Q2 2004 United Online Inc. Earnings Conference Call

 Good afternoon. My name is Aileene and I will be your conference facilitator today. At this time, I would like to welcome everyone to the United Online 2nd quarter earnings 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 period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I will now turn the call over to Mr. Brent Zimmerman, Vice President of Investor Relations.

 Thank you, operator. Hello and welcome to United Online's conference call to discuss the results of our 2nd quarter ended June 30, 2004. 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 principals 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 of the most comparable GAAP financial measures. We are also providing slides to accompany today's call that are available now on our website along with the webcast. I would encourage all of you to pull them up during the call. Before we get started I need to point out the [speaker interruption] Safe Harbor Provisions as outlined in the press release, any forward-looking statements may be made on this call. Statements regarding our current expectations about our future operations, our financial condition, our performance or 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 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 SEC. 

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 4th 2004 should recognize any non-historical information discussed in the call might not be current or valid after that date because circumstances and relying on such information that may have changed. With that, I am going to-- we're going start out with a few comments from Mark Goldston and Charles Hilliard and then we're going to open it up for questions. I'll turn the call over to our Chairman, Mark Goldston. 

 Thanks, Brent. Thanks, everybody for tuning into our call. I'm going to give you a brief overview of the June quarter, provide with you a glimpse of some of our new plans for the September quarter and then Charles Hilliard will give you an in-depth review of our financial performance in the quarter. Let me give you an overview on the numbers. The June quarter was a very strong quarter financially, as our revenues, our operating income and our adjusted OIBDA all reached record all time highs. Revenues were a record $110.6 million, which was up 39% versus the 79.6 million in the June 2003 quarter. Our operating income was a record 20 million, nearly double the 10.2 million in the June 2003 year.. Adjusted OIBDA was a record $28.4 million, which was a 76% increase versus the adjusted OIBDA, 16.2 million in the June 2003 quarter. We're very proud of our financial performance and we feel it's a testament to the efficiency of our business model and to our dedication of creating a highly profitable company. Charles Hilliard will go into more granular detail with you in a few minutes on our financial performance on the quarter. Let's talk about subscribers. For the June 2004 quarter, United Online recorded net growth in pay subscribers of 94,000 bringing our total pay subscriber count to a record 3.2 million as of June 30th, 2004. Total active accounts reached 6.8 million at June 30th, 2004. Our growth included the 51,000 paid subscribers and approximately 1.4 million active accounts we received at the closing of the April 2004 acquisition of the web hosting business of About, Incorporated. We achieved a 1 million subscriber milestone on our accelerated services during the June quarter, just 15 months after the launch of that product. Breaking the pay subscriber number down, in addition to the web hosting business subscribers, we added 19,000 net pay access subscribers and 25,000 net paid premium e-mail subscribers. While we would have liked the pay access subscriber numbers to have been higher than the reported 19,000 net, there were a number of factors that impacted subscriber growth during the June 2004 quarter. 

Let's take a look at a couple of those key factors that we believe impacted the internet access signups for our business in the June quarter. One was seasonality. Two was competition. First let's talk about seasonality. The June quarter is a seasonally slow quarter historically and it's typified by lower internet usage. We have seen this in each of the last three years that we've been in the pay internet access business. The result and effect is that billable services margins typically improve during the June quarter because people are paying us the same monthly fee and they are burning fewer hours. We absolutely saw that take place during this quarter, the June quarter, as we recorded a record billable services margin of 77.3%. While the margin impacted the lower usages quite positive, the negative aspect of lower seasonal usage is that we get less signups. Why? Because the vast majority of our subscribers come to our access brand via the downloading process on the internet and not through CD's they may have received through retail stores. While we're working to diversify that mix and add new off line retail partners, at present we rely heavily on people being online and going to our website to download; thus, the lower the hours online, the lower the signups we receive. A correlation that we've experienced previously. The flip side of being a very efficient acquirer of subscribers online because we've got that small two-minute download client is that we are more susceptible to the amount of online internet usage in a given quarter. The usage is lower, our signups would be lower. Second, we continue to see intense competition in the internet access market.

For example, Earthlink has been promoting its PeoplePC brand heavily on television and most of the other major ISPs are offering significant promotions to obtain new subscribers. And we believe AOL continues to promote its Netscape value brand, online and as a save tool for AOL's premium dial-up users. Also the broadband providers continue to actively promote their lower priced broadband services. But all of this has been very well publicized. In order to address some of these issue, we continue to pursue major off line retail distribution partners that we can add to our already impressive group headed by Best Buy. Our newest off line retail partner is Radio Shack. We just recently signed an agreement to have our NetZero CDs distributed in the more than 5,000 Radio Shack outlet's in the United States. We expect to be fully deployed that their stores sometime in the 4th quarter of this year. Radio Shack is an ideal partner for our business and we believe that they, along with our other retail partners, will help us diversify our source of signups away from being so dependent on the online medium. In addition, we recently signed a distribution agreement with a major PC manufacturer to have NetZero preloaded their computer starting this fall. Because of confidentiality agreements that we signed, we're not at liberty to disclose who that partner is until the preloaded computers begin shipping. We also announced a deal with LidRock, Incorporated to put NetZero software on CD's that are loaded in the tops of soda drinking cup covers in movie theaters, fast food outlets and others around the country as a gift with purchase beginning this fall. We're also working on a number of other initiatives that we hope to announce in the fall. Let's talk about discounted plans. From time to time, we at United Online experiment with a variety of pricing plans, as well as free months, both as promotion, as well as save tools. As you may know, competitors offer a variety of promotions with some offers up to six months free.

