UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
------------------------ ----------------
(State of Incorporation) (I.R.S. Employer
Identification No.)
9 West Broad Street;
Stamford, Connecticut 06902
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(Address of principal executive offices) (Zip Code)
(203) 324-7635
--------------
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes X No ___
The number of shares outstanding of the Registrant's capital stock: 14,985,092
shares of Common Stock, $0.01 par value as of October 25, 2001.
MEMBERWORKS INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2001
and June 30, 2001 2
Condensed Consolidated Statements of Operations for the three
months ended September 30, 2001 and 2000 3
Condensed Consolidated Statements of Cash Flows for the three
months ended September 30, 2001 and 2000 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Forward Looking Statements 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
1
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
September 30, June 30,
2001 2001
------------- ---------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 47,351 $ 22,736
Marketable securities 12,245 --
Accounts receivable 15,263 20,446
Prepaid membership materials 4,541 3,903
Prepaid expenses 2,528 5,857
Membership solicitation and other deferred costs 137,651 154,059
--------- ---------
Total current assets 219,579 207,001
Fixed assets, net 37,046 39,687
Goodwill, net 42,039 84,814
Intangible assets, net 9,314 14,283
Other assets 2,135 2,676
--------- ---------
Total assets $ 310,113 $ 348,461
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current maturities of long-term obligations $ 629 $ 516
Accounts payable 42,940 49,505
Accrued liabilities 52,244 64,634
Due to related parties -- 2,028
Deferred membership fees 209,797 243,024
--------- ---------
Total current liabilities 305,610 359,707
Long-term liabilities 2,646 3,057
--------- ---------
Total liabilities 308,256 362,764
Minority interest -- 6,505
Mandatorily redeemable convertible preferred securities of subsidiary -- 5,157
Shareholders' equity (deficit):
Preferred stock, $0.01 par value -- 1,000 shares
authorized; no shares issued -- --
Common stock, $0.01 par value -- 40,000 shares authorized;
17,392 shares issued (17,308 shares at June 30, 2001) 174 173
Capital in excess of par value 108,665 107,835
Accumulated deficit (45,752) (80,196)
Accumulated other comprehensive loss (534) (370)
Treasury stock, 2,234 shares at cost (1,920 shares at June 30, 2001) (60,696) (53,407)
--------- ---------
Total shareholders' equity (deficit) 1,857 (25,965)
--------- ---------
Total liabilities and shareholders' equity (deficit) $ 310,113 $ 348,461
========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
2
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
For the three months ended
September 30,
--------------------------
2001 2000
--------- --------
Revenues $ 118,964 $ 97,799
Expenses:
Operating 21,068 20,239
Marketing 76,790 61,254
General and administrative 23,009 23,630
Amortization of intangible assets 675 2,256
--------- --------
Operating loss (2,578) (9,580)
Gain on sale of subsidiary (Note 4) 65,608 --
Net (loss) gain on investment (Note 4) (22,296) 229
Other (expense) income, net, principally interest (90) 92
--------- --------
Income (loss) before equity in affiliate and minority interest 40,644 (9,259)
Equity in income of affiliate -- 83
Minority interest (Note 5) 450 2,018
--------- --------
Income (loss) before income taxes 41,094 (7,158)
Provision for income taxes 743 --
--------- --------
Income (loss) before cumulative effect of accounting change 40,351 (7,158)
Cumulative effect of accounting change (Note 2) (5,907) (25,730)
--------- --------
Net income (loss) $ 34,444 $(32,888)
========= ========
Basic earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 2.62 $ (0.48)
Cumulative effect of accounting change (0.38) (1.72)
--------- --------
Basic earnings (loss) per share $ 2.24 $ (2.20)
========= ========
Diluted earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 2.51 $ (0.48)
Cumulative effect of accounting change (0.37) (1.72)
--------- --------
Diluted earnings (loss) per share $ 2.14 $ (2.20)
========= ========
Weighted average common shares used in earnings (loss) per share calculations:
Basic 15,379 14,973
========= ========
Diluted 16,077 14,973
========= ========
The accompanying notes are an integral part of
these consolidated financial statements.
