1
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 DECEMBER 31, 2000
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
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(203) 324-7635
-------------------------------
(Registrant's telephone number,
including area code)
Indicate by checkmark 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: 15,400,196
shares of Common Stock, $0.01 par value as of February 1, 2001.
2
MEMBERWORKS INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of December 31,
and June 30, 2000 2
Condensed Consolidated Statements of Operations for the three and six
months ended December 31, 2000 and 1999 3
Condensed Consolidated Statements of Cash Flows for the six
months ended December 31, 2000 and 1999 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Forward Looking Statements 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Changes in Securities and Use of Proceeds 14
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
1
3
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
December 31, June 30,
2000 2000
--------------- -------------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 31,606 $ 30,169
Marketable securities - 6,326
Accounts receivable 19,924 17,836
Prepaid membership materials 6,026 4,891
Prepaid expenses 6,272 3,837
Membership solicitation and other deferred costs 179,896 128,767
--------------- -------------
Total current assets 243,724 191,826
Fixed assets, net 38,590 34,615
Intangible and other assets 106,991 90,331
--------------- -------------
Total assets $ 389,305 $ 316,772
=============== =============
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Current maturities of long-term obligations $ 823 $ 665
Accounts payable 49,967 49,693
Accrued liabilities 76,963 62,642
Due to related parties 1,943 1,852
Deferred membership fees 252,313 165,437
--------------- -------------
Total current liabilities 382,009 280,289
Long-term obligations 3,316 1,083
--------------- -------------
Total liabilities 385,325 281,372
--------------- -------------
Minority Interest 10,871 16,379
Mandatorily redeemable convertible preferred securities of Subsidiary 4,938 -
Shareholders' (deficit) equity:
Preferred stock, $0.01 par value --
1,000 shares authorized; no shares issued - -
Common stock, $0.01 par value --
40,000 shares authorized; 17,028 shares issued
(16,507 shares at June 30, 2000) 171 165
Capital in excess of par value 105,924 91,398
Deferred compensation (164) (44)
Accumulated deficit (67,864) (27,709)
Accumulated other comprehensive loss
Cumulative translation adjustments (123) (145)
Treasury stock, 1,765 shares at cost (1,585 shares at June 30, 2000) (49,773) (44,644)
--------------- -------------
Total shareholders' (deficit) equity (11,829) 19,021
--------------- -------------
Total liabilities and shareholders' (deficit) equity $ 389,305 $ 316,772
=============== =============
The accompanying notes are an integral part of
these consolidated financial statements.
2
4
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Three months ended Six months ended
December 31, December 31,
-------------------------- ------------------------
2000 1999 2000 1999
----------- ----------- ----------- ----------
Revenues $ 117,616 $ 78,908 $ 215,415 $ 150,566
Expenses:
Operating 21,711 14,201 41,950 27,197
Marketing 76,637 45,851 137,891 86,511
General and administrative 23,997 14,729 47,627 29,433
Amortization of goodwill and other intangibles 2,827 1,419 5,083 2,630
----------- ----------- ----------- ----------
Operating (loss) income (7,556) 2,708 (17,136) 4,795
Net loss on sale of investment (2,401) - (2,172) -
Other (expense) income, net principally interest (242) 300 (150) 659
----------- ----------- ----------- ----------
(Loss) income before equity in affiliate and minority interest (10,199) 3,008 (19,458) 5,454
Equity in income (loss) of affiliate - - 83 (112)
Minority interest (Note 7) 2,932 - 4,950 -
----------- ----------- ----------- ----------
(Loss) income before income taxes (7,267) 3,008 (14,425) 5,342
Provision for income taxes - - - -
----------- ----------- ----------- ----------
Net (loss) income before cumulative effect of accounting change (7,267) 3,008 (14,425) 5,342
Cumulative effect of accounting change - - (25,730) -
----------- ----------- ----------- ----------
Net (loss) income $ (7,267) $ 3,008 $ (40,155) $ 5,342
=========== =========== =========== ==========
Basic (loss) earnings per share:
(Loss) income before cumulative effect of accounting change $ (0.48) $ 0.20 $ (0.95) $ 0.35
Cumulative effect of accounting change - - (1.70) -
----------- ----------- ----------- ----------
Basic (loss) earnings per share $ (0.48) $ 0.20 $ (2.66) $ 0.35
=========== =========== =========== ==========
Diluted (loss) earnings per share:
(Loss) income before cumulative effect of accounting change $ (0.48) $ 0.18 $ (0.95) $ 0.31
Cumulative effect of accounting change - - (1.70) -
----------- ----------- ----------- ----------
Diluted (loss) earnings per share $ (0.48) $ 0.18 $ (2.66) $ 0.31
=========== =========== =========== ==========
Weighted average common shares used in (loss) earnings per
share calculations:
Basic 15,274 15,287 15,124 15,359
=========== =========== =========== ==========
Diluted 15,274 16,982 15,124 17,132
=========== =========== =========== ==========
The accompanying notes are an integral part of
these consolidated financial statements.
