Use these links to rapidly review the document
TABLE OF CONTENTS

Table of Contents

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, 2010

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 than 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 "accelerated filer," "large 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 2, 2010 there were 11,083,129 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

  3

Item 2.

 

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

  37

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 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

  58

Item 6.

 

Exhibits

  59

2


Table of Contents

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,
 
 
  2010   2009   2010   2009  
 
  (In thousands, except per share amounts)
 

Revenue

                         
   

LendingTree Loans

  $ 34,760   $ 24,109   $ 87,147   $ 94,738  
   

Exchanges and other

    15,204     18,610     48,013     52,662  
   

Real Estate

    3,213     7,997     11,825     21,549  
                   
 

Total revenue

    53,177     50,716     146,985     168,949  

Cost of revenue

                         
   

LendingTree Loans

    11,049     11,685     30,752     38,437  
   

Exchanges and other

    1,346     1,949     3,654     6,054  
   

Real Estate

    2,074     5,056     7,312     13,712  
                   
 

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

    14,469     18,690     41,718     58,203  
                   
 

Gross margin

    38,708     32,026     105,267     110,746  

Operating expenses

                         
 

Selling and marketing expense

    17,830     17,435     55,035     45,149  
 

General and administrative expense

    14,035     17,515     39,263     50,929  
 

Product development

    1,013     1,673     2,964     4,842  
 

Litigation settlements and contingencies

    1,546     14     1,588     406  
 

Restructuring expense

    321     78     3,363     (158 )
 

Amortization of intangibles

    519     1,055     2,405     3,636  
 

Depreciation

    1,523     1,698     4,539     5,049  
 

Asset impairments

                3,903  
                   
   

Total operating expenses

    36,787     39,468     109,157     113,756  
                   
   

Operating income/(loss)

    1,921     (7,442 )   (3,890 )   (3,010 )

Other income (expense)

                         
 

Interest income

        9     7     84  
 

Interest expense

    (60 )   (149 )   (393 )   (451 )
                   

Total other (expense), net

    (60 )   (140 )   (386 )   (367 )
                   

Income/(loss) before income taxes

    1,861     (7,582 )   (4,276 )   (3,377 )

Income tax (provision) benefit

    (42 )   182     (850 )   (121 )
                   

Net income/(loss)

  $ 1,819   $ (7,400 ) $ (5,126 ) $ (3,498 )
                   

Weighted average common shares outstanding

    11,023     10,844     10,993     10,413  
                   

Weighted average diluted shares outstanding

    11,163     10,844     10,993     10,413  
                   

Net income/(loss) per share available to common shareholders

                         
 

Basic

  $ 0.16   $ (0.68 ) $ (0.47 ) $ (0.34 )
                   
 

Diluted

  $ 0.16   $ (0.68 ) $ (0.47 ) $ (0.34 )
                   

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

3


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 
  September 30, 2010   December 31, 2009  
 
  (unaudited)
   
 
 
  (In thousands, except par value and
share amounts)

 

ASSETS:

             

Cash and cash equivalents

  $ 57,294   $ 86,093  

Restricted cash and cash equivalents

    11,104     12,019  

Accounts receivable, net of allowance of $511 and $518, respectively

    7,799     6,835  

Loans held for sale ($163,319 and $92,236 measured at fair value, respectively)

    164,460     93,596  

Prepaid and other current assets

    14,663     10,758  
           
 

Total current assets

    255,320     209,301  

Property and equipment, net

    12,543     12,257  

Goodwill

    12,917     12,152  

Intangible assets, net

    55,221     57,626  

Other non-current assets

    706     496  
           
 

Total assets

  $ 336,707   $ 291,832  
           

LIABILITIES:

             

Warehouse lines of credit

  $ 140,112   $ 78,481  

Accounts payable, trade

    5,810     5,905  

Deferred revenue

    1,982     1,731  

Deferred income taxes

    2,033     2,211  

Accrued expenses and other current liabilities

    39,806     54,694  
           
 

Total current liabilities

    189,743     143,022  

Income taxes payable

    94     510  

Other long-term liabilities

    12,987     12,010  

Deferred income taxes

    16,581     15,380  
           
 

Total liabilities

    219,405     170,922  

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 11,881,606 and 10,904,330 shares, respectively, and outstanding 11,211,581 and 10,904,330 shares, respectively

    119     109  

Additional paid-in capital

    908,031     901,818  

Accumulated deficit

    (786,143 )   (781,017 )

Treasury stock 670,025 and -0- shares, respectively

    (4,705 )    
           
 

Total shareholders' equity

    117,302     120,910  
           
 

Total liabilities and shareholders' equity

  $ 336,707   $ 291,832  
           

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

4


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

(Unaudited)

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

Balance as of December 31, 2009

  $ 120,910     10,904   $ 109   $ 901,818   $ (781,017 )     $  

Comprehensive loss:

                                           
 

Net loss for the nine months ended September 30, 2010

    (5,126 )               (5,126 )        
                                           

Comprehensive loss

    (5,126 )                        

Non-cash compensation

    2,840             2,840              

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

    (575 )   293     4     (579 )            

Issuance of restricted stock

        150     1     (1 )            

Purchase of treasury stock

    (4,705 )                   670     (4,705 )

Exchange of preferred stock issued by a subsidiary to common stock issued by the parent

    3,958     535     5     3,953              
                               

Balance as of September 30, 2010

  $ 117,302     11,882   $ 119   $ 908,031   $ (786,143 )   670   $ (4,705 )
                               

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

5


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
  Nine Months Ended
September 30,
 
 
  2010   2009  
 
  (In thousands)
 

Cash flows from operating activities:

             

Net loss

  $ (5,126 ) $ (3,498 )

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

             
 

Loss on disposal of fixed assets

    9     949  
 

Amortization of intangibles

    2,405     3,636  
 

Depreciation

    4,539     5,049  
 

Intangible impairment

        3,903  
 

Non-cash compensation expense

    2,840     3,060  
 

Non-cash restructuring expense

    301     161  
 

Deferred income taxes

    1,023     393  
 

Gain on origination and sale of loans

    (79,301 )   (89,701 )
 

Loss on impaired loans not sold

        564  
 

Loss on sale of real estate acquired in satisfaction of loans

    377     51  
 

Bad debt expense

    45     325  

Changes in current assets and liabilities:

             
 

Accounts receivable

    (1,010 )   (1,208 )
 

Origination of loans

    (1,940,925 )   (2,232,380 )
 

Proceeds from sales of loans

    1,953,564     2,335,100  
 

Principal payments received on loans

    1,200     781  
 

Payments to investors for loan repurchases and early payoff obligations

    (9,114 )   (5,641 )
 

Prepaid and other current assets

    (996 )   (1,149 )
 

Accounts payable and other current liabilities

    (14,931 )   3,580  
 

Income taxes payable

    (388 )   (551 )
 

Deferred revenue

    109     (130 )
 

Other, net

    4,363     1,154  
           

Net cash (used in) provided by operating activities

    (81,016 )   24,448  
           

Cash flows from investing activities:

             
 

Acquisitions

    (50 )   (5,726 )
 

Capital expenditures

    (4,999 )   (2,200 )
 

Other, net

    765     3,253  
           

Net cash used in investing activities

    (4,284 )   (4,673 )
           

Cash flows from financing activities:

             
 

Borrowing under warehouse lines of credit

    1,374,460     1,964,237  
 

Repayments of warehouse lines of credit

    (1,312,829 )   (1,973,294 )
 

Issuance of common stock, net of withholding taxes

    (575 )   3,373  
 

Purchase of treasury stock

    (4,705 )    
 

Decrease (increase) in restricted cash

    150     (875 )
           

Net cash provided by (used in) financing activities

    56,501     (6,559 )
           

Net (decrease) increase in cash and cash equivalents

    (28,799 )   13,216  

Cash and cash equivalents at beginning of period

    86,093     73,643  
           

Cash and cash equivalents at end of period

  $ 57,294   $ 86,859  
           

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

6


Table of Contents


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.

Company Overview

        Tree.com is the parent of LendingTree, LLC and the owner of several brands and businesses that provide information, tools, advice, products and services for critical transactions in our customers' lives. Our family of brands includes: LendingTree.com®, GetSmart.com®, RealEstate.com®, DegreeTree.comSM, HealthTree.comSM, LendingTreeAutos.com, DoneRight.com®, and InsuranceTree.comSM. Together, these brands serve as an ally for consumers who are looking to comparison shop for loans, real estate and other services from multiple businesses and professionals who will compete for their business.

