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 March 31, 2005
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: 9,800,000 shares of Common
Stock, $0.01 par value as of April 30, 2005.
VERTRUE INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of March 31, 2005
and June 30, 2004 1
Condensed Consolidated Statements of Operations for the Three and Nine
Months Ended March 31, 2005 and 2004 2
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended March 31, 2005 and 2004 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 25
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 6. Exhibits 28
Signatures 29
VERTRUE INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except per share amounts)
March 31, June 30,
2005 2004
----------------- ---------------
Assets
Current assets:
Cash and cash equivalents $ 67,728 $ 47,166
Restricted cash 3,275 3,120
Short-term investments 26,596 119,980
Accounts receivable (net of allowance for doubtful accounts of $283 and $235 at
March 31, 2005 and June 30, 2004, respectively) 13,876 10,557
Prepaid membership materials 2,977 3,233
Prepaid expenses and other current assets 7,279 4,886
Membership solicitation and other deferred costs 41,866 52,428
----------------- ---------------
Total current assets 163,597 241,370
Fixed assets, net 39,101 36,540
Goodwill 187,230 125,675
Intangible assets, net 48,997 38,872
Other assets 11,778 10,705
----------------- ---------------
Total assets $ 450,703 $ 453,162
================= ===============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 706 $ 338
Accounts payable 34,776 35,185
Accrued liabilities 80,153 66,075
Deferred revenues 118,771 138,381
Deferred income taxes 10,651 12,323
----------------- ---------------
Total current liabilities 245,057 252,302
Deferred income taxes 11,894 4,354
Other long-term liabilities 6,107 4,930
Long-term debt 237,773 237,659
----------------- ---------------
Total liabilities 500,831 499,245
----------------- ---------------
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;
19,658 shares issued (19,089 shares at June 30, 2004) 196 191
Capital in excess of par value 167,792 156,457
Accumulated earnings 27,963 10,131
Accumulated other comprehensive income (loss) 227 (373)
Treasury stock, 9,824 shares at cost (8,852 shares at June 30, 2004) (246,306) (212,489)
----------------- ---------------
Total shareholders' deficit (50,128) (46,083)
----------------- ---------------
Total liabilities and shareholders' deficit $ 450,703 $ 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 Nine months ended
March 31, March 31,
-------------------------------- ----------------------------------
2005 2004 2005 2004
----------------- -------------- ----------------- ----------------
Revenues $ 148,995 $ 118,519 $ 421,097 $ 355,507
Expenses:
Marketing 75,968 60,941 213,189 194,342
Operating 31,107 22,324 81,269 66,829
General and administrative 27,914 20,438 78,821 58,400
Amortization of intangibles 2,467 258 5,764 847
----------------- -------------- ----------------- ----------------
Operating income 11,539 14,558 42,054 35,089
Interest expense, net (4,993) (1,265) (14,247) (2,317)
Other income, net 13 672 306 459
----------------- -------------- ----------------- ----------------
Income before income taxes 6,559 13,965 28,113 33,231
Provision for income taxes 2,206 5,586 10,281 13,292
----------------- -------------- ----------------- ----------------
Net income $ 4,353 $ 8,379 $ 17,832 $ 19,939
================= ============== ================= ================
Basic earnings per share $ 0.44 $ 0.81 $ 1.77 $ 1.83
================= ============== ================= ================
Diluted earnings per share $ 0.40 $ 0.68 $ 1.55 $ 1.62
================= ============== ================= ================
Weighted average common shares used in earnings
per share calculations:
Basic 9,915 10,301 10,072 10,895
================= ============== ================= ================
Diluted 13,005 13,380 13,014 13,211
================= ============== ================= ================
The accompanying notes are an integral part of
these consolidated financial statements.
2
VERTRUE INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine Months Ended
March 31,
---------------------------------
2005 2004
---------------- ----------------
Operating activities
Net income $ 17,832 $ 19,939
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred revenues (24,309) (20,074)
Change in membership solicitation and other deferred costs 10,830 19,156
Depreciation and amortization 16,879 7,649
Deferred and other income taxes 3,516 6,127
Tax benefit from employee stock plans 1,545 6,497
Other 174 928
Change in assets and liabilities:
Restricted cash (155) 50
Accounts receivable (2,894) (3,140)
Prepaid membership materials 256 (963)
Prepaid expenses (1,424) (629)
Other assets (1,158) (267)
Accounts payable 1,457 (6,967)
Accrued and other liabilities 2,007 (3,038)
---------------- ----------------
Net cash provided by operating activities 24,556 25,268
---------------- ----------------
Investing activities
Acquisition of fixed assets (7,407) (4,876)
Purchases of short-term investments (397,462) (405,920)
Sales of short-term investments 491,548 410,920
Acquisitions of businesses (net of cash acquired) and other
investing activities (65,687) -
---------------- ----------------
Net cash provided by investing activities 20,992 124
---------------- ----------------
Financing activities
Net proceeds from exercise of stock options 9,795 23,632
Treasury stock purchases (33,817) (84,942)
(Debt issuance costs) net proceeds from issuance of debt (803) 87,948
Payments of long-term obligations (373) (368)
---------------- ----------------
Net cash (used in) provided by financing activities (25,198) 26,270
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents 212 35
---------------- ----------------
Net increase in cash and cash equivalents 20,562 51,697
Cash and cash equivalents at beginning of period 47,166 67,260
---------------- ----------------
Cash and cash equivalents at end of period $ 67,728 $ 118,957
================ ================
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 services that the Company offers to its customers. The
Company is a leading consumer services marketing company. The Company's services
are both subscription and transaction based offerings focused on meeting
consumer needs in large spending categories - healthcare, personal property,
discounts, security, insurance and personals. The Company's service offerings
provide 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 nine months ended
March 31, 2005 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. ("Lavalife") on April 1, 2004, Bargain
Network, Inc. ("Bargain") on November 30, 2004 and My Choice Medical Holdings,
Inc. ("MCM") effective January 1, 2005. Therefore, their results of operations
have been included in the consolidated results of operations since their
acquisition dates and are not included in the results of operations for the
three and nine months ended March 31, 2004. The results of Bargain and MCM have
been included in the Marketing Services segment and the results of Lavalife have
been included in the Personals segment.
