Ziff Davis Inc (ZD) 2008 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the j2 Global Communications third quarter 2008 earnings conference call.

It is my pleasure to introduce your host, Mr.

Scott Turicchi, President of j2 Global Communications.

Thank you.

Mr.

Turicchi, you may begin.

Thank you.

Good afternoon, and welcome to our Investor conference call for Q3 2008.

As the operator just mentioned, I'm Scott Turicchi, President of j2 Global, and with me today is Hemi Zucker, Chief Executive Officer, and Kathy Griggs, our Chief Financial Officer.

We'll be discussion our Q3 financial results, as well as providing an update on operations.

We will use the IR presentation as a road map for today's call.

A copy of that presentation is available at our website.

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

You can also access the webcast from this site.

In addition, you will also find in PDF file format a copy of the presentation and the metrics which are available for download and viewing.

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

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

However, at any time you may e-mail questions to us at investor@j2global.com.

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 would cause actual results to differ materially from the anticipated results.

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

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

Turning now to the quarter.

We're very pleased with the operational result for Q3, especially in light of the deteriorating economic conditions that occurred during the course of the quarter.

Our focus this year, as you know, has been and continues to be on the improvement of our already excellent margin structure, as well as the deployment of our cash balances and free cash flow into higher yielding assets.

Consistent with this philosophy, we have remained disciplined on our subscriber acquisition and other operational costs and focused on improving the overall cost structure of j2.

I'll now turn the presentation over to Kathy, who will give you further detail and further color.

Kathy?

Thank you, Scott.

Good afternoon, ladies and gentlemen.

I would like you to please refer to slide 9 in the presentation for a recap of our Q3 GAAP based results.

We were able to maintain a subscription revenue growth rate similar to last quarter's despite the current economy.

Our Q3 subscription revenue grew 12% or $6.5 million.

Total international revenues grew 18.3%, and our domestic revenue grew 9.2%.

Total Q3 revenues were $61.6 million compared to $55.7 million in Q3 of 2007, for an increase of approximately 11%.

Our revenue would have been higher, but we were impacted by approximately 200K for the rally of the U.S.

dollar versus our foreign currency markets.

The weak economy did have an a negative impact on our advertising revenue, and we expect this trend to continue into Q4.

Advertising revenue, which is approximately 7/10th of 1% of our total revenue, is a component of our non-subscription revenue and is primarily display and e-mail based.

In Q3, we added organically over 36,100 DIDs.

Similar to Q1 and Q2, our voice brands and corporate fax segments continue to perform the strongest.

In fact, compared to a year ago, our voice DIDs have increased by 200%.

In total, Q3 ending paid DIDs were almost $1.2 million, an 18% increase from a year ago.

The overall cancel rate remains the same as Q3 2007 at 3%; but somewhat elevated relative to the cancel rate experienced before the weakening in the credit sensitive sector in mid-2007.

The recent economic turmoil has had a minimal impact on our fax usage.

Usage trends in Q3 2008 were consistent with prior quarters.

Slide 20 provides you with a summary of usage for credit sensitive and non-credit sensitive industries.

We continue to see depressed levels of usage for our credit sensitive customers, but consistent usage since Q4 2007.

Our non-credit sensitive customers continue to see modest increase in usage.

Overall, variable revenue continues to remain stable at the low 20% range of our total DID based revenues.

We continue to strive to improve our processes and increase our operating efficiencies.

Our successes in these endeavors are reflected in our ability to steadily improve both our growth and operating margins.

Compared to a year ago, GAAP gross margins have improved by 1 percentage point from 80% to 81% in Q3.

GAAP operating margins have improved even more, a 2.7 percentage point increase to 40.9%.

Overall, expense as a percent of revenue declined across the board.

Q3 GAAP selling expense was 17.5% of revenues.

R&D was 4.9% of revenues, and G&A was 17.7% of revenues.

The improvement in our margins reflects our continued commitment to smart cost management, which we believe is essential to continued success of j2.

Our diluted GAAP EPS was $0.42 a share, which is an improvement of $0.05 or 14% from prior quarter.

One penny is attributable to favorable return to provision upon filing our 2007 Federal tax return, and approximately a penny more was added by the strengthening of the U.S.

dollar, which contributed to incremental other income.

When we compare diluted GAAP EPS to Q3 of 2007, our GAAP EPS improved to $0.42 from $0.35 for a 20% increase.

In Q4, the lowering of the interest rate by the Federal Reserve will put further pressure on our interest income.

Given the economic uncertainty, we have kept our cash in investment vehicles that are liquid and safe.

For those focusing on our non-GAAP EPS, you will need to adjust for 123R or $2 million pretax, or $1.4 million after tax.

The after tax impact of 1233R is approximately $0.03 per diluted share.

Excluding 123R expense, our non-GAAP EPS was $0.45 a share.

Our 10-Q and our press release exhibits will provide additional details by expense category.

Moving onto the balance sheet, in Q3 we provided our investors and shareholders with a return of equity on 32.7% annualized.

Free cash flow for the quarter was $12.8 million.

This was impacted by higher estimated tax payments due to higher earnings, significantly lower stock-based compensation deductions from the exercise of stock options, and the elimination of the R&D tax credit which Congress only recently restored as part of the TARP program.

In addition, we had a reduction in payables of approximately $4 million from Q2.

For the nine months ended 9/30/ 2008, we have had record free cash flows of $63 million.

Finally, during the third quarter, we completed our stock buyback program, deploying approximately $11 million to acquire the final 465,000 shares of our 5 million share buyback.

We ended the quarter with $152 million of funds available, and no debt.

Now I would like to turn the call over to Hemi, who will provide you with an operational update.

Thank you very much, Kathy, and good afternoon, everybody.

Here at j2, we're during well in a weak economy.

