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JCOM > SEC Filings for JCOM > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for J2 GLOBAL, INC.


12-Nov-2013

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, 2012 (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 increase our cloud services customer base and average
           revenue per user;


•          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 businesses on acceptable terms and successfully integrate and
           realize anticipated synergies from such acquisitions;


•          Continue to expand our businesses 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 tax liabilities,
           including those relating to federal and state income tax and indirect
           taxes, such as sales, value-added and telecommunication taxes;


•          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;


•          Create compelling digital media content causing increased traffic and
           advertising levels; additional advertisers or an increase in
           advertising spend; and effectively target digital media advertisements
           to desired audiences;


•          Manage certain risks inherent to our business, such as costs
           associated with fraudulent activity, system failure or network
           security breach; 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 integration of newly
           acquired businesses;


•          Successfully adapt to technological changes and diversify services and
           related revenues at acceptable levels of financial return;

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•          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; 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., together with its subsidiaries ("j2 Global", the "Company", "our", "us" or "we"), is a leading provider of Internet services. Through our Business Cloud Services Division, we provide cloud services to businesses of all sizes, from individuals to enterprises, and license our intellectual property ("IP") to third parties. Our Digital Media Division operates a portfolio of web properties providing technology, gaming and lifestyle content, and an innovative data-driven platform to connect advertisers with visitors to those properties in addition to websites operated by third parties that are part of the Division's advertising network.

We generate revenues primarily from subscription and usage fees for our business cloud services, advertising fees for our digital media businesses and license fees for the use of our IP.
In addition to growing our businesses organically, we acquire businesses to grow our customer bases, expand and diversify our service offerings, enhance our technologies and acquire skilled personnel. Since December 31, 2000, and including acquisitions closed thus far in 2013, we have completed 45 acquisitions.
On November 9, 2012, we acquired Ziff Davis, Inc. ("Ziff Davis"), a company with extensive digital content holdings within the technology vertical. This acquisition expanded our operations into the digital media market, an area we believe provides attractive profit and expansion opportunities. On February 1, 2013, Ziff Davis acquired IGN Entertainment, Inc. ("IGN"), an online publisher of video games, entertainment and men's lifestyle content. On May 16, 2013, Ziff Davis acquired NetShelter, the largest community of technology publishers dedicated to consumer electronics, computing and mobile communications. For additional information on our acquisitions, see Note 3 - Business Acquisitions in the Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.
j2 Global was founded in 1995 and is a Delaware corporation. We manage our operations through two business segments: Business Cloud Services and Digital Media. Information regarding revenue and operating income attributable to each of our reportable segments is included within Note 13 - Segment Information of the Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q, which is incorporated herein by reference. IP licensing activities are included within the Business Cloud Services segment. Our Business Cloud Services revenues are impacted by the number of effective business days in a given period. We traditionally experience lower than average Business Cloud Services usage and customer sign-ups in the fourth quarter. Revenues associated with our Digital Media operations are subject to seasonal fluctuations, becoming most active during the fourth quarter holiday period due to increased online retail activity.
Business Cloud Services Segment Performance Metrics

The following table sets forth certain key operating metrics for our Business Cloud Services segment as of and for the three and nine months ended September 30, 2013 and 2012 (in thousands, except for percentages):

September 30,
2013 2012
Paying telephone numbers 2,218 2,077

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                                             Three Months Ended September 30,           Nine Months Ended September 30,
                                                 2013                 2012                 2013                 2012
Subscriber revenues:
Fixed                                     $        74,540       $        72,284     $       220,370       $       214,699
Variable                                           18,753                17,182              56,177                47,663
Total subscriber revenues                 $        93,293       $        89,466     $       276,547       $       262,362
Percentage of total subscriber revenues:
Fixed                                                79.9 %                80.8 %              79.7 %                81.8 %
Variable                                             20.1 %                19.2 %              20.3 %                18.2 %
Subscriber revenues:
DID-based                                 $        85,710       $        82,937     $       254,394       $       242,961
Non-DID-based                                       7,583                 6,529              22,153                19,401
Total subscriber revenues                 $        93,293       $        89,466     $       276,547       $       262,362

Average revenue per paying telephone
number (ARPU)(1)                          $         12.87       $         13.27     $         13.04       $         13.11
Cancel Rate(2)                                        2.3 %                 2.3 %

(1) Quarterly ARPU is calculated using our standard convention of applying the average of the quarter's beginning and ending base to the total revenue for the quarter. We believe ARPU provides investors an understanding of the average monthly revenues we recognize associated with each DID deployed to our paying customers. As ARPU varies based on fixed subscription fee and variable usage components, we believe it can serve as a measure by which investors can evaluate trends in the types of services, levels of services and the usage levels of those services across our paying DID base.

(2) Cancel rate is defined as cancels related to individual customer DIDs with greater than four months of continuous service (continuous service includes customer DIDs which are administratively canceled and reactivated within the same calendar month).