3
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
For the three months ended
September 30,
2001 2000
--------- ---------
OPERATING ACTIVITIES
Net income (loss) $ 34,444 $ (32,888)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Cumulative effect of accounting change 5,907 25,730
Gain on sale of subsidiary (65,608) --
Net loss (gain) on investment 22,296 (229)
Minority interest (450) (2,018)
Equity in income of affiliate -- (83)
Revenues before deferral 105,496 113,391
Revenues recognized (118,964) (97,799)
Marketing costs before deferral (70,386) (72,744)
Marketing costs expensed 76,790 61,254
Depreciation and amortization 3,428 4,493
Other 42 313
Change in assets and liabilities:
Accounts receivable 4,053 (5,879)
Prepaid membership materials (638) (1,960)
Prepaid expenses 61 (1,969)
Other assets 23 940
Related party payables 12 92
Accounts payable (748) (5,781)
Accrued liabilities (8,483) 1,137
--------- ---------
Net cash used in operating activities (12,725) (14,000)
--------- ---------
INVESTING ACTIVITIES
Acquisition of fixed assets (1,890) (2,982)
Proceeds from sale of subsidiary, net of cash sold 45,998 --
Business combinations, net of cash acquired -- 2,996
--------- ---------
Net cash provided by investing activities 44,107 14
--------- ---------
FINANCING ACTIVITIES
Net proceeds from issuance of stock and warrants 886 443
Net borrowings from credit facility -- 315
Treasury stock purchases (7,330) (647)
Payments of long-term obligations (191) (18)
--------- ---------
Net cash (used in) provided by financing activities (6,635) 93
--------- ---------
Effect of exchange rate changes on cash and cash equivalents (132) (3)
--------- ---------
Net increase (decrease) in cash and cash equivalents 24,615 (13,896)
Cash and cash equivalents at beginning of period 22,736 30,169
--------- ---------
Cash and cash equivalents at end of period $ 47,351 $ 16,273
========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
4
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly, such
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three months ended September 30, 2001 are not
necessarily indicative of the results that may be expected for the fiscal year
ending June 30, 2002. For further information, refer to the financial statements
and footnotes thereto included in the Company's Annual Report on Form 10-K with
respect to the fiscal year ended June 30, 2001.
Certain reclassifications have been made to prior period financial statements to
conform to the current presentation of the financial statements.
NOTE 2 - CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Adoption of SFAS 142
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which is effective
for fiscal years beginning after December 15, 2001. Early adoption is permitted
for entities with fiscal years beginning after March 15, 2001, provided that the
first interim financial statements have not been previously issued. The Company
adopted SFAS 142 effective July 1, 2001. SFAS 142 addresses how intangible
assets that are acquired individually or with a group of other assets should be
accounted for in the financial statements upon their acquisition and after they
have been initially recognized in the financial statements. SFAS 142 requires
that goodwill and intangible assets that have indefinite useful lives not be
amortized but rather tested at least annually for impairment, and intangible
assets that have finite useful lives be amortized over their useful lives.
With the adoption of SFAS 142, the Company reassessed the useful lives and
residual values of all acquired intangible assets to make any necessary
amortization period adjustments. Based on that assessment, only goodwill was
determined to have an indefinite useful life and no adjustments were made to the
amortization period or residual values of other intangible assets. The Company
has determined that there is an impairment of goodwill of $5,907,000 at one of
its reporting units due to the change in methodology of calculating impairment
under SFAS 142 and recent downward trends in the operations of the reporting
unit (see Note 7). This amount has been recorded as a cumulative effect of
accounting change in the statement of operations for the three months ended
September 30, 2001.
