SPARK NETWORKS INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and the related notes that are included in this report.

Some of the statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report are forward-looking statements that involve substantial risks and uncertainties.

All statements other than historical facts contained in this report, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "believes," "expects," "anticipates," "intends," "estimates," "may," "will," "continue," "should," "plan," "predict," "potential" and other similar expressions. We have based these forward-looking statements on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. Our actual results could differ materially from those anticipated in these forward-looking statements, which are subject to a number of risks, uncertainties and assumptions described in the "Risk Factors" section and elsewhere in this report.

General The common stock of Spark Networks, Inc., a Delaware corporation, is traded on the NYSE Amex. On December 31, 2010, Spark Networks Limited ("SNUK") distributed its shareholdings in each of HurryDate, LLC; MingleMatch, Inc.; Kizmeet, Inc.; SN Holdco, LLC; SN Events, Inc.; Reseaux Spark Canada Ltd. and Spark SocialNet, Inc. by transferring its shares in those companies to the Spark Networks, Inc.

Spark Networks, Inc. subsequently transferred all of its shares in the same companies to LOV USA, LLC, a newly formed and wholly owned subsidiary of Spark Networks, Inc. SNUK continues to hold all of the shares of Spark Networks (Israel) Limited, VAP AG and JDate Limited. In addition, SNUK now holds all of the shares of Spark Networks USA, LLC, a newly formed subsidiary into which SNUK has transferred all of its United States based assets.

Membership to the Company's online services, which includes the posting of a personal profile and photos, and access to its database of profiles, is free.

The Company typically charges a subscription fee for varying subscription lengths (typically, one, three, six and twelve months) to members, allowing them to initiate communication with other members and subscribers using the Company's onsite communication tools, including anonymous email, Instant Messenger, chat rooms and message boards. For most of the Company's services, two-way communications through the Company's email platform can only take place between paying subscribers.

For the year ended December 31, 2011, we had 196,850 average paying subscribers, representing an increase of 21.3% from the year ended December 31, 2010. Paying subscribers are defined as individuals who have paid a monthly fee for access to communication and web site features beyond those provided to our non-paying members. Average paying subscribers for each month are calculated as the sum of the paying subscribers at the beginning and end of the month, divided by two.

Average paying subscribers for periods longer than one month are calculated as the sum of the average paying subscribers for each month, divided by the number of months in such period. Our key Web sites include JDate.com, which primarily targets Jewish singles in the United States, ChristianMingle.com, which primarily targets Christian singles in the United States, Spark.com, which targets singles in the United States, and BlackSingles.com, which primarily targets African-American singles in the United States. Our subscription fees have traditionally been charged on a monthly basis, with discounts for longer-term subscriptions.

We have grown both internally and through acquisitions of entities, and selected assets of entities, offering online personals services and related businesses.

Through our business acquisitions, we have expanded into new markets, leveraged and enhanced our existing brands to improve our position within new markets, and gained valuable intellectual property.

28-------------------------------------------------------------------------------- Table of Contents Our ability to compete effectively will depend on the timely introduction and performance of our future Web sites, services and features, the ability to address the needs of our members and paying subscribers and the ability to respond to Web sites, services and features introduced by competitors. To address this challenge, we have invested and will continue to invest in existing personnel resources, namely application developers and systems engineers, in order to enhance our existing services and introduce new services, which may include new Web sites as well as new features and functions designed to increase the probability of communication among our members and paying subscribers and to enhance their online personals experiences. We believe we have sufficient cash resources on hand to accomplish the enhancements currently contemplated.

Critical Accounting Policies, Estimates and Assumptions Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.

The preparation of these financial statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, cost of revenue, prepaid advertising, Web site and software development costs, goodwill, intangible and other long-lived assets, accounting for business combinations, legal contingencies, income taxes and stock-based compensation. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management has discussed the development and selection of our critical accounting policies, estimates and assumptions with our board of directors and the board has reviewed these disclosures. Past estimates have been in line with actual results.

We believe the following critical accounting policies reflect the more significant judgments and estimates we used in the preparation of our consolidated financial statements: Revenue Recognition and Deferred Revenue Substantially all of our revenue is derived from subscription fees. Revenue is presented net of credits and credit card chargebacks. We recognize revenue in accordance with accounting principles generally accepted in the United States.

Revenue recognition occurs ratably over the subscription period, beginning when there is persuasive evidence of an arrangement, delivery has occurred (access has been granted), the fees are fixed or determinable, and collection is reasonably assured. Paying subscribers primarily pay in advance using a credit card and, subject to certain conditions identified in our terms and conditions, all purchases are final and nonrefundable. Subscription fees collected in advance are deferred and recognized as revenue, using the straight-line method, over the term of the subscription. We reserve for potential credit card chargebacks based on our historical chargeback experience.

We also earn a small amount of revenue from advertising sales and offline events. We record advertising revenue as it is earned and included it in the total revenue of each segment that generates advertising sales. Revenue and the related expenses associated with offline events are recognized at the conclusion of each event.

Cost of Revenue Cost of revenue consists primarily of direct marketing costs, compensation and other employee-related costs (including stock-based compensation) for personnel dedicated to maintaining our data centers, data center expenses and credit card fees. We incur substantial expenses related to our advertising in order to generate traffic to our Web sites. These advertising costs consist of television and online advertising, including affiliate and co-brand arrangements, and are directly attributable to the revenue we receive from our subscribers. We have 29 -------------------------------------------------------------------------------- Table of Contents entered into numerous affiliate arrangements, under which our affiliates advertise or promote our Web site, and earn a fee whenever visitors click through the affiliate's advertisement to one of our Web sites and register or subscribe, on our Web site. We do not typically have any exclusivity arrangements with our affiliates, and some of our affiliates may also be affiliates for our competitors. Under our co-branded arrangements, our co-brand partners may operate their own separate Web sites where visitors can register and subscribe to our Web sites. Affiliate deals, co-brand deals and online advertising arrangements may fall in the categories of CPS, CPA, CPC, or CPM, as discussed below.

