|
||||||||||||||||||||||||||
| | SEC Info | |
| | Home | |
| | Search | |
| | My Interests | |
| | Help | |
| | Sign In | |
| | Please Sign In |
|
||||||||||||||||||||||||||
As Of Filer Filing As/For/On Docs:Pgs Issuer Agent 8/13/07 Classmates Media CORP S-1 2:188 Merrill Corp/New/- FA
Document/Exhibit Description Pages Size 1: S-1 Registration Statement (General Form) HTML 1,345K 2: EX-23.1 Consent of Experts or Counsel HTML 6K
|
As filed with the Securities and Exchange Commission on August 13, 2007
Registration No. 333-
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
CLASSMATES MEDIA CORPORATION
(Exact name of registrant as specified in its charter)
| Delaware (State or other jurisdiction of incorporation or organization) |
7389 (Primary Standard Industrial Classification Code Number) |
26-0657253 (I.R.S. Employer Identification Number) |
21301 Burbank Boulevard
Woodland Hills, California 91367
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
Mark R. Goldston
Chairman, President and Chief Executive Officer
21301 Burbank Boulevard
Woodland Hills, California 91367
(818) 287-3000
(Name, address, including zip code, and telephone number, including area code, of agent for service)
Copies to: |
||
| Gregg A. Noel Jeffrey H. Cohen Skadden, Arps, Slate, Meagher & Flom LLP 300 South Grand Avenue, Suite 3400 Los Angeles, California 90071 (213) 687-5000 |
Jeffrey D. Saper Steven V. Bernard Wilson Sonsini Goodrich & Rosati Professional Corporation 650 Page Mill Road Palo Alto, California 94304 (650) 493-9300 |
|
Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. o
If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
CALCULATION OF REGISTRATION FEE
| Title of each class of securities to be registered |
Proposed maximum aggregate offering price (1)(2) |
Amount of registration fee |
||
|---|---|---|---|---|
| Class A Common Stock, par value $0.0001 per share | $125,000,000 | $3,837.50 | ||
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
Subject to Completion. Dated August 13, 2007
Shares
CLASSMATES MEDIA CORPORATION
Class A Common Stock
This is an initial public offering of Class A common stock of Classmates Media Corporation. All of the shares of Class A common stock are being sold by us.
Prior to this offering, there has been no public market for our Class A common stock. It is currently estimated that the initial public offering price per share will be between $ and $ . Application will be made to have our Class A common stock quoted on the Nasdaq Global Market under the symbol "CLAS."
We are currently a wholly-owned subsidiary of United Online, Inc., or UOL, and following this offering UOL will continue to be our controlling stockholder. After completion of this offering, we will have two classes of authorized common stock: Class A common stock and Class B common stock. UOL will own 100% of the shares of our Class B common stock, representing approximately % of our total outstanding shares of common stock and approximately % of the combined voting power of our outstanding shares of common stock. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting, conversion and protective voting provisions as set forth in this prospectus. The holders of Class B common stock will be entitled to ten votes per share, and the holders of Class A common stock will be entitled to one vote per share.
See "Risk Factors" on page 10 to read about factors you should consider before buying our Class A common stock.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
| |
Per Share |
Total |
||
|---|---|---|---|---|
| Initial public offering price | $ | $ | ||
| Underwriting discount | $ | $ | ||
| Proceeds, before expenses, to Classmates Media Corporation | $ | $ |
To the extent that the underwriters sell more than shares of Class A common stock, the underwriters have the option to purchase up to an additional shares from us at the initial public offering price less the underwriting discount.
The underwriters expect to deliver the shares against payment in New York, New York on .
| Goldman, Sachs & Co. | JPMorgan |
Deutsche Bank Securities
Prospectus dated .
You should rely only on the information contained in this prospectus or to which we have referred you. We have not authorized anyone to provide you with information that is different. This prospectus may only be used where it is legal to sell these securities. The information in this prospectus may only be accurate on the date of this prospectus.
| |
Page |
|
|---|---|---|
| Prospectus Summary | 1 | |
| Risk Factors | 10 | |
| Special Note Regarding Forward-Looking Statements | 31 | |
| Use of Proceeds | 32 | |
| Dividend Policy | 33 | |
| Capitalization | 34 | |
| Dilution | 36 | |
| Unaudited Pro Forma Condensed Combined and Consolidated Financial Data | 38 | |
| Selected Historical Financial Data | 42 | |
| Management's Discussion and Analysis of Financial Condition and Results of Operations | 45 | |
| Our Business | 67 | |
| Management | 84 | |
| Compensation Discussion and Analysis | 88 | |
| Certain Relationships and Related Party Transactions | 96 | |
| Principal Stockholder | 103 | |
| Description of Capital Stock | 104 | |
| Shares Eligible For Future Sale | 113 | |
| U.S. Federal Income Tax Consequences For Non-United States Holders | 115 | |
| Underwriting | 117 | |
| Legal Matters | 121 | |
| Experts | 121 | |
| Where You Can Find More Information | 121 | |
| Index to Financial Statements | F-1 |
Dealer Prospectus Delivery Obligation
Through and including (25 days after commencement of this offering), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealer's obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.
i
This summary highlights information contained elsewhere in this prospectus. This summary sets forth the material terms of this offering but does not contain all of the information that you should consider before investing in our Class A common stock. You should read the entire prospectus carefully before making an investment decision, especially the risks of investing in our Class A common stock discussed under "Risk Factors." Unless the context otherwise requires, the terms "we," "us," "our" and "company" refer to Classmates Media Corporation and its subsidiaries. Unless the context otherwise requires, the term "UOL" refers to our parent company, United Online, Inc., and its consolidated subsidiaries other than us. Unless otherwise indicated, industry data is derived from publicly available sources, which we have not independently verified.
Overview
We operate leading online social networking and loyalty marketing services under our Classmates and MyPoints brands. Our success is driven by our expertise in growing and monetizing large online audiences in a cost-effective manner and enabling advertisers to reach relevant online consumers effectively. Revenues from our social networking services are derived from subscription and advertising fees, and revenues from our loyalty marketing services are derived from advertising fees.
On our social networking Web sites, we enable users to locate and interact with acquaintances from school, work and the military. Led by our flagship Classmates Web site, our social networking properties are comprised of a large and diverse group of users, with over 50 million registered accounts as of June 30, 2007. Social networking pay accounts at December 31, 2005 and 2006, and at June 30, 2007, were 1.8 million, 2.2 million and 2.7 million, respectively. Using our interactive tools and features, our members have contributed to our social networking Web sites a substantial number of distinct, relevant pieces of content, such as names, school affiliations, profiles, biographies, interests and photos.
MyPoints, our online loyalty marketing service, provides advertisers with an effective means to reach a large online audience with targeted marketing campaigns, while also enabling consumers to earn points-based rewards by responding to email offers, completing online surveys, shopping online and engaging in other online activities. During the last year, we marketed the products and services of over 400 advertisers to our MyPoints members, including NetQuote, Inc., Office Depot, Inc., VistaPrint Limited and Waterfront Media, Inc. As of June 30, 2007, over 8.4 million members were registered with MyPoints, over 5.7 million of whom had registered through a double opt-in process to receive email marketing messages from us.
Industry Background
Online Social Networking. Online social networking is rapidly growing and evolving to include a broad spectrum of Web sites and online services. From a category that attracted a relatively small number of users a few years ago, during June 2007, social networking Web sites attracted approximately 464.4 million unique visitors worldwide and an average of 155.4 million daily visitors according to comScore MediaMetrix, an Internet industry research company.
People have a fundamental drive to connect with others, be part of a community, express themselves and maintain personal relationships. Core, life-long relationships are often based on enduring affiliations related to shared experiences such as family, school, workplace or military service. People seek to foster these relationships as well as other meaningful affiliations, such as those based on common interests, hobbies and trends.
Social networking Web sites fulfill a number of different needs, allowing users to find and connect with individuals from their past and interact with new people based on shared interests, goals or other
1
criteria. Many social networking Web sites and services provide users with tools that enable individuals to identify, build and maintain personal networks from their relevant affiliations. Users of social networking services may interact and communicate through email as well as through a variety of other online forums, including instant messaging, blogging, the posting of pictures and videos, voice chat and discussion groups. Many advertisers, recognizing that consumers spend an increasing amount of time online, view social networking Web sites as an attractive marketing medium for their products and services. According to eMarketer, an independent Internet industry research firm, advertising spending on social networking Web sites is expected to increase more than 600%, from $350 million in 2006 to $2.5 billion in 2011 in the United States.
Online Loyalty Marketing. The Internet is a growing channel for advertisers and for consumers to find and purchase goods and services. According to IDC, a market research firm in the information technology industry, total advertising spending on the Internet is expected to almost double, from $16.9 billion in 2006 to $31.4 billion in 2011. In addition, more consumers are shopping online for goods and services. According to an April 2007 report by IDC, the number of unique buyers in the United States using the Internet to purchase goods or services is expected to grow from approximately 113.7 million in 2006 to approximately 170.0 million in 2010.
Online loyalty marketing enables advertisers to target consumers in ways that are generally impractical with traditional direct marketing channels. Online loyalty marketing programs often have the ability to segment members based on personal interests, purchasing behavior and demographic profiles in order to create highly targeted advertising campaigns, thereby optimizing value to the advertiser. Online loyalty marketing services use points as an incentive for members to update their personal interest profile, helping advertisers reach consumers interested in purchasing their products and services. Online loyalty marketing services can also easily measure click-through rates on display advertising and response rates to email offers, providing rapid feedback for advertisers that can be used to identify potential customers and create new targeted offers.
Our Competitive Strengths
We believe that our success to date is principally attributed to the following factors:
Our Strategy
Our objective is to continue to advance our position as a leader in online social networking and online loyalty marketing. Key elements of our business strategy include the following:
2
Our Services
Online Social Networking. On our social networking Web sites, we enable users to locate and interact with acquaintances from high school, college, work and the military. Our large membership base and the extensive user generated content posted on our Web sites assist us in acquiring new members. This valuable content also brings existing members back to our Web sites, with a significant number of our members visiting our Web sites on a recurring basis over many years.
We offer two levels of membership:
Online Loyalty Marketing. MyPoints connects advertisers with our members by allowing members to earn points for engaging in online activities. Rewards points are redeemable in the form of third-party gift cards and other benefits from over 60 merchants, including retailers, theaters, restaurants, airlines and hotels.
Our services include:
3
Risks Associated with Our Business
Our business involves various risks, including the following:
In addition, UOL will continue to control us following the completion of this offering and will be able to exercise control over all matters requiring stockholder approval, including the election of our directors and approval of significant corporate transactions. You should carefully consider the risks discussed in the section entitled "Risk Factors" in this prospectus before deciding to invest in our Class A common stock.
Our Relationship with United Online, Inc.
Immediately following this offering, UOL will own 100% of the shares of our Class B common stock, representing approximately % of our total outstanding shares of common stock and approximately % of the combined voting power of our outstanding shares of common stock. As a result, UOL will continue to control us following the completion of this offering and will be able to exercise control over all matters requiring stockholder approval, including the election of our directors and approval of significant corporate transactions.
In the ordinary course of our business, we have received various services provided by UOL, including management, sales, marketing, product development, administrative, including finance and accounting, legal, human resources and facilities management, and other services. UOL has also provided us with the services of a number of its executives and employees prior to this offering and will continue to do so after this offering. We will enter into several agreements with UOL prior to the completion of this offering, including a master transaction agreement, an administrative services agreement, a tax sharing agreement, an insurance matters agreement, an employee matters agreement, an intellectual property matters agreement, an advertising sales representation agreement, a technology services agreement and a real estate agreement. For a description of these agreements and the other agreements that we will enter into with UOL, see "Certain Relationships and Related Party Transactions—Relationship with United Online, Inc."
4
We were incorporated in Delaware in August 2007 and are a wholly-owned subsidiary of UOL. Our principal executive offices are located at 21301 Burbank Boulevard, Woodland Hills, California 91367 and our telephone number is (818) 287-3000. Our Internet address is www. .com.
Classmates Online, Inc., or Classmates Online, was incorporated in the state of Washington in 1995 and operates Classmates.com. Its subsidiary, Classmates International, Inc., operates three international social networking Web sites: Stayfriends (www.stayfriends.se) in Sweden, Trombi (www.trombi.com) in France and Stayfriends (www.stayfriends.de) in Germany. Classmates Online was a privately-held company prior to being acquired by UOL in November 2004. MyPoints.com, Inc., or MyPoints, was incorporated in Delaware in 1996. MyPoints was a public company from 1999 until it was acquired by UAL Corporation, a large U.S. airline holding company, in 2001. UOL acquired MyPoints in April 2006. Prior to this offering, Classmates Online and MyPoints were operated as wholly-owned subsidiaries of UOL and were included in UOL's Content & Media segment, along with UOL's Web hosting and photo sharing businesses. UOL contributed the stock of Classmates Online and MyPoints to us in August 2007 and both are now our wholly-owned subsidiaries.
Information contained on, or that can be accessed through, our Web site or the Web sites of UOL or its or our subsidiaries is not part of this prospectus. Classmates™, Classmates.com™, MyPoints™ and Bonusmail™ are our registered trademarks. All other trademarks, trade names or service marks appearing in this prospectus are the property of their respective owners.
5
| Class A common stock offered by us | shares | |||
Class A common stock to be outstanding after this offering |
shares |
|||
Class B common stock to be outstanding after this offering |
shares, all of which are held by UOL |
|||
Total common stock to be outstanding after this offering |
shares |
|||
Voting rights |
After completion of this offering, we will have two classes of authorized common stock: Class A common stock and Class B common stock. UOL will own 100% of the shares of our Class B common stock, representing approximately % of our total outstanding shares of common stock and approximately % of the combined voting power of our outstanding shares of common stock. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting, conversion and protective voting provisions as set forth in this prospectus. The holders of Class B common stock will be entitled to ten votes per share, and the holders of Class A common stock will be entitled to one vote per share. See "Description of Capital Stock." |
|||
Use of proceeds |
We intend to use the net proceeds of the offering to repay $50.0 million of notes payable to UOL, plus accrued and unpaid interest, and for working capital and other general corporate purposes, including to finance our growth and fund capital expenditures and potential acquisitions. See "Use of Proceeds." |
|||
Proposed Nasdaq Global Market symbol |
CLAS |
|||
Unless otherwise specifically stated, all information in this prospectus assumes:
The number of shares of common stock that will be outstanding after this offering is based on the number of shares outstanding as of and excludes:
6
Summary Combined and Consolidated Financial Data
The following table sets forth our summary historical combined and consolidated financial data as of March 31, 2007, for the quarter ended March 31, 2007 and for the years ended December 31, 2006 and 2005 and our summary pro forma combined and consolidated financial data for the year ended December 31, 2006, after giving effect to the acquisition of MyPoints, as if such acquisition had occurred on January 1, 2006.
Our financial statements included in this prospectus may not necessarily reflect our results of operations, financial position and cash flows as if we had operated as a stand-alone company without the shared services of UOL during all periods presented. Accordingly, our historical results should not be relied upon as an indicator of our future performance. In addition, the unaudited pro forma statement of operations data and other financial data are presented for informational purposes only and are not necessarily indicative of our operating results had the MyPoints acquisition and this offering occurred as of the dates indicated, nor is it necessarily indicative of future operating results.
You should read this table in conjunction with "Use of Proceeds," "Unaudited Pro Forma Condensed Combined and Consolidated Financial Data," "Selected Combined and Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and related notes included in this prospectus.
| |
Classmates Media Corporation(1) (A Wholly-Owned Subsidiary of United Online, Inc.) |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
|
|
Historical |
|||||||||||
| |
Historical |
Pro Forma(2) |
Year Ended December 31, |
|||||||||||
| |
Quarter Ended March 31, 2007 |
Year Ended December 31, 2006 |
||||||||||||
| |
2006 |
2005 |
||||||||||||
| |
(in thousands, except per share amounts) |
|||||||||||||
| Statement of Operations Data: | ||||||||||||||
| Revenue | $ | 42,434 | $ | 152,109 | $ | 139,446 | $ | 84,892 | ||||||
Operating expenses |
$ |
42,876 |
$ |
151,882 |
$ |
140,440 |
$ |
96,397 |
||||||
| Operating income (loss) | $ | (442 | ) | $ | 227 | $ | (994 | ) | $ | (11,505 | ) | |||
| Income (loss) before income taxes | $ | (532 | ) | $ | 1,731 | $ | (1,567 | ) | $ | (11,530 | ) | |||
| Loss before cumulative effect of accounting change | $ | (250 | ) | $ | (12 | ) | $ | (2,116 | ) | $ | (8,191 | ) | ||
| Cumulative effect of accounting change, net of tax(3) | $ | — | $ | 183 | $ | 183 | $ | — | ||||||
Net income (loss) |
$ |
(250 |
) |
$ |
171 |
$ |
(1,933 |
) |
$ |
(8,191 |
) |
|||
| Net income (loss) per share: | ||||||||||||||
| Income (loss) before cumulative effect of accounting change | $ | (25.00 | ) | $ | (1.20 | ) | $ | (211.60 | ) | $ | (819.10 | ) | ||
| Cumulative effect of accounting change, net of tax(3) | — | 18.30 | 18.30 | — | ||||||||||
| Net income (loss) per share | $ | (25.00 | ) | $ | 17.10 | $ | (193.30 | ) | $ | (819.10 | ) | |||
| Unaudited supplemental pro forma net income (loss) per share(4) | $ | — | ||||||||||||
7
| |
At March 31, 2007 |
||||||||
|---|---|---|---|---|---|---|---|---|---|
| |
Actual |
Supplemental Pro Forma(5) |
Pro Forma As Adjusted(6)(7) |
||||||
| |
(in thousands) |
||||||||
| Balance Sheet Data: | |||||||||
| Cash and cash equivalents | $ | 4,458 | $ | 4,458 | $ | ||||
| Total assets | $ | 210,407 | $ | 210,407 | $ | ||||
| Notes payable to UOL | $ | — | $ | 50,000 | $ | ||||
| Stockholder's equity | $ | 118,834 | $ | 68,834 | $ | ||||
| |
|
|
Historical |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Historical |
Pro Forma(2) |
Year Ended December 31, |
|||||||||
| |
Quarter Ended March 31, 2007 |
Year Ended December 31, 2006 |
||||||||||
| |
2006 |
2005 |
||||||||||
| |
(in thousands) |
|||||||||||
| Other Financial Data: | ||||||||||||
| Adjusted EBITDA(8) | $ | 5,139 | $ | 26,552 | $ | 23,178 | $ | 12,995 | ||||
8
offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and offering expenses payable by us.
| |
|
|
Historical |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Historical |
Pro Forma |
Year Ended December 31, |
|||||||||||
| |
Quarter Ended March 31, 2007 |
Year Ended December 31, 2006 |
||||||||||||
| |
2006 |
2005 |
||||||||||||
| |
(in thousands) |
|||||||||||||
| Net income (loss) | $ | (250 | ) | $ | 171 | $ | (1,933 | ) | $ | (8,191 | ) | |||
| Add (deduct): | ||||||||||||||
| Interest income | (24 | ) | (285 | ) | (16 | ) | (57 | ) | ||||||
| Interest expense | 114 | 492 | 492 | 49 | ||||||||||
| Depreciation | 1,895 | 8,202 | 8,202 | 5,514 | ||||||||||
| Amortization | 2,848 | 13,076 | 12,731 | 16,388 | ||||||||||
| Stock-based compensation | 838 | 4,872 | 4,872 | 2,631 | ||||||||||
| Bankruptcy restructuring | — | (1,719 | ) | (1,719 | ) | — | ||||||||
| Provision (benefit) for income taxes | (282 | ) | 1,743 | 549 | (3,339 | ) | ||||||||
| Adjusted EBITDA | $ | 5,139 | $ | 26,552 | $ | 23,178 | $ | 12,995 | ||||||
9
You should carefully consider the risks described below before making a decision to buy our Class A common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our Class A common stock could decline and you might lose all or part of your investment in our Class A common stock. You should also refer to the other information set forth in this prospectus and our combined and consolidated financial statements and related notes.
