Neustar (NSR) CEO Lisa Hook Discusses Q2 2014 Results - Earnings Call Transcript

| About: NeuStar, Inc. (NSR)

Neustar, Inc. (NYSE:NSR)

Q2 2014 Results Earnings Conference Call

July 23, 2014; 04:30 p.m. ET


Lisa Hook - President & Chief Executive Officer

Paul Lalljie - Chief Financial Officer

Dave Angelicchio - Head of Investor Relations


John Bright - Avondale Partners

Jack Snyder - JPMorgan

Will Power - Robert W. Baird

Nandan Amladi - Deutsche Bank


Good afternoon everyone. Thank you for standing by. Welcome to the Neustar, Second Quarter 2014 Earnings Conference Call. At this time all participants are in the listen-only mode. After the prepared remarks we will conduct a question-and-answer session. As a reminder, this conference is being recorded.

For opening remarks I will turn the call over to Mr. Dave Angelicchio, Head of Investor Relations. Please go ahead sir.

Dave Angelicchio

Thank you and good afternoon everyone. Welcome to today’s conference call. Joining us today from Neustar are Lisa Hook, President and Chief Executive Officer; and Paul Lalljie, our Chief Financial Officer. Our call today will begin with comments from Lisa Hook and Paul Lalljie, followed by Q&A.

Before we begin, I’d like to remind everyone that today’s discussion contains forward-looking statements based on information as of today July 23, 2014 and as such is subject to many risks and uncertainties that may cause actual results to differ materially from those anticipated.

Additional information concerning these risks and uncertainties can be found in our earnings release and our filings with the U.S. Securities and Exchange Commission, including our last annual report on Form 10-K and subsequent periodic and current reports. We assume no obligation to update any forward-looking statements.

As you listen to today’s call, we will discuss certain non-GAAP financial measures and supplemental key performance metrics. These supplemental materials and non-GAAP reconciliations can be found under our Investor Relations tab on our website,

With that, I’m pleased to introduce Neustar’s President and Chief Executive Officer, Lisa Hook. Lisa

Lisa Hook

Thank you, David and thank you all for joining us this afternoon. First, I’ll provide some perspective on this quarter and our progress towards the goal we set for the year and then I'll give you an update on the impact selection process. Paul will then walk you through a more detailed look at our second quarter results.

I’d like to start by reviewing our strong second quarter results. Over the last 3.5 years we've articulated and have been executing a strategy focused on building our presence and capability in the fast growing information services space.

We organized the company around our core strategy, we've made targeted acquisitions and we've hired the talent needed to launch and expand innovative services. We continue to advance this strategy during the second quarter with our acquisition of .CO Internet, which expanded our security services offering. We also continue to see strong results in our information services and analytics business, with revenue growing 9% in the quarter despite price in headwinds and data services.

Our marketing and security services delivered a combined revenue growth of 23% for the quarter. These high-growth services are outpacing the market and are approaching one-third of total revenue. In short we succeeded in pivoting to become an information services and analytics company and remain focused on continuing this momentum.

For the quarter revenue was up 8% to $237.5 million and adjusted net income per share was $0.95, an increase of 12% versus last year. We continue to hit our numbers driven by strong revenue growth, management of expenses and continued strong margins. We achieved this in dynamic markets against a backdrop of significant challenge for the company due to the NPAC rebid and an internal reorganization from three distinct business units to a single functional organization.

Also during the second quarter we consolidated three offices in the Bay Area into a single office in San Francisco, which will allow us to operate more efficiently and effectively. I'm very proud of the team's continued focus and execution in this chaotic environment.

In marketing services we continue to achieve double-digit revenue growth. Our clients are seeing the benefits of our strategy to expand our service offering in this space organically and through acquisitions.

A good example of this is Omnicom, which signed up for our data management platform at the end of 2013. By the second quarter of this year the company has exceeded our initial installation expectation, by launching the DMP across their large worldwide client-based. Omnicom has also reviewed our entire marketing product suite and has started to review licensing other portions of our service. We are thrilled with this partnership.

Security services also continued to show strong growth that is outpacing the market. The integration of .CO Internet is going well and helps us broaden our domain name services. New gTLDs are beginning to contribute and will continue to be a fast-growing area for us and we’ve been selected to provide services for over 350 new domain extensions as a result of ICANN ongoing global domain name expansion.

