10-Q 1 form10-q_13047.txt FORM 10-Q FOR THE PERIOD ENDED 9/30/04 ================================================================================ 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 SEPTEMBER 30, 2004 OR [_] 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. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ] As of October 14, 2004, the registrant had 23,494,470 shares of Common Stock outstanding. ================================================================================ j2 GLOBAL COMMUNICATIONS, INC. FOR THE QUARTER ENDED SEPTEMBER 30, 2004 INDEX PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements 3 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 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16 Item 4. Controls and Procedures 17 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 6. Exhibits 17 Signatures 19 Index of Exhibits 20 Exhibit 31(a) Exhibit 31(b) Exhibit 32(a) Exhibit 32(b) 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS j2 GLOBAL COMMUNICATIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31, 2004 2003 ----------- ----------- (Unaudited) ASSETS Cash and cash equivalents $ 42,343 $ 46,882 Short-term investments 12,738 8,539 Accounts receivable, net of allowances of $799 and $239, respectively 8,843 5,877 Prepaid expenses and other current assets 2,747 2,571 Deferred income taxes 5,063 10,004 ----------- ----------- Total current assets 71,734 73,873 Long-term investments 28,806 8,408 Property and equipment, net 8,670 6,594 Goodwill 19,975 15,616 Other purchased intangibles, net 10,916 2,320 Other assets 213 329 Deferred income taxes 1,967 5,716 ----------- ----------- Total assets $ 142,281 $ 112,856 =========== =========== LIABILITIES & STOCKHOLDERS' EQUITY Accounts payable and accrued expenses $ 5,368 $ 4,010 Deferred revenue 5,606 4,698 Current portion of long-term debt and capital leases 1,699 1,022 ----------- ----------- Total current liabilities 12,673 9,730 Long-term debt and capital leases 1,029 221 ----------- ----------- Total liabilities 13,702 9,951 Total stockholders' equity 128,579 102,905 ----------- ----------- Total liabilities and stockholders' equity $ 142,281 $ 112,856 =========== ===========
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 3 j2 GLOBAL COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED, IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Revenues: Subscriber $ 26,985 $ 17,806 $ 74,110 $ 48,567 Advertising 668 681 2,076 1,902 Licensing and Other 118 416 358 679 ----------- ----------- ----------- ----------- 27,771 18,903 76,544 51,148 Cost of revenues 4,363 3,494 12,066 9,751 ----------- ----------- ----------- ----------- Gross profit 23,408 15,409 64,478 41,397 ----------- ----------- ----------- ----------- Operating expenses: Sales and marketing 4,729 2,897 13,275 8,273 Research, development and engineering 1,418 1,006 3,732 3,055 General and administrative 5,321 4,085 14,537 11,296 ----------- ----------- ----------- ----------- Total operating expenses 11,468 7,988 31,544 22,624 ----------- ----------- ----------- ----------- Operating earnings 11,940 7,421 32,934 18,773 Interest and other income, net 505 126 1,043 269 ----------- ----------- ----------- ----------- Earnings before income taxes 12,445 7,547 33,977 19,042 Income tax expense 4,316 347 11,960 862 ----------- ----------- ----------- ----------- Net earnings $ 8,129 $ 7,200 $ 22,017 $ 18,180 =========== =========== =========== =========== Net earnings per common share: Basic $ 0.35 $ 0.32 $ 0.95 $ 0.81 Diluted $ 0.32 $ 0.28 $ 0.87 $ 0.73 Weighted average shares outstanding: Basic 23,348,269 22,857,057 23,227,534 22,578,729 Diluted 25,572,432 25,493,305 25,397,789 24,990,025
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 4 j2 GLOBAL COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED, IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, 2004 2003 ----------- ----------- Cash flows from operating activities: Net earnings $ 22,017 $ 18,180 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 3,455 2,986 Compensation in exchange for note reduction 130 130 Tax benefit of non-qualifying stock option exercises 2,019 726 Deferred income taxes 8,688 -- Decrease (increase) in: Accounts receivable (2,332) (557) Interest receivable 4 (27) Prepaid expenses 1,109 542 Other assets (360) (139) (Decrease) increase in: Accounts payable 1,175 (395) Deferred revenue 631 1,026 ----------- ----------- Net cash provided by operating activities 36,536 22,472 ----------- ----------- Cash flows from investing activities: Purchases of investments, net (24,517) (8,213) Purchase of property and equipment (3,098) (2,660) Proceeds from sale of equipment 73 Acquisition of businesses, net of cash received (8,561) (975) Payment of accrued exit costs (348) -- Purchase