TransUnion (NYSE:TRU) Q3 2023 Earnings Call Transcript

TransUnion (NYSE:TRU) Q3 2023 Earnings Call Transcript October 24, 2023

TransUnion misses on earnings expectations. Reported EPS is $0.91 EPS, expectations were $0.95.

Operator: Good morning. And welcome to TransUnion’s 2023 Third Quarter Earnings Conference Call [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Aaron Hoffman, Senior Vice President. Please go ahead.

Aaron Hoffman: Good morning, everyone, and thank you for attending today. Joining me on the call are Chris Cartwright, President and Chief Executive Officer; Todd Cello, Executive Vice President and Chief Financial Officer. We posted our earnings release and slides to accompany this call on the TransUnion Investor Relations Web site this morning. Our earnings release and the accompanying slides include various schedules, which contain more detailed information about revenue, operating expenses and other items as well as certain non-GAAP disclosures and financial measures along with their corresponding reconciliations of these non-GAAP financial measures to their most directly comparable GAAP measures. Today’s call will be recorded and a replay will be available on our Web site.

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We will also be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially from those described in the forward-looking statements because of factors discussed in today’s earnings release and the comments made during this earnings call and in our most recent Form 10-K, Forms 10-Q and other reports and filings with the SEC. We do not undertake any duty to update any forward-looking statement. With all that, let me turn it over to Chris.

Chris Cartwright: Thanks, Aaron. Let me add my welcome and share our agenda for the call this morning. First, I’ll discuss the macroeconomic conditions we’re facing and the impact that they had on our business in the third quarter. Then I’ll provide an overview of our third quarter financial performance. I’ll also review the continued progress we’re making with Neustar, accelerating revenue growth and achieving savings targets. I’ll wrap up with a short discussion about our approach to managing through a more challenging and uncertain macro environment. Finally, Todd will detail our third quarter results, along with our fourth quarter and full year guidance. Economic conditions softened across several TransUnion markets in the third quarter, most notably in the US and the UK.

While US consumers continue to benefit from low unemployment and modest real wage growth, lingering inflation and rising borrowing costs have taken a toll on household finances. Spending has slowed and consumers have largely spent through the excess savings accumulated during COVID. Although demand for credit remains strong despite elevated costs, banks have tightened lending standards due to weakening consumer finances and increasing capital constraints. Recent commentary from lenders supports these observations, noting that cracks have appeared across consumer lending, especially in the lower credit tiers. Now TransUnion entered the third quarter cautiously optimistic after exceeding guidance in the first two quarters, while maintaining our full year guidance as a cushion against ongoing economic uncertainty.

However, lending volumes in the US and UK softened progressively over the third quarter, causing our revenues to come in slightly under the low end of our guidance. In US Financial Services, year-over-year revenue grew 3% in July and 1% in August, but declined 5% in September. Rising rates in the quarter had a negative impact as the 10-year treasury rate spiked 50 basis points after only increasing 20 basis points in the first half of the year. The decrease in loan demand combined with tighter credit standards also fueled a pullback in marketing activity, which negatively affected our consumer audience and campaign management volumes. We experienced a similar slowdown in our insurance vertical where carriers remain primarily focused on increasing profitability and have reduced marketing to acquire new customers.

Insurance revenue grew 5% in July, 4% in August, but declined 4% in September. Increasing policy renewal rates and carriers exiting unprofitable geographies is fueling increased consumer shopping, which only partially offsets the decline in marketing volumes. And while policy attrition from large carriers is often acquired by smaller and nonstandard carriers, TU typically realizes less revenue per transaction as smaller carriers usually do not utilize our full product suite. Financial Services and insurance volumes have a high flow through to profits and their softening has weighed on our adjusted EBITDA dollars and margin. Our International segment continues to benefit from healthy economic conditions in India and Asia Pacific and strong market outperformance in Canada.

Other parts of the portfolio, such as the UK, Latin America and Africa slowed over the quarter, although segment revenues in total were up low double digits. In the third quarter, TransUnion grew revenues 3% organically driven by strength in international, Neustar and several verticals within US emerging markets. US markets grew 2% with Financial Services flat and Emerging Verticals up 4% in total due to high single digit revenue growth in Neustar. Our bookings remained strong overall, including within Financial Services insurance and media, and we continue to benefit from our portfolio diversification as we grew double digits in public sector and media and high single digits in tech, retail and e-commerce, all areas of recent organic and inorganic investment.

