UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
----- Exchange Act of 1934 for the quarterly period ended September 30, 2006
or
Transition report pursuant to Section 13 or 15(d) of the Securities
----- Exchange Act of 1934 for the transition period from to .
------ -----
Commission File No. 0-21527
VERTRUE INCORPORATED
--------------------
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
-------------------------- ----------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
20 Glover Avenue
Norwalk, Connecticut 06850
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(203) 324-7635
-----------------------------------
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ X ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 9,681,000 shares of Common
Stock, $0.01 par value as of October 31, 2006.
VERTRUE INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2006
and June 30, 2006 1
Condensed Consolidated Statements of Operations for the Three
Months Ended September 30, 2006 and 2005 2
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended September 30, 2006 and 2005 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Forward Looking Statements 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 1A. Risk Factors 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
Item 6. Exhibits 25
Signatures 26
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VERTRUE INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except per share amounts)
September 30, June 30,
2006 2006
------------- --------------
Assets
Current assets:
Cash and cash equivalents $ 49,109 $ 36,290
Restricted cash 2,079 2,699
Short-term investments 7,553 31,798
Accounts and notes receivable, net 27,385 21,014
Prepaid expenses 6,175 9,053
Deferred marketing costs 24,867 26,463
Other current assets 5,256 4,706
------------- --------------
Total current assets 122,424 132,023
Fixed assets, net 43,928 40,568
Goodwill 214,529 212,187
Intangible assets, net 37,019 37,798
Other long-term assets 23,637 20,452
------------- --------------
Total assets $ 441,537 $ 443,028
============= ==============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 773 $ 762
Accounts payable 41,164 42,281
Accrued liabilities 65,805 64,602
Deferred revenues 77,869 84,972
Deferred income taxes 12,093 11,687
------------- --------------
Total current liabilities 197,704 204,304
Deferred income taxes 5,738 6,920
Long-term debt 238,028 237,984
Other long-term liabilities 9,232 9,989
------------- --------------
Total liabilities 450,702 459,197
------------- --------------
Commitments and contingencies (Note 6)
Shareholders' deficit:
Preferred stock, $0.01 par value -- 1,000 shares authorized; no shares issued - -
Common stock, $0.01 par value -- 40,000 shares authorized;
20,240 shares issued (20,168 shares at June 30, 2006) 202 202
Capital in excess of par value 191,024 187,991
Retained earnings 75,058 68,382
Accumulated other comprehensive income 135 214
Treasury stock, 10,581 shares at cost (10,518 shares at June 30, 2006) (275,584) (272,958)
------------- --------------
Total shareholders' deficit (9,165) (16,169)
------------- --------------
Total liabilities and shareholders' deficit $ 441,537 $ 443,028
============= ==============
The accompanying notes are an integral part of these condensed consolidated financial statements.
1
VERTRUE INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
For the three months ended
September 30,
----------------------------
2006 2005
------------- -------------
Revenues $ 177,346 $ 157,528
Expenses:
Marketing 87,383 73,899
Operating 42,210 35,083
General and administrative 31,762 28,454
Amortization of intangible assets 2,039 2,436
------------- -------------
Operating income 13,952 17,656
Interest income 1,496 635
Interest expense (5,114) (5,089)
Other income (expense), net 195 (44)
------------- -------------
Income before income taxes 10,529 13,158
Provision for income taxes 3,853 4,517
------------- -------------
Net income $ 6,676 $ 8,641
============= =============
Earnings per share:
Basic $ 0.69 $ 0.89
============= =============
Diluted $ 0.59 $ 0.74
============= =============
Weighted average common shares used in earnings per share
calculations:
Basic 9,668 9,714
============= =============
Diluted 12,733 12,783
============= =============
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
VERTRUE INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Three months ended
September 30,
---------------------------
2006 2005
------------ ------------
Operating activities
Net income $ 6,676 $ 8,641
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred revenues (7,799) (9,580)
Change in deferred marketing costs 1,614 3,990
Depreciation and amortization 6,357 6,578
Stock-based compensation 1,185 1,106
Deferred and other income taxes (774) (209)
Excess tax benefit from stock-based compensation (434) (351)
Other 183 (26)
Changes in assets and liabilities:
Restricted cash 620 327
Accounts and notes receivable (7,492) (1,359)
Prepaid expenses 3,068 (1,124)
Other assets (577) (633)
Accounts payable (1,117) (10,313)
Accrued and other liabilities (642) 3,117
------------ ------------
Net cash provided by operating activities 868 164
------------ ------------
Investing activities
Acquisition of fixed assets (2,504) (1,816)
Purchases of short-term investments (9,000) (16,325)
Sales of short-term investments 33,219 29,636
Acquisitions of businesses, net of cash acquired, and other investments (8,787) (103)
------------ ------------
Net cash provided by investing activities 12,928 11,392
------------ ------------
Financing activities
Net proceeds from issuance of stock 1,414 1,620
Excess tax benefit from stock-based compensation 434 351
Treasury stock purchases (2,626) (1,747)
Debt issuance costs (60) -
Payments of long-term obligations (68) (182)
------------ ------------
Net cash (used in) provided by financing activities (906) 42
------------ ------------
Effect of exchange rate changes on cash and cash equivalents (71) 281
------------ ------------
Net increase in cash and cash equivalents 12,819 11,879
Cash and cash equivalents at beginning of period 36,290 64,356
------------ ------------
Cash and cash equivalents at end of period $ 49,109 $ 76,235
============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF BUSINESS
Vertrue Incorporated is a premier internet marketing services company. We
operate a diverse group of marketing businesses that share a unified mission: to
provide every consumer with access to savings and services that improve their
daily lives. Our members and customers have access to direct-to-consumer savings
across our five vertical markets of healthcare, personal property,
security/insurance, discounts, and personals, which are all offered online
through a set of diverse marketing channels. Throughout this report, we refer to
Vertrue Incorporated and its subsidiaries as the "Company", "we", "us", or
"our".
NOTE 2 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP") for interim financial information and include
the accounts of the Company, its wholly owned subsidiaries, and variable
interest entities as required by Financial Accounting Standards Board ("FASB")
Interpretation No. 46R, "Consolidation of Variable Interest Entities - an
Interpretation of ARB No. 51." All significant intercompany accounts and
transactions have been eliminated. Such statements do not include all of the
information and footnotes required by GAAP for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair statement have been included. The
year-end condensed consolidated balance sheet data was derived from audited
financial statements, but does not include all disclosures required by GAAP. The
preparation of these condensed consolidated financial statements in conformity
with GAAP requires us to make estimates, judgments, and assumptions that affect
the amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates. Operating results for the three
months ended September 30, 2006 are not necessarily indicative of the results
that may be expected for the fiscal year ending June 30, 2007. For further
information, refer to the financial statements and footnotes thereto included in
our Annual Report on Form 10-K for the fiscal year ended June 30, 2006.
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
NOTE 3 - ACCOUNTS AND NOTES RECEIVABLE
As of September 30, 2006 and June 30, 2006, we recorded accounts receivable of
$18.0 million and $14.0 million, respectively, in accounts and notes receivable,
net. As of September 30, 2006 and June 30, 2006, we recorded notes receivable of
$9.4 million and $7.0 million, respectively, in accounts and notes receivable,
net and $12.9 million and $9.9 million, respectively, in other long-term assets.
