UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2005

OR

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

For the transition period from            to            

Commission file number 001-32548

NeuStar, Inc.

(Exact name of registrant as specified in its charter)

46000 Center Oak Plaza
Sterling, Virginia 20166
(Address of principal executive offices) (zip code)

(571) 434-5400
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes o  No  ý

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

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

NeuStar, Inc.

Index

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PART I — FINANCIAL INFORMATION

Item 1.                    Financial Statements

NEUSTAR, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

See accompanying notes.

3

NEUSTAR, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

See accompanying notes.

4

NEUSTAR, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

See accompanying notes.

5

NEUSTAR, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes.

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NEUSTAR, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2005

1.    DESCRIPTION OF BUSINESS AND ORGANIZATION

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

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

•                  Addressing.  The Company enables CSPs to use critical, shared addressing resources, such as telephone numbers, several Internet domain names, and Common Short Codes.

•                  Interoperability.  The Company enables CSPs to exchange and share critical operating data so that communications originating on one provider’s network can be delivered and received on the network of another CSP. The Company also facilitates order management and work flow processing among CSPs.

•                  Infrastructure and Other.  The Company enables CSPs to more efficiently manage changes in their own networks by centrally managing certain critical data they use to route communications over their own networks.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Information

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of the results 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 at that date but does not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements.

These consolidated financial statements should be read 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 with the Securities and Exchange Commission on June 29, 2005.

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

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the conversion of all of the outstanding shares of preferred stock into shares of common stock, (ii) the amendment of the Company’s certificate of incorporation to provide for Class A common stock and Class B common stock, (iii) the split of each share of common stock into 1.4 shares and the reclassification of the common stock into shares of Class B common stock, and (iv) the ultimate conversion of all outstanding shares of Class B common stock into shares of Class A common stock at the election of the holder of such shares of Class B common stock (collectively, the “Recapitalization”).  Prior to the Company’s initial public offering, holders of 100,000 shares of Series B Voting Convertible Preferred Stock, 28,569,692 shares of Series C Voting Convertible Preferred Stock, and 9,098,525 shares of Series D Voting Convertible Preferred Stock converted their shares into 500,000, 28,569,692, and 9,098,525 shares of the Company’s common stock, respectively, after which the split by means of a reclassification, as described in clauses (ii) and (iii) of the previous sentence, was effected.

The accompanying unaudited consolidated financial statements give retroactive effect to the amendment of the Company’s certificate of incorporation to provide for Class A common stock and Class B common stock and the split of each share of common stock into 1.4 shares and the reclassification of the common stock into shares of Class B common stock, as though these events occurred at the beginning of the earliest period presented.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Reclassifications

Certain amounts in the prior periods’ financial statements have been reclassified to conform to the current period presentation.

Revenue Recognition

The Company provides the North American communications industry with essential clearinghouse services that address the industry’s addressing, interoperability, and infrastructure needs. The Company’s revenue recognition policies are in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, Revenue Recognition.

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

Addressing

The Company’s addressing services include telephone number administration, implementing the allocation of pooled blocks of telephone numbers, and directory services for Internet domain names and Common Short Codes. The Company generates revenue from its telephone number administration services under two government contracts. Under its contract to serve as the North American Numbering Plan Administrator, the Company earns a fixed annual fee, and recognizes this fee as revenue on a straight-line basis as services are provided. In the event the Company estimates losses on its fixed fee contract, the Company recognizes these losses in the period in which a loss becomes apparent. Under the Company’s contract to serve as the National Pooling Administrator, the Company is reimbursed for costs incurred plus a fixed fee associated with administration of the pooling system. During the construction period completed in March 2002, the Company recognized revenue based on costs incurred. Thereafter,

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

In addition to the administrative functions associated with its role as the National Pooling Administrator, the Company also generates revenue from implementing the allocation of pooled blocks of telephone numbers under its long-term contracts with North American Portability Management, LLC, and the Company recognizes revenue on a per transaction fee basis as the services are performed. For its Internet domain name services, the Company generates revenue for Internet domain registrations, which generally have contract terms between one and ten years. The Company recognizes revenue on a straight-line basis over the lives of the related customer contracts. The Company generates revenue from its Common Short Code services under short-term contracts ranging from three to twelve months, and the Company recognizes revenue on a straight-line basis over the term of the customer contracts.

