Ziff Davis Inc (ZD) 2003 Q3 法說會逐字稿

Welcome to the j2 Global Communications third quarter earnings conference call.

It is my pleasure to introduce today's host, Mr. Scott Jarus, President of j2 Global Communications, and Mr. Scott Turicchi, j2 Global's Chief Financial Officer.

Thank you, and welcome to j2 Global's third quarter conference call.

Good afternoon.

I'm Scott Turicchi, the Chief Financial officer.

And joining me today as the operator mentioned is Scott Jarus, our President, and also Greg Kalvin, our Chief Accounting Officer.

During this call today we will be discussing our third quarter financial results.

In addition, we will be reviewing operational highlights from the third quarter; recent activity in both our web and corporate channels; key operating metrics; tax considerations; guidance for the fourth quarter of 2003 and a view into 2004.

The field copy of our IR presentation is available at our website, www.j2global.com.

In addition, if you have not received a copy of the press release, you may access it through our corporate website at j2global.com/press.

In addition, you can also access this webcast from that same site.

After completing the formal presentation, we will be conducting a question-and-answer session.

The operator will instruct you at that time regarding the procedures for asking a question.

In addition, at any time you may e-mail us questions at investor@j2.com.

Before we begin our prepared remarks, allow me to read the safe harbor language.

As you know, this call and the webcast will include forward-looking statements.

Such statements may involve risks and uncertainties that would cause actual results to differ materially from the anticipated results.

Some of those risks and uncertainties include, but are not limited to, the risk factors that we have disclosed in our various SEC filings -- including our 10-K filings, recent 10-Q filings, various proxy statements and 8-K filings; as well as the additional risk factors that we have included as part of the slideshow for the webcast.

We refer you to discussions in those documents regarding safe harbor language, as well as forward-looking statements.

I would now like to highlight the results for the quarter.

Revenue for the third quarter was $18.9 million, as compared to $12.5 million in the third quarter of 2002, a 51 percent increase.

Gross profit for the quarter was 15.4 million, or 81.9 percent, compared to 10 million, or 79.6 percent, for the third quarter of a year ago.

Earnings before taxes were 7.4 million, an increase of 93 percent, compared to 3.9 million earned in the third quarter of 2002.

And our net earnings were 7.2 million for Q3 of 2003, compared with net earnings of 3.9 million for the third quarter of 2002, an 84 percent increase.

On a per-share basis, giving effect to the 2 for 1 stock split on August 29 of this year, our fully diluted earnings were 28 cents compared to 16 cents for the third quarter of last year.

The maximum possible number of shares that can be outstanding for use in fully diluted calculations is approximately 26 million.

Our cash balances in short-term investments as of September 30 were 54.5 million, an increase of approximately 8 million from the second quarter of 2003.

At this time, Scott Jarus will take you through some of the highlights contained in our current IR presentation.

Thank you, Scott.

Before I begin, let me remind everyone listening that you can submit questions to us both during this conference call and after by sending an e-mail to investor@j2global.com.

I would also remind you that the full investor presentation can be viewed online at www.j2global.com, which is also a good site for you to visit to learn more about the Company.

As in the past, I will not be stepping through the presentation page by page, but will instead focus on the highlights for the quarter.

I'll begin on slide number seven, entitled Unique Assets.

Since the second quarter, j2 Global has increased the number of subscribed telephone numbers -- or DIDs, in the parlance of the industry -- by approximately 300,000, bringing us to 5.5 million.

This increase in subscribed numbers came through our free advertising-supported and paid subscription offering in our web channel, and from growth in our corporate sales channel.

In addition, we added another 200,000 telephone numbers to our inventory of available numbers during the quarter.

I would remind everyone that this is important, because it provides the Company with a supply of DIDs, or telephone numbers, to support our growth, and because the acquisition of telephone numbers -- particularly in the United States -- can sometimes be difficult, given telephone number exhaustion issues in certain parts of the country.

We view these 6.7 million telephone numbers as a valuable asset for the Company.

J2 Global expanded its network of local access points -- in other words, those locations where we are able to offer subscriber local telephone numbers.

We are now able to offer local telephone numbers in over 1100 cities in 20 countries around the world.

During and immediately following the third quarter, we introduced service in Mexico, Israel, and added new locations in Canada.

