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aQuantive, Inc., (AQNT)

Q2 2006 Earnings Conference Call

August 1, 2006, 4:30 pm ET

Executives

Brian McAndrews - President and Chief Executive Officer

Wayne Wisehart - Chief Financial Officer

Bren Hoover - IR

Analysts

Richard Ingrassia - Roth Capital Partners

Lee Westerfield - BMO Capital

Stewart Barry – ThinkEquity

Ben Schachter - UBS

Youssef Squali - Jefferies

Christa Sober Quarles - Thomas Weisel Partners

Imran Khan - JP Morgan

Hester Chang - Merrill Lynch

Richard Fetyko - Merriman Curhan Ford

Chad Bartley - Pacific Crest

Marianne Wolk – Susquehanna

Jordan Rohan – RBC

Presentation

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2006 aQuantive Incorporated earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's conference, Ms. Bren Hoover. Please proceed, ma'am.

Bren Hoover

Hello and thank you for joining aQuantive's second quarter conference call. This is Bren Hoover, aQuantive's Investor Relations Director and with me are Brian McAndrews, President and CEO; and Wayne Wisehart, CFO.

The following remarks contain statements that are forward-looking, including statements about our expectations or projections regarding future results and plans for the business. It is important to remember that our actual results may differ materially from our expectations, projections or plans. A complete list of additional factors that may affect our business, future operating results, and financial conditions is in the risk factors and other sections of our SEC filings. Now Brian will provide an overview.

Brian Andrews

Thank you, Bren. I am pleased to report that aQuantive has completed another very strong quarter. Overall revenues for Q2 was $105.6 million, an increase of 37% over the same period in 2005. Adjusted EBITDA grew 63% to $28.8 million and net income increased 59% to $12.3 million, after including the impact of stock-based compensation expense. Before stock-based compensation expense, net income grew 97% year-over-year to $15.3 million. Organic revenue growth for the quarter was a very robust 29%.

This continued growth caused all of our business units is coming from existing clients as well as new clients, domestically as well as internationally. In the quarter our international business represented 20% of consolidated revenue. To help manage this international expansion, we recently made a key organizational change. Effective today, the role of DRIVEpm President Scott Howe is expanding to oversee the international operations of our digital performance media and digital performance, digital marketing technology segments.

In addition to experiencing strong organic growth, we continue to pursue strategic acquisitions, putting to productive use the funds raised in our recent follow-on equity offering. Since the end of the first quarter, we acquired franchise lead generation company Franchise Gator to help accelerate our performance media business growth.

Within the last week, Avenue A ¦ Razorfish continued it's expansion overseas with the acquisition of Amnesia, an interactive agency in Australia. Headquartered in Sidney, Amnesia is profitable, has a strong leadership team, and serves clients such as Disney, Xbox and Ikea, and is a great cultural fit with Avenue A ¦ Razorfish.

Now I would like to discuss a few key developments in each of our business segments. The Digital Marketing Services segment, made up of Avenue A ¦ Razorfish and DNA, had revenue of $64 million in Q2, a 33% increase over Q2 of 2005. In addition to DNA's contributions, fueling this growth is both new client wins as well as new business from existing clients.

By extending its global footprint with the acquisition of Amnesia to now include the U.S., the UK and Australia, Avenue A ¦ Razorfish is better positioned to serve it's U.S.-based multi-national clients, compete more aggressively for global clients, and participate in the rapid growth of Digital Marketing in markets outside of the U.S.

Of note, one new U.S. client has already begun working with DNA in the UK, and two new U.S. client wins were aided by the fact that Avenue A ¦ Razorfish has a UK presence. We will continue to look for other opportunities to expand in Europe and Asia in the coming quarters.

In addition to geographic diversification, DMS revenue continues to be well diversified across multiple key client segments. In Q2, the revenue breakout by segment was as follows: pharmaceutical clients at 17%; financial services clients, travel and entertainment clients and telecommunication clients each came in at 15%; technology clients at 12%; retail clients at 9%; consumer packaged goods clients at 8%; and other client sectors combined represented the remaining 9% of Avenue A ¦ Razorfish's quarterly revenue.

The digital marketing technology segment, or Atlas, had revenue of $29.7 million in Q2, 32% greater than a year ago. While the majority of overall revenue comes from ad serving in the United States, the strength of the business in Europe and southeast Asia has also increased, resulting in international revenue representing 26% of the overall Atlas business.

Continuing its industry thought leadership role the Atlas Institute, the research and education arm of Atlas, recently published the result of three research studies and presented the findings at national conferences. The topics included advising digital advertisers on how to avoid the duplicate counting and conversions, how search and display advertising interact to improve results necessitating measurement across channels, and finally, how the brand exposure duration metric can be used to measure the effectiveness of online video.

The Atlas strategy of providing the industry's first integrated offering of ad-serving search, rich media and site optimization, is winning in the marketplace as Atlas continues its strong sales momentum. With this expanded offering plus the prospect of playing a key role in the emerging media technologies areas, such as video on demand, comes the need for significant investments in technology and customer support.

