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United Online (NASDAQ:UNTD)

Q3 2013 Earnings Call

October 30, 2013 5:00 pm ET

Executives

David Bigelow

Mark R. Goldston - Former Chairman, Chief Executive Officer, President and Member of Secondary Compensation Committee

Neil P. Edwards - Chief Financial Officer, Chief Accounting Officer, Executive Vice President and Treasurer

Analysts

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

Michael Crawford - B. Riley Caris, Research Division

Jason Kreyer - Craig-Hallum Capital Group LLC, Research Division

Operator

Good day, and welcome to the United Online Q3 2013 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. David Bigelow, Vice President, Investor Relations. Please go ahead, sir.

David Bigelow

Thank you, Amber. Hello and welcome to United Online's conference call to discuss our financial results for the third quarter ended September 30, 2013. With me today is Mark Goldston, our Chairman, President and Chief Executive Officer; and Neil Edwards, our Executive Vice President and Chief Financial Officer.

Before I get started, I'd like to mention that we've created a PowerPoint presentation that summarizes our third quarter 2013 financial results and operating metrics. I would encourage you to download a copy of this presentation by going to our website, www.unitedonline.com, and clicking on Investor Relations at the top and going into the earnings release section.

On today's call, in today's press release and in the accompanying slides that are available within the Investor Relations section of our website, which can be found at www.unitedonline.com, we will refer to certain financial measures that are not determined in accordance with accounting principles generally accepted in the U.S., or GAAP, and should be considered in addition to, and not as a substitute for or superior to, the financial measures determined in accordance with GAAP. Definitions of these non-GAAP financial measures are provided in today's press release and the accompanying slides on our website, along with certain reconciliations to their most comparable GAAP financial measures.

In addition, the company applies the Safe Harbor provisions as outlined in today's press release to any forward-looking statements that may be made on this call. Statements regarding our current expectations or estimates about our future operations, financial performance, net interest expense, amortization, share numbers, capital expenditures, taxes, operating metrics, some planned reverse stock split and planned spinoff of FTE companies and the expected benefits of such transaction, changes of senior management, anticipated dividend, plans to reduce expenses, new or planned business initiatives, products, services, features, and functionality including coverage areas or strategies, the expected benefits of our business initiatives and strategies among others, are forward-looking statements that are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from those described or implied in the forward-looking statements.

More information about potential risks that could affect the company's business and its financial results is 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, including the company's annual reports on Form 10-K and quarterly reports on Form 10-Q.

Guidance, projections and other nonhistorical information provided in the press release and in today's call are based on information available to management at this time, and management expects that internal projections and expectations may change over time. However, the company does not intend to revise or update this information except as required by law and may not provide this type of information in the future.

And with that, we're going to start out with a few comments from Mark and Neil, and then we're going to open it up for question. So now I'll give the floor over to our Chairman, President and Chief Executive Officer, Mark Goldston.

Mark R. Goldston

Thank you, Dave, and welcome to our United Online earnings call for the third quarter ended September 30 of 2013. Well, after many months of preparation, it appears that the FTD tax free spinoff has finally arrived. The tax free spinoff is expected to take place this Friday, November 1. And as we previously announced, on October 31, 2013, prior to the spinoff, we intend to distribute 1 share of FTD stock for each 5 shares of United Online as of the October 10 record date and then United Online will execute a 1-for-7 reverse stock split.

As you know, the spinoff date will also be my last day with United Online after leading the company for 15 years as the only Chairman, President and CEO actually, United Online has ever had. I already had the opportunity to say farewell back in July during our Q2 earnings call. So a little bit like the Mariano Rivera farewell tour, but I would just like to reiterate that I am really grateful to the United Online Board of Directors, our employees, our partners and our investors for the support that all of you have given me over the years.

It's been a distinct honor and privilege to preside over the growth of this company from a raw start-up back in 1999 when I joined, to the highly profitable global enterprise we got today. And this is a testament to the world-class team that we've assembled at all levels of United Online and I've thoroughly enjoyed leading this company. Now looking ahead, post the spinoff this Friday, I believe both companies will be in good hands as Francis Lobo, the incoming President and CEO of United Online, and FTD president, Rob Apatoff, who will assume the additional role of Chief Executive Officer at FTD companies, these will each have outstanding teams underneath them as they transition into their new executive roles.

Now I've said this before, but the FTD spinoff is not an ending, it's actually just the beginning. After the spinoff is complete on this Friday, we will have created 2 outstanding companies. And I hope you will continue to follow both United Online and FTD.

So let's proceed on with the rest of the program. I'll provide an overview of our results of the third quarter and the status of the spinoff. Then Neil Edwards, my CFO, will conclude our prepared remarks with a look at the numbers for the quarter and then he'll give our guidance going forward. After that, we'll wrap up with some Q&A and final thoughts on the quarter.

So I was going through the highlights of the third quarter 2013 and when you look at it, basically, the way we see it, there's 5 key things that we want to cover. Number one, both the consolidated revenues and the consolidated adjusted OIBDA came in at the high-end of the guidance range for the quarter.