We opened additional markets in the United States.

The expansion of our international presence and launch in in-country marketing opportunities has been, and will be, a major focus for the Company going forward.

During the third quarter, j2 Global was granted 2 new U.S. patents covering key components of its technology and processes.

In addition, the Company filed an application for one new patent.

This brings the Company's stable of intellectual property to 7 issued patents and 8 patents pending.

J2 Global views its intellectual properties as a very important asset, and will continue to look for or develop new and unique opportunities to build and leverage its patent portfolio.

As Scott Turicchi stated at the outset of the call, the Company performed well during the third quarter.

Revenues came in at 18.9 million with net earnings of 7.2 million.

This continues the Company's track record of revenue and earnings growth.

It was the 26th consecutive quarter of revenue growth and the 7th consecutive quarter of positive earnings.

We ended the quarter with $54.5 million in cash or short-term investments, up from 27.4 million a year ago and 46.5 million in the second quarter of the year.

We continue to have a nominal amount of debt, totaling 1.6 million at the end of the third quarter.

Turning to slide number 8.

As previously announced, during the quarter j2 Global acquired a personalized permission-based e-mail messaging company -- M4Internet.

M4Internet has been providing a key component of our lifecycle management process for nearly three years.

The financial and marketing operations of this company have been added to our corporate sales channel.

For more information regarding M4Internet's services, please visit its website at www.M4Internet.com.

Turning to slide number nine.

As a reference point for the Company's vertical market penetration, I would like to briefly highlight a trend about our business.

J2 Global's corporate channel has and continues to experience considerable success marketing into the real estate sector of the economy.

This sector currently accounts for approximately 25 percent of our corporate usage.

During the period of declining mortgage rates over the past year and a half, we've reaped the benefits of the significant activity, such as refinancing, generated in this industry.

For us, this meant an increase in usage of our services; in other words, pages of faxes traveling across our network.

Conversely, as the real estate sector has seen a slowing trend, we are now seeing a decline in the volume of traffic placed on our network by our customers in this sector.

While our real estate-related customer base is not declining, the amount of usage they are generating has declined.

The most noticeable impact has been in our corporate sales channel, where customers are easily identifiable.

However, we also believe that the impact of the slowing real estate market is being felt in our web channel through the individual users of our service, such as real estate brokers.

That being said, our corporate and web channels are very diversified over many industries, and we continue to see growth in other industry sectors.

If you'll turn to slide number 10, I'll provide a summary of our telephone numbers, or DID, inventory.

Please focus on the bar and the data on the right side of the chart.

As previously stated, we had at the end of third quarter 5.5 million active DIDs.

Of those, 5.1 million are serving our free advertising supported base of customers, and approximately 380,000 are serving our paid base of customers.

These paid DIDs are further broken down into almost 317,000 for our subscription web channel customers, and more than 63,000 serving our corporate customers.

Growth continued across the entire base.

Over the next several quarters, we plan on increasing our base of free telephone numbers -- or DIDs -- as this population of users continues to be a good source of growth for our paid subscriber and corporate channels.

Continuing with slide number 11, you'll see it as the additional metrics we provide to help with an understanding of our business.

Of particular note on this slide, you'll see that the growth of new DIDs in our paid web channel continues to be healthy.

Our cancellation rate for this base of customers continued to improve.

We experienced a slight decline in ARPU from the previous quarter, due primarily to a decline in usage, particularly in August.

We believe this is a result of summer seasonality, the general impact of the slowing real estate market across our entire base of customers, a slight increase in our annual subscriptions and the effect of various promotions.

On a revenue basis, it is also important to note that only 10 percent of our DIDs during the course of the quarter were at the higher price points, following our rise in prices.

As you will recall, we began to roll out the price change to existing customers only in mid-September.

This effect -- the effect of this price increase will occur primarily during Q4 and Q1; however, it will take approximately one year to be fully complete.

With regard to our corporate channel, the growth in net DID additions and the number of new accounts were consistent with the previous quarter.

Note that September was our best single month ever for signups.

During the quarter, the number of corporate account managers declined by 1 to 15.

We are continuing to interview and hire account managers.

Our goal continues to be 20 account managers by the year end; however, it may not be possible to reach that goal if we do not want to hire simply for the sake of -- we do not wish to hire simply for the sake of hiring.