of intangible assets (4,860) (200) Repayments of notes receivable, net -- 539 ----------- ----------- Net cash used in investing activities (41,384) (11,436) ----------- ----------- Cash flows from financing activities: Issuance of common stock under employee stock purchase plan 325 270 Exercise of stock options and warrants 1,074 2,906 Repayment of long-term debt and capital leases (1,119) (676) ----------- ----------- Net cash provided by financing activities 280 2,500 ----------- ----------- Effect of exchange rate on cash and cash equivalents 29 -- ----------- ----------- Net (decrease) increase in cash and cash equivalents (4,539) 13,536 Cash and cash equivalents at beginning of period 46,882 32,777 ----------- ----------- Cash and cash equivalents at end of period $ 42,343 $ 46,313 =========== ===========
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5 j2 GLOBAL COMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2004 (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION j2 Global Communications, Inc. ("j2 Global" or the "Company") is a Delaware corporation founded in 1995. The Company provides outsourced, value-added messaging and communications services to individuals and businesses throughout the world. It offers fax, voicemail and email solutions, unified messaging & communications services, document management solutions and conference calling services. j2 Global markets its services principally under the brand names eFax(R), j2(R), jConnect(R), JFAX(R), eFax Corporate(R), Onebox(R), Electric Mail(R), jBlast(R), eFax BroadcastTM, eVoiceTM, PaperMaster(R), ConsensusTM, M4 Internet(R) and Protofax(R). The consolidated financial statements include the accounts of j2 Global and its direct and indirect, domestic and international, wholly-owned subsidiaries. All inter-company 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, 2003 included in the Company's Annual Report on Form 10-K filed with the SEC on March 15, 2004. 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. 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 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. The Company has adopted the disclosure only provisions of FASB Statement ("SFAS") No. 123, "Accounting for Stock-Based Compensation", and SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure", which is an amendment to SFAS No. 123. These statements establish accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123 and SFAS No. 148, the Company has elected to continue to apply the intrinsic value-based method of accounting described above. The Company accounts for option grants to non-employees using the guidance of SFAS No. 123, as amended by SFAS No. 148, and Emerging Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services," 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. 6 Under the intrinsic value method, 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, as amended by SFAS No. 148, the pro forma effect on net earnings and net earnings per share would have been as follows:
Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ---------- ---------- ---------- ---------- (In thousands, except per share data) Net earnings, as reported $ 8,129 $ 7,200 $ 22,017 $ 18,180 Add: Stock based employee compensation expense included in reported net earnings, net of related tax benefits -- -- -- -- Deduct: Stock based employee compensation expense determined under the fair value-based method for all awards, net of related tax effect (499) (531) (1,323) (1,420) ---------- ---------- ---------- ---------- Pro forma net earnings $ 7,630 $ 6,669 $ 20,694 $ 16,760 ========== ========== ========== ========== Basic net earnings per common share: As reported $ 0.35 $ 0.32 $ 0.95 $ 0.81 ========== ========== ========== ========== Pro forma $ 0.33 $ 0.29 $ 0.89 $ 0.74 ========== ========== ========== ========== Diluted net earnings per common share: As reported $ 0.32 $ 0.28 $ 0.87 $ 0.73 ========== ========== ========== ========== Pro forma $ 0.30 $ 0.26 $ 0.81 $ 0.67 ========== ========== ========== ==========
On October 13, 2004, the FASB concluded that its proposed Statement, "Share-Based Payment," which would require all companies to record compensation cost for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June 15, 2005. The FASB has tentatively concluded that companies could adopt the new standard, which it currently plans to issue on or around December 15, 2004, using the modified prospective transition method or the modified retrospective transition method. As of the date of this report, the FASB continues to discuss certain issues in relation to its proposed Statement. Until the proposed Statement is issued in its final form, the Company is unable to evaluate its impact or determine if it will have a material effect on the Company's financial condition or results of operations. 