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Spark Networks, Inc. (NYSEMKT:LOV)

Q4 2013 Earnings Conference Call

March 5, 2014 16:30 ET

Executives

Greg Liberman - Chairman, President, Chief Executive Officer

Brett Zane - Chief Financial Officer

Analysts

Michael Canaccord - Canaccord

George Askew - Stifel

Ralph Schackart - William Blair

Operator

Greetings, and welcome to the Spark Networks Fourth Quarter and Fiscal Year 2013 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host, Mr. Brett Zane, Chief Financial Officer for Spark Networks. Thank you, Mr. Zane, you may begin.

Brett Zane

Thank you for joining us today. I'm Brett Zane, Chief Financial Officer for Spark Networks. On today's call with me is Greg Liberman, our Chairman and Chief Executive Officer. Before we begin, there are a few items I need to cover with you. Today, we issued a press release announcing our fourth quarter financial results. It is available on our Company's website at www.spark.net in both the Investor Relations and Media Center sections.

In the press release and in our prepared remarks on this call, we refer to adjusted EBITDA, which we define as earnings before interest, taxes, depreciation, amortization, stock-based compensation, asset impairments, non-cash currency translation adjustments for intercompany loans and the income recognized from non-cash assets received in connection with a legal judgment.

Although adjusted EBITDA is a non-GAAP financial measure, we believe it may be useful to investors when evaluating the company's current financial performance. However, investors should not consider adjusted EBITDA as an alternative to net income, cash flow from operations or any other measure for determining the Company's operating performance calculated in accordance with GAAP.

In addition, because adjusted EBITDA is not calculated in accordance with GAAP, it may not be comparable to similarly titled measures employed by other companies. A reconciliation of EBITDA and adjusted EBITDA to net income can be found in the consolidated statements of operations included in our earnings release.

I would like to remind everyone listening today that any comments made on this call may contain forward-looking information within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Such information is subject to the risks and uncertainties described in the Company's news releases and securities filings. The information on this call shall not constitute an offer to sell or the solicitation of an offer to buy our securities. This call is being recorded.

At this time, I will turn the call over to Greg.

Greg Liberman

Thanks, Brett. Good afternoon everyone, and thank you for joining us. We look forward to both sharing our fourth quarter and full year 2013 results with you and taking a brief glimpse forward into the future.

2013 was another solid year as we delivered on the financial front, while continuing to execute against our strategic plan. Revenue grew for the third consecutive year totaling $69.4 million up another 12%. And that growth continued to be driven by the expansion of our paying subscriber base with average paying subscribers increasing another 15% to nearly 300,000 for 2013.

In addition, to our strong revenue growth despite increasing our direct marketing investment by 14%, we also demonstrated a meaningful 8% improvement in contribution to end the year at $17.3 million, reversing the 20% plus annual declines in contribution during the previous two years. Powering our performance once again were our dual engines, Christian Networks and Jewish Networks.

Christian Networks continue to grow both on an absolute basis and as a percentage of total revenue increasing its share to nearly 60% of our revenue base nearly doubled where it was 2 years ago. At the same time, our category leading Jewish Networks business maintained its leadership position with revenue inline with the prior year while posting its customary nearly 90% contribution margin.

While we are pleased with that performance in a vacuum, it is even more remarkable given where we started. Less than four years ago, Spark was largely viewed as a one-trick pony. But we made the decision to increase our focus on the Christian business in 2010, ChristianMingle had just over 25,000 average paying subscribers was a leading Christian online dating site though it had just about 1/3rd the subscribers of our Jewish Networks business. That same year, we created our first ChristianMingle Advisory Board; we architected the ChristianMingle website, launched Believe.com and added the first church to a church directory that now contains more than 115,000 churches in the U.S. alone.

Our audacious goal quite simply was to build another category leading brand. Now, as our largest business, ChristianMingle has developed into a true powerhouse. Over the past four years, ChristianMingle subscriber base has increased more than seven-fold. Its brand awareness has grown to nearly 80% in the general population and well north of 80% in its chartered market. ChristianMingle has become the undisputed leader in Christian dating and also regardless of how you choose to measure it, one of the largest Christian sites of any kind. And that scale not only continues to reinforce the ChristianMingle brand, but importantly sets the foundation for the rest of the Gospel Media Group family of content sites.

Throughout 2013, several key things dominated our business. First, we continued our focus on building ChristianMingle's brand and subscriber base to achieve critical mass and give us a long-term competitive advantage. Our long-term focus was evidenced by our successful effort to drive subscribers into higher life-time value multi-month subscription plans.