        These businesses and brands are operated under the segments known as LendingTree Loans, the Exchanges and Real Estate.

        The LendingTree Loans segment originates, processes, approves and funds various residential real estate loans through Home Loan Center, Inc. dba LendingTree Loans ("HLC"). 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, Tree.com, DegreeTree.com, LendingTreeAutos and GetSmart.com) that connect consumers and service providers principally in the lending, higher education and automobile 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 third party real estate brokerages around the country.

        The Corporate segment consists of unallocated expenses and consolidation transactions.

        Tree.com maintains operations solely in the United States.

Business Combinations

        In September 2010, Tree.com purchased certain assets of a company with an aggregate purchase price of $0.8 million in cash and contingent consideration. The purchase is part of our strategic initiative to diversify our revenue streams outside of the mortgage and real estate industries.

7


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 1—ORGANIZATION (Continued)

        This asset purchase is 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 has been allocated resulting in $0.8 million to be accounted for as goodwill. The pro forma effect of this purchase was not material to our results of operations.

Basis of Presentation

        The accompanying unaudited interim consolidated financial statements as of September 30, 2010 and 2009 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, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010, or any other period. These financial statements and notes should be read in conjunction with the audited financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2009, as amended by Amendment No. 1 to the Company's annual report on Form 10-K/A.

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 ("GAAP"). 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 consolidated financial statements include: valuation allowance for impaired loans held for sale; loan loss obligations; 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; restructuring reserves; contingent consideration related to business combinations; various other allowances, reserves and accruals; and assumptions related to the determination of stock-based compensation.

Reclassifications

        Certain prior period amounts have been reclassified to conform with the current presentation with no effect on net income/(loss) or accumulated deficit. Specifically, compensation and other-employee related costs within the Exchanges segment totaling $0.2 million for the nine months ended

8


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2—SIGNIFICANT ACCOUNTING POLICIES (Continued)


September 30, 2010, and $0.4 million and $1.3 million for the three and nine months ending September 30, 2009, respectively, were reclassified from the Exchanges segment to the LendingTree Loans segment, both within cost of revenue. There was no impact on the consolidated financial results.

Restricted Cash and Cash Equivalents

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

 
  September 30, 2010   December 31, 2009  

Cash in escrow for future operating lease commitments

  $   $ 788  

Cash in escrow for surety bonds

    5,030     5,030  

Cash in escrow for corporate purchasing card program

    800     2,203  

Minimum required balances for warehouse lines of credit

    1,725     1,875  

Mortgage lending escrow funds

    2,922     1,292  

Other

    627     831  
           
 

Total restricted cash and cash equivalents

  $ 11,104   $ 12,019  
           

Recent Accounting Pronouncements

        On June 12, 2009, the Financial Accounting Standards Board ("FASB") issued the accounting standard for transfers and servicing of financial assets. 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. Tree.com adopted this standard on January 1, 2010 and determined there was no material impact to the financial statements.

        On January 21, 2010, the FASB amended and Tree.com adopted the accounting standard for fair value measurements and disclosures, which added new requirements for disclosures about transfers into and out of Level 1 and 2 and separate disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements. The amendment also clarifies existing fair value disclosures about the level of disaggregation and the inputs and valuation techniques used to measure fair value. This amendment is effective for the first reporting period (including interim periods) beginning after December 15, 2009, except for the requirement to provide the Level 3 activity of purchases, sales, issuances and settlements on a gross basis, which will be effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. See Note 9 for further information.

9


Table of Contents


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, 2010   December 31, 2009  

Goodwill

  $ 12,917   $ 12,152  

Intangible assets with indefinite lives

    52,733     52,733  

Intangible assets with definite lives, net

    2,488     4,893  
           
 

Total goodwill and intangible assets, net

  $ 68,138   $ 69,778  
           

        Intangible assets with indefinite lives relate principally to trade names and trademarks acquired in various acquisitions.

        At September 30, 2010, intangible assets with definite lives relate to the following (in thousands):

 
  Cost   Accumulated
Amortization
  Net   Weighted Average
Amortization Life
(Years)
 

Purchase agreements

  $ 76,352   $ (76,175 ) $ 177     5.7  

Technology

    30,491     (29,728 )   763     3.0  

Customer lists

    7,388     (6,677 )   711     3.9  

Other

    9,813     (8,976 )   837     4.1  
                     
 

Total

  $ 124,044   $ (121,556 ) $ 2,488        
                     

        At December 31, 2009, intangible assets with definite lives relate to the following (in thousands):

 
  Cost   Accumulated
Amortization
  Net   Weighted Average
Amortization Life
(Years)
 

Purchase agreements

  $ 76,352   $ (74,657 ) $ 1,695     5.7  

Technology

    30,491     (29,396 )   1,095     3.0  

Customer lists

    7,388     (6,631 )   757     3.9  

Other

    9,813     (8,467 )   1,346     4.1  
                     
 

Total

  $ 124,044   $ (119,151 ) $ 4,893        
                     

        Amortization of intangible assets with definite lives is computed on a straight-line basis and, based on September 30, 2010 balances, such amortization for the next five years is estimated to be as follows (in thousands):

 
  Amount  

Three months ending December 31, 2010

  $ 307  

Year ending December 31, 2011

    1,086  

Year ending December 31, 2012

    411  

Year ending December 31, 2013

    144  

Year ending December 31, 2014

    84  

Thereafter

    456  
       
 

Total

  $ 2,488  
       

10


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 3—GOODWILL AND INTANGIBLE ASSETS (Continued)

        The following table presents the balance of goodwill by segment (in thousands):

 
  LendingTree
Loans
  Exchanges   Real
Estate
  Total  

Balance as of December 31, 2009

                         
 

Goodwill

  $ 46,526   $ 485,955   $ 70,091   $ 602,572  
 

Accumulated impairment losses

    (46,526 )   (483,088 )   (60,806 )   (590,420 )
                   

        2,867     9,285     12,152  
                   

Goodwill acquired during the year

        765         765  

Impairment losses

                 

Other deductions

                 
                   

Balance as of September 30, 2010

                         
 

Goodwill

    46,526     486,720     70,091     603,337  
 

Accumulated impairment losses

    (46,526 )   (483,088 )   (60,806 )   (590,420 )
                   

  $   $ 3,632   $ 9,285   $ 12,917  
                   

NOTE 4—PROPERTY AND EQUIPMENT

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

 
  September 30, 2010   December 31, 2009  

Computer equipment and capitalized software

  $ 39,367   $ 35,881  

Leasehold improvements

    2,503     2,888  

Furniture and other equipment

    3,834     4,096  

Projects in progress

    2,629     1,532  
           

    48,333     44,397  

Less: accumulated depreciation and amortization

    (35,790 )   (32,140 )
           
 

Total property and equipment, net

  $ 12,543   $ 12,257  
           

11


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 5—ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

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

 
  September 30, 2010   December 31, 2009  

Accrued loan loss liability related to loans previously sold

  $ 6,609   $ 6,115  

Loan loss settlement liability related to loans previously sold

    1,350     4,500  

Litigation accruals

    1,500     12,750  

Accrued advertising expense

    8,027     8,095  

Accrued compensation and benefits

    6,701     7,525  

Accrued professional fees

    1,026     1,528  

Accrued restructuring costs

    910     1,848  

Derivative liabilities

    832     356  

Customer deposits and escrows

    4,088     3,387  

Deferred rent

    486     793  

Other

    8,277     7,797  
           
 

Total accrued expenses and other current liabilities

  $ 39,806   $ 54,694  
           

        The other category above reflects an earnout payable related to an acquisition, franchise taxes, self-insured health claims and other miscellaneous accrued expenses.

        An additional $8.3 million and $6.4 million of accrued loan loss liability related to loans previously sold are classified in other long term liabilities at September 30, 2010 and December 31, 2009, respectively.

NOTE 6—WAREHOUSE LINES OF CREDIT

        Borrowings on warehouse lines of credit were $140.1 million and $78.5 million at September 30, 2010 and December 31, 2009, respectively.

