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JCOM > SEC Filings for JCOM > Form 10-Q on 6-Nov-2012All Recent SEC Filings

Show all filings for J2 GLOBAL, INC.

Form 10-Q for J2 GLOBAL, INC.


6-Nov-2012

Quarterly Report


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

Forward-Looking Information

In addition to historical information, the foregoing Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. These forward-looking statements involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those discussed below, the risk factors discussed in Part II, Item 1A - "Risk Factors" of this Quarterly Report on Form 10-Q (if any) and in Part I, Item 1A - "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2011 (together, the "Risk Factors"), and the factors discussed in the section in this Quarterly Report on Form 10-Q entitled "Quantitative and Qualitative Disclosures About Market Risk." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the Risk Factors and the risk factors set forth in other documents we file from time to time with the SEC.

Some factors that could cause actual results to differ materially from those anticipated in these forward-looking statements include, but are not limited to, our ability and intention to:

?          Sustain growth or profitability, particularly in light of an uncertain
           U.S. or worldwide economy and the related impact on customer
           acquisition and retention rates, customer usage levels and credit and
           debit card payment declines;


?          Maintain and expand our customer base and maintain or increase the
           average revenue per subscriber;


?          Generate sufficient cash flow to make interest and debt payments and
           reinvest in our business, and pursue desired activities and businesses
           plans while satisfying restrictive covenants relating to debt
           obligations;


?          Acquire sizeable businesses on acceptable terms and successfully
           integrate and realize anticipated synergies from such acquisitions;


?          Continue to expand our business and operations internationally in the
           wake of numerous risks, including adverse currency fluctuations,
           difficulty in staffing and managing international operations, higher
           operating costs as a percentage of revenues or the implementation of
           adverse regulations;


?          Maintain our financial position, operating results and cash flows in
           the event that we incur new or unanticipated costs or income, sales or
           other tax liabilities;


?          Accurately estimate the assumptions underlying our effective worldwide
           tax rate;

? Continue to pay a comparable cash dividend on a quarterly basis;

?          Maintain favorable relationships with critical third-party vendors
           whose financial condition will not negatively impact the services they
           provide;


?          Manage certain risks inherent to our business, such as costs
           associated with fraudulent activity, a system failure or security
           breach of our network, effectively maintaining and managing our
           billing systems, time and resources required to manage our legal
           proceedings or adhering to our internal controls and procedures;


?          Compete with other similar providers with regard to price, service and
           functionality;


?          Cost-effectively procure, retain and deploy large quantities of
           telephone numbers in desired locations in the United States and
           abroad;


?          Achieve business and financial objectives in light of burdensome
           domestic and international telecommunications, Internet or other
           regulations including data privacy, security and retention;


?          Successfully manage our growth, including but not limited to our
           operational and personnel-related resources, and integrate newly
           acquired businesses;


?          Successfully adapt to technological changes in the value added
           messaging and communications services industry;


?          Successfully develop and protect our intellectual property, both
           domestically and internationally, including our brands, patents,
           trademarks and domain names, and avoid infringing upon the proprietary
           rights of others;


?          Diversify our service offerings and derive more revenue from those
           services at acceptable levels of returns-on-

-25-

investment; and
? Recruit and retain key personnel.

In addition, our financial results could be materially impacted by risks associated with new accounting pronouncements.

Overview

j2 Global, Inc. ("j2 Global", "our", "us" or "we") is a Delaware corporation founded in 1995. We provide cloud services to businesses of all sizes, from individuals to enterprises. These services, which we provide through the Internet to our customers' computers, mobile devices and telephones, deliver our customers increased sales and greater efficiency, flexibility, mobility, business continuity and security. We offer online fax, virtual phone systems, hosted email, email marketing, online backup, customer relationship management and bundled suites of these services. We market our services principally under the brand names eFax®, eVoice®, FuseMail®, Campaigner®, KeepItSafe®, CampaignerCRMTM and Onebox®.