Our advertising expenses are recognized based on the terms of each individual contract. The majority of our advertising expenses are based on four pricing models: • Cost per subscription (CPS) where we pay an online advertising provider a fee based upon the number of new paying subscribers it generates; • Cost per acquisition (CPA) where we pay an online advertising provider a fee based on the number of new member registrations it generates; • Cost per click (CPC) where we pay an online advertising provider a fee based on the number of clicks to our Web sites it generates; and • Cost per thousand for banner advertising (CPM) where we pay an online advertising provider a fee based on the number of times it displays our advertisements.

We estimate, in certain circumstances, the total clicks or impressions delivered by our vendors in order to determine amounts due under these contracts.

Prepaid Advertising Expenses In certain circumstances, we pay in advance for online and offline advertising, and expense the prepaid amounts as cost of revenue over the contract periods as the vendor delivers on its commitment. We evaluate the realization of prepaid amounts at each reporting period and expense prepaid amounts if the vendor is unable to deliver on its commitment and is not willing or able to repay the undelivered prepaid amounts.

Web Site and Software Development Costs We capitalize costs related to developing or obtaining internal-use software.

Capitalization of costs begins after the preliminary project stage has been completed. Product development costs are expensed as incurred or capitalized into property and equipment. Costs incurred in the preliminary project and post-implementation stages of an internal use software project are expensed as incurred and certain costs incurred in the application development stage of a project are capitalized.

We expense costs related to the planning and post implementation phases of Web site development efforts. Direct costs incurred in the development phase are capitalized. Costs associated with minor enhancements and maintenance for a Web site are included in expenses in the accompanying consolidated statements of operations.

Valuation of Goodwill, Identified Intangibles and Other Long-lived Assets We test goodwill and indefinite-lived intangible assets for impairment at least annually, or more frequently when circumstances indicate that the carrying value may not be recoverable and test property, plant and equipment and other intangible assets for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Factors we consider important and which could trigger an impairment review include the following: • a significant decline in actual projected revenue; • a significant decline in the market value of our common stock; 30 -------------------------------------------------------------------------------- Table of Contents • a significant decline in performance of certain acquired companies relative to our original projections; • an excess of our net book value over our market value; • a significant decline in our operating results relative to our operating forecasts; • a significant change in the manner of our use of acquired assets or the strategy for our overall business; • a significant decrease in the fair value of an asset; • a shift in technology demands and development; and • a significant turnover in key management or other personnel.

When we determine that the carrying value of goodwill, other intangible assets and other long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. In the case of the other intangible assets and other long-lived assets, this measurement is only performed if the projected undiscounted cash flows for the asset are less than its carrying value.

In 2011 and 2010, the Company performed its annual impairment analysis and determined the fair value of each reporting unit and compared it to the carrying amount of the reporting unit. We estimate the fair value of the reporting unit based on the market approach and income approach. The income approach relies upon discounted future cash flows which are derived from various assumptions including: projected cash flows, discount rates, projected long-term growth rates and terminal values. We used a discount rate which we believe reflects the risks and uncertainty related to each reporting unit. The analysis concluded that the estimated fair value of the Jewish Networks business was higher than its carrying value and the estimated fair value of the Other Affinity Networks business was higher than its carrying value. At the conclusion of the analysis, it was determined that impairment was not warranted.

As of December 31, 2011, Jewish Networks and Other Affinity Networks carried goodwill balances of $6.8 million and $1.9 million, respectively.

In 2009, we performed our annual impairment analysis and determined the fair value of each reporting unit and compared it to the carrying amount of the reporting unit. The fair value of the Jewish Networks reporting unit was higher than the carrying value as of December 31, 2009 and thus did not require any impairment. Based upon several valuation assumptions, including lower expected performance and lower industry multiples, the analysis concluded that the book carrying value of the Other Affinity Networks business was higher than its estimated fair value. As a result, the Company performed the second step under the guidance to assess the fair value of the assets and liabilities of Other Affinity Networks. The analysis resulted in impairment to goodwill and domain names of $9.3 million and $1.3 million, respectively. In 2009, we paid the final $1.4 million in earn-out payments for the acquisition of the HurryDate business in 2007. The earn-out payments were recorded as impairment expense based on business performance. There were no additional impairments as a result of the assessment.

In 2011 and 2010, we impaired approximately $45,000 and $121,000, respectively, of capitalized software development costs when we determined that a web-based product failed to perform to Company standards.

In 2011 and 2010, the Company determined that certain domain names and computer software acquired from prior period acquisitions had no value based upon the expected future cash flows generated from the businesses associated with these assets, resulting in impairment charges of approximately $1.1 million and $187,000 respectively.

Accounting for Business Combinations We acquired the stock or specific assets of a number of companies from 1999 through 2008 some of which were considered to be business acquisitions. Under the purchase method of accounting, the costs are allocated to the underlying net assets, based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.

31 -------------------------------------------------------------------------------- Table of Contents The judgments made in determining the estimated fair value and expected useful life assigned to each class of assets and liabilities acquired can significantly impact net income. Different classes of assets will have varying useful lives.

For example, the useful life of a member database, which is typically three years, is not the same as the useful life of a paying subscriber list, which is typically three months, or a domain name, which is indefinite. Consequently, to the extent a longer-lived asset is ascribed greater value under the purchase method than a shorter-lived asset, there may be less amortization recorded in a given period or no amortization for indefinite lived intangibles.