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 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 January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51" ("FIN 46"). FIN 46 requires that variable interest entities be consolidated by a company if that company absorbs a majority of the entity's expected losses, receives a majority of its expected residual returns, or both, as a result of holding a variable interest. In December 2003, the FASB issued FIN 46R, which made certain amendments to FIN 46. The Company does not have any variable interest entities and the adoption of FIN 46 did not have a material effect on the Company's financial condition, results of operations or liquidity. 7 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. 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. 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 Nine Months Ended September 30, September 30, ------------------------- ------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- (In thousands, except share and per share data) Numerator for basic and diluted net earnings per common share: Net earnings $ 8,129 $ 7,200 $ 22,017 $ 18,180 ----------- ----------- ----------- ----------- Denominator: Weighted average outstanding shares of common stock 23,348,269 22,857,057 23,227,534 22,578,729 Dilutive effect of: Employee stock options 2,025,137 2,312,510 1,974,866 2,120,686 Warrants 199,026 323,738 195,389 290,610 ----------- ----------- ----------- ----------- Common stock and common stock equivalents 25,572,432 25,493,305 25,397,789 24,990,025 ----------- ----------- ----------- ----------- Net earnings per share: Basic $ 0.35 $ 0.32 $ 0.95 $ 0.81 =========== =========== =========== =========== Diluted $ 0.32 $ 0.28 $ 0.87 $ 0.73 =========== =========== =========== ===========
NOTE 6 - ACQUISITIONS During the nine months ended September 30, 2004, the Company completed three acquisitions. In the first acquisition, the Company purchased substantially all of the assets and operations of The Electric Mail Company Inc. ("Electric Mail"), a Canadian-based provider of outsourced email and value-added messaging services. In the second acquisition, the Company acquired all of the issued and outstanding shares of capital stock of Jump B.V. ("Jump"), a Netherlands-based provider of fax-to-email and unified messaging services. In the third acquisition, the Company acquired the Onebox(R) unified communications assets from Call Sciences, Ltd. and its direct and indirect wholly-owned subsidiaries (collectively, "Call Sciences"), a New Jersey and United Kingdom-based provider of unified communications solutions. The aggregate purchase price, including acquisition costs, for these three acquisitions was $8.6 million, payable in cash at closing, with a contingent earn-out based on future revenues with respect to the Jump acquisition. The transactions have been accounted for using the purchase method and, accordingly, the results of operations of Electric Mail, Jump and Call Sciences have been included in the consolidated results of the Company since the date of acquisition. For Electric Mail and Jump, the excess of the purchase price over the fair value of identifiable net assets acquired amounted to approximately US$6.0 million of which US$1.8 million was allocated to identifiable intangible assets. The 8 excess of the purchase price of the Call Sciences acquisition over the fair value of the intangible net assets acquired has not yet been allocated between goodwill and identifiable intangible assets. The results of operations for Electric Mail, Jump and Call Sciences during periods prior to our acquisition were not material to our consolidated results of operations and, accordingly, pro forma results of operations have not been prepared. NOTE 7 - GOODWILL AND PURCHASED INTANGIBLE ASSETS Intangible assets are recorded at cost, less accumulated amortization. Amortization of intangible assets with finite lives is provided over their estimated useful lives ranging from 30 to 132 months on a straight-line basis. Amortization expense, included in general and administrative expense, during the three- and nine-month periods ended September 30, 2004 approximated $292,000 and $522,000, respectively. Amortization expense is estimated to approximate $731,000, $991,000, $931,000, $896,000 and $825,000 for the fiscal years ended December 31, 2004, 2005, 2006, 2007 and 2008, respectively. Goodwill and a trade name with an indefinite useful life are recorded net of accumulated amortization through December 31, 2001. The changes in the carrying amount of goodwill for the nine months ended September 30, 2004 are as follows: (in thousands) Balance at December 31, 2003 $ 15,616 Acquisitions and other(1) 4,359 ------------ Balance at September 30, 2004 $ 19,975 ============ (1) Other primarily includes the effect of foreign currency translation. See also Note 6 - Acquisitions. As of September 30, 2004, intangible assets with finite lives, goodwill and trade name balances, net of accumulated amortization were as follows:
AMORTIZATION HISTORICAL ACCUMULATED PERIOD COST AMORTIZATION NET ------------ ---------- ------------ --------- (IN THOUSANDS) Intangible assets subject to amortization Patents 96-132 months $ 5,699 $ 404 $ 5,295 Customer relationships 30-60 months 1,775 263 1,512 Software 60 months 309 61 248 Intangible assets not subject to amortization Goodwill 19,975 Indefinite-lived trade name 1,268 Other Unallocated - refer to Note 6 2,633 40 2,593
NOTE 8 - INCOME TAXES Income tax expense amounted to approximately $4,316,000 and $347,000 for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, income tax expense was $11,960,000 and $862,000, respectively. During the nine months ended September 30, 2004, deferred income taxes decreased by $8.7 million primarily due to the offset of the Company's tax liability against available net operating loss and the tax credit carry-forwards. For the nine months ended September 30, 2003, income tax expense was substantially offset by net operating loss carry-forwards for which a valuation allowance had previously been recognized against the deferred tax assets. 9 Income tax expense for the three and nine months ended September 30, 2004 is based on our worldwide estimated effective annual tax rate of approximately 35%. NOTE 9 - SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest during the nine-month periods ended September 30, 2004 and 2003 approximated $51,000 and $40,000, respectively, substantially all of which related to long-term debt and capital leases. The Company paid cash of approximately $1.4 million and $300,000, respectively, for income taxes during the nine-month periods ended September 30, 2004 and 2003. During the nine months ended September 30, 2004, the Company entered into a loan arrangement approximating $1.2 million to finance computer software. During the nine months ended September 30, 2004 and 2003, the Company entered into loan arrangements approximating $944,000 and $1.2 million, respectively, to finance certain corporate insurance policies. During the nine months ended September 30, 2004 and 2003, the Company entered into capital lease arrangements for certain computer equipment and software approximating $289,000 and $239,000, respectively. Through the nine months ended September 30, 2004 and 2003, the Company recorded the tax benefit from the exercise of non-qualified stock options as a reduction of its income tax liability and an increase in equity in the amount of approximately $2.0 million and $726,000, respectively. NOTE 10 - LEGAL PROCEEDINGS The Company is not currently aware of any legal proceedings or claims that it believes are likely to have a material adverse effect on the Company's business, prospects, financial condition, results of operations or cash flows. However, the Company is currently engaged as plaintiff in the following two patent infringement actions: Venali Patent Infringement Lawsuit ---------------------------------- In February 2004, the Company filed a patent infringement suit against Venali, Inc. ("Venali"), a provider of Internet fax solutions, in United States District Court for the Central District of California, alleging that Venali infringes two of the Company's U.S. patents. The Company is seeking monetary damages for past infringement, injunctive relief prohibiting Venali from continuing to infringe these patents, and attorneys' fees. In April 2004, Venali filed an answer and counterclaim, in which it denied infringing the patents and counterclaimed for a declaration of noninfringement and invalidity of the patents. In October 2004, the Company amended its complaint to add allegations that Venali infringes two additional patents acquired by the Company after the filing of the original complaint. The parties are currently engaged in pretrial discovery and a trial date is currently set for January 2006. While the Company is optimistic about its prospects and is vigorously pursuing its claims against Venali, there can be no guarantee or certainty that the Company will prevail in this action. CallWave Patent Infringement Lawsuit ------------------------------------ In August 2004, the Company filed a patent infringement suit against CallWave, Inc. ("CallWave"), a provider of communications applications services, in United States District Court for the Central District of California, alleging that CallWave infringes one of the Company's U.S. patents. The Company is seeking monetary damages for past infringement, injunctive relief prohibiting CallWave from continuing to infringe the patent, and attorneys' fees. In September 2004, CallWave filed an answer, in which it denied infringing the patent and requested a declaration of noninfringement and invalidity of the patent and attorneys' fees. The litigation is currently in the pre-discovery stage. While the Company is optimistic about its prospects and is vigorously pursuing its claims against CallWave, there can be no guarantee or certainty that the Company will prevail in this action. 