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ValueClick, Inc. (VCLK)

Q4 2006 Earnings Call

February 21, 2007 4:30 pm ET

Executives

Gary Fuges – Manager of Investor Relations

James R. Zarley – Chairman and Chief Executive Officer

Samuel J. Paisley – Chief Administrative Officer

Scott H. Ray – Chief Financial Officer

Analysts

Aaron Kessler – Piper Jaffray

Youssef Squali - Jefferies & Co

Stewart Barry – Thinkequity Partners

Mark Mahaney – Citigroup

Mark Bacurin – Robert W. Baird & Co.

Heath Terry – Credit Suisse

William Morrison - JMP Securities

Eric Martinuzzi – Craig-Hallum Capital

Heather Chang - Merrill Lynch

Imran Khan - JP Morgan

Christa Quarles – Thomas Weisel Partners

Sameet Sinha – Kaufman Bros.

Clayton Moran – Stanford Financial Group

Richard Fetyko - Merriman Curhan Ford & Co.

Presenation

Operator

Hello and welcome to ValueClick’s fourth quarter 2006 earnings conference call. A replay of this call will be available by telephone beginning at 4:30 PM Pacific Time today and may be accessed through 10:00 PM Pacific Time on February, 28th 2007. Thereafter it can be accessed on ValueClick's website at www.valueclick.com or www.streetevents.com.

Previously found SEC filing can also be found on ValueClick's site. All lines have been placed in the listen-only mode to prevent any background noise.

After the speaker's remarks there will be a question and answers session. If you would like to ask a question, please press star one on your telephone keypad. Questions will be taken in the order that they are received. If you find that your question has already been asked and would like to withdraw your question, press the pound key on your telephone keypad.

At this time I'd like to turn the conference over to Mr. Gary Fuges, manager of Investor Relations for ValueClick Incorporated. Please go ahead, Sir.

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Gary Fuges

Thank you and good afternoon.

Welcome to ValueClick's fourth quarter and full year 2006 financial results conference call. Joining me on the call today are James Zarley, ValueClick's Chairman and CEO, Sam Paisley, Chief Administrative Officer and Scott Ray, Chief Financial Officer.

Today's call contains forward looking statements that involve risks and uncertainties including, but not limited to, trends in on-line advertising spending and estimates of future on-line performance based advertising. Actual results may differ materially from the results predicted and reported results should not be considered an indication of future performance.

Important factors which could cause actual results to differ materially from those expressed or implied in the forward looking statements are detailed under the risk factors section and elsewhere in the filings of Security and Exchange Commission made time to time by ValueClick, including its annual report on form 10K and an amendment to its annual report on form 10KA, recent quarterly reports on form 10Q and 10QA and current reports on form 8K.

Other factors that could cause actual results to differ materially from those expressed or implied in the forward looking statements include but are not limited to the risk that market demands from on-line advertising in general and performance based on-line advertising in particular will not grow as rapidly as predicted.

ValueClick undertakes no obligation to release publicly any revisions to any forward looking statements to reflect events or circumstances after the date here of, or to reflect the occurrence of unanticipated events.

With that I would like to turn the call over to Jim Zarley. Jim?

James R. Zarley

Thank you Gary. Good afternoon and thanks for joining us for ValueClick's fourth quarter 2006 conference call. I'll start with some comments on the quarter results and then Sam will provide more details on the financials and I'll return with a few comments on our outlook and then we'll take your questions.

The fourth quarter was another strong year for the company. Fourth quarter revenue, adjusted EBITDA, and EPS all beat the high end of our guidance fringes. We continue to benefit from the integration of our 2005 acquisitions, execution, and leadership positions in performance marketing solutions.

This was a strong quarter from top to bottom. Revenue increased 38% year-over-year to a record $160.4 million, $12 million above the high end of our guidance range of $146–148 million.

Full form organic growth is also 38%. All segments posted strong performance. Gross market expanded year-over-year and operating margins improved 260 basis points year-over-year to 22.4%.

Adjusted EBITDA was a record $46.1 million, more than $6 million above the high end of our $38–40 million guidance range. Adjusted ABITDA margin was 28.7% in the quarter and earnings per share was $0.22 which was $0.04 better than the high end of our $0.17-0.18 guidance range.

In this order we started reporting our four worldwide operating segments; media, comparison shopping, and affiliate marketing and technology. You'll find eight quarters historical financial performance by these segments in our earnings press release.

Media culmination was exceptional for the year with a fourth quarter year-over-year revenue growth of 43%. The synergies of integrating our 2005 acquisitions continue to pay off. Our scale on leadership position in ad networks and CPA campaigns allow us to capture more of the advertising budgets.

The key differentiator is not just the scale of the inventory we're selling but it's about adding value to the on-line inventory that helps our advertisers and publishers achieve their desired results. The combination of relationships, optimization technologies, behavioral targeting, active account management, and back off assistance position us to execute for both our advertisers and publishers thereby differentiating us in the market place.

As we continue to grow our large scale advertiser ROI and publisher eCPMs, we become even more entrenched with our partners. We see advance behavioral targeting in video as a future growth opportunity and we stand to benefit from the great reach we have in our network. We're also seeing early stage traction from lead generation in Europe and while it's early of course in these areas, we expect all to contribute to media throughout 2007.

Comparison shopping grew 49% year-over-year during the quarter. In December we acquired londonbayshopping.net which owned websites that provide comparison shopping search and variable market content to European on-line consumers.

Our European operations have already integrated shopping.net which will expand our presence in Europe and offer traffic opportunities to our European media and affiliate marketing businesses.

