UNITED STATES
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
December 31, 2003
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 No. 0-21527
MEMBERWORKS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
------------------------ ----------------
(State of Incorporation) (IRS Employer
Identification No.)
680 Washington Boulevard
Stamford, Connecticut 06901
--------------------------------------- ----------------
(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 (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
[X] Yes [ ] No
Indicate the number of shares outstanding of each of the registrant's class of
common stock as of the latest practicable date: 10,335,240 shares of Common
Stock, $0.01 par value as of January 23, 2004.
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, 2003
and June 30, 2003 2
Condensed Consolidated Statements of Operations for the three
and six months ended December 31, 2003 and 2002 3
Condensed Consolidated Statements of Cash Flows for the six
months ended December 31, 2003 and 2002 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Forward Looking Statements 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 17
Item 4 Controls and Procedures 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2 Changes in Securities and Use of Proceeds 19
Item 4 Submission of Matters to a Vote of Security Holders 19
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
1
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
December 31, June 30,
2003 2003
---------------- -------------
Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 119,995 $ 72,260
Restricted cash 3,169 2,732
Accounts receivable (net of allowance for doubtful accounts of $1,744 and
$1,743, at December 31, 2003 and June 2003, respectively) 11,477 8,713
Prepaid membership materials 3,742 2,196
Prepaid expenses and other current assets 6,932 7,571
Membership solicitation and other deferred costs 62,618 77,883
---------------- -------------
Total current assets 207,933 171,355
Fixed assets, net 22,855 24,969
Goodwill (Note 4) 42,039 42,039
Intangible assets, net (Note 4) 6,277 6,656
Other assets 6,102 3,486
---------------- -------------
Total assets $ 285,206 $ 248,505
================ =============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 28 $ 244
Accounts payable 29,365 32,644
Accrued liabilities 64,982 59,105
Deferred membership fees 150,062 167,643
Deferred income taxes 6,171 879
---------------- -------------
Total current liabilities 250,608 260,515
Deferred income taxes 5,157 5,145
Other long-term liabilities 2,993 3,128
Convertible debt (Note 6) 90,000 -
---------------- -------------
Total liabilities 348,758 268,788
---------------- -------------
Commitments and contingencies (Note 11) - -
Shareholders' deficit:
Preferred stock, $0.01 par value -- 1,000 shares authorized; no shares issued - -
Common stock, $0.01 par value -- 40,000 shares authorized;
18,998 shares issued (17,847 shares at June 30, 2003) 190 178
Capital in excess of par value 146,646 122,425
Accumulated deficit (6,269) (17,829)
Accumulated other comprehensive loss (453) (469)
Treasury stock, 8,604 shares at cost (6,126 shares at June 30, 2003) (203,666) (124,588)
---------------- -------------
Total shareholders' deficit (63,552) (20,283)
---------------- -------------
Total liabilities and shareholders' deficit $ 285,206 $ 248,505
================ =============
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)
Three months ended Six months ended
December 31, December 31,
--------------------------- ---------------------------
2003 2002 2003 2002
------------- ------------ ------------ ------------
Revenues $ 123,164 $ 114,045 $ 236,988 $ 219,049
Expenses:
Marketing 66,745 69,899 133,401 135,448
Operating 23,042 19,178 44,505 37,252
General and administrative 19,195 18,764 37,962 37,627
Amortization of intangible assets 271 346 589 739
---------- ---------- --------- ---------
Operating income 13,911 5,858 20,531 7,983
Settlement of investment related litigation - - - 19,148
Loss on sale of subsidiary - - - (959)
Net loss on investment - - - (206)
Interest expense (1,456) (25) (1,570) (57)
Other income, net 320 246 305 397
---------- ---------- --------- ---------
Income before income taxes 12,775 6,079 19,266 26,306
Provision for income taxes 5,110 2,432 7,706 10,523
---------- ---------- --------- ---------
Net income $ 7,665 $ 3,647 $ 11,560 $ 15,783
========== ========== ========= ==========
Basic earnings per share $ 0.71 $ 0.29 $ 1.03 $ 1.22
========== ========== ========= ==========
Diluted earnings per share $ 0.60 $ 0.27 $ 0.91 $ 1.17
========== ========== ========= ==========
Weighted average common shares used in earnings per share calculations:
Basic 10,756 12,735 11,192 12,949
========== ========== ========= ==========
Diluted 14,074 13,396 13,541 13,530
========== ========== ========= ==========
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 six months ended
December 31,
----------------------------
2003 2002
------------ -------------
Operating activities
Net income $ 11,560 $ 15,783
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred membership fees (17,733) (9,909)
Change in membership solicitation and other deferred costs 15,368 20,775
Depreciation and amortization 5,242 6,169
Deferred income taxes 5,304 9,744
Tax benefit from employee stock plans 1,553 297
Gain on settlement of investment related litigation - (19,148)
Loss on sale of subsidiary - 959
Net loss on investment - 206
Other 720 382
Change in assets and liabilities:
Restricted cash (437) 2,841
Accounts receivable (2,764) (1,529)
Prepaid membership materials (1,996) (1,169)
Prepaid expenses and other current assets 1,243 334
Other assets (140) (424)
Accounts payable (3,351) 1,044
Accrued liabilities 5,872 6,522
----------- -----------
Net cash provided by operating activities 20,441 32,877
----------- -----------
Investing activities
Acquisition of fixed assets (2,538) (2,762)
Settlement of investment related litigation - 19,148
Purchase price adjustments from sale of subsidiary - (750)
----------- -----------
Net cash (used in) provided by investing activities (2,538) 15,636
----------- -----------
Financing activities
Net proceeds from exercise of stock options 22,551 1,851
Treasury stock purchases (79,078) (14,957)
Net proceeds from issuance of convertible debt 86,568 -
Payments of long-term obligations (250) (927)
----------- -----------
Net cash provided by (used in) financing activities 29,791 (14,033)
----------- -----------
Effect of exchange rate changes on cash and cash equivalents 41 (32)
----------- -----------
Net increase in cash and cash equivalents 47,735 34,448
Cash and cash equivalents at beginning of period 72,260 45,502
----------- -----------
Cash and cash equivalents at end of period $ 119,995 $ 79,950
============ ===========
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
adjustments) considered necessary for a fair presentation have been included.