Second, as we have discussed since ChristianMingle's rebirth, once we felt we had achieved critical mass, we plan to begin slowing the growth rate of our direct marketing spend which you saw in the second half of 2013. As a result, exiting 2013, we delivered two consecutive quarters of improved contribution for Christian Networks, with contribution increasing 35% year-over-year for each of the third and fourth quarters of 2013 highlighting the leverage inherent in our model.

And finally, as we grew our branded base, we continued to invest in product development most notably mobile as well as our faith based media properties. To those end, mobile logins grew on average by 90% and 60% year-over-year for JDate and ChristianMingle respectively. And we exited 2013 with a best ad sales quarter in our Company's history.

The themes of critical mass operating leverage and product investments will prevail in 2014, but the forum of the head, but briefly looking in the rear view mirror at the fourth quarter, which in many ways set the foundation for what has to come. Q4 revenue was up 6% year-over-year driven by a 5% increase in subscriber count and a slight increase in APRU. And contribution grew even more up 16% benefiting from both our near 90% Jewish Networks contribution margin as well as another quarter in which Christian Network's revenue growth exceeded that of direct marketing spend with much of that revenue increase driven by growth in our win back and renewal subscriber base.

Looking at our two key businesses, I will start with the quick review of our Jewish Networks business, which performed as we have come to expect. Revenue in subscriber counts were inline with the prior period and contribution remain rock solid and is near 90% level. As the leader in this category and really the crown jewel of the niche online dating industry, Jewish Networks contribution margin provides a terrific goal for us to shot forward with our Christian Networks business.

Speaking of the Christian Networks business, once again, we delivered solid results. Q4 revenue increased nearly 15% driven primarily by a 14% increase in average paying subscribers. Christian Networks subscriber growth is particularly notable given the meaningful shift in our subscriber base towards multi-month, 3 and 6 months plan.

As we have mentioned before, first cycle renewal rates among those plans are the lowest we see and we had a large pool of first cycle expirations in the third and fourth quarters of 2013. And the more subscription to lapse in any period, the more first time subscribers and win backs we need to add to replace them just to maintain our subscriber base.

While in the near-term, the increase in early cycle multi-month plans will continue to pressure our subscriber count that effect will become less significant as our renewal for season and is comprised of a greater proportion of later cycle renewals.

To that end, we are especially pleased to report that despite the increase in early cycle multi-month plans I just described, our ChristianMingle renewal rates continue to progressively improve. In fact, as of the fourth quarter of 2013, ChristianMingle renewal rates were nearly 20% better than they were in the first quarter of 2012 less than two years ago.

Looking ahead, our focus in 2014 will be to continue to widen the most around our two category leading brands JDate and ChristianMingle further fortifying the foundation for long-term sustainable growth and cash flow.

One very visible recent example of that strategy is our JDate get chosen rebrand, the campaign represents the first full scale rebrand in JDate's history launched the date before Valentine's Day and was the feature story in the New York Times among many other media outlets.

On the ChristianMingle front, now that we have achieved critical mass as promised, we will turn our focus to demonstrating the inherent operating leverage within our business. As I touched upon earlier, with the solid ecosystem of subscribers and brand awareness at an all time high, we expect to reduce our direct marketing spend in several areas where we are seeing a lower return on marginal volume basket or channels with partners who operate in an inappropriate manner.

Our affiliate channel and most specifically our email affiliate channel, which has historically been a significant source of registration and subscriber acquisition for us, has become especially challenging. Many marketers in the affiliate channel has gotten more aggressive and we believe their practices are increasingly reflecting negatively on our variance.

Several affiliates have violated our terms and conditions and as a result of their actions we've spent much of 2013 dealing with the class action lawsuit and incurring out of pocket legal expense. As a result, we plan to aggressively lean ourselves from the affiliated channel and only work with the highest quality partners. In the short-term that decision will negatively impact growth. But over time, it is right decision for the Company and most specifically our JDate and ChristianMingle brands.

To give you a sense of scale, the affiliate channel constituted more than 22% of ChristianMingle's registrations in 2012, and about 13% in 2013, with email affiliates comprising the majority in each period. We currently anticipate affiliate traffic will comprise a single-digit percentage of our registrations on ChristianMingle in 2014.

Separately as I touched upon on our last call over the past quarter and a half we've been working very closely with the marketing attribution partner to identify the true value of each of our marketing investments both online and off. As a result of that work, we believe we've identified several partners and channels that are less efficient than more traditional, direct accretion methodologies would suggest and others which may be more efficient.

