we will file in
1999 and our Annual Report on Form 10-K, which was filed on February 22, 1999.
You are cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date of this Quarterly Report on Form 10-Q. We
undertake no obligation to publicly release any revisions to the forward-looking
statements or reflect events or circumstances after the date of this document.
OVERVIEW
VeriSign is the leading provider of Internet trust services needed by
websites, enterprises and individuals to conduct trusted and secure electronic
commerce and communications over IP networks. We have established strategic
relationships with industry leaders, including AT&T, BT, Checkpoint
Technologies, Cisco, Microsoft, Netscape, Network Associates, Network Solutions,
RSA, Security Dynamics and VISA, to enable widespread utilization of our digital
certificate services and to assure interoperability with a wide variety of
applications and network equipment. We have used our secure online
infrastructure to sell approximately 125,000 of our website digital certificates
to date. In addition, we have issued over 3.6 million of our digital
certificates for individuals. We believe that we have issued more digital
certificates than any other company in the world. Our website digital
certificate services are used by over 400 of the Fortune 500 companies and all
of the top 40 electronic commerce websites listed by Media Metrix, an
independent market research firm. We also offer VeriSign OnSite, a managed
service that allows an organization to leverage our trusted service
infrastructure to develop and deploy customized digital certificate services for
use by employees, customers and business partners. Since its introduction in
November 1997, we have sold over 400 OnSite service solutions to enterprises
including Bank of America, Barclays, Hewlett-Packard, the Internal Revenue
Service, Kodak, Southwest Securities, Sumitomo Bank, Texas Instruments and US
West.
We have derived substantially all of our revenues to date from fees for
services rendered in connection with deploying Internet trust services. Revenues
from these trust services consist of fees for the issuance of digital
certificates, fees for digital certificate software modules and fees for
consulting, training, support and maintenance services. We defer revenues from
the sale or renewal of digital certificates and recognize these revenues ratably
over the life of the digital certificate, generally 12 months. We recognize
revenues from the sale of digital certificate software modules to distributors
and affiliates upon delivery of the software and signing of an agreement,
provided the fee is fixed and determinable, collectibility is probable and the
arrangement does not require significant production, modification or
customization of the software. We recognize revenues from consulting and
training services using the percentage-of-completion method for fixed-fee
development arrangements or as the services are provided for time-and-materials
arrangements. We recognize revenues ratably over the term of the agreement for
support and maintenance services.
We market our Internet trust services worldwide through multiple distribution
channels, including the Internet, direct sales, telesales, value added
resellers, systems integrators and our affiliates. A significant portion of our
revenues to date has been generated through sales from our website, but we
intend to
9
continue increasing our direct sales force, both in the U.S. and abroad, and to
continue to expand our other distribution channels.
In connection with the formation of VeriSign Japan, we licensed certain
technology and contributed other assets to VeriSign Japan. Subsequent to its
formation, additional investors purchased minority interests in VeriSign Japan.
As of March 31, 1999, we owned 50.5% of the outstanding capital stock of
VeriSign Japan. Accordingly, our consolidated financial statements include the
accounts of VeriSign Japan and our consolidated statements of operations reflect
the minority shareholders' share of the net losses of VeriSign Japan.
We have experienced substantial net losses in each fiscal period since our
inception. As of March 31, 1999, we had an accumulated deficit of $53.4 million.
These net losses and accumulated deficit resulted from our lack of substantial
revenues and the significant costs incurred in the development and sale of our
Internet trust services and in the establishment and deployment of our
technology, infrastructure and practices. We intend to increase our expenditures
in all areas in order to execute our business plan. As a result, we expect to
incur substantial additional losses. Although our revenues have grown in recent
periods, we may be unable to sustain this growth. Therefore, you should not
consider our historical growth indicative of future revenue levels or operating
results. We may never achieve profitability or, if we do, we may not be able to
sustain it. A more complete description of these and other risks relating to our
business is set forth under the caption "Factors That May Affect Future Results
of Operations."
Results of Operations
Revenues
1999 1998 CHANGE
---- ---- ------
(DOLLARS IN THOUSANDS)
First quarter period:
Revenues .................... $15,582 $6,662 134%
Revenues increased significantly in the first quarter of 1999 from the first
quarter of 1998 primarily due to increased sales of our Internet trust services,
particularly our website digital certificates and VeriSign OnSite services, the
expansion of our international affiliate network and delivery of more training
and services.
No customer accounted for 10% or more of revenues during the first quarter of
1999 or 1998. Revenues of VeriSign Japan and revenues from other international
customers accounted for 22% of total revenues in the first quarter of 1999 and
10% of revenues in the first quarter of 1998.
