Ziff Davis Inc (ZD) 2006 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the j2 Global Communications second quarter earnings conference call.

It is my pleasure to introduce your host, Mr. Scott Turicchi, Co-President and Chief Financial Officer of j2 Global Communications.

Thank you, Mr. Turicchi, and you may begin.

Thank you very much.

Good afternoon ladies and gentlemen, and welcome to the j2 Global investor conference call for the second quarter of 2006.

As the operator mentioned, I'm Scott Turicchi, Co-President and Chief Financial Officer.

With me today is Hemi Zucker, our Co-President and Chief Operating Officer, and Gregg Kalvin, our Chief Accounting Officer.

During this call, we’ll be discussing our second quarter financial results, providing guidance for third quarter, as well as for the fiscal year.

In addition, we’ll be addressing other items and questions that we have fielded over the last several weeks on matters such as the Venali litigation, tax matters, and back-dating of stock options.

In addition, we’ll provide additional information from an operational standpoint regarding our corporate sales activity.

The IR presentation, which is a roadmap for today's call, can be found at our website, which is www.j2global.com.

In addition, if you have not received a copy of the press release, you may access it through the corporate website at the same address.

After completing the formal presentation, we’ll 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 email questions to investor@j2global.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 could 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 SEC filings, including our 10-K filings, recent 10-Q filings, various proxy statements and 8-K filings, as well as additional risk factors that we have included as part of the slideshow for today’s webcast.

We refer you to discussions in those documents regarding Safe Harbor language as well as forward-looking statements.

I would now turn to the results for the quarter.

This was another strong quarter for j2 Global.

Revenues were $44.4 million, up 27% from the second quarter in 2005.

The revenue was at the upper end of our range of guidance, due in part to an outstanding quarter from our corporate sales group, as well as strong patent licensing revenue.

Our net paid DID growth continued to be in the range of approximately 50,000 net paid DIDs per quarter.

Our gross profit margin was 79.3%, and increase from 78.8% in the first quarter of 2006.

Due to the implementation of FAS123-R, we are presenting both GAAP and non-GAAP financials.

For purposes of comparability, we will state our margins based upon the exclusion of the 123-R expense, and at the end of the presentation there is a reconciliation between the GAAP and the non-GAAP presentation.

Non-GAAP operating earnings were $19.2 million, or 43.4% of revenues.

Net earnings on a non-GAAP basis were $14.2 million, or $0.28 per share.

On a GAAP basis, net earnings were $13.1 million, or $0.26 per share.

We expect that for the full year 2006, expenses due to 123-R will have an impact of between $0.-8 and $0.09 per share.

Funds available to grow our business rose to $175 million, and during the quarter in May, the Company affected its 2-for-1 stock split.

At this time, I would now turn to the presentation that’s available on our website.

You will note that it’s in a slightly new format, but a lot of the content and the information you are seeing is familiar to you.

I’d like to just point our a few highlights before turning the call over to Hemi Zucker.

I would that during the quarter, the number of cities that j2 services on its network passed the 2,000 city threshold, and we’ve launched several new countries, bringing our total network to 31 countries on 5 continents.

We increased the total amount of our DID inventory to 15.4 million DIDs, and more importantly subscribed telephone number grew to 11.4 million from 11 million in the previous quarter.

At this time, I would ask you to turn to page 9 and Hemi will go through some additional operational areas relating to our corporate sales channel.

Good afternoon, everybody.

I’m glad to be here with you.

As you know, every quarter we take a look into our business to decide what is the segment that we are going to bring under the spotlight.

This quarter’s decision was very easy; the achievements of our corporate share mill made a very easy choice for us, and I am going to take you to page number 10.

Our recent corporate shareholder achievements have brought us to this moment when we have for the first time signed a contract of 10,000 minimum DIDs.

As you know, with a lot of enterprises it takes a lot of time to close a deal, and those deals involve a customized contract, which includes pricing terms, which we also refer as length of contract, and minimum DIDs or phone numbers that we have to deploy.

This is the first time that we’ve had a contract with a minimum of 10,000 phone numbers.

This deal was signed with a very large consulting firm with over 120,000 employees.

So obviously, 10,000 in a company of 120,000 employees, we have expectations to go above and beyond the minimum.

If we go to the second bullet point, we are showing here a deal that we signed last year with one of the large 4 accounting firms.

They signed originally with only 7,000 minimum commitment; it grew to 10,000 numbers, over 10,000 numbers last quarter, and recently has extended the size of the contract to be deployed during Q3 up to 20,000 DIDs.

All this phenomena of minimum and then contracts increasing, we have calculated for you and basically we are, if you take our contracts, we have 54% above and beyond the minimum and it’s still growing.

As you know, we have a lot of contracts that just recently have been signed, and the minimums are being met and exceeded.

In our pipeline, our pipeline grew from 53 to 59 contracts of 1,000 plus phone numbers; of those 17 are outside the U.S., mostly in Europe.

As Scott has mentioned, we have added 2 countries in the last quarter.

Those are Hungary and Greece, and we already see signs of demand in those additional markets.

We had during the second quarter a new deal of 1,000 plus contracts signed in Europe, and from last year when we had only one rep in Europe, we have now 3 sales people covering Europe; 2 of them are in the UK.

We are very encouraged by the business in Europe.

I just met last quarter a few customers, and the faxing is embedded in the corporate, corporations in Europe in a way that is very encouraging to us, and we are very optimistic about the opportunities in Europe.

Another thing that is very important to us, despite the fact that we have large deals and are reaching to 20,000 DIDs, none of our customers, no single customer is larger than 1% of our revenue.

Going to the next page to discuss a little bit more about other achievements in our picture in the last 3 years; in the last 3 years, our corporate staff grew only 33% while at the same time, number of DIDs or number of phone numbers grew 300%.

We have now 2 customers with more than 10,000 DIDs; we have 24 customers with more than 1,000; 3 of them are outside of the U.S.

