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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
----------------------- ------------------
(State of Incorporation) (I.R.S. Employer
Identification No.)
9 West Broad Street;
Stamford, Connecticut 06902
--------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(203) 324-7635
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(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:
15,348,067 shares of Common Stock, $0.01 par value as of April 27, 2001.
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MEMBERWORKS INCORPORATED
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of March 31, 2001
and June 30, 2000 2
Condensed Consolidated Statements of Operations for the
three and nine months ended March 31, 2001 and 2000 3
Condensed Consolidated Statements of Cash Flows for the
nine months ended March 31, 2001 and 2000 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Certain Factors That May Affect Future Results 13
Item 3. Quantitative & Qualitative Disclosures about Market Risk 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
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MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
March 31, June 30,
2001 2000
--------- --------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 18,935 $ 30,169
Marketable securities -- 6,326
Accounts receivable 19,449 17,836
Prepaid membership materials 5,985 4,891
Prepaid expenses 6,082 3,837
Membership solicitation and other deferred costs 168,668 128,767
-------- --------
Total current assets 219,119 191,826
Fixed assets, net 39,014 34,615
Goodwill, net 86,128 71,497
Intangible and other assets, net 17,536 18,834
-------- --------
Total assets $361,797 $316,772
======== ========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Current maturities of long-term obligations $ 3,880 $ 665
Accounts payable 42,391 49,693
Accrued liabilities 69,137 62,642
Due to related parties 1,988 1,852
Deferred membership fees 248,074 165,437
-------- --------
Total current liabilities 365,470 280,289
Long-term obligations 3,199 1,083
-------- --------
Total liabilities 368,669 281,372
-------- --------
Minority interest 8,344 16,379
Mandatory redeemable convertible preferred
securities of subsidiary 5,048 --
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; 17,147 shares issued
(16,507 shares at June 30, 2000) 172 165
Capital in excess of par value 106,431 91,398
Deferred compensation (151) (44)
Accumulated deficit (74,280) (27,709)
Cumulative translation adjustments (750) (145)
Treasury stock, 1,844 shares at cost (1,585 shares
at June 30, 2000) (51,686) (44,644)
-------- --------
Total shareholders' (deficit) equity (20,264) 19,021
-------- --------
Total liabilities and shareholders'
(deficit) equity $361,797 $316,772
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
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MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Three months ended Nine months ended
March 31, March 31,
------------------ ------------------
2001 2000 2001 2000
-------- ------- -------- --------
Revenues $133,877 $85,129 $349,292 $235,695
Expenses:
Operating 24,107 16,069 66,057 43,266
Marketing 85,422 50,279 223,313 136,790
General and administrative 27,023 16,858 74,650 46,291
Amortization of goodwill and other intangibles 2,939 1,693 8,022 4,323
Non-recurring charge (Note 10) 3,000 -- 3,000 --
-------- ------- -------- --------
Operating (loss) income (8,614) 230 (25,750) 5,025
Net (loss) gain on sale of investment -- 18,061 (2,172) 18,061
Other (expense) income, net principally interest (163) 206 (313) 865
-------- ------- -------- --------
(Loss) income before equity in affiliate and minority interest (8,777) 18,497 (28,235) 23,951
Equity in income of affiliate -- 130 83 18
Minority interest (Note 2 and 7) 2,361 403 7,311 403
-------- ------- -------- --------
(Loss) income before income taxes (6,416) 19,030 (20,841) 24,372
Provision for income taxes -- (201) -- (201)
-------- ------- -------- --------
(Loss) income before cumulative effect of accounting change (6,416) 18,829 (20,841) 24,171
Cumulative effect of accounting change (Note 5) -- -- (25,730) --
-------- ------- -------- --------
Net (loss) income $ (6,416) $18,829 $(46,571) $ 24,171
======== ======= ======== ========
Basic (loss) earnings per share:
(Loss) income before cumulative effect of accounting change $ (0.42) $ 1.26 $ (1.37) $ 1.59
