Total

Maximum

Number of

Number

Shares

of Shares

Purchased

That

as Part of

May Yet be

Total Number

Average Price

Publicly

Purchased

of Shares

Paid per

Announced

Under the

Period

Purchased

Share

Program

Program

October 2009

1,295

$

19.06

n/a

n/a

November 2009

129

$

18.01

n/a

n/a

December 2009

—

$

—

n/a

n/a

 

 

		Year Ended December 31,
		2009				2008				2007				2006				2005
		(In thousands, except per share and share amounts)
Consolidated Statements of Operations Data:
Net revenue		$	225,626			$	242,706			$	233,845			$	173,272			$	120,219
(Loss) income from operations			(10,950	)			7,052				27,531				20,739				9,831
(Loss) income before benefit (provision) for income taxes			(7,853	)			5,697				32,786				26,133				8,528
Net (loss) income		$	(4,334	)		$	1,736			$	19,752			$	19,336			$	4,468
Basic net (loss) income per share applicable to common stockholders (1)		$	(0.11	)		$	0.04			$	0.49			$	0.53			$	0.17
Diluted net (loss) income per share applicable to common stockholders  (1)		$	(0.11	)		$	0.04			$	0.47			$	0.51			$	0.13
Weighted average common stock outstanding (basic)			39,524,544				40,461,896				39,351,138				36,064,796				2,290,439
Weighted average common stock outstanding (diluted)			39,524,544				41,538,379				40,886,482				37,500,164				3,123,524

 

 

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	As of December 31,
	2009				2008				2007				2006				2005
	(In thousands)
Consolidated Balance Sheets Data:
Cash and cash equivalents, short-term and long-term investments		$	202,964			$	203,198			$	220,144			$	171,195			$	103,264
Working capital (2)			191,894				197,797				222,810				168,817				101,561
Total assets			472,327				437,215				482,926				321,513				220,615
Capital lease obligations (short and long-term), due to acquirees (short and long-term), deferred revenue (short and long-term) and other long-term liabilities			13,398				17,272				15,888				13,269				13,251
Retained earnings (accumulated deficit)			15,924				20,258				18,522				(1,230	)			(20,566	)
Total stockholders’ equity			420,886				396,220				438,362				284,337				186,671

 

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(1)	Earnings per share data for the years ended December 31, 2008, 2007, 2006 and 2005 have been retroactively adjusted to conform to the provisions of ASC Topic 260, Earnings Per Share, which did not have a significant impact on our historical earnings per share calculation. For further information, please refer to Note 2 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.
(2)	Working capital is defined as current assets less current liabilities.

 

 

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The following table sets forth the reconciliation of adjusted net income, a non-GAAP financial measure, to net (loss) income, our most directly comparable financial measure in accordance with GAAP (in thousands):

 

		Year Ended December 31,
		2009				2008				2007
GAAP net (loss) income		$	(4,334	)		$	1,736			$	19,752
Adjustments:
Amortization of acquired identifiable intangibles			20,341				26,781				28,217
Restructuring costs (including stock-based compensation)			6,686				—				—
Acquisition related professional fees			2,407				579				243
Realized (gain) loss on securities (non-taxable)			(1,393	)			5,956				—
Reversal of pre-acquisition accrued contingency (non-taxable)			(609	)			—				—
Acquisition related earn-out compensation expense ($0.4 million deductible for tax purposes)			1,000				—				—
Amended state tax returns – benefits (non-taxable)			(1,070	)			—				—
Stock-based compensation (excluding restructuring costs)			13,104				13,991				10,906
Tax impact of adjustments (9)			(16,165	)			(14,329	)			(14,795	)
Adjusted net income (Non-GAAP)		$	19,967			$	34,714			$	44,323

 

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(2)	We consider a dealer to be active as of a date if the dealer completed at least one revenue-generating credit application processing transaction using the DealerTrack network during the most recently ended calendar month.
(3)	We consider a lender to be active in our network as of a date if it is accepting credit application data electronically from dealers in the DealerTrack network, including lenders visible to dealers through drop down menus.
(4)	Each lender to dealer relationship represents a pair between an active U.S. lender and an active U.S. dealer.
(5)	Represents the number of dealerships with a current subscription in the DealerTrack or DealerTrack Canada networks at the end of a given period.
(6)	Represents revenue-generating transactions processed in the DealerTrack, DealerTrack Digital Services and DealerTrack Canada networks at the end of a given period.
(7)	Represents the average revenue earned per transaction processed in the DealerTrack, DealerTrack Digital Services and DealerTrack Canada networks during a given period.
(8)	Represents net subscription revenue divided by average subscribing dealers for a given period in the DealerTrack and DealerTrack Canada networks.
(9)	The tax impact of adjustments for the twelve months ended December 31, 2009, are based on a U.S. effective tax rate of 37.8% applied to taxable adjustments other than amortization of acquired identifiable intangibles which is based on a blended effective tax rate of 37.0%. The tax impact of adjustments for the twelve months ended December 31, 2008, are based on a U.S. effective tax rate of 34.8% applied to taxable adjustments other than amortization of acquired identifiable intangibles which is based on a blended effective tax rate of 34.6%. The tax impact of adjustments for the twelve months ended December 31, 2007, are based on a U.S. effective tax rate of 35.9% applied to taxable adjustments other than amortization of acquired identifiable intangibles which is based on a blended effective tax rate of 38.2%.

 

Revenue

 

      Transaction Services Revenue. Transaction services revenue consists of revenue earned from our lender customers for each credit application or contract that dealers submit to them. We also earn transaction services revenue from lender customers for each financing contract executed via our electronic contracting and digital contract processing solutions, as well as for any portfolio residual value analyses we perform for them. We also earn transaction services revenue from dealers or other service and information providers, such as aftermarket providers, accessory providers, and credit report providers, for each fee-bearing product accessed by dealers.

 

      Subscription Services Revenue. Subscription services revenue consists of revenue earned from our customers (typically on a monthly basis) for use of our subscription or license-based products and services. Our subscription services enable dealer customers to manage their dealership data and operations, compare various financing and leasing options and programs, sell insurance and other aftermarket products, analyze inventory, and execute financing contracts electronically.

 

Other Revenue. Other revenue consists of revenue primarily earned through forms programming, data conversion and training and start up fees from our DMS solution, shipping commissions earned from our digital contract business and consulting and analytical revenue earned from ALG.

 

Operating Expenses

 

      Cost of Revenue. Cost of revenue primarily consists of expenses related to running our network infrastructure (including Internet connectivity, hosting expenses, and data storage), amortization expense on acquired intangible assets, capitalized software and website development costs, compensation and related benefits for network and technology development personnel, amounts paid to third parties pursuant to contracts under which a portion of certain revenue is owed to those third parties (revenue share) and direct costs for data licenses and direct costs (printing, binding, and delivery) associated with our residual value guides. Cost of revenue also includes hardware costs associated with our DMS product offering, and compensation, related benefits and travel expenses associated with DMS installation personnel.

 

      Product Development Expenses. Product development expenses consist primarily of compensation and related benefits, consulting fees and other operating expenses associated with our product development departments. The product development departments perform research and development, as well as enhance and maintain existing products.

 

      Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of compensation and related benefits, facility costs and professional services fees for our sales, marketing, customer service and administrative functions.

 

     We allocate overhead such as occupancy and telecommunications charges, and depreciation expense based on headcount, as we believe this to be the most accurate measure. As a result, a portion of general overhead expenses is reflected in our cost of revenue and each operating expense category.

 

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We allocated the restructuring costs related to our January 5, 2009 realignment of our workforce and business to the appropriate cost of revenue and operating expense categories based on each of the terminated employees respective functions. For further information, please refer to Note 16 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

 

Acquisitions and Related Amortization Expense

     We have grown our business since inception through a combination of organic growth and acquisitions. The operating results of each business acquired have been included in our consolidated financial statements from the respective dates of acquisition.

On January 23, 2009, we acquired the AAX suite of inventory management solutions and other assets from JM Dealer Services, Inc., a subsidiary of JM Family Enterprises, Inc., for a purchase price of $30.9 million in cash, net of a $1.7 million purchase price adjustment. We expensed approximately $0.5 million of professional fees associated with the acquisition. For further information, please refer to Note 4 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

On August 1, 2007, we completed the purchase of all of the outstanding shares of AutoStyleMart, Inc. (ASM), for a purchase price of $4.0 million in cash (including direct acquisition costs of $0.2 million). ASM is a provider of accessories-related solutions to automotive dealerships. Under the terms of the merger agreement, we have future contingent payment obligations of up to $11.0 million based upon the achievement of certain operational targets from February 2008 through February 2011.  As of December 31, 2009, we determined that certain operational conditions were probable of being achieved and recorded a liability of $1.0 million. The additional consideration of $1.0 million was deemed compensation for services, as payment was contingent on certain former stockholders remaining employees or consultants of DealerTrack for a certain period. The $1.0 million was recorded as a selling, general and administrative expense for the year ended December 31, 2009. As of December 31, 2009, it has been determined that the operational targets related to the remaining $10.0 million in contingent payment obligations are not yet probable of being achieved. Any amounts deemed probable in the future will also be recorded as a selling, general and administrative expense.

On June 6, 2007, we completed the purchase of all of the outstanding shares of Arkona, Inc. (Arkona), for a cash purchase price of approximately $60.0 million (including direct acquisition costs of approximately $1.0 million). Arkona is a provider of on-demand dealer management systems for automotive dealerships.

On February 1, 2007, we completed the purchase of all of the outstanding shares of Curomax Corporation and its subsidiaries (Curomax) pursuant to a shares purchase agreement, dated as of January 16, 2007, for an adjusted cash purchase price of approximately $40.7 million (including direct acquisition and restructuring costs of approximately $1.6 million). Curomax is a provider of an Internet-based credit application and contract processing network in Canada. Under the terms of merger agreement, we had future contingent payment obligations of up to $1.8 million in cash based upon the achievement of certain operational targets over the subsequent twenty-four months. As of December 31, 2008, we determined that certain operational conditions had been met and as such, recorded a liability and additional goodwill of approximately $1.8 million. The additional consideration of $1.8 million was paid in the first quarter of 2009.

 

Our acquisitions have been recorded under the purchase method of accounting, pursuant to which the total purchase price, is allocated to the net assets acquired based upon estimates of the fair value of those assets. Any excess purchase price is allocated to goodwill. Amortization expense relating to intangible assets is recorded as a cost of revenue.

 

Critical Accounting Policies and Estimates

 

     Our management’s discussion and analysis of our financial condition and results of our operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the amounts reported for assets, liabilities, revenue, expenses and the disclosure of contingent liabilities.

 

    Our critical accounting policies are those that we believe are both important to the portrayal of our financial condition and results of operations and that involve difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The estimates are based on historical experience and on various assumptions about the ultimate outcome of future events. Our actual results may differ from these estimates if unforeseen events occur or should the assumptions used in the estimation process differ from actual results.

 

     We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

 

28

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Revenue Recognition

 

      Transaction Services Revenue. Transaction services revenue consists of revenue earned from our lender customers for each credit application or contract that dealers submit to them. We also earn transaction services revenue from lender customers for each financing contract executed via our electronic contracting and digital contract processing solutions, as well as for any portfolio residual value analyses we perform for them. We also earn transaction services revenue from dealers or other service and information providers, such as aftermarket providers, accessory providers, and credit report providers, for each fee-bearing product accessed by dealers.

 

     We offer our web-based service to lenders for the electronic receipt of credit application data and contract data for automobile financing transactions in consideration for a transaction fee. This service is sold based upon contracts that include fixed or determinable prices and that do not include the right of return or other similar provisions or significant post service obligations. Credit application and digital and electronic contracting processing revenue is recognized on a per transaction basis, after customer receipt and when collectability is reasonably assured. Set-up fees charged to the lenders for establishing connections, if any, are recognized ratably over the expected customer relationship period of four years.

 

     Our credit report service provides our dealer customers the ability to access credit reports from several major credit reporting agencies or resellers online. We sell this service based upon contracts with the customer or credit report provider, as applicable, that include fixed or determinable prices and that do not include the right of return or other similar provisions or other significant post-service obligations. We recognize credit report revenue on a per transaction basis, when services are rendered and when collectability is reasonably assured. We offer these credit reports on both a reseller and an agency basis. We recognize revenue from all but one provider of credit reports on a net basis due to the fact that we are not considered the primary obligor, and recognize revenue on a gross basis with respect to one of the providers as we have the risk of loss and are considered the primary obligor in the transaction.

 

      Subscription Services Revenue. Subscription services revenue consists of revenue earned from our customers (typically on a monthly basis) for use of our subscription or license-based products and services. Our subscription services enable dealer customers to manage their dealership data and operations, compare various financing and leasing options and programs, sell insurance and other aftermarket products, analyze inventory, and execute financing contracts electronically. These subscription services are typically sold based upon contracts that include fixed or determinable prices and that do not include the right of return or other similar provisions or significant post service obligations. We recognize revenue from such contracts ratably over the contract period. We recognize set-up fees, if any, ratably over the expected customer relationship of three years. For contracts that contain two or more products or services, we recognize revenue in accordance with the above policy using relative fair value.

 

Other Revenue.  Other revenue consists of revenue primarily earned through training and start up fees from our DMS solution, shipping commissions earned from our digital contract business and consulting and analytical revenue earned from ALG.

 

     Our revenue is presented net of a provision for sales credits, which are estimated based on historical results, and established in the period in which services are provided.

 

Allowance for Doubtful Accounts

 

     We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The amount of the allowance account is based on historical experience and our analysis of the accounts receivable balance outstanding. While credit losses have historically been within our expectations when the provisions are established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, additional allowances may be required which would result in an additional expense in the period that this determination was made.

 

Software and Website Development Costs and Amortization

 

     We capitalize costs of materials, consultants and payroll and payroll-related costs incurred by employees involved in developing internal use computer software. Costs incurred during the preliminary project and post-implementation stages are charged to expense. Software and website development costs are amortized on a straight-line basis over estimated useful lives ranging from two to four years. We perform periodic reviews to ensure that unamortized software and website costs remain recoverable from future revenue. Capitalized software and website development costs, net were $21.2 million and $12.7 million as of December 31, 2009 and 2008, respectively. Amortization expense totaled $7.6 million, $7.4 million and $6.2 million for the years ended December 31, 2009, 2008 and 2007, respectively.

 

Goodwill, Other Intangibles and Long-lived Assets

 

     We record as goodwill the excess of purchase price over the fair value of the tangible and identifiable intangible assets acquired. Goodwill is tested annually for impairment as well as whenever events or circumstances change that would make it more likely than not that an impairment may have occurred. Goodwill is tested for impairment using a two-step approach. The first step tests for potential goodwill impairment by comparing the fair value of our one reporting unit to our carrying. If the fair value of the reporting unit is less than its carrying value the second step is to record an impairment loss to the extent that the implied fair value of the goodwill of the reporting unit is less than its carrying value.

 

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     Goodwill is required to be assessed at the operating segment or lower level. We determined that the components of our one operating segment have similar economic characteristics, nature of products, distribution, shared resources and type of customer such that the components should be aggregated into a single reporting unit for purposes of performing the impairment test for goodwill. We perform our annual impairment analysis as of the first day of the fourth quarter. The evaluation of impairment involves comparing the current estimated fair value of our reporting unit to the carrying value, including goodwill. We estimate the fair value of or reporting unit by primarily using a market capitalization approach, and also looking at the outlook for the business. The results of our most recent annual assessments performed on October 1, 2009 and 2008 did not indicate any impairment of our goodwill.

 

  Subsequent to our October 1, 2008 goodwill impairment test, our market capitalization was impacted by the volatility in the U.S. equity markets.  For ten days between October 24, 2008 and November 21, 2008, the day of January 21, 2009 and for six trading days between March 3, 2009 and March 10, 2009, our market capitalization was on average approximately 5% below the approximately $405 million carrying value of our consolidated net assets, as of October 1, 2008.  The periods between October 24, 2008 and November 21, 2008 and March 3, 2009 to March 10, 2009 coincided with the overall stock market’s low periods for 2008, and 2009, respectively.

 

Despite the fact that our market capitalization traded below our book value for a brief period of time, we believed that there had not been an impairment anytime during 2009 or 2008, based on the limited duration and depth of the market decline. In addition, there was no factoring of an implied control premium.  A control premium is the amount that a buyer is willing to pay over the current market price of a company as indicated by the market capitalization, in order to acquire a controlling interest.  The premium is justified by the expected synergies, such as the expected increase in cash flow resulting from the cost savings and revenue enhancements. As of December 31, 2008, our market capitalization was approximately $475 million compared to our book value, including goodwill, of approximately $396 million. As of October 1, 2009, our market capitalization was approximately $750 million compared to our book value, including goodwill, of approximately $418 million.

     We evaluate our long-lived assets, including property and equipment and finite-lived intangible assets for potential impairment on an individual asset basis or at the lowest level asset grouping for which cash flows can be separately identified. Intangible asset impairments are assessed whenever changes in circumstances could indicate that the carrying amounts of those productive assets exceed their projected undiscounted cash flows. When it is determined that impairment exists, the related asset group is written down to its estimated fair market value. The determination of future cash flows and the estimated fair value of long-lived assets, involve significant estimates on the part of management. In order to estimate the fair value of a long-lived asset, we may engage a third party to assist with the valuation.

     Our process for assessing potential triggering events may include, but is not limited to, analysis of the following:

§

any sustained decline in the company's stock price below book value;

§

results of our goodwill impairment test;

§

sales and operating trends affecting products and groupings;

§

the impact on current and future operating results related to industry statistics including fluctuation of lending relationships between financing sources and automobile dealers, actual and projected annual vehicle sales, the number of dealers within our network;

§

any losses of key acquired customer relationships; and

§

changes to or obsolescence of acquired technology, data, and trademarks.

We expect to continue to experience challenges due to the ongoing adverse outlook for the credit markets and automobile sales.  If events and circumstances were to continue we may be required to write-off some of our goodwill or long-lived intangible assets and we could incur a significant non-cash charge to our income statement.

We also evaluate the remaining useful life of our long-lived assets on a periodic basis to determine whether events or circumstances warrant a revision to the remaining estimated amortization period.

 

As discussed in Note 6 of our consolidated financial statements included in this Annual Report on Form 10-K, during the fourth quarter of 2008, as a result of a specific event, we recorded an impairment of an intangible asset of approximately $1.9 million to cost of revenue.

 

Business Combinations

 

In December 2007, the FASB issued principles and standards which retained the previous fundamentals of accounting for business combinations, but revised certain principles, including the definition of a business, the recognition and measurement of assets acquired and liabilities assumed in a business combination, the accounting for goodwill, and financial statement disclosure. We have adopted the revised business combination standards as of January 1, 2009. The recently adopted business combination standards were applied to our 2009 acquisition of AAX. For further information on the AAX acquisition, please refer to Note 4 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K

 

Income Taxes

 

     We account for income taxes in accordance with the provisions of ASC Topic 740, Accounting for Income Taxes, which requires deferred tax assets and liabilities to be recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be reversed. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

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     The total liability for the uncertain tax positions recorded in our balance sheet in accrued other liabilities as of December 31, 2009 and December 31, 2008, was $0.8 million and $0.5 million, respectively. Interest and penalties, if any, related to tax positions taken in our tax returns are recorded in interest expense and general and administrative expenses, respectively, in our consolidated statement of operations. As of December 31, 2009 and December 31, 2008, we have accrued interest and penalties related to tax positions taken on our tax returns of approximately $47,000 and $28,000, respectively.

Retail Sales Tax

 The Ontario Ministry of Revenue (the Ministry) has conducted a retail sales tax field audit on the financial records of our Canadian subsidiary, DealerTrack Canada, Inc. (formerly known as DealerAccess Canada, Inc.), for the period from March 1, 2001 through May 31, 2003. We received a formal assessment from the Ministry indicating unpaid Ontario retail sales tax totaling approximately $0.2 million, plus interest. Although we are disputing the Ministry’s findings, the assessment, including interest, has been paid in order to avoid potential future interest and penalties.

 

As part of the purchase agreement dated December 31, 2003 between us and Bank of Montreal for the purchase of 100% of the issued and outstanding capital stock of DealerAccess, Inc., Bank of Montreal agreed to indemnify us specifically for this potential liability for all sales tax periods prior to January 1, 2004. The potential sales tax liability for the period covered by this indemnification is now closed due to the statutory expiration of the periods open for audit by the Ministry. To date, all amounts paid to the Ministry by us for this assessment have been reimbursed by the Bank of Montreal under this indemnity.