Consolidated revenues decreased 2% from the year ago quarter to $174.7 million, and the consolidated adjusted OIBDA decreased 3% to $25.9 million, so that was point one. Point two would be that FTD exhibited growth in both revenues and adjusted OIBDA for the third quarter. Now segment revenues increased 2% from the year ago quarter to $118.5 million and segment adjusted OIBDA increased 4% to $15.8 million. Third point is Content & Media segment pay accounts declined by only 30,000 during the quarter.

Now this is the best quarterly net pay account performance since the second quarter of 2010. The quarterly net decrease in segment pay accounts has now improved in 7 consecutive quarters. You might remember, we had a high of a 296,000 decline in the fourth quarter of 2011, which even makes the 30,000 during the most recent quarter that much more impressive. The fact that pay account churn was an all-time company best 2.9%, bears talking about because that's actually the lowest since we acquired Classmates in 2004, which is really remarkable.

The Content & Media Segment revenue declined 12%, segment adjusted OIBDA declined 5% from the year ago quarter. The fourth key point I wanted to make is that our Communications segment showed that we reduced our revenue decline to 3% year-over-year. Now this compares to 7% decline last quarter and 17% in the third quarter of 2012 a year ago.

The Communication segment's churn rate was only 2.7%. Now that's the lowest churn rate in the history of our Communications business. So both Classmates, Content & Media and the Communications division both recorded the lowest churn rates in the history of those businesses. And then the fifth point, is that during the quarter, we recorded an estimated $50.2 million goodwill impairment charge due to a material decline in the fair value of our Classmates reporting unit. Now this was a noncash charge, did not impact adjusted OIBDA cash flow from operating activities or free cash flow. And Neil will provide additional information on this during his remarks. So those are the 5 key elements I wanted to make. I want to now take a look at the individual operating segments and we'll start with a review of FTD.

So FTD segment as you know, includes both the domestic results of FTD in the U.S. and Canada and the results from our Interflora business in the U.K. and the Republic of Ireland. As I mentioned, FTD's third quarter segment revenues and adjusted OIBDA increased 2% and 4%, respectively, and that's compared to the year ago quarter. Consumer orders in the quarter increased 1% year-over-year, average order value also increased 1% but excluding the unfavorable impact of the foreign currency exchange rates, average order value actually grew 2% year-over-year. Segment adjusted OIBDA for FTD has now increased in 10 of the last 11 quarters when prior periods are adjusted for the timing of the U.K. Mother's Day in 2011 and the Easter holiday in 2013. Segment adjusted OIBDA margin for the quarter was up 30 basis points year-over-year to 13.4%.

I'd like you to note that the third quarter is seasonally FTD's slowest quarter because there's no major holidays. And so there's less of an opportunity to generate growth in the third quarter than any of the other quarters. So with this in mind, we're really pleased that FTD has maintained its positive momentum and delivered another solid quarter with year-over-year increases in revenues, adjusted OIBDA, consumer orders and average order values. So it's really impressive.

Now I'd like to turn your attention to the Content & Media segment. Now this segment includes the Classmates business as well as StayFriends in Europe, and the MyPoints business. Segment revenues in Content & Media were $32.2 million, which was down 12% compared to the year ago quarter, but segment adjusted OIBDA was $6.9 million, down 5% to the year ago quarter. If you exclude the favorable impact of foreign currency exchange rates, segment revenues and adjusted OIBDA, decreased 13% and 8%, respectively. Now the segment adjusted OIBDA increased on a sequential quarter basis for the second consecutive quarter, that's a great sign. But importantly, segment churn was an all-time record low of 2.9%, as I mentioned earlier, which really says a lot about that business and the health of its subscriber base.

Let's take a look at Classmates itself which is the Classmates domestic business. In the past quarter, Classmates domestic saw a sequential improvement in net decline of pay accounts. The net decline in pay accounts was 30,000 compared to a 66,000 decline in the second quarter of 2013 and 133,000 decline in third quarter 2012. That is a dramatic improvement. Classmates has now achieved better net pay account performance in each of the last 7 quarters. This improvement began in early 2012 and when we renewed our focus on creating the compelling high school value proposition as you remember.

So in 2013, this strategy continued to have a positive impact. So during the third quarter of 2013, Classmates' domestic members site visits, which is a really important metric, increased by 25% from the year ago quarter. So now, not only do we have all-time record low churn of our subscribers, which talks about how satisfied they are, but our domestic member site visits increased by 25% from the year ago quarter. We've continued to add substantial amounts in new user content, as you've seen on the site. Some of the recent highlights would be the Classmates archive of digital yearbook surpassed 220,000 digitized books by the end of the third quarter.

In the last year, we've more than tripled the percentage of our members who have a photo posted, that's huge. Stories have been added to profiles of more than 22 members on Classmates and this has really created compelling personal narratives that give a summary of the member's life since graduation from high school.

We're continuing to diversify our curiosity value proposition, as we like to call it, and reconnect high school friends in new and interesting ways. We've developed and introduced several new monetization paths over the past few months. These have been designed to convert free members to paid subscribers. And our mobile strategy that we launched in earnest just a year ago, has become an increasing utilized vehicle and an important way for members to access the Classmates website. As we look ahead, the Classmates strategy remains focused on delivering compelling high school experiences to users across multiple online platforms.

