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Executives

Adam Silverman – Investor Relations

Joseph D. Frehe - Chief Financial Officer

Matthew C. Diamond - Chairman of the Board, Chief Executive Officer

James K. Johnson, Jr. - President, Chief Operating Officer, Director

Analysts

Edward Einboden - William Smith Securities

Kevin Casey - Casey Capital

[P.J. Sullet - Potomac Capital]

[Russ Sylvestry - Skaritane Capital]

Steven Martin - Slater Capital

Alloy, Inc. (ALOY) F3Q08 Earnings Call December 3, 2008 5:00 PM ET

Operator

Welcome. My name is Patricia and I’ll be your conference operator today. At this time I would like to welcome everyone to Alloy, Inc. 2008 third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) Now Adam Silverman, I’d like to turn the call over to you sir.

Adam Silverman

Thank you for taking the time to join us for our conference call on Alloy’s third quarter 2008 earnings. Participating in today’s discussion are Matt Diamond, Alloy’s Chief Executive Officer, Jim Johnson, Alloy’s Chief Operating Officer, and Joe Frehe, Alloy’s Chief Financial Officer.

Alloy reported third quarter earnings after the close of the market today. If you’ve not previously received a copy of the press release, it is available on Alloy’s website at www.alloymarketing.com. Joe will begin by providing a discussion of our financial results and position followed by Matt who will provide a discussion of operational highlights and an update on recent events. We will then open the session up for questions and answers.

Our press release and this presentation reference several non-GAAP financial measures, specifically adjusted EBITDA and free cash flow. We’ve included these non-GAAP measures because we believe they are important in evaluating the company’s operating performance. Because they are not calculated in accordance with GAAP they should not be considered in isolation of or as a substitute for net income as an indicator of operating performance or net cash flow provided by operating activities as a measure of liquidity. At the end of our press release we’ve provided supplemental disclosures to reconcile the non-GAAP financial measures to their GAAP counterparts in accordance with the SEC’s Regulation G.

Certain remarks that we may make during this call about future expectations, plans and prospects for Alloy constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those that are discussed in our annual report on Form 10K for the fiscal year ended January 31, 2008 and in our other periodic SEC filings which are on file with the SEC and available on the SEC’s website at www.sec.gov. We refer you to these filings for a full description of such factors.

I’ll now turn this program over to Joe Frehe.

Joseph D. Frehe

Thank you for joining Alloy’s third quarter fiscal 2008 conference call. I’d like to begin by highlighting some of the key financial information for the quarter.

Revenue for our third quarter ended October 31, 2008 increased $3.4 million to $69.9 million from $66.5 million in the third quarter of fiscal 2007. Revenue in the media and promotion segments increased while the placement segment declined slightly.

Media segment revenue increased 16% or $3.4 million to $25 million. This increase was driven by the Channel One interactive and frontline businesses.

Promotion segment revenue increased 1% or $211,000 to $26.1 million. This increase was due to slightly higher sales in our on-campus marketing business partially offset by a decrease in our AMP agency business.

The placement segment revenue decreased slightly by 1% or $202,000 to $18.7 million. This decrease was primarily due to a decline in broadcast advertising partially offset by an increase in college and multicultural advertising.

Adjusted EBITDA, which we define as operating income plus depreciation and amortization and non-cash stock-based compensation, for the quarter increased approximately $2.6 million to $11.9 million from $9.3 million in the third quarter of fiscal 2007. The increase in adjusted EBITDA was primarily driven by a higher revenue in our media segment businesses.

Operating income increased $2.2 million to $9.2 million in the third quarter of fiscal 2008 from $7 million in the third quarter of fiscal 2007. The increase in operating income is primarily due to the improvement in adjusted EBITDA and partially offset by higher depreciation and amortization and stock-based compensation.

Net income decreased $3.3 million to $9.1 million in the third quarter of fiscal 2008 from net income of $12.4 million in the third quarter of fiscal 2007. This decrease is due to a one-time $5.5 million extraordinary gain that was recorded in fiscal 2007 related to the Channel One acquisition.