3
5
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six months ended December 31,
------------------------------------
2000 1999
---------------- ----------------
OPERATING ACTIVITIES
Net (loss) income $ (40,155) $ 5,342
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Cumulative effect of accounting change 25,730 -
Net loss on sale of investment 2,172 -
Minority interest (4,950) -
Equity in (income) loss of affiliate (83) 112
Membership solicitation and other deferred costs (132,572) (98,708)
Amortization of membership solicitation and other deferred costs 124,031 82,377
Deferred membership fees 18,451 20,738
Depreciation and amortization 9,375 5,352
Other 968 234
Change in assets and liabilities:
Accounts receivable (1,588) (3,810)
Prepaid membership materials (1,135) 74
Prepaid expenses (3,275) (1,481)
Other assets 1,252 (84)
Related party obligations 91 -
Accounts payable (265) (4,859)
Accrued liabilities 13,924 15,845
---------------- ----------------
Net cash provided by operating activities 11,971 21,132
---------------- ----------------
INVESTING ACTIVITIES
Acquisition of fixed assets (7,993) (7,167)
Business combinations, net of cash acquired and other investments (2,826) (16,010)
---------------- ----------------
Net cash used in investing activities (10,819) (23,177)
---------------- ----------------
FINANCING ACTIVITIES
Net proceeds from issuance of stock and warrants 6,123 932
Borrowings from credit facility 73,949 -
Repayments of credit facility (74,434) -
Treasury stock purchases (5,129) (20,023)
Payments of long-term obligations (188) (32)
---------------- ----------------
Net cash provided by (used in) financing activities 321 (19,123)
---------------- ----------------
Effect of exchange rate changes on cash and cash equivalents (36) 21
---------------- ----------------
Net increase (decrease) in cash and cash equivalents 1,437 (21,147)
Cash and cash equivalents at beginning of period 30,169 50,939
---------------- ----------------
Cash and cash equivalents at end of period $ 31,606 $ 29,792
================ ================
The accompanying notes are an integral part of
these consolidated financial statements.
4
6
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 generally accepted accounting principles 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 and six month
periods ended December 31, 2000 are not necessarily indicative of the results
that may be expected for the fiscal year ending June 30, 2001. 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, 2000.
NOTE 2 - MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
During October 2000, iPlace, Inc. ("iPlace"), a majority-owned subsidiary of the
company, authorized the sale and issuance of 184,000 shares of Series A
Preferred Stock at a purchase price of $5,000,000. The Series A Preferred Stock
has a par value per share of $0.01, and pays cumulative dividends at an annual
rate of 8.0%. Such dividends are accrued from the original issuance date.
The Series A Preferred Stock is convertible at the option of the holder, in
whole or part, at any time into iPlace's common stock at an initial conversion
rate of one for one. Upon the demand of at least a majority of holders on or
after October 10, 2004, all shares of Series A preferred stock could be redeemed
at a value of the initial purchase price plus any declared and unpaid dividends.
Series A Preferred Stock holders are entitled to vote upon all matters brought
before the iPlace stockholders and are entitled one vote per share. In the event
of the liquidation of iPlace, the preferred shareholders will receive $27.23 per
share plus all declared and unpaid dividends. As of December 31, 2000 the amount
of unpaid dividends totaled $89,000.
