UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________
FORM 10-Q
_____________
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 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: 0-25965
______________
j2 GLOBAL COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 51-0371142 |
(State or other jurisdiction | (I.R.S. Employer |
of incorporation or organization) | Identification No.) |
6922 Hollywood Boulevard
Suite 500
Los Angeles, California 90028
(Address of principal executive offices)
(323) 860-9200
(Registrant’s telephone number, including area code)
______________
Indicate by check mark whether the registrant (1) has filed all reports required 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.
Yesx Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yesx Noo
As of April 14, 2005, the registrant had 23,715,522 shares of Common Stock outstanding.
j2 GLOBAL COMMUNICATIONS, INC.
FOR THE QUARTER ENDED MARCH 31, 2005
INDEX
PAGE | |||
PART I. | FINANCIAL INFORMATION | ||
Item 1. | Financial Statements | ||
Condensed Consolidated Balance Sheets (unaudited) | 3 | ||
Condensed Consolidated Statements of Operations (unaudited) | 4 | ||
Condensed Consolidated Statements of Cash Flows (unaudited) | 5 | ||
Notes to Condensed Consolidated Financial Statements (unaudited) | 6 | ||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 10 | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 15 | |
Item 4. | Controls and Procedures | 16 | |
PART II. | OTHER INFORMATION | ||
Item 1. | Legal Proceedings | 16 | |
Item 6. | Exhibits | 17 | |
Signatures | 18 | ||
Index of Exhibits | 19 | ||
Exhibit 31(a) | |||
Exhibit 31(b) | |||
Exhibit 32(a) | |||
Exhibit 32(b) |
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
j2 Global Communications, Inc. | |||||||
Condensed Consolidated Balance Sheets | |||||||
(In thousands) | |||||||
March 31, | December 31, | ||||||
2005 | 2004 | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
Cash and cash equivalents | $ | 16,507 | $ | 18,814 | |||
Short-term investments | 54,125 | 47,225 | |||||
Accounts receivable, | |||||||
net of allowances of $615 and $529, respectively | 9,940 | 8,227 | |||||
Prepaid expenses and other current assets | 2,578 | 2,873 | |||||
Deferred income taxes | 2,520 | 2,520 | |||||
Total current assets | 85,670 | 79,659 | |||||
Long-term investments | 27,861 | 27,753 | |||||
Property and equipment, net | 13,609 | 12,386 | |||||
Goodwill | 20,344 | 20,173 | |||||
Other purchased intangibles, net | 17,707 | 11,256 | |||||
Other assets | 175 | 170 | |||||
Deferred income taxes | 1,520 | 1,520 | |||||
Total assets | $ | 166,886 | $ | 152,917 | |||
LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||
Accounts payable and accrued expenses | $ | 6,364 | $ | 5,324 | |||
Income taxes payable | 1,838 | 192 | |||||
Deferred revenue | 5,428 | 5,378 | |||||
Current portion of long-term debt | 965 | 1,196 | |||||
Total current liabilities | 14,595 | 12,090 | |||||
Long-term debt | 593 | 866 | |||||
Total liabilities | 15,188 | 12,956 | |||||
Total stockholders' equity | 151,698 | 139,961 | |||||
Total liabilities and stockholders' equity | $ | 166,886 | $ | 152,917 | |||
See accompanying notes to condensed consolidated financial statements |
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j2 Global Communications, Inc. | |||||||
Condensed Consolidated Statements of Operations | |||||||
(Unaudited, in thousands except share and per share data) | |||||||
Three Months Ended March 31, | |||||||
2005 | 2004 | ||||||
Revenues: | |||||||
Subscriber | $ | 31,275 | $ | 22,062 | |||
Other | 949 | 880 | |||||
32,224 | 22,942 | ||||||
Cost of revenues | 6,497 | 4,805 | |||||
Gross profit | 25,727 | 18,137 | |||||
Operating expenses: | |||||||
Sales and marketing | 5,462 | 3,779 | |||||
Research, development and engineering | 1,761 | 1,050 | |||||
General and administrative | 5,145 | 3,317 | |||||
Total operating expenses | 12,368 | 8,146 | |||||
Operating earnings | 13,359 | 9,991 | |||||
Interest and other income, net | 597 | 186 | |||||
Earnings before income taxes | 13,956 | 10,177 | |||||
Income tax expense | 3,768 | 3,778 | |||||
Net earnings | $ | 10,188 | $ | 6,399 | |||
Net earnings per common share: | |||||||
Basic | $ | 0.43 | $ | 0.28 | |||
Diluted | $ | 0.40 | $ | 0.25 | |||
Weighted average shares outstanding: | |||||||
Basic | 23,666,910 | 23,121,054 | |||||
Diluted | 25,382,088 | 25,564,338 | |||||
See accompanying notes to condensed consolidated financial statements |
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j2 Global Communications, Inc. | |||||||
Condensed Consolidated Statements of Cash Flows | |||||||
(Unaudited, in thousands) | |||||||
Three Months Ended March 31, | |||||||
2005 | 2004 | ||||||
Cash flows from operating activities: | |||||||
Net earnings | $ | 10,188 | $ | 6,399 | |||
Adjustments to reconcile net earnings to net cash | |||||||
provided by operating activities: | |||||||
Depreciation and amortization | 1,689 | 1,028 | |||||
