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J2 GLOBAL, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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 andcredit 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 andbusinesses 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 currencyfluctuations, 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 taxliabilities, 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; 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 and diversify services and related revenues at acceptable levels of financial return; -28--------------------------------------------------------------------------------- Successfully develop and protect our intellectual property, both domestically and internationally, including our brands, patents, trademarks and domain names, and avoid infringing upon theproprietary 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 services delivered through the Internet. Through our Business Cloud Services Division, we provide cloud services to businesses of all sizes, from individuals to enterprises. Our Digital Media Division operates a portfolio of web properties providing technology, gaming and lifestyle content, using an innovative data-driven platform to connect advertisers with targeted audiences. We generate revenues primarily from subscription and usage fees for our business cloud services and selling targeted advertising through our digital media businesses. We also generate revenues from intellectual property licensing and sales. 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 43 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 game, entertainment and men's lifestyle content. 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. 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 months ended March 31, 2013 and 2012 (in thousands, except for percentages): March 31, 2013 2012 Paying telephone numbers 2,155 2,025 -29- -------------------------------------------------------------------------------- Three Months Ended March 31, 2013 2012 Subscriber revenues: Fixed $ 71,387 $ 70,227 Variable 18,115 14,598 Total subscriber revenues $ 89,502 $ 84,825 Percentage of total subscriber revenues: Fixed 79.8 % 82.8 % Variable 20.2 % 17.2 % Subscriber revenues: DID-based $ 82,502 $ 78,487 Non-DID-based 7,000 6,338 Total subscriber revenues $ 89,502 $ 84,825 Average revenue per paying telephone number (ARPU)(1) $ 12.98 $ 12.85 Cancel Rate(2) 2.4 % 2.4 % (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. (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 months ended March 31, 2013 are presented with no prior comparable period (in millions): Three Months Ended March 31, 2013 Visits 377 Page views 1,249 Source: 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 March 31, 2013, there were no significant changes in our critical accounting policies and estimates. -30- --------------------------------------------------------------------------------Results of Operations for the Three Months Ended March 31, 2013 Revenues (in thousands, except percentages) Percentage Three Months Ended March 31, Change 2013 2012 Revenues $113,617 $86,652 31% 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 intellectual property licensing and sales, and advertising. 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 primarily due to the acquisitions of Ziff Davis and IGN in the Digital Media segment and an increase in our Business Cloud Services subscriber base due to business acquisitions and customer sign ups, net of cancellations. Cost of Revenues (in thousands, except percentages) Percentage Three Months Ended March 31, Change 2013 2012 Cost of revenue $20,235 $15,864 28% As a percent of revenue 18% 18% -% 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 months ended March 31, 2013 was primarily due to an increase in costs associated with the acquisitions of Ziff Davis and IGN within the Digital Media segment and other immaterial acquisitions within the Business Cloud Services segment. Operating Expenses Sales and Marketing. (in thousands, except percentages) Percentage Three Months Ended March 31, Change 2013 2012 Sales and Marketing $29,638 $14,860 99% As a percent of revenue 26% 17% 9% 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 March 31, 2013 and 2012 was $14.3 million and $11.7 million, respectively. The increase in sales and marketing expenses for the three months ended March 31, 2013 was primarily due to additional personnel and severance costs associated with the acquisition of Ziff Davis and IGN in the Digital Media segment and other immaterial acquisitions within the Business Cloud segment and an increase in advertising in comparison to the prior comparable quarter. -31- -------------------------------------------------------------------------------- Research, Development and Engineering. (in thousands, except percentages) Percentage Three Months Ended March 31, Change 2013 2012 Research, Development and Engineering $6,746 $4,489 50% As a percent of revenue 6% 5% 1% 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 March 31, 2013 was primarily due to additional personnel and severance costs associated with the acquisition of Ziff Davis and IGN in the Digital Media segment in comparison to the prior comparable quarter. General and Administrative. (in thousands, except percentages) Percentage Three Months Ended March 31, Change 2013 2012 General and Administrative $24,011 $13,829 74% As a percent of revenue 21% 16% 5% 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 months ended March 31, 2013 was primarily due to additional personnel costs, severance costs and amortization of intangible assets associated with the acquisition of Ziff Davis and IGN in the Digital Media segment and other acquisitions within the Business Cloud segment in comparison to the prior comparable quarter. 