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 December 31, 2004
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 of Incorporation) (IRS Employer
Identification No.)
680 Washington Boulevard
Stamford, Connecticut 06901
- --------------------- -----
(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 an accelerated filer (as
defined in Rule 12b-2 of the Act). [X] Yes [ ] No
Indicate the number of shares outstanding of each of the registrant's class
of common stock as of the latest practicable date: 9,256,000 shares of Common
Stock, $0.01 par value as of January 31, 2005.
VERTRUE INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of December 31, 2004
and June 30, 2004 1
Condensed Consolidated Statements of Operations for the Three and Six
Months Ended December 31, 2004 and 2003 2
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended December 31, 2004 and 2003 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Forward Looking Statements 24
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4. Controls and Procedures 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 30
Item 6. Exhibits 30
Signatures 31
VERTRUE INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except per share amounts)
December 31, June 30,
2004 2004
----------------- ---------------
Assets
Current assets:
Cash and cash equivalents $ 151,072 $ 159,496
Restricted cash 2,837 3,120
Short-term investments 7,675 7,650
Accounts receivable (net of allowance for doubtful accounts of $238 and $235 at
December 31, 2004 and June 30, 2004, respectively) 14,987 10,557
Prepaid membership materials 4,459 3,233
Prepaid expenses and other current assets 8,206 4,886
Membership solicitation and other deferred costs 44,049 52,428
----------------- ---------------
Total current assets 233,285 241,370
Fixed assets, net 40,617 36,540
Goodwill 161,636 125,675
Intangible assets, net 39,204 38,872
Other assets 11,702 10,705
----------------- ---------------
Total assets $ 486,444 $ 453,162
================= ===============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 705 $ 338
Accounts payable 34,091 35,185
Accrued liabilities 97,493 66,075
Deferred revenues 121,113 138,381
Deferred income taxes 10,679 12,323
----------------- ---------------
Total current liabilities 264,081 252,302
Deferred income taxes 11,547 4,354
Other long-term liabilities 5,609 4,930
Long-term debt 237,735 237,659
----------------- ---------------
Total liabilities 518,972 499,245
----------------- ---------------
Commitments and contingencies (Note 10) - -
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;
19,415 shares issued (19,089 shares at June 30, 2004) 194 191
Capital in excess of par value 163,630 156,457
Accumulated earnings 23,610 10,131
Accumulated other comprehensive loss 923 (373)
Treasury stock, 9,167 shares at cost (8,852 shares at June 30, 2004) (220,885) (212,489)
----------------- ---------------
Total shareholders' deficit (32,528) (46,083)
----------------- ---------------
Total liabilities and shareholders' deficit $ 486,444 $ 453,162
================= ===============
The accompanying notes are an integral part of
these consolidated financial statements.
1
VERTRUE INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
Three months ended Six months ended
December 31, December 31,
-------------------------------- ----------------------------------
2004 2003 2004 2003
---------------- --------------- ----------------- ----------------
Revenues $ 136,479 $ 123,164 $ 272,102 $ 236,988
Expenses:
Marketing 68,689 66,745 137,221 133,401
Operating 25,952 23,042 50,162 44,505
General and administrative 26,302 19,195 50,907 37,962
Amortization of intangibles 1,753 271 3,297 589
---------------- --------------- ----------------- ----------------
Operating income 13,783 13,911 30,515 20,531
Interest expense, net (4,611) (1,084) (9,254) (1,051)
Other income (expense), net 428 (52) 293 (214)
---------------- --------------- ----------------- ----------------
Income before income taxes 9,600 12,775 21,554 19,266
Provision for income taxes 3,717 5,110 8,075 7,706
---------------- --------------- ----------------- ----------------
Net income $ 5,883 $ 7,665 $ 13,479 $ 11,560
================ =============== ================= ================
Basic earnings per share $ 0.58 $ 0.71 $ 1.33 $ 1.03
================ =============== ================= ================
Diluted earnings per share $ 0.51 $ 0.60 $ 1.16 $ 0.91
================ =============== ================= ================
Weighted average common shares used in earnings per
share calculations:
Basic 10,128 10,756 10,151 11,192
================ =============== ================= ================
Diluted 13,063 14,074 13,003 13,541
================ =============== ================= ================
The accompanying notes are an integral part of
these consolidated financial statements.
2
VERTRUE INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six Months Ended
December 31,
----------------------------------
2004 2003
---------------- ----------------
Operating activities
Net income $ 13,479 $ 11,560
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred revenues (19,369) (17,733)
Change in membership solicitation and other deferred costs 8,685 15,368
Depreciation and amortization 10,422 5,242
Deferred and other income taxes 3,197 5,304
Tax benefit from employee stock plans 939 1,553
Other 422 720
Change in assets and liabilities:
Restricted cash 283 (437)
Accounts receivable (3,939) (2,764)
Prepaid membership materials (1,150) (1,996)
Prepaid expenses (2,247) 1,243
Other assets (19) (140)
Accounts payable 834 (3,351)
Accrued and other liabilities 3,089 5,872
---------------- ----------------
Net cash provided by operating activities 14,626 20,441
---------------- ----------------
Investing activities
Acquisition of fixed assets (4,339) (2,538)
Net settlement of short-term investments 264 -
Acquisition of business and other investing activities (16,097) -
---------------- ----------------
Net cash used in investing activities (20,172) (2,538)
---------------- ----------------
Financing activities
Net proceeds from exercise of stock options 6,237 22,551
Treasury stock purchases (8,396) (79,078)
(Debt issuance costs) net proceeds from issuance of debt (750) 86,568
Payments of long-term obligations (204) (250)
---------------- ----------------
Net cash (used in) provided by financing activities (3,113) 29,791
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents 235 41
---------------- ----------------
Net (decrease) increase in cash and cash equivalents (8,424) 47,735
Cash and cash equivalents at beginning of period 159,496 72,260
---------------- ----------------
Cash and cash equivalents at end of period $ 151,072 $ 119,995
================ ================
The accompanying notes are an integral part of
these consolidated financial statements.
3
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - NATURE OF BUSINESS
Vertrue Incorporated (the "Company"), a Delaware Corporation, began doing
business as Cardmember Publishing Corporation in 1986 and was organized as
MemberWorks Incorporated in 1996. On October 13, 2004, the Company began doing
business as Vertrue Incorporated. On November 18, 2004, the Company's
shareholders approved an amendment to the Company's charter formally changing
its name to Vertrue Incorporated. The name change was intended to reflect the
ever-broadening base of membership services that the Company offers to its
customers. The Company is a category leader in both membership and loyalty
programs. The Company's membership programs are both subscription and
transaction based offerings focused on meeting consumer needs in large spending
categories - healthcare, discounts, security and personals. The Company's
programs offer everyday savings, event-oriented discounts, peace of mind and
unique consumer benefits. Programs are available in English, French and Spanish
and are increasingly customized for specific client customer segments or
consumer communities. The Company's loyalty programs provide clients with a wide
range of benefits to offer or market to their customers and include stand-alone
benefits, reward point accumulation and management, gift certificate,
merchandise and travel reward redemption. The Company's versatility in designing
loyalty strategies and providing turnkey execution is essential in supporting
and promoting the client's brand.
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 for interim financial information. Accordingly, such
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
The preparation of these consolidated financial statements in conformity with
generally accepted accounting principles requires management of the Company 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 and six months ended
December 31, 2004 are not necessarily indicative of the results that may be
expected for the fiscal year ending June 30, 2005. For further information,
refer to the financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K with respect to the fiscal year ended June
30, 2004.
The unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
The Company acquired Lavalife Inc. on April 1, 2004 and Bargain Network,
Inc. on November 30, 2004. Therefore, the results of operations of Lavalife Inc.
and Bargain Network, Inc. have been included in the consolidated results of
operations since the dates of acquisition and are not included in the results of
operations for the three and six months ended December 31, 2003. The results of
Bargain Network, Inc. are included in the Membership segment and the results of
Lavalife Inc. are included in the Personals segment.