Interoperability

The Company’s interoperability services consist primarily of wireline and wireless number portability and order management services. The Company generates revenue from number portability under its long-term contracts with North American Portability Management, LLC and Canadian LNP Consortium, Inc. The Company recognizes revenue on a per transaction fee basis as the services are performed. The Company provides order management services consisting of customer set-up and implementation followed by transaction processing under contracts with terms ranging from one to three years. Customer set-up and implementation is not considered a separate deliverable; accordingly, the fees are deferred and recognized as revenue on a straight-line basis over the term of the contract. Per-transaction fees are recognized as the transactions are processed.

Infrastructure and Other

The Company’s infrastructure services consist primarily of network management and connection fees. The Company generates revenue from network management services under its long-term contracts with North American Portability Management, LLC. The Company recognizes revenue on a per transaction fee basis as the services are performed. In addition, the Company generates revenue from connection fees and system enhancements under its contracts with North American Portability Management, LLC. The Company recognizes its connection fee revenue as the service is performed. System enhancements are provided under contracts in which the Company is reimbursed for costs incurred plus a fixed fee. Revenue is recognized based on costs incurred plus a pro rata amount of the fee.

Significant Contracts

The Company provides wireline and wireless number portability, implements the allocation of pooled blocks of telephone numbers and provides network management services pursuant to seven contracts with North American Portability Management, LLC, an industry group that represents all telecommunications service providers in the United States.  The Company recognizes revenue under its contracts with North American Portability Management, LLC primarily on a per-transaction basis.  The aggregate fees for transactions processed under these contracts are determined by the total number of transactions, and these fees are billed to telecommunications service providers based on their allocable share of the total transaction charges.  This allocable share is based on each respective telecommunications service provider’s share of the aggregate end-user services revenues of all U.S. telecommunications service providers as determined by the Federal Communications Commission (FCC).  Under the Company’s contracts, the Company also bills a revenue recovery collections, or RRC, fee of a percentage of monthly billings to its customers, which is available to the Company if any telecommunications service provider fails to pay its allocable share of total transactions charges.  In the period in which the RRC fees are billed, the RRC

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fees are recorded as an accrued expense on the consolidated balance sheet, with a corresponding increase to accounts receivable.  If the RRC fee is insufficient for that purpose, these contracts also provide for the recovery of such differences from the remaining telecommunications service providers.  On an annual basis, (i) the Company evaluates the RRC fee reserve by comparing cash collections to billings and the RRC percentage is adjusted, and (ii) any excess RRC fee reserve is returned to the telecommunications service providers in accordance with the terms of these contracts.

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

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

In December 2003, these contracts 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 of the contracts was reduced.  Currently, the Company charges $1.08 per transaction under these contracts.  Each contract provides that over the life of the contract, as pre-determined cumulative transaction thresholds are surpassed in the region covered by that contract, the price per transaction will gradually decline to a minimum fee of $0.93 per transaction.  As part of the amendments, the Company agreed to retroactively apply the new transaction fee to all 2003 transactions processed and granted credits totaling $16.0 million.  These credits are being applied to customer invoices over a 23-month period beginning in January 2004. Additionally, the Company obtained letters of credit totaling $16.0 million in January 2004 to secure these customer credits. As of December 31, 2004 and June 30, 2005, approximately $15.5 million and $7.6 million, respectively, of these customer credits were outstanding. The amount of the Company’s revenue derived under its contracts with North American Portability Management, LLC was $69.2 million, $84.5 million, and $130.0 million for the years ended 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, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of SFAS No. 123 (SFAS No. 123), allows companies to account for stock-based compensation using either the provisions of SFAS No. 123 or the provisions of Accounting 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 disclosure in the notes to the financial statements as if the measurement provisions of SFAS No. 123 had been adopted. The Company accounts for its stock-based employee compensation in accordance with APB No. 25. Stock compensation expense to nonemployees has been determined in accordance with SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Connection with Selling Goods or Services (EITF 96-18), and represents the fair value of the consideration received or the fair value of the equity instrument issued, whichever may be more reliably measured.  For options that have

