**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM**** 10-Q**

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| **(Mark One)**                                              |       |                                                                                                    |
|-------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| x                                                           | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| **For the Quarterly Period Ended September 30,  2005** |
| **Or**                                                      |
| o                                                           | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom              to            **

**Commission file 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  Incorporation or Organization) | (I.R.S Employer  Identification No.) |
| **21301 Burbank Boulevard,**                                     | **91367**                            |
| **Woodland  Hills, California**                                  | (Zip Code)                           |
| (Address of Principal  Executive Office)                         |                                 |

 

**(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 markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

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

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

There were 62,300,417shares of the registrant’s common stock outstanding at October 31, 2005.

 

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**INDEX**

| **PART I.**  |       | **FINANCIAL INFORMATION**                                                                                                                     | ** ** |
|-------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|
|              | Item 1.    | Condensed Consolidated  Balance Sheets at September 30, 2005 (unaudited) and December 31,  2004                                     | 3          |
|              |       | Unaudited Condensed Consolidated Statements of  Operations for the Quarters and Nine Months Ended September 30, 2005 and  2004           | 4          |
|              |       | Unaudited Condensed Consolidated Statements of  Comprehensive Income for the Quarters and Nine Months Ended  September 30, 2005 and 2004 | 5          |
|              |       | Unaudited Condensed Consolidated Statements of Cash  Flows for the Nine Months Ended September 30, 2005 and 2004                         | 6          |
|              |       | Notes to the Unaudited Condensed Consolidated Financial  Statements                                                                           | 7          |
|              | Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                   | 19         |
|              | Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                                                                   | 52         |
|              | Item 4.    | Controls and  Procedures                                                                                                                      | 53         |
| **PART II.** | ** ** | **OTHER INFORMATION**                                                                                                                         | ** ** |
|              | Item 1.    | Legal Proceedings                                                                                                                             | 54         |
|              | Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                  | 56         |
|              | Item 6.    | Exhibits                                                                                                                                      | 57         |
| **SIGNATURES**    | 59         |

 

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—FINANCIAL INFORMATION**

**ITEM 1.**   FINANCIALSTATEMENTS

**UNITEDONLINE, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(inthousands)**

| ** **                                       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                       |       |                         |       |                        |       |   |   |   |   |
| Current assets:                                  |       |                         |       |                        |       |   |   |   |   |
| Cash and cash equivalents                        |       |                         | $          | 33,659                      |       |   |   | $ | 56,512 |   |   |
| Short-term investments                           |       |                         | 207,334    |                        |       |   | 176,281 |   |   |
| Accounts receivable                              |       |                         | 20,879     |                        |       |   | 17,534 |   |   |
| Deferred tax assets, net                         |       |                         | 17,203     |                        |       |   | 24,630 |   |   |
| Other current assets                             |       |                         | 9,944      |                        |       |   | 13,058 |   |   |
| Total current assets                             |       |                         | 289,019    |                        |       |   | 288,015 |   |   |
| Property and  equipment, net                     |       |                         | 32,383     |                        |       |   | 27,006 |   |   |
| Deferred tax  assets, net                        |       |                         | 53,506     |                        |       |   | 51,573 |   |   |
| Goodwill                                         |       |                         | 80,499     |                        |       |   | 76,458 |   |   |
| Intangible  assets, net                          |       |                         | 64,245     |                        |       |   | 70,558 |   |   |
| Other assets                                     |       |                         | 4,876      |                        |       |   | 6,242 |   |   |
| Total assets                                     |       |                         | $          | 524,528                     |       |   |   | $ | 519,852 |   |   |
| **Liabilities and Stockholders’ Equity**    |       |                         |       |                        |       |   |   |   |   |
| Current liabilities:                             |       |                         |       |                        |       |   |   |   |   |
| Accounts payable                                 |       |                         | $          | 51,333                      |       |   |   | $ | 45,379 |   |   |
| Accrued liabilities                              |       |                         | 37,102     |                        |       |   | 18,320 |   |   |
| Deferred revenue                                 |       |                         | 54,595     |                        |       |   | 49,293 |   |   |
| Current portion of term loan                     |       |                         | 16,498     |                        |       |   | 23,333 |   |   |
| Current portion of capital leases                |       |                         | 369        |                        |       |   | 621 |   |   |
| Total current liabilities                        |       |                         | 159,897    |                        |       |   | 136,946 |   |   |
| Deferred revenue                                 |       |                         | 2,723      |                        |       |   | 1,661 |   |   |
| Term loan                                        |       |                         | 41,835     |                        |       |   | 76,667 |   |   |
| Capital leases                                   |       |                         | 420        |                        |       |   | 698 |   |   |
| Other liabilities                                |       |                         | 4,334      |                        |       |   | 2,181 |   |   |
| Total liabilities                                |       |                         | 209,209    |                        |       |   | 218,153 |   |   |
| Commitments and  contingencies (see Note 8)      |       |                         |       |                        |       |   |   |   |   |
| Stockholders’ equity:                       |       |                         |       |                        |       |   |   |   |   |
| Common stock                                     |       |                         | 6          |                        |       |   | 6 |   |   |
| Additional paid-in capital                       |       |                         | 480,981    |                        |       |   | 491,757 |   |   |
| Deferred stock-based compensation                |       |                         | (18,565    | )                           |       |   | (8,477 | ) |   |
| Accumulated other comprehensive loss             |       |                         | (278       | )                           |       |   | (9 | ) |   |
| Accumulated deficit                              |       |                         | (146,825   | )                           |       |   | (181,578 | ) |   |
| Total stockholders’ equity                  |       |                         | 315,319    |                        |       |   | 301,699 |   |   |
| Total liabilities  and stockholders’ equity |       |                         | $          | 524,528                     |       |   |   | $ | 519,852 |   |   |

 

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

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

| ** **                                                                        | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                   | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                                         |       |                                       |       |                                                |       |   |   |   |   |
| Billable services                                                                 |       | $                                          | 117,670    |                                                | $          | 102,113 |   | $ | 351,389 |   | $ | 302,291 |   |
| Advertising and commerce                                                          |       | 15,108                                     |       | 8,591                                               |       | 43,440 |   | 26,706 |   |
| Total revenues                                                                    |       | 132,778                                    |       | 110,704                                             |       | 394,829 |   | 328,997 |   |
| Operating expenses:                                                               |       |                                       |       |                                                |       |   |   |   |   |
| Cost of billable services (including stock-based  compensation, see Note 1)  |       | 24,375                                     |       | 23,013                                              |       | 73,048 |   | 71,887 |   |
| Cost of free services                                                             |       | 2,858                                      |       | 1,605                                               |       | 9,383 |   | 4,919 |   |
| Sales and marketing (including stock-based  compensation, see Note 1)        |       | 52,767                                     |       | 43,294                                              |       | 160,653 |   | 131,274 |   |
| Product development (including stock-based  compensation, see Note 1)        |       | 10,116                                     |       | 7,069                                               |       | 28,780 |   | 19,456 |   |
| General and administrative (including stock-based  compensation, see Note 1) |       | 14,776                                     |       | 10,812                                              |       | 41,603 |   | 28,252 |   |
| Amortization of intangible assets                                                 |       | 5,252                                      |       | 4,395                                               |       | 16,884 |   | 12,752 |   |
| Total operating expenses                                                          |       | 110,144                                    |       | 90,188                                              |       | 330,351 |   | 268,540 |   |
| Operating income                                                                  |       | 22,634                                     |       | 20,516                                              |       | 64,478 |   | 60,457 |   |
| Interest and  other income, net                                                   |       | 1,675                                      |       | 1,380                                               |       | 4,684 |   | 4,236 |   |
| Interest expense                                                                  |       | (1,388                                     | )          | (321                                                | )          | (4,745 | ) | (946 | ) |
| Income before  income taxes                                                       |       | 22,921                                     |       | 21,575                                              |       | 64,417 |   | 63,747 |   |
| Provision for  income taxes                                                       |       | 10,327                                     |       | 8,955                                               |       | 29,664 |   | 26,456 |   |
| Net income                                                                        |       | $                                          | 12,594     |                                                | $          | 12,620 |   | $ | 34,753 |   | $ | 37,291 |   |
| Net income per  share—basic                                                  |       | $                                          | 0.21       |                                                | $          | 0.21 |   | $ | 0.57 |   | $ | 0.60 |   |
| Net income per  share—diluted                                                |       | $                                          | 0.20       |                                                | $          | 0.19 |   | $ | 0.55 |   | $ | 0.56 |   |
| Shares used to calculate  basic net income per share                              |       | 61,399                                     |       | 61,183                                              |       | 60,878 |   | 61,772 |   |
| Shares used to calculate  diluted net income per share                            |       | 64,107                                     |       | 64,955                                              |       | 63,416 |   | 66,178 |   |

 

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

4

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

| ** **                                                                                                                                                                                                                                                         | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                         | ** ** | **2005**                                   | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                                                                                                                                                                                                                                         |       | $                                          | 12,594     |                                                | $          | 12,620 |   | $ | 34,753 |   | $ | 37,291 |   |
| Unrealized gain  (loss) on short-term investments, net of tax of $(63) and $(173),  respectively, for the quarter and nine months ended September 30, 2005  and $265 and $(210), respectively, for the quarter and nine months ended  September 30, 2004 |       | (86                                        | )          | 386                                                 |       | (248 | ) | (1,313 | ) |
| Unrealized gain  on derivative, net of tax of $60 and $47 for the quarter and nine months  ended September 30, 2005, respectively                                                                                                                             |       | 82                                         |       | —                                              |       | 62 |   | — |   |
| Foreign currency  translation                                                                                                                                                                                                                                      |       | 4                                          |       | —                                              |       | (83 | ) | — |   |
| Comprehensive income                                                                                                                                                                                                                                               |       | $                                          | 12,594     |                                                | $          | 13,006 |   | $ | 34,484 |   | $ | 35,978 |   |

 

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

5

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**UNITEDONLINE, INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

| ** **                                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                                |       |                                                |       |   |   |
| Net income                                                                            |       | $                                                   | 34,753     |   | $ | 37,291 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:    |       |                                                |       |   |   |
| Depreciation and amortization                                                         |       | 27,862                                              |       | 18,732 |   |
| Stock-based compensation                                                              |       | 6,832                                               |       | 1,932 |   |
| Deferred taxes                                                                        |       | 1,385                                               |       | 4,641 |   |
| Tax benefits from stock options                                                       |       | 11,175                                              |       | 18,220 |   |
| Other                                                                                 |       | 770                                                 |       | 753 |   |
| Changes in  operating assets and liabilities (excluding the effects of acquisitions): |       |                                                |       |   |   |
| Accounts receivable                                                                   |       | (3,347                                              | )          | 943 |   |
| Other assets                                                                          |       | 3,570                                               |       | (3,448 | ) |
| Accounts payable and accrued liabilities                                              |       | 22,908                                              |       | 10,084 |   |
| Deferred revenue                                                                      |       | 6,215                                               |       | 1,882 |   |
| Other liabilities                                                                     |       | 2,153                                               |       | 1,189 |   |
| Net cash provided by operating activities                                             |       | 114,276                                             |       | 92,219 |   |
| Cash flows from  investing activities:                                                |       |                                                |       |   |   |
| Purchases of property and equipment                                                   |       | (16,454                                             | )          | (11,198 | ) |
| Purchases of rights, patents and trademarks                                           |       | (5,554                                              | )          | (916 | ) |
| Purchases of short-term investments                                                   |       | (282,718                                            | )          | (229,617 | ) |
| Proceeds from maturities of short-term investments                                    |       | 251,578                                             |       | 225,285 |   |
| Cash paid for acquisitions                                                            |       | (8,638                                              | )          | (11,934 | ) |
| Proceeds from sales of assets, net                                                    |       | —                                              |       | 92 |   |
| Net cash used for investing activities                                                |       | (61,786                                             | )          | (28,288 | ) |
| Cash flows from  financing activities:                                                |       |                                                |       |   |   |
| Payments on capital leases                                                            |       | (530                                                | )          | — |   |
| Payments on term loan                                                                 |       | (41,667                                             | )          | — |   |
| Proceeds from exercises of stock options                                              |       | 4,732                                               |       | 5,023 |   |
| Proceeds from employee stock purchase plan                                            |       | 1,678                                               |       | 1,636 |   |
| Payments of dividends                                                                 |       | (25,259                                             | )          | — |   |
| Repurchases of common stock                                                           |       | (14,206                                             | )          | (73,717 | ) |
| Net cash used for financing activities                                                |       | (75,252                                             | )          | (67,058 | ) |
| Effect of  exchange rate changes on cash and cash equivalents                         |       | (91                                                 | )          | — |   |
| Change in cash  and cash equivalents                                                  |       | (22,853                                             | )          | (3,127 | ) |
| Cash and cash  equivalents, beginning of period                                       |       | 56,512                                              |       | 8,908 |   |
| Cash and cash  equivalents, end of period                                             |       | $                                                   | 33,659     |   | $ | 5,781 |   |

 

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

6

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**UNITEDONLINE, INC.**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**1.   DESCRIPTION OF BUSINESS, BASIS OFPRESENTATION, SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTINGPRONOUNCEMENTS**

**Description of Business**

United Online, Inc. (“United Online” or the “Company”)is a leading provider of consumer Internet subscription services through anumber of brands, including NetZero, Juno and Classmates Online. The Company’spay services include dial-up Internet access, social-networking, VoIP telephony,personal Web-hosting, premium email services and online digital photo-sharing,among others. The Company also offers, at no charge, advertising-supportedversions of certain of its services. In addition, the Company offers marketersa broad array of Internet advertising products, including online marketresearch and measurement services.

United Online is aDelaware corporation that commenced operations in 2001 following the merger ofInternet access providers NetZero, Inc. and Juno Online Services, Inc.(the “Merger”). During 2004, the Company completed the acquisitions ofClassmates Online, Inc. (“Classmates”), a leading provider ofsocial-networking services, and the Web-hosting and domain name registrationbusiness of About Web Services, Inc. In March 2005, the Companyacquired certain assets related to PhotoSite, the online digital photo-sharingbusiness of Homestead Technologies, Inc. The Company’s corporateheadquarters are located in Woodland Hills, California, and the Company alsomaintains offices in Renton, Washington; New York, New York; San Francisco,California; Orem, Utah; Brisbane, California; Hyderabad, India; Munich,Germany; and Järfälla, Sweden.

**Basis of Presentation**

The accompanying consolidated financial statements forthe quarters and nine months ended September 30, 2005 and 2004, whichinclude United Online and its wholly-owned subsidiaries, are unauditedexcept for the balance sheet information at December 31, 2004, which isderived from the audited consolidated financial statements as filed with theSecurities and Exchange Commission (“SEC”) in the Company’s Annual Report on Form 10-Kon March 16, 2005. The Company’s interim financial statements have beenprepared in accordance with accounting principles generally accepted in the UnitedStates of America (“GAAP”) including those for interim financial informationand with the instructions for Form 10-Q and Article 10 ofRegulation S-X issued by the SEC. Accordingly, they do not include all of theinformation and note disclosures required by GAAP for complete financialstatements. The consolidated financial statements, in the opinion ofmanagement, reflect all adjustments (consisting only of normal recurringadjustments) that are necessary for a fair presentation of the results for the periodsshown. The results of operations for such periods are not necessarilyindicative of the results expected for any future periods.

The preparation offinancial statements in accordance with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent liabilities and the reported amountsof revenues and expenses. Actual results could differ from those estimates.These unaudited consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements and related notes for theyear ended December 31, 2004 included in the Company’s Annual Report on Form 10-Kfiled on March 16, 2005 with the SEC.

**Significant Accounting Policies**

*Stock-BasedCompensation*—The Companyaccounts for stock-based employee compensation arrangements in accordancewith the provisions of Accounting Principles Board (“APB”) Opinion No. 25,

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*Accountingfor Stock Issued to Employees*,Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”)44, Accounting for CertainTransactions Involving Stock Compensation,and Emerging Issues Task Force (“EITF”) Issue No. 00-23, Issues Related to the Accounting for StockCompensation under APB Opinion No. 25 and FIN No. 44  and complies with the disclosure provisions of SFAS No. 123,Accounting for Stock-BasedCompensation  and SFAS No. 148,Accounting for Stock-BasedCompensation—Transition and Disclosure, an amendment of FASB Statement No. 123.Under APB Opinion No. 25, employee stock-basedcompensation expense is recognized over the vesting period based on thedifference, if any, on the date of grant, between the fair value of the Company’sstock and the exercise price. The Company accounts for stock issued to non-employeesin accordance with the provisions of SFAS No. 123 and EITF Issue No. 96-18,Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services. Compensation expense is recorded in accordance with FIN No. 28, Accounting for Stock Appreciation Rights andOther Variable Stock Option or Award Plans, an interpretation of APB Opinions No. 15and 25.

As required by SFAS No. 148, the followingprovides pro forma net income and pro forma net income per common sharedisclosures for stock-based awards as if the fair-value-based method defined inSFAS No. 123 had been applied.