As Wayne will discuss further in our section on guidance, we do plan to increase our investments in these areas in the second half of the year. We are very pleased with our progress and market position at Atlas, however, we remain vigilant in our determination to innovate ahead of the competition.

The Digital Performance Media segment consisting of DRIVEpm, MediaBrokers and Franchise Gator, had revenue of $11.9 million in Q2, 84% greater than Q2 of 2005. Our UK-based business represented 53% of the second quarter segment revenue. Both DRIVEpm and MediaBrokers benefit greatly from the ongoing investments in Atlas technology, including increased sophistication and customer targeting, and back end analytics and reporting. Thus our increased investments in Atlas technology are designed to help support the strong growth and potential of these businesses as well.

We are pleased that the Franchise Gator team is integrating well with the aQuantive family. We are beginning to combine aQuantive's extensive experience in media and website design with Franchise Gator's lead generation expertise in the franchise industry to leverage new pay for performance growth. We believe Franchise Gator provides another avenue into a large and growing market, and may offer additional means to monetize our existing capability.

Now I'd like to turn the call over to Wayne to talk about the quarter's financial results in greater detail.

Wayne Wisehart

Thanks, Brian. Looking at the second quarter, revenue of $105.6 million represented total revenue growth of 37% over the second quarter of 2005. Each of the businesses had notable organic growth in the second quarter. Operating income during the second quarter was $17.9 million, including the $4.9 million in stock-based compensation expense, resulting in an operating margin of 17%.

For comparability, before the stock-based compensation expense, operating income increased 71% to $22.8 million or an operating margin of 22% versus $13.3 million in Q2 of 2005.

Net income was $12.3 million in the second quarter, or $0.15 per diluted share, compared to net income of $7.8 million or $0.11 per diluted share in Q2 of 2005. Net income before stock-based compensation was $15.3 million or $0.18 per diluted share in the second quarter.

Adjusted EBITDA, or EBITDA excluding the $4.9 million in stock-based compensation expense was $28.8 million or $0.33 per diluted share. On an adjusted basis, EBITDA increased by 63% year-over-year. The effective GAAP income tax rate was 41% in the second quarter. We expect the effective tax rate to be 40% in 2006. AQuantive's CapEx was $5.5 million in the second quarter.

We ended the quarter with $307.6 million in cash and short-term investments. This is an increase of about 14% or $36.6 million above our cash balance at the end of Q1. The quarter end cash included the impact of the sale of an additional $26 million in equity in the over-allotment granted to underwriters as a part of our offering process and the cash purchase of Franchise Gator. Quarter end cash balances are subject to significant swings due to variances in the timing of collections and disbursements on our receivables and payables.

Our days sales outstanding in accounts receivable for Q2 was 80 days. Unbilled accounts receivable was $11 million for the quarter, down from $16 million in Q1 2006. These accounts relate to our web development projects. We expect these accounts to fluctuate from quarter to quarter due to many variables, including the overall number of contracts, the overall number of projects within each contract, the timing of when contracts are signed, the progress of the projects, and the timing of invoicing.

The revenue related to these contracts is recognized in strict accordance with GAAP and has not changed. Revenue derived from fixed-price contracts is recognized on a percentage of completion basis. Revenues derived from time and materials contracts is recognized as the services are performed. Under these rules, revenue is frequently recognized prior to the generation of invoices, resulting in unbilled accounts receivable.

Now I'll review performance during the quarter by business segment. Digital Marketing Services, including Avenue A ¦ Razorfish and DNA, contributed revenue of $64.1 million in Q2, up 33% year-over-year. Operating income of $12.9 million increased by 80% over the second quarter of 2005, representing an operating margin of 20%. As of June 30th, 2006, Avenue A ¦ Razorfish employed 1,160 people, an increase of 32% over the same period in 2005.

Digital Marketing Technologies, the Atlas business, contributed revenue of $29.7 million in Q2, up 32% year-over-year. Operating income of $12.6 million increased by 26% over the second quarter of 2005, representing an operating margin of 43%. As of June 30, Atlas employed 313 people, an increase of 33% over the same period last year.

Digital Performance Media, including DRIVEpm and MediaBrokers and now Franchise Gator, contributed revenue of $11.9 million in Q2, up 84% year-over-year. Six weeks of revenue contribution from Franchise Gator, which closed May 16th, was not material to the second quarter.

Operating income of $2.6 million increased by 130% over the second quarter of 2005, representing an operating margin of 22%. As of June 30, DPM employed 62 people, an increase of 72% over the same period in 2005.

Now I'll spend a few minutes discussing our outlook for the year. Our outstanding financial performance in the first half of 2006 enables us to take advantage of great investment opportunities through external expansion as well as internal development; while at the same time, continuing to deliver good financial results.

During the second half of this year, we plan to invest more aggressively in our various technology businesses, including Rich Media, Atlas Search, Atlas on Demand, and other new product developments. In addition, Atlas Europe and MediaBrokers are expanding in Europe.

