e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2008
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
INTERSECTIONS INC.
(Exact name of registrant as specified in the charter)
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DELAWARE
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54-1956515 |
(State or other jurisdiction of incorporation or
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(I.R.S. Employer |
organization)
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Identification Number) |
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14901 Bogle Drive, Chantilly, Virginia
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20151 |
(Address of principal executive office)
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(Zip Code) |
(703) 488-6100
(Registrants telephone number including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule
12b-2).
Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the last practicable date:
As of November 3, 2008, there were 18,382,103 shares of common stock, $0.01 par value, issued and
17,315,687 shares outstanding, with 1,066,416 shares of treasury stock.
Form 10-Q
September 30, 2008
Table of Contents
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Page |
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PART I. FINANCIAL INFORMATION |
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Item 1. Financial Statements |
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3 |
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Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2008 and 2007 (unaudited) |
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3 |
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Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007 (unaudited) |
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4 |
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Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007 (unaudited) |
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5 |
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Notes to Condensed Consolidated Financial Statements (unaudited) |
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6 |
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |
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24 |
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Item 3. Quantitative and Qualitative Disclosure About Market Risk |
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42 |
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Item 4. Controls and Procedures |
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43 |
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PART II. OTHER INFORMATION |
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Item 1. Legal Proceedings |
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43 |
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Item 6. Exhibits |
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44 |
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2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
INTERSECTIONS INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2008 |
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2007 |
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2008 |
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2007 |
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Revenue |
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$ |
93,415 |
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$ |
71,403 |
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$ |
273,521 |
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$ |
194,708 |
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Operating expenses: |
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Marketing |
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12,776 |
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9,390 |
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38,573 |
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25,325 |
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Commissions |
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22,319 |
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13,992 |
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61,680 |
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35,830 |
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Cost of revenue |
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30,439 |
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27,074 |
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88,719 |
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75,070 |
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General and administrative |
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17,712 |
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14,968 |
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51,031 |
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44,268 |
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Depreciation |
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2,438 |
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2,221 |
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7,107 |
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6,669 |
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Amortization |
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2,739 |
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911 |
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8,132 |
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2,336 |
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Total operating expenses |
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88,423 |
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68,556 |
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255,242 |
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189,498 |
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Income from operations |
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4,992 |
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2,847 |
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18,279 |
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5,210 |
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Interest income |
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46 |
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171 |
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218 |
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667 |
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Interest expense |
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(537 |
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(304 |
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(1,722 |
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(968 |
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Other expense, net |
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(442 |
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(18 |
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(543 |
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(23 |
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Income before income taxes and minority interest |
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4,059 |
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2,696 |
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16,232 |
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4,886 |
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Income tax expense |
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(1,736 |
) |
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(1,269 |
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(6,715 |
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(2,196 |
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Income before minority interest |
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2,323 |
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1,427 |
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9,517 |
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2,690 |
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Minority interest in net loss of Screening International, LLC |
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374 |
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297 |
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971 |
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853 |
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Net income |
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$ |
2,697 |
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$ |
1,724 |
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$ |
10,488 |
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$ |
3,543 |
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Net income per share basic |
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$ |
0.16 |
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$ |
0.10 |
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$ |
0.61 |
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$ |
0.21 |
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Net income per share diluted |
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$ |
0.15 |
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$ |
0.10 |
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$ |
0.60 |
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$ |
0.20 |
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Weighted average common shares outstanding basic |
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17,296 |
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17,156 |
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17,244 |
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17,086 |
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Weighted average common shares outstanding diluted |
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17,707 |
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17,560 |
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17,586 |
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17,492 |
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See Notes to Condensed Consolidated Financial Statements
3
INTERSECTIONS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
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September 30, |
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December 31, |
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2008 |
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2007 |
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ASSETS |
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CURRENT ASSETS: |
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Cash and cash equivalents |
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$ |
16,344 |
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$ |
19,780 |
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Short-term investments |
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4,955 |
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Accounts receivable, net of allowance for doubtful accounts $182 (2008) and $37 (2007) |
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25,991 |
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25,471 |
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Prepaid expenses and other current assets |
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5,608 |
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6,217 |
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Income tax receivable |
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1,449 |
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4,329 |
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Deferred subscription solicitation costs |
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26,742 |
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21,912 |
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Total current assets |
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81,089 |
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77,709 |
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PROPERTY AND EQUIPMENTnet |
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17,042 |
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18,817 |
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LONG-TERM INVESTMENT |
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3,327 |
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GOODWILL |
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79,905 |
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76,506 |
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INTANGIBLE ASSETSnet |
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36,397 |
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16,855 |
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OTHER ASSETS |
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21,842 |
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16,381 |
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TOTAL ASSETS |
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$ |
239,602 |
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$ |
206,268 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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CURRENT LIABILITIES: |
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Note payablecurrent portion |
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$ |
7,013 |
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$ |
3,346 |
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Note payable to Control Risks Group Ltd. |
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900 |
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900 |
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Capital leasescurrent portion |
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603 |
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1,001 |
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Accounts payable |
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8,668 |
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10,647 |
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Accrued expenses and other current liabilities |
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19,156 |
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15,187 |
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Accrued payroll and employee benefits |
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5,124 |
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4,945 |
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Commissions payable |
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829 |
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2,413 |
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Deferred revenue |
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4,914 |
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2,886 |
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Deferred tax liability net, current portion |
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7,058 |
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6,019 |
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Total current liabilities |
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54,265 |
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47,344 |
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NOTE PAYABLE less current portion |
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36,337 |
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22,347 |
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OBLIGATIONS UNDER CAPITAL LEASESless current portion |
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250 |
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699 |
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OTHER LONG-TERM LIABILITIES |
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2,480 |
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2,071 |
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DEFERRED TAX LIABILITYnet, less current portion |
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8,733 |
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8,935 |
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TOTAL LIABILITIES |
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102,065 |
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81,396 |
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MINORITY INTEREST |
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9,067 |
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10,024 |
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STOCKHOLDERS EQUITY: |
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Common stock at $.01 par value; shares authorized, 50,000; shares issued, 18,381
(2008) and 18,172 (2007); shares outstanding, 17,315 (2008) and 17,106 (2007) |
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184 |
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182 |
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Additional paid-in capital |
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102,613 |
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99,706 |
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Treasury stock, 1,066 shares at cost |
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(9,516 |
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(9,516 |
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Retained earnings |
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34,845 |
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24,357 |
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Accumulated other comprehensive income: |
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Cash flow hedge |
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208 |
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Other |
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136 |
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119 |
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Total stockholders equity |
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128,470 |
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114,848 |
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TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
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$ |
239,602 |
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$ |
206,268 |
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See Notes to Condensed Consolidated Financial Statements
4
INTERSECTIONS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
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Nine Months Ended |
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September 30, |
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2008 |
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2007 |
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Net income |
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$ |
10,488 |
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$ |
3,543 |
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Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
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Depreciation |
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7,067 |
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6,756 |
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Amortization of intangible assets |
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8,132 |
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2,336 |
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Amortization of gain from sale leaseback |
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(29 |
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(72 |
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Loss on disposal of fixed assets |
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60 |
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Amortization of debt issuance cost |
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76 |
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57 |
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Provision for doubtful accounts |
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145 |
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19 |
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Share based compensation |
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3,251 |
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2,026 |
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Amortization of deferred subscription solicitation costs |
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38,624 |
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24,125 |
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Minority interest in net loss of Screening International, LLC |
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(971 |
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(853 |
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Foreign currency transaction losses, net |
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293 |
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29 |
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Changes in assets and liabilities, net of businesses acquired: |
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Accounts receivable |
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(557 |
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(4,523 |
) |
Prepaid expenses and other current assets |
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609 |
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(1,505 |
) |
Income tax receivable |
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2,880 |
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1,296 |
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Deferred subscription solicitation costs |
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(46,059 |
) |
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(34,122 |
) |
Other assets |
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(1,479 |
) |
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(6,585 |
) |
Accounts payable |
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(2,104 |
) |
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2,605 |
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Accrued expenses and other current liabilities |
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4,095 |
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2,228 |
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Accrued payroll and employee benefits |
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179 |
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(2,473 |
) |
Commissions payable |
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(1,584 |
) |
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872 |
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Deferred revenue |
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2,028 |
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(2,546 |
) |
Deferred income tax, net |
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(202 |
) |
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(26 |
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Other long-term liabilities |
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334 |
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2,273 |
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Net cash provided by (used in) operating activities |
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25,216 |
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(4,480 |
) |
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NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES: |
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Acquisition of property and equipment |
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(5,400 |
) |
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(4,325 |
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(Purchase) sale of short-term investments |
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(4,955 |
) |
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10,453 |
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Purchase of long-term investment |
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(3,327 |
) |
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Cash paid in the acquisition of Intersections Insurance Services, Inc |
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(5 |
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Cash paid in the acquisition of Net Enforcers, Inc., net of cash received |
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(867 |
) |
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Cash paid in the acquisition of Hide N Seek, LLC, net of cash received |
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(936 |
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Cash paid in the acquisition of intangible membership agreements |
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(30,176 |
) |
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Net cash (used in) provided by investing activities |
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(44,725 |
) |
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5,187 |
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NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES: |
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Note receivable |
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(750 |
) |
Repayments on note payable |
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(14,955 |
) |
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(2,546 |
) |
Capital lease payments |
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(846 |
) |
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(820 |
) |
Borrowings under credit facility |
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32,611 |
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|
450 |
|
Debt issuance costs |
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(132 |
) |
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Cash proceeds from stock options exercised |
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175 |
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|
940 |
|
Tax benefit of stock options exercised |
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|
372 |
|
Withholding tax payment on vesting of restricted stock units |
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(517 |
) |
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Repurchase of treasury stock |
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(471 |
) |
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Net cash provided by (used in) financing activities |
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16,336 |
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(2,825 |
) |
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EFFECT OF EXCHANGE RATE ON CASH |
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(263 |
) |
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|
71 |
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DECREASE IN CASH AND CASH EQUIVALENTS |
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(3,436 |
) |
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(2,047 |
) |
CASH AND CASH EQUIVALENTSBeginning of period |
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19,780 |
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15,580 |
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CASH AND CASH EQUIVALENTSEnd of period |
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$ |
16,344 |
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$ |
13,533 |
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: |
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Cash paid for interest |
|
$ |
1,348 |
|
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$ |
853 |
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Cash paid for taxes |
|
$ |
3,802 |
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$ |
1,575 |
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SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES: |
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Equipment accrued but not paid |
|
$ |
353 |
|
|
$ |
531 |
|
|
|
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|
See Notes to Condensed Consolidated Financial Statements
5
INTERSECTIONS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Business
We offer consumers a variety of consumer protection services and other consumer products and
services primarily on a subscription basis. Our services help consumers protect themselves against
identity theft or fraud and understand and monitor their credit profiles and other personal
information. Through our subsidiary, Intersections Insurance Services, Inc. (IISI), we expanded
our portfolio of services to include consumer discounts on healthcare, home and auto related
expenses, access to professional financial and legal information, and life, accidental death and
disability insurance products. Our consumer services are offered through relationships with
clients, including many of the largest financial institutions in the United States and Canada, and
clients in other industries. In addition, we also offer our services directly to consumers.
Through our majority-owned subsidiary, Screening International, LLC (SI), we provide personnel
and vendor background screening services to businesses worldwide. In May 2006, we created SI with
Control Risks Group, Ltd., (CRG), a company based in the UK, by combining our subsidiary,
American Background Information Services, Inc. (ABI) with CRGs background screening division. We
own 55% of SI, and have the right to designate a majority of the five-member board of directors.
CRG owns 45% of SI. We and CRG have agreed to cooperate to meet any future financing needs of SI,
including guaranteeing third party loans and making additional capital contributions on a pro rata
basis, if necessary, subject to certain capital call and minority protection provisions.
SI has offices in Virginia, the UK, and Singapore. SIs clients include leading United States, UK
and global companies in such areas as manufacturing, healthcare, telecommunications and financial
services. SI provides a variety of risk management tools for the purpose of personnel and vendor
background screening, including criminal background checks, driving records, employment
verification and reference checks, drug testing and credit history checks.
We have three reportable segments. Our Consumer Products and Services segment includes our consumer
protection and other consumer products and services. This segment consists of identity theft
management tools, membership product offerings and other subscription based services such as life
and accidental death insurance. Our Background Screening segment includes the personnel and vendor
background screening services provided by SI. Our Other segment includes services from our
relationship with a third party that administers referrals for identity theft to major banking
institutions and breach services reallocated from the Consumer Products and Services segment. This
segment also includes the software management solutions for the bail bond industry provided by
Captira Analytical, LLC (Captira) and corporate brand protection provided by Net Enforcers, Inc.
(Net Enforcers).
2. Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
The accompanying unaudited condensed consolidated financial statements have been prepared by us in
accordance with accounting principles generally accepted in the United States of America. Our
financial results include Captira, which we acquired from Hide NSeek, LLC on August 7, 2007 and
Net Enforcers, which we acquired on November 30, 2007. In the opinion of management, all
adjustments consisting of only normal recurring adjustments necessary for a fair presentation of
our financial position, the results of our operations and cash flows have been made. All
significant intercompany transactions have been eliminated. The condensed consolidated results of
operations for the interim periods are not necessarily indicative of results for the full year.
These condensed consolidated financial statements do not include all the information or notes
necessary for a complete presentation and, accordingly, should be read in conjunction with our
audited consolidated financial statements and accompanying notes for the year ended December 31,
2007, as filed in our Annual Report on Form 10-K.
6
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
We consider all highly liquid investments, including those with an original maturity of three
months or less, to be cash equivalents. Cash and cash equivalents consist primarily of
interest-bearing accounts and short-term U.S. treasury securities with original maturities less
than or equal to 90 days. Interest income on these short-term investments is recognized when
earned.
Investments
Our short-term investments consist of short-term U.S. Treasury securities with original maturities
greater than 90 days but no greater than one year. These investments are categorized as held to
maturity, in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities (SFAS 115), and are carried at amortized cost because we have both the intent and the
ability to hold these investments until they mature. Discounts are accreted into earnings over the
life of the investment. Interest income is recognized when earned. There are no restrictions on
the withdrawal of these investments.
Our long-term investments consist of investments in equity shares of privately held companies and
are evaluated in accordance Accounting Principles Board Opinion (APB) No. 18, The Equity Method
of Accounting for Investments in Common Stock (APB 18). During the three months ended September
30, 2008, we made a long-term investment of approximately $3.3 million in preferred stock of a
private company to expand our comprehensive identity theft protection services to consumers. The
investment is included in Long-Term Investment on our condensed consolidated balance sheet. See
Note 7, Long-Term Investments.
We evaluate impairment of investments in accordance with Emerging Issues Task Force 03-01, The
Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. Accordingly,
we consider both triggering events and tangible evidence that investments are recoverable within a
reasonable period of time, as well as its intent and ability to hold investments that may have
become temporarily or otherwise impaired.
Foreign Currency Translation
We account for foreign currency translation and transaction gains and losses in accordance with
Statement of Financial Accounting Standards (SFAS) No. 52, Foreign Currency Translation. We
translate the assets and liabilities of our foreign subsidiaries at the exchange rate in effect at
the end of the period and the results of operations at the average rate throughout the period. The
translation adjustments are recorded into other comprehensive income as a separate component of
shareholders equity, while transaction gains and losses are included in net income.
Accounts and Note Receivable
Accounts receivable represents trade receivables as well as in-process credit card billings. We
provide an allowance for doubtful accounts on trade receivables based upon factors related to
historical trends, a specific review of outstanding invoices and other information. We also record
a provision for estimated sales refunds and allowances related to sales in the same period that the
related revenues are recorded. These estimates are based on historical refunds and other known
factors.
In December 2006, we entered into a note receivable with Captira in the amount of $750 thousand. In
addition, we increased the note receivable by $750 thousand in 2007. In conjunction with the
acquisition of Captira, we forgave the outstanding note balance of $1.5 million in the year ended
December 31, 2007, including $67 thousand of interest.
7
Goodwill and Other Intangibles
We record, as goodwill, the excess of purchase price over the fair value of the identifiable net
assets acquired in a purchase transaction. The fair value of the identifiable net assets acquired
is determined based upon a third party valuation, evaluation of other information and management
review.
SFAS No. 142, Goodwill and Other Intangible Assets, prescribes a two-step process for impairment
testing of goodwill and intangibles with indefinite lives, which is required to be performed
annually, as well as when an event triggering impairment may have occurred. The first step tests
for impairment, while the second step, if necessary, measures the impairment. We have elected to
perform our annual analysis as of October 31 of each fiscal year. As of September 30, 2008, no
indicators of impairment have been identified.
Intangible assets subject to amortization include trademarks and customer, marketing and technology
related assets. Such intangible assets are amortized on a straight-line or accelerated basis over
their estimated useful lives, which are generally three to ten years.
Derivative Financial Instruments
We account for derivative financial instruments in accordance with SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended and interpreted. SFAS No. 133 requires us
to recognize all derivative instruments on the balance sheet at fair value, and contains accounting
guidance for hedging instruments, which depend on the nature of the hedge relationship. All
financial instrument positions are intended to be used to reduce risk by hedging an underlying
economic exposure. In 2008, we entered into certain interest rate swap transactions that convert
our variable-rate debt to fixed-rate debt. Our interest rate swaps are related to variable interest
rate risk exposure associated with our long-term debt and are intended to manage this risk. The
counterparty to our derivative agreements is a major financial institution for which we continually
monitor its position and credit ratings. We do not anticipate nonperformance by this financial
institution. The effective portion of the change in fair value of interest rate swaps designated as
cash flow hedges are recorded in the shareholders equity section in the accompanying condensed
consolidated balance sheet. The ineffective portion of the interest rate swaps, if any, is recorded
in interest expense in the accompanying condensed consolidated statement of income.
The interest rate swaps on our outstanding term loan amount and a portion of our outstanding
revolving line of credit have initial notional amounts of $28.0 million and $15.0 million,
respectively. The swaps modify our interest rate exposure by effectively converting the variable
rate on our term loan (3.74% at September 30, 2008) to a fixed rate of 3.20% per annum through
December 2011 and on our revolving line of credit (3.74% at September 30, 2008) to a fixed rate of
3.44% per annum through December 2011. The notional amount of the term loan interest rate swap
amortizes on a monthly basis through December 2011 and the notional amount of the line of credit
interest rate swap amortizes to $10.0 million in 2009 and terminates in December 2011. We use the
monthly LIBOR interest rate and have the intent and ability to continue to use this rate on our
hedged borrowings. Accordingly, we do not recognize any ineffectiveness on the swaps as allowed
under the hypothetical derivative method of Derivative Implementation Group Issue No. G7, Cash Flow Hedges: Measuring the Ineffectiveness
of a Cash Flow Hedge under Paragraph 30(b) When the Shortcut Method Is Not Applied. For the three
and nine months ended September 30, 2008, there was no ineffective portion of the hedge and
therefore, no impact to the condensed consolidated statement of income.
