10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-K

(Mark One)

 

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

For the fiscal year ended December 31, 2006.

OR

 

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

For the transition period from                      to                     .

Commission file number: 333-133895

 


AFFINION GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware   16-1732152

(State or other jurisdiction

of incorporation or organization)

  (I.R.S. Employer Identification Number)

100 Connecticut Avenue

Norwalk, CT 06850

(Address, including zip code, of

principal executive offices)

(203) 956-1000

(Registrant’s telephone number, including area code)

Securities registered pursuant to section 12(b) of the Act: None

 


Securities registered pursuant to section 12(g) of the Act: None

 


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes  ¨    No  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨            Accelerated filer  ¨            Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  ¨    No  x

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of the close of business on December 31, 2006 was zero.

The number of shares outstanding of the registrant’s common stock, $0.01 par value, as of March 20, 2007 was 100.

DOCUMENTS INCORPORATED BY REFERENCE: None

 



Table of Contents

TABLE OF CONTENTS

 

          Page

PART I

     

Item 1.

   Business    1

Item 1A.

   Risk Factors    20

Item 1B.

   Unresolved Staff Comments    29

Item 2.

   Properties    29

Item 3.

   Legal Proceedings    30

Item 4.

   Submission of Matters to a Vote of Security Holders    32

PART II

     

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    33

Item 6.

   Selected Financial Data    33

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    35

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk    67

Item 8.

   Financial Statements and Supplementary Data    69

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    70

Item 9A.

   Controls and Procedures    70

Item 9B.

   Other Information    70
PART III      

Item 10.

   Directors, Executive Officers and Corporate Governance    71

Item 11.

   Executive Compensation    74

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    91

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    93

Item 14.

   Principal Accountant Fees and Services    100

PART IV

     

Item 15.

   Exhibits and Financial Statement Schedules    101

GLOSSARY

   105

SIGNATURES

   107


Table of Contents

PART I

Unless the context otherwise requires or indicates, (i) all references to “Affinion,” the “Company,” “we,” “our” and “us” refer to Affinion Group, Inc., a Delaware corporation, and its subsidiaries on a consolidated basis after giving effect to the consummation on October 17, 2005 of the acquisition (the “Acquisition”) by Affinion Group, Inc. of Affinion Group, LLC (known as Cendant Marketing Group, LLC prior to the consummation of the Acquisition) (“AGLLC”) and Affinion International Holdings Limited (known as Cendant International Holdings Limited prior to the consummation of the Acquisition) (“AIH”) and the other transactions described in this Annual Report on Form 10-K under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—The Transactions,” but for periods prior to the Acquisition, refer to the historical operations of Cendant Marketing Services Division (a division of Cendant Corporation) (the “Predecessor”) that we acquired in the Acquisition, (ii) all references to “Holdings” refer to our parent company, Affinion Group Holdings, Inc., a Delaware corporation, (iii) all references to “Cendant Corporation” and “Cendant” refer to Cendant Corporation, which changed its name to Avis Budget Group in August 2006, and its consolidated subsidiaries, particularly in the context of its business and operations prior to, and in connection with, our separation from Cendant and (iv) all references to “fiscal year” are to the twelve months ended December 31 of the year referenced. In addition, a glossary of terms used in this Report to describe our business has been provided. See “Glossary.”

 

Item 1. Business.

Our Company

We are a leading affinity direct marketer of value-added membership, insurance and package enhancement programs and services to consumers, with over 30 years of experience. We offer our programs and services worldwide through more than 5,200 affinity partners as of December 31, 2006. Our diversified base of affinity partners includes leading companies in a wide variety of industries, including financial services, retail, travel, telecommunications, utilities and Internet. We market to consumers using direct mail, online marketing, in-branch marketing, telemarketing and other marketing methods. We generate predictable revenues and cash flows because of our large base of existing customers, which accounts for the majority of our near-term cash flow, and the fact that customer retention and renewals generally follow well-established patterns. We also have a loyalty solutions operation which administers points-based loyalty programs. As of December 31, 2006, we had approximately 70 million members and end-customers worldwide and approximately 2,900 employees in the U.S. and 10 countries, primarily in Europe. For the year ended December 31, 2006, we had net revenues of $1.1 billion, Adjusted EBITDA (as defined on page 60) of $264.0 million and a net loss of $438.2 million. For the years ended December 31, 2006 and 2005 (on a pro forma basis), we derived approximately 64% and 59%, respectively, of our net revenues from members and end-customers through marketing and servicing agreements with 10 of our affinity partners.

We utilize the brand names, customer contacts and billing vehicles of our affinity partners to market a broad portfolio of 30 core programs in approximately 225 configurations. Our core programs include PrivacyGuard (a credit monitoring and identity-theft resolution service), accidental death and dismemberment insurance (“AD&D”), Hotline and Payment Card Protection (credit card registration services), Travelers Advantage (discount travel services), as well as various checking account and credit card enhancement programs. Affinity partners value our services because we strengthen their relationships with their customers, promote their brands and provide them with incremental revenue while adhering to high standards in consumer privacy and protection. We provide our affinity partners with a broad scale of operations and wide breadth of programs and services, as well as a high level of analytical marketing expertise that results in more profitable marketing campaigns. We also allow our affinity partners to choose the extent to which they are involved in the acquisition and retention of customers. The customized options offered to our affinity partners range from a wholesale arrangement, in which they are largely responsible for customer acquisition, to a retail arrangement, where we are solely responsible. In addition, we have strong relationships with third-party vendors, such as call center providers, insurance underwriters and credit bureaus, who provide many elements of our programs and services to our members and end-customers, such as merchandise fulfillment and insurance underwriting.

We have developed a rigorous marketing approach, including powerful models and proprietary databases that analyze, by program, historical marketing performance data, customer preferences and historical usage and response rates. Our approach allows us to leverage the experience we have gained from our extensive marketing history, including more than 57,000 marketing campaigns conducted over the last decade. We design, customize and manage marketing campaigns which utilize multiple media and product offerings for each affinity partner. In addition, we

 

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use our data analytics capabilities to target minimum return thresholds tailored to each of our marketing campaigns. Based on sophisticated statistical analyses, our predictive models are designed to accurately forecast response rates, revenue generation and profitability potential of a prospective campaign. Our disciplined analytical approach allows us to target marketing opportunities with the most promising return potential and to provide our affinity partners with reports that measure individual campaign performance.

LOGO

We operate our business through the following operating segments:

 

   

Membership Operations (47.7% of 2006 net revenues) – Our membership operations in the U.S. are operated through Trilegiant, which designs, implements, and markets membership programs to customers of our affinity partners. We believe we are the leader in the U.S. affinity membership marketing industry with approximately 12.5 million members as of December 31, 2006. For an annual or monthly membership fee, we provide members with access to a variety of discounts and shop-at-home conveniences in such areas as retail merchandise, travel, automotive and home improvement; as well as personal protection benefits and value-added services including credit monitoring and identity-theft resolution services. Our membership programs include PrivacyGuard (a credit monitoring and identity-theft resolution service), Travelers Advantage (a discount travel service) and Shoppers Advantage (a discount shopping service), among many others. Our affinity partners, such as financial institutions, retailers and other consumer-oriented companies, offer individual membership programs to their customers as an enhancement to, or in connection with, their use of credit and/or debit cards, checking accounts, mortgage loans or other financial payment vehicles.

In general, membership services are offered under a retail arrangement in which membership fees are paid to us, and, in turn, we pay commissions on such fees to our affinity partners. Generally, we pay these commissions on both new members and their subsequent renewals. We also offer our services under a wholesale arrangement, which is a growing component of our operations, whereby our affinity partners market our programs and services and collect membership fees, and in return pay us administration and participant fees. We partner with a large number of third-party vendors to provide fulfillment of many elements of our diverse membership programs. For example, fulfillment of products purchased via our shopping-related programs is undertaken through a direct-ship network of over 200 vendors which we manage without taking ownership or physical possession of the products.

 

   

Insurance and Package Operations (32.2% of 2006 net revenues) – Our insurance and package enhancement operations in the U.S. are operated through Affinion Benefits Group, Inc. (formerly known as Progeny Marketing Innovations Inc.) (“ABG”). We believe we are a leading direct marketer of AD&D in the U.S. with over 32 million end-customers. We serve as an agent and third-party administrator for the marketing of AD&D and other insurance programs, and market private-label insurance programs to the customers of our affinity partners, typically financial institutions, primarily through direct mail. Our affinity partners use insurance programs to help improve customer loyalty, affinity and retention by offering a base level of AD&D at no cost to their customers and to generate incremental fee income from customers who choose to increase their coverage by purchasing

 

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supplemental insurance. We use retail arrangements with our affinity partners when we market our insurance programs to their customers.

We believe we are the largest distributor of checking account package enhancement programs in the U.S. with over 2,400 financial institutions and approximately 6.5 million end-customers as of December 31, 2006. We provide our affinity partners with a portfolio of more than 45 benefits in such areas as travel and shopping discounts, insurance and identity-theft resolution. Our affinity partners select a customized package of these programs and services to which they frequently then add their own services (e.g., unlimited check writing privileges, personalized checks, cashiers’ or travelers’ checks without issue charges). We design and provide package enhancement programs for financial institutions in order to improve their customer retention rates and generate additional fee income. Package enhancement programs, which are typically marketed in-branch by our affinity partners’ employees, are generally offered on a wholesale basis in which we earn up-front fees for implementing the package enhancement program and monthly fees based on the number of customers participating in the program.

 

   

International Operations (14.2% of 2006 net revenues) – Our international membership and package enhancement operations are operated primarily in Europe through Affinion International (formerly known as Cims). We believe we are the largest marketer of membership programs and package enhancement programs in Europe, with approximately 2.6 million members and 16.2 million end-customers as of December 31, 2006. In addition to our existing traditional international membership program offerings, we recently introduced a wider range of membership programs more comparable to those that we offer in the U.S. International membership services and package enhancement programs are offered under retail and wholesale arrangements comparable to those in the U.S.

 

   

Loyalty Operations (5.9% of 2006 net revenues) – Our loyalty operations are operated through Affinion Loyalty Group, Inc. (“ALG”) (formerly known as Trilegiant Loyalty Solutions). We believe we are a leader in online points redemption and administrative services and currently manage approximately 438 billion points for our customers with an estimated redemption value of over $4.4 billion, which reflects the addition of a major new program launched by an existing client in January 2007. We monitor and track the number of points issued as a leading indicator of the loyalty program’s customer appeal since points have a direct correlation to the usage of our client’s products. We track customer redemption behavior and focus our energy on delivering redemption options that are most popular with consumers. ALG derives approximately 10% of its revenues from fees and commissions generated from the redemption of points by the customers in those loyalty programs under its administration. We typically charge clients a per-member and/or a per-activity administrative fee for our services and do not retain any points-related liabilities. We also provide benefit enhancements, such as travel insurance, accident and collision damage waiver insurance and concierge services, to credit card issuers. We currently work with over 85 clients on their loyalty and enhancement products, including leading financial institutions, brokerage houses, premier hotels, timeshares and other travel-related companies.

See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Operating Segment Results” and Note 21 to our consolidated and combined financial statements included elsewhere herein for additional financial information about these segments.

Competitive Strengths

Global Leader in a Growing Industry. We are a leading affinity direct marketer of value-added membership, insurance and package enhancement programs and services with over 70 million members and end-customers worldwide and a network of more than 5,200 affinity partners as of December 31, 2006. Our leadership position in the growing affinity direct marketing industry is due to our more than 30-year track record, our experience from over 57,000 marketing campaigns conducted over the last decade and our core strengths in the areas of multi-media marketing, data analytics, customer service, and operations. We also believe our portfolio of programs and benefits is the broadest in the industry. We have 25 core membership programs, 5 core insurance programs, loyalty programs and more than 45 core benefits for our package enhancement programs, all of which are offered in approximately 225 different configurations to satisfy a wide range of consumer trends and fulfillment needs across industries.

 

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Proven Business Model Generates Predictable Financial Results with Significant Future Revenue Streams. Our business model includes planning new marketing initiatives based on predicted response and attrition rates, as well as other variables (such as product and servicing costs) drawn from in-depth analysis of our prior marketing campaigns. We are able to forecast the likely future range of results of our current and future marketing campaigns because the results of our marketing campaigns generally follow well-established patterns. Consequently, we are able to optimize the allocation of our marketing spend to the most profitable opportunities. Further, as our marketing campaigns generate revenues and cash flows over a number of years, our existing customer base (acquired from previous marketing campaigns for which we have already incurred the up-front marketing expense) produces highly predictable financial results as customer retention and related revenues and cash flows generally follow well-established patterns.

Flexible Operating Model Focused on Free Cash Flow Generation. We believe that our operating model will generate significant free cash flow (defined as cash provided by operating activities less capital expenditures and required debt service payments) as a result of our low capital expenditure requirements and variable cost structure. For example, 2006 capital expenditures represented less than 3% of 2006 net revenues. Our operating model is also highly scalable, allowing us to expand our business without significant additional fixed costs. As a result of our previous outsourcing of certain less critical functions such as data capture and call center operations, we were able to migrate to a more variable cost structure and are continuing to work to optimize our outsourced relationships. In addition to the ongoing integration of our international and travel agency operations, during 2004 and 2005, we integrated our domestic membership and insurance and package operations. As part of the Transactions, we made a special tax election referred to as a “338(h)(10) election” with respect to the target companies. Under the 338(h)(10) the target companies were deemed to have sold and repurchased their assets at fair market value. By adjusting the tax basis in such assets to fair market value for U.S. federal income tax purposes, the aggregate amount of our tax deductions for depreciation and amortization increased, which will reduce our cash taxes in the future and thus, further enhance our free cash flow generation.

Strong, Long-Term Relationships with Diverse Affinity Partners. We have cultivated strong long-term relationships with our affinity partners who are in a wide variety of industries, including financial services, retail, travel, telecommunications, utilities, Internet and other media. Our affinity partners value their relationship with us because it allows them to leverage our scale of operations and high level of analytical marketing expertise to generate incremental revenue without significant investment. Our relationships include 18 of the top 20 U.S. credit card issuers, 17 of the top 20 U.S. debit card issuers, 6 of the top 14 U.S. retail card issuers, 3 of the top 6 U.S. oil card issuers, 7 of the top 10 U.S. mortgage companies and 12 of the top 20 European retail banks. As the brand names and reputations of our affinity partners are crucial to their future success, they are very selective with regard to the use of their brand names. Due to the long-term relationships that we have with many of our affinity partners, we have built a level of trust that we believe would be difficult for our competitors or new entrants to the market to replicate. As a result, many of our key distribution partners have been with us for more than ten years.

Disciplined Marketing Approach Driven by Models and Proprietary Databases. We have over 30 years of experience in creating, executing and refining marketing programs with our affinity partners. Our marketing approach employs models and proprietary databases containing preferences and response rates for our products, as well as detailed performance and profitability data. This approach allows us to leverage historical information to design, customize and manage a large number of individual marketing campaigns across multiple media and product offerings tailored to each affinity partner. Furthermore, we believe that our database of customer contacts is the largest in the affinity direct marketing industry and that it enhances our ability to maximize the return on our marketing spend.

Leading Loyalty Solutions Platform. Through ALG, we currently manage approximately 438 billion points for our customers with an estimated redemption value of over $4.4 billion, which reflects the addition of a major new program launched by an existing client in January 2007. We have helped our clients manage points liabilities of loyalty programs for over 10 years. Loyalty programs reward customers with points that may be redeemable for, among other things, air travel, gift cards and merchandise. In order to help our clients manage the points liability of these programs, we strategize with our clients to develop redemption options that maximize the balance between perceived value and the actual cost of the reward. In addition, since we source many of the redemption items ourselves, we work with our clients to promote and drive redemption activity to those rewards that ensure mutual profitability. We believe we are well positioned in this business due to our scale, leading technical capabilities and experience in assisting companies to manage their points liabilities, which are vital to companies seeking to

 

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differentiate their programs and enhance their efficiency and profitability. These attributes, combined with the fact that it is expensive, as well as technically difficult for our customers to switch administrators once a loyalty solutions platform is operational, result in high customer retention rates. While we manage points with an estimated redemption value of over $4.4 billion, we do not retain any liability related to the redemption of points.

Committed and Experienced Management Team. Our senior management team has extensive experience in the direct marketing industry. The top 12 members of the team average more than 8 years of experience in the direct marketing industry. This extensive industry experience is combined with a proven operational track record and strong relationships with key decision-makers at our affinity partners. Our experienced management team has led the successful integration, which began in early 2004, of our membership, insurance and package enhancement, international and loyalty solutions operations, and our management remains committed to maintaining our market leadership position in the industry and continuing to increase our earnings and cash flows.

Business Strategy

Our strategy is to maintain and enhance our position as a leading global affinity direct marketer by providing valuable, high quality and affordable programs and services that reinforce the relationship between the customer and our affinity partners and to focus on attractive opportunities which would increase our growth and cash flows.

Focus on Increasing Profitability. The continuing integration of our operations will enable us to further optimize the allocation of our marketing spend across all of our operations and geographic regions in order to maximize the returns on each marketing campaign and, therefore, our overall long-term profitability. In addition, we expect that an expansion of our range of hybrid or bundled programs, such as premium versions of membership programs and combinations of membership and insurance programs, will increase our profitability as these programs generate higher revenues and margins. In addition, the ongoing shift of members from annual to monthly billing programs will continue to increase revenue per customer as annualized monthly membership fees are typically higher than annual membership fees. While increasing our revenues per customer, we also expect to increase our profitability by minimizing operating costs through operational efficiencies and capitalizing on the benefits of outsourcing and a more variable cost structure.

Continue to Execute Our Online Strategy for Customer Acquisition and Fulfillment. Since late 2003, we have pursued a strategy of leveraging the Internet for customer acquisition and fulfillment in order to capitalize on the increasing penetration and usage rates of the Internet. Our ability to attract new members, either through our affinity partners or directly, is enhanced by the fact that we target the online consumer at the moment of highest affinity – the transaction or point-of-sale. In 2004, we generated 0.4 million members via our online member acquisition programs. In 2005, we recorded over 1.1 million new members through similar programs and in 2006, we added an additional 1.5 million new members. The recognized and reputable brand names of our affinity partners assist us in attracting new members. The Internet also provides us with the opportunity to market programs directly to consumers beyond the customer bases of our affinity partners through the use of keywords on search sites as some of the most searched items on the Internet generally correlate well with the broad set of programs that we offer online such as travel, shopping and auto-related programs. In addition, the Internet will continue to enable us to significantly reduce our operating costs. For example, our online membership fulfillment costs are, on average, approximately 47% less than our regular mail fulfillment costs. We also pay lower associated commission rates to our affinity partners for new members generated via the Internet than via our offline marketing channels.

Expand Our Range of Affinity Partners. We believe there are substantial opportunities to increase our presence in the travel, cable, telecom and utilities industries, in both the U.S. and Europe. Companies in these industries are attractive candidates for our product offerings as they generally have strong brand names and extensive customer contacts and billing vehicles. Our highly customized marketing campaigns can assist these companies in attracting and retaining customers as well as generating incremental revenue.

Grow Our International Retail Operations. We believe that we are well positioned to provide our affinity partners and clients with comprehensive offerings on a global basis, particularly with our membership programs. We intend to grow our international retail membership operations by leveraging our significant U.S. experience to offer membership programs comparable to existing U.S. membership programs to European customers. We believe that the market for these kinds of membership programs is underserved in Europe and, as a result, has significant growth potential. In addition to the identity-theft resolution and credit monitoring programs launched in the U.K., our

 

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international operations continues to see promising initial results with our dining and leisure programs and our personal computer protection programs in the U.K. Interest among our affinity partners, including financial institutions and retailers, remains promising. We also intend to launch our personal computer protection and our dining and leisure programs across Europe.

Continue to Focus on New Program Development. We continually develop and test new programs to identify consumer trends that can be converted into revenue-enhancing opportunities. Our existing infrastructure, broad portfolio of benefits and extensive marketing experience enable us to develop new programs more efficiently. We introduced a number of new programs in 2005 and 2006, including a wine club that offers extensive savings on hard to find wines, a cutting-edge identity theft protection service that proactively monitors fraudulent use of members’ personally identifiable information and a comprehensive protection program that includes roadside assistance, extended warranty service, legal and tax resources and a pet locator. We believe that the programs that we are currently testing and plan to introduce in 2007 will continue our strong track record for developing new programs that increase profitability. We will also continue to create customized programs for our clients and bundle existing programs, program extensions and benefits into new packages, such as security and health care packages, to create significant incremental revenue opportunities, a practice which we have been successful in implementing in the past.

Leveraging Best Practices and Cross-Selling Opportunities. Since completing the integration of our operations, which we began in 2004, we have begun implementing best practices across our operations. We also intend to capitalize on the significant opportunities to cross-sell products across business lines and geographical regions that have been created by our business integration. By applying membership marketing best practices to our insurance business, we were able to increase our average revenue per insured. We believe that the further rationalization of our operations will also continue to generate economies of scale, including greater purchasing power with third-party vendors.

Industry Overview

Direct marketing is defined by the Direct Marketing Association (the “DMA”) as any direct communication to a consumer or business that is designed to generate a response in the form of an order. Affinity direct marketing is a subset of the larger direct marketing industry which involves direct marketing to the customers of affinity partners, such as financial institutions and retailers. In affinity direct marketing, programs, products and services are marketed either directly or indirectly, in each case using the affinity partner’s brand name, customer contacts and billing vehicles. We believe that being associated with the brand of an affinity partner provides a significant advantage over other forms of direct marketing. Affinity direct marketing provides us with access to our affinity partners’ large customer base, generally results in higher response rates as customers recognize and trust our affinity partners’ brands and provides additional credibility and validation as to the quality of the program or service we are offering. Affinity partners benefit as they are able to promote their brands while offering additional programs and services, which strengthens their relationships with their customers and generates incremental revenue for them.

The DMA estimates that overall sales in the U.S. generated by direct marketing initiatives will grow at a 6.4% compound annual growth rate from 2004 to 2009. According to the DMA, the EU represents almost 20% of the estimated global direct marketing driven estimated sales in 2007, and the EU market is expected to grow at a faster rate than the U.S. market as new members join the EU and member countries continue to integrate across economic, social and regulatory boundaries.

Industry research indicates that growth in direct marketing sales results from increasing direct marketing expenditures as well as marketers shifting their budgets from branding campaigns to direct marketing campaigns due to their increased measurability and effectiveness. Marketers with direct customer contact or with large marketing databases are expected to continue to pursue direct marketing initiatives, such as those offered by us, to increase customer penetration in an environment where attracting and retaining customers is becoming increasingly challenging. As a result, direct marketing driven sales as a percentage of total sales have been rising. Sales generated by direct mail, one of our primary marketing media, is projected by the DMA to grow at a compound annual growth rate of approximately 5.1% from 2005 through 2009 in the U.S. Online media, a growth vehicle for both the industry

 

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and our business, represents the fastest growing direct marketing medium due to the increasing use of the Internet and its significantly lower communication costs. DMA projects a compound annual growth rate of approximately 11.6% for online media from 2005 to 2009 in the U.S.

Company History

We have over 30 years of operational history. The business started with membership operations in 1973 through the formation of Comp-U-Card of America, Inc. (“CUC”). Between 1985 and 1986, CUC acquired the insurance and package enhancement operations of Financial Institution Services, Inc. and Madison Financial Corporation, both of which were formed in 1971. In 1988, CUC acquired National Card Control, Inc., which was formed in 1981 and provided loyalty solutions and package enhancement programs. The international operations were started by CUC in the early 1990s. In 1997, CUC merged with HFS Incorporated to form Cendant Corporation. The international operations were rebranded as Cendant International Membership Services after the formation of Cendant. In 2001, the U.S. membership operations were rebranded as Trilegiant and the loyalty solutions operations were rebranded as Trilegiant Loyalty Solutions. The insurance and U.S. package enhancement operations were rebranded as Progeny in 2002. In 2004, we realigned our organizational structure and began integrating the historically separate businesses in order to have a unified approach to the marketplace.

In 2005, we, along with our parent company, Holdings, entered into a purchase agreement with Cendant pursuant to which we purchased from Cendant all of the equity interests of AGLLC and all of the share capital of AIH (the “Acquisition”). See “Item 13. Certain Relationships and Related Transactions – Purchase Agreement and Ancillary Agreements to the Purchase Agreement.”

Marketing

We market our programs and services through retail and wholesale arrangements and combinations thereof. Under the retail arrangement, we market our programs to an affinity partner’s customers by using that affinity partner’s brand name, customer contacts and billing vehicles. In retail arrangements, we typically bear or share the acquisition marketing costs and the related retention cost. Under structures where we bear all or most of the acquisition marketing costs, we typically incur higher up-front marketing costs but pay lower commissions on related revenue to our affinity partners. Under structures where our affinity partners share more of the acquisition marketing costs, we typically have lower up-front acquisition marketing costs but pay higher commissions on membership and end-customer revenue to our affinity partners.

Under the wholesale arrangement, the affinity partner markets our programs and services to its customers, collects revenue each month from the customer and typically pays a monthly fee per participant. In addition, we also offer other services to our affinity partners, including enrollment, fulfillment, customer service and website development.

We utilize a variety of media to market our programs and services, including direct mail, online marketing, in-branch marketing, inbound telemarketing, outbound telemarketing and call-to-activate/voice response unit marketing. We have a full-service creative agency with expertise in utilizing all varieties of customer acquisition media with special emphasis on growing online and other higher margin media. We use a network of third-party operators for inbound and outbound telemarketing and develop all direct mail programs in-house, utilizing third parties only for limited services such as printing. In addition, we use standardized scripts and direct mail materials that are repeatedly tested and updated to ensure consistent quality and maximum effectiveness for each marketing campaign.

Direct Mail. We have developed considerable expertise in direct mail marketing, which remains our largest marketing medium in terms of new member acquisition, accounting for more than 42% of new joins globally in 2006. Our direct mail operations incorporate a variety of mailing types, including solo direct mail, detachable inserts, credit card inserts, statement inserts, promotion inserts, and other printed media. Additionally, we continually test variations of direct mail solicitations to drive higher customer response rates.

Online Marketing. We formed a dedicated Internet group for North American membership in late 2003 to market our programs and services and expand our reach online. In 2006, we recorded over 1.5 million new members through online membership acquisition programs as compared to 1.1 million in 2005 and 0.4 million new members in

 

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2004. We are pursuing new marketing partnerships (e.g. online retailers, travel providers, and service providers), expanding relationships with traditional affinity partners via the Internet (notably financial institutions who allow us to market to their online banking customers), and marketing directly to consumers. We use click-through advertising, search and email marketing techniques to enhance our online customer acquisitions and expect to significantly increase our use of these techniques. In 2006, we expanded our online capabilities in Europe which allowed us to begin marketing online and to expand several of our offline relationships to include online marketing and product benefit delivery with several existing affinity partners.

In-Branch Marketing. In-branch marketing is the primary distribution medium for our package enhancement programs. In-branch marketing utilizes a variety of promotional and display materials at our affinity partners’ branches to create interest and drive program inquiries. Affinity partner representatives coordinate sales with the opening of new accounts. We also train affinity partners’ branch personnel in sales techniques for our programs.

Live Operator Inbound Telemarketing (“Transfer Plus” and “Customer Service Marketing”). Transfer Plus is a live-operator call transfer program which operates from affinity partner call centers, and has proven successful in converting customer service calls into revenue opportunities. In Transfer Plus, qualified callers of an affinity partner are invited to hear about a special offer, and those callers who express interest in that offer are transferred to us to hear more about the product. Customer Service Marketing is similar to Transfer Plus, however, the affinity partner’s call center agent continues with the sales process instead of transferring the call to our vendor. This program is easy to implement and we handle all training and promotions. It also provides a no-cost employee retention program for our affinity partners as agents earn cash/awards from us for every call transferred.

Outbound Telemarketing. We use extensive modeling to target calling efforts to likely responders. Calls are fully scripted, and our representatives market only to those who are interested in hearing about our programs. Our outbound telemarketing programs are designed to comply with the “Do-Not-Call” Registry and other privacy legislation.

Call-to-Activate/Voice Response Unit. When a consumer contacts an affinity partner’s call center to activate a credit or debit card, the automated voice response system offers our product while the customer is waiting for, or after the completion of, the activation. The consumer then has the opportunity to accept or decline the offer. This low-cost marketing program is easy to implement and the call-to-activate technique generates significant revenue streams.

We utilize financial models that are designed to target and predict returns over a five-year period for membership and a seven-year period for insurance programs. These models are used to determine the minimum response rate required to attain a targeted return per newly acquired member, net of attrition, given an appropriate cost of capital. Our marketing systems model individual campaigns across multiple media and product offerings utilizing extensive data, customer contacts and results of over 57,000 marketing campaigns conducted over the last decade. We typically target a minimum profitability return after all costs for all marketing campaigns for our membership and insurance operations.

Programs and Services

Membership Operations. Through our Trilegiant operations, we market various private-label club memberships and services to individuals in North America, primarily through joint marketing arrangements with our affinity partners. The membership programs offer members discounts on many brand categories along with shop-at-home convenience in such areas as retail merchandise, travel, automotive and home improvement, as well as other benefits and value-added services in the growing area of credit monitoring and identity-theft resolution services, which are intended to improve the member’s sense of security and well-being.

 

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Our principal membership programs include:

 

Program

  

Description

  

Key Features

LOGO    Access and monitoring of credit report, credit score and credit history to help members manage their credit and prevent identity-theft   

Access to credit data from all three credit bureaus

Credit monitoring from one or all three credit bureaus

Fraud resolution

Identity-theft insurance

LOGO    Credit card and document registration   

Cancellation / replacement of credit cards with fraud liability, sales price and return guarantee protection

Emergency cash advance and airline ticket replacement

LOGO    Proactive identity theft solution to help consumers detect identity confusion and fraud    Public records management monitoring of personal data, social security number and credit cards to detect suspicious activity
LOGO    Computer and internet security protection   

Virus protection

Personal firewall and spam blocker

Parental internet control

PC repair reimbursement

LOGO    Discount travel service program offering a low-price guarantee on booking airline, hotel and car rental reservations    5% cash back; 24/7 full service travel agency
LOGO    Discount shopping program offering savings of 10%-50% off manufacturers’ suggested retail price on brand name consumer products   

200% low price guarantee for 60 days; automatic 2-year warranty on most items

Discount on over 50,000 items from more than 1,000 brand name manufacturers.

3.5% cash back on online orders

LOGO    Discount program with preferred prices on new cars and discounts on maintenance, tires and parts   

Emergency roadside assistance for up to 3 times per year

Up to 15% in service center network savings

 

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Program

  

Description

  

Key Features

LOGO    Discount program offering savings on dining, shopping, hotels, and admission to individual and family-oriented leisure activities   

Coupon book with entertainment, shopping and dining savings from over 20 national partners

Clip and save coupons from national retailers and entertainment locations

Dining discount of up to 50% at over 50,000 U.S. restaurants

LOGO    Discount program offering savings on home improvement and repair   

Benefits of Shoppers Advantage

Discount on home-related purchases and services

Approximately 47,000 pre-screened contractors

60-day low price guarantee

LOGO    Customer service that extends manufacturers’ warranties   

Automatic five-year warranty extension

20%–50% repair cost protection

New purchase price protection for 60-90 days

LOGO    Discounts on a variety of health-related programs and services   

5%-25% discounts off fees at approximately 265,000 physician specialists

5%-40% discounts on prescriptions, dental, vision, hearing and preventive care

LOGO    Insurance coverage service for breakdowns of household systems and appliances    24-hour, 365-day coverage with repair service network of over 20,000 pre-screened service professionals

In 2006, more than 38% of our membership programs’ members joined as a result of direct mail marketing. Other forms of marketing include our growing online initiatives, as well as telemarketing, customer service marketing and call-to-activate/voice response unit marketing. In general, membership programs are offered on a retail basis in which customers pay us an annual or monthly membership fee. In return, we pay our affinity partners commissions on initial and renewal memberships based on a percentage of the membership fees. We also offer our services under wholesale arrangements in which our affinity partners incur the marketing expense and risk of campaign performance and pay us a monthly fee and other fees for the administration and fulfillment of their membership programs. While it is a relatively small component of our business at present, we expect wholesale arrangements to be an increasingly larger component of our membership operations in the future.

Insurance and Package Operations. Through our ABG operations, we market our insurance and package enhancement programs in the U.S. In our insurance operations, we serve as an agent and third-party administrator for the marketing of AD&D and other insurance programs. We offer four primary insurance programs that pertain to supplemental health or life insurance. These programs, including AD&D, represent our core insurance offerings and the majority of our annual insurance revenue.