Net income per diluted share in the third quarter of fiscal 2008 was $0.67 compared to $0.90 per diluted share in the third quarter of fiscal 2007. Excluding the impact of the extraordinary gain in 2007 of $0.40 per share, our EPS per diluted share is up $0.17 on a quarter-versus-quarter basis.

We believe free cash flow is an important measure of our company’s operating performance as it represents the amount of cash available for debt service, acquisitions and stock repurchases. Our free cash flow which we define as the sum of net cash provided by or used in operating activities, changes in operating assets and liabilities less capital expenditures for the third quarter of fiscal 2008 increased approximately $2.6 million to $10.7 million from $8.1 million in the third quarter of fiscal 2007. This improvement was primarily due to higher adjusted EBITDA and improved accounts receivable cash collections.

Free cash flow per share in the third quarter of fiscal 2008 was $0.78 per diluted share compared with $0.59 per diluted share in fiscal 2007. Our weighted average shares used in the computation of free cash flow per share did not change.

Turning to our balance sheet. We believe our balance sheet was very strong on October 31. Our cash balance was $21.1 million, our working capital was $28.2 million and we do not have any debt. We also have a revolving credit facility with Bank of America with approximately $25 million available for borrowing. We are currently in the middle of a three-year agreement.

Our accounts receivable at the end of the quarter were $13.6 million, higher than our second quarter balance due to the seasonality of the business. DSO or days’ sales outstanding at the end of the quarter was approximately 63 days compared with 59 days at July 31, 2008. We are pleased with our DSO level in 2008 and continue to look for ways to improve our collection process.

Our capital expenditures for the quarter were $1.1 million, the same as the prior year’s third quarter. We have spent $6.4 million year-to-date and expect to spend an additional $1.5 million during the fourth quarter.

In November we completed the sale of our CCS.com domain name and related trademarks to dELiA*s, Inc. for $5.8 million in cash. We will recognize approximately $5.6 million in net income as a result of the sale during the fourth quarter.

With that let me turn the discussion over to Matt.

Matthew C. Diamond

As Joe mentioned, the company posted solid third quarter results despite a very difficult economic environment. Through the third quarter of this year we have generated $14.4 million of EBITDA versus $10.1 million from a year ago. I will touch on some aspects of our operating performance below and provide insight into what we’re seeing for the fourth quarter and full fiscal year. I will also discuss our strategy going forward in this unprecedented and difficult environment.

First, the operating results. Our media business segment drove most of the sales and EBITDA increases for the quarter. A revitalized Channel One and upgraded strategy in our interactive business unit and strong sales momentum in our in-store marketing business were positive contributors for us in the quarter.

However our promotions business is proving vulnerable to the deteriorating economic environment. We’ve had meaningful revenue that was forecasted for the fourth quarter get eliminated, reduced or moved to 2009. In response we are aggressively reducing our cost structure in this business to offset the sales declines and ensure maximum profitability.

Looking into the fourth quarter we definitely see more challenges than we did six months ago as clients continue to be cautious about marketing expenditures. Promotions will likely be hardest hit and will experience a year-over-year decline in fourth quarter sales and EBITDA.

Overall we expect the company to improve fourth quarter sales and EBITDA performance versus last year but we expect to fall short of the previously announced full year guidance of $225 million to $240 million in revenue and $20 million to $24 million of EBITDA for the year. Our revised guidance is now $215 million to $220 million of revenue and $16 million to $18 million of EBITDA.

We are not going to be issuing any estimates at this time for fiscal 2009 as it is too early to speak with any clarity about potential outlook in this environment. However, as a company we are budgeting very conservatively and focused on cost reduction and cash flow maximization.

We are extremely pleased with our balance sheet position. Our strategy of conservative cash management, the paying down of debt and the elimination of the convertible security means that we have a strong cash position. Cash is at $21 million at quarter end and in November we received $5.8 million as part of the ccs.com sale to dELiA*s. The company has no debt.

We are a company with good cash flow and large cash balance and this puts us in a strong competitive position. We will continue to look selectively at acquisitions, we will continue to be conservative but we will look to pick up inexpensive acquisitions in our core media business segment.