10 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. We provide outsourced, value-added messaging and communications services to individuals and businesses around the world. We offer fax, voicemail and email solutions, unified messaging & communications services, document management solutions and conference calling services. We market our services principally under the brand names eFax(R), j2(R), jConnect(R), JFAX(R), eFax Corporate(R), Onebox(R), Electric Mail(R), jBlast(R), eFax BroadcastTM, eVoiceTM, PaperMaster(R), ConsensusTM, M4 Internet(R) and Protofax(R). We deliver our services through our global telephony/Internet Protocol ("IP") network, which offers local telephone numbers in more than 1,400 cities in 20 countries across five continents. Our core services, each of which operates in large and distinct markets, include fax, voicemail, email, unified messaging & communications, document management and conference calling. Individuals and businesses are already using many of these services. Our primary challenge, therefore, is not to introduce new services to prospective customers. Rather, it is to communicate to prospects how our particular solutions are more secure, efficient and cost-effective than traditional alternatives. In addition, we offer permission-based, personalized email marketing services to help third parties maximize their advertising efforts, and third party advertising services to our Free base of customers (described below). 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 non-paid subscribers (sometimes referred to as "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 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. Of the more than 7.6 million telephone numbers (sometimes referred to as Direct Inward Dial numbers or "DIDs") deployed as of September 30, 2004, approximately 515,000 were deployed to paying subscribers, with the balance deployed to Free advertising-supported and international "calling party pays" subscribers. During the past three years, we have derived substantially all of our revenues from the sale of our eFax Plus(R) and jConnect Premier(R) paid services. 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 and nine months ended September 30, 2004 and 2003: 11
September 30, 2004 2003 ---------- ---------- (In thousands) Advertising-supported telephone numbers 7,106 5,147 Paying telephone numbers 515 380 ---------- ---------- Total active telephone numbers 7,621 5,527 ========== ========== Three Months Ended Nine Months Ended September 30, September 30, 2004 2003 2004 2003 ---------- ---------- ---------- ---------- (In thousands except percentages and average revenue per paying telephone number) Subscriber revenues: Fixed $ 19,122 $ 12,121 $ 52,893 $ 33,214 Variable 7,863 5,685 21,217 15,353 ---------- ---------- ---------- ---------- Total subscriber revenues $ 26,985 $ 17,806 $ 74,110 $ 48,567 ========== ========== ========== ========== Percentage of total subscriber revenues: Fixed 70.9% 68.1% 71.4% 68.4% Variable 29.1% 31.9% 28.6% 31.6% Revenues: DID based revenues $ 25,994 $ 17,478 $ 71,715 $ 47,376 Non-DID based revenues 1,777 1,425 4,829 3,772 ---------- ---------- ---------- ---------- Total revenues $ 27,771 $ 18,903 $ 76,544 $ 51,148 ========== ========== ========== ========== Average revenue per paying telephone number(1) $ 16.95 $ 15.36 $ 16.81 $ 15.54 ========== ========== ========== ==========
(1) See calculation of average 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 nine months ended September 30, 2004, 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 15, 2004. RESULTS OF OPERATIONS FOR THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003 REVENUES SUBSCRIBER REVENUES. Subscriber revenues are comprised primarily of monthly recurring subscription and usage based fees. Subscriber revenues were $27.0 million and $17.8 million for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, subscriber revenues were $74.1 million and $48.6 million, respectively. The increase in subscriber revenues was due to an increase in our base of paying subscribers combined with a price increase discussed below. The increase in our base of paid subscribers was the result of new sign-ups derived from subscribers coming directly to our websites, Free-to-Paid