**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

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**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Quarterly Period Ended September 30, 2006**

**Or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition periodfrom                         to**

**Commissionfile number 000-33367**

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**UNITED ONLINE, INC.**

(Exact Name of Registrantas Specified in Its Charter)

| **Delaware**                             |   | **77-0575839**                       |
|------------------------------------------|--------|--------------------------------------|
| (State or other  Jurisdiction of         |   | (I.R.S Employer  Identification No.) |
| Incorporation or  Organization)          |   |                                 |
| **21301 Burbank Boulevard,**             |   | ** **                           |
| **Woodland  Hills, California**          |   | **91367**                            |
| (Address of  Principal Executive Office) |   | (Zip Code)                           |

 

**(818) 287-3000**

(Registrant’s TelephoneNumber, Including Area Code)

**Not applicable**

(Former Name, FormerAddress and Former Fiscal Year, if Changed Since Last Report)

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x   No o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one)

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

 

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

There were 65,531,595 shares of the registrant’scommon stock outstanding at November 3, 2006.

 

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**INDEX**

| **PART I.**  | ** ** | ** ** | ** ** | **FINANCIAL INFORMATION**                                                                                                                     | ** ** | ** ** |
|-------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|              |       | Item  1.   |       | Condensed  Consolidated Balance Sheets at September 30, 2006 (unaudited) and  December 31, 2005                                     |       | 3          |
|              |       |       |       | Unaudited Condensed Consolidated Statements of  Operations for the Quarters and Nine Months Ended September 30, 2006 and  2005           |       | 4          |
|              |       |       |       | Unaudited Condensed Consolidated Statements of  Comprehensive Income for the Quarters and Nine Months Ended  September 30, 2006 and 2005 |       | 5          |
|              |       |       |       | Unaudited Condensed Consolidated Statement of  Stockholders’ Equity for the Nine Months Ended September 30, 2006                    |       | 6          |
|              |       |       |       | Unaudited Condensed Consolidated Statements of Cash  Flows for the Nine Months Ended September 30, 2006 and 2005                         |       | 7          |
|              |       |       |       | Notes to the Unaudited Condensed Consolidated  Financial Statements                                                                           |       | 8          |
|              |       | Item 2.    |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                   |       | 26         |
|              |       | Item 3.    |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                                   |       | 45         |
|              |       | Item 4.    |       | Controls and Procedures                                                                                                                       |       | 46         |
| **PART II.** | ** ** | ** ** | ** ** | **OTHER INFORMATION**                                                                                                                         | ** ** | ** ** |
|              |       | Item  1.   |       | Legal  Proceedings                                                                                                                            |       | 47         |
|              |       | Item  1A.  |       | Risk Factors                                                                                                                                  |       | 49         |
|              |       | Item 2.    |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                                  |       | 68         |
|              |       | Item 6.    |       | Exhibits                                                                                                                                      |       | 69         |
| **SIGNATURES**    |       | 71         |

 

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

2

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**PART I—FINANCIALINFORMATION**

**ITEM1.**   FINANCIAL STATEMENTS

**UNITED ONLINE, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(in thousands)**

| ** **                                       | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                       |       |                         |       |                        |       |   |   |   |   |
| Current assets:                                  |       |                         |       |                        |       |   |   |   |   |
| Cash and cash equivalents                        |       |                         | $          | 21,659                      |       |   |   | $ | 100,397 |   |   |
| Short-term investments                           |       |                         | 133,038    |                        |       |   | 143,965 |   |   |
| Restricted cash                                  |       |                         | 6,250      |                        |       |   | — |   |   |
| Accounts receivable                              |       |                         | 26,264     |                        |       |   | 19,201 |   |   |
| Deferred tax assets, net                         |       |                         | 9,835      |                        |       |   | 14,808 |   |   |
| Other current assets                             |       |                         | 11,252     |                        |       |   | 12,332 |   |   |
| Total current assets                             |       |                         | 208,298    |                        |       |   | 290,703 |   |   |
| Property and  equipment, net                     |       |                         | 36,860     |                        |       |   | 33,093 |   |   |
| Deferred tax  assets, net                        |       |                         | 54,944     |                        |       |   | 53,547 |   |   |
| Goodwill                                         |       |                         | 138,713    |                        |       |   | 80,499 |   |   |
| Intangible assets,  net                          |       |                         | 61,306     |                        |       |   | 59,338 |   |   |
| Other assets                                     |       |                         | 3,535      |                        |       |   | 4,008 |   |   |
| Total assets                                     |       |                         | $          | 503,656                     |       |   |   | $ | 521,188 |   |   |
| **Liabilities and Stockholders’ Equity**    |       |                         |       |                        |       |   |   |   |   |
| Current liabilities:                             |       |                         |       |                        |       |   |   |   |   |
| Accounts payable                                 |       |                         | $          | 37,897                      |       |   |   | $ | 46,955 |   |   |
| Accrued liabilities                              |       |                         | 38,997     |                        |       |   | 36,249 |   |   |
| Member redemption liability                      |       |                         | 14,794     |                        |       |   | — |   |   |
| Deferred revenue                                 |       |                         | 54,592     |                        |       |   | 52,835 |   |   |
| Current portion of term loan                     |       |                         | —     |                        |       |   | 16,498 |   |   |
| Current portion of capital leases                |       |                         | 403        |                        |       |   | 373 |   |   |
| Total current liabilities                        |       |                         | 146,683    |                        |       |   | 152,910 |   |   |
| Member redemption  liability                     |       |                         | 3,995      |                        |       |   | — |   |   |
| Deferred revenue                                 |       |                         | 2,936      |                        |       |   | 3,449 |   |   |
| Term loan                                        |       |                         | —     |                        |       |   | 37,710 |   |   |
| Capital leases                                   |       |                         | 51         |                        |       |   | 325 |   |   |
| Other liabilities                                |       |                         | 3,595      |                        |       |   | 4,379 |   |   |
| Total liabilities                                |       |                         | 157,260    |                        |       |   | 198,773 |   |   |
| Commitments and  contingencies (see Note 8)      |       |                         |       |                        |       |   |   |   |   |
| Stockholders’ equity:                       |       |                         |       |                        |       |   |   |   |   |
| Common stock                                     |       |                         | 7          |                        |       |   | 6 |   |   |
| Additional paid-in capital                       |       |                         | 443,341    |                        |       |   | 472,745 |   |   |
| Deferred stock-based compensation                |       |                         | —     |                        |       |   | (15,558 | ) |   |
| Accumulated other comprehensive loss             |       |                         | (214       | )                           |       |   | (327 | ) |   |
| Accumulated deficit                              |       |                         | (96,738    | )                           |       |   | (134,451 | ) |   |
| Total stockholders’ equity                  |       |                         | 346,396    |                        |       |   | 322,415 |   |   |
| Total liabilities  and stockholders’ equity |       |                         | $          | 503,656                     |       |   |   | $ | 521,188 |   |   |

 

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

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

| ** **                                                                        | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                                                                          |       | $                                          | 129,636    |                                                | $          | 132,778 |   | $ | 391,868 |   | $ | 394,829 |   |
| Operating  expenses:                                                              |       |                                       |       |                                                |       |   |   |   |   |
| Cost of revenues (including stock-based compensation,  see Note 6)      |       | 29,046                                     |       | 27,233                                              |       | 90,082 |   | 82,431 |   |
| Sales and marketing (including stock-based  compensation, see Note 6)        |       | 43,487                                     |       | 52,767                                              |       | 133,043 |   | 160,653 |   |
| Product development (including stock-based  compensation, see Note 6)        |       | 13,501                                     |       | 10,116                                              |       | 39,702 |   | 28,780 |   |
| General and administrative (including stock-based  compensation, see Note 6) |       | 17,504                                     |       | 14,776                                              |       | 51,172 |   | 41,603 |   |
| Amortization of intangible assets                                                 |       | 4,213                                      |       | 5,252                                               |       | 13,154 |   | 16,884 |   |
| Total operating expenses                                                          |       | 107,751                                    |       | 110,144                                             |       | 327,153 |   | 330,351 |   |
| Operating income                                                                  |       | 21,885                                     |       | 22,634                                              |       | 64,715 |   | 64,478 |   |
| Interest and  other income, net                                                   |       | 1,457                                      |       | 1,675                                               |       | 4,527 |   | 4,684 |   |
| Interest expense                                                                  |       | (199                                       | )          | (1,388                                              | )          | (2,326 | ) | (4,745 | ) |
| Income before  income taxes                                                       |       | 23,143                                     |       | 22,921                                              |       | 66,916 |   | 64,417 |   |
| Provision for  income taxes                                                       |       | 9,707                                      |       | 10,327                                              |       | 30,244 |   | 29,664 |   |
| Income before  cumulative effect of accounting change                             |       | 13,436                                     |       | 12,594                                              |       | 36,672 |   | 34,753 |   |
| Cumulative effect  of accounting change, net of tax (see Note 1)             |       | —                                     |       | —                                              |       | 1,041 |   | — |   |
| Net income                                                                        |       | $                                          | 13,436     |                                                | $          | 12,594 |   | $ | 37,713 |   | $ | 34,753 |   |
| Basic net income per  share:                                                      |       |                                       |       |                                                |       |   |   |   |   |
| Income before cumulative effect of accounting change                              |       | $                                          | 0.21       |                                                | $          | 0.21 |   | $ | 0.58 |   | $ | 0.57 |   |
| Cumulative effect of accounting change, net of tax                                |       | —                                     |       | —                                              |       | 0.01 |   | — |   |
| Basic net income  per share                                                       |       | $                                          | 0.21       |                                                | $          | 0.21 |   | $ | 0.59 |   | $ | 0.57 |   |
| Diluted net income per  share:                                                    |       |                                       |       |                                                |       |   |   |   |   |
| Income before cumulative effect of accounting change                              |       | $                                          | 0.20       |                                                | $          | 0.20 |   | $ | 0.56 |   | $ | 0.55 |   |
| Cumulative effect of accounting change, net of tax                                |       | —                                     |       | —                                              |       | 0.01 |   | — |   |
| Diluted net  income per share                                                     |       | $                                          | 0.20       |                                                | $          | 0.20 |   | $ | 0.57 |   | $ | 0.55 |   |
| Shares used to  calculate basic net income per share                              |       | 64,573                                     |       | 61,399                                              |       | 63,630 |   | 60,878 |   |
| Shares used to calculate  diluted net income per share                            |       | 66,583                                     |       | 64,107                                              |       | 65,815 |   | 63,416 |   |

 

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

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**UNITED ONLINE, INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**

**(inthousands)**

| ** **                                                                                                                                                                                                                                                         | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                         | ** ** | **2006**                                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                                                                                                                                                                                                                         |       | $                                          | 13,436     |                                                | $          | 12,594 |   | $ | 37,713 |   | $ | 34,753 |   |
| Unrealized gain  (loss) on short-term investments, net of tax of $93 and $116 for  the quarter and nine months ended September 30, 2006, respectively and  $(63) and $(173) for the quarter and nine months ended September 30,  2005, respectively |       | 141                                        |       | (86                                                 | )          | 167 |   | (248 | ) |
| Unrealized loss  on derivative, net of tax of $(60) for the nine months ended  September 30, 2006 and $60 and $47 for the quarter and nine months ended  September 30, 2005                                                                              |       | —                                     |       | 82                                                  |       | (83 | ) | 62 |   |
| Foreign currency  translation                                                                                                                                                                                                                                      |       | (8                                         | )          | 4                                                   |       | 29 |   | (83 | ) |
| Comprehensive income                                                                                                                                                                                                                                               |       | $                                          | 13,569     |                                                | $          | 12,594 |   | $ | 37,826 |   | $ | 34,484 |   |

 

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

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**UNITED ONLINE, INC.UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY(in thousands)**

| ** **                                                       | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Deferred  Stock-Based** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Accumulated**        | ** ** | **Total  Stockholders’** | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------|------------|---------------------------------------|------------|------------------------|------------|-------------------------------|------------|
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**               | ** ** | **Compensation**                      | ** ** | **Income (Loss)** | ** ** | **Deficit**                   | ** ** | **Equity** | ** ** |
| 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                                     |       | 1,855                 |       |                    | 1          |                      |       | 6,568                                 |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 6,569 |   |   |
| Issuance of  common stock through employee stock purchase plan   |       | 380                   |       |                    | —     |                      |       | 2,965                                 |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 2,965 |   |   |
| Vesting of  restricted stock units                               |       | 373                   |       |                    | —     |                      |       | —                                |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Repurchases of  common stock                                     |       | —                |       |                    | —     |                      |       | (2,374                                | )          |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | (2,374 | ) |   |
| Dividends paid on  shares outstanding and restricted stock units |       | —                |       |                    | —     |                      |       | (39,788                               | )          |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | (39,788 | ) |   |
| Stock-based  compensation                                        |       | —                |       |                    | —     |                      |       | 15,137                                |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 15,137 |   |   |
| Unrealized gain  on short-term investments, net of tax           |       | —                |       |                    | —     |                      |       | —                                |       |                   | —     |                          |       |   | 167 |   |   |   | — |   |   |   | 167 |   |   |
| Unrealized loss  on derivative, net of tax                       |       | —                |       |                    | —     |                      |       | —                                |       |                   | —     |                          |       |   | (83 | ) |   |   | — |   |   |   | (83 | ) |   |
| Foreign currency  translation                                    |       | —                |       |                    | —     |                      |       | —                                |       |                   | —     |                          |       |   | 29 |   |   |   | — |   |   |   | 29 |   |   |
| Tax benefits from  stock options                                 |       | —                |       |                    | —     |                      |       | 4,687                                 |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 4,687 |   |   |
| Net income                                                       |       | —                |       |                    | —     |                      |       | —                                |       |                   | —     |                          |       |   | — |   |   |   | 37,713 |   |   |   | 37,713 |   |   |
| Balance at  September 30, 2006                              |       | 65,214                |       |                    | $          | 7                         |       |                                  | $          | 443,341                |       |                          | $          | — |   |   |   | $ | (214 | ) |   |   | $ | (96,738 | ) |   |   | $ | 346,396 |   |   |

 

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

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**UNITEDONLINE, INC.UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**

| ** **                                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                |       |                                                |       |   |   |
| Net income                                                                            |       | $                                                   | 37,713     |   | $ | 34,753 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:    |       |                                                |       |   |   |
| Depreciation and amortization                                                         |       | 28,943                                              |       | 27,862 |   |
| Stock-based compensation                                                              |       | 15,137                                              |       | 6,832 |   |
| Deferred taxes                                                                        |       | 2,975                                               |       | 1,385 |   |
| Tax benefits from stock-based compensation                                            |       | 4,687                                               |       | 11,175 |   |
| Excess tax benefits from stock-based compensation                                     |       | (3,422                                              | )          | — |   |
| Cumulative effect of accounting change, net of tax                                    |       | (1,041                                              | )          | — |   |
| Other                                                                                 |       | 2,486                                               |       | 770 |   |
| Changes in operating assets and liabilities  (excluding the effects of acquisitions): |       |                                                |       |   |   |
| Accounts receivable                                                                   |       | 2,666                                               |       | (3,347 | ) |
| Other assets                                                                          |       | 2,397                                               |       | 3,570 |   |
| Accounts payable and accrued liabilities                                              |       | (15,106                                             | )          | 22,908 |   |
| Member redemption liability                                                           |       | 1,117                                               |       | — |   |
| Deferred revenue                                                                      |       | 181                                                 |       | 6,215 |   |
| Other liabilities                                                                     |       | (123                                                | )          | 2,153 |   |
| Net cash provided by operating activities                                             |       | 78,610                                              |       | 114,276 |   |
| Cash flows from  investing activities:                                                |       |                                                |       |   |   |
| Purchases of property and equipment                                                   |       | (16,892                                             | )          | (16,454 | ) |
| Purchases of rights, patents and trademarks                                           |       | (509                                                | )          | (5,554 | ) |
| Purchases of short-term investments                                                   |       | (256,595                                            | )          | (282,718 | ) |
| Proceeds from maturities and sales of short-term  investments                         |       | 267,566                                             |       | 251,578 |   |
| Cash paid for acquisitions, net of cash acquired                                      |       | (61,114                                             | )          | (8,638 | ) |
| Increase in restricted cash                                                           |       | (1,450                                              | )          | — |   |
| Escrow deposit related to pre-acquisition liability                                   |       | (4,800                                              | )          | — |   |
| Proceeds from sale of assets                                                          |       | 87                                                  |       | — |   |
| Net cash used for investing activities                                                |       | (73,707                                             | )          | (61,786 | ) |
| Cash flows from  financing activities:                                                |       |                                                |       |   |   |
| Payments on term loan                                                                 |       | (54,209                                             | )          | (41,667 | ) |
| Payments on capital leases                                                            |       | (244                                                | )          | (530 | ) |
| Proceeds from exercises of stock options                                              |       | 6,569                                               |       | 4,732 |   |
| Proceeds from employee stock purchase plan                                            |       | 2,965                                               |       | 1,678 |   |
| Repurchases of common stock                                                           |       | (2,374                                              | )          | (14,206 | ) |
| Payments for dividends                                                                |       | (39,788                                             | )          | (25,259 | ) |
| Excess tax benefits from stock-based compensation                                     |       | 3,422                                               |       | — |   |
| Net cash used for financing activities                                                |       | (83,659                                             | )          | (75,252 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                         |       | 18                                                  |       | (91 | ) |
| Change in cash and cash equivalents                                                   |       | (78,738                                             | )          | (22,853 | ) |
| Cash and cash equivalents, beginning of period                                        |       | 100,397                                             |       | 56,512 |   |
| Cash and cash  equivalents, end of period                                             |       | $                                                   | 21,659     |   | $ | 33,659 |   |

 

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

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**UNITED ONLINE, INC.NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**1.**                 DESCRIPTION OFBUSINESS, BASIS OF PRESENTATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENTACCOUNTING PRONOUNCEMENTS

**Description ofBusiness**

United Online, Inc. (“United Online” or the “Company”)is a leading provider of consumer Internet and media services through a numberof brands, including NetZero, Juno, Classmates and MyPoints. The Company’sCommunications services include Internet access, email and VoIP. The Company’sContent & Media services include social networking, online loyaltymarketing, Web hosting and photo sharing. On a combined basis, the Company’sWeb properties attract a significant number of Internet users each month andthe Company offers marketers a broad array of Internet advertising products aswell as online market research and measurement services.

On April 10, 2006,the Company acquired MyPoints.com, Inc. (“MyPoints”), a leading providerof online loyalty marketing services, for approximately $56.6 million in cash.The Company reports MyPoints within its Content & Media segment.

**Basis ofPresentation**

The accompanying consolidated financial statements forthe quarters and nine months ended September 30, 2006 and 2005, which includeUnited Online and its wholly-owned subsidiaries, are unaudited except forthe balance sheet information at December 31, 2005, which is derived fromthe audited consolidated financial statements filed with the Securities andExchange Commission (“SEC”) in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005 on March 6, 2006 but does notinclude all disclosures required by accounting principles generally accepted inthe United States of America (“GAAP”). The Company’s interim financialstatements have been prepared in accordance with GAAP including those forinterim financial information and with the instructions for Form 10-Qand Article 10 of Regulation S-X issued by the SEC. Accordingly, they donot include all of the information and note disclosures required by GAAP forcomplete financial statements. The year-end condensed balance sheet data wasderived from audited financial statements, but does not include all disclosuresrequired by GAAP. All significant intercompany accounts and transactions havebeen eliminated in consolidation. The consolidated financial statements, in theopinion of management, reflect all adjustments (consisting only of normalrecurring adjustments) that are necessary for a fair presentation of the resultsfor the periods shown. The results of operations for such periods are notnecessarily indicative 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.These unaudited condensed consolidated financial statements should be read inconjunction with the audited consolidated financial statements and relatednotes for the year ended December 31, 2005 included in the Company’sAnnual Report on Form 10-K filed on March 6, 2006 with the SEC.