5
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following pro forma net income and earnings per share have been prepared
assuming SFAS 142 was adopted as of July 1, 2000. Pro forma balances have been
adjusted to exclude goodwill amortization expense which is no longer recorded
under the provisions of SFAS 142 (in thousands, except per share data).
Three Months Ended
September 30,
-------------------------
2001 2000
---------- ----------
Net income (loss) from continuing operations:
Reported net income (loss) from continuing operations $ 40,351 $ (7,158)
Indefinite lived intangible asset amortization -- 1,643
---------- ----------
Adjusted net income (loss) from continuing operations $ 40,351 $ (5,515)
========== ==========
Basic earnings (loss) per share:
Reported earnings (loss) per share $ 2.62 $ (0.48)
Indefinite lived intangible asset amortization -- 0.11
---------- ----------
Adjusted earnings (loss) per share $ 2.62 $ (0.37)
========== ==========
Diluted earnings (loss) per share:
Reported earnings (loss) per share $ 2.51 $ (0.48)
Indefinite lived intangible asset amortization -- 0.11
---------- ----------
Adjusted earnings (loss) per share $ 2.51 $ (0.37)
========== ==========
Adoption of SAB 101
The Company adopted Staff Accounting Bulletin 101, "Revenue Recognition in
Financial Statements" ("SAB 101") as of July 1, 2000. SAB 101 establishes the
Security and Exchange Commission's (the "Staff") preference that membership fees
should not be recognized in earnings prior to the expiration of refund
privileges. Effective July 1, 2000, the Company changed its method of accounting
for membership fee revenue to comply with the Staff's preferred method as
outlined in SAB 101. Membership fees, and the related direct costs associated
with acquiring the underlying memberships, are no longer recognized on a
pro-rata basis over the corresponding membership period, but instead are
recognized in earnings upon the expiration of membership refund privileges. The
cumulative effect of this change in accounting principle as of July 1, 2000 of
$25,730,000 was recorded in the fiscal quarter ended September 30, 2000. The
membership fees, net of estimated refunds and associated direct costs, which
were deferred as part of the cumulative effect adjustment at July 1, 2000 were
recognized in earnings during fiscal year 2001 as the underlying refund
privileges expired. During the first quarter ended September 30, 2000, the
Company recognized $31,735,000 of revenue which was included as a component of
the cumulative effect of accounting change booked July 1, 2000.
6
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 3 - EARNINGS (LOSS) PER SHARE
Basic and diluted earnings (loss) per share amounts are determined in accordance
with the provisions of FASB Statement No. 128 "Earnings Per Share." The
following table sets forth the reconciliation of the numerators and denominators
in the computation of basic and diluted earnings (loss) per share (in thousands,
except per share data):
Three months ended
September 30,
----------------------
2001 2000
-------- --------
Numerator for basic and diluted earnings (loss) per share:
Net income (loss) before cumulative effect of accounting change $ 40,351 $ (7,158)
Cumulative effect of accounting change (5,907) (25,730)
-------- --------
Net income (loss) $ 34,444 $(32,888)
======== ========
Denominator for basic earnings (loss) per share:
Weighted average number of common shares outstanding - basic 15,379 14,973
Effect of dilutive securities:
Options 698 --
-------- --------
Weighted average number of common shares outstanding - diluted 16,077 14,973
======== ========
Basic earnings (loss) per share $ 2.24 $ (2.20)
======== ========
Diluted earnings (loss) per share $ 2.14 $ (2.20)
======== ========
The diluted earnings (loss) per common share calculation excludes the effect of
potentially dilutive shares when their effect is antidilutive. At September 30,
2001 and 2000 the Company had 2,027,000 and 1,329,000 shares, respectively, of
potentially dilutive stock options outstanding that are not included in the
calculation as they are antidilutive.