Internationally, our social networking business under the StayFriends and Trombi brand names continues to face competitive challenges. Looking ahead, our strategic priorities internationally are leverage the experience of our domestic business to add those new features and monetization opportunities to StayFriends, extend our mobile web presence in Europe and offer StayFriends paid membership experience to more users to expanded use of introductory pricing. We think these strategies will enhance our potential to attract new subscribers and improve retention in our Classmates International business.

Now at MyPoints, the other part of the Content & Media segment, we're continuing to address challenges that the business has faced in recent quarters. We've strengthened the management team and we're working on product enhancements and infrastructure improvements as we speak. Current initiatives, and those that are planned for the fourth quarter of 2013, include things like establishing partnerships, mini partnerships to improve customer acquisition sourcing; we're going to launch a points parity program to highlight the value we provide the shoppers; we're going to utilize a browser extension to alert members when they search or they visit a participating MyPoints merchant, so they know that if they buy something there, they can get points right away; and then lastly, we're going to be expanding our mobile presence on MyPoints just like we've done very successfully on Classmates.

I'm going to wrap with a review of the Communications segment, which, as you know, consists principally of our NetZero and Juno brands. I'm also going to give you an update on the NetZero mobile broadband service. In our Communications segment, the quarterly revenues decreased 3% compared to the third quarter of 2012. Last quarter, the year-over-year revenue decrease was 7% and in Q3 2012, it was 17%. So we've gone from a minus 17% to a minus 7%, and now most recently, a minus 3%, major improvement.

Now strong advertising revenues and then the growth in our mobile broadband service are what's driving this improved revenue performance in the Communications segment. Our Communications segment churn, as I said earlier, improved to an all-time lowest monthly churn rate of only 2.7%. That's down 40 basis points in the year ago quarter. So our average monthly revenue per pay account, what we call ARPU, was $9.41. Now, that compares to $8.97 in the year ago quarter and $9.34 in the second quarter of 2013. So average revenue per user continues to go up and churn is at an all-time record low. Those are 2 really great evaluative metrics of that business.

And ARPU has now increased sequentially for the last 4 quarters. This trend is largely driven by our growth in the mobile broadband business which has a higher ARPU than dial-up and an increase in ARPU in the mobile broadband business is what drives that.

In the third quarter 2013, the Communications segment adjusted OIBDA declined 7% to the year ago quarter and adjusted OIBDA margin was 35.3%. Now, that included a negative impact on the segment OIBDA of about $1.9 million in the third quarter of '13, which is due to our investment in the growth of the mobile broadband business. As of September 30, 2013, the NetZero mobile broadband business had about 44,000 accounts, up from 41,000 at June 30th of '13. And up from 19,000 at September 30 of 2012, 1 year ago. The number of accounts on the free introductory plan continues to decline, which is something we believe is a good that we've programmed to do.

We expect that our NetZero mobile broadband service over the Sprint network will launch in the first quarter of 2014 and this should bring a dramatic increase in our coverage area [indiscernible] the last call. It remains our goal to reach profitability in the mobile broadband business during 2014. And ultimately, we think that the combination of NetZero's dial-up and mobile broadband businesses will create a profitable, cash generating company with the potential for real growth.

So with that, I'm going to turn the presentation over to our EVP and Chief Financial Officer, Neil Edwards. And he's going to take you through a review of the results and provide the guidance. Neil?

Neil P. Edwards

Thank you, Mark. Before I go through our third quarter 2013 highlights, please note that during the quarter, we recorded an estimated $50.2 million goodwill impairment charge due to a material reduction in the fair value of our Classmates reporting unit, which includes our Classmates domestic business and our StayFriends from the International businesses. The impairment resulted primarily from a decline in our internal financial projections for the Classmates reporting unit. This was a noncash charge which did not directly impact adjusted OIBDA, cash flows from operating activities or free cash flow.

Now let me get into the highlights of the third quarter of 2013 and then I'll provide guidance going forward. All comparisons represent year-over-year quarterly comparisons unless I clarify otherwise and I'll start with the consolidated results for the third quarter.

Revenues were $174.7 million, a 2% decrease and at the high-end of our guidance range. Adjusted OIBDA was $25.9 million, a 3% decrease and also at the high end of our guidance range.

GAAP operating loss was $42.1 million compared to GAAP operating income of $8.4 million in the year ago quarter. Diluted net loss per common share was $0.51 compared to diluted net income of $0.06 per common share in the year ago quarter. The GAAP operating loss and diluted net loss per share were both impacted by the estimated $50.2 million Classmates reporting unit goodwill impairment charge.

Adjusted diluted net income per common share was $0.12, a decline of 14%. Cash flows from operating activities and free cash flow for the quarter were $10.7 million and $8.6 million, respectively, compared to $10.6 million and $7.9 million, respectively. Cash and cash equivalents at September 30, 2013, were $100.8 million compared to $122.4 million at June 30, 2013. As previously reported, during the quarter, FTD refinanced its credit facilities and used $19 million of its existing cash to repay, in full, its previously outstanding credit facilities and to pay fees and expenses related to the refinancing.

Net debt at September 30, 2013 was $119.2 million compared to $111 million at June 30, 2013. The company defines net debt as total debt net of discounts, less cash and cash equivalents.