Digital Media Segment Performance Metrics

Our Digital Media segment was established with our fourth quarter 2012
acquisition of Ziff Davis. As a result, the following performance metrics for
our Digital Media segment for the three and nine months ended September 30, 2013
are presented with no prior comparable period (in millions):
           Three Months Ended September 30,    Nine Months Ended September 30,
                         2013                                2013
Visits                                  601                              1,536
Page views                            2,002                              5,148

Sources: Omniture; Google Analytics

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 2012 Annual Report on Form 10-K filed with the SEC on March 1, 2013. During the three months ended September 30, 2013, there were no significant changes in our critical accounting policies and estimates.

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Results of Operations for the Three and Nine Months Ended September 30, 2013 Business Cloud Services Segment
Assuming a stable or improving economic environment, we expect the revenue and expense trends as included in the results of operations below in our Business Cloud Services segment to continue for the foreseeable future excluding the impact of acquisitions. The main focus of our Business Cloud Services offerings is to reduce or eliminate costs, increase sales and enhance productivity, mobility, business continuity and security of our customers as the technologies and devices they use evolve over time. As a result, we expect to continue to take steps to enhance our existing offerings and offer new services to continue to satisfy the evolving needs of our customers. Through our IP licensing operations, which are included in the Business Cloud Services segment, we seek to make our IP available for license to third parties, and we expect to continue to attempt to obtain additional IP through a combination of acquisitions and internal development in an effort to increase available licensing opportunities and related revenues.
We expect acquisitions to remain an important component of our strategy and use of capital; however, we cannot predict whether our current pace of acquisitions will remain the same within this segment. In a given period, we may close greater or fewer acquisitions than in prior periods. Also, as IP licensing often involves litigation, the timing of licensing transactions is unpredictable and can and does vary significantly from period-to-period. Digital Media Segment
Assuming a stable or improving economic environment, we expect the revenue trend in our Digital Media segment to improve over the next several quarters as we integrate our recent acquisitions and over the longer term as advertising transactions continue to shift from offline to online. The main focus of our advertising programs is to provide relevant and useful advertising to visitors to our websites and those included within our advertising networks, reflecting our commitment to constantly improve their overall web experience. As a result, we expect to continue to take steps to improve the relevance of the ads displayed on our websites and those included within our advertising networks. The operating margin we realize on revenues generated from ads placed on our websites is significantly higher than the operating margin we realize from revenues generated from those placed on third-party websites. Growth in advertising revenues from our websites has generally exceeded that from third-party websites. This trend has had a positive impact on our operating margins, and we expect that this will continue for the foreseeable future. However, the trend in advertising spend is shifting to mobile devices and other newer advertising formats which generally experience lower margins than those from desktop computers and tablets. We expect this trend to continue to pressure our margins.
We expect acquisitions to remain an important component of our strategy and use of capital; however, we cannot predict whether our current pace of acquisitions will remain the same within this segment. In a given period, we may close greater or fewer acquisitions than in prior periods. j2 Global Consolidated
We anticipate the stable revenue trend in our Business Cloud Services segment combined with the improving revenue trend in our Digital Media segment will result in an overall improved revenue trend for j2 Global on a consolidated basis, excluding the impact of any future acquisitions and revenues associated with licensing our IP which can and do vary dramatically from period-to-period. We expect operating profit as a percentage of revenues to generally decline in the future as we expect our less profitable Digital Media segment and the expected increasing pressure on margins as described above to grow at a faster rate than our more profitable Businesses Cloud Services segment, excluding the impact of any future acquisitions and partially offset by improved Digital Media segment margins due to economies of scale.

Revenues

(in thousands, Three Months Ended Percentage Nine Months Ended Percentage except percentages) September 30, Change September 30, Change 2013 2012 2013 2012 Revenues $127,788 $93,246 37% $382,766 $269,363 42%

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Our revenues consist of revenues from our Business Cloud Services segment and from our Digital Media segment. Business Cloud Services revenues primarily consist of revenues from "fixed" customer subscription revenues and "variable" revenues generated from actual usage of our services. We also generate Business Cloud Services revenues from IP licensing. Digital Media revenues primarily consist of advertising revenues, fees paid for generating business leads, and licensing and sale of editorial content and trademarks.

Our revenues have increased over the comparable three and nine month periods of 2012 primarily due to the following factors:

•Our acquisitions of Ziff Davis, IGN and NetShelter in the Digital Media segment;

•            As it relates to the nine month period of 2012, increase in our
             Business Cloud Services IP licensing revenues as a result of the $27
             million patent license agreement secured with Open Text during the
             second quarter of 2013, resulting in approximately $12.6 million of
             revenues during that quarter as associated with past damages; and



•            Growth in our Business Cloud Services subscriber base due to
             business acquisitions and new customer sign ups, net of
             cancellations.



