United Online, Inc. (NASDAQ:UNTD)
Q2 2006 Earnings Conference Call
August 3, 2006 5:00 pm ET
Scott Matulis - VP
Mark Goldston - Chairman, CEO
Charles Hilliard - President, CFO
Youssef Squali – Jeffries
Nat Schindler – Piper Jaffray
Jim Friedland – Cowen and Company
I would like to welcome everyone to the United Online, Inc. second quarter earnings release call. (Operator Instructions) I would now like to turn the call over to Mr. Scott Matulis, Vice President of Corporate Communications. Mr. Matulis, you may begin your conference.
Thank you. Hello and welcome to United Online conference call to discuss the results of our second quarter ended June 30, 2006. With me today are Mark Goldston, our Chairman and CEO, and Charles Hilliard, our President and CFO.
In today’s press release, the company refers to adjusted operating income before depreciation and amortization, OIBDA, adjusted net income and free cash flow, all of which management believes are useful in evaluating the company’s operating performance. These numbers are not determined in accordance with generally accepted accounting principals, or GAAP. Definitions of these numbers are provided in the press release along with reconciliations to the most comparable GAAP financial measures.
Before we get started, I need to point out that the company does apply the safe-harbor provisions as outlined in the press release to any forward-looking statements included on this call. Statements regarding our current expectations about our future operations, our financial condition, our performance, our pay account growth, future products and the industry in which we operate are forward-looking statements that are subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.
More information about potential risk factors that could affect the company’s business and financial results in included in today’s press release under the caption Cautionary Information Regarding Forward-Looking Statements and in United Online’s most recent filings with the Securities and Exchange Commission. Projections provided by management in the press release and in today’s call are based on information available to us at this time. Management expects that internal projections and expectations may change over time however the company does not intend to update these projections. Any person replaying this webcast after August 3, 2006 should recognize that any non historical information discussed in the call might not be current or valid after that date as a function underlying such information they obtained.
And with we will start out with comments from Mark and Charles, and then we’ll open it up for questions. Now I’ll give the floor to our Chairman and CEO, Mark Goldston.
Thanks, Scott. The June quarter was another great quarter for United Online as we recorded all-time high revenues and achieved our 20th consecutive record quarter of adjusted OIBDA. That’s every quarter for the last five years. This is actually my 28th earnings call since took the company public back in September of 1999 and I’m extremely proud of the results that we’ve consistently delivered.
We’ve engineered the transformation of our company from a pure Internet service provider where we used to generate 100% of our revenue to a diversified Internet company with over 40% of our pay accounts and nearly 30% of total revenues coming from our Content and Media business.
This segment contains well-known brand names and is anchored by Classmates Online, the world’s first major Internet social networking company started back in 1995 and MyPoints.com, one of the nation’s leading providers of online loyalty marketing rewards.
Most of our over 60 million registered accounts belong to the Content and Media segment, making this a very formidable business within the Internet industry.
Our corporate strategy of achieving diversification through acquisition of non-access businesses has been executed very effectively as we significantly changed the face and profile of United Online during the last 18 months.
This movement began in earnest with our November 2004 acquisition of Classmates Online and was bolstered most recently by the purchase of MyPoints.com.
As always, our goal for United Online is to create value for our shareholders. I think the way we deployed our capital over the last couple of years reflects our success in fulfilling this goal.
We’re reaping the benefits today of the approximately $190 million in cash we’ve used to acquire Content and Media companies and believe there are additional benefits to come as a result of these acquisitions.
At the same time, through August we will have paid out around $78 million in cash dividends to our shareholders. As you know, it takes time for companies to transform themselves, to change the risk profile, develop or purchase new businesses and then to try to grow those businesses organically. We’ve done just that at United Online and we’re very proud of those accomplishments.
With over $150 million in cash on the balance sheet and great free cash flow, we’re now in a strong position to continue to evaluate and potentially purchase additional assets that we can fold into our Content and Media segment, and continue to bulk up that important and dynamic part of United Online.
While we pursue that objective and we’re continuing to follow our previously articulated harvest strategy in the access business within the communications network - that still contributes, by the way, a large amount of our company’s profit, the access business continues to be extremely competitive though as Charles will discuss in some detail, we’re currently experiencing some positive trends in that access business.