Thefair value of options granted has been estimated at the date of grant using theBlack-Scholes option-pricing model, using the following weighted-averageassumptions:

| ** **                | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                | ** ** | **2005**                                   | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Risk-free  interest rate  |       |                                       | 4          | %                                                   |       |   | 3 | % |   |   | 4 | % |   |   | 3 | % |   |
| Expected life (in  years) |       |                                       | 5          |                                                |       |   | 5 |   |   |   | 5 |   |   |   | 5 |   |   |
| Dividend yield            |       |                                       | 7          | %                                                   |       |   | 0 | % |   |   | 2 | % |   |   | 0 | % |   |
| Volatility                |       |                                       | 86         | %                                                   |       |   | 99 | % |   |   | 92 | % |   |   | 103 | % |   |

 

If thefair value based method had been applied in measuring stock-based compensationexpense, the pro forma effect on net income and net income per share would havebeen as follows (in thousands, except per share amounts):

| ** **                                                                                                   | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2005**                                   | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income, as  reported                                                                                     |       | $                                          | 12,594     |                                                | $          | 12,620 |   | $ | 34,753 |   | $ | 37,291 |   |
| Add: Stock-based  compensation included in net income, net of tax                                            |       | 2,517                                      |       | 716                                                 |       | 5,860 |   | 1,932 |   |
| Deduct: Total  stock-based compensation determined under fair value-based method  for all awards, net of tax |       | (5,389                                     | )          | (6,569                                              | )          | (15,099 | ) | (23,829 | ) |
| Pro forma net  income                                                                                        |       | $                                          | 9,722      |                                                | $          | 6,767 |   | $ | 25,514 |   | $ | 15,394 |   |
| Net income per  share—basic, as reported                                                                |       | $                                          | 0.21       |                                                | $          | 0.21 |   | $ | 0.57 |   | $ | 0.60 |   |
| Net income per  share—basic, pro forma                                                                  |       | $                                          | 0.16       |                                                | $          | 0.11 |   | $ | 0.42 |   | $ | 0.25 |   |
| Net income per  share—diluted, as reported                                                              |       | $                                          | 0.20       |                                                | $          | 0.19 |   | $ | 0.55 |   | $ | 0.56 |   |
| Net income per  share—diluted, pro forma                                                                |       | $                                          | 0.15       |                                                | $          | 0.10 |   | $ | 0.40 |   | $ | 0.23 |   |

 

8

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The following tablesummarizes stock-based compensation included in the following operatingexpenses (in thousands):

| ** **                      | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Operating  expenses:            |       |                                       |       |                                                |       |   |   |   |   |
| Cost of billable services       |       | $                                          | 49         |                                                | $          | — |   | $ | 131 |   | $ | — |   |
| Sales and marketing             |       | 297                                        |       | 124                                                 |       | 621 |   | 331 |   |
| Product development             |       | 329                                        |       | —                                              |       | 742 |   | — |   |
| General and administrative      |       | 2,162                                      |       | 592                                                 |       | 5,338 |   | 1,601 |   |
| Total stock-based  compensation |       | $                                          | 2,837      |                                                | $          | 716 |   | $ | 6,832 |   | $ | 1,932 |   |

 

*Reclassifications—**Certain*prior periodamounts have been reclassified to conform to the current period presentation.These changes had no impact on previously reported results of operations orstockholders’ equity.

**Recent Accounting Pronouncements**

In December 2004, the FASB issued SFAS No. 123R,*Share-Based Payment*. Thisstatement replaces SFAS No. 123 and supersedes APB Opinion No. 25.This statement requires that the cost resulting from all share-based paymenttransactions be recognized in the financial statements. This statementestablishes fair value as the measurement objective in accounting forshare-based payment arrangements and requires all entities to apply afair-value-based measurement method in accounting for share-based paymenttransactions with employees except for equity instruments held by employeeshare ownership plans. This statement also establishes fair value as themeasurement objective for transactions in which an entity acquires goods orservices from nonemployees in share-based payment transactions. This statementuses the terms compensation and payment in their broadest senses to refer tothe consideration paid for goods or services, regardless of whether thesupplier is an employee. SFAS No. 123R becomes effective in the March 2006quarter and is likely to have a material effect on the Company’s results ofoperations although the exact amount is not currently known.

At the required effective date, the Company will applythis statement using a modified version of prospective application. Under themodified prospective application, this statement applies to new awards and toawards modified, repurchased, or cancelled after the required effective date.Additionally, compensation cost for the portion of awards for which therequisite service has not been rendered that are outstanding as of the requiredeffective date will be recognized as the requisite service is rendered on orafter the required effective date. The compensation cost for that portion ofawards shall be based on the grant-date fair value of those awards ascalculated for either recognition or pro forma disclosures under SFAS No. 123.

In March 2005, the SEC issued Staff AccountingBulletin (“SAB”) No. 107, *Share-BasedPayment*. The interpretations in this SAB express views of the staffregarding the interaction between SFAS No. 123R and certain SEC rules andregulations and provide the staff’s views regarding the valuation ofshare-based payment arrangements for public companies. In particular, this SABprovides guidance related to share-based payment transactions withnonemployees, the transition from nonpublic to public entity status, valuationmethods (including assumptions such as expected volatility and expected term),the accounting for certain redeemable financial instruments issued undershare-based payment arrangements, the classification of compensation expense,non-GAAP financial measures, capitalization of compensation cost related toshare-based payment arrangements, the accounting for income tax effects ofshare-based payment arrangements upon adoption of SFAS No. 123R, themodification of employee share options prior to adoption of SFAS No. 123Rand disclosures in Management’s Discussion and Analysis (“MD&A”) subsequentto adoption of SFAS No. 123R.

9

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

**2.   ACQUISITIONS**

*PhotoSite*

In March 2005, theCompany acquired certain assets related to PhotoSite, the online digitalphoto-sharing business of Homestead Technologies, Inc., for approximately$10.1 million in cash, including acquisition costs, and entered into a relatedlicensing and support agreement with Homestead Technologies. Included in thepurchase price of $10.1 million is a $1.5 million payment due in March 2006,which is included in accrued liabilities at September 30, 2005. Theacquisition was accounted for under the purchase method in accordance with SFASNo. 141, *Business Combinations*.The primary reason for the acquisition was to acquire PhotoSite’s software andservices to expand the Company’s subscription offerings.

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

 

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The weighted averageamortizable life of the acquired intangible assets is 4.8 years. The $5.7million of goodwill acquired is deductible for tax purposes. The pro formaeffect of the transaction is immaterial to the consolidated financialstatements.

**3. BALANCE SHEET COMPONENTS**

**Short-Term Investments**

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

| ** **            | ** ** | **September 30, 2005** | ** ** |
|-----------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**              | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| U.S. corporate  notes |       | $                                | 50,044     |   |   | $ | 10 |   |   |   | $ | (26 | ) |   | $ | 50,028 |   |
| Government  agencies  |       | 157,738                          |       |   | — |   |   |   | (432 | ) |   | 157,306 |   |
| Total                 |       | $                                | 207,782    |   |   | $ | 10 |   |   |   | $ | (458 | ) |   | $ | 207,334 |   |

 

TheCompany has reclassified certain Auction Rate securities from cash and cashequivalents to short-term investments. Auction Rate securities are variablerate bonds tied to short-term interest rates with maturities on the face of thesecurities in excess of 90 days. Auction Rate securities have interest rateresets through a modified Dutch auction, at predetermined short-term intervals,usually every 7, 28 or 35 days. They are traded at par and the interest paidduring a given period is based upon the interest rate determined during theprior auction. Although these securities are issued and rated as long-termbonds, they are priced and traded as short-term instruments due to theliquidity provided through the interest rate reset. The Company hashistorically classified these instruments as cash and cash equivalents if theperiod between interest rate resets was 90 days or less. Based on the Company’sre-evaluation of the maturity dates associated with the underlying bonds, theCompany has reclassified its Auction Rate securities, previously classified ascash equivalents, as short-term investments on its consolidated balance sheetat September 30, 2004. In addition, certain amounts were reclassified inthe consolidated statements of cash flows for the nine months ended September 30,2004.

| ** **            | ** ** | **September 30, 2004** | ** ** |
|-----------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**              | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| U.S. corporate  notes |       | $                                | 17,559     |   |   | $ | 199 |   |   |   | $ | (6 | ) |   | $ | 17,752 |   |
| Government  agencies  |       | 178,740                          |       |   | 519 |   |   |   | (147 | ) |   | 179,112 |   |
| Total                 |       | $                                | 196,299    |   |   | $ | 718 |   |   |   | $ | (153 | ) |   | $ | 196,864 |   |

 

| ** **            | ** ** | **September 30, 2004  (prior to reclass)** | ** ** |
|-----------------------|------------|----------------------------------------------------------------|------------|
| ** **            | ** ** | **Amortized  Cost**                                            | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
| U.S. corporate  notes |       | $                                                              | 17,559     |   |   | $ | 199 |   |   |   | $ | (6 | ) |   | $ | 17,752 |   |
| Government  agencies  |       | 121,115                                                        |       |   | 519 |   |   |   | (147 | ) |   | 121,487 |   |
| Total                 |       | $                                                              | 138,674    |   |   | $ | 718 |   |   |   | $ | (153 | ) |   | $ | 139,239 |   |

 

Gross unrealized gains and losses are presented net oftax in accumulated other comprehensive loss on the consolidated balance sheets.The Company had no material realized gains or losses from the sale ofshort-term investments in the nine months ended September 30, 2005. TheCompany recognized $25,000 and $0.1 million, respectively, of realizedgains from the sale of short-term investments in the quarter and nine monthsended September 30, 2004.

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

| ** **                           | ** ** | **September 30, 2005** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**              | ** ** | **Estimated  Fair  Value** | ** ** |
| Maturing within 1  year              |       | $                                | 73,988     |   | $ | 73,924 |   |
| Maturing between  1 year and 4 years |       | 57,608                           |       | 57,223 |   |
| Maturing after 4  years              |       | 76,186                           |       | 76,187 |   |
| Total                                |       | $                                | 207,782    |   | $ | 207,334 |   |

 

| ** **                           | ** ** | **September 30, 2004** | ** ** | **September 30, 2004  (prior to reclass)** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**              | ** ** | **Estimated  Fair  Value**                                     | ** ** | **AmortizedCost** | ** ** | **Estimated  Fair  Value** | ** ** |
| Maturing within 1  year              |       | $                                | 14,520     |                                                           | $          | 14,527 |   | $ | 14,520 |   | $ | 14,527 |   |
| Maturing between  1 year and 4 years |       | 124,154                          |       | 124,712                                                        |       | 124,154 |   | 124,712 |   |
| Maturing after 4  years              |       | 57,625                           |       | 57,625                                                         |       | — |   | — |   |
| Total                                |       | $                                | 196,299    |                                                           | $          | 196,864 |   | $ | 138,674 |   | $ | 139,239 |   |

 

**Accounts receivable**

At September 30, 2005, two customers comprisedapproximately 19% and 11% of the consolidated accounts receivable balance. At December 31,2004, two customers comprised approximately 18% and 14% of the consolidatedaccounts receivable balance. For the quarter and nine months ended September 30,2005 and 2004, the Company did not have any individual customers that comprisedmore than 10% of total revenues.

**Goodwill**

Thechanges in goodwill for the nine months ended September 30, 2005 were asfollows (in thousands):

| Balance at  December 31, 2004                          |   | $      | 76,458 |   |
|-------------------------------------------------------------|--------|--------|--------|--------|
| Adjustment to Classmates’ goodwill                     |   | (1,697 | )      |
| Goodwill recorded in connection with PhotoSite  acquisition |   | 5,738  |   |
| Balance at  September 30, 2005                         |   | $      | 80,499 |   |

 

The decrease inClassmates’ goodwill relates primarily to an increase in deferred tax assetsfor tax benefits associated with deductions identified in the March 2005quarter and a reduction in the September 2005 quarter in deferred taxliabilities due to an adjustment in the state income tax rate expected to applyto future reversals of acquired book/tax basis differences.

**Accrued Liabilities**

Accruedliabilities consist of the following (in thousands):

| ** **                                  | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Employee  compensation and related expenses |       |                         | $          | 17,414                      |       |   |   | $ | 11,459 |   |   |
| Income taxes  payable                       |       |                         | 13,242     |                        |       |   | 1,119 |   |   |
| Subscriber referral  fees                   |       |                         | 4,281      |                        |       |   | 4,281 |   |   |
| Other                                       |       |                         | 2,165      |                        |       |   | 1,461 |   |   |
| Total                                       |       |                         | $          | 37,102                      |       |   |   | $ | 18,320 |   |   |

 

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**TermLoan and Interest Rate Cap**

In December 2004,the Company borrowed $100 million through a term loan facility dated December 3,2004. Interest accrues at rates generally equal to the London inter-bankoffered rate (LIBOR) for dollar deposits plus a margin of 3.0%.

During the nine monthsended September 30, 2005, the Company made voluntary prepayments of$28.8 million on the term loan. The prepayments will reduce futureprincipal repayments on a pro rata basis.

Within ninety days aftereach fiscal year end, we are required to make a payment on the term loan equalto one half of our excess cash flow as defined in the term loan agreement.Excess cash flow is equal to our cash flows from operating activities for theprior year reduced by certain items, including capital expenditures, term loanrepayments, cash paid for acquisitions and dividend payments. This payment isin addition to the mandatory quarterly repayment.

The term loan agreementcontains certain financial and other covenants that place restrictions onadditional indebtedness by the Company, liens against the Company’s assets,payment of dividends, consolidation, merger, purchase or sale of assets,capital expenditures, investments and acquisitions. Under the terms of the termloan agreement, there are annual limitations on repurchases of common stock andthe payment of dividends (see Note 4).

On January 31, 2005,the Company purchased an interest-rate cap to reduce the variability in theamount of expected future cash interest payments that are attributable toLIBOR-based market interest rates. The interest-rate cap is designated andqualifies as a cash flow hedge. The Company paid a $0.2 million premium toenter into the cap, which provides protection through January 31, 2007 on$25 million of the Company’s outstanding term loan balance. The capprotects the Company from an increase in three month LIBOR over 3.5% on $25million of borrowings over a two-year term. Changes in the fair value of theeffective portion of the cap are recognized in accumulated other comprehensiveincome. Should the cap become ineffective as a hedge, gains and losses would berecognized in the results of operations in that period. The Company recognizedan unrealized gain of approximately $0.1 million in accumulated other comprehensiveincome during the quarter and nine months ended September 30, 2005 relatedto the effective portion of the cash flow hedge as the cap was consideredperfectly effective during the nine months ended September 30, 2005.Amounts in accumulated other comprehensive income will be reclassified intoearnings in the same periods during which the future hedged cash interestpayments affect earnings.

**4.   STOCKHOLDERS’EQUITY**

*Common StockRepurchase Program*

The Company’s Board ofDirectors authorized a common stock repurchase program that allows the Companyto repurchase shares of its common stock through open market or privatelynegotiated transactions based on prevailing market conditions and otherfactors. From time to time, the Board of Directors has increased the amountauthorized for repurchase under this program. On April 22, 2004, the Boardof Directors authorized the Company to purchase up to an additional$100 million of its 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, 2005, the Companyhad repurchased $139.2 million of its common stock under the program.

Under the term loanagreement, repurchases of common stock and the payment of cash dividends arelimited, in aggregate, to an additional $110.1 million at September 30,2005, subject to further annual limitations. As a result of these limitations,the company may be unable to repurchase the remaining $60.8 millionavailable under the program if it maintains a quarterly cash dividend of $0.20per share and 

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does notrepay or amend the terms of the term loan agreement. Additionally, in order torepurchase any common stock, no default or event of default shall have occurredand be continuing under the term loan agreement. Noncompliance with thefinancial covenants set forth in the agreement constitutes an event of defaultunder the agreement.

Sharerepurchases executed under the common stock repurchase program at September 30,2005 were as follows (in thousands, except per share amounts):

| **Period**         | ** ** | ** ** | ** ** | **Shares  Repurchased(1)** | ** ** | **Average Price  Paid per Share** | ** ** | **Maximum Approximate  Dollar Value that May  Yet be Purchased Under the  Program** | ** ** |
|--------------------|------------|------------|------------|----------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
| August 2001   |       |       | 138        |                       |       |                                             | $          | 1.67                                                                                                                        |       |   |   | $ | 9,770 |   |   |
| November 2001 |       |       | 469        |                       |       |                                             | 1.77       |                                                                                                                        |       |   | 8,940 |   |   |
| February 2002 |       |       | 727        |                       |       |                                             | 3.38       |                                                                                                                        |       |   | 6,485 |   |   |
| August 2002   |       |       | 288        |                       |       |                                             | 7.51       |                                                                                                                        |       |   | 27,820 |   |   |
| February 2003 |       |       | 193        |                       |       |                                             | 9.43       |                                                                                                                        |       |   | 26,005 |   |   |
| May 2003      |       |       | 281        |                       |       |                                             | 13.51      |                                                                                                                        |       |   | 22,207 |   |   |
| November 2003 |       |       | 2,024      |                       |       |                                             | 19.76      |                                                                                                                        |       |   | 48,706 |   |   |
| February 2004 |       |       | 2,887      |                       |       |                                             | 16.86      |                                                                                                                        |       |   | — |   |   |
| May 2004      |       |       | —     |                       |       |                                             | —     |                                                                                                                        |       |   | 100,000 |   |   |
| August 2004   |       |       | 2,657      |                       |       |                                             | 9.41       |                                                                                                                        |       |   | 74,989 |   |   |
| February 2005 |       |       | 1,268      |                       |       |                                             | 11.20      |                                                                                                                        |       |   | 60,782 |   |   |
| Total              |       |       | 10,932     |                       |       |                                             | $          | 12.74                                                                                                                       |       |   |   |   |   |   |

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(1)          Allshares were repurchased as part of a publicly announced program.

*Dividends*

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

The next quarterly dividend is payable on November 30,2005 to shareholders of record as of the close of business on November 11,2005. While the Company intends to pay regular dividends for the foreseeablefuture, the declaration and payment of future dividends are discretionary andwill be subject to determination by the Board of Directors each quarterfollowing its review of the Company’s financial performance. Dividends declaredand paid are not a return of profits but rather a distribution of amounts paidin by the stockholders.

