SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
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 0-16730
MKTG SERVICES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Nevada 88-0085608
------ ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
333 Seventh Avenue, 20th Floor
New York, New York 10001
------------------ -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (917) 339-7100
--------------
Marketing Services Group, Inc.
-------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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 ___
APPLICABLE ONLY TO CORPORATE ISSUERS
State number of shares outstanding of each of the issuer's classes of common
equity as of the latest practical date:
As of May 10, 2002 there were 6,650,381 shares of the Issuer's Common Stock, par
value $.01 per share outstanding.
1
MKTG SERVICES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
FORM 10-Q REPORT
MARCH 31, 2002
PART I - FINANCIAL INFORMATION Page
----
Item 1 Interim Condensed Consolidated Financial Statements
(unaudited)
Condensed Consolidated Balance Sheets as of
March 31, 2002 and June 30, 2001 (unaudited) 3
Condensed Consolidated Statements of Operations for the
three and nine months ended March 31, 2002 and 2001
(unaudited) 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended March 31, 2002 and 2001 (unaudited) 5
Notes to Condensed Consolidated Financial Statements
(unaudited) 6-13
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-22
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 23
Item 4 Submission of Matters to a Vote of Security Holders 24
Item 6 Exhibits and Report on Form 8-K 25
(a) Exhibits
(b) Report on Form 8-K
Signatures 26
2
PART I - FINANCIAL INFORMATION
Item 1 - Interim Condensed Consolidated Financial Statements (unaudited)
MKTG SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31, 2002 June 30, 2001
-------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $6,884,586 $1,725,412
Accounts receivable, net of allowance
for doubtful accounts of $2,167,936 and $2,423,610 as of
March 31, 2002 and June 30, 2001, respectively 22,033,673 27,507,629
Net assets held for sale - 80,882,272
Restricted cash 4,945,874 -
Other current assets 1,373,073 990,741
----------- ------------
Total current assets 35,237,206 111,106,054
Intangible assets, net 16,373,782 54,362,534
Related party note receivable, net 968,470 -
Property and equipment, net 3,265,238 2,346,152
Other assets 444,396 2,574,762
----------- -------------
Total assets $56,289,092 $170,389,502
=========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowing $2,403,305 $13,021,966
Accounts payable-trade 19,205,976 27,119,339
Accrued expenses and other liabilities 3,638,041 6,074,222
Related party payable - 400,000
Net current liabilities of discontinued operations 1,853,500 2,396,171
Current portion of capital lease obligations 93,810 115,598
Current portion of long-term obligations 4,751,027 32,833,101
---------- ----------
Total current liabilities 31,945,659 81,960,397
Capital lease obligations, net of current portion 41,618 89,913
Long-term obligations, net of current portion 286,460 4,339,078
Other liabilities 207,204 1,516,976
---------- ----------
Total liabilities 32,480,941 87,906,364
---------- ----------
Convertible preferred stock - $.01 par value; 150,000 shares
authorized; 23,201 and 30,000 shares of Series E issued and
outstanding as of March 31, 2002 and June 30, 2001, respectively 10,384,064 13,424,198
Minority interest in preferred stock of discontinued subsidiary 280,946 280,946
Stockholders' equity:
Common stock - $.01 par value; 75,000,000 authorized;
6,721,030 and 5,691,250 shares issued and outstanding as of
March 31, 2002 and June 30, 2001, respectively 67,210 56,912
Additional paid-in capital 229,840,379 231,555,514
Accumulated deficit (215,370,738) (161,440,722)
Less 70,649 shares of common stock in treasury, at cost (1,393,710) (1,393,710)
------------ ------------
Total stockholders' equity 13,143,141 68,777,994
----------- ------------
Total liabilities and stockholders' equity $56,289,092 $170,389,502
=========== ============
See Notes to Condensed Consolidated Financial Statements.
3
MKTG SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2002 AND 2001
(unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
2002 2001 2002 2001
---- ---- ---- ----
Revenues $8,696,035 $31,115,347 $28,556,431 $100,884,843
---------- ----------- ----------- ------------
Operating costs and expenses:
Salaries and benefits 7,850,421 19,557,121 27,150,618 54,655,987
Direct costs 1,008,618 7,970,402 4,508,921 28,650,708
Selling, general and administrative 2,329,262 5,615,708 8,437,373 16,212,344
Depreciation and amortization 919,755 2,928,887 2,767,316 8,749,745
Goodwill impairment 35,900,000 - 35,900,000 -
Gain on sale of subsidiary (25,067) - (1,747,830) -
---------- ---------- ----------- -----------
Total operating costs and expenses 47,982,989 36,072,118 77,016,398 108,268,784
---------- ---------- ---------- -----------
Loss from operations (39,286,954) ( 4,956,771) (48,459,967) (7,383,941)
Unrealized loss on investments - (7,275,214) - (7,275,214)
Interest expense and other, net (127,440) (1,990,375) (535,015) (6,003,444)
----------- ----------- ----------- ----------
Loss from continuing operations before
provision for income taxes (39,414,394) (14,222,360) (48,994,982) (20,662,599)
Provision for income taxes (24,892) (16,648) (76,195) (82,093)
----------- ----------- ----------- -----------
Loss from continuing operations (39,439,286) (14,239,008) (49,071,177) (20,744,692)
Gain from disposal of discontinued operations - 1,251,725 - 1,251,725
----------- ----------- ----------- -----------
Loss before extraordinary item (39,439,286) (12,987,283) (49,071,177) (19,492,967)
Extraordinary item:
Loss on early extinguishments of debt - - (4,858,839) -
----------- ----------- ----------- -----------
Net loss (39,439,286) (12,987,283) (53,930,016) (19,492,967)
Gain on redemption of preferred stock
of discontinued subsidiary - - - 13,410,273
Deemed dividend - preferred redemption (2,762,634) - (2,762,634) -
---------- ---------- ---------- ----------
Net loss available to common
stockholders before cumulative
effect of change in accounting (42,201,920) (12,987,283) (56,692,650) (6,082,694)
Cumulative effect of change in accounting (Note 2) - - - (14,063,897)
------------ ------------ ------------ ------------
Net loss available to common stockholders $(42,201,920) $(12,987,283) $(56,692,650) $(20,146,591)
============= ============= ============= =============
Basic and diluted earnings (loss) per share:
Continuing operations $(6.05) $(2.66) $(8.27) $(3.97)
Discontinued operations - .23 - 2.80
Extraordinary item - - (.82) -
Deemed dividend and change in accounting (.42) - (.46) (2.69)
------ ------ ------ ------
Basic and diluted loss per share $(6.47) $(2.43) $(9.55) $(3.86)
========= ======== ======= =======
Weighted average common shares outstanding 6,522,951 5,353,935 5,936,376 5,219,262
========= ========= ========= =========
See Notes to Condensed Consolidated Financial Statements.