 

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Our principal insurance programs include:

 

Product

  

Description

  

Key Features

LOGO    Provides coverage for accidental death or serious injury    $1,000 initial complimentary coverage; up to $300,000 in additional coverage
LOGO    Pays cash directly to the insured if hospitalized due to a covered accident    Up to $200 per day hospitalized
LOGO    Pays cash to insured or beneficiary for hospitalization due to a covered accident or illness    Choice of $50 or $100 per day hospitalized
LOGO    Provides coverage for accidental death    Up to $1,000,000 in accidental death insurance

We market our insurance programs primarily by direct mail and otherwise by telemarketing. We typically use retail arrangements with our affinity partners when we market our insurance programs to their customers. We earn revenue in the form of commissions from premiums collected as well as from economic sharing arrangements with the insurance carriers that underwrite the policies that we market. While these economic sharing arrangements have a loss-sharing feature that would be triggered in the event that the claims made against an insurance carrier exceed the premiums collected over a specified period of time, historically, we have never had to make a payment to insurance carriers under such loss-sharing feature.

We believe we are the largest distributor of checking account package enhancement programs in the U.S. We provide our affinity partners with a portfolio of more than 45 benefits in such areas as travel and shopping discounts, insurance and identity-theft resolution to create customized package offerings for their customers. For example, a financial institution can bundle retail checking enhancements such as grocery coupon packages, medical emergency data cards, movie ticket discounts, telephone shopping services, car rental discounts, half-price hotel directories, hotel savings, dining discounts, and other benefits, with a standard checking or deposit account and market these packages to its customers for an additional monthly fee.

 

Product

  

Description

  

Key Features

LOGO    Package of benefits tied to customer checking accounts in the U.S.    Broad array of features includes shopping, travel, and security benefits
LOGO    Package of benefits focused on office management and business discounts    Business services and solutions
LOGO    Health savings package includes discounts on prescriptions, dental & vision care and AD&D insurance    Health-oriented programs

A customer service representative at an affinity partner’s branch site or via direct mail solicitation offers package enhancement programs to checking account, deposit account and credit card customers at the time of enrollment. We typically offer package enhancement programs, such as Enhanced Checking, under wholesale arrangements where we earn an upfront fee for implementing the package enhancement program and a monthly fee

 

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based on the number of customers participating in the program. We typically offer Small Business Solutions and Wellness Extras programs on a retail basis.

International Operations. Through our Affinion International operations, we market our membership and package enhancement program lines internationally. We believe we are the largest marketer of membership programs and package enhancement programs in Europe. These membership services and package enhancement programs are offered under retail and wholesale arrangements comparable to those in the U.S.

Our principal international membership programs include:

 

Product

  

Description

  

Key Features

Sentinel Card Protection    Protection for all credit and debit cards against loss or theft   

Assistance services including change of address and luggage and key retrieval

Emergency services including medical, airline ticket replacement and hotel bill payment

Lost cash and wallet/ purse insurance

Privacy Guard    Access to and monitoring of credit report, credit score and credit history to help prevent identity-theft   

Online and offline single bureau reporting

Credit monitoring

Full fraud resolution

Identity-theft insurance

Leisure Time    Access to year round discounts on dining, days out and event tickets   

25% discount on dining bills at over 1,000 restaurants in the U.K.

10% discount on concert and other event tickets

Discounted entry to select attractions and other 2-for-1 promotions

PCProtection Plus    Online security and protection product with Identity Theft Protection   

Virus protection and personal firewall software

Spam Blocker and anti-spyware software

Identity-theft insurance

PC repair insurance for accidental and virus damage

Our principal package enhancement program, Cims Rewarding Relationships, is marketed through our financial institution affinity partners and provides a package of a broad array of benefits, including shopping, travel and security, to checking account customers in Europe. In addition to the identity-theft resolution and credit monitoring programs launched in the U.K., our international operations continues to see promising initial results with our dining and leisure programs and our personal computer protection programs in the U.K. We also intend to launch our personal computer protection and our dining and leisure programs across Europe.

Loyalty Operations. We manage loyalty solutions operations through ALG, which is a process outsourcer for points-based loyalty programs such as General Motors’ reward programs and Cendant’s Trip Rewards Program. We believe we are a leader in online points redemption as we currently manage approximately 438 billion points for our customers, which reflects the addition of a major new program launched by an existing client in January 2007. ALG’s loyalty program is a private-label, customizable, full-service rewards solution that consists of a variety of programs that are offered on a stand-alone and/or bundled basis depending on customer requirements. We typically charge a per-member and/or a per-activity administrative fee to clients for our services and do not retain any points-related liabilities.

 

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The following table illustrates the services provided to ALG’s clients:

 

Service

  

Description

Program Design    Establishes parameters for earning, redeeming, fulfilling, communicating, and analyzing points
Program Management    Provides loyalty industry research, including consumer behavior and competitive program trends across various industries
Technology Platform    Scalable, customizable and flexible proprietary loyalty accounting and data management platform to meet partners’ needs over the life of the programs
Rewards Fulfillment   

Ownership of vendor management, inventory and fulfillment of program rewards

Works directly with over 130 vendors to obtain rewards and provides loyalty partners with access to more than 21,000 available merchandise models

Points Administration    Track and maintain customer account records and customer activities upon which point awarding business rules are based
Customer Experience Management    Provides a full-service, in-house contact center as an extension of the partner’s existing contact center
Program Communications   

Produces HTML-based email newsletters and surveys which increase readership and are typically less expensive than direct mail campaigns for these programs

Hosts many of its partners’ loyalty websites

Performance Monitoring    Provides internal and external access to its data warehousing environment, including a dashboard of critical program performance metrics and allows for standard and ad-hoc reporting

ALG also provides credit card enhancements, such as travel insurance and concierge services. The enhancement program line, which has been offered by us for approximately 20 years, features both convenience (such as concierge service) and protection (such as travel accident insurance) programs. The programs are sold wholesale to our partners, who then provide the programs at no cost to their customers as an added value of doing business with them. Historically, these programs have been predominantly offered within the financial services industry as credit card enhancements.

Affinity Partners

We are able to market our value-added programs and services by utilizing the brand names, customer contacts and billing vehicles of our affinity partners. Our diversified base of affinity partners includes more than 5,200 companies in a wide variety of industries, including financial services, retail, travel, telecommunications, utilities and Internet. Select partners include JPMorgan Chase, Bank of America, HSBC, Royal Bank of Scotland, Lloyds TSB, Société Générale, BarclayCard, Wells Fargo, Washington Mutual, PNC, CompUSA, Boscov’s, Choice Hotels, GMAC, Countrywide, Orbitz and Columbia House.

Our two largest affinity partners, JPMorgan Chase and Bank of America, accounted for 16.0% and 13.6%, respectively, of total revenues for the year ended December 31, 2006. The Company has over 30 individual contracts with these two affinity partners and their various divisions and subsidiaries, including acquired businesses. Typically, our agreements with our affinity partners for the marketing and servicing of our retail membership products are for fixed terms which automatically renew and may be terminated upon at least 90 days written notice. While we generally do not have continued marketing rights following the termination of any such marketing agreements, the vast majority of our marketing agreements allow us to extend or renew memberships and bill and

 

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collect associated membership fees following any termination. While we usually do not have rights to use affinity partner branding in new marketing following termination of a marketing agreement, the products we provide to members are either our standard products which do not require our affinity partner’s branding, or are co-branded products where we typically have the ability to continue to service as co-branded products. Generally, our affinity partners agree not to solicit our members for substantially similar services both during the term of our agreement and following any termination thereof.

Membership Operations. We have almost 600 affinity partners in multiple industries. Our membership affinity partners include 14 of the top 20 U.S. credit card issuers, 15 of the top 20 U.S. debit card issuers, 6 of the top 14 U.S. retail card issuers, 3 of the top 6 U.S. oil card issuers, and 7 of the top 10 U.S. mortgage companies. Some of our largest affinity partners, such as JPMorgan Chase and Bank of America, have been marketing with us for over 10 years. Customers of our largest U.S. affinity partner generated approximately 21.5% of our U.S. membership revenue in 2006. Customers of our top 10 U.S. affinity partners generated approximately 75.0% of our U.S. membership revenue in 2006.

Insurance and Package Operations. Our insurance affinity partners consist of approximately 3,800 financial institutions including national financial institutions, regional financial institutions and credit unions. Marketing to the customers of our top 10 affinity partners resulted in a total of approximately 41.6% of our gross insurance revenue in 2006. Our package enhancement affinity partners are comprised of over 2,400 national financial institutions, regional financial institutions and credit unions. Marketing to the customers of our top 10 U.S. affinity partners resulted in a total of approximately 28.7% of our U.S. package enhancement revenue in 2006. In addition, we have held the endorsement of the American Bankers Association regarding account enhancement programs in the U.S. for over 15 years.

International Operations. Our international affinity partners include some of Europe’s most prominent retail banks, including 9 of the top 20 European retail banks on the package side and 5 of the top 20 European retail banks on the membership side, including 2 that are also package clients. Additionally, we own a 50% investment in Cims South Africa Ltd., a joint venture that offers wholesale package enhancement programs in South Africa, similar to those offered in Europe.

Customers

As of December 31, 2006, we had approximately 70 million members and end-customers worldwide. We currently offer our programs and services to our consumers through our more than 5,200 affinity partners as of December 31, 2006. We market to consumers using direct mail, online marketing, in-branch marketing, telemarketing and other marketing methods.

Membership Operations. As of December 31, 2006, we had approximately 12.5 million members in the U.S. We target customers of our affinity partners who are willing to pay a fee to gain access to a multitude of discount programs or who want to improve their sense of security and well-being. Our focus is on maximizing revenue and profitability per member over a five-year period, rather than the number of active members in our programs. As a result, we continually strive to target customers that are willing to pay more for value-added products with higher margins such as consumer protection programs and services that offer peace-of-mind benefits.

Insurance and Package Operations. As of December 31, 2006, we had approximately 32.1 million insurance end-customers in the U.S. We rely on access to our affinity partners’ large customer bases to market our insurance programs. The insurance programs we market, such as AD&D, provide customers with peace of mind benefits should they suffer a serious loss or injury.

As of December 31, 2006, we had approximately 6.5 million end-customers through approximately 2,400 financial institutions in our U.S. package operations. Financial institutions utilize our package programs to increase customer affinity, increase response and retention rates, and generate additional fee income.

International Operations. As of December 31, 2006, we had approximately 16.2 million international package end-customers and approximately 2.6 million membership members in 13 countries, primarily in Europe.

 

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Loyalty Solutions. In our ALG operations, we currently work with approximately 85 clients, who have over 60 million participants, on their loyalty and enhancement programs. These clients include leading financial institutions, brokerage houses, premier hotels, timeshares and other travel-related companies. We provide points-based loyalty programs and benefit package enhancement programs that they in turn offer to their customers. Many of the principal ALG client agreements have a term of at least two years and we typically charge a per member and/or a per activity administrative fee to clients for our services.

Third-Party Vendors

We partner with a large number of third-party vendors to provide fulfillment of many of our programs and services. Generally, our key relationships with these vendors are governed by long-term contracts. As we have a large number of vendors, we are generally not dependent on any one vendor and have alternative vendors should we need to replace an existing vendor. We believe we have very good relationships with our vendors who value their relationship with us, as we are able to provide them with access to a large customer base through our affinity partners, many of whom are leaders in their industry. In addition, because we purchase large volumes of programs and services across our various businesses, we are able to achieve significant price discounts from our vendors.

Membership Operations. We partner with a variety of third-party vendors to provide services, benefits and fulfillment for many of our membership programs. Our largest supply-side relationships in membership fulfill PrivacyGuard. Additionally, Travelers Advantage Service, Inc. (“TAS”), a full service travel agency, is the primary supplier for our Travelers Advantage program. We believe that TAS is one of the ten largest leisure travel agencies in North America.

Insurance and Package Operations. The Hartford, Inc. (“The Hartford”) is our primary carrier for the majority of our insurance programs. The Hartford is one of our largest suppliers across all divisions. Despite the strong relationship, our contractual relationship with The Hartford is non-exclusive. Other insurance underwriters that we have a contractual relationship with include American International Group and the Chubb Group.

Our package enhancement programs combine both insurance and membership programs to create a unique enhancement package that our affinity partners provide to their customers. Generally, programs include AD&D insurance and travel discounts that are supplied by our membership and insurance suppliers.

International Operations. Affinion International partners with a variety of third-party vendors to provide services, benefits, fulfillment and delivery for some of our programs and services offered to the customers of our affinity partners. Our largest supplier across the international business is RCI, a subsidiary of Cendant. RCI provides full-service travel agency services to Affinion International in a number of our markets and for a number of affinity partner relationships. In addition, Affinion International also has key supplier relationships with a third party for its benefits related to sports and entertainment events. Affinion International also uses third-party suppliers for its print and fulfillment operations.

Loyalty Operations. ALG acts as a business process outsourcer for points-based loyalty programs and provides enhancement benefits to credit card issuers. While many of the services ALG provides are supplied in-house as a result of ALG’ proprietary technology platform and program design support, third-party suppliers are used to fulfill the benefit enhancements. These benefit enhancements are supplied by our membership and insurance suppliers.

Program Development

Program development is integral to our ability to maximize value from each of our programs. In developing our programs, we focus on maximizing margins and revenue, leveraging marketplace trends and maximizing loyalty, with a continued emphasis on the needs of the consumer. Developing new programs involves the creation of test programs and feasibility studies to evaluate their potential value if implemented, as well as bundling existing programs and benefits into new packages such as SecureAll, Wellness Extras and the Elite Excursions programs. In our membership operations, we focus on improving profitability by enhancing our portfolios of products. In our insurance operations, we will introduce accident disability insurance and an enhanced term life product.

A number of new programs were introduced in 2005 and 2006, including an identity theft program focused on public information and further enhancements to our credit management and travel programs. Programs that we are

 

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testing and intend to introduce in 2007 include an enhanced version of our online identity theft product and additional benefits to our leisure programs.

Operations

Our operations group provides global operational support for marketing campaigns and business units, including management of our internal and outsourced contact centers, as well as certain key third-party relationships. The group is charged with improving cost performance across our operations, including increased outsourcing, while enhancing revenue and bottom-line profitability through increased customer satisfaction and retention.

Processing

The processing responsibilities of the operating group can be divided into (i) enrollments, (ii) fulfillment packages, (iii) billing, (iv) merchandise delivery, and (v) travel fulfillment.

Enrollments. Enrollment information is sent to us through a variety of different media, including mail, electronic file transfer from affinity partners, telemarketing vendors and the Internet. Average turnaround time from receipt to enrollment is 24 hours. On average, almost 300,000 mail enrollments are processed per month at our Trumbull, Connecticut and Franklin, Tennessee facilities and through our third-party vendor and more than 500,000 monthly electronic file transfer enrollments are sent from our telemarketing operations, which are processed in both our Trumbull, Connecticut and Franklin, Tennessee facilities. On average, more than 450,000 enrollments are processed monthly from our Affinion International European sites. Of these total enrollments, most are processed electronically. On average, approximately 125,000 enrollments are processed each month through the Internet (online).

Fulfillment Packages. Fulfillment packages, which include enrollment materials and premiums (e.g., gift cards, coupons, MP3 players) sent to customers via mail and electronically, are produced in thousands of combinations for membership, insurance and package enhancement programs. Fulfillment transactions are generally sent to the appropriate fulfillment vendor by 5 a.m. the next business day following receipt of the order for purchase. Physical fulfillment in North America is completed by our facility in Franklin, Tennessee or by outsourced vendors. Physical fulfillment in Europe is completed in five locations across Europe and totals around 12.5 million pieces per year. Approximately 95% of the pieces are completed by third-party vendors with only 5% being completed in-house by Affinion International employees. Increasingly, we use electronic delivery of membership materials and fulfillment packages, which drives further cost reductions.

Billing. We have the ability to accept a variety of different account types, including Visa (debit and credit), MasterCard (debit and credit), American Express, Discover, oil and retail company proprietary cards, mortgage loans and checking and savings accounts. Domestically, we process more than 140 million billing transactions each year for our membership, insurance and package programs. We use both generic and direct processing methods and work closely with a variety of payment processors and our affinity partners to maximize our ultimate collection rates.

Merchandise Delivery. We maintain a virtual inventory for our shopping programs of approximately 50,000 items, covering more than 1,000 brands sourced through a best-in-class direct-ship network of over 200 direct-ship vendors. We manage the process of customers purchasing these products but we outsource delivery logistics to back-end suppliers. While we manage the fulfillment process, we generally do not take ownership or physical possession of any of the products being delivered. By pooling the purchasing power of our membership programs and other programs, including ALG’ loyalty programs, we achieve significant price reductions on the products we offer, and deliver substantial value to our customers. Merchandise sales between our merchandise vendors and members of more than 400,000 units totaled $20.3 million in 2006, of which $1.7 million is included in our 2006 net revenues. Approximately 60% of these sales were made via the Internet or electronic file, with the rest coming through the contact centers. Shoppers Advantage members account for 47%, ALG programs account for 22% and gift card transactions account for the remaining 31% of customer sales.

Travel Fulfillment. TAS, our full-service travel agency, is dedicated primarily to servicing our customers; however, it also provides travel agency services to Resort Condominiums International, LLC, Lodging.com, Neat Group, and CheapTickets.com, each of which was an affiliate of Cendant. We believe that TAS is one of the ten largest leisure travel agencies in North America.

 

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TAS travel consultants use Cendant’s Galileo International GDS booking system, which offers 470 airlines, 23 car rental companies, 62,000 hotel properties, Amtrak, VIARail (Canada) and 13 national rail systems. This system provides us with access to online fares on the six network carriers covering 80% of available itineraries, electronic ticketing capability on 63 air carriers from 50 countries (more than any other GDS). Because TAS takes bookings primarily for its members, TAS is able to shift share from one travel vendor (airline, hotel, car rental, etc.) to another depending on which is more advantageous to us. Reservation and support services are provided by a combination of internally managed call centers, outsourcing relationships, and more than ten branded websites.

Contact Call Centers

Our contact call centers provide high-quality, predominantly inbound telemarketing service and retention support. We are committed to using internally managed and outsourced contact call centers to effectively handle peak service levels while achieving a semi-variable cost structure. Currently, 15 facilities handle the volume, 7 of these are internally managed (2 in North America and 5 in Europe) and 8 are outsourced. One internally managed and one outsourced center closed as scheduled during 2006.

Our contact call centers handle approximately 25.3 million customer contacts per year, 12.8 million of which are related to membership programs and the rest spread relatively evenly across insurance, package, travel reservation, loyalty and international. The contact call centers provide a primary point of interaction with our customers, driving customer satisfaction, retention and ultimately, profits. To this end, we are focused on developing expertise to improve service levels and to set the necessary quality benchmarks to keep third-party vendors performing at high levels. At the same time, we have reduced our internally managed contact call centers and increased the use of outsourcers, producing significant cost reductions and an improved variable cost structure.

Competition

Our competitors include any company seeking direct and regular access to large groups of customers through any affinity-based direct media contact. Our programs and services compete with those marketed by financial institutions and other third parties who have affinity relationships with our competition, including large, fully integrated companies that have financial, marketing, legal, and product development resources that are greater than ours. As a whole, the direct marketing services industry is extremely fragmented, with over 4,800 providers of various services. Most of these companies are relatively small and provide a limited array of programs and services. In general, the competition for the consumer’s attention is intense, with a wide variety of players competing in different segments of the direct marketing industry. More specifically, competition within our business lines comes from companies that vary significantly in size, scope, and primary core competencies.

Membership Operations. The membership services industry is characterized by a high degree of competition. However, strong and established relationships with affinity partners can mitigate the impact of competition. Participants in this industry include other membership services companies, such as Vertrue Incorporated (“Vertrue”) and Intersections, as well as large retailers, travel agencies, insurance companies and financial service institutions.

Insurance and Package Operations. Participants in the U.S. in the direct marketing of insurance programs include Aegon Direct Marketing Services, Coverdell (a unit of Vertrue), AIG, Fortis and UnumProvident.

The U.S. package enhancement operation faces competition from both similar direct marketing companies and financial institutions that choose to provide package enhancement programs in-house. Some of the direct marketers that participate in this space include Sisk, Generations Gold, Econocheck and Strategy Corp.

International Operations. In Europe, key competitors in the package enhancement business include Card Protection Plan Ltd., St. Andrews, a wholly-owned subsidiary of Halifax Bank of Scotland, Carlson Marketing Group, Cauldwell Group, Nectar Rewards and Airmiles in the U.K., Societe de Prevoyance Bancaire in France, Europe Assistance in Italy, and Sreg and DSV Group (the savings banks’ cooperative) in Central Europe. On the

 

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membership side of the business, participants include other membership services companies, as well as large retailers, travel agencies, insurance companies and financial service institutions.

Loyalty Operations. Participants in the loyalty arena provide in-house rewards programs and utilize third-party providers. Such third-party providers design, market and manage rewards-based loyalty programs for businesses that either have no desire to manage such a program or lack the core competencies necessary to compete in the industry effectively. Key industry participants include Maritz Loyalty Marketing, Carlson Marketing Group and Enhancement Services Corporation.

Information Technology

Our information technology team, comprised of approximately 380 employees worldwide, operates and supports approximately 200 of our individual applications. Membership, package and insurance programs and services are distributed through a multiple media approach, which allows us to interface with our affinity partners’ customers in a variety of ways to enhance file penetration in a cost effective manner. Our systems are able to manage marketing campaigns across all media. Servicing and subscription requests are processed through a workflow and messaging interface with our vendors and are stored within our subscriber management platform. This framework allows us to keep a virtual inventory of programs and services, as well as store customer information for future marketing data mining. Customer servicing and billing information are fed into the financial ledger and business intelligence platform for billing and future marketing analysis.

Intellectual Property

We own or have licenses to use a large number of patents relating to a significant number of programs and processes. We also have certain significant material trademarks including, but not limited to Affinion, Trilegiant, Progeny, Cims, Trilegiant Loyalty Solutions, PrivacyGuard, Hot-Line, Travelers Advantage, Shoppers Advantage, AutoVantage, CompleteHome, Buyers Advantage, HealthSaver, NHPA, Enhanced Checking, Small Business Solutions and Wellness Extras. We use our trademarks in the marketing of our services and program offerings. We renew our trademarks on a regular basis. No individual patent or trademark is considered to be material to our business; however, our overall portfolio of patents and trademarks are valuable assets.

Employees

We employed approximately 2,900 people as of December 31, 2006, of which 72% were located in North America and the remaining 28% were in our international operations. As a result of ongoing integration, rightsizing and outsourcing initiatives, we have realized significant headcount reductions, with headcount decreasing from approximately 5,100 employees in 2002 to approximately 2,900 employees as of December 31, 2006. With the exception of fewer than twenty of our European employees, none of our employees are members of, or are represented by, any labor union or other collective bargaining organization. We believe relationships with our employees are generally satisfactory.

Governmental and Regulatory Matters

The direct marketing industry is subject to U.S. federal and state regulation as well as regulation by foreign authorities in foreign jurisdictions. Certain regulations that govern our operations include: federal, state and foreign marketing laws; federal, state and foreign privacy laws; and federal, state and foreign insurance and consumer protection regulations. Federal regulations are primarily enforced by the Federal Trade Commission (the “FTC”) and Federal Communications Commission (the “FCC”). State regulations are primarily enforced by individual state attorneys general. Foreign regulations are enforced by a number of regulatory bodies in the relevant jurisdictions.

Federal and State Marketing Laws. The FTC and each of the states have enacted consumer protection statutes designed to ensure that consumers are protected from unfair and deceptive marketing practices. We review all marketing materials disseminated to the public for compliance with applicable FTC regulations and state marketing laws. In 2003, the FTC amended its Telemarketing Sales Rule to, among other things, establish a National “Do-Not-Call” Registry. As of December 2005, the “Do-Not-Call” Registry included more than 107 million phone numbers. To comply with the rule, prior to conducting outbound telemarketing, companies are required to match their call lists against the “Do-Not-Call” Registry to remove the names of consumers who requested not to be called. In addition,

 

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the amended Telemarketing Sales Rule requires additional disclosures and sales practices for goods and services sold over the phone. When these regulations went into effect, we began to match our call lists with the “Do Not Call Registry” and modified our telemarketing scripts so that they are designed to comply with the rule. These changes have not significantly affected our results, but may do so in the future.

Federal Privacy Laws. The Financial Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act (“GLB”), includes provisions to protect consumers’ personal financial information held by financial institutions. GLB places restrictions on the ability of financial institutions to disclose non-public personal information about their customers to non-affiliated third parties and also prohibits financial institutions from disclosing account numbers to any non-affiliated third parties for use in telemarketing, direct mail marketing or other marketing to consumers. We have implemented privacy solutions across our businesses designed to comply with this privacy law.

State Privacy Laws. In addition to federal legislation, some states are considering or have passed laws restricting the sharing of customer information. As an example, the California Financial Information Privacy Act (“SB 1”) places restrictions on financial institutions’ ability to share the personal information of their California customers. We have established a privacy solution that is designed to comply with the requirements of SB 1.

Domestic and International Insurance Regulations. As a marketer of insurance programs, we are subject to state rules and regulations governing the business of insurance including, without limitation, laws governing the administration, underwriting, marketing, solicitation and/or sale of insurance programs. Domestically, the insurance carriers that underwrite the programs that we sell are required to file their rates for approval by state regulators. Additionally, certain state laws and regulations govern the form and content of certain disclosures that must be made in connection with the sale, advertising or offer of any insurance program to a consumer. We review all marketing materials disseminated to the public for compliance with applicable insurance regulations. We are required to maintain certain licenses and approvals in order to market insurance programs. Further, in our international operations, we are regulated by various national and international entities, including the UK Financial Services Authority (“FSA”), in the sale of insurance programs. The FSA is responsible for enforcing the Financial Services and Markets Act 2000 which, among other things, implements the EU’s Insurance Mediation Directive.

Other Foreign Regulations. In the U.K., our direct marketing operations are subject to privacy and consumer protection regulations. These include (a) Data Protection regulation: imposing security obligations and restrictions on the use and transmission of consumers’ personal information data; (b) Privacy and Electronic Communications regulation: regulating unsolicited marketing activities carried out by telephone, fax and e-mail to users/subscribers to public electronic communication services; (c) Electronic Commerce regulation: imposing certain disclosures requirements in relation to commercial communications; (d) Distance Selling regulation: requiring information disclosure and “cooling off periods” in contracts for goods or services (other than financial services) supplied to a consumer where the contract is made exclusively by means of distance communication; and (e) Distance Marketing regulation: requiring information disclosure and “cooling off periods” in contracts for financial services supplied to a consumer where the contract is made exclusively by means of distance communication. In addition, various codes of advertising and direct marketing practice exist. Much of the U.K. regulation is based on EU directives, which apply to Affinion International’s operations elsewhere in the EU. We have established compliance procedures designed to comply with the requirements of these regulations.

Insurance

We believe we carry sufficient insurance coverage to protect us from material losses incurred by any of our operations due to an insurance recoverable circumstance.

Corporate Information

Our principal executive offices are at 100 Connecticut Avenue, Norwalk, Connecticut 06850. Our telephone number is (203) 956-1000.

 

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Item 1A. Risk Factors

You should carefully consider the risk factors set forth below as well as the other information contained in this Report. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or those we currently deem to be immaterial may also materially and adversely affect our business, financial condition, cash flow, or results of operations and prospects. The following is a description of the most significant factors that might cause the actual results of operations in future periods to differ materially from those currently desired or expected. Any of the following risks could materially adversely affect our business, financial condition or results of operations and prospects.

Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from servicing our debt.

We are a highly leveraged company. As of December 31, 2006, we had approximately $1.4 billion principal amount of outstanding indebtedness. Although our annual debt service payment obligations, exclusive of capital lease obligations, do not include any required principal repayments until 2012, our estimated 2007 debt service payments will be approximately $50.2 million. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition, Liquidity and Capital Resources – Contractual Obligations and Commitments.” Our ability to generate sufficient cash flow from operations to make scheduled payments on our debt will depend on a range of economic, competitive and business factors, many of which are outside our control. Our business may not generate sufficient cash flow from operations to meet our debt service and other obligations, and currently anticipated cost savings and operating improvements may not be realized on schedule, or at all. If we are unable to meet our expenses, debt service obligations, and other obligations we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or raise equity. We may not be able to refinance any of our indebtedness, sell assets or raise equity on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our obligations on commercially reasonable terms, would have a material adverse effect on our business, financial condition and results of operations.

Our substantial indebtedness could have important consequences, including the following:

 

   

it may limit our ability to borrow money or sell stock for our working capital, capital expenditures, debt service requirements, strategic initiatives or other purposes, such as marketing spend;

 

   

a substantial portion of our cash flow from operations will be dedicated to the repayment of our indebtedness and will not be available for other purposes;

 

   

it may limit our flexibility in planning for, or reacting to, changes in our operations or business;

 

   

we will be more highly leveraged than some of our competitors, which may place us at a competitive disadvantage;

 

   

it may make us more vulnerable to downturns in our business or the economy;

 

   

it may restrict us from making strategic acquisitions, introducing new technologies or exploiting business opportunities; and

 

   

it may limit, along with the financial and other restrictive covenants in our indebtedness, among other things, our ability to borrow additional funds or dispose of assets.

Furthermore, our interest expense could increase if interest rates increase because all of the debt under our credit facility is variable-rate debt.

 

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The terms of our credit facility and the indentures governing the 10 1/8% Senior Notes and 11 1/2% Senior Subordinated Notes may restrict our current and future operations, particularly our ability to respond to changes in our business or to take certain actions.

Our credit facility and the indentures governing our $314.0 million aggregate principal amount of 10 1/8% Senior Notes due 2013, which we refer to as our 10 1/8% Senior Notes, and our $355.5 million aggregate principal amount of 11 1/2% Senior Subordinated Notes due 2015, which we refer to as our 11 1/2% Senior Subordinated Notes, contain, and any future indebtedness of ours would likely contain, a number of restrictive covenants that impose significant operating and financial restrictions on us, including restrictions on our ability to, among other things:

 

   

incur or guarantee additional debt;

 

   

pay dividends and make other restricted payments;

 

   

create or incur certain liens;

 

   

make certain investments;

 

   

engage in sales of assets and subsidiary stock;

 

   

enter into transactions with affiliates; and

 

   

transfer all or substantially all of our assets or enter into merger or consolidation transactions.

In addition, our credit facility requires us to maintain certain financial ratios. As a result of these covenants, we will be limited in the manner in which we conduct our business and we may be unable to engage in favorable business activities or finance future operations or capital needs.

A failure to comply with the covenants contained in our credit facility could result in an event of default, which, if not cured or waived, could have a material adverse effect on our business, financial condition and results of operations. In the event of any default under our credit facility, the lenders thereunder:

 

   

will not be required to lend any additional amounts to us;

 

   

could elect to declare all borrowings outstanding, together with accrued and unpaid interest and fees, to be due and payable; and

 

   

could require us to apply all of our available cash to repay these borrowings;

any of which could result in an event of default under the 10 1/8% Senior Notes and the 11 1/2% Senior Subordinated Notes.

If the indebtedness under our credit facility, 10 1/8% Senior Notes or the 11 1/2% Senior Subordinated Notes were to be accelerated, there can be no assurance that our assets would be sufficient to repay such indebtedness in full.

We have limited history as a stand-alone company and may not be successful as an independent company. Further, we will need to implement financial and disclosure control procedures and corporate governance practices to comply with the requirements of the Sarbanes-Oxley Act of 2002.

Prior to the closing of the Acquisition in October 2005, we had no operating history as an independent company. Prior to the Acquisition, we relied on certain operational resources of Cendant. As a result of the Acquisition, we no longer had access to the borrowing capacity, cash flow and assets of Cendant, including cash management. We were also required to enter into new operating and other agreements with Cendant. See “Item 13. Certain Relationships and Related Transactions.”

 

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The historical combined financial information included in this Report for periods prior to October 17, 2005 is derived from the historical consolidated financial statements of Cendant. The preparation of this information is based on certain assumptions and estimates including corporate allocations of costs from Cendant. This information may not necessarily reflect what our results of operations, financial position and cash flows would have been had we been a separate, stand-alone entity during the periods presented or what our results of operations, financial position and cash flows will be in the future.