Adjusting per shopping.net comparison shopping organic growth was also 49%. Affiliate marketing growth accelerated 23% year-over-year versus 18% in 2003. We continued to grow the existing business while adding clients that help fuel growth going forward.

In 2006 we signed a record number of new clients in the US and in Europe including 18 clients apart from two of our largest US competitors. We expect these new clients to contribute in 2007.

Also in 2006 we entered into the final stages of migrating the remaining BEFREE platform legacy clients onto the commission junction platform. Since the acquisition of commission junction of December of 2003, we've enhanced the commission junction technology to incorporate some of the things that we did at BEFREE. Since these enhancements, we've only added new clients to the commission junction platform.

And while slowly migrating BEFREE clients to minimize the client disruption in 2006, we accelerated the process which had a small negative impact on the revenue during the year. But once the migration is completed we expect to see (inaudible) $2 million in the annual operating cost.

I'm optimistic about affiliate marketing. Our advertiser base is growing. Our affiliate marketing network is strong. And we're adding services like (inaudible) marketing, and creative website development that can provide additional growth going forward. We believe there are additional opportunities also with our other divisions as well.

Technology had a very strong quarter, up 20% year-over-year. Growth is being fueled primarily by new product enhancements. And the total revenue on a geographic basis grew 37% in the US and 43% in Europe. Europe now accounts for 14% of our revenue base and all four European business segments contribute to growth and profitability.

Now I'd like to turn the call over to Sam for some more details on the quarter and our preliminary 2007 guidance. Sam?

Samuel J. Paisley

Thanks, Jim. Before I discuss our financial results I want to mention that fourth quarter 2006 results include one month of activity from shopping.net which was acquired in December of 2006. Shopping.net's contribution was immaterial for the quarter's overall results.

I should mention we are now providing operating results across four global business segments: media, comparison shopping, affiliate marketing, and technology. We're reporting revenue, gross profit, and operative income for each segment.

In the fourth quarter of 2006, ValueClick generated revenue of $160.4 million, a record for the company and an increase of 38% over 2004-2005 revenue of $116.6 million. Revenue was $12.4 million above the high end of our guidance range of $146– 48 million.

Organic growth which includes the historical performance of the shopping.net acquisition was also 38% year-over-year. Gross profit was $112.6 million for the fourth quarter of 2006, an increase of 46% compared to gross profit of $77.3 million for Q4 of 2005. Gross margin expanded to 70.2% in the fourth quarter of 2006 from 66.3% in the fourth quarter of 2005.

Gross improvements were primarily due to improvements in the company's media gross margin since the FastClick acquisition, and an increase in a mix of lead-generation revenue in 2006.

Operating expenses, excluding stock-based compensation and amortization expense, totaled $69 million or 43% of revenue in the fourth quarter of 2006, compared to $46 million or 39% of revenue in Q4 2005.

These operating expenses increased primarily due to additional marketing expense and support, a significant growth in our lead-generation revenue, and an increase in corporate expense of $2.5 million, primarily attributable to Sarbanes-Oxley compliance costs.

Stock-based compensation in aggregate was $2.4 million during the fourth quarter of 2006, compared to $1.9 million in 2005. This increase is due primarily to the adoption of new accounting rules for stock-based compensation.

Amortization of intangible assets was $5.2 million during the fourth quarter of 2006, compared to $6.4 million in 2005. The decrease is due to the roll-off of amortization of intangible assets acquired prior to 2005, partially offset by amortization of intangible assets related to our 2005 and 2006 acquisitions.

As a result of this performance, the company generated an operating income of $36 million in Q4 2006, a 56% increase compared to operating income of $23.1 million in 2005. Operating margin increase 260 basis points to 22.4% in the quarter, versus 19.8% in the year-ago period.

Net-interest income was $2.4 million for the fourth quarter of 2006, compared to $1.6 million in Q4 2005, due primarily to higher cash balances and improved investment yields in our marketable securities portfolio.

Income tax expense for Q4 2006 was $16.4 million, with an effective tax rate of approximately 42.5%.

These figures result in fourth-quarter 2006 net income of $22.1 million, or $0.22 per share, based on the weighted-average number of 100.2 million fully diluted shares. This was $0.04 above the high end of our $0.17-$0.18 per-share guidance range.

The adjusted EBITDA was $46.1 million for the fourth quarter of 2006, $6.1 million above the high end of our guidance range of $38-40 million. Fourth quarter of 2006 adjusted EBITDA margin of 28.7% was in line with a Q4 2005 margin of 28.9%, in spite of a $2.5 million year-over-year increase in corporate expenses, attributable primarily to Sarbanes-Oxley compliance costs.

This corporate expense reduced Q4 2006 adjusted EBITDA margin by 150 basis points.

For fiscal year 2006, ValueClick had strong, organic revenue growth and expanding margins. On a pro-forma basis, adjusted to the effect of acquisitions, organic revenue growth was 34%, matching 2005's year-over-year growth rate.

Pro-forma 2006 gross margin improved from 65.6% in 2005 to 69.4% in 2006, and pro-forma adjusted EBITDA margin expanded from 25% in 2005 to 26.7% in 2006, in spite of an $11 million increase in corporate expenses in 2006, primarily attributable to Sarbanes-Oxley compliance codes.

The consolidated balance sheet as of December 31, 2006 remains strong with $282 million in cash, cash equivalents, and marketable securities, approximately $640 million in total stockholders' equity, and no long-term debt.