Fair Value Measurements
We adopted SFAS No. 157, Fair Value Measurements, as amended, on January 1, 2008. SFAS No. 157
defines fair value, establishes a framework and gives guidance regarding the methods used for
measuring fair value, and expands disclosures about fair value measurements. In February 2008, the
FASB released a FASB Staff Position (FSP FAS 157-2Effective Date of FASB Statement No. 157) which
delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial statements on a
recurring basis (at least annually) to fiscal years beginning after November 15, 2008. The partial
adoption of SFAS No. 157 for financial assets and liabilities did not have a material impact on our
condensed consolidated financial statements. We are currently analyzing the impact, if any, of
adopting SFAS No. 157 for non-financial assets and liabilities.
SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be
received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants. As such, fair value is a market-based measurement that
8
should be determined based on assumptions that market participants would use in pricing an asset or
liability. FASB Staff Position (FSP) No. 157-3, Determining the Fair Value of an Asset When the
Market For that Asset is not Active, clarifies the application of SFAS No. 157 in a market that is
not active and provides an example to illustrate key considerations in determining the fair value
of a financial asset when the market for that financial asset is not active. As a basis for
considering such assumptions, SFAS No. 157 establishes a three-tier value hierarchy, which
prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as
quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets
that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there
is little or no market data, which require us to develop our own assumptions. This hierarchy
requires us to use observable market data, when available, and to minimize the use of unobservable
inputs when determining fair value. On a recurring basis, we measure certain financial assets and
liabilities at fair value, including marketable securities and our interest rate swaps. See Note 4,
Fair Value Measurements.
We adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial
LiabilitiesIncluding an amendment of FASB Statement No. 115, on January 1, 2008. SFAS No. 159
expands the use of fair value accounting but does not affect existing standards which require
assets or liabilities to be carried at fair value. The objective of SFAS No. 159 is to improve
financial reporting by providing companies with the opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. Under SFAS No. 159, a company may elect to use fair value to
measure eligible items at specified election dates and report unrealized gains and losses on items
for which the fair value option has been elected in earnings at each subsequent reporting date.
Eligible items include, but are not limited to, accounts and loans receivable, available-for-sale
and held-to-maturity securities, equity method investments, accounts payable, guarantees, issued
debt and firm commitments. Currently, we have not expanded our eligible items subject to the fair
value option under SFAS No. 159.
For the financial instruments that are not accounted for under SFAS 157, which consist primarily of
cash and cash equivalents, short-term government debt instruments, trade accounts receivables,
notes payable, leases payable, accounts payable and short-term and long-term debt, we consider the
recorded value of the financial instruments to approximate the fair value based on the liquidity of
these financial instruments.
Revenue Recognition
We recognize revenue on 1) identity theft, credit management and background services, 2) accidental
death insurance and 3) other membership products.
Our products and services are offered to consumers primarily on a monthly subscription basis.
Subscription fees are generally billed directly to the subscribers credit card, mortgage bill or
demand deposit accounts. The prices to subscribers of various configurations of our products and
services range generally from $4.99 to $25.00 per month. As a means of allowing customers to become
familiar with our services, we sometimes offer free trial or guaranteed refund periods. No revenues
are recognized until applicable trial periods are completed.
Identity Theft, Credit Management and Background Services
We recognize revenue from our services in accordance with Staff Accounting Bulletin (SAB) No.
101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, Revenue Recognition.
Consistent with the requirements of SAB No.s 101 and 104, revenue is recognized when: a)
persuasive evidence of arrangement exists as we maintain signed contracts with all of our large
financial institution customers and paper and electronic confirmations with individual purchases,
b) delivery has occurred once the product is transmitted over the internet, c) the sellers price
to the buyer is fixed as sales are generally based on contract or list prices and payments from
large financial institutions are collected within 30 days with no significant write-offs, and d)
collectability is reasonably assured as individual customers pay by credit card which has limited
our risk of non-collection. Revenue for monthly subscriptions is recognized in the month the
subscription fee is earned. For subscriptions with refund provisions whereby only the prorated
subscription fee is refunded upon cancellation by the subscriber, deferred subscription fees are
recorded when billed and amortized as subscription fee revenue on a straight-line basis over the
subscription period, generally one year. We generate revenue from one-time credit reports and
background screenings which are recognized when the report is provided to the customer
electronically, which is generally at the time of completion.
Revenue for annual subscription fees must be deferred if the subscriber has the right to cancel the
service. Annual subscriptions include subscribers with full refund provisions at any time during
the subscription period and pro-rata refund provisions. Revenue
9
related to annual subscription with full refund provisions is recognized on the expiration of these
refund provisions. Revenue related to annual subscribers with pro-rata provisions is recognized
based on a pro rata share of revenue earned. An allowance for discretionary subscription refunds is
established based on our actual experience.
We also provide services for which certain financial institution clients are the primary obligors
directly to their customers. Revenue from these arrangements is recognized when earned, which is at
the time we provide the service, generally on a monthly basis.
The amount of revenue recorded by us is determined in accordance with Financial Accounting
Standards Boards (FASB) Emerging Issues Task Force (EITF) 99-19, Reporting Revenue Gross as a
Principal versus Net as an Agent, which addresses whether a company should report revenue based on
the gross amount billed to a customer or the net amount retained by us (amount billed less
commissions or fees paid). We generally record revenue on a gross basis in the amount that we bill
the subscriber when our arrangements with financial institution clients provide for us to serve as
the primary obligor in the transaction, we have latitude in establishing price and we bear the credit risk for the amount billed to the subscriber. We generally
record revenue in the amount that we bill our financial institution clients, and not the amount
billed to their customers, when our financial institution client is the primary obligor,
establishes price to the customer and bears the credit risk.
Accidental Death Insurance and Other Membership Products
We recognize revenue from our services in accordance with SAB No. 101, as amended by SAB No. 104.
Consistent with the requirements of SAB No.s 101 and 104 revenue is recognized when: a) persuasive
evidence of arrangement exists as we maintain paper and electronic confirmations with individual
purchases, b) delivery has occurred at the completion of a product trial period, c) the sellers
price to the buyer is fixed as the price of the product is agreed to by the customer as a condition
of the sales transaction which established the sales arrangement, and d) collectability is
reasonably assured as evidenced by our collection of revenue through the monthly mortgage payments
of our customers or through checking account debits to our customers accounts. Revenues from
insurance contracts are recognized when earned. Marketing of our insurance products generally
involves a trial period during which time the product is made available at no cost to the customer.
No revenues are recognized until applicable trial periods are completed.
The amount of revenue recorded by us is determined in accordance with FASBs EITF 99-19. For
insurance products, we generally record revenue on a net basis as we perform as an agent or broker
for the insurance products without assuming the risks of ownership of the insurance products. For
membership products, we generally record revenue on a gross basis as we serve as the primary
obligor in the transactions, have latitude in establishing price and bear credit risk for the
amount billed to the subscriber.
We participate in agency relationships with insurance carriers that underwrite insurance products
offered by us. Accordingly, insurance premiums collected from customers and remitted to insurance
carriers are excluded from our revenues and operating expenses. Insurance premiums collected but
not remitted to insurance carriers as of September 30, 2008 and December 31, 2007 totaled $2.2
million and $1.3 million, respectively, and is included in accrued expenses and other current
liabilities in our condensed consolidated balance sheet.
Other Monthly Subscription Products
We generate revenue from other types of subscription based products provided from our Other
segment. We recognize revenue on services provided from identity theft referrals from major banking
institutions and breach services previously allocated to the Consumer Products and Services
segment. We also recognize revenue from providing management service solutions, offered by Captira,
on a monthly subscription basis, and online brand protection and brand monitoring, offered by Net
Enforcers, on a monthly basis.
Deferred Subscription Solicitation and Advertising
We expense advertising costs the first time advertising takes place, except for direct-response
marketing costs. Direct-response marketing costs include telemarketing, web-based marketing and
direct mail costs related directly to subscription solicitation. In accordance with American
Institute of Certified Public Accountants Statement of Position (SOP) 93-7, Reporting on
Advertising Costs, direct-response advertising costs are deferred and charged to operations on a
cost pool basis as the corresponding revenues from subscription fees are recognized, but not for
more than one year.
10
The recoverability of the amounts capitalized as deferred subscription solicitation costs are
evaluated at each balance sheet date, in accordance with SOP 93-7, by comparing the carrying
amounts of such assets on a cost pool basis to the probable remaining future benefit expected to
result directly from such advertising. Probable remaining future benefit is estimated based upon
historical customer patterns, and represents net revenues less costs to earn those revenues.
Commission Costs
In accordance with SAB No. 101, as amended by SAB No. 104, commissions that relate to annual
subscriptions with full refund provisions and monthly subscriptions are expensed when incurred,
unless we are entitled to a refund of the commissions. If annual subscriptions are cancelled prior
to their initial terms, we are generally entitled to a full refund of the previously paid
commission for those annual subscriptions with a full refund provision and a pro-rata refund, equal
to the unused portion of the subscription, for those annual subscriptions with a pro-rata refund
provision. Commissions that relate to annual subscriptions with full commission refund provisions
are deferred until the earlier of expiration of the refund privileges or cancellation. Once the
refund privileges have expired, the commission costs are recognized ratably in the same pattern
that the related revenue is recognized. Commissions that relate to annual subscriptions with
pro-rata refund provisions are deferred and charged to operations as the corresponding revenue is
recognized. If a subscription is cancelled, upon receipt of the refunded commission from our
client, we record a reduction to the deferred commission.
We have prepaid commission agreements with some of our clients. Under these agreements, we pay a
one-time upfront commission on new subscribers in lieu of ongoing commission payments. We amortize
these upfront commissions, on an accelerated basis, over a period of time not to exceed three
years, which is the average expected life of customers. The short-term portion of the prepaid
commissions are shown in prepaid expenses and other current assets on our condensed consolidated
balance sheet. The long-term portion of the prepaid commissions are shown in other assets on our
condensed consolidated balance sheet. Amortization is included in commissions expense on our
condensed consolidated statement of income.
Deferred subscription solicitation costs included in the accompanying balance sheet as of September
30, 2008 and December 31, 2007, were $30.9 million and $23.5 million, which includes $4.2 million
and $1.6 million reported in other assets, respectively, on our condensed consolidated balance
sheet. Amortization of deferred subscription solicitation and commission costs, which are included
in either marketing or commissions expense in our condensed consolidated statement of income, for
the three months ended September 30, 2008 and 2007 were $13.2 million and $9.4 million,
respectively. Amortization of deferred subscription solicitation and commission costs for the nine
months ended September 30, 2008 and 2007 were $38.6 million and $24.1 million, respectively.
Subscription solicitation costs expensed as incurred related to marketing costs, which are included
in marketing expenses in our condensed consolidated statement of income, as they did not meet the
criteria for deferral in accordance with SOP 93-7, for the three months ended September 30, 2008
and 2007 were $1.1 million and $215 thousand, respectively. Subscription solicitation costs
expensed as incurred related to marketing costs in the nine months ended September 30, 2008 and
2007 were $3.5 million and $1.9 million, respectively.
Deferred Debt Issuance Costs
Deferred debt issue costs are stated at cost, less accumulated amortization, and are included in
other assets on our condensed consolidated balance sheet. Amortization of debt issue costs is over
the life of the loan using the effective interest method. Amortization is included in interest
expense on our condensed consolidated statement of income.
Software Development Costs
We develop software for internal use and capitalize software development costs incurred during the
application development stage in accordance with SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, and EITF 00-2, Accounting for Web Site Development
Cost. Costs incurred prior to and after the application development stage are charged to expense.
When the software is ready for its intended use, capitalization ceases and such costs are amortized
on a straight-line basis over the estimated useful life, which is generally three to five years.
11
In accordance with SOP 98-1, we regularly review our capitalized software projects for impairment
in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. We did not have any impairments in the three or nine months ended September 30,
2008 and 2007.
Income Taxes
We account for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes,
which requires an asset and liability approach to financial accounting and reporting 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. Deferred tax assets are reduced by a valuation allowance if, based
on the weight of available evidence, it is more likely than not (a likelihood of more than 50%)
that some portion or all of the deferred tax assets will not be realized.
We believe that our tax positions comply with applicable tax law. As a matter of course, we may be
audited by various taxing authorities and these audits may result in proposed assessments where the
ultimate resolution may result in us owing additional taxes. Financial Interpretation (FIN) No.
48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109,
Accounting for Income Taxes, addresses the determination of whether tax benefits claimed or
expected to be claimed on a tax return should be recorded in the financial statements. Under FIN
No. 48, we may recognize the tax benefit from an uncertain tax position only if it is more likely
than not that the tax position will be sustained on examination by the taxing authorities, based on
the technical merits of the position. The tax benefits recognized in the financial statements from
such a position should be measured based on the largest benefit that has a greater than fifty
percent likelihood of being realized upon ultimate settlement.
Share-Based Compensation
We currently have three equity incentive plans, the 1999 and 2004 Stock Option Plans and the 2006
Stock Incentive Plan which provide us with the opportunity to compensate selected employees with
stock options, restricted stock and restricted stock units. A stock option entitles the recipient
to purchase shares of common stock from us at the specified exercise price. Restricted stock and
restricted stock units (RSUs) entitle the recipient to obtain stock or stock units, $.01 par
value, which vest over a set period of time. RSUs are granted at no cost to the employee and
employees do not need to pay an exercise price to obtain the underlying common stock. All grants or
awards made under the Plans are governed by written agreements between us and the participants.
We account for share-based compensation under the provisions of SFAS No. 123 (revised 2004),
Share-Based Payment. We use the Black-Scholes option-pricing model to value all options and the
straight-line method to amortize this fair value as compensation cost over the requisite service
period.
Total share-based compensation expense included in general and administrative expenses in the
accompanying condensed consolidated statements of operations for the three months ended September
30, 2008 and 2007 was $1.1 million and $737 thousand, respectively. Total share-based compensation
expense included in general and administrative expenses on our condensed consolidated statements of
operations for the nine months ended September 30, 2008 and 2007 was $3.3 million and $2.0 million,
respectively.
The fair value of each option granted has been estimated as of the date of grant using the
Black-Scholes option pricing model with the following weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
2008 |
|
2007 |
Expected dividend yield |
|
|
0 |
% |
|
|
0 |
% |
Expected volatility |
|
|
37.7 |
% |
|
|
38.0 |
% |
Risk free interest rate |
|
|
3.1 |
% |
|
|
4.5 |
% |
Expected life of options |
|
|
6.2 years |
|
|
|
6.3 years |
|
Expected Dividend Yield. The Black-Scholes valuation model requires an expected dividend yield as
an input. We have not issued dividends in the past nor do we expect to issue dividends in the
future. As such, the dividend yield used in our valuations for the three and nine months ended
September 30, 2008 and 2007 were zero.
Expected Volatility. The expected volatility of the options granted was estimated based upon the
average volatility of comparable public companies, as described in the SECs Staff Accounting
Bulletin (SAB) No. 107. Due to the fact that we have only been a
12
public company for approximately four years, we believe that there is not a substantive share price
history to calculate accurate volatility and have elected to use the average volatility of
companies similar to us in size or industry. At the point when we have enough public history, we
will reconsider the utilization of our own stock price volatility.
Risk-free Interest Rate. The yield on actively traded non-inflation indexed U.S. Treasury notes was
used to extrapolate an average risk-free interest rate based on the expected term of the underlying
grants.
Expected Term. The expected term of options granted during the nine months ended September 30, 2008
and 2007 was determined under the simplified calculation provided in SAB No. 107, as amended by SAB
No. 110 ((vesting term + original contractual term)/2). For the majority of grants valued during
the nine months ended September 30, 2008 and 2007, the options had graded vesting over 3 and 4
years (equal vesting of options annually) and the contractual term was 10 years.
Net Income Per Common Share
Basic and diluted income per share are determined in accordance with the provisions of SFAS No.
128, Earnings Per Share. Basic income per common share is computed using the weighted average
number of shares of common stock outstanding for the period. Diluted income per share is computed
using the weighted average number of shares of common stock, adjusted for the dilutive effect of
potential common stock. Potential common stock, computed using the treasury stock method or the
if-converted method, includes the potential exercise of stock options under our share-based
employee compensation plans, our restricted stock units and warrants.
For the three and nine months ended September 30, 2008 and 2007, options to purchase 4.3 million
and 3.0 million shares, respectively, of common stock have been excluded from the computation of
diluted earnings per share as their effect would be anti-dilutive. These shares could dilute
earnings per share in the future.
A reconciliation of basic income per common share to diluted income per common share is as follows:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands, except per |
|
|
(in thousands, except per |
|
|
|
share data) |
|
|
share data) |
|
Net income available to common shareholders basic and diluted |
|
$ |
2,697 |
|
|
$ |
1,724 |
|
|
$ |
10,488 |
|
|
$ |
3,543 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstandingbasic |
|
|
17,296 |
|
|
|
17,156 |
|
|
|
17,244 |
|
|
|
17,086 |
|
Dilutive effect of common stock equivalents |
|
|
411 |
|
|
|
404 |
|
|
|
342 |
|
|
|
406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstandingdiluted |
|
|
17,707 |
|
|
|
17,560 |
|
|
|
17,586 |
|
|
|
17,492 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.16 |
|
|
$ |
0.10 |
|
|
$ |
0.61 |
|
|
$ |
0.21 |
|
Diluted |
|
$ |
0.15 |
|
|
$ |
0.10 |
|
|
$ |
0.60 |
|
|
$ |
0.20 |
|
Treasury Stock
In 2007, we repurchased shares of our common stock. We account for treasury stock under the cost
method and include treasury stock as a component of stockholders equity. We did not repurchase
shares of common stock in the nine months ended September 30, 2008.
Segment Reporting
SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, defines how
operating segments are determined and requires disclosure about products, services, major customers
and geographic areas. We have three reportable segments.
During the nine months ended September 30, 2008, we changed our segment reporting by realigning a
portion of the Consumer Products and Services segment into the Other segment. The Other segment now
contains services from our relationship with a third party that administers referrals for identity
theft to major banking institutions and breach services previously accounted for in the Consumer
Products and Services segment. The modification to the business segments were determined based on
how our senior management analyzed, evaluated, and operated our global operations beginning in the
three months ended June 30, 2008.
