Ziff Davis Inc (ZD) 2006 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the J2 Global Communications Year-End 2006 Conference Call.

Speaking this afternoon, we will have Mr. Scott Turicchi, Co-President of J2 Global and Chief Financial Officer.

We will also have Mr. Hemi Zucker, Co-President and Chief Operating Officer.

It is my pleasure to introduce your host, Mr. Scott Turicchi.

You may begin.

Thank you.

Thank you, everyone, and good afternoon.

It is a pleasure to be back after several months' hiatus to present to you our financial results for the fiscal year 2006, as well as to give you an update on our business and a look into our 2007 projects as well as revenue and EPS.

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

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

All of our regulatory documents are now on file.

We have both the Q2 and Q3 2006 10-Q, as well as the 2006 10-K on file.

Those documents can be accessed through SEC.gov.

I would note that while in historic periods there are changes to a number of the financial items, they are immaterial in the aggregate, and relate primarily to the four-month investigation regarding the Company's stock option granting practices and the choosing of measurement dates associated therewith.

As you know, beginning in August of last year, the Company self-imposed an outside investigation, which was inclusive of legal and forensic accountants, to look at the history of the Company's stock option granting processes, as well as the accounting associated with it.

After an exhaustive investigation that lasted approximately four months and was concluded December of 2006, the special committee presented its findings and recommendations to the full Board of Directors.

Their conclusions were as follows.

There was no willful backdating, there were measurement date errors associated with some option grants, however, they did not result from misconduct by any member of our current or former Management Team or Board members.

The measurement data errors were in connection with grants to all levels of employees, including new hires and non-executive employees, and were not focused on or confined to option grants to senior executives of Board members.

Finally, the measurement data errors resulted in option grants at prices at, above, or below the price on the proper measurement date for accounting purposes.

As we stated previously, those charges of non-cash compensation expense are approximately $2 million for the period mid-1999 through the end of the year 2005.

Those adjustments as well as related payroll tax and employee compensation for the adjustment of certain strike prices on the options has been reflected in the restated historical financial statements.

There is within those documents explanatory footnotes that takes you from the historical numbers to the current as-adjusted numbers.

And I would emphasis again, those adjustments individual and in the aggregate are immaterial to the Company's historical financial results.

Today we have released the fiscal year-end 2006 financial results on both a GAAP and a non-GAAP basis.

We will be explaining how we arrive at our non-GAAP presentation and using that as the basis for the analysis and comparative purposes for 2005.

We will also use the IR presentation today, which has been updated to reflect current financial results, as well as the historic quarterly results that had not been previously presented.

A copy of this presentation is available at our website.

If you've not received a copy of the press release you can access it through our corporate website at j2global.com/press.

In addition, you will be able to access the webcast from this site.

After completing our formal presentation, we'll be conducting a Q&A session.

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

In addition, you may email questions to investor@j2global.com at any time.

Before we begin the 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 risk and uncertainties including, but are not limited to, the risk factors that we have disclosed in our SEC filings, including our 10K filings, recent 10Q filings, various proxy statements and 8K filings, as well as 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.

At this time, I'd now like to return to the results for the full fiscal year.

It was another strong and outstanding year for j2 Global with our revenues reaching slightly in excess of $181 million, up 26% from 2005.

As I mentioned, we believe that it is appropriate to look at the non-GAAP operating gross margin and net income presentation.

So allow me to read to you the modifications that we make to our GAAP financials to achieve the modified results.

And a reconciliation table is available at the back of our earnings report.

Modified earnings or GAAP earnings with the following modifications - the elimination of stock-based compensation expense for 2006 and 2005, exclusion of charges for payroll tax and employee compensation liabilities in 2006 and 2005 associated with inadvertent measurement date errors in prior stock option grants, the elimination of approximately 1.7 million net of tax, approximately 3 million pre-tax in G&A related expense related to conducting the stock option investigation, and approximately 1.2 million pre-tax or 800,000 after tax in third party general and administrative expenses incurred principally to enhance internal controls related to the Company's global tax structure, one of the results of which was the elimination of the material weakness in 2005, and finally, the exclusion of 5.9 million net of tax on gain on the sale of investment for fiscal 2005 of the Oasis Semiconductor investment.

So those are the adjustments we've made.

And as I mentioned, they are available as a reconciliation table within our financial footnotes.

The gross profit margin for the Company for 2006 was 80%, an increase from the 79.3% achieved in 2005.

Modified operating earnings were 77.7 million or approximately 42.9% of revenues.

Net earnings on a modified basis were 60.9 million or $1.19 per fully diluted share.

In 2005, those numbers were 45.6 million, or $0.89, for an increase of approximately 34%.

We had 123R expense of approximately $0.08 in 2006 and we expect that for the full year 2007, 123R expense will have an impact of between $0.07 and $0.09 per share.

Funds available to grow our business were approximately 192 million at fiscal year end and that was after the repurchase of approximately 500,000 shares of common stock, as of 12/31 pursuant to our stock buyback program.

As you also know, the Company effected a two-for-one stock split in May 2006, so all of our financial results, both current and historic, reflect that stock split adjustment.

At this time, I would like to turn to the presentation, but it's accessible through our website and our webcast and take you through some of the existing slides to tell you where things have evolved for the Company.

Hemi will then discuss the price change, we'll come back and discuss the guidance, and then open it for questions.

So beginning on slide four, we have the slide you've seen previously, which is how we look at our space, which is as we call it, "messaging as a service," where we offer four core sets of services, although each brand has a different set of functionality and price points and there are different additional functionalities within each of these four general buckets.