We are convinced these are wise investments that will provide handsome returns in future years. These investments are balanced, of course, with our desire to continue to provide good current returns to our shareholders. Accordingly, for the full year, we anticipate revenue in the range of $420 million to $430 million, which includes revenue from acquisitions made to date.

GAAP net income, which includes the impact of FAS 123 R is projected to be in the range of $0.54 to $0.58 with net income before stock-based compensation in the range of $0.67 to $0.71 per diluted share for the year. Adjusted EBITDA is projected to be in the range of $1.28 to $1.33 per diluted share for the year.

For Q3, we anticipate revenue of $110 million to $114 million with net income in the range of $0.14 to $0.16 per diluted share. Net income before stock-based compensation of $0.17 to $0.20 per diluted share, and adjusted EBITDA of $0.33 to $0.36 per diluted share.

Our guidance is based on an average diluted share count of 86.4 million shares for the full year and 88.5 million shares for the third quarter. We forecast full year CapEx in the range of $18 million to $22 million.

With that I'll return the call to Brian.

Brian Andrews

Thanks, Wayne. This success of aQuantive’s business units has been driven by talented people working with great clients, combined with our ability to make investments in people, technology and M&A in order to remain on the forefront of industry growth and innovation. As we enter the second half of 2006 and look to the future, we are enthusiastic about the strong growth prospects of the digital marketing industry.

Further, because of our current capabilities and the prudent investments we're making in new capabilities, we also remain bullish about aQuantive's ability to continue to grow faster than the market.

And now we're happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)Your first question comes from the line of Richard Ingrassia - Roth Capital Partners.

Richard Ingrassia - Roth Capital Partners

Thanks, good afternoon everybody.

Brian McAndrews

Hi Rich.

Richard Ingrassia - Roth Capital Partners

Brian can you say a little more about the financial impact of the business investments you plan to make in the second half? Will you be using cash, drawing down cash to make investments or will we see it more on a margin impact?

Wayne Wisehart

Richard let me take a shot at that first. Actually, most of these investments internally will be the addition of additional people, development folks and those would be generally just paid from the operations of the business. While I expect there would be some impact to the margin, as you can tell, these are principally in the Atlas division.

There probably will be some impact to the margin which in this quarters as you know, is 43%, but I still expect for the rest of the year to deliver a very healthy margin for the Atlas business, probably something in the lower 40s.

Richard Ingrassia - Roth Capital Partners

Okay, and then related to the cash then Wayne in general are you looking to make the kind of acquisitions you made with Amnesia as in you’re looking for creative assets as oppose to technology assets?

Brian McAndrews

Rich, we’re looking for both, I mean depending on what the opportunities are. I think right now we do see a real opportunity in growing geographically for Avenue A ¦ Razorfish business. So, we have invested in that with DNA last year and Amnesia this year and we expect that to continue. On the capabilities technology front you know, we always are looking to enhance capabilities for our clients. I think we feel the bulk of that will be done by our own internal investments and that is part of what Wayne was just referring to in what we are investing. But if we do see opportunities we certainly, as we have in the past, we’ll also make purchases if it makes sense as a way of accelerating capabilities for our clients.

Richard Ingrassia - Roth Capital Partners

Part of the question is that there seems to be an awful lot of opportunity in the CPG segment going forward this year and would you identify that as a vertical where you can build your resources?

Brian McAndrews

I think we see opportunity there, we have seen that area grow for us and I would agree with you that is an area of opportunity. But I think that in terms of working with CPGs from the Avenue A ¦ Razorfish side, we’ll certainly continue to invest in technology enhancements and our website design development work. So we’re always investing in that respect, but I don’t feel that we need to make any particular acquisitions in order to serve the CPG companies well. We feel like we can do that extremely well right now.

Richard Ingrassia - Roth Capital Partners

Okay. Thank you.

Brian McAndrews

Sure, thanks Richard.

Operator

Your next question comes from the line of Lee Westerfield - BMO Capital Markets. Please proceed.

Lee Westerfield - BMO Capital

Thank you and good afternoon everyone. I just have two quick questions. The first is when I look into Europe, if you could comment on DoubleClick’s moves in Germany and how does it shape your decisions about other maneuvers in Europe, as you looked at acquisitions there?

Secondly, if you could elaborate on Avenue A ¦ Razorfish in the United States about any recent client wins that we should be attuned to? Thank you.

Brian McAndrews

Sure, Lee on the European front DoubleClick acquired Falk in Germany and Falk was the leading publisher side ad serving system in Germany; also did some buy side ad serving, really the main presence in Germany. From our standpoint, it was arguably a good move for DoubleClick it didn’t really have any negative impact on us. In fact, you could argue that it simply eliminated a competitor as we expand in other parts of Europe; but certainly in Germany, a potential competitor was eliminated for us, so we see it as a good thing for us.