subscriber upgrades, small to medium-sized enterprise sales, direct large enterprise sales and direct marketing spend for Paid subscribers, net of cancellations. At the end of the second quarter of 2003, we implemented a price increase for new individual subscribers. Commencing at the end of the third quarter of 2003, we began implementing this same price increase to a substantial portion of our existing individual subscribers, which at the time represented more than half of our subscriber revenues. These price changes resulted in increased monthly recurring revenues of between $2.50 and $3.00 per 12 individual paying customer, depending on the services provided. We substantially completed implementation of these price changes by June 30, 2004. The results of these price changes exceeded our expectations in terms of the rate of sign-ups and cancellations (i.e., we did not see a material decrease in new customer sign-ups and cancellations of existing subscribers were lower than anticipated). However, due to a number of factors affecting the Company's net sign-ups and related revenues during a given reporting period, it is not possible to quantify the financial impact of the price increase. ADVERTISING. Advertising revenues were $668,000 and $681,000 for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, advertising revenues were $2.1 million and $1.9 million, respectively. We generate advertising revenues primarily by delivering email messages on behalf of advertisers to our Free advertising-supported customers. The increase in advertising revenues year over year was due primarily to an increase in the size of our Free advertising-supported customer base which was partially offset by a decline in email advertising prices due to market conditions. LICENSING AND OTHER. Licensing and other revenues were $118,000 and $416,000 for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, licensing and other revenues were $358,000 and $679,000, respectively. Throughout these periods, our licensing and other revenues have consisted primarily of revenues from licensing our PaperMaster document management software. COST OF REVENUES. Cost of revenues is comprised primarily of costs associated with data and voice transmission, telephone numbers, customer service, on-line processing fees and equipment depreciation. Cost of revenues was $4.4 million, or 16% of total revenues, and $3.5 million, or 18% of total revenues, for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, cost of revenues was $12.1 million, or 16% of total revenues, and $9.8 million, or 19% of total revenues, 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. Sales and marketing expenses are comprised primarily of payments to sales and marketing personnel, advertising expenses and other business development related expenses. Sales and marketing expenses were $4.7 million, or 17% of total revenues, and $2.9 million, or 15% of total revenues, for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, sales and marketing expenses were $13.3 million, or 17% of total revenues, and $8.3 million, or 16% of total revenues, respectively. The increase in sales and marketing expenses was due primarily to increased Internet-based advertising 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 on-line service providers. During the second half of 2003, we experienced upward pricing pressure for certain Internet-based advertising, and we expect this trend to continue through at least the balance of 2004 and into 2005. RESEARCH, DEVELOPMENT AND ENGINEERING. Our research, development and engineering costs consist primarily of personnel-related expenses. Research, development and engineering costs were $1.4 million, or 5% of total revenues, and $1.0 million, or 5% of total revenues, for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, research, development and engineering costs were $3.7 million, or 5% of total revenues, and $3.1 million, or 6% of total revenues, 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 decreased year over year as a result of increases in revenues over the same periods versus a more stable level of research, development and engineering expenses. For 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. 