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DM > SEC Filings for DM > Form 10-K on 9-Mar-2012All Recent SEC Filings

Show all filings for DOLAN CO.

Form 10-K for DOLAN CO.


9-Mar-2012

Annual Report


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

Overview

In 2011, our total revenues decreased $21.3 million, or 6.9%, from $306.9 million in 2010 to $285.6 million in 2011, primarily as a result of a $33.9 million decrease in our mortgage default processing services revenues and a $5.3 million decrease in our Business Information Division revenues, offset by a $17.9 million increase in our litigation support services revenues as a result of the ACT Litigation Services, Inc. ("ACT") acquisition. The decrease in mortgage default processing services revenues was driven primarily by a decrease in the number of foreclosure files received for processing and change in the mix of types of files that we did receive, as discussed below. Net income attributable to The Dolan Company decreased to $19.5 million for 2011 from $32.4 million for the same period in 2010, but excluding the impact of fair value adjustments recorded on earnout liabilities of $15.8 million in 2011, net income attributable to The Dolan Company was $3.7 million for 2011. Income from continuing operations decreased to $22.4 million for 2011 from $35.7 million in 2010. As a result, income from continuing operations attributable to The Dolan Company per diluted share decreased to $0.68 in 2011 from $1.08 in 2010.

Recent Developments

Discontinued Operations / Assets Held for Sale

In 2011, management committed to a plan of action to dispose of two of our smallest-market operating units within the Business Information Division. As explained in "Business Information Division Results" below, we expect the sale of these assets to occur in 2012, and as such, have classified the results of these operations (net of tax benefit), including impairment charges and certain exit costs, as discontinued operations. We recorded an aggregate impairment of long-lived assets of $0.7 million, along with $0.4 million in estimated exit costs.

Impairment of Long-Lived Assets

In addition to the impairment taken related to discontinued operations/assets held for sale as discussed above, management tested certain long-lived assets in the Business Information Division for impairment as a result of certain triggering events. This resulted in an impairment of $1.2 million in 2011.

Increase in our Ownership in DiscoverReady

In May 2011, we purchased approximately one-third of the outstanding membership units of DiscoverReady held by its minority partner, DR Holdco LLC, for approximately $5.0 million in cash. We accounted for this acquisition as an equity transaction by reducing redeemable noncontrolling interest on our balance sheet by $5.0 million. No deal costs were incurred on this transaction. As a result of this transaction, our ownership percentage in DiscoverReady increased from 85.3% to 90.0%, and the noncontrolling interest decreased from 14.7% to 10.0%.


In connection with this purchase, the terms of the DiscoverReady limited liability company agreement were amended. Under the terms of the amended agreement, DR Holdco has the right, for a period of 90 days following November 2, 2012, to require DiscoverReady to repurchase approximately 50% of DR Holdco's equity interest in DiscoverReady, and for a period of 90 days following November 2, 2013, to require DiscoverReady to purchase DR Holdco's remaining equity interest in DiscoverReady. In addition, for a period of 90 days following November 2, 2013, DiscoverReady also has the right to require DR Holdco to sell its entire equity interest in DiscoverReady. In each case, if either party timely exercises its right, DiscoverReady would pay DR Holdco an amount based on the fair market value of the equity interest. These rights may be exercised earlier under certain circumstances.

Stock Buy-Back Plan

Our board of directors approved a stock buy-back plan in December 2010. This plan allows us to repurchase up to 2 million shares of issued and outstanding common stock at prevailing market prices or negotiated prices through December 31, 2013. The number of shares and the timing of the purchases will be determined at the discretion of management. During 2011, we repurchased 137,500 shares under this plan for an aggregate of $1.7 million, all of which were purchased in the first quarter of 2011.

Increase in our Ownership in NDeX

On December 31, 2009 and January 4, 2010, we, along with our wholly-owned subsidiary, Dolan APC, LLC, entered into two separate common unit purchase agreements with the Trott Sellers, under the terms of which the Trott Sellers sold an aggregate 7.6% ownership interest in NDeX to us, for an aggregate purchase price of $13.0 million and 248,000 shares of our common stock. We will pay the remaining balance to the Trott Sellers in connection with these transactions, or $1.1 million as of the date of this annual report on Form 10-K, in equal monthly installments of approximately $0.1 million, in the aggregate, excluding interest accruing on the unpaid principal balance at a rate of 4.25%.

