**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý****     QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly periodended June 30, 2005**

 

**OR**

 

**o****     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom            to           **

 

**Commission file number 001-32548**

 

**NeuStar, Inc.**

(Exact name of registrant asspecified in its charter) 

 
| **Delaware**                                                     | ** ** | **52-2141938**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**46000 Center Oak PlazaSterling, Virginia 20166**(Address of principalexecutive offices) (zip code)

 

**(571) 434-5400**(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  Yes o  No  ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).  Yes o  No ý

 

There were 57,915,439 sharesof Class A common stock, $0.001 par value, and 2,438,405 shares of Class Bcommon stock, $0.001 par value, outstanding at August 5, 2005.

 

 

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**NeuStar, Inc.**

**Index**

 
| **PART I**  | ** ** | **FINANCIAL  INFORMATION**                                                                                        | ** ** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
|             |       |                                                                                                              |       |
| Item 1.     |       | Financial Statements                                                                                              |       |
|             |       |                                                                                                              |       |
|             |       | Consolidated  Balance Sheets as of December 31, 2004 and June 30, 2005  (unaudited)                     |       |
|             |       |                                                                                                              |       |
|             |       | Consolidated Statements of Operations for the three  and six months ended June 30, 2004 and 2005 (unaudited) |       |
|             |       |                                                                                                              |       |
|             |       | Consolidated Statements of Cash Flows for the six  months ended June 30, 2004 and 2005 (unaudited)           |       |
|             |       |                                                                                                              |       |
|             |       | Notes to Unaudited Consolidated Financial Statements                                                              |       |
|             |       |                                                                                                              |       |
| Item 2.     |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |       |
|             |       |                                                                                                              |       |
| Item 3.     |       | Quantitative and  Qualitative Disclosures about Market Risk                                                       |       |
|             |       |                                                                                                              |       |
| Item 4.     |       | Controls and Procedures                                                                                           |       |
|             |       |                                                                                                              |       |
| **PART II** | ** ** | **OTHER  INFORMATION**                                                                                            |       |
|             |       |                                                                                                              |       |
| Item 1.     |       | Legal Proceedings                                                                                                 |       |
|             |       |                                                                                                              |       |
| Item 2.     |       | Unregistered Sales of Equity Securities and Use of Proceeds                                                       |       |
|             |       |                                                                                                              |       |
| Item 3.     |       | Defaults upon  Senior Securities                                                                                  |       |
|             |       |                                                                                                              |       |
| Item 4.     |       | Submission of  Matters to a Vote of Security Holders                                                              |       |
|             |       |                                                                                                              |       |
| Item 5.     |       | Other Information                                                                                                 |       |
|             |       |                                                                                                              |       |
| Item 6.     |       | Exhibits                                                                                                          |       |
|             |       |                                                                                                              |       |
|             |       |                                                                                                              |       |
| Signatures       |       |

 

2

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**PART I — FINANCIAL INFORMATION**

 

**Item 1.****                    FinancialStatements**

 

**NEUSTAR,INC.**

 

**CONSOLIDATED BALANCE SHEETS**

**(inthousands, except per share data)**

 
| ** **                                                                                  | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                  | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                                                                                  | ** ** | ** **            | ** ** | **(unaudited)**   | ** ** |
| ASSETS                                                                                      |       |                  |       |              |       |
| Current  assets:                                                                            |       |                  |       |              |       |
| Cash and  cash equivalents                                                                  |       | $                     | 19,019     |              | $          | 15,002 |   |
| Restricted  cash                                                                            |       | 4,835                 |       | 2,350             |       |
| Short-term  investments                                                                     |       | 44,910                |       | 66,198            |       |
| Accounts  receivable, net of allowance for doubtful accounts of $468 and $947, respectively |       | 29,171                |       | 29,077            |       |
| Unbilled  receivables                                                                       |       | 980                   |       | 3,252             |       |
| Securitized  notes receivable                                                               |       | 3,325                 |       | 2,322             |       |
| Notes  receivable                                                                           |       | 965                   |       | 475               |       |
| Prepaid  expenses and other current assets                                                  |       | 3,747                 |       | 3,499             |       |
| Deferred  costs                                                                             |       | 1,570                 |       | 2,177             |       |
| Deferred tax  asset                                                                         |       | 10,923                |       | 9,437             |       |
| Total  current assets                                                                       |       | 119,445               |       | 133,789           |       |
|                                                                                        |       |                  |       |              |       |
| Restricted  cash, long-term                                                                 |       | 835                   |       | 400               |       |
| Property and  equipment, net                                                                |       | 36,504                |       | 40,991            |       |
| Goodwill                                                                                    |       | 49,453                |       | 50,566            |       |
| Intangible  assets, net                                                                     |       | 1,250                 |       | 3,147             |       |
| Securitized  notes receivable, long-term                                                    |       | 1,074                 |       | 3⁄4            |       |
| Deferred  costs, long-term                                                                  |       | 1,932                 |       | 4,200             |       |
| Other  noncurrent assets                                                                    |       | 961                   |       | 965               |       |
| Total assets                                                                                |       | $                     | 211,454    |              | $          | 234,058 |   |
|                                                                                             |            |                       |            |                   |            |  |  |  |  |

 

*See accompanying notes.*

 

3

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**NEUSTAR, INC.**

 

**CONSOLIDATED BALANCE SHEETS**

**(in thousands, except per share data)**

 
| ** **                                                                                                                                                                                                                        | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                                                                        | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                                                                                                        | ** ** | ** **            | ** ** | **(unaudited)**   | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ (DEFICIT) EQUITY**                                                                                                                                                                          | ** ** | ** **            | ** ** | ** **        | ** ** |
| Current  liabilities:                                                                                                                                                                                                             |       |                  |       |              |       |
| Accounts  payable                                                                                                                                                                                                                 |       | $                     | 2,828      |              | $          | 4,361 |   |
| Accrued  expenses                                                                                                                                                                                                                 |       | 32,630                |       | 27,019            |       |
| Income taxes  payable                                                                                                                                                                                                             |       | 419                   |       | 4,342             |       |
| Customer  credits                                                                                                                                                                                                                 |       | 15,541                |       | 7,604             |       |
| Deferred  revenue                                                                                                                                                                                                                 |       | 13,972                |       | 17,976            |       |
| Notes  payable                                                                                                                                                                                                                    |       | 4,636                 |       | 2,679             |       |
| Capital  lease obligations                                                                                                                                                                                                        |       | 4,813                 |       | 5,240             |       |
| Accrued  restructuring reserve                                                                                                                                                                                                    |       | 1,330                 |       | 1,281             |       |
| Total  current liabilities                                                                                                                                                                                                        |       | 76,169                |       | 70,502            |       |
|                                                                                                                                                                                                                              |       |                  |       |              |       |
| Deferred  revenue, long-term                                                                                                                                                                                                      |       | 13,812                |       | 17,374            |       |
| Notes  payable, long-term                                                                                                                                                                                                         |       | 1,358                 |       | 1,758             |       |
| Capital  lease obligations, long-term                                                                                                                                                                                             |       | 6,606                 |       | 5,704             |       |
| Accrued  restructuring reserve, long-term                                                                                                                                                                                         |       | 3,719                 |       | 2,735             |       |
| Deferred tax  liability                                                                                                                                                                                                           |       | 1,194                 |       | 2,070             |       |
| Total  liabilities                                                                                                                                                                                                                |       | 102,858               |       | 100,143           |       |
|                                                                                                                                                                                                                              |       |                  |       |              |       |
| Commitments  and contingencies                                                                                                                                                                                                    |       | 3⁄4                |       | 3⁄4            |       |
|                                                                                                                                                                                                                              |       |                  |       |              |       |
| Series B  Voting Convertible Preferred Stock, $0.01 par value; 4,000 shares authorized;  100 shares issued and outstanding at December 31, 2004; no shares  authorized, issued or outstanding at June 30, 2005     |       | 66                    |       | 3⁄4            |       |
| Series C  Voting Convertible Preferred Stock, $0.01 par value; 28,600 shares  authorized; 28,570 shares issued and outstanding at December 31, 2004;  no shares authorized, issued or outstanding at June 30, 2005 |       | 85,717                |       | —            |       |
| Series D  Voting Convertible Preferred Stock, $0.01 par value; 10,000 shares  authorized; 9,099 shares issued and outstanding at December 31, 2004; no  shares authorized, issued or outstanding at June 30, 2005  |       | 54,671                |       | —            |       |
|                                                                                                                                                                                                                              |       |                  |       |              |       |
| Stockholders’  (deficit) equity:                                                                                                                                                                                             |       |                  |       |              |       |
| Class A  common stock, par value $0.001; no shares authorized, issued and outstanding  at December 31, 2004; 200,000 shares authorized, 56,200 shares issued  and outstanding at June 30, 2005                     |       | —                |       | 56                |       |
| Class B  common stock, par value $0.001; 100,000 shares authorized; 6,160 and 3,664  shares issued and outstanding at December 31, 2004 and June 30,  2005, respectively (See Note 2)                              |       | 6                     |       | 4                 |       |
| Additional  paid-in capital                                                                                                                                                                                                       |       | —                |       | 138,455           |       |
| Deferred  stock compensation                                                                                                                                                                                                      |       | (1,733                | )          | (1,516            | )          |
| Treasury  stock, at cost, 236 and zero shares at December 31, 2004 and June 30,  2005, respectively                                                                                                                     |       | (1,125                | )          | —            |       |
| Accumulated  deficit                                                                                                                                                                                                              |       | (29,006               | )          | (3,084            | )          |
| Total  stockholders’ (deficit) equity                                                                                                                                                                                        |       | (31,858               | )          | 133,915           |       |
| Total  liabilities and stockholders’ (deficit) equity                                                                                                                                                                        |       | $                     | 211,454    |              | $          | 234,058 |   |

 

*Seeaccompanying notes.*

 

4

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**NEUSTAR,INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands, except per share data)**

**(unaudited)**

 
| ** **                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenue:                                                                          |       |                                  |       |                                |       |   |   |   |   |
| Addressing                                                                        |       | $                                     | 11,846     |                                | $          | 18,854 |   | $ | 23,806 |   | $ | 38,575 |   |
| Interoperability                                                                  |       | 8,482                                 |       | 13,490                              |       | 16,089 |   | 26,577 |   |
| Infrastructure  and other                                                         |       | 19,282                                |       | 29,952                              |       | 38,429 |   | 54,936 |   |
| Total  revenue                                                                    |       | 39,610                                |       | 62,296                              |       | 78,324 |   | 120,088 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Operating  expense:                                                               |       |                                  |       |                                |       |   |   |   |   |
| Cost of  revenue (excluding depreciation and amortization shown separately below) |       | 12,066                                |       | 15,767                              |       | 22,536 |   | 29,030 |   |
| Sales and  marketing                                                              |       | 4,836                                 |       | 7,571                               |       | 8,982 |   | 14,589 |   |
| Research and  development                                                         |       | 1,740                                 |       | 2,878                               |       | 3,471 |   | 5,448 |   |
| General and  administrative                                                       |       | 5,078                                 |       | 8,829                               |       | 8,471 |   | 16,419 |   |
| Depreciation  and amortization                                                    |       | 4,304                                 |       | 3,935                               |       | 9,224 |   | 7,517 |   |
| Restructuring  charges (recoveries)                                               |       | 3⁄4                                |       | 300                                 |       | 3⁄4 |   | (406 | ) |
|                                                                              |       | 28,024                                |       | 39,280                              |       | 52,684 |   | 72,597 |   |
| Income from  operations                                                           |       | 11,586                                |       | 23,016                              |       | 25,640 |   | 47,491 |   |
| Other  (expense) income:                                                          |       |                                  |       |                                |       |   |   |   |   |
| Interest  expense                                                                 |       | (599                                  | )          | (586                                | )          | (1,346 | ) | (1,212 | ) |
| Interest  income                                                                  |       | 394                                   |       | 722                                 |       | 720 |   | 1,197 |   |
| Income  before income taxes                                                       |       | 11,381                                |       | 23,152                              |       | 25,014 |   | 47,476 |   |
| (Benefit  from) provision for income taxes                                        |       | (7,287                                | )          | 9,269                               |       | (7,187 | ) | 18,962 |   |
| Net income                                                                        |       | 18,668                                |       | 13,883                              |       | 32,201 |   | 28,514 |   |
| Dividends on  and accretion of preferred stock                                    |       | (2,513                                | )          | (2,170                              | )          | (4,990 | ) | (4,313 | ) |
| Net income  attributable to common stockholders                                   |       | $                                     | 16,155     |                                | $          | 11,713 |   | $ | 27,211 |   | $ | 24,201 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Net income  attributable to common stockholders per common share:                 |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                                             |       | $                                     | 2.94       |                                | $          | 1.45 |   | $ | 5.02 |   | $ | 3.43 |   |
| Diluted                                                                           |       | $                                     | 0.23       |                                | $          | 0.18 |   | $ | 0.40 |   | $ | 0.37 |   |
|                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Weighted  average common shares outstanding:                                      |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                                             |       | 5,487                                 |       | 8,097                               |       | 5,421 |   | 7,055 |   |
| Diluted                                                                           |       | 82,118                                |       | 78,039                              |       | 80,922 |   | 76,502 |   |

 

*Seeaccompanying notes.*

 

5

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**NEUSTAR, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                           | ** ** | **2005** | ** ** |
| Operating  activities:                                                             |       |                               |       |   |   |
| Net income                                                                         |       | $                                  | 32,201     |   | $ | 28,514 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                               |       |   |   |
| Depreciation  and amortization                                                     |       | 9,224                              |       | 7,517 |   |
| Stock  compensation                                                                |       | 1,381                              |       | 2,431 |   |
| Amortization  of deferred financing costs                                          |       | 88                                 |       | 38 |   |
| Deferred  income taxes                                                             |       | (9,610                             | )          | 1,363 |   |
| Noncash restructuring  benefit                                                     |       | 3⁄4                             |       | (406 | ) |
| Provision  for doubtful accounts                                                   |       | 300                                |       | 600 |   |
| Changes in  operating assets and liabilities, net of acquisitions:                 |       |                               |       |   |   |
| Accounts  receivable                                                               |       | (603                               | )          | (1,485 | ) |
| Unbilled  receivables                                                              |       | 226                                |       | (2,272 | ) |
| Notes and  securitized notes receivable                                            |       | 2,345                              |       | 2,568 |   |
| Prepaid  expenses and other current assets                                         |       | (1,823                             | )          | 964 |   |
| Deferred  costs                                                                    |       | (273                               | )          | (2,875 | ) |
| Other assets                                                                       |       | (342                               | )          | (41 | ) |
| Accounts  payable and accrued expenses                                             |       | (2,976                             | )          | (3,328 | ) |
| Income taxes  payable                                                              |       | 934                                |       | 3,923 |   |
| Accrued restructuring  reserve                                                     |       | (151                               | )          | (627 | ) |
| Customer  credits                                                                  |       | (9,000                             | )          | (7,937 | ) |
| Deferred  revenue                                                                  |       | 4,860                              |       | 7,291 |   |
| Net cash  provided by operating activities                                         |       | 26,781                             |       | 36,238 |   |
|                                                                               |       |                               |       |   |   |
| Investing  activities:                                                             |       |                               |       |   |   |
| Purchases of  property and equipment                                               |       | (5,190                             | )          | (7,400 | ) |
| Purchases of  investments, net                                                     |       | (25,655                            | )          | (21,288 | ) |
| Business  acquired, net of cash                                                    |       | 3⁄4                             |       | (2,164 | ) |
| Net cash  used in investing activities                                             |       | (30,845                            | )          | (30,852 | ) |
|                                                                               |       |                               |       |   |   |
| Financing  activities:                                                             |       |                               |       |   |   |
| (Release)  issuance of restricted cash                                             |       | (11,023                            | )          | 2,920 |   |
| Principal  repayments on notes payable                                             |       | (5,049                             | )          | (3,220 | ) |
| Principal  repayments on capital lease obligations                                 |       | (4,853                             | )          | (3,085 | ) |
| Proceeds  from exercise of common stock options                                    |       | 45                                 |       | 246 |   |
| Payment of  preferred stock dividends                                              |       | 3⁄4                             |       | (6,264 | ) |
| Net cash used  in financing activities                                             |       | (20,880                            | )          | (9,403 | ) |
| Net decrease  in cash and cash equivalents                                         |       | (24,944                            | )          | (4,017 | ) |
| Cash and  cash equivalents at beginning of period                                  |       | 60,232                             |       | 19,019 |   |
| Cash and  cash equivalents at end of period                                        |       | $                                  | 35,288     |   | $ | 15,002 |   |

 

*See accompanying notes.*

 

6

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**NEUSTAR, INC.**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND2005**

 

**1.    DESCRIPTION OF BUSINESS ANDORGANIZATION**

 

NeuStar, Inc. (theCompany) provides the North American communications industry with essentialclearinghouse services. The Company operates the sole authoritative directoriesthat manage virtually all telephone area codes and numbers, and enable thedynamic routing of calls among thousands of competing communications serviceproviders, or CSPs, in the United States and Canada. The Company also providesclearinghouse services to emerging CSPs including Internet service providers,cable television operators, and voice over internet protocol, or VoIP, serviceproviders. In addition, the Company manages the authoritative directories forthe .us and .biz Internet domains, as well as for Common Short Codes, part ofthe short messaging service, or SMS, relied on by the U.S. wireless industry.