13 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 $5.3 million, or 19% of total revenues, and $4.1 million, or 22% of total revenues, for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, general and administrative costs were $14.5 million, or 19% of total revenues, and $11.3 million, or 22% of total revenues, respectively. General and administrative costs as a percentage of revenues decreased because revenues increased over the same periods at a faster rate than general and administrative costs. AMORTIZATION OF OTHER INTANGIBLES. Amortization of intangible assets with finite lives is provided over their estimated useful lives ranging from 30 to 132 months on a straight-line basis. Amortization of intangibles, included in general and administrative expenses, aggregated $292,000 and $46,000 for the three months ended September 30, 2004 and 2003, respectively and $522,000 and $102,000 for the nine months ended September 30, 2004 and 2003, respectively. The increase in amortization of intangible assets was primarily attributable to the acquisitions of the shares of Driverworks.com Development Corporation (d/b/a M4 Internet) in September 2003, assets of The Electric Mail Company Inc. and the shares of Jump B.V. in March 2004 and assets of Call Sciences, Ltd. in July 2004. INTEREST AND OTHER INCOME. Our interest and other income is generated from interest earned on cash, cash equivalents and short- and long-term investments. Interest and other income amounted to $505,000 and $126,000 for the three months ended September 30, 2004 and 2003, respectively, and $1.0 million and $269,000 for the nine months ended September 30, 2004 and 2003, respectively. The increase in interest and other income was primarily due to higher cash and investment balances for 2004 and a shift in allocation to investments with longer maturities and higher returns. INCOME TAXES. Income tax expense amounted to approximately $4.3 million and $347,000 for the three months ended September 30, 2004 and 2003, respectively. For the nine months ended September 30, 2004 and 2003, income tax expense was $12.0 million and $862,000, respectively. For the nine months ended September 30, 2003, income tax expense was substantially offset by net operating loss carry-forwards for which a valuation allowance had previously been recognized against the deferred tax assets. Income tax expense for the three and nine months ended September 30, 2004 is based on our worldwide estimated effective annual tax rate of approximately 35%. LIQUIDITY AND CAPITAL RESOURCES Our cash and cash equivalents and short-term investments were $55.1 million at September 30, 2004. 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 $36.5 million and $22.5 million for the nine months ended September 30, 2004 and 2003, respectively. Our operating cash flows result primarily from cash received from our subscribers, offset by cash payments we make to third parties for their services and employee compensation. More than two-thirds of our subscribers pay us by credit card and therefore our receivables from subscribers settle quickly. We invest our short- and long-term investments primarily in high-grade debt securities. 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. Net cash used in investing activities was approximately $41.4 million and $11.4 million for the nine months ended September 30, 2004 and 2003, respectively. For the first three quarters of 2004, net cash used in investing activities was primarily attributable to purchases of investments, acquisition of businesses, purchases of intangible assets and purchases of property and equipment. For the first three quarters of 2003, net cash used in investing activities was primarily comprised of purchases of investments and property and equipment. Net cash provided by financing activities was approximately $280,000 and $2.5 million for the nine months ended September 30, 2004 and 2003, respectively. For the first three quarters of 2004 and 2003, net cash provided by financing activities was primarily comprised of proceeds from the exercise of stock options and common shares issued under our employee stock purchase plan, offset by repayments of long-term debt and capital lease obligations. 14 We have an investment with an immaterial carrying amount in Oasis Semiconductor, Inc. ("Oasis"), a privately-held company. This investment in an equity security is accounted for under the cost method and is included in "other assets" on our consolidated balance sheet. In March 2004, Oasis filed a registration statement on Form S-1 with the United States Securities and Exchange Commission regarding its intent to initiate an initial public offering ("IPO"). On April 27, 2004, Oasis filed an amended registration statement on Form S-1 indicating our intent to sell approximately 420,000 shares in the offering, resulting in us owning slightly under 10% of Oasis' issued and outstanding shares of capital stock after the offering. However, we are unable to determine when and if Oasis will complete the IPO, and if so, at what offering value. If this offering were to be completed, our carrying value or related proceeds from the offering may become material. 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. CONTRACTUAL OBLIGATIONS AND COMMERICAL COMMITMENTS PURCHASE OBLIGATIONS During the first quarter of 2004, we entered into an obligation to purchase computer software and related services totaling $2.6 million. 