Wednesday, April 30, 2003 8:00 AM PDT
OPERATOR: Good morning, everyone, my name is Thelma, I will be your conference facilitator. At this time I would like to welcome everyone to the United Online third quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question and answer period. If you would like to ask a question during that time, simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I will now turn the call over to Mr. Brent Zimmerman, Vice President of Investor Relations.
BRENT ZIMMERMAN, VP INVESTOR RELATIONS, UNITED ONLINE INC: Thank you Thelma. Hello and welcome to United Online's conference call to discuss the results of quarter ended March 31, 2003. United Online operates on a June 30th fiscal year, so this is the third quarter of our fiscal year ended June 2003. With me today is Mark Goldston, our Chairman, CEO and President. And Charles Hilliard, EVP and Chief Financial Officer.
In today's press release we refer to performance measures, that we call, perform EBITDA, performance at loss, free cash flow, or performance to income, I should say. All of which the company believes are useful measures of operating performance. These numbers are not determined in accordance with generally accepted accounting principles, GAAP, should not be considered as an alternative to or superior to historical financial results presented in accordance with GAAP. Definitions of numbers are provided in the press release with reconciliations to the most comparable GAAP financial measures. Before we get started, I need to point out the company does apply the safe harbor provision as outlined in the press release to any forward looking statements that may be made on this call, statements regarding our current expectations about future operating results, our financial condition, our performance, or the industry in which we operate, our forward-looking statements 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 effect the company's business and its financial results is included in today's press release under the caption cautionary information regarding forward-looking statements and in United Online's most recent form 10k, 10q and other filings with the Securities and Exchange Commission. Projections provided by management in the press release and in today's call are based on information available to us at this time, and management expects that internal projections and expectations may change over time, however the company does not intend to update these projections. Any persons replaying this broadcast after April 30th, 2003 should recognize that any non-historical information discussed in the call might not be current or valid after that date, because the circumstances and assumptions underlying such information may have changed.
And with that we will start out with a few comments from Mark and Charles and then we will open it up for questions. I will now give the floor to our Chairman Mark Goldston.
MARK GOLDSTON, CHAIRMAN CEO AND PRESIDENT, UNITED ONLINE INC: Thank you, Brent. Hello, everyone. Welcome to United Online earnings call for March, 2003 quarter. The quarter was another record quarter for United Online, we recorded record levels of earnings, revenues, EPS, billable subscribers, revenues per employee and billable services margins. Our performance during the quarter reflected the incredible appeal of a services we offer and outstanding level of operational execution that we exhibit time and time again. During the March 2003 quarter our net organic growth and billable subs was an all-time quarterly record of $229,000 netted addition. This compares to organic growth of 138,000 in the March 2002 quarter, and 154,000 in the December quarter, excluding the 174,000 users acquired from BlueLight in the December quarter.
This performance, which is greater than a 10% increase in our total billable subscribers in one quarter, was well beyond our expectations and brings our total billable subscribers to 2.4 million as of March 31st of 2003. While we anticipated a strong March quarter, we believe a number of unique factors, including very strong positive seasonality initial impact of new marketing, ad campaigns and expiration of long-term discounted service plans offered by competitive services led to the stunning organic growth in billable subscribers. Given the results posted recently by AOL, MSN and Earthlink showing organic declines in their dialup user bases we are especially pleased to again be the only major dialup ISP to register a growing billable dialup base. Another metric we're quite proud of is profitability performance, our results reflect our efficient cost structure and importantly, our strategy of pursuing a market opportunity that is both viable and profitable today. Our major competitors are investing a tremendous amount of capital and manpower resources pursuing the broadband market. Which I believe continues to negatively affect their profitability and cash flow. While broadband is certainly a growth segment of the ISP market, it's one that we intend to limit our investment in until we see the costs come down to a level where we can enter that market as a value provider and make money.
During the March 2003 quarter United Online reported record GAAP net income of $7 million, which was up $2.3 million dollars from the December 2002 quarter, and up $14.2 million dollars versus the March 2002 quarter. We have actually increased GAAP net income almost 5-fold since the September 2002 quarter when we reported GAAP net income of $1.5 million. We have seen an expansion in our billable services margins, additional lever renting of existing infrastructure and significant increase in our marketing spending during that period of time. We continue to strongly believe in fueling the marketing line of our P&L because of the incredibly attractive ROI economics of our business model. We entered March 2003 quarter with $172.3 million of cash, and no debt on the balance sheet. This is up from $160.6 million in cash in the December quarter. With an average interest earned of roughly 2% on that cash, we're significantly better off investing in our business with a 64.3% billable services margin than adding a few million dollars of extra cash that will earn 2% interest on top of an already large cash balance, while we fully intend to look for acquisitions and evaluate repurchases of United Online stock and other means to deploy our cash, we feel that our existing balance will be more than enough to amply serve our internal needs for at least the next year. Charles Hilliard will cover the company's financial performance during this quarter in much more detail in a few minutes.