We have 61 customers with more than 500 phone numbers deployed; and 31 of our customers are Fortune 100 companies.

Those are only corporate customers; we have more Fortune 100 companies that are including our web base, but we are now talking only about those that have significant contracts with us.

Let’s go to page 12; page 12, which is the next page, is demonstrating and talking about the structure of our sales people.

As you know, in 2004 we brought on board of VP of corporate Sales, Mr. Tom Dolan, and we started to reshape and reorganize the structure of the corporate channels.

And as you can see, we have 4 channels here, and we broke them into; what are the drivers that bring the sales in; what are the markets that we are targeting; what is the size of each sale; and what is the focus of each of those sub-channels.

Starting with the SMB channel, we are targeting small and medium-sized businesses; most of the leads are coming through the web, through advertising.

Those are inbound leads that come in usually a form via the web, via chat, via emails.

We are targeting companies with a size of 10 to 250 employees, and usually the typical sale would be anywhere between 10 and 100 phone numbers.

The focus is non-geographic, and mostly as I said comes in the form of chat, email etc.

The next one is called the medium market.

This is the newest channel that we just launched recently, in late 2005.

The drivers there are web, but we also do protective outreach to potential customers.

Those are companies that have 100 to 600 people.

We have coverage in major cities, and we have a group of sales people that are sitting on those big metropolitan, and are reaching for customers and unlike the SME channels, we do have face-to-face meetings and we are catering to those customers.

The last channel, which was also the first one and the oldest ones that we have, which is the enterprise sales; the drivers there are usually through outreaching, relationship selling, consulting, etc.

We target larger companies with 600 employees and above.

Typical sales are we start at 500 and the approach is customer centric; we meet, we try to understand the needs of the customers, and cater to them.

The other channel, which we call the inside account managers are a smaller group of people that are targeting existing customers and out selling and maintaining and trying to increase the relationship with existing customers.

Let’s move to the next page, page 13;

I’m going to discuss a few of our corporate channel success and demand drivers.

As you know, there is a continuous trend in the market to consolidate data centers; many companies that share 20 plus data centers are consolidating down to 6 or less.

Those consolidations are very good for j2 because they have to consolidate infrastructure of fax servers, and once they want to bring all the infrastructure under, move from the city level to the state or to those kinds of levels, j2 shows up as a one-stop shopping solution, and we replace the fax server because we can cover the entire state for them, plus internationally because of our geographic spread, it’s a very good solution for them, so they can basically quote the entire company the same solution, unlike in the old days when they gave only employees in larger cities; now they can give the same solutions to all their employee base

And we also I think recently, as everybody is aware, there is no comfort level towards outsourcing.

Companies are comfortable buying solutions or services other than [inaudible] on their own.

The regulatory environment is helping j2 acceptance as well.

We provide redundancy, security and because we provide our services outside the letter of the phone company, there is an added venue there that we sit outside of their infrastructure providing disaster recover solutions.

Companies are now smarter about the way they calculate their TCO, total cost of ownership; not only like in the old days, they used to include only the telephony costs in their hardware.

Today they factor in deficiency; they factor in the versatility; all of those things are working in our favor.

Last but now least, as you know we discussed I think a quarter or 2 ago about the fact that we acquired a company called Data-on-Call, and they brought fax applications and solutions.

Sometimes we walk into those big corporations; they have not only a need to receive and send documents; sometimes they have a certain application that is running on their infrastructure and this application is something that we need to replace.

In the old days, we would focus on selling only what we considered inbound and outbound document delivery.

This recent quarter, we are able with our eFax Developer product to give the one-stop shopping and provide all their needs.

Moving to the next slide, page 14; as you all know j2 is a web-based Company that worked its way up into the corporate and we think we’ll get our [inaudible] and in the beginning of this year, we launched a new website to the corporate channel; we invested in new website, new layout, new tools, new search, and the results are very encouraging.

Year-over-year from the middle of 2005 to the middle of 2006, our visits to this website increased 80%.

We generated 36% more leads; and while this website benefits all the channels, the one channel that has the most benefit is the SMB channel that directly is the result of improved website, has increased 27% in the revenue, inbound mostly, telesales, chat, email, etc.

I am going to pass the conversation over to Scott and he will discuss about some of the financials.

Thank you Hemi; and if you turn to slide 17, you’ll notice that we’ve made a couple of slight changes in the presentation of the financial results.

Slide 17 is just a snapshot of what I went over at the beginning the call, which is the revenue, the non-GAAP gross margin, the non-GAAP operating margin, the non-GAAP EPS and the GAAP EPS.

That is on a quarterly basis.

If you turn to slide 18, you’ll recall that in previous presentations, those were margins presented on a quarterly basis.

This presentation is on a 4-quarter rolling basis.

And the reason that we have moved to this form of presentation is I think the 4-quarter rolling margins give a better representation in terms of how the business flows over a fiscal year, not just merely a quarter.

As we stated before, things like sales and marketing expense can move around 1 or 2 percentage points on a quarterly basis, but over the course of the year, tend to smooth themselves out.

So you’ll notice that on a 4-quarter rolling basis, the gross margin is about 79%;

I will note it was higher in the quarter just ended.

The operating margin was 42.7%; with the 3 operating expense categories being about 16% for sales and marketing, 16% for G&A, and 4.3% for R&D and engineering.

On slide 19, we have our guidance for both the fiscal quarter Q3, as well as the full fiscal year 2006, which we are reaffirming.

For the quarter that we’re in, we’re expecting $46.2 to $47.2 million of revenues.

We do expect that this quarter somewhat less patent-licensing revenue than we received in the current quarter.

We had actually a very good quarter from our patent-royalty income stream, in the neighborhood of $900,000 plus, which was more than our original expectation.

However, we don’t expect that to repeat itself.