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 15, 2004 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; 15 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; 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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2004 2003 2004 2003 ---------- ---------- ---------- ---------- (In thousands except average revenue per paying telephone number) DID based revenues $ 25,994 $ 17,478 $ 71,715 $ 47,376 Less advertising and other revenues 968 681 2,456 1,902 ---------- ---------- ---------- ---------- Total paying telephone number revenues $ 25,026 $ 16,797 $ 69,259 $ 45,474 ========== ========== ========== ========== Average paying telephone number monthly revenue (total divided by number of months) $ 8,342 $ 5,599 $ 7,695 $ 5,053 Number of paying telephone numbers Beginning of period 469 349 400 270 End of period 515 380 515 380 Average of period 492 365 458 325 Average revenue per paying telephone number $ 16.95 $ 15.36 $ 16.81 $ 15.54
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 2004 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. 16 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. ITEM 4. CONTROLS AND PROCEDURES As of September 30, 2004, the end of the period covered by this report, j2 Global's management, with the participation of our President (principal executive officer) and Chief Financial Officer (principal financial officer), carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, our President (principal executive officer) and Chief Financial Officer (principal financial officer) concluded that these disclosure controls and procedures were effective as of the end of the period covered in this report. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 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 are currently engaged as plaintiff in the following two patent infringement actions: Venali Patent Infringement Lawsuit ---------------------------------- In February 2004, we filed a patent infringement suit against Venali, Inc. ("Venali"), a provider of Internet fax solutions, in United States District Court for the Central District of California, alleging that Venali infringes two of our U.S. patents. We are seeking monetary damages for past infringement, injunctive relief prohibiting Venali from continuing to infringe these patents, and attorneys' fees. In April 2004, Venali filed an answer and counterclaim, in which it denied infringing the patents and counterclaimed for a declaration of noninfringement and invalidity of the patents. In October 2004, we amended our complaint to add allegations that Venali infringes two additional patents acquired by us after the filing of the original complaint. The parties are currently engaged in pretrial discovery and a trial date is currently set for January 2006. While we are optimistic about our prospects and are vigorously pursuing our claims against Venali, there can be no guarantee or certainty that we will prevail in this action. CallWave Patent Infringement Lawsuit ------------------------------------ In August 2004, we filed a patent infringement suit against CallWave, Inc. ("CallWave"), a provider of communications applications services, in United States District Court for the Central District of California, alleging that CallWave infringes one of our U.S. patents. We are seeking monetary damages for past infringement, injunctive relief prohibiting CallWave from continuing to infringe the patent, and attorneys' fees. In September 2004, CallWave filed an answer, in which it denied infringing the patent and requested a declaration of noninfringement and invalidity of the patent and attorneys' fees. The litigation is currently in the pre-discovery stage. While we are optimistic about our prospects and are vigorously pursuing our claims against CallWave, there can be no guarantee or certainty that we will prevail in this action. 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. 17 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. 18 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: November 8, 2004 By: /s/ R. SCOTT TURICCHI ------------------------------ R. Scott Turicchi Chief Financial Officer (Principal Financial Officer) Date: November 8, 2004 By: /s/ GREGGORY KALVIN ------------------------------ Greggory Kalvin Chief Accounting Officer (Principal Accounting Officer) 19 INDEX TO EXHIBITS Exhibit Number Description -------------- ----------- 31(a) Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31(b) Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32(a) Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32(b) Certification by Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 20