I wanted to give you an overview how well the company is doing and how we see the future of our business and the ISP category unfolding. As the category continues to experience a high degree of turnover within all the major ISPs, and commoditization of the category becomes a reality, our company has become a major beneficiary of those trends. We have stated numerous times over the past two years that we believed the consumer market would become more and more aware of the fact that you get connected to the same Internet regardless of which ISP you select. In addition, our marketing efforts have been very successful at educating the consumer that they can get high quality dialup Internet access at $9.95 a month through NetZero, Juno, BlueLight brand versus $21.95, $23.90 a month charged by AOL, MSN and Earthlink. During the quarter, we launched the new phone jack and you know Juno TV ads which clearly describe the fact you can get the same quality Internet access from NetZero and Juno as you can get from AOL and MSN at less than half the price. We always believed in marketing ability and that's our strong suit, its not how much money you spend on marketing, it's how creative you can be and how compelling you can make your message. Our marketing efforts have had a direct impact on our revenue growth and the efficiency with which we acquire new billable subs, which is unparalleled.
United Online was built to be the model of efficiency from an operating perspective within the ISP industry we do it, we believe better than others with only 447 employees worldwide, we have managed to grow our billable sub base by 1.2 million subscribers since the completion of the NetZero and Juno merger on September 25 of 2001 without increasing our manpower base at all. We have doubled our billable subscribers during that period, and seen a tremendous scalability of the United Online business model. We have also managed to improve our billable services margin by over 2,000 basis points during that period, and that's why we have a business today that generates the kind of free cash flow and net income that it does. See we don't view dialup as a temporary weigh station on the road to the broadband frontier. We view dialup as a huge, viable, lucrative segment that will be the dominant Internet connectivity medium serving the masses for years to come.
Our corporate mission statement that we cemented on the date of the merger back in September of 2001 was to be the leading provider of value-based Internet connectivity in the U.S.A.. Everything we do at United Online is dedicated to profitably executing against that very clear mission statement and the dialup segment essential to that mission as we sit here today, the migration to broadband and the general consumer market is being adversely affected by high price points, a slow build-out of a spotty national footprint and a bifurcated medium between two competing platforms, cable and DSL. As broadband becomes more efficient, and the providers become hungrier for burden recovery versus gross margin preservation, we believe that the migration to broadband may accelerate for those who can afford to pay $25.00 to $35.00 a month for the product. And can actually bet the product. Whether or not premium dialup users actually migrate to a broadband connection, the mere potential existence of a broadband alternative at roughly the same price as premium dialup will cause those subscribers to rethink what they're doing. Our belief at United Online is that this scenario will actually have a very positive impact upon the value priced dialup category and as the dominant player in that space, we should be the primary beneficiary of downward migration due to commoditization. If the broadband market ultimately allows for the profitable existence of a value-priced entrant, then true to our corporate mission, we'll consider expanding into that market.
Until and unless that occurs, we will continue to vote most of our time, effort, resources and creativity against the huge dialup universe and attempting to increase our market share above the approximately 5% level that our pay services occupy in the market today. To that end, we are now marketing two new products that we feel have the potential to invigorate the dialup segment, elongate the category's lifecycle and give consumers a very economical way to surf the web at up to five times faster speed than existing dialup without requiring an expensive broadband connection. The products are called NetZero high speed and Juno speed band. We launched these two products at the end of the March quarter. Through a complex mixture of cashing and compression technologies, we can give the consumer a dramatically faster web surfing experience for only $5.00 a month more than our $9.95 services are. What's more, there's no additional equipment required, no home visits, nothing. If you have a phone jack and a computer, you can experience NetZero high speed and Juno speed band. While our NetZero and Juno $9.95 platinum services provide a two-minute download, the consumer can get our high speed or speed band product for an additional 3-minute download right off the NetZero and Juno web site. While these new products do not provide the benefits of broadband, which include faster music and video downloads, we think these products will be very appealing to the many consumers whose primary Internet activities are web surfing and E-Mail. From a financial perspective the brilliance of these two new product offerings is that they have very attractive margins. Even at the additional $5 per month over basic $9.95 services the consumer is still saving almost $9 per month versus AOL's standard service and $7 a month versus MSN and Earthlink standard services. So NetZero high speed and Juno speed band are enhanced dialup products that let consumers surf much faster than standard AOL, MSN, Earthlink and still save between $7 and $8.95 a month versus those ISPs.
We note that Earthlink launched a new accelerated dialup product with similar performance enhancements in the past month which would compete head on with NetZero high speed and Juno speed band. Interestingly, they have added $7 per month to their basic $21.95 dialup service for this product. That brings the monthly fee to $28.95, which is nearly double the $14.95 per month for NetZero high speed and Juno speed band. One of the true core competencies we have developed and refined at United Online is our ability to migrate our users from one platform to another through enticement and relevance of a value-added service. Clearly, we have demonstrated that competency over the last 21 months as we have migrated free users to our $9.95 platinum ISP services. In the March quarter we derived roughly 37% of our new billable subscribers from upgrades from NetZero and Juno free services, which is a very formidable and fertile pool of prospective-paying customers. It is because of that core competency that we feel confident in our ability to now migrate a portion of our existing 2.4 million NetZero and Juno platinum users to spend an additional $5 per month for high speed or speed band and further, we feel confident about the prospect of converting some of our existing 2.8 million free ISP users that are on NetZero and Juno to the $14.95 accelerated dialup product as well. In terms of the size of the dialup market going forward, and specifically looking at the size of the relevant audience for a value-priced ISP service, I would like to refer to some industry data. When you look at the data that was recently released by IDC, you see that the dialup Internet access market has a chance to be a very viable segment to the mass-market consumer for many years to come. Let me elaborate a little bit on that point.