Our Board has also approved up to $10 million to repurchase shares either in the open market or if parties need to make larger block sales, through privately negotiated transactions. We are not committed to spending any or all of this money but we will evaluate our situation periodically and have the ability to act if it is in our interest to do so.

Overall, despite a very tough economy we believe that our company is fundamentally strong and has the opportunity to create a lot of value for shareholders over the coming years.

With that operator if you could open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Edward Einboden - William Smith Securities.

Edward Einboden - William Smith Securities

Can you guys talk about a little bit on the promotion side what percent just back of the envelope was delayed versus canceled and what kind of outlook you guys are working in to your numbers?

Matthew C. Diamond

Maybe a more direct way to look at it is there is approximately $5 million or so in programs or projects that were slated for the fourth quarter that were very direct that are not going to be in the fourth quarter. They were either verbal; some are contracts and some were moved but they were definitely ones in which frankly in a normal economic environment would have gone as planned.

That’s the stuff that’s been shifted. Of that I think our caution for 2009 is even those that are moved into 2009, I think it’s safe to say we don’t want to feel that there’s any certainty until either there’s a signed contract or you start to execute a program. So even the portions that are in 2009 I would say we’re still treating pretty cautiously in the promotion segment.

Edward Einboden - William Smith Securities

So you guys are just kind of assuming the $5 million is a loss even though you really don’t believe all of that would be?

Matthew C. Diamond

Yes. It’s not as if you lost the clients. These aren’t clients that have told us they don’t want to work with us. They’re clients that have said that things are on hold. We do work with some of the automotive companies; we do work with some other sectors that have been hit; and they’re going to hold their spending until things stabilize. Fortunately it’s not a huge portion of our business and we can address it by cutting costs quickly and not anticipating it. But as we start 2009 our approach is if it’s not contracted for, we’re not going to assume it’s coming and we’re going to staff appropriately.

Edward Einboden - William Smith Securities

Can you talk about, you kind of addressed that really quickly, but any contracts or relationships that you might have lost or gained in the quarter? We don’t have good visibility in that. Or maybe companies that are no longer around that you guys previously had?

Matthew C. Diamond

On the I guess what would approach the negative side, the big segments obviously that have been most hurt would be the financial sector and automotive. They’re not enormous for us on the automotive front but we do business with all of them at least to a certain degree in the college market. Washington Mutual has historically been a good client of ours so that’s gone so we’ve lost them.

There isn’t any client there that I would point to that is financially stable or in business that has said we’re done; we’re not going to work with you; we want to cut all marketing. It hasn’t gotten to that point.

And we have certain segments of our business that I would say are more ROI focused segments, lead gen and things like that, that in a tough economy I think will hold its own and in fact could be even stronger.

There are no others that I would point to to say because of the demise of Bear Stearns or something like that it was lost other than Washington Mutual.

Edward Einboden - William Smith Securities

Maybe you could just allude to the four titles you had been talking about and the projects you’re working on on either television, theaters and DVD how those are going?

Matthew C. Diamond

On the Alloy entertainment front the biggest news there that we’re focused on is that a lot of the projects that are out now and those in the pipeline really capitalizing on other revenue streams or potential revenue streams including interactive, the teen.com TV platform is a fantastic outlet for content including our own content and a lot of the Alloy entertainment properties are going to be able to be exposed through that. So a lot of new properties that normally we would have licensed to a third party we can actually monetize directly now.

Some of the projects that are out today such as The Clique, it’s early in the DVD sales so it’s pretty early to tell. Sex Drive the Movie didn’t do all that well. Our economics weren’t enormous either way but it wasn’t a smash hit, it wasn’t like The Sisterhood of the Traveling Pants or anything. Obviously Gossip Girl and Privilege continue to be very strong. Gossip Girl continues to win its timeslot and Privilege has ordered a couple new episodes so those continue to be strong.

Operator

Our next question comes from Kevin Casey - Casey Capital.

Kevin Casey - Casey Capital

On the sale to dELiA*s what’s the after-tax gain you’re going to get or the after-tax cash?

Joseph D. Frehe

After-tax should be about $5.6 million.

Kevin Casey - Casey Capital

You’re not going to pay any tax on that?

Joseph D. Frehe

Well we’re going to pay it some [AMT]. They paid us $5.8 million and we’ll net about $5.6 million.