As we fine tune our investment strategy, we expect to both reduce and reallocate our Christian Networks marketing spend with the result being 2014 marketing spend in the $40 million to $44 million range is the majority of that reduction in spend coming from the second through fourth quarter of the year. It's worth noting that while our Christian Networks marketing investments will most likely drop between 10% and 20% year-over-year, we do not anticipate seeing more than a mid-single digit impact upon revenue in 2014. And we've consistently reiterated, phase one of our ChristianMingle growth plan was to build critical mass followed by improving our unit economics.

In 2014, unit economics will take center stage and we intent to demonstrate the significant leverage inherent in our business. Among other things, the power of our growing win back and renewal paying subscriber bases for whom we do not spend incremental marketing dollars continue to play meaningful roles. Additionally, we believe that our ARPU will improve in 2014 as our plan mix stabilizes three and six months subscribers renew at higher prices, and we optimize pricing leveraging the UPS-based dynamic pricing engine we described last quarter. The net effect of those efforts should produce meaningful improvement in Christian Networks contribution.

Additionally, as you may be aware a target credit and debit card data breach at the end of last year affected up to 70 million people. The short-term collateral impact on our business has been arrived in sales renewal transactions related to reported lost or stolen credit and more noticeably debit cards. While the situation is a temporal one, it may result in additional headwinds for subscriber and revenue growth on our subscription based properties in the very near term.

So after the transition towards profitability in 2014, what are the implications for 2015 and beyond? First of all, it is important to stress that we believe there is plenty of growth opportunity left in the Christian Networks business. Our plan shift and strategy will lead to a more natural stair steps subscriber growth pattern than a linear growth rate we experienced in the past due to our progressively increasing marketing investment. As we exit 2014, we believe our more profitable paying subscriber base will consist of a greater proportion of seasoned renewals. The more seasoned renewal pools should on a relative basis reduced the number of lapsed subscription and enable us to grow our subscriber base without having to add as many first time subscribers to our mix.

Additionally, we anticipate making further gains on the ARPU front through continued front-end price optimization, and the higher ARPU we naturally experience with the growing renewal pool. We expect the combination of those dynamics to reaccelerate both subscriber and subscription revenue growth. However, that growth will not be driven by incremental marketing dollars alone which should also yield meaningful incremental contribution dollars and cash flow.

In addition to subscription revenue, we remain focused on the third leg of our stool namely our media business. Currently, our media business is focused on the Christian space and is known as the Gospel Media Group. [indiscernible] enduring and not like stage specific, we have a unique opportunity to connect with and serve our members throughout all stages of their life. That dynamic allows us to connect with, stay connected with and market to our members in ways that other dating sites cannot. Although our media businesses are not currently meaningful revenue drivers, we are starting to build traction and will continue to be a significant area of focus in 2014.

During Q4, our advertising revenue hit an all-time high of nearly $800,000 primarily driven by Christian Networks, which posted a 60% year-over-year increase in ad sales. That increase in ad revenue was driven by both an increase in direct sales revenue as well as improved monetization of our running inventory through programmatic channels.

Finally, another area we remain excited about and will continue to invest in is product, specifically mobile. In fact, yesterday our mobile and media efforts intercepted as we launched the first native app for one of our media businesses, the Faith.com app on iOS. We will continue to both create and upgrade mobile web and native apps for our media and dating businesses throughout the year.

Before I turn the call back over to Brett, I would like to touch upon our capital markets related efforts from 2013. During the year, we executed our Investor Relations plan to rise this ability and improve liquidity and completed the two largest stock offerings in the Company's history in the process. In doing so, we diversified our institutional shareholder base meaningfully improved our liquidity and welcomed two new analysts to our coverage universe.

With that, I will turn the call back over to Brett.

Brett Zane

Thanks Greg.

Revenue was $17.2 million up 6% year-over-year driven by a higher subscription revenue from Christian Networks. Christian Networks revenue increased 15%, driven by a 14% increase in average paying subscribers and a 60% increase in advertising revenue. Although ARPU decreased 2% year-over-year in the fourth quarter, we sequentially grew ARPU for the first time since Q1 2013. The ARPU growth reflects a greater portion of subscribers renewing at higher ARPU or accolades [ph].

Jewish Networks revenue declined 3% year-over-year reflecting a slightly lower paying subscriber base. Total contribution was $4.3 million, up 16% year-over-year driven by a combination of Christian Networks revenue growth and a slowdown in the growth rate of our direct marketing spend. Looking specifically at Christian Networks contribution improved 35% year-over-year as an increasing proportion of our subscriber base is now comprised of win back and renewal subscribers, which we generally believe are not driven by our direct-marketing spend.