The big news in access, of course, is AOL’s announcement yesterday. They said that they will provide their email and content free of charge, continue charging existing customers and new users $25.90 a month for their premium dial-up service and offer new customers – not existing customer, new customers – a slimmed down version of the premium service for $9.95. They estimate that it will take $1 billion out of marketing and G&A by the end of 2007.
Only time will tell what the impact of their move will be on the access business in total and on our business in particular, but here are some of my initial thoughts.
You know, for years AOL dominated the dial up industry in terms of media spend and distribution deals, and their discounted and promotional offers were everywhere. Their marketing spend actually helped increase subscriber acquisition costs across the entire industry. In many cases, we were the direct target of those efforts, as evidenced by Netscape, which spent tens of millions of dollars on TV ads targeted directly at our own NetZero.
You know, I don’t know what sort of marketing they’re going to do going forward. It appears that we will no longer face the barrage of constant competition that we’ve experienced in the past from AOL. Any significant decrease in AOL’s marketing spending could significantly help our share of the market and it could advance the efficiency of our marketing effort.
AOL’s decision to allow users to keep their AOL email address regardless of their access provider also creates an interesting opportunity. We always believed that many AOL users stayed with AOL in order to keep their AOL email address. Now we have the opportunity to directly market a compelling proposition to the 17 million current AOL users. Here’s the proposition:
Keep your AOL email and content, and get your access through NetZero and Juno, which both rank higher in customer satisfaction than AOL.
For the millions of people on the premium priced AOL plan, we can save them a lot of money. Over the next several days, you may see a new advertising campaign that we launch based on this premise as we think it’s a quick and relatively inexpensive way to attract new users to our value-priced offering. It remains to be seen how AOL’s new $9.95 price point for their trimmed-down or stripped-down service will play out. It’s only available to new users, and I think that makes sense but they’ve got 11.5 million people paying them an average of $23.00 a month. If all of those users were to flock to the $9.95 service, their cash flow would be massively impacted by approximately $1.8 billion per year. So while their move is likely to increase price competition in the market, look, that already exists as a result of sub-$15.00 promotional broadband pricing. So we’ll have to wait and see how extensively the service is promoted before we get a good read on the impact in the marketplace.
And speaking of broadband, you know along with the declines in retail pricing for DSL, it now appears that wholesale pricing for DSL may also be declining. We’re currently in discussions with a number of broadband providers to act as resellers of their services under our NetZero and Juno brand name. While our intent is not to compete on TV or through the major distribution chains, with other broadband providers - in effect, not to get into the middle of that war – we are reviewing the possibility of offering value-priced broadband services to our existing customer base primarily as a save tool. In fact, we believe that this may provide us with the ability to elongate the life cycles of a significant number of our dial up subscribers who would otherwise just turn to broadband.
You know, as I’ve said before to you on numerous calls, our primary strategy in access is a harvest strategy and whether it be marketing to AOL users or offering a value-priced broadband service as a save tool, our goal will be to continue to find ways to manage the access business for profitability.
The product news in the communication segment during the June quarter was the launch of Private Phone, which happened in the month of June. Private Phone came out of our voice group and is a unique product because it provides a free voicemail to anyone who visits the privatephone.com web site or who calls the Private Phone signup number for any landline or cell phone, thereby not requiring the use of a computer.
The product is designed for 18 to 30 year old market. It provides a personal phone number that can be given out to anyone. Potential dates, telemarketers, business contact, basically anyone you don’t want to give your home, office or cell number to, and who might want to get in touch with you. The way it works is that you go, you call or you go online to sign up, you get to pick a number and an area code for free, and then you begin giving the number out to people. All calls to your number and they go directly into voice mail so the calls can be screened and then those that the user wishes to return, you do so and those that are important or are considered a nuisance can be discarded. We’re working on incorporating additional features in the Private Phone, such as a pay subscription product that may enable customers to either accept the call directly or automatically call back the individual who left the voice mail. We think Private Phone could provide a great entrée into the voice market, which is still an embryonic market in the U.S., and that over time we could possibly upsell these users to one of our pure voice products and allow them to keep the same phone number if they so desire.