Kevin Casey - Casey Capital

When you talked about part of your business being return on investment focused, what percent is that? And also another question, when you look at your business that you guys do that nobody else can, what percent would that be?

Matthew C. Diamond

Let’s broaden the question and maybe make it a little clearer. I don’t want to suggest anything’s immune to a bad economy but are less volatile in a bad economy. We have a portion of our promotions business that is direct marketing on behalf of the schools. Generally during a tough economy enrollment in colleges goes up so we don’t think that that segment will necessarily be as challenged as other segments and that’s much more ROI focused because it’s based on direct marketing for the school. So that’s a material portion of the promotions business.

The interactive piece is largely not ROI focused but I would say of our media segment totally, it’s not more than maybe 20%-ish or so of our earnings would be potentially ROI. But that’s a number that’s going to shift pretty dramatically based on advertisers’ needs. So a campaign say for a client that maybe was more CPM focused in ’08 may turn to be a little more ROI focused in ’09 and if we think we can deliver, we’ll do that. So that percentage could go up and obviously that’s how we can preserve decline.

And a thing to keep in mind as much as we are budgeting conservatively for next year, we certainly have a pretty compelling argument for advertisers that a savings of 10% on their broadcast budget shifted to what we do can save them $10 million, $20 million, $30 million while they’re increasing their spend with us and keeping the same audience eyeballs. We think we’re addressing the market as aggressively as we can on the sales front while being as conservative as we can on the cost side.

Kevin Casey - Casey Capital

Do you think the customers understand that yet?

Matthew C. Diamond

I think our sales force does and I think that the customers that are looking to be more efficient are hearing the pitch. It’s our job to convince them of that and show them it. I think we’ve got good empirical data. I think Channel One in particular has fantastic data to illustrate how effective the incremental spend is with us versus an incremental dollar on broadcast. So I think that world is there.

Interactive has a lot of factors in it so there are a lot of factors that are driving the growth of interactive. So I think that’s buyer specific whether or not they’re focused on that. But I think your big clients definitely understand that. Your consumer product companies, your Johnson & Johnson’s of the world; I think they’re certainly at the point where they’re looking at that.

Kevin Casey - Casey Capital

Then the second part of my question you kind of touched on but the percent that only basically Alloy can do such as Channel One where there’s no competitor?

Matthew C. Diamond

Again it’s all relative. We have a competitor everywhere. But I would say our whole media segment is obviously proprietary so you could put the whole media segment as something unique. Now having said that, clearly Channel One, someone could look at MTV or something on general broadcast and the same with interactive. But even in the interactive space our competitors in the interactive space are going to be the social networking sites which really aren’t great advertising vehicles as everybody knows or they’re going to be the broad-based sites like Yahoo or AOL or even MTV that don’t have the targeting that we do. So yes, they’re competitors but I would say our whole media segment is proprietary.

Placement is an open platform in the sense that other people can place ads in the papers that we place but with our dominant market share it’s hard to imagine in a tough economy that we don’t have significant advantages.

So the most vulnerable is clearly promotion because that’s the segment that is more driven by the economy. It’s a double-edged sword. On the negative side you’re going to have a reduction in new business because people are going to look to scale back. On the positive side we’ve already gotten indications from certain current advertisers that want to get rid of their fringe partners and consolidate on their core partner, and if that’s us obviously we benefit. That’s really where we have to just make sure our costs are in line and that we do quality work for our client base.

Kevin Casey - Casey Capital

Excluding the sale of the asset, is cash going to increase in the fourth quarter assuming positive cash flow?

Joseph D. Frehe

Yes. We expect it to increase.

Operator

Our next question comes from [P.J. Sullet - Potomac Capital].

[P.J. Sullet - Potomac Capital]

Just following up on the cash. You had the $21 million plus the call it a little under $6 million from ccs gets you $27 million. If I back in to the fourth quarter EBITDA based on the guidance, it’s kind of 2.5-ish. Should cash flow generation in the fourth quarter approximate EBITDA or seasonally is this a stronger working capital generation quarter?

