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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended September 30, 2004

Or

For the transition period from                               to                              

Commission file number 000-33367

UNITED ONLINE, INC.
(Exact Name of Registrant as Specified in Its Charter)

(818) 287-3000
(Registrant's Telephone Number, Including Area Code)

Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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

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

        There were 60,567,211 shares of the registrant's common stock outstanding at October 22, 2004.

INDEX

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

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

UNITED ONLINE, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

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

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UNITED ONLINE, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

(in thousands, except per share amounts)

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

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UNITED ONLINE, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

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

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UNITED ONLINE, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.     DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Description of Business

        United Online, Inc. ("United Online" or the "Company") is a leading provider of consumer Internet subscription services through a number of brands, including NetZero and Juno. The Company's pay services include dial-up Internet access, accelerated dial-up services, premium email, and personal Web-hosting and domain name registration services. It also offers consumers free Internet access, Web email and Web hosting. The Company's access services are available in more than 8,000 cities across the United States and in Canada. In addition, the Company offers marketers numerous online advertising products as well as online market research and measurement services. The Company is headquartered in Woodland Hills, California, with offices in New York, New York; San Francisco, California; Orem, Utah; and Hyderabad, India.

        United Online was incorporated in Delaware in June 2001 and was formed in connection with the merger of NetZero, Inc. ("NetZero") and Juno Online Services, Inc. ("Juno") into two of United Online's wholly-owned subsidiaries, which was consummated on September 25, 2001 (the "Merger"). The Merger was accounted for under the purchase method of accounting, and NetZero was the acquirer for financial accounting purposes and the Company's predecessor for financial reporting purposes. As a result of the Merger, NetZero and Juno each became wholly-owned subsidiaries of United Online. On November 4, 2002, the Company, through its wholly-owned subsidiary NetBrands, Inc., acquired the Internet access assets of BlueLight.com LLC ("BlueLight"). In April 2004, the Company acquired substantially all of the assets associated with the Web-hosting business of About, Inc. for $11.9 million in cash. The business offers consumers personal Web-site services, including hosting, domain and email services.

Basis of Presentation

        The accompanying consolidated financial statements, which include United Online and its wholly-owned subsidiaries, are unaudited except for the balance sheet information at December 31, 2003, which is derived from the audited consolidated financial statements as filed with the Securities and Exchange Commission in the Company's Transition Report on Form 10-KT on February 5, 2004. The Company's interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") including those for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X issued by the SEC. Accordingly, they do not include all of the information and note disclosures required by GAAP for complete financial statements. These financial statements, in the opinion of management, include all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation.

        The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates. The results of operations for interim periods are not necessarily indicative of the operating results for a full year. These unaudited consolidated financial statements should be read in conjunction with the audited financial statements and related notes for the six months ended December 31, 2003 included in the Company's Transition Report on Form 10-KT filed on February 5, 2004 with the SEC.

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Stock-Based Compensation

        The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 44, Accounting for Certain Transactions Involving Stock Compensation, and Emerging Issues Task Force ("EITF") Issue No. 00-23, Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FIN No. 44 and complies with the disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123. Under APB Opinion No. 25, employee stock-based compensation expense is recognized over the vesting period based on the difference, if any, on the date of grant, between the fair value of the Company's stock and the exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Compensation expense is recorded in accordance with FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, an interpretation of APB Opinions No. 15 and 25.

        As required by SFAS No. 148, the following provides pro forma net income and pro forma net income per common share disclosures for stock-based awards as if the fair-value-based method defined in SFAS No. 123 had been applied.

        For each option granted up to and including September 23, 1999, the Company calculated the minimum fair value on the date of grant using the minimum value option-pricing model as prescribed by SFAS No. 123. The fair value of the options granted subsequent to September 23, 1999 has been estimated at the date of grant using the Black-Scholes option-pricing model, using the following weighted-average assumptions:

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

        The following table summarizes the stock-based compensation included in the following operating expenses (in thousands):

2.     ACQUISITION

        In April 2004, the Company acquired substantially all of the assets associated with the Web-hosting business of About, Inc. The business offers consumers Web-site services, including hosting, domain and email services. The acquisition has been accounted for under the purchase method in accordance with SFAS No. 141, Business Combinations. The primary reason for the acquisition was to acquire About, Inc.'s Web-hosting services and user base in order to expand the Company's service offerings.

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        The purchase price of approximately $11.9 million was paid in cash and allocated to the net assets acquired based on their estimated fair values, including identifiable intangible assets. The following table summarizes the net assets acquired in connection with the acquisition (in thousands):

        The weighted average amortizable life of all acquired intangible assets is 3.8 years. The pro forma effect of the transaction is immaterial to the consolidated financial statements.

3.     BALANCE SHEET COMPONENTS

Short-Term Investments

        Short-term investments at September 30, 2004 consist of the following (in thousands):

        Gross unrealized gains and losses are presented net of tax in accumulated other comprehensive income on the consolidated balance sheets. The Company recognized $0 and $0.1 million of net realized gains during the quarter and nine months ended September 30, 2004. The Company had no material realized gains or losses from the sale of investments in the quarter and nine months ended September 30, 2003.

        Maturities of short-term investments at September 30, 2004 were as follows (in thousands):

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Accounts Receivable

        At September 30, 2004, receivables from two customers comprised approximately 21% and 19% of the Company's consolidated accounts receivable balance.

4.     INCOME TAXES

        For the quarter and nine months ended September 30, 2004, the Company 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 an annualized effective tax rate of approximately 41.5%.

        For the quarter and nine months ended September 30, 2003, the Company generated pre-tax income of $15.0 million and $34.0 million, respectively, and recorded a tax provision of $6.1 million and $3.6 million, respectively. The effective tax rate for the nine months ended September 30, 2003 differs from the statutory rate primarily as a result of a tax benefit recognized in the June 2003 quarter from the release of a portion of the valuation allowance against deferred tax assets relating primarily to the actual and expected utilization of net operating loss and credit carryforwards for fiscal 2003 and 2004.

        Consistent with prior periods, in determining the need for a valuation allowance at September 30, 2004, the Company reviewed both positive and negative evidence pursuant to the requirements of SFAS No. 109, Accounting for Income Taxes, including current and historical results of operations, the annual limitation on utilization of net operating loss carryforwards pursuant to Internal Revenue Code (the "Code") Section 382, future income projections and potential tax-planning strategies. Based upon the Company's assessment of all available evidence, it concluded that, with the exception of the net deferred tax assets that are expected to be utilized through December 31, 2005, it is not more likely than not that the remaining deferred tax assets will be realized. This conclusion is based primarily on the Company's history of net operating losses as compared to only a recent trend of profitable operations, the potential for future stock option deductions to significantly reduce taxable income, its annual net operating loss limitations under Section 382 of the Code and the need to generate significant amounts of taxable income in future periods, on a consistent and prolonged basis, in order to utilize the remaining deferred tax assets. The Company will continue to monitor all available evidence and reassess the potential realization of its deferred tax assets. If the Company continues to meet its financial projections and improve its results of operations, or if circumstances otherwise change, it is reasonably possible that the Company may release all, or a portion, of the remaining valuation allowance in the near term. Any such release would result in recording a tax benefit that would increase net income in the period the allowance is released. Additionally, any such release may result in the further reduction of goodwill and intangible assets acquired in connection with the Merger.

