UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X Annual report pursuant to Section 13 or 15(d) of the Securities
------ Exchange Act of 1934 for the fiscal year ended June 30, 2006
or
Transition report pursuant to Section 13 or 15(d) of the Securities
------- Exchange Act of 1934 for the transition period from ______ to _______.
Commission File No. 0-21527
VERTRUE INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
------------------------ -----------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
20 Glover Avenue
Norwalk, Connecticut 06850
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(Address of principal executive offices) (Zip Code)
(203) 324-7635
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(Registrant's telephone number,
including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $0.01
Par Value
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. [ ] Yes [X] No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
[ ] Yes [X] No
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. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
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.
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 [X] No
The aggregate market value of voting and non-voting common equity held by
non-affiliates of the registrant at December 31, 2005 was $258,129,671. This was
computed by reference to the closing price of the registrant's Common Stock on
December 31, 2005 For purposes of this calculation, all directors, executive
officers and shareholders reporting beneficial ownership of more than 10% of the
registrant's Common Stock are considered to be affiliates.
The number of shares of Common Stock outstanding as of August 28, 2006 was
9,688,778.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 2006 Annual Meeting of Stockholders of
Vertrue Incorporated are incorporated by reference in Parts III of this report.
Index
Item 1. Business.........................................................................................................3
Item 1A. Risk Factors....................................................................................................8
Item 1B. Unresolved Staff Comments......................................................................................14
Item 2. Properties......................................................................................................14
Item 3. Legal Proceedings...............................................................................................14
Item 4. Submission of Matters to a Vote of Security Holders.............................................................14
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities....15
Item 6. Selected Financial Data.........................................................................................16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................16
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.....................................................29
Item 8. Financial Statements and Supplementary Data.....................................................................29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................29
Item 9A. Controls and Procedures........................................................................................30
Item 9B. Other Information..............................................................................................30
Item 10. Directors and Executive Officers of the Registrant.............................................................30
Item 11. Executive Compensation.........................................................................................30
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.................30
Item 13. Certain Relationships and Related Transactions.................................................................31
Item 14. Principal Accountant Fees and Services.........................................................................31
Item 15. Exhibits and Financial Statement Schedules.....................................................................31
SIGNATURES...............................................................................................................32
Exhibits.................................................................................................................33
Part I
Item 1. Business
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OVERVIEW
Vertrue Incorporated and its subsidiaries ("Vertrue", the "Company", "we",
"our", or "us") is a leading internet marketing services company. We operate a
diverse group of marketing businesses with a unified mission: to provide every
consumer with access to savings and services that improve their daily lives.
Our consumer service offerings span healthcare, personal property,
security/insurance, discounts, and personals. We combine unique savings
opportunities from brand-name vendors and service providers to create compelling
value for consumers. To date, over 18 million consumers have enlisted our
services, which represent the contributions of over 500,000 vendors.
We operate a group of businesses that have a diverse mix of product and service
offerings that reach consumers through direct marketing efforts. We market our
services through internet marketing, inbound call marketing, television and
newspaper advertising, direct mail, and outbound telemarketing. Our internet
marketing efforts have been an area of significant investment over the last
three years. Virtually all of our services are now marketed online through a set
of diverse internet marketing channels. These channels include portals, search
advertising, affiliate network partners, and e-commerce partners. We leverage
over a decade of direct marketing experience to tailor our online marketing
efforts for maximum productivity. In addition to marketing online, we have
significantly increased the use of the internet to deliver our programs and
provide service to consumers online. Online marketing as a percentage of total
marketing expenditures has increased from 13% in 2004 to 39% in 2006. Revenues
driven by these marketing investments have also increased. Revenues before
deferral generated through internet marketing efforts were 38% of total revenues
before deferral in 2006, compared to 14% in 2004. Looking ahead to 2007, we
expect the internet channel to continue to grow.
Our internet marketing services form a key component of a corporate marketing
strategy. Our corporate clients use our programs to enhance market presence,
strengthen customer affinity, and generate additional value to their existing
products or service offerings. In addition to our client-based marketing
efforts, we also market our services directly to the consumer through our
proprietary internet sites. These sites enable us to refine our offerings,
target a broader consumer audience, and generate additional revenue through
advertising.
Vertrue continues to develop a portfolio of proprietary internet sites to market
programs directly to the consumer. These sites include www.bargain.com,
www.privacymatters.com, www.lavalife.com, www.beyourbest.com,
www.doctorssayyes.com, and www.breastimplants4you.com. These sites combine
unique content and access to services. In addition, by drawing increasing
traffic to these sites we should be able to generate additional advertising
revenue in the future.
Over the past three years we have successfully transformed our business into a
leading internet marketing services company. Our recent growth and
transformation is attributable to our sharp strategic focus on the Internet, the
development of our in house expertise on how to best market on the internet, and
several strategic acquisitions that have enabled us to reach a broader market
both in terms of our product and service offerings and direct to consumer
marketing expertise.
In April 2004, we broadened the scope of our business by acquiring Lavalife Inc.
("Lavalife"), a personals service. As a result of this acquisition, we became a
leading global provider of web-based and interactive voice response ("IVR")
based personals service. The acquisition of Lavalife provides us with access to
a fast growing consumer category on the internet while expanding our target
market. The Company cross-markets the products and services of the Company and
Lavalife.
In November 2004, we completed the acquisition of certain of the assets of
Bargain Network, Inc. ("Bargain"), a privately held provider of premier pricing
services for homes and vehicles. We acquired Bargain in order to expand our
direct to consumer marketing presence and to expand our discounted consumer
offerings to include personal property.
In January 2005, we completed the acquisition of certain of the assets of My
Choice Medical Holdings, Inc. ("MCM"), a privately held advertising and practice
management company serving cosmetic surgeons throughout the United States. We
acquired MCM in order to expand our consumer offerings to include cosmetic
surgery and to capitalize on the success MCM has had in both paid and natural
search marketing. We believe paid and natural search marketing could be an area
of significant growth in the future.
3
We have three reportable business segments: Marketing Services, Personals, and
Management Services. The Marketing Services business segment primarily provides
discounted products and services to consumers and generates recurring,
membership-based revenue. The Personals business segment provides web, phone,
and mobile personals services and generates transaction-based revenue. The
Management Services business segment provides advertising and practice
management services to healthcare professionals throughout the United States.
Revenues from the Marketing Services and Personals business segments represented
93% of our consolidated total revenues in 2006.
We were incorporated in 1989 in Delaware under the name Cardmember Publishing
Corporation. On October 17, 1996, we completed an initial public offering of our
stock and changed our name to MemberWorks Incorporated. On October 13, 2004, we
began doing business as Vertrue Incorporated and on November 18, 2004,
shareholders approved an amendment to our charter formally changing our name to
Vertrue Incorporated. The name change was intended to reflect the
ever-broadening base of services that we offer to our customers.
MARKETING SERVICES SEGMENT
Products. Our Marketing Services segment designs membership programs that
provide consumers with everyday savings, event-oriented discounts, benefits that
provide consumers with peace of mind and access to information. We partner with
leading, brand name merchants, and with service companies to offer members
valuable packages of members-only benefits. Programs are available in English,
French, and Spanish and can be customized for specific clients, customer
segments, or consumer communities. Our membership programs are packaged around
popular spending categories and offer potential savings greater than the program
fee. Our membership programs fall into the following four consumer spending
categories:
Healthcare
Our health, wellness, and self-improvement programs offer savings on nearly
every healthcare product and service, including prescription drugs, vitamins and
supplements, eye glasses and contact lenses, hearing aides, durable medical
equipment, and select consumer products. These programs also offer discounts on
professional services, including medical, dental, vision, hearing, chiropractic,
alternative medicine, elder care, diet, exercise, and other personal health
services. These programs offer real solutions for the uninsured and
underinsured.
Personal Property
Our personal property programs offer consumers online access to listings of
discounted homes and autos. Members also have access to complementary services
such as a mortgage center, roadside assistance, lemon checker, and extended
warranties.
Security and Insurance
Our security and insurance programs offer discounts on products and services
that enhance the consumer's sense of security and well-being. These programs
provide access to services that help manage privacy and protection, including
identity theft insurance, credit card registration, and credit reporting,
scoring, and monitoring. Our insurance programs offer competitively priced
insurance products, including life, supplemental health, accidental death,
short-term and long-term disability, warranty, and identity theft insurance
coverage. Our other program benefits include 24-hour protection services,
roadside assistance, and financial, tax and retirement consultation services.
Discounts
Our discount programs offer exclusive access to members-only savings with
leading brand name merchants covering a wide range of consumer spending
categories, including travel, transportation, entertainment, dining, shopping,
home improvement, and small business. Savings are available both online and
offline through discounted gift cards, coupons, promotion codes, and rebates.
Marketing and Distribution. We market all of our programs online through an
array of internet marketing channels. These channels are more cost effective
than traditional direct marketing methods and provide immediate feedback to
refine marketing strategies. Our primary internet marketing channels include:
Portals
Vertrue maintains strong advertising relationships with the top internet
portals. Our marketing efforts with portals primarily include the placement of
banner ads driving traffic to our proprietary internet sites. In 2006, we were
ranked among the top 20 in online impressions as measured by Nielsen/NetRatings.
Recently we have been pursuing the integration of banner ads with proprietary
content to improve response rates.
4
Affiliate Network Partners
We advertise through large promotional-based networks such as the Vendare Group
and Commission Junction that drive traffic from the entire spectrum of online
channels to their internet properties delivering customers and leads to
advertisers. This type of advertising is a low risk, high reward channel as we
pay these networks on a pay for performance basis.
E-commerce Partners
We partner with leading e-commerce vendors to market our programs through
post-transaction upsell opportunities. We are able to leverage our partners'
brands to increase conversion rates. Our broad spectrum of product offerings and
flexibility allow us to market membership programs that are complementary or
attractive to the customer base of the various e-commerce vendors.
Search Advertising
Vertrue also maintains strong relationships with major and second-tier search
engines for sponsored marketing links. We continue to grow and optimize our
marketing performance on several thousand keyword searches.
In addition to our internet marketing channels, Vertrue also employs traditional
direct marketing methods to market our programs. These include inbound call
marketing, newspaper and magazine advertising, television advertising, direct
mail, and outbound telemarketing.
Our inbound call marketing occurs when our partners' inbound callers who meet
certain criteria are offered our membership programs by the partner's service
representative or by one of our membership service representatives through a
call transfer. We pay the partner either a royalty for initial and renewal
membership fees or a fee per marketing offer or per sale.
Our membership programs are also delivered through loyalty arrangements with our
client partners. Our Marketing Services segment works with its clients to
incorporate elements from one or more of the standard membership programs to
design a custom program for the client. The client then either provides the
customized membership program to its customers as a value-added feature or
resells the customized membership program. In some cases, the client provides
loyalty memberships to its customers free of charge and pays the periodic
membership fee for each customer's membership. In other cases, the client
charges a reduced fee to its customer. Under these loyalty programs, we do not
pay for the marketing costs incurred to solicit memberships. Instead, the client
offering the memberships is responsible for the marketing. Our loyalty programs
provide clients with a wide range of benefits to offer or market to their
customers and include stand-alone benefits, reward point accumulation and
management, gift certificates, merchandise, and travel reward redemption. Our
versatility in designing loyalty strategies and providing turnkey execution is
essential in supporting and promoting our clients' brands.
Vendors. Our Marketing Services segment has established a large network of
vendor relationships that deliver the discounts and services in each of our
various membership programs. We evaluate and engage only those vendors who can
deliver high quality products and services. Our participating vendors generally
benefit by obtaining access to a large number of demographically attractive
consumers in a cost effective manner while incurring minimal incremental
marketing costs. Specifically, our vendors gain access and marketing exposure to
our membership base, and in almost all cases, pursuant to contractual
arrangements, provide members-only discounts on products or services. We
generally do not receive payments from these vendors for rendering services to
our members and, in certain cases, we pay the vendors a fee based on the number
of members enrolled in the membership program or based on other agreed-upon
factors.
Our contracts with vendors are generally for one year or more, with subsequent
one-year renewal terms at our option. In most cases, vendors may cancel
contracts only for cause and are subject to notice provisions that provide us
time to locate a substitute vendor. Most of our vendor contracts are
non-exclusive and require vendors to maintain the confidentiality of the
contract terms.
Clients. Our membership programs are marketed, in many cases, through
arrangements with our clients, which include banks and other financial
institutions, e-commerce companies, direct response television companies,
catalog companies, retailers, and other organizations with large numbers of
individual customers. These companies have outsourced the implementation of
membership programs to providers, such as us, that are able to apply advanced
database systems to capture, process, and store consumer and market information,
use their experience to provide effective membership programs, and realize
economies of scale. In addition, businesses that outsource their membership
programs demand that the program provider have the expertise to continue to
introduce innovative new programs and have resources, such as extensive vendor
networks and an experienced management team, to launch membership programs
quickly and successfully. Our clients receive royalty payments in exchange for
providing us with new members or access to potential members.
5
Our Marketing Services segment's clients supply substantially all the
information for marketing efforts in accordance with strict consumer privacy
safeguards. As a result, our ability to market a new program to an existing
customer base or an existing program to a new customer base may depend on first
obtaining our client's approval.
Our contracts with our clients typically grant us the right to indefinitely
continue to provide membership services directly to the clients' account
holders, even if our client terminates its contract. Many of our client
contracts may be terminated by the client upon 30 to 90 days notice without
cause and without penalty.
In 2006 and 2005, our largest client, West Corporation, accounted for 12% and
14%, respectively, of our total revenues. In 2004, our largest clients, West
Corporation and Citibank, N.A (and its affiliates), accounted for 18% and 12%,
respectively, of total revenues. The loss of our major clients could have a
material effect on our results of operations. The decrease in the concentration
of revenue with these clients demonstrates our efforts over the past several
years to diversify our business model and increase our direct to consumer
marketing thereby diminishing our reliance on key client partners.
Program Enrollment and Billing. When consumers agree to enroll in a program,
they generally receive a trial membership. During this time, the member may use
the program's services without obligation, as outlined in the marketing
solicitation. Membership materials, which include a membership brochure and a
membership card with a membership identification number, are either mailed or
emailed to the member during the trial period. The brochure outlines in detail
the benefits offered and contains a toll-free number and a web site address,
which may be used to access membership benefits and information. In the event
that a member elects not to participate in the membership program, he or she can
call a toll-free number or log on to the web site during the trial period to
cancel the service without incurring any additional charges. Trial memberships
are generally for a period ranging from 7 to 30 days and there are no conditions
with respect to the ability of the consumer to terminate a trial membership.
If the membership is not canceled during the trial period, the member is charged
the annual or monthly membership fee, depending upon the applicable payment plan
offered. Annual members who do not cancel their memberships after the initial
one year membership term receive a renewal notice in advance of each membership
year and are charged for the succeeding year's membership fee. During the course
of an initial annual membership term or renewal term, a member may cancel his or
her membership in the program generally for a pro rata refund of the membership
fee based on the remaining portion of the membership period at the time of the
cancellation. Monthly members are billed each month after the trial period ends
and continue to be billed each month until the membership is cancelled. During
2006, 91% of our Marketing Services segments' new member enrollments were in a
monthly payment program. Membership fees vary depending upon the particular
services offered in the membership program. Our Marketing Services segment had
approximately 5.8 million members as of June 30, 2006 compared to 5.7 million
members as of June 30, 2005.
Member Service. Providing high quality service to our members is an extremely
important factor in retaining our members and strengthening the affinity of our
clients' customers. Currently, our membership call centers are located in
Montreal, Canada, Houston, Texas, Omaha, Nebraska, and Chicago, Illinois, with a
total of over 1,400 membership service representatives. All of our new
membership service representatives are required to attend on-the-job training.
Through our training programs, systems and software, we seek to provide members
with friendly, rapid and effective answers to their questions. Our members can
access their benefits 24 hours a day via the program's web site or automated
telephone response technology. We also work closely with our clients' customer
service personnel to ensure that their representatives are knowledgeable in
matters relating to the membership programs.
Technology. We have invested substantially in new technology, including data
warehousing, data mining, and various Internet applications that allow us to
effectively and efficiently market our services to potential members. Over the
last 12 months, we have specifically invested in further upgrading our marketing
applications to state-of-the-art technology platforms, completing deployment of
a new internet marketing development plan and deployment platform with advanced
marketing optimization capabilities.
We continue to apply substantial resources to plan, develop, and deploy a new
Member Management platform based on state-of-the-art technology, including
advanced rules engine capabilities. As a new member enrolls on the internet,
membership information is immediately interfaced and maintained on a Member
Management platform that drives information constantly to the customer service
platforms ("CRM") and web sites, as well as to the fulfillment, billing, and
data warehousing systems. This approach allows for rapid fulfillment of member
information via e-mail or mail, immediate access to benefits such as coupons,
credit reports, and discounted gift cards, while facilitating responsive
targeted call center and web site interactions. If a member contacts us by
phone, the Member Management System interacts with our advanced call routing
system to display the member's profile information prior to an employee
answering the call. This allows our membership service representatives to access
the best possible information prior to serving a given member.
Telecommunications systems also monitor the performance quality of the
membership service representatives and other aspects of the business through
sophisticated reporting capabilities.
6
To provide the highest quality service to our members, we have deployed a new,
more advanced technology platform that offers increased capabilities for members
to access their membership benefits via the web sites. In addition, the
Marketing Services segment has increased its use of the data warehousing
capabilities to review, analyze, and model the membership base, in order to
optimize service and market additional products that are most appropriate for
each member.
Competition. We believe that the ability to identify, develop, and offer
innovative programs, the quality and breadth of programs offered, competitive
prices, and in-house marketing expertise are the principal competitive factors
in the marketing services industry. Our competitors offer programs which provide
services similar to or that compete directly with those we offer. Some of our
competitors have substantially larger customer bases and greater financial and
other resources. To date, we have effectively competed with our competitors.
However, there can be no assurance that our competitors will not increase their
emphasis on programs similar to ours, provide programs comparable or superior to
ours at lower membership prices, or adapt more quickly to evolving industry
trends or changing market requirements, or that new competitors will not enter
the market or that clients and vendors will not introduce competing programs of
their own. Such increased competition may result in price reductions, reduced
marketing margins or loss of market share, any of which could materially
adversely affect our business, financial condition and results of operations.
Additionally, because contracts between clients and program providers are often
exclusive with respect to a particular service, potential clients may be
prohibited from contracting with us to promote a program if our services are
similar to or overlap with the services provided by an existing program of a
competitor.
PERSONALS SEGMENT
The Personals segment consists of our Lavalife Inc. ("Lavalife") business.
Lavalife customers can choose to connect with other singles through three
distinct offerings - web, phone, and mobile. Lavalife's open-minded approach to
dating allows customers to choose how they want to "click with other singles" by
offering different dating communities including dating, relationships, and
intimate encounters. Our interactive services allow customers who want to
enhance their social lives, to search for a date, or meet new people to
communicate with other customers in a real time, "Anywhere," "Anytime," and
"Anyhow" environment. Customers can interact with each other from anywhere in
real time by phone, email, instant message, video, or text chat.
We rely on our innovative products, marketing relationships with major media
groups, advertising campaigns in large markets, a widely recognized brand name,
and an advanced technology infrastructure to acquire new users and to retain our
existing customers. In 2006, our marketing initiative with several leading
mobile phone carriers generated strong results. To further develop brand loyalty
and to encourage return visits, we continue to add features and functionality to
our existing service offerings and to introduce new innovative interactive
products.
We employ a transactional business model, in which customers buy non-refundable
credits up front and spend those credits only when they want to interact with
other customers. Our competitors generally employ a subscription-based business
model, in which customers pay a fixed periodic fee. We believe a transactional
model is more attractive to new customers, who will join due to the lower
initial cost and the ability to easily control their spending. Our customers
determine when to use their credits to communicate with other customers.
Furthermore, once a customer has an account balance, the customer has a strong
financial incentive to return to use their remaining credits.
Technology. We utilize an integrated network to support our phone, web, and
mobile operations. Our infrastructure is built on state of the art, industry
standard, high capacity technology designed to support the significant level of
member interaction and a quality experience. The phone-based IVR systems are all
voice over internet protocol platform based, and this technology supports such
high demand features as live chat, and voice messaging. The network operations
center, located in Toronto, Canada, allows the personals business to scale its
web, phone, and mobile operations with full remote management capabilities for
all services.
Competition. The personals industry is very competitive and highly fragmented.
Our primary competitors include numerous online and offline dating and
matchmaking services (both free and paid), some of which operate nationwide and
some of which operate locally, and the personals sections of newspapers and
magazines. In addition to broad-based personals services, there are numerous
niche web sites and offline personals services that cater to specific
demographic groups.
7
MANAGEMENT SERVICES SEGMENT
The Management Services segment consists of our My Choice Medical Holdings, Inc.
business, which provides advertising and practice management services to a
network of cosmetic physicians throughout the United States. Consultants assist
consumers with locating board certified physicians nearby, schedule initial
consultations, offer pre-negotiated fee schedules that are up to 60 percent less
than the usual and customary charges, and provide financing, if needed.