Our growth we expect to be primarily organic in Europe in our technology side of the business in the Atlas and MediaBrokers side, not to say we wouldn’t make acquisitions but we do think our growth so far has come from one acquisition we made a couple of years ago with Technology Brokers and MediaBrokers. We believe there is real potential to grow that business. We’ve already seen some growth outside of the UK and we think there is opportunity there. We wouldn’t rule out acquisitions, but that’s probably not our primary opportunity there.

In terms of Avenue A ¦ Razorfish, we have not announced any wins lately. We certainly do continue to win clients but we don't always have permission to announce them. We win clients with our total offering in terms of our website design, web media. We sometimes of course are continuing to cross-sell where we have web media clients that we are now doing creative for or development clients we are now doing media for. So we haven’t really announced anything in terms of new clients wins this quarter.

Lee Westerfield - BMO Capital

Well, that’s fair. Thank you very much.

Brian McAndrews

Thank you.

Operator

Your next question comes from the line of Stewart Barry - ThinkEquity.

Stewart Barry - ThinkEquity Partners

Good afternoon and congratulations. Brian, what does the recent acquisitions of Amnesia give aQuantive in opportunity or beachhead into the Asia market?

Brian McAndrews

You know, Stewart, I think it does in the sense that Amnesia does service some clients in Japan and certainly being in Australia, even though it is a European or more culture wise, is certainly very much pointed towards that part of the world. Having said that, we also will look at other opportunities to grow beyond Amnesia in Asia. So, it is not our only move, we intend to make in the long run into Asia. But it is a good toe hold, it is a better vantage point, obviously much closer than we are day-to-day to happenings over there in terms of opportunities.

Stewart Barry - ThinkEquity Partners

Just one more question. Wayne, where is utilization now in the Avenue A ¦ Razorfish business and what’s changed in the hiring environment? Maybe this is a question for Brian as well. Is hiring becoming more competitive in the marketing services area?

Wayne Wisehart

As far as the utilization is concerned, it’s very similar to what it has been historically at about 80%.

Stewart Barry - ThinkEquity Partners

Okay.

Brian McAndrews

And in terms of hiring, Stewart, in the last year we’ve hired, we’ve run 33% in terms of people. We certainly have been hiring at a strong pace. Having said that, it is competitive, certainly more competitive than it was several years ago. We do run into challenges.

I think one of the benefits we have given the nature of our business, certainly on the agency side, is we are spread all over the country and now outside the country. So, we are not looking for people just in one geographic area but we can grow in a lot of different ways.

I wouldn’t say it’s been an at all meaningful constraint to our growth, but it is something that we invest a lot of energy and we increased our recruiting resources internally. We’ve focused them more on verticals in the Avenue A ¦ Razorfish side: creative, media, different areas of technology to try to be more efficient and we are leveraging resources across the region.

So certainly something very important that we keep an eye on. It has gotten tougher, but has not been a big challenge that has caused serious problems for us at this point.

Stewart Barry - ThinkEquity Partners

Great. Thank you very much.

Operator

Your next question comes from the line of Ben Schachter - UBS. Please proceed.

Benjamin Schachter - UBS

Congratulations on a very nice quarter. A few questions. The first one, I was wondering if we can get an update to any changes to the long-term margins you have guided to in the past, particularly DMS was 15% to 20%, DMT 35% to 40% and DPM 20% to 30%.

Is there anything, given the recent acquisitions and some of the issues you may have come across in terms of what you are seeing, that’s changing your view on build versus buy? Or changing the strategy of where you may be investing more in terms of acquisitions?

Finally, the last question, should we be looking for more acquisitions on the affiliate marketing and pay per performance side of things? Thanks.

Wayne Wisehart

On the margin I think we are leaving our guidance the same for the long-term outlook on the margins as it has been, 35% to 40% on Atlas and 15% to 20% on DMS and between 20% and 30% on Performance Media.

Brian McAndrews

Ben, on your other questions, I would say there isn’t anything significant that has changed in the environment. I mean in terms of Avenue A ¦ Razorfish, our goal is to expand the global footprint to better service our clients and take advantage of opportunities and growth in other markets. We have felt that the best way to do that is through acquisition primarily. Its not the only way to do it and certainly if there was a market that was critical to us where we didn’t feel there was a good acquisition, we wouldn’t hesitate to build it ourselves. But we do think there’s real benefit to just starting with a critical mass of people, of talent, of local talent and capabilities and clients in market, not to mention we are always looking for profitable, well-run companies. So we just build in that advantage and then can leverage our strengths with theirs. So I think that’s continuing, but again we wouldn’t avoid building ourselves if we felt that that was a necessity.

On other businesses, other technology, other areas like Atlas or DMT or DPM things are more expensive. There’s more money out there. There’s more venture capital being thrown at things. So that might make a build versus buy, make a build more attractive relatively.

