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NeuStar, Inc. (NSR)

Q2 2007 Earnings Call

August 2, 2007, 8:00 AM ET

Executives

Jeffrey A. Babka - Sr. VP and CFO

Jeffrey E. Ganek - Chairman of the Board and CEO

Analysts

Sterling Auty - J.P. Morgan

Phil Winslow - Credit Suisse First Boston

John Bright - Avondale Partners

Joseph Bori - Deutsche Bank

Julie Santoriello - Morgan Stanley

Presentation

Operator

Welcome to the NeuStar Conference Call, discussing Second Quarter 2007 Results. Our release made earlier today is available from our website at www.neustar.biz. During the presentation all participants will be in a listen-only mode. Afterwards securities analysts and institutional portfolio managers will be invited to participate in a question-and-answer session. [Operator Instructions]. As a reminder this call is being recorded Thursday August 02, 2007. A replay of the call will be available until midnight August 9th by dialing toll free 1-888-203-1112 and entering conference ID number 604-0076, international callers should dial 719-457-0820. An archive of this call will be available on the NeuStar website as well at www.neustar.biz.

I would now turn the conference over to Jeff Babka, Senior Vice President and Chief Financial Officer of NeuStar. Please go ahead sir.

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Thank you and good morning everyone. Welcome to our second quarter 2007 earnings call, which will be hosted by Jeff Ganek, NeuStar CEO and Chairman of the Board and myself. Those of you on the call familiar with NeuStar will probably expecting to hear Paul Lalljie's voice introducing the NeuStar management team on the call today and reading the Safe Harbor.

Paul has been the go-to-guy from an Investor Relations perspective since the IPO and based on the feedback that I have received from our investors and analysts, he has done an outstanding job at it. With success, comes opportunity and I am pleased to announce the big change for Paul today. With the growth and added complexities in the NeuStar business, we are going to ask Paul to focus a 100% of its time on the financial planning and analysis and treasury responsibilities continuing to report to me. In addition, Paul will take on the key responsibility for financial support to our M&A and business development efforts. I know he will join me and thanking Paul for building a world class Investor Relations process at NeuStar and wish him well in his new assignment.

I am also pleased to announce today that taking Paul's place is Head of Investor Relations for NeuStar will be Brandon Pew [ph]. Brandon has been an outstanding performer on our NeuStar financial planning and analysis team for the past two and half years. Most recently focused on financial support to our M&A activities. Brandon was a key part of the UltraDNS and Followap acquisition in due diligence team and as such brings the intimate knowledge of those businesses.

Brandon started his career in 1997 with Lockheed Martin and work in the software industry before joining NeuStar two and half years ago. Please join me in welcoming Brandon to the NeuStar Investor Relations team and we look for an opportunity to introduce to you him in person at upcoming investor conferences and office business. With breadth of that Brandon the IR ball is now yours, won't you start off with your first day of Harbor Statement.

Unidentified Company Representative

Thanks JB and good morning everyone. Welcome to our second quarter 2007 earnings call. Our call today will begin with comments from Jeff Ganek. Then Jeff Babka will follow with the discussion our financial performance, after which we will open the line to questions from qualified investors and research analysts. Statements by NeuStar executives during this presentation include information that constitutes forward-looking statements made pursuant to the Safe Harbor provision by 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 material than those anticipated, including the risks and other factors listed in 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, 2006 and other subsequent 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, change expectations or otherwise. As you are from today's call, we encourage you to have our press release in front of you which includes our future results, metrics and commentary for the quarter and the full year 2006 as well as the reconciliation of certain non-GAAP measures with the most directly comparable GAAP measures.

With that I am pleased to introduce NeuStar's, Chairman and CEO Jeff Ganek. Jeff.

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

Thanks Brandon. Good morning and welcome to today's conference call, my pleasure to speak to you today about another successful factor. Jeff Babka, NeuStar's CFO will provide you with the details of our quarterly results and full year guidance, but first let me begin by going through a few second quarter highlights demonstrate NeuStar's ability to sustain growth.

Let's start with the summary of second quarter 2007 results, during which NeuStar's steady growth and momentum continued. Revenue for the second quarter rose to $99.7 million, driving net income margin 19%. Total number of transactions under our contracts to provide local member portability services grew to 74.4 million or 27% over the same quarter a year ago. These results reflect our continued focus on customer demand and innovation. This quarter, volumes grew as customers found new ways to use our services to meet need beyond what they used us for in the past.

Size of the market we addressed, grew larger and so did our revenues. We believe that our progress this quarter positions us to achieve significant growth in our core business as well as in our wireless and Internet infrastructure services business in 2008 and beyond. Our customer service providers continue to rely on our services to sort operational challenges and to meet end-user demands. The results have been growth in telephone number portability transactions for 21 consecutive quarters.

As in previous quarters many diverse market forces that cause change in the industry drove demand for our services. This phenomenon can be readily seen in the growth and demand for network management applications, or infrastructure services. Network management transactions accounted for 55% of total revenue in the second quarter and were our major driver of the 31% increase in infrastructure revenue over the same period a year ago.

