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, 2003
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
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(State of Incorporation) (I.R.S. Employer
Identification No.)
680 Washington Boulevard
Stamford, Connecticut 06901
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(Address of principal executive offices) (Zip Code)
(203) 324-7635
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----
Indicate the number of shares outstanding of each of the registrant's class of
common stock as of the latest practicable date: 12,050,619 shares of Common
Stock, $0.01 par value as of April 30, 2003.
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, 2003
and June 30, 2002 2
Condensed Consolidated Statements of Operations for the three and nine
months ended March 31, 2003 and 2002 3
Condensed Consolidated Statements of Cash Flows for the nine
months ended March 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 11
Forward Looking Statements 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
Certifications 25
1
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
March 31, June 30,
2003 2002
-------------- -------------
Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 70,679 $ 51,185
Marketable securities - 912
Accounts receivable 16,966 9,831
Prepaid membership materials 2,293 2,061
Prepaid expenses 5,119 4,325
Membership solicitation and other deferred costs 98,808 129,085
------------ -----------
Total current assets 193,865 197,399
Fixed assets, net 26,801 31,420
Goodwill 42,039 42,039
Intangible assets, net 6,974 8,049
Other assets 2,684 1,910
------------ -----------
Total assets $ 272,363 $ 280,817
============ ===========
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 253 $ 1,070
Accounts payable 30,529 32,769
Accrued liabilities 62,629 57,709
Deferred membership fees 187,011 206,272
Deferred income taxes 3,587 -
------------ -----------
Total current liabilities 284,009 297,820
Long-term liabilities 3,082 3,627
------------ -----------
Total liabilities 287,091 301,447
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; 17,790 shares issued (17,493 shares
at June 30, 2002) 178 175
Capital in excess of par value 121,242 109,254
Accumulated deficit (23,070) (42,185)
Accumulated other comprehensive loss (381) (373)
Treasury stock, 5,565 shares at cost (4,139 shares at June 30, 2002) (112,697) (87,501)
-------------- -------------
Total shareholders' deficit (14,728) (20,630)
-------------- -------------
Total liabilities and shareholders' deficit $ 272,363 $ 280,817
============== =============
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 Nine months ended
March 31, March 31,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- ----------
Revenues $ 118,647 $ 100,800 $ 337,696 $ 322,448
Expenses:
Operating 20,653 19,069 57,905 59,645
Marketing 73,012 52,099 208,460 186,333
General and administrative 19,130 18,385 56,757 59,964
Restructuring and other charges - - - 6,893
Amortization of intangible assets 336 431 1,075 1,546
----------- ----------- ----------- ----------
Operating income 5,516 10,816 13,499 8,067
Settlement of investment related litigation (Note 4) - - 19,148 -
(Loss) gain on sale of subsidiary (Note 3) - - (959) 65,608
Net loss on investment (Note 3) - - (206) (31,339)
Other income (expense), net 37 (321) 377 (357)
----------- ----------- ----------- ----------
Income before minority interest 5,553 10,495 31,859 41,979
Minority interest - - - 450
----------- ----------- ----------- ----------
Income before income taxes 5,553 10,495 31,859 42,429
Provision for income taxes (2,221) - (12,744) (743)
----------- ----------- ----------- ----------
Income before cumulative effect of accounting change 3,332 10,495 19,115 41,686
Cumulative effect of accounting change - - - (5,907)
----------- ----------- ----------- ----------
Net income $ 3,332 $ 10,495 $ 19,115 $ 35,779
=========== =========== =========== ==========
Basic earnings per share:
Income before cumulative effect of accounting change $ 0.27 $ 0.74 $ 1.49 $ 2.82
Cumulative effect of accounting change - - - (0.40)
----------- ---------- ----------- -----------
Basic earnings per share $ 0.27 $ 0.74 $ 1.49 $ 2.42
=========== =========== =========== ==========
Diluted earnings per share:
Income before cumulative effect of accounting change $ 0.25 $ 0.72 $ 1.43 $ 2.74
Cumulative effect of accounting change - - - (0.39)
----------- ---------- ----------- -----------
Diluted earnings per share $ 0.25 $ 0.72 $ 1.43 $ 2.36
=========== =========== =========== ==========
Weighted average common shares used in earnings per share calculations:
Basic 12,515 14,127 12,805 14,765
========== =========== =========== ===========
Diluted 13,104 14,561 13,387 15,190
=========== =========== =========== ==========
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 nine months
ended March 31,
---------------------------------
2003 2002
-------------- -------------
Operating activities
Net income $ 19,115 $ 35,779
Adjustments to reconcile net income to net cash provided by
operating activities:
Revenues before deferral 318,320 310,244
Marketing costs before deferral (178,143) (182,465)
Revenues recognized (337,696) (322,448)
Marketing costs expensed 208,460 186,333
Depreciation and amortization 9,150 9,870
Tax benefit from employee stock plans 8,782 -
Deferred income taxes 3,587 -
Gain on settlement (19,148) -
Net loss (gain) on sale of subsidiary 959 (65,608)
Net loss on investment 206 31,339
Restructuring and other charges - 1,585
Minority interest - (450)
Cumulative effect of accounting change - 5,907
Other 1,609 1,887
Change in assets and liabilities:
Accounts receivable (7,495) 10,111
Prepaid membership materials (232) (961)
Prepaid expenses (794) (1,117)
Other assets (349) 64
Related party payables - 12
Accounts payable (2,334) (11,910)
Accrued liabilities 4,788 914
-------------- -------------
Net cash provided by operating activities 28,785 9,086
-------------- -------------
Investing activities
Acquisition of fixed assets (4,099) (4,419)
Settlement of investment related litigation 19,148 -
(Purchase price adjustments) proceeds from sale of subsidiary,
net of cash sold (750) 45,997
Other investments (500) -
-------------- -------------
Net cash provided by investing activities 13,799 41,578
-------------- -------------
Financing activities
Net proceeds from issuance of stock and warrants 3,177 1,305
Treasury stock purchases (25,323) (25,962)
Payments of long-term obligations (1,001) (520)
-------------- -------------
Net cash used in financing activities (23,147) (25,177)
-------------- -------------
Effect of exchange rate changes on cash and cash equivalents 57 (229)
-------------- -------------
Net increase in cash and cash equivalents 19,494 25,258
Cash and cash equivalents at beginning of period 51,185 22,736
-------------- -------------
Cash and cash equivalents at end of period $ 70,679 $ 47,994
============== =============
The accompanying notes are an integral part of
these consolidated financial statements.