Having said that, you know its not like we’ve walked away from a lot of things based on price. So I would say that is something that it certainly could be a factor, but I think what we want to do in Atlas is we do see lots of opportunities in Atlas Search and Atlas Rich Media, ultimately emerging media areas where we can do a lot by enhancing the capabilities we currently have and in that case, building just makes a lot more sense.

In Performance Media if there opportunities again to enhance that area, help our clients, we have a war chest now and we are certainly open to the appropriate acquisitions. But we don’t feel we have a hole there. We don’t feel that there’s something that we need for our clients, but we certainly will continue to be opportunistic if we see things that we think makes sense. But there’s nothing that we’d say right now we have to have.

Benjamin Schachter - UBS

Okay, congratulations again.

Brian McAndrews

Thanks Ben.

Operator

Your next question comes from the line of Youssef Squali - Jefferies. Please proceed.

Youssef Squali - Jefferies

Thank you very much. Hi Brian, hi Wayne. A couple of questions. So, first for Wayne. Could you tell us what the organic growth of the business was in the quarter? If you stripped out the acquisitions, the Gator? Amnesia didn’t really hit.

In your guidance certainly, I think you are guiding for the year to $25 million to $30 million upside from your previous guidance. Can you again strip out the acquisitions and tell us what the organic growth in guidance would be? And then I have a follow up for Brian.

Wayne Wisehart

The first question on our organic growth, 29%. Secondly on the guidance, indeed the guidance does include the acquisitions of Amnesia and Franchise Gator, and if you strip out about $1.5 million to $2 million for Amnesia and strip out about $3.5 million to $4 million for Franchise Gator, the rest would be organic. DNA would not be organic, we acquired that in Q4. I think we said DNA would be about $8 million in revenue this year, so that also has an impact, we made that acquisition in Q4.

Youssef Squali - Jefferies

Okay. But clearly, even when you add all these up there is still increase to your organic guidance.

Wayne Wisehart

Yes.

Youssef Squali - Jefferies

Second question for Brian, you talked about the increase in investment in Atlas. By my math, I think your prior CapEx called for $18 million to $20 million, now you are guiding for $20 million to $22 million, so there is not much of an increase in there, just maybe about 10%. Can you just give us little more insight into what exactly that money is going to?

Brian McAndrews

Youssef, just to be clear, I think our previous guidance was $16 million to $20 million and now it’s $18 million to $22 million.

Youssef Squali - Jefferies

I think you are right. So, from the mid point, it’s $18 million to $21 million?

Brian McAndrews

Fair enough. It’s mostly, it’s not that completely, but it’s people. I mean it is hiring developers, primarily, in different areas to accelerate development growth. It’s hiring some customer service people. I mean one of the strengths of our business at Atlas, of course, is that we have an integrated solution across rich media, search, site optimization and ad serving. But with each of those introductions, comes the need to be competitive in each of those areas with the offerings.

The integration gives us a real advantage, but we still want to make sure we have appropriate industry-leading features. So, we want to make sure that each of those areas were staffed appropriately to develop rapidly and then also support new releases or updated releases through customer support.

The other thing that Wayne mentioned in his comments is Europe, where again, we have Atlas Europe and MediaBrokers in the UK are really strong players there. But outside of the UK, our presence is not as strong, and so, we are also investing in people to continue that growth beyond. We’ve had some revenue but we want to enhance that growth beyond the UK. So, it’s primarily people base beyond the CapEx that you referred to.

Youssef Squali - Jefferies

Okay. That’s very helpful. And lastly, if I may, on Atlas continue to impress with strong growth there. Could you talk about where that growth has come primarily from, pricing versus volume? Obviously pricing has been historically weak, growth has primarily come from volume. Can you kind of tell us if you have seen any changes in the dynamics there?

Brian McAndrews

Well in terms of our growth, our growth continues to come from growing certainly a lot of existing clients spending more money, we are bringing on new clients. I think one area of growth is rich media. Well two – rich media and search. We introduced search a couple of years ago, it’s gotten a larger base so it’s not growing as fast as Rich Media, but certainly in the last year we have seen significant growth in Rich Media. Still not a huge number, but we are certainly seeing good growth there.

I would say the dynamic hasn’t changed significantly, our growth is coming from more spending in online advertising. We benefit from that; more spending in search, more spending in rich media. So it’s really all of those things, I wouldn’t say there has been any big dynamic shift.

Youssef Squali - Jefferies

Okay, great and congrats.

Brian McAndrews

Thank you.

Operator

Your next question comes from the line of Christa Sober Quarles with Thomas Weisel Partners. Please proceed.

Christa Sober Quarles - Thomas Weisel Partners

Hi. Just a follow up on the changing guidance, if I strip out all of the acquisitions as well the out-performance this quarter, it still looks like $15 million to $20 million of additional revenue. Could you highlight where you are seeing that upside and what gives you confidence in that increased outlook?

I think you said that 26% of Atlas was international. I was wondering if you could give what that percentage was for the whole year?