4
MKTG SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED MARCH 31, 2002 AND 2001
(unaudited)
2002 2001
---- ----
Operating activities:
Net loss $(53,930,016) $(19,492,967)
Gain from discontinued operations - (1,251,725)
------------ ------------
Loss from continuing operations (53,930,016) (20,744,692)
Adjustments to reconcile loss to net cash used in
operating activities:
Extraordinary item-loss on early extinguishments of debt 4,858,839 -
Gain on sale of subsidiary (1,747,830) -
Depreciation 678,339 3,097,069
Amortization 2,088,977 5,652,676
Amortization of debt issuance costs 266,900 1,666,089
Goodwill impairment 35,900,000 -
Provision for bad debts 1,006,485 919,592
Settlement of litigation - 1,072,970
Unrealized loss on investments - 7,220,500
Changes in assets and liabilities:
Accounts receivable 7,189,773 (6,921,321)
Inventory (697,908) 943,297
Other current assets (371,272) (1,129,447)
Other assets 29,019 (316,158)
Accounts payable -trade (6,939,903) 3,660,950
Accrued expenses and other liabilities (1,708,951) 2,807,849
----------- -----------
Net cash used in operating activities (13,377,548) (2,070,626)
------------ -----------
Investing activities:
Proceeds from sale of Grizzard 78,609,258 -
Purchases of property and equipment (1,868,657) (1,246,864)
Increase in restricted cash (4,945,874) -
Purchases of capitalized software - (983,497)
---------- -----------
Net cash provided by (used in) investing activities 71,794,727 (2,230,361)
---------- -----------
Financing activities:
Proceeds from exercises of stock options - 8,142
Issuance of related party note receivable (1,000,000) -
Redemption of preferred stock (5,000,000) -
Proceeds from common stock subscription, net - 1,820,000
Payment of issuance costs of common stock (44,971) -
Payment of issuance costs of preferred stock - (56,977)
Net (repayments on) proceeds from credit facilities (10,618,661) 154,786
Repayment of capital lease obligations (75,997) (308,105)
Repayment of related party note payable (250,000) (5,650,000)
Proceeds of related party note payable - 650,000
Repayments of long-term debt (35,725,705) (3,666,539)
------------ ----------
Net cash used in financing activities (52,715,334) (7,048,693)
Net cash (used in) provided by discontinued operations (542,671) 3,973,244
----------- ----------
Net increase (decrease) in cash and cash equivalents 5,159,174 (7,376,436)
Cash and cash equivalents at beginning of period 1,725,412 9,903,799
---------- ----------
Cash and cash equivalents at end of period $6,884,586 $2,527,363
========== ==========
See Notes to Condensed Consolidated Financial Statements
5
MKTG SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The accompanying Condensed Consolidated Financial Statements include the
accounts of MKTG Services, Inc. and Subsidiaries ("MKTG" or the "Company").
These condensed consolidated financial statements are unaudited and should be
read in conjunction with the Company's Form 10-K for the year ended June 30,
2001 and the historical consolidated financial statements and related notes
included therein. In the opinion of management, the accompanying unaudited
condensed consolidated financial statements include all adjustments, consisting
of only normal recurring accruals, necessary to present fairly the condensed
consolidated financial position, results of operations and cash flows of the
Company. Certain information and footnote disclosure normally included in
financial statements prepared in conformity with generally accepted accounting
principles have been condensed or omitted pursuant to the Securities and
Exchange Commission's rules and regulations. Operating results for the
nine-month period ended March 31, 2002 are not necessarily indicative of the
results that may be expected for the fiscal year ending June 30, 2002. Certain
reclassifications have been made in the fiscal 2001 financial statements to
conform to the fiscal 2002 presentation. The Company has no items of other
comprehensive income or loss in periods presented.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. The most significant estimates and assumptions made in the
preparation of the condensed consolidated financial statements relate to the
carrying amount and amortization of intangible assets, deferred tax valuation
allowance and the allowance for doubtful accounts. Actual results could differ
from those estimates.
On October 9, 2001, the Board of Directors approved a six-for-one reverse split
of the common stock. Par value of the common stock remained $.01 per share and
the number of authorized shares of common stock remained at 75,000,000. The
stock split was effective October 15, 2001. The effect of the stock split has
been reflected in the balance sheets and in all share and per share data in the
accompanying condensed consolidated financial statements and Notes to Financial
Statements. Stockholders' equity accounts have been retroactively adjusted to
reflect the reclassification of an amount equal to the par value of the decrease
in issued common shares from the common stock account to the paid in capital
account.
Effective April 1, 2002, the Company changed its legal name from Marketing
Services Group, Inc. to MKTG Services, Inc.
2. INVESTMENTS
In the prior fiscal year, the Company acquired investments in certain internet
companies. The Company has taken charges of approximately $7.3 million for
unrealized losses on Internet investments made during the three and nine months
ended March 31, 2002, based on all available information. The Company has
suspended its Internet investment strategy. There are no remaining investments
recorded on the balance sheet as of March 31, 2002.
6
3. EARNINGS PER SHARE
Stock options and warrants in the amount of 2,725,372 shares, and convertible
preferred stock in the amount of 12,430,720 shares for the three and nine months
ended March 31, 2002 were not included in the computation of diluted earnings
per share as they were antidilutive as a result of net losses during the period.
Stock options and warrants in the amount of 1,384,722 shares, contingent
warrants in the amount of 1,778,334 and convertible preferred stock in the
amount of 408,497 for the three and nine months ended March 31, 2001 were not
included in the computation of diluted earnings per share as they were
antidilutive as a result of net losses during the period.
The Company did not meet certain financial goals for the fiscal year ended June
30, 2001 as set forth in the warrant issued in connection with a 1997 sale of
Series D preferred stock. Accordingly, the warrant in the amount of 1,778,334
shares with an exercise price of $.06 per share was issued in October 2001. As a
result of the issuance of the warrant, certain antidilultive provisions of the
Company's Series E preferred stock were triggered. The conversion price of such
shares was reset to a fixed price of $2.346 based on an amount equal to the
average closing bid price of the Company's common stock for ten consecutive
trading days beginning on the first trading day of the exercise period of the
aforementioned warrant. No further adjustments will be made to the conversion
price other than for stock splits, stock dividends or other organic changes. The
preferred shareholders converted 699 and 1,799 shares of preferred stock to
352,060 and 903,866 shares of common stock for the three and nine months ended
March 31, 2002, respectively. The preferred shareholders are limited in their
conversion to 903,866 shares of common stock pursuant to the conditions of the
agreement of February 24, 2000.
On February 19, 2002, the Company entered into standstill agreements with the
Series E preferred shareholders in order for the Company to continue to discuss
with multiple parties regarding the possibility of either restructuring or
refinancing the remainder of the preferred stock. The Company is also reviewing
options, which include replacing the existing Preferred Stockholders with an
alternative strategic investor. Under the terms of the agreements, and subject
to the conditions specified therein, each preferred shareholder has agreed that
it will not acquire, hedge (short), proxy, tender, sell, transfer or take any
action with regard to its holdings during the standstill period, which extends
until July 31, 2002. If the Company does not obtain refinancing or an
alternative investor by July 31, 2002, the Company is obligated under such
agreement to seek stockholder approval based upon the 19.99% NASDAQ stock
issuance limitations and the terms of the preferred stock itself due to the
change in conversion price and increase in the number of exercisable shares. In
the event the stockholders of the Company do not approve the conversion of the
additional shares, prior to September 17, 2002, the Company may be required to
redeem the Series E preferred stock. The redemption value of preferred stock
including interest at March 31, 2002 is $34,994,960. The Company's commitments
as a result of the agreements included a partial redemption of 5,000 of the
Series E preferred shares for $5,000,000, thereby reducing the number of Series
E preferred shares to 23,201 at March 31, 2002. The value of the preferred stock
was initially recorded at a discount allocating a portion of the proceeds to a
warrant. The redemption of such preferred shares for $5,000,000, less the
$2,237,366 carrying value of the preferred shares resulted in a deemed dividend.
The deemed dividend of $2,762,634 was recorded to additional paid-in capital and
treated as a deemed dividend in the calculation of net loss attributable to
common stockholders.
During the nine months ended March 31 2001, the Company exchanged 1,970,000
shares of unregistered MKTG common stock for WiredEmpire preferred stock. The
exchange resulted in a gain of $13,410,273, which was recorded through equity
and is included in net income available to common stockholders and earning per
share - discontinued operations for the nine months ended March 31,2001.
In September 2000, the FASB Emerging Issues Task Force issued EITF 00-27
"Application of EITF 98-5 to Certain Convertible Instruments." EITF 00-27
addresses the accounting for convertible preferred stock
7
issued since May 1999 that contain nondetachable conversion options that are in
the money at the commitment date. MKTG adopted EITF 00-27 in December 2000 and
as a result has recorded a cumulative effect of a change in accounting of
$14,063,897 in the three months ended March 31, 2001 related to the March 2000
issuance of the Series E Convertible Preferred Stock. The cumulative effect was
recorded to additional paid-in capital and treated as a deemed dividend in the
calculation of net loss attributable to common stockholders.
4. DEBT
In August 2001, the Company entered into a stand-by letter of credit with a bank
in the amount of $4,945,874 to support the remaining obligations under a certain
holdback agreement with the former shareholders of Grizzard Communications
Group, Inc. ("Grizzard".) The letter of credit is collateralized by cash, which
has been classified as restricted cash in the current asset section of the
balance sheet as of March 31, 2002. The letter of credit is subject to an annual
facility fee of 1.5%. The remaining obligation is included in current portion of
long-term obligations and is payable in March 2003.
