UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
----- Exchange Act of 1934 for the quarterly period ended December 31, 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
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(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
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(Address of principal executive offices) (Zip Code)
(203) 324-7635
-----------------------------------
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 9,671,000 shares of Common
Stock, $0.01 par value as of January 27, 2006.
VERTRUE INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Condensed Financial Statements (Unaudited)
Consolidated Balance Sheets as of December 31, 2005
and June 30, 2005 1
Consolidated Statements of Operations for the Three and Six
Months Ended December 31, 2005 and 2004 2
Consolidated Statements of Cash Flows for the Six
Months Ended December 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 19
Forward-Looking Statements 27
Item 3. Quantitative and Qualitative Disclosures about Market Risk 29
Item 4. Controls and Procedures 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 31
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 6. Exhibits 32
Signatures 33
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
December 31, June 30,
2005 2005
------------ ------------
Assets
Current assets:
Cash and cash equivalents $ 54,576 $ 64,356
Restricted cash 3,857 3,411
Short-term investments 17,217 16,223
Accounts receivable 16,930 12,559
Prepaid membership materials 3,499 2,557
Prepaid expenses and other current assets 11,200 8,695
Deferred marketing costs 33,359 39,226
------------ ------------
Total current assets 140,638 147,027
Fixed assets, net 37,603 39,062
Goodwill 212,859 201,499
Intangible assets, net 41,829 46,476
Other assets 13,496 13,098
------------ ------------
Total assets $ 446,425 $ 447,162
============ ============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 746 $ 686
Accounts payable 37,705 42,077
Accrued liabilities 75,114 82,157
Deferred revenues 97,736 108,117
Deferred income taxes 11,527 9,780
------------ ------------
Total current liabilities 222,828 242,817
Deferred income taxes 9,465 9,702
Other long-term liabilities 6,009 5,257
Long-term debt 237,897 237,814
------------ ------------
Total liabilities 476,199 495,590
------------ ------------
Commitments and contingencies - -
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;
19,834 shares issued (19,703 shares at June 30, 2005) 198 197
Capital in excess of par value 177,281 169,463
Retained earnings 51,985 35,680
Accumulated other comprehensive income (loss) 377 (148)
Treasury stock, 10,185 shares at cost (10,020 shares at June 30, 2005) (259,615) (253,620)
------------ ------------
Total shareholders' deficit (29,774) (48,428)
------------ ------------
Total liabilities and shareholders' deficit $ 446,425 $ 447,162
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
1
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three months ended Six months ended
December 31, December 31,
------------------------- ------------------------
2005 2004 2005 2004
------------ ------------ ----------- ------------
Revenues $ 160,130 $ 136,479 $ 317,658 $ 272,102
Expenses:
Marketing 76,270 68,689 150,169 137,221
Operating 35,258 25,952 70,341 50,162
General and administrative 29,527 26,302 57,981 50,907
Amortization of intangibles 2,197 1,753 4,633 3,297
------------ ------------ ----------- ------------
Operating income 16,878 13,783 34,534 30,515
Interest expense, net (4,387) (4,611) (8,844) (9,254)
Other (expense) income, net (120) 428 (161) 293
------------ ------------ ----------- ------------
Income before income taxes 12,371 9,600 25,529 21,554
Provision for income taxes 4,707 3,717 9,224 8,075
------------ ------------ ----------- ------------
Net income $ 7,664 $ 5,883 $ 16,305 $ 13,479
============ ============ =========== ============
Earnings per share:
Basic $ 0.79 $ 0.58 $ 1.68 $ 1.33
============ ============ =========== ============
Diluted $ 0.66 $ 0.51 $ 1.40 $ 1.16
============ ============ =========== ============
Weighted average common shares used in earnings per share
calculations:
Basic 9,695 10,128 9,705 10,151
============ ============ =========== ============
Diluted 12,776 13,063 12,802 13,003
============ ============ =========== ============
The accompanying notes are an integral part of these consolidated financial statements.
2
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six months ended
December 31,
------------------------
2005 2004
----------- -----------
Operating activities
Net income $ 16,305 $ 13,479
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred revenues (10,611) (19,369)
Change in deferred marketing costs 5,971 8,685
Depreciation and amortization 13,025 10,422
Stock-based compensation 2,250 -
Deferred income taxes 1,521 3,197
Excess tax benefit from stock-based compensation (560) 939
Other (243) 422
Change in assets and liabilities:
Restricted cash (446) 283
Accounts receivable (4,371) (3,939)
Prepaid membership materials (942) (1,150)
Prepaid expenses (1,138) (2,247)
Other assets (1,948) (19)
Accounts payable (4,372) 834
Accrued and other liabilities 375 3,089
----------- -----------
Net cash provided by operating activities 14,816 14,626
----------- -----------
Investing activities
Acquisition of fixed assets (6,518) (4,339)
Purchases of short-term investments (50,325) (368,533)
Sales of short-term investments 49,830 425,912
Acquisitions of businesses, net of cash acquired (14,942) (16,097)
----------- -----------
Net cash (used in) provided by investing activities (21,955) 36,943
----------- -----------
Financing activities
Net proceeds from issuance of stock 2,729 6,237
Excess tax benefit from stock-based compensation 560 -
Treasury stock purchases (5,995) (8,396)
Debt issuance costs - (750)
Payments of long-term obligations (392) (204)
----------- -----------
Net cash used in financing activities (3,098) (3,113)
----------- -----------
Effect of exchange rate changes on cash and cash equivalents 457 235
----------- -----------
Net (decrease) increase in cash and cash equivalents (9,780) 48,691
Cash and cash equivalents at beginning of year 64,356 47,166
----------- -----------
Cash and cash equivalents at end of period $ 54,576 $ 95,857
=========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
3
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF BUSINESS
Vertrue Incorporated ("Vertrue" or the "Company") is a leading internet
marketing services company. The Company gives consumers access to both
subscription and transaction based services focused on meeting consumer needs in
large spending categories - healthcare, personal property, discounts, security
and insurance and personals. The Company's service offerings provide consumers
everyday savings, event-oriented discounts, benefits that provide the consumer
with peace of mind and access to information and opportunities for
self-enrichment.
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 and include the
accounts of the Company, its wholly owned subsidiaries and variable interest
entities required to be consolidated. All significant intercompany accounts and
transactions have been eliminated. 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
statement have been included. The preparation of these consolidated financial
statements in conformity with generally accepted accounting principles requires
management of the Company to make estimates, judgments and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates. Operating results for the
three and six months ended December 31, 2005 are not necessarily indicative of
the results that may be expected for the fiscal year ending June 30, 2006. For
further information, refer to the financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
June 30, 2005.
The Company acquired Bargain Network, Inc. ("Bargain") on November 30, 2004 and
My Choice Medical Holdings, Inc. ("MCM") on January 1, 2005. Therefore, their
results of operations have been included in the consolidated results of
operations since their acquisition dates. The results of Bargain have been
included in the Marketing Services segment and the results of MCM have been
included in the Management Services segment.
NOTE 3 - RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year's presentation to reclassify auction rate securities from cash and cash
equivalents to short-term investments. Corresponding adjustments have been made
in the consolidated statements of cash flows for prior periods to reflect gross
purchases and sales of auction rate securities as investing activities rather
than as a component of cash and cash equivalents. The Company reclassified
$112,330,000 and $55,215,000 from cash and cash equivalents to short-term
investments at June 30, 2004 and December 31, 2004, respectively. These
reclassifications do not affect previously reported cash flows from operating or
financing activities in the consolidated statements of cash flows. For the six
months ended December 31, 2004, net cash provided by investing activities
related to auction rate securities was $57,115,000.
NOTE 4 - STOCK-BASED COMPENSATION
The Company adopted Financial Accounting Standards Board Statement ("SFAS") No.
123(R), "Share-Based Payment" ("SFAS 123R") on July 1, 2005. SFAS 123R
establishes the accounting for share-based compensation and requires companies
to measure and recognize compensation expense for all share-based payments at
fair value. Accordingly, share-based compensation cost is measured at grant date
based on the fair value of the award and is recognized as expense over the
requisite service period. The Company adopted the modified prospective
application method as permitted by SFAS 123R.
4
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Prior to the adoption of SFAS 123R, the Company accounted for its share-based
employee compensation plans under the recognition and measurement provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and the related interpretations. If compensation cost for the
Company's stock-based compensation plans had been determined based on the fair
value method (estimated using the Black-Scholes option pricing model) at the
grant dates in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," ("SFAS 123"), the Company's pro forma net income and earnings per
share would have been as follows for the three and six months ended December 31,
2004 (in thousands, except per share data):
Three months ended Six months ended
December 31, 2004 December 31, 2004
-------------------- --------------------
Net income reported $ 5,883 $ 13,479
Add: Stock-based employee compensation expense under the
intrinsic value method, net of related tax effects - -
Deduct: Stock-based employee compensation expense
under the fair value method, net of related tax effects (1) 961 1,940
-------------------- --------------------
Pro forma net income $ 4,922 $ 11,539
==================== ====================
Earnings per share:
As reported
Basic $ 0.58 $ 1.33
Diluted $ 0.51 $ 1.16
Pro forma
Basic $ 0.49 $ 1.14
Diluted $ 0.43 $ 0.99
(1) Compensation expense was reduced for forfeitures as they occurred.