The preparation of these consolidated financial statements in conformity with
generally accepted accounting principles requires management of MemberWorks
Incorporated ("the Company" or "MemberWorks") to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates. Operating results for
the three and six months ended December 31, 2003 are not necessarily indicative
of the results that may be expected for the fiscal year ending June 30, 2004.
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, 2003.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
include the accounts of the Company and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
NOTE 2 - RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
NOTE 3 - STOCK-BASED COMPENSATION
In accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), the Company applies the intrinsic value
method in accounting for employee stock options. Accordingly, the Company
generally does not recognize compensation expense with respect to stock-based
awards to employees. If compensation cost for the Company's stock-based
compensation plans had been determined based on the fair value (estimated using
the Black-Scholes option-pricing model) at the grant dates for awards under
those plans consistent with the method of Financial Accounting Standards Board
Statement ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), and SFAS No. 148, "Accounting for Stock-Based Compensation Transition and
Disclosure" ("SFAS 148"), the Company's pro forma net income and earnings per
share would have been as follows:
Three months ended Six months ended
December 31, December 31,
-------------------------- -------------------------
2003 2002 2003 2002
-------------------------- ------------ ------------
Net income reported $ 7,665 $ 3,647 $ 11,560 $ 15,783
Add: Stock-based employee compensation expense determined under
the intrinsic value based method for all awards, net of
related tax effects - - - -
Deduct: Stock-based employee compensation expense determined
under the fair value based method for all awards, net of
related tax effects 1,262 1,486 2,527 3,071
----------- ---------- ---------- ----------
Pro forma net income $ 6,403 $ 2,161 $ 9,033 $ 12,712
=========== ========== ========== ==========
Earnings per share:
As reported:
Basic $ 0.71 $ 0.29 $ 1.03 $ 1.22
Diluted $ 0.60 $ 0.27 $ 0.91 $ 1.17
Pro forma:
Basic $ 0.60 $ 0.17 $ 0.81 $ 0.98
Diluted $ 0.51 $ 0.16 $ 0.72 $ 0.94
5
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
As of December 31, 2003 As of June 30, 2003
------------------------------------ -----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------------------ ----------------- ----------------- ---------------
Amortized intangible assets:
Membership and Client Relationships $ 13,405 $ (7,269) $ 13,195 $ (6,730)
Other 950 (809) 950 (759)
------------- ------------- ------------- ------------
Total amortized intangible assets $ 14,355 $ (8,078) $ 14,145 $ (7,489)
------------- ------------- ------------- ------------
Intangible assets, net $ 6,277 $ 6,656
============= =============
Unamortized intangible assets:
Goodwill $ 42,039 $ 42,039
============= =============
Acquired intangibles, except member relationships, are recorded at cost and are
amortized on a straight-line basis over their estimated useful lives ranging
from 3 to 20 years. The value of member relationships is amortized using an
accelerated method based on estimated future cash flows. The future intangible
amortization expense for the next five years is estimated to be as follows (in
thousands):
Fiscal Year:
2004 1,090
2005 900
2006 755
2007 599
2008 485
As a result of increased integration of operations and management at three of
its five reporting units during fiscal 2003, the Company aggregated these three
reporting units into a single reporting unit for fiscal 2004 impairment testing
purposes, resulting in a total of three reporting units in the current year.
Goodwill was tested for impairment during the quarter ended September 30, 2003
as required by SFAS 142. The Company concluded that none of its goodwill was
impaired. Fair value was estimated using discounted cash flow methodologies. In
addition, the Company reassessed the estimated useful lives of its
definite-lived intangible assets and determined that the lives were appropriate.
The Company will test the goodwill of each of its reporting units annually or
more frequently if impairment indicators exist.
NOTE 5 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated balance
sheets as of December 31, 2003 and June 30, 2003 include an allowance for
membership cancellations of $21,320,000 and $20,934,000, respectively. Recording
an allowance for membership cancellations has the effect of reducing the amount
of deferred membership fees recorded.
NOTE 6 - CONVERTIBLE DEBT
On September 30, 2003, the Company issued $90,000,000 aggregate principal amount
of 5.5% convertible senior subordinated notes ("Notes") due September 2010 in a
private offering pursuant to rule 144A of the Securities Act of 1933, as
amended. The Notes bear interest at the rate of 5.5% per year, which will be
payable in cash semi-annually in arrears on April 1 and October 1 of each year,
with the first payment due on April 1, 2004. Holders of the Notes may convert
their Notes into shares of MemberWorks common stock at any time prior to
maturity at an initial conversion price of approximately $40.37 per share, which
is equivalent to an initial conversion rate of approximately 24.7739 shares per
$1,000 principal amount of the Notes. In accordance with Accounting Principles
Board Opinion No. 14, "Accounting for Convertible Debt and Debt Issued with
Stock Purchase Warrants," these Notes have been classified as a liability.
On December 3, 2003, Memberworks filed on Form S-3 a shelf registration
statement with the Securities and Exchange Commission covering the resale of the
Notes and the common stock issuable upon their conversion, which has not yet
been declared effective.
6
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Debt issuance costs associated with this issuance were $3,432,000 for the six
months ended December 31, 2003. Debt issuance costs are capitalized and
amortized as interest expense over the term of the Notes using the effective
interest method.
