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NeuStar Inc. (NYSE:NSR)

Q3 2008 Earnings Call

November 4, 2008 5:00 pm ET

Executives

Brandon Pugh – Director of Finance and Investor Relations

Jeffrey A. Babka – Chief Financial Officer

Jeffrey Ganek – Chairman and Chief Executive Officer

Analysts

Sterling Auty – JP Morgan

John Bright – Avondale Partners

Philip Winslow – Credit Suisse

Tom Ernst – Deutsche Bank

Scott Sutherland – Wedbush Morgan Securities

Jonathan Ho – William Blair

William Power – Robert W. Baird & Co.

Katherine Egbert – Jefferies & Company

Operator

Welcome to the NeuStar Conference Call discussing third quarter 2008 results. The company's release made earlier today is available from its Web site at www.neustar.biz. (Operator Instructions). I would now like to turn the conference call over Mr. Brandon Pugh, Director of Finance, and Investor Relations at NeuStar. Please go ahead, sir.

Brandon Pugh

Thank you and good afternoon everyone. Welcome to our third quarter 2008 earnings call for Investors and Analysts. On our call today, Jeff Babka, NeuStar's Chief Financial Officer will lead off with a quick run through of the numbers for the quarter and our guidance for the year. Jeff Ganek, NeuStar's Chairman and Chief Executive Officer, will then provide a state of the business review in light of current macro economic developments. Afterwards we'll open the line to questions from analysts and qualified investors.

Statements by NeuStar executives during the presentation include information that constitutes forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, including without limitation, statements about NeuStar's expectations, beliefs, and business results in the future. We cannot assure you that our expectations will be achieved or that any deviations will not be material.

Forward-looking statements are subject to many assumptions, risks, and uncertainties that may cause future results to differ materially from those anticipated, including the risks and other factors listed in the NeuStar's filings with the Securities and Exchange Commission, including without limitation, NeuStar's annual report on Form 10-K for the year ended December 31, 2007, and other subsequent and current periodic reports.

All forward-looking statements are based on information available to NeuStar as of today's date. NeuStar undertakes no obligation to update any of the forward-looking statements, including as a result of any new information, future events, changed expectations, or otherwise. As you listen to today's call we encourage you to have our press release in front of you, as well as the supplemental presentation we posted to our Investor Relations Web site.

These two documents include our financial results, metrics, and commentary for the quarter, as well as the reconciliation of certain non-GAAP measures with the most directly comparable GAAP measures.

With that I'm pleased to introduce NeuStar's Chief Financial Officer, Jeff Babka, Jeff.

Jeffrey Babka

Thank you, Brandon. Good afternoon everyone. We are pleased with out third quarter results, which are summarized in our press release this afternoon and on the supplemental information that we've made available just before the call on our website, and as an exhibit for Form 8-K filed today. Although my comments do not track specifically with the slides, I will make references to them periodically.

The highlights of the third quarter include the following, which can also be found on Slide 4 the supplemental information. Total revenue of $123.8 million, a 12% increase from the third quarter of last year, EBITDA for the quarter totaled $55.7 million, representing a 45% EBITDA margin. EBITDA was up $4.3 million from the third quarter of last year.

Net income of $28.4 million, representing a 23% net income margin and $0.38 per share on a diluted basis; net income was up $2.7 million from the third quarter of last year. Cash from operations for the quarter was $51.6 million with a year-to-date total of $118.3 million. Transactions on our contracts to provide number portability services in the United States totaled $95.1 million, up 14% from the third quarter of last year, and up 6% from the second quarter.

Revenue from Ultra services totaled $11.2 million, an increase of 45% from the third quarter of last year, and up 4% from the second quarter. Revenue from common short codes totaled $7.6 million, an increase of 22% from the third quarter of last year, and up 4% from the second quarter. NGM revenue totaled $3.6 million, up from $1.8 million in the third quarter of last year and $3.3 million in the second quarter.

Our revenue growth this quarter was driven primarily by three key areas – number portability services, primarily in infrastructure, Ultra services and U.S. common short codes. Addressing revenue totaled $32.5 million, up $4 million or 14% from the same quarter last year. Key contributors to this increase were Ultra services, common short codes, and registry services. Inner operability revenue totaled $16.2 million, up $1 million, or 7%, from the same quarter last year. This increase was driven by our increases in our NGM mobile instant messaging services.

Infrastructure revenue amounted to $75.1 million, up $8 million, or 12%, from the same quarter last year. In dollar magnitude, infrastructure was the largest growing revenue category this quarter driven predominantly by network optimization activities. Turning now to cost and expenses in the third quarter, operating expense totaled $78.6 million, an increase of 14% from the third quarter of last year, and a decrease of 2% on a sequential basis.

Our press release and the supplemental financial information provided on our website detail the expense numbers by category. To summarize, the variation from last year was driven by increases in cost of revenue commensurate with our revenue increase and R&D, primarily related to costs incurred at NGM.