NOTE 3 - RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation, including reclassification of auction rate securities from cash
and cash equivalents to short-term investments. Corresponding adjustments have
been made to reflect gross purchases and sales of auction rate securities as
investing activities in the Consolidated Statements of Cash Flows rather than as
a component of cash and cash equivalents in prior periods. The Company
reclassified $112,330,000 from cash and cash equivalents to short-term
investments at June 30, 2004. These reclassifications do not affect previously
reported cash flows from operations or financing activities in our consolidated
statements of cash flows.
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
Statements ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") and 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 Nine months ended
March 31, March 31,
---------------------------- ---------------------------
2005 2004 2005 2004
--------------- ------------ -------------- ------------
Net income reported $ 4,353 $ 8,379 $ 17,832 $ 19,939
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 986 1,145 2,926 3,672
--------------- ------------ -------------- ------------
Pro forma net income $ 3,367 $ 7,234 $ 14,906 $ 16,267
=============== ============ ============== ============
Earnings per share:
As reported:
Basic $ 0.44 $ 0.81 $ 1.77 $ 1.83
Diluted $ 0.40 $ 0.68 $ 1.55 $ 1.62
Pro forma:
Basic $ 0.34 $ 0.70 $ 1.48 $ 1.49
Diluted $ 0.32 $ 0.60 $ 1.31 $ 1.34
NOTE 5 - BUSINESS COMBINATIONS
On January 1, 2005, the Company completed the acquisition of certain of the
assets of MCM, a privately held marketing services company serving the cosmetic
surgery industry. The Company acquired certain of the assets of MCM in order to
expand its consumer offerings to include cosmetic surgery. The purchase price,
excluding fees and expenses, amounted to $33,000,000 and was paid in cash on the
closing date. 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 identified
$12,060,000 of intangible assets other than goodwill in conjunction with this
acquisition. The $23,367,000 of excess merger consideration over the net assets
acquired was allocated to goodwill and substantially all of the 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.
On November 30, 2004, the Company completed the acquisition of certain of the
assets of Bargain, a privately held provider of premier pricing services for
homes, vehicles and consumer durables. The Company acquired certain of the
assets of Bargain in order to expand its direct to consumer marketing presence
and to expand its discounted consumer offerings to include personal property.
The purchase price, which excludes fees and expenses and is subject to certain
purchase price adjustments, amounted to $39,118,000, of which $10,905,000 will
be paid in the June 2005 quarter, and was paid in cash. In addition, the Company
assumed certain liabilities amounting to $4,729,000. Additional contingent
payments of up to $20,750,000 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 $3,400,000 of intangible assets other than goodwill in conjunction
with this acquisition. The $38,957,000 of excess merger consideration over the
net assets acquired was allocated to goodwill and substantially all of the
amount is deductible for tax purposes. See Note 6 for a detailed description of
5
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
the identified intangible assets and goodwill identified in connection with this
business combination.
On April 1, 2004, the Company completed the acquisition of all the assets and
outstanding capital stock of 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 US$116,300,000. The acquisition was funded
with cash on hand and borrowings under the Company's $45,000,000 senior secured
credit facility.
Pro Forma Results
The following unaudited pro forma results of operations for the three and nine
months ended March 31, 2004 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 Nine months
Ended Ended
March 31, March 31,
------------------ ----------------
2004 2004
------------------ ----------------
Revenues $ 137,004 $ 409,535
Net income 8,111 21,048
Basic earnings per share $ 0.75 $ 1.93
Diluted earnings per share 0.64 1.65
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 March 31, 2005 As of June 30, 2004
------------------------------------- -----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------------------- ----------------- ------------------ ----------------
Amortizable intangible assets:
Membership and client relationships $ 40,215 $ 13,217 $ 27,999 $ 8,686
Trade names 21,860 1,299 18,543 310
Other 1,518 1,130 1,162 886
------------------- ----------------- ------------------ ----------------
Total amortizable intangible assets 63,593 15,646 47,704 9,882
------------------- ----------------- ------------------ ----------------
Amortizable intangible assets, net $ 47,947 $ 37,822
=================== ==================
Unamortizable intangible assets:
Goodwill $ 187,230 $ 125,675
Intangible asset related to minimum
pension liability $ 1,050 $ 1,050
The future intangible amortization expense for the current and next five years
is estimated to be as follows (in thousands):
Fiscal Year
2005 $ 8,146
2006 8,483
2007 6,825
2008 4,743
2009 4,322
6
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The changes in the carrying amount of goodwill by segment for the nine months
ended March 31, 2005 are as follows (in thousands):
Marketing
Services Personals Total
-------- --------- -----
Balance at June 30, 2004 $ 42,040 $ 83,635 $ 125,675
Arising from acquisitions 62,324 - 62,324
Arising from purchase adjustments - (983) (983)
Other 214 - 214
-------------- --------------- --------------
Balance at March 31, 2005 $ 104,578 $ 82,652 $ 187,230
============== =============== ==============
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 acquisitions of certain of the assets of MCM and Bargain, the
Company acquired intangible assets of $77,784,000. Of those amounts, $12,220,000
was assigned to membership and client relationships and $3,240,000 was assigned
to trade names. These identified intangible assets are subject to periodic
amortization over the estimated useful lives ranging from 1 to 15 years.
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 forecast 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 concurrently 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 March 31, 2005, the fair value of these instruments was $536,000
(asset). Derivative gains and losses recognized in earnings were recorded in
operating expenses and general administrative expenses and amounted to a gain of
$416,000 and $1,027,000 for the three and nine months ended March 31, 2005,
respectively. All forecast transactions currently being hedged are expected to
occur over the next three months.