Let me describe the drivers of this growth. First, our customers used our services to reconfigure traffic flows to reflect changes in their Signaling Systems. Signaling Systems are data networks deep in the infrastructure that manage traffic and features in a larger communication networks. Recently, changes in our customer's network technologies, in features in services for end-users and network consolidations have led to changing requirements for Signaling Systems. NeuStar services have been used to make those changes. In the second quarter 37% of our transactions were used by customers to adjust their Signaling Systems and related infrastructures.

Second, customers used NeuStar's infrastructure services to address new problems they previously did not address with our services. For example, they used millions of transactions in the Optional Data Field. The Optional Data Field is a new data field put into NeuStar's directory at the end of last year. It is used to identify the customer segment classification of specific telephone numbers. That's an application of our directory not previously utilized. Volume usage here reflects innovation, innovation that expanded the addressable market for NeuStar services. Once again, innovation has led to growth. It's significant to note that the Optional Data Field transactions which began in the first quarter of 2007 were responsible for just 3% of our total revenue during the first quarter this year. In the second quarter they generated 13% of our total revenue.

Third, customers used our infrastructure services for many other same purposes that drove demand in the past. NeuStar is woven into our customers operating fabric. Second quarter volumes were driven by technology migrations, network optimization and transactions following carrier consolidations. We believe that these customer usage trends will continue to drive transaction growth in the foreseeable, future as they have in the past. In that light, as stated today in our press release, we are raising our guidance for NPAC transactions for the full year to over 20%... 28% growth form last year's total. We believe that as new technologies and consumer demands continue to drive the rate of industry change, they also drive demand for transactions that can best be provided from the industry-wide hub that is NeuStar's directory. And as more numbers get into the LNP database, there is increased likelihood that some data element associated with that number will change which results in still another transaction for NeuStar. Our growth is not driven by the growth of telecommunication service providers per se, but by the rate of change within networks and across the industry. The recent introduction of the iPhone is just one of many, many examples. As long as change in the industry continues, so will demand for our services.

Let me now discuss our Next-Generation Messaging segment or NGM, where we have remade significant progress during the second quarter. We are even more firm in our conviction now as this was a great acquisition for us. We continue to grow our customer base and meet the operational deliverables of our current customers, and we are implementing an aggressive plan to expedite the development and delivery of new products, to new and existing customers.

Since forming NGM last November with the acquisition of Followap, market response has exceeded our plans. The number of mobile operators who bought our solution and services and the number of subscribers they serve, far exceed the numbers we projected. As of today, we have 29 mobile network operators in 20 countries, with close to 320 millions subscribers. And the scope of NGM services and features bought by the mobile operators is greater than we planned. In response to stronger than expected market demand, we've increased our expanding to ensure we develop and deliver the broader range of services that customers have already bought from us.

In the short term this increased demand has resulted in a delay in the introduction of instant messaging services by our mobile operator customers, as they implement a larger, far more robust systems that they have purchased from us. However, as we exit 2007, we are now more confident that we will be able to beat the revenue target of $50 million in 2008, due to strong customer acceptance of NGM. We believe NGM is now well positioned to address emerging market needs. Remember, today there are 1.5 billion handset users around the world, who regularly send and receive SMS text massages. They generate more than $60 billion of revenues for the mobile operators, instant messaging is the cheaper, better and quicker, next generation of messaging. It is the first IP-based service that will be used by the mass market of handset users.

In the second quarter, we also saw strong results from Common Short Codes in the United States. Common Short Codes in the United States grew to nearly 2,500 codes during the second quarter, that's a 9% sequential increase and 40% from the same quarter last year. Use of Common Short Codes continues to expand with one timely example being in the political arena, where codes are being used by five major presidential campaigns to communicate campaign information and alerts to grass-root supporters.

In the second quarter, our results were further belied by our continued growth as unique provider of essential internet infrastructure services. Through our Ultra Services and SIP-IX businesses, the company is pursuing a large and fast growing market, as we support e-commerce and fast growing IP traffic. NeuStar has a clear head start at proving intelligent internet infrastructure solutions, with nearly 3000 customers, of which 115 were added during the second quarter. Additionally, the company signed another 122 contracts with existing customers to upgrade existing service or utilize other services beyond our core product of external DNS resolution. Brand name customers added during this quarter, include Urban Outfitters, Stamps.Com and BMC Software. Ultra Services revenues grew nearly 8% sequentially, and queries to its directory increased nearly 8% quarter-over-quarter to 475 billion. This represented a 96% increase year-over-year.

NeuStar currently directs the routing for nearly a quarter of all the traffic on the world's Internet. In the future, we aim as essential to IP communications worldwide as we are today to voice traffic in North America. As in the case of NGM, we see in our Internet Infrastructure business a platform for future growth, in new emerging markets.

