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United Online, Inc. (NASDAQ:UNTD)

Q2 2007 Earnings Call

August 7, 2007 5:00 pm ET

Executives

Erik Randerson - Investor Relations

Mark R. Goldston - Chairman of the Board, President, Chief Executive Officer

Neil P. Edwards - Interim Chief Financial Officer

Analysts

Youssef Squali - Jefferies

Kevin Copeland - Cowen & Company

Ali Mogharabi - B. Riley & Co.

Lance Ettis

Presentation

Operator

Good afternoon. My name is Phil and I will be your conference operator today. At this time, I would like to welcome everyone to the United Online second quarter earnings release conference call. (Operator Instructions) Mr. Randerson, you may begin.

Erik Randerson

Thank you. Hello and welcome to United Online's conference call to discuss our financial results for the second quarter ended June 30, 2007. With me today is Mark Goldston, our Chairman, President and Chief Executive Officer; and Neil Edwards, our Interim Chief Financial Officer.

On today’s call, and in the accompanying slides that are available on our investor relations website, we refer to adjusted operating income before depreciation and amortization, or OIBDA, adjusted net income and free cash flow, all of which management believes are useful in evaluating the company’s operating performance. These and certain other numbers are not determined in accordance with generally accepted accounting principles in the U.S., or GAAP, and should not be considered as an alternative to or superior to historical financial results presented in accordance with GAAP.

Definitions of these non-GAAP financial metrics are provided in today’s press release and in the slides, along with reconciliations to the most comparable GAAP financial measures.

Before we get started, I need to also point out that the company does apply the Safe Harbor provisions as outlined in the press release to any forward-looking statements that may be made in this call. Statements regarding our current expectations about our future operations, our financial condition, our performance, our pay accounts, future services and the industry in which we operate are forward-looking statements that are subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

More information about potential risk factors that could affect the company’s business and 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.

Projections provided by management in the press release and in today’s call are based on information available to us at this time and management expects that internal projections and expectations may change over time. However, the company does not intend to update these projections.

Any persons replaying this broadcast after August 7, 2007 should recognize that any non-historical information discussed in the call might not be current or valid after that date because the circumstances and assumptions underlying such information may have changed.

With that, we are going to start out with a few comments from Mark and Neil and then we are going to open it up for questions. So now I’ll give the floor to our Chairman, President and Chief Executive Officer, Mark Goldston.

Mark R. Goldston

Thank you, Eric. Welcome, everyone, to United Online's June 2007 quarter earnings call. I am going to take you through a high level view of our quarterly highlights and then Neil Edwards, our longtime Chief Accounting Officer who has been with us for the past eight years and is serving as our Interim Chief Financial Officer, will provide a closer look at the numbers for the quarter and guidance going forward.

Before I get started I would like to mention that we’ve created a PowerPoint presentation that summarizes our second quarter financial results and operating metrics. You can download a copy of this at our Internet homepage at www.unitedonline.com in the investor relations section, right next to the earnings press release, and I would encourage you to do this.

Let me begin by stating how pleased I am at the second quarter results delivered by our team at United Online. Revenues and adjusted OIBDA came in at the high end and above our guidance respectively, and we continue to generate strong free cash flows. Advertising revenues increased significantly year over year across both segments, underscoring the progress our team has achieved in upgrading our ad sales efforts.

Equally important, our strong results continue to validate our strategy to diversify into Internet growth businesses that leverage our marketing and other expertise. Our content and media segment, anchored by our Classmates and MyPoints brands, delivered exceptional growth in the second quarter, due primarily to increase in social networking pay accounts.

Year over year, quarterly organic revenue growth for the segment accelerated during the second quarter to 24% from 14% in the first quarter. More impressively, content and media revenues grew 13% sequentially from the first quarter. Our content and media segment now comprises 38% of total revenues and 55% of total pay accounts. That is up from just 20% of revenues and 40% of pay accounts at the beginning of last year.

Meanwhile, our communications segment remains well-positioned in a mature market for Internet access services. Our flexible business model enables us to show continuing strong profitability at communications during the second quarter despite continuing declines in our subscriber base.

When you take these together, these segments generate a great deal of cash with limited capital needs and year-to-date, we’ve generated free cash flows representing nearly 20% of our total revenues. This capital allows us to continually evaluate strategic investments towards the goal of advancing our growth initiatives, while at the same time returning cash to shareholders.

In fact, just last week we announced our 10th consecutive dividend of $0.20 per share, which represents a current yield of approximately 7%. When we pay the dividend on August 31st, United Online will have returned over $130 million in cash to shareholders during the past three years.