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5.     NET INCOME PER SHARE

        The following table sets forth the computation of basic and diluted net income per share for the quarter and nine months ended September 30, 2004 and 2003, respectively (in thousands, except per share amounts):

        The diluted per share computations exclude antidilutive options. The number of antidilutive options at September 30, 2004 and 2003 was 5.9 million and 3.1 million, respectively. At September 30, 2004, there were approximately 13.3 million shares subject to issuance upon exercise of outstanding options with a weighted average exercise price of $12.40 per share.

6.     EQUITY AWARDS

        In January 2004, the Board of Directors issued 575,000 restricted shares of common stock at par value to certain of the Company's executive officers. The shares vest entirely on the fourth anniversary of the date of grant. In connection with these shares, the Company recorded deferred stock-based compensation of $11.4 million, which is being amortized on a straight-line basis over the four-year period.

        In January 2004, the Board of Directors approved stock option grants of 1.2 million shares to the Company's executive officers. The options are immediately exercisable and have an exercise price of $18.70 per share. The options and, to the extent exercised before vested, the shares vest over a three-year period from the date of grant.

        In January 2004, the Board of Directors approved stock option grants of 0.1 million shares to the members of the Board. The options are immediately exercisable and have an exercise price of $18.70 per share. The options and, to the extent exercised before vested, the shares vest monthly over a one-year period from the date of grant.

7.     COMMON STOCK REPURCHASE PROGRAM

        The Company's Board of Directors authorized a common stock repurchase program that allows the Company to repurchase shares of its common stock through open market or privately negotiated transactions based on prevailing market conditions and other factors. From time to time, the Board of

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Directors has increased the amount authorized for repurchase under this program. On April 22, 2004, the Board of Directors authorized the Company to purchase up to an additional $100 million of its common stock through May 31, 2005 under the program, bringing the total amount authorized under the program to $200 million. At September 30, 2004, the Company had repurchased $125 million of its common stock.

        Share repurchases executed under the common stock repurchase program at September 30, 2004 were as follows (in thousands, except per share amounts):

(1)

All share repurchases were repurchased as part of a publicly announced program.

8.     COMMITMENTS AND CONTINGENCIES

Financial Commitments

        The Company's financial commitments, including its operating leases and purchase commitments for telecommunications and media, are as follows at September 30, 2004 (in thousands):

        In connection with the relocation of its corporate offices to Woodland Hills, California, the Company entered into a lease for office space for approximately 112,000 square feet in March 2004. The lease, which expires in September 2014, represents a total commitment of $34.5 million. In connection with this lease, a $2.0 million letter of credit was issued in April 2004, reducing the total amount available under the Company's line of credit to $22.3 million.

        Operating lease commitments decreased from the March 2004 quarter as a result of lease termination agreements signed during the June 2004 quarter. The Company recognized $0.5 million and $1.7 million in lease termination fees in the quarter and nine months ended September 30, 2004, respectively.

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Legal Contingencies

        On April 20, 2001, Jodi Bernstein, on behalf of himself and all others similarly situated, filed a lawsuit in the United States District Court for the Southern District of New York against NetZero, certain officers and directors of NetZero and the underwriters of NetZero's initial public offering, Goldman Sachs Group, Inc., BancBoston Robertson Stephens, Inc. and Salomon Smith Barney, Inc. The complaint alleges that the prospectus through which NetZero conducted its initial public offering in September 1999 was materially false and misleading because it failed to disclose, among other things, that (i) the underwriters had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriters allocated to those investors material portions of the restricted number of NetZero shares issued in connection with the offering; and (ii) the underwriters had entered into agreements with customers whereby the underwriters agreed to allocate NetZero shares to those customers in the offering in exchange for which the customers agreed to purchase additional NetZero shares in the aftermarket at pre-determined prices. Plaintiffs are seeking injunctive relief and damages. Additional lawsuits setting forth substantially similar allegations were also served against NetZero on behalf of additional plaintiffs in April and May 2001. The case against NetZero was consolidated with approximately 300 other suits filed against more than 300 issuers that conducted their initial public offerings between 1998 and 2000, their underwriters and an unspecified number of their individual corporate officers and directors (the "Consolidated Cases"). Plaintiffs have filed a motion for preliminary approval of a proposed settlement with the issuers and their individual corporate officers and directors, and the underwriters have filed an opposition to such motion.

        On August 21, 2001, Juno commenced an adversary proceeding in U.S. Bankruptcy Court in the Southern District of New York against Smart World Technologies, LLC, dba "Freewwweb" (the "Debtor"), a provider of free Internet access that had elected to cease operations and had sought the protection of Chapter 11 of the Bankruptcy Code. The adversary proceeding arose out of a subscriber referral agreement between Juno and the Debtor. In response to the commencement of the adversary proceeding, the Debtor and its principals filed a pleading with the Bankruptcy Court asserting that Juno is obligated to pay compensation in an amount in excess of $80 million as a result of Juno's conduct in connection with the subscriber referral agreement. In addition, a dispute arose between Juno and UUNET Technologies, Inc., an affiliate of MCI WorldCom Network Services, Inc., regarding the value of services provided by UUNET, with UUNET claiming in excess of $1,000,000 and Juno claiming less than $300,000. On April 25, 2003, Juno, the Committee of Unsecured Creditors, WorldCom and UUNET (allegedly the largest secured creditor) entered into a Stipulation of Settlement. The Stipulation of Settlement provides for the payment by Juno of $5.5 million in final settlement of all claims against Juno. The Debtor has filed a motion of appeal of the district court order upholding the decision of the Bankruptcy Court approving the Stipulation of Settlement. The briefs have been filed in the Second Circuit Court of Appeals and the parties are awaiting the scheduling of oral arguments. At September 30, 2004, the Company had liabilities recorded of approximately $5.5 million.

        On April 27, 2004, plaintiff MyMail Ltd. filed a lawsuit in the United States District Court for the Eastern District of Texas 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 access to a computer network. An answer and affirmative defenses have been served on behalf of NetZero, Juno and NetBrands. Discovery is continuing and the court has set several dates for the parties to submit briefs on claim construction issues. No trial date has been set.

        The pending lawsuits involve complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources to defend. Although the Company does not believe the outcome of the above outstanding legal proceedings, claims and litigation will have a material adverse effect on its business, financial position, results of operations or cash flows, the results

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of litigation are inherently uncertain and the Company can provide no assurance that it will not be materially and adversely impacted by the results of such proceedings. The Company has established a reserve for the Freewwweb matter discussed above and such reserve is reflected in the consolidated financial statements.