Effective March 31, 2002 and December 31, 2001, the Company amended its line of
credit agreements to adjust the calculations for certain covenants. As of March
31, 2002, the Company was in compliance with its line of credit covenants, as
amended. The Company had approximately $.7 million available on its lines of
credit as of March 31, 2002.
Effective February 1, 2002, the Company amended its line of credit agreements
with a lender to lower the minimum interest rate to 6% per annum and minimum
annual interest requirement to $150,000 in aggregate. The lines of credit have
renewable two-year terms that have been extended until April 3, 2005. All other
terms and conditions of the line of credit agreements remain unchanged.
5. REVENUE RECOGNITION
Pursuant to the Securities and Exchange Commission's Staff Accounting Bulletin
(SAB) No. 101, "Revenue Recognition in Financial Statements," ("SAB 101") the
Company has reviewed its accounting policies for the recognition of revenue. SAB
101 was required to be implemented in fourth quarter 2001. SAB 101 provides
guidance on applying generally accepted accounting principles to revenue
recognition in financial statements. The Company's policies for revenue
recognition are consistent with the views expressed within SAB 101. The adoption
of SAB 101, did not have a material effect on the Company's consolidated
financial position, cash flows, or results of operations. Although net income
was not materially affected, the adoption did have an impact on the amount of
revenue recorded as the revenue associated with the Company's list sales and
services product line are now required to be shown net of certain costs. The
Company believes this presentation is consistent with the guidance in Emerging
Issues Task Force ("EITF") 99-19, "Reporting Revenue Gross as a Principal Versus
Net as an Agent." All prior periods presented have been restated.
6. SALE OF GRIZZARD
On June 13, 2001, the board of directors and management of the Company approved
a formal plan to sell Grizzard. On July 18, 2001, the Company entered into a
definitive agreement to sell Grizzard. On July 31, 2001, the Company completed
its sale of all the outstanding capital stock of its Grizzard subsidiary to
Omnicom Group, Inc. The purchase price of the transaction was $89.8 million
payable in cash, net of a working capital adjustment. As a result of the sale
agreement, the Company fully paid the term loan of $35.5 million and $12.0
million line of credit. The Company recorded an extraordinary loss of
approximately $4.9 million in the September 2001 quarter as a result of the
early extinguishment of debt. In the December 31, 2001 quarter, the estimated
working capital adjustment of $1.5 million and other liabilities of $1.6 million
representing the settlement of Grizzard intercompany debt were substantially
paid.
8
At June 30, 2001, the assets and liabilities of Grizzard were classified as net
assets held for sale in the amount of $80.9 million. In the quarter ended
September 30, 2001, the Company recognized a gain on sale of Grizzard in the
amount of $1.7 million. Grizzard's revenue included in the Company's statement
of operations for the three-months ended March 31, 2001 was $8.8 million and for
the nine months ended March 31, 2002 and 2001 was $2.8 million and $67.0
million, respectively. The Company's statement of operations for the three
months ended March 31, 2001 includes Grizzard's net loss of $1.1 million and for
the nine months ended March 31, 2002 and 2001 includes Grizzard's net losses of
$8.5 million and $.1 million, respectively.
Grizzard's net cash provided by operating activities was $1.9 million for the
nine months ended March 31, 2002 consisting of $1.9 million reduction in
accounts receivable and inventory, $3.2 million increase in accounts payable and
accrued expenses, offset by the net loss of Grizzard, excluding non-cash items.
The pro forma information is provided for informational purposes only and
assumes that Grizzard was sold as of the beginning of fiscal year 2001. It is
based on historical information and is not necessarily indicative of future
results of operations of the consolidated entities.
Supplemental
Pro forma information
For the three and nine months ended March 31,
(Unaudited)
(In $000's)
Three Months Ended Nine Months Ended
March 31, March 31,
--------- ---------
2002 2001 2002 2001
---- ---- ---- ----
Revenues $8,696 $11,728 $25,725 $33,886
------ ------- ------- -------
Operating costs and expenses:
Salaries and benefits 7,850 10,520 23,769 28,162
Direct costs 1,009 1,380 3,210 3,560
Selling, general and administrative 2,329 4,239 7,253 11,716
Goodwill impairment 35,900 - 35,900 -
Depreciation and amortization 920 906 2,767 2,746
------ ------ ------ -------
Total operating costs and expenses 48,008 17,045 72,899 46,184
------ ------ ------ -------
Loss from operations (39,312) (5,317) (47,174) (12,298)
Unrealized loss on investments - (7,275) - (7,275)
Interest expense and other, net (127) (273) (20) (432)
------- ------ ------ -------
Loss before provision for income taxes (39,439) (12,865) (47,194) (20,005)
Provision for income taxes (25) (17) (76) (83)
--------- --------- --------- ---------
Loss from continuing operations
before extraordinary item $(39,464) $(12,882) $(47,270) $(20,088)
========= ========= ========= =========
Net loss per common share
from continuing operations,
basic and diluted $(6.05) $(2.41) $(7.96) $(3.85)
======= ======= ======= =======
9
7. LIQUIDITY AND OTHER UNCERTAINTIES
The Company has limited capital resources and has incurred significant recurring
losses and negative cash flows from operations. The Company does not believe its
cash on hand along with existing sources of cash are sufficient to fund its cash
needs over the next twelve months under the current capital structure. In order
to address this situation, the Company has had and continues to have discussions
with multiple parties regarding the possibility of either restructuring or
refinancing the remainder of the Series E preferred stock. The Company is also
reviewing options, which include replacing the existing Preferred Stockholders
with an alternative strategic investor. The Company will also need to raise
additional equity financing or obtain other sources of liquidity (including debt
or other resources). In addition, the Company is reviewing it's present
operations with the view towards reducing it's cost structure and workforce and
to find alternative means of increasing revenue. There can be no assurance that
the Company will be successful in restructuring its preferred stock or obtaining
additional financing. Additionally, there can be no assurances that the
Company's cost reduction efforts will be successful or that the Company will
achieve a level of revenue that will allow it to return to profitability. In the
event the Company is unable to raise needed financing and achieve profitability,
operations will need to be scaled back or discontinued. The accompanying
financial statements do not include any adjustments relating to the
recoverability of the carrying amount of recorded assets or the amount of
liabilities that might result should the Company be unable to continue as a
going concern.
At each balance sheet date, the Company reviews the recoverability of goodwill,
not identified with long-lived assets, based on estimated undiscounted future
cash flows from operating activities compared with the carrying value of
goodwill, and recognizes any impairment on the basis of discounted cash flows.
Due to the weakened economy and lower than expected results based on current
information, the Company has determined that there will not be sufficient cash
flows to recover the remaining book value of goodwill. As a result, the Company
has recognized an impairment charge of approximately $35.9 million, which is
included in the loss from operations for the three and nine months ended March
31, 2002.
8. CONTINGENCIES AND LITIGATION
In October 2000, an action was filed by Red Mountain, LLP in the United States
Court for the Northern District of Alabama, Southern Division against J. Jeremy
Barbera, Chairman of the Board and Chief Executive Officer of MKTG, MKTG and
WiredEmpire, Inc. Red Mountains' complaint alleges, among other things,
violations of Section 12(2) of the Securities Act of 1933, Section 10(b) of the
Securities Act of 1934 and Rule 10(b)(5) promulgated there under, and various
provisions of Alabama state law and common law, arising from Red Mountain's
acquisition of WiredEmpire Preferred Series A stock in a private placement.
WiredEmpire is a discontinued majority-owned subsidiary of the Company. Red
Mountain invested $225,000 in WiredEmpire's preferred stock and it seeks that
amount, attorney's fees and punitive damages. The Company believes that the
allegations in the complaint are without merit. The Company intends to
vigorously defend against the lawsuit.