Costs and Expenses
Cost of revenues
1999 1998 CHANGE
---- ---- ------
(DOLLARS IN THOUSANDS)
First quarter period:
Cost of revenues ............. $6,601 $4,020 64%
Cost of revenues consists primarily of costs related to providing digital
certificate enrollment and issuance services, customer support and training,
consulting and development services and costs of facilities and computer
equipment used in these activities. Cost of revenues also includes fees paid to
third parties to verify certificate applicants' identities, insurance premiums
for our service warranty plan and errors and omission insurance, and the cost of
software resold to customers.
Growth of revenues was the primary cause of the increase in cost of revenues
in the first quarter of 1999 from the first quarter of 1998. We hired more
employees to support the growing demand for our products and to support the
growth of our security consulting and training activities. The cost of insurance
premiums for our service warranty plan increased because of greater volume. In
addition, we incurred
10
increased expenses for access to third-party databases, higher support charges
for our external disaster recovery program and increased expenses related to the
cost of software products resold to customers as part of network security
solution implementations.
Certain of our services require greater initial personnel involvement and
therefore have higher costs than other types of services. As a result, we
anticipate that cost of revenues will vary in future periods depending on the
mix of services sold.
Sales and marketing
1999 1998 CHANGE
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
First quarter period:
Sales and marketing.............. $7,515 $4,720 59%
Percentage of revenues........... 48% 71%
Sales and marketing expenses consist primarily of costs related to sales,
marketing and practices and external affairs. These expenses include salaries,
sales commissions and other personnel-related expenses, travel and related
expenses, costs of computer and communications equipment and support services,
facilities costs, consulting fees and costs of marketing programs.
Sales and marketing expenses increased in the first quarter of 1999 from the
first quarter of 1998 as a result of the continued growth of our direct sales
force and the expansion of our efforts, particularly in lead and demand
generation activities. The establishment of international sales offices in
Europe and Canada during the second half of 1998 also contributed to the
increase in these expenses. Sales and marketing expenses as a percentage of
revenues decreased from the first quarter of 1998 to the first quarter of 1999
primarily due to the increase in recurring revenue from existing customers,
which tend to have lower acquisition costs associated with them.
We anticipate that sales and marketing expenses will continue to increase in
absolute dollars as we expand our direct sales force and increase our marketing
and demand generation activities both in the U.S. and abroad.
Research and development
1999 1998 CHANGE
---------- ---------- ---------
(DOLLARS IN THOUSANDS)
First quarter period:
Research and development......... $2,988 $1,671 79%
Percentage of revenues...........
19% 25%
Research and development expenses consist primarily of costs related to
research and development personnel, including salaries and other personnel-
related expenses, consulting fees and the costs of facilities, computer and
communications equipment and support services used in service and technology
development.
Research and development expenses increased in absolute dollars in the first
quarter of 1999 from the first quarter of 1998 as we invested in the design,
testing and deployment of, and technical support for, our expanded Internet
trust service offerings and technology. The increase reflects the expansion of
our engineering staff and related costs required to support our continued
emphasis on developing new products and services as well as enhancing existing
products and services. During 1999, we continued to make significant investments
in development of all of our services. The decrease in research and development
expenses as a percentage of revenues from the first quarter of 1998 to the first
quarter of 1999 is primarily due to the fact that revenues increased faster than
research and development expenses.
We believe that timely development of new and enhanced Internet trust services
and technology are necessary to remain competitive in the marketplace.
Accordingly, we intend to continue to recruit
11
experienced research and development personnel and to make other investments in
research and development. As a result, we expect research and development
expenses will continue to increase in absolute dollars. To date, we have
expensed all research and development expenditures as incurred.
General and administrative
1999 1998 CHANGE
-------- ------- ---------
(DOLLARS IN THOUSANDS)
First quarter period:
General and administrative.......... $1,907 $1,735 10%
Percentage of revenues.............. 12% 26%
General and administrative expenses consist primarily of salaries and other
personnel-related expenses for our administrative, finance and human relations
personnel, facilities and computer and communications equipment, support
services and professional services fees.
Our expenses increased in the first quarter of 1999 compared to the first
quarter of 1998 due primarily to increased staffing levels required to manage
and support our expanded operations, the implementation of additional management
information systems and related procedures, and the expansion of our corporate
headquarters. The decrease in general and administrative expenses as a
percentage of revenues from the first quarter of 1998 to the first quarter of
1999 is primarily due to the fact that revenues increased faster than general
and administrative expenses as we begin to experience economies of scale on our
corporate infrastructure.
