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Executives

Matt Diamond - Chairman and CEO

Joe Frehe - CFO

Jodi Smith - IR

Analysts

Steven Martin

Ed Einboden

Julian Allen

P.J. Solit

Alloy, Inc. (ALOY) Q2 2008 Earnings Call Transcript September 4, 2008 5:00 PM ET

Operator

Good afternoon. My name is Vernel and I will be your conference operator today. At this time, I’d like to welcome everyone to the Alloy’s Second Quarter Conference 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.

Ms. Jodi Smith, you may begin your conference.

Jodi Smith

Thank you. Good afternoon. Thank you for taking the time to join us for our conference call on Alloy’s second quarter 2008 earnings. Participating in today’s discussion are Matt Diamond, Chief Executive Officer; Jim Johnson, Chief Operating Officer; and Joe Frehe, Chief Financial Officer.

Alloy reported its second quarter earnings after the close of the market today. If you have not previously received a copy of the press release, it is available on Alloy’s website at www.alloymarketing.com.

Joe will begin by providing a discussion of our financial results and position, followed by Matt, who will provide a discussion of our operational highlights and an update on recent events. We will then open the session up for questions and answers.

Our press release and this presentation reference several non-GAAP financial measures, specifically, adjusted EBITDA and free cash flow. We have included these non-GAAP measures because we believe that they are important in evaluating the company’s operating performance. Because they are not calculated in accordance with GAAP, they should not be considered in isolation of or as a substitute for net income as an indicator of operating performance or net cash flow, provided by operating activities as a measure of liquidity.

At the end of our press release, we have provided supplemental disclosures to reconcile the non-GAAP financial measures to their GAAP counterparts in accordance with the SEC’s Regulation G. Certain remarks that we may make during this call about future expectations, plans and prospects for Alloy constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995.

Our actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those that are discussed in our annual report on Form 10-K for the fiscal year ended January 31st, 2007, and in our other periodic SEC filings which are on file with the SEC and available on their website at www.sec.gov. Please refer to those filings for a full description of those factors.

I’ll now turn the program over to Joe Frehe.

Joe Frehe

Thank you, Jodi. Good afternoon and thank you for joining Alloy’s second quarter fiscal 2008 conference call. I’d like to begin by highlighting some of the key financial information for the quarter.

Revenue for our second quarter ended July 31st, 2008 increased $2.4 million to $54.1 million from $51.7 million in the second quarter of fiscal 2007. Revenue in the Media segment increased while the Promotion and Placement segments declined slightly. Media segment revenue increased 23% or $3.3 million to $17.3 million. This increase was driven particularly by the Alloy Entertainment, Channel One, Frontline, and Interactive businesses.

Promotion segment revenue decreased 2% or $517,000 to $27.7 million. This decrease was primarily due to fewer promotional programs and lower linen sales in our on-campus marketing business. Placement segment revenue decreased 3% or $293,000 to $9.1 million. This decrease was primarily due to a decline in military and broadcast advertising, partially offset by an increase in multicultural advertising.

Adjusted EBITDA, which we defined as operating loss plus depreciation and amortization and non-cash stock-based compensation, for the quarter increased approximately $600,000 to $1.5 million from $884,000 in the second quarter of fiscal 2007. An increase in adjusted EBITDA was primarily driven by a higher revenue in our Media segment businesses.

Operating loss decreased to $303,000 to $1.1 million in the second quarter of fiscal 2008 from $1.4 million in the second quarter of fiscal 2007. The decrease in operating loss is primarily due to the improvement in adjusted EBITDA and partially offset by higher depreciation and amortization.

Net loss decreased $100,000 to a net loss of $1.4 million in the second quarter of fiscal 2008, from a net loss of $1.5 million in the second quarter of fiscal 2007. Net loss for basic share in the second quarter of fiscal 2008 was negative $0.10 from negative $0.11 per basic share in the second quarter of fiscal 2007.

We believe free cash flow was an important measure of our company’s operating performance as they represent the amount of cash the value of our debt service, acquisitions and stock repurchases. Our free cash flow which we define as the sum of net cash provided by operating activities, changes in operating assets and liabilities less capital expenditures for the second quarter of fiscal 2008 increased approximately $5.4 million to $300,000 from negative $5.1 million in the second quarter of fiscal 2007.