4
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly, such
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included. 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 nine months ended March 31, 2003 are not necessarily indicative of
the results that may be expected for the fiscal year ending June 30, 2003. 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, 2002.
NOTE 2 - STOCK-BASED COMPENSATION
In accordance with Accounting Principles Board Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees," 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. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans consistent with the method of 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 Nine months ended
March 31, March 31,
-------------------------- -------------------------
2003 2002 2003 2002
-------------------------- ------------ ------------
Net income reported $ 3,332 $ 10,495 $ 19,115 $ 35,779
Add: Stock-based employee compensation expense determined under
the fair value based method for all awards, net of related
tax effects - 64 - 2
Deduct: Stock-based employee compensation expense determined
under the fair value based method for all awards, net of
related tax effects 1,456 2,783 4,523 8,520
----------- ---------- ---------- ----------
Pro forma net income $ 1,876 $ 7,776 $ 14,592 $ 27,261
=========== ========== ========== ==========
Earnings per share:
As reported:
Basic $ 0.27 $ 0.74 $ 1.49 $ 2.42
Diluted $ 0.25 $ 0.72 $ 1.43 $ 2.36
Pro forma:
Basic $ 0.15 $ 0.55 $ 1.14 $ 1.85
Diluted $ 0.14 $ 0.53 $ 1.09 $ 1.79
Under the stock option plans, the fair value of each option grant calculated
under the provisions of SFAS 123 is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions for the periods ended:
5
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three months ended Nine months ended
March 31, March 31,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
Dividend yield 0% 0% 0% 0%
Expected volatility 50% 50% 50% 50%
Risk-free interest rate 3.0% 4.3% 3.5% 4.8%
Expected lives 5 years 5 years 5 years 5 years
The weighted average fair value per share of options granted at market value for
the three months ended March 31, 2003 and 2002 was $6.53 and $6.92,
respectively. The weighted average fair value per share of options granted at
market value for the nine months ended March 31, 2003 and 2002 was $6.34 and
$9.57, respectively. For unaudited pro forma purposes, the estimated fair value
of the Company's stock-based awards to employees is amortized over the options'
vesting period, four years, and the ESPP's look-back period, six-months.
NOTE 3 - GAIN ON SALE OF SUBSIDIARY/LOSS ON INVESTMENT
During the quarter ended September 30, 2001, the Company sold its investment in
iPlace, Inc. for $50,111,000 in cash and 1,601,000 shares of Homestore.com, Inc.
stock. The Company reported a gain of $65,608,000 on the sale. During the
quarter ended September 30, 2002, the Company settled with Homestore.com, Inc.
all issues pending related to amounts held in escrow in connection with the
sale. The Company recorded a net loss of $959,000 related to this purchase price
adjustment in the quarter ended September 30, 2002.
In addition, the Company sold all of its Homestore.com, Inc. common stock during
the quarter ended September 30, 2002. The Company recognized a loss of $206,000
in connection with this sale.
NOTE 4 - SETTLEMENT OF INVESTMENT RELATED LITIGATION
During the quarter ended September 30, 2002, MemberWorks, along with certain of
the other former shareholders of iPlace, Inc., settled their lawsuit against
Homestore.com, Inc. The total settlement amount in favor of the plaintiffs was
$23,000,000 of which MemberWorks received $19,148,000.
NOTE 5 - INCOME TAX EXPENSE
Income tax expense as a percentage of pre-tax income was approximately 40% for
the three and nine months ended March 31, 2003. The effective tax rate was
higher than the U.S. statutory rate for the three and nine months ended March
31, 2003 primarily due to state taxes and other non-deductible items. During the
quarter ended September 30, 2001, the Company recorded a provision for
alternative minimum taxes of approximately $743,000 in connection with the gain
on the sale of iPlace, Inc. This provision for alternative minimum taxes was
later reversed in the June 2002 quarter due to a change in the tax laws.