As of December 31, 2007, we will be subject to the additional reporting requirements under the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and related SEC rules and we must implement control procedures in order to comply. Our 2006 financial statement audit was significantly less in scope than an integrated audit pursuant to Section 404 of the Sarbanes-Oxley Act which will include an audit of our internal controls over financial reporting. A financial statement audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of our internal controls. To ensure our ability to provide timely and reliable financial reports and our ability to certify as to, and our auditors ability to attest to, the effectiveness of our internal control over financial reporting, we have established an audit committee and we will need to continue to develop further our accounting and financial capabilities, as well as the continued development of certain documentation, systems and other controls. Failure to establish the necessary controls and procedures would make it difficult to comply with SEC rules and regulations with respect to internal control over financial reporting that could lead to a loss of confidence in the reliability of our financial statements. Further, the actual costs of implementing the necessary policies and procedures could exceed our current estimates, which could have an adverse effect on our financial condition, results of operations and cash flows.

We must replace the customers we lose in the ordinary course of business and if we fail to do so our revenue and customer base will decline.

We lose a substantial number of our customers each year in the ordinary course of business. The loss of customers may occur due to numerous factors, including:

 

   

changing customer preferences;

 

   

competitive price pressures;

 

   

general economic conditions;

 

   

customer dissatisfaction; and

 

   

credit or debit card holder turnover.

 

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Additionally, we expect to see a net loss of members and end-customers as we continue our strategy to focus on overall profitability and generating higher revenue from each member rather than the size of our member base. Failure to obtain new customers who produce revenue at least equivalent to the revenue from the lost customers would result in a reduction in our revenue as well as a decrease in the number of our customers. Because of the large number of customers we need to replace each year, there can be no assurance that we can successfully replace them. In addition, even if we are successful in adding new customers to replace lost revenues, our profitability may still decline. See “—Our profitability depends on members and end-customers continuing their relationship with us. Increased loss of customers could impair our profitability.”

We depend on various third-party vendors to supply certain products and services that we market. The failure of these vendors to provide these products or services could result in customer dissatisfaction and harm our business and financial condition.

We depend on various third-party vendors to supply the products and services that we market. Many of our third-party vendors are independent contractors. As a result, the quality of service they provide is not entirely within our control. If any third-party vendor were to cease operations, or terminate, breach or not renew its contract with us, or suffer interruptions, delays or quality problems, we may not be able to substitute a comparable third-party vendor on a timely basis or on terms favorable to us. With respect to the insurance programs that we offer, we are dependent on the insurance carriers that underwrite the insurance to obtain appropriate regulatory approvals. If we are required to use an alternative insurance carrier, it may materially increase the time required to bring an insurance related product to market. As we are generally obligated to continue providing our products and services to our customers even if we lose a third-party vendor, any disruption in our product offerings could harm our reputation and result in customer dissatisfaction. Replacing existing third-party vendors with more expensive third-party vendors could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We derive a substantial amount of our revenue from the members and end-customers we obtained through only a few of our affinity partners. If one or more of our agreements with our affinity partners were to be terminated or expire, or one or more of our affinity partners were to reduce the marketing of our services, we would lose access to prospective members and end-customers and could lose sources of revenue.

Although we market our programs and services through over 5,200 affinity partners, we derive a substantial amount of our net revenue from the customers we obtained through only a few of these affinity partners. For the year ended December 31, 2006, we derived more than half of our net revenues from members and end-customers we obtained through 10 of our affinity partners. See “Item 1. Business—Affinity Partners.”

Many of our key affinity partner relationships are governed by agreements that may be terminated without cause by our affinity partners upon notice of as few as 90 days without penalty. Some of our agreements may be terminated by our affinity partners upon notice of as few as 30 days without penalty. Moreover, under many of these agreements, our affinity partners may cease or reduce their marketing of our services without terminating or breaching our agreements. Further, in the ordinary course of business, at any given time one or more of our contracts with key affinity partners may be selected for bidding through a request for proposal process. A loss of our key affinity partners, a cessation or reduction in their marketing of our services or a decline in their businesses could have a material adverse effect on our future revenue from existing services of which such affinity partner’s customers are consumers of ours and on our ability to further market new or existing services through such affinity partner to prospective consumers. There can be no assurance that one or more of our key or other affinity partners will not terminate their relationship with us, cease or reduce their marketing of our services or suffer a decline in their business. The termination or non-renewal of a key affinity partner relationship could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our typical membership operations agreements with affinity partners provide that after termination of the contract we may continue to provide our services to existing members under the same economic arrangements that existed before termination. Under certain of our insurance operations agreements, however, affinity partners may require us to cease providing services to existing customers after time periods ranging from 90 days to five years after termination of the agreement. Affinity partners under certain agreements also may require us to cease providing services to their customers under existing arrangements if the contract is terminated for material breach by us. If one or more of these affinity partners were to terminate our agreements with them, and require us to cease providing our services to customers, then we could lose significant sources of revenue.

 

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Our profitability depends on members and end-customers continuing their relationship with us. Increased loss of customers could impair our profitability.

We generally incur losses and negative cash flow during the initial year of an individual retail member or end-customer relationship, as compared to renewal years. This is due primarily to the fact that the costs associated with obtaining and servicing a new retail member and end-customer exceed the fee paid to us for the initial year. In addition, we experience a higher percentage of cancellations during the initial period as compared to renewal periods. Members and end-customers may cancel their arrangement at any time during the membership period and we are typically obligated to pay them refund amounts. Accordingly, our profitability depends on recurring and sustained renewals and an increase in the loss of members or end-customers could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We market many of our programs and services through credit card issuers. A downturn or consolidation in the credit card industry or changes in the marketing techniques of credit card issuers could adversely affect us.

Our future success is dependent in large part on continued demand for our programs and services within our affinity partners’ industries. In particular, our programs, products and services marketed through our credit card issuer affinity partners accounted for a significant amount of our revenues in 2006. A significant downturn in the credit card industry, a trend in that industry to reduce or eliminate its use of our programs, products and services, or further consolidation in the industry leading customers to use fewer credit cards could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We depend on credit card processors to obtain payments for us.

We depend on credit card processors to obtain payments for us. The credit card processors operate pursuant to agreements that may be terminated with limited prior notice. In the event a credit card processor ceases operations or terminates its agreement with us, there can be no assurance a replacement credit card processor could be retained on a timely basis, if at all. Any service interruptions, delays or quality problems could result in delays in collecting payments, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The increase in the share of monthly payment programs in our program mix may adversely affect our cash flows.

We have traditionally marketed membership programs which have up-front annual membership fees. However, we recently expanded our marketing of membership programs for which membership fees are payable in monthly installments. Approximately 62% of our new member enrollments as of the year ended December 31, 2006 were in monthly payment programs. Our increased emphasis on monthly payment programs adversely affects our cash flow in the short term because the membership fee is collected over the course of the year as opposed to at the beginning of the membership term as with annual billing.

Our business is highly competitive. We may be unable to compete effectively with other companies in our industry that have financial or other advantages and increased competition could lead to reduced market share, a decrease in margins and a decrease in revenue.

We believe that the principal competitive factors in our industry include the ability to identify, develop and offer innovative membership, insurance, package enhancement and loyalty programs, products and services, the quality and breadth of membership, insurance, package enhancement and loyalty programs, products and services offered, competitive pricing and in-house marketing expertise. Our competitors offer programs, products and services similar to, or which compete directly with, those offered by us. These competitors include, among others, Aegon, N.V., Vertrue Incorporated (f/k/a MemberWorks Incorporated), Intersections, Fortis and General Electric Financial Assurance. In addition, we could face competition if our current affinity partners or other companies were to develop and market their own in-house programs, products and services similar to ours. In addition, certain of our affinity partners (who may have greater financial resources and less debt than we do) have attempted, or are attempting, to market and/or provide certain products to their customers, which marketing and servicing of such products historically were provided by us.

 

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Some of these existing and potential competitors have substantially larger customer bases and greater financial and other resources than we do. There can be no assurance that:

 

   

our competitors will not increase their emphasis on programs similar to those we offer;

 

   

our competitors will not provide programs comparable or superior to those we provide at lower membership fees;

 

   

our competitors will not adapt more quickly than us to evolving industry trends or changing market requirements;

 

   

new competitors will not enter the market; or

 

   

other businesses (including our current affinity partners) will not themselves introduce in-house programs similar to those we offer.

In order to compete effectively with all of these competitors, we must be able to provide superior programs and services at competitive prices. In addition, we must be able to adapt quickly to evolving industry trends, a changing market, and increased regulatory requirements. Our ability to grow our business may depend on our ability to develop new programs and services that generate consumer interest. Failure to do so could result in our competitors acquiring additional market share in areas of consumer interest. Any increase in competition could result in price reductions, reduced gross margin and loss of market share, any of which could have a material adverse impact on our business, financial condition and results of operations.

Additionally, because contracts between affinity partners and program providers are often exclusive with respect to a particular program, potential affinity partners may be prohibited for a period of time from contracting with us to promote a new program if the benefits to and services included in our program are similar to, or overlap with, the programs and services provided by an existing program of a competitor.

Internationally, our package programs have been primarily offered by some of the largest financial institutions in Europe. As these banks attempt to increase their own net revenues and margins, we have experienced significant price reductions from what we had previously been able to charge these institutions for our programs when our agreements come up for renewal. This pricing pressure on our international package offerings may continue in the future, thereby lowering the contribution to our operating results from such programs in the future.

Our business is increasingly subject to U.S. and foreign governmental regulation, which could impede our ability to market our programs and services and reduce our profitability.

We market our programs and services through various distribution media, including direct mail, online marketing, in-branch marketing, telemarketing and other methods. These media are regulated at both federal and state levels and we believe that these media will be subject to increasing regulation, particularly in the area of consumer privacy. Such regulation may limit our ability to solicit or sign up new customers or to offer products or services to existing customers.

Our U.S. membership and insurance operations are subject to extensive regulation and oversight by the Federal Trade Commission (the “FTC”), the Federal Communications Commission (the “FCC”), state attorney generals and other state regulatory agencies, including state insurance regulators. Our programs and services involve the use of nonpublic personal information that is subject to federal consumer privacy laws, such as the federal GLB, and various state laws governing consumer privacy, such as California’s SB 1, SB 1386 and others. Additionally, telemarketing of our programs and services is subject to federal and state telemarketing regulations, including the FTC’s Telemarketing Sales Rule, the FCC’s Telephone Consumer Protection Act and implementing regulations, as well as various state telemarketing laws and regulations. Furthermore, our insurance operations are subject to various state laws and regulations governing the business of insurance, including, without limitation, laws and regulations governing the administration, underwriting, marketing, solicitation or sale of insurance programs. While we do not believe that the laws and regulations passed to date will have a material impact on our business, additional federal or state laws, including subsequent amendments to existing laws, could cause a material adverse impact on our business, financial condition, results of operations and cash flows.

 

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The telemarketing industry has become subject to an increasing amount of federal and state regulation as well as general public scrutiny. For example, the Federal Telephone Consumer Protection Act of 1991 limits the hours during which telemarketers may call consumers and prohibits the use of automated telephone dialing equipment to call certain telephone numbers. The Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994 and FTC regulations prohibit deceptive, unfair or abusive practices in telemarketing sales. The FTC’s 2003 Amendment to its Telemarketing Sales Rule created a national “Do-Not-Call” Registry, which became effective October 1, 2003, and certain states have enacted separate “Do-Not-Call” Registries. Both the FTC and state attorneys general have authority to prevent telemarketing activities deemed by them to be “unfair or deceptive acts or practices.” Further, some states have enacted laws, and others are considering enacting laws, targeted directly at regulating telemarketing practices, including the creation of “Do-Not-Call” Registries, and any such laws could adversely affect or limit our operations.

Likewise, in the U.K. and EU, our marketing operations are subject to regulation, including data protection legislation restricting the use and transmission of consumers’ personal information, regulation of unsolicited marketing using electronic communications and financial services regulation of insurance intermediaries.

Compliance with these federal, state and foreign regulations is generally our responsibility, and we could be subject to a variety of enforcement and/or private actions for any failure to comply with such regulations. Any changes to such regulations could materially increase our compliance costs. The risk of our noncompliance with any rules and regulations enforced by a federal or state consumer protection authority or an enforcement agency in a foreign jurisdiction may subject us or our management to fines or various forms of civil or criminal prosecution, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows. Certain types of noncompliance may also result in giving our affinity partners the right to terminate certain of our contracts. Also, the media often publicizes perceived noncompliance with consumer protection regulations and violations of notions of fair dealing with consumers, and our industry is susceptible to peremptory charges by the media of regulatory noncompliance and unfair dealing.

We are subject to numerous legal actions that could have a negative impact on our financial condition, results of operations, cash flows or reputation.

We are involved in claims, legal proceedings and governmental inquiries related to employment matters, contract disputes, business practices, trademark and copyright infringement claims and other commercial matters. We and our affiliates are also parties to a number of class action lawsuits, each of which alleges that we violated certain federal and/or state consumer protection statutes. In addition, we have received inquiries from numerous state attorneys general relating to the marketing of our membership programs. See “Item 3. Legal Proceedings.” While we cannot predict the outcome of pending suits, claims, investigations and inquiries, the cost of responding to and defending such suits, as well as the ultimate resolution of any of these matters, could have a material adverse effect on our business, financial condition, results of operations, cash flows or reputation. In addition, although Cendant has agreed to indemnify us (which indemnification obligation has been assumed by Wyndham and Realogy as successors to various segments of Cendant’s business), with respect to certain litigation and compliance with law matters in connection with the purchase agreement, these indemnification obligations are subject to certain limitations and restrictions. See “Item 13. Certain Relationships and Related Transactions—Purchase Agreement—Indemnification.” Although we have accrued legal and professional fees of $23.3 million as of December 31, 2006, a portion of which relates to accruals for legal actions, there can be no assurance that these accruals will be sufficient to satisfy all related claims and expenses or any claims in excess of the Cendant indemnification.

We rely on our affinity partners to provide customer information to us for certain marketing purposes and to approve our marketing materials. If our affinity partners make significant changes to the materials that decrease results or if they limit the information that they provide to us, our ability to generate new customers may be adversely affected.

Certain of our marketing efforts depend in part on certain limited customer information being made available to us by our affinity partners. There can be no assurance that our affinity partners will, or will be able to, continue to provide us with the use of such customer information.

Our marketing efforts are largely dependent on obtaining approval of the solicitation materials from our affinity partners. We market our programs and services based on tested marketing materials, and any significant changes to those materials that are required by our affinity partners could cause a negative impact to our results. The material

 

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terms of each marketing campaign must be mutually agreed upon by the parties. There can be no assurance that we will obtain approvals of our marketing materials from our affinity partners, and the failure to do so could have a material adverse impact on our business, financial condition, results of operations and cash flows.

A significant portion of our business is conducted with financial institution affinity partners, many of which are merging with other financial institutions. Marketplace consolidation may have an adverse impact on our business if an acquiring financial institution is not an existing affinity partner or does not wish to market with us, or if consolidated clients pressure us to lower our prices.

In recent years, a number of our existing financial institution marketing partners have been acquired by or merged with other financial institutions. In the event one of our affinity partners undergoes a consolidation and the consolidated financial institution does not have an agreement with us or does not wish to continue marketing with us, we could experience an adverse impact on our revenue. In addition, the consolidation of financial institutions may result in increased leverage to pressure us to lower our prices. If consolidated affinity partners pressure us to lower our prices, we may experience an adverse impact on our revenue. Consolidation may also lead to fewer potential customers of affinity partners to whom we can sell our programs and services.

We may lose members or end-customers and significant revenue if our existing services become obsolete, or if we fail to introduce new services with broad consumer appeal or fail to do so in a timely or cost-effective manner.

Our growth depends upon developing and successfully introducing new services that generate member and end-customer interest. Our failure to introduce these services or to develop new services, or the introduction or announcement of new services by competitors, could render our existing offerings noncompetitive or obsolete. There can be no assurance that we will be successful in developing or introducing new programs and services. Our failure to develop, introduce or expand our programs and services could harm our business and prospects.

Our failure to protect private data could damage our reputation and cause us to expend capital and other resources to protect against future security breaches.

Certain of our services are based upon the collection, distribution and protection of sensitive private data. Unauthorized users might access that data, and human error or technological failures might cause the wrongful dissemination of that data. If we experience a security breach, the integrity of certain of our services may be affected and such a breach could violate certain of our affinity partner agreements. We have incurred, and may incur in the future, significant costs to protect against the threat of a security breach. We may also incur significant costs to alleviate problems that may be caused by future breaches. Any breach or perceived breach could subject us to legal claims from affinity partners or customers under laws (such as California’s SB 1386) that govern breaches of electronic data systems containing non-public personal information. There is no assurance that we would prevail in such litigation. Moreover, any public perception that we have engaged in the unauthorized release of, or have failed to adequately protect, private information could adversely affect our ability to attract and retain members and end-customers. In addition, unauthorized third parties might alter information in our databases, which would adversely affect both our ability to market our services and the credibility of our information.

Our success and growth depends to a significant degree upon intellectual property rights.

We have a significant intellectual property portfolio and have allocated considerable resources toward intellectual property maintenance, prosecution and enforcement. We may be unable to deter infringement or misappropriation of our data and other proprietary information, detect unauthorized use or take appropriate steps to enforce our intellectual property rights. Any unauthorized use of our intellectual property could make it more expensive for us to do business and consequently harm our business. Failure to protect our existing intellectual property rights may result in the loss of valuable technologies or having to pay other companies for infringing on their intellectual property rights. We rely on patent, trade secret, trademark and copyright law as well as judicial enforcement to protect such technologies. Some of our technologies are not covered by any patent or patent application. In addition, our patents could be successfully challenged, invalidated, circumvented or rendered unenforceable. Furthermore, pending patent applications may not result in an issued patent, or if patents are issued to us, such patents may not provide meaningful protection against competitors or against competitive technologies. We also license patent rights from third parties. To the extent that such third parties cannot protect and enforce the

 

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patents underlying such licenses or, to the extent such licenses are cancelled or not renewed, our competitive position and business prospects may be harmed.

We could face patent infringement claims from our competitors or others alleging that our processes or programs infringe on their proprietary technology. If we were subject to an infringement suit, we may be required to (1) incur significant costs to license the use of proprietary technology, (2) change our processes or programs or (3) stop using certain technologies or producing the infringing program entirely. Even if we ultimately prevail in an infringement suit, the existence of the suit could cause our customers to seek other programs that are not subject to infringement suits. Any infringement suit could result in significant legal costs and damages and impede our ability to market or provide existing programs or create new programs, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

In addition, effective patent, trademark, copyright and trade secret protection may be unavailable or limited in some foreign countries. In some countries we do not apply for patent, trademark, or copyright protection. We also rely upon unpatented proprietary expertise, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we generally enter into confidentiality agreements with our employees and third parties to protect our intellectual property, such confidentiality agreements could be breached, and may not provide meaningful protection for our trade secrets or proprietary manufacturing expertise. Adequate remedies may not be available in the event of an unauthorized use or disclosure of our trade secrets and manufacturing expertise. In addition, others may obtain knowledge of our trade secrets through independent development or other access by legal means. The failure of our patents or confidentiality agreements to protect our processes, apparatuses, technology, trade secrets and proprietary manufacturing expertise, methods and compounds could have a material adverse effect on our business, financial condition, results of operations and cash flows by jeopardizing critical intellectual property.

Our business is highly dependent on our existing computer, billing, communications and other technological systems. Any temporary or permanent loss of any of our systems could have a negative effect on our business, financial condition and results of operations.

Our business depends upon ongoing investments in advanced computer database and telecommunications technology as well as upon our ability to protect our telecommunications and information technology systems against damage or system interruptions from natural disasters, technical failures and other events beyond our control. In order to compete effectively and to meet our affinity partners’ and members’ needs, we must maintain our systems as well as invest in improved technology. A temporary or permanent loss of any of our systems or networks could cause significant damage to our reputation and could result in a loss of revenue.

In addition, we receive credit data electronically, and this delivery method is susceptible to damage, delay or inaccuracy. A significant portion of our business involves telephonic customer service as well as mailings, both of which depend upon the data generated from our computer systems. Unanticipated problems with our telecommunications and information technology systems may result in a significant system outage or data loss, which could interrupt our operations. Our infrastructure may also be vulnerable to computer viruses, hackers or other disruptions entering our systems from the credit reporting agencies, our affinity partners and members and end-customers or other authorized or unauthorized sources. Any damage to our telecommunications and information technology systems, failure of communication links or other loss that causes interruption in, or damage to, our operations could have a material adverse effect on our business, financial condition, results of operations and cash flows.

If we are unable to meet the rapid changes in technology, our services and proprietary technology and systems may become obsolete.

Due to the costs and management time required to introduce new services and enhancements, we may not be able to respond in a timely manner to avoid becoming uncompetitive. To remain competitive, we must meet the challenges of the introduction by our competitors of new services using new technologies or the introduction of new industry standards and practices. Additionally, the vendors we use to support our technology may not provide the level of service we expect or may not be able to provide their product or service on commercially reasonable terms or at all.

 

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We depend in part on the postal and telephone services we utilize to market and service our programs. An interruption of, or an increase in the billing rate for, such services could adversely affect our business.

We market and service our programs by various means, including through mail and via telephone. Accordingly, our business is dependent on the postal and telephone services provided by the U.S. Post Office and various local and long distance telephone companies. Any significant interruption of such services or any limitations in their ability to provide us with increased capacity could adversely impact our business, financial condition and results of operations. In addition, the U.S. Postal Service increases rates periodically and significant increases in rates could adversely impact our business.

Our future success depends on our ability to retain our key employees.

We are dependent on the services of Nathaniel J. Lipman, our President and Chief Executive Officer, and other members of our senior management team to remain competitive in our industry. The loss of Mr. Lipman or any other member of our senior management team could have an adverse effect on us. There is a risk that we will not be able to retain or replace these key employees. All of our current executive officers are subject to employment conditions or arrangements that contain post-employment non-competition provisions. However, these arrangements permit the employees to terminate their employment without notice.

We are controlled by Apollo who will be able to make important decisions about our business and capital structure.

Approximately 97% of the common stock of Holdings is held by investment funds affiliated with Apollo Management V, L.P. (Apollo). As a result, Apollo controls us and has the power to elect a majority of the members of our board of directors, appoint new management and approve any action requiring the approval of the holders of Holdings’ stock, including approving acquisitions or sales of all or substantially all of our assets. The directors elected by Apollo have the ability to control decisions affecting our capital structure, including the issuance of additional capital stock, the implementation of stock repurchase programs and the declaration of dividends. Additionally, Apollo is in the business of investing in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us. Apollo may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

Item 2. Properties

We are headquartered in Norwalk, Connecticut in a 115,000 square foot facility that houses management offices as well as the marketing and sales operations for our largest customers. Our corporate data center is in Trumbull, Connecticut with disaster recovery operations provided by a backup site in Westerville, Ohio. Some applications are also housed in Centennial, Colorado, Slough, U.K., and Oslo, Norway. The table below lists all of our facilities as of December 31, 2006, all of which are leased.

 

Location

  

Function

U.S. Facilities

  

Norwalk, CT

   Global Headquarters

Trumbull, CT

  

Call Center/ Data Ops Center/ Mail Operations/ Data Capture

Dublin, OH (2 sites)

   Software Development

Westerville, OH

   Call Center

Richmond, VA

   Call Center and ALG Corporate Office

Franklin, TN (3 sites)

  

Insurance & Package Sales, Marketing and Administration, Print Fulfillment Center

 

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Location

  

Function

International Facilities

  

Antwerp, Belgium

   Sales and Marketing

Copenhagen, Denmark

   Sales and Marketing

Roissy (Paris), France

   Call Center

Johannesburg, South Africa

   Sales and Marketing

Slough, U.K.

   International Headquarters

Millerntorplatz, Hamburg, Germany

   Sales, Marketing and Call Center

Milan, Italy

   Sales and Marketing

Milan, Italy

   Call Center

Oslo, Norway

   Call Center

Stockholm, Sweden

   Sales

Seafire Bldg., Portsmouth, U.K.

   Administration

Seahawk Bldg., Portsmouth, U.K.

   Administration and Call Center

We have noncancelable operating leases covering various facilities and equipment. Our rent expense, net of sub-lease income, for the year ended December 31, 2006, the period from October 17, 2005 to December 31, 2005, the period from January 1, 2005 to October 16, 2005 and for the year ended December 31, 2004 was $14.3 million, $3.2 million, $14.6 million and $21.7 million, respectively.

 

Item 3. Legal Proceedings

We are involved in claims, legal proceedings and governmental inquiries related to employment matters, contract disputes, business practices, trademark and copyright infringement claims and other commercial matters. We are also parties to a number of class action lawsuits, each of which alleges violations of certain federal and/ or state consumer protection statutes.

In April 2002, the Predecessor filed and served a complaint against American Bankers Insurance Company of Florida and certain affiliates (“Fortis”) relating to Fortis’ breach of the parties’ exclusive agreement to jointly market insurance programs underwritten by Fortis. Fortis counterclaimed alleging breach of contract, breach of fiduciary duty, fraudulent inducement and breach of covenant of good faith and fair dealing. In May 2005, the Chancery Court of Tennessee found a total judgment in the amount of $16.5 million, including prejudgment interest, in favor of the Predecessor and a total judgment in the amount of $75.8 million, including prejudgment interest, in favor of Fortis. As a result of the verdict and final judgment entered, a charge of $73.7 million was recorded in the Predecessor’s 2004 combined statement of operations. As part of the Transactions, Cendant retained this liability. In January 2007, Cendant settled the matter with Fortis. We have been indemnified for any liability with respect to this matter.

From 2001 through early 2005, the Florida State Attorney General (“Florida AG”) investigated whether the Predecessor’s sales practices were fully in compliance with Florida’s laws and regulations. On March 7, 2005, the Predecessor entered into a settlement agreement with the Florida AG’s office. Pursuant to this settlement, the Predecessor agreed to pay $0.4 million to the Florida AG’s office to cover the state’s cost of the investigation. The Predecessor also agreed, among other things, to make refunds to Florida consumers who complained to the Florida AG’s office during the course of the investigation and for a period of six months thereafter and to make certain settlement disclosures in connection with the marketing to Florida consumers.

Beginning in November 2003, the Predecessor received inquiries from numerous state attorney generals relating to the marketing of its membership programs. In July 2005, the Attorney Generals of California and Connecticut filed suit against the Predecessor, and the Attorney General of Maine filed a notice of its intention to sue (collectively, the “AG Matters”), alleging that deceptive marketing practices were used in connection with the offering of membership services. In December 2006, we reached a settlement with California, Connecticut, Maine and other states resolving the lawsuits filed by California and Connecticut as well as the inquiries by other state attorney generals described above. Pursuant to this settlement, we agreed to pay $12.5 million to cover the costs of the states’ investigation and for consumer restitution. Cendant has agreed to indemnify us for a portion of the settlement, which indemnification obligation has been assumed by Wyndham and Realogy as successors to various segments of Cendant’s business.

 

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We are also a party to a number of lawsuits which were brought against us or our affiliates, each of which alleges to be a class action in nature and each of which alleges that we violated certain federal or state consumer protection statutes (certain of which are described below). We intend to vigorously defend ourselves against these lawsuits.

On August 9, 2005, a class action suit (the “August 2005 Suit”) was filed against Trilegiant in the U.S. District Court for the Northern District of California, San Francisco Division. The claim asserts violations of the Electronic Funds Transfer Act and various California consumer protection statutes. The suit seeks unspecified actual damages, statutory damages, attorneys’ fees, costs and injunctive relief.

On January 28, 2005, a class action complaint (the “January 2005 Suit”) was filed against The Bon, Inc., FACS Group, Inc., and Trilegiant in the Superior Court of Washington, Spokane County. The claim asserts violations of various consumer protection statutes. We filed a motion to compel arbitration, which was denied by the court. We appealed the court’s decision, and the case has been stayed until the appellate court has ruled on the motion to compel arbitration.

On November 12, 2002, a class action complaint (the “November 2002 Class Action”) was filed against Sears, Roebuck & Co., Sears National Bank, Cendant Membership Services, Inc., and Allstate Insurance Company in the Circuit Court of Alabama for Greene County alleging, among other things, breach of contract, unjust enrichment, breach of duty of good faith and fair dealing and violations of the Illinois consumer fraud and deceptive practices act. The case was removed to the U.S. District Court for the Northern District of Alabama but was remanded to the Circuit Court of Alabama for Greene County.

On January 24, 2002, a class action complaint (the “January 2002 Class Action”) was filed against Trilegiant in the U.S. District Court for the Northern District of Alabama Western Division (the “Alabama Court”) alleging that Trilegiant violated the Credit Repair Organizations Act (“CROA”) in connection with its Creditline product. On November 18, 2005, the court preliminarily approved the terms of a class-wide settlement of this case. Pursuant to the terms of the settlement, Trilegiant has provided notice to the class members via first class mail advising them of the terms of the settlement. All class members have released their claims against Trilegiant under the settlement. All class members wanting to receive benefits under the settlement were required to return a claim form post-marked by February 16, 2006 and had the option of choosing a no-cost annual membership in one of three membership programs offered by Trilegiant. In lieu of a membership program, class members could elect to receive a cash payment. The total cash payments that Trilegiant has offered to make to the class is capped at $0.5 million. On March 13, 2006 the Alabama Court signed the final order approving the terms of the settlement. The judgment became final on April 12, 2006.

On November 15, 2001, a class action complaint (the “2001 Class Action”) was filed in Madison County, Illinois against Trilegiant alleging violations of state consumer protection statutes in connection with the sale of certain membership programs. Motions to dismiss were denied and certification of a class of consumers has been granted; the exact size of the certified class is not known at this time.

We believe that the amount accrued for the above matters is adequate, and the reasonably possible loss beyond the amounts accrued will not have a material adverse effect on our financial condition, results of operations, or cash flows based on information currently available. However, litigation is inherently unpredictable and, although we believe that accruals are adequate and we intend to vigorously defend ourselves against such matters, unfavorable resolution could occur, which could have a material adverse effect on financial condition, results of operations or cash flows.

Subject to certain limitations, Cendant has agreed to indemnify us for actual losses, damages, liabilities, claims, costs and expenses and taxes incurred in connection with certain of the matters described above. See “Item 13. Certain Relationships and Related Transactions, and Director Independence.”

 

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Item 4. Submission of Matters to a Vote of Security Holders

Holdings, as our sole stockholder, approved the following matters by written consent pursuant to Section 228(a) of the General Corporation Law of the State of Delaware:

 

   

on October 30, 2006, the election of Matthew Nord to our board of directors; and

 

   

on November 21, 2006, the election of Kenneth Vecchione to our board of directors.

 

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PART II

 

Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

We are a wholly-owned subsidiary of Holdings, and there is no established trading market for our common stock. As of March 20, 2007, approximately 97% of the common stock of Holdings was held by investment funds affiliated with our principal equity sponsor, Apollo Management, L.P. (collectively, “Apollo”).

Since the Acquisition, we have paid no cash dividends in respect of our common stock. Our senior secured credit facility and the indenture governing our 10 1/8% Senior Notes and 11 1/2% Senior Subordinated Notes contain covenants that limit our ability to pay dividends.

 

Item 6. Selected Financial Data

The following table presents our selected historical consolidated and combined financial data for years 2002 through 2006. The following information should be read in conjunction with, and is qualified by reference to, the section entitled “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated and combined financial statements and the notes thereto included elsewhere herein.

The consolidated balance sheet data of Affinion as of December 31, 2006 and 2005 and the related consolidated statements of operations data and cash flows data of Affinion for the year ended December 31, 2006 and the period October 17, 2005 to December 31, 2005 and the related combined statements of operations data and cash flows data of the Predecessor for the period from January 1, 2005 to October 16, 2005 and for the years ended December 31, 2004 are derived from the consolidated and combined financial statements and the notes thereto included elsewhere herein. The combined balance sheet data as of December 31, 2004 and 2003 has been derived from the audited combined balance sheet of the Predecessor, the combined balance sheet data as of December 31, 2002 has been derived from the unaudited combined balance sheet of the Predecessor, and the combined statement of operations data and cash flows data for the years ended December 31, 2003 and 2002 have been derived from the 2003 and 2002 audited combined financial statements, respectively, of the Predecessor, none of which are included herein.