Joseph D. Frehe

I think your calculation is fair. We expect it to be around $30 million excluding any stock repurchases depending on what we do in the quarter.

[P.J. Sullet - Potomac Capital]

It’s good to see the purchase and the authorization. Have you made any significant purchases since the end of last quarter?

Matthew C. Diamond

We had a 10b5 active which we’re not sure exactly where it all is. Well, I guess we do know. It’s in some small purchases but nothing all that material. While we were in our blackout period, we did one small block trade of approximately 72,000 shares or so. We continue to be active. We were limited by our own blackout period in volume in particular but we continue to be active and opportunistic.

Operator

Our next question comes from [Russ Sylvestry - Skaritane Capital].

[Russ Sylvestry - Skaritane Capital]

On the compensation charge, it’s significantly higher this year than it was last year and I was wondering what was behind that. That was question one. Question two is on the Channel One capacity utilization and also if you could talk a little bit about who the advertisers are on Channel One?

Matthew C. Diamond

I’ll answer your second and third question as we try to figure out the first. There wasn’t anything material that at least as Joe goes to check it year-over-year so it might have to do with just the timing of something full year with the acquisitions or something.

From a Channel One perspective obviously we’re extremely pleased with the performance. The team is fantastic; great leadership; obviously they’re at or ahead of our expectations at this point in its cycle. Having said that, we are years away from capacity. There is still $40 million to $50 million plus in capacity that we know is an opportunity over the years to come with good quality partners to advertise with. We’re nowhere near it. It’s running a nice profitable small segment for us. Obviously with some continued investment and sales force focus, we think that’ll just continue to grow over time.

[Russ Sylvestry - Skaritane Capital]

Who were some of the specific advertisers?

Matthew C. Diamond

We don’t disclose the specific advertisers but we’ve given segments. Government continues to be a very strong segment for us from everything from anti-smoking to education programming, etc. Entertainment continues to be a strong category as well from gaming to movies, etc. Health and beauty aids are a strong partner from acne to other products for young people. Those are probably your biggest core categories and they continue to be strong.

Joseph D. Frehe

On the stock-based compensation it looks like we’re running about 10% ahead of last year. There’s nothing that really stands out. We do issue restricted shares to the executives and the key members of the team as well. We did do a true-up on an acquisition last year so that’s increasing our cost a little bit this year.

Operator

Our next question comes from Steven Martin - Slater Capital.

Steven Martin - Slater Capital

Channel One just to follow up on some of the last questioner. I know you don’t want to break it out separately, but is there some metric or some metrics that you can give us so that we can see the progress you’ve made in terms of I don’t know booked minutes or price per minute or something like that looking forward?

Matthew C. Diamond

That’s a valid question and we’ll have to think about that. We’re not prepared to do that on this call but potentially going forward there might be some metrics that we can do just to show and maybe as it relates to the last question sell-through rates, etc. Bookings for the year, as the business matures, up front, things like that. I guess the biggest sensitivity in part is we want to make sure it’s a valid metric because it’s going to be growing pretty rapidly so we want to make sure we’re comparing apples-to-apples. But let us think about it and it’s a valid request.

Steven Martin - Slater Capital

In that regard when you look out in Channel One, how much of it is sort of booked out versus I call it spot market or at once?

Matthew C. Diamond

To date the majority has obviously been spot market largely because we missed just to the timing of the acquisition most upfront potential really for certainly the ‘07/’08 school year and even part of the ‘08/’09 school year. I think we would say that the goal would be 50+% can be upfront and we’re not too far from that now. So I think that bar will be raised and that’s one of the metrics probably that we can share and disclose and track.

But again I’m hesitant or sensitive because I want to make sure it’s a maturing number as opposed to one that’s just going to be volatile and bounce all over the place. Because you’re still not dealing with huge numbers. It is going up and particularly relative to other parts of our media business it’s the most upfront booked business. You compare that to interactive which is so month-to-month it’s certainly a good upfront business.

Steven Martin - Slater Capital

Cap ex, where do you stand on Channel One and is there anything you can tell us about the new programming partnerships and how it’s being received?