In the second and third quarters of 2006, ValueClick invested more than $103 million to repurchase 6.9 million shares of the company's common stock, or approximately 7% of total outstanding shares.

Capital expenditures were $2.7 million in Q4 2006, and approximately $10 million for the full year.

I will now discuss the fourth-quarter performance of each of our four new worldwide business segments.

As shown in more detail in today's press release, operating-segment income excludes corporate expenses, amortization of intangibles, and stock-based compensation.

Worldwide media revenue increased 43% to $111.6 million in the fourth quarter of 2006, compared to $77.9 million in 2005, due to strength in both our U.S. and European media businesses. Lead-generation revenue growth remains strong in the U.S. Market, and we continue to benefit from our leading display advertising network.

Media's gross margin of 64.4% improved from 56.5% in 2005, due to improvements in gross profit FastClick integration and an increase in the mix of lead-generation revenue in 2006. Segment-operating income increased 47% year-over-year, with a Q4 2006 margin of 25.4%, improving from 24.8% in the year-ago quarter.

Worldwide comparison-shopping revenue increased 49% to $8.8 million in the fourth quarter of 2006, compared to $5.9 million in 2005, primarily due to both strong growth in established markets and contribution from emerging positions in Germany, France, and the U.S.

Gross margin of 89.9% declined slightly from 96.3% in 2005. The segment-operating margin expanded to 23.1%, from 21.8% in the year-ago quarter, due to improved operating leverage.

Worldwide affiliate marketing revenue increased 23% to $32.7 million in the fourth quarter of 2006, compared $26.7 million in 2005, primarily due to the strength in both the affiliate marketing and in search business.

Year-over-year growth accelerated from 18% in Q3 2006. Gross margin of 81.5% declined from 85% in 2005, due primarily to the increased mix of search revenue. The segment operated margin increased to 56% from 53.7% in the year-ago quarter due to improved operating leverage in the business.

Worldwide technology revenue increased 20% to $7.7 million, compared to $6.4 million in 2005, primarily due to growth both in the U.S. and Europe. The gross margin of 82.1% expanded from 78.8% in 2005, and segment-operating income increase to 40% from 30.4% in the year-ago period.

Today we will be providing initial 2007 guidance. For the first quarter of 2007, ValueClick anticipates revenue in the range of $148-149 million, a 26-27% increase from first quarter 2006 reported revenue, and an organic growth rate of 25-26% compared to pro-forma Q1 2006 revenue.

We anticipate adjusted EBITDA in the range of $38-39 million for the first quarter of 2007, with an adjusted EBITDA margin of 26%. We anticipate diluted net income per share of $0.17, including stock-based compensation expenses of $0.02 per common share, based on an expected share count of approximately 103 million fully diluted shares.

For the full year 2007, we expect revenue of approximately $645-665 million, which represents 20% growth at the midpoint, compared to 2005 reported revenue. Organic growth year-over-year is anticipated to be approximately 17-21%.

We expect adjusted EBITDA in the range of $175-180 million, with an adjusted EBITDA margin of 27%. We anticipate diluted net income per common share of $0.78-$0.80, including stock-based compensation with $0.11 per common share, based on an expected share count of approximately 103 million fully diluted shares.

The full year 2007 guidance assumes approximately $20 million in amortization of the tangibles, approximately $10 million in depreciation, $18 million of stock based compensation, and effective income tax rate of 42.5% and capital expenditures of $10-12 million.

I will now turn the call back over to Jim for some closing comments.

James R. Zarley

Thank you Sam, thanks everyone who joined us on the call today. 2006 was another strong year for the company. We capitalized on synergy opportunities from our 2005 acquisitions to make ValueClick a significant leader in its co-offerings.

In 2007 we expect marketing dollars to continue to flow to the online space. With our large-scale display network, lead generation products, affiliate marketing product and comparison shopping services, and technology, we believe that we’re in a strong position to capture our fair share of the expanded market place.

In 2007 we expect emerging areas like video behavioral targeting to continue evolving and play a larger role in our media business, which will position us for strong growth in 2008 and beyond. We also expect continued growth and investment in expanding our affiliate marketing division with additional product enhancements such as graphic expansion.

Concerning M&A, we continue to be very active in looking for creative transactions and utilizing our cash wherever possible. We feel good about our performance in 2006 but we expect more to come in 2007.

Now I’d like to turn the call over to the operator to take your questions, Operator.

Question-and-Answer Session

Operator

The question and answer session will be conducted electronically, to ask a question please press the * key followed by the digit 1 on your touchtone telephone. Again that’s *1 to pose your questions.

We’ll have our first question from Aaron Kessler with Piper Jaffray.

Aaron Kessler – Piper Jaffray

Hey guys, great quarter. Couple questions, first on Media visibility, whether it was from the ad network or it was the CPA side or really a combination, on the Q1 guidance it looked like revenues were down about 7%. I’m trying to get a sense for the conservatism there, as last year it was approximately flat. And finally, I just want to get a sense for any of that attraction you’re getting on the video network product.

Thank you.

James R. Zarley

Aaron, the lift really came from both the display side but also the lead generation side… really just the difference in the billing dynamics. CPA continues to have great lift, where there is very little risk for the advertiser.

What was the second part of the question?

Samuel J. Paisley

The second part of the question was on the Q1 2007 guidance, it’s about 7% downdraft from fourth quarter 2006, that’s not an unusual seasonal pattern if you will, and we expect to have similar seasonality in 2007. The only thing about our progression in the quarters in 2007, in comparison to 2006, we had a pretty significant expansion in growth in Q2, mostly because of company specific internal matters concerning the integration of the 2005 acquisitions.