Under the term loanagreement, repurchases of common stock and the payment of cash dividends arelimited, in aggregate, to an additional $110.1 million at September 30,2005, subject to further annual limitations. Assuming the Company does notrepurchase any additional common stock, these limitations would restrict theCompany’s ability to pay the full quarterly cash dividend of $0.20 per share bythe second half of 2007 without amending the term loan agreement or repayingthe then remaining balance. Additionally, in order to pay dividends, no defaultor event of default shall have occurred and be continuing under the term loanagreement. Noncompliance with the financial covenants set forth in theagreement constitutes an event of default under the agreement.

*Equity Awards*

In March 2005, the Company issued approximately1.0 million restricted stock units (“RSUs”) to certain of the Company’sexecutive officers. Each RSU entitles the officer to receive one share of theCompany’s common stock upon vesting. The units vest 25% annually over thefour-year period beginning 

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February 15, 2005. Inconnection with these units, the Company recorded deferred stock-basedcompensation of $11.0 million, which is being amortized over the vestingperiod.

In March 2005, the Company issued approximately0.4 million additional RSUs to its other employees. Each RSU entitles theemployee to receive one share of the Company’s common stock upon vesting. Theunits vest 25% on February 15, 2006 and quarterly thereafter for threeyears. In connection with these units, the Company recorded deferredstock-based compensation of $3.7 million, which is being amortized overthe vesting period.

In March 2005, the Company approved stock optiongrants of 1.3 million shares to the Company’s employees with exerciseprices ranging from $10.55 per share to $10.58 per share. The options vest 25%on February 15, 2006 and monthly thereafter for three years.

In April 2005, the Company issued 37,500 RSUs tomembers of its Board of Directors. Each RSU entitles the Board member toreceive one share of the Company’s common stock upon vesting. The units vest100% on February 15, 2006. In connection with these units, the Companyrecorded deferred stock-based compensation of approximately $0.3 million, whichis being amortized over the vesting period.

In August 2005, theCompany approved stock option grants of 0.3 million to certain of theCompany’s executive officers with exercise prices ranging from $11.77 per shareto $12.47 per share. The options vest 25% after one year and monthly thereafterfor three years. In addition, the Company issued 0.2 million RSUs to theseexecutive officers. Each RSU entitles the officer to receive one share of the Company’scommon stock upon vesting. The units vest 25% annually over the four-yearperiod beginning August 15, 2005. In connection with these units, theCompany recorded deferred stock-based compensation of $2.5 million, whichis being amortized over the vesting period.

**5.**   EARNINGSPER SHARE

Thefollowing table sets forth the computation of basic and diluted net income pershare for the quarters and nine months ended September 30, 2005 and 2004(in thousands, except per share amounts):

| ** **                                                                                        | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                                   | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Numerator:                                                                                        |       |                                       |       |                                                |       |   |   |   |   |
| Net income                                                                                        |       | $                                          | 12,594     |                                                | $          | 12,620 |   | $ | 34,753 |   | $ | 37,291 |   |
| Denominator:                                                                                      |       |                                       |       |                                                |       |   |   |   |   |
| Weighted average common shares—basic                                                         |       | 61,920                                     |       | 61,775                                              |       | 61,394 |   | 62,397 |   |
| Adjustment to weighted average for common shares  subject to repurchase                           |       | (521                                       | )          | (592                                                | )          | (516 | ) | (625 | ) |
| Adjusted weighted average common shares—basic                                                |       | 61,399                                     |       | 61,183                                              |       | 60,878 |   | 61,772 |   |
| Effect of  dilutive securities:                                                                   |       |                                       |       |                                                |       |   |   |   |   |
| Stock options, restricted shares, restricted stock  units and employee stock purchase plan shares |       | 2,708                                      |       | 3,772                                               |       | 2,538 |   | 4,406 |   |
| Weighted average common shares—diluted                                                       |       | 64,107                                     |       | 64,955                                              |       | 63,416 |   | 66,178 |   |
| Net income per  share—basic                                                                  |       | $                                          | 0.21       |                                                | $          | 0.21 |   | $ | 0.57 |   | $ | 0.60 |   |
| Net income per  share—diluted                                                                |       | $                                          | 0.20       |                                                | $          | 0.19 |   | $ | 0.55 |   | $ | 0.56 |   |

 

The diluted per sharecomputations exclude options, restricted stock and RSUs, which areantidilutive. The number of antidilutive shares at September 30, 2005 and2004 was 6.9 million and 5.9 million, respectively. At September 30,2005, there were approximately 11.9 million shares subject to issuanceupon exercise of outstanding options with a weighted average exercise price of$13.05 per share. At September 30, 2005, there were approximately1.6 million RSUs outstanding.

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**6.**   EMPLOYEEBENEFIT PLANS

The Company has a savingsplan (the “Savings Plan”) that qualifies as a defined contribution plan under Section 401(k) ofthe Internal Revenue Code. Under the Savings Plan, participating employees maydefer a percentage (not to exceed 40%) of their eligible pre-tax earnings up tothe Internal Revenue Service annual contribution limit. All full-time employeeson the payroll of the Company may, subject to certain eligibility requirements,participate in the Plan. At December 31, 2004, the Company had made nocontributions since the inception of the Savings Plan; however, on January 1,2005, the Company began matching 25% of the employee’s contributions, up toplan limits. The Company recognized expenses of approximately $0.1 million and $0.5million during the quarter and nine months ended September 30, 2005related to the 401(k) match.

**7.**   INCOMETAXES

For the quarter and ninemonths ended September 30, 2005, the Company generated pre-tax income of$22.9 million and $64.4 million, respectively, and recorded a taxprovision of $10.3 million and $29.7 million, respectively, resultingin a year-to-date effective tax rate of approximately 46.0%. For the quarterand nine months ended September 30, 2004, the Company generated pre-taxincome of $21.6 million and $63.7 million, respectively, and recorded atax provision of $9.0 million and $26.5 million, respectively,resulting in a year-to-date effective tax rate of approximately 41.5%. Theincrease in the effective tax rate is primarily due to the issuance ofrestricted stock units in March 2005, for which the related compensationdeduction is limited under Section 162(m) of the Internal RevenueCode; foreign losses, the benefit of which is not currently recognizable due touncertainty regarding realization; and the re-measurement of certain deferredtax assets as a result of a change in New York State tax law that occurredduring the June 2005 quarter. This re-measurement resulted in an increaseto the tax provision for the nine months ended September 30, 2005 byapproximately $1.0 million, or 1.6%.

**8.**   COMMITMENTSAND CONTINGENCIES

*FinancialCommitments*

TheCompany’s financial commitments at September 30, 2005 are as follows (inthousands):

| ** **                       | ** ** | ** ** | ** ** | **Oct-Dec** | ** ** | **Year Ending December 31,** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|-------------|------------|---------------------------------------------|------------|------------|------------|
| **Contractual Obligations** | ** ** | ** ** | ** ** | **Total**   | ** ** | **2005**                                    | ** ** | **2006**   | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
| Term loan(1)                     |       | $          | 58,333     |        | $          | 4,125                                       |       | $          | 16,498     |   | $ | 16,498 |   | $ | 21,212 |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Capital leases(2)                |       | 832        |       | 100         |       | 399                                         |       | 333        |       | — |   | — |   | — |   |   | — |   |   |
| Operating leases                 |       | 47,043     |       | 1,659       |       | 6,724                                       |       | 6,898      |       | 6,904 |   | 5,820 |   | 4,238 |   |   | 14,800 |   |   |
| Telecommunications  purchases    |       | 22,259     |       | 3,182       |       | 10,585                                      |       | 8,492      |       | — |   | — |   | — |   |   | — |   |   |
| Media purchases                  |       | 7,372      |       | 7,372       |       | —                                      |       | —     |       | — |   | — |   | — |   |   | — |   |   |
| Total                            |       | $          | 135,839    |        | $          | 16,438                                      |       | $          | 34,206     |   | $ | 32,221 |   | $ | 28,116 |   | $ | 5,820 |   | $ | 4,238 |   |   | $ | 14,800 |   |   |
|                                  |            |            |            |             |            |                                             |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Thevariable-rate term loan accrues interest at rates generally equal to the Londoninter-bank offered rate (LIBOR) for dollar deposits plus a margin of 3.0%. Thetable reflects only principal amounts. See Note 3 to the condensedconsolidated financial statements.

(2)          Includes$43,000 of imputed interest.

The Company leases itsfacilities under operating leases expiring at various periods through 2014. Theleases generally contain annual escalation provisions as well as renewaloptions.

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*Legal Contingencies*

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 theunderwriters agreed to allocate NetZero shares to those customers in the offeringin exchange for which the customers agreed to purchase additional NetZeroshares in the aftermarket at pre-determined prices. Plaintiffs are seekinginjunctive relief and damages. Additional lawsuits setting forth substantiallysimilar allegations were also served against NetZero on behalf of additionalplaintiffs in April and May 2001. The case against NetZero wasconsolidated with approximately 300 other suits filed against more than 300issuers that conducted their initial public offerings between 1998 and 2000,their underwriters and an unspecified number of their individual corporateofficers and directors. In a court order dated February 15, 2005, theDistrict Court 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 is scheduled for April 24,2006.

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. 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 has commenced. No trial date has been set.At September 30, 2005, the Company had liabilities recorded ofapproximately $5.5 million in respect of this matter.

On April 27, 2004, plaintiff MyMail Ltd.filed a lawsuit in the United States District Court for the Eastern District ofTexas against NetZero, Juno, NetBrands, America Online, Inc., AT&T,EarthLink, Inc., SBC Communications, Inc., and Verizon Communications, Inc.alleging infringement of plaintiff’s patent which purports to cover user accessto a computer network. On October 28, 2005, the court issued an ordergranting defendants’ motions for summary judgment of non-infringement of thepatent.

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 the Company does not believe the outcomeof the above outstanding legal proceedings, claims and litigation will have amaterial adverse 

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effect on its business,financial position, results of operations or cash flows, the results oflitigation 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 established a reserve for the Freewwweb matterdiscussed above and such reserve is reflected in the consolidated financialstatements, though the Company can provide no assurance that such reserve willbe adequate.

The Company is subject to various other legalproceedings and claims that arise in the ordinary course of business.Management believes the amount and ultimate liability, if any, with respect tothese actions will not materially affect the Company’s business, financialposition, results of operations or cash flows. There can be no assurance,however, that such actions will not be material or adversely affect the Company’sbusiness, financial position, results of operations or cash flows.

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

**Overview**

We are a leading providerof consumer Internet subscription services through a number of brands,including NetZero, Juno and Classmates Online. Our pay services include dial-upInternet access, social-networking, VoIP telephony, personal Web-hosting,premium email and online digital photo-sharing, among others. We also offer, atno charge, advertising-supported versions of certain of our services. In addition,we offer marketers a broad array of Internet advertising products, includingonline market research and measurement services.

At September 30,2005, we had approximately 5.0 million pay accounts representing approximately6.4 million total subscriptions, and approximately 16.9 million activeaccounts. A pay account represents a unique billing relationship with acustomer who subscribes to one or more of our pay services. “Active” accountsinclude total pay accounts as well as free users who have logged onto ouraccess, social-networking or email services during the preceding 31 days.Active accounts also include those free hosted Web sites that have received atleast one visit during the preceding 90 days and the number of freephoto-sharing users that logged on to the service at least once within thepreceding 90 days.

United Online is aDelaware corporation that commenced operations in 2001 following the merger ofInternet access providers NetZero, Inc. and Juno Online Services, Inc.(the “Merger”). We completed the acquisition of Classmates Online, Inc. (“Classmates”),a leading provider of social-networking services, in November 2004 and theacquisition of the Web-hosting and domain name registration business of AboutWeb Services, Inc. in April 2004. In March 2005, we acquiredcertain assets related to PhotoSite, the online digital photo-sharing businessof Homestead Technologies, Inc. In October 2005, we launched our VoIPtelephony service. Our corporate headquarters are located in Woodland Hills, California.

**ConsumerBrands and Services**

We offer a variety ofconsumer Internet services under a number of brands, both free of charge andsubscription-based, which include the following:

*Internet Access:*   NetZero,Juno and BlueLight Internet;

*Social Networking:*   Classmatesand StayFriends;

*VoIP:*   NetZeroVoice

*Web Hosting:*   FreeServers,50megs, Bizhosting and Global Servers;

*Premium Email:*   NetZeroMegaMail, Juno MegaMail and emailMyName;

*Online Photos:*   PhotoSite;and

*Premium Content:*   NetZeroFamily Pack and Juno Family Pack.

*Internet Access*

Our standard pay accessservices include Internet access and an email account and are offered throughvarious pricing plans, generally $9.95 per month. We also offer “accelerated”access services, generally for an additional $5.00 per month, or a totalmonthly charge of $14.95. Our accelerated access services utilize compression,caching and other technologies that reduce the time for certain Web pages todownload to users’ computers when compared to our standard access services. Theprice for our accelerated access services also includes certain additionalbenefits such as pop-up blocking capabilities and enhanced email storage.Internet access comprised approximately 3.0 million of our pay accounts atSeptember 30, 2005, of which approximately 40% also subscribed to ouraccelerator services. We count a subscriber to our accelerator services as onepay account and two subscriptions, one for the Internet access 

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andanother for the accelerator. The NetZero and Juno pay access services differfrom their respective free access services in that the hourly and certain otherlimitations set for the free services do not apply. In addition, the freeaccess services incorporate certain advertising initiatives, including apersistent advertising banner, not present on the pay services. We do not offerfree access services under the BlueLight brand. Our access services areavailable in more than 8,200 cities across the United States and Canada.

*Social Networking*

Connecting millions ofusers primarily across the United States and, to a lesser extent, Canada,Germany and Sweden, our social-networking services provide a platform toacquire, organize and present user-generated content. Membership in ournetworking service is free and allows users to post a personal profile, accessand search our database of other registered members and conveniently search andreview personally relevant online communities from school, work and themilitary. Our pay service also enables subscribers to communicate with othermembers and is offered through various pricing plans, generally $39.00 per yearor $15.00 for three months. Our social-networking properties also containseveral advertising initiatives throughout their Web sites.

*VoIP*

NetZero Voice, aVoice-over-Internet Protocol (VoIP) telephony service, provides local and longdistance calling over dial-up and broadband Internet connections. We offer afree version of NetZero Voice which enables all users of our VoIP software tomake unlimited Internet calls and instant text messages to one another at nocharge and includes a free voicemail account integrated with email into oneconvenient message center. Our pay VoIP service plans offer all of the featuresof the free service and include: (1) a $3.95 per month plan which includesa dedicated phone number with  up to 100monthly outbound and inbound minutes to the publicly switched telephone network(PSTN) within the US, Canada and Puerto Rico; (2) a $9.95 per month planwhich includes all of the features of the $3.95 plan plus up to 250 monthlyoutbound minutes to the US, Canada and Puerto Rico and unlimited inbound PSTNminutes; and (3) a $14.95 per month plan which includes a dedicated phonenumber plus unlimited outbound PSTN minutes within the US, Canada and PuertoRico and unlimited inbound PSTN minutes; and (4) a “pay as you go” planwhere PSTN calling minutes can be purchased in $5, $10, $25 and $50 increments.In addition, NetZero Voice offers international PSTN calling at attractivelypriced rates per minute and a number of other features such as call forwarding.

*Web Hosting*

Our Web-hosting services,which include domain name registration services, are offered through variouspricing plans, generally $7.99 per month. A limited version of the service isoffered free of charge.

*Premium Email*

NetZero and Juno offerpremium email services with expanded features and storage capabilities throughvarious pricing plans, generally $9.95 per year. We also offer personalized,vanity email services with enhanced features and storage for $1.99 per month.

*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. A limited version of theservice is offered free of charge.

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*Premium Content*

The Family Pack of premiumcontent bundles together leading family-orientated subscription services and isoffered to subscribers through our NetZero and Juno brands for $4.95 per month.

**Advertising Services**

The United OnlineAdvertising Network connects advertisers to consumers through a variety ofonline marketing properties and channels integrated throughout our services.Our advertising and e-commerce products include a broad range of targetingtechniques for online advertising, email campaigns, start-page placementsand channel sponsorship opportunities, and the ability to deliver videocommercials online. We also provide consumers convenient access to third party Internetsearch services from many of our Web properties and services, and we generate asignificant portion of our advertising and commerce revenues from such searchservices. In addition, we offer advertisers sophisticated market researchcapabilities through our CyberTarget division, which can design and executecustomized, real-time market research in an Internet environment and helpadvertisers better understand their target audience.