David A. Trott and the other Trott Sellers are partners in the law firm, Trott & Trott, P.C., which is a customer of NDeX. Trott is the managing partner of Trott & Trott, P.C. and we also employ him as the chairman and chief executive officer of NDeX, where he is one of our executive officers. Under the common units purchase agreements described above where we purchased an aggregate 7.6% ownership interest in NDeX, Trott sold us his 5.1% ownership interest in NDeX for which we will pay him an aggregate of $8.8 million (exclusive of interest) and for which we issued to him 168,644 shares of our common stock. See also "Related Party Transactions and Policies-David A. Trott" in our proxy statement, which is expected to be filed with the SEC in early April 2011, for a description of certain other relationships between Trott, his law firm or his other affiliated entities and us.

Each Trott Seller had the right, until February 7, 2010, to require NDeX to repurchase their respective membership interest in NDeX at a price based on 6.25 times NDeX's trailing twelve month earnings before interest, taxes, depreciation and amortization less the aggregate amount of any interest bearing indebtedness outstanding for NDeX as of the repurchase date. The present value of the total consideration paid to the Trott Sellers in connection with the sale of their respective NDeX interests to us approximated the price we would have paid to the Trott Sellers had they elected to exercise, in full, their put right set forth in the NDeX operating agreement.

On February 28, 2010, NDeX redeemed 23,560 common units, representing a 1.7% interest in NDeX, from Feiwell & Hannoy, in connection with Feiwell & Hannoy's exercise of its put right as set forth in the NDeX operating agreement. NDeX redeemed these common units for $3.5 million, which was determined pursuant to the formula set forth in NDeX's operating agreement. The redemption price is payable to Feiwell & Hannoy over a period of three years, in quarterly installments, with interest accruing at a rate of 3.25%. Feiwell & Hannoy is a law firm customer of NDeX.

After the closing of the transactions described above, our ownership interest in NDeX increased from 84.7% to 93.8%.


Regulatory Environment

Beginning in 2008, federal, state and local governmental entities and leaders have increasingly focused attention on foreclosures and have proposed and enacted legislation or taken other action that may have, and some of which has had, an adverse impact on the number of mortgage default case files NDeX is asked to process, the length of time it takes to process such files, the time over which we recognize revenue associated with the processing of those files, and the number of foreclosure public notices placed in our Business Information products and DLNP (our equity method investment) for publication. This legislation includes the Hope for Homeowners Act of 2008, the Emergency Economic Stabilization Act, the Streamlined Modification Program, and the Homeowner Affordability and Stability Plan (including the Making Home Affordable Program, the Home Affordable Modification Program (HAMP), and the Home Affordable Foreclosure Alternatives Program (HAFA)), the Protecting Tenants at Foreclosure Act, and laws passed to mitigate foreclosures in California, Maryland, Michigan, Indiana, and Florida. There also have been voluntary foreclosure relief programs developed by lenders, loan servicers and the Hope Now Alliance (a consortium that includes loan servicers). We have described these programs in our annual and quarterly reports in the past few years.

Overall, 2011 included continued scrutiny of mortgage foreclosures processes by various government agencies and individuals, voluntary slowing of foreclosure referrals by servicers and lenders as they reviewed systems and provided information requested by the government, newly mandated procedures, and signs of progress in governmental review.

In February 2011, the Department of the Treasury submitted a report to Congress entitled "Reforming America's Housing Finance Market" which included a plan to responsibly reduce the role of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) in the mortgage market and expressed a goal of ultimately winding down both institutions. Many of the files we process are supported by Fannie Mae or Freddie Mac, meaning that any change to these institutions, or broader changes to the mortgage market as a whole, may adversely impact the number of mortgage default files received by our law firm customers from their clients (and therefore the number directed to us to process) and received by us for processing in California by our mortgage lender and loan servicer customers.