The Company evaluated its valuation method and assumptions in connection with
SFAS 123R. The Company determined that the use of the Black-Scholes
option-pricing model was appropriate and is consistent with the Company's pro
forma disclosures under the fair value recognition provisions of SFAS 123. The
Company believes it has used appropriate assumptions in accordance with SFAS
123R to estimate the fair value of its stock options and its employee stock
purchase plan during the three and six months ended December 31, 2005. The
following weighted average assumptions were used to estimate the fair value of
options granted:
Three months ended Six months ended
December 31, December 31,
------------------- -------------------
Black-Scholes Option Valuation Assumptions 2005 (4) 2004 2005 2004
------------------------------------------ --------- --------- --------- ---------
Dividend yield NA 0.0% 0.0% 0.0%
Expected volatility (1) NA 62% 65% 68%
Risk free interest rate (2) NA 3.4% 3.8% 3.7%
Expected lives (in years) (3) NA 5.0 5.6 5.0
(1) Estimated based on historical experience.
(2) Based on the U.S. Treasury constant maturity interest rate with a term
consistent with the expected life of the options granted.
(3) Estimated based on historical experience and expected future results.
(4) No options were granted during the quarter ended December 31, 2005.
The weighted average fair value of options granted during the six months ended
December 31, 2005 estimated on the grant date using the Black-Scholes
option-pricing model with the assumptions listed above was $21.13. The weighted
average fair values of options granted during the three and six months ended
December 31, 2004 estimated on the grant date using the Black-Scholes
option-pricing model with the assumptions listed above were $17.57 and $17.59,
respectively.
For the three and six months ended December 31, 2005, the Company recognized
$1,144,000 ($709,000 net of tax) and $2,250,000 ($1,437,000 net of tax),
respectively, in general and administrative expenses related to stock option
compensation. As of December 31, 2005, unrecognized stock compensation expense
related to unvested options was $9,257,000, which is expected to be recognized
over a weighted average period of 2.8 years.
5
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The total intrinsic value of options exercised during the three and six months
ended December 31, 2005 was $662,000 and $2,119,000, respectively, and
$3,686,000 and $4,547,000 during the three and six months ended December 31,
2004, respectively. The total cash received as a result of employee stock option
exercises for the three and six months ended December 31, 2005 was $1,109,000
and $2,729,000, respectively, and $5,318,000 and $6,237,000 during the three and
six months ended December 31, 2004, respectively. The tax benefits realized in
connection with these exercises were $209,000 and $560,000 during the three and
six months ended December 31, 2005, respectively, and $810,000 and $939,000
during the three and six months ended December 31, 2004, respectively.
As of December 31, 2005, the Company had the following stock-based compensation
plans which are described below.
Under the 1996 Stock Option Plan, the Board of Directors can determine the date
on which options vest and become exercisable as well as the term of the options
granted. The 1996 Stock Option Plan is authorized to grant options to acquire
5,524,000 shares of Common Stock, of which, 1,924,000 must be issued using
treasury stock.
Under the 1995 Executive Officers' Stock Option Plan and the 1995 Non-Employee
Directors' Stock Option Plan, the Board is authorized to grant 360,000 and
180,000 options, respectively, to acquire shares of Common Stock at a price per
share equal to or greater than fair market value at the grant date. Under the
Executive Officers' Stock Option Plan, the Board can determine the date on which
options vest and become exercisable.
Under the stock option plans described above, options generally become
exercisable over a four to five year period and expire at the earlier of
termination of employment or ten years from the grant date.
In addition, the 2005 Equity Incentive Plan has 1,000,000 shares authorized,
reserved and available for issuance. Awards granted may be in the form of stock
options, restricted stock, restricted stock units, stock appreciation rights,
performance stock and performance stock units. As of December 31, 2005, no
awards have been made under this plan. The Board of Directors has the authority
to determine the form, terms and conditions of awards at the time of grant,
including vesting, exercisability, payment, and the effect, if any, that a
participant's termination of service will have on an award.
As of December 31, 2005, 4,355,000 shares of common stock were reserved for
issuance under these stock incentive plans, of which 1,482,000 shares were
available for future grant.
Information with respect to options to purchase shares issued under the above
plans is as follows (shares in thousands):
Weighted
Average
Exercise
Shares Price
------------ ------------
Outstanding at July 1, 2005 2,872 $ 22.16
Granted 223 38.21
Exercised (122) 20.22
Forfeited or expired (100) 32.99
------------
Outstanding at December 31, 2005 2,873 23.12
============
6
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the Company's stock options outstanding and
exercisable as of December 31, 2005 (shares in thousands):
Options Outstanding Options Exercisable
-------------------------------------------- -------------------------------
Weighted
Average Weighted Weighted
Remaining Average Aggregate Average Aggregate
Contractual Exercise Intrinsic Exercise Intrinsic
Exercise Price Shares Term (Yrs) Price ($) Value ($) Shares Price ($) Value ($)
----------------- -------- ------------ ---------- ----------- -------- ----------- ----------
$4.167 - $13.05 558 5.43 11.53 13,280 430 11.07 10,432
$14.00 - $19.375 390 4.06 16.40 7,383 345 16.44 6,517
$20.31 - $26.50 658 5.86 20.73 9,607 596 20.72 8,708
$29.00 - $29.875 906 5.08 29.46 5,318 751 29.43 4,431
$31.249 - $39.20 361 9.29 36.69 (491) 17 33.76 27
-------- ----------- -------- ----------
2,873 5.72 23.12 35,097 2,139 21.26 30,115
======== =========== ======== ==========
The weighted average remaining contractual term of stock options exercisable as
of December 31, 2005 was 4.8 years.
NOTE 5 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
December 31, 2005 June 30, 2005
------------------------ -------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
----------- ------------ ----------- -------------
Amortizable intangible assets:
Membership and client relationships $ 40,215 $ 18,945 $ 40,215 $ 15,184
Trade names 21,859 2,388 21,859 1,662
Other 1,504 1,383 1,518 1,237
----------- ------------ ----------- -------------
Total amortizable intangible assets $ 63,578 $ 22,716 $ 63,592 $ 18,083
=========== ============ =========== =============
Amortizable intangible assets, net $ 40,862 $ 45,509
=========== ===========
Indefinite-lived intangible assets:
Goodwill $ 212,859 $ 201,499
Intangible asset related to minimum pension liability $ 967 $ 967
Changes in the carrying amount of goodwill by segment were as follows (in
thousands) during the six months ended:
December 31, 2005
-------------------------------------------------
Marketing Management
Services Personals Services Total
----------- ---------- ----------- -----------
Balance at beginning of period $ 95,917 $ 82,215 $ 23,367 $ 201,499
Purchase adjustments and other 515 - 10,845 11,360
----------- ---------- ----------- -----------
Balance at end of period $ 96,432 $ 82,215 $ 34,212 $ 212,859
=========== ========== =========== ===========
As required by SFAS 142, goodwill was tested for impairment during the quarters
ended September 30, 2005 and 2004 using a July 1 measurement date. The Company
concluded that none of its goodwill was impaired. Fair value was estimated using
discounted cash flow methodologies. 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.
7
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - FOREIGN CURRENCY INSTRUMENTS
The Company uses purchase option contracts and forward contracts to minimize its
exposure to changes in future cash flows caused by movements in foreign currency
exchange rates between the U.S. dollar and the Canadian dollar. Derivatives are
held only for the purpose of hedging such risks and are not used for speculative
purposes. Derivatives used to hedge forecasted cash flows associated with
Canadian dollar denominated forecasted transactions that meet the criteria for
hedge accounting are designated as cash flow hedges. The effective portion of
derivative gains and losses is deferred as a component of accumulated other
comprehensive income and is recognized when the underlying hedged item is
recognized in earnings.
The fair value of these contracts is included in prepaid and other current
assets. As of December 31, 2005 and June 30, 2005, the fair value of these
instruments was $582,000 (asset) and $559,000 (asset), respectively. Derivative
gains recognized in earnings were recorded in operating expenses and general and
administrative expenses and amounted to $285,000 and $413,000 for the three and
six months ended December 31, 2005, respectively, and $567,000 and $611,000 for
the three and six months ended December 31, 2004, respectively. All forecasted
transactions currently being hedged are expected to occur over the remaining
fiscal year.
NOTE 7 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities reported in the accompanying unaudited condensed
consolidated balance sheets as of December 31, 2005 and June 30, 2005 include an
allowance for membership cancellations of $12,256,000 and $11,232,000,
respectively.
NOTE 8 - 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.
The Company has an amended and restated senior secured credit facility, which
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. There were
no borrowings outstanding under this bank credit facility as of December 31,
2005. The bank credit facility matures on March 23, 2006 and management expects
it to be renewed or replaced during the third quarter of fiscal 2006.
Contingent payments related to the acquisition of MCM of up to $56,000,000 may
be paid if certain performance targets, including increasing levels of revenues
and earnings, are achieved during the three calendar years ending December 31,
2007. As of December 31, 2005, the Company has recorded $10,540,000 in accrued
liabilities related to contingent payments expected to be paid during fiscal
2006.
As of December 31, 2005, the Company had outstanding purchase obligations of
$24,837,000 primarily related to marketing agreements and maintenance contracts
on the Company's software, equipment and other assets. In addition, as of
December 31, 2005, the Company had commitments of $53,128,000 related to
existing operating leases.