Cumulative effect of accounting change -- -- (1.69) --
-------- ------- -------- --------
Basic (loss) earnings per share $ (0.42) $ 1.26 $ (3.06) $ 1.59
======== ======= ======== ========
Diluted (loss) earnings per share:
(Loss) income before cumulative effect of accounting change $ (0.42) $ 1.10 $ (1.37) $ 1.41
Cumulative effect of accounting change -- -- (1.69) --
-------- ------- -------- --------
Diluted (loss) earnings per share $ (0.42) $ 1.10 $ (3.06) $ 1.41
======== ======= ======== ========
Weighted average common shares used in (loss) earnings per
share calculations:
Basic 15,368 14,976 15,205 15,235
======== ======== ======== ========
Diluted 15,368 17,173 15,205 17,149
======== ======== ======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
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MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine months ended March 31,
-----------------------------
2001 2000
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OPERATING ACTIVITIES
Net (loss) income $ (46,571) $ 24,171
Adjustments to reconcile net (loss) income
to net cash provided by operating
activities:
Cumulative effect of accounting change 25,730 --
Net loss (gain) on sale of investment 2,172 (18,061)
Minority interest (7,311) (403)
Equity in income of affiliate (83) (18)
Membership solicitation and other deferred
costs (196,634) (164,143)
Amortization of membership solicitation and
other deferred costs 199,149 129,868
Deferred membership fees 14,362 36,721
Depreciation and amortization 14,833 8,705
Other 1,610 353
Change in assets and liabilities:
Accounts receivable (1,113) (4,354)
Prepaid membership materials (1,094) (406)
Prepaid expenses (3,085) (2,618)
Other assets 1,512 (939)
Related party obligations 136 --
Accounts payable (7,796) 1,365
Accrued liabilities 6,098 18,283
--------- ---------
Net cash provided by operating activities 1,915 28,524
--------- ---------
INVESTING ACTIVITIES
Acquisition of fixed assets (11,749) (11,863)
Business combinations, net of cash acquired and
other investments (3,041) (18,714)
--------- ---------
Net cash used in investing activities (14,790) (30,577)
--------- ---------
FINANCING ACTIVITIES
Net proceeds from issuance of stock and warrants 6,575 3,066
Net borrowings from credit facility 2,790 --
Treasury stock purchases (7,042) (29,725)
Payments of long-term obligations (500) (48)
--------- ---------
Net cash provided by (used in) financing activities 1,823 (26,707)
--------- ---------
Effect of exchange rate changes on cash and cash
equivalents (182) 20
--------- ---------
Net decrease in cash and cash equivalents (11,234) (28,740)
Cash and cash equivalents at beginning of period 30,169 50,939
--------- ---------
Cash and cash equivalents at end of period $ 18,935 $ 22,199
========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
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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 nine month
periods ended March 31, 2001 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 March 31, 2001,
the amount of unpaid dividends totaled $189,000.
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 Nine months ended
March 31, March 31,
------------------ -------------------
2001 2000 2001 2000
------- ------- -------- -------
Numerator for basic and diluted (loss) earnings per share:
(Loss) income before cumulative effect of accounting change $(6,416) $18,829 $(20,841) $24,171
Cumulative effect of accounting change -- -- (25,730) --
------- ------- -------- -------
Net (loss) income $(6,416) $18,829 $(46,571) $24,171
======= ======= ======== =======
Denominator for basic (loss) earnings per share:
Weighted average number of common shares outstanding -- basic 15,368 14,976 15,205 15,235
Effect of dilutive securities:
Options and warrants -- 2,197 -- 1,914
------- ------- -------- -------
Weighted average number of common shares outstanding -- diluted 15,368 17,173 15,205 17,149
======= ======= ======== =======
Basic (loss) earnings per share $ (0.42) $ 1.26 $ (3.06) $ 1.59
======= ======= ======== =======
Diluted (loss) earnings per share $ (0.42) $ 1.10 $ (3.06) $ 1.41
======= ======= ======== =======
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MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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 nine months ended March
31, 2001 are incremental weighted average stock option shares of approximately
3,077,000 and 2,949,000, respectively.