As we have previously stated, this is a relatively new sales channel for the Company, and we are continuing to learn and experiment with the best ways of attacking this opportunity.

The page index for the corporate channel did not grow as rapidly as previous quarters.

As stated a few minutes ago, we believe this is related to the general slowness in the real estate sector.

Turning to slide number 12, I would merely highlight again the fact that we continued to expand our international footprint during and immediately following the third quarter, adding Mexico and Israel and several new cities in Canada.

We currently have 59 physical points of presence around the world serving the 1100 cities.

Slide number 13, which describes our product roadmap, has also been updated to reflect the recent announcements.

During the third quarter, we introduced additional features to our secure fax offering and a new and enhanced version of our Messenger (indiscernible), the Company's desktop messaging and communications software package, which serves over 125,000 downloads per month.

It is also important to note that this new version of the Messenger also provides our customers with additional features and capabilities, including double (indiscernible) language capabilities in support of our international efforts, and has been engineered to act as a launching pad to provide our customers additional feature functionality, such as optical character recognition -- or OCR -- and secure fax sending.

At this point, I am going to turn the presentation back over to Scott Turicchi, and then we will come back to wrap it up with a review of recent events for the Company.

Scott?

Thank you.

I would like to direct your attention to slide 15.

This is an update of our historical revenue growth going back to the beginning of the first quarter of 1997.

It is our 26th consecutive quarter of revenue growth, and you can see that it has been continuous from the beginning, but also since we acquired eFax late in the fourth quarter of 2000.

Slide 16 shows you how we report our revenues; the vast majority fall into the subscriber revenue category.

We also do have advertising and licensed services.

And then the total revenue for the Company, which was 18.9 million, or an 11 percent quarter to quarter growth.

Slide 17 gives you some supplemental information by channel.

I'll just remind everybody that our advertising revenue is part of the web channel, in addition to a subscription revenue.

It has grown, as you can see, between 9 and 11 percent quarter to quarter over the last several quarters.

The corporate channel has continued to grow at a faster rate, at 9.5 percent in this current quarter relative to Q2, despite some of the issues that Scott mentioned regarding a decline in usage from the real estate sector.

Total revenues, once again, grew at 11 percent quarter to quarter.

Slide 18 is a breakdown of our cost structure.

Our gross margin has edged to 82 percent.

Our operating margins are a little in excess of 39 percent, as we continue to get leverage out of our G&A; although I would note that in absolute dollars, G&A did go up from the second quarter, primarily for three reasons -- one, as you know, we affected the stock split, and there were certain costs associated with that; secondly, we had a renewal of our D&O insurance policy, and those are costs that tend to be generally increasing; and third, we took additional space during the second quarter, for which we had the full effect in the third quarter, in terms of the additional lease payments.

Nevertheless, G&A as a percentage of revenue continues to decline.

And sales and marketing and engineering are relatively flat on a percentage basis.

Slide 19 is our free cash flow.

This shows how it relates to our GAAP net earnings.

As I have explained to people, it is the case that over the course of the year, our free cash flow -- which is our net cash provided by operating activity less our capital expenditures -- will be equal to or greater than our GAAP net earnings, but it need not be the case in any given quarter.

However, in this quarter as was the case in last quarter, our free cash flow did exceed our GAAP net earnings by about $450,000.

Slide 20 now deals with certain tax considerations.

As you are aware, we have a variety of net operating loss carryforwards, both for the state of California and for federal tax purposes.

As we have been discussing over the last several quarters, those NOLs are currently fully reserved against on our balance sheet.

And therefore, you do not see a deferred tax asset; however, at the end of next quarter we anticipate that we will reduce the valuation reserve that we have on that deferred tax asset.

And as a result, we will recognize most of the remaining NOL.

We believe at this point in time that will result in a onetime tax benefit for the fourth quarter of between 9 and $13 million.

Those are in aggregate dollars.

Then, beginning in the first quarter of 2004, for accounting purposes we will begin to accrue a full tax rate on our pre-tax earnings.

Based upon the information we have at this time, we do not anticipate that tax rate to be greater than 40 percent.

In fact, it may be less, depending upon several factors -- including the relative composition of our revenue base, in terms of our domestic revenue vis a vis our international business.