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

9.     SUBSEQUENT EVENT

        On October 23, 2004, the Company signed a definitive agreement and plan of merger, among the Company, Mariner Acquisition Corp., a wholly-owned subsidiary of the Company, and Classmates Online, Inc. to acquire Classmates Online, Inc. for approximately $128 million in cash. The Company anticipates that Classmates will have a cash balance of approximately $28 million at the time the acquisition closes. Classmates Online, Inc. operates Classmates.com, connecting millions of members throughout the U.S. and Canada with friends and acquaintances from school, work and the military. The closing of the proposed acquisition is subject to the fulfillment of a number of customary conditions, including regulatory approval. If the acquisition is consummated, the results of this business will be included in the Company's consolidated business, financial position, results of operations and cash flows from the date the acquisition closes.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements based on our current expectations, estimates and projections about our operations, industry, financial condition and liquidity. Statements containing words such as "anticipate," "expect," "intend," "plan," "believe," "may," "will" or similar expressions constitute forward-looking statements. These forward-looking statements include, but are not limited to, statements about our proposed acquisition of Classmates Online, Inc. and its anticipated cash balances at the time of closing, the Internet services market, our user base, our services and marketing initiatives, the advertising market, competition, seasonality, operating expenses, operating efficiencies, revenues, capital requirements and our cash position. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. The sections entitled "Risk Factors" in this Quarterly Report on Form 10-Q, our Transition Report on Form 10-KT as filed with the SEC on February 5, 2004 and our other filings with the SEC set forth some of the important risk factors that may affect our business, financial position, results of operations and cash flows. Statements indicating factors that we believe may impact our results are not intended to be exclusive. We undertake no obligation to revise or update publicly any forward-looking statements, other than as required by law.

Overview

        We are a leading provider of consumer Internet subscription services through a number of brands, including NetZero and Juno. Our pay services include dial-up Internet access, accelerated dial-up services, premium email, and personal Web hosting and domain name registration services. We also offer consumers free Internet access, Web email and Web hosting. Our access services are available in more than 8,000 cities across the United States and in Canada. In addition, we offer marketers numerous online advertising products as well as online market research and measurement services.

        At September 30, 2004, we had approximately 3.2 million subscribers to our pay services and approximately 6.6 million active accounts, including pay subscribers. Total pay subscribers currently include subscribers to our pay Internet access, premium email, Web hosting and domain name registration services. "Active" accounts include total pay subscribers, free users who have logged onto our access or email services during the preceding 31-day period and those free hosted Web sites that have received at least one visit during the preceding 90 days.

        Our standard pay access services are offered through various pricing plans, generally $9.95 per month. We also offer "accelerated" dial-up services generally for an additional $5.00 per month, or a total monthly charge of $14.95. Our accelerated services utilize compression, caching and other technologies that reduce the time for certain Web pages to download to users' computers when compared to standard dial-up access services. NetZero and Juno offer premium email services with expanded features and storage capabilities at prices ranging from $9.95 to $24.95 per year. As a result of an acquisition in April 2004, we began offering Web-site services, including hosting and domain name registration services. Our Web-hosting services are offered through various pricing plans, generally averaging approximately $9.00 per month.

        Our pay access services differ from our free access services in that the hourly and certain other limitations set for the free services do not apply. In addition, our free access services incorporate a number of advertising initiatives, including a persistent on-screen advertising banner, which are not included on our pay access services. Our pay Web-hosting services differ primarily from our free Web-hosting services in that the free service requires the Web site to incorporate advertising initiatives.

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At September 30, 2004, we had approximately 2.0 million free access and email active accounts and approximately 1.3 million free Web-hosting active accounts.

        At September 30, 2004, subscribers to our accelerated services comprised approximately 33% of our total pay subscriber base and subscribers to our premium email and Web-hosting and domain services each comprised approximately 2% of our total pay subscriber base. In general we count and track pay subscribers and free accounts by unique member identification. We recently began cross marketing some of our brands and services to our entire active account base. A by-product of cross marketing multiple brands and services is that users have the ability to register for separate services under separate brands and member identifications independently. We do not track whether pay subscribers have purchased more than one of our services if they are using more than one member identification. As a result, total pay subscribers may not represent unique pay subscribers and, similarly, total active free accounts may not represent unique free users. In addition, a free Web hosting account is determined to be active if there is a visit to the site during the preceding 90 days, and it may be that the creator of the site no longer maintains or updates the site. As such, a free Web hosting account may not represent an ongoing relationship with the person who set up the account. To the extent a user purchases multiple pay services under one unique member identification, we only count that user as one pay subscriber. At any point in time, our pay subscriber base includes a number of pay subscribers receiving a free period of service as either a promotion or retention tool and may include a few thousand internal test accounts.

        United Online commenced operations in September 2001, following the merger of NetZero and Juno into two of its wholly-owned subsidiaries (the "Merger"). The Merger was accounted for under the purchase method of accounting for business combinations as an acquisition of Juno by NetZero, which is considered the predecessor company to United Online.

Recent Developments

        On October 23, 2004, we signed a definitive agreement and plan of merger, among United Online, Mariner Acquisition Corp., a wholly-owned subsidiary of United Online, and Classmates Online, Inc. to acquire Classmates Online, Inc. for approximately $128 million in cash. We anticipate that Classmates will have a cash balance of approximately $28 million at the time the acquisition closes. Classmates Online, Inc. operates Classmates.com, connecting millions of members throughout the U.S. and Canada with friends and acquaintances from school, work and the military. The closing of the proposed acquisition is subject to the fulfillment of a number of customary conditions, including regulatory approval. If the acquisition is consummated, the results of this business will be included in the Company's consolidated business, financial position, results of operations and cash flows from the date the acquisition closes.

Results of Operations

        The following table sets forth (in thousands, except percentages), for the periods presented, selected historical statements of operations data. The information contained in the table below is unaudited and should be read in conjunction with Liquidity and Capital Resources and Financial

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Commitments included in this Item 2 as well as the unaudited consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

Revenues

Billable Services Revenues

        Billable services revenues consist primarily of monthly fees charged to users for dial-up Internet access services, accelerated dial-up services and, to a lesser extent, fees charged to users for Web-hosting and domain name registration services, live telephone technical support and premium email services. Our pay Internet access services have been offered under a number of pricing plans, generally ranging from $1.95 to $29.95 per month. Currently, our most common pricing plan for our standard dial-up Internet access service is $9.95 per month. Our standard pricing for our accelerated dial-up Internet access service is an additional $5.00 per month, or a total monthly charge of $14.95. We generally charge our users $1.95 per minute for live telephone technical support, and we currently charge prices ranging from $9.95 to $24.95 per year for our premium email services. Our Web-hosting services are offered through various pricing plans, generally averaging about $9.00 per month.

        Our billable services revenues are primarily dependent on two factors: the average number of pay subscribers for a period and the average monthly revenue per pay subscriber for a period. The average

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number of pay subscribers is a simple average calculated based on the number of pay subscribers at the beginning and end of a period. Changes in our pay subscriber base are dependent on a number of factors including: the effects of increasing competition; the number of free accounts upgrading to pay services; changes in our marketing and related distribution channels; the number of pay subscribers who cancel their accounts or have their accounts terminated; changes in our marketing expenditures; the effectiveness of our marketing and distribution activities; the effects of seasonality; the impact of new types of pay services; and acquisitions during the period, if any. Average monthly revenue per pay subscriber is calculated by dividing billable services revenues for a period by the average number of pay subscribers for that period. Average monthly revenue per pay subscriber may fluctuate from period to period as a result of a variety of factors including: the pricing and success of new pay services and the penetration of these types of services as a percentage of total pay subscribers; changes in the mix of pay subscribers and their related pricing plans; the use of promotions such as free service periods and discounted pricing plans to obtain or retain subscribers; increases or decreases in the price of our services; and the timing of pay subscribers joining and leaving our services during a period.