With the companies, always have been a prudent Company that managing our actions in a most prudent financial way, and I would like to tell you that we didn't start panicking last quarter or quarter ago.

We started to manage it as a bad economy already in Q3, Q4 '07; and as you can see, the results are showing off.

Let me take you through some of the expense -- major expense places where we did a good job.

On the marketing spend, we are continuing to managing on an ROI basis.

CPA cost for acquisition is managed by each brand.

We have integrated also lifetime value of every customer and venues where they're coming from, and by brands.

These yield efficiency on our marketing expense.

Then let's go on to our network.

Our network is spread over 40,50 locations around the world and we were able to move phone numbers or DIDs in other resources from one place to the other, maintaining higher reliability and reduced costs.

This also is something that you can see in our gross margins.

On the headcount side, we ended -- or we started the year with 400 people.

We acquired Phone People, which is our largest acquisition.

They added approximately 20 people, and we are now around the same employee base as we were and we have (inaudible) improvement in our talent pool, and will continue to grow our talent pool for next year.

Our contracts with major vendors, we took the opportunity to renegotiate some of them.

As a matter of fact, being a financial stable Company, they are happy to cooperate with us knowing we are going to be there in the long run.

One of the upsides of bad economy is our M&A opportunities.

We have currently two M&A opportunities on advanced due diligence.

One is a combination of VoIP and fax company -- the CEO, the management spend the last week in our Hollywood offices; and the other one is a (inaudible) company where our division CFO spent time in their offices last week.

Both seem positive and we hope to close them sometime this quarter and report it accordingly.

Additional M&A opportunities are on and off.

We have an international opportunity.

We have local opportunities, and we belief that all of these companies in the end will end up closing a deal with us as we go over the years expert in the field and we can offer them a smooth production with very high likelihood of closing and getting cash in the hand.

As you all know, we have $152 million cash and piling up, and we are planning to use this to further M&A.

We are focused on the market.

We are selling services that are defined as cost savings (inaudible), and we continue to (inaudible) to our customers, and we are focusing on our core competence which is outsourcing fax, outsourcing Voice and outsourcing e-mail.

Let's go to next page, 12, talk a little bit about our fax services.

I know that many of you are focused and interested in our corporate business.

Our corporate business had a record month.

We have signed seven deals larger than 1,000 DIDs each, and additional smaller deals increased their count of DIDs to come up to 1,000 DIDs; so now we have additional 9,000 -- sorry, 9 deals of 1,000 each.

This brings us to a record of nine deals.

I think the last one -- or the best one we ever had was six, and we have additional 66 active deals in our pipeline.

Those are both local and international, across multiple industries and we are -- we keep on seeing how we are replacing old fax infrastructure in a very successful way.

On the eFax field, which is a web product that is sold for $60.95, this is the most -- the highest priced product in the market.

We continue to command the price premium versus the other brands that are at $10.

We continue to increase the value of eFax; and one of the things that we are planning to launch on Beta this quarter is unique features that I'm keeping at this moment secretive while we (inaudible) engaged; but it's going to increase the value and the functionality and the experience of fax users to something that nobody here at j2 has seen before.

Enough said, but I hope to make press release soon.

On the international field, the economy is hitting Europe as well, but as the penetration is lower there we continue to grow during a faster rate than here in the U.S.

market.

Our 70 fax brands -- as you know, we have several brands that are selling and competing on the $10 level.

They are selling well.

This is bad economy, so lower cost product are doing better than higher cost product.

On the Voice, we are declaring ourselves the largest player in the marketplace.

We have now four brands -- eVoice, Onebox, and Phone People and eReceptionist which is our European product.

Why do we believe that we're the largest?

We have 180,000 DIDs deployed.

We have revenue that is an around rate of $27 million a year.

Our growth rate, including acquisitions from Q3 '07 to now, is $189 -- or almost three times larger than we were a year ago.

And from a geographical coverage, we are selling mostly into three, maybe even four large markets, which are the U.S.

, Canada, UK, and Ireland to a certain degree, and we are covering many, many local cities around the U.S.

and Europe.

We are proceeding well with our integration of Phone People.

This is the company we acquired this year.

We have consolidated their offices in San Diego.

We have consolidated the operations and realigning all of the professional people there under ours and planning on moving ahead with further consolidation.

We're also now viewing our budgeting season talking about our brand strategy; and we're going to take a lead brand and we are going to take leadership positions in educating the market this.

This product -- the Voice product is very complex and less is more -- simplifying the product, getting customers to buy online.

As you know, we are an online company and we are working hard to simplify so people can get comfortable sign online call and buy it, and I'm very pleased with the success.

With that said, I will now pass the conversation to Scott for our

Thank you, Hemi.

If you go to slide 15, as you know, as a Company, we give guidance on an annual basis, which on Slide 16 we reaffirming today.

We wanted to draw out and remind you of certain factors that are always the case in Q4 and certain factors that may be new to this Q4.

Obviously, what has gone on in the economy in the last several months, and specifically in the last several weeks, we believe will continue in Q4 and result in negative GDP growth.

We believe there will continue to be weakness in the economy in Europe, and the result of these two is a malaise in the productivity and the activity of businesses post Thanksgiving.

Usually, we always have a decline in business days from Q3 to Q4 sequential.

The calendar this year is a bit more unfavorable then in most years, resulting in a loss of five business days from Q3 to Q4.

As I just mentioned, because of the economy, we believe there will be an additional lost business day of productivity as people take additional vacation, longer lunches, show up later to work or not show up at all.

To remind you, each business day has about $200,000 of variable revenue.

So we're anticipating in Q4, relative to Q3, a reduction of approximately $1.2 million in our variable revenue, due primarily to the calendar and business days, and secondarily to the poor economy.