We generate substantially all of our revenues from "fixed" subscription revenues for basic customer subscriptions and "variable" usage revenues generated from actual usage by our subscribers. We also generate revenues from patent licensing and sales and advertising. We categorize our services and solutions into two basic groups: direct inward-dial number ("DID") -based, which are services provided in whole or in part through a telephone number, and non-DID based, which are our other cloud services for business. As of September 30, 2012, we had approximately 2.1 million DIDs deployed to our paying subscribers, with additional DIDs in inventory. We operate in one reportable segment: cloud services for business.

We market our services to a broad spectrum of prospective business customers including individuals, small to medium-sized businesses, large enterprises and government organizations. Our marketing efforts include enhancing brand awareness; utilizing online advertising, search engines and affiliate programs; and selling through both a telesales and direct sales force and cross selling. We continuously seek to extend the number of distribution channels through which we acquire paying customers and improve the cost and volume of customers obtained through our current channels.

In addition to growing our business organically, we have used acquisitions to grow our customer base, expand our service offerings, enhance our technology and acquire skilled personnel. Since fiscal year 2000, we have completed 39 acquisitions in the cloud services for business industry. We continue to evaluate acquisitions on an on-going basis and expect to complete additional acquisitions in 2012.

We have a global presence with over 625 employees across 11 offices in 6 countries, and are able to market, sell and provide our services virtually anywhere in the world where access to the Internet is available.

The following table sets forth certain key operating metrics for the three and nine months ended September 30, 2012 and 2011 (in thousands, except for percentages):

September 30,
2012 2011
Paying telephone numbers 2,077 1,994

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                                            Three Months Ended September 30,           Nine Months Ended September 30,
                                                2012                 2011                 2012               2011 (1)
Subscriber revenues:
Fixed                                    $        72,284       $        70,364     $       214,699       $       197,061
Variable                                          17,182                15,258              47,663                46,727
Total subscriber revenues                $        89,466       $        85,622     $       262,362       $       243,788
Percentage of total subscriber revenues:
Fixed                                               80.8 %                82.2 %              81.8 %                80.8 %
Variable                                            19.2 %                17.8 %              18.2 %                19.2 %
Subscriber revenues:
DID-based                                $        82,937       $        79,720     $       242,961       $       226,152
Non-DID-based                                      6,529                 5,902              19,401                17,636
Total subscriber revenues                $        89,466       $        85,622     $       262,362       $       243,788

(1) The amounts above reflect the change in estimate relating to the remaining service obligations to annual eFax® subscribers (See Note 1 - Basis of Presentation), which reduced subscriber revenues for the nine months ended September 30, 2011 by $10.3 million.

Critical Accounting Policies and Estimates

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements. Actual results could differ significantly from those estimates under different assumptions and conditions. Our critical accounting policies are described in our 2011 Annual Report on Form 10-K filed with the SEC on February 28, 2012. During the three months ended September 30, 2012, there were no significant changes in our critical accounting policies and estimates.

Results of Operations for the Three and Nine Months Ended September 30, 2012

Revenues

Subscriber Revenues.

(in thousands,
except           Three Months Ended September    Percentage     Nine Months Ended     Percentage
percentages)                  30,                  Change         September 30,         Change
                      2012             2011                      2012        2011
Subscriber           $89,466          $85,622        4%        $262,362    $243,788       8%
Revenues

Subscriber revenues consist of both a fixed monthly or annual recurring subscription component and a variable component driven by actual usage of our service offerings. Over the past three calendar years, the fixed portion of our subscriber revenues has grown and generally contributed an increasing percentage to our total subscriber revenues. This increase in subscriber revenues was due to an increase in our subscriber base and the impact of our first quarter 2011 change in estimate relating to remaining service obligations to eFax® annual subscribers (See Note 1 - Basis of Presentation) which reduced subscriber revenues for the nine months ended September 30, 2011 by $10.3 million. The increase in our subscriber base resulted from new subscribers due to business acquisitions and subscribers coming directly to our websites; corporate, enterprise and government sales; and free-to-paid subscriber upgrades, in each case net of cancellations.