In addition, the increase in G&A was driven by costs incurred and strengthening our management team, stock-based compensation, and operating efficiency programs such as SAD 70. On a sequential basis the decrease was primarily in sales and marketing. Depreciation and amortization totaled $10.6 million, an increase of 3% sequentially. Within this amount, amortization of intangibles related to the application of purchase accounting for acquisitions totaled $3.8 million.

Also in the third quarter we recorded a combined $605,000 in charges related to our $37.3 million in auction-rate securities, and $17.6 million short-term investments that we held as of September 30, 2008. Of this amount $324,000 relates to the decrease in market value of auction-rate securities, and $281,000 relates to the decrease in market value and realized loss on redemption of short-term investments. These charges are included in interest and other expenses.

The reduction of our third quarter effective tax rate to 36.1% was due to approximately $1.5 million of one-time benefits related to a reduction of tax reserves on tax positions, and $400,000 related to a reduction in our state tax rates. Moving now to balance sheet and capital, cash, cash equivalents, and short term investments ended the quarter at $120.2 million, an increase of $48 million from the beginning of the quarter.

In addition, as I just indicated, we have $37.3 million of cash and long-term investments that relate to auction-rate securities. The bank that offered these securities has committed to us that they will be redeemable in full by June 2010 if not sooner; however, GAAP requires that we book charges currently for changes in the current market value of the securities. Cash generation continues to remain healthy with cash provided from operations in the quarter amounting to $51.6 million.

At the end of the quarter accounts receivable amounted to $67.7 million, a decrease of $2.3 million from the start of the quarter. Deferred revenue decreased $2.2 million from the start of the quarter, primarily relating to recognition of deferred revenue for O&F and NGM. Capital expenditures year-to-date total $18.5 million, reflecting continued investment in our global infrastructure. We now anticipate our spending on capital for all of 2008 to approximate $25 million.

We also updated our guidance today as shown on Slide 10. 2008 revenues are now projected to range between $485 million and $490 million, down from the $500 million to $515 million previously projected. I'll discuss the revised revenue guidance in a moment. Our guidance on EBITDA and net income remains unchanged from our previous quarter. Excluding impairment charges relative to NGM, EBITDA is projected to exceed $206 million, or $2.71 per diluted share, and net income is projected to exceed $99 million, or $1.30 per diluted share.

With the impairment charge included, EBITDA is projected to exceed $177 million, or $2.33 per diluted share, and net income is projected to exceed $70 million, or $0.92 per diluted share. In respect to our revenue guidance, inherent in revenue projections for the full year is continuing strong performance of our number portability transactions now projected to be at least $367 million, which is $7 million higher than the previous guidance and $17 million higher than our projection at the start of the year. This represents year-over-year annual growth of over 15%.

As you can see on Slide 11 of our supplementals, at 367 million transactions, the per-transaction pricing for the year would average approximately $0.87. Now offsetting this increase in transaction revenue and contributing to the reduction in our revenue guidance are two items. First of all, we are now lowering our NGM revenue projection for 2008 to approximately $15 million. Jeff will discuss the reason for the shortfall later in his comments.

Secondly, across all of NeuStar, at the start of 2008 we projected incremental revenue from new service offerings, contracts, and geographic expansion in the third and fourth quarters. Some of these new revenue opportunities have not developed as quickly as we anticipated. In addition, in some cases we deliberately chose to either delay or forego opportunities in order to focus on generating strong earnings and cash flow. In light of the current macro economic environment we believe the decision was the correct call.

In closing, we believe that our third quarter results, strong balance sheet, and our outlook for the full year place us in a good position financially and operationally to maintain stability for the long term. Healthy profitability and cash generation for our shareholders in these times is our first priority, while still growing the business for years to come.

I'll now hand the ball over to NeuStar's Chairman and Chief Executive Officer, Jeff Ganek, for his comments, Jeff.

Jeffrey Ganek

Thanks, Jeff. This [inaudible] that Jeff reported, in the third quarter NeuStar produced record high revenue and strong profitability measured by EBITDA, EBITDA margin percentage, and earnings per share. Despite our strong performance, we recognize the potential challenge that we could face from the current global economic market conditions. While no company can ignore these conditions, at NeuStar we have attributes and assets that can be the foundation for strength in difficult times. Let me explain.

First, NeuStar has a strong balance sheet with more than $150 million in cash, and virtually no debt. Second, our business generates strong cash flow. Because many of our services are critical to the operations of our customers, demand for and revenues from those services historically have been strong in both good economic times and bad. On the cost side, our business model enables us to prudently manage investment in line with revenues. When we see changes coming in revenues we're able to manage our spending to maintain profitability and cash flow.

Third, our management team is strong, and over the last year we've added key new executives to senior team so that our experience and expertise matches the challenges that arise in difficult market conditions. In anticipation, we're already managing spending prudently. Let me briefly describe how we're adjusting our priorities.