 

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      The Predecessor     The Company  
      For the Years Ended December 31,    

Period From
January 1, 2005

to October 16,
2005

   

Period From
October 17, 2005

to December 31,
2005

   

For the Year
Ended

December 31,
2006

 
      2002     2003     2004        

Consolidated and Combined Statement of Operations Data:

            

Net revenues

   $ 1,458.4     $ 1,443.7     $ 1,530.9     $ 1,063.8     $ 134.9     $ 1,137.7  
                                                

Expenses:

            

Marketing and commissions(1)

     698.6       683.7       665.3       515.0       87.1       580.9  

Operating costs

     409.6       379.5       383.3       315.0       48.7       326.1  

General and administrative

     112.5       115.7       185.0       134.5       20.2       106.9  

Gain on sale of assets

     —         —         (23.9 )     (4.7 )     —         —    

Goodwill impairment

     —         —         —         —         —         15.5  

Depreciation and amortization

     45.3       44.5       43.9       32.3       84.5       396.8  
                                                

Total expenses

     1,266.0       1,223.4       1,253.6       992.1       240.5       1,426.2  
                                                

Income (loss) from operations

     192.4       220.3       277.3       71.7       (105.6 )     (288.5 )

Interest income

     3.2       2.0       1.7       1.9       1.3       5.7  

Interest expense

     (15.5 )     (14.1 )     (7.3 )     (0.5 )     (31.9 )     (148.8 )

Other income (expense), net

     (14.0 )     6.7       0.1       5.9       —         —    
                                                

Income (loss) before income taxes and minority interests

     166.1       214.9       271.8       79.0       (136.2 )     (431.6 )

Income tax (expense) benefit

     (116.6 )     (71.3 )     104.5       (28.9 )     —         (6.3 )

Minority interests, net of tax

     —         0.7       0.1       —         (0.1 )     (0.3 )
                                                

Income (loss) before cumulative effect of accounting change

     49.5       144.3       376.4       50.1       (136.3 )     (438.2 )

Cumulative effect of accounting change, net of tax

     (143.7 )     —         —         —         —         —    
                                                

Net income (loss)

   $ (94.2 )   $ 144.3     $ 376.4     $ 50.1     $ (136.3 )   $ (438.2 )
                                                

Consolidated and Combined Balance Sheet Data (at period end):

            

Cash and cash equivalents

   $ 86.2     $ 63.2     $ 22.5       n/a     $ 113.4     $ 84.3  

Working capital deficit

     (450.3 )     (463.9 )     (322.4 )     n/a       (92.7 )     (251.3 )

Total assets

     1,335.0       1,246.6       1,158.5       n/a       2,200.0       1,889.5  

Total debt

     140.4       131.2       31.6       n/a       1,491.0       1,408.4  

Stockholder’s/combined equity (deficit)

     123.7       115.6       293.6       n/a       233.9       (186.9 )

Consolidated and Combined Cash Flows Data:

            

Net cash provided by (used in):

            

Operating activities(2)

   $ 32.6     $ 145.5     $ 261.1     $ 106.5     $ 31.1     $ 98.3  

Investing activities(2)

     (38.2 )     (5.6 )     (2.3 )     (39.5 )     (1,640.1 )     (44.4 )

Financing activities

     (10.4 )     (165.6 )     (301.5 )     (23.4 )     1,722.9       (85.4 )

Other Financial Data:

            

Capital expenditures

   $ 42.5     $ 20.8     $ 25.8     $ 24.0     $ 9.0     $ 29.1  

Ratio of earnings to fixed charges(3)

     8.5 x     11.4 x     19.8 x     15.9 x     —         —    

(1) As discussed in Note 2 to the consolidated and combined financial statements, the Predecessor previously deferred costs which varied with and were directly related to acquiring new insurance business on its combined balance sheets as deferred acquisition costs to the extent such costs were deemed recoverable from future cash flows. These costs were amortized as marketing expense over a 12 year period using a declining balance method generally in proportion to the related insurance revenue, which amortization was based on attrition rates associated with the approximate rate that insurance revenues collected from customers decline over time. Amortization of deferred acquisition costs commenced upon recognition of the related insurance revenue. Immediately following the Transactions, the Company began expensing such costs as they are incurred. The acquisition costs incurred and capitalized by the Predecessor totaled approximately $57.2 million, $62.1 million and $58.9 million for the years ended December 31, 2002, 2003 and 2004, respectively, and $37.1 million for the period from January 1, 2005 to October 16, 2005. The Predecessor’s amortization expense of deferred acquisition costs was $31.0 million, $29.1 million and $43.7 million for the years ended December 31, 2002, 2003 and 2004, respectively, and $42.0 million for the period from January 1, 2005 to October 16, 2005. The Company incurred and expensed acquisition costs that totaled $12.6 million for the period from October 17, 2005 to December 31, 2005 and $57.4 million for the year ended December 31, 2006.

 

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(2) Certain restricted cash amounts have been reclassified from investing activities to operating activities. See Note 2 to our consolidated and combined financial statements included elsewhere herein.

 

(3) For purposes of computing the ratio of earnings to fixed charges, earnings consist of income before income taxes and minority interests plus fixed charges. Fixed charges consist of interest expense, amortization of debt issuance costs and a portion of rental expense that management believes is representative of the interest component of rental expense. Our earnings were insufficient to cover fixed charges by $136.2 million for the period from October 17, 2005 to December 31, 2005 and by $431.6 million for the year ended December 31, 2006 (see Exhibit 12.1—Statement re Computation of Ratio of Earnings to Fixed Charges).

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our results of operations and financial condition should be read in conjunction with the consolidated and combined financial statements included in “Item 8. Financial Statements.” This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in “Item 1A. Risk Factors.” Actual results may differ materially from those contained in any forward-looking statements. See “Cautionary Statements for Forward-Looking Statements.”

Introduction

Management’s discussion and analysis of results of operations and financial condition (“MD&A”) is provided as a supplement to the consolidated and combined financial statements and the related notes thereto included elsewhere herein to help provide an understanding of our financial condition, changes in financial condition and results of our operations. The MD&A is organized as follows:

 

   

Overview. This section provides a general description of our business and operating segments, as well as recent developments that we believe are important in understanding our results of operations and financial condition and in anticipating future trends.

 

   

Results of operations. This section provides an analysis of our results of operations for the years ended December 31, 2006, 2005 (on a pro forma basis) and 2004. This analysis is presented on both a consolidated and combined basis and on an operating segment basis. The 2005 results of operations are presented on a pro forma basis that gives effect to the Transactions as if they occurred on January 1, 2005.

 

   

Financial condition, liquidity and capital resources. This section provides an analysis of our cash flows for the years ended December 31, 2006, 2005 (combining the Company’s cash flows for the period from October 17, 2005 to December 31, 2005 and the Predecessor’s cash flows for the period from January 1, 2005 to October 16, 2005) and 2004 and our financial condition as of December 31, 2006, as well as a discussion of our liquidity and capital resources prior to and following the Transactions.

 

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Critical accounting policies. This section discusses certain significant accounting policies considered to be important to our financial condition and results of operations and which require significant judgment and estimates on the part of management in their application. In addition, all of our significant accounting policies, including our critical accounting policies, are summarized in Note 2 to our consolidated and combined financial statements included elsewhere herein.

Overview

Description of Business

We are a leading affinity direct marketer of value-added membership, insurance and package enhancement programs and services to consumers, with over 30 years of experience. We currently offer our programs and services worldwide through approximately 5,200 affinity partners as of December 31, 2006. We utilize the brand names, customer contacts and billing vehicles of our affinity partners to market a broad portfolio of 30 core programs in approximately 225 configurations. We market to consumers using direct mail, online marketing, in-branch marketing, telemarketing and other marketing methods. Our programs provide our members and end-customers with access to a variety of discounts and shop-at-home conveniences in such areas as retail merchandise, travel, automotive and home improvement; insurance programs such as accidental death and dismemberment, hospital accident protection and hospital indemnity protection, and personal protection benefits and services such as credit monitoring and identity-theft resolution services. In addition, we have a loyalty solutions operation which administers points-based loyalty programs. We market our programs under the Progeny Marketing Innovations, Cims and Trilegiant Loyalty Solutions service marks. As of December 31, 2006, we had approximately 70 million members and end-customers worldwide.

We currently operate in four operating segments:

 

   

Membership Operations — designs, implements, and markets membership programs to customers of our affinity partners in North America and provides travel agency services primarily to our membership customers.

 

   

Insurance and Package Operations — markets accidental death and dismemberment insurance (“AD&D”) and other insurance programs to customers of our affinity partners in North America and designs and provides package enhancement programs primarily to financial institutions in North America, who, in turn, market or provide these programs to their customers.

 

   

International Operations — markets membership programs and package enhancement programs to customers of our affinity partners outside North America.

 

   

Loyalty Operations — administers points-based loyalty programs and provides enhancement benefits to loyalty program providers.

These operations use both retail and wholesale arrangements. In our subscription-based retail arrangements, we incur marketing expenses to acquire new customers for our membership, insurance and package enhancement programs with the objective of building highly profitable and predictable recurring future revenue streams and cash flows. In our membership and package enhancement operations, these marketing costs are expensed when the campaign is launched, while in our insurance operations these costs through the date of the Transactions were capitalized and amortized over 12 years in proportion to the revenue expected to be earned from those campaigns. For periods following the closing of the Transactions, we have changed our accounting policy so that these insurance marketing costs are expensed when the costs are incurred as the campaign is launched, similar to our membership and package operations. This change will eliminate the historical differences between the actual cash marketing spend and the marketing costs expensed in a period.

Our membership programs are offered under a variety of terms and conditions. Members are usually offered incentives (e.g. free credit reports or other premiums) and one to three month risk-free trial periods to encourage them to use the benefits of membership before they are billed. We do not recognize any revenue during the trial period and expense the cost of all incentives and program benefits and servicing costs as incurred.

 

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Customers of our membership programs typically pay their membership fees either annually or monthly. Our membership operations may have significant timing differences between the receipt of membership fees for annual members and revenue recognition. Historically, memberships were offered primarily under full money back terms whereby a member could receive a full refund upon cancellation at any time during the current membership term. These revenues are recognized upon completion of the membership term when they are no longer refundable. Depending on the length of the trial period, this revenue may not be recognized for up to 16 months after the related marketing spend is incurred and expensed. Currently, annual memberships are primarily offered under pro-rata arrangements in which the member is entitled to a prorated refund for the unused portion of their membership term. This allows us to recognize revenue ratably over the annual membership term. In late 2003, we began to expand the types of memberships that we offer to include memberships under monthly payment programs. During the year ended December 31, 2006, approximately 62% of our new member enrollments were in monthly payment programs. Revenue is recognized monthly under both annual pro rata and monthly memberships, allowing for a better matching of revenues and related servicing and benefit costs when compared to annual full money back memberships. Memberships remain under the billing terms in which they were originated. As we replace annual memberships with monthly memberships we receive less cash at the beginning of the membership term and, therefore, have lower deferred revenue resulting in temporarily higher Segment EBITDA (as discussed under “Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures” below) than cash flows from operations. We believe that once monthly memberships, as a percentage of all members within the membership base, reach a constant level, Segment EBITDA and cash flows from operations will be more closely aligned.

We utilize the brand names, customer contacts and billing vehicles (credit or debit card, checking account, mortgage or other type of billing arrangement) of our affinity partners in our marketing campaigns. We generally compensate our affinity partners either with commissions based on revenues we receive from members (which we expense in proportion to the revenue we recognize) or up-front marketing payments, commonly referred to as bounties (which we expense when incurred). The commission rates which we pay to our affinity partners differ depending on the arrangement we have with the particular affinity partner and the type of media we utilize in the marketing campaign. For example, marketing campaigns which utilize direct mail and online programs generally have lower commission rates than other marketing media we use. As a result of recent changes in affinity partner arrangements and the use of more direct mail and online media in our new marketing campaigns, our commission rates have decreased.

In our insurance operations, we serve as an agent and third-party administrator for the marketing of AD&D and other insurance programs. Free trial periods and incentives are generally not offered with our insurance programs. Insurance program participants typically pay their insurance premiums either monthly or quarterly. Insurance revenues are recognized ratably over the insurance period and there are no significant differences between cash flows and related revenue recognition. We earn revenue in the form of commissions collected on behalf of the insurance carriers and participate in profit-sharing relationships with the carriers that underwrite the insurance policies that we market. Our estimated share of profits from these arrangements is reflected as profit-sharing receivables from insurance carriers on the accompanying consolidated balance sheets and any changes in estimated profit sharing are recorded as an adjustment to net revenue. Revenue from insurance programs is reported net of insurance costs in the accompanying consolidated and combined financial statements.

Our wholesale arrangements involve us providing services to our affinity partners to support programs for their customers. Our affinity partners are typically responsible for customer acquisition, retention and collection and typically pay us one-time implementation fees and ongoing monthly service fees based on the number of members enrolled in these programs. Implementation fees are recognized over the contract period while monthly service fees are recognized in the month earned. Wholesale revenues also include revenues from transactional activities associated with our programs such as the sales of additional credit reports and discount shopping and travel purchases by members. The revenues from such transactional activities are recognized in the month earned.

To increase the flexibility of our business model, we have made significant progress by transitioning our operations from a highly fixed-cost structure to a more variable-cost structure by combining similar functions and processes, consolidating facilities and outsourcing a significant portion of our call center and other back-office processing. This added flexibility should better enable us to redeploy our marketing capital globally across our operations to maximize returns.

 

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Factors Affecting Results of Operations and Financial Condition

Competitive Environment

As a leader in the affinity direct marketing industry, we are competing with many other organizations, including certain of our affinity partners, to obtain a share of the customers’ business. As affinity direct marketers, we derive our leads from customer contacts, which our competitors seek access to, and must generate sufficient earnings per lead for our affinity partners to compete effectively.

We compete with companies of varying size, financial strength and availability of resources. Our competitors include financial institutions, insurance companies, consumer goods companies, internet companies and others, as well as other direct marketers offering similar programs. Some of our competitors are larger than we are, with more resources, financial and otherwise.

We expect this competitive environment to continue in the foreseeable future.

Financial Industry Trends

Historically, financial institutions have represented a significant majority of our affinity partner base. In the past few years, a number of our existing financial institution affinity partners have been acquired by, or merged with, other financial institutions. Several recent examples include Bank of America Corporation and Fleet Boston Financial Corporation, JPMorgan Chase & Co. and Bank One Corporation, and Washington Mutual, Inc. and Providian Financial. As we generally have relationships with either the acquirer, the target or, as in most cases, both the acquirer and the target, this industry consolidation has not, to date, had a material long-term impact on either our marketing opportunities or our margins, but has created delays in new program launches while the merging institutions focus on consolidating their internal operations.

In certain circumstances, our financial affinity partners have sought to develop and market their own in-house programs, most notably programs that are analogous to our credit monitoring and identity-theft resolution services. As we have sought to maintain our market share and to continue these programs with our partners, in some circumstances we have shifted from a retail marketing arrangement to a wholesale arrangement. As a result, this trend has caused some margin compression for us, most notably in the inbound telemarketing channel, and has accelerated the shift from retail to wholesale arrangements for our credit monitoring and identity-theft resolution services.

Internationally, our package programs have been primarily offered by some of the largest financial institutions in Europe, as well as the world. As these banks attempt to increase their own net revenues and margins, we have experienced significant price reductions from what we had previously been able to charge these institutions for our programs when our agreements come up for renewal. We expect this pricing pressure on our international package offerings to continue in the near-term and that the results will directly impact the growth of the international package business.

Regulatory Environment

We are subject to federal and state regulation as well as regulation by foreign authorities in other jurisdictions. Certain regulations that govern our operations include: federal, state and foreign marketing laws; federal, state and foreign privacy laws; and federal, state and foreign insurance and consumer protection regulations. Federal regulations are primarily enforced by the FTC and the FCC. State regulations are primarily enforced by individual state attorneys general. Foreign regulations are enforced by a number of regulatory bodies in the relevant jurisdictions.

These regulations primarily impact the means we use to market our programs, which can reduce the conversion rates of our solicitation efforts, and impact our ability to obtain updated information from our members and end-customers and, in our insurance operations, limit our ability to implement pricing changes.

 

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We incur significant costs to ensure compliance with these regulations; however, we are party to lawsuits, including class action lawsuits, and state attorney general investigations involving our business practices which also increase our costs of doing business.

Seasonality

Historically, seasonality has not had a significant impact on our business. Our revenues are more affected by the timing of marketing programs which can change from year to year depending on the opportunities available and pursued.

Business History

General. Our business started with our North American membership operations in 1973. Over a decade later we expanded our business to include North American insurance and package operations. In 1988, we acquired a loyalty solutions and enhancement programs business and in the early 1990s, we expanded our membership and package operations internationally. During these periods, the various operations within the combined financial statements operated independently and were subject to certain non-compete agreements between them which limited their access to new channels, affinity partners, products and markets.

In 2004, we terminated the non-compete agreements described above and streamlined our organizational structure to integrate these historically separately managed operations. Accordingly, our North American membership, insurance, package and loyalty operations came under common management beginning in the first quarter of 2004 and the North American management team assumed responsibility for our international operations in late 2004 and oversight of the travel agency in the first quarter of 2005.

Integration and the 2005 Reorganization. In February 2004, we began integrating the North American membership and insurance and package operations. The organizational structures of the two operations were realigned to combine departments and eliminate redundant functions. We reorganized the sales forces to be more aligned with the needs of our affinity partners and have a unified and comprehensive approach to the North American market. We also combined our marketing and procurement efforts to take advantage of the larger scale of the combined businesses. During 2004 and continuing in 2005, as part of this initial integration effort, we incurred approximately $7.4 million of severance and other restructuring costs recorded primarily in general and administrative expense on the combined statements of operations. These severance and other restructuring costs have resulted in approximately $9.7 million of annual ongoing cost savings, a portion of which was realized in 2004 with the majority realized in 2005.

In 2005, we developed reorganization plans for our international and North American travel agency operations based on our successful earlier integration efforts, including facility consolidation, outsourcing of our call center and other back office functions, as well as eliminating redundant functions and centralizing oversight for common processes (the “2005 Reorganization”). During 2005 we incurred $8.1 million of costs as part of the 2005 Reorganization and during 2006 we incurred an additional $2.1 million of costs as part of the 2005 Reorganization recorded primarily in general and administrative expense on the consolidated and combined statements of operations. As a result, we have generated approximately $11.0 million of annual cost savings, a portion of which was realized in 2005 with the majority realized in 2006. We anticipate no offsetting increases in expenses or decreases in revenue at this time. We intend to review opportunities for further rationalization of all of our operations.

2004 Events. During 2004, we elected to monetize certain recurring revenue streams and assets (the “2004 Events”). These transactions consisted of the following:

 

   

In late 2001 and early 2002, we conducted one-time marketing programs to assist a third party in acquiring customers and in return we earned a royalty from revenues received by the third party from these customers. As this type of arrangement is not part of our core strategy, in December 2004 we sold this royalty stream back to the third party and terminated the related agreements. We recognized a gain of $33.8 million, which was recorded in net revenues.

 

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During 2003, to improve profitability from marketing programs in our insurance operations, we deemphasized the sale of term life insurance policies. In June 2003, we made a strategic decision to cease marketing and selling new long-term care insurance policies; however, we continued to derive commission revenue pursuant to agreements with the insurance carriers that underwrite the policies we previously marketed. On December 30, 2004, we sold 78% of our commission contract rights related to our long-term preferred care insurance operations. We realized a gain upon the sale of $23.9 million in 2004, with an additional gain of $4.7 million recognized in the first nine months of 2005 upon receipt of certain consents. Both gains were recorded in gain on sale of assets on the combined statements of operations.

 

   

During the fourth quarter of 2004, we sold a membership revenue stream in our international operations from a contract with an affinity partner where we had previously ceased marketing new memberships for that partner for a gain of $15.7 million recorded in net revenues.

The Transactions

On October 17, 2005, Cendant Corporation (“Cendant”) completed the sale of the Cendant Marketing Services Division (the “Predecessor”) to Affinion Group, Inc. (the “Company” or “Affinion”), an affiliate of Apollo Management V, L.P. (“Apollo”), pursuant to a purchase agreement dated July 26, 2005 for approximately $1.8 billion. The purchase price consisted of approximately $1.7 billion of cash, net of estimated closing adjustments, plus $125 million face value of newly issued preferred stock (fair value of $80.4 million) of Affinion Group Holdings, Inc. (“Holdings”), our parent company, and a warrant (fair value of $16.7 million) that is exercisable into 2,112,937 shares of common stock of Holdings, subject to customary anti-dilution adjustments, and $38.1 million of transaction related costs.

The warrant is exercisable on or after October 17, 2009 (or earlier, if Apollo achieves certain returns on its investment). The warrant is not currently exercisable and is not expected to become exercisable within 60 days. As a result of a special dividend on its common stock distributed by Holdings in January 2007, the exercise price of the warrant is $21.80.

The preferred stock entitles its holder to receive dividends of 8.5% per annum (payable, at Holdings’ option, in either cash or in kind) and ranks senior to shares of all other classes or series of stock with respect to rights upon a liquidation or sale of Holdings at a price of the then-current face amount, plus any accrued and unpaid dividends. The preferred stock is redeemable at Holdings’ option at any time, subject to the applicable terms of our debt instruments and applicable laws. In conjunction with a special dividend on its common stock distributed by Holdings in January 2007, Holdings also redeemed 95,107 shares of its preferred stock at its initial face value plus accrued and unpaid dividends. Immediately following the redemption, 29,893 shares of preferred stock with a face amount of $33.3 million, representing an initial face amount of $29.9 million plus accrued and unpaid dividends of $3.4 million, were outstanding. See “Item 12. Security Ownership of Certain Beneficial Owners and Management” for additional information about the terms of the preferred stock.

On October 14, 2005, the Predecessor acquired all of the outstanding shares of common stock of TRL Group, Inc. (“TRL Group”) not owned by the Predecessor for approximately $15.7 million and the credit agreement provided by Cendant to TRL Group was terminated. Pursuant to the purchase agreement, we acquired all of the outstanding capital stock and membership interests of the Predecessor, as well as substantially all of the Predecessor’s assets and liabilities. Certain assets and liabilities of the Predecessor were retained by Cendant pursuant to the purchase agreement.

As part of the Transactions, we made a special tax election referred to as a “338(h)(10) election” with respect to the target companies. Under the 338(h)(10) election, the target companies were deemed to have sold and repurchased their assets at fair market value. By adjusting the tax basis in such assets to fair market value for U.S. federal income tax purposes, the aggregate amount of our tax deductions for depreciation and amortization will increase, which will reduce our cash taxes in the future and thus further enhance our free cash flow generation.

 

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Results of Operations

Supplemental Data

The following table provides data for selected business segments.

 

    Three Months Ended
December 31,
    Years Ended December 31,  
    2006     2005     2006     2005     2004  

Membership Operations:

         

Retail

         

Average Members (1) (000’s)

    8,663       10,008       9,102       10,786       12,832  

% Monthly Members

    35.7 %     31.6 %     34.6 %     28.6 %     17.4 %

% Annual Members

    64.3 %     68.4 %     65.4 %     71.4 %     82.6 %

Annualized Net Revenue Per Average Member (2)

  $ 71.58     $ 64.59     $ 67.96     $ 61.13     $ 52.86  

Wholesale

         

Average Members (1)(3) (000’s)

    3,925       3,884       3,942       3,843       4,179  

Portion for service formerly retail (000’s)

    2,136       1,785       2,048       1,593       832  

Retail including wholesale formerly retail (000’s)

    10,799       11,793       11,150       12,379       13,664  

Global Membership Operations:

         

Retail

         

Average Members(1)(4) (000’s)

    8,828       10,008       9,200       10,786       12,832  

Annualized Net Revenue Per Average Member(2)

  $ 71.90     $ 64.59     $ 68.15     $ 61.13     $ 52.86  

Average Retail Members including wholesale formerly retail(4) (000’s)

    10,964       11,793       11,248       12,379       13,664  

Insurance and Package Operations:

         

Insurance(5)

         

Average Basic Insured (1) (000’s)

    26,940       29,090       27,672       29,396       32,111  

Average Supplemental Insured (000’s)

    5,263       5,401       5,315       5,512       5,866  

Annualized Net Revenue per Supplemental Insured (2)

  $ 54.18     $ 38.57     $ 49.22     $ 42.62     $ 43.04  

Package

         

Average Members (1) (000’s)

    6,543       7,341       6,843       7,532       8,543  

Annualized Net Revenue Per Average Member (2)

  $ 13.80     $ 13.74     $ 13.60     $ 13.72     $ 13.18  

International Operations:

         

Package

         

Average Members (1) (000’s)

    16,089       18,478       16,697       19,625       19,043  

Annualized Net Revenue Per Average Package Member (2)

  $ 7.83     $ 6.21     $ 7.04     $ 6.58     $ 8.13  

Other Retail Membership

         

Average Members(1)(6) (000’s)

    2,329       2,178       2,334       2,455       4,043  

Annualized Net Revenue Per Average Member (2)(7)

  $ 21.04     $ 22.61     $ 21.00     $ 21.31     $ 22.33  

New Retail Membership (8)

         

Average Members (1) (000’s)

    165       —         98       —         —    

Annualized Net Revenue Per Average Member (2)

  $ 88.40     $ —       $ 86.31       —         —    

(1) Average Members and Average Basic Insured for the period are calculated by determining the average members or insureds, as applicable, for each month (adding the number of members or insureds, as applicable, at the beginning of the month with the number of members or insureds, as applicable, at the end of the month and dividing that total by two) for each of the months in the period and then averaging that result for the period. A member’s or insured’s, as applicable, count is removed in the period in which the member or insured, as applicable, has cancelled.

 

(2) Annualized Net Revenue Per Average Member and Annualized Net Revenue Per Supplemental Insured are each calculated by taking the revenues as reported for the period and dividing it by the average members or insureds, as applicable, for the period. Upon cancellation of a member or an insured, as applicable, the member’s or insured’s, as applicable, revenues are no longer recognized in the calculation.

 

(3) Includes 2,048,000, 1,593,000 and 832,000 average members for the years ended December 31, 2006, 2005 and 2004, respectively, related to wholesale programs historically offered under retail arrangements.

 

(4) Includes International Operations New Retail Average Members.

 

(5) Excludes long-term preferred care programs which were monetized as part of the 2004 Events.

 

(6) Includes 970,000 average members for the year ended December 31, 2004 related to the programs monetized as part of the 2004 Events.

 

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(7) Excludes non-recurring revenue of $15.7 million for the year ended December 31, 2004 related to the programs monetized as part of the 2004 Events.

 

(8) As a result of initiating retail marketing in our International Operations during the second quarter of 2005, we began tracking retail joins in a manner consistent with our Membership Operations.

In late 2002, our membership operations changed its strategic focus to overall profitability and generating higher revenue from each member rather than the size of our member base. This has resulted in lower average members offset by higher average revenues per member at lower commission rates and lower variable cost and higher contribution per member. Following a competitive analysis of the marketplace, we recognized that our products were priced below similar products offered in the marketplace. Additionally, we recognized that there were opportunities to further optimize marketing campaigns that had the effect of acquiring less members but nonetheless such members were more profitable in the aggregate. By raising prices and marketing more efficiently, we were able to increase our revenues even though fewer aggregate members joined our programs. For example, 100 consumers joining a program with a $100 annual fee is likely to generate more revenue than 120 consumers joining a program with a $75 annual fee. Accordingly, by increasing the prices for our programs and engaging in marketing campaigns that were designed to achieve a greater return on marketing investment, we were able to increase our revenues even though the aggregate number of members in our base declined.

Wholesale members include members where we typically receive a monthly service fee to support programs offered by our partners. Certain programs historically offered as retail arrangements have switched to wholesale arrangements with lower annualized price points and no commission expense.

Basic insureds typically receive $1,000 of AD&D coverage at no cost to the consumer since the affinity partner pays the cost of this coverage. Supplemental insureds are customers who have elected to pay premiums for higher levels of coverage. Average supplemental members have decreased primarily due to reductions in new marketing spend. Average annualized net revenue per insured has increased primarily due to the introduction of higher-priced programs and higher levels of AD&D insurance coverage.

Domestic package members have declined primarily due to certain client terminations, some of which were at lower prices than the net revenue per average member.

2005 Pro Forma Results of Operations

The unaudited pro forma consolidated results of operations are presented for information purposes only and are not intended to represent or be indicative of the consolidated results of operations that we would have reported had the Transactions been completed as of the dates and for the period presented, and should not be taken as representative of our consolidated results of operations for future periods.

The unaudited pro forma results of operations for the year ended December 31, 2005 are based on the historical combined results of operations of the acquired business, the Predecessor, for the period January 1, 2005 to October 16, 2005, and our historical consolidated results of operations for the period October 17, 2005 to December 31, 2005 and give effect to the Transactions as if they had occurred on January 1, 2005. Pro forma adjustments were made to reflect:

 

   

Changes in depreciation and amortization expenses resulting from fair value adjustments to tangible assets and amortizable intangible assets;

 

   

Increase in interest expense resulting from additional indebtedness incurred in connection with the Transactions; and

 

   

Transaction and debt issuance costs incurred as a result of the Transactions.

 

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The pro forma adjustments (see Note 2 below) do not include the effect of the reductions in deferred revenue and prepaid commissions recorded in purchase accounting, nor the recording of a liability in purchase accounting for the fair value of servicing our members existing at the date of the Transactions for which no revenue will be recognized in the future. The effect of these purchasing accounting adjustments on the Company’s historical consolidated results of operations for the period from October 17, 2005 to December 31, 2005 is discussed in the “—Overview of 2005 Historical Operating Results” section below.

 

     Company
Historical (1)
    Predecessor
Historical (1)
          Company
Pro Forma
 
     October 17, 2005
to December 31, 2005
    January 1, 2005
to October 16, 2005
    Pro Forma
Adjustments (2)
    Year Ended
December 31,
2005
 
     (in millions)  

Net revenues

   $ 134.9     $ 1,063.8       —       $ 1,198.7  
                                

Expenses:

        

Marketing and commissions

     87.1       515.0       (13.8 ) (a)     588.3  

Operating costs

     48.7       315.0       —         363.7  

General and administrative

     20.2       134.5       (25.1 ) (b)     129.6  

Gain on sale of assets

     —         (4.7 )     —         (4.7 )

Depreciation and amortization

     84.5       32.3       290.6   (c)     407.4  
                                

Total expenses

     240.5       992.1       251.7       1,484.3  
                                

Income (loss) from operations

     (105.6 )     71.7       (251.7 )     (285.6 )

Interest income

     1.3       1.9       —         3.2  

Interest expense

     (31.9 )     (0.5 )     (119.2 ) (d)     (151.6 )

Other income, net

     —         5.9       —         5.9  
                                

Income (loss) before income taxes and minority interests

     (136.2 )     79.0       (370.9 )     (428.1 )

Income tax (expense) benefit

     —         (28.9 )     24.8   (e)     (4.1 )

Minority interests, net of tax

     (0.1 )     —         —         (0.1 )
                                

Net income (loss)

   $ (136.3 )   $ 50.1     $ (346.1 )   $ (432.3 )
                                

Note 1:

Reflects the Company’s consolidated results of operations for the period from October 17, 2005 to December 31, 2005 (Company Historical) and the Predecessor’s historical combined results of operations for the period from January 1, 2005 to October 16, 2005 (Predecessor Historical).

Note 2:

Reflects the following pro forma adjustments to give effect to the Transactions for the year ended December 31, 2005:

 

  (a) Represents: (i) the elimination of $8.9 million of marketing expenses related to the amortization of the Predecessor’s insurance contract rights and list fees that is reflected as amortization expense in 2005 (see adjustment (c) below); and, (ii) the adjustment to conform the Predecessor’s accounting for deferred acquisition costs to our accounting policy of expensing such costs as incurred in the amount of $4.9 million, which amount represents the net impact of the acquisition expenses incurred during 2005 being less than the Predecessor’s historical amortization expense related to such costs.

 

  (b) Primarily represents the elimination of $18.2 million of bonus payments to certain of our officers and employees in connection with the closing of the Transactions that were expensed by the Predecessor, and the elimination of the $6.7 million charge related to the accelerated vesting of Cendant restricted stock units and stock options in connection with the closing of the Transactions that were expensed by the Predecessor.

 

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  (c) Represents the net increase in amortization expense of $287.5 million resulting from the estimated new values allocated to our identifiable intangible assets using lives ranging from 3 years to 15 years, primarily on an accelerated basis, and the net increase in depreciation expense of $3.1 million resulting primarily from the estimated increased value and remaining useful life assigned to capitalized software. The identified intangible assets were comprised of member relationships, affinity relationships, proprietary databases and systems, trademarks and tradenames, and patents and technology.

 

 

(d)

Represents incremental interest expense for the additional indebtedness related to the Transactions, consisting of our 10 1/8% Senior Notes in the principal amount of $270.0 million, net of discount of $3.6 million, the term loan B under our credit facility in the principal amount of $860.0 million and our senior subordinated bridge loan facility in the principal amount of $383.6 million. The interest rates used for pro forma purposes are generally based on the rates in effect during the period from October 17, 2005 to December 31, 2005. The adjustment assumes amortization of the discount on the senior notes based upon an effective interest rate of 10.375%. Also, the adjustment assumes amortization of debt issuance costs of approximately $42.0 million using the effective interest method over the maturity of the debt. The estimated weighted average interest rate used to compute the pro forma adjustment for interest expense is approximately 8.8%.