We have found that providing a month free is, for us, becoming a fairly typical offer and a number of the offline channels, like the big retail chains. However, during the June 2004 quarter, we tested some promotional pricing plans on both NetZero and Juno that seemed to get quite a bit of attention within the investment community. These plans offered Juno and NetZero for a $6.95 per month price for basic dial-up and 9.95 a month for our accelerated product, but only if the user signed up for one full year of service. These programs were only offered through limited distribution channels and not as regular monthly plans. It makes perfect sense for us to try programs like that from time to time because they encourage consumer loyalty. They require a long-term commitment and return for a discounted price, a practice that's used in many our industries such as the cellular industry, et cetera. So in the end of the day, like everything else we do, these programs and our likelihood of repeating them, depends in large part on the success of the program, although I think it's important to point out that this discounted pricing program, is not and never was a standard offer for NetZero and Juno. We also launched an exciting new major ad campaign for NetZero, which we call Candidate Zero in late June of 2004. We have created a fictitious candidate who is going to be running through the November presidential election on a platform of access for all. These irreverent ads, there will be over 15 of them in all, are focused on the fact that Americans can save a lot of money by switching to NetZero for 9.95 a month and that they can get high speed web surfing for only $5 more. The tone and tenure is that Candidate Zero is a regular guy who is sick and tired for paying too much for internet access and who believes that if all Americans on the internet today switched to NetZero, they would save $20 billion during the course of his administration.

We're attempting to pick up on the spirit and tone we were able to create years ago with our now famous, highly acclaimed defenders of the free world and carry the irreverent tone as the pay access business. We were honored to have Candidate Zero, the new campaign, named the fourth highest recalled advertising campaign in the entire United States over the June 4th-July 4th period by Advertising Age Magazine in their just published consumer survey. We will have local PR tie-ins, market tie-ins, et cetera, tied to this campaign and we're going to make it look as real as possible, like he's a real candidate. We even think the candidate might even get some votes in the November presidential election, but I'm not going go there. Let's talk about new subscription services. In the last earnings call, we discussed the fact that we expanded our mission statement of the company to become a leading provider of value priced consumer internet subscription services. To that end, we launched our add-on accelerated dial-up product in April of 2003 for an additional $5 per month. We then introduced our mega mail premium e-mail product in December of 2003 at price points of 9.95 a year and 24.95 a year. We then purchased our web hosting business in April of 2004 and we're in the process of putting more Cap Ex into that asset so we can begin growing and integrating it into our ISP services later this year. And just last week, we introduced our two newest internet subscription services, our first ever broadband service, which is NetZero high speed for broadband, for $4.95 a month, which is a broadband accelerator product, and secondly, we launched a product called e-mail my name for $1.99 a month, which is a vanity e-mail product that we have created that let's you register an e-mail address as unforgettable as your first and last name because it is your first and last name. For example, Charles Hilliard's address is Charles@Hilliard.U.S.

These two exciting new products give us the opportunity to expand our subscription offerings beyond just access services. First, I want to talk about accelerated broadband. We call it NetZero high speed for broadband. This software application is targeted to user on lower speed, or what we call broadband-like services. As our first bring your own access, or BYOA application for broadband, it provides the ability to double the surfing speed on certain lower speed broadband services by utilizing the compression and caching technologies that we made famous in our accelerated dial up products. We're packaging this product with a number of other features to create a compelling BYOA package, including pop-up blocker, premium e-mail services, and we're also giving the user ten hours of dial-up access. We offer this product on our website today in a beta or what we call a prerelease format. We don't plan on aggressively marketing it in the near future, but we're going to gauge the initial take rate, particularly among our users who may be turning to broadband and then we'll determine our marketing plan. For those of our users who may be upgrading to broadband, this broadband accelerator BYOA product and its suite of services will potentially allow us to keep those individuals as pay users and allow them to keep their e-mail address if they so desire even if they choose broadband for their access. Let's talk about the second new product that we just launched, which is called e-mail my name. E-mail my name is a product we created to address the single stickiest application on the internet, e-mail. The product uses the dot.US suffix, which we believe will be very appealing to those in the USA. For example, the UK uses dot.UK. Germany uses dot.GR, France dot.FR, Japan dot.JA, et cetera.

We offer people the chance to register their name, first name and their last name at dot.US as their e-mail address regardless of which ISP they choose to use. So in the case of Charles Hilliard, he could register at Charles@Hilliard.US, or if he wants, Charles@CharlesHilliard.US and so on for just $1.99 a month. With e-mail my name, internet users, regardless of whether they use dial-up, broadband cable, DSL, Wifi or wireless devices for access, all of those people can now have a single compelling and uniquely personal and memorable e-mail address that they can take with them from service to service. E-mail my name will also offer features that are consistent with world class e-mail services. We're giving them one gigabite of storage, spam filters, the ability to pop their e-mail and use webmail and they will also be able to take advantage of our unique mail forwarding feature. We're going to integrate this product under a new unit of the company called mysite.com. Within our customer hosting services group, mysite will be the cornerstone asset. E-mail my name will be available on its own website at www.e-mailmyname.US and .com, as well as at mysite.com. We plan to eventually integrate e-mail my name into the signup processes for all of our United Online access and non-access subscription services. We intend to offer that ability in late 2004 or early 2005 and then we plan to extend the personalized address concept to the personal website business as well. So Charles Hilliard could have an e-mail address of Charles@Hilliard.US. He could also have a personal website to post photos, news, hobbies, et cetera at Charles.Hilliard.US. As we complete our building out of the capacity at our web hosting unit in Utah, we'll be able to offer a very compelling, attractively priced suite of services outside of our United Online internet access businesses that consumers using anyone's ISP, dial-up, broadband or wireless, could take advantage of.

