**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

| **(Mark One)**                                                                                                                                                                                                                                                      |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **x**                                                                                                                                                                                                                                                               | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                          |
| **For the  Fiscal Year Ended December 31, 2006**                                                                                                                                                                                                               |
| ** **                                                                                                                                                                                                                                                          |
| **or**                                                                                                                                                                                                                                                              |
| ** **                                                                                                                                                                                                                                                          |
| **o**                                                                                                                                                                                                                                                               | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                          | ** ** | ** ** |
| **For the  transition period from                      to                    ** |

 

**Commissionfile number 000-33367**

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**UNITEDONLINE, INC.**

(Exact name of registrantas specified in its charter)

| **Delaware**                             |   | **77-0575839**       |
|------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of         |   | (I.R.S. Employer     |
| incorporation or  organization)          |   | Identification  No.) |
| **21301 Burbank Boulevard**              |   | ** **           |
| **Woodland  Hills, California**          |   | **91367**            |
| (Address of  principal executive office) |   | (Zip Code)           |

 

**(818) 287-3000**

(Registrant’s telephonenumber, including area code)

Securities registered pursuant to Section 12(b) ofthe Act:

**None**

Securities registered pursuant to Section 12(g) ofthe Act:

**Common Stock, par value$0.0001 per share**

**PreferredStock Purchase Rights**

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes x No o

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o No x

Indicate by check markwhether the registrant (1) has filed all documents and reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):

| Large  accelerated filer x | Accelerated  filer o | Non-accelerated  filer o |
|---------------------------------|---------------------------|--------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2)of the Act). Yes o No x

At June 30, 2006, theaggregate market value of voting stock held by non-affiliates of theregistrant, based on the last reported sales price of the registrant’s commonstock on such date reported by the Nasdaq Stock Market, was $759,960,060(calculated by excluding shares beneficially owned by directors and officers).

At February 23, 2007,there were a total of 66,305,107 shares of the registrant’s common stockoutstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

The information required by Part III of this annual report, to theextent not set forth herein, is incorporated herein by reference to theregistrant’s definitive proxy statement relating to the 2007 annual meeting ofstockholders to be filed with the Securities and Exchange Commission not laterthan 120 days after the end of the registrant’s fiscal year.

 

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**UNITEDONLINE, INC.INDEX TO FORM 10-KFor the Year Ended December 31, 2006**

|                    | ** ** |                                                                                                                     | ** ** | **Page** |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I.**   |       |                                                                                                                |       |     |
| Item 1.            |       | Business                                                                                                            |       | 4        |
| Item 1A.           |       | Risk Factors                                                                                                        |       | 12       |
| Item  1B.          |       | Unresolved  Staff Comments                                                                                          |       | 22       |
| Item 2.            |       | Properties                                                                                                          |       | 22       |
| Item 3.            |       | Legal  Proceedings                                                                                                  |       | 22       |
| Item  4.           |       | Submission  of Matters to a Vote of Security Holders                                                                |       | 24       |
| **PART II.**  |       |                                                                                                                |       |     |
| Item  5.           |       | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       | 25       |
| Item  6.           |       | Selected  Financial Data                                                                                            |       | 27       |
| Item  7.           |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 29       |
| Item  7A.          |       | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       | 53       |
| Item  8.           |       | Financial  Statements and Supplementary Data                                                                        |       | 54       |
| Item  9.           |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                               |       | 54       |
| Item  9A.          |       | Controls  and Procedures                                                                                            |       | 54       |
| Item 9B.           |       | Other  Information                                                                                                  |       | 56       |
| **PART III.** |       |                                                                                                                |       |     |
| Item 10.           |       | Directors, Executive  Officers and Corporate Governance                                                             |       | 56       |
| Item 11.           |       | Executive Compensation                                                                                              |       | 56       |
| Item 12.           |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                     |       | 56       |
| Item 13.           |       | Certain Relationships and  Related Transactions, and Director Independence                                          |       | 56       |
| Item 14.           |       | Principal Accounting Fees  and Services                                                                             |       | 56       |
| **PART IV.**  |       |                                                                                                                |       |     |
| Item  15.          |       | Exhibits,  Financial Statement Schedules                                                                            |       | 56       |
| **Signatures**     |       | 59                                                                                                                  |

 

In this document, “UnitedOnline,” the “Company,” “we,” “us” and “our” refer to United Online, Inc.and its wholly-owned subsidiaries.

*This Annual Report on Form 10-K and the documentsincorporated herein by reference contain forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995 based on ourcurrent 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 similarexpressions constitute forward-looking statements. These forward-lookingstatements include, but are not limited to, statements about the markets inwhich we compete, our pay accounts and subscriptions, our product and serviceofferings, the advertising market, operating expenses, operating efficiencies,revenues, capital requirements, tax payments and our cash position. Inaddition, any statements that refer to expectations, projections or othercharacterizations of future events or circumstances, including any underlyingassumptions, are forward-looking statements. Such statements are not guaranteesof future performance and are subject to*

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*risks,uncertainties and assumptions that are difficult to predict. Therefore, ouractual results could differ materially and adversely from those expressed inany forward-looking statements as a result of various factors. The sectionentitled “Risk Factors” in this Annual Report on Form 10-K and our otherfilings with the SEC set forth some of the important risk factors that mayaffect our business, financial position, results of operations and cash flows.Statements indicating factors that we believe may impact our results are notintended to be exclusive. We undertake no obligation to revise or updatepublicly any forward-looking statements, other than as required by law.*

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**PART I**

**ITEM 1.**                BUSINESS

**OVERVIEW**

We are a leading provider of consumer Internet andmedia services through a number of brands including NetZero, Juno, Classmatesand MyPoints. We report our business in two segments: Communications andContent & Media. Our primary Communications services are Internetaccess and email. Our primary Content & Media services are socialnetworking and online loyalty marketing. On a combined basis, our Webproperties attract a significant number of Internet users each month and weoffer marketers a broad array of Internet advertising products and services aswell as online market research and measurement services.

Historically, our operations were focused on providingvalue-priced dial-up Internet access services in the U.S. and Canada. Beginningin 2004, our dial-up subscriber base started to decline and we begandiversifying our business to other Internet consumer offerings. In November 2004,we acquired Classmates Online, Inc., a provider of online social-networkingservices. In April 2006, we acquired MyPoints.com, Inc., a provider ofonline loyalty marketing services. Our strategy is to continue to leverage ourresources and core competencies to expand our businesses, through internaldevelopment and acquisitions, beyond dial-up Internet access while managing ourdeclining dial-up access services for profitability.

United Online, Inc., a Delaware corporationheadquartered in Woodland Hills, California, commenced operations in 2001following the merger of dial-up Internet access providers NetZero, Inc.and Juno Online Services, Inc. (the “Merger”).

Content & Media revenues were $14.1 millionin 2004, $93.1 million in 2005 and $146.7 million in 2006. Content &Media segment income from operations was $4.4 million in 2004, $16.5 million in2005 and $17.9 million in 2006. Communications revenues were $434.5 million in2004, $431.9 million in 2005 and $375.9 million in 2006. Communications segmentincome from operations was $126.6 million in 2004, $135.3 million in 2005 and $132.8million in 2006. At least in the near term, we expect our Content &Media revenues and segment income from operations to continue to grow and forour Communications revenues and segment income from operations to continue todecrease.

We generate revenues primarilyfrom selling subscriptions to our consumer services, which we call billableservices revenues, and from selling advertising on our services to advertisers.As part of our diversification strategy, we have increased our focus onadvertising. Our advertising revenues have increased from $37.8 million, or 8.4%of total revenues in 2004, to $59.1 million, or 11.3% of total revenues in2005, to $99.1 million, or 19.0% of total revenues in 2006. Substantially allof our billable services revenues in our Communications segment come fromsubscriptions to our dial-up Internet access services and substantially all ofour billable services revenues in our Content & Media segment comefrom subscriptions to our social-networking services.

**Segment Services**

***Communications***

Our primary Communicationspay services are consumer Internet access and email under the NetZero and Junobrands. We offer several additional Communications pay services, such asInternet security services, but these additional services and brands do notgenerate significant revenues. For additional information regarding ourCommunications segment, see Note 10—“Segment Information” of the Notes to theConsolidated Financial Statements, which appears in Part II, Item 8 ofthis Annual Report on Form 10-K.

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*Internet AccessServices*

Our Internet access services consist of both dial-upand broadband digital subscriber line (“DSL”) services. Our DSL services,however, were only launched at the end of 2006 and we do not currently generatesignificant revenues from our DSL services.

Our dial-up access services are provided on both afree and pay basis, with the free services subject to hourly and otherlimitations. Basic pay dial-up access services include Internet access and anemail account, although we also offer an enhanced email service as a standalonepay service. In addition, we offer accelerated dial-up access services whichreduce the time for certain Web pages to download when compared to ourbasic access services. Our accelerated access services are also bundled withadditional benefits such as pop-up blocking, antivirus software and enhancedemail storage. Our dial-up access services are available in more than 9,500cities across the United States and Canada. In general, monthly pricing for ourdial-up access services ranges from $6.95 for basic services to $14.95 for ourbundled services, with $9.95 our most prevalent price point.

Our DSL services are purchased from third parties and,as of the end of 2006, were only available in a limited coverage area. While weintend to expand our coverage area, our ability to do so will be dependent onacquiring services from additional third parties. In general, monthly pricingfor our DSL services ranges from $14.95 to $29.95, though we anticipate ourpricing may change and fluctuate by speed and coverage territory.

Our strategy for ourCommunications segment is to manage our dial-up business for profitabilitywhile extending the business life cycle of our dial-up subscribers by offeringthem a DSL alternative to their dial-up service.

*Industry Background*

The United States consumer Internet access servicemarket has evolved from one where the Internet was accessed primarily throughdial-up access to one in which consumers can access the Internet through dial-upor a variety of high-speed, or broadband, connection methods including cable modems,DSL or wireless connections. Consumer adoption of Internet applications, such asmusic downloads and video, which require a broadband connection has beenincreasing, while the retail pricing for broadband access services has beendecreasing. In addition, the Internet access market is now relatively maturewith the rate of growth in the U.S. Internet population slowing. These factorshave led to a significant decrease in dial-up accounts and a significantincrease in broadband accounts. It is anticipated that the number of dial-upaccounts will continue to decrease.

There are numerous dial-up access providers in theU.S. although a small number of national providers account for a significantmajority of the U.S. dial-up market, with AOL being the largest provider ofdial-up services. The dial-up market has been, to some extent, divided intopremium-priced services and value-priced services. In general, premium-pricedservices were priced over $15 per month and usually incorporated, in additionto Internet access and email, a number of complementary features, while value-pricedservices were priced below $15 per month and incorporated more limited featuresthan premium-priced services. While the primary providers of premium-pricedservices, particularly AOL and EarthLink, continue to offer premium-pricedservices, they also offer, either directly or through related entities, value-pricedservices. Some of these value-priced services include many features that arealso incorporated in premium-priced services. As a result, the distinctionbetween value-and premium-priced services is becoming increasingly unclear.

Broadband services, oncecharacterized by high prices and a limited coverage area, are now available tomost of the United States’ population at prices that, in some cases, are equivalentto or lower than dial-up services. Many broadband providers, including cablecompanies such as Comcast and incumbent local 

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exchangecarriers such as AT&T, bundle their offerings with phone, entertainment orother services, which may result in lower prices than standalone services. Pricingin the broadband market varies based on the geographic region and speed of theservice, with introductory pricing for slower speed services as low as $10 permonth.

***Content & Media***

Our primary Content &Media services are social networking under the Classmates brand and onlineloyalty marketing under the MyPoints brand. Our Content & Mediaservices also include international social-networking, Web-hosting and photo-sharingservices, though these services do not generate material revenues. Foradditional information regarding our Content & Media segment, see Note 10—“SegmentInformation” of the Notes to the Consolidated Financial Statements, whichappears in Part II, Item 8 of this Annual Report on Form 10-K.

*Social-NetworkingServices*

Our social-networking services connect millions ofusers primarily across the United States and, to a lesser extent, Canada,Germany, France, Sweden, India and Great Britain, among others. The primaryfocus of these services has been to enable members to locate and reconnect withpast acquaintances from school, work or military affiliations. Basic membershipin our social-networking services is free and the vast majority of our social-networkingaccounts are free accounts. A free account allows a user to engage in a varietyof activities on our Web sites including posting a personal profile and searchingour database for other registered members. We also offer pay services which, ingeneral, allow the member to engage in a variety of additional activities,including communicating with other registered members. The majority of oursocial-networking revenues are derived from our pay services. Our social-networkingservices also contain advertising initiatives throughout their Web sites. Ingeneral, pricing for our social-networking services varies by service and termof membership, with an average price of approximately $3.25 per month.

Our strategy for oursocial-networking services is to continue to enhance our members’ experience infinding and interacting with past acquaintances from school, work and themilitary, and to encourage our members to contribute user-generated content.Our strategy is to also expand the scope of our services to provide memberswith a platform to not only connect with past acquaintances, but also to meet andinteract with new people based on shared interests and communities.

*Social NetworkingIndustry Background*

The online social-networking market is a growing andrapidly changing market. Online social networking tends to be characterized by Websites or online services which enable users to display content and interactbased on shared interests, objectives or communities. Examples of social-networkingsites include community-based networks such as MySpace, Yahoo! 360 and Facebook,as well as personals and dating services such as Yahoo! Personals and Match.com.A number of general services, as well as services dedicated to specificinterests such as cars, music and business, continue to be developed.

Many social-networkingservices are free and dependent on advertising revenues. Other socialinteraction services, such as dating, are dependent upon subscription revenues.A common element to the success of both free and pay services is the ability toattract a significant number of users to the service and having those usersgenerate content for the service by posting information, such as a personalprofile or photograph, which is generally referred to as user-generated content.Consumer interest in user-generated content can result in the volume of page viewsnecessary to generate advertising revenues and provides a fundamental elementof the value proposition necessary to induce users to pay for subscriptionservices.

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*Loyalty MarketingServices*

Our MyPoints loyalty marketing service providesretailers an efficient means to reach a targeted online audience whileproviding consumers a compelling way to earn rewards while shopping andengaging in other online activities. MyPoints provides advertisers andretailers online direct marketing solutions such as rewards-based Web shopping,targeted emails based on self-reported and behavioral data, and online surveysthat pre-qualify its members for targeted offers. MyPoints’ members arerewarded with points for clicking or shopping through MyPoints’ emails, forshopping through the MyPoints Web site, and for completing surveys. The pointsare then redeemable for gift cards and other benefits with various partners. Hundredsof major brands have used MyPoints to market their products and services.

Our strategy for ourloyalty marketing services is to increase the number of users by generatingadditional awareness regarding its benefits and to encourage utilization of theservice as an online shopping portal. Our strategy is also to increase thenumber of major advertisers on our service.

*Loyalty MarketingIndustry Background*

Online loyalty marketingis a relatively new market and is based on the loyalty programs that theairlines began offering in the early 1980s. These programs are generally basedon a points system where consumers are provided benefits in the form ofredeemable points for purchasing products and services from specified vendors.There are only a limited number of companies that have designed points-basedloyalty rewards program specifically for Internet-related activities. It isestimated that revenues from online advertising will grow to more than $25billion in 2010, an increase of nearly 60%, when compared with 2005. The growthof online advertising may provide a significant opportunity for online loyaltyrewards programs.

**SOURCES OF REVENUE**

We generate revenue frombillable services and online advertising transactions.

**Billable ServicesRevenues**

In general, we charge ourpay accounts in advance of providing a service, which results in the deferralof billable services revenue to the period in which the services are provided.We have experimented with a variety of pricing plans, both in connection withoffers extended to some of our existing accounts and through external marketingchannels. We intend to continue testing a variety of pricing plans in thefuture to determine their impact on profitability, pay account acquisition,conversion rates of free accounts to pay accounts and retention rates. Weintend to regularly evaluate the desirability and effectiveness of our pricingplans and may, in the future, make changes to these plans. We may also offeradditional fee-based products and services as well as a wide range ofdiscounted metered plans and promotions, such as one or more free months ofservice or discounted rates for an initial period or an extended commitment.

**Advertising Revenues**

We provide advertising solutions to marketers withboth brand and direct response objectives through a full suite of display,search, email and text-link opportunities across our various properties. Wealso use targeting technologies and site integrations in order to provideeffective solutions.

We designate the initial Web site displayed to usersof our access services during an Internet session. This Web site, or “startpage,” displays sponsored links to a variety of content, products and services,including Internet search. We also display a toolbar on access users’ screensthroughout their online access sessions that is generally visible regardless ofthe particular Web site they visit. The toolbar contains Internet searchfunctionality and a variety of buttons, icons and drop-down menus. We generaterevenues 

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from our Web pages andthe access services’ toolbar by displaying, or users clicking on, banner,text-link and other advertisements that are linked to advertisers’ and sponsors’Web sites, or by users utilizing functionality offerings such as Internetsearch services. A variety of advertising opportunities also exist through ouremail platforms, including display advertising on the main pages and withinemails.

Our social-networking services generate advertising revenuesby selling links and advertisements on the Web pages for our services. Wealso generate revenues from referral fees as a result of advertising on our Webpages and placing partners in our registration process.

Our loyalty marketingservice generates revenues by selling direct marketing solutions to advertisers.Advertisers pay us for sending targeted emails to users based on self-reportedbehavioral data as well as users engaging in certain activities such as completingonline surveys that pre-qualify such members for targeted offers, clicking orshopping through emails, or shopping through the MyPoints Web site.

**MARKETING AND NEWACCOUNT ACQUISITION**

Our marketing efforts are focused primarily onattracting free and pay accounts, building our brands and cross-sellingexisting and new services to existing accounts. These efforts includetelevision, Internet, co-registration with third parties, sponsorships, radioand print as well as a variety of distribution initiatives. We intend tocontinue to evaluate and engage in a variety of distribution and marketingchannels to enable us to make our services better known and available to alarge population of potential users. We also devote a significant portion ofour own advertising inventory to up-sell our pay services and cross-sell ourother services. Our internal marketing resources consist of marketingmanagement, media, creative services, Web development, strategic alliance andbusiness development personnel. We produce a significant amount of ourmarketing materials in-house, using state-of-the-art design computers andgraphics program techniques.

We view our free services as a key component of ourpay account acquisition strategy, primarily for our social-networking servicesand to a lesser degree for our access services. We seek to up-sell the freeaccount bases of these services to pay versions of each service. Our marketingefforts to date for social networking have been comprised almost entirely ofInternet advertising designed to increase our free member base, with mostpayments to the advertiser made on per free member acquisition basis. Ourmarketing efforts to obtain members to our loyalty marketing services areprimarily based on co-registration with other third party services.

Our traditional marketingactivities for our access services are designed to drive prospective accountsto visit our main Web sites and download our software, or to call our toll freenumbers to purchase our services. We have also entered into a variety ofdistribution relationships for our access services including the distributionof our Internet access software on CDs at retail locations, the preloading ofour access software on personal computers and partner CDs, and links to ourservices on partner Web sites. In most cases, we pay a per pay accountacquisition fee to these distributors.

**SALES OFADVERTISING INVENTORY**

We have internal mediagroups dedicated to selling our Internet advertising products and services,with one group dedicated to selling advertising across our Communications and Content &Media properties, except for our loyalty marketing services, which has its owndedicated sales force. These groups work with internal operations personneldedicated to serving and monitoring the performance of our advertisinginitiatives. While we derive a significant portion of our advertising revenuesfrom transactions directly with advertisers and their agencies, we also sell aportion of our advertising inventory through third party advertising resellers.We have an agreement with Yahoo! Search to place search boxes and links totheir search services on certain of our Web properties, and substantially allof our search revenues are derived from this agreement.

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**COMPETITION**

The industries in which weoffer services are intensely competitive. Many of our competitors have longeroperating histories, greater name recognition, larger user bases andsignificantly greater financial, technical and sales and marketing resourcesthan we do. A summary of competitive factors is set forth below. For moreinformation on competition, see “Item 1A—Risk Factors.”

*Internet AccessServices*

We compete with a broadrange of companies for Internet access services including AOL, Comcast,AT&T/SBC, Road Runner, Verizon and EarthLink. We believe the primarycompetitive factors in the Internet access industry are price, speed, features,coverage area and quality of service. While we believe our dial-up servicescompete favorably based on these factors when compared to many dial-upproviders, we are at a competitive disadvantage with respect to some or all ofthese factors with respect to some of our competitors. Our dial-up services donot compete favorably with broadband providers with respect to speed. Thelimitations on the coverage area of our broadband services and, potentially,price, may put us at a disadvantage with respect to certain other broadbandproviders.

*Social Networking*

Our social-networkingservices compete for members directly against a small number of companies,including Reunion.com, offering similar online social-networking services, andagainst many schools, employers, Web sites, and associations that maintaintheir own Internet-based alumni information services. In addition to thisdirect competition, we compete for subscribers with companies offering a widevariety of social-networking services including Web portals, Web communityservices, and other community-based Web sites and personal-networkingcommunities. We believe the primary competitive factors in social networkingare size of user base, volume and quality of user generated content and scopeof features. We believe we compete favorably in each of these areas with ourdirect competitors, although certain of our indirect competitors have a competitiveadvantage over us in each of these areas.

*Loyalty Marketing*

Our loyalty marketingbusiness competes for members with other loyalty programs that offercompetitive online products or services, such as Ebates, Upromise andPoints.com. We also compete indirectly with airline, hotel and credit cardprograms to the extent they promote online shopping opportunities. We believethe primary competitive factors are the number, type and popularity of theparticipating merchants, the rewards offered, the ease and speed of earningrewards, and the ability to offer members a robust shopping experience. Webelieve we compete favorably with respect to each of these factors.

*Advertising*

We compete for advertisingrevenues with major Internet service providers, content providers, large Webpublishers, Web search engine and portal companies, Internet advertisingproviders, content aggregation companies, social-networking Web sites, directmarketing businesses, and various other companies that facilitate Internet advertising.We also compete with television, radio, cable and print media for a share ofadvertisers’ total advertising budgets. We believe the primary competitivefactors for Internet advertising are size of user base, the amount of timeusers spend on a site, the ability to target advertisements to users and thedemonstrated success of advertising campaigns. We believe we compete favorablyin each of these areas, although certain competitors have a competitiveadvantage over us as it relates to the sale of advertising on oursocial-networking and Internet access services.

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**SEASONALITY**

Our access services haveexperienced higher usage and a higher rate of new registrations during the March quarterwhen compared to other quarters. While this increases our Communications costof billable services and advertising inventory in the March quarter whencompared to other quarters, the impact on our costs and revenues has not beensignificant. Revenues from our loyalty marketing business have been higher inthe December quarter when compared to other quarters, resulting in higheradvertising revenues in the December quarter when compared to otherquarters. We do not know if these seasonal trends will continue.

**BILLING**

The vast majority of our pay accounts pay us in advancewith a credit card. Other payment options for some of our pay services includeACH, personal check or money order, or via a customer’s local telephone bill.Pay access accounts that elect to pay with a personal check or money order arenot provisioned until their payment is received and they are required to subscribefor one of our prepaid multi-month billing plans.

We utilize a combinationof third-party and internally developed software applications forcustomer billing. Customer billing is a complex process and our billing systemsmust efficiently interface with third-parties’ systems, such as ourcredit card, ACH and telephone bill processors’ systems. Our ability toaccurately and efficiently bill and collect payment from our accounts is dependenton the successful operation of our billing systems and various third-partyprocessors. In addition, our ability to offer new pay services or alternativepayment plans is dependent on our ability to customize our billing systems.

**CUSTOMER SUPPORTAND RETENTION**

We believe reliable customer service and technicalsupport are important to retaining our customers. Our customer relationshipmanagement and support infrastructure includes employees at our facilities inHyderabad, India; Woodland Hills, California; Fort Lee, New Jersey; Renton,Washington; San Francisco, California; and Orem, Utah. However, we outsourcesubstantially all of our telephone support and some of our email support tothird parties.

We offer a variety of online and offline “self-help”tools for our services, designed to provide comprehensive tutorials, advice,tips, step-by-step solutions and answers to frequently asked questions. Theseself-help tools are also designed to assist users in updating and verifyingbilling information, downloading and operating our software and setting uptheir accounts. We also offer live telephone technical support for our accessservices billed on a per-minute basis and telephone billing support for free.We monitor the effectiveness of our user support functions and measureperformance metrics such as average hold time and first call resolution andabandonment rates.

In addition, we providetraditional email support for our services. Communications with users arelogged and categorized to enable us to recognize and act on trends. An internalquality assurance team monitors the performance of our vendors and providesfeedback to improve their skills and establish consistency throughout ourcustomer support functions.

**TECHNOLOGY**

Our services are generally provided through acombination of internally developed and third-party software, industrystandard hardware and outsourced network services. We have developed softwareto enhance the functionality of certain components of our services, includingconnectivity, Web services, billing, email, customer support and targetedadvertising. We maintain data centers in multiple locations around the countrywith, in many cases, redundant systems to provide high levels of serviceavailability and 

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connectivity. We host themajority of our data center services in third-party co-locationfacilities and outsource all of our bandwidth and managed modem services.

We license a number of oursoftware applications and components, including the applications for ourbilling, customer support, advertising and database systems, our client andserver applications, and the applications for our accelerator services. Theselicenses generally have terms ranging from several years to perpetual.

**PROPRIETARY RIGHTS**

Our trademarks, patents,copyrights, domain names and trade secrets are important to the success of ourbusiness. We principally rely upon patent, trademark, copyright, trade secretand contract laws to protect our proprietary technology. We have filed numerouspatent applications relating to a variety of business methods and technologies.We generally enter into confidentiality or license agreements with ouremployees, consultants and corporate partners, and generally control access to,and distribution of, our technologies, documentation and other proprietaryinformation. We consider our United Online, NetZero, Juno, Classmates andMyPoints trademarks to be very valuable assets, and we have registered all ofthese trademarks in the United States and certain of them in some other countries.

**INTERNATIONALOPERATIONS**

We have foreign operationsin India and Germany. We have a significant number of employees located in ourIndia office. Our operations in India primarily handle email customer support,product development and quality assurance. A portion of our outsourced customersupport is also based in India. Our operations in Germany provide community-basednetworking services in Sweden, Germany and France. The revenues generated byour international operations constitute an immaterial portion of our totalrevenues and we do not generate revenues directly from our operations in India.For additional information relating to geographic segments, seeNote 10—“Segment Information” of the Notes to the Consolidated FinancialStatements, which appears in Part II, Item 8 of this Annual Report onForm 10-K, and for information regarding risks associated with ourforeign operations, see “Item 1A—Risk Factors.”

**EMPLOYEES**

At December 31, 2006,we had 1,006 employees, 753 of which were located in the United States, 243 ofwhich were located in Hyderabad, India and 10 of which were located in Europe.We had 533 employees in product development, including all employees located inour Hyderabad office, 158 employees in general and administrative, 234 employeesin sales and marketing, and 81 employees in network operations. None of theseemployees are subject to a collective bargaining agreement, and we consider ourrelationships with employees to be good.

**AVAILABLEINFORMATION**

Our corporate Web site is www.unitedonline.com. Onthis Web site, we make available, free of charge, our annual, quarterly andcurrent reports, changes in the stock ownership of our directors and executiveofficers, our code of ethics and other documents filed with, or furnished to,the SEC as soon as reasonably practicable after such documents are filed with,or furnished to, the SEC.

The public may read and copy any materials we filewith the SEC at the SEC’s Public Reference Room at 450 Fifth Street,NW, Washington, DC 20549. The public may obtain information on the operation ofthe Reference Room by calling the SEC at 1-800-SEC-0330.The SEC maintains an Internet site that contains reports, proxy and informationstatements and other information filed electronically at www.sec.gov.

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**ITEM 1A.**        RISKFACTORS

*Before deciding to invest in our company or tomaintain or increase your investment, you should carefully consider the risksdescribed below as well as the other information in this report and our otherfilings with the SEC. The risks and uncertainties described below are not theonly ones facing our company. Additional risks and uncertainties not presentlyknown to us or that we currently deem immaterial may also affect us. If any ofthese risks actually materialize, our business, financial position, results ofoperations and cash flows could be adversely impacted. In that event, themarket price of our common stock could decline and you may lose all or part ofyour investment.*

**Our business willsuffer if we are unable to compete effectively.**

*Competition for InternetAccess Services.*   Our principal Communicationsservices, our Internet access services, compete with many emerging and seasonedcompetitors, including the following:

·       establishedonline service and content providers such as AOL, AOL’s Netscape subsidiary andMSN;

·       independentnational Internet service providers (“ISPs”) such as EarthLink and its PeoplePCsubsidiary;

·       companiescombining their resources to offer Internet access in conjunction with otherservices such as Yahoo! and AT&T Internet Services, and Yahoo! and Verizon;

·       nationalcommunications companies and local exchange carriers such as AT&T Inc.,Qwest Communications International, Inc. and Verizon;

·       cablecompanies such as Comcast Corporation, Time Warner Cable, Inc., CoxCommunications, Inc., and Charter Communications, Inc.;

·       localtelephone companies;

·       regionaland local commercial ISPs; and

·       municipalities.

Our primary service offering is dial-up Internetaccess. Our historical success in competing for Internet access subscribers hasbeen based primarily on offering dial-up access services at prices lower thanthe prices of our principal competitors. However, in the last few years themarket has changed dramatically due to a variety of factors including increasedavailability of broadband services, decreases in broadband pricing andwidespread consumer adoption of applications that require a broadbandconnection. Dial-up services do not compete favorably with broadband serviceswith respect to connection speed, and dial-up services no longer have a significant,if any, price advantage over certain broadband services. As a result, dial-upservices have an increasingly difficult time competing with broadband servicesand the number of dial-up accounts in the United States has been declining atan increasing rate. In addition to competition from broadband providers,competition among dial-up providers has increased and neither our pricing norour features provide us with a significant competitive advantage, if any, overcertain of our dial-up competitors. We expect that competition, particularlywith respect to price, both for broadband as well as dial-up services, willcontinue to intensify, and that our dial-up subscriber base will continue todecrease, potentially at an increasing rate.

In the fourth quarter of 2006, we began offeringbroadband services by purchasing and reselling broadband services acquiredthrough third party providers. The providers from whom we purchase suchservices are either our direct competitors or acquire their services from our competitors.We currently have agreements with only a limited number of providers and theirservices cover only a portion of the U.S. There is no assurance that we will besuccessful in entering into the agreements necessary to offer 

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broadband services on a significantscale, that we will be able to maintain such agreements or that the pricingunder such agreements will enable us to profitably resell the services. Most ofthe largest providers of broadband services, such as cable andtelecommunications companies, control their own networks and offer a widervariety of services than we offer, including phone, data and video services andcontent. Their ability to bundle services and to offer broadband services atprices below the price that we can profitably offer comparable services puts usat a competitive disadvantage. Decreases in retail broadband pricing as aresult of competition would adversely impact our ability to offer such servicesprofitably or at a competitive price. We only have a limited number of subscribersto our broadband services and there can be no assurance that our broadbandservices will be commercially successful.

In order to compete effectively we may have to makesignificant revisions to our services, pricing and marketing strategies, andbusiness model. For example, we may have to lower our introductory rates, offeradditional free periods of service, offer additional features at little or noadditional cost to the consumer, and/or reduce the standard pricing of ourservices. Measures such as these could decrease our revenues and our averagerevenue per pay access account. We may also have to allocate more marketingresources toward our access services than we anticipate. All of the foregoingcould adversely affect the profitability of our access services which couldmaterially and adversely impact our financial condition, results of operationsand cash flows.

*Competitionfor Social-Networking Services.*   Competition forsubscribers in the social-networking market is intense and rapidly evolving.Our social-networking services compete directly against a small number ofcompanies, including Reunion.com and Monster.com’s Military.com service,offering similar online social-networking services based on work, school andmilitary communities. Our social-networking services also compete directly withmany schools, employers, Web sites, and associations that maintain their ownInternet-based alumni information services. In addition to this directcompetition, we compete for subscribers with companies offering a wide varietyof social-networking and search services, including Web portals such as Yahoo!,MSN and AOL, and other community-based Web sites; personal-networkingcommunities such as MySpace, Facebook and Friendster; and search services thathelp users locate individuals such as Google. Some of these services also havea wider variety of services and more sophisticated features than ours. Oursocial-networking services are used primarily to locate and contactacquaintances from school, work or military affiliations, and our subscribers,in general, do not spend a significant amount of time on the site for otherpurposes. Many social-networking services are free or only require payment ifcertain additional functionality is desired by the user. The continuedprevalence of free services could adversely impact our ability to market bothour free and pay social-networking services, maintain our current price levels,or maintain or grow our pay account base at current price levels, or at all.

Many competitors in this market have longer operatinghistories, larger customer bases, greater brand recognition and significantlygreater financial, marketing and other resources than we do. In addition, wehave relied extensively on Internet advertising through portals and otherInternet service providers, including AOL, MSN and Yahoo!, to grow our free andpay accounts. A number of these companies are competitors of United Online withrespect to Internet access and other services, and they may not be willing toretain the same advertising relationship going forward. To the extent we arenot able to maintain advertising relationships with these companies, ourability to obtain new social-networking pay and free accounts would beadversely impacted.

*Competitionfor Online Loyalty Marketing Services.*   Ourloyalty marketing buisness faces competition for members from other loyaltyprograms that offer competitive online products and services. Currently,several companies offer competitive online products and services, includingEbates, Upromise and Points.com. We also face competition from larger offlineloyalty point programs, such as those operated by credit card companies,airlines and hotels, to the extent they focus on developing a stronger onlinepresence or promote online shopping opportunities. The success of our loyaltymarketing business largely depends on our ability to maintain and expand anactive membership base. Our revenues are primarily 

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driven by fees paid byadvertisers and direct marketers based on specific actions taken by ourmembers. If we are unable to induce existing and new members to activelyparticipate in our programs, our business may be harmed. If the perceived valueof our points decreases, we may be required to offer more points to generatethe same revenue, which could adversely affect our results of operationsrelating to these services. A significant portion of the revenues from ourloyalty marketing business is generated from the activity of a small percentageof our members, and we cannot assure you that the number of active members willincrease. Data security and privacy concerns may cause consumers not to sign upfor our program or cause our members to stop using the service or resistproviding the personal data necessary to support our program’s profilingcapability. In addition, we acquire a significant number of our new membersthrough a few acquisition channels, and the loss of any of these channels or adecrease in the number of new members acquired through these channels couldhave an adverse affect our business. Although our membership has grown in priorperiods, there are no assurances that our membership growth will continue orincrease in the future. We have limited experience in this market and cannotassure you that we will be able to compete effectively.

*Competition forAdvertising Customers.*   We are dependent uponadvertising revenues for a significant portion of our revenues and profits. Wecompete for advertising revenues with major ISPs, content providers, large Webpublishers, Web search engine and portal companies, Internet advertisingproviders, content aggregation companies, social-networking Web sites, directmarketing businesses, and various other companies that facilitate Internetadvertising. Many of our competitors have longer operating histories, greatername recognition, larger user bases and significantly greater financial,technical and sales and marketing resources than we do. This may allow them todevote greater resources to the development, promotion and sale of theirproducts and services. These competitors may also engage in more extensiveresearch and development, offer more sophisticated or compelling products andservices, undertake more far-reaching marketing campaigns and adopt moreaggressive pricing policies. We also compete with television, radio, cable andprint media for a share of advertisers’ total advertising budgets. In certaininstances, we generate advertising revenues from companies who are also ourcompetitors. To the extent competitors who are also sources of significantadvertising revenue cease to do business with us, our revenues and profitscould suffer.

**Revenues andprofitability of our Communications segment are expected to decrease.**

Substantially all of ourCommunications revenues and profits come from our access services. As a resultof expected continued decreases in our pay access accounts and, potentially,the average monthly revenue per pay account, we expect that our Communicationsbillable services revenues and the profitability of this segment will declineover time. The rate of decline in billable services revenues has accelerated insome periods and may continue to accelerate. Our Communications advertisingrevenues may decline as well due to decreases in our access accounts. Continueddeclines, particularly if such declines accelerate, in Communications revenuesmay materially and adversely impact the profitability of this segment and the Companyas a whole.

**Revenues andprofitability of our Content & Media segment may not increase.**

A key element of ourstrategy involves the diversification from the declining access business tobusinesses with growth opportunities. We view the Content & Mediasegment as a growth opportunity. Both billable services revenues andadvertising revenues are key components in the profitability of this segment.We derive substantially all of this segment’s billable services revenues frompay accounts relating to our social-networking services. We derive significantadvertising revenues from both our social-networking as well as our loyalty marketingservices. We have experienced periods where our advertising revenues andbillable services revenues have declined. There can be no assurance that wewill be successful in increasing Content & Media advertising revenuesor billable services revenues in the future. If we are 

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notsuccessful in growing our revenues within this segment, it is likely toadversely affect our diversification strategy and our future prospects. Failureto increase revenues in this segment could also adversely impact theprofitability of this segment and the Company as a whole.

**We may be unable tomaintain or grow our advertising revenues. Reduced advertising revenues mayreduce our profits.**

Advertising revenues arean increasingly important component of our revenues and profitability. Ourrevenues from advertising have in the past fluctuated, and may in the futurefluctuate, due to a variety of factors including, without limitation, theeffect of key advertising relationships, changes in our business models,changes in the online advertising market, changes in our advertising inventory,and changes in usage. In particular, we derive significant revenues from searchand certain other advertising initiatives or partners, and any termination,change or decrease in revenues from these sources could have a material impacton our advertising revenues. In response to competition, we could be requiredto expend significant resources to develop or enhance our advertising services,although there can be no assurance that our efforts will be successful. Fromtime to time, we have undertaken initiatives that we believed would increaseour advertising revenues but have resulted in decreased advertising revenues.There can be no assurance our advertising initiatives will be effective, andour advertising revenues may decline in future periods.

**Our business issubject to fluctuations.**

Our results of operationsand changes in the number and mix of pay accounts from period to period havevaried in the past and may fluctuate significantly in the future due to avariety of factors, many of which are outside of our control and difficult topredict. A number of factors that may impact us are discussed in greater detailin this Annual Report on Form 10-K, and these factors may affect usfrom period to period and may affect our long-term performance. As a result,you should not rely on period-to-period comparisons as an indication of futureor long-term performance. In addition, these factors create difficulties withrespect to our ability to forecast our financial performance accurately. Webelieve that these difficulties in forecasting present even greater challengesfor financial analysts who publish their own estimates of our future financialresults and account metrics. We cannot assure you that we will achieve theexpectations or financial projections made by our management or by thefinancial analysts. In the event we do not achieve such expectations orprojections, the price of our common stock could be adversely affected.

**Our marketingactivities may not be successful.**

We spend significant fundsto market our services. From time to time, we may allocate our advertisingexpenditures to different services for various reasons, and these allocationsmay adversely impact some of our other services. Even if we choose to allocatesignificant marketing resources to a particular service, there is no assurancethat our marketing activities will be successful. At times we have increasedour profitability, in part, by decreasing our marketing expenditures. Futuredecreases in our marketing expenditures could adversely impact our business.Future increases in our marketing expenditures could adversely impact ourprofitability and there can be no assurance that our marketing activities willbe successful in growing our businesses. We rely on a variety of distributionchannels to obtain new accounts. If these channels prove to be ineffective, orif the cost to acquire new accounts increases, our financial results could bematerially and adversely impacted.