        Billable services revenues increased by $22.5 million, or 28%, to $102.1 million for the September 2004 quarter, compared to $79.6 million for the September 2003 quarter. Billable services revenues increased by $84.2 million, or 39%, to $302.3 million for the nine months ended September 30, 2004, compared to $218.1 million for the nine months ended September 30, 2003. The increase was due to an increase in our average number of pay subscribers and an increase in our average monthly revenue per pay subscriber. Billable services revenue decreased sequentially by $0.4 million to $102.1 million for the September 2004 quarter, compared to $102.5 million for the June 2004 quarter.

        Our average number of pay subscribers was approximately 3,211,000 and 3,062,000, respectively, during the quarter and nine months ended September 30, 2004, compared to approximately 2,634,000 and 2,448,000 during the quarter and nine months ended September 30, 2003. The increase in our average number of pay subscribers resulted from a number of factors including an expansion of our online and offline distribution channels, increased spending on marketing and promotion of our pay services, in particular our accelerated services, our Web-hosting acquisition in April 2004 and a significant number of our free accounts upgrading to our pay services. However, we experienced limited growth in the June 2004 and September 2004 quarters compared to historical periods as a result of significantly slower growth in pay access subscribers. We believe the slower growth in pay access subscribers is attributable to a variety of factors including, without limitation, seasonally lower Internet usage and increased competition. These factors and others may continue to adversely impact our ability to grow our pay access subscribers going forward. We cannot assure you that either our total pay subscriber base or our pay access subscribers will continue to grow or will not decrease in future periods. In addition, the growth we have experienced in our accelerated dial-up services decreased in the June 2004 and September 2004 quarters compared to historical periods and we may not continue to experience growth for these services in the future.

        Average monthly revenue per pay subscriber was $10.60 for the September 2004 quarter, compared to $10.08 for the September 2003 quarter. The increase in average monthly revenue per pay subscriber was due primarily to an increase in the number of access subscribers purchasing our accelerated dial-up services, which at September 30, 2004 and 2003 comprised approximately 33% and 15% of our total pay subscriber base, respectively. Average monthly revenue per pay subscriber for the September 2004 quarter decreased from the $10.88 and $10.87 reported in the March 2004 and June 2004 quarters, respectively. The sequential decreases in average monthly revenue per pay subscriber are due to a number of factors including: an increase in the number of free months of service offered for initial trial periods and retention programs; a greater percentage of pay subscribers on lower-priced subscription services, such as our premium email and Web-hosting services; and an increase in the number of subscribers signing up for promotional pricing plans. We currently anticipate that some or all of these

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trends may continue in the near term, and believe that average monthly revenue per pay subscriber will continue to decrease, at least in the near term. If we continue to experience decreases in average monthly revenue per pay subscriber, our billable services revenues may continue to decrease, and our total revenues may decrease.

Advertising and Commerce Revenues

        Our advertising and commerce revenues consist of fees from our Internet search partners that are generated as a result of our users utilizing our partners' Internet search services, fees generated by our users viewing and clicking on third-party Web site advertisements and fees from referring our users to, and our users making purchases on, sponsors' Web sites. We also generate revenues from providing third parties with data analysis capabilities and traditional market research services, such as surveys and questionnaires. Our advertising and commerce revenues are generated from both our pay subscribers and free accounts. Factors impacting our advertising and commerce revenues generally include changes in orders from significant customers, the state of the online search and advertising markets, seasonality, increases or decreases in our active accounts, limitations on our free services and increases or decreases in advertising inventory available for sale. In the past, we have imposed limitations on our free services that have adversely impacted our volume of advertising inventory.

        Advertising and commerce revenues decreased by $0.6 million, or 6%, to $8.6 million for the September 2004 quarter, from $9.1 million for the September 2003 quarter. The decrease is primarily due to a $4.7 million decrease in revenue generated from our agreement with General Motors ("GM"). We derived 0% of our advertising and commerce revenues for the September 2004 quarter from GM, compared to approximately 51% for the September 2003 quarter. Our agreement with GM expired in December 2003 but the revenues from GM have been partially offset by revenues from other arrangements. The decrease was offset by an increase in fees derived from our Internet search partner as a result of more favorable pricing and expanded search services. We derived approximately 47% and 18% of our advertising and commerce revenues for the September 2004 and 2003 quarters, respectively, from Internet search fees primarily provided through our search agreement with Overture Services, Inc. ("Overture"), a subsidiary of Yahoo! Inc.

        Advertising and commerce revenues increased by $2.6 million, or 11%, to $26.7 million for the nine months ended September 30, 2004, from $24.1 million for the nine months ended September 30, 2003. The increases were primarily due to an increase in fees derived from our Internet search partner as a result of more favorable pricing and expanded search services, partially offset by a decrease in other advertising and commerce sales. We derived approximately 42% and 20% of our advertising and commerce revenues for the nine months ended September 20, 2004 and 2003, respectively, from Internet search fees primarily provided through our search agreement with Overture. The increase in advertising and commerce revenues was offset partially by a $8.2 million decrease for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 in revenue generated from our agreement with GM. The revenue recognized from GM during the nine months ended September 30, 2004 was primarily related to an unanticipated final performance bonus received during the March 2004 quarter. We derived approximately 8% of our advertising and commerce revenues for the nine months ended September 30, 2004 from GM, compared to approximately 43% for the nine months ended September 30, 2003.

Cost of Billable Services

        Cost of billable services includes direct costs of billable services and costs that have been allocated to billable services. Direct costs consist of costs related to providing telephone technical support, customer billing and billing support to our pay subscribers and domain name registration fees. Allocated costs consist primarily of telecommunications and data center costs, personnel and overhead-related costs associated with operating our network and data centers, and depreciation of network

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computers and equipment. We allocate costs associated with access services between billable services and free services based on the aggregate hourly usage of our pay access subscribers as a percentage of total hours used by our active access users. We allocate costs associated with Web hosting between billable services and free services based on estimated bandwidth used by pay Web-hosting subscribers relative to estimated bandwidth used by free Web-hosting subscribers.

        Cost of billable services increased by $0.1 million, or 1%, to $23.0 million for the September 2004 quarter, compared to $22.9 million for the September 2003 quarter. The increase is due to a $0.8 million increase in customer support and billing-related costs as a result of an increase in the number of pay subscribers, a $0.4 million increase in network personnel and overhead-related costs allocated to billable services and a $0.3 million increase in network depreciation allocated to billable services. These costs were offset partially by a $1.4 million decrease in telecommunications costs. Telecommunications costs decreased as a result of a decrease in the average monthly usage per pay subscriber and a decrease in average hourly telecommunications costs, offset partially by an increase in the number of pay access subscribers. Our average hourly telecommunications costs decreased as a result of better port utilization, improvements made in allocating our telecommunications usage to our lower cost vendors and lower telecommunications prices. Telecommunications hours allocated to our pay access subscriber base increased to approximately 94% of total telecommunications hours purchased during the September 2004 quarter, compared to approximately 90% during the September 2003 quarter.