We estimate an allowance for accounts and notes receivable based on an aging
analysis, customer credit evaluations, collection history, and any specific,
known troubled accounts. As of September 30, 2006 and June 30, 2006, we recorded
$0.1 million of allowances for uncollectible accounts. As of September 30, 2006
and June 30, 2006, we recorded $5.3 million and $3.8 million, respectively, of
allowances for uncollectible notes.
4
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangible assets are as follows:
September 30, 2006 June 30, 2006
---------------------------- ----------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
(Dollar amounts in thousands) Amount Amortization Amount Amortization
------------- ------------- ------------- -------------
Membership and client relationships $ 41,315 $ 23,527 $ 40,215 $ 21,881
Trade names 21,859 3,477 21,859 3,114
Other 1,664 1,478 1,504 1,448
------------- ------------- ------------- -------------
Total amortizable intangible assets $ 64,838 $ 28,482 $ 63,578 $ 26,443
------------- ------------- ------------- -------------
Amortizable intangible assets, net $ 36,356 $ 37,135
============= =============
September 30, June 30,
(Dollar amounts in thousands) 2006 2006
------------- -------------
Goodwill $ 214,529 $ 212,187
Intangible asset related to minimum pension liability 663 663
5
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Future intangible amortization expense for the next five years is estimated to
be as follows:
(Dollar amounts in thousands)
Fiscal Year
Remainder of 2007 $ 5,703
2008 4,813
2009 4,300
2010 3,170
2011 3,099
Changes in the carrying amount of goodwill by segment during the three months
ended September 30, 2006 were as follows:
Marketing Management
(Dollar amounts in thousands) Services Personals Services Total
----------- ----------- ----------- -----------
Balance at beginning of period $ 96,432 $ 81,508 $ 34,247 $ 212,187
Acquisition - 2,342 - 2,342
----------- ----------- ----------- -----------
Balance at end of period $ 96,432 $ 83,850 $ 34,247 $ 214,529
=========== =========== =========== ===========
We acquired Mobile Lifestyles, Inc., an online provider of a variety of text
alerts (i.e. daily horoscopes, jokes and relationship advice) and unlimited
ringtones during the first quarter of fiscal 2007. In connection with this
acquisition, we recorded goodwill of $2.3 million and intangible assets of $1.3
million. The net assets and results of operations of Mobile Lifestyles have been
included in our Personals segment as of the date of acquisition.
NOTE 5 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities reported in the accompanying unaudited condensed
consolidated balance sheets as of September 30, 2006 and June 30, 2006 include
an allowance for membership cancellations of $8.2 million and $9.3 million,
respectively.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
We have an amended and restated senior secured credit facility dated as of March
17, 2006, which allows borrowings of up to $50.0 million. Borrowings under this
senior secured credit facility accrue interest at the Eurodollar rate or Prime
rate, plus an applicable margin. There were no borrowings outstanding under this
senior secured credit facility as of September 30, 2006. This credit facility
matures on March 31, 2009.
Contingent payments related to acquisitions of up to $52.3 million may be paid
if certain performance targets are achieved, including increasing levels of
revenues and earnings. These contingent payments may be paid over the next two
fiscal years. As of September 30, 2006, we had outstanding purchase obligations
of $8.3 million primarily related to marketing agreements and contracts for our
software, equipment, and services. In addition, we had commitments of $56.4
million related to existing operating leases.
Legal proceedings
In our opinion, there are no significant legal proceedings to which we or any of
our subsidiaries are a party or to which any of our properties are subject. We
are involved in lawsuits and claims generally incidental to our business,
including but not limited to various suits, including previously disclosed
suits, brought against us by individual consumers seeking monetary and/or
injunctive relief relating to the marketing of our programs. In addition, from
time to time in the regular course of our business, we receive inquiries from
various federal and/or state regulatory authorities.
6
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 7 - INCOME TAX EXPENSE
Income tax expense as a percentage of pre-tax income was 36.6% and 34.3% for the
three months ended September 30, 2006 and 2005, respectively. The effective tax
rate was higher than the U.S. statutory rate for the three months ended
September 30, 2006 primarily due to state taxes and other non-deductible items
offset by the favorable impact of foreign operations. The effective tax rate was
lower than the U.S. statutory rate for the three months ended September 30, 2005
due to the tax benefit associated with the Lavalife Inc. acquisition.
We have open tax years in the U.S., Canada, and other jurisdictions. There are
tax years that are not currently under examination by the applicable tax
authorities but may be subject to examination in the future. The results of
audits are inherently uncertain. We periodically evaluate the adequacy of our
tax reserves, taking into account our open tax return positions and tax law
changes. We believe that our tax reserves are appropriate. However, the final
determination of tax audits could have a material effect on our results of
operations, financial position, and cash flow.
NOTE 8 - EARNINGS PER SHARE
The table below reconciles the numerators and denominators used in the
computations of basic and diluted earnings per share:
Three months ended
September 30,
------------------------
(Dollar amount in thousands, except per share data) 2006 2005
----------- -----------
Numerator:
Income available to common shareholders used in basic earnings per share $ 6,676 $ 8,641
Add back interest expense on convertible securities, net of tax 784 813
----------- -----------
Income available to common shareholders after assumed conversion of dilutive
securities $ 7,460 $ 9,454
=========== ===========
Denominator:
Weighted average number of common shares outstanding - basic 9,668 9,714
Effect of dilutive securities:
Convertible securities 2,230 2,230
Stock options 835 839
----------- -----------
Weighted average number of common shares outstanding - diluted 12,733 12,783
=========== ===========
Basic earnings per share $ 0.69 $ 0.89
=========== ===========
Diluted earnings per share $ 0.59 $ 0.74
=========== ===========
The diluted earnings per common share calculations exclude the effect of
potentially dilutive shares when their effect is antidilutive. Excluded from the
diluted share calculation above for the three months ended September 30, 2006
and 2005 are incremental weighted average stock options of approximately 497,000
and 556,000, respectively.
NOTE 9 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three months ended
September 30,
-------------------------
(Dollar amounts in thousands) 2006 2005
----------- -----------
Net income $ 6,676 $ 8,641
Unrealized hedging (loss) gain (10) 518
Currency translation adjustment (69) 240
----------- -----------
Comprehensive income $ 6,597 $ 9,399
=========== ===========
7
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 10 - BUSINESS SEGMENTS
The operating business segments reported below are our reportable business
segments for which separate financial information is available and for which
operating results are evaluated regularly by our executive management in
assessing performance and deciding how to allocate capital and other resources.
We have three reportable business segments: Marketing Services, Personals, and
Management Services. The Marketing Services business segment primarily provides
discounted products and services to consumers and generates recurring,
membership-based revenue. The Personals business segment provides web, phone,
and mobile-based personals services and primarily generates transaction-based
revenue. The Management Services business segment provides advertising and
practice management services to healthcare professionals throughout the United
States. The Corporate business unit includes unallocated general corporate
expenses.