Determining the fair value of certain assets and liabilities acquired is subjective in nature and often involves the use of significant estimates and assumptions.

The value of our intangible and other long-lived assets, including goodwill, is exposed to future adverse changes if we experience declines in operating results or experience significant negative industry or economic trends or if future performance is below historical trends.

Legal Contingencies We are currently involved in certain legal proceedings, as discussed in the notes to the financial statements and under "Legal Proceedings." To the extent that a loss related to a contingency is reasonably estimable and probable, we accrue an estimate of that loss. Because of the uncertainties related to both the amount and range of loss on certain pending litigation, we may be unable to make a reasonable estimate of the liability that could result from an unfavorable outcome of such litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and make or, if necessary, revise our estimates. Such revisions in our estimates of the potential liability could materially impact our results of operations and financial position.

Accounting for Income Taxes We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities.

At December 31, 2011, we had gross net operating loss ("NOL") carry-forwards for income tax purposes of approximately $8.5 million and $36.4 million available to reduce future federal and state taxable income, respectively, which expire beginning in the years 2025 for federal purposes and 2018 for state purposes.

Under section 382 of the Internal Revenue Code, the utilization of the net operating loss carry-forwards can be limited based on changes in the percentage ownership of the Company.

As a result of the adoption of the share-based payment guidance, the Company will recognize excess tax benefits associated with the exercise of stock options directly to stockholders' equity only when realized. Accordingly, deferred tax assets are not recognized for NOL carry forwards resulting from excess tax benefits. As of December 31, 2011, deferred tax assets do not include approximately $4.8 million of these excess tax benefits from employee stock option exercises that are a component of the Company's NOL carry forwards.

Additional paid in capital will be increased up to an additional $4.8 million if and when such excess tax benefits are realized. During 2011, approximately $67,000 of net excess tax benefits were realized.

We operate in multiple taxing jurisdictions, both within the United States and outside the United States. We have filed tax returns with positions that may be challenged by the tax authorities. These positions relate to, among others, transfer pricing, the deductibility of certain expenses, intercompany transactions as well as other matters.

32-------------------------------------------------------------------------------- Table of Contents Although the outcome of tax audits is uncertain, we regularly assesses our tax position for such matters and, in management's opinion, adequate provisions for income taxes have been made for potential liabilities resulting from such matters. To the extent reserves are recorded, they will be utilized or reversed once the statute of limitations has expired and/or at the conclusion of the tax examination. We believe that the ultimate outcome of these matters will not have a material impact on our financial position or liquidity. We recognize the tax effects from an uncertain tax position in our financial statements, only if the position is more-likely-than-not of being sustained on audit, based on the technical merits of the position. Tax positions that meet the recognition threshold are reported at the largest amount that is more-likely-than-not to be realized.

Stock Based Compensation We adopted the "Share-Based Payment" guidance in 2005 using the modified prospective approach. Prior to our adoption of the guidance, we did not record tax benefits of deductions resulting from the exercise of stock options because of the uncertainty surrounding the timing of realizing the benefits of our deferred tax assets in future tax returns. The guidance requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. In 2011 and 2010, we recognized cash inflows of approximately $89,000 and $1.7 million, respectively, related to tax provision or benefit from stock-based compensation.

We calculate the fair value of stock options by using the Black-Scholes option-pricing model. The determination of the fair value of stock-based awards at the grant date requires judgment in developing assumptions, which involve a number of variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, the expected dividend yield and the expected stock option exercise behavior. Additionally, judgment is also required in estimating the number of stock-based awards that are expected to be forfeited. We used historical and empirical data to assess different forfeiture rates for three different groups of employees. We must reassess forfeiture rates when deemed necessary and we must calibrate actual forfeiture behavior to what has already been recorded.

Our computation of expected volatility is based on a combination of historical and market-based implied volatility. The volatility rate was derived by examining historical stock price behavior and assessing management's expectations of stock price behavior during the term of the option. The term of the options was derived based on the "simplified method" calculation. We are using the "simplified method" calculation, which is derived by averaging the vesting term with the contractual terms.

If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period. We believe the accounting for stock-based compensation is a critical accounting policy because it requires the use of complex judgment in its application.

Segment Reporting Segment reporting requires the use of the management approach in determining the reportable operating segments. The management approach considers the internal organization and reporting used by our chief operating decision maker for making operating decisions and assessing performance. The Company's financial reporting includes detailed data on four separate operating segments which were principally determined based on similarity of economic characteristics. For the periods covered by the financial statements in this report, our financial reporting data consists of four reportable segments: (1) Jewish Networks, which consists of JDate.com, JDate.co.il, JDate.co.uk, JDate.fr, Cupid.co.il and their respective co-branded and private label Web sites; (2) General Market Networks, which consists of AmericanSingles.com and Date.ca, which were both rebranded as Spark.com in December of 2009 and Date.co.uk which was rebranded as Spark.com in February 2010, and their respective co-branded and private label Web sites; (3) Other Affinity Networks, which consists of the Company's Provo, Utah-based properties which are primarily made up of sites targeted towards various religious, ethnic, geographic and special interest groups; and (4) Offline and Other Businesses, which consists of 33-------------------------------------------------------------------------------- Table of Contents revenue generated from offline activities, HurryDate events and subscriptions, and other Web sites and businesses.

Results of Operations The following is a more detailed discussion of our financial condition and results of operations for the periods presented.