 

We undertook a comprehensive review of the audit findings of the Ministry using external tax experts. Our position has been that our lender revenue transactions are not subject to Ontario retail sales tax. We filed a formal Notice of Objection with the Ministry on December 12, 2005. We received a letter dated November 2, 2007 from an appeals officer of the Ministry stating that the assessment was, in his opinion, properly raised and his intention was to recommend his confirmation to senior management of the Ministry. The officer agreed, however, to defer his recommendation for a period of thirty business days to enable us to submit any additional information not yet provided. We submitted additional information to the Ministry to support our position that the services are not subject to sales tax.

 

We received a letter dated December 21, 2007 from the Ministry stating that no change should be made to the appeals officer’s opinion. The letter further stated that we had ninety days from the date of the letter to file a Notice of Appeal with the Superior Court of Justice. A Notice of Appeal was filed on our behalf on March 18, 2008 to challenge the assessment because we did not believe these services are subject to sales tax. On December 15, 2008, the Ministry filed its response to our Notice of Appeal. The response reiterates the Ministry’s position that the transactions are subject to Ontario retail sales tax. The parties have completed the discovery process and we expect this matter will be heard by the Superior Court in 2010. We have not accrued any related sales tax liability for the period subsequent to May 31, 2003 for these lender revenue transactions. This appeal is supported by the financial institutions whose source revenue transactions were subject to the assessment. These financial institutions have agreed to participate in the cost of the litigation.

In the event we are obligated to charge sales tax for this type of transaction, we believe this Canadian subsidiary’s contractual arrangements with its lender customers obligate these customers to pay all sales taxes that are levied or imposed by any taxing authority by reason of the transactions contemplated under the particular contractual arrangement. In the event of any failure to pay such amounts by our customers, we would be required to pay the obligation, which could range from $5.2 million (CAD) to $5.8 million (CAD), including penalties and interest.

 

Stock-Based Compensation

We have four types of stock-based compensation programs: stock options, restricted stock units, restricted common stock, and an employee stock purchase plan (ESPP).

 

The following summarizes stock-based compensation expense recognized for the three years ended December 31, 2009, 2008 and 2007 (in thousands):

		Year Ended December 31,
		2009				2008				2007
Stock options		$	10,475			$	8,331			$	6,333
Restricted common stock			4,599				5,361				4,260
Restricted stock units			1,855				—				—
ESPP			60				299				313
Total stock-based compensation expense		$	16,989			$	13,991			$	10,906

 

 

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Stock-based compensation cost is measured at the grant date based on the fair value of the award, and recognized as an expense over the requisite service period net of an estimated forfeiture rate. Determining the appropriate fair value model and calculating the fair value of the share-based payment awards require the input of highly subjective assumptions, including the expected life, expected stock price volatility, and the number of expected options, restricted stock units, or restricted common stock that will be forfeited prior to the completion of the vesting requirements. We use the Black-Scholes and binomial lattice-based valuation pricing models to value our stock-based awards.

 

Due to our limited public company history, for the years ended December 31, 2009, 2008 and 2007, the expected volatility and for the year ended December 31, 2009, the expected life of an option grants were determined based on the expected volatility and expected lives of similar entities whose shares are publicly traded, except for the expected volatility and expected life assumptions utilized for awards granted in September 2009 under the Stock Option Exchange Program (SOEP) and the Long-Term Incentive Plan (LTIP). For the years ended December 31, 2008 and 2007, the expected lives of options were determined based on the “simplified” method under the provisions of ASC Topic 718-10, Compensation – Stock Compensation.

 

For options granted in September 2009 under the SOEP, we began estimating our expected volatility using a time-weighted average of our historical volatility in combination with the historical volatility of similar entities whose common shares are publicly traded.  We expect to apply this volatility methodology to future option grants.  The expected life under the SOEP was determined by an independent third party by means of Monte-Carlo simulations of future stock price based upon “in-the-money”, vesting schedule, contractual term, current life to date and applied an annual termination rate (after vesting) to the outstanding options in the simulation to reflect the probability of exercise behavior.  Stock-based compensation expenses related to the SOEP will be amortized over the new vesting schedule of 25% six months from the grant date, 25% twelve months from the grant date and 1/48 each month thereafter.

 

      Awards granted under the LTIP consisted of 455,000 shares of restricted common stock (net of cancellations). Each individual’s total award was allocated 50% to achieving earnings before interest, taxes, depreciation and amortization, as adjusted to reflect any future acquisitions (EBITDA Performance Award) and 50% to the market value of our common stock (Market Value Award). The awards were to be earned upon our achievement of EBITDA and market-based targets for the fiscal years 2007, 2008 and 2009, but would not vest unless the grantee remains continuously employed in active service until January 31, 2010. If an EBITDA Performance Award or Market Value Award was not earned in an earlier year, it could have been earned upon achievement of that target in a subsequent year. The awards were subject to acceleration in full upon a change in control. We valued the EBITDA Performance Award and the Market Value Award using the Black-Scholes and binomial lattice-based valuation pricing models, respectively. The total fair value of the entire EBITDA Performance Award was $6.0 million (prior to estimated forfeitures), of which, in 2007, we began expensing the amount associated with the 2007 award as it was deemed probable that the threshold for the year ending December 31, 2007 would be met. The EBITDA target for 2007 was achieved. As of December 31, 2009, no amounts were expensed related to the EBITDA Performance Awards for 2008 and 2009 as the targets were not achieved. The total value of the entire Market Value Award was $2.5 million (including estimated forfeitures), which was expensed on a straight-line basis from the date of grant over the applicable service period. As long as the service condition was satisfied, the expense was not reverseable, even if the market conditions were not satisfied. During the year ended December 31, 2009, 96,667 shares of long-term performance equity awards were cancelled and the vesting of 38,333 shares of long-term performance equity awards were accelerated due to the departure of certain executive officers, most of which were in connection with the realignment of our workforce and business as discussed in Note 16. On January 31, 2010, 151,697 shares of long-term performance equity awards vested relating to the 2007 EBITDA Performance Award and the 2007 Market Value Award and the remaining 303,303 shares of long-term performance equity awards were cancelled as the 2008 and 2009 EBITDA and Market Value targets were not achieved.

 

Other assumptions required for estimating fair value with Black-Scholes model are the expected risk-free interest rate and the expected dividend yield.  The risk-free interests used were the actual U.S. Treasury zero-coupon rates for bonds matching our expected life of an option on the date of grant.  The expected dividend yield is not applicable as we have not paid any dividends and current intend to retain any future earnings for use in our business.

 

Options granted generally (SOEP and LTIP exceptions noted above) vest over a period of four years from the vesting commencement date (three years for directors), and expire seven years from the date of grant, except for stock options granted prior to July 11, 2007, which expire ten years from the date of grant and terminate, to the extent unvested, on the date of termination of employment, and to the extent vested, generally at the end of the three-month period following termination of employment, except in the case of executive officers, who under certain conditions have a twelve-month period following termination of employment to exercise.

 

Application of alternative assumptions could produce significantly different estimates of the fair value of stock-based compensation and consequently, the related amounts recognized in our consolidated statements of operations.

 

     As of December 31, 2009, there was $9.3 million, $5.9 million, and $5.1 million of unamortized stock-based compensation expense related to stock options, restricted common stock units, and restricted common stock awards, respectively. The unamortized stock-based compensation expense related to stock options and restricted common stock units is expected to be recognized on a straight line basis over a weighted average remaining period of 1.8076 years and 3.1215 years, respectively. Of the $5.1 million of unamortized stock-based compensation expense related to restricted common stock awards, $2.1 million is expected to be recognized on a straight-line basis over a weighted average remaining period of 0.5384 years. The remaining $3.0 million of unamortized stock-based compensation expense related to restricted common stock awards relates to the long-term incentive equity awards, of which $0.1 million relates to the Market Value Awards and $2.9 million relates to the EBITDA Performance Awards. Of the $3.0 million of unamortized stock-based compensation expense related to the long-term incentive equity awards, $2.9 million will not be expensed due to the cancellation of 303,303 awards on January 31, 2010.

 

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   Fair Value Measurements

 

Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs used to measure fair value are prioritized into a three-level fair value hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair values are as follows:

 

·

Level 1 – Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

 

·

Level 2 – Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

 

·

Level 3 – Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

 

We have segregated all financial assets that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below.

 

Financial assets measured at fair value on a recurring basis include the following as of December 31, 2009 and 2008 (in thousands):

As of December 31, 2009		Quoted Prices in Active Markets (Level 1)				Significant Other Observable Inputs  (Level 2)			Significant Unobservable Inputs (Level 3)				December 31, 2009
Cash equivalents (1)		$	127,608			$	—			$	—			$	127,608
Short-term investments (2)			1,484				—				—				1,484
Long-term investments (3)			—				—				3,971				3,971
Total		$	129,092			$	—			$	3,971			$	133,063

As of December 31, 2008		Quoted Prices in Active Markets (Level 1)				Significant Other Observable Inputs  (Level 2)			Significant Unobservable Inputs (Level 3)				December 31, 2008
Cash equivalents (1)		$	124,497			$	—			$	—			$	124,497
Short-term investments (2)(4)			42,490				860				—				43,350
Long-term investments (3)(4)			—				2,842				1,550				4,392
Total		$	166,987			$	3,702			$	1,550			$	172,239

 

(1)

Cash equivalents consist primarily of money market funds with original maturity dates of three months or less, for which we determine fair value through quoted market prices.

 

(2)

As of December 31, 2009, Level 1 short-term investments include investments in tax-advantaged preferred securities. As of December 31, 2008, Level 1 short-term investments consisted primarily of corporate bonds and municipal notes with maturity dates of one year or less, for which we determined fair value through quoted market prices.

 

(3)

Level 3 long-term investments as of December 31, 2009 and 2008 include a $1.6 million, or 0.3% of total assets, auction rate security (ARS) invested in a tax-exempt state government obligation that was valued at par. Our intent is not to hold the ARS invested in tax-exempt state government obligations to maturity, but rather to use the interest reset feature to provide liquidity. However, should the marketplace auctions continue to fail we may hold the security to maturity. We have classified this as long-term due to the maturity date of the security being in 2011, coupled with ongoing failed auctions in the marketplace.

 

Level 3 long-term investments as of December 31, 2009 also include $2.4 million, or 0.5% of total assets, of tax-advantaged preferred stock of a financial institution. It is uncertain whether we will be able to liquidate these securities within the next twelve months; as such we have classified them as long-term on our consolidated balance sheets. Due to the lack of observable market quotes we utilized valuation models that rely exclusively on Level 3 inputs including those that are based on expected cash flow streams, including assessments of counterparty credit quality, default risk underlying the security, discount rates and overall capital market liquidity.

 

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(4)

As of December 31, 2008, Level 2 short-term and long-term investments of $3.7 million (net of impairment charge) consisted of ARS invested in tax-advantaged preferred stock trusts in which the underlying equities are preferred stock. Based upon our assessment we reduced the fair value of the investments in the preferred stock trusts from $9.6 million to $3.7 million and recorded an other-than-temporary charge of $6.0 million to earnings and an unrealized gain of $0.1 million to stockholders’ equity during the year ended December 31, 2008. These ARS were associated with failed auctions.

 

The change in the carrying amount of Level 3 investments for the years ended December 31, 2008 and 2009 is as follows (in thousands):

Balance as of January 1, 2008		$	—
Reclassification from Level 1 investments to Level 3 investments			169,580
Reclassification from Level 3 investments to Level 2 investments			(3,936	)
Net sales of auction rate securities			(158,430	)
Other-than-temporary impairment included in net income			(5,664	)
Balance as of December 31, 2008			1,550
Reclassification from Level 2 investments to Level 3 investments (5)			1,360
Realized gain on securities included in the statement of operations (5)			716
Unrealized gain on securities recorded in other comprehensive income (5)			345
Balance as of December 31, 2009		$	3,971

 

(5)

During 2009 our investments in ARS invested in certain tax-advantaged preferred stock trusts held as of December 31, 2008 dissolved and the trustees distributed the underlying preferred stock instruments. As a result of these conversions we measured the fair value of the Level 3 long-term tax-advantaged preferred stock on the distribution date and determined that the value increased from December 31, 2008 and as a result we recorded a realized gain in the statement of operations of $0.7 million from $1.4 million to $2.1 million. Subsequent to the trust dissolution through December 31, 2009 we re-measured the fair value and determined that the value had increased and recorded a gain in other comprehensive income of $0.3 million on the increased fair value.  The total value of the tax-advantaged preferred stock of a financial institution included in the $4.0 million of Level 3 long-term investments as of December 31, 2009 is $2.4 million.

We review the fair value of our short-term and long-tem investments for impairment in accordance with ASC Topic 320, Investments – Debt and Equity Securities.  A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income component of stockholders’ equity. It occurs if a loss in an investment is determined to be temporary in nature and we have the ability and intent to hold the investment until a recovery in market value takes place. Such an unrealized loss does not reduce our net income for the applicable accounting period because the loss is not viewed as other-than-temporary. An impairment charge is recorded against earnings to the extent we determine that there is a loss of fair value that is other-than-temporary. For the year end December 31, 2008, we determined that the significant reduction in fair value related to our preferred stock trusts ARS was other-than-temporary and we recorded an impairment charge in our consolidated statements of operations based on a variety of factors, including the significant decline in fair value indicated for the individual investments and the adverse market conditions impacting ARS.

 

Realignment of Workforce and Business

 

On January 5, 2009, we announced a realignment of our workforce and business aimed at sharpening our focus on high growth opportunities and to reflect current market conditions. We reduced our workforce by approximately 90 people, or 8% of our total employees, including several executive and senior-level positions. As a result of the realignment, we incurred total restructuring costs during the three months ended March 31, 2009 of approximately $6.7 million, including approximately $3.9 million of net non-cash compensation expense.

 

The table below sets forth the significant cash components and activity associated with the realignment of workforce and business under the restructuring program for the year ended December 31, 2009 (in thousands):

		Balance as of January 1, 2009				Charges				Cash Payments				Balance as of December 31, 2009
Severance		$	—			$	2,683			$	2,683			$	—
Other benefits			—				156				156				—
Total		$	—			$	2,839			$	2,839			$	—

 

 

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Results of Operations

 

     The following table sets forth, for the periods indicated, the selected consolidated statements of operations:

		Year Ended December 31,
		2009								2008								2007
		$ Amount				% of Net Revenue				$ Amount				% of Net Revenue				$ Amount				% of Net Revenue
		(In thousands, except percentages)
Consolidated Statements of Operations:
Net revenue		$	225,626				100.0	%		$	242,706				100.0	%		$	233,845				100.0	%
Operating expenses:
Cost of revenue (1)			113,875				50.5				113,731				46.9				99,631				42.6
Product development (1)			13,994				6.2				11,658				4.8				9,808				4.2
Selling, general and administrative (1)			108,707				48.2				110,265				45.4				96,875				41.4
Total operating expenses			236,576				104.9				235,654				97.1				206,314				88.2
(Loss) income from operations			(10,950	)			(4.9	)			7,052				2.9				27,531				11.8
Interest income			1,081				0.5				4,720				1.9				5,606				2.4
Interest expense			(221	)			(0.1	)			(324	)			(0.1	)			(355	)			(0.2	)
Other income, net			844				0.4				205				0.1				4				—
Realized gain (loss) on securities			1,393				0.6				(5,956	)			(2.4	)			—				—
(Loss) income before benefit (provision) for income taxes			(7,853	)			(3.5	)			5,697				2.4				32,786				14.0
Benefit (provision) for income taxes, net			3,519				1.6				(3,961	)			(1.7	)			(13,034	)			(5.6	)
Net (loss) income		$	(4,334	)			(1.9	)%		$	1,736				0.7	%		$	19,752				8.4	%

 

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(1) Stock-based compensation expense recorded for the years ended December 31, 2009, 2008 and 2007 was classified as follows:

	Year Ended December 31,
	2009								2008								2007
	$ Amount					% of Net Revenue			$ Amount					% of Net Revenue			$ Amount					% of Net Revenue
	(In thousands, except percentages)
Cost of revenue		$	2,354				1.0	%		$	2,497				1.0	%		$	2,022				0.9	%
Product development			755				0.3				712				0.3				589				0.3
Selling, general and administrative			13,880				6.2				10,782				4.4				8,295				3.5

---

 

 

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Years Ended December 31, 2009 and 2008

 

Revenue

		Year Ended December 31,
		2009				2008
		(in thousands)
Transaction services revenue		$	94,406			$	132,419
Subscription services revenue			114,931				94,690
Other			16,289				15,597
Total net revenue		$	225,626			$	242,706

 

     Total net revenue decreased $17.1 million, or 7%, to $225.6 million for the year ended December 31, 2009 from $242.7 million for the year ended December 31, 2008.

 

      Transaction Services Revenue. Transaction services revenue decreased $38.0 million, or 29%, to $94.4 million for the year ended December 31, 2009 from $132.4 million for the year ended December 31, 2008. The decrease was primarily due to a 35% decline in the volume of transactions processed through the DealerTrack network to 51.4 million for the year ended December 31, 2009 from 79.7 million for the year ended December 31, 2008, which was impacted by the 24% decrease in our number of lender to dealer relationships (LDRs) to 118,209 at December 31, 2009 from 156,437 as of December 31, 2008. The decrease in LDRs is primarily due to lenders continuing to exit the auto financing market, lenders limiting the number of dealers they lend through and dealership closings. The 35% decrease in transaction volume resulted in a $47.0 million reduction in revenue for the year ended December 31, 2009. The tightening of the credit market together with the continual decline in vehicle sales and captive lenders, and in particular captives not on the DealerTrack network, increased market share while independent finance companies and credit unions lost share collectively, has meaningfully impacted our transaction volume compared to historical levels. The revenue decline of $47.0 million related to the decrease in transaction volume was offset by a $9.5 million increase due to an increase in the average transaction price to $1.84 as of December 31, 2009 from $1.66 as of December 31, 2008. A contributing factor to the increase in average transaction price was the 12% increase in lender customers active in our network to 823 as of December 31, 2009 from 733 as of December 31, 2008. The additional 90 lender customers added are generally lower transaction volume customers with higher price per application tiers. Also, with overall lower transaction volumes, our existing lenders were generally in higher transaction price tiers.

      Subscription Services Revenue. Subscription services revenue increased $20.2 million, or 21%, to $114.9 million for the year ended December 31, 2009 from $94.7 million for the year ended December 31, 2008. Subscription services revenue growth was due to a 23% increase in the average monthly spend per subscribing dealer to $678 for the year ended December 31, 2009 from $550 for the year ended December 31, 2008. The increase in average monthly spend per subscribing dealer was positively impacted by the acquisition of AAX, the success of our DMS solution, our ability to cross sell existing customers and by the cancellation of a disproportionate number of lower priced subscriptions as dealerships consolidated. These factors contributed $18.0 million to the increase in subscription services revenue, which includes $14.3 million related to acquired customers.

Other Revenue. Other revenue increased $0.7 million, or 4%, to $16.3 million for the year ended December 31, 2009 from $15.6 million for the year ended December 31, 2008. The $0.7 million increase was primarily resulting from an approximately $1.7 million increase in forms programming, data conversion and training revenue from our DMS business, offset by a decrease of $0.4 million in revenue associated with our SCS business which we exited in February 2009, coupled with a decrease in ALG consulting and analytical revenue of $0.5 million.