We expect to continue to invest in a more comprehensive executive and
administrative infrastructure. As a result, we anticipate that general and
administrative expenses will continue to increase in absolute dollars.
Other Income
1999 1998 CHANGE
--------- --------- ---------
(DOLLARS IN THOUSANDS)
First quarter period:
Other income..................... $1,186 $ 392 203%
Percentage of revenues........... 8% 6%
Other income consists primarily of interest earned on our cash, cash
equivalents and short-term investments, less interest expense on bank borrowings
of VeriSign Japan and the effect of foreign currency transaction gains and
losses.
During January 1999, we sold 1,597,500 shares of our common stock in a follow-
on public offering. After deducting underwriting discounts and commissions and
offering expenses, proceeds from the offering were approximately $121.4 million.
The increase in other income in the first quarter of 1999 compared to the first
quarter of 1998 is primarily due to a significantly higher average cash and
short-term investment base in the 1999 period arising from this sale of shares
of our common stock. The increase in other income was slightly reduced by
increases in certain foreign withholding taxes and state franchise taxes.
Provision for Income Taxes
We have not recorded any provision for federal and California income taxes
because we have experienced net losses since inception. As of December 31, 1998,
we had federal net operating loss carryforwards of approximately $52.3 million
and California net operating loss carryforwards of approximately $46.5 million.
If we are not able to use them, the federal net operating loss carryforwards
will expire in 2010 through 2018 and the state net operating loss carryforwards
will expire in 2003. The Tax Reform Act of 1986 imposes substantial restrictions
on the utilization of net operating losses and tax credits in the event of a
corporation's ownership change, as defined in the Internal Revenue Code. Our
ability to utilize net operating loss carryforwards may be limited as a result
of an ownership change. We do not
12
anticipate that any material limitation exists on our ability to use our
carryforwards and credits. We have provided a full valuation allowance on our
deferred tax assets because of the uncertainty regarding their realization.
Minority Interest in Net Loss of Subsidiary
Minority interest in the net loss of VeriSign Japan was $250,000 in the first
quarter of 1999 and $389,000 in the first quarter of 1998. The decrease from the
first quarter of 1998 to the first quarter of 1999 was primarily due to VeriSign
Japan's increased revenue as compared to the prior year. VeriSign Japan is still
in the early stage of operations and, therefore, we expect that the minority
interest in net loss of subsidiary will continue to fluctuate in future periods.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
We have a limited operating history.
VeriSign was incorporated in April 1995, and we began introducing our Internet
trust services in June 1995. Accordingly, we have only a limited operating
history on which to base an evaluation of our business and prospects. Our
prospects must be considered in light of the risks and uncertainties encountered
by companies in the early stages of development. These risks and uncertainties
are often worse for companies in new and rapidly evolving markets. Our success
will depend on many factors, including, but not limited to, the following:
. the rate and timing of the growth and use of IP networks for electronic
commerce and communications;
. the extent to which digital certificates are used for electronic commerce
and communications;
. the continued evolution of electronic commerce as a viable means of
conducting business;
. the demand for our Internet trust services;
. competition levels;
. the perceived security of electronic commerce and communications over IP
networks;
. the perceived security of our services, technology, infrastructure and
practices; and
. our continued ability to maintain our current, and enter into additional,
strategic relationships.
To address these risks we must, among other things:
. successfully market our Internet trust services and our digital
certificates to our new and existing customers;
. attract, integrate, train, retain and motivate qualified personnel;
. respond to competitive developments;
. successfully introduce new Internet trust services; and
. successfully introduce enhancements to our existing Internet trust services
to address new technologies and standards.
We cannot be certain that we will successfully address any of these risks.
Our Business Depends on the Adoption of IP Networks.
In order for VeriSign to be successful, IP networks must be widely adopted, in
a timely manner, as a means of trusted and secure electronic commerce and
communications. Because electronic commerce and communications over IP networks
are new and evolving, it is difficult to predict the size of this market and its
sustainable growth rate. To date, many businesses and consumers have been
deterred from utilizing IP networks for a number of reasons, including, but not
limited to:
. potentially inadequate development of network infrastructure;
13
. security concerns including the potential for merchant or user
impersonation and fraud or theft of stored data and information
communicated over IP networks;
. inconsistent quality of service;
. lack of availability of cost-effective, high-speed service;
. limited numbers of local access points for corporate users;
. inability to integrate business applications on IP networks;
. the need to operate with multiple and frequently incompatible products; and
. a lack of tools to simplify access to and use of IP networks.