The following table presents our historical operating results as a percentage of revenue for the periods indicated: 2011 2010 2009 Revenue 100.0 % 100.0 % 100.0 % Costs and expenses: Cost of revenue 59.7 33.7 33.5 Sales and marketing 7.7 8.6 7.7 Customer service 4.1 3.9 4.0 Technical operations 2.8 3.0 3.3 Development 5.6 7.6 8.6 General and administrative 16.6 23.7 21.9 Depreciation 2.7 2.4 1.9 Amortization of intangible assets other than goodwill 0.8 1.0 1.5 Impairment of goodwill, long-lived assets and other assets 2.4 0.8 26.4 Total costs and expenses 102.4 84.7 108.8 Operating (loss) income (2.4 ) 15.3 (8.8 ) Interest and other (income) expenses, net 0.3 (0.1 ) (2.4 ) (Loss) income before income taxes (2.7 ) 15.4 (6.4 ) Provision for income taxes 0.6 6.3 7.7 Net (loss) income (3.3 )% 9.1 % (14.1 )% The following table describes certain selected information and Adjusted EBITDA (1) for the years ended December 31, (in thousands) 2011 2010 2009 Net (loss) income $ (1,611 ) $ 3,704 $ (6,404 ) Interest expense 102 207 378 Income taxes 305 2,558 3,479 Depreciation 1,320 962 873 Impairments 1,145 308 11,999 Amortization of intangible assets 370 421 663 Non-cash currency translation adjustments 337 (269 ) (30 ) Stock-based compensation 906 1,510 1,041 Non-repetitive property possession (247 ) - (1,507 ) Adjusted EBITDA(1) $ 2,627 $ 9,401 $ 10,492 (1) The Company reports Adjusted EBITDA as a supplemental measure to generally accepted accounting principles ("GAAP"). This measure is one of the primary metrics by which we evaluate the performance of our businesses, budget, forecast and compensate management. We believe this measure provides management and investors with a consistent view, period to period, of the core earnings generated from on-going operations and excludes the impact of: (i) non-cash items such as stock-based compensation, asset impairments, non-cash currency translation adjustments related to an inter-company loan and (ii) one-time 34 -------------------------------------------------------------------------------- Table of Contents items that have not occurred in the past two years and are not expected to recur in the next two years. Adjusted EBITDA has inherent limitations in evaluating the performance of the Company, including, but not limited to the following: • Adjusted EBITDA does not reflect the cash capital expenditures during the measurement period, • Adjusted EBITDA does not reflect any changes in working capital requirements during the measurement period, • Adjusted EBITDA does not reflect the cash tax payments during the measurement period, and • Adjusted EBITDA may be calculated differently by other companies in our industry, thus limiting its value as a comparative measure.

Adjusted EBITDA should not be construed as a substitute for net income (loss) (as determined in accordance with GAAP) for the purpose of analyzing our operating performance or financial position, as Adjusted EBITDA is not defined by GAAP.

Key Metric-Average Paying Subscribers We regularly review average paying subscribers as a key metric to evaluate the effectiveness of our operating strategies and monitor the financial performance of our business. Subscribers are defined as individuals for whom we collect a monthly fee for access to communication and Web site features beyond those provided to our non-paying members. Average paying subscribers for each month are calculated as the sum of the paying subscribers at the beginning and end of the month, divided by two. Average paying subscribers for periods longer than one month are calculated as the sum of the average paying subscribers for each month, divided by the number of months in such period.

Unaudited selected statistical information regarding average paying subscribers for our operating segments is shown in the table below: Year Ended December 31, 2011 2010 2009 Average Paying Subscribers Jewish Networks 89,429 90,452 86,030 Other Affinity Networks 103,768 64,851 66,078 General Market Networks 3,138 6,328 13,219 Offline and Other Businesses 515 680 940 Total Average Paying Subscribers 196,850 162,311 166,267 Average paying subscribers for the Jewish Networks segment decreased 1.1% to 89,429 for the year ended December 31, 2011 compared to 90,452 in 2010. Average paying subscribers for the Other Affinity Networks segment increased 60.0% to 103,768 for the year ended December 31, 2011 compared to 64,851 in 2010, reflecting increased direct marketing investment within this segment. Average paying subscribers for the General Market Networks segment decreased 50.4% to 3,138 for the year ended December 31, 2011 compared to 6,328 in 2010. This decrease can be primarily attributed to a reduction in inefficient marketing spend in prior and current periods. Average paying subscribers for the Offline and Other Businesses segment decreased 24.3% to 515 for the year ended December 31, 2011 compared to 680 in 2010, primarily due to the operating results of HurryDate.

Average paying subscribers for the Jewish Networks segment increased 5.1% to 90,452 for the year ended December 31, 2010 compared to 86,030 in 2009. We believe the increase in average paying subscribers is due in part to a shift in our pricing strategy and new product offerings. Average paying subscribers for the Other Affinity Networks segment decreased 1.9% to 64,851 for the year ended December 31, 2010 compared to 66,078 in 2009, reflecting a shift in brand investment within this segment. Average paying subscribers for the General 35-------------------------------------------------------------------------------- Table of Contents Market Networks segment decreased 52.1% to 6,328 for the year ended December 31, 2010 compared to 13,219 in 2009. This decrease can be primarily attributed to a reduction in inefficient marketing spend. Average paying subscribers for the Offline and Other Businesses segment decreased 27.7% to 680 for the year ended December 31, 2010 compared to 940 in 2009, primarily due to the operating results of HurryDate.

We expect the cost of customer acquisition for the Jewish Networks to remain below the acquisition cost for our other segments due to the brand recognition of JDate. Our General Market Networks and Other Affinity Networks segments operate in a much more competitive environment, and therefore we generally must spend more on marketing to attract new subscribers. We are constantly striving to improve our Web sites to retain our existing subscribers.