NOTE 4 - GAIN ON SALE OF SUBSIDIARY
In August 2001, the Company sold its investment in and advances to iPlace, Inc.
in exchange for $50,111,000 in cash, including $3,703,000 held in escrow, and
1,601,000 shares of Homestore.com common stock, including 451,000 shares held in
escrow. The fair value of the Homestore.com common stock as of the date of sale
was $34,540,000. The Homestore.com common stock received is unregistered and
MemberWorks is restricted from selling any Homestore.com stock for a period of
120 days after the closing date and subsequently may only sell 1/12th of the
shares in any calendar month. In connection with this sale, the Company
recognized a gain of $65,608,000.
Subsequently, the investment in Homestore.com declined in value and management
determined that the decline was other than temporary. As a result, the Company
wrote down its investment in Homestore.com to its fair value as of September 30,
2001 and recognized a loss of $22,296,000 in the first fiscal quarter of 2002.
NOTE 5 - MINORITY INTEREST
Prior to the sale of iPlace, Inc. in August 2001, the Company was the majority
shareholder of iPlace, Inc. with an approximate 58% ownership share. Minority
interest in the statement of operations for the first fiscal quarter of 2002
represents approximately 42% of iPlace's losses incurred from July 1, 2001
through the date of the sale.
7
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 6 - COMPREHENSIVE INCOME
The components of comprehensive income (loss) are as follows (in thousands):
Three Months Ended
September 30,
----------------------
2001 2000
-------- --------
Net income (loss) $ 34,444 $(32,888)
Unrealized loss on marketable securities -- (532)
Foreign currency translation loss (164) (84)
-------- --------
Comprehensive income (loss) $ 34,280 $(33,504)
======== ========
NOTE 7 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
As of September 30, 2001 As of June 30, 2001
----------------------------- -----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------------- ------------ -------------- -------------
Amortized intangible assets:
Membership and Client Relationships $13,194 $(4,339) $17,465 $(5,642)
Non-Compete Agreements 238 (196) 3,009 (999)
Other 950 (533) 950 (500)
------- ------- ------- -------
Total amortized intangible assets $14,382 $(5,068) $21,424 $(7,141)
======= ======= ======= =======
Unamortized intangible assets:
Goodwill $42,039 $84,814
The gross carrying amount and accumulated amortization of amortized intangible
assets at September 30, 2001 decreased from June 30, 2001 due to the sale of
iPlace.
The total intangible amortization expense reflected in the statement of
operations for the quarter ended September 30, 2001 is $675,000. The future
intangible amortization expense for the next five fiscal years is estimated to
be as follows (in thousands):
Fiscal Year:
2002 $1,172
2003 697
2004 419
2005 275
2006 183
The changes in the carrying amount of goodwill for the quarter ended September
30, 2001 are as follows (in thousands):
Balance as of July 1, 2001 $ 84,814
Goodwill disposed during the quarter due to
sale of subsidiary (36,868)
Impairment losses (5,907)
--------
Balance as of September 30, 2001 $ 42,039
========
8
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Goodwill was tested for impairment in the quarter ending September 30, 2001 in
connection with the adoption of SFAS 142. Due to the slow down in the business
of one of the Company's reporting units, future cash flows for this reporting
unit are expected to decline over the next few years. During the quarter ended
September 30, 2001, an impairment loss of $5,907,000 was recorded to write down
the goodwill related to this reporting unit to fair value. The impairment loss
was calculated utilizing the methodology set forth in SFAS 142. As prescribed by
SFAS 142, this write down is reflected in the statement of operations as a
cumulative effect of accounting change. The fair value of this subsidiary was
estimated by conducting a discounted cash flow analysis of the subsidiary's
future cash flows.
NOTE 8 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated balance
sheets as of September 30, 2001 and June 30, 2001 include an allowance for
membership cancellations of $20,809,000 and $30,004,000, respectively.
NOTE 9 - LEGAL PROCEEDINGS
Except as set forth below, in management's opinion, there are no significant
legal proceedings to which the Company or any of its subsidiaries is a party or
to which any of their properties are subject. The Company is involved in other
lawsuits and claims generally incidental to its business. In addition, from time
to time, and in the regular course of its business, the Company receives
inquiries from various federal and/or state regulatory authorities.
