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Spark Networks, Inc. (NYSEMKT:LOV)

Q2 2014 Earnings Conference Call

August 11, 2014 04:30 pm ET

Executives

Mike McConnell – Chairman

Greg Liberman – President & Chief Executive Officer

Brett Zane – Chief Financial Officer

Analysts

Michael Graham – Canaccord Genuity

[Ryan Dominick] – William Blair

George Askew – Stifel Nicolaus

Operator

Greetings and welcome to the Spark Networks’ Q2 2014 Earnings Call. (Operator instructions.) As a reminder this conference is being recorded. I would now like to turn the conference over to Mr. Brett Zane, CFO 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 are Greg Liberman, our President and Chief Executive Officer, and Mike McConnell, the Chairman of our Board of Directors.

Before we begin there are a few items I need to cover with you. Today we issued a press release announcing our Q2 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 noncash 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 with similarly entitled 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’d 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 Provisions 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 the 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, and good afternoon everyone. We appreciate your participation on our Q2 conference call and your continued support.

During Q2 we maintained our focus on leveraging the Christian Mingle brand and installed base as well as realizing the operating leverage inherent in our business model. As a result, despite a 10% year-over-year decline in revenue company-wide contribution improved 109% to hit its highest mark in four years.

As contribution grew most of that improvement hit our bottom line, with adjusted EBITDA improving 84% to nearly breakeven. And if not for the one-time costs associated with our recently concluded proxy contest adjusted EBITDA would have been positive for the first time since 2011 at nearly $1 million.

Those results were once again driven by our Christian network segment, which flipped in contribution from negative $2.6 million in Q2 2013 to positive $2.1 million in Q2 this year, setting a record for the segment in that process. That improvement was the result of a combination of a reduction and reallocation of marketing spend, corresponding increases in marketing efficiency, growth in our win back and renewal subscriber bases, and a 41% increase in Christian network’s advertising revenue.

Consistent with our focus on profitability, direct marketing spend decreased 45% compared to the prior-year period and is down approximately 30% year-to-date. Based upon our current plans we now expect our Christian Networks marketing spend for the full year to be 30% to 35% lower than it was in 2013.

As we have previously discussed, improving our Christian Networks’ unit economics is a key focus for this year and one of the tactics we are leveraging to do so is to strategically reduce and reallocate marketing spend for this segment. In addition, as a result of the affiliate-driven email deliverability problems we experienced for much of Q1 we have also more aggressively reduced our reliance on the email affiliate marketing channel, which has further driven down our overall marketing costs.

While we continue to believe that our shift away from the affiliate email channel and their overly-aggressive marketing practices is the right long-term decision for our brands it does have a near-term impact upon our subscriber base.

Another reason for our improved contribution during Q2 is visible in the subscriber composition table in today’s press release. As you can see, win back and renewal subscribers for whom we do not expend incremental acquisition marketing dollars now comprise the majority of our total Christian Networks subscriber base, growing from an aggregate of 45% of our average paying subscriber base in Q2 last year to nearly 55% of our paying subscriber base this year.

In addition, during Q2 we made progress on the pricing efforts we have discussed with you over the past couple of quarters. In February we leveraged our dynamic pricing engine to launch a 20-pronged price test on Christian Mingle which was aimed at a subset of members who had never before subscribed. In June we expanded our price tests to a broader portion of our member base. Going forward, we will expand our pricing work to an even broader group, including ex-subscribers.

While we are still in the relatively early stages of our pricing work initial results have been positive and over the long term we believe that our pricing optimization efforts combined with the normalization of our plan mix and increasing size of renewal base will drive improvement in our ARPU.

That dynamic however is not evident in our Q2 ARPU, which declined compared to the prior-year period. Brett will go into more detail on the factors at play here, but one of the big drivers of the overall ARPU decline was a meaningful increase in the percentage of our subscribers who bought six-month plans, which cost less on a per-month basis than do our one- and three-month plan. And many who purchase six-month plans initially do so via promotional pricing.