In December 2001, an action was filed by a number of purchasers of preferred
stock of WiredEmpire, Inc., a discontinued subsidiary, in the Alabama State
Court (Circuit Court of Jefferson County, Alabama, 10 Judicial Circuit of
Alabama, Birmingham Division), against J. Jeremy Barbera, Chairman of the Board
and Chief Executive Officer of MKTG, MKTG and WiredEmpire, Inc. The plaintiffs
complaint alleges, among other things, violation of sections 8-6-19(a)(2) and
8-6-19(c) of the Alabama Securities Act and various other provisions of Alabama
state law and common law, arising for the plaintiffs' acquisition of WiredEmpire
Preferred Series A stock in a private placement. The plaintiffs invested
approximately $1,650,000 in WiredEmpire's preferred stock and it seeks that
amount, attorney's fees and punitive damages. On February 8, 2002, the
defendants filed a petition to remove the action to federal court on the grounds
of diversity of citizenship. The Company believes that the allegations in the
complaint are without merit. The Company intends to vigorously defend against
the lawsuit.
10
In 1999, a lawsuit under Section 16(b) of the Securities Exchange Act of 1934
was commenced against General Electric Capital Corporation ("GECC") by Mark
Levy, derivatively on behalf of the Company, to recover short swing profits
allegedly obtained by GECC in connection with the purchase and sale of MKTG
securities. The case is pending in the name of Mark Levy v. General Electric
Capital Corporation, in the United States District Court for the Southern
District of New York, Civil Action Number 99 Civ. 10560(AKH). While the Levy
case was pending, the Company and GECC engaged in negotiations pertaining to the
warrant, dated December 24, 1997, in favor of GECC to purchase, at consideration
of $0.01 per share, up to 1,778,334 shares of MKTG common stock subject to
certain adjustments. Extensive negotiations among counsel for the plaintiff,
counsel for the Company, and counsel for GECC, as well as direct negotiations
between the Company and GECC, resulted in a preliminary settlement of the court
action against GECC for alleged short swing profits and all other issues under
the warrant. The parties entered into a stipulation of settlement, subject to
court approval. In August 2001, the court declined to approve the stipulation of
settlement. In February 2002, a new settlement was reached among the parties.
The settlement provides for a $1,250,000 payment to be made to MKTG by GECC and
for GECC to reimburse MKTG for the reasonable cost of mailing a notice to
stockholders up to $30,000. Counsel for the plaintiff intend to request the
Court to award $375,000 for attorney fees, plus disbursements, to be deducted
from the settlement payment to MKTG. On April 29, 2002, the court approved the
settlement for $1,250,000 and reimbursement of mailing costs; however, the award
for attorney fees is pending court approval.
In addition to the above, certain other legal actions in the normal course of
business are pending to which the Company is a party. The Company does not
expect that the ultimate resolution of the above matters and other pending legal
matters in future periods will have a material effect on the financial
condition, results of operations or cash flows of the Company.
9. RELATED PARTY TRANSACTIONS
During the quarter ending December 31, 2001, the Company advanced $1,000,000
pursuant to a promissory note receivable agreement with an officer due and
payable to the Company at maturity, October 15, 2006. The Company recorded the
note receivable at a discount of approximately $57,955 to reflect the
incremental borrowing rate of the officer and is being amortized as interest
income over the term of the note using the straight-line method. The note
receivable is collateralized by current and future holdings of MKTG common stock
owned by the officer and bears interest at prime. Interest is due and payable
yearly on October 15th. The Company recognized interest income of $15,000 and
$22,500 for the three and nine months ended March 31, 2002, respectively. The
note will be forgiven in the event of a change in control.
During the quarter ending December 31, 2000, the Company entered into a
promissory note agreement with an officer for up to $1,000,000, due and payable
at maturity, January 1, 2002. As December 31, 2000, the Company received
$650,000 in proceeds. The promissory note bore interest at 15% per annum and
included certain prepayment penalties. In March 2001, the principal amount owned
was paid in full. As of March 31, 2001, there was approximately $150,000 of
accrued interest and penalties, which is included in accrued expenses and other
liabilities.
10. SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the nine months ended March 31, 2001, the Company received $860,762 of
uncollaterialized financing to acquire additional capitalized software. The
notes bear interest at 9.5% per annum and are payable in monthly installments
over 36 months with maturity dates ranging from September 30, 2003 to December
31, 2003. These uncollateralized notes were sold in the July 2001 sale of
Grizzard.
11
11. GAIN ON REDEMPTION OF PREFERRED STOCK OF DISCONTINUED SUBSIDIARY
In the nine months ended March 31, 2001, the Company exchanged 1,970,000 shares
of unregistered MKTG common stock for WiredEmpire preferred stock. The exchange
resulted in a gain of $13,410,273 for the nine months ended March 31, 2001,
which was recorded through equity and is included in net income available to
common stockholders and included in the computation of earnings per
share-discontinued operations. As of March 31, 2002, 48,000 shares of
WiredEmpire preferred have not been exchanged.
12. SEGMENT INFORMATION
In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information" segment information is being reported consistent with
the Company's method of internal reporting. In accordance with SFAS No. 131,
operating segments are defined as components of an enterprise for which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. MKTG is organized primarily on the basis of products broken down
into separate subsidiaries. Based on the nature of the services provided and
class of customers, as well as the similar economic characteristics, MKTG's
subsidiaries have been aggregated. No single customer accounted for 10% or more
of total revenues. MKTG earns 100% of its revenue in the United States.
Supplemental disclosure of revenue by product:
Three Months Ended Nine Months Ended
March 31, March 31,
-----------------------------------------------------------
2002 2001 2002 2001
---- ---- ---- ----
List sales and services $2,224,383 $3,553,446 $6,222,559 11,510,499
Marketing communication services - 18,893,634 2,831,004 65,046,743
Database marketing 2,801,518 4,088,101 8,504,652 10,844,847
Telemarketing 3,380,648 3,622,192 10,099,724 11,436,789
Other 289,486 957,974 898,492 2,045,965
---------- ----------- ----------- ------------
$8,696,035 $31,115,347 $28,556,431 $100,884,843
========== =========== =========== ============
13. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB approved two new
pronouncements: SFAS No. 141, "Business Combinations," and SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 141 applies to all business
combinations with a closing date after June 30, 2001. This Statement eliminates
the pooling-of-interests method of accounting and further clarifies the criteria
for recognition of intangible assets separately from goodwill. SFAS No. 142
eliminates the amortization of goodwill and indefinite-lived intangible assets
and initiates an annual review for impairment. Identifiable intangible assets
with a determinable useful life will continue to be amortized. The amortization
provisions apply to goodwill and other intangible assets acquired after June 30,
2001. Goodwill and other intangible assets acquired prior to June 30, 2001 will
be affected upon adoption. The adoption will require the Company to cease
amortization of its remaining net goodwill balance and to perform an impairment
test of its existing goodwill based on a fair value concept. The Company is
still reviewing the provisions of SFAS No. 142, which must be adopted by the
Company on July 1, 2002. As of March 31, 2002, the Company has net unamortized
intangibles of $16,373,782, after the goodwill impairment recorded under SFAS
No. 121 of $35,900,000 and amortization expense of $2,088,977 and $5,652,676 for
the nine months ended March 31, 2002 and 2001, respectively.
12
In October 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and
reporting for the disposal of long-lived assets. SFAS No. 144 becomes effective
for financial statements issued for fiscal years beginning after December 15,
2001 and interim periods within those fiscal years. The Company does not expect
the adoption of this statement to have a material impact on the Company's
results of operations or financial position.
In April 2002, the FASB issued SFAS No. 145 "Rescission of SFAS Nos. 4, 44, and
64, Amendment of FAS 13, and Technical Corrections as of April 2002". SFAS No.
145 becomes effective for financial statements issued for fiscal years beginning
after May 15, 2002. The adoption will not have a material impact on the
Company's financial position and results of operations. However, the loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods will be reclassified to operating expense for fiscal year 2003 as the
loss does not meet the criteria in APB Opinion No. 30 "Reporting the Results of
Operations Reporting the Effects of Disposal of a Segment of a Business", for
classification as an extraordinary item.
13
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------
Special Note Regarding Forward-Looking Statements
-------------------------------------------------
Some of the statements contained in this Report on Form 10-Q discuss our plans
and strategies for our business or state other forward-looking statements, as
this term is defined in the Private Securities Litigation Reform Act of 1995.