**Significant AccountingPolicies**

*MemberRedemption Liability—**The**member redemptionliability represents the estimated costs associated with the Company’sobligation to redeem outstanding member balances (in Points), less an*

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*allowance for Points expected toexpire prior to redemption. Such members’ Points may be converted by enrolledmembers into various third-party gift certificates, frequent travel programs,coupons or other rewards. Points are granted to members when they respond todirect marketing offers delivered by the Company, purchase goods fromadvertisers or engage in other specified activities. The Company is liable forproviding the rewards to members if and when such members seek to redeemaccumulated Points upon reaching required redemption thresholds. The memberredemption liability is estimated based upon a weighted-average cost of Pointsthat may be redeemed in the future. The liability is based upon historicalredemption costs and managements’ estimate of future trends. Under the Company’scurrent policy, MyPoints reserves the right to cancel or disable accounts andexpire unredeemed Points in those accounts that are inactive for a period of 12consecutive months. “Inactive” shall be defined as a lack of one of thefollowing: Web site visit (click through); email response; survey completion;profile update; or any Point-earning or Point-spending transaction. However,the Company reserves the right to extend the life of the unredeemed Points ifthe member is active. The Company bases its estimate of Points that will not beredeemed on an analysis of historical point earning trends, redemption activityand individual member accounts. This analysis is updated quarterly.*

*RevenueRecognition—**MyPoints**earns revenueprimarily from corporate advertising customers by charging fees for sendingemails to the MyPoints’ members and placing advertising on the MyPoints Website. Under the terms of advertising contracts, MyPoints earns revenueprimarily based on three components: (1) transmission of emailadvertisements to enrolled members, (2) unique clicks on transmittedemails and (3) actual transactions by members over the Internet. Revenueis recognized when email is transmitted to members, when responses are receivedand when members complete online transactions. Each of these activities is adiscrete, independent activity, which generally is specified in the advertisingsales agreement entered into with the customer. As the earning activities takeplace, activity measurement data (e.g., number of emails sent and number ofresponses received) is accumulated and the related revenue is recorded. Revenuefrom the sale of Points to MyPoints’ customers is deferred over a 15-monthperiod, which is the expected time that either the Points are redeemed andMyPoints provides an award, 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.*

*Stock-BasedCompensation—**On**January 1, 2006, theCompany adopted Statement of Financial Accounting 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 awards and employeestock purchases related to the Employee Stock Purchase Plan (“employee stockpurchases”) based on the grant-date fair values of the awards. SFAS No. 123Rsupersedes the Company’s previous accounting under Accounting Principles Board(“APB”) Opinion No. 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 123R (see Note 6 for additional information).*

*The Company adopted SFAS No. 123R using the modifiedprospective transition method, and the Company’s consolidated financialstatements at and for the quarter and nine months ended September 30, 2006reflect the impact of SFAS No. 123R. In accordance with the modifiedprospective transition method, the Company’s consolidated financial statementsfor prior periods have not been restated to reflect, and do not include, theimpact of SFAS No. 123R. Stock-based compensation expense recognized underSFAS No. 123R for the quarter and nine months ended September 30,2006 was $4.3 million and $15.1 million, respectively, which was primarilyrelated to stock options, restricted stock and the discount on employee*

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*stock purchases. Stock-basedcompensation expense for the quarter and nine months ended September 30,2005 was $2.8 million and $6.8 million, respectively, which was primarilyrelated to restricted 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 statements of operations for the quarter and nine monthsended September 30, 2006 includes (i) compensation expense forshare-based payment awards granted prior to, but not yet vested at, December 31,2005 based on the grant-date fair value estimated in accordance with the proforma provisions of SFAS No. 123 and (ii) compensation expense forthe share-based payment awards granted subsequent to December 31, 2005,based on the grant-date fair value estimated in accordance with the provisionsof SFAS No. 123R. As stock-based compensation expense recognized in theconsolidated statement of operations for the quarter and nine months ended September 30,2006 is based on awards ultimately expected to vest, it has been reduced for estimatedforfeitures. In the Company’s pro forma information required under SFAS No. 123for the periods prior to 2006, the Company accounted for forfeitures as theyoccurred. Accordingly, a pretax cumulative effect adjustment totaling $1.1million ($1.0 million, net of tax) was recorded in the March 2006 quarterto adjust for awards granted prior to January 1, 2006 that are notultimately 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 SFAS No. 123R, the Company treats such awards as a single awardand recognizes stock-based compensation expense on a straight-line basis (netof estimated forfeitures) over the employee 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 SFAS 123(R)-3.*

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*Since theadoption of SFAS No. 123R, stock-based compensation expense reduced theCompany’s results of operations as follows (in thousands, except per share amounts),excluding the cumulative effect of accounting change:*

| ** **                                              | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Operating expenses:                                     |       |                                                          |       |   |   |
| Cost of revenues                                        |       |                                                          | $          | 669 |   |   |
| Sales and  marketing                                    |       |                                                          | 2,743      |   |   |
| Product  development                                    |       |                                                          | 4,248      |   |   |
| General and  administrative                             |       |                                                          | 7,477      |   |   |
| Stock-based  compensation                               |       |                                                          | 15,137     |   |   |
| Tax benefit  recognized                                 |       |                                                          | (3,258     | ) |   |
| Stock-based  compensation, net of tax                   |       |                                                          | $          | 11,879 |   |   |
| Stock-based  compensation, net of tax per common share: |       |                                                          |       |   |   |
| Basic                                                   |       |                                                          | $          | 0.19 |   |   |
| Diluted                                                 |       |                                                          | $          | 0.18 |   |   |

 

*Thefollowing table illustrates (in thousands, except per share amounts) the effecton net income and earnings per share in the prior year as if the Company hadapplied the fair value recognition provisions of SFAS No. 123, as amendedby SFAS No. 148,**Accountingfor Stock-Based Compensation—Transition and Disclosure**.*

| ** **                                                                                                  | ** ** | **Quarter Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net income, as  reported                                                                                    |       |                                                 | $          | 12,594                                                        |       |   |   | $ | 34,753 |   |   |
| Add: Stock-based compensation included in net  income, net of tax                                           |       |                                                 | 2,517      |                                                          |       |   | 5,860 |   |   |
| Deduct: Total stock-based compensation determined  under fair value-based method for all awards, net of tax |       |                                                 | (5,389     | )                                                             |       |   | (15,099 | ) |   |
| Pro forma net income                                                                                        |       |                                                 | $          | 9,722                                                         |       |   |   | $ | 25,514 |   |   |
| Basic net income per share, as reported                                                                     |       |                                                 | $          | 0.21                                                          |       |   |   | $ | 0.57 |   |   |
| Basic net income per share, pro forma                                                                       |       |                                                 | $          | 0.16                                                          |       |   |   | $ | 0.42 |   |   |
| Diluted net income per share, as reported                                                                   |       |                                                 | $          | 0.20                                                          |       |   |   | $ | 0.55 |   |   |
| Diluted net  income per share, pro forma                                                                    |       |                                                 | $          | 0.15                                                          |       |   |   | $ | 0.40 |   |   |

 

**Recent AccountingPronouncements**

*Accounting Changesand Error Corrections*

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 new accountingprinciple. SFAS No. 154 requires retrospective application to 

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priorperiods’ financial statements of changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. When it is impracticable to determine the period-specificeffects of an accounting change on one or more individual prior periodspresented, SFAS No. 154 requires that the new accounting principle beapplied 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. The Company iscurrently evaluating the impact of adopting FIN 48.

*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 yearmisstatements, but its use can lead to the accumulation of misstatements in thebalance sheet. The iron-curtain method, on the other hand, focuses primarily onthe effect of correcting the period-end balance sheet with less emphasis on thereversing effects of prior year errors on the income statement. In SAB No. 108,the SEC 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 

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endingon or before November 15, 2006. The implementation of SAB No. 108 isnot expected to have a material impact on the Company’s 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 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.

**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 Combinations*. The primary reasonfor the acquisition was to expand the Company’s Content & Mediabusiness offerings. MyPoints’ results of operations are included in theconsolidated financial statements from the date of acquisition.

Thepurchase price was allocated to the net assets acquired based on their estimatedfair values, 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 deductible for tax purposes.

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Thefollowing summarized unaudited pro forma information assumes that theacquisition of MyPoints had occurred at the beginning of each of the periodspresented (in thousands, except per share amounts). The pro forma effect of thetransaction is immaterial to the consolidated financial statements for thequarter ended June 30, 2006, and accordingly, is not included in thefollowing:

| ** **                                            | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                   | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Revenues                                              |       |                                       | $          | 140,980                                             |       |   | $ | 403,505 |   | $ | 420,391 |   |
| Income before  cumulative effect of accounting change |       |                                       | $          | 12,122                                              |       |   | $ | 36,786 |   | $ | 33,922 |   |
| Net income                                            |       |                                       | $          | 12,122                                              |       |   | $ | 37,827 |   | $ | 33,922 |   |
| Basic net income per  share:                          |       |                                       |       |                                                |       |   |   |   |   |
| Income before cumulative effect of accounting change  |       |                                       | $          | 0.20                                                |       |   | $ | 0.58 |   | $ | 0.56 |   |
| Net income                                            |       |                                       | $          | 0.20                                                |       |   | $ | 0.59 |   | $ | 0.56 |   |
| Diluted net income per  share:                        |       |                                       |       |                                                |       |   |   |   |   |
| Income before cumulative effect of accounting change  |       |                                       | $          | 0.19                                                |       |   | $ | 0.56 |   | $ | 0.53 |   |
| Net income                                            |       |                                       | $          | 0.19                                                |       |   | $ | 0.57 |   | $ | 0.53 |   |

 

*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 social-networking service that acts as an intermediarybetween members, allowing them to send messages through the site to one another.The acquisition was accounted for under the purchase method in accordance withSFAS No. 141. The primary reason for the acquisition was to acquire TheNames Database’s member relationships and software, which had the effect ofexpanding the Company’s social-networking business. The Names Database’sresults of operations are included in the consolidated financial statementsfrom the date of acquisition.

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Thepurchase price was allocated to the net assets acquired based on theirestimated fair values, including identifiable intangible assets. The purchaseprice allocation 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 amortizable life of the acquiredintangible assets is 6.6 years. The $9.1 million of goodwill acquired is notdeductible for tax purposes. The pro forma effect of the transaction isimmaterial to the consolidated financial statements.

Cash paid for acquisitionsduring the nine months ended September 30, 2006 included a $1.5 millionpayment for PhotoSite, which was included in accrued liabilities at December 31,2005.

**3.**                 BALANCESHEET COMPONENTS

**Short-TermInvestments**

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

| ** **            | ** ** | **September 30, 2006** | ** ** |
|-----------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**              | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| U.S. corporate  notes |       | $                                | 3,001      |   |   | $ | — |   |   |   | $ | (4 | ) |   | $ | 2,997 |   |
| Government  agencies  |       | 130,258                          |       |   | 16 |   |   |   | (233 | ) |   | 130,041 |   |
| Total                 |       | $                                | 133,259    |   |   | $ | 16 |   |   |   | $ | (237 | ) |   | $ | 133,038 |   |

 

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 quarters and nine months ended September 30,2006 and 2005.

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Thefollowing table summarizes the fair value and gross unrealized losses of ourshort-term investments, aggregated by type of investment instrument and lengthof time that individual securities have been in a continuous unrealized lossposition, at September 30, 2006 (in thousands):

| ** **            | ** ** | **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 |       | $                                      | 2,997      |                                    |       | $               | (4         | ) |   | $ | — |   |   | $ | — |   |   | $ | 2,997 |   |   | $ | (4 | ) |   |
| Government  agencies  |       | 8,857                                  |       |                                    | (2         | )               |       | 25,190 |   |   | (231 | ) |   | 34,047 |   |   | (233 | ) |   |
| Total                 |       | $                                      | 11,854     |                                    |       | $               | (6         | ) |   | $ | 25,190 |   |   | $ | (231 | ) |   | $ | 37,044 |   |   | $ | (237 | ) |   |

 

Our investment portfolio consists of both corporateand government securities that have a maximum maturity of four years. Thelonger the duration of these securities, the more susceptible they are tochanges in market interest rates and bond yields. As yields increase, thosesecurities purchased with a lower yield-at-cost show a mark-to-marketunrealized loss. All unrealized losses are due to changes in interest rates andbond yields.

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

| ** **                           | ** ** | **September 30, 2006** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**              | ** ** | **Estimated  Fair Value** | ** ** |
| Maturing within 1  year              |       | $                                | 22,450     |   | $ | 22,446 |   |
| Maturing between  1 year and 4 years |       | 35,160                           |       | 34,942 |   |
| Maturing after 4  years              |       | 75,649                           |       | 75,650 |   |
| Total                                |       | $                                | 133,259    |   | $ | 133,038 |   |

 

**Accounts Receivable**

At September 30,2006, one customer comprised approximately 15% of the consolidated accountsreceivable balance. At December 31, 2005, two customers comprisedapproximately 21% and 12% of the consolidated accounts receivable balance. Forthe quarters and nine months ended September 30, 2006 and 2005, theCompany did not have any individual customers that comprised more than 10% oftotal revenues.

**Property andEquipment**

Propertyand equipment consists of the following (in thousands):

| ** **                       | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Computer software  and equipment |       |                         | $          | 106,935                     |       |   |   | $ | 90,357 |   |   |
| Furniture and  fixtures          |       |                         | 13,532     |                        |       |   | 11,351 |   |   |
|                             |       |                         | 120,467    |                        |       |   | 101,708 |   |   |
| Less: accumulated  depreciation  |       |                         | (83,607    | )                           |       |   | (68,615 | ) |   |
| Total                            |       |                         | $          | 36,860                      |       |   |   | $ | 33,093 |   |   |

 

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**Goodwill andIntangible Assets**

Thechanges in goodwill for the nine months ended September 30, 2006 were asfollows (in thousands):

| Balance at  January 1, 2006                                     |   | $      | 80,499  |   |
|----------------------------------------------------------------------|--------|--------|---------|--------|
| Goodwill recorded in connection with The Names  Database acquisition |   | 9,092  |    |
| Goodwill recorded in connection with the MyPoints acquisition        |   | 49,122 |    |
| Balance at  September 30, 2006                                  |   | $      | 138,713 |   |

 

Intangibleassets consist of the following (in thousands):

| ** **                                       | ** ** | **September 30, 2006** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **Cost**                         | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Pay accounts and  free accounts                  |       | $                                | 108,351    |   |   | $ | (74,130 | ) |   | $ | 34,221 |   |
| Trademarks and  trade names                      |       | 25,786                           |       |   | (6,165 | ) |   | 19,621 |   |
| Advertising  contracts and related relationships |       | 7,229                            |       |   | (5,565 | ) |   | 1,664 |   |
| Software and  technology                         |       | 9,532                            |       |   | (5,916 | ) |   | 3,616 |   |
| Patents, domain  names and other                 |       | 4,637                            |       |   | (2,453 | ) |   | 2,184 |   |
| Total                                            |       | $                                | 155,535    |   |   | $ | (94,229 | ) |   | $ | 61,306 |   |

 

| ** **                                       | ** ** | **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 |   |

 

**Accrued Liabilities**

Accruedliabilities consist of the following (in thousands):

| ** **                                  | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Employee  compensation and related expenses |       |                         | $          | 22,459                      |       |   |   | $ | 20,353 |   |   |
| Income taxes  payable                       |       |                         | 9,116      |                        |       |   | 9,769 |   |   |
| Subscriber  referral fees                   |       |                         | 5,031      |                        |       |   | 4,281 |   |   |
| Other                                       |       |                         | 2,391      |                        |       |   | 1,846 |   |   |
| Total                                       |       |                         | $          | 38,997                      |       |   |   | $ | 36,249 |   |   |

 

**Term Loan andInterest Rate Cap**

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 is 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 recognized approximately $1.5 million in deferred financingcosts in connection with the repayment of the term loan.

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**4.**                 STOCKHOLDERS’EQUITY

*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, 2006.At September 30, 2006, the Company had repurchased $139.2 million of itscommon stock under the program, leaving $60.8 million remaining under theprogram.

Shares withheld fromrestricted stock units (“RSUs”) awarded to employees upon vesting to payapplicable withholding taxes on their behalf are considered common stockrepurchases, but are not counted as purchases against the 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. In the nine months ended September 30,2006, approximately 193,000 shares were withheld from RSUs that vested in orderto pay the applicable employee withholding taxes.

*Dividends*

The Company’s Board ofDirectors declared quarterly dividends of $0.20 per share in February 2006,May 2006 and August 2006 which were paid on February 28, 2006, May 31,2006 and August 31, 2006 and totaled $12.9 million, $13.4 million and $13.5million, respectively. In November 2006, the Company’s Board of Directorsdeclared a quarterly cash dividend of $0.20 per share of common stock. Therecord date for the dividend is November 13, 2006 and the dividend ispayable on November 30, 2006.

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**5.**                 EARNINGSPER SHARE

Thefollowing table sets forth the computation of basic and diluted earnings pershare for the quarters and nine months ended September 30, 2006 and 2005(in thousands, except per share amounts):

| ** **                                                                                | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Numerator:                                                                                |       |                                       |       |                                                |       |   |   |   |   |
| Income before  cumulative effect of accounting change                                     |       | $                                          | 13,436     |                                                | $          | 12,594 |   | $ | 36,672 |   | $ | 34,753 |   |
| Cumulative effect  of accounting change, net of tax                                       |       | —                                     |       | —                                              |       | 1,041 |   | — |   |
| Net income                                                                                |       | $                                          | 13,436     |                                                | $          | 12,594 |   | $ | 37,713 |   | $ | 34,753 |   |
| Denominator:                                                                              |       |                                       |       |                                                |       |   |   |   |   |
| Weighted average  common shares—basic                                                |       | 65,048                                     |       | 61,920                                              |       | 64,105 |   | 61,394 |   |
| Less: weighted average common shares subject to  repurchase                               |       | (475                                       | )          | (521                                                | )          | (475 | ) | (516 | ) |
| Shares used to  calculate basic net income per share                                      |       | 64,573                                     |       | 61,399                                              |       | 63,630 |   | 60,878 |   |
| Add: Dilutive effect of stock options, restricted  stock and employee stock purchase plan |       | 2,010                                      |       | 2,708                                               |       | 2,185 |   | 2,538 |   |
| Shares used to  calculate diluted net income per share                                    |       | 66,583                                     |       | 64,107                                              |       | 65,815 |   | 63,416 |   |
| Basic net income  per share:                                                              |       |                                       |       |                                                |       |   |   |   |   |
| Income before cumulative effect of accounting change                                      |       | $                                          | 0.21       |                                                | $          | 0.21 |   | $ | 0.58 |   | $ | 0.57 |   |
| Cumulative effect of accounting change, net of tax                                        |       | —                                     |       | —                                              |       | 0.01 |   | — |   |
| Basic net income  per share                                                               |       | $                                          | 0.21       |                                                | $          | 0.21 |   | $ | 0.59 |   | $ | 0.57 |   |
| Diluted net  income per share:                                                            |       |                                       |       |                                                |       |   |   |   |   |
| Income before cumulative effect of accounting change                                      |       | $                                          | 0.20       |                                                | $          | 0.20 |   | $ | 0.56 |   | $ | 0.55 |   |
| Cumulative effect of change in accounting principle,  net of tax                          |       | —                                     |       | —                                              |       | 0.01 |   | — |   |
| Diluted net income per  share                                                             |       | $                                          | 0.20       |                                                | $          | 0.20 |   | $ | 0.57 |   | $ | 0.55 |   |

 

The diluted per sharecomputations exclude stock options, unvested common stock and restricted stockunits, which are antidilutive. The number of antidilutive shares at September 30,2006 and 2005 was 3.8 million and 6.9 million, respectively.

**6.**                 STOCK-BASEDCOMPENSATION PLANS

*Stock-BasedCompensation Plans*

The Company has three active equity plans under which itis authorized to grant stock options, restricted stock awards and RSUs.

Stock options granted to employees generally vest overa three or four-year period. Stock options granted to directors generally vestover a nine-month to three-year period, either monthly or annually. Stockoption grants expire after ten years unless cancelled earlier due totermination of employment or Board service. Certain stock option grants areimmediately exercisable for unvested shares of common stock, with the unvestedportion of the shares remaining subject to repurchase by the Company at theexercise price until the vesting period is complete.

RSUs granted to employees generally vest over afour-year period. RSUs granted to non-employee directors generally vest over aone-year period.

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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 September 30,2006, an aggregate of 27.6 million shares were reserved under the Company’s plans,of which 4.0 million shares were available for issuance at September 30,2006.

*Stock-BasedCompensation Recognized*

Thefollowing table summarizes the stock-based compensation that has beenincluded in the following captions for each of the periods presented (inthousands):

| ** **                     | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Operating expenses:            |       |                                       |       |                                                |       |   |   |   |   |
| Cost of revenues               |       | $                                          | 176        |                                                | $          | 49 |   | $ | 669 |   | $ | 131 |   |
| Sales and  marketing           |       | 727                                        |       | 297                                                 |       | 2,743 |   | 621 |   |
| Product  development           |       | 1,137                                      |       | 329                                                 |       | 4,248 |   | 742 |   |
| General and  administrative    |       | 2,264                                      |       | 2,162                                               |       | 7,477 |   | 5,338 |   |
| Total stock-based compensation |       | $                                          | 4,304      |                                                | $          | 2,837 |   | $ | 15,137 |   | $ | 6,832 |   |
| Tax benefit  recognized        |       | $                                          | 1,088      |                                                | $          | 511 |   | $ | 3,258 |   | $ | 1,163 |   |

 

*Stock Options*

Thefair value 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.

| ** **                | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                | ** ** | ** 2006 **                       | ** ** | ** 2005 **                                | ** ** | **  2006  ** | ** ** | **  2005  ** | ** ** |
| Risk-free  interest rate  |       |                                       | N/A        |                                                |       |   | 4.1 | % |   |   | 4.6 | % |   |   | 4.2 | % |   |
| Expected life (in  years) |       |                                       | N/A        |                                                |       |   | 5.0 |   |   |   | 3.8 |   |   |   | 5.0 |   |   |
| Dividend yield            |       |                                       | N/A        |                                                |       |   | 6.6 | % |   |   | 6.1 | % |   |   | 2.1 | % |   |
| Volatility                |       |                                       | N/A        |                                                |       |   | 85.9 | % |   |   | 60.0 | % |   |   | 92.2 | % |   |

 

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Thefollowing table summarizes activity during the nine months ended September 30,2006:

| ** **                              | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average   Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **(in thousands)**  | ** ** | ** **                                   | ** ** | **(in years)**                                 | ** ** | **(in thousands)**         | ** ** |
| Outstanding at  January 1, 2006    |       |                     | 11,628     |                                         |       |                                                | $          | 13.31                           |       |   |   |   |   |   |   |   |   |   |
| Granted                                 |       |                     | 210        |                                         |       |                                                | 13.18      |                            |       |   |   |   |   |   |   |   |   |
| Exercised                               |       |                     | (1,855     | )                                            |       |                                                | 3.54       |                            |       |   |   |   |   |   |   |   |   |
| Cancelled                               |       |                     | (2,490     | )                                            |       |                                                | 23.83      |                            |       |   |   |   |   |   |   |   |   |
| Outstanding at  September 30, 2006 |       |                     | 7,493      |                                         |       |                                                | $          | 12.23                           |       |   |   | 6.76 |   |   |   | $ | 19,878 |   |   |
| Exercisable at  September 30, 2006 |       |                     | 6,109      |                                         |       |                                                | $          | 12.42                           |       |   |   | 6.33 |   |   |   | $ | 18,255 |   |   |

 

In March 2006, the Company offered eligibleemployees of the Company the opportunity to exchange any outstanding stockoptions granted to them which had an exercise price per share of the Company’scommon stock at or above $16.00 (the “Eligible Options”) in return for RSUs.The exchange offer expired in April 2006, and approximately 1.8 millionshares of common stock underlying Eligible Options were exchanged for RSUscovering approximately 0.4 million shares of common stock in exchange for thecancellation of the Eligible Options. The exchange was offered to 315 eligibleemployees and accounted for as a modification under SFAS No. 123R in the June 2006quarter. The number of RSUs that were issued in exchange for each tenderedEligible Option was based on the per share exercise price of that option andwas, in all events, less than the number of shares subject to the tenderedoption. Eligible Options with exercise prices between $16.00 and $20.00 wereexchanged based on a ratio of one RSU for four Eligible Options. Eligible Optionswith exercise prices greater than $20.00 were exchanged based on a ratio of oneRSU for five Eligible Options. Total expense associated with the exchange,prior to the consideration of expected forfeitures, is approximately $0.8million.