As our Christian Networks foundation has been strengthened, we have been able to pull back on the growth rate of our direct-marketing spend demonstrating the inherent leverage in our business model.

Cost and expenses totaled $20.7 million up 10% year-over-year, driving this increase was growth in direct-marketing spend, sales and marketing and G&A.

Looking at the specific line items, direct-marketing spend grew by $333,000 for the quarter reflecting growth in our Christian Networks offline marketing spend. Sales and marketing increased by $614,000 due to the addition of personnel related to our mobile team and our media businesses and consulting expenses primarily related to some media attribution modeling, graphic design work and the development and creative campaigns for our JDate rebrand.

We expect sales and marketing expense to be around these levels in 2014. G&A increased by $553,000 primarily due to higher legal fees of $327,000 higher SOX compliance and tax advisory fees of $135,000, and additional corporate personnel totaling $96,000. We also expect G&A to be around these levels in 2014.

Adjusted EBITDA was a loss of $2.8 million compared to a loss of $2 million in 2012. Net loss totaled $3.5 million, or a loss of $0.15 per share compared to a loss of $10.5 million or a loss of $0.51 per share in the prior year period.

For the quarter, weighted average shares outstanding totaled $23.9 million compared to $20.8 million in Q4 2012. Finally, since announcing our $5 million share repurchase plan, we have purchased through yesterday approximately 185,000 shares for a total of $1.1 million.

Now back to Greg for some closing remarks.

Greg Liberman

Thanks Brett. To recap, 2014 will be another important year for Spark Networks, and the team is doing a tremendous amount of work setting a stage for sustainable long-term growth and cash flow generation. As always, we look forward to keeping you appraised of our progress. Thank you all for your time today. That concludes our prepared remarks. Operator, please open up the call for questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Michael Graham from Canaccord. Please proceed with your question.

Michael Canaccord - Canaccord

Hey thanks. Hi guys. Just wonder if you could talk a little bit about the – what to expect from Christian Networks in terms of subscriber growth, we had Q4 was down sequentially you're talking about may be some pressure there going forward. And Greg, you talked about 2015 looking better, but can you just sort of talk about like are we still in growth mode here, and what to expect as we look out few years? Thanks.

Greg Liberman

Thanks Mike. So yes, to reiterate somewhat I said earlier. We still think that there is meaningful opportunity for growth but we're pivoting a little bit here and focusing on profitability as we've talked about through out our IR exercise. Our goal number one was to build critical mass scale and brand and our second focus is going to be on unit economic front. And so that's really where most of our focus is going to be this year and as we pull back on the marketing spend I think you will see some pressure on subscriber count and obviously, we haven't given guidance on actual subscriber numbers. But you'll see some pressure from that as well as frankly from the affiliate channel being taken out of our mix to a large degree as well as the near-term the target issue.

Michael Canaccord - Canaccord

That makes sense I guess, would you be able to measure that in someway in terms of an improvement and contribution like should we expect to see contribution margin meaningfully in 2014?

Greg Liberman

Yes. I think you will definitely will – definitely. We believe you will see an improvement a meaningful improvement in contribution margin this year.

Michael Graham - Canaccord

Okay. All right. Thanks guys.

Greg Liberman

Sure.

Brett Zane

Thanks Mike.

Operator

Our next question comes from the line of George Askew from Stifel. Please proceed with your question.

George Askew - Stifel

Yes, thank you. Just kind of following up on that question, you were referring to average paying subs I believe, from an ARPU standpoint, you do indicated it's going to improve. Will the two trends offset each other better ARPU, weaker subs to kind of support revenue and revenue growth?

Brett Zane

Hey, George, it's Brett. I think based upon the comments that we made, we're expecting some mid single-digit downward pressure on revenue. So they won't offset each other one-for-one, we will continue to see improvement. We believe in our ARPU, it was demonstrated in Q4 where our ARPU for Christian Networks is actually picked up from 1607 in Q3 to 1614 in Q4. So we think we're going to – we expect that trend to continue going up, it will be offset, however, by a little bit of a decline in our paying subscriber base and that's – this was cleansing out at the end of the day, some subscribers that we had in our ecosystem that were not necessarily that profitable to us. And so what we're doing is pivoting here where we have a core profitable subscriber base more so than what we had last year, and once we've level set that foundation, we think we're going to be in a position then further grow the business in 2015 and beyond.

