United Online Q3 2005 Earnings Conference Call Transcript (UNTD)

Nov. 2.05 | About: United Online, (UNTD)

Q3 2005 United Online Inc. Earnings Conference Call

Nov. 02. 2005 / 2:00PM PT

CORPORATE PARTICIPANTS

Elizabeth Gengl

United Online Inc. - SVP of Corporate Communications

Mark Goldston

United Online Inc. - Chairman CEO and President

Charles Hilliard

United Online Inc. - EVP and CFO

CONFERENCE CALL PARTICIPANTS

Youssef Squali

Jefferies & Company - Analyst

Matt Shindler(ph)

Piper Jaffray - Analyst

David Geisler

SG Cowen - Analyst

Michael Trotsky

Par Capital - Analyst

PRESENTATION

Operator

Good afternoon. My name is Natasha, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the United Online Third Quarter 2005 Earnings Call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

[OPERATOR INSTRUCTIONS]

Thank you.

I would now like to turn the call over to Elizabeth Gengl, Senior Vice President of Corporate Communications.

Elizabeth Gengl - United Online - SVP of Corporate Communications

Hello, and welcome to United Online's conference call to discuss the results of our third quarter ended September 30, 2005. With me today is Mark Goldston, our Chairman, CEO, and President; and Charles Hilliard, EVP and Chief Financial Officer.

In today's press release, the Company refers 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 numbers are not determined in accordance with generally accepted accounting principles, 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 numbers are provided in the press release, along with reconciliations to the most comparable GAAP financial measures.

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

More information about potential risk factors that could affect the Company's business and 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's expected internal projections and expectations may change over time. However, the Company does not intend to update these projections. Any persons replaying this broadcast after November 2, 2005 should recognize that any non-historical information discussed in the call might not be current or valid after that date because of the circumstances and assumptions underlying such information may have changed.

And, with that, we're going to start out with a few comments from Mark and Charles, and then we're going to open it up for questions. So now I'll give the floor to our Chairman, CEO and President Mark Goldston.

Mark Goldston - United Online - Chairman CEO and President

Thank you, Liz, and thank you, everyone, for joining us for the United Online's September 2005 earnings call.

I'm going to take you through some highlights of the quarter and discuss some of the important initiatives within the Company, and then Charles will take you through a detailed look at the financials.

The September 2005 quarter was another record quarter for the Company in a number of key financial areas, including revenues, operating income, adjusted OIBDA, and cash flows from operations. In the face of continued challenges in the access business, we had another strong financial quarter, and, in fact, recorded our 17th consecutive quarter of record revenues dating back to the September 2001 quarter, a milestone accomplishment that we're very proud of.

Our non-access businesses accounted for 100% of our sequential quarterly revenue growth, similar to what occurred in the June 2005 quarter, which further demonstrates that the United Online diversification strategy is being executed with a high degree of success, and the core of our non-access business is our Classmate subsidiary, which we purchased almost one year ago and I am very pleased with the way that business is performing. I'll elaborate on Classmates a little bit more in a few minutes.

I'm also glad to announce that the largest, most comprehensive technology initiative in the history of United Online, our entry into the VoIP, our Voice over Internet Protocol business, officially launched last Wednesday. The soft launch of the VoIP service, called NetZero Voice, represents an exciting new opportunity in what is predicted to be a very large global market.

In contrast to past earnings calls where I wouldn't talk about VoIP, today I will describe the VoIP product line in detail for you, and I think you'll see why we believe that our approach to the market is unique and compelling.

So as we sit here today, United Online has two key business opportunities beyond Internet access. One is web services, which include cell phone networking, and the second is VoIP. Our goal is to diversify as much as possible away from pure Internet access and to leverage our tens of millions of users across all of our businesses to be able to officially penetrate these other markets that we've described.

Let's talk about the access business. The access business as a category is a very competitive place right now and has been especially focused on aggressive pricing for the past six months. The broadband providers, DSL in particular, have resorted to deeply discounted pricing on their core DSL products while attempting to facilitate a land grab during the back half of 2005.

With VoIP on the horizon as a huge potential industry that can cause major headaches for the RBOCs as they attempt to protect their highly profitable local and long distance phone plan, certain of the RBOCs seem to be using DSL as a loss leader in an attempt to lock in consumers across a suite or bundle of services.

In response to these aggressive consumer DSL deals, many cable Operators have also become more aggressive in their pricing and promotions to try to hold their ground against the $14.95 to $19.95 DSL offering. Many dial-up providers have responded by aggressively pricing for running their services as well, and these activities continue to intensify. This trend, along with broadband's promotional pricing at the current point, and some quality issues that we had with our CRM vendor, as well as the impact of having a customer care call center in Mississippi contributed to an increase in our churn rate and let to a further decline in the core access business.

While we continue to test different promotional plans on our brand, we're not currently contemplating engaging in a permanent all-out price war to combat what appears to be unsustainable price cutting in the broadband market, as highlighted in the fact that SBC this week moved to raise pricing on their $14.95-a-month product for one year. They put it up to $16.99 a month with a 6-month commitment, and then it jumps all the way up to $29.99 a month thereafter.