On the far left, we have what we call the IP Fax set of solutions.

These are predominantly, if not exclusively fax inbound and outbound solutions for individuals up through large enterprises.

The core brand in that space is eFax.

But now we have two additional brands that we use, both of which came through acquisitions - the Unifax brand, which was part of the Data on Call acquisition in mid-2005, and the Send a Fax acquisition, which occurred in July of 2006.

The second piece of our business, which is one that has been evolving is the voice services.

There's actually two brands within that space.

There's eVoice, which is dedicated voice mail.

But more recently, there's eVoice Receptionist, which is a virtual PBX designed for small to mid-size businesses.

Hemi will probably during the Q&A discuss that in greater detail.

It's only recently rolled out.

The third column are the unified communications, which are really the bundling of our existing fax and voice and live communication services.

There's two brands - jConnect, which is more messaging based, and One Box, which is more live communication based.

Those three columns, IP Fax, voice, and unified communications, are all accessible through telephone numbers, which as we stated before is why most of our metrics are in the form of DIDs, or direct inward dial telephone numbers, their ARPU, their cancel rate, and the aggregate number outstanding.

They generally constitute 90-plus percent of our total revenue.

The fourth set of services we offer are hosted email and perimeter protection services, principally under the brand Electric Mail.

Slide five is what you've seen before with updated numbers as of 12/31/06.

We have about 11.2 million subscribed telephone numbers, both free, paid, and corporate, U.S. and International.

We had significant increase in the breadth of our network.

We now cover more than 2,700 cities in 37 countries on five continents.

Our total DID inventory, which includes phone numbers that have not yet been provisioned to customers, is in excess of 16.4 million.

As we stated before, we're big believers in intellectual property, particularly in the area of patents, but also trademarks, brand marks, and we enforce that intellectual property.

We have a total of 49 issued U.S. patents, both domestically and in foreign jurisdictions, and numerous patents pending.

As we stated before, we have licensing programs to monetize those portfolios.

They have consistently done that now for a number of quarters, generally generating anywhere from $500,000 to upwards of $1 million in quarterly revenue.

The third element is the expertise.

We have about 350 employees as we speak.

And as we've stated before, all of our marketing programs, all of our channels of distribution for sale are internally generated.

We constantly refine and rework these programs, both in terms of the content, the vendors with whom we do business, as well as the approach in our SME and corporate sales.

And then, we have a strong financial position - 11 now consecutive years of revenue growth since the company's founding, five consecutive years of positive and operating--growing operating earnings, almost 192 million in cash and investments available for M&A or for additional stock buybacks, and virtually no debt.

Slide six is how we think of our customer bases.

They really fall into two categories and it has to do with who is paying the bill, who is the one that is actually contracting for the service.

So our largest base of customers is what we call the individual customers, where they are the ones through generally a credit or debit card are subscribing for the service.

We charge them in advance of the fixed monthly fee, or in the case of an annual customer, we bill them once for the full year.

We then use our proprietary lifecycle management elements to communicate with those customers where the goals are to increase usage, take additional phone numbers, or if you happen to be a free customer, convert to paid.

Then we have what we think of as our B-to-B segment, which covers small businesses, midsize businesses and large enterprise.

The small business customer is covered through a website with a telesales group that closes the sales, so we're driving traffic to those websites.

They are coming in and learning about the service and the price points.

They are calling here to Los Angeles, and our telesales group is closing them, provisioning them, giving them the corporate admin tool, and getting them on our invoice program.

Our SMEs, large enterprise, and government are sold through a direct sales force.

They're going after larger numbers of DIDs per account.

That's north of 150 where the largest single account today has approximately 20,000 phone numbers [inaudible].

On slide seven, we have six drivers for generating our gross paid add, which drives the business model.

You've seen this before.

I highlight and point out to you that still about 50% of our monthly paid gross add comes right to one of our selling websites and they come and they pay with a credit or debit card.

About 10% of our gross paid adds come from our free model where those customers are upgrading on a monthly basis.

And then, the rest of the customer acquisitions coming from SMBs, SMEs, enterprises, international, and various direct spend marketing programs.

Slide eight is an update of the service roadmap.

We're pleased that in 2006 we were able to launch eFax Developer, eVoice Receptionist, and Vault Smart, which is an archiving solution that we offer to our email customers for additional fees.

There continue to be a number of feature sets and services, of which this is only a small fraction that are in development that would both add additional feature functionality to the existing brands and sets of services you see, but also, extend what those feature sets can do and start to bring together what we call the DID based services with the document storage [services].

At this point, I'll turn the presentation over to Hemi, who will walk you through in greater detail what is happening with our eFax domestic price points and the price change that we've been undergoing.

Good afternoon, everybody.

I'm really glad to go live after 7.5 months of silence with a lot to tell and today I will focus mainly on the hottest topic, which is our price change.

Our price change has a history of successful price adjustments in the [indiscernible - accented].

I like to call them price adjustments because if we enhance our features and our service is being enhanced, we add redundancy, we add security, we enhance the network, we added a disaster recovery system.

All those things in our minds not only increase the value, but also justify increase of our prices.

So our history starts with 2000, when we bought eFax.

They had 120,000 paying customers.

They had customers paying on a quarterly basis 2.95 and some of them paying 4.95.

We analyzed the price there and we did something that at the time was edgy and we tripled the price.

We tripled the price from 2.95 to 9.95.

And after a lot of work that we have done, we were able to keep most of--80% of the customers moved on to grow the Company.