 

The Company provides itsservices from its clearinghouse, which includes unique databases and systemsfor workflow and transaction processing. These services are used by CSPs tosolve a range of their technical and operating requirements, including:

 

•                  *Addressing.*  The Company enables CSPs to use critical, shared addressingresources, such as telephone numbers, several Internet domain names, and CommonShort Codes.

 

•                  *Interoperability.*  The Company enables CSPs to exchange and share criticaloperating data so that communications originating on one provider’s network canbe delivered and received on the network of another CSP. The Company alsofacilitates order management and work flow processing among CSPs.

 

•                  *Infrastructure and Other.*  The Company enables CSPs to moreefficiently manage changes in their own networks by centrally managing certaincritical data they use to route communications over their own networks.

 

**2.    SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

**Unaudited Interim Financial Information**

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial information and the instructions toForm 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and notes required by U.S. generally accepted accounting principlesfor complete financial statements. In the opinion of management, all adjustments(consisting of normal recurring adjustments) considered necessary for a fairpresentation have been included. The results of operations for the three andsix months ended June 30, 2005 are not necessarily indicative of theresults that may be expected for the full fiscal year. The balance sheet for December 31,2004 has been derived from the audited consolidated financial statements atthat date but does not include all of the information and notes required byU.S. generally accepted accounting principles for complete financialstatements.

 

These consolidated financial statements should beread in conjunction with the audited consolidated financial statements as of December 31,2003 and 2004 and for each of the three years in the period ended December 31,2004 included in the Company’s prospectus dated June 28, 2005 filed withthe Securities and Exchange Commission on June 29, 2005.

 

In March 2005, the Company’s Board of Directorsapproved a registration statement on Form S-1 to be filed with theSecurities and Exchange Commission in connection with the initial publicoffering of the Company’s Class A common stock. In connection with theCompany’s initial public offering, the Company’s Board of Directors approved arecapitalization of the Company, which occurred on June 28, 2005 andresulted in (i) payment of $6.3 million in cash for all accrued and unpaiddividends on all of the outstanding shares of preferred stock, followed by

 

7

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theconversion of all of the outstanding shares of preferred stock into shares ofcommon stock, (ii) the amendment of the Company’s certificate ofincorporation to provide for Class A common stock and Class B commonstock, (iii) the split of each share of common stock into 1.4 shares andthe reclassification of the common stock into shares of Class B commonstock, and (iv) the ultimate conversion of all outstanding shares of Class Bcommon stock into shares of Class A common stock at the election of theholder of such shares of Class B common stock (collectively, the “Recapitalization”).  Prior to the Company’s initial publicoffering, holders of 100,000 shares of Series B Voting ConvertiblePreferred Stock, 28,569,692 shares of Series C Voting ConvertiblePreferred Stock, and 9,098,525 shares of Series D Voting Convertible PreferredStock converted their shares into 500,000, 28,569,692, and 9,098,525 shares ofthe Company’s common stock, respectively, after which the split by means of areclassification, as described in clauses (ii) and (iii) of theprevious sentence, was effected.

 

The accompanying unaudited consolidated financialstatements give retroactive effect to the amendment of the Company’scertificate of incorporation to provide for Class A common stock and Class Bcommon stock and the split of each share of common stock into 1.4 shares andthe reclassification of the common stock into shares of Class B commonstock, as though these events occurred at the beginning of the earliest periodpresented.

 

**Use of Estimates**

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, the disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting periods. Actual results could differ fromthose estimates.

 

**Reclassifications**

 

Certain amounts in the prior periods’ financialstatements have been reclassified to conform to the current periodpresentation.

 

**Revenue Recognition**

 

The Company provides the North Americancommunications industry with essential clearinghouse services that address theindustry’s addressing, interoperability, and infrastructure needs. The Company’srevenue recognition policies are in accordance with Securities and ExchangeCommission Staff Accounting Bulletin No. 104, *Revenue Recognition*.

 

The Company provides the following services pursuantto various private commercial and government contracts.

 

*Addressing*

 

The Company’s addressing services include telephonenumber administration, implementing the allocation of pooled blocks oftelephone numbers, and directory services for Internet domain names and CommonShort Codes. The Company generates revenue from its telephone numberadministration services under two government contracts. Under its contract toserve as the North American Numbering Plan Administrator, the Company earns afixed annual fee, and recognizes this fee as revenue on a straight-line basisas services are provided. In the event the Company estimates losses on itsfixed fee contract, the Company recognizes these losses in the period in whicha loss becomes apparent. Under the Company’s contract to serve as the NationalPooling Administrator, the Company is reimbursed for costs incurred plus afixed fee associated with administration of the pooling system. During theconstruction period completed in March 2002, the Company recognizedrevenue based on costs incurred. Thereafter,

 

8

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theCompany received an award fee associated with its initial delivery of thepooling system, which the Company recognized when it was notified of the amountof the award fee earned. The Company recognizes revenue for administration ofthe system based on costs incurred plus a pro rata amount of the fixed fee.

 

In addition to the administrative functionsassociated with its role as the National Pooling Administrator, the Companyalso generates revenue from implementing the allocation of pooled blocks oftelephone numbers under its long-term contracts with North American PortabilityManagement, LLC, and the Company recognizes revenue on a per transaction feebasis as the services are performed. For its Internet domain name services, theCompany generates revenue for Internet domain registrations, which generallyhave contract terms between one and ten years. The Company recognizes revenueon a straight-line basis over the lives of the related customer contracts. TheCompany generates revenue from its Common Short Code services under short-termcontracts ranging from three to twelve months, and the Company recognizesrevenue on a straight-line basis over the term of the customer contracts.

 

*Interoperability*

 

The Company’s interoperability services consistprimarily of wireline and wireless number portability and order managementservices. The Company generates revenue from number portability under itslong-term contracts with North American Portability Management, LLC andCanadian LNP Consortium, Inc. The Company recognizes revenue on a pertransaction fee basis as the services are performed. The Company provides ordermanagement services consisting of customer set-up and implementation followedby transaction processing under contracts with terms ranging from one to threeyears. Customer set-up and implementation is not considered a separatedeliverable; accordingly, the fees are deferred and recognized as revenue on astraight-line basis over the term of the contract. Per-transaction fees arerecognized as the transactions are processed.

 

*Infrastructure and Other*

 

The Company’s infrastructure services consistprimarily of network management and connection fees. The Company generatesrevenue from network management services under its long-term contracts withNorth American Portability Management, LLC. The Company recognizes revenue on aper transaction fee basis as the services are performed. In addition, theCompany generates revenue from connection fees and system enhancements under itscontracts with North American Portability Management, LLC. The Companyrecognizes its connection fee revenue as the service is performed. Systemenhancements are provided under contracts in which the Company is reimbursedfor costs incurred plus a fixed fee. Revenue is recognized based on costsincurred plus a pro rata amount of the fee.

 

*Significant Contracts*

 

The Company provideswireline and wireless number portability, implements the allocation of pooledblocks of telephone numbers and provides network management services pursuantto seven contracts with North American Portability Management, LLC, an industrygroup that represents all telecommunications service providers in the UnitedStates.  The Company recognizes revenueunder its contracts with North American Portability Management, LLC primarilyon a per-transaction basis.  Theaggregate fees for transactions processed under these contracts are determinedby the total number of transactions, and these fees are billed totelecommunications service providers based on their allocable share of thetotal transaction charges.  Thisallocable share is based on each respective telecommunications service provider’sshare of the aggregate end-user services revenues of all U.S.telecommunications service providers as determined by the FederalCommunications Commission (FCC).  Underthe Company’s contracts, the Company also bills a revenue recovery collections,or RRC, fee of a percentage of monthly billings to its customers, which isavailable to the Company if any telecommunications service provider fails topay its allocable share of total transactions charges.  In the period in which the RRC fees arebilled, the RRC

 

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fees are recorded as an accrued expense on theconsolidated balance sheet, with a corresponding increase to accountsreceivable.  If the RRC fee isinsufficient for that purpose, these contracts also provide for the recovery ofsuch differences from the remaining telecommunications service providers.  On an annual basis, (i) the Companyevaluates the RRC fee reserve by comparing cash collections to billings and theRRC percentage is adjusted, and (ii) any excess RRC fee reserve isreturned to the telecommunications service providers in accordance with theterms of these contracts.

 

The per-transaction pricing under these contractsprovides for annual volume discounts (credits) that are earned on alltransactions in excess of the pre-determined annual volume threshold.  For 2005, the maximum aggregate volumediscount (credit) is $7.5 million which is applied via a reduction inper-transaction pricing once the pre-determined annual volume threshold hasbeen surpassed.  When the aggregatediscount (credit) has been fully satisfied, the per-transaction pricing isrestored to the prevailing contractual rate.

 

For 2003 and 2004, billingscontinued at the original contractual rate after the annual volume thresholdwas surpassed.  Billings in excess of thediscounted pricing was recorded as a customer credit liability on the balancesheet with a corresponding reduction to revenue.  In the following year when the credit wasapplied to invoices rendered, the customer credit liability was reduced with acorresponding credit to accounts receivable. The annual pre-determined volume threshold was surpassed in the fourthquarters of 2003 and 2004 resulting in the reduction of revenue and recognitionof a customer credit liability of $6.0 million and $11.9 million, respectively.

 

In December 2003, thesecontracts were amended to extend their expiration date from May 2006 to May 2011,and the per-transaction fee charged to the Company’s customers over the term ofthe contracts was reduced.  Currently,the Company charges $1.08 per transaction under these contracts.  Each contract provides that over the life ofthe contract, as pre-determined cumulative transaction thresholds are surpassedin the region covered by that contract, the price per transaction willgradually decline to a minimum fee of $0.93 per transaction.  As part of the amendments, the Company agreedto retroactively apply the new transaction fee to all 2003 transactionsprocessed and granted credits totaling $16.0 million.  These credits are being applied to customerinvoices over a 23-month period beginning in January 2004. Additionally,the Company obtained letters of credit totaling $16.0 million in January 2004to secure these customer credits. As of December 31, 2004 and June 30, 2005,approximately $15.5 million and $7.6 million, respectively, of these customercredits were outstanding. The amount of the Company’s revenue derived under itscontracts with North American Portability Management, LLC was$69.2 million, $84.5 million, and $130.0 million for the yearsended December 31, 2002, 2003 and 2004, respectively.

 

**Accounting for Stock-Based Compensation**

 

Statement of Financial Accounting Standards (SFAS) No. 123,*Accounting for Stock-Based Compensation*,as amended by SFAS No. 148, *Accountingfor Stock-Based Compensation—Transition and Disclosure, an amendment of SFAS No. 123*(SFAS No. 123), allows companies to account for stock-based compensationusing either the provisions of SFAS No. 123 or the provisions ofAccounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*(APB No. 25),but requires companies that use APB No. 25 to include pro forma disclosurein the notes to the financial statements as if the measurement provisions ofSFAS No. 123 had been adopted. The Company accounts for its stock-basedemployee compensation in accordance with APB No. 25. Stock compensationexpense to nonemployees has been determined in accordance with SFAS No. 123and Emerging Issues Task Force Issue No. 96-18, *Accounting for Equity Instruments that are Issued to Other thanEmployees for Acquiring, or in Connection with Selling Goods or Services*(EITF 96-18), and represents the fair value of the consideration received orthe fair value of the equity instrument issued, whichever may be more reliablymeasured.  For options that have

 

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notreached a measurement date under EITF 96-18, the fair value of the optionsgranted to nonemployees is periodically remeasured at each reporting date.

 

The following table illustrates the effect of netincome attributable to common stockholders and net income attributable tocommon stockholders per common share as if the Company had applied the fairvalue recognition provisions of SFAS No. 123 to stock-based compensation(in thousands, except per share data):

 
| ** **                                                                                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Pro forma basic  net income attributable to common stockholders:                                            |       |                                  |       |                                |       |   |   |   |   |
| As reported                                                                                                 |       | $                                     | 16,155     |                                | $          | 11,713 |   | $ | 27,211 |   | $ | 24,201 |   |
| Add:  stock-based compensation expense included in reported net income attributable  to common stockholders |       | 1,186                                 |       | 109                                 |       | 1,381 |   | 2,431 |   |
| Deduct:  total stock-based compensation expense determined under fair value-based  method for all awards    |       | (2,236                                | )          | (901                                | )          | (3,901 | ) | (3,806 | ) |
| Pro forma basic  net income attributable to common stockholders                                             |       | $                                     | 15,105     |                                | $          | 10,921 |   | $ | 24,691 |   | $ | 22,826 |   |
|                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Pro forma diluted  net income attributable to common stockholders:                                          |       |                                  |       |                                |       |   |   |   |   |
| Basic net  income attributable to comon stockholders — as reported                                     |       | $                                     | 16,155     |                                | $          | 11,713 |   | $ | 27,211 |   | $ | 24,201 |   |
| Dividends on  and accretion of convertible preferred stock                                                  |       | 2,513                                 |       | 2,170                               |       | 4,990 |   | 4,313 |   |
| Diluted net  income attributable to common stockholders                                                     |       |                                  | 18,668     |                                |       | 13,883 |   |   | 32,201 |   |   | 28,514 |   |
| Add:  stock-based compensation expense included in reported net income attributable  to common stockholders |       | 1,186                                 |       | 109                                 |       | 1,381 |   | 2,431 |   |
| Deduct:  total stock-based compensation expense determined under fair value-based  method for all awards    |       | (2,236                                | )          | (901                                | )          | (3,901 | ) | (3,806 | ) |
| Pro forma diluted  net income attributable to common stockholders                                           |       | $                                     | 17,618     |                                | $          | 13,091 |   | $ | 29,681 |   | $ | 27,139 |   |
|                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Net income  attributable to common stockholders per common share:                                           |       |                                  |       |                                |       |   |   |   |   |
| Basic 3⁄4  as reported                                                                                   |       | $                                     | 2.94       |                                | $          | 1.45 |   | $ | 5.02 |   | $ | 3.43 |   |
| Basic 3⁄4  pro forma                                                                                     |       | $                                     | 2.75       |                                | $          | 1.35 |   | $ | 4.55 |   | $ | 3.24 |   |
| Diluted 3⁄4  as reported                                                                                 |       | $                                     | 0.23       |                                | $          | 0.18 |   | $ | 0.40 |   | $ | 0.37 |   |
| Diluted 3⁄4  pro forma                                                                                   |       | $                                     | 0.21       |                                | $          | 0.17 |   | $ | 0.37 |   | $ | 0.35 |   |

 

The Black-Scholes option-pricing valuation model wasdeveloped for use in estimating the fair value of traded options that have novesting restrictions and are fully transferable. In addition, option valuationmodels require the input of highly subjective assumptions. Because the Company’sstock options have characteristics significantly different from those ofpublicly traded options, and because changes in the subjective inputassumptions can materially affect the fair value estimate, in management’sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of the Company’s employee stock options.

 

The effect of applying SFAS No. 123 on proforma net income attributable to common stockholders as stated above is notnecessarily representative of the effects on reported net income attributableto common stockholders for future years due to, among other things, the vestingperiod of the stock options and the fair value of additional options to begranted in the future years.

 

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The fair value of each option is estimated on thedate of grant using the Black-Scholes option-pricing model with the followingassumptions for grants issued during the three and six months ended June 30,2004 and 2005:

 
| ** **                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
|                             |       |                                  |       |                                |       |   |   |   |   |
| Dividend  yield                  |       | 0.0                                   | %          | 0.0                                 | %          | 0.0 | % | 0.0 | % |
| Expected  volatility             |       | 67.14                                 | %          | 63.11                               | %          | 67.14 | % | 63.11 | % |
| Average  risk-free interest rate |       | 3.43                                  | %          | 3.89                                | %          | 3.43 | % | 3.89 | % |
| Expected  term                   |       | 5.0                                   |       | 5.0                                 |       | 5.0 |   | 5.0 |   |

 

**Basic and Diluted Net Income Attributable to CommonStockholders per Common Share**

 

Basic net income attributable to common stockholdersper common share excludes dilution for potential common stock issuances and iscomputed by dividing net income attributable to common stockholders by theweighted-average number of common shares outstanding for the period. Dilutednet income attributable to common stockholders per common share reflects thepotential dilution that could occur if securities or other contracts to issue commonstock were exercised or converted into common stock.

