VeriSign Inc. (VRSN) reported second-quarter 2014 earnings (excluding all one-time items but including stock-based compensation) of 63 cents per share, which increased 16.4% year over year and 10.3% on a sequential basis. The strong growth was primarily driven by higher revenues and margin expansion.

Revenues

Revenues increased 4.6% year over year and 0.6% sequentially to $250.4 million, slightly lower than the Zacks Consensus Estimate of $252.0 million. Approximately 61.0% of the revenues were from the U.S., while the remaining came from overseas.

VeriSign Registry Services added 0.42 million net new names compared with 1.28 million in the previous quarter. Active domain names in the zone for .com and .net increased 3.7% year over year to $128.9 million (.com 113.7 million and .net 15.2 million) in the quarter.

VeriSign processed 8.5 million new domain name registrations for .com and .net, down from 8.7 million in the year-ago quarter and 8.6 million sequentially.

VeriSign estimates renewal rate to be approximately 71.7% in the second quarter, down year over year. Exact renewal rate figures will be available 45 days after the end of the quarter. In the first quarter of 2014, renewal rate was 72.6%.

VeriSign announced hike in the annual registry fee for .net domain names. The hiked rate of $6.79 (up from $6.18) will be effective from Feb 1, 2015.

Margins

As a percentage of revenues, total operating expenses decreased to 42.8% in the second quarter compared with 44.8% in the year-ago quarter and 43.9% in the previous quarter.

Lower sales & marketing (S&M) as well as research & development (R&D) expenses, down 30 basis points (bps) and 80 bps year over year, respectively, led to the decline in operating expenses. The sequential drop was primarily due to 110 bps contraction in S&M and 20 bps downside in general & administrative (G&A) expenses.

Operating margin was 57.2% in the quarter compared with 55.2% in the year-ago quarter and 56.1% in the previous quarter. The expansion in operating margin was primarily due to lower operating expenses.

Net income (including stock-based compensation excluding one-time items) was $89.2 million or 63 cents per share compared with $85.4 million or 58 cents reported in the year-ago quarter and $85.0 million or 57 cents in the previous quarter.

Balance Sheet & Cash Flow

Cash and cash equivalents (including marketable securities) were $1.55 billion compared with $1.72 billion in the previous quarter. During the quarter, VeriSign repatriated $741.0 million of cash held by subsidiaries.

Operating cash flow was $121.0 million in the quarter, down from $142.0 million in the first quarter. Free cash flow was $129.0 million compared with $130.0 million in the previous quarter.

VeriSign repurchased approximately 6.0 million shares for $300.0 million in the quarter. On Jul 23, the board of directors approved a new share buyback program that bought the total amount available for share repurchase to $1.0 billion.

Guidance

VeriSign expects third-quarter 2014 net additions to the .com and .net zone to be between 0.6 million and 1.1 million.

For 2014, VeriSign forecasts revenues in the range of $1.003 to $1.012 billion, which represents an annual growth rate of 4.0% to 5.0% (previous guidance was $1.0 to $1.015 billion). The Zacks Consensus Estimate is pegged at $1.014 billion.

Non-GAAP gross margin is expected to be at least 80%, while operating margin is forecast to be between 59.0% and 61.0% (up from 58.0% and 60.0%).

Interest expense and non-operating income, net is expected to be within the range of $76.0–$80.0 million (up from $73.0 to $77.0 million) for 2014.

Management now expects to pay cash taxes of approximately $35.0 to $45.0 million in 2014, which primarily relate to international taxes, including the $28.0 million in foreign tax withholding on the repatriation completed during the second quarter.

Capital expenditure is expected in the range of $50.0 to $60.0 million (previous guidance $50.0 to $70.0 million) for 2014.

Our Take

We believe 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.

Additionally, VeriSign has significant growth opportunities from its network security products as Distributed Denial of Service (DDoS) attacks continue to grow.

However, the 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, entry of Google (GOOGL) in the market will intensify competition in the long run. Further, significant competition from AT&T Inc. (T) and Verizon (VZ) in the NIA segment remains a major concern.

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

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