6
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 6 - EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance with
the provisions of Financial Accounting Standard Board Statement ("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 Nine Months Ended
March 31, March 31,
---------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- -----------
Numerator for basic and diluted earnings per share:
Net income before cumulative effect of accounting change $ 3,332 $ 10,495 $ 19,115 $ 41,686
Cumulative effect of accounting change - - - (5,907)
---------- ---------- ---------- -----------
Net income $ 3,332 $ 10,495 $ 19,115 $ 35,779
========== ========== ========== ===========
Denominator for basic earnings per share:
Weighted average number of common shares outstanding - basic 12,515 14,127 12,805 14,765
Effect of dilutive securities:
Options 589 434 582 425
---------- ---------- ---------- -----------
Weighted average number of common shares outstanding - diluted 13,104 14,561 13,387 15,190
========== ========== ========== ===========
Basic earnings per share $ 0.27 $ 0.74 $ 1.49 $ 2.42
========== ========== ========== ===========
Diluted earnings per share $ 0.25 $ 0.72 $ 1.43 $ 2.36
========== ========== ========== ===========
The diluted earnings per share calculation excludes the effect of potentially
dilutive shares when their effect is antidilutive. For the three months ended
March 31, 2003 and 2002, the Company had 2,812,000 and 3,311,000 shares,
respectively, of stock options outstanding that are not included in the
calculation as they are antidilutive. For the nine months ended March 31, 2003
and 2002, the Company had 3,108,000 and 3,077,000 shares, respectively, of stock
options that are not included in the calculations as they are antidilutive.
NOTE 7 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three months ended Nine months ended
March 31, March 31,
-------------------------- --------------------------
2003 2002 2003 2002
------------ ------------- ------------- ------------
Net income $ 3,332 $ 10,495 $ 19,115 $ 35,779
Foreign currency translation gain (loss) 72 (1) (8) (252)
------------ ------------- ------------- ------------
Comprehensive income $ 3,404 $ 10,494 $ 19,107 $ 35,527
============ ============= ============= ============
7
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 8 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
As of March 31, 2003 As of June 30, 2002
----------------------------------- -----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
----------------- ----------------- ----------------- ---------------
Amortized intangible assets:
Membership and Client Relationships $ 13,195 $ (6,444) $ 13,195 $ (5,466)
Other 950 (727) 950 (630)
----------------- ----------------- ----------------- ---------------
Total amortized intangible assets $ 14,145 $ (7,171) $ 14,145 $ (6,096)
================= ================= ================= ===============
Unamortized intangible assets:
Goodwill $ 42,039 $ 42,039
The future intangible amortization expense for the next five years is estimated
to be as follows (in thousands):
Fiscal Year:
2003 $ 1,393
2004 1,045
2005 840
2006 695
2007 554
Goodwill was tested for impairment during the quarter ended September 30, 2002
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
indefinite-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 9 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated balance
sheets as of March 31, 2003 and June 30, 2002 include an allowance for
membership cancellations of $22,502,000 and $23,753,000, respectively.
8
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 10 - RESTRUCTURING CHARGES
The major components of the restructuring charges and the remaining accrual
balances as of March 31, 2003 are as follows (in thousands):
Total Non-cash Cash Charges Liability
Charges Charges to date to date Balance
-------------- ----------------- --------------- --------------
Workforce reduction $ 2,214 $ - $ 2,096 $ 118
Lease obligations 3,094 - 1,364 1,730
Asset disposals 1,585 1,585 - -
-------------- ----------------- --------------- --------------
Total $ 6,893 $ 1,585 $ 3,460 $ 1,848
============== ================= =============== ==============
NOTE 11 - 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 in the 2002
Annual Report filed on Form 10-K, 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. Management does not believe that there will
be any material effect on the results of operations as a result of its
outstanding litigation proceedings.
In March 2002, the Company and other plaintiffs filed suit against
Homestore.com, Inc. in United States District Court for the District of
Connecticut. The action was transferred to the United States District Court for
the Central District of California. The suit, which sought injunctive and other
relief, alleged securities fraud, negligent misrepresentation, breach of
contract and other grounds in connection with the Company's sale of its interest
in iPlace, Inc. In response to plaintiffs' preliminary motions, the court
ordered Homestore.com, Inc. to place $58,000,000 in a constructive trust pending
resolution of the lawsuit or further order of the court. During the quarter
ended September 30, 2002, MemberWorks, along with certain of the other former
shareholders of iPlace, Inc., settled their lawsuit against Homestore.com, Inc.
The total settlement amount in favor of the plaintiffs was $23,000,000, of which
MemberWorks received $19,148,000.
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. However, the date that the judge will rule
on the motion is unknown. While the Company intends to vigorously seek to vacate
this award, as well as to take action to prevent the enforcement of the award
by, among other things, seeking to prevent the confirmation of the award, 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.
9
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 12 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"), which is effective for exit or disposal activities that are initiated
after December 31, 2002. SFAS 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan and nullifies Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs in a Restructuring)." The adoption of SFAS 146 did not have a material
impact on the Company's financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires a guarantor to include
disclosure of certain obligations, and if applicable, at the inception of the
guarantee, recognize a liability for the fair value of other certain obligations
undertaken in issuing a guarantee. The recognition requirement is effective for
guarantees issued or modified after December 31, 2002. The adoption of FIN 45
did not have a material impact on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion No. 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial information. The transition provisions of this statement are
effective for financial statements with fiscal years ending after December 15,
2002. The disclosure provisions of this statement are effective for financial
reports containing condensed financial statements for interim periods beginning
after December 15, 2002. The Company will continue to account for its stock
based compensation according to the provisions of APB Opinion No. 25.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51 and applies immediately to any variable
interest entities created after January 31, 2003 and to variable interest
entities in which an interest is obtained after that date. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15,
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.
