LendingTree, Inc.
Tree.com, Inc. (Form: 10-Q, Received: 11/05/2009 16:32:17)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-Q




ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2009

or

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                             to                            

Commission File No. 001-34063



TREE.COM, INC.
(Exact name of Registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  26-2414818
(I.R.S. Employer
Identification No.)

11115 Rushmore Drive, Charlotte, North Carolina 28277
(Address of principal executive offices)

(704) 541-5351
(Registrant's 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  ý     No  o

        Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes  o     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 definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o   Accelerated filer  o   Non-accelerated filer  ý
(Do not check if a smaller
reporting company)
  Smaller reporting company  o

        Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o     No  ý

        As of November 3, 2009 there were 10,902,525 shares of the Registrant's common stock, par value $.01 per share, outstanding.


Table of Contents


TABLE OF CONTENTS

 
   
  Page
Number

 

PART I—FINANCIAL INFORMATION

   

Item 1.

 

Financial Statements

 
1

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

  34

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  53

Item 4T.

 

Controls and Procedures

  54

 

PART II—OTHER INFORMATION

   

Item 1.

 

Legal Proceedings

 
55

Item 1A.

 

Risk Factors

  55

Item 6.

 

Exhibits

  57

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PART 1—FINANCIAL INFORMATION

Item 1.     Financial Statements


TREE.COM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2009   2008   2009   2008  
 
  (In thousands, except per share amounts)
 

Revenue

                         
   

LendingTree Loans

  $ 24,109   $ 19,993   $ 94,738   $ 76,049  
   

Exchanges and other

    18,610     20,484     52,662     76,007  
   

Real Estate

    7,997     9,781     21,549     28,378  
                   
 

Total revenue

    50,716     50,258     168,949     180,434  

Cost of revenue

                         
   

LendingTree Loans

    11,245     9,194     37,104     32,407  
   

Exchanges and other

    2,389     3,425     7,387     11,497  
   

Real Estate

    5,056     5,954     13,712     16,731  
                   
 

Total cost of revenue (exclusive of depreciation shown separately below)

    18,690     18,573     58,203     60,635  
                   
 

Gross margin

    32,026     31,685     110,746     119,799  

Operating expenses

                         
 

Selling and marketing expense

    17,435     23,282     45,149     81,028  
 

General and administrative expense

    17,529     22,672     51,335     58,358  
 

Product development

    1,673     1,797     4,842     5,349  
 

Restructuring expense

    78     2,394     (158 )   4,557  
 

Amortization of intangibles

    1,055     2,204     3,636     9,532  
 

Depreciation

    1,698     1,791     5,049     5,337  
 

Asset impairments

            3,903     164,335  
                   
   

Total operating expenses

    39,468     54,140     113,756     328,496  
                   
   

Operating loss

    (7,442 )   (22,455 )   (3,010 )   (208,697 )

Other income (expense)

                         
 

Interest income

    9     2     84     13  
 

Interest expense

    (149 )   (169 )   (451 )   (497 )
 

Other

        (2 )       (4 )
                   

Total other income (expense), net

    (140 )   (169 )   (367 )   (488 )
                   

Loss before income taxes

    (7,582 )   (22,624 )   (3,377 )   (209,185 )

Income tax (provision) benefit

    182     73     (121 )   13,915  
                   

Net loss

  $ (7,400 ) $ (22,551 ) $ (3,498 ) $ (195,270 )
                   

Weighted average common shares outstanding

    10,844     9,367     10,413     9,367  
                   

Weighted average diluted shares outstanding

    10,844     9,367     10,413     9,367  
                   

Net loss per share available to common shareholders

                         
 

Basic

  $ (0.68 ) $ (2.41 ) $ (0.34 ) $ (20.85 )
                   
 

Diluted

  $ (0.68 ) $ (2.41 ) $ (0.34 ) $ (20.85 )
                   

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

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TREE.COM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 
  September 30, 2009   December 31, 2008  
 
  (unaudited)
   
 
 
  (In thousands, except share amounts)
 

ASSETS:

             

Cash and cash equivalents

  $ 86,859   $ 73,643  

Restricted cash and cash equivalents

    12,826     15,204  

Accounts receivable, net of allowance of $418 and $367, respectively

    8,114     7,234  

Loans held for sale ($80,116 and $85,638 measured at fair value, respectively)

    81,931     87,835  

Prepaid and other current assets

    10,298     8,960  
           
 

Total current assets

    200,028     192,876  

Property and equipment, net

    13,320     17,057  

Goodwill

    13,185     9,285  

Intangible assets, net

    60,148     64,663  

Other non-current assets

    495     202  
           
 

Total assets

  $ 287,176   $ 284,083  
           

LIABILITIES:

             

Warehouse lines of credit

  $ 67,129   $ 76,186  

Accounts payable, trade

    5,431     3,541  

Deferred revenue

    1,633     1,231  

Deferred income taxes

    1,199     2,290  

Accrued expenses and other current liabilities

    42,042     37,146  
           
 

Total current liabilities

    117,434     120,394  

Income taxes payable

    470     862  

Other long-term liabilities

    11,042     9,016  

Deferred income taxes

    17,167     15,683  
           
 

Total liabilities

    146,113     145,955  

Commitments and contingencies (Note 12)

             

SHAREHOLDERS' EQUITY:

             

Preferred stock $.01 par value; authorized 5,000,000 shares; none issued or outstanding

         

Common stock $.01 par value; authorized 50,000,000 shares; issued and outstanding 10,892,405 and 9,369,381 shares, respectively

    109     94  

Additional paid-in capital

    900,995     894,577  

Accumulated deficit

    (760,041 )   (756,543 )
           
 

Total shareholders' equity

    141,063     138,128  
           
 

Total liabilities and shareholders' equity

  $ 287,176   $ 284,083  
           

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

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TREE.COM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

(Unaudited)

 
   
  Common Stock    
   
 
 
  Total   Number
of Shares
  Amount   Additional
Paid-in
Capital
  Accumulated
Deficit
 
 
  (In thousands)
 

Balance as of December 31, 2008

  $ 138,128     9,369   $ 94   $ 894,577   $ (756,543 )

Comprehensive loss:

                               
 

Net loss for the nine months ended September 30, 2009

    (3,498 )               (3,498 )
                               

Comprehensive loss

    (3,498 )                

Non-cash compensation

    3,060             3,060      

Sale of common stock

    3,656     935     9     3,647      

Issuance of common stock upon exercise of stock options and vesting of restricted stock units, net of withholding taxes

    (283 )   238     3     (286 )    

Issuance of restricted stock

        350     3     (3 )    
                       

Balance as of September 30, 2009

  $ 141,063     10,892   $ 109   $ 900,995   $ (760,041 )
                       

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

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TREE.COM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
  Nine Months Ended
September 30,
 
 
  2009   2008  
 
  (In thousands)
 

Cash flows from operating activities:

             

Net loss

  $ (3,498 ) $ (195,270 )

Adjustments to reconcile loss to net cash provided by (used in) operating activities:

             
 

Loss on disposal of assets

    949      
 

Amortization of intangibles

    3,636     9,532  
 

Depreciation

    5,049     5,337  
 

Intangible impairment

    3,903     33,378  
 

Goodwill impairment

        130,957  
 

Non-cash compensation expense

    3,060     10,024  
 

Non-cash restructuring expense

    161     1,092  
 

Deferred income taxes

    393     (13,916 )
 

Gain on origination and sale of loans

    (89,701 )   (68,739 )
 

Loss on impaired loans not sold

    564     265  
 

Loss on sale of real estate acquired in satisfaction of loans

    51     202  
 

Bad debt expense

    325     577  
 

Non-cash interest expense

        76  

Changes in current assets and liabilities:

             
 

Accounts receivable

    (1,208 )   2,812  
 

Origination of loans

    (2,232,380 )   (1,728,458 )
 

Proceeds from sales of loans

    2,335,100     1,816,273  
 

Principal payments received on loans

    781     697  
 

Payments to investors for loan losses and early payoff obligations

    (5,641 )   (3,780 )
 

Prepaid and other current assets

    (1,149 )   2,988  
 

Accounts payable and other current liabilities

    3,580     (17,842 )
 

Income taxes payable

    (551 )   2,376  
 

Deferred revenue

    (130 )   (309 )

Other, net

    1,154     (118 )
           

Net cash provided by (used in) operating activities

    24,448     (11,846 )
           

Cash flows from investing activities:

             
 

Contingent acquisition consideration

        (14,487 )
 

Acquisitions

    (5,726 )    
 

Capital expenditures

    (2,200 )   (3,322 )
 

Other, net

    3,253     (142 )
           

Net cash used in investing activities

    (4,673 )   (17,951 )
           

Cash flows from financing activities:

             
 

Borrowing under warehouse lines of credit

    1,964,237     1,586,413  
 

Repayments of warehouse lines of credit

    (1,973,294 )   (1,609,036 )
 

Principal payments on long-term obligations

        (20,045 )
 

Capital contributions from IAC

        109,417  
 

Issuance of common stock

    3,373      
 

Excess tax benefits from stock-based awards

        393  
 

Increase in restricted cash

    (875 )   (872 )
           

Net cash (used in) provided by financing activities

    (6,559 )   66,270  
           

Net increase in cash and cash equivalents

    13,216     36,473  

Cash and cash equivalents at beginning of period

    73,643     45,940  
           

Cash and cash equivalents at end of period

  $ 86,859   $ 82,413  
           

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—ORGANIZATION

Spin-Off

        On August 20, 2008, Tree.com, Inc. ("Tree.com" or the "Company") was spun off from its parent company, IAC/InterActiveCorp ("IAC") into a separate publicly traded company. In these consolidated financial statements, we refer to the separation transaction as the "spin-off." In connection with the spin-off, Tree.com was incorporated as a Delaware corporation in April 2008. Tree.com consists of the brands and businesses that formerly comprised IAC's Lending and Real Estate segments. We refer herein to these brands and businesses as the "Tree.com Businesses," which include LendingTree.com, RealEstate.com, GetSmart.com and Home Loan Center, Inc. (d/b/a LendingTree Loans).

        In conjunction with the spin-off, Tree.com completed the following transactions: (1) extinguished all intercompany payable balances with IAC, which totaled $56.2 million, by recording a non-cash contribution from IAC, (2) recapitalized the invested capital balances with common stock in the amount of $0.1 million, whereby holders of IAC stock received one-thirtieth of a share of common stock of Tree.com, and (3) received $55.2 million of cash from IAC.

Basis of Presentation

        The historical consolidated financial statements of Tree.com and its subsidiaries reflect the contribution or other transfer to Tree.com of all of the subsidiaries and assets and the assumption by Tree.com of all of the liabilities relating to the Tree.com Businesses in connection with the spin-off and the allocation to Tree.com of certain IAC corporate expenses relating to the Tree.com Businesses. Accordingly, the historical consolidated financial statements of Tree.com reflect the historical financial position, results of operations and cash flows of the Tree.com Businesses since their respective dates of acquisition by IAC, based on the historical consolidated financial statements and accounting records of IAC and using the historical results of operations and historical bases of the assets and liabilities of the Tree.com Businesses with the exception of accounting for income taxes. For purposes of these financial statements, income taxes have been computed for Tree.com on an as if stand-alone, separate tax return basis. Intercompany transactions and accounts have been eliminated.

