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Executives

Andrew Greenebaum – Investor Relations

Bob Brisco – Chief Executive Officer

Scott Friedman – Chief Financial Officer

Analysts

Christa Quarles – Thomas Weisel Partners

Youssef Squali – Jefferies & Co.

Yun Kim – Wedbush Morgan

Internet Brands Inc. (INET) Q4 2008 Earnings Call February 24, 2009 4:30 PM ET

Operator

Welcome to the Internet Brands fourth quarter 2008 earnings conference call. (Operator Instructions). There is a replay of this conference available today. The phone number is 303-590-3030 or 1-800-406-7325 followed by access code of 3970888. This conference is being recorded today, Tuesday, February 24, 2009. I would now like to turn the conference over to Andrew Greenebaum. Please go ahead, sir.

Andrew Greenebaum

Welcome to Internet Brands fourth quarter and fiscal 2008 conference call. By now everyone should have access to the fourth quarter and year end 2008 earnings release, which went out today at 4:00 pm Eastern Time. If you have not received a release, it's available on the Investor Relations portion of Internet Brands website at www.internetbrands.com by clicking on the Investor tab. This call is being webcast and it is available for replay.

Before we begin today, we'd like to remind everyone that the prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance therefore undue reliance should not be placed on them. We refer all of you to the risk factors contained in Internet Brands latest Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission for a more detailed discussion of the factors which could cause actual results to differ materially, as well as third quarter results filed on Form 10-Q.

And with that, I’ll turn the call over to Bob Brisco, Chief Executive Officer.

Bob Brisco

Internet Brands had a strong fourth quarter setting records for revenue EBITDA and operating income. The quarter was a nice ending to our first year as a public company. As you know, the economic environment was far more challenging that any of us imagined. Despite that, we met our 2008 guidance from a year ago without any revision.

We grew adjusted EBITDA by 26%. We grew our website traffic, as measured by unique visitors, by 68%. So this suggests two rather obvious questions, one, do you mostly expect this to continue? And two, what is it that you are doing to have your performance hold up in spite of the economy? The answers are yes we do, and let me explain. There are four factors that help us.

First, our revenues are increasingly diversified. While some sectors, such as new car sales, had been significantly and negatively impacted, other segments had been countercyclical. These segments include areas such as apartment rentals, do it yourself home repair, used cars, and most importantly shopping discounts and deals. Our new shopping segment was a significant contributor in the fourth quarter and that trend has continued into the new year.

Second, in addition to diversification, we also benefit from the fact that many of our websites, particularly ones we’ve acquired more recently, remain under monetized. Our teams are rapidly improving monetization. Revenues on a same store basis increased 13% in the fourth quarter and this trend is continuing and even accelerating in some cases.

Third, the vast majority of our advertising revenues are performance-based and we’ve benefited from strong performance. These types of ad programs with measurable ROIs are the least vulnerable to downturns.

Fourth and finally, in addition to revenues we are rapidly increasing traffic to many of our websites. Over time growing traffic equates to growing revenues. We believe we will grow EBITDA in spite of what we expect to be an exceptionally difficult year for the economy. We are guiding adjusted EBITDA growth in the range of 10% to 15% for the year.

The guidance includes our organic growth and some acquisitions, although our acquisition investment rate is moderating. I’ll say more about that in a moment. Our expected organic EBITDA growth of 10% to 15% is a result of more traffic and better yield from our website advertising business offset by anticipated further declines in automotive e-commerce.

Our auto e-commerce business is suffering with the sector overall including a bit of a slow start for the year. Now, though, auto e-commerce represents only approximately 15% of EBITDA. Stepping back, the shift of our business mix towards high margin advertising is resulting in a structurally higher margin business. Our Q4 adjusted EBIDA margin was a record 36% and we expect 2009 full year margins to be similar.

Turning now to acquisitions, in the second half of 2009 we deliberately slowed our investment rate in response to the financial market crises. We have since seen market valuations for targets considerably decline and we expect them to stay that way. We’ve done six acquisitions in Q4 and Q1 for a total outlay of less than $4 million. We intend to remain acquisitive but we will spend less since the average deal size is declining the result of reduced pricing.

