Annual Reports

 
Quarterly Reports

 
8-K

 
Other

United Online 8-K 2008

Documents found in this filing:

  1. 8-K
  2. Ex-23.1
  3. Ex-99.1
  4. Ex-99.2
  5. Ex-99.2

Exhibit 99.1

 

UNITED ONLINE, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Page

Management’s Report on Internal Control Over Financial Reporting

F-2

 

 

Report of Independent Registered Public Accounting Firm

F-3

 

 

Consolidated Balance Sheets

F-4

 

 

Consolidated Statements of Operations

F-5

 

 

Consolidated Statements of Comprehensive Income

F-6

 

 

Consolidated Statements of Stockholders’ Equity

F-7

 

 

Consolidated Statements of Cash Flows

F-8

 

 

Notes to Consolidated Financial Statements

F-9

 

 

Schedule II—Valuation and Qualifying Accounts

F-49

 

F-1



 

Management’s Report on Internal Control Over Financial Reporting

 

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

 

The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorization of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements.

 

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

 

Management assessed the effectiveness of the Company’s internal control over financial reporting at December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework. Based on that assessment under those criteria, management has determined that, at December 31, 2007, the Company’s internal control over financial reporting was effective.

 

The Company’s internal control over financial reporting at December 31, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

F-2



 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of United Online, Inc.:

 

In our opinion, the consolidated financial statements listed in the index appearing on page F-1 present fairly, in all material respects, the financial position of United Online, Inc. and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in “Management’s Report on Internal Control over Financial Reporting” appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

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

 

As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for uncertain tax positions in 2007.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

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

 

/s/ PRICEWATERHOUSECOOPERS LLP

 

Los Angeles, California

February 18, 2008, except for the condensed consolidating financial information
as described in Note 15, which is dated June 24, 2008.

 

F-3



 

UNITED ONLINE, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

 

 

 

December 31,

 

 

 

2007

 

2006

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

149,507

 

$

19,252

 

Short-term investments

 

68,800

 

143,110

 

Accounts receivable, net of allowance for doubtful accounts of $2,378 and $1,324 at December 31, 2007 and 2006, respectively

 

28,765

 

32,226

 

Deferred tax assets, net

 

7,050

 

11,705

 

Other current assets

 

19,992

 

13,426

 

Total current assets

 

274,114

 

219,719

 

Property and equipment, net

 

39,570

 

34,296

 

Deferred tax assets, net

 

57,559

 

59,655

 

Goodwill

 

132,352

 

133,018

 

Intangible assets, net

 

40,915

 

53,653

 

Other assets

 

7,883

 

2,678

 

Total assets

 

$

552,393

 

$

503,019

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

38,095

 

$

36,550

 

Accrued liabilities

 

30,586

 

39,547

 

Member redemption liability

 

19,499

 

15,835

 

Deferred revenue

 

63,086

 

53,121

 

Capital leases

 

13

 

17

 

Total current liabilities

 

151,279

 

145,070

 

Member redemption liability

 

5,061

 

4,154

 

Deferred revenue

 

4,691

 

3,227

 

Capital leases

 

 

13

 

Other liabilities

 

10,734

 

3,589

 

Total liabilities

 

171,765

 

156,053

 

 

 

 

 

 

 

Commitments and contingencies (see Note 13)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.0001 par value; 5,000 shares authorized; no shares issued or outstanding at December 31, 2007 and 2006

 

 

 

Common stock, $0.0001 par value; 300,000 shares authorized; 68,019 and 65,805 shares issued and outstanding at December 31, 2007 and 2006, respectively

 

7

 

7

 

Additional paid-in capital

 

414,841

 

439,383

 

Accumulated other comprehensive income (loss)

 

182

 

(245

)

Accumulated deficit

 

(34,402

)

(92,179

)

Total stockholders’ equity

 

380,628

 

346,966

 

Total liabilities and stockholders’ equity

 

$

552,393

 

$

503,019

 

 

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

 

F-4



 

UNITED ONLINE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

 

 

Year Ended December 31,

 

 

 

2007

 

2006

 

2005

 

Revenues

 

$

513,503

 

$

522,654

 

$

525,061

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Cost of revenues (including stock-based compensation, see Note 5)

 

117,203

 

119,990

 

110,672

 

Sales and marketing (including stock-based compensation, see Note 5)

 

163,424

 

176,980

 

209,292

 

Product development (including stock-based compensation, see Note 5)

 

51,044

 

52,602

 

40,009

 

General and administrative (including stock-based compensation, see Note 5)

 

73,312

 

67,511

 

56,729

 

Amortization of intangible assets

 

12,800

 

17,640

 

21,799

 

Restructuring charges

 

3,419

 

627

 

 

Impairment of goodwill, intangible assets and long-lived assets

 

 

13,285

 

 

Total operating expenses

 

421,202

 

448,635

 

438,501

 

Operating income

 

92,301

 

74,019

 

86,560

 

Interest and other income, net

 

7,555

 

6,076

 

6,885

 

Interest expense

 

(1,164

)

(2,571

)

(6,073

)

Income before income taxes

 

98,692

 

77,524

 

87,372

 

Provision for income taxes

 

40,915

 

36,293

 

40,245

 

Income before cumulative effect of accounting change

 

57,777

 

41,231

 

47,127

 

Cumulative effect of accounting change, net of tax (see Note 1)

 

 

1,041

 

 

Net income

 

$

57,777

 

$

42,272

 

$

47,127

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income per share:

 

 

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

0.87

 

$

0.64

 

$

0.77

 

Cumulative effect of accounting change, net of tax

 

 

0.02

 

 

Basic net income per share

 

$

0.87

 

$

0.66

 

$

0.77

 

 

 

 

 

 

 

 

 

Diluted net income per share:

 

 

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

0.83

 

$

0.62

 

$

0.74

 

Cumulative effect of accounting change, net of tax

 

 

0.02

 

 

Diluted net income per share

 

$

0.83

 

$

0.64

 

$

0.74

 

Shares used to calculate basic net income per share

 

66,768

 

64,001

 

61,135

 

Shares used to calculate diluted net income per share

 

69,287

 

66,269

 

63,815

 

 

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

 

F-5



 

UNITED ONLINE, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

 

 

Year Ended December 31,

 

 

 

2007

 

2006

 

2005

 

Net income

 

$

57,777

 

$

42,272

 

$

47,127

 

Change in unrealized gain (loss) on short-term investments, net of tax of $184, $120 and $(193) for the years ended December 31, 2007, 2006 and 2005

 

285

 

172

 

(282

)

Change in unrealized gain (loss) on derivative, net of tax of $0, $(60) and $60 for the years ended December 31, 2007, 2006 and 2005

 

 

(83

)

83

 

Foreign currency translation

 

142

 

(7

)

(119

)

Comprehensive income

 

$

58,204

 

$

42,354

 

$

46,809

 

 

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

 

F-6



 

UNITED ONLINE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Deferred

 

Other

 

 

 

Total

 

 

 

Common Stock

 

Paid-In

 

