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Executives

Alexander Mandel - Chief Financial Officer

Douglas R. Lebda - Founder, Chairman, Chief Executive Officer and Member of Executive Committee

Analysts

Hamed Khorsand - BWS Financial Inc.

Josh Goldberg - G2 Investment Partners Management LLC

Tree.Com (TREE) Q4 2012 Earnings Call March 13, 2013 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Tree.com Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. With us on the call today are Alex Mandel, CFO; and Doug Lebda, Chairman and CEO. I'll now turn the conference over to Alex Mandel. Sir, please go ahead.

Alexander Mandel

Thanks, operator, and thanks to everyone for joining us today for Tree.com's Q4 2012 Earnings Conference Call. First, a quick disclaimer. During this call, we may discuss the company's plans, expectations, outlook or forecasts for future performance. These forward-looking statements are typically preceded by words such as we expect, we believe, we anticipate, we are looking to or other similar statements.

These forward-looking statements are subject to risks and uncertainties, and Tree.com's actual results could differ materially from the views expressed today. Many, but not all, of the risks we face are described in Tree.com's periodic reports filed with the SEC.

On this call, we will discuss a number of non-GAAP measures, and I refer you today to the press release available on our website at investor-relations.tree.com for the comparable GAAP measures, definitions and full reconciliations of non-GAAP measures to GAAP.

Thanks to all of you for joining us today as we review our fourth quarter results. We're excited to share with you the details of our continued progress.

As many of you know, Q4 2012 was our second full quarter as a pure-play, asset-light performance marketing company, following the sale of our mortgage origination business back in June. We view our results this quarter as continued validation of the strategic course we have charted for the company. In both quarters following the sale of our mortgage origination business, we achieved top line growth in our mortgage Exchanges business, profitability in our continuing operations at all levels down to EPS and positive operating cash flow from our continuing operations.

One note as to terminology, our results for the fourth quarter are actual figures as are those for the preceding third quarter. However, figures for the fourth quarter 2011, which we refer to in making year-over-year comparisons, may reflect what we have termed "adjusted Exchanges metrics," which are non-GAAP metrics we used in the quarters preceding the sale of our mortgage origination business to demonstrate model results as if the company did not operate that business during those periods, to facilitate comparability of our results.

Starting at the top, the feedback from our mortgage customers continue to be strong and they are clearly voting with their wallets. We generated $21.9 million of revenue from our mortgage Exchanges in Q4, which is a 55% increase year-over-year from the adjusted Exchanges mortgage revenue in Q4 2011 and a 10% increase sequentially from Q3 2012.

We consider these results to be particularly robust, given: number one, the record low interest rate environment in which lenders can benefit from organic leads and reduce dependence on third-party customer acquisition sources; and secondly, seasonal challenges of the holidays, where retailers compete for both customers' attention and media inventory to place their adds.

Our non-mortgage verticals, overall, continue to face some headwinds in Q4 with the $2.1 million of revenue representing significant declines as compared to both the year-over-year and preceding quarterly periods. While our Autos business experienced growth and continues to advance its auto sales initiative in addition to its loan comparison shopping offerings, this was more than offset by our Education and Home Services businesses.

In Education, as we previously announced, we brought in a new General Manager from inside the company in the November timeframe. While we still have some wood to chop but we're encouraged by the transition in January of this year of substantially all of our online traffic to the DegreeTree-branded platform. This will enable us to both offer prospective students a more compelling experience as they research and seek out post-secondary degree programs, as well as leverage the Tree brand to enhance the trust and confidence in our offerings. Previously, a significant portion of consumers utilizing our services were doing so through an alternate branded version of our offering.

In Home Services, our results were somewhat impacted by the ensuing result of a book drop in August, which we did not have in the year-over-year period. That said, as we indicated in the last quarter's call, we have discontinued that effort and going forward, are focused exclusively on scaling our online marketing programs and adding national distribution in key service categories.