In our core services numbering, or local number portability, our priorities are to continue generating reliable revenues and managing spending. The revenue characteristics of numbering are important to note. As Jeff Babka said, numbering volumes and revenues surged in the third quarter. Since inception of numbering in 1996 there's been little or no correlation between either GDP growth or telco capital spending, and demand for our numbering service.

Even in difficult economic times, as in the third quarter, our customers use our numbering services to more efficiently and economically manage the growing volume of their traffics over their existing networks, demonstrating that we're tightly woven into their operating fabrics. In fact, in many cases our customers use NeuStar numbering transactions to manage their traffic and facilities to control spending and increase efficiency.

They rely on our services to economically manage network traffic routing, architecture changes, and infrastructure changes, including technology and signaling system changes that continue during tough economic times. Furthermore, customers use our services to manage the challenges prevented by the IP revolution and competitive pressures as was demonstrated in the last quarter by transaction volumes, generated our new products such as the iPhone.

As per our guidance projection, the current pipeline of numbering transaction opportunities for the fourth quarter remain strong with visibility comparable to previous quarters. We'll continue to work with our customers to adapt our relationships so we best serve their growing demands in changing markets. At the same time we've also made port management a high priority. Our existing systems and platforms are robust and able to handle increasing volumes of numbering transactions while operations are proven effective and scalable.

During the third quarter we delivered excellent quality and higher volumes from our numbering services while managing efficiently. We'll invest here wisely, especially in an uncertain market. In Internet Infrastructure Services our priority is to cautiously manage our leading position in this early-stage market. In the third quarter we saw continued growth in registry services as Internet usage and demand for domain names grew in the market, and as Jeff Babka said earlier, in the third quarter we also saw strong growth in Ultra services.

Demand grew as providers of ecommerce and other complex Web services utilize our Ultra services to manage their IP traffic. We believe this growth will continue its enterprise look to realize cost savings by using the Internet for sales, marketing, distribution, and customer support activity. Since most of the UltraDNS services are provided on our software as a service, or SAS model, our customers choosing to rely on NeuStar services require minimal capital outlay or additional IT staff on their part.

This should be a key value proposition in the near and long term, as organizations around the world look to reduce cost and best optimize their technology infrastructure and capital resources. As in numbering, we expect that with prudent investment in line with revenues, the platform we operate to deliver Ultra services will provide to us leverage for efficiency and cash generation. In the fourth quarter and beyond we'll closely monitor market demand for registry and Ultra services.

We expect demand will continue to grow enabling us to take advantage of our leadership position; however, the scale and the degree of the economic slowdown is unprecedented for NeuStar and for each of these new emerging market segments. So investment in these businesses will be prudent. Spending on new products and expansions of distribution channels will be governed by demonstrated demand for services. We'll focus our spending on tangible revenue opportunities.

Our position on common short codes is similar. In the third quarter customer demand and our revenues continue to grow; however, the resilience of common short codes in a serious economic downturn hasn't been tested. So as we continue to grow we again will closely monitor demand trends and adjust spending accordingly. We deliver common short codes again, over a robust, highly scalable platform that allows for efficient cost management. Our NGM, or Next Generation Messaging business, requires special attention.

In the last quarter we saw some growth in revenues for Mobile Instant Messaging Services; however, there has not yet been the broad market-wide uptake of the service by end users that was anticipated. Market analysts continue to project large future demands for the service, and NeuStar's NGM continues to be relied upon by mobile network operators for IM infrastructure more than any other provider.

When the market demand emerges NeuStar's NGM systems will be the foundation that delivers this early Internet protocol, or IP-based service, to the mass market of wireless handsets. In the long-term infrastructure that enabled IP-based service delivery will be desired by mobile operators so that they can bring to market a growing broad range of new advanced IP-based services. We aim to be a reliable provider of that infrastructure.

In the short term the impact of difficult economic conditions on the emergence of the end user demand for mobile IM is uncertain at best. So we’ll analyze consumer demand closely and we’ll carefully manage spending consistent with that demand. We’ve already moved to improve efficiency at NGM. In the third quarter we consolidated NGM’s dedicated technical and operational function into NeuStar's seasoned and well managed technical organization. As we fine tune operations and efficiencies, we’ll maintain our positions in the market and support our customers. But we’ll not spend needlessly ahead of demand.

So let me summarize, in the third quarter, NeuStar produced very strong profitability in cash flow, along with continued revenue growth. We managed spending prudently in line with market demand in volumes, in the face of difficult economic conditions. Our focus has been and will be, first and foremost, on profitability and cash flow.

In numbering we’ll continue to provide our customers with essentially high value services. As demonstrated in the third quarter and in the past we’ll serve the industry's evolving needs for services that they rely upon during good economic times as well as bad.

In Internet infrastructure we’ll closely monitor market demands and will scale our spending accordingly. At NGM we’ll control spending in line with market development, while we anticipate the market’s needs for infrastructure that will be necessary in the future to deliver IP-based mobile services.