In summary, during the second quarter NeuStar produced solid growth and profitability, while making productive investments in platforms for future growth. Before Jeff Babka talks about our second quarter numbers in more detail, I have an important announcement to make. Yesterday, we were notified by the FCC that following an open competitive procurement process, NeuStar has been selected as been Number Pooling Administrator. The pooling administrator plays a key roll in managing the telephone numbers for the entire industry. Revenues from the contract will be less that $15 million over five years. NeuStar has been serving as the pooling administrator since 2001, having been selected in a similar open competitive process in the past. This week selection has a term of two years with additional one year renewal options thereafter. I believe it is notable that the quality and reliability of service NeuStar has provided as the pooling administrator over the last years have been reflected in high grades we've gotten from on satisfaction surveys and evaluations. It is my sense that those perceptions by our customers were material in our selection as the pooling administrator recently.

Jeff Babka, our CFO will now provide an overview of our financial performance for this quarter. Jeff?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Thank you Jeff. Good morning everyone. As Jeff has already discussed, we are pleased with our first half of the year and are reaffirming our full year revenue and profitability guidance, as well as increasing our full year transaction guidance. I will discuss this in grater detail after reviewing our second quarter results.

So, here are the highlights. NeuStar's total revenue for the second quarter was $99.7 million, a 21% increase in the second quarter of last year. Net income for the quarter totaled $19.1 million representing 19% net income margin and $0.24 per share on a diluted basis. Net income was down $800,000 from the second quarter of last year. This decrease can be readily explained and I will cover it later in my comments.

Non-GAAP adjusted net income was $23.7 million, compared to 22.6 in the second quarter of 2006, representing $0.30 per diluted share for this quarter, compared to $0.29 per diluted share in the second quarter of 2006. Cash and cash equivalents ended the quarter at $110 million, an increase of over $38 million from the beginning of the quarter. Transactions on our contracts to provide local number portability services in the United States totaled $74.4 million, up 27% from the second quarter of last year and $1.1 million higher than our guidance provided on May 8.

NGM revenue totaled $1.5 million versus the guidance we provide on May 8, up $1 million to $1.5 million, with billings for the quarter totaling $2.2 million. With respect to revenue, addressing revenue totaled $26.9 million, up $3.4 million or 15% from the same quarter last year. Ultra Services revenue in the quarter amounted to $7.5 million which accounted for $3.6 million of the increase, followed by U.S. Common Short Codes which increased $2.2 million. Partially offsetting these increases was a $2.9 million decrease from addressing transactions under our contracts to provide telephone number portability services in the U.S.

Interoperability revenue totaled $13 million essentially flat with the second quarter of last year. Infrastructure revenue amounted to $59.8 million, up $14.2 million or 31% from the second quarter of last year. As we have stated in the past, industry trends drive transaction growth in each of our revenue categories. This quarter infrastructure continued to be the fastest growing revenue category, showing the increased value that the industry finds from using NeuStar's Clearinghouse Services to help them manage their network for such items as a service vendor changes, new fields added to the directory, the implementation of new technologies and Internet protocol telephony upgrades and other network optimization activities. In future quarters, industry trends may drive growth in our addressing or interoperability revenue categories.

To summarize, our growth and revenue this quarter came form our legacy Telephone Number Portability business, our internally developed Common Short Codes business and our recently acquired Ultra Services business.

Turning now to costs and expenses, I will compare the current quarter to the previous quarter which we believe provides better insight into our cost trends. In the second quarter, operating expense totaled $68.3 million essentially flat on a sequential basis but up 38% from a year ago as we continue to invest in the early stage acquisitions that came on board in April and November last year.

Looking at cost and expense by functional category, cost of revenue totaled $23.2 million flat with the first quarter of 2007 despite revenue increase of $4.3 million. Sales and marketing expense totaled $17.6 million in the second quarter, down a $1 million from the first quarter of 2007. Research and Development expense totaled $6.8 million generally in line with first quarter results, and general and administrative expense totaled $11.3 million, an increase of 500,000 from the first quarter. Included in the cost and expense for the second quarter was $4 million of pre-tax non-cash stock-based compensation expense recognized in accordance with FASB Statement Number 123R. In this quarter this expense was allocated as follows: cost of revenue, $500,000; sales and marketing, $1.4 million; research and development, $500,000; general and administrative, $1.6 million.

Depreciation and amortization totaled $9.4 million in the second quarter, up $300,000 from the first quarter. Of this amount, amortization of intangibles related to the application of purchase accounting for acquisitions totaled $3.8 million, $2 million of which is attributable to our Followap acquisition. So with revenue growing $17 million in the second quarter, our 2006 it raises the question as to why net income decreased by $800,000. First of all, starting in January the new pricing schedule which was renegotiated as the part of our NPAC contract amendments went into effect, resulting in a reduction of approximately $3.5 million in revenue and operating margin for the quarter.

Second, as mentioned a moment ago, our operating expenses have increased as a result of the acquisitions we did in 2006, which is being spent on both product development and sales expansion activities. We believe that the strong future revenue and margin growth coming from these new businesses justifies the near-term margin impact.