Our goal at United Online is to continue to find ways to mange the dial-up business through innovation and through the introduction of compelling new features and services to enhance the value proposition of our NetZero and Juno services while maintaining our hallmark financial discipline and our focus on managing cash flow in that business. We believe strongly that dial-up will be around for a long time to come, particularly in areas where broadband is not available and for consumers that either can't afford higher priced broadband or who don't need a broadband connection to meet their needs.

We're fortunate to have a top value brand in NetZero, and our job will be to convince the many people that remain on dial-up that NetZero and Juno provide the best quality and value in the dial-up market. As we continue to demonstrate success at diversifying United Online's overall revenue base with growth in our social networking business, other non-access services, and the exciting new NetZero Voice product line, we believe that as a corporation we will be less vulnerable to lose by competitors within the access arena.

I've said on previous earnings calls to all of you that our goal was to have a substantial portion of our revenues in the future come from non-access businesses, and we are well on our way towards achieving that goal. Let's take a look at the non-access business of United Online and the exciting growth that's occurring at Classmates.

When we purchased Classmates last November, basically one year ago, what appealed to us was the sheer size of the user base at almost 40 million members; the uniquely [protectable] positioning of the business as one of the largest social networks in America, connecting people to their past affiliations; and the opportunity to enhance the features available on Classmates to make the site more compelling and encourage people to spend more time on the site and more money in the form of subscriptions, transactions, and so on. I'm proud to say that the Classmates business has grown consistently since we have owned it and we've instituted numerous new programs which has stimulated the business and made the site much more relevant to the large user audience.

Perhaps the most compelling new idea on Classmates was just launched last week, and that has to do with photos. Think about when you were in high school or college and how many people were in your graduating class. Many of us had a few friends and the rest of the people were either acquaintances or people we really didn't have a lot to do with and have little contact with later in our lives. That being the case, why do so many people go back to reunions? In fact, a large percentage of Classmates' members are faced with a milestone reunion each year. Why go back to see the same people from high school or college that we didn't keep in touch with over the years?

The reason is really quite simple-- because we're all curious to see how people look and what they turned out to be. We realized that what was missing from Classmates was the ability to have 40 million people be able to use an easy photo application to actually see each other and see how they've changed, just like the experience they would have if they went back to their reunion, which many of them do.

Our new photo application, unlike our previous photo application, is very easy to use and should encourage a large number of Classmates' users to post photos to their profile and significantly increase the user-generated content on our site.

In fact, I'll let you in on a little bit of the data here. In the first few days that the new photo application was launched last week on the Classmates' website, the number of photos posted to Classmates increased 10 times to roughly 20,000 per day, up from 2,000 per day with the previous photo application. What's interesting is that the average user posting photos with the new feature is posting approximately four photos per member, which is very high.

Before the launch of the new photo application, we would get 1,000 members every day posting their first Classmates photo using our old application, as I said. Since the launch of our new application, we went from 1,000 members every day to 4,000 members every day posting photos, and our major email and marketing communication programs haven't even begun yet on this product.

So, as you can see, in the 12 months we've owned Classmates, we've really begun to transform this company. Our overall strategy for Classmates is what we call "Find-me, See-me, and Talk-to-me." The see-me portion was previously sorely neglected in that equation, so we pooled the collective intellectual resources within our United Online web services unit, which is Classmates' photo site in the web hosting business, and under the new technology leadership of that unit, last week we did introduce this vastly improved, easy-to-use photo feature to every Classmates user.

If we can successfully convince 40 million Classmates members to transfer photos from their hard drives, digital cameras, and so on to their Classmates profile, we believe that people will be more likely to increase their visit frequency and page use and even pay to see pictures. In fact, we believe that the likelihood of someone wanting to communicate with a classmate is greatly enhanced by being able to see what the classmate looks like before they determine if they want to talk to them.

This is just the tip of iceberg on Classmates, folks, and our new plans for the personal web hosting and photo businesses within United Online's web services unit we think are exciting as well. With the recent developments in the social networking category and the heightened interest in that category, we feel that with our critical mass and unique positioning, we're very well positioned in this area, and we're really excited about the prospects of this business.

Our Classmates' employees up in Renton, Washington at our headquarters there are doing an outstanding job, and we're thrilled with the results that they've achieved and we're putting a lot of time and effort into this asset that's starting to really pay off.

Now I want to turn our attention to the introduction of the new VoIP product called "NetZero Voice." NetZero Voice represents the largest collaborative technology effort in the history of United Online. Over 150 of our employees worked tirelessly over the past year to create this exciting new business for our Company. The VoIP category is just getting off the ground in the U.S.A. It has been gaining strength internationally for the last two years.

You may have noticed that the worldwide leader in VoIP, a company called Skype, based in Luxembourg, was just sold to eBay for $2.5 billion and a deal that could be worth as much as $4.2 billion. Clearly, there is a lot of buzz and excitement around the VoIP category.

There are two distinct models in the VoIP industry. The first involves the use of a terminal adaptor, or TA box, that is very much like a DSL adaptor, in that it contains a connection from the wall to the adaptor to your broadband line and from the adaptor to your telephone. The TA box model is commonly referred to as the "home phone replacement model," and from a revenue standpoint, it is the dominant form of VoIP in the U.S.A. today.

The second major business model in the VoIP industry does not involve the use of terminal adaptor boxes. Instead, it uses a proprietary software client downloaded onto your computer to connect your phone calls primarily over a broadband connection. This is the model that Skype has used very effectively to sign up millions of users worldwide.

