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VeriSign Inc. (VRSN - Analyst Report) reported an impressive fourth quarter with earnings of 54 cents per share, which beat the Zacks Consensus Estimate by 6 cents. The better-than-expected result was primarily driven by strong revenue growth and margin expansion.

Revenues

Total revenue increased 13.0% year over year and 3.0% sequentially to $230.2 million, slightly ahead of the Zacks Consensus Estimate of $229.0 million. Approximately 60% of the total revenue was from the U.S, while the remaining came from overseas. U.S. revenues increased 12.1% year over year, while international revenues grew 14.5% from the year-ago quarter.

VeriSign Registry Services added 1.25 million net new names in the quarter. Active domain names in the zone for .com and .net increased 6.4% year over year to $121.1 million (.com 106.2 million and .net 14.9 million) in the quarter. VeriSign processed 8.0 million new domain name registrations for .com and .net, up 1.0% from the year-ago quarter.

VeriSign estimates renewal rate to be approximately 72.9% in the fourth quarter compared with 73.5% in the year-ago quarter. Exact renewal rate figures will be available post 45 days of the end of the quarter. In the third quarter, renewal rate was 72.5%.

During the quarter, the U.S. Department of Commerce approved VeriSign’s renewal agreement with the Internet Corporation for Assigned Names and Numbers (ICANN) to serve as the authoritative operator for the .com registry for the term commencing Dec 1, 2012 through Nov 30, 2018.

VeriSign also announced hike in the registry fee for .net domain names. The hiked rate of $5.62 (up from $5.11) will be effective from Jul 1, 2013.

Margins

Operating expenses plunged 14.4% year over year and 11.7% sequentially to $94.8 million. As a percentage of revenues, operating expenses declined to 41.2% in the fourth quarter compared with 54.4% in the year-ago quarter and 48.1% in the previous quarter. These significant improvements in operating expenses were primarily driven by sharp decline in sales & marketing (S&A) and general & administrative (G&A) expenses.

Operating income improved significantly as a result of lower-than-expected growth in operating expenses and higher revenue base. Operating income surged 40.7% year over year and 16.9% sequentially to $135.9 million. Operating margin was 59.0% in the quarter, much better than 47.4% in the year-ago quarter and 52.0% in the previous quarter.

Net income surged 56.2% year over year and 14.2% sequentially to $87.5 million. Earnings per share (“EPS”) jumped 54.3% from the year-ago quarter and 17.4% from the previous quarter to 54 cents.

Balance Sheet & Cash Flow

Cash and cash equivalents (including marketable securities) were $1.56 billion compared with $1.49 billion in the previous quarter. Long-term debt was $697.6 million compared with $100.0 million in the previous quarter. This significant jump in debt was due to the addition of convertible debentures currently valued at $598.0 million.

Operating cash flow was $171.0 million in the quarter, up from $122.0 million in the third quarter. Free cash flow was $155.0 million in the fourth quarter of 2012. VeriSign repurchased approximately 2.3 million shares for $94.0 million in the fourth quarter.

Positive Guidance

VeriSign intends to focus more on developing new revenue streams in 2013. The company expects to add 2.0 million to 2.4 million net new names in the .com and .net registry in first quarter of 2013.

For full year 2013, VeriSign forecasts revenues to be in the range of $945.0 to $960.0 million, which represents an annual growth rate of 8% to 10%. Non-GAAP gross margin is expected to be at least 80%, while operating margin is forecasted to be at least 57%.

Our Take

We believe that the renewal of the .com contract is a major positive for VeriSign going forward. Moreover, the price hike in .net domain name will boost its top-line growth. Additionally, growing generic top-level domain (“gTLD”) customer base, international expansion through IDNs (internationalized domain names) and strong growth in the Network Intelligence and Availability (“NIA”) services will further boost revenues and profitability.

However, continuing macro-economic headwinds particularly in Europe, negative impact of search engine adjustments on domain monetization and increasing operating expenses related to the .com contract renewal remain the primary headwinds in the near term. Moreover, significant competition from AT&T Inc. (T - Analyst Report), Verizon (VZ - Analyst Report) and Infoblox Inc. (BLOX) in the NIA segment remains a major concern.

Currently, VeriSign has a Zacks Rank #4 (Sell).

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