Compensation expense in exchange for note reduction | — | 43 | |||||
Tax benefit of stock option exercises | 1,273 | 369 | |||||
Deferred income taxes | — | 3,248 | |||||
Changes in assets and liabilities, net of effects of business acquisitions: | |||||||
Decrease (increase) in: | |||||||
Accounts receivable | (1,531 | ) | (1,237 | ) | |||
Prepaid expenses | 247 | 374 | |||||
Other assets | 43 | (312 | ) | ||||
(Decrease) increase in: | |||||||
Accounts payable and accrued expenses | 157 | (59 | ) | ||||
Income taxes payable | 1,646 | — | |||||
Deferred revenue | 50 | 399 | |||||
Net cash provided by operating activities | 13,762 | 10,252 | |||||
Cash flows from investing activities: | |||||||
Net redemptions (purchases) of available-for-sale investments | 3,950 | (250 | ) | ||||
Net purchases of held-to-maturity investments | (10,957 | ) | (3,443 | ) | |||
Purchases of property and equipment | (2,473 | ) | (319 | ) | |||
Acquisition of businesses, net of cash received | (3,587 | ) | (6,020 | ) | |||
Purchases of intangible assets | (2,869 | ) | (74 | ) | |||
Net cash used in investing activities | (15,936 | ) | (10,106 | ) | |||
Cash flows from financing activities: | |||||||
Issuance of common stock under employee | |||||||
stock purchase plan | 124 | 114 | |||||
Exercise of stock options and warrants | 311 | 124 | |||||
Repayment of long-term debt | (501 | ) | (527 | ) | |||
Net cash used in financing activities | (66 | ) | (289 | ) | |||
Effect of exchange rate changes on cash and cash equivalents | (67 | ) | — | ||||
Net decrease in cash and cash equivalents | (2,307 | ) | (143 | ) | |||
Cash and cash equivalents at beginning of period | 18,814 | 32,882 | |||||
Cash and cash equivalents at end of period | $ | 16,507 | $ | 32,739 | |||
See accompanying notes to condensed consolidated financial statements |
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j2 GLOBAL COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
j2 Global Communications, Inc. (“j2 Global” or the “Company”) is a Delaware corporation founded in 1995. By leveraging the power of the Internet, the Company provides outsourced, value-added messaging and communications services to individuals and businesses throughout the world. j2 Global offers faxing and voicemail solutions; document management solutions; hosted email, email perimeter protection services (i.e., virus protection and spam detection) and email marketing services; call management and conference calling; and a bundled suite of these services. j2 Global markets its services principally under the brand names eFax®, j2®, jConnect®, eFax Corporate®, Onebox®, Electric Mail®, jBlast®, eFax BroadcastTM, eVoice®, M4 InternetTM, jBlast®, PaperMaster® and others.
The consolidated financial statements include the accounts of j2 Global and its direct and indirect wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
The accompanying interim condensed consolidated financial statements and related financial schedules are unaudited. The Company’s interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) including those for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X issued by the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and note disclosures required by GAAP for complete financial statements. These statements are unaudited and, in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been reflected in these condensed consolidated financial statements. These consolidated financial statements should be read in conjunction with the audited financial statements and related notes for the year ended December 31, 2004 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 28, 2005.
The results of operations for these interim periods are not necessarily indicative of the operating results for the full year or for any future period.
Certain prior year reported amounts have been reclassified to conform with the current year presentation. Included in these reclassifications were auction rate securities in the amount of $14.0 million and $14.3 million as of December 31, 2003 and March 31, 2004, respectively, which have been reclassified from cash equivalents to short-term investments in the accompanying consolidated statement of cash flows. The reclassification had the effect of increasing the net purchases of available-for-sale investments, increasing net cash used in investing activities, and decreasing the net increase in cash and cash equivalents by $0.3 million as previously reported on the consolidated statement of cash flows for the three months ended March 31, 2004. In addition, certain amounts in the accompanying consolidated balance sheet and statement of cash flows have been reclassified since previously reported in our press release dated April 18, 2005 based upon updated information, resulting in a decrease in cash and cash equivalents of $3.4 million, an increase of $1.2 million in short-term investments, a decrease of $0.3 million in accounts receivable and an increase of $2.5 million in long-term investments.