We had pretty good uplift in the second quarter of 2006 against first quarter 2006. We don’t expect to see that kind of uplift in 2007.

Aaron Kessler – Piper Jaffray

Got it. And finally something about the video network, can you give us a sense for what strengths are there? Maybe what percent do you expect to see from video network as a percent of your ad network business?

James R. Zarley

Aaron, it was a very small amount of business in Q4, as we’ve said before we think that this is an evolutionary transition to video. We’re very excited about the future of it. What percentage will it be of our business or growth of our network, I’m not sure at this point, but it is evolving and we feel very positive about its future.

Aaron Kessler – Piper Jaffray

Great, thank you.

Samuel J. Paisley

By the way, before we move to the next question, I just wanted to make a point of clarification. In the script I think we mentioned that our full year 2007 guidance was 20% growth at the midpoint over 2005, we really meant to say 2006 reported revenue.

So that’s 20% at the midpoint ’07 guidance against reported 2006 revenue, and the organic growth rate we’re expecting is 17-21%.

Operator

We’ll have our next question from Youssef Squali with Jefferies

Youssef Squali - Jefferies & Co

Thank you very much, Youssef Squali. Congratulations yet again on another strong quarter. By the way, thanks for the extra granular insight into the shopping business.

So my two questions, first on the implied guidance, Sam you just talked about 20% year on year over ’06, 17-21% organic. So in ’06 that number was 34%, if we look at kind of how fast the industry by in large has grown, we think it’ll probably grow somewhere in the mid-twenties (inaudible) ’07.

Is there any reason to believe that you guys will grow below industry norms, assuming that we’re correct? Are there any things in ’07 that you think may hamper your continuation of the growth you’ve seen?

And then I have a quick follow-up.

James R. Zarley

Yeah, Youssef I think that what you’ll see in ’07 is a more normalized growth. We’re growing closer to what the market is growing in ’06. We outgrew the market primarily because of some of the synergies that we were getting from the 2005 acquisitions, improving the margins of FastClick, but also then bringing the lead generation products and having a single sales force assisting in selling those products.

So we got a lot of great lift, and it really started in the second quarter of 2006. If you look at the numbers, and what we were quoting back there, you can see the spike that we got as a result from synergies.

So I think we’re pretty much in sync with kind of where the market is going, where other companies have kind of guided. I think we’re in sync with most of the analysts that have numbers out on us. I think we’re kind of agreeing that the numbers we’re guiding are really what we’ll do in 2007.

And I think as far as the research companies, we’re pretty much in line with them as well. So if the market grows 20%, I think we’ll get our share of that growth as well.

Youssef Squali - Jefferies & Co

But your saying at the same time that if the market were to grow faster, you don’t see any reason why you shouldn’t grow?

James R. Zarley

No I don’t see a reason why we would be behind the market.

Youssef Squali - Jefferies & Co

Ok, and then second, your affiliate marketing growth accelerated. We were actually surprised by how strong that is. How sustainable is that in ’07? And was there any particular client that accounted for that big bump?

James R. Zarley

I think there were several major clients that we did put on through the year that really started giving lift in the fourth quarter. But we also had lift in the fourth quarter as a result of the initiative that we’ve had with search engine marketing. I think that contributed to it as well.

Youssef Squali - Jefferies & Co

Ok great, and just one last clarification. I think you talked about some synergies between Commission Junction and BeFree resulting in some $2 million in annual cost savings. We’re you talking about ’06 or ’07?

James R. Zarley

’07, and depending on when we finished the migration, Youssef, we’re in the final stages of it, but we’re not going to just force anyone off because we frankly don’t want to lose the business, so we’ve been working very closely with the folks.

We haven’t been very outspoken about this in past quarters because we really didn’t want to trigger a feeding frenzy on the part of our competition to go out to our entire client base at BeFree and try and swing them over. So we’ve been kind of under the radar on it, this is the first time we’ve really spoke of it.

But since we’re in the final stages of it we wanted to bring that out, and there were some small revenue hits that we had through ’06 as a result of some of the folks just basically not continuing on with their current program, basically eliminating the affiliate marketing program all together.

So we wanted to get through all of that before we went public with these kinds of discussions. We didn’t want to have any of our customers move over to our competition.

Youssef Squali - Jefferies & Co

Great, thanks a lot.

Operator

On the call next is Stuart Barry from Thinkequity.

Stewart Barry – Thinkequity Partners

Hey thanks and congratulations. Can you guys discuss a little bit about what private company, private market multiples are doing for performance marketing companies? Can you comment a little bit and what are your strategic priorities?

James R. Zarley

You mean what are private companies expecting for their multiples?

Stewart Barry – Thinkequity Partners

Yeah, I mean if you’d seen those trending downward or upward, you know over the last six months and…

James R. Zarley

Outrageously high at this point.

Stewart Barry – Thinkequity Partners

Right.

James R. Zarley

Especially with some of the stuff that was announced by AOL in the tradewar acquisition. And as you know, I think that deal got killed. I don’t know if it’s still alive or not, but those things have made it extremely high.

While we would still love to acquire our competition, part of the difficulty in doing that is if you are going to go to one platform like we have with BeFree and Commission Junction. It’s a long process to migrate, but also it’s hard to get 100% of what you’re buying. So, we’ve kind of felt that we would not probably be able to buy one of the major competitors.

There are three major competitors in the market that we would identify. And instead we are really focusing on growing things like creative services and search engine marketing and other services within affiliate marketing.