The data by IDC indicates that in 2002 there were 10.7 million American households accessing the Internet who make under $35,000 a year, 10.7 million American households under 35,000 a year. By 2006, IDC projects that the number of American households making under $35,000 a year who will access the Internet will be 29.7 million households. An increase of 19 million American households making less than $35,000 per year who will be coming on to the Internet over the next four years. Now, I ask you: How much do you think those 29.7 million American households making less than $35,000 a year will be willing to pay for their ISP service? How much would they fiscally be able to pay? In the creative opinion of the management team at United Online, that number is $9.95 a month. Think of the burden that the current premium price dialup services place on the average American today who makes around $50,000 a year and how attractive our $9.95 service is because of that fact. Well, now imagine the appeal of our NetZero, Juno, BlueLight 9.95 services to a group of 29.7 million households that fall below that $35,000 income level. That's why we're so excited about the prospect for United Online and the dialup ISP universe and why we think that both our existing standard free and $9.95 services frankly along with our accelerated $14.95 service place us in an enviable position squarely within the sweet spot of the largest growth segment of the dialup market.
Remember that these are the same target customers that have made companies like Procter & Gamble, Gillette, Coca-Cola, McDonald's, Wal-Mart, and General Motors so dominant in the categories in which they compete. The affluent, highly educated, tech-savvy early adopters may fan the patina of more expensive newer technologies but it's the mass market consumer that represents the lion's share of virtually every major consumer product, service category and that is the constituency we defined as primary target audience and the focus of the majority of our efforts.
Remember that many predicted ten years ago that by the year 2000 the likes of Blockbuster video would be a thing of the past because of the advent and proliferation of video on demand technology. Why would anyone want to go to a Blockbuster store and rent a videotape or DVD when they could sit at home and pull up hundreds of movie choices on their television? The fact is that today Blockbuster video remains a huge force in the American home entertainment landscape and people still use their $99vcrs to play $2 rented videos of Top Gun rather than deploy expensive more high-tech video on demand technology that would greatly enhance their choices and provide much greater convenience.
Why do people do this? Because the behavior is very habitual and because the benefits to be derived from enhanced technology do not justify the price or fill a need gap for the vast majority of consumers. While much of that dynamic could be applied to the broadband versus dialup Internet access argument as well. Given the huge economic disparity between the services, the actual benefits desired and required by the majority of users basic dialup and now accelerated dialup appear to be very well positioned for that 35 to $50,000 a year consumer and will serve them well. So we spend a great deal of time as a management team studying this market and looking for cues from other industries that experienced a similar dynamic in their evolutionary process that I'm very proud of the job we have done in anticipating these trends in our market, which have saved us from investing in less profitable or worse yet, unprofitable lines of business.
We feel that the future of for United Online is very bright and that with the continued focus on skillful execution of our very focused business plan, we have got the opportunity to outperform the category and increase both our market share and most importantly, our profitability. One last point I want to make before I turn it over to Charles Hilliard. That is, beginning with the June 2003 quarter for the first time in the history of United Online, billable subscriber service revenue growth may no longer be solely dependent on pay subscriber growth in the quarter. So let me say that again. For the first time in the history of United Online, billable subscriber service revenue growth may no longer be solely dependent on pay subscriber growth in the quarter. The reason for that is quite simple. We have the opportunity to convert any or all of our 2.4 million pay subscribers today on NetZero, Juno and BlueLight to NetZero high speed or Juno speed band without actually increasing our pay subscriber count at all.
Specifically, if you're an existing NetZero or Juno platinum subscriber and you pay us $9.95 a month and we were to up sell you on adding high speed or speed band to your basic platinum service, while we would realize a 50% increase in revenue on that user and a dramatic increase in gross profit from the extra $5 a month for the new product, we would not actually record any additional subscribers from that transaction because we would already have been counting that individual as a paying sub because of their $9.95 platinum account. However, if we were to up sell a free sub to NetZero high speed or Juno speed band then they would begin paying us the full $14.95 a month, and they would be recorded as a new paying subscriber because they were previously on our free service. By the way, at the end of March 2003 we had 2.8 million free users of NetZero and Juno franchises.
So, its for these reasons that we have made the decision to allocate just over 40% of our June quarter media and marketing budget to the launch of NetZero high speed and Juno speed band with specific television spots for those products and we have redone our NASCAR Winston cup vehicle to read NetZero high speed rather than devoting 100% of marketing dollars towards attracting brand new $9.95 subs, we have taken a meaningful portion of that money toward attracting both new $14.95 users for these accelerated dialup products as well as using those TV spots to entice our existing users to pay the extra $5 a month to upgrade. This concept is very similar to what McDonald's did years ago when they added things like apple pie to their menu, with the purchase of any meal the salesclerks were prompted to up sell consumers to the apple pie for an extra 95 cents, which is usually about a 33% increase in the average McDonald's register ring. The result of these efforts would increase revenue and profitability dramatically per user, but not actually increase the number of people coming in to the restaurant. This is the most profitable way to expand the business.
We feel the addition of the high speed and speed band options to our existing base in addition to marketing to people who are not current NetZero and Juno users could have that same type of dynamic and create incremental addition to our revenue per user per month. With that I will turn the mike over to Charles who will give you a review of financial performance and discuss our future guidance. Charles?