With that high level overview, I would now like to provide a little more detail on our business segments, beginning with content and media. As mentioned previously, our content and media segment delivered impressive results in the June quarter. For the second consecutive quarter, we achieved record performance in attracting new pay accounts, with virtually all of the growth coming from social networking. We added 278,000 content and media pay accounts during Q2, more than triple the 89,000 accounts we added a year ago.

We also increased content and media pay accounts above the all-time record of 265,000 we recorded just last quarter in Q1 of 2007.

Looked at another way, in the first six months of 2007, we’ve added 543,000 pay accounts in content and media, which is 54% more than the 352,000 pay accounts we added throughout all of 2006, excluding pay accounts from acquisitions.

Now let’s drill down and take a look at Classmates. A frequent question I get asked at conferences and investor meetings is what is behind our recent success? Our strong metrics underscore the effectiveness of the new features, primarily the digital guestbook feature, initiated by Classmates near the end of 2006. In simple terms, we’ve done a more effective job in demonstrating to our members the value of a premium content subscription than ever before.

Please keep in mind that almost all of our pay accounts are simply upgrades from our free social networking members. That’s important to understand considering that we have more than 50 million social networking members and only 2.7 million pay accounts, which represent between 5% and 6% of the total member base. Clearly we have a great deal of potential built into our large member base that we expect to continue to monetize in future quarters.

Much of the opportunity inherent in our large over 50 million social networking member base reflects our unique selling proposition. That is, we offer members an efficient linkage to past acquaintances from high school, college, work, or the military. What is unique to our online social networking services is that these powerful affiliations nearly always will maintain their relevance, helping to ensure that members of Classmates have a long tenure on our services.

Our intent is to entice a greater percentage of our online social networking members to become more active with our services and to engage with other members more frequently. We are very pleased with the results in the early going on this initiative.

In terms of advertising, if you haven’t been to the Classmates site in a while, the next time you visit it is quite likely you’ll notice a quality of branded advertiser that you had not seen before. Additionally, we hope that our new website redesign will also help to make Classmates more attractive to advertisers and when the new design elements are introduced over the next several quarters, we think that should happen.

In fact, the first wave of the Classmates website redesign was launched just last week and I would invite you to go to Classmates.com to take a look at it. It features a contemporary design with several feature enhancements. In the future, you’ll see additional waves of this Classmates redesign being launched sequentially with new features that will allow our members to interact with each other outside of their respective school, work, or military silos based upon common interests, based on local connections, et cetera. So this new redesign is happening in waves and the first wave is out now.

As a final note on social networking, I am pleased to announce the recent launch of two new features on Classmates this quarter. Just a few weeks ago, we did a soft launch of our Classmates dating service, which enables our members to reconnect with past acquaintances interested in dating, or to meet new people with similar backgrounds without paying the large membership fee so common among dating services.

And just last week we launched our new events and reunion center, which includes a set of easy to use tools for arranging in-person events and virtual reunions on the Internet. The idea is to position Classmates as the central communications hub for all event planning logistics, which should help attract new members and encourage greater networking among the member communities.

Another really important goal of both of these features is to drive further interactions among our member base and provide another compelling reason for our free Classmates members to upgrade to premium content paid subscriptions.

Now let’s take a look at our other major component of our content and media segment, MyPoints, which also continues to perform very well and expand its member base. Please bear in mind that MyPoints is an online loyalty marketing site that is free to consumers. As a result, its business model is driven entirely by advertising revenues.

What advertisers like so much about MyPoints is that we can deliver highly targeted and personalized offers using more than 400 demographic points that our members willingly provide to us to earn additional points in our program.

For example, we recently partnered with a well-known cosmetic company to target women within a certain age demographic who were interested in receiving offers on cosmetics. These highly targeted offers often deliver very meaningful results, which is important to our advertisers who demand a very strong return on investment from their marketing dollars.

The success of our marketing campaign also benefits MyPoints because the vast majority of all of our advertising fees are structured based on performance incentives, such as click throughs, purchases, and other behaviors on MyPoints.

An exciting event happening at MyPoints this quarter is our new website design, which we expect to launch in a matter of weeks.

As well as the MyPoints business has performed, and it has performed exceptionally well since we purchased it, I don’t hesitate to admit that the current website is not optimized for the shopping experience. We recognize this limitation when we acquired MyPoints last year and we’ve been working closely with a leading web design firm for the past several months to improve the look and feel, as well as the functionality of MyPoints.