Stock-Based 

 

Comprehensive

 

Accumulated

 

Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Compensation

 

Income (Loss)

 

Deficit

 

Equity

 

Balance at January 1, 2005

 

61,074

 

$

6

 

$

491,757

 

$

(8,477

)

$

(9

)

$

(181,578

)

$

301,699

 

Issuance of common stock through employee stock purchase plan

 

426

 

 

3,169

 

 

 

 

3,169

 

Exercises of stock options

 

2,374

 

 

5,874

 

 

 

 

5,874

 

Repurchases of common stock

 

(1,268

)

 

(14,206

)

 

 

 

(14,206

)

Issuance of restricted stock units

 

 

 

18,033

 

(18,033

)

 

 

 

Cancellation of restricted stock units

 

 

 

(340

)

340

 

 

 

 

Cancellation of options assumed in connection with acquisition

 

 

 

(668

)

668

 

 

 

 

Dividends paid on shares outstanding and restricted stock units

 

 

 

(38,067

)

 

 

 

(38,067

)

Stock-based compensation

 

 

 

8

 

9,944

 

 

 

9,952

 

Unrealized loss on short-term investments, net of tax

 

 

 

 

 

(282

)

 

(282

)

Unrealized gain on derivative, net of tax

 

 

 

 

 

83

 

 

83

 

Foreign currency translation

 

 

 

 

 

(119

)

 

(119

)

Tax benefits from equity awards

 

 

 

7,185

 

 

 

 

7,185

 

Net income

 

 

 

 

 

 

47,127

 

47,127

 

Balance at December 31, 2005

 

62,606

 

6

 

472,745

 

(15,558

)

(327

)

(134,451

)

322,415

 

Cumulative effect of accounting change, net of tax

 

 

 

(1,041

)

 

 

 

(1,041

)

Balance at January 1, 2006

 

62,606

 

6

 

471,704

 

(15,558

)

(327

)

(134,451

)

321,374

 

Reversal of deferred stock-based compensation

 

 

 

(15,558

)

15,558

 

 

 

 

Exercises of stock options

 

2,163

 

1

 

9,451

 

 

 

 

9,452

 

Issuance of common stock through employee stock purchase plan

 

623

 

 

5,004

 

 

 

 

5,004

 

Vesting of restricted stock units

 

413

 

 

 

 

 

 

 

Repurchases of common stock

 

 

 

(2,684

)

 

 

 

(2,684

)

Dividends paid on shares outstanding and restricted stock units

 

 

 

(53,483

)

 

 

 

(53,483

)

Stock-based compensation

 

 

 

19,168

 

 

 

 

19,168

 

Unrealized gain on short-term investments, net of tax

 

 

 

 

 

172

 

 

172

 

Unrealized loss on derivative, net of tax

 

 

 

 

 

(83

)

 

(83

)

Foreign currency translation

 

 

 

 

 

(7

)

 

(7

)

Tax benefits from equity awards

 

 

 

5,781

 

 

 

 

5,781

 

Net income

 

 

 

 

 

 

42,272

 

42,272

 

Balance at December 31, 2006

 

65,805

 

7

 

439,383

 

 

(245

)

(92,179

)

346,966

 

Exercises of stock options

 

1,068

 

 

8,605

 

 

 

 

8,605

 

Issuance of common stock through employee stock purchase plan

 

583

 

 

5,413

 

 

 

 

5,413

 

Vesting of restricted stock units

 

688

 

 

 

 

 

 

 

Repurchases of common stock

 

 

 

(5,601

)

 

 

 

(5,601

)

Repurchase of forfeited restricted stock

 

(125

)

 

 

 

 

 

 

Dividends paid on shares outstanding and restricted stock units

 

 

 

(57,130

)

 

 

 

(57,130

)

Stock-based compensation

 

 

 

19,549

 

 

 

 

19,549

 

Unrealized gain on short-term investments, net of tax

 

 

 

 

 

285

 

 

285

 

Foreign currency translation

 

 

 

 

 

142

 

 

142

 

Tax benefits from equity awards

 

 

 

4,622

 

 

 

 

4,622

 

Net income

 

 

 

 

 

 

57,777

 

57,777

 

Balance at December 31, 2007

 

68,019

 

$

7

 

$

414,841

 

$

 

$

182

 

$

(34,402

)

$

380,628

 

 

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

 

F-7



 

UNITED ONLINE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Year Ended December 31,

 

 

 

2007

 

2006

 

2005

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

57,777

 

$

42,272

 

$

47,127

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

32,950

 

38,930

 

37,280

 

Stock-based compensation

 

19,549

 

19,168

 

9,952

 

Provision for (benefit from) doubtful accounts receivable

 

1,323

 

(81

)

633

 

Impairment of goodwill, intangible assets and long-lived assets

 

 

13,285

 

 

Deferred taxes

 

7,248

 

(3,609

)

1,577

 

Tax benefits from equity awards

 

4,622

 

5,781

 

15,170

 

Excess tax benefits from equity awards

 

(3,168

)

(3,863

)

 

Cumulative effect of accounting change, net of tax

 

 

(1,041

)

 

Other

 

929

 

3,023

 

748

 

Changes in operating assets and liabilities (excluding the effects of acquisitions):

 

 

 

 

 

 

 

Accounts receivable

 

2,138

 

(3,215

)

(2,302

)

Other assets

 

(9,018

)

844

 

1,806

 

Accounts payable and accrued liabilities

 

(9,025

)

(11,211

)

17,677

 

Member redemption liability

 

4,572

 

2,315

 

 

Deferred revenue

 

11,430

 

(999

)

5,181

 

Other liabilities

 

5,898

 

(129

)

2,198

 

Net cash provided by operating activities

 

127,225

 

101,470

 

137,047

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of property and equipment

 

(25,509

)

(24,329

)

(21,653

)

Purchases of rights, patents and trademarks

 

 

(509

)

(5,562

)

Purchases of short-term investments

 

(228,920

)

(324,328

)

(320,869

)

Proceeds from maturities of short-term investments

 

72,890

 

115,581

 

177,595

 

Proceeds from sales of short-term investments

 

229,994

 

209,599

 

175,738

 

Cash paid for acquisitions, net of cash acquired

 

 

(61,155

)

(8,638

)

Payment for settlement of pre-acquisition liability

 

 

(4,800

)

 

Proceeds from sales of assets, net

 

71

 

104

 

 

Net cash provided by (used for) investing activities

 

48,526

 

(89,837

)

(3,389

)

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Payments on term loan

 

 

(54,209

)

(45,792

)

Payments on capital leases

 

(16

)

(668

)

(621

)

Proceeds from exercises of stock options

 

8,605

 

9,452

 

5,874

 

Proceeds from employee stock purchase plan

 

5,413

 

5,004

 

3,169

 

Repurchases of common stock

 

(5,601

)

(2,684

)

(14,206

)

Payments for dividends

 

(57,130

)

(53,483

)

(38,067

)

Excess tax benefits from equity awards

 

3,168

 

3,863

 

 