Comprehensive income includes all changes in equity (net assets) during a period from non-owner sources. The change in accumulated other comprehensive income for all periods presented resulted from foreign currency translation gains and losses. Comprehensive income was approximately $10.0 million and $6.4 million for the three months ended March 31, 2005 and 2004, respectively. Net translation losses for the three months ended March 31, 2005 and 2004 were $159,000 and zero, respectively.
NOTE 2 - ACCOUNTING FOR STOCK OPTIONS
The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations to account
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for its fixed plan stock options. These interpretations include Financial Accounting Standards Board (“FASB”) Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation an interpretation of APB Opinion No. 25”, issued in March 2000. Under this method, compensation expense is generally recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, “Accounting for Stock-Based Compensation”, established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123.
The Company accounts for option grants to non-employees using the guidance of SFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, whereby the fair value of such options is determined using the Black-Scholes option pricing model at the earlier of the date at which the non-employee’s performance is complete or a performance commitment is reached.
The Company applies APB Opinion No. 25 in accounting for stock options and, accordingly, no compensation cost using the intrinsic value method has been recognized for stock option grants in the accompanying financial statements. If the fair value based method had been applied in measuring stock compensation expense under SFAS No. 123, the pro forma effect on net earnings and net earnings per share would have been as follows:
Three Months Ended March 31, | ||||||||||
2005 | 2004 | |||||||||
(In thousands, except per share data) | ||||||||||
Net earnings, as reported | $ | 10,188 | $ | 6,399 | ||||||
Deduct: Stock based employee compensation | ||||||||||
expense determined under the fair | ||||||||||
value-based method for all awards, | ||||||||||
net of related tax effect | (674 | ) | (488 | ) | ||||||
Pro forma net earnings | $ | 9,514 | $ | 5,911 | ||||||
Basic net earnings per common share: | ||||||||||
As reported | $ | 0.43 | $ | 0.28 | ||||||
Pro forma | $ | 0.40 | $ | 0.26 | ||||||
Diluted net earnings per common share: | ||||||||||
As reported | $ | 0.40 | $ | 0.25 | ||||||
Pro forma | $ | 0.38 | $ | 0.23 |
In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”, which stated SFAS 123R was effective for the interim or annual periods beginning after June 15, 2005. However, on April 15, 2005, the SEC issued Final Rule No. 33-8568, “Amendment to Rule 4-01(a) of Regulation S-X Regarding the Compliance Date for Statement of Financial Accounting Standards No. 123 (Revised 2004),Share Based Payment”. The SEC’s new rule allows companies to implement SFAS 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005. SFAS 123R therefore becomes effective for the Company in the first quarter of fiscal 2006. Statement 123R requires all share-based payments to employees, including grants of employee stock options and purchases under employee stock purchase plans, to be recognized as an operating expense in the income statement. The cost is recognized over the requisite service period based on fair values measured on grant dates, and the new standard may be adopted using either the “modified prospective transition” method or the “modified retrospective transition” method. The Company is currently evaluating the effect that the adoption of SFAS 123R will have on the Company’s consolidated statement of income and financial condition.
NOTE 3 - USE OF ESTIMATES
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period. On an ongoing basis, management
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evaluates its estimates, including those related to revenue recognition, allowances for doubtful accounts and the valuation of deferred income taxes, long-lived and intangible assets and goodwill. These estimates are based on historical experience and on various other factors that management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.
NOTE 4 - RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the EITF reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides guidance for determining when an investment is other-than-temporarily impaired to be applied in reporting periods beginning after June 15, 2004 and contains disclosure requirements effective in annual financial statements for fiscal years ending after December 15, 2003 for investments accounted for under SFAS Nos. 115 and 124. For all other investments within the scope of this Issue, the disclosures are effective for fiscal years ending after June 15, 2004. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective. The Company has evaluated the impact of the adoption of EITF 03-1 and does not believe it will have a material effect on the Company’s financial condition or results of operations.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions”. SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This standard is effective for fiscal periods beginning after June 15, 2005. The Company is currently evaluating the effect that the adoption of SFAS 153 will have on the Company’s consolidated statement of income and financial condition.