Wayne Wisehart

The guidance generally on additional revenue is fairly much across the board, and throughout all the business units. I don’t know that I could say that there is that much difference, I think we are looking for probably a little faster growth, relatively, from the Media Performance Group. But Atlas will continue to grow very well, as well as digital marketing services across the board. So, there isn’t any one particular unit that stands out above the rest. I am sorry, the second question?

Christa Sober Quarles - Thomas Weisel Partners

I was wondering, I think you said international was 26% of the DMT, but then I don’t know if I got it for the whole company?

Brian McAndrews

20% for the whole company.

Christa Sober Quarles - Thomas Weisel Partners

Just one more. The sales and marketing increase in DRIVEpm, was that almost all related to Franchise Gator?

Wayne Wisehart

No, it’s not all Franchise Gator.

Christa Sober Quarles - Thomas Weisel Partners

Of the increase, I meant?

Wayne Wisehart

No, it’s not all related to Franchise Gator. We are also enhancing our sales and marketing efforts in Performance Media. I think as we announced previously, we brought on Kirk McDonald, the new Head of Sales and Marketing. He is building a team there. So, there is a little bit more effort in that area.

Christa Sober Quarles - Thomas Weisel Partners

One last question on rich media, I know you are expanding the product. At what point do you think that you’ll be able to break that out, is it 2007 or ’08? Or do you plan to break it out?

Wayne Wisehart

Well, we certainly don’t plan to break it out this year. It is growing extremely fast and it is becoming a more important element of our business there. If it becomes extremely material to the operation, we’ll probably talk about it separately; but for the near future, we have no plans to break it out.

Christa Sober Quarles - Thomas Weisel Partners

Thanks guys.

Brian McAndrews

Thanks Christa.

Operator

Your next question comes from the line of Imran Khan - JP Morgan.

Imran Khan - JP Morgan

Good afternoon Brian and Wayne. Congratulations on a nice quarter. A couple of questions, first for Brian, it is a much more of a high-level question. Clearly you are highlighting international as a growth opportunity. If I look at UK, can you give us some sense about the competitive landscape? Outside UK, what do you think are some big growth opportunities, is it France or Germany or something else?

Secondly, Wayne, I am not sure if it’s the right place to bring it up, but I was looking at your EPS number. I think you said $0.15, but if you take the 12.327 and your share count I think 87.448, I am getting $0.14 and I am not sure if I am missing anything. Thanks.

Brian McAndrews

Okay. Well, let me answer the first question. In terms of European growth, where do we see the big opportunities? I think generally speaking, if we just look at what are the largest markets outside the US based on at least 2005 numbers that we have for online advertising spend and the online advertising growth rate, in Europe, UK is the largest. France and Germany, which you mentioned, both are next.

So, we are going to be opportunistic and go into the markets where there are appropriate opportunities. So we are not completely guided just by size, but clearly the biggest opportunities, in a sense, are in those markets. So, we are certainly spending energy looking at them as well as others.

In terms of competitive landscape, you know from the DMS size, it’s pretty similar to the US, traditional agencies and then smaller interactive agencies. So, it’s developed very similar to the US, probably just a little bit behind in terms of most capabilities and offerings. So I guess I would answer it that way.

Wayne Wisehart

With regard to the EPS, you need to exclude from the calculation of net income or the $12.337 million the interest expense, which applies to the convertible notes, which are converted into stock for this purpose. As a matter of fact, you need to exclude the tax affected interest and that number is about $350,000.

Imran Khan - JP Morgan

Thank you.

Brian McAndrews

Welcome.

Operator

Your next question comes from the line of Hester Chang - Merrill Lynch. Please proceed.

Hester Chang - Merrill Lynch

I was wondering if you could talk a little bit about -- I know you don’t break it out anymore -- but the growth between your media and web development business or just simply trends and what you’re seeing and what your increased guidance means in terms of these two areas?

Secondly, if you can talk about maybe some of the verticals you see really contributing to the growth that you’re anticipating?

Wayne Wisehart

Okay, let me start there. You’re right, we don’t break out web development from media, but I can tell you that there has been growth in both areas. We expect to continue to see growth in both areas. I think its probably fair to say that web development is perhaps growing a little bit faster than media, but both are growing; both are healthy and growing very well.

Brian McAndrews

In terms of sectors, our sector performance bounces around, but not huge swings from quarter-to-quarter. So, it’s hard to pull out any significant short-term trends. I think longer term to the question earlier that I got, I think that CPGs are certainly an area where we would expect to see more dollars coming online and so we would expect to participate in that.

But quarter-to-quarter, I think pharmaceuticals are up from last quarter for us, as is telecom, but again, those swings can be client specific and the quarter-to-quarter trends aren’t as meaningful as longer-term trends.

Hester Chang - Merrill Lynch

Okay. Thank you.

Operator

Your next question comes from the line of Richard Fetyko - Merriman Curhan Ford. Please proceed.