Net cash used for financing activities

 

(45,561

)

(92,725

)

(89,643

)

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

65

 

(53

)

(130

)

Change in cash and cash equivalents

 

130,255

 

(81,145

)

43,885

 

Cash and cash equivalents, beginning of period

 

19,252

 

100,397

 

56,512

 

Cash and cash equivalents, end of period

 

$

149,507

 

$

19,252

 

$

100,397

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of cash flows:

 

 

 

 

 

 

 

Cash paid for interest

 

$

2

 

$

862

 

$

4,245

 

Cash paid for income taxes

 

$

34,855

 

$

34,352

 

$

13,970

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

 

 

Reduction in goodwill in connection with a release of a portion of the deferred tax valuation allowance

 

$

375

 

$

 

$

 

 

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

 

F-8


 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Description of Business

 

United Online, Inc. (“United Online” or the “Company”) is a leading provider of consumer Internet and media services through a number of brands, including Classmates, MyPoints, NetZero, and Juno. The Company’s Classmates Media services are online social networking and online loyalty marketing. The Company’s primary Communications services are Internet access and email. On a combined basis, the Company’s Web properties attract a significant number of Internet users each month and the Company offers a broad array of Internet marketing products and services for advertisers.

 

United Online is a Delaware corporation that commenced operations in 2001 following the merger of Internet access providers NetZero, Inc. and Juno Online Services, Inc. (the “Merger”). In April 2004, the Company acquired the Web hosting and domain name registration business of About Web Services, Inc., and in November 2004, the Company acquired Classmates Online, Inc. (“Classmates”), a leading provider of online social networking services. In March 2006, the Company acquired The Names Database, a global social networking service. In April 2006, the Company acquired MyPoints.com, Inc. (“MyPoints”), a leading provider of online loyalty marketing services. The Company’s corporate headquarters are located in Woodland Hills, California, and the Company also maintains offices in New York, New York; Fort Lee, New Jersey; Renton, Washington; San Francisco, California; Schaumburg, Illinois; Orem, Utah; Erlangen, Germany; Berlin, Germany; and Hyderabad, India.

 

The Company believes that its existing cash, cash equivalents and short-term investments, and cash generated from operations will be sufficient to fund its working capital requirements, capital expenditures, dividend payments, and other obligations through at least the next twelve months. However, additional capital may be needed in order to fund the Company’s operations, expand marketing activities, develop new or enhance existing services or products, respond to competitive pressures or acquire services, businesses or technologies.

 

Basis of Presentation

 

The accompanying consolidated financial statements for the years ended December 31, 2007, 2006 and 2005 include United Online and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for any future periods.

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent liabilities and the reported amounts of revenues and expenses. Actual results could differ from these estimates and assumptions.

 

The most significant areas that require management judgment and which are susceptible to possible change in the near term include the Company’s revenue recognition, goodwill, intangible assets and other long-lived assets, member redemption liability, income taxes, and legal contingencies. The accounting policies for these areas are discussed elsewhere in these consolidated financial statements.

 

F-9



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

Reclassifications—Certain prior year amounts have been reclassified to conform to the current year presentation. These changes had no impact on the previously reported consolidated results of operations or stockholders’ equity.

 

Accounting Policies

 

Cash, Cash Equivalents and Short-Term Investments—The Company considers cash equivalents to be only those investments which are highly liquid, readily convertible to cash and which have a maturity date within ninety days from the date of purchase. The Company’s short-term investments consist of available-for-sale securities with maturities exceeding ninety days from the date of purchase. Consistent with Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company has classified these securities, all of which have readily determinable fair values and which are highly liquid, as short-term because the sale of such securities may be required prior to maturity to implement management’s strategies.

 

The Company’s short-term investments at December 31, 2007 consisted of municipal securities, and at December 31, 2006, U.S. corporate notes, U.S. Government agencies, and municipal securities, including auction rate securities. Auction rate securities have long-term underlying maturities, typically 20 to 30 years, but have interest rates that are reset every 7, 28 or 35 days, at which time the securities can typically be purchased or sold, historically creating a highly liquid market. As a result of the recent adverse conditions in the U.S. credit markets, the Company liquidated, without any losses in principal, its investments in auction rate securities and did not hold any auction rate securities as of December 31, 2007. The primary objective of the Company’s short-term investments portfolio is the preservation of principal and liquidity while maximizing yield without significantly increasing risk. The Company’s investment policy requires a minimum long-term credit rating of A, and if a long-term credit rating is not available, the Company requires a minimum short-term credit rating of A1 and P1. Furthermore, by policy, the Company limits the amount of credit exposure to any one issuer. The Company’s investments, at times in both fixed-rate and variable-rate interest-earning instruments, carry a degree of interest rate risk. Fixed-rate securities may have their fair market value adversely impacted due to a rise in interest rates, while variable-rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company’s future investment income may fall short of expectations due to changes in interest rates, or it may suffer losses in principal by selling securities which have declined in market value due to changes in interest rates.

 

The Company classifies all of its short-term investments as available-for-sale. Available-for-sale securities are carried at fair value, with changes in unrealized gains and losses, net of taxes, reported in the consolidated statements of comprehensive income. Realized gains or losses and permanent declines in value, if any, on available-for-sale securities are reported in interest and other income, net, in the consolidated statements of operations. The cost basis of a security that has been sold and any amount reclassified out of accumulated other comprehensive income (loss) in the consolidated balance sheets into earnings is determined by the specific identification method.

 

The Company classifies outstanding interest payments due on its short-term investments as interest receivable, the balance of which is reflected in other current assets in the consolidated balance sheets.

 

The Company regularly assesses whether an other-than-temporary impairment loss on its short-term investments has occurred due to declines in fair value or other market conditions. Declines in fair value that are considered other than temporary are recorded as an impairment charge and reported in the consolidated statements of operations. Factors considered by management in assessing

 

F-10



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

whether an other-than-temporary impairment has occurred include: the nature of the investment; whether the decline in fair value is attributable to specific adverse conditions affecting the investment; the financial condition of the investee; the severity and the duration of the impairment; and whether the Company has the ability to hold the investment to maturity. When it is determined that an other-than-temporary impairment has occurred, the investment is written down to its market value at the end of the period in which it is determined that an other-than-temporary decline has occurred. During the years ended December 31, 2007, 2006 and 2005, the Company did not record any such impairment charges.

 

Restricted Cash—Restricted cash, which is included in other current assets and other assets in the consolidated balance sheets, consists of certificates of deposit and, in general, collateralizes the Company’s obligations related to standby letters of credit pursuant to certain of the Company’s lease arrangements, and amounts held in escrow related to certain of the Company’s merchant services agreements.

 

Concentrations of Credit and Business Risk—Financial instruments that potentially subject the Company to a concentration of credit risk primarily consist of cash and cash equivalents, short-term investments and accounts receivable. The Company’s accounts receivable are derived primarily from revenue earned from advertising customers located in the United States and pay accounts. The Company extends credit based upon an evaluation of the customer’s financial condition and, generally, collateral is not required. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectibility of accounts receivable, and, to date, such losses have been within management’s expectations.