10
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MemberWorks addresses the needs of organizations seeking to leverage the
expertise of an outside provider in offering membership service programs.
Membership service programs offer selected products and services from a variety
of vendors for an annual fee or a monthly fee. Membership service programs
intend to enhance existing relationships between businesses and consumers.
MemberWorks derives its revenues principally from annually renewable membership
fees. The Company generally 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 paid to clients, are generally
recognized as the related revenue is recognized. Profitability and cash flow
generated from annual renewal memberships exceed that of annual new memberships
due to the absence of solicitation costs associated with new member procurement.
The Company recognizes revenue from members that are billed on a monthly payment
plan in the month the billing occurs.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that are important to the
Company's financial condition and results 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 intangible
assets, estimation of remaining useful lives of intangible assets, estimation of
the effective tax rate 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 of the Company's 2002 Annual
Report filed on Form 10-K.
Revenue recognition
Membership fees are billed through clients of the Company primarily through
credit cards. During an initial annual membership term or renewal term, a member
may cancel his or her membership in the program, either for a complete refund of
the membership fee for that period or a prorata refund based on the remaining
portion of the membership period depending upon the terms of the membership
program. Deferred membership fees are recorded, net of estimated cancellations,
after the trial period has expired, and are amortized as revenues from
membership fees upon the expiration of membership refund privileges. Revenue
from members who are charged on a monthly payment program is recognized, net of
estimated cancellations, as the membership fees are billed. An allowance for
cancellations is established based on management's estimates and is updated
regularly. In determining the estimate of allowance for 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 cancellations on a current
basis. If actual cancellations differ from the estimate, the results of
operations would be impacted.
11
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Membership solicitation and other deferred costs
Membership solicitation costs include marketing and direct mail costs related
directly to membership solicitation (i.e., direct response advertising costs).
In accordance with the American Institute of Certified Public Accountants
Statement of Position 93-7, "Reporting on Advertising Costs," direct response
advertising costs are deferred and charged to operations over the membership
period. Other deferred costs consist of royalties paid to clients, which relate
to the same revenue streams as the direct response advertising costs and are
also charged to income over the membership period. Total membership solicitation
costs incurred to obtain a new member generally are less than the estimated
total membership fees. However, if total membership solicitation costs were to
exceed total estimated membership fees, an adjustment would be made 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 Financial Accounting Standards Board ("FASB")
Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The
Company reviews the carrying value of its goodwill and other intangible assets
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 will 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, 2002 and
2001, was tested for impairment during the quarters ended September 30, 2002 and
2001, respectively. The Company concluded that none of its goodwill was impaired
as of July 1, 2002. As of July 1, 2001, the Company determined that there was an
impairment of goodwill of $5.9 million at one of its reporting units due to the
change in methodology of calculating impairment under SFAS 142 concurrent with
downward trends in the operations of the reporting unit. This amount was
recorded as a cumulative effect of accounting change in the statement of
operations in the fiscal quarter ended September 30, 2001.
Income tax provision
MemberWorks estimates current tax provisions or benefits based on a projected
effective tax rate for the fiscal year ended June 30, 2003 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 MARCH 31, 2003 VS. THREE MONTHS ENDED MARCH 31, 2002
REVENUES. Revenues increased 18% to $118.6 million for the quarter ended March
31, 2003 from $100.8 million for the quarter ended March 31, 2002. The increase
in revenues is primarily due to an increase in the average program price point.
In addition, as of December 31, 2002, virtually all of the Company's membership
base was enrolled in a prorata refund policy program. As a result of the
Company's strategic initiative to move its members to a prorata refund policy
program, revenues which would have been recognized at the end of a membership
year are now recognized ratably during the membership year as the refund
privileges expire in accordance with Staff Accounting Bulleting 101, "Revenue
Recognition in the Financial Statements" ("SAB 101"). As a percentage of total
annual revenues, annual renewal revenues were 58% in 2003 and 55% in 2002.
Revenue from members who are charged on a monthly payment program increased to
$20.1 million for the quarter ended March 31, 2003 from $10.7 million for the
quarter ended March 31, 2002 primarily due to an increase in members enrolled in
a monthly payment plan.
12
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
REVENUES BEFORE DEFERRAL. Revenues before deferral, which are revenues before
the application of SAB 101, are an important measure of the Company's
performance during the reporting period because they represent the actual
membership fees billed during the current reporting period less an allowance for
cancellations. Revenue, as recognized under SAB 101, includes membership fees
billed in prior periods less an allowance for cancellations that have been
amortized and recognized during the current period as the refund privileges
expire. Revenues before deferral increased 5% to $109.2 million for the quarter
ended March 31, 2003 from $103.5 million for the quarter ended March 31, 2002.
Revenues before deferral increased compared to the prior year primarily due to
an increase in the average annual program price point. The average first year
annual price point increased 17% to $111 as of March 31, 2003 from $95 as of
March 31, 2002. Revenue from members who are charged on a monthly payment
program also increased to $20.1 million for the quarter ended March 31, 2003
from $10.7 million for the quarter ended March 31, 2002. These increases were
partially offset by a decrease in annual renewal revenue which represented 50%
of total annual revenue before deferral in 2003 versus 60% in 2002. The
Company's membership base also decreased to approximately 6.3 million members at
March 31, 2003 from 6.6 million members at March 31, 2002. The decrease in
annual renewal revenue and the decreased membership base are due to the
controlled marketing slow down implemented in the beginning of fiscal 2002.