**Pay Accounts and Subscriptions**

Thefollowing table sets forth (in thousands), for the periods presented, ananalysis of our pay accounts and subscriptions. A pay account represents aunique billing relationship with a customer who subscribes to one or more ofour services. A subscription represents a unique subscription to any individualpay service offered by us including Internet access, social-networking,accelerator services, premium email, Web-hosting and domain name registration,premium content and online photo-sharing subscriptions. Internet access andaccelerator are counted as two subscriptions, although most subscribers to theaccelerated service currently purchase it bundled with our standard Internetaccess. While we currently consider our non-access services to includesocial-networking, premium email, Web-hosting and domain name registration,premium content, photo-sharing and VoIP, certain of these services are derivedfrom, or dependent on, our access services.

| ** **           | ** ** | **September 30,  2005** | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** | **September 30,  2004** | ** ** |
|----------------------|------------|------------------------------|------------|-------------------------|------------|--------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Pay Accounts:        |       |                         |       |                    |       |                     |       |                        |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Internet access      |       |                         | 2,980      |                    |       |                     | 3,078      |                        |       |                         | 3,130      |   |   |   | 3,100 |   |   |   | 3,111 |   |   |
| Non-access  services |       |                         | 2,060      |                    |       |                     | 1,955      |                        |       |                         | 1,822      |   |   |   | 1,726 |   |   |   | 121 |   |   |
| Total pay  accounts  |       |                         | 5,040      |                    |       |                     | 5,033      |                        |       |                         | 4,952      |   |   |   | 4,826 |   |   |   | 3,232 |   |   |
| Subscriptions:       |       |                         |       |                    |       |                     |       |                        |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Internet access      |       |                         | 2,980      |                    |       |                     | 3,078      |                        |       |                         | 3,130      |   |   |   | 3,100 |   |   |   | 3,111 |   |   |
| Accelerator          |       |                         | 1,205      |                    |       |                     | 1,196      |                        |       |                         | 1,170      |   |   |   | 1,105 |   |   |   | 1,074 |   |   |
| Non-access  services |       |                         | 2,186      |                    |       |                     | 2,064      |                        |       |                         | 1,900      |   |   |   | 1,781 |   |   |   | 165 |   |   |
| Total subscriptions  |       |                         | 6,371      |                    |       |                     | 6,338      |                        |       |                         | 6,200      |   |   |   | 5,986 |   |   |   | 4,350 |   |   |

 

In general we count and track pay accounts and freeaccounts by unique member identification. Users have the ability to registerfor separate services under separate brands and member identificationsindependently. We do not track whether a pay account has purchased more thanone of our services unless the account uses the same member identification. Asa result, unique pay accounts may not represent unique subscribers and,similarly, 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 

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the account. At any pointin time, our pay account base includes a number of accounts receiving a freeperiod of service as either a promotion or retention tool, a number of accountsthat have notified us that they are terminating their service but whose serviceis still in effect and may also include a few thousand internal test accounts.During the quarter ended September 30, 2005, we implemented an update toour billing reporting software, which resulted in a positive adjustment of12,000 pay access accounts and 15,000 subscriptions.

We have experienceddeclines in our pay access accounts and currently anticipate that our payaccess accounts will continue to decline in the future. In addition, the rateof growth in subscriptions to our accelerator access services has decreased andwe anticipate declines in subscriptions to these services in the future. Thedial-up Internet access market as a whole is decreasing, and the value-priced segmentis becoming increasingly competitive. We, as well as our competitors, havebecome more aggressive in offering discounts and free months of service toobtain and retain subscribers. While we intend to continue to devotesignificant resources to marketing our Internet access services, we havediversified our business by acquiring or developing a number of non-accessInternet services, including social-networking, VoIP, personal Web-hosting,premium email and content, and online digital photo-sharing. A significant partof our strategy is to enhance and market these services as well as to expandthe non-access services we offer by acquiring or developing new services. As aresult, we have shifted a greater portion of our management focus, marketing expendituresand product development initiatives away from Internet access to non-accessservices.

**Results of Operations**

Thefollowing table sets forth (with dollars in thousands), for the periodspresented, selected historical statements of operations data. The informationcontained in the table below is unaudited and should be read in conjunctionwith Liquidity and Capital Resources and Financial Commitments included in thisItem 2 as well as the condensed consolidated financial statements andnotes thereto included elsewhere in this Quarterly Report on Form 10-Q.

| ** **                                        | ** ** | **Quarter Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                  | ** ** | **2004**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Statements of Operations Data:** |       |                                      |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenues:                                         |       |                                      |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Billable services                                 |       | $                                         | 117,670    |                                               | 89         | % | $ | 102,113 |   | 92 | % | $ | 351,389 |   | 89 | % | $ | 302,291 |   | 92 | % |
| Advertising and  commerce                         |       | 15,108                                    |       | 11                                                 |       | 8,591 |   | 8 |   | 43,440 |   | 11 |   | 26,706 |   | 8 |   |
| Total revenues                                    |       | 132,778                                   |       | 100                                                |       | 110,704 |   | 100 |   | 394,829 |   | 100 |   | 328,997 |   | 100 |   |
| Operating expenses:                               |       |                                      |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of billable services                         |       | 24,375                                    |       | 18                                                 |       | 23,013 |   | 21 |   | 73,048 |   | 19 |   | 71,887 |   | 22 |   |
| Cost of free  services                            |       | 2,858                                     |       | 2                                                  |       | 1,605 |   | 1 |   | 9,383 |   | 2 |   | 4,919 |   | 1 |   |
| Sales and  marketing                              |       | 52,767                                    |       | 40                                                 |       | 43,294 |   | 39 |   | 160,653 |   | 41 |   | 131,274 |   | 40 |   |
| Product  development                              |       | 10,116                                    |       | 8                                                  |       | 7,069 |   | 6 |   | 28,780 |   | 7 |   | 19,456 |   | 6 |   |
| General and  administrative                       |       | 14,776                                    |       | 11                                                 |       | 10,812 |   | 10 |   | 41,603 |   | 11 |   | 28,252 |   | 9 |   |
| Amortization of  intangible assets                |       | 5,252                                     |       | 4                                                  |       | 4,395 |   | 4 |   | 16,884 |   | 4 |   | 12,752 |   | 4 |   |
| Total operating  expenses                         |       | 110,144                                   |       | 83                                                 |       | 90,188 |   | 81 |   | 330,351 |   | 84 |   | 268,540 |   | 82 |   |
| Operating income                                  |       | 22,634                                    |       | 17                                                 |       | 20,516 |   | 19 |   | 64,478 |   | 16 |   | 60,457 |   | 18 |   |
| Interest and other income, net                    |       | 1,675                                     |       | 1                                                  |       | 1,380 |   | 1 |   | 4,684 |   | 1 |   | 4,236 |   | 1 |   |
| Interest expense                                  |       | (1,388                                    | )          | (1                                                 | )          | (321 | ) | — |   | (4,745 | ) | (1 | ) | (946 | ) | — |   |
| Income before income taxes                        |       | 22,921                                    |       | 17                                                 |       | 21,575 |   | 19 |   | 64,417 |   | 16 |   | 63,747 |   | 19 |   |
| Provision for income taxes                        |       | 10,327                                    |       | 8                                                  |       | 8,955 |   | 8 |   | 29,664 |   | 8 |   | 26,456 |   | 8 |   |
| Net income                                        |       | $                                         | 12,594     |                                               | 9          | % | $ | 12,620 |   | 11 | % | $ | 34,753 |   | 9 | % | $ | 37,291 |   | 11 | % |

 

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**Revenues**

*Billable Services Revenues*

Billable services revenuesconsist of subscription fees charged to pay accounts for dial-up andaccelerated Internet access services, social-networking, Web-hosting and domainname registration services, premium email services, premium content,photo-sharing services and VoIP, although we did not generate any revenues fromVoIP in the quarter ended September 30, 2005 and do not anticipategenerating revenues from VoIP until the first quarter of 2006. In addition, wecharge fees for live telephone technical support. Our billable servicesrevenues are primarily dependent on two factors: the average number of payaccounts 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.Changes in our pay account base are dependent on a number of factors includingthe effects of acquisitions, if any, during a period; the effectiveness of ourmarketing and distribution activities; the effects of competition; the numberof free accounts upgrading to pay services, particularly during periods when weeffect changes to our free services; the number of pay accounts that canceltheir accounts or have their accounts terminated; changes in our marketing andrelated distribution channels; changes in our marketing expenditures; theeffects of seasonality; and the impact of new types of pay services. ARPU iscalculated by dividing billable services revenues for a period by the averagenumber of pay accounts for that period. ARPU may fluctuate from period toperiod as a result of a variety of factors including changes in the mix of paysubscriptions and their related pricing plans; the use of promotions, such asone or more free months of service, and discounted pricing plans to obtain orretain 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.

Billable services revenuesincreased by $15.6 million, or 15%, to $117.7 million for the quarterended September 30, 2005, compared to $102.1 million for the quarterended September 30, 2004. The increase in billable services revenues wasdue to an increase in our average number of pay accounts from 3,211,000 for thequarter ended September 30, 2004 to 5,036,000 for the quarter ended September 30,2005. The increase in the average number of pay accounts is primarilyattributable to the Classmates acquisition which had approximately 1,452,000pay accounts at the time of acquisition and, to a lesser extent, growth in payaccounts for the Classmates’ social networking services following theClassmates acquisition and growth in premium email and other non-accessaccounts. The increase in the average number of pay accounts was offsetpartially by a decrease in the number of pay access accounts which resulted ina decrease in revenues from our pay access services. This decrease in revenuesfrom our pay access services was partially offset by an increase in the numberof subscriptions to our accelerator services and, as a result, an increase inrevenues attributable to such services. The increase in billable servicesrevenues as a result of the increase in our average number of pay accounts wasoffset partially by a decrease in ARPU from $10.60 for the quarter ended September 30,2004 to $7.79 for the quarter ended September 30, 2005. The decrease inARPU is attributable to the increased percentage of non-access accounts as apercentage of total pay accounts since our non-access accounts generally have asignificantly lower ARPU. The decrease in ARPU is also attributable to a smalldecline in ARPU for our access services due to increased use of free months ofservice and promotional pricing to obtain or retain pay access accounts, offsetpartially by an increased number of subscriptions to our accelerator services.

For the quarter ended September 30,2005, approximately 17% of our billable services revenues were attributable tonon-access services as compared to approximately 2% for the quarter ended September 30,2004. We anticipate continued decreases in pay access accounts and increases innon-access accounts. As a result, we anticipate that an increasing percentageof our billable services revenues will be attributable to non-access services.However, because the ARPU for most of our non-access services is significantlylower 

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than theARPU for our access services, we anticipate a decrease in billable servicesrevenues, at least in the near term. We also anticipate continued declines inthe ARPU for our access services which will also adversely impact billableservices revenues.

Billable services revenuesincreased by $49.1 million, or 16%, to $351.4 million for the nine months endedSeptember 30, 2005, compared to $302.3 million for the nine months ended September 30,2004. The increase in billable services revenues was due to an increase in ouraverage number of pay accounts from 3,062,000 for the nine months ended September 30,2004 to 4,933,000 for the nine months ended September 30, 2005. Theincrease in the average number of pay accounts is primarily attributable to theClassmates acquisition which had approximately 1,452,000 pay accounts at thetime of acquisition and, to a lesser extent, growth in pay accounts for theClassmates’ social networking services following the Classmates acquisition andgrowth in premium email and other non-access accounts. The increase in theaverage number of pay accounts was partially offset by a decrease in the numberof pay access accounts which resulted in a decrease in revenues from our payaccess services. This decrease in revenues from our pay access services wasoffset partially by an increase in the number of subscriptions to ouraccelerator services and, as a result, an increase in revenues attributable tosuch services. The increase in billable services revenues as a result of theincrease in our average number of pay accounts was offset partially by adecrease in ARPU from $10.97 for the nine months ended September 30, 2004to $7.92 for the nine months ended September 30, 2005. The decrease inARPU is attributable to the increased percentage of non-access accounts as apercentage of total pay accounts since our non-access accounts generally have asignificantly lower ARPU. The decrease in ARPU is also attributable to a smalldecline in ARPU for our access services due to increased use of free months ofservice and promotional pricing to obtain or retain pay access accounts, offsetpartially by an increased number of subscriptions to our accelerator services.

For the nine months endedSeptember 30, 2005, approximately 15% of our billable services revenueswere attributable to non-access services as compared to approximately 1% forthe nine months ended September 30, 2004.

*Advertising andCommerce Revenues*

Our advertising and commerce revenues consist of feesfrom our Internet search partners that are generated as a result of our usersutilizing our partners’ Internet search services, fees generated by our usersviewing and clicking on third-party Web site advertisements and fees from referringour users to, and our users creating pay accounts or making purchases on,sponsors’ Web sites. We also generate revenues from providing third partieswith data analysis capabilities and traditional market research services, suchas surveys and questionnaires. Our advertising and commerce revenues aregenerated from our active account base, including our pay accounts. Factorsimpacting our advertising and commerce revenues generally include changes inorders from significant customers, the state of the online search andadvertising markets, seasonality, increases or decreases in our activeaccounts, limitations on our free services and increases or decreases in advertisinginventory available for sale. In the past, we have imposed limitations on ourfree services that have adversely impacted our volume of advertising inventory.

Advertising and commerce revenues increased by$6.5 million, or 76%, to $15.1 million for the quarter endedSeptember 30, 2005, from $8.6 million for the quarter endedSeptember 30, 2004. The increase was attributable primarily to increasedadvertising revenues associated with our Classmates business and, to a lesserextent, advertising revenues generated from our Web-hosting business.

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Advertising and commerce revenues increased by $16.7million, or 63%, to $43.4 million for the nine months ended September 30,2005, from $26.7 million for the nine months ended September 30, 2004. Theincrease was attributable primarily to increased advertising revenuesassociated with our Classmates business and, to a lesser extent, our searcharrangement with Overture and advertising revenues generated from ourWeb-hosting business. These increases were offset partially by a decrease inrevenues generated from our expired agreement with General Motors Corporation,from which we derived approximately 8% of our advertising and commerce revenuesfor the nine months ended September 30, 2004.

For the quarter and ninemonths ended September 30, 2005, 41% of advertising and commerce revenueswere attributable to our non-access services, which compares to 8% and 4%,respectively, for the quarter and nine months ended September 30, 2004.

**Cost of Billable Services**

Cost of billable services includes direct costs of billableservices and costs that have been allocated to billable services. Direct costsconsist of costs related to providing telephone technical support, customerbilling and billing support to our pay accounts and domain name registrationfees. Allocated costs consist primarily of telecommunications and data centercosts, personnel and overhead-related costs associated with operating ournetworks and data centers, depreciation of network computers and equipment andemail technical support. We allocate costs associated with access servicesbetween billable services and free services based on the aggregate hourly usageof our pay access accounts as a percentage of total hours used by our activeaccess accounts. We allocate costs associated with Web hosting between billableservices and free services based on estimated bandwidth used by pay Web-hostingaccounts relative to estimated bandwidth used by free Web-hosting accounts.Costs associated with our social-networking services are allocated based on thenumber of Web site visits by pay accounts relative to the total number ofvisits.

Cost of billable services increased by $1.4 million,or 6%, to $24.4 million for the quarter ended September 30, 2005, comparedto $23.0 million for the quarter ended September 30, 2004. The increase isprimarily due to our social-networking business, including a $0.6 millionincrease in network personnel and overhead-related costs, a $0.6 millionincrease in customer support and billing-related costs as a result of anincrease in the number of pay accounts and a $0.4 million increase in networkdepreciation allocated to billable services. These increases were partiallyoffset by a $0.3 million decrease in telecommunications costs.Telecommunications costs decreased as a result of a decrease in the averagemonthly usage per pay access account offset partially by a slight increase inaverage hourly telecommunications costs. Our average hourly telecommunicationscosts increased as a result of lower telecommunications hours purchased leadingto a relatively higher vendor pricing associated with lower volumes.Telecommunications hours allocated to our pay access account base increased toapproximately 96% of total telecommunications hours purchased during thequarter ended September 30, 2005, compared to approximately 94% during thequarter ended September 30, 2004.

Cost of billable services increased by$1.2 million, or 2%, to $73.0 million for the nine months ended September 30,2005, compared to $71.9 million for the nine months ended September 30,2004. The increase was primarily due to our social-networking business,including a $2.2 million increase in network personnel andoverhead-related costs allocated to billable services, a $1.9 million increasein customer support and billing-related costs as a result of an increase in thenumber of pay accounts and a $1.0 million increase in network depreciationallocated to billable services. These increases were significantly offset by a$4.1 million decrease in telecommunications costs. Telecommunicationscosts decreased as a result of a decrease in the average monthly usage per payaccess account and a decrease in average hourly telecommunications costs. Ouraverage hourly telecommunications costs decreased as a result of better portutilization, improvements made in allocating our telecommunications usage toour lower cost vendors and lower telecommunications prices. Telecommunicationshours allocated to our pay access account base increased to approximately 95%of total telecommunications hours purchased during the nine months 

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ended September 30,2005, compared to approximately 93% during the nine months ended September 30,2004.

Cost of billable services as a percentage of billableservices revenues was 20.7% and 20.8%, respectively, in the quarter and ninemonths ended September 30, 2005, compared to 22.5% and 23.8% in thequarter and nine months ended September 30, 2004. The decrease resultedprimarily from lower costs as a percentage of revenues associated with our paysocial-networking and Web-hosting services relative to our pay access services,and lower costs as a percentage of revenues associated with our pay accessservices due primarily to a decrease in average hourly telecommunications costsand average hourly usage per pay access account.

Our cost of billableservices as a percentage of billable services revenues is highly dependent onthe pricing for our services, our average hourly telecommunications cost andusage, and our average customer billing and support costs per pay account. Ifwe are not successful in continuing to increase the percentage of our payaccess accounts subscribing to our accelerated services, or increasing thepercentage of our pay account base subscribing to higher margin servicesincluding our Web-hosting and social-networking services, or if due tocompetitive or other factors we decrease the pricing for our access or otherservices or increase the use of promotions such as one or more free months ofservice, or if our new pay services are less profitable than our existing payservices, it is likely that our cost of billable services as a percentage ofbillable services revenues would be adversely impacted. In particular, weanticipate that our VoIP service will be less profitable than our existing payservices and have launched our pay VoIP services offering three months of freeservice which will negatively impact our cost of billable services as apercentage of revenues. While our average hourly telecommunications costs havedecreased consistently for some time, we experienced slightly higher hourlytelecommunications costs in the June 2005 quarter versus the March 2005quarter due to less efficient port utilization associated with a decrease intotal telecommunications hours utilized by our pay access account base. Thedecrease in total hours utilized was attributable to lower average monthlyusage per pay access account and a decrease in pay access accounts. We mayexperience increased average hourly telecommunications costs in future periods,particularly if these trends continue or if we expand our service coverage toadditional geographic areas where telecommunications costs are higher.Additionally, while the average hourly usage of our pay access accountsdecreased in the quarter ended September 30, 2005 compared to the quarterended September 30, 2004, we may experience increased average hourly usagein future periods when compared to the comparable period of the prior year,which would adversely impact this percentage.