 

  (e) Represents the elimination of the Predecessor’s historical provision for income taxes and the inclusion of a provision for income taxes based on our tax status following the Transactions. We have provided a valuation allowance against our net federal and state deferred tax assets with the exception of deferred tax liabilities relating to goodwill amortization for federal and state income tax purposes. The pro forma tax provision for income taxes primarily includes deferred taxes for goodwill deductible on our federal and state income tax returns, current state taxes and foreign income taxes.

 

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Year Ended December 31, 2006 Compared to Year Ended December 31, 2005 (on a pro forma basis)

We have presented 2005 results of operations on a pro forma basis and discussed the 2006 historical results of operations in relation to the 2005 pro forma results of operations. The following table summarizes our historical consolidated results of operations for the year ended December 31, 2006 and pro forma consolidated results of operations for the year ended December 31, 2005:

 

    

Company

Historical

    Company Pro
Forma
    Increase
(Decrease)
Related to the
Transactions
    Increase
(Decrease)
Other
 
    

Year Ended
December 31,

2006

   

Year Ended
December 31,

2005

     
     (in millions)  

Net revenues

   $ 1,137.7     $ 1,198.7     $ (73.6 )   $ 12.6  
                                

Expenses:

        

Marketing and commissions

     580.9       588.3       (21.9 )     14.5  

Operating costs

     326.1       363.7       (8.0 )     (29.6 )

General and administrative

     106.9       129.6       7.3       (30.0 )

Gain on sale of assets

     —         (4.7 )     —         4.7  

Goodwill impairment

     15.5       —         —         15.5  

Depreciation and amortization

     396.8       407.4       (6.4 )     (4.2 )
                                

Total expenses

     1,426.2       1,484.3       (29.0 )     (29.1 )
                                

Income (loss) from operations

     (288.5 )     (285.6 )     (44.6 )     41.7  

Interest income

     5.7       3.2       —         2.5  

Interest expense

     (148.8 )     (151.6 )     —         (2.8 )

Other income, net

     —         5.9       —         (5.9 )
                                

Income (loss) before income taxes and minority interests

     (431.6 )     (428.1 )     (44.6 )     41.1  

Income tax (expense) benefit

     (6.3 )     (4.1 )     17.6       (19.8 )

Minority interest, net of tax

     (0.3 )     (0.1 )     —         (0.2 )
                                

Net income (loss)

   $ (438.2 )   $ (432.3 )   $ (27.0 )   $ 21.1  
                                

Overview of 2006 Historical Operating Results

The following is an overview of major changes affecting our historical operating results in 2006 compared to 2005:

 

   

Purchase accounting adjustments made in the Transactions had a significant impact on our consolidated results of operations in 2006 and our pro forma results of operations in 2005 following the Transactions. These entries, which are non-cash in nature, reduced 2006 net revenues by $73.6 million more than the comparable entries reduced 2005 net revenues and reduced income from operations by $44.6 million more than the comparable entries reduced 2005 income from operations. Since deferred revenues were reduced in purchase accounting, net revenues recognized for periods following the Transactions have been and will be less than they otherwise would have been. Also, we recorded a liability in purchase accounting for the fair value of servicing our members existing at the date of the Transactions for which no revenue will be recognized in the future. Because the liability recorded in purchase accounting will be used to offset future servicing costs for such members, our operating costs have been and will be lower for periods following the Transactions than they otherwise would have been. Also, because prepaid commissions were reduced in purchase accounting, marketing and commissions expense for periods following the Transactions have been and will be less than they otherwise would have been. The effect of these purchase accounting adjustments on the Company’s historical consolidated results of operations for the year ended December 31, 2006 was to reduce net revenues by $67.6 million compared to 2005 pro forma net revenues, reduce marketing and commissions expense by $21.9 million compared to 2005 pro forma marketing and commissions expense, and reduce operating costs expense by $5.1 million compared to 2005 pro forma operating costs. In addition, amortization of an asset from a favorable non-market contract recorded in purchase

 

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accounting reduced 2006 net revenues by $6.0 million, while the amortization of a liability from unfavorable non-market contracts reduced 2006 operating costs by $2.9 million.

Historical 2006 Results Compared to Pro Forma 2005 Results

The following section provides an overview of our historical consolidated results of operations for the year ended December 31, 2006 compared to our pro forma consolidated results of operations for the year ended December 31, 2005.

Net Revenues. For the year ended December 31, 2006, the Company reported net revenues of $1,137.7 million, a decrease of $61.0 million, or 5.1%, as compared to net revenues of $1,198.7 million for the comparable period in 2005. Net revenues as a result of the Transactions decreased $73.6 million, primarily the result of a non-cash reduction in deferred revenue recorded in purchase accounting. Excluding the effect of the Transactions, net revenues increased $12.6 million primarily from increased revenue of $17.5 million in our Insurance and Package business primarily due to lower cost of insurance, and increased average premiums per insured, partially offset by lower package revenues, primarily due to lower average package members, along with higher net revenues of $16.7 million in our Loyalty business from an increase in loyalty and enhancement programs and royalty revenue from the licensing of patents to Cendant. Net revenues decreased in our Membership business by $21.0 million, primarily the result of lower retail member volumes, partially offset by higher average revenues per retail member and an increase in wholesale revenues. Net revenues decreased slightly in our International business, primarily due to the negative impact of contract renewal renegotiations with certain affinity partners, partially offset by increases due to new retail program introductions.

Marketing and Commissions Expense. Marketing and commissions expense decreased by $7.4 million, or 1.3%, to $580.9 million for the year ended December 31, 2006 from $588.3 million for the year ended December 31, 2005. A non-cash reduction to prepaid commissions related to deferred revenues recorded in purchase accounting as a result of the Transactions reduced marketing and commissions expense by approximately $21.9 million. This was partially offset by a $14.5 million increase in marketing and commissions expense excluding the impact of the Transactions, primarily due to higher marketing expenditures to generate future revenues in our International operations from new retail programs and in our Insurance and Package operations, partially offset by lower commissions in our Membership business.

Operating Costs. Operating costs decreased by $37.6 million, or 10.3%, to $326.1 million for the year ended December 31, 2006 from $363.7 million for the year ended December 31, 2005. Operating costs, excluding the impact of the Transactions, decreased by $29.6 million primarily due to decreases in our Membership and Insurance and Package operations of $30.1 million and $7.9 million, respectively, partially offset by increased costs in our Loyalty operations of $7.4 million primarily due to higher revenues. Operating cost reductions included lower product and servicing costs for a lower membership base, lower protection product costs and improvements in contact center operations in our Membership business of $14.0 million, lower employee related costs in our Insurance and Package operations of $7.5 million and benefits from outsourcing our travel call center operations of $3.4 million. As a result of the Transactions, operating costs decreased $8.0 million due to a $5.1 million adjustment for a liability recorded in purchase accounting to service our members (for which no revenue will be recognized in the future) and a non-cash purchase accounting adjustment for the amortization of unfavorable non-market contracts of $2.9 million.

General and Administrative Expense. General and administrative expenses decreased by $22.7 million, or 17.5%, to $106.9 million for the year ended December 31, 2006 from $129.6 million for the year ended December 31, 2005. Excluding the impact of the Transactions, general and administrative expenses declined $30.0 million, primarily due to the absence in 2006 of general corporate overhead charges from Cendant of $13.5 million and lower litigation settlement costs of $19.5 million. Partially offsetting these decreases was a $7.3 million charge related to accrued management retention bonuses as a result of the Transactions.

Gain on Sale of Assets. Gain on sale of assets decreased by $4.7 million during 2006, the result of a deferred payment recorded in 2005 in connection with the sale of 78% of our long-term preferred care commission rights in December 2004 as part of the 2004 Events.

 

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Goodwill Impairment. A goodwill impairment charge of $15.5 million was recorded in the fourth quarter of 2006 in our Loyalty business, primarily the result of lower projected future cash flows, principally due to the loss of a major program during the fourth quarter of 2006.

Depreciation and Amortization Expense. Depreciation and amortization expense decreased by $10.6 million to $396.8 million for the year ended December 31, 2006 from $407.4 million for the year ended December 31, 2005, primarily due to a $6.4 million decrease as a result of the Transactions, primarily the result of a decrease in the amortization rate of the intangible assets acquired in the Transactions during the fourth quarter of 2006. This decrease was partially offset by upward revisions in 2006 of the estimates of intangible assets resulting from the fair values allocated to our identifiable intangible assets as a result of the Transactions. Amortization expense is based on an allocation of values to intangible assets and is amortized over lives ranging from 3 years to 15 years, primarily on an accelerated basis. In addition, depreciation expense decreased by $4.2 million, excluding the effect of purchase accounting, principally due to property and equipment that became fully depreciated during 2006.

Interest Expense. Interest expense decreased by $2.8 million to $148.8 million for the year ended December 31, 2006 from $151.6 million for the year ended December 31, 2005, primarily due to the effect of a $20 million voluntary prepayment of our term loan during the fourth quarter of 2005 and $85 million of additional voluntary prepayments of the term loan made during 2006, coupled with the refinancing of our bridge loan facility during the second quarter of 2006.

Other Income, Net. Other income, net decreased $5.9 million for the year ended December 31, 2006, primarily due to the absence in 2006 of $5.9 million of non-cash other income recognized in 2005 resulting from the dissolution of our Japanese joint venture operations as discussed in Note 12 to our consolidated and combined financial statements included elsewhere herein.

Income Tax (Expense) Benefit. Income tax expense increased by $2.2 million to $6.3 million for the year ended December 31, 2006 from $4.1 million for the year ended December 31, 2005 due to the movement in valuation allowances established against foreign deferred tax assets offset by the reduction in current tax liabilities.

 

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Operating Segment Results

The following section provides an overview of our historical consolidated results of operations for the year ended December 31, 2006 compared to our pro forma consolidated results of operations for the year ended December 31, 2005.

Net revenues and Segment EBITDA by operating segment are as follows:

 

     Years Ended December 31,  
     Net Revenues     Segment EBITDA (1)  
     Historical
2006
    Pro
Forma
2005
    Increase
(Decrease)
Related to the
Transactions
    Other
Increase
(Decrease)
    Historical
2006
    Pro Forma
2005
    Increase
(Decrease)
Related to the
Transactions
    Other
Increase
(Decrease)
 
     (in millions)  

Membership operations

   $ 549.8     $ 655.9     $ (85.1 )   $ (21.0 )   $ (8.3 )   $ 25.6     $ (63.4 )   $ 29.5  

Insurance and package operations

     366.0       317.3       31.2       17.5       118.7       71.2       24.4       23.1  

International operations

     161.9       176.9       (12.6 )     (2.4 )     (1.1 )     9.9       (4.9 )     (6.1 )

Loyalty operations

     66.7       57.1       (7.1 )     16.7       19.3       15.1       (7.1 )     11.3  

Eliminations

     (6.7 )     (8.5 )     —         1.8       —         —         —         —    
                                                                

Total operations

     1,137.7       1,198.7       (73.6 )     12.6       128.6       121.8       (51.0 )     57.8  

Corporate

     —         —         —         —         (4.8 )     —         —         (4.8 )

Goodwill impairment

     —         —         —         —         (15.5 )     —         —         (15.5 )
                                                                

Total

   $ 1,137.7     $ 1,198.7     $ (73.6 )   $ 12.6       108.3       121.8       (51.0 )     37.5  
                                        

Depreciation and amortization

             (396.8 )     (407.4 )     (6.4 )     (4.2 )
                                        

Income (loss) from operations

           $ (288.5 )   $ (285.6 )   $ (44.6 )   $ 41.7  
                                        

(1) See “Covenant Compliance – Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures” below and Note 21 to the consolidated and combined financial statements included elsewhere herein for a discussion on Segment EBITDA.

Membership Operations. Membership net revenues decreased for the year ended December 31, 2006 by $106.1 million, or 16.2%, to $549.8 million from $655.9 million for the year ended December 31, 2005. The decrease was primarily attributable to an $85.1 million non-cash decrease in net revenues related to a reduction in deferred revenue recorded in purchase accounting from the Transactions, along with a decrease of $21.0 million, primarily due to lower retail member volumes, partially offset by higher average revenues per retail member and higher wholesale revenues, including revenue from programs that were formerly retail.

Segment EBITDA decreased by $33.9 million for the year ended December 31, 2006 compared to the year ended December 31, 2005. Segment EBITDA as a result of the Transactions was negatively affected by a reduction of $58.3 million in deferred revenue recorded in purchase accounting, net of prepaid commissions and the amortization of the liability to service our members (for which no revenue will be recognized in the future), and $7.3 million of charges recorded in 2006 related to accrued management bonuses as a result of the Transactions. Excluding the effects of the Transactions, the impact of lower membership revenue of $21.0 million was more than offset by expanded margins on the overall member base due to lower commissions and lower product benefit and servicing costs totaling $39.8 million, including approximately $14.0 million due to lower product and service costs associated with a lower membership base and improvements in contact center operations, and $3.4 million of benefits realized from outsourcing our travel call center operations. In addition, general and administrative expenses decreased by $10.3 million, primarily as a result of $11.3 million of litigation expenses recorded in 2005 which were not recurring and the absence in 2006 of $6.9 million of general corporate overhead charges in 2005 from Cendant, partially offset by increased fixed payroll and higher management incentive bonuses totaling $6.5 million.

Insurance and Package Operations. Insurance and package net revenues increased by $48.7 million, or 15.3%, to $366.0 million for the year ended December 31, 2006 compared to $317.3 million for the year ended December

 

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31, 2005, primarily due to a non-cash increase in deferred revenue as a result of purchase accounting of $31.2 million. Excluding the effects of the Transactions, higher insurance revenue of $26.1 million, primarily attributable to lower cost of insurance and increased average premiums per insured was partially offset by lower package revenues of $8.3 million, primarily due to lower average package members.

Segment EBITDA increased by $47.5 million for the year ended December 31, 2006 as compared to the year ended December 31, 2005, due in part to a non-cash increase in deferred revenue, net of prepaid commissions, as a result of purchase accounting of $24.4 million. Excluding purchase accounting, the impact of the net increase in revenue, net of higher commission and marketing costs, increased Segment EBITDA by $7.5 million. Segment EBITDA also benefited from lower employee costs of $7.5 million and the absence in 2006 of litigation settlement costs from the Fortis matter of $8.2 million and general corporate overhead charges from Cendant of $4.7 million. Segment EBITDA in 2006 was reduced by the absence of a $4.7 million gain on sale of assets recorded in 2005 resulting from a deferred payment on the Long Term Preferred Care commission rights sold as part of the 2004 Events.

International Operations. International net revenues decreased by $15.0 million, or 8.5%, to $161.9 million for the year ended December 31, 2006 compared to $176.9 million for the year ended December 31, 2005. The decline was primarily due to a $12.6 million non-cash reduction in deferred revenues as a result of purchase accounting adjustments from the Transactions. Excluding the effects of the Transactions, international package revenues decreased by $12.2 million as a result of contract renewal renegotiations with certain significant affinity partners and $3.2 million from a terminated contract in South Africa. These decreases were partially offset by increased revenues of $8.5 million from new program introductions including our new retail offerings and the positive impact from the weakening of the U.S. dollar of $1.8 million.

Segment EBITDA decreased by $11.0 million for the year ended December 31, 2006 as compared to the year ended December 31, 2005. The decrease was primarily due to lower net package revenues combined with higher marketing and commissions expense and operating costs principally associated with new retail programs which reduced Segment EBITDA by approximately $16.4 million, along with $4.7 million of higher travel service fee costs. This was partially offset by lower operating and general and administrative costs including $6.1 million of lower restructuring costs, $5.5 million of reduced IT infrastructure and related costs, and the absence in 2006 of $1.9 million in general corporate overhead charges from Cendant. Excluding the effects of the Transactions, Segment EBITDA was further reduced by a $5.6 million reduction of deferred revenues net of commissions and the amortization of the service liability to service our members (for which no revenue will be recognized in the future) as a result of purchase accounting adjustments.

Loyalty Operations. Revenues from Loyalty operations increased by $9.6 million, or 16.8%, to $66.7 million for the year ended December 31, 2006 compared to $57.1 million for the year ended December 31, 2005. Loyalty and enhancement programs increased $9.3 million over the prior year period including a $3.8 million one-time benefit for a contract termination penalty. Higher Loyalty revenue of $7.4 million received from the licensing of patents to Cendant was reduced by a $6.0 million non-cash purchase accounting adjustment as the agreement was determined to have a favorable component as compared to market. In addition, a reduction related to a deferred revenue adjustment recorded in purchase accounting from the Transactions further reduced net revenues by $1.1 million.

Segment EBITDA increased by $4.2 million for the year ended December 31, 2006 as compared to the year ended December 31, 2005, comprised of a decrease of $7.1 million related to the purchase accounting adjustments attributable to the Transactions and an increase of $11.3 million excluding the effects of the Transactions. The decrease related to purchase accounting was attributable to a $6.0 million non-cash purchase accounting adjustment referenced above and a $1.1 million adjustment to deferred revenue. The increase excluding the effects of the Transactions was due to $2.1 million higher loyalty and enhancement package contributions, including the benefit from a non-recurring $3.8 million contract termination penalty, $7.4 million from the licensing of patents to Cendant and settlement fees related to enforcement of patent rights of $3.5 million. These increases were partially offset by litigation costs incurred to enforce patent rights that were $1.7 million higher than the prior year.

Corporate. For the year ended December 31, 2006, the Company incurred $4.8 million of costs that were generally of a corporate nature or managed on a corporate basis, including stock-based compensation expense recorded in accordance with FASB Statement No. 123R and consulting fees paid to Apollo.

 

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Goodwill Impairment. A goodwill impairment charge of $15.5 million was recorded in the fourth quarter of 2006 in our Loyalty business, primarily the result of lower projected future cash flows, principally due to the loss of a major program.

Year Ended December 31, 2005 (on a pro forma basis) Compared to Year Ended December 31, 2004

We have presented 2005 results of operations on a pro forma basis and discussed the 2005 pro forma results of operations in relation to the 2004 historical results of operations. The following table summarizes our pro forma consolidated results of operations for the year ended December 31, 2005 and historical combined results of operations for the year ended December 31, 2004:

 

    

Company

Pro Forma

    Predecessor
Historical
    Increase
(Decrease)
Related to the
Transactions
    Increase
(Decrease)
Other
 
    

Year Ended
December 31,

2005

   

Year Ended
December 31,

2004

     
     (in millions)  

Net revenues

   $ 1,198.7     $ 1,530.9     $ (142.1 )   $ (190.1 )
                                

Expenses:

        

Marketing and commissions

     588.3       665.3       (48.4 )     (28.6 )

Operating costs

     363.7       383.3       (27.9 )     8.3  

General and administrative

     129.6       185.0       3.8       (59.2 )

Gain on sale of assets

     (4.7 )     (23.9 )     —         19.2  

Depreciation and amortization

     407.4       43.9       366.2       (2.7 )
                                

Total expenses

     1,484.3       1,253.6       293.7       (63.0 )
                                

Income (loss) from operations

     (285.6 )     277.3       (435.8 )     (127.1 )

Interest income

     3.2       1.7       —         1.5  

Interest expense

     (151.6 )     (7.3 )     (150.9 )     6.6  

Other income, net

     5.9       0.1       —         5.8  
                                

Income (loss) before income taxes and minority interests

     (428.1 )     271.8       (586.7 )     (113.2 )

Income tax (expense) benefit

     (4.1 )     104.5       (4.1 )     (104.5 )

Minority interest, net of tax

     (0.1 )     0.1       —         (0.2 )
                                

Net income (loss)

   $ (432.3 )   $ 376.4     $ (590.8 )   $ (217.9 )
                                

Overview of 2005 Historical Operating Results

The following is an overview of major changes affecting our historical operating results in 2005:

 

   

Purchase accounting adjustments made in the Transactions had a significant impact on our pro forma results of operations in 2005 following the Transactions. These entries, which are non-cash in nature, reduced net revenues by $142.1 million and income from operations by $435.8 million. Because deferred revenues were reduced in purchase accounting, net revenues recognized for periods following the Transactions will be less than they otherwise would have been. Also, we recorded a liability in purchase accounting for the fair value of servicing our members existing at the date of the Transactions for which no revenue will be recognized in the future. Because the liability recorded in purchase accounting will be used to offset future servicing costs for such members, our operating costs will be lower for periods following the Transactions than they otherwise would have been. Also, because prepaid commissions were reduced in purchase accounting, marketing and commissions expense for periods following the Transactions will be less than they otherwise would have been. The effect of these purchase accounting adjustments on the Company’s historical consolidated results of operations for the period from October 17, 2005 to December 31, 2005 was to reduce net revenues by $142.1 million, marketing and commissions expense by $36.6 million, and operating costs expense by $27.9 million. Marketing and commissions expense also decreased approximately $11.8 million related to the amortization of capitalized insurance contract rights and list fees whose fair value is now included

 

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in other intangibles, net. Amortization of existing insurance contract rights and list fees as of the transaction date is reflected as amortization expense for 2005. Additionally, the Company recorded $366.2 million incremental depreciation and amortization expense which negatively affected results of operations. The incremental depreciation expense relates primarily to a purchase accounting adjustment to capitalized software.

 

   

In the third and fourth quarters of 2004, we entered into the 2004 Events to monetize certain assets and recurring revenue streams. These 2004 Events, along with the related revenue streams, contributed approximately $98 million of non-recurring revenue and approximately $110 million of income from operations in 2004, which will not recur in the future. Additionally, there were certain other matters of a non-recurring nature impacting our 2004 results of operations further described below.

 

   

International operations had lower net revenues of $87.1 million and lower income from operations of $51.1 million in existing international package enhancement and retail programs primarily as a result of contract renewal renegotiations with certain significant affinity partners. Further, a restructuring plan was put in place to reduce operating costs. This plan includes centralization of certain functions and facilities both within Europe, as well as globally, including consolidation of data centers, outsourcing of call center activities and creating centralized oversight of human resources, IT, legal and other support functions. We expect package market erosion due to contract renegotiations for our international operations will continue in the near-term and that it will cause our income from operations and Segment EBITDA in our international operations for 2006 to be lower as compared to 2005.

 

   

During 2004, we began to integrate our historically separate operations into a single, global organization with a revised business strategy to achieve long-term growth. We began integrating our marketing spend to focus on more profitable opportunities and to maximize returns across all of our operations on a global basis. As a result, we reduced certain of our marketing spend in less profitable areas during 2004, which resulted in lower near-term net revenues and operating income contributions in 2005. During 2005 we increased our marketing spend to invest in internet channels.

 

   

Travel agency operations within our membership operations experienced lower net revenues and income from operations of $13.3 million and $5.2 million, respectively, during 2005 as compared to 2004. This was caused by lower levels of travel members, a reduction in travel sale conversion rates during the initial transition period to a new outsourcing partner for our travel call center operations and changes in intercompany arrangements. In response, a restructuring plan was put in place in early 2005 to lower operating costs. This plan includes reduction of fixed costs in the areas of facility and support service, as well as cost savings from outsourcing of the agency’s call center activities.

Pro Forma 2005 Compared to Historical 2004 Results

The following section provides an overview of our pro forma consolidated results of operations for the year ended December 31, 2005 compared to our historical combined results of operations for the year ended December 31, 2004.

Net Revenues. During 2005, net revenues decreased by $332.2 million, or 21.7%, to $1,198.7 million in 2005 from $1,530.9 million in 2004 of which $142.1 million of the decrease was due to a non-cash reduction in deferred revenue recorded in purchase accounting and approximately $98 million (which does not include certain other matters of a non-recurring nature described below) of the decrease was due to the monetization of certain agreements as part of the 2004 Events, that resulted in non-recurring revenues in 2004.

Membership net revenues decreased by $180.0 million, or 21.5%, to $655.9 million in 2005 from $835.9 million in 2004. The reduction in net revenues during 2005 was primarily due to a non-cash $99.9 million reduction in deferred revenues as a result of purchase accounting adjustments (see “—Overview of 2005 Historical Operating Results” and “—Operating Segment Results”), a loss of $14.8 million in royalties earned from one of the contracts discontinued as part of the 2004 Events in the third quarter of 2004 and related non-recurring revenue of $33.8 million upon contract termination and a $13.3 million decrease in travel agency revenues due to lower levels of travel members, a reduction in travel sale conversion rates during the transition period to a new outsourcing partner

 

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for our travel call center operations and changes in intercompany arrangements. An increase in wholesale net revenues of $23.7 million was offset by decreases in our retail membership net revenues of $22.0 million, primarily as a result of us selling more wholesale memberships which, unlike our retail arrangements, have no related commission expense. In addition, membership net revenues decreased as a result of a change in estimate for sales tax obligations of $18.5 million reflected as net revenues in 2004.

Insurance and package net revenues decreased by $74.4 million, or 19.0%, to $317.3 million in 2005 from $391.7 million in 2004. Insurance net revenues decreased by $64.4 million, primarily due to a $32.6 million non-cash reduction in deferred revenues as a result of purchase accounting adjustments (see “Overview of 2005 Historical Operating Results” and “Operating Segment Results”), a loss of $10.5 million in revenues from our the sale of 78% of our long-term care commission rights, which we sold as part of the 2004 Events, a $10.2 million increase in cost of insurance primarily as a result of higher claims experience, lower premium revenue of $6.8 million, a reduction of $2.6 million due to certain contract terminations and a one-time $2.1 million contract dispute settlement recorded during 2004 that did not recur in 2005. Package net revenues declined by $10.0 million primarily due to certain contract terminations in 2004 and 2005.

International net revenues decreased by $87.1 million, or 33.0%, to $176.9 million in 2005 from $264.0 million in 2004. The decrease in net revenues was primarily due to the loss of certain Payment Card Protection membership programs of $48.0 million of which $15.7 million represented non-recurring revenue recognized from the sale of a marketing contract which was monetized in the fourth quarter of 2004 as part of the 2004 Events and $21.0 million from revenues generated prior to the sale in 2004 which will not recur in the future, lower international package revenues, resulting from contract renewal renegotiations with certain significant affinity partners of $24.4 million, $9.1 million non-cash reduction in deferred revenues as a result of purchase accounting adjustments (see “Overview of 2005 Historical Operating Results” and “Operating Segment Results”) and $7.9 million related to the termination of our Japanese joint venture operations in late 2004.

Loyalty operations net revenues increased by $11.0 million, or 23.9%, to $57.1 million in 2005 from $46.1 million in 2004 primarily due to growth in new and existing loyalty programs.

Marketing and Commissions Expense. Marketing and commissions expense decreased by $77.0 million, or 11.6%, to $588.3 million in 2005 from $665.3 million in 2004.

Marketing and commissions expense in our membership operations decreased by $27.4 million primarily due to a reduction in membership commissions of $25.9 million as a result of non-cash purchase accounting adjustments to prepaid commissions (see “Overview of 2005 Historical Operating Results”), a $14.5 million reduction from changes in affinity partner arrangements (more wholesale memberships were sold which have no related commission expense) and a higher percentage of marketing spend on Internet and direct mail marketing (which generally have lower commissions than other marketing media), offset by a $9.1 million increase in new membership marketing program spending in 2005 as compared to 2004, including a significant increase in our marketing spend in online media and a $4.6 million commission reimbursement received in 2004 as part of the 2004 Events that did not reoccur in 2005.

Marketing and commissions expense in our insurance and package operations decreased by $20.1 million primarily due to marketing expense related to the Predecessor’s amortization of contract rights and list fees that was recorded as amortization expense in 2005 (due to the inclusion of the value of such assets in purchase accounting as intangible assets. See Note 2- Summary of Significant Accounting Policies – Goodwill and Identifiable Intangible Assets) whereas $11.8 million of such costs were included in marketing and commissions expense in 2004, a reduction in commissions of $6.8 million as a result of non-cash purchase accounting adjustments to prepaid commissions (see “—Overview of 2005 Historical Operating Results”), integration savings of $3.9 million, and reduction in package marketing and product costs of $2.1 million, offset by an increase in insurance marketing spend of $5.0 million.

Marketing and commissions expense in our international operations decreased by $28.3 million primarily due to a $23.5 million reduction in commission expense as a result of a membership revenue stream sold in 2004, non-cash purchase accounting adjustments of $3.9 million to prepaid commissions (see “—Overview of 2005 Historical Operating Results”), and $1.4 million related to the termination of our Japanese joint venture in late 2004.

 

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Operating Costs. Operating costs decreased by $19.6 million, or 5.1%, to $363.7 million in 2005 from $383.3 million in 2004. The decrease was primarily due to a $27.9 million non-cash purchase accounting adjustment in connection with the liability recorded in purchase accounting to service our members at the date of the Transactions (see “Overview of 2005 Historical Operating Results”), a reduction in travel agency operating costs of $9.0 million, $4.8 million in savings related to our 2004 integration program and $5.2 million related to the termination of our Japanese joint venture in late 2004. These decreases in operating costs were offset by a $22.4 million increase from the introduction of higher priced and associated higher cost membership protection programs that have higher costs due to enhanced benefits (which are disproportionately incurred during the first year of membership) and $5.0 million of start up and other operating costs associated with the launch of loyalty programs.

General and Administrative Expense. General and administrative expenses decreased by $55.4 million, or 30.0%, to $129.6 million in 2005 from $185.0 million in 2004. This decrease was primarily as a result of a $73.7 million charge in 2004 related to a verdict in a contractual dispute with one of our insurance providers (as discussed in Note 14 to the consolidated and combined financial statements included elsewhere herein), absence of $8.7 million of transaction costs incurred in connection with amending our relationship with TRL Group in 2004 and $4.4 million related to the termination of our Japanese joint venture in late 2004. The decrease was partially offset by $10.3 million in expense accruals for litigation matters, $3.8 million in retention bonuses expensed subsequent to the closing of the Transactions due to the continuing employment requirements of the bonus agreements, international severance costs of $5.1 million, higher legal costs of $2.9 million related to the contractual dispute mentioned above, and the impact from the favorable resolution of certain litigation during 2004 of $3.6 million which did not recur in 2005.

Gain on Sale of Assets. During 2005, we recognized $4.7 million of a deferred gain and other items upon delivery of certain consents required from third parties in connection with the sale of 78% of our long-term care commission rights in December 2004, as part of the 2004 Events offset by the gain recorded in 2004 of $23.9 million.

Depreciation and Amortization Expense. Depreciation and amortization expense increased by $363.4 million to $407.3 million in 2005 from $43.9 million in 2004, primarily due to $366.2 million in amortization expense of intangible assets resulting from the fair values allocated on a preliminary basis to our identifiable intangible assets as a result of the Transaction. The pro forma amortization expense is based on a preliminary allocation of values to intangible assets and is amortized over lives ranging from 3 years to 15 years, primarily on an accelerated basis.

Interest Expense. Interest expense increased by $144.3 million to $151.6 million in 2005 from $7.3 million in 2004, primarily due to impact of the new terms loans, senior notes and bridge loans entered into in October 2005. The effects of these costs have been presented on a pro forma basis to show the impact as if the debt was entered into on January 1, 2005.

Other Income, net. During 2005, we recognized other income primarily due to $5.9 million of non-cash other income realized from dissolving our Japanese joint venture operations as discussed in Note 11 to our consolidated and combined financial statements included elsewhere herein.

Income Tax (Expense) Benefit. Income tax (expense) benefit decreased by $108.6 million to a provision of $4.1 million in 2005 from an income tax benefit of $104.5 million in 2004. During the first quarter of 2004 we reversed a valuation allowance of $124.0 million as it became more likely than not that the deferred tax assets of TRL Group would be realized. The $124.0 million valuation allowance reversal was partially offset by a contract termination payment and other related expenses, net of income taxes, totaling approximately $11.0 million. TRL Group was included in the Predecessor’s combined financial statements but filed separate tax returns. Additionally, we reversed income tax reserves in 2004 of approximately $92.3 million. Our provision for income taxes in 2005 was also different than the benefit recorded for 2004 due to the loss we experienced in 2005 for which no tax benefit was reflected in our consolidated financial statements due to the uncertainty of its realization.

 

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Operating Segment Results

The following section provides an overview of our pro forma consolidated results of operations for the year ended December 31, 2005 compared to our historical combined results of operations for the year ended December 31, 2004.