During the quarter ended March 31, 2004, the Company used a forward contract to
protect itself against foreign currency movements with respect to a portion of
the cash outflows associated with the acquisition of Lavalife. As of March 31,
2004, the fair value of these instruments was $867,000. Realized gains of
$672,000 were recorded in other income during the three and nine months ended
March 31, 2004.
NOTE 8 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities reported in the accompanying unaudited condensed
consolidated balance sheets as of March 31, 2005 and June 30, 2004 include an
allowance for membership cancellations of $10,913,000 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 $1,524,000 and $1,644,000 as of March
31, 2005 and June 30, 2004, respectively. Cash payments for the three and nine
months ended March 31, 2005 were $51,000 and $120,000, 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.
7
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On March 1, 2005, 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 an outstanding letter of credit of $5,459,000 and was $39,541,000
as of March 31, 2005. There were no borrowings outstanding under this bank
credit facility as of March 31, 2005.
On November 30, 2004, the Company completed the acquisition of certain of the
assets of Bargain. Contingent payments of up to $31,655,000 may be paid if
certain performance targets, including increasing levels of earnings, are
achieved through June 30, 2005 (see Note 5). Of this amount, $10,905,000 will be
paid in the June 2005 quarter.
On January 1, 2005, the Company completed the acquisition of certain of the
assets of MCM. 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 (see Note 5).
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 is 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 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
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 were
ultimately unsuccessful in this or other available appeals and a final
unappealable court order confirming the arbitration award were rendered, 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 was entered.
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 as approved by the Board of Directors, and as set forth
in the Offer to Purchase filed as an exhibit to the Company's Schedule TO filed
on November 15, 2004, as amended (the "Offer to Purchase"), 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 with a total
of 605,000 shares tendered by shareholders. The Company exercised its right, as
set forth in the Offer to Purchase, to purchase the additional 105,000 shares
and repurchased a total of 605,000 shares for $38.50 per share, paying a total
of $23,293,000.
NOTE 12 - INCOME TAX EXPENSE
Income tax expense as a percentage of pre-tax income was 33.6% and 40% for the
three months ended March 31, 2005 and 2004, respectively, and 36.6% and 40% for
the nine months ended March 31, 2005 and 2004, respectively. The effective tax
rate was higher than the U.S. statutory rate for the nine months ended March 31,
2005 and 2004 primarily due to state tax expense. The estimated effective tax
rate for the three and nine months ended March 31, 2005 decreased from the same
8
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 disqualifying dispositions of shares issued under the Company's
stock-based compensation plans reduced taxes payable by $606,000 and $4,944,000
for the three months ended March 31, 2005 and 2004, respectively, and by
$1,545,000 and $6,497,000 for the nine months ended March 31, 2005 and 2004,
respectively. Such benefits are credited to capital in excess of par value.
The Company has open tax years in the U.S., Canada and other jurisdictions that
are not currently under examination by the applicable tax authorities but 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 of SFAS 128. The following table reconciles the numerators and
denominators used in the computation of basic and diluted earnings per share (in
thousands, except per share data):
Three Months Ended Nine months Ended
March 31, March 31,
--------------------------- ----------------------------
2005 2004 2005 2004
------------ -------------- ------------- -------------
Numerator:
Income available to common shareholders used in basic earnings per
share $ 4,353 $ 8,379 $ 17,832 $ 19,939
Add Back: Interest expense on convertible securities, net of tax 821 742 2,355 1,493
------------ -------------- ------------- -------------
Income available to common shareholders for diluted earnings per
share after assumed conversion of dilutive securities $ 5,174 $ 9,121 $ 20,187 $ 21,432
============ ============== ============= =============
Denominator:
Weighted average number of common shares outstanding - basic 9,915 10,301 10,072 10,895
Effect of dilutive securities:
Convertible securities 2,230 2,229 2,230 1,494
Stock options 860 850 712 822
------------ -------------- ------------- -------------
Weighted average number of common shares outstanding - diluted 13,005 13,380 13,014 13,211
============ ============== ============= =============
Basic earnings per share $ 0.44 $ 0.81 $ 1.77 $ 1.83
============ ============== ============= =============
Diluted earnings per share $ 0.40 $ 0.68 $ 1.55 $ 1.62
============ ============== ============= =============
The diluted earnings per common share calculation excludes the effect of
potentially dilutive shares when their effect is antidilutive. For the quarters
ended March 31, 2005 and 2004, the Company had 25,000 and 0 shares,
respectively, of potentially dilutive outstanding stock options that are not
included in the calculation since they are antidilutive. For the nine months
ended March 31, 2005 and 2004, the Company had 54,000 and 6,000 shares,
respectively, of potentially dilutive outstanding stock options that are not
included in the calculations since they are antidilutive.
NOTE 14 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three Months Ended Nine months Ended
March 31, March 31,
----------------------------- -------------------------
2005 2004 2005 2004
-------------- -------------- ------------ ------------
Net income $ 4,353 $ 8,379 $ 17,832 $ 19,939
Unrealized (loss) gain on derivative assets (680) - 523 -
Foreign currency translation (loss) gain (16) (5) 77 11
-------------- -------------- ------------ ------------
Comprehensive income $ 3,657 $ 8,374 $ 18,432 $ 19,950
============== ============== ============ ============
9
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 assessing
performance and deciding how to allocate resources. Before the acquisition of
Lavalife in April 2004, the Company operated as one reportable business segment.
The Company now operates as two reportable business segments: Marketing
Services, formerly known as the Membership segment, and Personals. The Marketing
Services business segment is primarily involved in marketing discounted products
and services to consumers and developing and maintaining the service provider
relationship. The Personals business segment is primarily involved in providing
both web-based and IVR-based personals services to its customers. The results of
Bargain and MCM have been included in the Marketing Services segment.