        In the opinion of Tree.com's management, the assumptions underlying the historical consolidated financial statements of Tree.com are reasonable. However, this financial information does not necessarily reflect what the historical financial position, results of operations and cash flows of Tree.com would have been had Tree.com been a stand-alone company during the periods presented.

        The accompanying unaudited interim consolidated financial statements as of September 30, 2009 and 2008 and for the three and nine months then ended have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements. In the opinion of the Company's management, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company's financial position for the periods presented. The results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the year ending December 31, 2009, or any other period. These financial statements and notes should be read in conjunction with the audited financial

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1—ORGANIZATION (Continued)


statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2008.

        Tree.com evaluated subsequent events through November 5, 2009, the issuance date of our consolidated financial statements for the period ended September 30, 2009, as this is the date on which we filed such financial statements on Form 10-Q with the SEC.

Company Overview

    LendingTree Loans

        The LendingTree Loans segment originates, processes, approves and funds various residential real estate loans through Home Loan Center, Inc. ("HLC"), (d/b/a LendingTree Loans). The HLC and LendingTree Loans brand names are collectively referred to in these consolidated financial statements as "LendingTree Loans."

    Exchanges

        The Exchanges segment consists of online lead generation networks and call centers (principally LendingTree.com and GetSmart.com) that connect consumers and service providers principally in the lending and higher education marketplaces.

    Real Estate

        The Real Estate segment consists of a proprietary full service real estate brokerage (RealEstate.com, REALTORS®) that operates in 20 U.S. markets, as well as an online lead generation network accessed at www.RealEstate.com , that connects consumers with real estate brokerages around the country.

        Tree.com maintains operations solely in the United States.

Business Combinations

        In 2009, Tree.com purchased certain assets of four separate companies, with an aggregate purchase price of $6.9 million in cash and contingent consideration. One of the purchases closed in January 2009, and the three other purchases closed in third quarter of 2009. All four transactions are part of our strategic initiative to diversify our revenue streams outside of the mortgage and real estate industries.

        These asset purchases are being accounted for under the acquisition method of accounting. Accordingly, the purchase price is allocated to the acquired assets and liabilities based on their estimated fair values at the acquisition date. The purchase price for three of the closed purchases has been allocated as $3.0 million to intangible assets with useful lives of five months to thirteen years and $2.5 million to goodwill. The allocation of the purchase price for the last transaction, including goodwill, if any, is not yet complete and will be finalized upon completion of the analysis of the fair values of the acquired assets and liabilities. The pro forma effect of these purchases was not material to our results of operations.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2—SIGNIFICANT ACCOUNTING POLICIES

Accounting Estimates

        Tree.com's management is required to make certain estimates and assumptions during the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles. These estimates and assumptions impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. They also impact the reported amount of net earnings during any period. Actual results could differ from those estimates.

        Significant estimates underlying the accompanying unaudited consolidated financial statements include: valuation allowance for impaired loans held for sale; loss reserves on previously sold loans; the fair value of loans held for sale and related derivatives; the recoverability of long-lived assets, goodwill and intangible assets; the determination of income taxes payable and deferred income taxes, including related valuation allowances; various other allowances, reserves and accruals; and assumptions related to the determination of stock-based compensation.

Reclassifications

        In connection with the change in reportable segments (see Note 7), certain prior period amounts have been reclassified to conform with the current year presentation with no effect on net loss or accumulated deficit. Specifically, compensation and other employee-related costs for loan officers within the LendingTree Loans segment totaling $2.8 million and $9.7 million for the three and nine months ending September 30, 2008, respectively, were reclassified from selling and marketing expense to cost of revenue, and certain other expenses totaling $0.1 million and $0.3 million for the three and nine months ending September 30, 2008, respectively, were reclassified from general and administrative expense to selling and marketing expense.

Restricted Cash and Cash Equivalents

        Restricted cash and cash equivalents consists of the following (in thousands):

 
  September 30, 2009   December 31, 2008  

Cash in escrow for future operating lease commitments

  $ 1,382   $ 5,587  

Cash in escrow for surety bonds

    5,030     5,016  

Cash in escrow for corporate purchasing card program

    2,202     2,200  

Minimum required balances for warehouse lines of credit

    1,875     1,000  

Other

    2,337     1,401  
           
 

Total restricted cash and cash equivalents

  $ 12,826   $ 15,204  
           

        Changes in restricted cash balances are shown within investing and financing activities in the accompanying consolidated statements of cash flows.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2—SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Pronouncements

        On July 1, 2009, the Financial Accounting Standards Board ("FASB") issued guidance with the objective of establishing the Accounting Standards Codification as the source of authoritative nongovernmental GAAP. This did not replace GAAP, however, all existing accounting standards have been superseded and all other accounting literature not included in the codification will be considered nonauthoritative. Accordingly, all references to accounting standards have been conformed to the new codification hierarchy.

        On January 1, 2009, Tree.com adopted the accounting standard for business combinations, which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. This standard also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. The standard applies prospectively to business combinations in fiscal years beginning after December 15, 2008. The Company applied this standard to its business combinations made subsequent to January 1, 2009. See Note 1 for further information.

        On January 1, 2009, Tree.com adopted the updated accounting standard for derivatives and hedging. This standard amends and expands the existing disclosure requirements with the intent to provide users of financial statements with an enhanced understanding of: (i) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for; and (iii) how derivative instruments and related hedged items affect an entity's financial position, financial performance and cash flows. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. See Note 9 for further information.

        On April 9, 2009, Tree.com adopted the updated accounting standards for financial instruments and interim reporting. The new standards require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The new standards also require those disclosures in summarized financial information at interim reporting periods. See Note 9 for further information.

        On May 28, 2009, Tree.com adopted the accounting standard for subsequent events. This standard establishes principles and requirements for subsequent events, in particular: (i) the period after the balance sheet date during which management of a reporting entity shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (ii) the circumstances under which an entity shall recognize events or transactions occurring after the balance sheet date in its financial statements; and (iii) the disclosures that an entity shall make about events or transactions that occurred after the balance sheet date. See Note 1 for further information.

        On June 12, 2009, the FASB amended the accounting standard for transfers and servicing. The objective is to improve relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor's continuing involvement, if any, in transferred financial assets. This standard is effective for annual reporting periods beginning after November 15, 2009. This amendment will not have a material impact on the Company's consolidated financial statements.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3—GOODWILL AND INTANGIBLE ASSETS

        The balance of goodwill and intangible assets, net, is as follows (in thousands):

 
  September 30, 2009   December 31, 2008  

Goodwill:

             
 

Goodwill—Real Estate

  $ 9,285   $ 9,285  
 

Goodwill—Exchanges

    3,900      
           
   

Total goodwill

    13,185     9,285  
           

Intangible assets:

             
 

Intangible assets with indefinite lives

    55,567     55,229  
 

Intangible assets with definite lives, net

    4,581     9,434  
           
   

Total intangible assets, net

    60,148     64,663  
           
     

Total goodwill and intangible assets, net

  $ 73,333   $ 73,948  
           

        Intangible assets with indefinite lives relate principally to trade names and trademarks.

        At September 30, 2009, intangible assets with definite lives relate to the following (in thousands):

 
  Cost   Accumulated
Amortization
  Net   Weighted Average
Amortization Life
(Years)
 

Purchase agreements

  $ 76,353   $ (74,010 ) $ 2,343     5.7  

Technology

    30,246     (29,285 )   961     3.0  

Customer lists

    7,389     (6,617 )   772     3.9  

Other

    10,034     (9,529 )   505     4.8  
                     
 

Total

  $ 124,022   $ (119,441 ) $ 4,581        
                     

        At December 31, 2008, intangible assets with definite lives relate to the following (in thousands):

 
  Cost   Accumulated
Amortization
  Net   Weighted Average
Amortization Life
(Years)
 

Purchase agreements

  $ 76,117   $ (68,898 ) $ 7,219     5.7  

Technology

    29,100     (29,100 )       3.0  

Customer lists

    6,607     (6,607 )       2.8  

Other

    9,512     (7,297 )   2,215     4.8  
                     
 

Total

  $ 121,336   $ (111,902 ) $ 9,434        
                     

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3—GOODWILL AND INTANGIBLE ASSETS (Continued)

        Amortization of intangible assets with definite lives is computed on a straight-line basis and, based on September 30, 2009 balances, such amortization is estimated to be as follows (in thousands):

 
  Amount  

Three months ending December 31, 2009

  $ 990  

Year ending December 31, 2010

    2,085  

Year ending December 31, 2011

    564  

Year ending December 31, 2012

    259  

Year ending December 31, 2013

    143  

Year ending December 31, 2014 and thereafter

    540  
       

  $ 4,581  
       

        In the second quarter of 2009, Tree.com recorded impairment charges of $3.9 million related to definite-lived intangible assets within the new homes referral service business of Real Estate. In the second quarter of 2009, the new Real Estate operating segment leadership undertook significant changes in management, operational focus and marketing efforts related to the new homes referral service business. These changes, combined with the continued deterioration of new housing starts and new homes sales in 2009, caused the Company to reassess the remaining useful lives and the likely future recoverability of the remaining value of these intangible assets. In testing the recoverability of these assets, indications of impairment were determined to exist, and subsequent impairment testing resulted in the charge noted above.

        In the second quarter of 2008, Tree.com recorded impairment charges of $131.0 million and $33.4 million related to goodwill and an indefinite-lived intangible asset, respectively. The charge related to LendingTree Loans was a goodwill impairment charge of $0.9 million. The charges associated with the Exchanges were $69.3 million related to goodwill and $33.4 million related to an indefinite-lived intangible asset. The charge related to Real Estate was a goodwill impairment charge of $60.8 million.

        The impairments in 2008 resulted from the Company's reassessment of its likely future profitability in light of the persistent adverse mortgage and real estate market realities. These adverse conditions included, among others, constrained liquidity, lender focus on low margin mortgage offerings, the decline in real estate values and a high rate of delinquency for existing mortgages. Tree.com updated its assessment of mortgage and real estate market conditions and Tree.com's responsive operational strategies during the second quarter of 2008, and quantified these considerations in Tree.com's future forecasted results.