A few brief comments relative to our balance sheet and capital expenditures, accounts receivable management continues to be strong with our AR balance going down by $3.2 million despite revenues increasing. Deferred revenue increased by $3.5 million to $49.3 million from the start of the quarter, due primarily to billings related to our subscription base businesses. And capital expenditures were $9.2 million in the quarter, primarily reflecting investments in our infrastructure.

Before I move to a discussion of our outlook for the year, I would like to provide an update on the work we have been doing relative to our recently acquired Next Generation Messaging business. On our May 8 call we advice that we are developing a new operational plan that would encompass the requirements of the new customers NGM had signed since the acquisition last November and the new service offerings that both our new and existing customers were now looking to NeuStar NGM to provide for them.

Over the past 2.5 months, we have been working with our NGM team to this end. With the end result being a detailed service and customer specific plan with milestones and deliverables that are linked to the financial guidance that I'll be providing shortly. We also continue to work with carriers to increase IM penetration rates, which continue to rise albeit in a nascent market. For 2007, we are building the foundation that we will put us on the trajectory to maximize revenue and profitability in 2008 and future years.

That completes the second quarter financial view. Now I'll move on to our outlook for the remainder of the year. Based on our year-to-date performance and prospect for continued revenue growth in our Clearinghouse business, reaffirm -- with NeuStar reaffirms its prior revenue and profit guidance provide on May 8, As such we expect full year revenue to range between $428 million and $438 million, representing growth in excess of 28% over 2006. This projection includes the reduction in revenue by approximately $30 million as a result of the decreased transaction pricing on our contracts to provide telephone number portability services in the United States which were renegotiated as a part of a four-year extension of these contracts that we announced on September 21st of last year.

We are projecting full year net income to range between $84 million and $88 million or between $1.6 and $1.11 per diluted share, based on an estimated 79.5 million diluted shares outstanding. This incorporates our estimate for pre-tax non-cash stock-based compensation expense for quarter in accordance with FASB Statement Number 123R up $17 million as compared to $11.9 million in 2006.

Full year non-GAAP adjusted net income is expected to range between $104 million and $108 million or between the $1.31 and $1.36 per diluted share. Transactions under our contracts to provide telephone number portability services in the United States are projected to exceed $300 million for the full year 2007, as compared to the 2006 total of $234 million.

For the third quarter, we are now projecting transactions to grow in excess of 28% over the third quarter of 2006 which amounts to more than 76 million transactions. Full year NGM revenue is now projected to range between $10 million and $13 million and between $1.8 million and $2.3 million for the third quarter of 2007. We have also have incorporated an additional $3 million in operating expenses and $5 million in capital expenditures to support the NeuStar NGM operating plan into our overall company guidance for the year.

In closing, we believe the second quarter was a strong one across all financial and operational measures, not only for the results that we produced in the quarter but also for the impact these results will have on our ability to continue to grow revenue and generate profits and cash in the future.

That concludes our formal remarks, operator you may now open the line to questions.

Question And Answer

Operator

Thank you. [Operator Instructions]. The first question comes from Sterling Auty with J.P. Morgan.

Sterling Auty - J.P. Morgan

Hi thanks. So you guys are increasing your full year transaction guidance by quite a fair amount. My question is what gives you the confidence or the visibility in the higher transaction guidance for the full year?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Sterling as we have discussed with you and others in the past. When we go into the quarter and then we are looking at for the remainder of the year, we look at our transactions in three buckets. One is the, the transactions things like competitive churn where we have got a pretty good handle looking at regression analyses, in terms of what it is ... we think, that it will portend for the upcoming quarters. We also have what are called our scheduled orders. These are specific opportunities that we are working with carriers on, that we know their planning on giving us these orders on processing these transactions over the upcoming period and we work with them to get them scheduled in accordance with their plans. The last bucket is what we call, go-get [ph].

Now these are all the opportunities that are currently being worked that when we take a look at them, we say okay, what is all... what is in all likelihood going to close and end up being a scheduled order. We take a look at all of these as a part of our normal process. For the current quarter, the third quarter, we can see visibility of 90% to a 100% of what's going to close in the third quarter, and then when we get out into the fourth quarter, we have a pretty good handicapping system of what's likely to close and we also what the capacities of our systems are and of the LSMS network that we feed these transactions into. Taking all that into consideration, we are confident that we can exceed the $300 million as we suggested. It really is no different than the processes we have used every quarter, and as you know since we have gone public, we have never missed a quarter relative to our transaction growth and have never missed a year.

Sterling Auty - J.P. Morgan

Okay and then --

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

Sterling, if I can just add to that. Jeff just described the management process we used to come up with the arithmetic, but let's remember what's happening out in the marketplace that fills up the three buckets that Jeff just talked about. There are... there is a new field in our database that's driving transactions that come from innovation that come from a new is that the customers have never made of our directory. Innovations in the industry that cause great change within the carriers networks like the iPhone continue to pop-up throughout the business, as technology in the networks changes as there is increased complexity among our customers, they continue to meet to dynamically, reliably, inexpensively, change the routing of traffic across their existing capital infrastructure. They rely on NeuStar to do it, and as a result when Jeff counts up all the transactions and our recurring pieces in our contracted and committed work for customers and in the pipeline of prospective new deals, we see more than enough demand to meet the numbers that Jeff described for the second half of this year.