        Cost of billable services increased by $2.4 million, or 3%, to $71.9 million for the nine months ended September 30, 2004, compared to $69.5 million for the nine months ended September 30, 2003. The increase is due to a $3.8 million increase in customer support and billing-related costs as a result of an increase in the number of pay subscribers and a $1.1 million increase in network personnel and overhead-related costs allocated to billable services. These costs were partially offset by a $1.7 million decrease in telecommunications costs. Telecommunications costs decreased as a result of a decrease in the average monthly usage per pay subscriber and a decrease in average hourly telecommunications costs, offset partially by an increase in pay access subscribers. Our average hourly telecommunications costs decreased as a result of better port utilization, improvements made in allocating our telecommunications usage to our lower cost vendors and lower telecommunications prices. Telecommunications hours allocated to our pay access subscriber base increased to approximately 93% of total telecommunications hours purchased during the nine months ended September 30, 2004, compared to approximately 88% during the nine months ended September 30, 2003. Network personnel and overhead-related costs allocated to billable services increased due to the increase in telecommunications hours utilized by pay access subscribers as a percentage of total telecommunications hours purchased.

        Cost of billable services as a percentage of billable services revenues was 22.5% and 23.8%, respectively, in the quarter and nine months ended September 30, 2004, compared to 28.7% and 31.9%, respectively, in the quarter and nine months ended September 30, 2003. The decreases resulted from an increase in average monthly revenue per pay subscriber due to significant adoption of our accelerated dial-up services; a decrease in average hourly telecommunications costs per pay access subscriber; decreased customer billing and support costs per pay subscriber primarily as a result of better pricing obtained from our principal customer support vendor; and a decrease in average hourly usage per pay access subscriber.

        Our cost of billable services as a percentage of billable services revenues is highly dependent on the pricing for our services, our average hourly telecommunications cost and usage and our average customer billing and support costs per pay subscriber. If we are not successful in continuing to increase the percentage of our pay access subscribers subscribing to our accelerated services and other pay services such as premium email and Web hosting, or if due to competitive or other factors we decrease the pricing for our access services or increase the use of promotions such as one or more free months

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of service, or if our new pay services are less profitable than our access services, it is likely that our cost of billable services as a percentage of billable services revenues would be adversely impacted. While our average hourly telecommunications costs have decreased for some time, we may experience increased average hourly telecommunications costs in future periods, particularly if we expand our service coverage to additional geographic areas where telecommunications costs are higher. Additionally, while the average hourly usage of our pay access subscribers decreased in the September 2004 quarter compared to the September 2003 quarter, we may experience increased average hourly usage in future periods when compared to the comparable period of the prior year.

Cost of Free Services

        Cost of free services includes direct costs incurred in providing certain telephone technical support services to our free access users as well as costs that have been allocated to free services. Allocated costs consist primarily of telecommunications and data center costs, personnel and overhead-related costs associated with operating our network and data centers, and depreciation of network computers and equipment. We allocate costs associated with access services between pay services and free services based on the aggregate hourly usage of our free access users as a percentage of total hours used by our active access users. We allocate costs associated with Web hosting between pay services and free services based on estimated bandwidth used by free Web-hosting accounts.

        Cost of free services decreased by $0.5 million, or 23%, to $1.6 million for the September 2004 quarter, compared to $2.1 million for the September 2003 quarter. The decrease was due primarily to a $0.4 million decrease in telecommunications costs. The decrease in telecommunications costs is a result of a decrease in average hourly telecommunications costs, a decrease in the number of active free access accounts and a decrease in the average hourly usage of these accounts. The decrease in free access accounts resulted from free accounts upgrading to our pay services and fewer new free account sign-ups. Telecommunications hours allocated to our free access accounts decreased to approximately 6% of total telecommunications hours purchased during the September 2004 quarter, compared to approximately 10% during the September 2003 quarter.

        Cost of free services decreased by $2.9 million, or 37%, to $4.9 million for the nine months ended September 30, 2004, compared to $7.8 million for the nine months ended September 30, 2003. The decrease was primarily due to a $2.2 million decrease in telecommunications costs. The decrease in telecommunications costs is a result of a decrease in average hourly telecommunications costs, a decrease in the number of active free access accounts, a decrease in the average hourly usage of these accounts and a decrease in telecommunications hours allocated to our free users.

Sales and Marketing

        Sales and marketing expenses include advertising and promotion expenses, fees paid to distribution partners to acquire new pay subscribers, personnel-related expenses for sales and marketing personnel and telemarketing costs incurred to acquire and retain pay subscribers and up sell pay subscribers to additional services, such as our accelerated dial-up and premium email services. We have expended significant amounts on sales and marketing, including national branding campaigns comprised of television, Internet, sponsorships, radio, print and outdoor advertising. Marketing and advertising costs to promote our products and services are expensed in the period incurred. 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 fees are expensed over the period the advertising runs.

        Sales and marketing expenses increased by $9.4 million, or 28%, to $43.3 million for the September 2004 quarter, compared to $33.9 million for the September 2003 quarter. The increase is primarily attributable to a $8.4 million increase in marketing, promotion and distribution costs as a

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result of an expansion in marketing activities which have focused on promoting our accelerated dial-up services, increasing our pay access subscriber base, and building our brands. Additionally, sales and marketing expenses increased as a result of a $0.7 million increase in telemarketing expenses related to customer acquisition, retention and up-sell activities. Our marketing expenditures may increase in the near term as a result of a more expensive advertising market and our expanded distribution efforts, which could result in increased fees paid to distribution partners to acquire new pay subscribers. Increases in prices to purchase advertising, combined with seasonal factors and more intense competition for pay subscribers, may adversely impact the effectiveness of our marketing activities and our ability to grow our pay subscriber base and revenues.

        Sales and marketing expenses increased by $47.2 million, or 56%, to $131.3 million for the nine months ended September 30, 2004, compared to $84.0 million for the nine months ended September 30, 2003. The increase is primarily attributable to a $41.0 million increase in marketing, promotion and distribution costs as a result of an expansion in marketing activities that focus on increasing our pay access subscriber base, promoting our accelerated dial-up services, and building our brands. Additionally, sales and marketing expenses increased as a result of a $5.5 million increase in telemarketing expenses related to customer acquisition, retention and up-sell activities, a $0.4 million increase in personnel-related expenses due to increased headcount and compensation costs and a $0.3 million increase in stock-based compensation related to restricted stock issued to certain of our executive officers in January 2004.