Total unrecognized compensation cost related tounvested stock options at September 30, 2006, prior to the considerationof expected forfeitures, is approximately $4.9 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 nine months ended September 30,2006 and 2005 was $4.51 and $7.12, respectively. The total intrinsic value ofoptions exercised during the nine months ended September 30, 2006 and 2005was $16.0 million and $17.5 million, respectively. Cash received from theexercise of stock options was $6.6 million and $4.7 million, respectively, forthe nine months ended September 30, 2006 and 2005. The tax benefitsrealized from stock options exercised in the nine months ended September 30,2006 and 2005 were approximately $3.4 million and $5.5 million, respectively.

*Restricted Stockand Restricted Stock Units*

At January 1, 2006 and September 30, 2006,475,000 restricted shares of common stock with a weighted-average grant datefair value of $19.91 were outstanding. The shares vest entirely at the end of afour-year vesting period in January 2008.

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Thefollowing table summarizes activity for RSUs during the nine months ended September 30,2006:

| ** **                              | ** ** | **RSUs  Outstanding**   | ** ** | **Weighted-  Average Grant  Date Fair Value** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|--------------------------------------------------------------|------------|
| ** **                              | ** ** | **(in thousands)** | ** ** | ** **                                                   | ** ** |
| Outstanding at  January 1, 2006    |       |                    | 1,642      |                                                         |       |   | $ | 10.78 |   |   |
| Granted                                 |       |                    | 2,083      |                                                         |       |   | 10.15 |   |   |
| Vested                                  |       |                    | (567       | )                                                            |       |   | 9.13 |   |   |
| Cancelled                               |       |                    | (342       | )                                                            |       |   | 9.21 |   |   |
| Outstanding at  September 30, 2006 |       |                    | 2,816      |                                                         |       |   | $ | 12.14 |   |   |

 

For the nine months ended September 30,2006, the Company issued approximately 2.1 million RSUs at a weighted-averagegrant date fair value of $10.15. For the nine months ended September 30,2005, the Company issued approximately 1.7 million RSUs at a weighted-averagegrant date fair value of $10.74. At September 30, 2006, the intrinsicvalue of outstanding restricted stock and RSUs was approximately $40.1 million.Total unrecognized compensation cost related to unvested restricted stock andRSUs at September 30, 2006 prior to the consideration of expectedforfeitures is approximately $25.4 million and is expected to be recognizedover a weighted-average period of 1.4 years. The fair value of RSUs that vestedduring the nine months ended September 30, 2006 was approximately $6.7million.

*Employee StockPurchase Plan*

The Company has a 2001 Employee Stock Purchase Plan (“ESPP”),which expires in the year 2011, and under which approximately 5.8 millionshares of the Company’s common stock were reserved under the plan at September 30,2006. At September 30, 2006, 2.8 million shares were available forissuance. Under the ESPP, each eligible employee may authorize payrolldeductions of up to 15% of their compensation to purchase shares of commonstock on two “purchase dates” each year at a purchase price per share equal to85% of the lower of (i) the closing selling price per share of commonstock on the employee’s entry date into the two-year offering period in whichthe purchase date occurs or (ii) the closing selling price per share onthe purchase date. Each offering period has a twenty-four month duration andpurchase intervals of six months.

Thefair value of ESPP shares was estimated using the Black-Scholes option pricingmodel with the following weighted-average assumptions: 

| ** **                | ** ** | **Quarter Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|---------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Risk-free  interest rate  |       |                                                 | 3.8        | %                                                             |       |   | 3.7 | % |   |
| Expected life (in  years) |       |                                                 | 0.5-2.0    |                                                          |       |   | 0.5-2.0 |   |   |
| Dividend yield            |       |                                                 | 8.2        | %                                                             |       |   | 8.5 | % |   |
| Volatility                |       |                                                 | 51.8       | %                                                             |       |   | 52.7 | % |   |

 

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 quarter and ninemonths ended September 30, 2006, the Company recognized approximately $0.3million and $1.5 million, respectively, of stock-based compensationexpense related to the ESPP. For 

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thequarter and nine months ended September 30, 2005, the Company recognized$0 of stock-based compensation expense related to the ESPP. Total unrecognizedcompensation cost related to the ESPP at September 30, 2006 isapproximately $1.1 million and is expected to be recognized over aweighted-average period of 0.6 years.

**7.**   SEGMENTINFORMATION

The Company complies with the reporting requirementsof SFAS No. 131, *Disclosures about Segmentsof an Enterprise and Related Information*. Historically, the Companyoperated in one principal operating 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 services and, subsequent to theacquisition of MyPoints, loyalty marketing. Unallocated corporate expenses arecentrally managed at the corporate level and consist of corporate-relatedexpenses, depreciation, amortization of intangible assets and stock-basedcompensation. The Company has restated the prior periods to reflect the changein the composition of the reportable segments. Management has determined thatsegment income from operations, which excludes corporate expenses,depreciation, amortization of intangible assets and stock-based compensation,is the appropriate measure for assessing performance of its segments and forallocating resources among its segments. Segment income from operations for thequarter and nine months ended September 30, 2006 includes restructuring chargesof approximately $0.6 million.

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

| ** **                      | ** ** | **Quarter Ended September 30, 2006** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|
| ** **                      | ** ** | **Communications**                                       | ** ** | **Content & Media** | ** ** | **Total** | ** ** |
| Billable services               |       |                                                     | $          | 82,057 |   |   |   | $ | 22,142 |   |   | $ | 104,199 |   |
| Advertising                     |       |                                                     | 10,096     |   |   |   | 15,341 |   |   | 25,437 |   |
| Total revenues                  |       |                                                     | $          | 92,153 |   |   |   | $ | 37,483 |   |   | $ | 129,636 |   |
| Segment income from  operations |       |                                                     | $          | 35,437 |   |   |   | $ | 4,987 |   |   | $ | 40,424 |   |

 

| ** **                      | ** ** | **Nine Months Ended September 30, 2006** | ** ** |
|---------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                      | ** ** | **Communications**                                                | ** ** | **Content & Media** | ** ** | **Total** | ** ** |
| Billable services               |       |                                                              | $          | 259,877 |   |   |   | $ | 64,336 |   |   | $ | 324,213 |   |
| Advertising                     |       |                                                              | 28,866     |   |   |   | 38,789 |   |   | 67,655 |   |
| Total revenues                  |       |                                                              | $          | 288,743 |   |   |   | $ | 103,125 |   |   | $ | 391,868 |   |
| Segment income from  operations |       |                                                              | $          | 104,479 |   |   |   | $ | 18,638 |   |   | $ | 123,117 |   |

 

| ** **                      | ** ** | **Quarter Ended September 30, 2005** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|
| ** **                      | ** ** | **Communications**                                       | ** ** | **Content & Media** | ** ** | **Total** | ** ** |
| Billable services               |       |                                                     | $          | 99,269 |   |   |   | $ | 18,401 |   |   | $ | 117,670 |   |
| Advertising                     |       |                                                     | 9,064      |   |   |   | 6,044 |   |   | 15,108 |   |
| Total revenues                  |       |                                                     | $          | 108,333 |   |   |   | $ | 24,445 |   |   | $ | 132,778 |   |
| Segment income from  operations |       |                                                     | $          | 34,872 |   |   |   | $ | 4,324 |   |   | $ | 39,196 |   |

 

| ** **                      | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|---------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                      | ** ** | **Communications**                                                | ** ** | **Content & Media** | ** ** | **Total** | ** ** |
| Billable services               |       |                                                              | $          | 301,272 |   |   |   | $ | 50,116 |   |   | $ | 351,388 |   |
| Advertising                     |       |                                                              | 26,596     |   |   |   | 16,845 |   |   | 43,441 |   |
| Total revenues                  |       |                                                              | $          | 327,868 |   |   |   | $ | 66,961 |   |   | $ | 394,829 |   |
| Segment income from  operations |       |                                                              | $          | 104,994 |   |   |   | $ | 7,572 |   |   | $ | 112,566 |   |

 

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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):

| ** **                            | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Segment income  from operations:      |       |                                       |       |                                                |       |   |   |   |   |
| Communications                        |       | $                                          | 35,437     |                                                | $          | 34,872 |   | $ | 104,479 |   | $ | 104,994 |   |
| Content & Media              |       | 4,987                                      |       | 4,324                                               |       | 18,638 |   | 7,572 |   |
| Total segment  income from operations |       | 40,424                                     |       | 39,196                                              |       | 123,117 |   | 112,566 |   |
| Corporate expenses                    |       | (4,285                                     | )          | (4,753                                              | )          | (14,322 | ) | (13,394 | ) |
| Depreciation                          |       | (5,737                                     | )          | (3,720                                              | )          | (15,789 | ) | (10,978 | ) |
| Amortization of intangible assets     |       | (4,213                                     | )          | (5,252                                              | )          | (13,154 | ) | (16,884 | ) |
| Stock-based compensation              |       | (4,304                                     | )          | (2,837                                              | )          | (15,137 | ) | (6,832 | ) |
| Consolidated operating  income        |       | $                                          | 21,885     |                                                | $          | 22,634 |   | $ | 64,715 |   | $ | 64,478 |   |

 

Pursuant to SFAS No. 131,total segment assets have not been disclosed as this information is notreported to, or used by, the chief operating decision maker. The vast majorityof the Company’s revenues and related results of operations and identifiableassets are in the United States of America. The Company’s $138.7 million ofgoodwill is allocated entirely to the Content & Media segment.

**8.**   COMMITMENTS ANDCONTINGENCIES

*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. In a court order dated February 15, 2005, the DistrictCourt granted preliminary approval of the issuer defendants’ proposedsettlement. On June 30, 2005, the United States Court of Appeals for theSecond Circuit granted the underwriter defendants’ petition for permission toappeal the District Court’s order granting plaintiffs’ motion for classcertification. A hearing on the settlement was held on April 24, 2006, andthe parties are awaiting the court’s ruling on the motion for final approval ofthe settlement.

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 adversary 

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proceeding,the Debtor and its principals filed a pleading with the bankruptcy courtasserting that Juno is obligated to pay compensation in an amount in excess of$80 million as a result of Juno’s conduct in connection with the subscriberreferral agreement. In addition, a dispute arose between Juno and UUNETTechnologies, 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 April 25,2003, Juno, the Committee of Unsecured Creditors, WorldCom and UUNET (allegedlythe largest secured creditor) entered into a Stipulation of Settlement, whichprovided for the payment by Juno of $5.5 million in final settlement of allclaims against Juno. On September 11, 2003, the court issued an orderapproving the Stipulation of Settlement. On September 12, 2005, the SecondCircuit Court of Appeals vacated the judgment of the bankruptcy court andremanded the case to the bankruptcy court. Discovery in the adversaryproceeding in the bankruptcy court is proceeding. No trial date has been set.On August 4, 2006, the Company entered into a settlement agreement withthe Committee of Unsecured Creditors providing for the settlement of all claimsagainst Juno pursuant to a proposed plan of liquidation of Debtor. If thesettlement and plan of liquidation are approved by the bankruptcy court,subject to certain conditions, Juno has agreed to pay $6.25 million. If thesettlement and plan of liquidation are approved by the bankruptcy court and notappealed, Juno has agreed to pay an additional $0.25 million. A hearing toconfirm the proposed plan of liquidation has been scheduled for December 21,2006.

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 whichpurports to cover user access to a computer network. Plaintiff is seekinginjunctive 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 has filed a notice of appeal of thetrial court’s ruling. Oral argument of the appeal is scheduled for December 6,2006.

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.

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. The Company has a reserve of $6.25 million for the Freewwwebmatter discussed above and such reserve is reflected in the consolidatedfinancial statements in restricted cash, accounts payable and accruedliabilities. There can be no assurance, however, that this reserve will besufficient to cover the possible losses from such litigation. We have notestablished reserves for any other matters.

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 cashflows.

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**ITEM 2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Overview**

We are a leading provider of consumer Internet andmedia services through a number of brands including NetZero, Juno, Classmatesand MyPoints. Our Communications services include Internet access, email andVoIP. Our Content & Media services include social networking, onlineloyalty marketing, Web hosting and photo sharing. 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 as well asonline market research and measurement services.

On April 10, 2006, weacquired MyPoints, a leading provider of online loyalty marketing services, forapproximately $56.6 million in cash. MyPoints is reported under ourContent & Media segment from the date of acquisition.

**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. |       |

 

**Consumer Brands andServices**

***Communications***

We offer a variety of Communications-based services,both free of charge and subscription-based, under a number of brands,which include the following:

*InternetAccess:*   NetZero, Juno andBlueLight;

*VoIP:*   NetZeroVoice and PrivatePhone;

*Email:**  *NetZeroMegaMail and Juno MegaMail; and

*Other Services:**  *NetZeroFamily Pack, Juno Family Pack and Norton Internet Security.

*Internet Access*

Our basic pay accessservices include Internet access and an email account and are offered throughvarious pricing plans, generally $9.95 per month. We also offer acceleratedaccess services which are bundled with additional benefits such as pop-upblocking, antivirus software, enhanced email storage and VoIP telephonycapabilities, for up to $14.95 per month. Our accelerated access servicesutilize technologies to reduce the time for certain Web pages to downloadto users’ computers when compared to our basic access services. We generallyoffer discounted pricing on our monthly access rates for subscribers that makeextended service commitments. NetZero and Juno also offer free access serviceswhich differ from their respective pay access services in that the hourly andcertain other limitations are set for the free services. In addition, the freeaccess services incorporate certain advertising initiatives, including apersistent advertising banner, not present on the pay services. Our accessservices are available in more than 9,000 cities across the United States andCanada.

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*VoIP*

NetZero Voice, a VoIPtelephony service, provides local and long distance calling over dial-up andbroadband Internet connections. We offer a free version of our VoIP servicewhich enables users to make unlimited computer-to-computer calls and instanttext message one another at no charge and includes a free voicemail accountintegrated with email into one convenient message center. Our pay VoIP serviceplans have all of the features of the free service and we offer pricing plansat $3.95 and $14.95 per month which include a dedicated phone number and up tounlimited minutes to and from the publicly switched telephone network (PSTN)within the U.S., Canada and Puerto Rico. In addition, NetZero Voice offersinternational PSTN calling at attractively priced rates per minute and a numberof other features such as call forwarding. PrivatePhone is a free Internetphone service that offers a free phone number and voicemail that does notrequire the use of a computer to sign up or check messages. Users can choose aphone number from most area codes in the U.S. and use it instead of their homeor mobile phone number as a way to screen calls.

*Email*

We offer free Web-basedemail services, including up to one gigabyte of storage, anti-spam protection,address book importing, photo viewing and more. NetZero and Juno offer premiumemail services under the MegaMail brand with expanded features and storagecapabilities through various pricing plans, generally $9.95 per year.

*Other Services*

The Family Pack bundlestogether leading third-party produced family-oriented Internet services and isoffered to subscribers for $4.95 per month. Our accelerated access servicesinclude Norton AntiVirus with antispyware free of charge, and members can upgradeto a more complete Norton Internet Security package that includes a personalfirewall, parental controls and other protection for an additional $1.95 permonth. These same security services are offered to our non-accelerated accessmembers for an additional $2.95 per month for Norton AntiVirus and $4.95 permonth for Norton Internet Security.

***Content & Media***

We offer a variety of Content & Mediaproducts and services, both free of charge and subscription-based, undera number of brands, which include the following:

*SocialNetworking:**  *Classmates,StayFriends, The Names Database, Klassträffen, and Trombi;

*LoyaltyMarketing:*   MyPoints;

*WebHosting:**  *FreeServers,50megs, Bizhosting and Global Servers; and

*Online Photos:**  *PhotoSite.

*Social Networking*

Connecting millions ofusers primarily across the United States and, to a lesser extent, Germany,Sweden, France, Canada and other major English-speaking countries, includingthe United Kingdom and India, our social-networking services allow members tostay in touch with people from their past. Membership in our social-networkingservices is free and allows users to post a personal profile, access and searchour database of other registered members within personally relevant onlinecommunities from school, work and the military. In addition to the features ofour free social-networking services, our pay services also enable subscribersto communicate with other members and are offered through various 

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pricingplans, generally $39.00 per year or $15.00 for three months in the U.S. Oursocial-networking properties also contain advertising initiatives throughouttheir Web sites.

*Loyalty Marketing*

In April 2006, weacquired MyPoints.com, Inc. MyPoints offers advertisers and retailersdirect marketing solutions such as rewards-based Web shopping, targeted emailsbased on self-reported and behavioral data, and online surveys that pre-qualifyits members for targeted offers. MyPoints members are rewarded with points forclicking or shopping through MyPoints’ emails, for shopping through theMyPoints’ Web site, and for completing surveys. The points are then redeemablefor gift cards and other benefits with various partners.

*Web Hosting*

Our Web-hosting services,which include domain name registration services, are offered through variouspricing plans, generally from $1.99 to $9.99 per month. A limited,advertising-supported version of the service is offered free of charge.

*Online Photos*

PhotoSite is an onlinedigital photo-sharing service which enables users to display photos, orderprints and create custom photo albums, Web logs and full computer screenslideshows on their own personal photo Web site. With PhotoSite, users cancatalog and store digital photos by subject matter, allowing convenientsearches of photos by other users. Prices for subscription services range from$1.99 per month to $4.99 per month and a limited version of the service isoffered free of charge.

**Account Metrics**

At September 30,2006, we had approximately 4.9 million pay accounts and approximately 20.8million 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 periods presented, an analysis of our pay accounts.

| ** **                 | ** ** | **September 30,  2006** | ** ** | **June 30,  2006** | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** | **September 30,  2005** | ** ** |
|----------------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Communications:            |       |                         |       |                    |       |                     |       |                        |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Access                     |       |                         | 2,425      |                    |       |                     | 2,556      |                        |       |                         | 2,751      |   |   |   | 2,855 |   |   |   | 2,980 |   |   |
| Other                      |       |                         | 323        |                    |       |                     | 330        |                        |       |                         | 321        |   |   |   | 313 |   |   |   | 301 |   |   |
| Total                      |       |                         | 2,748      |                    |       |                     | 2,886      |                        |       |                         | 3,072      |   |   |   | 3,168 |   |   |   | 3,281 |   |   |
| Content &  Media: |       |                         |       |                    |       |                     |       |                        |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Social networking          |       |                         | 2,079      |                    |       |                     | 2,029      |                        |       |                         | 1,945      |   |   |   | 1,766 |   |   |   | 1,686 |   |   |
| Other                      |       |                         | 85         |                    |       |                     | 81         |                        |       |                         | 76         |   |   |   | 75 |   |   |   | 73 |   |   |
| Total                      |       |                         | 2,164      |                    |       |                     | 2,110      |                        |       |                         | 2,021      |   |   |   | 1,841 |   |   |   | 1,759 |   |   |
| Total pay  accounts        |       |                         | 4,912      |                    |       |                     | 4,996      |                        |       |                         | 5,093      |   |   |   | 5,009 |   |   |   | 5,040 |   |   |

 

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In general, we count andtrack pay accounts and free accounts by unique member identifiers. Users havethe ability to registerfor separate services under separate brands and member identifiersindependently. We do not track whether a pay account has purchased more thanone of our services unless the account uses the same member identifier. As aresult, total active free accounts may not represent unique free users. Inaddition, a free Web-hosting account is determined to be active if there was avisit to the site during the preceding 90 days, and it may be that thecreator of the site no longer maintains or updates the site. As such, a freeWeb-hosting account may not represent an ongoing relationship with the personwho set up the account. At any point in time, our pay account base includes anumber of accounts receiving a free period of service as either a promotion orretention tool, a number of accounts that have notified us that they areterminating their service but whose service is still in effect and may alsoinclude a few thousand internal test accounts.