        As of September 30, 2010, LendingTree Loans had two committed lines of credit totaling $125.0 million of borrowing capacity. The total borrowing capacity under these lines was increased to $150.0 million effective October 29, 2010 upon renewal of the second line. LendingTree Loans also has a $25.0 million uncommitted line with one of these lenders. Borrowings under these lines of credit are used to fund, and are secured by, consumer residential loans that are held for sale. Loans under these lines of credit are repaid using proceeds from the sales of loans held for sale by LendingTree Loans.

        The $50.0 million first line is scheduled to expire June 29, 2011. This line can be cancelled at the option of the lender without default upon sixty days notice. This first line includes an additional uncommitted credit facility of $25.0 million. This first line is also guaranteed by Tree.com, Inc., LendingTree, LLC and LendingTree Holdings Corp. The interest rate under the first line is 2.25% plus the greater of (a) 30-day LIBOR or (b) 2.00%. The interest rate under the $25.0 million uncommitted line is 30-day LIBOR plus 1.50%. LendingTree Loans is also required to sell at least 25% of the loans it originates to the lender under this line or pay a "pair-off fee" of 0.25% on the difference between the required and actual volume of loans sold.

12


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 6—WAREHOUSE LINES OF CREDIT (Continued)

        The borrowing capacity of the second line was increased from $75.0 million to $100.0 million upon renewal of the line effective October 29, 2010. The expiration date of this line is October 28, 2011. This second line is also guaranteed by Tree.com, Inc., LendingTree, LLC and LendingTree Holdings Corp. The interest rate under this line was decreased from 30-day Adjusted LIBOR or 2.0% (whichever is greater) plus 2.50% to 3.0% prior to renewal, to 30-day Adjusted LIBOR or 2.0% (whichever is greater) plus 2.25% to 2.5% after renewal, for loans being sold to the lender. Additionally, the interest rate for loans not being sold to the lender was decreased from 30-day Adjusted LIBOR or 2.0% (whichever is greater) plus 2.75% prior to renewal, to 30-day Adjusted LIBOR or 2.0% (whichever is greater) plus 2.25% after renewal.

        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 $25.0 million, (ii) minimum liquidity, (iii) a minimum current ratio, (iv) a maximum ratio of total liabilities to net worth, (v) a maximum leverage ratio, (vi) pre-tax net income requirements and (vii) a maximum warehouse capacity ratio. During the quarter ended September 30, 2010, 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 one, but not both, 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.

        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) litigation loss contingencies and settlements, (6) pro forma adjustments for significant acquisitions, and (7) one-time items, which are truly one-time in nature and non-recurring, infrequent or unusual, and have not occurred in the past two years or are not expected to recur in the next two years, in accordance with SEC rules. For the periods presented in this report, there are no one-time items. These measures are two of the primary metrics by which Tree.com evaluates the performance of its businesses, on which its internal budgets are based and by which management is compensated. Tree.com believes that investors should

13


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)


have access to the same set of tools that it uses in analyzing its results. 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.

        During the third quarter of 2010, the Company changed its accounting policy for inter-segment revenue and inter-segment marketing expense between the LendingTree Loans and Exchanges segments. This change only impacts the segment results, and does not impact the consolidated financial results of Tree.com.

        Marketing expense 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 other segments as well. Previously, marketing expense for LendingTree Loans was primarily comprised of inter-segment purchases of leads from the Exchanges, leveraging the LendingTree and GetSmart brands. The Exchanges received inter-segment revenue for the sale of these leads, and that revenue and the related marketing expense at LendingTree Loans would then be eliminated in consolidation of the total Company results.

        The Company now uses a cost sharing approach for these marketing expenses, whereby LendingTree Loans and the Exchanges now share the marketing expense on a pro rata basis, based on the quantity of leads received by each segment. There is no longer inter-segment revenue or inter-segment marketing expense related to these leads. Management believes that this cost sharing approach is preferable because it more closely aligns the overall goals of the Company with the goals of segment management, and will ultimately drive the Company to better performance. Segment reporting results for prior periods have been restated to conform to the new presentation.

14


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

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

 
  For the Three Months Ended September 30, 2010:  
 
  LendingTree
Loans
  Exchanges   Real
Estate
  Unallocated—
Corporate
  Total  

Revenue

  $ 34,760   $ 15,307   $ 3,213   $ (103 ) $ 53,177  

Cost of revenue (exclusive of depreciation shown separately below)

    11,049     1,312     2,074     34     14,469  
                       
 

Gross margin

    23,711     13,995     1,139     (137 )   38,708  

Operating expenses:

                               
 

Selling and marketing expense

    4,432     12,944     454         17,830  
 

General and administrative expense

    6,714     669     951     5,701     14,035  
 

Product development

    135     804     74         1,013  
 

Litigation settlements and contingencies

    1,510         36         1,546  
 

Restructuring expense

    (14 )   44     288     3     321  
 

Amortization of intangibles

        294     212     13     519  
 

Depreciation

    395     559     306     263     1,523  
                       
 

Total operating expenses

    13,172     15,314     2,321     5,980     36,787  
                       

Operating income (loss)

    10,539     (1,319 )   (1,182 )   (6,117 )   1,921  

Adjustments to reconcile to EBITDA and Adjusted EBITDA:

                               
 

Amortization of intangibles

        294     212     13     519  
 

Depreciation

    395     559     306     263     1,523  
                       

EBITDA

    10,934     (466 )   (664 )   (5,841 )   3,963  
 

Restructuring expense

    (14 )   44     288     3     321  
 

Non-cash compensation

    94     73     28     583     778  
 

Litigation settlements and contingencies

    1,510         36         1,546  
 

Post acquisition adjustments

        (849 )   (221 )       (1,070 )
                       

Adjusted EBITDA

  $ 12,524   $ (1,198 ) $ (533 ) $ (5,255 ) $ 5,538  
                       

Reconciliation to net income in total:

                               

Operating income per above

                          $ 1,921  

Other expense, net

                            (60 )
                               

Income before income taxes

                            1,861  

Income tax provision

                            (42 )
                               

Net income

                          $ 1,819  
                               

15


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

 

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

Revenue

  $ 24,109   $ 18,610   $ 7,997   $   $ 50,716  

Cost of revenue (exclusive of depreciation shown separately below)

    11,685     1,409     5,056     540     18,690  
                       
 

Gross margin

    12,424     17,201     2,941     (540 )   32,026  

Operating expenses:

                               
 

Selling and marketing expense

    3,235     12,978     1,221     1     17,435  
 

General and administrative expense

    5,270     1,934     2,067     8,244     17,515  
 

Product development

    165     762     363     383     1,673  
 

Litigation settlements and contingencies

    6         8         14  
 

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

    9,433     16,307     4,655     9,073     39,468  
                       

Operating income (loss)

    2,991     894     (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

    3,802     1,477     (771 )   (9,197 )   (4,689 )
 

Restructuring expense

    (54 )   50     53     29     78  
 

Non-cash compensation

    63     48     79     877     1,067  
 

Litigation settlements and contingencies

    6         8         14  
                       

Adjusted EBITDA

  $ 3,817   $ 1,575   $ (631 ) $ (8,291 ) $ (3,530 )
                       

Reconciliation to net loss in total:

                               

Operating loss per above

                          $ (7,442 )

Other expense, net

                            (140 )
                               

Income before income taxes

                            (7,582 )

Income tax benefit

                            182  
                               

Net loss

                          $ (7,400 )
                               

16


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 7—SEGMENT INFORMATION (Continued)

 

 
  For the Nine Months Ended September 30, 2010:  
 
  LendingTree
Loans
  Exchanges   Real
Estate
  Unallocated—
Corporate
  Total  

Revenue

  $ 87,147   $ 48,197   $ 11,825   $ (184 ) $ 146,985  

Cost of revenue (exclusive of depreciation shown separately below)

    30,752     3,180     7,312     474     41,718  
                       
 

Gross margin

    56,395     45,017     4,513     (658 )   105,267  

Operating expenses:

                               
 

Selling and marketing expense

    14,597     38,885     1,537     16     55,035  
 

General and administrative expense

    16,446     3,733     4,049     15,035     39,263  
 

Product development

    134     2,360     276     194     2,964  
 

Litigation settlements and contingencies

    1,551         36     1     1,588  
 

Restructuring expense

    (7 )   126     652     2,592     3,363  
 

Amortization of intangibles

        884     1,483     38     2,405  
 

Depreciation

    1,310     1,373     933     923     4,539  
                       
 

Total operating expenses

    34,031     47,361     8,966     18,799     109,157  
                       

Operating income (loss)

    22,364     (2,344 )   (4,453 )   (19,457 )   (3,890 )