**If we are unable to retain users, our business andfinancial results will suffer.**

Historically, we have lost an average of four to fivepercent of our pay accounts each month, which we refer to as churn, with churnin recent periods approximating or exceeding five percent. Our churn 

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percentage is calculatedbased on the average number of pay accounts for a period. The average number ofpay accounts is a simple average calculated based on the number of pay accountsat the beginning and end of a period. We make certain normalizing adjustmentsto the calculation of our churn percentage for periods in which we add asignificant number of pay accounts due to acquisitions. We do not include inour churn calculation those accounts cancelled during the first thirty days ofservice unless the accounts have upgraded from free accounts, although a numberof such accounts will be included in our account totals at any givenmeasurement date. Subscribers who cancel one pay service but subscribe toanother pay service are not considered to have cancelled a pay account and, assuch, our overall churn rate is not necessarily indicative of the percentage ofsubscribers canceling any particular service. We have experienced, and willlikely continue to experience, a higher percentage of subscribers canceling ouraccelerated access and social-networking services than is indicated by ourchurn rate, and the percentage of subscribers canceling our social-networkingservices has fluctuated significantly from quarter to quarter due toseasonality and the timing of termination of multi-month programs. Ourchurn may be higher in future periods and will fluctuate from period to periodand from service to service. If we continue to experience a high percentage ofpay accounts canceling our services, it will make it more difficult to grow,maintain or minimize decreases in the number of pay accounts for thoseservices. If we experience an increased percentage of cancellations, ourrevenues and profitability may be adversely affected.

Each month, a significantnumber of free accounts become inactive and we may experience continued declinesin the number of active free accounts. In addition, a user may have more thanone account on more than one of our services, and we are not able to determinein most cases the number of accounts held by an individual. As such, the actualnumber of unique individuals using our services may be much lower than ourtotal number of accounts.

**We may beunsuccessful at acquiring additional businesses, product lines or technologies.Even if we complete an acquisition, it may not improve our results of operationsand may adversely impact our business and financial condition.**

One of our strategic objectives is to acquirebusinesses, product lines or technologies that will provide us with anopportunity to leverage our assets and core competencies, or that otherwisewill be complementary to our existing businesses. We may not succeed in growingor maintaining our revenues unless we are able to successfully completeacquisitions. The merger and acquisition market for companies offering Internetservices is extremely competitive, particularly for companies who havedemonstrated a profitable business model with long-term growth potential.Companies with these characteristics trade publicly or are privately valued atmultiples of earnings, revenues, operating income and other metricssignificantly higher than the multiples at which we are currently valued.Acquisitions may require us to obtain additional debt or equity financing,which may not be available to us on reasonable terms, or at all. These andother factors may make it difficult for us to acquire additional businesses,product lines or technologies at affordable prices, or at all, and there is noassurance that we will be successful in completing additional acquisitions.

We routinely engagein discussions regarding potential acquisitions and any of these transactionscould be material to our financial condition and results of operations.However, we cannot assure you that the anticipated benefits of an acquisitionwill materialize or that any integration attempts will be successful. Acquiringa business, product line or technology involves many risks, including:

·       disruptionof our ongoing business and diversion of resources and management time;

·       unforeseenobligations or liabilities;

·       difficultyassimilating the acquired customer bases, technologies and operations;

·       difficultyassimilating and retaining employees from the acquired business;

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·       risksof entering markets in which we have little or no direct prior experience;

·       lackof controls, policies and procedures appropriate for a public company, and thetime and cost related to the remediation of such controls, policies andprocedures;

·       potentialimpairment of relationships with employees, users or vendors as a result ofchanges in management; and

·       potentialdilutive issuances of equity, large write-offs either at the time of theacquisition or in the future, the incurrence of restructuring charges, theincurrence of debt, the amortization of identifiable intangible assets, and theimpairment of amounts capitalized as intangible assets.

We may seek to expand ourinternational business through acquisitions. Acquisitions of foreign businessesinvolve risks in addition to those mentioned above, including risks associatedwith potentially unfamiliar economic, political and regulatory environments andintegration difficulties due to language, cultural and geographic differences.We cannot assure you that any further acquisitions we make will be successful.

**We may notsuccessfully develop and market new services in a timely or cost-effectivemanner; consumers or advertisers may not accept our new products and services.**

We may not be able to compete effectively if we arenot able to adapt to changes in technology and industry standards or develop oracquire and successfully commercialize new and enhanced services. Services,such as our broadband services, may be dependent on our obtaining neededtechnology or services from third parties, which we may not be able to obtainin a timely manner upon terms acceptable to us, or at all. Our ability tocompete successfully will also depend upon the continued compatibility of ourservices with products offered by various vendors, which we may not be able toachieve. We have expended, and may in the future expend, significant resourcesenhancing our existing services and developing, acquiring and implementing newservices, such as our broadband services. Product development involves a numberof uncertainties, including unanticipated delays and expenses. New or enhancedservices may have technological problems or may not be accepted by consumers oradvertisers. For example, our VoIP services did not meet with commercialsuccess. We cannot assure you that we will be successful in developing,acquiring or implementing new or enhanced services, or that new or enhancedservices will be commercially successful.

**Our access businessis dependent on our ability to effectively manage our telecommunications andnetwork capacities.**

Our access businesssubstantially depends on the capacity, affordability, reliability and securityof our telecommunications networks. We will have to accurately anticipate ourfuture telecommunications capacity needs within lead-time requirements. Only asmall number of telecommunications providers offer the network and dataservices we currently require, and we purchase most of our telecommunicationsservices from a few providers. Some of our telecommunications services areprovided pursuant to short-term agreements that the providers can terminate orelect not to renew. Vendors may experience significant financial difficultiesand be unable to perform satisfactorily or to continue to offer their services.The loss of vendors has resulted, and may result, in increased costs, decreasedservice quality and the loss of users. If we are unable to maintain, renew orobtain new agreements with the third party providers of our telecommunicationsservices, or to secure new or alternative arrangements with other providers, toprovide the scope, quantity, quality, type and pricing of services to meet ourcurrent and future needs, our business, financial position, results ofoperations and cash flows could be materially and adversely affected.

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**Our business ishighly dependent on our billing and customer support systems, and on thirdparties for technical support and customer service, and our business may sufferif these systems do not function and we cannot perform and provide theseservices.**

Customer billing and serviceare highly complex processes, and our systems must efficiently interface withother third parties’ systems such as the systems of credit card processingcompanies and other companies to whom we outsource these functions. Our abilityto accurately and efficiently bill and service our users is dependent on thesuccessful operation of these systems. We have experienced customer billing andservice problems from time to time and may experience additional problems inthe future. We currently outsource a majority of the live technical and billingsupport functions. As a result, we maintain only a small number of internalcustomer service personnel. We are not equipped to provide the necessary rangeof customer service functions in the event that our vendors become unable orunwilling to offer these services to us. Problems with our third party softwareapplications, our internally developed software applications, our credit cardprocessors, our outsourced customer service vendors, other customer billing andsupport vendors, and any other failures or errors in our customer billing andservice systems, could materially and adversely affect our business, financialposition, results of operations and cash flows.

**If our software orhardware contains errors or fails, if we fail to operate our serviceseffectively or if we encounter difficulties integrating our systems andtechnologies, our business could be seriously harmed.**

Our services, andthe hardware and software systems underlying our services, are complex. Oursystems may contain undetected errors or failures and are susceptible to humanerror. We have in the past encountered, and may in the future encounter,software and hardware errors, system design errors, errors in the operation ofour systems, and technical and customer support issues associated with ourservices and software releases. This has resulted in, and may in the futureresult in, a number of adverse consequences, which have included or mayinclude:

·       usersbeing disconnected from our services or being unable to access our services;

·       lossof data or revenue;

·       injuryto reputation; and

·       diversionof development resources.

A number of our material technologies and systems arebased on different platforms. To the extent we attempt to integrate thesetechnologies and systems, we may experience a number of difficulties, errors,failures and unanticipated costs. In addition, our business relies on third-partysoftware for various applications including, without limitation, our internaloperations, our billing and customer support, our accelerated services, and ouradvertising products and services. Any significant failure of this softwarecould materially and adversely affect our business, financial position, resultsof operations and cash flows. Our services also rely on their compatibilitywith other third-party systems, particularly operating systems.Incompatibility with future changes to third-party software upon whichour systems rely could materially affect our ability to deliver our services.We cannot assure you that we will not experience significant technical problemswith our services in the future.

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**A security breachor inappropriate use of our network or services could expose us to claims or aloss of revenue.**

The success of ourbusiness depends on the security of our networks and, in part, on the securityof the network infrastructures of our third-party vendors. Unauthorizedor inappropriate access to, or use of, our networks, computer systems andservices could potentially jeopardize the security of confidential information,including credit card information, of our users and of third parties. Thirdparties have in the past used our networks, services and brand names toperpetrate crimes, such as identity theft or credit card theft, and may do soin the future. Users or third parties may assert claims of liability against usas a result of any failure by us to prevent security breaches, unauthorizeddisclosure of user information or other such activities. Although we usesecurity measures that we believe to be effective by industry standards, wecannot assure you that the measures we take will be successfully implemented orwill be effective in preventing these types of activities. We also cannotassure you that the security measures of our third-party networkproviders, providers of customer and billing support services or other vendorswill be adequate. In addition to potential legal liability, these activitiesmay adversely impact our reputation or our revenues and may interfere with ourability to provide our services, all of which could adversely impact ourbusiness.

**Harmful softwareprograms such as viruses could disrupt our business.**

Our business is dependenton the continued acceptance of the Internet as an effective medium. Damagingsoftware programs, such as computer viruses, worms and Trojan horses, have fromtime to time been disseminated through the Internet and have caused significantdisruption to Internet users. Certain of these programs have disabled theability of computers to access the Internet, requiring users to obtaintechnical support in order to gain access to the Internet. Other programs havehad the potential to damage or delete computer programs. The development andwidespread dissemination of harmful programs has the potential to seriouslydisrupt Internet usage. If Internet usage is significantly disrupted for anextended period of time, or if the prevalence of these programs results indecreased residential Internet usage, our business could be materially andadversely impacted. In addition, actions taken by us or our telecommunicationsproviders to attempt to minimize the spread of harmful programs could adverselyimpact our users’ ability to utilize our services.

**Our failure toprotect our proprietary rights could harm our business.**

Our trademarks, patents,copyrights, domain names and trade secrets are important to the success of ourbusiness. We principally rely upon patent, trademark, copyright, trade secretand contract laws to protect our proprietary technology. The protection of ourproprietary rights may require the expenditure of significant financial andinternal resources. We cannot assure you that we have taken adequate steps toprevent misappropriation of our rights. Our failure to adequately protect ourproprietary rights could adversely affect our brands.

**Legal actions,particularly those associated with proprietary rights, could subject us tosubstantial liability and expense and require us to change our businesspractices.**

We are currently, and have been in the past, party tovarious legal actions. These actions include, without limitation, claims byprivate parties in connection with consumer protection and other laws, claimsthat we infringe third party patents, claims in connection with employmentpractices, securities laws claims, breach of contract claims and otherbusiness-related claims. The nature of our business could subject us toadditional claims for similar matters, as well as a wide variety of otherclaims including, without limitation, claims for defamation, negligence,trademark infringement, copyright infringement, and privacy matters. Various governmentalagencies may also assert claims or institute investigations relating to ourbusiness practices, such as our marketing, billing, customer retention,cancellation, refund or disclosure practices. 

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We cannot assure you thatour services and business practices, or changes to our services and businesspractices, will not subject us to claims and liability by private parties orgovernmental agencies.

Defending against lawsuitsand investigations involves significant expense and diversion of management’s attentionand resources from other matters. We may not prevail in existing claims orclaims that may be made in the future. The failure to successfully defendagainst certain types of claims, including claims based on infringement ofproprietary rights, could require us to change our business practices or obtainlicenses from third parties, which licenses may not be available on acceptableterms, if at all. Lawsuits and investigations also involve the risk ofsignificant settlements or judgments against us. Both the cost of defendingclaims, as well as the effect of settlements and judgments, could cause ourresults of operations to fluctuate significantly from period to period andcould materially and adversely affect our business, financial position, resultsof operations and cash flows.

**We may not realizethe benefits associated with our intangible assets and may be required torecord a significant charge to earnings if we are required to impair ourgoodwill or identifiable intangible assets.**

We are required, underaccounting principles generally accepted in the United States, to review ourintangible assets for impairment when events occur or circumstances change thatwould more indicate the fair value of a reporting unit below its carrying valueamount. Goodwill is required to be tested for impairment at least annually.Certain of our services are relatively new and have not generated significantrevenues. We have capitalized certain proprietary rights related to some ofthese services as well as certain costs incurred by us in connection with thedevelopment of these services. We have also capitalized goodwill and intangibleassets in connection with some of our acquisitions. If these services are notcommercially successful, we would likely be required to record an impairmentcharge for these assets which would negatively impact our financial conditionand results of operations. For example, in the fourth quarter of 2006, we hadto write-down (impair) certain long-lived assets associated with our VoIP servicesand certain goodwill and intangible assets associated with the acquisition ofour photo-sharing service. We have experienced impairment losses in the pastand we cannot assure you that we will not experience impairment losses in thefuture. Any such loss could adversely and materially impact our financialcondition and results of operations.

**Our ability tooperate our business could be seriously harmed if we lose members of our seniormanagement team or other key employees.**

Our business is largelydependent on the efforts and abilities of our senior management, particularlyMark R. Goldston, our chairman and chief executive officer, and other keypersonnel. Any of our officers or employees can terminate his or her employmentrelationship at any time. The loss of these key employees or our inability toattract or retain other qualified employees could seriously harm our businessand prospects. We do not carry key person life insurance on any of our employees.

**Government laws andregulation changes and new laws and regulations.**

We are subject to a variety of international, federal,state and local laws and regulations, including those relating to issues suchas user privacy and data protection, defamation, pricing, advertising,taxation, sweepstakes, promotions, billing, content regulation, bulk email or “spam,”anti-spyware initiatives, security breaches and consumer protection. Compliancewith the various laws and regulations, which in many instances are unclear orunsettled, is complex. Any changes in such laws and regulations, the enactmentof any additional laws or regulations, or increased enforcement activity ofsuch laws and regulations, could significantly impact our costs or the mannerin which we conduct business, all of which could adversely impact our resultsof operations and cause our business to suffer.

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Currently, ISPs areconsidered “information service” providers and regulations that apply totelephone companies and other telecommunications common carriers do not applyto our Internet access services. However, our Internet access services couldbecome subject to Federal Communications Commission and state regulation asInternet access services and telecommunications services converge. If the regulatorystatus of ISPs changes, our business may be adversely affected. The InternetTax Freedom Act, which placed a moratorium on new state and local taxes onInternet commerce, is in effect through November 2007. However, futurelaws imposing taxes or other regulations on the provision of goods and servicesover the Internet could make it substantially more expensive to operate ourbusiness.

**Oursocial-networking services and loyalty marketing business rely heavily on emailcampaigns, and any restrictions on the sending of emails could materially andadversely affect our business.**

Our social-networking servicesand loyalty marketing business deliver a significant number of emails to ourmembers. In addition to any government laws and regulations, voluntary actionsby third parties to block, impose restrictions on or charge for the delivery ofemails through their email systems could materially and adversely impact ourbusiness. In addition, from time to time, ISPs block bulk email transmissionsor otherwise experience technical difficulties which result in the inability totransmit emails to our members. Restrictions on the sending of emails couldmaterially and adversely affect our business and results of operations.

**Our business couldbe shut down or severely impacted by a catastrophic event.**

Our computer equipment andthe telecommunications infrastructure of our third-party networkproviders are vulnerable to damage from fire, earthquakes, floods, power loss,telecommunications failures, terrorism and similar events. We have experiencedsituations where power loss and telecommunications failures have adverselyimpacted our services, although to date such failures have not been material toour operations. A significant portion of our computer equipment, includingcritical equipment dedicated to our Internet access services, is located inCalifornia, which is particularly subject to earthquakes. Despite ourimplementation of network security measures, our servers are also vulnerable tocomputer viruses, worms, physical and electronic break-ins, sabotage andsimilar disruptions from unauthorized tampering of our computer systems. Anyprolonged disruption of our services due to these and other events could resultin user turnover and decreased revenues and could severely impact or shutdown our business. We may not carry sufficient business interruption insuranceto compensate us for losses that may occur as a result of any events whichcause interruptions in our services.

**Our business couldbe severely impacted due to political instability or other factors in India.**

We have a significantnumber of employees located in our India office. Our product development,customer support and quality assurance operations would be severely disruptedif telecommunications issues, political instability, labor strife or otherfactors adversely impacted these operations or our ability to communicate withthese operations. Any disruption that continued for an extended period of timewould likely have a material adverse effect on our ability to service ourcustomers and develop our products and services. If we were to cease ouroperations in India and transfer these operations to another geographic area,such change could result in increased overhead costs which could materially andadversely impact our results of operations.

**We cannot predictour future capital needs and we may not be able to secure additional financing.**

We may need to raiseadditional funds in the future to fund our operations, for acquisitions ofbusinesses or technologies or for other purposes. Additional financing may notbe available on terms favorable to us, or at all. If adequate funds are notavailable or not available when required in sufficient amounts or on acceptableterms, our business and its future prospects may suffer.

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**We may stop payingquarterly cash dividends on our common stock.**

Commencing with the secondquarter of 2005, we have declared and paid a quarterly cash dividend of $0.20per share of common stock. The payment of future dividends is discretionary andwill be subject to determination by our Board of Directors each quarterfollowing its review of our financial condition, results of operations and cashflows and such other factors as are deemed relevant by our board of directors.Our future cash flows may significantly decline due to declines in our dial-upInternet access business, the payment of income taxes and other factors, andour cash balances will decline if we use our cash to acquire businesses ortechnologies, repurchase stock or for other purposes. A change in our businessneeds, including working capital and funding for acquisitions, or a change intax laws relating to dividends, could cause our Board of Directors to decide tocease the payment of, or reduce, the dividend in the future. We cannot assureyou that we will continue to pay quarterly cash dividends, and if we do not,our stock price could be negatively impacted.

**We haveanti-takeover provisions that may make it difficult for a third party toacquire us.**

Provisions of ourcertificate of incorporation, our bylaws and Delaware law could make itdifficult for a third party to acquire us, even if doing so might be beneficialto our stockholders because of a premium price offered by a potential acquirer.In addition, our Board of Directors adopted a stockholder rights plan, which isan anti-takeover measure that will cause substantial dilution to a person whoattempts to acquire our company on terms not approved by our Board of Directors.

**Our stock price hasbeen highly volatile and may continue to be volatile.**

The market price of ourcommon stock has fluctuated significantly since our stock began trading on theNasdaq Stock Market in September 2001 and it is likely to continue to bevolatile with extreme volume fluctuations. In addition, the Nasdaq StockMarket, where most publicly-held Internet companies are traded, has experiencedsubstantial price and volume fluctuations. The broad market and industryfactors that influence or affect such fluctuations may harm the market price ofour common stock, regardless of our actual operating performance, and for thisor other reasons we could suffer significant declines in the market price ofour common stock.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES

Our corporate headquarters is located in WoodlandHills, California, and consists of leased space of approximately 0.1 millionsquare feet. Office space is also leased in New York, New York; Fort Lee, New Jersey;and Hyderabad, India, and is generally used by our Communications segment.Additionally, office space is also leased in Renton, Washington; San Francisco,California; Schaumburg, Illinois; Orem, Utah; Erlangen, Germany; and Berlin,Germany, and is generally used by our Content & Media segment.

We believe that ourexisting facilities are adequate to meet our current requirements and thatsuitable additional or substitute space will be available as needed toaccommodate any physical expansion of our corporate and operations facilities,customer support and technology centers or for any additional sales offices.

**ITEM 3.**                LEGALPROCEEDINGS

On April 20, 2001, Jodi Bernstein, on behalf ofhimself and all others similarly situated, filed a lawsuit in the United StatesDistrict Court for the Southern District of New York against NetZero, certainofficers 

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and directors of NetZeroand the underwriters of NetZero’s initial public offering, Goldman Sachs Group, Inc.,BancBoston Robertson Stephens, Inc. and Salomon Smith Barney, Inc.The complaint alleges that the prospectus through which NetZero conducted itsinitial public offering in September 1999 was materially false andmisleading because it failed to disclose, among other things, that (i) theunderwriters had solicited and received excessive and undisclosed commissionsfrom certain investors in exchange for which the underwriters allocated tothose investors material portions of the restricted number of NetZero sharesissued in connection with the offering; and (ii) the underwriters hadentered into agreements with customers whereby the underwriters agreed toallocate NetZero shares to those customers in the offering in exchange forwhich the customers agreed to purchase additional NetZero shares in theaftermarket at pre-determined prices. Plaintiffs are seeking injunctive reliefand damages. Additional lawsuits setting forth substantially similarallegations were also served against NetZero on behalf of additional plaintiffsin April and May 2001. The case against NetZero was consolidated withapproximately 300 other suits filed against more than 300 issuers thatconducted their initial public offerings between 1998 and 2000, theirunderwriters and an unspecified number of their individual corporate officersand directors. The majority of issuers, including NetZero, and their insurershave approved a settlement agreement. The district court’s final approval ofthe settlement has been stayed pending the outcome of the Second Circuit’sdecision to vacate the district court’s decision granting class certificationin six of the suits.

On August 21, 2001, Juno commenced an adversaryproceeding in U.S. Bankruptcy Court in the Southern District of New Yorkagainst Smart World Technologies, LLC, dba “Freewwweb” (the “Debtor”), aprovider of free Internet access that had elected to cease operations and hadsought the protection of Chapter 11 of the Bankruptcy Code. The adversaryproceeding arose out of a subscriber referral agreement between Juno and theDebtor. In response to the commencement of the adversary proceeding, the Debtorand its principals filed a pleading with the bankruptcy court asserting thatJuno is obligated to pay compensation in an amount in excess of$80 million as a result of Juno’s conduct in connection with thesubscriber referral agreement. In addition, a dispute arose between Juno andUUNET Technologies, Inc., an affiliate of MCI WorldCom Network Services, Inc.,regarding the value of services provided by UUNET, with UUNET claiming inexcess of $1.0 million and Juno claiming less than $0.3 million. On August 4,2006, Juno entered into a settlement agreement with the Committee of UnsecuredCreditors providing for the settlement of all claims against Juno pursuant to aproposed plan of liquidation of the Debtor. The settlement and plan of liquidationwere approved by the bankruptcy court in December 2006 and the deadlinefor appealing elapsed in January 2007. We had previously reserved $6.25million for the Freewwweb settlement, which was increased by $0.25 million inthe December 2006 quarter. Pursuant to the settlement agreement, Juno paida total of $6.50 million.

On April 27, 2004, plaintiff MyMail Ltd.filed a lawsuit in the United States District Court for the Eastern District ofTexas against NetZero, Juno, NetBrands, America Online, Inc., AT&T,EarthLink, Inc., SBC Communications, Inc., and Verizon Communications, Inc.alleging infringement of plaintiff’s patent which purported to cover useraccess to a computer network. Plaintiff sought injunctive and declaratoryrelief and damages. On October 28, 2005, the court issued an ordergranting defendants’ motions for summary judgment of non-infringement of thepatent. MyMail appealed the trial court’s ruling, and on February 20,2007, the Federal Circuit affirmed the trial court’s ruling.

On March 6, 2006, plaintiff Anthony Piercy fileda purported consumer class action lawsuit in the Superior Court of the State ofCalifornia, County of Los Angeles, against NetZero claiming that NetZerocontinues to charge consumers fees after they cancel their Internet accessaccount. Plaintiff is seeking injunctive and declaratory relief and damages.NetZero has filed a response to the lawsuit denying the material allegations ofthe complaint.

On July 27, 2006, plaintiff Donald E. Ewart fileda purported consumer class action lawsuit in the Superior Court of the State ofCalifornia, County of Los Angeles, against NetZero claiming that NetZerocontinues to charge consumers fees after they cancel their Internet accessaccount. Plaintiff is seeking 

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injunctive and declaratoryrelief and damages. NetZero has filed a response to the lawsuit denying thematerial allegations of the complaint. On January 29, 2007, counsel for Mr. Ewartadvised the trial court that Mr. Ewart would be withdrawing from theaction as a class representative and that counsel would seek permission fromthe court to add one or more new class representatives. On that same date, thecourt ordered counsel for Mr. Ewart to file their motion to substitute anew class representative by March 2, 2007. As of February 27, 2007, Mr. Ewarthas not withdrawn from the action and his counsel has not filed a motion tosubstitute a new class representative.

The pending lawsuits involve complex questions of factand law and may require the expenditure of significant funds and the diversionof other resources to defend. Although we do not believe the outcome of theabove outstanding legal proceedings, claims and litigation will have a materialadverse effect on our business, financial condition, results of operations orcash flows, the results of litigation are inherently uncertain and we cannotassure you that we will not be materially and adversely impacted by the resultsof such proceedings. At December 31, 2006, other than an immaterialreserve for the then unpaid portion of the Freewwweb settlement payment, we hadnot established reserves for any of the matters described above.

We are subject to variousother legal proceedings and claims that arise in the ordinary course ofbusiness. We believe the amount, and ultimate liability, if any, with respectto these actions will not materially affect our business, financial condition,results of operations or cash flows. We cannot assure you, however, that suchactions will not be material and will not adversely affect our business,financial condition, results of operations or cash flows.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

We did not submit any matters to a vote of securityholders during the quarter ended December 31, 2006.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

Ourcommon stock has been quoted on the Nasdaq Stock Market (“NASDAQ”) under thesymbol “UNTD” since September 26, 2001. Prior to that, NetZero commonstock had been quoted on the NASDAQ under the symbol “NZRO” since September 23,1999. The following table sets forth, for the quarters indicated, the high andlow prices per share of our common stock as reported on the NASDAQ.

| ** **     | ** ** | **2005** | ** ** | **2006** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 11.85      |     | $          | 9.75 |   | $ | 15.40 |   | $ | 11.22 |   |
| Second Quarter |       | 13.08    |       | 8.51     |       | 13.68 |   | 10.79 |   |
| Third Quarter  |       | 14.05    |       | 10.70    |       | 12.37 |   | 10.05 |   |
| Fourth Quarter |       | 15.03    |       | 12.57    |       | 14.04 |   | 12.02 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

On February 23, 2007,there were 844 holders of record of our common stock.

**Dividends**

In May 2005, August 2005 and October 2005,the Company’s Board of Directors declared a quarterly cash dividend of $0.20per share of common stock. The quarterly dividends were paid on May 31,2005, August 31, 2005 and November 30, 2005 and totaled$12.6 million, $12.7 million and $12.8 million, respectively.

The Company’s Board of Directors declared quarterlydividends of $0.20 per share in February 2006, May 2006, August 2006and November 2006 which were paid on February 28, 2006, May 31,2006, August 31, 2006 and November 30, 2006 and totaled $12.9million, $13.4 million, $13.5 million and $13.7 million, respectively.

In February 2007, the Company’s Board ofDirectors declared a quarterly cash dividend of $0.20 per share of commonstock. The record date for the dividend was February 14, 2007 and thedividend, which totaled $13.7 million, was paid on February 28, 2007.

The payment of futuredividends is discretionary and will be subject to determination by the Board ofDirectors each quarter following its review of the Company’s financialperformance. Dividends are declared and paid out of our surplus, as defined andcomputed in accordance with the General Corporation Law of the State ofDelaware.

**Common StockRepurchases**

Our Board of Directors authorized a common stockrepurchase program that allows us to repurchase shares of our common stockthrough open market or privately negotiated transactions based on prevailingmarket conditions and other factors. From time to time, the Board of Directorshas increased the amount authorized for repurchase under this program. On April 22,2004, the Board of Directors authorized us to purchase up to an additional$100 million of our common stock through May 31, 2005 under theprogram, bringing the total amount authorized under the program to$200 million. On April 29, 2005, the Board of Directors extended theprogram through December 31, 2006. In January 2007, the Board furtherextended the program through December 31, 2007. At December 31, 2006,we had repurchased $139.2 million of our common stock under the program,leaving $60.8 million remaining under the program.

Shares withheld from restricted stock units (“RSUs”)awarded to employees upon vesting to pay applicable withholding taxes on theirbehalf are considered common stock repurchases, but are not 

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counted as purchasesagainst the Board-approved repurchase program. Upon vesting, the Companycurrently does not collect the applicable withholding taxes for RSUs fromemployees. Instead, the Company automatically withholds, from the RSUs thatvest, the portion of those shares with a fair market value equal to the amountof the withholding taxes due. The Company then pays the applicable withholdingtaxes in cash, which is accounted for as a repurchase of common stock.

Commonstock repurchases at December 31, 2006 were as follows (in thousands,except per share amounts):

| **Period**         | ** ** | ** ** | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price   Paid per Share** | ** ** | **Total Number of  Shares Purchased as  Part of a Publicly  Announced Program** | ** ** | **Maximum Approximate  Dollar Value that May  Yet be Purchased Under  the Program** | ** ** |
|--------------------|------------|------------|------------|------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
| 2001-2003          |       |       | 4,120      |                                                 |       |                                                   | $          | 12.43                                                                                                                   |       |                                                                                                                        |       | 4,120 |   |   |   | $ | 48,706 |   |   |
| February 2004 |       |       | 2,887      |                                                 |       |                                                   | 16.86      |                                                                                                                    |       |                                                                                                                        | 2,887      |   |   |   | — |   |   |
| May 2004      |       |       | —     |                                                 |       |                                                   | —     |                                                                                                                    |       |                                                                                                                        | —     |   |   |   | 100,000 |   |   |
| August 2004   |       |       | 2,657      |                                                 |       |                                                   | 9.41       |                                                                                                                    |       |                                                                                                                        | 2,657      |   |   |   | 74,989 |   |   |
| February 2005 |       |       | 1,268      |                                                 |       |                                                   | 11.20      |                                                                                                                    |       |                                                                                                                        | 1,268      |   |   |   | 60,782 |   |   |
| February 2006 |       |       | 129        |                                                 |       |                                                   | 12.77      |                                                                                                                    |       |                                                                                                                        | —     |   |   |   | 60,782 |   |   |
| May 2006      |       |       | 26         |                                                 |       |                                                   | 11.87      |                                                                                                                    |       |                                                                                                                        | —     |   |   |   | 60,782 |   |   |
| August 2006   |       |       | 38         |                                                 |       |                                                   | 10.92      |                                                                                                                    |       |                                                                                                                        | —     |   |   |   | 60,782 |   |   |
| November 2006 |       |       | 22         |                                                 |       |                                                   | 13.88      |                                                                                                                    |       |                                                                                                                        | —     |   |   |   | 60,782 |   |   |
| Total              |       |       | 11,147     |                                                 |       |                                                   | $          | 12.73                                                                                                                   |       |                                                                                                                        |       | 10,932 |   |   |   |   |   |   |

 

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**Performance Graph**

This performancegraph shall not be deemed “filed” for purposes of Section 18 of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”) or otherwisesubject to the liabilities under that Section and shall not be deemed tobe incorporated by reference into any filing of United Online under theSecurities Act of 1933, as amended or the Exchange Act.

Thefollowing graph compares, for the five year period ended December 31,2006, the cumulative total stockholder return for the Company’s common stock,the Nasdaq Stock Market (U.S. companies) Index (the “NASDAQ Composite”) and theMorgan Stanley Internet Index (“MS Internet Index”). Measurement points are thelast trading day of each of the Company’s fiscal years ended December 31,2001, 2002, 2003, 2004, 2005 and 2006. The graph assumes that $100 was investedon December 31, 2001 in the common stock of the Company, the NASDAQComposite and the MS Internet Index and assumes reinvestment of any dividends.The stock price performance on the following graph is not necessarilyindicative of future stock price performance.

| ** **           | ** ** | **Dec-01** | ** ** | **Dec-02** | ** ** | **Dec-03** | ** ** | **Dec-04** | ** ** | **Dec-05** | ** ** | **Dec-06** | ** ** |   |
|----------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|--------|
| United Online,  Inc. |       | $          | 100.00     |       | $          | 379.54     |       | $          | 599.64     |       | $          | 411.79     |       | $      | 530.70 |   | $ | 506.33 |   |
| NASDAQ Composite     |       | $          | 100.00     |       | $          | 68.47      |       | $          | 102.72     |       | $          | 111.54     |       | $      | 113.07 |   | $ | 123.84 |   |
| MS Internet Index    |       | $          | 100.00     |       | $          | 57.14      |       | $          | 93.80      |       | $          | 107.07     |       | $      | 107.94 |   | $ | 118.11 |   |

 

**ITEM 6.**                SELECTEDFINANCIAL DATA

The following selected consolidated financial datashould be read in conjunction with our consolidated financial statements andrelated notes and Management’s Discussion and Analysis of Financial Conditionand Results of Operations included elsewhere in this Annual Report on Form 10-K.

The following table presents the consolidatedstatements of operations data for the years ended December 31, 2006, 2005and 2004, and the consolidated balance sheet data at December 31, 2006 and2005. Such financial data are derived from our audited consolidated financialstatements included elsewhere in this Annual Report on Form 10-K.The table also presents the consolidated statements of 

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operations data for thesix months ended December 31, 2003 and the years ended June 30, 2003and 2002 and the consolidated balance sheet data at December 31, 2003 and June 30,2003 and 2002 and are derived from our audited consolidated financialstatements that are not included in this Annual Report on Form 10-K.

Thefollowing amounts are in thousands, except per share data:

| ** **                                       | ** ** | **Year Ended December 31, ** | ** ** | **Six Months  Ended  December 31,** | ** ** | **Year Ended June 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                       | ** ** | **2006(5)**                                      | ** ** | **2005**                                      | ** ** | **2004(4)**                            | ** ** | **2003(3)** | ** ** | **2003(2)** | ** ** | **2002(1)** | ** ** |
| **Consolidated  Statements of Operations Data:** |       |                                             |       |                                          |       |                                   |       |   |   |   |   |   |   |   |   |
| Total revenues                                   |       | $                                                | 522,654    |                                          | $          | 525,061                                |       | $ | 448,617 |   |   | $ | 185,738 |   |   | $ | 277,295 |   | $ | 167,515 |   |
| Operating income  (loss)                         |       | $                                                | 74,019     |                                          | $          | 86,560                                 |       | $ | 79,493 |   |   | $ | 32,639 |   |   | $ | 21,721 |   | $ | (53,946 | ) |
| Net income (loss)                                |       | $                                                | 42,272     |                                          | $          | 47,127                                 |       | $ | 117,480 |   |   | $ | 33,327 |   |   | $ | 27,792 |   | $ | (47,810 | ) |
| Net income (loss)  per share—basic          |       | $                                                | 0.66       |                                          | $          | 0.77                                   |       | $ | 1.91 |   |   | $ | 0.52 |   |   | $ | 0.45 |   | $ | (0.90 | ) |
| Net income (loss)  per share—diluted        |       | $                                                | 0.64       |                                          | $          | 0.74                                   |       | $ | 1.81 |   |   | $ | 0.48 |   |   | $ | 0.41 |   | $ | (0.90 | ) |

 

| ** **                                | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                | ** ** | **2006**              | ** ** | **2005**          | ** ** | **2004** | ** ** | **2003** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Consolidated  Balance Sheet Data:**     |       |                  |       |              |       |   |   |   |   |   |   |   |   |
| Total assets                              |       | $                     | 503,019    |              | $          | 521,188 |   | $ | 519,852 |   | $ | 307,879 |   | $ | 280,676 |   | $ | 233,593 |   |
| Non-current  liabilities                  |       | $                     | 10,983     |              | $          | 45,863 |   | $ | 81,207 |   | $ | — |   | $ | — |   | $ | — |   |
| Cash dividends declared  per common share |       | $                     | (0.80      | )(7)              | $          | (0.60 | )(6) | $ | — |   | $ | — |   | $ | — |   | $ | — |   |

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(1)          In September 2001,NetZero and Juno merged and became wholly-owned subsidiaries of UnitedOnline. The results of Juno are included in our consolidated results ofoperations from the date of the Merger.

(2)          Net income included taxbenefits of $4.3 million for the year ended June 30, 2003 for therealization of net operating loss (“NOL”) carryforward benefits due to a changein the valuation allowance.

(3)          Net income included NOLtax benefits of $12.3 million for the six months ended December 31,2003.

(4)          In November 2004,we acquired Classmates. The results of Classmates are included in ourconsolidated results of operations from the date of acquisition. See Note 2 ofthe consolidated financial statements. Net income included NOL tax benefits of$68.6 million for the year ended December 31, 2004.

(5)          In April 2006, weacquired MyPoints.com, Inc. (“MyPoints”). The results of MyPoints are includedin our consolidated results of operations from the date of acquisition. SeeNote 2 of the consolidated financial statements. Additionally, in the December 2006quarter, we recorded a $13.3 million ($8.0 million, net of tax), impairmentof goodwill, intangible assets and long-lived assets.

(6)          In May, August and October of2005, our Board of Directors declared a quarterly cash dividend of $0.20 pershare of common stock.

(7)          In February, May, August andNovember of 2006, our Board of Directors declared a quarterly cashdividend of $0.20 per share of common stock.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Forward-LookingStatements**

*This Annual Report on Form 10-K and thedocuments incorporated herein by reference contain forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995  based on our currentexpectations, 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 expressionsconstitute forward-looking statements. These forward-lookingstatements include, but are not limited to, statements about the markets inwhich we compete, our pay accounts and subscriptions, our product and serviceofferings, the advertising market, operating expenses, operating efficiencies,revenues, capital requirements, tax payments and our cash position. Inaddition, any statements that refer to expectations, projections or othercharacterizations of future events or circumstances, including any underlyingassumptions, are forward-looking statements. Such statements are notguarantees of future performance and are subject to risks, uncertainties andassumptions that are difficult to predict. Therefore, our actual results coulddiffer materially and adversely from those expressed in any forward-lookingstatements as a result of various factors. The section entitled “Risk Factors”in this Annual Report on Form 10-K and our other filings with theSEC set forth some of the important risk factors that may affect our business,financial position, results of operations and cash flows. Statements indicatingfactors that we believe may impact our results are not intended to beexclusive. We undertake no obligation to revise or update publicly any forward-lookingstatements, other than as required by law.*

**Overview**

We are a leading providerof consumer Internet and media services through a number of brands includingNetZero, Juno, Classmates and MyPoints. Our primary Communications servicesinclude Internet access and email. Our primary Content & Mediaservices include social networking and online loyalty marketing. On a combinedbasis, our Web properties attract a significant number of Internet users eachmonth and we offer marketers a broad array of Internet advertising products andservices as well as online market research and measurement services.