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not reached a measurement date under EITF 96-18, the fair value of the options granted to nonemployees is periodically remeasured at each reporting date.

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

The Black-Scholes option-pricing valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. Because the Company’s stock options have characteristics significantly different from those of publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of the Company’s employee stock options.

The effect of applying SFAS No. 123 on pro forma net income attributable to common stockholders as stated above is not necessarily representative of the effects on reported net income attributable to common stockholders for future years due to, among other things, the vesting period of the stock options and the fair value of additional options to be granted in the future years.

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

Basic and Diluted Net Income Attributable to Common Stockholders per Common Share

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

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

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Income Taxes

Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting bases and the tax bases of assets and liabilities. Deferred tax assets are also recognized for tax net operating loss carryforwards. These deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when such amounts are expected to reverse or be utilized. The realization of total deferred tax assets is contingent upon the generation of future taxable income. Valuation allowances are provided to reduce such deferred tax assets to amounts more likely than not to be ultimately realized.

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

As of June 30, 2004, the Company generated operating profits for six consecutive quarters and had fully utilized its federal net operating loss carryforwards. As a result of this earnings trend and projected operating results over future years, the Company reversed approximately $20.2 million of its deferred tax asset valuation allowance, having determined that it was more likely than not that these deferred tax assets would be realized. This reversal resulted in the recognition of an income 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 remainder representing the state deferred tax benefit. As a result, income tax expense has 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% for the three months ended June 30, 2004 and 2005 and (28.7%) and 39.9% for the six months ended June 30, 2004 and 2005, respectively.

Comprehensive Net Income

There were no material differences between net income 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 a revision of SFAS No. 123.  SFAS No. 123(R) supersedes APB No. 25, and amends SFAS No. 95, Statement of Cash Flows. Generally the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure 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 years beginning after June 15, 2005. The Company will continue to account for share-based compensation using the intrinsic value method set forth in APB No. 25 until adoption of SFAS No. 123(R) on January 1, 2006.

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

•                  A “modified prospective” method in which compensation cost is recognized beginning 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) based on the requirements of SFAS No. 123(R) for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.

•                  A “prospective” method, which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim 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 acquired fiducianet, Inc. (Fiducianet) for $2.2 million in cash and the issuance of 35,745 shares of Class B common stock for total purchase consideration of $2.6 million. The acquisition of Fiducianet enables the Company to serve as a single point of contact in managing all day-to-day customer obligations involving subpoenas, court orders and law enforcement agency requests under electronic surveillance laws including the Communications Assistance for Law Enforcement, Patriot and Homeland Security Acts. The acquisition was accounted for as a purchase, and the results of Fiducianet have been included in the accompanying consolidated statements of operations since the date of the acquisition.

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

4.    GOODWILL and INTANGIBLE ASSETS

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

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Amortization expense related to other intangible assets, which is included in depreciation and amortization expense, was $388,000 and $364,000 for the three months ended June 30, 2004 and 2005 and $833,000 and $673,000 for the six months ended June 30, 2004 and 2005, respectively. Amortization expense related to intangible assets for the years ended December 31, 2005, 2006, 2007, 2008 and 2009 thereafter is expected to 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 granted options to employees for the purchase of 341,844 shares of common stock with an exercise price of $10.86, which represented a contemporaneous determination of fair market value of the Company’s common stock by the Company’s board of directors.

During February 2005, the Company granted fully vested options to nonemployees for the purchase of 22,400 shares of common stock at a weighted average exercise price of $10.86 per share. The Company recognized compensation expense of approximately $180,000. The fair value of these awards was calculated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: expected life 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 option term.