Operating Expenses

		Year Ended December 31,
		2009				2008
		(in thousands)
Cost of revenue		$	113,875			$	113,731
Product development			13,994				11,658
Selling, general and administrative			108,707				110,265
Total cost of revenue and operating expenses		$	236,576			$	235,654

 

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      Cost of Revenue. Cost of revenue increased $0.1 million to $113.8 million for the year ended December 31, 2009 from $113.7 million for the year ended December 31, 2008. The $0.1 million increase was primarily the result of increased compensation and related benefit costs of $2.5 million due to increased bonus and other discretionary compensation, which includes $0.4 million of severance and benefit expense resulting from the realignment of our workforce and business on January 5, 2009 (for further information regarding the realignment of our workforce and business, please refer to Note 16 in the accompanying notes to the consolidated financial statement included in this Annual Report on Form 10-K), increased technology expense of $1.9 million which includes hosting expenses, technology support, and other consulting expenses, $0.6 million in software amortization and depreciation charges, $3.5 million in third party costs related to our Compliance and Inventory Management solutions, $0.9 million in compensation related to an increase in installation headcount and hardware costs associated with our DMS product offering, and $0.4 million in costs due to opening of a second processing facility in Memphis, Tennessee for our eDocs solution, offset by a decrease in amortization of intangible assets of approximately $6.6 million resulting from fully amortized acquired intangibles and an increase in amortization of intangible assets during the year ended December 31, 2008 of approximately $1.9 million related to an impaired application processing contract with DHL where the remaining amortization was accelerated and recorded to cost of revenue (for further information regarding this impairment charge, please refer to Note 6  in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K) , a decrease in revenue share of $2.1 million, a decrease in cost of revenue for eContracting of $0.5 million due to a decrease in revenue, and a decrease of $0.3 million in marketing expenses due to continued cost containment efforts.

 

Product Development Expenses. Product development expenses increased $2.3 million, or 20%, to $14.0 million for the year ended December 31, 2009 from $11.7 million for the year ended December 31, 2008. The $2.3 million increase was primarily a result of increased compensation and related benefit costs of $1.9 million due primarily to increased bonus and other discretionary compensation, including $0.2 million of severance and benefit expense resulting from the realignment of our workforce and business on January 5, 2009.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $1.6 million, or 1%, to $108.7 million for the year ended December 31, 2009 from $110.3 million for year ended December 31, 2008. The $1.6 million decrease in selling, general and administrative expenses was primarily the result of a decrease in professional fees of $6.6 million related primarily to litigation, a decrease in marketing and travel related expenses of $1.9 million due to continued cost containment efforts, a decrease in general and administrative expenses of $2.8 million primarily due to a decrease in bad debt expense, a decrease in accounting and other professional fees of $1.1 million, and a decrease of $0.6 million in public company costs related primarily to recruiting fees paid in 2008 to search for a new member for the board of directors, reduced compliance costs as a result of hiring internal resources and a decrease in printing related costs, offset by increased compensation and related benefit costs of approximately $3.6 million primarily due to increased bonus and other discretionary compensation, including $2.2 million of severance and benefit expense resulting from the realignment of our workforce and business, $3.1 million in increased stock-based compensation expense related to the realignment of our workforce and business on January 5, 2009, $0.6 million in depreciation expense, $2.2 million of professional fees primarily due to an increase in deal-related costs resulting from the acquisition of AAX and another potential acquisition we decided not to complete, $0.5 million in occupancy due to the AAX acquisition (for further information on the AAX acquisition, please refer to Note 4 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K), $0.8 million in selling and an increase of $1.0 million of contingent earn-out compensation expense relating to AutoStyleMart acquisition (for further information on the AutoStyleMart earn-out, please refer to Note 4 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K).

 

Interest Income

		Year Ended December 31,
		2009				2008
		(in thousands)
Interest Income		$	1,081			$	4,720

 

     Interest income decreased $3.6 million to $1.1 million for the year ended December 31, 2009 from $4.7 million for the year ended December 31, 2008. The $3.6 million decrease is primarily related to the decrease in our weighted average interest rate to approximately 0.69% for the year ended December 31, 2009 from approximately 2.38% for the year ended December 31, 2008.

 

Other Income, net

		Year Ended December 31,
		2009				2008
		(in thousands)
Other Income, net		$	844			$	205

Other income increased $0.6 million to $0.8 million for the year ended December 31, 2009 from $0.2 million for the year ended December 31, 2008. The $0.6 million increase is primarily due to a reversal of an Arkona pre-acquisition sales tax liability. The contingency was resolved subsequent to the close of the purchase accounting allocation period, as such, the $0.6 million was recorded as other income in the 2009 statement of operations. For further information on the Arkona acquisition, please refer to Note 4 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

 

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Realized Gain (Loss) on Securities

		Year Ended December 31,
		2009				2008
		(in thousands)
Realized gain (loss) on securities		$	1,393			$	(5,956	)

 

For the year ended December 31, 2009, the realized gain of $1.4 million is primarily due to the sale of a preferred security during the second quarter of 2009.

 

We measured the fair value of our auction rate securities at each of the quarters in 2008, and determined in the third and fourth quarters of 2008 that the valuation of certain of our auction rate securities had significantly declined from the previously reported amounts. As a result we recognized a $6.0 million impairment charge during the year ended December 31, 2008. For further information regarding this impairment charge, please refer to Note 3 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

 

Benefit (Provision) for Income Taxes, Net

		Year Ended December 31,
		2009				2008
		(in thousands)
Benefit (provision) for income taxes, net		$	3,519			$	(3,961	)

The benefit for income taxes for the year ended December 31, 2009 of $3.5 million consisted primarily of $5.5 million of federal income tax benefit and $1.6 million of state income tax benefit, offset by $3.6 million of tax expense for our Canadian subsidiary. Included in our state income tax benefit for the year ended December 31, 2009 is $1.1 million, net of reserves of $0.3 million, for refunds receivable due to the filing of amended tax returns for certain states.  This has a 13.6% impact on the effective tax rate for the year ended December 31, 2009.  The provision for income taxes for the year ended December 31, 2008 of $4.0 million consisted primarily of $0.7 million of federal tax expense, $0.6 million of state income tax benefit, and $3.9 million of tax expense for our Canadian subsidiary. Included in tax expense for our Canadian subsidiary for the year ended December 31, 2009 and 2008 is $0.7 million and $1.2 million, respectively, for a permanent item relating to intangible amortization. These amounts have an 8.9% and 20.2% impact on the effective tax rate for the year ended December 31, 2009 and 2008, respectively. Our effective tax rate for the year ended December 31, 2009 is 44.8% compared with 69.5% for the year ended December 31, 2008. The primary reason for the variation in tax rates is the impairment loss on auction rate securities recorded during the year ended December 31, 2008.  No tax benefit is recorded with respect to the impairment loss recorded on the auction rate securities.  If such securities were sold and the losses were realized for tax purposes, the losses on such sales would be capital losses.  Capital losses generally may only be used to offset income from capital gains.  Since we do not anticipate any capital gains in the foreseeable future, no tax benefit is recorded with respect to the impairment losses as it is not more likely than not that tax benefits would ultimately be realized from such losses. A full valuation allowance has been booked for the losses. Had it not been for the significant tax rate variation resulting from the impact of the impairment losses, our effective tax rate for the year ended December 31, 2008 would have been 34.0%. The primary reason for the increase in tax rate in 2009 compared to the 2008 rate excluding the impact of the impairment losses is the impact of filing the amended income tax returns offset by the impact of rate changes on deferred taxes, tax return true-ups, effect of foreign repatriation, and a decrease in tax exempt or tax preferred income as a percentage of overall pre-tax income.

 

In the event that the future income streams that we currently project do not materialize, we may be required to record a valuation allowance. Any increase in a valuation allowance would result in a charge that would adversely impact our operation performance.

 

Years Ended December 31, 2008 and 2007

 

Revenue

		Year Ended December 31,
		2008				2007
		(in thousands)
Transaction services revenue		$	132,419			$	147,312
Subscription services revenue			94,690				75,061
Other			15,597				11,472
Total net revenue		$	242,706			$	233,845

 

     Total net revenue increased $8.9 million, or 4%, to $242.7 million for the year ended December 31, 2008 from $233.8 million for the year ended December 31, 2007.

 

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      Transaction Services Revenue. Transaction services revenue decreased $14.9 million, or 10%, to $132.4 million for the year ended December 31, 2008 from $147.3 million for the year ended December 31, 2007. The decrease was primarily due to a 12% decline in the volume of transactions processed through the DealerTrack network to 79.7 million for the year ended December 31, 2008 from 90.9 million for the year ended December 31, 2007, which was impacted by the 31% decrease in our number of LDRs to 156,437 at December 31, 2008 from 226,314 at December 31, 2007. The decrease in LDRs is primarily due to lenders continuing to exit the auto financing market, lenders limiting the number of dealers they lend through and dealership closings. The 12% decrease in transaction volume resulted in an $18.2 million reduction in revenue for the year ended December 31, 2008. The tightening of the credit market together with the continual decline in vehicle sales, has meaningfully impacted our transaction volume compared to historical levels. The revenue decline of $18.2 million related to the decrease in transaction volume was offset by a $3.4 million increase due to the increase in the average transaction price to $1.66 as of December 31, 2008 from $1.62 as of December 31, 2007. A contributing factor to the increase in average transaction price was the 37% increase in lender customers active in our network to 733 as of December 31, 2008 from 536 as of December 31, 2007. The additional 197 lender customers added are generally lower transaction volume customers with higher price per application tiers. Also, with overall lower transaction volumes, our existing lenders were generally in higher transaction price tiers.

 

      Subscription Services Revenue. Subscription services revenue increased $19.6 million, or 26%, to $94.7 million for the year ended December 31, 2008 from $75.1 million for the year ended December 31, 2007. Subscription services revenue growth was due to a 16% increase in the average monthly spend per subscribing dealer to $550 for the year ended December 31, 2008 from $474 for the year ended December 31, 2007. The increase in average monthly spend per subscribing dealer was positively impacted by the success of our DMS solutions, our ability to cross sell existing customers and by the cancellation of a disproportionate number of lower priced subscriptions as dealerships consolidate. These factors contributed $19.5 million to the increase in revenue, which includes $5.1 million related to acquisitions. In addition to the $19.5 million increase in subscription service revenue is an increase of $4.3 million related to Chrome subscription revenue offset by a decrease of $1.4 million in ALG and other subscription revenue.

 

Other Revenue. Other revenue increased $4.1 million, or 36%, to $15.6 million for the year ended December 31, 2008 from $11.5 million for the year ended December 31, 2007. The $4.1 million increase was primarily resulting from an approximately $5.4 million increase in installation revenue from our DMS business acquired in June 2007, offset by a decrease in other revenue from SCS of $1.3 million.

 

Operating Expenses

		Year Ended December 31,
		2008				2007
		(in thousands)
Cost of revenue		$	113,731			$	99,631
Product development			11,658				9,808
Selling, general and administrative			110,265				96,875
Total cost of revenue and operating expenses		$	235,654			$	206,314

 

      Cost of Revenue. Cost of revenue increased $14.1 million, or 14%, to $113.7 million for the year ended December 31, 2008 from $99.6 million for the year ended December 31, 2007. The $14.1 million increase was primarily the result of increased software amortization and depreciation charges of $2.1 million, coupled with increased compensation and related benefit costs of $6.2 million and increased occupancy and telecommunications costs of $0.6 million due to headcount additions and salary increases, $2.4 million in technology expense which includes hosting expenses, technology support, and other consulting expenses, $2.1 million in cost of revenue from our DMS business, $0.5 million in increased stock-based compensation expense due to additional stock options and restricted common stock awards granted since December 31, 2007, an increase in amortization of intangible assets of approximately $1.9 million related to an impaired application processing contract with DHL where the remaining amortization was accelerated and recorded to cost of revenue (for further information regarding this impairment charge, please refer to Note 6 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K), offset by a decrease in amortization of intangible assets of approximately $3.3 million resulting from fully amortized acquired intangibles.

 

      Product Development Expenses. Product development expenses increased $1.9 million, or 19%, to $11.7 million for the year ended December 31, 2008 from $9.8 million for the year ended December 31, 2007. The $1.9 million increase was primarily a result of increased compensation and related benefit costs of $1.4 million and occupancy and telecommunications costs of $0.2 million, both due to overall headcount additions and salary increases, and increased depreciation expense of $0.2 million.

 

      Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $13.4 million, or 14%, to $110.3 million for the year ended December 31, 2008 from $96.9 million for year ended December 31, 2007. The $13.4 million increase in selling, general and administrative expenses was primarily the result of increased compensation and related benefit costs of approximately $6.6 million due to headcount additions and salary increases, $4.9 million in increased professional fees related primarily to pending litigation, $2.5 million in increased stock-based compensation expense due to additional stock options and restricted common stock awards granted since December 31, 2007 and $0.8 million in increased depreciation expense, offset by a decrease in marketing expenses of $1.0 million.

 

39

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Interest Income

		Year Ended December 31,
		2008				2007
		(in thousands)
Interest Income		$	4,720			$	5,606

 

     Interest income decreased $0.9 million to $4.7 million for the year ended December 31, 2008 from $5.6 million for the year ended December 31, 2007. The $0.9 million decrease is primarily related to the decrease in our cash balance attributable to the repurchase of 3.0 million shares of common stock for an aggregate price of approximately $49.8 million, and the decrease in our weighted average interest rate to approximately 2.38% for the year ended December 31, 2008 from approximately 3.99% for the year ended December 31, 2007.

 

Realized Loss on Securities

		Year Ended December 31,
		2008				2007
		(in thousands)
Realized loss on securities		$	(5,956	)		$	—

 

Due to the continued decline in the auction rate securities market we measured the fair value of our auction rate securities at each of the quarters in 2008, and determined in the third and fourth quarters of 2008 that the valuation of certain of our auction rate securities had significantly declined from the previously reported amounts. As a result we recognized a $6.0 million impairment charge during the year ended December 31, 2008. For further information regarding this impairment charge, please refer to Note 3 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

 

Provision for Income Taxes, Net

		Year Ended December 31,
		2008				2007
		(in thousands)
Provision for income taxes, net		$	(3,961	)		$	(13,034	)

 

     The provision for income taxes for the year ended December 31, 2008 of $4.0 million consisted primarily of $0.7 million of federal tax expense, $0.6 of state income tax benefit, and $3.9 million of tax expense for our Canadian subsidiary. The provision for income taxes for the year ended December 31, 2007 of $13.0 million consisted primarily of $8.3 million of federal tax expense, $2.1 million of state and local income taxes, $0.5 million of adjustments due primarily to the changes in the New York State tax rate, and $2.1 million of tax expense for our Canadian subsidiaries. Included in tax expense for our Canadian subsidiary for the year ended December 31, 2008 and 2007 is $1.2 million and $1.1 million, respectively, for a permanent item relating to intangible amortization. These amounts have a 20.2% and 3.4% impact on the effective tax rate for the year ended December 31, 2008 and 2007, respectively. Our effective tax rate for the year ended December 31, 2008 is 69.5% compared with 39.8% for the year ended December 31, 2007.  The primary reason for the variation in tax rates is the impairment loss on auction rate securities recorded during the year ended December 31, 2008.  No tax benefit is recorded with respect to the impairment loss recorded on the auction rate securities.  If such securities were sold and the losses were realized for tax purposes, the losses on such sales would be capital losses.  Capital losses generally may only be used to offset income from capital gains.  Since we do not anticipate any capital gains in the foreseeable future, no tax benefit is recorded with respect to the impairment losses as it is not more likely than not that tax benefits would ultimately be realized from such losses. A full valuation allowance has been booked for the losses. Had it not been for the significant tax rate variation resulting from the impact of the impairment losses, our effective tax rate for the year ended December 31, 2008 would have been 34.0 % compared with 39.8% for the year ended December 31, 2007. The primary reason for the reduction in tax rate are the impact of rate changes on deferred taxes, tax return true-ups, and an increase in tax exempt or tax preferred income as a percentage of overall pre-tax income. The rate reduction attributable to tax return true-ups is primarily the result of state and local tax reductions due to planning initiatives.

 

In the event that the future income streams that we currently project do not materialize, we may be required to record a valuation allowance. Any increase in a valuation allowance would result in a charge that would adversely impact our operation performance.

 

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Quarterly Results of Operations

 

		First				Second				Third				Fourth
		Quarter (3)				Quarter				Quarter				Quarter
		(Unaudited)
		(In thousands, except for share and per share data)
2009
Net revenue		$	55,700			$	57,870			$	58,809			$	53,247
Gross profit			26,579				29,018				30,144				26,010
Operating (loss) income			(9,871	)			224				1,282				(2,585	)
Net (loss) income			(5,625	)			2,187				(215	)			(681	)
Basic net (loss) income per share applicable to common stockholders (1)		$	(0.14	)		$	0.05			$	(0.01	)		$	(0.02	)
Diluted net (loss) income per share applicable to common stockholders (1)		$	(0.14	)		$	0.05			$	(0.01	)		$	(0.02	)
Weighted average common stock outstanding (basic)			39,095,730				39,499,313				39,705,553				39,787,985
Weighted average shares common stock outstanding (diluted)			39,095,730				40,458,174				39,705,553				39,787,985

		First				Second				Third				Fourth
		Quarter				Quarter				Quarter (4)				Quarter (5)
		(Unaudited)
		(In thousands, except for share and per share data)
2008
Net revenue		$	64,308			$	63,181			$	60,525			$	54,692
Gross profit			35,696				35,302				32,585				25,392
Operating income (loss)			2,822				4,208				3,056				(3,034	)
Net income (loss)			2,338				3,066				(2,603	)			(1,065	)
Basic net income (loss) per share applicable to common stockholders (1) (2)		$	0.05			$	0.07			$	(0.07	)		$	(0.03	)
Diluted net income (loss) per share applicable to common stockholders (1) (2)		$	0.05			$	0.07			$	(0.07	)		$	(0.03	)
Weighted average common stock outstanding (basic)			41,637,585				41,505,451				39,769,935				38,963,048
Weighted average shares common stock outstanding (diluted)			42,805,884				42,609,342				39,769,935				38,963,048

 

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(1)	The addition of earnings per share by quarter may not equal total earnings per share for the year.

(2)

Earnings per share data for each of the quarters in the year ended December 31, 2008 have been retroactively adjusted to conform to the provisions of ASC Topic 260, Earnings Per Share, which did not have a significant impact on our historical earnings per share calculations. For further information, please refer to Note 2  in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

(3)

Included in the first quarter of 2009 net loss is a restructuring cost of approximately $6.7 million, including approximately $3.9 million of net non-cash compensation expense, related to the realignment of our workforce and business on January 5, 2009. For further information, please refer to Note 16 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

(4)

Included in the third quarter of 2008 net loss is an impairment charge of $5.7 million, related to the significant decline in certain auction rate securities. For further information, please refer to Note 3  in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

 

 

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(5)

Included in the fourth quarter of 2008 net loss is an impairment charge of $0.3 million, related to the significant decline in certain auction rate securities, as described in Note 3 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K, and a charge of $1.9 million, related to the impairment of an application processing contract with DHL, as described in Note 6 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K.

 

		Year Ended December 31,
		2009				2008				2007
		(in thousands)
Net cash provided by operating activities		$	45,467			$	61,494			$	56,926
Net cash (used in) provided by investing activities			(8,283	)			94,874				(168,725	)
Net cash provided by (used in) financing activities			2,109				(47,816	)			114,216

 

Operating Activities

 

Net cash provided by operating activities of $45.5 million for the year ended December 31, 2009 was primarily attributable to net loss of $4.3 million, which includes depreciation and amortization of $35.1 million, stock-based compensation expense of $17.0 million, an increase to the provision for doubtful accounts and sales credits of $7.7 million, an increase in accounts payable and accrued expenses of $3.0 million, a decrease in prepaid expenses and other current assets of $3.7 million, partially offset by a deferred tax benefit of $7.3 million, an increase in accounts receivable of $6.3 million due to an increase in subscription revenues and the acquisition of AAX , a stock-based compensation windfall tax benefit of $0.7 million, a gain of $1.4 million realized on the sale or conversion of securities, a decrease in other long-term liabilities of $0.6 million, and a $0.6 million reversal of an Arkona pre-acquisition sales tax liability contingency resolved subsequent to the close of the purchase accounting allocation period. Net cash provided by operating activities of $61.5 million for the year ended December 31, 2008 was primarily attributable to net income of $1.7 million, which includes depreciation and amortization of $40.1 million, stock-based compensation expense of $14.0 million, an increase to the provision for doubtful accounts and sales credits of $9.6 million, an impairment recognized on auction rate securities of $6.0 million (for further information regarding this impairment charge, please refer to Note 3 in the accompanying notes to the consolidated financial statements included in this Annual Report on Form 10-K), an increase to deferred revenue and other current liabilities of $1.7 million, and an increase in other long-term liabilities of $1.5 million, partially offset by decreases in accounts payable and accrued expenses of $6.7 million, a deferred tax benefit of $2.1 million, a stock-based compensation windfall tax benefit of $0.4 million, an increase in prepaid expenses and other current assets of $2.9 million, and an increase in accounts receivable of $1.6 million. Net cash provided by operating activities of $56.9 million for the year ended December 31, 2007 was primarily attributable to net income of $19.8 million, which includes depreciation and amortization of $38.5 million, stock-based compensation expense of $10.9 million, an increase to the provision for doubtful accounts and sales credits of $6.8 million, an increase in accounts payable and accrued expenses of $3.9 million and an increase to deferred revenue and other current liabilities of $0.6 million, partially offset by a deferred tax benefit of $4.6 million, a stock-based compensation windfall tax benefit of $7.0 million, an increase in accounts receivable (including related party) of $11.0 million due to an overall increase in revenue.