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Other Revenues.

(in thousands,
except                 Three Months Ended       Percentage     Nine Months Ended     Percentage
percentages)             September 30,            Change         September 30,         Change

2012 2011 2012 2011 Other Revenues $3,780 $405 833% $7,001 $1,299 439%

Other revenues consist primarily of revenues generated from patent and technology licensing and sales transactions. Our licensing revenues are subject to fluctuations due to the nature of the litigations and licensing process. The increase in other revenues for the three and nine months ended September 30, 2012 resulted primarily from increased patent and technology related licensing revenues.

Cost of Revenues

(in thousands,
except               Three Months Ended      Percentage     Nine Months Ended     Percentage
percentages)            September 30,          Change         September 30,         Change
                     2012          2011                     2012         2011
Cost of revenue     $16,303       $15,002        9%       $48,354      $45,952        5%
As a percent of       17%           17%          -%         18%          19%         (1)%
revenue

Cost of revenues is primarily comprised of costs associated with data and voice transmission, DIDs, network operations, customer service, online processing fees and equipment depreciation. The increase in cost of revenues for the three and nine months ended September 30, 2012 was primarily due to an increase in costs associated with businesses acquired in the last twelve months that for at least some portion of the first nine months of fiscal 2012 were not yet fully integrated into j2 Global, partially offset by reduced processing fees and a decrease in personnel and severance costs associated with businesses acquired in the prior comparable period.

Operating Expenses

Sales and Marketing.

(in thousands,
except               Three Months Ended      Percentage     Nine Months Ended     Percentage
percentages)            September 30,          Change         September 30,         Change
                     2012          2011                     2012         2011
Sales and           $15,190       $15,073        1%       $43,910      $44,929       (2)%
Marketing
As a percent of       16%           18%         (2)%        16%          18%         (2)%
revenue

Our sales and marketing costs consist primarily of Internet-based advertising, sales and marketing, personnel costs and other business development-related expenses. Our Internet-based advertising relationships consist primarily of fixed cost and performance-based (cost-per-impression, cost-per-click and cost-per-acquisition) advertising relationships with an array of online service providers. We have a disciplined return-on-investment approach to our Internet-based advertising and marketing spend, which can cause sales and marketing costs as a percentage of total revenues to vary from period to period based upon available opportunities. Advertising cost for the three months ended September 30, 2012 and 2011 was $12.2 million and $11.8 million, respectively, and for the nine months ended September 30, 2012 and 2011 was $35.2 million and $34.2 million, respectively. The increase in sales and marketing expenses for the three months ended September 30, 2012 was primarily due to additional advertising partially offset by a decrease in personnel costs associated with businesses acquired and lower commissions and consulting fees in comparison to the prior comparable quarter. The decrease in sales and marketing expenses for the nine months ended September 30, 2012 was primarily due to a decrease in personnel and severance costs associated with businesses acquired partially offset by additional advertising in comparison to the prior comparable period.

-28-

Research, Development and Engineering.

(in thousands,
except               Three Months Ended      Percentage     Nine Months Ended     Percentage
percentages)            September 30,          Change         September 30,         Change
                     2012          2011                     2012         2011
Research,           $4,692        $4,105        14%       $13,798      $12,714        9%
Development and
Engineering
As a percent of       5%            5%           -%          5%           5%          -%
revenue

Our research, development and engineering costs consist primarily of personnel-related expenses. The increase in research, development and engineering costs for the three months ended September 30, 2012 was primarily due to an increase in personnel costs associated with businesses acquired in comparison to the prior comparable quarter and additional expenses for professional services. The increase in research, development and engineering costs for the nine months ended September 30, 2012 was primarily due to an increase in personnel costs associated with businesses acquired subsequent to the prior comparable period.