And over time, maybe some of the smaller players will get more realistic. Especially if they read what we are spending for shopping, golfing and some of the other things, makes them realize that it makes a lot more sense to team up with someone than it is to try to go public.

Stewart Barry – Thinkequity Partners

Okay. Can you address kind of specifically what were the products enhanced in technology that you saw a big reacceleration growth net unit? Can we expect that type of growth in 2007? How much is this company’s specific versus the overall environment getting better for technology?

James R. Zarley

Well some of the technology enhancements and affiliate marketing, we’re really configuring some of those things that BeFree had in their systems so that we can move people over and be somewhat seamless but also through enhancement…before I could increase their revenue that they were currently getting with BeFree.

So far, there’s other enhancements. There are things that we’re doing selectively with all of the technology platforms that we think are late 2007 perhaps even 2008 whereby we’re sharing information of the data between the platforms. That’s something we have not done in the past, but represents a pretty significant opportunity we believe in the late 2007, early 2008 time frame.

Stewart Barry – Thinkequity Partners

OK, just specifically that technology business did very well. Is that company specific or is that sort of just the overall market? I think your peers are doing very well there as well.

James R. Zarley

Are you speaking just of our technology?

Stewart Barry – Thinkequity Partners

Right.

James R. Zarley

We had some good lift in technology for a change. They have done very well in developing.

In the end, we really developed them like big management and search engine marketing and things of this nature. Folks that are in our media flux division have done a great job of going out and capitalizing, winning some of the market.

We continue to be a little skeptical of just how big that market will be over the long haul. We said in other conferences that we believe that that business today maybe at $300-350 million industry.

Stewart Barry – Thinkequity Partners

Right.

James R. Zarley

If you are looking to be a multibillion dollar company like we are with revenue, is that where you want to put your eggs? So we have focused more in the media space and in the affiliate marketing space because we think there are just a lot more opportunity revenue wise.

One of things that I do want to say about…since we’re talking about affiliate marketing and Commission Junction, there have been two rumors that had been out there in the press that Commission Junction might be for sale. Commission Junction is not for sale and never has been and we don’t intend that it would be for sale.

Operator

We’ll have our next question from Mark Mahaney with Citigroup.

Mark Mahaney – Citigroup

Thank you, two questions please. First, any details on comparison shopping particularly in the U.S. market. What kind of traction price runners are you having in the U.S. market? Are you happy with that now?

Secondly, I know that you mentioned that video offering has had limited traction to date. You’re pretty modest about the outlook for it. Worth become material, what kind of impact would that have on the margins for the media business given the theoretically much higher CPM’s but also probably likely a higher cost associated with it.

Thank you.

James R. Zarley

Okay Mark, let me start with the comparison shopping question. I would say no we are not happy with the growth that we have had in the U.S. It’s been slower than we anticipated. In other countries as well, in France and Germany, it’s been somewhat slow, slower than what we anticipated.

It’s all about being able to get the free traffic and it’s just not as plentiful as it was three, four, or five years ago. So, we continue to work on helping to increase that. We would still be very open to either acquiring more verticals, a little bit like we did in the UK with shopping.net and do that here in the U.S. to jumpstart and get that moving a little bit quicker.

We know what the margins will be once we get our scale. We think we are probably still a year away from getting this scale that we would like to see here in the United States. So no we are not really pleased with the speed of which this has grown.

Our boys are working very hard on it. It’s something that we are still committed to and if we do have an opportunity to help it along by acquiring a few verticals or even somebody outright here in the U.S. that might want to sell their position off to some of the larger comparison shopping players, we would be interested in that.

As far as video is concerned, as we said in the past, video will be an evolutionary product, not revolutionary product for us. I can’t quite give you a clear idea of what it will do to the margins, but obviously it will increase. It should increase pretty substantially if the prices that we’re seeing initially now in the video area continue to hold.

Mark Mahaney – Citigroup

Thank you very much.

Operator

We’ll go next to Mark Bacurin with Robert W. Baird.

Mark Bacurin – Robert W. Baird & Co.

Thank you and good afternoon and my congratulations for a great quarter.

James R. Zarley

Thanks Mark.

Mark Bacurin – Robert W. Baird & Co.

A couple of things. I guess go back to the affiliate marketing and the rebounding growth there. I know that you guys have been going through this link management initiative for several months now and it sounds like that it is largely completed which is why you are talking about some of that.

Can we read into the fact that the fourth quarter saw a nice rebound and revenue that kind of works most of the turn issues there and we’re back to more normal year to year trends?

James R. Zarley

Yeah, Mark I heard you mention link management. The link management is really different than the migration. We pulled back on length management. We still think that over time that that’s what the advertisers are probably going to demand. We’re not demanding it of our publishers right now.

We’re really focused on is to try and get BeFree and Commission Junctions platforms merged together. We would hope that some time, hopefully closer in the first half of this year, that we will have that behind us and that’s when we expect the $2 million cost savings on an annualized basis.

Mark Bacurin – Robert W. Baird & Co.

So the link management issue was not part of the conversion then?

James R. Zarley

No.

Mark Bacurin – Robert W. Baird & Co.

Okay. But you have rammed back in that process for the time being.

James R. Zarley

We pulled back on that.

Mark Bacurin – Robert W. Baird & Co.

OK.

Second, just talking about nice margin improvements in the media segment.

Obviously some of the upside in the margins was the process of getting the FastClick.

What publishers converted over to your traditionally value click revenue sharing model?

Just wondering where you stand on that process and how much additional upside we might see a margin or whether or not that process is completely finished and we don’t have any of that as the tailwind of 2007.

