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NSR > SEC Filings for NSR > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for NEUSTAR INC

Form 10-K for NEUSTAR INC


28-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with the information set forth under "Selected Financial Data" in Item 6 of this report and our consolidated financial statements and related notes in Item 8 of this report. The statements in this discussion related to our expectations regarding our future performance, liquidity and capital resources, and other non-historical statements in this discussion, are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in "Risk Factors" in Item 1A of this report and "Business - Cautionary Note Regarding Forward-Looking Statements" in Item 1 of this report. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Overview
In 2013, revenue continued to be strong and we positioned ourselves for future growth by aligning our client-facing functions with key industry verticals. In addition, we continued to pursue renewal of our contracts to provide number portability services, and returned capital to our shareholders through our share repurchase program.
Total revenue for the year increased 8.5% to $902.0 million as compared to $831.4 million in 2012. This increase in revenue was driven by a contractual increase of 6.5% in the fixed fee under our contracts to provide number portability services, and by greater demand for our Marketing Services. In the fourth quarter of 2013, we aligned our organizational structure to better serve our clients through a common understanding of their needs. This reorganization unified our sales and marketing teams, now aligned with the market verticals that we serve, and organized our products and technology teams into a functional structure. We believe this new organizational structure will give us greater insight into our clients' needs. This client focus is also expected to support an innovative product pipeline that can more effectively turn ideas into marketable products, and products into scalable offers tailored to our client verticals. This new alignment changed how we go to market and how we manage the business, including significant shifts in employee reporting responsibilities, and resulted in a single operating segment and a change in our financial reporting. We anticipate that this new structure will allow our operations to scale more effectively and more efficiently manage operating expenses by streamlining functions and organizational structure. In addition, our reorganization initiatives, which we expect will continue through fiscal 2014, are designed to result in greater synergies from our acquisitions and achieve further integration among our onsite businesses.
In May 2010, the NAPM announced a selection process for the administration of the local number portability contracts with the expiration of the current contracts, which continue through June 2015. We submitted our response to the RFP on the then current submission deadline of April 5, 2013. On April 17, 2013, the NAPM announced on its website that it had extended the deadline for interested parties to respond to its RFP until April 22, 2013. On February 21, 2014, the NAPM published a revised timeline for the selection process, indicating that the estimated date for the FCC approval of LNPA vendor selection for all regions had changed from January 20, 2014 to May 6, 2014. We have requested that the NAPM provide all bidders in the selection process the opportunity to submit additional revised proposals. We have also made filings with the FCC expressing our concerns regarding the selection process, including a petition for a declaratory ruling on February 12, 2014.


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During 2013, we issued $300 million of 10-year senior notes at 4.5% and completed a $525 million credit facility, which included a $325 million Term Loan A and $200 million Revolving Credit Facility, replacing our outstanding debt. This refinancing provides us with staggered maturities and a lower cost of debt. In addition, we used cash on hand to add campaign and predictive analytics capabilities to our marketing platform, giving us a comprehensive workflow solution that advertising agencies and marketers depend on. This capability allows our clients to measure the effectiveness of cross-channel campaigns in real-time in a single view.
Further, we continued to execute our capital allocation strategy through share purchases. During the year ended December 31, 2013, we purchased approximately 5.9 million shares of our common stock at an average price of $48.71 per share for a total of $285.3 million. On January 29, 2014, we announced the authorization of a 2014 share repurchase program, which will expire on December 31, 2014 and authorizes the purchase of up to $200 million of our Class A common shares.
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. We provide the authoritative solution that the communications industry relies upon to meet this mandate. Since then, we have grown to offer a broad range of real-time information services and analytics, including marketing services, business assurance services, security solutions, data services, and data registry services.
Our costs and expenses consist of cost of revenue, sales and marketing, research and development, general and administrative, depreciation and amortization, and restructuring charges.
Cost of revenue includes all direct materials costs, direct labor costs, and indirect costs related to the generation of revenue such as indirect labor, outsourced services, materials and supplies, payment processing fees, and general facilities cost. Our primary cost of revenue is personnel costs associated with service implementation, product maintenance, client deployment and client care, including salaries, stock-based compensation and other personnel-related expense. In addition, cost of revenue includes costs relating to developing modifications and enhancements of our existing technology and services, as well as royalties paid to third parties related to our U.S. Common Short Code services and registry gateway services. Cost of revenue also includes costs relating to our information technology and systems department, including network costs, data center maintenance, database management, data processing costs and general facilities costs.
Sales and marketing expense consists of personnel costs, such as salaries, sales commissions, travel, stock-based compensation, and other personnel-related expense; costs associated with attending and sponsoring trade shows; facilities costs; professional fees; costs of marketing programs, such as Internet and print marketing programs, as well as costs for product branding, market analysis and forecasting; and client relationship management.
Research and development expense consists primarily of personnel costs, including salaries, stock-based compensation and other personnel-related expense; contractor costs; and the costs of facilities, and computer and support services used in service and technology development.
General and administrative expense consists primarily of personnel costs, including salaries, stock-based compensation, and other personnel-related expense, for our executive, administrative, legal, finance and human resources functions. General and administrative expense also includes facilities, support services and professional services fees.
Depreciation and amortization relates to amortization of identifiable intangibles, and the depreciation of our property and equipment, including our network infrastructure and facilities related to our services. Restructuring charges relate to the termination of certain employees and reduction in or closure of leased facilities. 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. Under the rules and regulations of the SEC, an accounting policy is considered 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 our critical accounting policies with the audit committee of our Board of Directors, and the audit committee has reviewed our related disclosures in this report.