        The following table presents the balance of goodwill by segment, including changes in the carrying amount of goodwill, for the nine months ended September 30, 2008 (in thousands):

 
  Balance as of
January 1, 2008
  Additions   (Deductions)   Impairments   Balance as of
September 30, 2008
 

LendingTree Loans

  $ 898   $   $   $ (898 ) $  

Exchanges

    69,868         (615 )   (69,253 )    

Real Estate

    70,126         (35 )   (60,806 )   9,285  
                       
 

Total

  $ 140,892   $   $ (650 ) $ (130,957 ) $ 9,285  
                       

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3—GOODWILL AND INTANGIBLE ASSETS (Continued)

        Deductions principally relate to the establishment of deferred tax assets related to the acquired tax attributes and income tax benefit realized pursuant to the exercise of stock options assumed in a business acquisition that were vested at the transaction date and are treated as a reduction in goodwill when the income tax deductions are realized. The impairments are described above.

NOTE 4—PROPERTY AND EQUIPMENT

        The balance of property and equipment, net is as follows (in thousands):

 
  September 30, 2009   December 31, 2008  

Computer equipment and capitalized software

  $ 37,974   $ 34,416  

Leasehold improvements

    3,184     3,184  

Furniture and other equipment

    5,055     5,088  

Projects in progress

    708     3,169  
           

    46,921     45,857  

Less: accumulated depreciation and amortization

    (33,601 )   (28,800 )
           
 

Total property and equipment, net

  $ 13,320   $ 17,057  
           

NOTE 5—ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

        Accrued expenses and other current liabilities consist of the following (in thousands):

 
  September 30, 2009   December 31, 2008  

Accrued loan loss liability related to loans previously sold

  $ 8,165   $ 3,972  

Litigation accruals

        2,031  

Accrued advertising expense

    8,622     5,518  

Accrued compensation and benefits

    8,450     5,251  

Accrued professional fees

    1,416     1,576  

Accrued restructuring costs

    415     3,262  

Derivative liabilities

    1,916     2,164  

Customer deposits and escrows

    3,498     2,957  

Deferred rent

    858     1,035  

Other

    8,702     9,380  
           
 

Total accrued expenses and other current liabilities

  $ 42,042   $ 37,146  
           

        The other category above reflects an estimated earnout payable related to an acquisition and other miscellaneous accrued expenses.

        An additional $5.9 million and $6.5 million of accrued loan loss liability related to loans previously sold is classified in other long term liabilities at September 30, 2009 and December 31, 2008, respectively.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6—WAREHOUSE LINES OF CREDIT

        Borrowings on warehouse lines of credit were $67.1 million and $76.2 million at September 30, 2009 and December 31, 2008, respectively.

        As of September 30, 2009, LendingTree Loans had two committed lines of credit ("warehouse lines") totaling $100 million of borrowing capacity. In addition, LendingTree Loans obtained a third warehouse line for $75 million on October 30, 2009, bringing the total borrowing capacity to $175 million. Borrowings under these lines are limited for funding, and are secured by, consumer residential loans that are held for sale. Loans under these warehouse lines are repaid directly from proceeds from the sales of loans by LendingTree Loans.

        The $50 million first line is scheduled to expire on December 29, 2009; however, that lender has indicated it is exiting the warehouse lending business and will honor the existing contract only through the stated term. The interest rate under this line is 30-day LIBOR plus 125 basis points.

        The $50 million second line is scheduled to expire on April 30, 2010, but can be cancelled at the option of the lender without default upon sixty days notice. This second line includes an additional uncommitted credit facility of $75 million and is guaranteed by Tree.com, Inc., LendingTree, LLC and LendingTree Holdings Corp. The interest rate under the second line is 225 basis points plus the greater of (a) the 30-day LIBOR or (b) 200 basis points. The interest rate under the $75 million uncommitted line is 30-day LIBOR plus 150 basis points. LendingTree Loans is also required to sell at least 50% of the loans it originates to an affiliate of the lender under this line or pay a "pair-off fee" of 37.5 basis points on the difference between the required and actual volume of loans sold.

        The $75 million third line is scheduled to expire on October 29, 2010. The interest rate under this line is 30-day LIBOR or 2.0% (whichever is greater) plus 250 basis points for loans being sold to the lender and 30-day LIBOR or 2.0% (whichever is greater) plus 275 basis points for loans not being purchased by the lender.

        Under the terms of these warehouse lines, LendingTree Loans is required to maintain various financial and other covenants. These financial covenants include, but are not limited to, maintaining (i) minimum tangible net worth of $44.0 million, (ii) minimum liquidity, (iii) a minimum current ratio, (iv) a maximum ratio of total liabilities to net worth, (v) a maximum leverage ratio and (vi) pre-tax net income requirements. During the quarter ended September 30, 2009, LendingTree Loans was in compliance with the covenants under the lines.

        The LendingTree Loans business is highly dependent on the availability of these warehouse lines. Although we believe that our existing lines of credit are adequate for our current operations, reductions in our available credit, or the inability to renew or replace these lines, would have a material adverse effect on our business, financial condition and results of operations. Management has determined that it could continue to operate the LendingTree Loans business, at a reduced capacity, if two but not all of the warehouse lines were lost.

NOTE 7—SEGMENT INFORMATION

        The overall concept that Tree.com employs in determining its reportable segments and related financial information is to present them in a manner consistent with how the chief operating decision maker and executive management view the Tree.com businesses, how the businesses are organized as to segment management, and the focus of the Tree.com businesses with regards to the types of products or services offered or the target market.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

        Following the spin-off from IAC, the new chief operating decision maker began to realign the Tree.com Businesses into new operating segments. During the first quarter of 2009, management completed its realignment of staffing and direct revenue and costs for each new segment and created reporting structures to enable the chief operating decision maker and management to evaluate the results of operations for each of these new segments on a comparative basis with prior periods. In prior periods, the segments "Lending" and "Real Estate" were presented, which have been changed to "LendingTree Loans", "Exchanges" and "Real Estate" segments. Additionally, certain shared indirect costs that are described below are reported as "Unallocated—Corporate". All items of segment information for prior periods have been restated to conform to the new reportable segment presentation.

        The expenses presented below for each of the business segments include an allocation of certain corporate expenses that are identifiable and directly benefit those segments. The unallocated expenses are those corporate overhead expenses that are not directly attributable to a segment and include: corporate expenses such as finance, legal, executive, technology support, and human resources, as well as elimination of inter-segment revenue and costs.

        Tree.com's primary performance metrics are EBITDA and Adjusted EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation and amortization. Adjusted EBITDA is defined as EBITDA excluding (1) non-cash compensation expense, (2) non-cash intangible asset impairment charges, (3) gain/loss on disposal of assets, (4) restructuring expenses, (5) proceeds from litigation settlements, (6) pro forma adjustments for significant acquisitions, and (7) one-time items. Tree.com believes these measures are useful to investors because they represent the operating results from Tree.com's segments, but exclude the effects of any other non-cash expenses. EBITDA and Adjusted EBITDA have certain limitations in that they do not take into account the impact to Tree.com's statement of operations of certain expenses, including depreciation, non-cash compensation and acquisition related accounting. Tree.com endeavors to compensate for the limitations of the non-GAAP measure presented by also providing the comparable GAAP measure with equal or greater prominence and descriptions of the reconciling items, including quantifying such items, to derive the non-GAAP measure.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

        Summarized information by segment and a reconciliation to EBITDA and Adjusted EBITDA is as follows (in thousands):

 
  For the Three Months Ended September 30, 2009:  
 
  LendingTree
Loans
  Exchanges   Real Estate   Unallocated—
Corporate
  Total  

Revenue

  $ 24,109   $ 23,854   $ 7,997   $ (5,244 ) $ 50,716  

Cost of revenue (exclusive of depreciation shown separately below)

    11,245     1,849     5,056     540     18,690  
                       
 

Gross Margin

    12,864     22,005     2,941     (5,784 )   32,026  

Operating Expenses:

                               
 

Selling and marketing expense

    5,820     15,637     1,221     (5,243 )   17,435  
 

General and administrative expense

    5,276     1,934     2,075     8,244     17,529  
 

Product development

    165     762     363     383     1,673  
 

Restructuring expense

    (54 )   50     53     29     78  
 

Amortization of intangibles

    70     337     641     7     1,055  
 

Depreciation

    741     246     302     409     1,698  
                       
 

Total operating expenses

    12,018     18,966     4,655     3,829     39,468  
                       

Operating income (loss)

    846     3,039     (1,714 )   (9,613 )   (7,442 )

Adjustments to reconcile to EBITDA and Adjusted EBITDA:

                               
 

Amortization of intangibles

    70     337     641     7     1,055  
 

Depreciation

    741     246     302     409     1,698  
                       

EBITDA

    1,657     3,622     (771 )   (9,197 )   (4,689 )
 

Restructuring expense

    (54 )   50     53     29     78  
 

Non-cash compensation

    63     48     79     877     1,067  
                       

Adjusted EBITDA

  $ 1,666   $ 3,720   $ (639 ) $ (8,291 ) $ (3,544 )
                       

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

 

 
  For the Three Months Ended September 30, 2008:  
 
  LendingTree
Loans
  Exchanges   Real Estate   Unallocated—
Corporate
  Total  

Revenue

  $ 19,993   $ 25,625   $ 9,781   $ (5,141 ) $ 50,258  

Cost of revenue (exclusive of depreciation shown separately below)

    9,194     2,896     5,954     529     18,573  
                       
 

Gross Margin

    10,799     22,729     3,827     (5,670 )   31,685  

Operating Expenses:

                               
 

Selling and marketing expense

    5,022     21,218     1,803     (4,761 )   23,282  
 

General and administrative expense

    6,304     1,858     5,035     9,475     22,672  
 

Product development

    171     1,009     493     124     1,797  
 

Restructuring expense

    2,336     22     (28 )   64     2,394  
 

Amortization of intangibles

    70     1,046     1,088         2,204  
 

Depreciation

    894     197     248     452     1,791  
                       
 

Total operating expenses

    14,797     25,350     8,639     5,354     54,140  
                       

Operating loss

    (3,998 )   (2,621 )   (4,812 )   (11,024 )   (22,455 )

Adjustments to reconcile to EBITDA and Adjusted EBITDA:

                               
 

Amortization of intangibles

    70     1,046     1,088         2,204  
 

Depreciation

    894     197     248     452     1,791  
                       

EBITDA

    (3,034 )   (1,378 )   (3,476 )   (10,572 )   (18,460 )
 

Restructuring expense

    2,336     22     (28 )   64     2,394  
 

Non-cash compensation

        1,189     2,715     3,901     7,805  
                       

Adjusted EBITDA

  $ (698 ) $ (167 ) $ (789 ) $ (6,607 ) $ (8,261 )
                       

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

 

 
  For the Nine Months Ended September 30, 2009:  
 
  LendingTree
Loans
  Exchanges   Real Estate   Unallocated—
Corporate
  Total  

Revenue

  $ 94,738   $ 63,551   $ 21,549   $ (10,889 ) $ 168,949  

Cost of revenue (exclusive of depreciation shown separately below)

    37,104     5,760     13,712     1,627     58,203  
                       
 

Gross Margin

    57,634     57,791     7,837     (12,516 )   110,746  

Operating Expenses:

                               
 

Selling and marketing expense

    12,032     40,079     3,919     (10,881 )   45,149  
 

General and administrative expense

    16,524     7,390     7,130     20,291     51,335  
 

Product development

    412     2,201     1,244     985     4,842  
 

Restructuring expense

    (1,246 )   108     792     188     (158 )
 

Amortization of intangibles

    210     493     2,926     7     3,636  
 

Depreciation

    2,287     643     849     1,270     5,049  
 

Asset impairments

            3,903         3,903  
                       
 

Total operating expenses

    30,219     50,914     20,763     11,860     113,756  
                       

Operating income (loss)

    27,415     6,877     (12,926 )   (24,376 )   (3,010 )

Adjustments to reconcile to EBITDA and Adjusted EBITDA:

                               
 

Amortization of intangibles

    210     493     2,926     7     3,636  
 

Depreciation

    2,287     643     849     1,270     5,049  
                       

EBITDA

    29,912     8,013     (9,151 )   (23,099 )   5,675  
 

Restructuring expense

    (1,246 )   108     792     188     (158 )
 

Asset impairments

            3,903         3,903  
 

Loss on disposal of assets

        949             949  
 

Non-cash compensation

    199     467     210     2,184     3,060  
                       

Adjusted EBITDA

  $ 28,865   $ 9,537   $ (4,246 ) $ (20,727 ) $ 13,429  
                       

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

 

 
  For the Nine Months Ended September 30, 2008:  
 
  LendingTree
Loans
  Exchanges   Real Estate   Unallocated—
Corporate
  Total  

Revenue

  $ 76,049   $ 92,813   $ 28,378   $ (16,806 ) $ 180,434  

Cost of revenue (exclusive of depreciation shown separately below)

    32,407     9,864     16,731     1,633     60,635  
                       
 

Gross Margin

    43,642     82,949     11,647     (18,439 )   119,799  

Operating Expenses:

                               
 

Selling and marketing expense

    16,661     73,981     6,217     (15,831 )   81,028  
 

General and administrative expense

    19,023     5,750     11,973     21,612     58,358  
 

Product development

    575     2,852     1,759     163     5,349  
 

Restructuring expense

    3,142     173     485     757     4,557  
 

Amortization of intangibles

    210     6,038     3,284         9,532  
 

Depreciation

    2,544     577     702     1,514     5,337  
 

Asset impairments

    898     102,630     60,807         164,335  
                       
 

Total operating expenses

    43,053     192,001     85,227     8,215     328,496  
                       

Operating income (loss)

    589     (109,052 )   (73,580 )   (26,654 )   (208,697 )

Adjustments to reconcile to EBITDA and Adjusted EBITDA:

                               
 

Amortization of intangibles

    210     6,038     3,284         9,532  
 

Depreciation

    2,544     577     702     1,514     5,337  
                       

EBITDA

    3,343     (102,437 )   (69,594 )   (25,140 )   (193,828 )
 

Restructuring expense

    3,142     173     485     757     4,557  
 

Asset impairments

    898     102,630     60,807         164,335  
 

Non-cash compensation

        1,519     3,432     5,073     10,024  
                       

Adjusted EBITDA

  $ 7,383   $ 1,885   $ (4,870 ) $ (19,310 ) $ (14,912 )
                       

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

        Significant components of revenue for the three and nine months ended September 30, 2009 and 2008 are as follows (in thousands):

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2009   2008   2009   2008  

LendingTree Loans:

                         
 

Origination and sale of loans

  $ 22,495   $ 17,911   $ 89,701   $ 68,739  
 

Other(a)

    1,614     2,082     5,037     7,310  
                   
   

Total LendingTree Loans revenue

    24,109     19,993     94,738     76,049  

Exchanges:

                         
 

Match fees

    12,438     12,114     32,307     45,687  
 

Closed loan fees

    5,318     8,196     18,180     29,092  
 

Other

    854     554     2,175     2,203  
 

Inter-segment

    5,244     4,761     10,889     15,831  
                   
   

Total Exchanges

    23,854     25,625     63,551     92,813  

Real Estate revenue

    7,997     9,781     21,549     28,378  

Inter-segment elimination

    (5,244 )   (5,141 )   (10,889 )   (16,806 )
                   

Total revenue

  $ 50,716   $ 50,258   $ 168,949   $ 180,434  
                   

(a)
Other revenue within the LendingTree Loans segment includes $0.4 million and $1.0 million of inter-segment revenue for the three and nine months ended September 30, 2008, respectively, which is also included in the inter-segment elimination.

        Total assets by segment at September 30, 2009 and December 31, 2008 are as follows (in thousands):

 
  September 30,
2009
  December 31,
2008
 

LendingTree Loans

  $ 155,968   $ 149,310  

Real Estate

    31,207     38,085  

Exchanges and Unallocated—Corporate(a)

    100,001     96,688  
           

Total

  $ 287,176   $ 284,083  
           

(a)
Assets are jointly used by the Exchanges and Unallocated—Corporate segments, and it is not practicable to allocate assets between these segments.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8—EARNINGS PER SHARE AND STOCK-BASED COMPENSATION

        The following table sets forth the computation of basic and diluted earnings per share:

 
  Three Months Ended September 30,  
 
  2009   2008  
 
  Basic   Diluted   Basic   Diluted  
 
  (In thousands, except per share data)
 

Numerator:

                         

Net loss available to common shareholders

  $ (7,400 ) $ (7,400 ) $ (22,551 ) $ (22,551 )

Denominator:

                         

Weighted average common shares(a)

    10,844     10,844     9,367     9,367  
                   

Net loss per common share

  $ (0.68 ) $ (0.68 ) $ (2.41 ) $ (2.41 )
                   

 

 
  Nine Months Ended September 30,  
 
  2009   2008  
 
  Basic   Diluted   Basic   Diluted  
 
  (In thousands, except per share data)
 

Numerator:

                         

Net loss available to common shareholders

  $ (3,498 ) $ (3,498 ) $ (195,270 ) $ (195,270 )

Denominator:

                         

Weighted average common shares(a)

    10,413     10,413     9,367     9,367  
                   

Net loss per common share

  $ (0.34 ) $ (0.34 ) $ (20.85 ) $ (20.85 )
                   

(a)
The weighted average common shares for the period from January 1, 2008 until the spin-off from IAC is equal to the number of shares outstanding immediately following the spin-off from IAC.

        Non-cash compensation expense related to equity awards is included in the following line items in the accompanying consolidated statements of operations for the three and nine months ended September 30, 2009 and 2008 (in thousands):

 
  Three Months
Ended
September 30,
  Nine Months
Ended
September 30,
 
 
  2009   2008   2009   2008  

Cost of revenue

  $ 11   $ 600   $ 80   $ 762  

Selling and marketing expense

    38     659     124     836  

General and administrative expense

    991     6,534     2,756     8,412  

Product development

    27     12     100     14  
                   

Non-cash compensation expense

  $ 1,067   $ 7,805   $ 3,060   $ 10,024  
                   

        The forms of stock-based awards granted to Tree.com employees are principally restricted stock units ("RSUs"), restricted stock and stock options. RSUs are awards in the form of units, denominated in a hypothetical equivalent number of shares of Tree.com common stock and with the value of each award equal to the fair value of Tree.com common stock at the date of grant. RSUs may be settled in cash, stock or both, as determined by the Compensation Committee at the time of grant. Each stock-based award is subject to service-based vesting, where a specific period of continued employment must

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8—EARNINGS PER SHARE AND STOCK-BASED COMPENSATION (Continued)

pass before an award vests. Tree.com recognizes expense for all stock-based awards for which vesting is considered probable. For stock-based awards the accounting charge is measured at the grant date as the fair value of Tree.com common stock and expensed ratably as non-cash compensation over the vesting term.

        The amount of stock-based compensation expense recognized in the consolidated statement of operations is reduced by estimated forfeitures, as the amount recorded is based on awards ultimately expected to vest. The forfeiture rate is estimated at the grant date based on historical experience and revised, if necessary, in subsequent periods if the actual forfeiture rate differs from the estimated rate.

        A summary of changes in outstanding stock options for the nine months ended September 30, 2009 is as follows:

 
  Shares   Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual
Term
  Aggregate
Intrinsic
Value
 
 
   
   
   
  (In thousands)
 

Outstanding at January 1, 2009

    1,870,707   $ 14.43              

Granted

    21,250     7.46              

Exercised

    (11,961 )   6.89              

Forfeited

    (639,082 )   24.07              

Expired

    (18,657 )   9.04              
                       

Outstanding at September 30, 2009

    1,222,257   $ 9.43     7.4   $ 141  
                   

Options exercisable

    277,831   $ 9.64     4.0   $ 120  
                   

        The following table summarizes the information about stock options outstanding and exercisable as of September 30, 2009:

 
  Options Outstanding   Options Exercisable  
Range of Exercise Prices
  Outstanding at
September 30, 2009
  Weighted
Average
Remaining
Contractual
Life in Years
  Weighted
Average
Exercise Price
  Exercisable at
September 30, 2009
  Weighted
Average
Exercise Price
 

$.01 to $4.99

    20,891     2.84   $ 2.96     20,891   $ 2.96  

$5.00 to $7.45

    19,900     2.98     6.69     19,900     6.69  

$7.46 to $9.99

    921,045     8.56     8.15     103,275     7.79  

$10.00 to $14.99

    123,999     2.16     11.86     123,999     11.86  

$15.00 to $19.99

    86,880     5.33     15.30     6,887     18.73  

$20.00 to $24.99

    48,447     5.49     20.24     1,784     21.50  

Greater than $25.00

    1,095     0.24     38.69     1,095     38.69  
                             

    1,222,257     7.37   $ 9.43     277,831   $ 9.64  
                             

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 8—EARNINGS PER SHARE AND STOCK-BASED COMPENSATION (Continued)

        Nonvested RSUs and restricted stock outstanding as of September 30, 2009 and changes during the nine months ended September 30, 2009 were as follows:

 
  RSUs   Restricted Stock  
 
  Number of
Shares
  Weighted
Average
Grant
Date Fair
Value
  Number of
Shares
  Weighted
Average
Grant
Date Fair
Value
 

Nonvested at January 1, 2009

    380,205   $ 11.39     117,970   $ 7.46  

Granted

    503,220     5.29     350,000     5.42  

Vested

    (24,078 )   9.10     (117,970 )   7.46  

Forfeited

    (113,750 )   11.22          
                   

Nonvested at September 30, 2009

    745,597   $ 7.91     350,000   $ 5.42  
                   

NOTE 9—FAIR VALUE MEASUREMENTS

        Tree.com categorizes its assets and liabilities measured at fair value into a fair value hierarchy that prioritizes the assumptions used in pricing the asset or liability into the following three levels:

    Level 1: Observable inputs such as quoted prices for identical assets and liabilities in active markets obtained from independent sources.