CHARLES HILLIARD, EVP AND CFO, UNITED ONLINE INC: Thank you, Mark. We are pleased to report another very successful quarter for United Online. This morning I'm going to discuss key highlights for the March 2003 quarter. Second, I will cover other selective financial and subscribers for the quarter and third, I'll discuss our business outlook. Now, the key highlights, performing EBITDA with $13.7 million dollars which was up 206% versus the year ago quarter. Billable services margin, 64.3%, a 1400 basis point improvement year over year, a 200 -- 210 basis point improvement sequentially. Paid subscriber growth, 229,000.
As Mark mentioned, this was our strongest organic sub growth quarter ever, up 51% in terms of total subscriber growth over the past 12 months. Free cash flow which is an incredibly important metric to us here, was $15.9 million in the March quarter. And over the past 12 months, United Online generated over $55 million of free cash flow. [Inaudible] Selective data for the quarter: Total revenues were $73.8 million, up 45% year over year. Billable services revenues were $66 million. Up 49% year over year. And commerce revenues also continued to grow, $7.8 million which was up 20% year over year. Billable services revenue expanded to 89% of total revenues in the quarter versus 87% in the year ago quarter as paid subscriber growth out paid debt and commerce revenue growth. Average monthly revenue per user or rpu was $9.61, down less than 1% from the $9.68 we reported in the year ago quarter.
Advertising and commerce revenues increased for the fourth consecutive quarter and grew 20% versus the year ago quarter. Our four-year relationship with General Motors which ends December 31st of this year contributed 36% of ad and commerce revenues in the quarter versus 38% a year ago. Search revenue, the next largest portion of ad and commerce revenues more than tripled year over year and scaled nicely with user traffic and paid subscriber growth. We monetized search through two-year agreement with overture services and that expires in March 2004. Cost of billable services: $23.6 million or 35.7% of billable revenues versus 49.6% of billable revenues in the year ago quarter, and 37.8% in December of '02. Average hours per billable subscriber per month were up 3% sequentially and up 7% versus the year ago quarter. Which of course had a negative impact on our billable services margin.
However, the billable services margin benefited in the quarter from an average per hour Telecom cost slightly in excess of 8 cents per hour. Down from 9 cents in the December quarter and 12 cents in the year ago March quarter. Hourly Telecom costs dropped due to further improvements in port utilization, data center consolidation and better pricing obtained from managed modem vendors. Cost of free services $3.1 million this quarter, down 54% year over year. Our active per user base was flat sequentially, and down over 20% year over year. The decline in active users in the Telecom rate helped drive down our cost of free services year over year. As we have discussed with you on prior calls, we calculate our growth paid subscriber acquisition cost as follows: follows: Cost of free services, plus sales and marketing expenses, less ad and commerce revenues, although we do generate a significant portion of our ad and commerce revenues from our paid subscribers. In the quarter this net cost was $18.9 million versus $11.9 million a year ago and $15.4 million in December.
We added approximately 229,000 net new paid subscribers during the March quarter, and we estimate our cost per growth paid sub subscriber addition at about $36 during the March quarter. That compares to about $31.00 a year ago and $38.00 in the December 2002 quarter. We have been pleased with the returns generated in our investment sales and marketing, and as Mark discussed we plan to continue increasing marketing spend to drive our top-line growth. Our marketing plans for the June quarter, which Mark covered, include supporting the launch of our new NetZero high speed and Juno speed band services. For the past 7 quarters virtually all marketing spent has been directed towards $9.95 services.
Thus, we will be diversifying message for the first time in quite awhile, in attempt to build another important long-term driver of growth, which can increase both rpu as well as our billable services margin. Let me walk you through a brief example: Given the $14.95 price point potentially higher margin on high speed dialup services, we believe that each new high speed subscriber can over time contribute about 60% more cash flow per month than an average $9.95 user. Thus, if we were to successfully upgrade 100,000 of our existing paid subscribers, it could have the same economic impact you United Online of adding another 60,000 new $9.95 subscribers.
As Mark mentioned we believe these services hold significant potential and were pleased with early response we have had as always, we will continue to be disciplined with respect to marketing cost as we managed the business to achieve an attractive long-term bottom line growth rate. Let's talk about free cash flow. Free cash flow was up over 300% year over year to $15.9 million. And was impacted positively by change in working capital, but less so than in the December 2002 quarter when we reported over $19 million of free cash flow. Free cash flow also impacted by increased capital expenditures during the quarter, which at $2 million was up year over year and down slightly from approximately $2.2 million in the December quarter. Currently we expect fiscal 2003 CAPEX to be approximately $6 million, which is at the high end of our previous guidance. If we modestly exceed $6 million it would be attributable to brand new business initiatives such as HiSpeed products.
We're in the process of finalizing our capital-spending budget for fiscal 2004. So currently I do not have a firm estimate. But in general we expect capital expenditures for our existing initiatives in fiscal 2004 to be below fiscal 2003 spending levels. We will give you an update on that in 90 days or so. General and administrative expenses for the March 2003 quarter were flat year over year, and that was impacted during the quarter by $400,000 increase in estimate to reach a settlement for a pre merger Juno contractual dispute. To the extent the settlement is approved by the court and we pay the liability by June 30th, it will reduce free cash flow in the June quarter by the total amount currently accrued of $5.5 million.