Overall NeuStar is well positioned with strong cash balance and leading market conditions in fast growing markets. However the markets evolve going forward, we’ll produce reliable revenue and as the market allows, growth. Importantly we’ll manage spending to maintain strong profitability and cash flow. When the economy eventually turns up we’ll be positioned with customers, products and management to grow quickly.

With that overview I’ll now open it up to questions. Operator?

Question-and-answer Session

Operator

(Operator instructions). Your first question is from Sterling Auty – JP Morgan.

Sterling Auty – JP Morgan

So if I were to summarize what I heard, am I correct in just saying the core impact business continues to perform well; you state that it has a very defensive nature to it. That the rest of the businesses have a lot more sensitivity and that’s why you’re making the changes to the guidance where you’ll be prudent in the way you manage the expenses around them going forward?

Jeffrey Ganek

No, you’re exactly right about the base business. We saw growth there materially beyond what we and our customers had forecast to demonstrate how resilient the demand flow for that business is. And while that larger transaction flow was coming across our platforms we were able to manage expenses.

At the same time we saw very strong growth in Ultra in registry and common short codes. And that happened despite a serious downturn in the economy overall. We managed costs there in line with those revenues. I’m being especially cautious here, because as we look to the future, while we are confident in the importance of our base business number portability services to our carriers, we’ve been offering this for 13 years, in the other businesses we have not tested their sensitivity to changes in the economy. We are pushing every one of our business leads to drive for growth as high in the future as we’ve seen in the past. I am just offering a caution here to our investors because this is a set of market conditions that NeuStar and our new businesses have very little experience in.

Sterling Auty – JP Morgan

As a follow-up, is there a level of base business both in the impact and then broader across all of NeuStar that you feel – recurring is the wrong term – but that you feel very confident can happen year in and year out regardless of where we are in the business cycle?

Jeff Babka

Well, certainly, Sterling, on the numbering portability business, we have seen stability in the past. And as Jeff commented on in the comments the uses for this should be comparable in poor economic times as they would in good economic times. But it’s untested. We just have not seen what we’re seeing out in marketplace today. We go into 2009 with the expectation that we can get growth, but we still have yet to develop the plans and have really have yet to work through it.

Obviously on the other sides of our business it’s somewhat of an unknown territory for us. We like the profile of, certainly, on the Ultra business, as more and more traffic goes over the Internet and looking for the protection services that we provide there and we see nothing that tells us right now that that traffic is going to go down particularly if you look at it on more holistic sense of being both e-commerce and the queries by social networking and things of that nature.

NGM is still at this stage of the game very early stage. I believe that as we work through the finalization of our plan for this year, we’ll develop a better understanding of the resiliencies of these businesses and come up with a set of numbers for next year that again, wherever they end up are going to be strong from a profitability and cash flow perspective.

Sterling Auty – JP Morgan

Last question. What was the dilution from MGM in the quarter and how much of your flexibility do you have to kind of just spend the margin next year meaning what level of top line growth do you need to at least maintain the kind of profitability that you’re producing this year?

Jeff Babka

In the neighborhood of 10 million dilution for the quarter, and, quite honestly, it’s probably going to be in that same general neighborhood for the fourth quarter. We’re still working through some things because as Jeff mentioned we're, I mean we’ve consolidated the operations there. We’ve got plans in place. But obviously these changes don’t happen overnight. And some costs are trailing on that.

As we look going into next year, we have a new general manager there. We’re working through with the team the current requirements of the customers we have. We believe we’re going to get a more efficient operation by the centralization of the operations group that we mentioned, and we definitely believe we’re going to be able to improve that dilution in 2009.

It’s too early to say when it’s going to cross the breakeven threshold, but we’ve got a lot of smart people looking at it, and we’re confident in the fact that with the 37 customers that we have getting the platform solidified, meeting these customers’ requirements, having them, again, hopefully start putting the promotional activities into it, we can get this business on an upward trajectory.

But we’re obviously not going to spend ahead of the revenues on this. We’ll do everything we can to keep the spending down to the lowest level possible.

Operator

(Operator Instructions). Your next question is from John Bright – Avondale Partners.

John Bright – Avondale Partners

Jeff Ganek, following up on the prior question on mobile IM, at what point do you make a decision on this 10 million in dilution maybe not to move forward on this strategy? And how long are you going to give it?

Jeffrey Ganek

John, that goes right to the core of what Jeff Babka, [Lisa Hook] and I are focused on right now. Look, over the last two years we have seen large mobile operators come to NeuStar to depend upon our infrastructure for delivering a service. We’ve got 37 large mobile operators, signed contracts or paying customers of ours, and I’m just disappointed that the plans that were in the marketplace to introduce and promote and support mobile instant messaging to end users have not manifested themselves as we expected. We are not going to continue to chase an opportunity that is not going to grow.