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Although we believe that our judgments and estimates are appropriate and reasonable, actual results may differ from those estimates. In addition, while we have used our best estimates based on the facts and circumstances available to us at the time, we reasonably could have used different estimates in the current period. Changes in the accounting estimates we use are reasonably likely to occur from period to period, which may have a material impact on the presentation of our financial condition and results of operations. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations could be materially affected. See the information in our filings with the SEC from time to time and Item 1A of this report, "Risk Factors," for certain matters that may bear on our results of operations. Revenue Recognition
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 NAPM. The aggregate fees for transactions processed under the contracts are determined by an annual fixed-fee pricing model under which the annual fixed fee is subject to an annual price escalator of 6.5%. If actual volume of transactions in a given year is above or below the contractually established volume range for that year, the annual fixed fee may be adjusted up or down, respectively. At each reporting period, we assess the volume of transactions in comparison to the contractually established volume range for that year and determine the probability of an adjustment, either up or down, to the annual fixed fee. If we determine an adjustment is probable and measurable, we record the adjustment to revenue in the reporting period in which our assessment is made. We have not recorded any adjustments to the annual fixed fee since the inception of these contract terms in January 2009.
For more information regarding our revenue recognition policy, please see Note 2 to our Consolidated Financial Statements in Item 8 of Part II of this report. Service Level Standards
Some of our private commercial contracts require us to meet minimum service level standards and impose corresponding penalties for failure to meet those standards. We record a provision for these performance-related penalties when we become aware that we have failed to meet required service levels, which results in a corresponding reduction of our revenue. Goodwill
Goodwill represents the excess purchase price paid over the fair value of tangible or identifiable intangible assets acquired and liabilities assumed in our acquisitions. In accordance with the Intangibles-Goodwill and Other Topic of the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, we test our goodwill for impairment on an annual basis, or on an interim basis if an event occurs or circumstances change that indicate an impairment may have occurred.
In the fourth quarter of 2013, we reorganized our operating structure and internal financial reporting to a functional structure, to reflect of how our chief operating decision maker, or CODM, allocates resources and assesses performance. This reorganization changed our operating segments and the underlying reporting units. Prior to the reorganization, we reported our results of operations based on three operating segments and reporting units: Carrier Services, Enterprise Services, and Information Services. The new functional structure resulted in a single operating segment and reporting unit. We did not identify indicators of impairment in connection with this realignment. Our 2013 annual goodwill impairment analysis, which we performed as of October 1, 2013, did not result in an impairment charge. We compared our market capitalization to our reporting unit carrying value as of October 1, 2013. As a result of this analysis, we determined that the estimated fair value of our reporting unit was substantially in excess of the carrying value. We believe that the assumptions and estimates used to determine the estimated fair value of our reporting unit are reasonable; however, there are a number of factors, including factors outside of our control, including stock price volatility, that could cause actual results to differ from our estimates. Any changes to our key assumptions about our business and our prospects, or changes in market conditions, could cause the fair value of our reporting unit to fall below its carrying value, resulting in a potential impairment charge. In addition, changes in our organizational structure or how our management allocates resources and assesses performance could result in a change of our operating segment or reporting unit, requiring a reallocation and impairment analysis of our goodwill. A goodwill impairment charge could have a material effect on our consolidated financial statements because of the significance of goodwill to our consolidated balance sheet. As of December 31, 2013, we had $642.8 million in goodwill.