Our balance sheet grew stronger in the quarter with no long-term debt, total cash balances of a little over $172 million at March 31. Other metrics: Paid subscribers, 2.4 million versus 2.18 million at the end of December. That was up 229,000 versus up 138,000 in the year ago quarter. Paid subscriber growth benefited during the quarter from a combination of higher level of media spend, improved online distribution, which by the way has benefited from our quick start two-minute download technology, as well as seasonally higher consumer Internet usage and signups. While we cannot measure precise impact we do believe the sub growth in the quarter did benefit from strategy of some of the premium price players, now renew a number of their historical discounted or free trial plan. Total active users at the end of the quarter were 5.2 million, versus 5 million at the end of December.
The less than 2% decline in our active free user base during the quarter was more than offset by our paid subscriber growth. Although we are spending the vast majority of marketing dollars to build our pay business, we have seen some stabilization in our active free user base during the past two quarters. Revenue per employee was $663,000 in the quarter, up 44% year over year and 9% sequentially. This calculation is based on the average number of employees in each of these quarters. Lets talk a little bit about business outlook. Due to strong performance in the March quarter and current trends we are again raising guidance for fiscal 2003.
We project EBITDA for the June quarter between $14 million and $14.8 million. Bringing our pro forma EBITDA guidance for fiscal 2003 to between $48 million and $48.8 million, up from previous guidance of between $44 million and $45 million. Importantly, we are also introducing fiscal 2004 EBITDA guidance of between $68 million and $73 million. Implying at the midpoint of 45% year over year growth compared to the midpoint of current 2003 pro forma EBITDA guidance. We're going to net subscriber growth between 100,000 and 120,000 in the June 2003 quarter. In the year ago June quarter our net subscriber growth was 109,000. Due primarily to expected seasonally lower Internet usage we are gunning for a modest improvement in billable services margin in the June 2003 quarter. The press release also discusses the possibility that depending on our future performance and other factors, our expected tax rate for financial reporting may be as high as 41%. This may possibly occur as early as September 2003 quarter. As discussed in the release, if we increase effective tax rate because of this, it will not impact our cash tax payment or importantly our free cash flow metric going forward. Currently we estimate that our total net operating for federal tax purposes going in to fiscal 2004 will be approximately $260 million.
There are limitations on our annual usage of these NOLs, as such we estimate about $44 million will be available for use in fiscal 2004 with $12.5 million available per year there after. State NOL vary to some degree with federal amounts. Obviously NOL usage is dependent upon a variety of factors including actual results in the future as well as our tax planning strategies. Future exercises of non-qualified stock options could provide some added tax benefits. With that I will turn the call back to Mark for closing comments and we get in to Q&A. Mark Goldston: Thank you, Charles, thanks very much. Operator, I would like to open it up now to Q&A, if you could explain to people how they can go through the process of getting in the queue
OPERATOR: Thank you. At this time I would like to remind everyone in order to ask a question, press star 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.
Your first question comes from Naveen Sarma of Deutsche Bank.
NAVEEN SARMA, ANALYST, DEUTSCHE BANK: Hey, guys very nice numbers. I want to dive a little in to some of the overall things you were talking about, how large do you think the overall narrow band market is? And what do you think it's trending?
And what do you think your share of narrow band is? Sounds like a couple million -- or, you know, sounds like a couple million would give you a pretty good market share and where do you think, you know, narrow band value, how much do you think it can capture in the long run?
MARK GOLDSTON: Thank you, sir, for the comment. I think we basically think we have about a 5% share of the market. I mean there's several different estimates out there about market size. I have seen between $46 and $48 million, probably a pretty good number. I have been reading a lot of research lately, some of it is coming out of the analyst community, some of it came out of IDC and others, they're pretty much predicting over the next four years there could be a decline in the dialup category and that may go down to the low 40s, 42 million, 43 million, 41 million, pick a number. The reality is as we sit here today, we only have 5% of the market. So 95% of the 47, 48, whatever number you want to pick, 95% of those people do not use our brand. And we believe from a relevant standpoint that our products are such that regardless of what happens to the absolute size of that dialup market, that many more people will be migrating down to our $9.95 pay services in that category in general. So we feel really good about that.
NAVEEN SARMA: So if let's say, you know, if we go by the IDC numbers you gave us where the household grows from 10.7 to almost 30 million, the value, the narrow band value market could effectively triple over the next couple years?
MARK GOLDSTON: Again, without endorsing these numbers, just telling you what I read and you can do with them what you will.
NAVEEN SARMA: Sure.
MARK GOLDSTON: I have heard people saying today they believe the value segment is roughly 15 to 16% of the market. And they believe that it's going to go to between 30 and 40% of the market by 2006. So if you in fact buy those numbers and those aren't our company numbers, those are outside numbers, what they're basically saying is even if the absolute size of the dialup market itself doesn't grow or decline slightly, certainly the commoditization effect will have taken over and more and more people, like in other categories, will seek a value-priced product. Naveen Sarma: And on the subs that you added in the quarter, how many were acquisitions versus organic? All organic.
NAVEEN SARMA: Great, thank you.
MARK GOLDSTON: Thank you.
OPERATOR: Your next question comes from Safa Rashtchy U.S. Bancorp Piper Jaffrey.
SAFA RASHTCHY, ANALYST, U.S. BANCORP PIPER JAFFREY: Hi guys, congratulations, great quarter.
MARK GOLDSTON: Thank you.
SAFFA RHASSDI: Couple questions, one on your marketing plans going forward, you mentioned that you would be diverting something like 40% of the marketing expenditures towards promoting the high-speed option to convert the existing subscribers. Is that going to be in addition to, in other words, is your market expense going to have a net increase?