    Level 2: Other inputs that are observable directly or indirectly, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and inputs that are derived principally from or corroborated by observable market data.

    Level 3: Unobservable inputs for which there is little or no market data and require Tree.com to develop its own assumptions, based on the best information available in the circumstances, about the assumptions market participants would use in pricing the asset or liability.

        The following presents Tree.com's assets and liabilities that are measured at fair value on a recurring basis at September 30, 2009 and December 31, 2008 (in thousands):

 
  As of September 30, 2009  
 
  Recurring Fair Value Measurements Using  
 
  Quoted Market
Prices in Active
Markets for
Identical
Assets
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total Fair Value
Measurements
 

Loans held for sale

  $   $ 79,846   $ 270   $ 80,116  

Interest rate lock commitments ("IRLCs")

            6,179     6,179  

Forward delivery contracts

        (1,712 )   (32 )   (1,744 )
                   

Total

  $   $ 78,134   $ 6,417   $ 84,551  
                   

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

 

 
  As of December 31, 2008  
 
  Recurring Fair Value Measurements Using  
 
  Quoted Market
Prices in Active
Markets for
Identical
Assets
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
  Total Fair Value
Measurements
 

Loans held for sale

  $   $ 84,824   $ 814   $ 85,638  

Interest rate lock commitments ("IRLCs")

            5,904     5,904  

Forward delivery contracts

        (1,884 )   (20 )   (1,904 )
                   

Total

  $   $ 82,940   $ 6,698   $ 89,638  
                   

        The following presents the changes in Tree.com's assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2009 and 2008 (in thousands):

 
  Three Months
Ended September 30, 2009
  Nine Months
Ended September 30, 2009
 
 
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
 

Balance at beginning of period

  $ 6,616   $ 271   $ 5,884   $ 814  
 

Total net gains (realized and unrealized) included in earnings

    20,810         74,184     66  
 

Transfers of IRLCs to closed loans

    (13,682 )       (41,162 )    
 

Purchase, sales, issuances and settlements, net

    (8,064 )   (1 )   (32,741 )   (610 )
 

Transfers in or out of Level 3, net

    467         (18 )    
                   

Balance at September 30, 2009

  $ 6,147   $ 270   $ 6,147   $ 270  
                   

 

 
  Three Months
Ended September 30, 2008
  Nine Months
Ended September 30, 2008
 
 
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
 

Balance at beginning of period

  $ 3,059   $   $ 3,465   $  
 

Total net gains (realized and unrealized) included in earnings

    14,668     (692 )   43,805     (692 )
 

Transfers of IRLCs to closed loans

    (10,312 )       (25,893 )    
 

Purchase, sales, issuances and settlements, net

    (5,155 )   (1,397 )   (18,025 )   (1,397 )
 

Transfers in or out of Level 3, net

    20     2,580     (1,072 )   2,580  
                   

Balance at September 30, 2008

  $ 2,280   $ 491   $ 2,280   $ 491  
                   

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

        The following presents the gains included in earnings for the three and nine months ended September 30, 2009 and 2008 relating to Tree.com's assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) (in thousands):

 
  Three Months
Ended September 30, 2009
  Nine Months
Ended September 30, 2009
 
 
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
 

Total net gains included in earnings, which are included in revenue from LendingTree Loans

  $ 20,810   $   $ 74,184   $ 66  
                   

Change in unrealized gains relating to assets and liabilities still held at September 30, 2009, which are included in revenue from LendingTree Loans

  $ 6,147   $   $ 6,147   $ 1  
                   

 

 
  Three Months
Ended September 30, 2008
  Nine Months
Ended September 30, 2008
 
 
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
  Interest Rate
Lock Commitments
and Forward
Delivery Contracts
  Loans Held
for Sale
 

Total net gains (losses) included in earnings, which are included in revenue from LendingTree Loans

  $ 13,028   $ (692 ) $ 39,586   $ (692 )
                   

Change in unrealized gains (losses) relating to assets and liabilities still held at September 30, 2008, which are included in revenue from LendingTree Loans

  $ 2,280   $ (210 )   2,280   $ (210 )
                   

        LendingTree Loans economically hedges the changes in fair value of certain loans held for sale primarily by entering into mortgage forward delivery contracts. The changes in fair value of the forward delivery contracts are recognized in current earnings as a component of LendingTree Loans revenue.

        LendingTree Loans enters into commitments with consumers to originate loans at a specified interest rate (interest rate lock commitments—"IRLCs"). Tree.com reports IRLCs as derivative instruments at fair value. Accordingly, LendingTree Loans determines the fair value of IRLCs using current secondary market prices for underlying loans with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability. The fair value of IRLCs is subject to change primarily due to changes in interest rates and the loan funding probability. Under LendingTree Loans' risk management policy, LendingTree Loans economically hedges the changes in fair value of IRLCs primarily by entering into mortgage forward delivery contracts which can reduce the volatility of economic outcomes. IRLCs and the related hedging instruments are recorded at fair value with changes in fair value being recorded in current earnings as a component of revenue from the origination and

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)


sale of loans in the consolidated statement of operations. At September 30, 2009 and December 31, 2008, there were $289.1 million and $252.9 million, respectively, of IRLCs notional value outstanding.

        The following table summarizes the Company's derivative instruments not designated as hedging instruments as of September 30, 2009 and December 31, 2008 (in thousands):

 
  September 30, 2009   December 31, 2008  
 
  Balance Sheet Location   Fair Value   Balance Sheet Location   Fair Value  

Interest Rate Lock Commitments

  Prepaid and other current assets   $ 6,227   Prepaid and other current assets   $ 5,913  

Forward Delivery Contracts

  Prepaid and other current assets     124   Prepaid and other current assets     251  

Interest Rate Lock Commitments

  Accrued expenses and other current liabilities     (48 ) Accrued expenses and other current liabilities     (9 )

Forward Delivery Contracts

  Accrued expenses and other current liabilities     (1,868 ) Accrued expenses and other current liabilities     (2,155 )
                   

Total Derivatives

      $ 4,435       $ 4,000  
                   

        The gain/(loss) recognized in the consolidated statements of operations for derivatives for the three and nine months ended September 30, 2009 and 2008 was as follows (in thousands):

 
   
  Three Months
Ended
  Nine Months
Ended
 
 
  Location of Gain/(Loss)
Recognized in Income on
Derivative
  September 30,
2009
  September 30,
2008
  September 30,
2009
  September 30,
2008
 

Interest Rate Lock Commitments

  LendingTree Loans revenue   $ 21,227   $ 12,804   $ 74,178   $ 38,306  

Forward Delivery Contracts

  LendingTree Loans revenue     (2,270 )   1,516     149     3,786  
                       
 

Total

      $ 18,957   $ 14,320   $ 74,327   $ 42,092  
                       

        Tree.com has elected to account for loans held for sale originated on or after January 1, 2008 at fair value. Electing the fair value option allows a better offset of the changes in fair values of the loans and the forward delivery contracts used to economically hedge them without the burden of complying with the requirements for hedge accounting.

        Tree.com did not elect the fair value option on loans held for sale originated prior to January 1, 2008 and on loans that were repurchased from investors on or subsequent to that date. As of September 30, 2009 and December 31, 2008, 38 and 60 such loans, respectively, all of which were impaired, were included in loans held for sale and were carried at the lower of cost or market ("LOCOM") value assessed on an individual loan basis. The market value (or fair value) of these impaired loans at September 30, 2009 and December 31, 2008, measured on a non-recurring basis using

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)


significant unobservable inputs (Level 3), was $1.8 and $2.2 million, respectively. This fair value measurement is management's best estimate of the market value of such loans and considers current bids in the secondary market for similar loans.

        The following presents the difference between the aggregate principal balance of loans held for sale for which the fair value option has been elected and for loans measured at LOCOM as of September 30, 2009 and December 31, 2008 (in thousands):

 
  As of September 30, 2009  
 
  Loans Held
for Sale—
Measured at
Fair Value
  Loans Held
for Sale—
Measured at
LOCOM
  Total Loans
Held For Sale
 

Aggregate unpaid principal balance

  $ 78,246   $ 4,170   $ 82,416  

Difference between fair value and aggregate unpaid principal balance

    1,870         1,870  

Lower of cost or market valuation allowance

        (2,339 )   (2,339 )

Deferred loan fees, net of costs

        (16 )   (16 )
               

Loans held for sale

  $ 80,116   $ 1,815   $ 81,931  
               

 

 
  As of December 31, 2008  
 
  Loans Held
for Sale—
Measured at
Fair Value
  Loans Held
for Sale—
Measured at
LOCOM
  Total Loans
Held For Sale
 

Aggregate unpaid principal balance

  $ 83,094   $ 5,949   $ 89,043  

Difference between fair value and aggregate unpaid principal balance

    2,544         2,544  

Lower of cost or market valuation allowance

        (3,726 )   (3,726 )

Deferred loan fees, net of costs

        (26 )   (26 )
               

Loans held for sale

  $ 85,638   $ 2,197   $ 87,835  
               

        During the three months ended September 30, 2009 and 2008, the change in fair value of loans held for sale for which the fair value option has been elected was a gain of $1.6 million and a loss of $0.7 million, respectively, and is included as a component of LendingTree Loans revenue in the accompanying consolidated statements of operations.

        During the nine months ended September 30, 2009 and 2008, the change in fair value of loans held for sale for which the fair value option has been elected were losses of $0.4 million and $2.4 million, respectively, and is included as a component of LendingTree Loans revenue in the accompanying consolidated statements of operations.

        The following disclosures represent financial instruments in which the ending balances at September 30, 2009 and December 31, 2008 are not carried at fair value in their entirety on the Company's consolidated balance sheets. The additional disclosure below of the estimated fair value of financial instruments has been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)


interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies may have a material impact on the estimated fair value amounts. The Company's financial instruments include letters of credit and surety bonds. The Company had $5.0 million in restricted cash at September 30, 2009 and December 31, 2008 as collateral for the surety bonds. These commitments remain in place to facilitate the commercial operations of certain Tree.com subsidiaries.

 
  September 30, 2009   December 31, 2008  
 
  Carrying
Amount
  Fair
Value
  Carrying
Amount
  Fair
Value
 

Cash and cash equivalents

  $ 86,859   $ 86,859   $ 73,643   $ 73,643  

Restricted cash

    12,826     12,826     15,204     15,204  

Accounts receivable, net

    8,114     8,114     7,234     7,234  

Loans held for sale, net

    81,931     81,931     87,835     87,835  

Warehouse lines of credit and notes payable

    (67,129 )   (67,129 )   (76,186 )   (76,186 )

Accounts payable

    (5,431 )   (5,431 )   (3,541 )   (3,541 )

Accrued expenses

    (42,042 )   (42,042 )   (37,146 )   (37,146 )

Surety bonds and letters of credit

    N/A     (8,357 )   N/A     (7,732 )

        The carrying amounts of cash and cash equivalents and restricted cash reflected in the accompanying consolidated balance sheets approximate fair value as they are maintained with various high-quality financial institutions or in short-term duration high-quality debt securities. Accounts receivable, net, are short-term in nature and are generally settled shortly after the sale, and therefore the carrying amount approximates fair value. The fair value of loans held for sale, net, was estimated using current secondary market prices for underlying loans with similar coupons, maturity and credit quality. The carrying amounts for the remaining warehouse lines of credit and notes payable and all other financial instruments approximate their fair value.