13
Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141R, Business Combinations. SFAS No. 141R replaces SFAS
No. 141 on accounting for business combinations, specifically the cost-allocation process. SFAS No.
141R requires an acquirer to recognize the assets acquired, liabilities assumed and any
noncontrolling interest in the acquiree at the acquisition date, at their fair values as of that
date. In addition, an acquirer is required to recognize assets or liabilities arising from
contractual contingencies as of the acquisition date, at their acquisition date fair values.
Acquisition related costs that were previously allocated to the assets acquired and liabilities
assumed under SFAS No. 141 should be recognized separately from the acquisition under SFAS No.
141R. The provisions of SFAS No. 141R are effective for fiscal years beginning after December 15,
2008 and interim periods within those fiscal years. We are in the process of evaluating the impact,
if any, that SFAS No. 141R will have on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements an Amendment of ARB No. 51. SFAS No. 160 establishes accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. The presentation of a noncontrolling interest has been modified for both the income
statement and balance sheet, as well as expanded disclosure requirements that clearly identify and
distinguish between the interests of the parents owners and the interest of the noncontrolling
owners of a subsidiary. The provisions of SFAS No. 160 are effective for fiscal years beginning
after December 15, 2008 and interim periods within those fiscal years. We are in the process of
evaluating the impact, if any, that SFAS No. 160 will have on our consolidated financial
statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging
Activities. SFAS No. 161 amends SFAS No. 133 by improving financial reporting about derivative
instruments and hedging activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entitys financial position, financial performance, and cash flows.
The provisions of SFAS No. 161 are effective for fiscal years beginning after November 15, 2008 and
interim periods within those fiscal years. We are in the process of evaluating the impact, if any,
that SFAS No. 161 will have on our consolidated financial statements.
In April 2008, the FASB issued Staff Position (FSP) No. 142-3, Determination of the Useful Life
of Intangible Assets. FSP No. 142-3 amends the factors that should be considered in developing
renewal or extension assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142. The provisions of FSP No. 142-3 are effective for fiscal years beginning after
December 15, 2008 and interim periods within those fiscal years. We are in the process of
evaluating the impact, if any, that FSP No. 142-3 will have on our consolidated financial
statements.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principle. SFAS No. 162 identifies the sources of accounting principles and the framework for
selecting the principles to be used in the preparation of financial statements that are presented
in conformity with generally accepted accounting principles in the United States. This Statement is
effective 60 days following the SECs approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted
Accounting Principles. We are in the process of evaluating the impact, if any, that SFAS No. 162
will have on our consolidated financial statements.
In June 2008, the FASB issued FSP Emerging Issues Task Force (EITF) No. 03-6-1, Determining
Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. FSP
EITF No. 03-6-1 clarifies that unvested share-based payment awards that contain nonforfeitable
rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities
and are to be included in the computation of earnings per share under the two-class method
described in SFAS No. 128, Earnings Per Share. This FSP EITF is effective for us on January 1, 2009
and requires all presented prior-period earnings per share data to be adjusted retrospectively. We
are in the process of evaluating the impact, if any, that FSP EITF No. 03-6-1 will have on our
consolidated financial statements.
In October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset
When the Market for That Asset is Not Active. FSP No. 157-3 clarifies the application of SFAS No.
157 in a market that is not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that financial asset is not
active. The provisions of FSP No. 157-3 were effective upon issuance and for financial statements
not yet reported. The adoption of FSP No. 157-3 did not have a material impact on our consolidated
financial statements.
3. Business Acquisitions
14
Net Enforcers
On November 30, 2007, we acquired all of the outstanding shares of Net Enforcers, a Florida S
corporation, for approximately $15.2 million in cash, which included approximately $1.2 million in
acquisition costs. Additional consideration up to approximately $3.5 million in cash will be due if
such company achieves certain financial statement metrics and revenue targets in the future. This
transaction was accounted for as a business combination in accordance with the provisions of SFAS
No. 141. Therefore, once is the achievements are met and the payment is considered distributable,
we will record the fair value of the consideration issued as additional purchase price.
The estimated determination of the purchase price allocation was based on the fair values of the
acquired assets and liabilities assumed including acquired intangible assets. The estimated
determination was made by management through various means, including obtaining a third party
valuation of identifiable intangible assets acquired and an evaluation of the fair value of other
assets and liabilities acquired. In the nine months ended September 30, 2008, we modified our
purchase price allocation by reducing the fair value of intangible assets by $2.5 million and
increasing goodwill for the same amount, as a result of revisions to the preliminary purchase price
allocation. There were additional net increases to goodwill of approximately $751 thousand in the
nine months ended September 30, 2008 that were due to acquisition costs and ongoing adjustments to
the fair values of assets acquired.
The following table summarizes the estimated fair values of the assets acquired and liabilities
assumed at the date of acquisition (in thousands):
|
|
|
|
|
|
|
|
|
Current assets |
|
|
|
|
|
$ |
683 |
|
Intangible assets: |
|
|
|
|
|
|
|
|
Trade name (estimated useful life of 5 years) |
|
$ |
395 |
|
|
|
|
|
Customer relationships (estimated useful life of 7 years) |
|
|
2,290 |
|
|
|
|
|
Non-compete agreement (estimated useful life of 5 years) |
|
|
560 |
|
|
|
|
|
Existing developed technology assets (estimated useful life of 5 years) |
|
|
363 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets |
|
|
|
|
|
|
3,608 |
|
Goodwill |
|
|
|
|
|
|
11,697 |
|
Other current liabilities |
|
|
|
|
|
|
(812 |
) |
|
|
|
|
|
|
|
|
Net assets acquired |
|
|
|
|
|
$ |
15,176 |
|
|
|
|
|
|
|
|
|
The $11.7 million of goodwill was assigned to the Other segment. The total amount is expected to be
deductible for income tax purposes.
Net Enforcers is a leading provider of corporate identity theft protection services, including
online brand monitoring, online auction monitoring and enforcement, intellectual property
monitoring and other services. Through a combination of proprietary technology and specialized
business processes, Net Enforcers helps corporate brand owners prevent illegal trademark and
copyright abuse, counterfeit product and service sales, grey market sales, channel policy
violations, and other business risks of the online world. Net Enforcers complements our industry
leading, consumer-focused identity theft protection services with offerings of corporate identity
theft protection services.
The impact of Net Enforcers on our historical operating results is not material and as such,
pro-forma financial information is not presented.
Captira
On August 7, 2007, our wholly owned subsidiary, Captira, acquired substantially all of the assets
of Hide N Seek, an Idaho limited liability company, for $3.1 million, which included approximately
$105 thousand in acquisition costs. Additional consideration up to approximately $2.5 million in
cash will be due if Captira achieves certain cash flow milestones in the future. This transaction
was accounted for as a business combination in accordance with the provisions of SFAS No. 141.
Therefore, once the achievements are met and the payment is considered distributable, we will
record the fair value of the consideration issued as additional purchase price.
The purchase price consists of the following (in thousands):
15
|
|
|
|
|
Cash paid |
|
$ |
833 |
|
Assumption of operating liabilities |
|
|
637 |
|
Forgiveness of loans and accrued interest from Intersections |
|
|
1,567 |
|
Transaction costs |
|
|
105 |
|
|
|
|
|
|
|
$ |
3,142 |
|
|
|
|
|
The determination of the purchase price allocation was based on the fair values of the acquired
assets and liabilities assumed including acquired intangible assets. The determination was made by
management through various means, including obtaining a third party valuation of identifiable
intangible assets acquired and an evaluation of the fair value of other assets and liabilities
acquired.
The following table summarizes the fair values of the assets acquired and liabilities assumed at
the date of acquisition (in thousands):
|
|
|
|
|
|
|
|
|
Current assets |
|
|
|
|
|
$ |
12 |
|
Property, plant and equipment |
|
|
|
|
|
|
36 |
|
Intangible assets: |
|
|
|
|
|
|
|
|
Trade name (estimated useful life of 4 years) |
|
$ |
407 |
|
|
|
|
|
Existing developed technology assets (estimated useful life of 4 years) |
|
|
1,297 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets |
|
|
|
|
|
|
1,704 |
|
Goodwill |
|
|
|
|
|
|
1,390 |
|
|
|
|
|
|
|
|
|
Net assets acquired |
|
|
|
|
|
$ |
3,142 |
|
|
|
|
|
|
|
|
|
The $1.4 million of goodwill was assigned to the Other segment. The total amount is expected to be
deductible for income tax purposes.
Captira provides software and automated service solutions for the bail bonds industry, including
office automation, bond inventory and client tracking, and public records and reports for the
purpose of evaluating bond applications. The acquisition of Captira continues our diversification
into related business lines in which our skills and expertise in data sourcing, secure management
of personal confidential information, and commercialization of data-oriented products are key
success factors. Captiras services complement our security focused product offerings in our other
business lines and leverages our industry relationships to create a differentiated set of services
to the bail bonds industry.
The impact of Captira or Hide NSeek on our historical operating results is not material and as
such, pro-forma financial information is not presented.
4. Fair Value Measurement
Our cash and any investment instruments are classified within Level 1 or Level 2 of the fair value
hierarchy because they are valued using quoted market prices, broker or dealer quotations, or
alternative pricing sources with reasonable levels of price transparency. The types of instruments
valued, if any, based on quoted market prices in active markets are primarily U.S. government and
agency securities and money market securities. Such instruments are generally classified within
Level 1 of the fair value hierarchy.
The principal market where we execute our interest swap contracts is the retail market in an
over-the-counter environment with a relatively high level of price transparency. The market
participants usually are large money center banks and regional banks. These contracts are typically
classified within Level 2 of the fair value hierarchy.
Fair value hierarchy of our marketable securities and interest rate swap contracts at fair value in
connection with our adoption of SFAS No. 157 (in thousands):
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date using: |
|
|
|
|
|
|
Quoted Prices |
|
|
|
|
|
|
|
|
|
|
in Active |
|
Significant |
|
|
|
|
|
|
|
|
Markets for |
|
other |
|
Significant |
|
|
September |
|
Identical Assets |
|
Observable |
|
Unobservable |
|
|
30, 2008 |
|
(Level 1) |
|
Inputs (Level 2) |
|
Inputs (Level 3) |
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
US Treasury bills |
|
$ |
11,881 |
|
|
$ |
11,881 |
|
|
$ |
|
|
|
$ |
|
|
Interest rate
swap contracts |
|
|
208 |
|
|
|
|
|
|
|
208 |
|
|
|
|
|
5. Prepaid Expenses and Other Current Assets
The components of our prepaid expenses and other current assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands) |
|
Prepaid services |
|
$ |
1,396 |
|
|
$ |
1,167 |
|
Prepaid contracts |
|
|
2,075 |
|
|
|
1,825 |
|
Other |
|
|
2,137 |
|
|
|
3,225 |
|
|
|
|
|
|
|
|
|
|
$ |
5,608 |
|
|
$ |
6,217 |
|
|
|
|
|
|
|
|
6. Deferred Subscription Solicitation and Commission Costs
Deferred subscription solicitation costs included in the accompanying balance sheet as of September
30, 2008 and December 31, 2007, were $30.9 million and $23.5 million, which includes $4.2 million
and $1.6 million reported in other assets, respectively, on our condensed consolidated balance
sheet. Amortization of deferred subscription solicitation and commission costs, which are included
in either marketing or commissions expenses on our condensed consolidated statement of income, for
the three months ended September 30, 2008 and 2007 were $13.2 million and $9.4 million,
respectively. Amortization of deferred subscription solicitation and commission costs for the nine
months ended September 30, 2008 and 2007 were $38.6 million and $24.1 million, respectively.
Subscription solicitation costs expensed as incurred related to marketing costs that did not meet
the criteria for deferral in accordance with SOP 93-7, which are included in marketing expenses on
our condensed consolidated statement of income, for the three months ended September 30, 2008 and
2007 were $1.1 million and $215 thousand, respectively. Subscription solicitation costs expensed as
incurred related to marketing for the nine months ended September 30, 2008 and 2007 were $3.5
million and $1.9 million, respectively.
7. Long-Term Investments
During the three months ended September 30, 2008, we paid approximately $3.3 million in cash for a
preferred stock investment in GuardID Systems, Inc. (GuardID), a privately held company in
California. In addition, we received stock purchase warrants to purchase 1.4 million shares of
GuardIDs preferred stock at $1.05 per share. The warrants are contingently excercisable subject
to GuardID meeting certain revenue thresholds. GuardID provides smart card-based hardware
solutions to safeguard consumers against identity theft and online crime when they bank, shop and
invest online. As a result of the equity investment, we own less than 20% of GuardID.
As of September 30, 2008, no indicators of impairment were identified.
In addition to the investment, we entered into a commercial agreement with GuardID to receive
exclusivity on the sale of its ID Vault products. The strategic commercial agreement allows us to
include these products and services as part of our comprehensive identity theft protection services
to consumers.
8. Goodwill and Intangible Assets
Changes in the carrying amount of goodwill are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer Products |
|
|
Background |
|
|
|
|
|
|
|
|
|
and Services |
|
|
Screening |
|
|
Other |
|
|
Total |
|
Balance, December 31, 2007 |
|
$ |
43,235 |
|
|
$ |
23,583 |
|
|
$ |
9,688 |
|
|
$ |
76,506 |
|
Adjustments |
|
|
|
|
|
|
|
|
|
|
3,399 |
|
|
|
3,399 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, September 30, 2008 |
|
$ |
43,235 |
|
|
$ |
23,583 |
|
|
$ |
13,087 |
|
|
$ |
79,905 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
Goodwill increased by $3.4 million in the nine months ended September 30, 2008 due to revisions in
the estimated purchase price allocation related to the Net Enforcers and Captira acquisitions in
2007.
During the nine months ended September 30, 2008, we acquired membership agreements from Citibank,
which were recorded as a customer related intangible asset, for approximately $30.2 million. The
membership agreements are being amortized, on an accelerated basis, over the expected useful life
of the subscribers, which we have determined to be ten years. Amortization is included in
amortization expense on our condensed consolidated statement of income.
Intangibles consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
Gross |
|
|
|
|
|
|
Net |
|
|
Gross |
|
|
|
|
|
|
Net |
|
|
|
Carrying |
|
|
Accumulated |
|
|
Carrying |
|
|
Carrying |
|
|
Accumulated |
|
|
Carrying |
|
|
|
Amount |
|
|
Amortization |
|
|
Amount |
|
|
Amount |
|
|
Amortization |
|
|
Amount |
|
Amortizable intangible assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer related |
|
$ |
42,118 |
|
|
$ |
(9,726 |
) |
|
$ |
32,392 |
|
|
$ |
12,284 |
|
|
$ |
(3,069 |
) |
|
$ |
9,215 |
|
Marketing related |
|
|
3,780 |
|
|
|
(2,178 |
) |
|
|
1,602 |
|
|
|
4,499 |
|
|
|
(1,394 |
) |
|
|
3,105 |
|
Technology related |
|
|
3,159 |
|
|
|
(1,223 |
) |
|
|
1,936 |
|
|
|
4,599 |
|
|
|
(615 |
) |
|
|
3,984 |
|
Non-compete agreement |
|
|
559 |
|
|
|
(92 |
) |
|
|
467 |
|
|
|
560 |
|
|
|
(9 |
) |
|
|
551 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amortizable intangible assets |
|
$ |
49,616 |
|
|
$ |
(13,219 |
) |
|
$ |
36,397 |
|
|
$ |
21,942 |
|
|
$ |
(5,087 |
) |
|
$ |
16,855 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets are amortized over a period of three to ten years. For the three and nine months
ended September 30, 2008, we incurred aggregate amortization expense of $2.7 million and $8.1
million, respectively, which was included in amortization expense on the condensed consolidated
statements of operations. For the three and nine months ended September 30, 2007, we incurred
aggregate amortization expense of $911 thousand and $2.3 million, respectively.
We estimate that we will incur the following amortization expense for future periods as follows (in
thousands):
|
|
|
|
|
For the remaining three months ending December 31, 2008 |
|
$ |
2,640 |
|
For the years ending December 31, 2009
|
2009 |
|
|
8,549 |
|
2010 |
|
|
6,302 |
|
2011 |
|
|
4,882 |
|
2012 |
|
|
3,702 |
|
2013 |
|
|
2,973 |
|
Thereafter |
|
|
7,349 |
|
|
|
|
|
|
|
$ |
36,397 |
|
|
|
|
|
9. Other Assets
The components of our other assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Prepaid royalty payments |
|
$ |
18,592 |
|
|
$ |
14,207 |
|
Prepaid contracts |
|
|
157 |
|
|
|
496 |
|
Escrow receivable |
|
|
1,072 |
|
|
|
1,030 |
|
Other |
|
|
2,021 |
|
|
|
648 |
|
|
|
|
|
|
|
|
|
|
$ |
21,842 |
|
|
$ |
16,381 |
|
|
|
|
|
|
|
|
During 2005, we entered into agreements with two providers under which we receive data and other
information for use in the new consumer services that were introduced in the first quarter of 2006.
Under these agreements, we pay non-refundable royalties based on usage of the data or analytics,
and make certain minimum royalty payments in exchange for defined limited exclusivity rights.
Prepaid royalties will be applied against future royalties incurred and the minimum royalty
payments.
10. Accrued Expenses and Other Current Liabilities
18
The components of our accrued expenses and other liabilities are as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Accrued marketing |
|
$ |
2,511 |
|
|
$ |
894 |
|
Accrued cost of sales, including credit bureau costs |
|
|
7,696 |
|
|
|
6,083 |
|
Accrued general and administrative expense and
professional fees |
|
|
5,043 |
|
|
|
3,883 |
|
Transition costs |
|
|
|
|
|
|
264 |
|
Insurance premiums |
|
|
2,210 |
|
|
|
1,341 |
|
Other |
|
|
1,696 |
|
|
|
2,722 |
|
|
|
|
|
|
|
|
|
|
$ |
19,156 |
|
|
$ |
15,187 |
|
|
|
|
|
|
|
|
11. Accrued Payroll and Employee Benefits
The components of our accrued payroll and employee benefits are as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Accrued payroll |
|
$ |
3,570 |
|
|
$ |
3,559 |
|
Accrued severance |
|
|
|
|
|
|
104 |
|
Accrued benefits |
|
|
1,546 |
|
|
|
1,282 |
|
Other |
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,124 |
|
|
$ |
4,945 |
|
|
|
|
|
|
|
|
12. Income Taxes
Our effective tax rate for the three months ended September 30, 2008 and 2007 was 42.8% and 47.1%, respectively. Our effective tax rate for the nine months ended September 30, 2008 and 2007 was 41.4% and 44.9%,
respectively. The decrease is primarily a result of changes in the
proportion of income taxed to various jurisdictions including reduced losses outside of the United States,
which are subject to tax at rates different than the statutory U.S. federal income tax rate.