And I would also add that to the extent the dollar continues to remain strong against the Euro and the pound, that will add a little bit of pressure for international operations.

Our view is to continue to work on the margin structure, as Hemi has just outlined.

There are still additional opportunities in both the cost of goods sold and certain other of our other operating expenses to continue to maintain or improve margin structure and cash flows, complete the M&A deals that Hemi has already mentioned, as well as to pursue more deals that are in the pipeline.

I'll just give a quick commentary on the 2009 process.

We're in the midst of our budgeting.

It's relatively early stage.

I think it's safe to assume that we will not have a -- or we will have a consistent with what is going on in the marketplace view of the economy for '09.

We are working through of some of the items that Hemi just talked about such as brand strategy for Voice and how that, as well as some of the M&A that's in work now will work through our '09 numbers, and we'll be prepared to give the '09 guidance in conjunction with the Q4 conference call, which should be sometime in mid February.

And that is the end of our prepared remarks.

Slide 17 and following are the metrics, the reconciliation of free cash flow; and as Kathy mentioned, on Slide 20, the usage chart, which showed relative consistency over the first three quarters of this year, both in terms of the usage of the credit sensitive customers and the non-credit sensitive customers.

At this time, we will turn the conversation back to the operator, who will instruct you how to queue up for questions.

(OPERATOR INSTRUCTIONS).

Our first question comes from the line of Daniel Ives with FBR.

Please proceed with your question.

Hey, guys, a few questions.

The first, with the deals that are in the hopper on the M&A side, can you give us a general sense as to the total amount of that M&A opportunity, at least the near term one in the two deals?

The deals are relatively small.

Hi, Daniel, how are you?

Hey.

If we do both of them, they will be maybe 2% of our total revenue.

That's if you add them both together.

Got it.

And given the macro uncertainty, as you look into 2009, maintaining our operating margin structure, can you just walk us through as a managing team what you are doing maybe differently going into '09 than you did going into '08 in terms of cost and initiatives in the R&D front and stuff like that?

Thanks.

We're continuing to grow the business while maintaining the cost -- it's our main goal.

I mean, we think that we are not going to grow dramatically in headcount or not at all.

Again, this is assuming no further acquisitions beyond those that we already know.

So you should assume stable headcount, maintain or maybe slight improvement on the margins, and the rest is on the marketing standpoint.

It will be opportunistic, meaning if we could acquire customers and CPAs equal or better than what we have, we'll continue to do it.

We are not committing there to any number.

We are committing to efficiency.

And Scott, have I missed something?

No, I think as Hemi pointed out earlier, when we saw the credit sensitive weekend almost a year ago we took some of these incremental actions and applied them to 2008.

There are now further refinements than can be done as we go into '09.

Some you'll see in the gross margin because it relates to COGs.

But the items Hemi just mentioned will flow through operating expense.

And I think our fundamental view is that is what is primary importance.

We've seen on the flip side the M&A pipeline because more robust.

I think finally we're going to start to see the pricing come into line more where we thought it would have been seven, eight, nine months ago; but I think with a revaluation in the equity markets with negative GDP growth, it is going to make those negotiations -- at least as it relates to price -- much easier and much better.

So it's too early to tell, but I'm very optimistic and bullish about the kinds of M&A we'll be able to do in '09.

The two deals that Hemi mentioned, they're small; but as you know, the vast majority of the opportunities in all three of our spaces are small transactions.

So it's a combination of increasing the volume of those deals, but also having some spread across our three spaces.

If we close these two deals, we will have closed deals in '08 in each of the three spaces -- fax, Voice service is and e-mail.

And we have additional opportunities in each of those three.

And just a -- finally on the tax rate, what should we be thinking about for 4Q?

Well, the tax rate is an interesting question.

As Kathy mentioned, every Q3 you actually pay your prior year taxes, so you've been accruing for them from a GAAP prospective.

You pay them, and you have usually some modest differential.

This year, that differential went into our favor.

It was about a penny, and I would say that a normalized tax rate for us is 31, 31.5 GAAP.

Now one of the things that will come into play in Q4, as she also mentioned, is that as part of the TARP program, R&D credits were reinstated.

So we're evaluating what the positive will be of being able to take those R&D credits in 2008, which we have not accrued for, because up until literally a couple of weeks ago we didn't think they would be available.

But I'd say low 31 to 31.5 is the sort of the core tax rate.

Thanks.

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

Please proceed with your question.

Thank you very much, good afternoon.

A few questions.

So Scott, maybe this is more of a mechanical question, but I guess the guidance still has a -- you know, you can drive a truck through it.

Why not change it?

Is it because as long as you're going to land somewhere between the low end and the high end you're not going to change it, or -- I mean from listening to Hemi, the contribution from these acquisition is going to be relatively immaterial to Q4 for you to even come closer to the mid point, so what is the logic there?

You have got several questions.

You're correct on the acquisitions one, because we're obviously not quite halfway through a quarter but one-third or so through the quarter, and those deals are not closed and they're small, so whether they close tomorrow or close in three weeks, they're going to have a modest impact on Q4 revenue; so that's true.

You're also correct as to, as we stated before, the philosophical view point as it relates to giving guidance.

So as long as we're within the range -- top and bottom line -- we see no reason, and we do not intend, to alter range of those guidances -- even though it it may be clear, deep, deep, deep into a year that you're closer to one end of the range or another, and I don't see that.

Like I said, that's a philosophical view point.

I don't see that changing.

I've we've given a lot of information, so I don't think predicting it in Q4 that hard.

Right, right.

I think it fair to assume, considering where you sit today, that you will be coming in at the low end obviously.

I guess secondarily, I guess -- you guys talked a little bit about how variable revenues from credit sensitive areas was stabilizing.

Is that something that -- I mean, is it because you guys saw it so early on that now you're -- I think the first time you recognized it I think it was over a year ago.