General and Administrative.

(in thousands,
except               Three Months Ended      Percentage     Nine Months Ended     Percentage
percentages)            September 30,          Change         September 30,         Change
                     2012          2011                     2012         2011
General and         $14,784       $15,403       (4)%      $43,387      $44,037       (1)%
Administrative
As a percent of       16%           18%         (2)%        16%          18%         (2)%
revenue

Our general and administrative costs consist primarily of personnel-related expenses, depreciation and amortization, share-based compensation expense, bad debt expense, professional fees and insurance costs. The decrease in general and administrative expense for the three months ended September 30, 2012 was primarily due to a decrease in bad debt expense partially offset by additional amortization of intangible assets related to businesses acquired, compensation and professional fees in comparison to the prior comparable quarter. The decrease in general and administrative expense for the nine months ended September 30, 2012 was primarily due to a decrease in bad debt expense, personnel and severance costs associated with businesses acquired and certain losses on sublease and asset retirements in comparison to the prior comparable period partially offset by additional amortization of intangible assets related to businesses acquired, increase in professional fees and legal settlements.

Share-Based Compensation

The following table represents share-based compensation expense included in cost
of revenues and operating expenses in the accompanying condensed consolidated
statements of operations for the three and nine months ended September 30, 2012
and 2011 (in thousands):

                                         Three Months Ended September 30,    Nine Months Ended September 30,
                                               2012               2011              2012             2011
Cost of revenues                        $             199     $      246     $            633     $     736
Operating expenses:
Sales and marketing                                   390            350                1,117         1,049
Research, development and engineering                 111            110                  344           367
General and administrative                          1,703          1,542                4,757         4,532
Total                                   $           2,403     $    2,248     $          6,851     $   6,684

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Non-Operating Income and Expenses

Interest and Other Income (Expense), net. Our interest and other income (expense), net is generated primarily from interest charged on outstanding debt; gain or loss on foreign exchange; and interest earned on cash, cash equivalents and short-term and long-term investments. Interest and other income (expense), net was $(2.7) million and $0.3 million for the three months ended September 30, 2012 and 2011, respectively, and $(2.7) million and $0.3 million for the nine months ended September 30, 2012 and 2011. The change in interest and other income (expense), net for the three months ended September 30, 2012 was primarily due to interest accrued on the outstanding debt issued in July 2012 partially offset by additional interest income and gain on foreign exchange primarily from short-term intercompany balances denominated in foreign currencies that remained unsettled. The change in interest and other income (expense), net for the nine months ended September 30, 2012 was primarily due to interest accrued on the outstanding debt issued in July 2012 partially offset by a gain on sale of an investment and additional interest income.

Income Taxes

Our effective tax rate is based on pre-tax income, statutory tax rates, tax regulations (including those related to transfer pricing) and different tax rates in the various jurisdictions in which we operate. The tax bases of our assets and liabilities reflect our best estimate of the tax benefits and costs we expect to realize. When necessary, we establish valuation allowances to reduce our deferred tax assets to an amount that will more likely than not be realized.

Provision for income taxes amounted to $7.9 million and $11.2 million for the three months ended September 30, 2012 and 2011, respectively. Income tax expense for the nine months ended September 30, 2012 and 2011 was $25.9 million and $12.8 million, respectively. Our effective tax rate was 19.9% and 30.6% for the three months ended September 30, 2012 and 2011, respectively, and 22.1% and 13.1% for the nine months ended September 30, 2012 and 2011, respectively. The decrease in our effective income tax rate for the three months ended September 30, 2012 was primarily attributable to the following:

1. an increase during the third quarter 2012 in the U.S. federal domestic production activities deduction;

2. a decrease in return to provision adjustments; and

3. a decrease in state apportionment; partially offset by:

4. an increase during the third quarter 2012 in the valuation allowance for a U.S. federal foreign tax credit.