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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 NAPM, we bill a revenue recovery collections fee, or RRC fee, equal to a percentage of monthly billings to our clients. The aggregate RRC fees collected may be used to offset uncollectible receivables from an individual client. During the years ended December 31, 2011 and 2012 and for the six months ended June 30, 2013, the RRC fee was 0.65%. On July 1, 2013, the RRC rate was reduced to 0.50% and remained at that level through December 31, 2013. Any accrued RRC fees in excess of uncollectible receivables are paid back to the clients annually on a pro rata basis. All other receivables related to services not covered by the RRC fees are evaluated and, if deemed not collectible, are appropriately reserved. 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.
Our income tax provision includes U.S. federal, state, local and foreign income taxes and is based on pre-tax income or loss. In determining the annual effective income tax rate, we analyzed various factors, including our annual earnings and taxing jurisdictions in which the earnings were generated, the impact of state and local income taxes and our ability to use tax credits and net operating loss carryforwards.
We assess uncertain tax positions and recognize income tax benefits when, based on the technical merits of a tax position, we believe that if a dispute arose with the taxing authority and was taken to a court of last resort, it is more likely than not (i.e., a probability of greater than 50 percent) that the tax position would be sustained as filed. If a position is determined to be more likely than not of being sustained, the reporting enterprise should recognize the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority. Our practice is to recognize interest and penalties related to income tax matters in income tax expense.
We file income tax returns in the United States Federal jurisdiction and in many state and foreign jurisdictions. The tax years 2007 through 2012 remain open to examination by the major taxing jurisdictions to which we are subject. The Internal Revenue Service has initiated an examination of our 2009 federal income tax return. While the ultimate outcome of the audit is uncertain, management does not currently believe that the outcome will have a material adverse effect on our financial position, results of operations or cash flows. Stock-Based Compensation
We recognize stock-based compensation expense in accordance with the Compensation - Stock Compensation Topic of the FASB ASC which requires the measurement and recognition of compensation expense for stock-based awards granted to employees based on estimated fair values on the date of grant. See Note 14 to our Consolidated Financial Statements in Item 8 of Part II of this report for information regarding our assumptions related to stock-based compensation and the amount of stock-based compensation expense we incurred for the years covered in this report.
We estimate the fair value of our restricted stock unit awards based on the fair value of our common stock on the date of grant. Our outstanding restricted stock unit awards are subject to service-based vesting conditions and performance-based vesting conditions. We recognize the estimated fair value of service-based awards, net of estimated forfeitures, as stock-based compensation expense over the vesting period on a straight-line basis. Awards with performance-based vesting conditions require the achievement of specific financial targets at the end of the specified performance period and are subject to the employee's continued employment over the vesting period. We recognize the estimated fair value of performance-based awards, net of estimated forfeitures, as stock-based compensation expense over the vesting period, which considers each performance period or tranche separately, based upon our determination of the level of achievement of the performance targets. At each reporting period, we reassess the level of achievement of the performance targets within the related performance period. Determining the level of achievement of the performance targets involves judgment, and the estimate of stock-based


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compensation expense may be revised periodically based on changes. If any performance goals specific to the restricted stock unit awards are not met, no compensation cost ultimately is recognized for such awards, and to the extent previously recognized, compensation cost is reversed. As of December 31, 2013, the level of achievement of the performance target awards for performance years 2011, 2012 and 2013 was 134%, 129.5% and 111.2%, respectively. During 2013, we revised our estimate of the level of achievement of the performance awards for the performance year of 2013 from 100% of target to 111.2% of target. Our consolidated net income for the year ended December 31, 2013 was $162.8 million and diluted earnings per share was $2.46 per share. If we had continued to use the previous estimate of the level of achievement of 100% of the performance target for the performance year of 2013, the as adjusted net income for the year ended December 31, 2013 would have been approximately $163.6 million and the as adjusted diluted earnings per share would have had been approximately $2.47 per share. As of December 31, 2013, the performance years 2011 and 2012 were complete and the levels of achievement of the performance targets were fixed.
Consolidated Results of Operations
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2013 The following table presents an overview of our results of operations for the years ended December 31, 2012 and 2013.