Management evaluates the operating results of each reportable business segment
based on revenue and Adjusted EBITDA. The following is a summary of revenues,
Adjusted EBITDA, capital expenditures, depreciation and amortization, and assets
by business segment:
Three months ended
(Dollar amounts in thousands) September 30,
----------------------------
Revenues 2006 2005
------------- -------------
Marketing Services $ 140,835 $ 131,848
Personals 22,665 18,569
Management Services 14,008 7,191
Intersegment (162) (80)
------------- -------------
Total $ 177,346 $ 157,528
============= =============
Adjusted EBITDA (1)
Marketing Services $ 17,456 $ 21,625
Personals 2,040 2,230
Management Services 2,213 588
Corporate (7,876) (6,079)
------------- -------------
Total $ 13,833 $ 18,364
============= =============
Capital Expenditures (2)
Marketing Services $ 2,136 $ 1,545
Personals 209 253
Management Services 159 18
Corporate - -
------------- -------------
Total $ 2,504 $ 1,816
============= =============
Depreciation and Amortization
Marketing Services $ 2,808 $ 3,270
Personals 2,456 2,355
Management Services 641 399
Corporate 161 274
------------- -------------
Total $ 6,066 $ 6,298
============= =============
8
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
September 30, June 30,
Assets 2006 2006
------------- -------------
Marketing Services $ 224,376 $ 214,083
Personals 129,161 124,571
Management Services 70,367 62,730
Corporate (3) 17,633 41,644
------------- -------------
Total $ 441,537 $ 443,028
============= =============
(1) Defined as net income excluding interest and other expense, net, provision
for income taxes, depreciation and amortization and the changes in deferred
revenue and deferred marketing costs. See reconciliations below.
(2) Management does not allocate capital expenditures to the Corporate business
unit. However, the associated depreciation expense has been allocated for
purposes of evaluating performance.
(3) Includes unallocated non-operating assets including short-term investments,
debt issuance costs, and other.
The following tables reconcile Adjusted EBITDA to income before income taxes:
Three months ended September 30, 2006
---------------------------------------------------------------
(Dollar amounts in thousands) Marketing Management
Total Services Personals Services Corporate
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 10,529
Interest and other expense, net (1) 3,423
-----------
Operating income (expense) $ 13,952 $ 20,398 $ (380) $ 1,971 $ (8,037)
Depreciation and amortization 6,066 2,808 2,456 641 161
Change in deferred revenues (7,799) (7,364) (36) (399) -
Change in deferred marketing costs 1,614 1,614 - - -
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 13,833 $ 17,456 $ 2,040 $ 2,213 $ (7,876)
=========== =========== =========== =========== ===========
Three months ended September 30, 2005
---------------------------------------------------------------
Marketing Management
Total Services Personals Services Corporate
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 13,158
Interest and other expense, net (1) 4,498
-----------
Operating income (expense) $ 17,656 $ 23,699 $ (60) $ 370 $ (6,353)
Depreciation and amortization 6,298 3,270 2,355 399 274
Change in deferred revenues (9,580) (9,334) (65) (181) -
Change in deferred marketing costs 3,990 3,990 - - -
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 18,364 $ 21,625 $ 2,230 $ 588 $ (6,079)
=========== =========== =========== =========== ===========
(1) Management does not allocate interest and other expense, net to the individual segments.
9
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 11 - GUARANTOR FINANCIAL INFORMATION
In April 2004, we issued $150.0 million aggregate principal amount of 9.25%
Senior Notes due 2014. The Senior Notes are unsecured obligations and rank pari
passu in right of payment to all our existing and future senior unsecured
indebtedness and senior in right of payment to all of our existing and future
subordinated indebtedness that expressly provides for its subordination to the
Senior Notes. Effective April 28, 2006, the Senior Notes are fully and
unconditionally guaranteed by substantially all of our subsidiaries that
guarantee our Credit Facility (as defined in the First Indenture dated April 28,
2006 governing the Senior Notes). All prior periods have been restated to
conform to this presentation.
The following condensed consolidating financial information presents the balance
sheets as of September 30, 2006 and June 30, 2006 and the related statements of
operations and cash flows for the three months ended September 30, 2006 and
2005. The information includes the elimination entries necessary to consolidate
the Company ("Parent") with the guarantor entities.
Investments in subsidiaries are accounted for by the Parent using the equity
method of accounting. The principal elimination entries eliminate investments in
subsidiaries and intercompany balances and transactions.
Condensed Consolidating Balance Sheets
September 30, 2006
------------------------------------------------------
Guarantor
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Assets
Current assets $ 54,084 $ 129,276 $ (60,936) $ 122,424
Fixed assets, net 22,080 21,848 - 43,928
Goodwill - 214,529 - 214,529
Intangible assets, net 666 36,353 - 37,019
Other long-term assets 10,348 13,289 - 23,637
Investment in subsidiaries 314,634 - (314,634) -
------------ ------------ ------------ ------------
Total assets $ 401,812 $ 415,295 $ (375,570) $ 441,537
============ ============ ============ ============
Liabilities and Shareholders' (Deficit) Equity
Current liabilities $ 165,957 $ 92,683 $ (60,936) $ 197,704
Deferred income taxes (983) 6,721 - 5,738
Long-term debt 238,028 - - 238,028
Other long-term liabilities 7,975 1,257 - 9,232
------------ ------------ ------------ ------------
Total liabilities 410,977 100,661 (60,936) 450,702
------------ ------------ ------------ ------------
Shareholders' (deficit) equity:
Preferred stock - - -
Common stock 202 3 (3) 202
Capital in excess of par value 191,024 278,758 (278,758) 191,024
Retained earnings 75,058 35,664 (35,664) 75,058
Accumulated other comprehensive income 135 209 (209) 135
Treasury stock (275,584) - - (275,584)
------------ ------------ ------------ ------------
Total shareholders' (deficit) equity (9,165) 314,634 (314,634) (9,165)
------------ ------------ ------------ ------------
Total liabilities and shareholders' (deficit) equity $ 401,812 $ 415,295 $ (375,570) $ 441,537
============ ============ ============ ============
10
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Condensed Consolidating Balance Sheets
June 30, 2006
-------------------------------------------------------
Guarantor
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Assets
Current assets $ 37,724 $ 115,844 $ (21,545) $ 132,023
Fixed assets, net 22,532 18,036 - 40,568
Goodwill - 212,187 - 212,187
Intangible assets, net 675 37,123 - 37,798
Other long-term assets 10,205 10,247 - 20,452
Investment in subsidiaries 308,919 - (308,919) -
------------ ------------ ------------ ------------
Total assets $ 380,055 $ 393,437 $ (330,464) $ 443,028
============ ============ ============ ============
Liabilities and Shareholders' (Deficit) Equity
Current liabilities $ 149,958 $ 75,891 $ (21,545) $ 204,304
Deferred income taxes (318) 7,238 - 6,920
Long-term debt 237,984 - - 237,984
Other long-term liabilities 8,600 1,389 - 9,989
------------ ------------ ------------ ------------
Total liabilities 396,224 84,518 (21,545) 459,197
------------ ------------ ------------ ------------
Shareholders' (deficit) equity:
Common stock 202 9 (9) 202
Capital in excess of par value 187,991 278,751 (278,751) 187,991
Retained earnings 68,382 29,890 (29,890) 68,382
Accumulated other comprehensive income 214 269 (269) 214
Treasury stock (272,958) - - (272,958)
------------ ------------ ------------ ------------
Total shareholders' (deficit) equity (16,169) 308,919 (308,919) (16,169)
------------ ------------ ------------ ------------
Total liabilities and shareholders' (deficit) equity $ 380,055 $ 393,437 $ (330,464) $ 443,028
============ ============ ============ ============