Cost of Revenues

(in thousands, except   Three Months Ended      Percentage     Nine Months Ended     Percentage
percentages)               September 30,          Change         September 30,         Change
                        2013          2012                     2013         2012
Cost of revenue        $21,801       $16,303       34%       $64,715      $48,354       34%
As a percent of          17%           17%          -%         17%          18%         (1)%
revenue

Cost of revenues is primarily comprised of costs associated with data and voice transmission, DIDs, network operations, customer service, editorial and production costs, online processing fees and equipment depreciation. The increase in cost of revenues for the three and nine months ended September 30, 2013 was primarily due to an increase in costs associated with the acquisitions of Ziff Davis, IGN and NetShelter within the Digital Media segment and other acquisitions within the Business Cloud Services segment.

Operating Expenses

Sales and Marketing.

(in thousands,        Three Months Ended     Percentage     Nine Months Ended     Percentage
except percentages)      September 30,         Change         September 30,         Change
                       2013         2012                    2013         2012
Sales and Marketing  $34,787      $15,190       129%      $99,638      $43,910       127%
As a percent of        27%          16%         11%         26%          16%         10%
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. Advertising cost for the three months ended September 30, 2013 and 2012 was $13.9 million and $12.2 million, respectively, and for the nine months ended September 30, 2013 and 2012 was $42.5 million and $35.2 million, respectively. The increase in sales and marketing expenses for the three and nine months ended September 30, 2013 versus the prior comparable period was primarily due to additional personnel and severance costs associated with the acquisitions of Ziff Davis, IGN and NetShelter in the Digital Media segment and other acquisitions within the Business Cloud segment as well as increased advertising.

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Research, Development and Engineering.
(in thousands,        Three Months Ended     Percentage     Nine Months Ended     Percentage
except percentages)      September 30,         Change         September 30,         Change
                       2013         2012                    2013         2012
Research,             $6,000       $4,692       28%       $19,134      $13,798       39%
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 and nine months ended September 30, 2013 versus the prior comparable period was primarily due to additional personnel and severance costs associated with the acquisitions of Ziff Davis, IGN and NetShelter in the Digital Media segment during the fourth quarter of 2012 or subsequent periods.

General and Administrative.

(in thousands,
except               Three Months Ended      Percentage     Nine Months Ended     Percentage
percentages)            September 30,          Change         September 30,         Change
                     2013          2012                     2013         2012
General and         $25,892       $14,784       75%       $74,377      $43,387       71%
Administrative
As a percent of       20%           16%          4%         19%          16%          3%
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 increase in general and administrative expense for the three and nine months ended September 30, 2013 versus the prior comparable periods was primarily due to additional personnel costs, severance costs and amortization of intangible assets associated with the acquisitions of Ziff Davis, IGN and NetShelter in the Digital Media segment and other acquisitions within the Business Cloud segment during the fourth quarter of 2012 and subsequent periods.

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 income for the three and nine months ended September 30, 2013 and
2012 (in thousands):
                                              Three Months Ended
                                                 September 30,          Nine Months Ended September 30,
                                              2013           2012              2013             2012
Cost of revenues                          $       162     $     199     $            581     $     633
Operating expenses:
Sales and marketing                               465           390                1,315         1,117
Research, development and engineering             103           111                  311           344
General and administrative                      1,695         1,703                4,901         4,757
Total                                     $     2,425     $   2,403     $          7,108     $   6,851

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 $(4.6) million and $(2.7) million for the three months ended September 30, 2013 and 2012, respectively, and $(14.1) million and $(2.7) million for the nine months ended September 30, 2013 and 2012, respectively. The change in interest and other income (expense), net for the three and nine months ended September 30, 2013 was primarily due to interest accrued on the outstanding debt issued in July 2012.

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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 $7.1 million and $7.9 million for the three months ended September 30, 2013 and 2012, respectively. Income tax expense for the nine months ended September 30, 2013 and 2012 was $24.4 million and $25.9 million, respectively. Our effective tax rate was 20.5% and 19.9% for the three months ended September 30, 2013 and 2012, respectively, and 22.0% and 22.1% for the nine months ended September 30, 2013 and 2012, respectively. The increase in our effective income tax rate for the three months ended September 30, 2013 was primarily attributable to the following:

1. a decrease in the state tax deduction, net of federal tax; and

2. a decrease in foreign tax credits; and

3. a decrease in the U.S. federal domestic production activities deduction; partially offset by:

4. a decrease in Subpart F income; and

5. a decrease in the valuation allowance for U.S. federal foreign tax credit.

The decrease in our effective income tax rate for the nine months ended September 30, 2013 was primarily attributable to the following:

1. a decrease in the valuation allowance for the U.S. federal foreign tax credit; and

2. a decrease in Subpart F income; partially offset by:

3. a decrease in the U.S. federal domestic production activities deduction; and

4. a decrease in the portion of our income being taxed in foreign jurisdictions and subject to lower tax rates than in the U.S.

Segment Results
Our business segments are based on the organization structure used by management for making operating and investment decisions and for assessing performance. Our reportable business segments are: (i) Business Cloud Services; and (ii) Digital Media.
We evaluate the performance of our operating segments based on segment revenues, including both external and inter-segment net sales, and segment operating . . .

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