Net revenues and Segment EBITDA by operating segment are as follows:

 

     Years Ended December 31,  
     Net Revenues     Segment EBITDA (1)  
     Pro
Forma
2005
    Historical
2004
    Increase
(Decrease)
Related to the
Transactions
    Other
Increase
(Decrease)
    Pro
Forma
2005
   

Historical

2004

    Increase
(Decrease)
Related to the
Transactions
    Other
Increase
(Decrease)
 
     (in millions)  

Membership operations

   $ 655.9     $ 835.9     $ (99.9 )   $ (80.1 )   $ 25.6     $ 176.6     $ (49.3 )   $ (101.7 )

Insurance and package operations

     317.3       391.7       (32.6 )     (41.8 )     71.2       69.8       (15.0 )     16.4  

International operations

     176.9       264.0       (9.1 )     (78.0 )     9.9       61.0       (4.6 )     (46.5 )

Loyalty operations

     57.1       46.1       (0.5 )     11.5       15.1       13.8       (0.7 )     2.0  

Eliminations

     (8.5 )     (6.8 )     —         (1.7 )     —         —         —         —    
                                                                

Total

   $ 1,198.7     $ 1,530.9     $ (142.1 )   $ (190.1 )     121.8       321.2       (69.6 )     (129.8 )
                                        

Depreciation and amortization

             (407.4 )     (43.9 )     366.2       (2.7 )
                                        

Income (loss) from operations

           $ (285.6 )   $ 277.3     $ (435.8 )   $ (127.1 )
                                        

(1) See “Covenant Compliance – Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures” below and Note 20 to the consolidated and combined financial statements included elsewhere herein for a discussion on Segment EBITDA.

Membership Operations. Membership net revenues decreased by $180.0 million, or 21.5%, and Segment EBITDA decreased by $151.0 million, or 85.5%, during 2005 as compared to 2004. The decrease in membership net revenue was primarily due to the $99.9 million reduction in deferred revenues as a result of purchase accounting adjustments (see “Overview of 2005 Historical Operating Results”), a loss of $14.8 million in royalties earned from one of the contracts discontinued as part of the 2004 Events in the third quarter of 2004 and related non-recurring revenue of $33.8 million upon contract termination and an $13.3 million decrease in travel agency revenues due to lower levels of travel members, a reduction in travel sale conversion rates during the transition period to a new outsourcing partner for our travel call center operations and changes in intercompany arrangements. An increase in wholesale net revenues of $23.7 million was offset by decreases in our retail membership net revenues of $22.0 million, primarily as a result of us selling more wholesale memberships which unlike our retail arrangements have no related commission expense. In addition, membership net revenues decreased as a result of a change in the estimate for sales tax obligations of $18.5 million reflected as net revenues in 2004.

Marketing and commission costs decreased by $27.4 million primarily due to a $25.9 million purchase accounting adjustment to prepaid commissions (see “—Overview of 2005 Historical Operating Results”), $14.5 million resulting from changes in affinity partner arrangements (more wholesale memberships were sold which have no related commission expense) and a higher percentage of marketing spend on Internet and direct mail marketing (which generally have lower commissions than other marketing media), offset by a $9.1 million increase in new membership marketing program spending in 2005 as compared to 2004, including a significant increase in our marketing spend in online media and a $4.6 million commission reimbursement received in 2004 as part of the 2004 Events.

Operating and general and administrative costs decreased $2.6 million primarily due to a $27.9 million purchase accounting adjustment in connection with the liability recorded in purchase accounting to service our members at the date of the Transactions (see “—Overview of 2005 Historical Operating Results”), $9.3 million of lower travel agency operating costs (including a $1.8 million one-time set up fee incurred in connection with transferring this

 

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operation to us) offset by $22.4 million of costs associated with the introduction of higher priced and associated higher cost membership protection programs that have higher costs due to enhanced benefits (which are disproportionately incurred during the first year of membership), $10.3 million in litigation settlements and $3.2 million of retention bonuses. Our 2005 results benefited from the absence of $8.7 million of transaction costs incurred in connection with amending our relationship with TRL Group in 2004 partially offset by a $3.6 million favorable litigation settlement in 2004, neither of which recurred in 2005.

Insurance and Package Operations. Insurance and package net revenues decreased by $74.4 million, or 19.0%, and Segment EBITDA increased by $1.4 million, or 2.0%, during 2005 as compared to 2004. Insurance net revenues decreased by $64.4 million, primarily due to a $32.6 million reduction in deferred revenues as a result of purchase accounting adjustments (see “Overview of 2005 Historical Operating Results”), a loss of $10.5 million in revenues from our selling 78% of our long-term care commission rights, which we sold as part of the 2004 Events, a $10.2 million increase in cost of insurance primarily as a result of higher claims experience, lower premium revenue of $6.8 million, a reduction of $2.6 million due to certain contract terminations and a one-time $2.1 million contract dispute settlement recorded during 2004 that did not recur in 2005. Package net revenues declined by $10.0 million primarily due to certain contract terminations.

Marketing and commissions expense in our insurance and package operations decreased by $20.1 million primarily due to marketing expense related to the Predecessor’s amortization of contract rights and list fees that was recorded as amortization expense in 2005 (due to the inclusion of the value of such assets in purchase accounting as intangible assets. See Note 2- Summary of Significant Accounting Policies – Goodwill and Identifiable Intangible Assets) whereas $11.8 million of such costs were included in marketing and commissions expense in 2004, a reduction in commissions of $6.8 million as a result of purchase accounting adjustments to prepaid commissions, integration savings of $3.9 million, reduction in package marketing costs of $2.1 million offset by an increase in insurance marketing spend of $5.0 million.

Operating and general and administrative costs decreased $74.9 million primarily as a result of a $73.7 million charge in 2004 related to a verdict in a contractual dispute with one of our insurance providers (as discussed in Note 14 to the consolidated and combined financial statements included elsewhere herein) and by $7.6 million in incremental savings associated with the integration of our North American membership and insurance and package operations partially offset by higher legal costs of $2.9 million related to the contractual dispute mentioned above and $2.7 increase in package product costs. In addition, during 2005 we recognized $4.7 million of a deferred gain on sale (offset by the gain of $23.9 million that was recognized in late 2004) upon receipt of certain consents required from third parties in connection with the sale of 78% of our long-term care commission rights, as part of the 2004 Events recorded in gain on sale of assets.

International Operations. International net revenues decreased by $87.1 million, or 33.0%, and Segment EBITDA decreased by $51.1 million, or 83.8%, during 2005 as compared to 2004. The decline in net revenue was primarily due to the loss of certain Payment Card Protection membership programs of $48.0 million of which $15.7 million of non-recurring revenue recognized from the sale of a marketing contract which was monetized in the fourth quarter of 2004 as part of the 2004 Events and $21.0 million from revenues generated prior to the sale in 2004 which will not recur in the future, lower international package revenues, resulting from contract renewal renegotiations with certain significant affinity partners of $24.4 million, $9.1 million reduction in deferred revenues as a result of purchase accounting adjustments (see “—Overview of 2005 Historical Operating Results”), and $7.9 million related to the termination of our Japanese joint venture operations in late 2004.

The decrease in Segment EBITDA was primarily due to the loss of $25.0 million from programs monetized as part of the 2004 Events, $20.5 million from the contract renewal renegotiations described above, $7.6 million of incremental expenses associated with the restructuring plan described above offset by $3.1 million related to the termination of our Japanese joint venture in late 2004.

Loyalty Operations. Loyalty operations net revenues increased by $11.0 million, or 23.9%, and Segment EBITDA increased by $1.3 million, or 9.4%, in 2005 as compared to the 2004. Net revenue increased primarily as a result of growth in existing loyalty programs. Segment EBITDA increased as a result of the growth of new loyalty programs partially offset by approximately $5.0 million of start up and other operating costs net of related revenues associated with the launch of loyalty programs for a new client for which the revenue will be recognized over the term of the contract and we received $1.7 million from a favorable settlement of litigation in 2004, which did not recur in 2005.

 

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Financial Condition, Liquidity and Capital Resources

Financial Condition – December 31, 2006 and December 31, 2005

 

     The Company  
     December 31,
2006
    December 31,
2005
   Increase
(Decrease)
 
     (in millions)  

Total assets

   $ 1,889.5     $ 2,200.0    $ (310.5 )

Total liabilities

     2,075.8       1,966.0      109.8  

Total equity

     (186.9 )     233.9      (420.8 )

Total assets at December 31, 2006 compared to December 31, 2005 decreased by $310.5 million due to (a) a decrease in intangible assets of $312.3 million, due to amortization expense of $356.1 million, partially offset by increases resulting from purchase accounting adjustments and foreign currency translation of $43.8 million (the intangible assets were acquired as a result of the Transactions – see Notes 1 and 2 to our audited consolidated and combined financial statements included elsewhere herein), (b) a decrease in goodwill of $66.2 million, primarily due to a change in valuation of $50.9 million (see Note 2 to our audited consolidated and combined financial statements included elsewhere herein) and the write off of $15.5 million from an impairment in our Loyalty business, (c) a decrease in cash and cash equivalents of $29.1 million (see “– Liquidity and Capital Resources – Cash Flows”), (d) a decrease in profit share receivable from insurance carriers of $3.2 million as a result of $63.3 million in payments received, offset by new receivables and (e) a decrease in property and equipment of $7.7 million due to current depreciation exceeding capital expenditures. These decreases were partially offset by (a) an increase in trade accounts receivable of $9.2 million due to timing of receipts, (b) an increase of $1.8 million in receivables from related parties also due to timing of receipts, (c) an increase in contract rights and list fees of $60.2 million relating primarily to the acquisition of the servicing rights for a membership program and the members of such program from a major bank of $52.5 million and other contract requirements in our Insurance and Package business and (d) an increase in prepaid commissions of $31.8 million resulting from the increase in deferred revenue as discussed below.

Total liabilities at December 31, 2006 compared to December 31, 2005 increased by $109.8 million due to (a) an increase in deferred revenue of $143.8 million, (b) an increase in accounts payable and accrued expenses of $2.8 million and (c) an increase in other long-term liabilities, primarily due to $29.9 million recorded for the estimated present value of deferred payments related to the acquisition of servicing rights for a membership program and the members of such program from a major bank related to the purchase of contract renewal rights and (d) a $11.4 million liability for unfavorable contracts as a result of the Transactions. These increases were offset by $85.0 million of voluntary prepayments of the term loan portion of our credit facility. As a result of the purchase accounting valuation in relation to the Transactions, the deferred revenue balance at acquisition was reduced as was the related prepaid commission. As new members join our annual membership programs and existing members renew their annual memberships, deferred revenue and prepaid commissions will increase. The increase in accounts payable and accrued expenses resulted from the increase in accrued marketing and other payables of $30.0 million due to the timing of interest, vendor and employee payments. This increase was partially offset by the $27.2 million reduction of the liability established in purchase accounting for the estimated cost to service members who were enrolled in our programs at the date of the Transactions but will not result in future revenue.

Total stockholder’s equity decreased by $420.8 million, primarily due to a net loss of $438.2 million, partially offset by additional capital contribution from Holdings of $8.8 million and a favorable currency effect of $8.6 million.

Liquidity and Capital Resources

Our primary sources of liquidity are cash on hand and cash generated through operating and financing activities. Our primary cash needs are for working capital, capital expenditures and general corporate purposes, and to service the indebtedness incurred in connection with the Transactions and the subsequent refinancing. We believe that, based on our current operations and anticipated growth, our cash on hand, cash flows from operating activities and borrowing availability under our revolving credit facility will be sufficient to meet our liquidity needs for the next twelve months.

 

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Cash Flows – Years Ended December 31, 2006 and 2005

At December 31, 2006, we had $84.3 million of cash and cash equivalents on hand, a decrease of $29.1 million from $113.4 million at December 31, 2005. The following table summarizes our cash flows and compares changes in our cash and cash equivalents on hand to the same period in the prior year.

 

     Company Historical     Predecessor
Historical
    Change  
     Year ended
December 31,
2006
    October 17,
2005 to
December 31,
2005
    January 1,
2005 to
October 16,
2005
   
     (in millions)  

Cash provided by (used in):

        

Operating activities

   $ 98.3     $ 31.1     $ 106.5     $ (39.3 )

Investing activities

     (44.4 )     (1,640.1 )     (39.5 )     1,635.2  

Financing activities

     (85.4 )     1,722.9       (23.4 )     (1,784.9 )

Effects of exchange rate changes

     2.4       (0.5 )     (1.9 )     4.8  
                                

Net change in cash and cash equivalents

   $ (29.1 )   $ 113.4     $ 41.7     $ (184.2 )
                                

Operating Activities. During the year ended December 31, 2006, we generated $39.3 million less cash from operating activities in comparison with the same period in 2005. Segment EBITDA, excluding the non-cash impacts of purchase accounting and a non-cash charge for goodwill impairment increased $53.0 million for the year ended December 31, 2006 as compared to the year ended December 31, 2005 (see “– Results of Operations”). As a result of monthly memberships reaching a stable level as a percentage of all active members within the membership base, the change in deferred revenue net of prepaid commissions (before purchase accounting impacts) has significantly decreased resulting in increased cash flow from operations of approximately $43.1 million for the year ended December 31, 2006 as compared to the year ended December 31, 2005. This increase was offset by increased interest payments of $128.0 million. Due to the indebtedness incurred in connection with the Transactions, we have increased our interest payment commitments (see “– Contractual Obligations and Commitments”). In addition, expenditures for contract rights and list fees increased $7.8 million in 2006.

Investing Activities. We used $1,635.2 million less cash in investing activities during the year ended December 31, 2006 as compared with the same period in 2005. In 2005, we used $1,629.0 million for the Transactions and $15.7 million to acquire the remaining interest in TRL Group. Our restricted cash requirements in the international operations were $2.1 million less in 2006 as compared to 2005. We also used $3.9 million less cash for capital expenditures in 2006 as compared to 2005. This was partially offset by the payment of a portion of the purchase price for the acquisition of the servicing rights for a membership program and the members of such program from a major bank in December 2006 of $17.4 million.

Financing Activities. We generated $1,784.9 million less cash from financing activities during 2006 compared with 2005. In 2005, we generated $1,468.0 million from net borrowings related to the Transactions, net of financing costs, in addition to a capital contribution from Apollo of $275.0 million. During the year ended December 31, 2006, we made $85.0 million in voluntary prepayments of the term loan under our credit facility while during the same period in 2005 we repaid $30.0 million in borrowings under a Cendant credit agreement and made a $20.0 million voluntary prepayment on the term loan and $0.6 million on other borrowings. In connection with the 2006 refinancing of our senior subordinated bridge loan with the proceeds from the offering of senior subordinated notes and additional senior notes (see “– Credit Facilities and Long-Term Debt”), we incurred $10.9 million of financing costs.

In January 2007, Holdings incurred debt of $350 million in the form of a five-year senior unsecured term loan facility. We expect that Holdings will require us to pay dividends (to the extent we are permitted legally and contractually) to enable Holdings to service such debt. If Holdings elects to pay cash interest on its term loan facility, we expect that the cash required to service the debt in 2007 will be approximately $41.0 million. We plan to reduce our future prepayments on the term loan under the $960 million senior secured credit facility to a level that will allow for servicing the financing obligations on Holdings’ new five-year term loan facility.

 

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Cash Flows – Years Ended December 31, 2005 and 2004

At December 31, 2005, we had $113.4 million of cash and cash equivalents on hand, an increase of $90.9 million from $22.5 million at December 31, 2004. The following table summarizes our cash flows and compares changes in our cash and cash equivalents on hand to the same period in the prior year.

 

     Company
Historical
    Predecessor
Historical
    Change  
    

October 17,

2005 to

December 31,

2005

   

January 1,

2005 to

October 16,

2005

   

Year Ended

December 31,

2004

   
     (in millions)  

Cash provided by (used in):

        

Operating activities

   $ 31.1     $ 106.5     $ 261.1     $ (123.5 )

Investing activities

     (1,640.1 )     (39.5 )     (2.3 )     (1,677.3 )

Financing activities

     1,722.9       (23.4 )     (301.5 )     2,001.0  

Effects of exchange rate changes

     (0.5 )     (1.9 )     2.0       (4.4 )
                                

Net change in cash and cash equivalents

   $ 113.4     $ 41.7     $ (40.7 )   $ 195.8  
                                

Operating Activities. The decrease in cash generated from operating activities was primarily driven by the $110 million of income from operations generated in 2004 from the 2004 Events which did not recur in 2005 and an increase in restricted cash requirements of $6.0 million. Additionally, due to the increase in borrowings, our interest payments have increased and resulted in a $5.4 million decrease in cash provided by operations.

Investing Activities. In 2005, we used $1,677.3 million more cash in investing activities as compared with 2004. In 2005, we used $1,629.0 million for the Transactions and $15.7 million to acquire the remaining TRL Group interest, as compared to the use of $21.4 million to acquire Trilegiant Loyalty Solutions, Inc. and related companies in 2004. The decrease in cash, as compared to 2004, also reflects $39.6 million of proceeds from the sale of other assets during 2004. Our restricted cash requirements were $1.9 million higher in 2005 while our restricted cash requirements were $5.3 million lower in 2004 primarily due to changes in restricted cash requirements related to letters of credit and collateral security agreements. We also used $7.2 million more cash for capital expenditures during 2005 as compared with 2004.

Financing Activities. In 2005, we generated $2,001.0 million more cash in financing activities as compared with 2004. This change primarily reflects borrowings made during the fourth quarter for the Transactions (see “—Covenant Compliance” below). In addition, a principal prepayment of $20.0 million was made on the term loan in November of 2005 as compared to other principal payments of $18.8 million during 2004. Cash was provided by the sale of common stock of $275.0 million to Apollo. Also, principal payments were made under a credit agreement with Cendant totaling $30.0 million for 2005 and we received net advances from Cendant of $7.1 million during 2005 as compared to an increase in net advances to Cendant of $268.4 million during 2004, borrowings under the credit agreement with Cendant of $30.0 million in 2004, and the payment of a dividend totaling $45.3 million during 2004.

Credit Facilities and Long-Term Debt

Following the completion of the Transactions we became a highly leveraged company. As of December 31, 2006, we had $1.4 billion in indebtedness. Payments required to service this indebtedness have substantially increased our liquidity requirements as compared to prior years.

As part of the Transactions, we (a) issued $270 million principal amount of 10 1/8% senior notes due October 15, 2013 (the “senior notes”) ($266.4 million net of discount), (b) entered into our new senior secured credit facilities consisting of a term loan facility in the principal amount of $860.0 million (which amount does not reflect the $105 million in principal prepayments that we made as of December 31, 2006) and a revolving credit facility in an aggregate amount of up to $100 million and (c) entered into a senior subordinated bridge loan facility in the

 

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principal amount of $383.6 million. At December 31, 2006, we had $302.0 million outstanding under the senior notes, $755.0 million outstanding under the term loan facility, $350.8 million outstanding under the senior subordinated notes and $98.5 million available under the revolving credit facility (after giving effect to the issuance of $1.5 million letters of credit).

Any borrowings under the revolving credit facility are available to fund our working capital requirements, capital expenditures and for other general corporate purposes. The senior secured credit facility also generally requires us to prepay borrowings under the term loan with proceeds from asset dispositions, excess cash flow beginning in July 2006 and the net cash proceeds from certain debt issued in the future. The remaining balance of the term loan is due and payable in full in 2012. The revolving credit facility is available until 2011. The term loan provides, at our option, for interest rates of a) adjusted LIBOR plus 2.50% or b) the higher of i) Credit Suisse, Cayman Island Branch’s prime rate and ii) the Federal Funds Effective Rate plus 0.5% (“ABR”), in each case plus 1.50%. The revolving credit facility provides, at our option, for interest rates of adjusted LIBOR plus 2.75% or ABR, plus 1.75% subject to downward adjustment based on our senior secured bank leverage ratio, as set forth in the agreement governing the revolving credit facility.

On October 17, 2005, we issued $270.0 million aggregate principal amount of 10 1/8% senior notes due 2013 (the “senior notes”) and applied the gross proceeds of $266.4 million to finance a portion of the Transactions. On May 3, 2006, we issued an additional $34.0 million aggregate principal amount of senior notes and applied the gross proceeds, together with cash on hand, to repay the then remaining outstanding borrowings under our bridge loan facility. The interest on our senior notes is payable semi-annually. We may redeem some or all of the senior notes at any time on or after October 15, 2009 at the redemption prices (generally at a premium) set forth in the indenture governing the senior notes. In addition, on or before October 15, 2008, we may redeem up to 35% of the aggregate principal amount of our senior notes with the net proceeds of certain equity offerings, provided that at least 65% of the aggregate principal amount of our senior notes initially issued remain outstanding immediately after such redemption. The senior notes are unsecured obligations. The senior notes are guaranteed by the same subsidiaries of the Company that guarantee our $960.0 million senior secured credit facility and our senior subordinated notes. The senior notes contain restrictive covenants related primarily to our ability to distribute dividends, redeem or repurchase capital stock, sell assets, issue additional debt or merge with or acquire other companies.

Our senior subordinated bridge loan facility has since been refinanced with the proceeds from the offering of senior subordinated notes (as defined below) and additional senior notes. On April 26, 2006, we issued $355.5 million aggregate principal amount of 11 1/2% senior subordinated notes due October 15, 2015 (the “senior subordinated notes”) and applied the gross proceeds of $350.5 million to repay $349.5 million of outstanding borrowings under our senior subordinated loan facility, plus accrued interest, and used cash on hand to pay fees and expenses associated with such issuance. The interest on our senior subordinated notes is payable semi-annually. We may redeem some or all of the senior subordinated notes at any time on or after October 15, 2010 at the redemption prices (generally at a premium) set forth in the indenture governing the senior subordinated notes. In addition, on or before October 15, 2008, we may redeem up to 35% of the aggregate principal amount of our senior subordinated notes with the net proceeds of certain equity offerings, provided that at least 65% of the aggregate principal amount of our senior subordinated notes initially issued remain outstanding immediately after such redemption. The senior subordinated notes are unsecured obligations. The senior subordinated notes are guaranteed by the same subsidiaries of the Company that guarantee our $960.0 million senior secured credit facility and our senior notes. The senior subordinated notes contain restrictive covenants related primarily to our ability to distribute dividends, redeem or repurchase capital stock, sell assets, issue additional debt or merge with or acquire other companies.

Covenant Compliance

Our credit facility and the indentures that govern our senior notes and our senior subordinated notes contain various restrictive covenants. They prohibit us from prepaying indebtedness that is junior to such debt (subject to certain exceptions). Our credit facility requires us to maintain a specified minimum interest coverage ratio and a specified maximum consolidated leverage ratio. The interest coverage ratio as defined in the credit facility (Adjusted EBITDA, as defined, to interest expense, as defined) must be greater than 1.45 to 1.0 at December 31, 2006. The consolidated leverage ratio as defined in the credit facility (total debt, as defined, to Adjusted EBITDA, as defined) must be less than 7.25 to 1.0 at December 31, 2006. In addition, our credit facility, among other things, restricts our ability to incur indebtedness or liens, make investments or declare or pay any dividends. The indenture governing the senior notes and the indenture governing the senior subordinated notes, among other things: (a) limit our ability and the ability of our subsidiaries to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments and enter into certain transactions with affiliates; (b) place restrictions on the ability of certain of our subsidiaries to pay dividends or make certain payments to us; and (c) place restrictions on our ability and the ability of our subsidiaries to merge or consolidate with any other person or sell, assign, transfer, convey or otherwise dispose of all or substantially all of our assets. However, all of these covenants are subject to certain exceptions.

We have the ability to incur additional debt, subject to limitations imposed by our senior notes indenture, credit facility, and senior subordinated notes indenture. Under our indenture governing the senior notes and our indenture governing the senior subordinated notes, in addition to specified permitted indebtedness, we will be able to incur additional indebtedness so long as on a pro forma basis our fixed charge coverage ratio (the ratio of Adjusted EBITDA to consolidated fixed charges) is at least 2.0 to 1.0. As discussed above, our cash flow allowed us to make a voluntary prepayment of the term loan of $20 million in 2005 and voluntary prepayments of the term loan

 

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aggregating $85 million during 2006 for a total of $105 million of voluntary prepayments. Additionally, we made a $25 million principal prepayment on March 22, 2007 and we may elect to make additional prepayments if it is beneficial to do so.

Based on management’s expectations of the Company’s ability to voluntarily prepay principal during the next twelve months under its term loan, $50.0 million has been classified as current portion of long-term debt on the December 31, 2006 consolidated balance sheet.

Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures

Segment EBITDA consists of income from operations before depreciation and amortization. Segment EBITDA is the measure management uses to evaluate segment performance and we present Segment EBITDA to enhance your understanding of our operating performance. We use Segment EBITDA as one criterion for evaluating our performance relative to that of our peers. We believe that Segment EBITDA is an operating performance measure, and not a liquidity measure, that provides investors and analysts with a measure of operating results unaffected by differences in capital structures, capital investment cycles and ages of related assets among otherwise comparable companies. Adjusted EBITDA is defined as Segment EBITDA further adjusted to exclude non-cash and unusual items and other adjustments permitted in our debt agreements to test the permissibility of certain types of transactions, including debt incurrence. We believe that the inclusion of the adjustments to Segment EBITDA applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors about certain non-cash items and unusual items. However, Segment EBITDA and Adjusted EBITDA are not measurements of financial performance under U.S. GAAP, and our Segment EBITDA and Adjusted EBITDA may not be comparable to similarly titled measures of other companies. You should not consider our Segment EBITDA and Adjusted EBITDA as alternatives to operating income or net income determined in accordance with U.S. GAAP, as indicators of our operating performance or as alternatives to cash flows from operating activities determined in accordance with U.S. GAAP, or as indicators of cash flows, or as a measure of liquidity.

Set forth below is a reconciliation of 2006 historical consolidated net loss to Segment EBITDA and Adjusted EBITDA as required by our credit facility agreement, the indenture governing our senior notes and the indenture governing our senior subordinated notes.

 

     Historical  
    

Year Ended
December 31,

2006

 
     (in millions)  

Net loss

   $ (438.2 )

Interest expense, net

     143.1  

Income tax expense

     6.3  

Minority interests, net of tax

     0.3  

Other (income), net

     —    

Depreciation and amortization

     396.8  
        

Segment EBITDA

     108.3  

Effect of the Transactions, reorganizations and non-recurring revenue and gains (a)

     128.0  

Certain legal costs (b)

     1.0  

Net cost savings (c)

     7.4  

Other, net (d)

     19.3  
        

Adjusted EBITDA

   $ 264.0  
        

Interest coverage ratio(e)

     1.97  

Consolidated leverage ratio(f)

     5.08  

(a) Effect of the Transactions, reorganizations and non-recurring revenue and gains – eliminates the effect of the Transactions (principally purchase accounting), prior business reorganizations and non-recurring revenue and gains.

 

(b) Certain legal costs - represents legal costs for certain litigation matters.

 

(c) Net cost savings - represents: (i) the elimination of general corporate overhead allocations from Cendant, historical long-term incentive compensation charges and certain incremental stand-alone costs and (ii) the elimination of costs associated with facilities closure and severance incurred in 2006.

 

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(d) Other, net -represents: (i) net changes in other reserves in 2005, (ii) changing the Predecessor’s historical accounting policy for insurance program marketing costs to our policy of expensing such costs as incurred, (iii) changes in contractual arrangements between us and Cendant as if such contractual terms were in place for all periods presented, (iv) consulting fees paid to Apollo in 2006, (v) the 2006 goodwill impairment charge recorded related to goodwill ascribed to the Loyalty business, and (vi) the elimination of certain non-recurring costs.

 

(e) The interest coverage ratio is defined in our credit facilities (Adjusted EBITDA, as defined, to interest expense, as defined). The interest coverage ratio must be greater than 1.45 to 1.00 at December 31, 2006.

 

(f) The consolidated leverage ratio is defined in our credit facilities (total debt, as defined, to Adjusted EBITDA, as defined). The consolidated leverage ratio must be less than 7.25 to 1.0 at December 31, 2006.

 

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Contractual Obligations and Commitments

The following table summarizes our aggregate contractual obligations, including a $25 million voluntary prepayment of the term loan on March 22, 2007, at December 31, 2006, and the estimated timing and effect that such obligations are expected to have on our liquidity and cash flow in future periods. We expect to fund the firm commitments with operating cash flow generated in the normal course of business and availability under the $100 million revolving credit portion of our credit facility.

 

     2007    2008    2009    2010    2011    2012 and
thereafter
   Total
     (dollars in millions)

Term loan due 2012

   $ 50.0    $ —      $ —      $ —      $ —      $ 705.0    $ 755.0

10 1/8% senior notes due 2013(1)

     —        —        —        —        —        304.0      304.0

11 1/2% senior subordinated notes due 2015(1)

     —        —        —        —        —        355.5      355.5

Interest payments(2)

     129.2      125.2      125.2      125.2      125.2      269.4      899.4

Other purchase commitments(3)

     46.5      27.6      22.3      13.8      9.0      0.4      119.6

Operating lease commitments

     11.9      11.5      7.9      7.1      5.2      9.2      52.8

Capital lease obligations

     0.2      0.2      0.2      —        —        —        0.6

Consulting agreements (4)

     2.0      2.0      2.0      2.0      2.0      12.0      22.0

Employment agreements (5)

     3.4      2.3      1.9      0.9      —        —        8.5
                                                

Total firm commitments and outstanding debt

   $ 243.2    $ 168.8    $ 159.5    $ 149.0    $ 141.4    $ 1,655.5    $ 2,517.4
                                                

(1) Long-term debt reflected at face amount.

 

(2) Interest on variable rate debt based on December 31, 2006 interest rates.

 

(3) Represents commitments under purchase agreements for marketing and membership program support services.

 

(4) Represents annual management fee payable under the consulting agreement with Apollo. See “Certain Relationships and Related Party Transactions – Ancillary Agreements to the Purchase agreement – Consulting Agreement” below.

 

(5) Represents salary and target bonus amounts attributable to those employment agreements described under “Item 11. Executive Compensation.” Amounts are based on the assumption that no agreements are renewed beyond their initial terms and all performance metrics for bonus payouts are achieved. Amounts exclude severance and other payouts due upon termination of employment.

The above table does not give effect to contingent obligations, such as litigation claims, standard guarantees and indemnities, other guarantees associated with the 2004 Events, surety bonds and letters of credit, due to the fact that at this time we can not determine either the amount or timing of payments related to these contingent obligations. See Note 15 to our consolidated and combined financial statements included elsewhere herein for a discussion of these contingent obligations. In addition, we refer you to our audited consolidated financial statements as of and for the year ended December 31, 2006 and as of and for the period from October 17, 2005 to December 31, 2005 and our combined financial statements for the period from January 1, 2005 to October 16, 2005 and for the year ended December 31, 2004.

Affinion Group Holdings, Inc.’s Dependence on Us to Service its Obligations

On January 31, 2007, our parent, Affinion Group Holdings, Inc. (“Holdings”), entered into a five-year senior unsecured term loan facility (the “Holdings Loan Agreement”) with Deutsche Bank Trust Company Americas (“Deutsche Bank”), Bank of America, N.A., and certain other banks as the initial lenders, with Deutsche Bank Securities Inc. and Banc of America Securities LLC (“BAS”) as the joint lead arrangers and book-running managers, Deutsche Bank as administrative agent, and BAS as syndication agent. The principal amount of the Holdings Loan Agreement was $350 million. Loans under the Holdings Loan Agreement will initially accrue cash interest at the rate of six month LIBOR plus 6.25%, but the interest rate is subject to additional increases over time and further increases if, in lieu of paying cash interest, the interest is paid by adding such interest to the principal amount of the loans. In addition, the Holdings preferred stock entitles its holders to receive dividends of 8.5% per annum (payable, at Holdings’ option, in either cash or in kind) and ranks senior to shares of all other classes or series of stock with respect to rights upon a liquidation or sale of holdings at a price of the then-current face amount, plus any accrued and unpaid dividends. As a holding company with no significant assets other than the ownership of 100% of our common stock, Holdings depends on our cash flows to service its debt and to pay cash dividends (if any) on its preferred stock.

 

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As described above, we expect that Holdings will rely on distributions from us in order to pay cash amounts due (if any) in respect of the Holdings Loan Agreement and to pay cash dividends (if any) on its preferred stock. However, our ability to make distributions to Holdings is restricted by covenants contained in our credit facility and the indentures governing our 10 1/8% senior notes and our 11 1/2% senior subordinated notes and by Delaware law. To the extent we make distributions to Holdings, the amount of cash available to us to pay principal of, and interest on, our outstanding debt, including our credit facility, our 10 1/8% senior notes and our 11 1/2% senior subordinated notes, will be reduced, and we would have less cash available for other purposes, which could negatively impact our financial condition, our results of operations and our ability to maintain or expand our business. A failure to pay principal of, or interest on, our debt, including our credit facility, our 10 1/8% senior notes and our 11 1/2% senior subordinated notes, would constitute an event of default under the applicable debt agreements, giving the holders of that debt the right to accelerate its maturity. If any of our debt is accelerated, we may not have sufficient cash available to repay it in full and we may be unable to refinance such debt on satisfactory terms or at all.