I'm a little kind of confused about if this is a change of strategy because you feel there's a big market there or it's going to be totally incremental? You seem to have a pretty good tail wind in terms of catching subscribers.
You mentioned one of the reasons for the impressive gain was the expiration of some deals that the others were offering, so clearly there is price elasticity in the market, I'm wondering why not spend more on subscriber acquisition and build a critical mass before going on to the conversion. And I have a quick follow up.
MARK GOLDSTON: Okay. The answer to your question is both. We are going to increase the amount of money that we're spending, we do believe this is totally an incremental business and we will be spending a little bit in excess of 40% of our media budget, not necessarily total marketing, because as you know total marketing includes manpower and the like.
But in terms of media spend it will go up. We believe the business is incremental. We believe it's highly profitable and we will spend in excess of 40% of our media dollars against it, because we believe this is the first real big news to hit the dialup business, frankly, since we have been in the dialup business.
And we have been doing this now over four years, so it's the most exciting thing I personally have seen and I think from a category standpoint a lot of people would agree with that that. So we want to become known as the company that's bringing this to the dialup category, one.
And two, rather than waiting for the market to mature and then having a value priced offering appear, here you have a chance to do an innovative new technology that has dramatic impact on the dialup category and there is a dominant value player coming in to the space right at the beginning. That is highly unusual, that's why we're investing in it.
Having said that, you know, we will still be spending a very healthy amount of that marketing budget on the classic $9.95 platinum ISP product and if you have seen some of our TV advertising, which broke on April the 14th for the new high speed and speed band, what we basically have done is back to back 15-second commercials. So the first 15 is on the platinum product and then the second 15 seconds is a seamless segue in to the high speed or speed band offering. While we will over the next couple of months have solo commercials against high-speed products, by and large what you will be seeing from us are these back-to-back or book-ended 15-second spots.
So we certainly will not be neglecting the platinum business in any way, shape or form. But having said that, we believe we have got a good level of inertia going on in awareness against our platinum business and we think that by advertising high speed not only do we get incremental profitability, but the awareness that we build on high speed and excitement will drive people to our web site at which point they have a choice of either going for the basic product or going to the new higher speed product. You had a follow-on?
SAFA RASHTCHY: Well, just on that point, Mark. My assumption from your comments were that you will focus mostly on converting existing users. If that's the case, why is there a need for a media buy?
MARK GOLDSTON: Well, again, I don't know. I hope I didn't give that impression. What I was saying is I think the opportunity clearly to 2.4 million existing paying subs, not to mention 2.8 million free subs, is very large in terms of trying to get those people to convert.
Having said that, one of the ways we get them to convert is through online advertising, our NTV, et cetera. Another way is when we go to the general market to present our message, a lot of the people who respond to that message are existing users, who may not either be aware or have tuned out some of the online messaging, a lot of people have gotten very savvy about that.
So running a television commercial, yes, can get somebody who is not a current NetZero and Juno member to sign up for the product but in addition, it takes people who are current members who may either be on the fence or unaware and by seeing what the high speed can do, it basically pushes them in to a conversion position, we feel very strongly about that and we think we will be very successful with that effort.
SAFA RASHTCHY: Okay. One last follow up, if I may. You have been experimenting and fine-tuning several marketing tactics. Can you just talk about what has been the most effective one, what is your number one source, how have the broadcast buys been working for you? Thanks.
MARK GOLDSTON: The broadcast has been phenomenal. We started new ad campaign the very end of December, so in effect it was the first quarter impact, called phone jack on NetZero and whole new ad campaign on Juno, which is called you know Juno. And clearly differentiates the two brands.
I think our media buying has been phenomenal. I also think our NASCAR sponsorship now that it is a Winston cup team, we have gotten tremendous exposure from our NetZero team, I mean, we're on every weekend over the course of the year, there's over 300 million people who view Winston cup NASCAR and just not that many products or teams in there.
So I think we have a great exposure with our TV marketing, our NASCAR sponsorship and some of the online distribution-based programs we have been doing have been incredibly effective. We tend to call them our ten little Indians programs because in and of themselves they're not large individually but as a group they are a very powerful, viral mechanism that drives people to our business.
SAFA RASHTCHY: Great, thank you. Great quarter.
MARK GOLDSTON: Thank you very much, Safa.
OPERATOR: Your next question comes from Richard Klugman of Jefferies.
RICHARD KLUGMAN, ANALYST, JEFFERIES: Hi, thanks a lot. Terrific numbers. I had, I wanted to ask you a little bit about as we look at the subscriber trend and the competitive landscape going forward, I think you're referring to MSN having a lot of those long-term discount customers, churning and that helping you out.
I was wondering if you had any way of quantifying how much of a help you got from that because from what I understand, Microsoft is saying expect that to continue. So I imagine that would be whatever benefit you got this quarter you would be bet getting over the next few quarters.
Also on the competitive landscape, I have noticed Earthlink is picking up a little bit more marketing on PeoplePC and SBC Yahoo! has lowered their dialup price. So I'm wondering, are you anticipating perhaps in that lower sub count guidance for next quarter, you know, that in to effect or is it seasonality and a follow up question.
MARK GOLDSTON: I will take part that. Again, clarify, in terms of the lower sub guidance, it's not necessarily lower sub guidance. In this business is a seasonal business. I mean the December quarter and the March quarters are always very strong quarters, whether the competitors didn't happen to see that, we did. And intuitively we all know that May and June and July, early parts of August tend to be the dog days in the ISP business.