The adoption of IP networks will require a broad acceptance of new methods of
conducting business and exchanging information. Companies and government
agencies that already have invested substantial resources in other methods of
conducting business may be reluctant to adopt new methods. Also, individuals
with established patterns of purchasing goods and services and effecting
payments may be reluctant to change.
The use of IP networks may not increase or may increase more slowly than we
expect because the infrastructure required to support widespread use may not
develop. The Internet may continue to experience significant growth both in the
number of users and the level of use. However, the Internet infrastructure may
not be able to continue to support the demands placed on it by continued growth.
Continued growth may also affect the Internet's performance and reliability. In
addition, the growth and reliability of IP networks could be harmed by delays in
development or adoption of new standards and protocols to handle increased
levels of activity or by increased governmental regulation. Changes in, or
insufficient availability of, communications services to support IP networks
could result in poor performance and also adversely affect their usage. Any of
these factors could materially harm our business.
Our Market is New and Evolving.
We target our Internet trust services at the market for trusted and secure
electronic commerce and communications over IP networks. This is a new and
rapidly evolving market that may not continue to grow. Accordingly, the demand
for our Internet trust services is very uncertain. Even if the market for
electronic commerce and communications over IP networks grows, our Internet
trust services may not be widely accepted. The factors that may affect the level
of market acceptance of digital certificates and, consequently, our Internet
trust services, include the following:
. market acceptance of products and services based upon authentication
technologies other than those we use;
. public perception of the security of digital certificates and IP networks;
. the ability of the Internet infrastructure to accommodate increased levels
of usage; and
. government regulations affecting electronic commerce and communications
over IP networks.
Even if digital certificates achieve market acceptance, our Internet trust
services may fail to address the market's requirements adequately. If digital
certificates do not achieve market acceptance in a timely manner and sustain
acceptance, or if our Internet trust services in particular do not achieve or
sustain market acceptance, our business would be materially harmed.
System Interruptions and Security Breaches Could Harm our Business.
We depend on the uninterrupted operation of our secure data centers and our
other computer and communications systems. We must protect these systems from
loss, damage or interruption caused by fire, earthquake, power loss,
telecommunications failure or other events beyond our control. Most of our
systems are located at, and most of our customer information is stored in, our
facilities in Mountain View, California and Kawasaki, Japan, areas susceptible
to earthquakes. Any damage or failure that causes interruptions in our secure
data centers and our other computer and communications systems could materially
harm our business. In addition, our ability to issue digital certificates
depends on the efficient operation of the Internet connections from customers to
our secure data centers. These connections depend upon efficient
14
operation of web browsers, Internet service providers and Internet backbone
service providers, all of which have had periodic operational problems or
experienced outages in the past. Any of these problems or outages could
adversely affect customer satisfaction.
Our success also depends upon the scalability of our systems. Our systems have
not been tested at the volumes that may be required in the future. Thus, it is
possible that a substantial increase in demand for our Internet trust services
could cause interruptions in our systems. Any interruptions could adversely
affect our ability to deliver our Internet trust services and therefore could
materially harm our business.
Although we periodically perform, and retain accredited third parties to
perform, audits of our operational practices and procedures, we may not be able
to remain in compliance with our internal standards or those set by third-party
auditors. If we fail to maintain these standards, we may have to expend
significant time and money to return to compliance and our business could be
materially harmed.
We retain certain confidential customer information in our secure data
centers. It is critical to our business strategy that our facilities and
infrastructure remain secure and are perceived by the marketplace to be secure.
Despite our security measures, our infrastructure may be vulnerable to physical
break-ins, computer viruses, attacks by hackers or similar disruptive problems.
It is possible that we may have to expend additional financial and other
resources to address these problems. Any physical or electronic break-ins or
other security breaches or compromises of the information stored at our secure
data centers might jeopardize the security of information stored on our premises
or in the computer systems and networks of our customers. In this event, we
could face significant liability and customers could be reluctant to use our
Internet trust services. This type of occurrence could also result in adverse
publicity and therefore adversely affect the market's perception of the security
of electronic commerce and communications over IP networks as well as of the
security or reliability of our services.
We Must Manage our Growth and Expansion.
Our historical growth has placed, and any further growth is likely to continue
to place, a significant strain on our resources. VeriSign has grown from 26
employees at December 31, 1995 to 336 employees at March 31, 1999. We have also
opened additional sales offices and have significantly expanded our operations,
both in the U.S. and abroad, during this time period. We expanded our operations
by acquiring SecureIT during 1998. To be successful, we will need to implement
additional management information systems, develop further our operating,
administrative, financial and accounting systems and controls and maintain close
coordination among our executive, engineering, accounting, finance, marketing,
sales and operations organizations. Any failure to manage growth effectively
could materially harm our business.