During March 2005, an employee of the Company changed status to a consultant and, in accordance with the terms of the original option agreement, continued to vest in 26,250 options as of March 29, 2005.  As a result, the Company re-measured the fair value of the vested options and recognized compensation expense of approximately $331,000. The fair value of this award was calculated on the modification date using the Black-Scholes option-pricing model with the following weighted average assumptions: expected life of the award equal to the remaining 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 the vesting of certain options issued to nonemployees. This acceleration enabled the optionholders to immediately vest in approximately 102,000 options, which otherwise would have vested over the options’ original vesting period, generally 48 months. In connection with this acceleration, the Company recorded approximately $1.6 million as compensation expense based on the fair value of the options on the date of acceleration. The fair value of these awards was remeasured on the acceleration date using the Black-Scholes option-pricing model with the following weighted average assumptions: expected life 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 option term. As of March 31, 2005, all options granted to nonemployees had vested.

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

In connection with the formation of NeuLevel, Inc. (NeuLevel), the Company’s 90%-owned subsidiary, the Company granted the minority interest holder of NeuLevel an option to purchase, within 30 days of completion of the Company’s initial public offering, up to $20.0 million worth of common stock at a purchase price per share equal to the public offering price.  This option expired 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 contains forward-looking statements, including, without limitation, statements concerning the conditions in our industry, our operations and economic performance, and our business and growth strategy.  In some cases, you can identify forward-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 or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.  Many of these risks are beyond our ability to control or predict.  These forward-looking statements are based on estimates and assumptions by our management that, although we believe to be reasonable, are inherently uncertain and subject to a number of risks and uncertainties.  These risks and uncertainties include, without limitation, those described below under the heading “Additional Factors That May Affect Future Results.”

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

Overview

We provide the North American communications industry with essential clearinghouse services.  We operate the authoritative directories that manage virtually all telephone area codes and numbers, and enable the dynamic routing of calls among thousands of competing communications service providers, or CSPs, in the United States and Canada.  All CSPs that offer telecommunications services to the public at large, or telecommunications service providers, such as Verizon Communications Inc., Sprint Corporation, AT&T Corp. and Cingular Wireless LLC, must access our clearinghouse as one of our customers to properly route virtually all of their calls.  We also provide clearinghouse services to emerging CSPs, including Internet service providers, cable television operators, and voice over Internet protocol, or VoIP, service providers.  In addition, we manage the authoritative directories for the .us and .biz Internet domains, as well as for Common 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 and operational challenges of the communications industry when the U.S. government mandated local number portability in 1996. While we remain the provider of the authoritative solution that the industry relies upon to meet this mandate, we have developed a broad range of innovative services that meet an expanded range of customer needs. We provide the communications industry in North America with critical technology services that solve the industry’s addressing, interoperability and infrastructure needs.

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

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

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

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•                  Infrastructure and Other. We enable CSPs to more efficiently manage changes in their own networks by centrally managing certain critical data they use to route communications over their own networks.

We derive a substantial portion of our annual revenue on a transaction basis, most of which is derived from long-term contracts.

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

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

Sales and marketing expense consists of personnel costs, advertising costs and relationship marketing costs. This expense includes salaries, sales commissions, sales operations and other personnel-related expense, travel and related expense, trade shows, costs of computer 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, market analysis and forecasting, stock-based compensation and customer relationship management.

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

General and administrative expense consists primarily 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 debt expense.

Depreciation and amortization relates primarily to our property and equipment and includes our network infrastructure and facilities related to our services and the amortization of identifiable intangibles.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. The preparation of these financial statements in accordance with U.S. GAAP requires us to utilize accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the financial statements and the reported amounts of revenue and expense during a fiscal period. The Securities and Exchange Commission considers an accounting policy to be critical if it is important to a company’s financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. We have discussed the selection and development of the critical accounting policies with the audit committee of our board of directors, and the audit committee has reviewed our related disclosures in this report. Although we believe that our judgments and estimates are appropriate and correct, actual results may differ from those estimates.