Now looking at the Content and Media segment, you know our goal over there is to continue to develop that segment both organically and through additional acquisitions and, you know, unlike some of the other social networking sites out there which are dominated by the teenage, high school and college student market - they don’t have paid subscription models – our social networking business features predominantly adults over the age of 25 and we generate the majority of our revenues in the segment from paid subscription revenue. So the service that we sell is a connection with an element of your school, your work, your military history, and that relationship’s not going to change over time. Your past affiliations will always be important to you. Whether or not you’ll pay for connecting with someone from one or more of those affiliations has got a lot to do, frankly, with how strongly you felt about them and how effectively we, as a company, can convince you to get back in the game.
We think there are many opportunities to significantly develop the verticals within Classmates, which cover the work and the military segments, and we’re in the process of doing a deep dive analysis of the entire affiliation and registry segment within the Internet, beyond work, beyond school, beyond military, to see what other verticals would provide our 40 plus million members with something compelling that they value enough to pay a premium for.
Looking at MyPoints, the major member initiative is integration and cross-selling within the United Online family of companies. MyPoints is a fantastic product that’s historically has had limited customer acquisition dollars to spend. The company’s done an excellent job amassing over 4.5 million registered members and we bought MyPoints, you know, because not only was it a strong and profitability business but we believed that our 50 million plus U.S. members might find the concept of a MyPoints account compelling in the absolute and more compelling when attached to points earned for doing things that our users might do anyway such as post a photo, update a profile, pay another month’s subscription fee and things of this nature. So right now we’re actively analyzing the various ways in which we can cross-pollinate the MyPoints product with all the various United Online brands and services.
Looking at the pure media portion of our business, you know, we really believe that we’re underdeveloped in the advertising sales side of the business, in all candor and, you know, with a registered user base that’s consistently ranked among the top twenty largest unique audiences on the Internet, and with our total registered user base representing a significant portion of the adult Internet audience in the U.S., we believe that United Online should have a larger base of advertising revenue and to that end goal we significantly enhanced our ad sales effort by naming Jeremy Helfand as the company’s first ever Executive Vice President and Chief Sales Officer of the United Online Media Group.
Jeremy is a successful, seasoned Internet sales executive who most recently was the Senior Vice President and General Manager of Advertising.com, which is the largest and the most successful ad network in the country. Jeremy spent five years at Advertising.com and he presided over a massive increase in their revenues during his tenure. We feel that Jeremy is the perfect individual to lead our media sales group toward achieving the objectives I laid out earlier, and we’re very excited to see him make his mark on our company. All the sales executives outside of the MyPoints.com unit at United Online will fall under Jeremy’s supervision.
With that overview of our thoughts and strategies for the Communications and Content and Media segments, I’m now going to turn the Mike over to Charles Hilliard for a review of our financial performance in detail. Charles?
Thank you, Mark. By way of introduction, hopefully most of you are aware by now that in Q1 we introduced segment reporting. As such, we now report our business as two distinct segments: Purchase Communications, which includes our Internet access, email and voice businesses, and the second is Content and Media, which includes social networking, web posting, photo sharing and, beginning with the results we reported today, online loyalty marketing. With respect to the latter, you’ll recall that on April 10, we acquired MyPoints.com for $56 million in cash.
Our consolidated revenue mix was 71% Communications and 29% Content and Media for Q2. Content and Media revenues have grown significantly since we began our diversification efforts and in the year-ago quarter they comprised only 17% total revenues.
Please note that unallocated expenses includes costs associated with our corporate activities and stock-based compensation.
All right with that, let’s discuss our very strong second quarter results.
On a consolidated basis, our revenues were $134.9 million, which was up 3% year over year. Total revenues were above the high end of our guidance this quarter due to upside in Content and Media advertising revenues and better than expected ARPU for our communication segment. I’ll go into some more detail on segment performance later in the call.
Consolidated gross margin was 77.1%, which is down 210 basis points versus 79.2% in the year-ago quarter. Our voice offering decreased our gross margin by 70 basis points this quarter and the acquisition of MyPoints, which historically has generated a gross margin in the low 60% range also contributed to the decline in gross margin.
The adjusted OIBDA was $38 million, which was up 14% year over year. We continue to be very pleased with our ability to execute our transition to a major content and media player while generating strong adjusted OIBDA.