**Results ofOperations**

Thefollowing tables set forth (with dollars in thousands), for the periodspresented, selected historical statements of operations data. The informationcontained in the tables below should be read in conjunction with Liquidity andCapital Resources and Financial Commitments included in this Item 2 aswell as the consolidated financial statements and notes thereto includedelsewhere in this Quarterly Report on Form 10-Q.

| ** **                                            | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Billable services                                     |       | $                                          | 104,199    |                                                | $          | 117,670 |   | $ | 324,213 |   | $ | 351,389 |   |
| Advertising                                           |       | 25,437                                     |       | 15,108                                              |       | 67,655 |   | 43,440 |   |
| Total revenues                                        |       | 129,636                                    |       | 132,778                                             |       | 391,868 |   | 394,829 |   |
| Operating expenses:                                   |       |                                       |       |                                                |       |   |   |   |   |
| Cost of revenues                                      |       | 29,046                                     |       | 27,233                                              |       | 90,082 |   | 82,431 |   |
| Sales and marketing                                   |       | 43,487                                     |       | 52,767                                              |       | 133,043 |   | 160,653 |   |
| Product development                                   |       | 13,501                                     |       | 10,116                                              |       | 39,702 |   | 28,780 |   |
| General and administrative                            |       | 17,504                                     |       | 14,776                                              |       | 51,172 |   | 41,603 |   |
| Amortization of intangible assets                     |       | 4,213                                      |       | 5,252                                               |       | 13,154 |   | 16,884 |   |
| Total operating expenses                              |       | 107,751                                    |       | 110,144                                             |       | 327,153 |   | 330,351 |   |
| Operating income                                      |       | 21,885                                     |       | 22,634                                              |       | 64,715 |   | 64,478 |   |
| Interest and  other income, net                       |       | 1,457                                      |       | 1,675                                               |       | 4,527 |   | 4,684 |   |
| Interest expense                                      |       | (199                                       | )          | (1,388                                              | )          | (2,326 | ) | (4,745 | ) |
| Income before  income taxes                           |       | 23,143                                     |       | 22,921                                              |       | 66,916 |   | 64,417 |   |
| Provision for  income taxes                           |       | 9,707                                      |       | 10,327                                              |       | 30,244 |   | 29,664 |   |
| Income before  cumulative effect of accounting change |       | 13,436                                     |       | 12,594                                              |       | 36,672 |   | 34,753 |   |
| Cumulative effect  of accounting change, net of tax   |       | —                                     |       | —                                              |       | 1,041 |   | — |   |
| Net income                                            |       | $                                          | 13,436     |                                                | $          | 12,594 |   | $ | 37,713 |   | $ | 34,753 |   |

 

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Informationfor our two key segments is as follows:

| ** **                      | ** ** | **Communications**                         | ** ** | **Content & Media**          | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **Quarter Ended  September 30,** | ** ** | **Quarter Ended  September 30,** | ** ** |
| ** **                      | ** ** | **2006**                                   | ** ** | **2005**                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| Billable services               |       | $                                          | 82,057     |                                       | $          | 99,269 |   | $ | 22,142 |   | $ | 18,401 |   |
| Advertising                     |       | 10,096                                     |       | 9,064                                      |       | 15,341 |   | 6,044 |   |
| Total revenues                  |       | 92,153                                     |       | 108,333                                    |       | 37,483 |   | 24,445 |   |
| Operating  expenses:            |       |                                       |       |                                       |       |   |   |   |   |
| Cost of revenues                |       | 18,875                                     |       | 22,038                                     |       | 7,523 |   | 3,019 |   |
| Sales and marketing             |       | 25,493                                     |       | 40,001                                     |       | 17,203 |   | 12,420 |   |
| Product development             |       | 7,122                                      |       | 6,913                                      |       | 3,876 |   | 2,155 |   |
| General and administrative      |       | 5,226                                      |       | 4,509                                      |       | 3,894 |   | 2,527 |   |
| Total operating expenses        |       | 56,716                                     |       | 73,461                                     |       | 32,496 |   | 20,121 |   |
| Segment income  from operations |       | $                                          | 35,437     |                                       | $          | 34,872 |   | $ | 4,987 |   | $ | 4,324 |   |

 

| ** **                      | ** ** | **Communications**                                  | ** ** | **Content & Media**                   | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                      | ** ** | **Nine Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
| ** **                      | ** ** | **2006**                                            | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Billable services               |       | $                                                   | 259,877    |                                                | $          | 301,272 |   | $ | 64,336 |   | $ | 50,116 |   |
| Advertising                     |       | 28,866                                              |       | 26,596                                              |       | 38,789 |   | 16,845 |   |
| Total revenues                  |       | 288,743                                             |       | 327,868                                             |       | 103,125 |   | 66,961 |   |
| Operating  expenses:            |       |                                                |       |                                                |       |   |   |   |   |
| Cost of revenues                |       | 63,825                                              |       | 66,589                                              |       | 18,231 |   | 9,441 |   |
| Sales and marketing             |       | 83,944                                              |       | 123,416                                             |       | 46,172 |   | 36,459 |   |
| Product development             |       | 22,343                                              |       | 20,299                                              |       | 9,488 |   | 5,590 |   |
| General and administrative      |       | 14,152                                              |       | 12,570                                              |       | 10,596 |   | 7,899 |   |
| Total operating expenses        |       | 184,264                                             |       | 222,874                                             |       | 84,487 |   | 59,389 |   |
| Segment income  from operations |       | $                                                   | 104,479    |                                                | $          | 104,994 |   | $ | 18,638 |   | $ | 7,572 |   |

 

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):

| ** **                            | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                   | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Segment income from operations:       |       |                                       |       |                                                |       |   |   |   |   |
| Communications                        |       | $                                          | 35,437     |                                                | $          | 34,872 |   | $ | 104,479 |   | $ | 104,994 |   |
| Content & Media              |       | 4,987                                      |       | 4,324                                               |       | 18,638 |   | 7,572 |   |
| Total segment income  from operations |       | 40,424                                     |       | 39,196                                              |       | 123,117 |   | 112,566 |   |
| Corporate expenses                    |       | (4,285                                     | )          | (4,753                                              | )          | (14,322 | ) | (13,394 | ) |
| Depreciation                          |       | (5,737                                     | )          | (3,720                                              | )          | (15,789 | ) | (10,978 | ) |
| Amortization of  intangible assets    |       | (4,213                                     | )          | (5,252                                              | )          | (13,154 | ) | (16,884 | ) |
| Stock-based compensation              |       | (4,304                                     | )          | (2,837                                              | )          | (15,137 | ) | (6,832 | ) |
| Consolidated operating income         |       | $                                          | 21,885     |                                                | $          | 22,634 |   | $ | 64,715 |   | $ | 64,478 |   |

 

Segment income from operations for the quarter andnine months ended September 30, 2006 includes restructuring charges ofapproximately $0.6 million.

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**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 $13.5 million, or 11%, to $104.2million for the quarter ended September 30, 2006, compared to $117.7million for the quarter ended September 30, 2005. Consolidated billableservices revenues decreased by $27.2 million, or 8%, to $324.2 million forthe nine months ended September 30, 2006, compared to $351.4 millionfor the nine months ended September 30, 2005. The decrease in billableservices revenues was due to a decrease in billable services revenues from ourCommunications segment, partially offset by an increase in revenues from ourContent & Media segment. Billable services revenues from our Communicationssegment and from our Content & Media segment constituted 78.8% and21.2%, respectively, of our consolidated billable services revenues for thequarter ended September 30, 2006, compared to 84.4% and 15.6%,respectively, for the quarter ended September 30, 2005. Billable servicesrevenues from our Communications segment and from our Content & Mediasegment constituted 80.2% and 19.8%, respectively, of our consolidated billableservices revenues for the nine months ended September 30, 2006, comparedto 85.7% and 14.3%, respectively, for the nine months ended September 30,2005. We anticipate that the decline in our consolidated billable servicesrevenues will continue as a result of expected continued declines inCommunications billable services revenues.

*CommunicationsBillable Services Revenues.***  **Communicationsbillable services revenues consist of fees charged to pay accounts for access,email, Internet security, antivirus and VoIP services, with substantially allgenerated from access. Communications billable services revenues decreased by$17.2 million, or 17%, to $82.1 million for the quarter ended September 30,2006, compared to $99.3 million for the quarter ended September 30,2005. Communications billable services revenues decreased by $41.4 million, or14%, to $259.9 million for the nine months ended September 30, 2006,compared to $301.3 million for the nine months ended September 30, 2005.The decrease in billable services revenues was due to a 15% decrease in ouraverage number of pay accounts from 3,322,000 for the quarter ended September 30,2005 to 2,817,000 for the quarter ended September 30, 2006 and a 10%decrease in our average number of pay accounts from 3,293,000 for the ninemonths ended September 30, 2005 to 2,958,000 for the nine months ended September 30,2006. These decreases are attributable to a decreased number of pay accessaccounts. Additionally, Communications billable services revenues decreased dueto a 3% decrease in ARPU from $9.96 for the quarter ended September 30,2005 to $9.71 for the quarter ended September 30, 2006 and a 4% decreasein ARPU from $10.17 for the nine months ended September 30, 2005 to $9.76for the nine months ended September 30, 2006. The decrease in ARPU isprimarily attributable to a decline in ARPU for our access services due toincreased use of free months of service and promotional pricing to obtain orretain pay access accounts. We anticipate that the average number ofCommunications pay accounts will continue to decline due to decreases in payaccess accounts. We also may experience further declines in ARPU primarily as aresult of discounted prices for extended 

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service commitments on ouraccess services, including providing our $14.95 accelerated access services at$9.95 for a one-year commitment. As a result of these factors, the rate of declinein Communications billable services revenues has been increasing and maycontinue to increase, at least in the near term.

*Content & Media Billable Services Revenues.***  **Content & Media billable services revenuesconsist of fees charged to pay accounts for social-networking, Web-hosting andonline photo-sharing services, with substantially all generated fromsocial-networking. Content & Media billable services revenues increasedby $3.7 million, or 20%, to $22.1 million for the quarter ended September 30,2006, compared to $18.4 million for the quarter ended September 30,2005. The increase in Content & Media billable services revenues wasdue to a 25% increase in our average number of pay accounts from 1,714,000 forthe quarter ended September 30, 2005 to 2,137,000 for the quarter ended September 30,2006. Substantially all of this increase was associated with growth in oursocial-networking pay accounts primarily as a result of organic growth and, toa lesser extent, the acquisition of pay accounts associated with the NamesDatabase business in March 2006, which had approximately 58,000 payaccounts at the time of the acquisition. Billable services revenues from otherContent & Media services increased slightly for the quarter ended September 30,2006 compared to the quarter ended September 30, 2005. These increaseswere partially offset by 3% decrease in ARPU from $3.58 for the quarter ended September 30,2005 to $3.45 for the quarter ended September 30, 2006. The decrease inARPU is primarily attributable to decreases in ARPU for our Web-hosting andonline photo-sharing services, partially offset by an increase in ARPU for oursocial-networking services due to a greater percentage of those pay accountsrepresented by higher-priced, shorter-term pay service plans. At least for the December 2006quarter, we expect Content and Media billable services revenues to growmodestly as compared to the September 2006 quarter.

Content & Mediabillable services revenues increased by $14.2 million, or 28%, to$64.3 million for the nine months ended September 30, 2006, comparedto $50.1 million for the nine months ended September 30, 2005. Theincrease in Content & Media billable services revenues was due to a22% increase in our average number of pay accounts from 1,640,000 for the ninemonths ended September 30, 2005 to 2,002,000 for the nine months ended September 30,2006. Substantially all of this increase was associated with growth in oursocial-networking pay accounts primarily as a result of organic growth and, toa lesser extent, the acquisition of pay accounts associated with the NamesDatabase business in March 2006, which had approximately 58,000 payaccounts at the time of the acquisition. Billable services revenues from otherContent & Media services increased slightly for the nine months ended September 30,2006 compared to the nine months ended September 30, 2005. In addition,ARPU increased by 5% from $3.40 for the nine months ended September 30,2005 to $3.57 for the nine months ended September 30, 2006 primarily dueto an increase in ARPU for our social-networking services due to a greaterpercentage of those pay accounts represented by higher-priced, shorter-term payservice plans, partially offset by decreases in ARPU for our Web-hosting andonline photo-sharing services.

*AdvertisingRevenues*

We connect advertisers to consumers through a varietyof online marketing initiatives integrated throughout our services and Web properties,including advertising and search placements, email campaigns and userregistration placements. In addition, we offer advertisers sophisticated marketresearch capabilities. Factors impacting our advertising revenues generallyinclude changes in orders from significant customers, the performance of ouronline marketing initiatives, the state of the online search and advertisingmarkets, seasonality, increases or decreases in our active accounts, andincreases or decreases in advertising inventory available for sale.

*ConsolidatedAdvertising Revenues.*   Consolidatedadvertising revenues increased by $10.3 million, or 68%, to $25.4 million forthe quarter ended September 30, 2006, compared to $15.1 million for thequarter ended September 30, 2005. Consolidated advertising revenuesincreased by $24.2 million, or 56%, to $67.7 million for the nine months ended September 30,2006, compared to $43.4 million for the nine months 

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ended September 30,2005. The increase was primarily attributable to increases in advertisingrevenues in our Content & Media segment and, to a lesser extent, ourCommunications segment. Advertising revenues from our Communications segmentand from our Content & Media segment constituted 39.7% and 60.3%,respectively, of our consolidated advertising revenues for the quarter ended September 30,2006, compared to 60.0% and 40.0%, respectively, for the quarter ended September 30,2005. Advertising revenues from our Communications segment and from our Content &Media segment constituted 42.7% and 57.3%, respectively, of our consolidatedadvertising revenues for the nine months ended September 30, 2006,compared to 61.2% and 38.8%, respectively, for the nine months ended September 30,2005. We anticipate that our consolidated advertising revenues will increase inthe December 2006 quarter when compared to the September 2006quarter.

*CommunicationsAdvertising Revenues.*   Communicationsadvertising revenues increased by $1.0 million, or 11%, to$10.1 million for the quarter ended September 30, 2006, from$9.1 million for the quarter ended September 30, 2005. Communicationsadvertising revenues increased by $2.3 million, or 9%, to$28.9 million for the nine months ended September 30, 2006, comparedto $26.6 million for the nine months ended September 30, 2005. Theincreases were primarily attributable to increases in advertising sales anddata revenue, partially offset by decreases in revenue-related search queriesdue to a decline in our active access accounts.

*Content &Media Advertising Revenues.***  **Content &Media advertising revenues increased by $9.3 million, or 154%, to$15.3 million for the quarter ended September 30, 2006, compared to$6.0 million for the quarter ended September 30, 2005. The increasewas due to increased advertising revenues as a result of revenues generatedfrom our loyalty marketing service which was acquired in April 2006,partially offset by a decline in advertising revenues generated from oursocial-networking services.

Content & Mediaadvertising revenues increased by $21.9 million, or 130%, to$38.8 million for the nine months ended September 30, 2006, comparedto $16.8 million for the nine months ended September 30, 2005. Theincrease was related to the revenues associated with our loyalty marketingservice which was acquired in April 2006, partially offset by decreases inadvertising revenues generated from our social-networking and Web-hostingservices. It is anticipated that Content & Media advertising revenueswill increase in the December 2006 quarter when compared to the September 2006quarter primarily as a result of our loyalty marketing service which we believewill experiences positive seasonality in the December quarter and to alesser extent from increased advertising revenues from our social-networkingservices.

**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 awards to members of ourloyalty marketing programs. 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 the acquisition of our loyalty marketing service, these costs havebecome more variable and have increased significantly as a percentage ofrevenues.

*ConsolidatedCost of Revenues.*   Consolidatedcost of revenues increased by $1.8 million, or 7%, to $29.0 millionfor the quarter ended September 30, 2006, compared to $27.2 millionfor the quarter ended September 30, 2005. The increase was primarily dueto increased costs associated with our Content & 

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Media segment as well as a$0.3 million increase in depreciation and a $0.1 million increase instock-based compensation in connection with the adoption of Statement ofFinancial Accounting Standards (“SFAS”) No. 123R in the March 2006quarter. Cost of revenues for our Communications segment and for our Content &Media segment constituted 71.5% and 28.5%, respectively, of our total segmentcost of revenues for the quarter ended September 30, 2006, compared to88.0% and 12.0%, respectively, for the quarter ended September 30, 2005.

Consolidated cost of revenues increased by $7.6 million,or 9%, to $90.1 million for the nine months ended September 30, 2006,compared to $82.4 million for the nine months ended September 30,2005. The increase was primarily due to increased costs associated with ourContent & Media segment, as well as a $1.1 million increase indepreciation and a $0.5 million increase in stock-based compensation inconnection with the adoption of SFAS No. 123R in the March 2006quarter partially offset by decreased costs associated with our Communicationssegment. Cost of revenues for our Communications segment and for our Content &Media segment constituted 77.8% and 22.2%, respectively, of our total segmentcost of revenues for the nine months ended September 30, 2006, compared to87.6% and 12.4%, respectively, for the nine months ended September 30,2005.

*CommunicationsCost of Revenues.*   Communicationscost of revenues decreased by $3.2 million, or 14%, to $18.9 millionfor the quarter ended September 30, 2006, compared to $22.0 millionfor the quarter ended September 30, 2005. The decrease was primarily dueto a $3.5 million decrease in telecommunications costs and a$0.8 million decrease in customer support and billing-related costs as aresult of a decrease in the number of pay accounts. These decreases werepartially offset by $1.0 million in costs associated with our VoIP service.As a percentage of Communications revenues, Communications cost of revenuesincreased to 20.5% in the quarter ended September 30, 2006, compared to20.3% in the quarter ended September 30, 2005, primarily as a result ofVoIP cost of revenues exceeding VoIP revenues.

Communications cost of revenues decreased by$2.8 million, or 4%, to $63.8 million for the nine months ended September 30,2006, compared to $66.6 million for the nine months ended September 30,2005. The decrease was primarily due to a $5.9 million decrease intelecommunications costs and a $2.4 million decrease in customer supportand billing-related costs as a result of a decrease in the number of payaccounts. These decreases were partially offset by $3.4 million in costsassociated with our VoIP service and a $2.0 million increase in networkpersonnel and overhead-related costs. Telecommunications costs decreased as aresult of a decrease in the average number of pay accounts and a decrease inaverage hourly telecommunications costs. Additionally, average monthly usageper pay access account decreased slightly in the quarter ended September 30,2006 compared to the quarter ended September 30, 2005 and increasedslightly in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005. As a percentage of Communicationsrevenues, Communications cost of revenues increased to 22.1% in the nine monthsended September 30, 2006, compared to 20.3% in the nine months ended September 30,2005, primarily as a result of VoIP cost of revenues exceeding VoIP revenues.We anticipate that Communications cost of revenues as a percentage ofCommunications revenues will decrease in the near term as a result ofanticipated savings on telecommunications and customer support costs.

*Content &Media Cost of Revenues.***  **Content &Media cost of revenues increased by $4.5 million, or 149%, to$7.5 million for the quarter ended September 30, 2006, compared to$3.0 million for the quarter ended September 30, 2005. Content &Media cost of revenues increased by $8.8 million, or 93%, to $18.2 millionfor the nine months ended September 30, 2006, compared to$9.4 million for the nine months ended September 30, 2005. Theincrease was primarily related to costs associated with our loyalty marketingservice which was acquired in April 2006, and to a lesser extent,increased costs associated with our social-networking services. As a percentageof Content & Media revenues, Content & Media cost of revenuesincreased to 20.1% in the quarter ended September 30, 2006, compared to12.4% in the quarter 

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ended September 30,2005 due to loyalty marketing cost of revenues comprising a larger percentageof revenues than our other Content & Media properties. As a percentageof Content & Media revenues, Content & Media cost of revenuesincreased to 17.7% in the nine months ended September 30, 2006, comparedto 14.1% in the nine months ended September 30, 2005 due to loyaltymarketing cost of revenues comprising a larger percentage of revenues than ourother Content & Media properties.

We anticipate that Content &Media cost of revenues as a percentage of Content & Media revenueswill increase as a result of the loyalty marketing acquisition and may varysignificantly from quarter-to-quarter depending on increases or decreases inadvertising revenue, which can be impacted 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. Sales expensesare expensed in the period incurred or, in the case of commissions paid tosales personnel, when the associated advertising revenue is recognized.

*ConsolidatedSales and Marketing Expenses.*   Consolidatedsales and marketing expenses decreased by $9.3 million, or 18%, to$43.5 million for the quarter ended September 30, 2006, compared to$52.8 million for the quarter ended September 30, 2005. The decreaseis 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$0.4 million increase in stock-based compensation in connection with theadoption of SFAS No. 123R in the March 2006 quarter. Sales and marketingexpenses related to our Communications segment and our Content & Mediasegment constituted 59.7% and 40.3%, respectively, of total segment sales andmarketing expenses for the quarter ended September 30, 2006 versus 76.3%and 23.7%, respectively, for the quarter ended September 30, 2005.

Consolidated sales and marketing expenses decreased by$27.6 million, or 17%, to $133.0 million for the nine months ended September 30,2006, compared to $160.7 million for the nine months ended September 30,2005. The decrease is primarily attributable to a significant reduction inmarketing expenses related to our Communications segment, partially offset byan increase in marketing expenses related to our Content & Mediasegment and a $2.1 million increase in stock-based compensation inconnection with the adoption of SFAS No. 123R in the March 2006quarter. Sales and marketing expenses related to our Communications segment andour Content & Media segment constituted 64.5% and 35.5%, respectively,of total segment sales and marketing expenses for the nine months ended September 30,2006 versus 77.2% and 22.8%, respectively, for the nine months ended September 30,2005.

*CommunicationsSales and Marketing Expenses.*   Communicationssales and marketing expenses decreased by $14.5 million, or 36%, to$25.5 million for the quarter ended September 30, 2006, compared to$40.0 million for the quarter ended September 30, 2005. This decreaseis attributable to a $16.9 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 $1.3 million increase in VoIP marketing expenses anda $1.1 million increase in personnel and overhead-related expenses. Salesand marketing expenses as a percentage of Communications revenues declined to27.7% in the quarter ended September 30, 2006 from 36.9% in the quarterended September 30, 2005.