Such forward-looking statements involve known and unknown risks, uncertainties
and other factors which may cause the actual results, performance or
achievements of MKTG Services, Inc. ("MKTG" or the "Company"), or industry
results to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the following: general economic and business
conditions; industry capacity; direct marketing and other industry trends;
demographic changes; competition; the loss of any significant customers; changes
in business strategy or development plans; availability and successful
integration of acquisition candidates; availability, terms and deployment of
capital; advances in technology; retention of clients not under long-term
contract; quality of management; business abilities and judgment of personnel;
availability of qualified personnel; changes in, or the failure to comply with,
government regulations; and technology, telecommunication and postal costs.
Introduction
------------
This discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity/cash flows of the Company
for the three and nine-month periods ended March 31, 2002 and 2001. This should
be read in conjunction with the financial statements, and notes thereto,
included in this Report on Form 10-Q and the Company's financial statements and
notes thereto, included in the Company's Annual Report on Form 10-K for the year
ended June 30, 2001.
Financial Reporting Release No. 60, which was recently released by the SEC,
requires all companies to include a discussion of critical accounting policies
or methods used in the preparation of financial statements. The following is a
brief discussion of the more significant accounting policies and methods used by
the Company.
Revenue Recognition:
Pursuant to the Securities and Exchange Commission's Staff Accounting Bulletin
(SAB) No. 101, "Revenue Recognition in Financial Statements," ("SAB 101") the
Company has reviewed its accounting policies for the recognition of revenue. SAB
101 was required to be implemented in fourth quarter 2001. SAB 101 provides
guidance on applying generally accepted accounting principles to revenue
recognition in financial statements. The Company's policies for revenue
recognition are consistent with the views expressed within SAB 101. The adoption
of SAB 101, did not have a material effect on the Company's consolidated
financial position, cash flows, or results of operations. Although net income
was not materially affected, the adoption did have an impact on the amount of
revenue recorded as the revenue associated with the Company's list sales and
services product line are now required to be shown net of certain costs. The
Company believes this presentation is consistent with the guidance in Emerging
Issues Task Force ("EITF") 99-19, "Reporting Revenue Gross as a Principal Versus
Net as an Agent." All prior periods presented have been restated.
Revenues derived from list sales and services and database marketing are
recognized when the lists are shipped or the services have been performed and
completed. For all list sales and services, the Company serves as broker between
unrelated parties who wish to purchase a certain list and unrelated parties who
have the desired list for sale. Accordingly, the Company recognizes trade
accounts receivable and trade accounts payable, reflecting a "gross-up" of the
two concurrent transactions. The transactions are not structured providing for
the right of offset. List sales and services are reflected net of costs on the
accompanying statement of operations.
14
Revenues derived from on-site telemarketing and telefundraising are generally
based on hourly billing rates and a mutually agreed percentage of amounts
received by the Company's client from a campaign. These services are performed
on-site at the clients' location. These revenues are earned and recognized when
the cash is received by the respective client. Revenues derived from off-site
telemarketing and telefundraising are generally based on a mutually agreed
amount per telephone contact with a potential donor without regard to amounts
raised for the client. These services are performed at the Company's calling
center. These revenues are earned and recognized when the services are
performed.
Revenues derived from marketing communications are recognized when the campaign
is mailed provided that the Company has no remaining performance commitments
under marketing communications arrangements. The Company's revenue is not
dependent on the number of respondents to the direct mailing.
Prior to January 2001, revenues and costs derived from Website development were
deferred until services were completed and recognized using a straight-line
method over the remaining life of the contract. In January 2001, due to the
installation of a time management system, which allows for the gathering of
hours by project, all new contracts utilize the percentage of completion method
preferred by Statement of Position 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts". The contract lives are
generally three months to one year. The impact of changing revenue recognition
methods did not have a material impact on the Company's financial results.
Intangible Assets:
At each balance sheet date, the Company reviews the recoverability of goodwill,
not identified with long-lived assets, based on estimated undiscounted future
cash flows from operating activities compared with the carrying value of
goodwill, and recognizes any impairment on the basis of such comparison.
Long-Lived Assets:
In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of", the Company reviews for
impairment of long-lived assets and certain identifiable intangibles whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. In general, the Company will recognize an impairment
when the sum of undiscounted future cash flows (without interest charges) is
less than the carrying amount of such assets. The measurement for such
impairment loss is based on the fair value of the asset (see note 7).
Use of Estimates:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. The most significant estimates and assumptions made in the
preparation of the consolidated financial statements relate to the carrying
amount and amortization of intangible assets, deferred tax valuation allowance
and the allowance for doubtful accounts. Actual results could differ from those
estimates.
To facilitate an analysis of MKTG operating results, certain significant events
should be considered.
In September 2000, in connection with the discontinued operations of
WiredEmpire, the Company offered to exchange preferred shares of WiredEmpire for
MKTG common shares. In the nine months ended March 31, 2001, the Company
exchanged 1,970,000 shares of unregistered MKTG common stock for WiredEmpire
preferred stock. The exchange resulted in a gain of $13,410,273 for the nine
months ended March 31, 2001, which was recorded through equity and is included
in net income available to common stockholders and included in the computation
of earnings per share-discontinued operations. As of March 31, 2002, 48,000
shares of WiredEmpire preferred have not been exchanged.
15
On July 18, 2001, the Company entered into a definitive agreement to sell
Grizzard. On July 31, 2001, the Company completed its sale of all the
outstanding capital stock of its Grizzard subsidiary to Omnicom Group, Inc. The
purchase price of the transaction was $89.8 million, net of a working capital
adjustment, payable in cash. As a result of the sale agreement, the Company
fully paid the term loan of $35.5 million and $12.0 million line of credit. The
Company recorded an extraordinary loss of approximately $4.9 million in the
September 2001 quarter as a result of the early extinguishment of debt. The
Company retained $43.8 million in cash proceeds from the sale before closing
fees and other costs of approximately $8.0 million.
At June 30, 2001, the assets and liabilities of Grizzard were classified as net
assets held for sale in the amount of $80.9 million. In the quarter ended
September 30, 2001, the Company recognized a gain on sale of Grizzard in the
amount of $1.7 million. Grizzard's revenue included in the Company's statement
of operations for the three-months ended March 31, 2001 was $8.8 million and for
the nine months ended March 31, 2002 and 2001 was $2.8 million and $67.0
million, respectively. The Company's statement of operations for the three
months ended March 31, 2001 includes Grizzard's net loss of $1.1 million and for
the nine months ended March 31, 2002 and 2001 includes Grizzard's net losses of
$8.5 million and $.1 million, respectively.
On October 9, 2001, the Board of Directors approved a six-for-one reverse split
of the common stock. Par value of the common stock remained $.01 per share and
the number of authorized shares of common stock remained at 75,000,000. The
stock split was effective October 15, 2001. The effect of the stock split has
been reflected in the balance sheets and in all share and per share data in the
accompanying condensed consolidated financial statements and Notes to Financial
Statements. Stockholders' equity accounts have been restated to reflect the
reclassification of an amount equal to the par value of the decrease in issued
common shares from the common stock account to the paid in capital account.
The Company did not meet certain financial goals for the fiscal year ended June
30, 2001 as set forth in the warrant issued in connection with a 1997 sale of
Series D preferred stock. Accordingly, the warrant in the amount of 1,778,334
shares with an exercise price of $.06 per share was issued in October 2001. As a
result of the issuance of the warrant, certain antidilultive provisions of the
Company's Series E preferred stock were triggered. The conversion price of such
shares was reset to a fixed price of $2.346 based on an amount equal to the
average closing bid price of the Company's common stock for ten consecutive
trading days beginning on the first trading day of the exercise period of the
aforementioned warrant. No further adjustments will be made to the conversion
price other than for stock splits, stock dividends or other organic changes. The
preferred shareholders converted 699 and 1,799 shares of preferred stock to
352,060 and 903,866 shares of common stock for the three and nine months ended
March 31, 2002, respectively. The preferred shareholders are limited in their
conversion to 903,866 shares of common stock pursuant to the conditions of the
agreement of February 24, 2000.