While the benefits of our new website design are plentiful, I would say the three most notable improvements would be: one, significantly enhanced user navigation and search functionality, and that will allow members to locate products and shopping merchants far more efficiently; secondly, there is a new reward center on MyPoints that will showcase more than 60 merchants available for points redemption, which represents the heart of any loyalty program; and third, there are new personalization options on MyPoints that allow individual members to customize the layout of the MyPoints website to suit their personal interests.

In summary, the content and media segment has made huge strides over the past 12 months and we believe it is well-positioned from a competitive perspective going forward.

Now I would like to turn to the communications segment of United Online, which consists primarily of our NetZero and Juno IST brands. The segment really delivered against our objective of managing the business for profitability and cash flow, as our communications segment adjusted OIBDA as a percentage of segment revenues improved to a record 40%.

Our performance highlights the fact that United Online is well positioned in a mature dial-up industry. Please remember, we deliberately built our business model to rely primarily on outsourcing with a variable cost structure. Telecom services, credit card processing, and customer support are all variable costs that represent the majority of our direct costs in providing Internet dial-up access services. As a result, when usage goes down, many of our direct costs will naturally tend to decline as well.

Another reason United Online is well positioned in the dial-up Internet services market is that we are an established leader in the value segment of the market, which as you know, we pioneered back in 2001. Our most popular price point is $9.95 per month and it has been for six years.

We built our dial-up access business and cost structure to be optimized at these lower price points, which are considerably below the $18.45 per month consumers still pay on average today for dial-up services, according to JD Power & Associates.

As the dial-up industry continues to migrate from premium dial-up to value dial plans, we believe United Online is well positioned to capitalize upon that trend.

Our television marketing campaign also seems to have been quite effective over the past several months and we are continuing to forge new distribution relationships with retail partners and computer manufacturers as well.

Within the communications segment, we’ve also been working to reduce churn and extend the customer lifecycle, and that’s the principal reason we introduced DSL services as a save tool for dial-up customers interested in higher speed connections. In fact, we added 13,000 DSL subscribers during the second quarter at very little marketing cost, and since these subscribers came directly from our dial-up customer base, the cost was really quite efficient and we are now up to over 27,000 DSL customers.

Our current DSL coverage extends to approximately 30% of our dial-up base, and we hope to expand our coverage by establishing additional relationships with other broadband providers in the future.

The 30% coverage statistic brings up an interesting question that has been on the minds of many investors as to why our market coverage is not higher, considering that we partner with two of the larger broadband providers. Well, our limited DSL coverage of 30% actually supports our belief that there are many Americans who still do not have a lot of affordable choices, or any choices, for that matter, when it comes to broadband connection, particularly in some of the more rural geographies, or the B, C, and D counties of the U.S.A., which are served by NetZero and Juno. This is especially true with DSL, where subscribers are often required to reside within two-and-a-half miles of a phone company’s central office, which can limit DSL’s reach into less populated regions.

The large number of people who fall into that category, along with the lower income households all across the country, provide the opportunity that we see for United Online in continuing in the dial-up category in the U.S.A. for a number of years.

I would now like to turn the mic over to Neil Edwards, our Interim Chief Financial Officer, for a detailed look at the quarter and a discussion of our guidance going forward. By way of background, Neil previously was the Chief Financial Officer of Patagonia Incorporated. He joined my team at NetZero back in 1999 and he’s been our Chief Accounting Officer since 2001. Neil’s been a major contributor to our success over the past eight years, so we are in very capable hands until we determine what we are going to do with the CFO position on a permanent basis.

With that, I would like to turn the call over to Neil for a review of our financial results. Neil.

Neil P. Edwards

Thank you, Mark and good afternoon, everybody. Let me begin with a few financial highlights for the second quarter. Consolidated revenues were $131.4 million, coming in at the high end of guidance. Consolidated Q2 adjusted OIBDA was $36.3 million, exceeding the high end of guidance. Content and media revenue grew 29% year over year to $49.7 million. Content and media advertising revenue grew 35% year over year to $22.8 million, and free cash flow remains strong at over $31 million for the quarter.

Now for a more detailed review of our June 2007 quarterly financials. I’ll start with consolidated data and then we’ll get into the segments.

Consolidated revenues were $131.4 million, down 3% versus the year-ago quarter and up 1% sequentially. Continued growth in our content and media segment allowed us to achieve consolidated revenues near the high end of our guidance. Content and media now accounts for 38% of total revenues, up from 29% in the year-ago quarter and up from 34% in Q1.

Consolidated gross margin was 76.9%, flat with the year-ago quarter and down 60 basis points sequentially, primarily due to a decline in communications gross margin as a result of continued growth in our lower margin DSL service.

Consolidated adjusted OIBDA was $36.3 million, down 4% versus the year-ago quarter and up 6% sequentially. The year-over-year decline in consolidated adjusted OIBDA is due to lower communication segment revenues as a result of the decline in our dial-up pay access accounts.