 

The Company evaluates specific accounts receivable where information exists that the customer may have an inability to meet its financial obligations. In these cases, based on the best available facts and circumstances, a specific allowance is recorded for that customer against amounts due to reduce the receivable to the amount that is expected to be collected. These specific allowances are re-evaluated and adjusted as additional information is received that impacts the amount of the allowance. Also, an allowance is established for all customers based on the aging of the receivables. If circumstances change (i.e., higher than expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligations), the estimates of the recoverability of amounts due to the Company are adjusted.

 

At December 31, 2007, one customer comprised approximately 15% of the Company’s consolidated accounts receivable balance. At December 31, 2006, one customer comprised approximately 13% of the Company’s consolidated accounts receivable balance. For the years ended December 31, 2007, 2006 and 2005, the Company did not have any individual customers that comprised more than 10% of total revenues.

 

At December 31, 2007 and 2006, the Company’s cash and cash equivalents were maintained primarily with major financial institutions and brokerage firms in the United States. Deposits with these institutions and firms generally exceed the amount of insurance provided on such deposits.

 

Intangible Assets and Other Long-Lived Assets—The Company accounts for identifiable intangible assets and other long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment and disposition of identifiable intangible assets and other long-lived assets. The Company evaluates the recoverability of identifiable intangible assets and other long-lived assets, other than indefinite-lived intangible assets, for impairment when events occur or circumstances change that would indicate that

 

F-11



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

the carrying amount of an asset may not be recoverable. Events or circumstances that may indicate that an asset is impaired include, but are not limited to, significant decreases in the market value of an asset, significant underperformance relative to expected historical or projected future operating results, a change in the extent or manner in which an asset is used, significant declines in the Company’s stock price for a sustained period, shifts in technology, loss of key management or other personnel, significant negative industry or economic trends, and changes in the Company’s operating model or strategy and competitive forces. In determining if an impairment exists, the Company estimates the undiscounted cash flows to be generated from the use and ultimate disposition of these assets. If an impairment is indicated based on a comparison of the assets’ carrying values and the undiscounted cash flows, the impairment loss is measured as the amount by which the carrying amount of the assets exceeds the fair market value of the assets. Definite-lived intangible assets are amortized on either a straight-line basis or an accelerated basis over their estimated useful lives, ranging from two to ten years. The Company’s identifiable intangible assets were acquired primarily in connection with business combinations. The Company has no indefinite-lived intangible assets at December 31, 2007.

 

Property and Equipment—Property and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which is generally two to three years for computer software and equipment and three to seven years for furniture and fixtures. Leasehold improvements, which are included in furniture and fixtures, are amortized using the straight-line method over the shorter of the lease term or seven years. Upon the sale or retirement of property or equipment, the cost and related accumulated depreciation or amortization is removed from the Company’s consolidated financial statements with the resulting gain or loss reflected in the Company’s results of operations. Repairs and maintenance costs are expensed as incurred.

 

Goodwill—Goodwill represents the excess of the cost of an acquired entity over the fair value of the acquired net assets. The Company accounts for goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, which among other things, addresses financial accounting and reporting requirements for acquired goodwill and other intangible assets. SFAS No. 142 requires goodwill to be carried at cost, prohibits the amortization of goodwill and requires the Company to test goodwill for impairment at least annually at the reporting unit level. The Company performs an impairment test of its goodwill annually during the fourth quarter of its fiscal year or when events occur or circumstances change that would more likely than not indicate that goodwill might be permanently impaired. Events or circumstances which could trigger an impairment review include, but are not limited to, a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, a loss of key management or other personnel, significant changes in the manner of the Company’s use of the acquired assets or the strategy for the acquired business or the Company’s overall business, significant negative industry or economic trends or significant underperformance relative to expected historical or projected future results of operations.

 

The testing for a potential impairment of goodwill involves a two-step process. The first step of the impairment test involves comparing the estimated fair values of each of the Company’s reporting units with their respective net book values, including goodwill. If the estimated fair value exceeds net book value, goodwill is considered not to be impaired and no additional steps are necessary. If, however, the estimated fair value of the reporting unit is less than net book value, including goodwill, then the carrying amount of the goodwill is compared with its implied fair value. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss would be recognized in an amount equal to the excess.

 

F-12



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

Business Combinations—All of the Company’s acquisitions have been accounted for as purchase business combinations. Under the purchase method of accounting, the costs, including transaction costs, are allocated to the underlying net assets acquired, based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.

 

The judgments made in determining the estimated fair value and expected useful lives assigned to each class of assets and liabilities acquired can significantly impact net income. Consequently, to the extent an indefinite-lived, definite-lived or a longer-lived asset is ascribed greater value under the purchase method than a shorter-lived asset, there may be less amortization recorded in a given period. Definite-lived identifiable intangible assets are amortized on either a straight-line basis or an accelerated basis. The Company determines the appropriate amortization method by performing an analysis of expected cash flows over the estimated useful lives of the assets and matches the amortization expense to the expected cash flows from those assets.

 

Determining the fair value of certain assets and liabilities acquired is subjective in nature and often involves the use of significant estimates and assumptions. Two areas, in particular, that require significant judgment are estimating the fair value and related useful lives of identifiable intangible assets. To assist in this process, the Company may obtain appraisals from valuation specialists for certain intangible assets. While there are a number of different methods used in estimating the fair value of acquired intangible assets, there are two approaches primarily used: the discounted cash flow and market comparison approaches. Some of the more significant estimates and assumptions inherent in the two approaches include: projected future cash flows (including timing); discount rate reflecting the risk inherent in the future cash flows; terminal growth rate; subscriber churn; terminal value; determination of appropriate market comparables; and the determination of whether a premium or a discount should be applied to market comparables. Most of the above assumptions are made based on available historical and market information.

 

Member Redemption Liability—Member redemption liability for loyalty marketing points represents the estimated costs associated with MyPoints’ obligation to redeem outstanding points accumulated by its loyalty marketing members as well as those points purchased by its advertisers for use in such advertisers’ promotion campaigns as they have been earned by MyPoints’ members, less an allowance for points expected to expire prior to redemption. The estimated cost of points is primarily presented in cost of revenues, except for the portion related to member acquisition activities, internal marketing surveys and other non-revenue generating activities which are presented in sales and marketing expenses. The member redemption liability is recognized when members earn points and is reduced when members redeem accumulated points upon reaching required redemption thresholds or when points are expired prior to redemption.

 

MyPoints members may redeem points for third-party gift cards and other rewards. Members earn points when they respond to direct marketing offers delivered by MyPoints, purchase goods or services from advertisers, engage in certain promotional campaigns of advertisers or engage in other specified activities.

 

The member redemption liability is estimated based upon the weighted-average cost and number of points that may be redeemed in the future. On a monthly basis, the weighted-average cost of points is calculated by taking the total cost of items fulfilled divided by total points redeemed. The discounts and points needed to redeem vary by merchant and award denomination. MyPoints purchases gift cards and other awards from merchants at a discount and sets redemption levels for its members. MyPoints

 

F-13



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

has the ability to adjust the number of points required to redeem awards to reflect changes in the cost of awards.