However, on an actual cash payment of tax basis, we still retain several offsets for the payment of cash taxes.

First of all, we have remaining net operating loss carryforwards for tax purposes; we also have various federal and state tax credits; and finally, we have a series of stock options, about 770,000 of which are currently vested, and another 1.8 million which are vesting over the next 3 years -- 90 percent of which vest over the next 2.5 years.

Those options are substantially in the money, and as employees vest those options, we the Company receive a tax benefit that we can use.

So as a result, we believe that our GAAP tax accrual that you will see in our P&L next year will be greater than the actual taxes paid.

Slide 21 is our guidance.

This is for the fourth quarter.

We're estimating revenues to be 20.3 million and net earnings per share of 31 cents.

This is exclusive of that onetime gain that I just mentioned for the recognition of the deferred tax asset.

It's calculated on a base of 25.8 million shares, and assumes for tax purposes the 5 percent California tax rate we've been experiencing.

As a result, that will give us year-end 2003 numbers of 71.4 million and $1.03 per share.

Slide 22 looks forward into 2004.

We are currently in the midst of our budgeting process.

It is not currently complete.

We believe that our history over the last few years is representative of our future.

Specifically, our subscriber revenue, which accounts for about 94 percent of our revenue, has grown quarter to quarter, sequentially, between 5.3 percent and 12.8 percent.

Our advertising and licensed services, if you take them together, has varied.

They have grown as much as almost 60 percent quarter to quarter, sequentially, and they've also had declines of a similar magnitude.

We believe that of the incremental revenue growth experienced next year, 40 percent or more will flow through to the EBIT line.

Based upon everything that we see today, subject to all the risk factors you are aware of, we believe it is reasonable to expect that we will grow the Company in similar ranges for 2004 that we have experienced over these past 11 quarters.

I will now turn the presentation back to Scott Jarus.

Thank you, Scott.

I will wrap up this presentation by directing your attention to slide number 23, entitled Recent Events.

Some of this may be repetitive of what I previously said.

In mid-June of this year, j2 Global announced it would raise the prices for its new customers.

This change raised the monthly eFax Plus subscription rate from $9.95 to $12.95, and the jConnect premiere price from $12.50 to $15 per month.

In addition, we raised the activation fees for both services.

And then, in mid-September, we then announced that we would be increasing -- we would be affecting the same price increase for existing customers.

The process of this price increase for existing customers is being executed and phased in over the next 12 months, with the majority completed within six months.

Given that we started the process only a few weeks ago, it's too early to comment on the effect of this price change for our existing customers.

We completed a 2 for 1 stock split on August 29.

The effect of this split has been used throughout this presentation and in our earnings press release.

From a product and services perspective, the Company introduced new secure fax solutions -- including those which utilize Tumbleweed and VPN server architectures.

These additional features and capabilities enable us to serve larger enterprises with greater -- who have greater demands for security and privacy.

This is particularly relevant within the financial and health-care industries.

I previously mentioned that we expanded our network both internationally and domestically.

We released a new and enhanced version of our popular Messenger applet, which, as stated earlier, is the Company's desktop messaging and communications software.

J2 Global acquired M4Internet, which provides a personalized (indiscernible) based e-mail messaging solution, and is used by the Company as a key component of its lifecycle management process.

And finally, the Company was issued 2 new U.S. patents for components of its messaging services.

More information about each of these can be found through the press releases tab on the j2Global.com website.

This includes the formal presentation for this conference call.

At this time we will be taking questions live and via e-mail.

I remind the audience that they may submit questions to us during this period and anytime following by e-mailing us at investor@j2Global.com.

We will now turn the call over to the operator, Megan, for live questions.

(OPERATOR INSTRUCTIONS).

Youssef Squali, First Albany.

A few questions.

First of all I want to revisit this ARPU decline issue.

Can you just give us a little more color on it?

It was somewhat surprising to see it actually go down when 10 percent of your users are now paying you 30 percent more than what they have paid you historically.

Number two, on the corporate side -- I was actually under the impression that you already were at 16 account managers as of last quarter.

I think you said you were at 15 with the goal of getting to 20.

I'm sensing that potentially the growth in the corporate business may not be as robust as historically thought.