As of September 30, 2008, we have a $1.1 million net long-term liability for state income tax
matters and related interest and penalties in connection with our acquisition of IISI. This net
liability is offset entirely by an escrow receivable pursuant to the escrow agreement executed with
the former shareholders of IISI. In the fourth quarter of 2008, the net liability and corresponding
escrow receivable will be reduced by approximately $576 thousand due to the expiration of the
applicable statute of limitations.
13. Debt and Other Financing
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Term loan |
|
$ |
23,333 |
|
|
$ |
11,667 |
|
Revolving line of credit |
|
|
20,000 |
|
|
|
14,000 |
|
Note payable to CRG |
|
|
900 |
|
|
|
900 |
|
Other |
|
|
17 |
|
|
|
26 |
|
|
|
|
|
|
|
|
|
|
|
44,250 |
|
|
|
26,593 |
|
Less current portion |
|
|
(7,913 |
) |
|
|
(4,246 |
) |
|
|
|
|
|
|
|
Total long term debt |
|
$ |
36,337 |
|
|
$ |
22,347 |
|
|
|
|
|
|
|
|
On July 3, 2006 we negotiated bank financing in the amount of $40 million. Under terms of the
financing agreements, we were granted a $25 million line of credit and a term loan of $15 million
with interest at 1.00-1.75 percent over LIBOR. On January 31, 2008, we amended our credit agreement
in order to increase the term loan facility to $28 million. The amended term loan is payable in
monthly installments of $583 thousand, plus interest. Substantially all our assets and a pledge by
us of stock and membership interests we hold in certain subsidiaries are pledged as collateral to
these loans. In addition, pursuant to the amendment, our subsidiaries Captira and Net Enforcers
were added as co-borrowers under the credit agreement. The amendment provides that the maturity
date for the revolving credit facility and the term loan facility under the credit agreement will
be December 31, 2011.
19
On February 1, 2008, we borrowed $16.6 million under the term loan facility to acquire membership
agreements. As of September 30, 2008, the outstanding interest rate was 3.74% and principal balance
under the credit agreement was $43.3 million.
In addition, SI has an outstanding demand loan of $900 thousand with CRG at an average rate of
8.0%. Other notes outstanding of $17 thousand will be due in 2009.
Aggregate maturities during the subsequent years are as follows (in thousands):
|
|
|
|
|
For the remaining three months ending December 31, 2008 |
|
$ |
1,754 |
|
For the years ending December 31, 2009 |
|
|
|
|
2009 |
|
|
7,014 |
|
2010 |
|
|
6,999 |
|
2011 |
|
|
27,583 |
|
|
|
|
|
|
|
$ |
43,350 |
|
Demand loan |
|
|
900 |
|
|
|
|
|
Total |
|
$ |
44,250 |
|
|
|
|
|
The credit agreement contains certain customary covenants, including among other things covenants
that limit or restrict the incurrence of liens; the making of investments; the incurrence of
certain indebtedness; mergers, dissolutions, liquidation, or consolidations; acquisitions (other
than certain permitted acquisitions); sales of substantially all of our or any co-borrowers
assets; the declaration of certain dividends or distributions; transactions with affiliates (other
than co-borrowers under the credit agreement) other than on fair and reasonable terms; and the
creation or acquisition of any direct or indirect subsidiary of ours that is not a domestic
subsidiary unless such subsidiary becomes a guarantor. We are also required to maintain compliance
with certain financial covenants which includes our consolidated EBITDA, consolidated leverage
ratios, consolidated fixed charge coverage ratios as well as customary covenants, representations
and warranties, funding conditions and events of default. We are currently in compliance with all
such covenants.
As further described in Note 2, we entered into interest rate swap transactions that convert our
variable-rate debt to fixed-rate debt. As of September 30, 2008, the fair value of the interest
rate swaps was $125 thousand related to the term loan and $83 thousand related to the revolving
line of credit and these were recorded in other assets on the condensed consolidated balance sheet.
For the three months ended September 30, 2008, the effective portion of the change in fair value of
the term loan and line of credit interest rate swaps was $3 thousand and $22 thousand,
respectively, and has been recorded in accumulated other comprehensive income on our condensed
consolidated balance sheet. For the nine months ended September 30, 2008, the effective portion of
the change in fair value of the term loan and line of credit interest rate swaps was $444 thousand
and $324 thousand, respectively, and has been recorded in accumulated other comprehensive income on
our condensed consolidated balance sheet.
14. Stockholders Equity
Share Repurchase
On April 25, 2005, we announced that our Board of Directors had authorized a share repurchase
program under which we can repurchase up to $20 million of our outstanding shares of common stock
from time to time, depending on market conditions, share price and other factors. The repurchases
may be made on the open market, in block trades, through privately negotiated transactions or
otherwise, and the program may be suspended or discontinued at any time. We did not repurchase
shares during the nine months ended September 30, 2008.
Share Based Compensation
On August 24, 1999, the Board of Directors and stockholders approved the 1999 Stock Option Plan
(the 1999 Plan). The number of shares of common stock that may be issued under the 1999 Plan may
not exceed 4.2 million shares pursuant to an amendment to the plan executed in November 2001. As of
September 30, 2008, we have 1.5 million shares remaining to issue. We do not intend to issue
further options under the 1999 Plan. Individual awards under the 1999 Plan may take the form of
incentive stock options and nonqualified stock options.
20
On March 12, 2004 and May 5, 2004, the Board of Directors and stockholders, respectively, approved
the 2004 Stock Option Plan (the 2004 Plan) to be effective immediately prior to the consummation
of the initial public offering. The 2004 Plan provides for the authorization to issue 2.8 million
shares of common stock. As of September 30, 2008, we have 427 thousand shares remaining to issue.
Individual awards under the 2004 Plan may take the form of incentive stock options and nonqualified
stock options. Option awards are generally granted with an exercise price equal to the market price
of our stock at the date of grant; those option awards generally vest over three and four years of
continuous service and have ten year contractual terms.
On March 8, 2006 and May 24, 2006, the Board of Directors and stockholders, respectively, approved
the 2006 Stock Incentive Plan (the 2006 Plan). The 2006 Plan provides for the authorization to
issue 2.5 million shares of common stock. As of September 30, 2008, we have 558 thousand shares
remaining to issue. Individual awards under the 2006 Plan may take the form of incentive stock
options, nonqualified stock options, restricted stock awards and/or restricted stock units. These
awards generally vest over three and four years of continuous service.
The compensation committee administers the Plans, selects the individuals who will receive awards
and establishes the terms and conditions of those awards. Shares of common stock subject to awards
that have expired, terminated, or been canceled or forfeited are available for issuance or use in
connection with future awards.
The 1999 Plan will remain in effect until August 24, 2009, the 2004 Plan will remain in effect
until May 5, 2014, and the 2006 Plan will remain in effect until March 7, 2016, unless terminated
by the Board of Directors.
Stock Options
The following table summarizes our stock option activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Remaining |
|
|
|
Number of |
|
|
Exercise |
|
|
Aggregate |
|
|
Contractual |
|
|
|
Shares |
|
|
Price |
|
|
Intrinsic Value |
|
|
Term |
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
(in years) |
|
Outstanding at December 31, 2007 |
|
|
3,839,274 |
|
|
$ |
12.22 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
1,130,492 |
|
|
|
8.42 |
|
|
|
|
|
|
|
|
|
Canceled |
|
|
(53,600 |
) |
|
|
17.12 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(66,060 |
) |
|
|
10.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2008 |
|
|
4,850,106 |
|
|
$ |
11.41 |
|
|
$ |
1,597 |
|
|
|
6.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2008 |
|
|
2,944,190 |
|
|
$ |
12.93 |
|
|
$ |
1,597 |
|
|
|
4.18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average grant date fair value of options granted during the three months ended
September 30, 2008 was $3.87. There were no grants in the three months ended September 30, 2007.
The weighted average grant date fair value of options granted during the nine months ended
September 30, 2008 and 2007 was $3.56, and $6.39, respectively.
For options exercised, intrinsic value is calculated as the difference between the market price on
the date of exercise and the exercise price. The total intrinsic value of options exercised during
the three months ended September 30, 2008 and 2007 was $240 thousand and $254 thousand,
respectively. The total intrinsic value of options exercised during the nine months ended September
30, 2008 and 2007 was $487 thousand and $963 thousand, respectively.
Total share based compensation expense recognized for stock options, which was included in general
and administrative expense on our condensed consolidated statement of income, for the three months
ended September 30, 2008 and 2007 was $562 thousand and $256 thousand, respectively. Total share
based compensation expense recognized for stock options for the nine months ended September 30,
2008 and 2007 was $1.6 million and $658 thousand, respectively.
As of September 30, 2008, there was $5.9 million of total unrecognized compensation cost related to
nonvested stock option arrangements granted under the Plans. That cost is expected to be recognized
over a weighted-average period of 2.8 years.
21
Restricted Stock Units
The following table summarizes our restricted stock unit activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average |
|
|
|
|
|
|
|
Weighted |
|
|
Remaining |
|
|
|
Number of |
|
|
-Average Grant |
|
|
Contractual |
|
|
|
RSUs |
|
|
Date Fair Value |
|
|
Life |
|
|
|
|
|
|
|
|
|
|
|
(in years) |
|
Outstanding at December 31, 2007 |
|
|
568,512 |
|
|
$ |
9.69 |
|
|
|
|
|
Granted |
|
|
155,000 |
|
|
|
8.39 |
|
|
|
|
|
Canceled |
|
|
(61,722 |
) |
|
|
9.61 |
|
|
|
|
|
Vested |
|
|
(144,906 |
) |
|
|
9.61 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2008 |
|
|
516,884 |
|
|
$ |
9.33 |
|
|
|
2.19 |
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2008, there was $3.3 million of total unrecognized compensation cost related to
unvested restricted stock units compensation arrangements granted under the Plans. That cost is
expected to be recognized over a weighted-average period of 1.7 years.
Total share based compensation recognized for restricted stock units in our condensed consolidated
statement of income for the three months ended September 30, 2008 and 2007 was $562 thousand and
$481 thousand. Total share based compensation recognized for stock options for the nine months
ended September 30, 2008 and 2007 was $1.6 million and $1.4 million, respectively.
15. Segment and Geographic Information
We operate in three primary business segments: Consumer Products and Services, Background
Screening, and Other. In the nine months ended September 30, 2008, we changed our segment reporting
by realigning a portion of the Consumer Products and Services segment into the Other segment. The
Other segment now contains services from our relationship with a third party that administers
referrals for identity theft to major banking institutions and breach services previously accounted
for in the Consumer Products and Services segment. The modification in business segments was
determined based on how our senior management analyzed, evaluated, and operated our global
operations beginning in the three months ended June 30, 2008.
We have developed methodologies to fully allocate indirect costs associated with these revenues to
the Other segment. These costs include expenses associated with fulfillment, credit bureau costs,
indirect selling and general and administrative expenses. The allocation methodologies are based on
historical cost percentages of these services from our continuing operations.
As a result, we have modified the way we manage our business to utilize operating income (loss)
information to evaluate the performance of our business segments and to allocate resources to them.
We have recasted the results of our business segment data for the three and nine months ended
September 30, 2008 and 2007 into the new business segments for comparability with current
presentation.
The following is a description of our business segments:
|
|
|
Consumer Products and Services include our daily, monthly or quarterly monitoring of
subscribers credit files at one or all three major credit reporting agencies (Equifax,
Experian and TransUnion), credit reports from one or all three major credit reporting
agencies, credit score analysis tools, credit education, identity theft cost coverage and
other subscription based services such as consumer discounts on healthcare, home and auto
related expenses, access to professional financial and legal information and life,
accidental death and disability insurance. |
22
|
|
|
Background Screening includes pre-employment background screening, including criminal
background checks, driving records, employment verification and reference checks, drug
testing and credit history checks provided by SI. This segment includes the domestic and
global sales generated by the London and Singapore offices of SI. |
|
|
|
|
Other includes services from our relationship with a third party that administers
referrals for identity theft to major banking institutions and breach services reallocated
from the Consumer Products and Services segment. This segment also includes the software
management solutions for the bail bond industry provided by Captira and corporate brand
protection provided by Net Enforcers. |
The following table sets forth segment information for the three and nine months ended September
30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer Products |
|
Background |
|
|
|
|
|
|
and Services |
|
Screening |
|
Other |
|
Consolidated |
|
|
(in thousands) |
Three Months Ended September 30, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
83,788 |
|
|
$ |
7,814 |
|
|
$ |
1,813 |
|
|
$ |
93,415 |
|
Depreciation |
|
|
2,190 |
|
|
|
241 |
|
|
|
7 |
|
|
|
2,438 |
|
Amortization |
|
|
2,363 |
|
|
|
126 |
|
|
|
250 |
|
|
|
2,739 |
|
Income (loss) before income taxes
and minority interest |
|
$ |
6,149 |
|
|
$ |
(1,367 |
) |
|
$ |
(723 |
) |
|
$ |
4,059 |
|
Three Months Ended September 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
62,548 |
|
|
$ |
7,714 |
|
|
$ |
1,141 |
|
|
$ |
71,403 |
|
Depreciation |
|
|
1,982 |
|
|
|
230 |
|
|
|
9 |
|
|
|
2,221 |
|
Amortization |
|
|
714 |
|
|
|
126 |
|
|
|
71 |
|
|
|
911 |
|
Income (loss) before income taxes
and minority interest |
|
$ |
3,876 |
|
|
$ |
(1,185 |
) |
|
$ |
5 |
|
|
$ |
2,696 |
|
Nine Months Ended September 30, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
245,793 |
|
|
$ |
22,570 |
|
|
$ |
5,158 |
|
|
$ |
273,521 |
|
Depreciation |
|
|
6,375 |
|
|
|
724 |
|
|
|
8 |
|
|
|
7,107 |
|
Amortization |
|
|
6,940 |
|
|
|
379 |
|
|
|
813 |
|
|
|
8,132 |
|
Income (loss) before income taxes
and minority interest |
|
$ |
21,355 |
|
|
$ |
(3,358 |
) |
|
$ |
(1,765 |
) |
|
$ |
16,232 |
|
Nine Months Ended September 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
167,228 |
|
|
$ |
22,191 |
|
|
$ |
5,289 |
|
|
$ |
194,708 |
|
Depreciation |
|
|
6,016 |
|
|
|
644 |
|
|
|
9 |
|
|
|
6,669 |
|
Amortization |
|
|
1,886 |
|
|
|
379 |
|
|
|
71 |
|
|
|
2,336 |
|
Income (loss) before income taxes
and minority interest |
|
$ |
5,936 |
|
|
$ |
(3,135 |
) |
|
$ |
2,085 |
|
|
$ |
4,886 |
|
As of September 30, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment, net |
|
$ |
14,920 |
|
|
$ |
2,075 |
|
|
$ |
47 |
|
|
$ |
17,042 |
|
Identifiable assets |
|
$ |
225,341 |
|
|
$ |
11,656 |
|
|
$ |
2,605 |
|
|
$ |
239,602 |
|
As of December 31, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment, net |
|
$ |
16,534 |
|
|
$ |
2,145 |
|
|
$ |
138 |
|
|
$ |
18,817 |
|
Identifiable assets |
|
$ |
191,868 |
|
|
$ |
12,869 |
|
|
$ |
1,531 |
|
|
$ |
206,268 |
|
Information concerning the revenues and total assets of principal geographic areas is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
United Kingdom |
|
Other |
|
Consolidated |
|
|
(in thousands) |
Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended September 30, 2008
|
|
$ |
89,823 |
|
|
$ |
3,549 |
|
|
$ |
43 |
|
|
$ |
93,415 |
|
For the three months ended September 30, 2007
|
|
|
68,544 |
|
|
|
2,859 |
|
|
|
|
|
|
|
71,403 |
|
For the nine months ended September 30, 2008
|
|
|
264,501 |
|
|
|
8,932 |
|
|
|
88 |
|
|
|
273,521 |
|
For the nine months ended September 30, 2007
|
|
|
186,517 |
|
|
|
8,191 |
|
|
|
|
|
|
|
194,708 |
|
Total assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2008
|
|
$ |
231,393 |
|
|
$ |
9,003 |
|
|
$ |
(794 |
) |
|
$ |
239,602 |
|
As of December 31, 2007
|
|
|
196,419 |
|
|
|
9,976 |
|
|
|
(127 |
) |
|
|
206,268 |
|
23
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
Certain written and oral statements made by or on our behalf may constitute forward-looking
statements as defined under the Private Securities Litigation Reform Act of 1995. Words or phrases
such as should result, are expected to, we anticipate, we estimate, we project, or
similar expressions are intended to identify forward-looking statements. These statements are
subject to certain risks and uncertainties that could cause actual results to differ materially
from those expressed in any forward-looking statements. These risks and uncertainties include, but
are not limited to, those disclosed in our Annual Report on Form 10-K for the year ended December
31, 2007 filed on March 17, 2008, and our quarterly and current reports filed with the Securities
and Exchange Commission and the following important factors: demand for our services, general
economic conditions, including the possibility of a severe recession in the U.S. and a worldwide
economic slowdown, recent disruptions to the credit and financial markets in the U.S. and
worldwide, economic conditions specific to our financial institutions clients, product development,
maintaining acceptable margins, maintaining secure systems, ability to control costs, the impact of
federal, state and local regulatory requirements on our business, specifically the consumer credit
market, the impact of competition, ability to continue our long-term business strategy including
growth through acquisition, ability to attract and retain qualified personnel and the uncertainty
of economic conditions in general.
Readers are cautioned not to place undue reliance on forward-looking statements, since the
statements speak only as of the date that they are made, and we undertake no obligation to publicly
update these statements based on events that may occur after the date of this report.
Overview
We have three reportable segments. Our Consumer Products and Services segment includes our consumer
protection and other consumer products and services. This consists of identity theft management
tools, membership product offerings and other subscription based services such as life and
accidental death insurance. Our Background Screening segment includes the personnel and vendor
background screening services provided by SI. Our Other segment includes the services for our
relationship with a third party that administers referrals for identity theft to major banking
institutions and breach services reallocated from the Consumer Products and Services segment. This
segment also includes the software management solutions for the bail bond industry provided by
Captira and corporate brand protection provided by Net Enforcers.