Free cash flow was $32.9 million in Q2 on a reported basis versus $35.7 million in the year-ago quarter. I want to point out that the structure of our MyPoints acquisition actually reduced cash flow from operations and free cash flow by $6 million this quarter. MyPoints’ negotiated purchase price was $56 million, as we’ve discussed, and at the date of closing MyPoints had about $6 million in cash and $6 million of certain pre-existing liabilities, both of which have been negotiated out of the purchase price. But as you can see on our statement of cash flows, that $50 million cash paid for acquisition net of cash acquired was reduced by $6 million and the change in accrued liabilities was reduced by the amount.
But on a recurring basis, free cash flow was $38.9 million, up 9% versus the year-ago quarter. Very strong free cash flow.
Pay accounts decreased by a net 97,000 during the quarter.
With Q2 being our seasonally slowest for access, our Communications pay accounts were down 186,000. This decline was partially offset by Content and Media pay account growth of a net 89,000.
As I’ll discuss during the segment review, Q2’s focus and the sales and marketing dollar spend shifted quite a bit towards acquiring free users and generating advertising revenues but we believe there’s potential for additional future growth.
Consolidated churn during Q2 as flat sequentially at 4.8%.
Now let’s get into Q2 segment results.
Communications. Our Communications revenues were $96.2 million, which was 71.3% of consolidated revenues. It was down 12% form $109.5 million in the year-ago quarter.
90.6% of segment revenues were from billable services and 9.4% from advertising.
Communications average monthly revenue per pay account or ARPU was $9.75, down 2% from $9.96 in the year-ago quarter and up 1% from $9.69 sequentially, reversing a six-quarter trend that began in Q4 of 2004. As I mentioned earlier and Mark alluded to, Communications ARPU stabilization increased Q2’s revenue upside, and we’re also seeing some good things in Q3 from a subscriber point of view.
Communications adjusted OIBDA was $35.6 million, down 5% year over year.
While gross margins in the segment declined 200 basis points year over year to 76.8% due primarily to the negative impact of voice, it was up 230 basis points sequentially.
OIBDA margin increased 290 basis points to 37.0% percent due to an $11.4 million or 29% percent reduction in sales and marketing expenses ear over year.
During Q2, we dramatically increased our gross marketing spend compared with the first quarter of this year, and our gross marketing spend focused primarily on building our free user base and Private Phone, which Mark discussed.
Average hourly telecom costs in the segment remained in the low $0.06 range while average hourly usage per active access account was up 2% year over year due to increased activity including pay access accounts using voice over dialogue.
Average hourly usage was down 7% sequentially which reflects the seasonally slower nature of Q2.
Communications pay accounts, as I mentioned, declined by a net 186,000 in Q2, driven by a net 195,000 decline in pay access accounts. Pay access accounts were down 52,000 in the year-ago quarter and down 104,000 in Q1. Importantly in Q3, we’re beginning to see some very important competitive shifts in the pay access market even preceding AOL’s announcement.
First, our analysis showed that Netscape did not advertise value access offering on television for well over a month.
Second, AOL ran a $200 instant rebate in Best Buy stores with a one-year commitment in Q2. That promotion has not continued in Q3.
Our point of view is regardless of AOL’s pricing strategy, we welcome their new plan to focus on economically rational customer acquisition activities, which has been a hallmark of our strategy for years.
Third, we recently have been successful in winning key distribution deals with Office Max at retail and a leading flagship PC manufacturer.
Fourth, we’re seeing improved relative performance in our existing marketing initiatives across the board.
These are among the first encouraging signs we’ve seen in our legacy business for a long time. We going to continue to focus on financial discipline in this business as Mark mentioned and that fiscal platform has actually provided the platform for our transformation into Content and Media. Importantly, we currently anticipate a sequential deceleration of declines in pay access accounts in Q3 and just for a point of reference, declines actually accelerated by 46,000 pay accounts between Q2 and Q3 of last year.
Customer acquisition costs. Communications gross customer acquisition costs in Q2 was $127. That’s up 27% from $100 in the year-ago quarter and up 44% from $88 sequentially. The increase reflects significant spending towards building our free VoIP user base, including major investments in testing a number of marketing channels and messages.