NOTE 4 -- ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated
balance sheets as of March 31, 2001 and June 30, 2000 include an allowance for
membership cancellations of $28,356,000 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 Staff Accounting Bulletin 101 ("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.
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 nine months ended March 31, 2001, the Company recognized
$12,553,000 and $66,430,000, 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, loss before the
cumulative effect of accounting change and loss per share before the cumulative
effect of accounting change for the three months ended March 31, 2001, is an
increase of $11,172,000, $1,989,000 and $0.13, respectively. The effect of the
adoption of SAB 101 on reported revenue, loss before the cumulative effect of
accounting change and loss per share before the cumulative effect of accounting
change for the nine months ended March 31, 2001, is an increase of $9,328,000,
and a decrease of $165,000 and $0.01, 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 Nine months ended
March 31, March 31,
------------------ --------------------
2001 2000 2001 2000
------- ------- -------- -------
Net (loss) income $(6,416) $23,545 $(20,841) $38,228
Basic (loss) earnings per share $ (0.42) $ 1.57 $ (1.37) $ 2.51
Diluted (loss) earnings per share $ (0.42) $ 1.37 $ (1.37) $ 2.23
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.
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MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTES 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 March 31, 2001, the Company is the majority shareholder of iPlace, Inc.
with an approximate 58% ownership share. Minority interest in the Statements of
Operations represents approximately 42% of iPlace's losses for the three and
nine months ending March 31, 2001.
NOTE 8 -- COMPREHENSIVE (LOSS) INCOME
The components of comprehensive (loss) income are as follows (in thousands):
Three months ended Nine months ended
March 31, March 31,
------------------ -----------------
2001 2000 2001 2000
------- ------- -------- ------
Net (loss) income $(6,416) $18,829 $(46,571) $24,171
Unrealized losses on marketable
securities:
Unrealized loss on marketable
securities -- -- (532) --
Reclassification adjustment for
losses included in net loss -- -- 532 --
Foreign currency translation
(loss) gain (627) (1) (605) 20
------- ------- -------- -------
Comprehensive (loss) income $(7,043) $18,828 $(47,176) $24,191
======= ======= ======== =======
NOTE 9 -- BANK CREDIT FACILITY
During the third fiscal quarter of 2001, the Company amended its bank credit
facility originally dated September 15, 1999 to, among other things, increase
the amount available to the Company under the agreement from $20,000,000 to
$28,000,000. The amended bank credit facility bears interest at the higher of
the base commercial lending rate for the bank or the Federal Funds Rate plus
0.5% per annum. The amended bank credit facility is renewable March 1, 2002.
The amended bank credit facility requires that the Company maintain a
compensating balance of $10,000,000 in addition to certain financial covenants.
There were borrowings of $3,275,000 outstanding under this bank credit facility
as of March 31, 2001.
NOTE 10 -- 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.
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MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In July 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
interest against this suit.
In April 2001, the Company entered into a voluntary agreement with the State of
California and Ventura and Orange Counties to implement certain marketing
practices in the State of California. Pursuant to the agreement, the Company
will pay costs of investigation and civil penalties of $2,000,000 to be split
between the state and the counties. The Company has also established a reserve
of $1,000,000 to cover specific costs related to the agreement. As a result of
the agreement, the Company has taken a non-recurring charge of $3,000,000 during
the quarter ended March 31, 2001.
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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 MARCH 31, 2001 VS. THREE MONTHS ENDED MARCH 31, 2000
REVENUES. Revenues increased 57% to $133.9 million for the quarter ended March
31, 2001 from $85.1 million for the quarter ended March 31, 2000 due to an
increase in the Company's membership base, an increase in the weighted average
program fee and the impact of "Staff Accounting Bulletin No. 101 -- Revenue
Recognition in Financial Statements" ("SAB 101"). Excluding the effects of SAB
101, revenues would have increased 44% to $122.7 million in 2001. The Company's
membership base increased to approximately 7.9 million members at March 31,
2001 from 6.2 million members at March 31, 2000. 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 the
introduction of new programs with higher fees. Revenues from renewals increased
to $47.7 million in 2001 from $32.9 million in 2000. As a percentage of
individual membership revenues, these amounts represented 40% in 2001 and 42%
in 2000.