As I’ve noted before, patent-licensing revenues unlike our other forms of business, do not come on an even-flow basis.

It’s a function of how many deals have been negotiated; how man deals are likely to be negotiated; and the form in which those deals take.

Non-GAAP EPS is between $0.29 and $0.30 per share with the assumptions being an approximately 30% tax rate and 51.6 fully-diluted shares outstanding.

The information behind the supplemental page fall really into the metrics page that you’re familiar with seeing, which gives you all of the now 10 quarters of rolling metrics for our revenues, our DIDs and our financials; the computation of reconciliation of free cash flow, and then the GAAP reconciliation for the first quarter and the second fiscal quarter both inclusive and exclusive of 123R expense.

Before we turn the call over the questions and answers, as I mentioned at the beginning of the call, we have received questions on several matters that I would just like to address directly at this point, and if there are any questions, of course, we can answer them during Q&A.

But as one of the topics that clearly been top of mind to people has been how companies grant and date their stock options.

So as part of our Q2 financial review process, we’ve engaged in a detailed, in-depth review of every option this Company has granted since it went public in July 1999.

This process continues to be ongoing.

In fact, even the accounting and FCC standards relating to looking at that data is ongoing, and so we’re keeping in concert with both the FCC, the accounting standards, and our accountants.

Once we’ve completed this review, which we think will take no more than another couple of weeks, we’ll inform the public if there are any adjustments that would need to be made to prior period results.

Secondly, I mentioned taxes; as you know we booked a reserve in the fourth quarter of 2005 to reflect basically a FAS-5 reserve relating to the transfer pricing of certain services that are purchased by j2 Global from a foreign subsidiary.

In 2006, we’ve continued to accrue a reserve for taxes, based upon the same methodology as was booked in 2005.

Our Federal Income Tax Return for 2005 is due on September 15 of this year, and we are in the process of finalizing that return.

We would expect to comment if necessary on any additional details either during our third-quarter call as it relates to the filing of our tax return, or if it were warranted, earlier.

Please refer back to the risk factors that we have previously disclosed in the Form 10K that was filed on March 27.

Those risk factors we believe remain applicable at this time and going forward due to the complex nature of tax issues affecting j2 and its subs.

And the last area we want to comment on is Venali; as I think many of you are away about 5 or 6 weeks ago or so Venali initiated a lawsuit against us.

This was a recently-filed lawsuit in Florida.

We believe this is a tactic used by Venali to try to avoid the adjudication of our patent-infringement claims against them, which are based here in California.

Those claims charge Venali with infringement of numerous patents owned by j2 and Catch Curve, an entity in which we have an economic interest.

And we seek substantial damages and an injunction to preclude Venali from continuing to provide its infringing fax, email, and related services to customers without a license from us.

Venali filed this lawsuit in Florida only after the court here in California denied its attempt to transfer the patent infringement case to Florida, an act that we regard as an acknowledgement of concern and an attempt to avoid an adjudication of its liability here in the California Federal Courts.

We believe that the claims Venali has file are meritless and should never have been filed.

We intend to have them transferred to California and ultimately dismissed.

At the same time, we intend to vigorously prosecute our own patent-infringement claims against them and obtain substantial damages and injunction to which we believe we are entitled.

So hopefully, that gives you additional clarity and additional information.

At this time, I would ask the operator to instruct you how you can ask questions.

Also I remind you that anybody that wishes to ask a question vie email can do so by sending it to investor@j2global.com.

Thank you. [OPERATOR INSTRUCTIONS].

Daniel Ives, Friedman, Billings, Ramsey.

Thank you guys; good quarter.

My first question; on the enterprise core corporate, what’s the catalyst there?

I mean it seems you add another 3 this quarter, quarter-over-quarter.

What happened on the enterprise that’s giving you guys some good traction on there?

Hi Daniel, how are you; if you note those large enterprises are very conservative in their approach, and it took them several years to get comfortable the solution that we are bringing on board.

Those companies are usually not for the first time getting a solution which is fax or email.

They are replacing fax servers.

Those solutions really take a lot of time, and I think we broke the ice there, and now they understand, and one after the other, the relationship and the penetration is getting easier.

And therefore, when we make few deals with large accounts, 10,000 or 20,000 and those are big-4 consulting firms, they tend to visit many, many other customers and the influence is there.

And we just see that we have a bigger pipeline and things are easier.

Okay, and just on the stock options because I can already see the short [inaudible] tomorrow.

Now, you’re looking at stock options like every other company, correct?

There’s nothing different in regards to a catalyst that you’re looking at stock options grants just like every other company, you’re looking back to target dates etc., just so we’re clear on that.

Yes, in fact the TTA will be who the accounting firms are subject to, if you will; came out actually with some guidance this past Thursday, and that is giving a somewhat clear instruction as to what they must do as an audit firm to get comfortable as of Q2.

So it’s something that they have to deal with right now, and as a result we have to deal with it.

So we already had a degree of investigation or general analysis that we were doing.

We obviously are updating that for the guidance that was received as of this past Thursday afternoon/evening.

We’re not doing this in response to any inquiry or anything like that.

Perfect.

To satisfy ourselves and to satisfy our accountants that there isn’t an issue.

That sounds good; and just a final question.

When you look at the year-end guidance, I mean the last Q4, Q4 ’05 that was tough quarter where it seems like the way you were kind of modeling for a stronger Q4.

Cold you just speak to kind of your comfort with what that sort of guidance implies for Q4?

Is that typically the tough quarter for you, but I guess things are changing your business in regards to corporate use.

Could you just give more clarity around that in regards to the seasonal patterns and why we should have more comfort with a strong Q4?

Thank you.

First of all, we are ahead of Federal changes.

We discussed a price change, and we are going to start with our price change.

We have decided that we are going to do the price change.

We didn’t include in the presentation but we have come to a conclusion that we are going to launch price change.

We are adding some features and some applications that will make our service richer; we are working on those.