Now onto the FTD segment. Segment revenues were $118.5 million, an increase of 2%. Segment adjusted OIBDA was $15.8 million, an increase of 4%. FTD has now achieved year-over-year quarterly increases in segment revenue and adjusted OIBDA in 10 of the last 11 quarters, when prior periods are adjusted for the timing of the U.K. Mother's Day in 2011 and the Easter holiday in 2013. Segment adjusted OIBDA margin was 13.4% compared to 13.1% in the year ago quarter, FTD's third consecutive year-over-year margin expansion.

In terms of key metrics, consumer orders were 1.2 million, up 1%. Average order value or AOV was $61.69, an increase of 1%. Excluding the unfavorable impact of foreign currency exchange rates, AOV increased 2%.

Now onto the Content & Media Segment. Segment revenues were $32.2 million, a decrease of 12%. Excluding the favorable impact of foreign currency exchange rates, segment revenues decreased 13%. Segment adjusted OIBDA was $6.9 million, a decrease of 5%. Excluding the favorable impact of foreign currency exchange rates, segment adjusted OIBDA decreased 8%. On a sequential quarter basis, Content & Media segment adjusted OIBDA increased 5%.

And in terms of key metrics, pay accounts decreased by a net 30,000 in the third quarter compared to a net decrease of 66,000 in the second quarter of 2013, and a net decrease of 133,000 in the year ago quarter. This was the seventh consecutive quarterly improvement. Active accounts were 10.3 million, a decrease of 2% sequentially and 6% year-over-year. Churn was 2.9%, the lowest quarterly level for the segment since we acquired Classmates back in 2004.

Churn for the quarter represents a decrease of 20 basis points sequentially and a decrease of 50 basis points year-over-year. Churn has now improved in 6 of the last 7 quarters. Average monthly revenue per pay account or ARPU was $2.52, up 2% sequentially, and up 1% year-over-year. Excluding the favorable impact of foreign currency exchange rates, ARPU was down 1% year-over-year.

Now onto the Communications segment. Segment revenues were $24.4 million, a decrease of 3%. Segment adjusted OIBDA was $8.6 million, a decrease of 7%. The investment in our mobile broadband business resulted in a negative adjusted OIBDA impact of approximately $1.9 million during the third quarter of 2013 versus a negative adjusted OIBDA impact of $2.7 million in the year ago quarter.

Segment adjusted OIBDA margin was 35.3% compared to 36.9% in the year ago quarter. In terms of key metrics, segment pay accounts decreased by a net 22,000 in the third quarter versus a net decrease of 31,000 in the second quarter of 2013 and a net decrease of 34,000 in the year ago quarter. Mobile broadband accounts increased to 44,000 compared to 41,000 at the end of the second quarter of 2013, and 19,000 at the end of the year ago quarter. Growth in mobile broadband accounts continues to be slowed by a number of accounts on the first year free promotional plans that reached their 1 year anniversaries and churned. These accounts have been replaced by new pay subscribers and we are seeing a shift in new sign-ups to higher priced plans.

ARPU was $9.41 compared to $9.34 in the second quarter of 2013 and $8.97 in the year ago quarter. The year-over-year increase was due to a higher percentage of mobile broadband accounts which have higher ARPUs and an increase in ARPU for such accounts. Churn was 2.7%, the lowest level in company history. Churn decreased 30 basis points compared to the second quarter of 2013 and 40 basis points compared to the year ago quarter.

Now onto unallocated corporate expenses. For the quarter ended September 30, 2013, the impact of unallocated corporate expenses on consolidated adjusted OIBDA was $5.5 million, a 9% increase compared to the year ago quarter.

Now let's move onto the business outlook for the fourth quarter of 2013. Since the results of operations for FTD for the month of October will be reported by United Online as discontinued operations, United Online's fourth quarter 2013 guidance does not include guidance for FTD. Consolidated revenues are estimated in the range of $58.5 million to $61.5 million. Consolidated adjusted OIBDA is estimated in the range of $10 million to $13 million.

Amortization of intangible assets is estimated at $1.7 million. Weighted average diluted common shares are estimated to be $13.3 million on a GAAP basis and $13.4 million on an adjusted basis which reflects the 1-for-7 reverse stock split of United Online shares. We estimate that our GAAP provision for income taxes will be minimal. For the full year, 2013 capital expenditures excluding FTD, are estimated to range from $10 million to $12 million.

We are continuing to build our mobile broadband business in the Communications segment and we believe that the expected improved geographic coverage resulting from the new wholesale agreement with Sprint will begin to have a noticeable positive impact on our mobile broadband accounts starting in the first quarter of 2014, such that we anticipate the mobile broadband business will turn profitable during 2014.

And looking ahead, following the spinoff of FTD, United Online will consist of the Content & Media and Communications segments which together have generated $238 million in segment revenues and $57 million in segment adjusted OIBDA during the last 4 quarters. Both segments will enter the post spin era with momentum as both segments in the third quarter each recorded their lowest average monthly churn performance in United Online history.

Content & Media Segment pay accounts declined, improved for the seventh consecutive quarter. And in our Communications segment, mobile broadband accounts have increased. Excluding the cash and cash equivalents at FTD, the company had $72 million in cash and cash equivalents on hand and no debt as of September 30, 2013.

As previously announced, following the spinoff, the company's Board of Directors anticipates declaring a cash dividend of $0.15 per common share which reflects the 1-for-7 reverse stock split. Currently our unallocated corporate expenses impact adjusted OIBDA by approximately $21 million on an annualized basis. This level of corporate overhead was built to support a larger public company and we will be targeting to reduce this amount by between $6 million to $8 million on an annualized basis over the next 12 months as we look to position the company for future growth.