Consolidated adjusted OIBDA as a percentage of consolidated revenues was 27.7% in the second quarter compared to 28.2% a year ago and 26.5% in Q1.

Free cash flow for the quarter was $31.1 million, a 5% decline from the year-ago quarter. However, our year-to-date free cash flow of $51.4 million increased 24% year over year.

Pay accounts increased by 134,000 during the quarter, with content and media the catalysts with net growth of 278,000 pay accounts. As Mark mentioned, we have added 543,000 content and media pay accounts during the first half of 2007 which, excluding acquisitions, is 54% higher than our growth achieved throughout all of 2006.

Communications pay accounts declined by 144,000 in the second quarter. Consolidated churn during Q2 was 4.6%, a decline of 10 basis points from the first quarter.

Now let’s get into the Q2 segment results, and I’ll start with content and media. In Q2, content and media represented 38% of consolidated revenues, up from 29% of the consolidated revenues in the year-ago quarter and up from 34% in Q1.

Content and media revenues were $49.7 million, up 29% versus the year-ago quarter and up 13% sequentially. Our strong sequential growth in content and media reflects the 15% sequential increase in billable services revenues and a 10% sequential growth in advertising revenues. Fifty-four percent of segment revenues were from billable services and 46% were from advertising in the second quarter.

Excluding the impact of acquisitions, we achieved 24% organic revenue growth in the content and media segment year over year, which is up considerably from recent quarters.

As a reminder, advertising revenue within the content and media segment is highly seasonal. Historically, Q3 has represented [inaudible] period for our advertising revenues, due to seasonality with respect to our online loyalty marketing service. By comparison, the fourth quarter is typically the strongest seasonal quarter for advertising revenues.

As a result, we anticipate the content and media ad revenue growth will decrease in Q3 compared to Q2, and that Q4 will be our strongest quarter for ad revenues due to the seasonal factors.

Content and media adjusted OIBDA was $8.2 million, up 12% from $7.4 million versus the year-ago quarter. Measured as a percentage of content and media revenues, segment OIBDA was 16.6%, down from 19% a year ago but up from 13.1% in Q1.

Content and media pay accounts grew by a net 278,000 during the second quarter versus 89,000 net growth in the year-ago quarter and 265,000 net growth in Q1. Virtually all of our pay account additions in content and media have come from social networking.

Content and media average monthly revenue per pay account, or ARPU, was $3.37, down 4% from $3.50 in the year-ago quarter and up 3% sequentially from $3.26 in the first quarter. The slight variability in ARPU from quarter to quarter reflects a shifting mix of domestic and international pay accounts and a change in the mix of payment plans.

Now, on to the communications segment. Communications revenues were $81.7 million, or 62% of consolidated revenues, down 15% from $96.2 million, or 71% consolidated revenues in the year-ago quarter. Eighty-six percent of segment revenues were from billable services, 14% were from advertising.

Once again, segment advertising revenues grew year over year, increasing 26%. The year-over-year segment advertising revenue comparison benefited in Q2 from our recently renewed search agreement with Yahoo!.

Communications ARPU was $9.78, up slightly from $9.75 in the year-ago quarter, and also up 2% from $9.61 in Q1.

Communications adjusted OIBDA was $32.8 million, down 8% year over year and essentially flat with Q1. Segment adjusted OIBDA as a percent of segment revenues increased 310 basis points year over year to 40.1%, versus 37% in the year-ago quarter. The increased margin reflects our strong growth in advertising revenues, reduced marketing expenses, and lower hourly telecom costs.

Communications pay accounts declined by 144,000 in Q2 versus the loss of 186,000 pay accounts in the year-ago quarter and the loss of 135,000 in Q1. Our second quarter performance was primarily driven by a net decline of 142,000 pay accounts in our access services.

Now on to subscriber acquisition costs; communications subscriber acquisition costs, or SAC, was $106, down 17% versus the year-ago quarter and up 5% sequentially. The sequential increase in SAC reflects seasonality where Q1 is generally our strongest period for Internet access sign-up. The decline in SAC year over year primarily reflects the elimination of marketing expenses for our VOIP services.

Our SAC computation is total segment sales and marketing expenses divided by gross pay account additions.

Now on to the balance sheet. Total cash balances increased by $23.4 million to approximately $191.4 million at June 30, 2007, from $168 million at March 31, 2007. During the quarter, we paid $14.4 million in dividends and repurchased $1.1 million in common shares established by tax withholding on vested restricted stock units.