Also in the quarter we worked at the City of New York to launch the first phase of availability for the new .nyc web address. We are the official registry service provider for .nyc supporting marketing efforts and operating the technical infrastructure of the domain. We expect NYC general availability to open in the fourth quarter of this year.

As you can see from our accomplishments this quarter, we continue to make great progress in growing our information services portfolio and have a clear path forward to continued growth. We are supporting this momentum by making Neustar an employer of choice for talented people in our industry. In the second quarter Neustar was named the top 20 workplace by the Washington Post and was named a best place to work in Kentucky.

Now let me provide an update on the NPAC selection process. Since our first quarter earnings call in mid-April, the North American Numbering Council submitted to the FCC its recommendation of Ericsson to become the next Local Number Portability administrator.

In June the FCC issued a public notice and a protective order on confidential information and announced a period in which public comments would be solicited, as well as the subsequent period for reply comments. The comment period is to end July 25 and reply comments are due by August 8.

Over the past couple of weeks you have seen many of the redacted RFC documents filed in the FCC docket. We will be commenting on the merits of Ericsson’s proposal and are filing to the FCC this Friday. We continue to believe that we presented the best value proposition to the industry, taking into account all relevant factors, including our demonstrated record of performance, the capabilities in our service and transition risk.

The FCC has not fully explained the LNPA vendor selection process from this stage to conclusion. We will continue to raise issues that the FCC lawfully must address and issues that given the importance of the NPAC to the telecommunications industry and the consumers it services, the FCC should address.

We will continue to make the case that the rules is specified impartial and neutral administrator of Local Number Portability prevent a manufacturer of network equipment and services such as Ericsson or its operating unit Telporia (ph) or its subcontractor SunGard from serving as the LNPA.

We will continue to make known our assessment and those of independent analysts of the costs, risks and consequences of transition failure. Although much critical information has been shrouded from the public, we will continue to emphasize to the broader carrier community, law enforcement and other beneficiaries of the NPAC, that the performance of reliable and scalable and critical NPAC services would be jeopardized if the recommendation is adopted.

We will continue to challenge the unexplained refusal to consider our proposal from Neustar that promised hundreds of millions of dollars of savings, with no transition risk and no compromise for services.

In short, we will continue to press our case for renewal of the NPAC contract. At the same time we will continue to successfully execute our information services strategy.

With that, let me turn the call over to Paul.

Paul Lalljie

Thanks Lisa and good afternoon everyone. As you've seen in our earnings release, we continue to deliver strong results. Revenue for the quarter totaled $237.5 million with adjusted net income of $57.6 million, a margin of 24% and $0.95 per share. Our team delivered again while managing the NPAC selection process and completing the acquisition of .CO.

For a closer look at revenue for the quarter, revenue increased 8% over the second quarter of 2013. This increase was driven by 19% growth in marketing services as we continue to take share in a highly fragmented market. We continue to see increased demand for our customer intelligence, activation and media measurement services.

Security services revenue increased 28% to $34.4 million driven by $3.3 million in revenue from the acquisition of .CO and continued growth in our DDoS protection services. Of the 28% increase, 12% is related to the .CO acquisition. Our data services revenue decreased 6% to $49.4 million, reflecting a $4.4 million reduction in our Caller ID service and a $1.3 million decrease in revenues from Common Short Code services.

These reductions which I mentioned in previous calls relate to price step-downs onto long-term Caller ID contracts and the elimination of vanity Common Short Codes. One the other hand, our carrier provisioning service increased $2.4 million and to close out in revenue, NPAC service revenue increased 6% to $118.7 million due to higher established fees under our contracts to provide NPAC services.

Now for a closer look at expenses. Our operating expense totaled $172.7 million, a 19% increase from $145.6 million in the second quarter of 2013. Of this increase $11.9 million related to costs associated with our recent acquisitions.

Excluding acquisition related costs, operating expense increased $15.2 million or 10%. This 10% increase included $3.5 million in personal and personnel related expense. In particular, stock-based compensation expense increased $5.8 million, mainly in G&A and sales and marketing and was partially offset by lower headcount.

In addition, costs related to information technology and systems increased $3.4 million as we invest to enhance our data assets. We spent an additional $3.3 million to compete in the NPAC vendor selection process.

Adjusted net income for the quarter totaled $57.6 million. On a per-share basis this represents $0.95 per diluted share, an increase of 12% over the second quarter of 2013. This increase was driven primarily by a lower share count resulting from ongoing share repurchases.