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 months ended March 31, 2013 and 2012 (in thousands): Three Months Ended March 31, 2013 2012 Cost of revenues $ 214 $ 242 Operating expenses: Sales and marketing 418 375 Research, development and engineering 106 116 General and administrative 1,610 1,560 Total $ 2,348 $ 2,293 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 $(4.7) million and $(0.7) million for the three months ended March 31, 2013 and 2012, respectively. The change in interest and other income (expense), net for the three months ended March 31, 2013 was primarily due to interest accrued on the outstanding debt issued in July 2012 partially offset by a gain on foreign exchange primarily from short-term intercompany balances denominated in foreign currencies that remained unsettled. -32- --------------------------------------------------------------------------------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 $5.5 million and $8.4 million for the three months ended March 31, 2013 and 2012, respectively. Our effective tax rate was 19.5% and 22.6% for the three months ended March 31, 2013 and 2012, respectively. The decrease in our effective income tax rate for the three months ended March 31, 2013 was primarily attributable to the following: 1. a decrease in the valuation allowance for the U.S. federal foreign tax credit; 2. an increase in foreign tax credits; 3. an increase in the U.S. federal domestic production activities deduction; and 4. a reversal of uncertain income tax positions for the 2008 U.S. federal domestic production activities deduction; partially offset by: 5. an increase in Subpart F income; and 6. an increase in the portion of our income being taxed in foreign jurisdictions to foreign jurisdictions with higher tax rates than the previous comparable period. 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 income. We account for inter-segment sales and transfers based primarily on standard costs with reasonable mark-ups established between the segments. Identifiable assets by segment are those assets used in the respective reportable segment's operations. Corporate assets consist of cash and cash equivalents, deferred income taxes and certain other assets. All significant inter-segment amounts are eliminated to arrive at our consolidated financial results. Business Cloud Services Prior to the acquisition of Ziff Davis on November 9, 2012, we operated as one segment which is now the Business Cloud Services segment. The following segment results are presented for the three months ended March 31, 2013 and 2012 (in thousands): Three Months Ended Three Months Ended March 31, March 31, 2013 2012 Change External net sales $ 90,739 $ 86,652 $ 4,087 4.7 % Inter-segment net sales - - - - % Segment net sales 90,739 86,652 4,087 4.7 % Cost of revenues 16,643 15,864 779 4.9 % Gross profit 74,096 70,788 3,308 4.7 % Operating expenses 29,439 26,661 2,778 10.4 % Segment operating income $ 44,657 $ 44,127 $ 530 1.2 % Segment net sales of $90.7 million for the three months ended March 31, 2013 increased $4.1 million, or 4.7%, from the prior comparable period primarily due to an increase in our subscriber base partially offset by a decrease in patent and technology related licensing revenues. -33- -------------------------------------------------------------------------------- Segment gross profit of $74.1 million for the three months ended March 31, 2013 increased $3.3 million from the prior comparable period primarily due to an increase in net sales between the periods. The gross profit as a percentage of revenues for the three months ended March 31, 2013 was consistent with the prior comparable period. Segment operating expenses of $29.4 million in 2013 increased $2.8 million from 2012 primarily due to (a) an increase in sales and marketing costs primarily due to additional advertising and (b) additional amortization of intangible assets associated with businesses acquired in and subsequent to 2012. As a result of these factors, segment operating income of $44.7 million for the three months ended March 31, 2013 increased $0.5 million, or 1.2%, from the prior comparable period. Digital Media Our Digital Media segment was established with our fourth quarter of 2012 acquisition of Ziff Davis. As a result, the following segment results are presented with no prior comparable period (in thousands): Three Months Ended March 31, 2013 External net sales $ 22,878 Intersegment net sales 29 Segment net sales 22,907 Cost of revenues 3,593 Gross profit 19,314 Operating expenses 23,310 Segment operating loss $ (3,996 ) -34---------------------------------------------------------------------------------Liquidity and Capital Resources Cash and Cash Equivalents and Investments At March 31, 2013, we had cash and investments of $310.1 million compared to $343.6 million at December 31, 2012. The decrease resulted primarily from business acquisitions and dividends paid, partially offset by cash provided by operations. At March 31, 2013, cash and investments consisted of cash and cash equivalents of $193.1 million, short-term investments of $100.8 million and long-term investments of $16.1 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 that we may not liquidate until maturity, generally within 12 months. Restricted balances included in short-term investments were $20.4 million at March 31, 2013. We retain a substantial portion of our cash and investments in foreign jurisdictions for future reinvestment. As of March 31, 2013, cash and investments held within foreign and domestic jurisdictions were $178.8 million and $131.2 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. On May 7, 2013, our Board of Directors declared a quarterly cash dividend of $0.24 per share of common stock payable on June 4, 2013 to all stockholders of record