Revenue in our International segment grew by 11% in constant currency in September for the 10th consecutive quarter of double-digit growth. India led with 31% revenue growth while Canada and APAC also grew revenues double digits. We continue to outperform our underlying markets because of solution innovation, share gains and expansion into new adjacencies. We prepaid another $75 million of debt during the quarter, bringing our total for the first nine months to $225 million, and we expect to make further prepayments in the fourth quarter. We also settled two legal matters with the CFPB and the FTC with no admission of wrongdoing. We’re pleased to have resolved these matters and to proceed with our work of providing important business services to help consumers reach their goals.

Neustar delivered 7% revenue growth in the quarter despite increased macroeconomic headwinds and is proving to be nicely accretive to our growth rates in our core US verticals, even in these challenging market conditions. While bookings and subscriptions continued their strong growth, Neustar’s transactional revenues in Marketing and Risk Solutions softened in the quarter. As a result, we’re reducing our fourth quarter growth assumptions in line with volumes in September and lowering our full year guide to mid single digits growth instead of high single digits. We also expect a 31% EBITDA margin, up around 450 basis points over 2022 as we complete integration and achieve our target cost synergies. Now in the quarter, we announced a number of new partnerships that further support our confidence in Neustar’s growth prospects.

In marketing, we signed a substantial multiyear identity deal with a large CPG company as well as new business with a large apparel company in a major personal care brand. We also announced that our Marketing Solutions business through audience will integrate its identity product line with AWS entity resolution from Amazon Web Services. TruAudience brings advanced identity resolution capabilities to AWS customers to improve their data hygiene and customer insights from within AWS’ secure cloud environment. Communications Solutions continue to grow on the strength of our suite of trusted — of TruContact trusted call solutions or TCS, which grew about 70% in the third quarter across a range of verticals. We recently expanded our relationship with one of the three major wireless carriers in the US to become their exclusive provider for branded calling, part of our TCS solutions suite.

Branded calling allows users to place their brand and call purpose on outbound calls to cut through the fog of anonymous robo calls and securely engage with clients and prospects. We also won a multiyear multimillion dollar with a large federal government agency to provide branded call display. We’re enjoying strong growth in our TCS solutions and broad interest across our verticals as clients value improved answer rates and reduce costs. Now I want to wrap up my part of the call by reinforcing our long-term approach to creating shareholder value even as macroeconomic and lending market conditions may cycle. We’re focused on helping our customers address their current market challenges by applying our complementary credit, marketing and fraud solutions through our insight-led consultative approach.

With tightening lending standards, declining loan volumes and rising delinquencies, our rich trended and alternative credit data and powerful analytics and modeling tools will help lenders maximize their portfolios and find attractive segments for growth. Our marketing solutions enable customers to optimize their spending and ensure positive outcomes, which is even more important in challenging conditions. Our identity resolution, audience segmentation and predictive analytics help clients understand which customers to contact, how best to reach them and what messages will most likely resonate. Planning and measuring the effectiveness of marketing spending by utilizing our rich history of pipeline conversion data ensures that the best results are achieved with the least possible investment and our trusted call and fraud mitigation solutions also help clients reach consumers more efficiently and minimize their fraud losses.

We continue to invest in the strategic initiatives that will position us for our next chapter of growth and profitability. These include innovations from combining the best of Neustar and TransUnion, launching our next generation fraud mitigation platform and scaling our new products across our thriving international footprint and reducing our cost structurally by scaling our global capability centers, refining our organization structure and standardizing and modernizing our core technologies and operations remains key objectives for TransUnion. Through the series of initiatives, many of which have been in progress for some time now, we believe we can further reduce operating costs materially. Given the more challenging growth environment in which we find ourselves, we are accelerating these efforts and we’ll share additional details when appropriate.