In the meantime, we'll be offering e-mail my name to the NetZero, Juno and BlueLight user bases and we will selective market the product beyond those user bases via the internet. These products, broadband accelerator, e-mail my name, web hosting services, mysite.com, are all part of our overall plan at United Online to expand the reach and appeal of our company beyond basic internet access while also utilizing our base of access and web hosting accounts to sell additional incremental pay services. We believe strongly in the value dial-up space and we're committed to this business. We demonstrated that by our financial performance in the June quarter. It's a business with outstanding economic fundamental and it's provided us with an excellent platform. We're excited about the new initiatives that I've discussed and we think they will help expand our business and distribution channel. While we have seen the effects of seasonality and competition during the June 2004 quarter, we remain confident that the value segment of dial-up will be the growth segment in dial-up access and as the market leader in that segment, United Online is very well positioned for the future. With that, I will now turn the mike over to Charles to give you granular detail on our financial performance. 

 Thank you, Mark. Let me start with some of our highlights from Q2. Number one, we had another record billable services margin, which was up a strong 350 basis points sequentially and up 910 basis points versus a year ago. One benefit of seasonal declines, as Mark mentioned in internet usage for our business model is a positive impact on margins. Also, as I will cover later, per hour telecom costs continued to decline. Number two, we continued to generate strong free cash flow. After adding back cash paid for our headquarters move we generated nearly $26 million free cash flow during the quarter and our ratio of free cash flow to adjusted OIBDA was 91%. That is for every dollar of adjusted OIBDA we produced during the quarter we generated 91 cents of free cash flow. For the past 12 months United Online has generated almost $103 million of free cash flow breaking the $100 million mark on the trailing 12-month basis for the very first time. And number three, we produced record adjusted OIBDA which was up 76% year over year, $28.4 million and was up to 25.7% of revenue. Sequentially adjusted OIBDA was up 9%. We are pleased to be able to deliver this type of growth while investing in more product development personnel and new paid services like e-mail my name and NetZero high speed for broadband. Now let me go into some detail regarding Q2's challenges that Mark highlighted. Pay subscribers increased by 94 ,00 during the quarter. We added a net 75,000 premium e-mail web hosting, and as Mark mentioned, the net 19,000 new access. Excluding the web hosting acquisition our net organic sub growth was 43,000. Regardless of how you measure our sub growth in the quarter, it was certainly lower than our historical trends. As Mark discussed, each June quarter since we entered the pay subscription business we have experienced a sequential decline of subscriber growth along with seasonally lower internet usage. This June we are a bit surprised by more pronounced sequential declines for both.

Going into detail on this, last June, we experienced a 7% sequential decline in average hourly internet usage for pay access subscriber, and a 15% sequential drop in gross subscriber additions. This year, average subusage dropped 11%, which was our first double-digit sequential decline ever. While gross subscriber additions decreased 22% sequentially. Even more pronounced, our average free usage was down 23% sequentially, also the largest ever. Over the years we have seen a very high correlation between quarterly changes in average hourly usage for pay stubs and changes in gross subscriber addition. Or to summarize, higher sequential usage equals higher sequential growth adds and vice versa. As we analyze the correlation, a number of factors quickly become apparent. First, United Online generates the vast majority of its new signups online as opposed to offline channels as Mark mentioned such as mass mailing CD's, using retail partners like Best Buy and Radio Shack and OEMs like PC manufacturers to be sure we are intently focused on growing offline channels going forward and we are very pleased with our recent progress on that strategic front. However, today we remain highly dependent on software downloads. Thus to put it simply we need consumers online to be able to grow our sub base. Second, our target customers are more casual consumer internet users versus businesses or what some have referred to as power users. For example, our average usage is quite a bit below that of other major access players used [inaudible], which by the way, helps our margins. We believe that power users that have been migrating to broadband and that are very profitable casual users are more prone to seasonality factors. Further evidence of this trend is that our average usage for pay access was down 9% this quarter versus last June.

Finally we believe that the best [inaudible] activity for target access customer base happens to be our five-plus million access users. Also beyond the usage drop our users demonstrated this year, we have noted that other major internet players are reporting more pronounced seasonality. Beyond seasonality we're also well aware that this pronounced sequential dip in subscriber growth occurred while competition and value dial had continued to pick up. We're closely monitoring subscriber trends in light of both competitive and seasonality factors to assess their impact. We're also looking forward to the back to school and seasonally cooler months to hopefully show improvement in our access subscriber trends. In the meantime, as Mark mentioned, we're experiencing success in billing major off line distribution partnerships for our access business. Key to our strategy of capturing new, low income internet households, which we believe will be the largest driver of new access account growth in the U.S. for the next few years. Beyond access we are pleased with our accelerating growth in premium e-mail subscriptions and the beginning of our investment in the consumer web hosting business. As Mark discussed during our analyst day in May, we were not able to actively market our hosting business during Q2 because the assets had essentially no capacity for growth when we bought it in April but we have invested nearly $1.5 million in equipment to begin shoring up capacity, we do not expect to fully market this service in sometime in Q4 of this year. Now let's move on to RGUs, revenue-generating units, which encompasses all our subscription relationships and it grew by a net 220,000. At June 30th, we had multiple subscription relationships with a record 33% of our pay subscriber base. This includes subscribers to our accelerated product which added 105,000 subscriptions in the quarter. Excluding the web hosting acquisition, RGU's grew by 160,000. RGU's growth while quite strong was also slower than in previous quarters due to the factors I previously mentioned and the fact that we also needs our subs online to be able to upsell them additional services.