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 Nine months Ended
March 31, March 31,
------------------------------- --------------------------------
2005 2004 2005 2004
-------------- ------------- -------------- --------------
Revenues:
Marketing Services $ 131,071 $ 118,519 $ 367,063 $ 355,507
Personals 17,998 - 54,244 -
Intersegment (74) - (210) -
-------------- ------------- -------------- --------------
Total $ 148,995 $ 118,519 $ 421,097 $ 355,507
============== ============= ============== ==============
Operating Income (Loss) (1):
Marketing Services $ 12,997 $ 14,558 $ 44,795 $ 35,089
Personals (1,458) - (2,741) -
-------------- ------------- -------------- --------------
Total $ 11,539 $ 14,558 $ 42,054 $ 35,089
============== ============= ============== ==============
March 31, June 30,
2005 2004
-------------- -------------
Assets:
Marketing Services $ 260,971 $ 178,723
Personals 135,839 136,874
Corporate and other (2) 53,893 137,565
----------------- ----------------
Total $ 450,703 $ 453,162
================= ================
(1) Operating income includes amortization of intangible assets of:
Three Months Ended Nine months Ended
March 31, March 31,
---------------------------------- ----------------------------------
2005 2004 2005 2004
----------------- ---------------- ---------------- -----------------
Marketing Services $ 1,167 $ 258 $ 1,861 $ 847
Personals 1,300 - 3,903 -
----------------- ---------------- ---------------- -----------------
Total $ 2,467 $ 258 $ 5,764 $ 847
================= ================ ================ =================
(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 the Company's
10
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 March 31, 2005 and June 30, 2004, the related statements of
operations for the three and nine months ended March 31, 2005 and 2004 and the
related statements of cash flows for the nine months ended March 31, 2005 and
2004. The information includes the elimination entries necessary to consolidate
the Company ("Parent") with the guarantor and nonguarantor entities.
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 March 31, 2005
-------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- ------------- -------------- -------------- ----------------
Assets (in thousands)
Current assets $ 98,118 $ 58,918 $ 20,538 $ (13,977) $ 163,597
Fixed assets, net 19,285 12,455 7,361 - 39,101
Goodwill - 118,187 69,043 - 187,230
Intangible assets, net 1,257 33,298 14,442 - 48,997
Other assets 10,217 51 1,510 - 11,778
Investment in subsidiaries 254,225 - - (254,225) -
---------- ------------- -------------- -------------- ----------------
Total assets $ 383,102 $ 222,909 $ 112,894 $ (268,202) $ 450,703
========== ============= ============== ============== ================
Liabilities and Shareholders' (Deficit) Equity
Current liabilities $ 189,848 $ 46,884 $ 22,302 $ (13,977) $ 245,057
Deferred income taxes 2,038 10,006 (150) - 11,894
Other long-term liabilities 3,571 - 2,536 - 6,107
Long-term debt 237,773 - - - 237,773
---------- ------------- -------------- -------------- ----------------
Total liabilities 433,230 56,890 24,688 (13,977) 500,831
---------- ------------- -------------- -------------- ----------------
Shareholders' (deficit) equity:
Preferred stock - - - - -
Common stock 196 6 3 (9) 196
Capital in excess of par value 167,792 165,285 87,776 (253,061) 167,792
Accumulated (deficit) earnings 27,963 448 558 (1,006) 27,963
Accumulated other comprehensive loss 227 280 (131) (149) 227
Treasury stock (246,306) - - - (246,306)
---------- ------------- -------------- -------------- ----------------
Total shareholders' (deficit) equity (50,128) 166,019 88,206 (254,225) (50,128)
---------- ------------- -------------- -------------- ----------------
Total liabilities and shareholders' (deficit) equity $ 383,102 $ 222,909 $ 112,894 $ (268,202) $ 450,703
========== ============= ============== ============== ================
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 March 31, 2005
------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- -------------- ---------------- ------------- ---------------
(in thousands)
Revenues $ 91,512 $ 37,016 $ 26,286 $ (5,819) $ 148,995
Expenses:
Marketing 52,273 17,435 11,380 (5,120) 75,968
Operating 15,563 7,476 8,767 (699) 31,107
General and administrative 15,186 8,571 4,157 - 27,914
Amortization of intangible assets 76 1,522 869 - 2,467
---------- -------------- ---------------- ------------- ---------------
Operating income 8,414 2,012 1,113 - 11,539
Equity in income of subsidiary 2,065 - - (2,065) -
Interest (expense) income, net (5,031) 22 16 - (4,993)
Other income (expense), net 42 (14) (15) - 13
---------- -------------- ---------------- ------------- ---------------
Income before income taxes 5,490 2,020 1,114 (2,065) 6,559
Provision for income taxes 1,137 560 509 - 2,206
---------- -------------- ---------------- ------------- ---------------
Net income $ 4,353 $ 1,460 $ 605 $ (2,065) $ 4,353
=========== ============== ================ ============= ===============
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 2004
------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- -------------- ---------------- ------------- ---------------
(in thousands)
Revenues $ 98,329 $ 15,310 $ 5,216 $ (336) $ 118,519
Expenses:
Marketing 51,773 7,813 1,355 - 60,941
Operating 17,216 2,992 2,452 (336) 22,324
General and administrative 16,762 2,719 957 - 20,438
Amortization of intangible assets - 258 - - 258
---------- -------------- ---------------- ------------- ---------------
Operating income 12,578 1,528 452 - 14,558
Equity in income of subsidiaries 1,214 - - (1,214) -
Interest (expense) income, net (1,317) 26 26 - (1,265)
Other income (expense), net 681 (1) (8) - 672
---------- -------------- ---------------- ------------- ---------------
Income before income taxes 13,156 1,553 470 (1,214) 13,965
Provision for income taxes 4,777 621 188 - 5,586
---------- -------------- ---------------- ------------- ---------------
Net income $ 8,379 $ 932 $ 282 $ (1,214) $ 8,379
=========== ============== ================ ============= ===============
13
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Nine months Ended March 31, 2005
------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- -------------- ---------------- ------------- ---------------
(in thousands)
Revenues $ 280,148 $ 106,838 $ 41,632 $ (7,521) $ 421,097
Expenses:
Marketing 152,145 50,839 15,832 (5,627) 213,189
Operating 46,311 21,956 14,896 (1,894) 81,269