11
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Condensed Consolidating Statements of Operations
For the three months ended September 30, 2006
----------------------------------------------------------
Guarantor
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------- ------------- ------------- -------------
Revenues $ 100,383 $ 82,153 $ (5,190) $ 177,346
Expenses:
Marketing 55,369 37,199 (5,185) 87,383
Operating 19,207 23,008 (5) 42,210
General and administrative 19,332 12,430 - 31,762
Amortization of intangible assets 9 2,030 - 2,039
------------- ------------- ------------- -------------
Operating income 6,466 7,486 - 13,952
Equity in income of subsidiaries 5,774 - (5,774) -
Interest (expense) income, net (5,010) 1,392 - (3,618)
Other income, net - 195 - 195
------------- ------------- ------------- -------------
Income before income taxes 7,230 9,073 (5,774) 10,529
Provision for income taxes 554 3,299 - 3,853
------------- ------------- ------------- -------------
Net income $ 6,676 $ 5,774 $ (5,774) $ 6,676
============= ============= ============= =============
Condensed Consolidating Statements of Operations
For the three months ended September 30, 2005
----------------------------------------------------------
Guarantor
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------- ------------- ------------- -------------
Revenues $ 96,809 $ 65,899 $ (5,180) $ 157,528
Expenses:
Marketing 51,236 27,597 (4,934) 73,899
Operating 17,275 18,054 (246) 35,083
General and administrative 16,794 11,660 - 28,454
Amortization of intangible assets 76 2,360 - 2,436
------------- ------------- ------------- -------------
Operating income 11,428 6,228 - 17,656
Equity in income of subsidiaries 4,134 - (4,134) -
Interest (expense) income, net (4,716) 262 - (4,454)
Other income (expense), net 24 (68) - (44)
------------- ------------- ------------- -------------
Income before income taxes 10,870 6,422 (4,134) 13,158
Provision for income taxes 2,229 2,288 - 4,517
------------- ------------- ------------- -------------
Net income $ 8,641 $ 4,134 $ (4,134) $ 8,641
============= ============= ============= =============
12
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Condensed Consolidating Statements of Cash Flows
For the three months ended September 30, 2006
-----------------------------------------------------------
Guarantor
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------- ------------- ------------- -------------
Net cash (used in) provided by operating activities $ (1,824) $ 8,466 $ (5,774) $ 868
Investing activities
Acquisition of fixed assets (1,530) (974) - (2,504)
Purchases of short-term investments (9,000) - - (9,000)
Sales of short-term investments 33,224 (5) - 33,219
Acquisitions of businesses, net of cash acquired, and other
investments (367) (8,420) - (8,787)
Other investments (5,774) - 5,774 -
------------- ------------- ------------- -------------
Net cash provided by (used in) investing activities 16,553 (9,399) 5,774 12,928
------------- ------------- ------------- -------------
Financing activities
Net proceeds from issuance of stock 1,414 - - 1,414
Excess tax benefit from stock-based compensation 434 - - 434
Treasury stock purchases (2,626) - - (2,626)
Debt issuance costs (60) - - (60)
Payments of long-term obligations (68) - - (68)
------------- ------------- ------------- -------------
Net cash used in financing activities (906) - - (906)
------------- ------------- ------------- -------------
Effect of exchange rate changes on cash and cash equivalents - (71) - (71)
------------- ------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents 13,823 (1,004) - 12,819
Cash and cash equivalents at beginning of period 6,908 29,382 - 36,290
------------- ------------- ------------- -------------
Cash and cash equivalents at end of period $ 20,731 $ 28,378 $ - $ 49,109
============= ============= ============= =============
13
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Condensed Consolidating Statements of Cash Flows
Three months ended September 30, 2005
------------------------------------------------------
Guarantor
Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Net cash provided by (used in) operating activities $ 3,153 $ 1,145 $ (4,134) $ 164
Investing activities
Acquisition of fixed assets (880) (936) - (1,816)
Purchases of short-term investments (16,325) - - (16,325)
Sales of short-term investments 29,527 109 - 29,636
Acquisition of businesses, net of cash acquired,
and other investments (21) (82) - (103)
Investment in subsidiaries (4,134) - 4,134 -
------------ ------------ ------------ ------------
Net cash provided by (used in) investing activities 8,167 (909) 4,134 11,392
------------ ------------ ------------ ------------
Financing activities
Net proceeds from issuance of stock 1,620 - - 1,620
Excess tax benefit from stock-based compensation 351 - - 351
Treasury stock purchases (1,747) - - (1,747)
Payments of long-term obligations (85) (97) - (182)
------------ ------------ ------------ ------------
Net cash provided by (used in) financing activities 139 (97) - 42
------------ ------------ ------------ ------------
Effect of exchange rate changes on cash and cash equivalents - 281 - 281
------------ ------------ ------------ ------------
Net increase in cash and cash equivalents 11,459 420 - 11,879
Cash and cash equivalents at beginning of period 24,366 39,990 - 64,356
------------ ------------ ------------ ------------
Cash and cash equivalents at end of period $ 35,825 $ 40,410 $ - $ 76,235
============ ============ ============ ============
14
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 12 - NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans -- an amendment of FASB
Statements No. 87, 88, 106, and 132(R)" ("SFAS 158"). SFAS 158 requires an
employer to recognize the over-funded or under-funded status of a defined
benefit postretirement plan (other than a multiemployer plan) as an asset or
liability in its statement of financial position and to recognize changes in
that funded status in the year in which the changes occur through comprehensive
income. SFAS 158 also requires the measurement of defined benefit plan assets
and obligations as of the date of the employer's fiscal year-end (with limited
exceptions). Under SFAS 158, we are required to recognize the funded status of
our defined benefit postretirement plan and to provide the required disclosures
as of the end of our fiscal 2007 year end. We do not expect the adoption of SFAS
158 to have a material effect on our consolidated financial statements.
Also in September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring
fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS 157 emphasizes that fair value
is a market-based measurement, not an entity-specific measurement, and states
that a fair value measurement should be determined based on the assumptions that
market participants would use in pricing the asset or liability. SFAS 157 will
become effective for us beginning in fiscal 2009. We are currently evaluating
the impact, if any, that SFAS 157 will have on our consolidated financial
statements.
Also in September 2006, the Security Exchange Commission issued Staff Accounting
Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). SAB
108 requires entities to quantify misstatements using both balance sheet and
income statement approaches in evaluating whether or not a misstatement is
material. SAB 108 is effective for fiscal years ending on or after November 15,
2006. We do not expect the adoption of SAB 108 to have a material effect on our
consolidated financial statements.
In July 2006, the FASB issued Financial Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
48"). This interpretation clarifies the accounting for uncertainty in tax
positions and requires an entity to recognize in its financial statements the
impact of a tax position, if that position is more likely than not of being
sustained on audit, based on the technical merits of the position. The
provisions of FIN 48 are effective beginning in our first quarter of fiscal
2008. We are currently evaluating the impact of FIN 48 on our financial
statements.