NOTE 5 - EARNINGS PER COMMON SHARE
Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding stock options and warrants using the “treasury stock” method. The components of basic and diluted earnings per share are as follows:
Three Months Ended March 31, | ||||||||||
2005 | 2004 | |||||||||
(In thousands, except share and per share data) | ||||||||||
Numerator for basic and diluted net | ||||||||||
earnings per common share: | ||||||||||
Net earnings | $ | 10,188 | $ | 6,399 | ||||||
Denominator: | ||||||||||
Weighted average outstanding shares of | ||||||||||
common stock | 23,666,910 | 23,121,054 | ||||||||
Dilutive effect of: | ||||||||||
Employee stock options | 1,505,298 | 2,184,999 | ||||||||
Warrants | 209,880 | 258,285 | ||||||||
Common stock and common stock equivalents | 25,382,088 | 25,564,338 | ||||||||
Net earnings per share: | ||||||||||
Basic | $ | 0.43 | $ | 0.28 | ||||||
Diluted | $ | 0.40 | $ | 0.25 |
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NOTE 6 - ACQUISITION
In January 2005, the Company purchased substantially all of the assets and operations of a European provider of fax-to-email and unified messaging services. The purchase price, including acquisition costs, for this acquisition was $3.6 million, payable in cash at closing. The transaction has been accounted for using the purchase method and, accordingly, the results of operations for this acquisition have been included in the consolidated results of the Company since the date of acquisition. The excess of the purchase price over the fair value of identifiable net liabilities acquired amounted to $4.0 million. As of the date of this report, the Company has not completed the allocation of excess purchase price between goodwill and identifiable intangible assets. The results of operations for this acquisition during periods prior to the acquisition date were not material to the Company’s consolidated results of operations and accordingly, pro forma results of operations have not prepared.
NOTE 7 - GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. Intangible assets resulting from the acquisitions of entities accounted for using the purchase method of accounting are estimated by management based on the fair value of assets acquired. Identifiable intangible assets subject to amortization are being amortized using the straight-line method over estimated useful lives ranging from two to twenty years.
The changes in carrying amount of goodwill and other intangible assets for the three months ended March 31, 2005 are as follows (in thousands):
Balance as of January 1, 2005 | Additions | Amortization | Foreign Exchange Translation | Balance as of March 31, 2005 | ||||||||||||
Goodwill | $ | 20,173 | $ | 200 | $ | — | $ | (29 | ) | $ | 20,344 | |||||
Intangible assets with indefinite lives | 1,409 | — | — | — | 1,409 | |||||||||||
Intangible assets subject to amortization | 9,847 | 2,869 | (409 | ) | (54 | ) | 12,253 | |||||||||
Other - unallocated (refer to Note 6) | — | 4,045 | — | — | 4,045 | |||||||||||
Total | $ | 31,429 | $ | 7,114 | $ | (409 | ) | $ | (83 | ) | $ | 38,051 |
Intangible assets with indefinite lives relate primarily to a trade name. As of March 31, 2005, intangible assets subject to amortization relate primarily to the following (in thousands):
Weighted-Average | |||||||||||||
Amortization | Historical | Accumulated | |||||||||||
period | cost | amortization | Net | ||||||||||
Patents | 10.35 years | $ | 9,414 | $ | 731 | $ | 8,683 | ||||||
Technology | 2.47 years | 2,920 | 2,830 | 90 | |||||||||
Customer relationships | 4.86 years | 2,356 | 523 | 1,833 | |||||||||
Trade name | 20 years | 1,710 | 63 | 1,647 | |||||||||
Total | $ | 16,400 | $ | 4,147 | $ | 12,253 |
Amortization expense, included in general and administrative expense, during the three-month periods ended March 31, 2005 and 2004 approximated $409,000 and $78,000, respectively. Amortization expense is estimated to approximate $1.7 million, $1.6 million, $1.5 million, $1.5 million and $1.2 million for fiscal years 2005 through 2009, respectively.
NOTE 8 - INCOME TAXES
Income tax expense amounted to approximately $3.8 million and $3.8 million for the three months ended March 31, 2005 and 2004, respectively. During the quarter ended March 31, 2004, deferred income taxes decreased by $3.2 million primarily due to the offset of the Company’s tax liability against available net operating loss and tax credit carry-forwards.
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Income tax expense for the three months ended March 31, 2005 is based on our worldwide estimated effective annual tax rate of approximately 27%.
NOTE 9 - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest during the three-month periods ended March 31, 2005 and 2004 approximated $22,000 and $19,000, respectively, substantially all of which related to long-term debt.
The Company paid zero cash and approximately $330,000, respectively, for income taxes during the three-month periods ended March 31, 2005 and 2004.