We also remain laser focused on achieving the cost savings from our acquisition integrations and reducing our interest expense through prepayment of our debt. That concludes my comments this morning on our market conditions, our third quarter performance and our approach to managing through these softer market conditions. Todd will now provide further details on our third quarter financial results and our fourth quarter and our full year 2023 outlook. Over to you, Todd.

Todd Cello: Thanks, Chris, and let me add my welcome to everyone. I’ll start off with our consolidated financial results. Third quarter consolidated revenue increased 3% on a reported and constant currency basis. There was no impact from acquisitions and immaterial FX impact. Our business grew 2% on an organic constant currency basis, excluding mortgage from both the third quarter of 2022 and 2023. Adjusted EBITDA increased 5% on a reported basis and 4% in constant currency. This result was negatively impacted by an incremental $7 million charge for the recent legal settlements above the amount we previously reserved. We also benefited from a reversal of accruals for variable cash compensation to account for our current view of revenue and adjusted EBITDA for the full year.

Our adjusted EBITDA margin was 36.8%, up 50 basis points compared to the year ago third quarter and improved sequentially by 180 basis points from the second quarter of 2023. Third quarter adjusted diluted EPS declined 2% as a result of higher interest expense. Finally, we took a $495 million impairment to our UK business during the quarter. This remains an attractive market and business for TransUnion with a highly diversified portfolio, an array of successful product offerings like TruVision and TruEmpower and an adjusted EBITDA margin over 40%. Leveraging our innovation, we’ve gained meaningful share across the lending ecosystem and delivered market leading growth under our ownership. However, the UK has faced an unusually harsh confluence of macro events resulting in inflationary pressures and soaring interest rates which has slowed the underlying lending growth.

Before I get into US markets results, a reminder that we are reporting Neustar revenue within our Vertical market structure and we will discontinue providing stand-alone Neustar reporting at the end of 2023. Now looking at segment financial performance for the third quarter. US markets revenues were up 2% compared to the year ago quarter. Adjusted EBITDA for US markets increased 2% and adjusted EBITDA margin was flat at 35.2%. Financial Services revenue was flat. Consumer lending revenue declined 9% compared to single digit growth in the third quarter of 2022. Absolute lending [volumes] remain healthy as unsecured personal loans have become a mainstream product for our consumers. With that said, marketing activity remains depressed. Rising rates have weighed on consumer demand and capital funding continues to be highly selective.

Our credit card business was down 5% compared to low double-digit growth in the year ago quarter with marketing down mid-teens. Issuers continue to react to rising delinquencies by moderating marketing spend. With that said, like with consumer lending, activity levels for card remain healthy on a historical basis. Our auto business delivered 6% growth in the quarter on the strength of continued share gains, pricing, strong prequalification volumes, the impact of cross-selling Neustar marketing and call center solutions. We are seeing strong demand for new vehicles, somewhat offset by continued weakness in the used vehicle market and challenges around affordability. For mortgage, revenue was up 26% in the quarter despite inquiry volumes falling about 21%.

As Chris pointed out, growth slowed considerably over the course of the quarter as mortgage rates jumped to 20 year highs in recent weeks. Existing home sales reached their lowest level since 2011 and applications in mid-October fell to their lowest point since 1995. On a trailing 12-month basis, mortgage represented about 7% of total TransUnion revenue. For 2023, we now expect the inquiry market to be down roughly 30% and our revenue to increase roughly 15%. Let me now turn to our Emerging Verticals, which grew 4% in the quarter. Insurance delivered low single-digit growth despite the challenges that Chris described. Even in this environment, we continue to win new business for innovative products like TruVision driving history, which has grown fivefold over the past five years.

Penetration of newer markets like life and commercial auto and successful cross-selling of Neustar and Sontiq solutions. Tenant and employment screening was down as we’ve recalibrated our solutions to provide the most customer and consumer friendly approach possible. This has cost us some volume in the short term but we believe it will ultimately be a long-term competitive advantage. The public sector, media and tech, retail and e-commerce verticals all delivered strong growth, highlighting the value of our diversified business and in particular the benefits of integrating Neustar solutions into existing TransUnion end markets to enhance growth. The telco vertical was down slightly as declines in landline caller ID offset growth in other areas like trusted call solutions.