 

Investing Activities

 

    Net cash used in investing activities of $8.3 million for the year ended December 31, 2009 was primarily attributable to the sale of short-term investments of $44.6 million offset by the payment for the acquisition of AAX business and intangible assets of $30.9 million, the payment of the Curomax additional purchase consideration of $1.8 million, the payment of ALG additional purchase consideration of $1.9 million, capital expenditures of $5.4 million, capitalized software and website development costs of $13.0 million. Net cash provided by investing activities of $94.9 million for the year ended December 31, 2008 was primarily attributable to the net sale of investments of $115.8 million offset by capital expenditures of $6.5 million, capitalized software and website development costs of $8.6 million, and the payment for net assets acquired of $6.0 million. Net cash used in investing activities of $168.7 million for the year ended December 31, 2007 was primarily attributable to capital expenditures of $7.2 million, capitalized software and website development costs of $6.5 million, payment for net assets acquired of $109.6 million, and the net purchase of short-term investments of $45.5 million.

 

Financing Activities

 

    Net cash provided by financing activities of $2.1 million for the year ended December 31, 2009 was primarily attributable to net proceeds received from the exercise of employee stock options of $2.2 million, employee stock purchases under our employee stock purchase plan of $0.9 million, and a stock-based compensation windfall tax benefit of $0.7 million, partially offset by payment for shares surrendered for taxes of $0.4 million related to restricted stock vesting, principal payments on notes payable of $0.8 million, and principal payments on capital lease obligations of $0.4 million. Net cash used in financing activities of $47.8 million for the year ended December 31, 2008 was primarily attributable to the repurchase of 3.0 million shares of common stock for an aggregate price of approximately $49.8 million, offset by net proceeds received from employee stock purchases under our employee stock purchase plan of $1.7 million and the exercise of employee stock options of $1.0 million. Net cash provided by financing activities of $114.2 million for the year ended December 31, 2007 was primarily attributable to the receipt of cash proceeds from our public offering of $102.2 million, the exercise of employee stock options of $4.0 million, net proceeds received from employee stock purchases under our employee stock purchase plan of $1.8 million, and stock-based compensation windfall tax benefit of $7.0 million, offset by principal payments on note payable and capital lease obligations of $0.7 million.

 

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Contractual Obligations

 

     The following table summarizes our contractual obligations as of December 31, 2009:

 

						Less Than												After
		Total				1 Year			1-3 Years					4-5 Years				5 Years
									(In thousands)
Operating lease obligations		$	28,934			$	4,952			$	8,361			$	6,069			$	9,552
Capital lease obligations			762				466				296				—				—
Payments due to acquirees			2,888				2,888				—				—				—
Total contractual cash obligation		$	32,584			$	8,306			$	8,657			$	6,069			$	9,552

 

     Payments due to acquirees are non-interest bearing and fixed in nature.

 

     Pursuant to employment or severance agreements with certain employees, we have a commitment to pay severance of approximately $4.2 million as of December 31, 2009, in the event of termination without cause, as defined in the agreements, as well as certain potential gross-up payments to the extent any such severance payment would constitute an excess parachute payment under the Internal Revenue Code. We also have a commitment to pay additional severance of approximately $1.9 million as of December 31, 2009, if there is a change in control.

 

Under the terms of the merger agreement with AutoStyleMart, Inc., we have future contingent payment obligations of up to $11.0 million based upon the achievement of certain operational targets from February 2008 through February 2011. As of December 31, 2009, we determined that certain operational conditions were probable of being achieved and recorded a liability in accrued expenses of $1.0 million. The additional consideration of $1.0 million was deemed a contingent earn-out compensation expense for services on certain former stockholders remaining employees or consultants of DealerTrack for a certain period. The $1.0 million was recorded as a selling, general and administrative expense for the year ended December 31, 2009. As of December 31, 2009, it has been determined that the operational targets related to the remaining $10.0 million in contingent payment obligations are not yet probable of being achieved. Any future amounts deemed probable will also be recorded as a selling, general and administrative expense.

 

In connection with the purchase of Automotive Lease Guide on May 25, 2005, we have a contractual agreement with the seller to pay an additional $0.8 million per year for 2006 through 2010. There was additional contingent consideration of up to $11.3 million that could be paid contingent upon future increases in revenue of ALG and another one of our subsidiaries through December 2009. The total amount of contingent consideration remaining to be paid as of December 31, 2009 was $1.1 million.  The additional purchase price consideration was recorded as goodwill on our consolidated balance sheet.

On February 10, 2010, DealerTrack, Inc., a subsidiary of DealerTrack Holdings, Inc. (DealerTrack) entered into a strategic relationship with GMAC.  Under the terms of the agreement, GMAC will be listed as a financing option on the DealerTrack credit application processing network and DealerTrack has agreed to make a one-time payment to GMAC of $15.0 million payable upon GMAC becoming available to substantially all dealers that it does business with who are on the DealerTrack U.S. network.  The one-time $15.0 million payment will be recorded ratably as a reduction to revenue over an estimated period of five years.  GMAC will be available to General Motors and Chrysler dealers, as well as dealers of other manufacturers that GMAC elects to do business with.  GMAC will continue to accept credit applications through the RouteOne system.

 

Off-Balance Sheet Arrangements

 

     We do not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

Effects of Inflation

 

     Our monetary assets, consisting primarily of cash and cash equivalents, receivables and long-term investments, and our non-monetary assets, consisting primarily of intangible assets and goodwill, are not affected significantly by inflation. We believe that replacement costs of equipment, furniture and leasehold improvements will not materially affect our operations. However, the rate of inflation affects our expenses, which may not be readily recoverable in the prices of products and services we offer.

 

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Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (FASB) issued Revenue Recognition guidance around Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force. This guidance modifies the fair value requirements of Revenue Recognition-Multiple Element Arrangements by allowing the use of the “best estimate of selling price” in addition to VSOE and VOE (now referred to as third-party evidence or TPE) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted. The final consensus is effective for fiscal years beginning after June 15, 2010. Companies will have the option of adopting the guidance retrospectively or prospectively for new or materially modified agreements. Early adoption is permitted as of the beginning of an entity’s fiscal year. We are currently evaluating the impact of this guidance on our consolidated financial statements.

In June 2009, the FASB issued the The FASB Accounting Standards Codification™ (the Codification) which became the single authoritative U.S. accounting and reporting standards applicable for all nongovernmental entities, with the exception of guidance issued by the Securities and Exchange Commission (SEC). The Codification does not change current U.S. GAAP, but changes the referencing of financial standards, and is intended to simplify user access to authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. The Codification is effective for interim and annual periods ending after September 15, 2009, and was effective for our third quarter of 2009. At that time, all references made to U.S. GAAP used the new Codification numbering system prescribed by the FASB.

The Codification does not change or alter existing U.S. GAAP and did not have any impact on our consolidated financial position, cash flows, or results of operations.

In June 2009, the FASB issued a new standard which modified how a company determines when it is required to consolidate an entity and is based on, among other things, an entity’s purpose and design, a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance, and the obligation to absorb losses or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. This new standard requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity and also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. This standard is effective for fiscal years beginning after November 15, 2009. We are currently evaluating the impact of this guidance on our consolidated financial statements.

 

Item 8. Financial Statements and Supplementary Data

 

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

		Page
DEALERTRACK HOLDINGS, INC.:
Report of Independent Registered Public Accounting Firm			47
Consolidated Balance Sheets			48
Consolidated Statements of Operations			49
Consolidated Statements of Cash Flows			50
Consolidated Statements of Stockholders’ Equity and Comprehensive Income			51
Notes to Consolidated Financial Statements			54
Schedule II — Valuation and Qualifying Accounts			78

 

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of DealerTrack Holdings, Inc.:

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of DealerTrack Holdings, Inc. and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and the financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Part II, Item 9A in this Annual Report on Form 10-K. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PricewaterhouseCoopers LLP

 

New York, New York

 

February 24, 2010

 

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DEALERTRACK HOLDINGS, INC.

 

CONSOLIDATED BALANCE SHEETS

 

	December 31,
	2009				2008
	(In thousands,
	except share and per share
	amounts)
ASSETS
Current assets
Cash and cash equivalents		$	197,509			$	155,456
Short-term investments			1,484				43,350
Accounts receivable, net of allowances of $2,677 and $1,848 as of December 31, 2009 and 2008, respectively			17,478				18,462
Prepaid expenses and other current assets			6,844				9,624
Deferred tax assets			2,776				2,195
Restricted cash			—				142
Total current assets			226,091				229,229
Long-term investments			3,971				4,392
Property and equipment, net			13,514				13,448
Software and website developments costs, net			21,158				12,705
Intangible assets, net			41,604				44,405
Goodwill			134,747				114,886
Restricted cash			250				250
Deferred taxes and other long-term assets			30,992				17,900
Total assets		$	472,327			$	437,215
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	3,919			$	4,488
Accrued compensation and employee benefits			11,717				7,850
Accrued liabilities — other			11,324				11,385
Deferred revenues			4,992				5,609
Due to acquirees			1,820				1,740
Capital leases payable			425				360
Total current liabilities			34,197				31,432
Capital leases payable — long-term			281				454
Due to acquirees — long-term			—				682
Deferred tax liabilities — long-term			11,083				2,477
Deferred revenue and other long-term liabilities			5,880				5,950
Total liabilities			51,441				40,995
Commitments and contingencies (Note 14)
Stockholders’ equity
Preferred stock, $0.01 par value; 10,000,000 shares authorized and no shares issued and outstanding at December 31, 2009 and 2008, respectively			—				—
Common stock, $0.01 par value; 175,000,000 shares authorized; 43,469,945 shares issued and 40,430,330 shares outstanding at December 31, 2009; and 42,841,737 shares issued and 39,833,616 shares outstanding at December 31, 2008			435				428
Treasury stock, at cost, 3,039,615 and 3,008,121 shares as of December 31, 2009 and 2008, respectively			(50,440	)			(50,061	)
Additional paid-in capital			448,816				428,771
Deferred stock-based compensation			—				(446	)
Accumulated other comprehensive income			6,151				(2,730	)
Retained earnings			15,924				20,258
Total stockholders’ equity			420,886				396,220
Total liabilities and stockholders’ equity		$	472,327			$	437,215

 

The accompanying notes are an integral part of these financial statements.

 

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DEALERTRACK HOLDINGS, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

	Year Ended December 31,
	2009				2008				2007
	(In thousands, except per share and share amounts)
Revenue
Net revenue		$	225,626			$	242,706			$	233,845
Operating expenses :
Cost of revenue (1)			113,875				113,731				99,631
Product development (1)			13,994				11,658				9,808
Selling, general and administrative (1)			108,707				110,265				96,875
Total operating expenses			236,576				235,654				206,314
(Loss) income from operations			(10,950	)			7,052				27,531
Interest income			1,081				4,720				5,606
Interest expense			(221	)			(324	)			(355	)
Other income, net			844				205				4
Realized gain (loss) on securities (Note 3)			1,393				(5,956	)			—
(Loss) income before benefit (provision) for income taxes			(7,853	)			5,697				32,786
Benefit (provision) for income taxes, net			3,519				(3,961	)			(13,034	)
Net (loss) income		$	(4,334	)		$	1,736			$	19,752
Basic net (loss) income per share applicable to common stockholders (2)		$	(0.11	)		$	0.04			$	0.49
Diluted net (loss) income per share applicable to common stockholders (2)		$	(0.11	)		$	0.04			$	0.47
Weighted average common stock outstanding (basic)			39,524,544				40,461,896				39,351,138
Weighted average common stock outstanding (diluted)			39,524,544				41,538,379				40,886,482

(1)	Stock-based compensation expense recorded for the years ended December 31, 2009, 2008 and 2007 was classified as follows:

	Year Ended December 31,
	2009 (3)				2008				2007
	(In thousands)
Cost of revenue		$	2,354			$	2,497			$	2,022
Product development			755				712				589
Selling, general and administrative			13,880				10,782				8,295

(2)

Earnings per share data presented for the years ended December 31, 2008 and 2007 have been retroactively adjusted to conform to the provisions of ASC Topic 260,Earnings Per Share, which did not have a significant impact on our historical earnings per share calculation. For further information, please refer to Note 2.

(3)	Included in stock-based compensation expense for the year ended December 31, 2009 was $3.9 million of stock-based compensation expense related to the realignment of our workforce and business on January 5, 2009. For further information, please refer to Note 16.

 

The accompanying notes are an integral part of these financial statements

 

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DEALERTRACK HOLDINGS, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Year Ended December 31,
		2009				2008				2007
		(In thousands)
Operating activities:
Net (loss) income		$	(4,334	)		$	1,736			$	19,752
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization			35,059				40,076				38,479
Deferred tax benefit			(7,262	)			(2,051	)			(4,631	)
Stock-based compensation expense			16,989				13,991				10,906
Provision for doubtful accounts and sales credits			7,698				9,639				6,767
(Gain) loss on sale of property and equipment			(184	)			—				17
Reversal of pre-acquisition accrued contingency			(609	)			—
Amortization of bond premium			56				132				—
Amortization of deferred interest			152				178				187
Deferred compensation			300				264				294
Amortization of bank financing costs			—				30				122
Stock-based compensation windfall tax benefit			(673	)			(418	)			(6,995	)
Realized (gain) loss on securities			(1,393	)			5,956				—
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable			(6,342	)			(1,634	)			(10,973	)
Prepaid expenses and other current assets			3,725				(2,928	)			(1,286	)
Accounts payable and accrued expenses			3,025				(6,678	)			3,905
Deferred revenue and other current liabilities			14				1,650				567
Other long-term liabilities			(642	)			1,501				19
Deferred rent			145				473				86
Other long-term assets			(257	)			(423	)			(290	)
Net cash provided by operating activities			45,467				61,494				56,926
Investing activities:
Capital expenditures			(5,360	)			(6,502	)			(7,189	)
Restricted cash			142				149				—
Purchase of investments			—				(549,159	)			(554,445	)
Sale of investments			44,569				664,932				508,980
Capitalized software and website development costs			(13,021	)			(8,560	)			(6,474	)
Proceeds from sale of property and equipment			109				3				8
Payment for acquisition of business and intangible assets, net of acquired cash			(34,722	)			(5,989	)			(109,605	)
Net cash (used in) provided by investing activities			(8,283	)			94,874				(168,725	)
Financing activities:
Principal payments on capital lease obligations			(414	)			(742	)			(229	)
Proceeds from the exercise of employee stock options			2,202				951				4,009
Proceeds from employee stock purchase plan			875				1,691				1,779
Purchase of treasury stock			(379	)			(49,922	)			(108	)
Proceeds from public offerings, net of expenses			—				—				102,192
Principal payments on notes payable			(848	)			(212	)			(422	)
Stock-based compensation windfall tax benefit			673				418				6,995
Net cash provided by (used in) financing activities			2,109				(47,816	)			114,216
Net increase in cash and cash equivalents			39,293				108,552				2,417
Effect of exchange rate changes on cash and cash equivalents			2,760				(3,660	)			1,067
Cash and cash equivalents, beginning of year			155,456				50,564				47,080
Cash and cash equivalents, end of year		$	197,509			$	155,456			$	50,564

		Year Ended December 31,
		2009				2008				2007
		(In thousands)
Supplemental disclosure:
Cash paid for:
Income taxes		$	4,961			$	6,995			$	15,308
Interest			60				128				153
Non-cash investing and financing activities:
Asset sale through note receivable			500				—				—
Assets acquired under capital leases			307				—				219
Acquisition of capitalized software through note payable			—				867				—
Accrued capitalized hardware, software and fixed assets			2,515				795				1,186
Payable for acquired intangible assets			—				500				—
Deferred compensation reversal to equity			300				264				360
Capitalized stock-based compensation			133				59				—

 

The accompanying notes are an integral part of these financial statements.

 

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DEALERTRACK HOLDINGS, INC.

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME

																													Accumulated				Retained
														Common Stock,							Additional				Deferred				Other				Earnings				Total
		Preferred Stock						Common Stock						In Treasury							Paid-In				Stock-Based				Comprehensive				(Accumulated				Stockholders’				Comprehensive
		Shares			Amount			Shares			Amount			Shares			Amount				Capital				Compensation				Income (Loss)				Deficit)				Equity				Income
		(In thousands, except share amounts)
Balance as of January 1, 2007			—		$	—			39,358,769		$	393			1,219		$	(31	)		$	289,490			$	(4,322	)		$	37			$	(1,230	)		$	284,337
Exercise of stock options			—			—			633,320			6			—			—				4,003				—				—				—				4,009
Directors deferred compensation stock units			—			—			8,133			—			—			—				294				—				—				—				294
Officers deferred compensation stock units			—			—			2,177			—			—			—				66				—				—				—				66
Issuances of common stock under employee stock purchase plan			—			—			59,202			2			—			—				1,777				—				—				—				1,779
Compensation expense related to the employee stock purchase plan			—			—			—			—			—			—				314				—				—				—				314
Tax benefit from the exercise of stock options and restricted common stock			—			—			—			—			—			—				6,995				—				—				—				6,995
Foreign currency translation adjustment			—			—			—			—			—			—				—				—				8,144				—				8,144				8,144
Treasury stock			—			—			—			—			2,983			(108	)							—				—				—				(108	)
Issuance of restricted common stock grants			—			—			235,725			2			—			—				(2	)			—				—				—				—
Stock-based compensation expense (APB 25)			—			—			—			—			—			—				—				1,729				—				—				1,729
Stock-based compensation expense (FAS 123(R))			—			—			—			—			—			—				4,604				—				—				—				4,604
Restricted common stock-based compensation expense (APB 25)			—			—			—			—			—			—				—				397				—				—				397
Restricted common stock-based compensation expense (FAS 123(R))			—			—			—			—			—			—				3,862				—				—				—				3,862
Options and restricted share cancellations			—			—			(40,401	)		—			—			—				(140	)			140				—				—				—
Issuance of common stock — public offering			—			—			2,300,000			23			—			—				102,169				—				—				—				102,192
Other			—			—			—			—			—			—				(4	)			—				—				—				(4	)
Net income			—			—			—			—			—			—				—				—				—				19,752				19,752				19,752
Comprehensive income																																									$	27,896
Balance as of December 31, 2007			—		$	—			42,556,925		$	426			4,202		$	(139	)		$	413,428			$	(2,056	)		$	8,181			$	18,522			$	438,362

 

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																																		Accumulated				Retained
																		Common Stock,								Additional				Deferred				Other				Earnings				Total
		Preferred Stock								Common Stock								In Treasury								Paid-In				Stock-Based				Comprehensive				(Accumulated				Stockholders’				Comprehensive
		Shares				Amount				Shares				Amount				Shares				Amount				Capital				Compensation				Income (Loss)				Deficit)				Equity				Income
		(In thousands, except share amounts)
Exercise of stock options			—				—				102,182				1				—				—				950				—				—				—				951
Directors deferred compensation stock units			—				—				17,638				—				—				—				264				—				—				—				264
Issuances of common stock under employee stock purchase plan			—				—				123,587				1				—				—				1,690				—				—				—				1,691
Compensation expense related to the employee stock purchase plan			—				—				—				—				—				—				299				—				—				—				299
Tax benefit from the exercise of stock options and restricted common stock			—				—				—				—				—				—				(1	)			—				—				—				(1	)
Foreign currency translation adjustment			—				—				—				—				—				—				—				—				(10,926	)			—				(10,926	)			(10,926	)
Treasury stock			—				—				—				—				3,003,919				(49,922	)							—				—				—				(49,922	)
Unrealized gain on auction rate securities			—				—				—				—				—				—				—				—				15				—				15				15
Issuance of restricted common stock grants			—				—				49,357								—				—				—				—				—				—				—
Stock-based compensation expense (APB 25)			—				—				—				—				—				—				—				1,196				—				—				1,196
Stock-based compensation expense (FAS 123(R))			—				—				—				—				—				—				7,191				—				—				—				7,191
Restricted common stock-based compensation expense (APB 25)			—				—				—				—				—				—				—				342				—				—				342
Restricted common stock-based compensation expense (FAS 123(R))			—				—				—				—				—				—				5,022				—				—				—				5,022
Options and restricted share cancellations			—				—				(7,952	)			—				—				—				(72	)			72				—				—				—
Net income			—				—				—				—				—				—				—				—				—				1,736				1,736				1,736
Comprehensive income																																														$	18,721
Balance as of December 31, 2008			—			$	—				42,841,737			$	428				3,008,121			$	(50,061	)		$	428,771			$	(446	)		$	(2,730	)		$	20,258			$	396,220

 

 

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																																		Accumulated				Retained
																		Common Stock,								Additional				Deferred				Other				Earnings				Total
		Preferred Stock								Common Stock								In Treasury								Paid-In				Stock-Based				Comprehensive				(Accumulated				Stockholders’				Comprehensive
		Shares				Amount				Shares				Amount				Shares			Amount					Capital				Compensation				Income (Loss)				Deficit)				Equity				Income
		(In thousands, except share amounts)
Exercise of stock options			—				—				592,964				6				—				—				2,196				—				—				—				2,202
Directors deferred compensation stock units			—				—				18,097				—				—				—				300				—				—				—				300
Issuances of common stock under employee stock purchase plan			—				—				61,595				1				—				—				874				—				—				—				875
Compensation expense related to the employee stock purchase plan			—				—				—				—				—				—				60				—				—				—				60
Foreign currency translation adjustment			—				—				—				—				—				—				—				—				7,928				—				7,928				7,928
Treasury stock			—				—				—				—				31,494				(379	)							—				—				—				(379	)
Unrealized gain on auction rate securities			—				—				—				—				—				—				—				—				953				—				953				953
Issuance of restricted common stock grants			—				—				61,243				1				—				—				(1	)			—				—				—				—
Stock-based compensation expense (APB 25)			—				—				—				—				—				—				—				280				—				—				280
Stock-based compensation expense (FAS 123(R))			—				—				—				—				—				—				10,314				—				—				—				10,314
Restricted common stock-based compensation expense (APB 25)			—				—				—				—				—				—				—				118				—				—				118
Restricted common stock-based compensation expense (FAS 123(R))			—				—				—				—				—				—				6,350				—				—				—				6,350
Options and restricted share cancellations			—				—				(105,691	)			(1	)			—				—				(48	)			48				—				—				(1	)
Net (loss)			—				—				—				—				—				—				—				—				—				(4,334	)			(4,334	)			(4,334	)
Comprehensive income																																														$	23,268
Balance as of December 31, 2009			—			$	—				43,469,945			$	435				3,039,615			$	(50,440	)		$	448,816			$	—			$	6,151			$	15,924			$	420,886

 

The accompanying notes are an integral part of these financial statements.