In January 2001, a purported class action was instituted by plaintiff Brandy L.
Ritt against the Company and other defendants in the Court of Common Pleas in
Cuyahoga County, Ohio. The suit, which seeks unspecified monetary damages,
alleges that the Company and the other defendants violated various provisions of
Ohio's consumer protection laws in connection with the marketing of certain
membership programs offered by the Company. The Company believes that the claims
asserted against it are unfounded and the Company will vigorously defend its
interests against this suit.
In March 2001, a purported class action was instituted by plaintiff Teresa
McClain against Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of
the Company, and other defendants in the United States District Court for the
Eastern District of Michigan, Southern Division. The suit, which seeks
unspecified monetary damages, alleges that Coverdell and the other defendants
violated the Michigan Consumer Protection Act and other applicable Michigan laws
in connection with the marketing of insurance products. The Company believes
that the claims asserted against Coverdell are unfounded and the Company and
Coverdell will vigorously defend their interests against this suit.
In June 2001, purported class actions were instituted by plaintiffs Judith
Jeselskis and Marcia Walters against the Company and other defendants in Circuit
Court of the Tenth Judicial District, Highlands County Civil Division, Florida,
and Circuit Court of the Sixth Judicial Circuit, Pinellas County Civil Division,
Florida, respectively. The suits, which seek unspecified monetary damages,
allege that the Company and the other defendants violated the Florida Deceptive
and Unfair Trade Practices Act, in connection with the marketing of certain
membership programs offered by the Company. The Company believes that the
allegations made in this lawsuit are unfounded and the Company will vigorously
defend its interests against the suits.
In July 2001, a purported class action was instituted by Alan Stone against the
Company and other defendants in Superior Court of the State of California,
County of Orange. The suit, which seeks unspecified monetary damages, alleges
that the Company and the other defendants violated California business practices
law. The Company believes that the allegations made in this lawsuit are
unfounded and the Company will vigorously defend its interests against this
suit.
9
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 10 - SUBSEQUENT EVENT
In October 2001, the Company announced that it would institute certain cost
saving initiatives including cutting approximately 15% of its workforce, or 225
employees, and closing the Company's operations in the United Kingdom. The
Company expects to record a restructuring charge of approximately $7,000,000 in
the second quarter ending December 31, 2001.
10
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MemberWorks addresses the needs of organizations seeking to leverage the
expertise of an outside provider in offering membership service programs.
Membership service programs offer selected products and services from a variety
of vendors intended to enhance existing relationships between businesses and
consumers. The Company derives its revenues principally from annually renewable
membership fees. The Company receives full payment of annual fees at or near the
beginning of the membership period, but recognizes revenue as the member's
refund privilege expires. Similarly, the costs associated with soliciting each
new member, as well as the cost of royalties, are recognized as the related
revenue is recognized. Profitability and cash flow generated from renewal
memberships exceed that of new memberships due to the absence of solicitation
costs associated with new member procurement.
THREE MONTHS ENDED SEPTEMBER 30, 2001 VS. THREE MONTHS ENDED SEPTEMBER 30, 2000
REVENUES. Reported revenues increased 22% to $119.0 million for the quarter
ended September 30, 2001 from $97.8 million for the quarter ended September 30,
2000. The increase in reported revenues is due to the effect of the timing of
amortization of revenues deferred in prior periods. Revenues before deferral
decreased 7% to $105.5 million for the quarter ended September 30, 2001 from
$113.4 million for the quarter ended September 30, 2000. Revenues before
deferral decreased compared to the prior year due to a decrease in the net
active members during the quarter and the effect of the sale of iPlace. The
Company's membership base decreased to approximately 6.8 million members at
September 30, 2001 from 7.0 million members at September 30, 2000, adjusted for
the sale of iPlace in both periods. The decrease in the growth of the active
membership base in the September 30, 2001 quarter is a result of a decrease in
consumer response rates due to the slow down in the economy. As a percentage of
total reported revenues recognized, renewal revenues represented 43% in 2001 and
33% in 2000.