Consumer Products and Services
We offer consumers a variety of consumer protection services and other consumer products and
services primarily on a subscription basis. Our services help consumers protect themselves against
identity theft or fraud and understand and monitor their credit profiles and other personal
information. Through our subsidiary Intersections Insurance Services, Inc., we offer a portfolio of
services to include consumer discounts on healthcare, home, and auto related expenses, access to
professional financial and legal information, and life, accidental death and disability insurance
products. Our consumer services are offered through relationships with clients, including many of
the largest financial institutions in the United States and Canada, and clients in other
industries. We also offer our services directly to consumers.
Our products and services are marketed to customers of our clients, and often are branded and
tailored to meet our clients specifications. Our clients are principally credit card, direct
deposit, or mortgage issuing financial institutions, including many of the largest financial
institutions in the United States and Canada. With certain of our financial institution clients, we
have broadened our marketing efforts to access demand deposit accounts. Our financial institution
clients currently account for the majority of our existing subscriber base. We also are continuing
to augment our client base through relationships with insurance companies, mortgage
24
companies, brokerage companies, associations, travel companies, retail companies, web and
technology companies and other service providers with significant market presence and brand
loyalty.
With our clients, our services are marketed to potential subscribers through a variety of marketing
channels, including direct mail, outbound telemarketing, inbound telemarketing, inbound customer
service and account activation calls, email, mass media and the internet. Our marketing
arrangements with our clients sometimes call for us to fund and manage marketing activity. The mix
between our company-funded and client-funded marketing programs varies from year to year based upon
our and our clients strategies. In 2007 and through the first nine months of 2008, we
substantially increased our own investment in marketing with our clients. We anticipate this trend
of our company-funded marketing programs continuing, and possibly increasing, over the remaining
months in 2008 and into 2009, particularly as our financial institution clients continue to request
that we bear more of the new subscriber marketing costs as well as prepay commissions to them on
new subscribers. We expect this trend to continue for the foreseeable future until the financial
markets and the general economy start to recover.
We conduct our consumer direct marketing primarily through the internet. We also may market through
other channels, including direct mail, outbound telemarketing, inbound telemarketing, email and
mass media. We expect to continue making an investment in marketing direct to consumers in the
remaining months of 2008 and into 2009.
Our client arrangements are distinguished from one another by the allocation between us and the
client of the economic risk and reward of the marketing campaigns. The general characteristics of
each arrangement are described below, although the arrangements with particular clients may contain
unique characteristics:
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|
|
Direct marketing arrangements: Under direct marketing arrangements, we bear most of the
new subscriber marketing costs and pay our client a commission for revenue derived from
subscribers. These commissions could be payable upfront in a lump sum on a per subscriber
basis for the subscribers enrollment, periodically over the life of a subscriber, or
through a combination of both. These arrangements generally result in negative cash flow
over the first several months after a program is launched due to the upfront nature of the
marketing investments. In some arrangements we pay the client a service fee for access to
the clients customers or billing of the subscribers by the client, and we may reimburse
the client for certain of its out-of-pocket marketing costs incurred in obtaining the
subscriber. |
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|
|
|
Indirect marketing arrangements: Under indirect marketing arrangements, our client
bears the marketing expense and pays us a service fee or percentage of the revenue. Because
the subscriber acquisition cost is borne by our client under these arrangements, our
revenue per subscriber is typically lower than that under direct marketing arrangements.
Indirect marketing arrangements generally provide positive cash flow earlier than direct
arrangements and the ability to obtain subscribers and utilize marketing channels that the
clients otherwise may not make available. |
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|
|
|
Shared marketing arrangements: Under shared marketing arrangements, marketing expenses
are shared by us and the client in various proportions, and we may pay a commission to or
receive a service fee from the client. Revenue generally is split in proportion to the
investment made by our client and us. |
The classification of a client relationship as direct, indirect or shared is based on whether we or
the client pay the marketing expenses. Our policies for revenue recognition, however,
are not based on the classification of a client arrangement as direct, indirect or shared. We look
to the specific client arrangement to determine the appropriate revenue recognition policy, as
discussed in detail in Note 2 to our condensed consolidated financial statements.
Our typical contracts for direct marketing arrangements, and some indirect and shared marketing
arrangements, provide that after termination of the contract we may continue to provide our
services to existing subscribers, for periods ranging from two years to no specific termination
period, under the economic arrangements that existed at the time of termination. Under certain of
our agreements, however, including most indirect marketing arrangements and some shared marketing
arrangements, the clients may require us to cease providing services under existing subscriptions.
Clients under some contracts may also require us to cease providing services to their customers
under existing subscriptions if the contract is terminated for material breach by us. We look to
the specific client arrangement to determine the appropriate revenue recognition policy.
During the nine months ended September 30, 2008, we acquired membership agreements from Citibank,
which is recorded as a customer related intangible asset, for approximately $30.2 million. The
intangible asset is amortized, on an accelerated basis, over the
25
expected useful life of the subscribers, which we have determined to be ten years. The acquisition
of these contracts increases our revenue and amortization expenses over the useful life of the
asset.
On February 29, 2008, we received written notice from our client Discover that, effective September
1, 2008, it was terminating the Agreement for Services Administration between us and Discover dated
March 11, 2002, as amended (the Services Agreement), including the Omnibus Amendment dated
December 22, 2005 (the Omnibus Amendment). On the same date, we filed a complaint for declaratory
judgment in the Circuit Court for Fairfax County, Virginia. The complaint seeks a declaration that,
if Discover uses for its own purposes credit report authorizations given by customers to
Intersections or Discover, it will be in breach of the Services Agreement and Omnibus Amendment to
the Services Agreement. Intersections contends that Discover or its new credit monitoring service
provider must obtain new authorizations from the customers in order to provide credit monitoring
services to them. In the complaint, Intersections alleges that reliance on the credit report
authorizations by Discover or its new provider would be a breach of the Services Agreement and
Omnibus Amendment thereto, and thus seeks a declaratory judgment to prevent Discover from
committing a breach of the parties contract. On April 25, 2008, the court denied Discovers motion
to dismiss our claims. We and Discover each filed cross-motions for summary judgment and the
Court denied both parties motions. Trial is scheduled for January 6, 2009, and discovery is
ongoing.
The following table details other selected subscriber and financial data.
Other Data (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Subscribers at beginning of period |
|
|
5,657 |
|
|
|
4,850 |
|
|
|
5,259 |
|
|
|
4,626 |
|
New subscribers indirect |
|
|
366 |
|
|
|
578 |
|
|
|
1,551 |
|
|
|
1,659 |
|
New subscribers direct (1) |
|
|
659 |
|
|
|
472 |
|
|
|
1,774 |
|
|
|
1,331 |
|
Cancelled subscribers within first 90 days of subscription |
|
|
(269 |
) |
|
|
(258 |
) |
|
|
(844 |
) |
|
|
(768 |
) |
Cancelled subscribers after first 90 days of subscription |
|
|
(1,482 |
) |
|
|
(691 |
) |
|
|
(2,809 |
) |
|
|
(1,897 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Subscribers at end of period |
|
|
4,931 |
|
|
|
4,951 |
|
|
|
4,931 |
|
|
|
4,951 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
93,415 |
|
|
$ |
71,403 |
|
|
$ |
273,521 |
|
|
$ |
194,708 |
|
Revenue from transactional sales |
|
|
(9,094 |
) |
|
|
(8,673 |
) |
|
|
(26,481 |
) |
|
|
(27,229 |
) |
Revenue from lost/stolen credit card registry |
|
|
(9 |
) |
|
|
(7 |
) |
|
|
(27 |
) |
|
|
(37 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Subscription revenue |
|
$ |
84,312 |
|
|
$ |
62,723 |
|
|
$ |
247,013 |
|
|
$ |
169,442 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing and commissions |
|
$ |
35,095 |
|
|
$ |
23,382 |
|
|
$ |
100,253 |
|
|
$ |
61,155 |
|
Commissions paid on transactional sales |
|
|
(1 |
) |
|
|
(2 |
) |
|
|
(4 |
) |
|
|
(11 |
) |
Commissions paid on lost/stolen credit card registry |
|
|
(15 |
) |
|
|
(10 |
) |
|
|
(38 |
) |
|
|
(25 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing and commissions associated with subscription revenue |
|
$ |
35,079 |
|
|
$ |
23,370 |
|
|
$ |
100,211 |
|
|
$ |
61,119 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
We classify subscribers from shared marketing arrangements with direct marketing arrangements. |
Subscription revenue, net of marketing and commissions associated with subscription revenue, is a
non-GAAP financial measure that we believe is important to investors and one that we utilize in
managing our business as subscription revenue normalizes the effect of changes in the mix of
indirect and direct marketing arrangements.
Background Screening
Through our majority owned subsidiary Screening International, LLC, we provide a variety of risk
management tools for the purpose of personnel and vendor background screening services to
businesses worldwide. Our background screening services integrate data from various automated
sources throughout the world, additional manual research findings from employees and
subcontractors, and internal business logic provided by both Screening International and by our
clients into reports that assist in decision making. Our background screening services are
generally sold to corporate clients under contractual arrangements with individual per unit prices
for specific service specifications. Due to substantial difference in both service specifications
and associated data acquisition costs, prices for our background screening services vary
significantly among clients and geographies.
26
Our clients include leading US, UK and global companies in such areas as manufacturing, healthcare,
telecommunications and financial services. Our clients are primarily located in the United States
and the United Kingdom. Several of our clients have operations in other countries, and use our
services in connection with those operations. We have other clients in various countries, and
expect the number of these clients to increase as we develop our global background screening
business. Because we currently service the majority of our clients through our operations in the US
and the UK, we consider those two locations to be the sources of our business for purposes of
allocating revenue on a geographic basis.
We generally market our background screening services to businesses through an internal sales
force. Our services are offered to businesses on a local or global basis. Prices for our services
vary based upon complexity of the services offered, the cost of performing these services and
competitive factors. Control Risks Group provides marketing assistance and services, and licenses
certain trademarks to Screening International under which our services are branded in certain
geographic areas.
Other
Our Other segment includes Captira Analytical, LLC (Captira), which provides software and
automated service solutions for the bail bonds industry. Through our wholly owned subsidiary,
Captira, we provide automated service solutions for the bail bonds industry. These services include
accounting, reporting, and decision making tools which allow bail bondsmen, general agents and
sureties to run their offices more efficiently, to exercise greater operational and financial
control over their businesses, and to make better underwriting decisions. We believe Captiras
services are the only fully integrated suite of bail bonds management applications of comparable
scope available in the marketplace today. Captiras services are sold to retail bail bondsman on a
per seat license basis plus additional one-time or transaction related charges for various
optional services. As Captiras business model is relatively new, pricing and service
configurations are subject to change at any time.
Through our wholly owned subsidiary, Net Enforcers, Inc (Net Enforcers), we provide corporate
identity theft protection services, including online brand monitoring, online auction monitoring
and enforcement, intellectual property monitoring and other services. Net Enforcers services
include the use of sophisticated technology to search the internet in search of potential property
right infringements, value added analysis and recommendation from our trained staff of analysts,
and manual or automated enforcement activities as directed by our clients. Net Enforcers services
are typically priced as monthly subscriptions for a defined set of monitoring and analysis
services, as well as per transaction charges for enforcement related services. Prices for our
services vary based upon the specific configuration of services purchased by each client and range
from several hundred dollars per month to thousands of dollars per month.
The pro forma impact of Captira or Net Enforcers, prior to their acquisitions, on our historical
operating results is not material.
We also offer victim assistance services as part of our agreement with the Identity Theft
Assistance Corporation (ITAC) to help victims of identity theft that are referred to ITAC by
their financial institutions. We assist these customers in identifying instances of identity theft
that appears on their credit report, notifying the affected institutions, and sharing the data with
law enforcement. These victim assistance services are provided free to the customers and we are
paid fees by the ITAC Members for the services we provide to their customers. In addition, we offer
data security breach services to organizations responding to compromises of sensitive personal
information. We help these clients notify the affected individuals and we provide the affected
individuals with identity theft recovery and credit monitoring services offered by our clients at
no charge to the affected individuals. We generally are paid fees by the clients for the services
we provide their customers.
Critical Accounting Policies
In preparing our condensed consolidated financial statements, we make estimates and assumptions
that can have a significant impact on our financial position and results of operations. The
application of our critical accounting policies requires an evaluation of a number of complex
criteria and significant accounting judgments by us. In applying those policies, our management
uses its judgment to determine the appropriate assumptions to be used in the determination of
certain estimates. Actual results may differ significantly from these estimates under different
assumptions, judgments or conditions. We have identified the following policies as critical to our
business operations and the understanding of our results of operations. For additional information,
see Note 2 to our condensed consolidated financial statements.
Revenue Recognition
27
We recognize revenue on 1) identity theft, credit management and background services, 2) accidental
death insurance and 3) other membership products.
Our products and services are offered to consumers primarily on a monthly subscription basis.
Subscription fees are generally billed directly to the subscribers credit card, mortgage bill or
demand deposit accounts. The prices to subscribers of various configurations of our products and
services range generally from $4.99 to $25.00 per month. As a means of allowing customers to become
familiar with our services, we sometimes offer free trial or guaranteed refund periods. No revenues are recognized until applicable trial periods are completed.
Identity Theft, Credit Management and Background Services
We recognize revenue from our services in accordance with Staff Accounting Bulletin (SAB) No.
101, Revenue Recognition in Financial Statements as amended by SAB No. 104, Revenue Recognition.
Consistent with the requirements of SAB No.s 101 and 104, revenue is recognized when: a)
persuasive evidence of arrangement exists as we maintain signed contracts with all of our large
financial institution customers and paper and electronic confirmations with individual purchases,
b) delivery has occurred once the product is transmitted over the internet, c) the sellers price
to the buyer is fixed as sales are generally based on contract or list prices and payments from
large financial institutions are collected within 30 days with no significant write-offs, and d)
collectability is reasonably assured as individual customers pay by credit card which has limited
our risk of non-collection. Revenue for monthly subscriptions is recognized in the month the
subscription fee is earned. For subscriptions with refund provisions whereby only the prorated
subscription fee is refunded upon cancellation by the subscriber, deferred subscription fees are
recorded when billed and amortized as subscription fee revenue on a straight-line basis over the
subscription period, generally one year. We generate revenue from one-time credit reports and
background screenings which are recognized when the report is provided to the customer
electronically, which is generally at the time of completion.
Revenue for annual subscription fees must be deferred if the subscriber has the right to cancel the
service. Annual subscriptions include subscribers with full refund provisions at any time during
the subscription period and pro-rata refund provisions. Revenue related to annual subscription with
full refund provisions is recognized on the expiration of these refund provisions. Revenue related
to annual subscribers with pro-rata provisions is recognized based on a pro rata share of revenue
earned. An allowance for discretionary subscription refunds is established based on our actual
experience.
We also provide services for which certain financial institution clients are the primary obligors
directly to their customers. Revenue from these arrangements is recognized when earned, which is at
the time we provide the service, generally on a monthly basis.
The amount of revenue recorded by us is determined in accordance with Financial Accounting
Standards Boards (FASB) Emerging Issues Task Force (EITF) 99-19, Reporting Revenue Gross as a
Principal versus Net as an Agent, which addresses whether a company should report revenue based on
the gross amount billed to a customer or the net amount retained by us (amount billed less
commissions or fees paid). We generally record revenue on a gross basis in the amount that we bill
the subscriber when our arrangements with financial institution clients provide for us to serve as
the primary obligor in the transaction, we have latitude in establishing price and we bear the
credit risk for the amount billed to the subscriber. We generally record revenue in the amount that
we bill our financial institution clients, and not the amount billed to their customers, when our
financial institution client is the primary obligor, establishes price to the customer and bears
the credit risk.
Accidental Death Insurance and other Membership Products
We recognize revenue from our services in accordance with SAB No. 101, as amended by SAB No. 104.
Consistent with the requirements of SAB No.s 101 and 104, revenue is recognized when: a)
persuasive evidence of arrangement exists as we maintain paper and electronic confirmations with
individual purchases, b) delivery has occurred at the completion of a product trial period, c) the
sellers price to the buyer is fixed as the price of the product is agreed to by the customer as a
condition of the sales transaction which established the sales arrangement, and d) collectability
is reasonably assured as evidenced by our collection of revenue through the monthly mortgage
payments of our customers or through checking account debits to our customers accounts. Revenues
from insurance contracts are recognized when earned. Marketing of our insurance products generally
involves a trial period during which time the product is made available at no cost to the customer.
No revenues are recognized until applicable trial periods are completed.
28
The amount of revenue recorded by us is determined in accordance with FASBs EITF 99-19. For
insurance products we generally record revenue on a net basis as we perform as an agent or broker
for the insurance products without assuming the risks of ownership of the insurance products. For
membership products, we generally record revenue on a gross basis as we serve as the primary
obligor in the transactions, have latitude in establishing price and bear credit risk for the
amount billed to the subscriber.
We participate in agency relationships with insurance carriers that underwrite insurance products
offered by us. Accordingly, insurance premiums collected from customers and remitted to insurance
carriers are excluded from our revenues and operating expenses. Insurance premiums collected but
not remitted to insurance carriers as of September 30, 2008 and December 31, 2008 totaled $2.2
million and $1.3 million, respectively, and is included in accrued expenses and other current
liabilities in our condensed consolidated balance sheet.
Other Monthly Subscription Products
We generate revenue from other types of subscription based products provided from our Other
segment. We recognize revenue on services provided from identity theft referrals from major banking
institutions and breach services previously allocated to the Consumer Products and Services
segment. We also recognize revenue from providing management service solutions, offered by Captira,
on a monthly subscription basis and online brand protection and brand monitoring, offered by Net
Enforcers, on a monthly basis.
Deferred Subscription Solicitation and Advertising
Our deferred subscription solicitation costs consist of subscription acquisition costs, including
telemarketing, web-based marketing expenses and direct mail such as printing and postage. We
expense advertising costs the first time advertising takes place. Telemarketing, web-based
marketing and direct mail expenses are direct response advertising costs, which are accounted for
in accordance with American Institute of Certified Public Accountants Statement of Position (SOP)
93-7, Reporting on Advertising Costs. The recoverability of amounts capitalized as deferred
subscription solicitation costs are evaluated at each balance sheet date, in accordance with SOP
93-7, by comparing the carrying amounts of such assets on a cost pool basis to the probable
remaining future benefit expected to result directly from such advertising costs. Probable
remaining future benefit is estimated based upon historical subscriber patterns, and represents net
revenues less costs to earn those revenues. In estimating probable future benefit (on a per
subscriber basis) we deduct our contractual cost to service that subscriber from the known sales
price. We then apply the future benefit (on a per subscriber basis) to the number of subscribers
expected to be retained in the future to arrive at the total probable future benefit. In estimating
the number of subscribers we will retain (i.e., factoring in expected cancellations), we utilize
historical subscriber patterns maintained by us that show attrition rates by client, product and
marketing channel. The total probable future benefit is then compared to the costs of a given
marketing campaign (i.e., cost pools), and if the probable future benefit exceeds the cost pool,
the amount is considered to be recoverable. If direct response advertising costs were to exceed the
estimated probable remaining future benefit, an adjustment would be made to the deferred
subscription costs to the extent of any shortfall.