Excluding these initiatives, communications’ [stack] wholesale would have increased by a mid-single digit percentage year over year due primarily to increased overhead and marketing personnel.
As introduced last quarter, our stat computation is total segment sales and marketing divided by gross pay account additions.
Content and Media. Let’s get into our growth segment. As mentioned earlier, today’s results include the online loyalty marketing business of MyPoints for the first time. 100% advertising supported the business with the direct marketing and regeneration played to a registered base of over 4.5 million members who have gone through a double optimum process to join the service.
The vast majority of MyPoints’ cost of revenues is the cost of incentive points awarded to members in conjunction with their shopping and their purchasing activities. Incentive funds can be redeemed for products and services from a variety of retailers, restaurants and airlines and hotel.
During 2005, MyPoints grew 44% to over $38 million in revenue and generated nearly $5 million in adjusted OIBDA.
To date, we have been very pleased with MyPoints performance under our ownership and we believe it’s a [fit] with our other consumer Internet services if you look to integrate points to incent activity and loyalty among our users.
With that introduction, let’s get into segment results.
Content and Media revenues were $38.7 million, up 76% from $22 million in the year-ago quarter. Pro forma for the impact of the acquisitions, the largest of which was MyPoints, Q2 segment organic growth was 27%. 56.1% of segment revenues were from billable services and 43.9% from advertising.
Advertising revenues were particularly strong in Q2. We benefited from increased spending from a number of offline advertisers, including major pharmaceutical companies launching new drugs. Some of Q2’s ad revenue upside was offset by our approximately 65% reduction of ad placements per page on our social networking business beginning June 1. Our goal is to optimize the ad placements per page relative to pricing and user experience.
Near-term, this initiative has caused a decline in our monetization per page view, as a decrease in impressions has not been covered by improvements in pricing. We expect this initiative to negatively impact Q3 ad revenue as well.
Content and Media average monthly revenue per pay account or ARPU was $3.50, up from $3.43 in the year-ago quarter and down from $3.54 in Q1. The year over year increase in ARPU was due to a shift toward higher priced three-month social networking plans. The sequential decline was due to a decline in web hosting and photo sharing ARPU.
Content and Media adjusted OIBDA was $7.4 million, up dramatically from $53,000 a year ago.
Gross margin in the segment decreased 340 basis points to 78% given the impact of the MyPoints acquisition.
Sales and marketing as a percent of segment revenues decreased to 43.6% from 63.5% in the year-ago quarter. The decrease was due to testing television advertising for our social networking business last year, offset partially by the addition of MyPoints, whose revenues are 100% advertising and as such the sales expenses as a percent of revenues are relatively higher than our subscription-oriented businesses.
We anticipate significant quarter-to-quarter changes in margin within this segment due to the seasonal nature of the online advertising market as well as the effect from a number of operating and marketing initiatives over time.
Content pay accounts grew by a net 89,000 versus 100,000 in the year-ago quarter with virtually all growth in both quarters coming from social networking. During Q2 of this year we kept an initiative intended to increase free member activity on social networking as a potential expense in near-term pay account growth.
Stepping out of segments and back to consolidated discussion, our total cash balances were approximately $150 million at quarter end and during the quarter, once again, we used $56 million to acquire MyPoints and $13.4 million for dividends.
All right, let’s discuss business outlook. We are providing guidance for Q3 revenues of approximately $128 million to approximately $131 million and adjusted OIBDA for Q3 of between $34 and $36 million.
Our revenue guidance for Q3 reflects our expectations for continued declines in Communications revenue and a sequential decline in advertising revenue for Content and Media due to our testing of reduced ad placement as I mentioned, as well as seasonality particularly in the MyPoints businesses. For point of reference, last year MyPoints experienced a low double-digit percentage decline in ad revenues between Q2 and Q3 during a year when total revenues grew 44%.
As discussed previously, we currently anticipate that access pay accounts will decline in Q3 at a slower rate than we experienced in Q2.
For all of 2006, we are increasing adjusted OIBDA guidance to between $142 and $146 million, up from previous guidance of between $134 and $139 million. At the midpoint, our 2006 adjusted OIBDA guidance reflects 8% year over year growth.