This improvement was primarily due to higher accounts receivable of cash collections and lower capital expenditures. Free cash flow per share in the second quarter of fiscal 2008 was $0.02 per basic share compared with negative $0.38 per basic share in fiscal 2007. Our weighted average share used in the computation of free cash flow per share did not change.

Turning to our balance sheet. We believe our balance sheet is very strong at July 31. Cash and marketable securities were $20.4 million, this balance includes $2.1 million in option rate securities down from $3.2 million at Q1. The $1.1 million in liquidated securities were at face value as well we have liquidated additional $775,000 in securities in August, further reducing our balance to $1.3 million.

Our working capital was $22 million. We also paid off our entire $4 million balance on our credit facility and we converted $1.3 million of our senior convertible debt by primarily using Alloy cash. The final outstanding $15,000 and convertible debt was paid in cash on August 1.

Our accounts receivable at the end of the quarter were $4.5 million lower than our first quarter balance. DSO, or day sales outstanding at second quarter were approximately 59 days compared with 73 days at August 30. We are very pleased with this significant reduction in DSO from last quarter.

Our capital expenditures for the quarter were $1.1 million versus $5.9 million in the prior year's second quarter. [Fees] increases primarily due to the digital head and equipment operate for Channel One which was completed in Q1 2008.

With that let me turn the discussion over to Matt.

Matt Diamond

Thanks Joe. I would like to get color as to what’s driving our business as we enter our important third and fourth quarters. As you know these quarters have conditionally being incredible for us. It is when we generate most of our EBITDA. Generally speaking w are happy with our momentum in our Media business segment. We seem to have good sales momentum going into the back half of the year. I will outline more specifics on this below.

Our Placement and Promotions business segments, we are experiencing challenges in meeting our revenue estimates primarily because of our client to become more cautious with their 2008 marketing expenditures. However, we are maintaining the previously announced guidance of $20 million to $24 million in EBITDA. Given the economic environment we will continue to closely monitor the situation.

Overall, we believe our company is in very good shape, we continue to increase our Media business segment and we are showing growth in key areas, specifically Interactive, Alloy Entertainment and Channel One. Our balance sheet is very strong, in the last quarter we paid down our debt, accelerated our receivables collection and had a cash balance in excess of $20 million. Our interactive businesses are experiencing healthy sales growth from all key areas, displaying innovative advertising and lead-generation programs.

During the first part of this year, we invested in our partner network and our operations in ad sales infrastructure, and we are starting to see the benefits of that over the last month. We hope and expect this momentum to continue and we see this as being a key contributor for profit growth in the back half of the year.

Our entertainment continues to do well. On the CW Network, Gossip Girl started the second season last Monday with strong ratings and privilege also on the CW will debut the next Tuesday at 9:00 p.m. We continue to take steps to more fully monetize our entertainment momentum in developing valuable media properties without taking on unnecessary financial risks. We look forward to updating you more fully on this as our plans materialize.

Channel One continues to progress and we estimate that it will be nicely profitable in this fiscal year. The capital costs of the digital upgrade are behind us and the sales infrastructure is in place for continued growth. 2009 will mark the first year that we will have a full-selling season with a fully staffed sales force. This was not the case in 2008 as we were building our team for clients were committing to the 2008 marketing plan. With this massive new openings already reached, we believe it is an attractive option for advertisers looking to maximize our advertising spend in the new demographics. Our promotion in place of business segments are nicely profitable, but they are experiencing some headwinds as the economic issues persist.

We have mentioned on previous calls that our place of business segment would show a moderate decline in revenues and EBITDA as the economy weakens. Nothing has changed since our last call; we hope to see a turnaround for the fourth quarter, but we are not forecasting it.

As you recall, at the beginning of the year, we were forecasting our promotion segment to show significant increases in revenue and profits based on pre-booked business. Unfortunately we are seeing our clients are becoming increasingly hesitant to spend in 2008 and many are not spending at all in 2008, and some were pushing previously forecasted 2008 spendings into 2009.

