Tree.com, Inc. (LendingTree) — Q2 2012 Form 10-Q
Business context and period: The filing covers the three and six months ended June 30, 2012. Tree.com’s continuing business was its Exchanges operation, which generates leads for lenders and other service providers. On June 6, the company sold substantially all operating assets of LendingTree Loans to Discover; LendingTree Loans and the Real Estate businesses are reported as discontinued operations. Unless noted, amounts below are in millions of dollars.
Financial results and liquidity
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Continuing-operations revenue | $16.97 | $16.93 | $30.21 | $30.85 |
| Operating loss, continuing operations | $(2.76) | $(36.97) | $(8.04) | $(52.71) |
| Net loss, continuing operations | $(1.75) | $(25.12) | $(5.02) | $(41.20) |
| Adjusted EBITDA, continuing operations | $(0.32) | $(5.34) | $(2.86) | $(13.75) |
| Net income (loss), including discontinued operations | $25.77 | $(34.51) | $39.92 | $(74.00) |
| Cash used in continuing operating activities | Not presented quarterly | $(6.59) | $(14.94) |
- Q2 continuing revenue was nearly flat year over year; first-half revenue declined 2%. Match-fee revenue fell 6% in Q2 and 4% for the first half, while matched requests rose 2% and 4%, respectively. Lower average fees offset higher request volumes.
- Q2 selling and marketing expense was $10.97 million, 65% of revenue versus 90% a year earlier; first-half expense was $21.62 million, or 72% versus 99%. Management attributed the reduction to lower advertising and improved marketing efficiency.
- Q2 continuing-operations operating loss improved substantially from 2011, in part because 2011 included a $29.25 million impairment charge. The prior-year comparison is restated: a $29.0 million trade-name impairment was moved to Q2 2011 after an accounting error was identified.
- Reported net income includes discontinued operations and a $24.31 million after-tax gain on the LendingTree Loans sale. It should not be read as recurring continuing-operations profitability.
- Cash and cash equivalents were $94.68 million at June 30, versus $45.54 million at year-end 2011; restricted cash was $30.03 million versus $12.45 million. Total cash increased $49.14 million in the first half, with substantial cash flows attributable to discontinued operations and the sale/wind-down.
- Total liabilities were $74.82 million and shareholders’ equity was $87.34 million. The balance sheet includes discontinued-operation liabilities. LendingTree Loans had $0.35 million outstanding on warehouse lines at June 30; all three lines terminated July 21, 2012. The filing does not identify material continuing-operation borrowings.
Material changes, outlook, and risks
- The Discover transaction had an approximately $55.9 million cash purchase price: $8.0 million paid before closing, $37.9 million at closing, and $10.0 million due on the first anniversary subject to conditions. Approximately $17.1 million is held in escrow for contingent liabilities. The company also agreed to provide Discover marketing services for about 17 months after closing, expected to contribute revenue through the first half of 2013.
- Management said liquidity should fund operating needs for the foreseeable future and expects to use part of the sale proceeds for capital and other expenditures. It expects certain operating expense ratios to decline as formerly internal mortgage leads are sold through the Exchange; it will continue to adjust marketing spend to revenue opportunities. No quantified earnings or revenue guidance was provided.
- Legacy mortgage-loan indemnification, repurchase and premium-repayment obligations remain with the company. The estimated range of remaining possible losses for representations and warranties was $30–$40 million; the recorded loss reserve was $33.1 million. The $17.1 million escrow and Discover indemnification claim add uncertainty. Management cautioned that it cannot precisely determine maximum exposure.
- Disclosure controls were deemed ineffective at June 30 because of material weaknesses in tax accounting oversight and controls over impairment testing. The company had restated 2011 results for the $29.0 million impairment and said remediation was underway, but might not be adequate or timely.
- Other stated risks include mortgage-market and interest-rate volatility, insufficient lender demand to absorb leads formerly handled by LendingTree Loans, dependence on network lenders and marketing channels, regulatory and privacy obligations, litigation, and a three-year restriction on originating, funding or selling mortgages in the United States following the sale.
- A Discover indemnification claim over loans not conveyed as agreed had a $1.6 million reserve. A putative class-action matter against LendingTree Loans was appealed by plaintiffs after judgment for the company. The North Carolina Department of Revenue’s amended July 2012 audit reports confirmed no further franchise taxes were due.
Important facts for investors to verify
- Whether lead demand and pricing can absorb the additional mortgage leads after the LendingTree Loans sale, and how results develop after the transition.
- The amount and timing of the $10 million contingent sale payment, release of the $17.1 million escrow, and ultimate costs of legacy loan-loss obligations versus the $30–$40 million estimated exposure.
- Whether the company remediates both material weaknesses and avoids further restatements or reporting delays.
- Underlying continuing-business profitability and cash generation, excluding the sale gain and discontinued-operation results.
- Performance and duration of Discover marketing-services revenue, and whether non-mortgage exchanges can grow while maintaining acceptable margins.