We are also now of the view that our investment paid for acquisitions will further moderate in future years. The reason for this is that the early success of our organic growth initiative suggests that we should be able to extend our platform using smaller assets. Exceptions to this might be a few anchor properties as we continue to enter new verticals.

Our overall confidence about our website business in 2009 comes from the results we are seeing in same store sales and traffic growth. We are simply getting better about harnessing the power of the platform that we have built. We are getting better at managing content, better at maximizing yield and better at managing growth.

Before we turn to Scott with the financials I will wrap up my comments with how we are feeling and what we are thinking about the business overall. It is clearly impossible to predict how 2009 will play out in the economy overall and it’s difficult to know exactly what that will mean or not mean to Internet Brands.

But we remain excited about the business and view 2009 as a big opportunity to not only strengthen the company, but to grow our website and to accelerate our organic growth. Though challenged in some sectors, the 2009 growth of our bottom line has not been derailed by the economy, nor will we let it be. We are not waiting for an economic recovery. In fact, we are not planning on one at all.

This environment may or may not be “the new normal” but we are acting like it is. We are focusing on the many levers that work in our business in any economic climate namely growing our internet audiences, delivering accountable results to advertisers and building a highly scalable business platform. I’m very proud of how our company is responding to this climate and I know the best remains ahead.

Scott?

Scott Friedman

Now turning to our financial results, total revenues for the quarter increased 8% to $27 million from $24.9 million in the prior year period. This increase is comprised of a 10% increase from our consumer internet division and a 4% increase from our licensing division. Within our consumer internet division, our revenue mix continues to shift towards higher margin advertising revenues and away from lower margin automotive e-commerce revenues.

This is particularly evident in revenues from auto dealers, which have declined. Offsetting this trend has been strong growth of advertising revenues from our other websites and, as Bob mentioned, significant contribution during the fourth quarter came for our shopping websites. Net income attributable to common shareholders for the fourth quarter of 2008 was $3.1 million or $0.07 per diluted common share.

This is compared to net income of $2.8 million or $0.06 per diluted common share in the prior year period. Adjusted EBITDA, which we define as earnings before interest, taxes, depreciation and amortization, and excluding stock-based compensation, increased 29% to $9.8 million in the fourth quarter of 2008 from $7.6 million in the same period last year.

Benefiting from the mix shift in revenues I spoke of earlier, our adjusted EBITDA margin for the quarter increased to 36.3% from 30.6% in the prior year, an increase of 570 basis points. Additionally, our adjusted EBITDA margins continue to benefit from greater efficiencies from our operating and technology platforms. We expect this trend to continue in 2009.

Turning now to our full year results, revenues for the full year increased 16% to $104 million from $89.9 million in the prior year. Consumer internet revenues increased 12% to $71.6 million in 2008 from $63.7 in the prior year. Similar to our fourth quarter results, the increase in advertising revenues was partially offset by a reduction in e-commerce revenues from automotive dealers.

Licensing revenue increased 24% to $32.5 million in 2008 from $26.2 million in the prior year. Significant year-over-year increase is a result of strong performance from our Autodata division and organic growth from vBulletin, which the company acquired in June 2007.

Net income for the year ended 2008 was $11.6 million or $0.26 per diluted common share, compared to net income of $311,000 or $0.01 per diluted common share in the prior year.

For the year ended December 31, 2008, adjusted EBITDA grew by 26% to $35.3 million from $28.1 million in the prior year. We are especially pleased that despite the challenging economic environment in which we continue to operate, we delivered adjusted EBITDA in line with the guidance provided.

Now turning to the balance sheet, we ended 2008 with $57.4 million in cash and investments with no outstanding debt under our $35 million revolving line of credit. During the fourth quarter, we acquired four websites in the consumer internet segment for an aggregate purchase price of $2.8 million.

For the year ended December 31, 2008, we completed 29 website related acquisitions for an aggregate purchase price of $62.6 million. To date in 2009, we have completed two small acquisitions and anticipate announcing a new vertical by the end of the first quarter.

Now turning to guidance, as Bob discussed, we are guiding 2009 adjusted EBITDA growth of 10% to 15% over 2008. Factored into this guidance is the expectation of a difficult economic climate throughout the entire year. In terms of revenues we're guiding as follows, we expect our revenue growth rate to be somewhat lower than our EBITDA growth rate due to the mix shift toward higher margin advertising revenue.