Segment Reclassification During the first quarter of 2012, the Company changed management's internal reporting to include data on four newly-defined operating segments: (1) Jewish Networks, which consists of JDate.com, JDate.co.il, Cupid.co.il, and their respective co-branded Web sites; (2) Christian Networks, which consists of ChristianMingle.com, ChristianMingle.co.uk, ChristianMingle.com.au and Believe.com; (3) Other Networks, which consists of Spark.com and properties which are primarily made up of sites targeted towards various religious, ethnic, geographic and special interest groups; and (4) Offline & Other Businesses, which consists of revenue generated from offline activities and HurryDate events and subscriptions. The Company believes the new segments will provide investors with greater transparency into the performance of the business.

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010 Revenue Substantially all of our revenue is derived from subscription fees.

Approximately 5.0% and 5.2% of our revenue for the years ended December 31, 2011 and 2010, respectively, were generated through offline social and travel events, and advertising revenue. Revenue is presented net of credits and credit card chargebacks. Our subscriptions are offered in durations of varying length (typically, one, three, six and twelve months). Plans with durations longer than one month are available at discounted monthly rates. Following their initial terms, most subscriptions renew automatically until subscribers terminate them.

Revenue for the year ended December 31, 2011 increased 18.7% to $48.5 million from $40.9 million in 2010. The revenue increase can be primarily attributed to a 78.1% increase in Other Affinity Networks revenue.

Revenue for the Jewish Networks segment decreased 1.4% to $27.1 million for the year ended December 31, 2011, compared to $27.4 million in 2010. The lower Jewish Networks revenue reflects a 0.5% decrease in average revenue per user ("ARPU"), and a 1.1% decrease in average paying subscribers. The lower ARPU reflects a shift in the mix of plans purchased by our subscribers and their related price. Revenue for our Other Affinity Networks segment increased 78.1% to $20.1 million for the year ended December 31, 2011, compared to $11.3 million in 2010. The higher Other Affinity Networks revenue reflects an 11.3% increase in ARPU, and a 60.0% increase in average paying subscribers. The higher ARPU reflects a shift in the mix of plans purchased by our subscribers and their related price points as we shifted our focus to a select group of brands within this segment. Revenue for the General Market Networks segment decreased 50.5% to $578,000 for the year ended December 31, 2011, compared to $1.2 million in 2010.

The decrease in General Market Networks revenue is due to a 50.4% decrease in average paying subscribers, reflecting the elimination of inefficient online marketing expenses in prior and current periods. Revenue of our Offline and Other Businesses segment decreased 19.9% to $772,000 for the year ended December 31, 2011 compared to $1.0 million in 2010. The decrease in revenue is attributable to fewer hosted events in 2011.

36-------------------------------------------------------------------------------- Table of Contents Costs and Expenses Costs and expenses consist primarily of cost of revenue, sales and marketing, customer service, technical operations, development and general and administrative expenses. Costs and expenses increased 43.3% to $49.6 million for the year ended December 31, 2011, compared to $34.6 million in 2010. The increase is primarily attributable to a $15.2 million increase in cost of revenue.

Cost of Revenue. Cost of revenue consists primarily of direct marketing costs, compensation and other employee-related costs (including stock-based compensation) for personnel dedicated to maintaining our data centers, data center expenses and credit card fees. Cost of revenue increased 110.6% to $29.0 million for the year ended December 31, 2011, compared to $13.7 million in 2010.

This increase can be primarily attributed to higher Other Affinity Networks direct marketing expenses. Direct marketing expenses for the Other Affinity Networks segment increased 194.3% to $21.5 million for the year ended December 31, 2011, compared to $7.3 million in 2010. The higher marketing expense reflects management's focus on increasing market share and cultivating greater brand awareness for a handful of Web sites in this segment.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries for our sales and marketing personnel. Sales and marketing expenses increased 6.5% to $3.7 million for the year ended December 31, 2011, compared to $3.5 million in 2010. The increase can be primarily attributed to growth in compensation expense and consulting fees. The Company increased its marketing team headcount in 2011, which led to higher compensation expense.

Customer Service. Customer service expenses consist primarily of personnel costs associated with our customer service centers. The members of our customer service team primarily respond to billing questions, detect fraudulent activity and eliminate suspected fraudulent activity, as well as address site usage and dating questions from our members. Customer service expenses increased 23.7% to $2.0 million for the year ended December 31, 2011, compared to $1.6 million in 2010. The expense increase is primarily attributed to higher compensation costs, reflecting increased support for our growing Other Affinity Networks segment.

Technical Operations. Technical operations expenses consist primarily of the personnel and systems necessary to support our corporate technology requirements. Technical operations expenses increased 11.0% to $1.4 million for the year ended December 31, 2011, compared to $1.2 million in 2010. The increase reflects higher compensation expense associated with additional personnel.

Development. Development expenses consist primarily of costs incurred in the development, enhancement and maintenance of our Web sites and services.

Development expenses decreased by 12.4% to $2.7 million for the year ended December 31, 2011, compared to $3.1 million in 2010. The decreased costs reflect lower salary expense due to personnel changes and higher capitalized salaries associated with software development.

General and Administrative. General and administrative expenses consist primarily of corporate personnel-related costs, professional fees, occupancy and other overhead costs. General and administrative expenses decreased 17.5% to $8.1 million for the year ended December 31, 2011, compared to $9.8 million in 2010. In 2010, the Company incurred approximately $1.0 million in non-recurring charges associated with our Special Committee process, litigation related to the Special Committee process and the transfer of certain assets out of our United Kingdom entity into two United States entities.

Depreciation. Depreciation expenses consist primarily of depreciation of capitalized software costs, computer hardware and other fixed assets.

