| J2 GLOBAL COMMUNICATIONS INC Item 1A Risk Factors The following risk factors and other information included in this Annual Report should be carefully considered before deciding to invest in our company or to maintain or increase your investment |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations |
| If any of the following risks occur, our business, prospects, financial condition, operating results and cash flows could be materially adversely affected |
| Risks Related To Our Business In order to continue sustaining our growth, we must continue to attract new paid subscribers at a greater rate and with at least an equal amount of revenues per subscriber than we lose existing paid subscribers |
| We may not be able to continue to grow or even sustain our current base of paid customers on a quarterly or annual basis |
| Our future success depends heavily on the continued growth of our paid user base |
| In order to sustain our current rate of growth we must continuously obtain an increasing number of paid users to replace the users who cancel their service |
| In addition, these new users must provide revenue levels per subscriber that are greater than or equal to the levels of our current customers or the customers they are replacing |
| We must also retain our existing customers while continuing to attract new ones at desirable costs |
| We cannot be certain that our continuous efforts to offer high quality services at attractive prices will be sufficient to retain our customer base or attract new customers at rates sufficient to offset customers who cancel their service |
| In addition, we believe that competition from companies providing similar or alternative services has caused, and may continue to cause, some of our customers or perspective customers to sign up with or to switch to our competitors’ services |
| These factors may adversely affect our customer retention rates, the number of our new customer acquisitions and/or their usage levels |
| Any combination of a decline in our rate of new customer sign-ups, decline in usage rates of our customers or decline in customer retention rates may result in a decrease in our revenues, which could have a material adverse effect on our business, prospects, financial condition, operating results and cash flows |
| Our business is dependent on a small number of telecommunications carriers in each region and our inability to maintain agreements at attractive rates with such carriers may negatively impact our business |
| Our business substantially depends on the capacity, affordability, reliability and security of our telecommunications networks |
| Only a small number of telecommunications providers (carriers) in each region, and in some cases only one telecommunications carrier offers the telephone number and network services we require |
| Certain of our telecommunications services are provided pursuant to short-term agreements that the providers can terminate or elect not to renew |
| As a result, any or all of our current telecommunications service providers could discontinue providing us with service at rates acceptable to us, or at all, and we may not be able to obtain adequate replacements, which could materially and adversely affect our business, prospects, financial condition, operating results and cash flows |
| General market forces, the failure of providers, regulatory issues and other factors could result in increased rates |
| Any increase in market rates would increase the cost of providing our services and, if significant, could materially adversely affect our business, prospects, financial condition, operating results and cash flows |
| 9 _________________________________________________________________ Our financial results may be adversely impacted by higher than expected tax rates or exposure to additional income tax liabilities |
| We are a US based multinational company subject to tax in multiple US and foreign tax jurisdictions |
| Our provision for income taxes is based on jurisdictional mix of earnings, statutory rates, and enacted tax rules, including transfer pricing |
| Significant judgment is required in determining our provision for income taxes and in evaluating our tax positions on a worldwide basis |
| It is possible that these positions may be challenged or we may find tax beneficial intercompany transactions to be uneconomical, either of which may have a significant impact on our effective tax rate |
| A number of factors affect our income tax rate and the combined effect of these factors could result in an increase in our effective income tax rate as compared to our effective income tax rate in fiscal 2005 |
| This potential increase in future effective income tax rates would adversely affect net income in future periods |
| We operate in different countries that have different income tax rates |
| In the future, effective tax rates could be adversely affected by earnings being lower than anticipated in countries having lower statutory rates and higher than anticipated in countries having higher statutory rates, by changes in the valuation of deferred tax assets or liabilities or by changes in tax laws or interpretations thereof |
| In addition, we are subject to examination of our income tax returns by the US Internal Revenue Service and other tax authorities |
| We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our income tax reserves and expense |
| Following a review of the pricing of services purchased from a subsidiary, we recorded an income tax reserve of dlra1dtta9 million for 2005 relating to the tax impact of the purchase of such services |
| Should actual events or results differ from our current expectations, charges or credits to our income tax reserves and income tax expense may become necessary |
| Any such adjustments could have a significant impact on our results of operations |
| A system failure or breach of system or network security could delay or interrupt service to our customers, harm our reputation or subject us to significant liability |
| Our operations are dependent on our ability to protect our network from interruption by damage from fire, earthquake, power loss, telecommunications failure, unauthorized entry, computer viruses or other events beyond our control |
| There can be no assurance that our existing and planned precautions of backup systems, regular data backups, security protocols and other procedures will be adequate to prevent significant damage, system failure or data loss |
| Also, despite the implementation of security measures, our infrastructure also may be vulnerable to computer viruses, hackers or similar disruptive problems caused by our subscribers, employees or other Internet users who attempt to invade public and private data networks |
| Any damage, system failure or security breach that causes interruptions or data loss in our operations or in the computer systems of our customers or leads to or the misappropriation of our customers’ confidential information could result in significant liability to us, cause considerable harm to our reputation and deter current and potential customers from using our services |
| Our security measures may not prevent security breaches that could harm our business |
| Currently, a significant number of our users authorize us to bill their credit card accounts directly for all transaction fees charged by us |
| We rely on encryption and authentication technology licensed from third parties to provide the security and authentication technology to effect secure transmission of confidential information, including customer credit card numbers |
| Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect transaction data |
| Any compromise of our security could harm our reputation and, therefore, our business, and also subject us to significant liability |