The following information provides a reconciliation of revenues before deferral
to revenues reported for the quarter ended March 31:
2003 2002
--------------- ----------------
Revenues before deferral $ 109,180 $ 103,547
Deferred membership fees at beginning of period 196,290 208,273
Deferred membership fees at end of period (187,011) (210,993)
Effect of changes in foreign exchange rates 188 (27)
--------------- ----------------
Revenues reported $ 118,647 $ 100,800
=============== ================
OPERATING EXPENSES. Operating expenses consist of member service call center
costs, membership benefit costs and membership program fulfillment costs.
Operating expenses increased 8% to $20.7 million for the quarter ended March 31,
2003 from $19.1 million for the quarter ended March 31, 2002. As a percentage of
revenues, operating expenses decreased to 17.4% for the quarter ended March 31,
2003 from 18.9% for the quarter ended March 31, 2002 due to operating expense
leverage gained from increased revenues.
MARKETING EXPENSES. Marketing expenses consist of costs incurred to obtain new
members and royalties paid to clients. Those costs that are considered direct
response advertising costs and royalties paid to clients are generally amortized
in the same manner as the related revenue as required by Statement of Position
93-7, "Reporting on Advertising Costs," ("SOP 93-7") and SAB 101. Marketing
expenses increased 40% to $73.0 million for the quarter ended March 31, 2003
from $52.1 million for the quarter ended March 31, 2002 and, as a percentage of
revenue, marketing expenses increased to 61.5% in 2003 from 51.7% in 2002. These
increases are due to the 18% increase in revenue and an increased mix of
non-deferred marketing costs expensed in 2003.
MARKETING COSTS BEFORE DEFERRAL. Marketing costs before deferral, which are
marketing costs before the application of SAB 101 and SOP 93-7, are an important
measure of the Company's performance during the reporting period because they
represent the actual marketing costs incurred during the current reporting
period. Marketing expenses, as recognized under SAB 101 and SOP 93-7, include
marketing costs incurred in prior periods that have been amortized and
recognized in the same manner as the related revenues. Marketing costs before
deferral increased 11% to $63.5 million for the quarter ended March 31, 2003
from $57.0 million for the quarter ended March 31, 2002 due to increased levels
of new member marketing. The Company increased its marketing for both new annual
members and new monthly members. As a percentage of revenues before deferral,
marketing costs before deferral increased to 58.1% in 2003 from 55.1% in 2002
due to the increased levels of monthly member marketing.
13
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The following information provides a reconciliation of marketing costs before
deferral to marketing expense reported for the quarter ended March 31:
2003 2002
-------------- ---------------
Marketing costs before deferral $ 63,470 $ 57,019
Membership solicitation and other deferred costs at beginning of period 108,229 135,223
Membership solicitation and other deferred costs at end of period (98,808) (140,131)
Effect of changes in foreign exchange rates 121 (12)
-------------- ---------------
Marketing expenses reported $ 73,012 $ 52,099
============== ===============
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily include personnel-related costs, occupancy costs and other overhead
costs. General and administrative expenses increased 4% to $19.1 million for the
quarter ended March 31, 2003 from $18.4 million for the quarter ended March 31,
2002. As a percentage of revenues, general and administrative expenses decreased
to 16.1% in 2003 from 18.2% in 2002 primarily due to leverage gained from
increased revenues.
AMORTIZATION OF OTHER INTANGIBLES. Intangible amortization decreased to $0.3
million during the quarter ended March 31, 2003 from $0.4 million for the
quarter ended March 31, 2002.
OTHER INCOME, NET. Other income, net is primarily composed of interest income
from cash and cash equivalents and interest expense on the Company's borrowings
under its line of credit during the period. Other income increased to $37,000
for the quarter ended March 31, 2003 from other expense of $0.3 million for the
quarter ended March 31, 2002. The increase in other income is due to an
increased cash balance during the March 31, 2003 quarter.
PROVISION FOR INCOME TAXES. During the quarter ended March 31, 2003, the Company
recorded a tax provision of $2.2 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 March 31, 2003 primarily due to state taxes
and other non-deductible items. The Company was not required to record a
provision for income taxes for the quarter ended March 31, 2002 due to the
utilization of net operating losses during the period.
NINE MONTHS ENDED MARCH 31, 2003 VS. NINE MONTHS ENDED MARCH 31, 2002
REVENUES. Revenues increased 5% to $337.7 million for the nine months ended
March 31, 2003 from $322.4 million for the nine months ended March 31, 2002.
Excluding $9.4 million of revenue generated from iPlace, Inc., which was sold in
the first quarter of fiscal 2002, revenues would have increased 8% over the
prior year. The increase in revenues is due to the effects of the Company's
strategic initiative to migrate its members that participate in a
full-money-back refund policy program to a prorata refund policy program, in
addition to increased levels of monthly member marketing and an increase in the
average program price point. As of December 31, 2002, virtually all of the
Company's membership base was enrolled in a prorata refund policy program. As a
result of the Company's strategic initiative to move its members to a prorata
refund policy program, revenues which would have been recognized at the end of a
membership year are now recognized ratably during the membership year as the
refund privileges expire in accordance with SAB 101. Revenue from members who
are charged on a monthly payment program increased to $53.9 million during the
nine months ended March 31, 2003 from $26.2 million during the nine months ended
March 31, 2002 due to an increase in members enrolled in a monthly payment plan.