GOVERNMENT REGULATION
We market our products and services through various distribution channels
including internet marketing, inbound call marketing, television and newspaper
advertising, direct mail and telemarketing. These channels are regulated at both
the state and federal levels and we believe that these marketing methods may
increasingly be subject to such regulation, particularly in the area of consumer
privacy. Regulations may limit our ability to solicit new members or to offer
one or more products or services to existing members. The telemarketing industry
has become subject to an increasing amount of federal and state regulation. For
example, the Federal Telephone Consumer Protection Act of 1991 limits the hours
during which telemarketers may call consumers and prohibits the use of automated
telephone dialing equipment to call certain telephone numbers. Additionally, the
Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994 and
Federal Trade Commission ("FTC") regulations, including the Telemarketing Sales
Rule, as amended, promulgated thereunder, prohibit deceptive, unfair or abusive
practices in telemarketing sales. Both the FTC and state attorneys general have
authority to prevent marketing activities deemed by them to be "unfair or
deceptive acts or practices." Further, some states have enacted laws and others
are considering enacting laws targeted directly at regulating telemarketing
and/or internet marketing practices, and there can be no assurance that any such
laws, if enacted, will not adversely affect or limit our current or future
operations. Compliance with these regulations is generally our responsibility
and we could be subject to a variety of enforcement and/or private actions for
any failure to comply with such regulations. Our provision of products and
services requires us to comply with certain state regulations, changes in which
could materially increase our operating costs associated with complying with
such regulations. Noncompliance with any rules and regulations enforced by a
federal or state consumer protection authority may subject us or our management
to fines or various forms of civil or criminal prosecution, any of which could
have a material adverse affect on our business, financial condition and results
of operations. Also, the media often publicizes perceived noncompliance with
consumer protection regulations and violations of notions of fair dealing with
consumers that make the membership programs industry susceptible to peremptory
charges of regulatory noncompliance and unfair dealing by the media.
We currently maintain rigorous security and quality controls that are intended
to ensure that all of our marketing practices meet or exceed industry standards
and all applicable state and federal laws and regulations. We only collect and
maintain customer data that is necessary to administer our business activities,
such as a customer's name, address and encrypted billing information and only
public information is used for marketing and modeling purposes, such as
demographic, neighborhood, and lifestyle data.
FINANCIAL INFORMATION ABOUT SEGMENTS AND GEOGRAPHIC AREAS See Note 17 to the
consolidated financial statements in Item 8 of this report for financial
information about our segments and geographic areas.
EMPLOYEES
As of June 30, 2006, we employed 1,603 persons on a full-time basis and 768 on a
part-time basis. Our employees are not represented by a labor union. We believe
our employee relations are good.
AVAILABLE INFORMATION
Our Internet address is http://www.vertrue.com. Information on our web site is
not a part of this report.
We make available, free of charge through our web site, our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Section
16 filings, Code of Conduct, and all amendments to those reports as soon as
reasonably practicable after such material is electronically filed with or
furnished to the Securities and Exchange Commission ("SEC"). You may read and
copy any document filed with the SEC on its web site, http://www.sec.gov, or at
its Public Reference Room at 100 F Street, N.E., Washington, D.C. 20459. Please
call the SEC at 1-800-SEC-0330 for further information on the operation of the
Public Reference Room.
Item 1A. Risk Factors
------------
The statements in this section describe the major risks to our business and
constitute our cautionary statements under the Private Securities Litigation
Reform Act of 1995. These risks discussed below and elsewhere in this 2006 Form
10-K should be considered carefully when evaluating our business operations and
strategies. Additionally, there may be risks and uncertainties that we are not
aware of or that we currently deem immaterial, which may become material factors
affecting our operations and business success. Many of the factors are not
within our control.
8
Our disclosure and analysis in this 2006 Form 10-K contain some forward-looking
statements. From time to time, we also provide forward-looking statements in
other materials we release to the public. These forward-looking statements
involve known and unknown risks, uncertainties and other factors that may cause
our actual results, levels of activity or performance to be materially different
from any future results, levels of activity or performance expressed or implied
by these forward-looking statements. Such statements give our current
expectations or forecasts of future events and they do not relate strictly to
historical or current facts. We have generally identified such statements by
using words such as "anticipate," "estimate," "project," "intend," "plan,"
"believe," "will," "target," "forecast" and similar expressions in connection
with any discussion of future operating or financial performance. All statements
that address activities, events or developments that we intend, expect or
believe may occur in the future are forward-looking statements. In particular,
these include statements relating to future actions, future performance or
results of current and anticipated revenues, expenses, interest rates, foreign
exchange rates, the outcome of contingencies, such as legal proceedings, and
financial results.
We cannot guarantee that any forward-looking statement will be realized.
Achievement of future results is subject to risks, uncertainties and potentially
inaccurate assumptions. Should known or unknown risks or uncertainties
materialize, or should underlying assumptions prove inaccurate, actual results
could differ materially from past results and those anticipated, estimated, or
projected. You should bear this in mind as you consider forward-looking
statements.
We undertake no obligation to publicly update forward-looking statements,
whether as a result of new information, future events or otherwise. You are
advised, however, to consult any further disclosures we make on related subjects
in our Form 10-Q and Form 8-K reports to the SEC. The risks that follow,
individually or in the aggregate, are those that we think could cause our actual
results to differ materially from those stated or implied in forward-looking
statements. It may not be possible to predict or identify all such factors.
Consequently, you should not consider the following to be a complete discussion
of all potential risks or uncertainties.
Our long-term profitability depends on our ability to replace the members of our
membership programs or customers of our personals services that we lose in the
ordinary course of business, and, if we fail to do so, our member or customer
base and consequently our revenue will decline.
We lose a significant number of members of our membership programs and customers
of our personals and management services segments each year in the ordinary
course of business. The loss of such members or customers may occur as a result
of numerous factors including:
o changing consumer preferences;
o competitive price pressures;
o general economic conditions;
o customer dissatisfaction; and
o credit or debit card holder turnover.
Failure to obtain new members or customers who produce revenue at least
equivalent to the revenue from the lost members or customers would result in a
decrease in the number of our members or customers and, consequently, in a
reduction of our revenue. There can be no assurance that we can successfully
replace the lost members or customers.
In addition, even if we are successful in adding new members and customers to
replace lost revenue, our profitability and cash flow may still decline since we
generally incur losses and negative cash flow during the initial stages of an
individual membership program and customer procurement, as compared with renewal
periods, due primarily to higher marketing costs associated with initial
membership and customer procurement.
Increased cancellations could impair our financial condition, results of
operations and cash flows.
Monthly members of our membership programs are billed each month after their
trial period until they cancel their membership. Annual members who cancel their
membership at any time during the membership period generally receive a pro rata
refund of the membership fee based on the remaining portion of the membership
period. Increased cancellations could have a material adverse effect on our
business, financial condition, results of operations, and cash flows.
9
The success of our business depends on the introduction of popular new programs
or services or the enhancement of existing membership programs or personals
services.
Our business is substantially dependent on our ability to develop and
successfully introduce popular new membership programs or to provide
enhancements to existing membership programs which generate consumer loyalty.
Failure to introduce new membership programs in a timely manner could result in
our competitors acquiring additional market share. In addition, the introduction
or announcement of new innovative membership programs or personals services by
us or by others could render existing membership programs or personals services
obsolete or result in a delay or decrease in orders for existing membership
programs or personals services as customers evaluate new membership programs or
personals services. Therefore, the announcement or introduction of new
innovative membership programs by us or others, or our failure to introduce new
membership programs which generate broad consumer appeal, or our inability to
refine our service offerings or introduce new services in our personals business
could have a material adverse effect on our business, financial condition,
results of operations, and cash flows.
We may need to spend more money to advertise to generate the same revenue.
We believe that advertising spending on the Internet, as in traditional media,
fluctuates significantly with economic conditions. Because a majority of our
revenues are derived as a result of our advertising efforts, fluctuations in our
advertising spending generally, or with respect to our Internet-based spending
specifically, could have an adverse impact on our revenue and our profitability.
We depend on payment processors to process revenue and obtain payments for us.
We depend on payment processors to obtain payments for us. The payment
processors operate pursuant to agreements that may be terminated with limited
prior notice. In the event a payment processor ceases operations or terminates
its agreement with us, there can be no assurance a replacement payment processor
could be retained on a timely basis, if at all. Any service interruptions,
processing cost increases, delays or quality problems could result in delays in
collecting payments, decreased revenue and/or increased expense which could have
a material adverse effect on our business, financial condition, results of
operations, and cash flows.
We depend in part on the communication channels through which we market and
service our products and services such as telephone, internet, and the United
States Postal Service. An interruption of, or an increase in the billing rate
for, such services could adversely affect our business.
We market and service our programs by various communication channels, including
telephone, internet, and direct mail. Accordingly, our business is dependent on
the quality of the postal and telephone services provided by the U.S. Post
Office and various local and long distance telephone companies. Any significant
interruption of such services or any limitations in their ability to provide us
with increased capacity could adversely impact our business, financial
condition, and results of operation. In addition, rate increases imposed by
providers would increase our and our marketing partners' operating expenses and
could have a material adverse effect on our business, financial condition,
results of operations, and cash flows.
We depend on third-party vendors to supply the products and services that we
market. The failure of these vendors to provide such products or services could
result in customer dissatisfaction and could harm our business.
We depend on third-party vendors to provide most of the products and services
included in the membership programs and services that we market. The third-party
vendors generally operate pursuant to non-exclusive agreements with us that may
be terminated by the vendor with limited prior notice. There can be no assurance
that, in the event a vendor ceases operations, terminates, breaches, or chooses
not to renew its agreement with us, a replacement vendor could be retained on a
timely basis, if at all. In addition, our third-party vendors are independent
contractors and the level and quality of services they provide is outside our
control. Any product or service interruptions, delays, or quality problems could
result in customer dissatisfaction and membership cancellations and/or
termination of marketing partners' relationships with us, which could have a
material adverse effect on our business, financial condition, results of
operations, and cash flows.
Our business is highly dependent on our existing computer, billing,
communications, and other technological systems. Any temporary or permanent loss
of any of our systems could have a negative effect on our business, financial
condition, and results of operations.
Our business depends upon ongoing investments in advanced computer database and
telecommunications technology as well as upon our ability to protect our
telecommunications and information technology systems against damage or system
interruptions from natural disasters, technical failures, and other events
beyond our control. In order to compete effectively and to meet the needs of our
clients, members, and customers, we must maintain our systems as well as invest
in improved technology. A temporary or permanent loss of any of our systems or
networks could cause significant damage to our reputation and could result in a
loss of revenue.
10
In addition, we receive credit data electronically, and this delivery method is
susceptible to damage, delay, or inaccuracy. A significant portion of our
business involves telephonic customer service as well as mailings, both of which
depend upon the data generated from our computer systems. Unanticipated problems
with our telecommunications and information technology systems may result in a
significant system outage or data loss, which could interrupt our operations.
Our infrastructure may also be vulnerable to computer viruses, hackers, or other
disruptions entering our systems from the credit reporting agencies, our
marketing partners, members, customers, or other authorized or unauthorized
sources. Any damage to our telecommunications and information technology
systems, failure of communication links, or other loss that causes interruption
in, or damage to, our operations could have a material adverse effect on our
business, financial condition, results of operations, and cash flows.
We rely on our clients to provide customer information to us for certain
marketing purposes and to approve our marketing materials. If our clients make
significant changes to the materials that decrease our results or if they limit
the information that they provide to us, our ability to generate new customers
may be adversely affected.
Certain of our marketing efforts depend in part on limited customer information
being made available to us by our clients. There can be no assurance that our
clients will continue to provide us with the use of such customer information.
Our marketing efforts are largely dependent on obtaining approval of the
solicitation materials from our clients. We market our programs and services
based on tested marketing materials, and any significant changes to those
materials that are required by our clients could have a negative impact on our
results. The material terms of each marketing campaign must be mutually agreed
upon by the parties. There can be no assurance that we will obtain approvals of
our marketing materials from our clients, and the failure to do so could have a
material adverse impact on our business, financial condition, results of
operations, and cash flows.
The loss of key clients could have a material adverse effect on our results of
operations.
The loss of key clients could have a material adverse effect on our results of
operations. Membership programs marketed through one of these clients, West
Corporation, accounted for approximately 12% of our total revenue for the fiscal
year ended June 30, 2006. Though the status of members that have already joined
our membership programs through existing clients would not be affected, a loss
of key clients or a decline in their respective businesses would result in the
loss of our ability to draw new customers to our membership programs marketed
through these clients and could have a material adverse effect on our financial
condition, results of operations, and cash flows. There can be no assurance that
one or more of our clients will not terminate its relationship with us or suffer
a decline in its business.
We market certain of our membership programs through credit card issuers. A
downturn in the credit card industry or changes in the marketing techniques of
credit card issuers could adversely affect us.
Our success is dependent in large part on continued demand for our membership
programs within our clients' industries. Certain of our membership programs are
marketed through our credit card issuer clients. A significant downturn in the
credit card industry or a trend in that industry to reduce or eliminate its use
of membership programs could adversely affect our business.
Our failure to protect private data could damage our reputation and cause us to
expend capital and other resources to protect against future security breaches
and could harm our business.
Certain of our services are based upon the collection, distribution, and
protection of sensitive private data. Unauthorized users might access that data,
and human error or technological failures might cause the wrongful dissemination
of that data. If we experience a security breach, the integrity of certain of
our services may be affected and such a breach could violate certain of our
marketing partner agreements, which could give our marketing partners the right
to terminate such agreements with us. We have incurred, and may incur in the
future, significant costs to protect against the threat of a security breach. We
may also incur significant costs to solve problems that may be caused by future
breaches or to prevent such breaches. Any breach or perceived breach could
subject us to legal claims from our marketing partners or customers and/or
regulatory or law enforcement entities under laws that govern the protection of
non-public personal information. Moreover, any public perception that we have
engaged in the unauthorized release of, or have failed to adequately protect,
private information could adversely affect our ability to attract and retain
members and customers. In addition, unauthorized third parties might alter
information in our databases, which would adversely affect both our ability to
market our services and the credibility of our information.
We depend on key executive and marketing personnel.
We are dependent on certain key members of our management and marketing staff,
particularly our Chief Executive Officer, Gary Johnson. In addition, we believe
that our future success will depend in part upon our ability to attract and
retain highly skilled managerial and marketing personnel. We face significant
competition for such personnel, and we may be unsuccessful in hiring or
retaining the personnel we require. The failure to hire and retain such
personnel could have a material adverse effect on our business, financial
condition and results of operations.
11
The industries in which we operate are highly competitive. We may be unable to
compete effectively with other companies in our industries that have financial
or other advantages and increased competition could lead to reduced market
share, a decrease in margins and a decrease in revenue.
We believe that the principal competitive factors in the industries in which we
operate include the ability to identify, develop, and offer innovative programs
and services, the quality and breadth of programs and services offered,
competitive pricing and in-house marketing expertise. Our competitors offer
programs and services which are similar to, or which compete directly with,
those provided by us. In addition, in our Marketing Services segment, we could
face competition if our current clients or other companies were to introduce
their own in-house programs or services similar to ours.
Some of the existing and potential competitors to our Marketing Services and
Personals businesses have substantially larger customer bases and greater
financial and other resources than we do. There can be no assurance that:
o our competitors will not increase their emphasis on programs or
services similar to those we offer;
o our competitors will not provide programs or services comparable or
superior to those we provide at lower costs;
o our competitors will not adapt more quickly than us to evolving
industry trends or changing market requirements;
o new competitors will not enter the market; or
o other businesses (including our current marketing partners) will not
themselves introduce in-house programs or services similar to those we
offer.
In order to compete effectively with our competitors, we must be able to provide
superior programs and services at competitive prices. In addition, we must be
able to adapt quickly to evolving industry trends, a changing market and
increased regulatory requirements. Our ability to grow our business may depend
on our ability to develop new programs and services that generate consumer
interest. Failure to do so could result in our competitors acquiring additional
market share in areas of consumer interest. Any increase in competition could
result in price reductions, reduced gross margin, and loss of market share, any
of which could have a material adverse impact on our business, financial
condition, and results of operations.
Additionally, because contracts between clients and program providers in our
Marketing Services business are often exclusive with respect to a particular
program, potential clients may be prohibited from contracting with us to promote
a new program if the products and services provided by our program are similar
to, or overlap with, the products and services provided by an existing program
of a competitor.
Our industry is increasingly subject to U.S. state, federal, and foreign
government regulation, which could impede our ability to market our programs and
services and reduce our profitability.
We market our membership programs and services through various distribution
channels, including internet marketing, inbound call marketing, television and
newspaper advertising, direct mail, and telemarketing. These channels are
regulated at the state, federal, and foreign levels and we believe that these
channels will be subject to increasing regulation, particularly in the area of
consumer privacy. Such regulation may limit our ability to solicit new members
or customers or to offer products or services to existing members or customers.
Our Membership Services segment is subject to extensive regulation and oversight
by the FTC, the Federal Communications Commission (the "FCC"), state attorneys
general and other state regulatory agencies, including state insurance
regulators and various foreign regulatory entities. Our programs and services
involve the use of nonpublic personal information that is subject to federal
consumer privacy laws, such as the federal Gramm Leach Bliley Act, and various
federal and state telemarketing regulations, including the FTC's Telemarketing
Sales Rule, the FCC's Telephone Consumer Protection Act and implementing
regulations, as well as various state telemarketing laws and regulations. While
we do not believe that the laws and regulations passed to date will have a
material impact on our business, additional federal, state or foreign laws
and/or regulations, including subsequent amendments to existing laws and
regulations, could cause a material adverse impact on our business, financial
condition, results of operations, and cash flows.
12
Compliance with these laws and regulations is generally our responsibility, and
we could be subject to a variety of enforcement and/or private actions for any
failure to comply such laws and regulations. Any changes to these laws and
regulations could materially increase our compliance costs. Noncompliance with
any laws and regulations enforced by a state, federal, or foreign consumer
protection authority may subject us or our management to fines or various forms
of civil or criminal prosecution, any of which could have a material adverse
effect on our business, financial condition and results of operations. Also, the
media often publicizes perceived noncompliance with consumer protection laws and
regulations and violations of notions of fair dealing with consumers and the
membership services industry is susceptible to peremptory charges by the media
of regulatory noncompliance and unfair dealing.
We are subject to legal actions that could have a negative impact on our
financial condition, results of operations, cash flows or reputation.
We are involved in claims, legal proceedings, and governmental inquiries related
to employment matters, contract disputes, business practices, trademark and
copyright infringement claims, and other commercial matters. While we cannot
predict the outcome of pending suits, claims, investigations, and inquiries, the
cost of responding to and defending such suits, as well as the ultimate
resolution of any of these matters, could have a material adverse effect on our
business, financial condition, results of operations, cash flows, or reputation.
We may experience operational and financial risks in connection with
acquisitions. In addition, some of the businesses acquired by us may incur
significant losses from operations or experience impairment of carrying value.
Our future growth may depend, in part, on acquisitions. We may experience
operational and financial risks in connection with acquisitions. To the extent
that we grow through acquisitions, we will need to:
o retain senior management and other key personnel at acquired
businesses; and
o successfully manage acquisition-related strain on our management,
operations, and financial resources and on the management, operations,
and financial resources of the acquired company.
We may not be successful in addressing these challenges or any other problems
encountered in connection with historical and future acquisitions, and, the
failure to do so, could adversely affect our business, financial condition, and
results of operations. In addition, we may not achieve the operational synergies
and cost savings anticipated in connection with any such acquisition. The
failure to realize anticipated benefits of one or more of our acquisitions and
the undertaking of future acquisitions could result in potentially diluted
issuances of equity securities, additional contingent liabilities, or the
impairment of goodwill and/or other intangible assets, any of which could
adversely affect our business, financial condition, and results of operations.
We may need to raise additional capital in the future to fund liquidity and
capital requirements, which may not be available to us on favorable terms or at
all.
Our future liquidity and capital requirements will depend upon numerous factors,
including the success of our membership programs and other product and service
offerings, market developments, potential acquisitions and additional
repurchases of our common stock. We may need to raise additional funds to
support expansion, develop new products or services, respond to competitive
pressures, acquire complementary businesses or take advantage of unanticipated
opportunities. The indenture governing our senior secured credit facility and
our Senior Notes contain covenants that may restrict our ability to finance
operations or capital needs. We cannot be certain that we will be able to obtain
adequate financing on favorable terms or at all.
Our quarterly operating results are volatile and may adversely affect the market
price of our securities.
Our quarterly revenues, expenses, and operating results have varied
significantly in the past and may vary significantly from quarter to quarter in
the future. Factors which could cause our financial results to fluctuate
include:
o increased or decreased cancellation of member enrollments;
o the rate of renewal by existing members;
o increased default on notes receivables;
o our ability to introduce new programs or products or to enhance
existing programs or products on a timely basis and the introduction
of programs or products by our competitors;
o the mix of our client base;
o seasonality of the businesses of our clients;
o market acceptance and demand for our and our clients' membership
programs generally;
o the mix of programs we offer and the price points of such programs; o
increased commission rates and other compensation required by our
clients;
13
o the mix of our marketing channels;
o unanticipated service interruptions;
o movement in foreign exchange rates;
o adverse outcomes of litigation or regulatory matters;
o the availability of vendors to support programs we offer;
o the level of enthusiasm for health and fitness, travel, entertainment
and leisure activities, and other lifestyle elements underlying our
membership programs; and
o competitive pressures on selling prices.
Many of these factors are beyond our control. Operating results would be
adversely affected if projected revenues for a given quarter are not achieved.
In addition, any future acquisitions by us could have a material adverse effect
on our results of operations, particularly in quarters immediately following
consummation of such transactions, while the operations of the acquired business
are being integrated into our operations.