General and administrative 46,364 25,340 7,117 - 78,821
Amortization of intangible assets 152 4,593 1,019 - 5,764
---------- -------------- ---------------- ------------- ---------------
Operating income 35,176 4,110 2,768 - 42,054
Equity in income of subsidiary 4,652 - - (4,652) -
Interest (expense) income, net (14,380) 113 20 - (14,247)
Other income (expense), net (56) 341 21 - 306
---------- -------------- ---------------- ------------- ---------------
Income before income taxes 25,392 4,564 2,809 (4,652) 28,113
Provision for income taxes 7,560 1,402 1,319 - 10,281
---------- -------------- ---------------- ------------- ---------------
Net income $ 17,832 $ 3,162 $ 1,490 $ (4,652) $ 17,832
=========== ============== ================ ============= ===============
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Nine months Ended March 31, 2004
------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- -------------- ---------------- ------------- ---------------
(in thousands)
Revenues $ 299,505 $ 43,308 $ 13,814 $ (1,120) $ 355,507
Expenses:
Marketing 168,897 21,852 3,593 - 194,342
Operating 52,360 9,350 6,239 (1,120) 66,829
General and administrative 47,778 7,808 2,814 - 58,400
Amortization of intangible assets - 847 - - 847
---------- -------------- ---------------- ------------- ---------------
Operating income 30,470 3,451 1,168 - 35,089
Equity in income of subsidiaries 2,846 - - (2,846) -
Interest (expense) income, net (2,479) 82 80 - (2,317)
Other income (expense), net 497 32 (70) - 459
---------- -------------- ---------------- ------------- ---------------
Income before income taxes 31,334 3,565 1,178 (2,846) 33,231
Provision for income taxes 11,395 1,426 471 - 13,292
---------- -------------- ---------------- ------------- ---------------
Net income $ 19,939 $ 2,139 $ 707 $ (2,846) $ 19,939
=========== ============== ================ ============= ===============
14
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine months Ended March 31, 2005
---------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- -------------- ---------------- ------------- ---------------
(in thousands)
Net cash provided by (used in) operating activities $ 112,759 $ (89,116) $ 5,565 $ (4,652) $ 24,556
Investing activities
Acquisition of fixed assets (5,043) (1,208) (1,156) - (7,407)
Purchases of short-term investments (397,218) (244) - - (397,462)
Sales of short-term investments 490,735 813 - - 491,548
Acquisitions of businesses and other investing
activities (160,994) 93,937 1,370 - (65,687)
Investment in subsidiaries (4,652) - - 4,652 -
---------- -------------- ---------------- ------------- ---------------
Net cash (used in) provided by investing activities (77,172) 93,298 214 4,652 20,992
---------- -------------- ---------------- ------------- ---------------
Financing activities
Net proceeds from exercise of stock options 9,795 - - - 9,795
Treasury stock purchases (33,817) - - - (33,817)
Debt issuance costs (803) - - - (803)
Payments of long-term obligations (242) (14) (117) - (373)
---------- -------------- ---------------- ------------- ---------------
Net cash used in financing activities (25,067) (14) (117) - (25,198)
---------- -------------- ---------------- ------------- ---------------
Effect of exchange rate changes on cash and cash
equivalents - (272) 484 - 212
---------- -------------- ---------------- ------------- ---------------
Net increase in cash and cash equivalents 10,520 3,896 6,146 - 20,562
Cash and cash equivalents at beginning of period 18,251 26,657 2,258 - 47,166
---------- -------------- ---------------- ------------- ---------------
Cash and cash equivalents at end of period $ 28,771 $ 30,553 $ 8,404 $ - $ 67,728
========== ============== ================ ============= ===============
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine months Ended March 31, 2004
---------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
---------- -------------- ---------------- ------------- ---------------
(in thousands)
Net cash provided by (used in) operating activities $ 34,092 $ (5,923) $ (55) $ (2,846) $ 25,268
Investing activities
Acquisition of fixed assets (4,252) (279) (345) - (4,876)
Purchases of short-term investments (405,920) - - - (405,920)
Sales of short-term investments 410,920 - - - 410,920
Investment in subsidiaries (2,846) - - 2,846 -
---------- -------------- ---------------- ------------- ---------------
Net cash (used in) provided by investing activities (2,098) (279) (345) 2,846 124
---------- -------------- ---------------- ------------- ---------------
Financing activities
Net proceeds from exercise of stock options 23,632 - - - 23,632
Treasury stock purchases (84,942) - - - (84,942)
Net proceeds from the issuance of debt 87,948 - - - 87,948
Payments of long-term obligations (110) (258) - - (368)
---------- -------------- ---------------- ------------- ---------------
Net cash provided by (used in) financing activities 26,528 (258) - - 26,270
----------------------------------------------------------- ---------------
Effect of exchange rate changes on cash and cash
equivalents - - 35 - 35
---------- -------------- ---------------- ------------- ---------------
Net increase (decrease) in cash and cash equivalents 58,522 (6,460) (365) - 51,697
Cash and cash equivalents at beginning of period 46,895 18,716 1,649 - 67,260
---------- -------------- ---------------- ------------- ---------------
Cash and cash equivalents at end of period $ 105,417 $ 12,256 $ 1,284 $ - $ 118,957
========== ============== ================ ============= ===============
15
VERTRUE INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 17 - SUPPLEMENTAL CASH FLOW DISCLOSURE
During the nine months ended March 31, 2005, the Company accrued $10,905,000 of
contingent payments related to the acquisition of certain of the assets of
Bargain, which will be paid in the quarter ending June 30, 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.
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 services that the Company offers to its customers. The
Company is a leading consumer services marketing company. The Company's services
are both subscription and transaction based offerings focused on meeting
consumer needs in large spending categories - healthcare, personal property,
discounts, security, insurance and personals. The Company's service offerings
provide 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: Marketing Services and Personals.
For additional financial information about these business segments, see Note 15
to the condensed consolidated financial statements.