| In addition, a party who is able to circumvent our security measures could misappropriate proprietary information, or cause interruptions in our operations, damage our computers or those of our users, or otherwise damage our reputation and business |
| Increased cost of email transmissions could have a material adverse effect on our business |
| We rely on email for the delivery of our fax and voicemail messages |
| In addition, we derive some advertising revenues through the delivery of email messages to our free subscribers and we regularly communicate with our subscribers via email |
| If regulations or other changes in the industry lead to a charge associated with the sending or receiving of email or voicemail messages, the cost of providing our services would increase and, if significant, could materially adversely affect our business, prospects, financial condition, operating results and cash flows |
| If we experience excessive fraudulent credit card charges, we could lose the right to accept credit cards for payment and our subscriber base could decrease significantly |
| A significant number of our paid subscribers authorize us to bill their credit card accounts directly for all service fees charged 10 _________________________________________________________________ by us |
| We incur losses from claims that the customer did not authorize the credit card transaction to purchase our service |
| If the numbers of unauthorized credit card transactions become excessive, we could be assessed substantial fines for excess chargebacks, or we could lose the right to accept credit cards for payment |
| If we were unable to accept credit cards, our paid subscriber base could significantly decrease, which could have a material adverse effect on our business, prospects, financial condition, operating results and cash flows |
| Our business could suffer if we cannot obtain telephone numbers, are prohibited from obtaining local numbers or are limited to distributing local numbers to only certain customers |
| Our future success depends on our ability to (i) procure large quantities of local telephone numbers in the United States and foreign countries in desirable locations at a reasonable cost and (ii) offer our services to our perspective customers without restrictions |
| Our ability to procure and distribute telephone numbers depends on factors such as applicable regulations, the practices of telecommunications carriers that provide telephone numbers, the cost of these telephone numbers and the level of demand for new telephone numbers |
| Failure to obtain telephone numbers in a timely and cost-effective manner or regulatory restrictions on our ability to market our services without restriction may hinder or prevent us from entering some foreign markets or hamper our growth in domestic markets, and may have a material adverse effect on our business, prospects, financial condition, operating results and cash flows |
| Our ability to procure large quantities of telephone numbers may be particularly limited in area codes of large metropolitan areas, and we may eventually be unable to provide our customers with telephone numbers in the most desirable area codes (eg, 212 in Manhattan and 171 in London), having to rely instead on new area codes created for these areas, which may not be perceived by our potential customers as having the same value as the desirable area codes |
| We do not allow customers of our non-paid services to choose the area code for the telephone number we provide for their use and, to some extent, this makes our non-paid services less attractive, particularly in comparison to our subscription services or the subscription services provided by others where the customer may select an area code |
| In the United States, the FCC has adopted an order that could impede our ability to obtain telephone numbers in existing area codes |
| The order permits states to apply to the FCC for delegated authority to implement specialized area codes that would segregate services, which may include unified messaging and other services that the FCC perceives as being “geographically insensitive,” into unique area codes |
| We have petitioned the FCC for reconsideration of this decision, which remains pending |
| The outcome of this petition may reduce demand by our customers or perspective customers for new DIDs in the affected areas, if it restricts us from obtaining telephone numbers in area codes that are generally perceived as local by consumers |
| Two states, Connecticut and California, have petitioned the FCC for such authority |
| The FCC conditionally granted Connecticut’s petition in 2003, but the state has not adopted a specialized code |
| We participated in Connecticut’s proceedings to attempt to obtain a nondiscriminatory outcome |
| The FCC granted California’s petition with fewer conditions |
| We are now participating in the reconsideration stage of that FCC decision, asking that the FCC clarify that the decision will not apply to our services |
| The outcome of the FCC decision and California’s eventual implementation of that decision may affect our ability to obtain telephone numbers that are perceived by consumers as being local |
| Similar regulation has occurred in some international locations and may continue to be enacted in additional locations in the future |
| For instance, Germany prohibits issuing a local telephone number to anyone without a physical presence in the area associated with a local area code |
| In addition, some states have unilaterally attempted to restrict our access to telephone numbers, contrary to the established procedures of the FCC If this continues, it may materially affect our ability to acquire the telephone numbers for our operations |
| In addition, future growth in our subscriber base, together with growth in the subscriber bases of providers of other fax to email and unified messaging services, may increase the demand for large quantities of telephone numbers, which could lead to insufficient capacity and an inability on our part to acquire the necessary telephone numbers to accommodate our future growth |
| Inadequate intellectual property protections could prevent us from enforcing or defending our proprietary technology |
| Our success depends in part upon our proprietary technology |
| We rely on a combination of patents, trademarks, trade secrets, copyrights, and contractual restrictions to protect our proprietary technology |
| However, these measures provide only limited protection, and we may not be able to detect unauthorized use or take appropriate steps to enforce our intellectual property rights, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States |
| While we have been issued a number of patents and other patent applications are currently pending, there can be no assurance that any of these patents will not be challenged, invalidated or circumvented, or that any rights granted under these patents will in fact provide competitive advantages to us |
| Currently, three of our patents are subject to re-examination proceedings with the US Patent and Trademark Office |
| The result of these proceedings could limit or invalidate some or all of the claims under these patents |
| In addition, effective protection of patents, copyrights, trademarks, trade secrets and other intellectual property may be unavailable or limited in 11 _________________________________________________________________ some foreign countries |
| As a result, we may not be able to effectively prevent competitors in these regions from infringing our intellectual property rights, which could reduce our competitive advantage and ability to compete in those regions and negatively impact our business |
| Companies in the messaging industry have experienced substantial litigation regarding intellectual property |
| In fact, we have pending patent infringement lawsuits against four companies in this industry |
| For more information regarding these suits, please refer to the section entitled |