NOTE 7 - RESTRUCTURING CHARGES
During fiscal 2002, the Company announced the implementation of several cost
saving initiatives due to a slowdown in consumer response rates and increased
economic uncertainty in both the U.S. and abroad. This restructuring program
included a workforce reduction, the closing of the Company's United Kingdom
operations and the downsizing of the operational infrastructure throughout the
Company. As a result of the restructuring program, the Company recorded
restructuring charges of $6,893,000 during the quarter ended December 31, 2001.
The following is a rollforward of the major components of the restructuring
reserve (in thousands) which is recorded in accrued liabilities and other
long-term liabilities:
Workforce Lease
Reduction Obligations Total
-------------- ------------- -------------
Restructuring reserve balance at June 30, 2002 $ 391 $ 2,546 $ 2,937
Additions to the reserve - - -
Charges to the reserve 300 836 1,136
-------------- ------------- -------------
Restructuring reserve balance at June 30, 2003 91 1,710 1,801
Additions to the reserve - - -
Charges to the reserve 54 41 95
-------------- ------------- -------------
Restructuring reserve balance at December 31, 2003 $ 37 $ 1,669 $ 1,706
============== ============= =============
NOTE 8 - INCOME TAX EXPENSE
Income tax expense as a percentage of pre-tax income was 40% for the three and
six months ended December 31, 2003 and 2002. The effective tax rate was higher
than the U.S. statutory rate for the three and six months ended December 31,
2003 and 2002 primarily due to state taxes and other non-deductible items. Tax
benefits resulting from the exercise of nonqualified stock options and the
disqualifying dispositions of shares issued under the Company's stock based
compensation plans reduced taxes payable by $38,000 and $271,000 during the
quarter ended December 31, 2003 and 2002, respectively. Tax benefits resulting
from the exercise of nonqualified stock options and the disqualifying
dispositions of shares issued under the Company's stock based compensation plans
reduced taxes payable by $1,553,000 and $297,000 during the six months ended
December 31, 2003 and 2002, respectively. Such benefits are credited to capital
in excess of par value.
7
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 9 - EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance with
the provisions of SFAS 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 per share (in thousands, except per share data):
Three Months Ended Six Months Ended
December 31, December 31,
-------------------------- ------------------------
2003 2002 2003 2002
------------- ------------ ----------- ------------
Numerator:
Income available to common shareholders used in basic earnings per
share $ 7,665 $ 3,647 $ 11,560 $ 15,783
Add back: Interest expense on convertible securities 743 - 751 -
------------- ------------ ----------- ------------
Income available to common shareholders after assumed conversion of
convertible debt for diluted earnings per share $ 8,408 $ 3,647 $ 12,311 $ 15,783
============= ============ =========== ============
Denominator:
Weighted average number of common shares outstanding - basic 10,756 12,735 11,192 12,949
Effect of dilutive securities:
Convertible securities 2,230 - 1,127 -
Options 1,088 661 1,222 581
------------- ------------ ----------- ------------
Weighted average number of common shares outstanding - diluted 14,074 13,396 13,541 13,530
============= ============ =========== ============
Basic earnings per share $ 0.71 $ 0.29 $ 1.03 $ 1.22
============= ============ =========== ============
Diluted earnings per share $ 0.60 $ 0.27 $ 0.91 $ 1.17
============= ============ =========== ============
The diluted earnings per share calculation excludes the effect of potentially
dilutive shares when their effect is antidilutive. For the three months ended
December 31, 2003 and 2002, the Company had 996,000 and 3,041,000 shares,
respectively, of potentially dilutive stock options outstanding that are not
included in the calculation as they are antidilutive. For the six months ended
December 31, 2003 and 2002, the Company had 765,000 and 3,112,000 shares,
respectively, of potentially dilutive stock options that are not included in the
calculations as they are antidilutive.
NOTE 10 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three months ended Six months ended
December 31, December 31,
-------------------------- --------------------------
2003 2002 2003 2002
------------ ------------- ------------- ------------
Net income $ 7,665 $ 3,647 $ 11,560 $ 15,783
Foreign currency translation gain (loss) 14 5 16 (80)
------------ ------------- ------------- ------------
Comprehensive income $ 7,679 $ 3,652 $ 11,576 $ 15,703
============ ============= ============= ============
NOTE 11 - COMMITMENTS AND CONTINGENCIES
The Company operates in leased facilities. Management expects that leases
currently in effect will be renewed or replaced by other leases of a similar
nature and term.
As of December 31, 2003, the Company has purchase obligations of $1,407,000
outstanding, of which $250,000 has been recorded in the Condensed Consolidated
Balance Sheet.
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 including, but not
limited to, various suits, including previously disclosed suits, brought against
the Company by individual consumers seeking monetary and/or injunctive relief
relating to the marketing of
8
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
the Company's programs. 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 March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance 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 Monumental Life
Insurance Company insurance products. The complaint includes a claim that the
suit should be certified as a class action and the plaintiff has filed a motion
for class certification to which all of the defendants have filed opposing
papers regarding the same. The Court certified a class of Michigan residents.
The Court of Appeals denied the defendants' petition for leave to appeal the
certification order. No discovery scheduling order has been set. The Company
believes that the claims made against Coverdell are unfounded and Coverdell and
the Company will vigorously defend their interests against this suit.
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that MemberWorks was not liable to MedVal for
any compensatory damages, they awarded $5,495,000 in punitive damages and costs
against MemberWorks solely under CUTPA. MemberWorks believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. On June 22, 2003, the Superior Court
denied the Company's motion to vacate the award, and the Company filed an appeal
of that decision. While the Company intends to take action to prevent the
enforcement of the award by, among other things, vigorously pursuing an appeal,
there can be no assurance that MemberWorks will be successful in its efforts.