The Marketing Services segment, formerly known as the Membership segment, offers
consumers a variety of products and services from selected vendors and service
providers on an annual or monthly subscription basis or a fee for service
basis. Revenues are derived principally from recurring fees which are billed to
the member either on an annual or monthly basis; however, with the acquisition
of My Choice Medical Holdings, Inc. ("MCM") on January 1, 2005 and the evolution
of certain aspects of the Company's loyalty business, an increasing amount of
revenue is being derived from fee for service transactions. 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. Revenue derived from one time fees is recognized when
the service is performed. Profitability and cash flow generated from renewal
memberships exceed those 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 March 31, 2005 and March 31, 2004
Revenues
Three Months Ended Percent
March 31, Increase
----------------------------- ------------
2005 2004 '05 vs. '04
---- ---- -----------
Marketing Services $ 131,065 $ 118,519 11%
Personals 17,930 - NM
------------- ------------- ------------
Total $ 148,995 $ 118,519 26%
============= ============= ============
NM = Not Meaningful
Marketing Services
Revenues increased 11% in 2005 primarily due to revenues from Bargain Network,
Inc. ("Bargain") and MCM, which were acquired on November 30, 2004 and January
1, 2005, respectively. Excluding revenues from these acquisitions, revenues
would have decreased 3% from the prior year primarily due to a decrease in the
net active retail members. The net active retail members decreased 7% to 5.7
million as of March 31, 2005 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 mix of new members enrolled in a monthly payment plan program was
87% and 63% in 2005 and 2004, respectively.
Revenues generated from different payment programs are summarized below:
Percent
Three Months Ended Increase/
March 31, (Decrease)
----------------------------- ------------
2005 2004 '05 vs. '04
---- ---- -----------
Monthly payment plans $ 67,377 $ 45,911 47%
Annual payment plans:
Initial year 11,744 22,802 (48)%
Renewal year 36,780 43,057 (15)%
Other 15,164 6,749 NM
------------ ----------- ----------------
Total $ 131,065 $ 118,519 11%
============ =========== ================
NM = Not Meaningful
Other represents fee for service revenues. The increase in Other over the prior
year was primarily due to the acquisition of MCM.
Personals
Revenues were $17.9 million and represent the revenues of Lavalife, which was
acquired by the Company on April 1, 2004. On a pro forma basis giving effect to
the acquisition of Lavalife, revenues would have decreased 3% from the prior
year primarily due to increased competition in the U.S. online personals market.
There were approximately 0.6 million active customers as of March 31, 2005.
18
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Operating income
Three Months Ended March 31, Percent
Decrease
------------------------------- ------------
2005 2004 '05 vs. '04
---- ---- -----------
Marketing Services $ 12,997 $ 14,558 (11)%
Personals (1,458) - NM
------------- ------------- ------------
Total $ 11,539 $ 14,558 (21)%
============= ============= ============
NM = Not Meaningful
Marketing Services
Operating income decreased 11% due to an increase in marketing and operating
expenses as a percentage of revenue. Marketing expenses were $67.6 million in
2005 versus $60.9 million in 2004 and, as a percentage of revenues, marketing
expenses were 52% in 2005 versus 51% in 2004. The increase in marketing expenses
as a percentage of revenue was primarily due to an increase in the volume of new
monthly marketing. Operating expenses were $27.4 million in 2005 versus $22.3
million in 2004 and as a percentage of revenue, operating expenses were 21% in
2005 compared to 19% in 2004. The increase in operating expenses as a percentage
of revenue was due to a higher proportion of the recent acquisitions' costs that
are considered to be operating expenses while a lower proportion of costs are
considered to be marketing expenses.
Personals
Operating loss was $1.5 million in 2005 and reflected $1.3 million of
amortization expense. On a pro forma basis giving effect to the acquisition of
Lavalife, operating loss would have been $1.1 million in 2004. The increase from
prior year pro forma operating loss was primarily due to increased advertising
rates in the U.S. personals market.
Corporate
Three Months Ended March 31, Percent
Increase/
(Decrease)
------------------------------- ------------
2005 2004 '05 vs. '04
---- ---- -----------
Interest expense, net $ 4,993 $ 1,265 NM
Other income, net 13 672 98%
Provision for income taxes 2,206 5,586 (61)%
NM = Not Meaningful
Interest expense, net. The increase in interest expense, net in 2005 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 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, net. The decrease in other income was primarily due to a $0.7
million gain realized during the quarter ended March 31, 2004 on a forward
contract that the Company used to protect itself against foreign currency
movements with respect to the Lavalife acquisition.
Provision for income taxes. The Company recorded a provision for income taxes of
$2.2 million and $5.6 million based on an effective tax rate of 33.6% and 40% in
2005 and 2004, respectively. The estimated effective tax rate in 2005 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.
19
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Nine Months Ended March 31, 2005 and March 31, 2004
Revenues
Nine months Ended Percent
March 31, Increase
------------------------------- ------------
2005 2004 '05 vs. '04
---- ---- -----------
Marketing Services $ 367,057 $ 355,507 3%
Personals 54,040 - NM
------------- ------------- ------------
Total $ 421,097 $ 355,507 18%
============= ============= ============
NM = Not Meaningful
Marketing Services
Revenues increased 3% in 2005 primarily due to revenues from Bargain and MCM.
Excluding revenues from these acquisitions, revenues would have decreased 2%
from the prior year primarily due to a decrease in the net active retail
members. The net active retail members decreased 7% to 5.7 million as of March
31, 2005 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 mix of new
members enrolled in a monthly payment plan program was 85% and 64% in 2005 and
2004, respectively.
Revenues generated from different payment programs are summarized below:
Percent
Nine months Ended Increase/
March 31, (Decrease)
--------------------------- ----------------
2005 2004 '05 vs. '04
---- ---- -----------
Monthly payment plans $ 172,871 $ 113,664 52%
Annual payment plans:
Initial year 45,660 95,589 (52)%
Renewal year 118,717 126,190 (6)%
Other 29,809 20,064 49%
------------ ----------- ----------------
Total $ 367,057 $ 355,507 3%
============ =========== ================
Other represents fee for service revenues. The increase in Other over the prior
year was primarily due to the acquisition of MCM as well as increases in our
loyalty business.