There's a seasonality factor there that's not endemic to United Online. Having said that with guidance we have given of 100 to 120,000 net add, given last year in the quarter you did 109, you know, we think that speaks to the vitality of the business. In terms of the MSN situation, and I believe there was some CompuServe coming off as well but don't hold me to it, who knows? We don't have the ability to chart exactly how many of those people came from that.
What we do is look at the total churn bucket of the ISP market. When you've got close to 3 million people a month in the ISP dialup category, who churns. And within that 3 million bucket I would say in the March quarter and there was, probably a little bit higher proportion than normal of people coming off of those promotional plans and MSN says some will continue, there may be a tail that has to work itself out. I don't see there being a huge influx of anniversary three-year MSN people all of a sudden appearing in the June quarter. Charles?
CHARLES HILLIARD: Rick, what I would like to add is, you know, part of our low-cost customer acquisition strategy includes a strong emphasis on driving traffic to our web site. Thus, we are, we're very much tied to consumer Internet usage to get signups. The more people on the Internet at any given point in time, the more signups we potentially can get.
We're expecting lower Internet usage and we believe that lower Internet usage in the June quarter is, as the weather gets better and people use the net a little bit less it will impact our business as it has done in the past. We saw a sequential drop in growth subscriber additions between the March and June quarters a year ago and we're expecting that again this quarter.
RICHARD KLUGMAN: As a follow up to your comment you made about Earthlink, PeoplePC you asked and Yahoo!, they were out there marketing, as you know, people PC all throughout -- PeoplePC all throughout the March quarter based on what we read, heard and saw. And in the face of that, we had the single best quarter we have ever had for paid subscriber growth, number one. Number two, in terms of Yahoo! and SBC, I believe and you should check this because I just heard about it the other day, that what they're offering is a $15.95 a month product if you sign up for a year is the way we understand.
MARK GOLDSTON: That's right.
CHARLES HILLIARD: Promotional offer. So it is not a permanent reduction of price, it must be in response to whatever it is they're seeing on their business, so they have chosen to now try to promote that business at $15.95 a month if you sign up for a year, which is very different than $9.95 a month without having to make more than a one-month commitment.
RICHARD KLUGMAN: If I could just ask a follow up on the accelerator, Charles, you mentioned that it's 60% more profitable. I assume you're referring to the gross margin per customer.
CHARLES HILLIARD: As billable services margin level, we think that the product can be around 70% margin. So if you look at just rough numbers, 50% more revenue, slightly higher margins, that translates in to 60% or so more contribution to EBITDA over time.
RICHARD KLUGMAN: Okay. Okay. That would imply an incremental margin on that $5 is very high.
CHARLES HILLIARD: It is fairly high, yes.
RICHARD KLUGMAN: Okay. Okay. That's good. Is there any -
MARK GOLDSTON: That's one of the reasons why we have chosen to devote up to 40% of our media budget in this quarter to the product.
RICHARD KLUGMAN: That certainly makes sense. Have you, can you give us any initial sense on the take rate for that or subs, expectations?
CHARLES HILLIARD: We can't do that that. All I can tell you is we are very happy. We have been at it almost exactly one month today and we are very happy with the way that business is going. So much so that we have just disclosed to you how we intend to market it for the next three months.
RICHARD KLUGMAN: And just as a final point, Mark, I think in your Blockbuster analogy there, perhaps people are still using videotapes to the extent they're watching 15-year-old movies like Top Gun.
MARK GOLDSTON: Very good, Rick. [Laughter]
CHARLES HILLIARD: That's good.
RICHARD KLUGMAN: Thanks. All right.
OPERATOR: Your next question comes from Mark May of Kaufman brothers.
MARK MAY, ANALYST, KAUFMAN BROTHERS: Thanks, you have answered quite a few questions. So just trying to put this issue of the sales and marketing spend in the June quarter to rest, if I look at your guidance and I guess the EBITDA number and I look at sales and marketing, it looks as though that on a sales and marketing per new gross ad in the June quarter you're going to actually see a deceleration in the year on year growth.
Looks like it was up 40% in the March quarter, maybe somewhere in the 20% range in the June quarter. Just wanting to try to frame what the sales and marketing number might look like next quarter concerning the new marketing plans.
CHARLES HILLIARD: In the guidance is, you know, an expected increase on a per dollar basis, you know, on an absolute dollar basis, Mark. As a percentage of revenue it's, you know, I think that the guidance would get you to something that is, you know, at or slightly above as a percent of revenue.
So we are looking, we look at sales and marketing both as a percent of revenue as we try to manage that long-term growth in EBITDA, and then as we look at the return on sales and marketing we measure the absolute dollars brought in and cash flow versus the absolute numbers of subscribers. So we're looking at very attractive returns on the incremental marketing spend potentially on investing in high speed and adding a brand new leg of growth to our long-term story going forward.
MARK MAY: Great. If I could ask a follow up question, I know you don't want to give a whole lot of clarity on the early results for high speed, but Earthlink did mention with their roll-out they were seeing somewhere around 3,000 additions a week for the service, which is around I think 10, 15% of their gross ads -- adds and obviously their price point is twice as high as yours. Just wondering if we could use that as any early indication about the type of take rates we might be seeing.