Sterling Auty - J.P. Morgan

Okay and then my follow up question will be, there's been fair amount discussion over the last quarters in terms of share repurchase and any thoughts around it, can you give us an update there?

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

Sure Sterling. The question of a share repurchase by NeuStar is an important one. It is under consideration by the Board and the management. We have not yet reached the decision. We continue to consider it seriously.

Sterling Auty - J.P. Morgan

Alright. Thank you.

Operator

We will next go to Phil Cusick with Bear Stearns.

Unidentified Analyst

Hi this is Richard Chu [ph] for Phil. Just I wanted to follow up on Sterling's question about the buybacks. Can you give us any color if you... when are you considering what the size and the timing would be? And then, another quick question, in terms of the new NGM guidance, what level of confidence do you have in that guidance and is it to the same level of your transactions or can this be revised to be up or down?

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

Sure. Good questions. Let me take the first half and I will ask Jeff Babka to take the second half. As I said to Sterling on the share buyback, this a very, very important issue. The Board is seriously considering that. We don't lightly accept power capital structure. We continue to look at the marketplace, look at our business, look at our prospects and determine what's best for the business. We have not reached the decision. We are considering almost all alternatives and we will continue to do, what we think is best for the value of the business. Jeff do you want to take the second half?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Yes,let me talk a little bit about NGM, and it's opportunistic we have got Brandon here with us. Brandon Pew [ph] in his last assignment prior to going into the IR role actually worked with our NGM team to build a very detailed and intricate model, that takes all 26 of the customers that we started the quarter with and now 29, as Jeff had mentioned and factored them in terms of when is the launch date, what are the... what's the amount that comes out of deferred upon the launch, what are the monthly minimums that come in upon launch, and then on the customers that we have had for a while, what are the projected assumptions relative to penetration rates. Now the penetration rates vary significantly by customer. We have got some smaller customers that have a penetration rate in subscribers up close to 13%. The largest one we have on a very large customer is about 5%, and depending on the stage they are in, we monitor our progress of how we are doing on penetrations, and know when that will hit the monthly minimums and when we will start recognizing incremental revenue over the monthly minimums.

So, when we come up with our forecast to $10 million to $13 million for this year, we are looking at customer-specific with specific data tied back to detailed operational plans that we are committed to, and working with the customer to roll out and help them launch their product. Now if you ask the question, well could it change? Well certainly, our assumptions could be faulty. We feel pretty confident in them right now, particularly in looking at some of the penetration rates that carriers that have really started promoting the product significantly like VimpelCom and three in the UK. So we have got pretty high degree of confidence in that $10 million to $13 million. There is certainly a possibility, it could be higher if we signed any additional carriers in the quarter, where we have the opportunity to recognize revenue. If it's going to be lower, it's not going to be lower by that much. What could cause it to be lower? Well obviously if a carrier's delay for its launch for one reason... a carrier's launch is delayed for reason or the other that could cause it. But as Jeff mentioned, the real strength in this business is getting on the trajectory to drive significant revenue and profitability next year and this model that we have laid out, actually goes out all the way through next year and we have got very detailed assumptions and detailed plans. So when we throw that $50 million number out there, we are not doing it lightly. It's not aspirational, hoping that we will sign all these new customers and get there. It's based on current customers, some customers that are currently in the half or relative to what we think the contracts are going to be signed and what the anticipated revenue coming off that would be.

Unidentified Analyst

Great, thank you.

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

You bet.

Operator

We will next go to Liz Grausam with Goldman Sachs.

Unidentified Analyst

Hi, this is actually Kim Huynh [ph] for Liz. I just had a question regarding the revenue ramp that you are going see in the back half of the year. If you could talk a little bit about where that's coming from, other than follow up? Just because the transactions don't look that they're ramping up too much. So, I was wondering if you could give a little bit more color to that.

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Sure we have got... the transactions do actually ramp from where we are in the first half of the year to the second. So we will see some additional growth coming out of the NPAC transactions. Hopefully or even be higher than the $300 million floor that we've put out there. In addition Ultra is having a very good year. They are growing significantly over last year. We see that as contributing to the growth. NGM will grow in the fourth ticket. The $10 million to $13 million that we gave guidance, they are going to have hit about $7 plus million revenue in the fourth quarter. So that would be a part of the growth also. And Common Short Codes as Jeff mentioned here a 9% percent sequential growth quarter-over-quarter in transactions. So we are very comfortable and the recurring nature of the revenues in our business in the NGM and the Common Short Codes and the Ultra and that gives us good foundation for growth going into the last two quarters.

Unidentified Analyst

Okay, thanks. The other question that I had was regarding Canadian number portability. I was wondering if that contributes anything at all or is that's kind of just not that material?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Yes, in the first quarter it was up considerably because they introduced portability on wireless, so we got some significant transactions there. In the second quarter it was... amounted to about a $1 million, so we are still seeing some transactions coming up there and you have to keep part in the revenue stream, it's an important market to us.