As we announced last Friday, our board of directors has approved the payment of a $0.20 a share quarterly dividends during the quarter. This represents our 10th consecutive quarterly dividend payment of $0.20 per share dating back to early 2005.

Now on to the business outlook, and moving on to guidance. We are providing guidance for Q3 revenues of $124 million to $128 million. We expect adjusted OIBDA for Q3 of between $34.5 million and $36.5 million. Our revenue guidance today reflects our expectations for continued sequential declines in communications revenues, as well as the advertising seasonality in the content and media business, which I mentioned earlier.

The guidance for all of 2007, we are increasing the bottom end of our 2007 revenue guidance. We now expect revenues for 2007 in the range of between $512 million to $520 million, which is up from the $510 million to $520 million range we provided last quarter.

We are reiterating our 2007 guidance for adjusted OIBDA that we provided last quarter of between $143 million and $147 million for 2007.

We have increased our capital expenditure guidance to between $28 million and $33 million for 2007, which is up $6 million from our previous guidance. The increase reflects additional investments and data segment infrastructure for our Classmates and MyPoints businesses, provide redundancy for their operations.

Our estimate for cash taxes in 2007 remains unchanged from prior guidance of between $38 million and $41 million.

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

Mark R. Goldston

Thank you, Neil. Just in summary before we go into questions, it again was a tremendous quarter for the company. You can see that in our communications segment, we had a record level of adjusted OIBDA as a percentage of revenues and great cash flow, and certainly content and media with a record 278,000 net new pay accounts in social networking and continued outstanding performance at MyPoints. We feel very good about that and we are quite proud.

So with that, Operator, if you could explain to people how to get into the Q&A queue, we’d be happy to answer any questions for them.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Youssef Squali.

Youssef Squali - Jefferies

Thank you very much. Good afternoon, Mark and Neil. A couple of questions. First, I was wondering if the 250,000 to 300,000 net adds in your content and media business, which you’ve been able to achieve for a couple of quarters now, is that a good proxy for growth going forward? It seems that with all the new functionality and the marketing spend you are putting behind it, that that is reasonable but I wanted to get your take on it.

Mark R. Goldston

Actually, we don’t make projections on that number, as you know, so it would be hard for me to comment on that. I will say we’ve had a lot of great initial traction in the first eight months of some of these new products that we’ve put out on the recent launch of the website but on a going forward basis, we won’t be making any projections in terms of how the subscribers will actually -- in fact, I think you could expect in this particular quarter, there could be some modest decline there because of the churn that you get because you’ve got so many new subscribers. Remember, we’re 54% ahead of what we did for the entire year in 2006 and as you know in subscription businesses, some of the very early new users exhibit higher churn than long-time users.

So we’ll wait to see how that plays out. Of course, it’s a nice problem to have but if you would have asked me 12 months ago would I have expected that in June 30, 2007, to have 54% more than we had in all of 2006, I would have said no. But on the other hand, the dynamic of this business that we have experienced is really quite remarkable in terms of the social networking effect.

At Classmates a long time ago, people probably prophesized that that’s how it would become when it played out, but I think from a features standpoint, it was lacking. Now, with some of the new features that have been launched and some that are in the pipeline, we are really starting to see the social networking effect that a lot of people have spoken about actually come into play at Classmates.

Youssef Squali - Jefferies

Just to clarify what you just said, Mark, did you say that you could potentially see a decline in the quarter because of the increased churn from these newbies?

Mark R. Goldston

It all depends on the timing of the plans of the people who signed up. If we have more people who sign up for the three-month plan versus the one-year and the two-year plans, so again, these numbers will move around depending on what percentage of your brand new users go for the short-term versus the medium term and the long-term plans. It’s a little bit different dynamic than what we deal with in the ISP business, which is a lot more predictable.

But here we find that the mix is actually, it changes as we go. You’ll get some new people come in on a three-month plan and then if they are happy, they’ll make their commitment to a longer term plan, and where sometimes you’ll see on access, people will terminally be on a month-to-month plan.

I would say we’ve got some great plans in the process and we are going to read and see how this business goes and we’ll respond accordingly. But we are very happy with where we sit today in that business.

Youssef Squali - Jefferies

Okay, that’s great. And then Neil, the SBC was off by about $4 million from what you previously guided to. Could you explain what is going on there?

And lastly, I guess Mark, can you just give us any update on what the board is thinking in terms of the content and media IPO?

Mark R. Goldston

Let me just jump in on that. We can’t really make any comment. We said that in the last call that the board is exploring the opportunity to do a subsidiary IPO and that exploration is still underway but we really can’t say anything other than that.