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

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Revenue Recognition

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

Addressing.    Our addressing services include telephone number administration, implementing the allocation of pooled blocks of telephone numbers, and directory services for Internet domain names and Common Short Codes. We generate revenue from our telephone number administration services under two government contracts. Under our contract to serve as the North American Numbering Plan Administrator, we earn a fixed annual fee, and we recognize this fee as revenue on a straight-line basis as services are provided. In the event we estimate losses on our fixed fee contract, we recognize these losses in the period in which a loss becomes apparent. Under our contract to serve as the National Pooling Administrator, we are reimbursed for costs incurred plus a fixed fee associated with administration of the pooling system. During the construction period completed in March 2002, we recognized revenue based on costs incurred. Thereafter, we received an award fee associated with our initial delivery of the pooling system, which we recognized when we were notified of the amount of the award fee earned. We currently recognize revenue for administration of the system based on costs incurred plus a pro rata amount of the fixed fee.

In addition to the administrative functions associated with our role as the National Pooling Administrator, we also generate revenue from implementing the allocation of pooled blocks of telephone numbers under our long-term contracts with North American Portability Management, LLC, and we recognize revenue on a per transaction fee basis as the services are performed. For our Internet domain name services, we generate revenue for Internet domain name registrations, which generally have contract terms between one and ten years. We recognize revenue on a straight line basis over the lives of the related customer contracts. We generate revenues from our Common Short Code services under short-term contracts ranging from three to twelve months, and we recognize revenue on a straight line basis over the term of the customer contracts.

Interoperability.    Our interoperability services consist primarily of wireline and wireless number portability and order management services. We generate revenue from number portability under our long-term contracts with North American Portability Management, LLC and Canadian LNP Consortium, Inc. We recognize revenue on a per transaction fee basis as the services are performed. We provide order management services consisting of customer set-up and implementation followed by transaction processing under contracts with terms ranging from one to three years. Customer set-up and implementation is not considered a separate deliverable; accordingly, the fees are deferred and recognized as revenue on a straight-line basis over the term of the contract. Per-transaction fees are recognized as the transactions are processed.

Infrastructure and Other.    Our infrastructure services consist primarily of network management and connection services. We generate revenue from network management services under our long-term contracts with North American Portability Management, LLC. We recognize revenue on a per transaction fee basis as the services are performed. In addition, we generate revenue from connection fees and system enhancements under our contracts with North American Portability Management, LLC. We recognize our connection fee revenue as the service is performed. System enhancements are provided under contracts in which we are reimbursed for costs incurred plus a fixed fee. Revenue is recognized based on costs incurred plus a pro rata amount of the fee.

Significant Contracts

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

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any telecommunications service provider fails to pay its allocable share of total transactions charges. If the RRC fee is insufficient for that purpose, these contracts also provide for the recovery of such differences from the remaining telecommunications service providers.

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

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

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

Service Level Standards

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

For more information regarding how we recognize revenue for each of our service categories, please see the discussion above under “—Revenue Recognition.”

Valuation of Goodwill and Intangible Assets

Previous acquisitions resulted in the recording of goodwill, which represents the excess of the purchase price over the fair value of assets acquired, as well as other definite-lived intangible assets. Under present accounting rules (SFAS No. 142), goodwill is no longer subject to amortization; instead it is subject to new impairment testing criteria. Other acquired definite-lived intangible assets are being amortized over their estimated useful lives, although those with indefinite lives are not to be amortized but are tested at least annually for impairment, using a lower of cost or fair value approach.  We test for impairment on an annual basis or on an interim basis if circumstances change that would indicate the possibility of impairment. The impairment review may require an analysis of future projections and assumptions about our operating performance. If such a review indicates that the assets are impaired, an expense would be recorded for the amount of the impairment, and the corresponding impaired assets would be reduced in carrying value.