 

The following table provides a reconciliation of thenumerators and denominators used in computing basic and diluted net incomeattributable to common stockholders per common share and pro forma net incomeattributable to common stockholders per common share (in thousands):

 
| ** **                                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Basic net  income attributable to common stockholders per common share:        |       |                                  |       |                                |       |   |   |   |   |
| Net income                                                                     |       | $                                     | 18,668     |                                | $          | 13,883 |   | $ | 32,201 |   | $ | 28,514 |   |
| Dividends on  and accretion of convertible preferred stock                     |       | (2,513                                | )          | (2,170                              | )          | (4,990 | ) | (4,313 | ) |
| Basic net  income attributable to common stockholders                          |       | $                                     | 16,155     |                                | $          | 11,713 |   | $ | 27,211 |   | $ | 24,201 |   |
|                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Basic net  income attributable to common stockholders per common share         |       | $                                     | 2.94       |                                | $          | 1.45 |   | $ | 5.02 |   | $ | 3.43 |   |
|                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Diluted net  income attributable to common stockholders per common share:      |       |                                  |       |                                |       |   |   |   |   |
| Basic net  income attributable to common stockholders                          |       | $                                     | 16,155     |                                | $          | 11,713 |   | $ | 27,211 |   | $ | 24,201 |   |
| Dividends on  and accretion of convertible preferred stock                     |       | 2,513                                 |       | 2,170                               |       | 4,990 |   | 4,313 |   |
| Diluted net  income attributable to common stockholders                        |       | $                                     | 18,668     |                                | $          | 13,883 |   | 32,201 |   | $ | 28,514 |   |
| Diluted net  income attributable to common stockholders per common share       |       | $                                     | 0.23       |                                | $          | 0.18 |   | $ | 0.40 |   | $ | 0.37 |   |
|                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Weighted  average common shares outstanding 3⁄4  basic                      |       | 5,487                                 |       | 8,097                               |       | 5,421 |   | 7,055 |   |
| Dilutive  effect of:                                                           |       |                                  |       |                                |       |   |   |   |   |
| Stock  options for the purchase of common stock                                |       | 7,054                                 |       | 10,372                              |       | 6,863 |   | 9,758 |   |
| Conversion  of preferred stock and accrued dividends payable into common stock |       | 63,294                                |       | 53,231                              |       | 62,361 |   | 53,358 |   |
| Warrants for  the purchase of common stock                                     |       | 6,283                                 |       | 6,339                               |       | 6,277 |   | 6,331 |   |
| Weighted  average common shares outstanding 3⁄4  diluted                    |       | 82,118                                |       | 78,039                              |       | 80,922 |   | 76,502 |   |

 

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**Income Taxes**

 

Deferred tax assets and liabilities are determinedbased on temporary differences between the financial reporting bases and thetax bases of assets and liabilities. Deferred tax assets are also recognizedfor tax net operating loss carryforwards. These deferred tax assets andliabilities are measured using the enacted tax rates and laws that will be ineffect when such amounts are expected to reverse or be utilized. Therealization of total deferred tax assets is contingent upon the generation offuture taxable income. Valuation allowances are provided to reduce suchdeferred tax assets to amounts more likely than not to be ultimately realized.

 

Income tax expense includes U.S. federal, state andlocal income taxes and is based on pre-tax income. The interim period provisionfor income taxes is based upon the Company’s estimate of its annual effectiveincome tax rate. In determining the estimated annual effective income tax rate,the Company analyzes various factors, including projections of the Company’sannual earnings and taxing jurisdictions in which the earnings will begenerated, the impact of state and local income taxes and the ability of theCompany to use tax credits and net operating loss carryforwards.

 

As of June 30, 2004, the Company generatedoperating profits for six consecutive quarters and had fully utilized itsfederal net operating loss carryforwards. As a result of this earnings trendand projected operating results over future years, the Company reversedapproximately $20.2 million of its deferred tax asset valuation allowance,having determined that it was more likely than not that these deferred taxassets would be realized. This reversal resulted in the recognition of anincome tax benefit of $16.9 million and a reduction of goodwill of$3.3 million. Of the total income tax benefit recognized, approximately$14.5 million relates to a federal deferred tax benefit with the remainderrepresenting the state deferred tax benefit. As a result, income tax expensehas been recorded based on pre-tax income for the three and six months ended June 30,2005. The effective income tax (benefit) expense rate was (64.0%) and 40.0% forthe three months ended June 30, 2004 and 2005 and (28.7%) and 39.9% forthe six months ended June 30, 2004 and 2005, respectively.

 

**Comprehensive Net Income**

 

There were no material differences between netincome and comprehensive net income for the three and six months ended June 30,2004 and 2005.

 

**Recent Accounting Pronouncements**

 

On December 16, 2004, the FASB issued SFAS No. 123(revised 2004), *Share-Based Payment* (SFAS No. 123(R)), which is arevision of SFAS No. 123.  SFAS No. 123(R)supersedes APB No. 25, and amends SFAS No. 95, *Statement of Cash Flows*. Generallythe approach in SFAS No. 123(R) is similar to the approach described inSFAS No. 123. However, SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the statement of operations based on their fair values. Pro formadisclosure is no longer an alternative upon adopting SFAS No. 123(R). In April 2005,the Securities and Exchange Commission amended the compliance dates for SFAS No. 123(R)from fiscal periods beginning after June 15, 2005 to fiscal yearsbeginning after June 15, 2005. The Company will continue to account forshare-based compensation using the intrinsic value method set forth in APB No. 25until adoption of SFAS No. 123(R) on January 1, 2006.

 

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SFAS No. 123(R) permits public companies toadopt its requirements using one of two methods:

 

•                  A “modified prospective” method in whichcompensation cost is recognized beginning with the effective date (a) basedon the requirements of SFAS No. 123(R) for all share-based paymentsgranted after the effective date and (b) based on the requirements of SFASNo. 123(R) for all awards granted to employees prior to the effective dateof SFAS No. 123(R) that remain unvested on the effective date.

 

•                  A“prospective” method, which includes the requirements of the modifiedprospective method described above, but also permits entities to restate basedon the amounts previously recognized under SFAS No. 123 for purposes ofpro forma disclosures either (a) all prior periods presented or (b) priorinterim periods of the year of adoption.

 

The Company plans to adopt SFAS No. 123(R)using the modified prospective method on January 1, 2006.

 

**3.    ACQUISITION**

 

On February 1, 2005, the Company acquiredfiducianet, Inc. (Fiducianet) for $2.2 million in cash and theissuance of 35,745 shares of Class B common stock for total purchaseconsideration of $2.6 million. The acquisition of Fiducianet enables theCompany to serve as a single point of contact in managing all day-to-daycustomer obligations involving subpoenas, court orders and law enforcementagency requests under electronic surveillance laws including the CommunicationsAssistance for Law Enforcement, Patriot and Homeland Security Acts. Theacquisition was accounted for as a purchase, and the results of Fiducianet havebeen included in the accompanying consolidated statements of operations sincethe date of the acquisition.

 

The Company allocated the purchase price principallyto customer lists ($2.6 million) and goodwill ($1.1 million).  Customer lists are included in intangibleassets and are being amortized on a straight-line basis over five years.  In accordance with SFAS No. 109, *Accounting for Income Taxes*, the Companyrecorded a deferred tax liability of approximately $1.0 million with anoffset entry to goodwill.

 

**4.    GOODWILL and INTANGIBLEASSETS**

 

Goodwill and other intangible assets consist of thefollowing (in thousands):

 
| ** **                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                    | ** ** | ** **            | ** ** | **(unaudited)**   | ** ** |
| Goodwill                      |       | $                     | 49,453     |              | $          | 50,566 |   |
| Other  intangible assets:     |       |                  |       |              |       |
| Customer  lists               |       | 996                   |       | 3,566             |       |
| Acquired  technology          |       | 2,208                 |       | 2,208             |       |
| Total other  intangibles      |       | 3,204                 |       | 5,774             |       |
| Accumulated  amortization     |       | (1,954                | )          | (2,627            | )          |
| Other  intangible assets, net |       | $                     | 1,250      |              | $          | 3,147 |   |

 

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Amortization expense related to other intangibleassets, which is included in depreciation and amortization expense, was$388,000 and $364,000 for the three months ended June 30, 2004 and 2005and $833,000 and $673,000 for the six months ended June 30, 2004 and 2005,respectively. Amortization expense related to intangible assets for the yearsended December 31, 2005, 2006, 2007, 2008 and 2009 thereafter is expectedto be approximately $1,165,000, $858,000, $726,000, $514,000 and $557,000,respectively.

 

**5.    STOCKHOLDERS’ (DEFICIT)EQUITY**

 

**Common Stock**

 

On February 14, 2005, the Company grantedoptions to employees for the purchase of 341,844 shares of common stock with anexercise price of $10.86, which represented a contemporaneous determination offair market value of the Company’s common stock by the Company’s board ofdirectors.

 

During February 2005, the Company granted fullyvested options to nonemployees for the purchase of 22,400 shares of commonstock at a weighted average exercise price of $10.86 per share. The Companyrecognized compensation expense of approximately $180,000. The fair value ofthese awards was calculated on the date of grant using the Black-Scholesoption-pricing model with the following weighted average assumptions: expectedlife of the award equal to the remaining contractual life; volatility 63.11%;risk-free interest rate, 3.38%; and dividend yield of 0.00% during the optionterm.

 

During March 2005, an employee of the Companychanged status to a consultant and, in accordance with the terms of theoriginal option agreement, continued to vest in 26,250 options as of March 29,2005.  As a result, the Companyre-measured the fair value of the vested options and recognized compensationexpense of approximately $331,000. The fair value of this award was calculatedon the modification date using the Black-Scholes option-pricing model with thefollowing weighted average assumptions: expected life of the award equal to theremaining contractual life; volatility 63.11%; risk-free interest rate, 3.43%;and dividend yield of 0.00% during the option term.

 

During March 2005, the Company accelerated thevesting of certain options issued to nonemployees. This acceleration enabledthe optionholders to immediately vest in approximately 102,000 options, whichotherwise would have vested over the options’ original vesting period,generally 48 months. In connection with this acceleration, the Companyrecorded approximately $1.6 million as compensation expense based on thefair value of the options on the date of acceleration. The fair value of theseawards was remeasured on the acceleration date using the Black-Scholesoption-pricing model with the following weighted average assumptions: expectedlife of the award equal to the remaining contractual life; volatility 63.11%;risk-free interest rate, 3.72%; and dividend yield of 0.00% during the optionterm. As of March 31, 2005, all options granted to nonemployees hadvested.

 

On June 28, 2005, the Company made an initialpublic offering (“IPO”) of 31,625,000 shares of Class A common stock,which included the underwriters’ over-allotment option exercise of 4,125,000shares of Class A common stock.  Allthe shares of Class A common stock sold in the IPO were sold by sellingstockholders and, as such, the Company did not receive any proceeds from theoffering.  In connection with thistransaction, the Company incurred offering costs and other IPO-related expensesof approximately $4.9 million for the six months ended June 30, 2005,which is recorded in general and administrative expense on the unauditedconsolidated statements of operations.

 

In connection with the formation of NeuLevel, Inc.(NeuLevel), the Company’s 90%-owned subsidiary, the Company granted theminority interest holder of NeuLevel an option to purchase, within 30 daysof completion of the Company’s initial public offering, up to$20.0 million worth of common stock at a purchase price per share equal tothe public offering price.  This optionexpired unexercised.

 

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**Item 2.****                                    ****Management’s Discussion and Analysis of Financial Condition and Results of Operations**

 

**Forward-Looking Statements**

 

This quarterly report on Form 10-Q containsforward-looking statements, including, without limitation, statementsconcerning the conditions in our industry, our operations and economicperformance, and our business and growth strategy.  In some cases, you can identifyforward-looking statements by terminology such as “may,” “will,” “should,” “expects,”“intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,”“continue” or the negative of these terms or other comparable terminology.  These statements relate to future events orour future financial performance and involve known and unknown risks,uncertainties and other factors that may cause our actual results, levels ofactivity, performance or achievements to differ materially from any futureresults, levels of activity, performance or achievements expressed or impliedby these forward-looking statements. Many of these risks are beyond our ability to control or predict.  These forward-looking statements are based onestimates and assumptions by our management that, although we believe to bereasonable, are inherently uncertain and subject to a number of risks anduncertainties.  These risks and uncertaintiesinclude, without limitation, those described below under the heading “AdditionalFactors That May Affect Future Results.”

 

In light of these risks and uncertainties, thematters referred to in the forward-looking statements contained in thisquarterly report may not in fact occur. We undertake no obligation to publicly update or revise anyforward-looking statement as a result of new information, future events orotherwise, except as otherwise required by law. Reference is also made to such risks and uncertainties detailed fromtime to time in our filings with the SEC.

 

**Overview**

 

We provide the North American communicationsindustry with essential clearinghouse services. We operate the authoritative directories that manage virtually alltelephone area codes and numbers, and enable the dynamic routing of calls amongthousands of competing communications service providers, or CSPs, in the UnitedStates and Canada.  All CSPs that offertelecommunications services to the public at large, or telecommunicationsservice providers, such as Verizon Communications Inc., SprintCorporation, AT&T Corp. and Cingular Wireless LLC, must access ourclearinghouse as one of our customers to properly route virtually all of theircalls.  We also provide clearinghouseservices to emerging CSPs, including Internet service providers, cabletelevision operators, and voice over Internet protocol, or VoIP, serviceproviders.  In addition, we manage theauthoritative directories for the .us and .biz Internet domains, as well as forCommon Short Codes, part of the short messaging service relied upon by the U.S.wireless industry.

 

**Our Company**

 

We were founded to meet the technical andoperational challenges of the communications industry when the U.S. governmentmandated local number portability in 1996. While we remain the provider of theauthoritative solution that the industry relies upon to meet this mandate, wehave developed a broad range of innovative services that meet an expanded rangeof customer needs. We provide the communications industry in North America withcritical technology services that solve the industry’s addressing,interoperability and infrastructure needs.

 

These services are now used by CSPs to manage arange of their technical and operating requirements, including:

 

•                  *Addressing.* We enable CSPs to use critical, shared addressing resources, such astelephone numbers, Internet top-level domain names, and Common Short Codes.

 

•                  *Interoperability*. We enable CSPs to exchange and share critical operating data so thatcommunications originating on one provider’s network can be delivered andreceived on the network of another CSP. We also facilitate order management andwork flow processing among CSPs.

 

16

 

•                  *Infrastructure and Other*. We enable CSPs to more efficiently managechanges in their own networks by centrally managing certain critical data theyuse to route communications over their own networks.

 

We derive a substantial portion of our annualrevenue on a transaction basis, most of which is derived from long-termcontracts.

 

Our costs and expenses consist of cost of revenue,sales and marketing, research and development, general and administrative, anddepreciation and amortization.

 

Cost of revenue includes all direct materials,direct labor, and those indirect costs related to revenue such as indirectlabor, materials and supplies. Our primary cost of revenue is related to ourinformation technology and systems department, including network costs, datacenter maintenance, database management, and data processing costs, as well aspersonnel costs associated with service implementation, product maintenance,customer deployment and customer care. We also expense costs relating todeveloping modifications and enhancements of our existing technology and services.

 

Sales and marketing expense consists of personnelcosts, advertising costs and relationship marketing costs. This expenseincludes salaries, sales commissions, sales operations and otherpersonnel-related expense, travel and related expense, trade shows, costs ofcomputer and communications equipment and support services, facilities costs,consulting fees and costs of marketing programs, such as Internet and print.Included in these classifications are product branding and packaging, marketanalysis and forecasting, stock-based compensation and customer relationshipmanagement.

 

Research and development expense consists primarilyof costs related to personnel, including salaries and other personnel-relatedexpense, consulting fees and the costs of facilities, computer and supportservices used in service and technology development.

 

General and administrative expense consistsprimarily of salaries and other personnel-related expense for our executive,administrative, legal, finance, and human resources functions, facilities,management information systems, support services, professional services fees,certain audit, tax and license fees, stock-based compensation and bad debtexpense.

 

Depreciation and amortization relates primarily toour property and equipment and includes our network infrastructure andfacilities related to our services and the amortization of identifiableintangibles.