We are focusing on reducing costs to maintain our margins and generate as much EBITDA as possible. There are some exciting initiatives in other areas of our business as well, and as they become more immediate and financially relevant we will share them with you. We believe we can create a lot of value for shareholders over the coming year and look forward to continue to update you.

Now, I would like to turn the call over to Q&A

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steven Martin.

Steven Martin

I don’t know whether I should be honored or what to be first. Guys, congratulations on the receivables.

Joe Frehe

Thank you.

Steven Martin

That was a dramatic improvement. Just a quick question. When you talk about the back-half and the guidance of 20 million to 24 million, okay, is that adjusted EBITDA?

Joe Frehe

Correct.

Steven Martin

Okay. And, so that on the same basis, as this -- the six month EBITDA of 2.55 and 0.8 --and 800,000.

Joe Frehe

Correct.

Steven Martin

What is the comparable -- I am sorry, what is the comparable number for -- well, let me do it this way, if I take the mid-point of that range, and say it is 22, and I subtract 2.6, okay that means you're going to $19.4 million roughly in EBITDA in the second half of the year.

Joe Frehe

Correct.

Steven Martin

What is the comparable number in your mind for the second half of '07?

Joe Frehe

Last year was approximately $9 million or so. Again we can look at the specifics. Your question is just to clarify for everyone, it is an apples-to-apples comparison in adjusted EBITDA and the exact number last year was $9.3 million or so, I'm sorry, $9.5 million, $9.3 million in the third quarter and roughly $300,000 in the fourth quarter.

Steven Martin

Okay, so $9.3 in the third and --

Joe Frehe

And roughly $200,000, $300,000 in the fourth.

Steven Martin

Okay. So you're basically saying that you did 9.5 in the second half of last year and you’re going to do 19.5, if I take the mid point in the second half of this year?

Matt Diamond

If you take the mid point and a couple of things to point out that obviously we look at as well, first we're up approximately $2 million or so apples-to-apples in the first half of the year. The back half of the year, and this is again something we look at very closely, you're getting into the incremental portions of our business. You're covering your fixed cost and every dollar you bring in now above a certain point in the third and fourth quarter becomes very high margin dollars. Therefore, like last year but more importantly this year because we're dealing with a much higher base, for example on Channel One and with our other divisions that you do get incrementally lower profit.

So we're positioned well for it, as we said, we reaffirmed our guidance because based on what we see, we feel we're still in that range but we're also acknowledging that we still have a lot to book and the difference between 3% and 5% swing, let's say, on the top line revenue of $100 plus million that are still in Q3 and Q4, so its only $3 million to $5 million, but it's 3% to 5% is a significant portion of that profit. So we're obviously watching it very closely. But as of right now, because of the strength in the media segment, we are still focused on hitting that number and really our back-to-school selling season and what is going on right now.

Steven Martin

Okay. Now on the same basis, can you give me what the revenue was for the back half of '07?

Joe Frehe

The back half of '07, just a second here, the revenue was about $109 million or so. And so you're looking at slightly more if you take our mid range of our guidance less what we've done to date. And again you can see where a lot of the leverage comes from.

Steven Martin

Yes, because if I take the mid point of the range, it's what, $237?

Joe Frehe

Yes. $237 less the 10 --

Steven Martin

Less the 103 so that's 234.

Joe Frehe

Correct. So you’re looking --

Steven Martin

So on $25 million of incremental revenue.

Joe Frehe

And that incremental revenue if you fall to the map, we're saying it's approximately $10 million which of course makes sense because you're dealing with your higher margin portion of your business.

Steven Martin

Okay. Sisterhood, how does -- how did that shake out? I mean it just about got to $40 million and probably get some more and that was only domestic. How does that end up translating into profitability for sisterhood 2 I mean, for the company.

Matt Diamond

A couple of things. I did top 40, I think this week it's topping 40 for the first time. It does a couple of things for us. On the immediate side, while the numbers aren’t big we sell more books, so that's always a good thing. There is very back end participation, but we hadn’t projected or anticipate much back end participation on any of these. But in the future or after foreign DVD sales and everything else just certainly that possibility in something that could come down the road.