And you should expect to see our price changing towards the end of this quarter, September/October.

That is one of the things of interest.

We are seeing more other movements in the corporate side.

When we bring on board, as I said before, larger enterprises that are replacing their infrastructures, we have some competitors that are showing some signs of weakness, and we are getting business as a result as well.

But you sound clear on the price change because guidance is unchanged from the quarter ago.

So this guidance implies, I mean maybe first you could speak to the price increase; maybe give clarity in regards to the $2 or $3 price increase for new.

But does Q4 guidance imply a price increase factored into that?

Well, let me tell you what we’re doing with the price change, and then comment on the guidance.

Our view -- first of all, we’re not giving Q4 guidance at this point.

We give quarterly guidance, and then we make an affirmation or alter the annual range if necessary.

So you have a range of revenues or, and a range of EPS for the fiscal year which we believe the first 2 fiscal quarters plus the third quarter guidance, plus whatever occurs in Q4 will fall within those ranges.

We’re not attempting to imply a guidance for Q4 at this point in time.

So that’s been our philosophy on giving guidance.

Now the, as it relates to the price change, the decision that we have made is that there will be an increase of $4 per new subscriber.

As Hemi mentioned, there are additional features and functionalities and additional activities going on in our back-end systems, so it will probably not take effect until some time in September, possibly October 1.

The implication of that is that it has basically has no impact on our Q3 guidance or on our Q3 revenues.

However, as we look into Q4, we clearly expect there will be a positive impact on the revenues from a fixed-revenue perspective on certainly new customer sign-ups during the fourth quarter, and as we stated before, this is now triggering an analysis for us of to what extent, if any, we will also attempt to pass through that price increase to the existing individual base of customers.

Just so there’s clarity; so you’re saying the $4 increase in the new, in the existing is something you guys will probably pass over he next few months, maybe implement in fiscal ’07?

No I think we’re going to do an analysis in the next 30 to 40 days, and depending upon the outcome of that analysis then it become in order of priority whether that is something that could be attempted to begin in Q4 or whether we would wait until Q1 to begin it.

As I said before, if we were to do anything in terms of raising prices to the existing base, we are talking about several hundred thousand phone numbers;

I mean 650-some thousand phone numbers.

That is not a trivial exercise.

So it would probably take us several calendar months, probably 2 fiscal quarters, to affect the change.

So depending upon all the other priorities we have, maybe that is something that if we had a positive decision on it would begin in Q4, maybe the beginning of Q1.

But the first step, just to be clear, is an analytical step that we have to go through to determine whether there’s enough value in trying to move the price up on the existing base, balancing that against what we know will be some customer attrition, and balancing it against the hard and soft-dollar cost of doing it.

It’s not trivial at this point.

I don’t want to be a hog with questions, but just on this $4 price increase, obviously this is very significant news.

Can you just speak to the testing process coming up with that $4 increase, what you guys saw as opposed to a $2 or $3 increase?

And then I’ll hand it off.

Thanks guys.

Sure; we did a test from mid-April to mid-May I believe it was, and we tested 2 alternative price points.

For the quarterly fax service $12.95 is the current price point as of today.

We tested $15.95 and $16.95.

The reason we tested those price points is our philosophical view on pricing is that it’s something that we look at every 2 to 3 years.

You’ll notice that the Company is not that old, but it’s been about every 3 years that we’ve gone through this process and exercise, and the last 2 times we’ve done it, we have or course, actually raised the prices.

Part of the reason for doing that is that this process of raising prices is not a de minimis exercise.

So you also know that as you raise prices, you will have a lower number of sign-ups, at least initially at the higher price point.

We know people come, they investigate, they see $12.95 today, and then suddenly they’re asked to pay $16.95.

So you want to make sure that if you’re going to do a raise in prices, there’s enough percentage delta pick-up of 25% to 30% such that you can absorb a decline on the spot basis in your sign-ups, and if you’re looking to do it on the exiting base, you can afford to have attrition from the existing base and still have a positive delta from an economic revenue standpoint.

To give you some comparative statistics, the last time we did this, which was in 2003 through the end of the first quarter roughly of 2004, prices went from $9.95 to $12.95, and from $12.50 to $15 for the jConnect products.

So you are looking at 25% plus price increases.

As it relates to the existing base when the dust settled after about 6 months, we had about an 85% retention of that base.

So there was a very nice positive delta between a 25% price raise and an 85% retention rate.

So those are things we’re looking for; we look at philosophical reasons as to why we think it is warranted; we look at product evolution; we look at competitive landscape; and then we actually test, and the test is what we did during this past fiscal quarter, and the test is where we actually had customers come to our website, and they were presented either $12.95, $15.95, or $16.95; the data that we garnered did not show actually a material difference between $15.95 and $16.95; hence the decision to go with the higher price.

Ari Moses, Kaufman Brothers.

Hey guys, good afternoon; first just on the pricing question, just remind us; that price increase I know the $12.95; does this have to go through to individual and small business users as well?

How would this affect the SME and the enterprise markets if at all?

At this point, this would not.

There are implications of the individual spot price point and how it does ultimately ripple through to SMB, SME, enterprise customers, but initially w hat we’re talking about are those that we call individual customers.

So they are acting on their own behalf; they are coming to our websites; they’re coming through a promotion ala Google search or a promotion with Yahoo or AOL or somebody like that.

And so they’re acting on their own behalf.

Now, at some point in the future we may look at the SMB pricing table and say, “Well, how does that relate to the individual, and are they sufficiently in sync?” That is not what we’re doing right now; that’s not the current intention; and it’s also, as I mentioned a much smaller base of customers.

Also let me, Ari some of the features that we are adding for the customers will be features like storage the enterprise customers don’t have today.

If they elect to do services and features, they would have to pay on top of the pricing that they do.

So the approach there is; here are the new features; do you want them, you pay for them.