Consumer Interactive revenue declined 3% in line with our expectations. Adjusted EBITDA margins were 50.4%, up about 80 basis points as a result of more focused advertising spending. Our direct business continues to see moderating declines as we recalibrated our marketing approach to focus on higher value consumers. Thus far, we’ve seen good returns on the revamped tactics with better than expected customer acquisition stats at attractive cost to acquire. Our indirect business was flat as lenders have pulled back on utilizing offer aggregators and other channels for marketing, like the trends we’re experiencing in our financial services vertical. Our breach and identity protection offerings built through our acquisition of Sontiq, continued to deliver good growth.

For my comments about International, all revenue growth comparisons will be in constant currency. For the total segment, revenue grew 11% with three of our six reported markets growing by double digits. Adjusted EBITDA margin was 45.3%, up about 95 basis points. Now let’s dig into the specifics for each region. In India, our largest international market, we grew 31%, reflecting strong market trends and generally healthy consumers. We saw meaningful growth in both consumer and commercial credit markets as well as from fraud, marketing and direct to consumer offerings. We continue to expect India to deliver another year of over 30% growth. In the UK, revenue declined 4%. Excluding revenue related to onetime contracts included with the UK government, we would have declined 2%.

While the UK fintech market continues to be challenged, the rest of our business is growing despite the challenged macro environment with good growth in banking driven by share gains and traction with products like TruVision and CreditView as well as strong performance in insurance and gaming. Our Canadian business grew 17% in the third quarter. While the market remains low growth, we have generated strong outperformance across our portfolio and continue to win new share in financial services, fintech insurance and direct-to-consumer. In Latin America, revenue was up 3% with healthy online performance offset by a decline in batch marketing activity. Brazil was down in the quarter as we’ve seen some weakness in the fintech market. While macro conditions softened across Latin America, our teams continue to win new business in financial services, insurance, government and telcos.

In Asia Pacific, we grew 12% from continued good performance in Hong Kong and very strong growth in Philippines where we continue to add new offerings and win new business. Finally, Africa increased 8% based on a broadly strong performance across the portfolio and the region despite a challenging macroeconomic and social environment in several of our largest markets. We ended the quarter with roughly $5.4 billion of debt after prepaying another $75 million in the quarter, that left us with $421 million of cash on the balance sheet. We finished the quarter with a leverage ratio of 3.7 times. We have now prepaid $225 million of debt in 2023 and at this point, we intend to prepay additional debt in the fourth quarter. Looking back, since we announced the acquisition of Neustar in September of 2021, we’ve prepaid about $1.5 billion of debt.

We’re in the midst of refinancing our revolving credit facility and Term Loan A that matures on December 10, 2024. Based on early indications, we expect a favorable outcome and we will update you when we complete this transaction. And to reiterate our previous comment, at this time, we have no intention to pursue any large-scale acquisitions and even smaller bolt-on acquisitions are not in our plans this year. We are focused on integrating and maximizing the growth potential of Neustar, Sontiq and Argus. That brings us to our outlook for the fourth quarter. We expect FX to be insignificant to revenue and adjusted EBITDA. We expect revenue to come in between $917 million and $932 million or up 2% to 3% on an as reported and organic constant currency basis.

Our revenue guidance includes approximately 2 points of tailwind from mortgage, meaning that we expect the remainder of our business will be flat to up 1% on an organic constant currency basis. We are reducing our revenue assumption considerably from that implied in our previous guidance. We have essentially extrapolated the difficult September results across the fourth quarter to better match the current trends in our business. We expect adjusted EBITDA to be between $303 million and $315 million, down 2% to 6%. We expect adjusted EBITDA margin to be down 180 to 260 basis points. I want to spend a minute on the sequential change quarter-over-quarter in our adjusted EBITDA expectations. The high end of our fourth quarter is $41 million lower than the actual result for the third quarter.

More than three quarters of that change is a result of the reduced revenue outlook, which primarily came in financial services and carries a very high flow through to margin. The remainder is largely the result of the two items I mentioned earlier and the third quarter benefited from a reduction in variable cash compensation that was partially offset by the incremental reserve related to our settlement with the CFPB. We also expect adjusted diluted earnings per share to be between $0.67 and $0.72, a range of down 8% to 14%. Turning to the full year. We expect approximately 1 point of headwind from FX on revenue and adjusted EBITDA and we expect less than 1 point of impact from M&A. We expect revenue in between $3.794 billion and $3.809 billion or up 2% to 3% on an as reported and organic constant currency basis and up about 2%, excluding the impact of mortgage.