 

On a monthly basis, MyPoints accounts for and reduces the gross points issued by an estimate of points that will never be redeemed by its members. This reduction is calculated based on an analysis of historical point-earning trends, redemption activities and individual member account activity, in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-22, Accounting for Points and Certain Time-Based or Volume-Based Sales Incentive Offers, and Offers for Free Products and Services to be Delivered in the Future. MyPoints’ historical analysis takes into consideration the total points in members’ accounts that have been inactive for six months or longer, less an estimated reactivation rate, plus an estimate of future inactive points. Changes in, among other factors, the net number of points issued, redemption activities and members’ activity levels could materially impact the member redemption liability.

 

Points in active accounts do not expire. However, under the terms and conditions of membership in MyPoints’ loyalty marketing program, MyPoints reserves the right to cancel or disable accounts and expire unredeemed points in accounts that are inactive for a period of twelve consecutive months. For purposes of the member redemption liability, “inactive” means a lack of any of the following: Web site visit; email response; survey completion; profile update; or any point-earning or point-redeeming transaction. The cancelling or disabling of inactive accounts would have no impact on the Company’s consolidated financial statements, as the Company fully considers inactive accounts when establishing the member redemption liability, as discussed above.

 

Revenue Recognition—The Company’s revenues are comprised of billable services revenues, which are derived primarily from fees charged to pay accounts, and advertising revenues. The Company applies the provisions of SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the Securities and Exchange Commission (“SEC”). SAB No. 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable, no significant Company obligations remain, and collectibility is reasonably assured. The Company also applies the provisions of EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.

 

Billable services revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the customer. The Company’s pay accounts generally pay in advance for their service by credit card, and revenue is then recognized ratably over the service period. Advance payments from pay accounts are recorded on the consolidated balance sheets as deferred revenue. The Company offers alternative payment methods to credit cards for certain pay service plans. These alternative payment methods currently include ACH, payment by personal check or money order or through a local telephone company. In circumstances where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured.

 

Advertising revenues consist primarily of amounts from Internet search partners that are generated as a result of users utilizing partner Internet search services, amounts generated from the display of third-party registration offers at the end of Classmates’ pay account registration process, amounts generated from other display advertisements, and amounts generated from referring members to third-party Web sites or services. The Company recognizes advertising revenues in the period in which the

 

F-14



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

advertisement is displayed or, for performance-based arrangements, when the related performance criteria are met. In determining whether an arrangement exists, the Company ensures that a binding contract is in place, such as a standard insertion order or a fully executed customer-specific agreement. The Company assesses whether performance criteria have been met and whether the fees are fixed or determinable based on a reconciliation of the performance criteria and the payment terms associated with the transaction. The reconciliation of the performance criteria generally includes a comparison of internally tracked performance data to the contractual performance obligation and, when available, to third-party or customer-provided performance data.

 

Advertising revenues for the Company’s loyalty marketing service consist primarily of fees generated when emails are transmitted to members, when members respond to emails and when members complete online transactions. Each of these activities is a discrete, independent activity, which generally is specified in the sales agreement for each advertising customer. As the earning activities take place, activity measurement data (examples include the number of emails delivered and the number of responses received) is accumulated and the related revenue is recorded.

 

Probability of collection is assessed based on a number of factors, including past transaction history with the customer and the creditworthiness of the customer. If it is determined that collection is not reasonably assured, revenue is not recognized until collection becomes reasonably assured, which is generally upon receipt of cash. Deferred revenue also represents invoiced services that have not yet been performed.

 

Cost of Revenues—Cost of revenues includes telecommunications and data center costs; costs of providing rewards to members of our loyalty marketing service; personnel- and overhead-related costs associated with operating our networks and data centers; depreciation of network computers and equipment; email technical support and license fees; costs related to providing telephone technical support; customer billing and billing support to our pay accounts; fees associated with the storage and processing of customer credit cards and associated bank fees; and domain name registration fees. Historically, the costs that comprise the Company’s Classmates Media cost of revenues have been relatively fixed. However, as a result of the Company’s loyalty marketing service, which was acquired in April 2006, our cost of revenues has become more variable as the costs associated with this service tend to fluctuate with revenues. The majority of the costs that comprise the Company’s Communications cost of revenues are variable. As such, the Company’s Communications cost of revenues as a percentage of revenues is highly dependent on average monthly revenue per pay account (“ARPU”), average hourly telecommunications cost and usage, and average customer billing and billing support costs per pay account.

 

Sales and Marketing—Sales and marketing expenses include expenses associated with promoting the Company’s services and with generating advertising revenues. Expenses associated with promoting the Company’s services include advertising and promotion expenses; fees paid to distribution partners, third-party advertising networks and co-registration partners to acquire new pay and free accounts; personnel and overhead-related expenses for marketing personnel; and telemarketing costs incurred to acquire and retain pay accounts and up-sell pay accounts to additional services. Expenses associated with generating advertising revenues include sales commissions and personnel-related expenses. The Company has expended significant amounts on sales and marketing, including branding and customer acquisition campaigns consisting of television, Internet, sponsorships, radio, print and outdoor advertising, and on retail and other performance-based distribution relationships. Marketing and advertising costs to promote the Company’s products and services are expensed in the period incurred.

 

F-15



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

Advertising and promotion expenses include media, agency and promotion expenses. Media production costs are expensed the first time the advertisement is run. Media and agency costs are expensed over the period the advertising runs. Advertising and promotion expense for the years ended December 31, 2007, 2006 and 2005 was $99.5 million, $117.7 million, and $159.5 million, respectively. At December 31, 2007 and 2006, $1.3 million and $1.3 million, respectively, of prepaid advertising and promotion expense was included in other current assets in the consolidated balance sheets.

 

Product Development Costs—Product development expenses include expenses for the maintenance of existing software and technology and the development of new or improved software and technology, including personnel-related expenses for the software engineering department and the costs associated with operating the Company’s facility in India. Costs incurred by the Company to manage and monitor the Company’s product development activities are generally expensed as incurred, except for certain costs relating to the acquisition and development of internal-use software that are capitalized and depreciated over their estimated useful lives, generally three years.

 

Software Development Costs—The Company accounts for cost incurred to develop software for internal use in accordance with Statement of Position 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal Use, which requires such costs be capitalized and amortized over the estimated useful life of the software. We capitalize costs associated with customized internal-use software systems that have reached the application development stage. Such capitalized costs include external direct costs utilized in developing or obtaining the applications and payroll and payroll-related expenses for employees who are directly associated with the applications. Capitalization of such costs begins when the preliminary project stage is complete and ceases at the point in which the project is substantially complete and ready for its intended purpose. The Company capitalized costs associated with internal-use software of $8.4 million and $9.1 million in the years ended December 31, 2007 and 2006, respectively, which are being depreciated on a straight-line basis over each project’s estimated useful life which is generally three years. Capitalized internal-use software is included within the computer software and equipment category within property and equipment, net, in the consolidated balance sheets.