We amortize deferred subscription solicitation costs on a cost pool basis over the period during
which the future benefits are expected to be received, but no more than 12 months.
Commission Costs
In accordance with SAB No. 101, as amended by SAB No. 104, commissions that relate to annual
subscriptions with full refund provisions and monthly subscriptions are expensed in the month
incurred, unless we are entitled to a refund of the commissions. If annual subscriptions are
cancelled prior to their initial terms, we are generally entitled to a full refund of the
previously paid commission for those annual subscriptions with a full refund provision and a
pro-rata refund, equal to the unused portion of their subscription, for those annual subscriptions
with a pro-rata refund provision. Commissions that relate to annual subscriptions with full
commission refund provisions are deferred until the earlier of expiration of the refund privileges
or cancellation. Once the refund privileges have expired, the commission costs are recognized
ratably in the same pattern that the related revenue is recognized. Commissions that relate to
annual subscriptions with pro-rata refund provisions are deferred and charged to operations as the
corresponding revenue is recognized. If a subscription is cancelled, upon receipt of the refunded
commission from our client, we record a reduction to the deferred commission.
29
We have prepaid commission agreements with some of our clients. Under these agreements, we pay a
commission on new subscribers in lieu of ongoing commission payments. We amortize these prepaid
commissions, on an accelerated basis, over a period of time not to exceed three years, which is the
average expected life of customers. The short-term portion of the prepaid commissions are shown in
prepaid expenses and other current assets on our condensed consolidated balance sheet. The
long-term portion of the prepaid commissions are shown in other assets on our condensed
consolidated balance sheet. Amortization is included in commissions expense on our condensed
consolidated statement of income.
Deferred subscription solicitation costs included in the accompanying balance sheet as of September
30, 2008 and December 31, 2007, were $30.9 million and $23.5 million, which includes $4.2 million
and $1.6 million reported in other assets, respectively, on our condensed consolidated balance
sheet. Amortization of deferred subscription solicitation and commission costs, which are included
in either marketing or commissions expense in our condensed consolidated statement of income, for
the three months ended September 30, 2008 and 2007 were $13.2 million and $9.4 million,
respectively, and for the nine months ended September 30, 2008 and 2007 were $38.6 million and
$24.1 million, respectively. Subscription solicitation costs expensed as incurred related to
marketing costs, which are included in marketing expenses in our condensed consolidated statement
of income, as they did not meet the criteria for deferral in accordance with SOP 93-7, for the
three months ended September 30, 2008 and 2007 were $1.1 million and $215 thousand, respectively.
Subscription solicitation costs expensed as incurred related to marketing costs in the nine months
ended September 30, 2008 and 2007 were $3.5 million and $1.9 million, respectively.
Software Development Costs
We develop software for internal use and capitalize software development costs incurred during the
application development stage in accordance with SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, and EITF 00-2, Accounting for Web Site Development
Cost. Costs incurred prior to and after the application development stage are charged to expense.
When the software is ready for its intended use, capitalization ceases and such costs are amortized
on a straight-line basis over the estimated useful life, which is generally three to five years.
In accordance with SOP 98-1, we regularly review our capitalized software projects for impairment
in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. We did not have any impairments in the nine months ended September 30, 2008 and
2007.
Goodwill and Other Intangible Assets
We record, as goodwill, the excess of purchase price over the fair value of the identifiable net
assets acquired in a purchase transaction. The fair value of the identifiable net assets acquired
is determined based upon a third party valuation, evaluation of other information and management
review.
SFAS No. 142, Goodwill and Other Intangible Assets, prescribes a two-step process for impairment
testing of goodwill and intangibles with indefinite lives, which is required to be performed
annually, as well as when an event triggering impairment may have occurred. The first step tests
for impairment, while the second step, if necessary, measures the impairment. We elected to perform
our annual analysis as of October 31 of each fiscal year. As of September 30, 2008, no indicators
of impairment have been identified.
Intangible assets subject to amortization include trademarks and customer, marketing and technology
related assets. Such intangible assets, excluding customer related, are amortized on a
straight-line basis over their estimated useful lives, which are generally three to ten years.
Customer related intangible assets are amortized on either a straight-line or accelerated basis,
dependant upon the pattern in which the economic benefits of the intangible asset are consumed or
otherwise used up.
Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141R, Business Combinations. SFAS No. 141R replaces SFAS
No. 141 on accounting for business combinations, specifically the cost-allocation process. SFAS No.
141R requires an acquirer to recognize the assets acquired, liabilities assumed and any
noncontrolling interest in the acquiree at the acquisition date, at their fair values as of that
date. In addition, an acquirer is required to recognize assets or liabilities arising from
contractual contingencies as of the acquisition date, at their acquisition date fair values.
Acquisition related costs that were previously allocated to the assets acquired and liabilities
assumed under SFAS No. 141 should be recognized separately from the acquisition under SFAS No.
141R. The provisions of SFAS No. 141R
30
are effective for fiscal years beginning after December 15, 2008 and interim periods within those
fiscal years. We are in the process of evaluating the impact, if any, that SFAS No. 141R will have
on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements an Amendment of ARB No. 51. SFAS No. 160 establishes accounting and reporting
standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. The presentation of a noncontrolling interest has been modified for both the income
statement and balance sheet, as well as expanded disclosure requirements that clearly identify and
distinguish between the interests of the parents owners and the interest of the noncontrolling
owners of a subsidiary. The provisions of SFAS No. 160 are effective for fiscal years beginning
after December 15, 2008 and interim periods within those fiscal years. We are in the process of
evaluating the impact, if any, that SFAS No. 160 will have on our consolidated financial
statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging
Activities. SFAS No. 161 amends SFAS No. 133 by improving financial reporting about derivative
instruments and hedging activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entitys financial position, financial performance, and cash flows.
The provisions of SFAS No. 161 are effective for fiscal years beginning after November 15, 2008 and
interim periods within those fiscal years. We are in the process of evaluating the impact, if any,
that SFAS No. 161 will have on our consolidated financial statements.
In April 2008, the FASB issued Staff Position (FSP) No. 142-3, Determination of the Useful Life
of Intangible Assets. FSP No. 142-3 amends the factors that should be considered in developing
renewal or extension assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142. The provisions of FSP No. 142-3 are effective for fiscal years beginning after
December 15, 2008 and interim periods within those fiscal years. We are in the process of
evaluating the impact, if any, that FSP No. 142-3 will have on our consolidated financial
statements.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principle. SFAS No. 162 identifies the sources of accounting principles and the framework for
selecting the principles to be used in the preparation of financial statements that are presented
in conformity with generally accepted accounting principles in the United States. This Statement is
effective 60 days following the SECs approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted
Accounting Principles. We are in the process of evaluating the impact, if any, that SFAS No. 162
will have on our consolidated financial statements.
In June 2008, the FASB issued FSP Emerging Issues Task Force (EITF) No. 03-6-1, Determining
Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. FSP
EITF No. 03-6-1 clarifies that unvested share-based payment awards that contain nonforfeitable
rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities
and are to be included in the computation of earnings per share under the two-class method
described in SFAS No. 128, Earnings Per Share. This FSP EITF is effective for us on January 1, 2009
and requires all presented prior-period earnings per share data to be adjusted retrospectively. We
are in the process of evaluating the impact, if any, that FSP EITF No. 03-6-1 will have on our
consolidated financial statements.
In October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset
When the Market for That Asset is Not Active. FSP No. 157-3 clarifies the application of SFAS No.
157 in a market that is not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that financial asset is not
active. The provisions of FSP No. 157-3 were effective upon issuance and for financial statements
not yet reported. The adoption of FSP No. 157-3 did not have a material impact on our consolidated
financial statements.
Trends Related to the Current Economic Environment
We anticipate the weakening economy to have the following three principal effects on our business: We expect new card issuances
at our financial institution clients to slow, which in turn might translate into a softening of revenue for our Consumer Products
and Services segment. We also expect charge or credit card delinquencies and card cancellations to increase, which might result
in the increased cancellation of certain of our services. Our relationships with some financial institution clients may change
to more direct marketing arrangements as they look more for outside sources to fund partner programs and invest in marketing, which
can present both opportunities and challenges to us. The consolidation of the major financial institutions will also have an impact.
Results of Operations
We operate in three primary business segments: Consumer Products and Services, Background
Screening, and Other. In the nine months ended September 30, 2008, we changed our segment reporting
by realigning a portion of the Consumer Products and Services segment into the Other segment. The
Other segment now contains breach and identify theft referral services previously accounted for in
the Consumer Products and Services segment. The change in business segments was determined based on
how our senior management analyzed, evaluated, and operated our global operations beginning in the
three months ended June 30, 2008.
31
Our Consumer Products and Services segment includes our consumer protection and other consumer
products and services. It includes identity theft management tools, membership product offerings
and other subscription based services such as life and accidental death insurance. Our Background
Screening segment includes the personnel and vendor background screening services provided by SI.
Our Other segment includes breach and identity theft referral services reallocated from the
Consumer Products and Services segment. This segment also includes the software management
solutions for the bail bond industry provided by Captira and corporate brand protection provided by
Net Enforcers.
We have developed methodologies to fully allocate indirect costs associated with these revenues to
the Other segment. These costs include expenses associated with fulfillment, credit bureau costs,
indirect selling and general and administrative expenses. The allocation methodologies are based on
historical cost percentages of these services from our continuing operations.
As a result, we have modified the way we manage our business to utilize operating income (loss)
information to evaluate the performance of our business segments and to allocate resources to them.
We have recasted the results of our business segment data for the three and nine months ended
September 30, 2008 and 2007 into the new business segments for comparability with current
presentation.
Three Months Ended September 30, 2008 vs. Three Months Ended September 30, 2007 (in thousands):
The consolidated results of operations are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer |
|
|
|
|
|
|
|
|
|
|
|
|
Products |
|
|
Background |
|
|
|
|
|
|
|
|
|
and Services |
|
|
Screening |
|
|
Other |
|
|
Consolidated |
|
Three Months Ended September 30, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
83,788 |
|
|
$ |
7,814 |
|
|
$ |
1,813 |
|
|
$ |
93,415 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing |
|
|
12,776 |
|
|
|
|
|
|
|
|
|
|
|
12,776 |
|
Commissions |
|
|
22,199 |
|
|
|
|
|
|
|
120 |
|
|
|
22,319 |
|
Cost of revenue |
|
|
25,048 |
|
|
|
4,600 |
|
|
|
791 |
|
|
|
30,439 |
|
General and administrative |
|
|
12,444 |
|
|
|
3,898 |
|
|
|
1,370 |
|
|
|
17,712 |
|
Depreciation |
|
|
2,190 |
|
|
|
241 |
|
|
|
7 |
|
|
|
2,438 |
|
Amortization |
|
|
2,363 |
|
|
|
126 |
|
|
|
250 |
|
|
|
2,739 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
77,020 |
|
|
|
8,865 |
|
|
|
2,538 |
|
|
|
88,423 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations |
|
$ |
6,768 |
|
|
$ |
(1,051 |
) |
|
$ |
(725 |
) |
|
$ |
4,992 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
62,548 |
|
|
$ |
7,714 |
|
|
$ |
1,141 |
|
|
$ |
71,403 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing |
|
|
9,390 |
|
|
|
|
|
|
|
|
|
|
|
9,390 |
|
Commissions |
|
|
13,872 |
|
|
|
|
|
|
|
120 |
|
|
|
13,992 |
|
Cost of revenue |
|
|
21,904 |
|
|
|
4,662 |
|
|
|
508 |
|
|
|
27,074 |
|
General and administrative |
|
|
10,658 |
|
|
|
3,882 |
|
|
|
428 |
|
|
|
14,968 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation |
|
|
1,982 |
|
|
|
230 |
|
|
|
9 |
|
|
|
2,221 |
|
Amortization |
|
|
714 |
|
|
|
126 |
|
|
|
71 |
|
|
|
911 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
58,520 |
|
|
|
8,900 |
|
|
|
1,136 |
|
|
|
68,556 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations |
|
$ |
4,028 |
|
|
$ |
(1,186 |
) |
|
$ |
5 |
|
|
$ |
2,847 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer Products and Services Segment
Our Consumer Products and Services segment includes our consumer protection and other consumer
products and services. It includes identity theft management tools, membership product offerings
and other subscription based services such as life and accidental death insurance.
32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
% |
|
Revenue |
|
$ |
83,788 |
|
|
$ |
62,548 |
|
|
$ |
21,240 |
|
|
|
34.0 |
% |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing |
|
|
12,776 |
|
|
|
9,390 |
|
|
|
3,386 |
|
|
|
36.1 |
% |
Commissions |
|
|
22,199 |
|
|
|
13,872 |
|
|
|
8,327 |
|
|
|
60.0 |
% |
Cost of revenue |
|
|
25,048 |
|
|
|
21,904 |
|
|
|
3,144 |
|
|
|
14.4 |
% |
General and administrative |
|
|
12,444 |
|
|
|
10,658 |
|
|
|
1,786 |
|
|
|
16.8 |
% |
Depreciation |
|
|
2,190 |
|
|
|
1,982 |
|
|
|
208 |
|
|
|
10.5 |
% |
Amortization |
|
|
2,363 |
|
|
|
714 |
|
|
|
1,649 |
|
|
|
231.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
77,020 |
|
|
|
58,520 |
|
|
|
18,500 |
|
|
|
31.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations |
|
$ |
6,768 |
|
|
$ |
4,028 |
|
|
$ |
2,740 |
|
|
|
68.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue. The increase in Consumer Products and Services is primarily the result of existing client
revenue and increased revenue from direct to consumer. This is partially offset by the loss of
subscribers from our wholesale relationship with Discover. We expect the impact of this loss to
continue in the remaining months of 2008. In order to maintain and continue to grow our revenue,
we will have to offset this loss of revenue from existing and new client relationships and other
products and services. Growth in our subscriber base has been accomplished primarily from the
purchase of Citibanks membership agreements in January 2008 and additional subscribers obtained by
us through our continued direct marketing efforts, including continued growth from our largest
client relationship. Revenue from direct marketing arrangements, in which we recognize the gross
amount billed to the customer, has increased to 79.8% for the three months ended September 30, 2008
from 70.2% in the three months ended September 30, 2007.
The table below shows the percentage of subscribers generated from direct marketing arrangements:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
September 30, |
|
|
2008 |
|
2007 |
Percentage of subscribers from direct marketing arrangements to total subscribers |
|
|
52.5 |
% |
|
|
36.9 |
% |
Percentage of new subscribers acquired from direct marketing arrangements to total
new subscribers acquired |
|
|
64.3 |
% |
|
|
44.9 |
% |
Percentage of revenue from direct marketing arrangements to total subscription revenue |
|
|
79.8 |
% |
|
|
70.2 |
% |
Marketing Expenses. Marketing expenses consist of subscriber acquisition costs, including
telemarketing, web-based marketing and direct mail expenses such as printing and postage. The
increase in marketing is primarily a result of an increased investment in marketing for direct
marketing arrangements. Amortization of deferred subscription solicitation costs related to
marketing for the three months ended September 30, 2008 and 2007 were $11.7 million and $9.2
million, respectively. Subscription solicitation costs related to marketing costs expensed as
incurred for the three months ended September 30, 2008 and 2007 were $1.1 million and $215
thousand, respectively.
As a percentage of revenue, marketing expenses increased to 15.2% for the three months ended
September 30, 2008 from 15.0% for the three months ended September 30, 2007.
Commission Expenses. Commission expenses consist of commissions paid to clients. The increase in
commissions is related to an increase in sales and subscribers from our direct marketing
arrangements.
As a percentage of revenue, commission expenses increased to 26.5% for three months ended September
30, 2008 from 22.2% for three months ended September 30, 2007 primarily due to the increased
proportion of revenue from direct marketing arrangements with ongoing clients. We expect
commissions expenses, as a percentage of revenue, to continue to increase as we continue to
increase our direct marketing arrangements.
Cost of Revenue. Cost of revenue consists of the costs of operating our customer service and
information processing centers, data costs and billing costs for subscribers and one-time
transactional sales. The increase in cost of revenue was attributed mainly to $1.2 million in
increased data costs, higher cost of revenue for ongoing fulfillment and customer service costs to
support the current subscriber base.
As a percentage of revenue, cost of revenue was 29.9% for the three months ended September 30, 2008
compared to 35.0% for the three months ended September 30, 2007, as the result of an increase in
the ratio of direct revenue.
33
General and Administrative Expenses. General and administrative expenses consist of personnel and
facilities expenses associated with our executive, sales, marketing, information technology,
finance, and program and account management functions. The increase in general and administrative
expenses is related to increased payroll, which includes increased share based compensation expense
of approximately $363 thousand for additional grants in 2008, and professional services to support
the growth in our business.
Total share based compensation expense for the three months ended September 30, 2008 and 2007 was
$1.1 million and $737 thousand, respectively.
As a percentage of revenue, general and administrative expenses decreased to 14.9% for the three
months ended September 30, 2008 from 17.0% for the three months ended September 30, 2007, as the
result of an increase in the ratio of direct revenue.
Depreciation. Depreciation expenses consist primarily of depreciation expenses related to our fixed
assets and capitalized software. Depreciation expense increased for the three months ended
September 30, 2008 compared to the three months ended September 30, 2007.
As a percentage of revenue, depreciation expenses decreased to 2.6% for the three months ended
September 30, 2008 from 3.2% for the three months ended September 30, 2007.
Amortization. Amortization expenses consist primarily of the amortization of our intangible assets.
The increase in amortization is primarily attributable to the increase in intangible assets as the
result the membership agreements purchased from Citibank in January 2008.
As a percentage of revenue, amortization expenses increased to 2.8% for the three months ended
September 30, 2008 from 1.1% for the three months ended September 30, 2007.