The roughly $53 million reduction at the midpoint of our full year revenue expectation is comprised of $9 million from weaker mortgage inquiries and $6 million of FX headwinds, with the remainder largely as a result of the softening trends in consumer lending, insurance and Neustar. For our business segments, we expect US markets to grow low single digits and flat excluding mortgage. We anticipate financial services to be flat and down low single digits, excluding mortgage. We expect emerging verticals to be up low single digits. We anticipate that international will grow low double digits in constant currency terms, driven by ongoing strength in emerging markets. And we continue to expect Consumer Interactive to decline low single digits. Turning back to total company outlook.

We expect adjusted EBITDA to be between $1.32 billion and $1.333 billion, down 1% to 2%. That would result in adjusted EBITDA margin being down 130 to 150 basis points. We anticipate adjusted diluted EPS being down 9% to 11%. And we continue to expect our adjusted tax rate to be approximately 23%, depreciation and amortization is expected to be approximately $520 million, and we expect the portion excluding step-up amortization from our 2012 change in control in subsequent acquisitions to be about $225 million. We anticipate net interest expense will be about $270 million for the full year, down slightly as a result of our continued debt prepayments and we expect capital expenditures to come in at about 8% of revenue. Finally, given the current level of uncertainty about the global economy, we believe it is prudent to withdraw the 2025 financial targets that we provided in mid-March of 2022.

Clearly, a lot has changed in the macro backdrop since our Investor Day in March of 2022. However, we remain as bullish as ever about our long-term prospects, the value of our expanded product portfolio and our ability to outgrow our underlying markets. We intend to reestablish new targets when we have greater visibility into the trajectory of the global economy. I’ll now turn the call back to Chris for some final comments.

Chris Cartwright: Thank you, Todd. And to wrap up, the third quarter proved to be more challenging than expected and conditions deteriorated as it progressed. But despite these headwinds, we delivered growth from our diversified portfolio and we remain focused on delivering a good 2023. We continue to execute against our strategy and we’re proactively driving new revenue opportunities, investing in our business, managing our cost structure and maintaining our capital discipline. We remain highly confident in the long-term performance and potential of our business, and we’re taking all the necessary steps to deliver the best possible results for shareholders. Now let me turn the time over to Aaron.

Aaron Hoffman: Thanks, Chris. That concludes our prepared remarks today. For the Q&A, we ask that you each ask only one question so that we can include more participants. Operator, we can begin the Q&A session now.

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Q&A Session

Operator: [Operator Instructions] And our first question will come from Kelsey Zhu of Autonomous.

Kelsey Zhu: Chris, I was wondering if you can help us understand the Neustar revenue mix a little bit better in terms of what percentage of Neustar revenue comes from subscription versus usage based revenue across marketing, fraud and communications?

Chris Cartwright: Yes, sure. Aaron, you want to…

Aaron Hoffman: So Kelsey, so 80% roughly of the marketing portion of Neustar is subscription-based. Marketing is about 40% of the total. So 80% of 40 is about 32. So about a third of total Neustar is — would be truly subscription based revenue.

Chris Cartwright: And look, let’s take this opportunity to talk about Neustar’s performance in the third quarter. As you know, it was one of the leading growth areas at 7% organic year-over-year, which we feel is especially strong given the overall difficult macro conditions that we discussed in our prepared commentary. That said, we were expecting higher growth out of Neustar. We were expecting roughly 10% organic growth over the second half of the year. And what we experienced — well, just to break down the piece parts, when there’s a macroeconomic pullback as we’ve seen in lending and in insurance, it’s going to impact various components of our business. It will reduce the number of batch prescreens. It will reduce the number of marketing campaigns, which impacts our audience generation and segmentation and our campaign planning tools.