In the federal sector, 14 major mortgage servicers signed consent orders with the Board of Governors of The Federal Reserve System and the Office of the Comptroller of the Currency ("OCC") in April 2011, agreeing to submit action plans detailing how they will comply with new requirements for servicing defaulted loans. The OCC consent agreements required improvements to certain internal processes and enhanced controls related to third-party vendors that provide services related to residential default or foreclosure, including the law firm customers of NDeX. In June 2011, the OCC issued guidance clarifying that, in addition to these 14 major mortgage servicers, all mortgage servicers under OCC supervision must assure compliance with all appropriate foreclosure management standards. OCC Bulletin 2011-29 issued in June 2011 stressed that banks engaged in mortgage servicing must ensure compliance with foreclosure laws, conduct foreclosures in a safe and sound manner, and establish responsible business practices that provide accountability and appropriate treatment of borrowers. The bulletin provided additional clarification on expectations regarding governance of foreclosure process to include adequate staffing and training, dual-track processing, management of affidavit and notary practices, documentation, oversight of third-party service providers, and adherence to all laws and regulations related to mortgage foreclosure. The OCC required servicers to complete revisions in foreclosure processing to the satisfaction of the Federal Reserve and the OCC and to reorganize their related foreclosure operations to follow the amended procedures. In addition, all national banks were required by the end of September 2011 to conduct a self-assessment of foreclosure management practices and to correct any weaknesses identified. The OCC continues to review the plans and information the banks submitted. The OCC indicated that it may require changes to the plans provided and that it is working with the United States Department of Justice and other federal and state authorities to finalize and synchronize the plans into a consistent set of servicing requirements.

In July 2011, the Consumer Financial Protection Bureau ("CFPB") outlined its approach to supervising large depository institutions to ensure compliance with federal consumer protection laws. This supervisory process, which applies to the 111 depository institutions with total assets of more than $10 billion, began on July 21, 2011. More recently, the CFPB issued Supervision and Examination guidance for all lenders. This guidance covers lending and servicing principals and how the CFPB will examine lenders' and servicers' processes going forward. We do not see a direct impact of this process upon our operations except that it further


complicates operations of the mortgage servicers, making them more concerned about compliance issues and potentially extending their current slowdown in foreclosure referrals. In October 2011, the CFPB outlined its initial approach to supervising mortgage servicers to ensure they comply with federal consumer financial protection laws. It said it will focus initially on loans in default where consumers are struggling to make payments. CFPB examiners will be looking to ensure that information provided to consumers about loan modifications and foreclosures is timely and transparent.

At the state level in 2011, the attorneys general of all 50 states continued to investigate the mortgage servicing industry and to negotiate with mortgage servicers in hopes of achieving changes in the foreclosure process, possible payment of financial penalties and an increased level of mortgage loan modifications. (While these officials in most states lack direct regulatory authority over mortgage servicers, the attorneys general indicated a willingness to act in the courts if necessary to enforce their positions.) In January 2012 a draft settlement between the nation's five largest mortgage lenders and the U.S. state attorneys general was announced and sent to state officials for review. That settlement would only apply to privately held mortgages issued between 2008 and 2011, not those held by government-controlled Fannie Mae or Freddie Mac. Under the proposed deal, $17 billion would go toward reducing the principal that certain homeowners owe on their mortgages, $5 billion would be placed in a reserve account for various state and federal programs and approximately $3 billion would assist homeowners' efforts to refinance at an interest rate of 5.25%. As of this filing, the vast majority of states were reported to have agreed to this settlement.

Given the OCC deadlines for reports and compliance, the CFPB's requirements, the attorneys general efforts, and the generally heightened scrutiny that residential mortgage foreclosure servicers experienced in 2011, servicers continued to react to this scrutiny by reviewing and verifying their policies and procedures, applying more steps, checks, and reviews to pending foreclosures, and releasing into foreclosure only those cases that have been carefully reviewed. Many servicers also reacted to this environment of increased scrutiny by requesting additional information and process verification from law firms and other third-party vendors. These servicer actions continued to sharply reduce the number of mortgage defaults being referred to begin foreclosure in 2011. We believe that servicers will continue to exercise an abundance of caution, examining each default referral in extreme detail, effectively continuing the slow pace of referrals. Until any new foreclosure procedures are made uniform and final, such new procedures cannot become automated as part of our proprietary workflow process management systems. We believe that the reduced level of foreclosure referrals is likely to continue until final procedures are in place, but that a large number of defaulted loans in pre-foreclosure status and pending foreclosures remain to be undertaken and completed.

Recent Acquisitions

ACT Litigation Services, Inc.