OPERATING EXPENSES. Operating expenses increased 4% to $21.1 million in 2001
from $20.2 million in 2000. As a percentage of revenues before deferral,
operating expenses increased to 20.0% in 2001 from 17.8% in 2000. Operating
expenses increased as a percentage of revenues primarily due to lower revenues
in the quarter.
MARKETING EXPENSES. Marketing expenses reported increased 25% to $76.8 million
in 2001 from $61.3 million in 2000. Marketing expenses before deferral decreased
3% to $70.4 million from $72.7 million. As a percentage of revenues before
deferral, marketing expenses before deferral increased to 66.7% in 2001 from
64.2% in 2000. Marketing expenses before deferral increased as a percentage of
revenues before deferral primarily due to a decrease in consumer response rates.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 3% to $23.0 million in 2001 from $23.6 million in 2000. As a
percentage of revenues before deferral, general and administrative expenses
increased to 21.8% in 2001 from 20.8% in 2000. Expenses as a percentage of
revenues before deferral increased due to lower revenues.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Intangible amortization
decreased to $0.7 million in 2001 from $2.3 million in 2000 due to the adoption
of SFAS 142, which no longer requires indefinite lived intangible assets to be
amortized. Excluding the amortization of indefinite lived intangible assets in
2000, amortization of goodwill and other intangibles would have been $0.6
million.
11
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OTHER EXPENSE/INCOME, NET. Other expense/income, net is primarily composed of
interest income from cash and cash equivalents and interest expense on the
Company's borrowings under its line of credit during the period. Other expense
was $0.1 million in 2001 versus other income of $0.1 million in 2000 due to
increased borrowings under the Company's line of credit during the September 30,
2001 period.
PROVISION FOR INCOME TAXES. In connection with the gain on the sale of iPlace,
the Company recorded a provision for alternative minimum taxes of approximately
$0.7 million. The Company was not required to record a provision for taxes for
the period ended September 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
Operating cash flow before working capital changes was a negative $7.0 million
for the quarter ended September 30, 2001 compared to a negative $0.6 million in
2000. The decrease in operating cash flow before working capital changes was due
to a decrease in revenues before deferral and an increase in marketing costs
before deferral due to a slow down in consumer response rates. Changes in
working capital items resulted in a use of cash of $5.7 million for the quarter
ended September 30, 2001 compared to $13.4 million in 2000. In total, cash used
in operations was $12.7 million for the September 30, 2001 quarter versus $14.0
million for the September 30, 2000 quarter.
Net cash provided by investing activities was $44.1 million in 2001 versus
$14,000 in 2000. Net cash provided by investing activities increased due to the
receipt of $46.0 million in net proceeds from the sale of iPlace, Inc. Capital
expenditures were $1.9 million in 2001 and $3.0 million in 2000.
Net cash used in financing activities was $6.6 million in 2001 versus $0.1
million provided in 2000 primarily due to the increase in the number of treasury
stock shares repurchased in 2001. The Company purchased 315,000 shares of
treasury stock in 2001 and 24,000 shares in 2000. As of September 30, 2001, the
Company had 384,000 shares available for repurchase under its buyback program.
On October 25, 2001, the Board of Directors authorized an additional 1 million
shares to be repurchased under the buyback program.
As of September 30, 2001, the Company had cash and cash equivalents of $47.4
million and marketable securities of $12.2 million. In addition, the Company
has a $28 million bank credit facility which bears interest at the higher of
the base commercial lending rate for the bank or the Federal Funds Rate plus
0.5% per annum. There were no borrowings outstanding under this bank credit
facility as of September 30, 2001. The available bank credit facility is
temporarily limited to the sum of the compensating balance and eligible
securities on deposit with the bank. Such limitations may be imposed and
removed based on certain financial covenants. The bank credit facility
requires MemberWorks to maintain a compensating balance of $10.0 million in
addition to certain financial covenants. The Company believes that existing
cash balances, together with its available bank credit facility, will be
sufficient to meet its funding requirements for at least the next twelve
months.