As a percentage of total annual revenues, annual renewal revenues were 57% in
2003 and 53% in 2002.
14
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
REVENUES BEFORE DEFERRAL. Revenues before deferral increased 3% to $318.3
million for the nine months ended March 31, 2003 from $310.2 million for the
nine months ended March 31, 2002. Excluding revenue from iPlace, Inc. of $11.0
million and the United Kingdom of $1.7 million from the prior year, revenue
before deferral increased 7%. Revenues before deferral increased compared to the
prior year due to increased revenue from members who are charged on a monthly
payment program. Revenue from monthly members increased to $53.9 million during
the nine months ended March 31, 2003 from $26.2 million during the nine months
ended March 31, 2002. This increase was partially offset by a decrease in annual
renewal revenues. As a percentage of total annual revenues before deferral,
annual renewal revenues were 55% in 2003 and 57% in 2002. The decrease in annual
renewal revenue is due to the controlled marketing slow down implemented in the
beginning of fiscal 2002.
The following information provides a reconciliation of revenues before deferral
to revenues reported for the nine months ended March 31:
2003 2002
---------------- ---------------
Revenues before deferral $ 318,320 $ 310,244
Deferred membership fees at beginning of period 206,272 243,024
Deferred membership fees at end of period (187,011) (210,993)
Sale of iPlace, Inc. - (19,784)
Effect of change in foreign exchange rates 115 (43)
---------------- ---------------
Revenues reported $ 337,696 $ 322,448
================ ===============
OPERATING EXPENSES. Operating expenses decreased 3% to $57.9 million for the
nine months ended March 31, 2003 from $59.6 million for the nine months ended
March 31, 2002 primarily due to the sale of iPlace, Inc. As a percentage of
revenues, operating expenses decreased to 17.1% for the nine months ended March
31, 2003 from 18.5% for the nine months ended March 31, 2002 primarily due to
the cost savings initiatives implemented in the beginning of the December 2001
quarter and operating expense leverage gained from increased revenues.
MARKETING EXPENSES. Marketing expenses increased 12% to $208.5 million for the
nine months ended March 31, 2003 from $186.3 million for the nine months ended
March 31, 2002 resulting in the increase in revenue reported for the nine months
ended March 31, 2003. As a percentage of revenue, marketing expenses increased
to 61.7% in 2003 from 57.8% in 2002 primarily due to a higher level of
non-deferrable marketing expenses incurred in the nine months ended March 31,
2003.
MARKETING COSTS BEFORE DEFERRAL. Marketing costs before deferral decreased 2% to
$178.1 million for the nine months ended March 31, 2003 from $182.5 million for
the nine months ended March 31, 2002. As a percentage of revenues before
deferral, marketing costs before deferral decreased to 56.0% in 2003 from 58.8%
in 2002. These decreases were primarily due to an improvement in new member
marketing efficiencies.
The following information provides a reconciliation of marketing costs before
deferral to marketing expense reported for the nine months ended March 31:
2003 2002
---------------- ---------------
Marketing costs before deferral $ 178,143 $ 182,465
Membership solicitation and other deferred costs at beginning of period 129,085 154,059
Membership solicitation and other deferred costs at end of period (98,808) (140,131)
Sale of iPlace, Inc. - (10,003)
Effect of changes in foreign exchange rates 40 (57)
---------------- ---------------
Marketing expenses reported $ 208,460 $ 186,333
================ ===============
15
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 5% to $56.8 million for the nine months ended March 31, 2003 from
$60.0 million for the nine months ended March 31, 2002. As a percentage of
revenues, general and administrative expenses decreased to 16.8% in 2003 and
18.6% in 2002. These decreases were primarily due to the sale of iPlace, Inc.
and the closing of the United Kingdom operations.
AMORTIZATION OF OTHER INTANGIBLES. Intangible amortization decreased to $1.1
million during the nine months ended March 31, 2003 from $1.5 million for the
nine months ended March 31, 2002 due to the effect of the sale of iPlace, Inc.
Settlement of investment related litigation. During the quarter ended September
30, 2002, MemberWorks, along with certain of the other former shareholders of
iPlace, Inc., settled their lawsuit against Homestore.com, Inc. The total
settlement amount in favor of the plaintiffs was $23.0 million of which
MemberWorks received $19.1 million.
GAIN ON SALE OF SUBSIDIARY. During the quarter ended September 30, 2001, the
Company sold its investment in iPlace, Inc. for $50.1 million in cash and 1.6
million shares of Homestore.com, Inc. stock. The Company reported a gain of
$65.6 million on the sale. During the quarter ended September 30, 2002, the
Company settled with Homestore.com, Inc. all issues pending related to amounts
held in escrow in connection with the sale. The Company recorded a net loss of
$1.0 million related to this purchase price adjustment in the quarter ended
September 30, 2002.