 

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DEALERTRACK HOLDINGS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Business Description

 

     DealerTrack’s intuitive and high-value software solutions enhance efficiency and profitability for all major segments of the automotive retail industry, including dealers, lenders, OEMs, agents and aftermarket providers. We believe our solution set for dealers is the industry’s most comprehensive. DealerTrack operates the industry’s largest online credit application network, connecting approximately 17,000 dealers with over 800 lenders.  Our dealer management system (DMS) provides dealers with easy-to-use tools with real-time data access that will streamline any automotive business. With our inventory management solution, DealerTrack AAX, dealers get better data along with the tools to make smarter, more profitable inventory decisions. Our sales and finance & insurance (F&I) solution enables dealers to streamline the entire sales process, quickly structuring all types of deals from a single integrated platform. DealerTrack’s compliance solution helps dealers meet legal and regulatory requirements and protect their hard-earned assets. DealerTrack’s family of companies also includes data, accessories and consulting services providers, Automotive Lease Guide (ALG) and Chrome Systems (Chrome).

 

2. Summary of Significant Accounting Policies

 

     The consolidated financial statements of DealerTrack Holdings, Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America.

 

    Basis of Presentation

 

     The accompanying consolidated financial statements include the accounts of DealerTrack Holdings, Inc. and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated.

 

    Use of Estimates

 

  The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America  require management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in our consolidated financial statements and the accompanying notes. Actual results could differ from those estimates.

 

     On an on-going basis, we evaluate our estimates, including those related to the accounts receivable allowance, the fair value of financial assets, acquired intangible assets, goodwill, and other assets and liabilities; the useful lives of intangible assets, property and equipment, capitalized software and website development costs; assumptions used to calculate stock-based compensation including volatility, expected term and forfeiture; and income taxes, among others. We base our estimates on historical experience and on other various assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

 

    Revenue Recognition

 

      Transaction Services Revenue. Transaction services revenue consists of revenue earned from our lender customers for each credit application or contract that dealers submit to them. We also earn transaction services revenue from lender customers for each financing contract executed via our electronic contracting and digital contract processing solutions, as well as for any portfolio residual value analyses we perform for them. We also earn transaction services revenue from dealers or other service and information providers, such as aftermarket providers, and credit report providers, for each fee-bearing product accessed by dealers.

 

     We offer web-based service to lenders for the electronic receipt of credit application data and contract data for automotive financing transactions in consideration for a transaction fee. This service is sold based upon contracts that include fixed or determinable prices and that do not include the right of return or other similar provisions or significant post service obligations. Credit application and digital and electronic contracting processing revenue is recognized on a per transaction basis, after customer receipt and when collectability is reasonably assured. Set-up fees charged to the lenders for establishing connections, if any, are recognized ratably over the expected customer relationship period of four years.

 

     Our credit report service provides our dealer customers the ability to access credit reports from several major credit reporting agencies or resellers online. We sell this service based upon contracts with the customer or report provider, as applicable, that include fixed or determinable prices and that does not include the right of return or other similar provisions or other significant post service obligations. We recognize credit report revenue on a per transaction basis, when services are rendered and when collectability is reasonably assured. We offer these credit reports on both a reseller and an agency basis. We recognize revenue from all but one provider of credit reports on a net basis due to the fact that we are not considered the primary obligor, and recognize revenue on a gross basis with respect to one of the providers as we have the risk of loss and are considered the primary obligor in the transaction.

 

      Subscription Services Revenue. Subscription services revenue consists of revenue earned from our customers (typically on a monthly basis) for use of our subscription or license-based products and services. Some of these subscription services enable dealer customers to manage their dealership data and operations, compare various financing and leasing options and programs, sell insurance and other aftermarket products, analyze inventory and execute financing contracts electronically. These subscription services are typically sold based upon contracts that include fixed or determinable prices and that do not include the right of return or other similar provisions or significant post service obligations. We recognize revenue from such contracts ratably over the contract period. We recognize set-up fees, if any, ratably over the expected customer relationship of three years. For contracts that contain two or more products or services, we recognize revenue in accordance with the above policy using relative fair value.

 

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  Other Revenue.  Other revenue consists of revenue primarily earned through training and start up fees from our DMS solution, shipping commissions earned from our digital contract business and consulting and analytical revenue earned from ALG.

 

     Our revenue is presented net of a provision for sales credits, which is estimated based on historical results, and established in the period in which services are provided.

 

   Shipping Costs

 

     Shipping charges billed to customers are included in net revenue, and the related shipping costs are included in cost of revenue.

 

  Cash and Cash Equivalents

 

     Cash and cash equivalents consist of cash and highly liquid investments purchased with original maturity of three months or less.

 

  Short-term and long-term Investments

 

     Short-term and long-term investments as of December 31, 2009 consist of auction rate securities that are invested in tax-exempt state government obligations and tax-advantaged preferred securities. Short-term and long-term investments as of December 31, 2008 consist of corporate bonds, municipal notes, and auction rate securities (ARS) that are invested in tax-exempt state government obligations and tax-advantaged preferred securities. We classify investment securities as available for sale, and as a result, report the investments at fair value. For the years ended December 31, 2009, 2008 and 2007, there were unrealized gains of $1.0 million, $15,000, and $0 included in accumulated other comprehensive income, respectively. For further information regarding the fair value measurements of our investments, please refer to Note 3.

 

  Translation of Non-U.S. Currencies

 

     We have maintained business operations in Canada since January 1, 2004. The translation of assets and liabilities denominated in foreign currency into U.S. dollars is made at the prevailing rate of exchange at the balance sheet date. Revenue, costs and expenses are translated at the average exchange rates during the period. Translation adjustments are reflected in accumulated other comprehensive income on our consolidated balance sheets, while gains and losses resulting from foreign currency transactions are included in our consolidated statements of operations. Amounts resulting from foreign currency transactions included in our statement of operations were not material for the years ended December 31, 2009, 2008 and 2007.

 

  Allowance for Doubtful Accounts

 

     We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The amount of the allowance account is based on historical experience and our analysis of the accounts receivable balance outstanding. While credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, additional allowances may be required which would result in an additional expense in the period that this determination was made.

 

  Property, Equipment and Depreciation

 

     Property and equipment are stated at cost less accumulated depreciation, which is provided for by charges to income over the estimated useful lives of the assets using the straight-line method. Maintenance and repairs are charged to operating expenses as incurred. Upon sale or other disposition, the applicable amounts of asset cost and accumulated depreciation are removed from the accounts and the net amount, less proceeds from disposal, is charged or credited to income.

 

  Software and Website Development Costs and Amortization

 

     We capitalize costs of materials, consultants and payroll and payroll-related costs incurred by employees involved in developing internal use computer software. Costs incurred during the preliminary project and post-implementation stages are charged to expense. Software and website development costs are amortized on a straight-line basis over estimated useful lives ranging from two to four years. We perform periodic reviews to ensure that unamortized software and website costs remain recoverable from future revenue. Capitalized software and website development costs, net were $21.2 million and $12.7 million as of December 31, 2009 and 2008, respectively. Amortization expense totaled $7.6 million, $7.4 million and $6.2 million for the years ended December 31, 2009, 2008 and 2007, respectively.

 

  Goodwill, Other Intangibles and Long-lived Assets

 

     We record as goodwill the excess of purchase price over the fair value of the tangible and identifiable intangible assets acquired. Goodwill is tested annually for impairment as well as whenever events or circumstances change that would make it more likely than not that an impairment may have occurred. Goodwill is tested for impairment using a two-step approach. The first step tests for potential goodwill impairment by comparing the fair value of our one reporting unit to its carrying value. If the fair value of the reporting unit is less than its carrying value the second step is to record an impairment loss to the extent that the implied fair value of the goodwill of the reporting unit is less than its carrying value.

 

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     Goodwill is required to be assessed at the operating segment or lower level. We determined that the components of our one operating segment have similar economic characteristics, nature of products, distribution, shared resources and type of customer such that the components should be aggregated into a single reporting unit for purposes of performing the impairment test for goodwill. We perform our annual impairment analysis as of the first day of the fourth quarter. The evaluation of impairment involves comparing the current estimated fair value of our reporting unit to the carrying value, including goodwill. We estimate the fair value of our reporting unit by primarily using a market capitalization approach, and also looking at the outlook for the business. The results of our most recent annual assessments performed on October 1, 2009 and 2008 did not indicate any impairment of our goodwill.

 

 Subsequent to our October 1, 2008 goodwill impairment test, our market capitalization was impacted by the volatility in the U.S. equity markets.  For ten days between October 24, 2008 and November 21, 2008, the day of January 21, 2009 and for six trading days between March 3, 2009 and March 10, 2009, our market capitalization was on average approximately 5% below the approximately $405 million carrying value of our consolidated net assets, as of October 1, 2008. The periods between October 24, 2008 and November 21, 2008 and March 3, 2009 to March 10, 2009 coincided with the overall stock market’s low periods for 2008, and 2009, respectively.

  Despite the fact that our market capitalization traded below our book value for a brief period of time, we believed that there had not been an impairment anytime during 2009 or 2008, based on the limited duration and depth of the market decline. In addition, there was no factoring of an implied control premium.  A control premium is the amount that a buyer is willing to pay over the current market price of a company as indicated by the market capitalization, in order to acquire a controlling interest.  The premium is justified by the expected synergies, such as the expected increase in cash flow resulting from the cost savings and revenue enhancements. As of December 31, 2008, our market capitalization was approximately $475 million compared to our book value, including goodwill, of approximately $396 million. As of October 1, 2009, our market capitalization was approximately $750 million compared to our book value, including goodwill, of approximately $418 million.    

     We evaluate our long-lived assets, including property and equipment and finite-lived intangible assets for potential impairment on an individual asset basis or at the lowest level asset grouping for which cash flows can be separately identified. Intangible asset impairments are assessed whenever changes in circumstances could indicate that the carrying amounts of those productive assets exceed their projected undiscounted cash flows. When it is determined that impairment exists, the related asset group is written down to its estimated fair market value. The determination of future cash flows and the estimated fair value of long-lived assets, involve significant estimates on the part of management. In order to estimate the fair value of a long-lived asset, we may engage a third party to assist with the valuation.

     Our process for assessing potential triggering events may include, but is not limited to, analysis of the following:

§

any sustained decline in the company's stock price below book value;

§

results of our goodwill impairment test;

§

sales and operating trends affecting products and groupings;

§

the impact on current and future operating results related to industry statistics including fluctuation of lending relationships between financing sources and automobile dealers, actual and projected annual vehicle sales, the number of dealers within our network;

§

any losses of key acquired customer relationships; and

§

changes to or obsolescence of acquired technology, data, and trademarks.

  We expect to continue to experience challenges due to the ongoing adverse outlook for the credit markets and automobile sales. If events and circumstances were to continue we may be required to write-off some of our goodwill or long-lived assets and could incur a significant non-cash charge to our income statement.

 We also evaluate the remaining useful life of our long-lived assets on a periodic basis to determine whether events or circumstances warrant a revision to the remaining estimated amortization period.

 

  As discussed in Note 6 of our consolidated financial statements, during the fourth quarter of 2008, as a result of a specific event, we recorded and impairment of an intangible asset of approximately $1.9 million to cost of revenue.

 

  Income Taxes

 

     We account for income taxes in accordance with the provisions of ASC Topic 740, Accounting for Income Taxes, which requires deferred tax assets and liabilities to be recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be reversed. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

     The total liability for the uncertain tax positions recorded in our balance sheet in accrued other liabilities as of December 31, 2009 and December 31, 2008, was $0.8 million and $0.5 million, respectively. Interest and penalties, if any, related to tax positions taken in our tax returns are recorded in interest expense and general and administrative expenses, respectively, in our consolidated statement of operations. As of December 31, 2009 and December 31, 2008, we have accrued interest and penalties related to tax positions taken on our tax returns of approximately $47,000 and $38,000, respectively.

 

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  Advertising Expenses

 

     We expense the cost of advertising and promoting our services as incurred. Such costs are included in selling, general and administrative expenses in the consolidated statements of operations and totaled $1.3 million, $1.4 million and $1.7 million for the years ended December 31, 2009, 2008 and 2007, respectively.

 

  Concentration of Credit Risk

 

     Our assets that are exposed to concentrations of credit risk consist primarily of cash, cash equivalents, short-term and long-term investments and receivables from clients. We place our cash, cash equivalents, short-term investments and long-term investments with financial institutions. We regularly evaluate the creditworthiness of the issuers in which we invest. Our trade receivables are spread over many customers. We maintain an allowance for uncollectible accounts receivable based on expected collectability and perform ongoing credit evaluations of customers’ financial condition. As of December 31, 2009 and 2008 no customer accounted for more than 10% of our accounts receivable. For the three years ended December 31, 2009 no customer accounted for more than 10% of our revenue.

 

     Our revenue is generated from customers associated with the automotive industry.

 

  Net (Loss) Income per Share

 

     Effective January 1, 2009, we adopted ASC Topic 260-10-45, Earnings Per Share (ASC Topic 260). Under ASC Topic 260, unvested share-based payment awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing earnings per share. Our nonvested restricted common stock, which includes our long-term incentive equity awards, are considered participating securities since the share-based awards contain a non-forfeitable right to dividends irrespective of whether the awards ultimately vest and, therefore, have been included in the denominator of both the basic and diluted earnings per share calculations. Basic earnings per share is calculated by dividing net (loss) income, adjusted for amounts allocated to participating securities under two-class method, by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income, adjusted for amounts allocated to participating securities under two-class method, by the weighted average number of common shares outstanding, assuming dilution, during the period. All prior-periods earnings per share data presented have been adjusted retroactively to conform to the provision of ASC Topic 260, which did not have a significant impact on our historical earnings per share calculations.

 

     The following table sets forth the computation of basic and diluted net (loss) income per share (in thousands, except share and per share amounts):

		Year Ended December 31,
		2009				2008				2007
Numerator:
Net (loss) income		$	(4,334	)		$	1,736			$	19,752
Net income allocated to participating securities under two-class method			—				(36	)			(447	)
Net (loss) income applicable to common stockholders		$	(4,334	)		$	1,700			$	19,305
Denominator:
Weighted average common stock outstanding (basic)			39,524,544				40,461,896				39,351,138
Common equivalent shares from options to purchase common stock and restricted common stock units (1)			—				1,076,483				1,535,344
Weighted average common stock outstanding (diluted)			39,524,544				41,538,379				40,886,482
Basic net (loss) income per share applicable to common stockholders (2)		$	(0.11	)		$	0.04			$	0.49
Diluted net (loss) income per share applicable to common stockholders (2)		$	(0.11	)		$	0.04			$	0.47

 

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     The following is a summary of the weighted securities outstanding during the respective periods that have been excluded from the diluted net (loss) income per share calculation because the effect would have been antidilutive:

		Year Ended December 31,
		2009				2008 (2)				2007 (2)
Stock options			4,292,789				2,252,509				478,421
Restricted stock units			629,041				—				—
Total			4,921,830				2,252,509				478,421

 

(1)	Our restricted common stock units are not considered participating securities since they do not contain a non-forfeitable right to dividends and have, therefore, not been included in the denominator for basic earnings per share calculations.

(2)	Earnings per share data for the years ended December 31, 2008 and 2007 have been retroactively adjusted to conform to the provisions of ASC Topic 260, which did not have a significant impact on our historical earnings per share calculation.

  Stock-Based Compensation

     We have four types of stock-based compensation programs: stock options, restricted stock units, restricted common stock, and an employee stock purchase plan (ESPP).

 

     The following summarizes stock-based compensation expense recognized for the three years ended December 31, 2009, 2008 and 2007 (in thousands):

	Year Ended December 31,
	2009				2008				2007
Stock options		$	10,475			$	8,331			$	6,333
Restricted common stock (1)			4,599				5,361				4,260
Restricted stock units			1,855				—				—
ESPP			60				299				313
Total stock-based compensation expense (2)		$	16,989			$	13,991			$	10,906

(1)	The expense recorded to restricted common stock includes expense related to the EBITDA Performance Award and the Market Value Award for the years ended December 31, 2009, 2008 and 2007 as follows (in thousands):

		Year Ended December 31,
		2009				2008				2007
EBITDA Performance Award		$	486			$	682			$	640
Market Value Award			258				750				717
Total		$	744			$	1,432			$	1,357

(2)

Included in stock-based compensation expense for the year ended December 31, 2009 was $3.9 million of stock-based compensation expense related to the realignment of our workforce and business on January 5, 2009. For further information about the realignment of our workforce and business, please refer to Note 16.

 

  Stock-based compensation cost is measured at the grant date based on the fair value of the award, and recognized as an expense over the requisite service period, net of an estimated forfeiture rate. Determining the appropriate fair value model and calculating the fair value of the share-based payment awards require the input of highly subjective assumptions, including the expected life, expected stock price volatility, and the number of expected options, restricted stock units, or restricted common stock that will be forfeited prior to the completion of the vesting requirements. We use the Black-Scholes and binomial lattice-based valuation pricing models to value our stock-based awards.

 

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 Due to our limited public company history, for the years ended December 31, 2009, 2008 and 2007, the expected volatility and for the year ended December 31, 2009, the expected life of option grants were determined based on the expected volatility and expected lives of similar entities whose shares are publicly traded, except for the expected volatility and expected life assumptions utilized for awards granted in September 2009 under the Stock Option Exchange Program (SOEP) and the Long-Term Incentive Plan (LTIP). For the years ended December 31, 2008 and 2007, the expected lives of options were determined based on the “simplified” method under the provisions of ASC Topic 718-10, Compensation – Stock Compensation.