Our current estimates for 2006 capital expenditures is between $25 and $28 million, unchanged from previous guidance, and we are maintaining our 2006 cash flow estimate to between $35 and $40 million.
With that, I’ll hand things back to Mark.
Thanks, Charles. All in all, it was a very strong quarter, from a financial result standpoint for us, we have a lot of new initiatives going on, there’s a lot of dynamic changes going on in the dial-up communications market and we’re pretty excited to see how all this plays out.
But you know I said this numerous on previous calls, I have long felt that the dial up market, although it will obviously decline over time, that it will largely be 100% valued priced. I couldn’t see a reason why that wouldn’t be the case for what is essentially a commodity product. We were the pioneers of the value segment of that market which was a micro niche when we came out with it. It then developed into a bona fide niche and now it looks like it may end up being the entire market. We like where we sit. We like our brands. We like the dynamic that appears to be evolving in this category and we continue to run this business in a harvest mode from an access standpoint some of these competitive dynamics of reduced spending by the major player in the category and the ability to sort-of solve the motherlode, which has been the major issue in the dial up market all along, which is that people could not leave their AOL email addresses. Solving for that part of the equation should make your next six to 12 months an exciting time in the dial-up market and we’re all intrigued to see how it plays out.
With that, I’d like to open it for some questions. Operator, if you’d explain to people how to get into the queue, we will hand some questions as we go. A bit of a time constraint, so we’ll take them as we can and then we’ll have to cut them loose, okay? Thank you very much, operator.
(Operator Instructions) Your first question comes from Youssef Squali of Jeffries.
Youssef Squali - Jeffries
Thank you very much. Hi, Mark. Hi, Charles. A couple of questions. First, going back to your AOL comments, I understand the – what you said about the access part, but what about the non-access part. Can you just comment on how you think your business will be impacted from AOL coming out with free email, free storage, etc., which is an area that you guys have been moving into the last couple years?
Secondly, within Content and Media, which area outperformed the most relative to expectations? MyPoints, really, in particular, we know did about $38 million and last year about $2.4 million in operating income. What kind of – how did the group there do relative to expectations when you just acquired them?
Okay, Youssef. It’s Mark. It’s nice to hear from you. In terms of the AOL strategy look, a lot of our users, I mean, we have a great start page on our NetZero and Juno businesses and ask if people look at our start page. You know, we have a lot of users who go to the likes of Yahoo, Yahoo obviously being a very popular destination for our users as it is, frankly, for everybody else on the Internet. But AOL has some pretty good content and, in the past, you had to be an AOL member to take advantage of the content and, you know, if you go back to the walled garden that was AOL, the entire premise that they had for charging you more than twice what we charge you to access the Internet was their belief, right or wrong, that that content and that email address were worth that amount of money.
Now that that content and that email address are free, in our view, you could have the best of all worlds by using AOL’s content and AOL’s email address and bringing it with you to NetZero and getting, you know, perhaps the second-highest rated J.D. Power-ranked customer satisfaction in the category versus where you are today with AOL which is darn near the bottom of the customer satisfaction.
So we actually think, and I don’t mean this to sound glib because I don’t know how it’s going to play out, but I like the dynamic of all of the users on the Internet today being able to use AOL’s content for free, use their email for free, and migrate over to people like us for access.
Now you are correct that we do sell, you know, email, products for additional storage, etc. But as you also know, full information is not a natural state in the Internet or any other consumer market. There are certain individuals out there who are either unaware of what’s being offered by them, unaware of the changes or frankly for convenience purposes or laziness, just want to stay where they are or get everything from one place. So AOL will still have people paying the $25.90 a month for basic dial-up Internet access.
But those pigeons that were on the fence, as they say; people who were on the wall who said the only reason I’m staying is because of this email and your other content now have a reason to leave.
In terms of the second part of your question, I’m going to turn it over to Charles.
Youssef, I’d like to point out, within the Communications segment, email and storage represents less than 2% of revenue so our exposure there, you know, hadn’t even crossed my mind.
Within Content and Media’s performance, we had outperformance on advertising and MyPoints relative to expectations definitely outperformed. It had more than offset some of the revenue setback we took by testing the new user experience and reducing the ad placements on our social networking business by 65% beginning June 1.