**Segment Definitions**

Wereport our businesses in two reportable segments:

| **Segment**              | ** ** | ** **                                                            | ** ** | **Internet Services** |
|--------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------|
| Communications           |       | Internet access,  email, Internet security, family services and VoIP. |
| Content & Media |       | Social networking, loyalty marketing, Web hosting  and photo sharing. |

** **

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**Account Metrics**

At December 31,2006, we had approximately 4.9 million pay accounts and approximately 20.1million active accounts. A pay account represents a unique billing relationshipwith a customer who subscribes to one or more of our pay services. “Active”accounts include total pay accounts as well as free users who have logged ontoour access, social-networking, email or VoIP services during the preceding31 days. Active accounts also include those free hosted Web sites thathave received at least one visit during the preceding 90 days; the numberof free photo-sharing users that logged on to the service at least once withinthe preceding 90 days; and the number of MyPoints’ members who earned or spentpoints within the preceding 90 days. The following table sets forth (inthousands), for the dates presented, an analysis of our pay accounts.

| ** **                 | ** ** | **December 31,  2006** | ** ** | **September 30,  2006** | ** ** | **June 30,  2006** | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------|------------|-----------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Communications:            |       |                        |       |                         |       |                    |       |                     |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Access                     |       |                        | 2,282      |                         |       |                    | 2,425      |                     |       |                        | 2,556      |   |   |   | 2,751 |   |   |   | 2,855 |   |   |
| Other                      |       |                        | 317        |                         |       |                    | 323        |                     |       |                        | 330        |   |   |   | 321 |   |   |   | 313 |   |   |
| Total                      |       |                        | 2,599      |                         |       |                    | 2,748      |                     |       |                        | 2,886      |   |   |   | 3,072 |   |   |   | 3,168 |   |   |
| Content &  Media: |       |                        |       |                         |       |                    |       |                     |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Social networking          |       |                        | 2,169      |                         |       |                    | 2,079      |                     |       |                        | 2,029      |   |   |   | 1,945 |   |   |   | 1,766 |   |   |
| Other                      |       |                        | 86         |                         |       |                    | 85         |                     |       |                        | 81         |   |   |   | 76 |   |   |   | 75 |   |   |
| Total                      |       |                        | 2,255      |                         |       |                    | 2,164      |                     |       |                        | 2,110      |   |   |   | 2,021 |   |   |   | 1,841 |   |   |
| Total pay  accounts        |       |                        | 4,854      |                         |       |                    | 4,912      |                     |       |                        | 4,996      |   |   |   | 5,093 |   |   |   | 5,009 |   |   |

 

In general, we count and track pay accounts and freeaccounts by unique member identifiers. Users have the ability to register forseparate services under separate brands and member identifiers independently.We do not track whether a pay account has purchased more than one of ourservices unless the account uses the same member identifier. As a result, totalactive free accounts may not represent unique free users. At any point in time,our pay account base includes a number of accounts receiving a free period ofservice as either a promotion or retention tool, a number of accounts that havenotified us that they are terminating their service but whose service is stillin effect and may also include a few thousand internal test accounts.

We have made the decisionto curtail our efforts with respect to our VoIP services, although the planshave not yet been finalized. Our VoIP services had approximately 9,000 payaccounts and approximately 182,000 active accounts as of December 31,2006.

**Results ofOperations**

The following tables set forth (with dollars inthousands), for the periods presented, selected historical statements ofoperations data. The information contained in the tables below should be readin conjunction with Liquidity and Capital Resources, Financial Commitments andCritical Accounting Policies and Estimates included in this Item 7 as wellas the consolidated financial statements and notes thereto included elsewherein this Annual Report on Form 10-K.

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Consolidatedinformation is as follows:

| ** **                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Billable services                                                |       | $                                     | 423,565    |   | $ | 465,980 |   | $ | 410,821 |   |
| Advertising                                                      |       | 99,089                                |       | 59,081 |   | 37,796 |   |
| Total revenues                                                   |       | 522,654                               |       | 525,061 |   | 448,617 |   |
| Operating  expenses:                                             |       |                                  |       |   |   |   |   |
| Cost of revenues                                                 |       | 120,049                               |       | 110,672 |   | 102,392 |   |
| Sales and marketing                                              |       | 177,019                               |       | 209,292 |   | 178,981 |   |
| Product development                                              |       | 52,933                                |       | 40,009 |   | 27,454 |   |
| General and administrative                                       |       | 67,709                                |       | 56,729 |   | 39,894 |   |
| Amortization of intangible assets                                |       | 17,640                                |       | 21,799 |   | 20,403 |   |
| Impairment of goodwill, intangible assets and  long-lived assets |       | 13,285                                |       | — |   | — |   |
| Total operating expenses                                         |       | 448,635                               |       | 438,501 |   | 369,124 |   |
| Operating income                                                 |       | 74,019                                |       | 86,560 |   | 79,493 |   |
| Interest and  other income, net                                  |       | 6,076                                 |       | 6,885 |   | 5,138 |   |
| Interest expense                                                 |       | (2,571                                | )          | (6,073 | ) | (1,202 | ) |
| Income before  income taxes                                      |       | 77,524                                |       | 87,372 |   | 83,429 |   |
| Provision for  income taxes                                      |       | 36,293                                |       | 40,245 |   | (34,051 | ) |
| Income before  cumulative effect of accounting change            |       | 41,231                                |       | 47,127 |   | 117,480 |   |
| Cumulative effect  of accounting change, net of tax              |       | 1,041                                 |       | — |   | — |   |
| Net income                                                       |       | $                                     | 42,272     |   | $ | 47,127 |   | $ | 117,480 |   |

 

Informationfor our two key segments is as follows:

| ** **                                                       | ** ** | **Communications**                     | ** ** | **Content & Media**      | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                       | ** ** | **Year Ended  December 31,** | ** ** | **Year Ended  December 31,** | ** ** |
| ** **                                                       | ** ** | **2006**                               | ** ** | **2005**                               | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Billable services                                                |       | $                                      | 336,924    |                                   | $          | 396,331 |   | $ | 400,199 |   | $ | 86,641 |   | $ | 69,649 |   | $ | 10,622 |   |
| Advertising                                                      |       | 39,013                                 |       | 35,613                                 |       | 34,276 |   | 60,076 |   | 23,468 |   | 3,520 |   |
| Total revenues                                                   |       | 375,937                                |       | 431,944                                |       | 434,475 |   | 146,717 |   | 93,117 |   | 14,142 |   |
| Operating  expenses:                                             |       |                                   |       |                                   |       |   |   |   |   |   |   |   |   |
| Cost of revenues                                                 |       | 81,048                                 |       | 89,254                                 |       | 94,451 |   | 28,640 |   | 12,503 |   | 2,794 |   |
| Sales and marketing                                              |       | 109,245                                |       | 162,032                                |       | 174,585 |   | 64,035 |   | 46,093 |   | 3,986 |   |
| Product development                                              |       | 29,295                                 |       | 28,217                                 |       | 25,223 |   | 13,218 |   | 7,643 |   | 1,125 |   |
| General and administrative                                       |       | 19,006                                 |       | 17,155                                 |       | 13,575 |   | 14,130 |   | 10,337 |   | 1,790 |   |
| Impairment of  goodwill, intangible assets and long-lived assets |       | 4,504                                  |       | —                                 |       | — |   | 8,781 |   | — |   | — |   |
| Total operating expenses                                         |       | 243,098                                |       | 296,658                                |       | 307,834 |   | 128,804 |   | 76,576 |   | 9,695 |   |
| Segment income  from operations                                  |       | $                                      | 132,839    |                                   | $          | 135,286 |   | $ | 126,641 |   | $ | 17,913 |   | $ | 16,541 |   | $ | 4,447 |   |

 

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Areconciliation of segment income from operations (which excludes corporateexpenses, depreciation, amortization of intangible assets and stock-basedcompensation) to consolidated operating income, is as follows for each periodpresented (in thousands):

| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|
| ** **                            | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Segment income from  operations:      |       |                                  |       |   |   |   |   |
| Communications                        |       | $                                     | 132,839    |   | $ | 135,286 |   | $ | 126,641 |   |
| Content & Media              |       | 17,913                                |       | 16,541 |   | 4,447 |   |
| Total segment  income from operations |       | 150,752                               |       | 151,827 |   | 131,088 |   |
| Corporate expenses                    |       | (18,635                               | )          | (18,035 | ) | (20,740 | ) |
| Depreciation                          |       | (21,290                               | )          | (15,481 | ) | (8,003 | ) |
| Amortization of intangible assets     |       | (17,640                               | )          | (21,799 | ) | (20,403 | ) |
| Stock-based compensation              |       | (19,168                               | )          | (9,952 | ) | (2,449 | ) |
| Consolidated operating  income        |       | $                                     | 74,019     |   | $ | 86,560 |   | $ | 79,493 |   |

 

Communications segmentincome from operations for the year ended December 31, 2006 includedrestructuring charges of $0.6 million and impairment charges of $4.5 million.Content & Media segment income from operations for the year endedDecember 31, 2006 included impairment charges of $8.8 million. All ofthese charges are included in our operating expenses.

**Year EndedDecember 31, 2006 compared toYear Ended December 31, 2005**

**Comparability**

On January 1, 2006, we adopted Statement of FinancialAccounting Standards (“SFAS”) No. 123 (revised 2004), *Share-BasedPayment*, which requires the measurement and recognition ofcompensation expense for all share-based payment awards made to employees anddirectors including employee stock options, restricted stock awards andemployee stock purchases related to the Employee Stock Purchase Plan (“employeestock purchases”) based on the grant date fair values of the awards. SFAS No.123R supersedes our previous accounting under Accounting Principles Board(“APB”) Opinion No. 25, *Accounting for StockIssued to Employees*. In March 2005, the SEC issued Staff AccountingBulletin (“SAB”) No. 107 relating to SFAS No. 123R. We have applied theprovisions of SAB No. 107 in our adoption of SFAS No. 123R.

We adopted SFAS No. 123R using the modifiedprospective transition method, and the Company’s consolidated financialstatements at and for the year ended December 31, 2006 reflect the impact ofSFAS No. 123R. In accordance with the modified prospective transition method,our consolidated financial statements for prior periods have not been restatedto reflect, and do not include, the impact of SFAS No. 123R. Stock-basedcompensation expense recognized under SFAS No. 123R for the year ended December31, 2006 was $19.2 million, which was primarily related to stock options,restricted stock and the discount on employee stock purchases. Stock-basedcompensation expense, recorded in accordance with APB Opinion No. 25, for theyears ended December 31, 2005 and 2004 was $10.0 million and $2.4 million,respectively, which was primarily related to restricted stock.

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**SFAS No. 123R requires companies toestimate the fair value of share-based payment awards on the grant date usingan option-pricing model. Under SFAS No. 123, we used the Black-Scholesoption-pricing model for valuation of share-based awards for our pro formainformation. Upon adoption of SFAS No. 123R, we elected to continue to use theBlack-Scholes option-pricing model for valuing awards. The value of the portionof the award that is ultimately expected to vest is recognized as expense overthe requisite service periods in our consolidated statements of operations.Prior to the adoption of SFAS No. 123R, we accounted for share-based awards toemployees and directors using the intrinsic value method in accordance with APBOpinion No. 25 as allowed under SFAS No. 123, *Accountingfor Stock-Based Compensation*. Under the intrinsic value method, nostock-based compensation expense related to stock options had been recognizedin our consolidated statements of operations, other than as related toacquisitions, because the exercise price of our stock options granted toemployees and directors equaled the fair market value of the underlying stockat the grant date.**

**Stock-based compensation expenserecognized during the current period is based on the value of the portion ofshare-based payment awards that is ultimately expected to vest. SFAS No. 123Rrequires forfeitures to be estimated at the time of grant in order to calculatethe amount of share-based awards that will ultimately vest. The forfeiture rateis based on historical rates. Stock-based compensation expense recognized inour consolidated statement of operations for the year ended December 31, 2006includes (i) compensation expense for share-based payment awards granted priorto, but not yet vested at, December 31, 2005 based on the grant-date fair valueestimated in accordance with the pro forma provisions of SFAS No. 123 and (ii)compensation expense for the share-based payment awards granted subsequent toDecember 31, 2005, based on the grant-date fair value estimated in accordancewith the provisions of SFAS No. 123R. As stock-based compensation expenserecognized in the consolidated statement of operations for the year endedDecember 31, 2006 is based on awards ultimately expected to vest, it has beenreduced for estimated forfeitures. For the periods prior to 2006, we accountedfor forfeitures as they occurred. Accordingly, a pretax cumulative effect ofaccounting change adjustment totaling $1.1 million ($1.0 million, net of tax)was recorded in the March 2006 quarter to adjust for awards granted prior toJanuary 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 gradedvesting by treating each vesting tranche as a separate award and recognizingcompensation expense ratably for each tranche. For equity awards grantedsubsequent to the adoption of SFAS No. 123R, we treat such awards as a singleaward and recognize stock-based compensation expense on a straight-line basis(net of estimated forfeitures) over the employee service period.**

**In December 2005, our CompensationCommittee of the Board of Directors approved the acceleration of vesting of alloptions to purchase our common stock with exercise prices in excess of $16.00.These options were granted to executive officers and other employees. Optionsto purchase 1.3 million shares of our common stock were subject to thisacceleration and such options had exercise prices ranging from $16.01 to$64.17, and had a weighted-average exercise price of $18.47.**

**The acceleration of vesting ofthese out-of-the-money options was undertaken primarily to eliminate any futurecompensation expense we would otherwise recognize in our income statement withrespect to these options with the implementation of SFAS No. 123R effectiveJanuary 1, 2006. We estimated this compensation expense, before tax, would havetotaled approximately $3.8 million over the course of the original vestingperiods. Ninety-five percent of the options would have vested withinapproximately 1.5 years from the effective date of the acceleration with theremaining 5% vesting within approximately 2.5 years from the date ofacceleration. We also believed that because the options to be accelerated hadexercise prices in excess of the then current market value of our common stock,the options had limited economic value and were not fully achieving theiroriginal objective of incentive compensation and employee retention.**

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**Beginning in May 2006, we shiftedfrom a strategy of granting a combination of stock options and RSUs to solelygranting RSUs. Additionally, in March 2006, we offered eligible employees theopportunity to exchange any outstanding stock options granted to them, whichhad an exercise price per share of our common stock at or above $16.00 (the“Eligible Options”) in return for RSUs. The exchange offer expired in April2006, and approximately 1.8 million shares of common stock underlying EligibleOptions were exchanged for RSUs covering approximately 0.4 million shares ofcommon stock in exchange for the cancellation of the Eligible Options. Totalexpense associated with the exchange, prior to the consideration of expectedforfeitures, was approximately $0.8 million.**

**Totalunrecognized compensation cost related to unvested stock option**sat December 31, 2006, prior to theconsideration of expected forfeitures, is approximately $3.5 million and isexpected to be recognized over a weighted-average period of 1.0 years. Totalunrecognized compensation cost related to unvested restricted stock and RSUs atDecember 31, 2006 prior to the consideration of expected forfeitures isapproximately $23.8 million and is expected to be recognized over aweighted-average period of1.4 years.

**Revenues**

*Billable ServicesRevenues*

Billable services revenues consist of fees charged topay accounts for our pay services and for technical support. Our billableservices revenues are primarily dependent on two factors: the average number ofpay accounts for a period and the average monthly revenue per pay account (“ARPU”)for a period. The average number of pay accounts is a simple average calculatedbased on the number of pay accounts at the beginning and end of a period. ARPUis calculated by dividing billable services revenues for a period by theaverage number of pay accounts for that period. ARPU may fluctuate from periodto period as a result of a variety of factors including changes in the mix ofpay subscriptions and their related pricing plans; the use of promotions, suchas one or more free months of service, and discounted pricing plans to obtainor retain subscribers; increases or decreases in the price of our services; thenumber of services subscribed to by each pay account; pricing and success ofnew pay services and the penetration of these types of services as a percentageof total pay accounts; and the timing of pay accounts being added or removedduring a period.

*ConsolidatedBillable Services Revenues.*   Consolidatedbillable services revenues decreased by $42.4 million, or 9%, to $423.6 millionfor the year ended December 31, 2006, compared to $466.0 million for theyear ended December 31, 2005. The decrease in billable services revenueswas due to a decrease in billable services revenues from our Communicationssegment, partially offset by an increase in revenues from our Content &Media segment. Billable services revenues from our Communications segment andfrom our Content & Media segment constituted 79.5% and 20.5%,respectively, of our consolidated billable services revenues for the year endedDecember 31, 2006, compared to 85.1% and 14.9%, respectively, for the yearended December 31, 2005. We anticipate that our consolidated billableservices revenues will continue to decline as a result of expected continueddeclines in Communications billable services revenues.

*CommunicationsBillable Services Revenues.***  **Communicationsbillable services revenues consist of fees charged to pay accounts for access,email, Internet security and other services, with substantially all generatedfrom access. Communications billable services revenues decreased by $59.4million, or 15%, to $336.9 million for the year ended December 31,2006, compared to $396.3 million for the year ended December 31, 2005. Thedecrease in billable services revenues was due to an 11% decrease in ouraverage number of pay accounts from 3,236,000 for the year ended December 31,2005 to 2,883,000 for the year ended December 31, 2006. The decrease inaverage number of pay accounts is attributable to a decreased number of payaccess accounts. Additionally, Communications billable services revenuesdecreased due to a 5% decrease in ARPU from $10.21 for the year ended December 31,2005 to $9.74 for the year ended December 31, 2006. The decrease in ARPUis primarily attributable to a decline in ARPU for our access 

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services due to increaseduse of free months of service and promotional pricing to obtain or retain payaccess accounts. We anticipate that the average number of Communications payaccounts will continue to decline due to decreases in pay access accounts. Wealso may experience further declines in ARPU primarily as a result ofdiscounted prices for extended service commitments on our access services,including providing our $14.95 accelerated access services at $9.95 for aone-year commitment. As a result of these factors, the rate of decline in Communicationsbillable services revenues has been increasing and may continue to increase, atleast in the near term.

*Content & MediaBillable Services Revenues.***  **Content &Media billable services revenues consist of fees charged to pay accounts forsocial-networking, Web-hosting and other services, with substantially allgenerated from social-networking. Content & Media billable servicesrevenues increased by $17.0 million, or 24%, to $86.6 million for the yearended December 31, 2006, compared to $69.6 million for the year endedDecember 31, 2005. The increase in Content & Media billableservices revenues was due to a 22% increase in our average number of pay accountsfrom 1,681,000 for the year ended December 31, 2005 to 2,048,000 for theyear ended December 31, 2006. Substantially all of this increase wasassociated with growth in our social-networking pay accounts primarily as aresult of organic growth and, to a lesser extent, the acquisition of payaccounts associated with The Names Database business in March 2006, whichhad approximately 58,000 pay accounts at the time of the acquisition.Additionally, Content & Media billable services revenues increased dueto a 2% increase in ARPU from $3.45 for the year ended December 31, 2005to $3.53 for the year ended December 31, 2006. The increase in ARPU isattributable to an increase in ARPU for our social-networking services due to agreater percentage of those pay accounts represented by higher-priced,shorter-term pay service plans, partially offset by decreases in ARPU for ourWeb-hosting and online photo-sharing services. We expect Content & Mediabillable services revenues to grow sequentially at a faster rate in the March 2007quarter versus the growth rate we experienced in the December 2006quarter.

*AdvertisingRevenues*

We connect advertisers to consumers through a varietyof online marketing initiatives integrated throughout our services and Webproperties, including advertising and search placements, email campaigns anduser registration placements. In addition, we offer advertisers sophisticatedmarket research capabilities and online direct marketing solutions. Factorsimpacting our advertising revenues generally include changes in orders fromsignificant customers, the performance of our online marketing initiatives, thestate of the online search and advertising markets, seasonality, increases ordecreases in our active accounts, and increases or decreases in advertisinginventory available for sale.

*ConsolidatedAdvertising Revenues.*   Consolidatedadvertising revenues increased by $40.0 million, or 68%, to $99.1 million forthe year ended December 31, 2006, compared to $59.1 million for the yearended December 31, 2005. The increase was primarily attributable toincreases in advertising revenues in our Content & Media segment and,to a lesser extent, our Communications segment. Advertising revenues from ourCommunications segment and from our Content & Media segmentconstituted 39.4% and 60.6%, respectively, of our consolidated advertisingrevenues for the year ended December 31, 2006, compared to 60.3% and39.7%, respectively, for the year ended December 31, 2005. We anticipatethat our consolidated advertising revenues may decrease in the March 2007quarter when compared to the December 2006 quarter due to seasonality.

*CommunicationsAdvertising Revenues.*   Communicationsadvertising revenues increased by $3.4 million, or 10%, to$39.0 million for the year ended December 31, 2006, from$35.6 million for the year ended December 31, 2005. The increase wasprimarily attributable to increases in advertising sales and data revenue,partially offset by decreases in search revenues due to a decline in our activeaccess accounts.

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*Content & MediaAdvertising Revenues.***  **Content &Media advertising revenues increased by $36.6 million, or 156%, to$60.1 million for the year ended December 31, 2006, compared to$23.5 million for the year ended December 31, 2005. The increase wasdue to increased advertising revenues as a result of revenues generated fromour loyalty marketing service which was acquired in April 2006, partiallyoffset by a decline in advertising revenues generated from oursocial-networking services which was negatively impacted by our decision tosignificantly reduce the number of advertising placements per page inJune 2006. We anticipate that Content & Media advertisingrevenues may decrease in the March 2007 quarter when compared to the December 2006quarter due to seasonality.

**Cost of Revenues**

Cost of revenues includes telecommunications and datacenter costs; personnel and overhead-related costs associated with operatingour networks and data centers; depreciation of network computers and equipment;email technical support and license fees; costs related to providing telephonetechnical support; customer billing and billing support to our pay accounts;domain name registration fees; and costs of providing rewards to members of ourloyalty marketing service. The majority of the costs that comprise ourCommunications cost of revenues are variable. As such, our Communications costof revenues as a percentage of revenues is highly dependent on our ARPU, ouraverage hourly telecommunications cost and usage, and our average customerbilling and support costs per pay account. Although the costs that comprise ourContent & Media cost of revenues were relatively fixed in the past, asa result of our loyalty marketing service which was acquired in April 2006,these costs have become more variable and have increased significantly as apercentage of revenues.

*ConsolidatedCost of Revenues.*   Consolidatedcost of revenues increased by $9.4 million, or 8%, to $120.0 millionfor the year ended December 31, 2006, compared to $110.7 million forthe year ended December 31, 2005. The increase was primarily due toincreased costs associated with our Content & Media segment as well asa $0.8 million increase in depreciation and a $0.6 million increasein stock-based compensation in connection with the adoption of SFASNo. 123R in the March 2006 quarter. Cost of revenues for ourCommunications segment and for our Content & Media segment constituted73.9% and 26.1%, respectively, of our total segment cost of revenues for theyear ended December 31, 2006, compared to 87.7% and 12.3%, respectively,for the year ended December 31, 2005.

*CommunicationsCost of Revenues.*   Communicationscost of revenues decreased by $8.2 million, or 9%, to $81.0 millionfor the year ended December 31, 2006, compared to $89.3 million forthe year ended December 31, 2005. The decrease was primarily due to a$9.8 million decrease in telecommunications costs and a $3.3 milliondecrease in customer support and billing-related costs as a result of adecrease in the number of pay accounts. These decreases were partially offsetby an increase of $3.8 million in costs associated with our VoIP serviceand a $1.1 million increase in network and other overhead-related costs. As a percentageof Communications revenues, Communications cost of revenues increased to 21.6%in the year ended December 31, 2006, compared to 20.7% in the year endedDecember 31, 2005, primarily as a result of VoIP cost of revenuesexceeding VoIP revenues. We anticipate that Communications cost of revenues asa percentage of Communications revenues may be relatively flat in the nearterm. However, our Communications cost of revenues as a percentage ofCommunications revenues may be negatively impacted by our higher cost ofrevenue DSL broadband access service, which was launched in theDecember 2006 quarter.

*Content & MediaCost of Revenues.***  **Content &Media cost of revenues increased by $16.1 million, or 129%, to$28.6 million for the year ended December 31, 2006, compared to$12.5 million for the year ended December 31, 2005. The increase wasprimarily related to costs associated with our loyalty marketing service whichwas acquired in April 2006 and, to a lesser extent, increased costsassociated with our social-networking services. As a percentage ofContent & Media revenues, Content & Media cost of revenuesincreased to 19.5% in the year ended December 31, 2006, compared to 13.4%in the year ended 

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December 31,2005 due to loyalty marketing cost of revenues comprising a larger percentageof revenues than our other Content & Media properties. We anticipatethat Content & Media cost of revenues as a percentage ofContent & Media revenues will increase as a result of the loyaltymarketing acquisition and may vary significantly from quarter-to-quarterdepending on increases or decreases in advertising revenue, which can beimpacted by seasonality and other factors.

**Sales and Marketing**

Sales and marketing expenses include advertising andpromotion expenses, performance fees paid to distribution partners to acquirenew accounts, personnel-related expenses for sales and marketing personnel andtelemarketing costs incurred to acquire and retain pay accounts and up-sell payaccounts to additional services. Marketing and advertising costs to promote ourproducts and services are expensed in the period incurred. Advertising andpromotion expenses include media, agency and promotion expenses. Mediaproduction costs are expensed the first time the advertisement is run. Mediaand agency fees are expensed over the period the advertising runs. Salesexpenses are expensed in the period incurred or, in the case of commissionspaid to sales personnel, when the associated advertising revenue is recognized.

*ConsolidatedSales and Marketing Expenses.*   Consolidatedsales and marketing expenses decreased by $32.3 million, or 15%, to$177.0 million, or 33.9% of consolidated revenues, for the year endedDecember 31, 2006, compared to $209.3 million, or 39.9% ofconsolidated revenues, for the year ended December 31, 2005. The decreasewas primarily attributable to a significant reduction in marketing expensesrelated to our Communications segment, partially offset by an increase inmarketing expenses related to our Content & Media segment and a$2.5 million increase in stock-based compensation in connection with theadoption of SFAS No. 123R in the March 2006 quarter. Sales andmarketing expenses related to our Communications segment and ourContent & Media segment constituted 63.0% and 37.0%, respectively, oftotal segment sales and marketing expenses for the year ended December 31,2006 versus 77.9% and 22.1%, respectively, for the year ended December 31,2005.

*CommunicationsSales and Marketing Expenses.*   Communicationssales and marketing expenses decreased by $52.8 million, or 33%, to$109.2 million, or 29.1% of Communications revenues, for the year endedDecember 31, 2006, compared to $162.0 million, or 37.5% ofCommunications revenues, for the year ended December 31, 2005. This decreaseis attributable to a $61.4 million decline in advertising, promotion anddistribution costs related to our access services, the majority of which wasdue to reductions in media and other advertising costs. These decreases werepartially offset by a $5.1 million increase in VoIP marketing expenses anda $3.4 million increase in personnel and overhead-related expenses.

*Content & MediaSales and Marketing Expenses.*   Content &Media sales and marketing expenses increased by $17.9 million, or 39%, to$64.0 million, or 43.6% of Content & Media revenues, for the yearended December 31, 2006, compared to $46.1 million, or 49.5% ofContent & Media revenues, for the year ended December 31, 2005.The increase was the result of the costs associated with our loyalty marketingservice which was acquired in April 2006, a $3.4 million increase inpersonnel and overhead-related expenses and a $2.0 million increase inmarketing, promotion and distribution costs related to acquiring and retainingaccounts, particularly social-networking accounts. The vast majority ofnon-personnel Content & Media marketing expenses are associated withperformance-based advertising arrangements.

**Product Development**

Product development expenses include expenses for themaintenance of existing software and technology and the development of new orimproved software and technology, including personnel-related expenses for thesoftware engineering department and the costs associated with operating ourfacility in India. Costs incurred by us to manage, monitor and operate ourservices are generally expensed as 

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incurred, except forcertain costs relating to the acquisition and development of internal-usesoftware, which are capitalized and depreciated over their estimated usefullives, generally three years or less.

*ConsolidatedProduct Development Expenses.*   Consolidatedproduct development expenses increased by $12.9 million, or 32%, to $52.9million for the year ended December 31, 2006, compared to$40.0 million for the year ended December 31, 2005. The increase wasattributable to increases in expenses in the Content & Media segmentand, to a lesser extent, increases in expenses in the Communications segment,as well as a $4.3 million increase in stock-based compensation inconnection with the adoption of SFAS No. 123R in the March 2006quarter and a $2.0 million increase in depreciation. Product developmentexpenses related to our Communications segment and our Content & Mediasegment constituted 68.9% and 31.1%, respectively, of total segment productdevelopment expenses for the year ended December 31, 2006, compared to78.7% and 21.3%, respectively, for the year ended December 31, 2005.

*CommunicationsProduct Development Expenses.***  **Communicationsproduct development expenses increased by $1.1 million, or 4%, to$29.3 million for the year ended December 31, 2006, compared to$28.2 million for the year ended December 31, 2005. The increase wasthe result of a $0.4 million increase in overhead-related costs, a $0.3 millionincrease in personnel-related expenses and $0.3 million in restructuringcharges recorded in the September 2006 quarter for severance costsassociated with the relocation of Juno’s New York office to New Jersey.Capitalized compensation costs were $7.3 million and $4.0 million inthe years ended December 31, 2006 and 2005, respectively. The increase incapitalized compensation costs was due to projects associated with an upgradeto our customer billing system, projects adding new features and functionalityto our VoIP products and the preparation of our software for the anticipatedrelease of Microsoft’s newest operating system. The increase was partiallyoffset by capitalized compensation costs in 2005 related to the development ofour VoIP services.

*Content & MediaProduct Development Expenses.***  **Content &Media product development expenses increased by $5.6 million, or 73%, to$13.2 million for the year ended December 31, 2006, compared to$7.6 million for the year ended December 31, 2005. The increase wasprimarily due to a $5.1 million increase in personnel-related expenses dueto increased headcount related to our social-networking services and increasedheadcount associated with the acquisition of our loyalty marketing service inApril 2006.

**General andAdministrative**

General and administrative expenses includepersonnel-related expenses for executive, finance, legal, human resources andinternal customer support personnel. In addition, general and administrativeexpenses include fees for professional legal, accounting and financialservices; office relocation costs; non-income taxes; insurance; andoccupancy and other overhead-related costs, as well as the expensesincurred and credits received as a result of certain legal settlements.

*ConsolidatedGeneral and Administrative Expenses.***  **Consolidated general and administrative expensesincreased by $11.0 million, or 19%, to $67.7 million for the yearended December 31, 2006, compared to $56.7 million for the year endedDecember 31, 2005. The increase was due to increases in theContent & Media and Communications segments and unallocated corporateexpenses, a $3.0 million increase in depreciation and a $1.8 millionincrease in stock-based compensation in connection with the adoption of SFASNo. 123R in the March 2006 quarter. General and administrativeexpenses related to our Communications segment and our Content & Mediasegment constituted 57.4% and 42.6%, respectively, of total segment general andadministrative expenses for the year ended December 31, 2006, compared to62.4% and 37.6%, respectively, for the year ended December 31, 2005.

*CommunicationsGeneral and Administrative Expenses.*   Communicationsgeneral and administrative expenses increased by $1.9 million, or 11%, to $19.0million for the year ended December 31, 2006, 

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compared to $17.2 millionfor the year ended December 31, 2005. The increase was due to a$1.9 million increase in compensation costs, a $0.4 million increasein overhead-related costs and $0.2 million in restructuring chargesrecorded in the September 2006 quarter for severance and move costsassociated with the relocation of Juno’s New York office to New Jersey. Theseincreases were partially offset by a $0.5 million decrease in recruiting andrelocation expenses and a $0.2 million decrease in consulting fees.

*Content &Media General and Administrative Expenses.***  **Content & Media general and administrativeexpenses increased by $3.8 million, or 37%, to $14.1 million for theyear ended December 31, 2006, compared to $10.3 million for the yearended December 31, 2005. The increase was primarily due to increases in compensationcosts, facilities and other overhead-related costs related to our loyaltymarketing service which was acquired in April 2006.

*Unallocated CorporateExpenses.***  **Excludingstock-based compensation and depreciation,****unallocatedcorporate general and administrative expenses increased by $0.6 million,or 3%, to $18.6 million for the year ended December 31, 2006,compared to $18.0 million for the year ended December 31, 2005. Theincrease was primarily due to an increase in overhead-related costs, legal reservesand consulting fees, partially offset by a decrease in compensation costs.

**Amortization ofIntangible Assets**

Amortization of intangible assets includesamortization of acquired pay accounts and free accounts, acquired trademarksand trade names, purchased technologies and other identifiable intangibleassets. In accordance with the provisions set forth in SFAS No. 142, *Goodwill and Other Intangible Assets*, goodwill is not beingamortized but is tested for impairment at a reporting unit level on an annualbasis and between annual tests if an event occurs or circumstances change thatwould indicate the fair value of a reporting unit below its carrying valueamount.

Consolidated amortizationof intangible assets decreased by $4.2 million, or 19%, to $17.6 millionfor the year ended December 31, 2006, compared to $21.8 million forthe year ended December 31, 2005. The decrease was primarily attributableto the accelerated amortization of intangible assets in 2005 associated withthe Classmates acquisition in November 2004, partially offset by increasedamortization related to intangible assets acquired in connection with theacquisitions of The Names Database in the March 2006 quarter and MyPointsin the June 2006 quarter.

**Impairment ofGoodwill, Intangible Assets and Long-Lived Assets**

Under SFAS No. 142, goodwill and otherindefinite-lived intangibles must be tested for impairment annually or whenevents and circumstances change that would more likely than not indicate thatgoodwill might be permanently impaired. In the December 2006 quarter, wetested goodwill for impairment and recorded a goodwill impairment charge of$5.7 million and an intangible assets impairment charge of $3.0 millionrelated to our photo-sharing service within the Content & Mediasegment. The $3.0 million intangible assets impairment charge wascomprised of $2.9 million of acquired software technology and $0.1 millionof acquired pay accounts, proprietary rights and domain names. We determinedthe amount of the charge based on an estimate of the fair value of thephoto-sharing assets, using the income approach, discounted cash flow method.

Under SFAS No. 144, long-lived assets, other thanindefinite life intangible assets, must be tested for impairment when events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. In the December 2006 quarter, we recognized assetimpairment charges of $4.5 million attributable to certain assets of our VoIP serviceswithin the Communications segment. As a result of slower than expected growthof the VoIP market in the United States, current period operating losses andprojected continuing operating losses, we evaluated the recoverability ofcertain assets and wrote off $4.3 million of capitalized software and $0.2million of prepaid marketing and domain names. We were 

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required to reduce thecarrying value of the assets to fair value and recognized asset impairmentcharges because the carrying value of the affected assets exceeded the futureundiscounted cash flows. See Note 6 of the consolidated financial statements.

**Wedetermined that our goodwill and long-lived assets were not impaired based onour annual test during the year ended December 31, 2005.**

**Interest and OtherIncome, Net**

Interest income consists of earnings on our cash, cashequivalents and short-term investments. Other income and expense, net consistsof realized gains and losses recognized in connection with the sale ofshort-term investments.

Interest and other income,net decreased by $0.8 million, or 12%, to $6.1 million for the yearended December 31, 2006, compared to $6.9 million for the year endedDecember 31, 2005 as a result of lower average balances on our cash andcash equivalents and short-term investments, partially offset by higher yieldsin our investment portfolio. Net realized gains on our short-term investmentswere not significant for the years ended December 31, 2006 and 2005.

**Interest Expense**

Interest expense consistsof interest expense on our term loan retired in January 2006, capitalleases, the amortization of premiums on certain of our short-term investmentsand imputed interest on the acquired member retention liability.

Interest expense decreasedby $3.5 million, or 58%, to $2.6 million for the year endedDecember 31, 2006, compared to $6.1 million for the year endedDecember 31, 2005. The decrease was primarily the result of decreases ininterest expense and amortized deferred financing costs related to the termloan. In January 2006, we expensed the remaining $1.5 million in deferredfinancing costs upon the repayment of the $54.2 million balance of the termloan. The decrease was partially offset by a $0.5 million increase in imputedinterest on the acquired member retention liability.

**Provision for Income Taxes**

For the year endedDecember 31, 2006, we recorded a tax provision of $36.3 million onpre-tax income of $77.5 million, resulting in a year-to-date effective taxrate of 46.8%. The effective tax rate differs from the statutory rate primarilydue to (1) stock-based compensation that is limited underSection 162(m) of the Internal Revenue Code (the “Code”);(2) foreign losses, the benefit of which is not currently recognizable dueto uncertainty regarding realization; and (3) the re-measurement of net deferredtax assets in New York. Additionally, in 2006, the effective rate was increaseddue to employee stock purchase plan compensation, the benefit of which is notrecognized under SFAS No. 123R. This increase was completely offset by thebenefit of federal exempt interest income.

For the year endedDecember 31, 2005, we recorded a tax provision of $40.2 million on pre-taxincome of $87.4 million, resulting in an effective tax rate of 46.1%. Theeffective tax rate differs from the statutory rate primarily due tocompensation, including stock-based compensation, that is limited underSection 162(m) of the Code; foreign losses, the benefit of which isnot currently recognizable due to uncertainty regarding realization; and there-measurement of net deferred tax assets, including a change in New York statetax law. This re-measurement resulted in an increase to the tax provision forthe year ended December 31, 2005 by approximately $2.5 million, or 2.8%.

At December 31, 2006,we had net operating loss and tax credit carryforwards for federal and stateincome tax purposes of approximately $175 million and $61 million, respectively,which begin to expire in 2018 and 2007, respectively. With respect to the statenet operating losses, certain amounts will be further 

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reducedpursuant to the state allocation and apportionment laws. These carryforwardshave been adjusted to reflect our estimate of limitations underSection 382 of the Code. We have also claimed income tax deductions fromthe exercise of certain stock options and the related sale of common stock byemployees, and, in 2006, the deduction includes the excess deduction for vestedrestricted stock. For the years ended December 31, 2006, 2005 and 2004,benefits of $5.8 million, $7.2 million and $8.6 million, respectively, werecredited to stockholders’ equity.

**Cumulative Effect of Accounting Change, Net of Tax**

In the year endedDecember 31, 2006, we recorded a $1.1 million pretax benefit($1.0 million, net of tax) as the cumulative effect of a change inaccounting principle upon the adoption of SFAS No. 123R to recognize theeffect of estimating the number of awards granted prior to January 1, 2006that are not ultimately expected to vest.

**Year EndedDecember 31, 2005 compared toYear Ended December 31, 2004**

**Revenues**

*Billable ServicesRevenues*

*ConsolidatedBillable Services Revenues.**  *Consolidatedbillable services revenues increased by $55.2 million, or 13%, to$466.0 million for the year ended December 31, 2005, compared to$410.8 million for the year ended December 31, 2004. The increase inbillable services revenues was due to an increase in billable services revenuesfrom our Content & Media segment, partially offset by a decrease inbillable services revenues from our Communications segment. Billable servicesrevenues from our Communications segment and from our Content & Mediasegment constituted 85.1% and 14.9%, respectively, of our consolidated billableservices revenues for the year ended December 31, 2005, compared to 97.4%and 2.6%, respectively, for the year ended December 31, 2004.