Through the three months ended March 31, 2005 and 2004, the Company recorded the tax benefit from the exercise of non-qualifying stock options and disqualifying dispositions of incentive stock options as a reduction of its income tax liability and an increase in equity in the amount of approximately $1.3 million and $0.4 million, respectively.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
ORGANIZATION AND DESCRIPTION OF BUSINESS
j2 Global Communications, Inc. (“j2 Global”, “our” or “we”) is a Delaware corporation founded in 1995.By leveraging the power of the Internet, we provide outsourced, value-added messaging and communications services to individuals and businesses throughout the world. We offer faxing and voicemail solutions; document management solutions; hosted email, email perimeter protection services (i.e., virus protection and spam detection) and email marketing services; call management and conference calling; and a bundled suite of these services. We market our services principally under the brand names eFax®, j2®, jConnect®, eFax Corporate®, Onebox®, Electric Mail®, jBlast®, eFax BroadcastTM, eVoice®, M4 InternetTM, jBlast®, PaperMaster® and others.
We deliver many of our services through our global telephony/Internet Protocol (“IP”) network, which covers more than 1,500 cities in 23 countries across five continents. We have created this network, and continuously seek to expand it, through negotiating with U.S. and foreign telecommunications and co-location providers for telephone numbers (also referred to as Direct Inward Dial numbers or “DIDs”), Internet bandwidth and co-location space for our equipment. We maintain and seek to grow an inventory of telephone numbers to be assigned to new customers. Most of these numbers are “local” (as opposed to toll-free), which enables us to provide our paying subscription customers telephone numbers with a geographic identity.
Our core services include fax, voicemail, email, call management and conference calling and a bundled suite of these services. These are business services that make our customers more efficient, more mobile, more cost-effective and more secure than traditional alternatives. We generate substantially all of our revenue from subscribers that pay activation, subscription and usage fees. We also generate revenue from advertising and revenue share on premium rate DIDs issued to non-paid subscribers (sometimes referred to as “Free” subscribers). Of the more than 9.0 million telephone numbers (or DIDs) deployed as of March 31, 2005, approximately 598,000 were serving paying subscribers, with the balance deployed to Free subscribers.
We operate in one reportable segment: value-added messaging and communications services, which provides for the delivery of fax, voice and email messages via the telephone and/or Internet networks. Our services are distributed worldwide primarily over the telephone and Internet networks, and thus, we do not consider our operations subject to any geographic segment reporting.
We generate a substantial portion of our revenues from subscribers that pay us for activation, subscription and usage fees. Activation and subscription fees are referred to as “fixed” revenues, while usage fees are referred to as “variable” revenues. We also generate a small percentage of our overall revenue from advertising and international “calling party pays” arrangements to Free subscribers. These Free advertising-supported subscribers also serve as a source for attracting new paid subscribers. This process of migrating advertising-supported customers to paid services is part of our life cycle management program. Through this program, we monitor usage levels of
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advertising-supported customers, send them promotional up-sell messages and cull out subscribers that do not adhere to the limitations on our Free services set forth in our customer agreements.
During the past three years, we have derived a substantial portion of our revenues from the sale of our eFax and jConnect paid services, including eFax Corporate®, eFax Plus® and jConnect Premier®. These services are deployed through a DID. As a result, we believe that paying DIDs and the revenues associated therewith are an important metric for understanding our business. It has been and continues to be our objective to increase the number of paying DIDs through a variety of distribution channels, marketing arrangements and enhanced brand awareness. In addition, we continuously seek to increase revenues through a combination of stimulating use by our customers of usage-based services, introduction of new services and instituting appropriate price increases to our fixed monthly subscription and other fees.
The following table sets forth key operating metrics of our Company for the three months ended March 31, 2005 and 2004:
March 31, | |||||||
2005 | 2004 | ||||||
(In thousands) | |||||||
Free service telephone numbers | 8,449 | 5,843 | |||||
Paying telephone numbers | 598 | 435 | |||||
Total active telephone numbers | 9,047 | 6,278 | |||||
Three Months Ended March 31, | |||||||
2005 | 2004 | ||||||
(In thousands except percentages and average revenue per paying telephone number) | |||||||
Subscriber revenues: | |||||||
Fixed | $ | 22,773 | $ | 16,021 | |||
Variable | 8,502 | 6,041 | |||||
Total subscriber revenues | $ | 31,275 | $ | 22,062 | |||
Percentage of total subscriber revenues: | |||||||
Fixed | 72.8 | % | 72.6 | % | |||
Variable | 27.2 | % | 27.4 | % | |||
Revenues: | |||||||
DID based | $ | 30,186 | $ | 21,664 | |||
Non-DID based | 2,038 | 1,278 | |||||
Total revenues | $ | 32,224 | $ | 22,942 | |||
Average monthly revenue per paying | |||||||
telephone number(1) | $ | 16.85 | $ | 16.68 | |||
(1)See calculation of average monthly revenue per paying telephone number at the end of this section, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. |
DISCUSSION OF 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. During the three months ended March 31, 2005, there have been no changes in the Company’s critical accounting policies described in the Company’s Annual Report on Form 10-K filed with the SEC on March 28, 2005.