15
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Vertrue Incorporated is a premier internet marketing services company. We
operate a diverse group of marketing businesses that share a unified mission: to
provide every consumer with access to savings and services that improve their
daily lives. Our members and customers have access to direct-to-consumer savings
across our five vertical markets of healthcare, personal property,
security/insurance, discounts, and personals, which are all offered online
through a set of diverse marketing channels. Throughout this report, we refer to
Vertrue Incorporated and its subsidiaries as the "Company", "we", "us", or
"our". We have three reportable business segments: Marketing Services,
Personals, and Management Services.
The Marketing Services business segment primarily provides discounted products
and services to consumers and generates recurring, membership-based revenue. The
Marketing Services segment offers consumers a variety of products and services
from selected vendors and service providers on a monthly or annual subscription
basis or on a fee for service basis. Revenues are derived principally from
recurring fees which are billed to the member on either a monthly or annual
basis. In the case of annually billed membership fees, we receive full payment
at or near the beginning of the membership period, but recognize the revenues as
the member's refund privilege expires. Membership fees that are billed monthly
are recognized when earned. Revenues derived from one-time fees are recognized
when the service is performed.
The Personals business segment provides web, phone, and mobile-based personals
services and primarily generates transaction-based revenue. The Personals
segment primarily employs a transactional business model in which users buy
non-refundable credits up front and spend those credits only when they want to
interact with other customers. Personals revenues are recognized when the
services are used. During the first quarter of fiscal 2007, we acquired Mobile
Lifestyles, Inc., an online provider of a variety of text alerts (i.e. daily
horoscopes, jokes and relationship advice) and unlimited ringtones. The net
assets and results of operations of Mobile Lifestyles have been included in our
Personals segment as of the date of acquisition.
The Management Services business segment provides advertising and practice
management services to healthcare professionals throughout the United States.
Our consultants assist consumers with locating nearby board certified
physicians, schedule initial consultations, offer discounted fee schedules, and
provide financing, if needed. Management Services revenues are recognized when
the medical procedures performed by the healthcare professionals are complete.
The following discussion should be read in conjunction with Item 7,
"Management's Discussion & Analysis of Financial Condition and Results of
Operations" in our Annual Report on Form 10-K for the year ended June 30, 2006,
which describes, among other things, our critical accounting policies.
Adjusted EBITDA and EBITDA are used by our management to evaluate the
performance of our business. Management evaluates the operating results of each
reportable business segment based on Adjusted EBITDA. A discussion of Adjusted
EBITDA can be found in "Liquidity and Capital Resources" in this report. A
description and reconciliation of net income to EBITDA and Adjusted EBITDA are
disclosed in "Reconciliation of Non-GAAP Measures" in this report.
16
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
DISCUSSION OF RESULTS OF OPERATIONS
Three months ended
September 30,
---------------------- Increase/
(Dollars amounts in millions) 2006 2005 (Decrease)
---------- ---------- -----------
Revenues $ 177.3 $ 157.5 13%
Marketing expenses 87.4 73.9 18%
Operating expenses 42.2 35.1 20%
General and administrative expenses 31.8 28.5 12%
Amortization of intangible assets 2.0 2.4 (17%)
---------- ---------- -----------
Operating income 13.9 17.6 (21%)
Interest income 1.5 0.6 150%
Interest expense (5.1) (5.1) 0%
Other income, net 0.2 - NM
---------- ---------- -----------
Income before income taxes 10.5 13.1 (20%)
Provision for income taxes 3.8 4.5 (16%)
---------- ---------- -----------
Net income $ 6.7 $ 8.6 (22%)
========== ========== ===========
EBITDA $ 20.0 $ 24.0 (17%)
========== ========== ===========
NM= Not Meaningful
Three months ended
September 30,
----------------------
Percentage of revenues: 2006 2005
---------- ----------
Marketing expenses 49% 47%
Operating expenses 24% 22%
General and administrative expenses 18% 18%
Operating income 8% 11%
EBITDA 11% 15%
Effective tax rate 36.6% 34.3%
Revenues
The table below shows revenue by payment plan and by reportable segment:
Three months ended
September 30,
---------------------- Increase/
(Dollars amounts in millions) 2006 2005 (Decrease)
---------- ---------- -----------
Monthly payment plans $ 103.1 $ 83.1 24%
Annual payment plans 29.4 40.7 (28%)
Other 8.2 8.0 3%
---------- ---------- -----------
Total Marketing Services 140.7 131.8 7%
Personals 22.6 18.5 22%
Management Services 14.0 7.2 94%
---------- ---------- -----------
Total $ 177.3 $ 157.5 13%
========== ========== ===========
Revenues increased $19.8 million in the first quarter of fiscal 2007 compared
with the first quarter of fiscal 2006. Net active retail members and customers
increased 5% to 6.7 million at September 30, 2006 from 6.4 million at September
30, 2005.
17
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
Marketing Services revenues increased $8.9 million primarily due to a $20.0
million increase in revenues from members enrolled in monthly payment plans
partially offset by $11.3 million decrease in revenue from members enrolled in
annual payment plans. Revenues from monthly payment plans increased primarily
due to higher average monthly members billed, which grew 14% to 2.9 million, and
higher average monthly member price point, which grew 9% to $11.77 for the first
quarter of fiscal 2007 compared with the prior year period.(*) Revenues from
members enrolled in annual payment plans continue to decrease due to the
attrition of the annual renewal base and the continued shift to enrolling new
members in monthly payment programs.
Personals revenues increased $4.1 million, or 22%, primarily due to the
acquisition of Mobile Lifestyles during the first quarter of fiscal 2007.
Excluding revenues from this acquisition, Personals revenues would have
increased 3% primarily due to Lavalife's growing mobile dating business.
Management Services revenues increased $6.8 million primarily due to an increase
in the number of procedures completed and an increase in the mix of higher
priced procedures. These increases were due to the significant increase in
financed transactions.
Operating Income and EBITDA
The table below shows operating income and EBITDA by reportable segment and our
corporate unit that includes unallocated general corporate expenses:
Operating Income EBITDA
------------------------------- ------------------------------
Three months ended Three months ended
September 30, September 30,
------------------- Increase/ ------------------- Increase/
(Dollars amounts in millions) 2006 2005 (Decrease) 2006 2005 (Decrease)
--------- --------- ---------- --------- --------- ----------
Marketing Services $ 20.4 $ 23.7 (14%) $ 23.2 $ 27.0 (14%)
Personals (0.5) (0.1) (400%) 2.1 2.3 (9%)
Management Services 2.0 0.4 400% 2.6 0.8 225%
Corporate (8.0) (6.4) (25%) (7.9) (6.1) (30%)
--------- --------- ---------- --------- --------- ----------
Total Operating Income $ 13.9 $ 17.6 (21%) $ 20.0 $ 24.0 (17%)
========= ========= ========== ========= ========= ==========
Operating income decreased $3.7 million and, as a percentage of revenues, was 8%
during the first quarter of fiscal 2007 compared to 11% in the prior year
period. EBITDA decreased $4.0 million in the first quarter of fiscal 2007 from
the prior year period and, as a percentage of revenues, EBITDA was 11% this year
versus 15% last year.