*CommunicationsBillable Services Revenues.**  *Communicationsbillable services revenues decreased by $3.9 million, or 1%, to $396.3 millionfor the year ended December 31, 2005, compared to $400.2 million for theyear ended December 31, 2004. The decrease in billable services revenueswas due to a 5% decrease in ARPU from $10.76 for the year endedDecember 31, 2004 to $10.21 for the year ended December 31, 2005. Thedecrease in ARPU was primarily attributable to a decline in ARPU for our accessservices due to increased use of free months of service and promotional pricingto obtain or retain pay access accounts. This decrease was partially offset bya 4% increase in our average number of pay accounts from 3,098,000 for the yearended December 31, 2004 to 3,236,000 for the year ended December 31,2005. The increase in the average number of pay accounts is attributable to anincrease in average non-access pay accounts, partially offset by a decrease inaverage access pay accounts.

*Content & MediaBillable Services Revenues.**  *Content &Media billable services revenues increased by $59.0 million to $69.6 millionfor the year ended December 31, 2005, compared to $10.6 million for theyear ended December 31, 2004. The increase is primarily due to revenuesassociated with the acquisition of Classmates in the December 2004quarter.

*AdvertisingRevenues*

*ConsolidatedAdvertising Revenues.**  *Advertisingrevenues increased by $21.3 million, or 56%, to $59.1 million for theyear ended December 31, 2005, from $37.8 million for the year endedDecember 31, 2004. The increase was primarily attributable to increases inadvertising revenues in our Content & Media segment and, to a lesserextent, our Communications segment. Advertising revenues from our Communicationssegment and from our Content & Media segment constituted 60.3% and39.7%, 

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respectively, of ourconsolidated advertising revenues for the year ended December 31, 2005,compared to 90.7% and 9.3%, respectively, for the year ended December 31,2004.

*CommunicationsAdvertising Revenues.**  *Communicationsadvertising revenues increased by $1.3 million, or 4%, to $35.6 million for theyear ended December 31, 2005, compared to $34.3 million for the year endedDecember 31, 2004. The increase was primarily attributable to increasedadvertising sales, data revenue and revenues from our search agreement withYahoo! Search. These increases were partially offset by a decrease in revenuesgenerated from our expired agreement with General Motors Corporation.

*Content & MediaAdvertising Revenues.**  *Content &Media advertising revenues increased by $19.9 million to $23.5 million for theyear ended December 31, 2005, compared to $3.5 million for the year endedDecember 31, 2004. The increase was primarily due to increased advertisingrevenues associated with the acquisition of Classmates in theDecember 2004 quarter and, to a lesser extent, advertising revenuesgenerated from our Web-hosting services.

**Cost of Revenues**

*ConsolidatedCost of Revenues.**  *Consolidatedcost of revenues increased by $8.3 million, or 8%, to $110.7 million, or 21.1%of consolidated revenues, for the year ended December 31, 2005, comparedto $102.4 million, or 22.8% of consolidated revenues, for the year ended December 31,2004. The increase was primarily due to increased costs associated with ourContent & Media segment and a $3.6 million increase indepreciation, partially offset by decreased costs associated with ourCommunications segment. Cost of revenues for our Communications segment and forour Content & Media segment constituted 87.7% and 12.3%, respectively,of our total segment cost of revenues for the year ended December 31, 2005,compared to 97.1% and 2.9%, respectively, for the year ended December 31,2004.

*CommunicationsCost of Revenues.**  *Communicationscosts of revenues decreased by $5.2 million, or 6%, to $89.3 million, or 20.7%of Communications revenues, for the year ended December 31, 2005, comparedto $94.5 million, or 21.7% of Communications revenues, for the year endedDecember 31, 2004. The decrease was due to a $6.4 million decrease intelecommunications costs and a $1.3 million decrease in customer support andbilling-related costs. These decreases were partially offset by an increase of$1.3 million in network and overhead-related costs and $1.2 million in costsassociated with our VoIP service.

*Content & MediaCost of Revenues.**  *Content &Media cost of revenues increased by $9.7 million to $12.5 million, or 13.4% ofContent & Media revenues, for the year ended December 31, 2005,compared to $2.8 million, or 19.8% of Content & Media revenues, forthe year ended December 31, 2004. The increase was primarily related to costsassociated with the acquisition of Classmates in the December 2004 quarter,and to a lesser extent, increased costs associated with our Web-hostingservice.

**Sales and Marketing**

*ConsolidatedSales and Marketing Expenses.**  *Consolidatedsales and marketing expenses increased by $30.3 million, or 17%, to$209.3 million, or 39.9% of consolidated revenues, for the year endedDecember 31, 2005, compared to $179.0 million, or 39.9% of consolidatedrevenues, for the year ended December 31, 2004. The increase was primarilyattributable to an increase in marketing expenses related to ourContent & Media segment, partially offset by a reduction in marketingexpenses related to our Communications segment. The increase was also due to a$0.9 million increase in stock-based compensation in connection with theissuance of RSUs during 2005. Sales and marketing expenses related to ourCommunications segment and our Content & Media segment constituted77.9% and 22.1%, respectively, of total segment sales and marketing expensesfor the year ended December 31, 2005 versus 97.8% and 2.2%, respectively,for the year ended December 31, 2004.

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*Communications Sales andMarketing Expenses.**  *Communicationssales and marketing expenses decreased by $12.6 million, or 7%, to $162.0million, or 37.5% of Communications revenues, for the year ended December 31,2005, compared to $174.6 million, or 40.2% of Communications revenues, for theyear ended December 31, 2004. This decrease is attributable to a $16.3million decline in advertising, promotion and distribution costs related to ouraccess services, the majority of which was due to reductions in media and otheradvertising costs, and a $1.8 million decrease in personnel andoverhead-related expenses. These decreases were partially offset by a $3.6million increase in VoIP marketing expenses.

*Content & MediaSales and Marketing Expenses.**  *Content &Media sales and marketing expenses increased by $42.1 million to $46.1 million,or 49.5% of Content & Media revenues, for the year ended December 31,2005, compared to $4.0 million, or 28.2% of Content & Media revenues,for the year ended December 31, 2004. The increase is primarily due to a$30.2 million increase in expenses related to promoting our Classmatessocial-networking service and a $10.5 million increase in personnel andoverhead-related costs associated with the acquisition of our Classmatessocial-networking service in the December 2004 quarter.

**Product Development**

*Consolidated ProductDevelopment Expenses.**  *Consolidatedproduct development expenses increased by $12.6 million, or 46%, to$40.0 million for the year ended December 31, 2005, compared to$27.5 million for the year ended December 31, 2004. The increase wasattributable to increases in expenses in the Content & Media segmentand, to a lesser extent, increases in expenses in the Communications segment,as well as a $2.0 million increase in depreciation and a $1.0 million increasein stock-based compensation in connection with the issuance of RSUs during2005. Product development expenses related to our Communications segment andour Content & Media segment constituted 78.7% and 21.3%, respectively,of total segment product development expenses for the year ended December 31,2005, compared to 95.7% and 4.3%, respectively, for the year ended December 31,2004.

*Communications ProductDevelopment Expenses.**  *Communicationsproduct development expenses increased by $3.0 million, or 12%, to $28.2million for the year ended December 31, 2005, compared to $25.2 millionfor the year ended December 31, 2004. The increase was due to a $1.8million increase in compensation costs and a $1.2 million increase inoverhead-related costs. Capitalized compensation costs were $4.0 million and$0.2 million in the years ended December 31, 2005 and 2004, respectively.The majority of the capitalized compensation costs in the year ended December 31,2005 related to the development of our VoIP service and the new version of ouraccelerator service.

*Content & MediaProduct Development Expenses.**  *Content &Media product development expenses increased by $6.5 million to $7.6 millionfor the year ended December 31, 2005, compared to $1.1 million for theyear ended December 31, 2004. The increase was primarily due to anincrease in compensation costs associated with the acquisition of Classmates inthe December 2004 quarter.

**General and Administrative**

*Consolidated General andAdministrative Expenses.**  *Consolidatedgeneral and administrative expenses increased by $16.8 million, or 42%, to$56.7 million for the year ended December 31, 2005, compared to$39.9 million for the year ended December 31, 2004. The increase wasprimarily due to increases in expenses in the Content & Media segmentand, to a lesser extent, increases in expenses in the Communications segment,partially offset by a decrease in unallocated corporate expenses. Additionally,the increase was due to a $5.4 million increase in stock-based compensation inconnection with the issuance of RSUs during 2005 and a $1.9 million increase indepreciation. General and administrative expenses related to our Communicationssegment and our Content & Media segment constituted 62.4% and 37.6%,respectively, of total segment general and administrative expenses for the yearended December 31, 2005, compared to 88.4% and 11.6%, respectively, forthe year ended December 31, 2004.

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*Communications General andAdministrative Expenses.**  *Communicationsgeneral and administrative expenses increased by $3.6 million, or 26%, to $17.2million for the year ended December 31, 2005, compared to $13.6 millionfor the year ended December 31, 2004. The increase was due to a $1.0million increase in recruiting and relocation expenses, a $0.9 million increasein compensation costs, a $0.9 million increase in consulting fees and a $0.8million increase in facilities and other overhead-related expenses.

*Content & MediaGeneral and Administrative Expenses.**  *Content & Media general and administrativeexpenses increased by $8.5 million to $10.3 million for the year ended December 31,2005, compared to $1.8 million for the year ended December 31, 2004. Theincrease was primarily due to a $5.2 million increase in compensation costs anda $3.1 million increase in facilities and other overhead-related expensesassociated with the acquisition of Classmates in the December 2004 quarter.

*Unallocated Corporate Expenses.*   Excluding stock-based compensation anddepreciation, unallocated corporate general and administrative expensesdecreased by $2.7 million, or 13%, to $18.0 million for the year ended December 31,2005, compared to $20.7 million for the year ended December 31, 2004. Thedecrease was the result of $3.3 million in facility-exit costs recognized inthe year ended December 31, 2004 and a $0.2 million decrease in facilitiesand other overhead-related expenses, offset by a $0.5 million increase inconsulting fees and a $0.3 million increase in compensation costs.

**Amortization of Intangible Assets**

AtDecember 31, 2005, we had approximately $59.3 million in netidentifiable intangible assets resulting primarily from the acquisitions ofClassmates, BlueLight Internet assets and the Web-hosting and photo-sharingservices. At December 31, 2005, we had approximately $80.5 million ingoodwill resulting from the acquisitions of Classmates and the Web-hosting and photo-sharingservices. In accordance with the provisions set forth in SFAS No. 142, *Goodwill and Other Intangible Assets*, goodwill is not beingamortized but is tested for impairment at a reporting unit level on an annualbasis and between annual tests if an event occurs or circumstances change thatwould more likely than not reduce the fair value of a reporting unit below itscarrying value amount. We determined that our goodwill and long-lived assetswere not impaired based on our annual test during the years endedDecember 31, 2005 and 2004.

Amortizationof intangible assets increased by $1.4 million, or 7%, to$21.8 million for the year ended December 31, 2005, compared to$20.4 million for the year ended December 31, 2004. The increases aredue to the amortization of identifiable intangible assets from our acquisitionsof Classmates and the photo-sharing service, offset partially by a decrease inamortization of intangible assets from the Merger. We recorded a reduction inthe remaining intangible assets from the Merger of approximately$11.2 million during the December 2004 quarter in connection with therelease of the deferred tax valuation allowance. In addition, the increase wasrelated to the amortization of identifiable intangible assets throughout 2005from the acquisition of our Web-hosting services in April 2004. Certain ofthe acquired intangible assets are amortized on an accelerated basis to bettermatch the expense to the expected cash flows from those assets.

**Interest and Other Income,Net**

Interestand other income, net increased by $1.7 million, or 34%, to$6.9 million for the year ended December 31, 2005, compared to$5.1 million for the year ended December 31, 2004 as a result ofhigher interest rates and higher average balances on our cash and cashequivalents and short-term investments. Net realized gains on our short-terminvestments were not significant for the year ended December 31, 2005. Netrealized gains on our short-term investments were approximately$0.1 million for the year ended December 31, 2004.

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**Interest Expense**

Interestexpense increased by $4.9 million to $6.1 million for the year ended December 31,2005, compared to $1.2 million for the year ended December 31, 2004. Theincrease was primarily the result of interest on the outstanding balance on theterm loan, which was issued in December 2004. In January 2006, werepaid the remaining balance of $54.2 million on the term loan.

**Provision for Income Taxes**

Forthe year ended December 31, 2005, we recorded a tax provision of $40.2million on pre-tax income of $87.4 million, resulting in an effective tax rateof 46.1%. The effective tax rate differs from the statutory rate primarily dueto compensation, including stock-based compensation, that was limited under Section 162(m) ofthe Code; foreign losses, the benefit of which is not currently recognizabledue to uncertainty regarding realization; and the re-measurement of netdeferred tax assets, including a change in New York state tax law. Thisre-measurement resulted in an increase to the tax provision for the year ended December 31,2005 by approximately $2.5 million, or 2.8%.

For the year ended December 31, 2004, werecorded a tax benefit of $34.1 million on pre-tax income of $83.4 million,resulting in an effective tax rate benefit of 40.8%. The effective tax ratediffers from the statutory rate primarily due to the release of substantiallyall of the balance of the valuation allowance attributable to the expectedutilization of net deferred tax assets in the future.

**Liquidity and Capital Resources**

Our total cash, cash equivalent and short-terminvestment balances decreased by $82.0 million, or 34%, to$162.4 million at December 31, 2006, compared to $244.4 millionat December 31, 2005. Our summary cash flows for the years ended December 31,2006, 2005 and 2004 were as follows (in thousands):

|                                                       | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                            | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net cash provided  by operating activities            |       | $                                      | 101,470    |   | $ | 137,047 |   | $ | 123,960 |   |
| Net cash used for  investing activities               |       | (89,837                                | )          | (3,389 | ) | (108,010 | ) |
| Net cash provided by  (used for) financing activities |       | (92,725                                | )          | (89,643 | ) | 31,654 |   |
|                                                       |            |                                        |            |  |  |  |  |  |  |  |

 

***Year Ended December 31,2006 compared to Year Ended December 31, 2005***

Netcash provided by operating activities decreased by $35.6 million, or 26%,for the year ended December 31, 2006 compared to the year ended December 31,2005. Cash provided by operating activities is driven by our net incomeadjusted for non-cash items, including depreciation and amortization,stock-based compensation, impairment of goodwill, intangible assets andlong-lived assets, deferred taxes and tax benefits from stock options and changesin working capital. The year-over-year decrease was primarily the result of thefollowing:

·       a$2.3 million increase in other items including a $1.0 million increase in cashpaid for legal settlements and a $0.9 million increase in net amortization onshort-term investments; and

·       a$37.7 million net decrease in working capital accounts, including a$28.9 million decrease in accounts payable and accrued liabilities, a$6.2 million decrease in deferred revenue primarily due to decreases inpay access accounts, a $2.3 million decrease in other liabilities, a $1.6million increase in accounts receivable and a $1.0 million increase in otherassets. These decreases in working capital were partially offset by a$2.3 million increase in member redemption liability related to MyPoints.

The negative impact onworking capital from the change in accounts payable and accrued liabilitybalances was due to a $9.1 million year-over-year reduction in the change inincome taxes payable; a 

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$9.0 millionyear-over-year reduction in the change in accrued employee bonuses due to thetiming of bonus payments, including the payment of bonuses associated with theMyPoints acquisition; a $5.2 million year-over-year reduction in thechange in sales and marketing accruals primarily due to a reduction in mediaand other advertising costs associated with our Communications segment; and anet year-over-year reduction in other payables and accrued liabilitiesprimarily due to the timing of payments to vendors.

Netcash used for investing activities increased by $86.4 million for the yearended December 31, 2006 compared to the year ended December 31, 2005.The increase was primarily the result of the following:

·       a$52.5 million increase in cash paid for acquisitions. We acquired MyPointsin April 2006 for $49.5 million, net of cash acquired; The NamesDatabase in March 2006 for $9.5 million, net of cash acquired; and wepaid the remaining $1.5 million due in connection with the acquisition ofour photo-sharing service in March 2006 compared to the initial payment of$8.6 million in March 2005;

·       a$31.6 million net decrease in proceeds from maturities and sales ofshort-term investments;

·       a$4.8 million escrow deposit for the settlement of a pre-acquisition liabilityin the September 2006 quarter; and

·       a$2.7 million increase in purchases of property and equipment.

These increases in uses ofcash were partially offset by a $5.1 million decrease in purchases ofrights, patents and trademarks, primarily related to the purchase ofproprietary rights associated with the NetZero trademark for $6.0 million,$5.5 million of which was paid in the March 2005 quarter. Theremaining $0.5 million was paid in January 2006.

We have investedsignificantly in our network infrastructure, software licenses, leaseholdimprovements, and computer equipment and we will need to make furthersignificant investments in the future. Capital expenditures for the year ended December 31,2006 were $24.3 million. We anticipate that our total capital expendituresfor 2007 will be in the range of $22 million to $27 million. The actualamount of future capital expenditures may fluctuate due to a number of factorsincluding, without limitation, potential future acquisitions and new businessinitiatives, which are difficult to predict and could change significantly overtime. Additionally, technological advances may require us to make capitalexpenditures to develop or acquire new equipment or technology in order toreplace aging or technologically obsolete equipment.

Netcash used for financing activities increased by $3.1 million, or 3%, forthe year ended December 31, 2006 compared to the year ended December 31,2005. The increase was primarily the result of the following:

·       a$15.4 million increase in dividend payments; and

·       an$8.4 million increase in payments on the term loan. In January 2006,we paid, in full, the outstanding balance of the term loan of approximately$54.2 million.

Theincreases in uses of cash were offset by:

·       an$11.5 million decrease in repurchases of common stock;

·       a$5.4 million increase in proceeds from exercises of stock options and theemployee stock purchase plan; and

·       a$3.9 million increase in excess tax benefits from stock-based compensationas a result of the adoption of SFAS No. 123R, which requires a portion ofthe tax benefits from stock-based compensation to be presented in financingactivities versus its historical presentation in operating activities.

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The payment of dividendswill negatively impact cash flows from financing activities. In 2006, our Boardof Directors declared and paid quarterly cash dividends of $0.20 per share ofcommon stock for a total of $53.5 million. In February 2007, our Board ofDirectors declared and paid a quarterly cash dividend of $0.20 per share ofcommon stock totaling $13.7 million. The payment of future dividends isdiscretionary and will be subject to determination by the Board of Directorseach quarter following its review of our financial performance.

Future cash flows fromfinancing activities may also be affected by repurchases of common stock. OurBoard of Directors authorized a common stock repurchase program that allows usto repurchase shares of our common stock through open market or privatelynegotiated transactions based on prevailing market conditions and other factorsthrough December 31, 2007. At December 31, 2006, we had repurchased$139.2 million of our common stock under the program, and the remainingavailable under the program was $60.8 million.

Cash flows from financingactivities may also be negatively impacted by the withholding of a portion ofshares underlying the RSUs we award to employees. Upon vesting, we currentlyanticipate that we will not collect the applicable withholding taxes for RSUsfrom employees. Instead, we will automatically withhold, from the RSUs thatvest, the portion of those shares with a fair market value equal to the amountof the withholding taxes due. We will then pay the applicable withholding taxesin cash. Similar to repurchases of common stock, the net effect of suchwithholding will adversely impact our cash flows. The amount remitted in theyear ended December 31, 2006 was $2.7 million for which we withheldapproximately 215,000 shares of common stock that were underlying the RSUs. Theamount we pay in future quarters will vary based on our stock price and thenumber of RSUs vesting during the quarter.

Based on our currentprojections, we expect to continue to generate positive cash flows fromoperations, at least in the near term. We intend to use our existing cashbalances and future cash generated from operations to fund dividend payments,if declared by the Board; to develop and acquire complementary services,businesses or technologies; to repurchase shares of our common stock if webelieve market conditions to be favorable; to repurchase the common stockunderlying RSUs and pay the withholding taxes due on vested RSUs; and to fundfuture capital expenditures. We currently anticipate that our future cash flowsfrom operations and existing cash, cash equivalent and short-term investmentbalances will be sufficient to fund our operations over the next year, and inthe near term we do not anticipate the need for additional financing to fundour operations. However, we may raise additional debt or equity capital for avariety of reasons including, without limitation, developing new or enhancingexisting services or products, repurchasing our common stock, acquiringcomplementary services, businesses or technologies or funding significantcapital expenditures. If we need to raise additional capital through public orprivate debt or equity financings, strategic relationships or otherarrangements, it might not be available to us in a timely manner, on acceptableterms, or at all. Our failure to raise sufficient capital when needed could havea material adverse effect on our business, financial position, results ofoperations and cash flows, and could impair our ability to pay dividends. Ifadditional funds were raised through the issuance of equity securities, thepercentage of stock owned by the then-current stockholders would be reduced.Furthermore, such equity securities might have rights, preferences orprivileges senior to holders of our common stock.

***Year Ended December 31,2005 compared to Year Ended December 31, 2004***

Net cash provided byoperating activities increased by $13.1 million, or 11%, for the year ended December 31,2005 compared to the year ended December 31, 2004. Cash provided byoperating activities is driven by our net income adjusted for non-cash items,including depreciation and amortization, stock-based compensation, deferredtaxes and tax benefits from stock options, and changes in working capital.

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The year-over-yearincrease was primarily the result of a $15.0 million net increase in workingcapital accounts due to increases in revenues and operating expenses and thetiming of related cash receipts and payments, including an $8.7 millionincrease in income taxes payable.

Netcash used for investing activities decreased by $104.6 million, or 97%, for theyear ended December 31, 2005 compared to the year ended December 31,2004. The decrease was primarily the result of the following:

·       a$101.5 million decrease in cash paid for acquisitions in the year ended December 31,2005, compared to the year ended December 31, 2004, primarily the resultof the Classmates acquisition for $98.2 million in cash, net of cash acquired,in November 2004; and

·       a$17.0 million net increase in proceeds from maturities and sales of short-terminvestments in the year ended December 31, 2005 compared to the year endedDecember 31, 2004.

Thesedecreases were partially offset by:

·       a$9.1 million increase in capital equipment purchases and capitalized softwarecosts in connection with the development of new products and the ongoingoperations of our business; and

·       a$4.6 million increase in purchases of rights, patents and trademarks, primarilyrelated to the purchase of proprietary rights associated with the NetZerotrademark for $6.0 million, $5.5 million of which was paid in the March 2005quarter. The remaining $0.5 million was paid in January 2006.

Netcash used for financing activities increased by $121.3 million for the yearended December 31, 2005 to $89.6 million compared to $31.7 millionnet cash provided by financing activities in the year ended December 31,2004. The increase was primarily the result of the following:

·       theborrowing of $100 million in December 2004 through a four-year term loanfacility;

·       paymentsof $45.8 million on the term loan in the year ended December 31, 2005,including voluntary prepayments of $28.8 million. In January 2006, wepaid, in full, the outstanding balance of the term loan of approximately $54.2million; and

·       paymentsof $38.1 million for dividends in the year ended December 31, 2005.

Theincreases were offset by:

·       a$60.3 million decrease in repurchases of common stock in the year ended December 31,2005 compared to the year ended December 31, 2004.

In May, August and October of2005, our Board of Directors declared a quarterly cash dividend of $0.20 pershare of common stock. The quarterly dividends were paid on May 31, 2005, August 31,2005 and November 30, 2005 and totaled $12.6 million, $12.7 million and$12.8 million, respectively.

**Financial Commitments**

Ourfinancial commitments were as follows at December 31, 2006 (in thousands):

| ** **                        | ** ** | **Year Ending December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|
| **Contractual Obligations:** | ** ** | ** **                                  | ** ** | **Total** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Capital leases(1)                 |       | $                                           | 32         |   | $ | 18 |   | $ | 14 |   | $ | — |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Operating leases                  |       | 40,181                                      |       | 7,331 |   | 7,094 |   | 6,076 |   | 4,685 |   | 4,010 |   |   | 10,985 |   |   |
| Telecommunications  purchases     |       | 12,050                                      |       | 7,550 |   | 4,500 |   | — |   | — |   | — |   |   | — |   |   |
| Media purchases                   |       | 2,311                                       |       | 2,311 |   | — |   | — |   | — |   | — |   |   | — |   |   |
| Total                             |       | $                                           | 54,574     |   | $ | 17,210 |   | $ | 11,608 |   | $ | 6,076 |   | $ | 4,685 |   | $ | 4,010 |   |   | $ | 10,985 |   |   |
|                                   |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includes$2 of imputed interest.

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**Off-Balance SheetArrangements**

At December 31, 2006,we had no off-balance sheet arrangements that have, or are reasonably likely tohave, a current or future material effect on our consolidated financialcondition, results of operations, liquidity, capital expenditures or capitalresources.

**Critical Accounting Policies and Estimates**

*General*

Our discussion andanalysis of our financial condition and results of operations is based upon ouraudited and unaudited consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) including those for interim financialinformation and with the instructions for Form 10-K and Article 10of Regulation S-X issued by the Securities and Exchange Commission (“SEC”). Thepreparation of financial statements in accordance with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent liabilities and the reportedamounts of revenues and expenses. Actual results could differ from thoseestimates. The results of operations for interim or transition periods are notnecessarily indicative of the operating results for a full year.

The following is adiscussion of the accounting policies and related estimates that we believe aremost critical to understanding our consolidated financial statements, financialposition and results of operations and which require complex managementjudgments, uncertainties and/or estimates.

*Revenue Recognition*

*We*applythe provisions of SEC Staff Accounting Bulletin (“SAB”) No. 104, *Revenue Recognition in Financial Statements,*which provides guidance on the recognition, presentation and disclosure ofrevenue in financial statements filed with the SEC. SAB No. 104 outlinesthe basic criteria that must be met to recognize revenue and provides guidancefor disclosure related to revenue recognition policies. In general, werecognize revenue related to our billable services and advertising productswhen (i) persuasive evidence of an arrangement exists, (ii) deliveryhas occurred or services have been rendered, (iii) the fee is fixed ordeterminable and (iv) collectibility is reasonably assured. We also applythe provisions of Emerging Issues Task Force (“EITF”) Issue No. 00-21,*Revenue Arrangements with Multiple Deliverables*.

Billable services revenuesare recognized in the period in which fees are fixed or determinable and therelated products or services are provided to the user. Our pay accounts generallypay in advance for their service by credit card, and revenue is then recognizedratably over the period in which the related services are provided. Advancepayments from subscribers are recorded on the balance sheet as deferredrevenue. We offer alternative payment methods to credit cards for certain payservice plans. These alternative payment methods currently include ACH, paymentby personal check or money order or through a local telephone company. Incircumstances where payment is not received in advance, revenue is onlyrecognized if collectibility is reasonably assured.

Advertising revenuesconsist primarily of fees from Internet search partners that are generated as aresult of users utilizing partner Internet search services, fees generated byusers viewing and clicking on third-party Web site banners and text-linkadvertisements, fees generated by enabling customer registrations for partnersand fees from referring users to, or from users making purchases on, sponsors’Web sites. Revenues are recognized provided that no significant obligationsremain, fees are fixed or determinable, and collection of the relatedreceivable is reasonably assured. We recognize banner advertising andsponsorship revenues in the periods in which the advertisement or sponsorshipplacement is displayed, based upon the lesser of (i) impressions delivereddivided by the total number of guaranteed impressions or (ii) ratably overthe period in which the advertisement is displayed. Our obligations typicallyinclude a minimum number of impressions or the satisfaction of otherperformance criteria. Revenue from 

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performance-basedarrangements, including referral revenues, is recognized as the relatedperformance criteria are met. In determining whether an arrangement exists, weensure that a binding contract is in place, such as a standard insertion orderor a fully executed customer-specific agreement. We assess whetherperformance criteria have been met and whether the fees are fixed ordeterminable based on a reconciliation of the performance criteria and thepayment terms associated with the transaction. The reconciliation of theperformance criteria generally includes a comparison of internally trackedperformance data to the contractual performance obligation and to third-partyor customer performance data in circumstances where that data is available.Probability of collection is assessed based on a number of factors, includingpast transaction history with the customer and the creditworthiness of thecustomer. If it is determined that collection is not reasonably assured,revenue is not recognized until collection becomes reasonably assured, which isgenerally upon receipt of cash.

Our MyPoints subsidiaryearns revenue primarily from corporate advertising customers by charging feesfor sending emails to the MyPoints’ members and placing advertising on theMyPoints Web site. Under the terms of advertising contracts, MyPoints earnsrevenue primarily based on three components: (1) transmission of emailadvertisements to enrolled members, (2) unique clicks on transmitted emails and(3) actual transactions by members over the Internet. Revenue is recognizedwhen email is transmitted to members, when responses are received and when memberscomplete online transactions. Each of these activities is a discrete,independent activity, which generally is specified in the advertising salesagreement entered into with the customer. As the earning activities take place,activity measurement data (e.g., number of emails delivered and number ofresponses received) is accumulated and the related revenue is recorded. Revenuefrom the sale of points to MyPoints’ advertisers is deferred over a fifteen-monthperiod, which is the expected time that either the points are redeemed andMyPoints provides a reward, or the points expire prior to redemption. Revenueis also deferred if MyPoints has performed under the contract and has billedfor its services, but the collection of the receivable is not reasonablyassured. In such case, revenue is recognized once the collection of the cash isno longer in doubt. Also, deferred revenue represents invoiced services thathave not yet been performed.

*Long-Lived Assets—**We*account for long-lived assets in accordancewith SFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*, which addressesfinancial accounting and reporting for the impairment and disposition oflong-lived assets. We evaluate the recoverability of long-lived assets, otherthan indefinite life intangible assets, for impairment when events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. Events and circumstances that may indicate that an asset isimpaired include significant decreases in the market value of an asset,significant underperformance relative to expected historical or projectedfuture results of operations, a change in the extent or manner in which anasset is used, significant declines in our stock price for a sustained period,shifts in technology, loss of key management or personnel, changes in ouroperating model or strategy and competitive forces.

*Goodwill—**Goodwill**representsthe excess of the cost of an acquired entity over the fair value of theacquired net assets. We account for goodwill in accordance with SFAS No. 142,**Goodwill and Other IntangibleAssets**, which among other things, addresses financial accountingand reporting requirements for acquired goodwill and other intangible assets.SFAS No. 142 requires goodwill to be carried at cost, prohibits theamortization of goodwill and requires us to test goodwill for impairment atleast annually. We perform an impairment test of our goodwill annually duringthe fourth quarter of our fiscal year or when events and circumstances changethat would more likely than not indicate that goodwill might be permanentlyimpaired. Events or circumstances which could trigger an impairment reviewinclude a significant adverse change in legal factors or in the businessclimate, an adverse action or assessment by a regulator, unanticipatedcompetition, a loss of key personnel, significant changes in the manner of ouruse of the acquired assets or the strategy for our overall business,significant negative industry or economic*

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*trends, significant declines inour stock price for a sustained period or significant underperformance relativeto expected historical or projected future results of operations.*

*The testing for a potentialimpairment of goodwill involves a two-step process. The first step of theimpairment test involves comparing the estimated fair values of our reportingunits with their respective book values, including goodwill. If the estimatedfair value exceeds book value, goodwill is considered not to be impaired and noadditional steps are necessary. If, however, the fair value of the reportingunit is less than book value, then the carrying amount of the goodwill iscompared with its implied fair value. The estimate of implied fair value ofgoodwill may require independent valuations of certain internally generated andunrecognized intangible assets such as our pay account base, software andtechnology and patents and trademarks. If the carrying amount of goodwillexceeds the implied fair value of that goodwill, an impairment loss would berecognized in an amount equal to the excess.*

*Business Combinations—**All*of ouracquisitions have been accounted for as purchase business combinations. Underthe purchase method of accounting, the cost, including transaction costs, isallocated to the underlying net assets, based on their respective estimatedfair values. The excess of the purchase price over the estimated fair values ofthe net assets acquired is recorded as goodwill.

The judgments made indetermining the estimated fair value and expected useful lives assigned to eachclass of assets and liabilities acquired can significantly impact net income.Consequently, to the extent an indefinite-lived or a longer-livedasset is ascribed greater value under the purchase method than a shorter-livedasset, there may be less amortization recorded in a given period. Definite-livedidentifiable intangible assets are amortized on either a straight-line basis oran accelerated basis. We determine the appropriate amortization method byperforming an analysis of expected cash flows over the estimated useful life ofthe asset and matches the amortization expense to the expected cash flows fromthose assets.

Determining the fair valueof certain assets and liabilities acquired is subjective in nature and ofteninvolves the use of significant estimates and assumptions. Two areas, inparticular, that require significant judgment are estimating the fair value andrelated useful lives of identifiable intangible assets. To assist in thisprocess, we may obtain appraisals from valuation specialists for certainintangible assets. While there are a number of different methods used inestimating the value of acquired intangibles, there are two approaches primarilyused: the discounted cash flow and market comparison approaches. Some of themore significant estimates and assumptions inherent in the two approachesinclude: projected future cash flows (including timing); discount ratereflecting the risk inherent in the future cash flows; perpetual growth rate;subscriber churn and terminal value; determination of appropriate marketcomparables; and the determination of whether a premium or a discount should beapplied to comparables. Most of the above assumptions are made based onavailable historical information.

*Income Taxes—**Income*taxes areaccounted for under SFAS No. 109, *Accountingfor Income Taxes*. Under SFAS No. 109, deferred tax assets andliabilities are determined based on differences between the financial reportingand tax basis of assets and liabilities and are measured using the enacted taxrates and laws that will be in effect when the differences are expected toreverse. A valuation allowance is established when necessary to reduce deferredtax assets to the amount expected to be realized.

The computation oflimitations relating to the amount of such tax assets, and the determination ofappropriate valuation allowances relating to realizability of such assets, areinherently complex and require the exercise of judgment. As additionalinformation becomes available, we continually assess the carrying value of ournet deferred tax assets.

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*Legal Contingencies—**We**are*currentlyinvolved in certain legal proceedings. We record liabilities related to pendinglitigation when an unfavorable outcome is probable and management canreasonably estimate the amount of loss. We have not recorded liabilities forcertain pending litigation because of the uncertainties related to assessingboth the amount and the probable outcome of those claims. As additionalinformation becomes available, we continually assesses the potential liabilityrelated to all pending litigation.

**Recent AccountingPronouncements**

*Accounting Changesand Errors*

In June 2005, theFASB issued SFAS No. 154, *Accounting Changes andError Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3*.SFAS No. 154 changes the requirements for the accounting for and reportingof a change in accounting principle and applies to all voluntary changes inaccounting principle. APB Opinion No. 20 previously required that mostvoluntary changes in accounting principle be recognized by including in netincome of the period of change the cumulative effect of changing to the newaccounting principle. SFAS No. 154 requires retrospective application toprior periods’ financial statements of changes in accounting principle, unlessit is impracticable to determine either the period-specific effects or thecumulative effect of the change. When it is impracticable to determine theperiod-specific effects of an accounting change on one or more individual priorperiods presented, SFAS No. 154 requires that the new accounting principlebe applied to the balances of assets and liabilities as of the beginning of theearliest period for which retrospective application is practicable and that acorresponding adjustment be made to the opening balance of retained earningsfor that period rather than being reported in an income statement. When it isimpracticable to determine the cumulative effect of applying a change inaccounting principle to all prior periods, SFAS No. 154 requires that thenew accounting principle be applied as if it were adopted prospectively fromthe earliest date practicable. In addition, SFAS No. 154 makes adistinction between retrospective application of an accounting principle andthe restatement of financial statements to reflect the correction of an error.SFAS No. 154 is effective for accounting changes and corrections of errorsmade beginning in the March 2006 quarter. The implementation of SFAS No. 154did not have a material impact on our financial position, results of operationsor cash flows.

*Accounting forUncertainty in Income Taxes*

In July 2006, theFASB issued FASB Interpretation No. (“FIN”) 48, *Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109*,which clarifies the accounting for uncertainty in income tax positions. ThisInterpretation requires that we recognize in the consolidated financialstatements the impact of a tax position that is more likely than not to besustained upon examination based on the technical merits of the position. The provisionsof FIN 48 will be effective for us beginning in the March 2007 quarter,with the cumulative effect of the change in accounting principle recorded as anadjustment to opening retained earnings. While our analysis of the impact ofthis Interpretation is not yet complete, we do not anticipate it will have amaterial impact on our retained earnings at the time of adoption.

*Effects of PriorYear Misstatements*

In September 2006,the SEC issued SAB No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements*, in order to address the observed diversity inquantification practices with respect to annual financial statements. There havebeen two widely-recognized methods for quantifying the effects of financialstatement errors: the “roll-over” method and the “iron curtain” method. Theroll-over method focuses primarily on the impact of a misstatement on theincome statement, including the reversing effect of prior year misstatements,but its use can lead to the 

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accumulationof misstatements in the balance sheet. The iron-curtain method, on the otherhand, focuses primarily on the effect of correcting the period-end balancesheet with less emphasis on the reversing effects of prior year errors on theincome statement. In SAB No. 108, the SEC staff establishes an approachthat requires quantification of financial statement errors based on the effectsof the error on each of the company’s financial statements and the relatedfinancial statement disclosures. This model is commonly referred to as a “dualapproach” because it essentially requires quantification of errors under boththe iron-curtain and the roll-over methods. From a transition perspective, SAB No. 108permits existing public companies to record the cumulative effect of initiallyapplying the “dual approach” in the first year ending after November 15,2006 by recording the necessary “correcting” adjustments to the carrying valuesof assets and liabilities as of the beginning of that year with the offsettingadjustment recorded to the opening balance of retained earnings. Additionally,the use of the “cumulative effect” transition method requires detaileddisclosure of the nature and amount of each individual error being correctedthrough the cumulative adjustment and how and when it arose. These disclosuresare intended to make prior years’ materiality judgments easier for investorsand others to assess. Assuming that a company has properly applied its previousapproach to evaluating financial statement misstatements, the SEC staff hasindicated that it will not object if the company does not restate financialstatements for fiscal years ending on or before November 15, 2006. The implementationof SAB No. 108 did not have a material impact on our financial position,results of operations or cash flows.

*Fair ValueMeasurements*

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which clarifies the definition of fair value, establishes guidelines formeasuring fair value, and expands disclosures regarding fair valuemeasurements. SFAS No. 157 does not require any new fair valuemeasurements and eliminates inconsistencies in guidance found in various prioraccounting pronouncements. SFAS No. 157 will be effective for us on January 1,2008. We are currently evaluating the impact of adopting SFAS No. 157 onour financial position, cash flows, and results of operations.

*Fair Value Option*

In February 2007, theFASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*, which permits entitiesto choose to measure many financial instruments and certain other items at fairvalue that are not currently required to be measured at fair value. SFAS No. 159will be effective for us on January 1, 2008. We are currently evaluatingthe impact of adopting SFAS No. 159 on our financial position, cash flows,and results of operations.

**Inflation**

Inflation did not have amaterial impact during the years ended December 31, 2006, 2005 and 2004,and we do not currently anticipate that inflation will have a material impacton our results of operations for fiscal year 2007.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certainmarket risks arising from transactions in the normal course of business,principally risk associated with interest rate and foreign currencyfluctuations.