Adjustments to reconcile to EBITDA and Adjusted EBITDA:

                               
 

Amortization of intangibles

        884     1,483     38     2,405  
 

Depreciation

    1,310     1,373     933     923     4,539  
                       

EBITDA

    23,674     (87 )   (2,037 )   (18,496 )   3,054  
 

Restructuring expense

    (7 )   126     652     2,592     3,363  
 

Loss on disposal of assets

            6     3     9  
 

Non-cash compensation

    299     703     118     1,720     2,840  
 

Litigation settlements and contingencies

    1,551         36     1     1,588  
 

Post acquisitions adjustments

        (849 )   (221 )       (1,070 )
                       

Adjusted EBITDA

  $ 25,517   $ (107 ) $ (1,446 ) $ (14,180 ) $ 9,784  
                       

Reconciliation to net loss in total:

                               

Operating loss per above

                          $ (3,890 )

Other expense, net

                            (386 )
                               

Loss before income taxes

                            (4,276 )

Income tax provision

                            (850 )
                               

Net loss

                          $ (5,126 )
                               

17


Table of Contents


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   $ 52,662   $ 21,549   $   $ 168,949  

Cost of revenue (exclusive of depreciation shown separately below)

    38,437     4,427     13,712     1,627     58,203  
                       
 

Gross margin

    56,301     48,235     7,837     (1,627 )   110,746  

Operating expenses:

                               
 

Selling and marketing expense

    6,877     34,345     3,919     8     45,149  
 

General and administrative expense

    16,158     7,383     7,097     20,291     50,929  
 

Product development

    412     2,201     1,244     985     4,842  
 

Litigation settlements and contingencies

    366     7     33         406  
 

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

    25,064     45,180     20,763     22,749     113,756  
                       

Operating income (loss)

    31,237     3,055     (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

    33,734     4,191     (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  
 

Litigation settlements and contingencies

    366     7     33         406  
                       

Adjusted EBITDA

  $ 33,053   $ 5,722   $ (4,213 ) $ (20,727 ) $ 13,835  
                       

Reconciliation to net loss in total:

                               

Operating loss per above

                          $ (3,010 )

Other expense, net

                            (367 )
                               

Income before income taxes

                            (3,377 )

Income tax provision

                            (121 )
                               

Net loss

                          $ (3,498 )
                               

18


Table of Contents


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, 2010 and 2009 are as follows (in thousands):

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2010   2009   2010   2009  

LendingTree Loans:

                         
 

Origination and sale of loans

  $ 31,860   $ 22,495   $ 79,301   $ 89,701  
 

Other

    2,900     1,614     7,846     5,037  
                   
   

Total LendingTree Loans revenue

    34,760     24,109     87,147     94,738  

Exchanges:

                         
 

Match fees

    12,858     12,438     38,683     32,307  
 

Closed loan fees

    1,656     5,318     7,008     18,180  
 

Other

    690     854     2,322     2,175  
 

Inter-segment

    103         184      
                   
   

Total Exchanges

    15,307     18,610     48,197     52,662  

Real Estate revenue

    3,213     7,997     11,825     21,549  

Inter-segment elimination

    (103 )       (184 )    
                   

Total revenue

  $ 53,177   $ 50,716   $ 146,985   $ 168,949  
                   

        Total assets by segment at September 30, 2010 and December 31, 2009 are as follows (in thousands):

 
  September 30,
2010
  December 31,
2009
 

LendingTree Loans

  $ 232,440   $ 167,976  

Real Estate

    25,709     28,031  

Exchanges and Unallocated—Corporate(a)

    78,558     95,825  
           

Total

  $ 336,707   $ 291,832  
           

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

19


Table of Contents


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,  
 
  2010   2009  
 
  Basic   Diluted   Basic   Diluted  
 
  (In thousands, except per share data)
 

Numerator:

                         

Net income (loss) available to common shareholders

  $ 1,819   $ 1,819   $ (7,400 ) $ (7,400 )

Denominator:

                         

Weighted average common shares

    11,023     11,163     10,844     10,844  
                   

Net income (loss) per common share

  $ 0.16   $ 0.16   $ (0.68 ) $ (0.68 )
                   

 

 
  Nine Months Ended September 30,  
 
  2010   2009  
 
  Basic   Diluted   Basic   Diluted  
 
  (In thousands, except per share data)
 

Numerator:

                         

Net loss available to common shareholders

  $ (5,126 ) $ (5,126 ) $ (3,498 ) $ (3,498 )

Denominator:

                         

Weighted average common shares

    10,993     10,993     10,413     10,413  
                   

Net loss per common share

  $ (0.47 ) $ (0.47 ) $ (0.34 ) $ (0.34 )
                   

        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, 2010 and 2009 (in thousands):

 
  Three Months
Ended
September 30,
  Nine Months
Ended
September 30,
 
 
  2010   2009   2010   2009  

Cost of revenue

  $ (1 ) $ 11   $ 15   $ 80  

Selling and marketing expense

    18     38     127     124  

General and administrative expense

    742     991     2,587     2,756  

Product development

    19     27     111     100  
                   

Non-cash compensation expense

  $ 778   $ 1,067   $ 2,840   $ 3,060  
                   

20


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

        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 pass before an award vests. Certain restricted stock awards also include performance-based vesting, where certain performance targets set at the time of grant must be achieved 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. For performance-based awards, the expense is measured at the grant date as the fair value of Tree.com common stock and expensed as non-cash compensation over the vesting period if the performance targets are considered probable of being achieved.

        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, 2010 is as follows:

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

Outstanding at January 1, 2010

    1,177,319   $ 9.34              

Granted

                     

Exercised

    (42,963 )   6.81              

Forfeited

    (65,714 )   7.46              

Expired

    (95,615 )   9.83              
                       

Outstanding at September 30, 2010

    973,027   $ 9.54     6.4   $ 53  
                   

Options exercisable at September 30, 2010

    303,614   $ 12.13     4.6   $ 53  
                   

21


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

        The following table summarizes the information about stock options outstanding and exercisable as of September 30, 2010:

 
  Options Outstanding    
   
 
 
   
  Weighted
Average
Remaining
Contractual
Life in Years
   
  Options Exercisable  
Range of Exercise Prices
  Outstanding at
September 30,
2010
  Weighted
Average
Exercise Price
  Exercisable at
September 30,
2010
  Weighted
Average
Exercise Price
 

$.01 to $4.99

    14,265     1.63   $ 2.99     14,265   $ 2.99  

$5.00 to $7.45

    12,849     2.16     6.67     12,849     6.67  

$7.46 to $9.99

    763,034     7.17     8.28     93,621     7.69  

$10.00 to $14.99

    54,779     2.60     12.23     54,779     12.23  

$15.00 to $19.99

    81,437     4.65     15.03     81,437     15.03  

$20.00 to $24.99

    46,663     4.69     20.19     46,663     20.19  
                             

    973,027     6.44   $ 9.54     303,614   $ 12.13  
                             

        Nonvested RSUs and restricted stock outstanding as of September 30, 2010 and changes during the nine months ended September 30, 2010 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, 2010

    704,938   $ 8.03     350,000   $ 5.42  

Granted

    454,370     8.20     150,000     9.15  

Vested

    (283,845 )   10.53     (87,500 )   5.42  

Forfeited

    (282,638 )   7.33          
                   

Nonvested at September 30, 2010

    592,825   $ 7.48     412,500   $ 6.78  
                   

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:

22


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

        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 with changes in fair value being recorded in current earnings as a component of revenue from the origination and sale of loans. IRLCs for loans to be sold to investors using a mandatory or assignment of trade ("AOT") method are hedged using "to be announced mortgage-backed securities" ("TBA MBS") and are valued using quantitative risk models. The IRLCs derive their base value from an underlying loan type with similar characteristics using the TBA MBS market which is actively quoted and easily validated through external sources. The most significant data inputs used in this valuation include, but are not limited to, loan type, underlying loan amount, note rate, loan program, and expected sale date of the loan. IRLCs for loans sold to investors on a best efforts basis are hedged using best efforts forward delivery commitments and are valued on an individual loan basis using a proprietary database program. These valuations are based on investor pricing tables stratified by product, note rate and term. The valuation is adjusted at the loan level to consider the servicing release premium and loan pricing adjustments specific to each loan. The Company applies an anticipated loan funding probability based on its own experience to value IRLCs, which results in the classification of these derivatives as Level 3. At September 30, 2010 and December 31, 2009, there were $370.3 million and $258.4 million, respectively, of IRLCs notional value outstanding.