Then 2003 and 2004 came by and we looked again into the pricing and came with a price change of 30% and moved the price from 9.95 to 12.95.

And this time we raised most of the customers the initial four months.

And then, as we continued into it, increased the rest of the customers through the beginning of 2004, and again, were able to maintain most or 80% of the customer base.

Now, for the current one, it started in 2006.

We have raised the price from 12.95 to 16.95, 31% price increase to the eFax base, which is a little bit more than a [indiscernible - accented], approximately 500,000 customers on the web local U.S.

We focus on the local U.S. because our international prices are already higher, plus the currency situation with the dollar.

So we focus on the U.S.--in the U.S. market.

Before I go through the details, I also want to mention that in 2005 and 2006 we introduced a new product.

In fact, it's not a price change.

We introduced a product called [indiscernible - accented].

The [indiscernible - accented] is basically the service for 20 a month , or 1995, that includes 200 pages and is mostly geared to those that are heavy users, and again, even though it wasn't an imposed price change we did a lot of work to move customers and we have tens of thousands of customers today that are under the [indiscernible - accented] section, which are paying $20-plus.

Go to the next page, page 11.

We started by testing our price packages and we used all of the tools that over the years we have acquired.

We used cookies, telesales calls, track lifecycle management, [AP] testing, spent many hours on analyzing click rates, open rates, and analytics.

And after the testing in July 2006, we decided that the new price, the best optimized price for us is 16.95.

This comes also with annual price of 169.50.

And we moved from 130 inbound pages only to 160 pages, which are 130 inbound and 30 pages outbound.

So for those customers that in the past used to pay us for every page they sent, now it's the current pricing--it's a bundle and the bundle includes 30 pages of outbound pages within the U.S.

After the decision in the [organization] in Q3, we have actually started with the price change on the new customers, new customers coming to the website, so the new price--we analyzed it and got confidence it's [working].

End of the quarter we started to send notices to all existing about the new price. [Indiscernible - accented] we sent notices during the end of Q3 and Q4 and we started to convert the first group of existing customers and [indiscernible - accented] both the monthly and annual customers.

Let's move to the next page, page 12.

As of the end of the year, 90-plus percent of our customers have come to the website or new customers are paying us 16.95.

One might ask why only 90-plus percent, and the reason is because we have a lot of offers out there and the offers are sometimes at the old price.

Of course, we honor them.

And also, in a situation where the customer has already one account with us and the customer has not been notified of the new price, when these customers want to [indiscernible - accented] another account, we still allow them to come in with the older price.

So we are now on the very high end of--let me say about 90%.

It's about 95% of the customers that are coming new are paying us the new price.

Now, let's talk about the entire base.

The entire base at the end of Q4 was approximately 40% at the new price changes.

We are very bullish about the price change and by the end of Q1, which we are only a few weeks away from, we would be at approximately 60% of the base paying the new price.

And by the end of Q2, we are anticipating that 90% of the customers will be paying at the full price.

The reason that it's not 100%, we have some [indiscernible - accented], we have customers that are on annual programs and it will take basically till the end of the year to convert 100% of the customers.

I want to call your attention that one of things that used to be an issue for us several years ago was our inability to predict our revenue based on seasonality.

And many of these issues were related to what we call fixed invariable usage or fixed invariable price.

And as we moved into programs that are on one side higher and the other side includes more pages, [indiscernible - accented] we find that our fixed portion of the ARPU is increasing and therefore enables us to come and be more predictable--excuse me.

And before I move back to Scott, I will like also to discuss the increase in cities.

We put a lot of effort into increasing our coverage - 2,700 cities is huge, 37 countries.

It's not easy to get into those markets, but more than that, it's hard to do it while keeping our margins.

And as you saw, the margins [rose].

We are very clever.

We have very dedicated people on our telecom side that are able to negotiate good rates and get us into markets in cost effective ways.

And I'm going to pass now the discussion for Scott to discuss about our financial highlights.

Thank you, Hemi.

We'll go to slide 14 and this is the reconciliation between the GAAP 2006 numbers and the non-GAAP numbers that I referenced earlier.

The adjustments fall into three areas where one has two components.

Within that column of non-GAAP entries, there are 7.6 million pre-tax of stock based compensation, related payroll tax and employee compensation expenses. 5.6 million of that has to do with what we call the 123R expense, the additional 2 million relates to effects from the stock option investigation.

Then below that, affecting G&A, are two items aggregating slightly in excess of $4 million, the actual cost of the stock option investigation, which was a little under 3 million, and then, the global tax structure expense that as I mentioned helped to alleviate and remediate the material weakness we had in 2005, which is 1.26 million.

There are about $4 million of income tax effects on that 11.7 million, which then gives you a net adjustment to the bottom line of $7.7 million.

So 53.1 million of GAAP net earnings become 60.9 million of GAAP net earnings, or $1.04 moves to $1.19.

So those are the adjustments and we'll be using those numbers for the future discussion here over the next several pages.

Slide 15 encapsulates the 2006 modified financial results.

I want to highlight the 80% gross margin, as well as the approximately 43% operating margin.

Slide 16 shows in graphic format the historical success of the Company - the year-over-year revenue growth going back almost to inception.

The Company, as you know, was founded in late 1995.

And then, more importantly, the operating income on a GAAP basis, even including the additional charges in '06, from turning positive in early 2002 through the end of 2006--positive and growing operating earnings.

Slide 17 gives you on an annual basis a trend of the margins.

These are using the modified earnings for each of the three periods - '04, '05, and '06.