We Must Establish and Maintain Strategic Relationships.
One of our significant business strategies has been to enter into strategic or
other similar collaborative relationships in order to reach a larger customer
base than we could reach through our direct sales and marketing efforts. We may
need to enter into additional relationships to execute our business plan. We may
not be able to enter into additional, or maintain our existing, strategic
relationships on commercially reasonable terms. If we failed to do so, we would
have to devote substantially more resources to the distribution, sale and
marketing of our Internet trust services than we would otherwise need to do.
Furthermore, as a result of our emphasis on these relationships, our success in
them will depend both on the ultimate success of the other parties to these
relationships, particularly in the use and promotion of IP networks for trusted
and secure electronic commerce and communications, and on the ability of certain
of these parties to market our Internet trust services successfully. Failure of
one or more of our strategic relationships to result in the development and
maintenance of a market for our Internet trust services could materially harm
our business.
Our existing strategic relationships do not, and any future strategic
relationships may not, afford VeriSign any exclusive marketing or distribution
rights. In addition, the other parties may not view their relationships with us
as significant for their own businesses. Therefore, they could reduce their
commitment to VeriSign at any time in the future. These parties could also
pursue alternative technologies or develop
15
alternative products and services either on their own or in collaboration with
others, including our competitors. If we are unable to maintain our strategic
relationships or enter into additional strategic relationships, our business
could be materially harmed.
Certain of our Internet trust services have lengthy sales and implementation
cycles.
We market many of our Internet trust services directly to large companies and
government agencies. The sale and implementation of our services to these
entities typically involves a lengthy education process and a significant
technical evaluation and commitment of capital and other resources. This process
is also subject to the risk of delays associated with customers' internal
budgeting and other procedures for approving large capital expenditures,
deploying new technologies within their networks and testing and accepting new
technologies that affect key operations. As a result, the sales and
implementation cycles associated with certain of our Internet trust services can
be lengthy. Our quarterly and annual operating results could be materially
harmed if orders forecasted for a specific customer for a particular quarter are
not realized.
Our International Operations are Subject to Certain Risks.
Revenues of VeriSign Japan and revenues from other international affiliates
and customers accounted for approximately 22% of our revenues in the first
quarter of 1999 and 14% of our revenues for the full year of 1998. We intend to
expand our international operations and international sales and marketing
activities. Expansion into these markets has required and will continue to
require significant management attention and resources. We may also need to
tailor our Internet trust services for a particular market and to enter into
international distribution and operating relationships. We have limited
experience in localizing our Internet trust services and in developing
international distribution or operating relationships. We may not succeed in
expanding our Internet trust service offerings into international markets. Any
of these failures could harm our business. In addition, there are certain risks
inherent in doing business on an international basis, including, among others:
. regulatory requirements;
. legal uncertainty regarding liability;
. export and import restrictions on cryptographic technology and products
incorporating that technology;
. tariffs and other trade barriers;
. difficulties in staffing and managing foreign operations;
. longer sales and payment cycles;
. problems in collecting accounts receivable;
. difficulties in authenticating customer information;
. political instability;
. seasonal reductions in business activity; and
. potentially adverse tax consequences.
We have licensed to certain international affiliates the VeriSign Processing
Center platform, which is designed to replicate our own secure data centers and
allows the affiliate to offer back-end processing of Internet trust services.
The VeriSign Processing Center platform provides these affiliates with the
knowledge and technology to offer Internet trust services similar to those
offered by VeriSign. It is critical to our business strategy that the facilities
and infrastructure used in issuing and marketing digital certificates remain
secure and be perceived by the marketplace to be secure. Although we provide our
affiliates with training in security and trust practices, network management and
customer service and support, these practices are performed by our affiliates
and are outside of our control. Any failure of an affiliate to maintain the
privacy of confidential customer information could result in negative publicity
and therefore adversely affect the market's perception of the security of our
services as well as the security of electronic commerce and communication over
IP networks generally. See "--System interruptions and security breaches could
harm our business."
16
All of our international revenues from sources other than VeriSign Japan are
denominated in U.S. dollars. If additional portions of our international
revenues were to be denominated in foreign currencies, we could become subject
to increased risks relating to foreign currency exchange rate fluctuations.
Acquisitions Could Harm our Business.