CHARLES HILLIARD: I think, Mark, as in almost all of the cases you really probably can't use any of the directional information you have on the Earthlink business and use that to project United Online business. So I really can't give you any more color on it than the fact that we are very happy with what we have and we are looking forward to the marketing spend over the next 90 days on that product.
MARK GOLDSTON: Thank you, Mark.
MARK MAY: Thank you.
OPERATOR: Your next question comes from Youssef Squali of First Albany Corporations.
YOUSSEF SQUALI, ANALYST, FIRST ALBANY CORPORATIONS: Thank you, everybody. Youssef Squali, First Albany. Charles, I think I'm doing my math right here. If your cost customer acquisition is around $36, $37 this quarter and marketing spend going in to the fourth quarter is going to be slightly higher in absolute dollars, that translates into a CAC of into the mid 40s, is that something that you guys are looking at?
CHARLES HILLIARD: I would say that within the guidance that directionally the CAC would be higher. What you need to take in to account is adjusting for whatever impact on the economics and the CAC relationship of the accelerator benefit. And we are viewing on an economic basis an accelerator ad being roughly equivalent over the long-term to 1.6 - 9.95 ads.
YOUSSEF SQUALI: Sure, that makes sense. Going back to your marketing spend, what is your total marketing spend going to be, the one that we're assuming a 40% of which going to the high speed product?
CHARLES HILLIARD: Well, we reported total sales in marketing a little under $24 million in the March quarter, so we're looking at that absolute number going up. The 40% portion that Mark is referring is to a subset of total sales and marketing, that's just a pure off-line media spend.
So we invest marketing dollars in a variety of programs, including off-line media spend, including online programs, particularly pay per performance online distribution and then we have a number of other initiatives including a number of people internally that are dedicated to building the subscriber base. So he's only referring to the pure media portion.
YOUSSEF SQUALI: Right. No I understand. I was just trying to quantify it. Is a $5 million spend? Is at $10 million spend? Just to try to back in to a number.
CHARLES HILLIARD: Total media in the March quarter was somewhere in the $14 million range. So we're looking at that number going up and Mark is talking about 40% sore so of that number, should be able to get there.
YOUSSEF SQUALI: Or, that helps. Churn for billable subscribers during the quarter?
CHARLES HILLIARD: 4.2%.
YOUSSEF SQUALI: So didn't move from last quarter.
CHARLES HILLIARD: It was flat to the 4.2% in December.
YOUSSEF SQUALI: And what was the mix? You may have mentioned this, but what was the mix between subscribers coming from the free versus from other ISPs?
CHARLES HILLIARD: Upgrade from free percentage was 37%.
YOUSSEF SQUALI: And that's down some 45% last quarter?
CHARLES HILLIARD: Last quarter was -
MARK GOLDSTON: I think it was 38-
CHARLES HILLIARD: 39%
YOUSSEF SQUALI: Excellent. All right. This is very helpful.
CHARLES HILLIARD: Thank you, Youssef.
YOUSSEF SQUALI: Impressive number.
CHARLES HILLIARD: Thank you very much. Operator we will take one more question.
OPERATOR: Thank you, sir. The next question comes from Mark Vadell of Blaylock & Partners.
MARK VADELL, ANALYST, BLAYLOCK & PARTNERS: Thank you. Good morning. Could you give us color on where that media spend is going in terms of television and if you could even be more specific in terms of which networks and what time slots and then other media aside from television? Thank you.
MARK GOLDSTON: What are you looking for there, Mark? Why are you asking that?
MARK VADELL: I'm just-
MARK GOLDSTON: You want to know what programs?
MARK VADELL: I'm curious how you're choosing to target your potential audience.
MARK GOLDSTON: Okay, we will be on cable, likely we will be on network, we have a very broad array of shows that we use, it's very similar to what we have been doing on platinum. So it's virtually the same spectrum of media buy that we will be using for high speed and platinum this quarter as we used last quarter. Additionally, we have got a couple of new shows that we have been involved with on NBC. We have the Dog Eat Dog show, which feature it is NetZero sponsorship, we're the title sponsor. That show is the top-rated show last summer and it's going to be again re-airing this year, a new year, starting in June.
So we will be on network TV, we will be on cable. We're pretty adept at buying media and targeting the media which is I think why we have gotten the yield we have gotten on our spend. And we're pretty excited about it because as Charles said, as we have increased our overall media budget and we have increased our overall media budget for five running quarters, we have more and more opportunities to buy this high-quality programming and improve the reach, not just the frequency of our media plan.
And because of how compelling our message is, we believe that our reach strategy is very effective for our brands, because if you look at our television spots, they're not spots that you need to see ten times to get you to understand the message and then convert to purchase. They're sort of right between the eyes. So because of the nature and directness that messaging, we feel that a reach plan versus a plan that relies on heavy frequency will give us the best yield and it certainly has proven that over the last 12 months.
MARK VADELL: Thank you.
MARK GOLDSTON: Okay. Thank you. Operator, we don't have any time for any more questions. We have got a lot of things we need to get done. So I want to thank everybody for attending the call. If you have any follow-on questions, feel free to call either Charles Hilliard or Brent Zimmerman or if you can't get them, myself and we will be happy to try to help you in any way that we can. And we look forward to talking to all of you next quarter when we report our results. Thanks again, have a great day. Bye.
OPERATOR: Thank you. This concludes today's United Online third quarter results conference call. You may all disconnect.