Depreciation expense increased by 37.2% to $1.3 million for the year ended December 31, 2011, compared to $962,000 in 2010. Higher capitalized software which started in 2010 accounted for the increase in depreciation expenses.

Amortization of Intangible Assets. Amortization expenses consist primarily of amortization of intangible assets related to acquisitions, primarily LDSSingles and HurryDate. Amortization expense decreased 12.1% to 37-------------------------------------------------------------------------------- Table of Contents $370,000 for the year ended December 31, 2011, compared to $421,000 in 2010. The decrease reflects the full amortization of MingleMatch and LDSSingles assets.

Impairment of Long-lived Assets. Impairment of long-lived assets primarily represents the write-down of investments in businesses and computer software.

Long-lived assets impairment expense was $1.1 million for the year ended December 31, 2011, compared to $308,000 in 2010. In 2011, the Company determined that certain domain names and computer software acquired from prior period acquisitions had no value.

Interest Expense (income) and Other, Net. Interest expense (income) and other consist primarily of interest income associated with short-term investments and cash deposits in interest bearing accounts, income or expense related to currency fluctuations and interest expense associated with borrowings from our revolving credit facility. Interest expense (income) and other reflected a $162,000 expense for the year ended December 31, 2011, compared to income of $54,000 in 2010. The change is primarily due to non-cash foreign exchange rate fluctuations related to the intercompany loan with our Israel subsidiary, offset by a $247,000 gain recorded for assets received from a legal judgment.

Net (loss) Income and Net (loss) Income Per Share. Net loss was $1.6 million, or $0.08 per share, for the year ended December 31, 2011, compared to net income of $3.7 million or $0.18 per share in 2010. The net loss in 2011 was primarily due to increases in direct marketing investments.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009 Revenue Substantially all of our revenue is derived from subscription fees.

Approximately 5.2% and 4.9% of our revenue for the years ended December 31, 2010 and 2009, respectively, is generated through offline social and travel events, and advertising revenue. Revenue is presented net of credits and credit card chargebacks. Our subscriptions are offered in durations of varying length (typically, one, three, six and twelve months). Plans with durations longer than one month are available at discounted monthly rates. Following their initial terms, most subscriptions renew automatically until subscribers terminate them.

Revenue for the year ended December 31, 2010 decreased 10.0% to $40.9 million from $45.4 million in 2009. The revenue decrease can be primarily attributed to a 4.9% decrease in Jewish Networks revenue, a 56.6% decrease in General Market Networks revenue and an 11.7% decrease in Other Affinity Networks revenue.

Revenue for the Jewish Networks segment decreased 4.9% to $27.4 million for the year ended December 31, 2010, compared to $28.8 million in 2009. The lower Jewish Networks revenue reflects a 9.0% decrease in average revenue per user ("ARPU"), offset by a 5.1% increase in average paying subscribers. The lower ARPU reflects a shift in the mix of plans purchased by our subscribers and their related price points as we focused on growing our network. Revenue for the General Market Networks segment decreased 56.6% to $1.2 million for the year ended December 31, 2010, compared to $2.7 million in 2009. The decrease in General Market Networks revenue is due to a 52.1% decrease in average paying subscribers, reflecting the elimination of inefficient online marketing expenses. Revenue for our Other Affinity Networks segment decreased 11.7% to $11.3 million for the year ended December 31, 2010, compared to $12.8 million in 2009. The lower Other Affinity Networks revenue reflects an 11.9% decrease in ARPU, and a 1.9% decrease in average paying subscribers. The lower ARPU reflects a shift in the mix of plans purchased by our subscribers and their related price points as we shifted our focus to a select group of brands within this segment.

Revenue of our Offline and Other Businesses segment decreased 11.0% to $1.0 million for the year ended December 31, 2010 compared to $1.1 million in 2009.

The decrease in revenue is attributable to fewer hosted events in 2010.

38-------------------------------------------------------------------------------- Table of Contents Costs and Expenses Costs and expenses consist primarily of cost of revenue, sales and marketing, customer service, technical operations, development and general and administrative expenses. Costs and expenses decreased 29.9% to $34.6 million for the year ended December 31, 2010, compared to $49.4 million in 2009. Excluding asset impairment charges, operating expenses decreased 8.2% to $34.3 million in 2010 compared to $37.4 million in 2009. Lower cost of revenue and development expense accounted for the majority of the decrease.

Cost of Revenue. Cost of revenue consists primarily of direct marketing costs, compensation and other employee-related costs (including stock-based compensation) for personnel dedicated to maintaining our data centers, data center expenses and credit card fees. Cost of revenue decreased 9.6% to $13.7 million for the year ended December 31, 2010, compared to $15.2 million in 2009.

The decrease can be primarily attributed to an 11.1% decline in direct marketing expenses. The Other Affinity Networks segment accounted for the majority of the reduction in direct marketing expenses, where costs decreased 14.2% to $7.3 million for the year ended December 31, 2010, compared to $8.5 million in 2009.

The lower marketing expense reflects management's focus on increasing market share and cultivating greater brand awareness for a handful of Web sites in this segment.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries for our sales and marketing personnel. Sales and marketing expenses remained flat at $3.5 million for the years ended December 31, 2010 and 2009.

Customer Service. Customer service expenses consist primarily of personnel costs associated with our customer service centers. The members of our customer service team primarily respond to billing questions, detect fraudulent activity and eliminate suspected fraudulent activity, as well as address site usage and dating questions from our members. Customer service expenses decreased 12.6% to $1.6 million for the year ended December 31, 2010, compared to $1.8 million in 2009. The decrease in total dollars is primarily due to lower wages, reflecting the full year impact of migrating our customer service group from Beverly Hills, CA to Provo, UT.