Richard Fetyko - Merriman Curhan Ford

Thanks. Hi guys, congrats on the quarter. My question is on the graphical advertising side of the business, we have seen a lot of strength, anecdotal as well as hard core numbers from Yahoo! and others that suggest the graphical advertising inventory is increasing and they see strong pipeline for the second half of the year as well. I was just wondering what segments within your business will be benefiting from that trend?

Also, secondly on the rich media side of the business, I know you have some basic solution from the acquisition of Ads Forever, but when I look at some of the leaders in the space like Point.Roll, EyeBlaster, EyeWonder and others, there's a tremendous amount of demand. The technology has come a long ways, and I feel like you guys have some basic functionality there, but perhaps do you have plans to really invest into that? Is there an acquisition perhaps that you are thinking about to bolster that offering?

And then of course we saw Double Click acquire Click Mart which takes that company into sort of a flash media video advertising space as well, which us another hot area right now, so I am wondering if you plan to address video advertising as well. Thanks.

Brian McAndrews

Sure. Richard, to start at the beginning, on the display or graphical ad side, we certainly do feel we benefit from that, but I would say that our positioning has been that we have a full service solution on the Avenue A ¦ Razorfish side, and we have an integrated technology solution on the Atlas side.

So when dollars shift between, say, search and display media, we may see shifts ourselves but we're positioned to take advantage of wherever the dollars are being spent. So we want to have tools that allow people to do what's right for their business in digital marketing, and if that's search, great. We want to be a leader in search. Display ads, we want to be a leader there. We're certainly well equipped, though, to help support our clients as they do more in display ads.

When we put out our 2006 Digital Media outlook report in Q1, that report did project that for this year, we would see an increase, relative percentage-wise, in display media versus search. We are seeing that in our clients. So that has been coming to fruition so far.

On the rich media front, on the Atlas side, we feel really good about our product. When Ads Forever was in the market, it didn't have a big presence here, but that was largely because it wasn't really supported here. It didn't have a sales force and the like, but it had good technology and it was accepted by all of the major publishers.

So when we launched, we got quick publisher acceptance, we've been enhancing the product, and we have seen significant growth, albeit off a small base. Having started last year and we've seen significant growth. So we feel very good about that and we feel very good about our ability to compete in the rich media market.

I wouldn't, again, never say never in terms of acquisitions and the like, but we certainly don't feel like we need to make any acquisitions to be competitive.

In terms of video, that's something our clients want and we are certainly going to be there, and that could be a build versus buy, too, but again, I don't feel that we need to make an acquisition to be competitive. We have great technology and a lot of our investment over the years has been in the back end analytics and reporting and support, and that's where a huge amount of the investment is and where it's a lot harder for these smaller players to really compete.

So we feel offering an integrated solution with really strong analytics and the ability to serve floating ads, we can serve streaming video, we can serve expandable banners. Being able to do all those basics, that we can be extremely competitive.

Richard Fetyko - Merriman Curhan Ford

All right. Thank you very much.

Brian McAndrews

Thank you.

Operator

Your next question comes from the line of Chad Bartley - Pacific Crest. Please proceed.

Chad Bartley - Pacific Crest

Thank you. Just hoping for a bit of a update on the Atlas on Demand initiative. If you can comment on how the initiatives are going with some of the cable operators or maybe some information on the timing of when this might contribute to revenue, et cetera?

Brian McAndrews

Sure, Chad. We have announced relationships with a number of the leading video on demand technology providers, Seachange and Seacor earlier this year. In June, we announced a relationship with Tandberg TV and in July with Concurrent and Everstream. We are working with all of these players to develop the ability to dynamically insert advertising into video on demand and then provide measurement and analytics along with that.

In terms of the offering, we're very excited about it. The market isn't in there yet, there isn’t a big financial opportunity yet. But we're in the early stages of helping define the standards and work with the leading players. We'll continue to invest in areas that we think makes sense so that we can work with clients to develop the product appropriately.

We do hope to do a pilot or two before the end of this year, of that, an actual video on demand pilot where we would actually be doing that insertion of ads. But again, there are several players here, we need to make sure we're not getting too far ahead of the market.

Chad Bartley - Pacific Crest

Okay. Appreciate it, thanks.

Operator

Your next question comes from the line of Ben Schachter - UBS. Please proceed, sir.

Ben Schachter - UBS

Just a couple of quick follow-ups. On the margin side, if we look at the long-term margins, and I know we have talked about those for quite some time, and you seem to beat them. I'm just wondering how we should think about long term versus this year? When you say long term, are you thinking '07 or is this even further out?

Another question separate, are you seeing any impact to your business from the growth of MySpace and YouTube and other sites that have a lot of this user-generated video? Thanks.

Wayne Wisehart

Let me do the margin, Ben, we are still looking at those margins as guidance not only for 2007, but for the long term as well. As the year unfolds and as we make some of these investments we've talked about, there's the possibility of revisiting that at some point in the future, but for now, we would have no changes to those.