We may acquire additional businesses, technologies, product lines or service
offerings in the future. Acquisitions involve a number of risks including, among
others:
. the difficulty of assimilating the operations and personnel of the acquired
businesses;
. the potential disruption of our business;
. our inability to integrate, train, retain and motivate key personnel of the
acquired businesses;
. the diversion of our management from our day-to-day operations;
. our inability to incorporate acquired technologies successfully into our
Internet trust services;
. the additional expenses associated with completing acquisitions and
amortizing any acquired intangible assets;
. the potential impairment of relationships with our employees, customers and
strategic partners; and
. the inability to maintain uniform standards, controls, procedures and
policies.
If we are unable to successfully address any of these risks, our business
could be materially harmed.
YEAR 2000 ISSUES
Background of Year 2000 Issues
Many currently installed computer systems and software products are unable to
distinguish between twentieth century dates and twenty-first century dates. This
situation could result in system failures or miscalculations causing disruptions
of operations of any business, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities. As a result, many companies' software and computer systems
may need to be upgraded or replaced to comply with these "Year 2000"
requirements.
State of Readiness
Our business depends on the operation of numerous systems that could
potentially be affected by Year 2000 related problems. The systems include:
hardware and software systems used to deliver our Internet trust services,
including our proprietary software systems as well as software supplied by third
parties; communications networks such as the Internet and private intranets; the
internal systems of our customers and suppliers; digital certificates and
software products sold to customers; the computer and communications hardware
and software systems we use internally to manage our business; and non-
information technology systems and services we use to manage our business, such
as telephone systems and building systems.
Based on an analysis of all systems potentially affected by conducting
business in the year 2000 and beyond, we are applying a phased approach to
making these systems, and accordingly our operations, ready for the year 2000.
Beyond awareness of the issues and scope of systems involved, the phases of
activities in progress include: an assessment of specific underlying computer
systems, programs and/or hardware; remediation or replacement of Year 2000 non-
compliant technology; validation and testing of technologically compliant Year
2000 solutions; and implementation of the Year 2000 compliant systems. The table
below provides the status and timing of these phased activities.
17
Targeted
Impacted Systems Status Implementation
- ----------------------------------- ------------------------------------------------------ --------------
Internet trust services sold to Digital certificates tested and available for customer
customers....................... trial................................................. Completed
Non-information technology Systems upgraded or replaced as appropriate,
systems and services............ testing and implementation completed.................. Completed
Hardware and software systems Assessment completed, remediation underway,
used to deliver services........ conducting validation and testing..................... Q2 1999
Communication networks used Assessment completed, conducting validation
to provide services............. and testing........................................... Q2 1999
Operability with internal systems Assessment completed, conducting validation
of customers and suppliers...... and testing........................................... Q2 1999
Hardware and software systems
used to manage VeriSign's Assessment completed, remediation underway,
business........................ conducting validation and testing..................... Q3 1999
As a trusted third-party certificate authority providing, among other
services, digital certificates and related life cycle services, we depend on the
hardware and software products from third parties used to deliver these Internet
trust services. Inoperability of these products due to Year 2000 issues could
harm our business. We have completed our assessment of the underlying systems
and hardware. Certain components have been replaced and we are conducting
validation and testing.
Costs to Address Year 2000 Issues
We expect that costs directly related to Year 2000 issues will not exceed
approximately $500,000 for both costs incurred to date and future costs,
including cases where non-compliant information technology systems have been or
need to be replaced. We would have incurred the replacement cost of non-
information technology systems regardless of the Year 2000 issue due to
technology obsolescence and/or our growth. We have and will continue to expense
all costs arising from Year 2000 issues, funding them from working capital.
We do not believe that future expenditures to upgrade internal systems and
applications will materially harm our business. In addition, while we do not
know the potential costs of redeployment of personnel and any delays in
implementing other projects, we anticipate the costs to be immaterial and we
expect minimal adverse impact to our business.
Risks of the Year 2000 Issues
We believe our digital certificates and Internet trust services are Year 2000
compliant; however, success of our Year 2000 compliance efforts may depend on
the success of our customers in dealing with Year 2000 issues. We sell our
Internet trust services to companies in a variety of industries, each with
different issues and Year 2000 compliance challenges. Customer difficulties with
Year 2000 issues could interfere with the use of Year 2000 compliant digital
certificates, which might require us to devote additional resources to resolve
underlying problems. If problems exist within our digital certificate technology
as it relates to customers' management systems and applications, our business,
financial condition and results of operations could be materially harmed. This
risk is minimized by our current offering of Year 2000 compliant test digital
certificates that can validate the Year 2000 operation of customer applications
and systems. However, there is no method to determine which customers will
validate their applications and systems for Year 2000 compliance with our
technology.
Furthermore, the purchasing patterns of these customers or potential customers
may be affected by Year 2000 issues as companies expend significant resources to
become Year 2000 compliant. The costs of
18
becoming Year 2000 compliant for current or potential customers may result in
fewer funds being available to purchase and implement our Internet trust
services.