**Cost of Free Services**

Cost of free services includes direct costs and coststhat have been allocated to free services. Allocated costs consist primarily oftelecommunications and data center costs, personnel and overhead-related costsassociated with operating our network and data centers, depreciation of networkcomputers and equipment and email technical support. We allocate costsassociated with access services between pay services and free services based onthe aggregate hourly usage of our free access accounts as a percentage of totalhours used by our active access accounts. We allocate costs associated with Webhosting between pay services and free services based on estimated bandwidthused by free Web-hosting accounts. Costs associated with our social-networkingservices are allocated based on the number of Web site visits by free accountsrelative to the total number of user visits.

Cost of free servicesincreased by $1.3 million, or 78%, to $2.9 million for the quarterended September 30, 2005, compared to $1.6 million for the quarterended September 30, 2004. Cost of free services increased by$4.5 million, or 91%, to $9.4 million for the nine months ended September 30,2005, compared to $4.9 million for the nine months ended September 30,2004. The increase was due primarily to increased costs associated with oursocial-networking business since the acquisition. The increases include $1.1million and $3.8 million increases in personnel and overhead-related costs forthe quarter and 

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ninemonths ended September 30, 2005, respectively, and $0.3 million and $1.4million increases in depreciation for the quarter and nine months ended September 30,2005, respectively. The increases were partially offset by $0.2 millionand $0.6 million decreases in telecommunications costs for the quarter and ninemonths ended September 30, 2005, respectively. The decreases intelecommunications costs are a result of decreases in average hourlytelecommunications costs, decreases in the number of active free accessaccounts and slight decreases in the average hourly usage of these accounts.The decreases in free active access accounts resulted from free accountsupgrading to our pay services, fewer new free account sign-ups and additionalaccounts becoming inactive. Telecommunications hours allocated to our freeaccess accounts decreased to approximately 4% and 5% of totaltelecommunications hours purchased during the quarter and nine months ended September 30,2005, respectively, compared to approximately 6% and 7% during the quarter andnine months ended September 30, 2004, respectively.

**Sales and Marketing**

Sales and marketing expenses include advertising andpromotion expenses, fees paid to distribution partners to acquire new pay andfree 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. We have expended significant amounts onmarketing, including national branding campaigns comprised of television,Internet, sponsorships, radio, print and outdoor advertising and on retail andother performance-based distribution relationships. Marketing and advertisingcosts to promote our products and services are expensed in the period incurred.Advertising and promotion expenses include media, agency and promotionexpenses. Media production costs are expensed the first time the advertisementis run. Media and agency fees are expensed over the period the advertisingruns.

Sales and marketing expenses increased by$9.5 million, or 22%, to $52.8 million for the quarter ended September 30,2005, compared to $43.3 million for the quarter ended September 30,2004. Sales and marketing expenses increased by $29.4 million, or 22%, to$160.7 million for the nine months ended September 30, 2005, compared to$131.3 million for the nine months ended September 30, 2004. The increasesare primarily due to increased expenditures for our social-networking service.Marketing, promotion and distribution costs increased by $4.4 million and$14.4 million, respectively, for the quarter and nine months ended September 30,2005 primarily due to promotion of our non-access businesses, particularly oursocial-networking service, offset partially by a reduction in expenses relatedto promoting our access services. In addition, personnel-related expensesincreased by $2.8 million and $7.7 million, respectively, for the quarterand nine months ended September 30, 2005 and telemarketing expensesrelated to customer acquisition, retention and up-sell activities increasedby $1.6 million and $5.6 million, respectively, for the quarter and ninemonths ended September 30, 2005. Increases in prices to purchaseadvertising, combined with seasonal factors and more intense competition forpay accounts, may adversely impact the effectiveness of our marketingactivities and our ability to grow our pay account base and revenues.

Our marketing expendituresand the allocation of our marketing resources among our various services mayvary significantly from quarter to quarter depending on a number of factorsincluding the effectiveness of our marketing activities, changes in the mix ofour marketing activities, changes in the cost to purchase advertising, changesin the number of pay accounts, the introduction of new services, such as VoIP,and the impact of such activities on our results of operations. While weanticipate that sales and marketing expenses as a percentage of revenues willcontinue to be approximately 40%, we may choose to either significantlyincrease or decrease such expenses as a percentage of revenues in anyparticular quarterly period. We have decreased our sales and marketing expensesfor our pay access services and may continue to decrease such expenses infuture quarters. We have entered into a number of longer-term offlinedistribution relationships for our access services. We intend to continue tofocus on increasing both our offline and online distribution channels in thenear term, which could result in increased marketing 

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expendituresas a result of fees paid to distribution partners. Our ability to increase ordecrease our marketing expenditures from period to period may be more limitedto the extent distribution partners constitute a significant portion of ourmarketing expenditures. There is, however, no assurance that we will be able toincrease our distribution channels or that any future increase in marketingexpenditures will be successful in growing or maintaining our pay account base.Decreases in marketing expenditures would likely adversely impact our abilityto increase our pay account base.

**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.

Product developmentexpenses increased by $3.0 million, or 43%, to $10.1 million for thequarter ended September 30, 2005, compared to $7.1 million for thequarter ended September 30, 2004. Product development expenses increasedby $9.3 million, or 48%, to $28.8 million for the nine months ended September 30,2005, compared to $19.5 million for the nine months ended September 30,2004. The increases were primarily the result of increased personnel-relatedexpenses for our social-networking and Web-hosting businesses, including$1.4 million and $5.6 million increases in compensation costs for thequarter and nine months ended September 30, 2005, respectively.Additionally, headcount and compensation costs increased for the quarter andnine months ended September 30, 2005 compared to the quarter and ninemonths ended September 30, 2004 as a result of increased personnel relatedto the development of new products during 2005, including our enhancedaccelerator service and our VoIP service. The increases were also the result of$0.5 million and $1.5 million increases in depreciation for the quarter andnine months ended September 30, 2005, respectively; $0.3 million and $0.7million increases in stock-based compensation for the quarter and nine monthsended September 30, 2005 related to the issuance of restricted stock unitsbeginning in the March 2005 quarter; $0.3 million and $0.5 millionincreases in license fees in the quarter and nine months ended September 30,2005; and $0.3 million increases in professional and consulting fees in thequarter and nine months ended September 30, 2005. We anticipate that wewill continue to increase our product development expenses, both in dollarterms and as a percentage of revenues for the remainder of 2005. Productdevelopment expenses were reduced by capitalized compensation costs of approximately$1.5 million and $3.8 million during the quarter and nine months ended September 30,2005, respectively, compared to approximately $24,000 and $0.1 million for thequarter and nine months ended September 30, 2004. The majority of thecapitalized compensation costs in the quarter and nine months endedSeptember 30, 2005 related to the development of our VoIP telephonyservice and the new version of our NetZero accelerator service.

**General and Administrative**

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.

General and administrative expenses increased by $4.0million, or 37%, to $14.8 million for the quarter ended September 30,2005, compared to $10.8 million for the quarter ended September 30,2004 primarily due to increases in expenses attributable to oursocial-networking business and a $1.6 million increase in stock-basedcompensation primarily related to restricted stock units issued beginning in 

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March 2005. Weincurred a $1.4 million increase in personnel-related expenses as a resultof higher compensation costs; a $1.3 million increase in overhead-relatedcosts, including an increase of $0.5 million in depreciation; a $0.8 millionincrease in professional and consulting fees; and a $0.3 million increase infacilities costs as a result of increased rent for our corporate headquartersand new facilities related to our Web-hosting and social-networking businesses.These increases in the September 2005 quarter versus the September 2004were partially offset by the incurrence of $1.6 million in leasetermination fees and accelerated depreciation expenses in the September 2004quarter in connection with the relocation of our corporate offices in August 2004.

General and administrativeexpenses increased by $13.4 million, or 47%, to $41.6 million for the ninemonths ended September 30, 2005, compared to $28.3 million for the ninemonths ended September 30, 2004. The increase was primarily due toincreased expenses attributable to our social-networking business and a$3.7 million increase in stock-based compensation primarily related torestricted stock units issued beginning in March 2005. We incurred a $5.1million increase in personnel-related expenses as a result of highercompensation costs; a $3.1 million increase in overhead-related costs,including an increase of $1.5 million in depreciation; a $2.3 million increasein professional and consulting fees; and a $1.8 million increase in facilitiescosts as a result of increased rent for our corporate headquarters and newfacilities related to our Web-hosting and social-networking businesses. Theseincreases were partially offset by the incurrence of $3.2 million in leasetermination fees and accelerated depreciation expenses in the nine months endedSeptember 30, 2004 in connection with the relocation of our corporateoffices in August 2004.

**Amortization of Intangible Assets**

Amortization of intangible assets includesamortization of acquired pay accounts and free accounts, acquired trademarks andtrade names, purchased technologies and other identifiable intangible assets.At September 30, 2005, we had approximately $64.2 million in netidentifiable intangible assets resulting primarily from the acquisitions ofClassmates, BlueLight Internet assets and the Web-hosting and PhotoSitebusinesses. At September 30, 2005, we had approximately $80.5 millionin goodwill resulting from the acquisitions of Classmates and the Web-hostingand PhotoSite businesses. In accordance with the provisions set forth in SFAS No. 142,*Goodwill and Other Intangible Assets*,goodwill is not being amortized but is tested for impairment at a reportingunit level on an annual basis and between annual tests if an event occurs orcircumstances change that would more likely than not reduce the fair value of areporting unit below its carrying value amount.

Amortization of intangibleassets increased by $0.9 million, or 19%, to $5.3 million for thequarter ended September 30, 2005, compared to $4.4 million for thequarter ended September 30, 2004. Amortization of intangible assetsincreased by $4.1 million, or 32%, to $16.9 million for the nine monthsended September 30, 2005, compared to $12.8 million for the ninemonths ended September 30, 2004. The increases are due to the amortizationof identifiable intangible assets from our acquisitions of Classmates and thePhotoSite business, offset partially by a decrease in amortization ofintangible assets from the Merger. We recorded a reduction in the remainingintangible assets from the Merger of approximately $11.2 million duringthe December 2004 quarter in connection with the release of the deferredtax valuation allowance. In addition, the increase in the nine months ended September 30,2005 is related to the amortization of identifiable intangible assets from theacquisition of our Web-hosting business in April 2004. Certain of theacquired intangible assets are amortized on an accelerated basis to bettermatch the expense to the expected cash flows from those assets.

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**Interest and OtherIncome, Net**

Interest income consistsof earnings on our cash, cash equivalents and short-term investments. Otherincome and expense, net consists of realized gains and losses recognized inconnection with the sale of short-term investments. Interest and other income,net increased by $0.3 million, or 21%, to $1.7 million for thequarter ended September 30, 2005, compared to $1.4 million for thequarter ended September 30, 2004. Interest and other income, net increasedby $0.4 million, or 11%, for the nine months ended September 30, 2005 to$4.7 million, compared to $4.2 million for the nine months endedSeptember 30, 2004. Net realized gains on our short-term investments werenot significant for the quarter and nine months ended September 30, 2005.Net realized gains on our short-term investments were approximately $25,000 and$0.1 million for the quarter and nine months ended September 30,2004.

**Interest Expense**

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

Interest expense increasedby $1.1 million to $1.4 million for the quarter ended September 30, 2005,compared to $0.3 million for the quarter ended September 30, 2004.Interest expense increased by $3.8 million to $4.7 million for the nine monthsended September 30, 2005, compared to $0.9 million for the nine monthsended September 30, 2004. The increase is primarily the result of intereston the outstanding balance on the term loan, which was issued in December 2004.

**Provision for Income Taxes**

For the quarter and ninemonths ended September 30, 2005, we generated pre-tax income of $22.9million and $64.4 million, respectively, and recorded a tax provision of $10.3million and $29.7 million, respectively, resulting in a year-to-date effectivetax rate of approximately 46.0%. For the quarter and nine months ended September 30,2004, we generated pre-tax income of $21.6 million and $63.7 million,respectively, and recorded a tax provision of $9.0 million and $26.5 million,respectively, resulting in a year-to-date effective tax rate of approximately41.5%. The increase in the effective tax rate is primarily due to the issuanceof restricted stock units in March 2005, for which the relatedcompensation deduction is limited under Section 162(m) of theInternal Revenue Code; foreign losses, the benefit of which is not currentlyrecognizable due to uncertainty regarding realization; and the re-measurementof certain deferred tax assets as a result of a change in New York State taxlaw that occurred during the June 2005 quarter. This re-measurementresulted in an increase to the tax provision for the nine months ended September 30,2005 of approximately $1.0 million, or 1.6%.

**Liquidity and Capital Resources**

Ourtotal cash, cash equivalent and short-term investment balances increased byapproximately $8.2 million to $241.0 million at September 30,2005 compared to $232.8 million at December 31, 2004. Our summarycash flows for the nine months ended September 30, 2005 and 2004 were asfollows (in thousands):

| ** **                                 | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| Net cash provided  by operating activities |       | $                                                   | 114,276    |   | $ | 92,219 |   |
| Net cash used for  investing activities    |       | (61,786                                             | )          | (28,288 | ) |
| Net cash used for  financing activities    |       | (75,252                                             | )          | (67,058 | ) |
|                                            |            |                                                     |            |  |  |  |  |

 

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Net cash providedby operating activities increased by $22.1 million, or 24%, for the ninemonths ended September 30, 2005 compared to the nine months ended September 30,2004. The increase is primarily the result of the following:

·       a$20.8 million net increase in working capital accounts due to increases inrevenues and operating expenses and the timing of related cash receipts andpayments, including a $12.1 million increase in income taxes payable; and

·       a$14.0 million increase in depreciation, amortization and stock-basedcompensation in the nine months ended September 30, 2005 compared to thenine months ended September 30, 2004 due to increases in capitalexpenditures and the acquisitions of Classmates and the PhotoSite business,offset significantly by a decrease in amortization of intangible assets fromthe Merger.

These increases were partially offset by reductions inthe utilization of net operating loss and tax credit carryforwards and incometax deductions resulting from the exercise of stock options by employees, whichhave reduced payments for income taxes. Our net operating loss and tax creditcarryforwards available for use in 2005, when combined with exercises ofemployee stock options, have helped to reduce the level of cash paid for incometaxes in 2005. However, we believe that cash paid for income taxes in 2005 willbe approximately $11 million higher than the cash paid in 2004, with themajority occurring during the fourth quarter which will negatively impact netcash provided by operating activities. We have approximately $41 millionof net operating loss carryforwards available in 2005, $17 million in 2006and $13 million in 2007 through 2020.

Net cash used forinvesting activities increased by $33.5 million, or 118%, for the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004. The increase is primarily the result of the following:

·       a$26.8 million increase in purchases of short-term investments, net ofmaturities in the nine months ended September 30, 2005 compared to thenine months ended September 30, 2004;

·       a$5.3 million increase in capital equipment purchases and capitalized softwarecosts in connection with the development of new products and the ongoingoperations of our business; and

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

These increases were partially offset by a $3.3million decrease in cash paid for acquisitions in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004. We acquiredcertain assets related to the PhotoSite business in March 2005 forapproximately $10.1 million in cash, $8.6 million of which was paid in the ninemonths ended September 30, 2005, and we acquired substantially all of theassets associated with the Web-hosting business of About, Inc. in April 2004for approximately $11.9 million in cash.

In prior years, we have invested significantly in ournetwork infrastructure, 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, 2005were $16.5 million. We anticipate that our total capital expenditures forthe remainder of 2005 will be in the range of $5.5 million to $8.5million. The actual amount of future capital expenditures may fluctuate due toa number of factors including, without limitation, potential futureacquisitions and new business initiatives, including our VoIP telephonyservice, which are difficult to predict and could change significantly overtime. Additionally, technological advances may require us to make capitalexpenditures to develop or acquire new equipment or technology in order toreplace aging or technologically obsolete equipment.

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Net cash used forfinancing activities increased by $8.2 million, or 12%, for the ninemonths ended September 30, 2005 compared to the nine months ended September 30,2004. The increase is primarily the result of the following:

·       paymentsof $41.7 million on the term loan in the nine months ended September 30,2005, including voluntary prepayments of $28.8 million in the nine months endedSeptember 30, 2005, which will reduce future mandatory repayments on a prorata basis;

·       paymentsof $25.3 million for dividends in the nine months ended September 30,2005; and

·       a$59.5 million decrease in repurchases of common stock in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004.

In May, August and October of 2005, ourBoard of Directors declared a quarterly cash dividend of $0.20 per share ofcommon stock. The quarterly dividends were paid on May 31, 2005 and August 31,2005 and totaled $12.6 million and $12.7 million, respectively. The nextquarterly dividend is payable on November 30, 2005 to shareholders of recordas of the close of business on November 11, 2005. While we intend to payregular dividends for the foreseeable future, the declaration and payment offuture dividends are discretionary and will be subject to determination by theBoard of Directors each quarter following its review of our financialperformance.

Within ninety days after each fiscal year end, we arerequired to make a payment on the term loan equal to one half of our excesscash flow as defined in the term loan agreement. Excess cash flow is equal toour cash flows from operating activities for the prior year reduced by certainitems, including capital expenditures, term loan repayments, cash paid foracquisitions and dividend payments. This payment is in addition to themandatory quarterly repayment.