Personals
Revenues were $54.0 million and represent the revenues of Lavalife. On a pro
forma basis giving effect to the acquisition of Lavalife, revenues would have
remained flat from the prior year. There were approximately 0.6 million active
customers as of March 31, 2005.
Operating income
Nine months Ended Percent
March 31, Increase
------------------------------- ------------
2005 2004 '05 vs. '04
---- ---- -----------
Marketing Services $ 44,795 $ 35,089 28%
Personals (2,741) - NM
------------- ------------- ------------
Total $ 42,054 $ 35,089 20%
============= ============= ============
NM = Not Meaningful
Marketing Services
Operating income increased 28% primarily due to a 3% increase in revenues and a
3% decrease in marketing expenses. Marketing expenses were $189.3 million in
2005 versus $194.3 million in 2004 and, as a percentage of revenues, marketing
20
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
expenses were 52% in 2005 versus 55% in 2004. This decrease was primarily due to
the decrease in the level and mix of members enrolled through the higher cost
outbound telemarketing channel.
Personals
Operating loss was $2.7 million in 2005 and reflected $3.9 million of intangible
amortization expense. On a pro forma basis giving effect to the acquisition of
Lavalife, operating income would have been $0.3 million in 2004. The decrease
from prior year pro forma operating income was primarily due to increased
advertising rates in the U.S. online market.
Corporate
Nine months Ended Percent
March 31, Decrease
------------------------------- ------------
2005 2004 '05 vs. '04
---- ---- -----------
Interest expense, net $ 14,247 $ 2,317 NM
Other income, net 306 459 (33)%
Provision for income taxes 10,281 13,292 (23)%
NM = Not Meaningful
Interest expense, net. The increase in interest expense, net in 2005 was due to
$1.2 million of interest expense related to the 5.5% Convertible Senior
Subordinated Notes issued in September 2003 and $10.7 million of interest
expense related to the 9.25% Senior Notes issued in April 2004. For additional
information on these debt issuances, refer to the section titled "Management's
Discussion and Analysis of Financial Condition - Liquidity and Capital
Resources" of this Quarterly Report on Form 10-Q.
Provision for income taxes. The Company recorded a provision for income taxes of
$10.3 million and $13.3 million based on an effective tax rate of 36.6% and 40%
in 2005 and 2004, 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 2005 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 in the Reconciliation of
Non-GAAP Measures section in this Quarterly Report on Form 10-Q.
Net cash provided by operating activities was $24.6 million and $25.3 million
for the nine months ended March 31, 2005 and 2004, respectively.
Revenues before deferral increased 18% to $396.8 million for the nine months
ended March 31, 2005 from $335.4 million for the nine months ended March 31,
2004 primarily due to revenues before deferral generated by Lavalife, Bargain
and MCM. Excluding revenues before deferral from the recent acquisitions,
revenues before deferral would have decreased 4% primarily due to the effect of
an increase in the marketing of monthly memberships. For the nine months ended
March 31, 2005 and 2004, the mix of new members enrolled in a monthly payment
plan program was 85% and 64%, respectively. Monthly weighted average program
price points per retail member were $12.30 and $11.25 for the nine months ended
March 31, 2005 and 2004, respectively. The new annual weighted average program
price points per retail member were $104 and $106 for the nine months ended
March 31, 2005 and 2004, respectively.
21
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table below summarizes the components of revenues before deferral for the
nine months ended March 31:
2005 2004
----------------- --------------
Monthly payment plans $ 177,402 $ 120,490
Annual payment plans:
Initial year 31,026 63,299
Renewal year 103,211 131,580
Other 30,992 20,064
Personals 54,157 -
----------------- --------------
Total $ 396,788 $ 335,433
================= ==============
Marketing costs before deferral were $202.4 million and $175.2 million for the
nine months ended March 31, 2005 and 2004, respectively. For the nine months
ended March 31, 2005, marketing costs before deferral increased 16% primarily
due to marketing costs of $34.8 million incurred by Lavalife, Bargain and MCM.
As a percent of revenue before deferral, marketing costs before deferral were
51% for the nine months ended March 31, 2005 versus 52% for the nine months
ended March 31, 2004 due to the effect of the recent acquisitions which have
lower marketing expenses offset by higher operating expenses, the maturing base
of members enrolled in a monthly payment plan program and the reduced level and
mix of higher cost outbound telemarketing. As a result, marketing margin before
deferral was $194.4 million and $160.2 million for the nine months ended March
31, 2005 and 2004, 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 recent acquisitions, as well as increased interest costs associated
with the Convertible Notes and Senior Notes.
Net cash provided by operating activities was also affected by changes in assets
and liabilities, which used $1.9 million of cash for the nine months ended March
31, 2005 and $15.0 million of cash for the nine months ended March 31, 2004
primarily due to the timing of vendor payments.
Net cash provided by investing activities was $21.0 million for the nine months
ended March 31, 2005 and primarily reflected net settlements of short-term
investments of $94.1 million offset by $65.7 million of cash used in connection
with the Company's recent acquisitions. Net settlements of short-term
investments were $5.0 million for the nine months ended March 31, 2004. Capital
expenditures were $7.4 million and $4.9 million for the nine months ended March
31, 2005 and 2004, respectively.
Net cash used in financing activities was $25.2 million for the nine months
ended March 31, 2005 compared to net cash provided by financing activities of
$26.3 million for the nine months ended March 31, 2004. Net cash used in
financing activities for the nine months ended March 31, 2005 principally
reflected the use of $33.8 million in cash to repurchase the Company's stock,
which was partially offset by proceeds from the exercise of stock options of
$9.8 million. Net cash provided by financing activities for the nine months
ended March 31, 2004 principally reflected the issuance of $87.9 million in
debt, net of issuance costs, and proceeds from the exercise of stock options of
$23.6 million. These sources of cash in 2004 were partially offset by the use of
$84.9 million in cash to repurchase the Company's stock.