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Communications sales and marketing expenses decreasedby $39.5 million, or 32%, to $83.9 million for the nine months ended September 30,2006, compared to $123.4 million for the nine months ended September 30,2005. This decrease is attributable to a $49.7 million decline inadvertising, promotion and distribution costs related to our access services,the majority of which was due to reductions in media and other advertisingcosts. These decreases were partially offset by a $7.8 million increase inVoIP marketing expenses and a $2.4 million increase in personnel andoverhead-related expenses. VoIP marketing expenses included the launch ofPrivatePhone and the expensing of production costs for a VoIP televisioncommercial during the June 2006 quarter. Sales and marketing expenses as apercentage of Communications revenues declined to 29.1% in the nine monthsended September 30, 2006 from 37.6% in the nine months ended September 30,2005.

*Content &Media Sales and Marketing Expenses.*   Content &Media sales and marketing expenses increased by $4.8 million, or 39%, to$17.2 million for the quarter ended September 30, 2006, compared to$12.4 million for the quarter ended September 30, 2005. The increasewas the result of an increase in costs associated with our loyalty marketingservice which was acquired in April 2006, a $0.5 million increase inpersonnel and overhead-related expenses and a $0.2 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 distribution arrangements. As a result of the rate ofgrowth in Content & Media revenues, sales and marketing expenses as apercentage of Content & Media revenues declined to 45.9% in thequarter ended September 30, 2006 from 50.8% in the quarter ended September 30,2005.

Content & Mediasales and marketing expenses increased by $9.7 million, or 27%, to$46.2 million for the nine months ended September 30, 2006, comparedto $36.5 million for the nine months ended September 30, 2005. Theincrease was the result of an increase in costs associated with the acquisitionof our loyalty marketing service and a $2.6 million increase in personneland overhead-related expenses. These increases were partially offset by a$1.0 million decrease in marketing, promotion and distribution costsrelated to acquiring and retaining accounts, particularly Web hosting accounts.The vast majority of non-personnel Content & Media marketing expensesis associated with performance-based distribution arrangements. As a result ofthe rate of growth in Content & Media revenues, sales and marketingexpenses as a percentage of Content & Media revenues declined to 44.8%in the nine months ended September 30, 2006 from 54.4% in the nine monthsended September 30, 2005.

**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 incurred, except for certain costs relatingto the acquisition and development of internal-use software, which arecapitalized and depreciated over their estimated useful lives, generally threeyears or less.

*ConsolidatedProduct Development Expenses.*   Consolidatedproduct development expenses increased by $3.4 million, or 33%, to$13.5 million for the quarter ended September 30, 2006, compared to$10.1 million for the quarter ended September 30, 2005. The increasewas attributable to increases in expenses in the Content & Mediasegment and, to a lesser extent, increases in expenses in the Communicationssegment, as well as a $0.8 million increase in stock-based compensation inconnection with the adoption of SFAS No. 123R in the March 2006quarter and a $0.6 million increase in depreciation. Product developmentexpenses related to our Communications segment and our Content & Mediasegment constituted 64.8% and 35.2%, respectively, of total segment productdevelopment expenses for the quarter ended September 30, 2006, compared to76.2% and 23.8%, respectively, for the quarter ended September 30, 2005.

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Consolidated product development expenses increased by$10.9 million, or 38%, to $39.7 million for the nine months ended September 30,2006, compared to $28.8 million for the nine months ended September 30,2005. The increase was attributable to increases in expenses in theCommunications and Content & Media segments, a $3.5 millionincrease in stock-based compensation in connection with the adoption of SFAS No. 123Rin the March 2006 quarter and a $1.5 million increase indepreciation. Product development expenses related to our Communicationssegment and our Content & Media segment constituted 70.2% and 29.8%,respectively, of total segment product development expenses for the nine monthsended September 30, 2006, compared to 78.4% and 21.6%, respectively, forthe nine months ended September 30, 2005.

*CommunicationsProduct Development Expenses.***  **Communicationsproduct development expenses increased by $0.2 million, or 3%, to$7.1 million for the quarter ended September 30, 2006, compared to$6.9 million for the quarter ended September 30, 2005. The increasewas the result of $0.3 million in restructuring charges recorded in the September 2006quarter for severance costs associated with the relocation of our New Yorkoffice to New Jersey, partially offset by a $0.1 million decrease inoverhead-related costs. Capitalized compensation costs were $1.9 millionand $1.5 million in the quarters ended September 30, 2006 and 2005,respectively. The increase in capitalized compensation costs was due toprojects associated with an upgrade to our customer billing system, projectsadding new features and functionality to our VoIP products and the preparationof our software for the anticipated release of Microsoft’s newest operatingsystem. The increase was partially offset by capitalized compensation costs inthe September 2005 quarter related to the development of our VoIP service.

Communications product development expenses increasedby $2.0 million, or 10%, to $22.3 million for the nine months ended September 30,2006, compared to $20.3 million for the nine months ended September 30,2005. The increase was the result of a $1.3 million increase incompensation costs, a $0.4 million increase in overhead-related costs and$0.3 million in restructuring charges recorded in the September 2006quarter. Capitalized compensation costs were $5.9 million and$3.6 million in the nine months ended September 30, 2006 and 2005,respectively. The increase in capitalized compensation costs was due to anincrease in projects associated with an upgrade to our customer billing system;the preparation of our software for the anticipated release of Microsoft’snewest operating system; and projects adding new features and functionality toour VoIP products. The increase was partially offset by capitalizedcompensation costs in the nine months ended September 30, 2005 related toour enhanced accelerator service and costs associated with the development ofour VoIP service.

*Content &Media Product Development Expenses.***  **Content & Media product development expensesincreased by $1.7 million, or 80%, to $3.9 million for the quarterended September 30, 2006, compared to $2.2 million for the quarterended September 30, 2005. The increase was primarily due to a$1.6 million increase in personnel-related expenses due to increasedheadcount related to our social-networking service and increased headcountassociated with the acquisition, in April 2006, of our loyalty marketingservice.

Content & Mediaproduct development expenses increased by $3.9 million, or 70%, to$9.5 million for the nine months ended September 30, 2006, comparedto $5.6 million for the nine months ended September 30, 2005. Theincrease was primarily due to a $3.8 million increase in personnel-relatedexpenses due to increased headcount related to our social-networking andloyalty marketing services.

**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.

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*ConsolidatedGeneral and Administrative Expenses.***  **Consolidated general and administrative expensesincreased by $2.7 million, or 18%, to $17.5 million for the quarterended September 30, 2006, compared to $14.8 million for the quarterended September 30, 2005. The increase was due to increases in theCommunications and Content & Media segments and unallocated corporateexpenses, a $1.0 million increase in depreciation and a $0.1 millionincrease in stock-based compensation in connection with the adoption of SFAS No. 123Rin the March 2006 quarter. General and administrative expenses related toour Communications segment and our Content & Media segment constituted57.3% and 42.7%, respectively, of total segment general and administrativeexpenses for the quarter ended September 30, 2006, compared to 64.1% and35.9%, respectively, for the quarter ended September 30, 2005.

Consolidated general and administrative expensesincreased by $9.6 million, or 23%, to $51.2 million for the ninemonths ended September 30, 2006, compared to $41.6 million for thenine months ended September 30, 2005. The increase was due to increases inthe Communications and Content & Media segments and unallocatedcorporate expenses, a $2.2 million increase in depreciation and a$2.1 million increase in stock-based compensation in connection with theadoption of SFAS No. 123R in the March 2006 quarter. General andadministrative expenses related to our Communications segment and our Content &Media segment constituted 57.2% and 42.8%, respectively, of total segmentgeneral and administrative expenses for the nine months ended September 30,2006, compared to 61.4% and 38.6%, respectively, for the nine months ended September 30,2005.

*CommunicationsGeneral and Administrative Expenses.*   Communicationsgeneral and administrative expenses increased by $0.7 million, or 16%, to $5.2million for the quarter ended September 30, 2006, compared to $4.5 millionfor the quarter ended September 30, 2005. The increase was due to a$0.5 million increase in compensation costs, a $0.4 million increasein consulting fees and $0.2 million in restructuring charges recorded inthe September 2006 quarter for severance and move costs associated withthe relocation of our New York office to New Jersey. These increases werepartially offset by a $0.2 million decrease in recruiting and relocation expenses.

Communications general and administrative expensesincreased by $1.6 million, or 13%, to $14.2 million for the ninemonths ended September 30, 2006, compared to $12.6 million for thenine months ended September 30, 2005. The increase was due to a $1.6 millionincrease in compensation costs, a $0.2 million increase in facilities and otheroverhead-related costs and $0.2 million in restructuring charges recorded inthe September 2006 quarter, partially offset by a $0.4 milliondecrease in recruiting and relocation expenses.

*Content &Media General and Administrative Expenses.***  **Content & Media general and administrativeexpenses increased by $1.4 million, or 54%, to $3.9 million for thequarter ended September 30, 2006, compared to $2.5 million for thequarter ended September 30, 2005. The increase was primarily due toincreases in compensation costs, facilities and other overhead-related costsrelated to our loyalty marketing service which was acquired in April 2006.

Content & Media general and administrativeexpenses increased by $2.7 million, or 34%, to $10.6 million for thenine months ended September 30, 2006, compared to $7.9 million forthe nine months ended September 30, 2005. The increase was primarily dueto increases in compensation costs, facilities and other overhead-related costsrelated to our loyalty marketing service which was acquired in April 2006,partially offset by a decrease in compensation costs associated with oursocial-networking service and a slight increase in consulting fees.

*UnallocatedCorporate Expenses.***  **Excludingstock-based compensation and depreciation,****unallocatedcorporate general and administrative expenses decreased by $0.5 million,or 10%, to $4.3 million for the quarter ended September 30, 2006,compared to $4.8 million for the quarter ended September 30, 2005.The decrease was primarily due to decreased compensation costs and consultingfees.

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Unallocated corporategeneral and administrative expenses increased by $0.9 million, or 7%, to$14.3 million for the nine months ended September 30, 2006, comparedto $13.4 million for the nine months ended September 30, 2005. Theincrease was primarily due to an increase in legal reserves and increasedconsulting 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 more likely than not reduce the fair value of a reporting unit below itscarrying value amount.

Consolidated amortizationof intangible assets decreased by $1.0 million, or 20%, to$4.2 million for the quarter ended September 30, 2006, compared to$5.3 million for the quarter ended September 30, 2005. Consolidatedamortization of intangible assets decreased by $3.7 million, or 22%, to$13.2 million for the nine months ended September 30, 2006, comparedto $16.9 million for the nine months ended September 30, 2005. Thedecreases were primarily attributable to the accelerated amortization ofcertain intangible assets in the March 2005 quarter, partially offset byincreased amortization related to intangible assets acquired in connection withthe acquisitions of The Names Database in the March 2006 quarter andMyPoints in the June 2006 quarter.

**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$0.2 million, or 13%, to $1.5 million for the quarter endedSeptember 30, 2006, compared to $1.7 million for the quarter endedSeptember 30, 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 quarters ended September 30, 2006 and 2005.

Interest and other income,net decreased by $0.2 million, or 3%, to $4.5 million for the ninemonths ended September 30, 2006, compared to $4.7 million for thenine months ended September 30, 2005 as a result of lower average balanceson our cash and cash equivalents and short-term investments, partially offsetby higher yields in our investment portfolio. Net realized gains on ourshort-term investments were not significant for the nine months ended September 30,2006 and 2005.

**Interest Expense**

Interest expense consists of interest expense on ourterm loan, capital leases, the amortization of premiums on certain of ourshort-term investments and imputed interest on the acquired member retentionliability.

Interest expense decreased by $1.2 million, or86%, to $0.2 million for the quarter ended September 30, 2006,compared to $1.4 million for the quarter ended September 30, 2005.The decrease was primarily the result of decreases in interest expense andamortized deferred financing costs related to the term loan, which was repaidin full in January 2006.

Interest expense decreasedby $2.4 million, or 51%, to $2.3 million for the nine months ended September 30,2006, compared to $4.7 million for the nine months ended September 30,2005. The 

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decreasewas primarily the result of decreases in interest expense and amortizeddeferred financing costs related to the term loan. In January 2006, werepaid the remaining balance of $54.2 million on the term loan andexpensed the remaining $1.5 million in deferred financing costs. Thedecrease was partially offset by a $0.3 million increase in imputedinterest on the acquired member retention liability.

**Provision forIncome Taxes**

For the quarter and ninemonths ended September 30, 2006, we recorded a tax provision of$9.7 million and $30.2 million, respectively, on pre-tax income of$23.1 million and $66.9 million, respectively, resulting in ayear-to-date effective tax rate of 45.2%. For the quarter and nine months endedSeptember 30, 2005, we recorded a tax provision of $10.3 million and$29.7 million, respectively, on pre-tax income of $22.9 million and$64.4 million, respectively, resulting in a year-to-date effective taxrate of 46.0%. The effective tax rates differ from the statutory rate primarilydue to compensation, including (1) stock-based compensation that waslimited under Section 162(m) of the Internal Revenue Code, (2) foreignlosses, the benefit of which is not currently recognizable due to uncertaintyregarding realization and (3) the re-measurement of certain deferred taxassets in New York. Additionally, in 2006, the annualized effective rate wasincreased due to Employee Stock Purchase Plan compensation, the benefit ofwhich is not currently recognized under SFAS No. 123R. This increase wascompletely offset by the benefit of federal exempt interest income.

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

In the nine months ended September 30,2006, we recorded a $1.1 million pretax benefit ($1.0 million, net oftax), as the cumulative effect of a change in accounting principle upon theadoption of SFAS No. 123R to recognize the effect of estimating the numberof awards granted prior to January 1, 2006 that are not ultimatelyexpected to vest.

**Liquidity andCapital Resources**

Ourtotal cash, cash equivalent and short-term investment balances decreased by$89.7 million, or 37%, to $154.7 million at September 30, 2006,compared to $244.4 million at December 31, 2005. Our summary cashflows for the nine months ended September 30, 2006 and 2005 were asfollows (in thousands):

| ** **                                 | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Net cash provided  by operating activities |       | $                                                   | 78,610     |   | $ | 114,276 |   |
| Net cash used for  investing activities    |       | (73,707                                             | )          | (61,786 | ) |
| Net cash used for  financing activities    |       | (83,659                                             | )          | (75,252 | ) |
|                                            |            |                                                     |            |  |  |  |  |

 

Net cash providedby operating activities decreased by $35.7 million, or 31%, for the ninemonths ended September 30, 2006 compared to the nine months ended September 30,2005. The decrease was primarily the result of the following:

·       a $40.4 million netdecrease in working capital accounts, including $38.0 million related toaccounts payable and accrued liabilities primarily related to a $19.1 millionincrease in payments for income taxes, payments for employee bonuses and mediaand promotion expenses and the payment of approximately $6.0 million ofMyPoints acquisition-related liabilities. Additionally, working capitalaccounts were affected by a $6.3 million decrease in deferred revenue as aresult of decreases in pay access accounts, including multi-month accessaccounts, offset partially by an increase in multi-month social-networkingaccounts;

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·       a $9.9 milliondecrease in tax benefits from stock-based compensation, of which$3.4 million was related to the adoption of SFAS No. 123R, whichrequires a portion of the tax benefits from stock-based compensation to bepresented in financing activities versus its historical presentation inoperating activities; and

·       a $3.7 million decrease inamortization of intangible assets due to certain intangible assets related tothe Classmates acquisition that, in order to better match the expense to theexpected cash flows from those assets, are amortized on an accelerated basis.

These decreaseswere partially offset by:

·       an $8.3 millionincrease in stock-based compensation primarily due to the adoption of SFAS No. 123Rin the March 2006 quarter;

·       a $4.8 millionincrease in depreciation due to increased capital expenditures during 2005 and2006;

·       a $1.6 millionincrease in the utilization of deferred taxes;

·       a $1.9 millionincrease in net income, net of a $1.0 million cumulative effect of achange in accounting principle in connection with the adoption of SFAS No. 123R;and

·       a $0.5 millionincrease in amortization of deferred financing fees associated with therepayment of the term loan in January 2006.

Net cash used forinvesting activities increased by $11.9 million, or 19%, for the ninemonths ended September 30, 2006 compared to the nine months ended September 30,2005. The increase was primarily the result of the following:

·       a $52.5 millionincrease in cash paid for acquisitions. We acquired MyPoints in April 2006for $49.5 million, net of cash acquired; and The Names Database in March2006 for $9.5 million, net of cash acquired; and we paid the remaining$1.5 million due in connection with the PhotoSite acquisition in March 2006compared to the initial payment of $8.6 million for PhotoSite in March 2005;

·       a $4.8 million escrowdeposit for the settlement of a pre-acquisition liability in the September 2006quarter; and

·       a $1.5 million increase inrestricted cash.

These increases inuses of cash were partially offset by:

·       a $42.1 million netincrease in proceeds from maturities and sales of short-term investments; and

·       a $5.0 milliondecrease in purchases of rights, patents and trademarks, primarily related tothe purchase of proprietary rights associated with the NetZero trademark 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.

We have invested significantly in our networkinfrastructure, software licenses, leasehold improvements, and computerequipment and we will need to make further significant investments in thefuture. Capital expenditures for the nine months ended September 30, 2006were $16.9 million. We anticipate that our total capital expenditures forthe remainder of 2006 will be in the range of $7 million to $10 million,including anticipated capital expenditures related to our loyalty marketingbusiness acquired in April 2006. The actual amount of future capitalexpenditures may fluctuate due to a number of factors including, without limitation,potential future acquisitions and new business initiatives, which are difficultto predict and could change significantly over time. Additionally,technological advances may require us to make capital expenditures to developor acquire new equipment or technology in order to replace aging ortechnologically obsolete equipment.

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Net cash used forfinancing activities increased by $8.4 million, or 11%, for the ninemonths ended September 30, 2006 compared to the nine months ended September 30,2005. The increase was primarily the result of the following:

·       a $14.5 millionincrease in dividend payments in the nine months ended September 30, 2006compared to the nine months ended September 30, 2005; and

·       a $12.5 millionincrease 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.

The increases inuses of cash were offset by:

·       an $11.8 milliondecrease in repurchases of common stock;

·       a $3.4 millionincrease in excess tax benefits from stock-based compensation as a result ofthe adoption of SFAS No. 123R, which requires a portion of the taxbenefits from stock-based compensation to be presented in financing activitiesversus its historical presentation in operating activities; and

·       a $3.1 millionincrease in proceeds from exercises of stock options and the employee stockpurchase plan.

The payment of dividends will negatively impact cashflows from financing activities. In February 2006, May 2006 and August 2006,our Board of Directors declared quarterly cash dividends of $0.20 per share ofcommon stock, which were paid on February 28, 2006, May 31, 2006 and August 31,2006 and totaled $12.9 million, $13.4 million and $13.5 million,respectively. In November 2006, our Board of Directors declared aquarterly cash dividend of $0.20 per share of common stock. The record date forthe dividend is November 13, 2006, and the dividend is payable on November 30,2006. The payment of future dividends is discretionary and will be subject todetermination by the Board of Directors each quarter following its review ofour financial performance.

Future cash flows from financing activities may alsobe affected by repurchases of common stock. Our Board of Directors authorized acommon stock repurchase program that allows us to repurchase shares of ourcommon stock through open market or privately negotiated transactions based onprevailing market conditions and other factors through December 31, 2006.At September 30, 2006, we had repurchased $139.2 million of ourcommon stock under the program, and the remaining available under the programwas $60.8 million.

Cash flows from financing activities may also benegatively impacted by the withholding of a portion of shares underlying therestricted stock units we award to employees. Upon vesting, we currentlyanticipate that we will not collect the applicable withholding taxes forrestricted stock units from employees. Instead, we will automatically withhold,from the restricted stock units that vest, the portion of those shares with afair market value equal to the amount of the withholding taxes due. We willthen pay the applicable withholding taxes in cash. Similar to repurchases ofcommon stock, the net effect of such withholding will adversely impact our cashflows. The amount remitted in the nine months ended September 30, 2006 was$2.4 million for which we withheld approximately 193,000 shares of common stockthat were underlying the restricted stock units. The amount we pay in futurequarters will vary based on our stock price and the number of restricted stockunits 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 restricted stock units and pay the withholding taxes due on vestedrestricted stock units; and to fund future capital 

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expenditures.We currently anticipate that our future cash flows from operations and existingcash, cash equivalent and short-term investment balances will be sufficient tofund our operations over the next year, and in the near term we do notanticipate the need for additional financing to fund our operations. However,we may raise additional debt or equity capital for a variety of reasonsincluding, without limitation, developing new or enhancing existing services orproducts, repurchasing our common stock, acquiring complementary services,businesses or technologies or funding significant capital expenditures. If weneed to raise additional capital through public or private debt or equityfinancings, strategic relationships or other arrangements, it might not beavailable to us in a timely manner, on acceptable terms, or at all. Our failureto raise sufficient capital when needed could have a material adverse effect onour business, financial position, results of operations and cash flows, andcould impair our ability to pay dividends. If additional funds were raisedthrough the issuance of equity securities, the percentage of stock owned by thethen-current stockholders would be reduced. Furthermore, such equity securitiesmight have rights, preferences or privileges senior to holders of our commonstock.