I want to thank everyone at United Online and FTD for their work done to execute the spinoff transaction. I wish everyone at FTD the very best as they become their own stand-alone public company. And once again, I want to thank Mark for his invaluable contributions to United Online over the last 15 years.

That concludes my prepared remarks, so back to you, Mark.

Mark R. Goldston

Thank you, [indiscernible] and I echo Neil's comments, obviously, about the folks at FTD and wish them all the best. They're a tremendous team, they've done a wonderful job and we have great confidence in what they're going to accomplish.

Before we go to questions, I just want to go back and clarify something. When we were in the Classmates section and we were talking about the subscriber decline in pay accounts was only 30,000. I might have said -- I don't know if I have but I want to clarify the record. That is the total subscriber decline amount for both domestic and international. It is not a 30,000 decline in just Classmates domestic.

So for the quarter, Classmates both domestic and international combined, had a net decline in pay accounts of 30,000 which compared to a 66,000 decline in the second quarter of '13 and 133,000 decline in the third quarter of '12. So a dramatic improvement, that is a global net decline number, not domestic. And I don't know if I said it enough, but I just want to make sure for the record that I clarified it, okay?

So with that, operator, we'd like to start the Q&A. If you can explain to people how to get into the queue, no pun intended. Then Neil and I will be happy to take the questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Dan Kurnos with The Benchmark Company.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

Let me start with FTD first. I think, look, now that we're going into the spin -- maybe ask some questions that I think investors want to get a sense on going forward here. In terms of FTD, maybe give us a little color on what growth initiatives FTD has, how to keep the growth going there, what levers they have on the bottom line and how you think they might intend to use cash going forward?

Mark R. Goldston

I have to be cautious, as you can imagine, Dan, since as of Friday, it's going to be a separate company and I don't want to make statements on behalf of Rob Apatoff and Becky Sheehan because they're perfectly capable of doing this themselves. But given that they're not going to have a chance to speak to you before that happens, what I can tell you is that as we have been reporting all along, those guys are really hitting it on all cylinders. They're deep into investigating expansion of the partnerships they have and creating additional partnerships. They've done -- as you see on their site, they're doing a lot of testing from a marketing standpoint in terms of the value proposition they create, the amount of flowers that they offer in a particular bouquet in addition to their good, better, best, in terms of offering certain promotional offers in off-season periods. They got a lot of clever things in the hopper for the upcoming Valentine's Day and Mother's Day holiday periods. Their quality control systems and the things that they've done to try to improve that, I think are really impressive and they've got them, given that when we bought it 5 years ago, there really was no QA, QC system, they definitely got one in place now. I think they've seen from a florist community standpoint, a much happier network of florists because of the last couple of years, the increase in orders that have gone into that system. And they obviously will continue that strategy on a go forward basis. So these folks have really spent along with us, the last couple of years, really re-architecting that American iconic business that we've got, done an excellent job in a tough economy. And I think on a go forward basis, I've got great confidence in Rob Apatoff and Becky and that team, to do a continuation of the great work they've done. We'll be their biggest cheerleaders in the sidelines but I feel really good about that company and where it is and who's operating it.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

Let me just ask you a quick housekeeping question in FTD just in terms -- I don't know if they've ever broken this out and obviously, we have our own estimate but have they ever disclosed what the percent of revenue is from the shop-to-shop percentage of the wire business?

Mark R. Goldston

They haven't, no. That would be way granular from a disclosure standpoint, but, no, they haven't.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

Okay. So let's jump over to C&M. And Mark, the last time you were talking about sort of the 5 monetization paths and you've seen some pretty good pickup now in revenue. I'm just curious what kind of follow-through you've seen from the monetization efforts and what drove ARPU higher in the quarter?

Mark R. Goldston

Dan, I'm glad you asked that because as you know, when we invented that Guestbook which is really the lifeblood of Classmates in terms of getting people to convert from free to pay. And you know mechanistically how it works where somebody will visit your profile and then they'll leave their name. And if you're free member, you can't see who it was and you have to become a paid member to find out, that's the Guestbook. And that has historically been pretty much our mechanism for encouraging people to convert. We believed that we needed to have more than that. So Harold Zeits and his team up there developed 5 monetization paths which are ways to prompt you, Dan. For example, someone looked at your photo, you get a message. Somebody checked you out in your yearbook, you get a message. Somebody left you a message in your yearbook, you get a message. And so what we're basically doing is we're aligning the proliferation of content with the messaging system to the consumer so that every time this increase content prompts someone to look at it or engage with it, the person whose content is being viewed, gets a message. That has been very successful in, A, getting people to convert to pay; and B, creating more time on the site; and C, more stickiness. And this is all been reflected in the numbers. They've really done an outstanding job up there over the past 18 months, of taking a business that was devoid of graphic user content. Very few photos, very few profiles and a single monetization path called Guestbook. Today, they've got millions of photos, millions of profiles, 5 monetization paths, more yearbooks than they've ever had, a lower churn rate than they've ever had in the history of the company and a 25% improvement in their engagement levels. And so I feel like those guys have done a really good job. They've done everything that we said they ought to do and I think they're on the right path.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

In on pay accounts, any additional color you could give on timing of return to growth there? And given your clarification and knowing that international is lagging, have you reached or are you close to reaching domestic growth in pay accounts?