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Impairment of Long-Lived Assets

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, a review of long-lived assets for impairment is performed when events or changes in circumstances indicate the carrying value of such assets may not be recoverable. If an indication of impairment is present, we compare the estimated undiscounted future cash flows to be generated by the asset to its carrying amount. If the undiscounted future cash flows are less than the carrying amount of the asset, we record an impairment loss 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 comparison to fair values of similar assets or using a discounted cash flow analysis.

Accounts Receivable, Revenue Recovery Collections, and Allowance for Doubtful Accounts

Accounts receivable are recorded at the invoiced amount and do not bear interest.  In accordance with our contracts with North American Portability Management, LLC, we bill a RRC fee of a percentage of monthly billings to our customers. The aggregate RRC fees collected may be used to offset uncollectible receivables from an individual customer. The RRC fees are recorded as an accrued liability when collected. For the period January 1, 2002 through June 30, 2004, this fee was 3% of monthly billings. On July 1, 2004, the RRC fee was reduced to 2%.  On July 1, 2005, the RRC fee was reduced to 1%.  Any accrued RRC fees in excess of uncollectible receivables are paid back to the customers annually on a pro rata basis. RRC fees of $4.3 million and $2.2 million are included in accrued expense as of December 31, 2004 and June 30, 2005, respectively. All other receivables related to services not covered by the RRC fees are evaluated and, if deemed not collectible, are either directly written off as a bad debt expense or reserved.

Deferred Income Taxes

We recognize deferred tax assets and liabilities based on temporary differences between the financial reporting bases and the tax bases of assets and liabilities. These deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when such amounts are expected to reverse or be utilized. The realization of deferred tax assets is contingent upon the generation of future taxable income. When appropriate, we recognize a valuation allowance to reduce such deferred tax assets to amounts that are more likely than not to be ultimately realized. The calculation of deferred tax assets (including valuation allowances) and liabilities requires us to apply significant judgment related to such factors as the application of complex tax laws, changes in tax laws and our future operations. We review our deferred tax assets on a quarterly basis to determine if a valuation allowance is required based upon these factors. Changes in our assessment of the need for a valuation allowance could give rise to a change in such allowance, potentially resulting in additional expense or benefit in the period of change.

Stock-Based Compensation

We account for employee stock-based compensation in accordance 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 to recognize compensation cost for the excess of the fair value of the stock at the 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 to be recognized at the date of grant and amortized as compensation expense over the stock option’s vesting period. No stock-based employee compensation cost for stock options is reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Stock-based compensation for non-employees is accounted for using the fair value-based method in accordance with SFAS No. 123 and 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 common stock for total purchase consideration of $2.6 million. The acquisition of Fiducianet enables us to serve as a single point of contact in managing all day-to-day customer obligations involving subpoenas, court orders and

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law enforcement agency requests under electronic surveillance laws including the Communications Assistance for Law Enforcement, Patriot and Homeland Security Acts.

Current Trends Affecting Our Results of Operations

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

Wireless subscriber growth, new wireless applications, and wireless competition have driven increased demand for all of our clearinghouse services. Additionally, as wireless service providers upgrade their networks and technology to enable high-speed service, we anticipate that they will increasingly rely on our infrastructure services and that, as a result, wireless-related transactions will remain a major contributor to our addressing and interoperability transaction volume growth.

Advancements in the communications industry, such as changes 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 meet consumer demands and new technological advancements, consolidation among industry participants has increased. Consolidation requires the integration of disparate systems and networks, which has driven increased demand for our addressing, interoperability and infrastructure services. We anticipate that future consolidations will continue to drive growth in our transaction volumes.

During the first two quarters of 2005, addressing transactions also increased due to the emergence of IP service providers. In particular, VoIP service providers are rapidly expanding their operations and experiencing an increased need for access to inventories of telephone numbers, which has driven demand for our addressing services. We expect significant growth in the number of addressing transactions in the remainder of 2005 and 2006 as IP service providers continue to develop an inventory of telephone number resources.