Contingency Plans
With the assistance of an independent consulting firm, we developed a Year
2000 project plan template. This template suggested no additional work beyond
what we had internally identified. During the second and third quarters of 1999,
we will develop a contingency plan for handling Year 2000 problems that are not
detected and corrected prior to their occurrence. However, we have a
comprehensive business resumption plan in the event of a failure of our digital
certificate services delivered from our secure data centers. Upon completion of
testing and implementation activities, we will be able to assess additional
areas requiring contingency. Any failure to address any unforeseen Year 2000
issue could harm our business.
LIQUIDITY AND CAPITAL RESOURCES
March 31, December 31,
1999 1998 CHANGE
--------- ------------ -------
(DOLLARS IN THOUSANDS)
Cash, cash equivalents and
short-term investments.......... $157,283 $41,745 277%
Working capital.................. $148,916 $31,085 379%
Stockholders' equity............. $162,246 $40,728 298%
Prior to our initial public offering, we financed our operations primarily
through private sales of equity securities, raising approximately $46.1 million.
Our initial public offering, which completed in January 1998, yielded net
proceeds of approximately $43.7 million. In January 1999, we sold an additional
1,597,500 shares of common stock to the public for net proceeds of approximately
$121.4 million. At March 31, 1999, our principal source of liquidity was $157.3
million of cash, cash equivalents and short-term investments, consisting
principally of commercial paper, medium term notes, corporate bonds and notes,
market auction securities, United States government agency securities and money
market funds.
We have had significant negative cash flows from operating activities in each
period to date. Net cash used in operating activities was $3.3 million in the
first quarter of 1999 and $4.8 million in the first quarter of 1998. Net cash
used in operating activities in the first quarter of 1999 was primarily the
result of the $2.0 million net loss and increases in accounts receivable and
prepaid expenses which were partially offset by increases in accounts payable
and deferred revenue. Net cash used in operating activities in the first quarter
of 1998 was primarily the result of the $4.7 million net loss, the increase in
accounts receivable and the decrease in accounts payable which were partially
offset by the increases in accrued liabilities and deferred revenue.
Net cash used in investing activities was $34.0 million in the first quarter
of 1999 compared to $30.2 million in the first quarter of 1998. Net cash used in
investing activities in these periods was primarily the result of net purchases
of short-term investments of $29.4 million in the first quarter of 1999 and
$29.1 million in the first quarter of 1998. Capital expenditures for property
and equipment totaled $2.3 million in the first quarter of 1999 and $1.1 million
in the first quarter of 1998. Our planned capital expenditures for the full year
of 1999 are approximately $5 million to $7 million, primarily for computer and
communications equipment and leasehold improvements. As of March 31, 1999, we
also had commitments under noncancelable operating leases for our facilities for
various terms through 2005.
Net cash provided by financing activities was $123.5 million in the first
quarter of 1999, virtually all from the sale of additional common stock to the
public. In the first quarter of 1998, net cash provided by financing activities
was $43.9 million, derived virtually all from our initial public offering.
19
We believe our existing cash, cash equivalents and short-term investments,
will be sufficient to meet our working capital and capital expenditure
requirements for the foreseeable future. However, at some time, we may need to
raise additional funds through public or private financing, strategic
relationships or other arrangements. This additional funding, if needed, might
not be available on terms attractive to us, or at all. If we have to enter into
strategic relationships to raise additional funds we might be required to
relinquish rights to certain of our technologies. Our failure to raise capital
when needed could materially harm our business. If additional funds are raised
through the issuance of equity securities, the percentage of our stock owned by
our then-current stockholders would be reduced. Furthermore, these equity
securities might have rights, preferences or privileges senior to those of our
common stock.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. Because VeriSign
currently holds no derivative instruments and does not engage in hedging
activities, we expect that the adoption of SFAS No. 133 will have no material
impact on our financial position, results of operations or cash flows. We will
be required to implement SFAS No. 133 for the year ending December 31, 2000.