Okay, here's our June quarter financials in a little more detail. Total revenues were at 110.6 million, up 39% year-over-year and within guidance. Billable services revenues at 102.5 million were up 42% year-over-year and up 5% sequentially. Billable services revenues were 93% of total revenues in the current quarter compared to 91% in the prior year quarter. Average monthly revenue per pay user or RPU was $10.87 4,up 12% from $9.75 a year ago quarter and down a penny sequentially. While this quarter's RPU benefited from growth in accelerated [inaudible] and the timing of our web hosting acquisition, it was down sequentially due to relatively higher growth in our lower RPU premium e-mail service and due to an increase in promotional and in particular free service activity for acquisition and retention during Q2, which had a negative impact on RPU. Our high 70s billable service margin gives us financial flexibility to offer a variety of promotions across all of our services and we intend to continue to test and offer promotions which combined with growth and lower RPU services will likely produce a downward trend in RPU. For example, free service promotions are more customary in off line channels like Best Buy and Radio Shack if we continue to be successful in growing these channels over time, RPU will likely continue to be effected; however, given our expanding margins in this deflationary telecom and technology cost environment, we believe that trading RPU in order to help drive growth in subscribers and subscription relationships makes sense long-term. Especially at the breadth of our paid service offering expands. We believe this is the most effective way for a subscription business model to pass along a portion of its value creation and cost savings to consumers. Talking about add and commerce revenues which generated year-over-year growth of 13% or down sequentially by 19%. These comparisons were impacted by the inclusion of over $2 million of GM revenues in both the June 2003 and March 2004 quarters. There were minimal GM related revenues in the June 2004 quarter.

Excluding GM revenues in the March and June 2003 quarters, advertising commerce revenues were up about 82% year-over-year and surprisingly, 3% sequentially. Sequential comparisons were also impacted due to a decline in ad inventory from a drop in internet usage by both our pay and preactive account. Search continued to be a bright spot as it was flat in terms of dollars of revenue, despite the seasonality and represented 44% of ad revenues in Q2 up from 21% a year ago and 35% in March. Our billable services margin beyond the seasonal factors benefited from even further improvement in hourly telecom costs to about 6 1/3 cents in the quarter versus 6 3/4 cents in the March quarter and just under 8 cents a year ago. it also benefited from further efficiencies in customer support and billing while being negatively impacted from a price hike in credit card processing fees. Cost of free services was $1.6 million this quarter, down 38% year-over-year and 8% sequentially. Our active free account, which now include active free websites, were up 56% sequentially and about 40% year-over-year due to the web hosting acquisition. Excluding the acquisition, active free accounts would have been down about 7% sequentially and about 17% year-over-year. Cost of reservices also benefited from lower seasonal usage and the decline in telecom costs. Sales and marketing was nearly $45 million this quarter, or just over 40% of revenue, up about 720 basis points versus 33% in the year ago quarter and up 48 basis points from just under 40% in the March quarter. Marketing costs for the June quarter were negatively impacted by a sharp 32% sequential increase in average cost for television advertising, which was not dissimilar to last year. The June quarter, beyond being the seasonally lowest internet usage quarter also happens to be the most expensive quarter for buying television media, both in the upfront and scatter market.

Thus, while television ad spending increased about 7% sequentially, our TV media exposure as measured by target rating points, or PRPs actually dropped by about 18% sequentially. Given that TV is by far the largest component of our marketing activities, we believe the double-digit drop in exposure contributed quite a bit to the subscriber challenges I mentioned earlier. Which brings us to subscriber acquisition costs, or SAC. For the June quarter we estimated gross subscriber acquisition costs at about $82, up from about $58 in the March quarter. Using RGUs, our subscription acquisition costs was about $49 in the June quarter, up from 36 in March. SAC expanded due to the increased media cost in the face of seasonal and competitive challenges in the quarter; however, with the expansion in billable services margin and new subscription initiatives, we continue to see an increase in the average value of our subscribers. Consist went prior periods, we calculate total subscriber and subscription acquisition costs to include total sales and marketing expenses, plus cost of free services, less ad and commerce revenue. This total was $38.2 million in the June quarter. Product development expenses were up 16% year-over-year, primarily due to budgeted head count growth, and we are still anticipating that product development expenses will be up to 30% higher in 2004 compared to '03 as a result of our continued investment in head count. Also due to the impact of our recent acquisition. This head count will be critical to enable us to build new off line distribution channels, roll out new pay services and improve our ability to generate ad revenue. G&A expenses were up 21% year-over-year and 39% sequentially, due primarily to the inclusion of $1.6 million of lease termination fees and accelerated depreciation expenses related to our upcoming office move. Also G&A reflects $900,000 of cost related to the due diligence associated with the strategic acquisition discussion that was terminated during the quarter.

Our tax equivalent EPS using our 41.5% as the current effective tax rate was 19% this year versus 10% proforma in the year ago quarter, up 90%. Our tax equivalent adjusted EPS, which relates to our first call estimates, was 25 cents this quarter compared to 13 cents in the year ago quarter, up 92%. Free cash flow this quarter was positively impacted by an increase in working capital related primarily to an increase in payables, offset by an increase in AR, accounts receivable and prepaid expenses as a result of the number of contractual prepayments made in connection with marketing, product development and planned relocation activities. Also, excluding relocation payments, Cap Ex was up $1.8 million sequentially to $2.8 million in the quarter. Cash balances were about $204 million at June 30th, '04, up $14 million during the quarter, reflecting our strong operating cash flows and offset partially by the approximately $12 million in cash paid for the acquisition. Finish up with business outlook. We're projecting adjusted OIBDA for Q3 of between $28-29 million and are increasing our 2004 adjusted OIBDA guidance to between $110-112 million up from our previous range of 106-111. At the midpoint, our calendar 2004 guidance implies year-over-year adjusted OIBDA growth of 51%. Our updated revenue and subscriber guidance reflect the challenges we experienced in Q2 and the relative impact to our visibility for future growth as we make our way through the remaining summer months of seasonally slower internet usage. Thank you, everybody and I'll turn things back to Mark. 