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 October 17, 2005, the U.S. Supreme Court declined to review the Connecticut
Supreme Court's May 10, 2005 decision against the Company to uphold an
arbitration panel's award of $5,458,000 in punitive damages and costs to
MedValUSA Health Programs, Inc. Accordingly, the Company paid the full amount of
the award in the quarter ending December 31, 2005. The Company recorded a
one-time $5,458,000 charge in the quarter ended June 30, 2005 related to this
award.
8
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - INCOME TAX EXPENSE
Income tax expense as a percent of pre-tax income was 38.0% and 36.1% for the
three and six months ended December 31, 2005, respectively, and 38.7% and 37.5%
for the three and six months ended December 31, 2004, respectively. The
effective tax rate was higher than the U.S. statutory rate for the three and six
months ended December 31, 2005 primarily due to state taxes and other
non-deductible items offset by the favorable impact of foreign operations. The
effective tax rate was higher than the U.S. statutory rate for the three and six
months ended December 31, 2004 primarily due to state taxes and other
non-deductible items offset by the favorable impact of foreign operations.
The Company has open tax years in the U.S., Canada and other jurisdictions. The
Company is currently under examination by the Internal Revenue Service for the
fiscal year ended June 30, 2004. The audit is in the preliminary stages. The
scope has not been determined nor have any assessments been issued.
In addition, there are certain tax years that are not currently under
examination by the applicable tax authorities but may be subject to examination
in the future. The results of audits are inherently uncertain. 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 10 - 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 computations of basic and diluted earnings per share
(in thousands, except per share data):
Three months ended Six months ended
December 31, December 31,
--------------------- ---------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
Numerator:
Income available to common shareholders used in basic earnings per share $ 7,664 $ 5,883 $ 16,305 $ 13,479
Add back interest expense on convertible securities, net of tax 767 761 1,581 1,547
---------- ---------- ---------- ----------
Income available to common shareholders after assumed conversion
of dilutive securities $ 8,431 $ 6,644 $ 17,886 $ 15,026
========== ========== ========== ==========
Denominator:
Weighted average number of common shares outstanding - basic 9,695 10,128 9,705 10,151
Effect of dilutive securities:
Convertible securities 2,230 2,230 2,230 2,230
Stock options 851 705 867 622
---------- ---------- ---------- ----------
Weighted average number of common shares outstanding - diluted 12,776 13,063 12,802 13,003
========== ========== ========== ==========
Basic earnings per share $ 0.79 $ 0.58 $ 1.68 $ 1.33
========== ========== ========== ==========
Diluted earnings per share $ 0.66 $ 0.51 $ 1.40 $ 1.16
========== ========== ========== ==========
The diluted earnings per common share calculations exclude the effect of
potentially dilutive shares when their effect is antidilutive. Excluded from the
diluted share calculation above for the three and six months ended December 31,
2005 are incremental weighted average stock options of approximately 581,000 and
581,000, respectively, and 44,000 and 917,000, respectively, for the three and
six months ended December 31, 2004.
9
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three months ended Six months ended
December 31, December 31,
--------------------- ---------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
Net income $ 7,664 $ 5,883 $ 16,305 $ 13,479
Unrealized (loss) gain on derivative assets (404) 454 114 1,203
Foreign currency translation gain (loss) 171 (5) 411 93
---------- ---------- ---------- ----------
Comprehensive income $ 7,431 $ 6,332 $ 16,830 $ 14,775
========== ========== ========== ==========
NOTE 12 - SUPPLEMENTAL CASH FLOW INFORMATION
During the six months ended December 31, 2005, the Company incurred a capital
lease obligation of $231,000 to acquire equipment.
NOTE 13 - BUSINESS SEGMENTS
The operating business segments reported below are the reportable 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. The Company has
three reportable business segments: Marketing Services, Personals and Management
Services. The Marketing Services business segment primarily provides discounted
products and services to consumers. The Personals business segment provides both
web-based and phone-based personals services to its customers. During the
quarter ended December 31, 2005, the Management Services business segment became
reportable due to the increase in its assets. The Management Services business
segment provides management services to healthcare professionals throughout the
United States. The Corporate business unit includes unallocated general
corporate expenses.
Management evaluates the operating results of each reportable business segment
based on revenue and Adjusted EBITDA. The following is a summary of revenues,
Adjusted EBITDA, capital expenditures, depreciation and amortization and assets
by business segment (in thousands):
Three months ended December 31, Six months ended December 31,
--------------------------------- ---------------------------------
Revenues 2005 2004 2005 2004
---------------- ---------------- ---------------- ----------------
Marketing Services $ 134,479 $ 118,714 $ 266,327 $ 235,992
Personals 18,664 17,901 37,233 36,246
Management Services 7,047 - 14,238 -
Corporate - - - -
Intersegment (60) (136) (140) (136)
---------------- ---------------- ---------------- ----------------
Total $ 160,130 $ 136,479 $ 317,658 $ 272,102
================ ================ ================ ================
Adjusted EBITDA (1)
Marketing Services $ 28,280 $ 22,291 $ 49,905 $ 36,191
Personals 1,692 976 3,922 3,536
Management Services 395 - 983 -
Corporate (6,377) (5,216) (12,456) (10,310)
---------------- ---------------- ---------------- ----------------
Total $ 23,990 $ 18,051 $ 42,354 $ 29,417
================ ================ ================ ================
Capital Expenditures (2)
Marketing Services $ 4,435 $ 3,314 $ 5,980 $ 3,948
Personals 229 306 482 391
Management Services 38 - 56 -
Corporate - - - -
---------------- ---------------- ---------------- ----------------
Total $ 4,702 $ 3,620 $ 6,518 $ 4,339
================ ================ ================ ================
10
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three months ended December 31, Six months ended December 31,
--------------------------------- ---------------------------------
Depreciation and Amortization 2005 2004 2005 2004
---------------- ---------------- ---------------- ----------------
Marketing Services $ 3,078 $ 2,527 $ 6,348 $ 4,689
Personals 2,396 2,337 4,751 4,696
Management Services 406 - 805 -
Corporate 282 101 556 201
---------------- ---------------- ---------------- ----------------
Total $ 6,162 $ 4,965 $ 12,460 $ 9,586
================ ================ ================ ================
Assets December 31, June 30,
2005 2005
---------------- ----------------
Marketing Services $ 236,844 $ 245,635
Personals 129,580 132,992
Management Services 51,784 41,053
Corporate (3) 28,217 27,482
---------------- ----------------
Total $ 446,425 $ 447,162
================ ================
(1) Defined as net income excluding interest and other expense, net, provision
for income taxes, depreciation and amortization and the changes in deferred
revenue and deferred marketing costs. See reconciliation below.
(2) Management does not allocate certain capital expenditures to the Corporate
business unit. However, the associated depreciation expense has been
allocated for purposes of evaluating performance.
(3) Includes unallocated non-operating assets including short-term investments,
debt issuance costs and other.
The following tables reconcile Adjusted EBITDA to income before income taxes (in
thousands):
Three months ended December 31, 2005
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 12,371
Interest and other expense, net (1) 4,507
-----------
Operating income (expense) $ 24,071 $ (684) $ 150 $ (6,659) $ 16,878
Depreciation and amortization 3,078 2,396 406 282 6,162
Change in deferred revenues (850) (20) (161) - (1,031)
Change in deferred marketing costs 1,981 - - - 1,981
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 28,280 $ 1,692 $ 395 $ (6,377) $ 23,990
=========== =========== =========== =========== ===========
Three months ended December 31, 2004
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 9,600
Interest and other expense, net (1) 4,183
-----------
Operating income (expense) $ 20,332 $ (1,232) $ - $ (5,317) $ 13,783
Depreciation and amortization 2,527 2,337 - 101 4,965
Change in deferred revenues (2,905) (129) - - (3,034)
Change in deferred marketing costs 2,337 - - - 2,337
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 22,291 $ 976 $ - $ (5,216) $ 18,051
=========== =========== =========== =========== ===========
11
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Six months ended December 31, 2005
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 25,529
Interest and other expense, net (1) 9,005
-----------
Operating income (expense) $ 47,770 $ (744) $ 520 $ (13,012) $ 34,534
Depreciation and amortization 6,348 4,751 805 556 12,460
Change in deferred revenues (10,184) (85) (342) - (10,611)
Change in deferred marketing costs 5,971 - - - 5,971
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 49,905 $ 3,922 $ 983 $ (12,456) $ 42,354
=========== =========== =========== =========== ===========
Six months ended December 31, 2004
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Income before income taxes $ 21,554
Interest and other expense, net (1) 8,961
-----------
Operating income (expense) $ 42,310 $ (1,284) $ - $ (10,511) $ 30,515
Depreciation and amortization 4,689 4,696 - 201 9,586
Change in deferred revenues (19,493) 124 - - (19,369)
Change in deferred marketing costs 8,685 - - - 8,685
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 36,191 $ 3,536 $ - $ (10,310) $ 29,417
=========== =========== =========== =========== ===========
(1) Management does not allocate interest and other expense, net to the
individual segments.
NOTE 14 - GUARANTOR AND NONGUARANTOR FINANCIAL INFORMATION
In April 2004, the Company issued $150,000,000 aggregate principal amount of
9.25% Senior Notes due 2014. The Senior Notes are unsecured obligations and rank
pari passu in right of payment to all 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 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 condensed financial information presents the
consolidating balance sheets as of December 31, 2005 and June 30, 2005 and the
related statements of operations for the three and six months ended December 31,
2005 and 2004 and the cash flows for the six months ended December 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.