At the end of the quarter headcount totaled 1,566 compared to 1,553 in the March quarter and 1,623 at the end of 2013. The headcount reduction since last year was driven by workforce reduction that occurred in the first quarter of 2014.

Turning to the balance sheet, we ended the quarter with cash and cash equivalent of $245.9 million compared to $386.5 million at March 31, 2014 and $223.3 million at the end of 2013. The $140 million reduction in cash this quarter represents the outflows of $106.8 million net of cash acquired for the acquisition of .CO and $95.1 million in cash for the purchase of 3.7 million common shares.

In addition, cash generation for the quarter totaled $61.3 million. We have another $58.8 million remaining under our current share repurchase authorization and we expect that to be completed by the end of the third quarter. Additionally, capital expenditures for the quarter totaled $14.1 million as we continue to invest in our facilities and improve our infrastructure.

At the end of the quarter we had $793.5 million of outstanding debt, a slight increase from the first quarter balance of $792.8 million due to capital leases in the quarter. Our debt to adjusted-EBITDA ratio was 1.8 times as of June 30. Our accounts and unbilled receivable balance totaled $161.5 million versus $166 million at the end of the previous quarter and $163.6 million at the end of 2013.

Our day sales outstanding was 59 days compared to 62 days in the first quarter of this year and 60 days at December 31, 2013. Our payable and accrued expenses totaled $91.3 million and our days payable outstanding was 51 days compared to 41 days in the first quarter of this year and 50 days at the end of 2013. The 10 day decrease in our days payable outstanding this quarter represents the addition of payables from the .CO acquisition and increased balances for our infrastructure build-out in the quarter.

Before I turn to guidance, I'd like to comment on our capital allocation strategy. We are often asked for our thoughts on capital allocation, in light of the number portability vendor selection process. Off the bat, we remain committed to returning capital to shareholders. We will continue to buy back shares when our stock is trading below its intrinsic value and for the avoidance of doubt, our review of intrinsic value.

We have a repurchase plan in place now. It has another $58 million plus to go and we will reevaluate the landscape when this plan ends. We expect to generate approximately $225 million of the free cash flow this year and we will consider inorganic investments and share repurchases as potential uses of this cash. Basically nothing has changed with regard to our capital allocation strategy since 2010.

Now for a discussion on guidance, we are reaffirming our guidance, that is, revenue is expected to range from $945 million to $970 million, growth of 5% to 8% over 2013 and adjusted net income is expected to range from $233 million to $243 million. On a per share basis using weighted average shares outstanding of $60 million, adjusted net income for diluted share is expected to range from $3.88 to $4.05. These estimates do not contemplate future share repurchases.

On a year-over-year basis we have generated $467.4 million in revenue, which means, that to get to the midpoint of the guidance range we would have to generate another $490.1 million or growth of just under 5% in the second half of 2014. Last year second half revenue was 7% higher than the first half of 2013.

So what's the point? Basically we're targeting top end of the revenue guidance range because of the following items. First, the .CO acquisition is expected to contribute an additional $7 million in the second half. Second, our marketing services business is generally higher in the back half of the year. For example, second half of 2013 was 23% greater than the first half of 2013. And third, there are strong leading indicators on a year-to-date basis.

So to summarize, we continue to execute successfully on our information services and analytics strategy, delivering strong revenue growth, supplemented by targeted acquisitions and we continue to expand our market position and our suite of value added services. Based on our strong first half results and the momentum in the business, we are reaffirming our full year guidance and targeting the top end of the revenue range.

With that operator, you may now open the lines for questions.

Question-and-Answer Session


Thank you. (Operator Instructions) And we’ll take our first question from John Bright with Avondale Partners.

John Bright - Avondale Partners

Thank you. Good afternoon. Lisa, Paul. Paul, let me start with what you just said, the strong leading indicators. As your third point to the high end of your guidance on the revenue, can you elaborate more on those?

Paul Lalljie

Yes. So essentially we track our backlog, we look at our sales pipeline, our 90 day pipeline, our deployment schedules that we have, for sales that we have in there, that we’ve already closed on a year-to-date basis and we look at the transaction volumes that we see within, for example our carrier provisioning services. We have transactions that are scheduled and when we have that type of visibility into future performance, we tend to have some bit of momentum and you've seen that the past John, where we have transaction schedule and carrier provisioning that created increases in revenue in a given quarter.