Critical Accounting Policies

In presenting our consolidated and combined financial statements in conformity with accounting principles generally accepted in the United States of America, we are required to make estimates and assumptions that affect the amounts reported therein. We believe that the estimates, assumptions and judgments involved in the accounting policies related to revenue recognition, accounting for marketing costs, valuation of goodwill and intangible assets, and valuation of tax assets and liabilities could potentially affect our reported results and as such, we consider these to be our critical accounting policies. Several of the estimates and assumptions we are required to make relate to matters that are inherently uncertain, as they pertain to future events. However, certain events outside our control cannot be predicted and, as such, they cannot be contemplated in evaluating such estimates and assumptions. We believe that the estimates and assumptions used when preparing our consolidated and combined financial statements were the most appropriate at the time. For a summary of all of our significant accounting policies, see Note 2 to our consolidated and combined financial statements.

Purchase Accounting

On October 17, 2005, Cendant completed the sale of the Cendant Marketing Services Division to Affinion Group, Inc., an affiliate of Apollo Management. The sale was accounted for in accordance with the purchase method of accounting, which requires judgment regarding the allocation of the purchase price based on the fair values of the assets acquired (including intangible assets) and the liabilities assumed. The purchase accounting adjustments reflected in the Company’s records primarily consist of: (1) revaluation of certain property and equipment, including internally developed software; (2) valuing intangibles assets consisting of affinity and member relationships, patents, trademarks and tradenames and proprietary databases and systems; (3) recognizing deferred revenues and prepaid commissions; and (4) recognizing the liability to service certain of our members during the period in which no revenue will be received. The excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was recognized as goodwill, which will be reviewed for impairment at least annually. We recorded goodwill of approximately $315.3 million related to the Transactions described above.

Revenue Recognition

Our critical accounting policies in the area of revenue recognition pertain to our insurance profit-sharing arrangements. For our membership, package and loyalty programs, we operate in a business environment where we are paid a fee for a service performed and we do not recognize revenue until these services have been performed and such revenues are no longer subject to refund. Accordingly, revenue recognition for these programs is not particularly subjective or complex.

 

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We recognize insurance program commission revenue based on premiums earned by the insurance carriers that underwrite the policies we market. Premiums are typically paid either monthly or quarterly and revenue is recognized ratably over the underlying policy coverage period. We engage in revenue and profit-sharing arrangements with the insurance carriers that issue the underlying insurance policies. Commission revenue from insurance programs is reported net of insurance costs in our combined financial statements. On a semi-annual or annual basis, a profit-sharing settlement is made based on an analysis of the premiums paid to the insurance carriers less claims experience incurred to date, estimated claims incurred but not reported, reinsurance costs and carrier administrative fees. We accrue monthly revenue and related profit sharing receivables from insurance carriers resulting from our expected share of this excess based on the claims experience to date, including an estimate for claims incurred but not reported. Adjustments to the estimates recorded are made upon settlement with the insurance carriers. Historically, our claims experience has not resulted in a shortfall.

The estimate of the periodic amount of claims incurred but not reported to the insurance company is based on models we have developed and maintain in consultation with the insurance carriers. The models are updated periodically for the most recent loss rates that we receive from the insurance companies and current market conditions. Any change to the estimates, based on actual experience, is reported in earnings in the period the change becomes known. The impact on 2006 net revenue subject to profit sharing arrangements of a 1% change in the claims incurred but not reported estimate as of December 31, 2006 would be approximately $0.4 million.

Marketing Expense

Our critical accounting policy in the area of marketing expense pertains to the insurance business within our insurance and package segment. For the periods following the closing of the Transactions, we have adopted an accounting policy whereby costs related to acquiring new insurance business are expensed as incurred. This represents a different accounting policy than was applied by the Predecessor, as described below. Marketing solicitation costs for our membership and package businesses are expensed as incurred consistent with our membership business.

In the historical combined financial statements, marketing acquisition costs for our insurance programs were deferred to the extent such costs were deemed recoverable from future cash flows generated by us related to such acquisition costs. These costs were amortized as marketing expense over a 12 year period using a declining balance method generally in proportion to the related insurance revenue, which was based on attrition rates associated with the approximate rate that insurance revenues collected from customers decline over time. Amortization of deferred acquisition costs commenced upon recognition of the related insurance revenue. The Predecessor performed periodic reviews of our amortization expense, attrition rates and the recoverability of deferred acquisition costs. Any resulting changes were treated as a change in estimate unless the balance was considered non-recoverable, in which case the unrecoverable portion was expensed.

The effect of the change in accounting policy for insurance programs is that all our marketing solicitation costs are expensed as incurred post-October 16, 2005.

Goodwill and Intangible Assets

In connection with SFAS No. 142, “Goodwill and Other Intangible Assets,” there is a requirement to assess goodwill and indefinite-lived intangible assets for impairment annually, or more frequently if circumstances indicate impairment may have occurred. The Company assesses goodwill for such impairment by comparing the carrying value of the reporting units to their fair values. Reporting units are comprised of Membership, Insurance and Package, International and Loyalty. Fair values of the reporting units are determined utilizing discounted cash flows and incorporate assumptions that we believe marketplace participants would utilize. Indefinite-lived intangible assets are tested for impairment and written down to fair value, as required by SFAS No. 142.

Subsequent to the initial assessment, the Company performs reviews annually, or more frequently if circumstances indicate that an impairment may have occurred. During 2006, as part of the Company’s annual review, it was determined that the goodwill ascribed to the Loyalty business had been impaired, primarily due to the loss of a major program, and all of the goodwill of the Loyalty business was written off. In 2005 and 2004, no such impairment occurred. The Company’s intangible assets as of December 31, 2006 consist primarily of intangible assets with finite useful lives acquired by the Company in the Transactions and are recorded at their respective fair values in accordance with SFAS No. 141, “Business Combinations.”

 

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Income Taxes

The income tax provision (benefit) is determined using the asset and liability method, under which deferred tax assets and liabilities are calculated based upon the temporary differences between the financial statement and income tax bases of assets and liabilities using currently enacted tax rates. Deferred tax assets are recorded net of a valuation allowance when, based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Decreases to the valuation allowance are recorded as reductions to the income tax provision (benefit) or to goodwill if related to allowances established prior to the Transactions, while increases to the valuation allowance result in additional provision. The realization of deferred tax assets is primarily dependent on estimated future taxable income. As of December 31, 2006 and 2005, the Company has recorded a full valuation allowance for its U.S. deferred tax assets.

The Predecessor, excluding TRL Group and CIMS, was included in the consolidated federal income tax return filed by Cendant. In addition, the Predecessor, excluding TRL Group and CIMS, filed unitary and consolidated state income tax returns with Cendant in jurisdictions where required. The provision for income taxes on the accompanying combined statements of operations was computed as if the Predecessor filed its federal and state income tax returns on a stand-alone basis. Since Cendant maintained less than an 80% ownership interest in TRL Group, TRL Group was not included in Cendant’s consolidated federal and state income tax returns and filed separate tax returns. CIMS and its subsidiaries filed income tax returns in countries in which they operated.

Recently Issued Accounting Pronouncements

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS 154). SFAS 154 replaces Accounting Principles Board Opinion No. 20, “Accounting Changes”, and Statement of Financial Accounting Standards No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. The provisions of SFAS 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Effective January 1, 2006, the Company adopted SFAS 154, with no impact on the Company’s consolidated financial position, results of operations or cash flows.

In June 2006, the FASB issued Statement of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in income tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, with earlier application encouraged. The Company is currently evaluating the potential impact that the adoption of FIN 48 will have on its consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, with earlier application encouraged. The Company is currently evaluating the potential impact that the adoption of SFAS 157 will have on its consolidated financial position, results of operations or cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and other items at fair value. The fair value option permits entities to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value option has been elected would be recognized in earnings at each subsequent reporting date. Generally, the fair value option may be applied instrument by instrument and is irrevocable unless a new election date occurs. SFAS 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007, with earlier adoption permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided that the entity also elects to apply the provisions of SFAS 157. The

 

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Company is currently evaluating the potential impact that the adoption of SFAS 159 will have on its consolidated financial position, results of operations or cash flows.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB 108 requires companies to quantify misstatements using both a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. SAB 108 is effective for the first annual period ending after November 15, 2006. The Company does not believe that the adoption of SAB 108 will have any impact on its consolidated financial position, results of operations or cash flows.

Cautionary Statements for Forward-Looking Information

This Report contains “forward-looking statements” that involve risks and uncertainties. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs and other information that is not historical information and, in particular, appear under headings “Item 1A. Risk Factors” and “Item 7A. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” When used in this Report, the words “estimates,” “expects,” “anticipates,” “forecasts,” “plans,” “intends,” “believes,” “seeks,” “may,” “will,” “should,” and variations of these words or similar expressions (or the negative versions of any such words) are intended to identify forward-looking statements. All forward-looking statements, including without limitation, management’s examination of historical operating trends, are based on our current expectations and various assumptions. Our expectations, beliefs and projections are expressed in good faith, and we believe there is a reasonable basis for them. However, management’s expectations, beliefs and projections may not result or be achieved.

We claim the protection of the safe harbor for forward-looking statements provided in the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. Examples of forward-looking statements include:

 

   

business strategy;

 

   

financial strategy;

 

   

projections of revenue, earnings, capital structure and other financial items;

 

   

statements of our plans and objectives;

 

   

statements of expected future economic performance; and

 

   

assumptions underlying statements regarding us or our business.

There are a number of risks and uncertainties that could cause our actual results to differ materially from the results referred to in the forward-looking statements contained in this Report. Important factors that could cause our actual results to differ materially from the results referred to in the forward-looking statements we make in this Report are set forth elsewhere in this Report, including under the heading “Item 1A. Risk Factors.” As stated elsewhere in this Report, these risks, uncertainties and other important factors include, among others:

 

   

general economic and business conditions and international and geopolitical events;

 

   

a downturn in the credit card industry or changes in the marketing techniques of credit card issuers;

 

   

the effects of a decline in travel due to political instability, adverse economic conditions or otherwise, on our travel fulfillment business;

 

   

termination or expiration of one or more agreements with our affinity partners, or reduction of the marketing of our services by one or more of our affinity partners;

 

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changes in, or the failure or inability to comply with, laws and governmental regulations, including changes in global distribution service rules, telemarketing regulations and privacy laws and regulations;

 

   

the outcome of numerous legal actions;

 

   

our substantial leverage and restrictions in our debt agreements;

 

   

dependence on third-party vendors to supply certain products or services that we market;

 

   

ability to execute our business strategy, development plans or cost savings plans;

 

   

changes in accounting principles and/or business practices;

 

   

availability, terms, and deployment of capital; and

 

   

failure to protect private data, which would cause us to expend capital and resources to protect against future security breaches.

There may be other factors that may cause our actual results to differ materially from the results referred to in the forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Report and are expressly qualified in their entirety by the cautionary statements included in this Report. We undertake no obligation to publicly update or revise any forward-looking statement whether as a result of new information, future events or otherwise, except as required by law.

These risks and other uncertainties are discussed in more detail in “Item 1A. Risk Factors.” There may be other factors, including those discussed elsewhere in this Report that may cause our actual results to differ materially from the results referred to in the forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Report and are expressly qualified in their entirety by the cautionary statements included in this Report. We undertake no obligation to publicly update or revise any forward-looking statement whether as a result of new information, future events or otherwise, except as required by law.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

Following is a description of the risk management policies and those of our Predecessor.

Foreign Currency Risk

The Predecessor used foreign currency forward contracts to manage exposure to changes in foreign currency exchange rates associated with its foreign currency denominated payables, receivables and forecasted earnings of foreign subsidiaries. The Predecessor primarily hedged its foreign currency exposure to the British pound and Euro. The majority of forward contracts utilized did not qualify for hedge accounting treatment under SFAS No. 133. The fluctuations in the value of these forward contracts did, however, largely offset the impact of changes in the value of the underlying risk that they were intended to economically hedge. The impact of these forward contracts was not material to the Predecessor’s results of operations or financial position. We currently do not utilize foreign currency forward contracts as we do not consider our foreign currency risk to be material.

Interest Rate Swap

We entered into an interest swap as of December 14, 2005. This swap converts a notional amount of the Company’s floating rate credit facility into a fixed rate obligation. The notional amount of the swap is $300 million at December 31, 2006 and reduces in accordance with a contractual amortization schedule through December 31, 2010 when the swap terminates. The purpose of the swap was to maintain our fixed/variable ratio within policy guidelines. The interest rate swap is recorded at fair value either as an asset or liability. Changes in the fair value of the swap is not designated as a hedging instrument and therefore recognized currently in earnings in the accompanying consolidated statements of operations.

 

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The following table provides information about the Company’s financial instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity for the Company’s long-term debt as of December 31, 2006.

 

     2007     2008     2009     2010     2011     2012 and
Thereafter
    Total    Fair Value At
December 31, 2006

Fixed rate debt

   $ 0.2     $ 0.2     $ 0.2     —       —       $ 659.5     $ 660.1    $ 698.8

Average interest rate

     11.08 %     11.08 %     11.08 %   11.08 %   11.08 %     11.08 %     

Variable rate debt

   $ 50.0       —         —       —       —       $ 705.0     $ 755.0    $ 755.0

Average interest rate (a)

     7.87 %     7.87 %     7.87 %   7.87 %   7.87 %     7.87 %     

Variable to fixed - Interest rate swap (b)

                  $ 0.9

Average pay rate

     4.84 %     4.86 %     4.93 %   4.97 %         

Average receive rate

     5.24 %     4.88 %     4.86 %   4.96 %         

(a) Average interest rate is based on rates in effect at December 31, 2006, adjusted for a 25 basis points decrease, effective January 4, 2007.

 

(b) The fair value of the interest rate swap is included in other non-current assets at December 31, 2006

As disclosed in Note 2 to the consolidated and combined financial statements, as a matter of policy, neither we nor our Predecessor used derivatives for trading or speculative purposes.

Credit Risk and Exposure

Financial instruments that potentially subject the Company and its Predecessor to concentrations of credit risk consist primarily of receivables, profit-sharing receivables from insurance carriers and prepaid commissions. We manage such risk by evaluating the financial position and creditworthiness of such counterparties. As of December 31, 2006, there were no significant concentrations of credit risk. Receivables and profit share receivables from insurance carriers are from various marketing, insurance and business partners and we maintain an allowance for losses, based upon expected collectibility. Commission advances are periodically evaluated as to recovery.

 

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Item 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Balance Sheets of the Company as of December 31, 2006 and 2005

   F-3

Consolidated Statements of Operations of the Company for the year ended December 31, 2006 and for the period from October 17, 2005 to December 31, 2005, and Combined Statements of Operations of the Predecessor for the period from January 1, 2005 to October 16, 2005 and for the Year Ended December 31, 2004

   F-4

Consolidated Statements of Changes in Stockholder’s Equity (Deficit) of the Company for the year ended December 31, 2006 and for the period from October 17, 2005 to December 31, 2005, and Combined Statements of Changes in Combined Equity of the Predecessor for the period from January 1, 2005 to October 16, 2005 and for the Year Ended December 31, 2004

   F-5

Consolidated Statements of Cash Flows of the Company for the year ended December 31, 2006 and for the period from October 17, 2005 to December 31, 2005, and Combined Statements of Cash Flows of the Predecessor for the period from January 1, 2005 to October 16, 2005 and for the Year Ended December 31, 2004

   F-6

Notes to Consolidated and Combined Financial Statements

   F-7

 

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Item 9. Changes in and Disagreements with Accountants and Accounting and Financial Disclosure

None.

 

Item 9A. Controls and Procedures

Evaluation of Disclosure Control and Procedures. The Company, under the direction of the Chief Executive Officer and the Chief Financial Officer, has established disclosure controls and procedures (“Disclosure Controls”) that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The Disclosure Controls are also intended to ensure that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and the Vice President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our Disclosure Controls or our “internal controls over financial reporting” (“Internal Controls”) will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Notwithstanding the foregoing, our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.

As of December 31, 2006, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2006, the Company’s disclosure controls and procedures are effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 

Item 9B. Other Information

None.

 

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PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

Set forth below is certain information concerning the individuals that are currently serving as our executive officers and/or members of our board of directors.

 

Name

   Age   

Position

Nathaniel J. Lipman

   42    President, Chief Executive Officer and Chairman of the Board of Directors

Thomas A. Williams

   47    Executive Vice President and Chief Financial Officer

Robert G. Rooney

   49    Executive Vice President and Chief Operating Officer

Todd H. Siegel

   36    Executive Vice President and General Counsel

Thomas J. Rusin

   38    Executive Vice President and Chief Revenue Officer

Steven E. Upshaw

   36    Executive Vice President and Chief Executive Officer of Affinion International Limited

Marc E. Becker

   34    Director

Robert B. Hedges, Jr.

   47    Director

Stan Parker

   31    Director

Eric L. Press

   41    Director

Eric Zinterhofer

   35    Director

Matthew H. Nord

   27    Director

Kenneth Vecchione

   52    Director

Joseph W. Saunders

   61    Director

Nathaniel J. Lipman has served as our President and Chief Executive Officer and a director of Affinion since October 17, 2005. He was formerly the President and CEO of Trilegiant starting in August 2002. From September 2001 until August 2002, he was Senior Executive Vice President of Business Development and Marketing. He served as Executive Vice President of Business Development for Cendant Membership Services from March 2000 to August 2001. He joined the Alliance Marketing Division of Cendant in June 1999 as Senior Vice President, Business Development and Strategic Planning. Mr. Lipman was previously Senior Executive Vice President, Corporate Development and Strategic Planning, for Planet Hollywood International, Inc., from 1996 until June 1999. Prior to his tenure at Planet Hollywood, Mr. Lipman was Senior Vice President and General Counsel of House of Blues Entertainment, Inc., Senior Corporate Counsel at The Walt Disney Company and a corporate associate at Skadden, Arps, Slate, Meagher and Flom.

Thomas A. Williams has served as our Executive Vice President and Chief Financial Officer since January 1, 2007. Prior to joining Affinion Group, Mr. Williams was most recently Vice President and Chief Financial Officer of two operating divisions of AT&T Inc., AT&T Network and AT&T Customer Service, from January 2004 to December 2006 with additional responsibilities for the merger synergy between AT&T Corp. and SBC Communications Inc. Mr. Williams started in Bell Laboratories and spent over twenty-one (21) years at AT&T from June 1985 to December 2006, where he held numerous senior positions including the following: Chief Financial Officer, AT&T Global Networking Technology Services; AT&T Chief Process Officer; Chief Financial Officer, AT&T Laboratories; Vice President Business Planning, AT&T Network & Computing Services; Chief Financial Officer, AT&T Operations Service Management. Prior to his tenure at AT&T, Mr. Williams was International Controller of McLean Industries Inc. from 1984 to 1985, Industry Analyst of Interpool Ltd. from 1982 to 1984 and Commodity Trading Associate with Bache Halsey Stuart Shields, Inc. from 1981 to 1982.

Robert G. Rooney has served as our Executive Vice President and Chief Operating Officer overseeing Affinion’s operating functions and Loyalty business since January 2, 2006. In addition, from August 23, 2006 to December 31, 2006, Mr. Rooney also served as our Interim Chief Financial Officer. From October 17, 2005 to January 1, 2006, Mr. Rooney served as our Executive Vice President and Interim Chief Financial Officer. Mr. Rooney joined us in June 2001, as Executive Vice President and Chief Financial Officer of Trilegiant. From 1999 to 2001, Mr. Rooney was Senior Vice President and Chief Financial Officer with Sbarro, Inc. and was responsible for finance, investor relations, information systems, tax and risk management. Prior to 1999, Mr. Rooney held senior positions with numerous companies in the financial and entertainment sectors, including three years as Chief Financial Officer of Imagine Entertainment. From 1978 to 1986, he was employed as a certified public accountant with Ernst & Young.

Todd H. Siegel has served as our Executive Vice President and General Counsel since October 17, 2005. Mr. Siegel joined us in November 1999 as a member of the Membership Division of the Legal Department of Cendant and most recently served as General Counsel of Trilegiant starting in July 2003. From 1997 to 1999, Mr. Siegel was employed as a corporate associate at Skadden, Arps, Slate, Meagher and Flom. From 1992 until 1994, he was employed as a certified public accountant with Ernst & Young.

Thomas J. Rusin has served as our Executive Vice President and Chief Revenue Officer since October 17, 2005, responsible for overseeing all aspects of product benefits, new product development, marketing services, sales and account management and our Internet Group. Mr. Rusin joined us in December 1999 as Product Manager in the Netmarket Group overseeing Travel Marketing and was subsequently promoted to Vice President of Travel in January 2001, Senior Vice President Consumer Saving Group with responsibility for Travel, Auto and Leisure in

 

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October 2001, and then Executive Vice President of Product Management, New Product Development in December 2003. From 1990 to 1998, he owned and operated Just for Travel Inc., a business he then sold.

Steven E. Upshaw has served as our Executive Vice President and Chief Executive Officer for Cims since October 17, 2005. Prior to this role Mr. Upshaw held the position of Executive Vice President and Managing Director for Cims UK, Ireland. Mr. Upshaw joined us in August 1995 and has served in numerous positions, including Senior Vice President for Protection Products in North America for Trilegiant.

Marc E. Becker has been a director of Affinion since October 17, 2005. From October 17, 2005 to December 20, 2006 he served as the Chairman of the Board of Directors of Affinion. Mr. Becker has also been employed with Apollo Management, L.P. since 1996 and has served as an officer of certain affiliates of Apollo since 1999. Prior to that time, Mr. Becker was employed by Smith Barney Inc. within its Investment Banking division. Mr. Becker serves on several boards of directors, including National Financial Partners Corp., Quality Distribution, Inc., Metals USA, Inc and SourceCorp Incorporated.

Robert B. Hedges, Jr. has been a director of Affinion since May 11, 2006. Mr. Hedges is also employed as a managing director at Mercatus LLC, a private equity and strategy consulting firm focused on the retail financial services marketplace. Prior to joining Mercatus LLC, Mr. Hedges was employed with Fidelity Investments where he was an executive vice president from 2003 to 2005, and with Fleet Boston from 1992 to 2002, where he held numerous positions, most recently serving as a managing director.

Stan Parker has been a director of Affinion since October 17, 2005. Mr. Parker has also been employed with Apollo Management, L.P. since 2000. From 1998 to 2000, Mr. Parker was employed by Salomon Smith Barney, Inc. Mr. Parker serves on several boards of directors, including AMC Entertainment Inc. UAP Holdings Corp., Momentive Performance Materials Holdings, Inc. and CEVA Logistics.

Eric L. Press has been a director of Affinion since October 17, 2005. Mr. Press is a partner of Apollo Management, L.P. He has been employed with Apollo Management, L.P. since 1998 and has served as an officer of certain affiliates of Apollo Management, L.P. From 1992 to 1998, Mr. Press was associated with the law firm of Wachtell, Lipton, Rosen & Katz specializing in mergers, acquisitions, restructurings and related financing transactions. Mr. Press serves on several boards of directors, including Metals USA, Inc. and Quality Distribution, Inc. From 1987 to 1989, Mr. Press was a consultant with The Boston Consulting Group.

Eric Zinterhofer has been a director of Affinion since October 17, 2005. Mr. Zinterhofer has also been employed with Apollo Management, L.P. since 1998. From 1994 to 1996, Mr. Zinterhofer was a member of the Corporate Finance Department at Morgan Stanley Dean Witter & Co. From 1993 to 1994, Mr. Zinterhofer was a member of the Structured Equity Group at J.P. Morgan Investment Management. Mr. Zinterhofer serves on the boards of directors of Central European Media, Unity Media SCA and iPCS, Inc.

Matthew H. Nord has been a director of Affinion since October 30, 2006. Mr. Nord is a principal of Apollo Management, L.P. and has been associated with Apollo Management, L.P. since 2003. Prior to that time, Mr. Nord was a member of the Investment Banking division of Salomon Smith Barney Inc. Mr. Nord serves on several boards of directors, including SOURCECORP, Incorporated, Mobile Satellite Ventures and Hughes Telematics.

Kenneth Vecchione has been a director of Affinion since November 21, 2006. From 1998 to 2006, Mr. Vecchione was employed by MBNA Corporation in various capacities. From 2004 to 2006 Mr. Vecchione served as Vice-Chairman and Chief Financial Officer of MBNA Corporation. From 2000 to 2004, he served as Chief Financial Officer and Director of MBNA America Bank N.A. and from 1998 to 2000 he served as Division Head of Finance. From 2000 to 2006, Mr.Vecchione was also a member of the Executive and Management Committees of MBNA Corporation.

Joseph W. Saunders has been a director of Affinion since August 24, 2006. Mr. Saunders is the executive chairman of the Visa Inc. board of directors. He has been Executive Chairman of Visa, Inc. since February 2007. From October 2006 to February 2007, Mr. Sanders was president of Card Services for Washington Mutual, Inc. From November 2001 to October 2006, prior to its acquisition by Washington Mutual, Inc., Mr. Saunders was the Chief Executive Officer of Providian Financial Corp. Mr. Saunders is also a director of New Star Financial, Inc.

Director Compensation

Each of the members of our board of directors also serves as a director on the board of directors of Holdings. Our non-employee directors receive annual compensation in the amount of $45,000 payable in equal quarterly installments, plus $2,000 for each regular or special meeting of our board of directors or board committee that they attend in person, plus an additional $1,000 for each regular or special meeting of our board of directors or board committee that they attend by teleconference. Our directors are also eligible to participate in the 2005 Stock Incentive Plan described under “Item 11. Executive Compensation – 2005 Stock Incentive Plan.”

Committees of our Board of Directors

Our board of directors has a Compensation Committee, an Executive Committee and an Audit Committee.

 

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Compensation Committee

The current members of the compensation committee are Messrs. Becker and Press. The principal duties and responsibilities of the compensation committee are as follows:

 

   

to review, evaluate and make recommendations to the full board of directors regarding our compensation policies and establish performance-based incentives that support our long-term goals, objectives and interests;

 

   

to review and approve the compensation of our chief executive officer, the other executive officers, other officers and employees;

 

   

to review and make recommendations to the board of directors with respect to our incentive compensation plans and equity-based compensation plans;

 

   

to set and review the compensation of and reimbursement policies for members of the board of directors;

 

   

to provide oversight concerning selection of officers, management succession planning, expense accounts, indemnification and insurance matters, and separation packages; and

 

   

to prepare an annual compensation committee report, provide regular reports to the board, and take such other actions as are necessary and consistent with the governing law and our organizational documents.

Executive Committee

The current members of the executive committee are Messrs. Becker, Parker and Lipman. The principal duties and responsibilities of the executive committee are as follows:

 

   

to advise and counsel the chairperson of the board of directors and the president regarding Company matters;

 

   

to determine actions and responses to complaints regarding the conduct of directors, officers and committees, and make any findings or determinations as to the related cause;

 

   

to oversee our legal and regulatory compliance program;

 

   

to take such actions as are necessary due to their urgent or highly confidential nature, or where convening the board is impracticable, subject to certain limitations; and

 

   

to regularly report to the board, review the charter and take such other actions as are necessary and consistent with the governing law and our organizational documents.

Audit Committee

The current members of the audit committee are Messrs. Vecchione, Hedges and Nord. Mr. Vecchione is the chairman of the audit committee. In addition, our board of directors has determined that Mr. Vecchione is an “audit committee financial expert” within the meaning of NASDAQ Marketplace Rule 4200(a)(15) and Messrs. Vecchione and Hedges meet the criteria for independence set forth in Rule 10A-3(b)(1) under the Exchange Act. Mr. Nord is not independent because of his relationship with Apollo, our controlling stockholder. The principal duties and responsibilities of our audit committee are as follows:

 

   

to monitor our financial reporting process and internal control system;

 

   

to oversee the integrity of our financial statements;

 

   

to appoint and replace our independent registered public accounting firm from time to time, determine their compensation and other terms of engagement, approve audit and non-audit services to be performed by such auditor and oversee their work;

 

   

to oversee the performance of our internal audit function; and

 

   

to oversee our compliance with legal, ethical and regulatory matters.

The audit committee has the power to investigate any matter brought to its attention within the scope of its duties. It also has the authority, at its discretion, to retain counsel and advisors to fulfill its responsibilities and duties at our expense.

Code of Ethics

Although as a private company we are not obligated to adopt a formal code of ethics, we are in the process of developing and adopting a core policies manual which will include a formal code of ethics.

 

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Item 11. Executive Compensation

Compensation Discussion and Analysis

Overview of Compensation Program

The Compensation Committee of the Board of Directors, which we refer to herein as the “Committee,” is responsible for establishing, implementing and continually monitoring adherence with the Company’s compensation philosophy. The Committee ensures that the total compensation paid to the executive officers of the Company is fair, reasonable and competitive. Generally, the types of compensation and benefits provided to the executive officers of the Company, including the named executive officers, are similar to those provided to executive officers at comparable companies in similarly situated positions.

Throughout this Section, we refer to the individuals who served as the Company’s Chief Executive Officer and Chief Financial Officer during fiscal year 2006, as well as the other individuals included in the Summary Compensation Table on page 79, as the “named executive officers”.

Compensation Philosophy and Objectives

The Committee believes that the most effective executive compensation program is one that is designed to reward the achievement of specific annual, long-term and strategic goals by the Company, and which aligns executives’ interests with those of our stockholders by rewarding performance above established goals, with the ultimate objective of improving stockholder value. The Committee evaluates both performance and compensation to ensure that the Company maintains its ability to attract and retain superior employees in key positions and that compensation provided to key employees remains competitive relative to the compensation paid to similarly situated executives of our peer companies. To that end, the Committee believes executive compensation packages provided by the Company to its executives, including the named executive officers, should include both cash and stock-based compensation that reward performance as measured against established goals.

Role of Executive Officers in Compensation Decisions

The Committee was established on March 2, 2006, therefore fiscal year 2006 compensation disclosed herein was based on recommendations made by the Chief Executive Officer during 2005 and approved by our Board of Directors. The Chief Executive Officer annually reviews the performance of each of the named executive officers (other than the Chief Executive Officer, whose performance is reviewed by the Committee). The conclusions reached and recommendations based on these reviews, including with respect to salary adjustments and annual incentive award target and actual payout amounts, are presented to the Committee, which has the discretion to modify any recommended adjustments or awards to executives.

The Committee has final approval over all compensation decisions for the named executive officers and approves recommendations regarding cash and equity awards to all officers of the Company.

Setting Executive Compensation

Based on the foregoing objectives, the Committee has structured the Company’s annual and long-term incentive cash and stock-based executive compensation programs to motivate our executives to achieve the business goals set by the Company and to reward the executives for achieving these goals. In making compensation recommendations, the Committee compares various elements of total compensation against publicly-traded and privately-held companies of similar annual revenue size based on data provided to us by independent third-party compensation consultants Hewitt Associates, Inc. and Mercer Human Resource Consulting LLC. The Committee generally targets compensation for the executive officers at the 50th percentile of compensation paid to similarly situated executives of our peer companies. However, the Committee may deviate from this 50th percentile target if it determines this is warranted by the experience level of the individual and market factors.

 

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2006 Executive Compensation Components

The principal components of compensation for our named executive officers are:

 

   

base salary;

 

   

performance-based incentive compensation;

 

   

long-term equity incentive compensation;

 

   

retirement and other benefits; and

 

   

perquisites.

Base Salary

We provide our named executive officers and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary ranges for named executive officers are determined for each executive based on his or her position and scope of responsibility by using comparative market data. The initial base salary for our named executive officers, other than Mr. Rusin and Mr. Siegel, is established in their employment agreements.

Salary levels are typically reviewed annually as part of the Company’s performance review process as well as upon a promotion or other material change in job responsibility. Merit based increases to salaries of the executives are based on the Committee’s assessment of the individual’s performance.

During its review of base salaries for executives, the Committee primarily considers:

 

   

internal review of the executive’s compensation, both individually and relative to other officers; and

 

   

individual performance of the executive.