Within the United States at this time, many of the major VoIP players, albeit in what's currently a very small market at roughly 3 million users, those players utilize the TA box approach. You've heard of brands such as Vonage and AT&T CallVantage, Packet8, Lingo. They're all promoting the "Throw out your home phone and switch to VoIP" strategy. Their model is based upon a consumer buying the necessary equipment and installing it to enable the service.

While we believe that there is a future in that business, and ultimately United Online may enter that segment as well, it's our opinion that the home phone replacement services may initially be a bit radical for many Americans.

We believe that the software client download model in the convenience of your home, your office, your dorm room, like the one we used in the ISP business for the past seven years is an easier, more user-friendly, less costly way for the masses to experience the ease and benefit of calling someone over the Internet. Certainly, Skype proved the validity of that thesis.

NetZero Voice soft launched last Wednesday on the front door of www.netzerovoice.com, and represents an opportunity for everyone in America, if not the world, with a broadband or dial-up Internet connection to experience Internet phone calling. I said "broadband or dial-up." In previous calls, many have said, "Mark, it's not possible that you would be doing VoIP over dial-up, so what will you be doing?" and I couldn't answer the question. Now you can see why.

We are doing VoIP over both broadband and dial-up. Most of the major brands are designed to work primarily over broadband, and, to our knowledge, they have not focused their technical or marketing resources on the estimated 45 million U.S. dial-up users and the hundreds of millions of dial-up users around the globe who may find Internet phone calling an attractive idea. NetZero Voice is designed to be access agnostic and to work over both dial-up and broadband, so the spectrum of appeal for this product is as broad as it can possibly be.

What's also important here is that NetZero Voice works exceptionally well over broadband connection, so users can now experience high-quality VoIP connection even while they're downloading large files or applications. A lot of the current VoIP providers experience a high degree of call quality degradation during periods of heavy downloading. That is not the case with NetZero Voice and our unique software codes.

NetZero Voice can be used to call anyone, anywhere, any time, absolutely free, from one computer to another using the NetZero free VoIP software. It's important to note that in order to enjoy free calling PC-to-PC that users must each have the NetZero software downloaded onto their computer. While it will take some time to gain traction in critical mass, this is a very compelling proposition and promises to take the computer, which previously was only used for viewing images and typing, into a mode where the computer will now be able to talk.

For those who'd like the opportunity to call someone on a landline or a cell phone from their computer or to receive calls on their computer from a landline or a cell phone, NetZero Voice will enable that in true NetZero form through our various extremely low-priced pay plans. Specifically, we have a pay-as-you-go plan, which is like a preloaded calling card. It lets the user load their account for long-distance calling anywhere in the world.

And we've got three pay plans-- a $3.95 a month, $9.95 a month, and $14.95 a month that are among the most aggressively priced VoIP plans available anywhere today. To sign up for a NetZero Voice pay plan, all you need is a United States billing address. We're currently reviewing the possibility of adding pay plans internationally and expanding our focus beyond the domestic market.

NetZero Voice provides all users with free voice mail and free email, and we provide a message center that will contain their email and voice mail in a single location. We also give you a personalized phone number with all of our pay plans that lets you choose the area code and the number of your choice, and you use that number as your primary means of communication through something we call our "find-me/follow-me" feature.

Find-me/follow-me lets the user program up to five separate phone numbers-- your home, your car, your office, your cell phone, whatever, so that when the number that we gave you is dialed, each number will ring in succession until you answer it. In effect, it will follow you and it will find you to make the connection if you so desire. If not, you'll go into voice mail, which on NetZero Voice is absolutely free.

Another major advantage of NetZero Voice is that even dial-up users can enjoy the incredible call quality while they're surfing the Internet. There's no longer a need for a second phone line. Now users can make and receive calls over the same dial-up line that they're surfing the Internet with, which can save consumers between $20 and $40 a month on that second line being dropped.

Think of all the dial-up users in the United States or think of all the dial-up users around the world. Now they don't have to switch to the NetZero ISP, although we would love them to do so, but they don't have to switch to NetZero ISP for Internet access. If they want to stay with their current dial-up ISP, they can download NetZero Voice software in a couple of minutes and begin talking to each other for free using the PC-to-PC feature or call conventional phones using one of our attractive pay plans. We've got a product that all dial-up users can use without changing their ISP. That is a big potential market.

Our marketing for the NetZero Voice product will include a focused email program through our user base, key links on our site, a three-month free offer on all the NetZero Voice pay plans. So just in time for the holiday season consumers can start calling people immediately from their PC's to a landline or a cell phone without waiting for their friends or family or business colleague to download the NetZero software to take advantage of the free PC-to-PC calling. In terms of TV advertising, beginning in early 2006, we'll be using some clever new creative designed to highlight the new NetZero Voice product.

The growth of our VoIP business is going to take time. This is a new application for the consumer and it's going to take some education. However, we think that this category is going to be huge. Some estimates have it between 18 and 24 million over the next four years. All we know is that VoIP is going to get bigger and bigger, and we think there's an opportunity to have a substantial domestic and international business at some point in the future.