Is this a strategy whereby you guys may be kind of saving your energy, kind of waiting for a faster growth in this space before committing more capital?

And I have one follow-up.

Okay.

I'll start with the ARPU on the web channel.

Two basic reasons there are, the usage component that relates to the ARPU quarter to quarter, which we saw a decline particularly in the August month, that affected the ARPU for the whole period; and then also, the percentage of annual subscriptions went up in the third quarter relative to the second quarter.

If you subscribe with us for a year and you pay for a year in advance, you get 12 months for the price of 11, whether that's at the new price points or whether it was historical on the old price points.

So those two components are the major reasons why you see that offsetting what would be the ARPU bump from the 10 percent of the revenue paying customers who had higher price points throughout the course of the quarter.

Just so I understand your point, are you saying that that means in the fourth quarter we should actually see an acceleration in subscriptions, given the fact that you have had an increase in annual subscriptions this quarter?

I don't fully understand the question.

The annuals who signed up in Q3, the only effect they will have in Q4 is that they will be in for all of Q4 at their price point.

But there ARPU is always lower than the ARPU for our month to month customers, always.

Because there is always a discount given for you paying for a year in advance, and right now it's a 1/12 discount.

You pay for 11 months, you get 12 months worth of service.

And (multiple speakers) you take our 12.95 or our 15, and reduce it by 1/8.

Relative to the corporate channel, now we had 16 in the previous quarter.

We're down 1 to 15 in this quarter.

As I stated, our goal is still to be at 20 by the end of the year.

However, whether we hit that target or not is actually throttled by whether we find good salespeople to hire or not, not by any pullback in our strategy with regard to the growth of our corporate sales.

As a matter of fact, I would state that we continue to have high expectations for our corporate channel, and are seeing expected levels of growth in that channel and we're seeing the penetration into the large enterprises on a consistent basis.

As a matter of fact, September was our largest growth ever in our corporate channel.

Okay.

Lastly, just on the fourth quarter guidance.

I'm assuming M4 will be fully contributing to that?

We don't really know how big is it.

I'm assuming it's relatively minor, but --

It is relatively minor.

It is orders of magnitude of probably a couple hundred grand of revenue.

Okay, fair enough.

The other thing I just wanted to (indiscernible) follow-on to your comment -- Scott's comment back to you is that in the corporate channel I think there's two things to remember.

One is that as they go after larger opportunities, you probably will seem more spikiness going forward in the quarter to quarter weight of growth in corporate.

Because if they go in -- and they are targeting larger (indiscernible) enterprises, which have larger dollar tickets with them, but they are also longer in gestation in terms of acquiring them or winning them.

The second piece of the equation is that, remember that the corporate channel -- particularly if you look at it on an ARPU per DID basis -- has a lot more of the ARPU focused on the actual underlying usage versus the fixed fee, which is, of course, not the case in the web channel with the inverse.

Roughly 2/3 of the revenue coming through the corporate channel is based upon usage and 1/3 would be contractually fixed.

If you think about large corporate deployments, we may sell the account this month if the DID -- the telephone number is assigned rapidly, but it takes time for enterprises, large enterprises to distribute those numbers and get their employees and their underlying people to start using the service, where we start seeing that revenue on a recurring basis.

Daniel Ernst, Rodman & Renshaw.

A few questions.

The licensing revenue pickup to about $40,000 -- is that because of PaperMaster?

Yes.

Let me just, before you ask your follow-on question -- the thing is about license services.

Substantially all of the Q3 $416,000 relates to PaperMaster, which we began selling in July of this year.

That is the new version, PaperMaster Pro.

If you look back into historical quarters, we had anywhere from 100 to 150,000 of various royalty revenue that, if you may recall, going back about a year, we said was running off.

Most of that has run off, so most of the revenue you will see in license services in Q3, certainly in Q4, will be PaperMaster related.

There are little (indiscernible) and grabs of other revenue, but it's not material.

So do you expect to see continued sales at that level for PaperMaster, or is that just a onetime thing?

Let's put it this way, we began the marketing of it with probably some of the lower hanging fruit within Q3.

Marketing is continuing into 4 and will continue into next year, but there will be additional channels of distribution, some of which are in the process of being developed right now.

Follow-up questions -- let me just ask them, and then you guys can go into it.