All in, consolidated revenue of $23.9 million in Q4 represented a 33% increase over adjusted Exchanges revenue in the year-over-year period, and a 3% increase sequentially versus Q3 2012.

From a profitability perspective, our continuing operations achieved positive profitability from variable marketing margin, or VMM, after net income. At a VMM level, the company delivered $12.4 million, the strongest figure reported in the 8 quarters we've provided this metric. And as Doug has shared previously, our strategy has been to maximize VMM. Further, this quarter's VMM represents a margin of 52%, which was up both year-over-year and sequentially and represents the third consecutive quarter at 50% or above.

Adjusted EBITDA of $2.8 million in the quarter was down notably from the year-over-year and prior quarters, declining 14% and 28%, respectively and representing a margin of 12%. However, this performance is largely attributable to certain nonrecurring G&A items, without which, we would've seen the business pacing in the 15% margin area.

Further, despite the reduced margin profile reported for Q4, we nonetheless, reported full year adjusted Exchanges EBITDA of $14.3 million, which exceeded our prior guidance.

I'll touch very briefly on our discontinued operations which primarily represents our former mortgage origination business. The financial impact of this segment was substantially reduced in Q4 as our wind down efforts progressed. In Q4, we reported an after-tax net loss from discontinued operations of $313,000 compared with a gain of $4.1 million in Q3.

From a balance sheet perspective, our working capital position at year-end was $68.1 million. And as we've mentioned previously, this is before $10 million of deferred contingent consideration that will be due on the first anniversary of the HLC sale, which is this June, subject to various conditions.

Towards the end of Q4, we paid the previously announced $1 per share special dividend, totaling $11.4 million; and during the quarter, spent $519,000 repurchasing our shares. We have approximately $3.4 million remaining under our current buyback program. As I also noted at the beginning of my remarks, we generated positive cash flow from operating activities in our continuing operations in both the third and fourth quarters of 2012.

In conclusion, we delivered strong results in our second quarter, repositioned as a pure-play performance marketing company. We anticipate continued growth, operating improvements and opportunities for the LendingTree brand in 2013, which is reflected in our guidance.

With that, I'd like to turn it over to Doug.

Douglas R. Lebda

Thanks, Alex, and thanks, to all of you for joining us on the call today. Since Alex already touched on many of the important financial measurements and you can all read the release, I'll be brief.

Looking at Q4, I'm particularly pleased that we seem to, for almost the first time in our history, counter typically seasonal trends. We saw lender demand particularly strong throughout December and we were able to deliver the volume at great margins. Because of the strength we were seeing, we took it upon ourselves to loosen the reins a bit and let our GMs test some new things and accelerate projects. And we took a number of actions that hurt our financial results in the short-term, but set us up for success longer-term. For example, we moved our Education business to a new technology platform in one shot, and more quickly than we would have otherwise. While that hurt our Q4 by about $200,000, it's paying dividends now. As you know, we'll continue to follow that practice going forward so we don't substantially over deliver our results that set ourselves up for the future.

Looking to the mortgage Exchange, revenue was up 10% over Q3 and 55% over Q4 of last year. The number of lenders participating on the mortgage Exchange increased over 15% since last quarter and over 30 lenders increased their marketing spend with us at least 20%.

In an environment where there was, in fact, fewer consumers in the marketplace as there are in almost every fourth quarter, the quality of customers coming into our mortgage Exchange and the demand from our lenders for those consumers fueled a nearly 20% increase in the average revenue generated per lead. We think that bodes well for a rising interest rate environment.

In our non-mortgage business we did, in fact, feel the effects of seasonality with the revenue decline from Q3. We're managing these businesses to maximize VMM or variable marketing margin, and if the demand abates for those leads, we're not going to spend negative return advertising to generate volume.