Item 1B. Unresolved Staff Comments
-------------------------
Not Applicable.
Item 2. Properties
----------
A summary of key information with respect to our leased facilities is as
follows:
Calendar Year Lease
Location Square Footage Expires
--------------------- ------------------ ----------------------
Omaha, NE 124,832 2009 through 2015
Goleta, CA 82,798 2006 through 2011
Norwalk, CT 82,215 2016
Toronto, Canada 73,929 2009
Montreal, Canada 48,193 2006 through 2014
Houston, TX 41,848 2011
Chicago, IL 18,776 2010
Atlanta, GA 13,717 2010
Stroudsburg, PA 11,000 2014
During 2006, we relocated our corporate headquarters to Norwalk, Connecticut.
Our Norwalk office also includes non-corporate offices for our Marketing
Services segment. The Toronto, Canada office serves as the operational office
for our Personals segment. The Stroudsburg, Pennsylvania office serves as the
operational office for our Management Services segment. All other locations
serve as operational offices for our Marketing Services segment. We believe that
our properties are generally in good condition, are well maintained and are
suitable and adequate to carry on our business.
Item 3. Legal Proceedings
-----------------
In our opinion, there are no significant legal proceedings to which we or any of
our subsidiaries are a party or to which any of our properties are subject. We
are involved in lawsuits and claims generally incidental to our business,
including but not limited to various suits, including previously disclosed
suits, brought against us by individual consumers seeking monetary and/or
injunctive relief relating to the marketing of our programs. In addition, from
time to time in the regular course of our business, we receive inquiries from
various federal and/or state regulatory authorities.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
No matters were submitted to a vote of security holders during the quarter ended
June 30, 2006.
14
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
----------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
Market Information
Our common stock is listed on the NASDAQ National Market ("NASDAQ") under the
symbol VTRU. The following table sets forth the high and low closing sale prices
per share for the periods indicated as reported on the NASDAQ.
Fiscal Year Ended June 30, 2006: High Low
--------- ---------
First Quarter $ 40.61 $ 33.72
Second Quarter 38.47 33.79
Third Quarter 45.15 33.50
Fourth Quarter 44.38 38.21
Fiscal Year Ended June 30, 2005: High Low
--------- ---------
First Quarter $ 29.28 $ 24.42
Second Quarter 38.33 24.70
Third Quarter 40.89 35.34
Fourth Quarter 39.47 29.47
Holder and Dividend Information
As of August 28, 2006, there were 40,000,000 shares of our common stock
authorized of which 9,688,778 shares were outstanding, held by approximately
2,600 stockholders of record. We have not declared or paid any cash dividends to
date and anticipate that all of our earnings in the foreseeable future will be
retained for use in our business and to repurchase our common stock under our
stock repurchase program. Our future dividend policy will depend on our
earnings, capital requirements, financial condition, requirements of the
financing agreements to which we are a party, and other factors considered
relevant by our Board of Directors.
Purchases of Equity Securities by the Issuer
The following table summarizes the shares of our equity securities purchased by
us or on our behalf:
Maximum
Number of
Total Number of Shares that May
Shares Purchased Yet be
Total Number Average Price as Part of Publicly Purchased Under
of Shares Paid Announced Plans the Plans
Period Purchased per Share or Programs (1) or Programs
--------------------------------- ----------- ----------- ------------------- ---------------
April 1, 2006 to April 30, 2006 4,100 $ 41.54 4,100 545,630
May 1, 2006 to May 31, 2006 163,500 38.67 163,500 382,130
June 1, 2006 to June 30, 2006 55,000 39.69 55,000 327,130
----------- ----------- ------------------- ---------------
Total 222,600 $ 38.97 222,600 327,130
=========== =========== =================== ===============
(1) In October 2004, our Board of Directors authorized 1,000,000 shares, no
expiration date, to be purchased under our stock repurchase program
originally authorized during fiscal 1997. In August 2006, we announced
that our Board of Directors authorized the purchase of up to 1,000,000
shares, no expiration date, in addition to the authorization described
above, thereby increasing the maximum number of shares that may yet be
purchased to 1,327,130.
15
Item 6. Selected Financial Data
-----------------------
The selected consolidated operating and common stock data for each of the years
ended June 30, 2006 through 2002 and the selected consolidated financial
position data and liquidity as of June 30, 2006 through 2002 below are derived
from the Company's audited consolidated financial statements. All selected
financial information in this Item 6 is qualified by reference to and should be
read in conjunction with Item 8, "Financial Statements and Supplementary Data,"
and Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," in this report.
For the years ended June 30,
-----------------------------------------------------
(Dollar amounts in millions except per share data) 2006 (1) 2005 (2) 2004 (3) 2003 (4) 2002 (5)
-----------------------------------------------------
Consolidated Operating Data:
Revenues $ 658.9 $ 579.8 $ 488.7 $ 456.9 $ 427.6
Operating income 65.3 57.1 52.9 22.3 11.9
Income before provision for income taxes 48.6 38.9 46.6 40.6 43.9
Provision for income taxes 15.9 13.4 18.6 16.2 -
Income before cumulative effect of accounting change 32.7 25.5 28.0 24.4 43.9
Net income 32.7 25.5 28.0 24.4 38.0
Per Share Data:
Earnings before cumulative effect of accounting change per share:
Basic $ 3.36 $ 2.56 $ 2.60 $ 1.93 $ 3.03
Diluted $ 2.83 $ 2.22 $ 2.29 $ 1.84 $ 2.95
Earnings per share:
Basic $ 3.36 $ 2.56 $ 2.60 $ 1.93 $ 2.63
Diluted $ 2.83 $ 2.22 $ 2.29 $ 1.84 $ 2.55
Diluted weighted average common shares outstanding 12.7 13.0 13.2 13.2 14.9
June 30,
-----------------------------------------------------
2006 2005 2004 2003 2002
-----------------------------------------------------
Consolidated Financial Position Data and Liquidity:
Cash and cash equivalents $ 36.3 $ 64.4 $ 47.2 $ 67.3 $ 45.5
Short-term investments 31.8 16.2 120.0 5.0 -
Total assets 443.0 447.2 453.2 248.5 280.8
Long-term liabilities 254.9 252.8 246.9 8.3 3.6
Treasury stock, at cost (273.0) (253.6) (212.5) (124.6) (87.5)
(1) In 2006, the Company adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 123, Accounting for Share-Based Payments
(revised).
(2) In 2005, the Company acquired certain of the net assets of Bargain Network,
Inc. and My Choice Medical Holdings, Inc.
(3) In 2004, the Company completed the acquisition of all of the net assets and
outstanding capital stock of Lavalife Inc.
(4) In 2003, the Company received a settlement award from a lawsuit against
Homestore.com, Inc.
(5) In 2002, the Company sold its investment in iPlace, Inc. Additionally, the
Company recorded an impairment of goodwill as a cumulative effect of
accounting change in connection with the adoption of SFAS No. 142, "Goodwill
and Other Intangible Assets."
Item 7. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
OVERVIEW
Vertrue is a leading internet marketing services company. We operate a diverse
group of marketing businesses with a unified mission: to provide every consumer
with access to savings and services that improve their daily lives.
We have three reportable business segments: Marketing Services, Personals, and
Management Services. The Marketing Services business segment primarily provides
discounted products and services to consumers and generates recurring,
membership-based revenue. The Personals business segment provides web, phone,
and mobile-based personals services and generates transaction-based revenue. The
Management Services business segment provides advertising and practice
management services to healthcare professionals throughout the United States.
Revenues from the Marketing Services and Personals business segments represented
93% of our consolidated total revenues in 2006.
16
The Marketing Services segment offers consumers a variety of products and
services from selected vendors and service providers on a monthly or annual
subscription basis or a fee for service basis. Revenues are derived principally
from recurring fees which are billed to the member on either a monthly or annual
basis. In the case of annually billed membership fees, the Company receives full
payment at or near the beginning of the membership period, but recognizes the
revenues as the member's refund privilege expires. Membership fees that are
billed monthly are recognized when earned. Revenues derived from one time fees
are recognized when the service is performed.
The Personals segment employs a transactional business model in which users buy
non-refundable credits up front and spend those credits only when they want to
interact with other customers. Personals revenues are recognized when the
services are used.
During 2006, the Management Services segment became reportable due to the
increase in its assets and as such, all prior periods have been restated to
reflect this change. For additional financial information about these reportable
business segments, see Note 17 to the consolidated financial statements in Item
8 of this report.
The results of MCM, Bargain, and Lavalife have been included in the consolidated
results since their acquisitions on January 1, 2005, November 30, 2004, and
April 1, 2004, respectively. MCM, Bargain, and Lavalife are included in
Management Services, Marketing Services, and Personals segment, 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
this Item 7 under the heading "Liquidity and Capital Resources" in this report.
A description and reconciliation of net income to EBITDA and Adjusted EBITDA are
disclosed in this Item 7 under the heading "Reconciliation of Non-GAAP Measures"
in this report.
17
RESULTS OF OPERATIONS
Consolidated Overview
For the years ended June 30, Percent Increase/(Decrease)
---------------------------------- ---------------------------------
(Dollars amounts in millions) 2006 2005 2004 '06 vs. '05 '05 vs. '04
----------- ----------- ---------- --------------- ----------------
Revenues $ 658.9 $ 579.8 $ 488.7 14% 19%
Marketing expenses 313.2 286.4 255.8 9% 12%
Operating expenses 151.7 114.4 91.8 33% 25%
General and administrative expenses 120.3 108.2 85.8 11% 26%
Charge for arbitration award - 5.5 - (100%) NM
Amortization of intangible assets 8.4 8.2 2.4 2% 242%
----------- ----------- ----------
Operating income 65.3 57.1 52.9 14% 8%
Interest income 3.6 1.9 1.1 89% 73%
Interest expense (20.3) (20.7) (7.7) 2% (169%)
Other income, net - 0.6 0.3 (100%) 100%
----------- ----------- ----------
Income before income taxes 48.6 38.9 46.6 25% (17%)
Provision for income taxes 15.9 13.4 18.6 19% (28%)
----------- ----------- ----------
Net income $ 32.7 $ 25.5 $ 28.0 28% (9%)
=========== =========== ==========
EBITDA $ 89.8 $ 78.7 $ 65.4 14% 20%
=========== =========== ==========
NM = Not Meaningful
Revenues
The following table sets forth revenue by payment plan and by segment:
For the years ended June 30, Percent Increase/(Decrease)
--------------------------------------- -------------------------------
(Dollars amounts in millions) 2006 2005 2004 '06 vs. '05 '05 vs. '04
------------ ------------- ------------ --------------- ---------------
Monthly payment plans $ 357.2 $ 250.8 $ 160.6 42% 56%
Annual payment plans:
Initial year 33.6 56.5 113.2 (41%) (50%)
Renewal year 112.7 152.6 170.1 (26%) (10%)
Other 36.2 30.4 27.1 19% 12%
------------ ------------- ------------ --------------- ---------------
Total Marketing Services 539.7 490.3 471.0 10% 4%
Personals 74.5 72.1 17.7 3% 307%
Management Services 44.7 17.4 - 157% NM
------------ ------------- ------------ --------------- ---------------
Total $ 658.9 $ 579.8 $ 488.7 14% 19%
============ ============= ============ =============== ===============
In 2006, revenues increased $79.1 million, or 14%. Revenues related to the
Company's 2005 acquisitions were $81.4 million in 2006 compared to $38.4 million
last year. Excluding revenues from Bargain and MCM, revenues would have
increased 7% due to an increase in Marketing Services' revenues, as discussed
below. The remaining revenue increase is due to the inclusion of the full year
of revenues from Bargain and MCM. Net active retail members and customers
increased 3% to 6.5 million at June 30, 2006 from 6.3 million at June 30, 2005.
In 2006, Marketing Services revenues increased $49.4 million, or 10%. Excluding
revenues from Bargain, total marketing services revenues would have increased
7%. Revenues from members enrolled in monthly payment plans increased 42% and
were partially offset by a 30% decrease in revenue from members enrolled in
annual payment plans. The increase in revenues from monthly payment plans was
due to a 30% increase in average monthly members billed and a 9% 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. Revenues from other are
derived from one time fees that are recognized when the service is performed.
18
In 2006, Personals revenues increased $2.4 million, or 3%, primarily due to the
incremental revenue generated from Lavalife's growing mobile service. In 2006,
Management Services revenues increased $27.3 million, or 157%. 2005 included
revenues from MCM for only the second half of the fiscal year since that
acquisition was completed on January 1, 2005. Comparing the second half of 2005
to the second half of 2006, Management Services increased 74%. This increase is
due to growth in volume and increased pricing of transactions managed.
In 2005, revenues increased $91.1 million, or 19%, primarily due to the
inclusion of revenues from MCM and Bargain and the full-year effect of the
acquisition of Lavalife. Net active retail members and customers increased 2% to
6.3 million at June 30, 2005 from 6.2 million at June 30, 2004.
In 2005, Marketing Services revenues increased $19.3 million, or 4%, due to the
inclusion of revenues from Bargain. During 2005, the Marketing Services segment
increased direct to consumer marketing efforts in order to provide additional
growth opportunities and a more diverse business model. Offsetting this
increase, the Marketing Services segment decreased its level of marketing with
certain client partners in the outbound telemarketing channel.
In 2005, Personals revenues were $72.1 million and represented the revenues of
Lavalife. On a pro forma basis assuming the acquisition of Lavalife occurred on
July 1, 2003, revenues would have remained flat from 2004. Management Services
revenues were $17.4 million in 2005.
Marketing Expenses
In 2006, marketing expenses increased $26.8 million, or 9%, due to the inclusion
of a full year of costs incurred by Bargain and MCM as well as an increase in
online marketing efforts which resulted in higher revenues, as discussed above.
As a percentage of revenues, marketing expenses decreased to 48% in 2006 versus
49% in 2005 primarily due to increased price points, more efficient marketing
spending, and better retention in certain sectors of the business.
In 2005, marketing expenses increased $30.6 million, or 12%, primarily due to
the inclusion of marketing expenses incurred by Lavalife, Bargain, and MCM. As a
percentage of revenues, marketing expenses decreased to 49% in 2005 versus 52%
in 2004 primarily due to the decrease in the level and mix of members enrolled
through the higher cost outbound telemarketing channel and the effect of the
lower marketing expense ratios of Lavalife and MCM.
Operating Expenses
In 2006, operating expenses increased $37.3 million, or 33%, and as a percentage
of revenues, were 23% this year versus 20% in 2005 due to the full year of costs
incurred by Bargain and MCM. Operating expenses of the Management Services
segment increased 173% in 2006 to support the 157% increase in revenue and
accounted for a 2% increase in the overall operating expenses as a percentage of
revenue. The operating expense ratio of the Management Services segment is
higher than that of other segments. The remaining increase in operating expenses
was due to increased costs of servicing the higher member and customer base and
the higher mix of members enrolled in monthly payment plans compared with annual
payment plans.
In 2005, operating expenses increased $22.6 million, or 25%, and as a percentage
of revenues, were 20% in 2005 versus 19% in 2004 and were primarily due to the
effect of the higher operating expense ratio of Lavalife and MCM.
General and Administrative Expenses
In 2006, general and administrative expenses increased $12.1 million, or 11%,
and included a $4.5 million charge related to SFAS No. 123, "Share-Based
Payment," ("SFAS 123R"), which was adopted in July 2005, partially offset by a
one-time $1.0 million benefit realized on the recovery of certain expenses
related to litigation settled during 2006. Excluding the impact of these two
items in 2006 and excluding the $1.0 million in expenses related to that same
litigation from 2005, general and administrative expenses would have increased
9% to $116.8 million, or 18% of revenue, in 2006 from $107.2 million, or 19% of
revenue, in 2005. The increase in general and administrative expenses was
primarily due to the inclusion of a full year of expenses incurred by Bargain
and MCM and increased employee and occupancy related expenses. General and
administrative expenses decreased as a percentage of revenue due to leveraging
expenses with the increase in revenue.
In 2005, general and administrative expenses increased $22.4 million, or 26%,
and as a percentage of revenues were 19% in 2005 compared to 18% in 2004. These
increases were primarily due to the impact of the acquisition of Lavalife,
Bargain, and MCM.
19
Charge for Arbitration Award
In 2005, the Company recorded a $5.5 million charge related to an arbitration
award against the Company. For additional information, see Note 8 of the Notes
to Consolidated Financial Statements included in Item 8 of this report.
Operating Income
In 2006, operating income increased $8.2 million, or 14%. Excluding the expenses
associated with the adoption of SFAS 123R and the one time benefit realized
related to the settlement of litigation from 2006 and excluding the expenses
related to that same litigation in 2005 and the charge for the arbitration award
from 2005, operating income would have increased 8% to $68.9 million from $63.5
million due to the 14% increase in revenue partially offset by the increased
level of operating expenses, as described above.
In 2005, operating income increased $4.2 million, or 8%, due to the impact of
Lavalife, Bargain, and MCM and the decrease in marketing expense ratios. As a
percentage of revenues, marketing expenses were 49% in 2005 compared to 52% in
2004. Marketing expenses decreased as a percentage of revenues primarily due to
the decrease in the level and mix of members enrolled through the higher cost
outbound telemarketing channel and the effect of the lower marketing expense
ratios of Lavalife and MCM. The increase in operating income was partially
offset by the impact of the $5.5 million charge for the arbitration award.
Interest Income
Interest income included interest earned on cash, short-term investments, and
notes receivable. In 2006, interest income increased 89% primarily due to higher
outstanding notes receivable related to the growth of the Management Services
segment. Interest income increased 73% in 2005 due primarily to higher average
yield on our cash and short-term investments.
Interest Expense
Interest expense in 2006 and 2005 primarily included $14.3 million related to
the 9.25% Senior Notes issued in April 2004 and $5.0 million related to the 5.5%
Convertible Notes issued in September 2003. The increase in interest expense
during 2005 was due to a full year of interest expense related to this debt. For
additional information on these debt issuances, refer to "Liquidity and Capital
Resources" in this Item 7.
Provision for Income Taxes
In 2006, 2005, and 2004, the Company recorded provisions for income taxes of
$15.9 million, $13.4 million, and $18.6 million, respectively, which resulted in
effective tax rates of 32.7%, 34.4%, and 40.0%, respectively. The effective tax
rate in 2006 included a $2.0 million tax benefit primarily related to the
reversal of accrued income taxes due to the completion of a tax audit. The
effective tax rates in 2006 and 2005 included the full year impact of the
acquisition of Lavalife and certain tax benefits realized as a result. Excluding
the $2.0 million benefit, the effective tax rate increased in 2006 primarily due
to decreased losses in certain foreign branch operations. The effective tax rate
in 2004 was higher than the U.S. federal statutory rate due to state tax expense
and other non-deductible items.
EBITDA
For the years ended June 30, Percent Increase/(Decrease)
----------------------------------- -------------------------------
(Dollars amounts in millions) 2006 2005 2004 '06 vs. '05 '05 vs. '04
----------- ----------- ----------- --------------- ---------------
Marketing Services $ 99.9 $ 96.5 $ 86.7 4% 11%
Personals 11.0 6.2 2.7 77% 130%
Management Services 6.9 2.7 - 156% NM
Corporate (28.0) (26.7) (24.0) 5% 11%
----------- ----------- ----------- --------------- ---------------
Total $ 89.8 $ 78.7 $ 65.4 14% 20%
=========== =========== =========== =============== ===============
In 2006, EBITDA increased 14% to $89.8 million from $78.7 million in 2005.
Excluding the $4.5 million in expenses associated with SFAS 123R and the $1.0
million benefit realized related to the settlement of litigation from 2006 and
excluding the $1.0 million in expenses related to that same litigation in 2005
and the $5.5 million charge for the arbitration award from 2005, EBITDA would
have increased 10% to $93.3 million, or 14% of revenue, from $85.1 million, or
15% of revenue, in 2005. This was due to the 14% increase in operating income
discussed above. Marketing Services EBITDA increased 4% to $99.9 million in 2006
from $96.5 million in 2005 due to increased price points and synergies realized
from the Bargain acquisition. Personals EBITDA increased 77% to $11.0 million in
2006 from $6.2 million in 2005. Excluding the impact of the settlement of
litigation from both periods discussed above, Personals EBITDA would have
increased 39% to $10.0 million from $7.2 million due to Lavalife's growing
mobile service business and cost containment efforts. Management Services EBITDA
increased to $6.9 million in 2006 from $2.7 million in 2005 due to the growth in
revenue. Corporate EBITDA decreased to $(28.0) million in 2006 from $(26.7)
million in 2005 primarily due to increased employee and occupancy related
expenses. Corporate EBITDA included $4.5 million in expense related to the
adoption of SFAS 123R in 2006 and the $5.5 million charge for an arbitration
award in 2005.
20
In 2005, EBITDA increased 20% to $78.7 million from $65.4 million in 2004
primarily due to the impact of the acquisition of Bargain and MCM and improved
marketing margins partially offset by the impact of the $5.5 million charge for
the arbitration award. Marketing Services EBITDA increased 11% to $96.5 million
in 2005 from $86.7 million in 2004 due to a 4% increase in revenues while
marketing expenses only increased 1%. Personals EBITDA increased to $6.2 million
in 2005 due to the full year impact of Lavalife. On a pro forma basis assuming
the acquisition of Lavalife occurred on July 1, 2003, Personals EBITDA would
have been $9.9 million in 2004. The decrease from 2004 was primarily due to
increased employee related expenses. Management Services EBITDA was $2.7 million
in 2005. Corporate EBITDA decreased to $(26.7) million in 2005 from $(24.0)
million in 2004 primarily due to the impact of the $5.5 million charge for the
arbitration award.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2006, the Company had cash, cash equivalents, and short-term
investments of $68.1 million in addition to its $50 million unused line of
credit under 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 2007 and for the foreseeable
future.