On February 19, 2002, the Company entered into standstill agreements with the
Series E preferred shareholders in order for the Company to continue to discuss
with multiple parties regarding the possibility of either restructuring or
refinancing the remainder of the preferred stock. The Company is also reviewing
options, which include replacing the existing Preferred Stockholders with an
alternative strategic investor. Under the terms of the agreements, and subject
to the conditions specified therein, each preferred shareholder has agreed that
it will not acquire, hedge (short), proxy, tender, sell, transfer or take any
action with regard to its holdings during the standstill period, which extends
until July 31, 2002. If the Company does not obtain refinancing or an
alternative investor by July 31, 2002, the Company is obligated under such
agreement to seek stockholder approval based upon the 19.99% NASDAQ stock
issuance limitations and the terms of the preferred stock itself due to the
change in conversion price and increase in the number of exercisable shares. In
the event the stockholders of the Company do not approve the conversion of the
additional shares, prior to September 17, 2002, the Company may be required to
redeem the Series E preferred stock. The redemption value of preferred stock
including interest at March 31, 2002
16
is $34,994,960. The Company's commitments as a result of the agreements included
a partial redemption of 5,000 of the Series E preferred shares for $5,000,000,
thereby reducing the number of Series E preferred shares to 23,201 at March 31,
2002. The value of the preferred stock was initially recorded at a discount
allocating a portion of the proceeds to a warrant. The redemption of such
preferred shares for $5,000,000, less the $2,237,366 carrying value of the
preferred shares resulted in a deemed dividend. The deemed dividend of
$2,762,634 was recorded to additional paid-in capital and treated as a deemed
dividend in the calculation of net loss attributable to common stockholders.
The Company's business tends to be seasonal. Certain marketing services have
higher revenues and profits occurring in the second fiscal quarter, followed by
the first fiscal quarter based on the seasonality of its clients' mail dates to
coordinate with the Thanksgiving and Holiday season. Telemarketing services have
higher revenues and profits occurring in the fourth fiscal quarter, followed by
the first fiscal quarter. This is due to subscription renewal campaigns for its
performing arts clients, which generally begin in the springtime and continue
during the summer months.
Results of Operations for the Three Months Ended March 31, 2002, Compared to the
--------------------------------------------------------------------------------
Three Months Ended March 31, 2001
---------------------------------
Revenues of approximately $8.7 million for the three months ended March 31, 2002
(the "Current Period") decreased by $22.4 million or 72% over revenues of $31.1
million during the three months ended March 31, 2001 (the "Prior Period"). Of
the decrease, approximately $19.4 million is attributable to the sale of
Grizzard in July 2001. Revenue excluding the effects of the disposition of
Grizzard decreased by $3.0 million or 10% primarily due to decreased list
services and database marketing billing and the move of the telemarketing call
center. The decrease in such billing is a direct result of the impact of a
weaker economy resulting in a reduction of our clients' marketing campaigns.
Unexpected client cancellations, postponed fundraising campaigns and lost
clients contributed to the decrease. The Company expects the decline in revenue
from the prior year results to occur through next fiscal quarter due to the
weakened economy.
Salaries and benefits of approximately $7.9 million in the Current Period
decreased by approximately $11.7 million or 6% over salaries and benefits of
approximately $19.6 million in the Prior Period. Of the decrease, approximately
$8.8 million is attributable to the sale of Grizzard in July 2001. Salaries and
benefits, excluding the effects of the disposition of Grizzard, decreased by
approximately $2.9 million or 15% due to a one time charge of severance to an
officer of $2.0 million in the prior period and $.9 million decreased headcount
in several areas of the Company in the current period. The Company has been
actively consolidating its offices and infrastructure.
Direct costs of approximately $1.0 million in the Current Period decreased by
$7.0 million or 87% over direct costs of $8.0 million in the Prior Period. Of
the decrease, approximately $6.6 million is attributable to direct costs
associated with sale of Grizzard in July 2001. Direct costs, excluding the
effects of the Grizzard disposition, decreased by $.4 million or 5% resulting
from lower costs associated with the Database marketing business. The decrease
in these costs results from the decreased sales volume and cost savings programs
put in place this fiscal year.
Selling, general and administrative expenses of approximately $2.3 million in
the Current Period decreased by approximately $3.3 million or 58% over
comparable expenses of $5.6 million in the Prior Period. Of the decrease,
approximately $1.4 million is attributable to the sale of Grizzard in July 2001.
Selling, general and administrative expenses, excluding the effects of the
disposition of Grizzard, decreased by $1.9 million or 34%, principally due to
$1.3 million for a legal settlement in the prior period and $.6 million decrease
in professional fees, rent, travel and other expenses due to the consolidation
of certain office spaces and the reduction of head count in the current period.
Depreciation and amortization expense of approximately $.9 million in the
Current Period decreased by
17
approximately $2.0 million over expense of $2.9 million in the Prior Period.
This is primarily attributable to a decrease in depreciation and amortization
expense resulting from the sale of Grizzard in July 2001.
Due to the weakened economy and lower than expected results, the Company has
determined that there may not be sufficient cash flows to recover the remaining
book value of goodwill. As a result, the Company has recognized an impairment
charge of approximately $35.9 million, which is included in the loss from
operations for the current period.
Net interest expense of approximately $.1 million in the Current Period
decreased by approximately $1.9 million over net interest expense of
approximately $2.0 million in the Prior Period. The decrease is principally due
to the reduced interest expense due to the repayment of certain long-term debt
in connection with the sale of Grizzard, partially offset by interest income
earned on the net proceeds from the sale.
Unrealized loss of investments of approximately $7.3 million in the prior period
was attributable to the write-off of internet investments whose decline in value
was deemed to be other than temporary.
As a result of the above, net loss of $39.4 million in the Current Period
increased by $26.4 million over comparable net loss of $13.0 million in the
Prior Period. Grizzard's net loss included in the quarter ended March 31, 2001
was $1.1 million.
In the current period the redemption of the 5,000 preferred shares for $5.0
million, less the $2.2 million carrying value of the preferred shares resulted
in a deemed dividend. The deemed dividend of $2.8 million is included in the
calculation of net loss attributable to common stockholders.
Results of Operations for the Nine Months Ended March 31, 2002, Compared to the
-------------------------------------------------------------------------------
Nine Months Ended March 31, 2001
--------------------------------
Revenues of approximately $28.6 million for the nine months ended March 31, 2002
(the "Current Period") decreased by $72.3 million or 72% over revenues of $100.9
million during the nine months ended March 31, 2001 (the "Prior Period"). Of the
decrease, approximately $64.2 million is attributable to the sale of Grizzard in
July 2001. Revenue excluding the effects of the disposition of Grizzard
decreased by $8.1 million or 8% primarily due to the decreased list services and
database marketing billing and the move of the telemarketing call center. The
decrease in such billing is a direct result of the impact of a weaker economy
resulting in a reduction of our clients' marketing campaigns. In addition, since
September 11 unexpected client cancellations, postponed fundraising campaigns
and lost clients contributed to the decrease. Furthermore, for a period of time
following September 11 our telemarketing calling center was closed and all
calling campaigns for such a period were cancelled. The Company expected the
decline in revenue from the prior year results to occur through the next fiscal
quarter due to the weakened economy.
Salaries and benefits of approximately $27.2 million in the Current Period
decreased by approximately $27.5 million or 50% over salaries and benefits of
approximately $54.7 million in the Prior Period. Of the decrease, approximately
$22.6 million is attributable to the sale of Grizzard in July 2001. Salaries and
benefits, excluding the effects of the disposition of Grizzard, decreased by
approximately $4.9 million or 9% due to a one time charge of severance to an
officer of $2.0 million in the prior period and $2.9 million due to decreased
headcount in several areas of the Company in the current period. The Company has
been actively consolidating its offices and infrastructure.
Direct costs of approximately $4.5 million in the Current Period decreased by
$24.1 million or 84% over direct costs of $28.6 million in the Prior Period. Of
the decrease, approximately $23.8 million is attributable to the sale of
Grizzard in July 2001. Direct costs, excluding the effects of the disposition of
18
Grizzard, decreased $.3 million or 1% due to the lower costs associated with the
Database marketing business. The decrease in these costs results from the
decreased sales volume and cost savings programs put in place this fiscal year.