Steven Martin

But what kind of level of revenue do you have to get to to get --

Matt Diamond

We are close domestically now. You have to see a full audit to be honest with you because it tends on a market expanded that still to be determined. And keep in mind, Sisterhood in particular was our first major deal. So again, we have never projected significant profit participation for something like that. However, in that -- I think important point is the success now of both movies that we had, the one TV series that we put out there with Gossip Girl, the cancel of other products now on the pipeline are coming out in the next three months. All of that success really does give us significant leverage in as I alluded to in the script, changing the model without taking increased financial risk and we are in the middle of that process now, meaning striking new deals, negotiating new opportunities with now contents.

And keep in mind our content library is substantial numerous new books each year and for the last few years many new books. So, that is a good pipeline. In addition to that we got content from that group that we are able to put out immediately in the form of web series and other things on our broad-based teen.com network and not even wait for Hollywood deals to monetize by content. So the sisterhood, we were clearly rooting for because of our association with it, but the financial impact is really it just continuous to show the success of our properties, our content creation group, our marketing in translating that into popular consumer success and appeal.

Steven Martin

And can you tell us what's in the pipeline for new movies or what sign that you can talk about in the way of new movies or new TV shows?

Matt Diamond

In the immediate future, we've got privilege, which I referenced in the script is coming on Tuesday. This week, I believe tomorrow, a three part mini series on ABC Family call Samurai Girl is on. We've got a movie coming out in October, that's an R-rated movie coming out in October 17th I believe. We have the [click] which is a very popular book series, one of our most popular book series coming out in DVD form that comes out I believe in November. So those are all just this fall. And then we got about half of dozen I would say that are in the range of either web series or negotiation for either script television series, DVDs, movies, etcetera. So, just in the immediate three months, there is another handful that we will be looking at closely not only for the immediate success, but again even thought some of the deals were struck a while ago and now they're being green lit for project and now hopefully a couple of them get either picked up or have some successes will have even more proof that the model really is sustainable and is pretty impressive franchise.

Steven Martin

Will they generate revenues in the back half of '08?

Matt Diamond

In almost all of the cases that I just suggested other than the fact there is a couple that have -- if there is -- there is little hundreds of thousands of dollars I would say upside with certain pick up and things like that, the majority of them we were already paid for because the licensing deal has to do with whether or not the project gets green lit. For example with privilege as an example, we got paid when they shot the pilot and picked up series. Now if the series gets picked up, there is some upside beyond that. So for example, being specific with privilege, we'll get an episodic fee similar to Gossip Girl, if the series itself is picked up. So certainly we'll be rooting for that.

Steven Martin

Okay. Alright, why don’t you let someone go ahead and I'll come back.

Matt Diamond

Okay, great.

Operator

Your next question comes from the line of Ed Einboden.

Ed Einboden

Good afternoon everyone.

Matt Diamond

Good afternoon.

Ed Einboden

I just wanted to, obviously give you guys a great complement on your balance sheet. You guy have done a great job with that. But I just wanted to also ask some questions. Can guys kind of talk about the back to school environment and obviously Channel One and a better sales force that you've had in the past year. Is the improvement year-over-year primarily due to the better economics, which you guys had out of that and so the digital upgrade or do you think there is I guess more going on that you guys are excited about in that channel.

Matt Diamond

I think on the media side, which I would highlight both the Channel One and interactive properties which I didn't mention in the script as two areas that, I think there is couple of things going, first, the strength of the properties is outperforming any decline in the economy. So Channel One, a combination of the digital upgrade, a sales force which is focused on selling a very popular product with both the school system and advertisers is, which is a phenomenal place to work with both the schools and advertisers to deliver a message. Interactive, teen.com and our broad-based on line networks, our large networks deliver good click-through rates and are very popular with advertisers as well. We have a full sales force focused on selling that. So again I think it's a combination of factors that happen to be very strong properties and I think when you look at properties that are in our marketing services and promotion area they're strong properties but they're more susceptible now to a down economy and that's with counter balancing, really what we are seeing out there in the market.

Ed Einboden

Are you seeing that general economy has taken a worse downturn than expected, I guess more recently, or has it been sort of sustained downturn, which you guys are predicting for that to continue?