Neil P. Edwards

To answer your question on stock-based comp, the reduction in Q2 is stock-based comp is primarily due to the resignation of Charles Hilliett.

Youssef Squali - Jefferies

Thank you.

Operator

Your next question comes from the line of Jim Friedland with Cowen & Company.

Kevin Copeland - Cowen & Company

Thanks. It’s Kevin Copeland in for Jim. I was hoping that you could jump in a little bit on what some of the specific drivers were behind the strong sub growth in content and media, and also maybe what the subscriber acquisition costs trends look like there year over year? Thanks.

Mark R. Goldston

The strong growth in content and media continues to be as a result of the new features that we put in at the end of last year, primarily our digital guestbook. But we found just an increase in activity. More people are responding to the various and sundry programs that we have, marketing programs, e-mails, et cetera that we put our, our connections product. I think we are just finding that we’ve managed to hit the hot button on several of these people.

You’ve got to remember something -- the vast majority, if not all, of the paid subscribers that we get in our content and media segment on Classmates particularly, are people who came out of the free base. This is not a service where you go to sign up and on day one, sign up for a paid subscription. You sign up for free and so every one of those people who is now a paid subscriber is a migrant from free to pay, largely due to some stimuli that they’ve either received from us directly or from one of their peers in the member base.

I think what you’ve seen over the last eight to nine months, and this is that social networking effect that we’ve been talking about, that we’ve just gotten a lot more traction, both in terms of the response to what we query them with and also the response that they have on a peer-to-peer basis, which has caused many of them to change their value equation as it relates to Classmates and decide to start paying us to get the additional features.

From a customer acquisition standpoint, we’ve been very efficient over the years in analyzing that. No demonstrable changes. The market dynamics for this have been relatively constant. We are, as you know, a major player in the online advertising market in terms of what we spend and where we spend it and we have a pretty fine screen that we use in terms of where we will continue to move our money.

Our whole focus on this business, and you have to understand, is on getting free members. Our focus is bringing as many people as we can in our target audience, which is anyone who is an adult, into the top of that funnel. And then after they are in there, then it is the job of both their peers, our website, and our various marketing programs to try to get them over the wall and into pay, which as you see over the last six months has dramatically improved.

Kevin Copeland - Cowen & Company

Great, thanks. Also, you guys are anniversarying now the demonetization from last year of Classmates. Do you still expect an acceleration there in the back half, disregarding the normal seasonality? Also, if you could talk about trends in CPMs there on Classmates. Thanks.

Mark R. Goldston

Are you talking about the anniversary of the adware program, where we took the ads, a lot of the ads down a year ago?

Kevin Copeland - Cowen & Company

Yes.

Mark R. Goldston

We did not, as you know, we did not build all of that back in. A lot of that was done for user experience purposes. Obviously we sacrificed some advertising revenue by doing that but we did it willingly and knowingly, and I would say that probably turned out to be a smart move because we are now running 54% ahead of what we did all last year in paid subscribers. I think our users would tell you the user experience is a lot better.

So we’ve built a little bit of it back but really, the progress that’s been made in Classmates is specifically on an increase in the CPM. The sales organization has managed to get us a better quality of advertiser and to bring those people in at better CPMs, and it is our hope that that organization, as they continue to get familiar with the new Classmates website that we’ll be rolling out over the next several months, that that will continue.

Kevin Copeland - Cowen & Company

Great, and if I could, just one last question on dial-up. Should we expect kind of an updated outlook there? Should we expect that to decline at the same trend or are there any reasons for that to change one way or the other?

Mark R. Goldston

Well, as you know, we didn’t give any specific guidance or projections on that, so I can’t really comment on that. I will say that if you take a look at a snapshot of what’s going on in our dial-up business and where we are today and what we talked about a year ago, I think there’s a lot of consistency there.

The market is really experiencing a shakeout, a lot of which was caused by the announcement a year ago almost that AOL was kind of pulling back on marketing and moving away from this market. Now, a lot of there programs, as you know, are legacy programs that will anniversary off as you move towards the end of 2007, beginning of ’08 because a lot of them probably ran through holiday, especially with retail programs.

But I think you are starting to see the landscape in dial-up being such that we are -- you know, we are not the last of the Mohicans, obviously, but we are people who want to be in this category. We understand it. The dynamic is moving more towards value dial and while I don’t think it’s a near-term phenomenon, I think over the long-term you are going to find that 100% of this category is going to be value dial. And if it is, we are the company that is structured to be able to capitalize on that.

I kind of like the way the market is lining up. I like where we are positioned and I like the way infrastructurally we’ve built our company to be able to capitalize on that.

Kevin Copeland - Cowen & Company

Thanks, guys.