Risks Related to Our Business
We expect to face increasing competition that could result in a loss of users and reduced revenues or decreased profits.
The market for our services is competitive, and we expect competition to significantly increase in the future. Our social networking services compete with a wide variety of social networking Web sites, including broad social networking Web sites such as MySpace and Facebook; a number of specialty Web sites, including LinkedIn, Reunion.com and Monster.com's Military.com service, that offer similar online social networking services based on school, work or military communities; and an increasing number of schools, employers and associations that maintain their own Internet-based alumni information services. We also compete with a wide variety of Web sites that provide users with alternative networks and ways of locating and interacting with acquaintances from various affiliations, including Web portals such as Yahoo!, MSN and AOL, and online services designed to locate individuals such as White Pages and US Search. As Internet search engines continue to improve their technology and their ability to locate individuals, including by finding individuals through their profiles on social networking Web sites, these services will increasingly compete with our services. As a result of the growth of the social networking market, a number of companies are attempting to enter our market, either directly or indirectly, some of which may become significant competitors in the future. In addition, many existing social networking services are broadening their offerings to compete with our services. As we broaden our services and evolve into a service used for meeting new people with similar interests or affiliations, we may compete with the increasing number of social networking Web sites for special niches and areas of interest. For example, our recently launched dating feature competes with a number of online dating services.
Our MyPoints loyalty marketing business faces competition for members from several other loyalty programs that offer competitive online products and services, including Ebates, Upromise and ThankYou Network. We also face competition from offline loyalty rewards programs that have a significant online presence, such as those operated by credit card, airline and hotel companies.
We compete for advertising revenues with portal companies, social networking Web sites, online direct marketing businesses, content providers, large Web publishers, Web search engine companies, content aggregation companies, major Internet service providers and various other companies that facilitate Internet advertising. We also compete with traditional offline advertising media, such as radio, television and print advertising, because most companies currently spend only a small portion of their advertising budgets on Internet-based advertising. Internet advertising techniques are evolving, and if our technology and advertising serving techniques do not keep up with the needs of advertisers, we will not be able to compete effectively. If we fail to persuade companies to advertise on our Web sites, our advertising revenues will be adversely affected.
Some of our competitors have longer operating histories, greater name and brand recognition, larger customer bases, significantly greater financial, technical, sales and marketing resources, and engage in more extensive research and development than we do. Some of our competitors also have lower customer acquisition costs than we do and offer a wider variety of services and more sophisticated or compelling features than ours. If our competitors are more successful than we are in
10
attracting users, our ability to maintain a large and growing user base will be adversely affected. Some of our social networking competitors have more compelling Web sites with more extensive user generated content and offer their services free to their users. If our social networking services are not as compelling and we do not stay current with evolving consumer trends, we may not succeed in maintaining or increasing our membership base. If our competitors provide similar services for free, we may not be able to charge for any of our services. Competition could have a material adverse affect on our subscription revenues from social networking services, as well as on advertising revenues from our social networking and loyalty marketing services. More intense competition could also require us to increase our marketing expenditures. As a result of competition, our revenues and profitability could be adversely affected.
Failure to increase or maintain the number of paying subscribers for our social networking services would cause our business and financial results to suffer.
We may not be successful in increasing or maintaining the number of paying subscribers for our social networking services. Only a small percentage of members initially registering for our social networking services sign up for a paid subscription at the time of registration. As a result, our ability to generate subscription revenue is highly dependent on our ability to convince free members to return to our Web sites and become paying subscribers. The number of free members returning to our Web sites has been decreasing, and if we were to continue to experience such decreases, it would likely adversely impact our number of paying subscribers.
Although we have recently experienced an increase in the number of paying subscribers, this trend may not continue. Most of our paying subscribers elect to purchase our services as a result of a limited number of features. For example, we believe that our recently introduced Classmates digital guestbook feature is responsible for a significant portion of the increase in our new pay accounts since the end of 2006. If our social networking pay features are not as compelling and we do not stay current with evolving consumer trends, our free members may not subscribe for our pay features. Any decrease in our conversion rate of free members into paying subscribers could adversely affect our business and financial results.
Since the beginning of 2006, an average of four to six percent of our paying subscribers each month decide not to renew their subscriptions, which we refer to as "churn." The level of churn we experience fluctuates from quarter to quarter due to a variety of factors, including our mix of subscription terms, which affects the timing of subscription expirations. We must continually add new subscribers both to replace subscribers who elect not to renew their subscriptions and to grow our business beyond our current subscriber base. We expect that our churn rate will continue to fluctuate from period to period. A significant majority of our paying subscribers are on plans that automatically renew at the end of their subscription period. Our sales and marketing practices are currently subject to an inquiry by the United States Federal Trade Commission, or FTC, and any change in our renewal practices as a result of the inquiry or otherwise could have a material impact on our churn rate. If we experience a higher than expected level of churn, it will make it more difficult for us to increase or maintain the number of paying subscribers for our services, which could reduce our revenues.
Failure to increase or maintain the number of free members for our social networking services would cause our business and financial results to suffer.
The success of our social networking services depends upon our ability to increase or maintain our base of free members, because we generate paying subscribers and advertising revenues as a result of our free members. Our ability to increase our base of free members is dependent upon attracting users to our Web sites. From time to time, we have experienced decreases in the number of new free member registrations, and we may not be able to increase or maintain the level of new free member
11
registrations. Failure to increase or maintain our base of free members could have a material adverse effect on our business and on our ability to implement our strategies.
If we are not successful in increasing or maintaining the number of our loyalty marketing members, and in convincing members to actively participate in our programs, our business and financial results will suffer.
The success of our MyPoints loyalty marketing business is dependent upon our ability to maintain and expand our active member base. The vast majority of our new loyalty marketing members are derived from a few co-registration sources, which are services that provide new member registrations for MyPoints and unrelated third-party services. The loss of any of these sources of new member registrations or a decrease in the number of new members acquired through these sources could have an adverse affect on our loyalty marketing business. In addition, we generate a significant portion of our loyalty marketing revenues from the activity of a small percentage of MyPoints members. If the advertising campaigns directed to our MyPoints members and the rewards offered are not sufficiently compelling, we may not be able to maintain or increase the percentage of our MyPoints members who actively participate in our programs. If we are unable to increase or maintain the number of new MyPoints members and encourage existing members to actively participate in our service, our business and financial results could be adversely affected.
If our social networking members do not interact with our Web sites, our business and financial results will suffer.
Our success is dependent upon our social networking members interacting with our Web sites. Currently, the network effect on our social networking Web sites is limited, and the vast majority of our member activity is within our high school communities. Our members do not visit our Web sites frequently and spend a limited amount of time on our Web sites when they visit. In addition, only a limited number of our social networking members post photographs and information about themselves, engage in message board discussions, view other members' profiles or participate in the other features on our Web sites. If we are unable to encourage our members to interact more frequently with our social networking Web sites and to provide user generated content, our ability to attract new users to our Web sites, convert free members to paying subscribers and attract advertisers to our Web sites will be adversely affected. As a result, our business and financial results will suffer, and we will not be able to grow our business as planned.
We may be unable to increase or maintain our advertising revenues, which could reduce our profits.
We generate advertising revenue from the sale of display advertisements on our Web sites, from advertising campaigns through our loyalty marketing service and as a result of post-transaction sales. Our ability to increase or maintain advertising revenue from each of these sources is largely dependent upon the number of members actively using our services. We must increase user engagement with our services in order to increase our advertising revenues. In addition, Internet advertising techniques are evolving, and if our technology and advertisement serving techniques do not evolve to meet the needs of advertisers, our advertising revenue would decline. Changes in our business model, advertising inventory or initiatives could also cause a decrease in our advertising revenue. From time to time we have undertaken initiatives that we believed would increase our advertising revenues but resulted instead in decreased advertising revenues. In addition, our advertising revenue has fluctuated in the past, and may fluctuate in the future, due to changes in the online advertising market, including extreme fluctuations in online advertising spending patterns and advertising rates. In addition, Internet advertisements are reportedly becoming a means to distribute viruses over the Internet. If this practice becomes more prevalent, it could result in consumers becoming less inclined to click through online advertisements, which could adversely affect the demand for Internet advertising. We do not have
12
long-term agreements with most of our advertisers. Any termination, change or decrease in our advertising relationships could have a material adverse affect on our revenues and profitability. If we do not maintain or increase our advertising revenues, our business, results of operations and financial condition would be materially adversely affected.
We derive a significant portion of our social networking advertising revenues from a post-transaction sales agreement with Webloyalty, Inc. Under the post-transaction sales agreement, we offer Webloyalty's service to our Classmates members upon completion of the paid subscription registration process, and we generate revenues based on the number of members who are presented with the Webloyalty offer. Webloyalty and some of its post-transaction partners are subject to a consumer class action lawsuit relating to Webloyalty's subscription registration practices. There can be no assurance that we will maintain our post-transaction advertising revenues or that our business will not be adversely impacted.
Classmates Online does not have its own advertising sales group or advertising delivery technologies, and UOL provides all of these services for Classmates Online. In connection with this offering, we will enter into an advertising sales representation agreement with UOL pursuant to which UOL will continue to provide advertising services to Classmates Online. If our arrangement with UOL terminates or if UOL does not provide us with adequate services, we will have to transition these services in-house or to a third-party advertising sales group and also establish our own advertising delivery technologies. If we are unable to transition such services and develop advertising delivery technologies in an orderly, cost-effective and timely manner, our business and result of operations would suffer.
Our business could be shut down or severely impacted by a catastrophic event.
Our computer equipment and the telecommunications infrastructure of our third-party network providers are vulnerable to damage from fires, earthquakes, floods, power loss, telecommunications failures, terrorism and similar events. Despite our implementation of network security measures, our servers are also vulnerable to computer viruses, worms, physical and electronic break-ins, sabotage and similar disruptions from unauthorized tampering of our computer systems. In addition, a significant portion of our critical computer equipment, including our data centers, is located in areas of the states of California and Washington that are particularly susceptible to earthquakes, and a significant portion of Classmates Online's computer equipment and data centers are also located in a flood plain. We do not maintain redundant capabilities for our Classmates and MyPoints services and any of these events could result in a significant and extended disruption of these services. Currently, we do not have a disaster recovery plan to address these and other vulnerabilities. As a result, it would be difficult to operate these businesses in the event of a disaster. Any prolonged disruption of our services due to these, or other events would severely impact or shut down our business. We do not carry earthquake or flood insurance, and the property, business interruption and other insurance we do carry may not be sufficient to cover, if at all, losses that may occur as a result of any events which cause interruptions in our services.
Our marketing activities, which are very important to the success and future growth of our business, may not be successful and may become more expensive.
We use online advertising to promote our social networking services to potential new free members. Most of our online advertising arrangements are structured such that we pay a fee for each new free account registration generated through a particular advertisement. The cost of online advertising has generally been increasing in recent periods, which has resulted in an increase in our marketing expenditures. If the cost of online advertising continues to escalate, we may experience decreases in the number of new account registrations unless we increase our marketing expenditures. However, increases in our marketing expenditures could adversely impact our profitability, and there
13
can be no assurance that our marketing activities will be successful. Our loyalty marketing business relies on several co-registration sources for the vast majority of our new member registrations. If these third-party sources prove to be ineffective or become unavailable in the future, or if the cost to acquire new loyalty marketing members through these sources increases, our financial results could be materially and adversely impacted.
Our social networking and loyalty marketing businesses rely heavily on email campaigns, and any restrictions on the sending of emails could adversely affect our results of operations.
Our business is highly dependent upon email. Our emails generate the majority of the traffic on our social networking Web sites and are the most important driver of member activity for our loyalty marketing service. Each month, a significant number of email addresses for our social networking and loyalty marketing members become invalid. This disrupts our ability to email these members. Further, social networking members cannot contact or interact with members with invalid emails, which undermines a key reason that members use our social networking services. Because of the importance of email to our businesses, if we are unable to successfully deliver emails to our members, our revenue and profitability would be adversely affected.
The Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003, or the CAN-SPAM Act, regulates the distribution commercial emails. Among other things, the CAN-SPAM Act provides a right on the part of an email recipient to request the sender to stop sending messages. In compliance with the CAN-SPAM Act, we do not send commercial emails to our members if they elect to opt-out of receiving these emails. As a result, an increase in the number of members who opt-out of receiving commercial emails from us could adversely affect our business. In addition, voluntary actions by third-parties to block, impose restrictions on, or charge for the delivery of, emails through their email systems could materially and adversely impact our business. From time to time, Internet service providers block bulk email transmissions or otherwise experience technical difficulties that result in our inability to successfully deliver emails to our members. Any disruption or restriction on the distribution of emails or increase in the associated costs could adversely impact our ability to continue our email campaigns, which would materially and adversely affect our revenues and profitability.
We may be unsuccessful at acquiring additional businesses, services or technologies, and even if we complete an acquisition, it may not improve our results of operations and may adversely impact our business and financial condition.
We intend to actively review a variety of strategic businesses, services and technologies that we believe may provide us with the opportunity to leverage our assets and core competencies, expand our geographic reach or that may otherwise be complementary to our existing businesses. The merger and acquisition market for companies offering Internet services is extremely competitive. In addition, negotiating these transactions can be time-consuming, difficult and expensive, and our ability to close these transactions may often be subject to approvals that are beyond our control.
We routinely engage in discussions regarding potential acquisitions and any of these transactions could be material to our business and financial condition. The anticipated benefits of a particular acquisition may not materialize and the integration efforts relating to any particular acquisition may not be successful. Acquiring a business, service or technology involves many risks, including:
14
Any of these risks could harm our business and financial results. In addition, an acquisition of a foreign business involves risks in addition to those set forth above, including risks associated with potentially unfamiliar economic, political and regulatory environments and integration difficulties due to language, cultural and geographic differences.
If we are unable to develop new or enhanced features or fail to predict or respond to emerging trends and consumers' changing needs, our business and financial results will suffer.
Our future success will depend in part on our ability to modify or enhance our Web site features to meet consumer demands, add features and address technological advancements. If we are unable to predict consumer preferences or industry changes, or if we are unable to modify our Web site features in a timely manner, we may lose members and advertisers. New features may be dependent upon our obtaining needed technology or services from third parties, which we may not be able to obtain in a timely manner, upon terms acceptable to us, or at all. We spend significant resources developing and enhancing our features. However, new or enhanced features may have technological problems or may not be accepted by consumers or advertisers. For example, in 2006 we launched a new member registration process that was ineffective and was terminated. We have recently launched or announced the development of a number of new features and changes to our Web sites, and there can be no assurance that new designs or features will be launched as anticipated or will be commercially successful. If we are unable to successfully develop, acquire or implement new features or enhance our existing features in a timely and cost-effective manner, our business and results of operations may be adversely affected.
We have a history of losses and we may not achieve profitability in the future.
We have incurred losses in recent periods, including net losses of $250,000 for the three months ended March 31, 2007 and $1.9 million and $8.2 million for the years ended December 31, 2006 and 2005, respectively. As of March 31, 2007, our accumulated deficit was $12.1 million. We expect that our operating expenses will increase as we implement our strategies and incur expenses associated with being a public company. If our revenues do not increase to offset these expected increases in costs and operating expenses, our operating results would be materially and adversely affected. Accordingly, we may not be able to achieve or maintain profitability and we may continue to incur significant losses.
15
We have no operating history as an independent company, and our historical financial information as part of a business segment of UOL may not be representative of the results we would have achieved as an independent public company.
The historical financial information included in this prospectus has been derived from the combined and consolidated financial statements of UOL and does not necessarily reflect what our results of operations, financial position and cash flows would have been had we been an independent company during the periods presented. The historical costs and expenses reflected in our financial statements include an allocation for services historically provided by UOL, including management, sales, marketing, product development, administrative, including finance and accounting, legal, human resources, facilities management, and other services. The amounts recorded for these services are not necessarily representative of the amounts that would have been reflected in our financial statements had we been an independent company. We plan to expand our own administrative functions, including our finance and legal functions, which may be at higher costs than the comparable services currently provided by UOL. In addition, we expect to incur significant additional costs associated with operating as an independent public company, including legal, accounting, insurance and SEC reporting and compliance costs and other expenses. These costs and expenses may be materially different than those reflected in our historical results of operations. Accordingly, the financial statements included in this prospectus are not necessarily indicative of our future results of operations, financial position and cash flows. For additional information, see "Selected Combined and Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our combined and consolidated financial statements and notes thereto.
Our results of operations and key business metrics may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations.
Our results of operations and key business metrics may fluctuate as a result of a variety of factors, many of which are outside of our control. If our results of operations or key business metrics fall below the expectations of securities analysts or investors, the trading price of our Class A common stock could decline substantially. Fluctuations in our results of operations and key business metrics may be due to a number of factors, including:
16
We believe that our revenues, results of operations and key business metrics may vary significantly in the future and that period-to-period comparisons of our results of operations may not be meaningful. You should not rely on the results of one period as an indication of our future performance. In addition, if our quarterly revenues, results of operations and key business metrics do not meet or exceed the expectations of securities analysts or investors, the price of our Class A common stock could decline substantially.
Our international operations and plans for international expansion may not be successful.
We have invested significantly in expanding our social networking services into several international markets, primarily Sweden, Germany and France. One of our strategies is to continue the expansion of our social networking and loyalty marketing services into additional international markets. Our international operations are not currently profitable. We intend to continue investing significantly in our international operations, including through the expansion of our services into new markets. However, the investment of additional resources may not produce desired levels of revenue or profitability, and we may not be successful in expanding into new markets. Managing a global organization is difficult, time consuming and expensive. We have limited experience operating in foreign jurisdictions which may increase the risk that any international expansion efforts we undertake will not be successful. In addition, conducting international operations involves additional risks and uncertainties, including:
The occurrence of any one of these risks could negatively affect our international operations and consequently our financial results.
Some of our subscription fees are currently denominated in United States dollars and paid in local currency. As a result, fluctuations in the value of the United States dollar and foreign currencies may make our services more expensive for international customers, which could harm our ability to expand internationally and could increase our international operating costs.
17
We rely on third-parties for our customer billing, technical support and customer service operations, and our business may suffer if these systems do not function as planned.
Our customer billing, technical support and customer service operations are highly complex processes, and our systems must efficiently interface with the third-parties to whom we outsource some of these functions. These functions are central to our operations, because they involve sensitive interactions between us and our members, advertisers and partners. Our ability to accurately and efficiently bill our members is dependent on the successful operation of third-party billing systems. We have experienced customer billing problems from time to time and may experience additional problems in the future. We currently outsource some of our technical support and customer service functions. As a result, we maintain only a small number of internal technical support and customer service personnel. We are not equipped to provide the necessary range of technical support and customer service functions in the event that our vendor becomes unable or unwilling to provide these services to us. Problems with our credit card processors and other customer billing vendors or our outsourced technical support and customer service operations, and any other failures or errors in third-party systems, could materially and adversely affect our business and results of operations.