*Interest Rate Risk*

We have interest rate risk primarily related to ourinvestment portfolio.

We maintain a short-terminvestment portfolio consisting of U.S. commercial paper, U.S. Government orU.S. Government Agency obligations, municipal obligations, auction ratesecurities and 

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moneymarket funds. Our primary objective is the preservation of principal andliquidity while maximizing yield. The minimum long-term rating is A, andif a long-term rating is not available, we require a short-term creditrating of A1 and P1. The value of these investments may fluctuate with changesin interest rates. However, we believe this risk is immaterial due to therelatively short-term nature of the investments.

*Foreign CurrencyRisk*

We transact business indifferent foreign currencies and may be exposed to financial market riskresulting from fluctuations in foreign currency exchange rates, particularlythe Indian Rupee (INR) and the Euro, which may result in a gain or loss ofearnings to us. The volatility of the INR and the Euro (and all otherapplicable currencies) are monitored throughout the year. We face two risksrelated to foreign currency exchange: translation risk and transaction risk.Amounts invested in our foreign operations are translated into U.S. dollarsusing period-end exchange rates. The resulting translation adjustments arerecorded as a component of accumulated other comprehensive income (loss) instockholders’ equity. Our foreign subsidiaries generally collect revenues andpay expenses in currencies other than the U.S. dollar. Since the functionalcurrencies of our foreign operations are denominated in the local currency ofour subsidiaries, the foreign currency translation adjustments are reflected asa component of stockholders’ equity and do not impact operating results.Revenues and expenses in foreign currencies translate into higher or lowerrevenues and expenses in U.S. dollars as the U.S. dollar weakens or strengthensagainst other currencies. Therefore, changes in exchange rates may negativelyaffect our consolidated revenues and expenses (as expressed in U.S. dollars)from foreign operations. Currency transaction gains or losses arising fromtransactions in currencies other than the functional currency are included inoperating expenses. While we have not engaged in foreign currency hedging, wemay in the future use hedging programs, currency forward contracts, currencyoptions and/or other derivative financial instruments commonly utilized toreduce financial market risks if it is determined that such hedging activitiesare appropriate to reduce risk.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

For financial statements,see the Index to Consolidated Financial Statements on page F-1.

**ITEM 9.**                CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLS AND PROCEDURES

*Disclosure Controlsand Procedures*

Our management, with theparticipation of our Chief Executive Officer and Chief Financial Officer, hasevaluated the effectiveness of the Company’s disclosure controls and procedures(as such term is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. Based on such evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that, as of theend of such period, the Company’s disclosure controls and procedures areeffective in recording, processing, summarizing and reporting, on a timelybasis, information required to be disclosed by the Company in the reports thatit files or submits under the Exchange Act and are effective in ensuring thatinformation required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act is accumulated and communicated to theCompany’s management, including the Company’s Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

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*Management’s Reporton Internal Control Over Financial Reporting*

Management of United Online, Inc. is responsiblefor establishing and maintaining adequate internal control over financialreporting. The Company’s internal control over financial reporting has beendesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external reportingpurposes in accordance with accounting principles generally accepted in theUnited States of America.

The Company’s internal control over financialreporting includes policies and procedures that pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect transactionsand dispositions of assets of the Company; provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with accounting principles generally accepted in theUnited States of America, and that receipts and expenditures are being madeonly in accordance with authorization of management and directors of theCompany; and provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use or disposition of the Company’sassets that could have a material effect on the Company’s financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

Management assessed the effectiveness of the Company’sinternal control over financial reporting at December 31, 2006. In makingthis assessment, management used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (“COSO”) in *Internal Control—Integrated Framework*.Based on that assessment under those criteria, management has determined that,at December 31, 2006, the Company’s internal control over financialreporting was effective.

Management has excluded from its assessment of internalcontrol over financial reporting as of December 31, 2006 certain elementsof the internal control over financial reporting of MyPoints.com, Inc.(“MyPoints”), a wholly-owned subsidiary of the Company, because MyPoints wasacquired by the Company in a purchase business combination in April 2006.Subsequent to the acquisition, certain elements of the acquired business’internal control over financial reporting and related processes were integratedinto the Company’s existing systems and internal control over financialreporting. Those controls that were not integrated have been excluded frommanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting as of December 31, 2006. The excluded elementsrepresent controls over accounts of approximately 4% of the Company’sconsolidated assets as of December 31, 2006 and 8% of consolidated revenuefor the year then ended.

Management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting atDecember 31, 2006 has been audited by PricewaterhouseCoopers LLP, anindependent registered public accounting firm, as stated in their report whichappears herein.

*Changes in InternalControl Over Financial Reporting*

On April 10, 2006, we completed the acquisitionof MyPoints. We are in the process of integrating MyPoints and continuing ourevaluation of internal controls pursuant to the Sarbanes-Oxley Act of 2002.Excluding the changes described above, there have not been any changes in theCompany’s internal control over financial reporting (as such term is defined inRules 13a-15(f) and 15d-15(f) under the ExchangeAct) during the fourth quarter of 2006 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control over financialreporting.

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**ITEM 9B.**       OTHER INFORMATION

None.

**PART III**

**ITEMS10, 11, 12, 13 and 14**

The information requiredby Items 10, 11, 12, 13 and 14 is hereby incorporated by reference to ourdefinitive proxy statement relating to our 2007 annual meeting of stockholdersto be filed with the Securities and Exchange Commission within 120 daysafter the end of our fiscal year.

**PART IV**

**ITEM 15.**         EXHIBITS, FINANCIALSTATEMENT SCHEDULES

**(a)**         The following documentsare filed as part of this report:

1.   ***ConsolidatedFinancial Statements:***

|                                                          | ** ** | ** ** | **Page** | ** ** |
|----------------------------------------------------------|------------|------------|----------|------------|
| Report of Independent  Registered Public Accounting Firm |       |       | F-2      |       |
| Consolidated Balance Sheets                              |       |       | F-4      |       |
| Consolidated Statements of  Operations                   |       |       | F-5      |       |
| Consolidated Statements of Comprehensive  Income         |       |       | F-6      |       |
| Consolidated Statements of  Stockholders’ Equity    |       |       | F-7      |       |
| Consolidated Statements of  Cash Flows                   |       |       | F-8      |       |
| Notes  to Consolidated Financial Statements              |       |       | F-9      |       |
|                                                          |            |            |          |            |  |  |

 

2.   *F**inancial Statement Schedule:*

|                                                     | ** ** | ** ** | **Page** | ** ** |   |
|-----------------------------------------------------|------------|------------|----------|------------|--------|
| Schedule  II—Valuation and Qualifying Accounts |       |       | F-43     |       |
|                                                     |            |            |          |            |        |  |  |

 

All other schedules havebeen omitted because the information required to be set forth therein is notapplicable, not required or is shown in the consolidated financial statements ornotes thereto.

*3.**  **Exhibits:*

|           | ** ** | ** **                                                                                                               | ** ** | **Filed   with this**        | ** ** | **Incorporated by Reference to** |
|-----------|------------|--------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|
| **No.**   | ** ** | ** **                                                                                                               | ** ** | **Exhibit Description** | ** ** | **Form 10-K**               | ** ** | **Form** | ** ** | **File No.** | ** ** | **Date Filed** |
|  2.1 |       | Stock Purchase Agreement, dated as of April 9,  2006, by and between United Online, Inc. and UAL Corporation   |       |                         |       | 8-K                              |   | 000-33367 |   | 4/13/2006 |
|  3.1 |       | Amended and Restated  Certificate of Incorporation                                                                       |       | X                            |       |                             |   | 000-33367 |   | 3/1/2007 |
|  3.2 |       | Amended and Restated  Bylaws                                                                                             |       | X                            |       |                             |   | 000-33367 |   | 3/1/2007 |
|  3.3 |       | Certificate of  Designation for Series A Junior Participating Preferred Stock (included  in exhibit 4.1 below) |       | X                            |       |                             |   | 000-33367 |   | 3/1/2007 |
|           |            |                                                                                                                          |            |                              |            |                                  |  |  |  |  |  |  |

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|  4.1 |   | Rights Agreement, dated as of November 15,  2001, between the Company and U.S. Stock Transfer Corporation, which includes  the form of Certificate of Designation for the Series A junior  participating preferred stock as Exhibit A, and the form of Rights  Certificate as Exhibit B |   | X      |   |   |   | 000-33367  |   | 3/1/2007   |
|-----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|------------|--------|------------|
|  4.2 |   | Amendment No. 1 to Rights Agreement, dated as  of April 29, 2003, between the Registrant and U.S. Stock Transfer  Corporation                                                                                                                                                                     |   |   |   | 10-Q   |   | 000-33367  |   | 5/1/2003   |
| 10.1      |   | 2001 Amended and  Restated Employee Stock Purchase Plan                                                                                                                                                                                                                                                     |   |   |   | 10-Q   |   | 000-33367  |   | 5/3/2004   |
| 10.2      |   | 2001 Stock Incentive  Plan                                                                                                                                                                                                                                                                                  |   | X      |   |   |   | 000-33367  |   | 3/1/2007   |
| 10.3      |   | Form of Option  Agreement for 2001 Stock Incentive Plan                                                                                                                                                                                                                                                |   |   |   | 10-Q   |   | 000-33367  |   | 10/27/2004 |
| 10.4      |   | Form of Restricted  Stock Unit Issuance Agreement for 2001 Stock Incentive Plan                                                                                                                                                                                                                        |   |   |   | 10-Q   |   | 000-33367  |   | 8/8/2005   |
| 10.5      |   | 2001 Supplemental Stock  Incentive Plan                                                                                                                                                                                                                                                                     |   | X      |   |   |   | 000-33367  |   | 3/1/2007   |
| 10.6      |   | Form of Option  Agreement for 2001 Supplemental Stock Incentive Plan                                                                                                                                                                                                                                   |   |   |   | 10-Q   |   | 000-33367  |   | 10/27/2004 |
| 10.7      |   | Classmates  Online, Inc. Amended and Restated 1999 Stock Plan                                                                                                                                                                                                                                          |   |   |   | S-8    |   | 333-121217 |   | 2/11/2005  |
| 10.8      |   | Classmates  Online, Inc. 2004 Stock Plan                                                                                                                                                                                                                                                               |   |   |   | 10-Q   |   | 000-33367  |   | 5/10/2005  |
| 10.9      |   | Form of Option Agreement  for Classmates Online, Inc. 2004 Stock Plan                                                                                                                                                                                                                             |   |   |   | 10-Q   |   | 000-33367  |   | 5/10/2005  |
| 10.10     |   | United Online, Inc. 2006 Management Bonus Plan                                                                                                                                                                                                                                                         |   |   |   | 8-K    |   | 000-33367  |   | 3/30/2006  |
| 10.11     |   | Amended and Restated Employment Agreement between  the Registrant and Mark R. Goldston                                                                                                                                                                                                                 |   |   |   | 10-KT  |   | 000-33367  |   | 2/5/2004   |
| 10.12     |   | Amended and Restated  Employment Agreement between the Registrant and Charles S. Hilliard                                                                                                                                                                                                              |   |   |   | 10-KT  |   | 000-33367  |   | 2/5/2004   |
| 10.13     |   | Amended and Restated  Employment Agreement between the Registrant and Frederic A. Randall, Jr.                                                                                                                                                                                                    |   |   |   | 10-KT  |   | 000-33367  |   | 2/5/2004   |
| 10.14     |   | Employment Agreement  between the Registrant and Matt Wisk                                                                                                                                                                                                                                                  |   |   |   | 10-Q   |   | 000-33367  |   | 8/8/2005   |
| 10.15     |   | Employment Agreement  between the Registrant and Ted Cahall                                                                                                                                                                                                                                                 |   |   |   | 10-Q   |   | 000-33367  |   | 8/8/2005   |
| 10.16     |   | Employment Agreement  between the Registrant and Jon Fetveit                                                                                                                                                                                                                                                |   |   |   | 10-Q   |   | 000-33367  |   | 8/8/2005   |
| 10.17     |   | Employment Agreement  between the Registrant and Gerald Popek                                                                                                                                                                                                                                               |   |   |   | 10-Q   |   | 000-33367  |   | 8/8/2005   |

57

----

 

| 10.18 |   | Employment Agreement  between the Registrant and Robert Taragan                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005 |
|-------|--------|---------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|-----------|--------|----------|
| 10.19 |   | Employment Agreement between the Registrant and  Jeremy Helfand                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/9/2006 |
| 10.20 |   | Office Lease between LNR  Warner Center, LLC and NetZero, Inc.                                           |   |   |   | 10-Q   |   | 000-33367 |   | 5/3/2004 |
| 21.1  |   | List of  Subsidiaries                                                                                         |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 23.1  |   | Consent of  Independent Registered Public Accounting Firm                                                     |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 31.1  |   | Certification of the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 31.2  |   | Certification of the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 32.1  |   | Certification of the  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 32.2  |   | Certification of the  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |

* *

**(b)**         Exhibits

The exhibits filed as partof this report are listed in Item 15(a)(3) of this Form 10-K.

**(c)**          Financial StatementSchedules

Thefinancial statement schedules required by Regulation S-X and Item 8of this form are listed in Item 15(a)(2) of this Form 10-K.

58

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**SIGNATURES**

Pursuantto the requirements of Section 13 of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized on March 1, 2007.

|          | UNITED ONLINE, INC. |
|----------|---------------------|
|     | By:                 | /s/ MARK R. GOLDSTON |
|     |                | Mark R. Goldston |
| * * | * *            | *Chairman and Chief Executive Officer* |

 

KNOW ALL PERSONS BY THESE PRESENT, that each personwhose signature appears below constitutes and appoints Mark R. Goldston andCharles S. Hilliard, as his or her attorneys-in-fact, each with the power ofsubstitution, for him or her in any and all capacities, to sign any amendmentto this Annual Report on Form 10-K, and to file the same, withexhibits thereto and other documents in connection therewith with theSecurities and Exchange Commission, hereby ratifying and confirming all thateach of said attorneys-in-fact, or his or her substitute or substitutes may door cause to be done by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Company and in thecapacities indicated on March 1, 2007.
|                         | **Signature** | ** **                                          | ** ** |                    | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|-------------------------|---------------|-----------------------------------------------------|------------|--------------------|-----------|------------|------------|--|----------|------------|
| /s/ MARK R. GOLDSTON    |          | Chairman, Chief Executive Officer and Director      |       | March 1, 2007 |
| Mark R. Goldston        |          | (Principal Executive Officer and Director)          |       |               |
| /s/ CHARLES S. HILLIARD |          | President and Chief Financial Officer (Principal    |       | March 1, 2007 |
| Charles S.  Hilliard    |          | Financial Officer)                                  |       |               |
| /s/ NEIL P. EDWARDS     |          | Senior Vice President, Finance, Treasurer and Chief |       | March 1, 2007 |
| Neil P. Edwards         |          | Accounting Officer (Principal Accounting Officer)   |       |               |
| /s/ JAMES T. ARMSTRONG  |          | Director                                            |       | March 1, 2007 |
| James T.  Armstrong     |          |                                                |       |               |
| /s/ ROBERT BERGLASS     |          | Director                                            |       | March 1, 2007 |
| Robert Berglass         |          |                                                |       |               |
| /s/ KENNETH L. COLEMAN  |          | Director                                            |       | March 1, 2007 |
| Kenneth L.  Coleman     |          |                                                |       |               |
| /s/ DENNIS HOLT         |          | Director                                            |       | March 1, 2007 |
| Dennis Holt             |          |                                                |       |               |
| /s/ CAROL A. SCOTT      |          | Director                                            |       | March 1, 2007 |
| Carol A. Scott          |          |                                                |       |               |

 

59

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**EXHIBITINDEX**

|           | ** ** | ** **                                                                                                                                                                                                                                                                                                  | ** ** | **Filed   with this**   | ** ** | **Incorporated by Reference to** |
|-----------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------------------------|
| **No.**   | ** ** | ** **                                                                                                                                                                                                                                                                                                  | ** ** | **Exhibit Description** | ** ** | **Form 10-Q**                              | ** ** | **Form** | ** ** | **File No.** | ** ** | **Date Filed** |
|  2.1 |       | Stock Purchase  Agreement, dated as of April 9, 2006, by and between United  Online, Inc. and UAL Corporation                                                                                                                                                                                     |       |                         |       | 8-K                                             |   | 000-33367 |   | 4/13/2006 |
|  3.1 |       | Amended and  Restated Certificate of Incorporation                                                                                                                                                                                                                                                          |       | X                            |       |                                            |   | 000-33367 |   | 3/1/2007 |
|  3.2 |       | Amended and  Restated Bylaws                                                                                                                                                                                                                                                                                |       | X                            |       |                                            |   | 000-33367 |   | 3/1/2007 |
|  3.3 |       | Certificate of  Designation for Series A Junior Participating Preferred Stock (included  in exhibit 4.1 below)                                                                                                                                                                                    |       | X                            |       |                                            |   | 000-33367 |   | 3/1/2007 |
|  4.1 |       | Rights Agreement,  dated as of November 15, 2001, between the Company and U.S. Stock  Transfer Corporation, which includes the form of Certificate of Designation  for the Series A junior participating preferred stock as Exhibit A,  and the form of Rights Certificate as Exhibit B |       | X                            |       |                                            |   | 000-33367 |   | 3/1/2007 |
|  4.2 |       | Amendment  No. 1 to Rights Agreement, dated as of April 29, 2003, between the  Registrant and U.S. Stock Transfer Corporation                                                                                                                                                                     |       |                         |       | 10-Q                                            |   | 000-33367 |   | 5/1/2003 |
| 10.1      |       | 2001 Amended and  Restated Employee Stock Purchase Plan                                                                                                                                                                                                                                                     |       |                         |       | 10-Q                                            |   | 000-33367 |   | 5/3/2004 |
| 10.2      |       | 2001 Stock  Incentive Plan                                                                                                                                                                                                                                                                                  |       | X                            |       |                                            |   | 000-33367 |   | 3/1/2007 |
| 10.3      |       | Form of  Option Agreement for 2001 Stock Incentive Plan                                                                                                                                                                                                                                                |       |                         |       | 10-Q                                            |   | 000-33367 |   | 10/27/2004 |
| 10.4      |       | Form of  Restricted Stock Unit Issuance Agreement for 2001 Stock Incentive Plan                                                                                                                                                                                                                        |       |                         |       | 10-Q                                            |   | 000-33367 |   | 8/8/2005 |
| 10.5      |       | 2001 Supplemental  Stock Incentive Plan                                                                                                                                                                                                                                                                     |       | X                            |       |                                            |   | 000-33367 |   | 3/1/2007 |
| 10.6      |       | Form of  Option Agreement for 2001 Supplemental Stock Incentive Plan                                                                                                                                                                                                                                   |       |                         |       | 10-Q                                            |   | 000-33367 |   | 10/27/2004 |
| 10.7      |       | Classmates  Online, Inc. Amended and Restated 1999 Stock Plan                                                                                                                                                                                                                                          |       |                         |       | S-8                                             |   | 333-121217 |   | 2/11/2005 |
| 10.8      |       | Classmates  Online, Inc. 2004 Stock Plan                                                                                                                                                                                                                                                               |       |                         |       | 10-Q                                            |   | 000-33367 |   | 5/10/2005 |
| 10.9      |       | Form of Option Agreement  for Classmates Online, Inc. 2004 Stock Plan                                                                                                                                                                                                                             |       |                         |       | 10-Q                                            |   | 000-33367 |   | 5/10/2005 |
| 10.10     |       | United Online, Inc.  2006 Management Bonus Plan                                                                                                                                                                                                                                                        |       |                         |       | 8-K                                             |   | 000-33367 |   | 3/30/2006 |
|           |            |                                                                                                                                                                                                                                                                                                             |            |                              |            |                                                 |  |  |  |  |  |  |

60

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| 10.11 |   | Amended and Restated Employment Agreement between  the Registrant and Mark R. Goldston                   |   |   |   | 10-KT  |   | 000-33367 |   | 2/5/2004 |
|-------|--------|---------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|-----------|--------|----------|
| 10.12 |   | Amended and Restated Employment Agreement between  the Registrant and Charles S. Hilliard                |   |   |   | 10-KT  |   | 000-33367 |   | 2/5/2004 |
| 10.13 |   | Amended and Restated Employment Agreement between  the Registrant and Frederic A. Randall, Jr.      |   |   |   | 10-KT  |   | 000-33367 |   | 2/5/2004 |
| 10.14 |   | Employment Agreement between the Registrant and Matt  Wisk                                                    |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005 |
| 10.15 |   | Employment Agreement between the Registrant and Ted  Cahall                                                   |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005 |
| 10.16 |   | Employment Agreement between the Registrant and Jon  Fetveit                                                  |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005 |
| 10.17 |   | Employment Agreement between the Registrant and  Gerald Popek                                                 |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005 |
| 10.18 |   | Employment  Agreement between the Registrant and Robert Taragan                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005 |
| 10.19 |   | Employment  Agreement between the Registrant and Jeremy Helfand                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/9/2006 |
| 10.20 |   | Office Lease  between LNR Warner Center, LLC and NetZero, Inc.                                           |   |   |   | 10-Q   |   | 000-33367 |   | 5/3/2004 |
| 21.1  |   | List of Subsidiaries                                                                                          |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 23.1  |   | Consent of Independent  Registered Public Accounting Firm                                                     |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 31.1  |   | Certification of  the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 31.2  |   | Certification of  the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 32.1  |   | Certification of  the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |
| 32.2  |   | Certification of the  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 3/1/2007 |

 

61

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**UNITEDONLINE, INC.**

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**

|                                                          | ** ** | **Page** | ** ** |
|----------------------------------------------------------|------------|----------|------------|
| Report  of Independent Registered Public Accounting Firm |       | F-2      |       |
| Consolidated  Balance Sheets                             |       | F-4      |       |
| Consolidated  Statements of Operations                   |       | F-5      |       |
| Consolidated  Statements of Comprehensive Income         |       | F-6      |       |
| Consolidated  Statements of Stockholders’ Equity    |       | F-7      |       |
| Consolidated  Statements of Cash Flows                   |       | F-8      |       |
| Notes  to Consolidated Financial Statements              |       | F-9      |       |
| Schedule  II—Valuation and Qualifying Accounts      |       | F-43     |       |

 

F-1

----

**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholders of UnitedOnline, Inc.:

We have completedintegrated audits of United Online, Inc.’s consolidated financial statementsand of its internal control over financial reporting as of December 31,2006, in accordance with the standards of the Public Company AccountingOversight Board (United States). Our opinions, based on our audits, arepresented below.

*Consolidated financial statements and financial statement schedule*

In our opinion, the consolidated financial statementslisted in the index appearing under Item 15(a)(1) present fairly, inall material respects, the financial position of United Online, Inc. andits subsidiaries at December 31, 2006 and 2005, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2006 in conformity with accounting principles generallyaccepted in the United States of America. In addition, in our opinion, thefinancial statement schedule listed in the index appearing under Item 15(a)(2) presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements. Thesefinancial statements and financial statement schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits. Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An audit offinancial statements includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

As discussed in Note 1 tothe consolidated financial statements, the Company changed the manner in whichit accounts for stock-based compensation in 2006.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in “Management’s Report on Internal Control Over Financial Reporting”appearing under Item 9A, that the Company maintained effective internal controlover financial reporting as of December 31, 2006 based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria. Furthermore,in our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2006, basedon criteria established in *Internal Control—IntegratedFramework* issued by COSO. The Company’s management is responsiblefor maintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting. Ourresponsibility is to express opinions on management’s assessment and on theeffectiveness of the Company’s internal control over financial reporting basedon our audit. We conducted our audit of internal control over financialreporting in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we consider necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

F-2

----

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

Asdescribed in “Management’s Report on Internal Control Over Financial Reporting”,management has excluded from its assessment of internal control over financialreporting as of December 31, 2006, certain elements of the internalcontrol over financial reporting of MyPoints.com, Inc. (“MyPoints”), awholly-owned subsidiary, because MyPoints was acquired by the Company in apurchase business combination during 2006. Subsequent to the acquisition,certain elements of the acquired business’ internal control over financialreporting and related processes were integrated into the Company’s existingsystems and internal control over financial reporting. Those controls that werenot integrated have been excluded from management’s assessment of theeffectiveness of internal control over financial reporting as of December 31,2006. We have also excluded these elements of the internal control overfinancial reporting of the acquired business from our audit of the Company’sinternal control over financial reporting. The excluded elements representcontrols over accounts of approximately 4% of the Company’s consolidated assetsat December 31, 2006 and 8% of consolidated revenue for the year then ended.
| /s/ PRICEWATERHOUSECOOPERS LLP |   |
|--------------------------------|--------|
| Los Angeles,  California       |
| February 28,  2007        |

 

F-3

----

**UNITED ONLINE, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts)**

| ** **                                                                                                                                                     | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                     | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **Assets**                                                                                                                                                     |       |                  |       |   |   |
| Current assets:                                                                                                                                                |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                      |       | $                     | 19,252     |   | $ | 100,397 |   |
| Short-term investments                                                                                                                                         |       | 143,110               |       | 143,965 |   |
| Accounts receivable, net  of allowance for doubtful accounts of $1,324 and  $1,325 at December 31, 2006 and 2005, respectively                       |       | 32,226                |       | 19,201 |   |
| Deferred tax assets, net                                                                                                                                       |       | 11,705                |       | 14,808 |   |
| Other current assets                                                                                                                                           |       | 13,426                |       | 12,332 |   |
| Total current assets                                                                                                                                           |       | 219,719               |       | 290,703 |   |
| Property and  equipment, net                                                                                                                                   |       | 34,296                |       | 33,093 |   |
| Deferred tax  assets, net                                                                                                                                      |       | 59,655                |       | 53,547 |   |
| Goodwill                                                                                                                                                       |       | 133,018               |       | 80,499 |   |
| Intangible assets,  net                                                                                                                                        |       | 53,653                |       | 59,338 |   |
| Other assets                                                                                                                                                   |       | 2,678                 |       | 4,008 |   |
| Total assets                                                                                                                                                   |       | $                     | 503,019    |   | $ | 521,188 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                 |       |                  |       |   |   |
| Current liabilities:                                                                                                                                           |       |                  |       |   |   |
| Accounts payable                                                                                                                                               |       | $                     | 36,550     |   | $ | 46,955 |   |
| Accrued liabilities                                                                                                                                            |       | 39,547                |       | 36,249 |   |
| Member redemption  liability                                                                                                                                   |       | 15,835                |       | — |   |
| Deferred revenue                                                                                                                                               |       | 53,121                |       | 52,835 |   |
| Current portion of term  loan                                                                                                                                  |       | —                |       | 16,498 |   |
| Current portion of  capital leases                                                                                                                             |       | 17                    |       | 373 |   |
| Total current liabilities                                                                                                                                      |       | 145,070               |       | 152,910 |   |
| Member redemption  liability                                                                                                                                   |       | 4,154                 |       | — |   |
| Deferred revenue                                                                                                                                               |       | 3,227                 |       | 3,449 |   |
| Term loan                                                                                                                                                      |       | —                |       | 37,710 |   |
| Capital leases                                                                                                                                                 |       | 13                    |       | 325 |   |
| Other liabilities                                                                                                                                              |       | 3,589                 |       | 4,379 |   |
| Total liabilities                                                                                                                                              |       | 156,053               |       | 198,773 |   |
| Commitments and contingencies (see Note 11)                                                                                                                    |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                     |       |                  |       |   |   |
| Preferred stock, $0.0001 par value; 5,000 shares  authorized; no shares issued  or outstanding at December 31, 2006 and 2005                              |       |                  |       |   |   |
| Common stock, $0.0001 par  value; 300,000 shares authorized; 65,805 and 62,606 shares issued and  outstanding at December 31, 2006 and 2005, respectively |       | 7                     |       | 6 |   |
| Additional paid-in  capital                                                                                                                                    |       | 439,383               |       | 472,745 |   |
| Deferred stock-based  compensation                                                                                                                             |       | —                |       | (15,558 | ) |
| Accumulated other  comprehensive loss                                                                                                                          |       | (245                  | )          | (327 | ) |
| Accumulated deficit                                                                                                                                            |       | (92,179               | )          | (134,451 | ) |
| Total stockholders’  equity                                                                                                                               |       | 346,966               |       | 322,415 |   |
| Total liabilities and stockholders’ equity                                                                                                                |       | $                     | 503,019    |   | $ | 521,188 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-4

----

**UNITED ONLINE, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share amounts)**

| ** **                                                                    | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                    | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                                                                      |       | $                                      | 522,654    |   | $ | 525,061 |   | $ | 448,617 |   |
| Operating  expenses:                                                          |       |                                   |       |   |   |   |   |
| Cost of revenues (including stock-based compensation,  see  Note 5) |       | 120,049                                |       | 110,672 |   | 102,392 |   |
| Sales and marketing (including stock-based  compensation, see Note 5)    |       | 177,019                                |       | 209,292 |   | 178,981 |   |
| Product development (including stock-based  compensation, see Note 5)         |       | 52,933                                 |       | 40,009 |   | 27,454 |   |
| General and administrative (including stock-based  compensation, see Note 5)  |       | 67,709                                 |       | 56,729 |   | 39,894 |   |
| Amortization of intangible assets                                             |       | 17,640                                 |       | 21,799 |   | 20,403 |   |
| Impairment of goodwill, intangible assets and  long-lived assets              |       | 13,285                                 |       | — |   | — |   |
| Total operating expenses                                                      |       | 448,635                                |       | 438,501 |   | 369,124 |   |
| Operating income                                                              |       | 74,019                                 |       | 86,560 |   | 79,493 |   |
| Interest and  other income, net                                               |       | 6,076                                  |       | 6,885 |   | 5,138 |   |
| Interest expense                                                              |       | (2,571                                 | )          | (6,073 | ) | (1,202 | ) |
| Income before  income taxes                                                   |       | 77,524                                 |       | 87,372 |   | 83,429 |   |
| Provision (benefit)  for income taxes                                         |       | 36,293                                 |       | 40,245 |   | (34,051 | ) |
| Income before  cumulative effect of accounting change                         |       | 41,231                                 |       | 47,127 |   | 117,480 |   |
| Cumulative effect  of accounting change, net of tax (see Note 1)              |       | 1,041                                  |       | — |   | — |   |
| Net income                                                                    |       | $                                      | 42,272     |   | $ | 47,127 |   | $ | 117,480 |   |
| Basic net income  per share:                                                  |       |                                   |       |   |   |   |   |
| Income before cumulative effect of accounting change                          |       | $                                      | 0.64       |   | $ | 0.77 |   | $ | 1.91 |   |
| Cumulative effect of accounting change, net of tax                            |       | 0.02                                   |       | — |   | — |   |
| Basic net income  per share                                                   |       | $                                      | 0.66       |   | $ | 0.77 |   | $ | 1.91 |   |
| Diluted net income  per share:                                                |       |                                   |       |   |   |   |   |
| Income before cumulative effect of accounting change                          |       | $                                      | 0.62       |   | $ | 0.74 |   | $ | 1.81 |   |
| Cumulative effect of accounting change, net of tax                            |       | 0.02                                   |       | — |   | — |   |
| Diluted net  income per share                                                 |       | $                                      | 0.64       |   | $ | 0.74 |   | $ | 1.81 |   |
| Shares used to  calculate basic net income per share                          |       | 64,001                                 |       | 61,135 |   | 61,404 |   |
| Shares used to calculate  diluted net income per share                        |       | 66,269                                 |       | 63,815 |   | 65,012 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-5

----

**UNITED ONLINE, INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(in thousands)**

| ** **                                                                                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                                                                                                                          |       | $                                     | 42,272     |   | $ | 47,127 |   | $ | 117,480 |   |
| Unrealized gain  (loss) on short-term investments, net of tax of $120, $(193) and $(452)  for the years ended December 31, 2006, 2005 and 2004 |       | 172                                   |       | (282 | ) | (1,666 | ) |
| Unrealized gain  (loss) on derivative, net of tax of $(60) and $60 for the years ended  December 31, 2006 and 2005                             |       | (83                                   | )          | 83 |   | — |   |
| Foreign currency  translation                                                                                                                       |       | (7                                    | )          | (119 | ) | 9 |   |
| Comprehensive income                                                                                                                                |       | $                                     | 42,354     |   | $ | 46,809 |   | $ | 115,823 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-6

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**UNITED ONLINE, INC.**

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY**

**(inthousands)**

| ** **                                                       | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Deferred  Stock-  Based** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Accumulated**        | ** ** | **Total  Stockholders’** | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------------------|------------|---------------------------------------|------------|------------------------|------------|-------------------------------|------------|
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**                 | ** ** | **Compensation**                      | ** ** | **Income (Loss)** | ** ** | **Deficit**                   | ** ** | **Equity** | ** ** |
| Balance at January 1, 2004                                  |       |                  | 63,944     |                    |       |                        | $          | 6                                     |       |                   |       | $                             | 535,228    |   |   |   | $ | — |   |   |   | $ | 1,648 |   |   |   | $ | (299,058 | ) |   |   | $ | 237,824 |   |   |
| Issuance of common stock through employee stock  purchase plan   |       |                  | 381        |                    |       |                        | —     |                                  |       |                   | 3,045      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 3,045 |   |   |
| Exercises of stock options                                       |       |                  | 1,856      |                    |       |                        | —     |                                  |       |                   | 6,015      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 6,015 |   |   |
| Repurchases of common stock                                      |       |                  | (5,582     | )                       |       |                        | —     |                                  |       |                   | (74,509    | )                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (74,509 | ) |   |
| Issuance of restricted stock                                     |       |                  | 575        |                    |       |                        | —     |                                  |       |                   | 11,448     |                          |       |   | (11,448 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Repurchase of restricted stock                                   |       |                  | (100       | )                       |       |                        | —     |                                  |       |                   | (1,991     | )                             |       |   | 1,991 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Options assumed in connection with acquisition                   |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 4,325      |                          |       |   | (1,445 | ) |   |   | — |   |   |   | — |   |   |   | 2,880 |   |   |
| Stock-based compensation                                         |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 24         |                          |       |   | 2,425 |   |   |   | — |   |   |   | — |   |   |   | 2,449 |   |   |
| Unrealized loss on short-term investments, net  of tax           |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (452       | )                             |       |   | — |   |   |   | (1,666 | ) |   |   | — |   |   |   | (2,118 | ) |   |
| Foreign currency translation                                     |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | 9 |   |   |   | — |   |   |   | 9 |   |   |
| Tax benefits from stock options                                  |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 8,624      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 8,624 |   |   |
| Net income                                                       |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 117,480 |   |   |   | 117,480 |   |   |
| Balance at December 31, 2004                                |       |                  | 61,074     |                    |       |                        | 6          |                                  |       |                   | 491,757    |                          |       |   | (8,477 | ) |   |   | (9 | ) |   |   | (181,578 | ) |   |   | 301,699 |   |   |
| Issuance of common stock through employee stock  purchase plan   |       |                  | 426        |                    |       |                        | —     |                                  |       |                   | 3,169      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 3,169 |   |   |
| Exercises of stock options                                       |       |                  | 2,374      |                    |       |                        | —     |                                  |       |                   | 5,874      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 5,874 |   |   |
| Repurchases of common stock                                      |       |                  | (1,268     | )                       |       |                        | —     |                                  |       |                   | (14,206    | )                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (14,206 | ) |   |
| Issuance of restricted stock units                               |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 18,033     |                          |       |   | (18,033 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Cancellation of restricted stock units                           |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (340       | )                             |       |   | 340 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Cancellation of options assumed in connection with  acquisition  |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (668       | )                             |       |   | 668 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Dividends paid on shares outstanding and restricted  stock units |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (38,067    | )                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (38,067 | ) |   |
| Stock-based compensation                                         |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 8          |                          |       |   | 9,944 |   |   |   | — |   |   |   | — |   |   |   | 9,952 |   |   |
| Unrealized loss on short-term investments, net  of tax           |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | (282 | ) |   |   | — |   |   |   | (282 | ) |   |
| Unrealized gain on derivative, net of tax                        |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | 83 |   |   |   | — |   |   |   | 83 |   |   |
| Foreign currency translation                                     |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | (119 | ) |   |   | — |   |   |   | (119 | ) |   |
| Tax benefits from stock options                                  |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 7,185      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 7,185 |   |   |
| Net income                                                       |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 47,127 |   |   |   | 47,127 |   |   |
| Balance at December 31, 2005                                |       |                  | 62,606     |                    |       |                        | 6          |                                  |       |                   | 472,745    |                          |       |   | (15,558 | ) |   |   | (327 | ) |   |   | (134,451 | ) |   |   | 322,415 |   |   |
| Cumulative effect of accounting change, net of tax               |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (1,041     | )                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (1,041 | ) |   |
| Balance at January 1, 2006                                  |       |                  | 62,606     |                    |       |                        | 6          |                                  |       |                   | 471,704    |                          |       |   | (15,558 | ) |   |   | (327 | ) |   |   | (134,451 | ) |   |   | 321,374 |   |   |
| Reversal of deferred stock-based compensation                    |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (15,558    | )                             |       |   | 15,558 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Exercises of stock options                                       |       |                  | 2,163      |                    |       |                        | 1          |                                  |       |                   | 9,451      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 9,452 |   |   |
| Issuance of common stock through employee stock purchase  plan   |       |                  | 623        |                    |       |                        | —     |                                  |       |                   | 5,004      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 5,004 |   |   |
| Vesting of  restricted stock units                               |       |                  | 413        |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Repurchases of common stock                                      |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (2,684     | )                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (2,684 | ) |   |
| Dividends paid on shares outstanding and restricted  stock units |       |                  | —     |                    |       |                        | —     |                                  |       |                   | (53,483    | )                             |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (53,483 | ) |   |
| Stock-based compensation                                         |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 19,168     |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 19,168 |   |   |
| Unrealized gain on short-term investments, net  of tax           |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | 172 |   |   |   | — |   |   |   | 172 |   |   |
| Unrealized loss on derivative, net of tax                        |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | (83 | ) |   |   | — |   |   |   | (83 | ) |   |
| Foreign currency translation                                     |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | (7 | ) |   |   | — |   |   |   | (7 | ) |   |
| Tax benefits from stock options                                  |       |                  | —     |                    |       |                        | —     |                                  |       |                   | 5,781      |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 5,781 |   |   |
| Net income                                                       |       |                  | —     |                    |       |                        | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 42,272 |   |   |   | 42,272 |   |   |
| Balance at  December 31, 2006                               |       |                  | 65,805     |                    |       |                        | $          | 7                                     |       |                   |       | $                             | 439,383    |   |   |   | $ | — |   |   |   | $ | (245 | ) |   |   | $ | (92,179 | ) |   |   | $ | 346,966 |   |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-7

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**UNITED ONLINE, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**

| ** **                                                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                                                          |       |                                  |       |   |   |   |   |
| Net income                                                                                                     |       | $                                     | 42,272     |   | $ | 47,127 |   | $ | 117,480 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:                             |       |                                  |       |   |   |   |   |
| Depreciation and  amortization                                                                                 |       | 38,930                                |       | 37,280 |   | 29,151 |   |
| Stock-based  compensation                                                                                      |       | 19,168                                |       | 9,952 |   | 2,449 |   |
| Impairment of goodwill, intangible assets and  long-lived assets                                               |       | 13,285                                |       | — |   | — |   |
| Deferred taxes                                                                                                 |       | (3,609                                | )          | 1,577 |   | (61,478 | ) |
| Tax benefits from stock  options                                                                               |       | 5,781                                 |       | 15,170 |   | 25,156 |   |
| Excess tax benefits from stock-based compensation                                                              |       | (3,863                                | )          | — |   | — |   |
| Cumulative effect of accounting change, net of tax                                                             |       | (1,041                                | )          | — |   | — |   |
| Other                                                                                                          |       | 3,023                                 |       | 748 |   | 1,005 |   |
| Changes in operating assets and liabilities  (excluding the  effects of acquisitions):                         |       |                                  |       |   |   |   |   |
| Accounts receivable                                                                                            |       | (3,296                                | )          | (1,669 | ) | 220 |   |
| Other assets                                                                                                   |       | 844                                   |       | 1,806 |   | (4,122 | ) |
| Accounts payable and  accrued liabilities                                                                      |       | (11,211                               | )          | 17,677 |   | 11,356 |   |
| Member redemption liability                                                                                    |       | 2,315                                 |       | — |   | — |   |
| Deferred revenue                                                                                               |       | (999                                  | )          | 5,181 |   | 848 |   |
| Other liabilities                                                                                              |       | (129                                  | )          | 2,198 |   | 1,895 |   |
| Net cash provided by  operating activities                                                                     |       | 101,470                               |       | 137,047 |   | 123,960 |   |
| Cash flows from investing activities:                                                                          |       |                                  |       |   |   |   |   |
| Purchases of property and  equipment                                                                           |       | (24,329                               | )          | (21,653 | ) | (12,510 | ) |
| Purchases of rights,  patents and trademarks                                                                   |       | (509                                  | )          | (5,562 | ) | (926 | ) |
| Purchases of short-term  investments                                                                           |       | (324,328                              | )          | (320,869 | ) | (329,083 | ) |
| Proceeds from maturities  and sales of short-term investments                                                  |       | 325,180                               |       | 353,333 |   | 344,519 |   |
| Cash paid for  acquisitions, net of cash acquired                                                              |       | (61,155                               | )          | (8,638 | ) | (110,102 | ) |
| Payment for settlement of pre-acquisition liability                                                            |       | (4,800                                | )          | — |   | — |   |
| Proceeds from sales of  assets, net                                                                            |       | 104                                   |       | — |   | 92 |   |
| Net cash used for  investing activities                                                                        |       | (89,837                               | )          | (3,389 | ) | (108,010 | ) |
| Cash flows from financing activities:                                                                          |       |                                  |       |   |   |   |   |
| Proceeds from term loan  and line of credit, net                                                               |       | —                                |       | — |   | 107,569 |   |
| Payments on term loan                                                                                          |       | (54,209                               | )          | (45,792 | ) | — |   |
| Repayment of line of  credit                                                                                   |       | —                                |       | — |   | (10,300 | ) |
| Payments on capital  leases                                                                                    |       | (668                                  | )          | (621 | ) | (166 | ) |
| Proceeds from exercises  of stock options                                                                      |       | 9,452                                 |       | 5,874 |   | 6,015 |   |
| Proceeds from employee  stock purchase plan                                                                    |       | 5,004                                 |       | 3,169 |   | 3,045 |   |
| Repurchases of common  stock                                                                                   |       | (2,684                                | )          | (14,206 | ) | (74,509 | ) |
| Payments for dividends                                                                                         |       | (53,483                               | )          | (38,067 | ) | — |   |
| Excess tax benefits from stock-based compensation                                                              |       | 3,863                                 |       | — |   | — |   |
| Net cash provided by  (used for) financing activities                                                          |       | (92,725                               | )          | (89,643 | ) | 31,654 |   |
| Effect of exchange rate  changes on cash and cash equivalents                                                  |       | (53                                   | )          | (130 | ) | — |   |
| Change in cash and cash  equivalents                                                                           |       | (81,145                               | )          | 43,885 |   | 47,604 |   |
| Cash and cash  equivalents, beginning of period                                                                |       | 100,397                               |       | 56,512 |   | 8,908 |   |
| Cash and cash  equivalents, end of period                                                                      |       | $                                     | 19,252     |   | $ | 100,397 |   | $ | 56,512 |   |
| Supplemental disclosure of cash flows:                                                                         |       |                                  |       |   |   |   |   |
| Cash paid for interest                                                                                         |       | $                                     | 862        |   | $ | 4,245 |   | $ | 9 |   |
| Cash paid for income  taxes                                                                                    |       | 34,352                                |       | 13,970 |   | 2,851 |   |
| Supplemental disclosure of non-cash investing  and financing activities:                                       |       |                                  |       |   |   |   |   |
| Reduction in goodwill and  intangibles in connection with the release of the deferred tax valuation  allowance |       | —                                |       | — |   | 20,782 |   |
| Issuance of common stock and options assumed for  acquisitions                                                 |       | —                                |       | — |   | 2,880 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-8

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**UNITED ONLINE, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION,ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS**

**Description of Business**

United Online, Inc. (“UnitedOnline” or the “Company”) is a leading provider of consumer Internet and mediaservices through a number of brands, including NetZero, Juno, Classmates andMyPoints. The Company’s primary Communications services include Internet accessand email. The Company’s primary Content & Media services includesocial networking and online loyalty marketing. On a combined basis, theCompany’s Web properties attract a significant number of Internet users eachmonth and the Company offers marketers a broad array of Internet advertisingproducts and services as well as online market research and measurementservices.