James R. Zarley

Yeah, I did Mark. We’re done with the FastClick immigration. That’s been completed for probably three or four months now.

One of the things that Mark Mahaney mentioned a little earlier was the potential of market upside if video really takes off. And I think we're in a normalized pattern right now without video really kicking in. If video really kicks in, then I think we'll see some more increase.

Mark Bacurin – Robert W. Baird & Co.

Maybe clarify, to understand the integration I guess as well as complete, but that happened over the course of '06. But I'm wondering, do we still get some of that lift year-over-year in the first half, and then it becomes tough for comparisons in the back half of '07?

James R. Zarley

We may get some over the next quarter or so, but I think we'll be done by that time.

Mark Bacurin – Robert W. Baird & Co.

Okay, great, thanks. Congratulations again.

Operator

Our next question comes from Heath Terry with Credit Suisse.

Heath Terry – Credit Suisse

Great, thank you. I was wondering if you could give us an idea as to what percentage of your ad network inventory right now is going to CPA, and at what point do you think that starts to max out?

James R. Zarley

Yeah, we have not given out those kinds of numbers for obvious reasons with competition. But I would say that a very high percentage of what we do is on a CPA basis.

Heath Terry – Credit Suisse

OK, and are...

James R. Zarley

Whether it be lead generation, or whether it be display advertising.

Heath Terry – Credit Suisse

Okay, and so, I know that originally a big part of the FastClick acquisition was moving over more of your inventory over to that CPA model. Should we assume, based on what you just said, that you've more or less kind-of fully exploited that opportunity?

James R. Zarley

Yeah, I think we have capitalized on that opportunity. And I think that even in our display side, that you'll see more of it over time going to CPA.

Heath Terry – Credit Suisse

Okay, and then, just back on the video question. At this point when you look out at the size of your network, and your network partners there, what portion of them, would you say, is capable of hosting video advertising? And for the ones that aren't, how tough of a hurdle is that, as you start to see more demands for that time of inventory?

James R. Zarley

Yeah, I think the last that we spoke of is 25% of our network is video capable. And 25% of our network was in the process of becoming so. So I think we'd be safe to say that half of our network will be capable of doing that.

Heath Terry – Credit Suisse

Great. Thank you.

Operator

We'll go next to William Morrison with JMP Securities.

William Morrison - JMP Securities

Hi, thanks. I hate to beat a dead horse, but on video, I was wondering maybe if you could talk about some of the factors to seeing faster acceleration in that part of your business? Is it coming from inventory standards? Video standards for advertisers? I imagine the demand is very high from advertising. I was just curious what is kind-of preventing that from becoming a bigger business faster for you guys?

And then, secondly, I was wondering, Sam, if you could give us what your operating cash flow was in the quarter, and confirm...I think I heard you say that you were forecasting 103 million shares for the first quarter, and the full year…just wanted to confirm that I heard that right.

Samuel J. Paisley

Right. Well, let me deal with the last question first and then also make some comments on the complexities relative to growth in video.

Our projections are 103 million fully diluted shares, and that's based on measuring dilution at current share prices, if you will. Keep in mind that as we were in the fourth quarter of 2006, the average share price for the company was actually significantly lower than it has been coming into the first quarter here.

So the effects of the dilution of options that had previously been granted is part of the factor that drives that number up. And we can't in anticipating guidance…we can't really take a look at too aggressively forecasting future price increases throughout the year. So 103 million is kind-of where we are in that regard. And we think that's a reasoned guidance number, if you will.

With respect to the video ad product, there are a number of variables.

The first one is that we probably will not be in a position where a single video player becomes the standard. A lot of the proprietary owners of content have invested in their own players. A number of the sites across our network have already committed to what they consider to be a solution for playing video streams.

So our technology solution that we’ve comprehended allows for that environment. So we have our own capability relative to a video player, and we have a very flexible idea in the implementation of a technology solution so we could accommodate other preferences that our publishers and our content owners might have relative to whose video player will be used to do the rendering of both any proprietary content that’s sandwiched in between us, or the video content of an ad itself. And that implementation process is always something that takes some sorting out.

The second aspect is really for proprietary content owners. Who own the proprietary content? And is it under a specific license agreement that freely permits the owner to monetize the ad units, or ad units that might be at either end of that content string? So there are contractual limitations relative to the ad unit.

And then lastly, you have to reach a business agreement on relative sharing of the ad revenues if you will. And you have to have reasonable expectations on the part of the content owner, the part of the distribution partner, and on the part of the intermediary/technology solution provider. And until all of those things begin to develop in a way that everybody can say yeah, now I understand what I’m going to get out of the overall pie, we’re not going to have significant acceleration in those revenue streams. So it is a value stream that has quite a few moving parts.

William Morrison - JMP Securities

Great, and the operating cash flow Sam?

Samuel J. Paisley

I’m sorry, state that question again.

William Morrison - JMP Securities

I asked about what the actual operating cash flow was, and I don’t believe you have a cash flow statement in the release, so I’m just curious what the actual operating cash flow was in the year…so we can get to a free cash flow number.

Samuel J. Paisley

You know I’m going to have to get back to you on that because…you’re talking 2006, is that right?

William Morrison - JMP Securities

Yep.

Samuel Paisley

So the full year EBITDA number…I’ll give you some insight on that…the full year EBITDA number was … adjusted EBITDA was $145 million. We did state that the CapEx for 2006 was about $10 million. And we’ve indicated before, and I think it’s still a pretty good guidance number, that cash taxes paid are expected to be something in the range of 20% or so of the booked tax provision. So call that about $10 million.