If our security measures are breached and unauthorized access is obtained to our members' personal data, we may incur significant liabilities, our systems may be perceived as not being secure and consumers may stop using our services.
The services we offer involve the storage of large amounts of confidential information, including our members' personal data and credit card information. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise, we could be subject to liability. Our security measures may not be effective in preventing these types of activities. In addition, the security measures of our third-party data center facilities, customer billing services, technical support and customer service operations or other vendors may not be adequate. Because techniques used to obtain unauthorized access to, or to sabotage, systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventive measures. Our members or third-parties may assert liability claims against us as a result of any failure by us or third-parties to prevent security breaches or the unauthorized disclosure of our members' information, failure to comply with applicable data protection laws or our own posted privacy policies, and other activities. In addition to potential legal liability, these activities may adversely impact our reputation and may interfere with our ability to provide our services, all of which could adversely impact our business.
Assertions by a third-party that we infringe its intellectual property could result in costly and time-consuming litigation, expensive licenses or the inability to operate as planned.
The software and technology industries are characterized by the existence of a large number of patents, copyrights, trademarks and trade secrets and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us may grow. Our technologies may not be able to withstand third-party claims or rights restricting their use. Companies, organizations or individuals, including our competitors, may hold or obtain patents or other proprietary rights that would prevent, limit or interfere with our ability to provide our services or develop new services and features, which could make it more difficult for us to operate our business. We have in the past received, and may continue to receive, inquiries from third parties as to whether we infringe their proprietary rights. Any litigation or claims, whether or not valid, could be time-consuming, expensive to litigate or settle and could divert our managements' attention and financial resources.
If we are determined to have infringed upon a third-party's intellectual property rights, we may be required to pay substantial damages, stop using technology found to be in violation of a third-party's
18
rights or seek to obtain a license from the holder of the infringed intellectual property right, which license may not be available on reasonable terms, or at all, and may significantly increase our operating expenses or may require us to restrict our business activities in one or more respects. We may also be required to develop alternative non-infringing technology, that could require significant effort and expense or may not be feasible. In the event of a successful claim of infringement against us and our failure or inability to obtain a license to the infringed technology, our business and results of operations could be harmed.
Our business will be adversely affected if we are unable to protect our intellectual property rights from unauthorized use or infringement by third-parties.
We rely on a combination of trademark, patent, trade secret and copyright law, license agreements and contractual restrictions, including confidentiality agreements, invention assignment agreements and non-disclosure agreements with employees, contractors and suppliers, to protect our proprietary rights, all of which provide only limited protection.
We pursue the registration of our trademarks and service marks in the United States and other countries. We have 25 registered United States trademarks. We cannot assure you that any future trademark registrations will be issued for pending or future applications or that any registered trademarks or service marks will be enforceable or provide adequate protection of our proprietary rights. We currently have three issued patents and 24 patent applications pending in the United States, and four issued patents in foreign countries, that each relate to our MyPoints service. Patents may not issue from our currently pending patent applications or issue in a manner that gives us the protection that we seek, if at all, and any patent issued to us may be challenged, invalidated or circumvented. In addition, patents issued to us may not provide sufficiently broad protection or prove to be enforceable in actions against alleged infringers.
The steps we have taken to limit access to, and disclosure of, our proprietary information may not prevent unauthorized use of our technology. Moreover, others may independently develop technologies that are competitive with ours or infringe our intellectual property. We cannot be certain that the steps we have taken will prevent unauthorized use of our intellectual property rights.
In addition, effective patent, trademark, copyright and trade secret protection may not be available in every country in which our services are available. Legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving.
If we are unable to protect our domain names, our reputation and brands could be adversely affected.
We currently hold various domain name registrations relating to our brands, including Classmates.com and MyPoints.com. The registration and maintenance of domain names generally are regulated by governmental agencies and their designees. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. As a result, we may be unable to register or maintain relevant domain names. Furthermore, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is in flux. We may be unable, without significant cost or at all, to prevent third parties from registering domain names that are similar to, infringe upon or otherwise decrease the value of, our trademarks and other proprietary rights. Failure to protect our domain names could adversely affect our reputation and brands, and make it more difficult for users to find our Web sites and our services.
19
Our future success depends on the continued service and effective integration of our key management personnel, and the loss of one or more of these employees, or our inability to attract and retain qualified personnel, could harm our business.
Our business is largely dependent on the efforts and abilities of our key management personnel. The loss of one or more of our key management personnel could harm our business and prospects. In addition, Mark R. Goldston, our Chairman, President and Chief Executive Officer, is also the Chairman, President and Chief Executive Officer of UOL, which may result in significant diversion from his day-to-day responsibilities. We have entered into an employment agreement with our new chief financial officer and the President of Classmates Online, and are in the process of hiring other executive officers. These individuals will have to be integrated into our management team successfully. We do not carry key person life insurance on any of our employees and any of our employees can terminate his or her employment relationship with us at any time.
Our future success also depends on our ability to attract, retain and motivate highly skilled technical, managerial, sales, marketing and service and support personnel. Competition for sales, marketing and technology development personnel is particularly intense in the Internet and technology industries. As a result, we may be unable to successfully attract or retain qualified personnel, which could harm our business.
Our failure to accurately estimate levels of points redemption by our loyalty marketing members could adversely affect our business and results of operations.
We have a significant member redemption liability on our balance sheet as a result of our obligation to provide benefits to our loyalty marketing members when they redeem points earned in connection with our loyalty marketing service. The amount of this liability is based on a variety of estimates, including those relating to the amount of points that will ultimately be redeemed. If our assumptions prove to be incorrect, our liability may be greater than the liability reflected on our balance sheet, which could adversely affect our financial position and results of operations. In addition, if points redemptions are greater than what we have historically experienced, our cost of revenue would increase, which could adversely impact our results of operations.
Changes in laws and regulations and new laws and regulations may adversely affect our results of operations.
We are subject to a variety of international, federal, state and local laws and regulations, including those relating to issues such as user privacy and data protection, defamation, pricing, advertising, taxation, contests and sweepstakes, promotions, billing, content regulation, bulk email or "spam," anti-spyware initiatives, security breaches and consumer protection. Compliance with the various laws and regulations, which in many instances are unclear or unsettled, is complex. Any changes in such laws or regulations, the enactment of any additional laws or regulations, or increased enforcement activity of such laws and regulations, could significantly impact our costs or the manner in which we conduct business, all of which could adversely impact our results of operations and cause our business to suffer.
The FTC and certain state agencies have investigated Internet companies in connection with consumer protection and privacy matters. The federal government has also enacted consumer protection laws, including laws protecting the privacy of consumers' nonpublic personal information. Our failure to comply with existing laws, including those of foreign countries in which we operate, the adoption of new laws or regulations regarding the use of personal information or an investigation of our privacy practices could increase the costs of operating our business. In addition, in the European Union member states and other foreign countries, data protection is even more highly regulated and rigidly enforced. To the extent that we further expand our business into these countries, we expect that compliance with these regulations will be more burdensome and costly for us.
20
In June 2007, we received a letter from the FTC advising us that it was conducting an inquiry into Classmates Online's activities in the marketing and sale of subscriptions to consumers. We are in the process of providing the documents and information requested by the FTC, which include documents and information related to our auto-renewal practices. We cannot assure that our services and business practices, or future changes to our services and business practices, will not subject us to claims and liability by governmental agencies or private parties. To the extent that our services and business practices change as a result of claims or actions by governmental agencies, such as the FTC, or private parties, any such changes could materially and adversely affect our business, financial position, results of operations and cash flows.
In addition, taxation of services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. The Internet Tax Freedom Act, which placed a moratorium on new state and local taxes on Internet commerce, is in effect through November 2007. Future laws imposing taxes or other regulations on the provision of goods and services over the Internet could make it substantially more expensive to operate our business.
We may be required to seek additional funding, and such funding may not be available on acceptable terms or at all.
We may need to obtain additional funding due to a number of factors beyond our expectations or control, including a shortfall in revenue, increased expenses, increased investment in capital equipment or the acquisition of businesses or technologies. If we do need to obtain funding, it may not be available on acceptable terms or at all. If we are unable to obtain sufficient funding, our business would be harmed. Even if we were able to find outside funding sources, we might be required to issue securities in a transaction that could be highly dilutive to our investors or we may be required to issue securities with greater rights than the securities we have outstanding today. We may also be required to take other actions that could lessen the value of our common stock, including borrowing money on terms that are not favorable to us. If we are unable to generate or raise capital that is sufficient to fund our operations, we may be required to curtail operations, reduce our services, defer or cancel expansion or acquisition plans or cease operations in certain jurisdictions or completely. In addition, our amended and restated certificate of incorporation and the master transaction agreement prevent us, without the prior consent of UOL, from incurring aggregate outstanding indebtedness in excess of $150 million or issuing capital stock that would result in UOL owning less than a majority of the outstanding shares of our common stock or less than 80% of the total voting power of our outstanding common stock. If UOL does not provide the requisite consent, we may not be able to obtain additional funding or issue additional securities and as a result, our business and financial results may be harmed.
Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and harm our operating results.
A change in accounting standards or practices could harm our operating results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may harm our operating results or the way we conduct our business. For example, on January 1, 2006, we adopted Statement of Financial Accounting Standards (revised 2004), Share-Based Payment, or SFAS No. 123R. SFAS No. 123R requires that employee stock-based compensation be measured based on its fair-value on the grant date and treated as an expense that is reflected in the financial statements over the related service period. As a result of SFAS No. 123R, our operating results in 2006 reflect stock-based compensation expenses allocated to us by UOL that are not reflected in prior periods, making it more difficult for investors to evaluate our 2006 operating results relative to prior periods.
21
Risks Related to Our Relationship with United Online, Inc.
As long as UOL controls us, the ability of holders of our Class A common stock to influence matters requiring stockholder approval will be limited.
After completion of this offering, UOL will own 100% of the shares of our Class B common stock, representing approximately % of our total outstanding shares of common stock and approximately % of the combined voting power of our outstanding common stock. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting, conversion and protective voting provisions as set forth in this prospectus. The holders of our Class B common stock will be entitled to ten votes per share, and the holders of our Class A common stock will be entitled to one vote per share. If our Class B common stock is transferred to a person other than UOL or any of its subsidiaries (excluding us), other than in a distribution to its stockholders under Section 355 of the Internal Revenue Code of 1986, as amended, those shares would automatically convert into Class A common stock. In addition, prior to any such distribution, all shares of Class B common stock will automatically convert into shares of Class A common Stock at such time as UOL and its subsidiaries (excluding us) own less than a majority of the total voting power of our outstanding common stock or less than 331/3% of the outstanding shares of our common stock.
In addition, until such time as UOL and its subsidiaries (excluding us) own shares representing less than a majority of the total voting power of our outstanding common stock, UOL will be able to elect all of the members of our board of directors and will have the ability to take stockholder action without the vote of any other stockholder and without having to call a stockholder meeting, and investors in this offering will not be able to affect the outcome of any stockholder vote during this period. As a result, UOL will have the ability to control all matters affecting us, including:
Our amended and restated certificate of incorporation and the master transaction agreement that we will enter into with UOL as a part of this offering also contain provisions that require, as long as UOL and its subsidiaries (excluding us) own at least a majority of the total voting power of our outstanding common stock and at least 331/3% of the outstanding shares of our common stock, the prior affirmative vote or written consent of UOL in order for us to:
22
If UOL does not provide the requisite consent allowing us to conduct such activities when requested, we will not be able to conduct such activities and, as a result, our business and financial results may be harmed.
UOL's voting control may discourage transactions involving a change of control of us, including transactions in which you as a holder of our Class A common stock might otherwise receive a premium for your shares over the then-current market price. UOL is not prohibited from selling a controlling interest in us to a third-party and may do so without your approval and without providing for a purchase of your shares of Class A common stock. Accordingly, your shares of Class A common stock may be worth less than they would be if UOL did not maintain voting control over us or have the additional rights described above.
By becoming a stockholder in our company, you will be deemed to have notice of and have consented to the provisions of our amended and restated certificate of incorporation and the master transaction agreement with respect to the limitations that are described in this prospectus.
The corporate opportunity provisions in our amended certificate of incorporation could enable UOL to benefit from corporate opportunities that might otherwise be available to us.
Our amended and restated certificate of incorporation provides that UOL will have no duty to refrain from engaging in the same or similar business activities or lines of business as us or doing business with any of our clients, customers or vendors or employing or otherwise engaging or soliciting any of our officers, directors or employees.
In addition, the corporate opportunity policy set forth in our amended and restated certificate of incorporation addresses potential conflicts of interest between our company, on the one hand, and UOL and its officers and directors who are also officers or directors of our company, on the other hand. The policy provides that if UOL acquires knowledge of a potential transaction or matter that may be a corporate opportunity for both UOL and us, we will have renounced our interest in the corporate opportunity. It also provides that if one of our directors or officers who is also a director or officer of UOL learns of a potential transaction or matter that may be a corporate opportunity for both UOL and us, we will have renounced our interest in the corporate opportunity and the director or officer will have no duty to communicate or present that corporate opportunity to us and will not be liable to us or our stockholders for breach of fiduciary duty by reason of UOL's actions with respect to that corporate opportunity, unless that opportunity is expressly offered to that person in solely in his or her capacity as our director or officer.
This policy could result in UOL having rights to corporate opportunities in which both we and UOL have an interest. By becoming a stockholder in our company, you will be deemed to have notice of and have consented to these provisions of our amended and restated certificate of incorporation. The principles for resolving such potential conflicts of interest are described under "Description of Capital Stock—Corporate Opportunities and Interested Directors."
Our intercompany agreements with UOL may be less favorable to us than similar agreements between unaffiliated third-parties.
We will enter into several intercompany agreements with UOL while we are a wholly-owned subsidiary of UOL and while some of our executive officers and directors are also executive officers and directors of UOL. These agreements may be less favorable to us than agreements negotiated between unaffiliated third-parties. Under our agreements with UOL, we have agreed to indemnify UOL for, among other matters, liabilities related to our business, and we have assumed these and
23
certain other liabilities as part of our separation from UOL. See "Certain Relationships and Related Party Transactions—Relationship with United Online, Inc." for a description of these indemnification obligations, as well as the other terms and obligations of our agreements with UOL. Additionally, the allocation of assets and liabilities between UOL and us may not reflect the allocation that would have been reached by two unaffiliated parties.
Our agreements with UOL may deter transactions that would result in a change of control of us that may be in the best interest of our stockholders.
Our ability to engage in transactions that would result in a change in control of our company will be limited by provisions contained in our amended and restated certificate of incorporation and the master transaction agreement and the tax sharing agreement that we will enter into with UOL as part of this offering. Specifically, under our amended and restated certificate of incorporation and the master transaction agreement, UOL's consent is required for us to consolidate or merge with any other entity, sell all or substantially all of our assets or take any actions to dissolve, liquidate or wind-up our company, which may act as a deterrent to an acquisition of us by a third-party. Under the tax sharing agreement, we will agree, in the event UOL completes a spin-off, not to take certain actions, such as asset sales or contributions, mergers, stock issuances or stock sales within the two years following the spin-off without first obtaining the opinion of tax counsel or an Internal Revenue Service ruling to the effect that such actions will not result in the spin-off failing to qualify as a tax-free spin-off. These limitations may act as a deterrent to transactions involving a change in control of us that might be in the best interest of our stockholders. For more information, see "Certain Relationships and Related Party Transactions—Relationship with United Online, Inc." and "Description of Capital Stock—Approval Rights of Holders Class B Common Stock."
Our ability to operate our business effectively may suffer if we are unable to cost-effectively establish our own administrative and other support functions in order to operate as a stand-alone company after the expiration of our agreements with UOL.
As a subsidiary of UOL, we have relied on administrative and other resources of UOL to operate our business. In connection with this offering, we will enter into various service agreements to retain the ability for specified periods to use these resources. See "Certain Relationships and Related Party Transactions—Relationship with United Online, Inc." for a more detailed description of these various agreements. These services may not be provided at the same level as when we were a wholly-owned subsidiary of UOL, and we may not be able to obtain the same benefits that we received prior to this offering. We will eventually need to create our own administrative and other support systems, or contract with third-parties, to replace the resources that UOL currently provides, which will likely add to our operating expenses and could adversely affect our results of operations. In addition, we have received informal support from UOL that may not be addressed in the agreements we will enter into with UOL, and this informal support may diminish as we become a more independent company. Any failure or significant downtime in our own administrative systems or in UOL's administrative systems during the transitional period could result in unexpected costs, impact our results of operations and/or prevent us from paying our suppliers or employees and performing other administrative services on a timely basis.
In order to preserve the ability for UOL to distribute its shares of our Class B common stock on a tax-free basis, we may be prevented from pursuing opportunities to raise capital, to effectuate acquisitions or to provide equity incentives to our employees.
Beneficial ownership of at least 80% of the total voting power and 80% of each class of non-voting capital stock is required in order for UOL to effect a tax-free spin-off of us or certain other tax-free transactions. We have agreed that for so long as UOL continues to own greater than % of
24
the voting control of our outstanding common stock, we will not knowingly take or fail to take any action that could reasonably be expected to preclude UOL's ability to undertake a tax-free spin-off. Additionally, under our amended and restated certificate of incorporation and the master transaction agreement, we must obtain the consent of UOL to issue capital stock that would result in UOL owning less than majority of the outstanding shares of our common stock or less than 80% of the total voting power of our outstanding common stock, which could cause us to forgo capital raising or acquisition opportunities that would otherwise be available to us. As a result, we may be precluded from pursuing certain growth initiatives, such as acquisitions and raising additional capital through other public and private offerings of our securities.
Although we will enter into a tax sharing agreement with UOL under which our tax liabilities effectively will be determined as if we were not part of any consolidated, combined or unitary tax group of UOL and/or its subsidiaries, we nonetheless could be held liable for the tax liabilities of other members of these groups.
Classmates Online and MyPoints have historically been included in UOL's consolidated group for United States federal income tax purposes, as well as in certain consolidated, combined or unitary groups that include UOL and/or certain of its subsidiaries for state and local income tax purposes. We will enter into a tax sharing agreement with UOL that will become effective upon consummation of this offering. Under the tax sharing agreement, we and UOL generally will make payments to each other such that, with respect to tax returns for any taxable period in which we or any of our subsidiaries are included in UOL's consolidated group for United States federal income tax purposes or any other consolidated, combined or unitary group of UOL and/or its subsidiaries, the amount of taxes to be paid by us will be determined, subject to certain adjustments, as if we and each of our subsidiaries included in such consolidated, combined or unitary group filed our own consolidated, combined or unitary tax return.
We and our subsidiaries will be included in the UOL consolidated group for United States federal income tax purposes for periods in which UOL owned at least 80% of the total voting power and value of our outstanding stock. Each member of a consolidated group during any part of a consolidated return year is jointly and severally liable for tax on the consolidated return of such year and for any subsequently determined deficiency thereon. Similarly, in some jurisdictions, each member of a consolidated, combined or unitary group for state, local or foreign income tax purposes is jointly and severally liable for the state, local or foreign income tax liability of each other member of the consolidated, combined or unitary group. Accordingly, for any period in which we are included in the UOL consolidated group for United States federal income tax purposes or any other consolidated, combined or unitary group of UOL and/or its subsidiaries, we could be liable in the event that any income tax liability was incurred, but not discharged, by any other member of any such group.