Marketing Services operating income decreased $3.3 million and, as a percentage
of revenues, decreased to 14% from 18% in the prior year period. Marketing
Services EBITDA decreased $3.8 million and, as a percentage of revenues,
decreased to 16% from 20% in the prior year period. The decreases were primarily
due to an increase in marketing expenses, which grew $8.0 million, and as a
percentage of revenues were 52% this year compared to 49% last year, and were in
line with our expected revenue growth. Marketing expenses as a percentage of
revenues increased due to an increase in the level of marketing and an increase
in the monthly acquisition costs per new billed member. The monthly acquisition
cost per new billed member increased 24% to $44.81 from $36.28 in the prior year
period. Monthly member acquisition costs represent the cost to acquire a new
monthly member who has successfully billed and is not expected to cancel during
the reported period. We expect the increase in the monthly acquisition cost per
new billed member to be more than recovered by the monthly new member price
point which increased $2.48 to $17.07 per month during the September 30, 2006
quarter. In addition, operating expenses increased $3.2 million and as a
percentage of revenues were 21% this year compared to 20% last year. These
increases were primarily due to the increased cost of servicing the higher
member base.
Personals operating loss increased $0.4 million and, as a percentage of
revenues, decreased to (2%) from (1%) in the prior year period. Personals EBITDA
decreased $0.2 million and, as a percentage of revenues, decreased to 9% from
12% in the prior year period. The increase in operating loss and lower EBITDA
were primarily due to higher marketing expenses related to promotion,
advertising, and mobile-related expenses.
------------------------------
* During the first quarter of fiscal 2007, we changed the methodologies for
calculating average monthly member price point and average monthly members
billed. Prior periods have been restated to conform to this presentation.
18
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
Management Services operating income increased $1.6 million, and as a percentage
of revenue, increased to 14% from 6% in the prior year period. Management
Services EBITDA increased $1.8 million and as a percentage of revenue, increased
to 19% from 11% in the prior year period. These increases are primarily due to
the growth in revenues related to the increase in financed transactions.
Operating income and EBITDA increased at a greater rate than the increase in
revenue due to the leveraging of overhead expenses.
Corporate operating loss increased $1.6 million and EBITDA decreased $1.8
million primarily due to higher employee and legal related expenses.
Interest Income
Interest income increased $0.9 million primarily due to the increase in financed
transactions for the Management Services segment.
Provision for Income Taxes
The provision for income taxes decreased $0.7 million, or 16%, in the first
quarter of fiscal 2007 compared to the prior year because of lower income before
income taxes and was based on an effective tax rate of 36.6% versus 34.3% in the
prior year quarter. The increase in the effective tax rate for the quarter is
primarily due to the decrease in the U.S. tax benefit of the losses from certain
foreign operations that can be used in the foreign jurisdiction without a U.S.
tax cost.
The effective tax rate was lower than the U.S. statutory rate for the three
months ended September 30, 2005 due to the tax benefit associated with the
Lavalife acquisition.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2006, we had cash, cash equivalents, and short-term
investments of $56.7 million in addition to our $50.0 million unused line of
credit under our senior secured credit facility. We believe that existing cash,
short-term investment balances, and funds available under our senior secured
credit facility together with cash generated from operations will be sufficient
to meet our funding requirements for the foreseeable future.
We believe it is useful to analyze the components of net cash provided by
operating activities as follows: revenue before deferral, marketing costs before
deferral, Adjusted EBITDA, and changes in assets and liabilities. For
definitions and reconciliations of revenue before deferral, marketing costs
before deferral, and Adjusted EBITDA, refer to the discussion in "Reconciliation
of Non-GAAP Measures" in this report.
Net cash flow provided by operating activities is an important measure used to
understand our liquidity. Net cash provided by operating activities increased to
$0.9 million in the three months ended September 30, 2006 from $0.2 million in
the three months ended September 30, 2005. The $0.7 million increase in
operating cash flow was primarily due to a $3.9 million improvement in the
impact of changes in assets and liabilities and a $1.1 million increase in
interest and other expense, net, partially offset by a $4.6 million decrease in
Adjusted EBITDA.
Adjusted EBITDA
--------------------------------
Three months ended
September 30,
-------------------- Increase/
(Dollars amounts in millions) 2006 2005 (Decrease)
--------- --------- ----------
Marketing Services $ 17.5 $ 21.7 (19%)
Personals 2.0 2.2 (9%)
Management Services 2.2 0.6 267%
Corporate (7.9) (6.1) (30%)
--------- --------- ----------
Total $ 13.8 $ 18.4 (25%)
========= ========= ==========
Marketing Services Adjusted EBITDA decreased $4.2 million and as a percentage of
revenue before deferral, decreased to 13% from 18% in the prior year period. The
decreases were due to an increase in the level of marketing and an increase in
the monthly acquisition costs per new billed member, as discussed above. In
19
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
addition, operating expenses increased $3.2 million and as a percentage of
revenues before deferral were 22% this year compared to 21% last year primarily
due to the increased cost of servicing the higher member base discussed above.
Personals Adjusted EBITDA decreased $0.2 million and as a percentage of revenue
before deferral, decreased to 9% from 12% in the prior year period. These
decreases were primarily due to higher marketing expenses related to promotion,
advertising, and mobile-related expenses discussed above.
Management Services Adjusted EBITDA increased $1.6 million and as a percentage
of revenue before deferral, increased to 16% from 9% in the prior year period
primarily due to the leveraging of overhead expenses as revenues increased.
Corporate Adjusted EBITDA decreased $1.8 million primarily due to higher
employee and legal related expenses.
In the first quarter of fiscal 2007, cash used from changes in assets and
liabilities was $6.1 million compared to $10.0 million in the prior year period.
The decrease in the cash used from changes in assets and liabilities was
primarily due to the timing of trade payables and prepaid expenses, partially
offset by an increase in notes receivable. The increase in notes receivable is
related to the increase in procedures completed that are being financed.
In the first quarter of fiscal 2007, capital expenditures increased to $2.5
million from $1.8 million in the prior year period. Free cash flow, defined as
operating cash flow less capital expenditures, remained flat at $(1.6) million
for both periods.
In the first quarter of fiscal 2007, net cash provided by investing activities
increased $1.5 million from the prior year period. Net cash provided by
investing activities in the first quarter fiscal 2007 reflected $24.2 million
net sales of short-term investments partially offset by $8.8 million used in
connection with our recent acquisition and other investments. Net cash provided
by investing activities in the first quarter fiscal 2006 reflected $13.3 million
of net proceeds from sales of short-term investments.
In the first quarter of fiscal 2007, net cash used in financing activities
decreased $0.9 million from the prior year period. Net cash used in financing
activities in the first quarter fiscal 2007 reflected the use of $2.6 million to
repurchase our common stock, which was partially offset by $1.4 million of
proceeds from the exercise of stock options and $0.4 million of excess tax
benefit from stock-based compensation. Net cash provided by financing activities
in the first quarter of fiscal 2006 reflected the use of $1.7 million to
repurchase our common stock, which was offset by proceeds from the exercise of
stock options of $1.6 million and $0.4 million of excess tax benefits from
stock-based compensation.