12
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, 2005
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Assets
Current assets $ 63,501 $ 69,036 $ 28,628 $ (20,527) $ 140,638
Fixed assets, net 18,656 11,636 7,311 - 37,603
Goodwill - 117,750 95,109 - 212,859
Intangible assets, net 998 28,785 12,046 - 41,829
Other assets 10,600 289 2,607 - 13,496
Investment in subsidiaries 295,188 - - (295,188) -
-------------- -------------- -------------- -------------- --------------
Total assets $ 388,943 $ 227,496 $ 145,701 $ (315,715) $ 446,425
============== ============== ============== ============== ==============
Liabilities and Shareholders' (Deficit) Equity
Current liabilities $ 174,440 $ 45,350 $ 23,565 $ (20,527) $ 222,828
Deferred income taxes 1,846 7,185 434 - 9,465
Other long-term liabilities 4,534 - 1,475 - 6,009
Long-term debt 237,897 - - - 237,897
-------------- -------------- -------------- -------------- --------------
Total liabilities 418,717 52,535 25,474 (20,527) 476,199
============== ============== ============== ============== ==============
Shareholders' (deficit) equity:
Preferred stock - - - - -
Common stock 198 6 3 (9) 198
Capital in excess of par value 177,281 165,285 113,432 (278,717) 177,281
Accumulated earnings (deficit) 51,985 9,416 6,682 (16,098) 51,985
Accumulated other comprehensive income
(loss) 377 254 110 (364) 377
Treasury stock (259,615) - - - (259,615)
-------------- -------------- -------------- -------------- --------------
Total shareholders' (deficit) equity (29,774) 174,961 120,227 (295,188) (29,774)
-------------- -------------- -------------- -------------- --------------
Total liabilities and shareholders'
(deficit) equity $ 388,943 $ 227,496 $ 145,701 $ (315,715) $ 446,425
============== ============== ============== ============== ==============
13
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30, 2005
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Assets
Current assets $ 80,036 $ 60,684 $ 23,509 $ (17,202) $ 147,027
Fixed assets, net 18,797 13,098 7,167 - 39,062
Goodwill - 117,749 83,750 - 201,499
Intangible assets, net 1,097 31,789 13,590 - 46,476
Other assets 10,991 64 2,043 - 13,098
Investment in subsidiaries 275,213 - - (275,213) -
-------------- -------------- -------------- -------------- --------------
Total assets $ 386,134 $ 223,384 $ 130,059 $ (292,415) $ 447,162
============== ============== ============== ============== ==============
Liabilities and Shareholders' (Deficit) Equity
Current liabilities $ 190,595 $ 46,890 $ 22,534 $ (17,202) $ 242,817
Deferred income taxes 2,588 7,265 (151) - 9,702
Other long-term liabilities 3,565 - 1,692 - 5,257
Long-term debt 237,814 - - - 237,814
-------------- -------------- -------------- -------------- --------------
Total liabilities 434,562 54,155 24,075 (17,202) 495,590
-------------- -------------- -------------- -------------- --------------
Shareholders' (deficit) equity:
Preferred stock - - - - -
Common stock 197 6 3 (9) 197
Capital in excess of par value 169,463 165,285 102,484 (267,769) 169,463
Accumulated earnings (deficit) 35,680 3,884 3,667 (7,551) 35,680
Accumulated other comprehensive (loss) income (148) 54 (170) 116 (148)
Treasury stock (253,620) - - - (253,620)
-------------- -------------- -------------- -------------- --------------
Total shareholders' (deficit) equity (48,428) 169,229 105,984 (275,213) (48,428)
-------------- -------------- -------------- -------------- --------------
Total liabilities and shareholders'
(deficit) equity $ 386,134 $ 223,384 $ 130,059 $ (292,415) $ 447,162
============== ============== ============== ============== ==============
14
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
Three months ended December 31, 2005
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Revenues $ 96,964 $ 40,365 $ 27,335 $ (4,534) $ 160,130
Expenses:
Marketing 52,545 17,893 9,976 (4,144) 76,270
Operating 16,780 8,897 9,971 (390) 35,258
General and administrative 17,489 7,616 4,422 - 29,527
Amortization of intangibles 9 1,494 694 - 2,197
-------------- -------------- -------------- -------------- --------------
Operating income 10,141 4,465 2,272 - 16,878
Equity in income of subsidiaries 4,413 - - (4,413) -
Interest (expense) income, net (4,787) 202 198 - (4,387)
Other (expense) income, net (14) (120) 14 - (120)
-------------- -------------- -------------- -------------- --------------
Income before income taxes 9,753 4,547 2,484 (4,413) 12,371
Provision for income taxes 2,089 1,663 955 - 4,707
-------------- -------------- -------------- -------------- --------------
Net income $ 7,664 $ 2,884 $ 1,529 $ (4,413) $ 7,664
============== ============== ============== ============== ==============
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
Three months ended December 31, 2004
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Revenues $ 92,351 $ 35,316 $ 10,026 $ (1,214) $ 136,479
Expenses:
Marketing 49,373 16,839 2,984 (507) 68,689
Operating 15,616 7,291 3,752 (707) 25,952
General and administrative 15,664 8,588 2,050 - 26,302
Amortization of intangibles 76 1,527 150 - 1,753
-------------- -------------- -------------- -------------- --------------
Operating income 11,622 1,071 1,090 - 13,783
Equity in income of subsidiaries 1,767 - - (1,767) -
Interest (expense) income, net (4,649) 37 1 - (4,611)
Other (expense) income, net (5) 419 14 - 428
-------------- -------------- -------------- -------------- --------------
Income before income taxes 8,735 1,527 1,105 (1,767) 9,600
Provision for income taxes 2,852 321 544 - 3,717
-------------- -------------- -------------- -------------- --------------
Net income $ 5,883 $ 1,206 $ 561 $ (1,767) $ 5,883
============== ============== ============== ============== ==============
15
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
Six months ended December 31, 2005
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Revenues $ 193,773 $ 79,174 $ 54,425 $ (9,714) $ 317,658
Expenses:
Marketing 103,781 34,835 20,631 (9,078) 150,169
Operating 34,055 17,715 19,207 (636) 70,341
General and administrative 34,283 15,025 8,673 - 57,981
Amortization of intangibles 85 3,003 1,545 - 4,633
-------------- -------------- -------------- -------------- --------------
Operating income 21,569 8,596 4,369 - 34,534
Equity in income of subsidiaries 8,547 - - (8,547) -
Interest (expense) income, net (9,506) 299 363 - (8,844)
Other income (expense), net 13 (235) 61 - (161)
-------------- -------------- -------------- -------------- --------------
Income before income taxes 20,623 8,660 4,793 (8,547) 25,529
Provision for income taxes 4,318 3,128 1,778 - 9,224
-------------- -------------- -------------- -------------- --------------
Net income $ 16,305 $ 5,532 $ 3,015 $ (8,547) $ 16,305
============== ============== ============== ============== ==============
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
Six months ended December 31, 2004
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Revenues $ 188,636 $ 69,822 $ 15,346 $ (1,702) $ 272,102
Expenses:
Marketing 99,872 33,404 4,452 (507) 137,221
Operating 30,748 14,480 6,129 (1,195) 50,162
General and administrative 31,178 16,769 2,960 - 50,907
Amortization of intangibles 76 3,071 150 - 3,297
-------------- -------------- -------------- -------------- --------------
Operating income 26,762 2,098 1,655 - 30,515
Equity in income of subsidiaries 2,587 - - (2,587) -
Interest (expense) income, net (9,349) 91 4 - (9,254)
Other (expense) income, net (98) 355 36 - 293
-------------- -------------- -------------- -------------- --------------
Income before income taxes 19,902 2,544 1,695 (2,587) 21,554
Provision for income taxes 6,423 842 810 - 8,075
-------------- -------------- -------------- -------------- --------------
Net income $ 13,479 $ 1,702 $ 885 $ (2,587) $ 13,479
============== ============== ============== ============== ==============
16
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six months ended December 31, 2005
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Net cash provided by (used in) operating activities $ 15,537 $ 6,939 $ 887 $ (8,547) $ 14,816
Investing activities
Acquisition of fixed assets (3,538) (885) (2,095) - (6,518)
Purchases of short-term investments (50,325) - - - (50,325)
Sales of short-term investments 49,452 378 - - 49,830
Acquisitions of businesses, net of cash acquired (14,717) (224) (1) - (14,942)
Investment in subsidiaries (8,547) - - 8,547 -
-------------- -------------- -------------- -------------- --------------
Net cash (used in) provided by investing activities (27,675) (731) (2,096) 8,547 (21,955)
-------------- -------------- -------------- -------------- --------------
Financing activities
Net proceeds from issuance of stock 2,729 - - - 2,729
Excess tax benefit from stock-based compensation 560 - - - 560
Treasury stock purchases (5,995) - - - (5,995)
Payments of long-term obligations (195) - (197) - (392)
-------------- -------------- -------------- -------------- --------------
Net cash used in financing activities (2,901) - (197) - (3,098)
-------------- -------------- -------------- -------------- --------------
Effect of exchange rate changes on
cash and cash equivalents - 131 326 - 457
-------------- -------------- -------------- -------------- --------------
Net (decrease) increase in cash and cash equivalents (15,039) 6,339 (1,080) - (9,780)
Cash and cash equivalents at beginning of year 24,366 29,821 10,169 - 64,356
-------------- -------------- -------------- -------------- --------------
Cash and cash equivalents at end of period $ 9,327 $ 36,160 $ 9,089 $ - $ 54,576
============== ============== ============== ============== ==============
17
VERTRUE INCORPORATED
ITEM 1. CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six months ended December 31, 2004
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------- -------------- -------------- -------------- --------------
Net cash provided by (used in) operating activities $ 101,300 $ (82,693) $ (1,394) $ (2,587) $ 14,626
Investing activities
Acquisition of fixed assets (3,495) (538) (306) - (4,339)
Purchases of short-term investments (368,533) - - - (368,533)
Sales of short-term investments 425,691 221 - - 425,912
Acquisitions of businesses, net of cash acquired (111,322) 93,937 1,288 - (16,097)
Investment in subsidiaries (2,587) - - 2,587 -
-------------- -------------- -------------- -------------- --------------
Net cash (used in) provided by investing activities (60,246) 93,620 982 2,587 36,943
-------------- -------------- -------------- -------------- --------------
Financing activities
Net proceeds from issuance of stock 6,237 - - - 6,237
Treasury stock purchases (8,396) - - - (8,396)
Debt issuance costs (750) - - - (750)
Payments of long-term obligations (161) (13) (30) - (204)
-------------- -------------- -------------- -------------- --------------
Net cash used in financing activities (3,070) (13) (30) - (3,113)
-------------- -------------- -------------- -------------- --------------
Effect of exchange rate changes on
cash and cash equivalents - (291) 526 - 235
-------------- -------------- -------------- -------------- --------------
Net increase in cash and cash equivalents 37,984 10,623 84 - 48,691
Cash and cash equivalents at beginning of year 18,251 26,657 2,258 - 47,166
-------------- -------------- -------------- -------------- --------------
Cash and cash equivalents at end of period $ 56,235 $ 37,280 $ 2,342 $ - $ 95,857
============== ============== ============== ============== ==============
NOTE 16 - NEW ACCOUNTING PRONOUNCEMENTS
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections - A replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS 154"). This statement requires retrospective application to prior
periods' financial statements of changes in accounting principles unless it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. This statement applies to all voluntary changes in
accounting principles and changes required by an accounting pronouncement that
does not include specific transition provisions. SFAS 154 is effective beginning
in the Company's first quarter of fiscal 2007. The Company does not expect the
adoption of SFAS 154 to have a material effect on its consolidated financial
position, results of operations or cash flows.