United Online is aDelaware corporation that commenced operations in 2001 following the merger ofInternet access providers NetZero, Inc. and Juno Online Services, Inc.(the “Merger”). During 2004, the Company completed the acquisitions ofClassmates Online, Inc. (“Classmates”), a leading provider ofsocial-networking services, and the Web-hosting and domain name registrationbusiness of About Web Services, Inc. In March 2005, the Company acquiredcertain assets related to PhotoSite, the online digital photo-sharing service ofHomestead Technologies, Inc. In March 2006, the Company acquired TheNames Database, a global social-networking service. In April 2006, the Companyacquired MyPoints.com, Inc. (“MyPoints”), a leading provider of onlineloyalty marketing services. The Company’s corporate headquarters are located inWoodland Hills, California, and the Company also maintains offices in New York,New York; Fort Lee, New Jersey; Renton, Washington; San Francisco, California;Schaumburg, Illinois; Orem, Utah; Erlangen, Germany; Berlin, Germany; andHyderabad, India.

The Company believes thatits existing cash, cash equivalents and short-term investments, and cashgenerated from operations will be sufficient to fund its working capitalrequirements, capital expenditures, dividend payments and other obligationsthrough at least the next twelve months. However, additional capital may beneeded in order to fund the Company’s operations, expand marketing activities,develop new or enhance existing services or products, respond to competitivepressures or acquire complementary services, businesses or technologies.

**Basis of Presentation**

The accompanyingconsolidated financial statements for the years ended December 31, 2006,2005 and 2004, include United Online and its wholly-owned subsidiaries.All significant intercompany accounts and transactions have been eliminated inconsolidation. The consolidated financial statements, in the opinion ofmanagement, reflect all adjustments (consisting only of normal recurringadjustments) that are necessary for a fair presentation of the results for theperiods shown. The results of operations for such periods are not necessarilyindicative of the results expected for any future periods.

The preparation offinancial statements in accordance with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent liabilities and the reported amountsof revenues and expenses. Actual results could differ from those estimates.

**Accounting Policies**

*Use of Estimates—**The*preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand 

F-9

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assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andreported amounts of revenues and expenses during the reporting period. Actualresults may differ from those estimates.

*Cash, Cash Equivalents andShort-Term Investments—**The*Company considerscash equivalents to be only those investments which are highly liquid, readilyconvertible to cash and which have a maturity date within ninety days from thedate of purchase. The Company’s short-term investments consist ofavailable-for-sale securities with original maturities exceeding ninety days.Consistent with Statement of Financial Accounting Standards (“SFAS”) No. 115,*Accounting for Certain Investments in Debt andEquity Securities,* the Company has classified these securities, allof which have readily determinable fair values and are highly liquid, as shortterm because the sale of such securities may be required prior to maturity toimplement management’s strategies. The Company has short-term investmentsprimarily in U.S. commercial paper, U.S. Government or U.S. Government Agencyobligations, municipal obligations, auction rate securities and money marketfunds. The minimum long-term credit rating is A, and if a long-term rating isnot available, the Company requires a minimum short-term credit rating of A1and P1. The Company’s short-term investments are reported at fair value, withunrealized gains and losses, net of taxes, recorded in the consolidated statementsof comprehensive income. Realized gains or losses and permanent declines invalue, if any, on available-for-sale securities are reported in other income orexpense. The cost basis of a security that has been sold and any amountreclassified out of accumulated other comprehensive income into earnings isdetermined by the specific identification method. Significant fluctuations inshort-term interest rates could have a material impact on interest income andunrealized gains and losses from the Company’s investment portfolio.

The primary objectives ofthe Company’s short-term investment portfolio are preservation of principal andliquidity while maximizing yield. Investments are made to achieve the highestpossible rate of return for the Company, consistent with these two objectives.

The Company classifiesoutstanding interest payments due on its short-term investments as interestreceivable, the balance of which is reflected in other current assets.

The Company assesseswhether an other-than-temporary impairment loss on its investments has occurreddue to declines in fair value or other market conditions. Declines in fairvalue that are considered other than temporary are recorded as an impairmentcharge in the consolidated statements of income. During the years ended December 31,2006, 2005 and 2004, the Company did not record any such impairment charges.

*Restricted Cash—**Restricted*cash,which is included in other current assets and other assets, consists ofcertificates of deposit and, in general, collateralizes the Company’sobligations for operating leases and amounts held in escrow related to certainof the Company’s merchant services agreements.

*Concentrations of Creditand Business Risk—**Financial*instruments that potentiallysubject the Company to a concentration of credit risk consist of cash and cashequivalents, short-term investments and accounts receivable. The Company’saccounts receivable are derived primarily from revenue earned from pay accountsand advertising customers located in the United States. The Company extendscredit based upon an evaluation of the customer’s financial condition and,generally, collateral is not required. The Company maintains an allowance fordoubtful accounts based upon the expected collectibility of accountsreceivable, and, to date, such losses have been within management’sexpectations.

The Company evaluatesspecific accounts where information exists that the customer may have aninability to meet its financial obligations. In these cases, based on the bestavailable facts and circumstances, a specific reserve is recorded for thatcustomer against amounts due to reduce the receivable to the amount that isexpected to be collected. These specific reserves are reevaluated and adjustedas additional information is received that impacts the amount reserved. Also, ageneral reserve is established for all customers based on the aging of thereceivables. If circumstances change (i.e., higher 

F-10

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thanexpected defaults or an unexpected material adverse change in a major customer’sability to meet its financial obligations), the estimates of the recoverabilityof amounts due to the Company are adjusted.

At December 31, 2006,one customer comprised approximately 13% of the consolidated accounts receivablebalance. At December 31, 2005, two customers comprised approximately 21%and 12% of the consolidated accounts receivable balance. For the years ended December 31,2006, 2005 and 2004, the Company did not have any individual customers thatcomprised more than 10% of total revenues.

At December 31, 2006and 2005, the Company’s cash and cash equivalents were maintained primarilywith three major financial institutions in the United States. Deposits withthese institutions generally exceed the amount of insurance provided on suchdeposits.

*Long-Lived Assets—**The* Company accountsfor 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 anddisposition of long-lived assets. The Company evaluates the recoverability oflong-lived assets, other than indefinite life intangible assets, for impairmentwhen events or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Events and circumstances that may indicate thatan asset is impaired include significant decreases in the market value of anasset, significant underperformance relative to expected historical orprojected future results of operations, a change in the extent or manner inwhich an asset is used, significant declines in the Company’s stock price for asustained period, shifts in technology, loss of key management or personnel,changes in the Company’s operating model or strategy and competitive forces.

*Property*andequipment are stated at historical cost less accumulated depreciation.Depreciation is computed using the straight-line method over the estimateduseful lives of the assets, which is generally two to three years for computersoftware and equipment and three to seven years for furniture, fixtures and officeequipment. Leasehold improvements are amortized over the shorter of the leaseterm or the estimated useful lives. Upon the sale or retirement of property orequipment, the cost and related accumulated depreciation or amortization isremoved from the Company’s financial statements with the resulting gain or lossreflected in the Company’s results of operations. Repairs and maintenance costsare expensed as incurred.

Definite-livedidentifiable intangible assets are amortized over their estimated useful lives,ranging from two to ten years. The Company’s intangible assets were acquiredprimarily in connection with business combinations.

*Goodwill—**Goodwill**representsthe excess of the cost of an acquired entity over the fair value of theacquired net assets. The Company accounts for goodwill in accordance with SFAS No. 142,**Goodwill and Other IntangibleAssets**, which among other things, addresses financial accountingand reporting requirements for acquired goodwill and other intangible assets.SFAS No. 142 requires goodwill to be carried at cost, prohibits theamortization of goodwill and requires the Company to test goodwill forimpairment at least annually. The Company performs an impairment test of itsgoodwill annually during the fourth quarter of its fiscal year or when eventsand circumstances change that would indicate that goodwill might be permanentlyimpaired. Events or circumstances which could trigger an impairment reviewinclude a significant adverse change in legal factors or in the businessclimate, an adverse action or assessment by a regulator, unanticipatedcompetition, a loss of key personnel, significant changes in the manner of theCompany’s use of the acquired assets or the strategy for the Company’s overallbusiness, significant negative industry or economic trends, significantdeclines in the Company’s stock price for a sustained period or significantunderperformance relative to expected historical or projected future results ofoperations.*

*The testing for a potential impairment of goodwill involvesa two-step process. The first step of the impairment test involves comparingthe estimated fair values of the Company’s reporting units with theirrespective book values, including goodwill. If the estimated fair value exceedsbook value, goodwill is*

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*considered not to be impaired andno additional steps are necessary. If, however, the fair value of the reportingunit is less than book value, then the carrying amount of the goodwill iscompared with its implied fair value. The estimate of implied fair value ofgoodwill may require independent valuations of certain internally generated andunrecognized intangible assets such as the Company’s pay account base, softwareand technology and patents and trademarks. If the carrying amount of goodwillexceeds the implied fair value of that goodwill, an impairment loss isrecognized in an amount equal to the excess.*

*BusinessCombinations—**All***of theCompany’s acquisitions have been accounted for as purchase businesscombinations. Under the purchase method of accounting, the cost, includingtransaction costs, is allocated to the underlying net assets, based on theirrespective estimated fair values. The excess of the purchase price over theestimated fair values of the net assets acquired is recorded as goodwill.

The judgments made in determining the estimated fairvalue and expected useful lives assigned to each class of assets andliabilities acquired can significantly impact net income. Consequently, to theextent an indefinite-lived or a longer-lived asset is ascribedgreater value under the purchase method than a shorter-lived asset, theremay be less amortization recorded in a given period. Definite-livedidentifiable intangible assets are amortized on either a straight-line basis oran accelerated basis. The Company determines the appropriate amortizationmethod by performing an analysis of expected cash flows over the estimateduseful life of the asset and matches the amortization expense to the expectedcash flows from those assets.

Determining the fair value of certain assets andliabilities acquired is subjective in nature and often involves the use ofsignificant estimates and assumptions. Two areas, in particular, that requiresignificant judgment are estimating the fair value and related useful lives ofidentifiable intangible assets. To assist in this process, the Company mayobtain appraisals from valuation specialists for certain intangible assets.While there are a number of different methods used in estimating the value ofacquired intangibles, there are two approaches primarily used: the discountedcash flow and market comparison approaches. Some of the more significantestimates and assumptions inherent in the two approaches include: projectedfuture cash flows (including timing); discount rate reflecting the riskinherent in the future cash flows; perpetual growth rate; subscriber churn andterminal value; determination of appropriate market comparables; and thedetermination of whether a premium or a discount should be applied tocomparables. Most of the above assumptions are made based on availablehistorical information.

*MemberRedemption Liability—**The**memberredemption liability represents the estimated costs associated with the Company’sobligation to redeem outstanding member balances (in points), less an allowancefor points expected to expire prior to redemption. Such members’ points may beconverted by enrolled members into various third-party gift certificates,frequent travel programs, coupons or other rewards. Points are granted tomembers when they respond to direct marketing offers delivered by the Company,purchase goods from advertisers or engage in other specified activities. TheCompany is liable for providing the rewards to members if and when such membersseek to redeem accumulated points upon reaching required redemption thresholds.The member redemption liability is estimated based upon a weighted-average costof points that may be redeemed in the future. The liability is based uponhistorical redemption costs and management’s estimate of future trends. Underthe current policy, the Company reserves the right to cancel or disableaccounts and expire unredeemed points in those accounts that are inactive for aperiod of twelve consecutive months. “Inactive” shall be defined as a lack ofone of the following: Web site visit (click through); email response; surveycompletion; profile update; or any point-earning or point-spending transaction.The Company bases its estimate of points that will not be redeemed on ananalysis of historical point earning trends, redemption activity and individualmember accounts. This analysis is updated quarterly.*

*RevenueRecognition—**The*Company applies the provisionsof Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”)No. 104, *Revenue Recognition inFinancial Statements,* which 

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provides guidance on therecognition, presentation and disclosure of revenue in financial statementsfiled with the SEC. SAB No. 104 outlines the basic criteria that must bemet to recognize revenue and provides guidance for disclosure related torevenue recognition policies. In general, the Company recognizes revenue relatedto its billable services and advertising products when (i) persuasiveevidence of an arrangement exists, (ii) delivery has occurred or serviceshave been rendered, (iii) the fee is fixed or determinable and (iv) collectibilityis reasonably assured. The Company also applies the provisions of EmergingIssues Task Force (“EITF”) Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*.

Billable services revenues are recognized in theperiod in which fees are fixed or determinable and the related products orservices are provided to the user. The Company’s pay accounts generally pay inadvance for their service by credit card, and revenue is then recognizedratably over the period in which the related services are provided. Advancepayments from subscribers are recorded on the balance sheet as deferredrevenue. The Company offers alternative payment methods to credit cards forcertain pay service plans. These alternative payment methods currently include ACH,payment by personal check or money order or through a local telephone company.In circumstances where payment is not received in advance, revenue is onlyrecognized if collectibility is reasonably assured.

Advertising revenues consist primarily of fees which resultfrom users utilizing partner Internet search services, fees generated by usersviewing and clicking on third-party Web site banners and text-linkadvertisements, fees generated by enabling customer registrations for partnersand fees from referring users to, or from users making purchases on, sponsors’Web sites. Revenues are recognized provided that no significant obligationsremain, fees are fixed or determinable, and collection of the relatedreceivable is reasonably assured. The Company recognizes banner advertising andsponsorship revenues in the periods in which the advertisement or sponsorshipplacement is displayed, based upon the lesser of (i) impressions delivereddivided by the total number of guaranteed impressions or (ii) ratably overthe period in which the advertisement is displayed. The Company’s obligationstypically include a minimum number of impressions or the satisfaction of otherperformance criteria. Revenue from performance-based arrangements,including referral revenues, is recognized as the related performance criteriaare met. In determining whether an arrangement exists, the Company ensures thata binding contract is in place, such as a standard insertion order or a fullyexecuted customer-specific agreement. The Company assesses whetherperformance criteria have been met and whether the fees are fixed ordeterminable based on a reconciliation of the performance criteria and thepayment terms associated with the transaction. The reconciliation of theperformance criteria generally includes a comparison of internally trackedperformance data to the contractual performance obligation and to third-partyor customer performance data in circumstances where that data is available.Probability of collection is assessed based on a number of factors, includingpast transaction history with the customer and the creditworthiness of thecustomer. If it is determined that collection is not reasonably assured,revenue is not recognized until collection becomes reasonably assured, which isgenerally upon receipt of cash.

*The Company’s MyPoints subsidiary earns revenue primarilyfrom corporate advertising customers by charging fees for sending emails to theMyPoints’ members and placing advertising on the MyPoints Web site. Under theterms of advertising contracts, MyPoints earns revenue primarily based on threecomponents: (1) transmission of email advertisements to enrolled members, (2) uniqueclicks on transmitted emails and (3) actual transactions by members overthe Internet. Revenue is recognized when email is transmitted to members, whenresponses are received and when members complete online transactions. Each ofthese activities is a discrete, independent activity, which generally isspecified in the advertising sales agreement entered into with the customer. Asthe earning activities take place, activity measurement data (e.g., number ofemails delivered and number of responses received) is accumulated and therelated revenue is recorded. Revenue from the sale of points to MyPoints’ advertisersis deferred over a fifteen-month period, which is the expected time thateither the points are redeemed and MyPoints provides a reward, or the pointsexpire prior to redemption. Revenue is also deferred if MyPoints has*

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*performed under the contract andhas billed for its services, but the collection of the receivable is notreasonably assured. In such case, revenue is recognized once the collection ofthe cash is no longer in doubt. Also, deferred revenue represents invoiced servicesthat have not yet been performed.*

*Costof Revenues—**Cost**of revenuesincludes telecommunications and data center costs; personnel andoverhead-related costs associated with operating our networks and data centers;depreciation of network computers and equipment; email technical support andlicense fees; costs related to providing telephone technical support; customerbilling and billing support to our pay accounts; domain name registration fees;and costs of providing rewards to members of our loyalty marketing service.*

*Salesand Marketing—**Sales*and marketing expensesinclude advertising and promotion expenses, fees paid to distribution partnersto acquire new pay and free accounts, personnel-related expenses forsales and marketing personnel and telemarketing costs incurred to acquire payaccounts, retain pay accounts and up-sell pay accounts to additional services.The Company has expended significant amounts on sales and marketing, includingbranding and customer acquisition campaigns consisting of television, Internet,sponsorships, radio, print and outdoor advertising and on retail and otherperformance-based distribution relationships. Marketing and advertisingcosts to promote the Company’s products and services are expensed in the periodincurred. Advertising and promotion expenses include media, agency andpromotion expenses. Media production costs are expensed the first time theadvertisement is run. Media and agency costs are expensed over the period theadvertising runs. Advertising and promotion expense for the years ended December 31,2006, 2005 and 2004 was $117.7 million, $159.5 million and $147.1 million,respectively. At December 31, 2006 and 2005, $1.3 million and $3.6million, respectively, of prepaid advertising and promotion expense wasincluded in other current assets.

*ProductDevelopment Costs—**The***Companycapitalizes certain costs incurred for the development of software. Productdevelopment expenses include expenses for the maintenance of existing softwareand the development of new or improved software and technology, includingpersonnel-related expenses for the software engineering department andthe costs associated with operating the Company’s facility in India. Costsincurred by the Company to manage, monitor and operate the Company’s servicesare generally expensed as incurred, except for certain costs relating to theacquisition and development of internal-use software that are capitalized anddepreciated over their estimated useful lives, generally three years or less.

*SoftwareDevelopment Costs—**The* Company accounts for costincurred to develop software for internal use in accordance with Statement ofPosition 98-1, *Accounting for Costs ofComputer Software Developed or Obtained for Internal Use*, whichrequires such costs be capitalized and amortized over the estimated useful lifeof the software. We capitalize costs associated with customized internal-usesoftware systems that have reached the application development stage. Suchcapitalized costs include external direct costs utilized in developing orobtaining the applications and payroll and payroll-related expenses foremployees who are directly associated with the applications. Capitalization ofsuch costs begins when the preliminary project stage is complete and ceases atthe point in which the project is substantially complete and ready for itsintended purpose. The Company capitalized costs associated with internal-usesoftware of $8.1 million and $4.5 million in the years endedDecember 31, 2006 and 2005, respectively, which are being depreciated on astraight-line basis over each project’s estimated useful life which isgenerally three years. Capitalized internal use software isincluded within computer software and equipment category within propertyand equipment, net.

*Generaland Administrative—**General***andadministrative expenses include personnel-related expenses for executive,finance, legal, human resources and internal customer support personnel. Inaddition, general and administrative expenses include fees for professional,legal, accounting and financial services, non-income taxes, insurance, andoccupancy and other overhead-related costs, as well as the expensesincurred and credits received as a result of certain legal settlements.

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*Stock-BasedCompensation—**On**January 1, 2006, theCompany adopted SFAS No. 123 (revised 2004),**Share-Based Payment**, whichrequires the measurement and recognition of compensation expense for allshare-based payment awards made to employees and directors including employeestock options, restricted stock awards and employee stock purchases related tothe Employee Stock Purchase Plan (“employee stock purchases”) based on thegrant-date fair values of the awards. SFAS No. 123R supersedes theCompany’s previous accounting under Accounting Principles Board (“APB”) OpinionNo. 25,**Accountingfor Stock Issued to Employees**. In March 2005, theSEC issued Staff Accounting Bulletin (“SAB”) No. 107 relating to SFAS No. 123R.The Company has applied the provisions of SAB No. 107 in its adoption ofSFAS No. 123R (see Note 5 for additional information).*

*The Company adopted SFAS No. 123R using the modifiedprospective transition method, and the Company’s consolidated financialstatements at and for the year ended December 31, 2006 reflect the impactof SFAS No. 123R. In accordance with the modified prospective transitionmethod, the Company’s consolidated financial statements for prior periods havenot been restated to reflect, and do not include, the impact of SFAS No. 123R.Stock-based compensation expense recognized under SFAS No. 123R for theyear ended December 31, 2006 was $19.2 million, which was primarilyrelated to stock options, restricted stock and the discount on employee stockpurchases. Stock-based compensation expense, recorded in accordance with APBOpinion No. 25, for the years ended December 31, 2005 and 2004 was$10.0 million and $2.4 million, respectively, which was primarily related torestricted stock.*

*SFAS No. 123R requires companies to estimate the fairvalue of share-based payment awards on the grant date using an option-pricingmodel. Under SFAS No. 123, the Company used the Black-Scholesoption-pricing model for valuation of share-based awards for its pro formainformation. Upon adoption of SFAS No. 123R, the Company elected tocontinue to use the Black-Scholes option-pricing model for valuing awards. Thevalue of the portion of the award that is ultimately expected to vest isrecognized as expense over the requisite service periods in the Company’sconsolidated statements of operations. Prior to the adoption of SFAS No. 123R,the Company accounted for share-based awards to employees and directors usingthe intrinsic value method in accordance with APB No. 25 as allowed underSFAS No. 123,**Accountingfor Stock-Based Compensation**. Under the intrinsic valuemethod, no stock-based compensation expense related to stock options had beenrecognized in the Company’s consolidated statements of operations, other thanas related to acquisitions, because the exercise price of the Company’s stockoptions granted to employees and directors equaled the fair market value of theunderlying stock at the grant date.*

*Stock-based compensation expense recognized during thecurrent period is based on the value of the portion of share-based paymentawards that is ultimately expected to vest. SFAS No. 123R requiresforfeitures to be estimated at the time of grant in order to calculate theamount of share-based awards that will ultimately vest. The forfeiture rate isbased on historical rates. Stock-based compensation expense recognized in theCompany’s consolidated statement of operations for the year ended December 31,2006 includes (i) compensation expense for share-based payment awardsgranted prior to, but not yet vested at, December 31, 2005 based on thegrant-date fair value estimated in accordance with the pro forma provisions ofSFAS No. 123 and (ii) compensation expense for the share-basedpayment awards granted subsequent to December 31, 2005, based on thegrant-date fair value estimated in accordance with the provisions of SFAS No. 123R.As stock-based compensation expense recognized in the consolidated statement ofoperations for the year ended December 31, 2006 is based on awardsultimately expected to vest, it has been reduced for estimated forfeitures. Forthe periods prior to 2006, the Company accounted for forfeitures as theyoccurred. Accordingly, a pretax cumulative effect of accounting changeadjustment totaling $1.1 million ($1.0 million, net of tax) was recorded in theMarch 2006 quarter 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, the Companyrecognized stock-based compensation expense for awards with graded vesting bytreating each vesting tranche as a separate award and recognizing compensationexpense ratably for each tranche. For equity awards granted subsequent to theadoption of*

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*SFAS No. 123R, the Companytreats such awards as a single award and recognizes stock-based compensationexpense on a straight-line basis (net of estimated forfeitures) over theemployee service period.*

*In November 2005, the Financial Accounting StandardsBoard (“FASB”) issued FASB Staff Position (“FSP”) No. SFAS 123(R)-3,**Transition Election Related toAccounting for Tax Effects of Share-Based Payment Awards**. Thealternative transition method includes simplified methods to establish thebeginning balance of the additional paid-in capital pool (“APIC pool”) relatedto the tax effects of employee share-based compensation, and to determine thesubsequent impact on the APIC pool and consolidated statements of cash flows ofthe tax effects of employee share-based compensation awards that areoutstanding upon adoption of SFAS No. 123R. In the June 2006 quarter,the Company adopted the provisions of FSP No. SFAS 123(R)-3.*

*Since the adoption of SFAS No. 123R, stock-basedcompensation expense reduced the Company’s results of operations as follows (inthousands, except per share amounts), excluding the cumulative effect ofaccounting change:*

|                                                         | ** ** | **Year Ended  December 31, 2006** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------|------------|
| Operating expenses:                                     |       |                                             |       |   |   |
| Cost of revenues                                        |       |                                             | $          | 817 |   |   |
| Sales and  marketing                                    |       |                                             | 3,457      |   |   |
| Product  development                                    |       |                                             | 5,367      |   |   |
| General and administrative                              |       |                                             | 9,527      |   |   |
| Stock-based  compensation                               |       |                                             | 19,168     |   |   |
| Tax benefit  recognized                                 |       |                                             | (3,962     | ) |   |
| Stock-based  compensation, net of tax                   |       |                                             | $          | 15,206 |   |   |
| Stock-based  compensation, net of tax per common share: |       |                                             |       |   |   |
| Basic                                                   |       |                                             | $          | 0.24 |   |   |
| Diluted                                                 |       |                                             | $          | 0.23 |   |   |

* *

*The following table illustrates(in thousands, except per share amounts) the effect on net income and earningsper share in the prior year as if the Company had applied the fair valuerecognition provisions of SFAS No. 123, as amended by SFAS No. 148,**Accounting for Stock-Based Compensation—Transitionand Disclosure**.*

|                                                                                                             | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net income, as  reported                                                                                    |       | $                                      | 47,127     |   | $ | 117,480 |   |
| Add: Stock-based compensation included in net  income, net of tax                                           |       | 8,264                                  |       | 2,449 |   |
| Deduct: Total stock-based compensation determined  under fair value-based method for all awards, net of tax |       | (23,360                                | )          | (12,712 | ) |
| Pro forma net  income                                                                                       |       | $                                      | 32,031     |   | $ | 107,217 |   |
| Basic net income  per share, as reported                                                                    |       | $                                      | 0.77       |   | $ | 1.91 |   |
| Basic net income per  share, pro forma                                                                      |       | $                                      | 0.52       |   | $ | 1.75 |   |
| Diluted net  income per share, as reported                                                                  |       | $                                      | 0.74       |   | $ | 1.81 |   |
| Diluted net income per  share, pro forma                                                                    |       | $                                      | 0.50       |   | $ | 1.64 |   |

 

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*ComprehensiveIncome—**SFAS***No. 130, *Reporting Comprehensive Income,*establishes standards for reporting comprehensive income and its components infinancial statements. Comprehensive income, as defined, includes all changes inequity (net assets) during a period from non-owner sources. For the Company,comprehensive income consists of its reported net income, net unrealized gainsor losses on short-term investments and derivatives and foreign currencytranslation.

*ForeignCurrency—**The***functionalcurrency of the Company’s international subsidiaries is the local currency. Thefinancial statements of these subsidiaries are translated to U.S. dollars usingperiod-end rates of exchange for assets and liabilities, and average rates ofexchange for the period for revenues and expenses. Translation gains and lossesare recorded in accumulated other comprehensive income as a component ofstockholders’ equity. Net gains and losses resulting from foreign exchangetransactions were not significant during the periods presented.

*IncomeTaxes—**Income*taxes are accounted forunder SFAS No. 109, *Accounting forIncome Taxes*. Under SFAS No. 109, deferred tax assets andliabilities are determined based on differences between the financial reportingand tax basis of assets and liabilities and are measured using the enacted taxrates and laws that will be in effect when the differences are expected toreverse. A valuation allowance is established when necessary to reduce deferredtax assets to the amount expected to be realized.

The computation of limitations relating to the amountof such tax assets, and the determination of appropriate valuation allowancesrelating to realizability of such assets, are inherently complex and requirethe exercise of judgment. As additional information becomes available, wecontinually assess the carrying value of our net deferred tax assets.

*EarningsPer Share—**Basic***earningsper share is computed using the weighted-average number of common sharesoutstanding during the period, net of shares subject to repurchase rights, andexcludes any dilutive effects of options or warrants, restricted stock,restricted stock units (“RSUs”) and convertible securities, if any. Dilutedearnings per share is computed using the weighted-average number of commonstock and common stock equivalent shares outstanding (including the effect ofrestricted stock) during the period. Common stock equivalent shares areexcluded from the computation if their effect is antidilutive.

*LegalContingencies—**The*Company is currently involvedin certain legal proceedings. The Company records liabilities related topending litigation when an unfavorable outcome is probable and management canreasonably estimate the amount of loss. The Company has not recordedliabilities for certain pending litigation because of the uncertainties relatedto assessing both the amount and the probable outcome of those claims. Asadditional information becomes available, the Company continually assesses thepotential liability related to all pending litigation.

*Segments—**The**Companycomplies with the reporting requirements of SFAS No. 131,**Disclosures about Segments of an Enterpriseand Related Information**. Historically, the Companyoperated in one reportable segment, a provider of consumer Internetsubscription services through a number of brands, including NetZero, Juno andClassmates. Effective in the March 2006 quarter, the Company is operatingin two reportable segments: Communications—consisting of its Internet access,email and VoIP services; and Content & Media—consisting of itssocial-networking, Web-hosting, photo-sharing and, subsequent to theacquisition of MyPoints, loyalty marketing services. Unallocated corporateexpenses are centrally managed at the corporate level and consist ofcorporate-related expenses, depreciation, amortization of intangible assets andstock-based compensation. The Company has restated the prior periods to reflectthe change in the composition of the reportable segments. Management hasdetermined that segment income from operations, which excludes corporateexpenses, depreciation, amortization of intangible assets and stock-basedcompensation, is the appropriate measure for assessing performance of itssegments and for allocating resources among its segments.*

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*OperatingLeases—**The* Company leases office space,data centers and certain office equipment under operating lease agreements withoriginal lease periods of up to 10 years. Certain of the lease agreementscontain rent holidays and rent escalation provisions. Rent holidays and rentescalation provisions are considered in determining straight-line rent expenseto be recorded over the lease term. The lease term begins on the date ofinitial possession of the lease property for purposes of recognizing leaseexpense on a straight-line basis over the term of the lease. Lease renewalperiods are considered on a lease-by-lease basis and are generally not includedin the initial lease term.

*Reclassifications—**Certain*prior yearamounts have been reclassified to conform to current year presentation. Thesechanges had no impact on previously reported results of operations orstockholders’ equity.

**Recent AccountingPronouncements**

*Accounting Changesand Error Corrections*

In June 2005, the FASBissued SFAS No. 154, *Accounting Changes andError Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3*.SFAS No. 154 changes the requirements for the accounting for and reportingof a change in accounting principle and applies to all voluntary changes inaccounting principle. APB Opinion No. 20 previously required that mostvoluntary changes in accounting principle be recognized by including in netincome of the period of change the cumulative effect of changing to the newaccounting principle. SFAS No. 154 requires retrospective application toprior periods’ financial statements of changes in accounting principle, unlessit is impracticable to determine either the period-specific effects or thecumulative effect of the change. When it is impracticable to determine theperiod-specific effects of an accounting change on one or more individual priorperiods presented, SFAS No. 154 requires that the new accounting principlebe applied to the balances of assets and liabilities as of the beginning of theearliest period for which retrospective application is practicable and that acorresponding adjustment be made to the opening balance of retained earningsfor that period rather than being reported in an income statement. When it isimpracticable to determine the cumulative effect of applying a change inaccounting principle to all prior periods, SFAS No. 154 requires that thenew accounting principle be applied as if it were adopted prospectively fromthe earliest date practicable. In addition, SFAS No. 154 makes adistinction between retrospective application of an accounting principle andthe restatement of financial statements to reflect the correction of an error.SFAS No. 154 is effective for accounting changes and corrections of errorsmade beginning in the March 2006 quarter. The implementation of SFAS No. 154did not have a material impact on the Company’s financial position, results ofoperations or cash flows.

*Accounting forUncertainty in Income Taxes*

In July 2006, theFASB issued FASB Interpretation No. (“FIN”) 48, *Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109*,which clarifies the accounting for uncertainty in income tax positions. ThisInterpretation requires that the Company recognize in the consolidatedfinancial statements the impact of a tax position that is more likely than notto be sustained upon examination based on the technical merits of the position.The provisions of FIN 48 will be effective for the Company beginning in the March 2007quarter, with the cumulative effect of the change in accounting principlerecorded as an adjustment to opening retained earnings. While the Company’sanalysis of the impact of this Interpretation is not yet complete, the Companydoes not anticipate it will have a material impact on its retained earnings atthe time of adoption.

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*Effects of PriorYear Misstatements*

In September 2006,the SEC issued SAB No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements*, in order to address the observed diversity inquantification practices with respect to annual financial statements. Therehave been two widely-recognized methods for quantifying the effects offinancial statement errors: the “roll-over” method and the “iron curtain”method. The roll-over method focuses primarily on the impact of a misstatementon 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 ofcorrecting the period-end balance sheet with less emphasis on the reversingeffects of prior year errors on the income statement. In SAB No. 108, theSEC staff establishes an approach that requires quantification of financialstatement errors based on the effects of the error on each of the company’sfinancial statements and the related financial statement disclosures. Thismodel is commonly referred to as a “dual approach” because it essentiallyrequires quantification of errors under both the iron-curtain and the roll-overmethods. From a transition perspective, SAB No. 108 permits existingpublic companies to record the cumulative effect of initially applying the “dualapproach” in the first year ending after November 15, 2006 by recordingthe necessary “correcting” adjustments to the carrying values of assets andliabilities as of the beginning of that year with the offsetting adjustmentrecorded to the opening balance of retained earnings. Additionally, the use ofthe “cumulative effect” transition method requires detailed disclosure of thenature and amount of each individual error being corrected through thecumulative adjustment and how and when it arose. These disclosures are intendedto make prior years’ materiality judgments easier for investors and others toassess. Assuming that a company has properly applied its previous approach toevaluating financial statement misstatements, the SEC staff has indicated thatit will not object if the company does not restate financial statements forfiscal years ending on or before November 15, 2006. The implementation ofSAB No. 108 did not have a material impact on the Company’s financialposition, results of operations or cash flows.