Under the term loan agreement, repurchases of commonstock and the payment of cash dividends are limited, in the aggregate, to$110.1 million at September 30, 2005, subject to further annuallimitations. Assuming we do not repurchase any additional common stock, theselimitations would restrict our ability to pay the full quarterly cash dividendof $0.20 per share by the second half of 2007 without amending the term loanagreement or repaying the then remaining balance. Additionally, in order to paydividends, no default or event of default shall have occurred and be continuingunder the term loan agreement. Noncompliance with the financial covenants setforth in the agreement constitutes an event of default under the agreement.

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;develop and acquire complementary services, businesses or technologies; torepurchase shares of our common stock if we believe market conditions to befavorable; to make payments on our term loan; and to fund future capitalexpenditures. We currently anticipate that our future cash flows fromoperations and existing cash, cash equivalent and short-term investmentbalances will be sufficient to fund our operations over the next year, and inthe near term we do not anticipate the need for additional financing to fundour operations. However, we may raise additional debt or equity capital for avariety of reasons including, without limitation, developing new or enhancingexisting services or products, repurchasing our common stock, acquiringcomplementary services, businesses or technologies, refinancing our term loanor funding significant capital expenditures. If we need to raise additionalcapital through public or private debt or equity financings, strategicrelationships or other arrangements, it might not be available to us in a timelymanner, on acceptable terms, or at all. Our failure to raise sufficient capitalwhen needed could have a material adverse effect on our business, financialposition, results of operations and cash flows, and could impair our ability topay dividends. If additional funds were raised through the issuance of equitysecurities, the percentage of stock owned by the then-

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currentstockholders would be reduced. Furthermore, such equity securities might haverights, preferences or privileges senior to holders of our common stock.

**Financial Commitments**

Ourfinancial commitments are as follows at September 30, 2005 (in thousands):

| ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Oct-Dec** | ** ** | **Year Ending December 31,** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|-------------|------------|---------------------------------------------|------------|------------|------------|
| **Contractual Obligations** | ** ** | ** ** | ** ** | **Total**  | ** ** | **2005**    | ** ** | **2006**                                    | ** ** | **2007**   | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
| Term loan(1)                     |       | $          | 58,333     |       |       | $           | 4,125      |                                        |       | $          | 16,498     |   | $ | 16,498 |   | $ | 21,212 |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Capital leases(2)                |       | 832        |       |       | 100        |        |       | 399                                         |       | 333        |       | — |   | — |   | — |   |   | — |   |   |
| Operating leases                 |       | 47,043     |       |       | 1,659      |        |       | 6,724                                       |       | 6,898      |       | 6,904 |   | 5,820 |   | 4,238 |   |   | 14,800 |   |   |
| Telecommunications  purchases    |       | 22,259     |       |       | 3,182      |        |       | 10,585                                      |       | 8,492      |       | — |   | — |   | — |   |   | — |   |   |
| Media purchases                  |       | 7,372      |       |       | 7,372      |        |       | —                                      |       | —     |       | — |   | — |   | — |   |   | — |   |   |
| Total                            |       | $          | 135,839    |       |       | $           | 16,438     |                                        |       | $          | 34,206     |   | $ | 32,221 |   | $ | 28,116 |   | $ | 5,820 |   | $ | 4,238 |   |   | $ | 14,800 |   |   |

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(1)          Our variable-rate termloan accrues interest at rates generally equal to the London inter-bank offeredrate (LIBOR) for dollar deposits plus a margin of 3.0%. The table reflects onlyprincipal amounts. See Note 3 to the condensed consolidated financialstatements.

(2)          Includes$43,000 of imputed interest.

**Recent Accounting Pronouncements**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123R, *Share-BasedPayment*. This statement replaces SFAS No. 123, *Accounting for Stock-Based Compensation*, and supersedesAccounting Principles Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*. This statement requires that the costresulting from all share-based payment transactions be recognized in thefinancial statements. This statement establishes fair value as the measurementobjective in accounting for share-based payment arrangements and requiresall entities to apply a fair-value-based measurement method in accountingfor share-based payment transactions with employees except for equity instrumentsheld by employee share ownership plans. This statement also establishes fairvalue as the measurement objective for transactions in which an entity acquiresgoods or services from nonemployees in share-based payment transactions.This statement uses the terms compensation and payment in their broadest sensesto refer to the consideration paid for goods or services, regardless of whetherthe supplier is an employee. SFAS No. 123R becomes effective in the March 2006quarter and is likely to have a material effect on our results of operationsalthough the exact amount is not currently known.

At the required effective date, we will apply thisstatement using a modified version of prospective application. Under themodified prospective application, this statement applies to new awards and toawards modified, repurchased, or cancelled after the required effective date.Additionally, compensation cost for the portion of awards for which therequisite service has not been rendered that are outstanding as of the requiredeffective date shall be recognized as the requisite service is rendered on orafter the required effective date. The compensation cost for that portion ofawards will be based on the grant-date fair value of those awards as calculatedfor either recognition or pro forma disclosures under SFAS No. 123.

In March 2005, the SEC issued Staff AccountingBulletin (“SAB”) No. 107, *Share-Based Payment*.The interpretations in this SAB express views of the staff regarding theinteraction between SFAS No. 123 (revised 2004) and certain SEC rules andregulations and provide the staff’s views regarding the valuation ofshare-based payment arrangements for public companies. In particular, this SABprovides guidance 

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related to share-basedpayment transactions with nonemployees, the transition from nonpublic to publicentity status, valuation methods (including assumptions such as expectedvolatility and expected term), the accounting for certain redeemable financialinstruments issued under share-based payment arrangements, the classificationof compensation expense, non-GAAP financial measures, capitalization ofcompensation cost related to share-based payment arrangements, the accountingfor income tax effects of share-based payment arrangements upon adoption ofSFAS No. 123R, the modification of employee share options prior toadoption of SFAS No. 123R and disclosures in Management’s Discussion andAnalysis subsequent to adoption of SFAS No. 123R.

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

**Inflation**

Inflation did not have a material impact during thequarter and nine months ended September 30, 2005 and 2004, and we do notcurrently anticipate that inflation will have a material impact on our resultsof operations going forward.

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**RISK FACTORS**

*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.*

**Ourbusiness will suffer 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 SBCInternet 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; and regionaland local commercial ISPs.

The number of U.S. households using broadband hasgrown significantly over the last few years and is expected to continue togrow. Broadband access, which includes cable, digital subscriber lines (“DSL”),satellite and wireless, generally offers users faster connection and downloadspeeds than dial-up access for monthly fees currently ranging fromapproximately $15 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 dial-up access services priced higher than certainbroadband services. For example, both SBC Yahoo! and Verizon Yahoo! offer orhave recently offered DSL at $14.95 per month to customers who agree to aone-year commitment. As a result of broadband adoption, the total number ofdial-up accounts in the U.S. has declined and industry analysts predict that itwill continue to decline. The decline in the size of the dial-up market hasaccelerated and will likely continue to accelerate as broadband services becomemore widely available at lower prices and consumer adoption of broadbandapplications, such as online video, telephony and music downloads, which dependupon connections that provide significant bandwidth, increases. We currently offera broadband service in Nashville and Indianapolis through Comcast Corporation’scable systems. The service, however, is not value priced and we have had aminimal number of subscribers sign up for it. While we review the possibilityof offering broadband services from time to time, we currently do not plan tooffer broadband services on a significant scale, which has adversely impacted,and will continue to adversely impact, our ability to compete for newsubscribers and to retain existing subscribers.

Our success historically has been based on offeringdial-up Internet access services at prices below the standard monthly pricingof the premium dial-up services of most of our major competitors. Competitionfrom broadband providers and value-priced providers such as United Onlinehas resulted in significant declines in the number of subscribers to premiumpriced dial-up services over the last few years. In response to thiscompetition, many competitors have engaged, and are likely to continue toengage, in more aggressive pricing of their dial-up services under theirpremium-priced brands to obtain and retain users, such as offeringdiscounted pricing or extended periods of free service such as six months free.AOL has previously tested decreased price points on their dial-up service andmay continue to do so in the 

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future. Additionally, AOL,through its Netscape subsidiary, EarthLink, through its PeoplePC subsidiary,and a number of small providers now offer value-priced services at pricessimilar to our prices and which are, in some cases, priced below the prices ofour services. 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 declined and the rate of decline has beenincreasing. We experienced a net decline of approximately 98,000 pay accessaccounts in the September 2005 quarter. We expect that we will continue toexperience declines in our pay access account base in some, if not all, futureperiods, and the rate of decline may continue to accelerate. We believeincreased competition, including pricing competition, has adversely impactedour ability to obtain new pay access accounts and to retain our existingaccounts, will adversely impact our ability to maintain or grow our pay accessaccount base in the future and may make it more difficult to maintain thecurrent pricing of our services.

Price competition is particularly relevant to ourability to maintain or grow our accelerator subscription base. A significantportion of our growth in revenues and profitability since early 2003 has beenattributable to new subscribers to our accelerator services. When we beganoffering this service in early 2003, many of our competitors either did notoffer a similar service or charged substantially more than we charge for asimilar service. Since that time, most of our competitors have started offeringa similar service, and several competitors have either decreased their pricefor these services or have bundled these services into their premium serviceswith no additional fee. Many competitors now market these services as a featureof their value-priced services at no additional cost and these servicesare now offered, in certain cases, at a price point similar to or lower thanour standard price. In particular, Netscape has previously marketed theiraccelerator service as part of their standard $9.95 offering and currently marketsthis service at a $9.95 price point with a 12 month commitment. PeoplePC hasoffered their accelerator service combined with their standard value-pricedoffering at $5.47 per month for an introductory period of three months. Inaddition, price competition for broadband services has been growing and severalproviders, such as SBC Yahoo! and Verizon Yahoo!, have offered bundledbroadband services at promotional prices similar to the prices of ouraccelerated access services. We cannot assure you that broadband providers willnot continue to offer promotional pricing for broadband services similar to orlower than the price of our accelerated access services. Increased competitionfor subscribers to accelerated access services and broadband services couldadversely impact our ability to grow or maintain our accelerator subscriptionbase, or could cause us to lower or eliminate our pricing for these services,which would adversely impact our revenues and profits. For example, we recentlybegan offering our NetZero accelerator service at a $9.95 price point with a 12month commitment. The growth in the number of subscriptions to our acceleratedaccess services has been decreasing and we may experience a decrease in thenumber of subscriptions to these services. We cannot assure you that we will beable to continue to maintain or grow our accelerator subscription base atcurrent price levels, or at all.

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-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. While we offer some additional features tousers at no charge or for an incremental fee, we do not offer the range offeatures included in premium-priced services and, in some cases, includedin value-priced services. In particular, we do not offer our ownproprietary content. In addition, the incremental fees that we charge forcertain features are, in some cases, higher than the incremental fee, if any,charged by other value-priced providers for comparable features. Ourdecision not to offer a broader variety of features and our charges foradditional services or features, particularly 

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accelerated functionalityand telephone technical support, may adversely impact our ability to competeand undermine our position as a value-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 may be at acompetitive disadvantage. We cannot assure you that our marketing resourceswill be sufficient for us to continue to compete effectively with our major competitors.

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. Classmates competesdirectly against a small number of companies, including Reunion.com andMonster.com’s Military.com service, offering similar online social-networkingservices based on work, school and military communities. Classmates alsocompetes directly with many schools, employers, Web sites, and associationsthat maintain their own Internet-based alumni information services. Inaddition to this direct competition, Classmates competes for subscribers withcompanies offering a wide variety of social-networking services including Webportals such as Yahoo!, MSN and AOL that maintain chat rooms and are developingnew Web community services such as Yahoo! 360, MSN Spaces and AOL PeopleConnection, and other community-based Web sites and personal networkingcommunities such as Friendster and Myspace. Many of these companies offer awide variety of services in addition to their social-networking services, whichmay provide them with a competitive advantage in obtaining and retainingsubscribers. Many consumers maintain simultaneous relationships with multiplecommunities, including Internet alumni networks and offline associations, andcan easily shift their interest or their spending from one online or offlineprovider to another. Competitors may be able to launch new businesses servingvarious communities at relatively low cost. Competitors may be able to holdthemselves out as specialists in single communities, making them more appealingto consumers or giving them a perceived competitive advantage. In addition,many social-networking services are free or only require payment if certainadditional functionality is desired by the user. The continued prevalence offree services could adversely impact our ability to market both our free andpay services.

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, Classmates has relied extensively on Internetadvertising through portals and other Internet service providers, includingAOL, MSN and Yahoo!, to grow its base of free and pay accounts. A number ofthese companies are competitors of United Online with respect to Internetaccess and other services, and they may not be willing to retain the sameadvertising relationship going forward. To the extent we are not able tomaintain advertising relationships with these companies, our ability to obtainnew Classmates’ pay and free accounts would be adversely impacted.

*Competition in theTelephony Market*

We recently launched ournew consumer VoIP telephony services. The market for consumer telephoneservices is extremely competitive and competitors include established local andlong distance 

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telephonecompanies, cellular companies and providers of VoIP services. VoIP services area new and emerging application and it is uncertain whether VoIP services willreceive wide-spread consumer adoption. Competitors for our VoIP servicesinclude established telecommunications and cable companies, certain of ourcurrent competitors for Internet access services including AOL, MSN andEarthLink, leading Internet companies including Yahoo!, Google and Ebay throughits recently acquired Skype subsidiary, and a number of new companies thatoffer VoIP-based services as their primary business such as Vonage. Most of ourmajor competitors in the VoIP market have longer operating histories, largercustomer bases, greater brand recognition and significantly greater financial,marketing and other resources than we do. We cannot assure you that our VoIPservices will achieve significant consumer adoption or, even if such servicesdo achieve consumer adoption, that our VoIP services will generate growth inpay accounts, subscriptions or revenues.

*Competition inAdditional Service Markets*

One element of our strategy is to offer a variety ofnon-access subscription services. In addition to social-networking and VoIPservices, we currently offer Web-hosting and domain registration services,standalone premium email services, a broadband accelerator product, aprepackaged premium content offering, and digital photo sharing services. Whilethese services do not generate a significant portion of our revenues, we areactively investing resources in certain of these services. Competition forusers of premium email services is intense. The companies we compete with forInternet access subscribers also compete with us for subscribers to emailservices. In addition, a number of companies, including Yahoo!, MSN, AOL andGoogle, offer premium email services, in certain cases, for free. The marketfor premium email services is evolving at a rapid pace and we cannot assure youthat our offerings will be competitive or commercially viable. While thepersonal Web-hosting business is fragmented, a number of significant companies,including Yahoo!, currently compete actively for these users. In addition, thepersonal Web-hosting industry is very application specific, with many of thecompetitors focusing on specific applications, such as photo sharing, togenerate additional users. We have not expended significant resources tomarketing our digital photo sharing services, although we intend to allocatesubstantial resources to improving and promoting these services going forward. Digitalphoto sharing is an extremely competitive market and there is no assurance ourservices will be able to compete effectively. We cannot assure you that any ofthese subscription services will be competitive or will generate growth in payaccounts.

In addition, we haveevaluated, and expect to continue to evaluate, the development or acquisitionof new subscription services. New services may subject us to competition fromcompanies that have more experience with such services, more establishedbrands, and greater financial, marketing and other resources to devote to suchservices. We cannot assure you that our new services will be competitive orwill generate growth in pay accounts.

*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, andvarious other companies that facilitate Internet advertising. Many of ourcompetitors have longer operating histories, greater name recognition, largeruser bases and significantly greater financial, technical and sales andmarketing resources than we do. This may allow them to devote greater resourcesto the development, promotion and sale of their products and services. Thesecompetitors may also engage in more extensive research and development,undertake more far-reaching marketing campaigns and adopt more aggressivepricing policies. We also compete with television, radio, cable and print mediafor a share of advertisers’ total advertising budgets. In certain instances, wegenerate advertising revenues from companies who are also our competitors. Inparticular, we generate significant 

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advertisingrevenues from Overture. Overture is a subsidiary of Yahoo! and we competedirectly with Yahoo! for Internet access, email, Web-hosting and onlinephoto-sharing subscribers and indirectly for subscribers to oursocial-networking services. To the extent competitors who are also sources ofsignificant advertising revenue cease to do business with us, our revenues andprofits could suffer.

**We may be unable togrow our revenues.**

Our ability to grow our revenues is primarilydependent upon our ability to increase our number of pay subscriptions, ournumber of pay accounts and our average monthly revenue per pay account (“ARPU”).Increasing our pay subscriptions involves three components: converting freeaccounts to pay subscriptions, cross-marketing additional subscriptionsto pay accounts, and gaining pay accounts from new subscribers who have notpreviously used our services. The number of free accounts for certain of ourservices has been decreasing and may continue to decrease in the future. Thenumber of free accounts converting to pay accounts has, from time to time,decreased and may decrease in the future, and we may not be successful inconverting free accounts to pay accounts, particularly if our number of freeaccounts declines or if consumers do not perceive adequate value in our payservices. We have recently experienced an increasing rate of decline in our payaccess accounts and currently anticipate that our pay access accounts willcontinue to decline in the future and that the rate of decline may accelerate.The growth in new subscriptions to our accelerated access services has alsobeen declining and the number of subscriptions to these services may decline inthe future. We intend to devote resources to marketing our VoIP services whichwill result in decreased marketing resources for our other services. This islikely to result in decreased new pay accounts for these other services, and ifwe are not successful in acquiring pay VoIP accounts, our pay account base maybe adversely impacted. Our VoIP services involve a free component and thebusiness model for our VoIP services is predicated upon users upgrading to ourpay VoIP services. There can be no assurance that, even if we are successful inachieving a significant number of free VoIP accounts, that free VoIP accountswill upgrade to pay VoIP accounts. We do not know if we will be able tomaintain or grow the number of pay subscriptions to any of our services, andsubscriptions to some or all of our services may decrease in future periods.