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, 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 Item 7 of this report.
Net cash flow provided by operating activities is an important measure used to
understand the Company's liquidity. In 2006, net cash provided by operating
activities increased to $37.7 million from $32.3 million in 2005. In 2006,
operating cash flow increased $5.4 million primarily due to a $22.0 million
increase in Adjusted EBITDA, partially offset by a $10.0 million use of cash
from changes in assets and liabilities. In addition, operating cash flow in 2006
reflected a $3.1 million decrease compared to a $2.2 million increase in 2005,
due to the change in the classification of excess tax benefit from stock-based
compensation from operating activities to financing activities, as required by
SFAS 123R.
In 2005, net cash provided by operating activities decreased to $32.3 million
from $47.9 million in 2004. The $15.6 million decrease in operating cash flow in
2005 compared with 2004 was primarily due to a $16.4 million increase in
interest paid on the Convertible Notes and Senior Notes.
The table below summarizes the components of revenues before deferral:
For the years ended June 30, Increase/(Decrease)
----------------------------------- -----------------------
(Dollars amounts in millions) 2006 2005 2004 '06 vs. '05 '05 vs. '04
----------- ----------- ----------- ----------- -----------
Revenues before deferral
Monthly payment plans $ 361.4 $ 255.8 $ 166.3 41% 54%
Annual payment plans:
Initial year 26.7 40.3 78.2 (34%) (48%)
Renewal year 91.4 127.7 167.7 (28%) (24%)
Other 36.2 30.5 27.1 19% 13%
----------- ----------- ----------- ----------- -----------
Total Marketing Services 515.7 454.3 439.3 14% 3%
Personals 74.3 72.2 17.1 3% 322%
Management Services 45.3 18.4 - 146% NM
----------- ----------- ----------- ----------- -----------
Total $ 635.3 $ 544.9 $ 456.4 17% 19%
=========== =========== =========== =========== ===========
In 2006, revenues before deferral increased 17% to $635.3 million and excluding
revenues before deferral from Bargain and MCM, revenues before deferral would
have increased 9% in 2006. Revenues before deferral from monthly payment plans
increased 41% due to a 30% increase in the average monthly members billed to 2.2
million in 2006 and a 9% increase in the monthly weighted average program price
point. The monthly weighted average program price points were $13.69, $12.61,
and $11.37 for the 2006, 2005, and 2004 fiscal years, respectively. The average
monthly members billed increased due to the increase in the mix of new members
enrolled in monthly payment plan programs. New members enrolled in monthly
payment plan programs represented 91%, 85%, and 62% of total new members
enrolled in 2006, 2005, and 2004, respectively. 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 $107,
$104, and $107 in 2006, 2005, and 2004, respectively.
21
In 2006, Personals revenue before deferral increased 3% from 2005 primarily due
to Lavalife's growing mobile services. Management Services revenues before
deferral increased 146%. 2005 included revenue from MCM for only the second half
of the fiscal year since the acquisition was completed on January 1, 2005.
In 2005, revenues before deferral increased from 2004 primarily due to the
inclusion of revenues before deferral from Lavalife, Bargain, and MCM. Excluding
revenues before deferral from Lavalife, Bargain, and MCM, revenues before
deferral would have decreased 1% in 2005 due to the effect of an increase in
marketing of monthly payment programs. The table below presents Adjusted EBITDA
by segment.
For the years ended June 30, Increase/(Decrease)
----------------------------------- -----------------------
(Dollars amounts in millions) 2006 2005 2004 '06 vs. '05 '05 vs. '04
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA
Marketing Services $ 88.9 $ 74.0 $ 80.5 20% (8%)
Personals 10.8 6.3 2.1 71% 200%
Management Services 7.5 3.6 - 108% NM
Corporate (28.0) (26.7) (24.0) 5% 11%
----------- ----------- ----------- ----------- -----------
Total $ 79.2 $ 57.2 $ 58.6 38% (2%)
=========== =========== =========== =========== ===========
In 2006, marketing costs before deferral increased 10% to $300.2 million versus
$273.0 million in 2005 due to the inclusion of a full year of marketing costs
before deferral from Bargain and MCM as well as increased marketing required to
generate the increased revenue. As a percentage of revenue before deferral,
marketing costs before deferral were 47% in 2006 and 50% in 2005. The improved
marketing cost ratio in 2006 is due to increased price points, more efficient
marketing spending, and better retention in certain sectors of our business. The
increase in marketing margin before deferral (revenue before deferral less
marketing costs before deferral) in 2006 contributed to a $22.0 million increase
in Adjusted EBITDA, to $79.2 million in 2006 from $57.2 million in 2005.
In 2005, marketing costs before deferral increased 19% from 2004 primarily due
to the inclusion of marketing costs before deferral from Lavalife, Bargain, and
MCM.
In 2006, cash used from changes in assets and liabilities was $10.0 million
versus cash provided by changes in assets and liabilities of $2.9 million in
2005. The use of cash in 2006 primarily related to the increase in notes
receivable related to higher revenues from the Management Services segment and
the payment of the $5.5 million arbitration award, which was partially offset by
lower use of cash from an increase in accrued and other liabilities. In 2005,
cash provided by changes in assets and liabilities primarily related to the
timing of trade payments.
In 2005, cash provided by changes in assets and liabilities was $2.9 million
versus cash used of $4.1 million in 2004. In 2004 the use of cash primarily
related to the decrease in the allowance for membership cancellations and
reflected the decrease in the level of marketing as well as the decrease in the
programs marketed with an annual payment program.
In 2006, capital expenditures increased to $17.8 million compared to $11.0
million in 2005 due to the costs associated with the relocation of the Company's
corporate headquarters. As a result, free cash flow, defined as operating cash
flow less capital expenditures, was $19.9 million in 2006 compared to $21.3
million in 2005. In 2004, capital expenditures were $7.1 million and free cash
flow was $40.8 million. Free cash flow in 2004 did not reflect the annual cost
of debt service payments because of the timing of Senior and Convertible Notes
issuances, or the full impact of tax payments as the Company still had the full
Federal benefit of its net operating loss carry forwards.
In 2006, net cash (used in) provided by investing activities was $(58.0) million
versus $16.4 million in 2005. Net cash used in investing activities in 2006
reflected $25.7 million of contingent payments made related to acquisitions and
$14.6 million of net purchases of short-term investments. In 2005, net cash
provided by investing activities reflected $104.6 million of net proceeds from
sales of short-term investments offset by $77.2 million of cash used in
connection with the Company's acquisitions.
22
In 2005, net cash provided by (used in) investing activities was $16.4 million
compared with ($237.0) million in 2004. Net cash used in investing activities in
2004 reflected $114.9 million of cash payments in connection with the
acquisition of Lavalife and $115.0 million of net purchases of short-term
investments.
In 2006, net cash used in financing activities was $8.4 million in 2006 versus
$31.7 million in 2005. Net cash used in financing activities in 2006 principally
reflected the use of $19.3 million to repurchase the Company's common stock,
which was partially offset by proceeds from the exercise of stock options of
$8.6 million and the excess tax benefits from stock-based compensation of $3.1
million. Net cash used in financing activities in 2005 principally reflected the
use of $41.1 million to repurchase the Company's common stock, which was
partially offset by proceeds from the exercise of stock options of $10.8
million.
In 2005, net cash (used in) provided by financing activities was ($31.7) million
versus $168.8 million in 2004. In 2004, net cash provided by financing
activities principally reflected the issuance of $229.8 million in debt, net of
issuance costs, proceeds from the exercise of employee stock options of $24.5
million, and proceeds from the issuance of restricted stock of $9.1 million.
These sources of cash were partially offset by $94.2 million of cash used to
repurchase the Company's common stock.
Debt Issuances
As of June 30, 2006, the Company had $240.0 million of debt outstanding. In
September 2003, the Company issued $90.0 million aggregate principal amount 5.5%
convertible senior subordinated notes due September 2010. Interest on the
Convertible Notes is payable in cash semi-annually in arrears on April 1 and
October 1. Upon a change in control, holders of the Convertible Notes may
require the Company to repurchase all or part of the Convertible Notes for cash.
In April 2004, the Company issued $150.0 million aggregate principal amount of
9.25% Senior Notes due 2014. These Senior Notes were sold at 98.418% of the
principal amount, which resulted in an effective yield of 9.5%. Interest on the
Senior Notes is payable in cash semi-annually in arrears on April 1 and October
1. A portion of the proceeds from the offering of the Senior Notes was used to
repay amounts borrowed under the senior secured credit facility to fund a
portion of the Lavalife acquisition.
Credit Facility
The Company has an amended and restated senior secured credit facility dated as
of March 17, 2006, which allows borrowings of up to $50.0 million. Borrowings
under this senior secured credit facility accrue interest at the Eurodollar rate
or the Prime rate, plus an applicable margin. As of June 30, 2006, the base
interest rate for borrowings under this credit facility was 8.5%. There were no
borrowings outstanding under this credit facility as of June 30, 2006. The
senior secured credit facility has certain financial covenants, including a
maximum debt coverage ratio, potential restrictions on borrowings, and potential
restrictions on additional stock repurchases. As of June 30, 2006, the Company
was in compliance with all such debt covenants. The senior secured credit
facility matures on March 31, 2009.
Stock Repurchase Program
The Company purchased 498,000 shares of its common stock for $19.3 million at an
average price of $38.83 per share during 2006 compared to 1.2 million shares of
its common stock for $41.1 million at an average price of $34.92 per share
during 2005, and 3.0 million shares for $94.2 million at an average price of
$31.56 per share in 2004. The Company used cash from operations, stock
issuances, and the issuance of the Convertible Notes and Senior Notes to
repurchase shares.
As of June 30, 2006, the Company had 327,000 shares available for repurchase
under its stock repurchase program. In August 2006, the Company announced that
its Board of Directors authorized the additional repurchase of up to an
aggregate 1.0 million shares of the Company's common stock.
Acquisitions
In January 2005, the Company completed the acquisition of certain of the assets
of MCM, a privately held advertising and practice management company serving
cosmetic surgeons throughout the United States. The purchase price, excluding
fees and expenses, amounted to $33.0 million and was paid in cash on the closing
date. In addition, the Company paid $10.7 million of contingent payments in 2006
and additional contingent payments of up to $45.3 million may be paid if certain
performance targets, including increasing levels of revenues and earnings, are
achieved over the next two calendar years.
In November 2004, the Company completed the acquisition of certain of the assets
of Bargain, a privately held provider of premier pricing services for homes and
vehicles. The total purchase price, which excluded fees, amounted to $53.7
million and included $14.6 million in contingent payments paid during 2006. No
further contingent payments are required under the purchase agreement.
23
In April 2004, the Company completed the acquisition of all of the net assets
and outstanding capital stock of Lavalife, a leading provider of web-based and
phone-based interactive personals services. The purchase price, excluding fees
and expenses, was Cdn$152.5 million, or $116.3 million. In connection with this
acquisition, the Company received $9.1 million related to the issuance of the
Company's restricted common stock to Lavalife's senior management.
Other
The Company did not have any material commitments for capital expenditures as of
June 30, 2006. The Company expects to incur capital expenditures of $8.0 million
in 2007. In addition, the Company acquired certain assets during the first
quarter of fiscal 2007 for approximately $10.0 million in order to further its
internet strategy.
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 measures are not a
substitute for or superior to revenues and marketing expenses determined in
accordance with generally accepted accounting principles, or GAAP. 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. Two of the primary indicators of operating liquidity
for the period are revenues before deferral and marketing costs before deferral.
Revenues before deferral are revenues before the application of the Staff
Accounting Bulletin 104, "Revenue Recognition" ("SAB 104") and represent the
revenues billed during the current reporting period less an allowance for
membership cancellations. That is, revenues before deferral for a reporting
period include membership fees received in the current reporting period that
will be recorded as GAAP revenues in future reporting periods and exclude
membership fees received in prior reporting periods that are recorded as GAAP
revenues in the current reporting period. Marketing costs before deferral are
marketing costs before the application of SAB 104 and the American Institute of
Certified Public Accountants Statement of Position 93-7, "Reporting on
Advertising Costs" ("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.
Revenues before deferral are calculated as follows:
For the years ended June 30,
-------------------------------------
(Dollars amounts in millions) 2006 2005 2004
----------- ----------- -----------
Revenues $ 658.9 $ 579.8 $ 488.7
Change in deferred revenues (23.6) (34.9) (32.3)
----------- ----------- -----------
Revenues before deferral $ 635.3 $ 544.9 $ 456.4
=========== =========== ===========
Marketing costs before deferral are calculated as follows:
For the years ended June 30,
------------------------------------
(Dollars amounts in millions) 2006 2005 2004
----------- ----------- ----------
Marketing expenses $ 313.2 $ 286.4 $ 255.8
Change in deferred marketing costs (13.0) (13.4) (25.5)
----------- ----------- ----------
Marketing costs before deferral $ 300.2 $ 273.0 $ 230.3
=========== =========== ==========
EBITDA is calculated as net income excluding interest and other expense, taxes,
depreciation, and amortization. Adjusted EBITDA is calculated as EBITDA before
the deferral of revenues and the deferral of marketing costs.
24
EBITDA and Adjusted EBITDA are used by the Company's management to evaluate the
overall performance of its business and to measure that performance compared
with internal budgets. Additionally, Adjusted EBITDA is the primary measure used
by management to allocate capital and other resources to its operating segments
and assess the operating performance of those segments (See Note 17 to the
consolidated financial statements in Item 8 of this report). Adjusted EBITDA is
also one of the measures used to determine compensation under the Company's
management incentive plans.
Adjusted EBITDA is useful to management and investors because it provides
insight into the current period cash operating results. Adjusted EBITDA is
reconciled to net cash provided by operating activities because the Company
believes that it is the most directly comparable GAAP liquidity measure.
Adjusted EBITDA is also used by the Company's management as the primary
performance measure of the business both on an overall company basis as well as
for its operating segments. Adjusted EBITDA is reconciled to net income because
the Company believes it is the most directly comparable GAAP 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.
The usefulness of Adjusted EBITDA and EBITDA is limited as compared to net cash
provided by operating activities or net income in that Adjusted EBITDA and
EBITDA do not reflect the periodic amortization of certain capitalized tangible
and intangible assets used in generating revenues in the Company's businesses,
they do not reflect net income earned for GAAP reporting purposes, and they
exclude the effects of interest and taxes. Additionally, Adjusted EBITDA and
EBITDA exclude the impact of working capital changes.
Adjusted EBITDA and EBITDA should not be considered a substitute for or superior
to, operating income, net income, net cash from operating activities, or other
measures of financial performance and liquidity determined in accordance with
GAAP.
The following table reconciles net cash provided by operating activities to
Adjusted EBITDA:
For the years ended June 30,
--------------------------------------
(Dollars amounts in millions) 2006 2005 2004
------------ ------------ ------------
Net cash provided by operating activities $ 37.7 $ 32.3 $ 47.9
Changes in assets and liabilities (use of cash) 10.0 (2.9) 4.1
Interest and other expense, net (to be paid in cash) 15.6 16.7 5.6
Taxes 19.4 10.7 1.9
Stock compensation expense (4.5) - -
Other 1.0 0.4 (0.9)
------------ ------------ ------------
Adjusted EBITDA $ 79.2 $ 57.2 $ 58.6
============ ============ ============
25
The following tables reconcile EBITDA and adjusted EBITDA to net income:
For the year ended June 30, 2006
-----------------------------------------------------------
(Dollars amounts in millions) Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Net income $ 32.7
Interest and other expense, net (1) 16.7
Provision for income taxes (1) 15.9
-----------
Operating income (expense) $ 88.0 $ 1.2 $ 5.3 $ (29.2) $ 65.3
Depreciation and amortization 11.9 9.8 1.6 1.2 24.5
----------- ----------- ----------- ----------- -----------
EBITDA 99.9 11.0 6.9 (28.0) 89.8
Change in deferred revenues (24.0) (0.2) 0.6 - (23.6)
Change in deferred marketing costs 13.0 - - - 13.0
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 88.9 $ 10.8 $ 7.5 $ (28.0) $ 79.2
=========== =========== =========== =========== ===========
For the year ended June 30, 2005
-----------------------------------------------------------
(Dollars amounts in millions) Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Net income $ 25.5
Interest and other expense, net (1) 18.2
Provision for income taxes (1) 13.4
-----------
Operating income (expense) $ 85.5 $ (3.1) $ 1.9 $ (27.2) $ 57.1
Depreciation and amortization 11.0 9.3 0.8 0.5 21.6
----------- ----------- ----------- ----------- -----------
EBITDA 96.5 6.2 2.7 (26.7) 78.7
Change in deferred revenues (35.9) 0.1 0.9 - (34.9)
Change in deferred marketing costs 13.4 - - - 13.4
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 74.0 $ 6.3 $ 3.6 $ (26.7) $ 57.2
=========== =========== =========== =========== ===========
For the year ended June 30, 2004
----------------------------------------------------------
(Dollars amounts in millions) Marketing Management
Services Personals Services Corporate Total
----------- ----------- ----------- ----------- -----------
Net income $ 28.0
Interest and other expense, net (1) 6.3
Provision for income taxes (1) 18.6
-----------
Operating income (expense) $ 76.6 $ 0.3 $ - $ (24.0) $ 52.9
Depreciation and amortization 10.1 2.4 - - 12.5
----------- ----------- ----------- ----------- -----------
EBITDA 86.7 2.7 - (24.0) 65.4
Change in deferred revenues (31.7) (0.6) - - (32.3)
Change in deferred marketing costs 25.5 - - - 25.5
----------- ----------- ----------- ----------- -----------
Adjusted EBITDA $ 80.5 $ 2.1 $ - $ (24.0) $ 58.6
=========== =========== =========== =========== ===========
(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 shareholders from operating activities less capitalized
expenditures needed to continue funding these activities. Free cash flow is used
by the 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:
For the years ended June 30,
----------------------------------------
(Dollars amounts in millions) 2006 2005 2004
------------ ------------ ------------
Net cash provided by operating activities $ 37.7 $ 32.3 $ 47.9
Capital expenditures (17.8) (11.0) (7.1)
------------ ------------ ------------
Free cash flow $ 19.9 $ 21.3 $ 40.8
============ ============ ============
26
COMMITMENTS
The Company's significant contractual obligations as of June 30, 2006 and the
anticipated payments under these obligations are as follows:
Payments Due by Period
--------------------------------------------------------------------------------------------
(Dollars amounts in millions) Total Less than 1 year 1 - 3 years 3 - 5 years After 5 years
---------------- ---------------- ---------------- ---------------- ----------------
Operating leases $ 57.7 $ 9.4 $ 17.9 $ 13.2 $ 17.2
Capital leases 1.3 0.8 0.5 - -
Long-term debt 240.0 - - 90.0 150.0
Purchase obligations 10.7 10.7 - - -
Other(1) 182.6 29.5 72.3 35.5 45.3
---------------- ---------------- ---------------- ---------------- ----------------
Total payments due $ 492.3 $ 50.4 $ 90.7 $ 138.7 $ 212.5
---------------- ---------------- ---------------- ---------------- ----------------
(1) Included interest payments on long-term debt, pension obligations, and
expected contingent payments related to the MCM acquisition.
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 terms. For additional information, see Notes 7 and 8 to the
consolidated financial statements in Item 8 of this report.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that are important to the
Company's financial condition and results of operations and involve subjective
or complex judgments on the part of management, often as a result of the need to
make estimates. The following areas require the use of judgments and estimates:
revenue recognition, deferred marketing costs, allowances for notes receivable,
valuation of goodwill, estimation of remaining useful lives of intangible
assets, valuation of deferred tax assets and tax reserves, and stock-based
compensation. Estimates in each of these areas are based on historical
experience and various assumptions that management believes are appropriate.
Actual results may differ from these estimates. Management believes the areas
listed above represent the critical accounting policies of the Company as
contemplated by Financial Reporting Release No. 60, "Cautionary Advice Regarding
Disclosure about Critical Accounting Policies." For a summary of all the
Company's significant accounting policies, see Note 2 to the consolidated
financial statements in Item 8 of this report.
Revenue Recognition
The Marketing Services segment revenues are derived principally from recurring
fees, which are billed to the member on either a monthly or annual basis. In the
case of annually billed membership fees, the Company receives full payment at or
near the beginning of the membership period. The revenues are billed primarily
through credit and debit cards and are recognized when earned. Revenues derived
from one time fees are recognized when the service is performed. Members may
cancel their memberships at any time. Members enrolled in an annual payment plan
who cancel their memberships receive a pro rata refund of the remaining unused
portion of their membership fees. In accordance with SAB 104, revenues, net of
estimated cancellations, are deferred and recognized as revenues when membership
refund privileges expire. Management establishes and regularly updates the
allowance for membership cancellations. In estimating the allowance for
membership cancellations, management analyzes historical cancellation
experience, current economic trends, and changes in customer demand for the
Company's products and services. Actual membership refunds are charged against
the allowance for membership cancellations on a current basis. If actual
cancellations differ from the estimate, the results of operations would be
impacted.