NOTE 3 - RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
4
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4 - STOCK-BASED COMPENSATION
In accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25"), the Company applies the intrinsic
value method in accounting for employee stock options. Accordingly, the Company
generally does not recognize compensation expense with respect to stock-based
awards to employees. If compensation cost for the Company's stock-based
compensation plans had been determined based on the fair value (estimated using
the Black-Scholes option-pricing model) at the grant dates for awards under
those plans consistent with the method of Financial Accounting Standards Board
Statement ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), and SFAS No. 148, "Accounting for Stock-Based Compensation Transition and
Disclosure" ("SFAS 148"), the Company's pro forma net income and earnings per
share would have been as follows:
Three months ended Six months ended
December 31, December 31,
---------------------------- ---------------------------
2004 2003 2004 2003
--------------- ------------ -------------- ------------
Net income reported $ 5,883 $ 7,665 $ 13,479 $ 11,560
Add: Stock-based employee compensation expense determined under
the intrinsic value based method for all awards, net of
related tax effects - - - -
Deduct: Stock-based employee compensation expense determined
under the fair value based method for all awards, net of
related tax effects 961 1,262 1,940 2,527
--------------- ------------ -------------- ------------
Pro forma net income $ 4,922 $ 6,403 $ 11,539 $ 9,033
=============== ============ ============== ============
Earnings per share:
As reported:
Basic $ 0.58 $ 0.71 $ 1.33 $ 1.03
Diluted $ 0.51 $ 0.60 $ 1.16 $ 0.91
Pro forma:
Basic $ 0.49 $ 0.60 $ 1.14 $ 0.81
Diluted $ 0.43 $ 0.51 $ 0.99 $ 0.72
NOTE 5 - BUSINESS COMBINATIONS
On November 30, 2004, the Company completed the acquisition of certain of
the assets of Bargain Network, Inc., a privately held provider of premier
pricing services for homes, vehicles and consumer durables. The Company acquired
certain of the assets of Bargain Network, Inc. in order to expand its direct to
consumer marketing presence. The purchase price, which excludes fees and
expenses and is subject to certain purchase price adjustments, amounted to
$27,771,000, of which $16,000,000 was paid subsequent to December 31, 2004. In
addition, the Company assumed certain liabilities amounting to $4,729,000. The
Company estimates that contingent payments of up to $31,883,000 may be paid if
certain performance targets, including increasing levels of earnings, are
achieved through June 30, 2005. Any additional payments under the contingency
arrangement would be considered additional purchase price and allocated to the
net assets acquired. The Company identified $3,200,000 of intangible assets
other than goodwill in conjunction with the acquisition of certain of the assets
of Bargain Network, Inc. The $36,945,000 of unallocated excess merger
consideration over the net assets acquired was allocated to goodwill and the
entire amount is deductible for tax purposes. See Note 6 for a detailed
description of the identified intangible assets and goodwill identified in
connection with this business combination. The fair values of the acquired
assets and liabilities assumed at the date of acquisition are as follows (in
thousands):
Current assets $ 2,238
Fixed assets 6,066
Goodwill arising in the acquisition 36,945
Intangible assets 3,200
Other assets 995
Current liabilities (3,904)
Other long-term obligations (769)
--------------
Net assets acquired $ 44,771
==============
On April 1, 2004, the Company completed the acquisition of all of the
assets and outstanding capital stock of Lavalife Inc. ("Lavalife"), a leading
provider of online and IVR-based interactive personals services. The purchase
price, excluding fees and expenses, was Cdn$152,500,000, or $116,300,000, and is
subject to certain purchase price adjustments. The acquisition was funded with
cash on hand and borrowings under the Company's $45,000,000 senior secured
credit facility.
5
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Pro Forma Results
The following unaudited pro forma results of operations for the three and
six months ended December 31, 2004 and 2003 have been prepared assuming the
Lavalife acquisition had occurred on July 1, 2003. These pro forma results are
not necessarily indicative of the results of future operations or results that
would have occurred had the acquisition been consummated as of that date (in
thousands, except per share data).
Three Months Ended December 31, Six Months Ended December 31,
------------------------------------ ------------------------------------
2004 2003 2004 2003
------------------- ---------------- ------------------ ----------------
Revenues $ 136,479 $ 140,401 $ 272,102 $ 272,531
Net income 5,883 7,168 13,479 12,937
Basic earnings per share $ 0.58 $ 0.64 $ 1.33 $ 1.16
Diluted earnings per share 0.51 0.54 1.16 1.01
NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
As of December 31, 2004 As of June 30, 2004
------------------------------------- -----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------------------- ----------------- ------------------ ----------------
Amortizable intangible assets:
Membership and client relationships $ 29,695 $ (11,218) $ 27,999 $ (8,686)
Trade names 20,118 (935) 18,543 (310)
Other 1,520 (1,026) 1,162 (886)
------------------- ----------------- ------------------ ----------------
Total amortizable intangible assets 51,333 (13,179) 47,704 (9,882)
------------------- ----------------- ------------------ ----------------
Amortizable intangible assets, net $ 38,154 $ 37,822
=================== ==================
Unamortizable intangible assets:
Goodwill $ 161,636 $ 125,675
Intangible asset related to minimum
pension liability $ 1,050 $ 1,050
The future intangible amortization expense for the next five years is
estimated to be as follows (in thousands):
Fiscal Year
2005 $ 7,381
2006 6,870
2007 5,295
2008 3,275
2009 2,854
The changes in the carrying amount of goodwill by segment for the six
months ended December 31, 2004 are as follows (in thousands):
Membership Personals Total
---------- --------- -----
Balance at June 30, 2004 $ 42,040 $ 83,635 $ 125,675
Arising from the Bargain Network, Inc. acquisition 36,945 - 36,945
Arising from purchase adjustments - (984) (984)
----------------- ----------------- -----------------
Balance at December 31, 2004 $ 78,985 $ 82,651 $ 161,636
================= ================= =================
6
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Goodwill was tested for impairment during the quarters ended September 30,
2004 and 2003 as required by SFAS 142. The Company concluded that none of its
goodwill was impaired. Fair value was estimated using a discounted cash flow
method. In addition, the Company reassessed the estimated useful lives of its
definite lived intangible assets and determined that the lives were appropriate.
The Company will continue to test the goodwill of each of its reporting units
annually or more frequently if impairment indicators exist.
As part of the acquisition of certain of the assets of Bargain Network,
Inc. on November 30, 2004, the Company acquired intangible assets of
$40,145,000. Of that amount, $1,700,000 was assigned to membership and client
relationships and $1,500,000 was assigned to trade names. These identified
intangible assets are subject to periodic amortization over the estimated useful
lives ranging from 2 to 4 years. Goodwill of $36,945,000, which is not subject
to amortization, also arose in connection with the acquisition.
NOTE 7 - FOREIGN CURRENCY INSTRUMENTS
The Company uses purchase option contracts and forward contracts to
minimize its exposure to changes in future cash flows caused by movements in
foreign currency exchange rates between the U.S. dollar and the Canadian dollar.
Derivatives are held only for the purpose of hedging such risks and are not used
for speculative purposes. Derivatives used to hedge forecasted cash flows
associated with Canadian dollar denominated forecasted transactions that meet
the criteria for hedge accounting are designated as cash flow hedges. The
effective portion of derivative gains and losses is deferred as a component of
accumulated other comprehensive income and is recognized concurrent with the
recognition in earnings of the underlying hedged item.
The fair value of these contracts is included in prepaid and other current
assets. As of December 31, 2004, the fair value of these instruments was
$1,220,000 (asset). Derivative gains and losses recognized in earnings were
recorded in operating expenses and general administrative expenses and amounted
to a gain of $567,000 and $611,000 for three and six months ended December 31,
2004, respectively. All forecasted transactions currently being hedged are
expected to occur over the next six months. There were no such derivative
instruments utilized during the three or six months ended December 31, 2003.
NOTE 8 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying unaudited condensed
consolidated balance sheets as of December 31, 2004 and June 30, 2004 include an
allowance for membership cancellations of $14,465,000 and $14,156,000,
respectively. Recording an allowance for membership cancellations has the effect
of reducing the amount of deferred membership fees recorded.
NOTE 9 - RESTRUCTURING CHARGES
The restructuring reserve balance, which is recorded in accrued liabilities
and other long-term liabilities, amounted to $1,575,000 and $1,644,000 as of
December 31, 2004 and June 30, 2004, respectively. Cash payments for the three
and six months ended December 31, 2004 were $21,000 and $69,000, respectively,
and relate to lease obligations.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
The Company operates in leased facilities. Management expects that leases
currently in effect will be renewed or replaced by other leases of a similar
nature and term.
On March 25, 2004, the Company entered into an amended and restated senior
secured credit facility that allows borrowings of up to $45,000,000. Borrowings
under the senior secured credit facility accrue interest at either the
Eurodollar rate, or the higher of the Prime rate or the Federal Funds rate, plus
an applicable margin. The availability under the senior secured credit facility
is reduced by outstanding letters of credit of $19,859,000, of which $14,400,000
expired on January 5, 2005, and by one year's worth of interest on the Senior
Notes. There were no borrowings outstanding under this bank credit facility as
of December 31, 2004. As of December 31, 2004, the availability under the senior
secured credit facility was $11,266,000.
On November 30, 2004, the Company completed the acquisition of certain of
the assets of Bargain Network, Inc. Contingent payments of up to $31,883,000 may
be paid if certain performance targets, including increasing levels of earnings,
are achieved through June 30, 2005. See Note 5 for details.
7
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Legal proceedings
Except as set forth below, in management's opinion, there are no
significant legal proceedings to which the Company or any of its subsidiaries is
a party or to which any of their properties are subject. The Company is involved
in other lawsuits and claims generally incidental to its business including, but
not limited to, various suits, including previously disclosed suits, brought
against the Company by individual consumers seeking monetary and/or injunctive
relief relating to the marketing of the Company's programs. In addition, from
time to time, and in the regular course of its business, the Company receives
inquiries from various federal and/or state regulatory authorities.
On January 24, 2003, the Company filed a motion with the Superior Court for
the Judicial District of Hartford, Connecticut to vacate and oppose the
confirmation of an arbitration award issued in December 2002. The arbitration,
filed against the Company by MedValUSA Health Programs, Inc. ("MedVal") in
September 2000, involved claims of breach of contract, breach of the duty of
good faith and fair dealing, and violation of the Connecticut Unfair Trade
Practices Act ("CUTPA"). Even though the arbitrators found that the Company was
not liable to MedVal for any compensatory damages, they awarded $5,459,000 in
punitive damages and costs against the Company solely under CUTPA. The Company
believes that this arbitration award is unjustified and not based on any
existing legal precedent. Specifically, the Company is challenging the award on
a number of grounds, including that it violates a well defined public policy
against excessive punitive damage awards, raises constitutional issues and
disregards certain legal requirements for a valid award under CUTPA. The hearing
on the Company's motion was held on February 10, 2003. On June 22, 2003, the
Superior Court denied the Company's motion to vacate the award, and the Company
filed an appeal of that decision. While the Company intends to take action to
prevent the enforcement of the award by, among other things, vigorously pursuing
an appeal, there can be no assurance that the Company will be successful in its
efforts. The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company was
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
In March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance Company and other defendants in the United States
District Court for the Eastern District of Michigan, Southern Division. The
suit, which seeks unspecified monetary damages, alleges that Coverdell and the
other defendants violated the Michigan Consumer Protection Act and other
applicable Michigan laws in connection with the marketing of Monumental Life
Insurance Company insurance products. The Court certified a class of Michigan
residents. The Court has now signed an Order granting preliminary approval of a
settlement agreement that has been signed by all parties. The Court approved the
settlement at a Fairness/Approval hearing on November 22, 2004. The settlement
agreement will have no financial or other material impact on the Company's
business.