Our ability to grow or maintain our number of payaccounts and subscriptions may also be dependent on our success incommercializing new services that we either acquire or develop. To the extentwe are unable to successfully market our existing services to new users,successfully cross-market additional subscriptions to existing users orsuccessfully acquire or develop and commercialize new services, our payaccounts and subscriptions could decline. Even if we are successful in growingour pay accounts and subscriptions, our revenues may decrease if our ARPU decreases.

Our ARPU has declined inrecent periods primarily as a result of changes in the mix of pay accounts to alarger percentage of lower priced services, particularly as a result of theacquisition of Classmates and the introduction of premium email services, andincreased use of promotional pricing and discounted plans for our accessservices. Changes in ARPU in the future will be dependent on a variety offactors including changes in the mix of pay subscriptions and their relatedpricing plans; the use of promotions, such as one or more free months ofservice, and discounted pricing plans to obtain or retain subscribers;increases or decreases in the price of our services; the number of servicessubscribed to by each pay account; pricing and success of new pay services andthe penetration of these types of services as a percentage of total payaccounts; and the timing of pay accounts being added or removed during aperiod. Our pay access accounts, particularly those purchasing our acceleratorservices, generate higher ARPU than our other services, and our inability togrow these services, the use of promotions and discounted plans with respect tothese services, or decreases in the pricing for these services including ourcurrent $9.95 promotion with a 12 month commitment, will adversely impact ourARPU. We anticipate that our ARPU will continue to decrease, at least in thenear term. If we are not successful in growing our pay accounts andsubscriptions 

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ormaintaining or growing our ARPU, our revenues could decrease. A decrease in ourrevenues could adversely impact our profitability.

**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 and account metrics accurately.We believe that these difficulties in forecasting present even greaterchallenges for financial analysts who publish their own estimates of our futurefinancial results and account metrics. We cannot assure you that we willachieve the expectations or financial projections made by our management or bythe financial analysts. In the event we do not achieve such expectations orprojections, the price of our common stock could be adversely affected.

**If wecannot identify and complete acquisitions, we may not be able to grow andachieve our strategic 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 our revenues unless we are able to successfully completeacquisitions. The merger and acquisition market for companies offering Internetsubscription services is extremely competitive, particularly for companies whohave demonstrated 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. In addition, our term loan imposesrestrictions on our ability to make acquisitions. These and other factors maymake it difficult 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 ourWeb-hosting, photo-sharing and Classmates businesses.**

In April 2004, weacquired the assets of About, Inc.’s Web-hosting business, inNovember 2004, we acquired Classmates and in March 2005, we acquiredthe assets of Homestead Technologies, Inc.’s online digital photo-sharingbusiness. We do not have prior experience in any of these lines of business andmay not be able to compete successfully in them. To the extent we attempt tointegrate various aspects of these businesses, we may not be successful. Theremay 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 wewill be successful in maintaining or growing their pay or free accounts.

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**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 and financial 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. Acquiring a business, product line or technologyinvolves many risks, including:

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

·       unforeseenobligations or liabilities;

·       difficultyassimilating the acquired customer bases, technologies and operations;

·       difficultyassimilating and retaining employees from the acquired business;

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

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

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

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

Classmates hassubsidiaries operating in Germany and Sweden 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 regulatory environments and integrationdifficulties due to cultural and geographic differences. We cannot assure youthat any further acquisitions we make will be successful.

**Our marketingactivities may not be successful in growing our business or maintaining ourbrands.**

The success of our business model is predicated uponmaintaining a marketing budget that is sufficient to grow our revenues whilecontinuing to increase profitability. Our marketing activities may not beeffective in maintaining or increasing brand awareness or the size of our payaccounts base. We will be required to incur significant marketing expenses tomaintain our brands and we may not be successful in increasing pay accounts,subscriptions or revenues. This could result in increased costs without acommensurate increase in revenues, which could adversely affect ourprofitability. We have increased the number of brands under which our servicesare marketed and increased the number of services we offer. We may not have adequateresources to maintain all of our brands or promote all of our services. OurVoIP services, in particular, may require significant marketing resources andthere can be no assurance that we will allocate the necessary resources tomarket successfully these services, or that, even if we do allocate significantmarketing resources to these services, that our marketing activities will besuccessful. Capital limitations or other factors could cause us to decrease ourmarketing budget, which would adversely impact our ability to maintain ourbrands and grow our revenues. We cannot assure you that our marketingactivities will be successful.

We obtain a significantnumber of new pay access accounts through our offline distribution channels,primarily Best Buy. If the number of new pay accounts acquired through Best Buywere to decrease, such 

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decreasecould negatively impact the number of pay accounts and our 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. Our churnpercentage is calculated based on the average number of pay accounts for aperiod. The average number of pay accounts is a simple average calculated basedon the number of pay accounts at the beginning and end of a period. We makecertain normalizing adjustments to the calculation of our churn percentage forperiods in which we add a significant number of pay accounts due toacquisitions. We do not include in our churn calculation those accountscancelled during the first thirty days of service unless the accounts haveupgraded from free accounts, although a number of such accounts will be includedin our account totals at any given measurement date. Subscribers who cancel onepay service but subscribe to another pay service are not considered to havecancelled a pay account and, as such, our overall churn rate is not necessarilyindicative of the percentage of subscribers canceling any particular service.We have experienced, and will likely continue to experience, a higherpercentage of subscribers canceling our accelerated access and Classmatesservices than is indicated by our churn rate, and the percentage of subscriberscanceling Classmates’ service has fluctuated significantly from quarter toquarter due to seasonality and the timing of termination of multi-monthprograms. During the September 2005 quarter, we experienced increasedchurn in our access base as a whole, and this trend may continue. As a result,it is likely that our overall churn, which was 5% in the September 2005quarter, may be higher in future periods and will fluctuate from period toperiod. If we continue to experience a high percentage of subscribers cancelingour Classmates and accelerator services, it will make it more difficult to growor retain the number of subscribers to those services and the size of ouroverall pay accounts base. If we experience an increased percentage ofcancellations, or if we are unable to attract new pay accounts in numberssufficient to increase our overall pay accounts, our revenues and profitabilitymay 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 subscriptions we can potentially acquire throughmarketing our pay services to our active free accounts. Each month, asignificant number of free accounts become inactive and we may experiencecontinued declines in the number of active free accounts, particularly if wecontinue to focus all of our marketing efforts on our pay services or imposelimitations on our free services. 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.

**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 are notable to adapt to changes in technology and industry standards or develop oracquire and successfully commercialize new and enhanced services. New servicesmay be dependent on our obtaining needed technology or services from thirdparties, which we may not be able to obtain in a timely manner, upon termsacceptable to us, or at all. Our ability to compete successfully will alsodepend upon the continued compatibility of our services with products offeredby various vendors, which we may not be able to achieve.

We have expended, and mayin the future expend, significant resources enhancing our existing services,such as our enhanced accelerator service, and developing, acquiring andimplementing new services, such as our recently launched VoIP services. Productdevelopment involves a number of uncertainties, including unanticipated delaysand expenses. New or enhanced services, such as our VoIP 

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servicesand our enhanced accelerator service, may have technological problems or maynot be accepted by our consumers or advertisers. We cannot assure you that wewill be successful in developing, acquiring or implementing new or enhancedservices, or that new or enhanced services will be commercially successful.

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

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. Because our operating history for certain of our services is limited,particularly as it relates to our social-networking services, it is difficultfor us to accurately forecast seasonal trends and plan accordingly. Seasonalitymay result in significant fluctuations in our results of operations and thenumber of users signing up for, or accessing, our services.

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

Advertising and commerce revenues are an importantcomponent of our revenues and profitability. Our revenues from advertising havein the past fluctuated, and may in the future fluctuate, due to a variety offactors including, without limitation, changes in the online advertisingmarket, decreases in capital available to Internet and other companies, changesin our advertising inventory, changes in usage and the effect of keyadvertising relationships. Although we experienced an increase in advertisingrevenues in the September 2005 quarter from the immediately precedingquarter, we have experienced declines in advertising revenues in certain priorperiods. The majority of our advertising revenues are derived from our accessservices and decreases in our access account base would likely result in decreasedinventory and, potentially, decreased advertising revenues. As discussed above,competition for advertising dollars is intense and our advertising revenues maydecline 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 25% of our advertising and commerce revenues during the September 2005quarter from Internet search fees provided through our agreement with Overture.Our agreement with Overture expires in March 2007. The competition amongsearch services is increasing. If there were a significant decrease in searchfees from our agreement with Overture due to users using competitive servicesor 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.

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

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

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**Provisions of ourterm loan restrict our business operations and may restrict our access toadditional funding in the future.**

We have a term loan with a group of financialinstitutions secured by substantially all of our assets. The terms of the termloan contain customary events of default and covenants that limit us fromtaking certain actions without obtaining the consent of the lenders. Inaddition, our term loan agreement requires us to maintain certain financialratios. These restrictions and covenants limit our ability to respond tochanging business and economic conditions, and we may be prevented from engagingin transactions that might otherwise be considered beneficial to us, includingstrategic acquisitions. Covenants in our term loan agreement also restrict ourability to incur indebtedness, repurchase our common stock, distributedividends and provide financing to our foreign subsidiaries.

A breach of our term loanagreement, including our inability to comply with the required financialratios, could result in a default under our term loan. In the event of anydefault under our term loan, the lenders would be entitled to accelerate therepayment of amounts outstanding, plus accrued and unpaid interest. Moreover,these lenders would have the option to proceed to foreclose against the assetssecuring our obligations. In the event of a foreclosure on all or substantiallyall of our assets, we may not be able to continue to operate as a goingconcern.

**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 thecapacity, affordability, reliability and security of our telecommunicationsnetworks. Only a small number of telecommunications providers offer the networkand data services we require, and most of our telecommunications services iscurrently purchased from Level 3 Communications, MCI, Pac-West and Qwest.Furthermore, in the past, several vendors have ceased operations or ceasedoffering the services we require, causing us to switch vendors. Vendors mayexperience significant financial difficulties and be unable to performsatisfactorily or to continue to offer their services. MCI, Level 3Communications, Pac-West and Qwest have significant amounts of debtobligations. The loss of vendors has resulted, and may in the future result, inincreased costs, decreased service quality and the loss of users. Inparticular, the failure of Level 3 Communications, MCI, Pac-West or Qwest tocontinue to provide the scope, quality and pricing of services currentlyprovided could materially and adversely affect our business and results ofoperations. Some of our telecommunications services are provided pursuant toshort-term agreements that the providers can terminate or elect not to renew.In addition, each of our telecommunications carriers provides network access tosome of our competitors and could choose to grant those competitorspreferential network access or pricing. Certain of our telecommunicationsproviders compete with us in the market to provide consumer Internet access. Asa result, any or all of our current telecommunications service providers coulddiscontinue providing us with service at rates acceptable to us, or at all,which could materially and adversely affect our business, financial position,results of operations and cash flows.

Market rates fortelecommunications services used in our business have declined significantly inrecent years. We do not anticipate that such rates will continue to decline atthe same rate in the future, if at all. General market forces, the failure ofproviders, regulatory issues and other factors could result in increased rates.Any increase in market rates would increase the cost of providing our servicesand, if significant, could have a material adverse effect on our business,financial position, results of operations and cash flows.

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**If we fail tomanage our telecommunications or our internal network capacities, our accessservice levels may suffer 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. and Remedy, a BMC Software Company,and we use a combination of Portal, Remedy and other third-party andinternally developed software applications for such customer billing andsupport. The billing system for Classmates relies on a combination of softwarelicensed from Art Technology Group Inc. (“ATG”), other third-partysoftware applications as well as internally developed software applications.Customer billing and support is a highly complex process, and our systems mustefficiently interface with other third parties’ systems such as the systems ofcredit card processing companies and other companies to whom we outsourcebilling and support functions. Our ability to accurately and efficiently billand support our users is dependent on the successful operation of our billingand support systems and third parties’ systems upon which we rely. In addition,our ability to offer new pay services or alternative payment plans is dependenton our ability to customize our billing and support systems. Issues associatedwith these systems could cause a variety of problems including the failure tobill and collect from users on a timely basis, over-charging or under-chargingusers, inaccurate financial and customer data, excessive credit cardchargebacks or refunds, delays in new product or payment plan introductions andother billing-related errors. Such problems could lead to inaccuratereporting from time to time, which could adversely affect our business,financial position, results of operations and cash flows. We have experiencedbilling and support problems from time to time and may experience additionalproblems in the future. The failure of our software vendors to provide softwareupgrades and technical support, the failure of the Portal, Remedy, ATG orinternally developed software to operate accurately, problems with our creditcard processor or other billing and support vendors and 

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anyother failures or errors in our billing and support systems could materiallyand adversely affect our business, financial position, results of operationsand 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 their relationships with us.**

Our business and financialresults depend, in part, on the availability and quality of our customersupport services. We outsource a majority of the live technical and billingsupport functions to ClientLogic Corporation. As a result, we maintain only asmall number of internal customer service personnel. We are not equipped toprovide the necessary range of customer service functions in the event thatClientLogic becomes unable or unwilling to offer these services to us. Attimes, users seeking live customer support have experienced lengthy waitingperiods to reach support personnel who are trained to provide the technical orbilling support they require. ClientLogic has also experienced outages andother issues in the past which resulted in inadequate service quality andsupport which adversely impacted our business.  Maintaining desired customer support levelsmay require significantly more support personnel than are currently availableto us, or significantly greater expense than we choose to incur. If ClientLogicdoes not provide us with quality services, or if our relationship withClientLogic terminates and we are unable to transition such services in-houseor to a replacement vendor in an orderly, cost-effective and timely manner, ourreputation, business and results of operations would suffer. In addition, weprepay significant amounts in advance to ClientLogic under our agreement withthem, and any failure by them to perform the services for which we have prepaidwould 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 and technologies,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:

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

·                    lossof data or revenue;

·                    injuryto reputation; and

·                    diversionof development resources.

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 and Remedy for billing andcustomer support, software licensed from SlipStream Data Inc. for ouraccelerated services, and software licensed from certain third parties for ourVoIP services. Any significant failure of this software could materially andadversely affect our business, financial position, results of operations andcash flows. Our services also rely on their compatibility with other third-partysystems, particularly operating systems. Incompatibility with future changes tothird-party software upon which our systems rely could materially affectour ability to deliver our services. We cannot assure you that we will notexperience significant technical problems with our services in the future.

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Our recently launched VoIPservices are dependent upon internally developed software, licensed softwareand third party telecommunications services, all of which are relatively new. OurVoIP services have not yet been operated on a significant scale. There will bebugs and other issues associated with these services. If we experience anymaterial difficulties operating these services on a significant scale, or ifthe bugs or other issues we encounter with these services are material, ourability to obtain and maintain users will be adversely impacted.

**Asecurity breach or inappropriate use of our network or services could expose usto claims.**

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, and maydo 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,unauthorized disclosure of user information or other such activities. Althoughwe use security measures that we believe to be industry standard, we cannotassure you that the measures we take will be successfully implemented or willbe effective in preventing these types of activities. We also cannot assure youthat the security measures of our third-party network providers,providers of customer and billing support services or other vendors will beadequate. In addition to potential legal liability, these activities mayadversely impact our reputation and may interfere with our ability to provideour services, all of which could adversely impact our business.

**Harmfulsoftware programs such as viruses could disrupt our business.**

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

**Ourfailure to protect 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. For example, we do not own the domain name *www.unitedonline.com*. Furthermore, the relationship betweenregulations governing domain names and laws protecting trademarks and similarproprietary rights is unclear. Therefore, we may be unable to 

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preventthird parties from acquiring domain names that are similar to, infringe upon,dilute or otherwise decrease the value of our trademarks and other proprietaryrights.

**Legalactions, particularly those associated with proprietary rights, could subjectus to substantial 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. These actionsinclude, without limitation, claims that we infringe third party patents,claims and investigations by governmental agencies and private parties inconnection with consumer protection 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.

**Wemay not realize the benefits associated with our intangible assets and may berequired to record a significant charge to earnings if we are required toimpair our goodwill 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 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 and intangibleassets in connection with the acquisition of certain assets related to PhotoSitein March 2005. If these services are not commercially successful, we would likelybe required to impair these assets which would negatively impact our financialcondition and results of operations.

**Ourability to operate our business could be seriously harmed if we lose members ofour senior management team or other key employees.**

Our business is largelydependent on the efforts and abilities of our senior management, particularlyMark Goldston, our chairman, chief executive officer and president, and otherkey personnel. Any of our officers or employees can terminate his or heremployment relationship at any time. The loss of these key employees or ourinability to attract or retain other qualified employees could seriously harmour business and prospects. We do not carry key man life insurance on any of ouremployees.

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**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 and state regulation as Internet accessservices and telecommunications services converge. If the regulatory status ofISPs changes, our business may be adversely affected.

In general, VoIP services are deemed interstateservices subject to regulation by the FCC. The FCC made this determinationconcerning a VoIP service offering by a particular provider of VoIP services. Thisorder was specific to the particular company that provides a different servicethan we offer, and our offering of VoIP services may or may not be found to bean interstate offering. Further, the FCC’s order finding that a particular typeof VoIP service is interstate**has beenappealed. We cannot predict what the outcome of the appeal will be nor can wepredict what impact, if any, it may have on our business. The FCC is alsoconducting a rulemaking proceeding to consider whether to classify VoIPservices as information or telecommunications services under federal law. Basedon the conclusions reached in that rulemaking, additional regulatoryrequirements, fees and surcharges may apply to our VoIP services.