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

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

In 2003 and 2004, we were able to utilize net operating loss carryforwards and deferred tax benefits from previous years to offset taxable income and income tax expense related to U.S. federal income taxes. These carryforwards and deferrals were exhausted in 2004. In 2005 and future years, we expect our profits to be subject to U.S. federal income taxes at the statutory rates.

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Consolidated Results of Operations

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

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

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Revenue

Total revenue.    Total revenue increased $22.7 million due to increases in addressing, interoperability and infrastructure transactions.

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

Interoperability.    Interoperability revenue increased $5.0 million due to an increase in wireline and wireless competition and the associated movement of end users from one CSP to another, carrier consolidation, and broader usage of our expanding service offerings such as enhanced order management services for wireless data and Internet telephony providers. Specifically, revenue from number portability transactions increased $3.1 million and revenue from our order management services increased $1.7 million.

Infrastructure and other.    Infrastructure and other revenue increased $10.7 million due to an increase in the demand for our network management services. Of this amount, $8.9 million was attributable to customers making a large number of changes to their networks that required actions such as disconnects and modifications to network elements. We believe these changes were driven largely by trends in the industry, 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 revenue increased $3.7 million due to growth in personnel and contractor costs to support higher transaction volumes.  In particular, personnel and employee related expense increased $3.0 million due to increased personnel to support our customer deployment group, software engineering group and our operations group.  Contractor costs increased $0.7 million for software maintenance activities and the managing of industry changes to our clearinghouse. Additionally, cost of revenue increased by $0.5 million due to royalty expenses related to Common Short Code services and revenue share cost associated with our Internet domain names and registry gateway services. These increases were offset by a $0.5 million reduction of facilities expenses associated with the consolidation of our Oakland facilities.  Cost of revenue as a percentage of revenue decreased to 25.3% in the three months ended June 30, 2005, as compared to 30.5% for the three months ended June 30, 2004. This decrease in cost of revenue as a percentage of revenue is attributable to operating efficiencies in our clearinghouse operations, which allowed us to increase the number of transactions we processed without proportional increases in personnel costs.

Sales and marketing.    Sales and marketing expense increased $2.7 million due to headcount additions to our sales and marketing team to focus on branding and product launches.  In particular, personnel and employee related expense increased $1.8 million, and costs related to industry events and advertising increased $0.6 million. Sales and marketing expense as a percentage of 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 and development expense increased $1.1 million due to the development of Internet 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 to 4.6% in the three months ended June 30, 2005, as compared to 4.4% for the three months ended June 30, 2004.

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

Depreciation and amortization.    Depreciation and amortization expense decreased $0.4 million due to the expiration of certain capital leases and a change in the useful life estimate in June 2004 of certain acquired intangibles. Depreciation and amortization expense as a percentage 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 three months ended June 30, 2005, we recorded a restructuring liability of $0.3 million for the closure of our facility in Oakland, CA.  There was no similar expense for the three months ended June 30, 2004.

Interest expense.    Interest expense remained relatively consistent during the three months ended June 30, 2005 as compared to the three months ended June 30, 2004.  Interest expense as a percentage of revenue decreased to 0.9% in the three months ended June 30, 2005, as compared to 1.5% for the three months ended June 30, 2004.

Interest income.    Interest income increased $0.3 million due to higher average cash balances.  Interest income as a percentage of revenue increased to 1.2% in the three months ended June 30, 2005, as compared to 1.0% for the three months ended June 30, 2004.

(Benefit from)  provision for income taxes.    Income tax provision increased $16.6 million to $9.3 million to reflect the expected 2005 effective tax rate.  For the three months ended June 30, 2004 we recorded an income tax benefit of $7.3 million related to the one-time reversal of a deferred tax asset valuation allowance.  Provision for income taxes as a percentage of revenue increased to 14.9% for the three months ended June 30, 2005 compared 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 our results of operations for the six months ended June 30, 2004 and 2005.