Operator

Your next question comes from Ali Mogharabi with B. Riley & Company.

Mark R. Goldston

Okay. Ali, do you have a question?

Ali Mogharabi - B. Riley & Co.

Yes, I just wanted to make sure everyone understands that. I have a question about DSL. I may have missed it but have you guys yet gotten an idea of how much the DSL partnerships are helping you guys minimize the subscriber loss on the dial-up side of the business?

Mark R. Goldston

Well, you know, strategically, they are helping us a lot. Practically, we have 27,000 I think we said -- 27,000 DSL subs, so certainly better than not having any. But the DSL market for us is strictly a save tool market, and our footprint is about 30% coverage of the U.S., so we’re happy with where it is, as I told you when we launched it.

We didn’t have big number plans for it because we weren’t going to market it pretty much. We were going to use it as a save tool, and it is working as a save tool. It’s not making a major dent at this point but our broadband team is working hard, talking with other providers, both in DSL and cable, and frankly in other areas to try to determine who else we can and should partner with as part of this migratory path. I think they are making some real progress over there.

But right now, it is kind of early days. It is doing what we thought it would do and we are happy with it.

Ali Mogharabi - B. Riley & Co.

Okay, and then a couple more questions; in terms of cash, you guys just keep adding to that balance at the same time, of course, distributing the dividend. Any acquisitions in mind currently? If so, what side of the -- how would you like to make the acquisitions in terms of enhancing the Classmates or MyPoints services provided?

Mark R. Goldston

It’s a great question. This business, as I’ve said for going on my ninth year, this is a -- although the first couple of years when it was free, it was more challenging but this is a fabulous cash flow business. I’ve been doing this business for 30 years overall and I’ve never seen an industry like this that can generate these kinds of margin and cash flow.

Having said that, we definitely have plans to make acquisitions on both the content and media and communications side of the house, and they run from modest to major. We have proven over the last I want to say six years, starting with the Juno deal and then moving to Classmates and then MyPoints, that we as a company have a distinct knack for taking undervalued assets, some of whom are turnaround, some of whom are turn-ups, and being able to create significant value from them.

So we are very much on the hunt, Ali, for these assets. We have a group internally that is singularly focused against that and it is my goal that in 2008 that we will have at least one major acquisition, if not two that we can announce and continue on this great trend and put this capital to good use.

Ali Mogharabi - B. Riley & Co.

Makes sense. And then Neil, just a housekeeping item, you said that CapEx, $20 million to $33 million. Again, I may have missed it. Can you tell me why it is a little bit higher now?

Neil P. Edwards

Yes, we are improving or putting redundancy into MyPoints and Classmates data centers, and that increase of $6 million represents the costs to do that.

Mark R. Goldston

I will tell you we have, as a company, we are very, very focused on redundant, sometimes double redundant systems. When we bought Classmates two-and-a-half years ago and MyPoints just a year ago, one of the things on the agenda was once we got those businesses doing what we hoped that they would do, which they clearly are, we had to then start focusing on platform and structural redundancy. So those are -- they may not sound like sexy initiatives, but they are critical to operating your business and something that we as a company, as an ISP, have a lot of knowledge about, because obviously we’ve been doing this for years in this part of the business, so the extra CapEx reflects the investment that we finally need to make because of where those businesses are, to support them and make sure that they are redundant.

Ali Mogharabi - B. Riley & Co.

Makes sense. Thanks, guys.

Operator

(Operator Instructions) Your next question comes from Lance [Ettis] with [inaudible] Capital Management.

Lance Ettis

Hi, guys. Congratulations on another good quarter. I just wanted to go over a few questions. I just noticed that almost the entire ad spend, so far I think $600,000 was for the content and media side, which is pretty much the social networking side. I’m just wondering, one, does that ad spend include the partnerships you are doing when you do a deal with like a Best Buy or something like that? When you are selling the --

Mark R. Goldston

Before you go too far, I’m not sure I understand the question.

Lance Ettis

I think you only spent $600,000 on ad spend in the networking side, in the dial-up side. So my question is what --

Mark R. Goldston

Lance, no, that’s not even close. Where did you get that number from?

Lance Ettis

Well, it says in your slide, you spent $42.1 million in content and media sales and marketing and then your total is $42.7 million.

Mark R. Goldston

That is just content and media. Remember, we have two segments of the business. We have content and media and communications, so the dial advertising spend would be in communications. You are just looking at content and media, right?

Lance Ettis

Well, I’m looking in the slide versus the press release.

Erik Randerson

I think that was a year-to-date number. I think that is where the confusion may lie, that’s shown in the slide.