Mark R. Goldston

I can't break that out separately because we don't do that. But we have said previously and I will say again now, that we, without giving any numbers, we have seen that domestic business show significant improvement over the past 12 plus months and it's largely due to these programs I just talked to you about because those 5 monetization programs are domestic programs, not international. And because of their success, the international division is looking at them and thinking about adopting them. So the Classmates domestic division, which as you know, 2 years ago, was sorely in need of a turnaround on multiple levels, has absolutely seen itself improve across those multiple levels. And we feel really good about it and it will be up to the company on a go forward basis, what level of disclosure they do within the segments as to whether or not they give you more granularity, which we don't do today so I can't, but can tell you anecdotally that the domestic Classmates business had shown significant improvements and we're really happy with it.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

Okay. And just the last one for me. Are we through most of the free pay churn on the Communications side or are there any other significant events, and in terms of the mobile profit timing, I know you said 2014, are there any specifics, are we talking 2H '14, by the end of '14? Or just any clarity there, that would be helpful.

Mark R. Goldston

I'm going to let Neil take that one.

Neil P. Edwards

I mean, we started the service 18 months ago now and we had quite a few free sign-ups in the early days and much, much less free towards the end of last year. So while a lot of the frees have burned off, there's still some left to go.

Mark R. Goldston

Yes, but the net of it is -- and again Rusty Taragan and his team [indiscernible] division have done an outstanding job. What they did and we articulated this, that they used the free to get awareness to get this thing on the map, get people in the game, knowing that they would come to a churn cliff at the end of the 12-month anniversary for those people. So you're starting to burn through a lot of that because as we said for the past several quarters, a much higher percentage of the people who sign up for mobile broadband now are signing up for pay service. When we started out, it was very high towards the free service. Now, the pay service dwarfs the sign up for the free service which is exactly what you want to accomplish.

Daniel L. Kurnos - The Benchmark Company, LLC, Research Division

And on the mobile profits side, are we talking 2H '14, are we talking the end of '14?

Mark R. Goldston

Well, we're just right now saying -- we're just saying 2014, we're not getting that specific and that will be up to the guys on the next call to determine what kind of granularity they might want to give you on that. But we're sticking to what we said before. And then again, remember, the seminal event, Dan, to focus on, my perspective, is the Sprint launch because the Sprint launch is going to happen in the first quarter of 2014. And remember that's 3G and then 4G and so the footprint expansion that will be affected by the Sprint launch will be dramatic versus where we are today. So Rusty and his team, their theory is, and I totally subscribe to this, no pun intended, is that the yield should go up dramatically on the people who are visiting our site and calling our call center who, today, so many of them cannot get our service. That once we launch Sprint and get that dramatic increase in coverage, without an increase in marketing spend, they should be able to significantly increase the yield of the people who show up to the site and the phone line today, which really should give them some operating leverage going into next year.

Operator

We'll go next to Mike Crawford with B. Riley and Company.

Michael Crawford - B. Riley Caris, Research Division

Another thing you've been talking to us about for over a year is your efforts to monetize some of your foundational IP, having retained Evercore Partners and from time to time, we've been promised with some updates on that and it seems to continue to push to the right. Is there anything to report now or what have you? Have your thoughts changed as to what you might realize from that collection of assets?

Mark R. Goldston

Well, yes. Just to be clear, we never called it foundational IP, so I think that's important. One of the things we had, Mike, and you can appreciate this because I'm such a big proponent of patents in general and have a lot myself, is that we as a company, have a lot of intellectual property which we believe is very valuable. A lot of which is not foundational, central or frankly, even relevant to most of the businesses that we're in. We've just been in the Internet for so long, 15 years, and we never knew where the Internet was going to go. And so we got a lot of innovations in this company that are not foundational to the businesses we're in but they are foundational to the businesses that other people on the Internet are in. And that's what we're attempting to monetize. That process has been a long process. It is absolutely still ongoing. We still feel really good about it. We've identified somebody that we'd like to try to work with. And we're well down the path of that. We just obviously, didn't get anything done by this earnings call but we remain on the same path we talked about and the strength of that path is no less than it was. And whatever we do there for this company is pretty much gravy because we had not been monetizing those patents previously and most of them are not foundational to what we're doing.

Michael Crawford - B. Riley Caris, Research Division

And then looking at the x distribution United, so we have guidance for $8.4 million in transaction related cost in the quarter, I'm wondering how much of those are cash costs? And then further maybe, Neil, whatever color you could provide on the expected net cash position come December, assuming you perform in line with the rough midpoints of the guidance you've laid out today?

Neil P. Edwards

Mike, when you referred to the transaction costs, are you referring to that in the guidance?

Michael Crawford - B. Riley Caris, Research Division

Yes, $8.4 million.

Neil P. Edwards

Yes. That's primarily severance payments. And then as far as cash goes, I mean, we're at $72 million now. We have these certain payments that we need to make in the fourth quarter and we have some litigation that is out there which is also going to reduce the cash. I mean, as you know, the business is -- the remaining businesses, Content & Media and Communications, are both cash generating businesses. And you have the history, so you're starting position is the $72 million, the $8.4 million of severance and at some point in the future, we hope we will settle our litigation. So hopefully, that enables you to put cash broadcasts together.