 

**Critical Accounting Policies and Estimates**

 

The discussion and analysis of our financialcondition and results of operations are based on our consolidated financialstatements, which have been prepared in accordance with U.S. generally acceptedaccounting principles, or U.S. GAAP. The preparation of these financialstatements in accordance with U.S. GAAP requires us to utilize accountingpolicies and make certain estimates and assumptions that affect the reportedamounts of assets and liabilities, the disclosure of contingencies as of thedate of the financial statements and the reported amounts of revenue andexpense during a fiscal period. The Securities and Exchange Commissionconsiders an accounting policy to be critical if it is important to a company’sfinancial condition and results of operations, and if it requires significantjudgment and estimates on the part of management in its application. We havediscussed the selection and development of the critical accounting policieswith the audit committee of our board of directors, and the audit committee hasreviewed our related disclosures in this report. Although we believe that ourjudgments and estimates are appropriate and correct, actual results may differfrom those estimates.

 

We believe the following to be our criticalaccounting policies because they are important to the portrayal of ourfinancial condition and results of operations and they require criticalmanagement judgments and estimates about matters that are uncertain. If actualresults or events differ materially from those contemplated by us in makingthese estimates, our reported financial condition and results of operation forfuture periods could be materially affected. See “Additional Factors That May Affect Future Results” for certainmatters that may bear on our future results of operations.

 

17

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***RevenueRecognition***

 

Our revenue recognition policies are in accordancewith Securities and Exchange Commission Staff Accounting Bulletin No. 104,*Revenue Recognition*. We providethe following services pursuant to various private commercial and government contracts.

 

*Addressing.*    Our addressingservices include telephone number administration, implementing the allocationof pooled blocks of telephone numbers, and directory services for Internetdomain names and Common Short Codes. We generate revenue from our telephonenumber administration services under two government contracts. Under ourcontract to serve as the North American Numbering Plan Administrator, we earn afixed annual fee, and we recognize this fee as revenue on a straight-line basisas services are provided. In the event we estimate losses on our fixed feecontract, we recognize these losses in the period in which a loss becomesapparent. Under our contract to serve as the National Pooling Administrator, weare reimbursed for costs incurred plus a fixed fee associated withadministration of the pooling system. During the construction period completedin March 2002, we recognized revenue based on costs incurred. Thereafter,we received an award fee associated with our initial delivery of the poolingsystem, which we recognized when we were notified of the amount of the awardfee earned. We currently recognize revenue for administration of the systembased on costs incurred plus a pro rata amount of the fixed fee.

 

In addition to the administrative functionsassociated with our role as the National Pooling Administrator, we alsogenerate revenue from implementing the allocation of pooled blocks of telephonenumbers under our long-term contracts with North American PortabilityManagement, LLC, and we recognize revenue on a per transaction fee basis as theservices are performed. For our Internet domain name services, we generaterevenue for Internet domain name registrations, which generally have contractterms between one and ten years. We recognize revenue on a straight linebasis over the lives of the related customer contracts. We generate revenuesfrom our Common Short Code services under short-term contracts ranging fromthree to twelve months, and we recognize revenue on a straight line basis overthe term of the customer contracts.

 

*Interoperability.*    Our interoperabilityservices consist primarily of wireline and wireless number portability andorder management services. We generate revenue from number portability underour long-term contracts with North American Portability Management, LLC andCanadian LNP Consortium, Inc. We recognize revenue on a per transactionfee basis as the services are performed. We provide order management servicesconsisting of customer set-up and implementation followed by transactionprocessing under contracts with terms ranging from one to three years. Customerset-up and implementation is not considered a separate deliverable;accordingly, the fees are deferred and recognized as revenue on a straight-linebasis over the term of the contract. Per-transaction fees are recognized as thetransactions are processed.

 

*Infrastructure and Other.*    Our infrastructureservices consist primarily of network management and connection services. Wegenerate revenue from network management services under our long-term contractswith North American Portability Management, LLC. We recognize revenue on a pertransaction fee basis as the services are performed. In addition, we generaterevenue from connection fees and system enhancements under our contracts withNorth American Portability Management, LLC. We recognize our connection feerevenue as the service is performed. System enhancements are provided undercontracts in which we are reimbursed for costs incurred plus a fixed fee. Revenueis recognized based on costs incurred plus a pro rata amount of the fee.

 

***SignificantContracts***

 

We provide wireline and wireless number portability,implement the allocation of pooled blocks of telephone numbers and providenetwork management services pursuant to seven contracts with North AmericanPortability Management, LLC, an industry group that represents alltelecommunications service providers in the United States. We recognize revenueunder our contracts with North American Portability Management, LLC primarilyon a per-transaction basis. The aggregate fees for transactions processed underthese contracts are determined by the total number of transactions, and thesefees are billed to telecommunications service providers based on their allocableshare of the total transaction charges. This allocable share is based on eachrespective telecommunications service provider’s share of the aggregateend-user services revenues of all U.S. telecommunications service providers asdetermined by the Federal Communications Commission, or FCC. Under ourcontracts, we also bill a revenue recovery collections, or RRC, fee of apercentage of monthly billings to our customers, which is available to us if

 

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anytelecommunications service provider fails to pay its allocable share of totaltransactions charges. If the RRC fee is insufficient for that purpose, thesecontracts also provide for the recovery of such differences from the remainingtelecommunications service providers.

 

The per-transaction pricing under these contractsprovides for annual volume discounts (credits) that are earned on alltransactions in excess of the pre-determined annual volume threshold.  For 2005, the maximum aggregate volumediscount (credit) is $7.5 million which is applied via a reduction inper-transaction pricing once the pre-determined annual volume threshold hasbeen surpassed.  When the aggregatediscount (credit) has been fully satisfied, the per-transaction pricing isrestored to the prevailing contractual rate.

 

For 2003 and 2004, billings continued at theoriginal contractual rate after the annual volume threshold was surpassed.  Billings in excess of the discounted pricingwas recorded as a customer credit liability on the balance sheet with acorresponding reduction to revenue.  Inthe following year when the credit was applied to invoices rendered, thecustomer credit liability was reduced with a corresponding credit to accountsreceivable.  The annual pre-determinedvolume threshold was surpassed in the fourth quarters of 2003 and 2004resulting in the reduction of revenue and recognition of a customer creditliability of $6.0 million and $11.9 million, respectively.

 

In December 2003, these contracts were amendedto extend their expiration date from May 2006 to May 2011, and theper-transaction fee charged to our customers over the term of the contracts wasreduced.  Currently, we charge $1.08 pertransaction under these contracts.    Eachcontract provides that over the life of the contract, as pre-determinedcumulative transaction thresholds are surpassed in the region covered by thatcontract, the price per transaction will gradually decline to a minimum fee of$0.93 per transaction.  As part ofthe amendments, we agreed to retroactively apply the new transaction fee to all2003 transactions processed and granted credits totaling $16.0 million.These credits are being applied to customer invoices over a 23-month periodbeginning in January 2004. Additionally, we obtained letters of credittotaling $16.0 million in January 2004 to secure a portion of thesecustomer credits. As of December 31, 2004 and June 30, 2005,approximately $15.5 million and $7.6 million, respectively, of thesecustomer credits were outstanding. The amount of our revenue derived under ourcontracts with North American Portability Management, LLC was$69.2 million, $84.5 million, and $130.0 million for the yearsended December 31, 2002, 2003 and 2004, respectively.

 

***Service LevelStandards***

 

Pursuant to certain of our private commercialcontracts, we are subject to service level standards and to correspondingpenalties for failure to meet those standards. We record a provision for theseperformance-related penalties when incurred with a corresponding reduction ofour revenue.

 

For more information regarding how we recognizerevenue for each of our service categories, please see the discussion aboveunder “—Revenue Recognition.”

 

***Valuation ofGoodwill and Intangible Assets***

 

Previous acquisitions resulted in the recording ofgoodwill, which represents the excess of the purchase price over the fair valueof assets acquired, as well as other definite-lived intangible assets. Underpresent accounting rules (SFAS No. 142), goodwill is no longersubject to amortization; instead it is subject to new impairment testingcriteria. Other acquired definite-lived intangible assets are being amortizedover their estimated useful lives, although those with indefinite lives are notto be amortized but are tested at least annually for impairment, using a lowerof cost or fair value approach.  We testfor impairment on an annual basis or on an interim basis if circumstanceschange that would indicate the possibility of impairment. The impairment reviewmay require an analysis of future projections and assumptions about ouroperating performance. If such a review indicates that the assets are impaired,an expense would be recorded for the amount of the impairment, and thecorresponding impaired assets would be reduced in carrying value.

 

19

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***Impairment ofLong-Lived Assets***

 

In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, a review of long-lived assets for impairment isperformed when events or changes in circumstances indicate the carrying valueof such assets may not be recoverable. If an indication of impairment ispresent, we compare the estimated undiscounted future cash flows to begenerated by the asset to its carrying amount. If the undiscounted future cashflows are less than the carrying amount of the asset, we record an impairmentloss equal to the excess of the asset’s carrying amount over its fair value.The fair value is determined based on valuation techniques such as a comparisonto fair values of similar assets or using a discounted cash flow analysis.

 

***AccountsReceivable, Revenue Recovery Collections, and Allowance for Doubtful Accounts***

 

Accounts receivable are recorded at the invoicedamount and do not bear interest.  In accordancewith our contracts with North American Portability Management, LLC, we bill aRRC fee of a percentage of monthly billings to our customers. The aggregate RRCfees collected may be used to offset uncollectible receivables from anindividual customer. The RRC fees are recorded as an accrued liability whencollected. For the period January 1, 2002 through June 30, 2004, thisfee was 3% of monthly billings. On July 1, 2004, the RRC fee was reducedto 2%.  On July 1, 2005, the RRC feewas reduced to 1%.  Any accrued RRC feesin excess of uncollectible receivables are paid back to the customers annuallyon a pro rata basis. RRC fees of $4.3 million and $2.2 million areincluded in accrued expense as of December 31, 2004 and June 30,2005, respectively. All other receivables related to services not covered bythe RRC fees are evaluated and, if deemed not collectible, are either directlywritten off as a bad debt expense or reserved.

 

***Deferred IncomeTaxes***

 

We recognize deferred tax assets and liabilities basedon temporary differences between the financial reporting bases and the taxbases of assets and liabilities. These deferred tax assets and liabilities aremeasured using the enacted tax rates and laws that will be in effect when suchamounts are expected to reverse or be utilized. The realization of deferred taxassets is contingent upon the generation of future taxable income. Whenappropriate, we recognize a valuation allowance to reduce such deferred taxassets to amounts that are more likely than not to be ultimately realized. Thecalculation of deferred tax assets (including valuation allowances) andliabilities requires us to apply significant judgment related to such factorsas the application of complex tax laws, changes in tax laws and our futureoperations. We review our deferred tax assets on a quarterly basis to determineif a valuation allowance is required based upon these factors. Changes in ourassessment of the need for a valuation allowance could give rise to a change insuch allowance, potentially resulting in additional expense or benefit in theperiod of change.

 

***Stock-BasedCompensation***

 

We account for employee stock-based compensation inaccordance with the provisions of Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*(APB No. 25) and related interpretations, which require us torecognize compensation cost for the excess of the fair value of the stock atthe grant date over the exercise price, if any. An alternative method of accounting would apply the principles of SFAS No. 123,*Accounting for Stock-Based Compensation*(SFAS No. 123), which require the fair value of the stock option tobe recognized at the date of grant and amortized as compensation expense overthe stock option’s vesting period. No stock-based employee compensation costfor stock options is reflected in net income, as all options granted under theplans had an exercise price equal to the market value of the underlying commonstock on the date of grant. Stock-based compensation for non-employees isaccounted for using the fair value-based method in accordance with SFAS No. 123and EITF 96-18. See the discussion under “—Recent Accounting Pronouncements”below.

 

**Acquisitions**

 

On February 1, 2005, we acquired fiducianet, Inc.for $2.2 million in cash and the issuance of 35,745 shares of our Class B commonstock for total purchase consideration of $2.6 million. The acquisition ofFiducianet enables us to serve as a single point of contact in managing allday-to-day customer obligations involving subpoenas, court orders and

 

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lawenforcement agency requests under electronic surveillance laws including theCommunications Assistance for Law Enforcement, Patriot and Homeland SecurityActs.

 

**Current Trends Affecting Our Results of Operations**

 

We have experienced increased demand for ourclearinghouse services, which has been driven by market trends such as networkexpansion, the implementation of new technologies, subscriber growth,competitive churn, network changes and consolidations.

 

Wireless subscriber growth, new wirelessapplications, and wireless competition have driven increased demand for all ofour clearinghouse services. Additionally, as wireless service providers upgradetheir networks and technology to enable high-speed service, we anticipate thatthey will increasingly rely on our infrastructure services and that, as aresult, wireless-related transactions will remain a major contributor to ouraddressing and interoperability transaction volume growth.

 

Advancements in the communications industry, such aschanges from time division multiplexing, or TDM, to global system for mobile,or GSM, have driven increased infrastructure transactions in our clearinghouse.As the industry migrates towards next-generation technologies and applications,we anticipate that demand for our infrastructure services will increase.

 

As the communications industry has changed to meetconsumer demands and new technological advancements, consolidation among industryparticipants has increased. Consolidation requires the integration of disparatesystems and networks, which has driven increased demand for our addressing,interoperability and infrastructure services. We anticipate that futureconsolidations will continue to drive growth in our transaction volumes.

 

During the first two quarters of 2005, addressingtransactions also increased due to the emergence of IP service providers. Inparticular, VoIP service providers are rapidly expanding their operations andexperiencing an increased need for access to inventories of telephone numbers,which has driven demand for our addressing services. We expect significantgrowth in the number of addressing transactions in the remainder of 2005 and2006 as IP service providers continue to develop an inventory of telephonenumber resources.

 

To support the growth driven by the favorableindustry trends mentioned above, we continue to look for opportunities toimprove our operating efficiencies. In 2004, we initiated several programs toimprove operating efficiencies, such as the utilization of offshore technicalresources for systems engineering, implementation of new hardware and softwaretechnology in our clearinghouse, and management of process improvement teams.  We believe that these programs will continueto provide future benefits and position us to support revenue growth.

 

As a public company, we will experience increases incertain general and administrative expenses to comply with the laws andregulations applicable to public companies. These laws and regulations includethe provisions of the Sarbanes-Oxley Act of 2002 and the rules of theSecurities and Exchange Commission and the New York Stock Exchange. To complywith the corporate governance and operating requirements of being a publiccompany, we will incur increases in such items as personnel costs, professionalservices fees, fees for independent directors and the cost of directors andofficers liability insurance. We believe that these costs will approximate $3.0to $3.5 million annually.

 

In 2003 and 2004, we were able to utilize netoperating loss carryforwards and deferred tax benefits from previous years tooffset taxable income and income tax expense related to U.S. federal incometaxes. These carryforwards and deferrals were exhausted in 2004. In 2005 andfuture years, we expect our profits to be subject to U.S. federal income taxesat the statutory rates.