And, as I said earlier, the impact on the timing of final end user customer demand for mobile instant messaging, the impact of the economic downturn on that is uncertain at best, and perhaps worse. We are on a daily basis in communication with our existing mobile network operator customers. We are checking end user take rates on a daily basis. When it appears that there is bleak prospects for end user take rates to move up, we will decisively change our spending patterns. We have only in the past spent here because there were marketing plans because there were market analysts projecting growth.

To the extent that the worldwide economic conditions are going to change the forecast for that growth, we will change our strategy. There’s no religious commitment here to the business. Having said that, we do believe that in the long run, in the long run there is a large market opportunity here at a minimum. In the short run we are already moving quickly to manage costs and generating operating synergies where the results of those actions still don't move cross line with expected revenue opportunities, we’ll take further action.

John Bright – Avondale Partners

Thank you and to follow up, Jeff Babka, I think you mentioned in the guidance discussion a second reason for the difference in guidance with new revenue opportunities foregone. Could you shed some light on what those new revenue opportunities were that you forego?

Jeff Babka

John, you know as we start the year with the business profile we have, obviously in coming up with our estimate for projections on the impact, we’ve got a lot of history with it and we’ve got a lot of confidence in our ability to forecast industry trends and hopefully do it conservatively as we’ve done it this year on the impact as per our current guidance.

The newer businesses we have present us with interesting opportunities. These businesses are in markets that are not mature. They are in their nascent stage. And in many cases we’re faced with new product opportunities that can be, whether we can develop a product ourselves, potentially acquire the product, expand service into new areas, new geographic regions, and so forth.

As we entered the year we had a list of these that made the list of things that were likely to hit in the third and fourth quarter and in many cases they’re costly to chase them, particularly, as you get down into geographic expansion. As I mentioned in a previous call, we have a sales office in the UK doing Ultra services product. Initial reaction to that – there was a success there, wasn’t terribly good. Recently that’s turned around. So we delayed going with a kind of further geographic expansion in Ultra, really waiting to see whether or not we can really do this in foreign countries.

We’re seeing very positive results, but that’s recent. That’s really under Alex Berry’s new control there and under his management and so now we feel bullish about that. Intentions earlier on the year were to do that earlier, but it just wasn’t right for us. That’s a good example. And there’s other service offerings too that are related to the Internet infrastructure and IT business. We just felt it was in our best interest to delay this until we’re more confident in our ability to execute against the plan, and confident in the management team that we’ve got running those businesses. These aren’t foregone opportunities.

I’m not going to give you specifics on it, because quite honestly it’s competitive, really sensitive information here. But as we do going into the year, a lot of different ways we can fill that funnel, particularly as you get towards the end of the year.

This year we just made the decision back into the August time frame to say, look let’s stop chasing it, we’ve got enough in our current plate right now, and then we get the current management team in place there with a more stability in the team it’s something we can do as we enter into 2009.

Operator

Your next question is from Philip Winslow – Credit Suisse.

Philip Winslow – Credit Suisse

Just wanted to get a sense for just your outlook on the transaction side when you start to go, as you mentioned further into an uncertain economic time, you mentioned it wasn’t really tied to carrier CapEx or GDP. But how do you sort of think about the growth over the next couple of quarters?

Obviously you guys always say, at least in your guidance for transactions and for Q4, if I take a low into that it’s essentially flat sequentially, so I guess, two buttons. One, longer term, I don't know what you'd call it, 6, 12, 18 months, how do you think about transaction growth and then, more near term, how should we think about it not only for Q4 and Q1?

Jeffrey Ganek

Bill, first of all we believe that fourth quarter in fact is an increase from third quarter. While the GDP declined last quarter, we saw very high revenues from local member portability transactions. As you know, we've got a very detailed empirical project pipeline sales process for these transactions and we’ve got clarity, visibility into the fourth quarter, comparable to what we’d seen in the past. We see continued demand on the part of our existing customers for a long list, a great variety of application of the Number Portability Administrative Center services, the NPAC services.

In the future, based upon empirical results over 13 years of operation, we have not seen a material variation in demand for our services relative to changes in broad economic measures or relative to changes in telco capital spending.

And as a matter of fact, it turns out in tough markets, telcos rely on our services to manage efficiencies and cost constraints in ways that they don’t in good times. We have seen growth of demand for our local number portability services even when the economy has gone through tough times. You know what, I can’t guarantee that that’s going to happen in the coming years, but there is no reason based on any empirical data that we have to doubt it.

Operator

Your next question comes from Tom Ernst – Deutsche Bank.

Tom Ernst – Deutsche Bank

Good afternoon, thanks for taking my questions. This one follow-up question on the new revenue opportunities that you’re seeing less growth in this, but not deducted in, how large are those? How much of the growth do you expect them to contribute here in Q4 out of your total revenue?

Jeffrey Ganek

So growth from NGM, mobile instant messaging is minimal. We are focusing lots of attention there to make sure that we’re not spending out in front of the development of real market demand. In the third quarter, we saw material growth from Ultra and registry services. In fact in this market demand for Internet infrastructure services continue to grow because the Internet continues to grow. Because infrastructure there is so skinny we’re selling into a brand new market created by disruptive technology.