5
7
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 3 - EARNINGS PER SHARE
Basic and diluted (loss) earnings 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 (loss) earnings per share (in thousands,
except per share data):
Three months ended Six months ended
December 31, December 31,
---------------------- ------------------------
2000 1999 2000 1999
---------- --------- ----------- ----------
Numerator for basic and diluted (loss) earnings per share:
Net (loss) income before cumulative effect of accounting change $ (7,267) $ 3,008 $ (14,425) $ 5,342
Cumulative effect of accounting change - - (25,730) -
---------- --------- ----------- ----------
Net (loss) income $ (7,267) $ 3,008 $ (40,155) $ 5,342
========== ========= =========== ==========
Denominator for basic (loss) earnings per share:
Weighted average number of common shares outstanding- basic 15,274 15,287 15,124 15,359
Effect of dilutive securities:
Options and warrants - 1,695 - 1,773
---------- --------- ----------- ----------
Weighted average number of common shares outstanding- diluted 15,274 16,982 15,124 17,132
========== ========= =========== ==========
Basic (loss) earnings per share $ (0.48) $ 0.20 $ (2.66) $ 0.35
========== ========= =========== ==========
Diluted (loss) earnings per share $ (0.48) $ 0.18 $ (2.66) $ 0.31
========== ========= =========== ==========
The diluted net income per common share calculation excludes the effect of
potentially dilutive shares when their effect is antidilutive. Excluded from the
diluted share calculation above for the three and six months ended December 31,
2000 are incremental weighted average stock option shares of approximately
3,075,000 and 3,041,000, respectively.
NOTE 4 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated balance
sheets as of December 31, 2000 and June 30, 2000 include an allowance for
membership cancellations of $40,593,000 and $33,477,000, respectively.
NOTE 5 - CUMULATIVE EFFECT OF ACCOUNTING CHANGE
For over a year, the Company has disclosed in its public reporting that the
Securities and Exchange Commission staff (the "Staff") planned to issue guidance
on revenue recognition and that such guidance could have a material impact on
the way the Company has historically recognized revenue. The Staff issued SAB
101 in December 1999.
SAB 101 establishes the Staff's preference that membership fees should not be
recognized in earnings prior to the expiration of refund privileges.
Notwithstanding the Staff's preference described above, it is also stated in SAB
101 that the Staff will not object to the recognition of refundable membership
fees, net of estimated refunds, as earned revenue over the membership period
(the Company's historical method) in limited circumstances where all of certain
criteria set forth in SAB 101 have been met.
6
8
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 are deferred
as part of the cumulative effect adjustment at July 1, 2000 will be recognized
in earnings during fiscal year 2001 as the underlying refund privileges expire.
During the three and six months ended December 31, 2000, the Company recognized
$22,142,000 and $53,877,000, respectively, of revenue which was included as a
component of the cumulative effect of accounting change booked July 1, 2000. The
effect of the adoption of SAB 101 on reported revenue, net loss before the
cumulative effect of accounting change and net loss per share before the
cumulative effect of accounting change for the three months ended December 31,
2000 is an increase of $6,539,000, and a decrease of $617,000 and $0.04,
respectively. The effect of the adoption of SAB 101 on reported revenue, net
loss before the cumulative effect of accounting change and net loss per share
before the cumulative effect of accounting change for the six months ended
December 31, 2000 is a decrease of $1,844,000, and an increase of $2,154,000 and
$0.14, respectively.
The following pro forma net (loss) income and (loss) earnings per share have
been prepared assuming SAB 101 was adopted as of July 1, 1999 (in thousands,
except per share data).
Three months ended December Six months ended December
31, 31,
------------------------------- -----------------------------
2000 1999 2000 1999
--------------- -------------- --------------- ------------
Net (loss) income $ (7,267) $ 10,351 $ (14,425) $ 14,683
Basic (loss) earnings per share $ (0.48) $ 0.68 $ (0.95) $ 0.96
Diluted (loss) earnings per share $ (0.48) $ 0.61 $ (0.95) $ 0.86
This change in accounting for the recognition of membership fees in income has
no impact on the Company's cash flows or on the value of the underlying
memberships.