The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company were
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
On October 21, 2003, the Florida Attorney General's Office filed a civil
complaint against the Company based upon concerns that some of its past
marketing practices may have violated various consumer laws. The Company
believes that any legitimate concerns have previously been fully addressed,
including the implementation of industry-leading Best Marketing Practices and
voluntary agreements incorporating those practices, such as the nationwide
assurance agreement that the Company entered into with the State of Nebraska in
2001. The Company believes that the allegations of the complaint are unfounded
and the Company intends to vigorously defend its interests in this matter. The
Company further believes that the potential liability represented by the lawsuit
and the final resolution of this matter will not be material to the Company.
NOTE 12 - NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which was revised in December 2003. FIN
46 clarifies the application of Accounting Research Bulletin No. 51 and provides
guidance on the identification of and reporting for variable interest entities.
FIN 46 is effective immediately for variable interest entities formed after
January 31, 2003 and is effective for periods ending after March 15, 2004 for
any variable interest entity formed prior to February 1, 2003. While it will
continue to evaluate the requirements of FIN 46, MemberWorks does not believe
that the adoption of FIN 46 will have a material impact on the Company's
financial statements.
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity " ("SFAS 150"). This statement requires that certain
financial instruments that were accounted for as equity under previous guidance
be classified as liabilities in statements of financial position. SFAS 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS 150 did not have a material
impact on the Company's financial statements.
9
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MemberWorks designs and manages innovative membership programs and provides
organizations with an opportunity to leverage the expertise of an outside
provider in offering these membership programs to their customers. Membership
programs offer selected products and services from a variety of vendors for
either an annual fee or a monthly fee. MemberWorks derives its revenues
principally from renewable membership fees, which are billed to the customer
either on an annual or monthly basis. In the case of annual programs, the
Company receives full payment at or near the beginning of the membership period,
but recognizes the revenue as the member's refund privilege expires. Membership
fees that are billed monthly are recognized when earned. MemberWorks has
traditionally marketed its membership programs with an up-front annual
membership fee. However, during fiscal 2003, the Company expanded its marketing
of membership programs in which the membership fee is payable in monthly
installments. It is the Company's intention to further increase the mix of
monthly payment programs during fiscal 2004. 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.
In accordance with Financial Accounting Standards Board ("FASB") Statement 131,
"Disclosures about Segments of an Enterprise and Related Information,"
MemberWorks operates in one reportable operating segment.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that are important to the
Company's financial condition and results of operations and involve subjective
or complex judgments on the part of management, often as a result of the need to
make estimates. The following areas all require the use of judgments and
estimates: membership cancellation rates, deferred marketing costs, valuation of
goodwill and intangible assets, estimation of remaining useful lives of
intangible assets and valuation of deferred tax assets. Estimates in each of
these areas are based on historical experience and various assumptions that
MemberWorks believes are appropriate. Actual results may differ from these
estimates. MemberWorks believes the following represent the critical accounting
policies of the Company as contemplated by Financial Reporting Release No. 60,
"Cautionary Advice Regarding Disclosure about Critical Accounting Policies." For
a summary of all of the Company's significant accounting policies, see Note 2 of
the Notes to the consolidated financial statements located in the Company's 2003
Annual Report on Form 10-K.
Revenue recognition
Membership fees are billed through clients of the Company primarily through
credit cards. In the case of annually billed membership programs, members may
cancel their membership in the program generally for a prorata refund of the
membership fee based on the remaining portion of the membership period. In
accordance with Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"), deferred membership fees are recorded, net of estimated
cancellations, and are amortized as revenues from membership fees upon the
expiration of membership refund privileges. An allowance for membership
cancellations is established based on management's estimates and is updated
regularly. In determining the estimate of allowance for membership
cancellations, management analyzes historical cancellation experience, current
economic trends and changes in customer demand for the Company's products.
Actual membership cancellations are charged against the allowance for membership
cancellations on a current basis. If actual cancellations differ from the
estimate, the revenues would be impacted.
Membership solicitation and other deferred costs
The Company's marketing expenses are comprised of telemarketing, direct mail,
refundable royalty payments, non- refundable royalty payments and advertising
costs. Telemarketing and direct mail costs are direct response advertising costs
which are accounted for in accordance with American Institute of Certified
Public Accountants Statement of Position 93-7, "Reporting on Advertising Costs"
("SOP 93-7"). Under SOP 93-7, direct response advertising costs are deferred and
charged to operations over the membership period as revenues from membership
fees are recognized. Refundable royalty payments are also deferred and charged
to operations over the membership period in order to match the marketing costs
with the associated revenues from membership fees. Advertising costs and
non-refundable royalty payments, which include fee per pitch, fee per sale and
fee per impression marketing arrangements, are expensed when incurred.
10
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Total membership solicitation costs incurred to obtain a new member are
generally less than the estimated total membership fees. However, if total
membership solicitation costs were to exceed total estimated membership margins,
an adjustment would be made to the membership solicitation and other deferred
costs balance and marketing expenses to the extent of any impairment.
Valuation of goodwill and other intangibles
MemberWorks reviews the carrying value of its goodwill and other intangible
assets and assesses the remaining estimated useful lives of its intangible
assets in accordance with FASB Statement No. 142, "Goodwill and Other Intangible
Assets." The Company reviews the carrying value of its goodwill and other
intangible assets for impairment by comparing such amounts to their fair values.
MemberWorks is required to perform this comparison at least annually or more
frequently if circumstances indicate possible impairment. When determining fair
value, the Company utilizes various assumptions, including projections of future
cash flows. A change in these underlying assumptions would cause a change in the
results of the tests and, as such, could cause fair value to be less than the
carrying amounts. In such an event, MemberWorks would then be required to record
a corresponding charge, which would negatively impact earnings. Goodwill at July
1, 2003 and 2002 was tested for impairment during the quarters ended September
30, 2003 and 2002, respectively. The Company concluded that none of its goodwill
was impaired as of July 1, 2003 nor 2002.
Income Taxes
The Company accounts for income taxes under the provisions of FASB Statement No.