 Thanks, Charles. I just want to make a comment in closing about our cash position and the possible uses of that cash going forward. As you guys are aware, on top of the 100 million stock repurchases that we've already done, we completed that in the March quarter, we have an additional $100 million board approved stock buy back plan, which is something we may opportunistically utilize for some of our cash if we so choose. Additionally, we are actively looking for acquisitions and looking for acquisitions that we believe will be complimentary to our strategic goal of expanding our consumer internet subscription service businesses. So with that, I'm going to turn the mike over to the operator at the beginning of our Q&A session. Operator?

 

QUESTION AND ANSWER

 At this time, I would like to remind everyone in order to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from Richard Klugman with Jeffries. 

 Thank you. Mark, your last comment there, are we to assume that means you did not do any share buy backs in the quarter? 

 Rick, it's Charles, we did not do any share buyback during the quarter, and it would have been mentioned in our press release if we this had. 

 Okay. I assumed so. I just wanted to confirm that. 

 That's correct. It was partially impacted by the strategic conversation I mentioned to you, which would impact our-- 

 Okay. You talked a little bit about the 6.95 introduction and you also talked about impacting RPU. Can you quantify perhaps since you were only offering it I think for one month some quantification of the success of it? Because it appears like that was a, as you said, a significant factor in RPU. 

 

 Well, I'll talk to you about the strategic aspect of T I'm going to let Charles talk about the financial issues. One, you have to understand we can't be too granular about it because our competitors, not listening to this call will replay it and we have to be cautious about giving too much granular detail about what's in our marketing arsenal. Let me specifically state because this was for some reason a hot button in the investment marketplace, you know, which given that we're in the retail services business, was very surprising to us. But one of the things that we decided to do was to try this retention tool of giving people a discount and in return for a long-term commitment, long-term commitment being one year. Something that is not unique within the category, but it is unique to United Online. We haven't tried it before, so it's something that we decided that we would try and see how it went and the way we would measure the success of that program, Rick, by and large is on two measures; one, pure ROI and two, what is the resultant churn reduction, if there is churn reduction that occurs in such a promotion. So if this promotion were to end up yielding a positive ROI and it were to reduce churn, then in fact it would have been a success and one would say you possibly could repeat it or repeat something that would be like that or slightly different. So we consider this to be part of our marketing arsenal, I mean it is interesting. We did a competitive study on what's going on out in the space and I don't know if you guys know this or not, but I'm probably telling you something you already do know, but our major competitors are far more, far more aggressive in terms of what they have been offering to both new users and existing users and one of our major competitors, who is a 21.95 a month ISP, we learned today actually this has been going for a while, that if people call to churn up the 21.95 ISP, major brand, they will sell them their lower priced value ISP, which normally sells for $10.95 a month. They will sell it to them for 8.95 a month. They don't have to make a long-term commitment. They can also get a month for free and they can keep the e-mail address that they had on the premium ISP. So in effect, they are taking 21.95 a month, premium ISP users and allowing them to spend $8.95 without making a commitment on a value ISP and keep the e-mail address, which as you know, is the biggest reason why people would not leave a premium ISP. They can keep it on the value brand. That being the case, we're sitting in a competitive situation where we have to react to these things and, you know, as I've said, we are in this for the long haul. We've had a tremendous track record over the last several years. There will be months or weeks where competitors will try something where they will make inroads and we will have to read that and respond to it. So this program, the 6.95 program, was a response, one, to a lot of competitive pricing that were going on in the category and, two, rather than getting, you know, sucked into the monthly competitive pricing game, we chose to go in on a promotional basis only and use it as a 12-month commitment test, and I think that that's the great piece of our arsenal and we have other tricks up our sleeve that we're looking at as well. So Charles, do you want to talk about the numbers on this? 

 Certainly. Rick, I can give you some soft feedback. The promotion such as the 6.95 platinum, 12-month offer or 9.95 accelerator, 12-month offer, the impact to RPU on those was fairly minimal, maybe even less than minimal. The biggest impact to RPU was the the relative growth in lower RPU products like our premium e-mail product as well as the growth in our non-software download mix, off line channels such as Best Buy offering first month free in those channels, very customary to do that. That had a bigger impact than the promotion. 

 Okay, and it's interesting that you say that because on a couple of occasions in your prepared remarks, I think you used phrases like vast majority of customers coming, still coming from online and therefore kind of attributing it all to the seasonality. 

 Well, yeah, I think what we were trying to say and I want to make sure that it didn't get lost in it because we had a lot to say is while we do have an agreement with Best Buy, we did just sign the agreement with Radio Shack, which really is just getting under way, the vast majority of our users, well in excess of 90%, come to us from the online universe. That's why we developed the two-minute download. We told people on numerous earnings calls in the past that one of our key competitive advantages is and has been the fact that we don't have to drop a lot of CD's because we only have a two-minute downloadable client; however, we need people to be online in order to get them to our website to download and when you have a significant drop in internet usage in a particular quarter, meaning there is less people online, then our vulnerability on a relative basis would be higher than the vulnerability of the company or brand that has a preponderance of CD's distributed within the retail community. 

 Rick, what I would add to that, you make a good point that absent the bit of diversification we have done off line, that the seasonality impact to it could have been even more pronounced. 

 Okay. Final question, if I could, given that you had been in previous quarters kind of on a 150-200 net new pay subscribers per quarter and the trends that you identified appear to be, you know, recurring in nature, shifts in industry dynamics, should we anticipate that those days are behind you and this is more-- this quarter, the number of additions is indicative of a run rate? 