Performance-Based Incentive Compensation

Our annual incentive plan is designed to focus on delivery against the Company’s annual and long-term goals while providing appropriate recognition of divisional and individual contributions and results. The annual incentive plan is intended to focus the entire organization on meeting or exceeding EBITDA goals, which is a critical metric to the Company’s success, while providing significant opportunity to reward individual contributions. For each named executive officer, as well as for each eligible employee, a target bonus percentage is set and rewards are based upon the Company achieving and exceeding goals as well as the review of individual performance. The initial target bonus percentage for our named executive officers, other than Mr. Rusin and Mr. Siegel, is established in their employment agreements.

Mr. Lipman has a target annual incentive bonus equal to 125% of his base salary earned in the applicable fiscal year. The other named executive officers had target annual incentive bonuses equal to 75% of their respective base salaries earned for fiscal year 2006. For fiscal year 2007 and thereafter, the Committee approved an increase in the target annual incentive bonus for the named executive officers other than Mr. Lipman to 100% of their respective base salaries earned in the applicable fiscal year.

 

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Long-Term Equity Incentive Compensation

On October 17, 2005, Holdings adopted the Holdings’ 2005 Stock Incentive Plan. The plan allows Holdings’ board of directors to grant nonqualified stock options, rights to purchase shares of Holdings common stock and awards of restricted shares of Holdings’ common stock to our directors, employees, and consultants. The plan is administered by the Holdings’ compensation committee which has the power to grant awards under the plan, select eligible persons to receive awards under the plan, determine the specific terms and conditions of any award (including price and conditions of vesting), construe and interpret the provisions of the plan, and generally make all other determinations and take other actions as may be necessary or advisable for the administration of the plan. Options granted under the plan are evidenced by an award agreement and must have an exercise price that is no less than the fair market value of a share of Holdings’ common stock on the date of grant. In the event of a change in control of Holdings, Holdings may, but is not obligated to, purchase then-outstanding options for a per option amount equal to the amount per share received in respect of the shares sold in the change in control transaction less the option price multiplied by the number of shares subject to the option. Stock awards will have a purchase price as determined by the Holdings compensation committee and evidenced by an award agreement. Holdings may amend or terminate the plan at any time, but no such action as it pertains to an existing award may materially impair the rights of an existing holder without the consent of the participant.

On October 17, 2005, certain of our executives, including the named executive officers, other than Ms. O’Connell, received grants of options to purchase common stock of Holdings, and Mr. Lipman also received a grant of restricted shares of Holdings’ common stock. In the aggregate, these grants covered approximately 1.6 million shares.

The named executive officers received options that vest based on the passage of time (the “Tranche A Options”) and options that vest based on the realization of certain internal rates of return (the “Tranche B” and “Tranche C” options). Twenty percent of the Tranche A options vest and become exercisable on each of the first five anniversaries of the grant date. In the event of a sale of Holdings, any unvested Tranche A options will vest on the 18-month anniversary of the sale or, if earlier (but following the sale), upon the executive’s termination by us without cause, by the executive for good reason or as a result of the executive’s death or disability.

The Tranche B options vest on the eighth anniversary of the grant date, or, if earlier, the date on which a 20% or greater investor internal rate of return is realized.

The Tranche C options vest on the eighth anniversary of the grant date or, if earlier, the date on which a 30% or greater investor internal rate of return is realized.

Retirement Benefits

Our Employee Savings Plan is a tax-qualified retirement savings plan pursuant to which all U.S. based employees or U.S. expatriates, including the named executive officers, are able to contribute on a before-tax basis the lesser of up to 25% of their annual salary or the limit prescribed by the Internal Revenue Service. The Company matches 100% of the first 6% of each employee’s pay that is contributed to the Employee Savings Plan. All contributions to the Employee Savings Plan as well as any matching contributions are fully-vested upon contribution.

Nonqualified Deferred Compensation Plan

The named executive officers, in addition to certain other eligible executives, are entitled to participate in our Deferred Compensation Plan. Pursuant to the Deferred Compensation Plan, eligible employees can defer up to 50% of their annual base salary and 100% of earned annual incentive bonus. The Deferred Compensation Plan is discussed in further detail under the heading “—Nonqualified Deferred Compensation.”

Perquisites

The Company provides named executive officers with perquisites that the Company and the Committee believe are reasonable and consistent with the Company’s overall compensation program to better enable the Company to attract and retain superior employees for key positions. The named executive officers are entitled to either the use of Company automobiles or an equitable car allowance, and are eligible to participate in the plans and programs described above. The Committee periodically reviews the levels of perquisites provided to our named executive officers.

Attributed costs of the perquisites described above for the named executive officers for fiscal year 2006 are included in column (i) of the “—Summary Compensation Table.”

 

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Severance Payments

The Company has entered into Severance Agreements and/or Employment Agreements which provide for severance payments in certain circumstances, with certain key employees, including the named executive officers. The Severance Agreements and/or Employment Agreements are designed to promote stability and continuity of senior management. Information regarding applicable payments under such agreements for the named executive officers is provided under the heading “—Potential Payments Upon Termination or Change of Control.”

Employment Agreements

Nathaniel J. Lipman. On October 17, 2005, we entered into an employment agreement with Nathaniel J. Lipman pursuant to which he currently serves as our Chairman of the Board, President and Chief Executive Officer. The initial term of the agreement is five years from the commencement date of the agreement, subject to automatic one-year renewals unless either party provides at least 90 days’ prior written notice to the other party of its intent not to renew the agreement. Mr. Lipman’s employment agreement provides for an annual base salary of no less than $450,000, subject to annual review and increases. In 2006, Mr. Lipman’s base salary was $465,865. On November 16, 2006, the Committee approved an increase in Mr. Lipman’s 2007 annual base salary to $525,000. Mr. Lipman is also eligible for an annual target bonus of 125% of his base salary, provided that performance objectives determined each year by the Committee are met. Mr. Lipman is eligible to receive awards under the 2005 Stock Incentive Plan described above.

Robert G. Rooney. On June 15, 2005, we entered into an employment agreement with Robert G. Rooney pursuant to which he serves as our Executive Vice President and Chief Operating Officer. Mr. Rooney’s employment agreement was amended on August 28, 2006 to appoint Mr. Rooney as Chief Operating Officer and Interim Chief Financial Officer. The initial term of the agreement is from July 2005 through June 15, 2007. After the initial term, the agreement is subject to automatic one-year renewals unless either party provides at least 90 days’ prior written notice to the other party of its intent not to renew the agreement. Mr. Rooney’s employment agreement provides for an annual base salary of $325,000, subject to annual review and increases and an annual target bonus of a minimum of 50% of his base salary. In 2006, Mr. Rooney’s base salary was $334,750 and his annual target bonus was increased to 75% of base salary, provided that performance objectives determined by us were met. For 2007, Mr. Rooney’s target bonus was increased to 100% of base salary.

Steven E. Upshaw. On June 15, 2004, we entered an employment agreement with Steven E. Upshaw pursuant to which he serves as our Executive Vice President and Chief Executive Officer of Affinion International Limited. The initial term of the agreement was from June 1, 2004 to June 1, 2006, but was extended to August 31, 2008. Mr. Upshaw’s employment agreement provides for an annual base salary of no less than $225,000, subject to annual review and increases, and an annual target bonus of 50% of his base salary. Mr. Upshaw’s 2006 base salary was $280,000 and his annual target bonus was increased to 75% of his base salary, provided that performance objectives determined by us were met. For 2007, Mr. Upshaw’s target bonus was increased to 100% of his base salary. Also, Mr. Upshaw receives a $30,000 expatriate premium and a $25,000 cost of living adjustment for each year he is located in the United Kingdom. Mr. Upshaw is eligible to receive awards under the 2005 Stock Incentive Plan described above.

Thomas J. Rusin. We have not entered into an employment agreement with Mr. Rusin.

Todd H. Siegel. We have not entered into an employment agreement with Mr. Siegel.

Maureen E. O’Connell. On December 1, 2005, we entered into an employment agreement with Maureen E. O’Connell pursuant to which she served as Executive Vice President and Chief Financial Officer. The term of the agreement commenced on January 2, 2006 and ended on September 30, 2006, upon the termination of her employment. Ms. O’Connell’s employment agreement provided for an annual base salary of $400,000, subject to annual review and increases in 2006. In 2006, Ms. O’Connell’s base salary was $300,000 (reflecting her employment with us for only a portion of the year) and she was eligible for an annual target bonus of 75% of her base salary, provided that performance objectives determined by us were met. In addition, Ms. O’Connell received a signing bonus of $400,000. Due to the termination of her employment, Ms. O’Connell did not receive a bonus for 2006.

 

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Bonus Letter Agreements

Prior to the consummation of the acquisition, in order to compensate the named executive officers and a number of our other employees for the consummation of the acquisition and to encourage retention, the named executive officers and a number of our other employees are parties to certain bonus letter agreements dated September 28, 2005. Pursuant to these agreements, the employees received a bonus amount that varies with each employee, most of which were paid in 2005, but some of which were paid in 2006. The 2006 portion of the bonuses were paid if they were employed on the payment date of April 15, 2006.

The following payments were made in 2006 to the named executive officers pursuant to the bonus letter agreements in accordance with their terms: Mr. Lipman, $410,000; Mr. Rooney, $125,000; Mr. Siegel, $100,000; Mr. Rusin, $100,000 and Mr. Upshaw, $100,000.

Tax and Accounting Implications

Accounting for Stock-Based Compensation

Beginning on January 1, 2006, the Company began accounting for stock-based payments under the 2005 Stock Incentive Plan in accordance with the requirements of FASB Statement 123(R).

COMPENSATION COMMITTEE REPORT

The Compensation Committee of the Company has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.

 

THE COMPENSATION COMMITTEE
 

Marc E. Becker, Chairman

Eric L. Press

 

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SUMMARY COMPENSATION TABLE

The table below summarizes the total compensation paid or earned by each of our named executive officers for the fiscal year ended December 31, 2006.

 

(a)

  (b)   (c)     (d)     (e)       (f)   (g)   (h)   (i)     (j)

Name and Principal Position

  Year  

Salary

($)

    Bonus
($)(1)
    Stock
Awards
($)(2)
      Option
Awards
($)(2)
  Non-Equity
Incentive Plan
Compensation
($)(3)
  Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings
($)
  All Other
Compensation
($)(4)
   

Total

($)

Nathaniel J. Lipman

                   

Chairman of the Board, President & Chief Executive Officer

  2006   $465,865     $410,000     $99,900     $534,449   $582,332   $0   $38,392 (5)   $2,130,938

Robert G. Rooney

                   

Executive Vice President and Chief Operating Officer, Interim Chief Financial Officer

  2006   $334,750     $125,000     $0     $138,698   $301,063   $0   $32,132 (6)   $931,643

Steven E. Upshaw

                   

Executive Vice President and Chief Executive Officer, Affinion International Limited

  2006   $310,000 (7)   $100,000     $0     $63,010   $232,500   $0   $687,678 (8)   $1,393,188

Thomas J. Rusin

                   

Executive Vice President and Chief Revenue Officer

  2006   $290,000     $100,000     $0     $77,134   $217,500   $0   $28,882 (9)   $713,516

Todd H. Siegel

                   

Executive Vice President and General Counsel

  2006   $257,500     $100,000     $0     $115,064   $193,125   $0   $33,021 (10)   $698,710

Maureen O’Connell(11)

                   

Chief Financial Officer

  2006   $300,000 (12)   $400,000 (13)   $0     $0   $0   $0   $206,876 (14)   $906,876

 


(1) The amounts shown in this column reflect, for each named executive officer other than Ms. O’Connell, the amounts of retention and deal bonuses paid in 2006.

 

(2) The amounts shown in columns (e) and (f) reflect, for each named executive officer, the amounts of restricted stock and options which were expensed during fiscal year 2006 in accordance with the requirements of FASB Statement 123(R).

 

(3) Amounts shown in this column reflect, for each named executive officer, the amount of annual bonus earned in 2006 but paid in 2007 based on the achievement of performance goals established by the Committee.

 

(4) The amounts shown in column (i) reflect, for each named executive officer: matching contributions we made on behalf of the named executive offers to the Employee Savings Plan (which is more fully described under “Retirement Benefits” above) in the amounts of $13,200 for Mr. Lipman, $13,200 for Mr. Rooney, $13,200 for Mr. Rusin, $12,923 for Mr. Upshaw, $13,073 for Mr. Siegel and zero for Ms. O’Connell, and also certain perquisites disclosed in other footnotes to this Summary Compensation Table.

 

(5) Includes certain perquisites provided by the Company, including an automobile benefit valued at $25,192 including a tax gross-up based on an assumed 35% federal income tax rate.

 

(6) Includes certain perquisites provided by the Company, including an automobile benefit valued at $18,932 including a tax gross-up based on an assumed 25% federal income tax rate.

 

(7) Includes an expatriate premium payment of $30,000.

 

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(8) Includes (i) a cost of living adjustment of $25,000, (ii) relocation and housing expenses of $177,057, (iii) reimbursement of U.S. tax obligations of $93,239, (iv) reimbursement of foreign taxes of $369,709, (v) an automobile benefit valued at $9,250, and (vi) tax advice of $500.

 

(9) Includes certain perquisites provided by the Company, including an automobile benefit valued at $15,682, including a tax gross-up based on an assumed 25% federal income tax rate.

 

(10) Includes certain perquisites provided by the Company, including an automobile benefit valued at $19,948, including a tax gross-up based on an assumed 25% federal income tax rate.

 

(11) Ms. O’Connell’s employment with the Company terminated effective September 30, 2006.

 

(12) Reflects salary paid for the period from January 2, 2006 through September 30, 2006, the date of Ms. O’Connell’s termination of employment.

 

(13) Consists of a $400,000 sign-on bonus.

 

(14) Includes (i) a $180,000 severance payment and (ii) certain perquisites provided by the Company, including an automobile benefit valued at $26,876 including a tax gross-up based on an assumed 25% federal income tax rate. A final severance payment of $180,000 is due to Ms. O’Connell in April 2007 so long as she adheres to the terms and conditions of her severance agreement, which include, without limitation, covenants of non-competition and non-solicitation of the Company’s employees.

 

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GRANTS OF PLAN BASED AWARDS

The following table presents information regarding the equity awards granted to our named executive officers during fiscal year 2006.

 

        Estimated Future Payouts Under
Non-Equity Incentive Plan
Awards
  Estimated Future Payouts
Under
Equity Incentive Plan Awards
               

(a)

  (b)   (c)   (d)   (e)   (f)   (g)   (h)   (i)   (j)   (k)   (l)

Name

  Grant Date   Threshold
($)
 

Target

($) (1)

  Maximum
($)
  Threshold
(#)
  Target
(#) (2)
  Maximum
(#)
  All
Other
Stock
Awards:
Number
of
Shares
of Stock
or Units
(#) (3)
  All Other
Option
Awards:
Number of
Securities
Underlying
Options (#)
  Exercise
or Base
Price of
Option
Awards
($/sh)
  Grant
Date Fair
Value of
Stock and
Option
Awards
($)

Nathaniel J. Lipman

  —     —     $ 582,332   —     —     —     —     —     —       —       —  

Robert G. Rooney

  —     —     $ 301,063   —     —     —     —     —     —       —       —  

Thomas J. Rusin

  7/01/2006   —     $ 217,500   —     —     2,500   —     2,500   —     $ 3.00   $ 27,600

Steven E. Upshaw

  10/16/2006   —     $ 232,500   —     —     12,500   —     12,500   —     $ 3.00   $ 138,000

Todd H. Siegel

  —     —     $ 193,125   —     —     —     —     —     —       —       —  

Maureen O’Connell

  —     —     $ 0   —     —     —     —     —     —       —       —  

(1) Reflects target annual bonuses approved by the Committee for fiscal year 2006.

 

(2) Reflects the grant of Tranche B and Tranche C options which vest upon the realization of certain investor internal rates of return.

 

(3) Reflects the grant of Tranche A options, twenty percent of which will become exercisable on each of the first five anniversaries of the grant date.

 

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The following table presents information regarding the outstanding equity awards held by each named executive officer at the end of fiscal year 2006.

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

 

   

Option Awards

  Stock Awards

(a)

 

(b)

 

(c)

 

(d)

  (e)   (f)   (g)   (h)   (i)   (j)

Name

 

Number of

Securities

Underlying

Unexercised

Options (#)

Exercisable(1)

 

Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable (2)

 

Equity

Incentive Plan
Awards: Number
of Securities
Underlying
Unexercised
Unearned Options
(#)(2)

  Option
Exercise
Price
($) (3)
  Option
Expiration
Date
  Number of
Shares or
Units of
Stock
That Have
Not
Vested
  Market Value
of Shares or
Units of
Stock That
Have Not
Vested
  Equity
Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units or
Other
Rights
That
Have Not
Vested
  Equity
Incentive
Plan
Awards:
Market
or Payout
Value of
Unearned
Shares,
Units or
Other
Rights
That
Have Not
Vested

Nathaniel J. Lipman (4)

 

57,800 (Tranche A)

—  

—  

 

231,200 (Tranche A)

—  

—  

 

—  

144,500 (Tranche B)

144,500 (Tranche C)

  $
$
$
3.00
3.00
3.00
  10/17/2015
10/17/2015
10/17/2015
  50,000
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  

Robert G. Rooney

 

15,000 (Tranche A)

—  

—  

 

  60,000 (Tranche A)

—  

—  

 

—  

37,500 (Tranche B)

37,500 (Tranche C)

  $
$
$
3.00
3.00
3.00
  10/17/2015
10/17/2015
10/17/2015
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  

Thomas J. Rusin

 

  8,092 (Tranche A)

—  

—  

 

  32,368 (Tranche A)

—  

—  

 

—  

20,230 (Tranche B)

20,230 (Tranche C)

  $
$
$
3.00
3.00
3.00
  10/17/2015
10/17/2015
10/17/2015
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
 

—  

—  

—  

 

    2,500 (Tranche A)

—  

—  

 

—  

1,250 (Tranche B)

1,250 (Tranche C)

  $
$
$
3.00
3.00
3.00
  7/01/2016
7/01/2016
7/01/2016
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  

Steven E. Upshaw

 

  4,794 (Tranche A)

—  

—  

 

  19,176 (Tranche A)

—  

—  

 

—  

11,985 (Tranche B)

11,985 (Tranche C)

  $
$
$
3.00
3.00
3.00
  10/17/2015
10/17/2015
10/17/2015
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
 

  1,500 (Tranche A)

—  

—  

 

    6,000 (Tranche A)

—  

—  

 

—  

3,750 (Tranche B)

3,750 (Tranche C)

  $
$
$
3.00
3.00
3.00
  11/16/2015
11/16/2015
11/16/2015
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
 

—  

—  

—  

 

  12,500 (Tranche A)

—  

—  

 

—  

6,250 (Tranche B)

6,250 (Tranche C)

  $
$
$
3.00
3.00
3.00
  10/16/2016
10/16/2016
10/16/2016
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  

Todd H. Siegel

 

12,444 (Tranche A)

—  

—  

 

  49,776 (Tranche A)

—  

—  

 

—  

31,110 (Tranche B)

31,110 (Tranche C)

  $
$
$
3.00
3.00
3.00
  10/17/2015
10/17/2015
10/17/2015
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  

Maureen O’Connell

 

—  

—  

—  

 

—  

—  

—  

 

—  

—  

—  

  $
$
$
—  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  
  —  
—  
—  

(1) All Tranche A, Tranche B and Tranche C options identified in this Schedule are options to purchase shares of Holdings common stock. Except for the options granted to Mr. Upshaw on November 16, 2005 and October 16, 2006 and the options granted to Mr. Rusin on July 1, 2006, all options were granted on October 17, 2005. Vested options will expire earlier than the date indicated in column (f) if the executive terminates his relationship with us prior to the expiration date.

 

(2) Twenty percent of the Tranche A options vest and become exercisable on each of the first five anniversaries of the grant date. In the event of a sale of Holdings, any unvested Tranche A options will vest on the 18-month anniversary of the sale or, if earlier (but following the sale), upon the executive’s termination by us without cause, by the executive for good reason or as a result of the executive’s death or disability.

 

     The Tranche B options vest on the eighth anniversary of the grant date, or, if earlier, the date on which a 20% or greater investor internal rate of return is realized.

 

     The Tranche C options vest on the eighth anniversary of the grant date or, if earlier, the date on which a 30% or greater investor internal rate of return is realized.

 

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(3) On January 30, 2007, the compensation committee of Holdings reduced the exercise price of all Tranche A, Tranche B and Tranche C options from $10.00 per share to $3.00 per share as an equitable adjustment required by the 2005 Stock Incentive Plan in connection with the extraordinary dividends on Holdings’ common stock paid on January 31, 2007.

 

(4) Mr. Lipman’s Tranche A options vest as described in footnote (2) but are subject to the further requirement that upon termination by us without cause, by Mr. Lipman for good reason or as a result of his death or disability, the options will vest as if he continued to be employed by the Company until the second anniversary of the date of such termination, but only to the extent Mr. Lipman complies with certain contractual restrictive covenants.

 

OPTION EXERCISES AND STOCK VESTED

None of the Company’s named executive officers exercised any stock options during fiscal year 2006 and no shares of restricted stock vested during fiscal year 2006.

NONQUALIFIED DEFERRED COMPENSATION

Pursuant to the Company’s Deferred Compensation Plan, certain executives, including our named executive officers, may defer up to 50% of their base salaries and/or up to 100% of their compensation earned under the Company’s annual incentive plan. Deferral elections are generally made by eligible executives in November of each year for amounts to be earned by such executives in the following year.

Participating executives may select any combination of the deemed investment options offered by the plan. Participating executives’ accounts are notionally credited with earnings or losses based on the earnings or losses of their selected investment vehicles.

The plan provides that benefits under the plan will be paid to a participating executive upon the first to occur of the following events: (i) the executive’s retirement, disability, death or other separation from service, (ii) a change in control of the Company, Affinion Group, LLC, or any other subsidiary of the Company that employs the executive, and (iii) June 1st of the scheduled payment year (which must be at least 3 years following the date on which the deferral is made) selected by the executive at the time of deferral. In addition to the foregoing distribution events, the plan’s administrator can permit an early distribution of part or all of any amounts deferred by a participating executive under the plan if the plan’s administrator determines that such executive or such executive’s spouse or dependent has experienced a severe, unforeseeable financial hardship arising as a result of events beyond the executive’s control.

If a participating executive is entitled to receive a benefit payment under the plan due to retirement, disability, or other separation from service by the executive (other than death), this benefit payment will become payable as soon as administratively feasible, but no later than 60 days, following six full calendar months after the applicable distribution event. If a benefit payment becomes payable because of the participating executive’s death, a change of control (as described above), or pursuant to a scheduled payment date, it will be paid as soon as administratively feasible, but no later than 60 days, after the applicable distribution event. In general, benefits can be paid either in a

 

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lump sum payment or in annual installments, or a combination thereof, depending on the participating executive’s election made at the time of deferral and the nature of the specific distribution event.

None of our named executive officers deferred any of their compensation in 2006.

POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE OF CONTROL

The tables below reflect the amount of compensation that would be payable to each of our named executive officers in the event of the termination of such executive’s employment. The amount of compensation payable to each named executive officer upon termination for good reason, retirement, termination without cause, the named executive officer’s disability or death or in the event of a change of control, is shown below. The amounts shown assume that such termination was effective as of December 31, 2006, and thus includes amounts earned through such time and are estimates of the amounts which would be paid out to the executives upon their termination. The actual amounts to be paid out can only be determined at the time of such executive’s separation from the Company.

Forms of the Employment Agreement and/or Severance Agreement for each of the named executive officers can be found at Exhibits 10.22, 10.23, 10.24, 10.26, 10.27 and 10.28 hereto.

Payments Made Upon Termination, Generally

Regardless of the manner in which a named executive officer’s employment terminates, he or she is entitled to receive amounts earned during his or her term of employment. Such amounts include:

 

   

non-equity incentive compensation earned during the fiscal year of termination;

 

   

amounts earned and contributed under our Employee Savings Plan and Deferred Compensation Plan;

Payments Made Upon Retirement

In the event of the retirement of a named executive officer, in addition to the items identified above he or she will continue to be able to exercise vested options for ninety (90) days following termination of employment.

Payments Made Upon Termination due to Death or Disability

In the event of the death or disability of a named executive officer, in addition to the benefits listed under the headings “Payments Made Upon Termination, Generally” and “Payments Made Upon Retirement” above, the named executive officer will receive benefits under our disability plan or payments under our life insurance plan, as appropriate.

Payments Made Upon Termination “Without Cause” or Termination for “Good Reason”

We have entered into Employment and/or Severance Agreements with each named executive officer. Pursuant to these agreements, if an executive’s employment is terminated “without cause”, or if the executive terminates his employment in certain circumstances defined in the agreement which constitute “good reason”, or the executive’s employment is terminated by us for cause or by reason of death or disability, the named executive officers will receive the benefits set forth under the heading “Payments Made Upon Termination, Generally” and in the following tables.

 

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The named executive officers are only entitled to receive severance payments so long as they comply with their restrictive covenants regarding non-disclosure of confidential information, non-solicitation of employees, non-competition, and proprietary rights, each during and for specified periods after employment.

Nathaniel J. Lipman

In the event Mr. Lipman’s employment is terminated by us without cause or Mr. Lipman terminates his employment with us for good reason, he will be entitled, if he signs a general release of claims, to a lump sum payment of any unpaid annual base salary through the date of termination and any bonus earned for any fiscal year ended prior to the year in which the date of termination occurs, as well as the payment in eight quarterly installments commencing on the date of termination of an amount equal to 200% of the aggregate amount of Mr. Lipman’s annual base salary and target bonus. In the event Mr. Lipman’s employment is terminated due to death or disability, he will be entitled to a lump sum payment equal to 100% of his base salary (which was increased to $525,000 in November 2006). The agreement also subjects Mr. Lipman to restrictive covenants regarding non-disclosure of confidential information, non-solicitation of employees, non-competition, and proprietary rights, each during and for two years after his employment. Upon termination of Mr. Lipman’s employment for any reason, we will have the right to elect to purchase for fair market value any shares of Holdings common stock that he then holds, except that if the termination is for cause, we may instead elect to purchase the shares for their original cost (both as defined in the agreement). In the event Mr. Lipman violates any of the restrictive covenants, or if Mr. Lipman does not execute a general release in favor of the Company, he will have no further right to receive any severance payments. Mr. Lipman is not entitled to any type of severance payment in the event we timely exercise our right not to renew his employment agreement.

Pursuant to the terms of his restricted stock agreement dated October 17, 2005, all of Mr. Lipman’s restricted shares of Holdings common stock vest upon a sale of Holdings.

The following table shows the potential payments upon termination of Mr. Lipman’s employment on December 31, 2006 under the circumstances described above:

 

Executive Benefit and Payments Upon
Separation

   Voluntary
Termination
   Early
Retirement
   Normal
Retirement
  

Termination

Without
Cause

  

Termination
for Good
Reason

   Disability   Death   Change of
Control

Compensation:

                     

Annual Incentive Plan

   X    X    X    $ 1,312,500    $ 1,312,500      X     X   X

Cash Severance

   X    X    X    $ 1,050,000    $ 1,050,000    $ 525,000   $ 525,000   X

Long-Term Incentive Compensation:

                     

Stock Options(1)

   X    X    X             

Restricted Stock

   X    X    X      X      X      X     X  

$1,005,000(2)

Benefits & Perquisites:

                      X

Savings Plan

   X    X    X      X      X      X     X   X

Health and Welfare Benefits

   X    X    X      X      X      X     X   X

Life Insurance Proceeds

   X    X    X      X      X      X     X   X

(1) Pursuant to the terms of his option agreement dated October 17, 2005, in the event of a sale of Holdings, all of Mr. Lipman’s unvested Tranche A options will vest on the 18-month anniversary of the sale or, if earlier (but following the sale), upon his termination by us without cause, by Mr. Lipman for good reason or as a result of his death or disability. The value of the acceleration of vesting of Mr. Lipman’s options in connection with such a sale is impossible to calculate. Mr. Lipman’s option agreement also provides that upon his termination of employment by us without cause, by Mr. Lipman for good reason or as a result of his death or disability, his options will vest as if he continued to be employed by us until the second anniversary of his termination date, subject to his compliance with certain restrictive covenants. The value of the acceleration of vesting of Mr. Lipman’s options in connection with any such termination is impossible to calculate.

 

(2) Calculated by multiplying 50,000 shares by $20.10 which we believe to be the fair market value of a share of Holdings common stock on December 31, 2006 (not taking into account the adjustment made in connection with the extraordinary dividends paid on Holdings common stock on January 31, 2007).

 

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Robert G. Rooney

Our employment agreement with Mr. Rooney provides that in the event Mr. Rooney’s employment is terminated by us without cause or Mr. Rooney terminates his employment for good reason, he will be entitled, if he signs a general release of claims, to a lump sum payment of any unpaid annual base salary through the date of termination and any bonus earned for any fiscal year ended prior to the year in which the date of termination occurs, as well as a lump sum severance payment of 150% of his base salary (which was $334,750 in 2006). If we elect not to renew the agreement beyond June 15, 2007, and Mr. Rooney is terminated without cause during the twelve-month period following June 15, 2007, then the lump sum severance payment will be equal to 150% of his base salary reduced by a proportionate amount for the number of days Mr. Rooney is employed by us after June 15, 2007, with no lump sum payment required on or after June 15, 2008. The agreement also subjects Mr. Rooney to restrictive covenants regarding non-disclosure of confidential information, non-solicitation of employees, non-competition, and proprietary rights, each during and for specified periods after his employment. Pursuant to the Management Investor Rights Agreement, the non-competition covenant was amended and extended for a period of two years after Mr. Rooney’s employment is terminated for any reason.

The following table shows the potential payments upon termination of Mr. Rooney’s employment on December 31, 2006 under the circumstances described above:

 

Executive Benefit and Payments Upon Separation

   Voluntary
Termination
   Early
Retirement
   Normal
Retirement
   Termination
Without
Cause
  

Termination
for Good
Reason

   Disability    Death    Change
of
Control

Compensation:

                       

Annual Incentive Plan

   X    X    X      X      X    X    X    X

Cash Severance

   X    X    X    $ 502,125    $ 502,125    X    X    X

Long-Term Incentive Compensation:

                       

Stock Options(1)

   X    X    X               

Restricted Stock

   X    X    X      X      X    X    X    X

Benefits & Perquisites:

                       

Savings Plan

   X    X    X      X      X    X    X    X

Health and Welfare Benefits

   X    X    X      X      X    X    X    X

Life Insurance Proceeds

   X    X    X      X      X    X    X    X

 

(1) Pursuant to the terms of his option agreement dated October 17, 2005, in the event of a sale of Holdings, all of Mr. Rooney’s unvested Tranche A options will vest on the 18-month anniversary of the sale or, if earlier (but following the sale), upon his termination by us without cause, by Mr. Rooney for good reason or as a result of his death or disability. The value of the acceleration of vesting of Mr. Rooney’s options in connection with such a sale is impossible to calculate.

 

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Thomas J. Rusin

Mr. Rusin is a party to a severance agreement with us dated November 9, 2004. In the event we or our successor terminate Mr. Rusin’s employment without cause, he will be entitled to receive a lump sum payment of $225,000 (or the amount of his then-current base salary (which was $290,000 in 2006), if greater than $225,000 at the time of termination) plus any unpaid annual base salary through the date of termination and any bonus earned for any fiscal year ended prior to the year in which the date of termination occurs. Mr. Rusin’s receipt of severance benefits is conditioned upon his signing a general release of claims in favor of us and our affiliates. There is no fixed termination date for Mr. Rusin’s agreement. The agreement also subjects Mr. Rusin to restrictive covenants regarding non-disclosure of confidential information, non-solicitation of employees, non-competition, and proprietary rights, each during and for two years after his employment.

The following table shows the potential payments upon termination of Mr. Rusin’s employment on December 31, 2006 under the circumstances described above:

 

Executive Benefit and Payments Upon Separation

   Voluntary
Termination
   Early
Retirement
   Normal
Retirement
   Termination
Without
Cause
   Termination
for Good
Reason
   Disability    Death    Change
of
Control

Compensation:

                       

Annual Incentive Plan

   X    X    X      X      X    X    X    X

Cash Severance

   X    X    X    $ 290,000    $ 290,000    X    X    X

Long-Term Incentive Compensation:

                       

Stock Options(1)

   X    X    X               

Restricted Stock

   X    X    X      X      X    X    X    X

Benefits & Perquisites:

                       

Savings Plan

   X    X    X      X      X    X    X    X

Health and Welfare Benefits

   X    X    X      X      X    X    X    X

Life Insurance Proceeds

   X    X    X      X      X    X    X    X