When we go to the consumer we just add a feature, show them the value, and increase the price.

Got it, okay; if I can just switch gears for a second towards RPU;

RPU came in a little bit this quarter, but I was wondering if you could kind of tie the RPU conversation into seasonality.

Looking back at second quarter last year, you had kind of like -- and the year before -- you had the annual high quarter was second quarter for RPU.

This quarter, we’re seeing it come down off the first quarter, and I was wondering what the dynamic is there?

If there is a seasonal effect either in second quarter or maybe third quarter that you can link to.

I don’t’ think we have seasonality there in terms of the RPU.

I think what you have if you look at a more macro trend on a year-over-year basis, is that as Hemi pointed out in his presentation, we’re starting to see some real traction in that corporate enterprise space.

We have situations that are fairly typical when they deploy DIDs, they do them in very large increments and the quarter in which they deploy them sometimes there’s a very modest amount of revenue.

So we’re taking a larger denominator over the base of revenue.

Also, there’s an issue of them fully ramping to their potential because when you buy in these large quantities, you’re not buying $10 or $11 per DIDs per month.

You’re paying $4 on average roughly.

So it takes time also for those DIDs to not only be deployed to the hands of the employees, but also for them to ramp their usage, for us to get the full RPU effect, the full revenue per impact.

But when we sign and provision large enterprise deals in a given quarter, oftentimes they don’t come with much revenue and they can bring in our RPU.

And I think you’re starting to see -- we talked about it over the last couple of years -- I don’t think it’s a huge shift, but you’re starting to see some modest shift in the overall mix of j2’s business that’s going in the favor of these corporate/enterprise customers.

Got it; all right thanks.

Bill Benton, William Blair.

Good afternoon guys; just a couple of questions I guess.

Obviously, you additions remain pretty strong and you just talked about the RPU situation so maybe if you could just touch upon, were there any particular segments that you can point to that maybe were particularly strong, or weak in terms of addition or usage?

I mean, I know you talked about corporate, but I mean in terms of what your customers are using it for, your end customers’ business if you have some visibility to that.

I think the answer is they continue to be broad based; if it’s an indirect question about real estate.

No, no.

Because I think it’s fair to ask the question or fair to discuss it.

I’m looking at the data, and I see that the real estate activity as a percentage of our total revenue base continues to be sub-10%, and I think it’s even less than that.

As we said before, we cannot be absolutely precise.

In fact, real estate was quite fine in Q2 relative to Q1 so no, I don’t think we see any concentration.

As Hemi has pointed out, some of these larger deployments are in the professional services area of accounting firms and consulting firms, where actually they have generally higher than average use because of the nature of the employees and the fact that they’re in the field.

And their seasonality is usually at the end of the year, when everybody is on vacation, they work on their reports.

If you want.

If you want, so we don’t know yet.

But there is -- see as the Company gets bigger, things are smoothing themselves out.

Right okay; and then in terms, I mean you’ve obviously raised price the last 2 times you guys have done this, so could you maybe just give us a couple of bullet points on what would make you not move forward in terms of the price increase across your --?

I think it’s not a question of not moving; it’s a question of how fast we will move.

[Inaudible] the base, not just the new people.

Yes, you see for the new customers we have reached a decision.

We are just now trying to do it in the best way, and for us the best way is to introduce value, not only price hikes.

So you will see that we will come with packages that are more exciting, that are -- I don’t want to talk too much because we do have competition -- but basically we are going to create a situation that our customers are less stressed about how to use the service, and they immediately start using all the features because there would be bigger bundles of services, okay?

Okay.

But today you know the service includes only inbound.

We are going to include other things that are beneficial to them, and this we are going to launch, as I said, at the end of the quarter.

Now, let’s talk about the existing base; as Scott indicated, 600,000 give or take customers that are basically on credit cards.

We have done the last 2 times in a very methodical way; usually we’ll start with those we believe are the easy, easy ones, meaning they’ve been with us; they’re stable; they have a high usage of the service; their value is so high that we think the increase of $4 a months should not be too dramatic to them.

We start it though, and we move down the food chain, and this moving down from the customer that just has been with us many years and he uses the service a lot, to the customer that just joined recently and doesn’t take big benefit of their service yet.

So this is a process that we did it the last 2 times, it took us like 6 months to go through all the base, and you have to remember, we had a smaller base.

Then we have also annual customers, those customers will see the price change only when their annual will come.

We also have seen in the past that we have to count safe programs; safe programs usually are, “Okay I want to keep my price, I want to lock it, but I’m going to change from monthly to annual”.

So again, we have to field them; they come to our customer support; they come to our lines, so in -- we have to make sure we have enough staff to take those calls and save the customers; safe programs are very beneficial to us.

They get money up front; the customer is locking himself to a year if you can imagine those customers that buy a full hear up front have a higher retention rate.

So with all of these delicate issues, we have decided to do it and it will probably take a good 2 quarters to go through the entire base; and every earnings call we will give you some color about how much progress we have done.

Okay, and then sales and marketing, I guess, I know you guys have quite a bit of flexibility at the quarter ends in terms of making buys and it did tick up this quarter sequentially by a decent amount.

Was there anything one-time in nature in terms of buys there, or were you just increasing your infrastructure in a certain area that you’re focused on?

On the international side as you know, we added a few cities and we added a few employees and some other increase of expenses.

We are doing more advertising and more branding as well.

And we feel comfortable with doing it on markets where we have coverage.

Not only in the last quarter we added some countries; some countries that we have full coverage; we are now having full coverage, which means we cover 80 [inaudible] of the population, and we started spending money on advertising outside of the U.S.

And because those are [inaudible] markets for us, you see the increase, but as you know we are very conservative and responsive, and we are seeing a good return.

Also there was a little bit increase in the commissions that we paid in the corporate channel because we had some big wins.

But those together are the incremental increases that you see in the market expense.

Okay and then finally just a ramp up on the options thing.