 

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##### **Consolidated Results of Operations**

 

***Three MonthsEnded June 30, 2004 Compared to Three Months Ended June 30, 2005***

 

The following table presents an overview of ourresults of operations for the three months ended June 30, 2004 and 2005.

 
| ** **                                                                        | ** ** | **Three Months  Ended June 30,**      | ** ** | **Three Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                                   | ** ** | **2005**                              | ** ** | **2004 vs. 2005** | ** ** |
| ** **                                                                        | ** ** | **$**                                      | ** ** | **$**                                 | ** ** | **$****Change** | ** ** | **% Change** | ** ** |
| ** **                                                                        | ** ** | **(in thousands, except per share  data)** | ** ** |
| Revenue:                                                                          |       |                                       |       |                                  |       |   |   |   |   |
| Addressing                                                                        |       | $                                          | 11,846     |                                  | $          | 18,854 |   | $ | 7,008 |   | 59.2 | % |
| Interoperability                                                                  |       | 8,482                                      |       | 13,490                                |       | 5,008 |   | 59.0 |   |
| Infrastructure  and other                                                         |       | 19,282                                     |       | 29,952                                |       | 10,670 |   | 55.3 |   |
| Total  revenue                                                                    |       | 39,610                                     |       | 62,296                                |       | 22,686 |   | 57.3 |   |
|                                                                              |       |                                       |       |                                  |       |   |   |   |   |
| Operating  expense:                                                               |       |                                       |       |                                  |       |   |   |   |   |
| Cost of  revenue (excluding depreciation and amortization shown separately below) |       | 12,066                                     |       | 15,767                                |       | 3,701 |   | 30.7 |   |
| Sales and  marketing                                                              |       | 4,836                                      |       | 7,571                                 |       | 2,735 |   | 56.6 |   |
| Research and  development                                                         |       | 1,740                                      |       | 2,878                                 |       | 1,138 |   | 65.4 |   |
| General and  administrative                                                       |       | 5,078                                      |       | 8,829                                 |       | 3,751 |   | 73.9 |   |
| Depreciation  and amortization                                                    |       | 4,304                                      |       | 3,935                                 |       | (369 | ) | (8.6 | ) |
| Restructuring  charges                                                            |       | 3⁄4                                     |       | 300                                   |       | 300 |   | 100.0 |   |
|                                                                              |       | 28,024                                     |       | 39,280                                |       | 11,256 |   | 40.2 |   |
| Income from  operations                                                           |       | 11,586                                     |       | 23,016                                |       | 11,430 |   | 98.7 |   |
| Other  (expense) income:                                                          |       |                                       |       |                                  |       |   |   |   |   |
| Interest  expense                                                                 |       | (599                                       | )          | (586                                  | )          | 13 |   | (2.2 | ) |
| Interest  income                                                                  |       | 394                                        |       | 722                                   |       | 328 |   | 83.2 |   |
| Income  before income taxes                                                       |       | 11,381                                     |       | 23,152                                |       | 11,771 |   | 103.4 |   |
| (Benefit  from) provision for income taxes                                        |       | (7,287                                     | )          | 9,269                                 |       | 16,556 |   | (227.2 | ) |
| Net income                                                                        |       | 18,668                                     |       | 13,883                                |       | (4,785 | ) | (25.6 | ) |
| Dividends on  and accretion of preferred stock                                    |       | (2,513                                     | )          | (2,170                                | )          | 343 |   | (13.6 | ) |
| Net income  attributable to common stockholders                                   |       | $                                          | 16,155     |                                  | $          | 11,713 |   | $ | (4,442 | ) | (27.5 | )% |
|                                                                              |       |                                       |       |                                  |       |   |   |   |   |
| Net income  attributable to common stockholders per common share:                 |       |                                       |       |                                  |       |   |   |   |   |
| Basic                                                                             |       | $                                          | 2.94       |                                  | $          | 1.45 |   |   |   |   |   |
| Diluted                                                                           |       | $                                          | 0.23       |                                  | $          | 0.18 |   |   |   |   |   |
|                                                                              |       |                                       |       |                                  |       |   |   |   |   |
| Weighted  average common shares outstanding:                                      |       |                                       |       |                                  |       |   |   |   |   |
| Basic                                                                             |       | 5,487                                      |       | 8,097                                 |       |   |   |   |   |
| Diluted                                                                           |       | 82,118                                     |       | 78,039                                |       |   |   |   |   |

 

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***Revenue***

 

*Total revenue.*    Total revenueincreased $22.7 million due to increases in addressing, interoperabilityand infrastructure transactions.

 

*Addressing.*    Addressing revenueincreased $7.0 million due to the growth in the number of wirelesssubscribers, the increase in new communications services being offered by ourcustomers and the continued expansion of carrier networks. In particular,revenue from pooling transactions increased $5.2 million, primarily asservice providers built inventories of telephone numbers in multiple area codesand rate centers to be able to offer them to Internet telephony users.  In addition, Common Short Codes revenueincreased $1.2 million due to an increase in the number of subscribers forCommon Short Codes, as well as an increase in the number of service providerswho carry Common Short Codes across their networks.  Revenue from our domain name servicesincreased $0.2 million due in large part to the increased number ofsubscribers.  These increases werefurther supplemented by a $0.2 million increase in telephone numberadministration fees due to increased activity under our contract to serve asthe North American Numbering Plan Administrator.

 

*Interoperability.*    Interoperabilityrevenue increased $5.0 million due to an increase in wireline and wirelesscompetition and the associated movement of end users from one CSP to another,carrier consolidation, and broader usage of our expanding service offeringssuch as enhanced order management services for wireless data and Internettelephony providers. Specifically, revenue from number portability transactionsincreased $3.1 million and revenue from our order management servicesincreased $1.7 million.

 

*Infrastructure and other.*    Infrastructure andother revenue increased $10.7 million due to an increase in the demand forour network management services. Of this amount, $8.9 million wasattributable to customers making a large number of changes to their networksthat required actions such as disconnects and modifications to networkelements. We believe these changes were driven largely by trends in theindustry, including the implementation of new technologies by our customers,such as wireless technology upgrades and network optimization.  Connection fees and other revenues increased$1.7 million due to one-time functionality improvements.

 

***Expense***

 

*Cost of revenue.*    Cost of revenueincreased $3.7 million due to growth in personnel and contractor costs tosupport higher transaction volumes.  Inparticular, personnel and employee related expense increased $3.0 million dueto increased personnel to support our customer deployment group, softwareengineering group and our operations group. Contractor costs increased $0.7 million for software maintenanceactivities and the managing of industry changes to our clearinghouse.Additionally, cost of revenue increased by $0.5 million due to royaltyexpenses related to Common Short Code services and revenue share costassociated with our Internet domain names and registry gateway services. Theseincreases were offset by a $0.5 million reduction of facilities expensesassociated with the consolidation of our Oakland facilities.  Cost of revenue as a percentage of revenuedecreased to 25.3% in the three months ended June 30, 2005, as compared to30.5% for the three months ended June 30, 2004. This decrease in cost ofrevenue as a percentage of revenue is attributable to operating efficiencies inour clearinghouse operations, which allowed us to increase the number oftransactions we processed without proportional increases in personnel costs.

 

*Sales and marketing.*    Sales and marketingexpense increased $2.7 million due to headcount additions to our sales andmarketing team to focus on branding and product launches.  In particular, personnel and employee relatedexpense increased $1.8 million, and costs related to industry events andadvertising increased $0.6 million. Sales and marketing expense as a percentageof revenue remained constant at 12.2% in the three months ended June 30,2005, as compared to the three months ended June 30, 2004.

 

*Research and development.*    Research anddevelopment expense increased $1.1 million due to the development ofInternet telephony solutions to enhance our service offerings.  Personnel and employee related costs increased$0.8 million due to increased headcount. Research and development expense as a percentage of revenue increased to4.6% in the three months ended June 30, 2005, as compared to 4.4% for thethree months ended June 30, 2004.

 

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*General and administrative.*    General andadministrative expense increased $3.8 million primarily due to costsincurred to support business growth and costs incurred in preparation forbecoming a public company.  Inparticular, personnel and employee-related expense increased $0.4 million,and we recorded $3.4 million of offering costs related to our initial publicoffering and other IPO-related expense, which includes legal, accounting andconsulting fees.  General andadministrative expense as a percentage of revenue increased to 14.2% in thethree months ended June 30, 2005, as compared to 12.8% for the threemonths ended June 30, 2004.

 

*Depreciation and amortization.*    Depreciation andamortization expense decreased $0.4 million due to the expiration ofcertain capital leases and a change in the useful life estimate in June 2004of certain acquired intangibles. Depreciation and amortization expense as apercentage of revenue decreased to 6.3% for the three months ended June 30,2005, as compared to 10.9% for the three months ended June 30, 2004.

 

*Restructuring charges.*    During the threemonths ended June 30, 2005, we recorded a restructuring liability of $0.3million for the closure of our facility in Oakland, CA.  There was no similar expense for the threemonths ended June 30, 2004.

 

*Interest expense.*    Interest expenseremained relatively consistent during the three months ended June 30, 2005as compared to the three months ended June 30, 2004.  Interest expense as a percentage of revenuedecreased to 0.9% in the three months ended June 30, 2005, as compared to1.5% for the three months ended June 30, 2004.

 

*Interest income.*    Interest incomeincreased $0.3 million due to higher average cash balances.  Interest income as a percentage of revenueincreased to 1.2% in the three months ended June 30, 2005, as compared to1.0% for the three months ended June 30, 2004.

 

*(Benefit from)  provision for income taxes.*    Income tax provisionincreased $16.6 million to $9.3 million to reflect the expected 2005 effectivetax rate.  For the three months ended June 30,2004 we recorded an income tax benefit of $7.3 million related to the one-timereversal of a deferred tax asset valuation allowance.  Provision for income taxes as a percentage ofrevenue increased to 14.9% for the three months ended June 30, 2005compared to (18.4%) for the three months ended June 30, 2004.

 

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***Six Months Ended June 30,2004 Compared to Six Months Ended June 30, 2005***

 

The following table presents an overview of ourresults of operations for the six months ended June 30, 2004 and 2005.

 
| ** **                                                                        | ** ** | **Six Months Ended  June 30,**        | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                                   | ** ** | **2005**                            | ** ** | **2004 vs. 2005** | ** ** |
| ** **                                                                        | ** ** | **$**                                      | ** ** | **$**                               | ** ** | **$****Change** | ** ** | **% Change** | ** ** |
| ** **                                                                        | ** ** | **(in thousands, except per share  data)** | ** ** |
| Revenue:                                                                          |       |                                       |       |                                |       |   |   |   |   |
| Addressing                                                                        |       | $                                          | 23,806     |                                | $          | 38,575 |   | $ | 14,769 |   | 62.0 | % |
| Interoperability                                                                  |       | 16,089                                     |       | 26,577                              |       | 10,488 |   | 65.2 |   |
| Infrastructure  and other                                                         |       | 38,429                                     |       | 54,936                              |       | 16,507 |   | 43.0 |   |
| Total  revenue:                                                                   |       | 78,324                                     |       | 120,088                             |       | 41,764 |   | 53.3 |   |
|                                                                              |       |                                       |       |                                |       |   |   |   |   |
| Operating  expense:                                                               |       |                                       |       |                                |       |   |   |   |   |
| Cost of  revenue (excluding depreciation and amortization shown separately below) |       | 22,536                                     |       | 29,030                              |       | 6,494 |   | 28.8 |   |
| Sales and  marketing                                                              |       | 8,982                                      |       | 14,589                              |       | 5,607 |   | 62.4 |   |
| Research and  development                                                         |       | 3,471                                      |       | 5,448                               |       | 1,977 |   | 57.0 |   |
| General and  administrative                                                       |       | 8,471                                      |       | 16,419                              |       | 7,948 |   | 93.8 |   |
| Depreciation  and amortization                                                    |       | 9,224                                      |       | 7,517                               |       | (1,707 | ) | (18.5 | ) |
| Restructuring  (recoveries)                                                       |       | 3⁄4                                     |       | (406                                | )          | (406 | ) | (100.0 | ) |
|                                                                              |       | 52,684                                     |       | 72,597                              |       | 19,913 |   | 37.8 |   |
| Income from  operations                                                           |       | 25,640                                     |       | 47,491                              |       | 21,851 |   | 85.2 |   |
| Other (expense)  income:                                                          |       |                                       |       |                                |       |   |   |   |   |
| Interest  expense                                                                 |       | (1,346                                     | )          | (1,212                              | )          | 134 |   | 10.0 |   |
| Interest  income                                                                  |       | 720                                        |       | 1,197                               |       | 477 |   | 66.3 |   |
| Income  before income taxes                                                       |       | 25,014                                     |       | 47,476                              |       | 22,462 |   | 89.8 |   |
| (Benefit  from) provision for income taxes                                        |       | (7,187                                     | )          | 18,962                              |       | 26,149 |   | (363.8 | ) |
| Net income                                                                        |       | 32,201                                     |       | 28,514                              |       | (3,687 | ) | (11.4 | ) |
| Dividends on  and accretion of preferred stock                                    |       | (4,990                                     | )          | (4,313                              | )          | 677 |   | (13.6 | ) |
| Net income  attributable to common stockholders                                   |       | $                                          | 27,211     |                                | $          | 24,201 |   | $ | (3,010 | ) | (11.1 | )% |
|                                                                              |       |                                       |       |                                |       |   |   |   |   |
| Net income  attributable to common stockholders per common share:                 |       |                                       |       |                                |       |   |   |   |   |
| Basic                                                                             |       | $                                          | 5.02       |                                | $          | 3.43 |   |   |   |   |   |
| Diluted                                                                           |       | $                                          | 0.40       |                                | $          | 0.37 |   |   |   |   |   |
|                                                                              |       |                                       |       |                                |       |   |   |   |   |
| Weighted  average common shares outstanding:                                      |       |                                       |       |                                |       |   |   |   |   |
| Basic                                                                             |       | 5,421                                      |       | 7,055                               |       |   |   |   |   |
| Diluted                                                                           |       | 80,922                                     |       | 76,502                              |       |   |   |   |   |

 

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***Revenue***

 

*Total revenue.*    Total revenueincreased $41.8 million due to increases in addressing, interoperabilityand infrastructure transactions.

 

*Addressing.*    Addressing revenueincreased $14.8 million due to the growth in the number of wirelesssubscribers, the increase in new communications services being offered by ourcustomers, the continued consolidation of industry participants and thecontinued expansion of carrier networks.  In particular, revenue from poolingtransactions increased $12.1 million, primarily as service providers builtinventories of telephone numbers in multiple area codes and rate centers to beable to offer them to Internet telephony users. Carrier consolidation also required the use of our pooling services toreallocate pooled blocks of telephone numbers to new network addresses withinconsolidated networks.  In addition,Common Short Codes revenue increased $2.1 million due to an increase inthe number of subscribers for Common Short Codes, as well as an increase in thenumber of service providers who carry Common Short Codes across theirnetworks.    Revenue from our domain nameservices increased $0.7 million due in large part to the increased numberof subscribers.  These increases wereoffset by a reduction of $0.4 million in telephone number administrationfees due to reduced activity under our contract to serve as the North AmericanNumbering Plan Administrator for the six months ended June 30, 2005, whichwas partially offset by increased activity under our contract to serve as theNational Pooling Administrator during the three months ended June 30,2005.

 

*Interoperability.*    Interoperabilityrevenue increased $10.5 million due to an increase in wireline andwireless competition and the associated movement of end users from one CSP toanother, carrier consolidation, and broader usage of our expanding serviceofferings such as enhanced order management services for wireless data andInternet telephony providers. Specifically, revenue from number portabilitytransactions increased $6.3 million and revenue from our order managementservices increased $3.9 million.

 

*Infrastructure and other.*    Infrastructure andother revenue increased $16.5 million due primarily to an increase in thedemand for our network management services. Of this amount, $13.9 millionwas attributable to customers making a large number of changes to theirnetworks that required actions such as disconnects and modifications to networkelements.  We believe these changes weredriven largely by trends in the industry, including the implementation of newtechnologies by our customers, such as wireless technology upgrades and networkoptimization.  Connection fees and otherrevenues increased $2.5 million due to one-time functionality improvements andnew service offerings.

 

***Expense***

 

*Cost of revenue.*    Cost of revenueincreased $6.5 million due to growth in personnel and contractor costs tosupport higher transaction volumes. In particular, personnel and employeerelated expense increased $4.8 million due to increased personnel to supportour customer deployment group, software engineering group and our operationsgroup.  Contractor costs increased $1.4 millionfor software maintenance activities and the managing of industry changes to ourclearinghouse. Additionally, cost of revenue increased by $0.8 million dueto royalty expense related to Common Short Code services and revenue share costassociated with our Internet domain names and registry gateway services.  These increases were offset by a $0.5 millionreduction in facilities expense associated with the consolidation of ourOakland facilities.  Cost of revenue as apercentage of revenue decreased to 24.2% in the six months ended June 30,2005, as compared to 28.8% for the six months ended June 30, 2004. Thisdecrease in cost of revenue as a percentage of revenue is attributable tooperating efficiencies in our clearinghouse operations, which allowed us toincrease the number of transactions we processed without proportional increasesin personnel costs.

 

*Sales and marketing.*    Sales and marketingexpense increased $5.6 million due in large part to headcount additions toour sales and marketing team to focus on branding and product launches and therecording of stock-based compensation expense for non-employee optiongrants.  In particular, personnel andemployee related expenses, including stock-based compensation expense,increased $4.3 million due primarily to the acceleration of vesting on variousnon-employee stock options, and costs related to industry events andadvertising increased $0.6 million. Sales and marketing expense as a percentage of revenue increased to12.1% in the six months ended June 30, 2005, as compared to 11.5% for thesix months ended June 30, 2004.

 

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*Research and development.*    Research anddevelopment expense increased $2.0 million due to the development ofInternet telephony solutions to enhance our service offerings.  Personnel and employee related costsincreased $1.6 million due to increased headcount.  Research and development expense as apercentage of revenue increased to 4.5% in the six months ended June 30,2005, as compared to 4.4% for the six months ended June 30, 2004.

 

*General and administrative.*    General andadministrative expense increased $7.9 million primarily due to costs incurredto support business growth and costs incurred in preparation for becoming apublic company, as well as the recording of stock-based compensation expensefor non-employee stock option grants.  Inparticular, personnel and employee related expense, including stock-basedcompensation expense, increased $2.0 million due primarily to the accelerationof vesting on various non-employee stock options, and legal and accounting feesincreased $1.0 million.  Inaddition, we recorded $4.9 million of offering costs related to our initialpublic offering and other IPO-related expense, which includes legal, accountingand consulting fees.  General andadministrative expense as a percentage of revenue increased to 13.7% in the sixmonths ended June 30, 2005, as compared to 10.8% for the six months ended June 30,2004.