Michael Crawford - B. Riley Caris, Research Division

Okay. And then the $4.5 million in stock based comp in the period, I presume a lot of that relates to Francis Lobo hire. For 2014 as a whole, would you expect stock-based comp to be much lower than that rate, I would hope, yes?

Neil P. Edwards

The current quarter does not include any stock-based comp for Francis Lobo.

Michael Crawford - B. Riley Caris, Research Division

So it's good to think of $4.5 million of stock-based comp per quarter as standard?

Neil P. Edwards

No, no. In the current quarter, that's the acceleration of Mark's RSUs as part of his contract.

Michael Crawford - B. Riley Caris, Research Division

And so for 2014, you would expect stock-based comp to be, back to my question, how much less than that implied $18 million a year stock-based comp rate by the Q4 '13 guidance?

Mark R. Goldston

Neil, he's taking the $4.5 million and he's run rating it times 4...

Neil P. Edwards

Yes...

Mark R. Goldston

It's an average event of the acceleration of some of my RSUs, which obviously is a one-time event. You can't take that and project it going forward.

Michael Crawford - B. Riley Caris, Research Division

My question is, where do we think stock-based comp is next [indiscernible]

Neil P. Edwards

So Mike, we think on a quarterly basis, it's going to be somewhere between $1.9 million and $2.5 million.

Mark R. Goldston

Right. Right.

Michael Crawford - B. Riley Caris, Research Division

In the Communications, you're seeing -- I'm sorry, in Content, you're seeing some traction with your mobile strategy and what percent of the members -- of your members actually are accessing via the mobile platform?

Mark R. Goldston

We haven't disclosed that. I will say it's significant. I mean, we just started it a year ago. I really can't give you the number because we haven't disclosed it but have we said parametrically what it is?

Neil P. Edwards

No, I don't think we have.

Mark R. Goldston

So I can't give you the exact number, Mike. All I can tell you is it was pretty much de minimis a year ago and now it's significant. It is a major part of the Classmates business 1 year later.

Michael Crawford - B. Riley Caris, Research Division

Okay. And I know you're seeing declining declines in paid members. Is there a point on the horizon when you think you might actually see an increase instead of just smaller declines?

Mark R. Goldston

Well, I mean look, you're on the path, too, right? I mean, basically, these guys went from -- our folks went from losing 296,000 people a quarter to losing 30,000. The domestic division went from being -- it was bleeding to now being a real turnaround with major progress. And so, I mean, without making a projection, if you could plot the curve and you assume that these new programs, these 5 new monetization paths that have been launched in the past couple of months and which have great traction, that combined with a 25% increase in the site business, that combined with the lowest churn since 2004 when we bought the company, there's a thesis to be built there, that if all of this were to continue, yes, you would get to plus 1. And that's certainly the goal of everybody in that building in Seattle, if not everybody down here in Woodland Hills. I mean, we can't make the projection. Well, we could but we haven't and we won't. But I will tell you that all of the dials on the dashboard which would be indicators of whether or not you're on a path towards plus 1, are all pointing in the right direction. And that's the first time I could say that in years.

Operator

We'll go next to George Sutton with Craig-Hallum.

Jason Kreyer - Craig-Hallum Capital Group LLC, Research Division

It's Jason Kreyer on for George Sutton. First of all, as it relates to the FTD site, Amazon recently entered the flower market and it kind of creates another competitor in that space. But also, we've noticed that FTD kind of partners with Amazon in some ways. So I'm just wondering if you can walk through the relationship that you have with Amazon and exactly how that works on the FTD side of the business?

Mark R. Goldston

Well, I can't really give you the granularity on it, all I can tell you is we have a partnership with them as others have, as well and they have decided to go into this on their own. Amazon is in every category on the planet so I'm not sure why flowers should have taken them so long to do, but they are. And, look, they're doing tests, it looks like it's a small product menu that they're testing with, the last time I checked it. But what the FTD folks -- very confident in the business model with FTD, lots of innovative products. They got a great brand which is what people are shopping there because a rose is a rose and a tulip is a tulip. Really, it depends on what brand you're getting it from, how it's positioned, how it's arranged, what kind of accoutrements come with it, that's what makes FTD special. And we're not seeing any impact from Amazon at this point and it's not something we're particularly concerned about, to be candid with you.

Jason Kreyer - Craig-Hallum Capital Group LLC, Research Division

Okay. Well, I guess more specifically, in looking at the FTD product that Amazon offers, it looks like there's some price differences on the same products on the FTD site versus the Amazon site and is that a strategy that you're pursuing or is that just kind of a unique thing that we've noticed?

Mark R. Goldston

No. I mean, basically, look, when you compete in the -- you're finding that there are some sharper price points within the Amazon environment, is that what you're saying?

Jason Kreyer - Craig-Hallum Capital Group LLC, Research Division

Well, for FTD products, yes.