OPERATING EXPENSES. Operating expenses increased 50% to $24.1 million in 2001
from $16.1 million in 2000 due to the servicing requirements of the larger
membership base. As a percentage of revenues, operating expenses decreased to
18.0% in 2001 from 18.9% in 2000. Excluding the effect of SAB 101, operating
expenses would have been 19.8% of revenues in 2001. Operating expenses, as a
percentage of revenues, increased primarily due to an increase in the mix of
revenue generated from our online business which has a higher operating expense
ratio than our other businesses.
MARKETING EXPENSES. Marketing expenses increased 70% to $85.4 million in 2001
from $50.3 million in 2000 due to increased expenses required to grow the
membership base. As a percentage of revenues, marketing expenses increased
to 63.8% in 2001 from 59.1% in 2000. Excluding the effect of SAB 101, marketing
expenses would have been 62.0% of revenues in 2001. 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 60% to $27.0 million in 2001 from $16.9 million in 2000. As a
percentage of revenues, general and administrative expenses increased to 20.2%
in 2001 from 19.8% in 2000. Excluding the effect of SAB 101, general and
administrative expenses would have been 22.0% of revenues in 2001. Expenses
increased in 2001 compared to 2000 due to higher staff related expenses and
occupancy costs required to support the Company's growth.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Intangible amortization
increased to $2.9 million in 2001 from $1.7 million in 2000 due to the
acquisition of two additional businesses since March 31, 2000.
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MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
NON-RECURRING CHARGE. In April 2001, the Company entered into a voluntary
agreement with the State of California and Ventura and Orange Counties to
implement certain marketing practices in the State of California. Pursuant to
the agreement, the Company will pay costs of investigation and civil penalties
of $2.0 million to be split between the state and the counties. The Company has
also established a reserve of $1.0 million to cover specific costs related to
the agreement. As a result of the agreement, the Company has taken a
non-recurring charge of $3.0 million.
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 was $0.2 million in
2001 compared to other income of $0.2 million in 2000 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 March 31, 2001 due to tax losses
realized. The Company recorded a provision for income taxes of $0.2 million for
the three months ended March 31, 2000 related to alternative minimum taxes.
NINE MONTHS ENDED MARCH 31, 2001 VS. NINE MONTHS ENDED MARCH 31, 2000
REVENUES. Revenues increased 48% to $349.3 million for the nine months ended
March 31, 2001 from $235.7 million for the nine months ended March 31, 2000 due
to an increase in the Company's membership base and an increase in the weighted
average program fee. Excluding the effects of SAB 101, revenues would have
increased 44% to $340.0 million in 2001. The Company's membership base increased
to approximately 7.9 million members at March 31, 2001 from 6.2 million members
at March 31, 2000. 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 the introduction of new programs
with higher fees. Revenues from renewals increased to $123.6 million in 2001
from $90.1 million in 2000. As a percentage of individual membership revenues,
these amounts represented 40% in 2001 and 41% in 2000.
OPERATING EXPENSES. Operating expenses increased 53% to $66.1 million in 2001
from $43.3 million in 2000 due to the servicing requirements of the larger
membership base. As a percentage of revenues, operating expenses increased to
18.9% in 2001 from 18.4% in 2000. Excluding the effects of SAB 101, operating
expenses would have been 19.4% of revenues in 2001. Operating expenses, as a
percentage of revenues, increased primarily due to an increase in the mix of
revenue generated from our online business which has a higher operating expense
ratio than our other businesses as well as the expansion of the call center
capacity.