I guess I’m -- when you go back and you look at this, and I know you said you’re going to be done in a couple of weeks.

Some people say that it’s going to take a really long time.

So I’m trying to put this into some sort of perspective because I -- maybe I’m over-simplifying it a bit, but it feels you go back, you look at an option and you say, “What was the price on the date of that?” And then you compare it, and if it’s different then there’s a problem, and if not, then there’s not.

So it feels like it should be a quick type of resolution, and to your credit, you guys are talking about a fast resolution here.

But there are some people that take forever.

Is there a reason that I’m over-simplifying that?

No, I mean I think that the process is one -- the good news is we haven’t been public that long.

We’ve been public 7 years so we don’t’ have 25 years to go back and deal with.

We’re dealing with a 7-year timeframe.

The way the Company grants options, it had generally done it in block grant format for management, executives, and the Board, so those are infrequent, so there aren’t many of them.

And then, depending upon what period we’re talking about, employees generally were granted options upon hire, and so there are obviously more of those grants in terms of individual ones.

So our view in working with Deloitte and their sort of best practices understanding is that you go through and you look at each and every grant, and you look at what was the grant date; what was the grant price; what was the action taken by the appropriate authority, whether it’s a comp committee, the Board as a whole, or whether that authority was delegated in a given instance to a management executive, like the CEO.

And you’ve got to pull all the paperwork; you’ve got to pull all the minutes; you’ve got to basically gather all the data up, and then take a look at what was the behavior on each and every one of those grants.

And then to the extent you find any deviations between the grant date and the actual paperwork, then you have additional work to do to see if, how bit of a delta does it work for against the employee, etc.

It’s just a process;

I mean it’s -- I think we’ve actually done a fair amount of work in a fairly short timeframe.

As I say, we don’t have thousands of grants to look at, which is good news.

And so it’s really now conforming the data to the standard as really, as they evolve.

Okay, but you had been doing some work on this before, these kind of maybe the outline came out from the PCLB you said and so maybe, just so I understand it sounds like me from your early stuff, there’s nothing you can tell us today that you’ve sort of found out was unusual in your early analysis?

Well, I don’t think we’re prepared yet to make any conclusions.

We’re just gathering all the data; we’re looking at all the data; and we’re interpreting all the data pursuant to our and Deloitte’s understanding of what the rules say.

So that’s something we’re doing -- well not literally as we speak -- but we’ve been doing and will continue to do, and I think within the next couple of weeks we’ll be done.

You guys will probably put out an AK on that then.

Probably.

Yes, we’ll just say we’re done and there’s nothing or we’re done and here’s whatever the issues are.

Okay thanks guys.

Frank Marsala, First Albany.

Yes good afternoon guys; a couple of questions.

Scott, are you prepared to talk about the kind of gross add or net add impact that you are expecting from the price increases?

Is there a general sense you could give us there?

Well, as I said I don’t think there will be any effect in the current quarter, given the timing of when the increase takes effect.

So for Q3, as you know we don’t guide to gross or net add but obviously we’ve had 4 consecutive quarters of 50,000 roughly net DIDs added.

So other than normal movements in the business and how much we spend on sales and marketing and how productive the corporate channel is, I don’t see anything that influences the gross or the net add productivity in Q3.

Now, assuming -- let’s just make it simple -- assume the price change occurs on October 1, so that it’s completely disconnected from this quarter.

Then for our individual channel in the fourth quarter, I would expect somewhere, for the individual channel; it has nothing to do with the SMB or SME or corporate -- but for that channel I would expect probably 10% to 15% fewer sign-ups.

But obviously those sign-ups that we do generate will come at 27% higher revenue.

That’s just a range, but I think that people should understand and should expect that.

And obviously, depending on what happens on the cancels, if you have lesser growth adds in one channel, that channel will probably have lesser net adds for that channel.

Now, whether the channels compensate for it or not, it’s too early to tell.

And since the change is only going to go to new customers, it shouldn’t have material impact on cancels which are existing customers.

I would agree; so what percentage of your base today could you tell us, is the individual base?

What percentage of your adds comes from the individual.

Oh I think we’re looking at rounds numbers; depends on the quarter, but call it anywhere from 60-some to 70-some percent are individual adds.

Most of them who will probably float through the mechanics where the increased price would be felt.

Okay that’s fair; and then again, not to take too much time, but free cash flow this quarter was a little bit light; looked like operating cash a little lighter and CapEx a little more.

Could you tell us what’s going on in the components parts there?

Yeah, in the CapEx we, as you know, we don’t -- our CapEx is not spent [inaudible] so we’re still on a 4-quarter run rate in the $9 million to $10 million range for CapEx this year.

The CapEx in the current quarter just ended was $3.8 million; we’re doing some additional infrastructure expansion as it relates to our data centers and so there were massive amounts of equipment purchased during that quarter.

I don’t think you’ll necessarily see that level in Q3, but I do think it will accumulate to somewhere between $9 million and $10 million for the year.

On the operating cash flow side, we have a phenomenon as we get bigger that is somewhat punitive in Q2, which is that you make 2 estimated cash tax payments during the quarter.

So as we get bigger, those estimated cash tax payments are larger, and that impacted us negatively in terms of generation of cash flow before the deduction of CapEx.

Okay, that’s fair; and then the last question I have; you haven’t updated us on the bring your own number initiative that you’re working on.

Can you give an update there?

I’ll let Hemi do that.

Yes, we are encouraged by the initial results.

If you remember, I mentioned that we had coverage for bring your own number on certain areas of the U.S. before we launch a massive, and also including this option possibly at the new pricing.

We are trying to get better coverage -- better coverage means cooperate with more carriers.

So we are encouraged with the carrier -- we have done it now with the large carrier, but it’s only one large carrier.

We are trying to expand.

And also we are considering to allow new customers when we come with the new price to include the feature bring your own number as part of the new pricing.