Lance Ettis

That’s the year-to-date number? Okay, so that’s -- okay, I’m sorry about that. I’m just wondering also, the increase in ad spend, it looks like you are actually, you are a little bit, your cost per subscriber has actually increased a little bit. But should we be thinking about this in those terms? In other words, how much of this ad spend is going towards adding free subscribers which then you later turn into pay subscribers?

Mark R. Goldston

In the case of content and media, it is specifically on social networking, Classmates, every dollar that we spend goes into acquiring a free member because that’s the only way you can sign up for Classmates. And then you need to then migrate to pay.

In the case of MyPoints, it is not a subscription service system. It is 100% free and operated as an advertising supported system. So you can make the argument that every single dollar that is spent on marketing on the content and media side of the house is devoted to acquiring free subscribers.

Lance Ettis

Okay, and then what’s the average lead time you think that you can turn a free subscriber into a paid subscriber? I’m just looking to try to figure out your cost per subscriber add.

Mark R. Goldston

That’s a good question and if you would have asked us that a year ago, should we have answered it you would have gotten a very different answer than you’d get today because as we were saying, we’ve got $50 million free members on that side of the house who, because of some of the marketing programs we’ve been able to put into place, we have people who have been members for a year, two years, three years or more who have finally decided to become a paid member because there was some stimuli they received, either from us in terms of marketing or a ping that they got from a peer to get them to go.

So it is a very hard metric to calculate in the absolute. All that I can tell you is that on a trended basis, that we’ve been far more effective in the last six-plus months of getting legacy members to convert than previously, evidence the fact that we’ve got 54% more paid subscribers at six months through the year than we had for all of 2006.

Lance Ettis

I don’t think I hear -- I’m sure you guys -- what was your actual churn rate for the quarter?

Mark R. Goldston

The overall churn rate for the company was 4.6%.

Lance Ettis

Is there any seasonality you think to your free cash flow? I mean, just maybe fluctuates, sort of the ad spend maybe, and maybe that’s a little bit seasonal or --

Mark R. Goldston

Seasonality of the free cash flow?

Lance Ettis

Yes.

Neil P. Edwards

The main seasonality for our free cash flow is in Q1, where free cash flow is generally lower than the rest of the year. In the past, free cash flow has been a little lump due to the timing of payments. We’ve smoothed that out a little bit now and free cash flow is more consistent throughout the year.

Mark R. Goldston

And the Q1 aberration that Neil refers to is because that’s when we pay our corporate bonuses.

Lance Ettis

Okay, and the last question I have is just sort of -- just on your plan for the returning money to shareholder, really. I know you have the dividend but you are sitting on a lot of cash. I think as to your plans, as sort of -- you are looking at big acquisitions. Is your plan to use all that cash for an acquisition and then that gets the earnings going and constantly goes to shareholders that way? Or is you plan to use the cash and then some and then use debt? In other words, instead of doing a stock buy-back, you are buying another business that is producing earnings and you are increasing earnings and what is your sort of view on it?

Mark R. Goldston

You know, Lance, I would only ask you to just take a look at how we’ve operated historically. We as a company and I in particular am a lover of cash. If you look at our balance sheet, we’ve been affectionately referred to as running an iceberg of a balance sheet. It’s always had -- and in fact, it’s interesting. Classmates and MyPoints were acquired for cash, $156 million, I think $134 million net of the tax benefits. If you were to calculate the return that we’ve gotten on that investment, obviously it would be very high and all of that was done while we were issuing $0.20 a quarter cash dividends.

In the period of time since we bought Classmates and MyPoints, we spent $156 million buying businesses and we returned $130 million of cash to shareholders, so we’ve pretty much taken $286 million and between dividends and acquisitions have been able to make that work. So I think on a going forward basis, you could expect something similar from us. But depending on what deals we look at and the size of deals, we’ve got a lot of leverage in our capital structure, a lot of room, I should say in our --

Lance Ettis

You wouldn’t consider a share buy-back or --

Mark R. Goldston

Well, we have right now. We have an existing authorized share buy-back program from the board that’s got a $60 million authorization in it. So between the share buy-back, potential acquisitions, the dividend, et cetera, we will be good stewards of the cash and deploy it effectively.

Lance Ettis

Okay, thanks.

Mark R. Goldston

Thank you very much. Operator, I think we have over-run our time so I am going to encourage anybody who has any questions to please direct them to either myself or Erik Randerson’s office and then we will, along with Neil Edwards, answer anybody’s questions that they have and feel free to give us a call. I want to thank everybody for attending United Online's June quarter 2007 earnings call today. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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Source: United Online Q2 2007 Earnings Call Transcript
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