 

 For options granted in September 2009 under the SOEP, we began estimating our expected volatility using a time-weighted average of our historical volatility in combination with the historical volatility of similar entities whose common shares are publicly traded.  We expect to apply this volatility methodology to future option grants.  The expected life under the SOEP was determined by an independent third party by means of Monte-Carlo simulations of future stock price based upon “in-the-money”, vesting schedule, contractual term, current life to date and applied an annual termination rate (after vesting) to the outstanding options in the simulation to reflect the probability of exercise behavior.  Stock-based compensation expenses related to the SOEP will be amortized over the new vesting schedule of 25% six months from the grant date, 25% twelve months from the grant date and 1/48 each month thereafter.

 

  Awards granted under the LTIP consisted of 455,000 shares of restricted common stock (net of cancellations). Each individual’s total award was allocated 50% to achieving earnings before interest, taxes, depreciation and amortization, as adjusted to reflect any future acquisitions (EBITDA Performance Award) and 50% to the market value of our common stock (Market Value Award). The awards were to be earned upon our achievement of EBITDA and market-based targets for the fiscal years 2007, 2008 and 2009, but would not vest unless the grantee remained continuously employed in active service until January 31, 2010. If an EBITDA Performance Award or Market Value Award was not earned in an earlier year, it could have been earned upon achievement of that target in a subsequent year. The awards were subject to acceleration in full upon a change in control. We valued the EBITDA Performance Award and the Market Value Award using the Black-Scholes and binomial lattice-based valuation pricing models, respectively. The total fair value of the entire EBITDA Performance Award was $6.0 million (prior to estimated forfeitures), of which, in 2007, we began expensing the amount associated with the 2007 award as it was deemed probable that the threshold for the year ending December 31, 2007 would be met. The EBITDA target for 2007 was achieved. As of December 31, 2009, no amounts were expensed related to the EBITDA Performance Awards for 2008 and 2009 as the targets were not achieved. The total value of the entire Market Value Award was $2.5 million (including estimated forfeitures), which was expensed on a straight-line basis from the date of grant over the applicable service period. As long as the service condition was satisfied, the expense was not reverseable, even if the market conditions were not satisfied. During the year ended December 31, 2009, 96,667 shares of long-term performance equity awards were cancelled and the vesting of 38,333 shares of long-term performance equity awards were accelerated due to the departure of certain executive officers, most of which were in connection with the realignment of our workforce and business as discussed in Note 16. For the year ended December 31, 2009, we reversed approximately $0.5 million of stock-based compensation expense related to the cancelled shares and recorded stock-based compensation expense of approximately $0.2 million related to the accelerated shares. On January 31, 2010, 151,697 shares of long-term performance equity awards vested relating to the 2007 EBITDA Performance Award and the 2007 Market Value Award and the remaining 303,303 shares of long-term performance equity awards were cancelled as the 2008 and 2009 EBITDA and Market Value targets were not achieved.

 

  Other assumptions required for estimating fair value with Black-Scholes model are the expected risk-free interest rate and the expected dividend yield.  The risk-free interests used were the actual U.S. Treasury zero-coupon rates for bonds matching our expected life of an option on the date of grant.  The expected dividend yield is not applicable as we have not paid any dividends and current intend to retain any future earnings for use in our business.

 

  Options granted generally (SOEP and LTIP exceptions noted above) vest over a period of four years from the vesting commencement date (three years for directors), and expire seven years from the date of grant, except for stock options granted prior to July 11, 2007, which expire ten years from the date of grant and terminate, to the extent unvested, on the date of termination of employment, and to the extent vested, generally at the end of the three-month period following termination of employment, except in the case of executive officers, who under certain conditions have a twelve-month period following termination of employment to exercise.

 Application of alternative assumptions could produce significantly different estimates of the fair value of stock-based compensation and consequently, the related amounts recognized in our consolidated statements of operations. 

 

  For the year ended December 31, 2009, 2008, and 2007, the fair market value of each option grant has been estimated on the date of grant using the Black-Scholes Option Pricing Model with the following assumptions:

		Year Ended December 31,
		2009				2008				2007
Expected life (in years)			4.18 – 4.47				4.33 – 4.47				4.33 – 6.25
Risk-free interest rate			1.62 – 2.12	%			2.35 – 3.14	%			3.09 – 4.76	%
Expected volatility			48.6 – 51.6	%			47 – 48.6	%			47	%
Expected dividend yield			0	%			0	%			0	%
Weighted-average fair value of options granted		$	5.79			$	9.61			$	16.47

 

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  The fair value of the EBITDA Performance Award for the years ended December 31, 2007 and 2006 has been estimated on the date of grant using a Black-Scholes valuation pricing model with the following weighted-average assumptions

		July 21, 2007				November 2, 2006				August 2, 2006
Expected volatility			47.00	%			40.00	%			40.00	%
Expected dividend yield			0.00	%			0.00	%			0.00	%
Expected life (in years)			2.37				3.16				3.42
Risk-free interest rate			4.43	%			4.91	%			4.99	%
Weighted-average fair value of EBITDA Performance Award		$	38.01			$	25.39			$	18.95

 

     The number of shares of restricted common stock that management expects to be earned for the Market Value Award for the years ended December 31, 2007 and 2006 has been estimated on the date of grant using a binomial lattice-based valuation pricing model with the following weighted-average assumptions:

		July 21, 2007				November 2, 2006				August 2, 2006
Expected volatility			47.00	%			40.00	%			40.00	%
Expected dividend yield			0.00	%			0.00	%			0.00	%
Expected life (in years)			2.37				1.16-3.16				1.41-3.42
Risk-free interest rate			4.43	%			4.55-4.91	%			4.83-4.99	%
Weighted-average fair value of Market Value Award		$	29.77			$	15.86			$	7.49

 

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (FASB) issued Revenue Recognition guidance around Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force. This guidance modifies the fair value requirements of Revenue Recognition-Multiple Element Arrangements by allowing the use of the “best estimate of selling price” in addition to VSOE and VOE (now referred to as third-party evidence or TPE) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted. The final consensus is effective for fiscal years beginning after June 15, 2010. Companies will have the option of adopting the guidance retrospectively or prospectively for new or materially modified agreements. Early adoption is permitted as of the beginning of an entity’s fiscal year. We are currently evaluating the impact of this guidance on our consolidated financial statements.

In June 2009, the FASB issued the The FASB Accounting Standards Codification™ (the Codification) which became the single authoritative U.S. accounting and reporting standards applicable for all nongovernmental entities, with the exception of guidance issued by the Securities and Exchange Commission (SEC). The Codification does not change current U.S. GAAP, but changes the referencing of financial standards, and is intended to simplify user access to authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. The Codification is effective for interim and annual periods ending after September 15, 2009, and was effective for our third quarter of 2009. At that time, all references made to U.S. GAAP used the new Codification numbering system prescribed by the FASB. The Codification does not change or alter existing U.S. GAAP and did not have any impact on our consolidated financial statements.

In June 2009, the FASB issued a new standard which modified how a company determines when it is required to consolidate an entity and is based on, among other things, an entity’s purpose and design, a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance, and the obligation to absorb losses or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. This new standard requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity and also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. This standard is effective for fiscal years beginning after November 15, 2009. We are currently evaluating the impact of this guidance on our consolidated financial statements.

 

3. Fair Value Measurements

 

Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs used to measure fair value are prioritized into a three-level fair value hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair values are as follows:

 

·

Level 1 – Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

 

·

Level 2 – Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

 

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·

Level 3 – Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

 

We have segregated all financial assets that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below.

 

Financial assets measured at fair value on a recurring basis include the following as of December 31, 2009 and 2008 (in thousands):

As of December 31, 2009		Quoted Prices in Active Markets (Level 1)				Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)				December 31, 2009
Cash equivalents (1)		$	127,608			$	—			$	—			$	127,608
Short-term investments (2)			1,484				—				—				1,484
Long-term investments (3)			—				—				3,971				3,971
Total		$	129,092			$	—			$	3,971			$	133,063

As of December 31, 2008		Quoted Prices in Active Markets (Level 1)				Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)				December 31, 2008
Cash equivalents (1)		$	124,497			$	—			$	—			$	124,497
Short-term investments (2)(4)			42,490				860				—				43,350
Long-term investments (3)(4)			—				2,842				1,550				4,392
Total		$	166,987			$	3,702			$	1,550			$	172,239

(1)

Cash equivalents consist primarily of money market funds with original maturity dates of three months or less, for which we determine fair value through quoted market prices.

 

(2)

As of December 31, 2009, Level 1 short-term investments include investments in tax-advantaged preferred securities. As of December 31, 2008, Level 1 short-term investments consisted primarily of corporate bonds and municipal notes with maturity dates of one year or less, for which we determined fair value through quoted market prices.

 

(3)

Level 3 long-term investments as of December 31, 2009 and 2008 include a $1.6 million, or 0.3% of total assets, auction rate security (ARS) invested in a tax-exempt state government obligation that was valued at par. Our intent is not to hold the ARS invested in tax-exempt state government obligations to maturity, but rather to use the interest reset feature to provide liquidity. However, should the marketplace auctions continue to fail we may hold the security to maturity. We have classified this as long-term due to the maturity date of the security being in 2011, coupled with ongoing failed auctions in the marketplace.

 

Level 3 long-term investments as of December 31, 2009 also include $2.4 million, or 0.5% of total assets, of tax-advantaged preferred stock of a financial institution. It is uncertain whether we will be able to liquidate these securities within the next twelve months; as such we have classified them as long-term on our consolidated balance sheets. Due to the lack of observable market quotes we utilized valuation models that rely exclusively on Level 3 inputs including those that are based on expected cash flow streams, including assessments of counterparty credit quality, default risk underlying the security, discount rates and overall capital market liquidity.

 

(4)

As of December 31, 2008, Level 2 short-term and long-term investments of $3.7 million (net of impairment charge) consisted of ARS invested in tax-advantaged preferred stock trusts in which the underlying equities are preferred stock. Based upon our assessment we reduced the fair value of the investments in the preferred stock trusts form $9.6 million to $3.7 million and recorded an other-than-temporary charge of $6.0 million to earnings and an unrealized gain of $0.1 million to stockholders’ equity during the year ended December 31, 2008. These ARS were associated with failed auctions.

 

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The change in the carrying amount of Level 3 investments for the years ended December 31, 2008 and 2009 is as follows (in thousands):

Balance as of January 1, 2008		$	—
Reclassification from Level 1 investments to Level 3 investments			169,580
Reclassification from Level 3 investments to Level 2 investments			(3,936	)
Net sales of auction rate securities			(158,430	)
Other-than-temporary impairment included in net income			(5,664	)
Balance as of December 31, 2008			1,550
Reclassification from Level 2 investments to Level 3 investments (5)			1,360
Realized gain on securities included in the statement of operations (5)			716
Unrealized gain on securities recorded in other comprehensive income (5)			345
Balance as of December 31, 2009		$	3,971

 

(5)

During 2009 our investments in ARS invested in certain tax-advantaged preferred stock trusts held as of December 31, 2008 dissolved and the trustees distributed the underlying preferred stock instruments. As a result of these conversions we measured the fair value of the Level 3 long-term tax-advantaged preferred stock on the distribution date and determined that the value increased from December 31, 2008 and as a result we recorded a realized gain in the statement of operations of $0.7 million from $1.4 million to $2.1 million. Subsequent to the trust dissolution through December 31, 2009 we re-measured the fair value and determined that the value had increased and recorded a gain in other comprehensive income of $0.3 million on the increased fair value.  The total value of the tax-advantaged preferred stock of a financial institution included in the $4.0 million of Level 3 long-term investments as of December 31, 2009 is $2.4 million.

We review the fair value of our short-term and long-tem investments for impairment in accordance with ASC Topic 320, Investments – Debt and Equity Securities.  A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income component of stockholders’ equity. It occurs if a loss in an investment is determined to be temporary in nature and we have the ability and intent to hold the investment until a recovery in market value takes place. Such an unrealized loss does not reduce our net income for the applicable accounting period because the loss is not viewed as other-than-temporary. An impairment charge is recorded against earnings to the extent we determine that there is a loss of fair value that is other-than-temporary. For the year end December 31, 2008, we determined that the significant reduction in fair value related to our preferred stock trusts ARS was other-than-temporary and we recorded an impairment charge in our consolidated statements of operations based on a variety of factors, including the significant decline in fair value indicated for the individual investments and the adverse market conditions impacting ARS.

 

4. Business Combinations

 

AAX Acquisition

On January 23, 2009, we acquired the AAX ® suite of inventory management solutions and other assets, including without limitation all of the capital stock of AAX (collectively, AAX), from JM Dealer Services, Inc., a subsidiary of JM Family Enterprises, Inc. (seller), for a purchase price of $30.9 million (net of a purchase price adjustment of $1.7 million, which is discussed below). We expensed approximately $0.5 million of professional fees associated with this acquisition, which is classified in selling, general and administrative expenses.

This acquisition was recorded under the purchase method of accounting, resulting in the total purchase price being allocated to the assets acquired and liabilities assumed according to their estimated fair values at the date of acquisition as follows (in thousands):

Current assets		$	489
Property and equipment			1,035
Intangible assets			16,639
Goodwill			15,348
Total assets acquired			33,511
Total liabilities assumed			(2,636	)
Net assets acquired		$	30,875

 

The liabilities assumed includes a $2.3 million deferred tax liability that relates primarily to the future amortization of certain acquired intangibles.

 

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We allocated the amounts of intangible assets and goodwill based on fair value as follows: approximately $7.4 million of the purchase price has been allocated to customer contracts (weighted-average useful life is 6.5 years), $6.2 million to acquired technology and database (weighted-average useful life is 4.2 years), $2.0 million to the AAX trade name (seven year useful life), and $1.0 million to a non-compete agreement (four year useful life).  The useful life for each of the above acquired long-term intangible assets was determined based on the period which the asset is expected to contribute directly or indirectly to our future cash flows. We recorded approximately $15.3 million in goodwill, which represents the remainder of the excess of the purchase price over the fair value of the net assets acquired. The allocated value of goodwill primarily relates to the acquired workforce and the anticipated synergies resulting from combining AAX with our current inventory management solution, and $13.0 million of the goodwill recorded is deductible for tax purposes.

 

Certain acquired intangibles in our AAX acquisition are being amortized using an accelerated method of amortization.  In determining amortization expense under our accelerated method for any given period, we calculate the expected cash flows for that period that were used in determining the acquired value of the asset and divide that amount by the total expected cash flows over the estimated life of the asset.  We multiply that percentage by the initial carrying value of the asset to arrive at the amortization expense for that period.  Based on the nature of the asset and how the asset is valued in purchase accounting, we believe that this method better approximates the distribution of cash flows generated by the acquired intangible asset.  We will continue to use the straight line method for certain intangible assets if there is no better pattern in which the asset’s economic benefits are consumed or otherwise used up.

 

The results of AAX were included in our consolidated statement of operations from the date of acquisition. AAX revenue since the date of acquisition was $18.4 million. We are unable to provide AAX earnings since acquisition since we do not have stand-alone earnings reporting for AAX.

 

Other AAX deal terms

 

Service Credits

 

A condition of the purchase agreement gives the seller the right to service credits of $2.5 million, which may be applied against fees that are charged in connection with their purchase of any future products or services of DealerTrack.  These service credits expire on January 23, 2013. No revenue will be recorded for services provided under the service credits.

 

Purchase Price Adjustment

 

A condition of the purchase agreement provided that the seller and its affiliates would reimburse us $1.7 million for certain lost tax deductions due to the structuring of the transaction. The purchase price reimbursement has been recorded as a receivable in purchase accounting and was collected on October 1, 2009.

 

There is a contingency in the purchase arrangement that could have required the seller to reimburse a portion of the purchase price to DealerTrack if certain customers canceled their subscriptions based on certain factors.  We believed the probability for this contingency to occur was remote.  As such, no value was ascribed to this contingency in purchase accounting. The contingency period was amended during the third quarter 2009 to expire September 30, 2009 instead of October 31, 2009.

Unaudited Pro Forma Summary of Operations

     The accompanying unaudited pro forma summary presents our consolidated results of operations as if the acquisition of AAX had been completed as of the beginning of each period presented. The pro forma information does not necessarily reflect the actual results that would have been achieved, nor is it necessarily indicative of our future consolidated results.

		Year Ended December 31,
		2009				2008
		(in thousands, except share and per share amounts)
		(Unaudited)
Net revenue		$	227,209			$	268,789
Net loss		$	(4,559	)		$	(3,601	)
Basic net loss per share applicable to common stockholders		$	(0.12	)		$	(0.09	)
Diluted net loss per share applicable to common stockholders		$	(0.12	)		$	(0.09	)

 

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AutoSytleMart, Inc. (ASM) Acquisition

 

     On August 1, 2007, we completed the purchase of all of the outstanding shares of ASM, for a purchase price of $4.0 million in cash (including direct acquisition costs of $0.2 million). ASM is a provider of accessories-related solutions to automotive dealerships. Under the terms of the merger agreement, we have a future contingent payment obligation of up to $11.0 million based upon the achievement of certain operational targets from February 2008 through February 2011. As of December 31, 2009, we determined that certain operational conditions were probable of being achieved and recorded a liability of $1.0 million. The additional consideration of $1.0 million was deemed compensation for services, as payment was contingent on certain former stockholders remaining employees or consultants of DealerTrack for a certain period. The $1.0 million was recorded as a selling, general and administrative expense for the year ended December 31, 2009. As of December 31, 2009, it has been determined that the operational targets related to the remaining $10.0 million in contingent payment obligations are not yet probable of being achieved. Any amounts deemed probable in the future will also be recorded as a selling, general and administrative expense. Quarterly, we will re-assess the probability of the achievement of the operational targets.

 

     This acquisition was recorded under the purchase method of accounting, resulting in the total purchase price being allocated to the assets acquired and liabilities assumed according to their estimated fair values at the date of acquisition as follows (in thousands):

Current assets		$	69
Property and equipment			32
Intangible assets			4,126
Goodwill			808
Total assets acquired			5,035
Total liabilities assumed			(1,018	)
Net assets acquired		$	4,017

 

     The liabilities assumed includes a $1.4 million deferred tax liability that relates to the future amortization of acquired intangibles offset by a $1.0 million deferred tax asset that relates primarily to acquired net operating loss carryovers.

 

     We allocated the amounts of intangibles and goodwill based on fair value as follows: approximately $3.7 million of the purchase price has been allocated to purchased technology and $0.4 million to non-compete agreements. These intangibles are being amortized on a straight line basis over four to five years based on each intangible’s estimated useful life. We also recorded approximately $0.8 million in goodwill, which represents the remainder of the excess of the purchase price over the fair value of the net assets acquired.

 

     The results of AutoStyleMart were included in our consolidated statements of operations from the date of acquisition.

 

 Arkona, Inc. (Arkona) Acquisition

 

     On June 6, 2007, we completed the purchase of all of the outstanding shares of Arkona for a cash purchase price of approximately $60.0 million (including direct acquisition costs of approximately $1.0 million). This acquisition expands our product suite with an on-demand dealership management system that can be utilized by franchised, independent and other specialty retail dealers.

 

     This acquisition was recorded under the purchase method of accounting, resulting in the total purchase price being allocated to the assets acquired and liabilities assumed according to their estimated fair values at the date of acquisition as follows (in thousands):

Current assets		$	2,842
Property and equipment			2,065
Other assets			191
Intangible assets			25,660
Goodwill			39,091
Total assets acquired			69,849
Total liabilities assumed			(9,876	)
Net assets acquired		$	59,973

 

     The liabilities assumed includes a $9.3 million deferred tax liability that relates primarily to the future amortization of acquired intangibles offset by a $4.5 million deferred tax asset that relates primarily to acquired net operating loss carryovers. Additionally, the liabilities assumed include approximately a $2.8 million sales tax liability, which had been reduced by $0.8 million for the year ended December 31, 2008.   For the year ended December 31, 2009, we reversed an additional $0.6 million of the pre-acquisition sales tax liability. The contingency was resolved subsequent to the close of the purchase accounting allocation period and, as such, the $0.6 million was recorded as other income in the 2009 statement of operations.