 Rick, you know, the guidance that we've published specifically for subs for the end of the year, I mean stands on its own. You know, today we're sitting in early August and as I mentioned in my comments, we're waiting to see the back to school season and the seasonally cooler months while we build that off line distribution and add new pay products. Okay. Thank you. 

 Thanks. 

 Sure. Thank you, Rick. 

 Your next question comes from Safa Rashtchy with Piper Jaffray. 

 Good afternoon, guys. Couple of questions. First, kind of a broader question, Mark. You have often talked about the experience that United Online has had in highly competitive environments and how you have survived and in fact succeeded despite heavy promotions in the past. I'm wondering what is different this time around that you have been impacted pretty significantly given the fairly low number of net subs that you show. I understand part of that is attributable to seasonality, but that was pretty much known going into the season. So is there a, is there a, kind of a new focus by the competitors and much more aggressive promotion and if so, why do you think that's the case as the assumption up to now was that the segment wasn't attractive to most of the bigger players? Then I have a follow-up, please. 

 Safa, that's a very good question. I will tell you that, without sounding redundant, the seasonality which you know occurs every year in the June quarter, in our view and based on the telecommunications hours earned report, was far more pronounced this year than it has been in years past. That's number one. Number two, the aggressive nature of the competitive environment at one of which I just highlighted for you, where we've got people now where not only spending a ton of money out in the general public to get new users, but as a save tool, remember you take AOL and you take Earthlink combined, you take the size of those user bases and you look at the monthly churn that they incur, they typically dump a lot of fish into the pond and when you start offering people the chance to go to $8.95 a month from 21.95 and you can keep your e-mail address to boot, you're going to have an impact on anybody, us or anyone else, who is competing in that segment for those same users. Is that economically sustainable? Is that wise? Well, the proof will be in the pudding. That's why I said, I wasn't being sarcastic. We're a terrific marketing company. We've built some tremendous brands. That doesn't mean that we're infallible. That doesn't mean that we're not vulnerable to somebody on a week or during a particular month, running an aggressive campaign, promotion or otherwise, that can have an impact on our business. When you compound that with seasonality and the fact that TV media, which is our primary way of getting new customers, this is the most expensive quarter, so you have much less relative importance, you add that together and you get sort of a perfect storm effect. Now, having said that, how do we respond to that? I detailed for you what we're going to be doing going forward from a promotional standpoint from a diversification standpoint in terms of new products that we can add in. We're also aggressively marketing our access business with a new ad campaign that while it's only been out for a couple of weeks, has already received accolades as being the number four recall campaign in all of television. So we're not sitting hear saying that we think the bloom is off the value ISP rose by any stretch of the imagination. What we're saying is a quarter that we all thought was going to be a tough quarter turned out to be a tougher quarter because of a lot of factors. Having said that, I am really proud of the fact that we put up record financial numbers. I mean it seems to get lost, interestingly, when we used to put up huge subscriber numbers in the old days and we didn't make money, everybody used to say well, it's great you have all these subscribers, but you really don't make much money. Now we put up in the last 12 months, we've generated $103 million cash flow, we just put up record OIBDA, et cetera, record revenues and okay, our subscribers weren't where we wanted them to be. We're not being apologetic. We're not side stepping the issue, but do we think that the terminal issue, do we think that we can't see our way to having the value segment be what we hoped it was going to be? No. We don't say that at all. We actually still believe that the growth segment in dial-up is value and will be value and I think over time that's going be proven up. The other thing that I'll tell you has been going on is the broadband companies have been promoting much more aggressively. If you thought they were aggressive before, not just in bundled deals but in standalone deals, you're seeing more and more of this aggressively priced broadband offering out there and there is no question that that is having an impact on this whole dial-up space. I think not only was the seasonality a reason why the usage was down on our business, but I also think it was because the power users may be part of our churn numbers and they may be going to broadband so what we may be left with is a more recreational or casual user, which functionally is a great thing, but will have a great impact on the amount of hours that are burned. 

 Okay. Thanks. Couple of quick follow-ups if I may. Can you tell us how much of the revenues came from non-access subscriptions? And also, as you were offering these other non-access services and you were adding two more, how would you be marketing these services beyond the pool of subscribers that you already have? Will you be promoting them on their own and if so, what channels will you use for that?

 Well, I can't tell you necessarily the dollars, but I can tell you that 33% of our pay users were non-, at non-pure access users, which we think is pretty impressive number. In terms of how we're going to market these other services, in the case of e-mail my name, we're going to aggressively market it to our existing several million user base and we will selectively use probably the internet medium in the beginning to market it outside of there, but in the beginning, we're going to focus more on the millions of people that we have in our current house. In terms of broadband accelerator product, if you go right now to www.NetZero.net, you will see on a prereleased basis the broadband accelerator for 4.95 posted there. We'll read some initial take rates on this stuff and then determine how we're going to market it. As you can imagine, because everybody seems to copy what we do, happened in accelerator, happened in platinum, et cetera, I'm a little apprehensive about detailing how I'm going market these two new products because it's certain someone else is going to come out and copy them if they can and then do what we're doing. So I would rather show up after we've done what we've done and report what the results were than sit here and for lack of a better term, telegraph my punches. 

 Okay. Great. Thank you. 

 Thank you, Safa. 

 Your next question comes from Youssef Squali with Jefferies & Company. 