 

*Depreciation and amortization.*    Depreciation andamortization expense decreased $1.7 million due to the expiration ofcertain capital leases and a change in the useful life estimate in June 2004of certain acquired intangibles. Depreciation and amortization expense as apercentage of revenue decreased to 6.3% for the six months ended June 30,2005, as compared to 11.8% for the six months ended June 30, 2004.

 

*Restructuring charges(recoveries).*    Duringthe six months ended June 30, 2005, we recorded a restructuring liabilityof $0.3 million for the closure of our facility in Oakland, CA.  During the six months ended June 30,2005, we recorded a net restructuring recovery of $0.7 million after enteringinto a sub-lease for our leased property in Chicago because that sub-lease hadmore favorable rates than originally assumed when we recorded a restructuringliability in 2002 for the closure of excess facilities.

 

*Interest expense.*    Interest expensedecreased $0.1 million as a result of lower interest charges onoutstanding notes as principal was reduced, as well as a decrease in the numberof capital leases. Interest expense as a percentage of revenue decreased to1.0% in the six months ended June 30, 2005, as compared to 1.7% for thesix months ended June 30, 2004.

 

*Interest income.*    Interest incomeincreased $0.5 million due to higher average cash balances. Interestincome as a percentage of revenue increased to 1.0% in the six months ended June 30,2005, as compared to 0.9% for the six months ended June 30, 2004.

 

*(Benefit from) provision forincome taxes.*    Incometax provision increased $26.1 million to reflect the expected 2005 effectivetax rate. For the six months ended June 30, 2004 we recorded an income taxbenefit of $7.2 million related to the one-time reversal of a deferred taxasset valuation allowance. Provision for income taxes as a percentage ofrevenue increased to 15.8% for the six months ended June 30, 2005 comparedto (9.2%) for the six months ended June 30, 2004.

 

**Liquidity and Capital Resources**

 

Our principal source of liquidity has been cashprovided by operations.  Our principaluses of cash have been to fund facility expansions, capital expenditures,acquisitions, working capital, dividend payouts on preferred stock, and debtservice requirements.  We anticipate thatour principal uses of cash in the future will be facility expansion, capitalexpenditures, acquisitions and working capital.

 

Total cash and cash equivalents and short-terminvestments were $81.2 million at June 30, 2005, compared to$75.6 million at March 31, 2005. As of June 30, 2005, we had $4.8 million available under therevolving loan commitment of our bank credit facility, subject to the terms andconditions of that facility.

 

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We believe that our existing cash and cash equivalents,short-term investments and cash from operations will be sufficient to fund ouroperations for the next twelve months.

 

Prior to the recapitalization effected in connectionwith our initial public offering, we paid accrued and unpaid dividends on our preferredshares of approximately $6.3 million. On June 28, 2005, all of the preferred stock was converted intocommon stock, and no dividends are currently accruing.  We have paid or expect to pay offering costs,excluding underwriting discounts and commissions, and other IPO-relatedexpenses totaling $4.9 million in connection with our initial public offering.

 

**Discussion of Cash Flows**

 

***Cash flows from operations***

 

Net cash provided by operating activities for thesix months ended June 30, 2005 was $36.2 million, as compared to$26.8 million for the six months ended June 30, 2004.  This $9.4 million increase in net cashprovided by operating activities was principally the result of increasedtransactions across all of our service offerings.

 

***Cash flows from investing***

 

Net cash used in investing activities was$30.9 million for the six months ended June 30, 2005 compared to$30.8 million for the six months ended June 30, 2004.  This $0.1 million increase in net cashused in investing activities was principally due to the increase in purchasesof property and equipment of $2.2 million and the purchase of a businessfor $2.2 million, which increase was offset by a reduction in purchases ofshort-term investments of $4.4 million.

 

***Cash flows from financing***

 

Net cash used in financing activities was$9.4 million for the six months ended June 30, 2005 compared to$20.9 million for the six months ended June 30, 2004.  This $11.5 million decrease in net cashused in financing activities was principally the result of required letters ofcredit relating to our December 2003 contract amendments with NorthAmerican Portability Management, LLC, and the repayment of notes payable andcapital leases.

 

**Recent Accounting Pronouncements**

 

On December 16, 2004, the FASB issued Statementof Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*(SFAS No. 123(R)), which is a revision of SFAS No. 123. SFAS No. 123(R)supersedes APB No. 25, and amends SFAS No. 95, *Statement of Cash Flows*. Generallythe approach in SFAS No. 123(R) is similar to the approach describedin SFAS No. 123. However, SFAS No. 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the statement of operations based on their fair values. Proforma disclosure is no longer an alternative upon adopting SFAS No. 123(R).In April 2005, the Securities and Exchange Commission amended thecompliance dates for SFAS No. 123(R) from fiscal periods beginningafter June 15, 2005 to fiscal years beginning after June 15,2005.  We will continue to account forshare-based compensation using the intrinsic value method set forth in APB No. 25until adoption of SFAS No. 123(R) on January 1, 2006.

 

SFAS No. 123(R) permits public companiesto adopt its requirements using one of two methods:

 

•                  A“modified prospective” method in which compensation cost is recognizedbeginning with the effective date (a) based on the requirements of SFAS No. 123(R)for all share-based payments granted after the effective date and (b) basedon the requirements of SFAS No. 123(R) for all awards granted to employeesprior to the effective date of SFASNo. 123(R) that remain unvested on the effective date.

 

•                  A“prospective” method, which includes the requirements of the modifiedprospective method described above, but also permits entities to restate basedon the amounts previously recognized under SFAS No. 123 for purposes ofpro forma disclosures either (a) all prior periods presented or (b) priorinterim periods of the year of adoption.

 

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We plan to adopt SFAS No. 123(R) using themodified prospective method on January 1, 2006.

 

**Off-Balance Sheet Arrangements**

 

We had no off-balance sheet arrangements as of June 30,2005.

 

**Additional Factors That May Affect Future Results**

 

The following risk factors and other informationincluded in this quarterly report should be carefully considered. The risks anduncertainties described below are not the only ones we face.  Additional risks and uncertainties notpresently known to us or that we currently deem immaterial also may impair ourbusiness operations.  If any of thefollowing risks occur, our business, financial condition, operating results,and cash flows could be materially adversely affected.

 

***Risks Related to Our Business***

 

***Failures or interruptions of ourclearinghouse could materially harm our revenues and impair our ability toconduct our operations.***

 

We provide addressing, interoperability andinfrastructure services that are critical to the operations of ourcustomers.  Notably, our clearinghouse isessential to the orderly operation of the national telecommunications systembecause it enables CSPs to ensure that telephone calls are routed to theappropriate destinations.  Our systemarchitecture is integral to our ability to process a high volume oftransactions in a timely and effective manner. We could experience failures or interruptions of our systems andservices, or other problems in connection with our operations, as a result of:

 

•                  damageto or failure of our computer software or hardware or our connections andoutsourced service arrangements with third parties;

 

•                  errorsin the processing of data by our system;

 

•                  computerviruses or software defects;

 

•                  physicalor electronic break-ins, sabotage, intentional acts of vandalism and similarevents;

 

•                  increasedcapacity demands or changes in systems requirements of our customers; or

 

•                  errorsby our employees or third-party service providers.

 

If we cannot adequately protect the ability of ourclearinghouse to perform consistently at a high level or otherwise fail to meetour customers’ expectations:

 

•                  wemay experience damage to our reputation, which may adversely affect our abilityto attract or retain customers for our existing services, and may also make itmore difficult for us to market our services;

 

•                  wemay be subject to significant damages claims, under our contracts or otherwise,including the requirement to pay substantial penalties related to service levelrequirements in our contracts;

 

•                  ouroperating expenses or capital expenditures may increase as a result ofcorrective efforts that we must perform;

 

•                  ourcustomers may postpone or cancel subsequently scheduled work or reduce theiruse of our services; or

 

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•                  oneor more of our significant contracts may be terminated early, or may not berenewed.

 

Any of these consequences would adversely affect ourrevenues and performance.

 

***Security breaches could result in aninterruption of service or reduced quality of service, which could increase ourcosts or result in a reduction in the use of our services by our customers.***

 

Our systems may be vulnerable to physical break-ins,computer viruses, attacks by computer hackers or similar disruptiveproblems.  If unauthorized users gainaccess to our databases, they may be able to steal, publish, delete or modifysensitive information that is stored or transmitted on our networks and that weare required by our contracts and FCC rules to keep confidential.  A security or privacy breach could result inan interruption of service or reduced quality of service and we may be requiredto make significant expenditures in connection with corrective efforts we arerequired to perform.  In addition, asecurity or privacy breach may harm our reputation and cause our customers toreduce their use of our services, which could harm our revenues and businessprospects.

 

***The loss of, or damage to, a datacenter could interrupt our operations and materially harm our revenues andgrowth.***

 

Because telecommunications service providers mustquery a copy of our continuously updated databases to route virtually everytelephone call in North America, the integrity of our data centers is essentialto our business.  We may not havesufficient redundant systems or back up facilities to allow us to receive andprocess data in the event of a loss of, or damage to, a data center.  We could lose, or suffer damage to, a datacenter in the event of power loss, natural disasters such as fires,earthquakes, floods and tornadoes, telecommunications failures, such astransmission cable cuts, or other similar events that could adversely affectour customers’ ability to access our clearinghouse.  We may be required to make significantexpenditures to repair or replace a data center.  Any interruption to our operations due to theloss of, or damage to, a data center could harm our reputation and cause ourcustomers to reduce their use of our services, which could harm our revenuesand business prospects.

 

***The failure of the third-partysoftware and equipment we use in our clearinghouse could cause interruptions orfailures of our systems.***

 

We incorporate hardware, software and equipmentdeveloped by third parties in our clearinghouse.  Our third-party vendors include, amongothers, International Business Machines Corporation, or IBM, and OracleCorporation for database systems and software, and EMC Corporation andHewlett-Packard Company for equipment. As a result, our ability to provide clearinghouse services depends inpart on the continued performance and support of the third-party products onwhich we rely.  If these productsexperience failures or have defects and the third parties that supply theproducts fail to provide adequate support, this could result in or exacerbatean interruption or failure of our systems or services.

 

***Our seven contracts with NorthAmerican Portability Management, LLC represent in the aggregate a substantialportion of our revenues, are not exclusive and could be terminated or modifiedin ways unfavorable to us, and we may be unable to renew these contracts at theend of their term.***

 

Our seven contracts with North American PortabilityManagement, LLC, an industry group that represents all telecommunicationsservice providers in the United States, to provide telephone number portabilityand other clearinghouse services are not exclusive and could be terminated ormodified in ways unfavorable to us.  Theseseven separate contracts, each of which represented between 8.2% and 14.0% ofour total revenues in 2004, represented in the aggregate approximately 73.1% ofour total revenues in 2004.  NorthAmerican Portability Management, LLC could, at any time, solicit or receiveproposals from other providers to provide services that are the same as orsimilar to ours.  In addition, thesecontracts have finite terms and are currently scheduled to expire in May 2011.  Furthermore, any of these contracts could beterminated in advance of its scheduled expiration date in limitedcircumstances, most notably if we are in default of these agreements.  Although these contracts do not contain crossdefault provisions, conditions leading to a default by us under one of our contractscould lead to a default under others, or all seven.

 

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We may be unable to renew these contracts onacceptable terms when they are being considered for renewal if we fail to meetour customers’ expectations, including for performance and other reasons, or ifanother provider offers to provide the same or similar services at a lowercost.  In addition, competitive forcesresulting from the possible entrance of a competitive provider could createsignificant pricing pressure, which could then cause us to reduce the sellingprice of our services under our contracts. If these contracts are terminated or modified in a manner that isadverse to us, or if we are unable to renew these contracts on acceptable termsupon their expiration, it would have a material adverse effect on our business,prospects, financial condition and results of operations.

 

***Our contracts with North AmericanPortability Management, LLC contain provisions that may restrict our ability touse data that we administer in our clearinghouse, which may limit our abilityto offer services that we currently, or intend to, offer.***

 

In addition to offering telephone number portabilityand other clearinghouse services under our contracts with North AmericanPortability Management, LLC, some of our service offerings not related to thesecontracts require that we use certain data from our clearinghouse.  We have been informed by North AmericanPortability Management, LLC that they believe that use of this data, which isunrelated to our performance under these contracts, may not be permissibleunder the current agreements.  Althoughin 2004 less than 1% of our revenues came from the provision of these unrelatedservices, if we are subject to adverse terms of access or not permitted to usethis data, our ability to offer new services requiring the use of this data maybe limited.

 

***Certain of our other contracts maybe terminated or we may be unable to renew these contracts, which may reducethe number of services we can offer and damage our reputation.***

 

In addition to our contracts with North AmericanPortability Management, LLC, we rely on other contracts to provide some of theservices that we offer, including the contracts that appoint us to serve asthe:

 

•                  NorthAmerican Numbering Plan Administrator, under which we maintain theauthoritative database of telephone numbering resources in North America;

 

•                  NationalPooling Administrator, under which we perform the administrative functionsassociated with the administration and management of telephone number inventoryand allocation of pooled blocks of unassigned telephone numbers;

 

•                  providerof number portability services in Canada;

 

•                  operatorof the .us registry; and

 

•                  operatorof the .biz registry.

 

Each of these contracts provides for earlytermination in limited circumstances, most notably if we are in default. Inaddition, our contracts to serve as the North American Numbering PlanAdministrator and as the National Pooling Administrator and to operate the .usregistry, each of which is with the U.S. government, may be terminated by thegovernment at will.  If we fail to meetthe expectations of the FCC, the U.S. Department of Commerce or our customers,as the case may be, for any reason, including for performance-related or otherreasons, or if another provider offers to perform the same or similar servicesfor a lower price, we may be unable to extend or renew these contracts.  In that event, the number of services we areable to offer may be reduced, which would adversely affect our revenues fromthe provision of these services.  Inaddition, although these contracts in the aggregate constituted less than 9.7%of our revenues in 2004, and no single one of these contracts constituted morethan 6.1% of our revenues, each of these contracts establishes us as the soleprovider of the particular services covered by that contract during itsterm.  If one of these contracts wereterminated, or if we were unable to renew or extend the term of any particularcontract, we would no longer be able to provide the services covered by thatcontract and could suffer a loss of prestige that would make it more difficultfor us to compete for contracts to provide similar services in the future.

 

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***Failure to comply with neutralityrequirements could result in loss of significant contracts.***

 

Pursuant to orders and regulations of the U.S.government and provisions contained in our material contracts, we must continueto comply with certain neutrality requirements, meaning generally that wecannot favor any particular telecommunications service provider,telecommunications industry segment or technology or group oftelecommunications consumers over any other telecommunications serviceprovider, industry segment, technology or group of consumers in the conduct ofour business.  The FCC oversees ourcompliance with the neutrality requirements applicable to us in connection withsome of the services we provide.  Weprovide to the FCC and the North American Numbering Council, a federal advisorycommittee established by the FCC to advise and make recommendations ontelephone numbering issues, regular certifications relating to our compliancewith these requirements.  Our ability tocomply with the neutrality requirements to which we are subject may be affectedby the activities of our stockholders or other parties.  For example, if the ownership of our capitalstock subjects us to undue influence by parties with a vested interest in theoutcome of numbering administration, the FCC could determine that we are not incompliance with our neutrality obligations. Our failure to continue to comply with the neutrality requirements towhich we are subject under applicable orders and regulations of the U.S.government and commercial contracts may result in fines, corrective measures ortermination of our contracts, any one of which could have a material adverseeffect on our results of operations.

 

***Regulatory and statutory changesthat affect us or the communications industry in general may increase our costsor impair our growth.***

 

The FCC has regulatory authority over certainaspects of our operations, most notably our compliance with our neutralityrequirements.  We are also affected bybusiness risks specific to the regulated communications industry. Moreover, thebusiness of our customers is subject to regulation that indirectly affects ourbusiness.  As communications technologiesand the communications industry continue to evolve, the statutes governing thecommunications industry or the regulatory policies of the FCC may change.  If this were to occur, the demand for ourclearinghouse services could change in ways that we cannot easily predict andour revenues could decline.  These risksinclude the ability of the federal government, most notably the FCC, to:

 

•                  increaseregulatory oversight over the services we provide;

 

•                  adoptor modify statutes, regulations, policies, procedures or programs that aredisadvantageous to the services we provide, or that are inconsistent with ourcurrent or future plans, or that require modification of the terms of ourexisting contracts;

 

•                  prohibitus from entering into new contracts or extending existing contracts to provideservices to the communications industry based on actual or suspected violationsof our neutrality requirements, business performance concerns, or otherreasons;

 

•                  adoptor modify statutes, regulations, policies, procedures or programs in a way thatcould cause changes to our operations or costs or the operations of our customers;

 

•                  appoint,or cause others to appoint, substitute or add additional parties to perform theservices that we currently provide; and

 

•                  prohibitor restrict the provision or export of new or expanded services under ourcontracts, or prevent the introduction of other services not under thecontracts based upon restrictions within the contracts or in FCC policies.