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RESULTS OF OPERATIONS FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 2005 AND 2004
Revenues
Subscriber Revenues. Subscriber revenues consist of both a fixed monthly recurring subscription component and a variable component which is driven by the actual usage of the service offerings. We have only tracked this ratio since fiscal year 2003 so data is not available prior to 2003. Over the past nine quarters, the fixed portion of our subscriber revenues has consistently contributed approximately 70% to our subscriber revenues. Subscriber revenues were $31.3 million and $22.1 million for the three months ended March 31, 2005 and 2004, respectively. The increase in subscriber revenues was due to an increase in our base of paying subscribers. The increase in our base of paid subscribers was primarily the result of new sign-ups derived from subscribers coming directly to our websites, Free-to-Paid subscriber upgrades, small to mid-sized corporate sales, direct large enterprise and government sales and direct marketing spend for Paid subscribers, net of cancellations.
Other Revenues. Other revenues were $949,000 and $880,000 for the three months ended March 31, 2005 and 2004, respectively. Other revenues consist primarily of advertising revenues generated by delivering email messages and banners on behalf of advertisers to our Free customers and the sale of our PaperMaster Pro document management software. The increase in other revenues was due primarily to an increase in PaperMaster software sales, offset slightly by a decrease in advertising revenues due to a continued decline in email advertising prices due to market conditions, notwithstanding an overall increase in the number of Free telephone numbers deployed.
For the past three years, 90% or more of our total revenues have been produced by our DID based services. DID based revenues increased from $21.7 million to $30.2 million for the three-month periods ended March 31, 2004 and 2005, respectively. The primary reason is the increase in the number of paid DIDs over this period. We would expect that DID based revenues will continue to be a dominant driver of total revenues.
Cost of Revenues. Cost of revenues are primarily comprised of costs associated with data and voice transmission, telephone numbers, customer service, on-line processing fees and equipment depreciation. Cost of revenues was $6.5 million, or 20% of total revenues, and $4.8 million, or 21% of total revenues, for the three months ended March 31, 2005 and 2004, respectively. The increase in cost of revenues was due primarily to costs incurred in building and expanding our network infrastructure, enhancing and growing our customer support services and incurring increased variable transmission costs associated with a larger subscriber base and increased usage. Cost of revenues as a percentage of revenues decreased as a result of increases in revenues over the same periods with a relatively stable level of cost of revenues.
Operating Expenses
Sales and Marketing. Our sales and marketing costs consist primarily of payments to sales and marketing personnel, advertising expenses and other business development related expenses. Sales and marketing expenses were $5.5 million, or 17% of total revenues, and $3.8 million, or 16% of total revenues, for the three months ended March 31, 2005 and 2004, respectively. The increase in sales and marketing expenses was due primarily to increased Internet-based advertising and partner marketing spend and additional marketing personnel. 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. Throughout 2004 and the first quarter of 2005, we experienced upward pricing pressure for certain Internet-based advertising.
Research, Development and Engineering. Our research, development and engineering costs consist primarily of personnel-related expenses. Research, development and engineering costs were $1.8 million, or 5% of total revenues, and $1.0 million, or 5% of total revenues, for the three months ended March 31, 2005 and 2004, respectively. The increase in research, development and engineering costs was primarily due to an increase in personnel costs to maintain our existing services, accommodate our service enhancements, develop and implement additional service features and functionality and continue to bolster our infrastructure security. Research, development and engineering costs as a percentage of revenues remained fairly consistent year-over-year. For the
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rest of 2005, we expect research, development and engineering costs as a percentage of revenues to grow as we intend to increase spending to further develop and implement additional service features and functionality.
General and Administrative. Our general and administrative costs consist primarily of personnel-related expenses, depreciation and amortization, bad debt expense and insurance costs. General and administrative costs were $5.1 million, or 16% of total revenues, and $3.3 million, or 14% of total revenues, for the three months ended March 31, 2005 and 2004, respectively. The increase in general and administrative expenses was primarily attributable to a combination of increased depreciation and amortization due to additional property and equipment and intangible assets, increased bad debt expense due to a growing customer base, additional personnel due to internal growth and acquisitions, and increased professional and consulting fees primarily related to compliance with the Sarbanes-Oxley Act of 2002.
Interest and Other Income, Net. Our interest and other income, net is generated primarily from interest income earned on cash, cash equivalents and short- and long-term investments, offset primarily by interest expense on long-term debt. Interest and other income, net amounted to $597,000 and $186,000 for the three months ended March 31, 2005 and 2004, respectively. The increase in interest and other income, net was primarily due to higher cash and investment balances and higher interest rates period-over-period.