Reconciling tables for '05 and '04 are found at the back of this presentation.

As you can see, we've been able to maintain approximately 43% operating margins in all of the periods, while maintaining approximately an 80% gross margin.

As we stated before, there will be some shifting from quarter to quarter and below the line in terms of how much we spend in each of our categories.

We still had, even with the 4 million removed, higher than normal G&A expenses in 2006.

As we've stated previously, we expect those to be 16% or less of revenues in 2007.

Sales and marketing is generally in anywhere from the 16 to 17% of revs and R&D has been around 5%.

Slide 18 is our financial guidance, both for Q1 and the fiscal year.

It's reported on the same basis that we've done before, so we are excluding 123R expenses.

We're assuming an effective annual tax rate of 30%.

I would note that this is before our analysis is fully complete on FIN48, which we have adopted as of 1/1/07 and we will report as of the end of Q1, and 51.2 million fully diluted shares.

So 217 to 229 of revenues for the year.

We've talked about that before.

Modified EPS to take into account those adjustments of $1.35 to $1.45, and for the first fiscal quarter, ran 51.1 million to 52.1 million, or $0.32 to $0.33 of modified EPS.

The remaining slides are supplemental information, which include the metrics, reconciliation of free cash flow, 2005 and 2004 reconciliation of GAAP to non-GAAP.

And at this time, we will ask the operator to open the line up for questions.

Thank you. (Operator Instructions.) Our first question comes from the line of Daniel Ives, with Friedman, Billings, Ramsey.

Please proceed with your question.

Hey, guys.

First question.

What--so what were net sub adds for Q3 and Q4?

Okay.

If you go to the metrics slide, we had about 52,000 net adds Q2 to Q3 and a little under 20,000 Q3 to Q4.

About 70,000 for the six month period.

So you're starting to see in Q4 as you will again in Q1 and Q2 the impact of all the effects of the price change.

You'll also notice the cancel rate moved from that 26, 27 range to 29 in Q4.

It will probably be that or even a little bit higher in Q1.

It should then start to moderate in Q2 and the effects of the price change should be substantially gone during the Q3 quarter.

Okay.

What happened on ARPU from Q3 to Q4?

Well, you're seeing the ARPU, to give you specific numbers, we had 16.15 in Q2.

That's an average monthly ARPU for the three months .

It was $16 approximately for Q3 and then $16.45 in Q4.

Now you would not normally expect that, because as we commented before Q4 is handicapped by a lack of business days and we suffer particularly in the usage based or variable revenue.

But the combination of some of the things Hemi addressed earlier, which is the higher price point by the end of the quarter on approximately 40% of the eFax base, as well as some other shifts that moved revenue from variable to fixed, allowed that ARPU to be actually increased from Q3 to Q4 of approximately 50--$0.47.

Okay.

And--.

--And we would expect to see increasing ARPUs again in Q1 and in Q2, and then we're probably at a stable level of ARPU.

Okay.

And just a final question.

When you look at the buyback, I mean, how do you guys view that, especially with cash getting where it is?

And then, could we maybe expect an increase in the share buyback, once you guys use what you have?

Or how do you kind of view that?

Well, let me bring you up to date.

As I said, we did about 500,000 shares as of the end of the fiscal year - I think it was 470 to be exact.

We purchased a little under 1 million shares as we speak.

So there have been purchases that have occurred during the first couple and a half months of this year.

But remember that all of those purchases have occurred pursuant to an automatic program under a 10B51 plan.

Because of the stock option investigation, we've been under an extenuated blackout period for both the Company and our employees.

So that nearly 1 million shares has been purchased pursuant and exclusively through the formula.

Now, when we enter our next open trading window, then there would be the ability for Management to suggest to the Board purchases in addition to the formula.

So we'll have to take that up.

As we speak at this moment, we're in another blackout period, because we've gone beyond the seventh day of the third month of the quarter.

And so, I don't know whether there will be any relief from that for the Board or not.

Okay, thanks.

And did you or Hemi--.

--I mean, I certainly feel very good that we've--think about what we did since we last talked in August 1.

We bought a company, Send a Fax, paid $7, $8 million for that.

We bought back $10, $11, $12 million of stock.

So we spent $20 million and we've taken the cash from 175 to 192.

Okay, and just a final question.

Did you or Hemi earn your CPA over the last six months?

It's a matter of speaking.

A lot of people did.

I am teaching now.

Okay.

It's a very I think interesting process is the only way I can describe it.

Okay, thanks, guys.

Thank you.

Our next question comes from the line of Michael Latimore with Raymond James Associates.

Please proceed with your question.

Hi.

This is [Sean Patilla] for Mike.

Hi, Sean.

Hi.

When do you--when will you decide whether or not you're going to apply the price increase to non-eFax customers?

Good question.

I think that, as Hemi noted in his presentation, and as I've noted in a couple of conferences over the last several weeks, our primary focus has been for almost a year now on the eFax domestic base, and as you know, it has two parts - price adoption and success for new customer acquisition, and then, price adoption for existing customers that get converted.

I think we feel very comfortable that both of those are going very well, but there's still work to be done and it will take us clearly through the end of the second quarter.

This as I've mentioned before, is also a non-trivial process to many of the groups within j2.

So what we did three years ago, and I suspect what we will do again this time, is after some breather, and particularly as we're looking forward into '08, we will look at all of the other customer bases that at this moment in time are not being affected.

What are they?

Well, they would be our jConnect One Box customer bases, our Send A Fax customer base, our Unifax customer base.

They would be all of the international customer base and all of our corporate, SMB, SME, and enterprise.