*Fair ValueMeasurements*

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which clarifies the definition of fair value, establishes guidelines formeasuring fair value, and expands disclosures regarding fair valuemeasurements. SFAS No. 157 does not require any new fair valuemeasurements and eliminates inconsistencies in guidance found in various prioraccounting pronouncements. SFAS No. 157 will be effective for the Companyon January 1, 2008. The Company is currently evaluating the impact ofadopting SFAS No. 157 on its financial position, cash flows, and resultsof operations.

*Fair Value Option*

In February 2007, theFASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*, which permits entitiesto choose to measure many financial instruments and certain other items at fairvalue that are not currently required to be measured at fair value. SFAS No. 159will be effective for the Company on January 1, 2008. The Company iscurrently evaluating the impact of adopting SFAS No. 159 on its financialposition, cash flows, and results of operations.

**2.**                 ACQUISITIONS

*MyPoints.com, Inc.*

On April 10, 2006, the Company acquiredMyPoints.com, Inc. for approximately $56.6 million in cash, includingacquisition costs. MyPoints is a leading provider of member-driven Internetdirect marketing services and provides advertisers with an integrated suite ofincentive-based media products. The acquisition was accounted for under thepurchase method in accordance with SFAS No. 141, *Business*

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*Combinations*.The primary reason for the acquisition was to expand the Company’s Content &Media business offerings. MyPoints’ results of operations are included in theCompany’s consolidated financial statements from the date of acquisition.

Thepurchase price was allocated based on the estimated fair values of assets andliabilities, including identifiable intangible assets. The purchase priceallocation is considered final. The following table summarizes the netliabilities assumed and the intangible assets and goodwill acquired inconnection with the acquisition (in thousands):

| **Description**                          | ** ** | ** ** | ** ** | **Estimated  Fair  Value** | ** ** | **Estimated  Amortizable  Life** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------------|------------|
| Net liabilities  assumed:                |       |       |       |                       |       |                             |       |
| Cash                                     |       | $          | 7,137      |                       |       |                             |       |   |
| Accounts receivable                      |       | 9,667      |       |                       |       |                             |       |
| Other current assets                     |       | 1,905      |       |                       |       |                             |       |
| Property and equipment                   |       | 2,833      |       |                       |       |                             |       |
| Other assets                             |       | 496        |       |                       |       |                             |       |
| Accounts payable and accrued liabilities |       | (9,376     | )          |                       |       |                             |       |
| Deferred revenue                         |       | (471       | )          |                       |       |                             |       |
| Member redemption liability              |       | (17,673    | )          |                       |       |                             |       |
| Total net liabilities assumed            |       | (5,482     | )          |                       |       |                             |       |
| Intangible assets  acquired:             |       |       |       |                       |       |                             |       |
| Customer contracts                       |       | 9,230      |       |                       | 5 years    |                             |       |
| Proprietary rights                       |       | 3,700      |       |                       | 10 years   |                             |       |
| Total intangible assets acquired         |       | 12,930     |       |                       |       |                             |       |
| Goodwill                                 |       | 49,122     |       |                       |       |                             |       |
| Total purchase  price                    |       | $          | 56,570     |                       |       |                             |       |   |

 

The weighted-average amortizable life of the acquiredintangible assets is 6.4 years. The acquisition was treated as an acquisitionof net assets for tax purposes and, accordingly, the $49.1 million of goodwillacquired is tax deductible.

Thefollowing summarized unaudited pro forma information assumes that theacquisition of MyPoints had occurred at January 1, 2006 and 2005 (inthousands, except per share amounts):

| ** **                                            | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                            | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Revenues                                              |       | $                                      | 535,647    |   | $ | 563,343 |   |
| Income before  cumulative effect of accounting change |       | $                                      | 41,518     |   | $ | 48,540 |   |
| Net income                                            |       | $                                      | 42,559     |   | $ | 48,540 |   |
| Basic net income per  share:                          |       |                                   |       |   |   |
| Income before cumulative effect of accounting change  |       | $                                      | 0.65       |   | $ | 0.79 |   |
| Net income                                            |       | $                                      | 0.66       |   | $ | 0.79 |   |
| Diluted net income per  share:                        |       |                                   |       |   |   |
| Income before cumulative effect of accounting change  |       | $                                      | 0.63       |   | $ | 0.76 |   |
| Net income                                            |       | $                                      | 0.64       |   | $ | 0.76 |   |

 

*The Names Database*

In March 2006, the Company acquired The NamesDatabase for approximately $10.1 million in cash, including acquisition costs.The Names Database is a global social-networking service that acts as an 

F-20

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intermediary betweenmembers, allowing them to send messages through the site to one another. Theacquisition was accounted for under the purchase method in accordance with SFASNo. 141. The primary reason for the acquisition was to acquire The NamesDatabase’s member relationships and software, which had the effect of expandingthe Company’s social-networking services. The Names Database’s results ofoperations are included in the Company’s consolidated financial statements fromthe date of acquisition.

Thepurchase price was allocated based on the estimated fair values of assets andliabilities, including identifiable intangible assets. The purchase priceallocation is considered final. The following table summarizes the netliabilities assumed and the intangible assets and goodwill acquired inconnection with the acquisition (in thousands):

| **Description**                                 | ** ** | ** ** | ** ** | **Estimated  Fair  Value** | ** ** | **Estimated  Amortizable  Life** | ** ** |
|-------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------------|------------|
| Net liabilities assumed:                        | ** ** |       | ** ** | ** **                 |       |                             | ** ** | ** ** |   |
| Cash                                            |       |       | $          | 510                        |       |                             |       |   | ** ** |   |
| Accounts receivable                             |       |       | 51         |                       |       |                             |       | ** ** |   |
| Accounts payable and accrued liabilities        |       |       | (8         | )                          |       |                             |       | ** ** |   |
| Deferred revenue                                |       |       | (541       | )                          |       |                             |       | ** ** |   |
| Deferred income taxes                           |       |       | (545       | )                          |       |                             |       | ** ** |   |
| Total net liabilities assumed                   |       |       | (533       | )                          |       |                             |       | ** ** |   |
| Intangible assets  acquired:                    |       |       |       |                       |       |                             |       | ** ** |   |
| Pay accounts                                    |       |       | 500        |                       |       |                             | 4 years    | ** ** |   |
| Free accounts                                   |       |       | 600        |                       |       |                             | 10 years   | ** ** |   |
| Advertising contracts and related relationships |       |       | 29         |                       |       |                             | 2 years    | ** ** |   |
| Technology                                      |       |       | 245        |                       |       |                             | 5 years    | ** ** |   |
| Proprietary rights                              |       |       | 134        |                       |       |                             | 5 years    | ** ** |   |
| Other intangibles                               |       |       | 45         |                       |       |                             | 5 years    | ** ** |   |
| Total intangible assets acquired                |       |       | 1,553      |                       |       |                             |       | ** ** |   |
| Goodwill                                        |       |       | 9,092      |                       |       |                             |       | ** ** |   |
| Total purchase  price                           |       |       | $          | 10,112                     |       |                             |       |   | ** ** |   |

 

The weighted-average amortizablelife of the acquired intangible assets is 6.6 years. The $9.1 million ofgoodwill acquired is not deductible for tax purposes. The pro forma effect ofthe transaction is immaterial to the consolidated financial statements.

*PhotoSite*

In March 2005, the Company acquired certainassets related to PhotoSite, the online digital photo-sharing service ofHomestead Technologies, Inc., for approximately $10.1 million in cash,including acquisition costs, and entered into a related licensing and supportagreement with Homestead Technologies. The acquisition was accounted for underthe purchase method in accordance with SFAS No. 141, *Business Combinations*. The primary reasonfor the acquisition was to acquire PhotoSite’s software and services to enhancethe Company’s other services and to expand the Company’s subscription offerings.

F-21

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Thepurchase price was allocated based on the estimated fair values of assets andliabilities, including identifiable intangible assets. The purchase priceallocation is considered final. The following table summarizes the netliabilities assumed and the intangible assets and goodwill acquired inconnection with the acquisition (in thousands):

| **Description**                  | ** ** | ** ** | ** ** | **Estimated  Fair  Value** | ** ** | **Estimated  Amortizable  Life** | ** ** |
|----------------------------------|------------|------------|------------|----------------------------|------------|----------------------------------|------------|
| Net liabilities assumed:         |       |       |       |                       |       |                             |       |   |   |
| Property and equipment           |       |       | $          | 4                          |       |                             |       |   |   |   |
| Deferred revenue                 |       |       | (190       | )                          |       |                             |       |   |   |
| Total net liabilities assumed    |       |       | (186       | )                          |       |                             |       |   |   |
| Intangible assets  acquired:     |       |       |       |                       |       |                             |       |   |   |
| Pay accounts                     |       |       | 330        |                       |       |                             | 2 years    |   |   |
| Proprietary rights               |       |       | 20         |                       |       |                             | 5 years    |   |   |
| Software and technology          |       |       | 4,200      |                       |       |                             | 5 years    |   |   |
| Total intangible assets acquired |       |       | 4,550      |                       |       |                             |       |   |   |
| Goodwill                         |       |       | 5,738      |                       |       |                             |       |   |   |
| Total purchase  price            |       |       | $          | 10,102                     |       |                             |       |   |   |   |

 

The weighted-average amortizable life of the acquiredintangible assets is 4.8 years. The $5.7 million of goodwill is tax deductible.The pro forma effect of the transaction is immaterial to the consolidatedfinancial statements.

Cash paid for acquisitions during the year endedDecember 31, 2006 included a $1.5 million payment for the acquisition ofcertain assets related to PhotoSite, which amount was included in accruedliabilities at December 31, 2005.

In the December 2006quarter, the Company recorded impairment charges totaling $8.8 million relatedto its photo-sharing service (see Note 6).

*Classmates Online, Inc.*

In November 2004, the Company acquiredClassmates, which operates Classmates.com (www.classmates.com), connectingmillions of members throughout the U.S. and Canada with friends andacquaintances from school, work and the military. Its Classmates Internationalsubsidiary also operates leading community-based networking sites inSweden (www.klasstraffen.com), and in Germany (www.stayfriends.de). Theacquisition was accounted for under the purchase method in accordance with SFASNo. 141. The primary reason for the acquisition was to acquire Classmates’services and account base to continue to expand the Company’s subscriptionofferings. Classmates’ results of operations are included in the consolidatedfinancial statements from the date of acquisition.

F-22

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Thepurchase price of approximately $131.4 million, including acquisitioncosts of $3.1 million for professional, accounting, legal andadministrative fees, was allocated to Classmates’ net assets based on theirfair values. The excess of the purchase price over the estimated fair values ofthe net assets acquired, including identifiable intangible assets, was recordedas goodwill. The Company assumed 0.5 million unvested options as of theacquisition date, and the fair value of the options assumed was determinedbased on the Black-Scholes option pricing model using a weighted-averageexpected life of five years, 0% dividend, volatility of 99%, and arisk-free interest rate of 3%. The following table summarizes the purchaseprice (in thousands):

| Cash                                 |   | $      | 125,453 |   |
|--------------------------------------|--------|--------|---------|--------|
| Fair value of  options assumed       |   | 4,325  |    |
| Intrinsic value  of unvested options |   | (1,445 | )       |
| Acquisition costs                    |   | 3,065  |    |
| Total purchase price                 |   | $      | 131,398 |   |

n

Thefollowing table summarizes the net liabilities assumed and goodwill andintangible assets acquired in connection with the acquisition of Classmates (inthousands):

|                                                 | ** ** | ** **    | ** ** | **Estimated**       | ** ** |
|-------------------------------------------------|------------|---------------|------------|---------------------|------------|
| ** **                                      | ** ** | **Estimated** | ** ** | **Amortizable**     | ** ** |
| **Description**                                 | ** ** | ** **    | ** ** | **Fair Value** | ** ** | **Life** | ** ** |
| Net liabilities assumed:                        |       |          |       |                |       |   |   |
| Cash                                            |       | $             | 30,350     |                |       |   |   |   |
| Accounts receivable                             |       | 3,396         |       |                |       |   |   |
| Property and equipment                          |       | 9,700         |       |                |       |   |   |
| Other assets                                    |       | 2,384         |       |                |       |   |   |
| Accounts payable and accrued liabilities        |       | (6,742        | )          |                |       |   |   |
| Deferred revenue                                |       | (23,757       | )          |                |       |   |   |
| Deferred income taxes                           |       | (14,170       | )          |                |       |   |   |
| Capital leases                                  |       | (1,485        | )          |                |       |   |   |
| Other long-term liabilities                     |       | (286          | )          |                |       |   |   |
| Total net liabilities assumed                   |       | (610          | )          |                |       |   |   |
| Intangible assets  acquired:                    |       |          |       |                |       |   |   |
| Trademark and trade name                        |       | 13,800        |       |                | 10 years   |   |   |
| Advertising contracts and related relationships |       | 7,200         |       |                | 3.5 years  |   |   |
| Pay accounts                                    |       | 21,700        |       |                | 4 years    |   |   |
| Free accounts                                   |       | 21,500        |       |                | 10 years   |   |   |
| Other intangibles                               |       | 536           |       |                | 7 years    |   |   |
| Total intangible assets acquired                |       | 64,736        |       |                |       |   |   |
| Goodwill                                        |       | 67,272        |       |                |       |   |   |
| Total purchase  price                           |       | $             | 131,398    |                |       |   |   |   |
|                                                 |            |               |            |                     |            |  |  |  |  |  |

 

The weighted-average amortizable life of acquireddefinite-lived intangible assets is 7.2 years. The goodwill is notdeductible for tax purposes.

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Thefollowing summarized unaudited pro forma financial information assumes that theacquisition of Classmates had occurred at January 1, 2004 (in thousands,except per share amounts).

| ** **                         | ** ** | **Year Ended  December 31,  2004** | ** ** |
|------------------------------------|------------|----------------------------------------------|------------|
| Revenues                           |       |                                         | $          | 513,300 |   |   |
| Net income                         |       |                                         | $          | 111,882 |   |   |
| Net income per  share—basic   |       |                                         | $          | 1.82 |   |   |
| Net income per  share—diluted |       |                                         | $          | 1.70 |   |   |

 

*About Web Services*

In April 2004, the Company acquired substantiallyall of the assets associated with the Web-hosting business of About, Inc.The business offers consumers Web-site services, including hosting, domain andemail services. The acquisition has been accounted for under the purchasemethod in accordance with SFAS No. 141. The primary reason for theacquisition was to acquire About, Inc.’s Web-hosting services and accountbase in order to expand the Company’s service offerings.

Thepurchase price of approximately $11.9 million was paid in cash andallocated to the net assets acquired based on their estimated fair values,including identifiable intangible assets. The following table summarizes thenet liabilities assumed and the intangible assets and goodwill acquired inconnection with the acquisition (in thousands):

| ** **                       | ** ** | ** **    | ** ** | **Estimated**       | ** ** |
|----------------------------------|------------|---------------|------------|---------------------|------------|
| ** **                       | ** ** | **Estimated** | ** ** | **Amortizable**     | ** ** |
| **Description**                  | ** ** | ** **    | ** ** | **Fair Value** | ** ** | **Life** | ** ** |
| Net liabilities assumed:         |       |          |       |                |       |   |   |   |   |
| Accounts receivable              |       |          | $          | 292                 |       |   |   |   |   |   |
| Property and equipment           |       |          | 199        |                |       |   |   |   |   |
| Other assets                     |       |          | 69         |                |       |   |   |   |   |
| Accounts payable                 |       |          | (215       | )                   |       |   |   |   |   |
| Deferred revenue                 |       |          | (1,710     | )                   |       |   |   |   |   |
| Total net liabilities assumed    |       |          | (1,365     | )                   |       |   |   |   |   |
| Intangible assets  acquired:     |       |          |       |                |       |   |   |   |   |
| Pay accounts                     |       |          | 3,190      |                |       |   | 4 years |   |   |
| Proprietary rights               |       |          | 400        |                |       |   | 7 years |   |   |
| Software and technology          |       |          | 2,220      |                |       |   | 3 years |   |   |
| Total intangible assets acquired |       |          | 5,810      |                |       |   |   |   |   |
| Goodwill                         |       |          | 7,489      |                |       |   |   |   |   |
| Total purchase  price            |       |          | $          | 11,934              |       |   |   |   |   |   |
|                                  |            |               |            |                     |            |  |  |  |  |  |  |  |

 

The weighted-averageamortizable life of acquired intangible assets is 3.8 years. The$7.5 million of goodwill acquired is deductible for tax purposes. The proforma effect of the transaction is immaterial to the consolidated financialstatements.

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**3. BALANCE SHEET COMPONENTS**

**Short-Term Investments**

Short-terminvestments consist of the following (in thousands):

| ** **            | ** ** | **December 31, 2006** | ** ** |
|-----------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| U.S. corporate  notes |       | $                               | 2,500      |   |   | $ | — |   |   |   | $ | — |   |   | $ | 2,500 |   |
| Government  agencies  |       | 140,822                         |       |   | 15 |   |   |   | (227 | ) |   | 140,610 |   |
| Total                 |       | $                               | 143,322    |   |   | $ | 15 |   |   |   | $ | (227 | ) |   | $ | 143,110 |   |

 

| ** **            | ** ** | **December 31, 2005** | ** ** |
|-----------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| U.S. corporate  notes |       | $                               | 28,143     |   |   | $ | 3 |   |   |   | $ | (10 | ) |   | $ | 28,136 |   |
| Government  agencies  |       | 116,321                         |       |   | — |   |   |   | (492 | ) |   | 115,829 |   |
| Total                 |       | $                               | 144,464    |   |   | $ | 3 |   |   |   | $ | (502 | ) |   | $ | 143,965 |   |

 

Gross unrealized gains and losses are presented net oftax in accumulated other comprehensive income on the consolidated balancesheets. The Company had no material realized gains or losses from the sale ofshort-term investments in the years ended December 31, 2006 and 2005. TheCompany recognized $0.1 million of realized gains from the sale of short-terminvestments in the year ended December 31, 2004.

Thefollowing table summarizes the fair value and gross unrealized losses on theCompany’s short-term investments, aggregated by type of investment instrumentand length of time that individual securities have been in a continuousunrealized loss position, at December 31, 2006 and 2005 (in thousands):

| ** **            | ** ** | **December 31, 2006**        | ** ** |
|-----------------------|------------|----------------------------------------|------------|
| ** **            | ** ** | **Less than 12 Months** | ** ** | **12 Months or Greater** | ** ** | **Total** | ** ** |
| ** **            | ** ** | **Fair  Value**                        | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| U.S. corporate  notes |       | $                                      | —     |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   | $ | — |   |   |
| Government  agencies  |       | 21,432                                 |       |   | (5 | ) |   | 22,568 |   |   | (222 | ) |   | 44,000 |   |   | (227 | ) |   |
| Total                 |       | $                                      | 21,432     |   |   | $ | (5 | ) |   | $ | 22,568 |   |   | $ | (222 | ) |   | $ | 44,000 |   |   | $ | (227 | ) |   |

 

| ** **            | ** ** | **December 31, 2005**        | ** ** |
|-----------------------|------------|----------------------------------------|------------|
| ** **            | ** ** | **Less than 12 Months** | ** ** | **12 Months or Greater** | ** ** | **Total** | ** ** |
| ** **            | ** ** | **Fair  Value**                        | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| U.S. corporate  notes |       | $                                      | 26,132     |   |   | $ | (10 | ) |   | $ | — |   |   | $ | — |   |   | $ | 26,132 |   |   | $ | (10 | ) |   |
| Government  agencies  |       | 33,990                                 |       |   | (172 | ) |   | 19,819 |   |   | (320 | ) |   | 53,809 |   |   | (492 | ) |   |
| Total                 |       | $                                      | 60,122     |   |   | $ | (182 | ) |   | $ | 19,819 |   |   | $ | (320 | ) |   | $ | 79,941 |   |   | $ | (502 | ) |   |

 

The Company’s investmentportfolio consists of both corporate and government securities that have amaximum maturity of four years. The longer the duration of these securities,the more susceptible they are to changes in market interest rates and bondyields. As yields increase, those securities purchased with a loweryield-at-cost show a mark-to-market unrealized loss. All unrealized losses aredue to changes in interest rates and bond yields.

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Maturitiesof short-term investments were as follows (in thousands):

|                                      | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**             | ** ** | **Estimated  Fair Value**  | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
| Maturing within 1 year               |       | $                               | 24,502     |                            | $          | 24,499 |   | $ | 39,119 |   | $ | 39,091 |   |
| Maturing between 1 year  and 4 years |       | 34,930                          |       | 34,781                          |       | 39,995 |   | 39,584 |   |
| Maturing after 4 years               |       | 83,890                          |       | 83,830                          |       | 65,350 |   | 65,290 |   |
| Total                                |       | $                               | 143,322    |                            | $          | 143,110 |   | $ | 144,464 |   | $ | 143,965 |   |

 

**Property and Equipment**

Propertyand equipment consists of the following (in thousands):

|                                  | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Computer software  and equipment |       | $                     | 106,067    |   | $ | 90,357 |   |
| Furniture and  fixtures          |       | 15,195                |       | 11,351 |   |
|                             |       | 121,262               |       | 101,708 |   |
| Less: accumulated  depreciation  |       | (86,966               | )          | (68,615 | ) |
| Total                            |       | $                     | 34,296     |   | $ | 33,093 |   |

 

Depreciation expense forthe years ended December 31, 2006, 2005 and 2004 was $21.3 million, $15.5million and $8.7 million, respectively. Assets under capital leases areincluded in computer software and equipment. At December 31, 2006, theamount capitalized and the related accumulated depreciation were $0.4 millionand $0.4 million, respectively. At December 31, 2005, the amount capitalizedand the related accumulated depreciation were $1.3 million and $0.7 million,respectively.

**Goodwill andIntangible Assets**

Thechanges in goodwill for the years ended December 31, 2005 and 2006 were asfollows (in thousands):

| Balance at  December 31, 2004                                                                |   | $      | 76,458  |   |
|---------------------------------------------------------------------------------------------------|--------|--------|---------|--------|
| Adjustments to Classmates’ goodwill                                                          |   | (1,697 | )       |
| Goodwill recorded in connection with the acquisition  of the Company’s photo-sharing service |   | 5,738  |    |
| Balance at  December 31, 2005                                                                |   | 80,499 |    |
| Goodwill recorded in connection with The Names Database  acquisition                              |   | 9,092  |    |
| Goodwill recorded in connection with MyPoints  acquisition                                        |   | 49,122 |    |
| Goodwill recorded in connection with Trombi  acquisition                                          |   | 184    |    |
| Impairment of goodwill related to the Company’s  photo-sharing service (see Note 6)     |   | (5,738 | )       |
| Reduction of acquired deferred tax assets                                                         |   | (141   | )       |
| Balance at  December 31, 2006                                                                |   | $      | 133,018 |   |

 

The adjustment to Classmates’ goodwill is primarilydue to an increase in deferred tax assets for tax benefits associated withexpense deductions and a reduction in deferred tax liabilities due to anadjustment in the state income tax rate expected to apply to future reversalsof acquired book/tax basis differences.

F-26

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Intangibleassets consist of the following (in thousands):

|                                                  | ** ** | **December 31, 2006** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Cost**                        | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Pay accounts and  free accounts                  |       | $                               | 107,903    |   |   | $ | (76,810 | ) |   | $ | 31,093 |   |
| Trademarks and  trade names                      |       | 25,786                          |       |   | (6,839 | ) |   | 18,947 |   |
| Advertising  contracts and related relationships |       | 7,229                           |       |   | (6,130 | ) |   | 1,099 |   |
| Software and  technology                         |       | 5,340                           |       |   | (4,859 | ) |   | 481 |   |
| Patents, domain  names and other                 |       | 4,595                           |       |   | (2,562 | ) |   | 2,033 |   |
| Total                                            |       | $                               | 150,853    |   |   | $ | (97,200 | ) |   | $ | 53,653 |   |

 

|                                                  | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Cost**                        | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Pay accounts and  free accounts                  |       | $                               | 98,732     |   |   | $ | (66,103 | ) |   | $ | 32,629 |   |
| Trademarks and  trade names                      |       | 21,952                          |       |   | (4,254 | ) |   | 17,698 |   |
| Advertising  contracts and related relationships |       | 7,200                           |       |   | (3,871 | ) |   | 3,329 |   |
| Software and  technology                         |       | 9,280                           |       |   | (4,691 | ) |   | 4,589 |   |
| Patents, domain  names and other                 |       | 3,247                           |       |   | (2,154 | ) |   | 1,093 |   |
| Total                                            |       | $                               | 140,411    |   |   | $ | (81,073 | ) |   | $ | 59,338 |   |

 

Amortization expense for the years ended December 31,2006, 2005 and 2004 was $17.6 million, $21.8 million and $20.4 million,respectively.

Estimatedfuture amortization expense at December 31, 2006 is as follows (inthousands):

|            | ** ** | **Year Ending  December 31,** | ** ** |
|------------|------------|-----------------------------------------|------------|
| 2007       |       |                                    | $          | 12,796 |   |   |
| 2008       |       |                                    | 9,281      |   |   |
| 2009       |       |                                    | 7,904      |   |   |
| 2010       |       |                                    | 6,231      |   |   |
| 2011       |       |                                    | 5,217      |   |   |
| Thereafter |       |                                    | 12,224     |   |   |
| Total      |       |                                    | $          | 53,653 |   |   |

 

**Accrued Liabilities**

Accruedliabilities consist of the following (in thousands):

| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Employee  compensation and related expenses |       | $                     | 27,061     |   | $ | 20,353 |   |
| Income taxes  payable                       |       | 9,305                 |       | 9,769 |   |
| Subscriber  referral fees                   |       | 250                   |       | 4,281 |   |
| Other                                       |       | 2,931                 |       | 1,846 |   |
| Total                                       |       | $                     | 39,547     |   | $ | 36,249 |   |

 

**Line of Credit**

In December 2003, United Online obtained aone-year $25 million unsecured revolving line of credit from a bank thatwas to expire in December 2004. This facility was available for generalcorporate 

F-27

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purposes and the interestrates on borrowings were based on current market rates. The line of creditcontained covenants pertaining to the maintenance of a minimum quick ratio,minimum cash balances with the lender and minimum profitability levels. Theline of credit provided additional working capital to support the Company’sgrowth and overall business strategy.

In November 2004, theCompany borrowed $10.3 million from the line of credit and repaid theamount on the same business day. The line of credit was canceled in December 2004in connection with the signing of the term loan agreement under which theCompany borrowed $100 million.

**Term Loan andInterest Rate Cap**

In December 2004, the Company borrowed $100million through a term loan facility dated December 3, 2004. A smallportion of the proceeds of the term loan facility were used to purchase sharestendered pursuant to the Company’s tender offer and to pay related fees andexpenses. The funds were available for general corporate purposes, stockrepurchases and acquisitions, subject to certain limitations.

The term loan was to mature in four years andamortized in an annual amount of $23.3 million in years one, two and three and$30 million in year four, payable in quarterly installments. Any voluntarilyprepayments made by the Company reduced, on a pro-rata basis, the remainingoutstanding amortization payments. The Company had the option to maintain theterm loan as either base rate loans or Eurodollar loans, but at no time couldthere be outstanding more than four Eurodollar loans. Interest on the loansoutstanding under the term loan facility was payable, at the Company’s option,at (a) a base rate equal to the higher of (i) the prime rate plus amargin of 2% and (ii) 0.50% in excess of the overnight federal funds rateplus a margin of 2% or (b) at a eurodollar rate generally equal to LIBORwith a maturity comparable to a selected interest period, plus a margin of 3%.

The Company was able to make optional prepayments ofthe term loan, in whole or in part (subject to a minimum prepayment amount),without premium or penalty, and subject to the reimbursement of lenders’customary breakage costs in the case of a prepayment of Eurodollar borrowings.Subject to certain limitations, the Company was required to make prepayments ofa portion of the term loan from excess cash flow (commencing in the firstquarter of 2006), proceeds of asset sales, insurance recovery and condemnationevents and the issuance of equity and debt. During the year ended December 31,2005, the Company made voluntary prepayments of $28.8 million on the term loanwhich reduced future principal repayments on a pro rata basis.

The facility was collateralized by substantially allof the Company’s assets and was unconditionally guaranteed by each of theCompany’s domestic subsidiaries.

The credit agreement contained certain financial andother covenants that placed restrictions on additional indebtedness by theCompany, liens against the Company’s assets, payment of dividends,consolidation, merger, purchase or sale of assets, capital expenditures,investments and acquisitions. At December 31, 2005, the Company was incompliance with all covenants.

The credit agreement also included certain customaryevents of default such as payment defaults, cross defaults to otherindebtedness, bankruptcy and insolvency, and a change in control, theoccurrence of which would cause all amounts under the agreement to becomeimmediately due and payable. At December 31, 2005, no events of defaulthad occurred.

On January 31, 2005, the Company purchased aninterest-rate cap to reduce the variability in the amount of expected futurecash interest payments that were attributable to LIBOR-based market interestrates. The interest-rate cap was designated and qualified as a cash flow hedge.The Company paid a $0.2 million premium to enter into the cap, which providedprotection through January 31, 2007 on $25 million of the Company’soutstanding term loan balance. The cap protected the Company from an increasein three month LIBOR over 3.5% on $25 million of borrowings over a two-yearterm. Changes in the fair 

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value of the effectiveportion of the cap were recognized in accumulated other comprehensive income.Should the cap have become ineffective as a hedge, gains and losses would havebeen recognized in the results of operations in that period. The Companyrecognized an unrealized gain of approximately $0.1 million in accumulatedother comprehensive income during the year ended December 31, 2005 relatedto the effective portion of the cash flow hedge as the cap was consideredperfectly effective during the year ended December 31, 2005. Amounts inaccumulated other comprehensive income were reclassified into earnings in thesame periods during which the future hedged cash interest payments affectedearnings.

In January 2006, theCompany paid, in full, the outstanding balance on the term loan ofapproximately $54.2 million. Effective upon payment of the outstanding balance,the Credit Agreement terminated and was of no further force or effect. Inconnection with the repayment of the term loan in January 2006, theCompany terminated the interest rate cap. During the quarter ended March 31,2006, the Company accelerated and recognized approximately $1.5 million indeferred financing costs in connection with the early repayment of the termloan.

**4. STOCKHOLDERS’EQUITY**

*Stockholders’Rights Plan*

On November 15, 2001,the Board of Directors declared a dividend of one preferred share purchaseright for each outstanding share of its common stock. The dividend was paid on November 26,2001 to the stockholders of record at the close of business on that date. Eachright entitles the registered holder to purchase from the Company one unitconsisting of one one-thousandth of a share of its Series A juniorparticipating preferred stock at a price of $25 per unit. On April 29,2003, the Board of Directors voted to amend the purchase price per unit from$25 to $140. The rights generally will be exercisable only if a person or groupacquires beneficial ownership of 15% or more of the Company’s common stock orannounces a tender or exchange offer which results in a person owning 15% ormore of the Company’s common stock. The Company generally will be entitled toredeem the rights at $0.0007 per right at any time until 10 days after apublic announcement that a 15% position in the Company’s common stock has beenacquired or that a tender or exchange offer which would result in a personowning 15% or more of the Company’s common stock has commenced. The rightsexpire on November 26, 2011.

*Preferred Stock*

The Company has5.0 million shares of preferred stock authorized with a par value of$0.0001, of which 300,000 shares are designated as Series A juniorparticipating preferred stock. At December 31, 2006 and 2005, the Companyhad no shares issued or outstanding.

*Common StockSubject to Repurchase*

At December 31, 2006and 2005, there were 475,000 shares of common stock that were subject torepurchase related to unvested shares under restricted stock agreements.

*Common StockRepurchases*

The Company’s Board of Directors authorized a commonstock repurchase program that allows the Company to repurchase shares of itscommon stock through open market or privately negotiated transactions based onprevailing market conditions and other factors through December 31, 2007.At December 31, 2006, the Company had repurchased $139.2 million of itscommon stock under the program, leaving $60.8 million remaining under theprogram.

Shares withheld from RSUsawarded to employees upon vesting to pay applicable withholding taxes on theirbehalf are considered common stock repurchases, but are not counted aspurchases against the 

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Board-approvedrepurchase program. Upon vesting, the Company currently does not collect theapplicable withholding taxes for RSUs from employees. Instead, the Companyautomatically withholds, from the RSUs that vest, the portion of those shareswith a fair market value equal to the amount of the withholding taxes due. TheCompany then pays the applicable withholding taxes in cash, which is accountedfor as a repurchase of common stock. The first RSU vest occurred inFebruary 2006. In the year ended December 31, 2006, approximately215,000 shares were withheld from RSUs that vested in order to pay theapplicable employee withholding taxes.

*Dividends*

Dividends are paid on common shares and RSUsoutstanding as of the record date.

In May, August and October of 2005, theCompany’s Board of Directors declared a quarterly cash dividend of $0.20 pershare of common stock. The quarterly dividends were paid on May 31, 2005,August 31, 2005 and November 30, 2005 and totaled $12.6 million,$12.7 million and $12.8 million, respectively.

The Company’s Board of Directors declared quarterlydividends of $0.20 per share in February 2006, May 2006,  August 2006 and November 2006 whichwere paid on February 28, 2006, May 31, 2006,  August 31, 2006 and November 30,2006 and totaled $12.9 million, $13.4 million, $13.5 million and $13.7 million,respectively.

In February 2007, the Company’s Board ofDirectors declared a quarterly cash dividend of $0.20 per share of commonstock. The record date for the dividend was February 14, 2007 and thedividend, which totaled $13.7 million, was paid on February 28, 2007.

The payment of futuredividends is discretionary and will be subject to determination by the Board ofDirectors each quarter following its review of the Company’s financialperformance. Dividends are declared and paid out of the Company’s surplus, asdefined and computed in accordance with the General Corporation Law of theState of Delaware.

*Accumulated Other Comprehensive Income (Loss)*

Accumulatedother comprehensive income (loss) is as follows (in thousands):

| ** **                         | ** ** | **Unrealized  gain (loss) on  short-term  investments,  net of tax** | ** ** | **Unrealized  gain on  derivative,  net of tax** | ** ** | **Foreign  currency  translation** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** |
|------------------------------------|------------|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------|------------|
| Balance at  January 1, 2004   |       |                                                                                     | $          | 1,648                                                           |       |                               |       | $                                                         | —     |   |   |   | $ | — |   |   |   | $ | 1,648 |   |   |
| Current period change              |       |                                                                                     | (1,666     | )                                                               |       |                               | —     |                                                      |       |   | 9 |   |   |   | (1,657 | ) |   |
| Balance at  December 31, 2004 |       |                                                                                     | (18        | )                                                               |       |                               | —     |                                                      |       |   | 9 |   |   |   | (9 | ) |   |
| Current period change              |       |                                                                                     | (282       | )                                                               |       |                               | 83         |                                                      |       |   | (119 | ) |   |   | (318 | ) |   |
| Balance at  December 31, 2005 |       |                                                                                     | (300       | )                                                               |       |                               | 83         |                                                      |       |   | (110 | ) |   |   | (327 | ) |   |
| Current period change              |       |                                                                                     | 172        |                                                            |       |                               | (83        | )                                                         |       |   | (7 | ) |   |   | 82 |   |   |
| Balance at December 31, 2006  |       |                                                                                     | $          | (128                                                            | )          |                               |       | $                                                         | —     |   |   |   | $ | (117 | ) |   |   | $ | (245 | ) |   |

 

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**5. STOCK-BASED COMPENSATION PLANS**

The Company has threeactive equity plans under which it is authorized to grant stock options,restricted stock awards and RSUs.

Stock options granted toemployees generally vest over a three- or four-year period. Stock optionsgranted to directors generally vest over a nine-month to three-year period,either monthly or annually. Stock option grants expire after ten years unlesscancelled earlier due to termination of employment or Board service. Certainstock option grants are immediately exercisable for unvested shares of commonstock, with the unvested portion of the shares remaining subject to repurchaseby the Company at the exercise price until the vesting period is complete.

RSUs granted to employeesgenerally vest over a two- to four-year period. RSUs granted to non-employeedirectors generally vest over a one-year period.

Upon the exercise of astock option award, the vesting of an RSU or the grant of restricted stock,common shares are issued from authorized but unissued shares. At December 31,2006, an aggregate of 27.6 million shares were reserved under the Company’splans, of which 4.0 million shares were available for issuance at December 31,2006.

**Stock-Based CompensationRecognized**

The following tablesummarizes the stock-based compensation that has been included in thefollowing captions for each of the periods presented (in thousands):

| ** **                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|
| ** **                     | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Operating  expenses:           |       |                                  |       |   |   |   |   |
| Cost of revenues               |       | $                                     | 817        |   | $ | 183 |   | $ | 16 |   |
| Sales and marketing            |       | 3,457                                 |       | 954 |   | 76 |   |
| Product development            |       | 5,367                                 |       | 1,069 |   | 32 |   |
| General and administrative     |       | 9,527                                 |       | 7,746 |   | 2,325 |   |
| Total stock-based compensation |       | $                                     | 19,168     |   | $ | 9,952 |   | $ | 2,449 |   |
| Tax benefit recognized         |       | $                                     | 3,962      |   | $ | 1,688 |   | $ | 116 |   |

 

F-31

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**Stock Options**

The fairvalue of each option grant is estimated on the date of grant using theBlack-Scholes option-pricing model, consistent with the provisions of SFAS No. 123Rand SAB No. 107. Because option-pricing models require the use ofsubjective assumptions, changes in these assumptions can materially affect thefair value of the options. The assumptions presented in the table belowrepresent the weighted average of the applicable assumption used to value stockoptions at their grant date. The Company calculates expected volatility basedon historical volatility of the Company’s common stock. The expected term,which represents the period of time that options granted are expected to beoutstanding, is estimated based on historical exercise experience. The Companyevaluated historical exercise behavior when determining the expected termassumptions. The risk-free rate assumed in valuing the options is based on theU.S. Treasury yield curve in effect at the time of grant for the expected termof the option. The Company determines the expected dividend yield percentage bydividing the expected annual dividend by the market price of United Onlinecommon stock at the date of grant.

| ** **                | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------------|------------|----------------------------------------|------------|
| ** **                | ** ** | **2006**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Risk-free  interest rate  |       | 4.6                                    | %          | 4.2 | % | 3.3 | % |
| Expected life (in  years) |       | 3.8                                    |       | 5.0 |   | 5.0 |   |
| Dividend yield            |       | 6.1                                    | %          | 2.3 | % | 0.0 | % |
| Volatility                |       | 60.0                                   | %          | 91.6 | % | 103.0 | % |

 

Thefollowing table summarizes activity during the years ended December 31,2004, 2005 and 2006:

| ** **                              | ** ** | **Options  Outstanding** | ** ** | **Weighted-  Average   Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **(in thousands)**  | ** ** | ** **                                    | ** ** | **(in years)**                                  | ** ** | **(in thousands)**         | ** ** |
| Outstanding at  January 1, 2004    |       |                     | 13,207     |                                          |       |                                                 | $          | 10.83                           |       |   |   |   |   |   |   |   |   |   |
| Assumed in  connection with acquisition |       |                     | 540        |                                          |       |                                                 | 5.09       |                            |       |   |   |   |   |   |   |   |   |
| Granted                                 |       |                     | 1,818      |                                          |       |                                                 | 17.83      |                            |       |   |   |   |   |   |   |   |   |
| Exercised                               |       |                     | (1,856     | )                                             |       |                                                 | 3.24       |                            |       |   |   |   |   |   |   |   |   |
| Cancelled                               |       |                     | (479       | )                                             |       |                                                 | 14.37      |                            |       |   |   |   |   |   |   |   |   |
| Outstanding at  December 31,2004   |       |                     | 13,230     |                                          |       |                                                 | 12.50      |                            |       |   |   |   |   |   |   |   |   |
| Granted                                 |       |                     | 2,541      |                                          |       |                                                 | 11.20      |                            |       |   |   |   |   |   |   |   |   |
| Exercised                               |       |                     | (2,374     | )                                             |       |                                                 | 2.47       |                            |       |   |   |   |   |   |   |   |   |
| Cancelled                               |       |                     | (1,769     | )                                             |       |                                                 | 18.71      |                            |       |   |   |   |   |   |   |   |   |
| Outstanding at  December 31, 2005  |       |                     | 11,628     |                                          |       |                                                 | 13.31      |                            |       |   |   |   |   |   |   |   |   |
| Granted                                 |       |                     | 210        |                                          |       |                                                 | 13.18      |                            |       |   |   |   |   |   |   |   |   |
| Exercised                               |       |                     | (2,163     | )                                             |       |                                                 | 4.37       |                            |       |   |   |   |   |   |   |   |   |
| Cancelled                               |       |                     | (2,566     | )                                             |       |                                                 | 23.46      |                            |       |   |   |   |   |   |   |   |   |
| Outstanding at  December 31, 2006  |       |                     | 7,109      |                                          |       |                                                 | $          | 12.37                           |       |   |   | 6.50 |   |   |   | $ | 23,182 |   |   |
| Exercisable at  December 31, 2006  |       |                     | 5,775      |                                          |       |                                                 | $          | 12.56                           |       |   |   | 6.05 |   |   |   | $ | 20,689 |   |   |

 

Total unrecognized compensation cost related tounvested stock options at December 31, 2006, prior to the consideration ofexpected forfeitures, is approximately $3.5 million and is expected to berecognized over a weighted-average period of 1.0 years.