        Our marketing expenditures and the allocation of our marketing resources among our various services may vary significantly from quarter to quarter depending on a number of factors including the effectiveness of our marketing activities, changes in the cost to purchase advertising, changes in the number of pay subscribers, and the impact of such activities on our results of operations. Marketing expenditures decreased sequentially in the September 2004 quarter, and any future decreases in our marketing expenditures would likely impact our ability to increase our pay subscriber base. We can provide you no assurance that we will not decrease our marketing expenditures on a quarterly basis in the future. We have entered into a number of longer-term off-line distribution relationships. We intend to continue to focus on increasing both our off-line and on-line distribution channels in the near term, which could result in increased marketing expenditures as a result of fees paid to distribution partners. Our ability to increase or decrease our marketing expenditures from period to period may be more limited to the extent distribution partners continue to constitute an increasing portion of our marketing expenditures. There is, however, no assurance that we will be able to increase our distribution channels or that any future increase in marketing expenditures will be successful in growing or maintaining our pay subscriber base.

Product Development

        Product development expenses include expenses for the maintenance of existing software and technology and the development of new or improved software and technology, including personnel-related expenses for the software engineering department and the costs associated with operating our facility in India. Costs incurred by us to develop, enhance, manage, monitor and operate our services are generally expensed as incurred, except for certain costs relating to the acquisition and development of internal-use software, which are capitalized and depreciated over their estimated useful lives, generally three years or less.

        Product development expenses increased by $1.9 million, or 38%, to $7.1 million for the September 2004 quarter, compared to $5.1 million for the September 2003 quarter. The increase was primarily the result of a $1.7 million increase in personnel-related expenses as a result of increased headcount and compensation costs.

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        Product development expenses increased by $2.9 million, or 18%, to $19.5 million for the nine months ended September 30, 2004, compared to $16.5 million for the nine months ended September 30, 2003. The increase was primarily the result of a $4.0 million increase in personnel-related expenses as a result of increased headcount and compensation costs, partially offset by a $1.1 million decrease in depreciation expense. Depreciation expense allocated to product development decreased as a result of assets placed in service in prior years becoming fully depreciated and lower levels of capital expenditures in recent years versus prior years.

General and Administrative

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

        General and administrative expenses increased by $3.8 million, or 54%, to $10.8 million for the September 2004 quarter, compared to $7.0 million for the September 2003 quarter. The increase was the result of $1.6 million in lease termination fees and accelerated depreciation expenses in connection with the relocation of our corporate offices, a $1.0 million increase in professional and consulting fees primarily related to our Sarbanes-Oxley Section 404 compliance efforts and increased legal fees, a $0.6 million increase in stock-based compensation related to restricted stock issued to certain of our executive officers in January 2004, a $0.4 million increase in overhead-related costs and a $0.3 million increase in personnel-related expenses as a result of higher compensation costs. These increases were partially offset by a $0.2 million decrease in legal settlement costs.

        General and administrative expenses increased by $6.2 million, or 28%, to $28.3 million for the nine months ended September 30, 2004, compared to $22.1 million for the nine months ended September 30, 2003. The increase was the result of the incurrence of $3.2 million in lease termination fees and accelerated depreciation expenses incurred as a result of the relocation of our corporate offices, a $2.0 million increase in professional and consulting fees primarily related to due diligence process associated with a potential acquisition that was terminated, our Sarbanes-Oxley Section 404 compliance efforts and increased legal fees, a $1.6 million increase in stock-based compensation related to restricted stock issued to certain of our executive officers in January 2004 and a $0.8 million increase in personnel-related expenses as a result of higher compensation costs. These increases were offset partially by $1.8 million in legal settlement costs recognized in the nine months ended September 30, 2003.

Amortization of Intangible Assets

        Amortization of intangible assets includes amortization of acquired pay subscribers and free users, purchased technologies and other identifiable intangible assets. At September 30, 2004, we had approximately $24.7 million in net identifiable intangible assets resulting primarily from the Merger, the acquisition of the Internet access assets of BlueLight and the acquisition of the Web-hosting assets of About, Inc. At September 30, 2004, we had approximately $17.0 million in goodwill resulting from the Merger and the acquisition of the Web-hosting assets of About, Inc. In accordance with the provisions set forth in Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, goodwill acquired in connection with the Merger is not being amortized but is tested for impairment at a reporting unit level on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value amount.

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        Amortization of intangible assets increased by $0.4 million, or 11%, to $4.4 million for the September 2004 quarter, compared to $4.0 million for the September 2003 quarter. Amortization of intangible assets increased by $0.9 million, or 7%, to $12.8 million for the nine months ended September 30, 2004, compared to $11.9 million for the nine months ended September 30, 2003. The increases are due to the amortization of identifiable intangible assets from the acquisition of the Web-hosting assets of About, Inc. in April 2004.

Restructuring Charges

        During the nine months ended September 30, 2003, we recorded a $0.2 million benefit to restructuring charges as a result of contract termination fees expensed in earlier periods in excess of final negotiated settlements.

Interest and Other Income, Net

        Interest income consists of earnings on our cash, cash equivalents and short-term investments. Interest expense consists of interest expense on capital leases and the amortization of premiums on certain of our short-term investments. Other income consists of realized gains and losses recognized in connection with the sale of short-term investments.

        Interest and other income, net decreased by $0.1 million, or 10%, to $1.1 million for the September 2004 quarter, compared to $1.2 million for the September 2003 quarter. Interest and other income, net decreased by $0.1 million, or 4%, to $3.3 million for the nine months ended September 30, 2004, compared to $3.4 million for the nine months ended September 30, 2003. Interest income remained fairly constant as a result of higher average cash balances offset by lower average returns due to a shift toward tax-exempt holdings. Other income associated with net realized gains on our short-term investments was $0.1 million for the nine months ended September 30, 2004.

Provision for Income Taxes

        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 an annualized effective tax rate of approximately 41.5%.

        For the quarter and nine months ended September 30, 2003, we generated pre-tax income of $15.0 million and $34.0 million, respectively, and recorded a tax provision of $6.1 million and $3.6 million, respectively. The effective tax rate for the nine months ended September 30, 2003 differs from the statutory rate primarily as a result of a tax benefit recognized in the June 2003 quarter from the release of a portion of the valuation allowance against deferred tax assets relating primarily to the actual and expected utilization of net operating loss and credit carryforwards for fiscal 2003 and 2004.

        Consistent with prior periods, in determining the need for a valuation allowance related to our deferred tax assets at September 30, 2004, we reviewed both positive and negative evidence pursuant to the requirements of SFAS No. 109, Accounting for Income Taxes, including current and historical results of operations, the annual limitation on utilization of net operating loss carryforwards pursuant to Internal Revenue Code (the "Code") Section 382, future income projections and potential tax-planning strategies. Based upon our assessment of all available evidence, we concluded that, with the exception of the net deferred tax assets that are expected to be utilized through December 31, 2005, it is not more likely than not that the remaining deferred tax assets will be realized. This conclusion is based primarily on our history of net operating losses as compared to only a recent trend of profitable operations, the potential for future stock option deductions to significantly reduce taxable income, our annual net operating loss limitations under Section 382 of the Code and the need to generate significant amounts of taxable income in future periods, on a consistent and prolonged basis, in order to utilize the remaining deferred tax assets. We will continue to monitor all available evidence and

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reassess the potential realization of our deferred tax assets. If we continue to meet our financial projections and improve our results of operations, or if circumstances otherwise change, it is reasonably possible that we may release all, or a portion, of the remaining valuation allowance in the near term. Any such release would result in recording a tax benefit that would increase net income in the period the allowance is released. Additionally, any such release may result in the further reduction of goodwill and intangible assets acquired in connection with the Merger.