 

General and Administrative—General and administrative expenses include personnel-related expenses for executive, finance, legal, human resources, facilities, and internal customer support personnel. In addition, general and administrative expenses include professional fees for legal, accounting and financial services; office relocation costs; non-income taxes; insurance; occupancy and other overhead-related costs; and expenses incurred and credits received as a result of certain legal settlements.

 

Stock-Based Compensation—On January 1, 2006, the Company adopted SFAS No. 123R (revised 2004), Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options, stock awards and employee stock purchases related to the Company’s employee stock purchase plan based on the grant-date fair values of the awards. SFAS No. 123R supersedes the Company’s previous accounting under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107 relating to SFAS No. 123R. The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123R (see Note 5).

 

The Company adopted SFAS No. 123R using the modified prospective transition method, and the Company’s consolidated financial statements at and for the years ended December 31, 2007 and 2006

 

F-16



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

reflect the impact of SFAS No. 123R. In accordance with the modified prospective transition method, the Company’s consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123R. Stock-based compensation recognized under SFAS No. 123R for the years ended December 31, 2007 and 2006 was $19.5 million and $19.2 million, respectively, which was primarily related to restricted stock, stock options and the discount on purchases related to the Company’s employee stock purchase plan. Stock-based compensation, recorded in accordance with APB Opinion No. 25, for the year ended December 31, 2005 was $10.0 million, which was primarily related to restricted stock.

 

SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the grant date using an option-pricing model. Under SFAS No. 123, Accounting for Stock-Based Compensation, the Company used the Black-Scholes option-pricing model for valuation of share-based awards for its pro forma information. Upon adoption of SFAS No. 123R, the Company elected to continue to use the Black-Scholes option-pricing model for valuing share-based payment awards. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in the Company’s consolidated statements of operations. Prior to the adoption of SFAS No. 123R, the Company accounted for share-based payment awards to employees and directors using the intrinsic value method in accordance with APB No. 25 as allowed under SFAS No. 123. Under the intrinsic value method, no stock-based compensation related to stock options had been recognized in the Company’s consolidated statements of operations, other than as related to acquisitions, because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the grant date.

 

SFAS No. 123R requires forfeitures to be estimated at the time of grant in order to calculate the amount of share-based payment awards ultimately expected to vest. The forfeiture rate is based on historical rates. Stock-based compensation recognized in the Company’s consolidated statements of operations for the years ended December 31, 2007 and 2006 includes (i) compensation expense for share-based payment awards granted prior to or on, but not yet vested at, December 31, 2005 based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and (ii) compensation expense for share-based payment awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. As stock-based compensation recognized in the consolidated statements of operations for the years ended December 31, 2007 and 2006 is based on equity awards ultimately expected to vest, it has been reduced for estimated forfeitures. For the periods prior to 2006, the Company accounted for forfeitures as they occurred. Accordingly, a pre-tax cumulative effect of accounting change adjustment totaling $1.1 million ($1.0 million, net of tax) was recorded in the March 2006 quarter to adjust for share-based payment awards granted prior to January 1, 2006 that are not ultimately expected to vest.

 

Prior to the adoption of SFAS No. 123R, the Company recognized stock-based compensation for equity awards with graded vesting by treating each vesting tranche as a separate award and recognizing compensation expense ratably for each tranche. For equity awards granted subsequent to the adoption of SFAS No. 123R, the Company treats such awards as a single award and recognizes stock-based compensation on a straight-line basis (net of estimated forfeitures) over the employee service period.

 

F-17


 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

In November 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. SFAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee share-based payment awards that were outstanding upon adoption of SFAS No. 123R. In the June 2006 quarter, the Company adopted the provisions of FSP No. SFAS 123(R)-3.

 

As a result of the adoption SFAS No. 123R, the Company’s income before income taxes and net income for the year ended December 31, 2006 were $7.0 million and $5.1 million lower, respectively, than if the Company had continued to account for stock-based compensation under APB Opinion No. 25. Basic net income per share and diluted net income per share for the year ended December 31, 2006 were $0.08 and $0.08 lower, respectively, than if the Company had continued to account for stock-based compensation under APB Opinion No. 25.

 

The following table illustrates (in thousands, except per share amounts) the effect on net income and earnings per share in the year ended December 31, 2005 as if the Company had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure.

 

 

 

Year Ended
December 31,
2005

 

Net income, as reported

 

$

47,127

 

Add: Stock-based compensation included in net income, net of tax

 

8,264

 

Deduct: Stock-based compensation determined under fair value-based method for all equity awards, net of tax

 

(23,360

)

Pro forma net income

 

$

32,031

 

Basic net income per share, as reported

 

$

0.77

 

Basic net income per share, pro forma

 

$

0.52

 

Diluted net income per share, as reported

 

$

0.74

 

Diluted net income per share, pro forma

 

$

0.50

 

 

Comprehensive Income—SFAS No. 130, Reporting Comprehensive Income, establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. For the Company, comprehensive income consists of its reported net income, changes in net unrealized gains or losses on short-term investments and derivatives, and foreign currency translation.

 

Foreign Currency—The functional currency of the Company’s international subsidiaries is the local currency. The financial statements of these subsidiaries are translated to U.S. dollars using period-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues and expenses. Translation gains and losses are recorded in accumulated other comprehensive income

 

F-18



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

(loss) as a component of stockholders’ equity in the consolidated balance sheets. Net gains and losses resulting from foreign exchange transactions were not significant during the periods presented.

 

Income Taxes—Income taxes are accounted for under SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

 

The computation of limitations relating to the amount of such tax assets, and the determination of appropriate valuation allowances relating to the realizability of such assets, are inherently complex and require the exercise of judgment. As additional information becomes available, we continually assess the carrying value of our net deferred tax assets.

 

The Company applies the provisions of FASB Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. Under FIN 48, the Company recognizes, in its consolidated financial statements, the impact of tax positions that are more likely than not to be sustained upon examination based on the technical merits of the positions.

 

Net Income Per Share—Basic net income per share is computed using the weighted-average number of common shares outstanding during the period, net of shares subject to repurchase rights, and excludes any dilutive effects of options or warrants, restricted stock, restricted stock units, and convertible securities, if any. Diluted net income per share is computed using the weighted-average number of common stock and common stock equivalent shares outstanding (including the effect of restricted stock) during the period. Common stock equivalent shares are excluded from the computation if their effect is antidilutive.

 

Legal Contingencies—The Company is currently involved in certain legal proceedings. The Company records liabilities related to pending litigation when an unfavorable outcome is probable and management can reasonably estimate the amount of loss. The Company does not record liabilities for pending litigation when there are uncertainties related to assessing either the amount or the probable outcome of the claims asserted in the litigation. As additional information becomes available, the Company continually assesses the potential liability related to such pending litigation.