Our employees in Woodland Hills, California, New York City and Hyderabad, India worked collaboratively and have done a wonderful job of creating the VoIP business completely from scratch in a little over six months' time. That's remarkable. We've got a world class product in the market today, and I'm extremely proud of the effort put forth by our world class technology and business unit teams. They did an outstanding job.

Our diversification strategy is progressing very well as we move beyond pure access and continue to focus our efforts on growing the social networking and VoIP businesses. Financially, we're in an extremely strong position, and our Board of Directors has just approved a $0.20 per share dividend for the quarter to be paid on November 30, 2005 to shareholders as of November 11, 2005, our third consecutive quarterly dividend.

With that, I'm now going to turn the mike over to Charles for a detailed review of the financials of the September quarter. Charles?

Charles Hilliard - United Online - EVP and CFO

Thank you Mark, and good afternoon, everybody. Let's get straight into our financial highlights.

First, United Online generated record revenues of nearly $133 million this quarter, with growth of 20% year-over-year.

Second, we had another strong billable services margin. We were up 180 basis points versus the year-ago quarter to 79.3%. Sequentially, the billable services margin was down 10 basis points due to ramp-up costs associated with our VoIP launch.

Third, free cash flow, which is very important to us, remained very strong at $33.9 million in Q3, up 23% year-over-year. Third quarter free cash flow has benefited from changes in non-cash working capital, reflecting record quarterly investment of capital expenditures of $8 million.

And, fourth, we produced record adjusted OIBDA, up 18% year-over-year to $34.4 million or 25.9% of revenues versus $29.2 million or 26.4% of revenues a year ago.

Let's go to pay accounts and subscriptions. Pay accounts increased by a net 7,000 during the quarter. As we discussed in the press release, we made an update to our billing reporting [stock plan] in the quarter, which resulted in a positive adjustment of 12,000 pay accounts and 15,000 subscriptions.

While pay access accounts declined by a net 98,000, non-access pay accounts grew by 105,000. At September 30, 2005, non-access represented 41% of our pay account base, and that's up from 4% a year ago. Also, during the September quarter, our non-access pay accounts crossed the 2 million milestone for the first time.

Subscriptions grew by a net 33,000. Non-access subscription growth was 122,000, which took our non-access subscription base to nearly 2.2 million. We continue to be very pleased with our progress in growing the non-access portion of our business and the early success with growing the United Online Advertising Network.

All right, let's get into some more detail here. Billable services revenues were $117.7 million, up 15% year-over-year. Average monthly revenue for pay account, or RPU, was $7.79, down from $10.60 for the year-ago quarter and from $7.85 sequentially. The decline in RPU was due to an increasing percentage of our pay accounts attributable to non-access. In Q3, our non-access RPU remained in the low $3 range, with access in the mid to high $10 range.

Advertising and commerce revenues were definitely a highlight this quarter. They were up 76% year-over-year and [80%] sequentially to $15.1 million. The year-over-year growth reflects primarily the contribution from our Classmates acquisition. The sequential growth reflects the stronger sales by the United Online Ad Network. Ad and commerce revenues represented 11% of revenues this quarter versus 8% a year ago.

Importantly, approximately 20%, two-zero percent, of the United Online total revenues in Q3 were derived from our non-access businesses. That is up from 2% in the year-ago quarter and 18% in Q2. Sequentially, total non-access revenues grew 12%. Today, we view non-access revenues as billable service and ad revenues associated with pay and free non-access services, although a small portion of these accounts are to some extent derived from or dependent on our access business.

Our cost of billable services were $24.3 million this quarter, up 6% year-over-year. The increase is due to the Classmates acquisition and a 1% year-over-year increase in average-- pardon me-- in hourly telecom costs of just over $0.06, offset somewhat by a 3% decline year-over-year in average hourly usage for pay access. Sequentially, our hourly telecom costs decreased 2%. For Q3, we anticipate relatively stable telecom pricing per hour.

Cost of free services was $2.9 million this quarter, up 78% year-over-year. The increase was driven by the Classmates acquisition, offset partially by declining [telecom] costs for free access accounts.

Sales and marketing was $52.5 million in Q3, or 39.5% of revenue, versus 39% in the year-ago quarter and 40.7% in Q2.

Which takes us to customer acquisition costs. For the September quarter, we estimate our gross pay account acquisition costs at about $52, five-two, down from $79 in the year-ago quarter and down from $57 in the March quarter. The decrease year-over-year and sequentially reflects primarily the lower relative costs of acquiring non-access pay accounts. Consistent with prior periods, we calculate gross pay account acquisition costs to include total sales and marketing expenses, with costs of free services, less ad and commerce revenues. This total was $40.2 million in the September quarter.

Product development expenses were up 38% year-over-year, primarily due to our budgeted headcount growth in the Classmates acquisition. Currently, we anticipate product development expenses to grow between 40 and 45% year-over-year in absolute dollars for 2005.

General and administrative expenses were up 23% year-over-year due to the impact of Classmates and increased overhead costs, offset partially by the incurrence of facility exit costs in the September 2004 quarter. Excluding these facility exit costs, G&A was up 47% year-over-year.

Total cash balances were approximately $241 million at September 30th, up $17.2 million during the quarter. We used approximately $5 million to pay down our term loan of $58.3 million and $12.7 million for dividends.