As we’ve discussed in the past and we saw again this quarter, renewal ARPU for six-month plans is higher than new subscription ARPU. This quarter it was 35% higher since those plans typically renew at a higher price point.

The last item I will touch on with regard to our Christian Networks business is our media and commerce opportunity. Our Gospel Media Group family of sites has become a powerful engine for marketers who want to reach the Christian community. To that end, company-wide advertising revenue grew 33% in Q2 to $833,000 driven by a 41% increase in Christian Networks’ advertising revenue.

While positive contribution for Christian Networks was certainly the biggest driver of our Q2 improvement and profitability we continued to see near 90% contribution margins in our Jewish Networks segment. Despite the lingering effects of the affiliate-driven email deliverability that also impacted JDate in the first part of the year and put pressure on revenue in Q2 as well, sequential contribution for the Jewish Networks business increased for the first time since late 2012.

Finally, before I turn the call back over to Brett I want to talk for a moment about mobile where we remain excited about the opportunity. Following the re-launch of our JDate mobile-optimized site in May, we saw an uptick in many of our mobile key performance indicators. And immediately following that re-launch our mobile development POD’s primary focus shifted to new native applications, several of which we plan to introduce before the end of the year. Those apps aim not only to increase engagement and monetization for our sites but also broaden our opportunity to acquire new members and subscribers via the Android and iOS app ecosystems.

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

Brett Zane

Thanks, Greg. Q2 revenue was $15.8 million, a decrease of 10% compared to the year-ago period and a 5% sequential decline. This decline can primarily be attributed to lower subscription revenue from our Christian and Jewish Networks segments.

Christian Networks revenue was down approximately 10% year-over-year reflecting an 8% decrease in average paying subscribers and a 5% decrease in ARPU. The lower average paying subscriber base is a result of the affiliate-driven email deliverability challenges experienced in Q1, an increase in sales renewal transactions as a result of credit and debit card turnover associated with a security breach at a major US-based retailer, and the reduction and reallocation of our direct marketing investments – the latter of which resulted in lower direct marketing spend during the quarter.

The lower ARPU reflects a 16% increase in the six-month average paying subscriber base as a percentage of total average paying subscribers in Q2 2014 when compared to the same period in the prior year. This shift is a combination of a higher number of new six-month average paying subscribers as a percentage of total new average paying subscribers, and a higher number of six-month renewing subscribers as a percentage of total renewing paying subscribers in Q2 compared to the same period in the prior year.

Additionally, the ARPU for six-month plans in Q2 2014 was 5% lower than the same period in the prior year, reflecting a higher number of new subscriber promotional campaigns to drive long-term purchases.

Jewish Networks revenue was $5.9 million, a decrease of 9% year-over-year. The decline in revenue was primarily driven by a 7% decrease in average paying subscribers over the prior-year period. The decrease can be primarily attributed to the affiliate-driven email deliverability issues experienced in Q1, the payment card renewal issues previously discussed, and softness in our international operations.

Although we resolved the email deliverability issue in early March and the payment card renewal issue has continued to wane, we entered Q2 with an average paying subscriber base 6% lower than in the previous year.

Contribution in Q2 was $7.8 million, an increase of 109% compared to the year-ago period and a 50% increase compared to the prior quarter. Christian Networks was the primary factor for the gains in total company contribution as its contribution for Q2 was positive for the first time in 15 quarters.

The improvement in contribution was driven by a combination of improved returns on our marketing investments, growth in our win back and renewal average paying subscriber bases as a percentage of the total average paying subscriber base, and growth in Christian Networks advertising revenue.

Our planned reduction and reallocation of direct marketing spend in the Christian Networks segment reduced the number of first-time paying subscribers entering our ecosystem, which put downward pressure on our average paying subscriber count. However, the return on investment has improved meaningfully since Q4 2013. Additionally, our renewal rates continue to improve as Q2 renewal rates are approximately 26% higher than in Q1 2012.