Did I answer you?

Yes, that’s helpful;

I appreciate it very much thank you.

Youssef Squali, Jefferies & Company.

Hi, thank you; this is [inaudible];

I had a question about the gross margins.

They were up quarter-on-quarter.

How do you see these turning going forward?

Well, as you know we said in probably the last couple of conference calls, we’re not going to be satisfied until our gross margin is at the 80% level or even north of that.

I think 80% is the fair right gross margin for the Company.

We had some dilution in the gross margin that was introduced, if I recall correctly, the third quarter of last year, which had to do with major network expansion and capacity enhancements.

And so, we’ve been, and continue to work on in the case of new jurisdictions being able to ramp that revenue at a faster rate so that if those pops -- we call them pops -- don’t become a drag on the gross margin.

Also in the case of acquired companies, to get them fully integrated because usually a smaller acquired company has a lower gross margin that we do.

It is not of the same scalability.

So we made some strides over the last couple of quarters in that direction.

We’re now back north of 79% on the gross margin.

It was up roughly 0.5 percentage point quarter-to-quarter sequential.

I look for continued improvement in that gross margin.

The goal continues to be 80;

I have a hope that we will get there during, by or at the end of the fourth quarter of this year.

That continues to remain one of our objectives.

And it’s not really going to be done; there’s not probably a whole lot that we’ve done in terms of cost cutting; it’s not so much an issue of cost cutting.

It’s more making less efficient physical points of presence more efficient from revenue productivity.

So as we put more dollars to work in those markets, as we come up with more marketing programs to sell numbers in jurisdictions, even where we’re not fully localized, even if we’re selling them to U.S. people; any way that we can start selling those numbers so those pops are not a drag on the gross margin, or at least less of a drag than they’ve been in the last 4 quarters.

Thank you, and another question on churn; did you see any change in that Q2?

Not materially; you’ll notice in the metric slide that 2.6% was the average monthly cancel rate for the quarter ended versus 2.5 in the previous quarter, so it seems to be roughly in that range that we talked about at 2.5 to 2.75% per month.

It’s fairly stable within that range; it does move about within that range.

If you like, Hemi can talk to some programs that we’ve experimented with and that we’re going to be launching because we do have internally a campaign and desire to lower the cancel rate.

And we don’t know if those objectives will be successful, but there is a focus here operationally to make the cancel rate as low as is economically practically possible.

Hemi, do you want to comment?

Yes; there is nothing big but as we tend to take more international markets, we need to learn how to deal with our foreign credit cards and new ways of fraud, credit card fraud that we learn how to deal with it in the U.S.

There are some new ones that we are learning to deal with in Europe.

And at the end of the day, everything ends up being the same.

We just have to become better in those markets, and as you know we have local people that can improve; nothing dramatic there.

Okay, and one more question; given that the USF issue has been addressed in the short term by FCC, do you think you will start focusing on adding on a free sub-base more aggressively going forward?

Well, let me make 2 comments; first of all, you’ll notice the free sub-base did increase in the current quarter relative to Q1, but I would tell you, that is independent of the USF issue.

We’ve always viewed that there is a channel which is the free channel; the vast portion of that is in the United States, but there’s also a building international channel of free, and that given our view on the USF issue and what would happen in the even “worst-case scenario”, it is not impeding us from continuing to put resources toward that channel.

Now, in some quarters, it may go up more dramatically than others; in some cases it may even go down.

It has to do with how we clean up and how we’re spending our money.

So I would say that yes, there is a continued desire to put resources towards the free channel; no it is not connected to what the FCC did do in the last hearing in June or what they might do in the future.

Obviously, it will be of interest just to highlight and talk about the USF for a minute; how the actual changes they made impact the revenue and productivity to the USF fund in the month of August.

All the things they approve in June take effect today, August 1.

So the [voice] providers begin paying today; the Safe Harbor for the wireless goes off; the DSL carriers come out.

We’ll see in the next month or so what the net effects of all those changes are.

Thank you.

Rod Ratliff, Stanford Group.

Thank you; most everything has been asked and answered, but with regard to the free base Scott, you’ve talked in the past about possible plans for monetizing the free base should the thunder come down with regard to the USF.

And on the subject of new price plans and the price increase you have planned for the fourth quarter for new business, are you guys seriously considering at all moving forward with any plans for lower-usage level plans in an attempt to monetize the free base ahead of, as sort of a preemptive strike with regard to USF?

Two different answers to the question; different elements to the question.

Once again, I don’t think that at this point, given where USF is or maybe is not, we have or see nay motivation to do anything vis-à-vis the free base other than operate it in the most appropriate, ongoing normal manner.

Obviously things can change; bills can be passed; the FCC can have additional hearings, etc.

But in the normal course, our view would be that we continue to operate it; we make operational and marketing improvement; we try to increase conversion rates; you’ll notice we’re building actually more advertising revenue off of the base.

Our advertising revenue is ticking up.

I did notice that.

As well as the CPT revenue from international.

So if and when there’s ever a reason to do something motivated by, whether it’s USF or some other issue that is regulatory-natured, then I think we’d be prepared to act.

I think at this point in time, there is no intent, desire, and it is not on our priority list to independently attempt to monetize the base.

Now, separate from that you’ll notice in the financial release today that we a few days ago acquired a company called Send-a-Fax, which is based in South Carolina.

It’s what you guys would call one of our [inaudible] deals; small, immaterial in the scheme of things.

One of the things that’s interesting about Send-a-Fax and how we will ultimately integrate it is that they actually have already a variety-tiered pricing program, and they have pricing programs that are as little as $1.95 a month for a phone number; no usage.

So any usage you pay is incremental to that, all the way up to -- I call them SMB or SME deals, which would look price-wise more like ours.

So as part of our integration of Send-a-Fax, one of the things that we will inherit from them is a multi-tiered pricing program.