 

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 We allocated the amounts of intangible assets and goodwill based on fair value appraisals as follows: approximately $14.7 million of the purchase price has been allocated to purchased technology (five year life), $9.2 million to customer contracts (four year life) and $1.8 million to non-compete agreements (one and three year lives). These estimated intangibles are being amortized on a straight line basis over each intangible’s estimated useful life. We also recorded approximately $39.1 million in goodwill, which represents the remainder of the excess of the purchase price over the fair value of the net assets acquired.

 

     The results of Arkona were included in our consolidated statements of operations from the date of acquisition.

 

Curomax Corporation and its subsidiaries (Curomax) Acquisition

 

     On February 1, 2007, we completed the purchase of all of the outstanding shares of Curomax pursuant to a shares purchase agreement, dated as of January 16, 2007, for an adjusted cash purchase price of approximately $40.7 million (including direct acquisition and restructuring costs of approximately $1.6 million). Curomax is a provider of an Internet-based credit application and contract processing network in Canada. Under the terms of the share purchase agreement, we had future contingent payment obligations of approximately $1.8 million in cash to be paid out based upon the achievement of certain operational objectives over the subsequent twenty-four months. As of December 31, 2008, we had determined that certain operational conditions had been met and as such, recorded a liability and additional goodwill of approximately $1.8 million which was paid in the first quarter of 2009.

 

     This acquisition was recorded under the purchase method of accounting, resulting in the total purchase price being allocated to the assets acquired and liabilities assumed according to their estimated fair values at the date of acquisition as follows (in thousands):

Current assets		$	1,925
Property and equipment			339
Intangible assets			21,670
Goodwill			21,929
Total assets acquired			45,863
Total liabilities assumed			(5,154	)
Net assets acquired		$	40,709

 

     The liabilities assumed includes a $3.9 million deferred tax liability that relates primarily to the future amortization of acquired intangibles offset by a $0.3 million deferred tax asset that relates primarily to acquired net operating loss carryovers.

 

     We allocated the amounts to intangible assets and goodwill based on fair value appraisals as follows: approximately $17.2 million of the purchase price has been allocated to customer contracts (four year life), $0.8 million to purchased technology (one and two year lives) and $3.7 million to non-compete agreements (two year lives). These intangibles are being amortized on a straight-line basis over each intangible’s estimated useful life. We also recorded approximately $21.9 million in goodwill, which represents the remainder of the excess of the purchase price over the fair value of the net assets acquired.

 

     The results of Curomax were included in our consolidated statements of operations from the date of acquisition. On January 1, 2008, Curomax Corporation was amalgamated into DealerTrack Canada, Inc.

 

Automotive Lease Guide (ALG) Purchase Price Adjustment

 

     In connection with the purchase of Automotive Lease Guide on May 25, 2005, we have a contractual agreement with the seller to pay an additional $0.8 million per year for 2006 through 2010. There was additional contingent consideration of up to $11.3 million that could be paid contingent upon future increases in revenue of ALG and another one of our subsidiaries through December 2009. The total amount of contingent consideration paid or accrued as of December 31, 2009 was $3.1 million. The additional purchase price consideration was recorded as goodwill on our consolidated balance sheet.

 

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5. Property and Equipment

 

     Property and equipment are recorded at cost and consist of the following (dollars in thousands):

		Estimated Useful			December 31,
		Life (Years)			2009				2008
Computer equipment			3 - 5			$	22,662			$	20,431
Office equipment			5				3,550				2,896
Furniture and fixtures			5				3,343				3,068
Leasehold improvements			5 -11				3,188				1,233
Total property and equipment, gross							32,743				27,628
Less: Accumulated depreciation and amortization							(19,229	)			(14,180	)
Total property and equipment, net						$	13,514			$	13,448

 

     Depreciation and amortization expense related to property and equipment for the years ended December 31, 2009, 2008 and 2007, was $7.1 million, $5.9 million and $4.1 million, respectively, and is calculated on a straight line basis over the estimated useful life of the asset.

 

6. Intangible Assets

 

     The gross book value, accumulated amortization and amortization periods of the intangible assets were as follows (dollars in thousands):

		December 31, 2009								December 31, 2008
		Gross								Gross								Amortization
		Book				Accumulated				Book				Accumulated				Period
		Value				Amortization				Value				Amortization				(Years)
Customer contracts		$	40,352			$	(24,769	)		$	33,673			$	(17,289	)			2-7
Database			13,825				(10,945	)			13,333				(8,818	)			3-6
Trade names			12,510				(6,924	)			10,500				(5,469	)			5-10
Technology			27,170				(11,110	)			22,684				(7,209	)			1-5
Non-compete agreement			6,585				(5,090	)			10,697				(7,697	)			2-5
Total		$	100,442			$	(58,838	)		$	90,887			$	(46,482	)

 

     Amortization expense related to intangibles for the years ended December 31, 2009, 2008, and 2007, was $20.3 million, $26.8 million, and $28.2 million, respectively.

 

     Amortization expense that will be charged to income for the subsequent five years and thereafter is estimated, based on the December 31, 2009 book value, as follows (in thousands):

2010		$	19,211
2011			10,363
2012			5,476
2013			3,439
2014			2,177
Thereafter			938
Total		$	41,604

 

  On November 10, 2008, we entered into a perpetual license agreement for certain CRM technology components with AutoNation Holding Corp, Inc. for $3.0 million. The entire $3.0 million was allocated to the fair value of the technology acquired and will be amortized to cost of revenue over its useful life.

 

  During May 2006, as a part of our acquisition of Global Fax, LLC we recorded an intangible asset related to an application processing contract with DHL of $4.4 million. During the fourth quarter of 2008, we were notified by DHL that they would be cancelling their contract and as such management concluded that this asset was impaired and accelerated the remaining amortization of approximately $1.9 million to cost of revenue.    

 

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7. Goodwill

 

  The changes in the carrying amount of goodwill for the year ended December 31, 2009 is as follows (in thousands):

Balance as of January 1, 2009		$	114,886
Acquisition of AAX (Note 4)			15,348
Impact of change in Canadian dollar exchange rate			3,587
Exit from SCS business (Note 17)			(200	)
Purchase price adjustment – ALG (Note 4)			1,126
Balance as of December 31, 2009		$	134,747

 

     The changes in the carrying amount of goodwill for the year ended December 31, 2008 is as follows (in thousands):

Balance as of January 1, 2008		$	117,702
Purchase price adjustments — Curomax (Note 4)			1,799
Impact of change in Canadian dollar exchange rate			(4,610	)
Purchase price adjustments – ALG (Note 4)			1,139
Purchase price adjustments – Arkona (Note 4)			(836	)
Other			(308	)
Balance as of December 31, 2008		$	114,886

 

8. Accrued Liabilities - Other

 

     Following is a summary of the components of other accrued liabilities (in thousands):

		December 31,
		2009				2008
Customer deposits		$	2,357			$	2,749
Professional fees			2,197				1,158
Revenue share			1,284				1,700
Sales taxes			883				1,511
Software licenses			1,408				1,341
Accrued Curomax contingent consideration (Note 4)			—				1,837
Other			3,195				1,089
Total accrued liabilities - other		$	11,324			$	11,385

 

9. 401(k) Plan

 

  Our 401(k) plan covers substantially all employees meeting certain age requirements in accordance with section 401(k) of the Internal Revenue Code. Under the provisions of the 401(k) plan, we have the ability to make matching contributions equal to a percentage of the employee’s voluntary contribution, as well as an additional matching contribution at year end and a nonelective contribution. Effective April 1, 2009, we discontinued new matching contributions to the plan. At December 31, 2009, the Company elected to make a 1% matching contribution on eligible earnings under the 401(k) plan. Effective January 1, 2010 the Company reinstated the employer matching contributions to the 401(k) plan. Contributions under such plans for the years ended December 31, 2009, 2008 and 2007 were $1.3 million, $2.0 million and $1.6 million, respectively.

 

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10. Income Taxes

 

     The components of our (loss) income before income taxes are as follows (in thousands):

		Year Ended December 31,
		2009				2008				2007
United States		$	(16,676	)		$	(2,467	)		$	29,433
Canada			8,823				8,164				3,353
Total (loss) income before taxes		$	(7,853	)		$	5,697			$	32,786

 

     The (benefit) provision for income taxes consists of the following (in thousands):

		Year Ended December 31,
		2009				2008				2007
Current tax:
Federal		$	383			$	2,440			$	14,123
State and local			(1,066	)			290				2,373
Canada			4,426				3,283				1,169
Total current tax			3,743				6,013				17,665
Deferred tax:
Federal			(5,915	)			(1,783	)			(5,757	)
State and local			(498	)			(913	)			179
Canada			(849	)			644				947
Total deferred tax			(7,262	)			(2,052	)			(4,631	)
(Benefit) provision for income taxes, net		$	(3,519	)		$	3,961			$	13,034

 

     Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes using enacted tax rates in effect in the year in which the differences are expected to reverse.

 

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		December 31,
		2009				2008
Deferred tax assets:
Net operating loss carryforwards		$	3,363			$	4,465
Depreciation and amortization			77				—
Deferred compensation			15,438				11,053
Acquired intangibles			4,973				5,650
Tax credits			1,367				—
Impairment loss			1,135				2,171
Other			4,290				2,021
			30,643				25,360
Deferred tax liabilities:
Acquired Intangibles			(738	)			(1,299	)
Capitalized software and website development			(3,564	)			(2,076	)
Depreciation and amortization			—				(864	)
Tax credits			—				(100	)
Other			(1,088	)			(1,144	)
			25,253				19,877
Deferred tax asset valuation allowance			(3,862	)			(3,322	)
Total Deferred tax assets, net		$	21,391			$	16,555

 

As required by ASC Topic 740, Income Taxes, (ASC Topic 740) the conclusion that it is more likely than not that the net deferred tax asset of approximately $21.4 million and $16.6 million at December 31, 2009 and 2008, respectively, would be realized was based on careful evaluation of the nature and weight of all of the available positive and negative evidence in accordance with generally accepted accounting principles. In reaching our conclusion, we balanced the weight of both the negative and positive evidence including cumulative losses; recent positive earnings; the expected level of future earnings; the length of the carry forward periods applicable to the deferred tax assets; and the change in business activity in recent years as compared to the initial years of operation.

 

The Company’s deferred tax assets as of December 31, 2009 have been reduced in accordance with ASC 718. As such, foreign tax credit carryforwards which were increased due to excess tax benefits from the exercise of stock options are not recorded as deferred tax assets. Instead such amounts will be recorded as an addition to stockholders’ equity and will reduce current taxes payable if and when the carryovers are utilized. Deferred tax assets and the related valuation allowance in the above presentation have been reduced by the $1.3 million effect resulting from excess tax deductions from stock options.

 

We have state net operating losses which expire in various times and amounts through 2027. For the year ended December 31, 2009, we had a valuation allowance which may not be utilized of $3.9 million , of which approximately $1.1 million represents an allowance against our state net operating losses, $1.5 million represents an allowance against our impairment loss for auction rate securities, and $1.3 million represents an allowance against our Foreign Tax Credits. Capital losses generally may only be used to offset income from capital gains.  Since we do not anticipate any capital gains in the foreseeable future, no tax benefit is recorded with respect to the impairment losses as it is not likely that tax benefits would ultimately be realized from such losses. For the year ended December 31, 2008, approximately $1.1 million of the $3.3 million represents a valuation allowance against our state net operating losses, which may not be utilized, and $2.2 million of the $3.3 million represents a valuation allowance against our impairment loss for auction rate securities, which may not be utilized.

 

As of December 31, 2009 and 2008, we had U.S. federal net operating loss carryforwards of $6.3 million and $9.2 million, respectively. These loss carryforwards are subject to limitation under Section 382 of the Internal Revenue Code. These losses are available to reduce future taxable income and expire in varying amounts beginning in 2022.

 

As of December 31, 2009 and 2008, we had U.S. federal foreign tax credit carryovers of $1.3 million and $0.1 million respectively. These credits are available to offset future federal income tax subject to limitation and expire in varying amounts beginning in 2018.

 

As of December 31, 2008, all Canadian net operating loss carryforwards from prior periods were fully utilized.

 

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The difference in income tax expense between the amount computed using the statutory federal income tax rate and our effective tax rate is primarily due to state taxes and tax exempt income from investments. The effect of change in tax rate for 2009 and 2008 is primarily due to state taxes, differences in foreign tax rates, benefits derived from tax exempt income, effects of foreign repatriation and changes in earnings mix. The effect of change in tax rate for 2008 and 2007 is primarily due to state taxes, differences in foreign tax rates and the benefits derived from tax exempt income.

 

 

		Year Ended December 31,
		2009				2008				2007
Pre-tax book income			35.0	%			35.0	%			35.0	%
State taxes			2.3				(2.7	)			3.5
Foreign rate differential			(6.2	)			18.8				2.8
Deferred tax rate adjustment			2.2				(7.9	)			1.5
Valuation allowance and other			11.5				26.3				(3.1	)
Total			44.8	%			69.5	%			39.7	%

 

We do not provide for deferred taxes on the temporary differences related to investments in foreign subsidiaries since such profits are considered to be permanently invested.

 

We do not expect any significant increase or decrease in our unrecognized tax benefits within the next 12 months. We have adopted the revisions of generally accepted accounting principles, now included in ASC Topic 740 with respect to accounting for uncertain tax positions. ASC Topic 740 specifies the way public companies are to account for uncertainty in income taxes and prescribes the methodology for recognizing, reversing, and measuring the tax benefits of a tax position taken, or expected to be taken, in a tax return. Our adoption of ASC Topic 740 did not result in any change to the level of our liability for uncertain tax positions, and there was no adjustment to our retained earnings for the cumulative effect of an accounting change.

 

We file a consolidated US income tax return and tax returns in various state and local jurisdictions. Certain of our subsidiaries also file income tax returns in Canada. The Internal Revenue Service (IRS) has concluded a review of our consolidated federal income tax return for the periods ended December 31, 2006 and December 31, 2007 with no income tax adjustments. The IRS completed an examination of DealerTrack Systems, Inc. (f/k/a Arkona, Inc.) for the period ended March 31, 2006 (pre-acquisition period). The federal audit was concluded with no income tax adjustments. All of our other significant taxing jurisdictions are closed for years prior to 2006.

 

Interest and penalties, if any, related to tax positions taken in our tax returns are recorded in interest expense and general and administrative expenses, respectively, in our consolidated statement of operations. At December 31, 2007, no amounts were accrued for interest and penalties related to tax positions taken on our tax returns. At December 31, 2009 and December 31, 2008, we accrued interest and penalties related to tax positions taken on our tax returns of approximately $47,000 and $38,000, respectively.

 

 

Balance January 1, 2009		$	0.5
Additions			0.4
Statue expiration			(0.1	)
Payments			—
Balance December 31, 2009		$	0.8
Balance January 1, 2008		$	0.1
Additions			0.4
Payments			—
Balance December 31, 2008		$	0.5
Balance January 1, 2007		$	0.4
Additions			—
Payments			(0.3	)
Balance December 31, 2007		$	0.1

 

 

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As of December 31, 2009, approximately $0.5 million of the liability for uncertain tax positions recorded in our balance sheet would affect our effective rate upon resolution of the uncertain tax positions.

 

11. Stock Option and Deferred Compensation Plans

 

Third Amended and Restated 2005 Incentive Award Plan

 

On June 17, 2009, our stockholders approved a proposal to amend and restate our Second Amended and Restated Incentive Award Plan (2005 Plan) to, among other things, increase the aggregate number of shares authorized for issuance under the 2005 Plan by 4,855,847 shares. After giving effect to these additional shares there is an aggregate of 14,105,847 shares of common stock that have been reserved for issuance pursuant to the 2005 Plan. As of December 31, 2009, 5,430,632 shares were available for future issuance. Options granted generally vest over a period of four years from the vesting commencement date (three years for directors), and expire seven years from the date of grant (as defined by the plan document), except for stock options granted prior to July 11, 2007, which expire ten years from the date of grant (as defined by the plan document) and terminate, to the extent unvested, on the date of termination of employment, and to the extent vested, generally at the end of the three-month period following termination of employment, except in the case of executive officers, who under certain conditions have a twelve-month period following termination of employment to exercise.

 

Our stockholders also approved a proposal to amend our 2005 Plan to allow for a one-time stock option exchange program. For further information regarding the stock option exchange program, please refer to Note 12.

 

 

		Number of				Weighted-Average
		Shares				Exercise Price
Balance as of January 1, 2009			4,733,349			$	16.0616
Options Granted			1,188,907			$	14.1923
Options Exercised			(592,964	)		$	3.7129
Options Forfeited			(483,367	)		$	26.2041
Options Expired			(411,083	)		$	27.9625
Balance as of December 31, 2009			4,434,842			$	15.0110
Vested and unvested expected to vest as of December 31, 2009			1,489,077			$	17.3361

 

The intrinsic value of the stock options exercised during the years ended December 31, 2009, 2008 and 2007 was approximately $6.1 million, $1.1 million, and $18.9 million, respectively. The intrinsic value of the stock options vested and unvested expected to vest at December 31, 2009 was approximately $5.2 million. The weighted average remaining contractual term for options vested and unvested expected to vest at December 31, 2009 was 5.8491 years.

 

 

Options Outstanding

Options Exercisable

Weighted-

Weighted-

Average

Weighted-

Aggregate

Average

Weighted-

Aggregate

Exercise

Number of

Remaining

Average

Intrinsic

Remaining

Average

Intrinsic

Price

Shares

Contractual

Exercise

Value

Number

Contractual

Exercise

Value

Range

Outstanding

Life in Years

Price

(’000)

Exercisable

Life in Years

Price

(’000)

$2.80 — $47.98

4,434,842

4.9138

$

15.0110

$

26,425

2,855,556

4.3962

$

13.7253

$

20,990

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on our closing stock price of $18.79 for the year ended December 31, 2009.

 

We have granted restricted common stock awards and restricted common stock units to certain employees and directors under the 2005 Incentive Award Plan. The awards are generally subject to an annual cliff vest of four years from the date of grant (one year for directors).

 

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		Restricted Common Stock
						Weighted
		Number of				Average Grant
		Shares				Date Fair Value
Non-vested as of January 1, 2009			883,175			$	14.3609
Awards granted			61,243			$	15.4300
Awards vested			(217,859	)		$	21.3881
Awards canceled/expired/forfeited			(105,691	)		$	12.4730
Non-vested as of December 31, 2009			620,868			$	12.3219

 

The total fair value for restricted common stock awards that vested during the year ended December 31, 2009, 2008 and 2007 was $2.9 million, $2.7 million, and $2.5 million, respectively.

 

A summary of the status of the non-vested shares of restricted common stock units as of December 31, 2009 and changes during the year ended December 31, 2009, is presented below:

 

		Restricted Common Stock Units
						Weighted
		Number of				Average Grant
		Shares				Date Fair Value
Non-vested as of January 1, 2009			—			$	—
Awards granted			715,775			$	12.0253
Awards vested			—			$	—
Awards canceled/expired/forfeited			(31,850	)		$	11.7600
Non-vested as of December 31, 2009			683,925			$	12.0376

 

As of December 31, 2009, there was $9.3 million, $5.9 million, and $5.1 million of unamortized stock-based compensation expense related to stock options, restricted common stock units, and restricted common stock awards, respectively. The unamortized stock-based compensation expense related to stock options and restricted common stock units is expected to be recognized on a straight line basis over a weighted average remaining period of 1.8076 years and 3.1215 years, respectively. Of the $5.1 million of unamortized stock-based compensation expense related to restricted common stock awards, $2.1 million is expected to be recognized on a straight-line basis over a weighted average remaining period of 0.5384 years. The remaining $3.0 million of unamortized stock-based compensation expense related to restricted common stock awards relates to the long-term incentive equity awards, of which $0.1 million relates to the Market Value Awards and $2.9 million relates to the EBITDA Performance Awards. Of the $3.0 million of unamortized stock-based compensation expense related to the long-term incentive equity awards, $2.9 million will not be expensed due to the cancellation of 303,303 awards on January 31, 2010.

 

Employee Stock Purchase Plan

 

The total number of shares of common stock reserved under the ESPP is 1,500,000 and the total number of shares available for future issuance as of December 31, 2009 under the ESPP is 1,213,479. For employees eligible to participate on the first date of an offering period, the purchase price of shares of common stock under the ESPP will be 95% of the fair market value of the shares on the last day of the offering period, which is the date of purchase. Effective April 1, 2009, the discount was reduced from 15% to 5%. As of December 31, 2009, 286,521 shares of common stock were issued under the ESPP.