NOTE 10—ORIGINATION AND SALE OF LOANS, LOANS HELD FOR SALE AND LOAN LOSS OBLIGATIONS

Origination and Sale of Loans

        LendingTree Loans' revenues are primarily derived from the origination and sale of loans. Mortgage loans are funded through warehouse lines of credit and are recorded at fair value. Changes in the fair value of mortgage loans are recorded through revenue prior to the sale of the loans to investors, which typically occurs within thirty days. The gain or loss on the sale of loans is recognized on the date the loans are sold and is based on the difference between the sale proceeds received and the fair value of the loans. The Company sells its loans on a servicing released basis in which the Company gives up the right to service the loans.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 10—ORIGINATION AND SALE OF LOANS, LOANS HELD FOR SALE AND LOAN LOSS OBLIGATIONS (Continued)

        A summary of the initial unpaid principal balance of loans sold by type of loan for the three months ended September 30, 2009 and 2008 is presented below ($ amounts in millions):

 
  Three Months ended
September 30,
  Nine Months ended
September 30,
 
 
  2009   2008   2009   2008  
 
  Amount   %   Amount   %   Amount   %   Amount   %  

Conforming

  $ 512     79 % $ 388     77 % $ 1,899     85 % $ 1,448     83 %

FHA and Alt-A

    127     19 %   110     22 %   315     14 %   282     16 %

Jumbo

    11     2 %   5     1 %   23     1 %   19     1 %
                                   

Total

  $ 650     100 % $ 503     100 % $ 2,237     100 % $ 1,749     100 %
                                   

Loans Held for Sale

        LendingTree Loans originates all of its residential real estate loans with the intent to sell them in the secondary market. Loans held for sale consist primarily of residential first mortgage loans that are secured by residential real estate throughout the United States.

        The following table represents the loans held for sale by type of loan as of September 30, 2009 and December 31, 2008 ($ amounts in thousands):

 
  September 30,
2009
  December 31,
2008
 
 
  Amount   %   Amount   %  

Conforming

  $ 63,972     78 % $ 74,993     86 %

FHA and Alt-A

    17,075     21 %   11,737     13 %

Subprime

    760     1 %   878     1 %

Home equity

    124     %   227     %
                   

Total

  $ 81,931     100 % $ 87,835     100 %
                   

        The unpaid principal amount of loans on nonaccrual status at September 30, 2009 and December 31, 2008 was $4.6 million and $7.0 million, respectively. These loans have a net book value (net of lower of cost or market valuation allowances and fair value adjustments) of $2.1 million and $3.0 million at September 30, 2009 and December 31, 2008, respectively. Included within the loans on nonaccrual status are repurchased loans with a net book value of $1.0 million and $1.1 million at September 30, 2009 and December 31, 2008, respectively. During the three and nine months ended September 30, 2009 LendingTree Loans repurchased one loan with unpaid principal balance of $0.1 million. During the three months ended September 30, 2008, LendingTree Loans did not repurchase any loans. During the nine months ended September 30, 2008 LendingTree Loans repurchased 16 loans with $1.3 million of unpaid principal balances.

        Real estate properties acquired in satisfaction of loans totaled $0.8 million and $0.9 million, net of estimated selling expenses, at September 30, 2009 and December 31, 2008, respectively, and is included in prepaid and other current assets in the accompanying consolidated balance sheets.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 10—ORIGINATION AND SALE OF LOANS, LOANS HELD FOR SALE AND LOAN LOSS OBLIGATIONS (Continued)

Loan Loss Obligations

        LendingTree Loans sells loans it originates to investors on a servicing released basis so the risk of loss or default by the borrower is generally transferred to the investor. However, LendingTree Loans is required by these investors to make certain representations relating to credit information, loan documentation and collateral. These representations and warranties may extend through the contractual life of the mortgage loan. Subsequent to the sale, if underwriting deficiencies, borrower fraud or documentation defects are discovered in individual mortgage loans, LendingTree Loans may be obligated to repurchase the respective mortgage loan or indemnify the investors for any losses from borrower defaults if such deficiency or defect cannot be cured within the specified period following discovery.

        In the case of early payoffs and early defaults on certain loans, LendingTree Loans may be required to repay all or a portion of the premium initially paid by the investor. The estimated obligation associated with early payoffs and early defaults is calculated based on historical loss experience by type of loan.

        The obligation for losses related to the representations and warranties and other provisions discussed above is initially recorded at its estimated fair value, which includes a projection of expected future losses as well as a market based premium. Because LendingTree Loans does not service the loans it sells, it does not maintain nor have access to the current balances and loan performance data with respect to the individual loans previously sold to investors. Accordingly, the Company is unable to determine, with precision, its maximum exposure under its representations and warranties. However, LendingTree Loans utilizes the original loan balance (before it was sold to an investor), historical and projected loss frequency and loss severity ratios by loan segment as well as analyses of loss claims in process to estimate its exposure to losses on loans previously sold. As of September 30, 2009, LendingTree Loans has estimated the range of losses due to representations and warranty issues as $11 million to $18 million based on the methodology described below.

        The Company maintains a liability related to this exposure based, in part, on historical and projected loss frequency and loss severity using its claims history (adjusted for recent trends in claims experience), the original principal amount of the loans previously sold, the year the loans were sold, and loan type. Accordingly, subsequent adjustments to the obligation, if any, are not made based on changes in the fair value of the obligation, which might include an estimated change in losses that may be expected in the future, but are made once further losses are estimated to be both probable and estimable. As such, given current general industry trends in mortgage loans as well as housing prices, market expectations around losses related to the Company's obligations could vary significantly from the obligation recorded as of the balance sheet date or the range estimated above. In estimating its exposure to loan losses, LendingTree Loans segments its loan sales into four segments based on the extent of the documentation provided by the borrower to substantiate income and/or assets (full or limited documentation) and the lien position of the mortgage in the underling property (first or second position). Each of these segments has a different loss experience with full documentation, first lien position loans generally having the lowest loss ratios and limited documentation, second lien position loans generally having the highest loss ratios.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 10—ORIGINATION AND SALE OF LOANS, LOANS HELD FOR SALE AND LOAN LOSS OBLIGATIONS (Continued)

        For the nine months ended September 30, 2009, LendingTree Loans sold approximately 10,200 loans with an original principal balance of $2.2 billion. Through September 30, 2009 there had been no loans from this group which had experienced losses.

        For 2008, LendingTree Loans sold approximately 11,000 loans with an original principal balance of $2.2 billion. Through September 30, 2009 there were 10 loans from this group with an original balance of $2.1 million that had experienced aggregate losses of $0.3 million.

        For 2007, LendingTree Loans sold approximately 36,300 loans with an original principal balance of $6.1 billion. Through September 30, 2009 there were 112 loans from this group with an original balance of $13.6 million that had experienced aggregate losses of $3.8 million.

        For 2006, LendingTree Loans sold approximately 55,000 loans with an original principal balance of $7.9 billion. Through September 30, 2009 there were 155 loans from this group with an original balance of $17.6 million that had experienced aggregate losses of $8.8 million.

        For 2005 and prior years, LendingTree Loans sold an aggregate of approximately 86,700 loans with an original principal balance of $13.0 billion. Through September 30, 2009 there were 76 loans from this group with an original balance of $10.1 million that had experienced aggregate losses of $3.7 million.

        The current pipeline of 138 loan loss claims and indemnifications was considered in determining the appropriate reserve amount. The status of these 138 loans varies from an initial review stage, which may result in a rescission of the request, to in process, where the probability of incurring a loss is high, to indemnification, whereby the Company has agreed to reimburse the purchaser of that loan if and when losses are incurred. The indemnification may have a specific term, thereby limiting the Company's exposure. The original principal amount of these loans is approximately $17.8 million, comprised of approximately 37% full documentation first liens, 6% full documentation second liens, 25% low documentation first liens, and 32% being low documentation second liens.

        Based on historical experience, it is anticipated that the Company will continue to receive loss claims and incur losses on loans sold in prior years. The Company believes that it has adequately reserved for these losses.

        The activity related to loss reserves on previously sold loans for the three and nine months ended September 30, 2009 and 2008, is as follows (in thousands):

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2009   2008   2009   2008  

Balance, beginning of period

  $ 12,085   $ 11,392   $ 10,451   $ 13,886  

Provisions

    4,190     756     10,133     870  

Charge-offs

    (2,239 )   (1,086 )   (6,548 )   (3,694 )
                   

Balance, end of period

  $ 14,036   $ 11,062   $ 14,036   $ 11,062  
                   

        Based on an analysis of the Company's historical loan loss experience, it has been determined that a portion of the loss claims expected to be made by investors will be made more than twelve months

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 10—ORIGINATION AND SALE OF LOANS, LOANS HELD FOR SALE AND LOAN LOSS OBLIGATIONS (Continued)


following the initial sale of the underlying loan. Accordingly, the Company has estimated the portion of its Loans Sold Reserve that it anticipates it will be liable for after twelve months and has classified that portion of the reserve as a long-term liability. The liability for losses on previously sold loans is presented in the accompanying consolidated balance sheet as of September 30, 2009 and December 31, 2008 as follows (in thousands):

 
  September 30,
2009
  December 31,
2008
 

Current portion, included in accrued expenses and other current liabilities

  $ 8,165   $ 3,972  

Long term portion, included in other long-term liabilities

    5,871     6,479  
           

Total

  $ 14,036   $ 10,451  
           

NOTE 11—INCOME TAXES

        For the three months ended September 30, 2009 and 2008, Tree.com recorded a tax benefit of $0.2 million and $0.1 million, respectively, which represents effective tax rates of 2.4% and 0.3%, respectively. These tax rates are lower than the federal statutory rate of 35% due to the change in the valuation allowance on deferred tax assets.

        For the nine months ended September 30, 2009 and 2008, Tree.com recorded a tax (provision) benefit of $(0.1) million and $13.9 million, respectively, which represents effective tax rates of (3.6)% and 6.7%, respectively. These tax rates are lower than the federal statutory rate of 35% due principally to non-deductible impairment charges and an increase in the valuation allowance on deferred tax assets.

        The 2009 provision includes a benefit of $0.3 million related to the release of uncertain tax position reserves as a result of the expiration of the statute of limitations. Tree.com believes that it is reasonably possible that its unrecognized tax benefits could decrease by approximately $0.3 million within twelve months of the current reporting date due to the expiration of statutes of limitations. An estimate of other changes in unrecognized tax benefits cannot be made, but are not expected to be significant.