Matthew C. Diamond

I’ll address the second and Joe you can address the cap ex. We have a close partnership with NBC on the content side. We continue to talk to them about the next phase of the relationship either with them or we are open to other potential partners. We know having gone through this process two years ago that the interest and demand from other media companies is very high. I guess it’s safe to say at this point we’re very close with NBC but when the relationship ends a year and a half from now we’ll either renew it with NBC or with another partner. We’re confident in one of those options.

Joseph D. Frehe

From a cap ex perspective we don’t expect anything significant but we will have new schools that we add to the network. That’s probably $1 million to $2 million on an annual basis at this point.

Steven Martin - Slater Capital

Matt, you haven’t said very much about teen.com and the various metrics related to that on this call when in the past you’ve spent more time on it. Can you give us some idea of new partners in teen.com and new advertisers or something along those lines?

Matthew C. Diamond

To clarify just so that we don’t mislead, we’re as bullish and confident in teen.com as we’ve ever been. It was hopefully given as much attention in the script as normal. The questions haven’t revolved around it so we haven’t spent as much time on it in the Q&A. But teen.com continues to be very strong. The partnership with [inaudible] entertainment that I alluded to earlier for their content is a good partnership. Teen.com TV, so the television elements of teen.com, continue to grow in popularity and give us more opportunities for video views. I think it’s safe to say there just aren’t a lot of places on the web for teen video content and so I think teen.com is separating itself from everyone else as a destination for that.

Partners; we’re confident that we’ve got a good pipeline if we want to add new partners. We’re not aggressively adding partners because we’ve got very good traffic as it stands today. Adding partners doesn’t necessarily get you anything so long as you have the traffic to grow your ads, which is where we are today. I think over the course of the next six months we want to sustain the traffic level that we’re at, watch the ad market closely; clearly if the ad market online strengthens, then we’ll have the ability to just add partners.

I will say that we did add a small acquisition last week. We purchased the assets of gurl.com which was an NBC property that we represented and NBC felt was a better home with us and we agreed. For a small amount that we didn’t disclose but was less than $1 million we were able to purchase that property which is sort of a win-win because it’s a solid property that we can add to the teen.com ownership side of the site and you don’t share the rev share with that partner. It’s pretty quick ROI for us and a good site to not just add to the network because it was already on the network but add to the ownership side of the network.

Steven Martin - Slater Capital

You talked a lot again last call about the book of logs and some of the other things you’re doing on the media side. Three months later, what kind of progress have you made?

Matthew C. Diamond

Good progress. It’s one of those things in the entertainment world that things don’t happen overnight. In fact I expect the changes to happen over years really because it’s about the content and the ownership of that content.

So the key for us at this stage and the progress that we need to make at this stage is the development of that content and the negotiation of ownership rights as they go into other mediums; not just from the books but to the web series to television or movies; and at this point we’re working with a consulting partner that’s helping us significantly. We’re working with all the studios as we always have but we’re able to negotiate better deals. And then we have the added benefit as I’ve mentioned a couple times on the web series.

I would say very good solid progress but at the same time the change isn’t going to take place overnight because these are long-dated deals.

Steven Martin - Slater Capital

With respect to entertainment, what does it look like next year whether you have pilots in development, movies, what’s in the backlog?

Matthew C. Diamond

There’s about three to five I believe that are being pitched now. This is sort of our pitch season so we won’t’ know for three to six months. We hear oftentimes around April or May. It’s not as significant say as Gossip Girl, Sisterhood or the Clique and the big group from the last 18 months but it’s still a good group.

And keep in mind with the shift in strategy we’re not going to be as aggressive with some of those properties to Hollywood because we want to maintain ownership in other mediums. So again to be very specific we could have a property that we would normally be able to get a licensing deal from. For ’09 we may choose to not get that licensing deal, put it on the web, generate ad revenue from it on the web, maintain ownership and then do a partnership or licensing deal or something when the property has more strength.

Keep in mind we look forward to the leverage we’ve got and taking advantage of those properties a little bit longer than we have in the past.

Operator

There are no questions at this time.

Matthew C. Diamond

Thank you very much. We look forward to reporting our year-end results in April as we report our fourth quarter and 2008 final results. Thank you.

Operator

This concludes today’s conference. You may now disconnect.

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