The Personals segment employs a transactional business model in which users buy
non-refundable credits up-front and spend those credits only when they want to
interact with other customers. Personals revenues are recognized when the
services are used. Management Services revenues are recognized when the medical
procedures performed by the healthcare professionals are complete.
27
Marketing Expenses
Marketing expenses are comprised of advertising costs, non-refundable and
refundable royalty payments, telemarketing costs, and direct mail costs.
Advertising costs and non-refundable royalty payments, which include fee per
offer, fee per sale, and fee per impression marketing arrangements, are expensed
when incurred. Refundable royalty payments are charged to operations as the
associated revenues are recognized in accordance with SAB 104. Telemarketing
costs, including costs for third-party vendors to solicit members for the
Company, and direct mail costs, including costs of printing and mailing direct
mail pieces, are deferred direct response advertising costs and are charged to
marketing expenses over the expected future benefit period in accordance SOP
93-7.
Deferred marketing costs to enroll a new member are less than the related
estimated total net revenues. However, if deferred marketing costs were to
exceed the related estimated total net revenues, management would adjust the
deferred marketing costs for that impairment.
Allowance for Notes Receivable
The Management Service segment may finance the cost of the medical services
received by the patient through the use of notes receivable. These notes
receivable generally have a life of 21 to 48 months and bear interest at rates
ranging from 6% to 18%. The Company estimates an allowance for notes receivable
based on an aging analysis, customer credit evaluations, collection history, and
any specific, known troubled accounts. As of June 30, 2006 and 2005, the Company
recorded $3.8 million and $0.8 million, respectively, for allowances for
uncollectible notes. If actual bad debt differs from the estimate, the results
of operations would be impacted.
Valuation of Goodwill
The Company reviews the carrying value of its goodwill in accordance with SFAS
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Management reviews
goodwill for impairment by comparing their carrying values to their fair values
at least annually or more frequently if circumstances indicate possible
impairment. When determining fair value, management uses various assumptions,
including projections of future cash flows. A change in the underlying
assumptions could cause fair value to be less than carrying value and require
the Company to record a corresponding charge against operations. Management
performs its impairment testing in the first fiscal quarter of each year.
Intangible Assets
Management reassesses the estimated remaining useful lives of its definite-lived
intangible assets in accordance with SFAS 142. Intangible assets principally
include member and customer relationships and trade names that arose in
connection with business acquisitions. Acquired intangible assets are recorded
at cost and are generally amortized on a straight-line basis over their
estimated useful lives. The weighted average amortization periods for membership
and client relationships, trade names, other amortizable intangible assets, and
total amortizable intangible assets held at June 30, 2006, were 10 years, 15
years, 3 years, and 13 years, respectively. If there was a change in the
estimated useful life of definite lived intangible assets, the results of
operations would be impacted.
Income Taxes
The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes." Deferred tax assets and liabilities are
recognized for future tax consequences attributable to differences between the
financial statement carrying amounts of assets and liabilities and their
respective tax bases. Management assesses the realizability of deferred tax
assets considering various assumptions, including estimates of future taxable
income and ongoing tax strategies. In addition, management establishes and
evaluates tax reserves for uncertain tax positions based on the information
available at the time and makes certain assumptions and determinations with
respect to the application of existing tax law. A change in any of these
underling assumptions could impact the results of operations.
Stock-Based Compensation
The Company adopted SFAS 123R in July 2005. SFAS 123R established the accounting
for stock-based compensation and requires companies to measure and recognize
compensation expense for all share-based payments at fair value. Accordingly,
stock-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. This method requires the Company to apply the provisions of SFAS 123R to
new awards and to any awards that were unvested as of the adoption date and does
not require the Company to restate prior periods. The Company estimates the fair
value of stock options at the grant date using the Black-Scholes option pricing
model. Similar to other option pricing models, this model requires the input of
highly subjective assumptions, including the expected term and expected
volatility. In addition, the Company is required to estimate forfeiture rates at
the time of grant. Actual results, and future changes in estimates, may differ
substantially from our current estimates. For information on the Company's
stock-based compensation plans and on the assumptions used to value its options,
refer to Note 15 of Item 8 of this report.
28
The Company recorded pre-tax charges of $4.5 million ($2.8 million net of tax)
for 2006 in the consolidated statements of operations for compensation costs
related to our stock-based plans. As of June 30, 2006, unrecognized compensation
expense related to unvested options was $7.2 million to be recognized over a
weighted average period of less than 2.5 years.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 2 to the consolidated financial statements in Item 8 of this report for
a description of the effect of recently issued accounting pronouncements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
----------------------------------------------------------
Interest Rate
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 June 30, 2006, the carrying value of the Convertible
Notes and the Senior Notes was $90.0 million and $148.0 million, respectively,
and the fair value of the notes was $108.9 million and $155.2 million,
respectively. Interest payable on the Convertible Notes and the Senior Notes is
expected to be $18.8 million in each of the next four years and $16.4 million in
2011 assuming none of the Convertible Notes are converted into equity.
Holders of the Convertible Notes may convert their notes into shares of the
Company's common stock at any time prior to maturity, at a conversion price of
approximately $40.37 per share, subject to certain adjustments, which is
equivalent to a conversion rate of approximately 24.77 shares per $1,000
principal amount of the Convertible Notes. Such conversion would result in a
charge against earnings for the unamortized portion of capitalized issuance
costs relating to these notes, which aggregated $2.1 million at June 30, 2006.
Such charge would have no effect on the cash flows of the Company.
Foreign Currency
The Company conducts business in certain foreign markets, primarily in Canada.
The Company's primary exposure to foreign currency risk relates to investments
in foreign subsidiaries that transact business in functional currencies other
than the U.S. dollar, primarily the Canadian dollar. 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 and forward contracts to minimize its exposure
to changes in future cash flows caused by movements in currency exchange rates
between the U.S. dollar and the Canadian dollar. However, there can be no
assurance that the Company's foreign currency hedging activities will
substantially offset the impact of fluctuations in currency exchange rates on
its results of operations and financial position. The Company does not use
derivatives for speculative purposes.
Fair Value of Investments
The Company does not have material exposure to market risk with respect to its
short-term investments since these investments are highly liquid in nature.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The Company's financial statements and related notes and report of independent
registered public accounting firm are included following Part IV beginning on
page F-1 and identified in the index in Item 15(a).
Item 9. Changes in and Disagreements with Accountants on Accounting
------------------------------------------------------------
and Financial Disclosure
------------------------
None.
29
Item 9A. 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 in its timely reports under the
Exchange Act.
Because a cost-effective control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met, misstatements due to error or fraud
may occur and not be detected. In addition, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions or that the degree of compliance
with the policies or procedures may deteriorate.
Management's Report on Internal Control over Financial Reporting.
The Company's management is responsible for establishing and maintaining
adequate internal control over financial reporting, as defined in Exchange Act
Rule 13a-15(f). Under the supervision and with the participation of the Chief
Executive Officer and Chief Financial Officer, management evaluated the
effectiveness of the Company's internal control over financial reporting as of
June 30, 2006.
Management used the criteria set forth in "Internal Control - Integrated
Framework" of the Committee of Sponsoring Organizations of the Treadway
Commission in making its assessment. Based on those criteria, management
concluded that the Company's internal control over financial reporting was
effective.
PricewaterhouseCoopers LLP, the independent registered public accounting firm
that audited the Company's financial statements included in Item 8 of this
report, has also audited management's assessment of the Company's internal
control over financial reporting as of June 30, 2006 and the effectiveness of
the Company's internal control over financial reporting as of June 30, 2006.
Their report is included in Item 8.
Changes in internal control over financial reporting.
During the fourth 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.
Item 9B. Other Information
-----------------
None.
Part III
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
The information in the Company's Proxy Statement under the section titled
"Election of Directors" is incorporated herein by reference.
Item 11. Executive Compensation
----------------------
The information in the Company's Proxy Statement under the section titled
"Executive Compensation" is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
--------------------------------------------------------------
and Related Stockholder Matters
-------------------------------
The information in the Company's Proxy Statement under the section titled
"Security Ownership of Certain Beneficial Owners and Management" is incorporated
herein by reference.
30
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The information in the Company's Proxy Statement under the section titled
"Certain Relationships and Related Transactions" is incorporated herein by
reference.
Item 14. Principal Accountant Fees and Services
--------------------------------------
The information in the Company's Proxy Statement under the section titled
"Ratification of Selection of Independent Auditors" is incorporated herein by
reference.
Part IV
Item 15. Exhibits and Financial Statement Schedules
------------------------------------------
(a) Index to Financial Statements and Financial Statement Schedules Page
------------------------------------------------------------------- ----
(1) Report of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of June 30, 2006 and 2005 F-3
Consolidated Statements of Operations for the years ended June 30, 2006, 2005, and 2004 F-4
Consolidated Statements of Shareholders' Equity (Deficit) for the years ended June 30,
2006, 2005, and 2004 F-5
Consolidated Statements of Cash Flows for the years ended June 30, 2006, 2005, and 2004 F-6
Notes to Consolidated Financial Statements F-7
(2) The following Financial Statement Schedule is included:
Schedule II - Valuation and Qualifying Accounts - Years ended June 30, 2006, 2005, and 2004 F-30
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore
have been omitted.
(3) Exhibits:
Exhibits filed as part of this report are listed in the Exhibit Index
immediately following the signatures in this report.
31
VERTRUE INCORPORATED
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
By: /s/ GARY A. JOHNSON
---------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
Date: September 12, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
By: /s/ Gary A. Johnson President, Chief Executive Officer and Director September 12, 2006
---------------------------
Gary A. Johnson
By: /s/ James B. Duffy Executive Vice President, Chief Financial Officer September 12, 2006
--------------------------- and Chief Operating Officer
James B. Duffy
By: /s/ Alec L. Ellison Director September 12, 2006
---------------------------
Alec L. Ellison
By: /s/ Joseph E. Heid Director September 12, 2006
---------------------------
Joseph E. Heid
By: /s/ Robert Kamerschen Director September 12, 2006
---------------------------
Robert Kamerschen
By: /s/ Michael T. McClorey Director September 12, 2006
---------------------------
Michael T. McClorey
By: /s/ Edward M. Stern Director September 12, 2006
---------------------------
Edward M. Stern
By: /s/ Marc S. Tesler Director September 12, 2006
---------------------------
Marc S. Tesler
32
Exhibits
--------
No. Description
--- -----------
*3.1 Restated Certificate of Incorporation of the Registrant (filed as
Exhibit 3.3 to the Company's Registration Statement on Form S-1,
Registration No. 333-10541, filed on September 6, 1996; Certificate of
Amendment of Restated Certificate of Incorporation of the Registrant
(filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q,
File No. 000-21527, filed on February 9, 2005).
*3.2 Restated By-laws of the Registrant as amended (filed as Exhibit 3.3 to
the Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on August 21, 1996).
*4.1 Indenture dated as of September 30, 2003 between the Registrant and
Deutsche Bank Trust Company Americas, Trustee relating to the 5.5%
Convertible Senior Subordinated Notes due 2010 (filed as exhibit 4.1 to
the Company's Quarterly report on Form 10-Q, File No. 000-21527, filed
on November 13, 2003).
*4.2 Registration Rights Agreement dated as of September 30, 2003 among the
Registrant and Lehman Brothers Inc. and CIBC World Markets Corp. (filed
as exhibit 4.2 to the Company's Quarterly report on Form 10-Q, File No.
000-21527, filed on November 13, 2003).
*4.3 Indenture dated as of April 13, 2004 between the Registrant and each of
the Guarantors party thereto and LaSalle Bank National Association, as
Trustee relating to the 9.25% Senior Notes due 2014, including the form
of notes (filed as exhibit 4.1 to the Company's Registration Statement
on Form S-4, Registration No. 333-115500, filed on May 14, 2004).
*4.4 First Supplemental Indenture dated as of April 28, 2006 among Bargain
Network, Inc., Lavalife Inc., My Choice Medical Holdings, Inc.,
MemberWorks Canada Corporation, the current Guarantors of the 9.25%
Senior Notes due 2014, the Registrant and LaSalle Bank National
Association as trustee. (filed as exhibit 4.1 to the Company's Current
report on Form 8-K, Registration No. 000-21527, filed on May 3, 2006).
*10.1^ Amended Employee Incentive Stock Option Plan of the Registrant (filed
as Exhibit 10.1 to the Company's Registration Statement on Form S-1,
Registration No. 333-10541, filed on September 6, 1996).
*10.2^ 1995 Non-Employee Directors' Stock Option Plan of the Registrant (filed
as Exhibit 10.3 to the Company's Registration Statement on Form S-1,
Registration No. 333-10541, filed on August 21, 1996).
*10.3^ 1996 Stock Option Plan of the Registrant (filed as Exhibit 10.4 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on September 27, 1996).
*10.4^ 1996 Employee Stock Purchase Plan of the Registrant (filed as Exhibit
10.5 to the Company's Registration Statement on Form S-1, Registration
No. 333-10541, filed on September 27, 1996).
*10.5^ Amended and Restated 401(k) Profit Sharing Plan of the Registrant dated
July 1, 2000 (filed as Exhibit 10.6 to the Company's Annual Report on
Form 10-K, File No. 000-21527, filed on September 6, 2001).
*10.6 Second Amended and Restated Credit Agreement dated March 17, 2006 among
the Registrant, the Lenders Parties Hereto, and LaSalle Bank National
Association, as Agent (filed as exhibit 10.1 to the Company's Quarterly
report on Form 10-Q, File No. 000-21527, filed on May 10, 2006).
*10.7 Master Transaction Agreement dated March 3, 2004 among the Registrant,
Lavalife Inc., Lavalife's Investors and Lavalife's Senior Management
(filed as exhibit 99.2 to the Company's Current report on Form 8-K,
File No. 000-21527, filed on April 5, 2004).
*10.8^ Long-term Incentive Plan of the Registrant (filed as Annex C to the
Company's Definitive Proxy Statement on Schedule 14A, File No.
000-21527, filed on October 28, 2004).
*10.9^ First Amendment to the Vertrue Incorporated Long-term Incentive Plan
(filed as Annex A to the Company's Proxy Statement on Schedule 14A,
File No. 000-21527, filed on October 17, 2005).
*10.10^ Vertrue Incorporated 2005 Equity Incentive Plan (filed as Annex B to
the Company's Proxy Statement on Schedule 14A, File No. 000-21527,
filed on October 17, 2005).
*10.11 Arena Tower II Lease Agreement by and between Arena Tower II
Corporation and the Registrant dated February 12, 1996, as amended
(filed as Exhibit 10.24 to the Company's Registration Statement on Form
S-1, Registration No. 333-10541, filed on September 6, 1996).
33
*10.12 Second Amendment to Lease Agreement between Arena Tower II Corporation
and the Registrant dated January 24, 1997 (filed as Exhibit 10.24 to
the Company's Annual Report on Form 10-K, File No. 000-21527, filed on
September 29, 1997).
*10.13 Third Amendment to Lease Agreement between Arena Tower II Corporation
and the Registrant dated July 23, 1997 (filed as Exhibit 10.25 to the
Company's Annual Report on Form 10-K, File No. 000-21527, filed on
September 29, 1997).
*14.1 Code of Conduct of the Registrant (filed as Exhibit 14 to the Company's
Quarterly report on Form 10-Q, File No. 000-21527, filed on May 14,
2004).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Independent Registered Public Accounting Firm.
31.1 Rule 13a-14(a)/15d-14(a) CEO Certification.
31.2 Rule 13a-14(a)/15d-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.
---------------------------------------------------
* Previously filed and incorporated herein by reference.
^ Management contract or compensatory plan.
34
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Vertrue Incorporated:
We have completed integrated audits of Vertrue Incorporated's 2006 and 2005
consolidated financial statements and of its internal control over financial
reporting as of June 30, 2006, and an audit of its 2004 consolidated financial
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Our opinions, based on our audits, are
presented below.
Consolidated financial statements and financial statement schedule
------------------------------------------------------------------
In our opinion, the consolidated financial statements in the index appearing
under Item 15(a)(1) present fairly, in all material respects, the financial
position of Vertrue Incorporated and its subsidiaries at June 30, 2006 and 2005,
and the results of their operations and their cash flows for each of the three
years in the period ended June 30, 2006 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the index appearing under Item
15(a)(2) presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit of financial statements includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Notes 2 and 15 to the consolidated financial statements, the
Company changed the manner in which it accounts for share-based compensation in
fiscal 2006.
Internal control over financial reporting
-----------------------------------------
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
June 30, 2006 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of June 30,
2006, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
F-1
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
New York, New York
September 12, 2006
F-2
VERTRUE INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
June 30,
---------------------------
2006 2005
------------ ------------
Assets
Current assets:
Cash and cash equivalents $ 36,290 $ 64,356
Restricted cash 2,699 3,411
Short-term investments 31,798 16,223
Accounts and notes receivable, net 21,014 13,683
Prepaid expenses 9,053 5,758
Deferred marketing costs 26,463 39,226
Other current assets 4,706 4,370
------------ ------------
Total current assets 132,023 147,027
Fixed assets, net 40,568 39,062
Goodwill 212,187 201,499
Intangible assets, net 37,798 46,476
Other long-term assets 20,452 13,098
------------ ------------
Total assets $ 443,028 $ 447,162
============ ============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term debt $ 762 $ 686
Accounts payable 42,281 42,077
Accrued liabilities 64,602 82,157
Deferred revenues 84,972 108,117
Deferred income taxes 11,687 9,780
------------ ------------
Total current liabilities 204,304 242,817
Deferred income taxes 6,920 9,702
Long-term debt 237,984 237,814
Other long-term liabilities 9,989 5,257
------------ ------------
Total liabilities 459,197 495,590
------------ ------------
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;
20,168 shares issued (19,703 shares at June 30, 2005) 202 197
Capital in excess of par value 187,991 169,463
Retained earnings 68,382 35,680
Accumulated other comprehensive income (loss) 214 (148)
Treasury stock, 10,518 shares at cost (10,020 shares at June 30, 2005) (272,958) (253,620)
------------ ------------
Total shareholders' deficit (16,169) (48,428)
------------ ------------
Total liabilities and shareholders' deficit $ 443,028 $ 447,162
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
VERTRUE INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
For the years ended June 30,
----------------------------------------
2006 2005 2004
------------ ------------ ------------
Revenues $ 658,855 $ 579,839 $ 488,739
Expenses:
Marketing 313,219 286,437 255,818
Operating 151,620 114,418 91,832
General and administrative 120,315 108,231 85,826
Charge for arbitration award - 5,458 -
Amortization of intangible assets 8,360 8,201 2,393
------------ ------------ ------------
Operating income 65,341 57,094 52,870
Interest income 3,579 1,936 1,094
Interest expense (20,359) (20,741) (7,715)
Other income (expense), net (2) 652 349
------------ ------------ ------------
Income before income taxes 48,559 38,941 46,598
Provision for income taxes 15,857 13,392 18,638
------------ ------------ ------------
Net income $ 32,702 $ 25,549 $ 27,960
============ ============ ============
Earnings per share:
Basic $ 3.36 $ 2.56 $ 2.60
============ ============ ============
Diluted $ 2.83 $ 2.22 $ 2.29
============ ============ ============
Weighted average common shares used in earnings per share
calculations:
Basic 9,722 9,995 10,755
============ ============ ============
Diluted 12,743 12,973 13,208
============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
VERTRUE INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands)
Capital in Accumulated Accumulated Other
Common Stock Excess of Earnings Comprehensive Treasury
Shares Amount Par Value (Deficit) (Loss) Gain Stock Total
------- ------ --------- ---------- ----------- ----------- -----------
Balance - June 30, 2003 17,847 $ 178 $ 122,425 $ (17,829) $ (469) $ (124,588) (20,283)
Issuance of common stock 1,242 13 24,551 - - - 24,564
Issuance of restricted stock - - 2,774 - - 6,306 9,080
Tax benefit from employee stock options - - 6,520 - - - 6,520
Expense associated with
issuing stock options to a non-employee - - 187 - - - 187
Acquisition of treasury stock - - - - - (94,207) (94,207)
Comprehensive income:
Net income - - - 27,960 - - 27,960
Currency translation adjustment - - - - 105 - 105
Minimum pension
liability adjustment (net of tax) - - - - (9) - (9)
-----------
Total comprehensive income 28,056
------------------------------------------------------------------------------------
Balance - June 30, 2004 19,089 191 156,457 10,131 (373) (212,489) (46,083)
Issuance of common stock 614 6 10,786 - - - 10,792
Tax benefit from employee stock options - - 2,220 - - - 2,220
Acquisition of treasury stock - - - - - (41,131) (41,131)
Comprehensive income:
Net income - - - 25,549 - - 25,549
Currency translation adjustment - - - - 79 - 79
Unrealized hedging gain - - - - 239 - 239
Minimum pension liability
adjustment (net of tax) - - - - (93) - (93)
-----------
Total comprehensive income 25,774
-------------------------------------------------------------------------------------
Balance - June 30, 2005 19,703 197 169,463 35,680 (148) (253,620) (48,428)
Issuance of common stock 465 5 8,631 - - - 8,636
Stock-based compensation - - 4,531 - - - 4,531
Tax benefit from employee stock options - - 5,366 - - - 5,366
Acquisition of treasury stock - - - - - (19,338) (19,338)
Comprehensive income:
Net income - - - 32,702 - - 32,702
Currency translation adjustment - - - - 644 - 644
Unrealized hedging loss - - - - (384) - (384)
Minimum pension liability
adjustment (net of tax) - - - - 102 - 102
-----------
Total comprehensive income 33,064
------------------------------------------------------------------------------------
Balance - June 30, 2006 20,168 $ 202 $ 187,991 $ 68,382 $ 214 $ (272,958) $ (16,169)
====================================================================================
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
VERTRUE INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the years ended June 30,
----------------------------------------
2006 2005 2004
------------ ------------ ------------
Operating activities
Net income $ 32,702 $ 25,549 $ 27,960
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred revenues (23,549) (34,911) (32,272)
Change in deferred marketing costs 12,984 13,443 25,455
Depreciation and amortization 25,589 23,105 13,252
Stock-based compensation 4,531 - -
Deferred and other income taxes (467) 453 10,254
Excess tax benefit from stock-based compensation (3,086) - -
Tax benefit from stock-based compensation - 2,220 6,520
Other (1,009) (423) 890
Changes in assets and liabilities:
Restricted cash 712 (291) (388)
Accounts and notes receivable (15,911) (4,292) (112)
Prepaid expenses (3,249) (2,114) 5,172
Other assets 132 595 (2,050)
Accounts payable 434 8,758 (10,323)
Accrued and other liabilities 7,876 219 3,590
------------ ------------ ------------
Net cash provided by operating activities 37,689 32,311 47,948
------------ ------------ ------------
Investing activities
Acquisition of fixed assets (17,781) (11,006) (7,057)
Purchases of short-term investments (157,520) (402,630) (650,750)
Sales of short-term investments 142,937 507,260 535,770
Acquisitions of businesses, net of cash acquired (25,667) (77,237) (114,916)
------------ ------------ ------------
Net cash (used in) provided by investing activities (58,031) 16,387 (236,953)
------------ ------------ ------------
Financing activities
Net proceeds from issuance of stock 8,636 10,792 33,644
Excess tax benefit from stock-based compensation 3,086 - -
Treasury stock purchases (19,338) (41,131) (94,207)
(Debt issuance costs)/net proceeds from issuance of debt (154) (844) 229,825
Payments of long-term obligations (627) (549) (453)
------------ ------------ ------------
Net cash (used in) provided by financing activities (8,397) (31,732) 168,809
------------ ------------ ------------
Effect of exchange rate changes on cash and cash equivalents 673 224 102
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (28,066) 17,190 (20,094)
Cash and cash equivalents at beginning of year 64,356 47,166 67,260
------------ ------------ ------------
Cash and cash equivalents at end of year $ 36,290 $ 64,356 $ 47,166
============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
NOTE 1 - NATURE OF BUSINESS
Vertrue Incorporated ("Vertrue" or the "Company") is a leading internet
marketing services company. Vertrue gives consumers access to services that
offer substantial discounts and convenience for important decisions in their
everyday lives. The Company's services span healthcare, personal property,
security/insurance, discounts, and personals and are all offered online through
an array of marketing channels. The Company is a premier marketing partner to
corporate clients and the Company's services enable partners to enhance market
presence, strengthen customer affinity, and generate additional value. We are
comprised of three reportable business segments: Marketing Services, Personals,
and Management Services.