NET LOSS ON INVESTMENT. During the quarter ended September 30, 2001, the Company
reported a loss of $22.3 million reflecting the write-down of the Company's
investment in Homestore.com, Inc. common stock to its fair market value. During
the quarter ended September 30, 2002, the Company sold all of its Homestore.com,
Inc. common stock and recognized a loss of $0.2 million.
OTHER INCOME/EXPENSE, NET. Other income increased to $0.4 million in 2003 from
expense of $0.4 million in 2002 due to the increase in the Company's cash
balance.
PROVISION FOR INCOME TAXES. During the nine months ended March 31, 2003, the
Company recorded a tax provision of $12.7 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 nine months ended March 31, 2003 primarily due to state
taxes and other non-deductible items. During the nine months ended September 30,
2002, the Company recorded a provision for alternative minimum taxes of
approximately $0.7 million in connection with the gain on the sale of iPlace,
Inc. This provision for alternative minimum taxes was later reversed in the June
2002 quarter due to a change in the tax laws.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $28.8 million for the nine months
ended March 31, 2003 versus cash provided by operating activities of $9.1
million for the nine months ended March 31, 2002. The increase in operating cash
flow was due to a decrease in marketing costs before deferral as a percentage of
revenue before deferral, cost savings as a result of the restructuring plan and
the actual costs incurred in December 2001 related to the restructuring plan,
offset by the negative impact of changes in assets and liabilities. Revenues
before deferral were $318.3 million for the nine months ended March 31, 2003
versus $310.2 million for the nine months ended March 31, 2002. Marketing
expenses before deferral were $178.1 million for the nine months ended March 31,
2003 versus $182.5 million for the nine months ended March 31, 2002. As a
percent of revenues before deferral, marketing expenses before deferral were
56.0% in 2003 and 58.8% in 2002. These decreases were primarily due to an
improvement in new member marketing efficiencies achieved in fiscal 2003.
Changes in assets and liabilities decreased cash from operating activities by
$6.4 million in 2003 versus a decrease of $2.9 million in 2002. The negative
effect of changes in assets and liabilities during the nine months ended March
31, 2003 was primarily due to the timing of the collection of certain
receivables which the Company expects will reverse in the June 2003 quarter.
16
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Net cash provided by investing activities was $13.8 million in 2003 versus $41.6
million in 2002. During the nine months ended March 31, 2003, MemberWorks, along
with certain of the other former shareholders of iPlace, Inc., settled their
lawsuit against Homestore.com, Inc. The total settlement amount in favor of the
plaintiffs was $23.0 million of which MemberWorks received $19.1 million. In
addition, during the nine months ended March 31, 2003, the Company settled with
Homestore.com, Inc. all issues pending related to amounts held in escrow in
connection with the sale. The Company paid $0.8 million from the escrow account
related to the settlement. In March 2003, the Company made a $0.5 million
investment in Small Business Worldwide, a small business outsource marketing
company. The net cash provided by investing activities during the nine months
ended March 31, 2002 includes the receipt of $46.0 million in net proceeds from
the sale of iPlace, Inc. in August 2001. Capital expenditures were $4.1 million
during the nine months ended March 31, 2003 and $4.4 million during the nine
months ended March 31, 2002.
Net cash used in financing activities was $23.1 million for the nine months
ended March 31, 2003 versus $25.2 million for the nine months ended March 31,
2002 primarily due to the repurchase of treasury stock. The Company purchased
1,432,000 shares of treasury stock in 2003 for $25.3 million, an average price
of $17.69, and 1,752,000 shares in 2002 for $26.0 million, an average price of
$14.82. During the quarter ended September 30, 2002, the Board of Directors
authorized an additional 2.5 million shares to be repurchased under the buyback
program. As of March 31, 2003, the Company had 1,540,000 shares available for
repurchase under its buyback program.
As of March 31, 2003, the Company had cash and cash equivalents of $70.7 million
and 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. As of March 31, 2003, availability under the bank credit facility was
reduced by an outstanding letter of credit of $5.5 million. As of March 31,
2003, the effective interest rate for borrowings was 4.25%. The bank credit
facility has certain financial covenants, including a maximum debt coverage
ratio, a minimum fixed charges coverage ratio, potential restrictions on
additional borrowings and potential restrictions on additional stock
repurchases. The Company believes that existing cash balances, cash generated
from its operations and its available bank credit facility, will be sufficient
to meet its funding requirements for at least the next twelve months.
The Company did not have any material commitments for capital expenditures as of
March 31, 2003. The Company intends to utilize cash generated from operations to
fulfill any capital expenditure requirements for the remainder of fiscal 2003.
17
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
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 March 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 $ 26,430 $ 6,378 $ 13,598 $ 4,044 $ 2,410
Capital leases 18 18 - - -
Notes payable - - - - -
Purchase obligations 3,000 3,000 - - -
Other long-term obligations 340 235 105 - -
-------------- ------------- -------------- -------------- ---------------
Total payments due $ 29,788 $ 9,931 $ 13,703 $ 4,044 $ 2,410
============== ============= ============== ============== ===============
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 June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), which is effective
for exit or disposal activities that are initiated after December 31, 2002. SFAS
146 requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan and nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (Including Certain Costs in a Restructuring)." The adoption
of SFAS 146 did not have a material impact on the Company's financial
statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires a guarantor to include
disclosure of certain obligations, and if applicable, at the inception of the
guarantee, recognize a liability for the fair value of other certain obligations
undertaken in issuing a guarantee. The recognition requirement is effective for
guarantees issued or modified after December 31, 2002. The adoption of FIN 45
did not have a material impact on the Company's financial statements.