NOTE 6 - BUSINESS COMBINATIONS
In October 2000, the Company increased its ownership in Discount Development
Services, L.L.C. and its subsidiary Uni-Care, Inc. ("DDS") from 19% to 100%. The
Company paid $8,150,000 in cash and 425,232 shares of MemberWorks Common Stock
with an approximate fair market value of $13,641,000 as of the date the Company
entered into the purchase agreement. The acquisition was accounted for as a
purchase, with the purchase price allocated to the assets acquired and
liabilities assumed based upon their respective estimated fair value at the date
of acquisition. DDS is in the business of marketing and the administration of
healthcare network membership programs that provide its members access to
various healthcare networks including hearing, vision, prescription and
chiropractic. The results of DDS's operations are included in the consolidated
financial statements from the date of acquisition.
NOTE 7 - MINORITY INTEREST
As of December 31, 2000, the Company is the majority shareholder of iPlace, Inc.
with an approximate 58% ownership share. Minority interest in the Statement of
Operations represents approximately 42% of iPlace's losses for the three and six
months ending December 31, 2000.
7
9
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 8 - COMPREHENSIVE INCOME
The components of comprehensive (loss) income are as follows (in thousands):
Three months ended Six months ended
December 31, December 31,
2000 1999 2000 1999
---------------- ------------- --------------- ------------
Net (loss) income $ (7,267) $ 3,008 $ (40,155) $ 5,342
Unrealized losses on marketable securities:
Unrealized loss on marketable securities - - (532) -
Reclassification adjustment for losses included
in net loss 532 - 532 -
Foreign currency translation gain 106 15 22 21
---------------- ------------- --------------- ------------
Comprehensive (loss) income $ (6,629) $ 3,023 $ (40,133) $ 5,363
================ ============= =============== ============
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 is subject. The Company is involved in other
lawsuits and claims generally incidental to its business. The Company may be
involved in other litigation or proceedings regarding claims arising in the
normal course of business, the adverse outcome of which, could potentially
require substantial payments by the Company. 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.
On July 7, 1999, a purported class action was instituted by plaintiffs Kathryn
Rosebear and Anne Bergman against the Company and other defendants in the United
States District Court, District of Minnesota. The suit, which seeks unspecified
monetary damages, alleges that the Company and the other defendants violated
their privacy policies and Minnesota consumer law. The Company believes that the
allegations made in this lawsuit are unfounded and the Company will vigorously
defend its interests against this suit.
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.
8
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 DECEMBER 31, 2000 VS. THREE MONTHS ENDED DECEMBER 31, 1999
REVENUES. Revenues increased 49% to $117.6 million for the quarter ended
December 31, 2000 from $78.9 million for the quarter ended December 31, 1999 due
to an increase in the Company's membership base, an increase in the weighted
average program fee and the impact of SAB 101. Excluding the effects of "Staff
Accounting Bulletin No. 101-Revenue Recognition in Financial Statements" ("SAB
101"), revenues would have increased 41% to $111.1 million in 2000. The
Company's membership base increased to approximately 7.8 million members at
December 31, 2000 from 5.8 million members at December 31, 1999. The increase in
the Company's membership base was due to increased demand for the Company's
existing programs, as well as the introduction of new programs. The increase in
the weighted average program fee was due to an increase in program pricing and
introduction of new programs with higher fees. Revenues from renewals increased
to $43.7 million in 2000 from $29.7 million in 1999. As a percentage of
individual membership revenues, these amounts represented 41% in both periods.
OPERATING EXPENSES. Operating expenses increased 53% to $21.7 million in 2000
from $14.2 million in 1999 due to the servicing requirements of the larger
membership base. As a percentage of revenues, operating expenses increased to
18.5% in 2000 from 18.0% in 1999. Excluding the effect of SAB 101, operating
expenses would have been 19.5% of revenues in 2000. Operating expenses, as a
percentage of revenues, increased primarily due to expansion of the call center
capacity as well as increased cost of membership benefits.