In addition, if UOL decides to undertake a tax-free spin-off of our Class B common stock, we would generally be liable for, among other things, any taxes resulting from the failure of such spin-off to qualify as a tax-free transaction to the extent such taxes are attributable to, or result from, any action or failure to act by us or certain transactions involving us following a spin-off.
Our inability to resolve favorably any disputes that arise between us and UOL with respect to our past and ongoing relationships may result in a significant disruption of our business.
Disputes may arise between UOL and us in a number of areas relating to our ongoing relationship, including:
25
We may not be able to resolve any potential conflicts, and even if we do, the resolution may be less favorable to us than if we were dealing with an unaffiliated party that did not control us.
The agreements we will enter into with UOL may be amended upon agreement between the parties. While we are controlled by UOL, we may not have the leverage to negotiate any necessary amendments to these agreements on terms as favorable to us as we might be able to negotiate with an unaffiliated third-party.
Some of our directors and officers may have conflicts of interest because of their equity ownership of UOL or their management positions with UOL.
Some of our directors and officers own UOL common stock, restricted stock units and options to purchase UOL common stock. In addition, some of our directors and officers are also directors and officers of UOL. In particular, our Chairman, President and Chief Executive Officer, Mark R. Goldston, is also the Chairman, President and Chief Executive Officer of UOL. Equity ownership of UOL by our directors and officers after this offering and the presence of directors and officers of UOL on our board of directors or as members of our management could create, or appear to create, conflicts of interest on matters involving both us and UOL that could have different implications for UOL than they do for us. Provisions of our amended and restated certificate of incorporation and the master transaction agreement that we will enter into with UOL as a part of this offering address corporate opportunities that are presented to our directors or officers who are also directors or officers of UOL. However, these provisions may not adequately address potential conflicts of interest, and potential conflicts of interest may not be resolved in our favor. Furthermore, we may not be able to take advantage of corporate opportunities presented to individuals who are directors or officers of both us and UOL. As a result, we may be precluded from pursuing certain growth initiatives.
UOL's ability to control our board of directors may make it difficult for us to recruit high-quality independent directors.
So long as UOL beneficially owns shares of our common stock representing at least a majority of the votes entitled to be cast by the holders of outstanding voting stock, UOL can effectively control our board of directors. Furthermore, the interests of UOL and our other stockholders may diverge. Under these circumstances, individuals who might otherwise accept our invitation to join our board of directors may decline, and it may prove to be difficult for us to recruit high-quality independent directors.
Because we will be a "controlled company" within the meaning of the Nasdaq Global Market rules, our stockholders will not have the benefit of certain important corporate governance requirements that provide protection to stockholders of other publicly-held companies.
After the completion of this offering, UOL will own more than 50% of the total voting power of our capital stock, and as a result we will be a "controlled company" under the Nasdaq Global Market, or Nasdaq, corporate governance requirements. As a controlled company, we will be exempt from the obligation to comply with certain Nasdaq corporate governance requirements, including the requirements:
26
While we will voluntarily cause our corporate governance and nominating committee and our compensation committee to initially have charters that comply with the Nasdaq corporate governance requirements, we are not required to maintain those charters. As a result of our use of the "controlled company" exemptions, you will not have the same protection afforded to stockholders of companies that are subject to all of the Nasdaq corporate governance requirements.
Risks Related to this Offering
The trading price for our Class A common stock may be volatile, and you may not be able to resell shares of our Class A common stock at or above the price you paid.
Prior to this offering, our Class A common stock has not been traded in a public market. The estimated initial public offering price for the shares will be determined by negotiations between us and the representatives of the underwriters and may not be indicative of prices that will prevail in the trading market. The trading price of our Class A common stock could be subject to wide fluctuations due to the factors discussed in this risk factors section and elsewhere in this prospectus. These broad market and industry factors may decrease the market price of our Class A common stock, regardless of our actual operating performance. The stock market in general and technology companies in particular also have experienced extreme price and volume fluctuations. In addition, in the past, following periods of volatility in the overall market and the market price of a company's securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management's attention and resources.
No public market for our Class A common stock currently exists and an active trading market may not develop or be sustained following this offering.
Prior to this offering, there has been no public market for our Class A common stock. An active trading market may not develop following the closing of this offering or, if developed, may not be sustained. The lack of an active market may impair your ability to sell your shares at the time you wish to sell them or at a price that you consider reasonable. The lack of an active market may also reduce the fair market value of your shares. In addition, an inactive market may impair our ability to raise capital by selling shares and may impair our ability to acquire other businesses, services or technologies by using our shares as consideration, which in turn could materially adversely affect our business.
If securities or industry analysts do not publish or cease publishing research or reports about us, or if they change their recommendations regarding our Class A common stock, the trading price and volume of our Class A common stock could decline.
The trading market for our Class A common stock will be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If any of the analysts who may cover us change their recommendation regarding our stock adversely, or provide more favorable relative recommendations about our competitors, our stock price would likely decline. If any analyst who may cover us were to cease coverage of our company or fail to regularly publish reports on us, we could lose investor attention in the financial markets, which in turn could cause our stock price or trading volume to decline.
27
We will have broad discretion in the use of a significant portion of the net proceeds from this offering and may not use them effectively.
Our management will have broad discretion to use our net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply our net proceeds of this offering in ways that increase the value of your investment. We expect to use the net proceeds from this offering to repay $50.0 million of notes payable to UOL and for working capital and other general corporate purposes, including to finance our growth and fund capital expenditures and potential acquisitions. The amounts and timing of our actual expenditures will depend on numerous factors, including the status of our expansion efforts, development and marketing activities and competition. Our management might not be able to yield a significant return, if any, on any investment of these net proceeds. You will not have the opportunity to influence our decisions on how to use our net proceeds from this offering.
Substantial future sales of our common stock in the public market could cause the trading price of our Class A common stock to fall.
Sales of substantial amounts of our common stock in the public market after this offering, or the perception that these sales could occur, could cause the trading price of our Class A common stock to decline and impede our ability to raise capital through the issuance of additional equity securities. See "Shares Eligible for Future Sale" for a discussion of possible future sales of our common stock.
Upon completion of this offering, we will have shares of Class A common stock and shares of Class B common stock outstanding. UOL will own 100% of the shares of our Class B common stock, representing approximately % of our total outstanding shares of common stock. UOL has no contractual obligation to retain these shares owned by it, except that it has agreed not to sell or otherwise dispose of any of its shares of our common stock, subject to certain exceptions, without the consent of the representatives of underwriters for a period of 180 days from the date of this prospectus (as described under "Underwriting"). Subject to applicable United States federal and state securities laws, UOL may sell or otherwise dispose of any or all of the shares of our common stock that it owns, which may or may not include the sale of a controlling interest in us, either after the expiration of the 180-day lock-up period or before the expiration of the 180-day lock-up period with the consent of the underwriters. If UOL elects to convert its shares of Class B common stock into Class A common stock, an additional shares of Class A common stock will be available for sale after the period of 180 days from date of this prospectus, subject to applicable United States federal and state securities laws. In addition, UOL has the right to cause us to register the sale of its shares of our common stock under the Securities Act of 1933, as amended, or the Securities Act. Registration of these shares under the Securities Act would result in these shares, other than shares purchased by our affiliates, becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration.
If UOL distributes shares of our stock that it owns to its stockholders, all of these shares would be eligible for immediate resale in the public market. We are unable to predict whether significant amounts of our shares would be sold in the open market in anticipation of, or after, any such distribution. We also are unable to predict whether a sufficient number of buyers for our shares would be in the market at that time. Any sale by UOL or us of our shares in the public market or the perception that sales could occur, whether as a result of any distribution of our shares by UOL to its stockholders or otherwise, could harm the prevailing market price of our shares.
In addition, our directors and officers have entered into lock-up agreements with the representatives of the underwriters as described under "Underwriting." All shares sold in this offering will be freely transferable without further restriction or further registration under the Securities Act, unless these shares are held by "affiliates" as that term is defined in Rule 144 under the Securities Act.
28
Immediately after this offering, we intend to file a registration statement on Form S-8 under the Securities Act covering shares of, our Class A common stock that will be registered for issuance under our 2007 Incentive Compensation Plan. The Form S-8 registration statement will automatically become effective upon filing, and shares registered thereon will be available for sale in the open market, subject to the lock-up agreements, as well as any vesting requirements and the lapsing of restrictions on restricted stock, although sales of shares held by our affiliates will be limited by Rule 144 volume limitations. Significant sales of our shares pursuant to our 2007 Incentive Compensation Plan could also harm the prevailing market price for our Class A common stock.
Purchasers in this offering will immediately experience substantial dilution in net tangible book value.
Purchasers of our Class A common stock in this offering will incur immediate and substantial dilution of $ per share in the net tangible book value of our Class A common stock based on the assumed initial public offering price of $ per share (the midpoint of the range set forth on the cover page of this prospectus).
The difference in the voting rights of our Class A and our Class B common stock may harm the value and liquidity of our Class A common stock.
The rights of the holders of Class A and Class B common stock are identical, except with respect to voting, conversion, protective voting provisions as set forth in this prospectus. The holders of Class B common stock will be entitled to 10 votes per share, as well as certain other rights associated with the Class B common stock, and the holders of our Class A common stock will be entitled to one vote per share. The difference in the voting rights of our Class A and Class B common stock could harm the value of the Class A common stock to the extent that any current or future investor in our common stock ascribes value to the rights of the holders of our Class B common stock to 10 votes per share. The existence of two classes of common stock could result in less liquidity for either class of common stock than if there were only one class of our common stock. See "Description of Capital Stock" for a description of our common stock and rights associated with it.
If UOL spins off our high-vote Class B common stock to its stockholders, the voting rights of our Class A common stock will continue to be disproportionately lower than the voting rights of our Class B common stock.
If UOL spins off our Class B common stock to its stockholders, the voting rights of our Class A common stock will continue to be disproportionately lower than the voting rights of our Class B common stock. Therefore, the holders of our Class B common stock will continue to be able to direct the election of all of the members of our board of directors and exercise a controlling influence over our business and affairs.
Our amended and restated certificate of incorporation, amended and restated bylaws, Delaware law and our stockholder rights plan contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.
Our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could have the effect of making it more difficult or discouraging a change of control or changes in our management. These provisions include the following:
29
In addition, we expect that our board of directors will adopt a rights plan prior to the completion of this offering. The rights plan will make it more difficult for a third-party to acquire us without the approval of our board of directors. Although we believe these provisions provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders.
As a public company, we will incur additional costs and face increased demands on our management.
As a public company, we will incur significant legal, accounting and other expenses that we did not directly incur as a wholly-owned subsidiary of UOL. In addition, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as the rules subsequently implemented by the SEC and Nasdaq, have required changes in corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. For example, as a result of becoming a public company, we intend to add independent directors as and if required, create additional board committees and adopt policies regarding internal controls and disclosure controls and procedures. In addition, we will incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoring developments relating to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. Furthermore, our management will have increased demands on its time in order to ensure we comply with public company reporting requirements and the compliance requirements of the Sarbanes-Oxley Act, as well as the rules subsequently implemented by the SEC and Nasdaq.
30
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 based on our current expectations, estimates and projections about our operations, industry, financial condition and liquidity. Statements containing words such as "anticipate," "expect," "intend," "plan," "believe," "may," "will" or similar expressions constitute forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. The section entitled "Risk Factors" in this prospectus sets forth some of the important risk factors that may affect our business, financial position, results of operations and cash flows. Statements indicating factors that we believe may impact our results are not intended to be exclusive. We undertake no obligation to revise or update publicly any forward-looking statements, other than as required by law.
31
We estimate that our net proceeds from the sale of the Class A common stock will be approximately $ million, at an assumed initial public offering price of $ per share, the midpoint of the range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and offering expenses payable by us. If the underwriters' option to purchase additional shares in this offering is exercised in full, we estimate that our net proceeds will be approximately $ million. A $1.00 increase (decrease) in the assumed initial public offering price of $ per share would increase (decrease) the net proceeds to us by approximately $ million, assuming the underwriters do not exercise their option to purchase additional shares and assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and offering expenses payable by us.
We intend to use the net proceeds from this offering to repay $50.0 million of notes payable to UOL, plus accrued and unpaid interest, and for working capital and other general corporate purposes, including to finance our growth and fund capital expenditures and potential acquisitions.
The notes payable to UOL represent an aggregate of $50.0 million of dividends declared to UOL by Classmates Online and MyPoints in August 2007. The notes mature in August 2013 and bear interest at a rate of 95/8% per annum, with interest payable quarterly in arrears, commencing September 30, 2007. The notes may be repaid, in whole or in part, without penalty, at any time. See "Capitalization."
We may pursue the acquisition of businesses, services and technologies that we believe may provide us with the opportunity to leverage our assets and core competencies, expand our geographic reach or that may otherwise be complementary to our existing businesses. We do not have agreements or commitments for any specific acquisitions at this time. The amounts and timing of our actual expenditures will depend on numerous factors, including the status of our expansion efforts, development and marketing activities and competition. Accordingly, our management will have broad discretion in the use of the net proceeds from this offering. Pending the use of proceeds from this offering, we intend to invest the proceeds in a variety of capital preservation investments, generally government securities and cash.
32
We have never declared or paid any dividends on our capital stock, and we do not anticipate declaring any cash dividends in the foreseeable future. The August 2007 dividends to UOL by each of Classmates Online and MyPoints are not representative of our dividend policy and should not be considered indicative of future dividends. Any future determination to declare cash dividends will be made at the discretion of our board of directors. Holders of our Class A common stock and our Class B common stock will share equally on a per share basis in any dividend declared on our common stock by our board of directors. See "Description of Capital Stock—Common Stock—Dividend Rights."
33
The following table sets forth our capitalization at March 31, 2007 on:
The following data should be read in conjunction with "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Description of Capital Stock" and the financial information, including our historical combined and consolidated financial statements and related notes, included elsewhere in this prospectus.
| |
As of March 31, 2007 |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Actual |
Pro Forma |
Pro Forma As Adjusted |
|||||||||
| |
(in thousands, except share data) |
|||||||||||
| Long-term debt | $ | $ | $ | |||||||||
| Stockholders' equity: | ||||||||||||
| Undesignated preferred stock, $0.0001 par value; no shares authorized, no shares outstanding actual, pro forma and pro forma as adjusted | ||||||||||||
| Class A common stock, $0.0001 par value; shares authorized, shares outstanding actual, pro forma and pro forma as adjusted | ||||||||||||
| Class B common stock, $0.0001 par value; shares authorized, shares outstanding actual, pro forma and pro forma as adjusted | ||||||||||||
| Additional paid-in capital | ||||||||||||
| Accumulated deficit | ||||||||||||
| Accumulated other comprehensive loss | ||||||||||||
| Total equity | $ | $ | $ | |||||||||
| Total capitalization | $ | $ | $ | |||||||||
A $1.00 increase (decrease) in the assumed initial public offering price of $ per share would increase (decrease) each of cash and cash equivalents, additional paid-in capital, total equity and total capitalization by $ $ , $ and $ , respectively, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and offering expenses payable by us.
Unless otherwise specifically stated, all information in this prospectus assumes:
34
The number of shares of common stock that will be outstanding after this offering is based on the number of shares outstanding as of and excludes:
35
If you invest in our Class A common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our Class A common stock and the net tangible book value per share of our common stock immediately after the completion of this offering.
Net tangible book value per share represents the amount of total tangible assets less total liabilities, divided by the number of common shares then outstanding. Our net tangible book value as of was approximately $ million. After giving effect to our sale of shares of our Class A common stock in this offering at an assumed initial public offering price of $ per share (the midpoint of the range set forth on the cover page of this prospectus), and after deducting the estimated underwriting discounts and offering expenses payable by us and the repayment of $50.0 million of notes payable to UOL, our pro forma net tangible book value as of would have been $ million, or $ per share of Class A common stock (assuming no exercise of the underwriters' option to purchase additional shares). This represents an immediate increase in the net tangible book value of $ per share and an immediate and substantial dilution of $ per share to new investors purchasing shares of our Class A common stock in this offering. The following table illustrates this dilution per share:
| Assumed initial public offering price per share (the midpoint of the $ estimated offering range) | $ | ||||||
| Net tangible book value per share as of | $ | ||||||
| Increase in net tangible book value per share attributable to this offering | |||||||
| Pro forma net tangible book value per share before the offering | |||||||
| Net tangible book value per share after this offering | |||||||
| Dilution per share to new investors | $ | ||||||
A $1.00 increase (decrease) in the assumed initial public offering price of $ per share would increase (decrease) the increase in net tangible book value attributable this offering by $ per share, the pro forma net tangible book value after giving effect to this offering by $ per share and the dilution to new investors in this offering by $ per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and offering expenses payable by us.
If the underwriters exercise in full their option to purchase additional shares, the net tangible book value per share after this offering would be $ per share, and the dilution per share to new investors in this offering would be $ per share.
The following table sets forth, as of , the difference between the number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid by UOL and by the new investors in this offering at an assumed initial public offering price of $ per share (the midpoint of the range set forth on the cover page of this prospectus) and prior to deducting the estimated underwriting discounts and offering expenses.
| |
Shares Purchased |
Total Consideration |
|
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Average Price Per Share |
||||||||||||
| |
Number |
Percent |
Amount |
Percent |
|||||||||
| UOL | % | $ | % | $ | |||||||||
| New investors | |||||||||||||
| Total | % | $ | % | $ | |||||||||
36
A $1.00 increase (decrease) in the assumed initial public offering price of $ per share would increase (decrease) the total consideration paid by new investors, total consideration paid by all stockholders and the average price per share paid by all stockholders by $ million, $ million and $ , respectively, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and offering expenses payable by us.
If the underwriters' option to purchase additional shares is exercised in full, UOL will own % of and the new investors in this offering will own % of the total number of shares of our common stock outstanding after this offering.
As of , there were shares of Class A common stock reserved for issuance under our 2007 Incentive Compensation Plan, shares of which will be issuable upon the vesting of restricted stock units to be granted on the date of this offering and shares of which will be subject to options to be granted on the date of this offering at an exercise price equal to the initial public offering price. The foregoing information assumes no vesting of restricted stock units or stock options outstanding as of .
37
UNAUDITED PRO FORMA CONDENSED COMBINED AND CONSOLIDATED FINANCIAL DATA
We completed three acquisitions in 2006, and we include the results of operations for all of these acquisitions in our combined and consolidated results of operations starting from the date they were acquired.
We included the results of operations of MyPoints in our combined and consolidated operating results since the date it was acquired in 2006. The accompanying pro forma statement of operations for the year ended December 31, 2006 gives effect to the acquisition of MyPoints as if it had occurred at January 1, 2006. Because all of these acquisitions were completed in 2006, the assets and liabilities (including acquired intangible assets and goodwill) of the acquired companies are fully reflected in our most recently presented balance sheet at December 31, 2006. As a result, we have not presented a pro forma balance sheet at December 31, 2006. In August 2007, Classmates Online and MyPoints declared dividends to UOL in the aggregate amount of $50.0 million evidenced by notes payable to UOL. Such dividends are reflected in our unaudited pro forma balance sheet included elsewhere in this prospectus.
No adjustments have been made to the pro forma financial information for certain items that are included in our historical results of operations, including (1) the gain on chapter 11 bankruptcy reorganization of MyPoints prior to its acquisition by UOL of approximately $1.7 million and (2) imputed interest expense of approximately $0.5 million relating to accretion of a discount on the acquired member redemption liabilities established in connection with the MyPoints acquisition, but not expected to be immediately redeemed.