 

In addition, we are subject to risks arising out ofthe delegation of the Department of Commerce’s responsibilities for the domainname system to the International Corporation for Assigned Names and Numbers, orICANN. Changes in the regulations or statutes to which our customers aresubject could cause our customers to alter or decrease the services theypurchase from us.  We cannot predict when,or upon what terms and conditions, further regulation or deregulation mightoccur or the effect future regulation or deregulation may have on our business.

 

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***If we do not adapt to rapidtechnological change in the communications industry, we could lose customers ormarket share.***

 

Our industry is characterized by rapid technologicalchange and frequent new service offerings. Significant technological changes could make our technology and servicesobsolete.  We must adapt to our rapidlychanging market by continually improving the features, functionality,reliability and responsiveness of our addressing, interoperability andinfrastructure services, and by developing new features, services andapplications to meet changing customer needs. We cannot ensure that we will be able to adapt to these challenges orrespond successfully or in a cost-effective way.  Our failure to do so would adversely affectour ability to compete and retain customers or market share.  Although we currently provide our servicesprimarily to traditional telecommunications companies, many existing andemerging companies are providing, or propose to provide, IP-based voiceservices.  Our future revenues andprofits will depend, in part, on our ability to provide services to IP-basedservice providers.

 

***The market for certain of ouraddressing, interoperability, and infrastructure services is competitive, whichcould result in fewer customer orders, reduced revenues or margins or loss ofmarket share.***

 

Our services most frequently compete against thelegacy in-house systems of our customers. In addition, although we are not a telecommunications service provider,we compete in some areas against communications service companies, communicationssoftware companies and system integrators that provide systems and servicesused by CSPs to manage their networks and internal operations in connectionwith telephone number portability and other telecommunications transactions.  We face competition from large, well-fundedproviders of addressing, interoperability and infrastructure services.  Moreover, we are aware of other companiesthat are focusing significant resources on developing and marketing servicesthat will compete with us.  We anticipatecontinued growth of competition.  Some ofour current and potential competitors have significantly more employees andgreater financial, technical, marketing and other resources than we have.  Our competitors may be able to respond morequickly to new or emerging technologies and changes in customer requirementsthan we can.  Also, many of our currentand potential competitors have greater name recognition that they can use totheir advantage.  Increased competitioncould result in fewer customer orders, reduced revenues, reduced gross marginsand loss of market share, any of which could harm our business.

 

***Our failure to achieve or sustainmarket acceptance at desired pricing levels could impact our ability tomaintain profitability or positive cash flow.***

 

Our competitors and customers may cause us to reducethe prices we charge for services.  Theprimary sources of pricing pressure include:

 

•                  competitorsoffering our customers services at reduced prices, or bundling and pricingservices in a manner that makes it difficult for us to compete.  For example, a competing provider ofinteroperability services might offer its services at lower rates than we do,or a competing domain name registry provider may reduce its prices for domainname registration;

 

•                  customerswith a significant volume of transactions may have enhanced leverage in pricingnegotiations with us; and

 

•                  ifour prices are too high, potential customers may find it economicallyadvantageous to handle certain functions internally instead of using us.

 

Wemay not be able to offset the effects of any price reductions by increasing thenumber of transactions we handle or the number of customers we serve, bygenerating higher revenues from enhanced services or by reducing our costs.

 

***A decline in the volume oftransactions we handle could have a material adverse effect on our results ofoperations.***

 

We earn revenues for the vast majority of theservices that we provide on a per transaction basis.  There are no minimum revenue requirements inour contracts, which means that there is no limit to the potential adverseeffect on our revenues from a decrease in our transaction volumes.  As a result, if industry participants reducetheir usage of

 

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ourservices from their current levels, our revenues and results of operations willsuffer.  For example, if customer churnbetween CSPs in the industry stabilizes, or if CSPs do not compete vigorouslyto lure customers away from their competitors, use of our telephone numberportability and other services may decline. In addition, if CSPs develop internal systems to address theirinfrastructure needs, or if the cost of such transactions makes it impracticalfor a given carrier to use our services for these purposes, we may experience areduction in transaction volumes. Finally, the trends that we believe will drive the future demand for ourclearinghouse services, such as the emergence of IP services, growth ofwireless services, consolidation in the industry, and pressure on carriers toreduce costs, may not actually result in increased demand for our services,which would harm our future revenues and growth prospects.

 

***If we are unable to manage ourgrowth, our revenues and profits could be adversely affected.***

 

Sustaining our growth has placed significant demandson our management as well as on our administrative, operational and financialresources.  For us to continue to manageour growth, we must continue to improve our operational, financial andmanagement information systems and expand, motivate and manage ourworkforce.  If we are unable tosuccessfully manage our growth without compromising our quality of service andour profit margins, or if new systems that we implement to assist in managingour growth do not produce the expected benefits, our revenues and profits couldbe adversely affected.

 

***We may be unable to completesuitable acquisitions, or we may undertake acquisitions that could increase ourcosts or liabilities or be disruptive to our business.***

 

One of our strategies is to pursue acquisitionsselectively.  Although we do notcurrently have any commitments, contracts or understandings to acquire anyspecific businesses or other material operations, we have made a number ofacquisitions in the past and will consider other acquisitions in thefuture.  We may not be able to locatesuitable acquisition candidates at prices that we consider appropriate or tofinance acquisitions on terms that are satisfactory to us.  If we do identify an appropriate acquisitioncandidate, we may not be able to successfully negotiate the terms of anacquisition, finance the acquisition or, if the acquisition occurs, integratethe acquired business into our existing business.  Acquisitions of businesses or other materialoperations may require additional debt or equity financing, resulting inadditional leverage or dilution of ownership. Integration of acquired business operations could disrupt our businessby diverting management away from day-to-day operations.  The difficulties of integration may beincreased by the necessity of coordinating geographically dispersedorganizations, integrating personnel with disparate business backgrounds andcombining different corporate cultures. We also may not realize cost efficiencies or synergies or other benefitsthat we anticipated when selecting our acquisition candidates.  In addition, we may need to record writedowns from future impairments of intangible assets, which could reduce our futurereported earnings.  At times, acquisitioncandidates may have liabilities, neutrality-related risks or adverse operatingissues that we fail to discover through due diligence prior to theacquisition.  The failure to discoversuch issues prior to such acquisition could have a material adverse effect onour business and results of operations.

 

***Our potential expansion intointernational markets may be subject to uncertainties that could increase ourcosts to comply with regulatory requirements in foreign jurisdictions, disruptour operations, and require increased focus from our management.***

 

Our growth strategy could involve the growth of ouroperations in foreign jurisdictions. International operations and business expansion plans are subject tonumerous additional risks, including economic and political risks in foreignjurisdictions in which we operate or seek to operate, the difficulty ofenforcing contracts and collecting receivables through some foreign legalsystems, unexpected changes in regulatory requirements and the difficulties associatedwith managing a large organization spread throughout various countries.  If we continue to expand our businessglobally, our success will depend, in large part, on our ability to anticipateand effectively manage these and other risks associated with our internationaloperations.  However, any of thesefactors could adversely affect our international operations and, consequently,our operating results.

 

***We may need additional capital inthe future and it may not be available on acceptable terms.***

 

We have historically relied on outside financing andcash flow from operations to fund our operations, capital expenditures andexpansion.  However, we may requireadditional capital in the future to fund our operations, finance investments inequipment or infrastructure, or respond to competitive pressures or strategicopportunities.

 

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Wecannot assure you that additional financing will be available on termsfavorable to us, or at all.  In addition,the terms of available financing may place limits on our financial andoperating flexibility.  If we are unableto obtain sufficient capital in the future, we may face the following risks:

 

•                  wemay not be able to continue to meet customer demand for service quality,availability and competitive pricing;

 

•                  wemay be forced to reduce our operations;

 

•                  wemay not be able to expand or acquire complementary businesses; and

 

•                  wemay not be able to develop new services or otherwise respond to changingbusiness conditions or competitive pressures.

 

***Our senior management is importantto our customer relationships, and the loss of one or more of our seniormanagers could have a negative impact on our business.***

 

We believe that our success depends in part on thecontinued contributions of our Chief Executive Officer, Jeffrey Ganek, andother members of our senior management. We rely on our executive officers and senior management to generatebusiness and execute programs successfully. In addition, the relationships and reputation that members of ourmanagement team have established and maintain with our customers and ourregulators contribute to our ability to maintain good customer relations.  Although we may enter into employment contractswith some of our executive officers, nothing will prevent those officers fromterminating their employment.  The lossof Jeffrey Ganek or any other members of senior management could impair ourability to identify and secure new contracts and otherwise to manage ourbusiness.

 

***We must recruit and retain skilledemployees to succeed in our business, and our failure to recruit and retainqualified employees could harm our ability to maintain and grow our business.***

 

We believe that an integral part of our success isour ability to recruit and retain employees who have advanced skills in theaddressing, interoperability and infrastructure services that we provide andwho work well with our customers in the regulated environment in which weoperate. In particular, we must hire and retain employees with the technicalexpertise and industry knowledge necessary to maintain and continue to developour operations and must effectively manage our growing sales and marketingorganization to ensure the growth of our operations. Our future success dependson the ability of our sales and marketing organization to establish directsales channels and to develop multiple distribution channels with Internetservice providers and other third parties. The employees with the skills werequire are in great demand and are likely to remain a limited resource in theforeseeable future. If we are unable to recruit and retain a sufficient numberof these employees at all levels, our ability to maintain and grow our businesscould be negatively impacted.

 

***We will incur increased costs as apublic company as a result of recently enacted and proposed changes in laws andregulations.***

 

Recently enacted and proposed changes in the lawsand regulations affecting public companies, including the provisions of theSarbanes-Oxley Act of 2002 and rules of the Securities and ExchangeCommission and the New York Stock Exchange, will result in increased costs tous, including those related to corporate governance and the costs to operate asa public company.  Section 404 ofthe Sarbanes-Oxley Act requires companies to perform a comprehensive and costlyevaluation and audit of their internal controls.  The new rules could also make it moredifficult or more costly for us to obtain certain types of insurance, includingdirectors’ and officers’ liability insurance, and we may be forced to acceptreduced policy limits and coverage or incur substantially higher costs toobtain the same or similar coverage.  Theimpact of these events could also make it more difficult for us to attract andretain qualified persons to serve on our board of directors, our boardcommittees or as executive officers.

 

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***Risks Related to Our Common Stock.***

 

***Our common stock price may bevolatile.***

 

The trading price of our Class A common stockmay fluctuate widely in response to various factors, some of which are beyondour control.  These factors include:

 

•                  ourperceived prospects and the prospects of the telephone and Internet industriesin general;

 

•                  differencesbetween our actual financial and operating results and those expected byinvestors and analysts;

 

•                  changesin analysts’ recommendations or projections;

 

•                  changesin general valuations for communications companies;

 

•                  adoptionor modification of regulations, policies, procedures or programs applicable toour business;

 

•                  salesof our Class A common stock by our officers, directors or principalstockholders;

 

•                  salesof our Class A common stock due to a required divestiture under the termsof our certificate of incorporation; or

 

•                  changesin general economic or market conditions and broad market fluctuations.

 

Each of these factors, among others, could have amaterial adverse effect on your investment in our Class A common stock.Some companies that have had volatile market price for their securities havehad securities class action suits filed against them.  If a suit were to be filed against us,regardless of the outcome, it could result in substantial costs and a diversionof our management’s attention and resources. This could have a material adverse effect on our business, prospects,financial condition and results of operations.

 

***One of our stockholders holds asignificant block of shares in our company and, as a result, has significantinfluence over us.***

 

Two representatives of Warburg Pincus serve on ourseven-member board of directors and, pursuant to an agreement between us andcertain holders of our Class A common stock, we anticipate thatrepresentatives of Warburg Pincus will continue to serve on our board ofdirectors in the future.  In addition,affiliates of Warburg Pincus own or control approximately 27.9% of theoutstanding shares of Class A common stock as of August 5, 2005.  Although a substantial portion of the sharesowned by these stockholders is held in a voting trust that controls the votingrights with respect to some actions that are subject to the approval of ourstockholders under applicable law, these stockholders have full voting powerover any shares of Class A common stock that they own up to 9.9% of thevoting power of our outstanding shares of capital stock, as such shares are notrequired to be held in the voting trust. In addition, they will have the right to direct the voting trust as to howto vote their shares held in trust with respect to, among other things, anymerger, sale or similar transaction involving NeuStar, the issuance of capitalstock and the incurrence of substantial indebtedness.  As a result of their substantial ownership interest,these affiliates of Warburg Pincus may have the ability to significantlyinfluence the outcome of a vote by our stockholders in respect of these mattersand their interests could conflict with the interests of our otherstockholders.  Additionally, they andtheir affiliates are in the business of making investments in companies and mayfrom time to time acquire and hold interests in businesses that compete orcould in the future compete, directly or indirectly, with us.  For example, another Warburg Pincus fund hasa significant investment in Telcordia Technologies, Inc., which hascompeted (and may compete in the future) with us.  Warburg Pincus and its affiliates may alsopursue acquisition opportunities that may be complementary to our business, andas a result, those acquisition opportunities may not be available to us.

 

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***Holders of our options may haverescission rights against us, and we may be subject to fines and sanctionsunder federal and state securities laws.***

 

From March 2002 through February 2005, wedid not supply the holders of options granted under our 1999 Equity IncentivePlan with our financial statements or information about the risks associatedwith investment in our securities, as required to comply with Rule 701under the Securities Act.  Shares issuedupon exercise of options granted during this time were issued in violation of Section 5of the Securities Act of 1933.  Inaddition, we did not make certain required filings in California and Marylandor comply with other requirements in California, including requirements todeliver similar financial information, to qualify the issuance of our optionsunder the securities laws in those states. As a result, regulators could impose monetary fines or other sanctionsas provided under these federal and state laws. In addition, holders of those options and shares acquired upon exerciseof such options may have rescission rights against us.  We believe that, as of the date of ourinitial public offering, the number of outstanding shares of Class Acommon stock for which the holders could seek rescission from us is 412,106,which shares were held by approximately 31 different individuals.  We received aggregate proceeds ofapproximately $117,000 from the exercise of the options pursuant to which theseshares were issued, at a weighted average exercise price of $0.28 pershare.  Further, we believe that, as ofthe date of our initial public offering, the outstanding options for which theholders could seek rescission from us covered approximately 1,366,500 shares ofClass A common stock, which options were held by approximately 75different individuals.  The aggregateexercise price of these options was approximately $9,354,500, at a weightedaverage exercise price of approximately $6.85 per share.  If we are required, or elect to, makerescission offers to the holders of these shares and options, and if suchoffers are accepted, in general we would be required to make payments to theholders equal to the purchase price of such shares issued and the value ofoptions granted in violation of applicable federal and state securities lawsplus statutory interest. Moreover, our financial exposure could be higher if sodetermined by courts or regulators.

 

***Shares eligible for future sale maycause our stock price to decline.***

 

Sales of substantial amounts of our Class Acommon stock in the public market or the perception that these sales may occur,could cause the market price of our Class A common stock to decline.  Based on shares outstanding as of August 5,2005, we will have 57,915,439 shares of Class A common stock and 2,438,405shares of Class B common stock outstanding, excluding 20,903,591 shares ofClass A common stock issuable upon the exercise of outstanding optionsissued under our stock incentive plans and outstanding warrants.

 

Subject to the restrictions on ownership andtransfer set forth in our certificate of incorporation, which generallyprohibit any telecommunications service provider or affiliate of atelecommunications service provider from beneficially owning, directly orindirectly, 5% or more of our outstanding capital stock, all of the shares ofour Class A common stock sold in our initial public offering is freelytradable in the public market, without restriction, subject to compliance withthe volume limitations and other conditions of Rule 144 in the case ofshares sold by persons deemed to be our affiliates.  These shares represent approximately 52.4% ofour outstanding Class A common stock. Of the remaining shares:

 

•                  23,070,551shares held by our institutional investors that were selling stockholders inour initial public offering will be eligible for sale in the public market onor around December 27, 2005, after the applicable lock-up period expires,subject to the restrictions on ownership and transfer set forth in ourcertificate of incorporation, and subject to compliance with the volumelimitations and other conditions of Rule 144;

 

•                  1,750,000shares held by two of our institutional investors that were not sellingstockholders in our initial public offering will be eligible for sale in thepublic market on or around September 12, 2005, after the applicablelock-up period expires, subject to the restrictions on ownership and transferset forth in our certificate of incorporation, and subject to compliance withthe volume limitations and other conditions of Rule 144;

 

•                  3,347,936shares held by our directors and current and former employees will be eligiblefor sale in the public market on or around December 27, 2005, after theapplicable lock-up period expires, subject to the

 

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restrictions on ownership and transfer set forth inour certificate of incorporation, and subject to compliance with the volumelimitations and other conditions of Rule 144;

 

•                  254,978shares held by employees and former employees who are not affiliates will beeligible for sale in the public market on September 26, 2005, subject tothe restrictions on ownership and transfer set forth in our certificate ofincorporation, and subject to the manner of sale requirements in Rule 144;and

 

•                  291,675shares that have been outstanding for at least two years will be eligible forsale to the public immediately and an additional 13,704 shares will becomeeligible for sale in the public market by September 26, 2005.