Jewish Networks contribution was $5.2 million, an 8% decrease year-over-year and a 4% increase compared to the prior quarter. The lower year-over-year contribution is largely a result of the decline in Jewish Networks revenue. Sequentially, contribution improved as we resolved the Q1 email deliverability issue, the payment card renewal problem became less pronounced, and our direct marketing investment declined.

As we mentioned on our Q1 earnings call we made some strategic brand investments in JDate, both domestically and internationally, which temporarily increased our direct marketing expense and depressed contribution and contribution margin in Q1.

Total costs and expenses were $16.8 million, a decrease of 19% compared to the year-ago period and a decrease of 13% compared to the prior quarter. The year-over-year decline was driven by a 45% or $5.8 million decrease in Christian Networks direct marketing expense offset by a $1.8 million increase in G&A costs. The sequential decline was driven by a decrease in Christian and Jewish Networks direct marketing expenses of $3 million and $422,000 respectively offset by a $1.1 million increase in G&A costs.

General and administrative expenses were $4.1 million, up 79% year-over-year and 38% sequentially. The increase in general and administrative expenses can primarily be attributed to the increase in fees and expenses associated with our proxy contests, which totaled approximately $1.3 million in Q2.

Adjusted EBITDA was a loss of $363,000, an 84% improvement compared to a loss of $2.3 million in Q2 2013 and an 83% improvement compared to last quarter’s $2.1 million loss. As Greg mentioned earlier, had it not been for the one-time proxy-related fees and expenses our adjusted EBITDA would have been roughly $1 million for the quarter.

Net loss totaled $1.1 million or a loss of $0.05 per share compared to a net loss of $3.3 million or $0.15 per share in Q2 2013, and a net loss of $2.9 million or $0.12 per share in the prior quarter. For the quarter weighted average shares outstanding totaled $23.9 million compared to $22.5 million in Q2 2013. Now I will turn the call back to Greg for some closing remarks.

Greg Liberman

Thanks very much, Brett. Before we wrap up our prepared remarks there’s one more announcement I would like to make. After nearly a decade here, more than half of my professional career, I will be leaving Spark Networks. My time at Spark has been filled with special memories and I’m very proud of all we have accomplished.

Spark truly is a relationship business in every sense of the word. Through iconic brands like JDate and Christian Mingle we create countless relationships for our members every day. But Spark is about much more. The relationships we have in the communities we serve and those within our team drive everything.

I’m extremely proud and grateful to have played a role in building and leading such an incredible team and to have had the opportunity to work hand-in-hand with them to transform this company in the process. In their hands Spark’s future is very bright.

Before opening up the call to Q&A I am pleased to introduce Mike McConnell, the company’s Chairman of the Board, who will be stepping in to lead the company as Executive Chairman until they identify my successor.

Mike McConnell

First, I would like to thank Greg for his decade of service to Spark Networks. Looking forward I and the Board believe in the strength of our two core brands, the communities that we serve and the relationships that we help create. We are undertaking a thorough assessment and analysis of the business. The goal is to drive efficiency in every aspect of the company so that we strengthen and build upon our current core assets. We will provide ongoing updates as to progress against this goal.

Finally, my role is that of Executive Chairman with two primary objectives: first, to jumpstart improvements in efficiency as described; and second, to facilitate for the Board the search for a permanent CEO. The search for a permanent CEO has been initiated and we expect a normal four- to six-month process.

Thank you and I will now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. At this time we will conduct a question-and-answer session. (Operator instructions.) Our first question comes from Michael Graham with Canaccord. Please proceed with your question.

Michael Graham – Canaccord Genuity

Hey, thanks very much. So there’s a lot going on here. First of all, Greg, thanks for all your work here and best of luck to you in the future. I just wanted to maybe ask a question for the assembled team there about broadly, I know you’ve got a lot of things that you’re going to be working on strategically. I’m just trying to understand how you all are thinking about growth versus profitability I guess. I mean you’ve got a situation here where you’ve ramped way back on spend but this is, at least in the early days of building an ecosystem it’s a spend to grow kind of business. So just wondering at a high level is this still a growth company or is it something else? Thanks very much.