This takes us to business outlook. We're providing guidance for Q4 revenues of approximately $131 million to approximately $133 million and adjusted OIBDA for Q4 of between $32.8 to $35.8 million. For all of 2005 we are raising slightly our adjusted OIBDA guidance to between $132 to $135 million, up from our previous range of $131 to $134. At the midpoint, our calendar 2005 guidance implies year-over-year adjusted OIBDA growth of about 18%.

Pay account guidance for Q4 of slightly up to slightly down reflects our anticipation of continued trends with declines in access and growth in non-access pay accounts, which beginning in Q4 will include our Voice over IP product.

Also reflected in Q4 guidance are very two important forecasting issues with respect to our VoIP launch. First, we plan to allocate a substantial amount of resources, from technology to product management, to customer support to marketing, which will include advertising dollars, to support this launch. Most of these resources are being redirected from existing businesses with which we have significant forecasting experience, particularly Internet access.

We expect, number two, that there will be a learning curve, particularly with an entirely new line of business. As such, our Q4 business outlook includes a broader adjusted OIBDA range than in past quarters and implies that we have marginally less near-term visibility on revenues in pay accounts surrounding this launch.

Excluding potential acquisitions, we are tightening our estimate for 2005 capital expenditures to be within the range of $22 to $25 million versus previous guidance of between $20 and $25 million.

As we've discussed during the past, we anticipate an increase in cash taxes in Q4 due to limitations associated with our utilization of tax net operating loss carryovers, which at September 30th were approximately $192 million. Our cash taxes estimate for Q4 is approximately $10 million, which is at the low end of our previous guidance of between $10 and $15 million. Cash taxes in Q3 for record purposes were $1.5 million.

And with that, I'll hand things back to Mark and q-and-a. Thank you.

Mark Goldston - United Online - Chairman CEO and President

Thanks Charles. Operator, what I'd like to do now is please get people into the q-and-a queue so Charles and I can answer their questions.

QUESTION AND ANSWER

Operator

[OPERATOR INSTRUCTIONS]. Your first question comes from the line of Youssef Squali with Jefferies & Company.

Youssef Squali - Jefferies & Company - Analyst

Thank you very much. Good afternoon everybody. This is Youssef Squali. A couple questions. First, I was wondering if you could talk a little bit about the growth, the year-on-year growth we're seeing in Classmates. By our math, it's somewhere around 20%. So if you keep RPU relatively flat and you just look at the growth in the [parts discovered] where it's about 20%, is that the right number? And, second, is that the type of growth you expect potentially for next year?

And, second, on the access business, is it fair to basically assume that the access business going forward should decline by somewhere around 90,000 to 100,000 subs a quarter? Thanks.

Charles Hilliard - United Online - EVP and CFO

Okay, Youssef, it's Charles. I'll take this. First of all, we've not owned Classmates for a year. That one-year anniversary will come up on November 17th, so it would not be fair to use the year-over-year comparisons.

What I would say is if you look at the trend in non-access pay accounts, both in terms of RPU and in terms of the growth rate there, then Classmates is running roughly in line with that. So that trend is very similar. And in terms of any next year guidance, we'll consider when we announce Q4 results introducing guidance for 2006, but we're certainly not ready to do that right now.

And, second, on the access business front, trying to quantify that going forward, I would say we're managing it to cash flow, and the amount we invest in it is somewhat determined by the attractiveness of opportunities in non-access businesses, including Classmates, and we're not ready to give specific guidance on the access business going forward.

Youssef Squali - Jefferies & Company - Analyst

Okay. And then if you look at the year offering on Voice over IP, Mark, how will you be monetizing the PC-to PC VoIP model? I understand how you'll be monetizing the other one, but PC-to-PC, are you going to monetize it at all or is it just going to be a subscription acquisition channel?

Mark Goldston - United Online - Chairman CEO and President

No. We're going to monetize it. We actually have advertising. We have a unique "soft phone client" is what it's called, that goes on the screen, and on the free version at the bottom there is advertising that we can display. We're also looking at potential partnerships with people that we can tie into who want to reach this audience on things that are thematically consistent with the features that we've got on the free product. So we're looking at a bunch of different ways to tie in people. We absolutely plan, like we do with free access, to monetize these folks.

And understand, Youssef, that like Skype, the free product, which is really compelling, is-- it's like having a single walkie-talkie. In other words, somebody else has to have the walkie-talkie for you to talk to them. And so, it requires people to download the software, just like it does with Skype, and then if you want to talk to somebody right away-- so you see our commercial, you say, "Wow, this sounds like a great thing. I want to go sign up for it." We're giving people three months free on all of the pay plans, so that the minute you download the software, you can start calling people on their cell phone, on their landline phone. They don't have to have the software. So we're trying to get people into the game right away. So the free will monetize and the pay speaks for itself.

Youssef Squali - Jefferies & Company - Analyst

Okay. Great. Thank you.

Operator

Your next question comes from the line of [Matt Shindler] with Piper Jaffray.

Matt Shindler(ph) - Piper Jaffray - Analyst

Yes. This is Matt Shindler asking a question for Safa Rashtchy. Quickly, just trying to understand, what do the users get for the different pricing plans on the VoIP plan, those $3.95 versus the $9.95 per month plan?