        Loans held for sale measured at fair value and sold to investors using a mandatory or AOT method are also hedged using TBA MBS and valued using quantitative risk models. The valuation is based on the loan amount, note rate, loan program, and expected sale date of the loan. Loans held for sale measured at fair value and sold to investors on a best efforts basis are hedged using best efforts forward delivery commitments and are valued using a proprietary database program. The best efforts valuations are based on daily investor pricing tables stratified by product, note rate and term. These valuations are adjusted at the loan level to consider the servicing release premium and loan pricing adjustments specific to each loan. Loans held for sale, excluding impaired loans, are classified as Level 2. Loans held for sale measured at fair value that become impaired are transferred from Level 2 to Level 3, as the estimate of fair value is based on the Company's experience considering lien position and current status of the loan. LendingTree Loans recognizes interest income separately from other changes in fair value.

        Under LendingTree Loans' risk management policy, LendingTree Loans economically hedges the changes in fair value of IRLCs and loans held for sale caused by changes in interest rates by using TBA MBS and entering into best efforts forward delivery commitments. These hedging instruments are recorded at fair value with changes in fair value recorded in current earnings as a component of revenue from the origination and sale of loans. TBA MBS used to hedge both IRLCs and loans are valued using quantitative risk models based primarily on inputs related to characteristics of the MBS stratified by product, coupon, and settlement date. These derivatives are classified as Level 2. Best efforts forward delivery commitments are valued using a proprietary database program using investor pricing tables considering the current base loan price. An anticipated loan funding probability is applied to value best efforts commitments hedging IRLCs, which results in the classification of these contracts as Level 3. The best efforts forward delivery commitments hedging loans held for sale are classified as Level 2, so such contracts are transferred from Level 3 to Level 2 at the time the underlying loan is originated. For the purposes of the tables below, we refer to TBA MBS and best efforts forward delivery commitments collectively as "Forward Delivery Contracts".

23


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

        The following presents Tree.com's assets and liabilities that are measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009 (in thousands):

 
  As of September 30, 2010  
 
  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

  $   $ 162,283   $ 1,036   $ 163,319  

Interest rate lock commitments ("IRLCs")

            10,249     10,249  

Forward delivery contracts

        (503 )   (17 )   (520 )
                   

Total

  $   $ 161,780   $ 11,268   $ 173,048  
                   

 

 
  As of December 31, 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

  $   $ 91,459   $ 777   $ 92,236  

Interest rate lock commitments ("IRLCs")

            3,680     3,680  

Forward delivery contracts

        2,737     487     3,224  
                   

Total

  $   $ 94,196   $ 4,944   $ 99,140  
                   

24


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

        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, 2010 and 2009 (in thousands):

 
  Three Months
Ended September 30, 2010
 
 
  Interest Rate
Lock
Commitments
  Forward
Delivery
Contracts
  Loans
Held
for Sale
 

Balance at July 1, 2010

  $ 10,848   $ (20 ) $ 957  
 

Transfers into Level 3

            378  
 

Transfers out of Level 3

        (17 )    
 

Total net gains (losses) included in earnings (realized and unrealized)

    33,683     20     (34 )
 

Purchases, sales, and settlements

                   
   

Purchases

             
   

Sales

            (262 )
   

Settlements

    (3,533 )       (3 )
 

Transfers of IRLCs to closed loans

    (30,749 )        
               

Balance at September 30, 2010

  $ 10,249   $ (17 ) $ 1,036  
               

 

 
  Nine Months
Ended September 30, 2010
 
 
  Interest Rate
Lock
Commitments
  Forward
Delivery
Contracts
  Loans
Held
for Sale
 

Balance at January 1, 2010

  $ 3,680   $ 487   $ 777  
 

Transfers into Level 3

            640  
 

Transfers out of Level 3

        109      
 

Total net gains (losses) included in earnings (realized and unrealized)

    83,752     (613 )   (111 )
 

Purchases, sales, and settlements

                   
   

Purchases

             
   

Sales

            (262 )
   

Settlements

    (12,250 )       (8 )
 

Transfers of IRLCs to closed loans

    (64,933 )        
               

Balance at September 30, 2010

  $ 10,249   $ (17 ) $ 1,036  
               

25


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

 

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

Balance at July 1, 2009

  $ 6,698   $ (82 ) $ 271  
 

Transfers into Level 3

             
 

Transfers out of Level 3

        467      
 

Total net gains (losses) included in earnings (realized and unrealized)

    21,227     (417 )    
 

Purchases, sales, and settlements

                   
   

Purchases

             
   

Sales

             
   

Settlements

    (8,064 )       (1 )
 

Transfers of IRLCs to closed loans

    (13,682 )        
               

Balance at September 30, 2009

  $ 6,179   $ (32 ) $ 270  
               

 

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

Balance at January 1, 2009

  $ 5,904   $ (20 ) $ 814  
 

Transfers into Level 3

             
 

Transfers out of Level 3

        (18 )    
 

Total net gains (losses) included in earnings (realized and unrealized)

    74,178     6     66  
 

Purchases, sales, and settlements

                   
   

Purchases

             
   

Sales

            (358 )
   

Settlements

    (32,741 )       (252 )
 

Transfers of IRLCs to closed loans

    (41,162 )        
               

Balance at September 30, 2009

  $ 6,179   $ (32 ) $ 270  
               

26


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

        The following presents the gains (losses) included in earnings for the three and nine months ended September 30, 2010 and 2009 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, 2010
  Nine Months
Ended September 30, 2010
 
 
  Interest Rate
Lock
Commitments
  Forward
Delivery
Contracts
  Loans
Held
for Sale
  Interest Rate
Lock
Commitments
  Forward
Delivery
Contracts
  Loans
Held
for Sale
 

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

  $ 33,683   $ 20   $ (34 ) $ 83,752   $ (613 ) $ (111 )
                           

Change in unrealized gains (losses) relating to assets and liabilities still held at September 30, 2010, which are included in revenue from LendingTree Loans

  $ 10,249   $ (17 ) $ (112 ) $ 10,249   $ (17 ) $ 2  
                           

 

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

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

  $ 21,227   $ (417 ) $   $ 74,178   $ 6   $ 66  
                           

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

  $ 6,179   $ (32 ) $   $ 6,179   $ (32 ) $ 1  
                           

        The following table summarizes the Company's derivative instruments not designated as hedging instruments as of September 30, 2010 and December 31, 2009 (in thousands):

 
  September 30, 2010   December 31, 2009   
 
  Balance Sheet Location   Fair Value   Balance Sheet Location   Fair Value  

Interest Rate Lock Commitments

  Prepaid and other current assets   $ 10,262   Prepaid and other current assets   $ 3,919  

Forward Delivery Contracts

  Prepaid and other current assets     299   Prepaid and other current assets     3,341  

Interest Rate Lock Commitments

  Accrued expenses and other current liabilities     (13 ) Accrued expenses and other current liabilities     (239 )

Forward Delivery Contracts

  Accrued expenses and other current liabilities     (819 ) Accrued expenses and other current liabilities     (117 )
                   

Total Derivatives

      $ 9,729       $ 6,904  
                   

27


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

        The gain/(loss) recognized in the consolidated statements of operations for derivatives for the periods ended September 30, 2010 and 2009 was as follows (in thousands):

 
   
  Three Months Ended   Nine Months Ended  
 
  Location of Gain/(Loss) Recognized
in Income on Derivative
  September 30,
2010
  September 30,
2009
  September 30,
2010
  September 30,
2009
 

Interest Rate Lock Commitments

  LendingTree Loans revenue   $ 33,683   $ 21,227   $ 83,752   $ 74,178  

Forward Delivery Contracts

  LendingTree Loans revenue     3,252     (2,270 )   (3,905 )   149  
                       
 

Total

      $ 36,935   $ 18,957   $ 79,847   $ 74,327  
                       

        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, 2010 and December 31, 2009, 26 and 29 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, 2010 and December 31, 2009, measured on a non-recurring basis using significant unobservable inputs (Level 3), was $1.1 million and $1.4 million, respectively. This fair value measurement is management's best estimate of the market value of such loans and considers the lien position and loan status.