        Tree.com determined that its valuation allowance and permanent differences yielded an unusual effective tax rate, therefore Tree.com utilized the actual year to date effective tax rate for purposes of determining year to date tax expense.

NOTE 12—CONTINGENCIES

        HLC is party to various employment related lawsuits. During the nine months ended September 30, 2009 and 2008, provisions of $0.3 million and $1.1 million, respectively, were recorded in general and administrative expenses in the accompanying consolidated statements of operations. The balance of the related liability was $-0- and $2.0 million at September 30, 2009 and December 31, 2008, respectively.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 12—CONTINGENCIES (Continued)

        In the ordinary course of business, Tree.com is a party to various lawsuits. Tree.com establishes reserves for specific legal matters when it determines that the likelihood of an unfavorable outcome is probable and the loss is reasonably estimable. Management has also identified certain other legal matters where it believes an unfavorable outcome is not probable and, therefore, no reserve is established. Although management currently believes that an unfavorable resolution of claims against Tree.com, including claims where an unfavorable outcome is reasonably possible, will not have a material impact on the liquidity, results of operations, or financial condition of Tree.com, these matters are subject to inherent uncertainties and management's view of these matters may change in the future. It is possible that an unfavorable outcome of one or more of these lawsuits could have a material impact on the liquidity, results of operations, or financial condition of Tree.com. Tree.com also evaluates other contingent matters, including tax contingencies, to assess the probability and estimated extent of potential loss.

NOTE 13—RELATED PARTY TRANSACTIONS

        While affiliated with IAC, Tree.com's expenses included allocations from IAC of costs associated with IAC's accounting, treasury, legal, tax, corporate support, human resources and internal audit functions. These expenses were allocated based on the ratio of Tree.com's revenue as a percentage of IAC's total revenue. Allocated costs were $-0- and $0.3 million for the three and nine months ended September 30, 2008, respectively, and are included in "General and administrative expense" in the accompanying consolidated statements of operations. It is not practicable to determine the amounts of these expenses that would have been incurred had Tree.com operated as an unaffiliated entity. In the opinion of management, the allocation method was reasonable.

        For purposes of governing certain ongoing relationships between Tree.com and IAC at and after the spin-off, and to provide for an orderly transition, Tree.com and IAC entered into a separation agreement, a tax sharing agreement, an employee matters agreement and a transition services agreement (the "Spin-Off Agreements"), among other agreements.

NOTE 14—RESTRUCTURING CHARGES

        The restructuring charges in 2009 primarily relate to Tree.com's segment reorganizations and aligning the cost structure with future revenue opportunities. The restructuring charges in 2008 primarily relate to Tree.com's significant reduction in its mortgage origination and real estate operations in response to the adverse developments in mortgage and real estate market conditions.

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 14—RESTRUCTURING CHARGES (Continued)


Costs that relate to ongoing operations are not part of restructuring charges. Restructuring charges by segment and type are as follows (in thousands):

 
  For The Three Months Ended September 30, 2009  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Other   Total  

LendingTree Loans

  $   $ (54 ) $   $   $ (54 )

Exchanges

    50                 50  

Real Estate

    53                 53  

Unallocated—corporate

    29                 29  
                       

Total

  $ 132   $ (54 ) $   $   $ 78  
                       

 

 
  For The Three Months Ended September 30, 2008  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Other   Total  

LendingTree Loans

  $ 241   $ 1,429   $ 646   $ 20   $ 2,336  

Exchanges

    22                 22  

Real Estate

    4             (32 )   (28 )

Unallocated—corporate

    64                 64  
                       

Total

  $ 331   $ 1,429   $ 646   $ (12 ) $ 2,394  
                       

 

 
  For The Nine Months Ended September 30, 2009  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Other   Total  

LendingTree Loans

  $   $ (1,246 ) $   $   $ (1,246 )

Exchanges

    108                 108  

Real Estate

    595     73     124         792  

Unallocated—corporate

    237     (49 )           188  
                       

Total

  $ 940   $ (1,222 ) $ 124   $   $ (158 )
                       

 

 
  For The Nine Months Ended September 30, 2008  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Other   Total  

LendingTree Loans

  $ 644   $ 1,494   $ 984   $ 20   $ 3,142  

Exchanges

    173                 173  

Real Estate

    371         34     80     485  

Unallocated—corporate

    769             (12 )   757  
                       

Total

  $ 1,957   $ 1,494   $ 1,018   $ 88   $ 4,557  
                       

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TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 14—RESTRUCTURING CHARGES (Continued)

        The recovery of restructuring charges under the continuing lease obligations category for LendingTree Loans during the three and nine months ended September 30, 2009 primarily relate to the cancellation of certain lease agreements for facilities that had been previously exited. The remaining obligation was cancelled in conjunction with cancelling the lease agreement and renewing the lease on facilities currently occupied, resulting in the recovery of the expense.

        Restructuring charges and spending against liabilities are as follows (in thousands):

 
  For The Nine Months Ended September 30, 2009  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Other   Total  

Balance, beginning of period

  $ 385   $ 3,703   $   $   $ 4,088  
 

Restructuring charges

    940     (1,222 )   124         (158 )
 

Payments

    (1,266 )   (1,596 )           (2,862 )
 

Write-offs

        20     (124 )       (104 )
                       

Balance, end of period

  $ 59   $ 905   $   $   $ 964  
                       

        At September 30, 2009, restructuring liabilities of $0.4 million are included in "Accrued expenses and other current liabilities" and $0.6 million are included in "Other long-term liabilities" in the accompanying consolidated balance sheet. At December 31, 2008, restructuring liabilities of $3.3 million are included in "Accrued expenses and other current liabilities" and $0.8 million are included in "Other long-term liabilities" in the accompanying consolidated balance sheet. Tree.com does not expect to incur significant additional costs related to the prior restructurings noted above.

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Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations

Management Overview

        On August 20, 2008, Tree.com, Inc. ("Tree.com") was spun off from its parent company, IAC/InterActiveCorp ("IAC") into a separate publicly traded company. We refer to the separation transaction as the "spin-off." In connection with the spin-off, Tree.com was incorporated as a Delaware corporation in April 2008. Tree.com consists of the brands and businesses that formerly comprised IAC's Lending and Real Estate segments. These brands and businesses include LendingTree.com, RealEstate.com, GetSmart.com and Home Loan Center, Inc. (d/b/a LendingTree Loans).

        Following the spin-off from IAC, the new chief operating decision maker began to realign the Tree.com businesses into new operating segments. For the first quarter of 2009, management completed its realignment of staffing and direct revenue and costs for each new segment and created reporting structures to enable the chief operating decision maker and management to evaluate the results of operations for each of these new segments on a comparative basis with prior periods. In prior periods, the segments "Lending" and "Real Estate" were presented, which have been changed to "LendingTree Loans", "Exchanges" and "Real Estate" segments. Additionally, certain shared indirect costs that are described below are reported as "Unallocated—Corporate." All items of segment information for prior periods have been restated to conform to the new reportable segment presentation.

        The expenses presented below for each of the business segments include an allocation of certain corporate expenses that are identifiable and directly benefit those segments. The unallocated expenses are those corporate overhead expenses that are not directly attributable to a segment and include: corporate expenses such as finance, legal, executive, technology support, and human resources, as well as elimination of inter-segment revenue and costs.

        The LendingTree Loans segment originates, processes, approves and funds various residential real estate loans through Home Loan Center, Inc. ("HLC"), (d/b/a LendingTree Loans). The HLC and LendingTree Loans brand names are collectively referred to in these consolidated financial statements as "LendingTree Loans."

        The Exchanges segment consists of online lead generation networks and call centers (principally LendingTree.com and GetSmart.com) that connect consumers and service providers principally in the lending and higher education marketplaces.The Real Estate segment consists of a proprietary full-service real estate brokerage (RealEstate.com, REALTORS®) that operates in 20 U.S. markets, as well as an online lead generation network accessed at www.RealEstate.com , that connects consumers with real estate brokerages around the country.

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         Results of operations for the three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008:

    Revenue

    For the three months ended September 30, 2009 compared to the three months ended September 30, 2008

 
  Three Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in thousands)
 

LendingTree Loans:

                   
 

Origination and sale of loans

  $ 22,495     26 % $ 17,911  
 

Other

    1,614     (23 )%   2,082  
                 

Total LendingTree Loans

    24,109     21 %   19,993  

Exchanges:

                   
 

Match fees

    12,438     3 %   12,114  
 

Closed loan fees

    5,318     (35 )%   8,196  
 

Other

    854     54 %   554  
 

Inter-segment revenue

    5,244     10 %   4,761  
                 

Total Exchanges

    23,854     (7 )%   25,625  

Real Estate

    7,997     (18 )%   9,781  

Inter-segment revenue

    (5,244 )   2 %   (5,141 )
                 

Total revenue

  $ 50,716     1 % $ 50,258  
                 

        LendingTree Loans revenue in 2009 increased $4.1 million, or 21%, from the same period in 2008. Revenue generated from the origination and sale of loans in the secondary market increased $4.6 million, or 26%, primarily due to a dramatically declining mortgage interest rate environment that began late in the fourth quarter of 2008, improvement in revenue per closed loan and higher loan closing rates. Offsetting this increase in revenue was a higher charge to the provision for previously sold loans, which is recorded as a reduction of revenue. The provision increased from $0.8 million in 2008 to $4.2 million in 2009, reflecting an increase in the trend of loan repurchase requests received in the third quarter that related primarily to loans sold in 2006 and 2007.

        The dollar value of loans closed directly by LendingTree Loans is as follows:

 
  Three Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 538     48 % $ 363  

Purchase mortgages

    82     (31 )%   120  
                 

Total

  $ 620     29 % $ 483  
                 

        LendingTree Loans originates mortgage loans on property located throughout the United States. Revenue from loans originated for property in California totaled approximately 8% and 4% of Tree.com's consolidated revenue for the three months ended September 30, 2009 and 2008, respectively.

        Revenue from the Exchanges decreased $1.8 million, or 7%, due primarily to fewer loans closed through network lenders, reflecting the impact on consumers of continued tight credit standards at

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most lenders. Match fees did increase slightly during the period, which reflects an increase in matched requests for our education leads as a result of an acquisition in the third quarter of 2009, offset by fewer matched requests with network lenders. Matched requests with network lenders in the third quarter of 2009 were down 29% from the same period in 2008. Following the first five months of 2009 when consumer mortgage rates were at or near historical lows, rates increased significantly (50 to 60 basis points) over a short span late in the second quarter and early in the third quarter of 2009. This rapid increase in rates from historical low levels contributed to fewer consumers making a loan request in the third quarter. The decline in loan requests coupled with fewer consumers who could qualify for a loan in this tight credit market caused the decline in matched loan requests.