I can articulate an argument that says demand for Ultra and registry service will continue to grow even during a tough economic time; however, I’m being cautious here because we have not the empirical data from the past that says even when the economy is down demand for these services continue. Nothing empirically we saw in the third quarter says that a slow down is coming in those marketplaces.

Jeff Babka

Tom, this is Jeff, specifically to your question, the things that I mentioned in my comment earlier that were kind of taken out in the guidance, we have not put any of those into the fourth quarter. Those are basically out of there. They are still on our drawing board. We still plan on executing against them, but rather than let the spending get out in front of us this year, we hunkered down on it and basically it will be a part of our plan for 2009 within the context of the overall plan for 2009 basically. And looking at it in terms of taking what the market gives us and maximizing our profitability and cash flow off of that.

Tom Ernst – Deutsche Bank

One other follow-up question on impact business, understandably it is going to grow even in a weak economy, but I’m curious. With the kind of step-wise outlook decline that took place in September and October, did you see any sort of deflection of that growth in the numbers, in the transaction numbers?

Jeff Babka

No, not really. In fact if you do the math going forward at the 367, kind of backing out year-to-date, you get growth in the fourth quarter. We are hoping of course that the number could even come in higher than the 367, but at this stage of the game the things that are in the funnel right now are very comparable to when and what got us there so far this year, really no change in that – nothing in there that would cause any unusual activity.

Operator

We will take our next question from Scott Sutherland – Wedbush Morgan Securities.

Scott Sutherland – Wedbush Morgan Securities

I want to talk about one of the new services you guys have talked about at your Analyst Day that of the Member Resolution Service. Can you talk about what the investment and opportunity is on that front?

Jeffrey Ganek

As we said back in February, Member Resolution Service is a very exciting demonstration of where the work network operators have come to NeuStar to get the essential basic infrastructure they will all require for managing their IP traffic. Since then, as promised in February we have built, put into operation, the physical, technical platform that delivers the service. We have over the last seven or eight months conducted the pilot demonstrations of the service with – I believe it is eight carrier's worldwide, European and Asian operators.

The exact number is seven. Those have been very successful. We are now preparing for introduction of commercial service and our revenues from this year will be minimal as we projected, as we announced, as we cautioned back in February. Last February we also advised that we would not include material revenues from the Member Resolution Service in 2009. This is a world changing service.

It is going to change the way mobile operators route their services. Changes like that do not happen over night, and NeuStar won’t offer guidance based upon that kind of disruptive service until we can see where that demand is coming from. To date the progress has been – technology is up and operating, the carriers are happy with the pilot services that they have exercised with us, and we are working with those carriers and our partner, the GSM Association, to introduce this service on a commercial basis in the coming months.

Jeff Babka

We'll expand in the neighborhood of $3 million to $4 million on that this year, so it is not significant. As we work with Steve Edwards and kind of building out the plan for 2009, as you can suspect, I mean you would want him to come to us with a very aggressive plan, both on the commercialization of it and spending. We will be prudent in how we approach this. Things like this usually take a longer time.

GSM Association is a great partner for us for this. We certainly appreciate and value their endorsement, working with the carriers on the pilot, but something like this is going to take longer to kind of go through its gestation period to get to the point of being a solid revenue contributor for us.

As Jeff said, it is really building a game changing platform here, but we will continue to spend because it is the right thing for the company, for NeuStar to do, with the relationships we have built with both the GSMA and the carriers, but we are not going to let this horse get to far out of the gate here and keep control over the spending of what we have on it.

Scott Sutherland - Wedbush Morgan Securities

My second question is more for you, Jeff. Looking at your guidance for the year, on the bottom range of your revenue, you're kind of guiding flat for Q4 with expecting some revenue growth in Q4, yet on EPS value, it implied a pretty big tick downward. Is this a conservatism, I mean I know you said $0.92 or more. Are you looking to spend more? I know maybe tax rate goes back up to 40% to 41%, can you kind of give some more color there why it would go –

Jeff Babka

Obviously, with one quarter left into the year, I have got a plan that if we execute against it is going to deliver higher on the net income than I am willing to commit to the Street. I just do not know what is going to come from year end audit adjustments and so forth, so I am not going to increase EBITDA for $2 million to $3 million or net income by a couple $1 million for the last quarter of the year.

Hopefully we will be able to come in better than that, but I have got to keep a little bit aside. You just do not know when you're doing a full year audit whether something is going to come up that you missed in the first or second quarter on an expense side, and then to take guidance up and then have to lower it, that just would not make a whole lot of sense.

Operator

Your next question is from Jonathan Ho – William Blair.

Jonathan Ho – William Blair

Can you talk a little bit about the UltraDNS market, and what you are hearing from your customers? Has there been any kind of hesitancy or any change in the tone?