NOTE 11 - DUTCH AUCTION SELF-TENDER OFFER
On November 8, 2004, the Board of Directors authorized a modified Dutch
Auction self-tender offer for up to 500,000 shares of its common stock. Under
the terms of the self-tender offer and as approved by the Board of Directors,
the Company's stockholders were given the opportunity to tender part or all of
their shares to the Company at a price of not less than $33.50 per share and not
more than $38.50 per share. The self-tender offer closed on January 7, 2005 (See
Note 19).
NOTE 12 - INCOME TAX EXPENSE
Income tax expense as a percentage of pre-tax income was 38.7% and 40% for
the three months ended December 31, 2004 and 2003, respectively, and 37.5% and
40% for the six months ended December 31, 2004 and 2003, respectively. The
effective tax rate was higher than the U.S. statutory rate for the three and six
months ended December 31, 2004 and 2003 primarily due to state tax expense. The
estimated effective tax rate for the three and six months ended December 31,
2004 decreased from the same periods in the prior year due to certain tax
planning strategies implemented. The Company expects to report an effective tax
rate of approximately 37% for fiscal 2005. Tax benefits resulting from the
exercise of nonqualified stock options and the disqualifying dispositions of
shares issued under the Company's stock based compensation plans reduced taxes
payable by $810,000 and $38,000 for the three months ended December 31, 2004 and
2003, respectively, and by $939,000 and $1,553,000 for the six months ended
December 31, 2004 and 2003, respectively. Such benefits are credited to capital
in excess of par value.
8
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The Company has open tax years in the U.S., Canada and other jurisdictions
that are currently not under examination by the applicable tax authorities and
may be subject to examination in the future. The Company periodically evaluates
the adequacy of its related tax reserves, taking into account its open tax
return positions and tax law changes. The Company believes that its tax reserves
are appropriate. However, the final determination of tax audits could impact the
Company's assessment of tax requirements.
NOTE 13 - EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance
with the provisions SFAS 128. The following table sets forth the reconciliation
of the numerators and denominators in the computation of basic and diluted
earnings per share (in thousands, except per share data):
Three Months Ended Six Months Ended
December 31, December 31,
--------------------------- -------------------------
2004 2003 2004 2003
------------ -------------- ------------ ------------
Numerator:
Income available to common shareholders used in basic earnings per
share $ 5,883 $ 7,665 $ 13,479 $ 11,560
Add Back: Interest expense on convertible securities, net of tax 761 743 1,547 751
------------ -------------- ------------ ------------
Income available to common shareholders after assumed conversion of
dilutive securities for diluted earning per share $ 6,644 $ 8,408 $ 15,026 $ 12,311
============ ============== ============ ============
Denominator :
Weighted average number of common shares outstanding- basic 10,128 10,756 10,151 11,192
Effect of dilutive securities:
Convertible securities 2,230 2,230 2,230 1,127
Stock options 705 1,088 622 1,222
------------ -------------- ------------ ------------
Weighted average number of common shares outstanding- diluted 13,063 14,074 13,003 13,541
============ ============== ============ ============
Basic earnings per share $ 0.58 $ 0.71 $ 1.33 $ 1.03
============ ============== ============ ============
Diluted earnings per share $ 0.51 $ 0.60 $ 1.16 $ 0.91
============ ============== ============ ============
The diluted earnings per common share calculation excludes the effect of
potentially dilutive shares when their effect is antidilutive. For the three
months ended December 31, 2004 and 2003, the Company had 44,000 and 996,000
shares, respectively, of potentially dilutive stock options outstanding that are
not included in the calculation as they are antidilutive. For the six months
ended December 31, 2004 and 2003, the Company had 917,000 and 765,000 shares,
respectively, of potentially dilutive stock options that are not included in the
calculations as they are antidilutive.
NOTE 14 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three Months Ended Six Months Ended
December 31, December 31,
----------------------------- -------------------------
2004 2003 2004 2003
-------------- -------------- ------------ ------------
Net income $ 5,883 $ 7,665 $ 13,479 $ 11,560
Unrealized gain on derivative assets 454 - 1,203 -
Foreign currency translation (loss) gain (5) 14 93 16
-------------- -------------- ------------ ------------
Comprehensive income $ 6,332 $ 7,679 $ 14,775 $ 11,576
============== ============== ============ ============
NOTE 15 - BUSINESS SEGMENTS
The operating business segments reported below are the business segments of
the Company for which separate financial information is available and for which
operating results are evaluated regularly by executive management in deciding
how to allocate resources and in assessing performance. Prior to the acquisition
of Lavalife in April 2004, the Company operated as one reportable business
segment. Subsequent to the acquisition of Lavalife, the Company operates as two
reportable business segments: Membership and Personals. The Membership business
segment is primarily involved in the marketing of membership programs to
consumers. The Personals business segment is primarily involved in providing
both web-based and IVR-based personals services to its customers. The results of
Bargain Network, Inc. have been included in the Membership segment.
9
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Management evaluates the operating results of each of its reportable
business segments based upon revenue and operating income. The following is a
summary of revenues, operating income, and assets by business segment (in
thousands):
Three Months Ended Six Months Ended
December 31, December 31,
------------------------------- --------------------------------
2004 2003 2004 2003
-------------- ------------- -------------- --------------
Revenues:
Membership $ 118,714 $ 123,164 $ 235,992 $ 236,988
Personals 17,901 - 36,246 -
Intersegment (136) - (136) -
-------------- ------------- -------------- --------------
Total $ 136,479 $ 123,164 $ 272,102 $ 236,988
============== ============= ============== ==============
Operating Income (1):
Membership $ 15,015 $ 13,911 $ 31,798 $ 20,531
Personals (1,232) - (1,283) -
-------------- ------------- -------------- --------------
Total $ 13,783 $ 13,911 $ 30,515 $ 20,531
============== ============= ============== ==============
December 31, June 30,
2004 2004
----------------- ---------------
Assets:
Membership $ 236,306 $ 178,723
Personals 136,452 136,874
Corporate and other (2) 113,686 137,565
----------------- ---------------
Total $ 486,444 $ 453,162
================= ===============
(1) Operating income includes amortization of intangible assets of:
Three Months Ended Six Months Ended
December 31, December 31,
---------------------------------- ----------------------------------
2004 2003 2004 2003
----------------- ---------------- ---------------- -----------------
Membership $ 452 $ 271 $ 694 $ 589
Personals 1,301 - 2,603 -
----------------- ---------------- ---------------- -----------------
Total $ 1,753 $ 271 $ 3,297 $ 589
================= ================ ================ =================
(2) Represents unallocated non-operating assets including
non-operating cash, short-term investments, debt issuance costs
and other.
NOTE 16 - GUARANTOR AND NONGUARANTOR FINANCIAL INFORMATION
In April 2004, the Company issued $150,000,000 aggregate principal amount
of 9.25% Senior Notes in a private placement pursuant to Rule 144A. The Senior
Notes are unsecured obligations and rank pari passu in right of payment to all
of the Company's existing and future senior unsecured indebtedness and senior in
right of payment to all of the Company's existing and future subordinated
indebtedness that expressly provides for its subordination to the Senior Notes.
The Senior Notes are fully and unconditionally guaranteed by all of the
Company's existing and future domestic subsidiaries that guarantee our Credit
Facility (as defined in the Indenture governing the Senior Notes) and certain of
the Company's existing and future foreign subsidiaries.
The following consolidating financial information presents the
consolidating balance sheets as of December 31, 2004 and June 30, 2004, the
related statements of operations for the three and six months ended December 31,
2004 and 2003 and the related statements of cash flows for the six months ended
December 31, 2004 and 2003. The information includes the elimination entries
necessary to consolidate the Company ("Parent") with the guarantor and
nonguarantor entities.