John Bright - Avondale Partners

Okay. Let me hit the three questions I think are on most investors mind. The first question Lisa I think goes to you, is regarding the timeline associated with this contract process. I know we are kind of looking into a crystal ball when we ask that question, but what is the best information you can give investors regarding the timeline for resolution on this contract renewal?

Lisa Hook

Sure. So as I said in my prepared remarks, the only dates we have are the filing for comments this Friday, July 25 and then reply comments August 8. We don't have any timeline from the FCC thereafter. So they haven't announced anything that we can pass on to you. The FCC obviously has to evaluate the comments and the reply comments and then determine of course forward.

We believe that the course forward requires a notice of proposed rulemaking in the event that the FCC would want to select another provider. So this company, NeuStar, is named in the Code of Federal Regulations and the Code of Federal Regulations refers to rules that were put into place at the beginning of the day, 1997, regarding qualifications for the LNP Administrator. Those were the rules I was referring to in my comments regarding prohibiting telecom equipment manufacturers from doing this.

So we believe to both, to name another provider and specifically to name a provider that is a telecommunications manufacturer would require a rule change, which requires a notice of proposed rulemaking and then a series of activities along with that for comments and reply comments and then change in the Code of Federal Regulations.

John Bright - Avondale Partners

And if they don't pursue that then you would look to pursue some sort of, I assume appeal to the FCC or legal action outside the FCC?

Lisa Hook

Yes. We would look at a number of legal actions, but it’s our strong opinion that the law requires that rules only be changed through rulemaking.

John Bright - Avondale Partners

There are two questions on investors’ minds that go around what we talked about on the last conference call and that is your calendar 16 comments regarding revenue outside the contract of $650 million and EBITDA margins in the 35% to 40% range.

In this quarter it looks like you did 9% growth in the information service analytic segments and Paul, you might laugh about this, but if we backed out .CO and we backed out the one-time events in data services, what did that organic growth rate look like?

Paul Lalljie

Well, I mean if we back out just the .CO you’re talking about a 6%. In information services alone you are talking about an 8% year-over-year increase. But in terms of the reductions in data services, that may take me a little while to get there. That's closer to probably 11%.

John Bright - Avondale Partners

Okay. And then the 35% to 40% EBITDA margins in the information services analytics segments that's one where it's not segment breakout that you have in place. What is it that we can as investors do, look at to feel more comfortable with that statement?

Paul Lalljie

A couple of things. I think one of the things we try to do is provide external comparables to each of the revenue categories that we have. So for example, if we look at our marketing services business, you can compare that business, the customer intelligence piece can to be compared to a company such as Nexium or such as an Adobe or a Datalogix from a customer intelligence perspective and then same on the other piece of that business.

On the security services side of the business, you can consider comparables such as VeriSign or an Accumi (ph) in that business. As you know we have our top level domain name portion of that business and then the DNS portion of that business with the site protect piece in it. And if you think of the margins of the natural registry’s business and also of the DNS business that we have separately, you can easily get comfortable with margins that are in that range.

And then data services, if we just piece part the components of it, you have the Caller ID business; you have the Common Short Codes business and have the Carrier Provisioning business. I think looking at it as piece parts will provide some insight into getting comfort that the 35% to 40% range is a reasonable range.

John Bright - Avondale Partners

Final question. You mentioned the .nyc would start to impact results on the margin in the fourth quarter of this year. You also mentioned 350 other top level domain names that you are I think behind the scenes on. When should we see the impact really start moving the needle on those?

Paul Lalljie

I don't think we'll see that this year. The launch process is not a simple straightforward process. I mean the first phase is they have all sorts of names for it such as Sunrise and like that and there are different levels of entrance into the marketplace.

So our 2014 numbers, we have very little impact from the top level domain names coming in. 2015 should probably be the year where we start to see material impact or numbers that we can actually talk about. 2016 will be the full year of gTLD launches.

John Bright - Avondale Partners

Thank you.


And we will now go to Sterling Auty with JPMorgan.

Jack Snyder - JPMorgan

Hello guys this is Jack Snyder on for Sterling. We just had one question about the Caller ID renewals. When do you expect that to bottom out? And then, what kind of growth do you expect to see in data services once all the headwinds from Caller ID are in the past? Thanks.