 Yes, thanks a lot. Hi, everybody. Just a couple quick questions. I guess first, one of the, the things that you do have in your arsenal that you have not used in a while is the free base, so you're sitting here generating less than $1 RPU from the free base at a time when you could theoretically get them to at least get some of them to convert and get them to generate RPU plus $10. Again, you haven't done this in several quarters. Can you talk about why you would not do that at this point? I know they are profitable, but certainly converting them would be more profitable. 

 Couple reasons. That's a great question, Youssef. One is, I mean we just showed up making $28.4 million in adjusted OIBDA, so our margins were all time highs, both in terms of billable services and OIBDA margins. So we're not sitting in a situation where we're desperately trying to find additional ways to make money. The business that we're in is a tremendously-- it's more profitable than any of us even in our bullish views would have thought. And so that free user base, because the cost of it is so minimal, is still a great vehicle, especially in a good ad market. It's a great vehicle to have. It's profitable to have. It keeps powder dry for us, because it not only yields additional pay users but it allows us to go back over time and sell them other things and get them into the pay base, not just on access, but now we've got e-mail my name and some of these other things as well. So, you know, we have something that I have referred to before called a lever analysis. The lever analysis are various to before as a lever analysis. The lever analysis are various scenarios, depending on the climate we're facing is that we can pull to improve revenues and/or profitability. The one that would involve being more, being tougher on free user base is a bit more draconian and would require a climate that was far worse than both the competitive climate that we have today, one and, two, the financial climate we're in. What gets lost in a lot of this discussion, while we absolutely wish that we would have had more than 19,000 net subscribers, I mean if you look at the gross amount of subscribers that we had in the quarter, I mean our gross subscribers were very healthy and from our perspective, the fact that we made 28.4 million of OIBDA shows that we've got a terrific business here. So we keep the powder dry in the free base. It is a lever that we could ultimately pull. Either to try to force them to convert at a higher rate or at some point in the future, and I'm not saying that we would ever do this, but at some point in the future you could go to them and say you're not offering that free product anymore and if you want to keep your e-mail address and your access, you have to pay us. Those are things that are available to us. We're well aware of them. We scenario planned and tested them, but we don't really intend in the near future to pull the lever. 

 Right. 

 To add on to that, put a couple numbers behind it, the percentage of growth adds coming from free was actually up 24% this quarter versus 20% in the prior quarter. It was a tremendous asset for us in this quarter. It expands our reach not only for advertising, but also for our vast array of other subscription services. We like having this larger audience in a very low cost environment, and we view that as an important long-term asset. 

 Second, Charles, I got on the call a little late, so I don't know if you actually mentioned what churn during the quarter was. Do you know? 

 Churn was 4.5%. 

 Okay. Then on SAC, certainly it went up quite a bit, and understandably because TV rates are going up, but my understanding from what you're saying is that your commitment to TV advertising is there and then you are continuing to spend or to lock in these relationships with Best Buy and Radio Shack, which historically, not necessarily limited for you, but throughout the industry have demanded much higher SAC levels. So what's preventing SAC from going over 100 and at least on a unit basis? It doesn't look very, very attractive, although on an absolute number, company wise, yes, your margins continue to improve. 

 I can't speculate on where SAC's going to go. I can tell that we are very pleased with our off line distribution relationships and the economics there for both us and the partner, and that we intend to be a very important area focus for us going forward. 

 Okay, and just one last, if I may. You did-- the new bring your own access or the BYOA equivalent, is this for existing users or upgrading to broadband only or is it for everybody? If it is for everybody, how are you planning on marketing it?

 Mark Goldston  - United Online, Inc. - Chairman, President & CEO  

 It is for everybody, Youssef. In the beginning, it will appear that we're really only marketing it to people who come to the NetZero website and ultimately Juno website, but we have a plan there, we want to see what the initial traction rate is, and how it performs, but this is a product for the entire broadband universe, so, one, for people who are on our brands who might want to be leaving broadband and this way they can keep their e-mail, go to the cheaper broadband light and get accelerated, we would make tremendous margin on this product. Two, going out to the 19.4% of American households, which I just read a forester number, or actually it's North American households, who are using broadband and say if you're using broadband light, which a lot of them are, as you know, here's a product that can improve its speed and give you all these other features and we in that case are not the access provider and we've got tremendous margin on that product. So it's a way for us to play in the broadband arena, take advantage of the broadband growth and not have to be in the uneconomic position of providing broadband internet access. 

 Okay. Thanks a lot. 

 Thank you, Youssef. 

 Your next question comes from Peter Merski with Oppenheimer. 

 Thanks very much. I think I have two quick questions actually. First, Charles, did you-- I'm just not entirely clear from the wording. Did you change the definition of total pay subscribers or was the about.com completely contemplated in there in the previous guidance? 

 In the end of your guidance, it was contemplated. We expanded guidance after the March quarter results were reported to include the acquisition which was done in April, and it reflected the 50,000. And now we, we are lowering guidance for the rest of '04 down by 50,000.

 Right. Okay. Then the other question, just with-- I guess this is more for Mark. With your lower net exposure because of the TV costs, would you reconsider-- sounds like you're running the plan through the election and that's set in stone. Would you consider maybe more efficient means of marketing. 