        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, 2010 and December 31, 2009 (in thousands):

 
  As of September 30, 2010  
 
  Loans Held
for Sale—
Measured at
Fair Value
  Loans Held
for Sale—
Measured at
LOCOM
  Total Loans
Held For
Sale
 

Aggregate unpaid principal balance

  $ 157,796   $ 2,933   $ 160,729  

Difference between fair value and aggregate unpaid principal balance

    5,523         5,523  

Lower of cost or market valuation allowance

        (1,783 )   (1,783 )

Deferred loan fees, net of costs

        (9 )   (9 )
               

Loans held for sale

  $ 163,319   $ 1,141   $ 164,460  
               

28


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 9—FAIR VALUE MEASUREMENTS (Continued)

 

 
  As of December 31, 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

  $ 91,824   $ 3,217   $ 95,041  

Difference between fair value and aggregate unpaid principal balance

    412         412  

Lower of cost or market valuation allowance

        (1,848 )   (1,848 )

Deferred loan fees, net of costs

        (9 )   (9 )
               

Loans held for sale

  $ 92,236   $ 1,360   $ 93,596  
               

        During the three months ended September 30, 2010 and 2009, the change in fair value of loans held for sale for which the fair value option was elected were gains of $0.8 million and $1.6 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, 2010 and 2009, the change in fair value of loans held for sale for which the fair value option was elected was a gain of $5.5 million and a loss of $0.4 million, respectively, and is included as a component of LendingTree Loans revenue in the accompanying consolidated statements of operations.

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.

        A summary of the initial unpaid principal balance of loans sold by type of loan for the three and nine months ended September 30, 2010 and 2009 is presented below ($ amounts in millions):

 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 
  2010   2009   2010   2009  
 
  Amount   %   Amount   %   Amount   %   Amount   %  

Conforming

  $ 537     80 % $ 512     79 % $ 1,445     77 % $ 1,899     85 %

FHA

    107     16 %   127     19 %   346     19 %   315     14 %

Jumbo

    27     4 %   11     2 %   84     4 %   23     1 %
                                   

Total

  $ 671     100 % $ 650     100 % $ 1,875     100 % $ 2,237     100 %
                                   

29


Table of Contents


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)

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, 2010 and December 31, 2009 (in thousands):

 
  September 30,
2010
  December 31,
2009
 
 
  Amount   %   Amount   %  

Conforming

  $ 129,428     79 % $ 72,670     77 %

FHA

    29,294     18 %   16,596     18 %

Jumbo

    5,066     3 %   3,486     4 %

Subprime

    582     %   720     1 %

Home equity

    90     %   124     %
                   

Total

  $ 164,460     100 % $ 93,596     100 %
                   

        The following presents the difference between the aggregate principal balance of loans on nonaccrual status for which the fair value option has been elected and for loans measured at lower of cost or market valuation as of September 30, 2010 and December 31, 2009 (in thousands):

 
  As of September 30, 2010  
 
  Loans on
Nonaccrual—
Measured at
Fair Value
  Loans on
Nonaccrual—
Measured at
LOCOM
  Total Loans on
Nonaccrual
 

Aggregate unpaid principal balance

  $ 1,673   $ 2,933   $ 4,606  

Difference between fair value and aggregate unpaid principal balance

    (637 )       (637 )

Lower of cost or market valuation allowance

        (1,783 )   (1,783 )

Deferred loan fees, net of costs

        (9 )   (9 )
               

Loans on nonaccrual

  $ 1,036   $ 1,141   $ 2,177  
               

 

 
  As of December 31, 2009  
 
  Loans on
Nonaccrual—
Measured at
Fair Value
  Loans on
Nonaccrual—
Measured at
LOCOM
  Total Loans on
Nonaccrual
 

Aggregate unpaid principal balance

  $ 1,303   $ 3,217   $ 4,520  

Difference between fair value and aggregate unpaid principal balance

    (526 )       (526 )

Lower of cost or market valuation allowance

        (1,848 )   (1,848 )

Deferred loan fees, net of costs

        (9 )   (9 )
               

Loans on nonaccrual

  $ 777   $ 1,360   $ 2,137  
               

30


Table of Contents


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)

        Included within the loans on nonaccrual status are repurchased loans with a net book value of $0.5 million and $0.7 million at September 30, 2010 and December 31, 2009, respectively. During the three months ended September 30, 2010, LendingTree did not repurchase any loans. During the nine months ended September 30, 2010, LendingTree repurchased one loan with a balance of $0.3 million. During the three and nine months ended September 30, 2009, LendingTree Loans repurchased one loan with a balance of $0.1 million.

        Real estate properties acquired in satisfaction of loans totaled $0.1 million and $0.9 million, net of estimated selling expenses, at September 30, 2010 and December 31, 2009, respectively. This amount is included in prepaid and other current assets in the accompanying consolidated balance sheet.

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 loan payoffs, which occurs when a borrower prepays a loan prior to the end of a specified period, 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 loan payoffs 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 type as well as analyses of losses in process to estimate its exposure to losses on loans previously sold. The Company maintains a liability related to this exposure based, in part, on historical and projected loss frequency and loss severity using its loan loss history (adjusted for recent trends in loan loss 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 below. In estimating its exposure to loan losses, LendingTree Loans categorizes

31


Table of Contents


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)


its loan sales into four types 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 loan types 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.

        The following table represents the loans sold for the period shown and the aggregate loan losses through September 30, 2010:

 
  As of September 30, 2010  
Period of Loan Sales
  Number
of loans
sold
  Original
principal
balance
  Number of
loans with
losses
  Original
principal
balance of
loans with
losses
  Amount of
aggregate
losses
 
 
  (in billions)
  (in millions)
  (in millions)
 

Nine months ended September 30, 2010

    8,500   $ 1.9       $   $  

2009

    12,800     2.8     3     0.8     0.1  

2008

    11,000     2.2     17     3.4     0.7  

2007

    36,300     6.1     137     17.9     6.1  

2006

    55,000     7.9     196     21.9     11.9  

2005 and prior years

    86,700     13.0     86     11.6     4.6  
                       

Total

    210,300   $ 33.9     439   $ 55.6   $ 23.4  
                       

        The pipeline of 91 loan repurchase requests and indemnifications as of September 30, 2010 was considered in determining the appropriate reserve amount. The status of these 91 loans varied 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 $15.1 million, comprised of approximately 62% full documentation first liens, 4% full documentation second liens, 25% limited documentation first liens, and 9% limited documentation second liens.

        In the fourth quarter of 2009, LendingTree Loans entered into settlement negotiations with two buyers of previously purchased limited documentation loans. The settlement with one buyer was completed in December 2009 and included a payment of $1.9 million related to all second lien loans sold to this buyer, including both full and limited documentation. This amount was not determined on an individual loan basis and is, therefore, not included in the loss amounts disclosed above based on the year such loans were sold. The settlement was included as a charge off to the reserve in 2009. Negotiations with the second buyer were completed in January 2010. This settlement of $4.5 million, to be paid in four equal quarterly installments in 2010, relates to all future losses on limited documentation second lien loans sold to this buyer. LendingTree Loans must also pay an additional amount of up to $0.3 million in conjunction with this settlement if it does not sell a certain volume of loans to this buyer in 2010. This amount is being accrued throughout 2010 and is included in the total settlement amount and the estimated settlement payments remaining to be paid. This settlement amount is included as a charge off to the reserve in 2010 and is not included in the table above.

32


Table of Contents


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)

        Based on historical experience, it is anticipated that the Company will continue to receive repurchase requests and incur losses on loans sold in prior years. However, the two settlements discussed above will eliminate future repurchase requests from those buyers for the loan types included in those settlements. As of September 30, 2010 LendingTree Loans estimated the range of remaining possible losses due to representations and warranty issues based on the methodology described above, excluding the $1.4 million settlement remaining to be paid in 2010, as $11 million to $16 million. The Company believes that it has adequately reserved for these losses.

        The activity related to loss reserves on previously sold loans for the nine months ended September 30, 2010 and 2009, is as follows (in thousands):

 
  Nine Months Ended
September 30,
 
 
  2010   2009  

Balance, beginning of period

  $ 16,985   $ 10,451  

Provisions

    8,132     10,133  

Charge offs to reserves(a)

    (10,172 )   (6,548 )
           

Balance, end of period

  $ 14,945   $ 14,036  
           

(a)
The nine months ended September 30, 2010 includes a charge off for the amount of the $4.5 million loan loss settlement discussed above plus an estimated portion of the $0.3 million additional amount based on loans sold to this buyer in 2010. The remaining settlement payments due of $1.4 million are tracked as a liability separate from the loan loss reserve (see table below).