MARKETING EXPENSES. Marketing expenses increased 63% to $223.3 million in 2001
from $136.8 million in 2000 due to increased expenses required to grow the
membership base. As a percentage of revenues, marketing expenses increased to
63.9% in 2001 from 58.0% in 2000. Excluding the effect of SAB 101, marketing
expenses would have been 62.9% of revenues in 2001. 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 61% to $74.7 million in 2001 from $46.3 million in 2000. As a
percentage of revenues, general and administrative expenses increased to 21.4%
in 2001 from 19.6% in 2000. Excluding the effect of SAB 101, general and
administrative expenses would have been 22.0% of revenues in 2001. Expenses
increased in 2001 compared to 2000 due to higher staff related expenses and
occupancy costs required to support the Company's growth.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Intangible amortization
increased to $8.0 million in 2001 from $4.3 million in 2000 due to the
acquisition of two additional businesses since March 31, 2000.
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MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
NON-RECURRING CHARGE. In April 2001, the Company entered into a voluntary
agreement with the State of California and Ventura and Orange Counties to
implement certain marketing practices in the State of California. Pursuant to
the agreement, the Company will pay costs of investigation and civil penalties
of $2.0 million to be split between the state and the counties. The Company has
also established a reserve of $1.0 million to cover specific costs related to
the agreement. As a result of the agreement, the Company has taken a
non-recurring charge of $3.0 million.
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 $0.3
million in 2001 from income of $0.9 in 2000 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 nine months ended March 31, 2001 due to tax losses
realized. The Company recorded a provision for income taxes of $0.2 million for
the nine months ended March 31, 2000 related to alternative minimum taxes.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operations was $1.9 million for the nine months ended March
31, 2001 compared to $28.5 million in 2000. The nine months ended March 31,
2001 reflects increased spending related to the expansion of the Company's
online and international initiatives compared to last year. Changes in working
capital items decreased cash by $5.3 million in 2001 and increased cash by
$11.3 million in 2000. Changes in working capital items decreased cash in 2001
due to changes in the Company's mix of volume between marketing partners with
varying payment terms and a decrease in the liability for cancellations since
June 30, 2000. The decrease in the liability can be attributed to the timing of
billings and refunds rather than a decrease in the cancellation rates.
Net cash used in investing activities was $14.8 million in 2001 versus $30.6
million in 2000. Investing activities during the nine months ended March 31,
2001 included 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 nine months ended March 31, 2001 were $11.7
million. Investing activities during the nine months ended March 31, 2000
include the use of $15.9 million in cash for the acquisition of the remaining
81% of ConsumerInfo.Com and capital expenditures of $11.9 million.
Net cash provided by financing activities was $1.8 million in 2001 and cash
used by financing activities was $26.7 million in 2000. 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
262,000 shares for $7.0 million during the nine months ended March 31, 2001
compared to 924,000 shares for $29.7 million during the nine months ended March
31, 2000. 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 March 31, 2001, the Company had cash and cash equivalents of $18.9
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. There were borrowings of
$3.3 million outstanding under this bank credit facility as of March 31, 2001.
The bank credit facility requires that the Company maintain a compensating
balance of $10.0 million in addition to certain financial covenants. The Company
believes that existing cash balances, together with its available bank credit
facility, will be sufficient to meet its funding requirements for at least the
next twelve months.
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MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company did not have any material commitments for capital expenditures as
of March 31, 2001. However, the Company anticipates to incur spending for
capital expenditures consistent with its anticipated growth of operations. The
Company intends to utilize cash generated from operations and its funds
available under its credit facility to fulfill any capital expenditure
requirements for the remainder of Fiscal 2001.
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.
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 nine months ended March 31, 2001, the
Company recognized $12.6 million and $66.4 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,
loss before the cumulative effect of accounting change and loss per share before
the cumulative effect of accounting change for the three months ended March 31,
2001, is an increase of $11.2 million, $2.0 million and $0.13, respectively. The
effect of the adoption of SAB 101 on reported revenue, loss before the
cumulative effect of accounting change and loss per share before the cumulative
effect of accounting change for the nine months ended March 31, 2001, is an
increase of $9.3 million, and a decrease of $0.2 million and $0.01,
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.