 

Furthermore, an additional20,627,341 shares may be issued in the future upon exercise of options granted,options to be granted or equity awards to be granted under our existing stockoption and incentive compensation plans. We expect to register these sharesunder the Securities Act of 1933, and therefore the shares will be freelytradable when issued, subject to the restrictions on ownership and transfer setforth in our certificate of incorporation, and subject to compliance with thevolume limitations and other conditions of Rule 144 in the case of sharessold by persons deemed to be our affiliates.

 

Our principal stockholders,including affiliates of Warburg Pincus LLC, MidOcean CapitalInvestors, L.P. and affiliates of ABS Capital Partners have certainregistration rights.

 

We, all of our directors andmanagement, certain employees and former employees and each of the sellingstockholders in our initial public offering agreed that, until at least180 days from June 28, 2005, we and they, subject to limitedexceptions, will not dispose of or otherwise transfer any shares of our Class Acommon stock or any securities convertible into or exchangeable for our Class Acommon stock.  Two of our institutionalinvestors that were not selling stockholders in our initial public offeringagreed to such restrictions for a period of 75 days from June 28,2005.  With the consent of theunderwriters, any of the securities subject to these lock-up agreements may bereleased at any time without notice.

 

***Delaware law and provisions in ourcertificate of incorporation and bylaws could make a merger, tender offer orproxy contest difficult, and the market price of our Class A common stockmay be lower as a result.***

 

We are a Delawarecorporation and the anti-takeover provisions of the Delaware GeneralCorporation Law may discourage, delay or prevent a change in control byprohibiting us from engaging in a business combination with an interestedstockholder for a period of three years after the person becomes an interestedstockholder, even if a change of control would be beneficial to our existingstockholders.  In addition, ourcertificate of incorporation and bylaws may discourage, delay or prevent achange in our management or control over us that stockholders may considerfavorable.  Our certificate ofincorporation and bylaws:

 

•                  authorizethe issuance of “blank check” preferred stock that could be issued by our boardof directors to thwart a takeover attempt;

 

•                  prohibitcumulative voting in the election of directors, which would otherwise allowholders of less than a majority of the stock to elect some directors;

 

•                  establisha classified board of directors, as a result of which the successors to thedirectors whose terms have expired will be elected to serve from the time ofelection and qualification until the third annual meeting following election;

 

•                  requirethat directors only be removed from office for cause;

 

•                  providethat vacancies on the board of directors, including newly-createddirectorships, may be filled only by a majority vote of directors then inoffice;

 

•                  disqualifyany individual from serving on our board if such individual’s service as adirector would cause us to violate our neutrality requirements;

 

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•                  limitwho may call special meetings of stockholders;

 

•                  prohibitstockholder action by written consent, requiring all actions to be taken at ameeting of the stockholders; and

 

•                  establishadvance notice requirements for nominating candidates for election to the boardof directors or for proposing matters that can be acted upon by stockholders atstockholder meetings.

 

***In order to comply with ourneutrality requirements, our certificate of incorporation contains ownershipand transfer restrictions relating to telecommunications service providers andtheir affiliates, which may inhibit potential acquisition bids that ourstockholders may consider favorable, and the market price of our Class Acommon stock may be lower as a result.***

 

In order to comply withneutrality requirements imposed by the FCC in its orders and rules, no entitythat qualifies as a “telecommunications service provider” or affiliate of atelecommunications service provider, as such terms are defined under theCommunications Act of 1934 and FCC rules and orders, may beneficially own,5% or more of our capital stock.  As aresult, subject to limited exceptions, our certificate of incorporationprohibits any telecommunications service provider or affiliate of atelecommunications service provider from beneficially owning, directly orindirectly, 5% or more of our outstanding capital stock.  Among other things, our certificate ofincorporation provides that:

 

•                  ifone of our stockholders experiences a change in status or other event thatresults in the stockholder violating this restriction, or if any transfer ofour stock occurs that, if effective, would violate the 5% restriction, we mayelect to purchase the excess shares (i.e., the shares that cause the violationof the restriction) or require that the excess shares be sold to a third partywhose ownership will not violate the restriction;

 

•                  pendinga required divestiture of these excess shares, the holder whose beneficial ownershipviolates the 5% restriction may not vote the shares in excess of the 5%threshold; and

 

•                  ifour board of directors, or its permitted designee, determines that a transfer,attempted transfer or other event violating this restriction has taken place,we must take whatever action we deem advisable to prevent or refuse to giveeffect to the transfer, including refusal to register the transfer, disregardof any vote of the shares by the prohibited owner, or the institution ofproceedings to enjoin the transfer.

 

Our board of directors hasthe authority to make determinations as to whether any particular holder of ourcapital stock is a telecommunications service provider or an affiliate of atelecommunications service provider.  Anyperson who acquires, or attempts or intends to acquire, beneficial ownership ofour stock that will or may violate this restriction must notify us as providedin our certificate of incorporation.  Inaddition, any person who becomes the beneficial owner of 5% or more of our stockmust notify us and certify that such person is not a telecommunications serviceprovider or an affiliate of a telecommunications service provider.  If a 5% stockholder fails to supply therequired certification, we are authorized to treat that stockholder as aprohibited owner—meaning, among other things, that we may elect to purchase theexcess shares or require that the excess shares be sold to a third party whoseownership will not violate the restriction. We may request additional information from our stockholders to ensurecompliance with this restriction.  Ourboard will treat any “group,” as that term is defined in Section 13(d)(3) ofthe Securities Exchange Act of 1934, as a single person for purposes ofapplying the ownership and transfer restrictions in our certificate ofincorporation.

 

Nothing in our certificateof incorporation restricts our ability to purchase shares of our capitalstock.  If a purchase by us of shares ofour capital stock results in a stockholder’s percentage interest in ouroutstanding capital stock increasing to over the 5% threshold, such stockholdermust deliver the required certification regarding such stockholder’s status asa telecommunications service provider or affiliate of a telecommunicationsservice provider.  In addition, to theextent that a repurchase by us of shares of our capital stock causes anystockholder to violate the restrictions on ownership and transfer contained inour certificate of incorporation, that stockholder will be subject to all ofthe provisions applicable to prohibited owners, including required divestitureand loss of voting rights.

 

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These restrictions andrequirements may:

 

•                  discourageindustry participants that might have otherwise been interested in acquiring usfrom making a tender offer or proposing some other form of transaction thatcould involve a premium price for our shares or otherwise be in the bestinterests of our stockholders; and

 

•                  discourageinvestment in us by other investors who are telecommunications serviceproviders or who may be deemed to be affiliates of a telecommunications serviceprovider.

 

The standards fordetermining whether an entity is a “telecommunications service provider” areestablished by the FCC.  In general, atelecommunications service provider is an entity that offers telecommunicationsservices to the public at large, and is, therefore, providingtelecommunications services on a common carrier basis.  Moreover, a party will be deemed to be an affiliateof a telecommunications service provider if that party controls, is controlledby, or is under common control with, a telecommunications serviceprovider.  A party is deemed to controlanother if that party, directly or indirectly:

 

•                  owns10% or more of the total outstanding equity of the other party;

 

•                  hasthe power to vote 10% or more of the securities having ordinary voting powerfor the election of the directors or management of the other party; or

 

•                  hasthe power to direct or cause the direction of the management and policies ofthe other party.

 

The standards fordetermining whether an entity is a telecommunications service provider or anaffiliate of a telecommunications service provider and the rules applicableto telecommunications service providers and their affiliates are complex andmay be subject to change.  Eachstockholder will be responsible for notifying us if it is a telecommunicationsservice provider or an affiliate of a telecommunications service provider.

 

**Item 3.****                                    ****Quantitative and Qualitative Disclosures about Market Risk**

 

We are subject to marketrisk associated with changes in foreign currency exchange rates and interestrates.  Our exchange rate risk related toforeign currency exchange is due to our number portability contract withCanadian LNP Consortium, Inc.  Basedon this agreement, we recognize revenue on a per transaction basis as theservices are performed and bill for these services using the Canadian dollar ata fixed exchange rate that is updated annually. As a result, we are affected by currency fluctuations in the value ofthe U.S. dollar as compared to the Canadian dollar.  The net impact of foreign exchange ratefluctuations on earnings was not material for the three- and six-month periodsended June 30, 2004 and 2005, respectively.  Interest rate exposure is primarily limitedto the approximately $66.2 million of short-term investments owned by us at June 30,2005. Such investments consist principally of commercial paper, high-gradeauction rate securities and U.S. government or corporate debt securities.  We do not actively manage the risk ofinterest rate fluctuations; however, such risk is mitigated by the relativelyshort-term nature of our investments. We do not consider the present rate ofinflation to have a material impact on our business.

 

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**Item 4.****                                    ****Controls and Procedures**

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our reports filed or submitted under the Securities ExchangeAct of 1934 is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow for timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management is required to apply its judgment inevaluating the cost-benefit relationship of possible controls and procedures.

 

As of June 30, 2005, wecarried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and our Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures. Based on the foregoing, our Chief Executive Officerand Chief Financial Officer concluded that our disclosure controls andprocedures were effective and were operating at the reasonable assurance level.

 

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**PART II****3⁄4****OTHER INFORMATION**

 

**Item 1.      LegalProceedings.**

 

From time to time, we aresubject to claims in legal proceedings arising in the normal course of ourbusiness.  We do not believe that we areparty to any pending legal action that could reasonably be expected to have amaterial adverse effect on our business or operating results.

 

**Item 2.**                  **Unregistered Sales of Equity Securities and Use ofProceeds.**

 

**(a) Unregistered Sales of Equity Securities**

 

The following information isfurnished in connection with securities sold by us during the period covered bythis Form 10-Q.  Share numbers inthe following discussion have been adjusted to give effect to therecapitalization effected as part of the our initial public offering, andassume that the holders of all shares of common stock issued upon exercise ofoptions during the period covered by this Form 10-Q elected to convertsuch shares into Class A common stock.

 

From April 1, 2005through June 30, 2005, we issued 336,767 shares of Class A commonstock upon exercise of options by directors, officers, employees andconsultants.  We received aggregateproceeds of $156,647 from the payment of the exercise price with respect tosuch options.  This issuance wasundertaken in reliance upon the exemptions from the registration requirementsof the Securities Act of 1933, including by Rule 701 promulgatedthereunder, as a transaction pursuant to compensatory benefit plans andcontracts relating to compensation.

 

**(b) Use of Proceeds**

 

On June 28, 2005, theSEC declared our registration statement on Form S-1 effective, and on July 5,2005, we completed an initial public offering of 31,625,000 shares of our Class Acommon stock at a price of $22.00 per share for an aggregate offering price of$695,750,000.  The shares sold in ourinitial public offering included shares that were subject to the underwriters’over-allotment option, which was exercised by the underwriters on June 29,2005.  All of the shares sold in ourinitial public offering were sold by selling stockholders.  Accordingly, we received no proceeds from thesale of shares in our initial public offering. Our Class A common stock began trading on the New York StockExchange under the symbol “NSR” on June 29, 2005.

 

Morgan Stanley &Co. Incorporated, Credit Suisse First Boston LLC and J.P. Morgan SecuritiesInc. were the lead managers of this offering. Banc of America Securities LLC, Bear, Stearns & Co. Inc.,Friedman, Billings, Ramsey & Co., Inc., Jefferies &Company, Inc. and ThinkEquity Partners LLC acted as co-managers.  In connection with this transaction, weincurred offering costs and other IPO-related expenses of approximately$4.9 million for the six months ended June 30, 2005.

 

**Item 3.      Defaultsupon Senior Securities.**

 

None

 

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**Item 4.      Submissionof Matters to a Vote of Security Holders**

 

Prior to our initial publicoffering, on May 24, 2005, we solicited written consents from ourstockholders to approve our restated certificate of incorporation, bylaws and2005 Stock Incentive Plan, each as currently in effect.  As of June 28, 2005, we had receivedwritten consents from the holders of a sufficient number of shares to adopt theresolutions approving such matters. Specifically, we received written consents from holders of thefollowing:

 
| ** **                                        | ** ** | **Number of Shares**  | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **Consent  Received** | ** ** | **No Consent  Received** | ** ** |
| Common Stock  (1)                                 |       | 41,813,430            |       | 909,253 |   |
| Series B  Voting Convertible Preferred Stock |       | 100,000               |       | 3⁄4 |   |
| Series C  Voting Convertible Preferred Stock |       | 28,569,692            |       | 3⁄4 |   |
| Series D  Voting Convertible Preferred Stock |       | 9,098,525             |       | 3⁄4 |   |

 

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(1)  The number ofshares of common stock includes shares of common stock issuable upon conversionof the then-outstanding shares of preferred stock, all of which were convertedinto common stock prior to the initial public offering.  Shares of common stock have not beenadjusted to reflect the stock split effected as part of the recapitalization inconnection with our initial public offering.

 

Prior to our initial publicoffering, we paid accrued and unpaid dividends on each outstanding series ofour preferred stock.  In connection withthe payment of that dividend, we solicited written consents from the holders ofour then-outstanding Series D Voting Convertible Preferred Stock, who hadthe right under our then-effective certificate of incorporation to approve thedeclaration and payment of such dividend. As of June 21, 2005, we had received written consents from theholders of all of our outstanding shares of Series D Voting ConvertiblePreferred Stock (9,098,525 shares of Series D Voting Convertible PreferredStock in total) to approve the declaration and payment of such dividend.

 

**Item 5.      OtherInformation**

 

None.

 

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**Item 6.      Exhibits**

 

(a)          Exhibits:

 
| **Exhibit No.** | ** ** | **Description** |
|----------------------|------------|-----------------|
|                 |       |            |
|                 | 3.1        |            | Restated Certificate of Incorporation.* |
|                 | 3.2        |            | Amended and Restated Bylaws.* |
|                 | 4.1        |            | Specimen Class A Common Stock Certificate.* |
|                 | 4.2        |            | Specimen Class B Common Stock Certificate.* |
|                 | 4.3        |            | Stockholders Agreement, dated June 28, 2005, by and among  NeuStar, Inc. and the stockholders named therein.^ |
|                 | 4.4        |            | Registration Rights Agreement, dated as of June 5, 2001, by and  among NeuStar, Inc. and the stockholders named therein.* |
|                 | 4.5        |            | Form of Warrants dated December 7, 1999.* |
|                 | 10.1       |            | Contractor services agreement entered into the 7th day of November 1997  by and between NeuStar, Inc. and North American Portability Management,  LLC.^@ |
|                 | 10.2.1     |            | Amendment to amended and restated contractor services agreement by  and between Canadian LNP Consortium Inc. and NeuStar, Inc.^@ |
|                 | 10.3.1     |            | Amendment to National Thousands-Block Pooling Administration  agreement awarded to NeuStar, Inc. by the Federal Communications  Commission.^ |
|                 | 10.38.1    |            | Amendment to Credit Agreement among NeuStar, Inc., Bank of  America, N.A. and other lenders.^ |
|                 | 31.1       |            | Certification of Chief Executive Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.^ |
|                 | 31.2       |            | Certification of Chief Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.^ |
|                 | 32.1       |            | Certification of Chief Executive Officer and Chief Financial Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.^ |

 

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^             Filed herewith.

 

*            Incorporated byreference to NeuStar, Inc.’s registration statement on Form S-1 (FileNo. 333-123635).

 

†             Compensationarrangement.

 

@       Portions of thisdocument have been omitted pursuant to a request for confidential treatment that has beenrequested or has been granted.  The omittedportions of this document have been filed with the Securities and ExchangeCommission.

 

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SIGNATURES

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                       | **NeuStar, Inc.** |
|----------------------------|------------------------|
|                       | ** **             |
| Date: August 15, 2005 | By:                    | /s/ JEFFREY A. BABKA |
|                       |                   | Jeffrey A. Babka  Chief Financial Officer  (Principal Financial and Accounting Officer  and Duly Authorized Officer) |

 

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