109, "Accounting for Income Taxes." Deferred tax assets and liabilities are
recognized for future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. MemberWorks estimates current tax provisions or
benefits based on a projected effective tax rate for the fiscal year ended June
30, 2004 using the most currently available information and forecasts. The
projected effective tax rate is updated for actual results and estimates when
they become known. In addition, MemberWorks assesses the realization of deferred
tax assets considering various assumptions, including estimates of future
taxable income and ongoing tax strategies. A change in these underlying
assumptions would impact the results of operations.
THREE MONTHS ENDED DECEMBER 31, 2003 VS. THREE MONTHS ENDED DECEMBER 31, 2002
REVENUES. Revenues increased 8% to $123.2 million for the quarter ended December
31, 2003 from $114.0 million for the quarter ended December 31, 2002. The
increase in revenues is primarily due to an increase in the weighted average
program price point. As a result of the Company's strategic initiative to shift
new marketing towards members on a monthly payment program, the renewal revenues
from annual payment programs as a percentage of total revenues decreased to 41%
in 2003 from 50% in 2002. Revenues from members who are charged on a monthly
payment program increased to $41.4 million for the quarter ended December 31,
2003 from $17.4 million for the quarter ended December 31, 2002 due to an
increase in members enrolled in a monthly payment plan. Net active members at
December 31, 2003 were 6.3 million, which is flat from prior year.
MARKETING EXPENSES. Marketing expenses consist of costs incurred to obtain new
members and royalties paid to clients. Marketing expenses decreased 5% to $66.7
million for the quarter ended December 31, 2003 from $69.9 million for the
quarter ended December 31, 2002 and, as a percentage of revenue, marketing
expenses decreased to 54.2% in 2003 from 61.3% in 2002. The improvement in the
marketing expense ratio is primarily due to the increase in the mix of marketing
in the Company's more profitable MemberLink and online channels.
OPERATING EXPENSES. Operating expenses consist of member service call center
costs, membership benefit costs and membership program fulfillment costs.
Operating expenses increased 20% to $23.0 million for the quarter ended December
31, 2003 from $19.2 million for the quarter ended December 31, 2002. As a
percentage of revenues, operating expenses increased to 18.7% for the quarter
ended December 31, 2003 from 16.8% for the quarter ended December 31, 2002.
These increases were due to increased call center and other related costs
incurred to service the membership base.
11
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily include personnel-related costs, occupancy costs and other overhead
costs. General and administrative expenses increased 2% to $19.2 million for the
quarter ended December 31, 2003 versus $18.8 million for the quarter ended
December 31, 2002. As a percentage of revenues, general and administrative
expenses decreased to 15.6% in 2003 from 16.5% in 2002 primarily due to
leveraging the increase in our reported revenues.
INTEREST EXPENSE. Interest expense consists primarily of interest expense and
the amortization of debt issuance costs related to the Company's line of credit
and convertible senior subordinated notes. Interest expense increased to $1.5
million for the quarter ended December 31, 2003 from $25,000 for the quarter
ended December 31, 2002. The increase is due to the issuance of the convertible
senior subordinated notes in September 2003.
PROVISION FOR INCOME TAXES. During the quarter ended December 31, 2003, the
Company recorded a tax provision of $5.1 million based on an effective tax rate
of approximately 40%. The effective tax rate was higher than the U.S. federal
statutory rate for the quarter ended December 31, 2003 primarily due to state
taxes and other non-deductible items. During the quarter ended December 31,
2002, the Company recorded a tax provision of $2.4 million based on an effective
tax rate of approximately 40%.
SIX MONTHS ENDED DECEMBER 31, 2003 VS. SIX MONTHS ENDED DECEMBER 31, 2002
REVENUES. Revenues increased 8% to $237.0 million for the six months ended
December 31, 2003 from $219.0 million for the six months ended December 31,
2002. The increase in revenues is primarily due to an increase in the weighted
average program price point. As a result of the Company's strategic initiative
to shift new marketing towards members on a monthly payment program, renewal
revenues from annual payment programs as a percent of total revenues decreased
to 41% in 2003 from 48% in 2002. Revenues from members who are charged on a
monthly payment program increased to $67.7 million for the six months ended
December 31, 2003 from $33.8 million for the six months ended December 31, 2002
due to an increase in members enrolled in a monthly payment plan.
MARKETING EXPENSES. Marketing expenses decreased 2% to $133.4 million for the
six months ended December 31, 2003 from $135.4 million for the six months ended
December 31, 2002 and, as a percentage of revenue, marketing expenses decreased
to 56.3% in 2003 from 61.8% in 2002. The improvement in the marketing expense
ratio is primarily due to the increase in the mix of marketing in the Company's
more profitable MemberLink and online channels.
OPERATING EXPENSES. Operating expenses increased 19% to $44.5 million for the
six months ended December 31, 2003 from $37.3 million for the six months ended
December 31, 2002. As a percentage of revenues, operating expenses increased to
18.8% for the six months ended December 31, 2003 from 17.0% for the six months
ended December 31, 2002. These increases were due to increased call center and
other related costs incurred to service the membership base.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
$38.0 million for the six months ended December 31, 2003 versus $37.6 million
for the six months ended December 31, 2002. As a percentage of revenues, general
and administrative expenses decreased to 16.0% in 2003 from 17.2% in 2002
primarily due to leveraging the increase in our reported revenues.
INTEREST EXPENSE. Interest expense increased to $1.6 million for the six months
ended December 31, 2003 from $57,000 for the six months ended December 31, 2002.
The increase is due to the issuance of the convertible senior subordinated notes
in September 2003.
PROVISION FOR INCOME TAXES. During the six months ended December 31, 2003, the
Company recorded a tax provision of $7.7 million based on an effective tax rate
of approximately 40%. The effective tax rate was higher than the U.S. federal
statutory rate for the six months ended December 31, 2003 primarily due to state
taxes and other non-deductible items. During the six months ended December 31,
2002, the Company recorded a tax provision of $10.5 million based on an
effective tax rate of approximately 40%.