Youssef Squali - Jeffries
Very helpful, and just a quick clarification. In your guidance, there’s a $1.5 million restructuring charge. What’s that about?
We have downsized and we’re going to relocate our New York facility and so that’s partially attributable to some severance there. It’s a magnitude is less than two dozen people as well as some real estate exit costs. That’s an estimate right now and next call we’ll have a better number there. But that’s an estimate.
Youssef Squali - Jeffries
Okay. Thank you very much.
Thank you, Youssef.
Your next question comes from Safa Rashtchy of Piper Jaffray.
Nat Schindler – Piper Jaffray
Yes, hi. This is Nat Schindler calling in for Safa Rashtchy. Quick question on – going back to the $16 million, which was about $10 million more sequentially in advertising revenue in the Content and Media side, is that – what percentage of that was MyPoints?
Nat, our goal is not to break out ad revenue beyond the segmentation that we’ve done. I did point out the growth rate on an organic basis for the segment at 27%, so you can work through and do some math there. But, you know, a significant amount of that upside was the addition of MyPoints.
Nat Schindler – Piper Jaffray
Okay, that’s fine. I can work on that. Just then also on the Communications side, I know – I’m not looking for exact numbers here and I don’t even know if you know this but, when you look at your losses of I think 197,000 net losses on the Communications side, do you now have a good sense where they’re going? Like, for example, what percentage are going onto broadband versus what percentage are switching to another dial-up service versus what percentage are simply dropping off? Part of this is to get at where AOL – where you could see the AOL customers come in and whether or not they’re going to go to broadband or be able to be drawn into you.
Yeah, the number was 194.
Nat Schindler – Piper Jaffray
Yeah, that’s okay. We value every user, that’s why I said something and basically, yeah, we know where people are going in buckets. We don’t know where they’re going by brand name. In the old days, we did. We used to ask that. But we do know, we don’t disclose, but we do know what percentage of our users when they leave us go to broadband. It is a healthy percentage. Evidence the fact that we are now exploring potential relationships to be a reseller of broadband that we can use expressly for the purpose of the save tool which we think, you know, will appeal to a large percentage of our existing churning users.
But, having said all that, with the millions and millions of people that are on AOL and assuming they have an average monthly churn rate of 5% to 6%, which is a guess, based on the size of their user base there’s anywhere between 2.5 and 3 plus million people every quarter churning off AOL.
Now, a bunch of those people, obviously if you look at the category growth, are obviously going to broadband. Broadband is probably 70% plus of total access today, you know, with dial-up close to 30%. So if you just ran an exit analysis you would see that there’s still a large amount of people who are churning off dial-up in general, and AOL in particular, who still stay within the dial up category.
So our biggest issue is not so much where are we losing the people to, because we think we can address some of that if in fact these broadband things come to fruition for us. The bigger issue is, how many of the AOLers who are churning will stay in the dial-up pool and what’s our ability now to acquire those people as users, knowing that they can also bring with them their email and their content.
Nat Schindler – Piper Jaffray
Okay, great. I know this might be a hard question to answer at this stage of the broadband discussions you’re having, but you’ve said in the past that you see uneconomic pricing for broadband on the market. What can we think that you – what do you think you’ll be able to offer economically to your users to upgrade to broadband?
After 20 consecutive quarters of record adjusted OIBDA, you know where our hearts lie which is on that profit line, and I have said that repeatedly. It’s one of the reasons why we chose not to spend the hundred of millions of dollars that our competitors spent to get into broadband, most of which is either getting written off or underutilized.
Our theory all along has been, if you go back to earlier calls, that we looked at this sort of like, to use an example, like the hotel industry in that these hotels would be built, they’d be 50 stories tall and everybody would try to sell the rooms at the rack rate. And when they figured that they could only sell half the hotel at the rack rate, they would start looking to large tour groups to come in and sell those rooms at a lower price just to fill them. We are, in effect, the large tour group. We are a virgin tour group, because we haven’t made our bed in that category, and we’ve been approached by some of these folks with some very compelling wholesale economics. Previously they were terrible economics and now looking very compelling and I’ve always said that if and when we can find a way to be true to our value-price position and we can enter the broadband market in a manner in which we can be profitable, that we absolutely would look at it, not to go in there and slug it out on television in an uneconomic fashion, but to use it as a save tool to the rather percentage of our existing users who, when they churn, go to broadband and we have nothing for them.