        Based on an analysis of the Company's historical loan loss experience, it has been determined that a portion of the loan losses expected to be made by investors will be made more than twelve months after the current reporting date. 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, including the remaining portion of the settlement discussed above, is presented in the accompanying consolidated balance sheet as of September 30, 2010 and December 31, 2009 as follows (in thousands):

 
  As of September 30,
2010
  As of December 31,
2009
 

Current portion related to settlement above, included in accrued expenses and other current liabilities

  $ 1,350   $ 4,500  

Other current portion, included in accrued expenses and other current liabilities

    6,609     6,115  

Long term portion, included in other long-term liabilities

    8,336     6,370  
           

Total

  $ 16,295   $ 16,985  
           

33


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 11—INCOME TAXES

        For the three months ended September 30, 2010 and 2009, Tree.com recorded a tax (provision) benefit of $(0.05) million and $0.2 million, respectively, which represents effective tax rates of 2.2% and (2.4)%, respectively. For both periods, the tax rate is lower than the federal statutory rate of 35% mainly due to the change in the valuation allowance on deferred tax assets and a partial release of reserves for uncertain tax positions.

        For the nine months ended September 30, 2010 and 2009, Tree.com recorded a tax provision of $0.9 million and $0.1 million, respectively, which represents effective tax rates of 19.9% and 3.6%, respectively. For the nine months ended September 30, 2010, the tax rate is lower than the federal statutory rate of 35% mainly due to an increase in the valuation allowance on deferred tax assets. For the nine months ended September 30, 2009, there was an increase in the valuation allowance and non-deductible impairment charges that caused the tax rate to be lower than the federal statutory rate.

        Tree.com's unrecognized tax benefits decreased by approximately $0.5 million in the third quarter of 2010. The decrease was due to a partial release of the reserves for uncertain tax positions. Tree.com believes that it is reasonably possible that its remaining unrecognized tax benefits could decrease by approximately $0.1 million within twelve months of the current reporting date due to the expiration of state statute of limitations. An estimate of other changes in unrecognized tax benefits cannot be made, but are not expected to be significant.

        For the nine months ended September 30, 2010, Tree.com determined that its valuation allowance 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. This approach is consistent with the nine months ended September 30, 2009.

NOTE 12—CONTINGENCIES

        During the nine months ended September 30, 2010 and 2009, provisions for litigation settlements of $1.6 million and $0.4 million, respectively, were recorded in litigation settlements and contingencies in the accompanying consolidated statements of operations. The balance of the related liability was $1.5 million and $12.8 million at September 30, 2010 and December 31, 2009, respectively. The $12.8 million liability at December 31, 2009 was paid in 2010.

        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.

34


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 13—RESTRUCTURING CHARGES

        The restructuring charges in 2010 primarily relate to continuing lease obligations on facilities previously used for call center operations, for which management had a plan to exit at December 31, 2009, but the cease-use date did not occur until January 2010. The restructuring charges in 2009 primarily relate to Tree.com's segment reorganizations and aligning the cost structure with future revenue opportunities. 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, 2010  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Total  

LendingTree Loans

  $   $ (14 ) $   $ (14 )

Exchanges

    44             44  

Real Estate

        166     122     288  

Unallocated—corporate

    3             3  
                   

Total

  $ 47   $ 152   $ 122   $ 321  
                   

 

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

LendingTree Loans

  $   $ (54 ) $   $ (54 )

Exchanges

    50             50  

Real Estate

    53             53  

Unallocated—corporate

    29             29  
                   

Total

  $ 132   $ (54 ) $   $ 78  
                   

 

 
  For The Nine Months Ended September 30, 2010  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Total  

LendingTree Loans

  $   $ (5 ) $ (2 ) $ (7 )

Exchanges

    34         92     126  

Real Estate

    6     438     208     652  

Unallocated—corporate

    129     2,463         2,592  
                   

Total

  $ 169   $ 2,896   $ 298   $ 3,363  
                   

35


Table of Contents


TREE.COM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 13—RESTRUCTURING CHARGES (Continued)

 

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

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

 
  For The Nine Months Ended September 30, 2010  
 
  Employee
Termination
Costs
  Continuing
Lease
Obligations
  Asset
Write-offs
  Other   Total  

Balance, beginning of period

  $ 1,505   $ 1,043   $   $ 12   $ 2,560  
 

Restructuring charges

    169     2,896     298         3,363  
 

Payments

    (1,608 )   (1,100 )   9     (12 )   (2,711 )
 

Write-offs

        283     (307 )       (24 )
                       

Balance, end of period

  $ 66   $ 3,122   $   $   $ 3,188  
                       

        At September 30, 2010, restructuring liabilities of $0.9 million are included in accrued expenses and other current liabilities and $2.3 million are included in other long-term liabilities in the accompanying consolidated balance sheet. At December 31, 2009, restructuring liabilities of $1.8 million are included in accrued expenses and other current liabilities and $0.7 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.

NOTE 14—RELATED PARTY TRANSACTIONS

        On August 30, 2010, the Company entered into and consummated a Share Exchange Agreement (the "Share Exchange Agreement") with Douglas R. Lebda, the Company's Chairman and Chief Executive Officer. Pursuant to the Share Exchange Agreement, Mr. Lebda exchanged 2,902.33 currently outstanding shares of Series A Redeemable Preferred Stock, par value $0.01 per share (the "Preferred Stock"), of LendingTree Holdings Corp., a Delaware corporation and wholly-owned subsidiary of the Company (the "Subsidiary"), owned by him, together with $1.1 million in accrued and unpaid dividends in respect of such shares, for a total of 534,900 newly-issued shares of Tree.com common stock. The Preferred Stock has a liquidation preference of $1,000 per share and cumulative cash dividends accrue on the Preferred Stock at the rate of 12% of the liquidation preference per share per year and unpaid dividends compound at a rate per annum equal to the dividend rate. The value of the Common Stock issued to Mr. Lebda pursuant to the Share Exchange Agreement was approximately $4.0 million and was determined based on the closing price on the Nasdaq Global Market on the trading day preceding the closing of the exchange.

36


Table of Contents

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 is the parent of LendingTree, LLC and the owner of several brands and businesses that provide information, tools, advice, products and services for critical transactions in our customers' lives. Our family of brands includes: LendingTree.com®, GetSmart.com®, RealEstate.com®, DegreeTree.comSM, HealthTree.comSM, LendingTreeAutos.com, DoneRight.com, and InsuranceTree.comSM. Together, these brands serve as an ally for consumers who are looking to comparison shop for loans, real estate and other services from multiple businesses and professionals who will compete for their business.

        These businesses and brands are operated under the segments known as LendingTree Loans, the Exchanges and Real Estate. Additionally, certain shared indirect costs that are described below are reported as "Unallocated—Corporate."

        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. dba LendingTree Loans ("HLC"). 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, Tree.com, DegreeTree.com, LendingTreeAutos.com and GetSmart.com) that connect consumers and service providers principally in the lending, higher education and automobile 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 third party real estate brokerages around the country.

        From time to time, we may evaluate the potential acquisition of various assets and other businesses that may complement our current services, enhance our capabilities, improve or sustain our competitive position, or otherwise offer growth opportunities. From time to time, also we may consider the potential disposition of certain of our assets, subsidiaries or lines of businesses. As a general rule, we publicly announce any material acquisitions or dispositions when a definitive agreement has been reached.

37


Table of Contents

        Results of operations for the three and nine months ended September 30, 2010 compared to the three and nine months ended September 30, 2009:

        For the three months ended September 30, 2010 compared to the three months ended September 30, 2009:

 
  Three Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in thousands)
 

LendingTree Loans:

                         
 

Origination and sale of loans

  $ 31,860   $ 9,365     42 % $ 22,495  
 

Other

    2,900     1,286     80 %   1,614  
                     

Total LendingTree Loans

    34,760     10,651     44 %   24,109  

Exchanges:

                         
 

Match fees

    12,858     420     3 %   12,438  
 

Closed loan fees

    1,656     (3,662 )   (69 )%   5,318  
 

Other

    690     (164 )   (19 )%   854  
 

Inter-segment revenue

    103     103     100 %    
                     

Total Exchanges

    15,307     (3,303 )   (18 )%   18,610  

Real Estate

    3,213     (4,784 )   (60 )%   7,997  

Inter-segment revenue

    (103 )   (103 )   (100 )%    
                     

Total revenue

  $ 53,177   $ 2,461     5 % $ 50,716  
                     

        LendingTree Loans revenue in 2010 increased from the same period in 2009 due to a large increase in refinancing activity brought on by low consumer borrowing rates. Third quarter 2010 revenue increased 30% quarter-over-quarter on 17% higher closed units. The quarter again saw unprecedented lows in mortgage interest rates which in turn spurred another surge in refinance loan activity. Third quarter revenue increased 44% from the same period last year on 18% more closed loans and a 12% increase in the revenue generated per loan. Looking at the year-over-year revenue increase, the third quarter 2009 reflected a significant slowdown that followed the previously unprecedented refinance boom experienced earlier that year.