12
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $20.4 million for the six months
ended December 31, 2003 versus $32.9 million for the six months ended December
31, 2002. The decrease in operating cash flow in the six months ended December
31, 2003 versus the prior year was primarily due to the impact of changes in
assets and liabilities which reduced cash by $1.6 million in the six months
ended December 31, 2003 and increased cash by $7.6 million in the six months
ended December 31, 2002. The decrease in changes in assets and liabilities over
the prior year was primarily driven by the timing of vendor payments. Also
contributing to the decrease in operating cash flow were increased operating
expenses partially offset by an increase in marketing margin before deferral
(revenues before deferral less marketing costs before deferral). As a percent of
revenue before deferral, marketing costs before deferral were 53.8% in the six
months ended December 31, 2003 compared to 54.8% in the six months ended
December 31, 2002.
The Company's management believes that revenues before deferral and marketing
costs before deferral are important measures of liquidity. Revenues before
deferral are revenues before the application of SAB 101 and represent the actual
membership fees billed during the current reporting period less an allowance for
membership cancellations. Marketing costs before deferral are marketing costs
before the application of SAB 101 and SOP 93-7 and represent the Company's
obligation for marketing efforts that occurred during the current reporting
period.
Revenues before deferral for the six months ended December 31, 2003 and 2002 are
calculated as follows:
December 31,
----------------------------
2003 2002
------------- -------------
Revenues reported in the Statements of Operations $ 236,988 $ 219,049
Change in deferred membership fees (17,733) (9,909)
------------- -------------
Revenues before deferral $ 219,255 $ 209,140
============= =============
Revenues before deferral increased 5% to $219.3 million for the six months ended
December 31, 2003 from $209.1 million for the six months ended December 31,
2002. The increase in revenues is primarily due to an increase in the weighted
average program price point. The following table summarizes the weighted average
price points over the six months ended December 31:
Fiscal Year Fiscal Year
2004 2003
----------------- ----------
Weighted Average Annual Price Points:
First Quarter $105 $96
Second Quarter $107 $104
Weighted Average Monthly Price Points:
First Quarter $10.72 $9.44
Second Quarter $11.54 $9.76
Revenues before deferral from members who are charged on a monthly payment
program were $74.7 million during the six months ended December 31, 2003 and
$33.8 million during the six months ended December 31, 2002. The following table
summarizes the average monthly members billed each month during the six months
ended December 31:
Fiscal Year Fiscal Year
2004 2003
----------------- -------------
First Quarter 955 576
Second Quarter 1,239 588
13
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The following table summarizes the components of revenues before deferral for
the six months ended December 31:
2003 2002
----------------- -------------
New annual 19% 35%
Renewal annual 47% 49%
Monthly 34% 16%
As a percentage of total revenues before deferral, renewal revenues from annual
payment programs decreased to 47% in the six months ended December 31, 2003 from
49% in the six months ended December 31, 2002 due to the Company's strategic
initiative to shift new marketing towards members on a monthly payment program.
This shift to monthly payment programs has a near-term negative impact on
operating cash flow due to the timing of revenues collected relative to the
corresponding timing of marketing expenditures. Net active members as of
December 31, 2003 were 6.3 million, which is flat from prior year.
Marketing costs before deferral for the six months ended December 31, 2003 and
2002 are calculated as follows:
December 31,
----------------------------
2003 2002
------------- -------------
Marketing expenses reported in the Statements of Operations $ 133,401 135,448
Change in membership solicitation and other deferred costs (15,368) (20,775)
------------- -------------
Marketing costs before deferral $ 118,033 114,673
============= =============
Marketing costs before deferral increased 3% to $118.0 million for the six
months ended December 31, 2003 from $114.7 million for the six months ended
December 31, 2002. As a percent of revenues before deferral, marketing expenses
before deferral were 53.8% for the six months ended December 31, 2003 and 54.8%
for the six months ended December 31, 2002. The decrease is primarily due to the
increase in the mix of marketing in the Company's more profitable MemberLink and
Online channels.
Net cash used in investing activities was $2.5 million during the six months
ended December 31, 2003 versus net cash provided by investing activities of
$15.6 million during the six months ended December 31, 2002. Net cash provided
by investing activities during the six months ended December 31, 2002 included
$19.1 million of proceeds related to the settlement of a lawsuit and $0.8
million of funds paid in connection with a purchase price adjustment related to
the sale of iPlace, Inc. Capital expenditures were $2.5 million during the six
months ended December 31, 2003 and $2.8 million during the six months ended
December 31, 2002.
Net cash provided by financing activities was $29.8 million for the six months
ended December 31, 2003 versus net cash used in financing activities of $14.0
million for the six months ended December 31, 2002. The increase in cash
provided by financing activities was primarily due to the issuance of $90.0
million aggregate principal amount convertible senior subordinated notes
("Notes") due September 2010. The Notes bear interest at the rate of 5.5% per
year, which will be payable in cash semi-annually in arrears on April 1 and
October 1 of each year, with the first payment due on April 1, 2004. The net
proceeds will be used for general corporate purposes, including mergers and
acquisitions and additional repurchases of the Company's common stock under its
stock buyback program. Upon the occurrence of a change in control, holders of
the Notes may require the Company to repurchase all or part of the Notes for
cash. In addition, the Company received $22.6 million from the exercise of stock
options during the six months ended December 31, 2003. These increases in
financing activities during the six months ended December 31, 2003 were offset
by increased spending under the Company's stock repurchase program. The Company
purchased 2,478,000 shares for $79.1 million, an average price of $31.91, during
the six months ended December 31, 2003 compared to 873,000 shares for $15.0
million, an average price of $17.13, during the six months ended December 31,
2002. The Company utilized cash from operations, stock option exercises and the
issuance of the Notes to repurchase shares. During the six months ended December
31, 2003, the Board of Directors authorized 2.0 million additional shares to be
repurchased under the buyback program. As of December 31, 2003, the Company had
500,000 shares available for repurchase under its buyback program. In January
2004, the Board of Directors authorized an additional 1.0 million shares to be
repurchased under the buyback program.