Unidentified Analyst

Okay. And just one last question on the dot-US registry, I think it's coming up for negotiation or what not this year and I was wondering about your confidence on resigning that particular contract?

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

The dot-US registry is one that we have been managing under our franchise from the U.S. Department of Commerce for the last few years. The natural term of that franchise calls for it to be put into an open competitive procurement that is run by U.S. Department of Commerce. And you know what I never like to eat in a restaurant weather is not allowing. If this wasn't a good business there will be no one else interested and NeuStar is fully up to the competitive challenge.

The key attributes is that we depend upon as we go into this competitive procurement is the fact that we have delivered extraordinary quality of service over the term of our role as the dot-US registry operator. And we have worked very, very closely with the U.S. Department of Commerce in developing the policies necessary for managing this U.S. American national resource. We look forward to extending our quality of service and good relationship with the U.S. community. And you know what we believe that the competitive selection will be made based upon who can deliver the best quality of service and support of the policy objectives of the government.

Unidentified Analyst

Okay, great. Thanks.

Operator

We will now take a question from Phil Winslow with Credit Suisse.

Phil Winslow - Credit Suisse First Boston

Hi guys. Most of my questions have been answered but just two remaining here. First, just when you look the Next Generation Massaging business obviously it is taking a good amount on the balance sheet and you see that in deferred revenue growth. Jeff, what would you expect the balance in deferred revenue coming from NGM to represent at the end of the year? And then I am going to have one follow up question to that.

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Well Phil yes, we are projecting billings right now for the year to about... range between about $18 million and $20 million and that's right we are versus... about $6.5 that we have to date. So we have billings of $12, if you back out the amount of revenue recognized, we are probably end the year from between now and the end of the year probably add another $3 million or $4 million to deferred. It's interesting as I look out next year into the model I actually see GAAP revenues being a little bit higher than build revenue next year just by the flow of the deferred revenue through the income statement going into next year. I think once we get kind of a more quarters under our belt you are going to probably see a pretty flattening out of this where we are putting in versus what we are billing is pretty comparable.

Phil Winslow - Credit Suisse First Boston

Okay, great. And then also when you do just look at the UltraDNS business and Followap, I wonder if you could just talk about this margin structure there as you start to these new businesses do you know just continue to ramp here just, what are there possibilities right now and sort of what are your, you guys long-term goals are?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Well, Phil we look at thing... we try to get in the businesses that can have margin profile comparable to our NPAC business. And you know it's a healthy margin but it's an earned margin and you know we... when we did the acquisitions of both Ultra and Followap we saw these businesses as being able to scale up to margin levels that we know would throw off around 40% EBITDA on the businesses on a sustained basis and operating margin in the low to mid-30s.

Obviously, there are different stages, right now with Ultra we are really putting our heals to the ground, relative to building up a sales force here and getting them ramped up. I would say you know going out of the... into sometime in 2008, we should be able to get that business to the profitability level of our core business. Followap will take a little bit longer, but once that we start really scaling this up it ramps up very quickly and the overall platform isn't going to take a significant amount of incremental expenses to keep going once we get there. So we are very happy with the profit prospects for these businesses and again that's one of the key factors we look at when we acquire a business.

Phil Winslow - Credit Suisse First Boston

Great. Thanks guys.

Operator

We'll go next to John Bright with Avondale Partners.

John Bright - Avondale Partners

Thank you. Good morning. First Jeff Ganek, stock price has been flat over the past year, are you satisfied with your current stable of products and services to generate the types of organic growth over the next two to four years. Then I think the investors are expecting in, then how does that factor into your thought process today regarding M&A?

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

John very, very good question. I have to tell you is that, I am... I don't quite understand the stock price and what I do understand is that we have a very, very large solid secure fast growing customer base. We have got a set of products, services and capabilities that address those customer needs in ways unrivaled by any other source in the marketplace. And here is what I really know; I know that the NeuStar Company has been able to use our position in the marketplace to produce revenue profitability and n cash flow over the last... within 20 quarters to produce steady, very fast, very fast growth, very-very impressive profitability and very-very strong cash flow.

When we at NeuStar make decisions about new products, our first driver, our criteria is to we see need in the marketplace is that we can meet in ways better than any other provider in the world. And if so, we invest quickly, we invest efficiently and we deliver the solution before anybody else gets there and as a result, we produced these financial results which my Finance professor in college told me would drive the stock price up. That's how we make the decision.

So the choice as to whether we are going to introduce new products and services or not, is driven by the fundamentals of NeuStar in the marketplace and it really goes, attend to this point John; NeuStar's success to date is a demonstration that there has been a fundamental change of restructuring in the communications industry. For the fist time NeuStar has demonstrated that the industry needs a trusted authoritative directory, a hub to which all networks connect, a hub that provide a medium for the sharing, for the exchange of operationally essential data, like local number portability data, like DNS data for the routing of IP traffic, like all of the NGM products that enabled the interoperability of the first IP-based service is going to be used by the mass market of billions of handsets around the world. We will offer new products and services when our customers deploying new technologies to deliver new features and functions that deliver capabilities that end-user will pay networks for. That's what we have done in the past; don't expect any difference in the future.