18
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with 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, 2005, which describes, among other things, the Company's basic business
model and critical accounting policies.
The Company has three reportable business segments: Marketing Services,
Personals and Management Services. During the quarter ended December 31, 2005,
the Management Services business segment became reportable due to the increase
in its assets. The Management Services business segment provides management
services to healthcare professionals throughout the United States. For
additional information about these reportable business segments, see Note 13 to
the condensed consolidated financial statements in this Quarterly Report on Form
10-Q.
The results of My Choice Medical Holdings, Inc. ("MCM") and Bargain Network,
Inc. ("Bargain") (collectively the "Acquired Companies") have been included in
the consolidated results since their acquisitions on January 1, 2005 and
November 30, 2004, respectively.
Adjusted EBITDA and EBITDA are used by the Company's management to evaluate the
performance of its business. A discussion of Adjusted EBITDA can be found in
"Liquidity and Capital Resources" in this Quarterly Report on Form 10-Q. A
description and reconciliation of net income to EBITDA and Adjusted EBITDA are
disclosed in "Reconciliation of Non-GAAP Measures" in this Quarterly Report on
Form 10-Q.
Percent Percent
Three months ended Increase/ Six months ended Increase/
December 31, (Decrease) December 31, (Decrease)
-----------------------------------------------------------------------------
(Dollars in millions) 2005 2004 '05 vs.'04 2005 2004 '05 vs.'04
------------ ------------ ------------ ------------ ------------ ------------
Revenues $ 160.1 $ 136.5 17% $ 317.6 $ 272.1 17%
Marketing expenses 76.3 68.7 11% 150.2 137.2 9%
Operating expenses 35.2 25.9 36% 70.3 50.2 40%
General and administrative expenses 29.5 26.3 12% 58.0 50.9 14%
Amortization of intangibles 2.2 1.8 22% 4.6 3.3 39%
------------ ------------ ------------ ------------ ------------ ------------
Operating income 16.9 13.8 22% 34.5 30.5 13%
Interest expense, net (4.4) (4.6) (4)% (8.8) (9.2) (4)%
Other (expense) income, net (0.1) 0.4 (125)% (0.2) 0.3 (167)%
------------ ------------ ------------ ------------ ------------ ------------
Income before income taxes 12.4 9.6 29% 25.5 21.6 18%
Provision for income taxes 4.7 3.7 27% 9.2 8.1 14%
------------ ------------ ------------ ------------ ------------ ------------
Net income $ 7.7 $ 5.9 31% $ 16.3 $ 13.5 21%
============ ============ ============ ============ ============ ============
EBITDA $ 23.0 $ 18.7 23% $ 47.0 $ 40.1 17%
============ ============ ============ ============ ============ ============
19
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth revenue by payment plan and by segment (in
millions):
Percent Percent
Three months ended Increase/ Six months ended Increase/
December 31, (Decrease) December 31, (Decrease)
-----------------------------------------------------------------------------
Revenues 2005 2004 '05 vs.'04 2005 2004 '05 vs.'04
------------ ------------ ------------ ------------ ------------ ------------
Monthly payment plans $ 86.7 $ 56.0 55% $ 169.8 $ 105.5 61%
Annual payment plans:
Initial year 8.2 14.9 (45)% 17.8 33.9 (47)%
Renewal year 29.7 40.0 (26)% 60.8 81.9 (26)%
Other 9.9 7.8 27% 17.9 14.7 22%
------------ ------------ ------------ ------------ ------------ ------------
Total Marketing Services 134.5 118.7 13% 266.3 236.0 13%
Personals 18.6 17.8 4% 37.1 36.1 3%
Management Services 7.0 - NM 14.2 - NM
------------ ------------ ------------ ------------ ------------ ------------
Total $ 160.1 $ 136.5 17% $ 317.6 $ 272.1 17%
============ ============ ============ ============ ============ ============
For the Three Months Ended December 31, 2005 and 2004
Revenues increased $23.6 million, or 17%, in the 2006 fiscal second quarter
primarily due to the inclusion of revenues from the Acquired Companies.
Excluding revenues from the Acquired Companies, revenues would have increased 8%
due to an increase in Marketing Services revenues, as discussed below. Net
active members and customers increased 3% to 6.4 million at December 31, 2005
from 6.2 million at December 31, 2004.
Marketing Services revenues increased $15.8 million, or 13%, in the 2006 fiscal
second quarter due to the inclusion of revenues from Bargain. Excluding revenues
from Bargain, total marketing services revenues would have increased 9% due to a
47% increase in revenues from members enrolled in monthly payment plans
partially offset by a 31% decrease in revenue from members enrolled in annual
payment plans. The increase in revenues from monthly payment plans was due to a
31% increase in average monthly members billed and an 11% increase in the
monthly member price point. Revenues from members enrolled in annual payment
plans continue to decrease for both initial year members and renewal members due
to the continued shift to enrolling new members in monthly payment programs as
well as the attrition of the annual renewal base.
Personals revenues increased $0.8 million, or 4%, in the 2006 fiscal second
quarter primarily due to the incremental revenue generated from Lavalife's
growing mobile service. Management Services revenues represent the revenues from
MCM.
Marketing expenses increased $7.6 million, or 11%, in the 2006 fiscal second
quarter and as a percent of revenues, were 48% this year versus 50% last year.
The increase in marketing expenses was due to the inclusion of costs incurred by
the Acquired Companies as well as an increase in online marketing efforts which
resulted in increased revenues, as discussed above. The decrease in marketing
expenses as a percent of revenues was due to increased price points and
synergies realized from our Acquired Companies.
Operating expenses increased $9.3 million, or 36%, in the 2006 fiscal second
quarter and as a percent of revenues, were 22% this year versus 19% last year.
These increases were due to the inclusion of expenses incurred by the Acquired
Companies in addition to increased costs of servicing the higher member and
customer base. The Acquired Companies have a higher proportion of their cost
structure included as operating expenses which resulted in an increase in the
operating expense ratio.
General and administrative expenses increased $3.2 million, or 12%, in the 2006
fiscal second quarter and included a $1.1 million charge related to the adoption
of Financial Accounting Standards Board Statement No. 123(R), "Share-Based
Payment" ("SFAS 123R"). Excluding this expense, general and administrative
expenses would have increased $2.1 million, or 8%, and as a percent of revenues,
would have been 18% this quarter versus 19% in the prior year quarter. The
increase in general and administrative expenses was due to the inclusion of
expenses incurred by the Acquired Companies. General and administrative expenses
decreased as a percent of revenue due to leveraging expenses with the increased
revenue.
Amortization of intangible assets increased $0.4 million, or 22%, in the 2006
fiscal second quarter due to amortization expense related to the Acquired
Companies.