So it's not necessarily behind you, but you've already kind of hit bottom there?

Or is there anything else that's at play that we may not be aware of?

No, I think if you go to Slide 20 and you look at the data there, I can a lot of it is yes, we caught that piece of the business early.

Not so much we caught it.

It performed that way early on; and of course we now know in hindsight with the carnage that occurred in the brokerage firms and even some of the smaller banks, I think there's a collective better understanding of what was happening.

But if you look at the graph, you will see it was already in the 75 to 80% range relative to Q4 of '06 about a year ago, and has been hovering into the 72 to 80 range throughout the first nine months of this year.

So I think it's just that it took a big step down fairly quickly in the latter half of last year.

It's been kind of bouncing around at those lower levels -- some quarters a little better, some quarters a little worse -- but bouncing around those lower levels for the last nine, ten months.

Okay, and the lastly for me.

If I look at your RPU, it's been, I guess, in sequential decline for the last five quarters -- last quarter I think it was about $15.87.

What has the trend been in fixed RPU versus variable?

I'm assuming -- I guess the question is, has RPU -- has fixed RPU been stable?

No, it's declined too; because you'll see -- usually the variable RPU will have the biggest sequential change in three to four and four to one.

Three to four to go down.

I mean, if we're right and variable revenue is off a million two, that is $0.25, $0.30 in RPU per month.

That would be an impact to Q4's variable RPU, then that reverses itself out in Q1.

So the -- if you normalize it or you look at the four rolling quarter average, the bigger piece of it is this year, the fixed RPU declining because you've got lower fixed RPUs in the Voice and in the corporate enterprise faculties.

So as those are adding more net DIDs, they're creating a bigger proportion of our quarterly net DID ads, and as a result a larger and larger piece of the overall base you're seeing it pull fixed down.

And you know, if you see, Youssef, a --

And that will continue.

Yes, we have 180,000 Voice services.

They're going on about $10 a piece a month extension.

11.

11, and we are penetrating this market, being low price -- not leader, but we're participating in the market in the low price.

We are planning to add features later on once we grab larger market share and drive it up; but for now, we believe that we're providing amazing value there, but we're happy to do it in order to solidify our market position.

Okay, that makes sense.

I guess the other side of it is your subscriber acquisition is pretty healthy -- still very healthy.

Okay, great, thanks a lot.

Thank you.

Our next question comes from the line of Rai Archibold with Kaufman Brothers.

Please proceed with your question.

Great, thank you.

One just following up on the corporate activity, obviously very strong over the last several quarters.

I was curious, one, if you can give us a sense of the backlog of corporate DIDs that are remaining, given that they tend to be staged over time?

And then I have a follow-up.

Hi, Rai.

First of all, as we said, we have a pipeline of 66 deals -- 66 deals that are declaring themselves as potential of thousand and more.

We have much more DIDs that we are not counting.

Those DIDs are across the entire world, mostly a U.S., Canada, UK.

It is the end of the year, so some organizations are old world style.

They want to bring it in before they lose a budget and some want to push it to next year.

In most of those situations, we are competing with a decision to replace a server or another outdated technology, so we know that most of them tend to close.

We are competing.

We have some competitors that are trying to sell it for lower prices.

Our conversion rate is relatively high.

We actually sell more and usually to we're the highest bidder, but we have a lot to bring to those customers.

So I believe that it would be unresponsible for me to tell you how many that will close Q4 versus Q1, but it's a healthy pipeline.

Actually, wait, wait, wait.

I guess I didn't make my question clear.

Of the corporate accounts that you have booked today, all right, there are some number of DIDs that they've signed for and you turned them on over a period of time.

So of the deals that you have signed, what is the backlog of DIDs that have yet to be turned on?

It's going to be 4,000 to 5,000 DIDs.

How many, I'm sorry?

4.000 to 5,000.

Of the nine deals signed during Q3 -- and some of them were signed late in Q3 -- there's between 4,000 and 5,000 DIDs that have not been yet deployed.

Okay, so those will come on sometime over the next quarter?

Some of them have actually already come online in terms of speaking in realtime.

But during the course of this quarter, as you know, there's usually an up to one quarter backlog between when a contract is signed and when all of the DIDs are fully deployed.

Okay.

Because there's a combination of porting and there's a combination of taking from the inventory, and a lot of that is in the hands of the company that is buying and what is their own plan, and how do they wish to roll it out.

And my next question really is kind of use of cash here.

You're generating a fair amount of cash flow now.

You have $152 million of cash on the balance sheet.

Just curious what you're thinking about in terms of further repurchases?

I think right now the heavy focus is on M&A.

You know, we're not displeased with having bought stock earlier this year; but obviously in hindsight, we overpaid by $4 or $5 a share, at least relative to spot market.

And I think this is an environment -- but look, the only money you've got is the money you've got and the cash flow that you earned.

You can't be dependent upon banks or the financial markets.

So I think that in the near to intermediate term, until there's greater clarity as to the worldwide economy and the loosening up of the credit sector, that cash is most likely to be kept for M&A.

Okay.

Very good, thank you.

Thank you, Rai.

Our next question comes from the line of Shyam Patil with Raymond James & Associates.

Please proceed with your question.

Hi, good evening.

My first question is just around the two deals that you have in the pipeline in terms of M&A.

Should we think about those being in line with your historical targets in terms of accretion and multiples that you pay?

I think in terms of multiples, yes -- maybe even a little bit on the lower end.

Accretion is a harder thing to discuss, because a lot of it has to do the purchase price accounting, although I anticipate both deal dozen be acreative individually and in the aggregate.

And I don't have any reason to believe they're not going to be similar to what we've done in the past, but that's been an accounting question Kathy might have further commentary on?