10
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Investments in subsidiaries are accounted for by the Parent using the
equity method of accounting. The guarantor and nonguarantor subsidiaries are
presented on a combined basis. The principal elimination entries eliminate
investments in subsidiaries and intercompany balances and transactions.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2004
-------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ----------- -------------- ------------ ------------
Assets (in thousands)
Current assets $ 170,979 $ 55,192 $ 15,371 $ (8,257) $ 233,285
Fixed assets, net 19,567 12,913 8,137 - 40,617
Goodwill - 117,972 43,664 - 161,636
Intangible assets, net 1,332 34,822 3,050 - 39,204
Other assets 10,667 54 981 - 11,702
Intercompany notes receivable 2,052 - - (2,052) -
Investment in subsidiaries 219,089 - - (219,089) -
---------- ----------- -------------- ------------ ------------
Total assets $ 423,686 $ 220,953 $ 71,203 $ (229,398) $ 486,444
========== =========== ============== ============ ============
Liabilities and Shareholders' (Deficit) Equity
Current liabilities $ 213,344 $ 43,894 $ 15,100 $ (8,257) $ 264,081
Deferred income taxes 1,495 10,107 (55) - 11,547
Other long-term liabilities 3,640 - 1,969 - 5,609
Intercompany notes payable - 2,052 - (2,052) -
Long-term debt 237,735 - - - 237,735
---------- ----------- -------------- ------------ ------------
Total liabilities 456,214 56,053 17,014 (10,309) 518,972
---------- ----------- -------------- ------------ ------------
Shareholders' (deficit) equity:
Preferred stock - - - - -
Common stock 194 6 3 (9) 194
Capital in excess of par value 163,630 165,070 54,335 (219,405) 163,630
Accumulated (deficit) earnings 23,610 (1,012) (47) 1,059 23,610
Accumulated other comprehensive loss 923 836 (102) (734) 923
Treasury stock (220,885) - - - (220,885)
---------- ----------- -------------- ------------ ------------
Total shareholders' (deficit) equity (32,528) 164,900 54,189 (219,089) (32,528)
---------- ----------- -------------- ------------ ------------
Total liabilities and shareholders' (deficit)
equity $ 423,686 $ 220,953 $ 71,203 $ (229,398) $ 486,444
========== =========== ============== ============ ============
11
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED BALANCE SHEETS
As of June 30, 2004
-------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ----------- -------------- ------------ ------------
Assets (in thousands)
Current assets $ 194,227 $ 42,955 $ 10,760 $ (6,572) $ 241,370
Fixed assets, net 19,675 14,823 2,042 - 36,540
Goodwill - 118,956 6,719 - 125,675
Intangible assets, net 1,050 37,822 - - 38,872
Other assets 10,666 39 - - 10,705
Intercompany notes receivable 95,543 - - (95,543) -
Investment in subsidiaries 78,633 - - (78,633) -
---------- ----------- -------------- ------------ ------------
Total assets $ 399,794 $ 214,595 $ 19,521 $ (180,748) $ 453,162
========== =========== ============== ============ ============
Liabilities and Shareholders' (Deficit) Equity
Current liabilities $ 206,915 $ 40,549 $ 11,410 $ (6,572) $ 252,302
Deferred income taxes (2,402) 6,647 109 - 4,354
Other long-term liabilities 3,705 - 1,225 - 4,930
Intercompany notes payable - 95,543 - (95,543) -
Long-term debt 237,659 - - - 237,659
---------- ----------- -------------- ------------ ------------
Total liabilities 445,877 142,739 12,744 (102,115) 499,245
---------- ----------- -------------- ------------ ------------
Shareholders' (deficit) equity:
Preferred stock - - - - -
Common stock 191 6 3 (9) 191
Capital in excess of par value 156,457 71,744 9,564 (81,308) 156,457
Accumulated (deficit) earnings 10,131 (15) (2,305) 2,320 10,131
Accumulated other comprehensive loss (373) 121 (485) 364 (373)
Treasury stock (212,489) - - - (212,489)
---------- ----------- -------------- ------------ ------------
Total shareholders' (deficit) equity (46,083) 71,856 6,777 (78,633) (46,083)
---------- ----------- -------------- ------------ ------------
Total liabilities and shareholders' (deficit)
equity $ 399,794 $ 214,595 $ 19,521 $ (180,748) $ 453,162
========== =========== ============== ============ ============
12
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended December 31, 2004
-----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ----------- -------------- ------------ -------------
(in thousands)
Revenues $ 92,351 $ 35,316 $ 10,026 $ (1,214) $ 136,479
Expenses:
Marketing 49,373 16,839 2,984 (507) 68,689
Operating 15,616 7,291 3,752 (707) 25,952
General and administrative 15,664 8,588 2,050 - 26,302
Amortization of intangible assets 76 1,527 150 - 1,753
---------- ----------- -------------- ------------ -------------
Operating income 11,622 1,071 1,090 - 13,783
Equity in income of subsidiary 1,767 - - (1,767) -
Interest (expense) income, net (4,649) 37 1 - (4,611)
Other income (expense), net (5) 419 14 - 428
---------- ----------- -------------- ------------ -------------
Income before income taxes 8,735 1,527 1,105 (1,767) 9,600
Provision for income taxes 2,852 321 544 - 3,717
---------- ----------- -------------- ------------ -------------
Net income $ 5,883 $ 1,206 $ 561 $ (1,767) $ 5,883
========== =========== ============== ============ =============
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended December 31, 2003
-----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ----------- -------------- ------------ ------------
(in thousands)
Revenues $ 103,006 $ 15,128 $ 5,451 $ (421) $ 123,164
Expenses:
Marketing 58,013 7,532 1,200 - 66,745
Operating 17,762 3,156 2,545 (421) 23,042
General and administrative 15,631 2,583 981 - 19,195
Amortization of intangible assets - 271 - - 271
---------- ----------- -------------- ------------ -------------
Operating income 11,600 1,586 725 - 13,911
Equity in income of subsidiaries 1,423 - - (1,423) -
Interest (expense) income, net (1,139) 30 25 - (1,084)
Other income (expense), net (57) 31 (26) - (52)
---------- ----------- -------------- ------------ -------------
Income before income taxes 11,827 1,647 724 (1,423) 12,775
Provision for income taxes 4,162 659 289 - 5,110
---------- ----------- -------------- ------------ -------------
Net income $ 7,665 $ 988 $ 435 $ (1,423) $ 7,665
========== =========== ============== ============ =============
13
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Months Ended December 31, 2004
-----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ----------- -------------- ------------ ------------
(in thousands)
Revenues $ 188,636 $ 69,822 $ 15,346 $ (1,702) $ 272,102
Expenses:
Marketing 99,872 33,404 4,452 (507) 137,221
Operating 30,748 14,480 6,129 (1,195) 50,162
General and administrative 31,178 16,769 2,960 - 50,907
Amortization of intangible assets 76 3,071 150 - 3,297
---------- ----------- -------------- ------------ -------------
Operating income 26,762 2,098 1,655 - 30,515
Equity in income of subsidiary 2,587 - - (2,587) -
Interest (expense) income, net (9,349) 91 4 - (9,254)
Other income (expense), net (98) 355 36 - 293
---------- ----------- -------------- ------------ -------------
Income before income taxes 19,902 2,544 1,695 (2,587) 21,554
Provision for income taxes 6,423 842 810 - 8,075
---------- ----------- -------------- ------------ -------------
Net income $ 13,479 $ 1,702 $ 885 $ (2,587) $ 13,479
========== =========== ============== ============ =============
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Months Ended December 31, 2003
-----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ----------- -------------- ------------ -------------
(in thousands)
Revenues $ 201,176 $ 27,998 $ 8,598 $ (784) $ 236,988
Expenses:
Marketing 117,124 14,039 2,238 - 133,401
Operating 35,144 6,358 3,787 (784) 44,505
General and administrative 31,016 5,089 1,857 - 37,962
Amortization of intangible assets - 589 - - 589
---------- ----------- -------------- ------------ -------------
Operating income 17,892 1,923 716 - 20,531
Equity in income of subsidiaries 1,632 - - (1,632) -
Interest (expense) income, net (1,162) 58 53 - (1,051)
Other income (expense), net (184) 31 (61) - (214)
---------- ----------- -------------- ------------ -------------
Income before income taxes 18,178 2,012 708 (1,632) 19,266
Provision for income taxes 6,618 805 283 - 7,706
---------- ----------- -------------- ------------ -------------
Net income $ 11,560 $ 1,207 $ 425 $ (1,632) $ 11,560
========== =========== ============== ============ =============
14
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended December 31, 2004
-------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ------------ ------------ ------------ ----------
(in thousands)
Net cash provided by (used in) operating activities $ 101,300 $ (82,693) $ (1,394) $ (2,587) $ 14,626
Investing activities
Acquisition of fixed assets (3,495) (538) (306) -- (4,339)
Net settlement of short-term investments 43 221 -- -- 264
Acquisition of business and other investing
activities (111,322) 93,937 1,288 -- (16,097)
Investment in subsidiaries (2,587) -- -- 2,587 -
---------- ------------ ------------ ----------- ----------
Net cash (used in) provided by investing activities (117,361) 93,620 982 2,587 (20,172)
---------- ------------ ------------ ----------- ----------
Financing activities
Net proceeds from exercise of stock options 6,237 - - - 6,237
Treasury stock purchases (8,396) - - - (8,396)
Debt issuance costs (750) - - - (750)
Payments of long-term obligations (161) (13) (30) - (204)
---------- ------------ ------------ ----------- ----------
Net cash used in financing activities (3,070) (13) (30) - (3,113)
---------- ------------ ------------ ----------- ----------
Effect of exchange rate changes on cash and cash
equivalents - (291) 526 - 235
---------- ------------ ------------ ----------- ----------
Net (decrease) increase in cash and cash equivalents (19,131) 10,623 84 - (8,424)
Cash and cash equivalents at beginning of period 130,581 26,657 2,258 - 159,496
---------- ------------ ------------ ----------- ----------
Cash and cash equivalents at end of period $ 111,450 $ 37,280 $ 2,342 $ - $ 151,072
========== ============ ============ =========== ==========
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended December 31, 2003
-------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ------------ ------------- ------------ ------------
(in thousands)
Net cash provided by (used in) operating activities $ 21,296 $ 104 $ 673 $ (1,632) $ 20,441
Investing activities
Acquisition of fixed assets (2,082) (201) (255) - (2,538)
Investment in subsidiaries (1,632) - - 1,632 -
---------- ----------- ------------ ----------- ----------
Net cash (used in) provided by investing activities (3,714) (201) (255) 1,632 (2,538)
---------- ----------- ------------ ----------- ----------
Financing activities
Net proceeds from exercise of stock options 22,551 - - - 22,551
Treasury stock purchases (79,078) - - - (79,078)
Net proceeds from the issuance of debt 86,568 - - - 86,568
Payments of long-term obligations - (250) - - (250)
---------- ----------- ------------ ----------- ----------
Net cash provided by (used in) financing activities 30,041 (250) - - 29,791
---------- ----------- ------------ ----------- ----------
Effect of exchange rate changes on cash and cash
equivalents - - 41 - 41
---------- ----------- ------------ ----------- ----------
Net increase (decrease) in cash and cash equivalents 47,623 (347) 459 - 47,735
Cash and cash equivalents at beginning of period 51,895 18,716 1,649 - 72,260
---------- ----------- ------------ ----------- ----------
Cash and cash equivalents at end of period $ 99,518 $ 18,369 $ 2,108 $ - $ 119,995
========== =========== ============ =========== ==========
15
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 17 - SUPPLEMENTAL CASH FLOW DISCLOSURE
During the quarter ended December 31, 2004, the Company accrued $27,133,000
of purchase costs related to the acquisition of certain of the assets of Bargain
Network, Inc., which will be settled in cash during the quarter ending March 31,
2005.