John Bright - Avondale Partners

So, may I interpret that to mean your appetite for M&A may not be as thirsty as it was in the past and you feel pretty comfortable with your existing stable of products and services to generate the organic growth that people are anticipating.

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

We've got a great product suite that has produced, what I think are extraordinarily results in the first half this year. We are confident that this product suite will continue to produce growth and profitability. However, let me be clear. We are in a very dynamic market, where our success over the last ten years has resulted from our bringing innovation to the marketplace. We have brought new products, new features, new capabilities to solve new problems that didn't exist when my grandmother had a black dial telephone in the hallway and the whole family had to share it. What I think is that there is today and will continue to be great turmoil and change in the communications industry, change in technology, change in industry structure, change in menu of services that end users demand, and as that change drives new infrastructure requirements on the part of our existing network operating customers, NeuStar is going to continue to do what we've done in the past to succeed innovate, to the extent that we can develop those new products and services solutions to new and emerging customer challenges. We will do so organically, where there are strategic, well priced, economic, sound opportunities to do acquisitions, to buy technologies, distribution channels and customers that are important to our customers, we will do that. So the answer John is fundamentals in the market will determine how we grow organically and inorganically. It's important that we succeed with our existing integration of acquisitions and that is a core capability of NeuStar that we will apply in the future when it's pertinent to do so.

John Bright - Avondale Partners

Alright, then my second question for Jeff Babka. Jeff you and I talked about the visibility over past conference calls. How do you feel about your visibility today and given the increase in transaction guidance, do you think you still have wiggle room out there in front of you?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Well John, you know our philosophy and how we go about building our guidance, and you know that there are some possibilities as we have said in the past for lumps on the high side. That's what drove 1.5 or 1.1 million more transactions to this quarter that was within our guidance. So, I think you know as well and up to now that we are going to put a number out there. It's got a high degree of confidence and we have been pretty fortunate in the past to find these high side lumps, and I think there is a possibility that they can happen for the remainder of this year also. I mean we are feeling pretty good about our visibility, as we get more and more of these opportunities for things like NANC 399, then the use of that field. It's just more and more opportunities to continue to grow revenue.

John Bright - Avondale Partners

Gentlemen, thank you.

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Thanks John.

Operator

We next go to Joseph Bori with Deutsche Bank.

Joseph Bori - Deutsche Bank

Hi guys good morning, thanks for taking my call. The first question here will be regarding again the mobile IM and the NGM business. We understand that the option level is going to be definitely related to how the carriers actually address the marketing of these products to customers. So now that you've put together a plan for '07 and you know quite well, what they are going to be doing, can you give some details on what the large carriers are tending to do? Are they including the mobile IM as part of their data plans or they're putting that separately and customers have to obtain? What's the level of pricing, can you comment on that? And if you want to get into the details, if you could discuss what for instance, Vodafone or VimpleCom are doing. That would be very helpful. Thanks.

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

Well, obviously there are some things we can and we can't discuss on this. But we have been in conversation with our folks over at NGM and we asked them for some specifics. What we find is, that most carriers are looking to get ramped up to, they tell us that looked to get ramped up to 10% after the first year 10% penetration. We have seen some carriers get as high as 13%. So it's certainly possible and it all depends on how they are going to package it. We are seeing some pretty creative examples for what carriers can do and in particular markets, I have mentioned one here. So you can see what they could do to potentially increase the volume of subscribers. One carrier sends a web push message out, telling customers to log on to the campaign website and invite their friends to be a flat rate subscriber. When the friends logs on, both users get a free week of usage and the 10 people who bought the most gets a Sony PSP or an iPod or something like that. For that results in what's trial is 35% of subscribers invited at least one friend, the average number of invitations per participant was 7, there were 815 new subscribers and it grew their subscriber rate 49%. So we are finding that this can have an impact. So you know our sales guys... that was in one particular country. They go and then work with the operators and say, hey, you might want to try this. We were successful one place.

So there is varying ways customers can do it, our carriers can do it. You mentioned VimpleCom. I checked in with our team there a couple of weeks back. VimpleCom has exceeded their projected penetration rate in the first couple of months after implementation. So, it varies, three in the UK is seeing a very nice turn up of rates. Vodafone is committed to and they're doing it. We are seeing. If you go their website, you can see what they are doing in packaging the programs. Some carriers are going out there and they are bundling it and then they are not charging anything extra for the basic service, because they are getting their arm on the premium charges for sending videos and pictures and things like that. It really varies but what we are seeing now is a lot of success stories at individual carriers, and our sales guys are motivated to get that penetration rate up as quick as they can. So, working from a consultative basis to take the great ideas that have worked in one country and one carrier and take it over to the next.