        The dollar value of loans closed by Exchange network lenders is as follows:

 
  Three Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 991     (24 )% $ 1,310  

Purchase mortgages

    705     (43 )%   1,231  

Other

    155     (66 )%   429  
                 

Total

  $ 1,851     (38 )% $ 2,970  
                 

        No single Exchange network lender accounts for revenue representing more than 10% of Tree.com's consolidated revenue for any periods presented.

        Real Estate revenue decreased $1.8 million, or 18%, principally due to a decrease in closings year-over-year due to the persistent negative real estate market conditions contributing to lower home sales prices and fewer real estate transactions overall. The dollar value of the Company's real estate closings decreased $186 million, or 36%, from $516 million in 2008 to $330 million in 2009. However, Real Estate experienced positive growth in the number of agents working for our company-owned brokerage, which increased from 1,100 at the end of the third quarter 2008 to over 1,300 at the end of the third quarter 2009.

    For the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008

 
  Nine Months Ended September 30,  
 
  2009   % Change   2008  
 
  (Dollars in thousands)
 

LendingTree Loans:

                   
 

Origination and sale of loans

  $ 89,701     30 % $ 68,739  
 

Other

    5,037     (31 )%   7,310  
                 

Total LendingTree Loans

    94,738     25 %   76,049  

Exchanges:

                   
 

Match fees

    32,307     (29 )%   45,687  
 

Closed loan fees

    18,180     (38 )%   29,092  
 

Other

    2,175     (1 )%   2,203  
 

Inter-segment revenue

    10,889     (31 )%   15,831  
                 

Total Exchanges

    63,551     (32 )%   92,813  

Real Estate

    21,549     (24 )%   28,378  

Inter-segment revenue

    (10,889 )   (35 )%   (16,806 )
                 

Total revenue

  $ 168,949     (6 )% $ 180,434  
                 

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        LendingTree Loans revenue in 2009 increased $18.7 million, or 25%, from the same period in 2008. Revenue generated from the origination and sale of loans in the secondary market increased $21.0 million, or 30%, primarily due to a dramatically declining mortgage interest rate environment that began late in the fourth quarter of 2008, improvement in revenue per closed loan and higher loan closing rates. Offsetting this increase in revenue was a higher charge to the provision for previously sold loans, which is recorded as a reduction of revenue. The provision increased from $0.9 million in 2008 to $10.1 million in 2009, reflecting an increase in losses realized in the second and third quarters of 2009 that related primarily to loans sold in 2006 and 2007.

        The dollar value of loans closed directly by LendingTree Loans is as follows:

 
  Nine Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 1,997     47 % $ 1,356  

Purchase mortgages

    236     (37 )%   374  
                 

Total

  $ 2,233     29 % $ 1,730  
                 

        LendingTree Loans originates mortgage loans on property located throughout the United States. Revenue from loans originated for property in California totaled approximately 12% and 4% of Tree.com's consolidated revenue for the nine months ended September 30, 2009 and 2008, respectively.

        Revenue from the Exchanges declined $29.3 million, or 32%, due primarily to fewer loan requests from consumers, fewer matched requests with network lenders and fewer loans closed through network lenders. Matched requests in 2009 were down 27% from the same period in 2008 due to the five Federal Reserve interest rate cuts during the first quarter of 2008, which stimulated significant consumer demand on our network in the first quarter and the early part of the second quarter of 2008. Although mortgage rates remained at or near historical lows during most of 2009, the Exchanges experienced a decline in matched requests, reflecting both fewer qualified consumers in a tight credit market and lower network lender demand for consumer leads through the first six months of 2009. Management believes the lower demand for loan requests from network lenders during this time was primarily attributable to many lenders experiencing their own higher levels of organic lead volume through other channels during a low interest rate environment. This surge in organic volume likely caused production and warehouse capacity limitations for many of the lenders participating on the network. During the third quarter of 2009, network lender demand began to increase as the sudden rise in interest rates (50 to 60 basis points) in a brief span late in the second quarter and early in the third quarter caused many network lenders' organic consumer loan request volume to diminish. Additionally, as a result of fewer matched requests, closed loan units through the Exchange also declined resulting in 38% lower closed loan fees.

        The dollar value of loans closed by Exchange network lenders is as follows:

 
  Nine Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 4,880     (12 )% $ 5,551  

Purchase mortgages

    1,756     (44 )%   3,145  

Other

    453     (72 )%   1,650  
                 

Total

  $ 7,089     (31 )% $ 10,346  
                 

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        Real Estate revenue decreased $6.8 million, or 24%, principally due to a decrease in closings year-over-year due to the persistent negative real estate market conditions contributing to lower home sales prices and fewer real estate transactions overall. The dollar value of the Company's real estate closings decreased $528 million, or 36%, from $1.5 billion in 2008 to $944 million in 2009. However, Real Estate experienced positive growth in the number of agents working for our company-owned brokerage, which increased from 1,100 at the end of the third quarter 2008 to over 1,300 at the end of the third quarter 2009.

    Cost of revenue

    For the three months ended September 30, 2009 compared to the three months ended September 30, 2008

 
  Three Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in thousands)
 

LendingTree Loans

  $ 11,245     22 % $ 9,194  

Exchanges

    1,849     (36 )%   2,896  

Real Estate

    5,056     (15 )%   5,954  

Unallocated—corporate

    540     2 %   529  
                 

Cost of revenue

  $ 18,690     1 % $ 18,573  
                 

As a percentage of total revenue

    37 %         37 %

 

 
  Three Months
Ended
September 30,
 
As a Percentage of Segment Revenue
  2009   2008  

LendingTree Loans

    47 %   46 %

Exchanges

    8 %   11 %

Real Estate

    63 %   61 %

Unallocated—corporate, as a percentage of total revenue

    1 %   1 %

        Cost of revenue consists primarily of costs associated with loan originations, compensation and other employee-related costs (including stock-based compensation) related to customer call centers, real estate network support staff and loan officers, as well as credit scoring fees, consumer incentive costs, real estate agent commissions and website network hosting and server fees.

        Cost of revenue overall in 2009 remained flat from 2008, however, there was some variation within the operating segments. The costs associated with loan originations in LendingTree Loans increased by $1.3 million, which corresponds to the increases in both revenue from the origination and sales of loans and the dollar value of loans closed directly by LendingTree Loans. In addition, commissions paid to real estate agents increased $0.6 million.

        Offsetting these increases in cost of revenue were decreases of $0.7 million in compensation and other employee-related costs and $1.5 million in consumer incentive rebates related to decreased closings at the Exchanges and in Real Estate. The decrease in compensation and other employee-related costs reflects the net of reduced personnel costs associated with Tree.com's customer call center, settlement services operation and portions of its loan processing department, offset by an increase in commissions paid to loan officers at LendingTree Loans due to higher loan originations.

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    For the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008

 
  Nine Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in thousands)
 

LendingTree Loans

  $ 37,104     14 % $ 32,407  

Exchanges

    5,760     (42 )%   9,864  

Real Estate

    13,712     (18 )%   16,731  

Unallocated—corporate

    1,627     %   1,633  
                 

Cost of revenue

  $ 58,203     (4 )% $ 60,635  
                 

As a percentage of total revenue

    34 %         34 %

 

 
  Nine Months
Ended
September 30,
 
As a Percentage of Segment Revenue
  2009   2008  

LendingTree Loans

    39 %   43 %

Exchanges

    9 %   11 %

Real Estate

    64 %   59 %

Unallocated—corporate, as a percentage of total revenue

    1 %   1 %

        Cost of revenue in 2009 decreased $2.4 million from 2008 primarily due to decreases of $3.3 million in compensation and other employee-related costs and $4.6 million in consumer incentive rebates related to decreased closings at the Exchanges and in Real Estate. The decrease in compensation and other employee-related costs reflects the net of reduced personnel costs associated with Tree.com's customer call center, settlement services operation and portions of its loan processing department, offset by an increase in commissions paid to loan officers at LendingTree Loans due to higher loan originations.

        Offsetting these decreases in cost of revenue was an increase of $4.0 million in costs associated with loan originations in LendingTree Loans and a $1.0 million increase in commissions paid to real estate agents. The increase in loan origination costs corresponds to the increases in both revenue from the origination and sales of loans and the dollar value of loans closed directly by LendingTree Loans. The increase in commissions paid to real estate agents both in dollars and as a percentage of revenue is due to an increase in the number of closings from agent-generated leads compared to closings from company-generated leads. Commissions paid to agents for closings from self-generated leads are typically paid out at a higher percentage of revenue than closings from company-generated leads.

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    Selling and marketing expense

    For the three months ended September 30, 2009 compared to the three months ended September 30, 2008

 
  Three Months Ended
September 30,
 
 
  2009   % Change   2008  
 
  (Dollars in thousands)
 

LendingTree Loans

  $ 5,820     16 % $ 5,022  

Exchanges

    15,637     (26 )%   21,218  

Real Estate

    1,221     (32 )%   1,803  

Elimination of inter-segment marketing

    (5,243 )   10 %   (4,761 )
                 

Selling and marketing expense

  $ 17,435     (25 )% $ 23,282  
                 

As a percentage of total revenue

    34 %         46 %

 

 
  Three Months
Ended
September 30,
 
As a Percentage of Segment Revenue
  2009   2008  

LendingTree Loans

    24 %   25 %

Exchanges

    66 %   83 %

Real Estate

    15 %   18 %

        Selling and marketing expense consists primarily of advertising and promotional expenditures, fees paid to lead sources and compensation and other employee-related costs (including stock-based compensation) for personnel engaged in the sales function. Advertising and promotional expenditures primarily include online marketing, as well as television, print and radio spending. Advertising production costs are expensed in the period the related ad is first run.

        Advertising for the Exchanges is primarily the building and maintaining of the Company's core brands, using both online and offline spending, and generates leads not only for the Exchanges but for our other segments as well. Marketing expense for LendingTree Loans is primarily comprised of inter-segment purchases of leads from the Exchanges, leveraging the LendingTree and GetSmart brands. The remainder of the expense is comprised of lead purchases from third parties. Advertising for Real Estate primarily consists of lead generation through online spending, as well as lead purchases from the Exchanges.

        Overall selling and marketing expense in 2009 decreased $5.8 million from 2008 primarily due to a decrease of $5.5 million in advertising and promotional expenditures. In 2009, Tree.com decreased its online marketing advertising by $2.8 million, from $13.3 million in 2008 to $10.5 million in 2009. Tree.com also decreased its broadcast advertising by $2.3 million, from $6.4 million in 2008 to $4.1 million in 2009.

        The decline in selling and marketing expense for the Exchanges segment, both in dollars and as a percentage of revenue, is due to the Exchanges' ability to decrease advertising spend due to naturally higher consumer demand driven by the favorable mortgage rate trends and improvements in organic traffic.

        Tree.com anticipates that it will continue to adjust selling and marketing expenditures generally in relation to revenue producing opportunities and that selling and marketing will continue to represent a high percentage of revenue as it continues to promote its brands both online and offline.

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Table of Contents

    For the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008