MARKETING EXPENSES. Marketing expenses increased 67% to $76.6 million in 2000
from $45.9 million in 1999 due to increased expenses required to grow the
membership base. As a percentage of revenues, marketing expenses increased to
65.2% in 2000 from 58.1% in 1999. Excluding the effect of SAB 101, marketing
expenses would have been 63.7% of revenues in 2000. Marketing expenses, as a
percentage of revenues, increased primarily due to the expansion of our online
business initiatives and higher cancellation rates.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 63% to $24.0 million in 2000 from $14.7 million in 1999. As a
percentage of revenues, general and administrative expenses increased to 20.4%
in 2000 from 18.7% in 1999. Excluding the effect of SAB 101, general and
administrative expenses would have been 21.6% of revenues in 2000. Expenses
increased in 2000 compared to 1999 due to higher staff related expenses and
occupancy costs related to the expansion of our online and international
business initiatives.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Intangible amortization
increased to $2.8 million in 2000 from $1.4 million in 1999 due to the
acquisition of three additional businesses since December 30, 1999.
9
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. Other expense increased to $0.2
million in 2000 from income of $0.3 million in 1999 due to the Company's
borrowings under its line of credit during the period.
PROVISION FOR INCOME TAXES. The Company was not required to record a provision
for income taxes for the three months ended December 31, 2000 and 1999 due to
tax losses realized in those periods.
SIX MONTHS ENDED DECEMBER 31, 2000 VS. SIX MONTHS ENDED DECEMBER 31, 1999
REVENUES. Revenues increased 43% to $215.4 million for the six months ended
December 31, 2000 from $150.6 million for the six months ended December 31, 1999
due to an increase in the Company's membership base and an increase in the
weighted average program fee. Excluding the effects of "Staff Accounting
Bulletin No. 101-Revenue Recognition in Financial Statements" ("SAB 101"),
revenues would have increased 44% to $217.3 million in 2000. The Company's
membership base increased to approximately 7.8 million members at December 31,
2000 from 5.8 million members at December 31, 1999. The increase in the
Company's membership base was due to increased demand for the Company's existing
programs, as well as the introduction of new programs. The increase in the
weighted average program fee was due to an increase in program pricing and
introduction of new programs with higher fees. Revenues from renewals increased
to $75.8 million in 2000 from $57.2 million in 1999. As a percentage of
individual membership revenues, these amounts represented 39% in 2000 and 41% in
1999. The decreased ratio was due to the adoption of SAB 101.
OPERATING EXPENSES. Operating expenses increased 54% to $42.0 million in 2000
from $27.2 million in 1999 due to the servicing requirements of the larger
membership base. As a percentage of revenues, operating expenses increased to
19.5% in 2000 from 18.1% in 1999. Excluding the effects of SAB 101, operating
expenses would have been 19.2% of revenues in 2000. Operating expenses, as a
percentage of revenue, increased primarily due to expansion of the call center
capacity.
MARKETING EXPENSES. Marketing expenses increased 59% to $137.9 million in 2000
from $86.5 million in 1999 due to increased expenses required to grow the
membership base. As a percentage of revenues, marketing expenses increased to
64.0% in 2000 from 57.5% in 1999. Excluding the effect of SAB 101, marketing
expenses would have been 63.4% of revenues in 2000. Marketing expenses, as a
percentage of revenues, increased primarily due to the expansion of our online
business initiatives and higher cancellation rates.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 62% to $47.6 million in 2000 from $29.4 million in 1999. As a
percentage of revenues, general and administrative expenses increased to 22.1%
in 2000 from 19.5% in 1999. Excluding the effect of SAB 101, general and
administrative expenses would have been 21.9% of revenues in 2000. Expenses
increased in 2000 compared to 1999 due to higher staff related expenses and
occupancy costs related to the expansion of our online and international
business initiatives.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Intangible amortization
increased to $5.1 million in 2000 from $2.6 million in 1999 due to the
acquisition of three additional companies since December 30, 1999.
10
12
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. Other expense increased to $0.2
million in 2000 from income of $0.7 million in 1999 due to the Company's
borrowings under its line of credit during the period.