Credit Facility
We have an amended and restated senior secured credit facility dated as of March
17, 2006, which allows borrowings of up to $50.0 million. Borrowings under this
senior secured credit facility accrue interest at the Eurodollar rate or the
Prime rate, plus an applicable margin. As of September 30, 2006, the base
interest rate for borrowings under this credit facility was 8.5%. There were no
borrowings outstanding under this credit facility as of September 30, 2006. The
senior secured credit facility has certain financial covenants, including a
maximum debt coverage ratio, potential restrictions on borrowings, and potential
restrictions on additional stock repurchases. As of September 30, 2006, we were
in compliance with all such debt covenants. The senior secured credit facility
matures on March 31, 2009.
Stock Repurchase Program
In the first quarter of fiscal 2007, we purchased 62,600 shares of our common
stock for $2.6 million at an average price of $41.92 per share, compared to
49,900 shares for $1.7 million at an average price of $35.01 per share in the
prior year period. We use existing cash and cash from operations and stock
issuances to repurchase these shares. In July 2006, our Board of Directors
authorized the additional repurchase of up to a 1.0 million shares of our
common stock. As of September 30, 2006, we had approximately 1.3 million shares
available for repurchase under our stock repurchase program.
Other
We expect to incur capital expenditures of $8.0 million in fiscal 2007. In
addition, contingent payments related to acquisitions of up to $52.3 million may
be paid if certain performance targets are achieved, including increasing levels
of revenues and earnings. These contingent payments may be paid over the next
two fiscal years.
20
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
RECONCILIATION OF NON-GAAP MEASURES
We believe that revenues before deferral and marketing costs before deferral are
important measures of liquidity and are significant factors in understanding our
operating cash flow trends. These measures are not a substitute for or superior
to revenues and marketing expenses determined in accordance with generally
accepted accounting principles ("GAAP"). These non-GAAP measures are used by
management and our investors to understand the liquidity trends of our marketing
margins related to current period operations which are reflected within the
operating cash flow section of the cash flow statement. GAAP revenues and
marketing expenses are important measures used to understand the marketing
margins earned during the period in the income statement. However, in order to
understand our operating cash flow, it is important to understand the primary
current period drivers of that cash flow. Two of the primary indicators of
operating liquidity for the period are revenues before deferral and marketing
costs before deferral. Revenues before deferral are revenues before the
application of the Staff Accounting Bulletin 104, "Revenue Recognition" ("SAB
104") and represent the revenues billed during the current reporting period less
an allowance for membership cancellations. That is, revenues before deferral for
a reporting period include membership fees received in the current reporting
period that will be recorded as GAAP revenues in future reporting periods and
exclude membership fees received in prior reporting periods that are recorded as
GAAP revenues in the current reporting period. Marketing costs before deferral
are marketing costs before the application of SAB 104 and the American Institute
of Certified Public Accountants Statement of Position 93-7, "Reporting on
Advertising Costs," and represent marketing costs paid or accrued during the
current reporting period. Marketing costs before deferral for a reporting period
include costs paid or accrued in the current reporting period that will be
recorded as GAAP marketing expenses in future reporting periods and exclude
marketing expenses paid or accrued in prior reporting periods that are recorded
as GAAP marketing expenses in the current reporting period. Neither revenues
before deferral nor marketing costs before deferral exclude charges or
liabilities that will require future cash settlement.
Revenues before deferral are calculated as follows:
Three months ended
September 30,
------------------------
(Dollars amounts in millions) 2006 2005
---------- ----------
Revenues $ 177.3 $ 157.5
Change in deferred revenues (7.8) (9.6)
---------- ----------
Revenues before deferral $ 169.5 $ 147.9
========== ==========
Marketing costs before deferral are calculated as follows:
Three months ended
September 30,
------------------------
(Dollars amounts in millions) 2006 2005
---------- ----------
Marketing expenses $ 87.4 $ 73.9
Change in deferred marketing costs (1.6) (4.0)
---------- ----------
Marketing costs before deferral $ 85.8 $ 69.9
========== ==========
EBITDA is calculated as net income excluding interest and other expense, taxes,
depreciation, and amortization. Adjusted EBITDA is calculated as EBITDA before
the deferral of revenues and the deferral of marketing costs.
We use EBITDA and Adjusted EBITDA to evaluate the overall performance of our
business and to measure that performance compared with internal budgets.
Additionally, we use Adjusted EBITDA as our primary measure to allocate capital
and other resources to our operating segments and assess the operating
performance of those segments (See Note 10 to the condensed consolidated
financial statements in Item 1 of this report). Adjusted EBITDA is also one of
the measures used to determine compensation under our management incentive
plans.
Adjusted EBITDA is useful to our investors and us because it provides insight
into the current period cash operating results. Adjusted EBITDA is reconciled to
net cash provided by operating activities because we believe that it is the most
directly comparable GAAP liquidity measure. We also use Adjusted EBITDA as the
21
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
primary performance measure of the business both on an overall company basis as
well as for our operating segments. Adjusted EBITDA is reconciled to net income
because we believe it is the most directly comparable GAAP performance measure.
EBITDA is useful to our investors and us because it eliminates the effects of
interest and other expense, income taxes, non-cash depreciation of tangible
assets, and non-cash amortization of intangible assets. EBITDA is calculated
using as reported revenues and marketing expenses. EBITDA is reconciled to net
income because we believe that it is the most directly comparable GAAP measure.
The usefulness of Adjusted EBITDA and EBITDA is limited as compared to net cash
provided by operating activities or net income since Adjusted EBITDA and EBITDA
do not reflect the periodic amortization of certain capitalized tangible and
intangible assets used in generating revenues in our businesses, since they do
not reflect net income earned for GAAP reporting purposes, and since they
exclude the effects of interest and taxes. Additionally, Adjusted EBITDA and
EBITDA exclude the impact of working capital changes.
Adjusted EBITDA and EBITDA should not be considered a substitute for or superior
to, operating income, net income, net cash from operating activities, or other
measures of financial performance and liquidity determined in accordance with
GAAP.
The following table reconciles net cash provided by operating activities to
Adjusted EBITDA:
Three months ended
September 30,
------------------
(Dollars amounts in millions) 2006 2005
-------- --------
Net cash provided by operating activities $ 0.9 $ 0.2
Changes in assets and liabilities (use of cash) 6.1 10.0
Interest and other expense, net (to be paid in cash) 3.1 4.2
Taxes 5.1 5.1
Stock compensation expense (1.2) (1.1)
Other (0.2) -
-------- --------
Adjusted EBITDA $ 13.8 $ 18.4
======== ========
22
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
The following tables reconcile net income to EBITDA and Adjusted EBITDA:
Three months ended September 30, 2006
------------------------------------------------------
(Dollars amounts in millions) Marketing Management
Total Services Personals Services Corporate
---------- ---------- ---------- ---------- ----------
Net income $ 6.7
Interest and other expense, net (1) 3.4
Provision for income taxes (1) 3.8
----------
Operating income (expense) $ 13.9 $ 20.4 $ (0.5) $ 2.0 $ (8.0)
Depreciation and amortization 6.1 2.8 2.6 0.6 0.1
---------- ---------- ---------- ---------- ----------
EBITDA 20.0 23.2 2.1 2.6 (7.9)
Change in deferred revenues (7.8) (7.3) (0.1) (0.4) -
Change in deferred marketing costs 1.6 1.6 - - -
---------- ---------- ---------- ---------- ----------
Adjusted EBITDA $ 13.8 $ 17.5 $ 2.0 $ 2.2 $ (7.9)
========== ========== ========== ========== ==========
Three months ended September 30, 2005
------------------------------------------------------
(Dollars amounts in millions) Marketing Management
Total Services Personals Services Corporate
---------- ---------- ---------- ---------- ----------
Net income $ 8.6
Interest and other expense, net (1) 4.5
Provision for income taxes (1) 4.5
----------
Operating income (expense) $ 17.6 $ 23.7 $ (0.1) $ 0.4 $ (6.4)
Depreciation and amortization 6.4 3.3 2.4 0.4 0.3
---------- ---------- ---------- ---------- ----------
EBITDA 24.0 27.0 2.3 0.8 (6.1)
Change in deferred revenues (9.6) (9.3) (0.1) (0.2) -
Change in deferred marketing costs 4.0 4.0 - - -
---------- ---------- ---------- ---------- ----------
Adjusted EBITDA $ 18.4 $ 21.7 $ 2.2 $ 0.6 $ (6.1)
========== ========== ========== ========== ==========
(1) Management does not allocate interest and other expense, net nor does it
allocate provision for income taxes to the individual segments.