We expect to incur incremental cost increases and decreases as a stand-alone public entity. For example, UOL currently provides many corporate functions on our behalf. As an independent public company, our total costs related to functions such as treasury, tax, accounting, legal, internal audit, human resources, public and investor relations, general management, real estate, shared information technology systems, procurement and other statutory functions, including a board of directors and centrally managed employee benefit arrangements, are expected to differ from the costs of such functions that were historically allocated to us from UOL. The annual costs associated with replacing and/or establishing these functions are not estimable at this time, nor can we estimate the amount of any resulting decrease, if any, in the amount of allocated costs from UOL for these services.
38
We will incur significant additional personnel-related expenses associated with the hiring of new executive officers and key personnel. In August 2007, we hired a new Chief Financial Officer for the company and a President for Classmates Online. We entered into employment agreements with these individuals, as well as with the co-Presidents of MyPoints. We will incur direct compensation expenses previously allocated to us from UOL. These expenses may be significantly higher than those reflected in our historical results of operations, and we are not able to estimate the decrease, if any, in the amount of expenses and costs allocated by UOL for personnel-related expenses. In addition, upon completion of this offering, we will award an aggregate of restricted stock units and options to purchase shares of our Class A common stock to our executive officers. Any stock-based compensation expense is not estimable at this time.
39
CLASSMATES MEDIA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF UNITED ONLINE, INC.)
UNAUDITED PRO FORMA CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2006
(in
thousands, except per share amounts)
| |
Historical |
|
|
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Classmates Media Corporation For the Year Ended December 31, 2006 |
MyPoints.com, Inc. For the Period from January 1, 2006 to April 9, 2006 (last date immediately prior to acquisition by UOL) |
Pro Forma Adjustments |
Pro Forma |
|||||||||
| Revenues | $ | 139,446 | $ | 12,663 | $ | 152,109 | |||||||
Operating expenses |
140,440 |
11,385 |
(149 |
)(a) |
|||||||||
| 206 | (b) | 151,882 | |||||||||||
| Operating income (loss) | (994 | ) | 1,278 | (57 | ) | 227 | |||||||
| Interest and other income (expense), net | (81 | ) | 358 | 277 | |||||||||
| Gain on chapter 11 reorganization | — | 1,719 | 1,719 | ||||||||||
| Interest expense | (492 | ) | — | (492 | ) | ||||||||
| Income (loss) before income taxes | (1,567 | ) | 3,355 | (57 | ) | 1,731 | |||||||
| Provision for income taxes | 549 | — | 1,194 | (c) | 1,743 | ||||||||
| Income (loss) before cumulative effect of accounting change | $ | (2,116 | ) | $ | 3,355 | $ | (1,251 | ) | $ | (12 | ) | ||
| Loss before cumulative effect of accounting change per share | $ | (1.20 | ) | ||||||||||
| Shares used to calculate net loss per share | 10 | ||||||||||||
The
accompanying notes are an integral part of these
unaudited pro forma condensed combined and consolidated statement of operations.
40
CLASSMATES MEDIA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF UNITED ONLINE, INC.)
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF OPERATIONS
Explanations for detailed adjustments reflected in the accompanying pro forma statements of operations are as follows:
41
SELECTED HISTORICAL FINANCIAL DATA
The following table summarizes our selected historical combined and consolidated financial data and selected consolidated financial data of our predecessor, which should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and related notes included elsewhere in this prospectus.
Our selected historical combined and consolidated financial data at March 31, 2007 and for the three months ended March 31, 2007 and 2006 has been derived from our unaudited financial statements at those dates and for those periods, included elsewhere in this prospectus. Our unaudited financial statements were prepared on a basis consistent with our audited financial statements included elsewhere in this prospectus and include all adjustments, consisting of normal and recurring items and estimates that we consider necessary for a fair presentation of the financial position and results of operations for the unaudited periods.
Our selected historical combined and consolidated financial data at December 31, 2006 and 2005 and for the years ended December 31, 2006 and 2005 and for the period from November 17, 2004 (date of inception) through December 31, 2004 has been derived from our audited financial statements at those dates and for those periods, included elsewhere in this prospectus. Our selected historical combined and consolidated financial data at December 31, 2004 has been derived from our audited balance at that date, which is not included in this prospectus.
The consolidated financial data for our predecessor for the period from January 1, 2004 through November 16, 2004 (last date prior to acquisition by UOL) has been derived from the audited financial statements of our predecessor for that period, included elsewhere in this prospectus. The consolidated financial data for our predecessor at December 31, 2003 and 2002 and for the years ended December 31, 2003 and 2002 has been derived from the audited financial statements of our predecessor at those dates and for those periods, which are not included in this prospectus.
Our financial statements included in this prospectus may not necessarily reflect our results of operations, financial position and cash flows as if we had operated as a stand-alone company without the shared services of UOL during all periods presented. Accordingly, our historical results should not be relied upon as an indicator of our future performance. In addition, the results for the three months ended March 31, 2007 are not necessarily indicative of results to be expected for the full year.
42
| |
Classmates Media Corporation(1) (A Wholly-Owned Subsidiary of UOL) |
|
|
|
|||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Predecessor(2) |
||||||||||||||||||||||||
| |
|
|
|
|
Period from November 17, 2004 (date of inception) through December 31, |
||||||||||||||||||||
| |
|
|
|
|
Period from January 1, 2004 through November 16, 2004 (last date prior to acquisition by UOL) |
|
|
||||||||||||||||||
| |
Quarter Ended March 31, |
Year Ended December 31, |
Year Ended December 31, |
||||||||||||||||||||||
| |
2007 |
2006 |
2006 |
2005 |
2004 |
2003 |
2002 |
||||||||||||||||||
| |
(in thousands, except per share amounts) |
||||||||||||||||||||||||
| Statement of Operations Data: | |||||||||||||||||||||||||
| Revenue | $ | 42,434 | $ | 25,171 | $ | 139,446 | $ | 84,892 | $ | 8,630 | $ | 64,635 | $ | 78,477 | $ | 66,761 | |||||||||
| Total operating expenses | $ | 42,876 | $ | 25,789 | $ | 140,440 | $ | 96,397 | $ | 10,937 | $ | 59,647 | $ | 62,884 | $ | 57,610 | |||||||||
| Operating income (loss) |
$ | (442 | ) | $ | (618 | ) | $ | (994 | ) | $ | (11,505 | ) | $ | (2,307 | ) | $ | 4,988 | $ | 15,593 | $ | 9,151 | ||||
| Income (loss) before income taxes | $ | (532 | ) | $ | (656 | ) | $ | (1,567 | ) | $ | (11,530 | ) | $ | (2,307 | ) | $ | 5,190 | $ | 15,720 | $ | 8,858 | ||||
| Income (loss) before cumulative effect of accounting change | $ | (250 | ) | $ | (886 | ) | $ | (2,116 | ) | $ | (8,191 | ) | $ | (1,686 | ) | $ | 3,018 | $ | 10,496 | $ | 17,913 | ||||
| Cumulative effect of accounting change, net of tax(3) | $ | — | $ | 183 | $ | 183 | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||
Net income (loss) |
$ |
(250 |
) |
$ |
(703 |
) |
$ |
(1,933 |
) |
$ |
(8,191 |
) |
$ |
(1,686 |
) |
$ |
3,018 |
$ |
10,496 |
$ |
17,913 |
||||
| Net income (loss) per share: | |||||||||||||||||||||||||
| Income (loss) before cumulative effect of accounting change | $ | (25.00 | ) | $ | (88.60 | ) | $ | (211.60 | ) | $ | (819.10 | ) | $ | (168.60 | ) | ||||||||||
| Cumulative effect of accounting change, net of tax(3) | — | 18.30 | 18.30 | — | — | ||||||||||||||||||||
| Basic net income (loss) per share | $ | (25.00 | ) | $ | (70.30 | ) | $ | (193.30 | ) | $ | (819.10 | ) | $ | (168.60 | ) | $ | 0.32 | ||||||||
| Diluted net income (loss) per share | $ | (25.00 | ) | $ | (70.30 | ) | $ | (193.30 | ) | $ | (819.10 | ) | $ | (168.60 | ) | $ | 0.12 | ||||||||
| Supplemental pro forma net income (loss) per share(4) | |||||||||||||||||||||||||
| Shares used to calculate basic net income (loss) per share | 10 | 10 | 10 | 10 | 10 | 9,526 | |||||||||||||||||||
| Shares used to calculate diluted net income (loss) per share | 10 | 10 | 10 | 10 | 10 | 25,217 | |||||||||||||||||||
| Shares used to calculate supplemental pro forma net income (loss) per share | |||||||||||||||||||||||||
43
| |
|
Classmates Media Corporation |
Predecessor |
|||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
|
December 31, |
December 31, |
|||||||||||||||
| |
March 31, 2007 |
|||||||||||||||||
| |
2006 |
2005 |
2004 |
2003 |
2002 |
|||||||||||||
| Balance Sheet Data: | ||||||||||||||||||
| Cash and cash equivalents | $ | 4,458 | $ | 3,552 | $ | 4,746 | $ | 1,648 | $ | 31,426 | $ | 13,752 | ||||||
| Total assets | $ | 210,407 | $ | 214,869 | $ | 137,461 | $ | 148,659 | $ | 52,987 | $ | 40,704 | ||||||
| Long-term liabilities | $ | 19,656 | $ | 18,878 | $ | 19,908 | $ | 19,806 | $ | 3,937 | $ | 249 | ||||||
| Stockholders' equity | $ | 118,834 | $ | 126,773 | $ | 79,037 | $ | 102,812 | $ | 10,662 | $ | 1,102 | ||||||
44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, should be read in conjunction with our consolidated financial statements and notes thereto which appear elsewhere in this prospectus. The following discussion should be read in conjunction with section entitled "Forward-Looking Statements" and the risk factors set forth under "Risk Factors."
Introduction
We operate leading online social networking and loyalty marketing services under our Classmates and MyPoints brands. On our social networking Web sites, we enable users to locate and interact with acquaintances from school, work and the military. MyPoints, our online loyalty marketing service, provides advertisers with an effective means to reach a large online audience with targeted marketing campaigns, while also enabling consumers to earn points-based rewards by responding to email offers, taking market research surveys, booking travel, shopping online and engaging in other online activities.
Our social networking members can choose between a free membership and a paid subscription offering enhanced features. Free accounts constitute the vast majority of our social networking accounts. Revenues from our social networking services are derived from subscription fees, which we refer to as billable services revenues, and advertising fees. Pricing for a Classmates pay account varies by term of membership, with most pay accounts consisting of a three-month subscription for $15.00, or $5.00 per month, a 12-month subscription for $39.00, or $3.25 per month, or a 24-month subscription for $59.00, or $2.46 per month. Pricing for our international social networking services and The Names Database is lower than Classmates. Advertising revenues from our social networking services consist primarily of fees generated from the display of third-party registration offers at the end of our pay account registration process, other display advertisements and referring members to third-party Web sites or services.
All of our loyalty marketing revenues are derived from advertising fees, consisting primarily of fees generated when emails are transmitted to members, when members respond to emails and when members complete online transactions.
Basis of Presentation
We were incorporated in August 2007 and are a wholly-owned subsidiary of UOL. Classmates Online, Inc., or Classmates Online, was a privately held company prior to being acquired by UOL in November 2004. MyPoints.com, Inc., or MyPoints, was a subsidiary of an unrelated company prior to being acquired by UOL in April 2006. Prior to this offering, Classmates Online and MyPoints were operated as wholly-owned subsidiaries of UOL. UOL contributed the stock of Classmates Online and MyPoints to us in August 2007 and both are now our wholly-owned subsidiaries.
For financial accounting purposes, Classmates Online is considered the predecessor of Classmates Media Corporation, because the acquisition of Classmates Online constituted substantially all of our business, and our own operations prior to the acquisition were insignificant relative to the operations acquired. As a result, our historical combined and consolidated results of operations reflect the operating results of Classmates Online and its subsidiaries from November 17, 2004 through April 9, 2006. As of April 10, 2006, the date of the acquisition of MyPoints, our historical combined and consolidated results of operations also reflect the operating results of MyPoints. Our historical combined and consolidated results of operations also reflect the acquisition of The Names Database in March 2006 and the acquisition of Trombi, an online social networking service for France, in August 2006. The results of The Names Database and Trombi are not material to our operations.
45
UOL reports Classmates Online and MyPoints as part of its Content & Media segment. While Classmates Online and MyPoints constitute the vast majority of the revenues and expenses associated with UOL's Content & Media segment, there are differences between UOL's Content & Media segment results of operations and our results of operations for comparable periods. In particular, UOL's Web hosting and photo sharing businesses are part of the results of operations for UOL's Content & Media segment, and these businesses have not been transferred to us and are not included in our results of operations. In addition, UOL's Content & Media segment does not include unallocated corporate expenses.
Our financial statements are presented on a "carve-out" basis from the accounts of UOL, and may not necessarily reflect our results of operations, financial position and cash flows as if we operated as a stand-alone company without the shared services of UOL during all periods presented. In particular, we historically have received from, and relied upon UOL to provide, management, sales, marketing, product development, administrative, including finance and accounting, legal, human resources and facilities management, and other services. Our financial statements include allocations of corporate expenses and costs from UOL relating to theses services.
The expense and cost allocations have been determined on a basis that we and UOL consider to be a reasonable reflection of the utilization of services provided to, or the benefit received by, us during the periods presented. It is anticipated that we will remain a controlled subsidiary of UOL for a period of time subsequent to this offering. As such, we will continue to receive services from UOL pursuant to intercompany agreements and will be allocated our share of corporate expenses and costs under methods similar to those used in the preparation of our historical financial statements. The amounts recorded for these services are not necessarily representative of the amounts that would have been reflected in our financial statements had we been an entity that operated independent of UOL. We plan to expand our own administrative functions, including our finance and legal functions, which may be at higher costs than the comparable services currently provided by UOL. See "Certain Relationships and Related Party Transactions—Relationship with United Online, Inc." for a description of these intercompany agreements. In addition, we expect to incur significant additional costs associated with operating as an independent public company, including legal, accounting, insurance and SEC reporting and compliance costs and other expenses. These costs and expenses may be materially different than those reflected in our historical results of operations. Accordingly, our historical financial statements are not necessarily indicative of our future results of operations, financial position and cash flows.
Key Business Metrics
We review a number of key business metrics to help us monitor our performance and trends affecting our businesses, and to develop forecasts and budgets. These measures include:
Pay Accounts. Our social networking pay accounts generate the majority of our revenues and represent one of the most important drivers of our business model. A pay account is defined as a member who has subscribed to, and paid us for, our social networking services, and whose subscription has not expired. In general, the key metrics that drive revenue from our pay accounts base include the number of pay accounts and the average monthly revenue generated per pay account. In general, a pay account becomes a free account following the expiration or termination of the subscription.
ARPU. We monitor the average monthly revenue per pay account, or ARPU. ARPU is calculated by dividing billable services revenues for a period by the average number of pay accounts for that period, divided by the number of months in that period. The average number of pay accounts is the simple average of the number of pay accounts at the beginning and end of a period. ARPU may fluctuate from period to period as a result of a variety of factors including: changes in the mix of pay services and the related pricing plans; the use of promotional pricing to attract new or retain existing
46
paying subscribers; increases or decreases in the price of our services; and the timing of pay accounts being added or removed during a period.
Churn. To evaluate the retention characteristics of our membership base, we also monitor the percentage of pay accounts that terminate or expire, which we refer to as our monthly churn rate. Our churn rate is calculated as the total number of pay accounts that terminated or expired in a period divided by the average number of pay accounts for the same period, divided by the number of months in that period. Our churn percentage may fluctuate from period to period due to our mix of subscription terms, which affects the timing of subscription expirations, and other factors.
Active Accounts. We monitor the number of active accounts among our membership base. Active accounts represent: all social networking pay accounts as of the date presented; the monthly average for the quarter ended as of the date presented of all free social networking accounts who have visited our domestic or international Web sites, excluding The Names Database, at least once during the period; and the monthly average for the period of all loyalty marketing members who have earned or redeemed points during such period. Active accounts are critical to generating advertising revenues. In addition, our social networking members with free accounts who contribute content to our Web sites, can attract other members to our Web sites. This activity, in turn, provides us with additional opportunities to convert free members to paying subscribers.
The following table sets forth, for the dates or three-month periods presented, as applicable, our pay accounts (at the end of the period), ARPU (monthly average for the period), churn (monthly average for the period) and active accounts (at the end of the period).
| |
March 31, 2007 |
December 31, 2006 |
September 30, 2006 |
June 30, 2006 |
March 31, 2006(1) |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Pay accounts (in thousands) | 2,433 | 2,169 | 2,079 | 2,029 | 1,945 | |||||||||||
| ARPU | $ | 3.22 | $ | 3.31 | $ | 3.34 | $ | 3.42 | $ | 3.43 | ||||||
| Churn | 4.5 | % | 4.8 | % | 5.2 | % | 5.2 | % | 5.0 | % | ||||||
| Active accounts(2) (in millions) | 11.4 | 11.2 | 10.8 | 11.2 | 9.8 | |||||||||||
Adjusted EBITDA. Our management uses adjusted earnings before interest, taxes, depreciation and amortization, which we refer to as adjusted EBITDA, to measure our performance. Adjusted EBITDA is defined as net income (loss) before interest income, interest expense, taxes, depreciation, amortization, stock-based compensation, restructuring charges, and impairment of goodwill, intangible assets and long-lived assets. We believe that because adjusted EBITDA excludes (1) certain non-cash expenses (such as depreciation, amortization, stock-based compensation and impairment of goodwill, intangible assets and long-lived assets); and (2) expenses that are not reflective of our core operating results over time, this measure provides us with additional useful information to measure our performance on a consistent basis, particularly with respect to changes in performance from period to period. We use adjusted EBITDA in the preparation of our budgets and to measure and monitor our performance. We believe that adjusted EBITDA is useful in understanding our operating performance. Not every company in our industry defines this metric in precisely the same way that we do. Adjusted EBITDA is not determined in accordance with GAAP and is not a substitute for or superior to, financial measures determined in accordance with GAAP. A limitation associated with the use of adjusted EBITDA is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our business. We evaluate the costs of such tangible and intangible assets through other financial measures such as capital expenditures and purchase
47
accounting. An additional limitation associated with this measure is that it does not include stock-based compensation expenses. We compensate for this limitation by providing supplemental information about stock-based compensation expense in the notes to the combined and consolidated financial statements included elsewhere in this prospectus. A further limitation associated with the use of this measure is that it does not reflect the costs of restructuring charges and impairment charges. We will compensate for this limitation by providing information about restructuring charges and impairment charges, when applicable. We do not believe any of these limitations are material, particularly when such measure is disclosed with its most comparable GAAP financial measure, net income. The following table sets forth (in thousands), for the periods presented, a reconciliation of adjusted EBITDA to net income (loss).
| |
|
|
|
|
|
November 17, 2004 (date of inception) through December 31, 2004 |
|
|||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Quarter Ended March 31, |
Year Ended December 31, |
|
January 1, 2004 through November 16, 2004 (last date prior to acquisition by UOL) |
||||||||||||||||||
| |
Combined Year Ended December 31, 2004(1) |
|||||||||||||||||||||
| |
2007 |
2006 |
2006 |
2005 |
||||||||||||||||||
| Net income (loss) | $ | (250 | ) | $ | (703 | ) | $ | (1,933 | ) | $ | (8,191 | ) | $ | 1,332 | $ | (1,686 | ) | $ | 3,018 | |||
| Add (deduct): | ||||||||||||||||||||||
| Interest income | (24 | ) | (5 | ) | (16 | ) | (57 | ) | (130 | ) | (130 | ) | — | |||||||||
| Interest expense | 114 | 8 | 492 | 49 | — | — | — | |||||||||||||||
| Depreciation | 1,895 | 1,646 | 8,202 | 5,514 | 6,407 | 720 | 5,687 | |||||||||||||||
| Amortization | 2,848 | 3,020 | 12,731 | 16,388 | 3,326 | 3,256 | 70 | |||||||||||||||
| Stock-based compensation | 838 | 1,026 | 4,872 | 2,631 | 567 | 282 | 285 | |||||||||||||||
| Bankruptcy restructuring | — | — | (1,719 | ) | — | — | — | — | ||||||||||||||
| Provision (benefit) for income taxes | (282 | ) | 230 | 549 | (3,339 | ) | 1,551 | (621 | ) | 2,172 | ||||||||||||
| Adjusted EBITDA | $ | 5,139 | $ | 5,222 | $ | 23,178 | $ | 12,995 | $ | 13,053 | $ | 1,821 | $ | 11,232 | ||||||||
Critical Accounting Policies, Estimates and Assumptions
General
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for interim or transition periods are not necessarily indicative of the results expected for any future periods.