20
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Operating income increased $3.1 million, or 22%, in the 2006 fiscal second
quarter and as a percent of revenues, was 11% this year and 10% last year,
primarily due to the inclusion of the Acquired Companies' results of operations
and a 2% improvement in marketing margin as a percent of revenue, as discussed
above.
Interest expense, net decreased $0.2 million, or 4%, in the 2006 fiscal second
quarter and included $3.6 million of interest expense related to the 9.25%
Senior Notes and $1.2 million of interest expense related to the 5.5%
Convertible Notes.
The provision for income taxes increased $1.0 million, or 27%, in the 2006
fiscal second quarter and was based on an effective tax rate of 38.0% this year
versus 38.7% last year.
EBITDA increased 23% to $23.0 million in the 2006 fiscal second quarter from
$18.7 million in the 2005 fiscal second quarter due to the improvement in the
marketing margin discussed above and the inclusion of the Acquired Companies'
results. As a percent of revenues, EBITDA was 14% this year and last year. The
2006 fiscal second quarter included a $1.1 million charge related to the
adoption of SFAS 123R. Excluding this charge, EBITDA would have been 15% of
revenue this year versus 14% last year. Marketing Services EBITDA increased 19%
to $27.1 million in the 2006 fiscal second quarter from $22.8 million in the
2005 fiscal second quarter due to increased price points and synergies realized
from our Acquired Companies. Personals EBITDA increased 55% to $1.7 million in
the 2006 fiscal second quarter from $1.1 million in the 2005 fiscal second
quarter due to Lavalife's growing mobile service business and cost containment.
Management Services EBITDA was $0.6 million and represented the results of MCM.
Corporate EBITDA decreased 23% to $(6.4) million in the 2006 fiscal second
quarter from $(5.2) million in the 2005 fiscal second quarter due to the
adoption of SFAS 123R.
For the Six Months Ended December 31, 2005 and 2004
Revenues increased $45.5 million, or 17%, in the six months ended December 31,
2005 primarily due to the inclusion of revenues from the Acquired Companies.
Excluding revenues from the Acquired Companies, revenues would have increased 6%
due to an increase in Marketing Services' revenues, as discussed below. Net
active members and customers increased 3% to 6.4 million at December 31, 2005
from 6.2 million at December 31, 2004.
Marketing Services revenues increased $30.3 million, or 13%, in the six months
ended December 31, 2005 due to the inclusion of revenues from Bargain. Excluding
revenues from Bargain, total marketing services revenues would have increased 7%
due to a 49% increase in revenues from members enrolled in monthly payment plans
partially offset by a 32% decrease in revenues from members enrolled in annual
payment plans. The increase in revenues from monthly payment plans was due to a
34% increase in average monthly members billed and a 10% increase in the monthly
member price point. Revenues from members enrolled in annual payment plans
continue to decrease for both initial year members and renewal members due to
the continued shift to enrolling new members in monthly payment programs as well
as the attrition of the annual renewal base.
Personals revenues increased $1.0 million, or 3%, in the six months ended
December 31, 2005 primarily due to the incremental revenue generated from
Lavalife's growing mobile service. Management Services revenues represent the
revenues from MCM.
Marketing expenses increased $13.0 million, or 9%, in the six months ended
December 31, 2005 and as a percent of revenues, were 47% this year versus 50%
last year. The increase in marketing expenses was due to the inclusion of costs
incurred by the Acquired Companies as well as an increase in online marketing
efforts which resulted in increased revenues, as discussed above. The decrease
in marketing expenses as a percent of revenues was primarily due to increased
price points and synergies realized from our Acquired Companies.
Operating expenses increased $20.1 million, or 40%, in the six months ended
December 31, 2005 and as a percent of revenues, were 22% this year versus 18%
last year. The increased level of operating expenses was primarily due to the
inclusion of expenses incurred by the Acquired Companies in addition to the
increased costs of servicing the higher member and customer base. The increase
as a percent of revenue was primarily due to the inclusion of the Acquired
Companies which have a higher proportion of their cost structure included as
operating expenses resulting in an increase in the operating expense ratio.
General and administrative expenses increased $7.1 million, or 14%, in the six
months ended December 31, 2005 and included a $2.3 million charge related to the
adoption of SFAS 123R. Excluding this expense, general and administrative
21
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
expenses would have increased $4.8 million, or 9%, and as a percent of revenues,
would have been 18% this year versus 19% in the prior year. This increase in
general and administrative expenses was primarily due to the inclusion of
expenses incurred by the Acquired Companies. General and administrative expenses
decreased as a percent of revenue due to leveraging expenses with the increased
revenue.
Amortization of intangible assets increased $1.3 million, or 39%, in the six
months ended December 31, 2005 due to amortization expense related to the
Acquired Companies.
Operating income increased $4.0 million, or 13%, in the six months ended
December 31, 2005 primarily due to the 3% improvement in marketing margin as a
percent of revenue discussed above and the inclusion of the Acquired Companies'
results of operations. As a percent of revenues, operating income was 11% this
year and last year.
Interest expense, net decreased $0.4 million, or 4%, in the six months ended
December 31, 2005 and included $7.1 million interest expense related to the
9.25% Senior Notes and $2.5 million of interest expense related to the 5.5%
Convertible Notes.
The provision for income taxes increased $1.1 million, or 14%, in the six months
ended December 31, 2005 and was based on an effective tax rate of 36.1% this
year versus 37.5% last year. The effective tax rate decreased from the prior
year primarily due to the favorable impact of the foreign operations on our tax
rate.
EBITDA increased 17% to $47.0 million in the six months ended December 31, 2005
from $40.1 million in the six months ended December 31, 2004 primarily due to
the improvement in the marketing margin discussed above and inclusion of the
Acquired Companies' results. As a percent of revenues, EBITDA was 15% this year
and last year. The six months ended December 31, 2005 included a $2.3 million
charge related to the adoption of SFAS 123R. Excluding this charge, EBITDA would
have been 16% of revenue this year versus 15% last year. Marketing Services
EBITDA increased 15% to $54.1 million in the six months ended December 31, 2005
from $47.0 million in the six months ended December 31, 2004 due to increased
price points and synergies realized from our Acquired Companies. Personals
EBITDA increased 18% to $4.0 million in the six months ended December 31, 2005
from $3.4 million in the six months ended December 31, 2004 due to Lavalife's
growing mobile service business and cost containment. Management Services EBITDA
was $1.3 million in the six months ended December 31, 2005. Corporate EBITDA
decreased 20% to $(12.4) million in the six months ended December 31, 2005 from
$(10.3) million in the six months ended December 31, 2004 due to the adoption of
FAS 123R.
LIQUIDITY AND CAPITAL RESOURCES
Net cash flow provided by operating activities is an important measure used to
understand the Company's liquidity. Net cash provided by operating activities
increased to $14.8 million in the six months ended December 31, 2005 from $14.6
million in the six months ended December 31, 2004. 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, Adjusted EBITDA and changes in
assets and liabilities. For definitions and reconciliations of revenue before
deferral, marketing costs before deferral and Adjusted EBITDA, refer to the
discussion in "Reconciliation of Non-GAAP Measures" in this Quarterly Report on
Form 10-Q.
22
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The table below summarizes the components of revenues before deferral (in
millions):
Percent
Six months ended Increase/
December 31, (Decrease)
--------------------------------------
Revenues before deferral 2005 2004 '05 vs.'04
------------ ------------ ------------
Monthly payment plans $ 172.0 $ 108.2 59%
Annual payment plans:
Initial year 14.1 20.3 (31)%
Renewal year 52.2 73.5 (29)%
Other 17.8 14.5 23%
------------ ------------ ------------
Total Marketing Services 256.1 216.5 18%
Personals 37.0 36.2 2%
Management Services 13.9 - NM
------------ ------------ ------------
Total $ 307.0 $ 252.7 21%
============ ============ ============
Revenues before deferral increased 21% to $307.0 million in the six months ended
December 31, 2005 due to a 10% growth in revenues before deferral in the
existing business and the inclusion of revenues before deferral generated by the
Acquired Companies. Revenues before deferral from monthly payment plans
increased 59% due to a 39% increase in average monthly members billed to 2.1
million in the six months ended December 31, 2005 and a 14% increase in the
monthly weighted average program price point which increased to $13.69 for the
six months ended December 31, 2005. The average monthly members billed increased
due to the increase in the mix of new members enrolled in monthly payment plan
programs, which was 88% during the six months ended December 31, 2005 and 83%
during the six months ended December 31, 2004. Revenues before deferral from
annual payment plans declined due to the continued shift to enrolling new
members in monthly payment programs as well as the attrition of the annual
renewal base. The new annual weighted average program price points were $109 and
$106 for the six months ended December 31, 2005 and 2004, respectively.
Personals revenues before deferral increased 2% from the prior year due to
increased revenues before deferral related to mobile services. Management
Services revenues before deferral represent the revenues from MCM in the six
months ended December 31, 2005.
Marketing costs before deferral were $144.2 million and $128.5 million for the
six months ended December 31, 2005 and 2004, respectively. As a percent of
revenue before deferral, marketing costs before deferral were 47% and 51% in the
fiscal 2006 and 2005 year to date periods, respectively. The improved ratio is
due to increased price points, more efficient marketing spending and better
retention in certain sectors of our business. Marketing costs before deferral
increased 12% in the six months ended December 31, 2005 primarily due to the
inclusion of marketing costs before deferral from the Acquired Companies.