Matt Diamond

Again it's mixed because we're not seeing it in our media as much as we are in our promotions but I would say more sustained. Just, clearly when you get a call where a client says you got to work with us, we really want you push this off a little bit to ’'09. We got budgeting tightening. It feels like a good job, but I think if you look at it over the course of last few months in particular, it has been just a steady tightening. And look, some of these things may open-up in the fourth quarter, if economy improves, we have seen that happened, but at this point as I said, we want to watch it closely and monitor and hopefully the situation doesn’t get worse.

Ed Einboden

And you guys, kind of talk about how much are basic cancellations or are postponements at all?

Matt Diamond

It’s a fine line between the two, I would say for the most part, they are positioned as postponements of program. They are large client. So, even if someone wants to cancel a project, you hope to keep them as a partner for other programs that they are going to have. So, it’s not like our ad base is very small clients that have one initiative. These are going to be large clients that have multiple initiatives and want to scale something back which is why often you really are in a position that you want to work and accommodate them to the best of our ability.

Ed Einboden

And so you’re not losing relationships, necessarily, they’re just tightening the spending is really what’s going on.

Matt Diamond

That’s right. You also have clients on the promotion side that are going to stay status quo or not spend so you’re ability to drive new business in a top economy on a promotion segment is also a challenge. It is not as if -- including business away from us. It’s not as if we’re going to lose business to a competitor but also, it makes it hard with a good sales force and good offering to pry someone away when they’re not spending or would not take a chance on someone new. So we’ve seen this before with a down economy, the promotion segment is one in which is susceptible. I don’t think it’s as susceptible as broadcast or other parts of media that are more mass marketable because the ad spends is lower, and the very ROI focused programs and promotions, but in comparison to our other niche media properties, they are the ones we have to make sure we keep flexible and watch the economy closely.

Ed Einboden

Okay. And I guess -- can you talk about how you think -- the new series that are coming out and what you guys have in the pipeline, how do our really handicap that as being what is going to be picked up and sort of what kind of thoughts are on modeling, I guess.

Matt Diamond

I think, in general our view is to be conservative, just because you get paid for what you get paid for and don’t want to rely on something that’s still uncertain. I would say, overtime if you look at all of our properties, I think we have a reason and shareholders have a reason to be pretty confident that the track record implies that we are going to continue to have some success there. And with some of the new deals we’re striking, we are going to have more control over that including web distribution, as we talked about, because you could have a property that’s very good, you know it’s good. And in the past, you sell those rights to a studio right away because they had distribution and financing or you can build an even bigger audience with our TEEN.com network, and that gives you a lot more control.

So, the handicap would be, I think we are cautiously optimistic, but there is no lot of reasons to not be optimistic given the success of these properties. It’s not like we are hitting one out of ten. We’re, knock on wood, but we are three for three, and there is good reason to believe the click and some of the others that are coming out right now are going to have similar type of popularity.

Ed Einboden

Okay, great. And great job on the Gossip Girl. It sounds like the preview [wept] rather well. So congratulations on that.

Matt Diamond

Thank you very much.

Operator

(Operator Instructions). Your next question comes from the line of Julian Allen.

Julian Allen

Hi guys. Good afternoon.

Matt Diamond

Hi, Julian.

Julian Allen

Can you talk a little bit about a visibility you have into the current quarter bookings in a business like Channel One, because we are obviously now in the second month of the quarter? And am I to assume that most of the ads that will be shown this quarter have been pre-sold, and therefore, it’s a function of now delivering the impressions and then billing advertisers? And perhaps you could share some color around booking just to, again, reinforce the point about your confidence in your second half revenue, and therefore, EBITDA projections?

Joe Frehe

Sure, for Channel One, you described it I think accurately at this point you sold most of what you were going to sell or book for Q3, you are still booking, of course, for Q4 and still for Q3 it's not a 100%, you still up all October and part of September, but most of it is still going to be booked at this point. That is though only one component of the Media segment. Interactive is not nearly as long dated you get Interactive deals for tomorrow. So, that portion of the business you look at the momentum, you look at bookings, you look at what’s in the pipe line, you look at the comparisons of what’s in the pipe lien to last year, and all of that is goes in the us booking at the guidance and saying what we think is going to be for the back half.