PROVISION FOR INCOME TAXES. The Company was not required to record a provision
for income taxes for the six months ended December 31, 2000 and 1999 due to tax
losses realized in those periods.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operations was $12.0 million for the six months ended December
31, 2000 compared to $21.1 million in 1999. The six months ended December 31,
2000 reflects increased spending related to the expansion of the Company's
online and international initiatives compared to last year. Changes in working
capital items increased cash by $9.0 million in 2000 and $5.7 million in 1999.
Changes in working capital items increased in 2000 due to improved accounts
receivable collections and the timing of accounts payable terms.
Net cash used in investing activities was $10.8 million in 2000 versus $23.2
million in 1999. Investing activities during the six months ended December 31,
2000 include the receipt of $4.1 million in proceeds from the sale of a portion
of the Company's investment in 24/7 Media, Inc. and the use of $8.2 million in
cash for the acquisition of the remaining 81% of Discount Development Services,
Inc. and its subsidiary Uni-Care, Inc. The Company's capital expenditures for
the six months ended December 31, 2000 were $8.0 million in 2000. Investing
activities during the six months ended December 31, 1999 include the use of
$15.9 million in cash for the acquisition of the remaining 81% of
ConsumerInfo.Com and capital expenditures of $7.2 million.
Net cash provided by financing activities was $0.3 million in 2000 and net cash
used in financing activities was $19.1 million in 1999. The increase in cash
provided by financing activities was due to a reduction in treasury shares
acquired under the Company's stock repurchase program. The Company purchased
181,000 shares for $5.1 million during the six months ended December 31, 2000
and 727,000 shares for $20.0 million during the six months ended December 31,
1999. In addition, the Company received $5.0 million in proceeds from the sale
of its subsidiary's Preferred Stock during the December 2000 quarter.
As of December 31, 2000, the Company had cash and cash equivalents of $31.6
million. In addition, the Company has a $20 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 was no outstanding balance
under this bank credit facility as of December 31, 2000. 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.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
For over a year, the Company has disclosed in its public reporting that the
Securities and Exchange Commission staff (the "Staff") planned to issue guidance
on revenue recognition and that such guidance could have a material impact on
the way the Company has historically recognized revenue. The Staff issued SAB
101 in December 1999. SAB 101 establishes the Staff's preference that membership
fees should not be recognized in earnings prior to the expiration of refund
privileges. Notwithstanding the Staff's preference described above, it is also
stated in SAB 101 that the Staff will not object to the recognition of
refundable membership fees, net of estimated refunds, as earned revenue over the
membership period (the Company's historical method) in limited circumstances
where all of certain criteria set forth in SAB 101 have been met.
11
13
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 will be 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 $25.7
million was recorded in the fiscal quarter ended September 30, 2000. The
membership fees, net of estimated refunds and associated direct costs, which
will be deferred as part of the cumulative effect adjustment at July 1, 2000,
will be recognized in earnings during fiscal year 2001 as the underlying refund
privileges expire. During the three and six months ended December 31, 2000, the
Company recognized $22.1 million and $53.9 million, respectively, of revenue
which was included as a component of the cumulative effect of accounting change
booked July 1, 2000. The effect of the adoption of SAB 101 on reported revenue,
net loss before the cumulative effect of accounting change and net loss per
share before the cumulative effect of accounting change for the three months
ended December 31, 2000 is an increase of $6.5 million, and a decrease of $0.6
million and $0.04, respectively. The effect of the adoption of SAB 101 on
reported revenue, net loss before the cumulative effect of accounting change and
net loss per share before the cumulative effect of accounting change for the six
months ended December 31, 2000 is a decrease of $1.8 million, and an increase of
$2.2 million and $0.14, respectively.
This change in accounting for the recognition of membership fees in income has
no impact on the Company's cash flows or on the value of the underlying
memberships.
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains various forward-looking statements
and includes assumptions about future market conditions, operations and results.