In addition to market factors affecting our revenue mix, as you would expect, the company is purposely prioritizing resources and capital to the higher margin lines of business. We are entirely focused on driving EBITDA and free cash flow improvements year-over-year, and we hold ourselves accountable to these metrics internally.

We expect continued EBITDA margin growth, not only in 2009, but in future years as we gain additional leverage from our operating platform. Regarding quarterly EBITDA guidance, we will point you to the analysts who cover Internet Brands. On an apples-to-apples and year-over-year basis, we expect EBITDA growth in all four quarters.

Now we are ready to take any questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first call comes from Christa Quarles – Thomas Weisel Partners.

Christa Quarles – Thomas Weisel Partners

The first question would be I think you indicated the auto e-commerce was 15% of EBITDA. I'm assuming that was for the fourth quarter. I was wondering if you could give us a sense as to what you think it would be represent as a percentage of EBITDA for ‘09.

And then in terms of the two acquisitions post the end of the quarter, I was just wondering if you could give us a flavor as to the industry verticals that they're in, and then I have a follow up.

Scott Friedman

Christa, this is Scott here. I'll take the first question regarding the auto e-commerce percentage. The percentage we gave you is as of full year 2008. On a go forward basis, we're estimating that number to decline to be approximately 10% to 12% of total EBITDA.

Bob Brisco

Christa, your other question, I know you have another coming too, a follow-up. There were two very small deals. The aggregate purchase price of the two was under $1 million combined. They were both tuck-ins non-automotive and we'll be releasing the details of those either by the end of the quarter so by the end of March or just shortly thereafter.

Christa Quarles – Thomas Weisel Partners

And then my other question is just one of the four factors that I think you cited in terms of the growth was on the traffic side and in conjunction with, I guess, the lowered expectation for new acquisitions. I was just wondering if you could expand and articulate around some of the things that you're doing to augment traffic across the properties.

Bob Brisco

We're growing our properties on an organic traffic basis at even larger rates than we have historically by a combination of levers that we're pulling better than we did in the past. So those things include adding more content to sites, being more thoughtful in the user interface and the layout of those contents on the sites, better fidelity between the sites and the search engines such as Google, better linkages and traffic flow between the sites in Internet Brands portfolio, all of those things.

Our traffic is up again markedly in January over December, so we're finding that the organic growth levers that we're pulling are responding very nicely.

Christa Quarles – Thomas Weisel Partners

And did you guys give a page view number? I didn't see it in the release.

Bob Brisco

We did not. It's up same order of magnitude or more. It's actually up more than traffic was.

Scott Friedman

Yes. It's up in the neighborhood of around 90% plus.

Operator

Your next question comes from Youssef Squali – Jefferies & Co.

Youssef Squali – Jefferies & Co.

A couple of questions I guess to start. It seems like you're kind of changing your approach to growth of the business, so historically it was a little heavy on the acquisition side. It seems like your extraction enough organic now and leverage to kind of lighten up a little bit on the acquisition strategy. From a free capital perspective, can you speak to what you expect free cash flow growth in '09 to be and your need for capital going forward? And I have a follow-up.

Bob Brisco

There are a few questions there. I'll take each one in turn. Regarding the big picture of our acquisition strategy, there is a shift taking place. Since we are growing acquired assets more quickly from a traffic and monetization standpoint than before, we're finding that we're able to acquire smaller sites and spending less capital up front to get to the same business objective and financial result than we were previously.

Some of the sites we’ve acquired in the last year or so have experienced much more dramatic growth rates than our average. And these are the sites that we've spent the most time on and proven out the concept of just how quickly we can grow organically by pulling all the levers.

The results of that, is that our acquisition spending, which we had originally guided to be in the $20 million a quarter range, we've been guiding that since we went public in late 2007, is declining. The new guidance we would offer would be roughly half of that per quarter on average maybe just a little bit more than that. We have a few earn-outs that would add a point or two, or two and a half points to that.

But we guide in that range, $10 to $12 million a quarter for 2009. Looking out further into 2010, we'd expect that to stay at the new more moderate level, possibly even lower. It's premature for us to comment too much out into 2010 without breaking out a crystal ball.

