ZIFF DAVIS, INC. quarterly report, Q2 FY2019

Business context and reporting period

Entity identification: The supplied filing is J2 Global, Inc.’s Form 10-Q for the quarter ended June 30, 2019; it is not identified as a Ziff Davis filing. J2 Global operated Cloud Services and Digital Media businesses, reporting through three segments: Fax and Martech; Voice, Backup, Security, and Consumer Privacy and Protection; and Digital Media.

Financial performance and liquidity

Amounts below are in millions except per-share data. Quarter comparisons are with Q2 2018; six-month comparisons are with the first half of 2018.

Q2 revenue increased 12% and first-half revenue increased 9%. Growth reflected acquisitions and organic growth in both businesses. Despite higher gross profit, gross and operating margins declined, as cost of revenue and operating expenses grew faster than sales. First-half net income also benefited from a $3.6 million equity-method investment gain, compared with a $3.0 million loss in the prior-year period.

Cloud Services Q2 revenue was $169.1 million, up 12.5%, and operating income was $62.3 million, up 7.2%. Digital Media revenue was $153.4 million, up 11.5%, but operating income declined to $1.5 million from $3.2 million. For the first half, Digital Media operating income was $0.5 million versus a $0.2 million loss.

At June 30, cash and cash equivalents were $155.5 million and long-term investments were $104.0 million. Current assets were $365.3 million versus current liabilities of $387.7 million. Long-term debt carrying value was $1.119 billion, including a $100 million credit-facility draw; the filing reports no current portion. The company said it was in compliance with debt covenants. Operating cash flow of $212.2 million was more than offset by $311.5 million of investing outflows, principally acquisitions, contributing to a $54.0 million decrease in cash and restricted cash during the half.

Material changes and unusual items

• First-half acquisitions included iContact, Safe Send, Highwinds/Cloak (Net Protect), and smaller businesses. Consideration totaled approximately $276.1 million, net of cash acquired and assumed liabilities; acquired businesses contributed $26.8 million of revenue. The acquisition purchase-price allocation remained provisional.
• Cash used for acquisitions was $266.0 million in the first half, versus $103.2 million a year earlier. Goodwill rose to $1.590 billion from $1.380 billion, largely reflecting acquisitions.
• General and administrative expense increased 15% in Q2 and 14% in the first half, primarily from acquired-asset amortization, depreciation and personnel costs. First-half amortization expense was $81.8 million versus $66.9 million.
• The company corrected the first-half revenue-recognition timing disclosure: $5.4 million was reclassified from over-time to point-in-time revenue. It said this correction did not affect first-quarter income from continuing operations or net income.
• Operating lease right-of-use assets and liabilities were recognized following adoption of the new lease standard in 2019.
• The Board suspended dividends for the foreseeable future after the June 4, 2019 payment, citing investment opportunities and historical investment returns. First-half dividends paid were $43.5 million.
• A July 1, 2019 amendment increased the credit facility from $100 million to $150 million, after the reporting date.

Outlook, risks and contingencies

Management expected Cloud Services revenue and profits to remain stable for the foreseeable future, excluding acquisitions, assuming a stable or improving economy. It expected Digital Media revenue and profits to improve over coming quarters as recent acquisitions are integrated and online advertising grows. Management anticipated overall improvement excluding future acquisitions, while warning that consolidated operating margin may generally decline as lower-margin Digital Media becomes a larger share of revenue. No specific numerical earnings or revenue guidance was provided.

Management said existing cash and cash generated from operations should be sufficient for anticipated needs for at least 12 months. Key risks cited include customer growth and retention, advertising economics and mobile-format margin pressure, acquisition integration and returns, debt service and covenant compliance, cybersecurity and system reliability, competition, regulation, foreign exchange, and income and indirect taxes.

The company maintained a $21.6 million reserve for indirect-tax matters and disclosed that additional liabilities could arise and materially affect results. It also had $49.1 million of uncertain income-tax-position liabilities; ongoing IRS, state and foreign audits could change reserves, potentially materially. Reported litigation included a TCPA class-action matter with class certification appealed and a pending dispute over remand. Management did not consider the disclosed proceedings likely to have a material adverse effect overall, but noted an unfavorable resolution could materially affect an individual period. The OCV investment is a related-party arrangement involving an entity linked to the Board chairman; the company reported a $50.6 million carrying amount and a $200 million investment commitment.

Most important facts for investors to verify

• Confirm the issuer: the provided filing is for J2 Global, Inc., despite the request metadata naming Ziff Davis.
• Assess whether acquisition-driven growth can translate into sustained operating profit and margins, particularly in Digital Media.
• Review debt maturities, variable-rate exposure, facility terms and covenants; the company had drawn the full $100 million facility at quarter-end and expanded capacity afterward.
• Track acquisition integration, provisional purchase accounting, goodwill and contingent consideration.
• Evaluate the dividend suspension and the company’s capital-allocation priorities, including the related-party OCV commitment.
• Monitor indirect-tax reserves, uncertain tax positions, audits and litigation developments.