One of the dynamics that Greg touched on is, as we get whatever our core subscriber base is, that pool will be comprised of more folks that are season renewers. And when you have more season renewers, they renew at a higher renewal rate, I think we commented that was about 20% improvement since Q1 2012 to end of the 2013 year in terms of a renewal rate. So as those renewal rates go up, our paying subscriber base is comprised of folks that renew at higher rates that translates into less people that are leaving out of our ecosystem and doesn't require us to get as many fresh folks into the ecosystem.

So things stabilize, we believe by the time we get to the end of 2014 and that positions us for paying subscriber growth going into 2015 and 2016.

George Askew - Stifel

Got it. And you kind of touched on this but just thinking sequentially throughout the year, you mentioned marketing spend benefits, reduced marketing spend for ChristianMingle and Christian Network would kind of be a 2Q to 4Q timeframe as you cleanse the affiliate channel email marketing, how quickly will that impact the subs and the things stabilize by the second half of the year and third and fourth quarters specifically?

Brett Zane

I don't know if I have got. I can't say right now the stabilization is which particular quarter, we think by the end of the year though we're in a place where it's pretty stable that I can say, but period-to-period, it's hard to comment on that.

Greg Liberman

And also to keep in mind the other point that I want to make sure that we hammer home and said it's not just a reduction in marketing spend, it's a reduction in reallocation to channels that we believe the reflection. And even within channels with all the attribution work we've done, we think we see opportunities to become more efficient on the marketing front and so that will help to counter balance that too.

George Askew - Stifel

Last one for me. The new branding campaign for JDate, you jumped up the marketing spend there a bit in the fourth quarter also low base obviously and it sounds like you've added [indiscernible] in the first quarter, what should we see there, are we going to see a faster pace of marketing spend through the year for JDate, and how does that sort of show up in their results and then profits? Thanks.

Greg Liberman

Yes, I actually don't think you will, I think most of that bump, if not all that in Q4 was international marketing spend, so you're not going to see a meaningful increase where we spend money on the campaign for sure, but it's not going to show up materially in the numbers.

Brett Zane

Yes, I would expect that 2014, the marketing spend is going to be flat with 2013 George.

George Askew - Stifel

Got it. Okay. I'll step aside. Thank you.

Greg Liberman

Thanks George.

Brett Zane

Thank you.

Operator

Our next question comes from the line of Ralph Schackart from William Blair. Please proceed with your questions.

Ralph Schackart - William Blair

Hey, good afternoon. Two questions, first just clarifying in the prepared remarks, did you say that you'd be spending $40 million to $44 million -- $40 million - $44 million in the marketing spend this year and then mid-digit single revenue offset, was that for the entire consolidated company on the revenue offset or was that just for Christian?

Greg Liberman

That was Christian.

Ralph Schackart - William Blair

Okay. Thanks. And then just now that your sort of the bulk of the way through your seasonally strong quarter, can you give us any color in terms of what you're seeing with sort of the shifts in the marketing spend and how the sub-additions have been trending in Q1?

Brett Zane

I think typically Q1 is the stronger period for us sequentially, the headwinds we experience between having to cut back on some of our affiliate relationships with target issue actually worked against us. So we're not going to experience that same road, it will be temporal; it won't be a huge contraction. But we're not going to grow sequentially the way that we've experienced in the past because of those dynamics.

Ralph Schackart - William Blair

And then just in terms of kind of the puts and takes from a seasonally strong quarter, how should we think about and particular Christian subs in Q1 vis-à-vis where you exited in Q4?

Brett Zane

My expectation is that will be down relative to Q4 on our subs for Christian.

Ralph Schackart - William Blair

Okay. And then just one more, if I could. On the credit card renewals obviously impacted lot of the companies and it's impacting the behavior here. Are you through the sort of the bulk of that or is that something that will trend and more specifically, I was talking about the credit card breach?

Greg Liberman

Yes. So two things to note. So yes, it's a credit card issue also a debit card issue and it's a more significant issue on the debit side, but we think that sort of late Q4, I mean the issue happened in late Q4, in the Q1 it's a very temporal issue, and it really hits the first time we try to renew someone's card. When someone signs up for the first time, we always get a good card before they subscribe. So it's a very, very temporal issue that its Q4, Q1 and I expect that we are through that after that.

Ralph Schackart - William Blair

Okay. Thank you.

Operator

Ladies and gentlemen, we're run out of time for questions. This does conclude our call. Thank you for your participation. You may disconnect your lines at this time. And have a wonderful day.

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