Selling, general and administrative expenses of approximately $8.4 million in
the Current Period decreased by approximately $7.8 million or 48% over
comparable expenses of $16.2 million in the Prior Period. Of the decrease,
approximately $3.2 million is attributable to the sale of Grizzard in July 2001.
Selling, general and administrative expenses, excluding the effects of the
disposition of Grizzard, decreased by $4.6 million or 28%, principally due to
$1.3 million for a legal settlement in the prior period and $2.0 million
decrease in professional fees, rent, travel and other expenses due to the
consolidation of certain office spaces and the reduction of head count in the
current period.
Depreciation and amortization expense of approximately $2.8 million in the
Current Period decreased by approximately $5.9 million over expense of $8.7
million in the Prior Period. This is primarily attributable to a decrease in
depreciation and amortization expense resulting from the sale of Grizzard in
July 2001.
Due to the weakened economy and lower than expected results, the Company has
determined that there may not be sufficient cash flows to recover the remaining
book value of goodwill. As a result, the Company has recognized an impairment
charge of approximately $35.9 million, which is included in the loss from
operations for the current period.
On July 31, 2001, the Company completed its sale of all the outstanding capital
stock of its Grizzard subsidiary to Omnicom Group, Inc. In the current period,
the Company recognized a gain on sale of Grizzard in the amount of $1.7 million.
Net interest expense of approximately $.5 million in the Current Period
decreased by approximately $5.5 million over net interest expense of
approximately $6.0 million in the Prior Period. The decrease is principally due
to the reduced interest expense due to the repayment of certain long-term debt
in connection with the sale of Grizzard in addition to the interest income
earned on the net proceeds from the sale.
Unrealized loss of investments of approximately $7.3 million in the prior period
was attributable to the write-off of internet investments whose decline in value
was deemed to be other than temporary.
As a result of the above, loss before extraordinary item of $49.1 million in the
Current Period increased by $29.6 million over comparable net loss of $19.5
million in the Prior Period. The Company's results for the nine months ended
March 31, 2002 and 2001 includes Grizzard's net losses of $8.5 million and $.1
million, respectively.
The Company records provisions for state and local taxes incurred on taxable
income or equity at the operating subsidiary level, which cannot be offset by
losses incurred at the parent company level or other operating subsidiaries. The
Company has recognized a full valuation allowance against the deferred tax
assets because it is not certain sufficient taxable income will be generated
during the carry forward period to utilize the deferred tax assets.
In connection with the sale of Grizzard, the Company fully paid the term loan of
$35.5 million and $12.0 million line of credit. As a result, the Company
recorded an extraordinary loss of approximately $4.9 million in the nine months
ended March 31, 2002 as a result of the early extinguishment of debt.
In the prior period, the Company exchanged 1,970,000 shares of unregistered MKTG
common stock for WiredEmpire preferred stock. The exchange resulted in a gain of
$13.4 million for the nine months ended March 31, 2001, which was recorded
through equity and is included in net income available to common stockholders
and earnings per share - discontinued operations.
19
In the current period the redemption of the 5,000 preferred shares for $5.0
million, less the $2.2 million carrying value of the preferred shares resulted
in a deemed dividend. The deemed dividend of $2.8 million is included in the
calculation of net loss attributable to common stockholders.
In September 2000, the FASB Emerging Issues Task Force issued EITF 00-27
"Application of EITF 98-5 to Certain Convertible Instruments." EITF 00-27
addresses the accounting for convertible preferred stock issued since May 1999
that contain nondetachable conversion options that are in the money at the
commitment date. MKTG adopted EITF 00-27 in December 2000 and as a result has
recorded a cumulative effect of a change in accounting of $14.1 million in the
prior period related to the March 2000 issuance of the Series E Convertible
Preferred Stock. The cumulative effect was recorded to additional paid-in
capital and treated as a deemed dividend in the calculation of net loss
attributable to common stockholders.
Capital Resources and Liquidity
-------------------------------
Financial Reporting Release No. 61, which was recently released by the SEC,
requires all companies to include a discussion to address, among other things,
liquidity, off-balance sheet arrangements, contractual obligations and
commercial commitments. The Company currently does not maintain any off-balance
sheet arrangements.
Leases: The Company leases various office space and equipment under
non-cancelable long-term leases. The Company incurs all costs of insurance,
maintenance and utilities.
Future minimum rental commitments under all non-cancelable leases, as of March
31,2002 are as follows:
Operating Leases Capital Leases
2002 $946,676 $ 30,673
2003 2,828,422 79,665
2004 2,721,065 30,811
2005 2,386,229 -
2006 1,774,390 -
Thereafter 6,633,772 -
---------- ---------
17,290,554 141,149
Less interest (5,721)
-------
Present value of
capital lease obligations $135,428
========
Debt: In August 2001, the Company entered into a stand-by letter of credit with
a bank in the amount of $4,945,874 to support the remaining obligations under a
certain holdback agreement with the former shareholders of Grizzard
Communications Group, Inc. ("Grizzard".) The letter of credit is collateralized
by cash, which has been classified as restricted cash in the current asset
section of the balance sheet as of March 31, 2002. The Company has a remaining
obligation of $4,502,064 under the holdback agreement. The remaining obligation
is included in current portion of long-term obligations and is payable in March
2003. In connection with an acquisition, the Company incurred promissory notes
payable to former shareholders, payable monthly at 5.59% interest through
January 2004. The remaining obligation is $535,423 in aggregate with $286,460
included in long-term obligations, net of current portion.
Preferred Stock: In the event the stockholders of the Company do not approve the
conversion of
20
the Series E Preferred Stock, the Company would be required to redeem the Series
E preferred stock. The redemption value of preferred stock including interest at
March 31, 2002 is $34,994,954 The redemption may occur after July 31, 2002.
Historically, the Company has funded its operations, capital expenditures and
acquisitions primarily through cash flows from operations, private placements of
common and preferred stock, and its credit facilities. At March 31, 2002, the
Company had cash and cash equivalents of $6.9 million and accounts receivable
net of allowances of $22.0 million, offset by accounts payable of $19.2 million.
The Company generated a net loss of $39.4 million in the Current Period.
Cash used in operating activities was $13.4 million. Cash used by operating
activities principally consists of the net loss and decrease in accounts payable
and accrued expenses, offset by a decrease in accounts receivable, extraordinary
loss from extinguishment of debt and other non-cash items.
In the Current Period, net cash of $71.8 million was provided by investing
activities consisting of net proceeds from the sale of Grizzard of $78.6
million, offset by the increase in restricted cash of $4.9 million and purchases
of property and equipment of $1.9 million. In the Prior Period, net cash of $2.2
million was use for purchases of property and equipment and capitalized
software.
In the Current Period, net cash of $52.7 million was used in financing
activities consisting of repayments of long term debt, credit facilities and
capital leases of $46.5 million, repayment of preferred stock of $5.0 million,
issuance of related party note receivable of $1.0 million and repayments of
related party notes payable of $.2 million. In the Prior Period, net cash of
$7.0 million was used in financing activities consisting of $9.6 million
repayments of debt and capital leases, net of $1.8 million in proceeds from
common stock, and $.2 million in proceeds from credit facilities and $.6 million
in proceeds from a related party.
At March 31, 2002, the Company had amounts outstanding of $2.4 million on its
lines of credit. The Company had approximately $.7 million available on its
lines of credit as of March 31, 2002. As of March 31, 2002, the Company was in
compliance with its line of credit covenants, as amended.
At each balance sheet date, the Company reviews the recoverability of goodwill,
not identified with long-lived assets, based on estimated undiscounted future
cash flows from operating activities compared with the carrying value of
goodwill, and recognizes any impairment on the basis of discounted cash flows.
Due to the weakened economy and lower than expected results based on current
information, the Company has determined that there will not be sufficient cash
flows to recover the remaining book value of goodwill. As a result, the Company
has recognized an impairment charge of approximately $35.9 million, which is
included in the loss from operations for the three and nine months ended March
31, 2002.