In August 2001, the Company received $34.5 million in Homestore.com common
stock. The Homestore.com common stock received is unregistered and MemberWorks
is restricted from selling any Homestore.com stock for a period of 120 days
after the closing date and subsequently may only sell 1/12th of the shares in
any calendar month. During the quarter ended September 30, 2001, the Company
wrote down its investment in Homestore.com to its fair value as of September 30,
2001 and recognized a loss of $22.3 million. As of October 2001, Homestore.com
stock is trading below the book value of Company's investment in Homestore.com.
The Company did not have any material commitments for capital expenditures as of
September 30, 2001. The Company intends to utilize cash generated from
operations and its funds available under its credit facility to fulfill any
capital expenditure requirements for the remainder of fiscal 2002.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 141, "Business Combinations" ("SFAS 141"), which is effective for business
combinations initiated after June 30, 2001. SFAS 141 eliminates the pooling of
interest method of accounting for business combinations and requires that all
business combinations occurring on or after July 1, 2001 are accounted for under
the purchase method. The Company has evaluated the impact of SFAS 141 and
believes that it will not have a material impact on its financial statements.
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MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In July 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142"), which is effective for fiscal years beginning after
December 15, 2001. Early adoption is permitted for entities with fiscal years
beginning after March 15, 2001, provided that the first interim financial
statements have not been previously issued. The Company adopted SFAS 142
effective July 1, 2001. SFAS 142 addresses how intangible assets that are
acquired individually or with a group of other assets should be accounted for in
the financial statements upon their acquisition and after they have been
initially recognized in the financial statements. SFAS 142 requires that
goodwill and intangible assets that have indefinite useful lives not be
amortized but rather tested at least annually for impairment, and intangible
assets that have finite useful lives be amortized over their useful lives.
With the adoption of SFAS 142, the Company reassessed the useful lives and
residual values of all acquired intangible assets to make any necessary
amortization period adjustments. Based on that assessment, only goodwill was
determined to have an indefinite useful life and no adjustments were made to the
amortization period or residual values of other intangible assets. The Company
has determined there is an impairment of goodwill of $5.9 million at one of its
reporting units due to the change in methodology of calculating impairment under
SFAS 142 and recent downward trends in the operations of the reporting unit.
This amount has been recorded as a cumulative effect of accounting change in the
statement of operations for the three months ended September 30, 2001.
In August 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"), which is effective for fiscal years
beginning after June 15, 2002. SFAS 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The adoption of SFAS 143 will
not have a material impact on the Company's financial statements.
In October 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which is effective
for fiscal years beginning after December 15, 2001. SFAS 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets to be Disposed of." The adoption of SFAS 144 will not have a material
impact on the Company's financial statements.
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements that are
based on current expectations, estimates, forecasts and projections about the
industry in which MemberWorks operates and the Company's management's beliefs
and assumptions. These forward-looking statements are made pursuant to safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance and are
based on a number of assumptions and estimates that are inherently subject to
significant risks and uncertainties, many of which are beyond our control,
cannot be foreseen and reflect future business decisions that are subject to
change. Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements. Among the many
factors that could cause actual results to differ materially from the
forward-looking statements are:
- The Company's ability to integrate into the Company's management and
operations and operate successfully acquired businesses;
- Changes in the marketing techniques of credit card issuers;
- Unanticipated cancellation or termination of marketing agreements and
the extent to which we can continue successful development and
marketing of new products and services;
- The Company's ability to develop and implement operational and
financial systems to manage rapidly growing operations;
13
- The Company's ability to obtain financing on acceptable terms to
finance the Company's growth strategy and to operate within the
limitations imposed by financing arrangements;
- Further changes in the already competitive environment for the
Company's products or competitors' responses to the Company's
strategies;
- Changes in the growth rate of the overall U.S. economy, or the
international economies where MemberWorks does business, such that
consumer spending and related consumer debt are impacted;
- Additional government regulation of the Company's industry; and
- New accounting pronouncements
MemberWorks cautions that such factors are not exclusive. All of the
forward-looking statements made in this Quarterly Report on Form 10-Q are
qualified by these cautionary statements and readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date of this Quarterly Report on Form 10-Q. Except as required under the Federal
Exchange Commission, MemberWorks does not have any intention or obligation to
publicly update any forward-looking statements, whether as a result of new
information, future events or otherwise.