Income Taxes. Our effective tax rate is based on pre-tax income, statutory tax rates, tax regulations and different tax rates in the various jurisdictions in which we operate. Income tax expense amounted to approximately $3.8 million and $3.8 million for the three months ended March 31, 2005 and 2004, respectively. Income tax expense for the three months ended March 31, 2005 is based on a worldwide estimated effective annual tax rate for 2005 of approximately 27%. Our effective annual tax rate was approximately 33% for 2004. Our estimated effective annual tax rate for 2005 decreased to approximately 27% due to an increased percentage of our income being sourced in lower tax jurisdictions.
Liquidity and Capital Resources
At March 31, 2005, we had cash and cash equivalents of $16.5 million, short-term investments of $54.1 million and $27.9 million of long-term investments. Our investments are comprised primarily of readily marketable corporate debt securities, U.S. government agency securities, and auction rate debt and preferred securities. For financial statement presentation, we classify our investments as short-term and long-term based upon their maturity dates. Short-term investments primarily mature within one year of the date of the financial statements and long-term investments mature between one and two years from March 31, 2005. We classify auction rate securities as short-term investments as the established interest rate reset periods are less than one year.
Our primary sources of liquidity are cash flows generated from operations, together with cash and cash equivalents and short-term investments. We generate our cash primarily from payments received from our subscribers, offset by cash payments we make to third parties for their services, employee compensation and capital expenditures. Net cash provided by operating activities was $13.8 million and $10.3 million for the three months ended March 31, 2005 and 2004, respectively. More than two-thirds of our subscribers pay us by credit card and therefore our receivables from subscribers settle quickly. Allocations of our total cash and cash equivalents and short- and long-term investments on hand will generally vary during any given reporting period based on our short-term working capital requirements and return on investment opportunities. Our cash and cash equivalents and short-term investments were $70.6 million at March 31, 2005.
Net cash used in investing activities was approximately $15.9 million and $10.1 million for the three months ended March 31, 2005 and 2004, respectively. For the first quarter of 2005, net cash used in investing activities was primarily attributable to net purchases of investments, acquisition of a business, purchases of intangible assets and purchases of property and equipment. For the first quarter of 2004, net cash used in investing activities was primarily comprised of acquisition of businesses and purchases of investments.
Net cash used in financing activities was approximately $66,000 and $289,000 for the three months ended March 31, 2005 and 2004, respectively. For the first quarters of 2005 and 2004, net cash used in financing activities was primarily comprised of repayments of long-term debt, offset by proceeds from the exercise of stock options and common shares issued under our employee stock purchase plan.
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For 2004 and in prior years, our cash payments related to the accrual of income tax expense were substantially offset by net operating losses and tax credit carryforwards. As of December 31, 2004, our usable federal NOLs and tax credit carryforwards were approximately $2.3 million and $2.3 million, respectively, and our usable state NOLs and tax credit carryforwards were approximately $10.2 million and $192,000, respectively. These usable federal and state NOLs were substantially exhausted in the first quarter of 2005. As a result, for 2005 we expect the amount of our cash tax payments primarily to depend upon the number of stock options exercised, which generally reduce taxable income.
We currently anticipate that our existing cash and cash equivalents and short-term investment balances will be sufficient to meet our anticipated needs for working capital and capital expenditures for at least the next 12 months.
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 results of any acquisition we may complete 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 described below, those identified in the “Risk Factors” section of our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 28, 2005 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 to:
o | Sustain growth or profitability; |
o | Continue to maintain, expand and retain our customer base; |
o | Compete with other similar providers with regard to price, service and functionality; |
o | Cost-effectively procure large quantities of telephone numbers in desired locations in the United States and abroad; |
o | Achieve business and financial objectives in light of burdensome telecommunications or Internet regulation; |
o | Obtain large quantities of non-paying users on a cost effective basis, and effectively derive revenues from those users through advertising to them and selling them paid services; |
o | Successfully manage our cost structure, including but not limited to our telecommunication and personnel related expenses; |
o | Successfully adapt to technological changes in the messaging, communications and document management industries; |
o | Successfully protect our intellectual property and avoid infringing upon the proprietary rights of others; |
o | Adequately manage growth in terms of managerial and operational resources; |
o | Maintain and upgrade our systems and infrastructure to deliver acceptable levels of service quality and security of customer data and messages; |
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o | Introduce new services and achieve acceptable levels of returns-on-investment for those new services; and |
o | Recruit and retain key personnel. |
Calculation of Average Revenue per Paying Telephone Number: | |||||||
Three Months Ended March 31, | |||||||
2005 | 2004 | ||||||
(In thousands except average monthly revenue per paying telephone number) | |||||||
DID based revenues | $ | 30,186 | $ | 21,664 | |||
Less other revenues | 1,065 | 781 | |||||
Total paying telephone number revenues | $ | 29,121 | $ | 20,883 | |||
Average paying telephone number monthly | |||||||
revenue (total divided by number of months) | $ | 9,707 | $ | 6,961 | |||
Number of paying telephone numbers | |||||||
Beginning of period | 554 | 400 | |||||
End of period | 598 | 435 | |||||
Average of period | 576 | 418 | |||||
Average monthly revenue per paying telephone number(1) | $ | 16.85 | $ | 16.68 | |||
(1)Due to rounding, individual numbers may not recalculate. |
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following discussion of the market risks we face contains forward-looking statements. Forward-looking statements are subject to risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements.