**FinancialCommitments**

Ourfinancial commitments are as follows at September 30, 2006 (in thousands):

| ** **                        | ** ** | ** ** | ** ** | **Oct-Dec** | ** ** | **Year Ending December 31,** | ** ** |
|-----------------------------------|------------|------------|------------|-------------|------------|---------------------------------------------|------------|
| **Contractual Obligations:** | ** ** | ** ** | ** ** | **Total**   | ** ** | **2006**                                    | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
| Capital leases(1)                 |       | $          | 469        |        |       | $                                           | 104        |   |   | $ | 351 |   | $ | 14 |   | $ | — |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Operating leases                  |       | 41,394     |       |        | 1,854      |                                        |       | 7,042 |   | 6,816 |   | 6,024 |   | 4,663 |   | 4,010 |   |   | 10,985 |   |   |
| Telecommunications  purchases     |       | 14,865     |       |        | 2,870      |                                        |       | 7,495 |   | 4,500 |   | — |   | — |   | — |   |   | — |   |   |
| Media purchases                   |       | 2,137      |       |        | 2,137      |                                        |       | — |   | — |   | — |   | — |   | — |   |   | — |   |   |
| Total                             |       | $          | 58,865     |        |       | $                                           | 6,965      |   |   | $ | 14,888 |   | $ | 11,330 |   | $ | 6,024 |   | $ | 4,663 |   | $ | 4,010 |   |   | $ | 10,985 |   |   |
|                                   |            |            |            |             |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includes$15 of imputed interest.

**Off-Balance SheetArrangements**

At September 30,2006, we had no off-balance sheet arrangements that have, or are reasonablylikely to have, a current or future material effect on our consolidated financialcondition, results of operations, liquidity, capital expenditures or capitalresources.

**Critical AccountingPolicies and Estimates**

*Revenue Recognition*

MyPoints earns revenueprimarily from corporate advertising customers by charging fees for sendingemails to the MyPoints’ members and placing advertising on the MyPoints Website. Under the terms of advertising contracts, MyPoints earns revenueprimarily based on three components: (1) transmission of emailadvertisements to enrolled members, (2) unique clicks on transmittedemails and (3) actual transactions by members over the Internet. Revenueis recognized when email is transmitted to members, when responses are receivedand when members complete online transactions. Each of these activities is adiscrete, independent activity, which generally is specified in the advertisingsales agreement entered into with the customer. As the earning activities takeplace, activity measurement data (e.g., number of emails sent and number ofresponses received) is accumulated and the related revenue is recorded. Revenuefrom the sale of Points to MyPoints’customers is deferred over a 15 monthperiod, which is the expected time that either the Points are redeemed andMyPoints provides an award, 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 

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once thecollection of the cash is no longer in doubt. Also, deferred revenue representsinvoiced services that have not yet been performed.

**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 to priorperiods’ financial statements of changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. When it is impracticable to determine the period-specificeffects of an accounting change on one or more individual prior periodspresented, SFAS No. 154 requires that the new accounting principle beapplied 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. Theprovisions of FIN 48 will be effective for us beginning in the March 2007quarter, with the cumulative effect of the change in accounting principle recordedas an adjustment to opening retained earnings. We are currently evaluating theimpact of adopting FIN 48.

*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 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 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 

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both theiron-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. Theimplementation of SAB No. 108 is not expected to have a material impact onour 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 on ourfinancial position, cash flows, and results of operations.

**ITEM 3.**   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-term investment portfolioconsisting of U.S. commercial paper, U.S. Government or U.S. Government Agencyobligations, municipal obligations, auction rate securities and money marketfunds. Our primary objective is the preservation of principal and liquiditywhile maximizing yield. The minimum long-term rating is A, and if along-term rating is not available, we require a short-term credit ratingof A1 and P1. The value of these investments may fluctuate with changes ininterest rates. However, we believe this risk is immaterial due to therelatively short-term nature of the investments.

We were exposed tointerest rate risk on a portion of the outstanding balance of our term loanthrough the date we repaid the outstanding balance in full, which was January 3,2006.

*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 

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subsidiaries,the foreign currency translation adjustments are reflected as a component ofstockholders’ equity and do not impact operating results. Revenues and expensesin foreign currencies translate into higher or lower revenues and expenses inU.S. dollars as the U.S. dollar weakens or strengthens against othercurrencies. Therefore, changes in exchange rates may negatively affect ourconsolidated revenues and expenses (as expressed in U.S. dollars) from foreignoperations. Currency transaction gains or losses arising from transactions incurrencies other than the functional currency are included in operatingexpenses. While we have not engaged in foreign currency hedging, we may in thefuture use hedging programs, currency forward contracts, currency optionsand/or other derivative financial instruments commonly utilized to reducefinancial market risks if it is determined that such hedging activities areappropriate to reduce risk.

**ITEM 4.**   CONTROLSAND 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.

*Changes in InternalControls Over Financial Reporting*

On April 10, 2006, we completed the acquisitionof MyPoints.com, Inc. We are in the process of integrating MyPoints andwill be conducting an evaluation of internal controls pursuant to theSarbanes-Oxley Act of 2002. Excluding the MyPoints acquisition, there have notbeen any changes in the Company’s internal controls over financial reporting(as such term is defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) during our most recent fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrols over financial reporting.

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**PART II—OTHERINFORMATION**

**ITEM 1.   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 and directors of NetZero and the underwriters of NetZero’s initialpublic offering, Goldman Sachs Group, Inc., BancBoston Robertson Stephens, Inc.and Salomon Smith Barney, Inc. The complaint alleges that the prospectusthrough which NetZero conducted its initial public offering in September 1999was materially false and misleading because it failed to disclose, among otherthings, that (i) the underwriters had solicited and received excessive andundisclosed commissions from certain investors in exchange for which theunderwriters allocated to those investors material portions of the restrictednumber of NetZero shares issued in connection with the offering; and (ii) theunderwriters had entered into agreements with customers whereby the underwritersagreed to allocate NetZero shares to those customers in the offering inexchange for which the customers agreed to purchase additional NetZero sharesin the aftermarket at pre-determined prices. Plaintiffs are seeking injunctiverelief and 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. In a court order dated February 15, 2005, the DistrictCourt granted preliminary approval of the issuer defendants’ proposedsettlement. On June 30, 2005, the United States Court of Appeals for theSecond Circuit granted the underwriter defendants’ petition for permission toappeal the District Court’s order granting plaintiffs’ motion for classcertification. A hearing on the settlement was held on April 24, 2006, andthe parties are awaiting the court’s ruling on the motion for final approval ofthe settlement.

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 April 25,2003, Juno, the Committee of Unsecured Creditors, WorldCom and UUNET (allegedlythe largest secured creditor) entered into a Stipulation of Settlement, whichprovided for the payment by Juno of $5.5 million in final settlement ofall claims against Juno, and we have reserved $5.5 million in connectionwith this proceeding. On September 11, 2003, the court issued an orderapproving the Stipulation of Settlement. On September 12, 2005, the SecondCircuit Court of Appeals vacated the judgment of the bankruptcy court andremanded the case to the bankruptcy court. Discovery in the adversaryproceeding in the bankruptcy court is proceeding. On August 4, 2006, weentered into a settlement agreement with the Committee of Unsecured Creditorsproviding for the settlement of all claims against Juno pursuant to a proposedplan of liquidation of Debtor. If the settlement and plan of liquidation areapproved by the bankruptcy court, subject to certain conditions, Juno hasagreed to pay $6.25 million. If the settlement and plan of liquidation areapproved by the bankruptcy court and not appealed, Juno has agreed to pay anadditional $0.25 million. A hearing to confirm the proposed plan of liquidationhas been scheduled for December 21, 2006.

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, 

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EarthLink, Inc., SBCCommunications, Inc., and Verizon Communications, Inc. alleginginfringement of plaintiff’s patent which purports to cover user access to acomputer network. Plaintiff is seeking injunctive and declaratory relief anddamages. On October 28, 2005, the court issued an order grantingdefendants’ motions for summary judgment of non-infringement of the patent.MyMail has filed a notice of appeal of the trial court’s ruling. Oral argumentof the appeal is scheduled for December 6, 2006.

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 injunctive and declaratory relief and damages.NetZero has filed a response to the lawsuit denying the material allegations ofthe complaint.

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. We have a reserve of $6.25 million for the Freewwwebmatter discussed above and such reserve is reflected in our consolidatedfinancial statements. We cannot assure you, however, that this reserve will besufficient to cover the possible losses from such litigation. We have notestablished reserves for any other matters.

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, financialcondition, results of operations or cash flows.

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**ITEM 1A.   RISKFACTORS**

*Beforedeciding to invest in our company or to maintain or increase your investment,you should carefully consider the risks described below as well as the otherinformation in this report and our other filings with the SEC. The risks anduncertainties described below are not the only ones facing our company.Additional risks and uncertainties not presently known to us or that wecurrently deem immaterial may also affect us. If any of these risks actuallymaterialize, our business, financial position, results of operations and cashflows could be adversely impacted. In that event, the market price of ourcommon stock could decline and you may lose all or part of your investment.*

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

*Internet AccessCompetition*

Competition in the Internet access market is intense.We compete with established online service and content providers such as AOL,AOL’s Netscape subsidiary and MSN; independent national ISPs such as EarthLinkand its PeoplePC subsidiary; companies combining their resources to offerInternet access in conjunction with other services such as Yahoo! and AT&TInternet Services, Yahoo! and Verizon, and AOL and Walmart.com; nationalcommunications companies and local exchange carriers such as AT&T WorldNet,Qwest Communications International, Inc. and Verizon; cable companies suchas Comcast Corporation, Cox Communications, Inc., Charter Communications, Inc.and Adelphia Communications Corporation; local telephone companies; andregional and local commercial ISPs. Also, a number of municipalities haveannounced their intention to make available wireless broadband access servicesto their communities free of charge or for discounted fees, and significantcompanies, including Google, are bidding to provide some or all of theseservices. While this form of competition is new and its potential impact iscurrently unknown, the availability of free or inexpensive wireless broadbandservices in major metropolitan markets could have a significant impact upon theindustry and our Communications segment.

The number of U.S. households using broadband hasgrown significantly and the rate of broadband adoption has been increasing andmay continue to increase. Broadband access, which includes cable, DSL,satellite and wireless, generally offers users faster connection and downloadspeeds than dial-up access for monthly fees currently ranging fromapproximately $13 to $55 per month, although offers for promotional periodshave been as low as $10 per month. Pricing for broadband services, particularlyfor introductory promotional periods, services bundled with cable and telephoneservices, and services with slower speeds, has been declining and the pricinggap between broadband and dial-up access services has been narrowing with, insome cases, premium and value dial-up access services priced at or abovepricing for certain broadband services. For example, Verizon Yahoo! currentlyoffers DSL at $14.95 per month to new customers who agree to a one-yearcommitment, and AT&T Yahoo! currently offers DSL at $14.99 per month to newcustomers. As a result of broadband adoption, the total number of dial-upaccounts in the U.S. has declined at an increasing rate and industry analystspredict that it will continue to decline at an increasing rate. The decline inthe size of the dial-up market will likely continue to accelerate as broadbandservices become more widely available at lower prices and consumer adoption ofbroadband applications, such as online video, telephony and music downloads,which depend upon connections that provide significant bandwidth, increases. Ifwe do not offer broadband services, it will continue to adversely impact ourability to compete for new subscribers and to retain existing subscribers.

We recently announced our intention to offer broadbandservices by purchasing and reselling broadband services acquired through thirdparty providers. The providers from whom we would purchase such services areeither our direct competitors or acquire their services from our competitors,and we currently only have an agreement with Verizon and their service onlycovers a portion of the U.S. There is no assurance that we will be successfulin entering into the agreements necessary to offer broadband services on asignificant scale, that we will be able to maintain such agreements or that thepricing under 

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such agreements willenable us to profitably resell the services. Most of the largest providers ofbroadband services, such as cable and telecommunications companies, controltheir own networks and offer a wider variety of services than we offer,including phone services and content. Their ability to bundle services and tooffer broadband services at prices below the price that we can profitably offercomparable services puts us at a competitive disadvantage. Decreases in retailbroadband pricing as a result of competition would adversely impact our abilityto offer such services profitably or at a competitive price.

The success of our Communications segment historicallyhas been based on offering dial-up Internet access services at prices below thestandard monthly pricing of the premium dial-up services of most of our majorcompetitors. Competition from broadband providers and value-pricedproviders such as United Online has resulted in significant declines in thenumber of subscribers to premium priced dial-up services. In response to thiscompetition, many competitors have engaged, and will likely continue to engage,in more aggressive pricing of their dial-up services under their premium-pricedbrands to obtain and retain users, such as offering discounted pricing orextended periods of free service such as six months free. AOL currently offers a$9.95 pricing plan which includes unlimited dial-up access, acceleratorservices and a number of other features. Additionally, AOL, through itsNetscape subsidiary, EarthLink, through its PeoplePC subsidiary, and a numberof small providers now offer value-priced services at prices similar toour prices and which are, in some cases, priced below the prices of ourservices. Partially in response to this competition, we have become moreaggressive in offering discounted services and one or more free months ofservices in order to obtain and retain pay access accounts. Despite thesemeasures, our pay access base has continued to decline. The rate of decline hasaccelerated in prior periods and may accelerate in future periods. We believeincreased competition, including pricing competition from broadband providers,has adversely impacted our ability to obtain new pay access accounts and toretain our existing accounts, will adversely impact our ability to minimize thedecline in our pay access account base in the future and has made it moredifficult to maintain the current pricing of our services.

Price competition is particularly relevant to ourability to maintain our $14.95 standard monthly pricing for our pay accessaccounts bundled with our accelerator services. Maintaining this price point isan important factor in the profitability of our Communications segment. When webegan offering this service in early 2003, many of our competitors either didnot offer a similar accelerator service or charged substantially more than wecharge for a similar service. Accelerator services are now widely available inthe market and many dial-up competitors, including AOL, now offer theiraccelerator services at prices equal to or lower than our standard monthlypricing. In addition, several broadband providers offer promotional pricing forDSL at prices equal to or lower than our standard monthly pricing foraccelerator services, and it is likely that pricing competition from broadbandand dial-up providers will continue to increase. AT&T recently proposedoffering DSL for $10 per month to new customers for a 30-month period inan effort to obtain governmental approval of its proposed merger withBellSouth. If the government were to accept this proposal, it would likely furtherincrease the pricing competition in the broadband and dial-up markets. We havebeen offering our NetZero and Juno dial-up services bundled with acceleratorservice at a $9.95 price point with a 12-month commitment. We have beenalso offering additional features or services without additional charge as partof our accelerated dial-up service, including enhanced email features,antivirus protection, and a VoIP account with 100 free computer-to-telephonedomestic long distance minutes per month, and we may incorporate additionalfeatures or services in the future. Adding additional features increases ourcost of providing the service which makes the service less profitable, althoughthere is no assurance that additional features will make the service more attractiveto consumers or will enable us to maintain its $14.95 standard monthly price.The number of users paying us the standard monthly price for our acceleratedservices and the number of subscribers to these services have been decreasingand it is likely that we will experience decreases in the average price paidfor these bundled services and continued decreases in the number of subscribersto these services in the future, all of which could adversely impact ourrevenues and profits.

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Premium-priced Internet access services, ingeneral, include a much wider variety of features than are included in value-pricedservices, and providers of premium-priced services continue to enhancethe features of their offerings in response to competition from broadband andvalue-priced providers. In particular, many premium-priced servicesinclude at no additional charge telephone technical support, proprietarycontent, parental controls, multiple accounts and email addresses, increasedemail storage, virus protection, firewalls, spyware protection and accelerateddial-up functionality. Some providers of value-priced offerings are alsoincorporating certain of these features into their offerings either at nocharge or for an incremental fee. In addition, certain providers ofpremium-priced services occasionally offer promotional pricing that is similarto the pricing of value-priced offerings. For example, EarthLink currentlyoffers its premium-priced services at $9.95 per month for an introductory periodof six months. AOL’s new $9.95 offering, while not offering all of the featuresof its premium priced $25.90 offering, contains a significant number offeatures that are not always included in value-priced services, and thisdevelopment is likely to make the value-priced services market morecompetitive, both from a feature and a pricing standpoint. While we offer someadditional features to users at no charge or for an incremental fee, we do notoffer the range of features included in premium-priced services and, insome cases including the AOL $9.95 offering, included in value-pricedservices. In particular, we do not offer our own proprietary content. Inaddition, the incremental fees that we charge for certain features are, in somecases, higher than the incremental fee, if any, charged by other value-pricedproviders for comparable features. Our decision not to offer a broader varietyof features and our charges for additional services or features, particularlyaccelerated functionality, virus protection and telephone technical support,may adversely impact our ability to compete and undermine our position as avalue-priced provider.

Many of our competitors have significantly greaterbrand recognition than we do and spend significantly more on marketing theirservices than we spend. As a result, we have not participated as extensively asour major competitors in a variety of large distribution channels, such asbeing pre-bundled on branded computers or being offered at retail outlets ofmany different major franchises. To the extent our competitors spendsignificantly more than we do in these and other channels, we are at acompetitive disadvantage. In addition, we have significantly decreased ourmarketing expenditures for our access services, primarily with respect toadvertising and media, and may further decrease these expenditures in thefuture. Decreased marketing of our access services has adversely impacted, andwill continue to adversely impact, our pay access account base. While we havenot decreased the marketing expenditures on distribution arrangements as muchas we have on advertising and media, the decreased advertising and mediaexpenditures may also adversely impact the efficacy of our distributionarrangements, which could cause our pay access account base to decrease at afaster rate than we currently anticipate. Even if we decide to increase suchadvertising and marketing expenditures, there are no assurances that suchincrease will have a positive impact on our pay access account base. We cannotassure you that the marketing resources we allocate to our access services willbe sufficient for us to compete effectively with our major competitors, and webelieve our base of access accounts will continue to decline.

We expect competition forpay access accounts to continue to intensify and cannot assure you that we willbe able to compete successfully. Our inability to compete effectively couldrequire us to make significant revisions to our services and pricingstrategies, which could result in increased costs, decreased revenues and theloss of pay access accounts, all of which could materially and adversely impactour financial condition, results of operations and cash flows.

*Competition in theOnline Relationships Market*

Competition for subscribers in the onlinerelationships market is intense and rapidly evolving. Our social-networkingservices compete directly against a small number of companies, includingReunion.com and Monster.com’s Military.com service, offering similar onlinesocial-networking services based on work, school and military communities. Oursocial-networking services also compete directly with many schools, 

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employers, Web sites, andassociations that maintain their own Internet-based alumni informationservices. In addition to this direct competition, we compete for subscriberswith companies offering a wide variety of social-networking services includingWeb portals such as Yahoo!, MSN and AOL that maintain chat rooms and aredeveloping new Web community services such as Yahoo! 360, MSN Spaces and AOLPeople Connection, and other community-based Web sites andpersonal-networking communities such as MySpace, Facebook and Friendster. Someof these social-networking services also have school- or work-based communitiesor search capabilities as well as more sophisticated features than ours, suchas personalized Web pages, instant messaging and blogs. In addition, many ofthese companies offer a wide variety of services in addition to theirsocial-networking services, which provides them with an additional competitiveadvantage in obtaining and retaining subscribers. Our social-networkingservices are used primarily to locate and contact acquaintances from school,work or military affiliations, and our subscribers, in general, do not spend asignificant amount of time on the site for other purposes. Our strategy is toexpand the features and functionality of our social-networking services, butthere can be no assurance we will be commercially successful in doing so.

Many consumers maintain simultaneous relationshipswith multiple communities, including Internet alumni networks and offlineassociations, and can easily shift their interest or their spending from oneonline or offline provider to another. Competitors may be able to launch newbusinesses serving various communities at relatively low cost. Competitors maybe able to hold themselves out as specialists in single communities, makingthem more appealing to consumers or giving them a perceived competitiveadvantage. In addition, many social-networking services are free or onlyrequire payment if certain additional functionality is desired by the user. Thecontinued prevalence of free services could adversely impact our ability tomarket both our free and pay social-networking services, maintain our currentprice levels, or maintain or grow our pay account base at current price levels,or at all.

Many competitors in thismarket have longer operating histories, larger customer bases, greater brandrecognition and significantly greater financial, marketing and other resourcesthan we do. In addition, we have relied extensively on Internet advertisingthrough portals and other Internet service providers, including AOL, MSN andYahoo!, to grow our free and pay accounts. A number of these companies arecompetitors of United Online with respect to Internet access and otherservices, and they may not be willing to retain the same advertisingrelationship going forward. To the extent we are not able to maintainadvertising relationships with these companies, our ability to obtain newsocial-networking pay and free accounts would be adversely impacted.

*Competition in theVoIP Market*

VoIP services are arelatively new and emerging application and it is uncertain whether VoIPservices, particularly the type we offer, will receive wide-spread consumeradoption. We have attracted only a modest number of users to these services.Competitors for our VoIP services include established telecommunications andcable companies, certain of our current competitors for Internet accessservices including AOL, MSN and EarthLink, leading Internet companies includingYahoo!, Google and eBay through its Skype subsidiary, and a number of othercompanies that offer VoIP-based services as their primary business such asVonage. Most of our major competitors in the VoIP market have longer operatinghistories, larger customer bases, greater brand recognition and significantlygreater financial, marketing and other resources than we do. Some of ourcompetitors, such as Vonage, spend a significant amount of resources onmarketing their services and participate in large, retail distributionchannels. In addition, many competitors offer services designed to serve asreplacements for home telephone services, and our VoIP offerings are notdesigned as home phone replacement services and also lack a number of otherfeatures being offered by certain competitors. We currently do not intend toexpend significant marketing resources on our VoIP services. If we do choose toexpend significant marketing resources on our VoIP services, there is noassurance that such efforts will be commercially successful. We cannot 

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assureyou that our marketing efforts will be effective, that our VoIP services willachieve significant consumer adoption or, even if such services do achieveconsumer adoption, that our VoIP services will generate growth in pay accounts,revenues or profitability.