Vertrue was incorporated in 1989 in Delaware under the name Cardmember
Publishing Corporation. On October 17, 1996, the Company completed an initial
public offering of its stock and changed its name to MemberWorks Incorporated.
On October 13, 2004, the Company began doing business as Vertrue Incorporated
and on November 18, 2004, shareholders approved an amendment to the Company's
charter formally changing its name to Vertrue Incorporated. The name change was
intended to reflect the ever-broadening base of services that Vertrue offers to
its customers.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - Consolidation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") and include the accounts of the Company, its wholly owned subsidiaries,
and variable interest entities as required by Financial Accounting Standards
Board ("FASB") Interpretation No. ("FIN") 46R, "Consolidation of Variable
Interest Entities - an Interpretation of ARB No. 51." All significant
intercompany accounts and transactions have been eliminated.
The Company acquired Lavalife Inc. ("Lavalife") on April 1, 2004, Bargain
Network, Inc. ("Bargain") on November 30, 2004, and My Choice Medical, Inc.
("MCM") on January 1, 2005. The results of operations of these acquisitions have
been included in the consolidated results of operations since their acquisition
dates. The results of Bargain, Lavalife, and MCM have been included in the
Marketing Services, Personals, and Management Services segments, respectively.
Variable Interest Entities
The Management Services segment provides advertising and practice management
services to a network of cosmetic physicians throughout the United States. The
cosmetic physicians form their own wholly-owned professional corporations
("PCs") and provide medical services to patients generated only by the
Management Services segment. Since the Management Services segment is the
primary beneficiary of these PCs, the financial statements of the PCs are
included in the Company's consolidated financial statements in accordance with
FIN 46R. The PCs maintain minimal assets, and generally have no operations or
obligations other than operations and obligations directly generated from doing
business with the Management Services segment.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP
requires management to make estimates, judgments, and assumptions that affect
the reported amounts of assets and liabilities, disclosure of contingent assets
and liabilities at the date of the financial statements, and the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates. The most significant judgments and estimates
include: membership cancellation rates, deferred marketing costs, allowance for
notes receivable, valuation of goodwill, intangible assets' remaining useful
lives, deferred tax asset valuations and tax reserves, and stock-based
compensation.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
Foreign Currency Translation
Assets and liabilities of foreign subsidiaries, whose assets and liabilities are
denominated in their local currencies, are translated at the exchange rates in
effect as of the balance sheet dates. Equity accounts are translated at
historical exchange rates and revenues, expenses, and cash flows are translated
at average exchange rates for the periods presented. Translation gains and
losses are included as a component of comprehensive income in the consolidated
statements of shareholders' deficit. Transaction gains and losses are included
in the consolidated statements of operations.
F-7
Fair Value of Financial Instruments and Concentration of Credit Risk
All current assets and liabilities are carried at cost, which approximates fair
value due to their short-term maturities. Long-term notes receivable also
approximate fair value since they are recorded at the lesser of cost or net
realizable value. The recorded amounts of the Company's long-term liabilities
also approximate fair value except for differences with respect to the
Convertible Notes and the Senior Notes (see Note 7) which had carrying values of
$90,000,000 and $147,984,000, respectively, and fair values of $108,900,000 and
$155,250,000, respectively, as of June 30, 2006 The Convertible Notes and the
Senior Notes had carrying values of $90,000,000 and $147,814,000, respectively,
and fair values of $103,050,000 and $151,500,000, respectively, as of June 30,
2005. The fair value information is based on publicly available information.
Financial instruments that potentially subject the Company to concentration of
credit risk consist primarily of notes receivable from the Management Services
segment and accounts receivable from third-party payment processors who
facilitate payments from membership and personals.
Revenue Recognition
Revenues are billed primarily through credit and debit cards. Revenues from
membership programs are recognized when earned. Members may cancel their
memberships at any time. Members enrolled in an annual payment plan who cancel
their memberships receive a pro rata refund of the remaining unused portion of
their membership fees. In accordance with Staff Accounting Bulletin ("SAB") 104,
"Revenue Recognition" ("SAB 104"), revenues, net of estimated cancellations, are
deferred and recognized as revenues when membership refund privileges expire.
Management establishes and regularly updates the allowance for membership
cancellations. In estimating the allowance for membership cancellations,
management analyzes historical cancellation experience, current economic trends,
and changes in customer demand for the Company's products and services. Actual
membership refunds are charged against the allowance for membership
cancellations on a current basis. Accrued liabilities set forth in the
accompanying consolidated balance sheets as of June 30, 2006 and 2005 include an
allowance for membership cancellations of $9,290,000 and $11,232,000,
respectively.
Revenues generated by the Personals segment are recognized when the services are
used. Revenues generated by the Management Services segment are recognized when
the medical procedures performed by the healthcare professionals are complete.
In 2006 and 2005, the Company's largest client accounted for 12% and 14% of
revenues, respectively. In 2004, the Company's two largest clients accounted for
18% and 12% of revenues. The revenues from these clients were included in the
Marketing Services segment.
Marketing Expenses
The Company's marketing expenses are comprised of advertising costs,
non-refundable and refundable royalty payments, telemarketing costs, and direct
mail costs. Advertising costs and non-refundable royalty payments, which include
fee per offer, fee per sale, and fee per impression marketing arrangements, are
expensed when incurred. Refundable royalty payments are charged to operations as
the associated revenues are recognized in accordance with SAB 104. Telemarketing
costs, including costs for third-party vendors to solicit members for the
Company, and direct mail costs, including costs of printing and mailing direct
mail pieces, are deferred direct response advertising costs and are charged to
marketing expenses over the expected future benefit period in accordance with
American Institute of Certified Public Accountants Statement of Position 93-7,
"Reporting on Advertising Costs" ("SOP 93-7").
Deferred marketing costs to enroll a new member are less than the related
estimated total net revenues. However, if deferred marketing costs were to
exceed the related estimated total net revenues, management would adjust the
deferred marketing costs for that impairment.
Earnings per Share
Basic and diluted earnings per share are determined in accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share" ("SFAS 128"). Basic earnings per share is computed using
the weighted average number of common shares outstanding during the reporting
period. Diluted earnings per share is computed using the weighted average number
of common shares outstanding and the dilutive effect of potentially outstanding
common shares determined using the treasury stock method.
Cash and Cash Equivalents
The Company considers highly liquid investment instruments with original
maturities of three months or less to be cash equivalents. The Company's cash
and cash equivalents are carried at cost, which approximates fair market value,
and primarily consist of money market funds.
F-8
Restricted Cash
The Company excludes from cash and cash equivalents restricted cash that is held
in an escrow account for payment of commissions to a client.
Short-Term Investments
Short-term investments consist of commercial paper with original maturities of
more than three months but less than or equal to one year and auction rate
securities with interest rates that reset every 49 days or less but have stated
contractual maturities greater than one year. As of June 30, 2006, these
investments were classified as available-for-sale and recorded at cost, which
approximates fair value due to their short-term reset dates. Historically, the
Company has been able to liquidate auction rate securities at any reset date to
provide funds for investing or financing activities or to invest in securities
that would generate higher yields.
Accounts and Notes Receivable
Accounts receivable are generally from third-party payment processors. As of
June 30, 2006 and 2005, the Company recorded accounts receivable of $14,015,000
and $12,559,000, respectively, in accounts and notes receivables, net.
Additionally, the Management Service segment finances the cost of the medical
services received by patients through the use of notes receivable. These notes
receivable generally have a life of 21 to 48 months and bear interest at rates
ranging from 6% to 18%. Interest on these notes is included in interest income
in the statement of operations. As of June 30, 2006 and 2005, the Company
recorded notes receivable of $6,999,000 and $1,124,000, respectively, in
accounts and notes receivable, net, and $9,870,000 and $1,311,000, respectively,
in other long-term assets.
The Company estimates an allowance for accounts and notes receivable based on an
aging analysis, customer credit evaluations, collection history, and any
specific, known troubled accounts. As of June 30, 2006 and 2005, the Company
recorded $60,000 and $63,000, respectively, of allowances for uncollectible
accounts, and $3,847,000 and $825,000, respectively, of allowances for
uncollectible notes.
Fixed Assets
Fixed assets, computer software costs, and capital leases are carried at cost,
less accumulated depreciation. Depreciation is calculated using the
straight-line method over the estimated useful lives of the related assets.
Useful lives are generally between three and seven years for computer software
and equipment, the shorter of the estimated remaining useful life or the
remaining life of the lease, for leasehold improvements, and seven to ten years
for furniture and fixtures. Maintenance and repair expenditures are charged to
operations as incurred.
Valuation of Goodwill
The Company reviews the carrying value of its goodwill in accordance with SFAS
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Management reviews
goodwill for impairment by comparing their carrying values to their fair values
at least annually or more frequently if circumstances indicate possible
impairment. When determining fair value, management uses various assumptions,
including projections of future cash flows. A change in the underlying
assumptions could cause fair value to be less than carrying value and require
the Company to record a corresponding charge against operations. Management
performs its impairment testing in the first fiscal quarter of each year.
Intangible Assets
Management reassesses the estimated useful lives of its definite lived
intangible assets and determined that they were appropriate. Intangible assets
principally include member and customer relationships and trade names that arose
in connection with business acquisitions. Acquired intangible assets are
recorded at cost and are generally amortized on a straight-line basis over their
estimated useful lives. The weighted average amortization periods for membership
and client relationships, trade names, other amortizable intangible assets, and
total amortizable intangible assets held at June 30, 2006, were 10 years, 15
years, 3 years, and 13 years, respectively.
Impairment of Long-Lived Assets
The Company accounts for impairment and disposition of long-lived assets in
accordance with SFAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The Company reviews its long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable, as determined based on their projected undiscounted future
cash flows. If this review indicates that the carrying value will not be
recoverable, the carrying value is reduced to its estimated fair value. During
fiscal 2006, there were no impairment charges recorded.
F-9
Contingent Liabilities
In accordance with SFAS 5, "Accounting for Contingencies," and FIN 14,
"Reasonable Estimation of the Amount of a Loss," the Company accrues for
contingent liabilities when it is probable that future costs will be incurred
and those costs can be reasonably estimated and measured.
Income Taxes
The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes". Deferred tax assets and liabilities are
recognized for future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases.
Stock-Based Compensation
The Company adopted SFAS No. 123(R), "Share-Based Payment" ("SFAS 123R") on July
1, 2005. SFAS 123R established 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. 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 ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and
the related interpretations.
New Accounting Pronouncements
In July 2006, the FASB issued FIN 48, "Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109" ("FIN 48"). This
interpretation clarifies the accounting for uncertainty in tax positions and
requires an entity to recognize in its financial statements the impact of a tax
position, if that position is more likely than not of being sustained on audit,
based on the technical merits of the position. The provisions of FIN 48 are
effective beginning in the Company's first quarter of fiscal 2008. The Company
is currently evaluating the impact of FIN 48 on its financial statements.
In February 2006 the FASB issued Statement No. 155, "Accounting for Certain
Hybrid Financial Instruments - An Amendment of FASB Statements No. 133 and 140."
The Statement allows financial instruments that have embedded derivatives to be
accounted for as a whole under certain circumstances. Additionally, in March
2006, the FASB issued Statement No. 156, "Accounting for Servicing of Financial
Assets - An Amendment of FASB Statement No. 140." Among other requirements, the
Statement requires as entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a financial asset by
entering into a servicing contract in certain situations. Both of these
Statements are effective beginning in the Company's first quarter of fiscal
2008. The Company does not expect the adoption of either Statement to have a
material effect on its consolidated financial position, results of operations,
or cash flows.
NOTE 3 - FIXED ASSETS
June 30,
---------------------------------
(Dollar amounts in thousands) 2006 2005
--------------- ---------------
Computer software and equipment $ 67,323 $ 68,273
Furniture and fixtures 9,672 8,269
Leasehold improvements 13,075 7,906
--------------- ---------------
90,070 84,448
Accumulated depreciation (49,502) (45,386)
--------------- ---------------
Fixed assets, net $ 40,568 $ 39,062
=============== ===============
Depreciation expense was $16,087,000, $13,485,000, and $10,189,000 for the years
ended June 30, 2006, 2005, and 2004, respectively.
Fixed assets, net recorded under capital leases were $1,387,000 and $1,749,000
as of June 30, 2006 and 2005, respectively. Accumulated depreciation on these
fixed assets was $1,172,000 and $581,000 as of June 30, 2006 and 2005,
respectively.
F-10
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of amortizable intangible
assets was as follows:
June 30, 2006 June 30, 2005
------------------------------- -------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
(Dollar amounts in thousands) Amount Amortization Amount Amortization
------------ ---------------- ------------ ----------------
Membership and client relationships $ 40,215 $ 21,881 $ 40,215 $ 15,184
Trade names 21,859 3,114 21,859 1,662
Other 1,504 1,448 1,518 1,237
------------ ---------------- ------------ ----------------
Total amortizable intangible assets $ 63,578 $ 26,443 $ 63,592 $ 18,083
------------ ---------------- ------------ ----------------
Amortizable intangible assets, net $ 37,135 $ 45,509
============ ============
The carrying amounts of our indefinite-lived intangible assets were as follows:
June 30,
---------------------------
(Dollar amounts in thousands) 2006 2005
------------ ------------
Goodwill $ 212,187 $ 201,499
Intangible asset related to minimum pension liability $ 663 $ 967
Future intangible amortization expense for the next five years is estimated to
be as follows:
(Dollar amounts in thousands)
Fiscal Year
2007 $ 6,652
2008 4,681
2009 4,260
2010 3,130
2011 3,096
Changes in the carrying amount of goodwill by segment were as follows:
Marketing Management
(Dollar amounts in thousands) Services Personals Services Total
----------- ---------- ---------- ----------
Balance at June 30, 2004 $ 42,039 $ 83,636 $ - $ 125,675
Acquisitions 53,664 - 23,367 77,031
Purchase adjustments and other 214 (1,421) - (1,207)
----------- ----------- ----------- -----------
Balance at June 30, 2005 95,917 82,215 23,367 201,499
Contingent purchase price payments, MCM
acquisition (See Note 9) - - 10,880 10,880
Purchase adjustments and other 515 (707) - (192)
----------- ----------- ----------- -----------
Balance at June 30, 2006 $ 96,432 $ 81,508 $ 34,247 $ 212,187
=========== =========== =========== ===========
As part of the acquisitions of certain of the assets of MCM and Bargain in
fiscal 2005, the Company acquired intangible assets of $92,491,000. Of those
amounts, $12,220,000 was assigned to membership and client relationships, and
$3,240,000 was assigned to trade names. These identified intangible assets are
subject to periodic amortization over the estimated useful lives ranging from
one to 15 years. Goodwill of $88,426,000, which is not subject to amortization,
also arose in connection with these acquisitions.
As part of the purchase of Lavalife in fiscal 2004, the Company acquired
intangible assets of $115,632,000. Of that amount, $14,799,000 has been assigned
to membership and client relationships, and $18,619,000 has been assigned to
trade names, both of which are subject to periodic amortization over the
estimated useful lives ranging from three to 15 years. Goodwill of $81,508,000,
which is not subject to amortization, also arose in connection with this
acquisition.
F-11
NOTE 5 - FOREIGN CURRENCY INSTRUMENTS
The Company uses purchase option and forward contracts to minimize its exposure
to changes in future cash flows caused by movements in currency exchange rates
between the U.S. dollar and the Canadian dollar. Derivative instruments are held
only for the purpose of hedging such risks and are not used for speculative
purposes. Derivative instruments 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 for cash flow hedges 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 other current assets. As of
June 30, 2006 and 2005, the fair value of these instruments was $156,000 (asset)
and $559,000 (asset), respectively. Derivative gains recognized in earnings were
recorded in operating expenses and general and administrative expenses, and
amounted to $1,045,000 and $1,382,000 for 2006 and 2005, respectively. All
forecasted transactions currently being hedged are expected to occur over the
next year.
During 2004, the Company used purchase option and forward contracts to protect
against the foreign currency exchange risk inherent in the purchase price for
its acquisition of Lavalife, which was denominated in Canadian dollars (see Note
9). The risk of loss associated with purchase option contracts was limited to
premium amounts paid for them. The risk of loss associated with forward
contracts was equal to the exchange rate differential from the time the contract
was entered into until it was settled. These contracts expired on April 1, 2004
concurrently with the closing of the Lavalife acquisition. Derivative gains
recognized in earnings were recorded as a component of other income, net and
amounted to $353,000 in 2004.
NOTE 6 - RESTRUCTURING CHARGES
The restructuring reserve balance, which consists of lease obligations and is
recorded in accrued liabilities and other long-term liabilities, was $1,391,000
and $1,499,000 as of June 30, 2006 and 2005, respectively. Cash payments related
to lease obligations for the years ended June 30, 2006 and 2005 were $108,000
and $145,000, respectively.
NOTE 7 - LONG-TERM LIABILITIES
Long-term liabilities were as follows at June 30:
(Dollar amounts in thousands) 2006 2005
---------- ----------
Senior Notes $ 147,984 $ 147,814
Convertible Notes 90,000 90,000
Other long-term liabilities 9,989 5,943
---------- ----------
247,973 243,757
Less current maturities 762 686
---------- ----------
Long-term liabilities $ 247,211 $ 243,071
========== ==========
The Company has outstanding $150,000,000 aggregate principal amount of
registered, unsecured 9.25% senior notes due 2014 (the "Senior Notes"). The
Senior Notes have an effective yield of 9.5%, and interest is payable in cash
semi-annually in arrears on April 1 and October 1. A portion of the proceeds was
used to repay amounts borrowed to partially fund the Lavalife acquisition (see
Note 9). At any time prior to April 1, 2007, the Company may redeem up to 35% of
the Senior Notes with net cash proceeds of certain equity offerings, as long as
at least 65% of the aggregate principal amount of the Senior Notes issued
remains outstanding after the redemption. The Company may redeem all or part of
the Senior Notes prior to April 1, 2009 by paying a make-whole premium. At any
time on or after April 1, 2009, the Company may redeem some or all of the Senior
Notes at certain redemption prices plus accrued and unpaid interest and
liquidation damages, if any, to the date of redemption. Debt issuance costs and
debt discount associated with this issuance were capitalized and are being
amortized as interest expense over the term of the Senior Notes using the
effective interest method.