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MEMBERWORKS INCORPORATED
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate
The Company has a $28.0 million bank credit facility which bears interest at the
higher of the base commercial lending rate for the bank or the Federal Funds
Rate plus 0.5% per annum. There were no borrowings outstanding under this bank
credit facility as of September 30, 2001. Management believes that an increase
in the commercial lending rate or the Federal Funds rate would not be material
to the Company's financial position or its results of operations. If the Company
is not able to renew its existing credit facility agreement, which matures on
March 1, 2002, it is possible that any replacement lending facility obtained by
the Company may be more sensitive to interest rate changes. The Company does not
currently hedge interest rates with respect to its outstanding debt.
Foreign Currency
The Company has international sales and facilities in the United Kingdom and
Canada and therefore, is subject to foreign currency rate exposure.
Historically, international sales have been denominated in British pounds
sterling and the Canadian dollar. The functional currencies of the Company's
foreign operations are the local currencies. Assets and liabilities of these
subsidiaries are translated into U.S. dollars at exchange rates in effect as of
the Balance Sheet date. Income and expense items are translated at average
exchange rates for the period. Accumulated net translation adjustments are
recorded in shareholders' equity. Foreign exchange transaction gains and losses
are included in the results of operations, and were not material for all periods
presented. As a result, the Company's financial results could be affected by
factors such as changes in foreign currency exchange rates or weak economic
condition. To the extent the Company incurs expenses that are based on locally
denominated sales volume paid in local currency, the exposure to foreign
exchange risk is reduced. The Company has determined that the impact of a
near-term 10% appreciation or depreciation of the U.S. dollar would have an
insignificant effect on its financial position, results of operations and cash
flows. The Company does not maintain any derivative instruments to mitigate the
exposure to translation and transaction risk. However, this does not preclude
the Company's adoption of specific hedging strategies in the future. MemberWorks
will assess the need to utilize financial instruments to hedge currency
exposures on an ongoing basis.
Fair Value
In August 2001, MemberWorks acquired stock in Homestore.com valued at $34.5
million in exchange for its interest in iPlace, Inc. The carrying value of this
investment is affected by changes in the quoted market prices of Homestore.com
common stock. The investment in Homestore.com declined in value and management
determined that the decline was other than temporary. As a result, the Company
wrote down its investment in Homestore.com by $22.3 million. MemberWorks does
not use derivative financial instruments for speculative or trading purposes.
However, this does not preclude the Company's adoption of specific hedging
strategies in the future.
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MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
None
b) Reports on Form 8-K
On August 21, 2001, the Company filed a Current Report on Form 8-K under
Item 5 "Other Events" and Item 7 "Financial Statements and Exhibits" a press
release announcing that a definitive agreement to sell iPlace, Inc. to
Homestore.com, Inc. had been signed.
On September 7, 2001, the Company filed a Current Report on Form 8-K under
Item 2 "Acquisition or Disposition of Assets" and Item 7 "Financial
Statements and Exhibits" a press release announcing the completion of the
sale of iPlace, Inc. to Homestore.com, Inc.
16
MEMBERWORKS INCORPORATED
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEMBERWORKS INCORPORATED
(Registrant)
Date: November 14, 2001 By: /s/ Gary A. Johnson
-------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
November 14, 2001 By: /s/ James B. Duffy
-------------------------------
James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
17