Lisa Hook

Can Paul and I tag team on this? We think that we already have seen that correction. This market was pretty stable for a long time with a premium price provider and that limited to a certain extent our addressable market. Since we have re-priced a couple of contracts, we are now in a place where we can go after many more carriers than we’ve been able to reach prior to this. So it's exciting in the sense that we can expand our market share. So you should see that – It's never going to be at high growth market but you should see increased single digits from here.


And we will now go to Will Power with Robert W. Baird.

Will Power - Robert W. Baird

Great, thanks. Maybe just actually just following-up on the previous question a bit. So if we look at the – think about the overall data services trajectory, it sounds like you feel better about the Caller ID growth and looks like Common Short Codes actually picked up a little bit in June. So I guess (a) do you expect the Common Short Codes business to continue to pick up and I guess just thinking about the data services group as a whole, do we think this is the bottom or data services should grow sequentially off this level through the back half of the year and then I have a couple other questions.

Paul Lalljie

So I mean, I think the Caller ID contract, those are step downs right. There is an annual step down to a new level. We are at that new level, but because we are doing a year-over-year comparison you will see that decline in each of the quarters.

Now keep in mind, we are winning businesses in that category of revenue and we are growing revenues in that category, but it's being offset by the step down if you will. So to some extent you should see sequential change. There are multiple categories of revenue within data services, the carrier provisioning services and then some of our smaller services, the user authentication registries etcetera.

So from a pure Caller ID perspective, I think you will see a sequential flat to increase on a quarterly basis, and then on a year-over-year basis when 2015 is compared to 2014, you should see an increase in that.

Lisa Hook

And then similarly on caller ID, there was a large group of premium codes that were taken out of business by the industry. So that was a one-time downward correction and that now sequentially should return a bit to growth. But again, I caution that both of those are going to be low single digits in terms of growth rates.

Will Power - Robert W. Baird

Okay. And then on the security services business where you are seeing nice growth, I wonder if you could just elaborate a little further on that. I know you gave I guess the .CO contribution, but maybe if you could just talk about the key drivers and the outlook there. I know DDoS is part of that too. May be a little more color on that front?

Lisa Hook

I would say DDoS service, what we called the SiteProtect Service is the big driver there. The number volume and velocity of denial of service attacks continues to increase massively and so that's just growing like a weed, although I would say that all of the services in-security services are up, so up across the board led by the SiteProtect.

Will Power - Robert W. Baird

Okay then Paul, I think you may have gave this last quarter and maybe I missed it this time. But do you have an update on legal costs associated with the impact renewal process where that was in the quarter?

Paul Lalljie

It was probably less this quarter. It was just over $30 million this quarter. I think last quarter it was 5-plus, so it’s a little lower now.

Will Power - Robert W. Baird

Okay, all right. Thank you.


(Operator Instructions) And we’ll take our next question form Nandan Amladi with Deutsche Bank.

Nandan Amladi - Deutsche Bank

Hi, good afternoon. Thanks for taking my question. Lisa, you mentioned some restructuring efforts in this quarter. Can you provide a little more detail on what that was and why now ahead of such a big decision on the RFP front?

Lisa Hook

So let me answer your second question first, why now I have a big decision? If we waited on everything for the big decision, God only knows how long we’d be sitting around waiting to run our business. So our view as we've expressed on prior conference calls is we are going to continue to run our business as we have, both in capital allocation and on the operating side and feel sort of confident that that is the right choice to make as we pursue the NPAC renewal.

The restructuring is primarily around moving into a single venue in San Francisco. We had four offices in the Bay Area. We combined three of those offices into the San Francisco site, so that we could get better talent. Most folks out in the Bay Area are now coming out of the city and we thought that being in the city made us a more attractive employment or a more attractive employer and we've been in about a month and I can tell you, we’ve have already seen a dramatic increase in collaboration among the product groups. So we’re very excited about the move.


And that does conclude today's question-and-answer session. I will now turn the call back over to Ms. Lisa Hook for closing remarks.

Lisa Hook

So, I'd like to thank you all for joining us on today's call. We are excited about the momentum we see in information services. We are going to continue to advocate our position and fight vigorously to renew the NPAC contract. In our view the vendor selection process is far from over.

As it turns out, the best way to get all of the facts, an important information about the vendor selection process out in the open is also what's required by law. If the issues are made public, we have confidence that the right decision will be made.

We look forward to updating you on our progress and we’ll see you on our next quarterly call. Thank you.


Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.

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