On June 3, 2005, the FCC released an order andnotice of proposed rulemaking concerning the provision of emergency services byVoIP providers. While the FCC’s VoIP enhanced emergency service order does notcurrently apply to our VoIP services, the FCC’s rulemaking is consideringwhether to extend the VoIP E-911 Order to VoIP services like ours. Shouldthis occur, we would incur additional expenses and could be restricted fromoffering our service and accepting new customers in markets where we have notdeployed an E-911 solution that conforms to the requirements of the VoIPE-911 Order. We have not deployed an E-911 solution and do not expect tohave an E-911 solution available in the near term, if at all.

The Communications Assistance for Law Enforcement Act,or CALEA, mandates that providers of communications services assist lawenforcement agencies in conducting lawfully authorized electronic surveillance.On September 23, 2005, the FCC released an order concluding that CALEAapplies to certain VoIP providers. Currently, that order does not apply to VoIPservices like those we provide. However, the FCC is considering whether toexpand the scope of the order to include VoIP providers like us. We cannotpredict what the FCC will conclude in that proceeding or what effect, if any,it may have on our business.

Although these federal regulations applicable tocertain VoIP services do not currently apply to our VoIP services, our VoIPservices may subsequently become subject to these regulations as well as otherstate or federal regulations as a result of changes we make to these services,changes made to the regulations or the interpretation of them, or the adoptionof new laws and regulations applicable to our VoIP services. Moreover, if weoffer new services that are subject to different and additional governmentalregulation, we may have to comply with additional laws and regulations thatcurrently are not applicable to us. If the regulatory status of our VoIPservice offerings changes or if we offer new services that subject us to newlaws and regulations, our business may be adversely affected.

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. In addition, the FCCis in the process of determining whether certain federal taxes and otherregulatory charges, such as Universal Service Funding, should apply to VoIPservice providers. The FCC’s state preemption order also did not precludestates from attempting to tax 

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VoIP service providers. Accordingly,future action could be taken to impose various federal, state and local taxeson our VoIP services.

Our business is alsosubject to a variety of other U.S. and foreign laws and regulations that couldsubject us to liabilities, claims or other remedies, such as laws relating tobulk email or “spam,” access to various types of content by minors, anti-spywareinitiatives, encryption, data protection, security breaches and consumerprotection. Compliance with these laws and regulations is complex and mayimpose significant additional costs on us. In addition, the regulatoryframework relating to Internet services is evolving and both the federalgovernment and states from time to time pass legislation that impacts ourbusiness. It is likely that additional laws and regulations will be adoptedthat would affect 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.

**Changesin, or interpretations of, laws regarding consumer protection could subject usto liability or cause us to change our 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. Junoand the FTC entered into a consent agreement, which was approved by the FTC on June 29,2001, that provides for redress payments and specific disclosures or noticesregarding, among other things, the cost of its Internet access services, itscancellation terms and local versus long-distance charges, as well as therequirement to provide adequate customer support to process cancellations. Wereceived an inquiry regarding our compliance with the consent agreement on October 14,2005.

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 and disclosure practices. We cannot assure youthat our services and business practices, or changes to our services andbusiness practices, will not subject us to claims and liability by privateparties, the FTC or other governmental agencies.

**Ourbusiness could be 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 Jose, California; Ashburn, Virginia; Renton,Washington and New York, New York. In the past, areas in California haveexperienced repeated episodes of diminished electrical power supply, or “rollingblackouts.” A natural disaster, terrorism, power blackout or otherunanticipated problem at our headquarters or at a network hub, or within athird-party network provider’s network, could cause interruptions in theservices that we provide. Our systems are not fully redundant. Any prolongeddisruption of our services due to system failures could result in user turnoverand decreased revenues.

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**Ourbusiness could be severely impacted due to political instability or otherfactors 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 tocommunicate with these operations. Any disruption that continued for anextended period of time would likely have a material adverse effect on ourability to service our customers and develop our products since it would take asignificant period of time to transition these operations internally or to anoutside vendor. If we were to cease our operations in India and transfer theseoperations to another geographic area, such change could result in increasedoverhead costs which could materially and adversely impact our results ofoperations.

**Wecannot predict our future capital needs and we may not be able to secureadditional 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.

**Wehave anti-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.

**Ourstock price has been 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 3.**   QUANTITATIVE ANDQUALITATIVE 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 and our term loan.

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 rating of A1and P1. The value of these investments may fluctuate with changes in interestrates. However, we believe this risk is immaterial due to the short-term natureof the investments.

Weare exposed to interest rate risk on the outstanding balance of our term loan.In January 2005, we converted the outstanding base rate loan intoEurodollar loans with staggered interest periods including three months and upto six months. In July 2005, we converted the only outstanding Eurodollarloan into three Eurodollar loans with staggered interest periods includingthree months and up to six months. In October 2005, we elected to continueour three month Eurodollar loan. Interest accrues at rates generally equal tothe London inter-bank offered rate (LIBOR) for dollar deposits plus a margin of3.0%. We purchased an interest-rate cap to reduce the variability in the amountof expected future cash interest payments that are attributable to LIBOR-basedmarket interest rates. The cap provides protection through January 31,2007 from an increase in three month LIBOR over 3.5% on $25 million of ouroutstanding term loan balance.

*Foreign CurrencyRisk*

We transact business in different foreign currenciesand may be exposed to financial market risk resulting from fluctuations inforeign currency exchange rates, particularly the Indian Rupee (INR) and theEuro, which may result in a gain or loss of earnings to us. The volatility ofthe INR and the Euro (and all other applicable currencies) is monitoredthroughout the year. We face two risks related to foreign currency exchange:translation risk and transaction risk. Amounts invested in our foreignoperations are translated into U.S. dollars using period-end exchange rates.The resulting translation adjustments are recorded as a component ofaccumulated other comprehensive income (loss) in stockholders’ equity. Ourforeign subsidiaries generally collect revenues and pay expenses in currenciesother than the U.S. dollar. Since the functional currencies of our foreignoperations are denominated in the local currency of our subsidiaries, theforeign 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.

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**ITEM 4.**   CONTROLS ANDPROCEDURES

*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*

There have not been any changes in the Company’sinternal controls over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during our most recent fiscalquarter that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal controls over financial reporting.

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**PART II—OTHER INFORMATION**

**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 is scheduled for April 24,2006.

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 has commenced. No trial date has been set.

On April 27, 2004, plaintiff MyMail Ltd.filed a lawsuit in the United States District Court for the Eastern District ofTexas against NetZero, Juno, NetBrands, America Online, Inc., AT&T,EarthLink, Inc., SBC Communications, Inc., and Verizon Communications, Inc.alleging infringement of plaintiff’s patent which purports to cover user accessto a computer network. On October 28, 2005, the court issued an ordergranting defendants’ motions for summary judgment of non-infringement of thepatent.

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 

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of the above outstandinglegal proceedings, claims and litigation will have a material adverse effect onour business, financial condition, results of operations or cash flows, theresults of litigation are inherently uncertain and we cannot assure you that wewill not be materially and adversely impacted by the results of suchproceedings. We have established a reserve for the Freewwweb matter discussedabove and such reserve is reflected in our consolidated financial statements.We cannot assure you, however, that any of the reserves that have beenestablished for outstanding litigation is sufficient to cover the possiblelosses from such litigation.

We are subject to various other legal proceedings andclaims that arise in the ordinary course of business. We believe the amount,and ultimate liability, if any, with respect to these actions will notmaterially affect our business, financial condition, results of operations orcash flows. We cannot assure you, however, that such actions will not bematerial and will not adversely affect our business, financial condition,results of operations or cash flows.

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

**Common Stock Repurchase Program**

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, 2005, we hadrepurchased $139.2 million of our common stock under the program.

Under the term loan agreement, repurchases of commonstock and the payment of cash dividends are limited, in aggregate, to $110.1million at September 30, 2005, subject to further annual limitations. As aresult of these limitations, we may be unable to repurchase the remaining $60.8million available under the program if we maintain a quarterly cash dividend of$0.20 per share and do not repay or amend the terms of the term loan agreement.Additionally, in order to repurchase any common stock, no default or event ofdefault shall have occurred and be continuing under the term loan agreement.Noncompliance with the financial covenants set forth in the agreementconstitutes an event of default under the agreement.

Share repurchases executed under the common stockrepurchase program at September 30, 2005 were as follows (in thousands,except per share amounts):

| **Period**         | ** ** | ** ** | ** ** | **Shares  Repurchased(1)** | ** ** | **Average Price Paid  per Share** | ** ** | **Maximum Approximate Dollar  Value that May Yet be  Purchased Under the Program** | ** ** |
|--------------------|------------|------------|------------|----------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
| August 2001   |       |       | 138        |                       |       |                                             | $          | 1.67                                                                                                                            |       |   |   | $ | 9,770 |   |   |
| November 2001 |       |       | 469        |                       |       |                                             | 1.77       |                                                                                                                            |       |   | 8,940 |   |   |
| February 2002 |       |       | 727        |                       |       |                                             | 3.38       |                                                                                                                            |       |   | 6,485 |   |   |
| August 2002   |       |       | 288        |                       |       |                                             | 7.51       |                                                                                                                            |       |   | 27,820 |   |   |
| February 2003 |       |       | 193        |                       |       |                                             | 9.43       |                                                                                                                            |       |   | 26,005 |   |   |
| May 2003      |       |       | 281        |                       |       |                                             | 13.51      |                                                                                                                            |       |   | 22,207 |   |   |
| November 2003 |       |       | 2,024      |                       |       |                                             | 19.76      |                                                                                                                            |       |   | 48,706 |   |   |
| February 2004 |       |       | 2,887      |                       |       |                                             | 16.86      |                                                                                                                            |       |   | — |   |   |
| May 2004      |       |       | —     |                       |       |                                             | —     |                                                                                                                            |       |   | 100,000 |   |   |
| August 2004   |       |       | 2,657      |                       |       |                                             | 9.41       |                                                                                                                            |       |   | 74,989 |   |   |
| February 2005 |       |       | 1,268      |                       |       |                                             | 11.20      |                                                                                                                            |       |   | 60,782 |   |   |
| Total              |       |       | 10,932     |                       |       |                                             | $          | 12.74                                                                                                                           |       |   |   |   |   |   |

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(1)          All shares wererepurchased as part of a publicly announced program.

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**ITEM 6.**        EXHIBITS

|         | ** ** | ** **                                                                                                                                                                                                                                                                                                  | ** ** | **Filed   with this** | ** ** | **Incorporated by Reference to** |
|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------------|
| **No.** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                | ** ** | **Form 10-Q**    | ** ** | **Form**                         | ** ** | **File No.** | ** ** | **Date Filed** |
| 2.1     |       | Agreement and Plan of  Merger, dated October 23, 2004, among United Online, Inc., Mariner  Acquisition Corp. and Classmates Online, Inc.                                                                                                                                                     |       |                  |       | 8-K                              |   | 000-33367 |   | 11/4/2004 |
| 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.  2005 Management Bonus Plan                                                                                                                                                                                                                                                        |       |                  |       | 8-K                              |   | 000-33367 |   | 3/30/2005 |
| 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 |

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| 10.14 |   | Employment Agreement  between the Registrant and Matt Wisk                                                                                                                                                                                                                            |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005   |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|-----------|--------|------------|
| 10.15 |   | Employment Agreement  between the Registrant and Ted Cahall                                                                                                                                                                                                                           |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005   |
| 10.16 |   | Employment Agreement  between the Registrant and Jon Fetveit                                                                                                                                                                                                                          |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005   |
| 10.17 |   | Employment Agreement  between the Registrant and Gerald Popek                                                                                                                                                                                                                         |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005   |
| 10.18 |   | Employment Agreement  between the Registrant and Robert Taragan                                                                                                                                                                                                                       |   |   |   | 10-Q   |   | 000-33367 |   | 8/8/2005   |
| 10.19 |   | Office Lease between LNR  Warner Center, LLC and NetZero, Inc.                                                                                                                                                                                                                   |   |   |   | 10-Q   |   | 000-33367 |   | 5/3/2004   |
| 10.20 |   | Credit Agreement,  dated as of December 3, 2004, among United Online, the Lenders party  thereto from time to time, Deutsche Bank Trust Company Americas, as  Administrative Agent, and Deutsche Bank Securities Inc., as Lead  Arranger (the “Credit Agreement”) |   |   |   | 8-K    |   | 000-33367 |   | 12/3/2004  |
| 10.21 |   | First Amendment to  Credit Agreement, dated as of December 13, 2004                                                                                                                                                                                                              |   |   |   | 8-K    |   | 000-33367 |   | 12/14/2004 |
| 10.22 |   | Second Amendment to  Credit Agreement, dated as of March 11, 2005                                                                                                                                                                                                                |   |   |   | 10-K   |   | 000-33367 |   | 3/16/2005  |
| 31.1  |   | Certification of the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |   | X      |   |   |   | 000-33367 |   | 11/9/2005  |
| 31.2  |   | Certification of the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |   | X      |   |   |   | 000-33367 |   | 11/9/2005  |
| 32.1  |   | Certification of the  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |   | X      |   |   |   | 000-33367 |   | 11/9/2005  |
| 32.2  |   | Certification of the  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |   | X      |   |   |   | 000-33367 |   | 11/9/2005  |

 

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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, 2005.
|          | UNITED ONLINE, INC. |
|----------|--------------------------|
|     | By:                      | /s/  CHARLES S. HILLIARD |
|     |                     | Charles S.  Hilliard |
| * * | * *                 | *Executive  Vice President, Finance 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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**EXHIBIT INDEX**

|         | ** ** | ** **                                                                                                                                                                                                                                                                                                  | ** ** | **Filed  with this** | ** ** | **Incorporated by Reference to** | ** ** |
|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------------------------------|------------|
| **No.** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                | ** ** | **Form 10-Q**        | ** ** | **Form**                                        | ** ** | **File No.** | ** ** | **Date Filed** | ** ** |
| 2.1     |       | Agreement and  Plan of Merger, dated October 23, 2004, among United Online, Inc.,  Mariner Acquisition Corp. and Classmates Online, Inc.                                                                                                                                                     |       |                      |       |                                            |       | 8-K |   | 000-33367 |   | 11/4/2004 |   |
| 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. 2005 Management Bonus Plan                                                                                                                                                                                                                                                        |       |                      |       |                                            |       | 8-K |   | 000-33367 |   | 3/30/2005 |   |
| 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 |   |

 

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|         | ** ** | ** **                                                                                                                                                                                                                                                                            | ** ** | **Filed  with this** | ** ** | **Incorporated by Reference to** | ** ** |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------------------------------|------------|
| **No.** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                          | ** ** | **Form 10-Q**        | ** ** | **Form**                                        | ** ** | **File No.** | ** ** | **Date Filed** | ** ** |
| 10.13   |       | Amended and  Restated Employment Agreement between the Registrant and Frederic A.  Randall, Jr.                                                                                                                                                                             |       |                      |       |                                            |       | 10-KT |   | 000-33367 |   | 2/5/2004 |   |
| 10.14   |       | Employment  Agreement between the Registrant and Matt Wisk                                                                                                                                                                                                                            |       |                      |       |                                            |       | 10-Q |   | 000-33367 |   | 8/8/2005 |   |
| 10.15   |       | Employment  Agreement between the Registrant and Ted Cahall                                                                                                                                                                                                                           |       |                      |       |                                            |       | 10-Q |   | 000-33367 |   | 8/8/2005 |   |
| 10.16   |       | Employment  Agreement between the Registrant and Jon Fetveit                                                                                                                                                                                                                          |       |                      |       |                                            |       | 10-Q |   | 000-33367 |   | 8/8/2005 |   |
| 10.17   |       | Employment  Agreement between the Registrant and Gerald Popek                                                                                                                                                                                                                         |       |                      |       |                                            |       | 10-Q |   | 000-33367 |   | 8/8/2005 |   |
| 10.18   |       | Employment  Agreement between the Registrant and Robert Taragan                                                                                                                                                                                                                       |       |                      |       |                                            |       | 10-Q |   | 000-33367 |   | 8/8/2005 |   |
| 10.19   |       | Office Lease  between LNR Warner Center, LLC and NetZero, Inc.                                                                                                                                                                                                                   |       |                      |       |                                            |       | 10-Q |   | 000-33367 |   | 5/3/2004 |   |
| 10.20   |       | Credit Agreement,  dated as of December 3, 2004, among United Online, the Lenders party  thereto from time to time, Deutsche Bank Trust Company Americas, as  Administrative Agent, and Deutsche Bank Securities Inc., as Lead  Arranger (the “Credit Agreement”) |       |                      |       |                                            |       | 8-K |   | 000-33367 |   | 12/3/2004 |   |
| 10.21   |       | First Amendment  to Credit Agreement, dated as of December 13, 2004                                                                                                                                                                                                              |       |                      |       |                                            |       | 8-K |   | 000-33367 |   | 12/14/2004 |   |
| 10.22   |       | Second Amendment  to Credit Agreement, dated as of March 11, 2005                                                                                                                                                                                                                |       |                      |       |                                            |       | 10-K |   | 000-33367 |   | 3/16/2005 |   |
| 31.1    |       | Certification of  the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |       |                      | X          |                                            |       |   |   | 000-33367 |   | 11/9/2005 |   |
| 31.2    |       | Certification of  the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |       |                      | X          |                                            |       |   |   | 000-33367 |   | 11/9/2005 |   |
| 32.1    |       | Certification of  the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |       |                      | X          |                                            |       |   |   | 000-33367 |   | 11/9/2005 |   |
| 32.2    |       | Certification of the  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                         |       |                      | X          |                                            |       |   |   | 000-33367 |   | 11/9/2005 |   |

 

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