as of the close of business on May 20, 2013. On February 12, 2013, our Board of Directors declared a quarterly cash dividend of $0.2325 per share of common stock which was paid on March 4, 2013 to all stockholders of record as of the close of business on February 25, 2013. Future dividends are subject to Board approval and certain restrictions within the Credit Agreement, as amended (the "Credit Agreement"), with Union Bank, N.A. (the "Lender") and within the Indenture relating to the debt 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, we completed the sale in a private offering of $250 million in aggregate principal amount of 8.0% 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. We are using the net proceeds from the offering for general corporate purposes, including 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 $40.0 million and $38.9 million for the three months ended March 31, 2013 and 2012, respectively. Our operating cash flows resulted primarily from cash received from our subscribers offset by 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 $9.0 million at March 31, 2013 and December 31, 2012, respectively. A significant portion of our Cloud Business Services segment subscribers pay us via credit cards and therefore those receivables generally settle quickly. In the Digital Media segment, advertisers generally pay in arrears and receivables generally settle within a range of 90 days. Net cash (used in) provided by investing activities was approximately $(54.4) million and $2.9 million for the three months ended March 31, 2013 and 2012, respectively. For the three months ended March 31, 2013, net cash used in investing activities was primarily attributable to business acquisitions, the purchase of available-for-sale investments, purchase of certificates of deposit, property and equipment and intangible assets partially offset by the sale of available-for-sale investments and maturity of certificates of deposit. For the three months ended March 31, 2012, net cash provided by investing activities was primarily attributable to the sale of available-for-sale investments partially offset by the purchase of available-for-sale investments, purchase of certificates of deposit, business acquisitions and property and equipment. Net cash used in financing activities was approximately $(10.4) million and $(47.3) million for the three months ended March 31, 2013 and 2012, respectively. For the three months ended March 31, 2013, net cash used in financing activities was primarily attributable to dividends paid and repurchases of stock partially offset by the proceeds from the exercise of stock options -35- -------------------------------------------------------------------------------- and excess tax benefit from share-based compensation. For the three months ended March 31, 2012, net cash used in financing activities was primarily attributable to repurchase of stock and dividends paid partially offset by proceeds received upon the exercise of options and excess tax benefit from share-based compensation. Contractual Obligations and Commitments The following table summarizes our contractual obligations and commitments as of March 31, 2013: Payments Due in (in thousands) Contractual Obligations 2013 2014 2015 2016 2017 Thereafter TotalLong-term debt - principal (a) $ - $ - $ - $ - $ - $ 250,000 $ 250,000 Long-term debt - interest (b) 9,722 20,000 20,000 20,000 20,000 60,000 149,722Operating leases (c) 3,494 3,695 3,284 2,045 1,720 3,509 17,747 Mandatorily redeemable financial instrument - dividends (d) 1,466 1,283 1,283 1,283 1,283 - 6,598 Mandatorily redeemable financial instrument - redemption (e) - - - - 8,556 - 8,556 Telecom services and co-location facilities (f) 1,960 434 286 283 125 - 3,088 Holdback payment (g) 1,916 2,425 - - - - 4,341 Other (h) 586 162 120 120 - - 988 Total $ 19,144 $ 27,999 $ 24,973 $ 23,731 $ 31,684 $ 313,509 $ 441,040 ________________________ (a) These amounts represent principal on long-term debt. (b) These amounts represent interest on long-term debt. (c) These amounts represent undiscounted future minimum rental commitments under noncancellable leases. (d) These amounts represent the non-controlling interest portion of dividends accrued on the mandatorily redeemable financial instrument. (e) These amounts represent the non-controlling interest portion of the redemption amount with respect to the mandatorily redeemable financial instrument. (f) These amounts represent service commitments to various telecommunication providers. (g) These amounts primarily represent the holdback amounts in connection with certain business acquisitions. (h) These amounts primarily represent certain consulting and Board of Director fee arrangements, software license commitments and others. As of March 31, 2013, our liability for uncertain tax positions was $39.0 million. The future payments related to uncertain tax positions have not been presented in the table above due to the uncertainty of the amounts and timing of cash settlement with the taxing authorities. Credit Agreement On January 5, 2009, we entered into a Credit Agreement with Union Bank, N.A. in order to further enhance our liquidity in the event of potential acquisitions or other corporate purposes. The Credit Agreement was amended on August 16, 2010, July 13, 2012 and November 9, 2012. The July 13, 2012 amendment was entered into in connection with the issuance of senior unsecured notes as discussed in Note 7 - Long-Term Debt, and extended the Revolving Credit Commitment Termination Date (as defined in the Credit Agreement) to November 14, 2013. The November 9, 2012 amendment was entered into in connection with the acquisition of Ziff Davis. We have not drawn down any amounts under the Credit Agreement. -36--------------------------------------------------------------------------------- |