These statements are based on current expectations and are subject to
significant risks and uncertainties. They are made pursuant to safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Among the
many factors that could cause actual results to differ materially from the
forward-looking statements are:
- Further changes in the already competitive environment for the Company's
products or competitors' responses to the Company's strategies;
- The Company's ability to integrate into the Company's management and
operations and to successfully operate acquired businesses, including
iPlace and DDS;
- Economic conditions in areas outside the United States;
- Continued growth within the United States;
- The Company's ability to develop and implement operational and financial
systems to manage rapidly growing operations;
- 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;
- Additional government regulation of the Company's industry; and
- New accounting pronouncements.
The Company undertakes no obligation to publicly update or revise any
forward-looking statement as a result of new information, future events or
otherwise.
12
14
MEMBERWORKS INCORPORATED
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate
The Company has a $20.0 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 December 31, 2000. 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
August 31, 2001, 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 and is, therefore, subject to
foreign currency rate exposure. Historically, its international sales have been
denominated in British pounds sterling. However, with the acquisition of a
Canadian subsidiary, certain sales are denominated in 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 at 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
MemberWorks does not use derivative financial instruments for speculative or
trading purposes. In February 2000, the Company sold its equity interest in
AwardTrack, Inc. in exchange for stock in 24/7 Media, Inc. ("24/7"). The
carrying value of this investment is affected by changes in the quoted market
prices of 24/7 common stock. The Company determines, on a quarterly basis, the
fair market value of the 24/7 shares and records an unrealized gain or loss
resulting from the change in the fair market value from the previous quarter to
the measurement date. If the Company sells all or a portion of this stock, any
unrealized gain or loss on the date of the sale will be recorded as a realized
gain or loss in the Company's results of operations. As of December 31, 2000,
the value recorded for this investment is $0.
13
15
MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION
ITEM 1. 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.
On May 5, 2000, Eye Care International, Inc. filed a complaint against the
Company in the United States District Court, Middle District of Florida. The
complaint sought monetary damages based upon the alleged breach of a vendor
contract. The complaint has been dismissed.
On July 7, 1999, a purported class action was instituted by plaintiffs Kathryn
Rosebear and Anne Bergman against the Company and other defendants in the United
States District Court, District of Minnesota. The suit, which seeks unspecified
monetary damages, alleges that the Company and the other defendants violated
their privacy policies and Minnesota consumer law. The Company believes that the
allegations made in this lawsuit are unfounded and the Company will vigorously
defend its interests against this suit.
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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
a) None
b) None
c) In October 2000, the Company increased its ownership in Discount Development
Services, L.L.C. and its subsidiary Uni-Care, Inc. from 19% to 100%. As
partial consideration, on October 12 and 20, 2000, the Company issued to
Innovative Group, L.L.C. a total of 425,232 shares of MemberWorks Common
Stock with an approximate fair value of $13,641,000 (as of the date the
Company entered into the purchase agreement). The securities were issued in
reliance on the private placement exemption under Section 4(2) of the
Securities Act, as amended. The Company subsequently registered the shares
pursuant to a Registration Statement filed on form S-3 on October 27, 2000.
c) None
14
16
MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION (CONTINUED)
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a) MemberWorks Incorporated's 2000 Annual Meeting of Stockholders was held on
November 15, 2000.
b) At the annual meeting the following Class I Directors were elected to the
Board of Directors as follows:
Marc S. Tesler: For - 12,681,983
Against - 69,670
Abstain - 0
Nonvotes - 2,226,195
Alec L. Ellison: For - 12,681,983
Against - 69,670
Abstain - 0
Nonvotes - 2,226,195
Class II Directors, Stephen J. Clearman and Michael R. O'Brien, and Class
III Directors, Gary A. Johnson and Dennis P. Walker, continue to serve as
Directors of the Company.
c) The ratification of PricewaterhouseCoopers LLP as the Company's independent
auditors was also approved at the annual meeting as follows:
For - 12,745,082
Against - 1,715
Abstain - 4,856
Nonvotes - 2,226,195
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
None
b) Reports on Form 8-K
None
15
17
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: February 12, 2001 By: /s/ Gary A. Johnson
---------------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
February 12, 2001 By: /s/ James B. Duffy
-----------------------------------
James B. Duffy, Executive Vice President
and Chief Financial Officer (Principal
Financial and Accounting Officer)
16