The following is a discussion of the accounting policies and related estimates that we believe are most critical to understanding our combined and consolidated financial statements, financial position and results of operations and which require complex management judgments, uncertainties and/or estimates.
Revenue Recognition
Our revenues are comprised of billable services revenues, which are derived from paid subscription fees, and advertising revenues. We apply the provisions of SAB No. 104, Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB No. 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, we recognize revenue when persuasive evidence of an arrangement
48
exists, delivery has occurred or services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured. We also apply the provisions of Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.
Billable services revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the customer. Our paying subscribers generally pay in advance for their subscription by credit card, and revenue is then recognized ratably over the subscription period. Advance payments from subscribers are recorded on the balance sheet as deferred revenue.
Advertising revenues from our social networking services consist primarily of fees generated from the display of third-party registration offers at the end of our pay account registration process, other display advertisements and referring members to third-party Web sites or services. We recognize advertising revenues in the period in which the advertisement is displayed or, for performance-based arrangements, when the related performance criteria are met. In determining whether an arrangement exists, we ensure that a binding contract is in place, such as a standard insertion order or a fully executed customer-specific agreement. We assess whether performance criteria have been met and whether the fees are fixed or determinable based on a reconciliation of the performance criteria and the payment terms associated with the transaction. The reconciliation of the performance criteria generally includes a comparison of internally tracked performance data to the contractual performance obligation and, when available, to third-party or customer performance data.
Advertising revenues for our loyalty marketing service consist primarily of fees generated when emails are transmitted to members, when members respond to emails and when members complete online transactions. Each of these activities is a discrete, independent activity, which generally is specified in the sales agreement for each advertising customer. As the earning activities take place, activity measurement data (examples include number of emails delivered and the number of responses received) is accumulated and the related revenue is recorded. Revenue from the sale of points to MyPoints advertisers is deferred and amortized to revenue over the estimated time frame that the points are expected to either be redeemed (with MyPoints providing a reward) or expire prior to redemption. This time frame is estimated to be approximately a fifteen-month period.
Probability of collection is assessed based on a number of factors, including past transaction history with the customer and the creditworthiness of the customer. If it is determined that collection is not reasonably assured, revenue is not recognized until collection becomes reasonably assured, which is generally upon receipt of cash. Deferred revenue also represents invoiced services that have not yet been performed.
Stock-Based Compensation
Our employees participate in the stock-based compensation plans of UOL. Under these plans, certain employees have received grants of stock options and restricted stock units for UOL common stock. Additionally, all eligible Company employees are provided the opportunity to participate in UOL's employee stock purchase plan. As a result, the reported amounts for stock-based compensation reflected in the accompanying financial statements may not be reflective of the amounts that would have been reported if we were an independent company with our own compensation plans.
On January 1, 2006, we adopted Statement of Financial Accounting Standards, or SFAS, No. 123 (revised 2004), Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, restricted stock awards and employee stock purchases based on the grant-date fair values of the awards. SFAS No. 123R supersedes our previous accounting under Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees. In March 2005, the SEC issued SAB No. 107 relating to SFAS No. 123R. We have applied the provisions of SAB No. 107 in our adoption of SFAS No. 123R. Although the equity awards have been made in UOL's common stock, the
49
compensation related to these equity awards has been pushed down and included as a component of our stockholder's equity.
We adopted SFAS No. 123R using the modified prospective transition method, and our combined and consolidated financial statements at and for the year ended December 31, 2006 reflect the impact of SFAS No. 123R. In accordance with the modified prospective transition method, our combined and consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123R. Stock-based compensation expense recognized under SFAS No. 123R for the year ended December 31, 2006 was $4.9 million, which was primarily related to stock options, restricted stock, restricted stock units and the discount on employee stock purchases. Stock-based compensation expense, recorded in accordance with APB Opinion No. 25, for the years ended December 31, 2005 and 2004 was $2.6 million and $0.3 million, respectively, which was primarily related to restricted stock, restricted stock units and charges for shares issued with grant prices below fair value for Classmates Online.
SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the grant date using an option-pricing model. Under SFAS No. 123, Accounting for Stock-Based Compensation, we used the Black-Scholes option-pricing model for valuation of share-based awards for our pro forma information. Upon adoption of SFAS No. 123R, we elected to continue to use the Black-Scholes option-pricing model for valuing awards. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our combined and consolidated statements of operations. Prior to the adoption of SFAS No. 123R, we accounted for share-based awards to employees and directors using the intrinsic value method in accordance with APB Opinion No. 25 as allowed under SFAS No. 123. Under the intrinsic value method, no stock-based compensation expense related to stock options had been recognized in our combined and consolidated statements of operations, other than as related to acquisitions, because the exercise price of stock options granted to our employees and directors equaled the fair value of the underlying stock at the grant date.
Stock-based compensation expense recognized subsequent to the adoption of SFAS No. 123R on January 1, 2006 is based on the value of the portion of share-based payment awards that is ultimately expected to vest. SFAS No. 123R requires forfeitures to be estimated at the time of grant in order to calculate the amount of share-based awards that will ultimately vest. The forfeiture rate is based on historical rates for UOL which we do not believe would be materially different for us. Stock-based compensation expense recognized in our combined and consolidated statement of operations for the year ended December 31, 2006 includes compensation expense for share-based payment awards granted prior to, but not vested at, December 31, 2005 based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. As stock-based compensation expense recognized in the combined and consolidated statement of operations for the year ended December 31, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. For the periods prior to January 1, 2006, we accounted for forfeitures as they occurred. Accordingly, a pretax cumulative effect of accounting change adjustment totaling $0.3 million ($0.2 million, net of tax) was recorded upon adoption to adjust for awards granted prior to January 1, 2006 that are not ultimately expected to vest.
Prior to the adoption of SFAS No. 123R, we recognized stock-based compensation expense for awards with graded vesting by treating each vesting tranche as a separate award and recognizing compensation expense ratably for each tranche. For equity awards granted subsequent to the adoption of SFAS No. 123R, we treat such awards as a single award and recognize stock-based compensation expense on a straight-line basis (net of estimated forfeitures) over the employee service period.
50
Long-Lived Assets
We account for long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment and disposition of long-lived assets. We evaluate the recoverability of long-lived assets, other than indefinite-lived intangible assets, for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events and circumstances that may indicate that an asset is impaired include significant decreases in the market value of an asset, significant underperformance relative to expected historical or projected future results of operations, a change in the extent or manner in which an asset is used, shifts in technology, loss of key management or personnel, changes in our operating model or strategy and competitive forces.
Property and equipment are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which is generally two to three years for computer software and equipment and three to seven years for furniture, fixtures and office equipment. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful lives. Upon the sale or retirement of property or equipment, the cost and related accumulated depreciation or amortization is removed from our financial statements with the resulting gain or loss reflected in our results of operations. Repairs and maintenance costs are expensed as incurred.
Definite-lived identifiable intangible assets are amortized over their estimated useful lives, ranging from two to ten years. Our intangible assets were acquired in connection with business combinations.
Goodwill
Goodwill represents the excess of the cost of an acquired entity over the fair value of the acquired net assets. We account for goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, which among other things, addresses financial accounting and reporting requirements for acquired goodwill and other intangible assets. SFAS No. 142 requires goodwill to be carried at cost, prohibits the amortization of goodwill and requires us to test goodwill for impairment at least annually. We perform an impairment test of our goodwill annually during the fourth quarter of our fiscal year or when events and circumstances change that would more likely than not indicate that goodwill might be permanently impaired. Events or circumstances which could trigger an impairment review include a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends or significant underperformance relative to expected historical or projected future results of operations.
The testing for a potential impairment of goodwill involves a two-step process. The first step of the impairment test involves comparing the estimated fair values of our reporting units with their respective book values, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired and no additional steps are necessary. If, however, the fair value of the reporting unit is less than book value, then the carrying amount of the goodwill is compared with its implied fair value. The estimate of implied fair value of goodwill may require independent valuations of certain internally generated and unrecognized intangible assets such as our pay account base, software, technology, patents and trademarks. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss would be recognized in an amount equal to the excess. We have not recognized any impairment losses since the date of our inception.
51
Business Combinations
Acquisitions are accounted for as purchase business combinations. Under the purchase method of accounting, the cost, including transaction costs, is allocated to the underlying net assets, based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.
The judgments made in determining the estimated fair value and expected useful lives assigned to each class of assets and liabilities acquired can significantly impact net income. Consequently, to the extent an indefinite-lived or a longer-lived asset is ascribed greater value under the purchase method than a shorter-lived asset, there may be less amortization recorded in a given period. Finite-lived identifiable intangible assets are amortized on either a straight-line basis or an accelerated basis. We determine the appropriate amortization method by performing an analysis of expected cash flows over the estimated useful life of the asset and match the amortization expense to the expected cash flows from the asset.
Determining the fair value of certain assets and liabilities acquired is subjective in nature and often involves the use of significant estimates and assumptions. Two areas in particular that require significant judgment are estimating the fair value and related useful lives of identifiable intangible assets. To assist in this process, we may obtain appraisals from valuation specialists for certain intangible assets. While there are a number of different methods used in estimating the value of acquired intangibles, there are two approaches primarily used: the discounted cash flow and market comparison approaches. Some of the more significant estimates and assumptions inherent in the two approaches include: projected future cash flows (including timing); discount rate reflecting the risk inherent in the future cash flows; perpetual growth rate; subscriber churn and terminal value; determination of appropriate market comparables; and the determination of whether a premium or a discount should be applied to comparables. Most of the above assumptions are made based on available historical information.
Member Redemption Liability for Loyalty Marketing Points
Member redemption liability represents the estimated costs associated with MyPoints' obligation to redeem outstanding points accumulated by its loyalty marketing members, less an allowance for points expected to expire prior to redemption. MyPoints members may redeem points for third-party gift cards and other benefits. Members earn points when they respond to direct marketing offers delivered by MyPoints, purchase goods from advertisers or engage in other specified activities. MyPoints is liable for providing rewards when members seek to redeem accumulated points upon reaching required redemption thresholds. The member redemption liability is estimated based upon a weighted-average cost of points that may be redeemed in the future. The liability is based upon historical redemption costs and our management's estimate of future trends. We reserve the right to cancel or disable accounts and expire unredeemed points in accounts that are inactive for a period of twelve consecutive months. For purposes of member redemption liability, "inactive" means a lack of any of the following: Web site visit; email response; survey completion; profile update; or any point-earning or point-spending transaction. We base our estimate of points that will not be redeemed on an analysis of historical point earning trends, redemption activity and the number of individual member accounts. This analysis is updated quarterly.
Allocated Costs
The combined and consolidated statements of operations include our direct expenses as well as allocated corporate expenses and costs of UOL relating to management, sales, marketing, product development, administrative, including finance and accounting, legal, human resources and facilities management and other services. These expenses and cost allocations have been determined on a basis
52
that we and UOL consider to be a reasonable reflection of the utilization of services provided to, or benefits received by, us. The allocations were based on our proportionate revenues compared to total revenues of UOL and usage of services. Going forward, we expect these costs to be allocated in accordance with intercompany agreements between us and UOL. For a description of the agreements we will enter into with UOL, see "Certain Relationships and Related Party Transactions—Relationship with United Online, Inc."
Income Taxes
Income taxes are accounted for under SFAS No. 109, Accounting for Income Taxes, and have been prepared on the separate-return basis in our accompanying financial statements. Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.
The computation of limitations relating to the amount of such tax assets, and the determination of appropriate valuation allowances relating to realizability of such assets, are inherently complex and require the exercise of judgment. As additional information becomes available, we continually assess the carrying value of our net deferred tax assets. Going forward, we expect our tax assets and liabilities to be governed by the tax sharing agreement between us and UOL.
We file income taxes as part of a consolidated group with UOL. For purposes of the accompanying financial statements, the provision for (or benefit from) income taxes has been computed as if we were a stand-alone corporate tax payer, in accordance with GAAP. Current income tax expense (or benefit) is settled with UOL through intercompany cash transfers. Deferred tax assets receivable from, or deferred tax liabilities payable to, UOL will be settled with UOL in a future period when current income taxes would be due on a stand-alone basis. Such amounts are reflected in the accompanying balance sheet as deferred tax assets and liabilities. We will enter into a tax sharing agreement with UOL to be effective upon consummation of this offering.
Transactions with United Online, Inc.
In connection with this offering, we will enter into certain agreements with UOL governing the ongoing relationships between us and UOL. These agreements will include:
The agreements referred to above will be filed as exhibits to the registration statement of which this prospectus is a part. We encourage you to read the full text of these material agreements. We will continue to receive services from UOL pursuant to intercompany agreements and will be allocated our share of corporate expenses and costs under methods similar to those used in the preparation of the
53
accompanying financial statements. The amounts recorded for these services are not necessarily representative of the amounts that would have been reflected in our financial statements had we been an entity that operated independent of UOL.
Results of Operations
The following table sets forth for the periods presented selected historical statements of operations data. The information contained in the table below should be read in conjunction with "—Liquidity and Capital Resources" and "—Critical Accounting Policies, Estimates and Assumptions" as well as our combined and consolidated financial statements and notes thereto.
Quarter Ended March 31, 2007 Compared to Quarter Ended March 31, 2006
| |
Quarter Ended March 31, |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| |
2007 |
2006 |
||||||||
| |
(unaudited) |
|||||||||
| Billable services | $ | 22,227 | $ | 19,103 | ||||||
| Advertising | 20,207 | 6,068 | ||||||||
| Total revenues | 42,434 | 25,171 | ||||||||
| Operating expenses: | ||||||||||
| Cost of revenues | 9,394 | 3,443 | ||||||||
| Sales and marketing | 20,465 | 11,351 | ||||||||
| Product development | 3,703 | 2,289 | ||||||||
| General and administrative | 6,466 | 5,686 | ||||||||
| Amortization of intangible assets | 2,848 | 3,020 | ||||||||
| Total operating expenses | 42,876 | 25,789 | ||||||||
| Loss from operations | (442 | ) | (618 | ) | ||||||
| Interest and other income (expense), net | 24 | (30 | ) | |||||||
| Interest expense | (114 | ) | (8 | ) | ||||||
| Loss before income taxes | (532 | ) | (656 | ) | ||||||
| Provision (benefit) for income taxes | (282 | ) | 230 | |||||||
| Loss before cumulative effect of accounting change | (250 | ) | (886 | ) | ||||||
| Cumulative effect of accounting change, net of tax | — | 183 | ||||||||
| Net loss | $ | (250 | ) | $ | (703 | ) | ||||
Revenues
Billable Services Revenues. Billable services revenues consist of subscription fees charged for our social networking pay services. Billable services revenues are primarily dependent on the number of paying subscribers and the monthly price paid to us for our services, which pricing varies based on the term of our plans and the mix of our plans between domestic and international. Longer term plans and international plans are typically lower priced.
Billable services revenues increased by $3.1 million, or 16%, to $22.2 million for the quarter ended March 31, 2007, compared to $19.1 million for the quarter ended March 31, 2006. The increase in billable services revenues was due to a 24% increase in our average number of pay accounts from 1,855,000 for the quarter ended March 31, 2006 to 2,301,000 for the quarter ended March 31, 2007. This increase in the number of pay accounts was primarily attributable to the introduction of a new pay feature by Classmates in the fourth quarter of 2006. The increase in billable services revenues was
54
partially offset by a 6% decrease in ARPU from $3.43 for the quarter ended March 31, 2006 to $3.22 for the quarter ended March 31, 2007. The decrease in ARPU was attributable to a greater percentage of international pay accounts.
Advertising Revenues. Advertising revenues from our social networking services consist primarily of fees generated from the display of third-party registration offers at the end of our pay account registration process, other display advertisements and referring members to third-party Web sites or services. Advertising revenues from our loyalty marketing service consist primarily of fees generated when emails are transmitted to members, when members respond to emails and when members complete online transactions. Factors impacting our advertising revenues generally include fluctuations in revenues related to significant customers, the performance of our online advertising initiatives, the state of the online advertising markets, prevailing advertising rates, seasonality, increases or decreases in our active accounts and changes in their behavior on our services such as increased page views, and increases or decreases in advertising inventory available for sale.
Advertising revenues increased by $14.1 million, or 233%, to $20.2 million for the quarter ended March 31, 2007, compared to $6.1 million for the quarter ended March 31, 2006. The increase was due to revenues from our loyalty marketing service, which we acquired in April 2006, partially offset by a decline in advertising revenues generated from our social networking services. As a result of our decision in the second quarter of 2006 to enhance the user experience by significantly decreasing the number of advertising placements on our Classmates Web site, advertising revenues for our social networking services were adversely impacted. This decrease in advertising revenues was partially offset by increased revenues from our post-transaction sales partner as a result of pay account growth in the quarter ended March 31, 2007.
Cost of Revenues
Cost of revenues includes the cost of providing rewards to our loyalty marketing members; data center costs; personnel and overhead-related costs associated with the operation, licensing, support and maintenance of our internal networks, data centers, non-capitalized software and hardware; and depreciation of network computers and equipment. Cost of revenues also includes fees associated with the storage and processing of customer credit cards and associated bank fees as well as personnel-related expenses associated with creating, testing, delivering and monitoring our email and Web campaigns. Historically, the costs that comprise our costs of revenues were relatively fixed. However, as a result of our loyalty marketing service, these costs have become more variable and increased significantly as a percentage of revenues.
Cost of revenues increased by $6.0 million, or 173%, to $9.4 million, or 22.1% of revenues, for the quarter ended March 31, 2007, compared to $3.4 million, or 13.7% of revenues, for the quarter ended March 31, 2006. The increase was primarily related to costs associated with our loyalty marketing service which was acquired in April 2006 and, to a lesser extent, increased costs associated with our social networking services. As a percentage of revenues, cost of revenues increased primarily due to our loyalty marketing service which has a higher cost of revenues as a percentage of revenues as compared to our social networking services.
Sales and Marketing
Sales and marketing expenses include expenses associated with acquiring new free members and generating advertising revenues. Expenses associated with acquiring new free members include fees paid to third-party advertising networks and co-registration partners to acquire new accounts, online advertising expenses and personnel-related expenses for marketing personnel. Most of our sales and marketing expenses are fees paid to third parties for the successful registration of new free members.
55
Expenses associated with generating advertising revenues include sales commissions and personnel-related expenses for sales personnel.