Some of them, probably like last time, I suspect we will not touch.

Others we may.

But those are discussions that are yet to be had.

They'll take place later this year and probably in the context of '08 budgeting.

Okay.

And then, to focus on the enterprise side, how many customers did you guys sign up in 3Q and 4Q?

We signed up an additional four.

It was three in Q3 and one in Q4 of the big--we'll call them the big guns - the 1,000 or more DID accounts.

The base of the whole though has grown across [all spectra], very fast in its DID count.

I think it has something like 40% in its paying DIDs from the end of 2005 to the end of 2006.

So--and I'm talking about across all three segments of the channel - the SMB, the SME and the enterprise/government.

The increase of four is only relating to the enterprise piece of it.

Okay.

And--.

--And the pipeline continues to be healthy.

It's--I don't have the exact number.

I want to say it's approximately 50--it's in the 50s - 55 or so.

And [indiscernible - accented] a portion of it is growing [indiscernible - accented].

Yes.

So should we see the number of new enterprise customers per quarter be higher in '07 versus '06?

We don't know.

I mean, it's something that, as you know, is very hard to predict.

I'm unwilling to make a prediction on that.

What I do think you'll see is that the deals that happen will be larger in size and more relevant and important to the Company, whether they're the same in number or more.

I would like to believe it will be more, but as we've said before, these deals take a long, long time to come to fruition.

Sometimes things we think that are likely to happen - the company - not with any respect to us, but the company itself delays its decision, defers it to another year or another budget cycle.

Okay, and this is my final question.

When you look at pricing for enterprise deals, is it better or worse than expected?

Thanks.

The enterprise pricing?

I'd say it's been steady.

As we said before, those are negotiated prices.

So while there is some connection with the general price curve that goes from a single DID out to 10,000 DID, those are separately negotiated contracts.

And so, there are deals we'll walk away from because if somebody wants to give the service away effectively, we're not interested in that business.

So we've held the line on our pricing and I think that's served us quite well.

We've been able to grow the business both in customer count and in revenues and in deployed DIDs.

But certainly, we've let some piece of the business go or some instances we're not participating in some piece of the business because we just think they are either marginally profitable or unprofitable.

Thank you.

Thank you.

Our next question comes from the line of Youssef Squali with Jefferies.

Please proceed with your question.

Thank you very much, Scott and Hemi.

It's good to have you back.

It's good to be back.

So my first question is to Hemi.

Hemi, you talked about the entire base being impacted or at least 90% by the end of Q2.

I think you're making a pretty compelling argument there.

But can you quantify for us what the entire base, as of last--as of December 31, consisted of?

The entire base--I meant the entire eFax web channel, which is a little bit more than half of our entire base.

So about 500,000 customers did so.

Out of 906.

Right.

About 500,000 customers by the end of Q2 should be paying us on the 16.95 level.

Okay, that makes sense.

Good to talk with you again, Youssef.

Thanks.

On a--backing into gross margin for Q4, my math suggests that you're--assuming I'm correct here, but you're at around 82% for Q4.

Yes, which is a little bit high.

Yes.

And let me explain that.

It's been a while, but we've stated before that sometimes there will be accounting adjustments and/or true ups with our telecos in Q4.

It's been probably two or three years since we made that comment, but those things can happen.

Sometimes they go for or against us.

Historically, they've always gone to our benefit.

So we have a little bit of an accounting true up related to that.

And then, we also have in addition to that, federal excise tax that was a refund that goes back over several years.

It was about $750,000 that benefits the gross margin.

You could choose to pro forma that out.

If you do, it would knock down your margin by a couple points.

But I think the margin for the year of 80% pro forma or modified is an appropriate margin off of which to build your model.

And there should be some lift in that margin through Q2 as the price increase continues to ripple through the base.

Right.

That's what I'm trying to get to.

So what's baked into your model in terms of margin expectations for '07?

Well, the margin for '07 starts kind of at the 80 level.

And I think in our model goes to about 81%, which I think there can be more lift in the gross margin than one point.

But we temper it both in the budget and in the guidance because there are elements of our budget that we think of as future investment.

There's actually several million dollars in this budget of investment that will not have current year payback.

As it would affect the gross margin is additional investment in customer service to handle more languages, as we roll out more websites, and we do business in more countries, we need more customer service that can speak through email or the spoken word in more and more languages.

Also, we continue to extend the network.

As you see there's been a jump in city and country count.

Obviously, not all of those cities are today actively engaged from a marketing standpoint.

So our budget assumes there will continue to be those kinds of investments made in the network, in the equipment, in the breadth of the city, and in customer service.

Wouldn't a lot of that actually be hitting your CapEx and so only a slight piece of it will be hit in the cost of revenue?

Well, when we expand the network, it hits in two ways.

If we're going with a physical top, there is a CapEx and a depreciation, but we also maintain all the monthly charges for bandwidth, co-location, if there are costs for the DIDs.

So there is an ongoing monthly charge when we launch a new country or new cities.

Yes.

Independent of the depreciation.

Also, Youssef, as we are growing and become larger and larger, we are getting better deals with the long distance carriers.

So you will see [indiscernible - accented] but you will see slight improvement.

Our teleco teams are using our muscle to get our better terms.

On the--with the price increase, at least on the new Bs, can you speak a little bit to the subscriber acquisition costs.

What has it done?

Has it gone up?

If so, by how much?

No.

It's been--it's been fairly stable.

I think just a few weeks ago I noted that the average [SAC] cost for a DID is about $25.