Brian McAndrews

Ben on the MySpace, YouTube, I guess I would answer that on the short-term/long-term way as well. I'd say on the short term, there's not a huge impact on our business, one way or the other. I mean there are new opportunities to advertise and Avenue A ¦ Razorfish certainly looks at all new opportunities, and the more opportunities out there, whether they are user-generated content or different kinds, the better for us, because we act as an agent on our advertiser's behalf to help them figure out where to advertise and measure what works and what doesn't.

I would say long term, I think the user-generated video, particularly the YouTube angle and other sites that no doubt will get more into the video space, I think presents a long-term opportunity for the whole industry. It certainly helps to participate in the growth of video, as we talked about earlier.

To Richard's questions about rich media, we certainly intend to have a video offering beyond what we do now, which is video within rich media and streaming video. But we plan to have opportunities to take video advertising to the next level in terms of interactivity and the like.

So I think in the long run, the more opportunities that are out there for content that attracts people, the more opportunities there are for advertising and video will be a particularly dynamic and probably a big growth area.

Operator

Your next question comes from the line of Marianne Wolk - Susquehanna, please proceed.

Marianne Wolk - Susquehanna

Yes, I had couple of quick follow-ups. I noticed your recent acquisitions were relatively small. I was wondering if that was a strategy and a Company decision, or is it a reflection of the size of the targets available to you?

Another question, I calculate the U.S. business grew about 16% year on year, is that about roughly correct? Can you give us some guidance on the year-over-year growth rate?

Finally, thank you so much for providing the unbilled receivables information. That was very helpful. Could you just confirm that the balance is relatively current, say 90 days or less. Thank you.

Brian McAndrews

On the size of acquisitions, I would say it is driven as much by just the individual opportunity. We aren't setting goals one way or the other in terms of size of acquisition -- obviously smaller ones present less risk and arguably more upside, but we made a large one a couple of years ago, certainly large for us, in terms of Razorfish and that has paid off extremely well.

So we don't have any specific guidelines or barriers that way, but I would say when we're growing internationally, we're clearly looking for obviously independent agencies where we think we can bring some benefit to them, but that they have a big enough critical mass they can serve big clients and establish a strong business.

So those have been what the opportunities have been in the markets, and have made sense. These are also bought on earn outs, so of course the initial payment does not reflect what the ultimately payment will be for the businesses in terms of agency acquisition.

Marianne Wolk - Susquehanna

Thank you.

Wayne Wisehart

Let's see the U.S. business growth, let me just say that, again -- I guess this is little bit of a repeat here -- but the overall growth from a year ago is 37%. The organic is 29%. I don't have in front of me at the moment the numbers on just the U.S. growth. I don't have that number in front of me at the moment.

Unbilled receivables. Let me tell you about unbilled receivables. The short answer is yes, it is current. It's very current, and just as a frame of reference, let me tell you that the $16 million that was there at the end of Q1 most of that has been billed by the end of Q2. As matter of fact, at least 87% of that has been billed and/or collected since Q1. So these are fairly current balances.

Marianne Wolk - Susquehanna

Great. That's really what is important. Thank you.

Operator

Your next question comes from the line of Jordan Rohan - RBC. Please proceed.

Jordan Rohan - RBC

Since we're taking a lot about international markets, I was curious about Panama. There's been much discussion about the push-out of the timeline for the improved monetization efforts at Yahoo! Search. We picked up some skepticism about whether the providers of search engine campaign management tools like Atlas are going to be ready for the change, or was Atlas even running late?

Can you comment on how much additional coding and software development needs to be done for Atlas to be ready for Panama, or whether the advertisers themselves are the ones that provided resistance and not necessarily the tools providers? Thank you.

Brian McAndrews

Yes, Jordan, I guess I would just say, Goggle, Yahoo, MSN, MSN with their new search offering are relatively new. Google is always updating their capabilities, and whenever they do we need to update our offering to make sure we are working alongside helping our clients measure across all three and use our tool for everything. So we do have to continue to have to invest in Atlas Search to make sure we can do what is necessary to adapt and make our tools as useful as possible. I guess that's all I would comment.

I mean, we're not holding anything up, I think Yahoo! will work at their own pace and based on what their customers want. Our job is to make sure that we adapt our tools to work closely with Google, with Yahoo!, and MSN, and we work closely with all of them to do so.

Jordan Rohan - RBC

Any specific insight on why Yahoo! decided to push out the timeline, and whether it's advertiser feedback or possibly other tools providers beyond Atlas?

Brian McAndrews

I don't have any insight into that.

Jordan Rohan - RBC

All right. Thank you very much.

Brian McAndrews

Thanks, Jordan.

Operator

Ladies and gentlemen, this does conclude the question and answer portion. I would like to turn the call back over to Mr. Brian McAndrews for closing comments.

Brian McAndrews

I just want to thank you all for your time today. We appreciate your questions, and we look forward to talking with you again in the future. Thank you.

Operator

Ladies and gentlemen, this concludes today' presentation. You may now disconnect. Good day.

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Source: aQuantive Q2 2006 Earnings Conference Call Transcript (AQNT)
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