Sales and marketing expenses increased by $9.1 million, or 80%, to $20.5 million, or 48.2% of revenues, for the quarter ended March 31, 2007, compared to $11.4 million, or 45.1% of revenues, for the quarter ended March 31, 2006. The increase was primarily the result of costs associated with our loyalty marketing service which we acquired in April 2006, a $2.6 million increase in marketing costs related to acquiring new free social networking members and a $0.7 million increase in personnel and overhead-related expenses related to our social networking services.
Product Development
Product development expenses include expenses for the maintenance of existing software and technology and the development of new or improved software and technology, including personnel-related expenses for the software engineering, quality assurance and product and project management departments. Costs incurred by us to manage, monitor and operate our services are generally expensed as incurred, except for certain costs relating to the acquisition and development of internal-use software, which are capitalized and depreciated over their estimated useful lives, generally three years or less.
Product development expenses increased by $1.4 million, or 62%, to $3.7 million, or 8.7% of revenues, for the quarter ended March 31, 2007, compared to $2.3 million, or 9.1% of revenues, for the quarter ended March 31, 2006. The increase in expenses was primarily due to increases in personnel-related expenses due to increased headcount related to our social networking services and headcount associated with our loyalty marketing service which we acquired in April 2006.
General and Administrative
General and administrative expenses include personnel-related expenses for executive, finance, legal, human resources, facilities and customer support. In addition, general and administrative expenses include professional fees for legal, accounting and financial services; recruiting; customer relationship management services; non-income taxes; insurance; bad-debt expense; occupancy; and other overhead-related costs.
General and administrative expenses increased by $0.8 million, or 14%, to $6.5 million, or 15.2% of revenues, for the quarter ended March 31, 2007, compared to $5.7 million, or 22.6% of revenues, for the quarter ended March 31, 2006. The increase was primarily due to compensation costs, facilities costs and other overhead-related costs associated with our loyalty marketing service which we acquired in April 2006, partially offset by decreases in facilities and other overhead-related costs, consulting fees and compensation costs related to our social networking services and a $0.4 million decrease in stock-based compensation expense primarily related to forfeitures of previously expensed stock awards.
Amortization of Intangible Assets
Amortization of intangible assets includes amortization of acquired pay accounts and free accounts, acquired trademarks and trade names, purchased technologies and other identifiable intangible assets. In accordance with the provisions of SFAS No. 142, goodwill is not being amortized but is tested for impairment at a reporting unit level on an annual basis and between annual tests if an event occurs or circumstances change that would indicate the fair value of a reporting unit is below its carrying value amount. We determine the appropriate amortization method by performing an analysis of expected cash flows over the estimated useful life of the asset and matching the amortization expense to the expected economic benefit to be received from the asset.
56
Amortization of intangible assets decreased by $0.2 million, or 6%, to $2.8 million for the quarter ended March 31, 2007, compared to $3.0 million for the quarter ended March 31, 2006. The decrease was primarily attributable to a higher level of amortization of intangible assets in the quarter ended March 31, 2006 associated with the Classmates Online acquisition, partially offset by increased amortization related to intangible assets acquired in connection with the MyPoints acquisition in April 2006. Certain of the acquired intangible assets were amortized on an accelerated basis to better match the patterns of economic benefits received.
Interest and Other Income (Expense), Net
Interest income consists of earnings on our cash and cash equivalents. Other income and expense, net consists of equity earnings on investments in subsidiaries and exchange rate gains and losses.
Interest and other income, net increased by $54,000 to $24,000 for the quarter ended March 31, 2007, compared to ($30,000) for the quarter ended March 31, 2006.
Interest Expense
Interest expense consists of interest expense on capital leases and imputed interest on the acquired member redemption liability.
Interest expense increased by $92,000 to $0.1 million for the quarter ended March 31, 2007, compared to $8,000 for the quarter ended March 31, 2006.
Provision for Income Taxes
For the quarter ended March 31, 2007, we recorded a tax benefit of $0.3 million on pre-tax loss of $0.5 million, resulting in an effective tax rate of 53.0%. For the quarter ended March 31, 2006, we recorded a tax provision of $0.2 million on pre-tax loss of $0.7 million, resulting in a negative effective tax rate of 35.0%. The effective tax rates differ from the statutory rate primarily due to foreign losses, the benefit of which was not recognizable due to uncertainty regarding realization.
Cumulative Effect of Accounting Change, Net of Tax
In the quarter ended March 31, 2006, we recorded a $0.3 million pretax benefit ($0.2 million, net of tax) as the cumulative effect of a change in accounting principle upon the adoption of SFAS No. 123R, to recognize the effect of estimating the number of stock-based awards granted prior to January 1, 2006 that are not ultimately expected to vest.
Years Ended December 31, 2006 and 2005 and Combined Year Ended December 31, 2004
The following table sets forth for the periods presented selected historical statements of operations data. The information contained in the table below should be read in conjunction with "—Liquidity and Capital Resources" and "—Critical Accounting Policies, Estimates and Assumptions" as well as our combined and consolidated financial statements and notes thereto.
57
Unless otherwise indicated, references to our 2004 operating results refer to the combined year ended December 31, 2004, as more fully explained in footnote 1 below.
| |
|
|
|
|
Period from January 1, 2004 (last date prior to acquisition by UOL) through November 16, 2004 |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
|
|
|
Period from November 17, 2004 (date of inception) through December 31, 2004 |
||||||||||||||
| |
Year Ended December 31, |
|
||||||||||||||||
| |
Combined Year Ended December 31, 2004(1) |
|||||||||||||||||
| |
2006 |
2005 |
||||||||||||||||
| Billable services | $ | 81,146 | $ | 63,550 | $ | 54,861 | $ | 6,471 | $ | 48,390 | ||||||||
| Advertising | 58,300 | 21,342 | 18,404 | 2,159 | 16,245 | |||||||||||||
| Total revenues | 139,446 | 84,892 | 73,265 | 8,630 | 64,635 | |||||||||||||
| Operating expenses: | ||||||||||||||||||
| Cost of revenues | 29,853 | 13,035 | 14,638 | 1,620 | 13,018 | |||||||||||||
| Sales and marketing | 60,782 | 43,184 | 32,886 | 3,604 | 29,282 | |||||||||||||
| Product development | 11,857 | 6,883 | 8,511 | 771 | 7,740 | |||||||||||||
| General and administrative | 25,217 | 16,907 | 11,223 | 1,686 | 9,537 | |||||||||||||
| Amortization of intangible assets | 12,731 | 16,388 | 3,326 | 3,256 | 70 | |||||||||||||
| Total operating expenses | 140,440 | 96,397 | 70,584 | 10,937 | 59,647 | |||||||||||||
| Income (loss) from operations | (994 | ) | (11,505 | ) | 2,681 | (2,307 | ) | 4,988 | ||||||||||
| Interest and other income (expense), net | (81 | ) | 24 | 202 | — | 202 | ||||||||||||
| Interest expense | (492 | ) | (49 | ) | — | — | — | |||||||||||
| Income (loss) before income taxes | (1,567 | ) | (11,530 | ) | 2,883 | (2,307 | ) | 5,190 | ||||||||||
| Provision (benefit) for income taxes | 549 | (3,339 | ) | 1,551 | (621 | ) | 2,172 | |||||||||||
| Income (loss) before cumulative effect of accounting change | (2,116 | ) | (8,191 | ) | 1,332 | (1,686 | ) | 3,018 | ||||||||||
| Cumulative effect of accounting change, net of tax | 183 | — | — | — | — | |||||||||||||
| Net income (loss) | $ | (1,933 | ) | $ | (8,191 | ) | $ | 1,332 | $ | (1,686 | ) | $ | 3,018 | |||||
58
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Revenues
Billable Services Revenues. Billable services revenues increased by $17.6 million, or 28%, to $81.1 million for the year ended December 31, 2006, compared to $63.6 million for the year ended December 31, 2005. The increase in billable services revenues was due to a 22% increase in our average number of pay accounts from 1,616,000 for the year ended December 31, 2005 to 1,967,000 for the year ended December 31, 2006. The increase in pay accounts was primarily attributable to organic growth in our Classmates business and, to a lesser extent, the acquisition of pay accounts associated with the acquisition of The Names Database in March 2006, which had approximately 58,000 pay accounts at the time of the acquisition. Additionally, billable services revenues increased due to a 5% increase in ARPU from $3.28 for the year ended December 31, 2005 to $3.44 for the year ended December 31, 2006 due to a greater percentage of higher-priced, shorter-term pay subscription plans.
Advertising Revenues. Advertising revenues increased by $37.0 million, or 173%, to $58.3 million for the year ended December 31, 2006, compared to $21.3 million for the year ended December 31, 2005. The increase was due to revenues from our loyalty marketing service, which we acquired in April 2006, partially offset by a decline in advertising revenues generated from our social networking services. As a result of our decision in the second quarter of 2006 to enhance the user experience by significantly decreasing the number of advertising placements on our social networking Web sites, advertising revenues for our social networking services were adversely impacted.
Cost of Revenues
Cost of revenues increased by $16.8 million, or 129%, to $29.9 million, or 21.4% of revenues, for the year ended December 31, 2006, compared to $13.0 million, or 15.4% of revenues, for the year ended December 31, 2005. The increase was primarily related to costs associated with our loyalty marketing service which was acquired in April 2006 and, to a lesser extent, increased costs associated with our social networking services and a $0.2 million increase in stock-based compensation in connection with the adoption of SFAS No. 123R in the quarter ended March 31, 2006. As a percentage of revenues, cost of revenues increased primarily due to our loyalty marketing service which has a higher cost of revenues as a percentage of revenues as compared to our social networking services.
Sales and Marketing
Sales and marketing expenses increased by $17.6 million, or 41%, to $60.8 million, or 43.6% of revenues, for the year ended December 31, 2006, compared to $43.2 million, or 50.9% of revenues, for the year ended December 31, 2005. The increase was primarily related to costs associated with our loyalty marketing service which was acquired in April 2006, and, to a lesser extent, a $2.8 million increase in marketing costs related to acquiring new free social networking members, a $2.0 million increase in personnel and overhead-related expenses related to our social networking services and a $0.6 million increase in stock-based compensation in connection with the adoption of SFAS No. 123R in the quarter ended March 31, 2006.
Product Development
Product development expenses increased by $5.0 million, or 72%, to $11.9 million, or 8.5% of revenues, for the year ended December 31, 2006, compared to $6.9 million, or 8.1% of revenues, for the year ended December 31, 2005. The increase in expenses was primarily due to a $2.5 million increase in personnel-related expenses due to increased headcount related to our social networking services, headcount associated with our loyalty marketing service which we acquired in April 2006, and a $0.5 million increase in stock-based compensation in connection with the adoption of SFAS No. 123R in the quarter ended March 31, 2006.
59
General and Administrative
General and administrative expenses increased by $8.3 million, or 49%, to $25.2 million, or 18.1% of revenues, for the year ended December 31, 2006, compared to $16.9 million, or 19.9% of revenues, for the year ended December 31, 2005. The increase was primarily due to compensation costs, consulting fees, facilities costs and other overhead-related costs associated with our loyalty marketing service which we acquired in April 2006, a $1.6 million increase in depreciation of fixed assets and a $0.9 million increase in stock-based compensation expense in connection with the adoption of SFAS No. 123R in the quarter ended March 31, 2006. The increase was partially offset by a $0.9 million decrease in compensation costs associated with our social networking services.
Amortization of Intangible Assets
Amortization of intangible assets decreased by $3.7 million, or 22%, to $12.7 million for the year ended December 31, 2006, compared to $16.4 million for the year ended December 31, 2005. The decrease was primarily attributable to a higher level of amortization of intangible assets in the year ended December 31, 2005 associated with the Classmates Online acquisition, partially offset by increased amortization related to intangible assets acquired in connection with the acquisitions of The Names Database in March 2006 and MyPoints in April 2006.
Interest and Other Income, Net
Interest and other income, net decreased by $0.1 million to ($0.1 million) for the year ended December 31, 2006, compared to $24,000 for the year ended December 31, 2005.
Interest Expense
Interest expense increased by $0.4 million to $0.5 million for the year ended December 31, 2006, compared to $49,000 for the year ended December 31, 2005. The increase was primarily the result of imputed interest on the acquired member redemption liability.
Provision for Income Taxes
For the year ended December 31, 2006, we recorded a tax provision of $0.5 million on pre-tax loss of $1.6 million, resulting in a negative effective tax rate of 35.0%. The effective tax rate differs from the statutory rate primarily due to foreign losses, the benefit of which was not recognizable due to uncertainty regarding realization and to a lesser extent by the impact of stock-based compensation and the result of tax examinations concluded in 2006.
For the year ended December 31, 2005, we recorded a tax benefit of $3.3 million on pre-tax loss of $11.5 million, resulting in an effective tax rate of 29.0%. The effective tax rate differs from the statutory rate primarily due to foreign losses, the benefit of which was not recognizable due to uncertainty regarding realization.
At December 31, 2006, we had foreign net operating loss carryforwards of approximately $6.1 million.
Cumulative Effect of Accounting Change, Net of Tax
In the year ended December 31, 2006, we recorded a $0.3 million pretax benefit ($0.2 million, net of tax) as the cumulative effect of a change in accounting principle upon the adoption of SFAS No. 123R to recognize the effect of estimating the number of awards granted prior to January 1, 2006 that are not ultimately expected to vest.
60
Year Ended December 31, 2005 Compared to Combined Year Ended December 31, 2004
Information presented in the discussions below that relates to our 2004 operating results is presented for a combined twelve-month period ended December 31, 2004, which is the sum of the financial data for Classmates Online (predecessor) for the period from January 1, 2004 through November 16, 2004 and our financial data for the period from November 17, 2004 through December 31, 2004. These combined financial results are for informational purposes only and do not purport to be a presentation in accordance with GAAP or to represent what our results of operations would have actually been in such period.
Revenues
Billable Services Revenues. Billable services revenues increased by $8.7 million, or 16%, to $63.6 million for the year ended December 31, 2005, compared to $54.9 million for the year ended December 31, 2004. The increase in billable services revenues was due to a 2% increase in our average number of pay accounts from 1,590,000 for the year ended December 31, 2004 to 1,616,000 for the year ended December 31, 2005. The increase was primarily due to an increase in pay accounts and an increase in ARPU due to a greater percentage of higher-priced, shorter-term pay subscription plans. Additionally, had the adjustments mentioned in footnote 1 to the table above been applied on a pro forma basis, there would have been a $2.0 million decrease in billable services revenue in the year ended December 31, 2004 related to a reduction in revenue related to a fair value adjustment to our acquired deferred revenue balance in connection with the Classmates Online acquisition.
Advertising Revenues. Advertising revenues increased by $2.9 million, or 16%, to $21.3 million for the year ended December 31, 2005, compared to $18.4 million for the year ended December 31, 2004. The increase was primarily due to an increase in post-transaction revenues.
Cost of Revenues
Cost of revenues decreased by $1.6 million, or 11%, to $13.0 million, or 15.4% of revenues, for the year ended December 31, 2005, compared to $14.6 million, or 20.0% of revenues, for the year ended December 31, 2004. The decrease was primarily related to a $1.6 million decrease in personnel-related expenses and a $1.0 million decrease in depreciation, partially offset by a $1.2 million increase in customer support and billing-related costs. Additionally, had the adjustments mentioned in footnote 1 to the table been applied on a pro forma basis, depreciation would have increased by $1.8 million for the year ended December 31, 2004.
Sales and Marketing
Sales and marketing expenses increased by $10.3 million, or 31%, to $43.2 million, or 50.9% of revenues, for the year ended December 31, 2005, compared to $32.9 million, or 44.9% of revenues, for the year ended December 31, 2004. The increase was primarily due to a $7.4 million increase in expenses related to marketing costs related to acquiring new free social networking members and a $2.8 million increase in personnel and overhead-related expenses.
Product Development
Product development expenses decreased by $1.6 million, or 19%, to $6.9 million, or 8.1% of revenues, for the year ended December 31, 2005, compared to $8.5 million, or 11.6% of revenues, for the year ended December 31, 2004. The decrease in expenses was primarily due to a $1.8 million decrease in personnel-related expenses, partially offset by a $0.3 million increase in depreciation.
61
General and Administrative
General and administrative expenses increased by $5.7 million, or 51%, to $16.9 million, or 19.9% of revenues, for the year ended December 31, 2005, compared to $11.2 million, or 15.3% of revenues, for the year ended December 31, 2004. The increase was primarily due to a $4.0 million increase in compensation costs, a $2.0 million increase in stock-based compensation expense in connection with the issuance of restricted stock units in 2005 and a $0.6 million increase in facilities costs and other overhead-related costs, partially offset by a $0.8 million decrease in consulting fees.
Amortization of Intangible Assets
Amortization of intangible assets increased by $13.1 million to $16.4 million for the year ended December 31, 2005, compared to $3.3 million for the year ended December 31, 2004. The increase was due to a higher level of amortization of intangible assets in the year ended December 31, 2004 associated with the acquisition of Classmates Online. Additionally, had the adjustments mentioned in footnote 1 to the table been applied on a pro forma basis, there would have been an additional $14.1 million of amortization of intangible assets recorded in the year ended December 31, 2004.
Interest and Other Income, Net
Interest and other income, net decreased by $0.2 million to $24,000 for the year ended December 31, 2005, compared to $0.2 million for the year ended December 31, 2004, as a result of significantly lower cash balances due to the transfer of the majority of our cash to UOL.
Interest Expense
Interest expense was $49,000 for the year ended December 31, 2005. There was no interest expense for the year ended December 31, 2004.
Provision for Income Taxes
For the year ended December 31, 2005, we recorded a tax benefit of $3.3 million on pre-tax loss of $11.5 million, resulting in an effective tax rate of 29.0%. For the year ended December 31, 2004, we recorded a tax provision of $1.6 million on pre-tax income of $2.9 million, resulting in an effective tax rate of 53.8%. The effective tax rates differ from the statutory rate primarily due to foreign losses, the benefit of which was not recognizable due to uncertainty regarding realization.
Liquidity and Capital Resources
Our summary cash flows for the quarters ended March 31, 2007 and 2006, the years ended December 31, 2006 and 2005 and for the period from November 17, 2004 (date of inception) through December 31, 2004 were as follows (in thousands):
| |
Quarter Ended March 31, |
Year Ended December 31, |
|
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
November 17, 2004 (date of inception) through December 31, 2004 |
|||||||||||||||
| |
2007 |
2006 |
2006 |
2005 |
||||||||||||
| Net cash provided by (used for) operating activities | $ | 10,389 | $ | 8,554 | $ | 25,135 | $ | 26,794 | $ | (1,200 | ) | |||||
| Net cash used for investing activities | (891 | ) | (12,117 | ) | (69,948 | ) | (4,848 | ) | (98,315 | ) | ||||||
| Net cash provided by (used for) financing activities | (8,590 | ) | 1,560 | 43,673 | (18,718 | ) | 101,162 | |||||||||
Cash necessary for our initial capitalization and subsequent acquisitions was provided by us to UOL in the form of capital contributions. Cash generated by us, offset by costs for management and shared administrative services which were allocated to us from UOL, was transferred to UOL in
62
accordance with UOL's centralized treasury practices. The net amount transferred from, or distributed to, UOL was accounted for as a contribution from, or distribution to, UOL. We intend to use a portion of the net proceeds of this offering to repay $50.0 million of notes payable to UOL. See "Use of Proceeds."