Can you talk about more specifically what your plans are for London, Hong Kong and internationally? (indiscernible) on the call, Scott, you plan that that would be a continued push for growth, and could you just give us a little more color on that?

And secondly on the web channel, can you talk about where you stand with re-upping with Yahoo!.

Let me deal with the international first.

As those of you who have been following the Company for a while know, the locations that we have internationally are locations where we're offering our services in an English-only format for the most part, and it is marketed exclusively through the web for those people who are English-speaking, and certainly United States, but -- have a U.S.-centric sort of approach to their business.

We have been over the last many months working on plans to expand our marketing efforts on an international basis, by localizing our efforts in-country to be able to sell directly to the populations where we are offering those services.

Now, it would be done more on a language basis than a country basis.

So as an example, we may start offering services in Spanish, which will allow us to cover a number of Spanish-speaking parts of the world.

And that means we'll be marketing in Spanish; the sites will have a Spanish component, and we'll be delivering faxes with Spanish headers, etc. etc.

So our efforts will be changing from what was a deployment of network and local assets numbers in 1100 markets around the world to a continued deployment of those services with local market penetration.

But also, the addition of localized marketing efforts and localization of languages in those markets.

The second part of your question with regard to the Web channel, the answer is is that our contract with Yahoo! -- our agreement with Yahoo! expires by its term in November.

We continue to be pleased with that, but as of yet, neither we nor Yahoo! have come to terms on a renewal of that contract.

Though we are, as I said, we are pleased with it.

We are always looking for other opportunities of a similar nature, and we'll go through an evaluation as to whether we wish to continue the Yahoo! relationship -- whether we wish to put it in some sense of the (indiscernible) for a while -- let the Yahoo base build again for those who haven't seen our message -- or whether we want to have Yahoo! in companionship with other opportunities that are presented to us.

So I can't answer whether we will continue beyond November, except to say that we continue to be pleased with the Yahoo! success that we've had.

And we look for it, and or similar opportunities, going forward.

Does the Yahoo! relationship represent more than 10 percent of sign-ons.

I can't nor would I want to tell you that, because we don't release where our customers come from.

What I can tell you is that the Yahoo! advertising -- the button on the Yahoo mail page primarily isn't used to attract free customers.

And as we've stated, the free to paid upgrade path accounts for either the number one or the number two sort of our paid subscriptions at any one time.

So in an indirect way, we like those sort of deals, because they do eventually lead to a paid subscriber.

Last follow-up on the international.

What's the timing and initial target of that language-based upgrade, (indiscernible) language based focus?

I can tell you that we're starting out very conservatively and cautiously, because those who have followed others who have expanded internationally know that the road is littered with both small and large companies who have gone to fast without understanding the market.

So we are growing cautiously.

To that end, we have taken one of our senior people within the Company and made the international plan his primary focus.

And the goal is to make our international localization rollout, doing the -- the early markets will probably be other English-speaking nations.

Because then we don't have to worry too much about the language.

Then we will move into other of what you might call the top five languages of the world, and in no particular order -- like German and Spanish and French, etc.

And we will do that one at a time, until we've learned exactly how to do it well.

And then we will have a plan in place which will call for the escalated deployment of a localized service.

Stephen DeLucia, Sidoti & Company.

Could you tell us what your assumptions are for the percentage of the base that should be converted to higher pricing in your Q4 guidance?

Yes.

I will answer your question one way, you can probably impude (ph) it.

The way the price rollout is working is roughly of the old 293 customers -- 293,000 web channel DIDs that were not effected as of June 30.

In essence, about 40 to 50,000 a month are being run through the upgrade pricing beginning in mid-September.

Now it's not going to be necessarily 40 or 50 each and every month, but on average it'll work that way, such that by the time you get to March 31 of next year, most of the 293 will be affected.

The only residual portion that will not be affected would be those customers who had signed up from March 31 of '03 through June 18 of '03, under an annual subscription.

It will be some residual amount that we picked up over the next quarter.

Okay.

And the Web subscriber additions in the third quarter were down from the second quarter.

Is this normal variability or was there something unusual in the quarter?

No, I think you have a few things.

One is, yes, you do have some normal variability.

Our quarters are not all sequentially perfect in their growth rate quarter to quarter.