Mark R. Goldston

Yes. Well, listen, it's a promotional relationship and obviously, it will change depending on what day you go on there and what you're looking at. But, yes, there will be a moment in time where they may be offering things at a sharper price point just to try to move merchandise, just like you might take a particular branded product and find it at a sharper price point in Target one day than you might find it at Walmart or K-mart or Kohl's or somewhere else. So it's basically -- look, it's a competitive industry and day-to-day, they're dealing FTD and Amazon, with the rigors of the competitive environment that they live in and you will, on time to time, see things which may be promoted differently just like you do [indiscernible] the retail world. Really, no different.

Jason Kreyer - Craig-Hallum Capital Group LLC, Research Division

Okay. Okay and then switching gears to the NetZero opportunity here. We disclosed that the Verizon agreement has been terminated and I'm just wondering if you can give some color on what exactly that means for that business? Do you feel that's something that you need to replace or can you move forward and you're pretty comfortable with the Sprint opportunity you have?

Mark R. Goldston

Yes. So, yes, as it relates to the -- that agreement got terminated, it had been around for 30 days. They had some issues in being able to procure the service that they were going to be offering to us. But the beauty of it is -- or not the beauty of it is, but, for us, the silver lining is the Sprint deal for us, always, as we said, was the big important deal we've been trying to do for a couple of years because Sprint is providing us with both 3G and 4G LTE. And that is what's going to -- if we're going to be much bigger and more successful in mobile broadband, that's what we need. The other agreement that we terminated was only 3G. So if you think about it in sort of an ordinal ranking, we have a deal with Clearwire, which provides us with 4G WiMAX. And they have their coverage. We stated that they're a very good company with a very good product, but the coverage has been more spotty than our -- not to our liking. So we sought other partners. The only other partner that we have today who will provide us with both 3G and 4G coverage, covering approximately 200 million plus people is Sprint and that will start to rollout in Q1 of 2014. The other deal, Verizon, was just for Verizon global wholesale. It was just for 3G alone so we've got 3G redundancy with the Sprint deal and we've obviously got 4G with both Clearwire and Sprint. So, is it nice to have another partner? Sure. Is it mission-critical? Mission-critical to us is the Sprint deal because it is 3G and 4G LTE. And we continue, by the way, to talk to other people to gain other partners in that network. This is exactly the strategy that we successfully deployed on the dial-up business. If you go back and think about it, when we first started out, our original deal was with GTE/Genuity, BBN at the time. We then expanded to them plus level 3 and then we got to an entire network of providers and that's what Rusty and his teams are striving to do on mobile broadband. So the stable that we've got with Sprint and Clearwire, 3G, WiMAX and 4G LTE, going through '14, I think, is a great stable to have and should get the Communications division the growth they need.

Jason Kreyer - Craig-Hallum Capital Group LLC, Research Division

Just the last one for me then. Regarding the e-mail initiatives that you have on the Classmates side, I'm just wondering if you can talk a little bit about the conversion rates that you've seen on these, attracting additional site visits and if you think that's responsible for the 25% increase?

Mark R. Goldston

Yes, it's a really good question. So when you talk about the e-mail initiatives, just so I can clarify this for the transcript, you're thinking about the fact that when people visit Classmates, look at content, et cetera, where the recipient will get an e-mail prompting them to say somebody checked your website, somebody checked your photos, somebody checked your profile, that's what you're talking about, correct?

Jason Kreyer - Craig-Hallum Capital Group LLC, Research Division

Exactly. That's -- traditionally you've had 1 e-mail that you sent, that someone checked your profile. And now, you have 3 or 4 different ways to reach out to people, correct?

Mark R. Goldston

Correct. Yes, that is correct. And the response rate, the open rate, the response rates on those -- I can't give the exact numbers, are markedly and I mean, markedly improved over the past 12 plus months, which as you know, has been and is the lifeline of that Classmates monetization business. So, one, I think they're doing a much better job in terms of the subject matter that they're sending out in the e-mails, one; two, because now, they've got 5 monetization paths versus 1, those e-mails are more meaningful because there's more variety in them; and three, people are finding it to be very intriguing so they're coming to the site more often, they're staying longer, they're doing more, there's more to see and they're churning, therefore, at an all-time record low level. Because normally, when you see a dramatic reduction in churn in a subscription business, you look for a dramatic reduction in ARPU because typically, the only way you get a lower churn rate is by giving away the farm on your pricing. Massive discounting usually is what leads to lower churn. In this case, you look at the stability of that ARPU and a dramatic reduction in the churn and the only thing you could point to is that they have a much better user experience today than they've ever had before, which is evidenced in the open rate, the response rate, the engagement rate, the time on site and the churn rate. So all of those dials are pointing north, which is a very good thing.

Operator, it looks like that concludes the time that we've allocated. I'm going to say thank you to everybody. This has been an honor and a privilege. This is my 58th United Online earnings call, which is kind of stunning and I've truly enjoyed the time that I've had here. I've enjoyed working with all of you as investors and the analytical community. And I feel great about the company and the management that's in place and what they're going to be doing. And as I said, I hope that all of you will continue to stay engaged and follow the companies. Any questions you have, please direct them to either Neil Edwards, our CFO or David Bigelow, Head of Investor Relations here at United Online. And after Friday, those questions can be directed to Becky Sheehan, Chief Financial Officer and Jan Bitomi [ph] who will head up their Investor Relations at FTD in Downers Grove, Illinois. Thanks very much, everyone. Bye.

Operator

Thank you. This does conclude our conference. You may now disconnect.

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