NOTE 18 - NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board issued Statement
No. 123 (Revised 2004), "Share-Based Payment," ("SFAS 123R"). This statement is
a revision of SFAS 123 and supersedes ABP 25. SFAS 123R will require the Company
to measure all employee stock-based compensation awards using a fair value
method and record such expense in its consolidated financial statements. In
addition, the adoption of SFAS 123R will require additional accounting related
to the income tax effects and additional disclosure regarding the cash flow
effects resulting from share-based payment arrangements. SFAS 123R is effective
beginning in the Company's first quarter of fiscal 2006. The adoption of SFAS
123R will have a material impact on the Company's consolidated financial
position, results of operations, cash flows and related disclosures.
NOTE 19 - SUBSEQUENT EVENTS
On January 6, 2005, the Company completed the acquisition of certain of the
assets of My Choice Medical Holdings, Inc., a privately held advertising and
practice management company serving cosmetic surgeons throughout the United
States. The purchase price, excluding fees and expenses, amounted to $33,000,000
and was paid in cash on January 6, 2005. In addition, contingent payments of up
to $56,000,000 may be paid if certain performance targets, including increasing
levels of revenues and earnings, are achieved over the next three calendar
years. Any additional payments under the contingency arrangement will be
considered additional purchase price and allocated to the net assets acquired.
The Company is in the process of completing its assessment of the fair value of
assets acquired and liabilities assumed.
On January 7, 2005, the Company completed the Dutch Auction self-tender
offer for up to 500,000 shares of its Common Stock as discussed in Note 11.
Shareholders tendered a total of 605,000 shares. The Company exercised its right
to purchase the additional 105,000 shares in addition to the 500,000 shares for
which it originally solicited tenders. In total, the Company repurchased 605,000
shares for $38.50 per share and paid $23,293,000 to repurchase these shares.
Subsequent to the completion of the self-tender offer, the Company had 1,074,000
shares available for repurchase under its stock repurchase program.
16
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
On October 13, 2004, MemberWorks Incorporated began doing business as
Vertrue Incorporated (the "Company"). On November 18, 2004, the Company's
shareholders approved an amendment to the Company's charter formally changing
its name to Vertrue Incorporated. The name change was intended to reflect the
ever-broadening base of membership services that the Company offers to its
customers. The Company is a category leader in both membership and loyalty
programs. The Company's membership programs are both subscription and
transaction based offerings focused on meeting consumer needs in large spending
categories - healthcare, discounts, security and personals. The Company's
programs offer everyday savings, event-oriented discounts, peace of mind and
unique consumer benefits. Programs are available in English, French and Spanish
and are increasingly customized for specific client customer segments or
consumer communities. The Company's loyalty programs provide clients with a wide
range of benefits to offer or market to their customers and include stand-alone
benefits, reward point accumulation and management, gift certificate,
merchandise and travel reward redemption. The Company's versatility in designing
loyalty strategies and providing turnkey execution is essential in supporting
and promoting the client's brand.
The Company operates in two business segments: Membership and Personals.
For additional financial information about these business segments, see Note 15
to the condensed consolidated financial statements.
Membership service programs offer consumers a variety of products and
services from selected vendors for an annual or monthly fee. Revenues are
derived principally from recurring fees which are billed to the member either on
an annual or monthly basis. In the case of annually billed membership fees, the
Company receives full payment at or near the beginning of the membership period,
but recognizes the revenues as the member's refund privilege expires. Membership
fees that are billed monthly are recognized when earned. Profitability and cash
flow generated from renewal memberships exceed that of new memberships due to
the absence of solicitation costs associated with new member procurement.
The Personals business segment 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 users. Personals revenues are generally
recognized when the services are used.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that are important to the
Company's financial condition and results of operations and involve subjective
or complex judgments on the part of management, often as a result of the need to
make estimates. The following areas require the use of judgments and estimates:
membership cancellation rates, deferred marketing costs, valuation of goodwill
and other intangible assets, estimation of remaining useful lives of intangible
assets and valuation of deferred tax assets. Estimates in each of these areas
are based on historical experience and various assumptions that the Company
believes are appropriate. Actual results may differ from these estimates. The
Company believes the areas listed above represent the critical accounting
policies of the Company as contemplated by Financial Reporting Release No. 60,
"Cautionary Advice Regarding Disclosure about Critical Accounting Policies." The
Company's critical accounting policies are disclosed in Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations in the
Company's Annual Report on Form 10-K for the year ended June 30, 2004. Since the
date of the Annual Report on Form 10-K, there have been no material changes to
the Company's critical accounting policies. For a summary of all of the
Company's significant accounting policies, see Note 2 to the consolidated
financial statements located in the Company's 2004 Annual Report on Form 10-K.
17
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
For the Three Months Ended December 31, 2004 and December 31, 2003
Revenues
Percent
Three Months Ended Increase/
December 31, (Decrease)
------------------------------- ------------
2004 2003 '04 vs. `03
---- ---- -----------
Membership $ 118,714 $ 123,164 (4)%
Personals 17,765 - NM
------------- ------------- ------------
Total $ 136,479 $ 123,164 11%
============= ============= ============
NM = Not Meaningful
Membership
Revenues decreased 4% in 2004 primarily due to a decrease in the net active
retail members. The net active retail members decreased 11% to 5.6 million as of
December 31, 2004 primarily due to the decrease in members enrolled through the
outbound telemarketing channel which was not completely offset by an increase in
members enrolled through the Company's online and MemberLink channels. The
decline in net active retail members may impact future revenues and
profitability. The mix of new members enrolled in a monthly payment plan program
was 82% and 66% in 2004 and 2003, respectively.
Revenues from members enrolled in different payment programs are summarized
below:
Percent
Three Months Ended Increase/
December 31, 2004 (Decrease)
--------------------------- ----------------
2004 2003 '04 vs. `03
---- ---- -----------
Monthly payment plans $ 56,037 $ 41,405 35%
Annual payment plans:
Initial year 14,866 31,732 (53)%
Renewal year 47,811 50,027 (4)%
------------ ----------- ----------------
Total $ 118,714 $ 123,164 (4)%
============ =========== ================
Personals
Revenues were $17.8 million and represent the revenues of Lavalife, which
was acquired by the Company on April 1, 2004. There were approximately 0.6
million active customers as of December 31, 2004.
Operating income
Percent
Three Months Ended Increase/
December 31, 2004 (Decrease)
--------------------------- ----------------
2004 2003 '04 vs. `03
---- ---- -----------
Membership $ 15,015 $ 13,911 8%
Personals (1,232) - NM
------------- ------------- ------------
Total $ 13,783 $ 13,911 (1)%
============= ============= ============
NM = Not Meaningful
Membership
Operating income increased 8% due to a decrease in marketing expenses of
9%. Marketing expenses were $60.8 million in 2004 versus $66.7 million in 2003
and, as a percentage of revenues, marketing expenses were 51% in 2004 versus 54%
in 2003. These decreases were primarily due to the decrease in the level and mix
of members enrolled through the higher cost outbound telemarketing channel.
18
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Personals
Operating loss was $1.2 million in 2004 and represented the results of
Lavalife. Operating loss reported for 2004 reflected $1.3 million of expense for
the amortization of intangible assets.
Corporate
Three Months Ended Percent
December 31, 2004 Decrease
--------------------------- ----------------
2004 2003 '04 vs. `03
---- ---- -----------
Interest expense, net $ (4,611) $ (1,084) NM
Other income (expense), net 428 (52) NM
Provision for income taxes 3,717 5,110 (27)%
NM = Not Meaningful
Interest expense, net. The increase in interest expense, net in 2004 was
due to $3.6 million of interest expense related to the 9.25% Senior Notes issued
in April 2004 ("Senior Notes"). For additional information on this debt
issuance, refer to the related discussion located in the section titled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" of this Quarterly Report on Form
10-Q.
Other income (expense), net. The increase in other income (expense), net is
due to gains recognized on foreign currency transactions.
Provision for income taxes. The Company recorded a provision for income
taxes of $3.7 million and $5.1 million based on an effective tax rate of 38.7%
and 40% in 2004 and 2003, respectively. The effective tax rate was higher than
the U.S. federal statutory rate due to state tax expense. The estimated
effective tax rate in 2004 decreased from the prior year due to certain tax
planning strategies implemented. The Company expects to report an effective tax
rate of approximately 37% for fiscal 2005.