So the market, I believe, has now gotten to the point where that prognostication, just like the prognostication about the home market going value, just like the other things that we’ve said, it turns out that a lot of things we said have come true and I think we’re in a great position to take advantage of it. So we’re not being hypocritical at all. In fact, what we had hypothesized could happen, looks like it’s going to happen. So we are now in a position where the big dog in the category has made a move to release what has been the motherlode, which is the lack of mobility in the email address and the broadband providers look like, in the spirit of trying to find more traffic on their pipe, they’d like to provide more traffic at wholesale prices, both of which I believe could bode well for our company.
Nat Schindler – Piper Jaffray
Great. Thank you.
Your next question comes from Jim Friedland of Cowen and Company.
Jim Friedland – Cowen and Company
Thanks. A couple questions. First, on MyPoints. I know, again, you’re not going to disclose revenues but it does appear like it had a pretty strong quarter. On a seasonality basis, can we expect just – should we look at it like a retailer where, you know, flattish revenues in Q3 and then Q4 is the big quarter? Does it dip in Q3? Is it just sequentially up every quarter? Then if you could talk about any kind of efficiencies you can gain by combining MyPoints in with the entire Media group?
Then secondly, on Classmates, it’s a good net adds quarter but it’s roughly flat year over year and I just want to confirm this is the quarter that – this is the seasonally strong quarter for Classmates and other – is this just sort of a steady as she goes business or is there anything you could do to accelerate that?
You want to take the first two and I’ll take the third one?
Absolutely. A good way of looking at MyPoints for our business is somewhat tied to retail. They have a number of retail customers. I mentioned last year they experienced a low, double-digit sequential decline between Q2 and Q3 in a year where they grew revenue by 44%. So, but Q4 is out there. We’re not providing any guidance there. Historically they’ve had a bigger Q4 than any other quarter and we’ll wait and see what happens. But, yeah. Q3 we expect revenue to be sequentially down, in line with what they did last year.
In terms of efficiencies on combination, it’s not going to be in the media selling as their media selling group is not going to run by Jeremy Helfand. Mark mentioned that in his comments. However, we are looking at a number of efficiencies with respect to customer acquisition channels and let’s say in-house technology and knowledge of the [inaudible] for our customers.
So that’s, yeah, there are some efficiencies there but it’s not going to be on the outselling.
And in terms of you question on Classmates?
Jim Friedland – Cowen and Company
Yes. It’s a good question, Jimmy, and the Classmates business, because they’ve got 40 plus million people, it is underdeveloped in its verticals and it sounds funny to say since we have more people, I think, in our military vertical than the entire VFW of America has, but the work vertical, the military vertical, even the college vertical, are relatively underdeveloped, even within the 40 plus million member base so we’ve got some pretty dynamic plans in place to try to further build out these verticals so that we can make having a membership in Classmates more compelling and more relevant to what you do with frequency versus being relevant to what you may do with a relatively modest to low frequency, which is check old friends from high school.
So that clearly is the honey that attracts the bee but we think once we get there that these other vertical ideas that we’re working on can be very compelling.
The last thing I will say, and Classmates would be at the cornerstone of this, we are very big over the next 12 months on looking at cross-pollenization of our various businesses. With over 50 million registered members, we’ve got a business in photo, we’ve got a business in online loyalty points, we’ve got some great businesses which, quite frankly, could never go out in the market and spend $10, $20, $30, $50 million on marketing to get access to 50 million people. We’ve got 50 million people, and so we’re going to start trying to work on ways between cross-registration, etc., where we can take advantage of this vault and drive some of these dynamic businesses going forward.
So, with that, operator, I do notice that we have promised you this is when we would close the call down so what I’d like to do is to get – if anybody’s got any further questions, obviously you can direct them into the company and we will do our best, as we always do, to answer them and I greatly appreciate all of you attending the call today. Thank you very much.
Thank you for participating in today’s United Online Inc. second quarter earning release conference call. You may now all disconnect.
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