Joseph Bori - Deutsche Bank

Okay, great. And if I may I will ask you a second question here. And this one is related to the number of portability contract, potential contract in the U.K, where we are hearing lately news from the ALTECOM kind of pushing for maybe central registry solutions there. Can you give us an update on what the situation in the UK right now? Is there another deal ready out there or you expect that happen soon? And if so, how easy do you think it's possible that a U.S. company eventually win such a large country in the Europe given the kind of the political sensitivities here?

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

That is a very important question. Look NeuStar has been all over the world for the last ten years looking for opportunities in other countries like those that we have capitalized on in United States and Canada. You remember that few years ago that there was open competitive procurement for a local number of portability directory in Taiwan, we were selected for that. We have been in the UK regularly. Over the last ten years we have been placed their, we been working with OPCOM on their continuing consideration of development of local number portability directories. What there has been a slurry of activity there over the last few months and it is a continuation of considerations that have been going on for years. For a number of years, there are people who tell me that they are less than a year away from selecting, running up, comparative procurement to select directory operator.

We continue to pay attention to these opportunities, however no where outside of North America have we found a local number portability opportunity. Is that it can be developed and managed to produce the kinds of revenue growth and profitability that we've got in here in North America and as a result while we continue to look at these opportunities our highest priority outside of North America has been the development of IP-based directories and services to support instant messaging and Internet traffic via our NGM and Internet infrastructure business initiatives. I think we are going to continue to put our primary focus in those to us.

Joseph Bori - Deutsche Bank

Okay. Thank you very much.

Operator

We'll go next to Julie Santoriello with Morgan Stanley.

Julie Santoriello - Morgan Stanley

Thanks good morning. First the question for Jeff Babka, you mentioned in your discussion on the outlook for NGM that there will be an extra $3 million in operating expenses and an extra $5 million in CapEx, is that for the second half or the full year?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

That's full year and that's baked into the guidance numbers.

Julie Santoriello - Morgan Stanley

Okay. How many expect that to trend in 2008, or you have to keep up that level of investment or will it begin to trail off next year?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

I don't think it's going to be incrementally very significant. We are building the platforms now, we will probably spend in neighborhood of $30 million to $35 million across the total business on capital, that's not likely to go up significantly for next year. What we are really trying to do is get as much start as we possibly can this year to build the platforms. The capitalized labor on the platform build is what to comprises the bulk of the capital. Once we get the platform build we think we are pretty comfortable that that will go to a steady state type ramp.

Julie Santoriello - Morgan Stanley

Okay, great. And on the OpEx side is that primarily just the addition of sales people?

Jeffrey A. Babka - Senior Vice President and Chief Financial Officer

It's sales people, it's additional development people that can't be capitalized, yes, I mean it kind of runs the full gambit here as we set up operations but that business will ramp up considerably on the revenue side and we'll have no problem covering their operating expenses.

Julie Santoriello - Morgan Stanley

Okay, great. And on the transactions growth side just generally, we are seeing newer and different drivers of transactions growth now things like the new data field and so on. I am wondering about some of the old drivers that were pretty significant at one point, the carrier consolidation related transaction the Voice over IP related stuff. For these opportunities, do you think... is the best of the growth behind these as drivers of transactions or are these still going to be significant factors going forward?

Julie Santoriello - Morgan Stanley

Well Julie on the VoIP that was about 10% of revenue, I think you are going to gradually start seeing that increase as you get into the softswitch migration. It will be a pretty stable component of the revenue stream likely to grow into the future. Tech migration still very strong, vendor changes, industry consolidation was little less than 5% this quarter. We still have some a head way, above way ahead of this year with the technology change out Sprint Nextel. So, we are likely to see those transactions when they make their change out of technology on the IBN platform sometime in the future. So, good news is as we have a got a lot of traditional ones are still there. They have kind of been baked into our recurring transaction drivers and the new ones are coming and that's were lot of a growth is going to come from the new sources as Jeff had mentioned.

Julie Santoriello - Morgan Stanley

Okay, great. Thank you very much.

Operator

And at this time I would like to turn the call over to Jeff Ganek. Please go ahead.

Jeffrey E. Ganek - Chairman of the Board and Chief Executive Officer

Thanks very much. In closing I want to reiterate three things, first our growth continues, growth of transaction volumes is not limited by our ability to scale infrastructure and invent new ways to use existing technology. Transaction growth is likely to remain a vital element in our growth as the rate of change within the communication industry continues.

Second, NeuStar will continue to penetrate both the global fast growing wireless and Internet communication markets with highly scalable and attractively priced directory services. This penetration will not only be rapid but built on stable recurring revenue models that lead to long-term sustainable growth. And third, the contracts under which NeuStar provides local member portability services are secure. The industry recently renegotiated these contracts and approved the commercial terms by a super majority vote.

Thanks for listening to our quarterly earnings call. We look forward to updating you next quarter.

Operator

Ladies and gentlemen, this does conclude today's conference call. We thank everyone for the participation and you may disconnect at this time.

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Source: NeuStar Q2 2007 Earnings Call Transcript
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