And the other movements in working capital haven’t been finalized yet as we’re moving towards the 10K, but those out to give you a pretty good impression of what the operating cash flow might be pegged at.

William Morrison - JMP Securities

Thanks a lot, that’s very helpful.

Operator

We’ll go next to Eric Martinuzzi of Craig-Hallum.

Eric Martinuzzi – Craig-Hallum Capital

Thanks, the organizational changes that you’ve undergone to this point, I understand now that you’re reporting on the four segments. Were there organizational changes that also took place behind the scenes? And could you comment on headcount, where you finished 2006, where you plan to grow to over 2007, and which of the segments picks up the most people?

Samuel J. Paisley

Well with respect to the organizational changes, honestly in the different segments…the auditors and accountants really have to consider the management reporting structure. We had some changes that occurred throughout and during the course of 2006, there really haven’t been any changes in that regard, the total headcount I believe is still sitting around worldwide 1100.

James R. Zarley

Yeah, actually maybe a little bit higher level. Maybe 1050 to 1100, Eric. I wouldn't expect that it would be over 12-1250 in 2007.

Eric Martinuzzi – Craig-Hallum Capital

Okay and then as far as which of the four segments sees the percentage wise employee growth significance?

James R. Zarley

We're going to have growth on the affiliate marketing side and we're going to have growth on the media side. I would anticipate that {inaudible} comparison shopping will have minimal growth and technology will have minimal growth.

Eric Martinuzzi – Craig-Hallum Capital

Okay. And then lastly, just the search business, I hadn't heard you comment before that that sounded like that was a positive...there was upside in the quarter on search. Is this the search123 business or is this something different?

James R. Zarley

No this is search engine marketing, Eric. We've been investing in expanding out our search engine marketing services and commission junction and some of that headcount that we talked about is going to be really to that area.

I don't know if you recall but when we bought FastClick about a little over a year ago now, they did have a search engine marketing initiative. What we did with that technology is we took the technology and rewrote it to serve our internal needs. And if you recall we said that we believe that search engine marketing for us is an internal service that we would offer not so much a separate product that we go out to the market place with.

And that's what we're doing with it right now. They did finish redeveloping that product in 2006. We launched to, oh I'd guess in the second half of this year and start hiring people to go into the commission junction install base and start offering those services. And it's doing quite nicely. We're up to maybe 17 or 20 people. We think that could probably triple by the year.

Samuel J. Paisley

And one of the other things that we measure our operating leverage on is really revenue generated by employee. And as we've often referenced in the fourth quarter of 2006 we didn't have to add a lot of bodies in order to be able to deliver the revenue level that we achieved in that quarter.

So we're generating, in an up period, operating leverage per employee at well over $600,000 in revenue per employee. So that's one thing you should keep in mind with respect to our business. We get a lot of leverage on each employee relative to the fact that they're working on sophisticated technology platforms, structured data bases that allow us to conduct for our activities, and obviously establish long-term relationships on both the publisher network side as well as with advertisers.

Eric Martinuzzi – Craig-Hallum Capital

Thank you.

Operator

We’ll go next to Heather Chang with Merrill Lynch.

Heather Chang - Merrill Lynch

Hi, just a couple of questions. My first one, being given the strength in the affiliate marketing this quarter with 23% growth I was wondering, you know, what that normalized growth does look like? You know, in the past you've mentioned like a mid-20% growth based on your old segments but I was kind of wondering what that is for your new break out?

James R. Zarley

I think we are holding pretty much to that Heather, that we would expect the affiliate marketing to grow in that mid 20's range throughout 2007.

Heather Chang - Merrill Lynch

Okay. And then my second question relates to margins. Looking at your EBITDA guidance you're looking at like 27% EBITDA margins which is slightly up from your 26% this year in '06 so I guess we'll see. You mentioned some possible, aside from video, but I presume that's kind of not really in there. So I'm wondering which segment you really expect to see some of that margin potential?

James R. Zarley

Alright I hope that some of our G&A classes would help.

(laughter)

We kind of just gave them the whole bank account this year. But we do think that there are some savings there next year so...

Heather Chang - Merrill Lynch

Okay. So if this goes back to corporate costs then...

James R. Zarley

That's correct.

Heather Chang - Merrill Lynch

Okay. Thank you.

Operator

We’ll go next to Imran Khan with JP Morgan.

Imran Khan - JP Morgan

Yes, hi thanks. Two questions. Number one, you know, if I look at the affiliate business, it had very nice market improvement on a year-over-year basis. How should we think about the longer term margins for that business? And second, since you didn't buy back any shares this quarter, I was wondering what's your view about share-buy-back? Thanks.

James R. Zarley

Briefly that the markets for the affiliate will continue to hold and that it has scaling although we will have some investments as we mentioned earlier with the search engine marketing and perhaps opening real markets but also to expand into some other creative design side which we currently are turning over to others.

The second part of your question was...

Imran Khan - JP Morgan

Yeah. About share-buy-back.

James R. Zarley

Yeah we just, some of that noise you hear in the background is Sam kicking himself for not buying more.

(laughter)

But it seems like every time we went into the stock-buy-back program and we set a number for ourselves and said, "OK we're going to buy in this region" that we always looked back on it and have remorse that we weren't a little more aggressive with it.

I don't think that today you're going to see us initiate anything immediately because we continue to be hopeful that we can use our cash more productively by finding cash purchases of other, either peripheral sort of businesses that we're looking for.