Liquidity and Capital Resources

        Our total cash, cash equivalent and short-term investment balances decreased by approximately $1.1 million to $202.6 million at September 30, 2004 compared to $203.7 million at December 31, 2003. Our summary cash flows for the periods were as follows (in thousands):

        Net cash provided by operating activities increased by $37.7 million, or 69%. Significant factors that have impacted the variability in our cash provided by operating activities in these periods are as follows:

•

increases in operating income before depreciation, amortization and stock-based compensation as a result of increased revenue and operating profitability due to overall improvements in our business;



•

the utilization of net operating loss and tax credit carryforwards and income tax deductions resulting from the exercise of stock options by employees, which have reduced payments for income taxes. We currently anticipate that our net operating loss and tax credit carryforwards available for use in 2004, when combined with anticipated exercises of employee stock options, will help to reduce the level of cash paid for income taxes in 2004. We currently anticipate that cash paid for income taxes will increase significantly in 2005 and thereafter due to the annual limitations on the utilization of net operating loss carryforwards pursuant to Internal Revenue Code Section 382. We have approximately $19 million of net operating loss carryforwards available in 2005, $17 million in 2006 and $12.5 million in 2007 through 2020;



•

changes in working capital accounts due to increases in revenue and operating expenses and the timing of related cash receipts and payments

        Net cash used for investing activities decreased by $11.9 million, or 27%. Significant factors that have impacted the variability in our cash used for investing activities in these periods are as follows:

•

the acquisition of the Web-hosting services assets of About, Inc. in April 2004 for $11.9 million in cash;



•

changes in our short-term investment portfolio based on the liquidity requirements of our business;



•

increases in capital equipment purchases in connection with the ongoing operation of our business and the relocation of our corporate offices.

        In prior years, we have invested significantly in our network infrastructure, software licenses, leasehold improvements, and computer equipment and we may need to make further significant investments in the future. Capital expenditures for the nine months ended September 30, 2004 were

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$11.2 million. We anticipate that our total capital expenditures for the remainder of 2004 will be in the range of $3 million to $5 million. The actual amount of future capital expenditures may fluctuate due to a number of factors including, without limitation, our potential acquisition of Classmates, potential future acquisitions and new business initiatives which are difficult to predict and could change significantly over time. Additionally, significant technological advances may require us to make capital expenditures to develop or acquire new equipment or technology in order to replace aging or technologically obsolete equipment.

        Net cash used for financing activities increased by $74.7 million. Significant factors that have impacted the variability in our cash used for financing activities in these periods are as follows:

•

repurchases of common stock under our common stock repurchase program. In April 2004, our Board of Directors authorized us to purchase up to an additional $100 million of our common stock through May 31, 2005;



•

increases and decreases in cash received from employee stock option exercises and employee stock purchase plan proceeds. Future proceeds from employee stock option exercises are difficult to predict as such amounts are a function of our stock price, the number of vested and in-the-money options outstanding and the timing of employee exercises.

        We currently have access to a $25 million unsecured revolving line of credit with Silicon Valley Bank, which expires in December 2004. The interest rates available for borrowings are based on current market factors. This facility is available for general corporate purposes. While we believe that we currently possess adequate cash reserves, the line of credit provides us with additional financial flexibility with respect to short-term working capital requirements. At September 30, 2004, a $0.7 million letter of credit in connection with one of our leased facilities and a $2.0 million letter of credit in connection with the lease of our new corporate headquarters were outstanding, reducing the total amount available under the line of credit to $22.3 million.

        We recently signed a definitive agreement to acquire Classmates Online, Inc. for $128 million, which will be funded with our existing cash reserves. We anticipate that Classmates will have a cash balance of approximately $28 million at the time the acquisition closes and that our cash and short-term investment balances will be reduced by approximately $100 million as a result of the acquisition, not including associated expenses.

        Based on our current projections, we expect to continue to generate positive cash flows from operations through the remainder of 2004. We intend to use our existing cash balances and future cash generated from operations to acquire complementary services, businesses or technologies; to repurchase shares of our common stock if we believe market conditions to be favorable; and to fund future capital expenditures. We currently anticipate that our future cash flows from operations and existing cash, cash equivalent and short-term investment balances will be sufficient to fund our operations over the next year, and in the near term we do not anticipate the need for additional financing to fund our operations. However, we may raise additional debt or equity capital for a variety of reasons including, without limitation, developing new or enhancing existing services or products, repurchasing our common stock, acquiring complementary services, businesses or technologies or funding significant capital expenditures. If we need to raise additional capital through public or private debt or equity financings, strategic relationships or other arrangements, it might not be available to us in a timely manner, on acceptable terms, or at all. Our failure to raise sufficient capital when needed could have a material adverse effect on our business, financial position, results of operations and cash flows. If additional funds were raised through the issuance of equity securities, the percentage of stock owned by the then-current stockholders would be reduced. Furthermore, such equity securities might have rights, preferences or privileges senior to holders of our common stock.

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Financial Commitments

        Our financial commitments, including our operating leases and purchase commitments for telecommunications and media are as follows at September 30, 2004 (in thousands):

        In connection with the relocation of our corporate offices to Woodland Hills, California, we entered into a lease for office space for approximately 112,000 square feet in March 2004. The lease, which expires in September 2014, represents a total commitment of $34.5 million.

        Operating lease commitments decreased from the March 2004 quarter as a result of lease termination agreements signed during the June 2004 quarter. We recognized $0.5 million and $1.7 million in lease termination fees in the quarter and nine months ended September 30, 2004, respectively.

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RISK FACTORS

        Before deciding to invest in our company or to maintain or increase your investment, you should carefully consider the risks described below as well as the other information in this report and our other filings with the SEC. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect us. If any of these risks actually materialize, our business, financial position, results of operations and cash flows could be adversely impacted. In that event, the market price of our common stock could decline and you may lose all or part of your investment.

Our business is subject to fluctuations.

        Our results of operations have varied in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control and difficult to predict. The following are some of the factors that may affect us from period to period and may affect our long-term performance:

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changes to service offerings and pricing by us or our competitors;



•

fluctuations in our pay subscriber and free user bases, including fluctuations caused by seasonality, churn, competition and the impact of marketing;



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changes in the mix of our pay subscriber base, particularly changes in the number of subscribers to our accelerated services, premium email services and subscribers on discounted plans or free trial periods;



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fluctuations in our average monthly revenue per pay subscriber;



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changes in the number of hours active accounts use our access services;



•

fluctuations in our efficiency in acquiring new pay subscribers and selling existing subscribers additional products or services;



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the amount of marketing expenditures we incur, including fluctuations in payments to third party distributors for subscriber acquisition, and fluctuations in the media pricing we are able to obtain;



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changes in terms, including pricing, with our telecommunications providers;



•

the effect of acquisitions and the expense associated with potential acquisitions;



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conditions or trends in the Internet services industry generally;



•

changes in the demand and market rates for Internet advertising;



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increases or reductions in advertising and commerce revenues from significant customers;



•

the effects of litigation and the timing of resolutions of disputes;



•

the amount and timing of operating costs and capital expenditures;



•

changes in governmental regulation and taxation policies; and



•

changes in, or the effect of, accounting rules, such as recording expenses for restricted stock and stock option grants or the realization of our deferred tax assets.