The challenge is as I indicated earlier is the difference at this stage in the year particularly as you get in the fourth quarter between that incremental $3 million to $5 million which makes a big difference in the EBITDA level. So, the booking are where they are, the pipe line is where it is, Channel One is going to be probably the most of all our Media properties booked at this point relative to what they are going finish the year at and Interactive is going to be on the other strem.

Julian Allen

Great. Thanks very much.

Joe Frehe

Yes, thank you.

Operator

(Operator Instructions). The next question comes from the line of P.J. Solit.

P.J. Solit

Hey Matt, how are you doing?

Matt Diamond

Hey P.J.

P.J. Solit

So, I missed the beginning of the call, just wondered if you didn’t talk about -- wondering if you could give some more metrics on teen.com and if their business was progressing like you thought it would, and kind of be able to produce incremental margins you thought it would?

Matt Diamond

Yes, we touched on just a little bit. It is progressing as we expected to put a number of things in place like infrastructure, the network size is where we wanted to be -- continues to be 20 millionish and that’s a good place for us in the teen market. You know, certainly that most important and significant team network for advertisers, premium sites couldn’t be in a better position as far as the ad positioning is concerned. We are seeing fantastic and record days in ad sales as we should in the back-to-school season. So, it’s right where we expect it to be. It is going to continue. We talked about our promotion in placement segments being down a bit, the offset to that is media and the two big areas that are offsetting that in media are Alloy Entertainment Interactive and Channel One, and Interactive is really driven by the success of the network, and some of the initiatives.

I also alluded to a couple of times, the strength of the network also enables us to have yet another distribution channel to the US market which helps things like Alloy Entertainment get its content out there. So there is lot of opportunities that we are following up on with that. We really are developing between Channel One and Teen.com to incredible distribution points into the US network.

P.J. Solit

And you are not looking to add many traffic partners at this point, it is just looking to some more inventory and grab more advertiser’s rent?

Matt Diamond

Yes. We have a group of network partners that we could add to the network today which would benefit us really by just putting us big glossy number out there and quoting it as more unique. But it doesn’t necessarily, we're already at a point where we have plenty of site traffic and partners to deliver ads to our advertisers. So, we're much more focused on the right side. So we'll add some here and there and as a popular site pops up and we think it's a good ad network or good ad site for advertisers, we'll of course add it to the network. But at this point we're very content with the size and the position that we've got and we know there is sort of a group that would like to join it and we'll evaluate each one on a case by case but we're not aggressively pursuing that.

P.J. Solit

Got you. Okay, thanks.

Operator

Your next question is a follow-up from the line of Steven Martin.

Steven Martin

With respect to the books, Matt, are you selling the books directly or is this third party sales via the publisher and Barnes & Noble, etcetera?

Matt Diamond

Yes, they're all third party so they start with a publishing partner like a family choose their payment [Putnam] and then distribute it through their channels it could be Barnes & Noble, Wal-Mart and all of the traditional distribution channels. We are significant partners, of course, in the teen segment because of the importance that we are to that segment for each one of these publishers. So we work very closely with them, on different concepts and ideas every time we come up with a new idea.

Steven Martin

Is there anything that stops you, you've got the Alloy website and the [deal U.S.] website and some of these other. Is there anything that stops you from selling the books directly?

Matt Diamond

We have a good partnership and good economic with the book publishers. And I am comfortable that they have taken into consideration what some of our options are. So we do things, including marketing and promotion on those websites to help us and to help them. We build for example, emailed data bases and book clubs and other marketing programs and frankly the deal we strike with each of the publishers takes into consideration the fact we do have these distribution channels and we do have this marketing effort. And on that front given the scale of our business relative to their teen business we are comfortable in that we have good favorable deals for both parties.

Steven Martin

Okay. Thank you.

Operator

(Operator Instructions). There are no further audio questions at this time.

Matt Diamond

Thank you. We appreciate you joining us our Q2 call and look forward to updating you as the quarter end and year progresses.

Operator

This concludes today's conference call. You may now disconnect.

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