The marginal of those deals that we like and accept is in the high 50s to mid-60s.

That's the price discipline that we have within the marketing channel.

There was a giveback last year of a little under 2 million of spend, because that 2 million couldn't be spent within those SAC criterias.

And as we've mentioned before, we will, once the price change is substantially behind us, revisit whether we as management are being too punitive in terms of the marginal SAC cost.

Our customers obviously are very, very profitable.

We can afford to pay more for a customer, particularly in light of receiving more revenue.

Right.

At 16.95.

So to this day, we're holding the price discipline, but I think we're certainly open to revisiting that question with our marketing people.

But right now, it's more important and most important to get through the price change.

Yes.

I will discuss maybe next time or--but we are testing new venues, like radio and maybe some of you have heard it in some other venues.

And we are--because the price is higher, [indiscernible - accented] measure how many months of customer subscription new need to get a customer, and those are improving.

So you should expect us to spend more in chasing new venues and new creative ways to get customers.

I guess arguably that should accelerate your customer acquisition.

Just lastly, what was the aggregate cash expense related to the adjustment?

Is it only the $3 million?

No.

It's the 3 million and then there is approximately--at this point, it's an accrual.

But there's another 2 million of tax related--well, there's 2 million net of tax of various payments to employees to in essence correct the errors that now would occur based upon options that were granted but now have a different exercise price.

Okay.

Now, some of those payments have already been made in cash.

If there is already disclosure out, we file an 8K.

Some of those are accrued because the goal of the company is to work with the IRS and to step into the shoes of those employees and pay the amount on their behalf, so that you don't have to involve many of our either former or current employees, because now they thought the exercise price was X and it's X-plus.

Okay.

Okay?

Thanks a lot.

Thank you.

Thank you.

Our next question comes from the line of Rod Ratliff with the Stanford Group.

Please proceed with your question.

Thanks a lot.

Scott, the enterprise effect on margins with the caveat that larger accounts are historically lower, does that mitigate the margin expansion you're looking for, or is this accounted for in the guidance?

No, it's accounted for in the guidance.

But I want to use that question actually to make some further explanations that I didn't make when I was giving the guidance presentation.

Youssef just asked the question that answered part of it.

We are going to be generating obviously some amount of incremental revenue from the price change is why we're doing it.

We're not doing it to be standing still.

There are about $6 million in our budget of investments in the future, meaning that they will--if they are all spent--and I'm not convinced that all of that will be spent this year, even though it's in the budget.

But there's about $6 million of investment in a variety of categories, and I'll go through them with you, where we will not get any or any amount of material payback from a revenue standpoint in this year.

Let me give you some of the things.

Part of it we just talked about - further investments in customer service and the network really to aid future growth on an international basis.

and there's no revenue benefit from that in '07?

Very little.

Also, we're making inroads, particularly into Asia and Japan, where we will hire people, for the first time have a local presence.

We're going to do a lot of engineering work to produce double by character set acceptance of our database.

We can have websites in the Asian languages.

Those will be investments expensed this year of several hundred thousand dollars.

I doubt we'll have any incremental revenue from Asia this year versus what we currently generate.

As I mentioned earlier, we have an increasing number of projects to enhance our existing services, extend what they do.

What does that mean?

Well, there's always been a tension of having more people in the R&D effort.

These are essentially people who do programming.

So we've got to prove in the budget a number of new additional hires whose expense will flow through R&D.

Now, whether we can hire them all this year and get them trained, I don't know.

But they are in the budget, and certainly those that do get hired and trained will not obviously contribute immediately, and even if they do, a new service is something that will be launched later this year or next year.

We're trialing, as Hemi mentioned, some new marketing campaigns, not only within--or new form of the marketing--not only within the individual web channel, but for the first time, we're doing some things online in our corporate channel, really targeting the SMB base.

So we've got this $6 million of expense that, as I say, not all of it will be spent this year.

Probably half or so will flow through the budget, that will just hit the bottom line.

So wink-wink, nudge-nudge, there a little bit of wiggle room.

Well, no, we intend to spend this money.

Yes, okay.

Okay.

I think the 6 is too much.

We intend to spend 3 or more of it and we might spend all 6.

But understand how much we spend will be a function in the hiring case of how quickly we can hire and train.

We're not going to have a bunch of hires just sitting around.

So we need to make sure the departments can train them, deploy them in their locations.

In the case of marketing, it will still be effectiveness based.

But what I am saying is we will throw a few hundred thousand dollars, if not a couple million, at trialing some new marketing programs.

And we need those programs to have a certain life to them to determine whether they are successful.

I want to make a comment, Rod.

If we see that we're spending all the money, I would consider it as good news meaning that we have success.

Because we are not going to throw all the money in one shot.

So we are trying to launch new products and services.

Usually when you introduce a new service, it's more expensive.

If we will be able to launch the services and we will be able to throw the money out, I would consider it very good news.

Yes, they call that a high class problem in Texas.

You've got it.

You've got it.

Rod, I didn't mention, part of the marketing dollars will be for eVoice Receptionist, which is one of the things--if there's a brand--eVoice reception is brand new.

One Box we've owned for a couple of years, but it really incubated.

That would be new spend for education of the services, better brand awareness, et cetera.

I would probably elect to talk about this topic in the May--in the beginning of May, end of April.

When we do our Q1 '07 call.

Yes.

And we will talk about all those new services.

There's a lot of excitement there and a good story to tell, but we'll keep it for next time.

Good enough.

I've got two more quick ones here.

Sure.

The old telecom pricing guy that I was earlier in my life is happy to hear you say you'll walk away from bad business.

