Tax Savings Should Drive Long Term Bottom Line Growth for VeriSign

Shares of VeriSign (NASDAQ:VRSN) rose over 10% on July 25, 2014 after the company reported strong profit figures in the second quarter of 2014. The company reported revenues of $250.4 million, marginally missing consensus estimates by about $1.3 million. However, net income per share for the quarter increased to 68 cents and was 4 cents higher than consensus estimates, fueled by a $300 million share buyback program. In year-on-year growth terms, revenues increased 4.6% this quarter while net income expanded 15.3% over Q2FY13.

In this article, we take a look at various trends that have shaped VeriSign’s Q2FY14 performance. We are in the process of revising our Trefis price estimate of $54 for VeriSign to incorporate the latest quarterly results.

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Slowing New Additions to Domain Base Should Suppress Effect from .net Fee Hike

Revenue growth continued to remain soft, with the company making 0.42 million net additions to the domain name base after processing 8.5 million registrations. Comparatively, VeriSign added 1.22 million net new names out of 8.7 million registrations in Q2FY13, and 1.28 million names out of 8.6 million registrations in Q1FY14. During the first quarter conference call, VeriSign guided to some weakness in net additions for Q2FY14, primarily driven by a greater focus on increasing  bundled product offerings compared to domain name sales from domestic and international domain registrars.

For the upcoming Q3FY14, the company expects net additions to range between 0.6-1.1 million names. ^[1] However, net additions for Q3FY14 would certainly remain lower than the 1.55 million names added in Q3FY13. This trend of slowing net additions is expected to continue as the .com and .net domain name bases continue to saturate. On the flipside, the hike in .net domain fee from $6.18 to $6.79 beginning February 2015 could partially temper the growing pressure on its overall domain name base. ^[1] On the whole, VeriSign’s .com and .net market share is expected to continue declining as new additions migrate towards less saturated domain bases.

Bottom Line Jumps Despite Taxes Levied on Cash Repatriation

In the quarter gone by, VeriSign repatriated approximately $741 million of cash held by foreign subsidiaries. This conversion of cash held in foreign currencies across low tax jurisdictions to dollar denominations requires companies to pay the standard U.S. corporate tax rate on repatriated cash, less the tax paid in the low tax foreign country. VeriSign paid approximately $28 million in foreign withholding tax on the repatriation completed in Q2FY14.

The 15% jump in net income reflects both the after-tax impact of the repatriated cash as well as lower operating expenses incurred during the quarter. Cost of sales dropped 1.4% on a year-on-year basis while R&D expenses decreased 7% compared to Q2FY13, contributing to higher margin numbers. Going forward, the company expects to competitively drive margins higher and has upped its non-GAAP operating margin guidance for FY14 from 58-60% to 59-61%. ^[1]

Apart from the increased operating margin guidance, future net income levels are expected to bolstered further by favorable tax benefits. The cash repatriation activity has freed up about $191 million of foreign tax credits that expire by 2024. According to the IRS, these foreign tax credits could either be taken as a credit to offset deferred tax liabilities or as a deduction to reduce taxable income. Additionally, interest payments on its convertible debentures offer a tax shield and provide further deductions in its taxable income. Both these long-term benefits set up VeriSign’s bottom line on a strong growth trajectory going forward.

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1. VeriSign’s (VRSN) CEO James Bidzos on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 2014 [↩] [↩] [↩]