Marketing margin before deferral was $162.8 million and $124.2 million for the
six months ended December 31, 2005 and 2004, respectively. The effect of the
increase in marketing margin before deferral in the fiscal 2006 year to date
period on net cash provided by operating activities was partially offset by
increased operating and general and administrative expenses and resulted in a
$13.0 million, or 44%, increase in Adjusted EBITDA to $42.4 million for the six
months ended December 31, 2005 from $29.4 million for the six months ended
December 31, 2004. The increase in Adjusted EBITDA was primarily driven by the
Marketing Services segment. The table below presents Adjusted EBITDA by segment.
Percent
Six months ended Increase/
December 31, (Decrease)
--------------------------------------
Adjusted EBITDA 2005 2004 '05 vs.'04
------------ ------------ ------------
Marketing Services $ 49.9 $ 36.2 38%
Personals 3.9 3.5 11%
Management Services 1.0 - NM
Corporate (12.4) (10.3) (20)%
------------ ------------ ------------
Total $ 42.4 $ 29.4 44%
============ ============ ============
23
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Changes in assets and liabilities used $12.9 million of cash in the six months
ended December 31, 2005 compared to $3.2 million in the six months ended
December 31, 2004. The use of cash in fiscal 2006 primarily related to the
timing of trade and tax payments during the period and the $5.5 million
arbitration award payment made during the December 2005 quarter.
Capital expenditures were $6.5 million and $4.3 million in the 2006 and 2005
year to date periods, respectively. As a result, free cash flow, defined as
operating cash flow less capital expenditures, was $8.3 million for the six
months ended December 31, 2005 compared to $10.3 million for the prior year
period.
Net cash (used in) provided by investing activities was $(22.0) million and
$36.9 million in the six months ended December 31, 2005 and 2004, respectively.
Net cash used in investing activities in the six months ended December 31, 2005
primarily reflected $14.9 million used in connection with the Company's recent
acquisitions. Net cash provided by investing activities in the six months ended
December 31, 2004 primarily reflected $57.4 million of net proceeds from sales
of short-term investments and $16.1 million related to business acquisitions.
Net cash used in financing activities was $3.1 million in both fiscal 2006 and
2005 six-month periods. Net cash used in financing activities in 2006
principally reflected the use of $6.0 million to repurchase the Company's stock,
which was partially offset by $2.7 million of proceeds from the exercise of
stock options and $0.6 million of excess tax benefit from stock-based
compensation. Net cash used in financing activities in 2005 principally
reflected the use of $8.4 million to repurchase the Company's stock, which was
partially offset by proceeds from the exercise of stock options of $6.2 million.
Credit Facility
The Company has a senior secured credit facility, which allows borrowings of up
to $45.0 million. Borrowings under the senior secured credit facility accrue
interest at either the Eurodollar rate, or the higher of the Prime rate or the
Federal Funds rate plus an applicable margin. As of December 31, 2005, the
effective interest rate for borrowings under the senior secured credit facility
was 7.25%. The senior secured credit facility has certain financial covenants,
including a maximum debt coverage ratio, potential restrictions on additional
borrowings and potential restrictions on additional stock repurchases. As of
December 31, 2005, the Company was in compliance with all such debt covenants.
The bank credit facility matures on March 23, 2006 and management expects it to
be renewed or replaced during the third quarter of fiscal 2006.
Stock Repurchase Program
The Company purchased 164,800 shares of its common stock for $6.0 million at an
average price of $36.38 per share during 2006 compared to 314,500 shares for
$8.2 million at an average price of $26.05 per share in 2005. The Company
utilized cash from operations, stock issuances and the issuance of the
Convertible Notes and Senior Notes to repurchase shares in fiscal 2006 and 2005.
As of December 31, 2005, the Company had 0.7 million shares available for
repurchase under its stock repurchase program.
Other
As of December 31, 2005, the Company had cash, cash equivalents and short-term
investments of $75.7 million in addition to its senior secured credit facility.
The Company believes that existing cash and short-term investment balances and
funds available under its senior secured credit facility together with cash
generated from operations will be sufficient to meet its funding requirements
for the foreseeable future.
The Company expects to incur capital expenditures of $15.0 million in fiscal
2006. In addition, contingent payments related to the acquisition of MCM of up
to $56.0 million may be paid if certain performance targets, including
increasing levels of revenues and earnings, are achieved during the three
calendar years ending December 31, 2007. As of December 31, 2005, the Company
expects to pay $10.5 million during fiscal 2006 related to these contingent
payments. The Company intends to utilize cash on hand, short-term investments
and cash generated from operations to fulfill payment obligations during 2006.
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 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.
24
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 future 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.
Revenues before deferral are calculated as follows (in millions):
Six months ended
December 31,
--------------------------
2005 2004
------------ ------------
Revenues $ 317.6 $ 272.1
Change in deferred revenues (10.6) (19.4)
------------ ------------
Revenues before deferral $ 307.0 $ 252.7
============ ============
Marketing costs before deferral are calculated as follows (in millions):
Six months ended
December 31,
--------------------------
2005 2004
------------ ------------
Marketing expenses $ 150.2 $ 137.2
Change in deferred marketing costs (6.0) (8.7)
------------ ------------
Marketing costs before deferral $ 144.2 $ 128.5
============ ============
Adjusted EBITDA and EBITDA are used by the Company's management to evaluate the
year over year performance of its business and to measure that performance
compared with internal budgets. Additionally, Adjusted EBITDA is used to
determine compensation under the Company's management incentive plans.
Adjusted EBITDA is useful to management and investors because it eliminates the
effects of interest and other expense, income taxes, non-cash depreciation of
tangible assets and non-cash amortization of intangible assets and the
amortization related to the recognition of GAAP revenues and GAAP marketing
expenses and therefore includes only membership fees billed in the current
reporting period less an allowance for cancellations and marketing costs paid or
accrued in the current reporting period. Adjusted EBITDA is reconciled to net
cash provided by operating activities because the Company believes that it is
the most directly comparable liquidity measure. Adjusted EBITDA is also
reconciled to net income because it is also used by the Company's management as
a performance measure. EBITDA is useful to management and investors because it
eliminates the effects of interest and other expense, income taxes, non-cash
depreciation of tangible assets and non-cash amortization of intangible assets
and is calculated using revenues and marketing expenses. EBITDA is reconciled to
net income because the Company believes that it is the most directly comparable
GAAP measure.
A limitation of Adjusted EBITDA and EBITDA is that they do not reflect the
periodic amortization of certain capitalized tangible and intangible assets used
in generating revenues in the Company's businesses nor do they reflect the
effects of interest and taxes.
These non-GAAP measures should be considered in addition to, not as a substitute
for or superior to, operating income, net income, operating cash flows or other
measures of financial performance and liquidity determined in accordance with
generally accepted accounting principles.
25
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table reconciles net cash provided by operating activities to
Adjusted EBITDA (in millions):
Six months ended
December 31,
--------------------------
2005 2004
------------ ------------
Net cash provided by operating activities $ 14.8 $ 14.6
Changes in assets and liabilities (use of cash) 12.9 3.2
Interest and other expense, net (to be paid in cash) 8.5 8.1
Taxes 8.3 3.9
Stock compensation expense (2.3) -
Other 0.2 (0.4)
------------ ------------
Adjusted EBITDA $ 42.4 $ 29.4
============ ============
The following tables reconcile net income to EBITDA and Adjusted EBITDA (in
millions):
Three months ended December 31, 2005
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Net income $ 7.7
Interest and other expense, net (1) 4.5
Provision for income taxes (1) 4.7
-----------
Operating income (expense) $ 24.1 $ (0.7) $ 0.2 $ (6.7) $ 16.9
Depreciation and amortization 3.0 2.4 0.4 0.3 6.1
----------- ----------- ----------- ----------- -----------
EBITDA $ 27.1 $ 1.7 $ 0.6 $ (6.4) $ 23.0
=========== =========== =========== =========== ===========
Three months ended December 31, 2004
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Net income $ 5.9
Interest and other expense, net (1) 4.2
Provision for income taxes (1) 3.7
-----------
Operating income (expense) $ 20.3 $ (1.2) $ - $ (5.3) $ 13.8
Depreciation and amortization 2.5 2.3 - 0.1 4.9
----------- ----------- ----------- ----------- -----------
EBITDA $ 22.8 $ 1.1 $ - $ (5.2) $ 18.7
=========== =========== =========== =========== ===========
Six months ended December 31, 2005
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Net income $ 16.3
Interest and other expense, net (1) 9.0
Provision for income taxes (1) 9.2
-----------
Operating income (expense) $ 47.8 $ (0.8) $ 0.5 $ (13.0) $ 34.5
Depreciation and amortization 6.3 4.8 0.8 0.6 12.5
----------- ----------- ----------- ----------- -----------
EBITDA 54.1 4.0 1.3 (12.4) 47.0
Change in deferred revenues (10.2) (0.1) (0.3) - (10.6)
Change in deferred marketing 6.0 - - - 6.0
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 49.9 $ 3.9 $ 1.0 $ (12.4) $ 42.4
=========== =========== =========== =========== ===========
26
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Six months ended December 31, 2004
-----------------------------------------------------------
Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Net income $ 13.5
Interest and other expense, net (1) 8.9
Provision for income taxes (1) 8.1
-----------
Operating income (expense) $ 42.3 $ (1.3) $ - $ (10.5) $ 30.5
Depreciation and amortization 4.7 4.7 - 0.2 9.6
----------- ----------- ----------- ----------- -----------
EBITDA 47.0 3.4 - (10.3) 40.1
Change in deferred revenues (19.5) 0.1 - - (19.4)
Change in deferred marketing 8.7 - - - 8.7
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 36.2 $ 3.5 $ - $ (10.3) $ 29.4
=========== =========== =========== =========== ===========
1) Management does not allocate interest and other expense, net nor does it
allocate provision for income taxes to the individual segments.