Background Screening Segment
Our Background Screening segment includes the personnel and vendor background screening services
provided by SI.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
% |
|
Revenue |
|
$ |
7,814 |
|
|
$ |
7,714 |
|
|
$ |
100 |
|
|
|
1.3 |
% |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue |
|
|
4,600 |
|
|
|
4,662 |
|
|
|
(62 |
) |
|
|
(1.3 |
%) |
General and administrative |
|
|
3,898 |
|
|
|
3,882 |
|
|
|
16 |
|
|
|
0.4 |
% |
Depreciation |
|
|
241 |
|
|
|
230 |
|
|
|
11 |
|
|
|
4.8 |
% |
Amortization |
|
|
126 |
|
|
|
126 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
8,865 |
|
|
|
8,900 |
|
|
|
(35 |
) |
|
|
(0.4 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations |
|
$ |
(1,051 |
) |
|
$ |
(1,186 |
) |
|
$ |
135 |
|
|
|
(11.4 |
%) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue. The revenue increase is primarily attributable to growth in UK revenues of $689 thousand,
partially offset by decreased domestic revenue of $596 thousand. The increase in UK revenue is
primarily attributable to renegotiated pricing and increased volume for a major client. The
reduction in domestic revenues is due to a decrease in volume. The general economic slowdown has
reduced new hirings by our clients and, accordingly, the demand for our services. Therefore, our
revenue is growing at a slower rate than we anticipated at the start of the year. This is
particularly true in the UK where a significant portion of our clients are in the financial
services industry. We anticipate this trend continuing into 2009 and possibly beyond until the
economy starts to recover.
Cost of Revenue. Cost of revenue consists of the costs to fulfill background screens and is mainly
composed of direct labor costs, consultant costs, database fees and access fees. Cost of revenue
decreased primarily due to reductions in consultant, access, database fees and other direct costs
of $211 thousand offset by $115 thousand of implementation costs associated with a new fulfillment
center and the addition of the Singapore operation of $5 thousand.
As a percentage of revenue, cost of revenue was 58.9% for the three months ended September 30, 2008
compared to 60.4% for the three months ended September 30, 2007.
34
General and Administrative Expenses. General and administrative expenses consist of personnel and
facilities expenses associated with our sales, marketing, information technology, finance, and
account management functions. The increase in general and administrative expenses is related to the
addition of the Singapore office of $127 thousand offset by a reduction in domestic and UK
facilities of $111 thousand.
As a percentage of revenue, general and administrative expenses decreased to 49.9% for the three
months ended September 30, 2008 from 50.3% for the three months ended September 30, 2007.
Depreciation. Depreciation expenses consist primarily of depreciation expenses related to our fixed
assets and capitalized software. Depreciation expense has increased due to increasing capital
expenditures related to the global operations.
As a percentage of revenue, depreciation expenses slightly increased to 3.1% for the three months
ended September 30, 2008 from 3.0% for the three months ended September 30, 2007.
Other Segment
Our Other segment includes the services for our relationship with a third party that administers
referrals for identity theft to major banking institutions and breach services reallocated from the
Consumer Products and Services segment. This segment also includes the software management
solutions for the bail bond industry provided by Captira and corporate brand protection provided by
Net Enforcers.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
% |
|
Revenue |
|
$ |
1,813 |
|
|
$ |
1,141 |
|
|
$ |
672 |
|
|
|
58.9 |
% |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions |
|
|
120 |
|
|
|
120 |
|
|
|
|
|
|
|
0.0 |
% |
Cost of revenue |
|
|
791 |
|
|
|
508 |
|
|
|
283 |
|
|
|
55.7 |
% |
General and administrative |
|
|
1,370 |
|
|
|
428 |
|
|
|
942 |
|
|
|
220.1 |
% |
Depreciation |
|
|
7 |
|
|
|
9 |
|
|
|
(2 |
) |
|
|
(22.2 |
%) |
Amortization |
|
|
250 |
|
|
|
71 |
|
|
|
179 |
|
|
|
252.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
2,538 |
|
|
|
1,136 |
|
|
|
1,402 |
|
|
|
123.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income from operations |
|
$ |
(725 |
) |
|
$ |
5 |
|
|
$ |
(730 |
) |
|
|
NM |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue. The increase is primarily attributable additional business operations acquired in the
latter half of 2007.
Commissions Expense. Commission expenses consist of commissions paid to clients.
As a percentage of revenue, commission expense was 6.6% for the three months ended September 30,
2008 compared to 10.5% for the three months ended September 30, 2007.
Cost of Revenue. Cost of revenue consists of the costs of operating our customer service and
information processing centers, data costs and billing costs for subscribers and one-time
transactional sales. Cost of revenue primarily increased due to the additional business operations
acquired in 2007.
As a percentage of revenue, cost of revenue was 43.6% for the three months ended September 30, 2008
compared to 44.5% for the three months ended September 30, 2007.
General and Administrative Expenses. General and administrative expenses consist of personnel and
facilities expenses associated with our executive, sales, marketing, information technology,
finance, and program and account management functions.
Captira has successfully completed development of an initial commercial version of its applications
and is in the early stages of market development and adoption of its service offerings by the bail
bonds industry. As such, Captira has few clients and revenue is
35
immaterial. However, Captira still incurs substantial monthly overhead expenses for management
functions, business development and sales, customer support, technology operations and other
functions despite the lack of a large customer base.
As a percentage of revenue, general and administrative expenses increased to 75.5% for the three
months ended September 30, 2008 from 37.4% for the three months ended September 30, 2007.
Depreciation. Depreciation and amortization expenses consist primarily of depreciation expenses
related to our fixed assets and capitalized software.
Amortization. Amortization expenses consist primarily of the amortization of our intangible assets.
This increase is primarily attributable to the increase in intangible assets as the result of
acquisitions of Captira and Net Enforcers in 2007.
As a percentage of revenue, amortization expenses increased to 13.8% for the three months ended
September 30, 2008 from 6.2% for the three months ended September 30, 2007.
Nine Months Ended September 30, 2008 vs. Nine Months Ended September 30, 2007 (in thousands):
The consolidated results of operations are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer |
|
|
|
|
|
|
|
|
|
|
|
|
Products |
|
|
Background |
|
|
|
|
|
|
|
|
|
and Services |
|
|
Screening |
|
|
Other |
|
|
Consolidated |
|
Nine Months Ended September 30, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
245,793 |
|
|
$ |
22,570 |
|
|
$ |
5,158 |
|
|
$ |
273,521 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing |
|
|
38,573 |
|
|
|
|
|
|
|
|
|
|
|
38,573 |
|
Commissions |
|
|
61,320 |
|
|
|
|
|
|
|
360 |
|
|
|
61,680 |
|
Cost of revenue |
|
|
73,769 |
|
|
|
12,814 |
|
|
|
2,136 |
|
|
|
88,719 |
|
General and administrative |
|
|
35,759 |
|
|
|
11,663 |
|
|
|
3,609 |
|
|
|
51,031 |
|
Depreciation |
|
|
6,375 |
|
|
|
724 |
|
|
|
8 |
|
|
|
7,107 |
|
Amortization |
|
|
6,940 |
|
|
|
379 |
|
|
|
813 |
|
|
|
8,132 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
222,736 |
|
|
|
25,580 |
|
|
|
6,926 |
|
|
|
255,242 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations |
|
$ |
23,057 |
|
|
$ |
(3,010 |
) |
|
$ |
(1,768 |
) |
|
$ |
18,279 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
167,228 |
|
|
$ |
22,191 |
|
|
$ |
5,289 |
|
|
$ |
194,708 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing |
|
|
25,325 |
|
|
|
|
|
|
|
|
|
|
|
25,325 |
|
Commissions |
|
|
35,436 |
|
|
|
|
|
|
|
394 |
|
|
|
35,830 |
|
Cost of revenue |
|
|
59,792 |
|
|
|
13,269 |
|
|
|
2,009 |
|
|
|
75,070 |
|
General and administrative |
|
|
32,528 |
|
|
|
11,020 |
|
|
|
720 |
|
|
|
44,268 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation |
|
|
6,016 |
|
|
|
644 |
|
|
|
9 |
|
|
|
6,669 |
|
Amortization |
|
|
1,886 |
|
|
|
379 |
|
|
|
71 |
|
|
|
2,336 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
160,983 |
|
|
|
25,312 |
|
|
|
3,203 |
|
|
|
189,498 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations |
|
$ |
6,245 |
|
|
$ |
(3,121 |
) |
|
$ |
2,086 |
|
|
$ |
5,210 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer Products and Services Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
% |
|
Revenue |
|
$ |
245,793 |
|
|
$ |
167,228 |
|
|
$ |
78,565 |
|
|
|
47.0 |
% |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketing |
|
|
38,573 |
|
|
|
25,325 |
|
|
|
13,248 |
|
|
|
52.3 |
% |
Commissions |
|
|
61,320 |
|
|
|
35,436 |
|
|
|
25,884 |
|
|
|
73.0 |
% |
Cost of revenue |
|
|
73,769 |
|
|
|
59,792 |
|
|
|
13,977 |
|
|
|
23.4 |
% |
36
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
% |
|
General and administrative |
|
|
35,759 |
|
|
|
32,528 |
|
|
|
3,231 |
|
|
|
9.9 |
% |
Depreciation |
|
|
6,375 |
|
|
|
6,016 |
|
|
|
359 |
|
|
|
6.0 |
% |
Amortization |
|
|
6,940 |
|
|
|
1,886 |
|
|
|
5,054 |
|
|
|
268.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
222,736 |
|
|
|
160,983 |
|
|
|
61,753 |
|
|
|
38.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations |
|
$ |
23,057 |
|
|
$ |
6,245 |
|
|
$ |
16,812 |
|
|
|
269.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue. The increase in Consumer Products and Services is primarily the result of existing client
revenue and increased revenue from direct to consumer. This is partially offset by the loss of
subscribers from our wholesale relationship with Discover. We expect the impact of this loss to
continue in the remaining months of 2008. In order to maintain and continue to grow our revenue,
we will have to offset this loss of revenue from existing and new client relationships and other
products and services. Growth in our subscriber base has been accomplished primarily from the
purchase of Citibanks membership agreements in January 2008 and additional subscribers obtained by
us through our continued direct marketing efforts, including continued growth from our largest
client relationship. Revenue from direct marketing arrangements, in which we recognize the gross
amount billed to the customer, has increased to 76.5% for the nine months ended September 30, 2008
from 67.0% in the nine months ended September 30, 2007.
The table below shows the percentage of subscribers generated from direct marketing arrangements:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
September 30, |
|
|
2008 |
|
2007 |
Percentage of subscribers from direct marketing arrangements to total subscribers |
|
|
52.5 |
% |
|
|
36.9 |
% |
Percentage of new subscribers acquired from direct marketing arrangements to total
new subscribers acquired |
|
|
53.4 |
% |
|
|
44.5 |
% |
Percentage of revenue from direct marketing arrangements to total subscription revenue |
|
|
76.5 |
% |
|
|
67.0 |
% |
Marketing Expenses. The increase in marketing is primarily a result of an increased investment in
marketing for direct marketing arrangements. Amortization of deferred subscription solicitation
costs related to marketing for the nine months ended September 30, 2008 and 2007 were $35.1 million
and $23.4 million, respectively. Subscription solicitation costs related to marketing costs
expensed as incurred for the nine months ended September 30, 2008 and 2007 were $3.5 million and
$1.9 million, respectively. This includes approximately $1.4 million of advertising that occurred
in the nine months ended September 30, 2008 related to a media campaign.
As a percentage of revenue, marketing expenses increased to 15.7% for the nine months ended
September 30, 2008 from 15.1% for the nine months ended September 30, 2007.
Commission Expenses. The increase in commissions is related to an increase in sales and subscribers
from our direct marketing arrangements.
As a percentage of revenue, commission expenses increased to 24.9% for nine months ended September
30, 2008 from 21.2% for nine months ended September 30, 2007 primarily due to the increased
proportion of revenue from direct marketing arrangements with ongoing clients. We expect
commissions expenses, as a percentage of revenue, to continue to increase as we continue to
increase our direct marketing arrangements.
Cost of Revenue. The increase in cost of revenue was attributed mainly to $7.2 million in increased
data costs and higher cost of revenue for initial fulfillment and customer service costs to support
the increased subscriber base, which are incurred prior to the commencement of related revenue due
to the trial periods.
As a percentage of revenue, cost of revenue was 30.0% for the nine months ended September 30, 2008
compared to 35.8% for the nine months ended September 30, 2007, as the result of an increase in the
ratio of direct revenue.
General and Administrative Expenses. The increase in general and administrative expenses is related
to increased payroll, which includes increased share based compensation expense of approximately
$1.3 million primarily for additional grants in 2008, and professional services to support the growth in our
business.
Total share based compensation expense for the nine months ended September 30, 2008 and 2007 was
$3.3 million and $2.0 million, respectively.
37
As a percentage of revenue, general and administrative expenses decreased to 14.5% for the nine
months ended September 30, 2008 from 19.5% for the nine months ended September 30, 2007, as the
result of an increase in the ratio of direct revenue.
Depreciation. Depreciation expense increased for the nine months ended September 30, 2008 compared
to the nine months ended September 30, 2007.
As a percentage of revenue, depreciation expenses decreased to 2.6% for the nine months ended
September 30, 2008 from 3.6% for the nine months ended September 30, 2007.
Amortization. The increase in amortization is primarily attributable to the increase in intangible
assets as the result of the membership agreements purchased from Citibank in January 2008.
As a percentage of revenue, amortization expenses increased to 2.8% for the nine months ended
September 30, 2008 from 1.1% for the nine months ended September 30, 2007.
Background Screening Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
% |
|
Revenue |
|
$ |
22,570 |
|
|
$ |
22,191 |
|
|
$ |
379 |
|
|
|
1.7 |
% |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue |
|
|
12,814 |
|
|
|
13,269 |
|
|
|
(455 |
) |
|
|
(3.4 |
%) |
General and administrative |
|
|
11,663 |
|
|
|
11,020 |
|
|
|
643 |
|
|
|
5.8 |
% |
Depreciation |
|
|
724 |
|
|
|
644 |
|
|
|
80 |
|
|
|
12.4 |
% |
Amortization |
|
|
379 |
|
|
|
379 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
25,580 |
|
|
|
25,312 |
|
|
|
268 |
|
|
|
1.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations |
|
$ |
(3,010 |
) |
|
$ |
(3,121 |
) |
|
$ |
111 |
|
|
|
3.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue. The increase is primarily attributable to growth in the UK and Singapore of $749 thousand,
offset by decreased domestic revenues of $370 thousand. The increase in UK revenue is primarily
attributable to revised pricing and volume increases for a major client and the addition of several
small volume clients in 2008. The reduction in domestic revenues is due to a decrease in volume.
The general economic slowdown has reduced new hirings by our clients and, accordingly, the demand
for our services. Therefore, our revenue is growing at a slower rate than we anticipated at the
start of the year. This is particularly true in the UK where a significant portion of our clients
are in the financial services industry. We anticipate this trend continuing into 2009 and possibly
beyond until the economy starts to recover
Cost of Revenue. Cost of revenue decreased due to reductions in UK labor costs of $348 thousand,
partially offset by domestic labor increases of $230 thousand. Additional reductions in
consultant, access, database fees and other direct costs totaled $366 thousand. These reductions
were partially offset by the costs incurred by the addition of the Singapore operation of $30
thousand. The net reductions reflect our ongoing efforts to improve productivity in our
operations.
As a percentage of revenue, cost of revenue was 56.8% for the nine months ended September 30, 2008
compared to 59.8% for the nine months ended September 30, 2007.
General and Administrative Expenses. The increase in general and administrative expenses is
primarily attributable to a one time severance expense of $250 thousand and expenses related to the
addition of the Singapore operation of $463 thousand, partially offset by a reduction in expenses
incurred for global operations of $61 thousand.
As a percentage of revenue, general and administrative expenses increased to 51.7% for the nine
months ended September 30, 2008 from 49.7% for the nine months ended September 30, 2007.
Depreciation. Depreciation expense has increased due to increasing capital expenditures related to
the global operations.
As a percentage of revenue, depreciation expenses increased to 3.2% for the nine months ended
September 30, 2008 from 2.9% for the nine months ended September 30, 2007.
38
Other Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
% |
|
Revenue |
|
$ |
5,158 |
|
|
$ |
5,289 |
|
|
$ |
(131 |
) |
|
|
(2.5 |
%) |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions |
|
|
360 |
|
|
|
394 |
|
|
|
(34 |
) |
|
|
(8.6 |
%) |
Cost of revenue |
|
|
2,136 |
|
|
|
2,009 |
|
|
|
127 |
|
|
|
6.3 |
% |
General and administrative |
|
|
3,609 |
|
|
|
720 |
|
|
|
2,889 |
|
|
|
NM |
|
Depreciation |
|
|
8 |
|
|
|
9 |
|
|
|
(1 |
) |
|
|
(11.1 |
%) |
Amortization |
|
|
813 |
|
|
|
71 |
|
|
|
742 |
|
|
|
NM |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
6,926 |
|
|
|
3,203 |
|
|
|
3,723 |
|
|
|
116.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income from operations |
|
$ |
(1,768 |
) |
|
$ |
2,086 |
|
|
$ |
3,872 |
|
|
|
NM |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue. The decrease is primarily attributable to a reduction in referral and breach services from
a one time breach sale that was recognized in the nine months ended September 30, 2007. This was
partially offset by additional business operations acquired in the latter half of 2007. The
general economic slowdown has negatively impacted sales at Net Enforcers for the nine months ended
September 30, 2008. Although we anticipate this trend continuing into 2009 and possibly beyond, we
are attempting to make corresponding reductions in our costs.
Commissions Expense. The decrease in commissions is related to a decrease in sales and subscribers
from our referral and breach business.
As a percentage of revenue, commissions expense was 7.0% for the nine months ended September 30,
2008 compared to 7.5% for the nine months ended September 30, 2007.
Cost of Revenue. Cost of revenue primarily increased due to the additional business operations
acquired in 2007.
As a percentage of revenue, cost of revenue was 41.4% for the nine months ended September 30, 2008
compared to 38.0% for the nine months ended September 30, 2007.
General and Administrative Expenses. Captira has successfully completed development of an initial
commercial version of its applications and is in the early stages of market development and
adoption of its service offerings by the bail bonds industry. As such, Captira has few clients and
revenue is immaterial. However, Captira still incurs substantial monthly overhead expenses for
management functions, business development and sales, customer support, technology operations and
other functions despite the lack of a large customer base.
In addition, the acquisition of Net Enforcers business operations in late 2007 contributed to the
increase in general and administrative expenses for the nine months ended September 30, 2008.
As a percentage of revenue, general and administrative expenses increased to 70.0% for the nine
months ended September 30, 2008 from 13.6% for the nine months ended September 30, 2007.