She's shaking her head no, so.

She needs a few more facts I think before she can weigh in on that.

And Shyam, you know, we don't have an actual history of buying e-mail companies pe say besides Electric Mail when we bought it.

The first one in '04.

It was a public company, so -- but the multiples came down.

Yes, absolutely.

We are living in the current environment, and we believe we are paying fairly, but less.

Got it, got it.

And could you just talk about how you view the free cash flow number this quarter relative to what you're expectations might have been?

And I know you don't provide explicit annual free cash flow guidance; but how should we thick about it for the year, and maybe if you could break that down between the operating cash and the CapEx?

Well, I think in terms of the -- the CapEx is right on target.

We were a little under $1 million for Q3.

I think it's that or less in Q4.

So we'll be within the range we've talked about for the year in terms of CapEx.

In terms of the cash provided from operations, payables come and payables go.

I think going forward we're going to try to make sure we don't pay so quickly on some of those payables.

And then the biggest issue has to do on the tax side of it.

The -- and it was really -- there's probably actually four effects.

Obviously, one, we have higher earnings.

Two, because of the way we invest our cash, we have very little -- we have none, actually, that are in the form of MUNI getting us triple tax free -- I understand -- and Kathy can comment on this -- that there was a change this year in the way estimated taxes are paid, which changed the way they flow over the four quarters.

But the biggest piece probably of all of those is the fact that when the stock is in the mid to high 20s, people exercise stock options and we get a cash-- not a GAAP earnings, but a cash -- tax deduction.

With the stock at these levels, a vast majority of (inaudible) options are out of the money, so there will be no exercises, and as are a result there will be no offset for cash tax purposes.

So you'll notice in the first nine months of this year, if you take our non-GAAP -- exclude the 123R -- non-GAAP pretax earnings, our cash taxes are 30% of that, roughly equal to our GAAP tax rate.

If you look at last year, you'll see we were only paying about 14 or 15% of the pretax earnings, and a big difference between the 15 and the 30 in terms of the cash rate of taxes we pay is the fact that people were exercising options and the Company is getting deduction.

That's not occurring.

Right, that's right.

Okay, great, thanks.

And then, moving onto Voice services.

The sequential increase this quarter, can you may be help us understand how many of those ads were from the installed fax base?

You mean gross sales and up sales?

Yes.

And I actually don't have an exact number; but I can tell you that we are growing across our base with several on e-mails, and I really don't have the number, but I would say definitely, you know, not more than a third.

but I have to qualify the number.

Scott, do you have a better guess?

No.

Okay, and then last quarter you talked about having a Voice services deal -- that was about -- I want to say to 700 DIDs -- into an enterprise.

I was wondering if you had any similar deal his quarter?

No, this quarter, all of our deals were standard --

SNBs

Yes.

All right, great, thanks.

Thank you.

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

Please proceed with your question.

Hi, thanks for taking my questions -- I've got three of them.

First, Scott, I wonder if you could elaborate on any of the deliberations going on with the SEC, whether you expect any outcome there to have an impact, positive or negative to you -- If you expect any impact.

I'm glad you asked.

Okay, what's your next question?

The other on is,

one of your competitors in the Voice space mentioned in an article at an an online site today they've seen really good trends in last three or four weeks in their Voice business, and I was wondering if you could comment a little bit about that business, perhaps being not as negatively impacted by the economy, if you're seeing that?

If you're seeing companies trade down to virtual PBXs, if that's the right way to put it.

And then, I also want some details on the churn rate, if you could talk about it.

Is the churn rate increasing?

Is it in the premium price brand, eFax is in the lower price brand, or is in the Voice or -- or kind of -- anything you can give us about where the increased churn is coming from?

Okay, let's take them somewhat in different order.

I'll let Hemi start with commenting on the Voice piece, and then we'll discuss the churn.

And then finally, we'll end with the USF because that could take forever.

Hi, Tavis.

I think that your comment is regarding Ring Central.

I didn't read it, but I just got before the earning call the headline.

This is a private company that spends tons of money on CPA.

I guess they have somebody who gives them tons of money.

But our approach to CPA has been always based on ROI.

We're not trying to impress anybody with quick deals.

We're also not paying for trials.

We are counting only customers that have been with us.

Our growth rate with the Voice services -- and again by the way, they are mentioning, to the best of my knowledge -- did you read it, Scott?

Quickly.

To the best of my knowledge, they're mentioning gross (inaudible).

We're mentioning net.

It's a different world.

And so I hope that they are seeing as much success as we do and our growth (inaudible) are doing very well and so are the net, as we reported.

And I cannot comment -- there is no point of comparison to what they're doing today versus previously, and I hope that they will do excellently because we also do well if they do well.

I mean, it's a big market.

And considering the question about the churn, while I would say that may be it is harder to maintain more expensive customers like on the eFax side, I say that the churn is across the board, and I wouldn't say that we are having excellent results for one versus the other.

Usually churn is limited to how long has the customer been with you.

Those customers that are passing -- you know, the 90 to 120 days, including in Voice -- are stable ones; and those that have been shorter or suffering from (inaudible).

But I could not indicate to you that the churn is burning a hole in our pocket in a certain area versus the other.

It's every business has its own numbers.

All are, again, focused on usage and value and, Scott, do you have anything else to say?

Have you noticed anything else?

No, I think as Hemi said, it's pretty much across the board, possibly with the exception of some of the larger enterprise deals given how their contracts work.

But certainly whether it's international or Voice or domestic, it's across all of those.

Yes, and I believe -- even though I don't want to be committed or something -- I believe that despite the economy going -- continuing to be bad -- the weak players may be already out and maybe we should see now stabilization of improvement, because at end of the day they're using the service -- it's not going to kill you.

I mean, it's not a big amount of money.