Now, we’ve not yet decided exactly what will happen to those pricing programs over time, but clearly it gives us an opportunity to experiment, to play around with it; we want to test things.

There’s another added element I that acquisition, although in and of itself it’s not material to us.

Got it, and just one point of clarity with regard to sales and marketing expense; talk about it ticking up a few minutes ago.

Can you give any granularity at all with regard to what degree of that was an uptick in sales commissions for the corporate channel and what uptick, what percentage or what portion of it was an uptick in international marketing spend?

The biggest piece -- we’d have to get you, we can get you that data -- the biggest piece though was spend on, and it’s primarily domestic but it also relates internationally on what we call brand marketing, brand awareness marketing.

So we did some testing -- you might recall we talked about it a couple of quarters ago on our conference call -- about the effect of online marketing and its tail effect beyond the instantaneous gratification of whatever customers you get within a 72-hour window.

And we used some technology that we found was very instructive in showing us that yes, there was a benefit of generally brand marketing, much like you’d see in other media on the Internet where you create an awareness and an individual does not respond immediately.

They may come back in 30 or even in 60 days.

Though some of the spend -- I think it was one-half a point of revenues was invested in those kinds of programs during Q2.

The implication of that is they don’t generally have full current quarter revenue impact, because you’re building that awareness, some of which will occur in the succeeding quarter, or maybe even longer, but I’d say within a 60-day window.

Great, thank you.

Let me, before we go to the next live question, we received an email question which I’d like to address.

Is says if the price increase is implemented, and it’s not clear to me; clearly we’re going to do a price increase on new customers.

I think the implication here is that we do it on the existing base.

What would be the impact on gross and operating margins, and to what extent do we intend to reinvest the increase?

I think clearly there will be a portion of that incremental $4 that will be available to enhance our gross and operating margins, but there will be a piece of that, and I think it’s a minority right now that would be reinvested in a combination of areas.

One is clearly in the further extension of the network; we continue to look at Asia as we talked about previously, as further expansion.

We’d certainly like to have more presence than we have today in Japan.

We’re continuing to pursue opportunities in China, although I would tell you it’s very complicated.

So some portion of that increase will be reinvested in hopefully launching pops, presence, etc. in the new jurisdiction.

Also investing marketing dollars, but I think at least in the near term, the larger portion is something that would benefit both the gross and the operating margins.

Also, the other area that I see reinvestment is within our R&D and engineering group.

There will be additional employees added; there are already, the open to hires, the process; as we add more developers and coders and technical people to the engineering and operations staff, you will see the R&D expense, at least in dollars if not in percentage also move up somewhat.

Okay, the next live question.

Amit Dayal, Rodman & Renshaw.?

Thanks; congratulations guys; just one question.

How many of the new DIDs were acquired versus organic?

This past quarter?

Yes.

Basically all; the acquisition that we announced today occurred after the end of the quarter.

Okay.

So everything.

Okay, thank you.

John Mark Duncan, Pacific Growth Equities.

Good afternoon; can you give us what your total headcount is today and what it grew quarter-over-quarter?

I believe the number is about 320, our headcount, and the growth was probably about 10 heads net quarter-to-quarter.

Okay.

We had 300 at the end of the year, 12/31/05, so we’ve grown about 20 over the 6-month period.

I don’t have the exact breakdown, but I’d say roughly 10 and 10.

Okay thanks.

There are no further questions at this time.

At this time, I’d also like to turn the floor back to management for closing comments.

I understand actually we do have one more question.

Mike Latimore, Raymond James and Associates.

Thanks, I snuck in there; international, what percent of revenues was that and what percentage of subs was the free to pay channel this quarter?

The percent of international revenue was I think in the 12% range.

If I recall correctly, it’s about $5.3 million, so $5.3 million over the $44.4.

And your other question?

The free to pay, what percent of total sub-adds was that?

I don’t have the exact number, but once again I did not go over it in the presentation this specific quarter, but it was once again less than 10% of the gross adds.

The straight-to-web site continued to be approximately 50% of the gross adds produced during this quarter; the free to pay channel was less that 10, and the various corporate channels had a very strong quarter, and contributed probably the lion’s share combined with international, the remainder.

And it seems like, going back to the price increase, this time around you’ll have more international in the mix; you’ll have perhaps free to pay in the mix, and the last price increase.

Is there any sort of qualitative feel for what a price increase would mean this time around with those different dynamics involved?

With the free to pay, they’re not paying so pricing doesn’t change a lot.

But one thing I wanted to supplement Scott is we did discuss a few quarters ago but the quality of the free customers that we are gaining in the last I want to say 2 quarters is significantly higher because we launched this plan that we call it internally “match your DID” or we’re trying to match the last 4 digits of our customer telephone numbers.

This is because we find out that it’s easier to remember it, and people not only take it free now, but are starting to use it, and therefore the quality of those people, those customers, increased on the conversion rate and in their receptiveness to our marketing and advertising.

So a price change has no impact on the free customers, but the free customers’ quality is increasing.

On the international market, the price change will be implemented later on, and the first thing as we said we’re talking about 600,000 plus//minus customers that mostly do not include the international customers that pay in non-U.S. currency.

So some of our international customers are paying the U.S. prices; they will be subject to new pricing.

Some of them, Euros, Pounds and other currencies we will [inaudible] at a later stage.

Okay, thanks.

There are no further questions in the queue at this time.

All right; well, we thank you for joining us for the second quarter call.

I would encourage you to look to our website as well as to various press releases for upcoming conferences that we’ll be presenting at.

The schedule is relatively light until post-Labor Day.

There is one conference coming up in August that we’ll be participating at.

And then after Labor Day, several of them in September and October, and then we would look to have you join us for our Q3 conference call some time in either late October of around November 1.

Thank you very much.

Ladies and gentlemen, this does conclude today’s teleconference.

You may disconnect your lines at this time, and we thank you for your participation.