In December 1998, the AICPA issued SOP No. 98-9, "Modification of SOP 97-2,
Software Revenue Recognition, with Respect to Certain Transactions." SOP No. 98-
9 requires recognition of revenue using the "residual method" in a multiple-
element software arrangement when fair value does not exist for one or more of
the delivered elements in the arrangement. Under the "residual method," the
total fair value of the undelivered elements is deferred and recognized in
accordance with SOP No. 97-2. VeriSign will be required to implement SOP No. 98-
9 for the year ending December 31, 2000. SOP No. 98-9 also extends the deferral
of the application of SOP No. 97-2 to certain other multiple-element software
arrangements through the year ending December 31, 1999. We are evaluating the
provisions of SOP No. 98-9 and we have not yet determined what impact, if any,
SOP No. 98-9 will have on our financial position, results of operations or cash
flows.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
The primary objective of VeriSign's investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we have invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed rate
equal to the then-prevailing interest rate and the prevailing interest rate
later rises, the fair value of our investment will decline. To minimize this
risk, we maintain our portfolio of cash equivalents and short-term investments
in a variety of securities, including commercial paper, medium-term notes,
corporate bonds and notes, market auction securities and money market funds. In
general, money market funds are not subject to market risk because the interest
paid on these funds fluctuates with the prevailing interest rate. In addition,
we invest in relatively short-term securities. As of March 31, 1999, 80% of our
investments had maturity dates within one year.
The following table presents the amounts of our cash equivalents and short-
term investments that are subject to market risk by range of expected maturity
and weighted-average interest rates as of March 31, 1999. This table does not
include money market funds because these funds are not subject to market risk.
MATURING IN
-----------------------
ONE YEAR OVER FAIR
OR LESS ONE YEAR TOTAL VALUE
------------ --------- ------- -------
Included in cash and cash equivalents.. $98,499 None $98,499 $98,499
Weighted-average interest rate........ 4.90%
Included in short-term investments..... $38,774 $9,560 $48,334 $48,334
Weighted-average interest rates....... 4.98% 5.49%
EXCHANGE RATE SENSITIVITY
VeriSign considers its exposure to foreign currency exchange rate fluctuations
to be minimal. Our recently established subsidiary in Sweden has not had
significant operations to date. All revenues derived from our European
affiliates are denominated in U.S. dollars and, therefore, are not subject to
exchange rate fluctuations.
Both the revenues and expenses of our majority-owned subsidiary in Japan are
denominated in Japanese yen. This serves as a natural hedge since even though an
unfavorable change in the exchange rate of the Japanese yen against the U.S.
dollar results in lower revenues when the subsidiary's revenues are translated
to U.S. dollars, operating expenses will also be lower.
Because of our minimal exposure to foreign currencies, we have not engaged in
any hedging transactions to date.
21
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) Use of Proceeds.
In January 1998, VeriSign completed the initial public offering of its common
stock. The managing underwriters in the offering were Morgan Stanley & Co.
Incorporated, Hambrecht & Quist LLC and Wessels, Arnold & Henderson L.L.C. We
realized net proceeds from the offering of approximately $43.7 million after
deducting the underwriting discounts and commissions and expenses of the
offering. Through March 31, 1999, we used approximately $14.9 million of the net
proceeds from the offering to fund operating expenses, the transaction charges
related to the acquisition of SecureIT and increase working capital and
approximately $6.7 million to purchase and install computers and peripheral
equipment and leasehold improvements. The remaining $22.1 million has been
invested in short-term, interest-bearing, investment grade securities.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
Exhibit
Number Exhibit Title
------ ------------------------------------------------------------
27.01 Financial Data Schedule (available in EDGAR format only)
(b) Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended March 31, 1999.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VERISIGN, INC.
Date: May 12, 1999 By: /s/ Stratton D. Sclavos
-------------------------------
Stratton D. Sclavos
President
and
Chief Executive Officer
(Principal Executive Officer)
Date: May 12, 1999 By: /s/ Dana L. Evan
-------------------------------
Dana L. Evan
Executive Vice President of
Finance and Administration and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
23
SUMMARY OF TRADEMARKS
The following trademarks and service marks of VeriSign, Inc., which may be
registered in certain jurisdictions, may be referenced in this Form 10-Q:
TRADEMARKS
SecureIT(TM)
VeriSign Logo
VeriSign is a registered trademark exclusively licensed to VeriSign, Inc.
SERVICE MARKS
Digital ID(SM)
Digital ID Center(SM)
NetSure(SM) Protection Plan
VeriSign OnSite(SM)
VeriSign Trust Network(SM)
VeriSign V-Commerce(SM)
WebPass(SM) ID
WorldTrust(SM)
All other brand or product names are trademarks or registered trademarks of
their respective holders.
24
5
1,000
3-MOS
DEC-31-1999
JAN-01-1999
MAR-31-1999
108,949
48,334
13,823
606
0
174,922
18,590
8,123
188,966
26,006
0
0
0
25
162,221
188,966
15,582
15,582
0
6,601
12,410
0
0
(1,993)
0
(1,993)
0
0
0
(1,993)
(.08)
(.08)