The Company has limited capital resources and has incurred significant recurring
losses and negative cash flows from operations. The Company does not believe its
cash on hand along with existing sources of cash are sufficient to fund its cash
needs over the next twelve months under the current capital structure. In order
to address this situation, the Company has had and continues to have discussions
with multiple parties regarding the possibility of either restructuring or
refinancing the remainder of the Series E preferred stock. The Company is also
reviewing options, which include replacing the existing Preferred Stockholders
with an alternative strategic investor. The Company will also need to raise
additional equity financing or obtain other sources of liquidity (including debt
or other resources). In addition, the Company is reviewing it's present
operations with the view towards reducing it's cost structure and workforce and
to find alternative means of increasing revenue. There can be no assurance that
the Company will be successful in restructuring its preferred stock or obtaining
additional financing. Additionally, there can be no assurances that the
Company's cost reduction efforts will be successful or that the Company will
achieve a level of revenue that will allow it to return to profitability.
21
In the event the Company is unable to raise needed financing and achieve
profitability, operations will need to be scaled back or discontinued. The
accompanying financial statements do not include any adjustments relating to the
recoverability of the carrying amount of recorded assets or the amount of
liabilities that might result should the Company be unable to continue as a
going concern.
Recent Accounting Pronouncements
--------------------------------
In June 2001, the FASB approved two new pronouncements: SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 applies to all business combinations with a closing date after June 30,
2001. This Statement eliminates the pooling-of-interests method of accounting
and further clarifies the criteria for recognition of intangible assets
separately from goodwill. SFAS No. 142 eliminates the amortization of goodwill
and indefinite-lived intangible assets and initiates an annual review for
impairment. Identifiable intangible assets with a determinable useful life will
continue to be amortized. The amortization provisions apply to goodwill and
other intangible assets acquired after June 30, 2001. Goodwill and other
intangible assets acquired prior to June 30, 2001 will be affected upon
adoption. The adoption will require the Company to cease amortization of its
remaining net goodwill balance and to perform an impairment test of its existing
goodwill based on a fair value concept. The Company is still reviewing the
provisions of SFAS No. 142, which must be adopted by the Company on July 1,
2002. As of March 31, 2002, the Company has net unamortized intangibles of
$16,373,782, after the goodwill impairment recorded under SFAS No. 121 of
$35,900,000 and amortization expense of $2,088,977 and $5,652,676 for the nine
months ended March 31, 2002 and 2001, respectively.
In October 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and
reporting for the disposal of long-lived assets. SFAS No. 144 becomes effective
for financial statements issued for fiscal years beginning after December 15,
2001 and interim periods within those fiscal years. The Company does not expect
the adoption of this statement to have a material impact on the Company's
results of operations or financial position.
In April 2002, the FASB issued SFAS No. 145 "Rescission of SFAS Nos. 4, 44, and
64, Amendment of FAS 13, and Technical Corrections as of April 2002", SFAS No.
145 becomes effective for financial statements issued for fiscal years beginning
after May 15, 2002. The adoption will not have a material impact on the
Company's financial position and results of operations. However, the loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods will be reclassified to operating expense as the loss does not meet the
criteria in APB Opinion No. 30 "Reporting the Results of Operations Reporting
the Effects of Disposal of a Segment of a Business", for classification as an
extraordinary item.
22
PART II - OTHER INFORMATION
---------------------------
Item 1 - Legal Proceedings
--------------------------
In October 2000, an action was filed by Red Mountain, LLP in the United States
Court for the Northern District of Alabama, Southern Division against J. Jeremy
Barbera, Chairman of the Board and Chief Executive Officer of MKTG, MKTG and
WiredEmpire, Inc. Red Mountains' complaint alleges, among other things,
violations of Section 12(2) of the Securities Act of 1933, Section 10(b) of the
Securities Act of 1934 and Rule 10(b)(5) promulgated there under, and various
provisions of Alabama state law and common law, arising from Red Mountain's
acquisition of WiredEmpire Preferred Series A stock in a private placement.
WiredEmpire is a discontinued majority-owned subsidiary of the Company. Red
Mountain invested $225,000 in WiredEmpire's preferred stock and it seeks that
amount, attorney's fees and punitive damages. The Company believes that the
allegations in the complaint are without merit. The Company intends to
vigorously defend against the lawsuit.
In December 2001, an action was filed by a number of purchasers of preferred
stock of WiredEmpire, Inc., a discontinued subsidiary, in the Alabama State
Court (Circuit Court of Jefferson County, Alabama, 10 Judicial Circuit of
Alabama, Birmingham Division), against J. Jeremy Barbera, Chairman of the Board
and Chief Executive Officer of MKTG, MKTG and WiredEmpire, Inc. The plaintiffs
complaint alleges, among other things, violation of sections 8-6-19(a)(2) and
8-6-19(c) of the Alabama Securities Act and various other provisions of Alabama
state law and common law, arising for the plaintiffs' acquisition of WiredEmpire
Preferred Series A stock in a private placement. The plaintiffs invested
approximately $1,650,000 in WiredEmpire's preferred stock and it seeks that
amount, attorney's fees and punitive damages. On February 8, 2002, the
defendants filed a petition to remove the action to federal court on the grounds
of diversity of citizenship. The Company believes that the allegations in the
complaint are without merit. The Company intends to vigorously defend against
the lawsuit.
In 1999, a lawsuit under Section 16(b) of the Securities Exchange Act of 1934
was commenced against General Electric Capital Corporation ("GECC") by Mark
Levy, derivatively on behalf of the Company, to recover short swing profits
allegedly obtained by GECC in connection with the purchase and sale of MKTG
securities. The case is pending in the name of Mark Levy v. General Electric
Capital Corporation, in the United States District Court for the Southern
District of New York, Civil Action Number 99 Civ. 10560(AKH). While the Levy
case was pending, the Company and GECC engaged in negotiations pertaining to the
warrant, dated December 24, 1997, in favor of GECC to purchase, at consideration
of $0.01 per share, up to 1,778,334 shares of MKTG common stock subject to
certain adjustments. Extensive negotiations among counsel for the plaintiff,
counsel for the Company, and counsel for GECC, as well as direct negotiations
between the Company and GECC, resulted in a preliminary settlement of the court
action against GECC for alleged short swing profits and all other issues under
the warrant. The parties entered into a stipulation of settlement, subject to
court approval. In August 2001, the court declined to approve the stipulation of
settlement. In February 2002, a new settlement was reached among the parties.
The settlement provides for a $1,250,000 payment to be made to MKTG by GECC and
for GECC to reimburse MKTG for the reasonable cost of mailing a notice to
stockholders up to $30,000. Counsel for the plaintiff intend to request the
Court to award $375,000 for attorney fees, plus disbursements, to be deducted
from the settlement payment to MKTG. On April 29, 2002, the court approved the
settlement for $1,250,000 and reimbursement of mailing costs; however, the award
for attorney fees is pending court approval.
The Company believes the impact of these legal proceedings will not have a
material impact on the results of operations.
23
Item 4 - Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
On February 8, 2002, the Company held its annual meeting of stockholders to vote
on election of directors and an amendment to the Company's Amended and Restated
Articles of Incorporation to change the name of the Company to MKTG Services,
Inc. Of the 5,620,603 shares of the Company's common stock, par value $.01 per
share, entitled to vote at the meeting, holders of 4,262,376 shares were present
in person or were represented by proxy at the meeting.
The directors elected at the meeting and the results of the voting were as
follows:
General nominee For Withheld
--- --------
Alan I. Annex 4,045,502 216,874
John T. Gerlach 4,045,502 216,874
The shares voted regarding the Board of Directors' proposal to amend the Amended
and Restated Articles of Incorporation to change the name of the Company to MKTG
Services, Inc. were as follows:
For 4,103,685
Against 153,975
Abstain 4,716
Broker non-votes -
24
Item 6 - Exhibits and Reports on Form 8-K
-----------------------------------------
a) Exhibits
None
Notes relating to Exhibit:
a) Filed herewith.
b) Report on Form 8-K
On or about February 21, 2002 the Company filed a current report on Form
8-K regarding the Standstill agreements with its Series "E" Preferred
Stockholders.
25
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
MKTG SERVICES, INC.
(Registrant)
Date: May 15, 2002 By: /s/ J. Jeremy Barbara
------------------------------------------
J. Jeremy Barbera
Chairman of the Board and Chief Executive Officer
Date: May 15, 2002 By: /s/ Cindy H. Hill
------------------------------------------
Cindy H. Hill
Chief Accounting Officer
26