Mike McConnell

Michael, this is Mike McConnell. As I indicated the Board is undertaking a thorough assessment of everything at the company including the direct marketing spend, and naturally as that relates to the question that you asked. So there’s nothing further to add at the moment unless management would like to add a comment.

Brett Zane

No, I think that’s a fair comment.

Michael Graham – Canaccord Genuity

Okay, alright. Thanks guys.

Operator

Our next question comes from [Ryan Dominick] with William Blair. Please proceed with your question.

[Ryan Dominick] – William Blair

Hi, good afternoon. So we’ve seen ARPU decline here on the Christian Networks business, and Brett, I realize there’s a number of things going on here that you clearly outlined. Just wondering when do you think all that starts to lapse and when do we kind of start seeing the pricing program take control and that ARPU number start to tick back upwards? Thanks.

Brett Zane

Hey Ryan. I think based upon what we have planned today I think things have kind of bottomed out. You saw over the last couple of quarters we actually saw our ARPU ticking up primarily because we were starting to have a larger portion of our paying subscriber base in the form of renewing average paying subscribers, and the ARPU of the renewing paying subscribers is higher than the folks that come in for the first time or win backs. What we experienced in Q2 this year was a little bit of an anomaly and really was focused or driven by the purchase of six-month plans by the FTS and win back crew.

So I believe that things should reverse and start picking back up in Q3 when actually as Greg had mentioned we’re rolling out the price test to a larger universe. So my expectation is that you should start seeing that filter its way through our Q3 and Q4 going forward.

[Ryan Dominick] – William Blair

Great, that’s helpful. Thank you.

Brett Zane

Sure.

Operator

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

George Askew – Stifel Nicolaus

Yes, thanks very much. Greg, sorry to hear of your departure; best of luck as well and best wishes. For Brett and Mike, over the last month or so have you reevaluated or changed the algorithms that you’re using to measure marketing effectiveness or ROI and kind of the analysis of how cohorts behave in the future in terms of win backs and renewals? Or were there any changes in how you’re viewing those analyses?

Brett Zane

The short answer, George, is no.

George Askew – Stifel Nicolaus

Okay. And then Mike, I realize that you’ve only been inside the company for five or six weeks now but obviously you’ve been a very close observer of what’s been happening there and kind of how you view the business over the last at least eight months and I think much longer. Can you give us a sense of how you view the multi-brand strategy at the company, obviously two brands primarily but what kind of synergies do you see between the two, does it make sense for them to be under the same umbrella so to speak?

Mike McConnell

Sure. Two comments: one, I’ve been encouraged by the strength of those communities that we serve and our product offerings to them. With respect to the synergies obviously there’s operating leverage with respect to corporate functions like finance, HR, legal, etc., so I’ve not seen anything that suggests that they ought to be separated and there’s some natural synergies that occur in a company structure like this one.

George Askew – Stifel Nicolaus

Okay, great. And then just one final one: you mentioned weakness in JDate included international. Does that fall into the geopolitical camp in Israel or are there other things going on in that part of the business?

Brett Zane

There’s some of that going on. I think that’s more indicative of what’s happened in Q3 but really there’s that that exists. I think in Q2 it was more some competitive dynamics within our international operations that created some of that softness.

George Askew – Stifel Nicolaus

And is that ongoing at this point?

Brett Zane

I think it’s more the political unrest that’s the driver there than the competitive elements, although they still exist as well.

George Askew – Stifel Nicolaus

Got it. Okay, thank you very much and congrats on the positive adjusted EBITDA. That’s a great sign, we’d love to see more of that. Thank you.

Mike McConnell

Thanks, George.

Operator

At this time we have run out of time for the allotted time for the Q&A portion today so this does conclude today’s teleconference. You may disconnect your lines at this time and have a great day.

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