For the Six Months Ended December 31, 2004 and December 31, 2003
Revenues
Six Months Ended Percent
December 31, Increase
------------------------------- ------------
2004 2003 '04 vs. `03
---- ---- -----------
Membership $ 235,992 $ 236,988 -
Personals 36,110 - NM
------------- ------------- ------------
Total $ 272,102 $ 236,988 15%
============= ============= ============
NM = Not Meaningful
Membership
Revenues decreased 0.4% in 2004 primarily due to a decrease in the net
active retail members. The net active retail members decreased 11% to 5.6
million as of December 31, 2004 primarily due to the decrease in members
enrolled through the outbound telemarketing channel which was not completely
offset by an increase in members enrolled through the Company's online and
MemberLink channels. The decline in net active retail members may impact future
revenues and profitability. The mix of new members enrolled in a monthly payment
plan program was 83% and 65% in 2004 and 2003, respectively.
19
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Revenues from members enrolled in different payment programs are summarized
below:
Percent
Six Months Ended Increase/
December 31, (Decrease)
------------------------------- ------------
2004 2003 '04 vs. `03
---- ---- -----------
Monthly payment plans $ 105,494 $ 67,753 56%
Annual payment plans:
Initial year 33,916 72,787 (53)%
Renewal year 96,582 96,448 1%
------------ ----------- ----------------
Total $ 235,992 $ 236,988 -
============ =========== ================
Personals
Revenues were $36.1 million and represent the revenues of Lavalife. There
were approximately 0.6 million active customers as of December 31, 2004.
Operating income
Six Months Ended Percent
December 31, Increase
------------------------------- ------------
2004 2003 '04 vs. `03
---- ---- -----------
Membership $ 31,798 $ 20,531 55%
Personals (1,283) - NM
------------- ------------- ------------
Total $ 30,515 $ 20,531 49%
============= ============= ============
NM = Not Meaningful
Membership
Operating income increased 55% primarily due to a decrease in marketing
expenses of 9%. Marketing expenses were $121.7 million in 2004 versus $133.4
million in 2003 and, as a percentage of revenues, marketing expenses were 52% in
2004 versus 56% in 2003. These decreases were primarily due to the decrease in
the level and mix of members enrolled through the higher cost outbound
telemarketing channel.
Personals
Operating loss was $1.3 million in 2004 and represented the results of
Lavalife. Operating loss reported for 2004 reflected $2.6 million of expense for
the amortization of intangible assets.
Corporate
Six Months Ended Percent
December 31, Increase
------------------------------- ------------
2004 2003 '04 vs. `03
---- ---- -----------
Interest expense, net $ (9,254) $ (1,051) NM
Other income, net 293 (214) NM
Provision for income taxes 8,075 7,706 5%
NM = Not Meaningful
Interest expense, net. The increase in interest expense, net in 2004 was
due to interest expense related to the 5.5% Convertible Senior Subordinated
Notes issued in September 2003 and interest expense related to the 9.25% Senior
Notes issued in April 2004. For additional information on these debt issuances,
refer to the section titles "Management's Discussion and Analysis of Financial
Condition - Liquidity and Capital Resources" of this Quarterly Report on Form
10-Q.
Other income (expense), net. The increase in other income (expense), net is
due to gains recognized on foreign currency transactions.
20
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Provision for income taxes. The Company recorded a provision for income
taxes of $8.1 million and $7.7 million based on an effective tax rate of 37.5%
and 40% in 2004 and 2003, respectively. The effective tax rate was higher than
the U.S. federal statutory rate due to state tax expense. The estimated
effective tax rate in 2004 decreased from the prior year due to certain tax
planning strategies implemented. The Company expects to report an effective tax
rate of approximately 37% for fiscal 2005.
LIQUIDITY AND CAPITAL RESOURCES
Net cash flow provided by operating activities is an important measure used
to understand the Company's liquidity. Management believes it is useful to
analyze the components of net cash provided by operating activities as follows:
Revenue before deferral, marketing costs before deferral, operating expenses,
general and administrative expenses and changes in assets and liabilities. For
definitions and reconciliations of revenue before deferral and marketing costs
before deferral, refer to the related discussion located in the Reconciliation
of Non-GAAP Measures section in this Quarterly Report on Form 10-Q.
Net cash provided by operating activities was $14.6 million and $20.4
million for the six months ended December 31, 2004 and 2003, respectively.
Revenues before deferral increased 15% to $252.7 million for the six months
ended December 31, 2004 from $219.3 million for the six months ended December
31, 2003 primarily due to revenues before deferral generated by Lavalife. The
new annual weighted average program price points per retail member were $106 and
$106 for the six months ended December 31, 2004 and 2003, respectively. Monthly
weighted average program price points per retail member were $11.98 and $11.18
for the six months ended December 31, 2004 and 2003, respectively.
The table below summarizes the components of revenues before deferral for
the six months ended December 31:
2004 2003
----------------- --------------
Monthly payment plans $ 108,243 $ 74,695
Annual payment plans:
Initial year 20,290 42,165
Renewal year 87,967 102,395
Personals 36,233 -
----------------- --------------
Total $ 252,733 $ 219,255
================= ==============
Marketing costs before deferral were $128.5 million and $118.0 million for
the six months ended December 31, 2004 and 2003, respectively. For the six
months ended December 31, 2004, marketing costs before deferral increased 9%
primarily due to marketing costs incurred by Lavalife, which were partially
offset by a decrease in the level of marketing through the outbound
telemarketing channel. As a percent of revenue before deferral, marketing costs
before deferral were 51% for the six months ended December 31, 2004 versus 54%
for the six months ended December 31, 2003 due to the effect of the Lavalife
acquisition, the maturing base of members enrolled in a monthly payment plan
program and the reduced level and mix of the higher cost outbound telemarketing.
As a result, marketing margin before deferral was $124.2 million and $101.2
million for the six months ended December 31, 2004 and 2003, respectively. The
effect of the increase in marketing margin before deferral on net cash provided
by operating activities was more than offset by increased general and
administrative and operating expenses primarily due to the Lavalife acquisition
and increased interest costs associated with the Convertible Notes and Senior
Notes.
Net cash provided by operating activities was also impacted by changes in
assets and liabilities, which used $3.1 million of cash for the six months ended
December 31, 2004 and $1.6 million of cash for the six months ended December 31,
2003 primarily due to the timing of accounts receivable collections.
Net cash used in investing activities was $20.2 million for the six months
ended December 31, 2004 and primarily reflected the acquisition of certain of
the assets of Bargain Network, Inc. Capital expenditures were $4.3 million and
$2.5 million for the six months ended December 31, 2004 and 2003, respectively.
21
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net cash used in financing activities was $3.1 million for the six months
ended December 31, 2004 compared to net cash provided by financing activities of
$29.8 million for the six months ended December 31, 2003. Net cash used in
financing activities for the six months ended December 31, 2004 principally
reflected the use of $8.4 million in cash to repurchase the Company's stock,
which was partially offset by proceeds from the issuance of stock of $6.2
million. Net cash provided by financing activities for the six months ended
December 31, 2003 principally reflected the issuance of $86.6 million in debt,
net of issuance costs, and proceeds from the exercise of employee stock options
of $22.6 million. These sources of cash were partially offset by the use of
$79.1 million in cash to repurchase the Company's stock.
Debt Issuances
As of December 31, 2004, the Company had $237.7 million of debt
outstanding. In September 2003, the Company issued $90.0 million aggregate
principal amount 5.5% convertible senior subordinated notes ("Convertible
Notes") due September 2010. The Convertible Notes bear interest at the rate of
5.5% per year, which is payable in cash semi-annually in arrears on April 1 and
October 1 of each year. Upon the occurrence of a change in control, holders of
the Convertible Notes may require the Company to repurchase all or part of the
Convertible Notes for cash.
In April 2004, the Company issued $150.0 million aggregate principal amount
of 9.25% Senior Notes due 2014. The Senior Notes were sold at 98.418% of the
principal amount which resulted in an effective yield of 9.5%. Interest on the
Senior Notes is payable in cash semi-annually in arrears on April 1 and October
1 of each year. A portion of the proceeds from the offering of the Senior Notes
was used to repay amounts borrowed under the senior secured credit facility to
fund a portion of the Lavalife acquisition. The Company intends to use the
remaining proceeds for general corporate purposes, including working capital,
future acquisitions and repurchases of the Company's common stock under the
Company's stock buyback program to the extent permitted under the indenture
governing the Senior Notes and the senior secured credit facility. The Senior
Notes offering was made solely by means of a private placement to qualified
institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as
amended, and to certain persons in offshore transactions pursuant to Regulation
S under the Securities Act. All Senior Notes were exchanged for registered notes
on December 10, 2004.
Credit Facility
The Company has an amended and restated senior secured credit facility that
allows borrowings of up to $45.0 million. Borrowings under the senior secured
credit facility accrue interest at either the Eurodollar rate, or the higher of
the Prime rate or the Federal Funds rate, plus an applicable margin. As of
December 31, 2004, the availability under the senior secured credit facility was
reduced by outstanding letters of credit of $19.9 million, of which $14.4
million expired on January 5, 2005, and one year's worth of interest on the
Senior Notes. As of December 31, 2004, the availability under the senior secured
credit facility is approximately $11.3 million. As of December 31, 2004, the
effective interest rate for borrowings under the senior secured credit facility
was 5.25%. The senior secured credit facility has certain financial covenants,
including a maximum debt coverage ratio, potential restrictions on additional
borrowings and potential restrictions on additional stock repurchases. As of
December 31, 2004, the Company was in compliance with all such debt covenants.