14
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
As of December 31, 2003, the Company had cash and cash equivalents of $120.0
million. In addition, 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. As of December 31, 2003, the
effective interest rate for borrowings was 4.0%. As of December 31, 2003,
availability under the bank credit facility was reduced by an outstanding letter
of credit of $5.5 million. The bank credit facility has certain financial
covenants, including a maximum debt coverage ratio, a minimum fixed charges
ratio, potential restrictions on additional borrowings and potential
restrictions on additional stock repurchases. As of December 31, 2003, the
Company was in compliance with all such debt covenants. The Company believes
that existing cash balances, together with its available bank credit facility,
will be sufficient to meet its funding requirements for the foreseeable future.
The Company did not have any material commitments for capital expenditures as of
December 31, 2003. The Company intends to utilize its existing cash balances and
cash generated from operations to fulfill any capital expenditure requirements
for the remainder of fiscal 2004.
COMMITMENTS
The Company is not aware of any factors that are reasonably likely to adversely
affect liquidity trends, other than the risk factors presented in the Forward
Looking Statements in this Form 10-Q filing. The Company does not have
off-balance sheet arrangements, non-exchange traded contracts or material
related party transactions.
Future minimum payments of contractual obligations as of December 31, 2003 are
as follows (amounts in thousands):
Payments Due by Period
-------------------------------------------------------------------------------
Less than
Total 1 year 1-3 years 4-5 years After 5 years
-------------- ------------- -------------- -------------- ---------------
Operating leases $ 24,314 $ 6,630 $ 9,363 $ 4,838 $ 3,483
Convertible notes payable 90,000 - - - 90,000
Purchase obligations 1,407 1,407 - - -
Other long-term obligations 28 28 - - -
-------------- ------------- -------------- -------------- ---------------
Total payments due $ 115,749 $ 8,065 $ 9,363 $ 4,838 $ 93,483
============== ============= ============== ============== ===============
The Company operates in leased facilities. Management expects that leases
currently in effect will be renewed or replaced by other leases of a similar
nature and term.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which was revised in December 2003. FIN
46 clarifies the application of Accounting Research Bulletin No. 51 and provides
guidance on the identification of and reporting for variable interest entities.
FIN 46 is effective immediately for variable interest entities formed after
January 31, 2003 and is effective for periods ending after March 15, 2004 for
any variable interest entity formed prior to February 1, 2003. While it will
continue to evaluate the requirements of FIN 46, MemberWorks does not believe
that the adoption of FIN 46 will have a material impact on the Company's
financial statements.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity "
("SFAS 150"). This statement requires that certain financial instruments that
were accounted for as equity under previous guidance be classified as
liabilities in statements of financial position. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS 150 did not have a material impact on the
Company's financial statements.
15
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 include statements that do not
relate solely to historical or current facts and can be identified by the use of
words such as "believe," "expect," "estimate," "project," "continue" or
"anticipate." 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:
o Higher than expected membership cancellations or lower than expected
membership renewal rates;
o Changes in the marketing techniques of credit card issuers;
o Increases in the level of commission rates and other compensation
required by marketing partners to actively market with MemberWorks;
o Potential reserve requirements by business partners such as the
Company's credit card processors;
o Unanticipated termination of marketing agreements;
o The extent to which MemberWorks can continue to successfully develop
and market new products and services;
o Unanticipated changes in or termination of the Company's ability to
process membership fees through third parties, including credit card
processors and bank card associations;
o The Company's ability to introduce new programs on a timely basis;
o The Company's ability to develop and implement operational and
financial systems to manage growing operations;
o The Company's ability to recover from a complete or partial system
failure or impairment, other hardware or software related malfunctions
or programming errors;
o 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;
o The Company's ability to integrate acquired businesses into the
Company's management and operations and operate successfully;
o Further changes in the already competitive environment for the
Company's products or competitors' responses to the Company's
strategies;
o Changes in the growth rate of the overall U.S. economy, or the
international economy where MemberWorks does business, such that
credit availability, interest rates, consumer spending and related
consumer debt are impacted;
o Additional government regulations and changes to existing government
regulations of the Company's industry, including the Federal Trade
Commission's 2003 Amendment to its Telemarketing Sales Rule which
creates a national do-not-call list; and
o New accounting pronouncements.
Many of these factors are beyond MemberWorks' control, and, therefore, its
business, financial condition, results of operations and cash flows may be
adversely affected by these factors.
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 by law,
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.
16
MEMBERWORKS INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate
As of December 31, 2003, 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 December 31, 2003. As of
December 31, 2003, availability under the bank credit facility was reduced by an
outstanding letter of credit of $5.5 million. In addition, the Company has $90.0
million aggregate principal amount of 5.5% convertible senior subordinated notes
due September 2010. The Notes bear interest at the rate of 5.5% per year payable
in cash semi-annually in arrears on April 1 and October 1 of each year, with the
first payment due on April 1, 2004. 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 29,
2004, 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.
Foreign Currency
The Company has international sales and facilities in Canada and, therefore, is
subject to foreign currency rate exposure. Canadian sales have been denominated
in the Canadian dollar and its functional currency is the local currency. Assets
and liabilities of the Canadian subsidiary are translated into U.S. dollars at
the exchange rate in effect as of the balance sheet date. Income and expense
items are translated at the average exchange rate 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
The Company does not have material exposure to market risk with respect to
investments, as the Company does not hold any marketable securities as of
December 31, 2003. 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.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures.
The Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined
under Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this
report and have concluded that the Company's disclosure controls and procedures
were effective. The Company's disclosure controls and procedures are designed to
ensure that material information relating to MemberWorks and its consolidated
subsidiaries that is required to be disclosed in its reports under the Exchange
Act is accumulated and communicated to the chief executive officer and chief
financial officer.
Notwithstanding the foregoing, although there can be no assurance that the
Company's disclosure controls and procedures will detect or uncover all failures
of persons within the Company and its consolidated subsidiaries to disclose
material information otherwise required to be set forth in the Company's
periodic reports, the Chief Executive Officer's and Chief Financial Officer's
evaluation concluded that they are reasonably effective to do so.
Changes in internal control over financial reporting.
During the second quarter of fiscal 2004, there were no changes in the Company's
internal control over financial reporting that could have materially affected,
or are reasonably likely to materially affect our internal control over
financial reporting.
17
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 including, but not
limited to, various suits, including previously disclosed suits, brought against
the Company by individual consumers seeking monetary and/or injunctive relief
relating to the marketing of the Company's programs. 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 March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance 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 Monumental Life
Insurance Company insurance products. The complaint includes a claim that the
suit should be certified as a class action and the plaintiff has filed a motion
for class certification to which all of the defendants have filed opposing
papers regarding the same. The Court certified a class of Michigan residents.
The Court of Appeals denied the defendants' petition for leave to appeal the
certification order. No discovery scheduling order has been set. The Company
believes that the claims made against Coverdell are unfounded and Coverdell and
the Company will vigorously defend their interests against this suit.
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that MemberWorks was not liable to MedVal for
any compensatory damages, they awarded $5.5 million in punitive damages and
costs against MemberWorks solely under CUTPA. MemberWorks believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. On June 22, 2003, the Superior Court
denied the Company's motion to vacate the award, and the Company filed an appeal
of that decision. While the Company intends to take action to prevent the
enforcement of the award by, among other things, vigorously pursuing an appeal,
there can be no assurance that MemberWorks will be successful in its efforts.
The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company were
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
On October 21, 2003, the Florida Attorney General's Office filed a civil
complaint against the Company based upon concerns that some of its past
marketing practices may have violated various consumer laws. The Company
believes that any legitimate concerns have previously been fully addressed,
including the implementation of industry-leading Best Marketing Practices and
voluntary agreements incorporating those practices, such as the nationwide
assurance agreement that the Company entered into with the State of Nebraska in
2001. The Company believes that the allegations of the complaint are unfounded
and the Company intends to vigorously defend its interests in this matter. The
Company further believes that the potential liability represented by the lawsuit
and the final resolution of this matter will not be material to the Company.
18
MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION (CONTINUED)
Item 2. Changes in Securities and Use of Proceeds
On September 30, 2003, the Company completed the sale of $90.0 million aggregate
principal amount of 5.5% convertible senior subordinated notes due September
2010 to qualified institutional buyers pursuant to Rule 144A of the Securities
Act of 1933, as amended. Net proceeds from this offering are estimated to be
$86.6 million. The net proceeds will be used for general corporate purposes,
including mergers and acquisitions and additional repurchases of the Company's
common stock under its stock buyback program. The Notes bear interest at a rate
of 5.5% per year payable in cash semi-annually in arrears on April 1 and October
1 of each year, with the first payment due on April 1, 2004.
The Notes are convertible into shares of MemberWorks common stock at any time
prior to maturity at an initial conversion price of approximately $40.37 per
share, which is equivalent to an initial conversion rate of approximately
24.7739 shares per $1,000 principal amount of the Notes. The conversion rate is
subject to adjustment in certain circumstances.
The Company may redeem all or a portion of the Notes for cash at any time on or
after October 6, 2008, at 100% of their principal amount plus accrued and unpaid
interest to, but excluding, the redemption date.
On December 3, 2003, MemberWorks filed on Form S-3 a shelf registration
statement with the Securities and Exchange Commission ("SEC") covering the Notes
and the common stock issuable upon their conversion, which has not yet been
declared effective. MemberWorks intends to use its best efforts to cause the
shelf registration statement to be declared effective by the SEC no later than
210 days after the original issuance of the Notes.
Item 4. Submission of Matters to a Vote of Security Holders
a) MemberWorks Incorporated's 2003 Annual Meeting of Stockholders was held on
November 20, 2003.
b) At the annual meeting the following Class I Directors were elected to the
Board of Directors as follows:
Alec L. Ellison: For - 9,514,279
Against - 508,793
Abstain - 0
Nonvotes - 0
Marc S. Tesler: For - 8,796,790
Against - 1,226,282
Abstain - 0
Nonvotes - 0
Class II Directors, Scott N. Flanders, Michael T. McClorey and Edward M.
Stern, and Class III Directors, Gary A. Johnson and Robert Kamerschen
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 - 9,046,744
Against - 971,382
Abstain - 4,945
Nonvotes - 0
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MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION (CONTINUED)
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
31.1 Rule 13a-14(a) CEO Certification.
31.2 Rule 13a-14(a) CFO Certification.
32.1 CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
b) Reports on Form 8-K
On October 24, 2003, the Company filed on Form 8-K under Item 5 "Other Events"
and Item 7 "Financial Statements and Exhibits" a press release announcing a
civil complaint filed by the Florida Attorney General.
On October 27, 2003, the Company furnished on Form 8-K under Item 7 "Financial
Statements and Exhibits" and Item 12 "Results of Operations and Financial
Condition" a press release announcing fiscal year 2004 first quarter results.
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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 7, 2004 By: /s/ Gary A. Johnson
----------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
February 7, 2004 By: /s/ James B. Duffy
-----------------------------------
James B. Duffy, Executive Vice President
and Chief Financial Officer (Principal
Financial and Accounting Officer)
21