Mark Goldston - United Online - Chairman CEO and President

The $3.95 plan that you basically get is 100 minutes that you can use for incoming and outgoing calls to and from cell phones, landlines, anything you'd like. And then you get, obviously, unlimited PC-to-PC.

If you have the other plan, which is the NetZero Voice 250 Plan, that's the $9.95 a month. That gives you 250 outgoing computer to telephone minutes, but it gives you unlimited incoming minutes. So anyone can call your phone number unlimited, and then, obviously, unlimited computer to computer. And with each of these, obviously, you get your own personal phone number, you get voice mail, you get caller ID, you get call waiting, a very long list of features.

And then the $14.95 a month product is unlimited all the way around-- unlimited outbound calls, unlimited inbound calls, unlimited PC-to-PC, personal phone number, etcetera, etcetera, instant messaging. All of these things give you instant messaging as well. So you can be typing IM's, you can conference chat with 5, 6, 7, 8 people on the phone and have one-to-one or one-to-many conversations on IM, all very packaged into this, very easy to use, and it's a very compelling product suite.

Unlike some of our major competitors, I think including Skype, on these products, including the free product, we give you free voice mail. You don't have to pay for it. So we've got a very compelling suite of features here. And, obviously, what really makes it unique is in addition to being phenomenal over broadband, we can give everybody in the world or most people in the world who are on a dial-up a connection the ability to use VoIP, which is a real neat idea.

Matt Shindler(ph) - Piper Jaffray - Analyst

Okay. Two quick follow-ups then. How do those pricing plans compare to current Skype out-pricing, because that doesn't tend to be on a prepackaged monthly basis? So I can't-- I haven't made the conversions yet. I'm wondering if you had.

And, additionally, concerning the number of free products available from Google Talk to the new MSN Messenger system to Yahoo's system, and as well as Skype, do you believe--? It sounds like you're going to have a fairly heavily ad monetized system. On the pure PC-to-PC system, will that be a deterrent to users?

Mark Goldston - United Online - Chairman CEO and President

Those are good questions. One, I don't have the Skype numbers in front of me, so I don't have their pricing plan. I'm not online right now. If I were, I would pull up their website and give it to you. But I believe if you look at it, you will see that our pricing plan is, if not as, more competitive than what you would see there, number one.

Number two, in terms of the free product that's available, as a category what we think is going to happen is if you have people in this network, you will use the free product. But you have to remember, even though we have let's say 40 million people in the Classmates, let's assume that every single one of them downloaded the software, all 40 million of those people don't know each other. And so, you have to know who it is you're going to be talking to, for us or Skype or anyone else, to use the free product.

So over time, I think it's a big idea. Like, for example, if you wanted to use it, you would have to tell 5, 10, 15, 20 of your friends, "Download this software so that we can talk PC-to-PC." Now that's not onerous, but that requires word-of-mouth, etcetera. Well, right out of the gate, a $3.95, $9.95, $14.95 program, but we also have something called "pay-as-you-go," which is like loading a calling card, you can immediately start calling anybody you want at price points that are not only a fraction of conventional long-distance that you would buy, but even if you look at somebody like Vonage, who I think has a million subscribers in the U.S., I mean their unlimited package is $24.99.

And so, it's a huge savings versus that. AT&T Call Vantage, which is another major player in the category, is $29.99. So the price points here are very attractive. It couldn't be easier to use. You don't need any equipment. You download this thing in a matter of minutes. You either use the speakers or the mikes on your computer or you plug in a headset, either/or. It's very easy.

And the advertising that will be on the free product, to your question, is unobtrusive but in a place that will be effective. It is not big banner ads flashing all over your screen, but it is something that's integrated so that it will be meaningful and relevant to the consumer.

Matt Shindler(ph) - Piper Jaffray - Analyst

One just final follow-up. Sorry. If--? Is your product standard spaced, because it seems that the likelihood, and at least with the IM products it looks like it's going that way already, does the true--? The PC-to-PC systems are likely to go to complete interoperability sometime in the future. Are you using [Jabber] or some other?

Mark Goldston - United Online - Chairman CEO and President

Interoperability is what people are planning could ultimately happen to the category. I actually believe that ultimately that probably [won't] happen in the category. So the PC-to-PC calling, I think over the next couple years there's probably a good chance that it will be interoperable.

But having said that, and while I do think that's absolutely a compelling product and certainly Skype has proven that a lot of people will do that, that product from us or anyone else is only as good as both people being at their computers. Given that people move around a lot all day and in the evening and are constantly getting calls either at their office, their car, their cell phone, whatever the case may be, the free product demands that both people be at the destination; whereas, our paid product, one, doesn't because you can call any phone, and, two, because of our find-me/follow-me feature, it really doesn't matter where you are because you can program in a series of numbers and the phone call will find you.

So, while I think interoperability, free PC-to-free PC is a good idea, and I think may be coming in the future, I don't think it's the pure panacea for people who are looking at this as a viable phone service. It absolutely is a panacea to people who say it's boring just to sit in front of my computer and only be able to type and see images and now I can actually talk. I mean it's almost like voice instant messaging. From that standpoint, we think it's very attractive. But for people who want to make phone calls and are going to use this as a way to save them a lot of money, the free PC-to-PC, from us, Skype or anyone else, I don't think is going to be the most compelling solution for them.