Debt Issuances
As of March 31, 2005, the Company had $240.0 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
22
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 privately placed Senior Notes were exchanged for
registered Senior Notes on December 10, 2004.
Credit Facility
The Company has a senior secured credit facility, which was amended and restated
on March 1, 2005, 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 March 31, 2005, the availability under the senior
secured credit facility was reduced by an outstanding letter of credit of $5.5
million and was $39.5 million. As of March 31, 2005, the effective interest rate
for borrowings under the senior secured credit facility was 5.75%. 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 March 31, 2005,
the Company was in compliance with all such debt covenants.
Stock Repurchase Program
The Company purchased 972,000 shares of common stock for $33.8 million at an
average price of $34.43 during the nine months ended March 31, 2005 compared to
2.7 million shares for $84.9 million at an average price of $31.91 during the
nine months ended March 31, 2004. During the nine months ended March 31, 2005,
the Company's Board of Directors authorized the repurchase of 1.0 million shares
of its common stock under its ongoing stock repurchase program. As of March 31,
2005, the Company had 1.0 million shares available for repurchase under its
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 as approved by the Board of Directors, and as set forth
in the Offer to Purchase filed as an exhibit to the Company's Schedule TO filed
on November 15, 2004, as amended, (the "Offer to Purchase"), 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 with a total
of 605,000 shares tendered by shareholders. The Company exercised its right, as
set forth in the Offer to Purchase, to purchase the additional 105,000 shares
and repurchased a total of 605,000 shares for $38.50 per share, paying a total
of $23.3 million.
Acquisitions
On January 1, 2005, the Company completed the acquisition of certain of the
assets of MCM, a privately held marketing services company serving the cosmetic
surgery industry. 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.
On November 30, 2004, the Company completed the acquisition of certain of the
assets of Bargain, 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
$39.1 million, of which $10.9 million will be paid in the June 2005 quarter. In
addition, the Company assumed certain liabilities amounting to $4.7 million.
Additional contingent payments of up to $20.8 million may be paid if certain
performance targets, including increasing levels of earnings, are achieved
through June 30, 2005.
As of March 31, 2005, the Company had cash, cash equivalents and short-term
investments of $97.6 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
March 31, 2005. The Company intends to utilize cash on hand and cash generated
from operations to fulfill any capital expenditure requirements during 2005 and
2006.
23
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 or accrued 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 determined 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 uses these measures solely as liquidity measures and
not as performance measures.
Revenues before deferral for the nine months ended March 31, 2005 and 2004 are
calculated as follows:
2005 2004
------------- -------------
Revenues $ 421,097 $ 355,507
Change in deferred revenues, net of deferred revenues acquired (24,309) (20,074)
------------- -------------
Revenues before deferral $ 396,788 $ 335,433
============= =============
Marketing cost before deferral for the nine months ended March 31, 2005 and 2004
is calculated as follows:
2005 2004
------------- -------------
Marketing expenses $ 213,189 $ 194,342
Change in membership solicitation and other deferred costs (10,830) (19,156)
------------- -------------
Marketing costs before deferral $ 202,359 $ 175,186
============= =============
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.
24
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Future minimum payments of contractual obligations as of March 31, 2005 are as
follows (amounts in thousands):
Payments Due by Period
-------------------------------------------------------------------------------
Less than After
Total 1 year 1-3 years 4-5 years 5 years
-------------- ------------- -------------- -------------- ---------------
Operating leases $ 28,926 $ 9,148 $ 10,971 $ 7,472 $ 1,335
Capital leases 2,013 706 1,186 121 -
Long term debt 240,000 - - - 240,000
Purchase obligations 101,848 36,114 65,734 - -
-------------- ------------- -------------- -------------- ---------------
Total payments due $ 372,787 $ 45,968 $ 77,891 $ 7,593 $ 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 forecast 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 on 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;
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 affected;
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;
25
VERTRUE INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
26
VERTRUE INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Interest Rate
The Company has a senior secured credit facility, which was amended and restated
on March 1, 2005, 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 March 31, 2005. As of March 31, 2005, availability
under the senior secured credit facility was reduced by an outstanding letter of
credit of $5.5 million and was $39.5 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. 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 is affected by
changes in interest rates and, with respect to the Convertible Notes, is 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 March 31, 2005, the carrying value of the Convertible Notes and the Senior
Notes was $90.0 million and $147.8 million, respectively, and the fair value of
the notes was $99.9 million and $150.0 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 is 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 forecast
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 since 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 during the last quarter 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.
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 is 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 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
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 were
ultimately unsuccessful in this or other available appeals and a final
unappealable court order confirming the arbitration award were rendered, 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 was entered.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
The following table summarizes the shares of the Company's equity securities
purchased by or on behalf of the Company:
Maximum
Total Number of Number of Shares
Total Shares Purchased that May Yet be
Number of as Part of Publicly Purchased Under
Shares Average Price Announced Plans the Plans or
Period Purchased Paid per Share (1) or Programs (2) Programs
------------------------------------------- --------------- ------------------- ------------------- -------------------
January 1, 2005 to January 31, 2005 604,977 $ 38.50 604,977 1,074,030
February 1, 2005 to February 28, 2005 13,000 $ 39.89 13,000 1,061,030
March 1, 2005 to March 31, 2005 39,600 $ 36.94 39,600 1,021,430
--------------- ------------------- ------------------- -------------------
Total 657,577 $ 38.44 657,577 1,021,430
=============== =================== =================== ===================
(1) Excludes expenses paid in connection with the modified Dutch Auction
self-tender offer that closed on January 7, 2005.
(2) 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.
Item 6. Exhibits
--------
Exhibits
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.
28
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: May 10, 2005 By: /s/ Gary A. Johnson
-----------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
May 10, 2005 By:/s/ James B. Duffy
-----------------------------------------
James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
29