 Well, you know, it's interesting, Peter. Because of what we spent on television, I mean our aided brand awareness most recently released specific on the NetZero and Juno brands is up over 85%. Two years ago they were 49%. So we're getting a tremendous return from a branding standpoint on what we have built, number one. Number two, because of how profitable we are, I mean with these exorbitant billable services margins and the operating margin that we've got, trying to get more cost efficient in terms of how we're spending is not really the issue. The issue is trying to make the total amount of money that we spend go a long way and also help build our brands, it's one of the competitive advantages that we've got within this space is that a lot of people know our brand and when they think of value priced internet access or consumer internet subscription services, they think of us and so for us to pull money out of television and put it into other areas, I don't think frankly would serve us well in the near term because television has been a great asset for us. You have to be careful in this business and I'm sure you can appreciate this. We're long-term players. We've all been doing this for almost six years and we're going to be in in this for a long time, so you can't knee-jerk react something that happened climatically in a particular quarter when you have, you know, three, four plus years of having it work fabulously well. We were in a quarter that had some dynamics that didn't go in our direction from a subscriber standpoint, but it did not talk to the effectiveness of our marketing and certainly we don't think negatively impacted our financial statements. So we intend to stick with it and we think we've got a great formula and we're going to tweak it. We've-- we launched this new ad campaign, got a bunch of new concepts in the marketplace, new partners, and, you know, we know we have a big challenge in front of us and a lot of competition and we think we're up for it and the proof will be in the pudding. We'll see how we do.

 Okay. Thanks. 

 Thank you, Peter. 

 Your next question comes from Ned Zachar with Thomas Weisel Partners. 

 Good afternoon, everybody. Can you hear me? 

 Yes, Ned. 

 Couple of questions, bigger picture question about-- we talked a lot about internet usage being down in the quarter. We would love to hear your theories or if there is a specific explanation as to why it's down more this quarter than it had been in the past and then the second question I think is for Charles. The period, the March period, you have three, just over 3 million, 83,000 internet access. I think the last quarter was 3.095. I'm just trying to understand if there is a change in definition or where those 12,000 subscribers might be if you know off the top of your head. Thank you. 

 Charles, while you're generating that, let me answer the first part of his question, which is why was the seasonality issue here apparently greater than it was in prior years. I can certainly talk about it year-over-year, which is the most relevent. If you remember, last year, and a lot of this was the fallout of what had gone on with 9/11. People weren't traveling. The airline business almost literally went bankrupt. The hotel business was in the worst situation it had been in in years. If you just looked at the report that had come out recently from the online travel businesses, whether it be priceline or others, you can see their businesses were way up. People were traveling a ton in this last couple of months period, and obviously when they are traveling, meaning not at home, their internet usage goes down significantly. So I think that the seasonality impact was one. We had a lot more travel than we had last year and that's been born out in the competitive numbers. Two, I think a lot of the power users have migrated to broadband when we give you seasonal usage figures, remember, what we're giving you is dial-up. Since broadband is an always on open pipe, very difficult for people to read the hours of usage on broadband. That's a faucet that doesn't get turned off. What we're telling you is that because of what we think was climatic issues, meaning it was great weather. We had a lot of people traveling that weren't traveling before, number two. And number three, lot of power users probably going off into broadband and the last thing is, remember last year we had the introduction of our high speed products. So we had a ton of people out there that thought we were launching -- of course they might have seen our ads, launching a 14.95 broadband product. So there was a feeding frenzy going on around this new product launch that we had and we didn't have an anniversary to that event this year. So you take the weather factor, you take the terrorist impact that seemingly had waned a bit. You take the fact that the travel industry is reporting outstanding numbers, take the fact that we didn't anniversary a, the biggest new product introduction in the history of the company, I think that kind of tells you what's going on.

 Okay.

 Ned, on your second question, at the end of March, we had 12,000 premium e-mail subscribers that were stand alones and 3,083,000 internet access subs there. There is a full reconciliation of it on the last page of our press release called analysis of revenue-generating units. 

 I see that. 

 And I would be happy to walk through that in more detail with you if you would like.

 That's fine. The call's been long enough already. So I'll call you back. 

 Thank you. 

 You have you a follow-up question with Richard Klugman with Jeffries. 

 Thank you. My follow-up question was answered. 

 Thank you. Operator, we've got time for one more question, I think. 

 Yes, sir. Your next question comes from Jason Avila with First Albany. 

 Hey, guys, I think most of my questions have been answered, but just one question on churn. Mark, I know you alluded to maybe some broadband users migrating, or some existing dial-up users migrating upstream to broadband connection, but wondering if there is anything else implicit in the churn number. If I look back at Q2 of last year, your gross sub, if my math is correct, your gross sub add numbers are pretty similar with what they were in Q2 of this year. However, the number of subs churned was up by, you know, well over 100,000, so I'm wondering if you attribute all of that to just people moving upstream to a broadband connection there is there some other dynamic maybe moving over to competitors. Thanks. 

 Hey, Jason, it's Charles. I'll take that question. In the year ago June quarter we launched the second biggest product launch in the history of our company in April, which was NetZero high speed and Juno speed band, which we think created quite a bit of interest especially from people that may have perceived they were signing up for a $15 broadband product. I think that helps with the sequential trend and actually surge in signups at the time. The surge in signups helped translate into a lower churn number. Then if we recall going into September, a number of people thought they were getting $15 broadband canceled because we had a 30-basis point sequential increase in churn in Q3 of last year. We went from 4.1% in Q2 of '03 to 4.4%. So I think that was impacting that entire launch of high speed, impacted a year ago. This year we're including web hosting subs in our sub base. We have a slightly higher churn rate, as well as, you know, we have the highest percentage all time of accelerator subs in part of our sub base that has a slightly higher churn percentage, and we're looking to stabilize those, keep it in the mid 4 range going forward, which we still view as, you know, extremely successful. And growth adds were up year-over-year. They were up nearly 6% year-over-year. 

 Thanks. 

 Okay. Operator, with that, we're going to have to conclude the call. We have kept these good people long enough. If anybody has any additional follow-up questions, as always, feel free to call either myself, Charles or Brent Zimmerman. Thank you, everybody and have a great evening. 

 Ladies and gentlemen, this concludes today's United Online 2nd quarter earnings conference call. You may now disconnect.