Did you in fact say that SAC is stable right now?

Yes.

Okay.

And lastly, to flog an old dead horse, what's up with the USF situation?

Funny you should ask.

I'm glad you did ask, as a matter of fact.

Let me give you, hopefully it will be brief, an update.

And my information is very current as I was just in Washington a couple of days ago.

First of all, as you know, the last time we had a conversation there were still bills flying around the 109th Congress, particularly in the Senate, but at the time the Republicans had both houses.

Senator Stevens, who was the Chair of the Senate Commerce Committee, was unable to muster the 60 votes to get his bill to the floor of the Senate before the election and certainly once the election occurred and the houses were about to change political control his bill was dead.

So no bills made it out of either house - House or Senate - in the 109th Congress.

The 110th Congress got seated in January.

Obviously, all of the committee, subcommittee chairs have changed.

They are all Democrats now, as well as some of the people that were around the 109th Congress are gone.

They're not just in a different position.

They are actually out of those bodies.

So one of the things obviously that's been going on is for this 110th Congress to set its own priorities, it's own agenda.

I'd say it's been diverted with Iraq, it's been diverted with Walter Reed, it's been diverted with a number of issues.

But the two relevant bodies that exist are the Senate Commerce Committee on the Senate side, and the House Energy Committee on the House side.

Both of them have, in one case on the Senate side, Stevens reintroduced his bill, which I think Senator Inouye, who is the Chair of that committee now did as an accommodation to Senator Stevens.

The House side, I believe the [indiscernible] [Terry] bill has not yet been introduced, but my sense is it could be reintroduced soon.

We were supporters of that bill in the 109th Congress.

I don't know at this point whether there'll be any modifications when it is reintroduced in this Congress.

But what I can tell you and having been there for a couple of days is they are clearly as a Congress getting up to speed, setting their priorities.

I think that clearly we and others had an impact in the 109th Congress of educating people that a numbers based approach is not so simple.

That there are many, many details, corner cases, and unusual consequences that can come about.

So I think that the time we spent in '06 in talking to the SEC and in talking to staff members, congressmen, and senators, was very positive.

I think they recognize there is no simple answer for USF reform.

Also, it appears that in the 110th Congress, if USF is to go forward, it will go forward by itself, meaning it won't be bundled as Senator Stevens did with a series of other bills, which is good if you want to horse-trade down the road to try to get something out of a conference committee or even get it out of your own committee or your own house of Congress.

So we'll continue to monitor this.

I think that you can't make any definitive predictions at this point, but I think as we've learned the last couple of years, this is an ongoing long, drawn out process.

Clearly, the bills that we were aware in the 109th Congress and those that have been introduced in the 110th, don't answer the questions.

They basically throw to the SEC for further review.

In essence, they would permit the SEC to do more things, give them more broader authority.

But the SEC would have to go through its process and then we know there would have to be an implementation process.

I find it very hard to believe that anything could be implemented, whether it's positive, negative, or neutral before late 2008 or early 2009.

And that's assuming this Congress takes action in the [next] session, meaning in 2007.

So you don't think there's much of a chance the SEC will just act alone?

It's unclear, but even Chairman Martin's language this year has softened from the rhetoric he had last year.

Last year he was numbers, numbers, numbers.

One of the political things that has happened is that now, even though there are only two Democrats at the SEC out of a five-member committee, they I think rightly have more power and influence because both of the houses of Congress are now controlled by Democrats.

So even he has--I can't remember if it was January or February, which meeting it was.

But in one of the SEC meetings, even he has sort of begun to backpedal a little bit from a hard and fast numbers approach.

Great, thank you.

Thank you.

Our next question comes from the line of Tavis McCourt with Morgan Keegan.

Please proceed with your question.

Hey, guys.

And Hemi, I have seen--heard the radio ads.

They sound great.

Scott, I wonder if you could talk a little bit about FIN48, how it impacts you guys.

Does it impact a geographical distribution of pre-tax income or is it a lot more complex than that?

Not directly in terms of that.

FIN48 just to bring you up to speed, has to do with uncertain tax positions the companies have taken back into history as well as taxes that you take on a going forward basis.

So the first sort of step in the analysis is to look at all the taxes that you've taken, in our case going back about 7, 8 years, see if any of those returns are still open for audit, and then to determine whether given there's a different standard under FIN48 and FAS5, whether there should be any historic accrual if you will or reserve against that tax position.

The aggregation of all of those through 12/31/06 will be reflected as a hit to the retained earnings on the opening balance sheet.

So they will now run through the P&L.

We do anticipate, we've done enough work, we think there will be some number.

We don't yet have a quantification of what that will be.

So you're looking at a 12/31/06 balance sheet.

You've got a retained earnings number.

When we filed the Q1 '07 Q, that number will be different.

But at this point, we cannot quantify what that number will be.

The second step would be well what positions is the Company taking currently as it would influence your '07 tax return and then your '07 GAAP accounting.

So as we finish phase one of the analysis, then we go into phase two and say, okay, we only have maybe a handful of positions that are material that we're taking today.

Do any of them require a FIN48 adjustment?

And then, if they do, we'd flow that through the tax provisioning calculation and come up with whatever the rate would be.

It does not per se affect our domestic international mix of revenue.

They are what they are.

And--I can't see the metric pages that well, but I just want to make sure I kind of have a handle on what the gross adds were in the fourth quarter.

It looks like they were around 100,000.

Is that right?

The gross?

We don't have gross adds.

We only have net adds.