Technical Operations. Technical operations expenses consist primarily of the personnel and systems necessary to support our corporate technology requirements. Technical operations expenses decreased 18.1% to $1.2 million for the year ended December 31, 2010, compared to $1.5 million in 2009. The decrease in total dollars is due primarily to an increase in capitalized software, lower recruiter placement fees and a reduction in technology support and maintenance expense.

Development. Development expenses consist primarily of costs incurred in the development, enhancement and maintenance of our Web sites and services.

Development expenses decreased by 20.6% to $3.1 million for the year ended December 31, 2010, compared to $3.9 million in 2009. The decrease in total dollars is primarily due to lower wages and consulting fees. The lower wages reflect a reduction in headcount, while the lower consulting fees reflect the completion of the launch of Kizmeet.com, the completion of certain new product features and the absorption of other projects by our existing workforce in the fourth quarter of 2009.

General and Administrative. General and administrative expenses consist primarily of corporate personnel-related costs, professional fees, occupancy and other overhead costs. General and administrative expenses decreased 1.5% to $9.8 million for the year ended December 31, 2010, compared to $9.9 million in 2009.

In 2010, the Company incurred approximately $1.0 million in non-recurring charges associated with our Special Committee process, litigation related to the Special Committee process and the transfer of certain assets out of our United Kingdom entity into two United States entities.

Depreciation. Depreciation expenses consist primarily of depreciation of capitalized software costs, computer hardware and other fixed assets.

Depreciation expense increased by 10.2% to $962,000 for the year ended December 31, 2010, compared to $873,000 in 2009.

39-------------------------------------------------------------------------------- Table of Contents Amortization of Intangible Assets. Amortization expenses consist primarily of amortization of intangible assets related to acquisitions, primarily MingleMatch, LDSSingles and HurryDate. Amortization expense decreased 36.5% to $421,000 for the year ended December 31, 2010, compared to $663,000 in 2009. The decrease is mainly due to fully amortized costs associated with HurryDate members in early 2010.

Interest Expense (Income) and Other, Net. Interest expense (income) and other consist primarily of interest income associated with short-term investments and cash deposits in interest bearing accounts, income or expense related to currency fluctuations and interest expense associated with borrowings from our revolving credit facility. Net interest and other income was $54,000 for the year ended December 31, 2010, compared to $1.1 million in 2009. The income in 2009 primarily reflects a $1.5 million gain associated with the possession of certain assets pursuant to a judgment awarded in favor of the Company.

Net Income (Loss) and Net Income (Loss) Per Share. Net income was $3.7 million, or $0.18 per share, for the year ended December 31, 2010, compared to a net loss of $6.4 million or $0.31 per share in 2009. The lower net income in 2009 was primarily due to an impairment expense related to goodwill and other long-lived assets of $12 million in 2009.

40-------------------------------------------------------------------------------- Table of Contents Quarterly Results of Operations You should read the following tables presenting our quarterly results of operations in conjunction with the consolidated financial statements and related notes contained elsewhere in this report. We have prepared the unaudited information on substantially the same basis as our audited consolidated financial statements which, in the opinion of management, includes all adjustments, consisting only of normal recurring adjustments, except as otherwise indicated, necessary for the presentation of the results of operations for such periods. You should also keep in mind, as you read the following tables, that our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year.

Three Months Ended (1) Dec. 31, Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30, March 31, 2011 2011 2011 2011 2010 2010 2010 2010 (in thousands) Consolidated Statement of Operations Data: Revenue $ 12,861 $ 12,677 $ 11,995 $ 10,960 $ 10,109 $ 9,916 $ 10,289 $ 10,537 Cost of revenue 8,420 7,373 7,347 5,815 4,002 3,206 3,384 3,157 Sales and marketing 1,062 923 837 900 788 774 851 1,083 Customer service 539 531 449 461 420 403 382 396 Technical operations 281 336 336 414 302 252 315 363 Development 643 643 679 745 760 773 778 781 General and administrative 1,071 2,435 2,199 2,363 2,141 2,316 2,538 2,787 Depreciation 343 341 346 290 263 242 222 235 Amortization 89 90 93 98 97 98 104 122 Impairment of goodwill and other assets 1,100 45 - - 187 - - 121 Total operating expenses 13,548 12,717 12,286 11,086 8,960 8,064 8,574 9,045 Income (loss) from operations (687 ) (40 ) (291 ) (126 ) 1,149 1,852 1,715 1,492 Interest expense (income) and other, net 144 120 (45 ) (57 ) (72 ) (182 ) 241 (41 ) Income (loss) before income taxes (831 ) (160 ) (246 ) (69 ) 1,221 2,034 1,474 1,533 Provision for income taxes 277 78 (165 ) 115 595 808 551 604 Net (loss) income $ (1,108 ) $ (238 ) $ (81 ) $ (184 ) $ 626 $ 1,226 $ 923 $ 929 Basic and diluted net (loss) income per share $ (0.05 ) $ (0.01 ) $ (0.00 ) $ (0.01 ) $ 0.03 $ 0.06 $ 0.04 $ 0.05 Shares used in computation of basic net income per share1 20,595 20,595 20,589 20,587 20,587 20,587 20,587 20,582 Shares used in computation of diluted net income per share 20,595 20,595 20,589 20,587 20,588 20,590 20,598 20,582 Average paying subscribers2 212,850 206,099 190,160 178,292 160,744 158,422 160,239 169,833 Costs and expenses include stock-based compensation as follows: Cost of revenue $ 2 $ 2 $ 2 $ 2 $ 3 $ 3 $ 3 $ 2 Sales and marketing 15 17 14 34 35 39 42 117 Customer service - - - - - - - 1 Technical operations 31 30 27 31 33 30 31 73 Development 10 10 10 12 12 14 15 13 General and administrative 125 124 226 182 187 172 181 504 (1) For information regarding the computation of per share amounts, refer to Note 1 of our consolidated financial statements.