However we're feeling that we're covering an increasing amount number of the verticals that we want to cover ultimately. And as our footprint gets bigger across those, we're able to do smaller deals that are essentially tuck-ins around some of the anchor properties we have.

Then turning to the third part of your question, which was about free cash flow. We would expect that our cash position will remain strong through the end of the year. We have no intention of using the credit line, though it’s in place. We don’t currently see a scenario where we would draw upon that.

Further we expect the level of acquisitions investment rate to decline to be inside of the free cash flow level relatively soon, meaning much sooner than we thought. So I would expect those lines to cross somewhere at this point in 2010, all else equal. Of course, if we see something that’s incredibly acquisitive and a little lumpier we might do it, but that’s not currently in the plan or the path we’re on.

We’re seeing even lower prices than we saw before in the market place and we’re able to drive the returns of those assets up higher than we’ve seen before. So those are the adjustments we made. I wouldn’t characterize it as a new strategy, but I would characterize it as a significant refinement to what we were doing before based on our results and our learning’s today.

Youssef Squali – Jeffries & Co.

Then I think the guidance you gave on the revenue was that it would grow kind of sub 10% to 15%, so out of the leverage that you see in the model then, where would you see that leverage coming out of? Do you expect it mostly on the OpEx line or gross margin line? Because if I look at your G&A, your G&A actually went in the other direction this past quarter, so I’m trying to get a sense of where you’d see the improving leverage in ’09.

Bob Brisco

You’ll see it in both the gross margin line and in the other operating expenses declining and it has to do with the mix shift. As our advertising business grows faster than other parts of the business, the incremental flow through on those lines is very high. There is deminimus cost of sale against those lines and the flow through all the way down the EBIT line is much higher than our average, of the order of magnitude of double maybe our average EBITDA contribution.

Youssef Squali – Jeffries & Co.

Was there anything in the fourth quarter G&A line that came in at 13.6% that may have inflated that number a little bit, because it’s up year-on-year and sequentially?

Scott Friedman

I think part of it for the year, and actually for the quarter is some of it pertained to being public company related costs, so there is a bit higher cost there. There’s also probably a bit more, as we’ve added a lot more sites, a little bit more addition to bad debt expense.

Bob Brisco

On the first part of Scott’s response, we only had a partial quarter of public company costs in the year ago quarter and this year we had a full quarter of that. We’ll dig into that some more, but nothing else leaps to mind of any cost pressure that we’re feeling that’s going to drive that up in any way going forward.

Youssef Squali – Jeffries & Co.

And lastly, how do you look at seasonality of the business throughout the year? Is there any reason to believe that they it would be different than what we’ve seen in ’08?

Bob Brisco

There is no significant change year-over-year. There’s a little bit of category mix and emphasis so as automotives become a bit less of our overall mix, that category tends to be softer in both Q4 and Q1 and shopping becomes stronger, and as we mentioned, the shopping assets performed very well in Q4. That tends to be more fourth quarter as the peak.

Having said that and this won’t shock you, in this economy our shopping sites are way up on a same store sales basis year-over-year and it’s because of the focus of those sites. It’s about deals and discounts and coupons and all that has a very large growth rate. So I know Scott works with all the folks who follow us to fine-tune thinking about quarter, so we may have some more to say about that to you all. But there’s nothing too dramatic there?

Operator

Your next question comes from Yun Kim – Wedbush Morgan.

Yun Kim – Wedbush Morgan

Can you just give us some flavor around your exposure to the auto vertical in your license business and what can we expect around that for the year?

Scott Friedman

Autodata, which is our licensing business in that segment, had a record year again in 2008 with significant year-over-year growth. They have grown each and every year of the last nine years that we’ve been fortunate enough to have that terrific business in our portfolio and working with Internet Brands.

For 2009, and I think your question gets to this we’ve obviously taken a close look at what the trouble in the manufacturing sector in automotive might mean to Autodata, so far, so good. We’ve had no contract cancellations of anything material and our pipeline in that business is as large, or larger, than it’s ever been.