We do have variations, whether you are looking at it by metric or by revenue.

Two other things that I think that did affect it specifically in the third quarter is -- you'll recall that when we introduced the price change back on June 18, we articulated there was a decline in gross signups, and that as we had gotten farther away from that date that gap had begun to narrow.

But you did have some fall-off in gross signups in Q3, relative to Q2.

And you also have some timing differences on the amount of upgrades from free to paid that occurred in the third quarter relative to the second quarter.

As Scott mentioned, when we get free customers in, they are not immediately ripe for upgrade to paid.

It takes actually several months to season them.

So in essence you create a backlog of free customers who become ripe for upgrade.

The upgrades were (technical difficulty) in Q2, on an absolute number basis.

Steve Levenson, Advest.

Can you give us an idea on mix between -- the mix between annual subscribers and month to month subscribers?

Yes.

As of the end of Q3, it is about 82, 83 percent in favor of month to month and about 17 percent annual.

That 17 percent, though, was up relative to the percentage in Q2.

Okay.

Second, can you give us an idea what's going on with government customers?

I know you started with a dedicated account manager last year.

Is that getting better, holding steady or declining at all?

The answer is it hasn't changed appreciably since we started it.

The government contract that we have right now continued to perform well.

We haven't acquired any new ones of any size subsequent to that one.

However, during that same period we filed with the GSA for inclusion in their certified vendor list.

Those of you who have been involved with federal government contracting know that that process takes what seems like forever, and it is forever for us.

We're still waiting for that certification, even though we've completed the work we needed to do for the filing.

So our anticipation is that we should get the certification soon.

I don't know what soon means, though, for the federal government.

And that once we have that, we will be in a better position to market aggressively to federal agencies and hopefully start seeing some benefit from that.

But right now, our government channel has not changed very much since the last time we talked about it.

Okay.

Thank you.

Last question.

Is there any focus on any particular segment for new corporate paid customers?

Even though, as I mentioned, that a good portion of our corporate channel, and perhaps even our web channel, is real estate-related -- and by the way, that includes, like, mortgage banking, brokerages, title insurance, title searches, etc. -- we continue to make inroads into that sector, even though that particular business has slowed considerably.

Other vertical markets where we are seeing good success is the legal profession, particularly with the introduction of our secure fax offering.

Health care is a growing base for us of a vertical market.

So I think we continue to be seeing successes in those industries which are traditionally dealing with signatures, replicated documents and fax in the traditional sense of the word.

Joe Noel, Pacific Growth.

A couple of quick questions here.

With the net adds on the web channel area being down a little bit, down from Q2 -- how much of that is seasonality; how much do you think that is price increase?

Second is, on the percentage sequential growth, the page maker software makes a difference.

I know you described it briefly, but can you give me a little more color on that?

Do you expect page maker to be the same, 50 percent less or 25 percent less?

Can you give me some color there?

You mean PaperMaster?

I'm sorry, PaperMaster.

The 416,000 -- let's put it this way, in our guidance for Q4, we've assumed that it will not be as good as Q3.

But that's not that we are not trying to market it and not that it couldn't be as good as Q3.

The difference (indiscernible) extending the PaperMaster marketing into new channels of distribution.

And some of those channels of distribution, the timing of it is not totally in our control.

Would you say that it would be down 50 percent or down less?

It could be down 50 percent.

It could be.

What about the new patents?

Can you just give us the ten-second version?

There were two of them.

One of them had to do with sending capabilities of objects through the public telephone network, as opposed to receiving, a sending patent.

And the second one had to do with a fax machine to e-mail sort of patent.

And it's an older patent, whereby we describe the process of sending a fax from a fax machine directly into e-mail.

One quick one, maybe one that might take a little longer.

First of all, can you comment on the churn trend?

We don't really have a full effect of higher prices that would affect the churn number, which of course was down again.

What effect might that have in Q4?

I was hoping you could also spend a second on a longer term trend for the Company, new business areas that the Company would need to enter to maintain growth over the longer-term?

Let me address the cancel question and then I'll turn it over to Scott for the business trends.

You are correct that the 2.8 percent we reported for Q3 has virtually no effect from the change to the existing base of customers, because the first round began on about September 15.

So there's very little effect in the Q3 numbers.