        In addition, the number of pay subscribers and active free accounts on our services and the mix in our pay subscriber base from period to period has fluctuated significantly in the past and may fluctuate significantly in the future. Projecting the number and mix of pay subscribers on our services in future periods is inherently difficult and the rate at which users sign up for or terminate our services will vary

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as a result of a number of factors, many of which are out of our control. These factors include, without limitation, the effects of competition, seasonality, user satisfaction with our services and the impact of our marketing efforts.

        We have entered into agreements with third parties that result in payments based upon the number of subscribers acquired through the third parties' marketing channels. In certain cases, such as our agreement with Best Buy, the number of subscribers acquired during a particular quarter could vary significantly from our expectations. If the number of subscribers acquired through such a channel significantly exceeded our expectations during a quarter, the resulting payment obligation could adversely impact our results of operations in the quarter during which the subscribers were acquired, although our results of operations could be impacted positively in future periods due to the additional subscribers. Alternatively, if the number of subscribers acquired through such a channel was significantly less than our expectations and we had limited our marketing expenditures during the quarter based on our initial expectations, our results of operations for such quarter might be positively impacted but our user growth for the quarter and our results of operations in future periods may be negatively impacted.

        As a result of the foregoing and the other factors discussed in this report, you should not rely on period-to-period comparisons as an indication of future or long-term performance. In addition, these factors create difficulties with respect to our ability to forecast our financial performance and user metrics accurately. We believe that these difficulties in forecasting present even greater challenges for financial analysts who publish their own estimates of our future financial results and user metrics. We cannot assure you that we will achieve the expectations or financial projections made by our management or by the financial analysts. In the event we do not achieve such expectations or projections, the price of our common stock could be adversely affected.

Our revenues will suffer if we are unable to compete effectively.

Competition

Competition for Subscribers

        Competition for subscribers of Internet access services is intense. We compete with established online service and content providers such as AOL and MSN; independent national ISPs such as EarthLink and its PeoplePC subsidiary; companies combining their resources to offer Internet services in conjunction with other services such as Yahoo! and SBC Internet Services, and AOL and Walmart.com; national communications companies and local exchange carriers such as AT&T WorldNet, Qwest Communications International, Inc. and Verizon; cable companies such as Comcast Corporation, Cox Communications, Inc., Charter Communications, Inc. and Adelphia Communications Corporation; local telephone companies; and regional and local commercial ISPs. We also compete against companies that offer services or products such as personal computers, bundled with, or as promotions for, Internet access services. We believe that the primary competitive factors determining success in the market for Internet access users include price, speed, a reputation for reliability of service, effective customer support, easy to use and reliable software, geographic coverage and scope of services. Other important factors include the timing and introduction of new products and services as well as general economic trends. While we believe that we compete favorably with respect to price and most of these factors, many of our competitors have an advantage over us with respect to specific factors, particularly technical support and scope of services.

        One element of our strategy is to offer a variety of subscription services in addition to Internet access services. We currently offer Web hosting and domain registration services, as well as stand-alone premium email services and a stand-alone broadband accelerator product. While these services do not constitute a significant portion of our revenues, we are actively investing substantial resources in certain of these services. Competition for users of premium email services is intense. The companies we

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compete with for Internet access customers also compete with us for subscribers to email services. In addition, a number of companies, including Yahoo!, MSN and Google, offer premium email services, in certain cases, for free. The market for premium email services is evolving at a rapid pace and we cannot assure you that our offerings will be competitive or commercially viable. While the personal Web hosting business is fragmented, a number of significant companies, including Yahoo!, currently compete actively for these users. In addition, the personal Web hosting industry is very application specific, with many of the competitors focusing on specific applications, such as photo sharing, to generate additional users. We cannot assure you that our premium email offerings or our Web hosting offerings will be competitive or will generate growth in pay subscribers.

        Our monthly pricing for our standard dial-up services is currently lower than the monthly pricing of the premium dial-up services of most of our major competitors. Certain significant competitors, however, are engaging in more aggressive pricing of their dial-up services either under their primary brands or alternative brands, such as AOL's CompuServe and Netscape brands and EarthLink's PeoplePC brand. In particular, AOL's Netscape brand and EarthLink's PeoplePC brand, priced at $9.95 and $10.95 respectively, compete directly with our standard offering. A certain number of our new subscribers are subscribers switching from the AOL premium dial-up service, and the CompuServe and Netscape services, in addition to being additional competition in the value-priced market, have adversely impacted and may continue to adversely impact the number of subscribers switching from the AOL premium dial-up service to our services. In addition, our competitors have engaged and are likely to continue to engage in a number of aggressive pricing plans to entice new users and keep existing users from leaving their services, such as one or more free months of service or extended periods of discounted pricing, which are less expensive than our current offerings, and many of our competitors do not charge an additional monthly fee for their accelerated service. We believe this increased competition has adversely impacted our ability to obtain new pay access subscribers and to retain our existing subscribers, and is likely to adversely impact our ability to maintain or grow our pay access subscriber base in the future.

        Partially in response to this competition, we have become more aggressive in offering discounted services and one or more free months of services in order to obtain new subscribers and retain existing subscribers. Additional price decreases or aggressive offers by our competitors could adversely affect our ability to compete for pay access subscribers and could cause us to lower our prices or engage in additional discounting, any of which could adversely impact our results of operations. In addition, from time to time, we have increased our emphasis on marketing additional services, including our accelerated services, and decreased our marketing efforts on our standard access services, which may adversely impact the number of new standard access service subscribers we obtain. To the extent we shift resources away from our access services to market additional services and products, including premium email and Web hosting, our ability to compete for access subscribers could be adversely impacted. We cannot assure you that we will be able to compete effectively, grow or maintain our pay access subscriber base, grow our pay subscriber base as a whole, or maintain the pricing of our services.

        A significant portion of our growth in billable services revenue and average monthly revenue per pay subscriber since early 2003 has been attributable to new subscribers to our accelerated dial-up services. When we began offering this service in early 2003, many of our competitors either did not offer a similar service or charged substantially more than we charge for a similar service. Since that time, several competitors have either decreased their price for these services or have bundled these services into their premium services with no additional fee. Many competitors now market these services as a feature of their value-priced services and these services are now offered, in certain cases, at a price point similar to or lower than our offering. While EarthLink's PeoplePC brand offers an accelerated service for $15.95 per month, they have tested various pricing plans that are lower than our $14.95 per month offering, including an offering of $12.95 per month. In addition, several of our competitors have increased their emphasis on marketing these services. Increased competition for

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subscribers to accelerated services could adversely impact our ability to grow or maintain our accelerated services subscriber base, or could cause us to lower or eliminate our pricing for these services, which would adversely impact our results of operations. The growth in the number of subscribers to this service has been decreasing and is likely to continue to decrease. We cannot assure you that we will be able to continue to maintain or grow our accelerated services subscriber base at current price levels, or at all.