Nonetheless, we budgeted the business carefully this year. As you would expect, the decision making process for green-lighting new projects is taking longer than it did previously, so it’s hard to know exactly when you’re going to get the growth kicking in from new projects in your pipeline. So that’s something we’ll update you on through the year.

We think we budgeted anticipating it being very soggy. It’s possible that it accelerates a bit as the projects move through the pipeline and get green-lighted. But we’ve taken a cautious approach to that and left that business much more flat, in fact virtually flat in the way we budgeted it compared to prior years when we expected growth heading into the year.

Yun Kim – Wedbush Morgan

With the shift towards more performance-based advertising, like you said, is your advertiser base changing? For instance, are you doing more business with the third party vendors, or region vendors or middle men rather than dealing directly with the end companies, and has this focus on performance-based advertising changing the overall visibility in your revenue?

Scott Friedman

So a two part question, on the first part, our advertising revenues are still direct sold for a vast majority of that revenue line, so we would guide you that 75% to 80% of our advertising revenue is direct sold. The balance of 20% to 25% would be through ad networks and affiliates and various other advertising partners. The non-direct sold, the other group, is up about 5% over the last 12 months, so there’s been a slight expansion in the contribution of that piece of our business.

You do have cross-cutting currents there. As we move into new verticals, we often begin by using advertising networks, and sometimes as we get to larger scale inside of those networks, we reach a tipping point where it makes a lot more sense to do the advertising sales ourselves, or at least a portion of those sales ourselves.

So I would still guide you in that range of probably the 75% range for the longer term because our business dynamics are that the ad networks represent a really terrific floor of monetization, but in a lot of places we’re able to do better through direct sales.

Bob Brisco

You were asking about the accountability of those ads and how they perform in visibility forward. I wouldn’t say that our visibility is diminished by that piece growing. We’ve got about 40,000 direct advertisers now, so the diversification of that is huge.

If one sector or one pocket is down, the likelihood is that something else is up more is quite high, and on the ad network piece, sort of the same thing. The pool of advertisers coming through our ad network channels, from Google to a Commission Junction and on and on. We use about 30 or 40 networks in total.

The pool is very deep such that if an advertiser or set of advertisers fall away, there is usually somebody either standing in that category or related category at a bid that’s very close to the prior bid. So we find those lines of business quite forecastable for us.

Yun Kim – Wedbush Morgan

Then on the operating expenses, it looks like the technology and product development and sales and marketing came in much lower than expected. Is this kind of a new base level going forward or do you adjust to the uncertainty out there or were there some one-time items in the quarter that we should adjust for in our model?

Scott Friedman

Yun, Scott here. There are no one-time items here. We do expect these items in the way we’re budgeting is to have them probably go up slightly year-over-year as we grow out our website communities we expect that these lines will steadily increase but we do get a lot of leverage across our multiple verticals.

So I think it was slightly down I think just for general cost cutting measures just keeping things down in the quarter, but year-over-year we’re projecting slight increases probably in the 0% to 5% range on those line items.

Bob Brisco

We’re talking in absolute numbers.

Yun Kim – Wedbush Morgan

Scott, also on the balance sheet, can you just talk about what drove the accounts receivable down in the quarter and then also saw that deferred revenue went down sequentially if you can explain that as well.

Scott Friedman

On the accounts receivable side, most of that comes from collections from our Autodata business. We’ve been very diligent about collections from the OEMs and have been successful there.

Yun Kim – Wedbush Morgan

What about the sequential decline in deferred revenue?

Scott Friedman

In the deferred revenue, I think this is just a change in less revenues from some of our subscription-related sites.

Yun Kim – Wedbush Morgan

It doesn’t have anything to do with the Autodata business?

Scott Friedman

No.

Operator

There are no further questions at this time. I would like to turn the conference over to Bob Brisco for closing comments.

Bob Brisco

I just want to thank everyone for attending today. I’ll wrap it up on this note. We feel very good about the way we ended up 2008 and we also feel very good about where the business is going. Two thousand nine should be a good up year for us on the bottom line and we expect to see some acceleration as our new plans come to fruition. Thanks again everyone for being with us.

Operator

Ladies and gentlemen, this concludes the Internet Brands fourth quarter 2008 earnings conference call. Thank you for your participation. You may now disconnect.

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