*Competition inOnline Loyalty Marketing Business*

Our online loyaltymarketing business faces intense competition from both traditional and onlineadvertising and direct marketing businesses. We expect competition to increasedue to the lack of significant barriers to entry for online businessesgenerally. As we expand the scope of our product and service offerings, we maycompete with a greater number of media companies across a wide range ofadvertising and direct marketing services. Our ability to generate significantrevenue from advertisers and loyalty partners will depend on our ability todifferentiate ourselves through the services we provide and to obtain adequateparticipation from consumers in our online direct marketing and rewardsprograms. Currently, several companies offer competitive online products orservices, such as Coolsavings, Coupons.com and Eversave.com. In the future, wemay also face competition from larger offline loyalty point programs, such asthose operated by credit card companies or airlines, if they focus ondeveloping a stronger online presence. We have limited experience in this marketand cannot assure you that we will be able to compete effectively.

*Competition inAdditional Service Markets*

In addition to Internet access and VoIP services, ourCommunications segment also includes standalone premium email services and aprepackaged Family Pack offering. In addition to social-networking services andloyalty marketing, our Content & Media segment also includesWeb-hosting and domain registration services and digital photo-sharingservices. While these additional services do not generate a significant portionof the revenues for the applicable segment, we are actively investing resourcesin certain of these services. Competition for users of premium email servicesis intense. The companies we compete with for Internet access accounts also competewith us for premium email accounts. In addition, a number of companies,including Yahoo!, MSN, AOL and Google, offer premium email services, in certaincases, for free. The market for premium email services is evolving at a rapidpace and we cannot assure you that our offerings will be competitive orcommercially viable. While the personal Web-hosting business is fragmented, anumber of significant companies, including Yahoo!, currently compete activelyfor these users. In addition, the personal Web-hosting industry is veryapplication specific, with many of the competitors focusing on specificapplications, such as photo sharing, to generate additional users. We have notexpended significant resources marketing our digital photo sharing services, althoughwe may allocate additional resources to improving and promoting these servicesgoing forward. Digital photo sharing is an extremely competitive market andthere is no assurance our services will be able to compete effectively. Wecannot assure you that any of these additional services will be competitive orwill generate growth in pay accounts or revenues.

In addition, we haveevaluated, and expect to continue to evaluate, the development or acquisitionof new services. New services may subject us to competition from companies thathave more experience with such services, more established brands, and greaterfinancial, marketing and other resources to devote to such services. We cannotassure you that our new services, if any, will be competitive or will generategrowth in pay accounts or revenues.

*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 Internet 

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advertising.Many of our competitors have longer operating histories, greater namerecognition, larger user bases and significantly greater financial, technicaland sales and marketing resources than we do. This may allow them to devotegreater resources to the development, promotion and sale of their products andservices. These competitors may also engage in more extensive research anddevelopment, offer more sophisticated products and services, undertake morefar-reaching marketing campaigns and adopt more aggressive pricing policies. Wealso compete with television, radio, cable and print media for a share ofadvertisers’ total advertising budgets. In certain instances, we generateadvertising revenues from companies who are also our competitors. Inparticular, our Communications segment generates significant advertisingrevenues from Yahoo! Search. We compete directly with Yahoo! for Internetaccess, email, Web-hosting and online photo-sharing subscribers and indirectlyfor subscribers to our social-networking services. To the extent competitorswho are also sources of significant advertising revenue cease to do businesswith us, our revenues and profits could suffer.

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

Substantially all of our Communicationssegment’s revenues and profits come from our access services. As a result ofexpected continued decreases in our pay access accounts and, potentially, theARPU for such accounts, we currently expect that our Communications billableservices revenues and the profitability of this segment will decline. The rateof decline in billable services revenues has accelerated in some periods andmay continue to accelerate. Our Communications advertising revenues may declineas well due to decreased inventory resulting from decreases in our pay accessaccounts. Continued declines, particularly if such declines accelerate, inCommunications revenues may materially and adversely impact the profitabilityof this segment and, potentially, the Company as a whole.

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

A key element of ourstrategy involves the diversification from the declining access business tobusinesses with growth opportunities. We currently view the Content &Media segment as a growth opportunity. Billable services revenues are a keycomponent in the profitability of this segment and we derive substantially allof such revenues from pay accounts relating to our social networking services.The Company has experienced periods of deceleration of the growth in payaccounts for these services, and there can be no assurance that either thenumber of pay accounts or the billable services revenues associated with suchaccounts will increase in future periods. Advertising revenues are also a keycomponent of the profitability of this segment. We derive significantadvertising revenues from both our social networking as well as our onlineloyalty marketing services. We have experienced periods where our advertisingrevenues relating to each of these services has decreased on a sequentialbasis, although in certain cases the decrease has been, to some extent,attributable to seasonal factors. There can be no assurance that we will besuccessful in increasing Content & Media advertising revenues in thefuture. If we are not successful in growing our revenues within this segment,it is likely to adversely affect our diversification strategy and our futureprospects. Failure to increase revenues in this segment could also adversely impactthe profitability of this segment and, potentially, the Company as a whole.

**We may be unable tomaintain or grow our advertising revenues, particularly if we lose key advertising relationships.Reduced advertising revenues may reduce our profits.**

Advertising and commerce revenues are an increasinglyimportant component of our revenues and profitability. Our revenues fromadvertising have in the past fluctuated, and may in the future fluctuate, dueto a variety of factors including, without limitation, changes in the onlineadvertising market, decreases in capital available to Internet and othercompanies, changes in our advertising inventory, changes in usage, the effectof key advertising relationships and general economic conditions. A significantportion of our advertising revenues is derived from our access services anddecreases in our access account base will, 

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over time, likely resultin decreased inventory and advertising revenues. The Internet advertisingindustry continues to evolve and competitors are continually enhancing theirtechnology and advertising techniques. We could be required to expendsignificant resources to enhance our advertising services, although there canbe no assurance that our efforts will be successful. We have undertaken initiativesthat we believed would increase our advertising revenues but have resulted indecreased advertising revenues, and there can be no assurance our advertisinginitiatives will be effective. As discussed above, competition for advertisingdollars is intense and our advertising revenues may decline in future periods.

A small number ofcustomers have accounted for, and may in the future account for, a significantportion of our advertising and commerce revenues. In the past, we haveexperienced a number of situations where significant advertising arrangementswere terminated early, were not renewed, were renewed at significantly lowerrates or were renegotiated during the term of the arrangement. We derivedapproximately 34% of our Communications advertising and commerce revenues, andapproximately 14% of our total advertising and commerce revenues, during the September 2006quarter from Internet search fees provided through our agreement with Yahoo!Search. Our agreement with Yahoo! Search expires in March 2007, althoughwe have the right to extend the term for one additional year. The competitionamong search services is increasing. If there were a significant decrease insearch fees from our agreement with Yahoo! Search due to users using competitiveservices or other factors, such decrease would adversely impact our results ofoperations. Our business, financial position, results of operations and cashflows may be materially and adversely affected if we are unable either tomaintain or renew our significant agreements or to replace such agreements withsimilar agreements with new customers.

**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 Form 10-Q, and these factors may affect us from period toperiod and may affect our long-term performance. As a result, you should notrely on period-to-period comparisons as an indication of future or long-termperformance. In addition, these factors create difficulties with respect to ourability to forecast our financial performance accurately. We believe that thesedifficulties in forecasting present even greater challenges for financialanalysts who publish their own estimates of our future financial results andaccount metrics. We cannot assure you that we will achieve the expectations orfinancial projections made by our management or by the financial analysts. Inthe event we do not achieve such expectations or projections, the price of ourcommon stock could be adversely affected.

**Our marketingactivities may not be successful.**

Our marketing activities may not be effective. We willbe required to continue to incur significant marketing expenses to maintain ordevelop our brands. We have increased the number of brands under which ourservices are marketed and increased the number of services we offer. We may nothave adequate resources to maintain all of our brands or promote all of ourservices. From time to time, we may allocate our advertising and mediaexpenditures 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. We have increased ourprofitability, 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 our profitabilityand there can be no assurance that our marketing activities will be successfulin growing our businesses.

We have significantly decreased marketing expendituresfor our access services, particularly advertising and media expenditures, andmay further reduce such expenditures going forward, which we 

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believe has negativelyimpacted, and may continue to negatively impact, our pay access base. Whileadvertising and media expenditures continue to represent the majority of themarketing expenses for our Communications segment, decreases in advertising andmedia expenditures have increased our reliance on distribution arrangements,which are relatively more difficult to change or replace. As such, ourflexibility to manage our marketing expenses without significantly impactingour ability to obtain new pay access accounts may be adversely impacted goingforward.

We obtain a significantnumber of new pay access accounts through our offline distribution channels,primarily Best Buy. The number of new pay accounts we acquire through Best Buyis subject to fluctuations, and it has decreased from time to time as comparedto prior periods as a result of competitive offers, seasonality or for otherreasons. If the number of new pay accounts acquired through Best Buy were tocontinue to decrease for an extended period, such decreases could negativelyimpact the number of pay access accounts and our Communications revenues andprofitability could be negatively impacted.

**If we are unable toretain users, our business and financial 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 five percent. Our churn percentage iscalculated based on the average number of pay accounts for a period. Theaverage number of pay accounts is a simple average calculated based on thenumber of pay accounts at the beginning and end of a period. We make certainnormalizing adjustments to the calculation of our churn percentage for periodsin which we add a significant number of pay accounts due to acquisitions. We donot include in our churn calculation those accounts cancelled during the firstthirty days of service unless the accounts have upgraded from free accounts,although a number of such accounts will be included in our account totals atany given measurement date. Subscribers who cancel one pay service butsubscribe to another pay service are not considered to have cancelled a payaccount and, as such, our overall churn rate is not necessarily indicative ofthe percentage of subscribers canceling any particular service. We haveexperienced, and will likely continue to experience, a higher percentage ofsubscribers canceling our accelerated access and social-networking servicesthan is indicated by our churn rate, and the percentage of subscriberscanceling our social-networking services has fluctuated significantly fromquarter to quarter due to seasonality and the timing of termination of multi-monthprograms. Our churn may be higher in future periods and will fluctuate fromperiod to period and from service to service. If we continue to experience ahigh percentage of pay accounts canceling our services, it will make it moredifficult to grow, maintain or minimize decreases in the number of pay accountsfor those services. If we experience an increased percentage of cancellations,our revenues and profitability may be adversely affected.

In addition, the number ofactive free accounts has a significant impact on our ability to attractadvertisers, on the number of advertising impressions we have available tosell, and on how many pay accounts we can potentially acquire through marketingour pay services to our active free accounts. Each month, a significant numberof free accounts become inactive and we may experience continued declines inthe number of active free accounts. In addition, a user may have more than oneaccount on more than one of our services, and we are not able to determine inmost 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.

**If we cannotidentify and complete acquisitions, we may not be able to grow and achieve ourstrategic objectives.**

One of our strategicobjectives is to acquire businesses, product lines or technologies which willprovide us with an opportunity to leverage our assets and core competencies, orwhich otherwise will be complementary to our existing businesses. We may notsucceed in growing or maintaining our revenues unless we are able tosuccessfully complete acquisitions. The merger and acquisition market forcompanies 

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offeringInternet services is extremely competitive, particularly for companies who havedemonstrated a profitable business model with long-term growth potential.Recently, the public equity markets have been very receptive to companies withthese characteristics. As a result, in many cases, companies with thesecharacteristics trade publicly or are privately valued at multiples ofearnings, revenues, operating income and other metrics significantly higherthan the multiples at which we are currently valued. Acquisitions may requireus to obtain additional debt or equity financing, which may not be available tous on reasonable terms, or at all. These and other factors may make itdifficult for us to acquire additional businesses, product lines ortechnologies at affordable prices, or at all, and there is no assurance that wewill be successful in completing additional acquisitions.

**We cannot assureyou that we will be able to successfully manage, integrate or grow our acquired businesses.**

In April 2004, weacquired the assets of About, Inc.’s Web-hosting business; in November 2004,we acquired Classmates; in March 2005, we acquired the assets of HomesteadTechnologies, Inc.’s online digital photo-sharing business; in March 2006,we acquired The Names Database; in April 2006, we acquired MyPoints.com, Inc.;and in August 2006, we acquired Trombi, a small social-networking businessin France. We do not have prior experience in most of these lines of businessand may not be able to compete successfully in them. To the extent we attemptto integrate various aspects of these businesses, we may not be successful.There may be unanticipated risks, liabilities and costs associated with thesebusinesses, and we cannot assure you that these businesses will have a positiveimpact on our results of operations. In addition, we cannot assure you that we willbe successful in maintaining or growing their pay or free accounts.

**Even if we aresuccessful at acquiring additional businesses, product lines or technologies,acquisitions may not improve our results of operations and may adversely impactour business andfinancial condition.**

We have evaluated,and expect to continue to evaluate, a wide variety of potential strategictransactions that we believe may complement our current or future businessactivities. We routinely engage in discussions regarding potential acquisitionsand any of these transactions could be material to our financial condition andresults of operations. However, we cannot assure you that the anticipatedbenefits of an acquisition will materialize. Acquiring a business, product lineor technology involves many risks, including:

·       disruption of our ongoingbusiness and diversion of resources and management time;

·       unforeseen obligations orliabilities;

·       difficulty assimilating theacquired customer bases, technologies and operations;

·       difficulty assimilating andretaining employees from the acquired business;

·       risks of entering marketsin which we have little or no direct prior experience;

·       lack of controls, policiesand procedures appropriate for a public company, and the time and cost relatedto the remediation of such controls, policies and procedures;

·       potential impairment ofrelationships with employees, users or vendors as a result of changes inmanagement; and

·       potential dilutiveissuances of equity, large write-offs either at the time of the acquisition orin the future, the incurrence of restructuring charges, the incurrence of debt,the amortization of identifiable intangible assets, and the impairment ofamounts capitalized as intangible assets.

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Classmates hassubsidiaries operating in Germany and France, and 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.

**Our loyaltymarketing business depends on our ability to maintain and expand an activemembership base.**

The success of our loyaltymarketing business largely depends on our ability to maintain and expand anactive membership base. Our revenues are primarily 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. The attractiveness ofour program to current and potential members, advertisers and loyalty partnersdepends in large part on the attractiveness of the rewards and point redemptionopportunities that we offer. If the perceived value of our points decreases, wemay be required to offer more points to generate the same revenue, which could adverselyaffect our results of operations relating to these services. A significantportion of the revenues from loyalty marketing are generated from the activityof a small percentage of our members, and we cannot assure you that the numberof active members will increase. Data security and privacy concerns may causeconsumers not to sign up for our program or cause our members to stop using theservice or resist providing the personal data necessary to support our program’sprofiling capability. In addition, we acquire a significant number of our newmembers through a few acquisition channels, and the loss of any of thesechannels or a decrease in the number of new members acquired through thesechannels could have an adverse effect on our business. Although membership hasgrown in prior periods, there are no assurances that our membership growth willcontinue or increase in the future.

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

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. New services,such as our VoIP services and our proposed broadband services, may be dependenton our obtaining needed technology or services from third parties, which we maynot be able to obtain in a timely manner upon terms acceptable to us, or atall. Our ability to compete successfully will also depend upon the continuedcompatibility of our services with products offered by various vendors, whichwe may not be able to achieve.

We have expended, and mayin the future expend, significant resources enhancing our existing services anddeveloping, acquiring and implementing new services, such as our VoIP servicesand our proposed broadband services. Product development involves a number ofuncertainties, including unanticipated delays and expenses. New or enhancedservices may have technological problems or may not be accepted by ourconsumers or advertisers. We cannot assure you that we will be successful indeveloping, acquiring or implementing new or enhanced services, or that new orenhanced services will be commercially successful.

**Our VoIP servicesmay not be commercially successful.**

Only a limited number ofusers have signed up for our VoIP services, and we have experienced losses inconnection with these services due to fraud and the costs of developing,marketing and operating them. We may continue to expend significant resourcesdeveloping, enhancing, operating and marketing these services. We expect theseservices to continue to adversely impact our profitability, at least in the nearterm. If our VoIP services are not commercially successful, we will continue toincur operating losses in 

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connectionwith these services, which would negatively impact our financial condition andresults of operations.

**Our proposedbroadband services may not be commercially successful.**

We have expended resourcestowards developing our proposed broadband services and we intend to expendadditional resources towards developing, operating and marketing them. Thecosts associated with delivering broadband services include recurring servicecosts such as telecommunications and customer support costs as well as costsincurred to add new broadband subscribers, such as sales and marketing andhardware costs. We currently intend to focus the marketing of our proposedbroadband services primarily on our dial-up access subscriber base which, whilelimiting our costs, will limit the number of potential subscribers who are madeaware of our services. It is anticipated that we will incur, at least in thenear term, operating losses in connection with these services. There can be noassurance that these services will be made available on a significant scale,that they will generate a significant number of subscribers or that they willbe profitable.

**Seasonal trends inInternet usage and advertising sales may cause fluctuations in our results of operations.**

Seasonal trends couldaffect revenues, operating expenses and the rate at which users sign up for ourservices. Decreased usage during seasonal periods could decrease advertisinginventory and search activity and adversely impact advertising revenue.Increased usage due to seasonality may result in increased telecommunicationscosts for such period. We have experienced lower usage of our access servicesin the summer months and this trend may continue. We also have experienced alower rate of people signing up for our access services during the spring andsummer months when compared to the fall and winter months, and this trend maycontinue. While we have only operated our loyalty marketing business for ashort period of time, historically their revenues have decreased in the September quarterand increased in the December quarter, although there are no assurancesthat this trend will continue. Seasonality may result in significantfluctuations in our results of operations and the number of users signing upfor, or accessing, our services.

**If our accessaccounts usage increases or our telecommunications costs increase, our businessmay suffer.**

Other than sales andmarketing, our telecommunications costs are our largest Communications expense.If the average monthly usage of our access users increases, or if our averagehourly telecommunications cost increases, the profitability of ourCommunications segment may be adversely impacted.

**Our access businessis dependent on a small number of telecommunications carriers. Our inability tomaintain agreements at attractive rates with these carriers may negativelyimpact our business.**

Our access business substantially depends on the capacity,affordability, reliability and security of our telecommunications networks.Only a small number of telecommunications providers offer the network and dataservices we require, and most of our telecommunications services are currentlypurchased from Level 3 Communications, Verizon, Pac-West, Qwest, O1Communications and StarNet. Furthermore, in the past, several vendors haveceased operations or ceased offering the services we require, causing us toswitch vendors. Vendors may experience significant financial difficulties andbe unable to perform satisfactorily or to continue to offer their services.Verizon, Level 3 Communications, Pac-West and Qwest have significant amounts ofdebt obligations. The loss of vendors has resulted, and may in the futureresult, in increased costs, decreased service quality and the loss of users. Inparticular, the failure of Level 3 Communications, Verizon, Pac-West, Qwest, O1Communications or StarNet to continue to provide the scope, quality and pricingof services currently provided could materially and adversely affect ourbusiness 

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and results of operations.Some of our telecommunications services are provided pursuant to short-termagreements that the providers can terminate or elect not to renew. In addition,each of our telecommunications carriers provides network access to some of ourcompetitors and could choose to grant those competitors preferential networkaccess or pricing. Certain of our telecommunications providers compete with usin the market to provide consumer Internet access. As a result, any or all ofour current telecommunications service providers could discontinue providing uswith service at rates acceptable to us, or at all, which could materially andadversely affect our business, financial position, results of operations andcash flows.

Market rates fortelecommunications services used in our business have declined significantly inrecent years. General market forces, the failure of providers, regulatoryissues and other factors could result in increased rates. Any increase inmarket rates would increase the cost of providing our services and, ifsignificant, could have a material adverse effect on our business, financialposition, results of operations and cash flows.

**If we fail tomanage our telecommunications or our internal network capacities, our accessservice levels maysuffer or we may experience increased per-account costs.**

We will have to accurately anticipate our futuretelecommunications capacity needs within lead-time requirements. If we fail toprocure sufficient quantities of telecommunications services, we may be unableto provide our users with acceptable service levels. Conversely, if we purchaseexcessive amounts of telecommunications services we will have increased costs,which could decrease our profitability. We have experienced such overcapacityin the past, and we may experience overcapacity in the future. Our failure toeffectively manage telecommunications costs could adversely affect ourreputation as a quality provider of Internet services or could adversely affectour profitability.

In addition, we may fromtime to time experience increases in our telecommunications usage that exceedour then-available telecommunications capacity and the capacity of our internalservers. As a result, users may be unable to register or log on to ourservices, may experience a general slow-down in their Internet access or may bedisconnected from their sessions. Excessive user demand could also result insystem failures of our internal server networks, which would prevent us fromgenerating advertising revenues. Inaccessibility, interruptions or otherlimitations on the ability to access our services due to excessive user demand,or any failure of our servers to handle user traffic, could adversely effectour reputation, lead to subscriber cancellations and could adversely affect ourrevenues.

**Our business willsuffer if the scope or quality of service from our telecommunications carriersis inadequate.**

If our telecommunicationsservice providers deliver unacceptable service, the quality of our Internetaccess service would suffer. In this event, we would likely lose users who aredissatisfied with our service. Since we do not have direct control over ourtelecommunications carriers’ network reliability and the quality of theirservice, we cannot assure you that we will be able to provide consistentlyreliable Internet access for our users.