Amortization. This increase is primarily attributable to the increase in intangible assets as the
result of acquisitions of Captira and Net Enforcers in 2007.
As a percentage of revenue, amortization expenses increased to 15.8% for the nine months ended
September 30, 2008.
Interest Income
Interest income decreased 72.7% to $46 thousand for the three months ended September 30, 2008 from
$171 thousand for the three months ended September 30, 2007. Interest income decreased 67.3% to
$218 thousand for the nine months ended September 30, 2008
39
from $667 thousand for the nine months
ended September 30, 2007. This is primarily attributable to the reduction in short-term investments
in the latter portion of 2007 to fund business operations, including an increased investment in
marketing.
Interest Expense
Interest expense increased 76.4% to $537 thousand for the three months ended September 30, 2008
from $304 thousand for the three months ended September 30, 2007. Interest expense increased 77.9%
to $1.7 million for the nine months ended September 30, 2008 from $968 thousand for the nine months
ended September 30, 2007. This is primarily attributable to increased interest expense on a greater
amount of outstanding long term debt in the three and nine months ended September 30, 2008.
In February 2008, we entered into interest rate swaps to effectively fix our variable rate term
loan and a portion of the revolving credit facility under our Credit Agreement.
Income Taxes
Our consolidated effective tax rate for the nine months ended September 30, 2008 was 41.4% as
compared to 44.9% for the nine months ended September 30, 2007. The decrease is primarily a result
of reduced losses outside of the United States, which are subject to tax at rates different than
the statutory U.S. federal income tax rate.
Liquidity and Capital Resources
Cash and cash equivalents were $16.3 million as of September 30, 2008 compared to $19.8 million as
of December 31, 2007. Cash includes $557 thousand held within our 55% owned subsidiary SI, and is
not directly accessible to us. We believe our cash and cash equivalents are highly liquid
investments and include short-term U.S. Treasury securities with original maturity dates of less
than or equal to 90 days.
During the nine months ended September 30, 2008, we purchased short term U.S. treasury securities
with a maturity date greater than 90 days of approximately $5.0 million, which are classified as
short-term investments on our condensed consolidated financial statements.
Our accounts receivable balance as of September 30, 2008 was $26.0 million, including approximately
$4.3 million related to our Background Screening segment, compared to $25.5 million, including
approximately $3.7 million related to our Background Screening segment, as of December 31, 2007.
Our accounts receivable balance consists of credit card transactions that have been approved but
not yet deposited into our account, several large balances with some of the top financial
institutions and accounts receivable associated with background screening clients. The likelihood
of non-payment has historically been remote with respect to subscriber based clients, however, we
do provide for an allowance for doubtful accounts with respect to background screening clients and
corporate brand protection clients. Given the events in the financial markets, we are continuing to
monitor our allowance for doubtful accounts with respect to our financial institution obligors. In
addition, we provide for a refund allowance, which is included in liabilities on our condensed
consolidated balance sheet, against transactions that may be refunded in subsequent months. This
allowance is based on historical results.
Our sources of capital include, but are not limited to, cash and cash equivalents, cash from
continuing operations, amounts available under the credit agreement and other external sources of
funds. Our short-term and long-term liquidity depends primarily upon our level of net income,
working capital management and bank borrowings. We had a working capital surplus of $26.8 million
as of September 30, 2008 compared to $30.4 million as of December 31, 2007. We believe that
available short-term and long-term capital resources are sufficient to fund capital expenditures,
working capital requirements, scheduled debt payments and interest and tax obligations for the next
twelve months.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
|
(in thousands) |
|
Net cash provided by (used in) operating activities |
|
$ |
25,216 |
|
|
$ |
(4,480 |
) |
|
$ |
29,696 |
|
Net cash (used in) provided by investing activities |
|
|
(44,725 |
) |
|
|
5,187 |
|
|
|
(49,912 |
) |
Net cash provided by (used in) financing activities |
|
|
16,336 |
|
|
|
(2,825 |
) |
|
|
19,161 |
|
Effect of exchange rate changes on cash and cash
equivalents |
|
|
(263 |
) |
|
|
71 |
|
|
|
(334 |
) |
|
|
|
|
|
|
|
|
|
|
40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
Difference |
|
|
|
(in thousands) |
|
Decrease in cash and cash equivalents |
|
|
(3,436 |
) |
|
|
(2,047 |
) |
|
|
(1,389 |
) |
Cash and cash equivalents, beginning of year |
|
|
19,780 |
|
|
|
15,580 |
|
|
|
4,200 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of year |
|
$ |
16,344 |
|
|
$ |
13,533 |
|
|
$ |
2,811 |
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operations was $25.2 million for the nine months ended September 30, 2008
compared to net cash used in operations of $4.5 million for the nine months ended September 30,
2007. The $29.7 million increase in net cash provided by operations was primarily the result of an
increase in earnings, accounts payable and amortization of intangible assets. Over the past year,
as certain of our financial institution clients have requested that we bear more of the new
subscriber marketing costs as well as prepay commissions to them on new subscribers, we have needed
to use an increasing portion of our cash flow generated from operations to finance our business.
We anticipate this trend to continue with our financial institutions clients in 2009, and if we
consent to the specific requests and choose to incur the costs, we may need to raise additional
funds in the future in order to operate and expand our business. There can be no assurances that
we will be successful in raising additional funds on favorable terms, or at all, which could
materially adversely affect our business, strategy and financial condition, including losses of or
changes in the relationships with one or more of our clients.
Net cash used in investing activities was $44.7 million for the nine months ended September 30,
2008 compared to net cash provided by investing activities of $5.2 million during the nine months
ended September 30, 2007. Cash used in investing activities for the nine months ended September 30,
2008 was primarily attributable to the purchase of the Citibank membership agreements in January
2008 for $30.2 million, a $5.0 million purchase of short-term investments in September 2008 and a
$3.3 million long-term minority investment in Guard ID Systems.
Net cash provided by financing activities was $16.3 million compared to net cash used in financing
activities of $2.8 million for the nine months ended September 30, 2008 and 2007, respectively.
Cash provided by financing activities for the nine months ended September 30, 2008 was primarily
attributable to debt proceeds of $32.6 million used to purchase the membership agreements,
partially offset by the repayment of $15.0 million on our outstanding debt.
On July 3, 2006, we entered into a $40 million credit agreement with Bank of America, N.A. (Credit
Agreement). The Credit Agreement consists of a revolving credit facility in the amount of $25
million and a term loan facility in the amount of $15 million with interest at 1.00-1.75% over
LIBOR. On January 31, 2008, we amended our credit agreement in order to increase the term loan
facility to $28 million. As of September 30, 2008, the outstanding interest rate was 3.74% and
principal balance under the Credit Agreement was $43.3 million.
The Credit Agreement contains certain customary covenants, including among other things covenants
that limit or restrict the incurrence of liens; the making of investments; the incurrence of
certain indebtedness; mergers, dissolutions, liquidation, or consolidations; acquisitions (other
than certain permitted acquisitions); sales of substantially all of our or any co-borrowers
assets; the declaration of certain dividends or distributions; transactions with affiliates (other
than co-borrowers under the credit agreement) other than on fair and reasonable terms; and the
creation or acquisition of any direct or indirect subsidiary by us that is not a domestic
subsidiary unless such subsidiary becomes a guarantor. We are also required to maintain compliance
with certain financial covenants which include our consolidated EBITDA, consolidated leverage
ratios, consolidated fixed charge coverage ratios as well as customary covenants, representations
and warranties, funding conditions and events of default. We are currently in compliance with all
such covenants.
In November 2007, we amended our credit agreements financial covenants to remove the requirement
that we maintain compliance with a minimum consolidated tangible net worth covenant.
In 2008, we entered into certain interest rate swap transactions that convert our variable-rate
debt to fixed-rate debt. Our interest rate swaps are related to variable interest rate risk
exposure associated with our long-term debt and are intended to manage this risk. The counterparty
to our derivative agreements is a major financial institution for which we continually monitor its
position and credit ratings. We do not anticipate nonperformance by this financial institution.
The interest rate swaps on our outstanding term loan amount and a portion of our outstanding
revolving line of credit have initial notional amounts of $28.0 million and $15.0 million,
respectively. The swaps modify our interest rate exposure by effectively converting the variable
rate on our term loan (3.74% at September 30, 2008) to a fixed rate of 3.20% per annum through
December 2011 and on our revolving line of credit (3.74% at September 30, 2008) to a fixed rate of
3.44% per annum through December 2011.
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The notional amount of the term loan interest rate swap
amortizes on a monthly basis through December 2011 and the notional amount of the line of credit
interest rate swap amortizes to $10.0 million in 2009 and terminates in December 2011. We use the
monthly LIBOR interest rate and have the intent and ability to continue to use this rate on our
hedged borrowings. Accordingly, we do not recognize any ineffectiveness on the swaps as allowed
under the hypothetical derivative method of Derivative Implementation Group Issue No. G7, Cash Flow Hedges: Measuring the Ineffectiveness
of a Cash Flow Hedge under Paragraph 30(b) When the Shortcut Method Is Not Applied. For the three
and nine months ended September 30, 2008, there was no ineffective portion of the hedge and
therefore, no impact to the condensed consolidated statement of income.
On April 25, 2005, we announced that our Board of Directors had authorized a share repurchase
program under which we can repurchase up to $20 million of our outstanding shares of common stock
from time to time, depending on market conditions, share price and other factors. The repurchases
may be made on the open market, in block trades, through privately negotiated transactions or
otherwise, and the program has no expiration date but may be suspended or discontinued at any time.
We did not repurchase any common stock in the nine months ended September 30, 2008.
Contractual Obligations
Except as discussed below, there have been no material changes to our contractual obligations since
December 31, 2007, as previously disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2007.
Our other arrangements include payments related to agreements to a service provider under which we
receive data and other information for use in our new fraud protection services. Under these
arrangements we pay non-refundable royalties based on usage of the data or analytics, and make
certain minimum royalty payments in exchange for defined limited exclusivity rights. In the
remaining months in 2008 we are obligated to pay an additional $1.5 million of minimum royalties.
Any further minimum royalty payments in excess of this amount will be paid by us at our sole
discretion or are subject to termination by us under certain contingent conditions.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate
We had cash and cash equivalents totaling $16.3 million and $19.8 million at September 30, 2008 and
December 31, 2007, respectively. We believe our cash and cash equivalents are highly liquid
investments and consist primarily of short-term U.S. Treasury securities with original maturity
dates of less than or equal to three months. We do not enter into investments for trading or
speculative purposes. Due to the short term nature of these investments, we believe that we do not
have any material exposure to changes in the fair value of our investment portfolio as a result of
changes in interest rates. Declines in interest rates, however, will reduce future investment
income.
Market risks related to our operations result primarily from changes in interest rates. Our
interest rate exposure is related to long-term debt obligations. A significant portion of our
interest expense is based upon changes in the benchmark interest rate (LIBOR). We have entered into
a series of interest rate swaps to mitigate the variable-rate risk on our long-term debt
obligations. The fixed rate is 3.44% and 3.20% on notional amounts of $15.0 million and $28.0
million, respectively.
Foreign Currency
We have a foreign majority-owned subsidiary, Screening International, and therefore, are subject to
foreign currency exposure. Screening Internationals wholly-owned subsidiary, Control Risks
Screening Limited, is located in the UK, conducts international business and prepares financial
statements per UK statutory requirements in British pounds. Control Risks Screenings financial
statements are translated to US dollar for US GAAP reporting. As a result, our financial results
are affected by fluctuations in this foreign currency exchange rate. During 2007 and the first half
of 2008, the U.S. dollar has generally been weaker relative to the British pound. This weakness had
a positive impact on our consolidated results of operations during those periods. However, during
the past several months, the U.S. dollar has strengthened relative to the British pound, which has
adversely impacted our results of operations as British pounds are translating into less U.S.
dollars. The impact of the transaction gains and losses from the UK statutory records on the
income statement was a loss of $241 thousand for the nine months ended September 30, 2008. We do
not believe that the volatile impact of exchange risk from recent prior periods is indicative of
the future, however, there can be no assurances that this volatility will not continue. We have
determined that the impact of the conversion has an insignificant effect on
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our consolidated
financial position, results of operations and cash flows and we believe that a near term 10%
appreciation or
depreciation of the US dollar will continue to have an insignificant effect on our consolidated
financial position, results of operations and cash flows.
We have international sales in Canada and, therefore, are subject to foreign currency rate
exposure. We collect fees from subscriptions in Canadian currency and pay a portion of the related
expenses in Canadian currency, which mitigates our exposure to currency exchange rate risk. As a
result, our financial results could be affected by factors such as changes in foreign currency
exchange rates or weak economic conditions. We have determined that the impact of the depreciation
of the U.S. dollar had an insignificant effect on our financial position, results of operations and
cash flows and we believe that a near term 10% appreciation or depreciation of the U.S. dollar will
continue to have an insignificant effect on our financial position, results of operations and cash
flows.
We have commenced startup operations in Singapore and therefore, are subject to foreign currency
rate exposure. The impact of the transaction gains and losses from the Singapore statutory records
on the income statement was a loss of $26 thousand for the nine months ended September 30, 2008. We
have determined that the impact of the conversion has an insignificant effect on our consolidated
financial position, results of operations and cash flows and we believe that a near term 10%
appreciation or depreciation of the US dollar will continue to have an insignificant effect on our
consolidated financial position, results of operations and cash flows.
We do not maintain any derivative instruments to mitigate the exposure to foreign currency risk;
however, this does not preclude our adoption of specific hedging strategies in the future. We will
assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.
The foreign exchange transaction gains and losses are included in our results of operations, and
were not material for all periods presented.
Fair Value
We do not have material exposure to market risk with respect to investments. We do not use
derivative financial instruments for speculative or trading purposes; however, this does not
preclude our adoption of specific hedging strategies in the future.
Item 4. Controls and Procedures
The Company, under the supervision and with the participation of its management, including the
Chief Executive Officer and Principal Financial Officer, evaluated the effectiveness of the design
and operation of its disclosure controls and procedures (as such term is defined in Rule
13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Our officers
have concluded that our disclosure controls and procedures are effective to ensure that information
required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934
is accumulated and communicated to our management, including our chief executive officer and
principal financial officer, to allow timely decisions regarding required disclosure. Our
disclosure controls and procedures are designed, and are effective, to give reasonable assurance
that the information required to be disclosed by us in reports that we file under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange Commission.
There have been no changes in our internal control over financial reporting during the three months
ended September 30, 2008 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On February 29, 2008, we received written notice from our client Discover that, effective September
1, 2008, it was terminating the Agreement for Services Administration between us and Discover dated
March 11, 2002, as amended (the Services Agreement), including the Omnibus Amendment dated
December 22, 2005 (the Omnibus Amendment). On the same date, we filed a complaint for declaratory
judgment in the Circuit Court for Fairfax County, Virginia. The complaint seeks a declaration that,
if Discover uses for its own purposes credit report authorizations given by customers to
Intersections or Discover, it will be in breach of the Services Agreement and Omnibus Amendment to
the Services Agreement. Intersections contends that Discover or its new credit monitoring service
provider must obtain new authorizations from the customers in order to provide credit monitoring
services to them. In the
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complaint, Intersections alleges that reliance on the credit report
authorizations by Discover or its new provider would be a breach of
the Services Agreement and Omnibus Amendment thereto, and thus seeks a declaratory judgment to
prevent Discover from committing a breach of the parties contract. On April 25, 2008, the court
denied Discovers motion to dismiss our claims. We and Discover each have filed cross-motions for
summary judgment, and the Court denied both parties motions. Trial is scheduled for January 6,
2009, and discovery is ongoing.
On August 5, 2008, an action captioned Michael
McGroarty v. American Background Information Services, Inc., was commenced in the Superior Court of the State
of California for the County of Riverside, alleging that Screening International's subsidiary, American Background
Information Services, Inc. (ABI), makes prohibited use of California's Megan Law website information during
pre-employment background checks in violation of California law. The plaintiff seeks certification of a class on
behalf of all individuals who have undergone a pre-employment background screen conducted by ABI within the three-year
period prior to the filing of the complaint. The plaintiff seeks an unspecified amount of compensatory and statutory
damages, including attorneys' fees and costs. On October 3, 2008, ABI removed the action to the U.S. District Court
for the Central District of California. On November 7, 2008, ABI answered the complaint and denied any liability.
ABI intends to defend the action vigorously.
Item 1A. Risk Factors
A detailed discussion of risk factors is provided in Item 1A, Risk Factors in our Annual Report
on Form 10-K for the year ended December 31, 2007. Other than the additional or modified risk
factors described below, no material changes in risk factors occurred during the third quarter of
2008. Additional risks and uncertainties that we are unaware of, or that are currently deemed
immaterial, also may become important factors that affect us.
An economic recession could harm our business.
Our Consumer Products and Services and Background Screening businesses are dependent on favorable
economic conditions. Our financial institution clients might reduce or eliminate marketing
programs which would materially adversely impact our ability to obtain new subscribers and to
expand our service offerings to existing subscribers. We are also anticipating an increase in
credit card declines and delinquencies as card holders balances continue to increase. Any of
these events would result in lower revenue for us. In addition, we might be required to finance an
increasing portion of the upfront marketing costs and/or to prepay commissions to our financial
institution clients, which could materially adverse affect our financial condition and short-term
operating results, including the loss of or changes in our client relationships because we are
unable to fund upfront marketing costs or prepay commissions. Our Background Screening business is
substantially dependent on companies hiring new employees. During times of downsizing or flat
growth in head count, there is a reduced demand for our services, which causes are revenue to
decline.
Consolidation in the financial services industry will increase competition for us obtaining
clients.
We are substantially dependent on revenue from subscribers obtained from our largest financial
institution clients, including Bank of America. Due to the increasing consolidation, increasing
concentration of our business in fewer material clients, and financial turmoil within the financial
services industry, there will be fewer opportunities to obtain new client relationships, and
increasing competition to maintain existing client relationships. In addition, if an existing
client is acquired or files for bankruptcy, there are no assurances that we will be able to
maintain the client relationship following the acquisition or the bankruptcy. Any of these events
could materially decrease our revenue, negatively impact our financial condition and harm our
growth prospects.
Item 6. Exhibits
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31.1*
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Certification of Michael R. Stanfield, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2*
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Certification of Madalyn C. Behneman, Principal Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1*
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Certification of Michael R. Stanfield, Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002. |
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32.2*
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Certification of Madalyn C. Behneman, Principal Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 10, 2008
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INTERSECTIONS INC.
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By: |
/s/ Madalyn C. Behneman
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Madalyn C. Behneman |
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Principal Financial Officer |
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