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VeriSign Inc. (VRSN - Analyst Report) reported third-quarter 2013 earnings of 55 cents per share, which beat the Zacks Consensus Estimate by a couple of cents. Earnings (minus stock-based compensation) increased 19.6% year over year but remained flat on a sequential basis.

Revenues

Revenues surged 9.0% year over year and 1.8% sequentially to $243.7 million, slightly ahead of the Zacks Consensus Estimate of $241.0 million. Approximately 61.0% of the revenues were from the U.S, while the remaining came from overseas.

VeriSign Registry Services added 1.55 million net new names compared with 1.22 million in the previous quarter. Active domain names in the zone for .com and .net increased 5.0% year over year to $125.9 million (.com 110.7 million and .net 15.2 million) in the quarter.

VeriSign processed 8.3 million new domain name registrations for .com and .net, up from 7.8 million in the year-ago quarter but slightly down from 8.7 million in the previous quarter.

VeriSign estimates renewal rate to be approximately 72.5% in the third quarter, flat compared with the year-ago quarter. Exact renewal rate figures will be available post 45 days of the end of the quarter. In the second quarter of 2013, renewal rate was 72.7%.

Margins

As a percentage of revenues, operating expenses declined to 45.5% in the third quarter compared with 48.1% in the year-ago quarter but increased from 44.8% in the previous quarter.

A sharp decline in sales & marketing (S&M) as well as general & administrative (G&A) expenses, down 90 basis points (bps) and 250 bps, respectively, drove the year-over-year decline. Research & development (R&D) expense increased a modest 30 bps from the year-ago quarter.

The sequential rise in operating expense as a percentage of revenues was primarily due to a 140 bps expansion in G&A and a 10 bps upside in R&D, which offset a 30 bps decrease in S&M.

Operating margin was 54.5% in the quarter compared with 52.0% in the year-ago quarter and 55.2% in the previous quarter. The year-over-year improvement was primarily due to lower operating expenses. However, a sharp rise in operating expenses on a sequential basis negatively impacted operating margin in the quarter.

Net income margin was 34.7% compared with 35.5% in the year-ago quarter and 36.1% in the previous quarter.

Balance Sheet & Cash Flow

Cash and cash equivalents (including marketable securities) were $1.80 billion (out of which $389.0 million was held in the U.S.) compared with $2.0 billion in the previous quarter.

Operating cash flow was $134.0 million in the quarter, down from $147.0 million in the second quarter. Free cash flow was $134.0 million compared with $132.0 million in the previous quarter.

VeriSign repurchased approximately 6.8 million shares for $331.0 million in the quarter.

Positive Guidance

VeriSign intends to focus more on developing new revenue streams in 2013. The company expects to add 1.0 to 1.5 million net new names in the .com and .net registry for the fourth quarter of 2013.

During the fourth quarter, the company expects to liquidate one of its domestic subsidiaries for tax purpose, which may result in an income tax benefit of $300.0 million to $400.0 million.

For full year 2013, VeriSign forecasts revenues in the range of $960.0 to $965.0 million (up from prior outlook of $952.0 to $962.0 million), which represents an annual growth rate of 10% (up from the range of 9.0% to 10.0%). Non-GAAP gross margin is expected to be at least 80%, while operating margin is forecast to be between 58.0% and 59.0%.

Interest expense and non-operating income, net is expected to be within the range of $60.0–$62.0 million for fiscal 2013. Capital expenditure is expected in the range of $65.0 million to $75.0 million (revised from $60.0 million to $80.0 million) for fiscal 2013.

Our Take

We believe that growing generic top-level domain (“gTLD”) customer base, international expansion through IDNs (internationalized domain names), strong growth in the Network Intelligence and Availability (“NIA”) services and investments on developing new intellectual properties will boost revenues and profitability going forward.

However, negative impact of search engine adjustments on domain monetization and increasing marketing expenses related to the introduction of new gTLDs and IDNs remain the primary headwinds in the near term. Moreover, the ongoing cash repatriation issue remains a concern with respect to liquidity in the near term.

Additionally, significant competition from AT&T Inc. (T - Analyst Report), Verizon (VZ - Analyst Report) and Infoblox Inc. (BLOX - Snapshot Report) in the NIA segment remains a concern going forward.

Currently, VeriSign has a Zacks Rank #3 (Hold).

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