I actually got an e-mail question that was asking a slightly different variation of your question, Joe, which is what is the effect we've seen relative to that base?

And I would tell you that we see relatively little (indiscernible) it is too small of a sample to do any kind of extrapolation, and infer that there is going to be no effect or modest effect on our cancel rate.

I would expect over the next quarter or two, as larger percentages of that historical base get affected, you could see that cancel rate move up.

On the new industries -- or new product offerings, I'm sorry -- new product offerings, I again point you to the product roadmap, which I know you've seen over and over again quarter after quarter.

And we've been moving things from the bottom up.

What I would tell you is that we continue to develop or seek out new messaging capabilities or new messaging services that we believe our customers would find of value.

Those sort of messaging services range from different ways of delivering faxes -- hence, the secure fax opportunity -- to extensions into what we call the food chain of our business; meaning ways of handling e-mail, ways of collaborating with messaging, expanding perhaps even into areas that we have just touched on such as conferencing, etc.

So there are a number of areas that we are exploring, and all of them have in common an extension, both vertically and horizontally, into various new messaging capabilities and features.

But I have one comment, because there was, I think, an implication in your question that we needed to do additional things to maintain our growth rate.

We do not believe that is the case.

We do not believe that is the case.

We believe that the combination of taking what we do today, continuing to pursue the domestic marketplace -- which is our backyard, obviously -- extend it out into international opportunities, and then finally, layer on some additional feature and functionality, is really the core in terms of the business going forward over the next year or so.

So you say as far as -- rather than expanding into other product lines, you think your better growth path would be to expand internationally?

It's not an either or.

Our business will continue to produce well for us doing exactly what we're doing now, both domestically and internationally, even if we chose not to go into more localization.

We believe that localization is additive eventually to our core business, just as adding new features, functionalities and messaging products is also additive to either our core business or our core business and international localization.

Last question here, maybe a little bit more difficult question.

It's impossible to draw a trend from your net adds on the web channel, they are really all over the map.

And you may even have some seasonality in Q3.

Would we expect Q4 net adds to be above or below the $24,000 -- I'm sorry -- 24,000 number?

A lot of that is a function of what the cancel rate will be on the older customers affected by the price change increase.

So you're going to have some potential noise in Q4.

If there is very little to no effect, then your number may have some merit to it.

But you could see additional cancels flowing through Q4, which would be perfectly acceptable to the Company, in terms of having those people at higher price points.

So are you saying --

-- it's too early to tell.

Too close to call?

No, it's too early to tell, in that as the next batch of price changes goes out, and as we get more data and there is some answer to whether the cancel rate is going to change materially from the 2.8 percent you see -- obviously if it goes up even 100 basis points.

While on the net adds you would see higher -- you could have the same gross adds as Q3, but you'll see more deductions, and as a result, lower net.

So a lot of it is going to be a function of what goes on in that cancel rate, and a lot of that's going to be (technical difficulty) of the core business but how the price change is rippling through.

Gentlemen, there are no further questions in the queue.

We have -- we think we answered by e-mail most of the questions that have come in.

There was one additional question I don't think we addressed, which we will answer now before we close.

We got a question here that says --

Recently Microsoft announced a teleconferencing service.

In fact, they're running television commercials regarding the service.

How do we expect this service to affect our business?

We don't expect it to affect our business.

First of all, our teleconferencing product is a very small part of our business.

It is intended primarily for our existing customers who use our core services.

We believe that it has good value and will have good value even after the Microsoft announcement for our existing customers, based on price point and feature functionality.

But in a worst-case, it would have no material impact on our business going forward.

If the question is getting to whether there is a positive upswing based upon this announcement, based upon our announcement that we'll be a part of Microsoft Office 11 (technical difficulty) have any way of knowing except that we would hope that, as Microsoft fully engaged and rolls out Microsoft Office 11, any advertising or promotion which has to do with Microsoft services and software would by its nature hopefully bring us along with the drag, since they tend to reach out and touch a whole lot of people.

So it could be positive for us in that regard.

Do we have any other questions?

We have no more questions by e-mail.

Are there any other live questions?

No sir, there are not.

Okay.

We thank you very much for your participation in this quarter's conference call, and we look forward to talking to you again after the first of the year.

Thank you.

This does conclude today's teleconference.