Free cash flow represents net cash provided by operating activities less capital
expenditures. Free cash flow is important because it represents the cash that is
available to us to pursue opportunities that enhance shareholder value, such as
make acquisitions, reduce debt, and develop new products. The following table
reconciles operating cash flow to free cash flow:
Three months ended
September 30,
--------------------
(Dollars amounts in millions) 2006 2005
--------- ---------
Net cash provided by operating activities $ 0.9 $ 0.2
Capital expenditures (2.5) (1.8)
--------- ---------
Free cash flow $ (1.6) $ (1.6)
========= =========
23
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(continued)
COMMITMENTS
Future minimum payments of contractual obligations as of September 30, 2006 are
as follows:
Payments Due by Period
---------------------------------------------------------------
(Dollars amounts in millions) Less than 1 After 5
Total year 1 - 3 years 3 - 5 years years
----------- ----------- ----------- ----------- -----------
Operating leases $ 56.4 $ 9.3 $ 18.4 $ 12.5 $ 16.2
Capital leases 1.1 0.8 0.3 - -
Long-term debt 240.0 - - 90.0 150.0
Purchase obligations 8.3 8.3 - - -
Other (1) 191.7 62.3 48.0 35.5 45.9
----------- ----------- ----------- ----------- -----------
Total payments due $ 497.5 $ 80.7 $ 66.7 $ 138.0 $ 212.1
=========== =========== =========== =========== ===========
(1) Includes interest payments on long-term debt, pension obligations, and
expected contingent payments related to acquisitions.
CRITICAL ACCOUNTING POLICIES
There were no material changes in our critical accounting policies during the
first quarter of fiscal 2007. For further information on our critical accounting
policies, please refer to the discussion contained in the management's
discussion and analysis section of our Annual Report on Form 10-K for the fiscal
year ended June 30, 2006.
FORWARD LOOKING STATEMENTS
This report on Form 10-Q contains forward looking statements that are based on
current expectations, estimates, forecasts, and projections about the industry
in which we operate and our management's beliefs and assumptions. These forward
looking statements include statements that do not relate solely to historical or
current facts and can be identified by the use of words such as "believe,"
"expect," "estimate," "project," "continue," or "anticipate." These forward
looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended, are intended to qualify for the safe harbor provisions from liability
provided by the Private Securities Litigation Reform Act of 1995.
Forward looking statements are not guarantees of future performance and are
based on many assumptions and estimates that are inherently subject to
significant risks and uncertainties, many of which are beyond our control,
cannot be foreseen and reflect future business decisions that may change.
Therefore, actual outcomes and results may differ materially from what is
expressed or forecasted in such forward looking statements. Factors that could
cause these differences include, but are not limited to, those set forth under
Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30,
2006.
24
VERTRUE INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
We are exposed to potential loss from exposure to market risks represented
principally by changes in interest rates and foreign exchange rates. There were
no material changes in our market risk during the first quarter of fiscal 2007.
For additional information, please refer to Item 7A of our Annual Report on Form
10-K for the fiscal year ended June 30, 2006.
Item 4. Controls and Procedures
-----------------------
Evaluation of disclosure controls and procedures
Our Chief Executive Officer and Chief Financial Officer evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities
and Exchange Act of 1934) as of the end of the period covered by this report and
have concluded that the Company's disclosure controls and procedures were
effective at the reasonable assurance level. The Company's disclosure controls
and procedures are designed to ensure that material information relating to the
Company and its consolidated subsidiaries that is required to be disclosed in
its reports under the Exchange Act is accumulated, communicated to the Chief
Executive Officer and Chief Financial Officer and disclosed appropriately and
timely in its reports under the Exchange Act.
Because a cost-effective control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met, misstatements due to error or fraud
may occur and not be detected. In addition, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions or that the degree of compliance
with the policies or procedures may deteriorate.
Changes in internal control over financial reporting
During the first quarter of fiscal 2007, there were no changes in the Company's
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
25
VERTRUE INCORPORATED
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In our opinion, there are no significant legal proceedings to which we or any of
our subsidiaries are a party or to which any of our properties are subject. We
are involved in lawsuits and claims generally incidental to our business,
including but not limited to various suits, including previously disclosed
suits, brought against us by individual consumers seeking monetary and/or
injunctive relief relating to the marketing of our programs. In addition, from
time to time in the regular course of our business, we receive inquiries from
various federal and/or state regulatory authorities.
Item 1A. Risk Factors
------------
Information regarding risk factors is included in our Annual Report on Form
10-K for the fiscal year ended June 30, 2006. There were no material changes in
risk factors during the first quarter of fiscal 2007.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
The following table summarizes the shares of the Company's equity securities
purchased by or on behalf of the Company:
Maximum
Number of
Total Number of Shares that May
Total Shares Purchased Yet be
Number of Average Price as Part of Publicly Purchased Under
Shares Paid Announced Plans the Plans
Period Purchased per Share or Programs (1) or Programs
------ ----------- ------------- ------------------- ----------------
July 1, 2006 to July 31, 2006 - $ - - 1,327,000
August 1, 2006 to August 31, 2006 20,700 43.52 20,700 1,306,300
September 1, 2006 to September 30, 2006 41,900 41.13 41,900 1,264,400
----------- ------------- ------------------- ----------------
Total 62,600 $ 41.92 62,600 1,264,400
=========== ============= =================== ================
(1) In July 2006, our Board of Directors authorized an additional 1,000,000
shares, no expiration date, to be purchased under our stock repurchase
program originally authorized during fiscal 1997. There are 264,400 shares
remaining authorized under the Board of Directors approval from October
2004.
Item 6. Exhibits
--------
10.1 Executive Termination Benefits Policy.
31.1 Rule 13a-14(a) CEO Certification.
31.2 Rule 13a-14(a) CFO Certification.
32.1 CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
26
VERTRUE INCORPORATED
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VERTRUE INCORPORATED
(Registrant)
Date: November 9, 2006 By: /s/ Gary A. Johnson
---------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
Date: November 9, 2006 By: /s/ James B. Duffy
---------------------------------
James B. Duffy, Executive Vice President, Chief
Operating Officer, and Chief Financial Officer
(Principal Financial and Accounting Officer)
27