                                                   Years Ended December 31,
                                     2012            2013                2012 vs. 2013
                                       $               $           $ Change        % Change
                                             (in thousands, except per share data)
Revenue                          $   831,388     $   902,041     $    70,653            8.5  %
Operating expense:
Cost of revenue (excluding
depreciation and amortization
shown separately below)              185,965         212,572          26,607           14.3  %
Sales and marketing                  163,729         178,017          14,288            8.7  %
Research and development              29,794          27,993          (1,801 )         (6.0 )%
General and administrative            81,797          93,930          12,133           14.8  %
Depreciation and amortization         92,955         100,233           7,278            7.8  %
Restructuring charges                    489               2            (487 )        (99.6 )%
                                     554,729         612,747          58,018           10.5  %
Income from operations               276,659         289,294          12,635            4.6  %
Other (expense) income:
Interest and other expense           (34,155 )       (34,527 )          (372 )          1.1  %
Interest and other income                596             357            (239 )        (40.1 )%
Income before income taxes           243,100         255,124          12,024            4.9  %
Provision for income taxes            87,013          92,372           5,359            6.2  %
Net income                       $   156,087     $   162,752     $     6,665            4.3  %

Net income per share:
Basic                            $      2.34     $      2.52
Diluted                          $      2.30     $      2.46
Weighted average common shares
outstanding:
Basic                                 66,737          64,463
Diluted                               67,956          66,108


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Revenue
Revenue. Revenue increased $70.7 million driven by strong demand for our services and a $26.7 million increase in the fixed fee established under our contracts to provide NPAC Services. Revenue from our Marketing Services increased $19.1 million, driven by increased demand for our services that help our clients make instant and high impact decisions to promote their businesses and increase customer retention. Data Services revenue increased $13.4 million driven by increased demand for services that enable our carrier clients to exchange essential operating information with multiple carriers. Revenue from our Security Services increased $6.8 million driven by an increase in demand for our DDoS mitigation services.
Expense
Cost of revenue. Cost of revenue increased $26.6 million due to an increase of $10.4 million in personnel and personnel-related expense, an increase of $8.4 million in costs related to our information technology and systems, an increase of $5.4 million in royalties, and an increase of $2.4 million in contractor costs incurred to support our business operations. The increase in personnel and personnel-related expense was due to increases in stock-based compensation and salary and benefits, which were driven by increased headcount. In addition, the increase in costs related to our information technology and systems was associated with increased sales that resulted in increased data processing, telecommunications, and maintenance costs.
Sales and marketing. Sales and marketing expense increased $14.3 million due to an increase of $9.3 million in personnel and personnel-related expense and an increase of $5.0 million in advertising and marketing costs. The increase in personnel and personnel-related expense was due to increases in stock-based compensation and salary and benefits, which were driven by increased average headcount related to the expansion of our sales and marketing teams to support service offerings. The increase in advertising and marketing costs was driven by costs incurred to promote awareness of our services and outsourced fees incurred to support our long-term sales strategy.
Research and development. Research and development expense decreased $1.8 million due to a decrease of $1.3 million in personnel and personnel-related expense.
General and administrative. General and administrative expense increased $12.1 million due to an increase of $6.8 million in personnel and personnel-related expense, an increase of $3.6 million in professional fees, and an increase of $2.1 million in bad debt expense. The increase in personnel and personnel-related expense was driven by stock-based compensation. The increase in professional fees was driven by costs incurred to support business growth, strategic planning and pursuit of new business opportunities.
Depreciation and amortization. Depreciation and amortization expense increased $7.3 million due to an increase of $9.2 million in depreciation expense related to capitalized development costs. This increase was partially offset by a decrease of $2.1 million in depreciation expense related to assets under capital leases.
Restructuring charges. Restructuring charges for the year ended December 31, 2012 were comparable to the charges recorded for the year ended December 31, 2013.
Interest and other expense. Interest and other expense increased $0.4 million due to a $10.9 million loss on debt modification and extinguishment recorded in the first quarter of 2013 in connection with the refinancing of our 2011 Credit Facilities. This increase was partially offset by lower interest expense of $10.3 million driven by the refinancing of our 2011 Credit Facilities. Interest and other income. Interest and other income for the year ended December 31, 2012 was comparable to the income recorded for the year ended December 31, 2013.
Provision for income taxes. Our effective tax rate for the year ended December 31, 2013 increased to 36.2% from 35.8% for the year ended December 31, 2012. During 2013, we recorded $4.8 million of discrete tax benefits primarily due to research tax credits and a worthless stock deduction. During 2012, we recorded $6.8 million of discrete tax benefits due to our domestic production activities deduction and utilization of foreign tax credits against federal income taxes. Excluding discrete tax benefits, our effective tax rate would have been approximately 38.6% and 38.1% for the years ended December 31, 2012 and 2013, respectively. This decrease is primarily associated with federal research tax credits recorded in 2013, partially offset by nondeductible transaction related costs in connection with our acquisition completed in the fourth quarter . . .

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