I think that it takes usually several quarters to rid off the weak players and then I'd assume stability or improvement towards the first half of next year, but I can't forecast it.

Okay, and now I'll address USF.

There was a lot of activity going on in anticipation of the FCC's meeting tomorrow, which will still go forward.

Earlier today, Chairman Martin pulled his consideration for a vote on his intercarrier compensation in USF reform, so there will not be a vote on that tomorrow.

It is unclear what if any vote will occur in their December meeting, and then there will be some probably fair substantial changes in the Commission come January or February of next year.

The Commission is composed of three members of the party that occupies the White House and two members of the minority party; so there's three republicans, Chairman Martin being a republican with two other republicans occupying three of the seats and Commissioners (Inaudible) and Adelstein, the three democrats; we'll know by tomorrow night whether there's going be three democrats and two republicans.

But in almost any scenario, Chairman Martin will not be the chairman sometime in '09.

It's been a goal of his for years to try to address USF reform, which has many tentacles, the only one of which that we had any interest in is the contribution system of how people pay into USF.

And it's a percentage of long distance revenues today.

He's had various proposal for a fixed fee per number.

Part of the controversy for the meeting tomorrow is that his 160-page policy statement and order is not public.

So only his fellow commissioners and may be others who -- it might have been leaked to have any actual real knowledge of what is in that 160 page order.

Four commissioners today -- meaning everyone but Chairman Martin -- put out a statement and they've actually asked in a variety of ways, as have various members of Congress, that this be put out for public comment so everyone knows exactly what is being proposed.

We have heard all kinds of things.

there maybe carveouts.

You will see in the last -- really over the last year -- several filings by j2, because as we meet with commissioners and/or their legislative staff, we file what are known as ex partes.

It summarizes the nature of the meetings; in some instances, there's even attached presentations and commentary.

So it is unclear at this point in his current order what carveouts exist, if any.

He has a distinction between residential and business.

We also don't know the full extent of those definitions.

So at this point, it's difficult to say definitively if or had his proposal had gone through, what impact to j2, if any it would have had.

It is clear that if something is approved there will be a many, many month transition period.

Even AT&T and Verizon, who have their own proposals on the table, are saying that changing from a revenue-usage based system to a fixed DIDs base will take 18 months.

You'll see in our filings, we have suggested up to 30 months if there's no caveat.

And this is primarily relating -- I mean, the last 3 1/2 to almost 4 years of this -- to what is the impact and how would it influence our free base of customers.

And so we've talked about over that time period that if something were to occur, if there were to be no exemptions, and whenever the final date of transition occurred, it would effectively mean a change to the way the free base operates.

Either it would disappear in its entirety and become fully monetized, meaning that those customers will become paid in some form, albeit it maybe at lower prices than what we currently maintained today because of their history of being a good free customer.

And that would include whatever USF charge would be passed through; an alternative when they're not mutually exclusive would be to ask those customers to provide a billing relationship and to pay on an annual basis the USF charge.

So if it were $0.85 or $1 per month you take that and multiply by 12, add a small administrative fee and charge that annually, collect the money, make no profit, send it to the Universal Service Agency and allow the free customers to maintain their service under the same terms and service that they have currently as a free customer.

So nothing has changed from our view point in terms of how we would address it, if and when such time would occur, and I'm sure we'll know more over the next coming weeks.

I would also make this statement: That even if there had been a vote tomorrow and had it been successful and had it been unfavorable because it didn't provide the relief we wanted, because of the election and because of the change that will occur in Washington and because there will be a transition period, what you would have seen are a combination of petitions for reconsideration, possible legal challenges, and maybe even congressional intervention of the 111th Congress; and of course those petitions for reconsideration before the FCC would be actually before a newly constituted Commission.

So as I tell people, whenever something happens here, you're at the beginning not the end.

And can you elaborate a little more, Scott?

As I said, it could take all day.

If you really want to know more, it could take all day.

I was just kidding.

(inaudible, overlapping speakers).

Thanks for the commentary.

I tried to make it brief.

Hopefully it's helpful.

He's excited about it.

That's good.

No, that's sad.

That's sad.

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

Please proceed with your question.

Thank you, can you hear me okay?

(Overlapping Speakers).

Yes, how are you doing?

Doing pretty well, Scott, how about yourself?

Good.

Tavis stole my thunder on the USF question, because one of our policy analysts just put a note out today about the Chairman's statement.

But suffice it to say, j2's stance about this has not changed since April of 2005 when the controversy really started to hit the wires, right?

That's correct.

Okay.

So we'll move on.

Hemi, are you seeing any -- what you would classify as sort of flight to quality, given what you said earlier about the tight credit markets and the tough economy?

Any of the smaller guys in the space that you would consider to be in trouble?

Say it again.

You used a word -- that was what?

Flight to quality.

Flight to quality.

You know, my English is not my (inaudible).

What do you mean?

Going away from -- customers that are leaving companies that are in trouble and coming to j2 because j2's not in trouble.

Yes, we see it absolutely in the corporate environment.

As I said, we are usually -- I say 100% of the time, those companies, they do -- are excused and those as you know request for bids, and we are always the higher bidder, and financial capability equals not only stability in hitting your numbers, also in many times they are worried about security, you know, security shortcuts.

Yes.

So we are definitely on the corporate side.

On the individual, I don't know who today makes the decision based on eFax versus our competitors.

Some of them have been around.

Some of them have been established.

I believe the individual guys are more focused on came first, who is the most known brand and pricing, of course.

But definitely when it comes to our corporate, it is every day that we're getting the bids even though we command a higher price.

On the Voice side, I don't know what is -- and if you remember, I said that we have to better learn and better get -- get better knowledge of this space.