(2) Represents average paying subscribers calculated as the sum of the average paying subscribers for each month in the period, divided by the three.

Average paying subscribers for each month are calculated as the sum of the paying subscribers at the beginning and end of the month, divided by two.

41 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of December 31, 2011, we had cash and cash equivalents of $15.1 million. We have historically financed our operations with internally generated funds.

Net cash provided by operations was $3.1 million for the year ended December 31, 2011 compared to $5.8 million for the same period in 2010.

Net cash used by investing activities was $1.9 million for 2011 compared to net cash provided by investing activities of $199,000 for 2010. In 2010, the Company received $1.6 million in connection with the sale of certain real property received in 2009 as a result of a judgment in favor of the Company. Capital expenditures for 2011 and 2010 were $1.6 million and $1.3 million, respectively, representing the purchase of computer hardware and capitalized software.

Net cash provided by financing activities was $88,000 for the year ended December 31, 2011 compared to $1.7 million for 2010. Cash provided by financing activities in 2010 was primarily related to the recognition of an excess tax benefit from stock-based compensation of $1.7 million compared to $67,000 in 2011.

The Company and its wholly-owned subsidiary, Spark Networks USA, LLC have a $15.0 million revolving credit facility with Bank of America which was entered into on February 14, 2008 with subsequent amendments (the "Credit Agreement").

The Credit Agreement matures on February 14, 2014. The per annum interest rate under the Credit Agreement is LIBOR, or the Eurodollar rate under certain circumstances, plus 1.75%, 2.00% and 2.50% based upon a financial leverage ratio of less than 1.00, 1.00 to 1.49 and 1.50 and greater, respectively. In the event the Company elects to borrow under a base rate loan, the corresponding interest rates are increased to the prime rate plus, 0.75%, 1.00% and 1.50%, respectively. The Company pays a 0.250% to 0.375% per annum commitment fee on all funds not utilized under the facility, measured on a daily basis. The Company is required to maintain a consolidated leverage ratio of no greater than 2.00 to 1.00, and a fixed charge coverage ratio of no less than 1.50 to 1.00.

The Company is permitted to repurchase or redeem equity interests or issue dividends of up to $15 million during the first 365 days following February 7, 2011, the date of a subsequent amendment to the Credit Agreement.

On May 11, 2011, the parties executed a Third Amendment to the Credit Agreement (the "Amendment"). The Amendment requires the Company to maintain a consolidated adjusted EBITDA for each fiscal quarter ending on March 31, 2011 through September 30, 2011 of $400,000; for the quarter ending on December 31, 2011 of $750,000; for each quarter ending on March 31, 2012 through June 30, 2012 of $1,000,000; for each quarter ending on September 30, 2012 through December 31, 2012 of $1,500,000; and for each quarter ending on or after March 31, 2013 of $2,000,000. In addition, the Amendment requires the Company to maintain a trailing twelve month contribution level of $20,000,000 from its Jewish Networks segment for each fiscal quarter ending on or after March 31, 2011.

The Company was compliant with the Credit Agreement's customary affirmative and negative covenants, as of December 31, 2011.

As of December 31, 2011, there was no outstanding amount under the Credit Agreement. In connection with the original Credit Agreement and the Amendment, the Company paid deferred financing costs of approximately $446,000 and $80,000, respectively. Costs associated with both the original Credit Agreement and the Amendment were included in prepaid expenses and other, and deposits and other assets. The deferred financing costs are amortized to interest expense in the Consolidated Statements of Operations over the full term of the Credit Agreement. Amortization expense for the deferred financing costs for the year ended December 31, 2011 and December 31, 2010 were $56,000 and $141,000, respectively.

We believe that our current cash and cash equivalents, marketable securities and cash flow from operations will be sufficient to meet our anticipated cash needs for working capital, capital expenditures and contractual obligations, for at least the next 12 months. We do not anticipate requiring additional capital; however, if required or desirable, we may utilize our revolving credit facility, or raise additional debt or issue additional equity in the private or public markets.

42 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table describes our contractual commitments and obligations as of December 31, 2011 (in thousands): Less than More than 1 year 1-3 years 4-5 years 5 years Total Operating leases $ 623 $ 760 $ 320 $ - $ 1,703 Other commitments and obligations 321 321 - - 642 Total contractual obligations $ 944 $ 1,081 $ 320 $ - $ 2,345 We had commitments and obligations consisting of operating leases, contracts with software licensing, communications, computer hosting and marketing service providers. Other commitments and obligations totaled $321,000 for less than one year. Contracts with other service providers are for 30 day terms or less. For contingences related to our tax positions, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the table above.

Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually, narrow or limited purposes. We do not have any outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions or foreign currency forward contracts.

Recent Accounting Developments In May 2011, the FASB issued a new accounting standard update, which amends the fair value measurement guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. We adopted this standard in the first quarter of 2012 and the adoption will not have a material impact on our financial statements and disclosures.

In June 2011, the Financial Accounting Standards Board issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. In addition, in December 2011, the FASB issued an amendment to an existing accounting standard which defers the requirement to present components of reclassifications of other comprehensive income on the face of the income statement. The new guidance will be effective for the Company beginning January 1, 2012 and will only impact the presentation of financial statements.

In September 2011, the FASB issued an amendment to an existing accounting standard, which provides entities an option to perform a qualitative assessment to determine whether further impairment testing on goodwill is necessary.

Specifically, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. This standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We adopted this standard in the first quarter of 2012 and the adoption will not have a material impact on our financial statements.

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