The increase in our effective income tax rate for the nine months ended September 30, 2012 was primarily attributable to the following:

1. a reversal during the first quarter 2011 of approximately $14.1 million of uncertain income tax positions as a result of expiring statutes of limitations; and

2. an increase during the third quarter 2012 in the valuation allowance for a U.S. federal foreign tax credit; partially offset by:

3. an increase during the third quarter 2012 in the U.S. federal domestic production activities deduction.

4. a decrease in return to provision adjustments; and

5. a decrease in state apportionment.

-30-

Liquidity and Capital Resources

Cash and Cash Equivalents and Investments

At September 30, 2012, we had cash and investments of $469.8 million compared to $220.9 million at December 31, 2011. The increase resulted primarily from the proceeds from our issuance of $250 million of long-term debt in July 2012 and cash provided by operations, partially offset by share repurchases, dividends and business acquisitions. At September 30, 2012, cash and investments consisted of cash and cash equivalents of $287.5 million, short-term investments of $143.6 million and long-term investments of $38.7 million. Our investments are comprised primarily of readily marketable corporate and governmental debt securities, money-market accounts and time deposits. For financial statement presentation, we classify our investments primarily as available-for-sale; thus, they are reported as short- and long-term based upon their maturity dates. Short-term investments mature within one year of the date of the financial statements and long-term investments mature one year or more from the date of the financial statements. Short-term investments include restricted balances in which the Company may not liquidate certain investments until maturity, generally within 12 months. Restricted balances included in short-term investments were $34.9 million at September 30, 2012. We retain a substantial portion of our cash and investments in foreign jurisdictions for future reinvestment. As of September 30, 2012, cash and investments held within foreign and domestic jurisdictions were $137.8 million and $ 332.0 million, respectively. If we were to repatriate funds held within foreign jurisdictions, we would incur U.S. income tax on the repatriated amount at the federal statutory rate of 35% and the state statutory rate where applicable, net of a credit for foreign taxes paid on such amounts.

The Company's Board of Directors approved several quarterly cash dividends during the nine months ended September 30, 2012, totaling approximately $0.65 per share of common stock. On October 31, 2012, the Company's Board of Directors approved a quarterly cash dividend of $0.225 per share of common stock payable on November 26, 2012 to all stockholders of record as of the close of business on November 12, 2012. Future dividends are subject to Board approval and certain restrictions within the Credit Agreement (the "Credit Agreement") with Union Bank, N.A. (the "Lender") and within the Indenture relating to the note issuance referenced below, a copy of which the Company filed with the SEC as an exhibit to its Current Report on Form 8-K on July 26, 2012.

On July 26, 2012, the Company completed the sale in a private offering of $250 million in aggregate principal amount of 8.000% senior unsecured notes due 2020. The net proceeds of the sale were $243.7 million after deducting the initial purchaser's discounts, commissions and expenses of the offering. The Company intends to use the net proceeds from the offering for general corporate purposes, which may include acquisitions.

We currently anticipate that our existing cash and cash equivalents and short-term investment balances and cash generated from operations will be sufficient to meet our anticipated needs for working capital, capital expenditure, investment requirements, stock repurchases and cash dividends for at least the next 12 months.

Cash Flows

Our primary sources of liquidity are cash flows generated from operations, together with cash and cash equivalents and short-term investments. Net cash provided by operating activities was $123.5 million and $109.2 million for the nine months ended September 30, 2012 and 2011, respectively. Our operating cash flows resulted primarily from cash received from our subscribers offset by excess tax benefit from share-based compensation, cash payments we made to third parties for their services and employee compensation. Certain tax payments are prepaid during the year and included within prepaid expenses and other current assets on the consolidated balance sheet. Our prepaid tax payments were $7.4 million and $11.0 million at September 30, 2012 and December 31, 2011, respectively. A significant portion of our subscribers pay us via credit cards and therefore our receivables from subscribers generally settle quickly.

Net cash used in investing activities was approximately $(135.4) million and . . .

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