And that’s what we experienced. Now the subscription piece of overall Neustar revenue has held up quite well and consistent with the financial expectations that we outlined. So that’s a positive. We’ve also booked exactly what we expected to book at this point in the year and we’re trending toward achieving our full bookings targets, which will be a little bit above last year’s bookings, which were a record year for Neustar. So the sale of Neustar products across the three lines is positive. Now the mix of what we’re selling at Neustar varied from our expectations in that we’re selling less data and audience services that are quicker to fulfill and recognize revenue than we expected, and we’re selling more effectiveness measurement, which are consulting type projects where the booking takes more time to realize.

And so some of the revenue from the bookings pushed out of the third quarter and even out of fourth quarter expectations. So that was one of the components in our guide down for Neustar. And then the third component really rests on the volume of data sales of TruAudience, audience generation in the specific marketing campaign management. And again, that’s going to correlate with growth or decline in lending volume and insurance origination. So hopefully, that gives you a sense of the dynamics that underpin Neustar performance.

Operator: The next question comes from Faiza Alwy of Deutsche Bank.

Faiza Alwy: I wanted to touch on your comment regarding lending standards that tightened through the course of the quarter. I’m curious if it was across the board in terms of lenders, whether it’s regional banks, fintechs or big banks. And if you can talk about any trends across various consumer cycles whether it’s subprime versus prime, so just a bit more color around what’s happening with lending standards.

Chris Cartwright: So happy to start with some overview on the macro conditions we see across banking. So as the quarter progressed, I think — well, first, on the positive, unemployment remains low and there is some real wage growth. Although I think the consensus is that the employment market is deteriorating somewhat. That said, the metrics and measures of that, you’ve got pros and you’ve got cons. That said, though, the excess in savings that had accumulated on consumer balance sheets declined a lot and recently the Federal Reserve Bank in San Francisco suggested that those excess savings balances would be gone by the end of the third quarter and have been gone for some time for all segments of the population, except the most affluent quintile, right?

And so over the course of the quarter but really pronounced in September we saw banks becoming more cautious about originating new loans. Now over the past couple of weeks, the large banks, the large publicly traded banks have reported their results, and while they were down a bit they were generally more positive than expectations. The one area, though, that underperformed expectations has been new lending volumes. Now if you tease that apart, the revolving component of new loans is fine, it’s the incremental volume to consumers that was most impacted. Now the other dynamic to be aware of in the market, and this really goes back to the earlier part of the year where we had some stability concerns. There was a flight of deposits upmarket to larger institutions that were perceived as more stable.

And so in this recent round of earnings, you see that those banks, while they’re performing well, it’s driven by net interest income growth but the lending activity is down. When you look at the performance of mid-market banks in smaller banks, the pinch on new credit origination is quite pronounced. And we see that in our numbers because — I mean, obviously, lending is a big part of our portfolio and we serve banks — traditional banks of all sizes in fintech, of course, as well, we got the largest share there, and we’re just seeing a pullback in lending volumes. And when banks become more cautious, that’s going to reduce the number of batch prescreens that we produce, it’s going to reduce the credit pools that happen, and it’s going to reduce the marketing planning.

And so it’s really this macro retreat that we’ve seen in the lending that’s impacting the business fundamentals.

Operator: The next question comes from Jeff Meuler of Baird.

Jeff Meuler: So I know Chris had more details to come on accelerating structural expense in efficiency programs. But just anything else you can talk to regarding how much opportunity there is to adjust the expense structure to a weaker volume environment? And I caught the decremental margins and the incentive comp adjustment in Q3, but the Q4 margins and implied decremental margins in Q4 still seem really weak. And I’m just trying to understand if that’s more a function of time to implement the new programs or just how we can think through like incremental margins going forward if the volume environment remains [weak] for a while. Sorry for the long question.

Chris Cartwright: So listen, it’s a good question and there are several things to unpack in it. The first I would say is — and we purposely included our year-over-year revenue growth rates in each month in the quarter, so you can appreciate how materially volumes fell in September in lending origination and also insurance, right? So we’ve had a revenue drop very recently without much time to adjust the expense structure, right? And so over the past 18 months as our markets have progressively slowed we’ve been proactively managing the expenses. It starts with the easy things of reducing travel and entertainment of cutting external consulting, if you will, reducing marketing. And of course, being very judicious about headcount.