Net Cash Provided by (Used for) Operating Activities
Our working capital is affected by changes in the number of pay accounts in a period, changes in the mix of our billing plans, the timing of new pay accounts and renewals related to our online social networking services and the timing of cash receipts and payments at each period end relating to items such as receipts from customers and payments made to vendors, as well as the seasonality within our business.
Net cash provided by operating activities increased by $1.8 million in the quarter ended March 31, 2007, compared to the quarter ended March 31, 2006 primarily as a result of an increase in working capital account changes.
Net cash provided by operating activities decreased by $1.7 million in the year ended December 31, 2006, compared to the year ended December 31, 2005. A $12.3 million decrease in working capital in the year ended December 31, 2006 compared to the year ended December 31, 2005 was partially offset by a $6.3 million reduction in net loss and a $4.3 million increase in non-cash charges in 2006 compared to 2005. Working capital decreased in 2006 compared to 2005 primarily as a result of a smaller increase in deferred revenue, a reduction in accounts payable and accrued liabilities, an increase in accounts receivable due to increased revenues and an increase in other assets.
Net cash provided by operating activities increased by $28.0 million for the year ended December 31, 2005, compared to the period from November 17, 2004 (date of inception) through December 31, 2004. The increase was primarily the result of a $16.6 million increase in working capital and a $17.9 million increase in non-cash expenses in 2005, partially offset by a $6.5 million decrease in net loss. Working capital increased primarily as a result of an increase in deferred revenue and accounts payable and accrued liabilities in 2005 compared to 2004.
Net Cash Used for Investing Activities
Net cash used for investing activities decreased by $11.2 million for the quarter ended March 31, 2007, compared to the quarter ended March 31, 2006. The decrease was primarily the result of $9.5 million, net of cash acquired, paid for the acquisition of The Names Database in March 2006 and a $1.7 million decrease in purchases of property and equipment in the quarter ended March 31, 2007, compared to the quarter ended March 31, 2006.
Net cash used for investing activities increased by $65.1 million for the year ended December 31, 2006, compared to the year ended December 31, 2005. The increase was primarily the result of $9.5 million, net of cash acquired, paid for the acquisition of The Names Database in March 2006, $49.5 million, net of cash acquired, paid for the acquisition of MyPoints in April 2006, $0.6 million, net of cash acquired, paid for the acquisition of Trombi in August 2006 and a $5.4 million increase in purchases of property and equipment in the year ended December 31, 2006, compared to the year ended December 31, 2005.
Net cash used for investing activities decreased by $93.5 million in the year ended December 31, 2005, compared to the period from November 17, 2004 (date of inception) through December 31, 2004 as a result of $98.2 million, net of cash acquired, paid for the acquisition of Classmates Online in November 2004, partially offset by an increase of $4.7 million in purchases of property and equipment in the year ended December 31, 2005, compared to the period from November 17, 2004 (date of inception) through December 31, 2004.
63
Net Cash Provided by (Used for) Financing Activities
Net cash used for financing activities was $8.6 million for the quarter ended March 31, 2007, compared to net cash provided by financing activities of $1.6 million for the quarter ended March 31, 2006. In the March 2007 quarter, we transferred cash to UOL to be centrally managed by UOL. In the March 2006 quarter, UOL contributed $9.5 million of capital to us for the acquisition of The Names Database, and we transferred $7.9 million to UOL to be centrally managed.
Net cash provided by financing activities was $43.7 million for the year ended December 31, 2006, compared to net cash used for financing activities of $18.7 million for the year ended December 31, 2005. The difference of $62.4 million was due to $56.6 million in contributed capital from UOL related to the MyPoints acquisition in 2006 and a $5.8 million decrease in cash transferred to UOL to be centrally managed in 2006 compared to 2005.
Net cash used for financing activities for the year ended December 31, 2005 was $18.7 million of which $18.1 million represented cash transferred to UOL to be centrally managed. In the period from November 17, 2004 (date of inception) through December 31, 2004, UOL contributed $98.2 million to us for the acquisition of Classmates Online and approximately $3.2 million for working capital purposes.
Contractual Obligations
Our financial commitments were as follows at December 31, 2006 (in thousands):
| |
|
Year Ending December 31, |
|
|||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Total |
2007 |
2008 |
2009 |
2010 |
2011 |
Thereafter |
|||||||||||||||
| Capital leases | $ | 32 | $ | 18 | $ | 14 | $ | — | $ | — | $ | — | $ | — | ||||||||
| Operating leases | 3,812 | 1,667 | 1,513 | 632 | — | — | — | |||||||||||||||
| Total | $ | 3,844 | $ | 1,685 | $ | 1,527 | $ | 632 | $ | — | $ | — | $ | — | ||||||||
Seasonality
Advertising revenues have been higher in the fourth quarter and, to a much lesser extent, in the second quarter when compared to the first and third quarters. Seasonality does not have a material affect on our billable services revenues.
Off-Balance Sheet Arrangements
At March 31, 2007, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our combined and consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.
Inflation
Inflation did not have a material impact on our business during the quarter ended March 31, 2007 and the years ended December 31, 2006, 2005 and 2004, and we do not anticipate that inflation will have a material impact on our results of operations for fiscal year 2007.
Recent Accounting Pronouncements
Accounting for Uncertainty in Income Taxes
In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in income tax
64
positions. FIN 48 requires that we recognize, in our combined and consolidated financial statements, the impact of a tax position that is more likely than not to be sustained upon examination based on the technical merits of the position. The provisions of FIN 48 were effective for us at the beginning of the March 2007 quarter, with any cumulative effect of a change in accounting principle recorded as an adjustment to opening retained earnings. The implementation of FIN 48 did not have a material impact on our financial position, results of operations or cash flows.
Effects of Prior Year Misstatements
In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements, in order to address the observed diversity in quantification practices with respect to annual financial statements. There have been two widely-recognized methods for quantifying the effects of financial statement errors: the "roll-over" method and the "iron curtain" method. The roll-over method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. In SAB No. 108, the SEC staff establishes an approach that requires quantification of financial statement errors based on the effects of the error on each of the company's financial statements and the related financial statement disclosures. This model is commonly referred to as a "dual approach" because it essentially requires quantification of errors under both the iron-curtain and the roll-over methods. The implementation of SAB No. 108 did not have a material impact on our financial position, results of operations or cash flows.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which clarifies the definition of fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 will be effective for us on January 1, 2008. We are currently evaluating the impact of adopting SFAS No. 157 on our financial position, results of operations and cash flows.
Fair Value Option
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will be effective for us on January 1, 2008. We are currently evaluating the impact of adopting SFAS No. 159 on our financial position, results of operations and cash flows.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks arising from transactions in the normal course of business, principally risk associated with foreign currency fluctuations.
Foreign Currency Risk
We transact business in different foreign currencies and may be exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly the Euro, which may result in a gain or loss of earnings to us. The volatility of the Euro (and all other applicable currencies) is monitored throughout the year. We face two risks related to foreign currency exchange: translation risk
65
and transaction risk. Amounts invested in our foreign operations are translated into United States dollars using period-end exchange rates. The resulting translation adjustments are recorded as a component of accumulated other comprehensive income (loss) in stockholder's equity. Our foreign subsidiaries generally collect revenues and pay expenses in currencies other than the United States dollar. Since the functional currencies of our foreign operations are denominated in the local currency of our subsidiaries, the foreign currency translation adjustments are reflected as a component of stockholder's equity and do not impact operating results. Revenues and expenses in foreign currencies translate into higher or lower revenues and expenses in United States dollars as the United States dollar weakens or strengthens against other currencies. Therefore, changes in exchange rates may negatively affect our consolidated revenues and expenses (as expressed in United States dollars) from foreign operations. Currency transaction gains or losses arising from transactions in currencies other than the functional currency are included in operating expenses. While we have not engaged in foreign currency hedging, we may in the future use hedging programs, currency forward contracts, currency options and/or other derivative financial instruments commonly utilized to reduce financial market risks if it is determined that such hedging activities are appropriate to reduce risk.
66
Classmates Media Corporation Overview
We operate leading online social networking and loyalty marketing services under our Classmates and MyPoints brands. Our success is driven by our expertise in growing and monetizing large online audiences in a cost-effective manner and enabling advertisers to reach relevant online consumers effectively. Revenues from our social networking services are derived from subscription and advertising fees, and revenues from our loyalty marketing services are derived from advertising fees.
We have built our businesses on the unique characteristics of the Internet, which has transformed the way people express themselves and connect and interact with each other. As Internet usage grows and as new and extensive sources of consumer data become available, online advertising methods are evolving and improving, leading advertisers to increase total advertising spending on the Internet. As a result of these trends, we believe there is a growing opportunity to build and monetize online audiences.
On our social networking Web sites, we enable users to locate and interact with acquaintances from school, work and the military. Led by our flagship Classmates Web site, our social networking properties are comprised of a large and diverse group of users, with over 50 million registered accounts as of June 30, 2007. Social networking pay accounts at December 31, 2005 and 2006, and at June 30, 2007, were 1.8 million, 2.2 million and 2.7 million, respectively. Using our interactive tools and features, our members have contributed to our social networking Web sites a substantial number of distinct, relevant pieces of content, such as names, school affiliations, profiles, biographies, interests and photos. This valuable content is a key component in attracting and retaining members.
MyPoints, our online loyalty marketing service, provides advertisers with an effective means to reach a large online audience with targeted marketing campaigns while also enabling consumers to earn points-based rewards by responding to email offers, completing online surveys, shopping online and engaging in other online activities. During the last year, we marketed the products and services of over 400 advertisers to our MyPoints members, including NetQuote, Inc., Office Depot, Inc., VistaPrint Limited and Waterfront Media, Inc. As of June 30, 2007, over 8.4 million members were registered with MyPoints, over 5.7 million of whom had registered through a double opt-in process to receive email marketing messages from us.
Industry Background
Online Social Networking
Online social networking is rapidly growing and evolving to include a broad spectrum of Web sites and online services. From a category that attracted a relatively small number of users a few years ago, during June 2007, social networking Web sites attracted approximately 464.4 million unique visitors worldwide and an average of 155.4 million daily visitors according to comScore MediaMetrix, an Internet industry research company.
People have a fundamental drive to connect with others, be part of a community, express themselves and maintain personal relationships. Core, life-long relationships are often based on enduring affiliations related to shared experiences such as family, school, workplace or military service. People seek to foster these relationships as well as other meaningful affiliations, such as those based on common interests, hobbies and trends.
Some affiliations, such as those based on school, workplace and the military, encompass large numbers of individuals. According to the United States Census Bureau, as of 2006 there were approximately 186.2 million high school graduates in the United States, and approximately 116.7 million people in the United States had attended college. As of 2006, the United States military and armed
67
forces included more than 24.7 million active members and veterans. As of 2004, there were 1.1 million workplaces with over 500 employees in the United States.
Over time, people frequently lose touch with each other for a variety of reasons including geographic moves and job changes. According to the United States Census Bureau, approximately 39.9 million people relocate and nearly one-third of America's workforce changes jobs each year. In addition, it is estimated by the United States Department of Labor that the average American worker will hold more than 10 jobs by age 40. People looking to reconnect with past friends, colleagues and acquaintances have traditionally interacted through a variety of forums, including alumni associations, clubs, family and class reunions and professional organizations, as well as through various communication channels, including the telephone, postal mail and email. We believe there is a growing trend towards using new mediums of communication that facilitate social interaction and enable individuals to find and connect with friends, family and colleagues.
The Internet has helped bridge boundaries as a new communications platform. Email was an early means by which people communicated on the Internet. However, email by itself does not help people find others with common interests or backgrounds or locate past friends and acquaintances. Online social networking Web sites were developed to facilitate the social interaction of large numbers of individuals and are becoming increasingly popular for socializing with friends, family and colleagues. Widespread adoption of broadband Internet access, digital photography and online video has also served as a catalyst for growth in online social networking, facilitating the sharing of content over the Internet.
Social networking Web sites fulfill a number of different needs, allowing users to find and connect with individuals from their past and interact with new people based on shared interests, goals or other criteria. As such, we believe that social networking users generally choose to participate in and develop affiliations through more than one online social networking service. These Web sites and services are used by individuals to post content about themselves and to comment on the content posted by others. Users of social networking services may interact and communicate through email as well as through a variety of other online forums, including instant messaging, blogging, the posting of pictures and videos, voice chat and discussion groups. Many social networking Web sites and services provide users with tools that enable individuals to identify, build and maintain personal networks from their relevant affiliations.
Many advertisers, recognizing that consumers spend an increasing amount of time online, view social networking Web sites as an attractive marketing medium for their products and services. According to eMarketer, an independent Internet industry research firm, advertising spending on social networking Web sites is expected to increase more than 600%, from $350 million in 2006 to $2.5 billion in 2011 in the United States.
While social networking Web sites have attracted significant online audiences and, as a result, the attention of advertisers, certain aspects of many social networking Web sites pose challenges for advertisers. For example, many branded advertisers want the ability to deliver targeted advertisements to users with certain desirable demographics and demonstrated purchasing ability. However, not all social networking Web sites collect comprehensive demographic data on their members, and many enable users to create "alias" identities whose related profiles may contain incomplete or inaccurate information. In addition, members on social networking Web sites may post forms of user generated content with which advertisers may not want their products or services to be associated.
Many social networking Web sites also face challenges in attracting, retaining and monetizing online audiences. While there is a wide range of online social networking Web sites available today, only a limited number have demonstrated an ability to build large-scale and sustainable audiences. Scale in a social network is required to create a "network effect," where members of the network benefit from the presence of other members, potentially accelerating growth in user activity and Web
68
site visits. In addition, only a limited number of social networking Web sites have demonstrated that users are willing to pay for online social networking services.
Online Loyalty Marketing
The Internet is a growing channel for advertising and for consumers to find and purchase goods and services. According to IDC, a market research firm in the information technology industry, total advertising spending on the Internet is expected to almost double, from $16.9 billion in 2006 to $31.4 billion in 2011. In addition, more consumers are shopping online for goods and services. According to an April 2007 report by IDC, the number of unique buyers in the United States using the Internet to purchase goods or services is expected to grow from approximately 113.7 million in 2006 to approximately 170.0 million in 2010. As a result of this growth, advertisers are seeking effective ways to target and reach online consumers.
Loyalty marketing programs are generally designed to reward consumers with points that accumulate based on activities and may be redeemed for products and services from participating vendors. These programs have long been popular with airlines, credit card vendors, hotels and retailers. According to Aite Group, an independent research and advisory firm, 84% of credit card purchases will be made on rewards cards in the United States during 2007, more than double the comparable percentage in 2001, underscoring the growth in popularity of loyalty marketing programs. In recent years, loyalty marketing programs have expanded into a comprehensive direct marketing and targeted advertising strategy. Consumer adoption of loyalty marketing programs, however, has traditionally been associated with a single type of activity, such as airline, hotel or credit card selection.
Given the challenges faced by offline direct marketing, such as low response rates and rising costs of direct mail, advertisers are increasingly turning to the Internet to cost-effectively reach and target consumers. Online loyalty marketing enables advertisers to target consumers in ways that are generally impractical with traditional direct marketing channels. Online loyalty marketing services often have the ability to segment members based on personal interests, purchasing behavior and demographic profiles in order to create highly targeted advertising campaigns, thereby optimizing value to the advertiser. Online loyalty marketing services use points as an incentive for members to update their personal interest profile, helping advertisers reach consumers interested in purchasing their products and services. Online loyalty marketing services can also easily measure click-through rates on display advertising and response rates to email offers, providing rapid feedback for advertisers that can be used to identify potential customers and create new targeted offers.
In addition, an online loyalty marketing program that has attracted a large, responsive and loyal member base helps maximize returns on the advertisers' marketing investments. Online loyalty marketing programs that are not explicitly sponsored by a single large consumer brand, such as an airline, hotel chain or department store, appeal to a potentially broader audience because of the breadth of offers and the ability of the consumer to earn rewards quickly and more often.
Our Competitive Strengths
We believe that our success to date is principally attributed to the following factors:
Market leadership position and strong brand recognition. Classmates and MyPoints are leading brands in their respective industries, which has enhanced their ability to attract new users and build on their leadership positions. We register tens of thousands of new social networking free accounts and thousands of new loyalty marketing accounts every day.
69
acquaintances. Our social networking Web sites have over 50 million registered accounts and over 2.7 million pay accounts.
Large audience and rich databases. We believe our large membership bases and our databases of member information provide us with significant competitive advantages over existing and potential competitors.
Compelling services and sustainable consumer proposition. We attract and retain members through differentiated services.
70
Attractive demographics. The demographics of our user base are important to our business model.
Proven business model. We have demonstrated a long history of cost-effectively obtaining new members while generating strong revenue growth through subscription and advertising revenues.
Our Strategy
Our objective is to continue to advance our position as a leader in online social networking and online loyalty marketing. Key elements of our business strategy include the following:
Enhance member experience and engagement on our Web sites. We intend to continue to increase and improve our service offerings through our social networking and loyalty marketing platforms.
71
Expand our membership base. We plan to continue to increase consumer awareness of our brands and build upon our market leadership position in order to expand our membership base.
Increase monetization of our Web sites. We intend to increase both subscription and advertising revenues by enhancing the value of our services to our members as well as to advertisers.
Pursue strategic acquisitions and international expansion opportunities.
Our Services
Online Social Networking
On our social networking Web sites, we enable users to locate and interact with acquaintances from school, work and the military. Led by our flagship Classmates Web site, our social networking properties comprise a large and diverse collection of users, with over 50 million registered accounts as of June 30, 2007.
72
Using our interactive tools and features, our members have contributed to our social networking Web sites a substantial number of distinct, relevant pieces of content, such as names, school affiliations, profiles, biographies, interests and photos. Our large membership base and the extensive user generated content posted on our Web sites assist us in acquiring new members, and we receive tens of thousands of new free account registrations each day. This valuable content also brings existing members back to our Web sites, with a significant number of our members visiting our Web sites on a recurring basis over many years.
Our social networking members can choose between free membership and a paid subscription offering additional features. Free accounts constitute the vast majority of our social networking accounts. Revenues from our social networking services are derived from subscription fees and advertising fees. As of June 30, 2007, we had 2.7 million pay accounts. During the quarter ended June 30, 2007, our average monthly revenue per pay account was $3.32 per month.
Basic Membership. Basic membership on our Classmates Web site is free and provides members with access to a number of interactive features. Visitors to Classmates can become free members by completing the registration process and providing their name, age, graduation year and a valid, confirmed email address. Free members are required to affiliate with at least one school, work or military community. In addition, free members can elect to provide information about their personal interests and post photos.
Free members have free access to the following features:
Gold Membership. Gold membership on our Classmates Web site is a paid subscription service that provides members with access to all of the features of a free membership as well as several additional features.
73
Paying subscribers have access to the following additional features:
We are currently developing several new free and pay features on our Classmates Web site that we believe will enhance the free member experience while providing an additional incentive for our free members to upgrade to a pay account. For example, we previously required a free member to upgrade to a pay account to view another member's photos, and we made this a free feature early in 2007. We expect the features available to free members and paying subscribers to change from time to time.
Pricing for a Classmates pay account varies by term of membership, with most pay accounts consisting of a three-month subscription for $15.00, or $5.00 per month, a 12-month subscription for $39.00, or $3.25 per month, or a 24-month subscription for $59.00, or $2.46 per month. We continually review our pricing strategies and from time to time offer a variety of promotions. We currently offer a 7-day free trial promotion to encourage free members to upgrade to a pay account.
International. In addition to our flagship Classmates