**Our business ishighly dependent on our billing and customer support systems, which are basedon a combination of third-party software and internally developedsoftware.**

The software that operatesmost of our billing and customer support systems for our access service islicensed from Portal Software, Inc., a subsidiary of Oracle, and Remedy, aBMC Software company, and we use a combination of Portal, Remedy and otherthird-party and internally developed software applications for suchcustomer billing and support. The billing system for Classmates relies on acombination of software licensed from Art Technology Group Inc. (“ATG”),other third-party software 

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applicationsas well as internally developed software applications. Customer billing andsupport is a highly complex process, and our systems must efficiently interfacewith other third parties’ systems such as the systems of credit card processingcompanies and other companies to whom we outsource billing and supportfunctions. Our ability to accurately and efficiently bill and support our usersis dependent on the successful operation of our billing and support systems andthird parties’ systems upon which we rely. In addition, our ability to offernew pay services or alternative payment plans is dependent on our ability tocustomize our billing and support systems. Issues associated with these systemscould cause a variety of problems including the failure to bill and collectfrom users on a timely basis, over-charging or under-charging users,inaccurate financial and customer data, excessive credit card chargebacks orrefunds, delays in new product or payment plan introductions and other billing-relatederrors. Such problems could lead to inaccurate reporting from time to time,which could adversely affect our business, financial position, results ofoperations and cash flows. We have experienced billing and support problemsfrom time to time and may experience additional problems in the future. Thefailure of our software vendors to provide software upgrades and technicalsupport, the failure of the Portal, Remedy, ATG or internally developedsoftware to operate accurately, problems with our credit card processor orother billing and support vendors and any other failures or errors in ourbilling and support systems could materially and adversely affect our business,financial position, results of operations and cash flows.

**We are dependent onthird parties for technical support and customer service and our business maysuffer if they are unable to provide these services, cannot expand to meet ourneeds or terminate theirrelationships with us.**

Our business and financialresults depend, in part, on the availability and quality of our customersupport services. We currently outsource a majority of the live technical andbilling support functions to ClientLogic Corporation and Sutherland GlobalServices. As a result, we maintain only a small number of internal customerservice personnel. We are not equipped to provide the necessary range ofcustomer service functions in the event that either ClientLogic or Sutherlandbecomes unable or unwilling to offer these services to us. At times, usersseeking live customer support have experienced lengthy waiting periods to reachsupport personnel who are trained to provide the technical or billing supportthey require. ClientLogic has also experienced outages and other issues in thepast which resulted in inadequate service quality and support which adverselyimpacted our business. Maintaining desired customer support levels may requiresignificantly more support personnel than are currently available to us, orsignificantly greater expense than we choose to incur. If either ClientLogic orSutherland does not provide us with quality services, or if our relationshipwith ClientLogic or Sutherland terminates and we are unable to transition suchservices in-house or to a replacement vendor in an orderly, cost-effective andtimely manner, our reputation, business and results of operations would suffer.In addition, we prepay significant amounts in advance to ClientLogic under ouragreement with them, and any failure by them to perform the services for whichwe have prepaid would negatively impact our financial position.

**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 and errors in the operationof our systems. This has resulted in, and may in the future result in, a numberof adverse consequences, which have included or may include:

·       users being disconnectedfrom our services or being unable to access our services;

·       loss of data or revenue;

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·       injuryto reputation; and

·       diversion of developmentresources.

We have experienced technical and customer supportissues associated with our services and software releases. These issues haveresulted in users discontinuing their service and have adversely impacted ourrevenues. A number of our material technologies and systems are based ondifferent platforms. To the extent we attempt to integrate these technologiesand systems, we may experience a number of difficulties, errors, failures andunanticipated costs. In addition, our business relies on third-partysoftware including, without limitation, software licensed from Oracle for ourinternal operations, software licensed from Portal, an Oracle subsidiary, andRemedy for billing and customer support, software licensed from SlipStreamData Inc. for our accelerated services, software licensed from certainthird parties for our VoIP services, and software licensed from certain thirdparties for our advertising products and services. Any significant failure ofthis software could materially and adversely affect our business, financialposition, results of operations and cash flows. Our services also rely on theircompatibility with other third-party systems, particularly operatingsystems. Incompatibility with future changes to third-party software uponwhich our systems rely could materially affect our ability to deliver ourservices. We cannot assure you that we will not experience significanttechnical problems with our services in the future.

Our VoIP services aredependent upon internally developed software, licensed software and third partytelecommunications services, all of which are relatively new. Our VoIP serviceshave not yet been operated on a significant scale. There will be bugs and otherissues associated with these services. If we experience any materialdifficulties operating these services on a significant scale, or if the bugs orother issues we encounter with these services are material, our ability toobtain and maintain users will be adversely impacted.

**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 telecommunicationsservice providers, providers of customer support services and other vendors.Unauthorized or inappropriate access to, or use of, our networks, computersystems and services could potentially jeopardize the security of confidentialinformation, including credit card information, of our users and of thirdparties. Third parties have in the past used our networks, services and brandnames to perpetrate crimes, such as identity theft or credit card theft, andmay do so in the future. Users or third parties may assert claims of liabilityagainst us as 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 

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thepotential to seriously disrupt Internet usage. If Internet usage issignificantly disrupted for an extended period of time, or if the prevalence ofthese programs results in decreased residential Internet usage, our businesscould be materially and adversely impacted. In addition, actions taken by us orour telecommunications providers to attempt to minimize the spread of harmfulprograms could adversely impact our users’ ability to utilize our services.

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

Our trademarks, patents, copyrights, domain names andtrade secrets are important to the success of our business. We principally relyupon patent, trademark, copyright, trade secret and contract laws to protectour proprietary technology. We cannot be certain that we have taken adequatesteps to prevent misappropriation of our rights. Our failure to adequatelyprotect our proprietary rights could adversely affect our brands.

Governmental agencies andtheir designees generally regulate the acquisition and maintenance of domainnames. The regulation of domain names in the United States and in foreigncountries is in flux and may change. As a result, we may be unable to acquireor maintain relevant domain names in the countries that we conduct, or plan toconduct, business. Furthermore, the relationship between regulations governingdomain names and laws protecting trademarks and similar proprietary rights isunclear. Therefore, we may be unable to prevent third parties from acquiringdomain names that are similar to, infringe upon, dilute or otherwise decreasethe value of our trademarks and other proprietary rights.

**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 in the ordinary course of our business, including actionsdiscussed elsewhere in this Form 10-Q. These actions include, withoutlimitation, claims that we infringe third party patents, claims andinvestigations by governmental agencies and private parties in connection withconsumer protection and other laws, claims in connection with employmentpractices, securities laws claims, breach of contract claims and other businessrelated claims. The nature of our business could subject us to additionalclaims for similar matters, as well as a wide variety of other claimsincluding, without limitation, claims for defamation, negligence, trademarkinfringement, copyright infringement, and privacy matters.

Defending against lawsuitsinvolves significant expense and diversion of management’s attention andresources from other matters. We may not prevail in existing actions or actionsthat may be brought in the future. The failure to successfully defend againstcertain types of claims, including claims based on infringement of proprietaryrights, could require us to change our business practices or obtain licensesfrom third parties, which licenses may not be available on acceptable terms, ifat all. Lawsuits also involve the risk of significant settlements or judgmentsagainst us. Both the cost of defending claims, as well as the effect ofsettlements and judgments, could cause our results of operations to fluctuatesignificantly from period to period and could materially and adversely affectour business, financial position, results of 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, under accounting principles generallyaccepted in the United States, to review our intangible assets for impairmentwhen events occur or circumstances change that would more likely than notreduce the fair value of a reporting unit below its carrying value amount.Goodwill is required to be tested for impairment at least annually. We haveexperienced impairment losses in the past and we cannot 

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assure you that we willnot experience impairment losses in the future. Any such loss could adverselyand materially impact our financial condition and results of operations.

Our VoIP services and ourdigital photo-sharing services are relatively new and have not generatedsignificant revenues. We have capitalized certain proprietary rights related toour VoIP services as well as certain costs incurred by us in connection withthe development of our VoIP services. We have also capitalized goodwill andintangible assets in connection with the acquisitions of MyPoints, The NamesDatabase and PhotoSite. If these services are not commercially successful, wewould likely be required to impair these assets which would negatively impactour financial condition and results of operations.

**Our ability tooperate our business could be seriously harmed if we lose members of our senior management team or otherkey employees.**

Our business is largelydependent on the efforts and abilities of our senior management, particularlyMark 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.

**Governmentregulation or taxation of the provision of Internet access, VoIP services andother services could decrease our revenues and increase our costs.**

Changes in the regulatory environment regarding theInternet could decrease our revenues and increase our costs. Currently, ISPsare considered “information service” providers rather than “telecommunications”providers, and regulations that apply to telephone companies and othertelecommunications common carriers currently do not apply to our Internetaccess services. However, our Internet access services could become subject toFederal Communications Commission (“FCC”) and state regulation as Internetaccess services and telecommunications services converge. If the regulatorystatus of ISPs changes, our business may be adversely affected.

Laws, regulations and legal liability issues regardingVoIP services are evolving at a rapid pace. Measures under consideration by theFCC, Congress, the courts and/or other federal and state legislatures and/oragencies include, without limitation, new laws and regulations, or theinterpretation of existing laws and regulations, regarding access to telephonenumbers, taxes, fees and surcharges, contributions to the federal UniversalService Fund and any state Universal Service Funds, consumer protection rules,intercarrier compensation arrangements, consumer privacy, assistance to lawenforcement, and the provision of E-911 services. Some or all of thesemeasures, if adopted and determined to be applicable to our VoIP services,could make it significantly more expensive to operate some or all of our VoIPservices and could cause us to cease operating or enhancing some or all of ourVoIP services. For example, we do not believe we are required to offer E-911services with our existing VoIP services. that we must comply with theCommunications Assistance for Law Enforcement Act (CALEA), or that we have theobligation to contribute to the federal or any state Universal Service Funds.We do not currently have the ability to offer E-911 services nor can wecomply with CALEA. If the regulatory status of our VoIP service offeringschanges or if we offer new VoIP services that subject us to additional laws andregulations, our VoIP services may be materially and adversely affected. Inaddition, while we are considering developing and implementing an internationalstrategy for our VoIP services, foreign laws and regulations regarding theprovision of VoIP services could adversely impact our ability to implement thisstrategy.

The Internet Tax Freedom Act, which placed amoratorium on new state and local taxes on Internet commerce, has been extendedthrough November 2007. However, future laws imposing taxes or otherregulations on the provision of goods and services over the Internet could makeit substantially more expensive to operate our business.

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Our business is also subject to a variety of otherU.S. and foreign laws and regulations that could subject us to liabilities,claims or other remedies, such as laws relating to bulk email or “spam,” accessto various types of content by minors, anti-spyware initiatives, encryption,data protection, security breaches and consumer protection. Compliance withthese laws and regulations is complex and may impose significant additionalcosts on us. Certain of our services, particularly our social-networking andloyalty marketing services, are dependent on the ability send a significantvolume of emails to members through third parties’ email systems. Additionalgovernment regulation regarding sending bulk email, as well as voluntaryactions by third parties to restrict the delivery of emails through their emailsystems, could adversely impact our business. For example, AOL and Yahoo!recently announced their plans to reduce the amount of bulk email sent throughtheir email services by charging bulk email senders to guarantee the deliveryof their messages.

In addition, theregulatory framework relating to Internet services is evolving and both thefederal government and states from time to time pass legislation that impactsour business. There are a number of legislative proposals before the UnitedStates Congress and various state legislative bodies that may relate to ourbusiness. It is likely that additional laws and regulations will be adoptedthat would affect our business. The adoption of additional laws and regulationsthat affect our competitors, for example, network neutrality proposals, couldalso have an effect our business. We cannot predict the impact that futureregulatory changes or developments may have on our business, financialcondition, results of operations or cash flows. The enactment of any additionallaws or regulations, increased enforcement activity of existing laws andregulations, or claims by individuals could significantly impact our costs orthe manner in which we conduct business, all of which could adversely impactour results of operations and cause our business to suffer.

**Changes in, orinterpretations of, laws regarding consumer protection could subject us to liabilityor cause us to changeour practices.**

Consumer protection laws and enforcement actionsregarding advertising and user privacy, especially relating to children, arebecoming more prevalent. The FTC has conducted investigations into the privacypractices of companies that collect information about individuals on theInternet. The FTC has also investigated us and other ISPs in connection withmarketing, billing, customer retention, cancellation and disclosure practices.Juno and the FTC entered into a consent agreement, which was approved by theFTC on June 29, 2001, that provides for redress payments and specificdisclosures or notices regarding, among other things, the cost of its Internetaccess services, its cancellation terms and local versus long-distance charges,as well as the requirement to provide adequate customer support to processcancellations. We received an inquiry regarding our compliance with the consentagreement on October 14, 2005, and we submitted a response on December 14,2005. We subsequently received a request for additional information and haveprovided the requested information.

Various state agencies aswell as individuals have also asserted claims against, or instituted inquiriesinto, ISPs, including Juno and NetZero, in connection with marketing, billing,customer retention, cancellation, refund and disclosure practices. We cannotassure you that our services and business practices, or changes to our servicesand business practices, will not subject us to claims and liability by privateparties, the FTC or other governmental agencies.

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

Our social-networking andloyalty marketing businesses deliver a significant number of emails to ourmembers. Yahoo! and AOL recently announced that they will phase out theirIP-based whitelists and implement a pay-per-email program. In addition, fromtime to time, Internet Service Providers block bulk email transmissions orotherwise experience technical difficulties which result in the inability totransmit 

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emailsto our members. Our social-networking and loyalty marketing businesses relyheavily on email campaigns and 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, 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 at ourheadquarters in Woodland Hills, California and at facilities in and around LosAngeles, California; San Francisco, California; San Jose, California; Ashburn,Virginia; Renton, Washington and New York, New York. In the past, areas inCalifornia have experienced repeated episodes of diminished electrical powersupply, or “rolling blackouts.” A natural disaster, terrorism, power blackoutor other unanticipated problem at our headquarters or at a network hub, orwithin a third-party network provider’s network, could cause interruptionsin the services that we provide. Our systems are not fully redundant. Anyprolonged disruption of our services due to system failures could result inuser turnover and decreased revenues.

**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 operations in Indiaprimarily handle email customer support, product development and qualityassurance. A portion of our outsourced customer support is also based in India.Our product development, customer support and quality assurance operationswould be severely disrupted if telecommunications issues, political instabilityor other factors adversely impacted these operations or our ability to communicatewith these operations. Any disruption that continued for an extended period oftime would likely have a material adverse effect on our ability to service ourcustomers and develop our products since it would take a significant period oftime to transition these operations internally or to an outside vendor. If wewere to cease our operations in India and transfer these operations to anothergeographic area, such change could result in increased overhead costs whichcould materially and adversely 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, we may not be able to devote sufficient cash resources to continue toprovide our services in their current form, acquire additional users, enhanceor expand our services, respond to competitive pressures or take advantage ofperceived opportunities, and our business and its future prospects may suffer.

**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 performance. Our future cash flows willsignificantly decline from what we experienced in 2005 due to the payment ofincome taxes and other factors, and our cash balances will decline if we useour cash to acquire businesses, repurchase stock or for other purposes. Wecannot assure you that we will continue to pay quarterly cash dividends, and ifwe do not, our stock price could be negatively impacted.

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**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 ofdirectors.

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

The market price of our common stock has fluctuatedsignificantly since our stock began trading on the Nasdaq National Market in September 2001and it is likely to continue to be volatile with extreme volume fluctuations.In addition, the Nasdaq National Market, where most publicly held Internetcompanies are traded, has experienced substantial price and volumefluctuations. These broad market and industry factors may harm the market priceof our common stock, regardless of our actual operating performance, and forthis or other reasons we could suffer significant declines in the market priceof our common stock.

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**ITEM 2.**   UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

**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. At September 30, 2006, we hadrepurchased $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 counted aspurchases against the Board approved repurchase program. Upon vesting, theCompany currently does not collect the applicable withholding taxes for RSUsfrom employees. Instead, the Company automatically withholds, from the RSUsthat vest, the portion of those shares with a fair market value equal to theamount of the withholding taxes due. The Company then pays the applicablewithholding taxes in cash, which is accounted for as a repurchase of commonstock.

Commonstock repurchases at September 30, 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** | ** ** |
|--------------------|------------|------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
| August 2001   |       |       | 138        |                                                 |       |                                             | $          | 1.67                                                                                                                    |       |                                                                                                                        |       | 138 |   |   |   | $ | 9,770 |   |   |
| November 2001 |       |       | 469        |                                                 |       |                                             | 1.77       |                                                                                                                    |       |                                                                                                                        | 469        |   |   |   | 8,940 |   |   |
| February 2002 |       |       | 727        |                                                 |       |                                             | 3.38       |                                                                                                                    |       |                                                                                                                        | 727        |   |   |   | 6,485 |   |   |
| August 2002   |       |       | 288        |                                                 |       |                                             | 7.51       |                                                                                                                    |       |                                                                                                                        | 288        |   |   |   | 27,820 |   |   |
| February 2003 |       |       | 193        |                                                 |       |                                             | 9.43       |                                                                                                                    |       |                                                                                                                        | 193        |   |   |   | 26,005 |   |   |
| May 2003      |       |       | 281        |                                                 |       |                                             | 13.51      |                                                                                                                    |       |                                                                                                                        | 281        |   |   |   | 22,207 |   |   |
| November 2003 |       |       | 2,024      |                                                 |       |                                             | 19.76      |                                                                                                                    |       |                                                                                                                        | 2,024      |   |   |   | 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      |                                                                                                                    |       |                                                                                                                        | —     |   |   |   |   |   |   |
| Total              |       |       | 11,125     |                                                 |       |                                             | $          | 12.73                                                                                                                   |       |                                                                                                                        |       | 10,932 |   |   |   |   |   |   |

 

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**ITEM6.**   EXHIBITS
|         | ** ** | ** **                                                                                                                                                                                                                                                                                                  | ** ** | **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                                                                                                                                                                                                                                                           |       |                         |       | 8-K                                             |   | 000-33367 |   | 10/1/2001 |
| 3.2     |       | Amended and Restated Bylaws                                                                                                                                                                                                                                                                                 |       |                         |       | 8-K                                             |   | 000-33367 |   | 10/1/2001 |
| 3.3     |       | Certificate of Designation for Series A Junior  Participating Preferred Stock (included in exhibit 4.1 below)                                                                                                                                                                                     |       |                         |       | 8-K                                             |   | 000-33367 |   | 11/23/2001 |
| 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 |       |                         |       | 8-K                                             |   | 000-33367 |   | 11/23/2001 |
| 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                                                                                                                                                                                                                                                                                   |       |                         |       | 10-Q                                            |   | 000-33367 |   | 11/14/2001 |
| 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                                                                                                                                                                                                                                                                     |       |                         |       | 10-Q                                            |   | 000-33367 |   | 11/14/2001 |
| 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 |
|         |            |                                                                                                                                                                                                                                                                                                             |            |                              |            |                                                 |  |  |  |  |  |  |

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| 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 Gerald Popek                                                 |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005  |
| 10.17 |   | Employment Agreement  between the Registrant and Robert Taragan                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005  |
| 10.18 |   | Employment  Agreement between the Registrant and Jeremy Helfand                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/9/2006  |
| 10.19 |   | Office Lease between LNR  Warner Center, LLC and NetZero, Inc.                                           |   |   |   | 10-Q   |   | 000-33367 |   | 5/3/2004  |
| 31.1  |   | Certification of the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |
| 31.2  |   | Certification of the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |
| 32.1  |   | Certification of the  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |
| 32.2  |   | Certification of the  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |
|       |        |                                                                                                               |        |        |        |        |        |           |        |           |  |

 

 

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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 November 9, 2006.

|          |     | UNITED ONLINE, INC. |
|----------|----------|--------------------------|
|     |     | By:                      | /s/  CHARLES S. HILLIARD |   |
|     |     |                     | Charles S.  Hilliard |   |
| * * | * * | * *                 | *President  and Chief Financial Officer* | * * |
|     |     | By:                      | /s/  NEIL P. EDWARDS |   |
| * * |     |                     | Neil P. Edwards |   |
| * * | * * | * *                 | *Senior  Vice President, Finance, Treasurer and Chief Accounting Officer* | * * |

 

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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                                                                                                                                                                                                                                                          |       |                       |       | 8-K                                             |   | 000-33367 |   | 10/1/2001 |
| 3.2     |       | Amended and Restated  Bylaws                                                                                                                                                                                                                                                                                |       |                       |       | 8-K                                             |   | 000-33367 |   | 10/1/2001 |
| 3.3     |       | Certificate of  Designation for Series A Junior Participating Preferred Stock (included  in exhibit 4.1 below)                                                                                                                                                                                    |       |                       |       | 8-K                                             |   | 000-33367 |   | 11/23/2001 |
| 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 |       |                       |       | 8-K                                             |   | 000-33367 |   | 11/23/2001 |
| 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                                                                                                                                                                                                                                                                                  |       |                       |       | 10-Q                                            |   | 000-33367 |   | 11/14/2001 |
| 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                                                                                                                                                                                                                                                                     |       |                       |       | 10-Q                                            |   | 000-33367 |   | 11/14/2001 |
| 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 |

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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 Gerald Popek                                                 |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005  |
| 10.17 |   | Employment Agreement  between the Registrant and Robert Taragan                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005  |
| 10.18 |   | Employment Agreement  between the Registrant and Jeremy Helfand                                               |   |   |   | 10-Q   |   | 000-33367 |   | 8/9/2006  |
| 10.19 |   | Office Lease between LNR  Warner Center, LLC and NetZero, Inc.                                           |   |   |   | 10-Q   |   | 000-33367 |   | 5/3/2004  |
| 31.1  |   | Certification of the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |
| 31.2  |   | Certification of the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |
| 32.1  |   | Certification of the  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |
| 32.2  |   | Certification of the  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |   | X      |   |   |   | 000-33367 |   | 11/9/2006 |

 

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