 

Segments—The Company complies with the reporting requirements of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Company has modified its segment reporting structure during 2007 to establish Classmates Media as a separate reportable operating segment in the place of the former Content & Media segment that no longer will be reported. The new Classmates Media segment includes the Company’s online social networking and online loyalty marketing operations, which had formerly been part of the Content & Media segment. Web hosting and photo sharing, which also had formerly been part of the Content & Media segment, have been moved to the Communications segment. In addition, the Company has eliminated its historical practice of separately reporting certain unallocated corporate expenses. Under the new reporting structure, corporate expenses are allocated to the operating segments. The new segment reporting structure is aligned with how management reviews and measures segment performance for internal reporting purposes in accordance with the “management approach” defined in SFAS No. 131. All prior periods have been adjusted to conform to the current presentation. Management has determined that segment

 

F-19



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

income from operations, which excludes depreciation and amortization of intangible assets, is the appropriate measure for assessing performance of its segments and for allocating resources among its segments.

 

Operating Leases—The Company leases office space, data centers and certain office equipment under operating lease agreements with original lease periods of up to 10 years. Certain of the lease agreements contain rent holidays and rent escalation provisions. Rent holidays and rent escalation provisions are considered in determining straight-line rent expense to be recorded over the lease term. The lease term begins on the date of initial possession of the leased property for purposes of recognizing lease expense on a straight-line basis over the term of the lease. Lease renewal periods are considered on a lease-by-lease basis and are generally not included in the initial lease term.

 

Recent Accounting Pronouncements

 

Fair Value Measurements

 

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which clarifies the definition of fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 was effective for the Company on January 1, 2008. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its financial position, results of operations and cash flows.

 

Fair Value Option

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 was effective for the Company on January 1, 2008. The Company does not expect the adoption of SFAS No. 159 to have a material impact on its financial position, results of operations and cash flows.

 

Business Combinations

 

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R) requires an acquirer to measure the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No. 141(R) is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. The Company has not yet determined the effect on its consolidated financial statements, if any, upon adoption of SFAS No. 141(R).

 

Noncontrolling Interests in Consolidated Financial Statements

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The

 

F-20



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

1.  DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, ACCOUNTING POLICIES, AND RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. The Company has not yet determined the effect on its consolidated financial statements, if any, upon adoption of SFAS No. 160.

 

2.  ACQUISITIONS

 

MyPoints.com, Inc.

 

In April 2006, the Company acquired MyPoints.com, Inc. for approximately $56.6 million in cash, including acquisition costs. MyPoints is a leading provider of online loyalty marketing services. The acquisition was accounted for under the purchase method in accordance with SFAS No. 141, Business Combinations. The primary reason for the acquisition was to expand the Company’s Classmates Media business offerings. This factor contributed to a purchase price in excess of the fair value of MyPoints’ net liabilities assumed and intangible assets acquired, and, as a result, the Company has recorded goodwill in connection with this transaction. MyPoints’ results of operations are included in the Company’s consolidated financial statements from the date of acquisition.

 

The purchase price was allocated based on the estimated fair values of assets and liabilities, including identifiable intangible assets. The purchase price allocation is considered final. The following table summarizes the net liabilities assumed and the intangible assets and goodwill acquired in connection with the acquisition (in thousands):

 

Description

 

Estimated
Fair
Value

 

Estimated
Amortizable
Life

 

Net liabilities assumed:

 

 

 

 

 

Cash

 

$

7,137

 

 

 

Accounts receivable

 

9,667

 

 

 

Other current assets

 

1,905

 

 

 

Property and equipment

 

2,833

 

 

 

Other assets

 

496

 

 

 

Accounts payable and accrued liabilities

 

(9,376

)

 

 

Deferred revenue

 

(471

)

 

 

Member redemption liability

 

(17,673

)

 

 

Total net liabilities assumed

 

(5,482

)

 

 

Intangible assets acquired:

 

 

 

 

 

Customer contracts

 

9,230

 

5 years

 

Proprietary rights

 

3,700

 

10 years

 

Total intangible assets acquired

 

12,930

 

 

 

Goodwill

 

49,122

 

 

 

Total purchase price

 

$

56,570

 

 

 

 

F-21



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

2.  ACQUISITIONS (Continued)

 

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

 

The following summarized unaudited pro forma information assumes that the acquisition of MyPoints had occurred on January 1, 2006 and 2005 (in thousands, except per share amounts):

 

 

 

Year Ended
December 31,

 

 

 

2006

 

2005

 

Revenues

 

$

535,647

 

$

563,343

 

Income before cumulative effect of accounting change

 

$

41,518

 

$

48,540

 

Net income

 

$

42,559

 

$

48,540

 

Basic net income per share:

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

0.65

 

$

0.79

 

Net income

 

$

0.66

 

$

0.79

 

Diluted net income per share:

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

0.63

 

$

0.76

 

Net income

 

$

0.64

 

$

0.76

 

 

The Names Database

 

In March 2006, the Company acquired The Names Database for approximately $10.1 million in cash, including acquisition costs. The Names Database is a global social networking service that acts as an intermediary between members, allowing them to send messages through the Web site to one another. The acquisition was accounted for under the purchase method in accordance with SFAS No. 141. The primary reason for the acquisition was to acquire The Names Database’s member relationships and software, which had the effect of expanding the Company’s social networking services. This factor contributed to a purchase price in excess of the fair value of The Names Database’s net liabilities assumed and intangible assets acquired, and, as a result, the Company has recorded goodwill in connection with this transaction. The Names Database’s results of operations are included in the Company’s consolidated financial statements from the date of acquisition.

 

F-22



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

2.  ACQUISITIONS (Continued)

 

The purchase price was allocated based on the estimated fair values of assets and liabilities, including identifiable intangible assets. The purchase price allocation is considered final. The following table summarizes the net liabilities assumed and the intangible assets and goodwill acquired in connection with the acquisition (in thousands):

 

Description

 

Estimated
Fair
Value

 

Estimated
Amortizable
Life

 

Net liabilities assumed:

 

 

 

 

 

Cash

 

$

510

 

 

 

Accounts receivable

 

51

 

 

 

Accounts payable and accrued liabilities

 

(8

)

 

 

Deferred revenue

 

(541

)

 

 

Deferred income taxes

 

(545

)

 

 

Total net liabilities assumed

 

(533

)

 

 

Intangible assets acquired:

 

 

 

 

 

Pay accounts

 

500

 

4 years

 

Free accounts

 

600

 

10 years

 

Advertising contracts and related relationships

 

29

 

2 years

 

Technology

 

245

 

5 years

 

Proprietary rights

 

134

 

5 years

 

Other intangible assets

 

45

 

5 years

 

Total intangible assets acquired

 

1,553

 

 

 

Goodwill

 

9,092

 

 

 

Total purchase price

 

$

10,112

 

 

 

 

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

 

PhotoSite

 

In March 2005, the Company acquired certain assets related to PhotoSite, an online digital photo sharing service for approximately $10.1 million in cash, including acquisition costs, and entered into a related licensing and support agreement with the seller. The acquisition was accounted for under the purchase method in accordance with SFAS No. 141. The primary reason for the acquisition was to acquire PhotoSite’s software and services to enhance the Company’s other services and to expand the Company’s subscription offerings. This factor contributed to a purchase price in excess of the fair value of PhotoSite’s net liabilities assumed and intangible assets acquired, and, as a result, the Company has recorded goodwill in connection with this transaction.