I would say if I was your consultant and you asked me and I said be really careful not to chose a weak player for your Voice because your Voice is your lead number that breaks into four and ten extensions, and you don't really want to be there in a bit for it.

It's much easier to tell people that you have a new fax number versus your lead Voice structure.

So again, I don't know how many people think, but if I would advise you I would say be careful when you chose your Voice provider.

Yes.

Anybody -- any of the three, I guess, can chime in on this one.

RPU, would you say that recent downward trend -- well, is it being effected by the growing preponderance of corporate accounts and multi-thousand DID accounts -- and they've got to drive RPU down?

There are four reasons.

First of all, is as you say corporate day, very profitable to us.

Their property is higher, but RPU's lower.

As you know, you send one bill for 1,000 bids -- and I'm not churning because they're multi-year contracts and they'rer fully automated.

So they're more profitable profitable, lower in the RPU.

And the next one, as you know, international.

Dollar becoming weaker, prices are fixing in the Euro and in pounds, et cetera.

Is the next one is usage.

Usage also declines -- the apple goes down.

And the last one is the voice product.

We're offering the product at 11:00, when eFax is $60.95.

So all of those are impacted -- and there's another one.

The fifth one we are selling more -- $10 DIDs on the fax (inaudible).

The alternative fax.

The alternative fax/print.

So all of those -- and in this economy, our decision is to focus on how many customers versus, you know, giving their hard dime on (inaudible), trying to extract another dollar out of them.

That's not the thing to do.

The right thing to do is to get them in, and we have stories of successful price changes not (inaudible).

Great, thanks a lot, guys.

Our next question is a follow-up from the line of Rai Archibold.

Please proceed with your question.

Yes, I just wanted to touch base on '09.

In the the past you've given sort of preliminary ideas in terms of what your growth expectations are for the following year at this point.

So I was just curious -- I realize you're in the middle of your budget planning, but perhaps you can give us a sense as to what you're thinking as to the sort of growth outlook for '09 at this point.

Well, Rai, you're correct we've done in the past -- I think it -- I'm not sure why we did it in the past, because you get kind of two bites of the apple.

You kind of give a view today and then you firm it up with your guidance in about 60 to 90 days.

We made a decision this year that there were enough moving pieces within the economy and also within the fluidity of some of the M&A transactions that it didn't make sense for us to do what could effectively become two budgets.

So we started the process more recently.

It will finish up -- my guess is probably late December, early January.

Technically, it won't close and never closes until we get the 1231 actual DID counts and numbers.

So we do the last bit of cleanup the first couple of weeks of January.

I think we're on schedule to meet that, but we're still in the early stages and I don't think we have a -- I know we don't have a view right now in terms of the organic or combined growth rate for '09.

Also, Rai, we, by design, decided this year to to drag -- and start all of the budgeting later because of all of the those reasons.

You know, it's very hard in this environment to predict.

So the more actual data, the more knowledge we have on the M&A, and the more we are closer to the stabilization of the dollar; so we by design, while we have all of the templates ready, we are still later than any time I've been here since the beginning.

We've never been sitting in November and not having the number yet.

It's by design.

Very good.

Thank you.

Thank you.

Our next question comes from the line of (Inaudible) with Cardinal Capital Management.

Please proceed with your question.

Yes, thank you.

I just wondered with the growth in Voice and enterprise, can you give a ballpark of how the customer mix sort of looks like from a DID prospective?

My notes had 66% individual and then about 30% vis-a-vis and 4% instead of a mix.

Has that changed material?

At a macro level, no.

I think it probably has shifted a point or two.

The corporate enterprise is probably mid to high single digits.

The SMB was a little bit rich at the 30 level -- it's probably closer to the mid-20s.

And whatever's left over is individual -- now I say -- well, the SMB is probably a little bit larger than that.

It depends whether you're including or excluding the Voice piece, because the Voice is all SMB -- and as Hemi pointed, out that's 15% of our DIBs.

Got you.

Okay, yes --

(Inaudible) take SMB fax and SMB Voice combined, yes, you're probably in the 35% range.

Okay, great.

And then on the credit sensitive side, just sort of a breakdown -- I don't know if I missed it -- fixed versus variable?

Do you have anything?

Is it still half and half?

And I think you all said it would remain in the low 20s, right, as a percent of revenues?

Yes, I -- to be honest with you, I did not update that; but I have no reason to believe that the mix is still not -- it shifted a little bit because obviously, as you see from the chart, some of the usage revenue and variable revenue has bled off.

So I think 50/50 is probably -- that was what it was about a year ago when the credit sensitive first started deteriorating their usage.

t's probably closer to 60/40 in favor of fixed today.

Yes, you're right.

I think in Q3 you said about 7 plus and then 5.5 (inaudible).

Right.

So I guess that trend sort of stayed on?

Right.

Great, thank you so much.

You're welcome.

You're welcome.

I would just remind everybody, we do also -- we've not received -- We do have and will accept any questions by e-mail if there's anybody that is out there that does not want to queue in and give us the question verbally, and also I'd ask the operator to poll for any additional questions at this point.

(OPERATOR INSTRUCTIONS).

Our next question comes from the line of Scott (Inaudible) with Emerald Advisers.

Please proceed with your question.

Good afternoon, Hemi, Scott, Kathy.

How are you, Scott?

Yes, it is.

Okay.

Kathy, should we read anything into or be concerned about the fact that deferred revenues are down a little bit?

No, I think that if you look back over the course of time, you'll find that deferred revenues do tend to dip at certain points during the year -- Q3 is one of them.

So I don't think there's any concern there.

We continue to sign up deferred -- on a deferred basis -- the number of customers that want to pay ahead annually.

That really hasn't changed to any significant level.

So I think what you're going to find is as time goes off, you'll see decreases but you'll also see increases coming on board as people sign up.