The weighted-average grantdate fair value of stock options granted during the years ended December 31,2006, 2005 and 2004 was $4.51, $7.08 and $13.75, respectively. The totalintrinsic value of 

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optionsexercised during the years ended December 31, 2006, 2005 and 2004 was$17.3 million, $20.9 million and $20.5 million, respectively. Cash receivedfrom the exercise of stock options was $9.5 million, $5.9 million and $6.0million, respectively, for the years ended December 31, 2006, 2005 and2004. The tax benefits realized from stock options exercised in the years endedDecember 31, 2006, 2005 and 2004 were approximately $3.9 million, $6.8million and $7.7 million, respectively.

*Modifications*

*Accelerationof Stock Options—**In*December 2005, the Company’sCompensation Committee of the Board of Directors approved the acceleration ofvesting of all options to purchase the Company’s common stock with exerciseprices in excess of $16.00. These options were granted to executive officersand other employees of the Company under the Company’s 2001 Stock IncentivePlan and 2001 Supplemental Stock Incentive Plan. Options to purchase 1.3million shares of the Company’s common stock were subject to this accelerationand such options had exercise prices ranging from $16.01 to $64.17, and had aweighted- average exercise price of $18.47.

The acceleration of vesting of these out-of-the-moneyoptions was undertaken primarily to eliminate any future compensation expensethe Company would otherwise recognize in its income statement with respect tothese options with the implementation of SFAS No. 123R effective January 1,2006. The Company estimated this compensation expense, before tax, would havetotaled approximately $3.8 million over the course of the original vestingperiods. Ninety-five percent of the options would have vested withinapproximately 1.5 years from the effective date of the acceleration with theremaining 5% vesting within approximately 2.5 years from the date ofacceleration. The Company also believed that because the options to beaccelerated had exercise prices in excess of the then current market value ofthe Company’s common stock, the options had limited economic value and were notfully achieving their original objective of incentive compensation and employeeretention.

*Tender Offer—**In* March 2006,the Company offered eligible employees of the Company the opportunity toexchange any outstanding stock options granted to them which had an exerciseprice per share of the Company’s common stock at or above $16.00 (the “EligibleOptions”) in return for RSUs. The exchange offer expired in April 2006,and approximately 1.8 million shares of common stock underlying EligibleOptions were exchanged for RSUs covering approximately 0.4 million shares ofcommon stock in exchange for the cancellation of the Eligible Options. Theexchange was offered to 315 eligible employees and was accounted for as a modificationunder SFAS No. 123R in the June 2006 quarter. The number of RSUs thatwere issued in exchange for each tendered Eligible Option was based on the pershare exercise price of that option and was, in all events, less than thenumber of shares subject to the tendered option. Eligible Options with exerciseprices between $16.00 and $20.00 were exchanged based on a ratio of one RSU forfour Eligible Options. Eligible Options with exercise prices greater than$20.00 were exchanged based on a ratio of one RSU for five Eligible Options.Total expense associated with the exchange, prior to the consideration ofexpected forfeitures, was approximately $0.8 million.

**Restricted Stockand Restricted Stock Units**

In January 2004, the Company granted 575,000restricted shares of common stock with a weighted-average grant date fair valueof $19.91. In January 2005, 100,000 of these shares were cancelled. At December 31,2006, 475,000 restricted shares of common stock were outstanding. The sharesvest entirely at the end of a four-year vesting period in January 2008.

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Thefollowing table summarizes activity for RSUs during the years ended December 31,2005 and 2006:

| ** **                             | ** ** | **RSUs  Outstanding**   | ** ** | **Weighted-  Average Grant  Date Fair Value** | ** ** |
|----------------------------------------|------------|-------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)** | ** ** | ** **                                                   | ** ** |
| Outstanding at  January 1, 2005   |       |                    | —     |                                                         |       |   | $ | — |   |   |
| Granted                                |       |                    | 1,674      |                                                         |       |   | 10.77 |   |   |
| Vested                                 |       |                    | —     |                                                         |       |   | — |   |   |
| Cancelled                              |       |                    | (32        | )                                                            |       |   | 10.55 |   |   |
| Outstanding at  December 31, 2005 |       |                    | 1,642      |                                                         |       |   | 10.78 |   |   |
| Granted                                |       |                    | 2,208      |                                                         |       |   | 10.36 |   |   |
| Vested                                 |       |                    | (629       | )                                                            |       |   | 8.74 |   |   |
| Cancelled                              |       |                    | (381       | )                                                            |       |   | 9.46 |   |   |
| Outstanding at December 31, 2006  |       |                    | 2,840      |                                                         |       |   | $ | 11.08 |   |   |

 

At December 31, 2006,the intrinsic value of outstanding restricted stock and RSUs was approximately$44.0 million. Total unrecognized compensation cost related to unvestedrestricted stock and RSUs at December 31, 2006 prior to the considerationof expected forfeitures is approximately $23.8 million and is expected to berecognized over a weighted-average period of 1.4 years. The fair value of RSUsthat vested during the year ended December 31, 2006 was approximately $7.6million.

*Recent Awards*

On February 15, 2007,the Compensation Committee of the Board of Directors approved grants of 0.6 millionRSUs with a fair value equal to $8.2 million to the Company’s executiveofficers. Each RSU entitles the officers to receive one share of the Company’scommon stock upon vesting. The units vest one third annually over thethree-year period beginning February 15, 2007.

On February 15, 2007,the Company approved grants of 1.3 million RSUs with a fair value equal to $18.0 millionto the Company’s employees. The units vest twenty-five percent on February 15,2008 and quarterly thereafter for three years.

**Employee Stock Purchase Plan**

The Company has a 2001Employee Stock Purchase Plan (“ESPP”), which expires in the year 2011, andunder which approximately 5.8 million shares of the Company’s common stockwere reserved under the plan at December 31, 2006. At December 31,2006, 2.6 million shares were available for issuance. Under the ESPP, eacheligible employee may authorize payroll deductions of up to 15% of theircompensation to purchase shares of common stock on two “purchase dates” eachyear at a purchase price per share equal to 85% of the lower of (i) theclosing selling price per share of common stock on the employee’s entry dateinto the two-year offering period in which the purchase date occurs or (ii) theclosing selling price per share on the purchase date. Each offering period hasa twenty-four month duration and purchase intervals of six months.

The fair value of ESPPshares was estimated using the Black-Scholes option pricing model with thefollowing weighted-average assumptions: 

| ** **               | ** ** | **Year Ended   December 31, 2006** | ** ** |
|--------------------------|------------|--------------------------------------------------------|------------|
| Risk-free interest rate  |       |                                                   | 3.8        | % |   |
| Expected life (in years) |       |                                                   | 0.5-2.0    |   |   |
| Dividend yield           |       |                                                   | 8.3        | % |   |
| Volatility               |       |                                                   | 52.1       | % |   |

 

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The assumptions presented in the table above representthe weighted average of the applicable assumptions used to value ESPP shares.The Company calculates expected volatility based on historical volatility ofthe Company’s common stock. The expected term represents the amount of timeremaining in the 24-month offering period. The risk-free rate assumed invaluing the ESPP shares is based on the U.S. Treasury yield curve in effect atthe time of grant for the expected term. The Company determines the expecteddividend yield percentage by dividing the expected annual dividend by themarket price of United Online common stock at the date of grant.

For the year ended December 31,2006, the Company recognized approximately $1.9 million of stock-basedcompensation expense related to the ESPP. For the years ended December 31,2005 and 2004, the Company recognized $0 of stock-based compensation expenserelated to the ESPP. Total unrecognized compensation cost related to the ESPPat December 31, 2006 is approximately $1.1 million and is expected to berecognized over a weighted-average period of 0.6 years.

**6. IMPAIRMENT OFGOODWILL, INTANGIBLE ASSETS AND LONG-LIVED ASSETS**

Under SFAS No. 142, goodwill and other indefinite-livedintangibles must be tested for impairment annually or when events andcircumstances change that would indicate that goodwill might be permanentlyimpaired. In the December 2006 quarter, the Company tested goodwill forimpairment and recorded a goodwill impairment charge of $5.7 million and anintangible assets impairment charge of $3.0 million related to its photo-sharingservice within the Content & Media segment. The $3.0 million intangibleassets impairment charge was comprised of $2.9 million of acquiredsoftware technology and $0.1 million of acquired pay accounts, proprietaryrights and domain names. The Company determined the amount of the charge basedon an estimate of the fair value of the photo-sharing assets, using the incomeapproach, discounted cash flow method.

Under SFAS No. 144, long-lived assets, other thanindefinite life intangible assets, must be tested for impairment when events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. In the December 2006 quarter, the Company recognized assetimpairment charges of $4.5 million attributable to certain assets of its VoIP serviceswithin the Communications segment. As a result of slower than expected growthof the VoIP market in the United States, current period operating losses andprojected continuing operating losses, the Company evaluated the recoverabilityof certain assets and wrote off $4.3 million of capitalized software and $0.2million of prepaid marketing and domain names. The Company was required toreduce the carrying value of the assets to fair value and recognized assetimpairment charges because the carrying value of the affected assets exceededthe Company’s estimate of future undiscounted cash flows.

The Company determined that its goodwill andlong-lived assets were not impaired based on its annual tests during the yearsended December 31, 2005 and 2004.

Thefollowing table summarizes the impairment charges by segment recorded by the Companyduring the quarter and year ended December 31, 2006:

| **Communications:**                                                    |   |   |   |
|------------------------------------------------------------------------|--------|--------|--------|
| VoIP-related  long-lived assets                                        |   | $      | 4,504  |   |
| **Content &  Media:**                                         |   |   |   |
| Goodwill related  to the Company’s photo-sharing service          |   | 5,738  |   |
| Intangible assets  related to the Company’s photo-sharing service |   | 3,043  |   |
|                                                                   |   | 8,781  |   |
| Total impairment  charges                                              |   | $      | 13,285 |   |

 

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**7. INCOME TAXES**

Theprovision (benefit) for income taxes for the years ended December 31,2006, 2005 and 2004 is comprised of the following (in thousands):

| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|
| ** **                                 | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Current:                                   |       |                                  |       |   |   |   |   |
| Federal                                    |       | $                                     | 33,433     |   | $ | 33,043 |   | $ | 23,385 |   |
| State                                      |       | 6,469                                 |       | 5,625 |   | 4,042 |   |
|                                       |       | 39,902                                |       | 38,668 |   | 27,427 |   |
| Deferred:                                  |       |                                  |       |   |   |   |   |
| Federal                                    |       | (8,629                                | )          | (3,958 | ) | 2,780 |   |
| State                                      |       | 2,275                                 |       | 3,529 |   | 3,423 |   |
| Foreign                                    |       | (719                                  | )          | (726 | ) | (203 | ) |
| Increase (decrease) in valuation allowance |       | 3,464                                 |       | 2,732 |   | (67,478 | ) |
|                                       |       | (3,609                                | )          | 1,577 |   | (61,478 | ) |
| Provision  (benefit) for income taxes      |       | $                                     | 36,293     |   | $ | 40,245 |   | $ | (34,051 | ) |

 

Thefollowing is a reconciliation of the statutory federal income tax rate to theCompany’s effective income tax rate (in thousands):

| ** **                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Taxes on income  at the statutory federal rate (35% for all periods presented) |       | $                                     | 27,133     |   | $ | 30,580 |   | $ | 29,200 |   |
| State income  taxes, net of federal tax benefits                               |       | 3,858                                 |       | 4,454 |   | 4,853 |   |
| Re-measurement of  net deferred tax assets                                     |       | 2,265                                 |       | 2,473 |   | 4 |   |
| Other  differences, net                                                        |       | (427                                  | )          | 6 |   | (630 | ) |
| Increase (decrease)  in valuation allowance                                    |       | 3,464                                 |       | 2,732 |   | (67,478 | ) |
| Provision (benefit) for  income taxes                                          |       | $                                     | 36,293     |   | $ | 40,245 |   | $ | (34,051 | ) |

 

For the year ended December 31, 2006, the Companyrecorded a tax provision of $36.3 million on pre-tax income of $77.5 million,resulting in an effective tax rate of 46.8%. The effective tax rate differsfrom the statutory rate primarily due to (1) stock-based compensation thatis limited under Section 162(m) of the Internal Revenue Code (the “Code”);(2) foreign losses, the benefit of which is not currently recognizable dueto uncertainty regarding realization; and (3) the re-measurement of netdeferred tax assets in New York. Additionally, in 2006, the effective rate wasincreased due to the employee stock purchase plan compensation, the benefitwhich is not currently recognized under SFAS No. 123R. This increase wascompletely offset by the benefit of federal exempt interest income.

For the year ended December 31, 2005, the Companyrecorded a tax provision of $40.2 million on pre-tax income of $87.4 million,resulting in an effective tax rate of 46.1%. The effective tax rate differsfrom the statutory rate primarily due to compensation, including stock-basedcompensation, that is limited under Section 162(m) of the Code; foreignlosses, the benefit of which is not currently recognizable due to uncertaintyregarding realization; and the re-measurement of net deferred tax assets,including a change in New York State tax law.

For the year ended December 31, 2004, the Companyrecorded a tax benefit of $34.1 million on pre-tax income of$83.4 million, resulting in an effective tax rate benefit of 40.8%. Theeffective tax rate differs from the statutory rate primarily due to the releaseof substantially all of the balance of the valuation allowance attributable tothe expected utilization of net deferred tax assets in the future.

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Componentsof net deferred tax assets at December 31, 2006 and 2005 are as follows(in thousands):

| ** **                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Deferred tax assets:                                |       |                  |       |   |   |
| Net operating loss carryforwards                    |       | $                     | 66,303     |   | $ | 74,459 |   |
| Depreciation and amortization                       |       | 7,899                 |       | 2,126 |   |
| Stock-based compensation                            |       | 8,841                 |       | 4,817 |   |
| Other                                               |       | 8,719                 |       | 8,725 |   |
| Total deferred tax assets                           |       | 91,762                |       | 90,127 |   |
| Less: valuation allowance                           |       | (6,850                | )          | (4,670 | ) |
| Total deferred tax assets after valuation allowance |       | 84,912                |       | 85,457 |   |
| Deferred tax liability:                             |       |                  |       |   |   |
| Amortization of acquired intangible assets          |       | (13,552               | )          | (17,102 | ) |
| Total deferred tax liability                        |       | (13,552               | )          | (17,102 | ) |
| Net deferred tax  assets                            |       | $                     | 71,360     |   | $ | 68,355 |   |

 

The increase in the valuation allowance of $2.2million during the year ended December 31, 2006 is attributable tocompensation that is expected to be limited under Section 162(m) ofthe Code and foreign losses, the benefit of which is not currently recognizabledue to uncertainty regarding utilization. Based upon the Company’s assessmentof all available evidence, it concluded that, primarily with the exception ofcertain compensation that is expected to be limited under Section 162(m)of the Code and foreign net operating losses, it is more likely than not thatthe remaining deferred tax assets will be realized. The Company will continueto monitor all available evidence in assessing the realization of its deferredtax assets in future periods, including recognizing an amount of taxable incomeduring the carryforward period that equals or exceeds the Section 382limitation.

The increase in the valuation allowance of $2.7million during the year ended December 31, 2005 is attributable tocompensation that is expected to be limited under Section 162(m) ofthe Code and foreign losses, the benefit of which is not currently recognizabledue to uncertainty regarding utilization.

The decrease in the valuation allowance of$85.3 million during the year ended December 31, 2004 is primarilyattributable to the release of the valuation allowance due to the expectationthat the Company will realize its deferred tax assets in the future.

In accordance with APB Opinion No. 23, *Accounting for Income Taxes—Special Areas*, the Company hasnot recognized federal deferred income taxes on the undistributed earnings ofcertain of its foreign subsidiaries that are indefinitely reinvested outsidethe U.S. The Company has indefinitely reinvested approximately $1.6 million ofthe cumulative undistributed earnings of certain foreign subsidiaries, of which$0.4 million was earned during the year ended December 31, 2006. If theseearnings were distributed, a U.S. income tax liability would result.

At December 31, 2006,the Company had net operating loss and tax credit carryforwards for federal andstate income tax purposes of approximately $175 million and$61 million, respectively, which begin to expire in 2018 and 2007,respectively. With respect to the state net operating losses, certain amountswill be further reduced pursuant to the state allocation and apportionmentlaws. These carryforwards have been adjusted to reflect the Company’s estimateof limitations under Section 382 of the Code. The Company has also claimedincome tax deductions from the exercise of certain stock options and therelated sale of common stock by employees, and, in 2006, the deduction includesthe excess deduction for vested restricted stock. For the years endedDecember 31, 2006, 2005 and 2004, benefits of $5.8 million, $7.2 millionand $8.6 million, respectively, were credited to stockholders’ equity.

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**8. NET INCOME PERSHARE**

Thefollowing table sets forth the computation of basic and diluted net income pershare for the years ended December 31, 2006, 2005 and 2004 (in thousands,except per share amounts):

| ** **                                                                                       | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                       | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Numerator:                                                                                       |       |                                  |       |   |   |   |   |
| Income before  cumulative effect of accounting change                                            |       | $                                     | 41,231     |   | $ | 47,127 |   | $ | 117,480 |   |
| Cumulative effect  of accounting change, net of tax                                              |       | 1,041                                 |       | — |   | — |   |
| Net income                                                                                       |       | $                                     | 42,272     |   | $ | 47,127 |   | $ | 117,480 |   |
| Denominator:                                                                                     |       |                                  |       |   |   |   |   |
| Weighted-average  common shares—basic                                                       |       | 64,476                                |       | 61,641 |   | 62,012 |   |
| Less: weighted-average common shares subject to  repurchase                                      |       | (475                                  | )          | (506 | ) | (608 | ) |
| Shares used to  calculate basic net income per share                                             |       | 64,001                                |       | 61,135 |   | 61,404 |   |
| Add: Dilutive effect of stock options, restricted  stock and employee stock purchase plan shares |       | 2,268                                 |       | 2,680 |   | 3,608 |   |
| Shares used to  calculate diluted net income per share                                           |       | 66,269                                |       | 63,815 |   | 65,012 |   |
| Basic net income  per share:                                                                     |       |                                  |       |   |   |   |   |
| Income before cumulative effect of accounting change                                             |       | $                                     | 0.64       |   | $ | 0.77 |   | $ | 1.91 |   |
| Cumulative effect of accounting change, net of tax                                               |       | 0.02                                  |       | — |   | — |   |
| Basic net income  per share                                                                      |       | $                                     | 0.66       |   | $ | 0.77 |   | $ | 1.91 |   |
| Diluted net  income per share:                                                                   |       |                                  |       |   |   |   |   |
| Income before cumulative effect of accounting change                                             |       | $                                     | 0.62       |   | $ | 0.74 |   | $ | 1.81 |   |
| Cumulative effect of change in accounting principle,  net  of tax                                |       | 0.02                                  |       | — |   | — |   |
| Diluted net income per  share                                                                    |       | $                                     | 0.64       |   | $ | 0.74 |   | $ | 1.81 |   |

 

The diluted per sharecomputations exclude stock options, unvested common stock and RSUs, which areantidilutive. The number of antidilutive shares at December 31, 2006, 2005and 2004 was 3.0 million, 6.8 million and 6.4 million, respectively.

**9. EMPLOYEE BENEFITPLANS**

The Company has a savingsplan (the “Savings Plan”) that qualifies as a defined contribution plan under Section 401(k) ofthe Code. Under the Savings Plan, participating employees may defer apercentage (not to exceed 40%) of their eligible pretax earnings up to theInternal Revenue Service annual contribution limit. All full-time employees onthe payroll of the Company are eligible to participate in the Plan. At December 31,2004, the Company had made no contributions since the inception of the SavingsPlan; however, on January 1, 2005, the Company began matching 25% of theemployee’s contributions, up to plan limits. The Company recognized expenses ofapproximately $0.8 million and $0.6 million during the years ended December 31,2006 and 2005 related to the Savings Plan match.

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**10. SEGMENTINFORMATION**

Revenueand income from operations by segment are as follows (in thousands):

| ** **                      | ** ** | **Year Ended December 31, 2006** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **Communications**                                   | ** ** | **Content & Media** | ** ** | **Total** | ** ** |
| Billable services               |       |                                                 | $          | 336,924 |   |   |   | $ | 86,641 |   |   | $ | 423,565 |   |
| Advertising                     |       |                                                 | 39,013     |   |   |   | 60,076 |   |   | 99,089 |   |
| Total revenues                  |       |                                                 | $          | 375,937 |   |   |   | $ | 146,717 |   |   | $ | 522,654 |   |
| Segment income from  operations |       |                                                 | $          | 132,839 |   |   |   | $ | 17,913 |   |   | $ | 150,752 |   |

 

| ** **                      | ** ** | **Year Ended December 31, 2005** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **Communications**                                   | ** ** | **Content & Media** | ** ** | **Total** | ** ** |
| Billable services               |       |                                                 | $          | 396,331 |   |   |   | $ | 69,649 |   |   | $ | 465,980 |   |
| Advertising                     |       |                                                 | 35,613     |   |   |   | 23,468 |   |   | 59,081 |   |
| Total revenues                  |       |                                                 | $          | 431,944 |   |   |   | $ | 93,117 |   |   | $ | 525,061 |   |
| Segment income from  operations |       |                                                 | $          | 135,286 |   |   |   | $ | 16,541 |   |   | $ | 151,827 |   |

 

| ** **                      | ** ** | **Year Ended December 31, 2004** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **Communications**                                   | ** ** | **Content & Media** | ** ** | **Total** | ** ** |
| Billable services               |       |                                                 | $          | 400,199 |   |   |   | $ | 10,622 |   |   | $ | 410,821 |   |
| Advertising                     |       |                                                 | 34,276     |   |   |   | 3,520 |   |   | 37,796 |   |
| Total revenues                  |       |                                                 | $          | 434,475 |   |   |   | $ | 14,142 |   |   | $ | 448,617 |   |
| Segment income from  operations |       |                                                 | $          | 126,641 |   |   |   | $ | 4,447 |   |   | $ | 131,088 |   |

 

Communications segment income from operations for theyear ended December 31, 2006 included restructuring charges of $0.6million and impairment charges of $4.5 million. Content & Mediasegment income from operations for the year ended December 31, 2006included impairment charges of $8.8 million. All of these charges areincluded in the Company’s operating expenses.

Areconciliation of segment income from operations (which excludes corporateexpenses, depreciation, amortization of intangible assets and stock-basedcompensation) to consolidated operating income, is as follows for each periodpresented (in thousands):

| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|
| ** **                            | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Segment income from operations:       |       |                                  |       |   |   |   |   |
| Communications                        |       | $                                     | 132,839    |   | $ | 135,286 |   | $ | 126,641 |   |
| Content & Media              |       | 17,913                                |       | 16,541 |   | 4,447 |   |
| Total segment income  from operations |       | 150,752                               |       | 151,827 |   | 131,088 |   |
| Corporate expenses                    |       | (18,635                               | )          | (18,035 | ) | (20,740 | ) |
| Depreciation                          |       | (21,290                               | )          | (15,481 | ) | (8,003 | ) |
| Amortization of  intangible assets    |       | (17,640                               | )          | (21,799 | ) | (20,403 | ) |
| Stock-based compensation              |       | (19,168                               | )          | (9,952 | ) | (2,449 | ) |
| Consolidated operating income         |       | $                                     | 74,019     |   | $ | 86,560 |   | $ | 79,493 |   |

 

The Company manages itsworking capital on a consolidated basis and does not allocate long-lived assetsto segments. In addition, segment assets are not reported to, or used by, thechief operating decision maker and therefore, pursuant to SFAS No. 131,total segment assets have not been disclosed. The Company’s $133.0 millionof goodwill is related entirely to purchase transactions in theContent & Media segment.

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The Company has notprovided information about geographic segments because the vast majority of theCompany’s revenues and related results of operations and identifiable assets arein the United States of America and additional geographic information is thusnot material nor meaningful.

**11. COMMITMENTS AND CONTINGENCIES**

*Financial Commitments*

TheCompany’s financial commitments were as follows at December 31, 2006 (inthousands):

| ** **                        | ** ** | **Year Ending December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|
| **Contractual Obligations:** | ** ** | ** **                                  | ** ** | **Total** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Capital leases(1)                 |       | $                                           | 32         |   | $ | 18 |   | $ | 14 |   | $ | — |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Operating leases                  |       | 40,181                                      |       | 7,331 |   | 7,094 |   | 6,076 |   | 4,685 |   | 4,010 |   |   | 10,985 |   |   |
| Telecommunications  purchases     |       | 12,050                                      |       | 7,550 |   | 4,500 |   | — |   | — |   | — |   |   | — |   |   |
| Media purchases                   |       | 2,311                                       |       | 2,311 |   | — |   | — |   | — |   | — |   |   | — |   |   |
| Total                             |       | $                                           | 54,574     |   | $ | 17,210 |   | $ | 11,608 |   | $ | 6,076 |   | $ | 4,685 |   | $ | 4,010 |   |   | $ | 10,985 |   |   |
|                                   |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includes$2 of imputed interest.

The Company leases itsfacilities under operating leases expiring at various periods through 2014. Rentalexpense for operating leases for the years ended December 31, 2006, 2005and 2004 was $6.6 million, $6.5 million and $4.3 million, respectively.

*Legal Contingencies*

On April 20, 2001,Jodi Bernstein, on behalf of himself and all others similarly situated, filed alawsuit in the United States District Court for the Southern District of NewYork against NetZero, certain officers and directors of NetZero and theunderwriters of NetZero’s initial public offering, Goldman Sachs Group, Inc.,BancBoston Robertson Stephens, Inc. and Salomon Smith Barney, Inc.The complaint alleges that the prospectus through which NetZero conducted itsinitial public offering in September 1999 was materially false and misleadingbecause it failed to disclose, among other things, that (i) theunderwriters had solicited and received excessive and undisclosed commissionsfrom certain investors in exchange for which the underwriters allocated tothose investors material portions of the restricted number of NetZero sharesissued in connection with the offering; and (ii) the underwriters hadentered into agreements with customers whereby the underwriters agreed toallocate NetZero shares to those customers in the offering in exchange forwhich the customers agreed to purchase additional NetZero shares in theaftermarket at pre-determined prices. Plaintiffs are seeking injunctive reliefand damages. Additional lawsuits setting forth substantially similarallegations were also served against NetZero on behalf of additional plaintiffsin April and May 2001. The case against NetZero was consolidated withapproximately 300 other suits filed against more than 300 issuers thatconducted their initial public offerings between 1998 and 2000, theirunderwriters and an unspecified number of their individual corporate officersand directors. The majority of issuers, including NetZero, and their insurershave approved a settlement agreement. The district court’s final approval ofthe settlement has been stayed pending the outcome of the Second Circuit’sdecision to vacate the district court’s decision granting class certificationin six of the suits.

On August 21, 2001,Juno commenced an adversary proceeding in U.S. Bankruptcy Court in the SouthernDistrict of New York against Smart World Technologies, LLC, dba “Freewwweb”(the “Debtor”), a provider of free Internet access that had elected to ceaseoperations and had sought the protection of Chapter 11 of the Bankruptcy Code.The adversary proceeding arose out of a subscriber referral agreement betweenJuno and the Debtor. In response to the commencement of the adversaryproceeding, the Debtor and its principals filed a pleading with the bankruptcycourt asserting that Juno is obligated to pay compensation in an amount inexcess of $80 million as a result of Juno’s conduct in connection with thesubscriber referral agreement. In addition, a dispute arose between Juno andUUNET 

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Technologies, Inc.,an affiliate of MCI WorldCom Network Services, Inc., regarding the valueof services provided by UUNET, with UUNET claiming in excess of $1.0 millionand Juno claiming less than $0.3 million. On August 4, 2006, Juno enteredinto a settlement agreement with the Committee of Unsecured Creditors providingfor the settlement of all claims against Juno pursuant to a proposed plan ofliquidation of the Debtor. The settlement and plan of liquidation were approvedby the bankruptcy court in December 2006 and the deadline for appealelapse in January 2007. We had previously reserved $6.25 million for theFreewwweb settlement, which was increased by $0.25 million in the December 2006quarter. Pursuant to the settlement agreement, Juno paid a total of $6.5million.

On April 27, 2004,plaintiff MyMail Ltd. filed a lawsuit in the United States District Court forthe Eastern District of Texas against NetZero, Juno, NetBrands, America Online, Inc.,AT&T, EarthLink, Inc., SBC Communications, Inc., and VerizonCommunications, Inc. alleging infringement of plaintiff’s patent whichpurported to cover user access to a computer network. Plaintiff soughtinjunctive and declaratory relief and damages. On October 28, 2005, thecourt issued an order granting defendants’ motions for summary judgment ofnon-infringement of the patent. MyMail appealed the trial court’s ruling, andon February 20, 2007, the Federal Circuit affirmed the trial court’sruling.

On March 6, 2006,plaintiff Anthony Piercy filed a purported consumer class action lawsuit in theSuperior Court of the State of California, County of Los Angeles, againstNetZero claiming that NetZero continues to charge consumers fees after theycancel their Internet access account. Plaintiff is seeking injunctive anddeclaratory relief and damages. NetZero has filed a response to the lawsuitdenying the material allegations of the complaint.

On July 27, 2006,plaintiff Donald E. Ewart filed a purported consumer class action lawsuit inthe Superior Court of the State of California, County of Los Angeles, againstNetZero claiming that NetZero continues to charge consumers fees after theycancel their Internet access account. Plaintiff is seeking injunctive anddeclaratory relief and damages. NetZero has filed a response to the lawsuitdenying the material allegations of the complaint. On January 29, 2007,counsel for Mr. Ewart advised the trial court that Mr. Ewart would bewithdrawing from the action as a class representative and that counsel wouldseek permission from the court to add one or more new class representatives. Onthat same date, the court ordered counsel for Mr. Ewart to file theirmotion to substitute a new class representative by March 2, 2007. As of February 27,2007, Mr. Ewart has not withdrawn from the action and his counsel has notfiled a motion to substitute a new class representative.

The pending lawsuitsinvolve complex questions of fact and law and may require the expenditure ofsignificant funds and the diversion of other resources to defend. Although theCompany does not believe the outcome of the above outstanding legalproceedings, claims and litigation will have a material adverse effect on itsbusiness, financial position, results of operations or cash flows, the resultsof litigation are inherently uncertain and the Company can provide no assurancethat it will not be materially and adversely impacted by the results of suchproceedings. At December 31, 2006, other than an immaterial reserve forthe then unpaid portion of the Freewwweb settlement payment, the Company hadnot established reserves for any of the matters described above.

The Company is subject tovarious other legal proceedings and claims that arise in the ordinary course ofbusiness. Management believes the amount and ultimate liability, if any, withrespect to these actions will not materially affect the Company’s business,financial position, results of operations or cash flows. There can be noassurance, however, that such actions will not be material or adversely affectthe Company’s business, financial position, results of operations or cash flows.

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**12. QUARTERLY FINANCIAL DATA (UNAUDITED) (inthousands, except per share data)**

Yearended December 31, 2006:

| ** **                                                        | ** ** | **Quarter Ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                        | ** ** | **December 31,**  | ** ** | **September 30,** | ** ** | **June 30,** | ** ** | **March 31,** | ** ** |
| Revenues                                                          |       |                   | $          | 130,786 |   |   |   | $ | 129,636 |   |   | $ | 134,900 |   | $ | 127,332 |   |
| Impairment of goodwill,  intangible assets and long-lived assets  |       |                   | $          | 13,285 |   |   |   | — |   |   | — |   | — |   |
| Operating income                                                  |       |                   | $          | 9,304 |   |   |   | $ | 21,885 |   |   | $ | 22,258 |   | $ | 20,572 |   |
| Income before cumulative  effect of accounting change             |       |                   | $          | 4,559 |   |   |   | $ | 13,436 |   |   | $ | 11,585 |   | $ | 11,651 |   |
| Cumulative effect of  accounting change, net of tax               |       |                   | —     |   |   |   | — |   |   | — |   | 1,041 |   |
| Net income                                                        |       |                   | $          | 4,559 |   |   |   | $ | 13,436 |   |   | $ | 11,585 |   | $ | 12,692 |   |
| Basic net income per share:                                       |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Income before cumulative  effect of accounting change, net of tax |       |                   | $          | 0.07 |   |   |   | $ | 0.21 |   |   | $ | 0.18 |   | $ | 0.19 |   |
| Cumulative effect of  accounting change, net of  tax              |       |                   | —     |   |   |   | — |   |   | — |   | 0.01 |   |
| Basic net income per  share                                       |       |                   | $          | 0.07 |   |   |   | $ | 0.21 |   |   | $ | 0.18 |   | $ | 0.20 |   |
| Diluted net income per share:                                     |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Income before cumulative  effect of accounting change, net of tax |       |                   | $          | 0.07 |   |   |   | $ | 0.20 |   |   | $ | 0.18 |   | $ | 0.18 |   |
| Cumulative effect of  accounting change, net of  tax              |       |                   | —     |   |   |   | — |   |   | — |   | 0.02 |   |
| Diluted net income per share                                      |       |                   | $          | 0.07 |   |   |   | $ | 0.20 |   |   | $ | 0.18 |   | $ | 0.20 |   |

 

Year ended December 31, 2005:

| ** **                         | ** ** | **Quarter Ended** | ** ** |
|------------------------------------|------------|------------------------|------------|
| ** **                         | ** ** | **December 31,**  | ** ** | **September 30,** | ** ** | **June 30,** | ** ** | **March 31,** | ** ** |
| Revenues                           |       |                   | $          | 130,232 |   |   |   | $ | 132,778 |   |   | $ | 131,520 |   | $ | 130,531 |   |
| Operating income                   |       |                   | $          | 22,082 |   |   |   | $ | 22,634 |   |   | $ | 20,859 |   | $ | 20,985 |   |
| Net income                         |       |                   | $          | 12,374 |   |   |   | $ | 12,594 |   |   | $ | 10,672 |   | $ | 11,487 |   |
| Net income per share—basic    |       |                   | $          | 0.20 |   |   |   | $ | 0.21 |   |   | $ | 0.18 |   | $ | 0.19 |   |
| Net income per  share—diluted |       |                   | $          | 0.19 |   |   |   | $ | 0.20 |   |   | $ | 0.17 |   | $ | 0.18 |   |

 

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**UNITED ONLINE, INC.SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS(in thousands)**

| ** **                                        | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged/  (Credited) to  Expense** | ** ** | **Charged  to Other  Accounts** | ** ** | **Charges  Utilized/  Writeoffs** | ** ** | **Balance at End  of Period** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------|------------|-------------------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|----------------------------------------------|------------|
| **Allowance for doubtful accounts:**              |       |                                           |       |                                      |       |                                 |       |                              |       |                                         |       |   |   |   |   |   |   |   |   |
| Year ended  December 31, 2006                |       |                                           | $          | 1,325                                     |       |                                 |       | $                                 | (298       | )                                            |       | $ | 300 | (a) |   | $ | (3 | )(b) |   |   | $ | 1,324 |   |   |
| Year ended  December 31, 2005                |       |                                           | 647        |                                      |       |                                 | 678        |                              |       | —                                       |       |   | — |   |   |   | 1,325 |   |   |
| Year ended  December 31, 2004                |       |                                           | 288        |                                      |       |                                 | 75         |                              |       | 284                                          | (c)        |   | — |   |   |   | 647 |   |   |
| **Valuation allowance for  deferred tax assets:** |       |                                           |       |                                      |       |                                 |       |                              |       |                                         |       |   |   |   |   |   |   |   |   |
| Year ended  December 31, 2006                |       |                                           | $          | 4,670                                     |       |                                 |       | $                                 | 3,464      | (d)                                          |       | $ | — |   |   | $ | (1,284 | )(e) |   |   | $ | 6,850 |   |   |
| Year ended  December 31, 2005                |       |                                           | 1,938      |                                      |       |                                 | 2,732      | (d)                               |       | —                                       |       |   | — |   |   |   | 4,670 |   |   |
| Year ended  December 31, 2004                |       |                                           | 87,212     |                                      |       |                                 | (67,478    | )(f)                              |       | (20,783                                      | )(g)       |   | 2,987 | (h) |   |   | 1,938 |   |   |

 

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(a)           Represents allowancefor doubtful accounts acquired in connection with the acquisition of MyPoints.

(b)          Represents specificamounts written off that were considered to be uncollectible.

(c)           Represents allowancefor doubtful accounts acquired in connection with the acquisition ofClassmates.

(d)          Represents the increasein valuation allowance primarily due to executive compensation that is limitedunder Section 162(m) of the Code and foreign losses, the benefit ofwhich is not currently recognizable.

(e)           Represents the releaseof valuation allowance for executive compensation subject to Section 162(m)of the Code.

(f)             Represents therelease of valuation allowance primarily to recognize the actual and future taxbenefits of deferred tax assets.

(g)           Represents the releaseof valuation allowance primarily to recognize the future tax benefits for stockoption deductions and net operating losses acquired in the Merger.

(h)          Represents net adjustmentsto the valuation allowance primarily related to the Merger.

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