Jeffrey Ganek

That is a good question. The answer is we have heard nothing different. We have seen no change in the trend of sales. In fact, Jeff what was the growth rate there?

Jeff Babka

45%

Jeffrey Ganek

45%. Remarkable growth rate, this is a new market, one that we believe NeuStar was key to defining out in the marketplace. We are the leading provider of services there. There are now as compared to just a few years ago, a whole industry of e-commerce providers and providers of complex web services, all of whom suddenly have large portions of their revenue streams dependent upon web traffic on the Internet.

There is no 611 customer service for the Internet. If you are a large e-commerce provider, and your website suddenly starts diminishing in hits, you can not call the telephone company and say come on over and fix the service. Customers, e-commerce providers are turning to NeuStar with continued growth to provide the kind of traffic management monitoring security and other kinds of infrastructure support that are essential to the kind of commercial applications that are out there.

There is all reason in the world to believe that demand for this service will continue to grow, as the Internet continues to be a more important part of our economy. We are there with the best service in the marketplace. We continue to strengthen, not only our platform, our feature and functionality offerings and our sales and distribution customer support capabilities, and we are doing that driving for continued fast growth.

Today, Jeff Babka and I are reporting those great results, saying we are continuing to push. However, in this economy, nobody can be too confident about the continuing growth of a brand new market, even if you have got a leadership successful position like ours.

Jeff Babka

One of the things about that business for us is our model, kind of a revenue model is based on queries. So one could say while looking forward what if in the holiday season Internet purchases go down? Well queries is the basis that are getting paid. One of the customers we signed up last quarter was LinkedIn. Now I don’t know how many emails you get a quarter or a month asking you to sign up for LinkedIn service. I probably get ten of them.

People are using the Internet for a lot of different social networking type things and just about every one of those is a customer of Ultra. And their volumes are continuing to go up. So as [Alex Berry] is going to take charge here, he’s really on an upswing in terms of the use of these services. It offers the quality of service that if you’re a heavy Internet user, you’re going to want this.

And we see the opportunities here being very significant and again, looking forward, maybe one segment might be down a little bit in retailing, let’s say, but certainly on the overall social networking side we’ve seen a significant uptick of volumes coming out of that customer.

Jonathan Ho – William Blair

And just as a follow-up with regards to the NGM business, if you want to talk a little bit about maybe the change in manager and how that’s going to impact the strategy? You guys had talked a little bit about cost control, but I just wanted to know sort of the high level on the strategic side whether there’s a shift there in the thinking or the targeting of the markets.

Jeffrey Ganek

Boy is there a shift there, and look, in any new embryonic business, you don’t go a year without a shift in your strategy and what you’re doing. And in markets like this you don’t continue doing what you’ve done in the past. You’ve got to adjust yourself to meet the market. So let’s start with what’s already happened that’s dramatic. We have changed the functional processes of the organization is the large technical and development capabilities that were in the NGM organization have been consolidated into the mature technical organization at NeuStar.

There are substantial increases in productivity and reliability and efficiency that are beginning to result already from that material move. In addition, we have now and the general manager of that business a European with lots of experience in the U.S. in managing software businesses in the mobile industry.

We have an opportunity here to take the improved technology, the improved and more efficient platform and bring it more effectively to our existing new customers and make that work in a cost effective way within the very different market environment we see coming up in 2009. We are not going to continue doing the same thing.

Operator

And we’ll go next to Will Power – Robert W. Baird & Co.

William Power – Robert W. Baird & Co.

Just really a follow-up question on the core business, I mean it sounds like you have good visibility for Q4. Normally you have at least pretty good visibility, call it six to nine months out although some levels of on a declining basis I guess. Based on the conversations, ongoing conversations you all continue to have with carriers, how would you characterize the six to nine month visibility today versus maybe where you would have been a year ago?

Jeff Babka

Yes, well, really no difference. I mean I have to say as we look at the list, got it going out, the types of opportunities that are out there, the things that people are doing and what’s being announced in the industry with the various consolidations and so forth that have been recently announced and intentions and some of the carriers. Yes, as we look into the first quarter, we say this; if I were sitting here a year ago looking forward into the next quarter and the first quarter next year, visibility is really not appreciably different.

Okay, we’re seeing similar types of things, and again, a lot of smaller transactions in the industry. But all the things that we seem to talk about, things like the iPhone, the carriers trying to do things to combat the growth that AT&T is seeing in the iPhone. These are all things that are going to put wind in our sails here. We’re really no different this year than we were a year ago relative to that visibility.

Operator

And we’ll take our next question from Katherine Egbert – Jefferies & Company.

Katherine Egbert – Jefferies & Company

A couple things, first, you said you had some history on the impact side with the down economic environments. Can you tell us how you’ve done in the past? And then also, can you just give us what you think kind of long-term growth projection might be for the overall business and also what a long-term EBITDA might be?