Okay, but I'm just saying, the churn rate was 2.9%.

Did I read that part right?

Yes.

The churn is 2.9.

The ending base is 906 652.

And so the predecessor quarter [space] was 887 801.

That's the end of Q2.

So there are about 20,000 net DIDs, 2.9% monthly cancel rate, and yes, you're going to reverse--do your reverse engineer math.

And you would expect at least based on the--what happened last time, churn rates should come back down once you're through this process?

Yes.

I would expect it to stay at this rate or possibly go higher during--on average for Q1, probably hold that level to come down a little bit in Q2, and then return to its normal range in Q3.

Got you.

And then, in terms of the strength in free cash flow in Q4, I haven't had a chance to look at the balance sheet metrics or anything like that.

But is there anything that was unusually strong there, or should we still continue pretty strong free cash flow in Q1?

Well, let me explain.

That's a good point in terms of the four quarters--how they roll.

The S&A tax payments occur predominantly in Q2 and Q3.

So I think in Q1 and Q4 of '06, we had a 2 million of estimated tax payments.

And in Q2 and Q3, it was probably closer to 7 or 8 million.

So it kinds of smoothes itself out over the course of the year, but it's lumpy when you look at the quarterlies.

That really is the primary difference between or across the four quarters.

Got you.

But I think however you want to normalize it, the 65 million of free cash flow, taking into account some of the cash charges that we detailed, because that's not a pro forma number, that's a GAAP number.

We're using GAAP numbers there.

Yes.

That is an annual--good annual number for 2006.

Obviously, we would expect it to grow in 2007.

Great.

Also, Tavis, a little comment here.

As we raise the prices, one of the [indiscernible - accented] for customers to keep the old price or to lower is to take annual and if more of them are taking annual we gain more cash.

Right.

And then, the last question is just where do you guys stand right now on the total headcount for enterprise sales reps?

And is that an area you're looking to grow this year?

I think the enterprise has been pretty stable.

I believe it's around 15, which is kind of where it's been.

I'll have to get--I'll have to confirm that.

I believe it's 15.

It's 14 or 15.

It's been pretty stable.

There are some open to hires.

But as we've stated before, we don't think it's a channel that needs massive increases.

Clearly, there are some open to hires, both domestically and internationally.

I think as we become more localized in more international locations, we will examine what is the best way to sell corporate or enterprise sales and in some instances, it will certainly be to direct sales force.

So you'll probably see a headcount go up by a few.

This year, I think the budget might take us to 20.

Because it's not going to go up dramatically.

Got you.

And we don't think it needs to--I think more importantly.

Also, as we grow, we have more business coming from the [leasing] space.

One way of calling it is more farmers, less hunters.

And usually those cost less than [indiscernible - accented].

Those [indiscernible - accented] executives that go after new accounts are usually paid and compensated better than those that go after existing customers to increase their productivity.

So you might see the side effect that we are increasing some of the people, the cost is not increasing as dramatically.

I understand.

Thanks a lot.

I have a question by email and then we'll go back to any live questions, if there are any left.

The question by email was we are at about 42--at the midpoint of our range about a 42 million increase in revenues in '07 versus '06.

These are absolute dollars, not percentages.

The question is what are the primary contributors of how that's breaking down between individual subs, corporate business, international, and the price change.

I'll give you a qualitative answer on that.

Clearly, the price change as we believe and have stated is a net positive to the Company.

You could never answer this question definitively because you never know how many customers you would have had in the individual channel had we not raised prices.

We do believe there's a positive delta there.

I think I stated before that it's probably in a guestimate range, probably three to maybe six percentage points of our growth this year comes from the price change, but you have to take that, as I say, as a generalized pro forma because we'll never know what it would have been.

As it relates to the various pieces of business, the corporate piece continues, or the corporate/enterprise piece and the international continue to grow at a faster rate than the Company's overall growth rate.

We expect that to continue to be true in '07 relative to '06.

And of course, the new products are beginning to contribute to our revenue.

They were not really a factor in 2006, given the point of the year in which they were released.

But they've actually had excellent traction here in early '07.

They are growing very rapidly off a small base.

We do expect them to have some contribution this year, and so far, that event is happening.

Any other questions?

(Operator Instructions.) There are no further questions, gentlemen.

Do you have any closing comments?

Yes, just one.

As I say, we thank all of the shareholders and analysts for their patience over the last 7.5, 8 months.

It's been obviously difficult for many of you, particularly as we were going through a price change, because we know that's very tricky analytically and mathematically.

Unfortunately, we happen to be launching it right as we into this unforeseen extended blackout period.

So we're very grateful for all of you that have had extreme patience with us.

We had a couple of delays along the way primarily to determine not so much the outcome of the investigation, but how it should be financially reported and accounted and what documents had to be filed.

The good news, as I mentioned in the beginning of the call, is we are current with all the regulatory filings.

I encourage you to take the Q2, Q3, and the 2006K and read them.

There's all the reconciliations for all the adjustments that we talked about embedded within those documents.

Also, I'd let you know that tomorrow I'll be making a presentation at the JP Morgan Conference in New York and I'll be on the road for a couple of days thereafter trying to catch up with many of our shareholders who we've had, as I say, limited or no ability to talk to in the last 7.5 months.

We will as a result continue to participate in conference invites as they arrive.

I think there's a couple coming up in the May timeframe.

We would expect to have a call either in late April or early May to discuss Q1 2007 results, and look forward to being on regular schedule from this point going forward.

Thank you.

Thank you.

This concludes today's teleconference.

You may disconnect your lines at this time.