 

Employees’ Deferred Compensation Plan

 

The Employees’ Deferred Compensation Plan is a non-qualified retirement plan. The Employees’ Deferred Compensation Plan allows a select group of our management to elect to defer certain bonuses that would otherwise be payable to the employee. Amounts deferred under the Employees’ Deferred Compensation Plan are general liabilities of ours and are represented by bookkeeping accounts maintained on behalf of the participants. Such accounts are deemed to be invested in share units that track the value of our common stock. Distributions will generally be made to a participant following the participant’s termination of employment or other separation from service, following a change of control if so elected, or over a fixed period of time elected by the participant prior to the deferral. Distributions will generally be made in the form of shares of our common stock. As of December 31, 2009, 2,177 deferred stock units were recorded under a memo account and 147,823 shares of common stock are reserved and available for distribution under the Employees’ Deferred Compensation Plan.

 

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Directors’ Deferred Compensation Plan

 

The Directors’ Deferred Compensation Plan is a non-qualified retirement plan that allows each board member to elect to defer certain fees that would otherwise be payable to the director. Amounts deferred under the Directors’ Deferred Compensation Plan are general liabilities of ours and are represented by bookkeeping accounts maintained on behalf of the participants. Such accounts are deemed to be invested in share units that track the value of our common stock. Distributions will generally be made to a participant following the participant’s termination of service following a change of control if so elected, or over a fixed period of time elected by the participant prior to the deferral. Distributions will generally be made in the form of shares of our common stock. As of December 31, 2009, 58,785 deferred stock units were recorded under a memo account and 16,215 shares of common stock are reserved and available for distribution under the Directors’ Deferred Compensation Plan.

 

Long Term Incentive Equity Awards

 

Awards granted under the LTIP, consisted of 455,000 shares of restricted common stock (net of cancellations). Each individual’s total award was allocated 50% to achieving earnings before interest, taxes, depreciation and amortization, as adjusted to reflect any future acquisitions (EBITDA Performance Award) and 50% to the market value of our common stock (Market Value Award). The awards are earned upon our achievement of EBITDA and market-based targets for the fiscal years 2007, 2008 and 2009, but will not vest unless the grantee remains continuously employed in active service until January 31, 2010. If an EBITDA Performance Award or Market Value Award is not earned in an earlier year, it can be earned upon achievement of that target in a subsequent year. The awards will accelerate in full upon a change in control.

 

During the year ended December 31, 2009, 96,667 shares of long-term performance equity awards were cancelled and the vesting of 38,333 shares of long-term performance equity awards were accelerated due to the departure of certain executive officers, most of which were in connection with the realignment of our workforce and business as discussed in Note 16. For the year ended December 31, 2009, we reversed approximately $0.5 million of stock-based compensation expense related to the cancelled shares and recorded stock-based compensation expense of approximately $0.2 million related to the accelerated shares.

 

On January 31, 2010, 151,697 shares of long-term performance equity awards vested relating to the 2007 EBITDA Performance Award and the 2007 Market Value Award and the remaining 303,303 shares of long-term performance equity awards were cancelled as the 2008 and 2009 EBITDA and Market Value targets were not achieved.

 

 

Years Ending December 31,
2010		$	4,952
2011			4,370
2012			3,991
2013			3,416
2014			2,653
Thereafter			9,552
		$	28,934

 

 

Years Ending December 31,
2010		$	466
2011			231
2012			65
Total minimum lease payments		762
Less: Amount representing taxes, included in total minimum lease payments			(27	)
Net minimum lease payments			735
Less: Amount representing interest			(55	)
Present value of net minimum lease payments		$	680

 

 

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Retail Sales Tax

 

The Ontario Ministry of Revenue (the Ministry) has conducted a retail sales tax field audit on the financial records of our Canadian subsidiary, DealerTrack Canada, Inc. (formerly known as DealerAccess Canada, Inc.), for the period from March 1, 2001 through May 31, 2003. We received a formal assessment from the Ministry indicating unpaid Ontario retail sales tax totaling approximately $0.2 million, plus interest. Although we are disputing the Ministry’s findings, the assessment, including interest, has been paid in order to avoid potential future interest and penalties. 

 

As part of the purchase agreement dated December 31, 2003 between us and Bank of Montreal for the purchase of 100% of the issued and outstanding capital stock of DealerAccess, Inc., Bank of Montreal agreed to indemnify us specifically for this potential liability for all sales tax periods prior to January 1, 2004. The potential sales tax liability for the period covered by this indemnification is now closed due to the statutory expiration of the periods open for audit by the Ministry. To date, all amounts paid to the Ministry by us for this assessment have been reimbursed by the Bank of Montreal under this indemnity.

 

We undertook a comprehensive review of the audit findings of the Ministry using external tax experts. Our position has been that our lender revenue transactions are not subject to Ontario retail sales tax. We filed a formal Notice of Objection with the Ministry on December 12, 2005. We received a letter dated November 2, 2007 from an appeals officer of the Ministry stating that the assessment was, in his opinion, properly raised and his intention was to recommend his confirmation to senior management of the Ministry. The officer agreed, however, to defer his recommendation for a period of thirty business days to enable us to submit any additional information not yet provided. We submitted additional information to the Ministry to support our position that the services are not subject to sales tax. 

 

We received a letter dated December 21, 2007 from the Ministry stating that no change should be made to the appeals officer’s opinion. The letter further stated that we had ninety days from the date of the letter to file a Notice of Appeal with the Superior Court of Justice. A Notice of Appeal was filed on our behalf on March 18, 2008 to challenge the assessment because we did not believe these services are subject to sales tax. On December 15, 2008, the Ministry filed its response to our Notice of Appeal. The response reiterates the Ministry’s position that the transactions are subject to Ontario retail sales tax. The parties have completed the discovery process and we expect this matter will be heard by the Superior Court in 2010. We have not accrued any related sales tax liability for the period subsequent to May 31, 2003 for these lender revenue transactions. This appeal is supported by the financial institutions whose source revenue transactions were subject to the assessment. These financial institutions have agreed to participate in the cost of the litigation.

 

In the event we are obligated to charge sales tax for this type of transaction, we believe this Canadian subsidiary’s contractual arrangements with its lender customers obligate these customers to pay all sales taxes that are levied or imposed by any taxing authority by reason of the transactions contemplated under the particular contractual arrangement. In the event of any failure to pay such amounts by our customers, we would be required to pay the obligation, which could range from $5.2 million (CAD) to $5.8 million (CAD), including penalties and interest.

 

Commitments

 

Pursuant to employment or severance agreements with certain employees, we had a commitment to pay severance of approximately $4.2 million as of December 31, 2009 and $5.4 million as of December 31, 2008, in the event of termination without cause, as defined in the agreements, as well as certain potential gross-up payments to the extent any such severance payment would constitute an excess parachute payment under the Internal Revenue Code. We also have a commitment to pay additional severance of $1.9 million as of December 31, 2009 and $2.9 million as of December 31, 2008, if there is a change in control.

 

We are a party to a variety of agreements pursuant to which we may be obligated to indemnify the other party with respect to breach of contract, infringement and other matters. Typically, these obligations arise in the context of agreements entered into by us, under which we customarily agree to hold the other party harmless against losses arising from breaches of representations, warranties and/or covenants. In these circumstances, payment by us is generally conditioned on the other party making a claim pursuant to the procedures specified in the particular agreement, which procedures typically allow us to challenge the other party’s claims. Further, our obligations under these agreements may be limited to indemnification of third-party claims only and limited in terms of time and/or amount. In some instances, we may have recourse against third parties for certain payments made by us.

 

It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. To date, we have not been required to make any such payment. We believe that if we were to incur a loss in any of these matters, it is not probable that such loss would have a material effect on our business or financial condition.

 

 

		Year Ended December 31,
		2009				2008				2007
Transaction services revenue		$	94,406			$	132,419			$	147,312
Subscription services revenue			114,931				94,690				75,061
Other			16,289				15,597				11,472
Total net revenue		$	225,626			$	242,706			$	233,845

 

 

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16. Realignment of Workforce and Business

 

On January 5, 2009, we announced a realignment of our workforce and business aimed at sharpening our focus on high growth opportunities and to reflect current market conditions. We reduced our workforce by approximately 90 people, or 8% of our total employees, including several executive and senior-level positions. As a result of the realignment, we incurred total restructuring costs during the three months ended March 31, 2009 of approximately $6.7 million, including approximately $3.9 million of net non-cash compensation expense.

 

The table below sets forth the significant cash components and activity associated with the realignment of workforce and business under the restructuring program for the year ended December 31, 2009 (in thousands):

 

		Balance as of January 1, 2009				Charges				Cash Payments				Balance as of December 31, 2009
Severance		$	—			$	2,683			$	2,683			$	—
Other benefits			—				156				156				—
Total		$	—			$	2,839			$	2,839			$	—

 

17. Exit from SCS Business

On February 14, 2009, DealerTrack exited its SCS business in a transaction with a former senior executive of the company who left the organization in January 2009 as part of the realignment of our workforce. The SCS business, which accounted for approximately $1.9 million of revenue in 2008, is an administration system used by aftermarket providers as their back-end origination solution. The SCS entity was and will continue to be funded through owner contributions and through ongoing operations. DealerTrack recorded a gain of approximately $0.2 million upon sale which is classified as a contra expense in selling, general and administrative expenses for the twelve months ended December 31, 2009.

If the purchaser of the business goes through a change of control prior to February 14, 2014, we can earn up to $2.0 million in contingent purchase price from this transaction.  If the purchaser does not undergo a change of control by February 14, 2014, the purchaser will pay DealerTrack a one time payment of $0.5 million. These contingent payments accrue interest at an annual compound interest rate of 12 month LIBOR plus 3%. As of December 31, 2009, DealerTrack’s maximum exposure is approximately $0.4 million. As of December 31, 2009, we have recorded a long-term receivable of approximately $0.4 million, which represents the present value of the expected future contingent payments.

The newly formed company is a variable interest entity (VIE), as defined in ASC Topic 810-10-25-20 through ASC Topic 810-10-25-30, which provides a framework for identifying VIEs and determining when a company should include the assets, liabilities, non controlling interests and results of activities of a VIE in its consolidated financial statements.  The primary beneficiary is the party that consolidates a VIE based on its assessment that it will absorb a majority of the expected losses or expected residual returns of the entity, or both. We have determined that we are not the primary beneficiary of the newly formed entity described above and, therefore, have not included the assets and liabilities or results of operations in our consolidated financial statements. The significant assumptions and judgments used in determining whether we are the primary beneficiary included the fair value of the note receivable from the SCS entity and the fair value of the SCS entity. Unfavorable changes to the fair values could result in consolidation of the SCS entity. We will assess the need for consolidation on a quarterly basis.

18. Subsequent Events

We evaluated subsequent events through February 24, 2010, the date on which this Annual Report on Form 10-K was filed with the SEC. There were no events or transactions occurring during this subsequent event reporting period that require recognition or disclosure in the financial statements, except as noted below:

Strategic Agreement with General Motors Acceptance Corporation (GMAC)

On February 10, 2010, DealerTrack, Inc., a subsidiary of DealerTrack Holdings, Inc. (DealerTrack) entered into a strategic relationship with GMAC.  Under the terms of the agreement, GMAC will be listed as a financing option on the DealerTrack credit application processing network and DealerTrack has agreed to make a one-time payment to GMAC of $15.0 million payable upon GMAC becoming available to substantially all dealers that it does business with who are on the DealerTrack U.S. network.  The one-time $15.0 million payment will be recorded ratably as a reduction to revenue over an estimated period of five years.  GMAC will be available to General Motors and Chrysler dealers, as well as dealers of other manufacturers that GMAC elects to do business with.  GMAC will continue to accept credit applications through the RouteOne system.

 

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PART IV

 

 

Number		Description
3.1 (4)		Form of Fifth Amended and Restated Certificate of Incorporation of DealerTrack Holdings, Inc.
3.2  (4)		Form of Amended and Restated By-laws of DealerTrack Holdings, Inc.
4.1 (1)		Fourth Amended and Restated Registration Rights Agreement, dated as of March 19, 2003, among DealerTrack Holdings, Inc. and the stockholders of DealerTrack Holdings, Inc. party thereto.
4.2 (3)		Form of Certificate of Common Stock.
10.1 (3)		License Agreement, made and entered into as of February 1, 2001, by and between The Chase Manhattan Bank and J.P. Morgan Partners (23A SBIC Manager), Inc.
10.2 (3)		Asset Purchase Agreement, dated as of May 25, 2005, by and among Santa Acquisition Corporation, Automotive Lease Guide (alg), LLC, Automotive Lease Guide (alg) Canada, Inc., Douglas W. Aiken, John A. Blair and Raj Sundaram.
10.3 (9)		Amended and Restated Senior Executive Employment Agreement, dated as of August 8, 2007, by and between Mark F. O’Neil and DealerTrack Holdings, Inc.
10.4 (10)		Amendment No. 1 To Amended and Restated Senior Executive Employment Agreement, dated December 31, 2008, by and between Mark F. O’Neil and DealerTrack Holdings, Inc.
10.5 (11)		Amendment No. 2 to Amended and Restated Executive Employment Agreement dated November 3, 2009 between DealerTrack Holdings, Inc. and Mark F. O’Neil
10.6 *		Amended and Restated Senior Executive Employment Agreement, dated as of August 8, 2007, by and between Richard McLeer and DealerTrack Holdings, Inc.
10.7 *		Amendment No. 1 To Amended and Restated Senior Executive Employment Agreement, dated December 31, 2008, by and between Richard McLeer and DealerTrack Holdings, Inc.
10.8 *		Amendment No. 2 to Amended and Restated Executive Employment Agreement dated November 3, 2009 between DealerTrack Holdings, Inc. and Richard McLeer
10.9 *		Amended and Restated Senior Executive Employment Agreement, dated as of August 8, 2007, by and between Rick G. Von Pusch and DealerTrack Holdings, Inc.
10.10*		Amendment No. 1 To Amended and Restated Senior Executive Employment Agreement, dated December 31, 2008, by and between Rick G. Von Pusch and DealerTrack Holdings, Inc.

 

 

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Number		Description
10.11 *		Amendment No. 2 to Amended and Restated Executive Employment Agreement dated November 3, 2009 between DealerTrack Holdings, Inc. and Rick G. Von Pusch
10.12 (9)		Amended and Restated Senior Executive Employment Agreement, dated as of August 8, 2007, by and between Eric D. Jacobs and DealerTrack Holdings, Inc.
10.13 (10)		Amendment No. 1 To Amended and Restated Senior Executive Employment Agreement, dated December 31, 2008, by and between Eric D. Jacobs and DealerTrack Holdings, Inc.
10.14 (11)		Amendment No. 2 to Amended and Restated Executive Employment Agreement dated November 3, 2009 between DealerTrack Holdings, Inc. and Eric D. Jacobs.
10.15 (9)		Amended and Restated Senior Executive Employment Agreement, dated as of August 8, 2007, by and between Raj Sundaram and DealerTrack Holdings, Inc.
10.16 (10)		Amendment No. 1 To Amended and Restated Senior Executive Employment Agreement, dated December 31, 2008, by and between Raj Sundaram and DealerTrack Holdings, Inc.
10.17 (11)		Amendment No. 2 to Amended and Restated Executive Employment Agreement dated November 4, 2009 between DealerTrack Holdings, Inc. and Rajesh Sundaram
10.18 (8)		Unfair Competition and Nonsolicitation Agreement, dated as of May 25, 2005, by and between Raj Sundaram and Automotive Lease Guide (alg), Inc.
10.19 (8)		Amendment No. 1 to Unfair Competition and Nonsoliciation Agreement, made as of August 21, 2006, by and between Automotive Lease Guide (alg), Inc. and Raj Sundaram.
10.20 (9)		Amended and Restated Senior Executive Employment Agreement, dated as of August 8, 2007, by and between Robert Cox and DealerTrack Holdings, Inc.
10.21 (10)		Amendment No. 1 To Amended and Restated Senior Executive Employment Agreement, dated December 31, 2008, by and between Robert Cox and DealerTrack Holdings, Inc.
10.22 (11)		Severance Agreement and General Release between DealerTrack Holdings, Inc. and Robert Cox dated March 2, 2009.
10.23 (1)		2001 Stock Option Plan of DealerTrack Holdings, Inc., effective as of August 10, 2001.
10.24 (1)		First Amendment to 2001 Stock Option Plan of DealerTrack Holdings, Inc., effective as of December 28, 2001.
10.25 (1)		Second Amendment to 2001 Stock Option Plan of DealerTrack Holdings, Inc., effective as of March 19, 2003.
10.26 (1)		Third Amendment to 2001 Stock Option Plan of DealerTrack Holdings, Inc., effective as of January 30, 2004.
10.27 (6)		Fourth Amendment to 2001 Stock Option Plan of DealerTrack Holdings, Inc. effective as of February 10, 2006.
10.28 *		Third Amended and Restated 2005 Incentive Award Plan, effective as of June 17, 2009.
10.29 (7)		Amendment to Asset Purchase Agreement, dated October 18, 2006, by and among Santa Acquisition Corporation, Automotive Lease Guide (alg), LLC, Automotive Lease Guide (alg) Canada, Inc., Douglas W. Aiken, John A. Blair and Raj Sundaram.
10.30 (5)		Form of Stock Option Agreement.
10.31 (5)		Form of Restricted Stock Agreement.
10.32 (10)		Form of Restricted Stock Unit Agreement.
10.33 (1)		Senior Executive Incentive Bonus Plan, effective as of May 26, 2005.

 

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Number		Description
10.34 (8)		Stock Ownership and Retention Program, adopted May 26, 2005.
10.35 (1)		Employee Stock Purchase Plan, adopted May 26, 2005.
10.36 (1)		Directors’ Deferred Compensation Plan, effective as of June 30, 2005.
10.37 (9)		First Amendment to DealerTrack Holdings, Inc. Directors’ Deferred Compensation Plan effective as of January 1, 2007.
10.38 (1)		Employees’ Deferred Compensation Plan, effective as of June 30, 2005.
10.39 (9)		First Amendment to DealerTrack Holdings, Inc. Employees’ Deferred Compensation Plan effective as of January 1, 2007.
10.40 (1)		401(k) Plan, effective as of January 1, 2001, as amended.
10.41 (2)		Lease Agreement, dated as of August 5, 2004, between iPark Lake Success, LLC and DealerTrack, Inc.
14.1 (6)		Code of Business Conduct and Ethics.
21.1 *		List of Subsidiaries.
23.1 *		Consent of PricewaterhouseCoopers LLP.
31.1 *		Certification of Mark F. O’Neil pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 *		Certification of Eric D. Jacobs pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 *		Certification of Mark F. O’Neil and Eric D. Jacobs pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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*	Filed herewith.
(1)	Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-126944) filed July 28, 2005.
(2)	Incorporated by reference to Amendment No. 1 to our Registration Statement on Form S-1 (File No. 333-126944) filed September 22, 2005.
(3)	Incorporated by reference to Amendment No. 2 to our Registration Statement on Form S-1 (File No. 333-126944) filed October 12, 2005.
(4)	Incorporated by reference to Amendment No. 3 to our Registration Statement on Form S-1 (File No. 333-126944) filed October 24, 2005.
(5)	Incorporated by reference to our Quarterly Report on Form 10-Q filed May 12, 2006.
(6)	Incorporated by reference to our Annual Report on Form 10-K filed March 30, 2006.
(7)	Incorporated by reference to our Quarterly Report on Form 10-Q filed November 14, 2006.
(8)	Incorporated by reference to our Annual Report on Form 10-K filed March 16, 2007.
(9)	Incorporated by reference to our Quarterly Report on Form 10-Q filed August 9, 2007.
(10)	Incorporated by reference to our Annual Report on Form 10-K filed on February 24, 2009.
(11)	Incorporated by reference to our Quarterly Report on Form 10-Q filed November 5, 2009.

 

 

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     DealerTrack hereby files as part of this Form 10-K the exhibits listed in Item 15(a) (3) above. Exhibits which are incorporated herein by reference can be inspected and copied at the public reference rooms maintained by the SEC in Washington, D.C., New York, New York, and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. SEC filings are also available to the public from commercial document retrieval services and at the Website maintained by the SEC at http://www.sec.gov.

 

 

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EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K