Stock Repurchase Program
The Company purchased 315,000 shares for $8.2 million at an average price
of $26.05 for the six months ended December 31, 2004 compared to 2.5 million
shares for $79.1 million at an average price of $31.91 for the six months ended
December 31, 2003. During the six months ended December 31, 2004, the Company's
Board of Directors authorized the repurchase of 1.0 million shares of its common
stock under its ongoing stock repurchase program
On November 8, 2004, the Board of Directors authorized a modified Dutch
Auction self-tender offer for up to 500,000 shares of its common stock. Under
the terms of the self-tender offer and as approved by the Board of Directors,
the Company's stockholders were given the opportunity to tender part or all of
their shares to the Company at a price of not less than $33.50 per share and not
more than $38.50 per share. The self-tender offer closed on January 7, 2005 and
a total of 605,000 shares were tendered by shareholders. The Company exercised
its right to purchase the additional 105,000 shares in addition to the 500,000
shares for which it originally solicited tenders. In total, the Company
repurchased 605,000 shares for $38.50 per share and paid $23.3 million to
repurchase these shares. Subsequent to the completion of the self-tender offer,
the Company had 1,074,000 shares available for repurchase under its stock
repurchase program.
22
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Acquisitions
On November 30, 2004, the Company completed the acquisition of certain of
the assets of Bargain Network, Inc., a privately held provider of premier
pricing services for homes, vehicles and consumer durables. The purchase price,
which excludes fees and expenses and is subject to certain purchase price
adjustments, amounted to $27.8 million, of which $16.0 million was paid
subsequent to December 31, 2004. In addition, the Company assumed certain
liabilities amounting to $4.7 million. The Company estimates that contingent
payments of up to $31.9 million may be paid if certain performance targets,
including increasing levels earnings, are achieved through June 30, 2005.
On January 6, 2005, the Company completed the acquisition of certain of the
assets of My Choice Medical Holdings, Inc., a privately held advertising and
practice management company serving cosmetic surgeons throughout the United
States. The purchase price, excluding fees and expenses, amounted to $33.0
million and was paid in cash on the closing date. In addition, contingent
payments of up to $56.0 million may be paid if certain performance targets,
including increasing levels of revenues and earnings, are achieved over the next
three calendar years.
As of December 31, 2004, the Company had cash, cash equivalents and
short-term investments of $161.6 million in addition to its senior secured
credit facility. The Company believes that existing cash and short term
investment balances, together with funds available under its senior secured
credit facility, will be sufficient to meet its funding requirements for the
foreseeable future.
The Company did not have any material commitments for capital expenditures
as of December 31, 2004. The Company intends to utilize cash on hand and cash
generated from operations to fulfill any capital expenditure requirements during
2005.
RECONCILIATION OF NON-GAAP MEASURES
Management believes that revenues before deferral and marketing costs
before deferral are important measures of liquidity and are significant factors
in understanding the Company's operating cash flow trends. These non-GAAP
measures are used by management and the Company's investors to understand the
liquidity trends of the Company's marketing margins related to the 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 the Company's 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 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 SOP 93-7 and represent
marketing costs paid for or accrued for during the current reporting period.
That is, 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
cash settlement. Additionally, these measures are not a substitute for, or
superior to, Revenues and Marketing Expenses prepared in accordance with
generally accepted accounting principles. In light of the difference between
revenues before deferral, marketing expenses before deferral and their most
directly comparable GAAP measures, the Company solely uses these measures as
liquidity measures and not as performance measures.
Revenues before deferral for the six months ended December 31, 2004 and
2003 are calculated as follows:
2004 2003
------------- -------------
Revenues $ 272,102 $ 236,988
Change in deferred revenues, net of deferred membership fees acquired (19,369) (17,733)
------------- -------------
Revenues before deferral $ 252,733 $ 219,255
============= =============
23
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Marketing cost before deferral for the six months ended December 31, 2004
and 2003 is calculated as follows:
2004 2003
------------- -------------
Marketing expenses $ 137,221 $ 133,401
Change in membership solicitation and other deferred costs (8,685) (15,368)
------------- -------------
Marketing costs before deferral $ 128,536 $ 118,033
============= =============
COMMITMENTS
The Company is not aware of any factors that are reasonably likely to
adversely affect liquidity trends, other than the risk factors presented in the
Forward Looking Statements in this Form 10-Q filing. The Company does not have
off-balance sheet arrangements, non-exchange traded contracts or material
related party transactions.
Future minimum payments of contractual obligations as of December 31, 2004
are as follows (amounts in thousands):
Payments Due by Period
-------------------------------------------------------------------------------
Less than After 5
Total 1 year 1-3 years 4-5 years years
-------------- ------------- -------------- -------------- ---------------
Operating leases $ 28,439 $ 8,883 $ 10,678 $ 7,543 $ 1,335
Capital leases 2,137 705 1,250 182 -
Long term debt 240,000 - - - 240,000
Purchase obligations 96,193 36,460 59,733 - -
-------------- ------------- -------------- -------------- ---------------
Total payments due $ 366,769 $ 46,048 $ 71,661 $ 7,725 $ 241,335
============== ============= ============== ============== ===============
The Company operates in leased facilities. Management expects that leases
currently in effect will be renewed or replaced by other leases of a similar
nature and term.
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements that
are based on current expectations, estimates, forecasts and projections about
the industry in which the Company operates and the Company's 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 are made pursuant
to safe harbor provisions of the Private Securities Litigation Reform Act of
1995.
Forward-looking statements are not guarantees of future performance and are
based on a number of 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 are subject to
change. Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements. Among the many
factors that could cause actual results to differ materially from the
forward-looking statements are:
o higher than expected membership cancellations or lower than expected
membership renewal rates;
o changes in the marketing techniques of credit card issuers;
o increases in the level of commission rates and other compensation
required by marketing partners to actively market with the Company;
o potential reserve requirements by business partners such as the
Company's credit card processors;
o unanticipated termination of marketing agreements;
o the extent to which the Company can continue to successfully develop
and market new products and services and introduce them in a timely
basis;
o the Company's ability to integrate acquired businesses into the
Company's management and operations and operate successfully;
o unanticipated changes in or termination of the Company's ability to
process revenues through third parties, including credit card
processors and bank card associations;
24
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
o the Company's ability to develop and implement operational and
financial systems to manage growing operations;
o the Company's ability to recover from a complete or partial system
failure or impairment, other hardware or software related malfunctions
or programming errors;
o the degree to which the Company is leveraged;
o the Company's ability to obtain financing on acceptable terms to
finance the Company's growth strategy and to operate within the
limitations imposed by financing arrangements;
o further changes in the already competitive environment for the
Company's products or competitors' responses to the Company's
strategies;
o changes in the growth rate of the overall U.S. economy, or the
international economy where the Company does business, such that
credit availability, interest rates, consumer spending and related
consumer debt are impacted;
o additional government regulations and changes to existing government
regulations of the Company's industry;
o the Company's ability to compete with other companies that have
financial or other advantages;
o adverse movement of foreign exchange rates;
o the Company's ability to attract and retain active members and users;
o adverse results of litigation or regulatory matters; and
o new accounting pronouncements.
Many of these factors are beyond the Company's control, and, therefore, its
business, financial condition, results of operations and cash flows may be
adversely affected by these factors.
The Company cautions that such factors are not exclusive. All of the
forward-looking statements made in this Quarterly Report on Form 10-Q are
qualified by these cautionary statements and readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date of this Quarterly Report on Form 10-Q. Except as required by law, the
Company does not have any intention or obligation to publicly update any
forward-looking statements, whether as a result of new information, future
events or otherwise.
25
VERTRUE INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Interest Rate
The Company has a senior secured credit facility that allows borrowings of
up to $45.0 million. Borrowings under the senior secured credit facility accrue
interest at either the Eurodollar rate or the higher of the Prime rate or the
Federal Funds rate plus an applicable margin. There were no borrowings
outstanding under this senior secured credit facility as of December 31, 2004.
As of December 31, 2004, availability under the senior secured credit facility
was reduced by outstanding letters of credit of $19.9 million, of which $14.4
million expired on January 5, 2005, and one year's worth of interest on the
Senior Notes. As of December 31, 2004, the availability under the senior secured
credit facility is approximately $11.3 million. Management believes that an
increase in the Eurodollar rate, the Prime rate or the Federal Funds rate would
not be material to the Company's financial position or its results of
operations. If the Company is not able to renew its existing credit facility
agreement, which matures on March 25, 2005, it is possible that any replacement
lending facility obtained by the Company may be more sensitive to interest rate
changes. In addition, the Company has $90.0 million aggregate principal amount
of 5.5% Convertible Notes due 2010 and $150.0 million aggregate principal amount
of 9.25% Senior Notes due 2014. The Convertible Notes and the Senior Notes pay
interest in cash semi-annually in arrears on April 1 and October 1 of each year.
The fair value of the fixed interest instruments are affected by changes in
interest rates, and with respect to the Convertible Notes, are also affected by
changes in the Company's stock price and volatility. The Company does not
currently hedge interest rates with respect to its outstanding debt. As of
December 31, 2004, the carrying value of the Convertible Notes and the Senior
Notes was $90.0 million and $147.7 million, respectively, and the fair value of
the notes was $105.8 million and $159.0 million, respectively.
Foreign Currency
The Company conducts business in certain foreign markets, primarily in
Canada. The Company's primary exposure to foreign currency risk relates to
investments in foreign subsidiaries that transact business in functional
currencies other than the U.S. Dollar, primarily the Canadian Dollar. As the
Company increases its operations in international markets, it becomes
increasingly exposed to potentially volatile movements in currency exchange
rates. The economic impact of currency exchange rate movements on the Company
are often linked to variability in real growth, inflation, interest rates,
governmental actions and other factors. These changes, if material, could cause
the Company to adjust its financing and operating strategies. As currency
exchange rates change, translation of the income statements of the Company's
international business into U.S. dollars affects year-over-year comparability of
operating results.