 

F-23



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

2.  ACQUISITIONS (Continued)

 

The purchase price was allocated based on the estimated fair values of assets and liabilities, including identifiable intangible assets. The purchase price allocation is considered final. The following table summarizes the net liabilities assumed and the intangible assets and goodwill acquired in connection with the acquisition (in thousands):

 

Description

 

Estimated
Fair
Value

 

Estimated
Amortizable
Life

 

Net liabilities assumed:

 

 

 

 

 

Property and equipment

 

$

4

 

 

 

Deferred revenue

 

(190

)

 

 

Total net liabilities assumed

 

(186

)

 

 

Intangible assets acquired:

 

 

 

 

 

Pay accounts

 

330

 

2 years

 

Proprietary rights

 

20

 

5 years

 

Software and technology

 

4,200

 

5 years

 

Total intangible assets acquired

 

4,550

 

 

 

Goodwill

 

5,738

 

 

 

Total purchase price

 

$

10,102

 

 

 

 

The weighted-average amortizable life of the acquired intangible assets is 4.8 years. The acquisition was treated as an acquisition of net assets for tax purposes and, accordingly, the $5.7 million of goodwill acquired is tax deductible. The pro forma effect of the transaction is immaterial to the consolidated financial statements.

 

In the December 2006 quarter, the Company recorded impairment charges totaling $8.8 million related to its photo sharing service (see Note 6). We made the decision during 2007 to exit our photo sharing business and we have entered into a commercial arrangement with a third-party in connection therewith.

 

F-24



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

3.  BALANCE SHEET COMPONENTS

 

Short-Term Investments

 

Due to the lack of liquidity and other concerns related to the U.S. credit markets, the Company has liquidated much of its short-term investments portfolio and converted it to cash and cash equivalents. Cash and cash equivalents and short-term investments were $218.3 million at December 31, 2007, compared to $162.4 million at December 31, 2006.

 

Short-term investments consisted of the following (in thousands):

 

 

 

December 31, 2007

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

Municipal securities

 

$

68,546

 

$

254

 

$

 

$

68,800

 

Total

 

$

68,546

 

$

254

 

$

 

$

68,800

 

 

 

 

December 31, 2006

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

U.S. corporate notes

 

$

2,500

 

$

 

$

 

$

2,500

 

Municipal securities

 

126,822

 

15

 

(114

)

126,723

 

Government agencies

 

14,000

 

 

(113

)

13,887

 

Total

 

$

143,322

 

$

15

 

$

(227

)

$

143,110

 

 

Gross unrealized gains and losses are presented net of tax in accumulated other comprehensive income (loss) on the consolidated balance sheets. The Company had no material realized gains or losses from the sale of short-term investments in the years ended December 31, 2007, 2006 and 2005.

 

The Company did not have any gross unrealized losses in its short-term investments at December 31, 2007. The following table summarizes the fair value and gross unrealized losses on the Company’s short-term investments, aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 (in thousands):

 

 

 

December 31, 2006

 

 

 

Less than 12 Months

 

12 Months or Greater

 

Total

 

 

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Municipal securities

 

$

21,432

 

$

(5

)

$

8,681

 

$

(109

)

$

30,113

 

$

(114

)

Government agencies

 

 

 

13,887

 

(113

)

13,887

 

(113

)

Total

 

$

21,432

 

$

(5

)

$

22,568

 

$

(222

)

$

44,000

 

$

(227

)

 

F-25



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

3.  BALANCE SHEET COMPONENTS (Continued)

 

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

 

 

 

December 31, 2007

 

 

 

Amortized
Cost

 

Estimated
Fair Value

 

Maturing within 1 year

 

$

39,103

 

$

39,135

 

Maturing between 1 year and 4 years

 

29,443

 

29,665

 

Maturing after 4 years

 

 

 

Total

 

$

68,546

 

$

68,800

 

 

Other Current Assets

 

Other current assets consisted of the following (in thousands):

 

 

 

December 31,

 

December 31,

 

 

 

2007

 

2006

 

Prepaid expenses

 

$

 8,198

 

$

 8,696

 

Income taxes receivable

 

4,878

 

 

Gift cards related to member redemption liability

 

3,653

 

2,644

 

Interest receivable

 

1,448

 

1,379

 

Other

 

1,815

 

707

 

Total

 

$

19,992

 

$

13,426

 

 

Property and Equipment

 

Property and equipment consisted of the following (in thousands):

 

 

 

December 31,

 

 

 

2007

 

2006

 

Computer software and equipment

 

$

124,637

 

$

106,067

 

Furniture and fixtures

 

13,644

 

15,195

 

 

 

138,281

 

121,262

 

Less: accumulated depreciation and amortization

 

(98,711

)

(86,966

)

Total

 

$

39,570

 

$

34,296

 

 

Depreciation expense, including the amortization of leasehold improvements, for the years ended December 31, 2007, 2006 and 2005 was $20.2 million, $21.3 million, and $15.5 million, respectively. Assets under capital leases are included in computer software and equipment. At December 31, 2007, the amount capitalized under capital leases and the related accumulated depreciation were $0.4 million and $0.4 million, respectively. At December 31, 2006, the amount capitalized under capital leases and the related accumulated depreciation were $0.4 million and $0.4 million, respectively.

 

F-26



 

UNITED ONLINE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

3.  BALANCE SHEET COMPONENTS (Continued)

 

Goodwill and Intangible Assets

 

The changes in goodwill for the years ended December 31, 2006 and 2007 were as follows (in thousands):

 

Balance at January 1, 2006

 

$

80,499

 

Goodwill recorded in connection with The Names Database acquisition

 

9,092

 

Goodwill recorded in connection with MyPoints acquisition

 

49,122

 

Goodwill recorded in connection with other acquisitions

 

184

 

Impairment of goodwill related to the Company’s photo sharing service (see Note 6)

 

(5,738

)

Increase in acquired deferred tax assets

 

(141

)

Balance at December 31, 2006

 

133,018

 

Increase in acquired deferred tax assets and other

 

(666

)

Balance at December 31, 2007

 

$

132,352

 

 

Goodwill by reportable operating segment was as follows (in thousands):

 

 

 

December 31,
2007

 

December 31,
2006

 

Classmates Media

 

$

124,863

 

$

125,529

 

Communications

 

7,489

 

7,489

 

Total

 

$

132,352

 

$

133,018

 

 

Intangible assets consisted of the following (in thousands):

 

 

 

December 31, 2007

 

 

 

Cost

 

Accumulated
Amortization

 

Net

 

Pay accounts and free accounts

 

$

107,958

 

$

(85,113

)

$

22,845

 

Trademarks and trade names

 

25,786

 

(9,528

)

16,258

 </