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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 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:
o Further changes in the already competitive environment for the
Company's products or competitors' responses to the Company's
strategies;
o The Company's ability to integrate into the Company's management and
operations and to successfully operate acquired businesses, including
iPlace and DDS;
o Economic conditions in areas outside the United States;
o Continued growth within the United States;
o The Company's ability to develop and implement operational and
financial systems to manage rapidly growing operations;
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 Additional government regulation of the Company's industry; and
o 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.
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MEMBERWORKS INCORPORATED
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate
The Company has a $28.0 million bank credit facility which bears interest at
the higher of the base commercial lending rate for the bank or the Federal
Funds Rate plus 0.5% per annum. There were borrowings of $3,275,000 outstanding
under this bank credit facility as of March 31, 2001. Management believes that
an increase in the commercial lending rate or the Federal Funds rate would not
be material to the Company's financial position or its results of operations.
If the Company is not able to renew its existing credit facility agreement,
which matures on March 1, 2002, it is possible that any replacement lending
facility obtained by the Company may be more sensitive to interest rate changes.
The Company does not currently hedge interest rates with respect to its
outstanding debt.
Foreign Currency
The Company has international sales and facilities in the United Kingdom and
Canada and therefore, is subject to foreign currency rate exposure.
Historically, international sales have been denominated in British pounds
sterling and the Canadian dollar. The functional currencies of the Company's
foreign operations are the local currencies. Assets and liabilities of these
subsidiaries are translated into U.S. dollars at exchange rates in effect 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. As of March 31, 2001, this investment has no
recorded value.
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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 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.
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.
In January 2001, a purported class action was instituted by plaintiff Brandy L.
Ritt against the Company and other defendants in the Court of Common Pleas in
Cuyahoga County, Ohio. The suit, which seeks unspecified monetary damages,
alleges that the Company and the other defendants violated various provisions
of Ohio's consumer protection laws in connection with the marketing of certain
membership programs offered by the Company. The Company believes that the
claims asserted against it are unfounded and the Company will vigorously defend
its interests against this suit.
In April 2001, the Company and Sears, Roebuck and Co. ("Sears") voluntarily
settled an investigation by the Attorney General of California and the District
Attorneys of Ventura and Orange Counties (the "California Parties") of possible
consumer confusion over disclosures made while marketing membership programs in
California. On April 27, 2001, the Superior Court of the State of California in
the County of Orange entered an Injunction and Final Judgement pursuant to a
voluntary stipulation among the parties, which settles all claims raised by the
complaint filed on April 27, 2001 by the California Parties. The Company and
Sears agreed to the settlement without filing a response to the complaint. The
settlement is not an admission of any issue of law or fact or any violation of
law. Pursuant to the terms of the settlement, the Company and Sears will pay
costs of investigation and civil penalties of $1.5 million and $0.5 million,
respectively, to be split between the state and the counties. Under the
Company's marketing agreement with Sears, the Company will reimburse Sears for
the $0.5 million. The Company has also established a reserve of $1.0 million to
cover specific costs related to the agreement. As a result of the agreement,
the Company has taken a non-recurring charge of $3.0 million. A more detailed
description of the settlement was filed on May 8, 2001 as a report on Form 8-K.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
None
b) Reports on Form 8-K
On January 31, 2001, the Company filed on Form 8-K under Item 9
"Regulation FD Disclosure" a press release concerning, among other things,
the filing of a Current Report on Form 8-K and the attached transcript of
the second quarter fiscal 2001 results which took place on January 30,
2001.
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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: May 14, 2001 By: /s/ Gary A. Johnson
---------------------------------
Gary A. Johnson, President,
Chief Executive Officer and Director
May 14, 2001 By: /s/ James B. Duffy
---------------------------------
James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
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