On July 25, 2011, we, through DiscoverReady, completed the acquisition of substantially all of the assets of ACT Litigation Services, Inc. ("ACT") for
(i) an upfront payment of approximately $60.0 million in cash that was paid in full at closing, plus (ii) up to $5.0 million in potential additional purchase price that will be held back for a period of 20 months (subject to partial early release) to secure certain obligations of ACT and its shareholders, plus
(iii) an earnout payment based primarily upon the extent to which an agreed-upon multiple of ACT's pro forma EBITDA for the year ended December 31, 2011, exceeds the base purchase price of $65.0 million, plus (iv) two additional earnout payments of up to a maximum of $15.0 million in the aggregate that are contingent upon reaching certain revenue milestones for the years ended December 31, 2012, and 2013. All of the earnout payments are subject to certain set-off rights under the purchase agreement. Management estimated the fair value of the earnouts to be paid, in the aggregate, to be $39.9 million at acquisition date. As a result of 2011 actual pro forma EBITDA (which was lower than the initial estimate) as well as revised expectations regarding certain of the earnout targets, the estimated fair value of the earnouts to be paid, in the aggregate, was reduced to $26.7 million at December 31, 2011. As a result, we recorded a non-cash fair value adjustment in the amount of $13.2 million to the estimated earnout liability in 2011. The total fair value of the long-lived tangible and intangible assets acquired was $100.9 million, and the total working capital acquired was $8.9 million.

We used funds available under our revolving line of credit to fund the closing payments in connection with this acquisition. The acquired operations of ACT are part of our Litigation Support Services segment within our Professional Services Division.


ACT specializes in providing technology and process solutions to clients with electronic discovery needs. It also provides hosting and review services. For more information on the products and services ACT provides, see "Our Products and Services-Professional Services" earlier in this annual report.

Revenues

We derive revenues from our two operating divisions, our Professional Services Division and our Business Information Division, operating as three reportable segments: (1) mortgage default processing services; (2) litigation support services; and (3) business information. For the year ended December 31, 2011, our total revenues were $285.6 million, and the percentage of our total revenues attributed to each of our divisions and segments was as follows:

73% from our Professional Services Division (46% from mortgage default processing services and 27% from litigation support services); and

27% from our Business Information Division.

Professional Service Division. Our Professional Services Division generates revenues primarily by providing mortgage default processing, outsourced discovery management and document review, and appellate services through fee-based arrangements. We further break down our Professional Services Division into two reportable segments, mortgage default processing services and litigation support services.

Mortgage Default Processing Services. Through NDeX, we assist eight law firms in processing foreclosure, bankruptcy, eviction and to a lesser extent, litigation and other mortgage default processing case files for residential mortgages that are in default. We also provide foreclosure processing services directly to mortgage lenders and loan servicers for properties located in California. In addition, NDeX provides loan modification and loss mitigation support on mortgage default files to its customers and related real estate title work to the Barrett Law Firm. Shareholders and/or principal attorneys of our law firm customers, including David A. Trott, chairman and chief executive officer of NDeX, are executive management employees of NDeX.

For the year ended December 31, 2011, we received approximately 317,200 mortgage default case files for processing. Our mortgage default processing service revenues accounted for 46% of our total revenues and 63% of our Professional Services Division's revenues during 2011. We recognize mortgage default processing services revenues over the period during which the services are provided. We consolidate the operations, including revenues, of NDeX and record a noncontrolling interest adjustment for the percentage of earnings that we do not own. See "Noncontrolling Interest" below for a description of the impact of the noncontrolling interest in NDeX on our operating results. With the exception of foreclosure files we process for our law firm customer, Feiwell & Hannoy, and California foreclosure files, we bill our customers upon receipt of the file and record amounts billed for services not yet performed as deferred revenue. For foreclosure files we process for Feiwell & Hannoy, we bill Feiwell & Hannoy in two installments and record amounts for services performed but not yet billed as unbilled services and amounts billed for services not yet performed as deferred revenue. For the majority of California foreclosure files processed by us, we bill our customers for services at the time the file is complete and record amounts related to services performed, but not yet billed, as unbilled services. In California, because we provide mortgage default processing services directly to mortgage lenders and loan servicers, we incur certain costs on behalf of our customers, such as trustee sale guarantees, title policies, and post and publication charges. We pass these costs directly through to our mortgage lender and loan servicer customers, and bill them at the time the file is complete. We have determined that these expenses should be recorded at net and, accordingly, do not record any revenue for these pass-through costs. We also provide title services primarily to the Barrett Law Firm, and we bill for these services when the title matter is completed and recognize revenue as we perform the services.