Matt Shindler(ph) - Piper Jaffray - Analyst

Thank you.

Operator

Your next question comes from the line of David Geisler with SG Cowen.

David Geisler - SG Cowen - Analyst

Hi. It's Dave Geisler calling in for Jim Friedland. Last quarter you gave some color on the allocation of your marketing dollars. I was wondering kind of given the competitive activity on the access side of the business if you could kind of update us as to how you're allocating your marketing dollars between access, VoIP now that it's launched, and as well as web services.

Mark Goldston - United Online - Chairman CEO and President

Sure. The vast majority of the television dollars, 90-some-odd percent, obviously, has been on access. We do not intend on VoIP to go on the air-- it will either be late December or it may actually be into January in terms of going on to broadcast media for that. We spend a modest amount of money, and I mean very modest, on Classmates on a quarterly basis on television. As you know, we are with Classmates one of the largest, if not the largest, online advertiser in America. So, and that's been consistent and those numbers haven't really changed dramatically quarter-over-quarter.

So, from a mixed standpoint, through September 30th at least, nothing really different from what you've been used to in the past. And I would say even in the fourth quarter, because we don't intend to spend a lot of money on the VoIP launch until late in the quarter when we want to make sure this thing is out and doing all the things it needs to do, I don't think you'll see a big shift on that.

Now, going into 2006, we'll have to see what the traction is, but the VoIP business may end up getting a lot more of our expenditures. It depends on how it goes, but we are committed however long it takes to building that business and marketing it through NetZero fashion.

So don't know yet what the mix is going to be yet for 2006, and we also have a lot of new initiatives coming on in Classmates, which will probably demand that we spend some marketing dollars [in there]. But, just like we have in the past, we're going to allocate the dollars to wherever we think we're going to get the highest and best use while keeping an eye towards maximizing cash flow, really no different than what we've been doing for the last several years.

David Geisler - SG Cowen - Analyst

Okay. Great. Just another question on the voice business. Do you have a sense--? I know you just launched recently, but what's your sense on getting the break even in terms of number of subscribers?

Mark Goldston - United Online - Chairman CEO and President

Well, I'm not going to give any projections on that. I mean, first of all, the product's been out for six days, so-- You know it's really going to depend on when we decide to turn on the jets from a marketing standpoint and which products within the VoIP seem to get the most traction. If we find out that the pay products are getting a lot of traction early on that might change the model somewhat from when if we use the plan of getting a lot of free people early on and then, obviously, getting them to migrate like we do in access over to the pay product.

So, it will really depend and we've got three different plans that we've developed right now. One of them is modest, one of them is sort of middle-of-the-road, the other one is really aggressive, and we've got to give this thing a couple, six to eight weeks, and see what kind of [tape rate] we get, what kind of usage we get, and what's going on in the market before we unveil the big marketing blast. It wouldn't make sense to launch a product immediately, then turn on the TV and blast it away. It's just not how we've launched virtually anything in the Company, including accelerated dial-up when we launched it.

David Geisler - SG Cowen - Analyst

Okay.

Mark Goldston - United Online - Chairman CEO and President

I'd say you'll see more of this in late '05 to early '06.

David Geisler - SG Cowen - Analyst

Okay. And then, quick, just a last question on the capital spend in the quarter, it was record levels, as you mentioned Charles. Is that primarily due to equipment spent for the Voice over IP launch or what else in that-- the increase in that number?

Charles Hilliard - United Online - EVP and CFO

Quite a bit of it is associated with VoIP. I would say a little over half of it, and then between Classmates and replacing some older equipment on the access business is in the remainder.

David Geisler - SG Cowen - Analyst

Okay. Great. Thank you.

Operator

Your next question comes from the line of Michael Trotsky with Par Capital.

Michael Trotsky - Par Capital - Analyst

Thank you. Just a couple of clarifications on a question. The 7,000 net sub ads, does that include the 12,000 that were found in the new billing software upgrade?

Mark Goldston - United Online - Chairman CEO and President

It does.

Michael Trotsky - Par Capital - Analyst

Okay. So without that it would have been negative?

Mark Goldston - United Online - Chairman CEO and President

Yes.

Michael Trotsky - Par Capital - Analyst

Okay. And then did you--? Did you say what churn was in the quarter and what you expect it will be next quarter?

Charles Hilliard - United Online - EVP and CFO

We've got churn in the quarter was at 5%, which is within about 10 basis points of where we were in Q1, but it was up from Q2.

Michael Trotsky - Par Capital - Analyst

Okay. And your expectations there?

Charles Hilliard - United Online - EVP and CFO

Right now it's somewhat of a stable outlook.

Michael Trotsky - Par Capital - Analyst

Okay. And then on-- your business is rapidly transforming from one of access into one of social networking and other things. The social networking website that's getting a lot of press these days is myspace.com, and they're growing at something like 8 to 10 million users a quarter, and they've quadrupled this year for example. Can you just say how you compete with them and if it's a different demographic or different service, or is there any overlap?

Mark Goldston - United Online - Chairman CEO and President

Yes. This is Mark, Mike. That's a good question. The last numbers we saw on My Space as part of the acquisition was I think 18 million, if I'm not mistaken. Our Classmates business has got about 40 million members, four-0, just to compare the two companies because there are a lot of differences, but I mean the revenues are [orders of magnitude higher]. Classmates is a company, as you know, that's been profitable since 2001.