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

 
  Three Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 675   $ 137     25 % $ 538  

Purchase mortgages

    47     (35 )   (42 )%   82  
                     

Total

  $ 722   $ 102     17 % $ 620  
                     

        LendingTree Loans originates mortgage loans on property located throughout the United States. Revenue from loans originated for property in California totaled approximately 12% and 8% of Tree.com's consolidated revenue for the three months ended September 30, 2010 and 2009, respectively.

        Revenue from Exchanges in 2010 decreased from the same period in 2009 due primarily to a reduction in the amount of closings. Overall matched requests in the third quarter of 2010 declined 7% from the same period in 2009, which reflects a decline of 28% in home loan matches and an increase of 19% in matches for the new consumer vertical areas of higher education, home services and

38


Table of Contents


insurance. Home loan matches were down because of the expansion of volume taken by LendingTree Loans and many lenders experiencing their own high levels of organic lead volume during this low interest rate environment. Matches in new consumer verticals have grown as a result of both business acquisitions completed in 2009 and increased marketing spending. The overall impact on match fees was an increase of 3%, reflecting a shift in pricing on home loan related matches to increase the average match fee (and decrease the average closed loan fee). Also impacting the revenue from closed loan fees was a 24% decline in closed units in the period as a result of the decline in matched loan requests.

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

 
  Three Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 979   $ (12 )   (1 )% $ 991  

Purchase mortgages

    455     (250 )   (35 )%   705  

Other

    74     (81 )   (52 )%   155  
                     

Total

  $ 1,508   $ (343 )   (19 )% $ 1,851  
                     

        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 in 2010 decreased from the same period in 2009 principally due to a decrease in closings due to the persistent negative real estate market conditions contributing to lower home sales prices and fewer real estate transactions overall. In addition, the Company consolidated three office locations in the fourth quarter of 2009, which resulted in lower agent count and transactions in 2010. The dollar value of the Company's real estate closings decreased 58% in 2010, from $330 million in 2009 to $138 million in 2010.

        For the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009:

 
  Nine Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in thousands)
 

LendingTree Loans:

                         
 

Origination and sale of loans

  $ 79,301   $ (10,400 )   (12 )% $ 89,701  
 

Other

    7,846     2,809     56 %   5,037  
                     

Total LendingTree Loans

    87,147     (7,591 )   (8 )%   94,738  

Exchanges:

                         
 

Match fees

    38,683     6,376     20 %   32,307  
 

Closed loan fees

    7,008     (11,172 )   (61 )%   18,180  
 

Other

    2,322     147     7 %   2,175  
 

Inter-segment revenue

    184     184     100 %    
                     

Total Exchanges

    48,197     (4,465 )   (8 )%   52,662  

Real Estate

    11,825     (9,724 )   (45 )%   21,549  

Inter-segment revenue

    (184 )   (184 )   (100 )%    
                     

Total revenue

  $ 146,985   $ (21,964 )   (13 )% $ 168,949  
                     

        LendingTree Loans revenue in 2010 decreased from the same period in 2009 because loan closing rates declined from 2009. The decrease in loan closing rates was primarily driven by tight secondary credit markets that are unable to serve many consumers who do not have sufficient collateral value or

39


Table of Contents


are not eligible for conforming prime first-lien position loans. The total dollar value of loans closed declined by 13% during 2010, even though the number of consumer loan requests increased by 13% in the same period.

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

 
  Nine Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 1,759   $ (238 )   (12 )% $ 1,997  

Purchase mortgages

    182     (54 )   (23 )%   236  
                     

Total

  $ 1,941   $ (292 )   (13 )% $ 2,233  
                     

        LendingTree Loans originates mortgage loans on property located throughout the United States. Revenue from loans originated for property in California totaled approximately 12% of Tree.com's consolidated revenue for the nine months ended both September 30, 2010 and 2009.

        Revenue from the Exchanges in 2010 decreased for the same period in 2009 due primarily to a reduction in the amount of closings. Overall matched requests through the third quarter of 2010 declined 11% from the same period in 2009, which reflects a decline of 39% in home loan matches and an increase of 90% in matches for the new consumer vertical areas of higher education, home services and insurance. Home loan matches were down because of the expansion of volume taken by LendingTree Loans and many lenders experiencing their own high levels of organic lead volume during this low interest rate environment. Matches in new consumer verticals have grown as a result of both business acquisitions completed in 2009 and increased marketing spending. The overall impact on match fees was an increase of 20%, reflecting a shift in pricing on home loan related matches to increase the average match fee (and decrease the average close loan fee). Also impacting the revenue from closed loan fees was a 33% decline in closed units in the period as a result of the decline in matched loan requests.

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

 
  Nine Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in millions)
 

Refinance mortgages

  $ 2,716   $ (2,164 )   (49 )% $ 4,880  

Purchase mortgages

    1,741     (15 )   (4 )%   1,756  

Other

    194     (259 )   (57 )%   453  
                     

Total

  $ 4,651   $ (2,438 )   (39 )% $ 7,089  
                     

        Real Estate revenue in 2010 decreased principally due to a decrease in closings due to the persistent negative real estate market conditions contributing to lower home sales prices and fewer real estate transactions overall. In addition, the Company consolidated three office locations in the fourth quarter of 2009, which resulted in lower agent count and transactions in 2010. The dollar value of the Company's real estate closings decreased 47% in 2010, from $944 million in 2009 to $502 million in 2010.

40


Table of Contents

        For the three months ended September 30, 2010 compared to the three months ended September 30, 2009:

 
  Three Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in thousands)
 

LendingTree Loans

  $ 11,049   $ (636 )   (2 )% $ 11,685  

Exchanges

    1,312     (97 )   (7 )%   1,409  

Real Estate

    2,074     (2,982 )   (59 )%   5,056  

Unallocated—corporate

    34     (506 )   (97 )%   540  
                     

Cost of revenue

  $ 14,469   $ (4,221 )   (23 )% $ 18,690  
                     

As a percentage of total revenue

    27 %         (10 )%   37 %

 

 
  Three Months
Ended
September 30,
 
As a Percentage of Segment Revenue
  2010   2009  

LendingTree Loans

    32 %   48 %

Exchanges

    9 %   8 %

Real Estate

    65 %   63 %

Unallocated—corporate, as a percentage of total revenue

    %   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 in 2010 decreased from 2009 primarily due to decreases of $1.5 million in costs associated with loan originations at LendingTree Loans, $0.6 million in consumer incentive rebates related to decreased closings at the Exchanges and in Real Estate, and $2.7 million in commissions paid to real estate agents as a result of decreased closings, offset by an increase of $1.0 million in compensation costs at LendingTree Loans. The decreases in the cost of loan originations are primarily due to a change in the fee structure in October 2009 whereby the origination fee charged to the borrower was reduced and no longer covered certain origination costs that were previously paid and recorded as expense by LendingTree Loans. Under the current fee structure, these origination costs are passed through to the borrower directly.

        For the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009:

 
  Nine Months Ended September 30,  
 
  2010   $ Change   % Change   2009  
 
  (Dollars in thousands)
 

LendingTree Loans

  $ 30,752   $ (7,685 )   (18 )% $ 38,437  

Exchanges

    3,180     (1,247 )   (41 )%   4,427  

Real Estate

    7,312     (6,400 )   (47 )%   13,712  

Unallocated—corporate

    474     (1,153 )   (71 )%   1,627  
                     

Cost of revenue

  $ 41,718   $ (16,485 )   (28 )% $ 58,203  
                     

As a percentage of total revenue

    28 %         (6 )%   34 %

41


Table of Contents