Jeffrey Ganek

You know what? I don’t off the top of my head have a statistic to tell you about how we grew volumes very, very quickly in ’98, ’99. But then continued to grow volumes very quickly in 2000, 2001, 2002 as the communications industry went through very, very difficult times. I can go out and dig up that data. If you call [Brandon] here tomorrow and later this week, I’m sure he can give you that data. It’s all probably available.

In the third quarter where there was negative GDP growth we saw remarkable growth beyond expectations, beyond our projections and beyond our customers’ expectations for volumes of LNP transactions. And as I’ve said a couple of times just tonight, it turns out that not only does innovation and new technology, new services for end users drive our network operator customers to use our services, but so does managing growing volumes of traffic over existing technology in tough economic markets. That’s what’s happened in the past. We saw it as recently as the third quarter.

Jeff Babka

Yes, on your question in relative to the future EBITDA, Katherine, obviously we’re not making any projections on that and we don’t report EBITDA specifically for any of our service offerings. It gets combined in with the overall number management. Suffice to say that we built a very efficient process. We’ve got a pricing table that by its nature as volumes increase would go down, and if volumes should happen to go down in a given year, the price per transaction goes up. So there’s to say that flexibility is built into the schedule.

We see nothing going forward that would cause any discontinuous change in our ability to generate offering a very strong EBITDA margins and cash flow out of this business as we have done over the last three years since being public. And that would hold for in periods of growth and periods where the growth may stem a bit. It is a well run business and we continue to invest in it because cost of quality is very important to us in making sure that we maintain that, and Jeff?

Jeffrey Ganek

Let me respond with this. We’ve just gone through our files here and I’m looking at a chart that we have used frequently over the last four years when we’ve been out talking to investors. It shows impact in number portability transactions by year and the stats starting on the left from 1999 through 2007 on the right show a smooth exponentially rising curve from the very bottom on the left to the very top on the right.

When we draw in the 2008 column way over on the right, the exponentially rising pattern of this nine, 10-year pattern is going to continue. We saw no desertion of this trend in the third quarter. We see no change in the pipeline and the visibility we’ve got for the next quarter. That’s going to change. We’ve got a robust, scalable platform that has been delivering high quality increasing volumes of these transactions and we have demonstrated an ability to manage that platform with great efficiency and we think we’ll be able to do that even in the face of every growing volumes.

Katherine Egbert – Jefferies & Company

Quick follow-up, can you talk about the use of cash? Do you think at some point you get more aggressive with buy backs or maybe pull your dividends?

Jeffrey Ganek

That is certainly an alternative that we have and always will consider. Looking at the market conditions today, we think that a great strength that NeuStar has in this marketplace is that – is our cash. We’ve got a large cash balance. We are generating cash every quarter. We have virtually no debt. And in tough markets, when others are back on their heels, we will look for opportunities to wisely, prudently, but strategically use our competitive advantage in cash.

Operator

And we’ll take our final question from Sterling Auty – JP Morgan.

Sterling Auty – JP Morgan

Let me go back to, if I could, last quarter I think there was $1 million spent on that Member Resolution Service and you're – can you quantify what was included this quarter?

Jeff Babka

Well, as I mentioned earlier, about $3 to $4 million for the year. So it’s probably in the $1 million range for the quarter.

Sterling Auty – JP Morgan

And then can you describe for us, you talk about in the prepared remarks specific to the infrastructure is the biggest historical transactions. You talked about the CapEx, but have you had a chance to kind of dissect things and go through what are the maybe two or three biggest drivers in the transactions this quarter? And did you have any lumpy kind of large contributors, in other words, were there any one or two big projects that did a big chunk of transactions?

Jeff Babka

Yes, as we look, Sterling, I’m looking at a board here that has the numbers comparing the three quarters of this year, there is an appreciable difference in the drivers. If you look at the current quarter, network optimization obviously is the biggest share. It has been the biggest share in each of the three quarters of this year. Disconnects into that to recovery is there as a piece; you’ve got some tech migration, all be it, relatively small, and vendor changes continue to be very strong. So nothing, as I look at this chart, there’s nothing in there suggests any difference in trend that we’ve seen even, in fact, going back for the last four, three or four quarters here.

Operator

And that concludes the question and answer session today. At this time, Mr. Ganek, I will turn the conference back over to you for any additional or closing remarks.

Jeffrey Ganek

Sure, let me leave you all with the very, very important message Jeff Babka are delivering today. NeuStar is very well positioned with a strong cash balance and leading positions in fast growing markets. We’re going to produce reliable revenues and as the market allows growth. We’re managing spending, we’re going to maintain strong profitability and cash flow, because when this economy eventually turns up, we will be, as we are now, positioned with customers, products and management to grow quickly. Thank you all for taking the time to listen to our very, very strong third quarter results. Have a good evening.

Operator

Ladies and gentlemen, this does conclude today’s presentation.

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Source: NeuStar Inc. Q3 2008 Earnings Call Transcript
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