Scott, there's nothing that we're aware of that should impact the deferred revenue.

Okay, so that's just a function of when customers had signed up?

Yes, that's right.

You'll find a lot of your customers on the annual signups -- typically we see the most robustness in that occurring in the first and second quarters, and then Q3 and 4 tend to be a little quieter.

The spring is very -- usually heavy for annual signups.

Right.

Also, I think it has to do with the life of the customer, right?

No?

Am I wrong?

So no, there's nothing that we are aware of, Scott, that should should alert you.

Okay, great.

And Hemi, something that you said earlier, in English.

Ha.

By the way, Scott speaks Hebrew, so be careful -- I know this guy.

Well, it led me to believe that you possibly have or may have the potential to suggest an enterprise voice customer.

Does such a thing exist?

Yes, we talked about it, I think two quarters ago.

We had a [candy] date and they signed.

It was something like 700 and some extensions.

I don't remember exactly who it was, but it's a company that has done it with their sales force.

Okay, terrific.

And that -- I guess kind of staying on that topic, do you -- you talked about a couple of customers who were kind of SMBs that have graduated to the enterprise level.

Yes, yes.

And you've mentioned in the past that once you kind of get in there and install things, (inaudible) tends to lead these customers, whether they're SMBs or enterprise customers, to add more DIDs.

And you do -- you have been focusing on the enterprise customers, the 66.

But can you give us -- I'm going to call them graduates --

I think I understand.

You're asking me there are customers that had five and now are marching up to seven, which is a free bonus 2 DIDs for us.

It's happening on a much larger scale.

It's 500 going to 800.

Look, we have -- on our corporate side, more than half of the customers that those that came with a minimum of 10 DIDs; and we're seeing their improvements, not only because they are always adding numbers.

To add a number when are you that kind of customer, you don't need to call us.

You don't need to do anything.

You go to the administrative tool and you pull down the area code that you want and you enter your e-mail address and you're done.

So there's constant growth there.

Also, we have -- and you know, I'm ashamed to say, but up to now we didn't monetize these customers very well.

And now we have (inaudible) a new director managing our telesales, and he's started in the last few months to address those customers.

Those customers, we kept them away from our marketing and e-mails and everything.

Didn't call them out, so recently we started and we are seeing there encouraging signs, and that's about it.

You know, we are not maximizing our upsale opportunities in.

We always focus on grabbing market share, because those that we have, you know, we have said they are secondary in our effect.

We always prefer to take somebody who's not with us rather than sell another unit to existing customers.

But it is growing, and I just recently while preparing my presentation for our Board of Directors meeting, I noticed that this segment of the media, they are growing.

Yes.

Okay.

That's really helpful.

And if you look at the, I guess the SMB customers that you currently have, how many of them do you think -- and maybe you can give me a degree compared to enterprise customers -- but how many of them do you have are potentially enterprise customers?

Do you have four times the number of SMB customers that have potential to be enterprise customers as you have enterprise customers?

10 times?

Let me draw the distinction, Scott.

When we look at corporate DIDs.

The ones that are graduating up, we used to have actually in a separate category, an intermediate designation called SMP -- (inaudible) to immediate enterprises.

Okay.

Those are the ones when you talk about upgrading to 1,000 DIDs, it's that subset that is the most likely, because upon initial deployment, there's not full penetration.

Sure.

What I'm talking about a small business with ten employees, somehow growing to the size of 1,000 employees and as a result taking DIDs along the way.

Great, we're talking about --

So it's the SME component of j2's corporate piece, which has technically got three components -- SMB, SME and enterprise -- and I don't know, Hemi -- do you have a -- I don't have a sense of that customer count.

I would say that the general answer to your question is yes.

The SME segment of our corporate business is right for growth as we further penetrate additional elements of that business.

I would say also.

But I don't have the order of the magnitude off the top of my head.

Scott, when we have those smaller deals, they are usually managed by automation by our computers by what we call, you know, our CRM programs.

But those that are the larger that are a few hundred.

They have a designated salesperson and he/she will go to the organization and say okay, you took a large (inaudible), you took 200 numbers from me on your -- you know, our future (inaudible).

But I'm talking about your -- I know that your major corporation is seeping in in Chicago.

He/she would follow up with them until the server dies and then a desponder will strike, and then you'll see a customer moving from 200 to 1,200.

Those are (inaudible) deals that we have, and those are, if you saw, we said the Geek Squad -- we had two of them (inaudible).

your language graduated, those are those.

Yes, okay, great, and just one last question -- thank you for being so patient with me.

I am assuming -- I'm not sure if everyone is -- but I'm assuming that the churn rate in some customers is close to zero, because those are, like you said, Hemi, it's kind of a pain to change your phone number and tell everybody else?

Yes and no.

They are very sensitive in the initial 90 to 120 days.

Usually what you need to do, you need to make sure that they getting the number out.

Because remember, Scott, those guys come if w their mobile number or their home office number, and they have to start to give the number that we give them out.

If they fail, then it's not good.

And if they succeed, then the only reason for them to decline is, you know, going out of business.

Right.

So -- and also I can tell you it's not the same.

With toll free numbers versus regular numbers.

Toll free numbers are more sensitive.

Okay.

All right, that's really helpful.

Thank you.

You're welcome

There are no further questions in the live electronic queue.

All right, thank you very much.

We do not have any other e-mail questions at this point, So we will conclude the Q3 conference call.

We thank you.

We will be participating at the upcoming UBS conference in New York on Thursday, November the 20th.

There will be a press release that will go out shortly with the time of the presentation, which will be webcast.

I will be there also hosting one on ones throughout the day, and then we will look forward to speaking to you probably sometime in February for Q4 results and fiscal year-end.

Thank you.

Bye-bye.

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

Thank you for your participation.

You may disconnect your lines at this time.