Additionally, the Company has outstanding $90,000,000 aggregate principal amount
of registered 5.5% convertible senior subordinated notes due 2010 ("Convertible
Notes"). The Convertible Notes bear interest at the rate of 5.5% per year, which
is payable in cash semi-annually in arrears on April 1 and October 1. Holders of
the Convertible Notes may convert their notes into shares of the Company's
common stock at any time prior to maturity at an initial conversion price of
approximately $40.37 per share, which is equivalent to an initial conversion
rate of approximately 24.77 shares per $1,000 principal amount of the
Convertible Notes. There are no beneficial conversion features related to these
Convertible Notes. In accordance with APB Opinion No. 14, "Accounting for
Convertible Notes and Debt Issued with Stock Purchase Warrants," these
Convertible Notes have been classified as a liability. Debt issuance costs
associated with this issuance were capitalized and are being amortized as
interest expense over the term of the Convertible Notes using the effective
interest method.
F-12
Other long-term obligations are comprised of the long-term portion of the
restructuring reserve (see Note 6), minimum pension liability (see Note 14), and
lease incentives related to certain operating leases. The lease incentives are
amortized as a reduction to rent expense over the terms of the leases.
The Company has an amended and restated senior secured credit facility dated as
of March 17, 2006, which allows borrowings of up to $50,000,000. Borrowings
under this senior secured credit facility accrue interest at the Eurodollar rate
or the Prime rate, plus an applicable margin. As of June 30, 2006, the base
interest rate for borrowings under this credit facility was 8.5%. There were no
borrowings outstanding under this credit facility as of June 30, 2006 and 2005.
As of June 30, 2005, the availability under the senior secured credit facility
was reduced by an outstanding letter of credit of $5,458,000 and was
$39,542,000. The senior secured credit facility has certain financial covenants,
including a maximum debt coverage ratio, potential restrictions on borrowings,
and potential restrictions on additional stock repurchases. The senior secured
credit facility matures on March 31, 2009. All of the Company's assets,
including the stock of its subsidiaries, are pledged as collateral for the
senior secured credit facility. Debt issuance costs associated with the
amendment and restatement of the senior secured credit facility were capitalized
and are being amortized over the term of the secured credit facility using the
effective interest method.
Interest expense in 2006, 2005, and 2004, included $972,000, $1,373,000, and
$742,000 amortization of debt issuance costs, respectively, and $170,000,
$155,000, and $32,000 amortization of debt discount, respectively. The
unamortized portion of debt issuance costs aggregated $7,312,000 and $8,130,000
at June 30, 2006 and 2005, respectively.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
The Company operates in leased facilities. Rent expense under operating leases
was $9,463,000, $8,643,000, and $6,779,000 for the years ended June 30, 2006,
2005, and 2004, respectively.
The Company has certain capital leases for equipment. At June 30, 2006, the
weighted average interest rate on the Company's capital leases was 8.1% with
individual lease rates generally ranging from 5% to 20%.
Future minimum lease payments under operating and capital leases as of June 30,
2006 are as follows:
(Dollar amounts in thousands) Operating Capital
Fiscal Year Leases Leases
---------- ----------
2007 $ 9,376 $ 839
2008 8,998 474
2009 8,929 91
2010 7,225 -
2011 5,939 -
Thereafter 17,197 -
---------- ----------
Total minimum lease payments $ 57,664 1,404
========== ==========
Less amount representing interest (101)
----------
Present value of net minimum capital lease obligations 1,303
Less current portion (762)
----------
Long-term capital lease obligations $ 541
==========
As of June 30, 2006, the Company had outstanding purchase obligations of
$10,715,000 primarily related to marketing agreements and contracts for the
Company's software, equipment, and services. In addition, the Company has
$45,274,000 of potential contingent payments related to the MCM acquisition (see
Note 9).
F-13
Legal proceedings
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 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.
MedValUSA Health Programs, Inc. ("MedVal") filed an arbitration against the
Company in September 2000 involving claims of breach of contract, breach of the
duty of good faith and fair dealing, and violation of the Connecticut Unfair
Trade Practices Act ("CUTPA"). In October 2005, the U.S. Supreme Court declined
to review the Connecticut Supreme Court's May 2005 decision to uphold an
arbitration panel's award of $5,458,000 in punitive damages and costs to MedVal.
The Company recorded a one-time charge in the year ended June 30, 2005 related
to this award.
NOTE 9 - BUSINESS COMBINATIONS
On January 1, 2005, the Company completed the acquisition of certain of the
assets of MCM, a privately held advertising and practice management company
serving cosmetic surgeons throughout the United States. The Company acquired
these assets of MCM in order to expand its consumer offerings to include
cosmetic surgery. The purchase price, excluding fees and expenses, amounted to
$33,000,000 and was paid in cash on the closing date. In addition, the Company
paid $10,726,000 of contingent payments in 2006 and additional contingent
payments of up to $45,274,000 may be paid if certain performance targets,
including increasing levels of revenues and earnings, are achieved over the next
two calendar years. Additional payments under the contingency arrangement are
considered additional purchase price and allocated to the net assets acquired.
The Company identified $12,060,000 of intangible assets other than goodwill,
including membership and client relationships and trade name, in conjunction
with this acquisition. The $34,247,000 of excess purchase consideration over the
net assets acquired was allocated to goodwill, substantially all of which is
deductible for tax purposes.
On November 30, 2004, the Company completed the acquisition of certain of the
assets of Bargain, a privately held provider of premier pricing services for
homes and vehicles. The Company acquired these assets of Bargain in order to
expand its direct to consumer marketing presence and to expand its discounted
consumer offerings to include personal property. The purchase price, which
excluded fees and expenses, was paid in cash and amounted to $39,118,000. In
addition, the Company paid $14,624,000 of contingent payments in 2006. The
Company also assumed certain liabilities amounting to $4,729,000. The Company
identified $3,400,000 of intangible assets other than goodwill, including
membership and client relationships and trade name, in conjunction with this
acquisition. The $54,179,000 of excess purchase consideration over the net
assets acquired was allocated to goodwill, substantially all of which is
deductible for tax purposes.
On April 1, 2004, the Company completed the acquisition of all of the net assets
and outstanding capital stock of Lavalife, a leading provider of web-based and
phone-based interactive personals services. The Company acquired Lavalife in
order to broaden the scope of services offered to include personals services.
The acquisition of Lavalife benefited the Company by providing access to one of
the largest and fastest growing consumer categories on the internet while
expanding its target market. The purchase price, excluding fees and expenses,
was Cdn$152,500,000, or $116,300,000. In connection with this acquisition, the
Company received $9,080,000 related to the issuance of the Company's restricted
common stock to Lavalife's senior management. The acquisition was funded with
cash on hand and borrowings under the Company's senior secured credit facility.
The Company identified $33,418,000 of intangible assets other than goodwill. The
$81,508,000 of unallocated excess purchase consideration over the net assets
acquired was allocated to goodwill. The amount of tax deductible goodwill was
$77,436,000.
See Note 4 for detailed descriptions of the intangible assets and goodwill
identified in connection with these business combinations.
F-14
The fair values of the assets acquired and liabilities assumed at the
acquisition dates were as follows:
(Dollar amounts in thousands) MCM Bargain Lavalife
------------ ------------ ------------
Current assets $ 258 $ 2,163 $ 6,160
Fixed assets 600 4,017 14,730
Other assets - 871 -
Goodwill arising in the acquisition 34,247 54,179 81,508
Intangible assets 12,060 3,400 33,418
Current liabilities (3,060) (4,066) (19,284)
Other long-term liabilities - (769) (2,498)
------------ ------------ ------------
Net assets acquired $ 44,105 $ 59,795 $ 114,034
============ ============ ============
Pro Forma Results
The following unaudited pro forma results of operations for the year ended June
30, 2004 was prepared assuming the Lavalife acquisition occurred on July 1,
2003. These pro forma results are not necessarily indicative of the results of
future operations or results that would have occurred had the acquisition been
consummated as of that date (in thousands, except per share data).
Revenues $ 542,766
Net income 28,979
Basic earnings per share $ 2.58
Diluted earnings per share 2.28
The results of operations and balance sheets of Bargain and MCM for periods
prior to the acquisitions were not material to the Company and accordingly, pro
forma results of operations have not been presented.
NOTE 10- INCOME TAXES
The provision for income taxes is as follows:
For the years ended June 30,
----------------------------------------
(Dollar amounts in thousands) 2006 2005 2004
------------ ------------ ------------
Current Payable
Federal $ 13,325 $ 9,922 $ 7,219
State 2,278 2,249 2,245
Foreign 778 802 1,028
------------ ------------ ------------
Total current payable 16,381 12,973 10,492
------------ ------------ ------------
Deferred
Federal 1,916 3,047 8,673
State (678) (595) 140
Foreign (1,762) (2,033) (667)
------------ ------------ ------------
Total deferred (524) 419 8,146
------------ ------------ ------------
Total provision for income taxes $ 15,857 $ 13,392 $ 18,638
============ ============ ============
The following is a reconciliation of the Company's effective tax rate to the
U.S. statutory rate:
For the years ended June 30,
----------------------------------------------
2006 2005 2004
-------------- -------------- --------------
Statutory rate 35.0% 35.0% 35.0%
State and local 1.9% 2.8% 3.3%
Foreign (1.5%) (3.7%) (0.5%)
Other (2.7%) 0.3% 2.2%
-------------- -------------- --------------
Effective rate 32.7% 34.4% 40.0%
============== ============== ==============
F-15
The Foreign reconciling item included the U.S. tax benefit of the losses from
certain foreign branch operations that can be used in the foreign jurisdiction
without a U.S. tax cost. The Other reconciling item included the reversal of a
$1,416,000 tax reserve related to an Internal Revenue Service ("IRS") audit for
the year ended June 30, 2004.
The Company has open tax years in the U.S., Canada, and other jurisdictions.
There are tax years that are not currently under examination by the applicable
tax authorities but may be subject to examination in the future. The results of
audits are inherently uncertain. The Company periodically evaluates the adequacy
of its 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 have a material effect on
the results of operations, financial position, and cash flow.
Consolidated U.S. income before taxes was $49,238,000, $43,459,000 and
$44,861,000 in 2006, 2005, and 2004, respectively. The corresponding amounts for
non-U.S.-based operations were (loss) income of ($679,000), ($4,518,000) and
$1,737,000, respectively.
Undistributed earnings of the Company's foreign subsidiaries amounted to
$1,020,000 and $500,000 at June 30, 2006 and 2005, respectively. U.S. income
taxes were not provided on certain unremitted earnings from foreign subsidiaries
since the Company intends to permanently reinvest substantially all of such
earnings outside the U.S. However, if some portion of these earnings is
remitted, the Company expects the effect of any remittance after considering
available tax credits and amounts previously accrued not to be significant to
the consolidated results of operations. A calculation of the amount of
unrecognized deferred U.S. income tax liability is not practicable due to the
complexities associated with the calculation.
The following is a summary of the Company's deferred tax assets and liabilities
as of June 30:
(Dollar amounts in thousands) 2006 2005
-------------- --------------
Deferred Tax Assets
Benefit of federal, state, and
foreign net operating loss carry forwards $ 2,456 $ 1,672
Allowance for membership cancellations 3,765 4,459
Charge for arbitration award - 2,088
Stock option expense - FAS 123R 1,178 -
Other deferred tax assets 4,142 5,194
-------------- --------------
Deferred tax assets 11,541 13,413
Valuation allowance (657) (222)
-------------- --------------
Deferred tax assets 10,884 13,191
-------------- --------------
Deferred Tax Liabilities
Deferred marketing costs (9,657) (14,854)
Deferred revenues (7,961) (5,497)
Goodwill and other intangible assets (7,449) (6,221)
Depreciation (3,410) (5,678)
Other deferred tax liabilities (1,014) (423)
-------------- --------------
Gross deferred tax liabilities (29,491) (32,673)
-------------- --------------
Net deferred tax liability $ (18,607) $ (19,482)
============== ==============
As of June 30, 2006, the Company has fully utilized all federal net operating
loss carry forwards. The Company has state net operating loss carry forwards
available to reduce future state taxable income which expire beginning fiscal
2007 through fiscal 2019. In addition, the Company has foreign net operating
losses of $10,233,000 expiring beginning June 30, 2014 through June 30, 2016.
Tax benefits resulting from the exercise of nonqualified stock options and the
disqualifying dispositions of shares issued under the Company's stock-based
compensation plans reduced taxes payable by $5,852,000 and $2,220,000 in 2006
and 2005, respectively. These benefits were credited to additional paid-in
capital and deferred tax assets.
F-16
NOTE 11 - EARNINGS PER SHARE
The following table reconciles the numerators and denominators in the
computations of basic and diluted earnings per share:
For the years ended June 30,
----------------------------
(Dollar amount in thousands, except per share data) 2006 2005 2004
-------- -------- --------
Numerator:
Income available to common shareholders used in
basic earnings per share $32,702 $25,549 $27,960
Add back interest expense on convertible securities,
net of tax 3,334 3,247 2,236
-------- -------- --------
Income available to common shareholders after
assumed conversion of dilutive securities $36,036 $28,796 $30,196
======== ======== ========
Denominator:
Weighted average number of common shares outstanding
- basic 9,722 9,995 10,755
Effect of dilutive securities:
Convertible securities 2,230 2,230 1,678
Stock options 791 748 775
-------- -------- --------
Weighted average number of common shares outstanding
- diluted 12,743 12,973 13,208
======== ======== ========
Basic earnings per share $ 3.36 $ 2.56 $ 2.60
======== ======== ========
Diluted earnings per share $ 2.83 $ 2.22 $ 2.29
======== ======== ========
The diluted earnings per common share calculation excludes the effect of
potentially dilutive shares when their effect is antidilutive. Excluded from the
diluted share calculation above for the years ended June 30, 2006, 2005, and
2004 are incremental weighted average stock options of approximately 51,000,
67,000, and 26,000, respectively.
NOTE 12 - SHAREHOLDERS' EQUITY
The Company has a stock repurchase program. During 2005 and 2004, the Board of
Directors authorized the Company to repurchase up to an aggregate additional
4,000,000 shares of the Company's common stock. As of June 30, 2006,
approximately 327,000 shares remained authorized for repurchase under this
program. The Company repurchased 498,000 shares for $19,338,000, an average
price of $38.83 per share, in 2006, 1,168,000 shares for $41,131,000, an average
price of $34.92 per share, in 2005 and 2,985,000 shares for $94,207,000, an
average price of $31.56 per share, in 2004. In August 2006, the Company
announced that its Board of Directors authorized the Company to repurchase up to
an aggregate additional 1,000,000 shares of the Company's common stock.
In fiscal 2005, the Board of Directors authorized a modified Dutch Auction
self-tender offer for up to 500,000 shares of its common stock. Under the terms
of the self-tender offer as approved by the Board of Directors, and as set forth
in the Offer to Purchase filed as an exhibit to the Company's Schedule TO filed
on November 15, 2004, as amended (the "Offer to Purchase"), the Company's
stockholders were given the opportunity to tender part or all of their shares to
the Company at a price of not less than $33.50 per share and not more than
$38.50 per share. The self-tender offer closed on January 7, 2005 with a total
of 605,000 shares tendered by shareholders. The Company exercised its right, as
set forth in the Offer to Purchase, to purchase the additional 105,000 shares
and repurchased a total of 605,000 shares for $38.50 per share, paying a total
of $23,293,000.
NOTE 13 - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The components of accumulated other comprehensive income (loss) are as follows:
June 30,
-----------------------
(Dollar amounts in thousands) 2006 2005
---------- ----------
Unrealized hedging (loss) gain $ (145) $ 239
Currency translation adjustment 359 (285)
Minimum pension liability adjustment, net
of tax - (102)
---------- ----------
Total $ 214 $ (148)
========== ==========
F-17
NOTE 14 - EMPLOYEE BENEFIT PLANS
The Company has a defined contribution 401(k) profit sharing plan. Employees may
contribute up to 20% of their compensation subject to certain limitations. The
Company makes matching contributions in cash. Matching contributions were
$646,000, $376,000, and $168,000 for 2006, 2005, and 2004, respectively.
Effective January 1, 2004, the Company has an unfunded, nonqualified defined
benefit pension plan that benefits certain executives selected by the
Compensation Committee of the Board of Directors. This plan provides for fixed
annual payments for ten years upon retirement after attaining the age of 55 and
ten years of service. Pension expense was $390,000, $306,000, and $212,000 in
2006, 2005, and 2004, respectively.
The Company used weighted-average discount rate assumptions of 6%, 5%, and 6% in
its 2006, 2005, and 2004, respectively. The following tables present information
about this pension plan:
For the years ended June 30,
------------------------------------
(Dollar amounts in thousands) 2006 2005 2004
----------- ----------- -----------
Pension expense by component
Interest cost $ 85 $ 77 $ 35
Service cost 174 146 71
Prior service cost 131 83 106
----------- ----------- -----------
Pension expense $ 390 $ 306 $ 212
=========== =========== ===========
June 30,
------------------------
(Dollar amounts in thousands) 2006 2005
----------- -----------
Pension benefit obligation
Balance at beginning of year $ 1,645 $ 1,276
Interest cost 85 77
Service cost 174 146
Actuarial (gain) loss (333) 146
----------- -----------
Balance at end of year $ 1,571 $ 1,645
=========== ===========
Funded status of the plan
Cumulative pension expense recognized $ 908 $ 518
Unrecognized net actuarial (gain) loss (220) 160
Unrecognized prior service cost 883 967
----------- -----------
Excess of the benefit obligation over the
value of plan assets $ 1,571 $ 1,645
=========== ===========
Net recognized amounts as classified in
the balance sheet
Intangible asset $ (663) $ (967)
Other long-term liabilities 1,571 1,645
Accumulated other comprehensive loss - (160)
----------- -----------
Cumulative pension expense recognized $ 908 $ 518
=========== ===========
No benefits are expected to be paid by the plan during the next two years. The
Company expects it could pay benefits of $60,000, $175,000, and $175,000 in
2009, 2010, and 2011, respectively, and $3,639,000 thereafter.
F-18
NOTE 15 - STOCK-BASED COMPENSATION
The Company adopted SFAS 123R in July 2005. Prior to the adoption of SFAS 123R,
the Company accounted for its share-based employee compensation plans under the
recognition and measurement provisions of APB Opinion No. 25 and its 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
years ended June 30:
(Dollar amount in thousands, except per share data) 2005 2004
------------ ------------
Net income, as reported $ 25,549 $ 27,960
Deduct: Stock-based employee compensation expense
under the fair value method, net of related tax
effects (1) (4,013) (4,762)
------------ ------------
Pro forma net income $ 21,536 $ 23,198
============ ============
Earnings per share:
As reported
Basic $ 2.56 $ 2.60
Diluted $ 2.22 $ 2.29
Pro forma
Basic $ 2.15 $ 2.16
Diluted $ 1.89 $ 1.90
(1) Compensation expense was reduced for forfeitures as they occurred.
The Company evaluated its valuation method and assumptions in connection with
the implementation of 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 following weighted average assumptions were used to estimate the
fair value of options granted for the years ended June 30:
2006 2005 2004
------------ ------------ ------------
Dividend yield 0% 0% 0%
Expected volatility (1) 63% 64% 74%
Risk free interest rate (2) 3.90% 3.70% 2.90%
Expected lives (3) 5 years 5 years 5 years
(1) Estimated based on the historical volatility of the Company's stock.
(2) Based on the U.S. Treasury yield curve in effect at the time of grant with a
term consistent with the expected life of the options granted.
(3) Estimated based on historical exercise experience and expected future
results of similar grants.
The weighted average fair values of options granted during the years ended June
30, 2006, 2005, and 2004 estimated on the grant date using the Black-Scholes
option-pricing model with the assumptions listed above were $21.86, $18.23, and
$14.98, respectively. The estimated fair value of the Company's stock-based
awards to employees is amortized over the options' vesting periods of four years
and the estimated fair value of the Company's awards issued under the Employee
Stock Purchase Plan is recognized in the period the stock is issued.
For the year ended June 30, 2006, the Company recognized $4,531,000 ($2,838,000
net of tax, $0.29 per basic share, or $0.22 per diluted share) in general and
administrative expenses related to stock option compensation. As of June 30,
2006, unrecognized stock compensation expense related to unvested options was
$7,226,000, which is expected to be recognized over a weighted average period of
2.5 years.
The total intrinsic value of options exercised during the years ended June 30,
2006, 2005, and 2004 was $10,074,000, $11,138,000, and $17,053,000,
respectively. The total cash received as a result of employee stock option
exercises for the years ended June 30, 2006, 2005, and 2004 was $8,636,000,
$10,792,000, and $24,564,000, respectively. The tax benefits realized in
connection with these exercises were $5,366,000, $2,220,000, and $6,520,000
during the years ended June 30, 2006, 2005, and 2004, respectively.
As of June 30, 2006, the Company had the following stock-based compensation
plans which are described below.
F-19
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.
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 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 June 30, 2006, 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 June 30, 2006, 4,028,000 shares of common stock were reserved for issuance
under these stock incentive plans, of which 1,498,000 shares were available for
future grant.