18
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion No. 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial information. The transition provisions of this statement shall
be effective for financial statements with fiscal years ending after December
15, 2002. The disclosure provisions of this statement shall be effective for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002. The Company will continue to account for its
stock based compensation according to the provisions of APB Opinion No. 25.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51 and applies immediately to any variable
interest entities created after January 31, 2003 and to variable interest
entities in which an interest is obtained after that date. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15,
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.
19
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:
- Higher than expected membership cancellations;
- Lower than expected membership renewal rates;
- Changes in the marketing techniques of credit card issuers;
- Increases in the level of commission rates and other compensation required
by marketing partners to actively market with MemberWorks;
- Potential reserve requirements by business partners such as the Company's
payment processors;
- Unanticipated cancellation or termination of marketing agreements and the
extent to which MemberWorks can continue successful development and
marketing of new products and services;
- Unanticipated changes in or termination of the Company's ability to process
membership fees through third parties, including clients, payment
processors and bank card associations;
- The Company's ability to introduce new programs on a timely basis;
- The Company's ability to develop and implement operational and financial
systems to manage growing operations;
- The Company's ability to recover from a complete or partial system failure
or impairment, other hardware or software related malfunctions or
programming errors;
- 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;
- The Company's ability to integrate acquired businesses into the Company's
management and operations and operate successfully;
- Further changes in the already competitive environment for the Company's
products or competitors' responses to the Company's strategies;
- Changes in the growth rate of the overall U.S. economy, or the
international economy where MemberWorks does business, such that credit
availability, interest rates, consumer spending and related consumer debt
are impacted;
- Additional government regulations and changes to existing government
regulations of the Company's industry; and
- New accounting pronouncements.
20
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Many of these factors are beyond MemberWorks' control, and, therefore, its
ability to generate predictable revenue and income growth 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.
21
MEMBERWORKS INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate
As of March 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 March 31, 2003. As of March 31, 2003,
availability under the bank credit facility was reduced by an outstanding letter
of credit of $5.5 million. 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 March
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 in
the Securities Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a date
within 90 days of the filing of this quarterly report (the "Evaluation Date")
and have concluded that as of the Evaluation Date, 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 are required to be disclosed
in its reports under the Exchange Act is accumulated and communicated to the
chief executive officer and chief financial officer.
Changes in internal controls.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect our controls subsequent to the
Evaluation Date.
22
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 suits previously disclosed in the 2002
Annual Report filed on Form 10-K , 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. Management does not believe that there will
be any material effect on the results of operations as a result of its
outstanding litigation proceedings.
In March 2002, the Company and other plaintiffs filed suit against
Homestore.com, Inc. in United States District Court for the District of
Connecticut. The action was transferred to the United States District Court for
the Central District of California. The suit, which sought injunctive and other
relief, alleged securities fraud, negligent misrepresentation, breach of
contract and other grounds in connection with the Company's sale of its interest
in iPlace, Inc. In response to plaintiffs' preliminary motions, the court
ordered Homestore.com, Inc. to place $58.0 million in a constructive trust
pending resolution of the lawsuit or further order of the court. During the
quarter ended September 30, 2002, MemberWorks, along with certain of the other
former shareholders of iPlace, Inc., settled their lawsuit against
Homestore.com, Inc. The total settlement amount in favor of the plaintiffs was
$23.0 million, of which MemberWorks received $19.1 million.
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. However, the date that the judge will rule
on the motion is unknown. While the Company intends to vigorously seek to vacate
this award, as well as to take action to prevent the enforcement of the award
by, among other things, seeking to prevent the confirmation of the award, 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.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
99.1 CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
On January 31, 2003, the Company filed on Form 8-K under Item 5 "Other Events"
and Item 7 "Financial Statements and Exhibits" a Press Release announcing fiscal
year 2003 second quarter and six month results.
.
23
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 15, 2003 By: /s/ Gary A. Johnson
------------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
May 15, 2003 By: /s/ James B. Duffy
-----------------------------------
James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
24
CERTIFICATIONS
I, Gary A. Johnson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MemberWorks
Incorporated,
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: May 15, 2003 By: /s/ Gary A. Johnson
------------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
25
CERTIFICATIONS
I, James B. Duffy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MemberWorks
Incorporated,
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: May 15, 2003 By: /s/ James B. Duffy
-----------------------------------
James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
26
EXHIBIT 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SABANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of MemberWorks Incorporated (the
"Company") on Form 10-Q for the period ended March 31, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Gary A.
Johnson, President, Chief Executive Officer and Director of the Company,
certify, to the best of my knowledge, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities and Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Gary A. Johnson
--------------------------
Gary A. Johnson
President, Chief Executive Officer and Director
MemberWorks Incorporated
May 15, 2003
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
27
EXHIBIT 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SABANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of MemberWorks Incorporated (the
"Company") on Form 10-Q for the period ended March 31, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, James
B. Duffy, Executive Vice President and Chief Financial Officer of the Company,
certify, to the best of my knowledge, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities and Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ James B. Duffy
-------------------------
James B. Duffy
Executive Vice President and Chief Financial Officer
MemberWorks Incorporated
May 15, 2003
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
28