NDeX's revenues are primarily driven by the number of residential mortgage defaults in each of the states for which it processes files as well as the quantity and mix of the files we process (e.g., foreclosures, evictions, bankruptcies or litigation) because each has a different pricing structure. We have entered into long-term services agreements with each of our law firm customers. These agreements provide for the exclusive referral of files from the law firms to NDeX for servicing, except that the Barrett Law Firm and Trott & Trott may refer files elsewhere if they are otherwise directed by clients. During 2011, each of the Barrett Law Firm, Trott & Trott and Albertelli Law accounted for more than 10% of our mortgage default processing services revenues, with the Barrett Law


Firm accounting for 45%, Trott & Trott accounting for 26%, and Albertelli Law accounting for 13% of these revenues. Our services agreements with Trott & Trott, Albertelli Law and the Barrett Law Firm have initial terms that expire in 2021, 2029 and 2033, respectively. However, these terms may be automatically extended for up to two successive ten year periods, in the case of our agreements with Trott & Trott and Albertelli Law, or successive five year periods, in the case of our agreement with the Barrett Law Firm, unless either party elects to terminate the term then-in-effect with prior notice. The initial terms of our services agreements with our other law firm customers expire between 2022 to 2030, which terms may be automatically extended for up to two successive five or ten-year periods depending upon the law firm customer unless either party elects to terminate the term then-in-effect with prior notice.

Under each services agreement, we are paid a fixed fee for each residential mortgage default file the law firm sends to us for processing, with the amount of such fixed fee being based upon the type of file. We typically bill this fee upon receipt of a default case file, which consists of any mortgage default case file sent to us for processing, regardless of whether the case actually proceeds to foreclosure. If such file leads to a bankruptcy, eviction or litigation proceeding, we are entitled to an additional fixed fee in connection with handling a file for such proceedings. We also receive a fixed fee for handling files in eviction, litigation and bankruptcy matters that do not originate from mortgage foreclosure files. The Barrett Law Firm also pays us a monthly trustee foreclosure administration fee. Although the services agreements with our law firm customers contemplate the review and possible revision of the fees for the services we provide, price increases have not historically affected our mortgage default processing services revenues materially. In some cases, our services agreements adjust the fee paid to us for the files we process on an annual basis pursuant to an agreed-upon consumer price index. In other cases, our services agreements require us to agree with our law firm customer regarding the terms and amount of any fee increase.

Deferred revenue includes revenues billed for mortgage default processing services that we expect to recognize in future periods due to the extended period of time it takes to process certain files. At December 31, 2011, we had such deferred revenue on our balance sheet in the amount of $12.3 million.

Litigation Support Services. Our litigation support services segment generates revenues by providing discovery management and document review services through DiscoverReady and appellate services through Counsel Press. For the year ended December 31, 2011, our litigation support services revenues accounted for 27% of our total revenues and 37% of our Professional Services Division's revenues. DiscoverReady provides its services to major United States and global companies and their counsel and assists them in document reviews and helping them manage the discovery process. Discovery is the process by which parties use the legal system to obtain relevant information, primarily in litigation and regulatory matters. This process can be expensive and time-consuming for companies depending upon the volume of emails, electronic files and paper documents a company must review to respond to a document request. DiscoverReady also provides related technology management services. DiscoverReady bills its customers primarily based upon the number of documents reviewed and the amount of data or other information it processes in connection with those reviews. Accordingly, our discovery management and document review services revenue are largely determined by the volume of data we review, process and host. Our discovery management and document review services revenue accounted for 22% of our total revenues, 81% of our litigation support services segment revenues, and 30% of our total Professional Services Division revenues for the year ended December 31, 2011. During 2011, DiscoverReady's top customer, who is in the financial services industry, accounted for 41% of DiscoverReady's total revenues.

Counsel Press assists law firms and attorneys throughout the United States in organizing, preparing and filing appellate briefs, records and appendices, in paper and electronic formats, that comply with the applicable rules of the U.S. Supreme Court, any of the 13 federal courts of appeals and any state appellate court or appellate division. Counsel Press charges its customers primarily on a per-page basis based on the final appellate product that is filed with the court clerk. Accordingly, our appellate service revenues are largely determined by the volume of appellate cases we handle and the number of pages in the appellate cases we file. For the year ended December 31, 2011, our appellate services revenues accounted for 5% of our total revenues, 19% of our litigation support services revenues, and 7% of our total Professional Services Division revenues.

We recognize litigation support services revenues during the month in which the services are provided. In the case of Counsel Press, this is when our final . . .

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