Information with respect to options to purchase shares issued under the above
plans as of June 30 is as follows:
2006 2005 2004
------------------------- ------------------------ -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
(Share amounts in thousands) Shares Price Shares Price Shares Price
----------- ------------ ----------- ----------- ----------- ------------
Outstanding at beginning of
year 2,872 $ 22.16 3,305 $ 20.10 4,532 $ 19.88
Granted 235 38.43 366 32.35 240 24.92
Exercised (449) 18.27 (607) 17.49 (1,227) 19.78
Forfeited or expired (127) 32.43 (192) 20.87 (240) 22.48
----------- ----------- -----------
Outstanding at end of year 2,531 23.85 2,872 22.16 3,305 20.10
=========== =========== ===========
The following table summarizes the Company's stock options outstanding and
exercisable as of June 30, 2006:
Options Outstanding Options Exercisable
------------------------------------------------ ---------------------------------
Weighted
Average Weighted Weighted
Remaining Average Aggregate Average Aggregate
Contractual Exercise Intrinsic Exercise Intrinsic
(Share amounts in thousands) Shares Term (Yrs) Price Value Shares Price Value
----------- ----------- ----------- ----------- ----------- ---------- -----------
$7.98 to $13.05 419 5.96 $ 12.40 $ 12,842 294 $ 12.12 $ 9,098
$13.05 to $19.375 377 3.60 16.43 10,012 354 16.42 9,416
$19.375 to $25.563 546 5.44 20.65 12,221 486 20.62 10,891
$25.563 to $29.875 829 4.59 29.47 11,241 683 29.44 9,279
$29.875 to $43.00 360 8.82 36.86 2,221 51 34.14 454
----------- ----------- ----------- -----------
2,531 5.46 23.85 $ 48,537 1,868 22.08 $ 39,138
=========== =========== =========== ===========
The weighted average remaining contractual term of stock options exercisable as
of June 30, 2006 was 4.58 years. Of the options outstanding, the Company expects
2,464,000 options to vest. Options expected to vest have a weighted average
exercise price of $23.57, a weighted average remaining contractual term of 5.2
years and an intrinsic value of $47,940,000.
F-20
Employee Stock Purchase Plan
During 1997, the Company adopted the 1996 Employee Stock Purchase Plan which
provides for the issuance of up to 360,000 shares of common stock. The plan
permits eligible employees to purchase Common Stock through payroll deductions,
which may not exceed 10% of an employee's compensation, at a price equal to 85%
of the closing price of the Common Stock on the day the purchase period
commences or terminates, whichever is lower. During 2006, 2005, and 2004,
14,000, 11,000, and 14,000 shares were purchased under the plan, respectively.
NOTE 16 - SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information was:
For the years ended June 30,
----------------------------------------
(Dollar amounts in thousands) 2006 2005 2004
------------ ------------ ------------
Cash paid for interest $ 19,224 $ 18,754 $ 2,640
Cash paid for income taxes 12,729 8,036 5,568
NOTE 17 - 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 capital and other
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 web, phone, and mobile-based personals
services to its customers. During 2006, the Management Services business segment
became reportable due to the increase in its assets and all prior periods have
been restated to reflect this change. The Management Services business segment
provides advertising and practice management services to healthcare
professionals throughout the United States. The Corporate business unit includes
unallocated general corporate expenses.
F-21
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:
(Dollar amounts in thousands) For the years ended June 30,
------------------------------------------
Revenues 2006 2005 2004
------------ ------------ ------------
Marketing Services $ 539,723 $ 490,289 $ 471,049
Personals 74,646 72,336 17,690
Management Services 44,699 17,513 -
Intersegment (213) (299) -
------------ ------------ ------------
Total $ 658,855 $ 579,839 $ 488,739
============ ============ ============
For the years ended June 30,
------------------------------------------
Adjusted EBITDA (1) 2006 2005 2004
------------ ------------ ------------
Marketing Services $ 88,867 $ 74,060 $ 80,434
Personals 10,873 6,267 2,073
Management Services 7,528 3,639 -
Corporate (28,045) (26,763) (23,947)
------------ ------------ ------------
Total Reportable Segment $ 79,223 $ 57,203 $ 58,560
============ ============ ============
For the years ended June 30,
------------------------------------------
Capital Expenditures (2) 2006 2005 2004
------------ ------------ ------------
Marketing Services $ 16,327 $ 8,512 $ 6,486
Personals 1,188 2,447 571
Management Services 266 47 -
Corporate - - -
------------ ------------ ------------
Total $ 17,781 $ 11,006 $ 7,057
============ ============ ============
For the years ended June 30,
------------------------------------------
Depreciation and Amortization 2006 2005 2004
------------ ------------ ------------
Marketing Services $ 11,860 $ 10,978 $ 10,085
Personals 9,839 9,323 2,327
Management Services 1,629 802 -
Corporate 1,119 474 66
------------ ------------ ------------
Total $ 24,447 $ 21,577 $ 12,478
============ ============ ============
June 30,
------------------------------------------
Assets 2006 2005 2004
------------ ------------ ------------
Marketing Services $ 214,083 $ 245,635 $ 178,723
Personals 124,571 132,992 136,874
Management Services 62,730 41,052 -
Corporate (3) 41,644 27,483 137,565
------------ ------------ ------------
Total $ 443,028 $ 447,162 $ 453,162
============ ============ ============
(1) Defined as net income plus interest and other (expense) income, 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.
F-22
The following tables reconcile Adjusted EBITDA to income before income taxes:
For the year ended June 30, 2006
-------------------------------------------------------------------------
(Dollar amounts in thousands) Marketing Management
Total Services Personals Services Corporate
------------- ------------- ------------- ------------- -------------
Income before income taxes $ 48,559
Interest and other expense, net (1) 16,782
-------------
Operating income (expense) $ 65,341 $ 88,010 $ 1,203 $ 5,292 $ (29,164)
Depreciation and amortization 24,447 11,860 9,839 1,629 1,119
Change in deferred revenues (23,549) (23,987) (169) 607 -
Change in deferred marketing costs 12,984 12,984 - - -
------------- ------------- ------------- ------------- -------------
Adjusted EBITDA $ 79,223 $ 88,867 $ 10,873 $ 7,528 $ (28,045)
============= ============= ============= ============= =============
For the year ended June 30, 2005
-------------------------------------------------------------------------
Marketing Management
Total Services Personals Services Corporate
------------- ------------- ------------- ------------- -------------
Income before income taxes $ 38,941
Interest and other expense, net (1) 18,153
-------------
Operating income (expense) $ 57,094 $ 85,498 $ (3,129) $ 1,962 $ (27,237)
Depreciation and amortization 21,577 10,978 9,323 802 474
Change in deferred revenues (34,911) (35,859) 73 875 -
Change in deferred marketing costs 13,443 13,443 - - -
------------- ------------- ------------- ------------- -------------
Adjusted EBITDA $ 57,203 $ 74,060 $ 6,267 $ 3,639 $ (26,763)
============= ============= ============= ============= =============
For the year ended June 30, 2004
-------------------------------------------------------------------------
Marketing Management
Total Services Personals Services Corporate
------------- ------------- ------------- ------------- -------------
Income before income taxes $ 46,598
Interest and other income, net (1) 6,272
-------------
Operating income (expense) $ 52,870 $ 76,576 $ 336 $ - $ (24,042)
Depreciation and amortization 12,507 10,085 2,327 - 95
Change in deferred revenues (32,272) (31,682) (590) - -
Change in deferred marketing costs 25,455 25,455 - - -
------------- ------------- ------------- ------------- -------------
Adjusted EBITDA $ 58,560 $ 80,434 $ 2,073 $ - $ (23,947)
============= ============= ============= ============= =============
(1) Management does not allocate interest and other expense, net to the
individual segments.
During 2006, the Company's assets and operations were primarily in the United
States and Canada. Revenues are attributable to geographic areas based on the
country where the sales were made. Geographic information is presented below:
(Dollar amounts in thousands) For the years ended June 30,
-------------------------------------
Revenues 2006 2005 2004
----------- ----------- -----------
United States $ 592,380 $ 520,167 $ 460,606
Canada 64,053 57,076 27,450
Other countries 2,422 2,596 683
----------- ----------- -----------
Total $ 658,855 $ 579,839 $ 488,739
=========== =========== ===========
June 30,
------------------------
Long-lived assets 2006 2005
----------- -----------
United States $ 43,552 $ 35,188
Canada 11,146 7,366
Other countries 14 2,434
----------- -----------
Total $ 54,712 $ 44,988
=========== ===========
F-23
NOTE 18 - QUARTERLY FINANCIAL DATA (unaudited)
For the year ended June 30, 2006
--------------------------------------------------
First Second Third Fourth
(Dollar amount in thousands, except per share data) Quarter Quarter Quarter Quarter
----------- ----------- ----------- -----------
Revenues $ 157,528 $ 160,130 $ 163,841 $ 177,356
Operating income 17,656 16,878 10,962 19,845
Net income 8,641 7,664 4,141 12,256
Basic earnings per share 0.89 0.79 0.43 1.26
Diluted earnings per share 0.74 0.66 0.38 1.03
For the year ended June 30, 2005
--------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- ----------- -----------
Revenues $ 135,623 $ 136,479 $ 148,995 $ 158,742
Operating income 16,732 13,783 11,539 15,040
Net income 7,596 5,883 4,353 7,717
Basic earnings per share 0.75 0.58 0.44 0.79
Diluted earnings per share 0.65 0.51 0.40 0.67
Net income for the fourth quarter of fiscal 2005 included a one-time pretax
charge of $5,458,000 resulting from the settlement of the MedVal arbitration
(see Note 8).
NOTE 19 - GUARANTOR 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. Effective April 28, 2006, the Senior
Notes are fully and unconditionally guaranteed by substantially all of the
Company's subsidiaries that guarantee the Company's Credit Facility (as defined
in the First Indenture dated April 28, 2006 governing the Senior Notes). All
prior periods have been restated to conform to this presentation.
The following consolidating condensed financial information presents the
consolidating balance sheets as of June 30, 2006 and 2005, the related
statements of operations and cash flows for the years ended June 30, 2006, 2005,
and 2004. The information includes the elimination entries necessary to
consolidate the Company ("Parent") with the guarantor entities.
Investments in subsidiaries are accounted for by the Parent using the equity
method of accounting. The guarantor subsidiaries are presented on a combined
basis. The principal elimination entries eliminate investments in subsidiaries
and intercompany balances and transactions.
F-24
CONSOLIDATING CONDENSED BALANCE SHEETS
June 30, 2006
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Assets
Current assets $ 37,724 $ 115,844 $ (21,545) $ 132,023
Fixed assets, net 22,532 18,036 - 40,568
Goodwill - 212,187 - 212,187
Intangible assets, net 675 37,123 - 37,798
Other long-term assets 10,205 10,247 - 20,452
Investment in subsidiaries 308,919 - (308,919) -
------------ ------------ ------------ ------------
Total assets $ 380,055 $ 393,437 $ (330,464) $ 443,028
============ ============ ============ ============
Liabilities and Shareholders'
(Deficit) Equity
Current liabilities $ 149,958 $ 75,891 $ (21,545) $ 204,304
Deferred income taxes (318) 7,238 - 6,920
Long-term debt 237,984 - - 237,984
Other long-term liabilities 8,600 1,389 - 9,989
------------ ------------ ------------ ------------
Total liabilities 396,224 84,518 (21,545) 459,197
------------ ------------ ------------ ------------
Shareholders' (deficit) equity:
Common stock 202 9 (9) 202
Capital in excess of par value 187,991 278,751 (278,751) 187,991
Retained earnings 68,382 29,890 (29,890) 68,382
Accumulated other comprehensive
income 214 269 (269) 214
Treasury stock (272,958) - - (272,958)
------------ ------------ ------------ ------------
Total shareholders' (deficit)
equity (16,169) 308,919 (308,919) (16,169)
------------ ------------ ------------ ------------
Total liabilities and
shareholders' (deficit)
equity $ 380,055 $ 393,437 $ (330,464) $ 443,028
============ ============ ============ ============
F-25
CONSOLIDATING CONDENSED BALANCE SHEETS
June 30, 2005
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Assets
Current assets $ 80,036 $ 84,193 $ (17,202) $ 147,027
Fixed assets, net 18,797 20,265 - 39,062
Goodwill - 201,499 - 201,499
Intangible assets, net 1,097 45,379 - 46,476
Other long-term assets 10,991 2,107 - 13,098
Investment in subsidiaries 275,213 - (275,213) -
------------ ------------ ------------ ------------
Total assets $ 386,134 $ 353,443 $ (292,415) $ 447,162
============ ============ =========== ============
Liabilities and Shareholders'
(Deficit) Equity
Current liabilities $ 190,595 $ 69,424 $ (17,202) $ 242,817
Deferred income taxes 2,588 7,114 - 9,702
Long-term debt 237,814 - - 237,814
Other long-term liabilities 3,565 1,692 - 5,257
------------ ------------ ------------ ------------
Total liabilities 434,562 78,230 (17,202) 495,590
------------ ------------ ------------ ------------
Shareholders' (deficit) equity:
Common stock 197 9 (9) 197
Capital in excess of par value 169,463 267,769 (267,769) 169,463
Retained earnings 35,680 7,551 (7,551) 35,680
Accumulated other comprehensive
loss (148) (116) 116 (148)
Treasury stock (253,620) - - (253,620)
------------ ------------ ------------ ------------
Total shareholders' (deficit)
equity (48,428) 275,213 (275,213) (48,428)
------------ ------------ ------------ ------------
Total liabilities and
shareholders' (deficit) equity $ 386,134 $ 353,443 $ (292,415) $ 447,162
============ ============ =========== ============
F-26
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
For the year ended June 30, 2006
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Revenues $ 389,867 $ 290,013 $ (21,025) $ 658,855
Expenses:
Marketing 214,566 118,913 (20,260) 313,219
Operating 69,020 83,365 (765) 151,620
General and administrative 73,336 46,979 - 120,315
Amortization of intangible assets 103 8,257 - 8,360
------------ ------------ ------------ ------------
Operating income 32,842 32,499 - 65,341
Equity in income of subsidiaries 22,353 - (22,353) -
Interest (expense) income, net (19,183) 2,403 - (16,780)
Other income (expense), net 13 (15) - (2)
------------ ------------ ------------ ------------
Income before income taxes 36,025 34,887 (22,353) 48,559
Provision for income taxes 3,323 12,534 - 15,857
------------ ------------ ------------ ------------
Net income $ 32,702 $ 22,353 $ (22,353) $ 32,702
============ ============ ============ ============
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
For the year ended June 30, 2005
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Revenues $ 376,112 $ 216,822 $ (13,095) $ 579,839
Expenses:
Marketing 202,429 94,441 (10,433) 286,437
Operating 62,911 54,169 (2,662) 114,418
General and administrative 62,839 45,392 - 108,231
Charge for arbitration award 5,458 - - 5,458
Amortization of intangible assets 228 7,973 - 8,201
------------ ------------ ------------ ------------
Operating income 42,247 14,847 - 57,094
Equity in income of subsidiaries 11,167 - (11,167) -
Interest (expense) income, net (19,068) 263 - (18,805)
Other income (expense), net (55) 707 - 652
------------ ------------ ------------ ------------
Income before income taxes 34,291 15,817 (11,167) 38,941
Provision for income taxes 8,742 4,650 - 13,392
------------ ------------ ------------ ------------
Net income $ 25,549 $ 11,167 $ (11,167) $ 25,549
============ ============ ============ ============
F-27
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
For the year ended June 30, 2004
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Revenues $ 395,074 $ 95,205 $ (1,540) $ 488,739
Expenses:
Marketing 213,884 41,934 - 255,818
Operating 69,222 24,150 (1,540) 91,832
General and administrative 65,640 20,186 - 85,826
Amortization of intangible assets - 2,393 - 2,393
------------ ------------ ------------ ------------
Operating income 46,328 6,542 - 52,870
Equity in income of subsidiaries 2,661 - (2,661) -
Interest expense, net (4,613) (2,008) - (6,621)
Other income (expense), net 447 (98) - 349
------------ ------------ ------------ ------------
Income before income taxes 44,823 4,436 (2,661) 46,598
Provision for income taxes 16,863 1,775 - 18,638
------------ ------------ ------------ ------------
Net income $ 27,960 $ 2,661 $ (2,661) $ 27,960
============ ============ ============ ============
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
For the year ended June 30, 2006
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Net cash provided by operating
activities $ 55,103 $ 4,939 $ (22,353) $ 37,689
Investing activities
Acquisition of fixed assets (11,629) (6,152) - (17,781)
Purchases of short-term
investments (138,047) (19,473) - (157,520)
Sales of short-term investments 133,088 9,849 - 142,937
Acquisitions of businesses,
net of cash acquired (25,442) (225) - (25,667)
Other investments (22,353) - 22,353 -
------------ ------------ ------------ ------------
Net cash used in investing
activities (64,383) (16,001) 22,353 (58,031)
------------ ------------ ------------ ------------
Financing activities
Net proceeds from issuance of
stock 8,636 - - 8,636
Excess tax benefit from
stock-based compensation 3,086 - - 3,086
Treasury stock purchases (19,338) - - (19,338)
Debt issuance costs (154) - - (154)
Payments of long-term obligations (408) (219) - (627)
------------ ------------ ------------ ------------
Net cash used in financing
activities (8,178) (219) - (8,397)
------------ ------------ ------------ ------------
Effect of exchange rate
changes on cash and
cash equivalents - 673 - 673
------------ ------------ ------------ ------------
Net decrease in cash and
cash equivalents (17,458) (10,608) - (28,066)
Cash and cash equivalents at
beginning of year 24,366 39,990 - 64,356
------------ ------------ ------------ ------------
Cash and cash equivalents
at end of year $ 6,908 $ 29,382 $ - $ 36,290
============ ============ ============ ============
F-28
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
For the year ended June 30, 2005
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Net cash provided by
(used in) operating
activities $ 124,196 $ (80,718) $ (11,167) $ 32,311
Investing activities
Acquisition of fixed assets (6,418) (4,588) - (11,006)
Purchases of short-term
investments (402,970) 340 - (402,630)
Sales of short-term investments 506,960 300 - 507,260
Acquisitions of businesses,
net of cash acquired (172,977) 95,740 - (77,237)
Other investments (11,167) - 11,167 -
------------ ------------ ------------ ------------
Net cash (used in) provided by
investing activities (86,572) 91,792 11,167 16,387
------------ ------------ ------------ ------------
Financing activities
Net proceeds from issuance of
stock 10,792 - - 10,792
Treasury stock purchases (41,131) - - (41,131)
Debt issuance costs (844) - - (844)
Payments of long-term obligations (326) (223) - (549)
------------ ------------ ------------ ------------
Net cash used in financing
activities (31,509) (223) - (31,732)
------------ ------------ ------------ ------------
Effect of exchange rate changes
on cash and cash equivalents - 224 - 224
------------ ------------ ------------ ------------
Net increase in cash and cash
equivalents 6,115 11,075 - 17,190
Cash and cash equivalents at
beginning of year 18,251 28,915 - 47,166
------------ ------------ ------------ ------------
Cash and cash equivalents at
end of year $ 24,366 $ 39,990 $ - $ 64,356
============ ============ ============ ============
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
For the year ended June 30, 2004
------------------------------------------------------
Guarantor Consolidated
(Dollar amounts in thousands) Parent Subsidiaries Eliminations Total
------------ ------------ ------------ ------------
Net cash (used in)
provided by operating
activities $ (55,030) $ 105,639 $ (2,661) $ 47,948
Investing activities
Acquisition of fixed assets (5,599) (1,458) - (7,057)
Purchases of short-term
investments (650,750) - - (650,750)
Sales of short-term investments 535,770 - - 535,770
Acquisitions of businesses,
net of cash acquired - (114,916) - (114,916)
Investment in subsidiaries (22,109) 19,448 2,661 -
------------ ------------ ------------ ------------
Net cash used in investing
activities (142,688) (96,926) 2,661 (236,953)
------------ ------------ ------------ ------------
Financing activities
Net proceeds from issuance of
stock 33,644 - - 33,644
Treasury stock purchases (94,207) - - (94,207)
Net proceeds from issuance of
debt 229,825 - - 229,825
Payments of long-term obligations (188) (265) - (453)
------------ ------------ ------------ ------------
Net cash provided by (used in)
financing activities 169,074 (265) - 168,809
------------ ------------ ------------ ------------
Effect of exchange rate
changes on cash and
cash equivalents - 102 - 102
------------ ------------ ------------ ------------
Net (decrease) increase
in cash and cash
equivalents (28,644) 8,550 - (20,094)
Cash and cash equivalents at
beginning of year 46,895 20,365 - 67,260
------------ ------------ ------------ ------------
Cash and cash equivalents at
end of year $ 18,251 $ 28,915 $ - $ 47,166
============ ============ ============ ============
F-29
Vertrue Incorporated
Schedule II - Valuation and Qualifying Accounts
(in thousands)
(Dollar amounts in thousands) Balance at Charged to Charged to Balance at
beginning of Costs and Other Accounts Deductions End of
Description Period Expenses Describe Describe Period
----------- ------------ ----------- -------------- ----------- -----------
For the year ended June 30, 2006
Allowance for membership cancellations $ 11,232 $ - $ 94,210 (A) $ 96,152 (B) 9,290
Allowance for notes receivable 825 3,022 - - 3,847
For the year ended June 30, 2005
Allowance for membership cancellations 14,156 - 122,886 (A) 125,810 (B) 11,232
Allowance for notes receivable - 825 - - 825
For the year ended June 30, 2004
Allowance for membership cancellations 20,934 - 183,086 (A) 189,864 (B) 14,156
(A) Charged to deferred revenues account. Includes $240,000 added in connection
with acquisitions in fiscal 2005.
(B) Charges for refunds upon membership cancellations.
F-30