In marketing, we are still seeing excellent results in key channels. Display advertising continues to grow consumer volume and margin with another 50% increase in consumer volume and once again, doubling VMM over Q3. And the search channel also grew substantially, increasing consumer volume over 20% from Q3 and maintaining very strong margins. It's clear to me that this marketing success goes hand-in-hand with the quality and higher lender demand that I mentioned before.

On the product front, we've had some important recent developments. As you've seen in our recent announcement, Nikul Patel was promoted to Chief Product Officer. He's doing a great job accelerating our product and tech throughput and making great things happen. I'm particularly pleased that we've released a new Reverse Mortgage product and launched our rate table product on schedule. It's getting great reception in the market and we're really pleased to have it out there.

Regarding the future, as you all know, we're still operating in a very low interest rate environment and what happens when the mortgage market shrinks is still the subject of speculation. I'm still cautiously optimistic that our unit economics will improve as rates rise and I'm also optimistic that our marketing team will be able to produce the volume and maintain margins. All that said, we really can't prove that until we actually operate in the environment.

Financially for 2013, we're increasingly comfortable with the picture unfolding this year, and certainly have a lot of specificity around a very solid first quarter, as you'd expect, sitting here in mid-March. As we outlined in the press release, we expect 2013 revenue to be in the 15% to 20% over 2012, and variable marketing margin to be in the range of 45% to 48% of revenue. For now we're holding our adjusted EBITDA guidance to the $15 million to $17 million range, but we'll be comfortable taking that up as the year unfolds, if present trends continue and if we choose not to reinvest that good news back in the business as we've talked about in the past.

For Q1, we're expecting revenue to be 12% to 15% higher than Q1 of last year and expect adjusted EBITDA to be in the $4 million to $4.5 million range. There are 2 reasons driving this very solid performance.

First, the business is performing well, continuing the trends from Q4. And for that, we're very pleased. At the same time, we had originally planned our launch of our TV campaign in late Q1 and now it's looking like a Q2 event. So while we're certainly doing better than we would've expected in that quarter, we're also seeing some additional investment in marketing that will offset Q2.

So in closing, I'm pleased with Q4 and our start to 2013. In Q4, we've pushed through seasonal headwinds and performed well. In 2013, we're hoping to continue our progress and advance our business even more. While the specter of a changing mortgage market is still out there, we're hopeful that the experience we've gained managing daily, weekly and monthly changes will enable us to navigate whatever the market brings in the months and years ahead.

With that, let's open it up to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Hamed Khorsand from BWS Financial.

Hamed Khorsand - BWS Financial Inc.

Just want to touch on 2 things this morning. First off, on your loan exchange, what you just said -- the rate table, have you seen any incremental improvement as far as revenue goes in Q1? I mean, what kind of incremental benefit have you seen from that so far?

Douglas R. Lebda

Sure. It's still early. We just launched it a couple of months ago, so it's definitely early in terms of revenue and we're not going to break that out separately. What I can say is, we've got over 20 lenders already on the platform, they're very pleased with the quality and we've begun to syndicate that out to partners. So our plan there is to syndicate that to other websites. It's a resident on LendingTree.com but clearly, a pay-per-click platform won't monetize like a pay-per-lead platform, so you see it in areas where the pay-per-lead model isn't going to monetize as well, but it's going to primarily be syndication. So we're rolling it out as we speak, lenders are happy, the syndication partners are happy. We think it will out-monetize our competitors, which means that we should be able to steal some nice share there.

Hamed Khorsand - BWS Financial Inc.

Okay. And the second thing is, you touched on it a little bit towards the end of your comments, but just to get a little bit more granular on this. Your full year guidance for adjusted EBITDA is $15 million to $17 million, in Q1, you said $4 million to $4.5 million. So if I just looked at that from a run rate perspective, I'm at $16 million. And I understand in Q2, you're increasing expenses on the -- your marketing side, but Q2 is seasonally up anyways from activity in the mortgage business. So wouldn't there have to be, I mean, it just sounds like you guys are being a little bit conservative on the adjusted EBITDA right now.