We believe that our exposure to market risk related to changes in interest rates and foreign currency exchange rates is not significant, primarily because our indebtedness under financing arrangements has fixed interest rates and our transactions are substantially denominated in US Dollars. During the balance of 2005 and in future years, we believe we will expand our international customer base and, as a result, we expect a greater level of foreign currency market risk.
We invest our cash primarily in high-grade interest-bearing securities. Our return on these investments is subject to interest rate fluctuations.
We do not have derivative financial instruments for hedging, speculative or trading purposes.
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Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, j2 Global’s management, with the participation of Scott M. Jarus, our co-President and principal executive officer and R. Scott Turicchi, our Chief Financial Officer and principal financial officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, Messrs. Jarus and Turicchi concluded that these disclosure controls and procedures were effective as of the end of the period covered in this report.
(b) Changes in Internal Controls
There was no change in internal control over financial reporting that occurred during the first quarter of 2005 that has materially affected or is reasonably likely to materially affect j2 Global’s internal control over financial reporting except that in January 2005, the Company implemented a new accounting software application and certain business processes and accounting procedures have been modified as a result of this new system. In addition, the Company purchased a new fixed asset tracking system which it will be implementing throughout 2005. This system will improve the Company’s visibility into the physical location of its assets and their valuation at any moment in time.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are not currently aware of any legal proceedings or claims that we believe are likely to have a material adverse effect on our business, prospects, financial condition, results of operations or cash flows. However, we have initiated litigation against two companies for infringing our patents. These lawsuits are described below:
j2 Global v. Venali, Inc.
In February 2004, we filed suit against Venali, Inc. (“Venali”) in the United States District Court for the Central District of California, alleging that Venali infringed and continues to infringe two of our patents. In October 2004, we amended our complaint to include allegations that Venali also infringed and continues to infringe an additional two of our patents. We are seeking a reasonable royalty for the infringement of all four patents, treble damages for the willful infringement of the first two patents, attorney’s fees, interest and costs. In November 2004, Venali counterclaimed for a declaratory judgment of invalidity and non-infringement of all four patents, attorney’s fees, interest and costs. The case is now in discovery.
j2 Global v. CallWave, Inc.
In August 2004, we filed suit against CallWave, Inc. (“CallWave”) in the United States District Court for the Central District of California, alleging that CallWave infringed and continues to infringe one of our patents. In December 2004 and again in April 2005, we amended our complaint to add allegations that CallWave also infringed and continues to infringe three additional patents. We are seeking a reasonable royalty for the infringement of all three patents, treble damages for the willful infringement of two of these patents, attorney’s fees, interest and costs. In January 2005, CallWave filed an answer to our first amended complaint, in which it denied infringing the patents, asserted affirmative defenses and requested a declaration of non-infringement and invalidity of the patents and attorneys’ fees and costs. The case is now in discovery.
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Item 6. Exhibits
31(a) | Rule 13a-14(a) Certification by Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 | |
31(b) | Rule 13a-14(a) Certification by Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 | |
32(a) | Section 1350 Certification by Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002. | |
32(b) | Section 1350 Certification by Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002. |
Items 2, 3, 4 and 5 are not applicable and have been omitted.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
j2 Global Communications, Inc. | ||
| | |
Date: May 9, 2005 | By: | /s/ R. Scott Turicchi |
R. Scott Turicchi | ||
Chief Financial Officer (Principal Financial Officer) |
| | |
Date: May 9, 2005 | By: | /s/ Greggory Kalvin |
Greggory Kalvin | ||
Chief Accounting Officer (Principal Accounting Officer) |
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INDEX TO EXHIBITS
Exhibit Number | Description | |
31(a) | Rule 13a-14(a) Certification by Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 | |
31(b) | Rule 13a-14(a) Certification by Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 | |
32(a) | Section 1350 Certification by Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002. | |
32(b) | Section 1350 Certification by Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002. |
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