Business context and reporting period
Tree.com, Inc. (parent of LendingTree, LLC) reported the quarter and nine months ended September 30, 2012. Continuing operations are its Exchanges business, which generates leads and connects consumers with providers. The LendingTree Loans business was sold to Discover on June 6, 2012; LendingTree Loans and the former Real Estate businesses are presented as discontinued operations.
Financial performance and liquidity
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Continuing revenue | $23.3 million | $13.1 million | $53.5 million | $44.0 million |
| Operating income (loss), continuing | $0.8 million | $(3.8) million | $(7.2) million | $(56.5) million |
| Net income (loss), continuing | $0.3 million | $(3.4) million | $(4.8) million | $(44.6) million |
| Net income (loss), all operations | $4.4 million | $13.3 million | $44.3 million | $(60.7) million |
| Adjusted EBITDA, continuing operations | $3.9 million | $(0.5) million | $1.0 million | $(14.3) million |
- Q3 continuing operating margin was 3%, versus negative 29% a year earlier; continuing Adjusted EBITDA margin was 17%, versus negative 4%.
- Q3 continuing revenue rose 78%, driven by a 23% increase in matched requests and higher lending match fees. Nine-month revenue rose 22%.
- Cash and cash equivalents were $89.8 million at September 30, 2012, plus $29.4 million of restricted cash. Continuing operating cash use was $4.3 million and continuing investing cash use was $6.1 million for the nine months; continuing financing provided $3.5 million.
- Warehouse-line borrowings were zero at September 30, 2012; the lines were terminated in July after the LendingTree Loans sale. The balance sheet reports $60.6 million of total liabilities, including discontinued-operation liabilities. Management said available liquidity should fund operating needs for the foreseeable future.
- Q3 diluted EPS was $0.37 overall and $0.02 from continuing operations. Nine-month diluted EPS was $3.92 overall, including discontinued operations, and $(0.42) from continuing operations.
Material changes versus prior periods
- The sale of LendingTree Loans shifted formerly internal mortgage leads to the Exchanges network, boosting continuing revenue while also increasing related marketing expense. Q3 selling and marketing expense rose 58% to $13.4 million; nine-month expense fell 11% to $35.0 million, reflecting lower advertising and marketing efficiencies.
- Q3 total net income declined year over year, chiefly because discontinued-operation income was $4.1 million versus $16.7 million. Nine-month total income includes $24.3 million gain on sale of LendingTree Loans; continuing operations remained loss-making.
- 2011 results were restated for a $29.0 million intangible impairment recorded in the wrong quarter. The nine-month 2011 continuing operating loss includes that charge; Q3 2011 net income was also revised upward by $0.7 million.
- Continuing cash increased year over year in the balance sheet, while total assets declined from $331.3 million at year-end 2011 to $153.5 million, largely reflecting the disposition and reclassification of the loan business.
Outlook, risks, contingencies and unusual items
- No numerical earnings or revenue guidance is provided. Management said it will adjust marketing spending to revenue opportunities and expects Discover marketing-services revenue to continue through the first half of 2013.
- Mortgage market activity is sensitive to interest rates, lender lead demand, housing conditions and seasonal trends. Management noted low mortgage rates and improving home sales, but also stringent lending qualifications and continuing housing-market uncertainty.
- Following the exit from loan origination, the company revised its estimate of losses on previously sold loans. The estimated remaining loss range was $18 million to $33 million; the recorded reserve was $26.6 million. The methodology change reduced the reserve by $6.5 million in Q3. Management cautioned actual losses could differ significantly; loan-level performance information is limited. A $17.1 million sale-proceeds escrow is held against certain contingent liabilities.
- Tree.com remains exposed to mortgage repurchase, indemnification and warranty obligations. It also guarantees certain obligations tied to loans sold to two investors. A separate $1.6 million reserve relates to Discover’s indemnification claim concerning loans listed for transfer but sold before closing.
- One network customer represented 22% of Q3 revenue and 11% of nine-month revenue, creating concentration risk.
- Disclosure controls were judged ineffective at September 30, 2012 due to material weaknesses in income-tax accounting oversight and impairment testing controls. Remediation was underway, but management warned it might not be adequate or timely.
- After quarter-end, the board approved a $3.3 million cash redemption of the CEO’s remaining preferred shares, scheduled to close November 30, 2012. The quarter also included a $0.3 million cumulative interest-expense correction related to those preferred shares.
Important facts for investors to verify
- Progress and final cash impact of resolving loan-loss and indemnification exposures, including the $26.6 million reserve, $17.1 million escrow, and Discover claim.
- Whether the $10.0 million sale payment due on the first anniversary is received, subject to transaction conditions.
- Customer concentration, mortgage lead pricing and volume, and the sustainability of post-sale revenue growth and marketing efficiency.
- Remediation of the two material weaknesses and whether future tax and intangible-asset reporting avoids further errors or restatements.
- Completion and funding of the $3.3 million preferred-stock redemption, and the company’s liquidity after that payment.