Douglas R. Lebda

Yes, I think -- I honestly, I think that's safe to say. I mean, I think we're generally conservative folks, I think the -- from my perspective, Q1 was very, very solid or is running very, very solid. Q4 was extremely solid; Q2, because of the ad spend, will be down on adjusted EBITDA basis. And the second half of the year right now the MBA is projecting extreme downfall in mortgage, in mortgage originations and I think we just want to be cautious. So I think I want to just -- before we adjust guidance upward, I want to see a couple of more months. And then, the other thing I'd say is, our practice here is very much, we want to deliver solid earnings, solid growth on the top line and the bottom line, but we can hit numbers within some range of specificity. We're never surprised by the results we post, given the way the business runs, and we reinvest back in either testing or product development, et cetera, if we're going to be substantially over. So I want to give ourselves room to pull the trigger on some things, if opportunities present themselves.

Hamed Khorsand - BWS Financial Inc.

Okay. And is the non-mortgage business, are you expecting that to be EBITDA-accretive this year? Or is that going to be a drain for you guys?

Douglas R. Lebda

The plan is that those businesses -- that each of those businesses make us money this year. That obviously, did not happen last year, but one of the 3 was solid and they're on the right trajectory, I just reviewed those yesterday in great depth and revenue end is moving up and to the right for both Home Services and EDU, they're both still losing money, but they're losing less money every month. And they're on -- they're doing well. So I'm cautiously optimistic and pleased with the direction that those are running in. I really want to give hats off to Tamara Kotronis who came in, in November and has got EDU on the right path very quickly and also, the team there. I'm hearing very good things about -- from our clients. I've dug in personally with that and I'm hearing very good things from them about lead quality improvements and pacing of leads improving and I'm really pleased with the new tech platform and think that's on the right track.

Operator

[Operator Instructions] And we also have a question from the line of Josh Goldberg from G2 Investment Partners.

Josh Goldberg - G2 Investment Partners Management LLC

This is Joe. Just a couple of questions. First is, in terms of your guidance for the Q1 period, how much growth is coming from, do you think, the mortgage versus the non-mortgage side?

Douglas R. Lebda

I'm going to -- on the mortgage side, we're getting significant growth. Year-over-year, non-mortgage is probably -- I'm going to get a data point here, but I think it's flattish, I'll get a real -- it's actually down year-over-year. So it's all coming -- and that's -- we had some -- last year was lumpy and bumpy in the non-mortgage stuff, particularly. EDU really got us in the mid- to late part of the year. So EDU, at the first quarter was -- had a lot of revenue and not much earnings. So it's all coming from mortgage. And I'm particularly pleased with the fact that rates are actually up; and originations, I'm waiting on some final numbers, but the market is flat to down-ish in terms of total originations. And I'm hearing really good things from the lenders. We're hearing -- we're seeing people up their buys with us and I'm -- so I'm cautiously optimistic that we're seeing some of the effects of the way we always said the business model was going to operate, that as rates tick up and originations fall that lenders are going to come to us with increased orders. And I think we might be seeing that. I want to -- I'm still holding my breath and still want to prove that out a little bit, but I'm hearing really good things.

Josh Goldberg - G2 Investment Partners Management LLC

Okay. Great. And then, just in terms of that, the mortgage Exchange revenue being strong here in Q1. Is there any concern that as you go into June and September, as the purchase market ticks up, that your traffic will grow organically? Or are you nervous that you're going to have to acquire traffic during that peak selling season?