The Company uses purchase option contracts and forward contracts to
minimize its exposure to changes in future cash flows caused by movements in
foreign currency exchange rates between the U.S. dollar and the Canadian dollar.
However, there can be no assurance that the Company's foreign currency hedging
activities will substantially offset the impact of fluctuations in currency
exchange rates on its results of operations and financial position. The Company
does not use derivatives for speculative purposes. Derivatives used to hedge
forecasted transactions and specific cash flows associated with Canadian dollar
denominated financial assets and liabilities that meet the criteria for hedge
accounting are designated as cash flow hedges. The effective portion of gains
and losses is deferred as a component of accumulated other comprehensive income
and is recognized in earnings in the same line item as the underlying hedged
item at the time the hedged item affects earnings.
Fair Value of Investments
The Company does not have material exposure to market risk with respect to
investments, as the Company's investments are short-term in nature (original
maturities of less than one year).
Item 4. Controls and Procedures
-----------------------
Evaluation of disclosure controls and procedures.
The Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined
under Rules 13a-15(e) and 15d-15(e)) 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 and communicated
to the Chief Executive Officer and Chief Financial Officer. In addition, there
were no changes in the Company's internal control over financial reporting that
have materially affected, or are reasonably likely to materially affect, these
internal controls over financial reporting.
26
VERTRUE INCORPORATED
Notwithstanding the foregoing, although there can be no assurance that the
Company's disclosure controls and procedures will detect or uncover all failures
of persons within the Company and its consolidated subsidiaries to disclose
material information otherwise required to be set forth in the Company's
periodic reports, the Chief Executive Officer's and Chief Financial Officer's
evaluation concluded that they are reasonably effective to do so.
27
VERTRUE INCORPORATED
PART II. OTHER INFORMATION
Item 1. Legal proceedings
-----------------
Except as set forth below, in management's opinion, there are no
significant legal proceedings to which the Company or any of its subsidiaries is
a party or to which any of their properties are subject. The Company is involved
in other lawsuits and claims generally incidental to its business including, but
not limited to, various suits, including previously disclosed suits, brought
against the Company by individual consumers seeking monetary and/or injunctive
relief relating to the marketing of the Company's programs. In addition, from
time to time, and in the regular course of its business, the Company receives
inquiries from various federal and/or state regulatory authorities.
On January 24, 2003, the Company filed a motion with the Superior Court for
the Judicial District of Hartford, Connecticut to vacate and oppose the
confirmation of an arbitration award issued in December 2002. The arbitration,
filed against the Company by MedValUSA Health Programs, Inc. ("MedVal") in
September 2000, involved claims of breach of contract, breach of the duty of
good faith and fair dealing, and violation of the Connecticut Unfair Trade
Practices Act ("CUTPA"). Even though the arbitrators found that the Company was
not liable to MedVal for any compensatory damages, they awarded $5.5 million in
punitive damages and costs against the Company solely under CUTPA. The Company
believes that this arbitration award is unjustified and not based on any
existing legal precedent. Specifically, the Company is challenging the award on
a number of grounds, including that it violates a well defined public policy
against excessive punitive damage awards, raises constitutional issues and
disregards certain legal requirements for a valid award under CUTPA. The hearing
on the Company's motion was held on February 10, 2003. On June 22, 2003, the
Superior Court denied the Company's motion to vacate the award, and the Company
filed an appeal of that decision. While the Company intends to take action to
prevent the enforcement of the award by, among other things, vigorously pursuing
an appeal, there can be no assurance that the Company will be successful in its
efforts. The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company was
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
In March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance Company and other defendants in the United States
District Court for the Eastern District of Michigan, Southern Division. The
suit, which seeks unspecified monetary damages, alleges that Coverdell and the
other defendants violated the Michigan Consumer Protection Act and other
applicable Michigan laws in connection with the marketing of Monumental Life
Insurance Company insurance products. The Court certified a class of Michigan
residents. The Court has now signed an Order granting preliminary approval of a
settlement agreement that has been signed by all parties. The Court approved the
settlement at a Fairness/Approval hearing on November 22, 2004. The settlement
agreement will have no financial or other material impact on the Company's
business.
28
VERTRUE INCORPORATED
PART II. OTHER INFORMATION
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:
Total Number of
Shares Purchased Maximum Number of
as Part of Shares that May
Total Number Publicly Yet be Purchased
Period of Shares Average Price Announced Plans Under the Plans
Purchased Paid per Share or Programs (1) or Programs
------------------------------------------- --------------- ------------------- ------------------- -------------------
October 1, 2004 to October 31, 2004 36,000 $ 26.17 36,000 1,679,007
November 1, 2004 to November 30, 2004 - $ - - 1,679,007
December 1, 2004 to December 31, 2004 - $ - - 1,679,007
--------------- ------------------- ------------------- -------------------
Total 36,000 $ 26.17 36,000 1,679,007
=============== =================== =================== ===================
(1) During 2004, the Board of Directors authorized the following share
amounts to be purchased under the Company's stock buyback program
originally authorized during fiscal 1997:
January 2004 - authorized an additional 1,000,000 shares, no
expiration.
October 2004 - authorized an additional 1,000,000 shares, no
expiration.
(2) On November 8, 2004, the Board of Directors authorized a modified
Dutch Auction self-tender offer for up to 500,000 shares of its common
stock. Under the terms of the self-tender offer and as approved by the
Board of Directors, the Company's stockholders were given the
opportunity to tender part or all of their shares to the Company at a
price of not less than $33.50 per share and not more than $38.50 per
share. The self-tender offer closed on January 7, 2005 and a total of
605,000 shares were tendered by shareholders. The Company exercised
its right to purchase the additional 105,000 shares in addition to the
500,000 shares for which it originally solicited tenders. In total,
the Company repurchased 605,000 shares for $38.50 per share and paid
$23.3 million to repurchase these shares. Subsequent to the completion
of the self-tender offer, the Company had 1,074,000 shares available
for repurchase under its stock repurchase program.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Company's 2004 Annual Meeting of Stockholders was held on November 18, 2004.
At the annual meeting, the following Directors were elected to the Board of
Directors for a term of one year:
Name For Withheld Nonvotes
---- --- -------- --------
Scott N. Flanders 9,075,903 82,534 919,004
Michael T. McClorey 9,141,087 17,350 919,004
Edward M. Stern 9,144,513 13,924 919,004
Alec L. Ellison 7,018,676 2,139,761 919,004
Marc S. Tesler 9,141,240 17,197 919,004
Gary A. Johnson 9,144,679 13,758 919,004
Robert Kamerschen 9,106,000 52,437 919,004
At the annual meeting, the following proposals were approved:
To change the Company's name to Vertrue Incorporated:
For - 9,115,201
Against - 43,036
Abstain - 200
Nonvotes - 919,004
To elect all directors annually:
For - 9,130,687
Against - 27,150
Abstain - 600
Nonvotes - 919,004
29
VERTRUE INCORPORATED
PART II. OTHER INFORMATION
To adopt the 2004 Long Term Incentive Plan:
For - 6,903,619
Against - 291,589
Abstain - 1,762
Nonvotes - 2,880,471
To ratify PricewaterhouseCoopers LLP as the independent auditors:
For - 9,148,517
Against - 9,458
Abstain - 462
Nonvotes - 919,004
Item 5. Other Information
-----------------
1.01 Entry into a Material Definitive Agreement
The Board adopted the Long-Term Incentive Plan ("LTIP") on January 22,
2004, subject to stockholder approval. On November 18, 2004, the shareholders of
the Company approved the LTIP filed as Annex C to the Definitive Proxy Statement
on Schedule 14A on October 28, 2004.
The LTIP provides incentive to certain officers and employees of the
Company and its subsidiaries with competitive incentive compensation
opportunities based on the achievement of specified performance goals. The
Executive Officer Development and Compensation Committee of the Board of
Directors (the "Committee") has the sole authority and discretion to designate
the employees who are eligible for a LTIP award, subject to the terms of the
Plan. In determining the amount and form of an award, consideration will be
given to the functions and responsibilities of the employee, his or her
potential contributions to the success of the Company and other factors deemed
relevant by the Committee.
The LTIP expires on the fifth anniversary of the date of stockholder
approval, unless terminated earlier by the Board.
The Committee may grant long-term incentive performance awards payable in
cash or stock at the end of a 3-year performance period. A separate 3-year
performance period begins each fiscal year and, accordingly, the fiscal years
included in a 3-year performance period will overlap. Payment will be contingent
upon the achievement of pre-established performance goals by the end of the
3-year performance period. The Committee has the sole authority to determine the
range of the payment values of an award and the performance goals required
before payment will be made. In general, a participant will not be entitled to
payment of a long-term incentive performance award unless the participant is
continuously employed by the Company until the end of the 3-year performance
period, except in cases of the participant's death or total disability. If the
Committee determines that a participant's employment has terminated during the
3-year performance period due to retirement or an involuntary termination
without cause, the participant will receive a pro-rata portion of the award
payable for that performance period. A maximum of $3 million for each three-year
performance period may be awarded to any one participant.
Item 6. Exhibits
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Exhibits
3.1 Amended and Restated Certificate of Incorporation of the Registrant.
10.1 Long-Term Incentive Plan (filed as Annex C to the Company's Definitive
Proxy Statement on Schedule 14A, File No. 000-21527, filed on October
28, 2004).
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.
30
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: February 9, 2005 By: /s/ Gary A. Johnson
-------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
February 9, 2005 By: /s/ James B. Duffy
------------------
James B. Duffy, Executive Vice President
and Chief Financial Officer (Principal
Financial and Accounting Officer)
31