Free cash flow represents net cash provided by operating activities less capital
expenditures. Free cash flow is important because it represents the cash that is
available to a company to pursue opportunities that enhance shareholder value,
such as make acquisitions, reduce debt and develop new products. The following
table reconciles operating cash flow to free cash flow (in millions):
Six months ended
December 31,
--------------------------
2005 2004
------------ ------------
Net cash provided by operating activities $ 14.8 $ 14.6
Capital expenditures (6.5) (4.3)
------------ ------------
Free cash flow $ 8.3 $ 10.3
============ ============
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 Quarterly Report on Form 10-Q. The Company
does not have off-balance sheet arrangements, non-exchange traded contracts or
material related party transactions.
Future minimum payments of contractual obligations as of December 31, 2005 are
as follows (in millions):
Payments Due by Period
----------------------------------------------------------------
Less than After 5
Total 1 year 1 - 3 years 3 - 5 years years
------------ ------------ ------------ ------------ ------------
Operating leases $ 53.1 $ 9.3 $ 17.2 $ 13.2 $ 13.4
Capital leases 1.7 0.8 0.9 - -
Long-term debt 240.0 - - 90.0 150.0
Purchase obligations 24.8 22.3 2.5 - -
Other (1) 157.8 29.4 37.7 38.0 52.7
------------ ------------ ------------ ------------ ------------
Total payments due $ 477.4 $ 61.8 $ 58.3 $ 141.2 $ 216.1
============ ============ ============ ============ ============
(1) Includes interest payments on long-term debt, pension obligations and
expected contingent payments related to the MCM acquisition.
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 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
27
VERTRUE INCORPORATED
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
"believe," "expect," "estimate," "project," "continue" or "anticipate." These
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, are intended to qualify for the safe harbor provisions from
liability provided by the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance and are
based on many assumptions and estimates that are inherently subject to
significant risks and uncertainties, many of which are beyond our control,
cannot be foreseen and reflect future business decisions that may change.
Therefore, actual outcomes and results may differ materially from what is
expressed or forecasted in such forward-looking statements. Among the many
factors that could cause actual results to differ materially from the
forward-looking statements are:
o higher than expected membership cancellations or lower than expected
membership renewal rates;
o changes in the marketing techniques of credit card issuers;
o increases in the level of commission rates and other compensation
required by marketing partners to actively market with the Company;
o potential reserve requirements by business partners, such as the
Company's credit card processors;
o unanticipated termination of marketing agreements;
o the extent to which the Company can continue to successfully develop
and market new products and services and introduce them in a timely
manner;
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 the Company's ability to obtain new financing or re-finance existing
debt;
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, related consumer
financing 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 movements of foreign exchange rates;
o the Company's ability to attract and retain active members and users;
o adverse results of litigation or regulatory matters; and
o new accounting pronouncements.
Many of these factors are beyond the Company's control and therefore its
business, financial condition, results of operations and cash flows may be
adversely affected by these factors.
The Company cautions that these factors are not exclusive. All 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 otherwise required by federal
securities law, the Company has no obligation and does not intend to publicly
update or revise any forward-looking statements to reflect subsequent events or
circumstances.
28
VERTRUE INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Interest Rate
The Company has a senior secured credit facility which allows borrowings of up
to $45.0 million. Borrowings under this senior secured credit facility accrue
interest at either the Eurodollar rate or the higher of the Prime rate or the
Federal Funds rate plus an applicable margin. There were no borrowings
outstanding under this senior secured credit facility as of December 31, 2005.
As of December 31, 2005, the effective interest rate for borrowings under the
senior secured credit facility was 7.25%. 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. The
bank credit facility matures on March 23, 2006 and management expects it to be
renewed or replaced during the third quarter of fiscal 2006.
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. The fair
value of the fixed interest instruments is affected by changes in interest rates
and, with respect to the Convertible Notes, by changes in the Company's stock
price and volatility. The Company does not currently hedge interest rates with
respect to its outstanding debt. As of December 31, 2005, the carrying value of
the Convertible Notes and the Senior Notes was $90.0 million and $147.9 million,
respectively, and the fair value of the notes was $95.9 million and $155.2
million, respectively. Cash paid in connection with interest on the Convertible
Notes and the Senior Notes in each of the next five years is expected to be
$18.8 million assuming none of the notes is converted into equity.
Foreign Currency
The Company conducts business in certain foreign markets, primarily 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. The Company's recent
acquisitions, which are based in the United States, have reduced the proportion
of its operations 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 businesses into U.S. dollars affects year-to-year comparisons of
operating results.
The Company uses purchase option contracts and forward contracts to minimize its
exposure to certain 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 all fluctuations in currency
exchange rates on its results of operations, cash flows and financial position.
The Company does not use derivatives for speculative purposes. Derivatives used
to hedge forecasted transactions and specific cash flows associated with
Canadian dollar denominated financial assets and liabilities that meet the
criteria for hedge accounting are designated as cash flow hedges. The effective
portion of gains and losses is deferred as a component of accumulated other
comprehensive income and is recognized in earnings in the same line item as the
underlying hedged item at the time the hedged item affects earnings.
Fair Value of Investments
The Company does not have material exposure to market risk with respect to
investments 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 evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities
and Exchange Act of 1934) as of the end of the period covered by this report and
have concluded that the Company's disclosure controls and procedures were
effective at the reasonable assurance level. The Company's disclosure controls
and procedures are designed to ensure that material information relating to the
Company and its consolidated subsidiaries that is required to be disclosed in
its reports under the Exchange Act is accumulated, communicated to the Chief
Executive Officer and Chief Financial Officer and disclosed appropriately and
timely in its reports under the Exchange Act.
Because a cost-effective control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met, misstatements due to error or fraud
may occur and not be detected. In addition, projections of any evaluation of
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VERTRUE INCORPORATED
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions or that the degree of compliance
with the policies or procedures may deteriorate.
Changes in internal control over financial reporting
During the second quarter of 2006, there were no changes in the Company's
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
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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 October 17, 2005, the U.S. Supreme Court declined to review the Connecticut
Supreme Court's May 10, 2005 decision against the Company to uphold an
arbitration panel's award of $5.5 million in punitive damages and costs to
MedValUSA Health Programs, Inc. Accordingly, the Company paid the full amount of
the award in the quarter ending December 31, 2005. The Company recorded a
one-time $5.5 million charge in the quarter ended June 30, 2005 related to this
award. For additional information about the MedValUSA Health Programs, Inc.
arbitration, refer to Item 3 - "Legal Proceedings" in the Company's Annual
Report on Form 10-K for the year ended June 30, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
The following table summarizes the shares of the Company's equity securities
purchased by or on behalf of the Company:
Maximum
Number of
Total Number of Shares that May
Total Shares Purchased Yet Be
Number of Average Price as Part of Publicly Purchased Under
Shares Paid Announced Plans the Plans
Period Purchased per Share or Programs (1) or Programs
------ ------------------- ------------------- ------------------- -------------------
October 1, 2005 to October 31, 2005 2,200 $35.82 2,200 773,130
November 1, 2005 to November 30, 2005 67,600 37.27 67,600 705,530
December 1, 2005 to December 31, 2005 45,100 36.58 45,100 660,430
------------------- -------------------
Total 114,900 36.97 114,900 660,430
=================== ===================
(1) In October 2004, the Board of Directors authorized an additional 1,000,000
shares, no expiration date, to be purchased under the Company's stock
repurchase program originally authorized during fiscal 1997.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Company's 2005 Annual Meeting of Stockholders was held on November 17, 2005.
At the annual meeting, the following Directors were elected to the Board of
Directors for a term of one year:
Name For Withheld
---- --- --------
Alec L. Ellison 8,745,784 279,372
Joseph E. Heid 8,542,519 482,637
Gary A. Johnson 8,826,661 198,495
Robert Kamerschen 8,501,452 523,704
Michael T. McClorey 8,807,707 217,449
Edward M. Stern 8,730,623 294,533
Marc S. Tesler 8,542,519 482,637
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PART II. OTHER INFORMATION
At the annual meeting, the following proposals were approved:
To approve an amendment to the 2004 Long-Term Incentive Plan:
For 6,699,578
Against 213,178
Abstain 13,445
Nonvotes 2,098,945
To approve the adoption of the 2005 Equity Incentive Plan:
For 3,972,914
Against 2,939,842
Abstain 13,455
Nonvotes 2,098,945
To ratify PricewaterhouseCoopers LLP as the independent auditors:
For 8,925,645
Against 99,511
Abstain 0
Nonvotes 0
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.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VERTRUE INCORPORATED
(Registrant)
Date: February 9, 2006 By: /s/ Gary A. Johnson
---------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
February 9, 2006 By: /s/ James B. Duffy
---------------------------------
James B. Duffy, Executive Vice President
and Chief Financial Officer (Principal
Financial and Accounting Officer)
33