Douglas R. Lebda

We're definitely seeing very solid organic growth. We've put a lot of focus on that last year and it's paying off. Over 20% of our traffic is actually organic and I'm pleased with that. That said, I don't mind paid advertising, I think a lot of sites talk about "organic" and really, what that means is they're good at getting SEO traffic and then, therefore, you're at the mercy of Google's algorithm. As we see revenue per lead increase as rates tighten up, and the market shrinks, we think we're going to be able to spend aggressively into that. And as I've said in my prepared remarks, I've been pleased week-by-week, day-by-day. You guys see something kind of smooth and steady but under the surface of the water, there's a lot of paddling going on and it's really neat to watch our marketing team and our sales team react to the daily ups and downs of supply and demand and adjust, and that VMM line is up into the right. But there's a lot of technology and a lot of effort and a lot of smarts that go to make that happen, and I'm confident that it's going to continue.

Josh Goldberg - G2 Investment Partners Management LLC

Okay, great. Last question for me is, your VMM for the first quarter, at $13 million to $14 million would be the highest you've ever had. However, your margin is going to be a little bit below the 50% level that you've been reaching in the last 2 quarters. Can you just touch upon a little bit what you're doing that's kind of lowering the margin but increasing the total dollars? And is there some upside to that, over time, back to the 50% level?

Douglas R. Lebda

There potentially could be and I just want to give us a little bit of room, too. I wouldn't focus as much on margin percentage, we really think about dollar -- VMM dollars. And as we spend adds and spend into rising expected values, I think the percentage margin could go down. But I have our team fully geared to dollar -- dollar margin and so at any given time, we're doing things that are lower margin. Particularly, on the syndication and rev share side, so we see a great opportunity to go out and get share from our competitors and we'll do that at lower percentage margin, but at significantly less risk because it's a rev share and we think we can go, put a hurting on some of our competitors and go get some of those deals at lower margins than they would typically pay, but it'll still be very dollar-accretive and no risk to us.

Josh Goldberg - G2 Investment Partners Management LLC

Would you be able to give us a sense of how much revenue you think could just come strictly from the rate table over the next couple of quarters?

Douglas R. Lebda

Not yet because it's competitive and quite frankly, as I look at the list of our call participants, I see lots of our competitors on the line and I'd rather keep that a little more close to the vest so we don't telegraph what we're doing. It's going to be small but material and growing very rapidly, but I'd rather keep that one inside right now.

Josh Goldberg - G2 Investment Partners Management LLC

Okay. Last one for me, Doug, is sitting on the cash, you have -- I know you use a working capital number but you talked a little bit of up to $10 million are coming due in June with the acquisition close subject to certain conditions. Just can you talk a little bit about what conditions that would cause you not to get that cash?

Douglas R. Lebda

Yes, I think this is actually public information, I'm pretty sure we had to file all the reports with this. But essentially, it's -- they're covenants but they're essentially, that we: a, don't sell the business to a competitor of the mortgage company; and b, that we're still in business, there are things like minimum threshold of lenders and minimum thresholds of volume. But it's effectively, if we're still in the lead -- in the mortgage lead business and the things not owned by one of Discover's competitors we're fine. When we signed up for that, I was only willing to do it if we were, essentially, 100% confident that we could hit all the covenants and that they were fully in our control and they were easy hurdles and just the accounting of it is different.

Operator

[Operator Instructions]

Douglas R. Lebda

With that, I think, operator, we can -- I'm happy to wrap it up.

Operator

Certainly. Ladies and gentlemen, thank you for your participation in today's conference.

Douglas R. Lebda

Well, if I can give some closing comments?

Operator

Certainly.

Douglas R. Lebda

I just want to thank you, all, for your attention. Thank you for your time. It's an exciting time for our company. I feel pleased with the people we're working with, very pleased with the performance we put on the board. I do apologize for the lateness of the call in the earnings season. We -- as you all know, we have a new audit firm and a new CFO and a new Chief Accounting Officer. We wanted to make sure that things were buttoned up and ready to go. We look forward to talking to you all in about another 6 weeks, about Q1. And we're off to the races this year. I'm thrilled with our progress, thrilled with everything that's happening, completely thrilled with our team and we're excited about, here -- about the future. So thank you, all, very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a good day.

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