Lendingtree, Inc. quarterly report, Q1 FY2014

Business context and reporting period

Tree.com, Inc., parent of LendingTree, LLC, filed this unaudited Form 10-Q for the quarter ended March 31, 2014. Continuing operations comprise its lending business and smaller auto, education, and home-services businesses. RealEstate.com and LendingTree Loans are reported as discontinued operations.

Financial performance and liquidity

Revenue grew 43%, led by Lending, up 44% to $36.9 million. The number of consumers matched with lenders rose 62%, while average revenue per matched consumer fell 11%, partly reflecting a greater mix of purchase and non-mortgage products. Selling and marketing expense increased 59% to $27.4 million, or 69% of revenue versus 61%; advertising expense rose 70% to $24.8 million.

The operating loss widened despite revenue growth, primarily due to higher marketing costs and litigation expense. Litigation settlements and contingencies were $7.7 million, compared with $1.0 million a year earlier, largely reflecting the Zillow patent trial. Product development expense rose 60% to $1.9 million. Adjusted EBITDA increased despite the GAAP loss; it excludes items including litigation costs, depreciation, and stock compensation.

At March 31, cash and cash equivalents were $89.5 million and restricted cash was $24.1 million, versus $91.7 million and $26.0 million at year-end 2013. Total assets were $149.2 million and shareholders’ equity was $79.3 million. The balance sheet reports $69.9 million of total liabilities, including $31.9 million of current liabilities of discontinued operations. No material continuing-operations debt balance is separately presented. Management said cash, cash flows, and available resources should cover operating and other needs for the next twelve months and beyond.

Material changes, outlook, and risks

• Litigation: In March, a jury found that Zillow, Adchemy, and NexTag did not infringe Tree.com’s patents and found the patents invalid due to inventorship defects. The company appealed and had post-trial motions pending. It estimated possible loss from defendants’ sanctions and attorneys’ fee motions at $0–$9.7 million; management disputed those motions. Q1 trial-related legal costs materially affected results, and the company expected significant cash outflow in Q2 as legal bills were paid.
• Legacy loan exposure: LendingTree Loans’ recorded reserve for losses on previously sold loans was $28.5 million, within an estimated range of $17–$31 million. About $21.2 million was held in escrow for contingent liabilities. The company noted that actual losses could differ significantly and that it lacked precise access to current loan performance data.
• Market outlook: Management cited an average mortgage rate of 4.36% in Q1 2014 and weaker mortgage originations than in 2013. MBA projections cited in the filing anticipated 2014 originations of nearly $1.1 trillion, down 39% from 2013, with rates projected to rise; the filing also noted expected improvement from Q1 levels in later 2014 quarters. These are industry forecasts, not company revenue guidance. Management said it would adjust marketing spending in response to revenue opportunities.
• Other contingencies: Potential losses in the West Virginia class action were estimated at $0.6–$1.95 million, with a $0.6 million reserve and $0.5 million insurance recoverable. A Massachusetts regulatory matter had an estimated range of $0.5–$6.5 million and a $0.5 million reserve. The discontinued-loan loss reserve and related indemnities remain material uncertainties.
• Capital allocation and controls: No shares were repurchased under the public repurchase program during Q1. On May 7, 2014, the board authorized an additional $10 million for repurchases. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.

Important facts for investors to verify

• How much of the $7.7 million litigation expense and associated cash payments recurs, and the outcome and cost of the Zillow appeal and post-trial motions.
• Whether the $28.5 million discontinued-loan reserve adequately covers claims, and how escrowed cash and guarantees affect ultimate exposure.
• Whether higher consumer matching volumes can translate into revenue and margin growth despite lower revenue per match and elevated advertising spending.
• The timing and financial effect of the Massachusetts and West Virginia matters, including insurance recoveries.
• The company’s cash outlook after Q2 legal payments and any subsequent share repurchases.