Samuel J. Paisley

We still have $66 million worth of authority available to us under the current buy-back program, however.

Imran Khan - JP Morgan

Right, yeah. But you didn't buy back anything on the fourth quarter and I was wondering if the opportunity brought cash.

Samuel J. Paisley

No.

Imran Khan - JP Morgan

OK that's it. Thank you.

James R. Zarley

Okay, thank you.

Operator

We'll go next to Christa Quarles of Thomas Weisel Partners.

Christa Quarles – Thomas Weisel Partners

Hi. Just two questions. First, looking quickly at the percentage of product development, spending was a little bit lower in the fourth quarter and I was just wondering, certainly there's a seasonal list of revenues, I was just wondering from an investment standpoint in '07, would you expect that to increase and what are the primary projects you're looking at there?

And the second question was, clearly web-clients has been a phenomenal success. What happened the case success factors there and what do you see as the driver of it? Having the access to the ValueClick inventory, etc? Thanks.

James R. Zarley

You know, Christa, I think the success of web-clients has been A) due to the fact that they have a phenomenal technology capability and when we came together we did two things, well three actually. We did have some additional inventory that we could pass on from other of the divisions but we also were able to take the current lead generation business that ValueClick had and poured it over to web-clients technology. The third key component was that we were able to take our 25-30 sales reps that we had in ValueClick media display sign and have them sell and assisted selling the web-client's product.

And what happened as we saw, we had a very good deal flow, we'd been able to go out and either build or acquire the content and then the outstanding team that we have in Harrisburg along with their technology really executed marvelously on delivering those campaigns that were being sold.

The second part of the question was...?

Oh yeah, I'll deal with the general in a minute. In terms of the technology, you know, we already have capabilities. (inaudible) is the behavioral targeting optimization technologies and also video screening, but given the opportunities in those areas in fact they can never be good enough. Those are areas that we continuously place emphasis on relative to developmental activities. And I don't see that changing quite frankly.

Samuel J. Paisley

And in addition to that, Christa, I think that you'll see what we constantly are doing is refreshing the hardware in our system to make sure that we have state of the art and as it becomes faster and more efficient, we continue to invest and make sure that we got the product that's going to be able to deliver but also the final piece of that is we think whether the building the state of mining capability is taking the information that we have from the various platforms and consolidating that information into one data and mining title, and there's some of our CapEx that we're talking about for 2007 in that area.

Christa Quarles – Thomas Weisel Partners

OK, but on the product development that you would still that 5-6% range?

Samuel J. Paisley

Yes.

Christa Quarles – Thomas Weisel Partners

OK. Thanks.

Operator

We'll have our next question from Sameet Sinha with Kaufman Brothers.

Sameet Sinha – Kaufman Bros.

Yes good evening. Quick question on those of the ad-network, with the (inaudible) you deserve, used generated content, are you seeing any pricing in software? If not, then what's really causing that pricing in 2007?

James R. Zarley

You're speaking of our display network?

Sameet Sinha – Kaufman Bros.

That's correct. Yes.

James R. Zarley

We're not seeing really pricing softness. There's always a high demand for high quality traffic. And that hasn't really changed a whole lot. And for the lower end of the spectrum, what we refer to as the run-of-network debt-net, pretty much remains stable. We think it will remain stable. As video continues to grow and expand then you'll see our prices increasing.

Sameet Sinha – Kaufman Bros.

Okay and second question. You've seen so much traction and lead generation in the US. How about taking that to Europe? Any chances you could do that especially since outsizings are common and has indicated that it's time to move into that geography. Maybe 3M7 gets it?

James R. Zarley

Yes. We've already done that. We are actually in Europe today. We're also in Canada. And we're in Australia as well.

Sameet Sinha – Kaufman Bros.

OK, thank you very much.

James R. Zarley

OK.

Operator, we have time for two more questions please.

Operator

We'll have our next question from Clayton Moran with Stanford Group.

Clayton Moran – Stanford Financial Group

I thought I had logged my out. My questions been answered. Thank you.

James R. Zarley

So one more question then.

Operator

We'll have our final from Richard Fetyko with Merriman.

Richard Fetyko - Merriman Curhan Ford & Co.

Hey guys. Thanks. I only have one left so let's say I'd ask about the extent that the web-clients…the web-clients is using for the lead-gen business or just your lead-gen business in general. How much of that inventory is coming off of your network versus what you're buying off of other network sources as you will?

James R. Zarley

Well I don't think we really have a hard fix on a specific number. Obviously in that business, network sources are important to the business. We have to complement those network sources with our traffic on our own destination sites. We actually use both and we try and leverage capacity and distribution that's available to us from our display ad-network and also to the extent we can from the affiliated market networks. And we take advantage of each of those sources and the specific percentage we really haven't released that kind of...

Richard Fetyko - Merriman Curhan Ford & Co.

Can you at least compare which one is larger?

James R. Zarley

Yeah. Purchasing the traffic from outside sources probably. Clearly a large part of it, Rich.

Richard Fetyko - Merriman Curhan Ford & Co.

Okay. Thanks a lot.

James R. Zarley

Alright, thank you operator and thanks for everyone that joined us this afternoon. That concludes our call.

Operator

Thank you for participating in today's ValueClick fourth quarter conference call.

A replay of today's conference will be available beginning at 4:30 PM Pacific Time today by dialing 888-203-1112 or 719-457-0820. The access code for the program will be 7134623. This replay will be available through February the 28th, 2007. Thereafter the call can be accessed on ValueClick's website at www.valueclick.com.

We thank you for your participation. You may disconnect at this time.

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