Business context and reporting period
This is j2 Global, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2013; the filing is not a standalone Ziff Davis, Inc. report. j2 Global reports Business Cloud Services and Digital Media. Ziff Davis and its subsidiaries are consolidated within Digital Media and were designated unrestricted subsidiaries under the notes indenture.
Financial results and liquidity
Amounts are in millions of dollars except per-share data. Comparisons are with the corresponding 2012 period.
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $141.4 | $89.5 | $255.0 | $176.1 |
| Gross profit / margin | $118.7 / 84.0% | $73.3 / 81.9% | $212.1 / 83.2% | $144.1 / 81.8% |
| Operating income / margin | $52.6 / 37.2% | $40.0 / 44.7% | $85.6 / 33.6% | $77.6 / 44.1% |
| Net income attributable to j2 Global | $36.0 | $31.2 | $59.0 | $59.7 |
| Diluted EPS | $0.77 | $0.67 | $1.26 | $1.27 |
| Operating cash flow | Not separately reported | Not separately reported | $109.0 | $85.3 |
For the six months, investing activities used $95.6 million, including $81.2 million for acquisitions net of cash received; financing activities used $15.9 million, primarily for dividends. Cash and cash equivalents were $214.9 million at June 30, versus $218.7 million at year-end. Cash and investments totaled $352.9 million, including $108.9 million of short-term and $29.0 million of long-term investments; $11.4 million of short-term investments were restricted.
Long-term debt was $245.4 million, consisting of $250 million principal of 8.0% senior unsecured notes due 2020, net of discount. The notes’ estimated fair value was $272.6 million. The company reported compliance with indenture covenants and no amounts drawn under its revolving credit agreement. Management said cash, short-term investments and operating cash generation should meet anticipated needs for at least the next 12 months.
Material changes versus the prior comparable period
- Q2 revenue rose 58%; six-month revenue increased 45%. The increase reflected acquisitions, higher Business Cloud Services subscriber revenue and patent/technology licensing revenue.
- Business Cloud Services revenue increased 21.6% in Q2 and 13.3% for the six months. Segment operating income rose 27.4% and 14.8%, respectively. Q2 paying telephone numbers were 2.189 million versus 2.058 million; ARPU was $13.16 versus $13.19, and the cancel rate was 2.2% versus 2.3%.
- Digital Media, which had no comparable 2012 segment period, generated Q2 revenue of $32.8 million and an operating loss of $0.5 million; its six-month revenue was $55.7 million and operating loss was $4.5 million.
- Q2 attributable net income rose about 16%, while six-month attributable net income declined about 1%. Net interest and other expense was $4.8 million in Q2 and $9.5 million for the six months, primarily reflecting interest on the notes issued in July 2012.
- Operating expenses increased materially, including Q2 sales and marketing of $35.2 million versus $13.9 million and general and administrative expense of $24.5 million versus $14.8 million. Management attributed increases largely to acquired businesses, staffing, advertising and acquisition-related intangible amortization. The six-month operating margin declined to 33.6% from 44.1%.
Outlook, commentary, risks and unusual items
- Management expects Business Cloud Services revenue trends to remain stable, assuming a stable or improving economy, and expects Digital Media revenue trends to improve over coming quarters as acquisitions are integrated. No numerical earnings or revenue guidance was provided.
- Management expects consolidated revenue trends to improve excluding future acquisitions, but anticipates operating margin may generally decline as the lower-margin Digital Media segment grows faster. Mobile and newer advertising formats may add margin pressure.
- In April, OpenText agreed to pay $27 million for patent licenses and grant j2 Global a reciprocal patent license. Approximately $12.6 million was recognized in Q2 for past damages; the filing says the remainder relates to license arrangements but does not provide a clear recognition schedule.
- Five acquisitions were completed in the first half, including IGN and NetShelter. They contributed $31.9 million of revenue; their net income was not separately identifiable. Purchase accounting remained provisional. Total consideration was $106.0 million, including $14.0 million in assumed liabilities.
- Legal matters include patent litigation and counterclaims involving Vitelity, EC Data and IGC, as well as a Canadian customer dispute. j2 Global said it did not expect the matters, after reserves, to materially affect consolidated results overall, but acknowledged an unfavorable resolution could materially affect a particular period. Certain potential losses were not accrued because they were not considered probable or estimable.
- Tax audits were ongoing with U.S., California and Canadian authorities. Uncertain tax position liabilities were $41.2 million; the potential amount and timing of audit-related changes were not estimable. Repatriating foreign-held funds could result in U.S. tax expense.
- Other risks include acquisition integration, customer retention and payment declines, competition, cybersecurity and system disruptions, regulation, foreign exchange and interest-rate exposure. The filing identifies no material change in internal control over financial reporting and says disclosure controls were effective.
Important facts for investors to verify
- How much of the reported revenue and earnings growth is recurring and organic versus acquisition-related or attributable to the one-time past-damages component of the OpenText settlement.
- Digital Media integration progress and whether revenue growth can offset the segment’s operating losses and expected lower margins.
- Cash generation, acquisition spending, dividend sustainability and the practical availability of cash held overseas or in restricted investments.
- Debt-service requirements, covenant restrictions and the status and possible financial impact of outstanding litigation and tax audits.
- Final acquisition purchase accounting, including goodwill and acquired intangible values, which the filing says could change materially.