The Classmates business, by and large, gets people in starting at about 28 years old. The reason is that's usually when they're coming upon their tenth class reunion. I don't think a lot of people must not go to their fifth, but by their tenth reunion that's when people are signing up. So it's very much at age 28 to age-- and literally we have people in their 80's on Classmates, but the vast majority, probably between the ages of 28 and 70.

The business of My Space, a lot of people on My Space are unidentified. They're on-- they're on different names. A lot of them, a 14, 15-year-old guys will say, "I'm 19 years old." A lot of the content that you view on there can be somewhat fallacious. It originally started out as a place where people would sort of post their interests. A lot of it was music related, etcetera. There wasn't a lot of monetization and I think that's why that company does not or did not have a lot of revenue, but they were very good at aggregating a lot of people. Whether or not those people were identified as being exactly who they said they were, they nonetheless could do that.

Classmates is a very different model in that Classmates is a registry that defines who you are by where you went to school or where your worked or what military you were in and what years you did it and who your peer group is. So it's a very efficient model in that it is unidentified registry versus an unidentified registry, which is very valuable to marketers because we know who these people are, we know what age they are, we know where they're from, etcetera.

And as we move forward, and now that we've launched this new photo option and some of the other new features that we have planned for Classmates, we are going to turn it into more of a personal portal type of business, but it will be a relevant personal portal. The personal portal will be related to why that person is there in the first place and what they want to post about themselves versus some of the more let's say content that's really out there that isn't related to what 28- to 70-year-old people are going to do.

We are looking at the younger market. We've got some ideas around that. Our International Division tends to be relatively effective at getting the younger people in, so we have some things that we're looking at. The Classmate stuff that we've got coming out in '06 I think could be appealing in that regard. But the business model for Classmates I think is much more defined. It's a much larger business. It's got a lot more traction and I think there's a lot more tentacles that you can put on it than some of the other narrower focused social networking businesses. Although they've done a good job, so hats off to them.

Michael Trotsky - Par Capital - Analyst

Okay. And then you know Yahoo has a new beta site out, I guess Yahoo 360.

Mark Goldston - United Online - Chairman CEO and President

Yes.

Michael Trotsky - Par Capital - Analyst

Can you just tell us about that and the same kind of discussion?

Mark Goldston - United Online - Chairman CEO and President

Yes, I mean Yahoo 360, again, is their attempt at sort of the personal content, personal portal, social networking space. I mean this is the hot space right now on the Internet. I mean people are realizing that the next wave of user-generated content is going to be people generating content largely about themselves and their interests.

And it's one of the reasons why we bought PhotoSite. It's why we bought Classmates. It's also why we bought our About.com web services unit which does personal websites. I mean we sort of saw this coming 24 months ago, and now everybody else is starting to see it as well. It's going to be the law of large numbers, I believe, that prevail, and there are very few people who have the critical mass that we've got here at United Online.

You know, our overall strategy of being able to find people, see people, and talk to people, all of which have revenue attached to it-- pay to find, pay to see, pay to talk. We like where we stand. And Yahoo, I'm sure in true Yahoo form will do a good job at whatever they do because that's what they do, but it's a big category and there is plenty of room for a lot of people.

Michael Trotsky - Par Capital - Analyst

Okay, and then one more for Charles. You know we're seeing a huge transformation in your Company and the financials have held in really well. You're in essence replacing a higher RPU customer with a lower RPU customer, and I'm just wondering at what point will you give us a longer term financial model, what to expect as this transition unfolds?

Charles Hilliard - United Online - EVP and CFO

Michael, we try to provide people quarterly guidance on a quarterly basis, and we consider at the end of each year providing guidance for the year going forward, and, generally, we do that just on an EBITDA basis or an adjusted OIBDA basis, because managing the bottom line going through this transformation and given the dynamics for the subscription and ad supported business, we have more control over managing that bottom line.

Beyond that, I would give you the comment that the existing guidance is the existing guidance and that's as much as we're providing today.

Michael Trotsky - Par Capital - Analyst

Right. And then next call you'll give '06 guidance as bottom line?

Charles Hilliard - United Online - EVP and CFO

We're not saying that today. We will provide you that update in about 90 days. I would tell you we've done that each of the past few years, but we review that every quarter.

Michael Trotsky - Par Capital - Analyst

Okay. Thank you.

Mark Goldston - United Online - Chairman CEO and President

Thank you, Michael. I mean we're about to run out of time on this, so I want to thank everybody. If you have additional questions, you should really direct them in through Charles Hilliard's office.

I would say though just as a follow-on and in summary, we really have made a lot of progress in transforming the business against the stated objective of 18 months ago to try to diversify a way into more non-access businesses. And as we sit here today, I am really proud of the fact that through three quarters of 2005, 41% of that pay account base was in non-access and 20% of our total revenues were from that, and I think that is something we're very proud of.

And I look forward to coming back next quarter, giving you an update on how VoIP is doing, and Classmates and access, and any of these other new initiatives that we've got coming out. So thank you everybody for attending and we look forward to talking to you guys next quarter.

Thank you Operator.

Operator

This concludes today's United Online Third Quarter 2005 Earnings Call. You may now disconnect.

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